Improving access to financial services is on the agenda of central banks and development-focused organisations around the world. Yet, in many cases, efforts to reach unbanked individuals – around two billion – collide with outdated regulations and policies. Antonio Separovic, Founder and CEO at Oradian, believes regulators must embrace innovation to solve financial inclusion challenges.
In light of new technology, the financial services sector is undergoing rapid transformation and it’s time for regulations and policies to adapt as well. Regulators must embrace innovation and enable the sector to correct flaws in our current financial system that leave certain communities disconnected from the economy.
The case for digital financial services
Financial institutions are looking to digital financial services (DFS) as a way to serve individuals, many of whom live on less than $2 per day, in rural hard-to-reach communities. With DFS, essential banking services, most notably loans for small business, secure ways to save, convenient money transfers and bill pay become more accessible and more affordable.
Financial institutions that provide DFS also benefit. Unlike with cash and pen-and-paper accounting processes, financial institutions and their decision-makers gain accurate, digitised data that can be used to make data-driven, informed decisions. With digital financial services, leaders of financial institutions can know and control their portfolios.
Macro or micro?
Innovation in banking is occurring much faster than regulations are evolving. Central banks that regulate emerging markets are criticised for their preference to cater to the needs of Tier 1 banks over individuals who are excluded from the financial services industry.
More often than not, traditional banks do not meet the specific the needs of unbanked people, and leave these communities isolated from the global economic system. A study from Elixirr in 2015 revealed swathes of micro, small and medium enterprises (MSME) owners in Uganda held strong levels of distrust conventional banks. The focus group interview revealed that they were wary to use ATMs or online banking platforms, afraid that money would never reach the recipient. MSME owners in these regions can rarely afford introductory fees to open an account with a bank, and are often located only in large cities, far from isolated, rural communities.
Advances in payment technologies and cloud platforms have the potential to render these barriers to entry obsolete. In fact, cloud-based banking is now enabling an entirely new way of banking in many frontier markets. Because of cloud-based solutions for financial institutions like cooperatives, rural bank and microfinance institutions, the potential to reach rural areas with limited network bandwidth and low barriers to entry has never been higher. With new technology, non-bank financial institutions are enabled to become more efficient, grow and serve more individuals in their communities.
And given the lack of trust in commercial banks, out-of-reach pricing and inconvenient locations, non-bank financial institutions are often the most viable option for individuals seeking loans, savings accounts and microinsurance. Commercial banks often require collateral to secure loans, require government issued IDs, require a credit score and have high minimum loan sizes that aren’t suitable for microenterprises. Their requirements can block individuals from accessing their services. Because of the strict requirements from commercial banks, many individuals rely on non-bank financial institutions that cater to sectors that are excluded.
There is a remarkable opportunity for central banks to realign their focus on what microfinance institutions (MFIs) can do for unbanked communities by supporting digitisation through cloud-based technology. Yet regulatory hurdles persist in many instances.
Know Your Customer (KYC) requirements are a prime example of where regulations are poorly targeted to the needs of the unserved. While comprehensive KYC regulations have been effective for anti-money laundering campaigns, they present a stark problem on a micro-level: many individuals remain undocumented.
For instance, of 338 million citizens in the Southern African Development Community, 138 million lack authentic identification from national governments. Stringent KYC regulations in Africa can block unserved individuals from financial services by requiring credentials and documents that many don’t have.
What is clear is that central banks need an overhaul of regulations to meet the needs of the excluded. By reassessing regulations that restrict these communities’ access to financial services and encouraging further deployment of cloud-based banking platforms to users, financial institutions will finally be in place to help bank the unbanked and give them a chance of a better life.
A case study to model
In the last two years, regulators in Southeast Asia have pioneered new opportunities to reach unbanked individuals. Take the case of the Philippines, the Asian Development Bank and Cantilan Bank, one of the largest rural banks in the Philippines. Cantilan Bank, as announced in July 2017, will become the first regulated bank in the Philippines to move their core banking to a cloud-based system. To do so, Cantilan Bank collaborated with the Bangko Sentral ng Pilipinas (BSP), the body regulating rural banks, to get the necessary approvals on their innovative move. Cantilan Bank also successfully gained support for the project from the Asian Development Bank – a grant to finance the financial inclusion focused pilot project.
The process included the BSP, in collaboration with Cantilan and Oradian, to operate in a sandbox environment, as to explore and review policies that regulate technology within rural banks in the Philippines. The Bangko Sentral ng Pilipinas (BSP) Governor Nestor Espenilla Jr. said: “The pioneering introduction of cloud banking in the Philippines is a key moment in solving the challenges of financial inclusion. Cloud technology can upgrade the competitiveness of rural banks and enable them to provide affordable, high quality financial services.”
The project aims to make Cantilan Bank the first rural bank in the Philippines to use cloud-based core banking technology in its operations and can set the tone for the future use of the model in other parts of the Philippines and the greater region in the future.
Advice to regulators and financial institutions
Financial institutions that are working in underserved communities know their business needs and which technologies will enable their operations to reach more individuals. Financial institutions know how to boost financial inclusion. For this, regulators should be receptive to innovations that financial institutions are leading.
Regulators are in the unique position to support their efforts to implement new technology – either by refreshing policies to allow new technologies to be implemented or with additional resources like grants for change management and technical assistance. Non-bank financial institutions must push for attention, support and change.