DEEP DIVESExclusive to Strategy Plans
April 26, 2017
Carla walked alone on a cold Friday night. She was relieved: it was payday. With her salary in her purse, she made plans: pay rent, buy food and – if there was any money left – bring her three children to McDonald’s! Suddenly though, her relief turned into tragedy. She was punched and stolen. Her monthly income was gone.
Like Carla, many others in Brazil and other developing countries have similar stories to tell.
It turns out that Carla, like 68% of Brazilians, has a bank account. However, this is of almost no use to her: she pays all her expenses in cash and does not have a credit card. Electronic transfers are prohibitive, too expensive – better to withdraw money from her bank and deposit it at the payee’s bank. The same goes for bills – they are paid in cash at the lottery outlet, after waiting in a long line. In any case, she always needs to carry cash and she always loses time.
Carla is un(der)banked, like 2 billion² other people.
Source: McKinsey, Digital Finance For All: Powering Inclusive Growth In Emerging Economies, 2016.
Turning Carla into a profitable client is nearly impossible for traditional banks. The risks are misunderstood, the cost to serve is high, and potential revenues are narrow. Serving her is considered uneconomical.
And, contrary to common sense, it is not only the low-income Carlas around the world that don’t fit in the current system – many in the middle class don’t fit either and the same goes for SMEs.
Traditional banks generally apply a low-volume, high-value approach to value creation – a handful of wealthy, high-revenue generating clients sustain the business and a large number of low-revenue clients complete the lot. To properly serve Carla, banks would need to shift their business model to make a large number of low-revenue clients a profitable unit as an aggregate. This would mean applying a high-volume, low-value approach.
While microfinance institutions specialize in low-value, short-maturity loans, many do not achieve sufficient transaction volumes to grasp benefits of scale. Additionally, the close relationship with clients for financial education, risk assessment, and loan monitoring; the often limited use of technology and, for many, physical presence in remote areas result in a high cost to serve and thus high-interest rates for clients such as Carla.
This is when FinTech steps in, increasing efficiency to better serve the un(der)banked.
The universal bank model is under increasing scrutiny – high regulatory costs, large operational footprint, the slow pace of change; there are many client segments but only a few are fully understood. Full service has created a lack of focus and inefficiency. As a result, replicating this model to the un(der)banked might not be ideal. Technology can support new approaches that deliver more effective results in terms of financial inclusion.
An alternative could be to integrate players that have emerged as a result of the unbundling of universal banks into a common platform to create a financial inclusion app store. Bank and non-bank platform creators would give niche players access to their customer base via an API-based ecosystem. Attracted by a potentially easier and faster way of acquiring customers, niche players would bring product-specific expertise that would enable a better quality of service with lower levels of risk.
Source: The Finanser, Why Fintech banks will rule the world, 2015.
In addition to fostering adoption on the supply-side by offering access to customers, platform creators would also need to address demand-side adoption, i.e., they would need to create practical reasons for un(der)banked to join and use the platform: incentives to go cashless.
Classic strategies include offering free services (e.g. budgeting tools for SMEs) to capture user base and monetizing with additional products (e.g. working capital); or building freemium models (e.g. offering free cash transfers up to a certain threshold from which fees apply).
Whichever approach is implemented, as more customers join the platform, network effects are created – more clients attract more product developers that in turn attract more clients. Competition grows, fostering product innovation, and customer loyalty spikes: the total value of the platform increases as it scales. And as it scales – and enables a significant number of un(der)banked to have access to relevant services – it achieves its social purpose.
In addition to building new models, FinTech can improve the unit economics of serving the poor, enabling existing players to start doing so (e.g. traditional banks), or do it better (e.g. MFIs).
FinTech provides a clearer understanding of the needs and risks of the un(der)banked, enabling new approaches to product development and risk assessment. It has the potential support for new operating models and decreasing costs, improving the unit economics of serving the poor.
However, there are still challenges to overcome and FinTech cannot do it all.