Serving the Underbanked: Implications for Risk Management

Why Inclusive Banking is Important

A significant part of the world's population is unbanked or underbanked, as many organisations report. An unbanked person has no bank account and does not use basic financial products. Such individuals tend to be in developing countries and are disproportionately women. An underbanked person has a basic bank account but does not use other financial services, particularly automated transactions. Unbanked people often avoid banks due to:

• A lack of financial literacy
• Distrust of banks
• Distance from the nearest branch
• Inability to afford fees or maintain a minimum balance
• Lack of necessary identity documents

Making banking services inclusive can boost a country's economic growth. In 2016, the G20 group of nations issued High-Level Principles for Digital Financial Inclusion policy​​.[1]

Impact on the Business

The business case for inclusive banking is driven by key conditions. The target market should receive new, simplified products distinct from existing offerings. These products will likely have low initial usage, be mostly automated, and provide easy access. Such a product profile must be digitally delivered because margins are low, automation is needed to manage costs, and scale is required to benefit from economies of operation.

These new products will likely have different features from mainstream versions, with varying income thresholds and targeting specific generational segments or single-parent families. They will also need to operate with minimal credit history for risk assessments.

While we will discuss the impact on the bank’s risk function shortly, another key factor in making this service a success is the wider, typically government-sponsored, ecosystem. Governments have several measures to put in place:

• A supportive regulatory environment with a framework to handle financial crime and provide customer protection for digital finance, such as KYC requirements. Examples include China, Mexico, and Tanzania.
• Open financial data/open banking initiatives. Such data exchange helps increase access to financial services, makes switching accounts easier, and provides greater convenience. There are initiatives at varying degrees of maturity in Australia, Brazil, the European Union, Nigeria, and the UK, to name a few.
• Government promotion of cost-effective digital infrastructure, such as in Ghana
• Use of digital IDs, such as in India
• Use of digitalised government-to-person payments, such as in Brazil, Mexico, and Turkey

An interim step for a bank is to first offer a prepaid card product, thus improving financial literacy as a stepping stone to other products, particularly those offering credit.

Impact on the Risk Management function

Given this complex environment, risk management is impacted in three fundamental ways. Credit risk assessment must be automated using scorecard models and should utilise open banking data where possible. Operational risk will be impacted due to the need to comply with regulatory requirements for KYC and open banking initiatives. Lastly, financial crime risk will be modified for this new market segment as new customers will need to be assessed, onboarded, and managed.

Broadly, these risk types will require an updated risk operating model for a new market segment and be integrated into the risk management lifecycle.

Linking a new product for the underbanked market to the risk management lifecycle

Practical Requirements for Each Risk Type

Firstly, the bank’s risk management policy will need updating for this new market segment. This involves the lending criteria to be used in an environment with limited or no credit history and informal employment. One criterion that can be used is assessing on-time rental payments, mobile phone usage, or utility bill payments to build a pseudo-credit profile. 

Operational risk changes are needed because this segment must be mostly served through a digital banking app, focusing on automated payments. The shift from physical branch use to mobile apps means that processes previously done in person are now remote. The remote identity verification process is critical to get right.

Lastly, financial crime practices need to change to address the needs of new customers who may be less financially sophisticated. Increasing financial literacy is key, with education needed to recognise and avoid fraudulent schemes. Particular focus should be on the remittance process, with the bank using regulated channels wherever possible. Banks will also need to obtain available identification documents and consider other verification methods.

[1] You can find the report here: https://www.gpfi.org/sites/gpfi/files/G20%20High%20Level%20Principles%20for%20Digital%20Financial%20Inclusion.pdf

About the Author:

Jeremy has had an extensive career in international banking and management consulting. His most recent role was at Lloyds Banking Group in the UK as Head of Business Design for the risk function. He is also the author of ‘Designing the Digital Bank of the Future,’ available on Amazon.