FinTech for the underserved?

Nearly 2 billion people in the world are absent from the formal financial system. This unbanked population holds almost $9 billion in property. It is estimated that 42% of the adult global population is “unbanked” and not participating in the formal banking system, which is considered critical for lifting these populations out of poverty, reducing income disparity and driving economic growth. Hence, a growing movement towards financial inclusion.

In light of the recent findings of the IMF showing that elimination of blockages to financial inclusion has significant and unambiguous direct impacts on GDP growth, many governments are prioritizing financial inclusion. Over the last decade, a new wave of technological innovations in financial services has brought in a fundamental shift in how consumers use their money and interact with financial institutions. Since the 2007-08 financial crisis, we are witnessing a FinTech revolution that is forcing innovations to disrupt the traditional banking system, an industry that had hitherto been fairly resistant to technological changes. FinTech is possibly positioned to be one of the most effective means to create social impact by increasing access to financial services for all. It has almost become a synonym for the word ‘financial inclusion’. This review attempts to define what FinTech is and explores its impact on the underserved.

What is FinTech?
“FinTech” can be defined as the technological innovations that improve the design and delivery of financial products and services. It is a digital arena where traditional financial institutions, technology firms, entrepreneurs, e-commerce companies, infrastructure players are all competing to respond effectively to the needs of their customers. From mobile payment to cryptocurrency, FinTech companies offer a wide range of services, including: mobile banking, peer-to-peer lending, digital wallets, financial advisory, money management tools, crowdfunding. All these diverse services and products offered by FinTech entities have a common attribute — they are all technological interventions that enable financial markets and systems become more efficient. The space is mostly dominated by startups and financial corporations that offer targeted services to individuals. Global FinTech investment grew by 75% in 2015, from $9.6 billion to $22.4 billion. With currently around 2000 FinTech startups operating in the space, analysis by McKinsey suggests that the number of startups have more than doubled in the last two years.

FinTech offers many benefits, such as customized services, increased access to financial services, convenience and customer friendliness, quality and affordability. Whereas, credit scores were previously dependent on data from financial transactions in traditional banks, technology now allows us to perform superior analytics of BigData and alternate credit scoring models, based on nontraditional means, such as, willingness, behavior and ability. Startups such as Lenddo, Kabbage, DemystData are all leveraging on data to extend services to newer customer segments in banking. Robo advisors, such as FutureAdvisor, which was recently bought by BlackRock, offer asset management solutions. LendUp which is in the business of improving payday lending, uses machine learning and algorithms to pinpoint the top 15% that are most likely to repay their loans. There is growing evidence for the success of AI in creating algorithms capable of outperforming humans at detecting trends, making predictions and taking appropriate action. Not just loans and insurance, even banks are turning 100% digital. Atom Bank in UK is a “mobile only” bank that uses biometric data instead of passwords.

How have all these technological advancements impacted the underserved?
As some 2 billion low income people in the world are currently excluded from the formal financial system lacking access to banks, due to lack of credit scores and collateral, they are often viewed by banks as high risk candidates. Additionally, financial institutions are concentrated in urban areas and charge high service fees. Through FinTech, it is now easier and less expensive to identify the “invisible” bottom-of-the-pyramid individuals and bring them into the formal financial system. The 2016 G20 High Level Principles include financial inclusion through FinTech as their main focus by promoting digital interconnection among participants in economic activities.

The FinTech sector has seen tangible successes in the developing markets. M-Pesa, a mobile-based money transfer system by telecommunications company Safaricom in Kenya grew at a blistering speed since its inception in 2007, gaining 2 million users in its first year and reaching 80% of household in Kenya in just 4 years. With its affordable rates to transfer money, M-Pesa improves individual outcomes by promoting banking and increasing transactions. The value of mobile money transactions in Kenya is about 55% of its GDP. bKash, a Bangladesh-based mobile financial service provider and a subsidiary of BRAC bank, reached 11 million customers in just 30 months of its launch in 2011. Zoona, a startup, in Zambia is bridging the urban-rural divide in financial services. Similarly, Kifiya is creating innovative electronic banking and mobile money services in Ethiopia.

Digital payments have reduced risks associated with cash-based transactions, improved security, turn-around time, transparency and lowered the transaction costs for both customers and organizations. In the developing world, digital payments often are the first entry point into the formal financial system. In Sub-Saharan Africa, mobile money accounts are held by 12% of adults, as opposed to the global average of 2%. FINCA (a network of microfinance institutions) is partnering with First Access, a data analytics company that configures credit scores from local mobile phone usage to provide uncollateralized loans in East Africa.

Cutting-edge FinTech companies have the ability to track data based on behavioral clues found in call detail records, airtime credit records, phone usage data (including battery use), social media data, web browsing data, GPS coordinates and personal contact lists without having to conduct extensive, in-person interviews. Not just financial inclusion, FinTech has also reached conflict zones to provide emergency services to refugees in Syria. Bitnation, utilizes Blockchain technology to authenticate and validate emergency services. The BE-ID cards, provided to the refugees, allows anyone in the world to load the card electronically through Bitcoin technology.

Many big organizations such as, Facebook, Bill & Melinda Gates Foundation and Omidyar Network are investing in FinTech. Bill & Melinda Gates Foundation’s Level One Project has developed a country-level digital financial services model to bring lower income individuals into the formal system. Accion Venture Lab is a leading investor of FinTech startups that increase the quality of financial services to the underserved. Quona, a fund manager that is managing the $140 million Accion Frontier Inclusion Fund, is the largest FinTech company that serves the underbanked. Quona’s management team is set out to prove that the right combination of values and pragmatic investments can not only benefit the people at the bottom of the pyramid, but also generate substantial financial returns.

Some observations

Regulations have to ensure that FinTech can indeed deliver the promise it has set out to achieve. Many regulators, skeptical of the progress of FinTech, tend to often design regulatory policies to curb the autonomy of the users. Such paternalistic regulations and lack of guidelines to support responsible innovation in banking are a significant barrier to FinTech. Regulators such as CFPB, CFTC are holding office hours and innovation labs to test out FinTech services. Countries like the Philippines, Peru and Kenya, with their more liberal policies towards FinTech, offer a good testing ground to validate the true impact of FinTech in developing countries.

Obtaining data about customers has become easy now more than ever before. Regulators need to guide financial institutions on how they can engage with FinTech start-ups to leverage this sea of data safely and ethically. Consistency in rules and standards across FinTech organizations is necessary to navigate regulatory requirements. Regulators must collaborate with FinTech innovators to develop deeper understanding of the technology. Singapore is setting up a “regulatory sandbox” to experiment innovative finance services and products, but within a well-defined space and duration.

FinTech, has still not taken the ownership to build the capacity of the small borrowers and the overall objectives of financial inclusion. The industry seems to be missing opportunities to improve financial literacy by focusing too much on payment and lending. While it is now easier for an entrepreneur in Malawi to access digital loans, she may not be fully aware of the interest rate (or “facilitation fee”) she now has to pay. That interest rate is likely unregulated (or under-regulated). While risks may be better understood for improved loan decision-making, but some of the risks may not be fully realized as yet. The Digital Credit Observatory (DCO), managed by Center for Effective Global Action(CEGA) and funded the Gates Foundation is analyzing both positive and negative impact of digital credit.

FinTech has shown enormous possibilities, but it is important to leverage this disruptive technology to drive the right levers. Deliberate efforts to increase financial literacy through digital services to help small businesses grow, to help the underbanked to save more and to plan for education and retirement is the need of the hour. While the FinTech narrative is thus far a positive one, its rapid growth does prompt some concerns and challenges. Risk, security, data-privacy, unequal access to internet, digital divide, limited supervisory capacity to understand and monitor are some of the unanswered questions of FinTech. The economic consequences in the event of a system-wide breakdown will be a tough one to recover from. By: Shreemathi Tumkur, Research Associate @AboutMicrofinance



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