The National Bank of Cambodia has got its job cut out in solving multiple problems including low financial inclusion and countless payment app providers. Is Project Bakong the tool that fixes this?

‘We had nothing to lose,” Chea Serey, assistant governor of the National Bank of Cambodia (NBC) confided in an interview on Project Bakong, Southeast Asia’s first fiat-backed central bank digital currency (CBDC), with The Fintech Power 50 publication in Singapore last December.

“It just so happened that we have problems that we want to solve and there is technology available. So it’s either you go for it – test it or try it, or you have nothing. So, there is nothing to lose, is what I am saying,” she explained.

The development of the CBDC using blockchain, a type of permissioned distributed ledger technology (DLT), raised eyebrows as many central banks including those in advanced nations plod through different stages of research and experimentation, mulling its consequences.

In Cambodia, the need seemed critical, owing to the low financial inclusion as a large portion of the 16 million population remained unbanked or underbanked.

Nearly 70 per cent live in the countryside with scant financial literacy, which NBC often alluded as the reason behind increased indebtedness and shockingly high outstanding microfinance loans.

The phenomenal rise of peer-to-peer bank and payment system institution (PSI) applications in the last five years is another factor that prompted Bakong’s eventual implementation, as many of them have some form of access to people nationwide.

Up to June this year, some 24 PSIs were recorded by NBC but it is believed that only about 10 are active.

What Bakong wants to do is connect all financial institutions (FIs), where 38 offer online banking facilities, and payment service providers under a single payment platform. Termed next generation, Bakong allows fund transfers to be processed in real-time basis without the need for a centralised clearing house.

This removes transfer charges because it is instant. Furthermore, as it is built on Hyperledger Iroha, it preserves privacy and finality. One of the features enables NBC to record every financial transaction with NBC controlling the master ledger.

In a white paper on Bakong last June, the NBC said the project eliminates the need for banks and PSIs to develop their own public mobile application.

“Existing PSIs can integrate with Bakong via the open application programming interface (API),” the paper wrote, but it is yet to be seen if PSIs accede to it because they are not obligated to join.

However, Cambodia Association of Finance and Technology (CAFT) secretary-general and Pi Pay Plc CEO Tomas Pokorny said regulators and industry professionals “strongly recommend” doing so.

“Whether an institution joins is subject to its technical readiness and many other strategic factors [but] in the long-term, it is to the industry’s benefit and infrastructure cost-saving for each financial company to be part of it,” he said.

In the meantime, Cambodia’s highly unbanked population continues to lure investors. At the time of writing, two payment app firms from Singapore had voiced interest to set up shop here.

According to NBC, money transfers surged to $58 billion in 2019, representing 219 per cent of gross domestic product (GDP) whereas money payments constituted 23 per cent of GDP.

In the same period, e-wallets expanded by 64 per cent to 5.2 million in 2019 from a year ago while total deposit accounts touched 7.6 million.

“Bridging wallet providers and banks”

“Many questions were asked as to why a small country like Cambodia dares to take the first move to adopt blockchain while many others are just looking into it. I said well, we have nothing to start with and we felt that it can’t be perfect when Titanic sank on its first sail.

“But if we don’t sail, we won’t know [if] we will sink. So our thinking is to let it sail. If it works, then it works. If it doesn’t, then we will do something else,” Serey then told Fintech Power 50 chief operating officer Mark Walker.

The NBC had been studying the project since 2016, leading to an initial implementation of a pilot project on a backbone payment system in 2019 to test the application, and iron out the kinks.

By digital currency, the NBC means that users are able to hold their money, in dematerialised form such as bank deposits, in e-wallets.

Bakong facilitates instant US dollar and Khmer riel retail and wholesale transactions, and settlements, interoperability across payment platforms while lowering costs, and raising speed and security.

The electronic payment system also unburdens users from having to carry large amounts of riel banknotes to pay for high value transactions.

Slightly under a month ago, it officially rolled out Bakong in collaboration with Tokyo-based blockchain specialist fintech firm Soramitsu Co Ltd, with some 20 financial institutions on board.

Seeing that the app is primarily aimed at raising financial inclusion, the NBC is leveraging on over 100 per cent year-on-year mobile penetration and some 20 million mobile subscriptions in the country.

“We have a banking industry serving the affluent and corporates in the economy, microfinance institutions providing micro-lending to the rural areas and lower segment of the market, and then you have payment service providers who provide e-wallet or money transfers,” she said.

For now, Bakong works on a premise of issuing a “national wallet” to users as banks surrender their fiat money to NBC which in turn credits their electronic vault (e-vault).

In terms of money supply, nothing changes. Banks will hold the tokenised fiat money which can be issued to the end-user.

“So a customer can walk into a bank and choose to either withdraw cash to put in his leather wallet or have it transferred to an e-wallet. For e-wallet, the bank can transact the money from the e-vault … so money can flow easily,” Serey said.

In effect, Bakong prompts payment applications to “speak the same language system-wise” with banks via a common channel.

“Payment service providers will be able to incorporate our application through the application programming interface into their existing wallet, allowing customers to use the wallet for cross-institution payments and transfers,” she added.

While bank customers are sufficiently accounted for, totalling 3.5 million accounts, as of September 30, 2020, scores of e-wallet users registered with payment service providers are not necessarily banked.

“Hence, why Bakong is built to bridge wallet providers and banks. We require banks to be part of Bakong to open bank accounts and wallets for customers so they can get money through payment service providers or e-wallet, withdraw cash and transfer money into their accounts.

“This means they can use money and save some,” she said, referring to garment workers or civil servants, who live in remote areas, and receive wages through e-wallets owned by payment service providers such as Wing (Cambodia) Limited Specialised Bank.

Ownership of bank accounts enable customers to earn interest on their deposits which is not allowed in purely e-wallet accounts of payment service providers.

“We don’t want people to get confused that this [e-wallet] is the means or instrument of saving because we don’t regulate payment service providers as stringently as we would banks. So we want people to go to a proper institution,” Serey stressed.

Tackling money laundering

This circles back to the meteoric growth of payment apps in Cambodia. Numerous PSIs, not including FIs, have been operating independently to provide services such as money remittances, mobile payments, and e-commerce.

“PSIs are allowed by regulation to participate in the central infrastructure, but most institutions are still reluctant to do so and instead expand their services through their own investment in agent networks and points of sale,” NBC’s white paper read.

Pokorny of Pi Pay, one of the pioneer payment apps in the Kingdom with some 320,000 users, agreed that the market has been increasingly busy, which he said is natural in a developing economy. The market needs competition and options for both business and consumers.

“But in time, and that time is approaching, in my opinion, initiatives of common infrastructure, such as Bakong, partnerships [of] same commercial goals will lead [to] market consolidation, signalling that Cambodia’s fintech ecosystem is slowly maturing,” he said.

However, will Bakong phase out low performing or unscrupulous PSIs in the long-run? There is a likelihood of that happening, Pokorny indicated.

“While payment apps are mainly regulated by the NBC, essentially ensuring that consumer protection and stringent industry selection process is maintained, there are instances and attempts by firms without licenses to enter the market.

“However, so far, those are usually short-lived ventures and are organically removed from the market by both regulatory efforts and customers’ natural behaviour,” he said.

Likewise, he said, Bakong is one way to further support anti-money laundering measures. Similarly, by encouraging more online transactions, central banks are able to monitor the sector better. This puts paid to NBC’s strategy to pool payment apps under one plaform.

In a note on CBDC in October, Moody’s Investors Service Inc asserts the same idea. It said by reducing hard cash transactions, central banks are able to monitor online transfers better.

Often, payments by cash are anonymous and virtually instant. This very anonymity makes it a favoured means of exchange for criminal transactions.

For this reason, some countries have banned its use for transactions above a certain threshold.

“In addition, being physical and practically untraceable, it can also be stolen, which limits its usefulness and imposes on users costs for its handling and storage,” Moody’s wrote.

Bottomline affected?

The global rating agency also suggested that CBDCs could address the fears arising from Covid-19 where cash might harbour disease, and thereby become a means of contagion.

However, it cautioned that some forms of CBDC might have profound negative consequences for commercial banks as CBDCs could displace the banks’ role in payments system and force changes in their funding model.

What it meant was that the ongoing digitalisation trends that have sped up in the pandemic continue to pose a long-term threat to physical cash which plays an important, yet diminishing role in most societies.

“CBDCs could be a part of the central banks’ response to this pressure, but they would create another challenge for commercial banks to contend with, on top of existing competitive threats from technological giants,” it said.

Does this mean that banks’ bottomline could be impacted? Association of Banks in Cambodia chairman In Channy did not think so because the CBDC enables financial institutions to reach out to existing and potential customers to take part in local fund transfers.

“Therefore, Bakong complements the financial sector. My bank does not lose anything because we don’t charge fees when transferring funds,” said Channy, who is also the president and group managing director of Acleda Bank Plc, which has over 1.6 million internet bankers.

Acleda instead earns from the annual maintenance fees of $6 per customer who connect to ToanChet, the bank’s online banking app.

For Bakong users, the arrangement is good as they bear no costs if they transfer funds from their own banking account to Bakong account or vice versa.

And with the user-friendly application and simplified know-your-customer (KYC) procedure, Bakong users can access its channels for various actions such as bank account openings, payments and remittances.

Conversely, PSIs might feel a pinch, in terms of competitiveness. “Investment costs on one-on-one integration could ease up for companies which would help them expand faster but Bakong could also remove some competitive edge,” Pokorny said.

It will mean that everyone can be connected to everyone which is great for financial inclusion but peculiar for some payment companies.

“So, it is up to fintech then and being at the forefront of innovations, to find ways how to fit into the system and how to make best of it,” he said.