Once upon a time, paying for a product or service was a straightforward process. All you needed was to take the medium of payment — cash, cowries, favours — to the service provider and exchange it for what you needed.
With technology's addition to the process, it has gotten more complicated, with the uninitiated often clueless about what goes on behind the scenes.
In this article, we’d look at this process, focusing on payment switching, with insights from Obi Emetarom, CEO and Co-founder of Nigerian fintech company, Appzone.
What is a payment switch?
According to Emetarom, a payment switch is a company that connects financial institutions to enable the flow of value from one to the other. To facilitate these transactions, a central body is needed to authenticate, ease, and keep a record of them.
A payment switch enables several transaction options, including ATM activities, PoS transactions, inter-bank transfers, and debit and credit cards.
What does the digital payment process look like?
On a fundamental level, paying for a product is as simple as giving some wads of cash, cowries, or whatever medium of exchange is acceptable to a value provider (business or individual). In exchange, the person provides you with the desired product or service.
Digital payments take the same format, but because many more options and transactions are processed using technology, much more goes on behind the scenes. Generally, payments take two forms – an issuer-initiated transaction and an acquirer-initiated transaction.
An example of an issuer-initiated transaction is when you make a bank transfer to a friend or family member using a different bank. In this case, your bank where the transaction originates debits your account (because they have access to your balance) and instructs the recipient’s bank, through the payment switch, to credit them. The payment switch keeps a record of this transaction which would often be reconciled by the next day.
On the other hand, an acquirer-initiated transaction is not initiated by a platform owned by the sender’s institution. An example of this is paying for a headset on Jumia or making a withdrawal using an ATM.
When you initiate a transaction on Jumia, the system has to contact your bank to confirm that the transaction was initiated by you using an authentication method. This is one reason why your PIN is requested at checkout.
When the confirmation is gotten, a debit is made on the sender’s account while the beneficiary of the transaction receives their payment and settlement is done later. In most cases, settlement is done within 24 hours of a transaction being completed.
Requirements for getting a payment switching licence in Nigeria
To offer services as a payment switching company in Nigeria, a company must be licensed by the Central Bank of Nigeria. Often referred to as the CBN’s highest licence, only a few companies, including Interswitch, Flutterwave, Appzone, TeamApt, eTranzact, and Unified Payments, own this licence.
All requirements for getting this licence are contained in this document (PDF), but a few conditions are outlined below.
First, the company that wants to obtain the licence must be registered with the Corporate Affairs Commission with a Memorandum and Article of Association. In addition, a deposit of ₦2 billion ($3.3 million), which is shareholders’ funds unimpaired by losses, is paid to the CBN.
An application fee of ₦100,000 ($166) and licensing fee of ₦1 million ($1,666) are also paid, while a further escrowed ₦2 billion ($3.3 million) is paid to the CBN. This second ₦2 billion ($3.3 million) can be refunded to the company.
Other requirements include the company's audited financial statements and tax clearance certificate for the preceding three years, where applicable.
Is it profitable to obtain a payment switching license?
Although a payment switching licence enables quick payments for a business’ customers, it has low margins. While Emetarom agrees with this, he believes that the growing adoption of digital payments means that this is the right time for anyone to obtain a payment switching licence.
“In the days when you had to literally beg people to use ATMs or PoS machines, the challenge was when you combined the low margins with the restricted adoption, you saw a lot of businesses try to augment with other streams of income.
"For us, we think that things have evolved. Now you have the rate of adoption ramping up significantly, so the scale is there and even growing. We think the timing is better now for having a focused play in that space as opposed to earlier in the day when the other players had to do other stuff.”
Benefits of owning a switching license
There are two categories of companies that may attempt to get a payment switching license.
The first is infrastructure providers, meaning their primary service is facilitating payments between financial institutions. An example of such an institution is Appzone. The other category is payment service providers like Flutterwave and Paystack, which intend to facilitate payments for their users and customers of similar companies.
For companies in the second category, Emetarom points out that getting other payment companies on board may be difficult as they could be seen as competitors, which could restrict them to processing only their own transactions.
Consequently, these companies need to depend on the scale of their transactions to justify the expenses involved in owning a switching licence.
Regardless, getting the licence comes with huge benefits. For one, having the backing of the CBN counts toward how credible other financial institutions will perceive the company. It also means investors might be more willing to fund such a company.
A payment switching licence also means a business does not have to depend on a third party to process its payments. More control over this part of the business could help them provide faster and more efficient services to their customers.