Banking the Underbanked: Formal vs Informal Financial Inclusion, Does It Matter?

Banking the underbanked requires collaborative interventions from the formal and informal industries

Collaborative interventions and solutions hold the key to banking the underbanked. This underbanked segment, which consists of millions of people, could be rapidly moved into the formal financial service ecosystem in a relatively short time.

The financial inclusion discourse revolves around three customer segments, namely — the banked, the unbanked and the underbanked. The banked segment refers to consumers with bank accounts or digital wallets in deposit money (or microfinance) banks and mobile money operators respectively. The unbanked segment refers to consumers without a bank account or digital wallet who conduct all their financial transactions independently.

The underbanked segment, which is the focus of this article, refers to financial service consumers who use informal and unregulated financial services provided by savings groups (like the Alajos and Esusu) and cooperatives. It could also refer to consumers who may have a bank account to their name, but rarely if ever, use it, opting to empty their accounts once they receive any funds in them.

EFinA’s 2016 Access to Finance Survey pegs the number of these underbanked adults at about 9 million. These 9 million people are low hanging fruit for financial inclusion efforts, provided the formal financial service industry can explore interventions and solutions for the informal financial service sector which would enable them to deliver their services better.

How? First of all, most, if not all, consumers in the underbanked segment are already banked by proxy. Everytime they opt to save with a local savings group or cooperative, their funds eventually end up within the formal financial service ecosystem, usually via the cooperative’s bank account.

Secondly, banks have been known to develop and deploy solutions which help their customers do business better within different industries — education, engineering, oil and gas, and so on, as well as bring in more deposits. However, we are yet to witness key solutions specifically targeting the informal financial service industry.

This is a big opportunity for both formal and informal providers and creates exciting possibilities for financial inclusion. The informal financial service sector is a 9 million customer market, currently being served by diverse and unregulated financial service providers. We have informal savings clubs and cooperatives who have carved out a niche for themselves, targeting select groups and individuals. There’s also the rotating savings clubs that are near ubiquitous among Nigerian market traders. Then the local creditors and loan sharks.

For several reasons, these informal providers are attractive to a lot of people, especially people who operate majorly within the informal economy (which is estimated to constitute about 60 percent of the entire Nigerian economy according to the International Monetary Fund).

The informal financial services sector would be a lucrative vertical for the formal financial service sector because these informal providers have done a lot of the heavy lifting of financial inclusion. They have the networks, the market knowledge, the customer base and a system that works. Through collaboration and partnerships, formal providers can leverage these strengths and resources, towards a common goal.

For example, a program led by CARE International across sub-Saharan Africa with over 5,000 informal savings groups provided linkages to banks while supporting the development of products that met the needs of the group members. These partnerships enhanced the benefits of the informal providers and reduced their risks while helping thousands of women attain greater financial security and access other financial services including insurance, mobile banking and others.

In Ghana, Tanzania and Zambia, Savings at the Frontier (SatF), a multi-year partnership between Mastercard Foundation and Oxford Policy Management, helps formal financial service providers to find ways to link with informal savings mechanisms (ISMs) in a mutually beneficial partnership that leads to better service delivery to consumers.

By joining forces, actors within the two ecosystems have been able to reach more customers and provide better products and services to them. At the end of the day, financial inclusion is advanced while creating win-win partnerships.

Evidence has shown that financial inclusion requires significant collaboration between all ecosystem actors. The burden of driving financial inclusion cannot be borne solely either by the formal or the informal sector, due to their respective weaknesses and blind spots. However, through collaboration, these weaknesses and blind spots can be mitigated.

There’s a school of thought that says banking will change through collaboration and not just the disruptive power of fintechs. We agree, especially where the underbanked are concerned.

Collaboration would be a more optimal needle moving strategy. In fact, the evolution of Nigeria’s financial service industry rests on how fast or how soon the two ecosystems — the formal and informal — can foster collaborative relationships.