Fintech and the Future of Banking

By Muhammad Amir CEO Rohi Support Program

Few issues in financial inclusion have generated more hype — and confusion — in recent years than fintech. Digital technology continues to inspire a dizzying array of new companies, business models, and products, transforming financial services value chains in the process. While many fintechs claim to advance financial inclusion, the link between specific innovations and financial inclusion is often assumed rather than proven. For all the buzz around fintech, it is hard for funders, investors, and social entrepreneurs to know which innovations matter for low-income, underserved customers. The excitement around fintech can also obscure risks it poses to financial systems and low-income customers, as we have seen with digital credit in East Africa.

To help funders, providers, and regulators understand how fintech is evolving and identify promising innovations, CGAP is working to bring clarity to the space with a focus on what matters for the poor. At the market level, our research has demonstrated that technology-enabled disruptors are increasing competition for mass-market customers while breaking down vertically integrated value chains in the financial sector, with potentially wide-ranging implications for financial institutions and financially underserved customers. At the level of individual financial services, we find a range of new business models emerging among fintechs, digital banks, and platforms that enable challengers and incumbents alike to put useful, user-friendly, lower-cost solutions into the hands of poor customers so that they can use them to improve their lives.

The Big Picture: How Is Fintech Disrupting Financial Services in Emerging Markets?

While some business models are more relevant to financial inclusion than others, the overall impact of fintech innovation has been to unbundle value chains in ways that could prove beneficial for low-income customers and providers who serve them. On the consumer end, this means customers gain access to a rapidly growing range of financial service providers, often with innovative models that offer products in a different way, at lower cost, with fewer preconditions, and less administrative red tape. On the back end, it means that providers themselves are able to rely on a growing range of third-party fintechs who offer highly specialized, value-adding, and cost-effective solutions to core banking processes. In both cases, highly scalable innovators are transforming financial services.

How Fintech Is Unbundling Banking and What That Means for Financial Inclusion

Banks used to be the sole providers of formal financial services, responsible for both the customer-facing and back-end aspects of delivering these services. Nowadays, fintechs that specialize in specific financial products are competing with banks on those products and often benefiting consumers by providing more choices. Poor consumers especially benefit when these fintechs bring financial products that were previously unavailable or unsuited to their needs. Fintechs that specialize in delivering specific processes and elements that go into making financial services are becoming better at those tasks, making their services available to multiple financial service providers, creating economies of scale. When combined with improved effectiveness due to specialization, these economies of scale can lower costs, bring higher quality services, and help reach previously underserved or unserved people.

The Evolution of Financial Services: A Business Model Perspective

Innovation is profoundly transforming many economic sectors, and financial services are no exception. This paradigm shift is not just bringing innovative services to the market but potentially changing the very nature of banking. As legacy banks struggle to digitize, whole new categories of business models are emerging that approach financial services in a very different way. This transformation is driven by technology forces, changing how financial services are produced and consumed, and altering the nature of retail banking as we know it.

Digital Banks: How Can They Deepen Financial Inclusion?

Fully digital retail banks, marketplace banks, and banking-as-a-service (BaaS) are three new business models that are particularly relevant to financial inclusion. BaaS, for instance, enables non-banks to offer banking services under their own brand and seamlessly embedded into their digital offering. By embedding financial services into almost any digital context, BaaS could lead to a profound evolution of the financial sector. TymeBank in South Africa, Kotak 811 in India, and UnionBank of the Philippines are examples of digital banks innovating to drive financial inclusion.

Development Funders and Inclusive Fintechs: A Strategic Approach

Development funders have an important role to play in helping fintechs at all stages reach their full potential to serve low-income customers. Funders should carefully assess which fintechs have the real potential to improve the lives of low-income customers and align their goals and approaches with the stage of fintech they are targeting. Supporting the broader fintech ecosystem with infrastructure, policies, regulations, and local capital markets is also crucial.

How Can Regulators Encourage Fintech Innovation While Managing Risks?

Fintech can harm low-income consumers if not properly regulated. For instance, CGAP’s research has raised serious questions about the digital credit boom in East Africa. Regulators must design frameworks that encourage innovation while managing risks to ensure fintech can benefit low-income consumers.

Conclusion

Fintech is unbundling banking and transforming the financial services landscape. This shift presents both opportunities and risks for financial inclusion. By understanding the evolving fintech space, stakeholders can harness its potential to create inclusive financial systems that serve the needs of low-income customers while mitigating associated risks.