DIGITAL FINANCIAL SERVICES AND FINANCIAL INCLUSION

Vagish Mishar and Rajesh Kumar M.Phil Research Scholars, School of Economics

University of Hyderabad Telangana, India

Abstract

A significant number of the world’s emerging economies share a common hurdle – The untapped

potential of financial services. With a huge number of adults, mostly women who doesn’t have

any access to financial services such as investment products, lines of credit, mortgage loans and

insurance has put these countries’ GDP growth rate at a perilous situation. Difficult access, limited

product choice and higher price among other intangible costs like travelling expenses can be

blamed for it. Fortunately digital financial services can prove to a turning point for this scenario.

Keywords: Digital Finance, Financial Inclusion, GDP

1. Introduction:

Most of the developing countries and the emerging economies are facing the same problem of their

major population being financially excluded. This is due to different factors ranging from financial

literacy, to transaction costs and other social stigmas. But with the fast emergence and accessibility

of Digital Financial Services things has started to look differently. In many African and Latin

American countries mobile money accounts have exceeded the bank accounts and also made

people more accessible for loans insurance and other financial services. In India Digital Financial

Services is not a recent phenomenon but even now people are still not aware of all the benefits and

services provided by it. India having over more than 80% mobile penetration has a huge advantage

of popularising DFS and bringing people under the umbrella of financial inclusion and offering

them financial services like savings, credit, insurances etc. for something like this to happen the

government, the service providers and regulatory bodies have to work on strengthening the digital

infrastructure of the country and providing people basic financial literacy about DFS trough agents,

Business Correspondents and others. DFS in India has a huge potential to serve the masses but

for that all the organisations in the digital ecosystem have to work in sync. Digital Financial

Services can also be very helpful to the SMEs and the small merchants in optimising their financial

needs and have a hassle free transaction.

2. A Contemporary Analysis:

Recent researches has revealed that around 1.6Bn people are in need of financial services among

which more than half of them are women. This untapped potential could unarguably increase the

volume of loans extended to individuals and business as well help government to save around a

$110Bn/annually by preventing leakages on spending and tax revenue. Thus enabling the

government to focus more on relevant issues and boosting the annual GDP. A significant rise in

GDP eventually would open up newer opportunities for job creation.Among most emerging

economies, India would be the perfect beneficiary to the cause with an expected GDP growth rate

from 10-12%.

As digital technologies like mobile phones are becoming more readily available to the general

public, the opportunity for digital finance making a precise inclusion into the socio-economic

activity of the society increases. Reports have revealed that while a very huge proportion of the

population, almost 80% in India has proper access to mobile phone but only a mere half of them

have/had any financial accounts. Fortunately this could prove out to be a boon as mobile phone

penetrates deep into the day-to-day activities of an individual, he/she is more likely to use it further

for their financial services. Thus lowering the cost of providing financial services significantly,

which we have witnessed in the African countries and they are doing great in this area.

In India even less than one percent of the total payments are done through digital portals and other

digital payment platforms even after all the innovations, technological advancements and fintech,

which is way less than that of the other developing nations and emerging economies like that of

South Africa, Peru, Philippines, Chile etc. But with regulatory changes by the government and the

schemes like that of Direct Benefit Transfers in which all the subsidies and other government

monitoring benefits directly go to the bank accounts of the person, the volume of the digital

transaction is going at a really fast pace and suppose to show exponential growth in the coming

years.

Figure 1: Percentage of total digital transaction by volume, 2014.

Source: McKinsey Global Payments Map; World Bank; McKinsey Global Institute Analysis.

But to ensure a rather smooth and efficient functioning of all digital financial services,

governments and businesses need to cooperate with each other laying down the building blocks of

the digital infrastructure. These building blocks are essential for the proper functioning of any

digital financial services and their inclusion. This can be done by ensuring a dynamic environment

for businesses involved with financial services to prosper, reinforcing the existing mobile and

digital infrastructure and promoting the need of digital financial products.

2.1 An Empirical Analysis:

Almost all the developing countries and emerging economies are facing the problem of untapped

potential of financial services and people being financially excluded. This is a major problem in

the regions like South Asia and Southeast Asia. Main sufferer of this are women, poor and rural

population which are financially excluded and constitute around 70% of such population. Digital

Financial Services along with MFIs and financial institutions can provide solution to the financial

exclusion of the major part of the population. But for this to work the government along with the

service providers need to invest in digital infrastructure and providing financial literacy to people

so that the transition from cash to digital platform be swiftly. Also the financial services should be

made in the way that they target the financial excluded population and fulfil their needs.

Looking at the larger picture, around 642Bn people in the South Asian region alone are excluded

from any sort of financial services. Among which 71% of them are from the rural background and

57% are women.Apart from that there are around 35Mn un-served or underserved Micro, small

and medium-sized enterprises (MSMEs) with a total credit gap of $170Bn within this region of

South Asia alone. As 90% of all payment transactions occur through cash, it stands up as a major

hindrance for financial institutions to provide better financial services to these individuals and

businesses.

Figure 3. : Micro, Small and Medium Sized Enterprises across developing regions and their

access to credit

Excessive reliance on cash can prove to be disastrous as it creates a leaky pipeline for tax revenue

and expenditures on the government’s behalf, enabling corruption, weakening the very pillars of

democracy that it serves. According to an International Monetary Fund (IMF) report, it was

estimated that barely 43% of the supposed subsidies on fuel worldwide goes to the wealthiest while

a mere 7% reaches the intended target group i.e. the poorer section of the society. Cash payments

can also at times pose hindrance to competition in the market, depriving the governments of its

valuable tax revenue and impede on proper business investments.

These issues can be easily resolved as more and more individuals and businesses embrace digital

payments, they would involuntarily create a trail of data from their receipts and expenditures. This

information could prove useful for financial service providers to gauge on their credit risk appetite.

This information can be considered useful not just for the financial service providers but the

government as well since that would enable them to formulate policies for a larger set of borrowers

and lenders.

As digital payments permeate into the society deeper, the utility of these services can be shared by

everyone. As mentioned earlier on how there are more women without any financial accounts than

men. As various other studies revealed that a notable portion of a women’s expenditure goes on

food, education and healthcare. Thus as more and more women realise the utilitarian benefits of

digital payments, the welfare and productivity of their families would increase manifold

eventually. Over time digital finance can eventually help in reducing poverty & hunger, eradicate

gender inequality and revamp the existing education and healthcare systems.

The increased productivity can improve GDP growth rate by an exceptional margin gaining huge

profits as less time and resources are spent on manual procedures like procuring paper documents

for record keeping. The government on the other hand can amalgamate the informal businesses,

which means the GDP estimates would be better and higher than before. Especially for countries

like India, they might witness an overall increase of 4.8 in productivity, 6.8 increase in investment

and 0.2 increase in labour availability by 2025.

2.2. An In-depth Analysis:

As mentioned earlier, the benefits of digital finance are far-flung but to reap those benefits, certain

infrastructural improvements must be taken care of initially. First and foremost, widespread mobile

connectivity and ownership must be ensured regardless of the socio-economic status. For ensuring

the success of digital finance it’s important that even the poorest section of society has affordable

access to mobile phones and data plans. Secondly and arguably the most essential factor of digital

finance is ensuring a robust payment system, acting as the backbone. For a safe, low-cost and

reliable transaction facility between any two parties, this is of utmost importance. For such an

environment to coexist at the same lines with a profitable and innovative business model, a broad

set of merchants and business has to be compelled to accept digital payments. Third would be the

existence of a well-disseminated personal ID system reliable enough such that financial services

can verify individuals as and whenever required.

Apart from the aforementioned initiatives it’s necessary that people are aware of the benefits over

existing alternatives. It’s is important to note that the new digital payment services are obligated

to provide a more cost effective and better utilitarian alternative product to use over the pre-

existing ones. Thus it the government might have to step in with incentives and certain policy

measures to promote digital financial services adoption during the early stage of market

development.

Figure 4: GDP Impact of Digital Financial Services

If properly implemented, digital financial services promise a bright future of development and

other facilities in the long run. For an instance, with increased transparency and instant availability

of information about the users, a new door to various types of financial services open up like

lending credit to those who deserve it, the ones with proper credit-handling characteristics. Thus

as more and more people transact digitally, in small amounts, newer business model ideas are

created developing the e-commerce and on-demand service market in the economy.

As mentioned previously, some of the major issues to digital financial services implementation are

deep rooted within the socio-economic scenario. With difficult access to branches that avail certain

financial services, it seems that people living around the urban are well off that their counterparts

in that aspect. Sometimes even for the urban dwellers the bank officials in their respective branches

are intimidating making them lose their trust on the banks. The worst affected among these are

women.

As proper financial services aren’t readily available, people often resort on make transactions on

cash or prefer to stock up on cash at home rather than saving it in bank deposits. Some even invest

on livestock or gold forgoing the opportunity to earn interest and building a proper credit history.

Thus without a secure and cost-effective alternative, many households don’t have the ability to

invest in their future securities. The scenario is worse in India among all other emerging economies

with only a mere 15% of the whole population involved with any sort of digital financial services.

Economic development is a long-term promise or an investment into the future and digital finance

can exponentially speed up the progress, reliably and at an affordable cost. With already pre-

existing digital infrastructure, it’s a matter of time and when the government and business would

wire it up and create the products that society needs. Fortunately digital technologies are spreading

at an extraordinary speed transforming lives in ways unimaginable. The use of these technologies

has already become part of how people communicate with their family and friends, or the way they

read news or even find a job. Thus as it’s quite obvious, the finance sector is just waiting to be

tapped into.

3. Digital Financial Inclusion Prospects:

In fact digital technologies has the potential to revolutionise the finance sector by providing easy

financial solutions to how certain financial needs are accessed and by decreasing the cost of

providing financial services significantly. As the cost of providing financial services goes down,

more and more financial service enterprises would be willing to serve the poorer and remote

consumers of the society. Last and arguably the most important among all, digital financial

services open up a new opportunity for newer business models to come up, offering newer services

to customers which results in diversified revenue stream for the providers. That one thing to keep

in mind is that these benefits are opportunities which complement each other forming a virtuous

cycle in the economy.

The cost of setting up proper digital financial service infrastructure might be quite high but the

eventual progress made with each step towards a more diverse network of digital financial service

would reduce costs in the long run. Lower costs would mean a profitable and sustainable service

to a wide range of customers. As more users diverge into using digital finance, the economies of

scale drives down costs significantly attracting more people in using such services. Once there are

sufficient active users in the financial service which creates an incentive among various enterprises

and the financial providers to further create a various other products for the customers to use

actively.

Financial services in actual reality mayn’t seem like a distant dream since a sort of digital

technology already exist around us today. In an ideal economy, emphasizing digital payments more

than the traditional use of cash, the customers can receive or make payments accordingly. The

individual can receive remittances; wages among other governmental subsidies while at the same

time make payments to stores for their purchases. All of these are possible with access to the

Internet supported by a mobile phone.

The use of digital finance is such a way removes the need for an individual to deposit and withdraw

cash from their bank accounts when they need. Before the existence of financial services

individuals receiving their salary would withdraw the full amount in cash as soon as they receive

it for fear of running short of liquid cash when needed. Fortunately here in India, among the 63%

financial account holders 53% of those account holders have access to a mobile phone

subscription. Thus it’s quite obvious that the cost incurred for digitizing the financial services has

been lowered substantially making it readily available to a wide range of customers.

But the benefits aren’t for the customers alone, the financial service providers can profit

significantly as well, since the cost of providing financial services to the customers through a

digital portal can be 80-90% cheaper than using physical branches. In a country like India where

the network of digital infrastructure is already spread out, the overall cost for providing such a

service decreases due to economies of scale. Thus with a lower cost base the providers earn a

decent profit which wouldn’t have been possible without the advent of digital finances.

Considering India in particular the transaction cost per digital credit transfer is almost at 0.30$

which is still quite high considering the amount of digital infrastructure users around the country.

Regardless of that fact India still stands at the minimum scale required to operate digital financial

transaction profitably as seen from the figure below.

Figure 5 : Digital Financial Services and its Operational Efficiency and Service Costs.

Source: McKinsey Global Payments Map 2016 (2014 data).

The aforementioned diagram shows India’s position in the Digital Financial services market, as

it’s quite obvious that it’s in a favorable position where the transaction costs per digital credit

transfer is reasonably lower than most other developed countries. Even though countries with a

higher volume of digital transactions have a lower transaction costs per credit transfer, there is still

a lot of room for further improvements. Fortunately for India it’s just at the “sweet” spot where

the unrealised potential is yet to be siphoned.

These potential can be achieved by taking advantage of the third party individuals who are

involved with money transactions at a much lower price than what the other financial services can

avail. The difference in costs of transaction money between the lenders and customers in the

agent’s business and the bank’s business seems to be quite lopsided as well. The bar graph

portrayed below is proof of the fact that financial services are readily available at a cheaper rate

from various third-party agents rather than the banks and financial service providers.

Figure: 6: Comparison of Average cost per Transaction (in INR for an Indian PSU bank).

Source: MicroSave IFN 80, Driving Viability for Banks and BCs.

An important aspect of the aforementioned graph that needs special attention is the average cost

for opening a new bank account, with a Indian PSU bank branch and an agent. The difference

between the two is significantly huge as compared to the other aspects of financial transactions

costs incurred. Another aspect that has some significance but not as much as the previous is the

costs incurred in the recovery of NPA (Non-performing Assets). If taken care of properly, these

aspects can reduce the price of providing financial services to the excluded community at a much

cheaper rate which would ultimately result in better financial inclusion

The above image on the other hand shows a relative comparison between the transaction costs of

providing financial services through various means. Making transactions through a bank branch

seems to be costliest with the least amount of outreach, leaving out a significant portion of the

customers without any financial fulfilment. It is also wise to note that in developing countries like

India where the mobile network penetration is deeper than its counterpart in terms of infrastructure,

the potential for siphoning these technologies to gain more customers and providing financial

services to the excluded seems prominent.

Thus with an improved and efficient business model banks can leverage the already existing

potential of needy customers and maintain a cost-effective as well as sustainable digital financial

services through the existing technological infrastructure. The path to a full-fledged digital

financial inclusion doesn’t come without any hurdles. There are a number of challenges like large

number of resources involved at supporting small-scale transactions, completing paper works

which can be quite inefficient and daunting at times, lower outreach towards including everyone

in the society towards a scenario where digital financial inclusion is not just a myth.

4. Challenges to Digital Financial Inclusion:

Some of the challenges to full-fledged financial inclusion can be mentioned as follows: An

important approach towards digital financial inclusion is ensuring that the business model is

market-led and profitable for the providers. It also has to be scalable just enough to provide

adequate outreach to all section of the population.

Innovation is also as important as maintain profitability since the demand of a certain financial

services and its elasticity has to be ascertained beforehand. Achieving it, the financial service

providers can thus pay better heed to consumer expectations and their needs.

Another major challenge towards financial inclusion is the dormancy rate of customers. It is wise

to note that as more and more customers go inactive after registering to a financial service, it gets

costlier for the service provider to acquire that specific customer back on track. According to a

2010 CAGP survey report, it was found out that 64% of mobile managers reported that only 30%

of their total registered users were active.

Finally, restrictions to payment systems, high risks of money laundering used in terrorist funding,

ensuring security to the illiterate about their savings and certain technological patents can prove to

be a huge hindrance to economies of scale. They add up costs both to maintain and at certain times

to be accepted along with a licence. Fortunately for countries like India, with the help of external

intervention, digital financial inclusion might as well be possible soon. For example, in India the

RBI has made the two-factor authentication system mandatory for any sort of e/m transactions

while at the same time the government has relaxed many bank agents to hand out savings account

to the needy without any need for KYC documentation.

5. Conclusion:

Digital financial services has grown multiple folds in past years providing people financial services

who were earlier under served and taking under the umbrella of financial inclusion. Low cost and

extensive reach of digital financial services (DFS) has made it as one of the major tool to provide

people the basic financial services. Also, the road of digital financial inclusion is not even half

travelled and has many challenges which regulators and service providers need to work out with.

Financial Inclusion has been priority of the government agencies and regulators from the past

decade or so to achieve Universal Financial Access goal set by the World Bank. But with the new

government in the past three and a half year is investing heavily in the digital financial services

and digital infrastructure. They opened up the path of digital economy for achieving the goal of

Financial Inclusion. With these progresses we see that monads for financial services being

accessible for all are getting in line in India. Now the digital financial services providers and

technology providers through agents and business correspondents have to go down to the grass

root level and serve the underserved and listen to the needs and demands of the customers across

the segment and deliver it. Also a huge investment is needed for developing the telecommunication

infrastructure in the rural part of India and ensuring a good provision of services that is not

inhabited by poor network coverage.

Government and the financial service providers have invested a great deal of resources to tackle

and mitigate the risks involved in digital financial services and made sure that people get good

experience while using digital financial services. Still risk management is an ongoing process and

for that all the people involved need to update themselves and make sure that no mobile money or

digital financial services fraud happens and to mitigate the risk.

With all said and done , digital financial services is a great tool to provide the underserved the

basic financial services and bring them under the umbrella of financial inclusion. We all can agree

that still a lot to done in the field of digital economy and digital financial services but with the rate

things are accelerating , we can expect that till 2020, we can achieve the goal of universal financial

access.

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