05 October 2012
The efforts of the global development community to harness the power of electronic money for the social good got a big shot in the arm last week. On the sidelines of the 2012 UN General Assembly a coalition of leading countries, global NGO’s, development agencies and the private sector came together and formed the “Better-Than-Cash” Alliance. This coalition can make a real difference. The leading country members (Colombia, Kenya, Peru, and the Philippines) are already shifting their own payment flows onto electronic platforms. Global NGOs are doing so as well. And the donor members (including the Bill & Melinda Gates Foundation, Ford Foundation, Omidyar, USAID) and corporations (Citi and Visa) are willing to put up additional seed funding to help others follow the lead.
The development field has had its fair share of promising silver bullets and subsequent disappointments. So it’s probably important to parse the considerable upside electronic money can bring about, but also to understand where the issues go beyond better-than-cash transactions. Essentially, for the development community, there are two separate promises and the potentially beneficial interaction between the two that have created excitement.
The first promise is on financial inclusion. More than 75% percent of the world’s poor are excluded from formal financial services according to 2011 World Bank/Gallup data. They typically work and live in the informal economy and need financial access as much as anyone else to build assets, create livelihoods, manage risks and smooth consumption. Living on average below $2 dollars a day does not mean you have $2 dollars every day. Without access to formal financial services, poor families have to rely on age-old informal mechanisms: Families & friends, rotating savings schemes, the pawn-broker, the moneylender, money under the mattress. These informal mechanisms can be very unreliable and are often very expensive.
Electronic money, in particular mobile-phone-based, has the proven potential to reach far more people at lower costs than traditional brick-and-mortar, for example for domestic remittances or low denomination, short-term money safekeeping. A ubiquitous, low-cost electronic retail payment platform will also make new business models viable that rely on collecting huge numbers of tiny amounts, for example user fees for community-based infrastructure such as off-grid solar power. In Kenya, where M-Pesa by now reaches 80%+ of the population, we are seeing a wave of this second-generation business model innovation happen.
But transaction costs are only one part of financial intermediation. Take long-horizon, term-savings that functions as a micro-pension for example. There is a real need for such a product as traditional multi-generational families are breaking up over urban migration of the next generation and uptake has been very high where offered. Some financial intermediary has to actually make the asset/liability transformation and earn the promised 5-6 percent annual real rate of return over 10, 15 years plus some to cover administrative costs and margin. Or take insurance: Some financial intermediary has to aggregate diverse exposures at actuarially-relevant scale and properly manage and reinsure that pooled risk so that claims can be paid out and the corpus remains solvent in the event of a large-scale crop failures or wide-spread property-damage. Lower transaction costs help, but are not a sufficient condition for the viability of these forms of financial intermediation required for real welfare gains.
The second promise of electronic money is on the effectiveness and efficiency of government, development, and NGO payments, in particular for social protection purposes. Governments in developing countries spend tens of billions each year on social transfer payments. Some of these do very good. In some cases, the transaction costs of handing out cash eat up a significant share, and leakage through local-level corruption can be immense. Electronic payments combined with unique IDs have the potential to dramatically increase effectiveness in the targeting and efficiency in the distribution of such transfers. The Indian Government, for example, has announced its intention to shift over a myriad of existing programs, the cash leakage for some of which have been estimated to be as high as 40 percent.
In Brazil, the Bolsa Familia program reduced its transaction costs from 14.7 percent of total to 2.6 percent when it bundled several benefits onto one electronic payment card. But social transfers are still social transfers. Somebody has to pay for them. And to ensure that a social transfer enables poor families to graduate into sustainable livelihoods likely requires other costly interventions, such as skills training, financial capability building, and an asset transfer such as livestock that creates future income streams.
The third promise of electronic money is a beneficial interaction between financial inclusion and social transfer payment flows. An inclusive financial system that reaches all citizens allows for more effective and efficient targeting of other social policies, such as conditional payments in health or education, for example when parents are rewarded for making sure their children get all recommended vaccinations or for sending their girls go to school. Conversely, a shift of the often large government payment flows can truly catalyze the development of the inclusive financial system by bringing previously excluded segments into the financial system and lowering everybody else’s transaction costs.
For this virtuous cycle to kick in a number of elements must line up. Social protection ministries must be convinced that the electronic payment route meets their primary objectives. Governments must be willing to pay providers for the usage of a general purpose, retail payment infrastructure. In early examples, governments built closed-loop, single-purpose electronic mechanisms that can be more expensive than cash. Beneficiaries must trust the system.
In many early schemes, poor families converted their monthly electronic deposit immediately into cash because they feared that accumulating a savings balance might exclude them from being a transfer beneficiary in the future. Based on these findings, countries and the global development community are learning and improving design and execution of their programs. The “Better-than-Cash” Alliance is picking up on this learning and has thrown its considerable weight behind an exciting global effort.
The development field has had its fair share of promising silver bullets and subsequent disappointments. So it’s probably important to parse the considerable upside electronic money can bring about, but also to understand where the issues go beyond better-than-cash transactions. Essentially, for the development community, there are two separate promises and the potentially beneficial interaction between the two that have created excitement.
The first promise is on financial inclusion. More than 75% percent of the world’s poor are excluded from formal financial services according to 2011 World Bank/Gallup data. They typically work and live in the informal economy and need financial access as much as anyone else to build assets, create livelihoods, manage risks and smooth consumption. Living on average below $2 dollars a day does not mean you have $2 dollars every day. Without access to formal financial services, poor families have to rely on age-old informal mechanisms: Families & friends, rotating savings schemes, the pawn-broker, the moneylender, money under the mattress. These informal mechanisms can be very unreliable and are often very expensive.
Electronic money, in particular mobile-phone-based, has the proven potential to reach far more people at lower costs than traditional brick-and-mortar, for example for domestic remittances or low denomination, short-term money safekeeping. A ubiquitous, low-cost electronic retail payment platform will also make new business models viable that rely on collecting huge numbers of tiny amounts, for example user fees for community-based infrastructure such as off-grid solar power. In Kenya, where M-Pesa by now reaches 80%+ of the population, we are seeing a wave of this second-generation business model innovation happen.
But transaction costs are only one part of financial intermediation. Take long-horizon, term-savings that functions as a micro-pension for example. There is a real need for such a product as traditional multi-generational families are breaking up over urban migration of the next generation and uptake has been very high where offered. Some financial intermediary has to actually make the asset/liability transformation and earn the promised 5-6 percent annual real rate of return over 10, 15 years plus some to cover administrative costs and margin. Or take insurance: Some financial intermediary has to aggregate diverse exposures at actuarially-relevant scale and properly manage and reinsure that pooled risk so that claims can be paid out and the corpus remains solvent in the event of a large-scale crop failures or wide-spread property-damage. Lower transaction costs help, but are not a sufficient condition for the viability of these forms of financial intermediation required for real welfare gains.
The second promise of electronic money is on the effectiveness and efficiency of government, development, and NGO payments, in particular for social protection purposes. Governments in developing countries spend tens of billions each year on social transfer payments. Some of these do very good. In some cases, the transaction costs of handing out cash eat up a significant share, and leakage through local-level corruption can be immense. Electronic payments combined with unique IDs have the potential to dramatically increase effectiveness in the targeting and efficiency in the distribution of such transfers. The Indian Government, for example, has announced its intention to shift over a myriad of existing programs, the cash leakage for some of which have been estimated to be as high as 40 percent.
In Brazil, the Bolsa Familia program reduced its transaction costs from 14.7 percent of total to 2.6 percent when it bundled several benefits onto one electronic payment card. But social transfers are still social transfers. Somebody has to pay for them. And to ensure that a social transfer enables poor families to graduate into sustainable livelihoods likely requires other costly interventions, such as skills training, financial capability building, and an asset transfer such as livestock that creates future income streams.
The third promise of electronic money is a beneficial interaction between financial inclusion and social transfer payment flows. An inclusive financial system that reaches all citizens allows for more effective and efficient targeting of other social policies, such as conditional payments in health or education, for example when parents are rewarded for making sure their children get all recommended vaccinations or for sending their girls go to school. Conversely, a shift of the often large government payment flows can truly catalyze the development of the inclusive financial system by bringing previously excluded segments into the financial system and lowering everybody else’s transaction costs.
For this virtuous cycle to kick in a number of elements must line up. Social protection ministries must be convinced that the electronic payment route meets their primary objectives. Governments must be willing to pay providers for the usage of a general purpose, retail payment infrastructure. In early examples, governments built closed-loop, single-purpose electronic mechanisms that can be more expensive than cash. Beneficiaries must trust the system.
In many early schemes, poor families converted their monthly electronic deposit immediately into cash because they feared that accumulating a savings balance might exclude them from being a transfer beneficiary in the future. Based on these findings, countries and the global development community are learning and improving design and execution of their programs. The “Better-than-Cash” Alliance is picking up on this learning and has thrown its considerable weight behind an exciting global effort.
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