The internet won’t fix financial inclusion. What will?

I would start this week’s dispatch by telling you an economics joke but there seems to be no demand.

With that lukewarm attempt at humor, I want to draw your attention to an interesting hypothesis I have been building over the past couple of months. It relates to the role of supply and demand in financial inclusion.?

While modern economic theory tells us that demand creates its own supply, it seems to me that the laws of economics get warped in public welfare spaces.?

Let me give you an example - almost every edition of this newsletter (and I assume most other publications) have harped on the importance of digitalization to improve access and deepen financial inclusion.?

But, it seems to me that just putting banking services on an app can’t overnight transform millions of Indians from financially excluded to savvy market participants.?

So, what’s missing?

I submit to you that digitization is a necessary but not a sufficient condition for deepening financial inclusion.?

As a proponent of FinTech and a cheerleader of the digital economy, it is a slightly controversial take but bear with me.

What do we talk about when we talk about financial inclusion??

Financial inclusion is often misunderstood as just access to financial services. This is a myopic and supply-side view of things which assumes that a person is included in the financial system if they have a mobile internet connection, a smartphone and a Jan Dhan bank account. After all, these are the only necessary means to access banking services digitally.?

But, this is merely the beginning of a very arduous journey if we are to achieve true and meaningful inclusion.?

Financial inclusion is not simply the theoretical existence of means to access financial services. It’s a trifecta of access, meaningful utilization and quality.?

The digital payments story in India is somewhat a story of meaningful inclusion. It satisfies the above three conditions while also continuously evolving to include even more people into the ecosystem - be it through the deepening infrastructure, hyperlocal use-cases, government subsidies and an overall ecosystem push towards moving India’s day-to-day transactions online.?

The indicators grouped under each of these dimensions vary depending on the region and demographics. The RBI’s data shows that while we have done well on improving access over the years, we still lag behind in terms of usage and quality of the infrastructure.?

Access performance

India has 51 bank branches per 1000 km2 and 15 bank branches per 1,00,000 population – numbers that indicate a much better performance compared to similarly developing economies like China and Indonesia.?

In rural areas, there has been a 60% rise in the number of bank branches between 2010 and 2021. Meanwhile, the number of banking correspondents in villages with a population higher than 2,000 has increased from 8,390 to 15,18,496.

Utilization performance

A World Bank survey shed some light on the usage of financial infrastructure in India. The ownership of accounts in financial institutions rose from 35% in 2011 to 77% in 2021. At least 73% of the respondents said that public sector wages were distributed through digital channels in 2021 compared to 63% in 2017.

However, the country’s financial infrastructure isn’t being used optimally. For instance, 33% of account owners made no transactions in 2020, despite the growing ownership in bank accounts under the PMJDY. As many as 31% of the respondents borrowed from family or friends, instead of utilizing institutional credit.

Solving for access is a great first step. But how do you ensure usage?

There’s a concept that many in the start-up sphere may be well familiar with – ‘crossing the chasm’. For the uninitiated, here’s all you need to know:

Little-known technological products face an adoption challenge. They need to be catapulted from the early market to the mainstream market to ensure the survival of the company.?

The gap between access to and usage of financial infrastructure is not unlike this chasm. To realize the complete benefits of our financial inclusion efforts, it is necessary that we bridge this gap.

How? By turning to the third dimension essential to financial inclusion –?quality.?

The natural progression towards complete financial inclusion would be to first ensure access, then work on adoption (usage) and finally do some quality control.?

Access → Usage → Quality

However, I propose that instead of leaving quality focus for the end, they be implemented early on in every product’s journey, every policymaker’s proposals, every company’s roadmap and be burnished in the larger civil society discourse around inclusion.?

Quality-related factors,?such as affordability, transparency, convenience, assistance, consumer protection and the ones described above, can help ensure a smooth transition from access to active uptake of financial services.

Account for diversity

As illustrated through the RBI and World Bank data above, utilization of financial infrastructure has been recorded at a very quantitative level across India. It fails to account for hyper-specific regional, economic and demographic differences within the country.?

The qualitative impact of financial inclusion initiatives will only be felt if there is an explicit acknowledgement of these differences and policy-level decision making is sensitive to the unique needs of various groups.

Two examples from recent memory will help me illustrate my point.?

1. The launch of digital banking units

Digital banking units – fixed point units with minimum digital infrastructure that provide banking services in both self-serve and assisted mode – were launched in 75 tier-2 and tier-3 districts across India last year.?

These units would allow users to either perform digital banking functions themselves, or provide assistance to customers who may be lacking in digital education.

Commensurate with the digital literacy levels of these districts, these units would service a mixed population of digitally nescient and savvy individuals. DBUs would both encourage the use of digital banking, and educate digitally unlettered populations and spur digital financial literacy.

In doing so, these units would incentivize sustained use of financial infrastructure. I wrote on the subject in detail?here.

2. Evidence from the aspirational district programme in eastern India

In a recent bulletin, the RBI released a?survey?from aspirational districts in Eastern India that concluded that an ex-ante supply of bank branches can, in fact, improve credit intermediation.

Contrary to the instinctive belief that low levels of economic activity would hamper the expansion of financial infrastructure, its supply actually spurred on its demand. The unique economic attributes of this region enabled expansion of financial infrastructure to make the most of untapped credit demand.

In both cases, the establishment of financial infrastructure was tailored to the needs of the region in question. Their utilization is thus dependent on the qualitative aspects of the accessible infrastructure.

Building the bridge over the digital divide

Positioning access as the only means to financial inclusion is a short-sighted strategy. It impedes scalability, especially in the Indian context where regional differences must be accounted for. It is only through ground-level experience in these diverse regions that we can draw insights which could impact user behavior. Moreover, the product and its delivery must be reinvented for these economic and regional variations.?

Access – whether to financial services or digitalization – won’t solve financial inclusion challenges. As evidenced by the expansion of bank branches in eastern India’s aspirational districts, physical infrastructure is more conducive to education and continues to foster a sense of familiarity – making the conditions right for assistance and handholding.

Written by Rajat Deshpande