Supporting Digital Financial Services? 5 Lessons for Funders
Development agencies are increasingly exploring how to harness the power of digital financial services. In the last CGAP cross-border funder survey, which collected data from 23 funders representing 66% of total funding for financial inclusion, at least 97 projects included a focus on digital financial services. More than half of these projects target Sub-Saharan Africa. When asked about their intentions going forward at a recent learning event for funders, a majority of participants said their organizations would increase their focus on digital financial services in the future.
For many funders, digital financial services is a new area to explore, and it’s different from traditional microfinance. So what should funders know when considering supporting the advancement of digital financial services?
Diversity of business models and use cases: the term “digital financial services” can describe a range of financial services, starting with payments and extending to digital credit, savings and insurance, delivered via digital infrastructure (mobile or Internet). Different business models are emerging globally including bank-led models, MNO-led models, and third-party models. This wider range of financial services providers and potential partners adds a layer of complexity for funders, since supporting digital financial services requires working with different types of actors and untested business models. Due diligence procedures are no longer neatly defined and standard performance indicators from the microfinance world don’t apply.
It’s not all about the money: Launching digital financial services requires a significant up-front investment. MNOs who are launching mobile money services usually take at least three years to break even, according to GSMA, thus requiring patient funding and a significant risk appetite. But money is not enough. Funders who want to work with a bank, an MFI or mobile network operator (MNO) to develop digital financial services need to understand the incentives of these market actors, which may not always align with the social or development objectives of donor agencies. Funders also need to develop a clear theory of change that links what’s good for the providers to what’s good for the poor.
Barriers are not (only) at the supply side: When asked about where they see the main barriers that hinder the development of digital financial services, funders most frequently point to weak or non-existent supporting functions and market infrastructure. Without internet connectivity and functioning retail payment systems, it’s hard to develop digital financial services. India has shown that putting in place the technology “stack,” from authentication systems to payment platforms, services start emerging and innovation takes off. Not all countries will take such a proactive approach, but there is a lot that other governments and funders can learn about all the different pieces that need to be in place for a digital ecosystem to emerge. The enabling environment, including adequate supervision, is a critical piece and includes: i) the use of agents; ii) AML/CFT and account opening requirements; iii) regulation of non-bank electronic-money issuers and other stored value instruments, and; iv) financial consumer protection.
Timing is important: Development agencies’ program implementation periods typically range from 3 to 5 years. While the number and types of digital finance business models grow each year, development agencies need to commit for the long term to ensure that digital ecosystems are evolving sustainably. It requires flexibility, patience and deep technical knowledge beyond traditional microfinance. It also requires careful analysis of competitive market dynamics and the flexibility to adjust program theories of change as markets and assumptions evolve.
Coordination is a priority, not an afterthought: While some funders have invested heavily in understanding demand for DFS, available research is often not used effectively. And there are still many open questions about digital financial services. For instance, will they really help increase outreach for hard to reach segments including women, rural populations, and the elderly? What use cases will drive customer adoption and increase activity levels of mobile accounts? The list goes on. Market research is one area where funders see an opportunity to collaborate. Similarly, funders should always aim to extract lessons from their programs that can be applied globally. With most funders so far focusing on digital financial services in East Africa, coordination also needs to be a priority, even before programs start. And funders should think about addressing barriers in markets that are still lagging behind or are more difficult to work in, such as post-conflict situations. Digital financial services can help address emergency needs in such contexts, and they can also contribute toward the reconstruction of markets.
Advancing digital financial services requires a different approach to development compared to traditional microfinance. It requires an understanding of the incentive structures and capacities of a much broader set of market actors. Transferring knowledge and building robust supporting functions also require patience, flexibility, and technical skills. This might sound like a formidable list of requirements, but funders should not feel intimidated. Digital financial services might not fit into every funder’s strategy.
For those who are interested in engaging further in this area, peer-learning and leveraging the knowledge products produced by CGAP and similar organizations will help acquaint funders with key concepts, avoid potential pitfalls, and work together to increase the synergies of individual investments across different funders. To get started, we recommend checking out the resources listed below, along with the "related content" noted in the sidebar.