Applying Market Systems Approaches to Financial Inclusion Projects

The market systems approach to economic development has gained prominence within development work that prioritizes inclusive economic growth. Donors such as the U.S. Agency for International Development (USAID), U.K. Department for International Development (DFID), and Swiss Agency for Development and Cooperation (SDC) have endorsed market systems development as a way to help large numbers of poor people achieve sustainable increases in income, opportunities, and resilience. In 2013, these donors formalized their agreement and pledged to work together on related research and learning.

Over the past decade, market systems approaches have been increasingly applied to financial inclusion work—connecting “unbanked” people to services such as savings, credit, and e-payments. This includes DFID’s Financial Sector Deepening (FSD) projects and trusts in Africa and ancillary components within larger economic growth projects. Drawing from DAI’s experience, this article offers lessons and practices that donors and practitioners may find useful as they apply market systems thinking to pro-poor financial inclusion work.

DAI implements market systems development projects for USAID, DFID, and the SDC. DAI is currently implementing more than 30 economic growth projects with a combined budget of more than $1 billion, each sharing the goal of increasing sustainable and inclusive economic growth. DAI launched FSD programs for DFID in Zambia and Mozambique in 2013 and 2014, respectively, and has worked in pro-poor financial expansion since 1980.

Market Systems Development—An Overview

The market systems approach—also known as Making Markets Work for the Poor and by other names—relies on contributions from the totality of a system’s demand, supply, business-enabling, and government stakeholders. To include poor and marginalized households and enterprises in the formal financial sector, a market systems approach requires collaboration between government, financial sector infrastructure and supporting services, and key supply and demand players to identify and address constraints to financial inclusion, including doubts on the part of the unbanked or underserved and unwillingness on the part of financial service providers to serve these market segments.

Applying Market Systems Approaches to Financial Inclusion

Applying a market systems approach can be more art than science because each financial inclusion project is unique. Certain market systems principles and tools are required, but equally important is for projects to perform activities that comply with exogenous factors—such as donor requirements, unique logical frameworks, market dynamics, and project tools and modalities. Projects rarely can apply a “pure” market systems approach but can uphold its principles, even if those principles are focused on a single component or target market.

In 2015, DAI developed and published “Market Systems Development: A Primer on Pro-Poor Programming,” an overview of market systems development and examples of interventions that have produced positive results. Presented below are additional key lessons from DAI’s implementation of financial inclusion projects that apply market systems principles:

1. To understand financial inclusion dynamics, you need to understand a variety of interconnected market systems.

As its name implies, a tenet of the market systems approach is to develop a deep and nuanced understanding across across macro-, meso-, and micro-levels within markets. While a focused market system (for example, trekking in Nepal) may benefit from a straightforward approach, the myriad markets that affect financial inclusion—including related products, services, institutions, and delivery mechanisms, as well as socioeconomic factors—are far more complex. Each influences customers’ needs, capabilities, protection, reporting and data, and access to technology.

Commercial banking, microfinance, insurance, digital financial services, and capital markets and equity investment all have supervisory structures, financial infrastructure, and demand and supply dynamics. Broad-based financial inclusion projects require sustained effort that keeps pace with these market dynamics and evolving stakeholders. Even project interventions that have a pre-focused design (such as mobile money) experience political economy dynamics that constantly evolve with new governments, ministers, and laws and regulations, along with rapidly evolving supply and demand.

In FSD programs, teams spend four to six months mapping markets, analyzing the political economy, and identifying core constraints to pro-poor development. These assessments orient project design and monitoring and evaluation constructs; yet they are typically outdated within 12 months and regularly challenged when entering into project rollout or grant-making. In the absence of a formal re-analysis, direct stakeholder engagement and early project rollout or grant investments can provide teams with additional and updated information.

2. A positive political economy environment is crucial but complex.

Financial inclusion is not the purview of a single government unit. The Ministry of Finance and the Central Bank may share oversight of financial markets; telecom regulators are crucial to developing digital financial services, particularly in telecommunications-led environments; and education ministries are needed to promote financial literacy strategies. Other ministries oversee sectors where financial transactions happen—in agriculture, trade and industry, health, and elsewhere. The policy positions of each will have knock-on effects and require strategies to ensure cross-collaboration. Financial inclusion projects using market systems approaches must invest up front to build relationships across decision-makers and influencers. To keep abreast of political economy requires engaging key government champions, maintaining positive momentum, and leveraging local, regional, and international networks and forums such as the Alliance for Financial Inclusion and others.

Political economy analysis in Mozambique found that, contrary to conventional thinking, the Ministry of Planning and Development has a strong influence on the financial inclusion agenda. While the Central Bank is looked at as the operational arm for policy and regulation, FSD Mozambique is keeping attuned with that ministry and other government units to set a vision for financial inclusion.

3. The best financial inclusion goals are integrated with real economy issues and dynamics.

Financial inclusion should be promoted widely for what it is: a tool for unlocking opportunities in economic growth and stability in marginalized places. For example, by achieving financial inclusion, “banked” households and small businesses can access loans or payment mechanisms to acquire critical assets such as off-grid energy (such as solar), or higher-quality seeds or fertilizer that increase agricultural yields. More broadly, working in complement with a country’s economic development goals can maximize the potential for a market systems approach to mesh with other government and donor programming in ways that promote financial inclusion.

4. Strong demand-side analysis provides the backbone to product and marketing innovation.

While demand-side interrogation is critical to developing new products and marketing, it can also support advocacy, behavior-change communications, and financial literacy campaigns and facilitate partnering. Once policy and economic growth dynamics are understood, program teams can engage potential financial service end-users to ascertain their demands and identify providers that are best positioned to serve them. For example, it may be that community-based institutions are best positioned to serve certain rural communities rather than microfinance institutions or commercial banks. Facilitation teams can then proceed to encourage such partnerships, with demand-side analysis available to support the commercial negotiations.

Customer Centric Analysis in Democratic Republic of the Congo (DRC).Financial institutions have barely penetrated the latent demand among micro, small, and medium-sized enterprises (MSMEs) in the DRC. ESSOR (a DFID business enabling environment flexible facility) completed immersive interviews with MSMEs in Kinshasa across trade, construction, light industry, and artisanal work via introductions from business associations. While the methodology was designed to explore demand for insurance and leasing, it also  helped ESSOR better understand the needs of businesses and shortage of working capital loans. This understanding has served to encourage alternative or ancillary financial instruments that target businesses’ needs. These demand-side insights are helping financial institutions see their potential customer base differently and see the potential to invest in and scale such enterprises.

5. It takes a village to achieve financial market systems change.

The commonalities around “financial inclusion” programming are growing. Global data sets such as the World Bank’s Findex, The Economist’s Global Microscope, and the Making Access Possible diagnostic and programmatic framework provide new platforms for articulating financial inclusion statistics, issues, and needs. However, at the same time, donor mandates for such programming can differ across sectors (agriculture, water, sanitation, competitiveness), market level (macro to micro), product or delivery mechanisms (microfinance, digital), and even target beneficiaries (women, vulnerable populations).

Projects within DFID’s FSD portfolio—including two implemented by DAI—can combine many mandates involving myriad market systems into single countrywide projects. Similarly, DFID is incubating financial inclusion activities inside of larger economic growth or business enabling environment programs, such as the Private Enterprise Programme Ethiopia and the DaNa Business Innovation Facility in Myanmar, also being implemented by DAI.

It is crucial for countries, donors, and implementers to “connect the dots” between parallel financial inclusion projects and their related market systems to share lessons and avoid duplication. When success does not come quickly, it is also important to fail fast and learn swiftly, with parallel project teams asking critical questions of themselves and each other.

It Pays to Coordinate. Our DFID Financial Sector Deepening Mozambique (FSDM) team joined up with SDC's Innovation for Agribusiness (InovAgro) team to learn lessons about smallholder farmers participating in savings and credit groups. The joint team engaged a commercial bank interested in adapted credit products for cash-crop farmers in Zambezia province; FSDM helped the bank gain insights into this client base, while InovAgro brought household insights on specific value chains. The partnership provided critical technical inputs into the Consultative Group to Assist the Poor's recent Smallholder Diaries work.

6. Engage local knowledge and capacity at all times to stimulate change.

Sustainability is central to a strengthened enabling environment for financial inclusion, increased financial services and delivery channels, and scaled uptake. These positive changes require building the capacity of and linkages between local market actors and encouraging local ownership of interventions—efforts that will support lasting behavior-change within financial inclusion systems. Market systems approaches stimulate the conditions in which local market actors can collaborate, innovate, and adapt.

Engage Local Consultancies for Sustainability.The USAID/Kenya Financial Inclusion for Rural Enterprises project has experimented in its approach to investment in new sectors and succeeded at bringing in local consultants to lead engagements. Simultaneously, the project is building consultants' capacity in niche areas of infrastructure and innovation investment, bringing them into donor and government discussions, and giving them the space to innovate and build their expertise.

7. Investing project resources is a constant balancing act.

Ideally, project resources would be flexible enough to allow for a thoughtful sequencing of activities that address the core constraints to pro-poor financial inclusion. However, most donor-funded projects are driven by their respective logistical frameworks, budgets, and spending modalities (such as grants versus technical assistance). Pressure to show local results can lead to deal-making with the strongest local entities, that is, the ones that can absorb and manage technical assistance and funding. As a result, addressing macro- and meso-level constraints, which take more time to fix but can produce returns at scale, can take a back seat to local, quick wins. Projects can balance this potential conflict by working with stakeholders from these different levels to identify common, “synthesized” constraints, clearly articulate their importance, and then target these constraints.

8. Communications between team members can expedite the crowding-in process.

Strategic communication facilitates traction toward the development of an inclusive financial sector. Planned communication, such as through a call for proposals or innovation challenge, can help broadcast a project’s intentions and procure local information about markets, ideas, and participation. In the course of partnerships, teams should consider issuing external communications jointly and repetitively with local partners to help pull in others.

Expanding Digital Financial Services: A Tale of Two Approaches

The DFID-funded FSD programs take a broad view of digital financial services and pro-poor financial services. In contrast, the USAID Scaling Innovations in Mobile Money (SIMM) in the Philippines also applied a market systems approach to digital financial services development, but with a “local ecosystem” mandate for electronic payment of government services, payroll distribution, and payment of private services such as utilities.

FSD aims to facilitate change across macro, meso, and micro institutions and stakeholders. The projects explicitly examine infrastructure, systems, policies, and regulations to identify and alleviate core constraints to pro-poor market development. The FSDs focus on all poor segments and are not limited by geography, community, or beneficiary group, which allows for a broader business case for potential providers of inclusive financial services.

FSD Mozambique started with meso-level advisory services to the national payment system. The team then initiated a partnership with a mobile money operator to adapt its solutions to a rural client-base and convert these transaction pools into digitally sustainable operations.

As part of DFID’s Private Enterprise Programme Ethiopia, implemented by DAI, the inclusive finance team employed a market systems approach for diagnosing the constraints in demand, supply, and the enabling environment for digital financial services. In doing so, they uncovered the critical need to look more precisely at demand-side information gaps: quantifying market opportunities in terms of potential physical cash "hot spots" that could be converted into electronic money at scale, existing mechanisms used to date, cost and pain points of customers, the extent of pent-up demand, and willingness to pay for DFS services.

SIMM applied a local ecosystem approach to increase digital payment services within several local government units. While SIMM had a geographic and product focus, its local engagements quickly highlighted that innovations in retail e-payments were not likely to scale with existing structural barriers. Instead, SIMM’s success was partly anchored on its work with the Commission on Audit in releasing a circular that described how government agencies could collect fees and taxes using electronic payments.

The Importance of Being “Banked”

Informal mechanisms such as moneylenders and community based savings and credit groups are often the only available solutions in rural and peri-urban areas and they often provide a plausible option. However, their quality can be unpredictable and, in such cash economies, there is a heightened risk in transporting money as well as of exorbitant interest and fees charged. People in these households and businesses, which are are typically rural-based or economically marginalized, also do not have access to a variety of financial and payment services that may be relevant to their lives or businesses. In addition, low-income people are especially vulnerable to economic shocks such an expensive and debilitating illness or farm crops that are destroyed by weather or other phenomenon. By accessing more financial services, households and businesses can benefit from more predictable, stable, secure, and relatively low-cost services such as saving, borrowing, and paying on credit, including for necessities such as school expenses and farming supplies.

To be sustainable, financial inclusion projects require engaging the numerous markets that can stand between the suppliers of basic financial services and those who demand them. A market systems approach has proven to be a productive way to promote these engagements.