What Is the Role of Start-Ups in Financial Inclusion?

A couple of weeks ago we were at Finovate in New York City (NYC), an extraordinary event that has become an important pit stop for innovators in the finance and technology industries in the United States. At Finovate, 64 start-ups and other innovators have seven minutes each to pitch their ideas to investors, established companies looking for acquisitions, fellow entrepreneurs and industry-watchers. It’s a rapid-fire, fast-moving and a highly entertaining event. Finovate has grown over time from its NYC flagship event to include events in San Francisco, London and Singapore.

We have attended Finovate’s flagship event two years in a row in part to see what kinds of innovations are taking place and in part to see what are the problems at the intersection of technology and finance that start-ups and innovators are looking to solve.

The environment at Finovate is also a reminder to those of us working in financial inclusion, from Mexico to Pakistan, of the importance of start-ups and individual innovators. In fact, the interests of innovators and those of us interested in inclusion often intersect: we both want to solve the same problems and resolve what we see as a market failure, i.e., millions without formal financial access.

Undoubtedly, there is some ambivalence towards the role of start-ups and individual innovators when it comes to financial inclusion. Oddly enough, this ambivalence stems from the view that start-ups cannot scale, and inclusion is ultimately about reaching the millions outside the realm of formal financial services. There is also a view that when it comes to the specialized and highly regulated nature of finance, the established banks, larger organizations and other players are better placed to lead the way. For example, you might be able to bootstrap a credit operation up to a point, but not insurance or large scale payment operations. Most of the few start-ups that do get funded in emerging markets trying to reach the unbanked or underbanked fail completely or under-deliver on their promise, which adds to the ambivalence towards start-ups more generally.

The truth is that whether it is in finance or other industries, many start-ups do fail or get acquired, or the problem they were trying to solve goes away as industry structures shift. A recent report by Harvard’s Shikhar Ghosh looking at 2000 U.S. companies over a six year period, shows that 3 out of 4 venture-backed firms failed. In fact, if we define failure as the inability to meet projected return on investment, then 95 percent of firms failed.

But don’t start-ups teach us even when they do fail? Their failure may show us how not to do it or what not to do. The question we need to ask is whether it is sufficient that the ultimate benefit of start-ups may lie in spurring the rest of us along?

In fact, we propose that start-ups play an important role in the ecosystem of providers of financial services for the poor. First, they point out where innovation is needed. At last year's closed-door partner event, participating MNOs and banks were asked which organizations were more likely to innovate: 37% of the participants said start-ups.

Innovation can be incremental. At Finovate this year, a number of companies such as Dashlane were trying to find ways for people to rapidly fill in forms. On the other end of the innovation spectrum Locaid showcased never-before-seen ways of using location tools in finance, and the company C.K. Mack suggested that rental income from properties could be securitized.

Second, start-ups identify or spotlight a new consumer need. Arguably that need is greater if more of them are falling over each other to meet it. Start-ups like Bolstr, Shopkeep and a number of others at Finovate spotlight the needs of the smallest mom-and-pop stores, a segment that perhaps the entire financial industry in the U.S. needs to pay closer attention to. Solutions for recent graduates to navigate and manage school loans were another area of consumer need highlighted by companies like Tuition.io.

And, lastly, start-ups identify new business opportunities. In other words, start-ups give definition to a “white space” and illustrate what solutions might look like and how money might be made. If we look closer at the world of branchless banking, we have already seen a handful of start-ups that identified gaps in the market, developed innovative solutions and went on to successfully raise funding and even acquire other firms. For example, Mumbai-based FINO received backing from HSBC, Intel Capital and the IFC to expand its branchless banking business and even recently acquired the now-defunct Nokia Money.

The risk attached to expecting start-ups to identify innovation, consumer needs, and new business opportunities is that they display a herd mentality. One start-up’s success in securing funding and “making it big” pulls others into the same space even when they propose nothing new. For example, a lot of companies seem to be throwing up different solutions and dashboards for Americans in the area of personal financial management. These dashboards increasingly look the same with colourful nifty wheel graphs and so on. We saw some of that again at Finovate this year.

Over the next couple of months, we will be looking more closely at the role of start-ups in financial inclusion. In particular, we will explore the challenge we face in building provider ecosystems in developing countries that foster more start-up led innovation in financial inclusion. We want more start-ups doing what they do best. An ecosystem like this is sprouting up in Nairobi, a place The Economist recently dubbed the “Silicon Savanah”. The question is where else and how?