Why digital banks are the future of financial inclusion in emerging markets

As digital banking proliferates through the developed world, its adoption in emerging markets in Southeast Asia continues to lag. A McKinsey study in 2018 noted that whilst digital banking penetration has grown by as much as 300%in certain emerging Asian countries, the median level is only around 52%.

Nowhere is this difference more evident than in Indonesia, where an estimated 66%of its more than 260 million population remains fully unbanked. That equates to nearly 180 million Indonesians not owning a bank account.

That is not to say Indonesians aren’t virtually-savvy. A 2018 study by Polling Indonesia and the Indonesian Internet Providers Association found that 171 million locals, or 64.8%of the population were already connected to the internet, with the majority of the users aged between 15 and 19 years.

Indonesia’s internet — and smartphone users — have been drawn online in recent years due to the tech startup boom in the country, which has in turn birthed so-called “super apps” like GoJek and Grab. Whilst millions of Indonesians use these apps daily for any manner of purposes, including as ride-hailing, food delivery, and grocery shopping, many of their transactions remain cash-based via online-to-offline (O2O) intermediaries, particularly in rural areas.

In recent years, the archipelago’s much-talked-about e-money apps such as LinkAja, Ovo (via Grab), GoPay, and Dana have been vying for the title of champion when it comes to recreating AliPay’s success in China, albeit in the Indonesian ecosystem. And yet, a Google survey in 2017 discovered that only 11% of these e-money app users are daily users.

So why the disconnect? Whilst other Southeast Asian countries such as Thailand and Malaysia are concentrated in one or two landmasses, Indonesia is an archipelago nation made up of more than 17,000 islands across 1.9 million square kilometers. Its unique geographic distribution (although one could point to the Philippines having a similar, yet much smaller makeup) has for decades been a major stumbling block to the expansion of traditional banking activities nationwide.

Today’s “super-apps” have helped soften the initial hesitation to go digital whilst O2O intermediaries have bridged the human gap where needed. It’s fair to say that current conditions have helped pave the way for banks to retake the mantle and offer digital banking services to drive higher financial inclusion in the country.

Rise of the super-apps

In the battle of the super-apps, Ovo within GrabPay and GoPay within GoJek have taken slightly different routes to expand their digital wallet offerings. GoPay bolstered its payments dominance in 2018 by acquiring three major financial services companies — an offline payments processor that works with retailers, a payments company that serves online merchants, and a savings and lending network that helps rural and working-class families buy household appliances.

Meanwhile, GrabPay partnered with Mastercard to issue prepaid cards, as well as Japan’s Credit Saison to offer loans to unbanked people based on consumer behavior data. Grab acquired O2O player Kudo in 2017, which uses a network of more than 400,000 human agents across more than 500 Indonesian towns to help people without internet access shop online.

This head-to-head competition amongst the super-apps have made more Indonesians comfortable with going digital in some way, softening the initial hesitation to buy goods and services online. However, there remains some gaps to fill outside of Java Island (where around 140 million Indonesians reside), with connectivity between rural towns and islands hindering digital adoption.

The role of O2O 

This is where O2O comes in. Whilst Kudo’s human agents place orders on behalf of their offline customers and take commissions, a company called Kioson boasts 50,000 “cash point kiosks” in 384 cities and the app’s fintech arm offers collateral-free loans to aid its 3,000 kiosk partners in expanding their own businesses.

Kudo now operates as a subsidiary of Grab whilst Kioson acts as a payment method for Indonesia’s largest online marketplace Tokopedia. In November 2018, Tokopedia decided to enter the O2O space directly via its Mitra Tokopedia app, aimed at owners of small shops and kiosks, who will bridge the gap between online retail and offline customers.

There are a couple of direct competitors to Kudo on the playing field. One such O2O player coordinates with banks to create a distributed network of bank agents that can operate from anywhere. The startup largely deals in bill payments, with agents collecting commissions from transactions. The service is currently limited to payment of bills and other expenses, with no cash deposit or loan offerings.

In Indonesia and other emerging Southeast Asian countries, O2O is now seen as a necessary feature for many tech startups, and learnings from O2O players have quickly bled through the processes of traditional banking players as well as financial regulators.

Bridging the trust gap

The widespread use of O2O players indicates there remains trust issues, particularly in rural Indonesia and smaller cities outside Jakarta. A 2018 PwC survey of digital banking in Indonesia found that physical branches still provide the best experience, followed closely by mobile banking.

The Google survey also found that both banked and unbanked Indonesians have concerns about personal data loss and phone theft.

Full financial inclusion remained out of reach so long as brick-and-mortar banks with legacy names — and the inherent brand trust — do not participate in the country’s digital revolution.

Recognizing this, the financial authority of Indonesia (OJK) launched the Laku Pandai or ‘Smart Practice’ initiative amongst local financial institutions in 2015 that sought to promote branchless banking throughout Indonesia.

This initiative takes a leaf out of the O2O book by using human agents (existing bank customers), offline retail merchants, or kiosks to act as mini-ATMs and mini-branches throughout rural Indonesia. Products under the programs offered basic savings accounts, microfinancing, and microinsurance.

Since its June 2015 inception, the initiative has grown by leaps and bounds across the archipelago. Between June 2015 and March 2019, the number of participating banks and financial institutions went from six to 30. The number of agents grew from 3,734 to more than 1 million and the number of accounts jumped from roughly 36,000 to more than 23.3 million.

The success of the Laku Pandai initiative in just four years paints a blueprint for digital banking in emerging markets. With the backing of heavyweight brand-name banks and human interaction at the local level, digital branchless banking has spread to almost every town in Indonesia.

Financial inclusion requires the marriage of trust in local solutions and the ease of going digital — all regulators and bankers need to do is find the correct mix for their markets.