Digital lenders can help unlock full financial inclusion

Digital financial services aren’t just for fintechs

The market for lending is changing across the globe. A new category of digital lenders has emerged that uses digitized customer data, lower-cost digital channels, and advances in machine learning and analytics to offer better products to more clients in faster, more cost-efficient and engaging ways. The market opportunity is significant: the total transaction value is expected to show an annual growth rate of 18.2 percent between 2018 and 2022. And the IFC estimates the financing gap for small businesses in developing countries at more than US$5 trillion.

Around the world — and especially in emerging markets — these lenders are developing innovative business models that leverage technology to reach customers whom banks have largely ignored in the past. In Mexico, small businesses can now access funding within hours from Konfio, a fintech that use alternative data to better understand applicant behavior. In Ghana, the solar company PEG is enabling low-income customers in remote rural areas to use mobile money to affordably pay for solar units, gaining access to light, radios, and even television sets in their homes.

What does this mean for traditional financial institutions? These institutions historically have used a “high touch” approach to serving the low-income segment, relying on an extensive network of loan officers who canvass regions and build personal relationships with their customers. While effective, this manual approach is expensive and has been a key roadblock to providing personalized financial products at scale.

Improvements in infrastructure and access to technologies have provided all lenders — including traditional institutions — with a new and compelling alternative. Digital technologies allow for more customized products and experiences at a fraction of the cost of physical delivery. One key component of this opportunity in emerging markets is the improvement of mobile network coverage and the proliferation of low-cost smartphones. GSMA predicts the number of unique mobile subscribers will reach 5.9 billion by 2025, with growth driven by new customers in India, sub-Saharan Africa, and Latin America. Another factor is government action; policymakers around the world are setting digital and financial inclusion agendas that offer increased regulatory and infrastructure support for digital lending.

In addition, customers in emerging markets are becoming more tech-savvy. More than half own a smartphone, and many use digital services on a daily basis — in Kenya, almost two-thirds of the adult population makes or receives payments using mobile phones. And global exposure to multinational brands like Facebook and Amazon has heightened customer expectations around product design and service. Financial institutions that don’t offer a similar customer experience risk losing customers to new digital competitors.

Digital lending offers great promise, but it is not a magic bullet. If not well-designed and delivered, digital products can negatively impact both providers and customers. On the customer side, poorly-executed digital lending can lead to over-indebtedness, aggressive digital collections practices, and, in extreme instances, even financial exclusion. For example, in 2017 Microsave reported that 2.7 million people in Kenya were blacklisted for non-repayment of digital credit in the three years prior, with 400,000 blacklisted for loans of less than $2. These negative impacts are often the result of overly aggressive sales tactics or not ensuring the customer understands (or needs) the product. To avoid these effects, digital lenders must offer financial products with transparency and customer protection at the core of their design.

While fintechs will continue to drive much of the innovation in digital lending, it is essential to recognize that they are only part of the picture. It is the traditional financial institutions that have built strong regional brands, hold banking licenses, offer a wide variety of financial products, and importantly have access to capital that can enable scale. And microfinance institutions have been successful at reaching the unbanked, particularly because they use physical touch points to engage, educate and support their customers.

Arguably the biggest opportunity for scalable digital lending innovation sits at the convergence of fintechs and traditional financial service providers. There are promising signs that through partnerships, fintechs and traditional lenders are harnessing their respective strengths to design customer-centric products that can sustainably drive financial inclusion. If resourced and managed well, these partnerships have the potential to drive significant scale of digital lending in emerging markets — resulting in increased access and inclusion.

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