How financial inclusion must evolve to enable a COVID-19 recovery

Sub-Saharan Africa has long been one of the financial inclusion sector’s top success stories. But according to David Ferrand, despite strong gains in inclusion across the region, the overall impact of that newfound financial access has been disappointing. Even before COVID-19, there were few signs at the macro level that the continent’s financial sector was set to drive the level of investment needed to achieve sustainable and inclusive economic transformation. And now, as the pandemic has caused a health and economic crisis that threatens to become a financial crisis, there are growing questions about how the sector should respond – and whether it can play a leading role in helping Africa to “build back better” after the pandemic ends.

Ferrand is the former director of FSD Kenya, and was involved in the inception of the FSD network nearly 20 years ago. In the Q&A below, he discusses the current challenges and future outlook of sub-Saharan Africa’s financial sector – and how financial inclusion players can help the region emerge stronger after COVID-19 subsides.

First, let’s focus on the positive: Describe some of the key signs of progress in financial inclusion and its impact on broader development across Africa – what’s most encouraging to you?

We are beginning to get to real scale in many markets such that the network effects of financial inclusion can be achieved. Creating at least a basic financial connection to a majority of the populations in a number of African countries is highly significant. An effective real-time low-value retail payments system has tremendous value first for the immediate functionality it offers, but second for the potential it opens up.

There are lots of bright sparks of real impact – exemplars of where financial inclusion is making a difference. This goes back even to microcredit (which has somewhat lost its place in the sun in the last few years). Recent research has finally caught up with what those who were closer to the field were saying for a long time – credit can be great when it makes sense, but it is only in a minority of cases where credit was the binding constraint for micro-entrepreneurs. Graduation programmes show how more integrated approaches are needed if we’re to expand the extent of impact.

Despite these gains, there are reasons to question their overall impact on underserved communities. What has been most disappointing to you on that score?

Without doubt the most disappointing development has been the emergence of serious consumer protection problems. We’ve seen some pretty predatory lenders riding on the back of the microcredit story. The principle of “first do no harm” applies to development as much as medicine.

But the persistent overselling of a simplistic narrative about financial inclusion is pretty disappointing too. It is one thing to be wrong (or at least far from right), but to willfully ignore the evidence on the basis of a dogmatic adherence to a conceptual worldview is less forgivable. Ironically, financial inclusion could have more impact if we stopped insisting on its singular importance, and instead preconceived it as part of a necessarily much broader approach to addressing the constraints to economic and social inclusion. Financial services provide valuable tools, not panaceas.

What are the main factors preventing financial inclusion efforts from having a greater impact on the people who need it most?

The starting point is probably conceptual. There is much talk at the moment about making finance relevant to the real economy, but we’ve yet to explain sufficiently clearly what this means in practice. There is a danger that it will become just another empty slogan. In a way it is actually quite simple – finance is not magic: It is only going to create value if it enables something useful to happen in the real world.

A huge elephant in the room is affordability. How can someone whose average daily income is equivalent to $2 pay transaction fees of 5%-10% to manage their money? Technology offers unprecedented opportunities to make relevant financial solutions affordable.

Finally, we shouldn’t underestimate the importance of trust. This obviously starts with eliminating the rogue players from the system and addressing systemic issues. But an arguably even harder nut to crack is making sure that the financial services provided to low-income communities are actually comprehensible to them and make sense within their own frames of reference.

What are donors and development organisations doing wrong, in terms of programming priorities – and how can they turn things around?

Often development partners are lofty in their rhetoric, but insufficiently ambitious in terms of what they actually do. First, there are too many incentives to simply do the same things endlessly in the face of evidence that they have little or no impact. Plain vanilla financial education and poorly engineered loan guarantee schemes keeps reappearing. Second, there is a lack of real seriousness about taking a systemic approach to development. Too many superficially attractive initiatives are funded without any credible path to system change.

What should financial services providers themselves be doing differently to increase their impact?

A realistic starting point is whether they actually want to do so or not. The notion of the “Fortune at the Bottom of the Pyramid” led to enticing but deeply flawed thinking. Of course there are a few areas in which there are short-term gains to be made. Mobile money can make a good return for shareholders while offering real value to low-income people. But this is the exception, and there is an increasing amount of credit provision which is simply extractive. A genuine commitment to the long-term is essential. The huge unrealised potential in Africa and its people does represent a fortune at the bottom of the pyramid – but realising it will take patient investment.

What are some of the biggest obstacles to the changes you’ve laid out above, considering the considerable financial pressure providers and development players are under in the current crisis?

The demand for short-term returns was hugely problematic before we went into the crisis. There has clearly been significant value destruction during the COVID-19 lock-down period, but there is no real understanding of where the losses have been distributed and how they are to be resolved. Exceptional degrees of collaboration are going to be required, including between governments and the financial sector.

COVID-19 has clearly increased both the challenges facing the sector, and the costs of failure. But it has also opened up some opportunities. How can financial sector players respond to the crisis in a way that positions them to meet communities’ short-term needs, and contribute to longer-term growth on the continent?

There are financial sector players positioned to play a pivotal role in restoring liquidity to communities and investing in rebuilding. But it would be unrealistic to expect that financial sector players can do this alone. There needs to be a new partnership between financial sector players, communities and governments. Only governments have the balance sheets necessary to bear the risks needed – but they need help from across the financial system in providing the support where it is needed. There is a need for genuine innovation in developing solutions to deal with the human and economic losses.

There’s a lot of excitement about the opportunities of digitalisation within the financial sector – but there are also growing concerns about the consequences of getting this wrong. Looking forward five years, what’s the best-case scenario for the impact of digital finance in Africa, and what’s the worst-case scenario? What can be done now to ensure that actual outcomes are closer to the former than the latter? 

Digital transformation has extraordinary potential to change our societies, leading to ever greater economic, social and cultural integration of countries and the world. The best-case scenario is that we can start to reap the potential of digital finance to empower the development of local communities. It means acknowledging the massive imbalances in power and resource endowments. To take this high road requires long-term investment in people and their communities. Commercial finance has a huge role to play here in enabling markets to work and allocating resources. But it cannot do it alone, and we will need to see blending of finance from impact/developmental and governmental sources.

The worst-case scenario is that we do not acknowledge these imbalances. Digital technology has huge network economies associated with it, leading to the risk of domination by a few massive players who could readily suppress innovation. We could see an increasing problem of consumer and labour rights being undermined.

We need to create an open digital economy which will be powered by open digital finance. This isn’t about sweeping away regulation (which will all but guarantee the worst-case outcome). Rather it is about developing ways to harness the potential of digital. We need payment systems run as utilities, not as sources of massive rents. Digital identity has to be universal and ultimately a basic right for citizens. Data must be owned by the consumers and businesses that generate it. Market conduct needs to be regulated effectively – not through generating ever more rules – but on an outcomes basis. Players in digital finance must be prepared to accept responsibility for what they do – their obligations cannot be reduced to mere compliance. This need not fetter innovation – regulators around the world have developed sandbox models which allow genuinely valuable innovations to be tested and emerge safely.

Highlight one traditional financial sector player, and one fintech innovator, that are currently finding the right balance: both making a tangible positive impact on people’s lives and developing a viable business model that isn’t reliant on donor funding or venture capital.

It is easy to point to several banks and innovators who have made genuine progress from earlier positions and have done so profitably. The examples are pretty obvious in the market I know best – Kenya – and I scarcely need to point to them. That they really made progress and were able to do so viably is clearly very important. Had they not succeeded, we would be much further back. But we are so far from having a financial system which really works for Africa that I think we should rather focus on where we need to go next. I’m less concerned about seeing successful business models replicate.  Where there are no structural or regulatory impediments to competition, replication and scale-up happens pretty reliably. (Of course, I’m not saying one should be sanguine about these barriers). The point where finance is most interesting at the moment is precisely the point at which the business models are uncertain.

There’s a natural tendency for development professionals to focus on the positive, but what’s your most clear-eyed, brutally honest prediction on the likelihood that the financial inclusion sector will turn things around in the coming decade? Does the sector have what it takes to overcome the considerable challenges it’s facing?

Much depends, I think, on factors beyond financial inclusion. The indications remain relatively positive that COVID-19’s health impact on Africa will be relatively bearable – notwithstanding the tragic loss of life. But we still don’t know yet the eventual economic cost to Africa, either in absolute terms or how it will be distributed. There is a very real concern that the recovery from the crisis could see the micro and smaller-scale business sectors re-emerging significantly disadvantaged with respect to larger scale. And many people who have lost their livelihoods in the crisis may end up in long-term poverty traps. This is sadly not hyperbole – the continent is replete with people whose lives have never recovered from a major shock and remained locked in poverty.

There is lots of talk of building back better, but less in terms of concrete innovative action. It will be unfortunate if we see the same sort of response to COVID-19 as we did to the global financial crisis, in which the opportunity for decisive action was lost, and far from building back better we simply returned to the status quo. But I do remain optimistic. We may yet see waves of crisis and the failure of many financial institutions. But this in itself could provide the impetus for new, better forms of finance. We have all the means at our disposal to develop truly inclusive financial systems. The question is whether we choose to do so or not.