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The Promise of Financial Inclusion

Mahmoud Mohieldin's picture

The following post first appeared on the Huffington Post.

Half the world's adults, approximately 2.5 billion individuals, do not have an account with a formal financial institution. Lack of access to finance is disproportionately skewed towards the poor, women, youth, and rural residents. Defined as the proportion of individuals and firms that use financial services, financial inclusion is increasingly seen as critical for ending extreme poverty and supporting inclusive and sustainable development. It provides people with the tools to invest in themselves by saving for retirement, investing in education, capitalizing on business opportunities, and confronting shocks (Global Financial Development Report, 2014). According to the World Bank Group's newly launched Global Financial Development Report 2014 on Financial Inclusion, most of the unbanked cite barriers such as cost, lack of documentation, distance, lack of trust, or religious reasons.

At the firm level, increasing access to finance encourages innovation, creates jobs and fosters growth. However, entrepreneurs and micro, small, and medium enterprises in developing countries point to poor access to finance as the biggest constraint to firm growth. According to the International Finance Corporation, the estimated financing gap globally for micro, small, and medium enterprises is more than 3.1-3.8 trillion dollars. Approximately 70 percent of micro, small, and medium enterprises in the developing world do not use external financing. Another 15 percent are underfinanced, despite some form of access to formal financial services. Micro, small, and medium enterprises have the potential to expand their activities, take on new workers, and generate income, and alleviating their credit constraints will be part of the solution.

Many of the financially excluded use the informal sector for financial services. Moving transactions from the informal to the formal sector increases a country's capacity to leverage domestic financial resources, strengthen its investment climate, and improve asset and tax management. The appeal of financial services in the formal sector have to be more competitive and agile relative to informal alternatives, by providing easy access, low transaction cost and adequate financial services that help address people's needs.

What is encouraging is that policy solutions can address most barriers to access. Reflecting its importance for households, firms, and governments, over 50 countries have recently set targets for improving financial inclusion. These efforts are supported by the Alliance for Financial Inclusion, the Consultative Group for Assisting the Poor, and the World Bank through its recently launched Financial Inclusion Support Framework. The implementation of the country targets is informed by the financial inclusion indicators developed by the Global Partnership for Financial Inclusion.

Governments have an important role to play in developing appropriate legal and regulatory frameworks that reduce barriers and ensure effective regulation of competition, as well as educate and protect the users of financial services. The Global Financial Development Report shows new evidence that governments have a particularly critical role in overseeing the standards and flow of information.

 Broadening access to finance must also be done prudently: overextending credit has repeatedly led to crises of over-indebtedness at the household, business and government levels when not accompanied by financial management skills and fiscal prudence to ensure productive investments and financial sustainability.

Fostering financial literacy matters. In Brazil, for example, a National Strategy for Financial Education partnered with the Ministry of Education to teach high school students financial concepts, with some activities meant to be completed at home, jointly with the parents. The results revealed sizeable improvements in financial knowledge, as well as significant changes in financial behavior. These policies are already being scaled-up to 5,000 high schools, with research exploring the potential impact of pilot programs in other countries as well.

There is a critical role for technology in expanding financial inclusion. Mobile banking, borrower identification using biometric data, electronic payments, and related technologies are revolutionizing access to finance. Technological innovations significantly lower the cost of accessing financial services, while minimizing the impact of geographical isolation. Mobile banking has been perhaps the most visible new technology to expand financial inclusion. A notable private sector example is "M-PESA", a mobile-phone based money transfer and microfinance service adopted by mobile companies in Kenya and Tanzania. But new and improved technologies also have the potential to facilitate access to government services. Government-to-person (G2P) payments bring in previously unbanked individuals into formal financial services by consistently channeling government payments directly into the beneficiary's financial account. Colombia and Pakistan have fully digitized disbursement of G2P payments, which reduces administrative costs and increases transparency, while expanding the number of people with access to a formal financial institution. Another example is found in Malawi and India, which are expanding biometric forms of identification in order to improve transparency and reduce information challenges in the credit market. Evidence in Malawi reveals that using biometrics tripled repayment rates for those at highest risk of default. The transformative nature of new technologies must be leveraged to maximize impact and ensure that services reach the most isolated people while minimizing costs and barriers of delivery.

Policy approaches derived from cultural and local contexts have the potential to create impact as well. Core to the principles of Islamic finance, for example, are the ideas of risk-sharing and redistribution of wealth. Islamic finance instruments that share risk and reward amongst participants and link financial transactions directly to the real economy are increasingly being used in recent years. Financial cooperatives, based on the notion of communities overcoming barriers in the marketplace by grouping together, are currently one of the largest providers of financial intermediation to the poor, serving approximately 78 million people globally who live on under $2 a day. Overcoming their governance challenges will enable them to live up to their full potential.

As we look ahead to the Post-2015 development agenda, the international community must devote its efforts to addressing the root causes of poverty, exclusion, and inequality. Although global development goals have historically been based on proportions and absolute figures, what will truly reflect success is our ability to harness the productive potential of every individual -- irrespective of gender, ethnicity, region of residence or familial background. One sure way to achieve this entails allowing people to define their own future, and providing them with the opportunity to do so.
 

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