The problem of being unbanked
Every second adult in the world is underbanked meaning they lack assess to services such as loans. That’s 2.3 billion adults. Many of them, 1.7 billion, do not even have a bank account and are thereby unbanked. But why exactly is this a problem?
Formal accounts and savings help people smooth their consumption and safeguard against unexpected events such as unemployment, accidents, illnesses and deaths. Access to loans is one of the most important factors for surviving and escaping poverty. It is so because loans allows people to invest in their future. Whether you take the loan to buy some seed to sow in your field, buy vegetables and travel to town to resell them, buy a bread cooker and start selling bread or pay for your children’s education - you are essentially making an investment. You are investing in improving the living situation of your family. This is why access to small loans for unbanked individuals also known as microfinance is so important. And it is the reason financial inclusion is a prominent enabler for realising UN Sustainable Development Goal No. 1 No Poverty along with 7 others of the 17 development goals*.
Financial exclusion entails people lacking access to affordable financial services that meet their needs. 63% of people in developing countries have a bank account today and are thereby not technically unbanked **. However, having a bank account does not mean that you have access to other vital financial services such as loans, transactions or insurance. That is why we talk about people being underbanked or financially underserved. Most people in developing countries are financially underserved, which hugely impacts their quality of life and chances of surviving or escaping poverty.
Some adults are more likely to be financially excluded than others. If you are a young adult, a woman, or from a poor household in a developing country, you are more likely to be unbanked. Among those living below the UN poverty line of $2 per day, 77% do not have a formal bank account.
Barriers to financial inclusion
Financial services of traditional banks are not easily available for low income people in developing countries. Neither does tradition financial products match the needs of this segment. According to the World Council of Credit Unions** the most common reason for not having an account is the lack of money to use it. But issues such as poor infrastructure, a lack of formal identification, and a lack of financial education are all contributing factors to the problem.
Banks are subject to heavy regulation and high costs related to money-handling that incur high overheads. This means that their services become more costly. Classically, this has meant that banks in developing countries have focused on the higher income segment. Many lower income households do not even consider themselves as potential customers for banks.
Cost of opening a bank account and transaction fees makes traditional banking services too expensive to many people. Services are made even more expensive by travel costs as a large amount of the population, often 80% in a developing country, live in rural areas far from banks. It is therefore too costly and inconvenient for people to use the banks for their regular savings. This in turn limits their access to loans and insurance which require a credit history.
The key(s) to financial inclusion
Three aspects are particularly important to increase financial inclusion for the lowest income households in developing countries: Availability, regulation and relevance.
Financial service providers catering to this segment have all realised that the services needs to be tech-based and agent-based. It is not financially viable to service the majority of people in rural areas with traditional bank branches. Instead, financial service providers have combined mobile technology with an agent structure. This is known as mobile-banking with the first example, m-pesa, emerging in Kenya more than a decade ago.
States often require banks to have the process of Know Your Customer (KYC) that in turn require people to own formal identification. However, 1 billion people in the world, mostly living in developing countries, do not own formal ID. It is typically the poorest who lack formal identification making them unable to use financial services. Some countries are now changing these rules allowing banks to service people with very small savings and loans, without formal identification, and allowing for other forms of identification such as School ID. This is know as Tiered KYC or Risk based KYC. Similarly, it is necessary for states to allow for so called “agent-banking” in order for mobile-banking solutions to develop.
Financial products must be specifically designed to meet the needs of low income households. This require financial service providers to understand the needs of these people and to co-design financial products with these end-users. Mobile-banking has come a long way in servicing transactions for lower income customers. However, fee structures often make these services too costly for the very poorest. Mobile-banking is now moving into providing credit and loans, but this is still early days. Microfinance institutions, which became widely know when Muhammad Yunus and Grameen Bank where rewarded the Nobel Peace Prize i 2006, have been providing loans to low income customers since the 1970s but are often limited by collateral requirements that the poorest cannot met.
Collateral requirements and credit rating is a prerequisite in providing loans in both traditional banking and microfinance, that exclude the segment jamiipay wants to reach. Therefore, Reinventing how credit history work in a way that capture the creditworthiness of this segment is therefore key if services such as loans and insurance are to become available to the lowest income households.
** World Council of Credit Unions https://www.woccu.org/