Increasing Access to Financial Services Boosts Economic Growth
By Joseph Pileri, NLC Los Angeles | Progressives should embrace focused strategies to provide access to capital at all levels of society
A young woman in Mali sells mangoes at her local market every weekend. Her mangoes are the best — people from all the surrounding villages come to buy from her. Her fruit is in fact so popular that a distributor has offered to take her mangoes to other cities to sell if she can double her output. Land is available, but she has very little money saved to buy the land. The distributor has told her that he prefers to pay her via a mobile payment system, but she has always done business in cash only.
Meanwhile, a young man lives in a neighborhood in Los Angeles that has few banks. Few people he knows have ever opened a checking account; his neighbors all contribute a couple hundred dollars each month to a savings group. He has borrowed from the savings group for large purchases in the past, but now he wants to start a business selling handmade goods his grandmother taught him to make. With no credit history and no experience with banks, he has no idea how to get enough money to start his business.
Both these would-be entrepreneurs suffer from a lack of access to financial services. Around the world, the lack of access to financial services, such as checking accounts, mobile banking, business loans, and others, inhibits economic growth, entrenches poverty, and prevents people and communities from accessing global markets as consumers and producers. Access to financial institutions encourages investments and deepens markets. These institutions allow people to increase income, build enterprises, and reduce exposure to catastrophic events. Solving this problem will require creative policy solutions that modernize regulatory schemes and use technology to bring millions of people at home and abroad into the modern global economy.
Who are the “Unbanked?”
In 2013, the Federal Deposit Insurance Corporation (“FDIC”) surveyed U.S. households and found that 9.6 million households were “unbanked” and that another 24.8 millions households were “underbanked.” “Unbanked” households are those households that do not have an account at an insured institution; “underbanked” households are those with bank accounts but who also use alternative financial services outside the banking system, examples of which are described below. In the U.S., fees for check cashing, bill payment, and money order services, a limited ability to accumulate wealth and assets, and an inability to access formal lending markets.”
Estimates of the number of people in the developing world without access to financial services range from two to four billion — numbers that approach or even exceed half the world’s adult population. While these people are spread throughout the societies in which they live, being unbanked has a particularly profound effect on women and rural populations. This further exacerbates the gap in wealth between these and other groups and serves as one more barrier to these groups sharing in the prosperity of a global economy. That is not to say, however, that these people do not participate in the economy. Quite the contrary — these individuals often start small business or microenterprises like our young mango grower. Those microenterprises in turn suffer from high cost of credit in the absence of formal financial institutions and are prevented from expanding and reaching new markets.
As we have seen, alternative financial services are used the world over in the absence of formal financial institutions. One such alternative — informal savings group — is mentioned above. Informal savings group, sometimes called “susus,” involve groups of family members or friends depositing a certain amount of money into a central pot each week. The pot is then given to one member of the group. In regions like Subsaharan Africa, nearly half of unbanked individuals use these methods to save money and manage their financial needs. Other alternative services include specialized microfinance instructions, financial cooperatives, low-capital rural banks, state development and agricultural banks, postal savings banks, and others. These institutions serve an important role in the financial lives of hundreds of millions, but many ultimately fall short in providing stability and financial opportunity when compared to the formal financial sector.
Why does this Problem Persist?
The deleterious effects of being “unbanked” are undeniable. Why, then, does this situation persist? In 2010 the Organization for Economic Co-operation and Development looked at this situation and identified five major obstacles to increasing access to financial institutions in the developing world. One, places with lower socio-economic indicators have less developed financial cultures than elsewhere and more people who cannot afford the initial costs of entering the formal financial sector. Two, macroeconomic instability slows the provision of financial services and erodes public trust in financial institutions. Three, financial institutions often employ poor methods and practices in conducting their operations. Four, countries with low-quality public institutions see a greater lack of access to financial resources. Finally, poor or inadequate regulations discourage financial market development, hinder the adoption of safe financial products, promote inefficiencies and threaten the stability of the financial system.
In the United States, the FDIC similarly found that rules like minimum account requirements and account fees prohibit people from using traditional banking services, while large numbers of Americans lack trust in financial institutions.
As we have already mentioned, solving this problem will require a variety of creative policy solutions to bring millions of people at home and abroad into the modern global economy.
Modernizing Regulatory Schemes
The regulatory systems of both the U.S. and the developed world were created in response to traditional financial institutions and neither recognizes nor facilitates alternative systems. Regulatory reforms are needed to do just that. These reforms can take a variety of forms — advocates in the U.S., for example, have proposed allowing the Postal Service to provide basic banking services as an alternative to costly products such as payday loans and check-cashing services. Others push for linking formal and informal banking services like susus in the developing world as part of broader financial regulatory reform. As reforms progress, policy makers would be wise to keep in mind the financial systems that their constituents actually use and create regulations that reflect and legitimize that reality.
Technology, particularly mobile, can connect people and enterprises with financial institutions in traditionally underserved areas. Digitizing payments, supporting mobile banking initiatives and formalizing savings are three examples of technology-driven initiatives that can benefit the unbanked. One, converting cash wages to digital payments (and necessarily assisting people in setting up accounts to receive these payments) has the potential to move millions into the formal banking sector and improve the security, transparency, and efficiency of those payments. Two, once people are using digital bank accounts person-to-person payments can be made via mobile phone, which has the potential to be more secure and cheaper than cash payments or using wire transfer services. Finally, converting people to using formal savings accounts can safeguard investment returns as compared to other informal methods.
The Role of Financial Literacy
Financial literacy is invaluable to any initiative aimed at closing the global financial services gap. Lack of financial literacy is often a barrier to opening a banking account, and the initiatives referenced above will depend on having users who understand how financial services operate to succeed. Users will need to be educated on how to use digital and mobile payment systems, for example, as well as basics of how checking and savings accounts operate. Any initiative aimed at the unbanked, whether at a specific population or at broad swaths of countries, required well-designed, targeted intervention to enhance financial knowledge, business skills, attitudes, and behaviors. These educational interventions must go hand-in-hand with policy initiatives if policy changes are to be successful in bringing the unbanked into the global economy.
Joseph Pileri is an Attorney at Human Rights First