Why M-PESA Can Increase Financial Inclusion but Won’t Displace Cash in Kenya

Last month, the Central Bank of Nigeria began a pilot in Lagos aimed at reducing the high dominance of cash in the economy by imposing limits on cash transactions. In similar fashion, Sweden, through its emphasis on technology and innovation, is likely to become the world’s first cashless economy. The emergence of electronic money (e-money) in these two countries has revived the discourse over the future of cash, but in particular, the rise of e-money has opened the debate about the ways to leverage the benefits of this technology for financial development in the developing world.

M-PESA, a Kenyan mobile-based cash transfer service, leads the e-money phenomenon in Africa by allowing its customers to turn cash into “e-float” – a commodity issued in exchange for cash. Its great success has turned M-PESA into one of the focal points of the economic development community in Kenya. Studies of M-PESA cite several of its benefits including: increased security of funds, female empowerment, and improved access and use of information for businesses. Although M-PESA certainly has many benefits, its greatest impact lies in its potential to extend financial inclusion – and not as a nascent form of e-money, as some have argued, ultimately displacing cash in Kenya.

The different applications of M-PESA are of particular importance to organizations seeking to find alternative methods to alleviate poverty, which is one of the main objectives of financial inclusion. Many economic development experts have received Kenya’s M-PESA positively, as they have seen the ability of such a technology in increasing financial inclusion among the poor. The remarkable uptake of M-PESA among Kenyans had several proponents of this technology eagerly anticipating a major impact on the lives of poor Kenyan households. However, M-PESA users are more likely to be younger, wealthier, and better-educated urbanites, which, needless to say, is not exactly the demographic in direst need of financial inclusion.

Nevertheless, some studies suggest that M-PESA increases savings among those without access to formal methods of saving, which is the majority of those living in poverty. Additionally, qualitative data of M-PESA suggests that it serves as a partial substitute for the formal banking system, thus becoming more of a complement rather than a substitute for banking. Most of the people using M-PESA for savings already owned a bank account, but those previously without a bank account have also increased their use of it, albeit modestly, as a mechanism for saving.

The quick evolution of M-PESA has not occurred without some consequences. Recently, the African Development Bank (AfDB) reported that inflation in Kenya was in an upward trend last year, peaking at 19.7 percent in November. According to the AfDB report, one of the main causes of the uptick in inflation is the rapid expansion of M-PESA. The popularity of M-PESA among Kenyans has increased the circulation of cash thereby increasing the pace at which monetary transactions occur in the economy. The way this affects inflation in the short-term is by increasing demand for goods and services in the economy. Some economists, including the central bank’s governor, disagree with these findings, attributing the rise in inflation to other factors.

Recent talk using M-PESA as an example of the future path of e-money is not only premature, but fails to grasps the complexity of monetary policy. A preliminary conclusion from the attempt to measure the velocity of M-PESA is that its velocity is higher than other monetary instruments held by households, particularly cash. This higher velocity may complicate the implementation of monetary policy for central bank authorities. M-PESA’s higher velocity is likely because Kenyans do not use M-PESA as a store of value. Theoretically, the better that money serves as a store of value, the more people hold, so the lower its velocity. For instance, the introduction of interest-bearing accounts made money a better store of value. Similarly, interest-bearing M-PESA accounts could improve its use as a store of value; however, the chances of it replacing cash are slim until this happens. Some evidence underscoring the fact that Kenyans do not yet use M-PESA as a store of value includes: low value of average M-PESA holdings, high velocity, and a small number of times e-money is transferred before it is cashed out.

Regardless of its macroeconomic impacts, M-PESA can potentially introduce the poorest Kenyans into the financial system. For this to occur, however, financial inclusion should emphasize the delivery of savings products through branchless banking and eventually include other financial services, such as loans and insurance schemes, targeted to the various needs of low-income individuals. If M-PESA is to become a major force for financial inclusion, the government should relax regulations hindering banks from offering financial services via mobile operators. Additionally, better analysis of M-PESA’s impact on monetary policy is necessary to attenuate our expectations and maximize the true potential of this technology for financial development without imposing any serious burdens on the economy.