Financial inclusion: incentives for banks will do the trick

Govt, regulators should provide banks with right tools to promote financial literacy

KARACHI: Technological advancements and the emergence of innovative business models have caused havoc across the established norms of almost every industry - hoteling, communications, ride-hailing and even banking.

The onset of fintechs and the collective power they now wield over consumers across the world has begun to gnaw at the pie once considered a safe territory for the banking industry.

Shift in consumer behaviour and their adaptability to new technology has aided the transition – most millennials now consider banks out of favour, both in terms of employability as well as adoption of their products and services.

Many in the West now opt for digital-only banks, with physical branches and ATMs slowly beginning to phase out across major cities. Others adopt products and services of technology firms slowly entering the financial services industry with radically innovative and appealing products aimed at catering to the tech-savvy consumer – value for money, ease of use and instant gratification.

It is fair to say that Pakistan is still at a nascent stage when it comes to financial services.

Products, services and instruments that are considered a staple across the Western capitals are yet to be developed and over 80% of the population is financially excluded, an accusation levelled on banks in every discussion regarding financial inclusion.

For what it’s worth, the State Bank of Pakistan (SBP) has drawn up a strategy – National Financial Inclusion Strategy (NFIS) – and tasked banks across the industry to increase the adoption of financial services in Pakistan.

However, much to one’s dismay, industry players have merely focused on the adoption of basic current accounts and have not really been able to provide any valueadded services to the common man, resulting in low adoption and high churn rates.

Even the most ardent supporters of the banking industry fail to defend the banks when it comes to justifying the extremely low rate of financial inclusion – which is the lowest in the region and worse than in some of the smaller economies across Africa. Most critics fail to understand that banks are not NGOs or development-sector organisations funded by donor money, they are private enterprises that work to create value for their shareholders and would, by design, grab the most lucrative, riskaverse and profitable avenues to create that very shareholder value.

Blame game

Pinning the blame for financial inclusion solely on banks is akin to blaming the prime minister for a pothole in your street – it is inexorably their fault, however, all other stakeholders in the ecosystem carry a larger share of the blame.

It is this detail that is often overlooked by many policymakers and one that needs to be honed in: in a market-driven economy, with the availability of a range of lucrative instruments such as PIBs and T-bills, why would banks risk their shareholders’ and, in some cases, the regulator’s ire by venturing into the risky segments of consumer financing, SME financing and agri-financing?

The recent push towards digitisation is also market-driven since banks have begun to fear losing out their space due to the entry of multiple fintechs and the issuance of Electronic Money Institutions’ (EMI) licences for their facilitation by the regulator. This question does not reflect a lethargic banking industry willing only to profit off the spreads of government-backed securities but a lack of sustainable and suitable array of products to meet the risk appetite of banks in a market-driven system.

If the government debt securities were to dry up, banks would have no alternative but to focus on developing these sectors for achieving the desired shareholder values.

However, this is an unlikely scenario, hence supporting the banking industry with alternative means to create the same shareholder value through innovative financial product development that could spur the engine of growth is more likely to yield better results and should be at the forefront of policymakers’ agenda.

Derivatives

This mechanism should enable banks to offload risky assets onto desirous investors with suitable risk appetite through an enabling regulatory framework that permits the development and trading of derivatives through special purpose vehicles (SPVs) and regulated entities.

Derivatives are complex financial instruments that are used by financial institutions to offload their portfolios onto investors, thereby developing a secondary market, generating liquidity and offloading risk onto institutional or retail investors.

As the name implies, derivatives are any financial product that derive their value from the underlying source such as financial assets, commodities, currencies or interest rates. Collateralised Debt Obligations (CDOs) are a type of derivative being used by the financial services industry in the West, repackaging the individual loans – these include auto loans, credit card debt, mortgages or corporate debt – into a product categorised and graded as per the risk level and available for investors.

Effectively, banks can use these instruments to offload their consumer, agri and SME financing portfolios onto investors with varied risk appetites, regulated through strict oversight by the SBP and the Securities and Exchange Commission of Pakistan (SECP).

Not only would this generate additional liquidity for the banks, it would also incentivise the banks to offer financing across all strata and possibly target riskier segments as well, driving the cause of financial inclusion through a more effective methodology - providing access to finance to a credit-hungry market.

As the products mature, extensive regulatory oversight would be required to discourage the misuse of these products, which resulted in the financial crash of 2008.

The SBP has already ensured the implementation of a deferred remuneration policy based on risks associated to particular designations across the banking industry and a similar structure can be implemented for those job positions that are dealing with derivatives to create a balanced approach across all transactions.

New ideas

In conclusion, while economists and analysts harp on about the need for macroeconomic structural fixes, lowering the import bill, expanding exports and economic turnaround, one hears very little about introducing and experimenting with radically new ideas to spur the consumer economy. These have been perfected through multiple iterations in the financial capitals across the globe, albeit do have a stigma of causing the latest global financial crisis.

Instead of blaming banks to fill in the shoes of the government and redesign their business models, the government should work with the regulators to provide one of the best-performing industries of this country the right tools and incentives to promote the cause of financial literacy and financial inclusion.

However, if the policymakers continue to harp on the mantra through a stick, the status quo is unlikely to change. It may well be time for the carrot to be introduced!

THE WRITER IS THE ASSISTANT VICE PRESIDENT AT A COMMERCIAL BANK