Financial inclusion needs legal and regulatory framework

Monday, 17 October 2016


Financial exclusion is a critical challenge to growth, and the benefits of financial inclusion go beyond growth both at the individual and macro level. In addition, access to financial services is often viewed as essential factors like access to safe water, health services and primary education, in order to ensure participation of the common people in economic activities. Building inclusive financial sectors improves common people's lives in particular those of the poor and well-structured inclusive financial system accelerate efficient allocation and utilisation of scarce resources.
Creation and expansion of financial services targeted to poor and low-income population can play a vital role in enhancing financial access. A small loan, a savings account or an insurance policy can make a great difference to a low-income family. In many developing countries, small-scale enterprises and micro-entrepreneurs face severe financing constraints and access to finance help them creating business, employment and realise their full potentials. 
Global leadership and institutions have been working to raise global awareness of the pivotal role that more inclusive finance can play in achieving both social and economic goals. The evidences justify undertaking policy initiatives to promote financial inclusion especially in the developing countries.  It is also a critical challenge for the policy makers and market players to design and introduce right kind of financial services or products targeting poor and low-income populations. Lack of suitable products, high cost, poor level of technological infrastructure, high requirement of minimum balance, requirement for collateral are some of the impediments to inclusive financial products.
To get right outcome, financial inclusion products are expected to target the true needs of the smallholders. Small households have a range of financial needs: savings to manage irregular cash flow, respond to external shocks and make investments; working capital to finance their engagement in agriculture; micro insurance services; money transfers to send and receive payments from family at reasonable cost, and to sell and buy goods; liquidity for their normal and extraordinary household expenditures; insurance to help manage the impact of risks and unexpected events. To address the need, a comprehensive inclusive finance framework could be useful. An inclusive finance framework must be supported by a sound policy, legal and regulatory framework. Inclusive finance should be part of any financial sector development strategy which is about sustainability. To attain sustainability, financial services for poor and low-income people should be seen as an important and integral component of the financial sector and various types of financial institutions, based on their own comparative access to financial services.
Financial inclusion should satisfy several needs of the common people like saving facility; payment and remittance service; affordable credit; bank account; insurance; and financial advice. And, an individual should be treated as financially included if that individual has affordable access to basic financial services, which include saving, payment and remittance, credit, bank or mobile bank account and insurance in a timely and transparent manner.  Financial inclusion requires financial awareness; minimum knowledge about financial services, alternative delivery channels, and the benefits of using a financial service and involves making people financially literate.
There is no doubt that designing appropriate products is one of the crucial challenges, and demand is a key issue connected with inclusive financial products. The attractiveness of the product matters which is connected with the kinds of financial products and services that customers would like to buy and in what quantity. Products must be featured to target particular group to particular market segments. Providing better information to the customer helps to improve understanding of the product's features, benefits and obligations. The ultimate requirement is to provide the products that customers need, want and value enough to pay for.
In regard to saving services, a key inclusive product in broadest demand globally is safe savings. The question from the perspective of the prospective customer is whether safe, appropriate institutional savings services are on offer and accessible. About credit services, a good number of specially designed innovative credit products were made available in last two decades targeting low-income and vulnerable people. These are commonly small, short-term, repeat loans that are compatible with the income and spending patterns of poor households and enterprises. Credit delivery process and joint liability are key characteristics of these products that perform the task of risk management. About payment products, safe, quick and low-cost payments services are important for low-income people. Technological advancement has brought remarkable changes in the payment services in terms of speed, safety, and feasibility.  Technical innovations are driving the change in the industry by using mobile, internet and stored-value plastic cards.   Insurance is another crucial financial service for the poor, but one that has thus far found a smaller market among poor and low-income populations than credit and savings.
The design of financial products can have a major impact on the use by individuals of financial services and several recent studies show that product design features can affect both the extent and the impact of the use by individuals and firms of financial services. Certain design features of credit products aid in mitigating market imperfections and increasing inclusion like product may help reveal hidden information assist in channelling credit by mitigating asymmetric information problems. Group lending is an often-discussed and arguably the most controversial solution to information asymmetries in developing economies. Group lending also addresses moral hazard by providing incentives for clients to employ peer pressure to ensure that funds are invested properly and effort exerted until the loans are repaid.  However, group lending may also create problematic incentives like joint liability produced free riding. Timing of repayments is vital of designing credit products that have considerable impact on performance of credit facilities. It has been observed in several instances that a grace period before repayment results in better performance of the credit products, and service providing entities earned better outcome and profit.  
Households in developing economies are exposed to risks that can generate extreme income volatility and design features matters in insurance products. This is particularly true in the case of covariate risks, such as droughts or natural disasters, which affect large geographical areas or large segments of the population and are not adequately covered by informal insurance mechanisms. Modern insurance products can substantially reduce the resulting welfare losses. However, much of this potential remains unfulfilled because extending access to basic insurance products among vulnerable populations is extremely challenging. Because insurance providers can often form only a poor estimate of an individual client's true risk profile, the market price of insurance is often substantially higher than the actuarially fair value of the contract. In many developing economies, this means that basic insurance products either are not available, or are outside the reach of the most vulnerable households. 
Mobile banking and payment technologies change the economics of banking because they dramatically reduce the cost of providing financial services. This reduction in transaction costs is especially large in environments with low population densities and low per capita income, precisely the settings that have been underserved by traditional providers of financial services. These are the settings in which mobile banking technologies have the greatest potential welfare benefits because the technologies offer a commercially viable way of reaching locations and customers that were previously excluded from formal financial services due to the prohibitively high costs of providing such services.  However, an important prerequisite for the adoption of technologies that can enhance financial inclusion across all market environments is an adequate legal and regulatory framework.
Dr. Shah Md Ahsan Habib is Professor and Director (Training), Bangladesh Institute of Bank Management (BIBM).
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