Digital Banking & Poverty: A Light at the End of the Tunnel?
Authors: Aaron Lionel D’cruz, Pua Yen Ting
Region Head: Clarice Lim Hui Wen
Editor: Chok Geow
COVID-19 has undoubtedly devastated economies all around the world. But the rise in digitalisation has certainly been the prominent silver lining in the stream of loss and grief that followed since the pandemic. Some see this as a benefit, propelling developing sunrise industries into an accelerated pace of development while other sunset industries have fallen from the lack of contact and content distribution. Amazingly, as banking services have found a new market in the Latin American economies in the lower-income groups, one must wonder if this can be the first step towards eliminating poverty in Latin America for good.
The prevalence of COVID-19 pandemic has certainly forced economies to adopt different means of trade and investment that has accelerated digital penetration among the poorer communities in Latin America. Interestingly, digital banking services have seen a development and advancement over the years where new technologies are not only readily available but readily utilised at the convenience of bank users. Particularly in the Latin American economies, the lower income groups have gained increased access to such services. Hence, one must wonder if such access to these financial services are warranted as a gain to the financial institutions or are they seen to be too high risk to entertain? According to the Senior Vice President of Visa Latin America, Mr Reuben Salazar Genovez, he cited that in lieu of COVID-19, as of July, the active e-commerce credentials increased 11% in Brazil, and in a less developed e-commerce market like Argentina, active e-commerce card growth exceeded more than 100% (The Dialogue, 2020). Could this rise in digital banking have a strong if not, significant correlation with the reduction of poverty in the Latin American countries?
The Premise: Prevalent lack of access to financial services
Increasingly, there are growing urban-rural disparities in access to physical banking services. Unlike other advanced financial systems, Latin American economies tend to have disparities in the access to financial services. As such, traditional banking systems that typically exist within the cities present physical constraints for the rural population to gain access to legitimate and regulated financial services. Statistics seems to show some correlation between the use of such financial services and income growth development.
History could point to us that the deregulation of the banking sector in Latin American economies over the years could have had an impact on this lack of access which is now fulfilled through digital banking. Global competitive forces and bank crises in the 1990s resulted in a shift in the tide where market participants and state-banks began to deregulate their industries and open them up to domestic non-banks and foreign intermediaries for management (Monetary and Economic Department, 2007).
Despite the decline in the share of state-owned banks of up to 50%, the state-banks began to give out loans to households under subsidies housing schemes but rather encouraged taking up of loans. This deregulation meant that this would potentially exclude poorer households since they might serve as a significant risk to the payment of loans and thus pose various threats to the valuation of assets sold. This was particularly so in the housing market in Latin American economies like Brazil and Argentina, where such access to housing loans were scarce.
Consequently, this lack of access to such services breeds the prevalence of low financial literacy among the poor. According to survey findings from OECD, less than half the population in countries like Colombia, Chile, Guatemala and Peru understands “interest rates” or are capable of carrying out calculations of simple or compound interest rates (Garcia, N. et al., 2013).
Correlation between digital banking and alleviation of poverty
The access to digital banking and its correlation to alleviating poverty might seem to be a tenuous one. But digital banking serves as a means by which financial services can reach beyond their physical boundaries and could aid and benefit the lower income groups. It has been reported that higher financial inclusion will have a positive effect on inequality and poverty reduction (Garcia, N. et al., 2013). Typically, it is considered that an increase of 10% in the access to financial services has the effect of a reduction of 0.6 points in the Gini inequality coefficient (Honohan, 2007), and an increase of 10% in private credit reduces poverty by close to 3% (Clarke, Xu and Zou, 2006; Honohan, 2007). There are several factors in helping to identify this correlation.
Firstly, lower non-interest income in both households and firm inclusions. Typically, banks that have higher non-interest income from households have fewer incentives to extend credit to risky customers. For example, large holdings of low-risk government securities by the banks in some countries could result in higher non-interest income through bond valuation changes, which, in turn, could reduce incentives of the banks to provide loans to more risky customers. Anecdotal evidence on cases of predatory lending and excessively large number of bank fees in some Latin American countries also supports this finding.
Secondly, the prevalence of lower bank safety buffers (for household inclusion). In order to maintain higher safety buffers the banks charge higher interest rates to riskier customers, which prevent inclusion of low-income households who find it too expensive to borrow. However, reverse causality cannot be excluded: higher inclusion could lead to higher losses, which, in turn, could reduce return on assets and eat up bank capital as well as possibly increase asset return volatility as riskier customers obtain financing (Sahay, R. et. al, forthcoming).
Thirdly, lower bank efficiency (for firm inclusion), as measured by the overhead costs. One possibility is that more efficient banks, those that are able to keep their costs in check, tend to be less inclusive. For example, there is evidence that foreign-owned banks/private banks, which are often more efficient than domestic/public banks, are also less willing to provide loans to smaller customers. As a result, financial systems dominated by domestic and/or public banks could appear as less efficient but more inclusive. However, the direction of causality is not clear. For instance, banking systems may become more inclusive at the cost of losing efficiency because higher inclusion could entail higher costs of reaching customers in remote areas and could potentially lead to higher losses associated with riskier customers.
Finally, the presence of a stronger regulatory environment (for firm inclusion), as measured by the Global Microscope score. The latter captures the regulatory environment for micro-finance as well as other institutional aspects such as client-protection rules and credit systems, which help promote financial inclusion. It is somewhat puzzling, however, that a favourable regulatory environment helps improve firm inclusion but has limited impact on household inclusion, though it helps explain the puzzle of Peru mentioned earlier. It is possible that regulatory aspects relevant for household inclusion are not well captured by the Microscope score (Dablas-Norris, E., et al., 2015).
However, there is a pertinent trend between expanding digital banking and reducing poverty in Latin American economies by imbuing them with financial knowledge and tools to expand their income flows. In Colombia, at least 1.6 million people who never had a bank account have joined the nation’s financial network since April (Palau, M., 2020). Eighty percent use digital wallets like DaviPlata, according to Luis Alberto Rodríguez, director of the Department of National Planning. Officials say 85.9% of Colombians now have some type of account, a level the government did not expect to reach until 2022.
Challenges in implementing Digital Banking in Reducing Poverty
While there is a rise in digital banking technologies, access to internet and mobile technologies remains a problem among the poor. According to the World Bank Report, the access to broadband internet is less than 50% in the Latin American countries (Jaramillo, C.F., 2020). Furthermore, even with the access to such financial services, the lack of understanding and financial literacy among the poor will further worsen the effect of lack of awareness in savings and investments that might be more helpful for lower income groups. According to the World Development Report 2016: Digital Dividends, “socioemotional skills” such as being able to navigate certain key decisions acutely has become increasingly important in developing human capital in this information age, propelling a rising demand for non-routine cognitive skills (Beylis, G., et al., 2020).
Additionally, the reality that Latin American economies would also have to face is that the financial sectors themselves hasn’t quite taken off. Despite the significance of retail and the service industry in the Latin American economies, the resilience of the financial sector has not quite taken off to a point that there are sufficient reserves and wealth made available to support the lower income groups. Based on the Service Trade Restriction Index in certain emerging economies (Figure 1), we can see most of the Latin American economies have yet to expand further into building a resilient financial sector that is sufficient to support trade within the countries (Beylis, G., et al., 2020). While Peru seems to have one of the highest STRs than most Latin American economies, it has not been able to expand their financial sector to support other areas such as the industrial sectors.
Figure 1: Service Trade Restriction Index (Source: World Bank: COVID-19 and the Accelerated Transformation of Jobs in Latin America and the Caribbean)
Latin America still has a long way to go regarding the introduction of digital banking and financial services in helping to alleviate poverty. However, the rise in digital banking signals its first step towards improving the financial divide between the lower and higher income groups of Latin America.
1. Beylis, G., Jaef, R.F., Morris, M., Sebastian, A.R., Sinha, R. (2020). Going viral: Covid-19
and the accelerated transformation of jobs in Latin America and the Caribbean. Retrieved from World Bank: https://openknowledge.worldbank.org/bitstream/handle/10986/34413/9781464814488.pdf?sequence=6
2. Clarke, G., Xu, L., & Zou, H. (2006). Finance and income inequality: What do the data tell
us? Southern Economic Journal, 72(3), 578-596.
3. Dabla-Norris, E., Deng, Y.X., Ivanova, A., Kawpowicz, I., Unsal, F., VanLeemput, E., Wong,
J. (2015, September). IMF Working Paper. Financial inclusion: zooming in on Latin America. Retrieved from: https://www.imf.org/external/pubs/ft/wp/2015/wp15206.pdf
4. Garcia, N., Grifoni, A., Lopez, J.C. and Mejía, D., (2013), “Financial Education in Latin
America and the Caribbean: Rationale, Overview and Way Forward”, OECD Working Papers on Finance, Insurance and Private Pensions, No.33, OECD Publishing. Retrieved from: https://www.oecd.org/finance/wp33finedulac.pdf
5. Honohan, P. (2007). Cross-country variation in household access to financial services. Paper
presented at conference Access to Finance, Washington, DC.
6. Jaramillo, C.F. (2020, October 16). Closing the digital gap to end poverty in Latin America
and the Caribbean. Retrieved from World Bank Blogs: https://blogs.worldbank.org/latinamerica/closing-digital-gap-end-poverty-latin-america-and-caribbean
7. Monetary and economic department. (2007, February). Evolving banking systems in Latin
America and the Caribbean: challenges and implications for monetary policy and financial stability. Retrieved from Bank for International Settlements: https://www.bis.org/publ/bppdf/bispap33.pdf
8. Palau, M. (2020, November 13). Pandemic draws more Latin America poor into banking
system. Retrieved from AP News: https://apnews.com/article/international-news-pandemics-bogota-coronavirus-pandemic-colombia-d99ec5c7bba396d6d5b634b1d05af156
9. Sahay, R., M. Cihak, P. N'Diaye, A. Barajas, D. Ayala Pena, R. Bi; Y. Gao, A. Kyobe, L.
Nguyen, C. Saborowski, K. Svirydzenka, R. Yousefi, Forthcoming, “Financial Inclusion: Can It Meet Multiple Macroeconomic Goals?” IMF Staff Discussion Notes.
10. The Dialogue. (2020, December 2). Is online banking reducing poverty in Latin America?
Retrieved from The Dialogue: https://www.thedialogue.org/analysis/is-online-banking-reducing-poverty-in-latin-america/