Digitalization, Microfinance and Financial Inclusion in the Context of the Covid-19 Crisis

This article is extracted from the MFW4A Covid-19 Report.

The Covid-19 virus that has been spreading around the world since December 2019 is impacting all real and financial activities. Microfinance institutions (MFIs) and their clients are affected to varying degrees by the restrictive measures taken by political authorities across the world. Enforced social distancing and lockdowns have led to a slowdown in, and, on some occasions, halted, the activities of MFIs.

A few quick surveys conducted by organizations such as ADA and Fondation Grameen Crédit Agricole (2020), among their partners, from 18 May to 27 May 2020, paint a partial picture of the effects of the Covid-19 pandemic on MFIs in 47 countries in Europe, Asia, Latin America and Africa. Three questions guided this discussion:

• First, what stylized facts and data exist to aid in rigorous analysis and to measure the effects of the Covid-19 pandemic on micro actors?
•  Second, given the effects of social distancing and lockdown, is the uptake of digital tools not a panacea for continuous operations of MFIs?
• Third, isn’t digitalization opening the way to a new form of microbanks and telecommunication operators in the provision of local digital services?

For the most part, the Covid-19-induced economic crisis has affected the microfinance sector in three ways:

1. MFIs around the world, and especially in Africa, have found it difficult to continue repaying their loans.
2. MFIs’ clients have experienced enormous difficulties in accessing their service points.
3. The portfolio at risk has more than doubled for 41% of MFIs in Sub-Saharan Africa, in particular.

The use of digital tools, both for existing services and for new solutions to be put in place, is the strategy MFIs should adopt.

Digitalization in the form of the provision of mobile payment services or mobile banking is a factor of financial inclusion. The notion of digitalization is extended in our understanding to that of quasi-digitalization. It refers to basic IT strategies that do not require the use of smartphones or the internet, but simply older generation phones adapted to the operation of two services: SMS (Short Message Service) and the USSD (Unstructured Supplementary Service Data) technology for payment. The main aspect of digitalization currently used in microfinance services is mobile banking. The providers of these new services are banks, fintech companies, e-currency institutions and some microfinance institutions.

The entry of microfinance service providers into the digital economy is subject to two types of barriers: the ability to create a network of retailers and to secure a mobile phone operator’s license. While these two obstacles are easier for banks and mobile phone operators to overcome, they are difficult for microfinance institutions to surmount. In this case, the difficulty in overcoming these challenges increasingly excludes MFIs from the digital micro-lending business. In the mobile banking or mobile money service market, they are relegated to the role of distributors of these new services for the banks or Telcos. This new role for MFIs is also explained by the two-sided nature of digital service markets. The product or service distributed by MFIs (mobile money, mobile banking) belong to mobile phone operators or banks. MFIs can only act as distributors of these products or services.

However, there are signs of the emergence of a new microfinance model induced by the offer of mobile money or mobile banking services by MFIs in Senegal, Uganda and Kenya.

Digital technology is ultimately changing the microfinance value chain. Entry into this new segment requires the simultaneous possession of the three advantages identified in Dunning’s OLI paradigm (ownership, localization and internalization). The first advantage (ownership) is specific to Telcos, fintechs and multinational banks (or their local subsidiaries) operating in Africa. This advantage threatens the very existence of traditional microfinance. In terms of the second advantage (localization), the use of the digital platform (mobile money, mobile banking), which eliminates physical distance, creates a crowding-out effect on the proximity service (which was the specific advantage of MFI branches). The presence in the same or nearby geographic areas of both the Telcos’ “cash in and cash out” kiosks and MFI service points (branches) diverts a large fraction of the clientele that used to go to the MFIs to these entities, which are easily movable (at low cost). And the last advantage (internalization) allows structures that have been approved to issue electronic money to “siphon off” both the MFIs’ traditional activity and cash- only clientele by reducing these types of operation, particularly with the use of mobile money. The new banking operators and Telcos offer even smaller loans than traditional microcredit— pico or even nano credit.

From the above, it is clear that microfinance needs to be re-imagined, where its current actors are supported by strengthening their resilience. To prevent this new form of competition that has arisen in the Covid-19 pandemic that is threatening to run them out of business, small organizations need to be supported.