The digital revolution has allowed new actors, such as non-bank financial service providers (FSPs) (like mobile money providers) and fintechs (companies that apply new technologies such as Artificial Intelligence to the provision of financial services and products), to leverage connectivity, new technologies, and data analytics to bring innovative financial solutions to market. This has resulted in dramatic transformations of the financial sector in both mature and emerging economies. New products such as nano-credit and mobile person-to-person (P2P) transfers have allowed alternative market players to reach consumers that formal banking and payments providers had never served before.
Such innovative solutions have often brought real competition to segments of the financial services industry, resulting in greater consumer choice, lower retail prices, higher quality of service and increased financial inclusion. Mobile money in Sub-Saharan Africa is a good example, due to its dual functionality as payments and low-cost value-storage vehicle, which matches poor peoples’ uneven cash flow. When Safaricom first launched M-Pesa in Kenya, it offered an innovative way for the middle class to send money home, competing with formal and informal providers of remittances services. That innovation and competition has turned out to be one of the greatest game-changers in the pursuit of financial inclusion that emerging countries have seen in the past half century.
Today, fresh on the heels of mobile money and digital credit, there is a much larger fintech wave challenging incumbents and creating new markets based on novel technologies, such as artificial intelligence, big data, and geospatial intelligence. These solutions range from robo-advising (such as StashAway and Autowealth) and crowdfunding (e.g., Kiva) to virtual currency-based remittances (Bitpesa) and blockchain-enabled capital raising platforms (Capexmove). At the same time, super platforms such as Google, Facebook, and Amazon are entering the financial services sector, leveraging their massive databases of customer data to do so.
Traditional, established players have been stepping up to these competitive challenges by innovating. For example, by using a combination of technology, data analytics, and client research, traditional FSPs are identifying patterns in customers’ financial behaviors and decisions in order to determine which customer segments may benefit from cross-selling and what cross-sell strategies are appropriate for each segment. Cooperativa Acreimex, Banco WWB, Capital Aid Fund for Employment of the Poor (CEP), and SAJIDA Foundation are examples of FSPs in Mexico, Colombia, Vietnam, and Bangladesh, respectively, that are intentionally pursuing cross-selling strategies that impact the institutions and their customers.
Some innovative products, however, raise concerns that supervisors should monitor and regulators consider carefully. For instance, the rise of digital lending in Kenya has raised the risk of over-indebtedness. Moreover, the World Bank’s Consultative Group to Assist the Poor (CGAP) has pointed out that at least one digital credit product in the country resembles a Ponzi scheme.
The digital revolution can render financial sectors extremely competitive at different levels of the value chain. The nimble fintechs, which are often not regulated by the primary financial authority, use technology as a way of tackling distinct parts of the financial services value chain, thereby undercutting incumbents that have relied on economies of scale and customer inertia for market share. At the same time, super platforms make formidable competitors to both incumbents and fintechs alike, due to the intrinsic network effects that they exhibit (whereby each new member exponentially increases the value of the platform), their lack of interoperability among themselves and their tendency towards standardization of service features, to the exclusion of small players. Lastly, traditional players, increasingly aware of these competitive threats, are repositioning themselves to remain competitive through collaborations via accelerators and joint ventures, as well as by undertaking acquisitions and internal reorganizations.
The vigorous competition triggered by technological innovation and the entrance of new players in financial services can bring a multitude of benefits to financial inclusion. Effective competition in price makes financial products more affordable, which is essential to drive adoption among low-income populations. Competition equally drives up quality and service standards, which helps adopters remain active users, and encourages the development of new products that are often targeted at specific consumer needs, including those of low-income individuals. Lastly, competition and innovation reinforce each other in a circular manner, as competition promotes further innovation, which may foster financial inclusion.
However, there is a dark side of unchecked market innovation and competition that regulators and supervisors must heed. In particular, the increasing significance of digital channels as the way to access financial services, the rise of customer data as a critical asset for business development, and the existing market power in the sector of origin of many new actors may require closer scrutiny from financial authorities. For instance, in a sector where the value of data has significantly increased, given its utility for credit scoring or customer targeting purposes, the entities that control these data have important market advantages. Similarly, the control of the USSD channel grants an advantage to mobile network operators (MNOs) for downstream digital financial services.
Unfair leverage of these assets could ultimately stifle competition, rendering existing customers worse off and curbing the market’s incentives to reach untapped customers, including those at the bottom of the income pyramid. Traditional incumbents may also be pressured to undertake problematic actions that preserve their market share, including unfairly bundling products, preventing interoperability with competitors in regard to their proprietary platforms or to other payment infrastructure, such as switches, creating opaque pricing structures or inappropriately forcing exclusivity on their agents and distributors.