Affordable Housing Innovations 01: Inclusionary banking goes global

As our world urbanizes, the world’s cities have a vast and growing need for inclusionary banking – whereby banks deliver loans, equity investments, and financial services down-market and into informal neighborhoods. And the world’s progressive central bankers, including India, South Africa, and the US, are shaping rules to incentivize private bankers to deploy their financial creativity and business innovation for the benefit of the urban poor.



The case for inclusionary banking

Though we think of banks as having money, in fact a bank is a marketplace where capital is traded like any other commodity. Banks act as a repository for other people’s money, mainly depositors, bank lenders, and bank shareholders. Banks give this money out to people who will pay more to rent money than the bank has to pay its depositors to rent money from them.



When it comes to the urban poor, banks are perfectly happy to take their informal and irregular incomes in the form of deposits; but those same banks are reluctant to give money back to those same informally employed people with their informal and irregular incomes. That’s not symmetrical, and both poor people and their elected representatives often find it deeply unfair. Meanwhile, banks are able to make money (on the spread between loan rates and deposit rates) because capital and property rights are protected by the force of law, which is provided by government.



So banks need to do more, because without inclusionary banking they take more from government than they give back.





And when economies are suffering, banks cannot retreat behind their credit policies, pull up the drawbridge, and wait out the global recession.



For the banks, in turn, inclusionary banking is an innovations window, an R&D initiative, and an opportunity to go down-market with government endorsement and often government support. As one South African said to me at a brainstorming workshop, “Our biggest emerging-market nation is our own under-banked population.”




Principles of inclusionary banking

• What may look like ‘careful credit’ to a bank could be bigotry in disguise. So we have to have distinguish the two, which is hard.
• The public interest conveys a public authority to ensure inclusionary banking. The reliance on government bailout for their business model gives the ‘pay to play’ element an ethical foundation.
• Banks should fulfill their community service through banking. Banks should be encouraged to do banking business – lending, investing, and financial services – because that is what they know how to do and, as they get better at it, they can make money at it.
• Bankers should not have to take non-commercial risks – like political risk, such as non-enforceability of foreclosure rights or the government’s respect for contract, including those involving the government.
• Banks’ performance should be scored quantitatively, transparently, and in real time. High scores should be quantitatively rewarded; low scores penalized.

Global leadership: US, India, South Africa, Brazil

As you might expect, the nations most adoptive of inclusive banking rules also have national legacies of segregating populations and keeping them apart.



The United States has the world’s original inclusionary banking regulation, the Community Reinvestment Act, which became law in 1977. CRA tasks every financial institution with three tests: lending, investing, and community service. Every three years, every bank is rated, on a range from Poor to Outstanding, via a public process where community input is sought (and received in quantity). All results are published, and they influence whether the bank will be approved to acquire other banks.



South Africa. In 2003, under political pressure, the banking sector volunteered, a unilateral industry-wide pledge. Under the Financial Sector Charter, banks voluntarily negotiated lending and investment goals with quantitative targets, agreed to report their performance publicly and transparently, and subjected themselves to consequences (prohibited from certain kinds of government contracting) for subpar performance or rewards for superior performance (preferred access to government contracts).



India. India’s Priority Sector Lending directs banks to deliver a portion of their net bank credit into 14 sectors. Targets are quantitative and related to deposit levels. Recently the Reserve Bank of India (RBI), which administers PSL, raised the targets for foreign banks; and increasingly, the RBI is encouraging banks to lend directly into the sectors, and not simply to invest in intermediaries such as housing finance companies (HFCs) or microfinance institutions (MFIs).



Brazil. Land of the burgeoning and dangerous favelas, Brazil has a 2003 law (Resolução 3109 Conselho Monetario Nacional) whereby banks must earmark 2% of their deposits for micro-credit loans, but they are unenthusiastic participants and use of the resource is low.




Where is inclusionary banking going?

Globally, inclusionary banking is growing, because given time and appropriate entry conditions, it works. Banks initially resist but then discover that they gain system-wide benefits, including knowledge transfer between banks and community development entities; financial product innovation by banks into new business spaces; and new business activities and profit centers (e.g., community development banks).



All of these innovative byproducts have permanently and positively influenced affordable housing lending and investment. They have also helped government make subsidies smarter, not just bigger.



Inclusionary banking is coming. Governments are taking it up. Banks with brains and ambition should embrace it. Banks should and can forthrightly acknowledge a social responsibility to bank expansively (reaching out to those as yet underbanked) but sensibly, and to work with government to craft programs that make government responsible for noncommercial risk, and for permanent subsidy.



For the banks, the devil one designs for oneself is far better than the one a frustrated government can impose. For their own survival and self-preservation, they must help evolve the regulatory ecosystem. Global inclusive banking is part and parcel of what banking is supposed to do.