That was a fun debate at Fletcher.

This or that? Formal or informal? Pro or con? Of course the answer always lies somewhere in the middle, it’s about and rather than or, to use the trite expression. It would certainly be ironic to seek to be inclusive by excluding options.

But in the case of financial inclusion, where a number of formal and informal services vie for relevance, what does this happy medium look like? I don’t see it as a bountiful fruit platter that people can pick from (now formal, now informal) as much as a richly layered cake.

The cake analogy is to represent the idea of platforms, of capabilities arranged horizontally and interworking with each other. Each layer brings a flavor, a texture, a color to the cake, but it is only when slices cut through the entire stack that the full cakeness comes through.

Let’s count the layers of financial inclusion. You need an identity layer, so that information can be traced back to individuals and histories can be constructed. You need an efficient money transfer layer, so that money can move efficiently and without delay between the various players when they are near or far. You need a cash distribution layer, with a multitude of localities where you can exchange various forms of money (cash to electronic, large bills into small change), on demand. You need enforcement mechanisms, so that IOUs can be trusted. You need a reliable accounting layer to keep track of all these contracts and IOUs. You need creative packaging of money transfers and IOUs into higher-level financial contracts (savings, credit, insurance, and combinations of all these) that connect more directly with people’s problems and needs. You need social connections and knowledge, so that people can variously give, lend, guarantee, and vouch for each other. You need people who can become evangelists, connectors, educators, marketers, to get others involved. You need, you need, you need…

I don’t mean to make it sound more complicated than it really is, or to bias the discussion towards formal just because I used some big words in there. Go through the list again: each of these functions can be done formally or informally, and in fact savings groups do all of the above in their own way. But we shouldn’t strive to create two layered cakes, the nutritious-but-wobbly and the glitzy-but-indigestible. The formal and informal layers need to mix in seamlessly.

M-PESA is a good example of that. It builds on a formal national ID layer, a semi-formal cash in/out layer, and an informal “send money home” customer use case layer. This interworking of the hugely formal (the biggest telco in the land, acting under the watchful eye of the all-powerful Central Bank) with the all-pervasive, timeless informal (the gifting and sharing economy) is what Susan Johnson called The Rift, and she appropriately revealed it to be the source of the magic that has lit up Kenya with electronic money. M-PESA is as much a triumph of the formal as it is of the informal.

At the Fletcher debate, I may have surprised some who know my personal journey by stating that M-PESA is not financial inclusion. It most certainly is not, but neither is any single layer in the cake. I said it not for the reason that most people tend to argue: that, since the M-PESA product offering is spartan, then it cannot be true financial inclusion. I most vehemently reject that the “true” financial inclusion layer, the litmus test of whether something is or isn’t financial inclusion, concerns the product layer. Consider this analogy: do we count access to clean water by the number of people who can find 500cc bottles of water at the local shop? No, with access we expect pipes and taps and stuff like that. That’s what creates convenience, reliability, affordability. It’s about the delivery mechanism as much as it is about the water itself. Again, the magic is happening lower down the layer stack.

So no, by itself M-PESA does not amount to financial inclusion, but in a sense it is also much more than financial inclusion. By making larger and remote payments more efficient, it has enabled a whole bunch of impacts that goes well beyond whether people decide to borrow or save. That’s the advantage of operating at the lower layers: it is less glamorous because the customer benefits are far less concrete and measurable, but it creates a much broader array of potential channels to impact. Vested as we are in the topic, we cannot make the mistake of judging M-PESA only through the lens of financial inclusion.

So why is that, despite all this M-PESA talk and forced to pick at the debate, I sided with the informals? Because I don’t think we as a development community should see our role mainly or exclusively as being to serve up billions of poor people captively to a small set of larger formal institutions who heretofore have shown little interest in helping the mass market. Let’s continue to build layers of the cake, as many and as diverse as possible, formal if they’ll play ball, informal if they don’t.

Image credit: Livelob.com

Ignacio Mas is an independent consultant. You can learn more about his work here.

Have you read?

Green High Heels vs. Pink Flip Flops: The Extreme Inclusion Debate

Extreme Inclusion Debate Part II: Financial Inclusion is Informal Financial Inclusion

In Defense of Formal Financial Services: Moving Beyond the Parking Lot and Onto the Highway

Today’s post continues the debate from the Extreme Inclusion conference at the Fletcher School at Tufts University. The proposition, as you will recall: “Financial inclusion means formal inclusion.” Yesterday, we heard from the Pro side of the argument (represented by green high heels), and today we hear from the Con side (pink flip flops). The Con team is represented here by Jenny C. Aker on behalf of herself and teammates Ignacio Mas and Daryl Collins.

What we have heard from the opposing team is that financial inclusion – real financial inclusion – means “formal” financial inclusion. We heard that in order to get out of the poverty trap, poor individuals want – and need – financial services that build financial security, manage risks against shocks, and invest in new business opportunities. In other words, things that the informal sector can’t fully provide.

But is formal always better? Formal services are often laden with fees (how many of you know the APR on your credit card?), unfamiliar, or simply unsafe. The 1999 banking crisis in Uganda depleted smallholder savings. It was a formal system. The collapse of the Russian banking system defrauded depositors. This, too, was a formal system. And as the financial sector has become wider and deeper in many countries, the effects of such volatility — boom one day, bust the next — are felt by more people, including the poor.

Even without these formal sector collapses, the poor must often choose between high-priced formal financial services or none at all. We often criticize the moneylenders for being usurers. But what about Banco Compartamos, which has interest rates well above 70 percent and still doesn’t offer savings services? Is that fair? Or the compulsory two savings account system of the Grameen Bank, each with separate rules? Is that useful?

Financial inclusion, broadly defined, is the ability of an individual, household, or group to access appropriate financial services or products. Informal services – from friends and family members, ROSCAs, tontines, susu collectors, and yes, even moneylenders – provide those services. Services that may not be regulated, but are useful, fair, dignified, and familiar. They have helped millions of people borrow, save, insure, and invest, all on their own terms. These systems have survived and thrived for centuries in the face of inflation, financial collapse, coups d’etat, earthquakes, and floods. Why would we not encourage people to manage their existing networks better, rather than encourage them to no longer use that network?

It is with these arguments that we ask you all to reject the proposition that financial inclusion means formal financial inclusion. Like our enthusiasm for microfinance as the “next big thing”— for which, by the way, we have little rigorous evidence of its impact on the world’s poor — a focus on formal financial inclusion will encourage the poor to use formal financial products that are not useful, fair, or familiar, potentially at the expense of their existing social networks. Do we have something to gain? Possibly, but the jury is still out. Do the poor have something to lose? Absolutely. We should not be willing to take that risk.

Jenny C. Aker is an Assistant Professor of Economics at The Fletcher School and the Department of Economics at Tufts University. She is also a Non-Resident Fellow at the Center for Global Development and a member of the Advisory Board for Frontline SMS.

After working for Catholic Relief Services as Deputy Regional Director in West and Central Africa between 1998 and 2003, Jenny returned to complete her PhD in agricultural economics at the University of California-Berkeley. Jenny works on economic development in Africa, with a primary focus on the impact of information and information technology on development outcomes, particularly in the areas of agriculture, agricultural marketing, and education; the relationship between shocks and agricultural food market performance; the determinants of agricultural technology adoption; and impact evaluations of NGO and World Bank projects.

Image credits: The Fletcher School

Have you read?

Scaling Up Formal Savings: Lessons from the SEEP Annual Conference

In Defense of Formal Financial Services: Moving Beyond the Parking Lot and Onto the Highway

Promoting Formal Financial Savings: Know Your Goal, Know Your Competition

Kim Wilson, of the Fletcher School of Law and Diplomacy, is a consummate educator who knows that drama leads to learning. That’s why she staged a competitive debate to kick off her Extreme Inclusion conference.

The Proposition: Financial inclusion means formal inclusion.

On the Pro side were myself and my esteemed colleagues Marguerite Robinson, emerita extraordinaire, Lauren Hendricks, of Care’s Access Africa conference, with coaching from Ahmed Dermish of Bankable Frontier Associates.

Taking the Con side were Ahmed’s colleague from BFA, Daryl Collins, together with Ignacio Mas, unaffiliated innovative thinker, and Jenny Aker of Fletcher, coached by Nick Sullivan, author of Money Real Quick: The Story of M-PESA.

Peter Walker of Tufts wielded the gavel with wit and a tiny hint of malice. He symbolized the Pro side with a green spike heeled shoe, and the Con side with a pink flip flop.

Unaccustomed as I am to public speaking, I took up the last position on the Pro side, with three minutes to make my points. Here’s what I said:

1. Development is about building societies that offer opportunity and connection to everyone. The important word is building. Let’s look where we are going. While many low income people today use and possibly even prefer informal financial services, one cannot consider this the path to the future. If we want to see the bottom 20 percent of the population become economically successful, there must be a path to success. We need only look to the accomplishments of microfinance in bringing microcredit to hundreds of millions in the past two decades to be confident about the prospects for major change in the future.

2. Formal financial services have the power to do what financial services are designed to do at a level that accomplishes more for the people who use them: they pool and diversify more risks; bridge longer distances and time spans. Now, with technology helping, they can do this faster, safer, cheaper, and more conveniently. And for millions of people. As more people have higher incomes, they will need the extended capabilities of formal services. Informal services might be good for meeting small emergencies, but formal services will be needed for building a business, buying a home, or preparing for old age.

3. Informal services have their place as precursors, for those who cannot be reached formally, and they will continue to be used throughout a person’s transition from informal to formal. But ultimately, informal services will become marginal or supplemental. How many of us here today would want to turn back the clock in our own lives and revert only to informal services? (The room grew deathly still and not a hand was raised.)

4. Many of us are tempted to portray the best of informal (so friendly and social) versus the worst of formal. The best qualities of informal services stand as a challenge to formal providers – a bar providers must clear if people are going to use their services. On the other hand, informal services can be harsh and harmful, and people may choose formal services to avoid some of these problems. But in truth, all financial services have light and dark sides. That’s why it’s the duty of everyone working in financial inclusion to bring the power of formal services to people in a safe, prudent, and respectful manner.

5. The hundreds of millions of people around the world, many of whom are seeing their incomes rise and seeking formal services, deserve the chance to benefit from what such services can offer. We are here at a school dedicated to training development professionals who want to work for a better world. If we don’t work for formal financial inclusion, we are relegating today’s financially excluded to stay off the path of development and remain marginal members of their societies forever. (Applause.)

I’m sure after reading these remarks, you will cast your vote with the green high heel team.

Unfortunately, the audience went with pink flip flops.

Stay tuned and we will bring you the words from the winning side.

Image credits: The Fletcher School

Have you read?

In Defense of Formal Financial Services: Moving Beyond the Parking Lot and Onto the Highway

A Holistic Approach to Money Management

Promoting Formal Financial Savings: Know Your Goal, Know Your Competition