A dynamic business environment, widespread mobile and digital infrastructure and digital finance products are the three building blocks towards achieving the promise of inclusion

Digital technologies have now become the most powerful lever for financial inclusion and are considered the smartest way to rapidly unlock economic opportunity and accelerate social development with economic empowerment. Digital tools have fostered speedier and more inclusive growth by dramatically reducing financial service providers’ costs and making services more convenient and accessible for users, especially low-income subscribers in remote locations. Money sits in a virtual account on a server where it can be transferred with the click of a button.

Digital finance payments and financial services delivered via mobile phones and the internet are greasing the wheels of the economic system and  transforming the lives and economic prospects of individuals, businesses and Governments across the developing world, thus boosting GDP and making the goal of financial inclusion a reality.

In contrast to digital financial systems, physical channels are prohibitive for even low income populations. First, physical banking is relatively costlier and riskier for consumers to perform even while engaging in basic financial activities — payments, savings, investments and remittances. Second, it is very costly for utility firms, banks, insurance companies and other institutions to transact with them as it makes their operations infeasible and unsustainable. Digital channels offer a robust fix for the problems encountered by both consumers and financial institutions in traditional systems of finance.

Digital finance can be defined as financial services delivered over digital infrastructure, including internet and mobile, with low use of cash and traditional bank branches. Computers, mobile phones or biometric payment cards used over Point-of-Sale (PoS) devices connect individuals and businesses to a digitised payments infrastructure, enabling seamless transaction across all parties.

The popular term for the digital financial revolution is “fintech,” which has fundamentally changed people’s lives and transformed the business landscape. In many markets, cash is fast becoming obsolete and transactions are mostly via digital tools. Banking is also moving into a presence-less, paperless and real-time era: While there will always be bank branches, banks will become more “invisible” in how they deliver their services — many of which will primarily be accessed online.

The fintech revolution is led by a host of players, including commercial banks, telecommunication firms, payment banks, small finance banks and financial technology companies. It is harnessing technology to reinvent traditional business models, creating opportunities to connect India’s hitherto unbanked communities to affordable and reliable financial tools at an unprecedented speed and scale. It offers a preview of what the global banking model may look like a generation from now.

Fintech has freed bank staff from counters and relieved customers of the inconvenience of transacting solely during banking hours. Most of the financial work can now be done via the smartphone, improving payment systems, eliminating paper receipts and reducing a number of frictions thus not only saving customers’ time and money, but improving their quality of life. Meanwhile, the phenomenal data footprint provided by smartphones and data-connected mobile phones is providing an unprecedented opportunity to bring people with limited credit-history into the formal mainstream through alternate credit profiles. In conjunction with this digital data, Artificial Intelligence and machine learning algorithms can assess the credit worthiness of the user, making it possible to provide loans to them even in the absence of a traditional credit history.

Digital finance also offers major technological and infrastructure challenges. Sparse populations, inconsistent network coverage, insufficient capital for building new business models and customers’ lack of trust and comfort with technology can stand in the way of success, particularly in remote or undeserved communities. And the risks of implementing digital financial services are not just operational and technical: There are also concerns about the security, affordability and safety of these new financial channels. To take just one example, loss of customer privacy is all but inevitable, despite efforts to create safeguards. For India’s financial inclusion industry to capitalise fully on the benefits of digital finance, the accompanying risks must be understood and adequately addressed.

However, digital finance can have negative effects for financial inclusion. Providers of digital finance services can be profit-seeking corporations that use digital finance to maximise their profitability or to maximise the profitable opportunities of businesses affiliated with digital finance providers, namely banks, financial and non-financial institutions. Corporate providers of digital finance services can discriminately use a more aggressive marketing tactic to persuade high and middle income customers to use a new or existing digital finance platform or infrastructure. They must use a less-aggressive marketing tactic to persuade low-income and poor customers to use new or existing digital platforms or infrastructure if they believe the latter cannot afford the associated fees.

The most important need is to strengthen the entire ecosystem within which last-mile agents, clients and financial service providers interact with technology. To facilitate a seamless transition in digital financial services, India will have to consider the following:

• The need to balance the regulatory framework to support innovation and competition, while ensuring the safety and soundness of the financial system.
• Maintain openness to new players and models such as non-bank players like fintechs, telecom-supported financial services providers, crowd funding and big data analytics.
• The role of regulatory sandboxes to test new digital ideas and initiatives.
• The importance of sufficient digital infrastructure.
• The role of national identification systems, biometrics and tiered know-your-customer digital solutions that reach beyond the banking system.
• While ground-breaking technology and innovative business operations provide fresh business opportunities, there are also new risks, which relate to implementing digital financial services, not just operational and technical. Loss of privacy is the most obvious one. Despite efforts to create safeguards, it is all but inevitable. Though these risks cannot be eliminated, they can be mitigated. We must keep in mind the concerns of security, affordability and safety.

India’s central bank has been espousing a cautious approach in addressing concerns around consumer protection and law enforcement. The key objectives of the regulator have been to create an environment for responsible fintech innovations, to expand the reach of financial services for the unbanked population, to regulate an efficient electronic payment system and to provide suitable options to consumers.

While India is right in espousing a cautious approach, it would be more practical if it strikes a balance between protecting investors and consumers and giving banks, retailers and financial technology and telecommunications companies room to compete and innovate. Because regulations often shut out non-bank competitors, Governments should consider a tiered approach, whereby businesses, without a full banking licence, can provide basic financial products to customers.

Success cannot occur in a vacuum. To capture the opportunity, Government, leaders and businesses have to make a concerted and coordinated effort. Three building blocks are required: A dynamic business environment for financial services, widespread mobile and digital infrastructure and digital finance products that meet the needs of individuals and small businesses in ways that are superior to the informal financial tools used today. As the Government and the fintech industry work to navigate the many challenges ahead, efforts to maintain a balance between safety and innovation must continue.

(The writer is Member, NITI Aayog’s National Committee on Financial Literacy and Inclusion for Women)