Global economic inequality continues to be an unsolved problem as economic resources are not homogeneously spread across the globe. According to the World Bank, more than 700 million people live on less than $2 a day, with half of those extreme poor living in Sub-Saharan Africa.
This daily income entails that the population is completely excluded from the financial system as the payments they need to make are too small for conventional payment networks such as debit and credit cards, where minimum fees make so-called micropayments impossible. This situation is known as financial exclusion and is one of the elements underlying inequality and poverty worldwide.
Financial exclusion and poverty
The term financial exclusion refers to the situation of all those agents in society (e.g. individuals, towns) that have no access to the financial system and are not able to have a bank account, to save or to borrow money and are “involuntarily excluded”. Financial exclusion is a complex phenomenon linked to several underlying factors, and it is not only present in developing countries, as shown by the fact that in industrialized nations, between 1% and 17% of adults lack a bank account of any kind.
The following maps show how this financial exclusion is present to some extent in every country, but it clearly affects certain regions more severely:
Typically, people on the lowest income brackets are twice as likely to have no bank account as the average, and we can find a prevalence among lone parents, young people (between 18 and 25), students and the unemployed. According to the World Bank, important factors include gender, age, education, income and whether one is living in a city or a country area.
However, despite all this, it is important to note the correlation between financial exclusion and extreme poverty (living under 2$ a day). The following map illustrates the percentage of people living in poverty, and it is easy to observe that those countries with more profound and more widespread financial exclusion are those where poverty is sharper.
In the past, a number of models have tried to reduce financial exclusion, the best-known being microfinance, but recently the focus has shifted from microcredits to promoting financial inclusion, a term that encompasses a far broader range of financial products and providers.
Microfinance: The attempt to reduce poverty
The term microfinance is used to indicate a range of financial services/products involving small amounts offered to low-income/non-bankable customers and micro-enterprises. Microfinance covers a wide range of financial services that include savings, credit, insurance and remittance, targeting those who are not able to obtain credit from formal financial and banking institutions. The theory of how microfinance can reduce poverty is simple: Access to money can give poor people the possibility of being entrepreneurs and starting an activity which could generate a profit. The Nobel Peace Prize Mohammad Yunus was the originator of the term “microfinance” and he defended the claim that the 5% of the population that were helped by microfinance each year managed to move out of poverty.
In practice, it is important to note that some factors limit the efficiency of this system, and despite the initial impression that microfinance could represent a final solution to the problem of poverty, a new debate on this issue has emerged in recent years.
One limitation on the effectiveness of microfinance is the evidence found that the final beneficiaries of the system were those living above the poverty line or people considered “transient poor” instead of the chronic poor people. Those in a situation of chronic poverty are more likely to choose not to establish a business using microcredits since they may have to deal with urgent bills (e.g. medical, funeral) and they are usually more risk-averse and afraid of losing whatever they have, even if it is not a significant amount. Another factor that makes the transient poor more likely to use microcredits is that the interest charged is generally too high for those suffering from extreme poverty.
Also, several studies point to the fact that not all poor people are prepared to develop or maintain a business. Most people do not have the skills, vision, creativity, and persistence to be entrepreneurial. Even in developed countries with high levels of education and access to financial services, about 90 percent of the labor force are employees rather than entrepreneurs. The existence of a sustainable microcredit model, with an adequate entrepreneurial climate and a stable demand that will generate profits for small businesses, is an essential condition to make microfinance more effective. Yunus himself recognized that microfinance is not a final solution to poverty, but can at least mitigate its effects and is more powerful when combined with other actions.
FinTech may solve some of the microfinance problems
FinTech, meaning any financial services provided through technology, is already having an impact on emerging markets ensuring access to financial services and products for the unbanked. The term social FinTech refers to those FinTech tools aimed at solving or at least having a positive impact, on social problems.
Microfinance is not going to be eliminated by new technology but rather there is room for cooperation between the two, technology acting as a booster for microfinance: Technology could help to tackle the inability of businesses to grow with microcredits because of a lack of skills and entrepreneurial vision required to run a business properly. New technologies could make a significant contribution as the NGOs or microcredit operations could introduce mentoring plans to help local people to gain these skills and build an entrepreneurial environment. And, although money is not the only factor driving demand, technology would allow everybody to accumulate some savings in an account which could then be used to consume goods or services offered by the entrepreneur.