Financial inclusion through digitalisation: a double-edged sword
By Xenia Karametaxas, 7 October 2020
At first glance, the ongoing digital transformation offers great potential for democratising financial services by expanding access to previously unbanked or underserved groups and individuals. Recent data-based fintech developments, such as block chain, mobile payment systems, peer-to-peer lending platforms, crowdfunding and other financial services provide consumers with better targeted services and lower prices, facilitate access to credit, and enhance productivity of traditional financial institutions. While the process of integrating economic agents into the financial system, commonly referred to as financial inclusion, may create wealth and economic development, it can also be a double-edged sword. This blog post sets out the opportunities and threats that financial inclusion through digitalisation poses to the quest of social justice and social sustainability.
Financial inclusion as a public policy concern
Even though access to financial services has drastically improved over the last decade, about one third of the world’s adult population remain without an account at a financial institution or through a mobile money provider. A brief look at the data shows wide disparities, with the financially excluded almost entirely living in developing regions, with women, poorly educated, and rural individuals overrepresented.
The fundamental premise behind financial inclusion is that the expansion of financial markets leads to development, and poverty alleviation. According to its advocates, notably the World Bank, creating efficient and affordable financial products and services boosts prosperity and contributes to income equality and improves overall economic welfare. From a macroeconomic perspective, enhanced inclusion should lead to a more efficient allocation of capital and support central bank efforts to maintain price stability (see Mehrotra and Yetman 2015).
Fintech connects services directly with consumers, bypassing financial intermediaries. Sitting at the crossroads of financial services and the digital market, fintech lowers entry to the market for new financial providers, which gives rise to new business models, applications, processes, and products. Furthermore, fintech offers the promise to reach people and businesses in remote and marginalized areas. An example frequently mentioned in this context is the Kenyan mobile payment provider M-Pesa, which substantially facilitates digital cash transfers by providing mobile banking access through standard text messages. In a country where many people have cell phones but no debit cards and, especially in rural areas, where poor infrastructure has made going to the bank burdensome, M-Pesa appeared as a leading example of a fintech company responding to an unmet market need.
In this way, financial inclusion is an enabler of other sustainable development goals (SDGs) to reduce poverty and promote gender equality economically. Fintech enables this by driving down transaction costs in the provision of capital and credit (see Suri and Jack, 2016). The emphasis on financial inclusion in the 2030 SDG agenda is premised on the important role that the financial system plays in the shift towards a circular and more sustainable economy.
Advantages and risks of the technological transformation
While the fast pace of financial innovation has exacerbated policymakers’ interest in financial inclusion, we should not ignore the multiple unintended economic and social consequences, which raise policy questions about appropriate regulation and supervision.
Firstly, financial inclusion blends financial logics with the idea of social justice and equality (see Mader, 2018). Yet, financial markets are fundamentally responsible for creating inequality. Incorporating underprivileged and often poorly educated people into the financial system through advances in technology may reinforce existing inequalities and lead to an increase in indebtedness, especially in developing countries with a less established traditional banking system. The widely acclaimed example of M-Pesa (see the UNGSA Annual Report 2017), for instance, has led to a higher level of over-indebtedness of individuals and small businesses (see Bateman et al. 2019).
Secondly, while one of the great powers of technology is its global accessibility, its decentralized nature may pose a significant systemic threat to financial systems (see Magnuson 2018). At first glance, the arrival of new depositors creates more diversity on the lending market which, in turn, contributes to financial stability. However, expanding access to financial products and services may also lead to excessive credit growth with inadequate lending standards and, thus, to instability in the lending market.
Thirdly, since virtual currency transactions are irreversible and do not come with traditional protection due to the absence of a physical exchange, fintech also presents new concerns about consumer and investor protection (see Mader 2017). Access to lending and credit can also raise concerns about privacy and the way data is employed or exploited. An example in this regard is India’s centralized strategy for managing its digital financial transformation, the Aadhaar System, contested for its unconstitutionality before the Indian Supreme Court and described by its opponents as a mass surveillance technology (see Henne 2019). Indeed, wwhereas traditional financial institutions are bound by a detailed regulatory framework to protect the use of their customer’s data, fintech companies often do not fit into existing legal categories, which may allow them to avoid compliance with data protection regulation.
Turning digital transformation into inclusive growth
What is the appropriate way for policymakers to regulate and supervise fintech? This question goes far beyond the scope of this blog post, yet I would like to propose some avenues of reflection. The challenge is to ensure that fintech develops in a way that maximises the opportunities and minimises the risks for society as a whole, which is all the more relevant as fintech companies, and individuals or small businesses are not operating on a level playing field.
Directing fintech innovation towards inclusive growth and increased social equity involves coordination on an international level that brings together all relevant stakeholders such as fintech companies, standard-setting bodies, and national financial regulators. Financial regulators need to take into account the international dimension of fintech and align their actions on a global level, notably by developing good practices for regulating and monitoring fintech innovation (see UNSGSA 2017). From a perspective of social justice, it is important to ensure that developing and emerging economies, often confined to the role of standard-takers, are able to express their voice and take an active part in global standard setting.
This blogpost is based on a research paper written in collaboration with Prof. Kern Alexander (University of Zurich).
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