In recent years, a growing number of authorities both at national and international levels have made financial inclusion a policy priority. The international financial sector standard-setting bodies are increasingly engaged as well, moving to incorporate financial inclusion explicitly in their agenda. Financial inclusion opens potential benefits to the safety, soundness and integrity of the financial system. Financial inclusion can also bring potential risks to service providers and customers alike as well as entail the transfer of well-known risks to new players. Financial inclusion significantly increases macroeconomic growth, broadens access to credit but sometime it can compromise macro financial stability when any poor quality of banking supervision prevails in the financial system. Thus, there are risks associated with financial inclusion programme of banks and non-bank financial institutions in their endeavour to reach unserved and underserved customers due to lack of adequate prudential regulatory and supervisory approach.
Financial inclusion refers to access to financial services which relate to the ability of firms and households to use financial products and services, given in particular the constraints of time and distance. Common elements of financial inclusion include universal access to a wide range of financial services at a reasonable cost. In financial inclusion relevant measures include the proximity of access points, the variety of access channels such as branches, ATM (automated teller machine) and POS (point of sale) networks, agent banking, mobile banking, etc., as well as socio-economic barriers limiting these uses. In a broader dimension, the pricing and other terms and conditions of financial products and services can also be relevant factors limiting the scope for access to financial services for segregated groups.
Regulators and policymakers have taken a variety of steps to support financial inclusion at both the national and international levels. Many of them have also sought to enhance financial literacy, while others have committed to achieving numerical inclusion targets. Measures are being taken in many countries to improve financial literacy as more households join the formal financial system. Financial education can help consumers to manage their financial risks by ensuring that they can better determine their capacity to spend, save and borrow, as well as choose suitable financial services. For instance, Bangladesh Bank, the central bank, has an in-house centre integrated with its main website that provides information about the financial services available to small and medium-sized enterprises, students, bankers, general public and other stakeholders. Some national policymakers have committed to achieving financial inclusion targets. For example, internationally, over sixty central banks plus public sector institutions from more than ninety countries are part of the Alliance for Financial Inclusion (AFI), a member-driven peer learning network. Some have agreed to quantifiable goals by signing the Maya Declaration which is an initiative to unlock the economic and social potential of the two billion unbanked population through greater financial inclusion.
There are many positive impacts of financial inclusion and financial development more generally, on long-term economic growth and poverty reduction, and thus on the macroeconomic environment. Access to appropriate financial instruments may allow the poor or otherwise disadvantaged to invest in physical assets and education, reducing income inequality and contributing to economic growth.
Financial inclusion has important implications for monetary and financial stability as well as the policy areas. Increased financial inclusion significantly changes the behaviour of firms and consumers, in turn, influencing the efficacy of monetary policy. For instance, greater inclusion should make interest rates more effective as a policy tool which may facilitate to maintain price stability. Thus financial inclusion also strengthens the case for using interest rates as the primary policy tool. At low financial inclusion level, a large share of the money stock is typically accounted for by currency in circulation, with many families saving in cash "under the mattress".
An increase in financial inclusion interacts with monetary policy in many dimensions. Financial inclusion helps more consumers to smooth their consumption over time that could potentially influence basic monetary policy choices, including which price index to target. Financial inclusion also encourages consumers to move their savings away from physical assets and cash into deposits which may have implications for monetary policy operations and the role of intermediate policy targets. Financially excluded farmers can trade livestock or other income generating assets or they can adjust how much they work in response to shocks. Hence, as for borrowing, friends and family can act as important lenders in place of banks. However, access to the formal financial system does facilitate consumption smoothing at remarkable level. Financial stability too may be affected, since the composition of savers and borrowers is altered. Broader base of depositors and more diversified lending could contribute to financial stability. On the other hand, greater financial access may increase financial risks if it results from rapid credit growth or the expansion of relatively unregulated parts of the financial system.
Financial inclusion through improving firms' access to finance/credit can help financial institutions to diversify their loan portfolios in multiple approaches. Financing to firms which were previously financially excluded may also lower the average credit risk of loan portfolios. An increased number of borrowers from small and medium-sized enterprises (SMEs) is associated with a reduction in nonperforming assets and a lower probability of default by financial institutions. The repayment rates of borrowers from conventional microfinance institutions are much higher than any other traditional bank and non-bank financial institutions. However, the required rate of Islamic microfinance is much lower than any form of financial service providers. Some experts have opined that increased financial inclusion is no guarantee of improved financial stability. When financial inclusion is associated with excessive credit growth, or the rapid expansion of unregulated parts of the financial sector, financial risks may increase at large scale.
Unregulated parts of finance flow are also a risk area. Banks' attempts to reduce the overall riskiness of their business, i.e., de-risking, or minimising regulatory compliance costs also contribute significantly. Small unregulated institutions may also pose a little threat to financial stability. Their growth momentum and systematic risk prevail side by side. Microfinance institutions account for a disproportionate share of increased financial inclusion in some countries, highlighting the need for supervisors to identify and measure risks that are specific to this sector.
Financially excluded households lack a financial history. So, the absence of a verifiable track record may be especially prevalent where personal identification systems are weak. There are bound to be speed limits to banks' ability to absorb new customers without seeing deterioration in credit quality, owing to limits in screening capacity. Empirical analysis shows that greater financial inclusion due primarily to increased access to credit could contribute to financial excesses in the economy where variations between structural financial deepening, leading to a widening pool of borrowers, and an unsustainable lending boom that sees a smaller number of borrowers amassing large debts are pertinent. In fact, both phenomena could occur side by side. However, it is possible to nurture increased financial inclusion without a large increase in aggregate credit. For low-income populations, for instance, the most pressing financial needs may consist in having reliable savings and payment instruments rather than credit.
Broad landscape of financial service providers striving to serve unserved and underserved customers can quickly move beyond the remit of a traditional banking supervisor. As the financial inclusions are channelized via various evolving instruments like banks, non-banks, telco and other unrelated industries through participating in innovative financial services, the risk assessment area is pertinent to consider while devising any policy and procedure. The financial integrity, financial consumer protection as well as data protection and competition are also vital areas while accommodating financial inclusion strategies. Even anti-money laundering and combating the financing of terrorism (AML/CFT) need to be prioritized when extending the financial services to the underserved people of society. As such productive and constructive dialogue among all stakeholders such as regulators, supervisors and service providers is required while targeting unserved and underserved customers.
Concerned institutions ought to have a comprehensive risk management process as well as effective Board and senior management oversight to identify, measure, evaluate, monitor, report and control or mitigate all material risks on a timely basis related to the tools and techniques to financial inclusion. They also need to assess the adequacy of their capital and liquidity in relation to their risk profile and market and macroeconomic conditions and also to development and review of contingency arrangements which take into consideration the specific circumstances of the service providers. Thus, the risk management process will be commensurate with the risk profile and systemic importance of the institutions. The financial institutions will systematically review the required procedure and policies while introducing new products or services or delivery channels, and also adjust their expectation of risk management processes for Strategic Business Units (SBU)/branches/service points targeting unserved and underserved customers as required.
Major risk management challenges faced by financial institutions targeting unserved and underserved customers may relate to the lack of a comprehensive view of risks in a fast changing environment, unavailability of qualified professionals in respective areas and deficient management information systems. The banks should have proper policies and procedures in place as well as specialized knowledge of the specific dynamics of assets and liabilities in targeting underserved and unserved customers, particularly traditional microlending/microfinance and the nature, structure and behaviour of funding sources. Traditional microfinance providers face the danger of rapid deterioration of capital in the case of loan defaults due to over-reliance on their loan portfolio as their most important source of revenue. Thus, liquidity risk management need to focus on comprehensively measuring and forecasting cash flows and maintaining an adequate minimum liquidity cushion for business-as-usual and stressed situations, taking into account the likely behavioural responses of relevant counter parties. Banks must have adequate "risk-based approach" policies and processes including strict customer due diligence (CDD) rules to promote high ethical and professional standards in the financial sector and prevent the bank from being used, intentionally or unintentionally, for criminal activities.
Increased financial inclusion could be beneficial for financial stability as well as the financial well-being of the people, particularly for low-income group. But these strategies related to inclusion of unbanked people in the banking arena may be sensitive to the nature of the improved financial access. Too strong a focus on improving access to credit could increase risks, if it leads to deterioration in credit quality/exposure at default or too rapid growth in unregulated parts of the financial system as well as shortage of proper integrated policy at global and national levels. Last but not least, all interested parties/stakeholders need to collaborate and cooperate with each other for further acceleration of financial inclusion ensuring risk mitigation strategies, policies, programmes and procedures in proper place for balanced socio-economic development.
The writer works at a private bank.
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