Why digital banking services are vital to reduce poverty in the developing world

By Kaiser Naseem, head of IFC’s digital finance advisory services in EMENA

We may live in the 21st century and the age of technology but access to basic banking and financial services is still remarkably low around the world. Latest figures show that about 2 billion adults remain outside the formal financial system globally, many of them in the developing world. The World Bank data showed that only 14 percent of adults in the Middle East, for example, have a banking account.

Poor access to these services hinders growth because it limits opportunities to start and grow a business, create jobs, and gain access to skills and knowledge.

One way to overcome the problem is by expanding branchless and digital banking and financial services. Given their ability to transform the way low-income people can access these services and manage their money, and gradually move them to full financial inclusion, such services have started to generate substantial interest.

Photo by IFC Photo Gallery

Over the past five years, digital or mobile money has enabled the previously unbanked in many emerging markets to access banking and financial services like remittances, savings, and loans that were previously impossible. In Sub-Saharan Africa, for example, the number of African adults with an account at a formal financial institution has increased from less than a quarter to more than a third of the population since 2011, thanks to digital services. The use of mobile accounts, meanwhile, stands at 11.5 percent, by far the highest in the world and far above the world average of 2 percent.

M-Pesa, a mobile money transfer service launched in Kenya back in 2007, is a good example — it has revolutionized the country’s financial services landscape and made Kenya one of the continent’s leading emerging financial technology (fintech) hubs.

Clearly Digital Financial Services (DFS) have huge potential to extend banking and financial services to the poor, un-banked and under-banked. Despite these developments, however, the vast majority of countries are still undeveloped when it comes to adopting and leveraging technology for financial inclusion. Regulators remain generally conservative, with little or no regulation developed. Many central banks also adopt a cautionary approach, restricting all types of financial activities to prudentially regulated entities.

Even if they are in favor of allowing digital operations, many of these countries are at a loss to know where to begin. This not only restricts the development of digital product offerings but also the use of digital product/services and alternative distribution channels (ADC).

Given the reluctance of banks — or should we say lack of vision — to embrace technology, the past several years have also seen the rise of financial technology companies, or fintechs, as they are now known. The advent of such platforms has challenged banks into action and many now want to rethink their strategies.

For traditionally conservative banks carrying the burden of legacy systems, however, this is not an easy task. Leveraging technology becomes even more difficult given that the legal and regulatory framework surrounding it is still evolving.

Fortunately, banks are now looking at the possibility of working together with fintechs to use their technology base to enhance their product offerings, including customer experience. Meanwhile, fintechs are also realizing that they’re unable to attain scale without a banking license and outreach to a huge client base, both of which banks can offer. Hence, a natural alignment has started to take place.

Regulators have now also started designing and implementing regulations to encourage the use of technology and digital finance services, especially with financial inclusion becoming critical for many governments around the world. They realize that DFS allows the delivery of financial services at a reduced cost to people who remain unreachable through the traditional banking system.

For banks struggling to survive under the current economic conditions, where capital is tied up owing to tighter regulatory controls and non-performing loans (NPLs) are on the rise, the use of technology provides an opportunity to increase revenue streams. This can be done both by reaching out to a wider number of clients using digital banking and ADCs, and by improving the quality of their portfolios and thus reducing NPLs.

Like the regulators, however, banks are also struggling with how to embrace technology and which part of the DFS value chain they should work in to create the most value for themselves. They need assistance in formulating a digital strategy, designing relevant products and digitizing their risk assessment methodologies.

Several institutions are supporting banks in the adoption and use of DFS to enhance financial inclusion. As the largest development finance institution in the world targeting the private sector, International Finance Corporation (IFC), a member of the World Bank Group, works with banks and other financial institutions to assist them in their journey towards digitalization.

Based on the successful experiences in Africa, IFC is now working in other regions of the world to promote digitalization. It works both with regulators on creating an enabling environment to introduce DFS, and with individual banks to help them formulate a digital strategy, develop ADC and products and roll these out, and partner with relevant fintechs. IFC also assists the broader sector by commissioning research on strategy formulation and product design; educating the market and end-users; and sharing knowledge based on its global experience.

Increasing access to finance for the unbanked and underbanked and promoting financial inclusion is vital to reduce poverty and enhance shared prosperity around the globe. Leveraging technology to enhance outreach, better assess risk, and facilitate digital payments can now enable this to happen.

Offering digital financial services could provide nearly 2 billion more individuals with better access to banking and financial services, thus bringing us closer to ensuring better living standards for all.