NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Editor’s note: As part of NextBillion Financial Innovation’s launch, we invited a number of top innovators and leaders to contribute their views on financial innovation – what’s driving it, where momentum is heading, and what obstacles remain. Today, Anurag Agrawal, CEO of Intellecap, lays out the core isssues involved in bringing low-cost financial products to customers at the base of the pyramid.

Over the last two decades, with the widespread adoption of technology in the financial services domain, we have seen a fair amount of innovation in the way different financial products and services are delivered. During the same period, we have also seen rising income disparities across the world and therefore a greater thrust towards more inclusive growth, particularly in the developing world where there still exist large sections of unbanked populations that do not have access to basic financial services.

This unbanked population at the base of the economic pyramid also represents a massive business opportunity. For me, the next level of financial innovation will include the emergence of business models that can successfully cater to this segment by providing a complete suite of financial services – including savings, insurance, credit, investment, remittance and payment products – at an affordable price.

The issue is how one does this in a cost-effective manner. Typically, financial transactions with low-income populations are characterized by:

a) smaller transaction sizes,

b) higher distribution costs and

c) greater perceived risk of default in case of credit products.

In addition to all these issues, lower levels of financial literacy in this customer segment mean that one needs to invest in building greater financial awareness before one does any business with them at all.

Thanks to higher levels of education and the almost universal reach of electronic media and telecom, the awareness issue is already being addressed to a large extent. And we have seen how group-based lending models that have evolved in microfinance have at least partially addressed the small transaction size and distribution cost issue by aggregating demand. They have also successfully demonstrated over a sustained period of time and across multiple geographies that these clients are credit-worthy, and the empirical evidence is now available to validate this claim.

But in spite of concerted efforts and multiple incentives offered by various governments and central banks to push for greater financial inclusion, there is still a significant differential in the costs at which such financial services are available to excluded sections of the population. When it comes to the costs of servicing, one of the biggest devils in the system is the handling of cash. For example, even successful mobile money models still depend on expensive networks of cash-in/cash-out agents to complete transactions.

Yet technology is now available to transact electronically which could drastically reduce the need for physical infrastructure and make the transaction size issue irrelevant. Systemic efforts have been made to capture the financial records and credit history of these customers in credit bureaus, and hopefully over time we can use emerging concepts like Big Data, psychometric profiling etc. to analyze and assess their true credit-worthiness. I am hopeful that the next stage of financial innovation will be able to bring the incremental cost of dealing with the poor close to zero so that they are also able to access the full bouquet of financial services at an affordable cost.

Anurag Agrawal is the CEO of Intellecap. He has worked with several socially oriented investors assisting them in identifying suitable impact investment opportunities and facilitating investment transactions.