How high interest rates threaten reversal on financial inclusion gains

For a decade, financial inclusion levels around the world steadily rose as interest rates were low and economies grew, driving private capital to many emerging markets. This created a virtuous cycle which spurred wealth and job creation, and allowed people to plan for the future. Now, the situation has reversed, with benchmark interest rates set by central banks at highs not seen in decades. Investors are backing off riskier investments, including in low-income countries. This means capital is drying up for a slew of projects, including financial inclusion. International financial institutions now need to step in to fill in the gap left by the private sector — and work to draw investors back, according to John Fischer, the chief investment officer of Accion, a nonprofit that works on impact investing and microfinance lending, helping to promote financial inclusion and draw in private capital to promote development. “Under the zero interest rates in developed markets, there was a lot of appetite from investors in the U.S. and Europe to jump into new emerging markets. But certainly on the inclusive fintech side, we’ve seen a pause on that,” Fischer said. Sub-Saharan Africa — where almost half the population, or about 530 million people, is still unbanked — is an area of “big concern,” he added. Governments are cash strapped and struggling to invest on their own, and the region is seen as riskier, leading to higher demanded returns from investors. Financial inclusion refers to things like having a savings account and banking services. Setbacks on this front are a major obstacle to achieving many of the United Nations’ Sustainable Development Goals, as access to capital can lift people out of poverty and ensure children stay in school. Already, SDGs are lagging far behind targets, and global poverty is on the rise for the first time in a generation. “We got used to a world where the numbers continued looking better and better. Poverty was going down, inclusion was going up. It was all very positive. We are now facing a period where in many countries that is being reversed,” Fischer told Devex in an interview. He oversees an investment portfolio of about $500 million in countries from Latin America to Southeast Asia. Also, microfinance lending rates are starting to tick up as higher interest rates trickle through. Microfinance loans are generally small in size and target populations that are not served by the regular financial system — these people can hardly absorb more costs, putting them under more strain. “The microentrepreneuers of many [African] countries will face more sharply reduced public expenditure, higher prices, and slower growth than in other regions,” noted Fischer. The debt burden will severely constrain governments, who are using their resources to pay back the higher interest rates on loans. The World Bank, which tracks financial inclusion, reported a 50% increase in the worldwide share of adults with a bank account between 2011 and 2021. That progress could now be threatened — at the very least, the steady march of progress could stagnate. Ajay Banga, the lender’s new president, said he will aim to drive more private sector investment to emerging markets. His time as chief executive at Mastercard included a focus on financial inclusion, and sources say the issue remains close to his heart. “We need the international financial institutions to step in,” Fischer said. Not just with money, he added, but with their ability to create markets and build local capacity, which will help lower-income nations absorb new outside investment. One thing Fischer observes in the post-COVID-19 era is the risk that people who recently gained financial inclusion can lose that precarious toehold in the system. The culprit: technology. Just as digital payments made things easier for many people, it also can push older generations beyond their comfort zones or disenfranchise users without smartphones. “We have to make sure we are not excluding people in the digital transformation ... We know that smartphone ownership can skew towards wealthier, more urban, more male populations,” Fischer said. And this means companies with financial offerings need to maintain two tracks: the old-fashioned way and the way of the future. At least until there is a convergence. Looking ahead, Fischer said he still sees opportunities for impact investors, including in “embedded financial plays,” which are ways for non-financial firms to mix financial products into their offerings. This can range from supply chain financing to insurance programs. One big upside to the embedded approach is that it can make people in low-income countries more resilient to shocks. For example, farmers getting insurance as part of their seed purchases would become more insulated from the financial fallout of climate change. It shows the ways financial inclusion can help achieve other critical development objectives.