The Opening Act
The last two decades saw billions of dollars directed towards financial inclusion which has led to an incredible rise in the percentage of banked adults in developing economies. The last accurate data point available was in 2017 but projecting out to 2020 it is safe to assume that 70-80% of adults in developing markets are now formally financially included. A phenomenal achievement. But rather than nearing a conclusion, I see it more as an opening act.
Beyond Basic Financial Inclusion
If the global venture capital FinTech investment trend is anything to go by, business and consumer financial needs have still not been satisfied. Despite a Covid induced dip in 2020, global FinTech investment is projected to reach almost $150B in 2021 (Source: Traxcn) with thousands of new companies being created each year. The whole premise of venture capital is that there is a large addressable market and acute pain worth solving. So what are the financial pains that these FinTechs are seeking to address?
The International Finance Corporation estimates that 65 million MSMEs in developing markets have an unmet credit gap of over $5 trillion. To serve the credit needs of these businesses, a more specialised approach is required and embedded finance business models are leading the way. The concept of embedded finance is simple and replicable across multiple sectors and typically goes like this:
- provide a service to a specific subset of users (eg. FMCG goods to convenience stores)
- gather alternative primary data, sector insights and develop a more advanced credit underwriting process than traditional lenders can manage
- improve the user experience by offering credit as part of the offer or at the point of sale
- lend higher amounts at a lower risk often with an automatic loan repayment process
- embed an asset recovery process in case of default (optional)
Embedded credit examples:
- AgroCenta, Ghana: Beginning life as an off-taker of key grains from small-holder farmers, AgroCenta subsequently offered inputs (i.e. grains, fertiliser) and then the input financing in partnership with a bank. The financing is fully embedded with store credit provided and interest/principal deducted directly from the capital flowing back to the farmers through the app.
- Dastgyr, Pakistan: The 2 million convenience store owners in Pakistan face several challenges including being regularly stocked out, losing hours travelling to the market 2-3 times a week to restock, not receiving significant bulk buy discounts, slim margins and a lack of credit. Dastgyr aims to solve all this with a B2B ecommerce platform offering next day delivery and embedded credit.
- Ilara Health, Kenya: Small health clinics in Kenya don’t typically have the capital required to purchase key diagnostics equipment (eg. for diabetes or cardiac diseases). Ilara Health sources and imports the most appropriate devices for the African context and provides financing options. The devices permit clinics to serve a broader set of health needs and increase revenue and they can be recovered in the case of default.
The list could go on and on covering various other sectors such as farmers purchasing tractors in Mexico/Argentina (Siembro), importers in Colombia (FinKargo), or second hand clothing retailers in Kenya (Zumi).
Many of these companies had to make a decision regarding the embedded finance component – buy or build. Some (like FinKargo and Siembro) built themselves as FinTechs from day one. Others added in the lending competent later on and many turned to specialist embedded finance service providers to support them. Another portfolio company, Pezesha, is providing the embedded finance infrastructure for companies like Zumi, Twiga and MarketForce.
Consumer credit killer?
Consumer credit has been available by fully digital means (a stark contrast to the pen and paper methods microfinance institutions started with and still frequently use) for years in most developing markets. However beyond the embedded financial literacy or reduced rate incentives, interest rates remain high.
One innovation currently spreading rapidly across the globe has the potential to make a difference. It allows employees to access a portion of the salary they have already earned but won’t receive until month end. It’s aptly named Earned Wage Access and is NOT to be confused with payday lending. The key difference is that providers of an Earned Wage Access service must be plugged into the employers systems, have accurate data on the employees salaries and are paid directly by the employer each month. Fees are typically flat and drawdowns limited to some percent (eg 50%) of earned wages.
Going by the number of businesses we see launching this service, it’s going to be rapidly adopted by employers as a key value proposition for workers. Of course the service will only work for those that are formally employed but this is already 67% of the working adult base. As an example, Seedstars portfolio company MyRobin is offering this service for blue collar workers in Indonesia typically employed by ecommerce companies including Shipper and Lazada.
Full financial wellness:
Beyond savings and credit, a whole host of financial services from remittances, to insurance and investing are required by businesses and individuals before one can claim to have complete financial wellness.
Remittances, a $700B annual capital flow, has been costly (the global average cost of sending $200 was 6.8%, 2x the SDG target of 3%) and a poor user experience until recently. Companies like Wise (ex. TransferWise) have dramatically lowered costs and made the process 100% digital. Wise is now 8x cheaper than banks or any other money transfer company with an average fee of 0.67% for each transaction, compared to +5% or more that banks often charge. The next level of service we are starting to see is a full financial service dedicated to the diaspora making remittances. Companies such InstaKin (for Pakistanis globally) aim to go beyond the simple remittance process and rather permit specific services or bills to be paid, errands to be run or gifts to be sent. The services crucially allow the diaspora to determine exactly what the remittances are used for.
Investing in stock markets remains a luxury for high net worth individuals in many developing markets. In Nigeria for example, prior to the recent arrival of digital brokers such as portfolio company Chaka, a minimum balance of $10,000 was required versus the $10 people can now invest. Affordable, digital insurance offers for everything from health to crops, cars and motorbikes are now available in many markets. However health and crop insurance for the low income segment remains a major challenge (eg. 8% health insurance coverage in Sub-Saharan Africa in 2020) and it’s an area we’re still searching for the right investment opportunities.
The super app most likely to deliver (or at least be the portal to) full financial wellness is of course the digital bank. Digital banks are being created either as generic services (think Revolut) or with a specific user in mind (eg. gig economy workers – Friz, women – Jefa, Islamic + blue collar – JinglePay, children – Mozper). The challenge for all pure play digital banks is that unit economics are poor, regulatory hurdles and costs high and significant capital is required to sustain them. Capital is however free flowing (see chart above) and these companies have been able to finance their launch and growth.
Many of the digital lenders we’ve spoken to have a goal to transition into a fully fledged bank once they’ve cracked the hardest most profitable service – credit. This dynamic will create an even more competitive landscape for the digital banks, already battling against the incumbents. While failures, regulatory issues and mergers should be expected, this competitive landscape will ultimately drive innovation and the delivery of a full financial wellness package for users.
The future of finance remains core to our investment thesis, is our largest portfolio exposure and continues to be the top source of deal flow. We salute the founders of the financial inclusion movement that started decades ago as it has set the scene for a much broader opportunity to deliver financial wellness in developing markets.