A New Miracle? The Promises of Digitalization and Financial Inclusion in Latin America
Economist in the Research Department of the Inter-American Development Bank
Lead Economist in the Development Effectiveness Division (DVF) of IDB Invest
Latin America and the Caribbean has made a big leap towards using digital technologies to expand financial inclusion, and there are reasons to be hopeful: Several initiatives in the region have expanded the supply of innovative digital financial products which, in theory, should untap inclusive growth by enabling millions of micro and small firms and households to integrate into modern financial markets.
But there are also reasons to be skeptical. Firms and individuals either lack trust in the financial sector or lack digital skills or savviness, limiting the adoption of digital financial technologies in larger numbers.
Solving these challenges is crucial for ensuring the development effectiveness of both private and public innovations. Without financial inclusion, governments are condemned to spend millions in disbursing social programs using costly in-person methods. Monetary policy is likely to be less effective if it can only influence those that are integrated in the financial system, and micro and small firms are unlikely to scale up their production if they can’t afford to implement new innovations.
Four studies produced by the Latin American Research Network through FINLAC—a new initiative by the IDB, IDB Lab, and IDB Invest to promote financial inclusion—reveal rigorous evidence on the hopes and challenges of leveraging digital technologies to increase financial inclusion.
Broadband Infrastructure Can Spur Financial Inclusion and Economic Growth.
A study in Peru shows how the rollout of broadband internet positively affected firms through greater financial inclusion. Firms increased their total borrowing from banks and the number of banks they borrowed from. Micro and small enterprises and those firms with less experience with formal banks (i.e., those with “thin” files in the credit bureau) benefited the most. The increase in credit coincided with higher sales and the entrance of new firms into places that recently got broadband. The expansion of broadband also generated productivity gains among firms, which achieved a higher output per worker ratio.
The Challenge in Increasing the Use of Digital Payments at Scale
The evidence from Peru shows how important financial inclusion is for micro and small firms. However, the link between financial inclusion and households’ financial well-being is still unclear. In part this is due to the reluctance of people in the region to open and actively use bank accounts. One out of four adults in Latin America and the Caribbean still do not have a bank account. Two pieces of evidence from Uruguay and Argentina show how government efforts to promote the usage of digital financial products at scale fell short in delivering the transformative effects that digital-finance enthusiasts would hope for.
One study in Uruguay analyses the effect of a mandate that required private employers to pay salaries directly into employees’ bank accounts as part of Uruguay’s financial inclusion law. The mandate increased the share of formal private-sector workers who received their salary in bank accounts from 65% during the first quarter of 2017 to approximately 80% in the first quarter of 2018. This stimulated those workers’ use of debit cards relative to public formal workers who received their salaries directly into their accounts even before the mandate. But the authors did not find any impact on savings, spending, and access to short-term credit.
In Argentina, the government reduced the cost of using digital payments by providing rebates of 15% for each transaction made with debit cards. Surprisingly, many low-income households that received government transfers into their bank accounts chose to use their debit card to withdraw the transfers from an ATM rather than using them directly to pay for transactions and benefit from the rebates. One study analyzed the effects of a large-scale intervention that provided information about the rebates on the use of digital payments to recipients of a cash transfer program. Providing this information caused a small increase in the use of digital payments. But the authors found no evidence of increased loan records in the credit bureau, a proxy for credit-market formalization. Despite the rebates, many people simply said that they preferred cash.
These results underscore a challenging reality: Without changing people’s perceptions and preferences towards digital financial tools, future interventions may fall short in their attempt to increase the adoption of digital tools and the expected impacts in terms of inclusive growth.
Modifying the status quo may require bold policies or dramatic changes in the economy. At an extreme, what would happen if the financial system suddenly ran out of physical money? Would the economy collapse? Or would the potentially negative impact be offset by a transition to digital payments? A recent study in Brazil suggests that a disruption in the availability of physical cash can cause massive changes in how transactions are made. The authors study a rash of bank robberies in Brazil, which effectively depleted the stock of cash in brick-and-mortar branches. These robberies increased the number of users and digital transactions on Brazil’s government-backed and free digital payments platform (PiX). Digital transactions not only increased in the areas of the robberies. Long distance (inter-municipal) transactions did as well, as did transactions among clients of banks that were not victimized by the robberies. These positive effects following a sharp disruption in cash services suggest that the reign of cash could come to an end. For that to happen, however, users would need access to low-cost digital payments platforms, such as PiX, and potentially a little push to encourage them to use these types of tools.
These four studies teach important lessons. They indicate that there is an untapped potential for digital tools to facilitate access to credit for micro, small and medium-sized enterprises and spur economic growth; they suggest that with the help of well-designed instant payments platforms, a move away from cash can rewire the transactions in the economy; and they point to the crucial importance of changing user perceptions of digital payments. There is also a word of caution for digital-payments enthusiasts in the Uruguay study: switching cash for digital payments may be more convenient, but it may not fundamentally change a household’s financial situation.