Why We Urgently Need Alternatives to the Investor-Driven Fintech Model
Fintech is the latest financial innovation thought capable of dramatically improving the lives of the global poor. Its key attribute is that it greatly extends financial inclusion, meaning basic financial services such as credit, savings, and payments are made much more widely available to the poor.
The current narrative on fintech is that it will deliver for the global poor what the microfinance model failed to achieve despite its considerable progress in extending financial inclusion. There is a widely held belief that fintech’s ability to reach the “last mile” individual will help achieve full financial inclusion, which in turn will make major inroads towards resolving global poverty.
While this uplifting narrative seems to resonate with many, we argue that a more critical look at fintech is necessary to challenge its core assumptions. Although many individuals in low-income countries have indeed seen an improvement in their lives following the introduction of many basic fintech services, we believe that most of these benefits will be short-lived and will be outweighed by the longer-term downsides now emerging into view. These problems essentially arise because the dominant fintech model can be defined as an “investor-driven” one: that is, it is primarily intended to benefit individual and institutional investors, including many of the world's largest financial, telecom and digital payments corporations.
There are at least five downsides to the investor-driven fintech model that suggest it is unlikely to serve the real needs of the poor.
- Supporting microenterprise development does not benefit the poor. One of the core advantages attributed to fintech is that it will provide financial support to allow more microenterprise development among the poorest, who are expected to create their own jobs and incomes as the best, if not only, way to escape poverty. However, this line of thinking is flawed because markets across low-income countries today are now pretty much saturated with informal microenterprises and the simple goods and services they aim to provide to local inhabitants. As a result, new microenterprises today have very high rates of exit, largely canceling out most of the initial employment and income gains arising from their entry into the market. The high rate of failure among start-ups also means that we should not be promoting new business entry as a solution to youth unemployment. In the end, stimulating more competition tends to further depress already low average microenterprise incomes across the whole informal sector. Providing more support for microenterprises with the help of fintech will only serve to extend this largely zero-sum outcome.
- It promotes over-indebtedness. The easier availability of digital microcredit feeds into another serious problem - rising individual over-indebtedness. The extreme ease with which the poor can now access a deceptively expensive digital microloan is good for some, but a bane for others. Already pioneering countries like Kenya have been plunged into an over-indebtedness crisis caused by unstoppable borrowing. Other countries are not far behind.
- It will tend to favor already profitable SMEs. Fintech lenders rely on complex algorithms, machine learning and other techniques to identify those enterprises best able to repay a loan over a short period of time. While these techniques can help some new SME projects which are able to reach break-even point in a short time, in general we would expect fintech lenders to use their new tools to locate and support already profitable SMEs. As a result of this tendency, very little is offered to local communities in the form of “patient” capital with which to gradually build a sustainable base of SMEs over time.
- It does not create value for local communities. Effective SME development typically requires a local eco-system of support institutions operating on trust, participation, cooperation, knowledge exchange, and a longer-term goal-orientation. Locally embedded SME financing institutions, especially public or cooperatively-owned bodies, often create such a vital infrastructure. However, fintech-based SME lending platforms and their investors lack the incentives, the long-term commitment and the deep understanding of the local economy required to help build and operate such a vital local infrastructure.
- In fact, investor-driven fintech takes resources from poor communities to enrich investors. Fintech platforms take a slice of the value generated by the billions of tiny financial transactions made by the poor. This creates a large pool of value owned by investors, many of which are located in the wealthiest countries. Like the old colonial regimes that exploited the natural resource endowments of their colonies to fund their own development, many of today's fintech behemoths have evolved into “digital extraction” operations that do exactly the same thing. Communities in low-income countries are now quietly, but relentlessly, being separated from the scarce financial resources they need to reinvest in their own productive capacities.
So what is the solution? research in Maricá showed that these benefits include lower cost public services (especially with regard to running Maricá's widely appreciated Basic Income program), a higher level of local business activity and less environmental impact thanks to local purchasing, and the promotion of local democracy and self-management in business and in the community. Crucially, all surpluses generated by the community development bank are retained and proactively reinvested back into the local community.One such model operates in the Brazilian city of Maricá. Thanks to its pioneering use of fintech applications, including a local digital currency operated by a publicly owned community development bank, the Banco Comunitário Popular de Maricá, the local community as a whole has begun to enjoy the many important benefits that a “people-centered” fintech platform can offer. Our
Source: Maricá City Hall – Photo by Elsson Campos.
The fintech revolution underway possesses the potential to generate great benefit for all of humankind. But for this outcome to become a meaningful reality requires that the operating modalities, ownership structures and long-term objectives of the fintech sector must be thoroughly revised. Otherwise, sadly, we see this latest financial innovation joining the long list of financial innovations that, as history abundantly shows, start well but end up only enriching a tiny elite at the expense of the many.