Financial Inclusion through Strategic Digital Infrastructures: Four Pillars

Professors Douglas W. Arner, Ross P. Buckley and Dirk A. Zetzsche

Commentators invariably observe that the World Bank’s 2018 Global Findex reveals that, as of 2017, 1.7 billion people lacked access to an account with a financial institution or mobile money provider, representing some 31 percent of the world’s total population of 7.6 billion.

However, what is often lost is that the vey same data reveal that as between 2011 and 2017, 1.2 billion people gained access to a financial or mobile money account for the first time.

These figures represent a truly outstanding achievement: over the past 8 years, the percentage of the world’s population without access to an account dropped from almost 50 percent to approximately 31 percent. The proportion of financially excluded people remains, of course, disproportionately higher in developing and emerging market countries than in developed countries, but we have seen very substantial progress in a number of developing countries, in particular in India where 80 percent of adults now have an account.

What has accounted for these figures?

From 2010 to 2017, much of the progress related to the development of mobile money particularly in Africa, as highlighted in particular by the 2014 Global Findex. As a result, efforts in this respect have been redoubled in recent years. At the same time, most would agree that limits have been reached in many places, although substantial potential still exists among many of the world’s poorest countries.

In addition, during this period, China experienced perhaps the single most dramatic financial transformation in history, moving from an essentially traditional and not overly effective financial system, to perhaps the world’s most digitized financial system. This process has of course taken place on the back of the single greatest decrease in poverty in world history.

Meanwhile, the greatest, most recent (2017) contribution to increases in account access comes from India, the result of a major strategy to build the infrastructure for a new digital economy and financial system (“India Stack”), which has led – among other things – to approximately 350 million people gaining access to accounts so that now 80 percent of adults have an account.

These developments are part of a global phenomenon encapsulated under the rubric of FinTech – financial technology, encompassing the interaction between finance, technology and regulation. While finance and technology have a very long relationship – with today’s cryptocurrencies being only the latest in a line of evolution dating back to the world’s first forms of money and coins – over the past decade, the FinTech era has been characterized by unprecedented speed of change combined with an ever increasing range of new participants, from startups to telecoms companies to internet and ecommerce companies, leading to new opportunities but also new challenges and risks. Today’s FinTech encompasses not only the long-term digitization and datafication of global financial markets but also the emergence of new startups (“FinTechs”) around the world and the technological transformation of finance through digital financial services in developing countries and emerging markets to most recently the emergence of giant technology firms engaging in finance such as Alibaba and Tencent (“TechFins”).

What can we learn from these experiences?  Experience to date now provides a sufficient base from which to consider strategies to support development while also identifying a range of issues that need to be considered. Based on this experience, we identify in a new report for the Alliance for Financial Inclusion four pillars of digital financial infrastructure that deserve especially close attention by policymakers in order to realize Fintech’s promise for financial inclusion and economic development.  These pillars are sources of promise, just as policymakers should continue to prudently observe the important objectives of financial stability, consumer protection and financial integrity.

Pillar I: Digital ID and eKYC

Experience indicates that identity and in particular digital identity is central to the transformation process. This is a particular challenge in developing countries and emerging markets where often substantial proportions of the population lack any form of formal identification documents.

At the same time, such systems – while technically feasible – may not be politically feasible in many countries. In these cases, systems of optional digital identity separate from national / sovereign identification systems hold the greatest transformative potential, with the EU eIDAS Directive illustrating one framework, and systems developed by Alibaba and Tencent in China representing other approaches.

Base identity is essential in and of itself for many purposes but it also provides the fundamental element of the know-your-customer (KYC) process. Particularly when linked electronically with other golden source data (such as telephone, utility, tax and address information, usually collected for other independent purposes), it provides the basis of a simple eKYC system which can dramatically reduce costs in account opening while at the same time addressing concerns regarding market integrity (e.g. anti-money laundering – AML – and related considerations). The core objective is to make it as simple and inexpensive as possible to open accounts for the vast majority of the public, including SMEs, allowing resources to be focused on higher risk customers, thereby supporting financial inclusion and better protecting market integrity. Such approaches also offer the potential to reduce the role of the shadow or underground economy, with potentially widely beneficial effects, particularly when combined with the second and third pillars of the strategy.

Pillar II: Open electronic payment systems

Mobile money has focused on a combination of simple mobile money accounts combined with mobile based payment systems, usually offered by non-bank telecommunication or other technology providers. While mobile money has been very powerful, it nonetheless has been naturally constrained by the limitations of the simple mobile devices (dumb phones) widely available in many countries so far.

The combination of digital ID / eKYC with open electronic payments provides the fundamental infrastructure to support a wide range of transactions, including e-commerce and service payments. However, it is when combined with Pillar III that the greatest potential transformation can be achieved.

Pillar III: Account opening and government provision of services

While a wide range of governments have experimented with electronic provision of government services and an increasing number are also experimenting with a range of mandatory account approaches, these tend to be of limited effectiveness unless combined with Pillar I and Pillar II infrastructure. It is this combination which has underpinned the impact of the third element of the India Stack strategy, namely providing government salaries and services electronically through bank accounts. A similar approach can be seen in the UN refugee approach in Jordan, whereby benefits are transferred electronically (via the existing national payment system and delivered via iris scan equipped ATM machines) to bank accounts established on the basis of biometric digital identification.

Such systems support financial inclusion, empowerment and savings and also – if designed appropriately – have the potential to dramatically reduce leakage, thereby increasing the impact of transfers and other payments and reducing corruption. Over time, such systems also have the potential to improve tax collection, as SMEs grow within the formal financial system instead of outside it. In addition to simple savings, the Pillar I-II-III infrastructure can also support national pension systems, which can enhance the financial safety net and also provide additional financial resources to support the real economy.

This combination – in addition to core government services – supports a range of service payments, particularly for utilities and telecommunications services, that fundamentally improve the lives of individuals and also enhance collections by service providers. With Pillars I, II and III, comprehensive infrastructure also supports ecommerce which in turn has significant benefits for SMEs, both in local and foreign markets, as increasing numbers of businesses run large portions of their activities through ecommerce platforms.

Pillar IV: Digital financial infrastructure and access to finance

In addition to the fundamental infrastructures of Pillars I-III, a range of additional digital infrastructure supports increases in access to finance as well as financial stability and market integrity. These include digitized systems for securities trading, clearing and settlement (in addition to Pillar II payment), both for debt (supporting debt market development) as well as equity. Combined with the foundational infrastructure of Pillars I-III, these systems can dramatically increase access to a range of financial services, including credit, investment and insurance.

These pillars together form a package of digital financial infrastructure, supporting both financial transformation and economic growth and development. Pillars I, II and III are foundational for Pillar IV. At the same time, in order to maximize potential benefits, Pillars I, II and III must be, and be seen as, strongly mutually reinforcing.

Crucially for their future financial inclusion status and economic prospects, of the remaining 1.7 billion unbanked adults in 2017, two-thirds have a mobile phone.

Looking forward, this digital financial transformation taking place across the world highlights two major new challenges going forward: the risk of a permanent digital divide both within and between economies, and the challenges of cybersecurity and data protection.

This strategy of digital financial infrastructure development rests fundamentally upon the availability of communications infrastructure, with the greatest potential deriving from a combination of high smart phone penetration rates combined with inefficient traditional financial systems. While this remains a challenge in a very large number of countries, supply factors are dramatically reducing the cost of smart phones while at the same time dramatically increasing demand resulting in economic conditions supportive of infrastructure development and increased access, at least in urban areas. Nonetheless, this remains a key risk going forward: the potential emergence of an insurmountable digital divide between economies which manage to put in place the necessary conditions to support smart phone access combined with a digital infrastructure development strategy and those which do not, as well as the challenge within countries of extending such access to the poorest, to rural areas and to the elderly.

While this strategy will not solve all aspects of the financial inclusion challenge, it is designed to address the large percentage which can be dealt with in this way, including the inclusion of women, leaving resources to focus on the remaining areas of greatest challenge, particularly the poorest, residents in rural areas and the elderly – who are generally also the groups who suffer the most from the digital divide.

Douglas W. Arner is the Kerry Holdings Professor in Law, University of Hong Kong, Ross P. Buckley is the KPMG Law – King & Wood Mallesons Professor of Innovative Disruption, UNSW Sydney, and Dirk A. Zetzsche is Professor of Law, ADA Chair in Financial Law, University of Luxembourg.

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