DFS: Regulatory and Fiscal Impediments

Jun 28, 2019
Tags :
  • Access points,
  • bottlenecks,
  • Branchless Banking,
  • Several governments in developing world, along with the donor community, seem keen on developing an “enabling environment” for digital financial services (DFS)[1]. DFS is seen as a pathway towards financial inclusion, which is being promoted as part of global development agenda. Likewise, Pakistan also acknowledges the criticality of creating such an environment. In this regard, Enhanced National Financial Inclusion Strategy (NFIS) is the latest policy blueprint[2] developed as part of the 100-day agenda of the incumbent government.

    The issue of “enabling environment” in Pakistan can be further explored by looking at two policy areas: i) regulatory; and ii) fiscal measures.

    Regulatory environment

    a) Bank-led model

    Pakistan follows a bank-led model for DFS[3] where a financial institution – commercial or microfinance bank – is responsible for overall operations. The SBP considers DFS an extension of conventional banking, with the bank-led model safeguarding public’s trust in the digital space. The bank-led model has achieved some success. A virtually non-existent segment in June 2008, the Branchless Banking (BB) segment, by Dec 2018, had a footprint of ~425,000 agents and 20 million active accounts[4].

    But some critics maintain that following a conservative banking mindset in the BB segment is resulting in limited product innovation. The regulatory requirement to form or acquire a bank in order to enter the DFS segment – a requirement that was met by the main telco’s who acquired microfinance banks – is cited as one of the barriers for the development of local FinTech sector.

    b) Interoperability

    Currently, there is no mandatory one-to-one interoperability with in DFS segment and conventional banking system. This results in higher costs and delays. The federal government is trying to make interoperability a mandatory requirement for all kinds of accounts – conventional and digital. Besides, it is looking to develop a micro-payment gateway to minimize the costs and delays for payment settlement. For this initiative, enhanced NFIS has mentioned deadline of December 2020[5].

    Also limiting interoperability is the fact that telecom companies only extend their Unstructured Supplementary Services Data (USSD) service to their partner bank and not to all banks. USSD is a user-friendly technology that helps private data to travel securely through mobile phones. The Enhanced NFIS calls for a market-based pricing structure to open up telco’s USSD sessions for all banks[6].

    c) Legal capacity

    Operating in a weak legal environment, the DFS segment suffers from similar legal bottlenecks as faced by the conventional banking sector. Basic payments lack a secured transaction framework. In addition, lending to low-income borrowers becomes highly risky due to issues, ranging from weak contract enforcement (judicial & ADR), authenticity of land records management, and absence of electronic collateral registry. DFS also lacks specific consumer protection guidelines.

    d)  Service Access Points

    As per the State Bank of Pakistan’s Branch Licensing Regulations, commercial banks while applying for new branches under their annual expansion plan shall ensure 20% penetration in rural and underserved areas by 2021 (refer to grid below). No such requirements are in place for the BB service providers. A geo-spatial mapping study needs to assess how many of the 400,000+ agents are located in the under-served areas. This can help in achieving a meaningful level of minimum geographic presence, which is currently unknown.

    Annual Branch Expansion Plan
    Year Tier 1 (Big Cities) Tier II (Other Cities) Tier III (Rural and Underserved Areas) Tier IV (Un-Banked)
    2017 52% 27% 16% 5%
    2018 49% 29% 17% 5%
    2019 46% 31% 18% 5%
    2020 43% 33% 19% 5%
    2021 40% 35% 20% 5%

    Source: SBP Branch Licensing Policy 2016

    Fiscal regime

    a) Tax measures

    No significant tax incentives exist to encourage uptake of digital accounts or their usage. The only exception was in the Finance Bill 2018 when cash withdrawals by BB agents were exempted from withholding tax[7].

    Perhaps a targeted tax break can work enhance the DFS penetration. It could take the form of i) income-tax exemption to service providers on earnings from specific DFS products like digital savings and credit and ii) tax exemption to users on profits from digital savings.

    In the Finance Supplementary (Second Amendment) Act, effective from March 2019, the incumbent government reduced income tax rate to 20 percent on income from additional advances of commercial and microfinance banks extended to segments like housing, SME and Agri finance. Perhaps this exemption could be extended to DFS segment as well. Also, the digital payments segment can specifically be incentivized by charging a lower GST rate, a proposal under consideration in India.

    b) 2Support for R&D, credit and investment

    If the government cannot provide direct funding for R&D, it can possibly allow accelerated depreciation of R&D expenses, as applicable in some countries. To help digital startups raise capital, it can offer angel investors tax benefits in initial years. The government can also provide low-cost capital to help DFS startups capitalize and scale themselves.

    c) ID verification

    On each instance of account opening or over-the-counter transaction, NADRA charges Rs 10 per VeriSys (a system-generated report confirming the authenticity or lack thereof of the submitted CNIC) – down from Rs 25 per request. However, NADRA can further consider to slash this rate to zero to ease the verification procedure even more. The BB players can innovate and extend their product portfolio if NADRA can also provide other useful data fields like father’s name, which is required to meet e-CIB requirement for extending digital credit.

    d) Government’s digitization

    The government can play its role even better if it puts its own digital house in order. Currently, less than 20 percent of all government payments and receipts are digitized[8]. The Enhanced NFIS calls for 100 percent of public-sector digitization by 2023. A Transformation Center at the PM’s office should expedite the process of front-end and back-end digitization of government revenues and expenses.


    To smooth out the above impediments, the SBP can follow a “regulatory sandbox” approach that is in practice in countries like Singapore, Hong Kong and the United Kingdom. A DFS sandbox can serve to become a testing ground for new business models. The models are developed in a limited-exposure, real-time marketplace. In this flexible environment, innovation is not impeded by regulatory compliance. This approach can help local FinTech players to develop their disruptive ideas in areas like digital remittances, peer-to-peer lending, retail payment solutions, and startup credit bureaus. Another area to explore is the development of the Universal Service Fund in Pakistan. Government may create a fund for R&D and infrastructure development in under-served and unserved areas, as this can enhance the overall outreach of domestic financial services market.



    [1] Alliance for Financial Inclusion | Official Member List | (January, 2019)(URL: https://www.afi-global.org/sites/default/files/inline-files/AFI%20Official%20Members_8%20Jan%202019.pdf)

    [2] Enhanced National Financial Inclusion Strategy, 2018 | Ministry of Finance(URL: http://finance.gov.pk/NFIS.pdf)

    [3] State Bank of Pakistan | Branchless Banking Regulations (revised July 2016)(URL: http://www.sbp.org.pk/bprd/2016/C9-Annx-A.pdf)

    [4] Branchless Banking Newsletter: Apr-Jun 2018 | State Bank of Pakistan(URL: http://www.sbp.org.pk/publications/acd/2018/BranchlessBanking-Apr-Jun-2018.pdf)

    [5] Enhanced NFIS (2018) – Ministry of Finance

    [6] Ibid

    [7] Ministry of Finance | Budget Speech by the Finance Minister | Federal Budget, 2017-18(URL: http://finance.gov.pk/budget/budget_speech_english_2017_18.pdf)

    [8] As per the Enhanced NFIS (2018) – Ministry of Finance

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