Lecture 26, 27 Financial Inclusion risk

Financial inclusion is defined as the availability and equality of opportunities to access financial
services. It refers to a process by which individuals and businesses can access appropriate,
affordable, and timely financial products and services. These include banking, loan, equity, and
insurance products

Highlights the need for an enabling and aligned regulatory environment that will protect client
interests.

Trends

 Facilitating low cost

 Fostering innovation
 Transformation in services
 Diversified models to meet ever changing client needs
 “Fintegration”, - integration of new fintech models into their core business, and digital client
acquisition seen as the way forward for many banks and other established providers.
 Evolution of tech-centric business models such as renewable energy with pay-as-you-go
models for solar.
 The new entrants are able to exploit new techniques of electronic communication and data
management to reach millions of new customers, extending the reach of financial inclusion
and the range of products available.
 Cloud adoption in fintech is set to be predominant as more and more cloud in the banking
sector is evident.
 The developments of fintech racing the market have posed a threat to the traditional banks
with the dominance of digital-only banks
 Block chain will make financial transactions instant and secure.
 Documentation of each and every step will fight the illegal Hawala and Hundi system at the
international level.

Problem

The promises of technology enabled models may also bring potential dangers to the client, which
could result in increased exclusion rather than inclusion.

New structures and business methods bring new risks - not least failure by service providers to
understand it and use it prudently.

Technology opens the way to growth in the provision of financial services, but it contains

risks of its own:

Risk that providers will fail to understand and exploit it effectively and place themselves at risk.

Weakness in strategy is seen as a major potential pitfall which could damage poorly managed
institutions.

By facilitating access to credit for less sophisticated customers, technology could also lead to
irresponsible borrowing and debt difficulties

It may also attract providers who are more interested in commercial gain than social goals, or those
who are unable or unwilling to design products specifically for this market
Technology is having a huge impact on the financial inclusion business. It is facilitating growth but
making excessive risk-taking more likely, particularly by encouraging people to over borrow.

The availability of human talent at all levels, governance, management and staffing, is being reduced
by competition.

Concern about crime, particularly cybercrime, fraud, hacking and data theft, is rising. The perception
that microfinance institutions are too small to attract criminals is changing.

microfinance is not working as successfully as in the past, and the days of very high repayment rates
among low income borrowers are numbered as access to finance has become simple [and] more
widespread and available from different sources…Fund manager, Germany

The use of technology has huge potential in reaching and servicing the unbanked, yet we cannot do
it without a probable increase in the inherent risk of failure of systems or infrastructure, data
breaches and leakage of information. These pose a threat to cyber security, while the multiplicity
and network of providers involved in providing finance could blur lines of accountability that could
pose risk to consumers.

Service providers: People working in financial inclusion service provision, e.g. banks, MFIs, non-bank
financial institutions, payment services, telecommunications etc.

Failure to master new technology could mean elimination from the market.

Political risk, increasing in two ways:

Failure by governments to create a sufficiently stable political environment for financial inclusion
to flourish - linked to the risk of poor regulation. Direct government interference in the market
through rate capping, debt waivers, taxation etc.

Politicians are changing policies and regulations without proper consultation or the involvement of
key stakeholders.

Support providers: People who support financial inclusion service providers as networks,
associations and through grants and technical assistance.

Regulation could become an obstruction to better performance.

Regulation is always behind innovation, not only in terms of timing, but also because of archaic
instruments, and an inability to muster technology to assist.

Investors: People who invest in financial inclusion

Institutions not giving enough thought to strategy to ensure their survival and growth.

Strategic risk is ever-evolving and requires the same, if not more, attention as other key

risks, such as credit risk.

There are myriad innovative business models that are looking to disrupt the traditional banking
model, which, while major commercial banks may have the resources to compete and/or adapt,
many MFIs do not.

Competition risk - The entrance of new providers, especially non-regulated ones, can lead to

over-indebtedness.

Regulators: Officials who regulate financial institutions active in the provision of financial inclusion
services

Weak management could also lead to failure.

Observers: People who observe the financial inclusion business as academics, consultants, industry
experts etc.

Fintech would encourage the development of “one product-fits-all” resulting in a loss of service
diversity and quality.

A strong independent board could ensure all other uncertainties are covered by adequate controls.
The risk that service providers fail to capitalise on new developments in IT, cannot effectively
manage data, or suffer losses from IT mismanagement.

New technologies are driving tumultuous change in every area of the marketplace –competition,
customer expectations, public policy, etc. – and undermining traditional business models.

Pakistan when entering election year, and like any other unstable democracy this has its own risks.
We need to manage any intervention from government that affects a market-based pricing policy.
Similarly, we need to realise that the last time we had a turbulent election year, government policies
affected inflation and the availability of commodities. This led to a reduction of liquidity and an
inability of clients to repay their loans. CEO, Support Network, Pakistan
Post COVID Impact

Digital money and Fintech apps haveseen significant usage growth in thie market turmoil caused by
virus. The COVID-19 pandemic has fuelled a 72% surge in the use of Fintech app in Europe during the
few last weeks. Risk of handling potential virus-infected physical currency created a new world that
prefers electronic payments. Bitcoin is proving to an alternative of currencies and precious metals.

The term Financial Technologies or “Fintech” is used to describe “technologically enabled financial
innovation that could result in new business models, applications, processes, or products with an
associated material effect on financial markets. Term covers a broad array of technical innovations
that are finding their way into the financial industry.

Insurtech refers to the use of technology innovations designed to create more efficient insurance
industry model. Insurtech is a combination of the words “insurance” and “technology,” inspired by
the term fintech. Insurtech is a subset of fintech. It’s the technology that lies behind the creation,
distribution and administration of insurance business. Smartphone apps, wearables, claims
processing tools, online policy handling and automated processing are all insurtech. Insurtech is
useful for collecting and analyzing customer data to provide a better service.

Technology offers the efficiencies needed to provide the service consumers demand while enabling
carriers to streamline their processes and tailor and scale their product offerings. But insurtech
doesn’t just mean offering products more quickly online. It means transforming the offerings and the
customer experience.

Utilizing updated data to process existing models and renewing them with the use of AI algorithms
and mathematics

 Demand Modeling: To assess demands

 Detecting Frauds: To detect abnormal behaviors
 Processing Claims: To compute claims by customers
 Underwriting: Verification of data to form final underwriting
 Tracking auto vehicles for their behavior and confinement to rules Using that data to process
claims and calculate discounts
 Collecting data from various wearable devices that insurance companies giveto their
customers in order to detect their behaviour
 Development of IOS and Android apps to help the customers keeping them up to date with
the changing policies of insurance companies.
 keep in touch with their coverage plans and all the details.
 process the payments.
 Help to generate insurance claims.
 Insurance companies use drones for the purpose of surveillance
 To reach the properties that are not easily accessible
 To detect the damage as claimed by customers without their knowledge
 To detect the conditions of properties which are to be enlisted in the insurance plan without
physically showing up

With help of digital tools as mentioned in previous slide InsurTech is able to achieve more customize,
flexible and affordable insurance models.By using technology such as data analysis and AI, InsurTech
allows products to be priced more competitive. customers do not have to pay fixed premium .
Companies make flexibility in there Premium according to income of there client. With the help data
analytics. In short it offers more personalize insurance. Among other things, InsurTech is looking to
tackle data and analysis issue head-on. Using inputs from all manners of devices, including GPS
tracking of cars to the activity trackers on our wrists, these companies are building more precisely
groupings of risk, allowing products to be more flexible and priced more competitively.
The issues around protection of data in digital world have always concerned all the stakeholders.
Data breaches in recent times always make customers scare of using such initiatives. InsurTech
companies are striving to develop and find technologies that can satisfy their customer Government
changes rules and regulation frequently can create new challenge for the companies to get
compliant with. Most of the companies are using advanced cloud technologies for the storage of
data these technologies are constantly evolving keeping up with it is a challenge.

 Financial Illiteracy
 Lack of technology acceptance
 Lack of technological developments and outreach
 Inability of governments to regulate insurtech companies
 Inflexible laws and legislations

Investech

Improving the Modes of Customer Acquisition, Lowering the cost of services, Advanced Analytics,
Segment Specific Offering. These emerging services are quickly becoming the new normal for the
financial sector By 2025, an estimated 30 % of banking positions will disappear as a result of these
disruptive technologies

Transforming how financial advisors do their jobs The types of advice they provide to clients. Fintech
Start-ups are threatening advisors’ role with automated financial advice, automated portfolio
management, and lower fees Changing customer behaviour, market dynamics Advisors are under
pressure from many directions to effectively serve their clients

Internet revolution is enabling rapid growth of financial technology (Fintech) for increasing financial
inclusion in Pakistan. Financial inclusion is good for the individuals as well as the national economies

 Easy paisa
 Karandaaz
 Finja's SimSim Mobile Payment
 Private Credit Bureaus

Change the way people invest

Entered the most profound era of change for financial services companies since the 1970s

No firm is immune from the coming disruption

Every company must have a strategy to harness the powerful advantages of the new Fintech
revolution

Rising investor expectations and competitive pressures. Enable them to drive more effective
interactions with prospects and clients. UCC technology enables effective “screen time” between
advisors and investors. Natural language generation makes advisors more efficient.

Investec's decision highlights that digital transformation involves more than just upgrading
technology

The digital innovation power has become a significant multiple compare to one of the traditional
disruption
“Digital disruptors” changing

investment banking Crowd-sourcing, price comparison tools,

collaborative filtering and self-service applications that replace intermediaries

With improved client technology and digitalized processes, enabling superior service level Efficient
service level to win new clients and increasing the profitability of the existing clients

Deliver a superior client experience may be able to leapfrog the competition. Capitalize on emerging
market opportunities

Client will expect unified customer experience

Increase in data transparency

Stakeholder will receive information for more quickly- Real time management decision making and
compliance monitoring. Increased demand for on-the-go service The trade life cycle will be split
among the best in class providers helping the control cost but also share the trading revenue pools
broadly Increasing portion of the traditional investment banking model will be threatened by smaller
niche players.

Robo advisors. The robo advisors are basically a computer program. To help investors invest their
nest eggs. A program that delivers an asset allocation and then trades the portfolio New tool for
investors

Technology is your business. E.g. analytics, artificial intelligence (AI), natural language processing
(NLP), and machine learning (ML)

AI and machine learning applications. Analyze massive amounts of structured and unstructured data
Produce insights in a fraction of the time and at a fraction of the cost of consultants in the financial
markets. Algorithms are capable of building computer models. Detecting patterns and inferring rules
from data

Involves setting up an account with a brokerage of your choice, providing

contact and financial information

To facilitate electronic transfers

When you place an order, the complex technology enables the brokerage to interact with all the
securities exchanges looking to execute trades.Those exchanges simultaneously interact with all the
brokerages. A computerized matching engine performs a high volume of trades each Minute. All
work is backed up and accessible to be reviewed by investors, market makers and government
regulators

Investech workings: Involves setting up an account with a brokerage of your choice, providing
contact and financial information. To facilitate electronic transfers When you place an order, the
complex technology enables the brokerage to interact with all the securities exchanges looking to
execute trades. Those exchanges simultaneously interact with all the brokerages. A computerized
matching engine performs a high volume of trades each minute. All work is backed up and accessible
to be reviewed by investors, market makers and government regulators.

Opaque nature of innovations.

COVID-19 has Hurt Tech Industry

The impact of the coronavirus outbreak is impacting both financial markets and consumer behavior
as never before. Impact of the expected drop in transactions at all levels of the economy worldwide,
fewer fees collected by companies on the payments side of the Fintech sector Stock market plunge
from novel covid-19 fear, world investment

Price fall down

Major disruption to supply chains significantly for example reduced forecast in iPhone 10% Apple
analyst Ming-Chi Kuo. Drop in establishment of new Fintech firms

P2P Lending

Workings, a borrower first goes through a quick soft credit check with the P2P lending platform of
their choice to determine initial eligibility. If eligible to continue after credit check the lender likely
will conduct a hard credit check and then assign borrower a “loan grade” (which helps the lenders to
access how riskier the loan can be. The borrower can then make a listing for their loan, including the
interest rate they’re willing to pay. A compelling creative listing might have more luck grabbing a
lender’s attention and trust. Next, lenders can bid on the listing with the amount they can lend and
interest rates they’d be willing to offer. After the listing has ended, the qualified bids are combined
into a single loan and that amount is deposited into the borrower’s bank account.

Fintech benefits

Faster, online experience. Lower interest ranges for the borrowers. Requirements are less strict as
compared to traditional bank loan. Flexible use of funds. Provides access to alternative investments
outside of stocks and bonds for the lenders. Most of the platforms automatically allows you to
diversify your portfolio.

Risk of losing your money if the borrowers default.

Simplification of investments through crowdfunding portals online. In the offline world, it is hard for
investors to find and invest in private companies. Fintech provides the right platform for Equity
Crowd funding StartEngine, HelpTheCrowd some of the examples

Use algorithms to match borrowers with investors.

Lower regulatory burdens

P2P loan is fast and convenient

Transactions take place online, not in an office

The rise of FinTech provides a wealth of opportunities that has allowed e-commerce to flourish and
enable a faster and more efficient cross-border financial service like lending and borrowing.

We prefer Crowdfunding over Peer to Peer Lending because of the potential to raise more money
through a larger group of people, and not having to pay the money back. However, the two funding
sources are NOT mutually exclusive. So definitely consider using BOTH Crowdfunding and Peer to
Peer Lending, since both are great forms of funding which help us to rise money.

RegTech

RegTech is the management of regulatory processes within the financial industry through
technology. Main functions of RegTech include regulatory monitoring, reporting, and compliance.
RegTech, consists of a group of companies that use cloud computing technology through software-
as-a-service (SaaS) to help businesses comply with regulations efficiently and less expensively.

Organizations have struggled with regulatory-driven transformations. Regulatory Technology

(RegTech) established a solid foundation within the FinTech ecosystem. Overcome complex
regulations, litigation & regulatory remediation areas faced by financial institutions (FI) Combined
with overall reduction in cost compliance

 RegTech is redefining the future for financial services

 New digitization technologies are changing the way risk management
 Collaboration plays important role

RegTech workings

RegTech solutions work best in “information based obligations and risk identification and
management tools. Include tools for legislation and regulation gap analysis, compliance, health
checks, management information, transaction reporting, regulatory reporting, training, case
management and riskdata warehouses.

RegTech companies can offer a solution in the form of platforms that bridge the

communications gap between various types of systems to facilitate the compliance

process. 3 buckets: Point Solutions Workflow Management Knowledge Automation. RegTech

businesses can help financial services companies to stay current in regards to new regulations so
they remain compliant. RegTech businesses can track regional and country regulatory changes. Also
conduct internal audits to make sure that companies are complying with the most current
requirements

RegTech can provide real-time transaction monitoring

In Pakistan it can improve the quality of data that financial services providers report It will strongly
change market structure and supervision. RegTech has the potential to be a transformative tool that
will revolutionize regulation and the finance sector. A data- driven approach and more powerful
technology can facilitate continuous monitoring and close to real- time insights that can identify
problems as they are developing. The thematic objectives include incorporating proportionality in
all aspects of the regulation, recognizing the technological needs of the industry and promoting the
use of regulatory technology (RegTech) in the insurance industry and enhanced focus on the
principles for sustainable insurance.

SECP has also introduced an educational policy to encourage its employees to obtain an insurance-
related qualification in the areas of actuarial sciences and operational aspects of the insurance
business. SECP has also undertaken internal restructuring to focus on market development and
growth-conducing policymaking. 8.5b investment in 2019 from 1.1bn in 2015.
Impact of emerging technologies remains in the nascent stage However, efforts to experiment via
accelerators and strategic partnerships are likely to become increasingly commonplace Focus is on
outcomes that will help companies to retain relevance and competitiveness in a rapidly evolving
market with a ‘better, cheaper and faster’ approach

 Greater demand for data analytics

Big data is a growing phenomenon in Asia. With more digital tools available to collate data,
the need for serious processing power is inevitable. Without the investment in data analytics,
banks will not be able to leverage customer data and create greater value for their customers.
What's needed is a unified command centre with a direct connection between the back and
front-end of banks to ensure appropriate and timely service.

 To reduce costs: 

Banks are under pressure to reduce their costs to remain competitive. If you don’t make
the switch to digital banking, you must, for example, continue to invest in expensive
legacy hardware and software to keep these systems up to date.

 To increase revenue

 Established banks don’t have a 360-degree view of their customers. They lack intelligent
systems to gather customer intelligence and help them become more customer-centric.
Poor customer experience leads to a lower market share.

 To attract and retain customers and stay ahead of the competition:

 Fintechs and other newcomers have shaken up the banking landscape. As a result, the
demand for improved customer experience and personalized services grows, and the products
and services of established banks are more expensive. Digital banking enables you to
improve customer experience and lower costs, which is needed to stay ahead of the pack

Alternative Payment Method’ (APM) used to refer to anything that wasn’t cash or a credit
card. In the internet era, the definition of an APM has expanded to include any online
payment that doesn’t use major card schemes (Visa, MasterCard, American Express). Instead
of being tied to a single type of payment method, companies can now offer several for their
customers
The FinTech for banking has impacted numerous applications and revolutionized the way
consumers access their finances. Its impact ranges from mobile payment apps like Square to
investment and insurance companies. This profound impact of FinTech can also be seen as a
potential threat to the brick-and-mortar or traditional banks. Recently, Fintech technologies
have taken shape in digital banking across the globe.
The Money Laundering Cycle Money laundering is the process that disguises illegal profits without
compromising the criminals who wish to benefit from the proceeds. There are two reasons why
criminals -- whether drug traffickers, corporate embezzlers or corrupt public officials -- have to
launder money: the money trail is evidence of their crime and the money itself is vulnerable to
seizure and has to be protected. Regardless of who uses the apparatus of money laundering, the
operational principles are essentially the same. Money laundering is a dynamic three-stage process
that requires:

How is money laundered?

In the initial or placement stage of money laundering, the launderer introduces his illegal profits
into the financial system. This might be done by breaking up large amounts of cash into less
conspicuous, smaller sums that are then deposited directly into a bank account, or by purchasing a
series of monetary instruments (cheques, money orders, etc.) that are then collected and deposited
into accounts at another location. After the funds have entered the financial system,

the second--or layering--stage takes place. In this phase, the launderer engages in a series of
conversions or movements of the funds to distance them from their source. The funds might be
channelled through the purchase and sale of investment instruments, or the launderer might simply
wire the funds through a series of accounts at various banks across the globe. This use of widely
scattered accounts for laundering is especially prevalent in those jurisdictions that do not cooperate
in anti-money laundering investigations. In some instances, the launderer might disguise the
transfers as payments for goods or services, thus giving them a legitimate appearance. Having
successfully processed criminal profits through the first 2 phases of the money laundering process,

the launderer then moves them to the third stage—integration--in which the funds re-enter the
legitimate economy. The launderer might choose to invest the funds in real estate, luxury assets, or
business ventures.

Effective anti-money-laundering policies, on the other hand, reinforce a variety of other good-
governance policies that help sustain economic development, particularly through the strengthening
of the financial sector.

Strong correspondence between anti-money-laundering policies and financial good governance

rules. As noted in the previous section, a strong rule of law governing financial institutions in
developing countries is a fundamental prerequisite for economic growth. Anti-money-laundering
policies are a constituent element in the good-governance policies that form a solid rule-of-law
environment for developing-country financial institutions. A strong indicator of this is the large
overlap that exists between the Prudential Financial-stability rules promoted by governmental and
inter-governmental organizations on the one hand, and fundamental anti money-laundering policies
on the other. Banks may lay themselves open to direct losses from fraud, either through negligence
in screening undesirable customers or where the integrity of their own officers has been
undermined through association with criminals.

which further elaborated the importance of "know your customer" (KYC) banking rules as a
prudential risk-management issue, again citing the potential for reputational damage and fraud if
such policies are absent, and identified KYC rules as an integral element of a bank's "internal control"
mechanism for risk management.

Conclusion part

The risk that service providers will fail to stay relevant and competitive in a changing marketplace.
New technologies are driving tumultuous change in every area of the marketplace – competition,
customer expectations, public policy, etc. – and undermining traditional business models.
. A tectonic shift in the marketplace, where digital transformation of financial service providers no
longer is seen as a competitive advantage, but rather becomes a necessary condition for survival.
Risk that all MFIs want to become digital and abandon a functioning relationship and high-touch
human business while entering a winner-takes-all competitive market