Banking the Un(der)Banked: Opportunities and Limits of Blockchain Technology
Recently, Facebook released their specification for the Libra project, a global currency to connect the world and empower millions of people who might suffer from financial exclusion (the unbanked) or high fees within the financial system (e.g. remittance). This ideas are often expressed within the Crypto community where Blockchain technology can be a major game changer. In this piece we take a closer look at the unbanked and underbanked and the role Blockchain technology could play to accelerate progress towards resolution.
- The unbanked can be categorised along various characteristics like geography, gender, education or employment status. A viable approach has to take this characterisation into account in order to offer a working solution. A one-size-fits all solution might at best have no and at worst have a negative effect.
- Almost universally women are overrepresented among the unbanked, independent of any other characteristic and nearly unchanged since the start of the Global Findex database in 2011. Globally, 56% of the unbanked are women compared to 44% of men.
- Two-thirds of the unbanked have a mobile phone, but only 25% have also access to the internet (not necessarily via a smartphone) with big geographical differences. Thus, a feasible solution might not necessarily be app-based.
- One key-driver for financial inclusion could be easier identification as demonstrated by India, where the share of adults with an account has more than doubled since 2011, to 80%, through a government campaign to push for biometric-based payments and account opening.
Financial Inclusion at the Click of a Button
When it comes to Blockchain narratives in the context of social impact, the two most cited topics are banking the unbanked and the remittance fee market. Both ideas seem pretty logical given that Blockchain is often enough proclaimed as a global technology that reaches across national borders to empower people where governments and corporations fail. The most recent player to tap into this idea is Facebook with its Libra initiative. In fact, the virtual currency is positioned as a global solution for both the unbanked and underbanked, making monetary transactions as simple as a WhatsApp message. Considering Facebook’s global reach of 2.37 billion users and financial firepower, many see a realistic chance of the virtual currency making a significant impact. The numbers seem to add up as well: 1.7 billion unbanked people, cross-border money transfers take 3-5 days and the average remittance transfer costs are 7% (all numbers are taken from the Libra website). Given our current state of technology, the scale of the problems seem unbelievable and at least our general feeling tells us that a solution shouldn’t be too complicated. After all, even if not through cryptocurrencies, how hard can it be to extend PayPal to all those people in developing countries with smartphones? In this piece we examine the current situation of the unbanked and underbanked, the next steps and the role Blockchain technology could play in a potential solution. All statistics are taken from the 2017 Global Findex Database. In case that other sources were used, references will be provided.
Banking the Unbanked Is More Than Just Adding People to the Financial System
The most obvious reasons for financial inclusion and the improvement of financial services such as remittances are ethical: Accounts provide a safe way to store money, pay bills, buy goods and receive payments such as salaries or pensions. Sadly, purely ethical reasons are rarely enough to start and grow an initiative to a degree that can solve a problem. Unless economic or political reasons are presented (which mostly go hand-in-hand), the real money won’t start pouring in. Luckily, there is plenty of evidence that financial inclusion is not only good for the people affected but for everyone in this world:
- Financial inclusion is key to fragile and conflict-affected economies or areas which are affected by catastrophes such as the Ebola epidemic or earthquakes. In certain circumstances, having access to an account can make the difference between life and death if access to food or medicine is needed. Such regions usually profit disproportionately from mobile technologies, as a bank in areas of conflict might be just as safe as your mattress. As for the economic argument: Markets are made up of people, without people there is no market.
- It can have a positive effect on savings, which in turn can have a positive effect on new business development. In both high-income and developing countries, 14% of people that reported to have saved in the past 12 months have done so to start, operate or expand a business. This rate was twice as high (29%) in many Sub-Saharan African countries like Ethiopia, Kenya, Liberia, Nigeria, Uganda, and Zambia. In Kenya, a study found that access to a financial account through the mobile M-Pesa system allowed 185,000 women to save at a higher rate, leave farming and eventually develop business or retail activities. Mobile accounts also helped reduce extreme poverty among women-headed households by 22%. In Nepal, more was spent on nutrition foods (+15%) and education (+20%). And in Malawi, farmers were able to increase their crop values by 15% by spending 13% more on farming equipment.
- In many regions the cost of receiving payments, in particular from the government can be very high. As part of a study in Niger, some villages received monthly social benefits from the government digitally through mobile phones rather than in cash. On average, this saved the recipients 20 hours in traveling and waiting time - almost one entire day per month. Additionally, for governments, switching from cash to digital payments can help fighting corruption. In India, pension payments leakage declined by 47% when the payments were made through biometric smart cards rather than cash.
The studies above show that not only did the application of modern technology help advance financial inclusion, but it did so faster and more efficiently than by just using the same old tools over and over again. In particular, successful strategies targeted the specific local characteristics instead of broadly using a one-size-fits-all solution. Mobile payments were used in countries where receiving costs (distance, money or otherwise) were high, whereas biometric smart cards were targeting the unidentified. Moreover, when it came to saving accounts, women-headed households were targeted, where women were traditionally in charge of the money. Thus overall, a clear understanding of the characteristics and the distribution of the unbanked is required.
The Unbanked Are a Very Diverse Group — and Female
The term unbanked usually refers to people without a financial account. The Global Findex database defines account ownership as having an individual or jointly owned account either at a financial institution (e.g. a bank) or through a mobile money provider (e.g. M-Pesa). Globally, around 74% of the world population can be classified as an adult, of which 31% or 1.7 billion are unbanked as of 2017. Huge differences exist depending on geography and the economic strength of the country, gender, social and financial status, education, employment status and the urban-rural location. And while some differences might be obvious, such as the higher rate of unbanked among unemployed compared to employed adults, there are three points that stand out:
- Women are almost always overrepresented among the unbanked, independent of any other characteristic and nearly unchanged since the start of the database in 2011. Globally, 56% of the unbanked are women (compared to 44% men), but the gender gap varies from low single digits in most high-income economies, East Asia and East Europe to almost 30% in Bangladesh, Pakistan, and Turkey. Other notable countries with a double-digit gender gap include Morocco, Mozambique, Peru, Rwanda, Zambia, Saudi Arabia and the United Arab Emirates. The last two being high-income economies with almost universal account ownership among men but with over 20 percent points less among women. Exceptions to that are Argentina, Indonesia, and the Philippines, where there are more female account holders than male (however only slightly).
- Nearly half of the unbanked adults (46%) are located in only seven countries — China, India, Indonesia, Mexico, Nigeria, Pakistan and Bangladesh — obviously correlating with the individual countries respective share of total population. It should also be noted that a big share of the world population’s unbanked does not mean that the rate of unbanked within that country is high. For example, China is home to most of the unbanked (13% of total) but has an account ownership of 80%.
In economies with high rates of account ownership (defined as above 66%, such as China or Kenya), the unbanked are mostly poor, while in economies with 50% or less, the unbanked are equally distributed among the rich and the poor (e.g. Colombia or Nigeria). Because the Global Findex database defines “the poor” as the 40% poorest in terms of income and “the rich” as the 60% richest, this effect might be due to the very skewed distribution of wealth within the respective economy. Nonetheless, this fact has to be taken into consideration when thinking about possible problem solving approaches.
The Reasons for Being Unbanked: Poverty, High Cost and Lack of Documents
Just as the distribution of the unbanked varies among various characteristics, so do the reasons why they remain outside the financial system. By far the most common reason was lack of monetary funds, which was given by over 60% of the people as a reason and by 20% as the sole reason. Note that this is different from the reason that an account is too expensive, which was given by 26% as a reason. Approximately the same number of people named distance as a reason as well as no need of an account due to the ownership of another family member.
While the lack of funds seems to be a problem independent of any characteristic, a further breakdown of other reasons reveals economical, political and cultural differences: Latin America and the Caribbean mostly report too expensive accounts (50 - 60 %) and lack of trust in the financial system (over 30%). Additionally, Brazil suffers from distance to the next provider of financial services (33%). Distrust in the financial system is also overrepresented in Europe and Central Asia. A lack of documents in particular is a problem in Sub-Saharan Africa (all above 30%) and some East Asian countries such as the Philippines (45%) and Myanmar (31%). Interestingly, a gender gap is present when naming the reason that a family member is already in possession of an account. In Turkey, 72% of women selected this as a reason compared to 51% of men, and in China the rate was 35% of women compared to 27% of men.
Digitization Done Right Is the Key to Financial Inclusion
Despite the high numbers of unbanked adults, there has been progress overall. Although some countries stagnated, others reported impressive gains in account ownership. India doubled the account ownership within 6 years since 2011 to 80% while also closing the gender gap from 20 percentage points to only 6 in 2017. This advancement was achieved largely through the establishment of Aadhaar, a biometric ID system, and a respective electronic payment system, by the government. Moreover, the Pradhan Mantri Jan Dhan Yojana financial inclusion campaign, mostly targeting the people in remote rural areas. The nationwide push for payments through biometric authentication also led to a decrease in corruption, e.g. reducing pension payments leakage. Despite the criticism and failures following those campaigns, they have brought progress to the country through three major strategies: Digitization of identity and transactions, lowering the bar to opening an account by relaxing KYC norms and increase the reach of financial services through a network of agents like grocery stores or post offices called business correspondents.
Another impressive progress has been achieved in Sub-Saharan Africa, most notably in East Africa. Countries like Kenya or Uganda have doubled account ownership from 42% to 82% and 20% to 59%, respectively, between 2011 and 2017. This achievement was overwhelmingly due to mobile accounts through telecommunication companies like Vodafone instead of the usual bank accounts. Although this strategy has since caught on in West Africa and even some conflict-affected countries outside Africa like Haiti, mobile accounts remain mostly concentrated in the Sub-Saharan regions. Furthermore, there are signs that mobile accounts can help close the gender gap. In many countries with a high number of mobile-only accounts, like Kenya, Senegal or Tanzania, men are 18 percentage points more likely to own a financial institution account or both, a financial institution account and a mobile account. On the other hand, women are 11 percentage points more likely to have a mobile money account only. It is not clear why this is the case, but it might have something to do with the employment situation and the traditional role of women in households. Unbanked women are significantly more likely to be unemployed compared to men (59% vs. 32%). This opens up opportunities for self-employment, in particular since Sub Saharan economies rely heavier on agricultural products than other developing countries (30% of payments are for agricultural products, compared to 15% on average for other developing countries). Additionally, a a study found that after providing account owners with free automated teller machine (ATM) cards, account accessibility increased. However, this made accounts less attractive to women as they lost bargaining power when it became harder to keep personal savings away from husbands.
Another simple way to increase account ownership is to switch from cash-based payments to digital payments. Globally, 9 percent of adults — that is, around 500 million people — opened their first account specifically to receive private sector wages, government payments, or payments from self-employment. Other countries have an even higher share: In Iran, Malaysia, and Zambia it was nearly 20%, in Egypt and Kazakhstan even 40%. And in Tajikistan, an economy with just 3% of banked people in 2011, the share rose to 47% in 2017, mostly due to the government’s efforts to transfer pensions into an official account instead of paying it in cash. This of course requires a basic digital financial infrastructure. But combined with a government effort the transition from a cash-based economy to a digital economy might be an efficient strategy. In most cases, it will pay off far beyond the increase of account ownership: Increased speed of payments and reduced cost, enhanced security and transparency, less crime and corruption and significant increase in saving are just a few advantages that studies have revealed.
Digitization for the Unbanked, Blockchain for the Underbanked
Of course, digital technology is just the first important step to account ownership, but not enough to increase financial inclusion. To fully benefit from an account, people need to be able to use it safely and conveniently tailored to their requirements. A good physical and digital infrastructure, a sound payment system and a regulated environment with protection especially for the financially disadvantaged groups, like women, the poor and the less educated who might have low (financial) literacy skills. In order to understand where Blockchain technology can make a difference, we have to examine the opportunities and challenges ahead.
First, it’s important to clarify one very important requirement for Blockchain technology: the internet. Apart from the Bitcoin network, which allows to send and receive payments via satellites or even by radio (although not very user friendly yet), other Blockchain networks require an internet connection. Despite the fact that two thirds of unbanked adults possess a mobile phone, only 25% have access to the internet. This includes home computers, internet cafes as much as smartphones. And often enough these connections are unstable and the electrical infrastructure unreliable. There are also obvious variations by country: In Brazil, nearly 60 percent of unbanked adults have access to both technologies. In South Africa about 33 percent do, in China 25 percent do, and in Indonesia almost 20 percent do. The share drops to about 10 percent in Bangladesh, Nigeria, and Pakistan.
Second, the type of account usage can determine if and how Blockchain technology can help. There are two basic usages for financial accounts: payments and savings. Further, the Global Findex Database clusters payment activity into five broad categories: payments from government to people (public sector wages, public sector pensions, and government transfers); payments from businesses to people (private sector wages); other payments for work (payments for the sale of agricultural products and payments from self- employment); payments from people to businesses (utility payments); and payments between people (domestic remittances, both those sent and those received).
Globally, 23% of adults have received at least one payment from the government. The number drops to 19% if we only look at developing countries (and goes up to 43% for high-income economies). Among those between 15% and 75%, depending on the economy and the type of transaction, receive their transfer in cash or other means. As for private sector wages, the global share was 28%, with 46% for high-income economies and 24% of developing ones. However the share of wages received in cash is similar to the public sector. With economies like Brazil, China, Russia or South Africa being on the better end with around 30%, while adults in Egypt, India, Indonesia, and Nigeria are almost entirely paid in cash. From these numbers it becomes very clear that just by transitioning from cash-based to digital payments, hundreds of millions of adults can be included into the financial system. In order to do so, however, people need to be convinced to abandon cash (a reliable and flexible saving and payment vehicle) for new technologies. At the very least this requires a reliable physical infrastructure with stable electricity and mobile networks. Something that most people in high-income economies take as a given. Further, an adequate financial infrastructure is key to be able to deposit and withdraw money in all corners of the economy, since digital payments don’t cover most of the day-to-day payment activities in developing countries (like paying utility bills). Finally, appropriate regulations and consumer protection has to be put in place to protect people from fraud and abuse.
While physical infrastructure lies outside of the scope of Blockchain technology, financial infrastructure and consumer protections might offer some potential. Biometric identification cards have proven to lower the barrier to account ownership, a concept that can be further developed into a decentralized identity network where the government takes the role of a credential issuer, such that bank accounts can be opened at the click of a button. Stationary agent points could provide onramps for cryptocurrencies like Bitcoin in the form of ATMs, possibly in combination with simple hardware wallets or mobile phones. But most importantly, interoperability between the existing financial system and the Blockchain system has to be built instead of inventing a parallel financial system from scratch. If people can easily exchange their money into cryptocurrencies and vice versa, chances are they might find cryptocurrencies like Bitcoin are a better way to save money than using fiat money in their account. This provides an easier road to much needed education in order for people to understand the advantages of cryptocurrencies. Of course, the first step in this process will be to convince people to switch to an official digital account. But only if appropriate bridges are in place is the next step towards cryptocurrency possible. A common complaint among those receiving digital government transfers is that payment products are difficult to use, help is limited and lines at bank agents are long. Improving on those points could give cryptocurrency an edge over traditional digital accounts. Although it is unlikely that cryptocurrencies present a viable alternative to payments, they might provide a better way to store value.
Another sector where digitization could help financial inclusion are retail payments, in particular regarding agricultural products, online shopping, and utility. About 15% of adults in developing economies received payments for the sale of agricultural products. However, only 25% received them to an account, while the rest was done in cash. Notable exceptions like Kenya and South Africa which have high rates of digital payments for agricultural goods due to mobile phone accounts present possible opportunities. Outside of agricultural products, shopping online is another surprisingly cash-intensive business. On average, in all developing economies except China, 53% of adults pay for their online purchases with cash on delivery. Furthermore, around one billion adults pay their utility bills in cash. Providing offers to pay from digital accounts could bring higher efficiencies. As with government payments, Blockchain could provide an appropriate digital identity layer that links a national identification, the utility service and a bank account. This could help fight corruption through reducing payment leakage of water and electricity.
Finally, the remittance market and its high fees are often cited as a huge opportunity for blockchain-based payments. The current average fee for remittance payments stands at 6.84% (Q2 2019), down from 6.94% in Q1 2019 according to the June 2019 report from the World Bank. Although, in the last year fees for remittance payments from the G8 states remained stable, the general trend is a steady decline from almost 10% in 2008. The only exception is Europe and Central Asia, which went up from 6% to almost 7%. Contrary to other use cases, digitization of remittance payments don’t necessarily provide an advantage over cash. On average, with 10.5% the highest fees are paid for bank transfers (excluding credit/debit cards). This number decreases by 1.2 percentage points when the transfer is made within the same bank, but it remains significantly above the 6% at money transfer operators or even the 8.8% at the post office. However, the best option offer mobile operators with 3.3%. Although the number should be considered with care, since this includes domestic remittances — the transfer between two people from different regions of the same country — that is particularly popular in Sub-Saharan Africa, a region with high concentration of mobile phones. Despite the narrative of cryptocurrency projects to lower remittance fees they can only do so in areas with an internet connection. However, this group of people is usually the one not suffering from extraordinary high fees, although still high compared to bank transfers in high-income economies. Taking the mobile money development in Sub-Saharan Africa as an example, Blockchain technology could add value by developing methods to interact with Cryptocurrencies without an internet connection.
In this article we gave an overview of the landscape of the unbanked and underbanked by using data and research supported by the World Bank. We have also shown some examples where blockchain technology can add value. Nevertheless, the single best way of accelerating financial inclusion is to digitize payment processes, especially tailored to the disadvantaged like women, the poor, less educated or unemployed. In 2016 the Better Than Cash Alliance identified ten accelerators for a digital payment system. Among them activities like “leverage existing networks”, “establish a shared digital infrastructure”, “digitize routine cases” and “establish interoperability” could include cryptocurrencies with a better store of value or more efficient transfer properties (like stablecoins) if they built appropriate and easy to use bridges to existing networks (be it financial networks or mobile networks). Possibly even more important could be the “development of a unique identification program” through decentralized identity initiatives that use the Blockchain to anchor important metadata. Leveraging the existing infrastructure like India's biometric database could help significantly lower the barrier to open accounts as well as fight corruption through transparency. However, the first step remains the leap from a cash-based economy to a digital one. A strategy to completely rebuild a new financial system from scratch, trying to onboard the unbanked who use cash to cryptocurrencies directly might work for some, but is unlikely to help the majority of people desperately in need of financial inclusion.