Martin Herrndorf

Building Markets for Financial Inclusion … Beyond Micro-credit!

Understanding the financial inclusion challenge

While micro-credit has been one of the most visible and prominent success stories over the last decade, other financial services have received less attention (but still, some here and there). This is likely to change – due to various reasons.

The first is demand for the full-range of financial products. People consistently demand products beyond credit – which may not even rank highest in their priorities. The book, Portfolios of the Poor has shed light on the multitudes of services already used by the poor – both formal and informal. The poor have long used savings and credit clubs – called ROSCAs, SACCOs, Stokvels or Arisans depending on governance rules and location – before micro-credit entered the scene. And even with credit, over 60% of borrowing is done through money-lenders, according to the numbers in the McKinsey Global Financial Inclusion report. Globally, 60 % of adults globally remain without access to formal or semi-formal financial services. For Sub-Saharan Africa, 80% or 326 million adults are without access, in East and South-East Asia, 59 % or 876 million are excluded. This exclusion comes with a price: people rely on insecure places to store wealth, or do so in depreciating assets like livestock. They have high costs in making payments, for example for utilities, or for receiving money from abroad. And they have difficulties to protect themselves against ever-prevalent risks: death of a household member, illness, or drought and floods affecting their crops.

These costs of the poor have spurred significant donor and regulatory attention. The G20 has put financial inclusion on its agenda – with a broad view, beyond micro-credit. While the G20’s main activities currently still focus on credit (especially on SME financing), this is likely to change in the future. Donors like the often trend-setting Gates Foundation have already put significant resources into promoting micro-savings and micro-insurance. And national regulators recognising that financial inclusion is indeed a challenge – and may push companies to provide coverage (as exemplified by India or South Africa), or relax conditions that allow them to do so (for example in Colombia or Brazil).

Last, new technologies and business models allow financial service providers to access clients previously out of reach. Mobile phones are a prominent example. Due to the fast growth of mobile phone providers, the report summarizes succinctly that “for every 10,000 people, these countries (emerging economies) have one bank branch and one ATM – but 5,100 mobile phones.” First break-through success stories (like M-PESA, see below) have led to a change in mindsets in companies and entrepreneurs (both active and potential) that could lead to a larger stream of innovation in the future.

A closer look: Correspondent and mobile banking

The McKinsey report singles out Correspondent Banking and Mobile Banking as two promising candidates for increasing financial inclusion and delivering the full suite of financial services.

Correspondent Banking delivers financial services through networks not previously involved in banking. While traditional banking relies on branches (and increasingly the Internet), correspondent banking can be carried out by all different kind of agents: Retailers, post offices, mom-and-pop stores. Regulatory restrictions have long held the model back – but examples like Brazil or Mexico, both repeatedly cited in the report, show the potential once these restrictions are lifted. In Brazil, 1,600 municipalities, or one quarter of all, rely solely on Correspondent Banking – their constituents would go un-served without the model. In Mexico, government support and the need to establish channels for the payment of public transfers to poor families helped to significantly advance the model. Various sources come to the conclusion that correspondent banking indeed allows cost savings, and thus reaching poorer consumers, of around 20 to 25% (the later number is reported for urban Mexico in the McKinsey study).

The second model featured in the report is Mobile Banking, which clearly is concerned with making payments over mobile phones, and offering additional services like savings, credit and insurance through this channel. Several models made it to a market-stage: M-PESA started as a ’stand-alone’ project by Safaricom, the Kenyan subsidiary of Vodafone. A hands-off financial regulator allowed Safaricom to establish a payment model with cash-in and cash-out at kiosks around the country. While the model has been an astounding success, there have been difficulties replicating it in other markets. Taking South Africa as an example: Much stricter regulations required Vodafone to team up local incumbent Nedbank for setting up the product. Most the mobile phone providers already have some kind of mobile-money offering, only hesitantly accepted, and the wizzit bank has long pioneered and refined its model for banking the unbanked in townships and rural areas. The only “real” other success story in mobile banking comes from the Philippines, with the two providers SmartMoney and G-Cash marching towards a combined ten million customers. This still leaves a total of 21 million phone subscribers unbanked, a market potential of up to 160 million USD in direct and indirect revenue, according to McKinsey.

In reality, both of these business models are inter-related, with mobile phone-based business models normally relying on some kind of correspondent structure. The McKinsey study has some interesting data on this: With rising distance from the next “cash agent,” the number of transaction drops: From 30 transactions per month when the next cash agent is within 2 minutes to once to twice per month if the cash agent is more then 15 minutes away. This is a crucial insight when designing mobile payment systems and the “brick” infrastructure behind them.

How to make it happen?

The McKinsey study closes with a discussion on the role of “middle managers” in driving financial inclusion. With financial-inclusion, the study argues, more middle managers are needed that combine ’normal’ technical skills with an understanding of new business models and a mission-base.

One source for this can be “re-orienting” finance professionals from traditional banks and service providers. While they often have strong skills, Jaime González Aguadé, director general of Bansefi, complains that they “often lack the sense of mission that is so important” – his organization spends significant resources on integrating these experts into the existing culture.

Bindu Ananth, president of IFMR Trust, thus stresses the value of looking for talent inside existing organizations dedicated to financial inclusion: “People who are brought up through an organization will have already internalized the culture and demonstrated their commitment to the mission.” This not only makes them more effective in aligning with an organization’s mission, it might also increase retention. Trained staff with a mission are less likely to be enticed by (probably still) higher wages in mainstream industries, even though the “mission discount” to working in financial inclusion may be lower then in the past.

Quo vadis, financial inclusion?

Financial inclusion is at a crucial step from “models” that work in reaching certain parts of the population previously excluded, to “markets” where a number of organizations compete for similar customer segments, and different models can be tested and refined in parallel. With this step come human resources challenges and regulatory attention: Are agents properly trained? Are outlets secure? Are customers properly protected? Do organizations collide to keep interest rates high? The specific development path of non-traditional forms of banking is still uncertain – which led CGAP to apply a scenario approach when thinking about the sector’s development in the next ten years.

One area where the McKinsey report seems to miss the mark is where financial inclusion starts. Even M-PESA, the now a widely praised success, started as a project by two dedicated individuals, and with public sector co-funding. Apparently, top-level decision makers were not convinced from the outset. Most financial inclusion models so far have not yet been successful on a large scale, as the report readily admits. It will take strong individual efforts and risk-taking to develop product offerings and distribution channels that make enough sense for people to dig that pile of crinkled bills out under their mattresses – and deposit it in their brand new, low-fee, mobile-enabled, street-side-served, multi-functional bank account of the future.

Find the full report on the website of the McKinsey Social Sector Office here.

financial inclusion