LONDON When the Afghan government used mobile phones instead of cash to pay some of its policemen, the officers thought they'd just had a 30 percent pay rise. In truth, they had just been paid the full amount, with nothing skimmed off by middlemen, for the first time.
This anecdote from the U.S. Agency for International Development shows how technological innovations such as mobile banking and biometrics have helped integrate more people in emerging markets into the formal financial system, opening up opportunities for banks willing to take a chance.
While the market for more affluent and business clients becomes saturated, providing the world's poorest with access to financial products is an unmatched growth opportunity.
Half the world's adults, over 2.5 billion people, do not have a formal bank account, according to the World Bank. In low-income economies it can be less than a quarter.
Many developing countries also offer banks the allure of a growing working-age population and an emerging middle class.
"Twenty years ago we spoke about the poor with a sense of futility, and I think now when you talk about the base of the pyramid, more often than not you're talking about markets and opportunities," said Michael Schlein, chief executive of Accion, a non-profit organization that invests in microfinance institutions and companies advancing financial inclusion.
Between 2010 and 2020, the world's poorest 40 percent will nearly double their spending power to $5.8 trillion from $3 trillion, according to Accion's Center for Financial Inclusion (CFI).
The idea of providing the world's poorest with small loans was pioneered 30 years ago by Nobel Peace Prize winner Mohammad Yunus and Grameen Bank in Bangladesh.
Microfinance grew into a global industry with a loan portfolio of $78 billion in 2011, according to data provider MIX Market, but it has come under fire for high interest rates and excessive credit expansion during the financial crisis.
Big banks, which suffered more than a little reputational damage of their own during the crisis, realized they needed to go beyond branch-based models to profitably reach such customers in a market traditionally reliant on cash.
"The competition and the saturation in those (developed) markets are getting higher and higher, so they have to look for the next wave, the next area of possible profitable ventures," said Gerhard Coetzee, Senior Financial Sector Specialist at the Consultative Group to Assist the Poor, a think-tank housed at the World Bank.
Citigroup (C.N) launched a mobile payments scheme called Mobile Collect for small stores in the Dominican Republic earlier this year, while MasterCard (MA.N) teamed up with the Nigerian government in May to roll out 13 million national identity cards that double as electronic payment cards.
COMPETE OR COLLABORATE
Tapping the potential in the market of the unbanked requires alternative business models. Fragmentation makes it harder to achieve economies of scale, and banks also have to overcome the hurdles of poor communications infrastructure and the often non-existent credit history of many potential customers.
"Many banks think of the digitization opportunity around the world. There is, however, a constraint, which is the whole issue of infrastructure," Aigboje Aig-Imoukhuede, chief executive of Nigeria's Access Bank (ACCESS.LG), told a recent conference organized by the CFI.
Another issue is competition. Banks' biggest rivals are not their peers but rather mobile network operators and large retailers. Coetzee says they face a difficult balancing act of rolling out competing products and collaborating to serve a bigger chunk of the market.
Banks also need mobile network operators to allow their payment systems to work across rivals' systems - a commonplace in developed banking markets - if they are to achieve scale.
M-Pesa, Safaricom's (SCOM.NR) successful mobile payment system in Kenya, benefited from the telecoms operator's hefty market share to roll out its service, so it had an in-built advantage. But that doesn't apply everywhere, Schlein said.
Bob Annibale, Global Director of Community Development and Microfinance at Citigroup, also highlighted the importance of integrating different payment systems.
"It is about that financial architecture ... The bank payment system also connects to the mobile payments system. If that becomes the norm, it's a lot easier for us."
But getting competitors to collaborate is not easy.
"If you're waiting for the industry to come together and collaborate, it's like asking the turkeys to vote for Christmas," a participant said at the conference.
Clearing such obstacles could unlock huge rewards.
Barclays, which teamed up with NGOs Care International and Plan UK to form the Banking on Change partnership, connecting village savings groups with the formal financial system, estimated that $145 billion - about a quarter of the Nigerian economy - could be injected into the global economy each year if all 2.5 billion of the unbanked were included in the scheme.
Tapping in to existing networks could be the key.
"Coca-Cola is consumed by everybody ... How difficult is it going to be for us to tag on payments, savings and so on around the value chain by which Coke is sold?" Aig-Imoukhuede said.
"Once you have scale ... I think it's easy."
(Additional reporting by Carolyn Cohn; Editing by Will Waterman)