How access to credit can save the world
It’s hard to believe that more than half of the world’s total adult population (an estimated 2 billion working-age adults) do not have an account at a formal financial institution and another billion simply lack credit. Before starting Certn, I had no idea what financial inclusion was, nor did I care. Could offering loans to people without credit help the world? Wouldn’t it just create more debt, more bankruptcies, and outrageously high-interest rates? I was a skeptic, to say the least, but, after months of research, I’ve completely changed my tune. How could I have known that financial inclusion could increase economic and social development or promote gender equality?
“We estimate more than 3,000,000 consumers globally could gain access to credit at affordable rates if there was an effective way to assess their ability and willingness to repay loans.” - Jim Wehmann, Executive Vice President of Scores at FICO
The concept of financial inclusion is to ensure that all households and businesses, regardless of income level, have access to and can effectively use the appropriate financial services they need to improve their lives. It’s a pretty basic concept but currently, the world’s poor live and work in what is known as the “informal economy”. Even though they have little money (relatively speaking), they still save, borrow and manage day-to-day expenses. They have credit, but not with the banks or credit bureaus, they have street credit or “social credit” (which I’ll talk about more in another article).
However, without access to a bank, savings account, debit card, insurance, or line of credit, for example, they rely on informal means of managing money. This includes family and friends, (no, peer to peer lending is not new, just new to the internet) cash-on-hand, pawn-brokers, moneylenders, or keeping it under the mattress. These choices are insufficient, risky, expensive, and unpredictable. Plus they don’t allow people to leverage their assets to create wealth.
Being included in the formal financial system helps people:
- Make day-to-day transactions, including sending and receiving money;
- Safeguard savings, which can help households manage cash flow spikes, smooth consumption and build working capital;
- Finance small businesses or micro enterprises, helping owners invest in assets and grow their businesses;
- Plan and pay for recurring expenses, such as school fees;
- Mitigate shocks and manage expenses related to unexpected events such as medical emergencies, a death in the family, theft, or natural disasters; and
- Improve their overall welfare.
These seemingly little things can have a big impact. The benefits of financial inclusion are not only significant for individuals but for economies as well. Financial inclusion is linked to a country’s economic and social development and plays a role in reducing extreme poverty. How do you think Henry Ford was able to build his first factory? How do you think Uber built its empire? All through access to finance.
Recent research indicates that financial inclusion is not only positively correlated with growth and employment, but it impacts growth. Imagine 3,000,000,000 more people who have the opportunity to create businesses, invest in stock markets and grow their small or micro businesses to employ more people. It has a big impact locally, nationally and internationally.
Increasing access to financial services also has some less clear benefits. Consider that poor women account for 1.1 billion of unbanked adults, or most of the financially excluded. When savings accounts were offered to female market vendors in Kenya, their daily expenditure increased by 37%, relative to a comparable group of women who did not receive an account. This concept had a huge impact on gender equality.
Financial inclusion of farmers has also shown to unleash bigger investments in the planting season. The result is higher yields and progress toward greater food security. When Malawian farmers had their earnings deposited into a new bank account, they spent 13% more on equipment and increased the value of their crop output by 21%.
Financial inclusion can also encourage good health. A savings account allows parents to pay for a clinic appointment for kids. Out-of-pocket healthcare costs are an important reason people are stuck in poverty. But give them an account, and:
- A study in Kenya found that giving people a safe place to store money increased health spending by 66%.
- Emerging research in Jordan suggests insurance can help women defray treatment costs and manage health-related shocks that would otherwise disrupt their economic activities and result in lost income.
Now that we’ve established why financial inclusion is so important, why hasn’t it been adopted everywhere and why are 3 billion people still excluded? The answer is simple, the risk for financial institutions is too high because they don’t have the tools to appropriately evaluate the risk of people without robust credit. The solution isn’t as easy as government funding, it’s about giving banks the resources and technology to effectively assess applicants without a credit history because, let's face it, not all 3 billion of these people are going to be the right fit for credit.