‘Financial inclusion’ is one of the buzzwords in the development circle that always finds mention. It is considered a critical component in the process of economic development. Among its many touted benefits is its potential to reduce poverty by giving the poor access to financial services. In fact, there is a concerted effort to make access to banking and financial services a basic right.
However, it is important to understand what financial inclusion really means and how it really benefits people. I was reminded of this lag in understanding by two recent news stories. One related to the finance minister, who opined at a conference that financial inclusion is a must for economic development. The second news story was about an interesting research report by Insight2Impact (i2i), which found that almost 60 percent of bank accounts in Pakistan are only used as ‘mailboxes’, for only a single transaction every month.
These news items offer two contrasting pictures. One relates to theory, the other to reality. The finance minister was dabbling in theory, which assumes that if you include people financially (by opening an account) then they will ultimately realise something good out of it. The research by i2i reflects reality, reminding us that just opening a bank account is not necessarily financial inclusion and will not automatically lead to the purported benefits.
Behind this transformation of the financial sector’s existence is a long story that many people have documented extensively through books and other media. Last year’s movie ‘Big Short’, which won an Oscar, also deals with the financial sector and its role in the onset of the global recession in 2008. In short, the financial sector has moved away from the traditional model of matching savers with investors towards the deeply complex, speculative territory of derivatives, securities, mortgage backed financial instruments, etc.
This change over time implies that an activity which resulted in a flow of funds into the real economy is now mostly directed at speculative economic and financial activity. One implication is that the number of people who could directly benefit from the traditional role of the financial sector has dwindled substantially, and is now limited to only those who are familiar with the complex notions of finance. These include those who have a specialisation in the financial sector and in investment banking, a minority that hardly make up a percent of the population in the world.
Given the role of traditional banks in the modern economy and their failure to add much to social value, the development of alternative platforms offers a ray of hope. All over the world, financial services are now being increasingly provided by smaller level firms that do add value (economic and social) through their work.
In the US, companies like LendStreet and Accion are doing something that really falls in the ambit of financial inclusion. LendStreet is helping indebted households reduce their debt by making smarter use of their financial resources. RevolutionCredit is providing credit to households to whom banks wouldn’t lend due to low income and wealth profile. eMoneyPool induces savings in poorer households through group-oriented savings. Similarly, Accion US Network enables technology use and learning for lower-income households to help them make smarter financial choices that lead to savings.
What these firms, and others like them, are doing is that they are really making the money count. There is always money within an economy or within a society, but the difference comes in the form of utilising it properly so that the majority can benefit from it. That is where the difference between the traditional financial sector (mostly banks) and the newer one comes into focus.
One of the reasons for the strong blowback against traditional banking and finance, post the 2008 recession, comes in the form of their diminishing value to society. They use depositors’ money to either invest in speculative assets or invest in riskless government securities.
The benefit of these investments is only limited to CEOs, bankers and their shareholders (to some extent). But the depositors and the larger section of the populace recognise little gain from it. In fact, their activities may bring harm to society. Two recent examples are the collapse of financial firms that set in motion the great recession since 2008, and the recent news that activities of big banks pose a threat to the existence of Indonesia’s precious rain forests.
We can see clearly see this mechanism working in Pakistan too. An analysis of the banking sector would reveal that its contribution to the population at large is limited, and banks are mostly investing by lending to the government at exorbitant interest rates.
Only a negligible portion of their gains accrue to depositors, not enough to make a difference to their incomes. In this case, financial inclusion in the form of opening accounts and depositing money is actually making it worse for the population. Consider, for example, the fact that the banks invest depositors’ money in government securities at a high interest rate. The depositors get hit twice, one from the banks’ side (which share little of their accrued profits with the depositors) and then by the government (which taxes them to pay off the principal and the interest). And if the majority of taxes are in the form of indirect taxation (as in Pakistan), then the middle class and the poor are worse off. In this case, those who do not have a bank account are saved from this predicament. In essence, financial non-inclusion becomes a blessing for them.
There is, thus, a need to move away from mere lip service to a paradigm which works towards real benefit of the people through financial inclusion. The present working of the financial system is proving to be of limited benefit (if any) to those who become part of it. It is the responsibility of the both the financial sector and the government to ensure that financial system outcomes are not stacked against the people but are, instead, in their favour.