It was almost a decade ago that digital financial services (DFS) became the great catalyst of financial inclusion. As a milestone, the first Global Findex survey conducted in 2011 had no mention of DFS; by 2014 it devoted a whole battery of questions to the topic. Since then, DFS has been a major (and often the primary) area of focus for many organizations in the sector, including such pacesetters as the Gates Foundation; it headlines conferences and its ubiquity in discussions at times threatens to crowd out just about everything else. The annual Financial Inclusion Compass surveys of sector trends (and which two of us oversee) has made the importance of the topic to all kinds of stakeholders abundantly clear.
However, it was not until with the emergence of Covid-19 that DFS - and digital transformation more broadly - finally seemed poised to make the hype a reality, even among the traditional financial providers that the Sentinels represent. There was a presumption that the pandemic - with its enforced distancing, immobility of staff and closure of branches - has catalyzed the digitalization of the sector, vastly accelerating underlying trends towards a predominantly digital future.
But few things are ever as simple as that. Throughout the Sentinel project, the researchers have continued to ask about the Sentinels’ digitization experience, so it’s opportune to now consider what they’ve said. In this piece, we’ll examine the challenges Sentinels have faced (and opportunities grasped) on the supply side; we’ll then explore some of the demand-side trends that the pandemic has brought; and conclude - with support from other Sentinel researchers - by exploring how much digitalization is an enduring reality. Could it be that what we see among traditional microfinance providers is better understood as an incrementalism than the transformative digital revolution that seemed to be happening?
The supply-side ‘push’
The start of the pandemic saw the Sentinel institutions at different stages of digitalization. Some had already made the transition, others were in process, and still others had not yet begun. Unsurprisingly, each responded to the pressures of the pandemic differently.
Facing its first pandemic wave in spring 2020, one Sentinel in India was able to use its digital channel through which customers could make digital payments. Built in the aftermath of demonetization¹, this channel consists of apps linked to existing payments infrastructure, a partnership with a digital payments bank, as well as a network of customer service points (mostly local stores). When traditional payment channels were closed, the significant minority of clients willing to continue their repayments despite the initial moratorium in spring 2020 all used these digital channels. During the second moratorium in the summer of 2020, digital payments dropped to 60% of the total, though the share of clients making payments had roughly doubled. This trend – an increase in digital payments during the height of the pandemic, followed by return to traditional cash payments in subsequent months – mirrors the experience of other MFIs in India (see box below).
Another Sentinel in East Asia also had launched a digital wallet and payments platform just before the pandemic. One of the features is a behavioral ‘nudge’, allowing clients to direct spare change into savings, as well as conduct the more typical transactions of paying utilities, buying airtime, and making transfers. However, integration with the country’s payment infrastructure, including linkage with a G2P social benefits program and access to a large ATM network, still remains a work in progress. The Sentinel has also been investing substantial resources into educating and training its clients on using the platform, while accelerating digital rollout overall. A partnership with a local bank to provide agent banking was a plan for the start of 2022. The promise of widespread use by clients remains therefore a plan for the future, rather than reality right now.
A Sentinel in Central Asia had a similar quasi-digital system in place before the pandemic, which allowed clients to make payments digitally or via third-party agents. With the advent of the pandemic, the MFI put its digitalization process into overdrive, with a complex and ambitious strategy that includes “building out a fully-fledged electronic dossier platform, which involves not only the digitalization of all customer data but also their documents”. By the end of 2022, the Sentinel says, “we have set a goal to cover 100% of the company's clients with the electronic dossier”, in addition to launching an internal platform, also in 2021, “where all the company's regulatory documents are posted and each employee, depending on access levels, can get acquainted with the necessary documents.”
As if this wasn't enough, the Sentinel implemented “a mobile application for loan officers, which allows them to accept loan applications outside the company's offices and send them to the credit committee. It allowed us to reduce the process of obtaining a loan to 1 hour.” Finally, the MFI began to “write the terms of reference for a new core banking system, which [we] plan to introduce this year. Thus the main elements of digitalization will be done before the end of 2023.”
Among the Sentinels, about half had some meaningful digital systems ready to go prior to the pandemic. The other half were playing catch-up. One Sentinel in Latin America was in the process of a two-year digitalization project when the pandemic hit, a process that had to be suddenly accelerated. Others were even further behind.
In several cases, these Sentinels are operating in countries where at least some of their competitors had moved substantially further ahead along the path to digitalization. One Latin American Sentinel admitted that they and many other MFIs “were taken by surprise and did not have a digital presence. The banks ‘beat us’ by having greater advances in digital financial technological development.”
Another Sentinel in Latin America was forced to “improvise”, creating WhatsApp groups to communicate with clients. The change was so great that by May 2021, the Sentinel was questioning the MFI’s long-held belief that “the personal touch is fundamental…we went from 16 meetings in a loan cycle to just 1 (for disbursement)...the group continues to maintain contact.” This experience was inspiring rapid digitalization: “We want 100% digital outreach. We will not fire the loan officer, but use them to reach more clients, growing productivity from 200 clients to 500 in their portfolio.” [For more context and some warning signs on the changing role of loan officers in the pandemic, see the recent post by Kristina Czura and Lisa Spantig--eds]
By the end of the year, the digital strategy had evolved and expectations had moderated. Now, says the Sentinel, technology “is not about saving operational costs but about serving clients better.” Even so, the focus on digitalization remains: “We are institutionalizing digitalization with more formal processes…. developing two apps: the first is the loan officer app, the second is an app for the loan group president. Payments will still be physical at the branch, but the group president can enter information on the app and track status on the app”. What’s the result so far? “Some clients are starting to ask for loans to be disbursed on their debit cards, but we are still relying on in-person disbursements.” A significant part of this more moderate digital strategy is simply the recognition that capacity for change is finite: “We put too much pressure on the IT department regarding communication with clients. They were not quite ready.”
The State as Digital Facilitator
The rapid changes brought about by the shift to digital have highlighted the critical role of the state, with the ability to act as either a brake or accelerator for digital innovation. For a Sentinel in Latin America, the emphasis is more on the former: “as we move toward digital loan applications, we are moving toward asking for less information rather than more. And the regulator is not keeping up. For example, they require you to save a physical copy of information in the clients’ physical loan file… We have to drag the regulators because technology advances at a brutal speed and the capacity of the regulator is not the same.”
On the other hand, for a South Asian Sentinel, the regulator has been leading more than following, “actively pursuing digitizing the opening of bank accounts, digital payments, and ensuring an interoperable digital infrastructure. [Though] this would mean initial implementation costs for us, but we are keen to launch a digital wallet version and look forward to this initiative being fully implemented.” Another Sentinel in Southeast Asia reports similarly good news. “The government is supportive of digital processes nationwide. They're behind the digital roadmap for agent banking.”
THE DEMAND MIRAGE?
Despite its apparent institutional benefits, the most prominent argument driving digital transformation has always been about the purported value it offers to clients. It rests on the presumption that clients will see the value of mobile wallets, branchless banking and other client-side digital innovations, and move much of their financial transactions into the digital world. The enforced immobility of the pandemic - with its relentless push for mobile banking by providers coupled with reduced access to physical branches - should therefore have been a litmus test for digital. Do clients actually want and use these products and services?
In North Africa, a Sentinel bemoans that the sector is far behind - held back by the refuseniks. Merchants “don't want to play the mobile money game.” Accustomed to a cash economy and opaque attitudes to tax reporting, they fear that mobile money means traceability. “They think they are going to be taxed or prosecuted”, he says, so it’s “not taking off.” The banks are well established in DFS, he says, but the MFI sector is well behind that of other countries, where mobile money actors are increasingly playing the role of bankers – an offer with which their customers have become more comfortable. At the same time, there is, he says, a developed money transfer network in the country, which offers many of the key services of a mobile wallet (being able to send and receive money easily) but in physical form. But even if bank customers have been more willing to adopt mobile money, when it comes to MFI clients making the leap, he says, “people are just not able to take the step, they don’t want to move to it, they are hold-outs; we will have to wait another five to ten years for this to change.”
Elsewhere, there’s a different story. In Eastern Europe, a Sentinel observes that the biggest determinant of digital uptake is age. Younger people are more open; older generations more averse. For this reason, this Sentinel’s organization continues to hedge its bets, continuing with a “hybrid” approach. The same is reported by the latest Sentinel to join the project, from Western Europe, who says that the proportion of young people as clients increased during the pandemic, driven largely by their preference for accessing loans online.
One of the most vibrant and complex markets for digital finance in the world is India, with its enormous population, exploding connectivity, and a competitive landscape of financial and technology providers. According to Dvara Research (one of the Sentinel project researchers, and who will write a standalone piece on this site to explore this topic more deeply), the pre-pandemic context in India was diverse and tiered. Most of the MFIs with assets over US$70 million had robust (digital) core banking solutions and loan management systems, writes Dwijaraj Bhattacharya, while only some of these already had a customer-facing app - mostly those with a significant urban or peri-urban presence. As the box below shows, others who had not yet rolled out a finished app sought to rapidly expedite their development as the severity of the pandemic became clear.
The DFS experience during the pandemic in India
The Dvara team outlines three distinct phases of digital roll-out and uptake during the pandemic. In Phase 1 (April-May 2020), loan officers promoted apps to clients, many of whom downloaded and explored them, but with the repayment moratorium in place, transactions - especially repayments - remained rare. In Phase 2 that followed, initial curiosity and the ‘push’ from loan officers gave way to a dramatic decrease in monthly downloads and log-ins. By the end of 2020, most customers’ interest had waned completely and they had returned to physical repayments. Phase 3, from April 2021, was marked by the second wave of Covid-19 in India, a collapse in physical repayments, and a renewed push from MFIs’ loan officers on promoting the use of apps. What transpires is an increase in downloads and log-ins, but without overtaking that from Phase 1. However, there is an increase in transactions per log-in, possibly because this time round a lack of physical collections is not accompanied by a repayment moratorium. Customers have to repay, and have little alternative but to use the apps. At the end of this second wave, however, the numbers of users once more tapered off.
This enduring reluctance among clients to permanently embrace certain digital platforms is echoed by some Sentinels. One MFI in India has had a digital loan origination mechanism for quite some time, but repayments still predominantly happen through cash, says the Sentinel, who sees the behavioral change needed taking place over a longer timescale than implied by more bullish forecasts. “For this segment of customers, it is challenging, because they are used to cash. There has to be systemic and behavioral change to induce customers to convert their cash into digital. This happens over a long time. Currently, the focus is more on increasing collections as well as disbursements, and it is agnostic of…whether it’s digital or physical.”
Although “most of our logistical work has become digitized”, he says, client uptake of the app, which “was designed to become a digital interface for customers where they can access all digital services, including digital repayments…remains very small”. It’s important, he says, that many more interactive features are introduced so that the customers use the app more. “The challenge is now to encourage the customers to use the app. It has been a difficult phase.”
This interview was in mid-2021. At that time, the Sentinel said the priorities were using available data to better understand customers’ behavior, and communicate with them to acknowledge good repayment and flag any issues: ”We must leverage the data science and analytics to understand what the data says about these questions”. However, by December 2021 there had been a pivot, with a “low” number of customers using the digital repayment feature, and the MFI is “now planning on using the app more as a behavioral tool to induce customers to keep repaying, rather than leveraging the app to digitize repayments.”
At another Indian Sentinel, however, a mobile app has allowed “significant customer outreach and education”, leading to “good uptake of the product, and significant increase in payments through digital channels”.
And elsewhere, the picture is just as mixed. In a different South Asian market, a Sentinel describes clients’ “high familiarity with digital platforms”, and pilots are underway to on-board them - a process that will take “2-3 more years, but we are looking forward to it”. In Central Asia, incremental and steady progress from a low baseline is the story of that Sentinel’s pandemic to date. Fourteen percent were using digital wallets for repayments by the end of 2020, a figure which reached 16% by mid-2021 and 18% by the end of the year - incremental growth, nothing like a digital revolution so far.
And at one of the Southeast Asian Sentinels, the past two years has been a story of determined, almost desperate attempts to pivot to a fully digital client model - with loan officers training clients on use of the new platforms, with the MFI deploying strong incentives and even pressure, alongside the removal of alternatives via branch consolidation that will be permanent. Uptake, says that organization’s Sentinel, is slow but positive. “Client morale is high considering the changes we’re asking them to make”.
It’s not just about what mechanism clients use to borrow, remit or repay - and therefore not just about the relationship between client and provider, but rather to what extent a client adopts digital platforms for their businesses. And while there is progress on this (one Southeast Asian Sentinel has poured resources and leveraged its social media outreach into developing an e-commerce model to promote and sell its clients’ produce and products), this requires institutional support for the client. Without it, MSMEs can struggle, with recent data from a CFI study suggesting that microfinance customers are not embracing digitalization (see box) as much as it first appeared in the early stages of the pandemic.
Adoption of DFS by MSMEs is lagging
According to a recent study by CFI, MSMEs (that are typically microfinance clients themselves) are largely not adopting digitalization and therefore not seeing the potential benefits. They might test using a digital platform, but there is considerable usage drop-off, perhaps due to lack of digital literacy or challenges with onboarding. This is true even in markets with more built-out digital ecosystems.
While some studies are finding that small businesses have accelerated their digitalization efforts in response to COVID-19, CFI’s research points to an emerging risk that very small firms are at risk of being left further behind.
Few micro and small firms are able to make this transition to digital adoption without access to robust services and tools as well as support with digital capacity building and overcoming the barrier of the high cost of digitalization. For technology to make a lasting, consistent impact, MSME owners and the financial service providers that serve them need support to demonstrate the ways in which digital products can assist businesses and their customers, and also how to leverage tech touch business models to make technology approachable and accessible to people with differing levels of digital literacy and capability.
DIGITIZING THE HUMAN TOUCH
As argued in an upcoming paper by the Microfinance Centre (one of the Sentinel researchers) the notion that digital transformation is revolutionary, fast-moving and inevitable has become a sort of industry orthodoxy. “Digitize or Die!” goes the saying, but this is only useful to a certain degree, posing a false binary choice. There’s no doubt that over the long term, business growth and customer satisfaction cannot be achieved without adopting digital tools. However, there remains a great deal of uncertainty for MFIs about what kind of technologies to adopt and how their clients will engage with them. The challenge is surely not whether to digitize, but how.
If there is unanimity among the Sentinels on any single thing, it is probably - reassuringly - that a future of digital absolutism is neither viable nor desirable. There are enormous gains to be realized, of course - for traditional providers, regulators, credit bureaus, fintechs, and most importantly, for clients. But perhaps the legacy of these last two years is not so much the hyper-digitalization of the sector, but rather the renewed appreciation among FSPs of a hybrid future with an enduring ‘human touch’ - the very concept that has underpinned the microfinance model since its modern inception.
Many of the Sentinels now say as much. “For microfinance and financial services, it’s all about people-to-people interaction”, says a South Asian Sentinel. A different South Asian Sentinel says that his MFI wants to “intensify its touch-experience” with customers, with loan officers not only concerned with disbursements and collection, but also the well-being of the households. This is not just altruism, but self interest: “a more human touch would ensure that customers always prioritize the institution to make repayments”.
In Latin America, one Sentinel does emphasize the value to clients, but in the context of the threat from new entrants. “Technology is not to save operational costs but to serve clients better and compete with fintech better. Fintechs are trying to address client pain points. We want to continue to be relevant to clients and we have to do this in competition with fintechs”. But technology must be meaningful and actually useful as well; this Sentinel describes their future plans as “being better at being close to clients…[who] are not yet digitized but [also serving] new generations and new clients who want to see something relevant for them”.
In a different Latin American country, the Sentinel describes digitalization as “complementing, not displacing, client interaction”. This should “give [clients] a sense of being more supported, leading to higher retention and brand loyalty”. In South Asia, a Sentinel from a network of MFIs thinks similarly, that many of its members “struggle with this question and have approached it as if digital means a loss of relationships, but are now realizing that the two are complementary”. And a South-East Asian Sentinel is keen to point out that loan officers are “agents of change…not just loan disbursers”. He says that “this is going to be more and more our value-add, especially as there is more e-banking, fintech. But for our market, I don’t believe the low-touch digital model is what our clients need or want”. In fact, of all the reasons that clients took a loan with this MFI, top is “their relationship with the loan officer. I want to build on that”.
At one of the Indian Sentinels, finalizing the digitalization strategy is its “primary thrust” - emulating some, but not all, of the practices and advantages that new entrants are bringing. "The focus is on bringing small, incremental, innovative changes - in the way the company works and communicates with the customers. Many tech companies are already doing this: reaching to the borrowers directly. Technology is something that can bring lots of changes in the sector.”
TOWARDS DIGITAL INCREMENTALISM
In some respects, the modern history of digital microfinance parallels that of the internet itself - with hype and hubris, bull and bear, boom and bust. In the 1990s, most MFIs still used paper records. In the 2000s, they may have switched to Excel for loan management. The 2010s saw the emergence of management information systems, with prices coming down to make them viable for even small providers. The smartphone becoming affordable and ubiquitous will inevitably leave its lasting mark too, like the earlier advances.
There are new entrants everywhere in the financial inclusion sector - MNOs, MTOs, fintechs, online consumer lenders. Their emergence is transformative, no doubt. But not all evolution mandates revolution, and the digital transformation of traditional players - like the Sentinel MFIs - is characterized much more by incrementalism. After all, most sustainable progress is incremental, and revolution is rare and hazardous. For the Sentinels taking part in this project, the pandemic has been an almost-perfect driver to catalyze the digitalization of their operations, to make a quantum leap forward at both the institutional and client-facing ends. The reality, from the many interviews conducted throughout this project, is more nuanced; more guarded. The gains have been uneven and progress typically incremental. It almost begs the question – if a pandemic and endless lockdowns couldn’t really digitally transform and revolutionize the sector – whatever will?
The 1990s saw a maniacal boom in the nascent World Wide Web, followed by a tremendous crash. However, that same dotcom boom-and-bust of the late-90s laid the ground for the internet of today - building out the infrastructure, awareness and capabilities the ultimate uses for which were then mostly unforeseeable. The same may well be true here. It’s not only the past incremental improvement in how MFIs have collected and stored client data that has laid the ground for the digitalization of tomorrow; the investment and impetus for DFS as a result of the pandemic will similarly create opportunities that are difficult to imagine, let alone predict. The apparent reluctance of the Sentinels’ clients to adopt some new technologies doesn’t mean those platforms are objectively valueless, but only that their real value isn’t yet fully apparent or realized.
It seems likely that generation change will lead to much more digitalization, but that is a change that is much slower than a great deal of the current expectation for the COVID-induced “digital revolution”. The bottom line, ultimately, is that there is no set of consistent signals indicating rapid, permanent digitization. There remains a gap in the capabilities and resources of MFIs, along with a large segment of customers who are not yet ready to make the leap. It’s important to keep an eye on both phenomena as they will play an outsize role in how, when and whether the MFI sector recovers and what it looks like on the other side. Many futures are still possible.
*On 8th November 2016, the Indian Prime Minister declared that from the next day all large-denomination currency will cease to be legal tender. These large denominations represented over 80% of currency in circulation. Thus, cash transactions virtually came to a halt all over the country leading to a proliferation of digital payments at the time across all levels of the supply chain.
