There has been so much noise around fintech recently that it is very easy to do both either get caught up in the hype or believe that it is another tulip mania. Matt Levine in a brilliant piece in Bloomberg wrote about the three ways fintech companies are trying to disrupt banking; 1. with the same business model, 2. with more computers or 3. by wearing a hoodie because being cool is a technology. He goes on to elaborate how most fintech companies are not replacing banking but just disaggregating services or making it customer friendly, something that banks can easily co-opt.
While technology companies are gung-ho about their ability to develop a great front end product while banks lag in customer experience, very few have any experience in dealing with the myriad regulations and licenses that come with handing public money. Because of this inherent weakness, fintech companies have been happy to outsource the back-end operations to banks. This essentially amounts to outsourcing the banking to banks. The net effect being that banks remain entrenched in the system without much disruption. A beneficiary of this has been Cross River Bank which is pitches itself as the bank of choice for fintech companies and has in the process become the darling of Silicon Valley venture capitalists, a strategy being replicated in India by RBL Bank. Quite a few people have expressed similar apprehensions with payment banks and online wallets not being a panacea of financial inclusion problems as they are not disruptive enough or have viability issues (Payment Banks).
For all the calls to sobriety, there are many things fintech companies can do to address failures of the banking system in providing access to the financial system at the bottom of the pyramid. At the annual conference of the Bank of International Settlements, a paper discussed that the cost of financial intermediation has remained constant at 2 per cent across many developed countries for the past 100 years, implying that the gains from technology have not been passed to consumers. Eliminating the cost of opening a savings account can increase the uptake, savings levels and reduce informal savings according to studies in Sub-Saharan Africa. Similarly, in Nepal ease of access to basic bank accounts via tellers visiting houses led to significant uptake and increase in welfare (GONESA). These costs of financial intermediation can easily be eliminated by the use of technology.
Accounts which apply behavioral insights can further increase the benefits for the poorest. A study by RAND revealed that less educated people are more likely to choose the default options in any financial product. This should allow companies to make products that further the objective of increasing savings for the poor by introducing commitment or lock-in features to bank accounts.
The poor live risky lives. The limited research into insurance shows significant benefits for the poor from insurance products. Crop insurance and micro-insurance products though proven to be effective from a welfare perspective, do not scale without government subsidy. ICICI Bank has had a crop insurance product for over a decade but it cannot be considered successful by any stretch. Finally, lack of information about credit-worthiness and lack of screening ability among lenders hinders the efficacy of any rural lending programs. Traditional banks are not profitable in these areas without high transaction costs.
Access to digital payment services is a potential platform for providing insurance to the poor because firstly, they reduce financial institutions costs while enabling informal P2P risk sharing by enabling easy payment services. Like in other industries, fintech companies propose disruptive innovations for specific services. Their key advantage is that they aren’t held back by legacy systems like most banks and are more focused on data. Are there viable models to insure poor households? How does a company scale digital credit on a small scale? How to support the delivery of advanced savings products and not the no-fills account that are pervasive in policymaking circles? Finally, finance is just a means to an end. We need to achieve tighter linkages between finance interventions and other sectors to magnify impact. These are some of the key questions that fintech companies can answer to be as transformative as Grameen Bank was.
This article first appeared in thedialogue.