Viewpoint: Reach the World's Poor with a Transaction-Based Approach

As banks in the U.S. consider new ways to reach low-income client segments and broaden their service propositions, they may be interested in new business models that are being experimented with in the developing world.

Most banks in developing countries struggle to find economical ways to reach the bulk of the population, not to mention the poorest among them. It's a sweeping statement, but the statistics are stark: at least 70% of people in developing countries don't have access to a simple bank account.

The poor, by definition, maintain relatively low average savings balances, and credit may be inappropriate for them if it commits them to future payment streams beyond what they can sustain with their meager, erratic income. Thus, the traditional sources of revenue for banks — interest margin and credit cross-selling fees — are weak.

At the same time, poor people may require as many if not more financial transactions than average bank customers, since their income is less predictable, they are often paid more frequently (daily or weekly) and their daily financial circumstances may be more easily overwhelmed by regularly occurring health or other shocks. Cash-flow management, rather than longer-term accumulation, is often the prime reason poor people seek formal financial services, at least to begin with.

Which leads to the precarious economics of low-balance accounts: low revenue, many small transactions. Banks often fight this reality by giving poor-quality services (congested branches), imposing fixed monthly fees (asking for a commitment that few poor people can entertain), or selecting customers who are able and willing to absorb debt.

These approaches put banks on a slow path to universal financial access.

Banks need to rework their business models away from those things that poor people don't do much of (leave large balances, take on lots of credit) and embrace what they do want to do abundantly: making frequent transactions to help make ends meet on a daily, weekly, monthly or seasonal basis.

Banks might make it easy for them to park money when they have had a good day at the market, save up for school fees which are due next month, save down on the crop proceeds they got three months ago or send money to support relatives in need.

Banks shouldn't fight transactions, they should make them their friend. That means shifting to a transaction-based pricing model, so that banks have an opportunity to make money every time customers actually choose to do something. That is a model that has served mobile operators well: no commitments, no monthly fees, no minimum spend — but you pay each time you call, send a message or access information.

It also means creating a network of transactional points that delivers convenience and proximity to customers. Customers will be OK paying for transactions if the capability is available as and when they need to do something. And service needs to be fast and welcoming.

Again, mobile operators come to mind, with their very dense network of airtime resellers. For every branch that a bank has, the mobile operator will typically be operating through 100 third-party retail outlets.

And while the branch manager is busy thinking about how to get people out of the branch, retail stores are welcoming of the additional foot traffic.

Finally, a transaction-based business model requires that transactions be undertaken at very low cost, so that they are not priced out of the market. There is plenty of evidence that customers are willing to pay for service that is relevant to them, convenient and immediately available.

Banks are burdened by the mass of fixed costs tied up in the dedicated physical infrastructure through which they operate. Their cost-allocation rules make the profitability of individual transactions an impossible stretch. Banks should seek to reduce fixed costs at the retail endpoints (bricks and mortar, teller salaries) and instead shift to per-transaction commissions utilizing existing stores.

All this points to the need for banks catering to the mass of poor people in developing countries to embrace indirect channels.

Why not let customers do their basic deposit and withdrawal functions at the same store where they buy their bread, rice or cooking oil?

This can be done safely with the use of technology: deploying cards to customers and point of sale terminals to stores so that all transactions are properly verified, authorized and recorded in real time.

This can be done even more cheaply if people's mobile phones are used as an alternative to both cards and point of sale terminals, since they are functionally equivalent devices.

The key is to avoid all credit risk on the store, which can be done by ensuring that all customer cash transactions at the store are immediately offset by a transfer of money between the customer and the store's bank account. This is equivalent to airtime resellers prepaying the stock of scratch cards they sell.

There has been remarkable innovation with this kind of model. Equity Bank in Kenya has been in the forefront of transactional charging models. Major banks in Brazil and Peru are world leaders in banking through normal retail outlets. Their experiences deserve to be scrutinized.

The transactional model works as a two-pronged approach: reduce unit transaction costs to a very low figure and have the rest covered by a small transaction fee.

The key principle here is to make transactions profitable. If each transaction is profitable, then by definition every customer is profitable.

This financial certainty should push banks to adopt mass-marketing approaches, and that is what it will take to give financial access to all.

Mobile operators in India are comfortable with any customer buying a 20-cent prepaid card, at any of a million locations. If only banks were comfortable taking on a 20-cent deposit from any customer as well, at thousands of locations.

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