The Financial Inclusion Team
This week's impact investing sector focus is financial inclusion. The Financial Inclusion team includes first year Investment Associates Isabel, Amy, Vinayak, Giselle, Alice, and Pramatha, and undergrad Investment Analyst Megan.
Approximately 2 billion adults worldwide do not have a bank account. Financial inclusion seeks to provide all households and businesses with access to effective and affordable financial services. These services include but are not limited to payments, credit, insurance, and savings. Instrumental in helping people start and expand businesses, invest in education and health, and weather unexpected emergencies, financial inclusion is considered by the international community as an enabler for 7 of the 17 Sustainable Development Goals. Recent financial innovation, especially in digital financial technology, has given rise to many companies looking to improve the unbanked and underbanked communities' access to services, increase their frequency of usage, and deliver better quality products.
Over the past decade there has been exponential growth in services targeted at financial inclusion. Today, 62 percent of the world’s adult population has a bank account, which is up from 51 percent in 2011.
In the US, the challenges remain less about financial inclusion (only 6 percent of adults do not have access to financial services) and more about integrating the underbanked into the mainstream. Access to formal financial services for the underbanked and unbanked is limited and, when available, tends to be more expensive and on the ‘periphery’ of the formal financial system. In the US, through using services like money orders, payday loans, and pawn shop loans, families without a checking account pay from $220 up to $1,100 in extra fees compared to banked households who pay an average of $104 annually. This does not account for lost economic gains that households experience due to lack of access to formal financial services.
Technology, and in particular the mobile phone, will be a critical platform for financial inclusion. Technology has reduced the cost of scaling and providing financial services around the world. The mobile phone will be an important platform for this, with 92 percent of the population in the US owning a mobile phone in 2015. While technology-based payment approaches like digital wallets and “peer to peer” payments are expanding services, they often require a customer to link to an existing bank or credit card account. They therefore do not always directly address financial inclusion, but may help increase financial capability.
Alongside technology, transaction data facilitates better monitoring, screening and approval. Financial institutions are now establishing key partnerships with social media companies and credit bureaus to examine data related to customers’ preferred service points and technology platforms, credit worthiness, reliability in paying bills, and payment preferences. An exciting new example of this being done at scale is the ‘India Stack’ which is building a digital infrastructure on the new ID system that allows for conducting financial transactions.
Prepaid is important. Prepaid instruments, particularly the general purpose reloadable (GPR) card, has several characteristics that make it better for the underbanked: lower cost structure, more accessible reload points, less intimidating, easy to open, and lower/more transparent fees. With 1.5 billion people unable to prove their identity globally, prepaid instruments may be an important way of broadening financial inclusion.
Nonbank players are driving innovation. Startups and nonbank players are leading the charge to build businesses targeting the underbanked. In particular, many are taking the lead in introducing new financial products that address key customer pain points, improve the customer experience and focus highly on the user interface.
Financial health alongside financial inclusion. A recent trend in the financial inclusion community has been improving the financial health of the underbanked community. Financial health is defined as the ability of customers to not only access financial products but also use them often and effectively to improve financial outcomes. Due to distrust towards bank representatives, low technology literacy and unfamiliarity with formal financial services, initial digital payments have not always resulted in active accounts or improved outcomes. Furthermore, a wide array of disjointed new financial products has made it difficult for customers to pick and choose what best aligns with their needs and capabilities. The startup community has responded by introducing comprehensive suites of financial products that often transcend specific categories to include, for instance, financial education combined with consumer credit and insurance services.
Key Impact Goals
Within the financial inclusion sector, we believe that social impact is achieved when high quality, affordable services offered to unbanked and underbanked communities result in empowerment and improved quality of life. When assessing companies, we will identify their target customers, what the unmet needs of these customers are, how the company addresses these unmet needs, and existing alternatives to the company’s products and services. Then, we will assess the companies across the following three dimensions to determine whether they are improving the financial health of underserved communities:
- Access: Does the offered product/service improve access for underserved populations?
- Supply-side: penetration and availability of financial product/service offerings targeted at underserved populations
- Demand-side: information access and affordability which improve customer adoption rates
- Usage: Is the offered product/service relevant and valuable? Is the product/service being used, and how often or to what extent?
- Quality: Does the offered product/service meet customers' needs in an effective way?
- Is the product/service an improvement compared to alternative existing offerings?
- Does the product/service include consumer protection (is it non-predatory)?
By evaluating the sector with these goals in mind, we are better able to gauge the level of impact of the investments sourced.
The Financial Inclusion sector is primarily segmented into five sub-sectors in this report: (i) Payments, (ii) Insurance, (iii) Credit, (iv) Savings, and (v) Financial Capabilities. We recognize that high-potential companies offer products that transcend multiple sub-sectors, but we believe this framework is effective for understanding the financial inclusion landscape.
Payments is defined as money transferred from one individual and/or entity to another individual and/or entity. This sub-sector is comprised of both cash inflows and outflows, and has the following verticals:
- Remittances: funds that a migrant sends to country of origin via wire, mail, or online transfer.
- Check clearing: the deposit bank is where the check has been deposited, and the issuing bank is where the check was issued. When a check is cleared, the deposit bank collects the funds from the issuing banks and transfers them into the account of the entity that deposited the check. For unbanked or underbanked communities, this consists of commissions paid for cashing checks at non-traditional financial institutions.
- B2B (Business to Business): payments made from one business entity to another business entity.
- Salaries: fixed regular payments, made by an employer to an employee, typically paid on a monthly or biweekly basis but often expressed as an annual sum.
- Government benefits: financial assistance provided by the government to certain segments of a population, such as welfare, subsidies, and tax breaks.
- Bill payments: funds that are sent by an individual, family or business entity to pay for services or products rendered.
Technology innovation is transforming traditional methods of payment across these verticals. Digital products like digital currencies and mobile money are facilitating low-cost, widespread adoption of new payment systems.
The Payments verticals with the greatest potential to receive impact investments are Remittances, Check Clearing and B2B. Under the current system, Remittances and Check Clearing do not have an adequate alternative for underbanked communities. Remittances are frequently sent via high-cost transfer companies such as Western Union, removing a high percentage of a migrant’s funds. Similarly, check clearing companies charge exorbitant rates to cash checks for underbanked communities. Innovation in these two areas is critical to expanding the financials inclusion sector. There are also interesting developments surrounding B2B, particularly regarding enterprises that design products with a heavy emphasis on the “user experience.” As mentioned, digital products play a pioneering role in these high-potential verticals.
The Payments verticals with low potential to receive impact investments are Salaries, Government Benefits, and Bill Payments. These verticals are difficult to innovate in given their high transactional nature and bureaucratic stakeholders, such as the government.
Insurance instruments pool risk across a segment of a population by collecting premiums and guaranteeing compensation for a small portion of the population that suffers losses from a risky event. Specifically, for low-income households and businesses, insurance products can smooth volatile cash flows and provide protection from unexpected events like death or injury of an income-earner. Verticals in the Insurance sub-sector include:
- Health insurance: pays for medical expenses. It is often riskier and more complex to offer, and can come with high premiums and other associated costs.
- Crop/livestock insurance: protects farmers from unexpected events like natural disasters (e.g. floods, droughts). It can also be known as weather insurance, and protects from the declines in prices of agricultural commodities.
- Home insurance: a form of property insurance protecting an individual's home against unexpected accidents and often provides liability coverage to the insurer.
- Life insurance: provides coverage against the death of an insured person, relieving surviving family members from some financial burden associated with the death.
- Business insurance: minimizes financial risks associated with unexpected events like injury of an employee, a lawsuit, or a natural disaster.
Recently, there has been a surge of interest in this sub-sector. While many startups are not equipped to take on insurance risk directly, they are looking to solve different pain points under existing business models in the B2B space, such as claims management and the existing distribution system. Furthermore, increased adoption of the Internet of Things (IoT) provides a unique method for insurance companies to tap into consumer behavior.
Health and Crop insurance are two high potential verticals. They have the potential to create a large impact on low-income households' livelihoods. Recently, there has been immense innovation in building effective solutions for these complex products.
Other forms of insurance are as important, however the scale of their impact on low-income households may not be as high. In addition, local microfinance institutions and other entities have been offering some of these insurance products already (e.g. creditors using their home as collateral and thus getting home insurance).
Credit is a contractual agreement in which a borrower can receive a sum of money upfront and agree to repay the lender at a predetermined date, often with interest. Credit to low-income households, traditionally known as microcredit, was one of the earliest forms of financial inclusion to take off. Today, the sector continues to see innovation, especially with the emergence of digital lending platforms and alternative credit assessment models. Verticals in the Credit sub-sector include:
- Business to consumer (B2C): Credit to consumers has expanded beyond traditional financial institutions, with startups and enterprises offering innovative solutions that provide more affordable credit (e.g. accepting alternative forms of collateral, asset-backed lending, gold lending).
- Peer to peer (P2P): Through crowd-funding platforms online, improved services over traditional forms of community-based P2P lending.
- Business to business (B2B): Digital platforms that allow lending to small businesses.
- Government to businesses (G2B): Government-subsidized loans to small businesses with more attractive loan terms.
P2P, B2B and B2C lending are identified as high potential verticals. There has been substantial innovation in these sub-sectors allowing for more transparent transactions, more attractive loan terms and lower costs of servicing. When applied to low-income households, these verticals can create a lot of impact.
As for G2B lending, there may exist a need for improved efficiencies and better services among governmental services offered. However, we believe the potential currently for immediate and large-scale impact is limited.
Savings are defined as products that take money from consumers as a deposit and pay them a return in exchange for holding and using their money. Their return rates are normally attached to time of the deposit, as well as quantity saved. Savings often is only considered an option when a household's total income is greater than its average normal expenditure. This is a common misconception which many startups are attempting to overcome by offering innovative new savings products. This sub-sector has the following verticals:
- Deposit taking firms: financial model that pays an established rate of return to the money in the account based on time and/or amount at the time of the deposit.
- Pension and retirement funds: savings that are expected to be used in the long term as retirement income and are saved in low-risk assets with flexible interest rates.
- Money market funds: a type of low-risk investment with an expected return close to the market average.
- Non-money market investment fund: a savings product that invests in a variable return rate and has a broader scope of investment, normally customized to client risk-tolerance.
As underserved communities begin to adopt savings products in greater numbers, there are significant opportunities for innovation in this sector. Furthermore, the market variable interest rate is expected to rise and become more attractive for small account holders looking to save. New savings products are making it easier for customers to align their risk-return expectations without the need for intermediaries.
Another significant, pertinent trend in this sector is educating people to adopt a savings habit. Many enterprises are automating saving patterns, leveraging “big lifetime events” to transmit their message and grow the savings market.
We identify Pension funds and Retirement funds as high potential verticals. The opportunity for impact is high given the potential to ease the burden on younger and/or working family members when older family members retire.
Financial Capabilities are defined as the combination of attitude, knowledge, skills, and self-efficacy needed to make and exercise money management decisions that best fit the circumstances of one's life, within an enabling environment that includes access to appropriate financial services. This sub-sector has the following verticals:
- Awareness & Education: developing an awareness and sophistication around financial literacy.
- Know your customer (KYC): a business identifies and verifies its clients.
- Consumer subscription models: an individual consumer subscribes to a particular financial product or service that enhances financial literacy.
- B2B models: a business subscribes to a particular financial product or service that enhances financial literacy.
The Financial Capabilities verticals with the greatest potential to receive impact investments are Awareness & Education and Know Your Customer (KYC). There is a large opportunity to create financial inclusion products that promote financial literacy, and help businesses identify and verify underbanked populations. For the latter, this could also include alternative forms of credit score measurement for underbanked populations.
The financial capabilities verticals with low potential to receive impact investments are consumer subscription models and B2B models. The financial sustainability of companies within these verticals is dubious, assuming that the customer base is low-income communities/businesses that are based in developing countries.
Sub-Sector Breakdown: STATUS
The grid maps out the sectors and subsectors in a heat map. It denotes a first assessment of each sub-sector’s current status measured against our three key impact measures. When the sector is under-developed or underserved there are clear opportunities for new comers. However, there can also be interesting opportunities in sectors that are already developed. The opportunities can come from efficiencies, new business models, different way of targeting the clientele, and many more.
- Green represents high current development stage / offering, Yellow represents medium, and Red is low or untapped sector.
- Example: Remittances has a green box on access = Remittances are relatively well spread among population in terms of availability of services regardless of income or location.
 The World Bank, Financial Inclusion Overview, October 2016. http://www.worldbank.org/en/topic/financialinclusion/overview
 The World Bank, Financial Inclusion Overview, October 2016. http://www.worldbank.org/en/topic/financialinclusion/overview
 Dated but useful- https://www.cgap.org/blog/financial-inclusion-usspending-time-our-own-backyard