Risk Exposure at the Bank Level

In the mobile payment context, banks offer banking services via the mobile device.227 _{They hold the e-float}228 _{on behalf of the MNOs and handle cross-border}

transactions while managing foreign exchange risk.229 _{Foreign exchange risk is that which}

exists when a financial transaction is denominated in a currency other than that of the base currency of the company. Foreign exchange risk also exists when the foreign subsidiary of a firm maintains financial statements in a currency other than the reporting currency of the consolidated entity. The risk is that there may be an adverse movement in the exchange rate of the denomination currency in relation to the base currency before the date when the transaction is completed. In Kenya, banks whose primary function is to take deposits for distribution in loans and other permitted investments dominate retail

payments.230 _{These banks are well-positioned to employ risk management programmes}

that ensure regulatory compliance, and they have an important role as the mobile payment system deposits funds in bank accounts held by the mobile network operator in exchange for e-float.

To diversify their risk, MNOs hold such deposits in different banks. These accounts impose no restrictions of access on MNOs, and the banks face no special reserve requirements with regard to the MNOs’ deposits. Similarly, no regulation compels the MNO to give notice of their purpose to withdraw large quantities of cash at whatever time, since the Central Bank treats these trusts like current account deposit in terms of regulatory policy. This absence of particular regulation makes the framework within

227 _{See Chapter 2 System Design of Mobile Payments.} 228 _{The stored value of the payment.}

229_{. See generally Maurice D Levi, International Finance: Contemporary Issues (4}th _{edn, Routledge 2005).} 230 _{See Generally, Cynthia Merritt, 'Mobile Money Transfer Services: The Next Phase in The Evolution of} Person-To-Person Payments' (2011) 5 Journal of Payments Strategy & Systems.

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which mobile payments currently operate vulnerable, as the MNOs and the banks have no legal obligation to fulfil expectations.231

The bank imposes the most identifiable risks that mobile payments systems incur, since the bank holds all deposits from the mobile money chain, including consumer funds. This forms a concentration of risk as the trust account expands; this may have a material impact on the trustee bank’s balance sheet, particularly for those trust funds on deposit with the trustee bank.232 _{Most MNOs use a single bank to hold the trust fund,}

for instance Safaricom uses one bank, Commercial Bank of Africa.233 _{Therefore a}

successful MNO’s trust fund could become significant to the point of representing a funding concentration risk for the trustee bank, which would therefore be vulnerable to systemic risk. The trust account would also be vulnerable to liquidity risk, should the volume of items in transit through the MNO’s system suddenly reduce, for example because of losing market share to other MNOs, changes in regulations, an MNO’s decision to diversify its own risks, or through civil disturbances that cause a flight to cash.234

The Central Bank of Kenya typically limits risk concentrations as a normal part of its supervisory activities, but it is unclear presently in the regulation whether this process includes funds held in trust.235 _{Regulators typically impose this key prudential requirement}

to ensure that a customer’s funds are available on demand. This means that funds held in trust would require the MNO, according to Brian Muthiora, ‘to maintain liquid assets

231 _Ibid.

232 _{Mobile-Financial.com, ‘Mobile Financial Services Risk Matrix’ (2010) 71 <http://mobile-} financial.com/blog/mobile-financial-services-risk-matrix> accessed 3 September 2014.

233 _Ibid.

234 _{This civil disturbance reflects political instability in a state such as the post-election violence in Kenya} after the disputed 2007 general elections.

235 _{Trust accounts are accounts in which a bank or trust company (acting as} an authorisedcustodian) holdsfunds for specific purposes.

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equal in value to the amount of money issued electronically.’236 _{One common approach}

is to require entities to ring-fence assets237 _{and hold them in a bank account in several}

prudentially regulated banks. All funds are then backed in the pooled accounts. These requirements would be more stringent than those imposed on deposit-taking financial institutions, which typically mandate only small amounts to be deposited to guarantee potential depositor claims.238

The trust account in a prudential bank imposes legal uncertainty and risks, especially in the event of bank insolvency. The stored value in the funds is usually matched to the float in the bank account.239 _{The money on deposit is the float held against}

customers’ mobile money accounts.240 _{The MNO should ring-fence this money from the}

custodial bank’s other assets to protect it from bankruptcy and shareholder claims. However, only minimal legal guidance dictates how capital reserves and/or deposit insurance should and can protect the trust account contents, how banks in distress would handle insolvency or how such proceedings would evolve.241 _{This lack of legal clarity}

leaves many stakeholders within the mobile money transfer ecosystem exposed.

Concerns with managing risk concentrations may restrict bank’s interests in providing trust services. The financial institution which holds the trust account for the MNO takes on reputational risk in the event of the MNO’s mismanagement of the trust

account or mismanagement of its payment system.242 _{Although the MNOs claim that the}

236 _{Brian Muthiora, ‘Ring-fencing and Safeguard of Customer Money’ (2014)} <http://www.gsma.com/mobilefordevelopment/kenyas-new-regulatory-framework-for-e-money- issuers> accessed 3 September 2014.

237 _{Ring-fencing occurs when a portion of a company’s assets or profits are financially separated without} necessarily being operated as a separate entity. This might respond to regulation, protect assets from financing arrangements, or segregate funds into separate income streams for taxation purposes.

238 _{Joy Malala, (2014) (n 208) 29.}

239 _{Maria C Stephens, ‘Promoting Responsible Financial Inclusion: A Risk-Based Approach To Supporting} Mobile Money Transfer Services Expansion’ (2011) 27(1) Banking And Finance Law Review.

240 _Ibid. 241 _Ibid.

242 _{Mobile-Financial.com, ‘Mobile Financial Services Risk Matrix’ (2010) 71 <http://mobile-} financial.com/blog/mobile-financial-services-risk-matrix> accessed 3 September 2014.

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funds held in trust are not invested, if this claim is false and the trust funds are invested in instruments that do not conserve their value, the liability coverage provided by the trust assets may become inadequate, potentially leading to a crisis in confidence in the service.