Digital Banks Poised for Financial Inclusion

The key word that differentiates a digital bank from a traditional bank is ‘efficiency’. Efficiency in managing costs, efficiency in developing products, efficiency in taking those products to market, and efficiency in reaching target customers. All this efficiency is powered by digital technology!

Digital banks have typically focused on retail services – from deposits, savings, money transfers from accounts, and payments e.g., via cards. But they’ve arisen from recurring issues that have constrained retail services (from both provider and consumer perspectives) offered by traditional banks for a long time.

Challenges leading to the rise of digital banks

Typically, banks have expanded by growing a physical branch presence across areas where it makes business sense (e.g., access to a large number of clients with disposable income to save and make investments). But growing distribution further via physical branches is too expensive, and gets more so the more remote the target area is. Some banks have tried the agency banking model, but it’s not quite a capability that banks have.

Banks’ IT systems are also old and they have a high-risk view (perhaps understandably) of not changing anything that isn’t broken – so this means that digital transformations are slow and constrained. And because their costs are so high (from branches, personnel and IT systems they’re managing), its hard to develop and scale a low-cost product that appeals to the typical unbanked and underserved customer.

On the other hand, and unsurprisingly, many customers find these banking products too expensive to bother with, and too cumbersome and complicated to even access.

Most digital banks aim to solve the above.

Digital banks’ pathways to financial inclusion

Many digital banks are primarily focused on providing banking products and services that solve financial issues for the common man, for the masses. And in doing so, they (sometimes unintentionally) also reach underserved or unbanked customers, simply because the financial products they provide are cheaper, simpler, and easier to understand and access.

These low-cost products are a typical feature for a digital bank - particularly no/low fee accounts and higher savings accounts. Because they don’t have to maintain legacy IT systems and infrastructure, or branches, many personnel, or even build a solution from scratch (cause they can white-label it from a bank or partner with third parties easily) digital banks can pass on their savings to customers through these products much better than a traditional bank could.

Such a low-cost play alone easily attracts an unbanked customer who already recognizes that they need a financial product.

It’s probably worth reinforcing again that the low-cost operations of a digital bank is critical. According to a CGAP study, customer acquisition costs for a digital bank can be up to 15% lower than for a traditional bank. That’s a lot of savings! Digital banks can also spend only 1%-5% of the cost of running a branch on other distribution methods (e.g., simple kiosks, partnerships with retail chains, digital-only channels) that are now just as effective for the masses. That’s a whole lot of savings!

In addition, the general characteristics that define a digital bank make their products easy to access and use: Cost of opening and using accounts are low because the banks have so many opportunities to save on costs; products are more accessible – either via a digital-only mobile app or agents that can reach customers where they are because distribution methods aren’t limited to bank-owned branches; products are simple to use with great user experience and user interfaces, primarily leveraging a tool that everyone has – the mobile phone.

What’s next for digital banks promoting financial inclusion

The above shows that digital banks are well positioned to provide products and services to the masses, including an unbanked customer who knows they have a need for financial products. But how effective have these banks been in reaching the unbanked segment in particular, and in getting them to actually use the products/services?

I’ll be working on a high-level examination of this in a second part of this story.