Careful What You Assume About Financial Inclusion

By: Phil Mader, Institute of Development Studies, UK

Microfinance is a key element in the global push for financial inclusion. The terms “microfinance” and “financial inclusion” are increasingly being used interchangeably. Perhaps one is gradually replacing the other, just as “microfinance” once did with “microcredit”. This switch certainly seems to be happening in journalistic reporting, as the graph below shows.

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Regardless of whether financial inclusion is just the new term for microfinance, or indeed something wholly new and broader than (high-interest, debt-focused) microfinance, the hype is real, and the efforts to promote it will affect hundreds of millions of people. Different actors have different understandings of what financial inclusion means in detail, but they generally agree it means having access to (and using) a broad palette of services including credit, savings, cashless payments, and insurance.

The assumptions underlying the push for ”global, “universal, or “full” financial inclusion will shape the effects it has on people’s lives. In a recently published paper, I examined and questioned three assumptions:

  1. There is a causal relationship running from financial inclusion to development and broader benefits.
  2. The extension of financial services is directly beneficial to the poor.
  3. There is an untapped business opportunity in providing financial services to the poor.

Why these assumptions? Because they’re core, key assumptions in the push for financial inclusion. And because there are a number of reasons to question their validity. Here, I’ll discuss three statements – for lack of a better word, “facts” – that challenge these assumptions.

Fact #1: We don’t really know how financial inclusion affects growth or development.

Many proponents of financial inclusion claim that it drives positive broader socio-economic changes; particularly enhancing economic growth, driving gender empowerment, and reducing inequalities. The Alliance for Financial Inclusion declares there is broad agreement on the “critical importance of financial inclusion to empowering and transforming the lives of all our people, especially the poor … and its essential contribution to strong and inclusive growth”.

What’s the evidence for such claims? Proponents routinely point out how countries with greater financial inclusion are wealthier and less unequal. The World Bank’s 2014 Global Financial Development Report, for instance, heavily discusses these correlations. But as any economics undergraduate knows, correlations don’t mean causation.

Indeed, the causation is perhaps likelier to be the reverse: i.e. that development outcomes drive financial inclusion. In wealthier and more equal societies, more people can afford commercial financial services. More people can calculate, read and write (probably as a result their inclusive education). And the infrastructure for a broad-based banking system exists. Indeed, you could argue that, prioritising financial inclusion over more directly reducing poverty, building infrastructure, and realising education, is putting the cart before the horse.

There’s really not much in economic theory or evidence to show that expanding access to finance has ever driven social and economic development. Expanding finance to the poor may even result in quite the opposite of economic development, if it overindebts the poor, or rations (or “crowds out”) finance for larger firms which create more and better jobs, adopt innovations, and drive growth.

Fact #2: We don’t really know how financial inclusion benefits poor people.

Is being able to save, transfer or borrow money practical and useful? No doubt – especially if the terms are reasonable. But do “we know that access to a well-functioning financial system can economically and socially empower individuals, in particular poor people”, as the United Nations proclaims? Or even that “financial services can mean the difference between surviving or thriving” (G20 Financial Inclusion Experts Group)? Some enthusiasts (for instance these scholars, p. 11) even claim that access to finance in itself already represents a form of empowerment.

Poor people can certainly use financial services in many ways. But it’s hardly evident they have a transformative impact. If the microfinance experience shows anything, it’s that scholars and practitioners have often simply assumed finance would make a huge difference, but rigorous studies later concluded the effect was hard to find, or negligible to non-existent.

Some of the claims about the benefits of financial inclusion are more vague and intangible than claims about outright poverty reduction. The widely-praised book Portfolios of the Poor, for instance, evocatively argues that financial services are key to managing volatile and irregular incomes. The problem of having low incomes, the authors propose, is trumped by having bad financial tools. This culminates in the idea that “Not having enough money is bad enough. Not being able to manage whatever money you have is worse. This is the hidden bind of poverty” (p. 184). In such perspectives, one simplistic view of poverty (just lacking money) is replaced by another (lacking financial tools).

We don’t yet have any clear evidence that people benefit in significant, let alone transformative, ways from accessing financial services, and the present evidence from microfinance is far from encouraging. As an alternative, programmes for generating employment or social insurance (such as sustained cash transfers), could help households smooth incomes and expenditures just as well, but also raise their incomes and reduce expenditures. Yet a focus on financial inclusion (as a palliative) diverts attention away from these and other more transformational anti-poverty strategies.

Fact #3: The business case for financial inclusion is very unclear.

Many believe that the private sector holds the key to financial inclusion; authors often allude to an untapped business opportunity (Accion for instance estimates $6 to 8.5 billion of additional revenue in Mexico alone). Why, then, do billions of people not have access to financial services? Three explanations are commonly given: first, poor people still don’t recognise what formal finance offers them; second, financial exclusion represents a market failure caused by information problems; third, government is a hindrance.

How plausible are these explanations? The first may be true, but clearly goes against the otherwise accepted wisdom (e.g. from Portfolios of the Poor) that poor people are very financially savvy. Many proponents suggest that financial education is needed to make the “business opportunity” real. Suffice it to point to the very real risk of mixing up marketing and education.

The second explanation emphasises information problems, suggesting that banks exclude low-income clients due to mistrust. But is lack of trust or knowledge the key issue? The inherent transaction costs of serving low-income customers (particularly low-volume depositors) may be far more problematic, going beyond easy technical fixes like setting up credit bureaus.

The third explanation ignores the (historically perhaps uniquely) supportive role that governments already currently play: relaxing regulation, liberalising financial markets, cutting back state loan programmes, and subsidising microfinance institutions. Blaming government appears to be a relic of 1980s anti-state rhetoric, or just simply a smokescreen.

That banking on the poor isn’t impossible has been proven for centuries by moneylenders, and more recently by Compartamos Banco. But the business case for decent, supportive financial services for the poor remains very unclear. What has been attained so far hinges on high prices, lax regulation, heavy subsidies, and debt. Most “financial inclusion” until today is loans, and not inclusive finance broadly defined. The success of the mobile payments provider M-PESA in Kenya, often upheld, has proven very difficult to replicate elsewhere. Since efforts everywhere depend on high charges, philanthropic money and public subsidies, couldn’t those resources also be spent in better ways than hoping to create an uncertain business opportunity?

Check what you assume

A common saying goes: “Assumption is the mother of all mistakes”. Questioning these assumptions certainly doesn’t equate to proving them wrong. But it invites aficionados, practitioners, policymakers and students of financial inclusion to double-check what they take for granted, and why. If financial inclusion doesn’t drive development, alleviate poverty, or make that much business sense, perhaps it is time to ditch the hype.

Download the paper (Questioning Three Fundamental Assumptions in Financial Inclusion, IDS Evidence Report 176, February 2016).

Philip Mader is a Research Fellow at the Institute of Development Studies, Brighton, UK. His 2015 book, “The Political Economy of Microfinance: Financializing Poverty” builds on research which won the German Thesis Award and Otto Hahn Medal. It argues that microfinance heralds less the end of poverty than new, more financialised forms of poverty, and challenges donors, policymakers and enthusiasts to critically reconsider it.


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