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Financial Apartheid

Every year, millions of people around the world transition out of poverty with the help of tools that enable them to build more stable economic lives. At the same time, similar numbers continue to remain trapped in a cycle of poverty they are not able to escape. Similarly, millions of people are pushed back into poverty as they are unable to cope with unexpected economic pressures. A significant driver of this cycle is financial exclusion. Banking is an essential building block to reach greater prosperity and help build a better system where financial services empower disadvantaged groups. Broader access to financial services can create a path out of poverty.

However, big traditional banks often exclude low-income populations by requiring credit score thresholds or minimum balance requirements or by using historically discriminatory practices that keep this low-income customer away from formal finance. Modern lifestyles are predicated on debt. If you have a stable and reliable income, have a bank account with access to a range of modern financial products, you can manage your debts efficiently. This is what the entire financial system is for.

But debt becomes a lifetime’s trap if you don’t have easy access to those financial products. Contrary to common impression, poor people need and use the same variety of financial services and for the same reasons as wealthier clients: educate their children, improve their homes, cope with unexpected emergencies, protect against hazards, seize business opportunities and build assets. Ironically, the people who lack access to these financial tools are also the people who need them the most. Poorer people who remain excluded from the financial system are forced to rely on expensive and substandard financial products, raising the risk that they will turn to high-cost sources of credit such as usurious loans. The financially excluded have little to no tools to save, send payments, borrow and insure. This makes it hard for them to prepare for life’s most basic events, let alone unforeseen challenges.

The main problem is not that the poor have nothing to save but rather that they are not profitable customers, so banks and other service providers do not try to reach them. Financial exclusion can be highly oppressive and stifling for talented individuals in low-income communities. They don’t have access to affordable capital for setting up their enterprises. Financial exclusion often leads to broader social exclusion. People who are financially excluded might not be able to access affordable, adequate, and timely credit; they may struggle to budget and manage money or plan for the unexpected and may not know how to make the most of their money. Low population density, high transaction costs, the need for small and frequent transactions, adverse social and cultural norms, and regulatory restrictions on savings deposits are major barriers to the sustainable provision of formal financial services in underserved markets. Financial exclusion has several serious consequences for low-income communities, such as dependency, inability to access benefits due to living exclusively with cash, the impossibility of saving money or access to credit and therefore to buying a house or starting a business, and finally, the inability to improve their situation via financial tools. Thus, financial exclusion imposes large opportunity costs on those who suffer from it the most. When coupled with high transaction costs, information asymmetries, lack of collateral or credit histories, these communities are stuck in a bad equilibrium with no escape. Financial inclusion addresses and offers solutions to the constraints that exclude people from the financial sector. Access to formal financial services is increasing, but many people in the developing world still do not have savings accounts, and many who have one do not use it. While some people exhibit no demand for accounts, most are excluded because of barriers such as distance, cost, and the paperwork involved. Barriers like lack of financial literacy, policy gaps, irregular incomes, remoteness, and high cost of banking services keep vast sections of the population out of the formal financial market.Many households may be forced to take on debt or sell assets to remain afloat. Those with access to accumulated savings can maintain consumption levels with consistency and avoid more drastic measures, such as distress sale of assets or agricultural produce when faced with income shocks associated with unexpected events such as natural disasters or health emergencies. The socio-cultural and economic factors that drive financial exclusion are complex, so the solutions must be holistic. The main demand-side barriers to the provision of financial services are lack of awareness, limited financial literacy, and limited access. The designs of most of the products or services offered by banks or the way they are administered are unsuitable for the poor and further dampen the demand for them. The most intimidating aspect is the hard-to-understand paperwork that uses technical language.

At the same time, a lack of financial literacy can result in people making wrong choices and becoming vulnerable to excessive financial risks. From the supply side, the main barrier is transaction cost. This includes requirements of minimum balances or other thresholds and recurring fees that cannot be met by a large number of people.

 

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