The Trials of Banking the Unbanked

banking biometrics mobile blockchain microfinanceThe worst inconvenience I have with my bank is that they don’t have a lot of branches or ATM’s around Boston. But it’s not too much trouble because I just use their mobile app for my day-to-day needs. Access to your banking services is probably not an issue that you think about or even deal with on a daily a basis either, right?

Well, for nearly 3.5 billion people worldwide, access to banking and financial services is a huge deal. Traditional banking models require physical access to branches and several forms of identification to open accounts. This model has failed to work in developing areas, which has led to the exclusion of billions from the financial world. Without access to financial services, many people have to rely on informal sources for cash – family and friends, rotating saving schemes, pawnbrokers, money lenders…the list goes on. However, these sources are insufficient and, in many cases, predatory.

To date, there have been various efforts to bank the unbanked. You could write an entire thesis on even just one aspect of these efforts, but today we’ll be talking about microfinance and a relatively newer innovation – mobile wallets. Let’s dive in.

What is Microfinance?

Microfinancing is usually understood as giving small loans to impoverished communities without requiring collateral. The loans are usually less than 100 USD. The idea of microfinance is to promote financial independence among poor, underserved communities. If you received a microloan, you could more easily pay for living expenses, and maybe even start a small handicraft business, as long as you felt you could pay the loan back with interest.

People, specifically donors, have been intrigued by microfinance for decades. It sidesteps government, is perceived to be fiscally responsible, promotes the neoliberal value of self-help, and – perhaps most importantly – has been heralded as the silver bullet to end poverty forever.

But this extreme view of microfinance is a fallacy. At its most basic level, microfinance does help poverty-stricken people through hard times. At the next level up, it could even involve using the loans to start a small enterprise. But, under more scrutiny, there is no hard evidence to verify the actual impact of microfinance compared to other factors.

Much of these misconceptions around microfinance can be tied to the tremendous success and shortcomings of Grameen Bank and its now legendary founder.

Grameen Bank is Born

During the 1974 Bangladesh famine, Professor Muhammad Yunus gave a loan of 27 USD to a group of families who were suffering. He requested they use it as start-up money and pay him back (with a little interest) when they were able. This simple act of kindness sparked an idea in him, which led him to launch a research project at the University of Chittagong to study how to design credit delivery systems to provide banking to the rural poor. He thought, with a little elbow grease, this idea could scale and stimulate business and reduce poverty in rural areas of Bangladesh.

To make his dream a reality, Yunus partnered with the Rural Economics Project to create a basic microcredit model to test. In 1976, Yunus’ model was first tested in Jobra, a small, poor area near the University of Chittagong. Yunus and his partners noticed that his model worked. Very small loans could make a difference to the poor villagers. Especially since these villagers were not eligible for traditional bank loans due to high risk of default and lack of funds to pay banking fees.

In 1979, Yunus was able to expand his test because of the success in Jobra village, and in 1983 he officially launched Grameen Bank with the help of ShoreBank (a community development bank in Chicago which closed in the aftermath of the 2008 housing crisis) and a grant from the Ford Foundation. Upon launch, Yunus declared that poverty would be eradicated within a generation. He even went so far as to say that people would have to go to “poverty museums” in the future, to understand what poverty was like.

The world took notice, launching Yunus’ microcredit model from an experiment into a worldwide movement. 2005 was declared the Year of Microcredit by the UN, and, the very next year, Yunus and his bank were jointly awarded the Nobel Peace Prize. The enormous success of Yunus’s microfinance model with Grameen Bank has inspired similar projects in more than 40 countries. Sounds great, right? Well, not so fast.

Grameen Bank’s model did help people who were formerly underserved – women, illiterates, unemployed, etc. It helped people to survive. Many borrowers were able to pay for three meals a day, send their children to school, have clean drinking water, and a sanitary home. However, as the international community began to take note, things changed. The US pushed to institute a policy of “full recovery” – meaning the people who benefited from the loans needed to pay for the full cost of the programs. This new wave model differed slightly from the original Grameen Bank one – it would impose high-interest rates to achieve maximum efficiency and profit. The era of massive microfinance was beginning, and it spelled disaster for many people. Suddenly, the burden of payments was put on the people who Yunus had set out to help. A cycle was beginning to form, where people got loans to help them survive and then needed to take out more to pay off the debt.

But, you might ask, why is microfinancing still around today if it’s not actually helping? Because, it has been supremely difficult to actually measure the success of these programs, and banks, foundations, and other institutions continue to tout the impact of microfinance on financial inclusion.  

Where Microfinancing Fails

Yunus’ experiment with microfinance is romanticized. It did not, and probably will not, achieve the lofty goal it set out to achieve. To be blunt, it will not end poverty, and it might even be part of the problem.

More than 40 years later, and Jobra village is still in deep poverty and debt. Microcredit submerges communities into debt they can’t get out of. Let’s say you are one of Grameen Bank’s borrowers. The loan would help you pay for meals and school for your kids, but when it comes time to pay, you haven’t earned enough (or anything) to pay it back. You are now in debt, and in terms of financial well-being, you are worse off than before. Most borrowers only realize very small gains, and the poorest benefit the least because they are least able to make repayments. Microfinance should be seen as a cause, not a cure for problems around poverty.

Moreover, not everyone is in the microfinance world to help. It’s actually a lucrative industry with high-interest rates that drive the self-interest of lenders. Pawn Shops, payday loan operations, loan sharks, etc, charge high rates because they know poorer people are usually more desperate for cash and lack access to more traditional credit lines.

The opportunity for microfinance was created by this lack of access to traditional finance. While Yunus and other microcredit visionaries did bring financial services to the underserved, they failed to address underlying needs that keep the poor in a cycle of poverty and keeps them outside of the warm embrace of financial inclusion.

How to Bring Banking to the Unbanked

A key step in breaking this cycle of poverty is bringing banking and financial services, not just microloans, to the unbanked. Bringing banking to under- and unbanked populations is no simple task. It is a challenge, but it needs to start somewhere. For instance, providing financial services with little to no costs, or making bank account enrollment a user-friendly experience. Empower people to take control of their finances without weighing them down in debt. To do this, we need to move past the idea of traditional, physical banking. There needs to be a better way to access and use formal financial services, but how?

Physical banking is totally impractical today. We’re at one of the greatest turning points in the history of financial services for the masses – and it’s time to be on the right side – the mobile side! There are many reasons to be excited about smartphones as a way to distribute cash transfers and financial services. It can be more secure and more accessible. You would also be able to track payments electronically, which would reduce fraud and corruption in developing areas.

The emergence of mobile money and financial services is huge. Mobile money can greatly reduce transaction costs and reduces the barrier to enter the financial world. Two main mobile money programs that are emerging in developing areas today are: Over the Counter (OTC) transactions and mobile wallets.

What are OTC transactions?

OTC transactions are when individuals transact with cash through an agent, who executes the transactions on the users’ behalf. Agent-assisted transactions are popular in Sub-Saharan Africa, where many people already have mobile money accounts, but no actual bank tied to it. However, the delivery of mobile money in this way raises questions about unregistered and unverified transactions, and it’s very costly. The agents can take up to 30 percent of the value of the transfer for themselves. In addition, the way people identify themselves for these OTC transactions isn’t 100 percent secure. In general, they will give the agents their personal phones and their PIN number so the agent can execute the transaction. This is insane!

Enter Wala, FinTech Start-Up

Welcome to the stage Tricia Martinez, a University of Chicago Harris School graduate. She saw the high fees agents charge for OTC transactions, and the persistent lack of financial inclusion in South Africa, and realized there had to be a better way.

Tricia wanted to increase security, convenience, and accountability for underserved populations in South Africa. To do this, she discovered she could leverage blockchain, as a way to sit between banks and customers. Utilizing blockchain would lower banking fees significantly. Tricia was able to create a digital financial services platform, Wala, that overcomes many of the hurdles traditional banks and micro-financing institutions couldn’t get past.

Wala doesn’t require its users to have existing bank accounts, but you can make one through the app without ever walking into a bank branch. To increase adoption of the platform, Wala even offers rewards for financial milestones. Users can pay their bills, save money, and grow their financial footprint, all on their mobile phone.

Another reason Wala’s platform is so accessible is because of its enrollment and authentication process. Users are able to use their biometrics to verify their identity by utilizing Veridium’s authentication software. Wala’s users can use their biometrics to enroll from anywhere, authenticate any transaction, and make purchases on the platform without lengthy KYC protocols or passwords. Biometrics truly change the game. They help the underserved community prove they are who they say they are, without having to fill out piles of forms and trek to a bank branch for service. The partnership between Veridium and Wala was made possible by the Digital Services Innovation Lab, which is part of the Bill & Melinda Gates Foundation.

This disruption of digital banking services has been most impactful in the developing world, but these innovations have the potential to affect lives in the developed world too. Already, we’re seeing more and more young people shifting to digital payments and banking services (myself included). In the United States, 27 percent of Americans are also under and unbanked, and could benefit from services like Wala too.

There have been many attempts over the years to increase financial inclusion around the globe. Microfinance was one such attempt, but it had high costs, failed to establish financial security, and created a cycle of debt. New mobile innovations and fintech companies like Wala won’t necessarily take down poverty alone, but they do reduce costs and make it easier to access banking and financial services. Only time will tell what actually sticks, but by leveraging technology, blockchain, and biometrics, we are one step closer to banking the unbanked.

Learn more about this project and how we’re using our technology to make financial, government, and other critical services available to millions around the world in our webinar “Banking the Unbanked.”