Account Use (Developing Economies) – Click to Enlarge

Especially since the Global Findex report made headlines around the world with its finding that the number of financially excluded dropped from 2.5 billion to 2 billion during the period 2011-2014, I have been increasingly uneasy with equating account access as financial inclusion, and especially as equivalent to the essential concept of full financial inclusion as defined by CFI. The Center’s new publication “By the Numbers” does an excellent job helping people to digest all the publicly available data about financial inclusion, and make sense of them. It also reinforces my unease.

Despite the progress in account openings, the report makes it clear that the number of people actually using accounts is unfortunately not growing. Even more worrying, it argues that most accounts “are not really functioning as the hoped-for ‘on-ramp’ to financial inclusion.” The risk, as I see it, is that by adopting a stunted definition of financial inclusion that emphasizes account openings, we may be measuring and incentivizing the wrong things. The report wisely urges “caution regarding the value of mass drives for account opening, such as mandated no frills accounts…”

While the available data may overstate progress in some areas, the data may understate it in others due to the tendency to focus only on transactions at formal financial institutions. As the report notes, the percentage of people in low and middle income countries who save increased from 31 percent to 54 percent — quite a jump! — over three years, but this “is not reflected in a commensurate increase in saving in financial institutions.” Global surveys tend to miss savings groups and microfinance institutions, which in many markets play important roles. The alarming gaps in data related to access among vulnerable populations are also noted.

Saving Activity (Developing Economies) – Click to Enlarge

Which brings us to the continuing relevance, and in my view the unique role, of microfinance in achieving full financial inclusion. Based on its assessment of the numbers and trends, especially those related to discouraging levels of inclusion and product take-up amongst the poorest and most vulnerable groups, the report posits that “microfinance providers will continue to be significant players in the delivery of financial services, especially basic credit and savings, at the base of the pyramid.”

My view, shared by many members of the Microfinance CEO Working Group (MCWG) that I Co-Chair, is that MFIs can play an important role in facilitating the elusive on-ramp between limited use of accounts including digital financial services and achieving the most robust vision of being fully included. This is one reason why Grameen Foundation is working hard to set up leading MFIs in the Philippines, India, and Kenya to play this essential bridging role. The MCWG is likely to have something formal to say about this later in 2015.

The report is chock full of interesting tidbits about the changing financial inclusion landscape:

• While the gender gap in financial inclusion stubbornly persists, the urban/rural gap is slowly closing.
• Countries with national financial inclusion strategies achieved double the growth in account access compared to countries without such a strategy in place.
• Indian government incentives to provide microinsurance to lower income segments over the last decade have resulted in that country having 40 percent of the global total of microinsurance policies.
• Four countries – Indonesia, Tanzania, Sri Lanka, and Pakistan – “became fully interoperable for mobile money” by the end of 2014.
• Nokia recently released a $29 smartphone, which could presage the acceleration of the use of apps that make it easier for illiterate (or even non-English speaking) people to use digital financial services more.
• Global actors in financial inclusion have tended to focus on large countries and countries where relatively easy progress was thought to be possible. Left unsaid is how many countries have been largely ignored and what their fates may be.
• Most adopters of mobile money were already “banked.”

This excellent report should underscore the importance of shifting our attention from account access to the quality and value of financial services available to the base of the pyramid. In other words, our “north star” should be full financial inclusion. Furthermore, it shows that we ignore the real and potential contributions of actors other than formal financial institutions and mobile money operators – such as microfinance institutions, savings groups and other informal approaches – at our collective peril. To again quote the report, “full financial inclusion should consider informal services an important, ongoing part of the mix.”

At the outset of the report, the authors state that they have always considered the notion of Financial Inclusion 2020 as a “thought experiment.” To me, this notion calls to mind Professor Muhammad Yunus’ idea of creating a social fiction literature akin to science fiction, since so many things we imagined as science fiction a generation or two ago are realities today. What we imagine can become reality, and often does. How important then, that we train our imaginations on the robust notion of full financial inclusion rather than on something much more limited, and potentially limiting, than this bold and compelling vision.

Figures credits: “By the Numbers” – CFI

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By the Numbers: Benchmarking Progress Toward Financial Inclusion

Financial Inclusion by 2020? It Depends

Global Findex Offers Next Steps for How to Give People Bank Accounts

The Microfinance CEO Working Group, as part of its commitment to client protection in microfinance and financial inclusion, set out in early 2014 to develop a model law that could be adapted, in whole or in part, into different national contexts. The Working Group’s partners were the global law firm DLA Piper and its “Council of Microfinance Counsels” which is composed of the in-house counsels of all Working Group members. After 15 months of effort, the first version of this law has now been completed and released. The blog below describes this tool and how it can be used.

Those who set policy for consumer protection in financial inclusion have a powerful new tool at their disposal, one that financial inclusion practitioners, legal experts, and regulators have had a hand in creating.

Over recent months, the law firm DLA Piper/New Perimeter has been working with the Microfinance CEO Working Group and a subgroup of the Council of Microfinance Counsels to prepare the Model Law and Commentary for Financial Consumer Protection. This is a framework of suggested legislation on financial consumer protection based on the Client Protection Principles as promoted by the Smart Campaign. The seven Client Protection Principles set standards that clients should expect to receive when doing business with a microfinance institution, and cover such critical areas as transparency, fair and respectful treatment, privacy, and prevention of over-indebtedness. The team that developed this studied multiple countries that had the most progressive and effective laws related to client protection in financial services, and in other areas.

The Model Law can be used in a variety of ways.

First, it offers a template for policy-makers that can help them in developing actual, enacted legislation. In its entirety, it can help regulators build a complete legal regime for client protection. But it serves equally well as a guide for those policy-makers who may only need provisions for addressing particular legal or regulatory gaps.

Second, the Model Law may be used to assess a jurisdiction’s current client protection regulations. By holding up the Model Law against a current national or regional legislation and regulation, policy-makers and commentators can easily assess how those laws and regulations compare with a model client-centric framework that is relevant around the world.

Third, it can serve as a resource for the development of codes of conduct and guidelines, either for a single financial service provider or for groups or country associations. While the document is framed as legislation, its systems and approaches offer guidance on effective ways to promote client protection through the internal operation of service providers.

Like the Client Protection Principles themselves, the Model Law reflects years of consideration and study by a broad cross-section of stakeholders from the entire spectrum of microfinance and financial inclusion. More critically, it offers real, actionable guidelines and tools for helping to ensure that client protection principles can, in fact, be embedded into the fabric of the microfinance industry. We urge you to have a look and also send us feedback so we can further improve the Model Law through revisions and publication of enhanced versions. Send feedback to ModelLaw@MicrofinanceCEOWorkingGroup.org.

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Can Self-Regulation Protect Microfinance Clients?

> Posted by Susy Cheston, Senior Advisor, CFI

There was good news from the Alliance for Financial Inclusion (AFI) yesterday: the announcement of a partnership with MasterCard Worldwide to build technical capacity so that AFI members are better equipped to regulate innovations in products and business models.

Since its birth seven years ago, we have admired AFI for so effectively galvanizing a powerful regulator community to set a high bar on financial inclusion. Part of AFI’s strategy has been a fierce commitment to ownership of the issue by the regulators themselves. The results have been measured not only in dramatically increased access among AFI member countries, but also in higher standards around the quality of those services, as evidenced by Maya Commitments around client protection and financial capability. AFI Working Groups have also been developed for peer learning on digital financial services, financial inclusion data, and other key issues.

Yet we are among many in the industry who have felt that AFI’s circling of the wagons meant that their policy solutions were not always smart about encouraging innovation and investment in financial inclusion. To its credit, AFI got the message, and in 2014, it launched a Public-Private Dialogue Platform (PPD) to incentivize policymakers and regulators to cooperate with the private sector. Yesterday’s announcement about the new relationship with MasterCard is a strong next step toward realizing the PPD’s promise.

This trajectory resonates with recent interviews on client protection that we have carried out at FI2020. Among the regulators we interviewed, what was striking was the path many have followed toward empowering the private sector to play an active role in customer protection. We heard about a number of good practices that build capacity and break down communication silos between the public and private sectors.

As one example, the Financial Consumer Agency of Canada (FCAC) takes pride in fostering strong business relationships with its regulated entities. According to FCAC Commissioner Lucie Tedesco, “collaboration and the ability to have an open dialogue are fundamental to achieving richer outcomes.” In a keynote address to the PBOC International Seminar on Financial Consumer Protection held in Shanghai last October, Tedesco describes the Agency’s early years as ones in which their consumer protection policies were sometimes thwarted by misunderstandings and disagreements with providers. After starting a new strategy of assigning dedicated relationship managers—individual officers who worked closely with specific regulated entities–the Agency found a dramatic increase in compliance, with greater collaborative problem-solving. FCAC also actively reaches out before enacting policies to ensure their compliance materials are practical, effective, and engender corporate acceptance and support.

Similarly, we talked with regulators in Kenya and the Philippines that have adopted a “watch, dialogue and learn” approach regarding the e-money industry and non-banks providing these services. Regulators in those countries have been eager to learn more about technology and have engaged with the private sector in order to understand the practical issues of implementation. A training on financial inclusion technologies carried out by Bankable Frontier Associates for Bangko Sentral ng Pilipinas (BSP) in the Philippines was especially helpful.

What we observe with financial inclusion is that generally regulators lead, providers follow, and consumer voices are rarely to be found. In Canada, not only has FCAC engaged with the industry, but the Government has recently reached out directly to consumers for input through cross-country public consultations on the development of a new financial consumer code. Some regulators look directly at the demand side of the equation. Rudy Araujo, Secretary General of the Association of Bank Supervisors of the Americas (ASBA), told us that his members are asking how they can better understand customers at the base of the pyramid. Regulators in some countries have worked to understand different market segments and have even undertaken behavioral research on a wide range of issues, including why specific demographics complain; the impact of different delivery channels; the emerging risks of digital financial services; and borrowing habits.

Now that AFI is taking a leadership role in engaging with the private sector, will engaging directly with consumers be next? That’s the highest bar of all—but we have seen AFI rise to challenges on more than one occasion!

Have you read?

Three Ways Financial Inclusion Makes Life Harder for Regulators

Calling All Countries to Get Their Policies Right

AFI Global Policy Forum Concludes with Declaration of the Sasana Accord

> Posted by Elisabeth Rhyne, Managing Director, CFI

The following post was originally published on the MasterCard Center for Inclusive Growth blog.

Reaching full financial inclusion by 2020 will require supportive policies in every country around the globe. The Economist Intelligence Unit’s “Global Microscope on Financial Inclusion, 2014” assesses the policy environment for financial inclusion in 55 countries. The Microscope examines 12 policy dimensions essential for creating an inclusion-friendly regulatory and institutional framework. The rigorous model incorporates input from hundreds of policy makers and participants in the financial sector and a review of existing policies and implementation. The resulting rankings represent the best readily available source for judging the state of financial inclusion policy around the world.

What’s surprising about the 2014 Microscope results is their wide range. Out of a possible 100 points, the top scorer (Peru) received 87 while the lowest (Haiti) earned only 16. If full inclusion requires good policies, it is disappointing to learn that the median score across all countries was a mediocre 46.

Why do some countries score so much better than others? The best-scoring countries, led by Peru, Colombia, and the Philippines, boast capable financial sector regulators who have exerted sustained effort over years. They issue, test, and revise their rules as the market evolves. Many of the worst-scoring countries (notably in the Middle East) have recently suffered political instability. However, in the vast middle group, regulators have worked on some aspects of financial inclusion policy leaving major gaps in others. Most countries have the regulatory basics down – like prudential supervision and regulation of deposit-taking – but fewer have mastered areas important for reaching lower-income customers, especially electronic payments, supervising smaller financial service providers, and protecting consumers.

When new Global Findex results come out this month, we will learn more about how good policies contribute to progress toward inclusion. And in the next few years we hope to see advances, especially in the biggest countries covered in the Microscope – China, India, Indonesia, Brazil, Pakistan, Nigeria, and Bangladesh. These giants’ policies are better than average, reflecting their capability as large economies and their priorities as high population countries. But not by much. Average score? 51.

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The ‘Global Microscope 2014′: Results and Surprises

The Political Economy of Financial Inclusion Policy

Asia’s Top Country on Financial Inclusion Policy, the Philippines, Strengthens Its Microfinance Market

How has the microfinance industry leveraged regulation and supervision to safeguard client wellbeing? In priority areas like over-indebtedness, acceptable pricing, and transparency, what progress has been made to ensure that institutions are operating responsibly? And in cases where regulatory actions have been taken, how have they been implemented? A recent research project conducted by EY and the Platform for Inclusive Finance (NpM) investigates these questions across 12 country markets and assesses the current state of client protection regulation in microfinance.

The growth of the inclusive finance sector has helped create significant opportunities for low-income people around the world. However, when not done correctly, access to financial products also has the potential to bring harm. Of the increasing importance of client protection and sound regulation, EY Senior Manager and one of the report’s authors, Justina Alders-Sheya remarked: “The sector is growing and to do so responsibly, it is necessary that supervisory authorities perform their role.”

Drawing on questionnaires completed by local stakeholders, the study examined whether laws and regulations on client protection have been implemented in any way in the 12 studied countries: Azerbaijan, Bolivia, Cambodia, Ghana, India, Kenya, Peru, the Philippines, Rwanda, Russia, Tanzania, and Uganda. The study also examined the regulatory and supervisory landscape for client protection in each country. It investigated who is creating the regulations, how they’re being enforced, and the role of industry players like microfinance associations and credit bureaus.

Key players in the microfinance sector launched the Smart Campaign to improve protection of clients throughout the industry. This international initiative for responsible microfinance has seven Client Protection Principles. This study focused on three of those principles: prevention of over-indebtedness, responsible pricing, and transparency.

What did the research uncover?

In large part, the legal and regulatory landscape for microfinance is still developing. Not all countries have specific law or regulations for the microfinance sector, but seven of the 12 studied countries (Bolivia, Cambodia, Ghana, India, Kenya, Russia, and Uganda) do. However, these specific measures do not necessarily include provisions on client protection, as most are focused on financial requirements for microfinance institutions.

In terms of over-indebtedness, the research shows that less than half of the studied countries have rules for adequate care during all steps in the credit process. Only five countries have specific microfinance regulation aimed at preventing over-indebtedness, despite the fact that research participants perceive over-indebtedness as a big issue across the global industry. Many MFIs are non-deposit-taking (NBFC-MFIs) and thus don’t fall within the regulatory framework for commercial banking, which may address over-indebtedness more explicitly. In Cambodia, for example, NBFC-MFIs are excluded from the obligation of monitoring total loan exposure to single beneficiaries. A bright spot in this space is Tanzania, which through the Microcredit Activities Regulations (2004), requires all institutions engaged in offering microcredit to conduct an appraisal of the character, payment history, and payment capacity of each client. Credit-reporting bureaus are still developing, making the availability of information on borrower indebtedness and repayment history, especially for smaller microfinance institutions, a concern.

On responsible pricing, seven countries do not have applicable regulations, referring instead to transparency and the sales process, with price-setting being left to the market. As for the five countries with such regulation, in Peru, Russia, and the Philippines microfinance institutions are covered by regular financial law and regulation concerning price-setting, and Cambodia and India have specific price-setting rules for the microfinance sector.

Laws and regulations on transparency in microfinance are the most well-developed of the three targeted client protection areas. Nine countries have regulations on the communication and dissemination of information between microfinance institutions and their clients. Beyond rules on clearly outlining the pricing, costs, and expenses, some countries extend their transparency regulations to other areas, like advertising, in Peru’s case.

Across the surveyed countries central banks are the most important law and regulation enforcement entities (in 11 countries). The study indicated that in countries where MFIs are under supervision, regular oversight visits to institutions occurred. Microfinance associations and special microfinance authorities also get involved in the monitoring and auditing of MFIs in some cases. In instances where there is no specific microfinance regulation, NBFC-MFIs are not always audited. Consumer protection agencies also sometimes contribute to addressing client protection in microfinance. On the whole, many different types of authorities are involved in law and regulation, with varying levels of monitoring and audit scrutiny.

Beyond these areas, Josien Sluijs, Director of  NpM points out the role of empowered clients in client protection: “In addition to regulation and enforcement, attention to financial literacy of clients is as important to develop and implement.” Enhancing financial literacy among clients is a necessary step in the movement to ensure that microfinance best serves its clients.

A logical step for follow-up of the study would be to research how to improve law and regulation in a practical way and to even develop a ranking of countries so that investors have good insight on the current status on law and regulation in different countries. This knowledge might even be included in investors’ due diligence. Points to consider for further research on this topic may be obtained from the report, which can be read by clicking here. To learn more about NpM, the Platform for Inclusive Finance, click here.

Have you read?

Regulatory Complexity and Financial Inclusion

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Can Self-Regulation Protect Microfinance Clients?

Often, we hold out hope that innovation will happen through the great leap forward, the stroke of luck, the miracle cure – and when one candidate fails, we go off in search of another.

There is justifiable concern that this yes-or-no approach hampers international development. A recent article in the New Republic listed “big ideas” in international development that failed – not because they were bad, but because they were big. The article describes a $15 million-plus project to install thousands of water pumps attached to merry-go-rounds in sub-Saharan Africa, as well as Jeffrey Sachs’s Millennium Villages which sought to overhaul entire villages by building housing, schools, clinics, roads, and other key infrastructure. In these and the article’s other cases, with expectations high and money and attention flowing in, the projects sank, often because they outgrew the scale at which they had proven to work. Yet some of a project’s apparent lack of success may simply come down to the measurement you’re using. Many of the world’s most successful development efforts – deworming campaigns, for example – only improve the average life in tiny increments.

Microfinance has also suffered from the boom and bust phenomenon. Over-enthusiasm led to massive expansion, which has been followed by disillusion among many who expected greater miracles. Now, rigorous studies in several countries suggest that the average effect of the availability of microcredit on poverty alleviation is modest. But wholesale rejection may represent a missed opportunity to find the aspects that do work.

Rohini Pande is an economist at Harvard’s Kennedy School and the faculty co-chair of “Rethinking Financial Inclusion: Smart Practice for Policy and Practice,” a weeklong executive education program coming up in May. She thinks that to continue to innovate in the financial inclusion space we should seek out the small changes that emerge from the data and inspect all of microfinance’s varied effects – not just the average impacts on poverty.

Pande and her colleagues recently researched whether changing some features of a loan contract can alter its impact for the women who choose to take them up. Certain aspects of the classic microfinance loan contract, developed by the Grameen Bank in Bangladesh in the 1970s and still prevalent today in South Asia, seem more conducive to some business activities than others. For instance, borrowers with these loans generally start paying installments immediately after receiving the loan. They often keep back part of the money to make the first payments rather than using it to invest in assets or inventory. Wouldn’t that discourage a bigger investment – say, in a sewing machine for a seamstress or refrigerator for a shopkeeper– which would take longer to show a return?

Working with a West Bengal microfinance institution, Pande and colleagues Erica Field, Natalia Rigol, and John Papp separated clients into two groups: the first got a microfinance contract with immediate repayments, and the second got one that featured a two-month grace period before the first repayment installment. The researchers surveyed clients at the time of the loans and revisited them three years later to check on their businesses.

Clients who received the grace period invested 6 percent more in their businesses and were twice as likely to start new ones. Three years later, their weekly business profits were 41 percent greater and monthly household income about 20 percent greater. They also reported roughly 80 percent more business capital. However, there was also a cost, which points to the reason many MFIs have gone in for contracts that start repayment immediately: grace period clients were three times as likely to default.

This study suggested that for microfinance to best foster female entrepreneurship, it should take into account the real needs of small, fragile businesses and start thinking of a broader array of financial products to meet these needs. Perhaps grace period contracts should be accompanied by insurance and financial literacy programs to help address default risk. Or alternatively, perhaps governments in low-income countries should be more willing to consider interest-rate subsidies for poor borrowers, as the United States has.

More broadly, this research supports the notion of carefully identifying the varied effects of microfinance – which may be quite subtle – and not just focusing on the average impacts on poverty. Pande and Field are conducting a series of such studies to understand the nuanced effects of microfinance, not only on entrepreneurship, but on women’s social networks, their levels of financial stress, the number of children they have, and other measures of empowerment and wellbeing. Interesting results, even modest ones, could be the seeds for future studies.

This process, which Pande calls “smart policy design,” could counteract the “big idea” tendency in development. In a chapter from a book on financial inclusion forthcoming from the Upjohn Institute for Employment Research, Pande, Field, and their coauthor Abraham Holland point out that even the best example of a “miracle cure,” penicillin, was in fact the product of much trial and error. The many years between the initial discovery in 1928 and when the public began to reap the benefits in 1945 is typical and to be expected in policy as well as medicine. They write, “This intervening period is filled with years of iterations, attempts, failures, intermediate successes, and a little serendipity. The penicillin strain ultimately found to have the best properties for commercial production came from a moldy cantaloupe in an Illinois fruit market.”

Pande and her Co-Director at Harvard’s Evidence for Policy Design, Asim Khwaja, teach smart policy design as a framework for policy research, both to students and to practitioners. The process involves collaborating to identify problems that can be approached through research, then working to diagnose the underlying causes. The results of evaluations are used to refine the policy and ask new questions.

Last March, Pande and Khwaja introduced this process to leaders in the microfinance sector – as well as regulators and representatives from NGOs – in the “Rethinking Financial Inclusion” program. In daily afternoon sessions over the five-day course, participants, working in groups, attempted to design an approach to a real-world financial inclusion problem one member brought with them. These included how to draw shop owners away from illegal and possibly dangerous lenders in marketplaces in Peru, how to improve financial literacy and decrease over-indebtedness among borrowers in Mexico, and how to extend insurance to rural farmers in Indonesia.

The practice of taking methods from medicine and applying them to the social sciences has caused a revolution in development economics: randomized trials now give policymakers far better information to use in their decision-making. To advance microfinance farther, perhaps the financial inclusion community should take another lesson from medicine, and prepare for the long process of finding a miracle cure.

Rohini Pande and Asim Khwaja of Evidence for Policy Design (EPoD) at Harvard Kennedy School will offer the “Rethinking Financial Inclusion: Smart Design for Policy and Practice” program again May 10-15, 2015. Visit the HKS Executive Education website for details.

V. McIntyre is a freelance social science writer for the Harvard Kennedy School.

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The marijuana industry is burgeoning. While consumer demand has always spurred this black market business, commerce has expanded over the last few years with the legalization of medical use in 23 U.S. states and recreational use in Washington, Colorado, and (just a few days ago) Washington, D.C. It may come as a surprise that cannabis growers and sellers face some steep financial inclusion challenges.

Despite state decriminalization or legalization, marijuana remains a “controlled substance” per federal statutes and unfortunately for “Ganga Station” or “Glorious Buds” it is federal jurisdiction that matters when it comes to the banking sector and disciplining its dealings with what it categorizes as illegal enterprise. As a result, banks must ultimately worry about criminal charges. Most decide the risks associated with pot proprietors as clients are too high. As a result of their limbo position between state and federal law and enforcement, those in the business are increasingly speaking about their frustrations in being unbanked.

Our colleagues often discuss the challenge being unbanked poses to overcoming poverty. Among other things, banking and related services help a person manage risk, give them tools for financial flexibility, and keep their money safe. Businesses that grow and sell marijuana without access to banking services have big challenges. For starters, they have to track their cash flows themselves. Moreover, it’s very inconvenient to not have a checking or savings account into which you can deposit the cash customers pay you – since you cannot accept credit cards. You have to pay your employees in cash. Expanding your places of business and buying a new piece of equipment is tough without a loan from a bank. And there are also additional costs. For instance, the IRS adds a 10 percent fee to those who pay their quarterly business taxes with cash rather than bank wire. In an ironic development, the IRS advised the companies to avoid the assessment by using techniques that amount to money-laundering, according to a petition filed in U.S. Tax Court. Further, there are security risks for a business with piles of cash, and as armored vehicles, guards, safes, and weapons are needed, operational expenses rise.

It’s possible that banks may eventually feel comfortable opening their doors to these businesses. The Justice Department has signaled that it has bigger fish to fry. In Washington and Colorado the Obama administration has simply chosen not to enforce the federal statutes. Additionally, a year ago, the U.S. Treasury’s Financial Crimes Enforcement Network issued guidance for banks that deal with marijuana businesses and the Justice Department advised U.S. attorneys not to go after banks conducting business with legal marijuana dispensers adhering to these guidelines. However, Senators from both sides of the aisle complained that in their states this approach would facilitate fraudulent activity and allow ill-gotten gains to enter the nation’s financial system. They warned that banks accepting these customers were exposing themselves to civil and criminal liability. As a result, most banks have continued to file suspicious activity reports on all marijuana transactions and to refuse such clients.

Cannabis businesses are working creatively to get around such restrictions. For example, some use “cashless ATMs” that provide a scrip receipt to customers that the merchant can redeem as if it were cash. This allows customers to pay with a credit or debit card, even though the merchant has no bank account. And some pot sellers have opened a state-licensed credit union but have not gained access to the federal payments system that would allow them to operate smoothly.

While I certainly don’t want to equate the challenge of expanding quality financial access to the world’s financially excluded with the perils of operating a marijuana business, this example illustrates some of the challenges involved when businesses attempt to operate without bank accounts and when multiple regulators provide conflicting rules.

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Recently, Dean Karlan published an article in the Stanford Social Innovation Review titled “The Next Stage of Financial Inclusion.” The key points of his article are that while non-profits led the way in developing microcredit for the poor and started the movement for financial inclusion, for-profit companies have increasingly found it worth their while to offer financial services for the base of the pyramid. The entrance of new players to the market, Karlan offers, is a testament to the success of the early microfinance-focused non-profits. However, Karlan suggests that non-profits still have an important role in continuing to innovate in the financial services space. We agree. This is particularly true for extending financial services to people that banks still consider unprofitable: “the too rural, the too poor and the too young.” We would add disabled populations and the “too old.”

Recently, Rupert Scofield, CEO of FINCA International, acknowledged the role that new credit providers and technologies are playing in the industry and how their entry into the market is changing how established microfinance organizations must now work to remain competitive. Scofield’s perspective, shared in a piece in The Guardian, is that this is a “positive disruption, from the perspective of the clients, and that’s the most important thing because it’s lowering their transaction costs, it’s making their lives easier in the sense that it’s easier for them to deal with financial institutions and to move money around.”

When we consider these realities with all of their challenges and opportunities, a few points seem important to highlight.

1. Government regulations determine whether institutions can experiment with services for marginal clients, especially non-financial services

In some countries, for example, financial regulators create interest-rate caps that can penalize organizations that are trying to innovate. Over the past several years, Freedom from Hunger has seen an increasing number of microfinance organizations offer or promote other development services designed to meet their clients’ needs. This has been valuable for clients, and also a way for providers to distinguish themselves in an increasingly competitive marketplace.

While responsible microfinance providers all agree that not overcharging the poor for financial services is important, interest-rate caps and other regulatory measures have forced some highly successful microfinance institutions (MFIs) to split into two entities: a formal financial institution or bank and a non-governmental organization (NGO). In this model, profits from the financial institution “bank” fund development services that are offered through the NGO. Making this kind of transformation is tricky, and costly and takes time, but it can also free the institution to innovate without restrictions. It is important to note, however, though that this approach is only feasible for mature organizations that can afford to invest in establishing a second organization.

“Unified services” are often more cost-effective, since the cost of providing the financial service can subsidize the marginal costs of the development services. Excessive regulation, therefore, can really hurt smaller and newer organizations that are trying to provide unified financial and development services under one roof. They are forced to choose financial services over the other services. As a result, the opportunity to provide development services to the poor in areas where they do not yet exist or are inadequate is often lost.

2. Financial institutions’ new interest in savings groups

As Karlan points out, savings groups have proven an important innovation for reaching very rural areas. They are helping to expand outreach as well as improve client outcomes.

Interestingly, we’re seeing more interest in savings groups from formal financial providers, such as credit unions and MFIs. They are increasingly recognizing the business case for organizing groups and designing savings products for them as part of their portfolio of services. This is an exciting opportunity, particularly with the advent of new technologies that can link savings groups to bank accounts.

Similar to their interests in serving the financial needs of young people, financial institutions see savings groups as a way to bolster their pipeline of future clients. NGOs are playing an important role in testing linkage models and in the direct provision of services to savings groups in underserved markets.

3. “Hybridity”

Karlan recommends that non-profits have an important role in continuing to innovate in the financial services space, but should focus primarily on extending financial services for the most rural areas, the extreme poor, and to young people.

Yet, some of the best innovations that hold the most promise for the unserved and underserved have come from successful financial institutions—not NGOs—that have sought to combine a social mission with financial performance and have thus remained effective enough to support innovation. This suggests a hybrid approach that combines innovating with mainstream financial institutions that possess a strong social mission, while also identifying new organizations and new strategies to reach and serve the unserved and underserved poor.

4. The promise of “collaborative marketing”

MFIs have become and can continue to be effective brokers of development services for the poor.

While some MFIs directly provide development services, they can also effectively link their clients to other services offered by other organizations. This can be done at a very low cost to the MFI and provide considerable value to the client. Such arrangements have included partnerships between MFIs and national health insurance schemes as well as linkages to health and agricultural organizations. These cross-sector collaborations can support the needs of the poor more comprehensively while also helping to meet the business and social goals of MFIs.

5. Self-regulation is necessary for institutional betterment

Karlan highlights the challenges inherent with self-regulation efforts, such as the Smart Campaign certification for ethical treatment of clients, the Truelift certification for pro-poor organizations, and the Universal Standards for Social Performance Management. Self-regulation cannot always be trusted, especially in the absence of third-party verifications. There are incentives for assessed organizations to “lie” or not be completely transparent. At the same time, self-regulation is a necessary part of the picture, a mechanism to hold ourselves accountable for the goals we’ve set together. Self-regulation, when supported and followed with good intentions, is meant to improve performance and should not be discounted, even as some might question inherent biases. A justice system is only useful when extreme cases force decisions. Until then, we can only rely on internal standards of ethical behavior; social performance initiatives are playing an important role in driving this.

As a sector, financial inclusion non-profits are at a crossroads, amid sweeping shifts in the way banking is conducted globally. It is imperative that our shared social mission continues to drive our efforts. This is ultimately what distinguishes us among the expanding rank of those in financial services.

In his book, Better, Atul Gwande highlights the challenges within the medical industry that are also applicable to our own context. He maintains that:

“Better is possible. It does not take genius. It takes diligence. It takes moral clarity. It takes ingenuity. And above all it takes a willingness to try….Be willing to recognize the inadequacies in what you do and to seek out solutions…In the end, no guidelines can tell us what we have power over and what we don’t. In the face of uncertainty, wisdom is to err on the side of pushing, to not give up. But you have to be ready to recognize when pushing is only ego, only weakness. You have to be ready to recognize when the pushing can turn to harm. In a way, our task is to ‘Always Fight.’ But our fight is not always to do more. It is to do right by our [clients], even though what is right is not always clear.”

This is our moral imperative.

Have you read?

Savings Groups, Mobile Phones, and a New Solution for Rural Women

What Kinds of Regulation Promote the Development of Microfinance Markets?

Can Self-Regulation Protect Microfinance Clients?

*Post title taken from Atul Gwande, Better: A Surgeon’s Notes on Performance, 2008, New York: Picador.

Financial inclusion stories and research are published daily, lauding various efforts to bring lower-income people into the formal banking fold. All progress deserves celebration, but also closer examination. When a new initiative takes effect, or a new service deployed, how does that advance us in achieving financial inclusion? A backdrop of sound measurement is critical. A BBVA research team, Noelia Cámara and David Tuesta, recently set out to construct an index that measures the extent of financial inclusion at the country or region level. The index is discussed and applied to 82 countries in the team’s new paper, Measuring Financial Inclusion: A Multidimensional Index. We were especially intrigued to learn that this research incorporates both supply and demand-side data. I recently sat down with Cámara to talk about the project, from challenges in measuring financial inclusion to the implications of the newly-available index.

1. What are the challenges in measuring financial inclusion?

Many issues arise when it comes to measuring financial inclusion. First, there is no single definition for financial inclusion universally accepted in the literature. Most definitions include three dimensions: use, quality, and access. However, when it comes to defining these dimensions, no consensus is found. For instance, the use of financial services is part of the financial inclusion concept, but it is not clear what “use of financial services” really means. Thus, several questions come to the fore: Do we consider having a bank account in the formal financial system to be a necessary condition for financial inclusion? Is having a pre-paid card or microinsurance enough to classify an individual as included? Is using electronic payment intermediation (e.g. paying bills with a mobile phone) a sufficient condition?

Second, and this may be the most important challenge to be addressed in the near future, there is a lack of harmonized data. For example, measuring access can be approached by assessing the number of bank branches and ATMs, but there isn’t always information available about the number of banking correspondents’ outlets. There is also access to financial services through mobile phones and electronic devices like laptops and smartphones. However, having a mobile phone or a computer is not a sufficient condition for access to the financial system; in order to generate broader access and foster financial inclusion, many other things such as regulation, new financial digital channels, or infrastructure are necessary. Finding workable data and measuring these elements of access is difficult. These challenges very much apply to measuring the quality of financial services in a given market, as well.

2. What dimensions do you use to measure financial inclusion? Which dimensions are more important than others?

We postulate that the degree of financial inclusion is determined by the three dimensions of usage, barriers, and access. Barriers are used as a proxy for the quality dimension. We define an inclusive financial system as one that maximizes usage and access, while minimizing involuntary exclusion. Involuntary financial exclusion is measured by a set of barriers perceived by those individuals who do not participate in the formal financial system.

The weights of the variables in our index are calculated endogenously, by applying a technique called Principal Component Analysis (PCA) in two stages. As shown by our estimates, access is the most important dimension for measuring the level of financial inclusion (0.42). Access represents a necessary but not sufficient condition for using formal financial services. The weight for the usage dimension is 0.29, and for barriers it is 0.28.

3. Which counties performed well and which performed poorly?

As expected, developed countries have the most inclusive financial systems, and the African countries are more financially excluded. There are some exceptions among developing countries, such as Mongolia and Thailand, which perform relatively well.

4. Your study is unique in that it combines both supply and demand-side data sets. What are the limitations of relying on supply-side data?

Supply-side data is only accurate in measuring some aspects of financial inclusion, such as access. These data are not conclusive in terms of measuring use of financial services. For instance, with number of bank accounts, we have no information about how these figures are distributed among the population. Supply-side data may overestimate the inclusiveness of financial systems, as one person can have more than one account or loan, which is a very common practice in developed countries. By contrast, having individual micro-data for the demand-side is desirable because it enables us to identify who is actually using the financial services.

5. You write that “We find that the degree of financial inclusion is highly correlated with some macroeconomic variables such as GDP per capita, education, efficiency of a financial system, and financial stability.” What do you think the policy implications are since financial inclusion is so intertwined with broader economic and social issues?

Talking about policy implications from a macroeconomic perspective needs further analysis to check for causality. What we illustrate in our study is that some important macroeconomic variables such as GDP per capita, education, efficiency of a financial system, and financial stability perform similarly with financial inclusion, which then shows that a causal relationship may exist.

6. At CFI, we are very much focused on the quality of services provided to the base of the pyramid, and client protection in particular. Where do you see the role of more qualitative issues like client protection in measuring financial inclusion?

The quality dimension is, so far, the most difficult of financial inclusion to measure. As I mentioned earlier, in our index we try to approach quality of financial services by the perceptions of excluded people. Particularly, the variable trying to proxy the lack of trust in the financial system should capture part of this client protection information. We are aware that this is only a partial approach, particularly since only excluded people provide answers to this question. Our current research focuses on improving the measurement of the quality dimension.

7. As you may know, the CFI has defined financial inclusion as a state in which “everyone who can use them has access to a full suite of quality financial services, provided at affordable prices, in a convenient manner, with respect and dignity. Financial services are delivered by a range of providers, in a stable, competitive market to financially capable clients.” How do you feel this definition corresponds to your index and research and in what ways do they diverge/differ?

The CFI’s definition for financial inclusion includes the three dimensions that we use to define financial inclusion, with quality-related issues included only partially from the perception of excluded people. There are also some aspects such as “respect and dignity” that we are unable to measure with the available information.

The only divergence between the CFI’s definition and our index is the inclusion of the financial capability concept. This is a broad concept that is difficult to define. It includes financial literacy, learning by using financial services, having the money to use the services, and so forth. Financial capability is not only difficult to measure for all the countries in our sample, but we also consider financial capability as a variable related to financial inclusion, rather than one to be included in the financial inclusion measurement. We believe that financial capability could be either a cause or a consequence of financial inclusion.

8. What about the role of insurance, pensions, and other financial services not accounted for in the index?

There are different degrees of financial inclusion. Our index is a basic measure that can be interpreted as a lower bound. We consider a financially included individual as having one of the following financial products: a bank account, savings account, or loan. Although other financial products such as pensions and insurance are important, we do not consider an individual to be financially included if holding only insurance with none of the previous specific financial products.

9. Were there any surprises in your research?

Surprises are common when creating an index. One may have a general idea about the ranking of a group of countries, however, there are always surprises. In our case, Mongolia and Thailand rank much better than expected. These two low-income Asian countries outperform other low-to-middle income countries, their East Asian neighbors, and even some high-income countries. For Mongolia, the degree of financial inclusion in the country is even higher than developed countries such as Sweden, Ireland, and Austria. It may be due in large part to universal cash hand-outs from the government. Thailand, which is ranked higher than Greece, has a high position in the ranking mainly due to the large number of bank accounts and the insurance schemes offered by the government.

10. What gaps in research still remain and which do you think are the most important to address?

For measurement issues, the quality of the data is the most important challenge that we need to address. Working on improving quality and generating accurate data are key for improving the measurement of financial inclusion. Big data generated by financial institutions (provided in an aggregated manner) should substantially improve the measurement of the three inclusion dimensions. Examples of such provider-generated data might include information regarding the range of financial services used by income group and access to financial services by channel. On the other hand, information about the unbanked is only possible through surveys.

Theoretical research and industry alignment is important in terms of operationalizing and acceptance of a definition of financial inclusion. Identifying how mechanisms behind financial inclusion work may help to reach a single, commonly accepted definition.

Have You Read?

Measuring Financial Inclusion: The ‘Basic Set’ Solution

Lean Research – Is It Time to Reimagine the Study of Financial Inclusion?

Reality Check: Three Ways We Hype Financial Inclusion Breakthroughs

— Tammy, age 60, U.S. Financial Diaries participant

According to the U.S. Census Bureau, the U.S. supplemental poverty rate is 15.5 percent, meaning that 48.7 million Americans live below the poverty line.¹ While poorer households face higher difficulties to make ends meet, households across the lower and middle-income spectrum in the U.S. struggle with income volatility, unplanned expenses, and finding ways to save and invest. But they also use creative ways to manage their budgets and money.

The U.S. Financial Diaries project, a joint initiative of NYU Wagner’s Financial Access Initiative (FAI) and The Center for Financial Services Innovation (CFSI), collected data from 200 low and moderate-income households across the U.S. in both urban and rural areas for a year. It asked how they spend their money, what financial services they use, and how they manage their money on a day-to-day basis. Considering that over 30 million low-income families in the U.S. lack access to traditional banking and financial services, the study can help policymakers and financial services providers better address and meet the needs of lower-income Americans.

What did they find?

• The use of informal tools – outside of banks or other institutions — is common and contributes to financial well-being. These tools aren’t seen as a last resort to use only when desperate. Rather, they are often preferred to institutions, and families use them in combination with formal tools such as bank accounts. Savings groups, loans among family and friends, and “money guards” (a person who is relied upon to hold savings for another person) are common.
• Income varies from month to month and is outside the control of many households. The amount coming in varies along with the source of income and the timing. According to one of the project’s issue briefs: “Households regularly experience swings in their ability to cover basic expenses, pay down debt or save for the future. In this context, budgeting and planning become quite difficult. New financial services cannot increase household incomes. However, there is tremendous potential for high-quality financial services to help households achieve greater financial health and better manage income uncertainty.”
• Reflecting the precarious financial state of many American families, 77 percent of those in the study say that financial stability is more important than “moving up the income ladder.”

Much more data and analysis from the project is available on the USFD website, and I urge readers to check it out. The USFD diary features issue briefs on informal financial tools, how income uncertainty affects households, and the study’s methodology; charts and data; and a series of household profiles that each examine the financial life of one family in the study. Working papers and additional findings will be added over the coming weeks and months.

[1] Unlike the Official Poverty Rate, the Supplemental Poverty Rate takes into account the impact of different benefits and necessary expenses on the resources available to families, as well as geographic differences in housing costs.

Have you read?

300 Households for One Year – Results of the Kenya Financial Diaries

What Financial Diaries Reveal about M-Pesa Use

An Innocent Visits the Pawn Shop