staci warden, is the executive director of global market development at the Milken Institute and a member of the board of the Global Blockchain Business Council, an industry association for the blockchain ecosystem.
Illustrated by peter horvath
Published July 30, 2020
A variety of strategies have proved profitable for banks in developing countries – but going after the smallest and most marginalized customers does not count among them. It’s hard to provide financial services to the poor and make a buck in the bargain. Their deposits and payments are small, their credit profiles are nonexistent or difficult to obtain, and their financial literacy is low. All told, the cost of due diligence on small loans is about the same as that for larger loans, yet the fees the market will bear are much smaller. For the most part, the poor are just not worth it. The feeling is mutual. Some 30 percent of unbanked (an awkward term, but a useful one) households surveyed in the World Bank’s latest FinDex report in 2017 gave “distrust of banks” as a reason for avoiding them. Minimum balance requirements are too high and fees are not transparent, for one thing. And in rural communities, the value proposition is even more dubious. A bank branch might be a full day’s bus ride away, forcing a farmer or schoolteacher to make unacceptable sacrifices simply to cash a check or make a payment.
To make matters worse, banks in rural areas face less competition, and therefore often charge higher fees.
Not surprisingly, then, there are still 1.7 billion unbanked people in the world, and they are, for the most part, among the poorest. They operate in a cash economy and hold savings in the form of jewelry, with the greater expense and security risk this entails. They have few ways to earn on savings or to buffer their incomes against shocks – think low crop prices, insect pests, flooded roads, pandemics and so on. And their only access to credit is through local loan sharks or illiquid reciprocal lending schemes with family and friends.
The situation is improving dramatically, though. About 15 years ago, while banks were complaining about the regulatory and operational costs of banking, the poor and the economic development community was measuring financial inclusion solely in terms of bank accounts, a handful of entrepreneurs realized that technology could change everything. The explosive rise in internet access and mobile telecom networks was connecting ever more people around the world and, in the process, sharply lowering the cost of doing business among them. And with that (though slowly at first), the digital financial services – aka fintech – revolution was on.
Today, fintech includes a wide range of applications delivered on an endless variety of platforms, including digital offerings from traditional banks, new kinds of digital-only banks, and stand-alone apps and crowdfunding platforms. But at the top of the list in terms of impact stand the telecommunications networks (telcos) that facilitate digital payments, digital platforms (“techfin,” to the geeks) that use reams of data to identify risk/ return factors and customer preferences, and cryptocurrency/blockchain offerings that, although still more sizzle than steak, hold unique promise to advance financial inclusion at scale. Each of these brings progressively better operational efficiencies as a result, in part, of their progressively arm’slength relationship with the banking sector. And, as such, each offers a potentially better solution to financial inclusion.
The promise of each can be judged principally on the extent to which it can deliver on a number of mutually reinforcing value propositions for low-income consumers and small businesses:
- Improving the ubiquity and lowering the cost of making payments
- Expanding the portfolio of financial services available at micro-unit sizes needed by the poor
- Enabling the currently disenfranchised to marshal their own income, spending and social data to improve their access to credit
The Cradle of Civilized Payments
It’s possible that the fintech revolution actually started when some smarties in one of the very poorest countries in the world, Chad (GDP about $2,000 per capita in purchasing power terms), figured out how to game the system for prepaid mobile airtime minutes. The telcos had agents all over the continent who sold prepaid mobile airtime and earned a commission when – but not before – those minutes were used. Soon a system was established whereby a worker in, say, N’Djamena, could send some of his wages in the form of airtime minutes to Aunt Luiza out in Fada, paying his agent an upfront fee in cash.
The agent would then send the minutes, plus the to-be-earned telco commission, to another agent in Fada, who would cash out Aunt Luiza and keep the minutes. He could sell those minutes and collect the commission from the telco. But he could also repeat the process with somebody else, collecting a cash commission up-front instead. This process could be, and was, repeated multiple times as a way to transfer remittances all around Chad. The thing to notice about this system, though, is that the telco itself doesn’t make any money until the minutes are actually used to talk on the phone.
Bemused Afghani police officers suddenly found themselves 30 percent richer because their superiors could no longer routinely skim a little something off the top before handing over their salaries.
Safaricom in Kenya formalized this process in 2007 with its now famous M-Pesa mobile money platform, making sure not to forget to take a transaction fee on every leg. It took M-Pesa less than a year to get its first million active users in Kenya, and within four years it had reached 80 percent of Kenyan households. With some 32 million users, MPesa now operates in multiple countries across East Africa, North Africa and South Asia. In Kenya, M-Pesa handles transactions equivalent to more than half of Kenya’s GDP. BKash, in Bangladesh (one of many M-Pesa copycats), now processes about $84 million per day from 34 million customers.
Today, according to the GSMA’s recently released “2019 State of the Industry” report, there are over one billion mobile money accounts in 95 countries doing a combined average of $1 billion in transactions daily. Sub-Saharan Africa alone added 50 million accounts in 2019, while East Asia and the Middle East are now seeing 40 percent growth rates (albeit from a smaller base).
The Promise of Mobile Payments…
The effects on quality of life from digital payments alone have been profound. MPesa has lifted one million Kenyans out of poverty, many of whom left agriculture to start small businesses and many of whom were women. And, according to the World Bank, small vendors with mobile accounts saved at higher rates and plowed 60 percent more into their businesses than other vendors dependent on cash. The benefits in waiting and travel times alone have been significant for the rural poor. In Niger, for example, mobile money saves households an average of 20 hours in travel to collect government social benefits.
As you might imagine, direct digital payments have also had a significant dampening effect on corruption. In a famous early example, bemused Afghani police officers suddenly found themselves 30 percent richer because their superiors could no longer routinely skim a little something off the top before handing over their salaries. (The pilot program also revealed that 10 percent of the paid police workforce didn’t actually exist!) In India, the Economist estimated, the government has saved about $5 billion in “lost” transfer payments to the poor since digitizing them.
The benefits are also thought to be more pronounced for households headed by women, where – in Africa and the Middle East, in particular – they have lower rates of financial inclusion than men. This is good news for everyone in the household, because women tend to spend more than men on family-welfare-improving items like fresh food and schooling.
Software has further enhanced the value of digital payments by expanding services for the poor as well as boosting the systems’ commercial viability. The added value can be as simple as better information services (confirming account balances, say, or SMS reminders when bills are due) to the provision of a range of financial products in micro-form, such as life insurance and crop insurance – all of which are now expanding on the back of mobile money accounts.
Making micro-payments viable has delivered myriad benefits. A startup called Tienda Pago in Peru set up digital short-term working capital loans via mobile phone for tiendas (neighborhood shops) to buy shelf inventory from a network of pre-approved distributors.
Loan amounts were too small to be of interest to banks. But limiting shopkeeper spending to pre-approved suppliers reduced the risk to acceptable levels for Tienda Pago. And because shopkeeper payments to delivery trucks were now made by text message, drivers no longer had to carry cash. Seventy-five percent of these shops had no previous formal access to finance (and 74 percent of their proprietors are women).
Likewise, Mastercard’s Center for Inclusive Growth teamed up with Unilever in several African countries to use the inventory sales data in Unilever’s books to ascertain the creditworthiness of small businesses for working capital loans. This kind of factoring is a staple of merchant finance for large companies. But by factoring inventory data into lending decisions (instead of traditional collateral), Mastercard and Unilever were able to create a practical micro-version of it and lend to micro-merchants at reasonable rates.
The benefits of low-cost digital platforms also show up in unexpected ways. For example, in pay-as-you-go solar power systems (a rapidly growing approach in Africa and southern Asia), participating households work toward ownership of solar panels on a daily payment layaway. Layaway is a triedand- true path to asset accumulation. But the interesting feature/incentive here (apart from the minuscule size of the individual transactions) is that, with a missed daily payment, the electricity shuts off. This ability to remotely inflict pain for nonpayment is what makes it viable for solar companies to service poor households in the first place. But more than that, the system gives the poor a way to manage their scarce capital. On any given day, they can make a small mobile payment for a day’s worth of electricity – or not.
There has also been a lot of experimentation in behavioral-finance-based add-ons that could further augment outcomes for the poor. The World Bank’s Consultative Group to Assist the Poor has tested ideas such as offering voice-delivered information to farmers about best practices, savings incentive mechanisms like lottery drawings from among those making debt payments, and different kinds of messaging interfaces and nudge reminders to encourage savings.
… And the War on Cash
While digital payment systems have helped bring multitudes into the formal financial ecosystem, in and of themselves they don’t deliver on the full potential of financial inclusion. Most importantly, transaction costs are generally still high enough to limit usage. Telco-based mobile wallets almost always charge a transaction fee. And more traditional digital payment systems, such as credit and debit cards, charge hefty fees to merchants. To avoid these charges, it’s still easier to use cash.
In fact, government efforts to promote digital payments have sometimes exacerbated the problem. Research into big social welfare programs that deliver benefits by debit card rather than cash, such as Bolsa Familia in Brazil and the Benazir program in Pakistan, found that in the vast majority of cases, a recipient typically just goes to a shopkeeper to exchange the e-payment for cash. This, in turn, strains small merchants, who must serve as cash-in/ cash-out agents, though their primary business is to sell goods and take money, not the reverse. So, to make sure they have enough cash on hand, they insist on cash payments from customers. You see the problem.
To win the war on cash, then, a digital ecosystem has to reach a tipping point where it is better for everyone to be part of the digital ecosystem. And this means that payment options have to be more ubiquitous, and payment transaction costs have to come down. Governments have an important role to play in creating this ecosystem, including through initiatives like advancing interoperability among the telcos to widen payment networks and standardizing software interfaces so that mobile wallets can easily talk to, say, utility companies.
The grande dame of government-led initiatives to reach such a digital ecosystem tipping point (well, after Estonia, the true pioneer) is probably the India Stack. This is the Indian government’s war on both paper and cash, built on its Aadhaar biometric identity system (whose deployment to its 1.2 billion citizens was, by the way, the fastest IT rollout in human history). The India Stack also includes a Unified Payments Interface that allows Indians to make virtually free payments to anyone from any device in real time, just by knowing their mobile number, Aadhaar ID or merchant QR code.
Short of centralized systems like the India Stack, initiatives like moving to a system of QR codes (or barcodes, a similar technology) will also help bring down the cost of payments for merchants, as they will not have to rent point-of-sale devices or even have internet access (barcodes can be printed on paper). Scannable codes alone may arguably make all the difference for thin-margin retailers, thereby bringing them into the digital ecosystem (although the customer must have a smartphone). In China, even beggars use QR codes.
Ant Financial utilizes its down-to-the-yuan understanding of customer liquidity positions to enable tiny, automated, instantaneous sweeps between mobile wallets and money market accounts.
And since the annual value of transactions by micro-merchants and small-to-mediumsize enterprises worldwide is estimated to exceed $6.5 trillion, any means of making payments easier and cheaper for merchants would in itself be a huge win for financial inclusion.
On top of this, though, free or very low transaction costs are also an important part of what makes the other two components of the financial inclusion value proposition possible – micro-financial services and data-as-an-asset.
The Power of Platforms
Marketplace platforms that offer free embedded payments create a kind of mini-digital ecosystem in which free transactions are a public good. In this system, insofar as a merchant can sell goods and then pay its suppliers and employees with funds that they, in turn, are willing to use on the platform with other merchants, payments are free. And, although cash payments (for a fee) can be accommodated in various ways, the whole system can work toward a tipping point where cash customers are induced to make the switch to digital.
The platform-for-financial-inclusion revolution started in China, and it all began when a young man named Jack Ma visited California in 1999. Upon returning to China, he said to himself (I’m paraphrasing), “You know, this internet thing could work really well here.” At the time, China was a poster child for financial exclusion, with an economy dominated by large banks on the one hand and large stateowned enterprises on the other. It was a mutually reinforcing loop of lazy finance among titans in which retail consumers and small businesses were rendered invisible.
Ma used the “internet thing” to build an online market-based ecosystem, Alibaba. He then scrupulously catered to the financial needs of his (mostly very small) customers, providing them with a complete range of financial services. In the process he built a financial behemoth, Ant Financial, that is now worth an estimated $150 billion. Over the course of these two decades, China has tipped from being an almost completely cash-based society to one that will soon have 700 million people making mobile merchant payments.
Most important, the reams of data generated from activities on the Alibaba marketplace has enabled Ant Financial to provide granular pricing of financial services of all kinds, particularly for merchants. For example, it provides micro-insurance against product returns with premiums priced (incredibly) on an item-by-item basis (men’s ties low; women’s shoes high). Ant Financial’s most famous offering, though, is its 310 loan program, which stands for three minutes for a merchant to fill out an application, one second to get approved, and zero human intervention in the process.
Platform vendors on Alibaba are given credit based on “1,000 criteria,” the most important of which are things like sales volume, customer satisfaction and past performance – the better the history, the better the credit. No collateral required. When a vendor goes below a certain threshold score on an index of these criteria, the credit line is immediately withdrawn. To date, Ant Financial has made over $100 billion in loans to vendors at an average size of only $11,000, the majority of which had never had previous access to finance.
Ant Financial shows the way in which big technology platforms have a distinct advantage over banks in terms of lending to small merchants. First, their offerings are preferred by small business (data obviate the need for physical collateral, and the money comes instantly). Second, it is easier for platforms to ensure merchant repayment (by attaching revenues at point of sale). Third, platforms can better retaliate against deadbeats (by posting, say, low reputational scores or by kicking them off the platform).
The underlying idea, though, is that a deep transactional knowledge of small business behavior should enable a more efficient and inclusive financing of them. In Latin America, for example, Mercado Libre was able to leverage its sales data to make a more accurate assessment of the creditworthiness of the merchants on its online platform. Today, it boasts that it offers a full 30 percent of its total credit to companies that local credit bureaus have ranked as “high risk,” yet with the same level of loan performance as its average borrowers.
Ant Financial utilizes its down-to-theyuan understanding of customer liquidity positions to enable tiny automated instantaneous sweeps between mobile wallets and money market accounts. Talk about reaching the bottom of the pyramid: it requires a minimum deposit of just $0.125 into its money market account.
Kakao in South Korea and PayTM in India (both messaging apps), Grab in Singapore and Go-Jek in Indonesia (ride hailing) and Sansai and Opera in Africa (aggregation platform and search engine, respectively) are all examples of platforms that are now leveraging “big data” to provide financial services in small packages with zero transaction costs. It’s a flywheel system. The better the data, the more expansive the financial services offering. The more compelling the value proposition to customers, the more usage data they provide.
With sufficient economies of scale and low enough marginal costs, the argument goes, even low-income customers can be properly banked. And for these customers, their own data become an asset to them that can, in a very real sense, increase their overall wealth.
Cryptocurrencies: The Next Revolution in Financial Inclusion?
Cryptocurrencies, I believe, can take the potential value proposition of free payments, micro-packaging and data-asan- asset to the next level. They offer an underappreciated, potentially powerful tool in the quest for global financial inclusion.
What makes cryptocurrencies unique is that, by definition, they are not liabilities of the banking system. As a result, they are not passed back and forth along the expensive payment rails that credit cards and banks use. For this reason, stablecoin cryptocurrencies in particular (that is, cryptocurrencies whose exchange value is pegged to conventional fiat money) can bring huge savings to the poor – most immediately through savings on international remittances.
Last year, $550 billion of remittances went to developing countries, at an average cost of 7 percent of the amount sent and taking at least two to three days to be processed. Most of these costs – banking fees, scheme fees, interchange fees and telecommunications fees – would be eliminated or markedly reduced using a token-based stablecoin exchange system operating outside the U.S.-dollardenominated correspondent banking system. Using such a system would have saved the world’s poor some $38 billion in 2019.
In this scenario, there would still be foreign exchange fees to convert from one currency to another – and there would be charges for any on- and off-ramps back to the banking sector. But imagine a global platform big enough that most all financial activity stayed inside it, with tokens just trading back and forth among users of the system.
Facebook is a good candidate for that kind of ecosystem, what with the 2.3 billion people on its platform, including the 400 million in India and 130 million in Africa for whom it is the sum total of their internet experience.
Imagine a payment token that could be passed around via Facebook’s WhatsApp messaging service and used to pay any person, merchant or utility – instantly and free of charge. That could arguably be the most important advance in the quest for financial inclusion yet.
In the beginning, it would need to have a stable exchange rate back to a fiat currency like the dollar, but the bigger the ecosystem, the less that would matter. If big enough, a platform like that could operate almost completely independently of the banking system, and in theory even beyond the enforcement realm of national financial regulators. It’s no surprise, then, that last year, when Facebook floated the idea of a new global stablecoin called Libra, it set off cries of alarm, despite its promises to turn the project over to a global consortium and to follow local laws. It is still unclear whether the project will proceed.
Wide-scale cryptocurrency usage could also do a much better job than fiat currency systems of enabling micropayments. Because they are nothing but digits, crypto payments can be infinitesimally small and thus enable a whole new class of monetization of small activities and, by extension, new kinds of business models for the poor. Very small fees (even less than a penny), hardly noticeable to the consumer, could add up to real income for the provider of small services.
Last, blockchain technologies that power cryptocurrency transactions offer unparalleled ways for customers to securely store and control their personal data and to decide with whom they share it, particularly with respect to their own identity. Digital identity is a foundational essential of digital financial inclusion.
While widespread adoption (and in what form) is still uncertain, at the very least, stablecoins provide a model for central banks to begin seriously contemplating the idea of national digital currencies that could be (but do not have to be) offered through the banking system.
Getting to the Next Billion
To date, fintech’s record on financial inclusion is mixed. While it has brought hundreds of millions of low-income people into the financial system in one form or another, the numbers who lack access to formal financial services remain stubbornly high. Fintech still represents a minuscule part of the overall financial services industry, and cash still overwhelmingly rules.
In addition, while an assessment of the risks of fintech usage for the poor is outside the scope of this article, they are clearly significant. In part that’s because fintech enables more immediate execution, putting the poor at potentially greater risk from nefarious actors who might exploit their possible lack of financial or technical sophistication. Likewise, platforms and their monopolistic control over customer data pose important challenges for policymakers on a range of complicated issues ranging from financial stability to personal privacy to cybersecurity (trust me, they are doozies). Finally, the next billion is also going to be harder to get to, as it will mostly consist of the poorest of the poor.
There’s one bright side here, though: of those 1.7 billion without access to a bank account today, 1.1 billion of them have a mobile phone. So the potential of fintech for financial inclusion continues to inspire.
To reach the next billion unbanked, policymakers would do well to improve regulatory and operational environments to create economy-wide digital ecosystems that mimic the best aspects of platform economies. They can ensure that data can be easily shared across bank and non-bank platforms at customer discretion, and they can provide or enable digital public goods such as self-sovereign biometric identity for citizens and strong public databases like collateral registries and compliance platforms.
This world would not be a world without cash, nor would it be a world without banks. But it would be a better-integrated, more competitive and more digital world than we have now. The cost of digital payments might approach ever closer to zero, perhaps even becoming a digital public good. There might even be a good answer to African entrepreneur Michael Kimani’s million-dollar puzzle: “Ask yourself why we cannot pay 5 bob online, yet we can send a 20MB video on WhatsApp.”
We are getting closer, which is surely good news for the world’s poor. And perhaps good news for public health as well, because with paper money – especially those new synthetic bills that are sturdier and harder to counterfeit – well, viruses can hang on to them for days.