Daniel Makina, Department of Finance, Risk Management and Banking, UNISA
Research has shown beyond any reasonable doubt that well-functioning, healthy and competitive financial systems are an effective tool in spreading opportunity and fighting poverty. They achieve this by enabling people and firms to have access to a wide range of services such as savings, investment, credit, payment, and risk management services. Access to financial services for all is facilitated by an inclusive financial system that ensures accessibility, availability and usage of formal financial services by the entire population including disadvantaged communities. Thus, the term financial inclusion has come to be a buzzword for finance to all, and it is now one of the strategies for empowering communities that is being promoted by governments globally.
Notwithstanding the virtues of financial inclusion, the World Bank reports that about 2 billion of the world’s adult population is still unbanked, loosely meaning that they do not have an account in a formal financial institution. The problem of financial exclusion (the corollary of financial inclusion) is more acute in the developing world where more than half the adult population is unbanked, and Sub-Saharan Africa is the least banked. There are both price and non-price barriers to financial inclusion. Price barriers include, among others, lack of income to maintain account, financial literacy, complicated products, lack of competition, and lack of appropriate products. Non-price barriers may include, among others, distance from financial institutions, lack of documentation (e.g. proof of identification), psychological fear of the traditional financial institution, and poor communication about services and products.
Crucially, empirical research has shown that financial inclusion is critical in the achievement of an inclusive growth, which in turn is critical for reducing poverty and inequality. Indeed, without access to financial services, the poor and marginalised segments of the population cannot fully participate in economic activities as either consumers or entrepreneurs.
Global Efforts to achieve Financial Inclusion
Recognizing the importance of inclusive finance, the Group of 20 (G20) developed and emerging economies convened the Pittsburgh Summit in 2009 where they committed to improve access to financial services for the poor. The Pittsburgh Summit created a Financial Inclusion Experts Group (FIEG) whose mandate was to facilitate strategies to expand access to finance for households, micro, small- and medium-sized enterprises. The FIEG developed nine Principles for Innovative Financial Inclusion, viz. leadership, diversity, innovation, protection, empowerment, cooperation, knowledge, proportionality and framework, which principles reflected the experiences and lessons learned from policymakers worldwide. Subsequently, at their Toronto Summit in June 2010, the G20 endorsed the nine principles that formed the basis of the Financial Inclusion Action Plan. The Plan was endorsed at the G20’s Korean Summit in November 2010 where the Global Partnership for Financial Inclusion was created as an instrument to execute global commitments to financial inclusion.
Prior to the efforts of the G20, the United Nations (UN) had long recognised the role financial inclusion played in poverty reduction when it formulated Millennium Development Goals (MDGs) that were targeted to be achieved by 2015. The MDGs have since been superseded by 17 Sustainable Development Goals (SDGs) adopted in September 2015. Although none of the UN’s new 17 SDGs explicitly focuses on financial inclusion as a stand-alone goal, SDG 10 –promoting economic inclusion – implicitly embraces financial inclusion. Furthermore, SDG 8 on promoting shared economic growth has sub-goal 8.10 with a specific financial inclusion target. SDG Sub-goal 8.10 states: “Strengthen the capacity of domestic financial institutions to encourage and expand access to banking, insurance and financial services for all.” It goes on to provide two indicators –(1) number of commercial bank branches and automated teller machines (ATMs) per 100,000 adults, and (2) proportion of adults (15 years and older) with an account at a bank or other financial institution or with a mobile money service provider.
Meanwhile financial technology (FinTech) has revolutionised financial services. The PwC Global Fintech Report of 2017 provides salient features regarding its growing influence on financial services. The Report’s first observation is that FinTech is a major disruptor to the traditional financial institutions, which have acknowledged losing revenue to innovators. In other words, an increasing number of consumers are planning to increase usage of non-traditional financial services providers. Alternative finance being spawned by FinTech is a fast-growing innovative part of the financial system operating outside the traditional regulated financial system. It has made significant impact on consumer and small business lending and revolutionised the way banks and traditional lenders approach the marketplace.
The PwC Report further observes that in response to this threat, traditional financial institutions are embracing the disruptive nature of FinTech by significantly increasing their internal efforts to innovate. They hope to achieve this feat through partnering and integrating with FinTech companies. To underscore this approach, PwC’s global survey captures the general response of financial institutions as follows: “We learn from innovative FinTech firms, partner with them, and give them projects to deliver for us. It is a symbiotic relationship.”
One by-product of FinTech is its potential to promote financial inclusion. Its ability to reduce information asymmetries and transactions costs and foster wider outreach makes it a potent weapon for fostering financial inclusion. Indeed, this has been quickly recognized by both private players and policymakers. Two products of FinTech that have readily fostered financial inclusion are mobile money and crowdfunding. Mobile money facilitated by mobile technology has brought millions of unbanked into owning a formal financial account. The World Bank reports that in Africa there are more people having a mobile money account than those with purely an account with a financial institution. Crowdfunding, which has been spurred by Web 2.0 technologies, is seen extending financial access to entrepreneurial and innovative small businesses.
Realising the potential of FinTech to promote digital financial services, in 2016 the G20 published 8 Principles for Digital Financial Inclusion to guide country action plans in embracing digital technologies.
Principle 1 -Promote a Digital Approach to Financial Inclusion -calls for countries to recognize FinTech and incorporate it in their national strategies and action plans in a coordinated and monitored manner. In other words, it is recommended that countries should promote digital financial services as one means of developing inclusive financial services.
Principle 2 -Balance Innovation and Risk to Achieve Digital Financial Inclusion -recognises that there are risks involved in adopting FinTech. Hence, it is advised to strike a balance on its adoption. This can be achieved by identifying, assessing, monitoring and managing the inherent risks.
Principle 3 -Provide an Enabling and Proportionate Legal and Regulatory Framework for Digital Financial Inclusion – recognizes the dangers of over-regulation. Regulation can stifle innovation and hence a balance should be struck taking into account international best practices and standards.
Principle 4 -Expand the Digital Financial Services Infrastructure Ecosystem -recognizes the need to upgrade ICT infrastructure in under-served rural areas. Otherwise, digital financial services would not have the intended wider outreach to marginalised segments of the population.
Principle 5 -Establish Responsible Digital Financial Practices to Protect Consumers -recognizes issues regarding privacy and confidentiality of consumer information. Thus, in the course of providing digital financial services, it is advised to pay attention to consumer and data protection issues.
Principle 6 -Strengthen Digital and Financial Literacy and Awareness -emphasizes the importance of technological and financial education. Cognisant of the risks inherent in providing digital financial services, it is necessary to support that enhances both digital and financial literacy.
Principle 7 –Facilitate Customer Identification for Digital Financial Services –recognizes that one of the barriers to financial inclusion is lack of identity documentation. Hence, a risk-based approach to customer due diligence is recommended.
Principle 8 –Track Digital Financial Inclusion Progress –emphasizes that progress should be measurable. There must be a system in place capable of analysing and monitoring the supply of and demand for digital financial services.
Digital Financial Services in South Africa
In the last consecutive three years, KPMG has published an annual report called FinTech 100 on the best global FinTech innovators. These innovators comprise companies that are using technology to drive disruption in the financial services industry. The FinTech 100 report lists 50 leading global FinTech companies and 50 emerging FinTech stars with potentially new game-changing ideas. In the 2016 FinTech 100, one South African company, Wealth Migrate, features in the top 50 global FinTech companies coming 41st in rankings. Wealth Migrate is an innovator company that provides an online portal to enable investors to have easy exclusive access to global premier real estate investment opportunities. In the “Emerging Stars” global category there were two South African companies that featured –EasyEquities and Zoona. The EasyEquities platform enables people to invest on the JSE by accepting small amounts as low as R10 and charging very low fees per transaction. Zoona is a mobile money platform that provides technology, capital and business support to emerging entrepreneurs in Africa. Thus, South Africa is one of the 23 countries in the world featured in the 2016 FinTech 100.
Challenges in delivering Digital Financial Services
The emergence of FinTech and its transformative implications for the financial system require regulators to shift their attention from a rule-based approach to a risk-based approach. Currently, legislative landscape in South Africa can be classified as leaning towards more rule-based than risk-based meaning that regulators are still lagging behind in regulating digital financial services.
FinTech development also creates some challenges for central bank supervision. For instance, many loans that are offered by various mobile phone companies are not recorded on central banks’ credit register. Thus the more business activities move to mobile channels, the more the risk of fraud, hacking, data compromise and other cyber vulnerabilities. Meanwhile, central banks have not yet developed digital technical capacity to be able to supervise a digital financial services ecosystem.
In mature developed economies, FinTech companies are solving their compliance challenges through using an amalgamation of regulation and technology (RegTech), another emerging innovation meant to automate compliance tasks so as to meet compliance and reporting obligations. RegTech entails applying technology to solve a specific regulatory problem. While technology has always been used to address regulatory requirements, RegTech innovations are distinguished by their agility, speed, integration and its use of analytics tools. They reduce compliance costs and enable adherence to high standards of regulatory compliance, which they achieve through use of advanced data analytics, risk and control convergence, and sustainable and scalable solutions. In South Africa, the adoption of RegTech has not yet taken root.
The major driver of FinTech is its potential to increase revenues. The 2017 PwC Global FinTech Report emphasizes that financial institutions are embracing it because of expected annual ROI on FinTech related projects currently estimated to be at least 20%. In other words, they would want to exploit technology so as to expand new products and services and reach new customers with the objective of increasing returns and not necessarily financial inclusion. However, the ability of FinTech to reduce information asymmetries and transaction costs facilitates financial inclusion by breaking both price and non-price barriers.
Mobile money is a good example of how FinTech has potential to advance the financial inclusion agenda. It is transforming communities in Sub-Saharan Africa where an estimated 326 million adults are without access to financial services. The phenomenal success of mobile money in East Africa is attributed to regulators allowing a telecommunications company-led approach to mobile money development. In contrast, where regulators have insisted on a bank-led approach, whereby commercial banks are licensed to offer mobile money rather than telecommunications companies, mobile money development has lagged. Thus, going forward, allowing the private sector to drive innovation without a stifling regulation environment is the key to accelerating financial inclusion.