Fish vendor in the Philippines. Photo by Jaime Singlador, 2014 CGAP Photo Contest.
Each year, I find myself reflecting on the progress we have made on financial inclusion, but also on the challenges ahead and how we as CGAP can contribute towards tackling them. This question came into sharp focus for me in the closing months of 2018, when I attended two events focusing on fintech – the Singapore Fintech Festival and IFC’s annual meeting of its fintech investees.
There is an incredible amount of excitement around fintech. I met people working on insurtech, payments, reverse factoring platforms, blockchain-based identity solutions, digital micropensions, marketplace lending platforms, digital credit, e-commerce, regtech, suptech, artificial intelligence, machine learning…literally, everything under the sun. There is so much energy, creative thinking and money going into this space, it is breathtaking. And a bit overwhelming, if I am honest. Between the opportunity for mass market financial services in emerging markets and the opening up of financial services in Europe thanks to the revised Payment Services Directive (PSD2), there is rightly a lot of excitement about how we can rethink financial services for the digital age.
Asia is ground zero for all this excitement, given the momentum we are seeing out of China and India. With Chinese companies aggressively expanding into neighboring markets, there are great expectations for what this will mean for financial inclusion from Pakistan to the Philippines. Whether the Chinese big tech platforms can build the same explosive growth in these new markets as they experienced in China remains to be seen. They will not have the same advantages they enjoyed on their home turf, but the money and know-how are pouring in, and it makes these markets fascinating to watch. India is also extremely dynamic, albeit in a different way, given the government’s heavy investment in building the connected market infrastructure. India’s unique technology stack has attracted tech giants from both China and Silicon Valley, and it will be interesting to see who emerges as winners in this new marketplace.
Poor people are the critical piece of this equation. They remain central to the story but are easy to lose sight of in the excitement around technology and innovation.
At the same time, I was really struck at both meetings that although the term financial inclusion was used quite liberally, I can’t remember the words, “the poor” being used much at either event. Certainly, there were a few companies at both events focused on serving the poor, but the poor were definitely not the focus, even in the context of financial inclusion. Despite M-Pesa generating some initial inspiration for how financial services could be delivered differently to the mass market, financial inclusion has moved way beyond its origins as financial services for the poor. My sense is that today people mean very different things when they talk about it. Given all the enthusiasm and money flooding into fintech for financial inclusion, I think it is important for the development community to pause and reflect on how our work fits into this fast-moving new universe.To my mind, poor people are the critical piece of this equation. They remain central to the story but are easy to lose sight of in the excitement around technology and innovation.
Beware the Hype
As we think about the fintech revolution, it presents a couple of challenges for our industry to consider. Firstly, fintech is the subject of an off-the-charts amount of hype. Fintech seems to be the solution to every development problem, sometimes in ways that have me questioning my sanity. Anything with a technology tag gets funding and attention, whether it is solving a real problem or not. I recently read a rather breathless piece about a blockchain solution that solved the problem of…. Microfinance! …. at the hefty price of 1 percent for a four-day loan. Have they not heard of digital credit?
I know I am developing a bit of a reputation as a blockchain skeptic, but my problem with blockchain is not necessarily the technology itself, but rather that we are letting the latest shiny new object distract us from what are complicated real-world problems that require patience, investment and focus to solve, not a magic tech solution. Technology is definitely part of the solution, but it is just a tool. Real change requires solid business models, skills and delivery capacity to make a real difference. It also requires a very solid understanding of the development context in which one is operating.
Mind the Gap
The other issue that continues to give me pause, particularly as digital services pertain to reaching the poor, is the challenging question of how the digital world connects with the non-digital one, which for most poor people still operates in cash. Despite the exponential growth in payments over Unified Payments Interface (UPI) in India, I still have real questions about how this very impressive infrastructure will actually reach the poor. Companies can build profitable businesses serving the top 10 percent in India, without even thinking about reaching the poor. And payments banks, which were meant to be the cash-in, cash-out (CICO) interface for low-income clients, have struggled to get business models off the ground, given the commercial constraints built into the license. But to get the poor into the digital ecosystem, people need to be able to convert cash into digital and back again, and for this, CICO infrastructure remains vitally important.
It has been similarly difficult to see how the big tech giants will make significant inroads into Africa, at least in the near term, since the only way they can currently monetize their services runs right through the business model of the mobile network operators. That is not to say we won’t solve the CICO challenge. But to reach the poor, distribution is a topic that requires further attention, both to improve its efficiency and to extend its reach. Otherwise, the risk of a digital divide is very real.
A Forward Look
So how can those of us focused on financial services for the poor think about this, going into 2019? There are three dimensions that I believe will be crucial to our success in the coming years:
Creating a ubiquitous and frictionless interface between the digital and non-digital economies, at a cost that makes it accessible for the poor;
Bringing full-spectrum financial services business models to bear on meeting the needs of the poor; and
Making sure regulators are equipped to enable the experimentation required, while managing for risks in emerging business models.
I offer a few thoughts on each.
The future of financial inclusion is in the cloud…and the agent
India and China have both demonstrated the power of building integrated tech platforms, albeit in very different ways. But it is one thing to build integrated infrastructure for China with its 1.4 billion people, and another entirely to do the same in Zambia with only 18 million. A platform economy requires scale, abhors borders and regulators, and needs many-to-many solutions, which makes Africa a particular challenge for big tech players. It is therefore critically important to continue building interconnected and open digital platforms (for example, through interoperability and open APIs), to invest in shared market infrastructure and data (like payments infrastructure, credit reporting and e-KYC utilities), and to support public goods like foundational IDs. All of these contribute to the emergence of the kinds of ubiquitous, frictionless, large platforms that are required to help reach down market to serve the poor. To achieve scale in Africa, these solutions will also need to reach across borders and regulators, which will require a new way of licensing and overseeing these providers.
Equally important, for poor people to be able to participate in the digital economy, we also need to make CICO a better value proposition for providers, and that pathway requires greater rather than less openness. As GSMA noted in its most recent State of the Industry report, providers with high activity rates and high average revenue per user (ARPU) shared four characteristics: strong distribution networks, enabling regulation, an account-based model and a higher number of integrations with other service providers. In other words, to drive the volumes required to make CICO a viable proposition for providers, operators need to start thinking like platforms, not extensions of a mobile telephony business. Developments in Asia provide some inspiration: the online giant Alibaba demonstrated that e-commerce-led distribution could anchor the development of a payments infrastructure in China. GO-JEK, the ride-hailing, delivery and financial services startup out of Indonesia, has shown that CICO can be bundled with other services that people want to use. Eko in India is a platform for financial transactions that is trying to create completely decentralized CICO by turning anyone with a smart phone and a bit of cash in their pocket into a human ATM. And Facebook is emerging as an informal e-commerce solution in multiple markets around the world, including in Africa. These lessons are now being picked up in other markets through ride-hailing, e-commerce and food delivery business models.
Traditional financial services still matter … but providers need to adapt
Willie Sutton, a famous American bank robber, was once asked why he robbed banks. His response? “Because that is where the money is.” While the story appears to be apocryphal, the statement is as true today as it was in the 1930s. Banks play an important role in injecting liquidity into markets and intermediating deposits, and it is important we don’t lose sight of that amidst all the excitement and disruption created by technology. It seems to me that there is still an important role for banks and microfinance institutions in the new financial services landscape. Poor people need more than payments and short-term digital credit. They need to save, invest and insure. And financial institutions are particularly well equipped to meet those needs, in many respects. But they do need to think about how to do this differently in the digital age.
There is still an important role for banks and microfinance institutions in the new financial services landscape. Poor people need more than payments and short-term digital credit.
I recently read a paper that demonstrated the effects of the withdrawal of microfinance services at the community level in the wake of the Andhra Pradesh crisis. While the impact literature provides a fairly ambivalent picture of the impact of microcredit on individual business growth and profitability, this research examined what the sudden withdrawal of microcredit did to rural communities. It found that credit contraction reduced casual daily wages, household wage earnings and consumption in the affected areas. It is obvious, really – if you suddenly take liquidity out of a market, that market will shrink. Credit and other financial services are important to making an economy function efficiently, whether that market is in the United States or a rural village in Andhra Pradesh.
But the economics around serving the poor remain vexing. While it is quite clear that fintech is going to challenge existing models of financial services delivery, it is not yet clear to me that these new players have completely cracked the cost dynamics of serving the poor – and when the banks do weigh in, they have some important comparative advantages. These include a mastery of financial regulation, big balance sheets, the ability to intermediate low-cost deposits, strong risk-management capabilities, sticky customer relationships and formidable data assets. MFIs certainly do not enjoy all the strengths of the banks, but they bring something else to the table: a strong focus on providing financial services to the poor, and an understanding of the needs of their customer base. Integrating banks and MFIs into the digital platform economy in a way that helps make it economical for them to serve the mass market will be as important to the future of financial inclusion as building the platforms that make it possible. This will require some soul searching on the part of banks to understand their comparative advantage in a financial services value chain that is being rapidly disaggregated and responding far more nimbly to change. It will also require understanding technology and embedding it deeply in their businesses, embracing greater openness, putting customers at the center of everything they do, investing in new skills and thinking hard about partnerships. There are some intriguing new banking models emerging in Europe as a result of PSD2, and it will be interesting to see how this new thinking can be applied in emerging markets.
We also need to make sure we are not disrupting in a way that unintentionally creates harm. Recent reports out of Kenya illustrate the hazards of the new paradigm: microfinance banks in Kenya currently face a serious threat, ironically, not directly from M-Pesa, but from the entry of banks with low-cost deposits into the digital consumer lending space. Interest rates caps imposed on their traditional credit products have encouraged banks to shift toward digital channels, where providers have largely been able to circumvent the cap. This has resulted in dramatic growth in digital credit, and signs of competitive pressure on the microfinance sector. While there is much to improve in the microfinance sector in Africa, it is not obvious to me that we want it to disappear entirely and be replaced by short-term, expensive digital products. Disruption can and should be a force for good in the financial sector, but we need to take care that responsible financial inclusion for the poor does not become collateral damage along the way.
Regulators are critical … but they have to keep pace with accelerating rates of change
The case of Kenya illustrates the challenges for regulators and supervisors in overseeing this brave new financial services landscape. An interest rate cap, unevenly applied, can create strong incentives towards a certain type of product, which may not create the outcome the regulator wishes to achieve. Kenya has generated huge amounts of interest for the innovation it has fostered, with improvements in financial inclusion indicators that outperform virtually every country in the world. But with this shift comes new hazards, and regulators must stay attuned to emerging threats. The faster the innovation train moves, the harder it will be to keep up.
We have a pretty good idea of the kinds of policy choices that enable financial services for the poor, but we do not yet have as solid a grasp on how to manage once we make these changes. The regulatory perimeter needs to be reviewed and perhaps redefined, new providers licensed and supervised, cyber-security standards improved, consumer protections made more robust, and data protection and privacy and competition laws strengthened, among others. There is a growing need to better equip regulators to deal with the challenges ahead, and this is an area that is often overlooked by the development community. If we want to protect the gains made in financial inclusion in recent years, the role of regulators strikes me as being of critical importance. Sandboxes and digital fiat currencies are great, but there are some pretty big gaps in the basics that urgently need to be addressed in parallel.
Cheerleader No More
Which brings me back to CGAP. CGAP has often thought of itself as being at the leading edge of developments in financial inclusion, but as the world jumps on the bandwagon of fintech, I think we may need to adjust our thinking. It is increasingly difficult to make the case that we are operating at the leading edge of technology when big institutions with deep pockets like Ant Financial, TenCent, BBVA, Google, Facebook, Amazon and the World Bank are all investing heavily into using technology to expand access to financial services. We are as excited about the pace of change as everyone else, but I don’t think we need to persuade anyone of the value of technology in financial services anymore.
Technology is very much at the heart of change in financial services. CGAP’s comparative advantage is around our deep roots in microfinance and financial inclusion for the poor, combined with our experience of digital finance over the last ten years. The challenge for CGAP will be to bring those two worlds together, keeping the poor at the center of our work while at the same time thinking rigorously about how we harness the amazing innovation going on to achieve our goals of ensuring that poor people are effectively able to seize opportunities and manage risk. To do this, we need to look beyond the hype, test new approaches both private and public, understand what really works for the poor and where the limitations of these new approaches lie, and apply that learning to the delivery and regulation of financial services for the poor. And, of course, to share the learning with our many partners and stakeholders, so they can incorporate it into their own efforts.
The good news is that there is a lot of good work going on that in the year ahead will generate new insights and provide inspiration for those of us working on financial inclusion for the poor. I, for one, can’t wait to see what 2019 has in store for us.
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