(Editor's note: This post forms part of the month-long HBR Debate, "Finance: The Way Forward." It is the first post on this week's topic: "Do we really need banks — and what might take their place?")
Imagine for a moment that you did not have a bank account. No debit or credit card, no access to an ATM. No checks, no loans, no savings account. In other words, no access to cheap, reliable, safe and convenient means of saving, borrowing, sending, and spending money.
This situation, which may seem truly frightening to you and me, is a daily reality for more than half the people on earth. The majority of people in emerging economies, and a significant minority in developed ones, are unbanked or under-banked. Even the U.S. is home to 106 million under-banked citizens.
Yet these underserved markets are now availing of financial services offered by an emerging and dynamic ecosystem of non-banking institutions, which include cell phone companies, small technology vendors and non-governmental organizations. By offering basic financial services that deliver more value at lower cost for more users, players in this emerging ecosystem are threatening the monopoly of banks on financial services, and questioning their very raison d'être.
In Kenya, for instance, only 10% of the population has access to traditional banking services. Yet mobile penetration in the country is higher than 50%. Sensing an opportunity, Safaricom, a local telecoms service provider which is 40% owned by U.K.-based Vodafone, launched a service called M-Pesain 2007 to enable people to send/receive and spend small amounts of money using their cellphones.
No bank account is required to participate in these transactions, and today, over 8 million Kenyans have subscribed to M-Pesa (more than double the number a year ago!). The Philippines has a similar cell phone-based micro-payments service which has been similarly successful. Meanwhile, in Bangladesh, Sri Lanka and India, millions of unbanked rural women have for several years now formed self-help groups to help them save and borrow money to generate income.
Developing nations like Kenya, Philippines, and India are leveraging technological innovations like M-Pesa and organizational innovations like self-help groups to drive financial inclusion without involving traditional banks.
If you were one of the unbanked of Nairobi, Manila or New Delhi what would prevent you from availing of the financial services of a traditional bricks-and-mortar bank? First, you may be illiterate, and intimidated by the formality of signing up to a bank. Second, you may be on a daily wage and not find the bank's monthly fees affordable or worth the expense. Third, there may not be a bank within easy reach of your town or village.
Now let's flip the question. What would prevent traditional banks from reaching out to you? After all, the unbanked represent a huge growth opportunity. In countries like India where over 50% of the population is unbanked, the Central Bank and several state-owned banks have had it as their mission to achieve broader financial inclusion. What has prevented them from making a dent in these figures?
The simple answer is the cost of reaching remote and relatively impoverished consumers. India for instance, has over 600,000 villages. Setting up a bank branch in each of these villages would simply, well, break the bank. But branchless services like M-Pesa could help circumvent this fundamental scaling problem facing traditional banks.
Now that non-financial institutions are encroaching into their territory, what should traditional banks do?
They have two options: fight off these new players or partner with them. While we expect many big banks to keep their heads buried in the sand, nimble banks led by creative CEOs will embrace the "if you can't beat them, join them" principle and plug into alternative banking service ecosystems. In India, for instance, YES Bank — a leading private bank — has partnered with Nokia and Obopay, a mobile payment platform provider, to deliver mobile banking services to even the remotest areas of India. Closer to home, here in the US, Obopay has teamed up with Citi, AT&T, and Verizon to deliver mobile payment services to the 106 million under-banked Americans.
As they recover from the recession, can banks regain their relevance globally? Or will the world increasingly ask: Can we do without banks? We believe that the future of banks depends on their ability to adopt and scale up innovations from nonbanking contexts, and transform their parochial culture and mindset in the process. Only then will banks ensure that the frightening scenario outlined at the beginning of this post never materializes (for their own sake!).