The State of Financial Inclusion in Developing Economies

In the third of Clinton Lectures at the Georgetown University in April 2015, the 42nd president of the United States, Bill Clinton noted, “If you have a vision, a strategy and you have the support of people at the grassroots level because you’re inclusive, these kinds of things can be done by ordinary citizens.” What he was referring to was the idea of radical inclusion for ensuring broad-based prosperity in America and the world.

In today’s world where more than three billion people live on less than $2.50 a day and more than 1.3 billion on less than $1.25 a day, the idea of radical inclusion has never been more pertinent than it is now. Of all kinds of inclusion–political, cultural and financial–providing fair and widespread access to financial services has the most direct impact on poverty reduction.

Why financial inclusion is important

Developed economies have long recognised the significance or financial inclusion as a strategic lever to alleviate poverty and realise the goal of inclusive economic growth. There is strong evidence to prove that financial inclusion benefits poor families by providing them access to saving vehicles, credit and investment services, and low-cost payment mechanisms. This in turn allows them to start and expand small-scale businesses and hence achieve financial self-reliance without depending on the arbitrary financial ecosystem that is hallmark of many rural and feudal societies in developing countries.

Financial inclusion also has positive impacts on economic well being of women. Surprisingly, a major beneficiary segment of microcredit in developing countries like Bangladesh and Nigeria has been women entrepreneurs. Apart from a rise in household savings and consumption rates, this has resulted in increased investment in education and healthcare.

In addition to the direct benefits of financial inclusion, another important and often overlooked benefit is the documentation of economic activity and bringing the hitherto unbanked segments into the fold of the formal economy. Channeling transactions through bank accounts and other semi-formal financial mechanisms boosts tax revenue, reduces the cost of collecting taxes, and promotes fiscal accountability. The ensuing benefits in form of increased public spending and development work further improves the income generating potential of the poorest segments of the economy.

By the numbers

The Global Findex report of the World Bank for 2014 reveals that 62% of adults worldwide have bank accounts, up from 51% in 2011. Between 2011 and 2014, 700 million adults worldwide became account holders. The number of adults without an account dropped by 20% to 2 billion. In nearly every country, the proportion of adults with a bank account increased. However, as one would expect, there is a vast difference in the penetration of bank accounts in different countries around the world. In high-income OECD economies, 94% of adults had an account in 2014. In developing economies on the contrary, only 54% of adults reported having an account. A look at the World Bank’s Global Findex database also reveals significant differences among developing regions, with account penetration ranging from 14% in the Middle East to 69% in East Asia and the Pacific.

While much remains to be desired, the case of developing economies is encouraging. Between 2011 and 2014, account penetration increased by 13% in the developing counties. The highest increase was seen in East Asia and the Pacific, South Asia, and Latin America and the Caribbean, with each seeing an increase in account penetration of more than 10%.

Another encouraging trend in the developing economies has been the narrowing of the gap between adults in the poorest 40% of households and those in the richest 60%. Between 2011 and 2014, this gap narrowed by 6% to 14%. In the poorest 40% households within individual developing economies, the share of adults without an account fell by 17% on average between 2011 and 2014.

Amid these positive signs, results of the Wold Bank’s survey show that huge opportunities in the developing economies lie untapped. Worldwide 65% of men had an account in 2014, compared to only 58% of women. However, in developing economies, where average account penetration went up by 13% from 2011 and 2014, the gender gap stayed at 9%. Only 50% of women reported having an account compared to 59% of men.

Financial innovation in Sub-Saharan Africa

While the adoption of innovative financial solutions such as M-PESA, MTN Mobile Money, Airtel Money, or Orange Money has been remarkable in the developing economies, the case of Sub-Saharan Africa has been particularly interesting. Everywhere else the growth of accounts held by adults was in formal financial institutions, however in Sub-Saharan Africa, mobile money accounts contributed to the growth of accounts from 24% in 2011 to 34% in 2014.

Globally, a paltry 2% of adults have a mobile money account. On the contrary, 12% adults in Sub-Saharan Africa have a mobile money account with half of them having a mobile money account only. All of the 13 countries where 10% or more of the adult population has a mobile money account are in Sub-Saharan Africa. In five of these 13 countries—Côte d’Ivoire, Somalia, Tanzania, Uganda, and Zimbabwe—more adults have a mobile money account than an account at a financial institution.

The opportunity

Overall, the past four years show significant gains in the expansion of financial inclusion globally. However around the word, 38% of adults still do not have an account. Among adults in the poorest 40% households within individual developing economies, 54% remain unbanked, compared to 40% in the richest 60% households.

Excluding Sub-Saharan Africa, penetration of mobile money accounts in developing economies remains limited. In South Asia, only 3% of adults have a mobile money account, in Latin America and the Caribbean 2%, and in all other regions less than 1%. This is a significant area of opportunity for these economies.

Similarly, payment of wages and government transfers has been a largely untapped area on the financial inclusion scorecard. Worldwide, more than 20% of adults without accounts (over 400 million people), receive wages or government transfers in cash. According to World Bank, paying government wages and transfers into accounts rather than in cash could increase the number of adults with an account by up to 160 million. And doing the same for private sector wages could increase the number of adults with an account by up to 280 million.

In developing economies 1.3 billion adults with an account pay utility bills in cash, and more than half a billion pay school fees in cash. World Bank experts maintain that digitizing payments like these would enable account holders to make the payments in a way that is easier, more affordable, and more secure.

While the need for public and private sectors in the developing economies to strategically target these opportunities cannot be overemphasized, it would be crucial to simultaneously address the underlying causes of low financial inclusion among the poor segments of these economies. Among others, these causes include a general lack of trust in financial institutions, inflexible fee structure for financial services, cultural and religious opposition to interest-based banking, social pressures to stick to informal and semi-formal economic structure, and general lack of awareness. Until these root causes are addressed, the success of efforts by governments and other sectors of developing economies will remain limited.

Title photo credit: UK Department for International Development

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