Why Financial Inclusion is a Priority for Banks in Emerging Markets

Financial inclusion – the idea that individuals and businesses should have access to useful and affordable financial products and services – is not just a feel-good initiative in emerging markets. It has become a strategic imperative for banks operating in these regions. While the moral and social benefits are undeniable, the hardnosed reality is that financial inclusion presents a significant opportunity for growth, stability, and long-term profitability for banks operating in these dynamic economies. This article delves into the core reasons why financial inclusion is a top priority for banks in emerging markets, exploring the intricate details and providing real-world contexts.

Table of Contents

1. Unlocking Untapped Market Potential: The “Unbanked” and “Underbanked”
2. Enhancing Stability and Reducing Systemic Risk
3. Leveraging Technology for Scalability and Efficiency
4. Building Customer Loyalty and Long-Term Relationships
5. Meeting Regulatory and ESG Expectations
6. Conclusion

Unlocking Untapped Market Potential: The “Unbanked” and “Underbanked”

Emerging markets are characterized by large segments of the population that remain either “unbanked” (having no access to formal financial services) or “underbanked” (having limited access to basic services like savings or credit). This demographic, often residing in rural areas or informal economies, represents a vast, untapped market.

• Scale of the Opportunity: Estimates vary, but the World Bank consistently highlights that hundreds of millions, if not billions, of adults globally remain unbanked. In emerging markets, this proportion is significantly higher than in developed nations. Examples like India’s push for Jan Dhan Yojana or various initiatives in sub-Saharan Africa demonstrate the sheer scale of the potential customer base.
• Graduation to Formal Services: Bringing these individuals into the formal financial system opens up a cascade of opportunities for banks. Initial products may be simple savings accounts or basic remittance services. As customers build trust and financial literacy, they progress to more sophisticated offerings like microcredit, insurance, and even investment products. This is a gradual process, often referred to as the “ladder of financial inclusion.”
• Diversification of Revenue Streams: Relying solely on a small segment of high-net-worth individuals or large corporations can make banks vulnerable to economic downturns affecting specific sectors. Financial inclusion allows banks to diversify their revenue streams by tapping into a much broader customer base, albeit with smaller transaction values initially. The aggregate volume can be substantial.

Enhancing Stability and Reducing Systemic Risk

A financially excluded population often relies on informal and often predatory financial practices, such as loan sharks or informal savings groups (ROSCA – Rotating Savings and Credit Associations). While these informal mechanisms can be valuable, they lack the regulatory oversight and stability of formal institutions, increasing the risk of financial instability for individuals and, by extension, the broader economy.

• Absorption of Shocks: Access to formal savings and credit allows individuals and small businesses to better absorb economic shocks, such as job loss, illness, or natural disasters. This reduces the strain on informal safety nets and government support programs.
• Reduced Dependence on Informal Lenders: High-interest rates and predatory practices prevalent in informal lending can trap individuals in cycles of debt. Banks offering affordable credit alternatives help break this cycle, promoting financial well-being and reducing social inequalities.
• Improved Data and Transparency: Bringing financial transactions into the formal system provides banks and regulators with valuable data. This data can be used for risk assessment, fraud detection, and macroeconomic analysis, leading to a healthier and more transparent financial system. For example, widespread adoption of mobile money provides granular transaction data previously unavailable.

Leveraging Technology for Scalability and Efficiency

The rise of digital technologies, particularly mobile phones and the internet, has been a game-changer for financial inclusion in emerging markets. Banks are leveraging these technologies to reach previously inaccessible populations efficiently and cost-effectively.

• Mobile Banking and Payments: Platforms like M-PESA in Kenya exemplify how mobile technology can revolutionize financial services in areas with limited physical infrastructure. Mobile banking allows for account opening, deposits, withdrawals, transfers, and payments directly from a mobile phone, bypassing the need for brick-and-mortar branches.
• Agent Networks: Banks are building extensive networks of local agents (often small shopkeepers or entrepreneurs) who facilitate transactions like cash deposits and withdrawals in remote areas. This “branchless banking” model significantly reduces the cost of serving rural and underserved populations.
• Digital Identity and Biometrics: Advancements in digital identity verification and biometric technology are making it easier and more secure to onboard new customers, even those without traditional forms of identification. Initiatives like India’s Aadhaar system have played a crucial role in this regard.
• Data Analytics and AI: Banks are using data analytics and artificial intelligence to assess creditworthiness for individuals and small businesses lacking traditional credit histories. This allows for the development of innovative credit scoring models based on alternative data sources like mobile phone usage or utility payments.

Building Customer Loyalty and Long-Term Relationships

Early engagement with customers through simple financial products can build trust and loyalty, leading to a long-term relationship as their financial needs evolve. Banks that prioritize financial inclusion are positioning themselves as trusted partners in their customers’ financial journeys.

• Lifetime Value of Customers: While initial transactions from financially included customers may be small, their lifetime value can be significant as they access more services and potentially move up the economic ladder.
• Cross-selling Opportunities: Once a customer is onboarded and comfortable using basic services, the bank can cross-sell other products like insurance, investment plans, or small business loans.
• Community Engagement and Brand Building: By actively participating in financial inclusion initiatives, banks can build strong relationships with local communities, enhancing their brand reputation and fostering a sense of social responsibility.

Meeting Regulatory and ESG Expectations

Governments and international bodies are increasingly prioritizing financial inclusion as a key driver of economic development and poverty reduction. Banks are facing growing pressure to demonstrate their commitment to these goals.

• Regulatory Push: Many emerging market governments are implementing policies and regulations specifically aimed at promoting financial inclusion, such as simplified KYC (Know Your Customer) requirements for small accounts, promotion of digital payments, and licensing of non-bank financial institutions for specific services.
• Environmental, Social, and Governance (ESG) Factors: Investors and stakeholders are increasingly considering ESG factors when evaluating banks. Financial inclusion is a significant “Social” component of ESG, demonstrating a bank’s commitment to broader societal well-being.
• Access to International Funding: Development finance institutions and international aid organizations often prioritize funding for projects that promote financial inclusion. Banks with a strong track record in this area are better positioned to access such funding and partnerships.

Conclusion

Financial inclusion is not merely a philanthropic endeavor for banks in emerging markets; it is a strategic imperative driven by significant market opportunities, the potential for enhanced stability, the power of technological innovation, the value of long-term customer relationships, and growing regulatory and ESG expectations. By proactively embracing financial inclusion, banks are not only contributing to the economic empowerment of millions but also securing their own future growth and sustainability in these dynamic and rapidly evolving markets. The journey towards full financial inclusion is ongoing, but the commitment from leading banks in emerging markets signals a profound shift in their strategic priorities, recognizing that serving the historically underserved is key to unlocking their full potential.