The African Liquidity Challenge. 🌍

To understand the problem, let’s take a concrete example.

Let's imagine a fictional company called "KenyaCrafts Ltd.", a small business based in Nairobi, Kenya, specializing in handcrafted home décor items.

KenyaCrafts Ltd. imports raw materials such as fabrics and dyes from India to create their products and needs to pay $10,000 to its Indian supplier.

Here’s a breakdown of the different fees they will go through:

• Bank Transfer Fee: Traditional banks often charge a flat fee plus a percentage of the transaction. For simplicity, let's assume:

  • Flat Fee: $50 per transaction.

  • Exchange Rate Markup: 2% above the interbank rate.

  • Correspondent Bank Fees: $20 (fees charged by intermediary banks involved in the transfer).

Let’s calculate the overall transaction fee for the company:

• Flat Fee: $50.

• Exchange Rate Markup: 2% of $10,000 = $200.

• Correspondent Bank Fees: $20.

  Total Cost = $50 (Flat Fee) + $200 (Exchange Rate Markup) + $20 (Correspondent Fees) = $270 🫠.

The $270 represents 2.7% of the transaction amount, which significantly impacts the company's profit margins.

KenyaCrafts Ltd, like many businesses in Africa, must navigate high fees, delayed processing times, and poor exchange rates, which strain their cash flow and reduce their ability to invest in business growth.

Now let’s take another example.

Let's consider a fictional U.S.-based company, "EcoGoods Inc.," that has a subsidiary in Kenya producing eco-friendly products.

After a successful year, EcoGoods Inc. wants to repatriate $100,000 in profits from Kenya to the United States.

With that same logic, EcoGoods Inc could pay up to $3000 in transaction fees + delays.

The question now is: why is it so expensive and inefficient?

Here are some reasons:

• Fragmented Financial Infrastructure: Limited direct banking connections require intermediary banks, adding fees at each step, raising overall costs for cross-border payments.

• Currency Exchange Risk: Banks add markups on exchange rates to cover currency fluctuation risks, significantly increasing transaction costs for businesses.

• Compliance and Regulatory Costs: Strict international regulations (AML, KYC) increase operational costs for banks, which are passed on as higher fees.

• Operational Inefficiencies: Outdated banking technology and manual processes lead to higher operational costs, reflected in elevated transaction fees.

• Lack of Competition: Few banks dominate, leading to higher fees due to reduced competition and lack of pressure to lower costs.

• Low Transaction Volumes: Fewer transactions spread fixed costs thinly, resulting in higher fees per transaction to maintain bank profitability.

• Risk Premium: Transactions with developing countries are seen as high-risk, prompting banks to charge premium fees, further raising costs.

Now, let’s see how startups are tackling this issue.

The $7 Trillion opportunity for startups ✅

Cross-border payments are heating up, and not just in Africa.

In April this year, TechCrunch released an article titled ‘Cross-border fintech stands out in Y Combinator’s Winter 2024 cohort.'

Last week, I had the chance to meet with Eric, General Manager for Africa at Conduit, and Joshua, founder of Durrafx and former VP of Africa at Patch Cap.

Both of them have been working in this area for many years and were able to share some of the secrets powering those startups.

While each startup has its own system in the backend, they all rely on the same basic principle: finding people who need to convert dollars/euros to local currency, and vice versa.

Due to the large amounts involved, much of their work is built on relationships and trust (a lot happens in Whatsapp conv ).

Eric’s job primarily involved finding companies that needed to pay suppliers or import goods (converting local currency to dollars) and working with remittance companies that usually need to convert dollars to local currencies.

This sector is just getting started, and startups have different strategies behind the scenes.

In the coming weeks, I’ll probably delve deeper into the technicalities behind it.

If you're interested in understanding the technicalities, respond to this email with 'MONEY TREE.'😉