by: mauricio_nm
Much has been done. But much remains to be done. Digital technology the great ally
Financial inclusion has been identified as an enabler for 7 out of the 17 Sustainable Development Goals.1
And there is good news. Financial inclusion is on the rise. Globally, in the last decade, 1 billion adults opened an account at a financial institution or through a mobile money provider and 69% of the adult population now has an account. Despite this progress, 1.7 billion adults are still unbanked and inequalities persist, with large gaps across countries, gender, age and social groups.2
Digital technology is being responsible for this growth in the opening of bank accounts and access to means of payment. Mobile money continues to grow in all regions. In low-income economies, there are already twice as many mobile money accounts as bank accounts.3
Access to credit. The great challenge
Financial inclusion involves much more than just having an account. Financial inclusion means that individuals and businesses have access to useful and affordable financial products and services that meet their needs — transactions, payments, savings, credit and insurance — delivered in a responsible and sustainable way.
SMEs are mostly excluded from formal lending despite having an account with a financial service provider. For example, in Latin America and the Caribbean, about 90% of businesses have an account, although only half have a bank loan or a line of credit from a bank.4
The inclusion of 1.7 billion individuals and 200 million unbanked (small, medium and micro) businesses will create a large pool of new borrowers. These individuals and small businesses are expected to drive a loan demand of about $2.1 trillion.5
The determinants of access to credit are multiple, reinforce each other in combination and vary from one country to another. They are related to demand (e.g. financial education, geographic location, access to the internet, etc.), to supply (depth of financial services, characteristics of the credit offered, etc.) and to context (institutional framework, macroeconomy, etc.).6
In addition, providing financial services is costly and certain structural features affect these costs. As innovation is introduced to reduce these costs, the relevance of some structural characteristics is bound to diminish.7
But, even if the barriers that limit access to a credit provider are overcome, there will remain a barrier that is part of the very nature of a loan: the problem of trust… “okay, but…. will you fulfill our contract? will you pay me back what I lent you?”
Solving the trust problem
Throughout history, various ways have been sought to solve — non-violently — the problem of “guarantee” for loans. The provision of collateral (mortgage, pledge, etc.), the existence of a guarantor, or based on information (reputation, credit score) are the most commonly used tools and the ones that have become more sophisticated and institutionalized.
In Latin America and the Caribbean, one of the main current obstacles for SMEs to obtain bank credit is the high agency costs associated with their administrative costs, risk analysis and lack of credit history. As a result, banks require high levels of collateral and guarantees, the highest in the world.8
Reciprocal Guarantee Companies encounter similar difficulties when scaling up and penetrating the micro and small enterprise segment. They end up serving a limited range of (medium-sized) companies, have relatively high operating costs for a retail approach, and their limited geographic coverage and proximity to companies prevents them from providing high quality credit risk assessment and monitoring.9
Reputational systems were and continue to be widely used. Currently, in most parts of the world, loans are granted by relatives, friends or stores that, due to their proximity, know the reputation of individuals.
But, scaling reputation systems has its problems.
Credit systems based on credit scores rewards people who already have credit and penalizes those that don’t yet have credit. Consumers and start-ups with no credit history may appear as invisible or without a credit score because they do not have enough trade lines to generate a score. But they also cannot obtain credit to improve their score. This creates a cycle of exclusion that is difficult to break. In the United States 28 million consumers are considered ”credit invisible,” while another 21 million are deemed “unscorable,” meaning they don’t have the types of accounts that have been traditionally used to generate a credit score.11
On the other hand, the collection of private data to create credit scores that is making people’s online lives possible is an attack on the privacy and sovereignty of personal data.12
Scaling trust has historically been the biggest challenge in scaling access to credit.
Open and Decentralized Finance. In code we trust
Web3 will revolutionize everything, but it started by revolutionizing the world of finance. Today, financial innovation is happening in WEB3 and it’s called DeFi.
Over the past 3 years, a whole world of decentralized financial applications has been emerging, ffrom stablecoins, to borrowing and lending, decentralized exchanges, and more.13
Currently, an estimated 100 million people worldwide are using cryptocurrency-based assets. Global adoption has grown by over 2300% since Q3 2019 and over 881% in the last year.14 15
At DeFi financial solutions are implemented through smart contracts. Smart Contract are computer programs stored on the blockchain that allow us to convert traditional contracts into digital parallels. One of the most significant benefits that smart contracts have over traditional contracts is that the outcome is automatically executed when the conditions of the contract are met without anyone being able to stop or change it. Smart contracts eliminate the need for trust.
Web3 also brings the technological possibility to develop the full potential of Self-Sovereign Identity. According to Doc Searls, “Identity isn’t about who you are. It’s about what others might want or need to know about you and how you let them know” The advent of the blockchain presents the opportunity to move from a centralized to a decentralized model for managing one’s identity. Only data required to complete a transaction can be shared instead of entire documents. With the blockchain as the underlying infrastructure, tpersonal data is never stored in a central server; hence, data breaches are reduced. Self-Sovereign Identity is a new concept where autonomy is in the hands of the user. 16 17
In addition, Smart Contracts are enabling the creation of a new generation of cooperative enterprises, the Decentralized Autonomous Organizations. In DAOs, ownership and management is collectively administered by their members. They have built-in funds over which no one has the authority to access without group approval. Decisions are governed by proposals and voting to ensure that everyone in the organization has a voice. There is no need for the owners to know and trust each other as everything is in plain sight and the rules about the uses of the funds are written in the DAO Smart Contracts with their immutable code.
WEB3 is developing the technological foundations for scaling trust, thus opening the opportunity to scale access to credit.
References
1 Financial Inclusion for Development: Better access to financial services for women, the poor, and migrant workers
2 The Drive for Financial Inclusion: Lessons of World Bank Group Experience
3 IMF data Financial access survey
4 G20 Financial Inclusion Indicators
5 World Economic Forum. The key to tackling financial exclusion
6 The Global Findex Database
7 Financial Inclusion: What Have We Learned So Far? What Do We Have to Learn?
8 The 2030 Agenda for Sustainable Development and the challenges of financing for development
9 SME and Entrepreneurship Financing: The Role of Credit Guarantee Schemes and Mutual Guarantee Societies in supporting finance for small and medium-sized enterprises
10 Inclusion financiera en america Latina y el Caribe
11 Driving growth with greater credit access
12 Data Protection and Privacy for Alternative Data
13 web3 report q3–2021
14 The 2021 Global Crypto Adoption Index
15 2022 Global State of Crypto
16 Blockchain for Decentralized Identity — Self-Sovereign Identity De-mystified
17 Self-Sovereign Identity: The Future of Identity: Self-Sovereignity, Digital Wallets, and Blockchain
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