A Digital Pathway To Financial Inclusion

Wealthy households live their financial lives embedded in a digital financial system which “greases the wheels” of their economic activity by making it cheap and easy for them to send and receive payments. Their money sits in a virtual account as ones and zeroes on a server, where it can be transferred with the click of a button. In contrast, 2.5 billion people are cut off from that system. They store and transfer value through physical assets, such as cash, jewelry, or livestock. This cash-digital divide creates two mutually-reinforcing inequities in the financial lives of poor households. First, it makes it costlier and riskier for them to perform basic financial activities – from sending wages to one’s wife and children to financing an investment in seeds or fertilizer. Second, it perpetuates the poor’s marginalization from the formal economy by making it prohibitively costly for utility companies, banks, insurance companies, and other institutions to transact with them.  

In a new paper entitled “A Digital Pathway to Financial Inclusion,” we present a growing body of evidence which indicates that connecting poor people to a digital financial system will generate sizable welfare benefits. We also argue that countries will not bridge the cash-digital divide in one giant leap. Instead, countries will pass through several stages of market development along the path to an inclusive digital economy. The figure below depicts these stages and categorizes several countries based on their progress in leveraging mobile phones or other digital interfaces to connect large numbers of citizens to a digital financial system. While not all markets will follow this linear path, our current read of the evidence suggests that, in aggregate, countries will tend to pass through each of these four stages.

The commercial assets required to navigate this pathway vary across each stage. For example, the assets required to leverage mobile connectivity (Stage 1) to extend cash-digital conversion networks and payment platforms into poor and rural communities (Stage 2) are different from those required to deliver enhanced financial services over those platforms (Stage 3). As a result, financial regulations and business models must be calibrated to harness those assets at each stage.

Digital financial inclusion will accelerate when stakeholders step outside their comfort zones to test new commercial and regulatory models. Banks, for example, are unlikely to cultivate “bank-led” pathways to digital payments in poor and rural communities (Stage 2) if they try to maintain a tight grip on all aspects of their distribution channels. Instead, they will have to give their distribution partners (e.g. mobile operators, retail distributors) enough compensation and branding space to incent them to do the heavy lift of building a national cash-digital conversion network.

Mobile operators are unlikely to facilitate the migration from payments (Stage 2) to financial services (Stage 3) unless they loosen their grip on the user experience. Indeed, we suspect mobile operators will have to convert their closed application programming interfaces (APIs) into open platforms that make it easier for banks and other application providers to integrate with their payment systems. And policymakers are unlikely to see material gains in digital financial inclusion if they cling to regulatory models which fail to distinguish between the risks posed by payments from those posed by financial intermediation.

The digital pathway to financial inclusion will indeed be carved by those willing to revisit long-held assumptions in financial regulation, telecommunications, and banking.

Dan Radcliffe is a Program Officer and Rodger Voorhies a Director in the Bill & Melinda Gates Foundation’s Financial Services for the Poor team.