Getting Ready for Digital Money

Citi GPS Opinion Article

13 March 2014 – The digitization of money has emerged as one of the top items on governments’ agendas all over the planet. About half the world’s adult population – almost 2.5 billion working-age people – has no access to formal financial services. There is evidence that financial inclusion can help improve individual lifestyles and support small enterprise growth, thereby indirectly helping a country’s economy. At the same time, consumers in more mature economies are experiencing the benefits of growth in digital commerce applications and payment choice. The adoption of digital money — credit/debit cards, stored-value schemes and other non-paper-based value transfer mechanisms — improves transaction speed, user experience and convenience, in emerging and developed economies alike. These benefits flow to governments and corporations, as well as individuals.

Citi and Imperial College have partnered to develop a Digital Money Readiness Index, motivated by wanting to better understand the linkage between digital money adoption and socio-economic outcomes as well as to examine strategies on a country-by-country basis on which governments, policymakers and private sector firms could implement and execute to increase digital money readiness and drive adoption. To do this, we gathered evidence and analyzed the topic on a reasonably global basis, in order to answer the following questions.

* The “Why Bother” Question – Does digital adoption make a difference? Is it possible to quantify the benefit to governments, corporations and individuals?

* The “What Matters” Question – What are the factors that affect the outcome of a digital money initiative? Why are there varying degrees of success across digital money initiatives in some countries and jurisdictions?

Measuring Digital Money Readiness
We believe that the following four “pillars” explain, for the most part, how ready a given country is to adopt digital money. We further disaggregated each pillar into attribute “indicators” that help quantify country-level readiness. There are cultural and other country-specific factors that can be qualitatively used to explain what the index does not.

* Institutional Environment: This pillar considers the national institutional characteristics within which digital money needs to operate – this includes factors like property rights and a government’s support for innovation.

* Enabling infrastructure: This pillar considers technological and financial infrastructure that underpins the deployment and operation of digital money. Both regulatory and operational aspects are considered.

* Solution Provisioning: This pillar consists of the industries and functions that drive the provision of digital money solutions (and the most frequent use cases).

* Propensity to adopt: This pillar captures the rate at which consumers and corporates adopt new innovation.

To measure digital money readiness, we created a composite score consisting of the four pillars that drive readiness and measured these with data collected across 15 different indicators.

Understanding Digital Money Readiness
Our analysis of the readiness scores of the 90 countries in our study yielded four distinct clusters – we call them stages of readiness – based on characteristics exhibited by underlying pillars and indicators. These groupings will allow stakeholders, including governments and policymakers, to recognize their nation’s current level of Digital Money Readiness and provide a perspective on how to move up to the next stage or move higher within the same stage.

Analyzing the indicator-level scores within the index sheds light on the general attributes of each stage.

1. Inicipient Stage: Often characterized by a lack of affordability (and basic) information & communication technlogies (ICT) infrastructure and expensive / limited fianncial services.

2. Emerging Stage: Basic ICT infrastructure and financial services do exist. Relevant regulation is on the books. The challenges here tend to be one of more of the following: the presence and size of the informal economy; (perceived) lack of enforcement of existing regulation, both for consumers and corporates; lack of ICT ubiquity and affordability; and consumer preference for cash.

3. In-Transition Stage: the challenges of the Incipient and Emerging stages have been largely resolved. Often, these countries have successfully deployed accelerators such as social disbursements via Digital Money. But they may need to make investment in Solution Provisioning, i.e. digital payments for transit or the seeding of e-commerce initiatives. Sometimes, it may be a matter of lowering restrictions on financial instruments so that a healthy system of private enterprises can take root.

4. Materially Ready Stage: Characterized by ubiquitous ICT diffusion coupled with familiarity of digital solutions. They also exhibit a market friends business and regulatory environment that facilitates private sector investment and innovation in digitally enabled solutions. The challenge at this stage is to create compelling use cases and ecosystems that drive increased digital money usage and ubiquity.

Relationship between the Index and Cashless Intensity
Our Digital Money Readiness Index attempts to measure how ready the individuals and businesses in a country are to adopt or use electronic forms of monetary value. The key question is: does readiness drive adoption?

To answer this question, we plotted the relationship between our Index values and a Citi-developed indicator of digital money adoption (i.e., “cashlessness”), called “Cashless Intensity,” which calculates consumer spending via digital channels as a percentage of the total consumer spend. We found a reasonable relationship between the digital money readiness index and Citi’s cashless intensity rankings – about 60%-65% of adoption can be explained by the index variables. (1) Further research is required to better understand the factors that explain the remainder.

As with all indices, our index is static, i.e., it cannot account for situations where investments in digitization have been made but the benefits are yet to accrue and be measured. For example, consider the impact of the two ICT indicators, readiness and usage. The International Telecommunications Union (ITU) acknowledges country-level variability in the timing and extent of ICT investment benefits for the following reasons. (i) Countries dependent on transactional services (e.g., financial services) and high labor content (e.g., tourism) may benefit to a greater extent than countries dependent on resource industries (e.g., mining). (ii) Investment returns depend on people being trained and business processes being changed. (iii) Businesses must be incentivized to use the infrastructure. Improving affordability is more important than just having the ICT infrastructure.

This exercise also confirms a view we had at the onset of the analysis – the index can only provide guidelines to increase readiness. Actual adoption is influenced by the unique characteristics of each individual country.

Quantifying the Benefits of Digital Money Adoption
There is ample anecdotal evidence on the benefits of digital money adoption. One of our primary objectives was to establish a more concrete correlation between digital money adoption and the associated benefits.

We have attempted to provide a perspective on benefits to governments, the private sector and to individual consumers.

Benefits for Government
Digital money holds the promise of several benefits for governments including financial inclusion and its broader social and economic advantages, but also efficiencies and cost savings in government disbursements.

According to our estimates, a 10% increase in the digital money readiness score and commensurate increase in adoption for the countries included in the index can translate to USD $1 trillion moving from the informal economy to the formal economy. This can translate to USD ~$100 billion in increased tax collections for the government.

And this may only be the tip of the iceberg. Studies indicate that significant benefits can be realized from arresting leakage and increasing the efficiency of government disbursements. Several programs such as Bolsa Escola in Brazil and Plan Jefes y Jefas program in Argentina have adopted electronic distribution of benefits and witnessed material benefits. In Argentina, the share of participants who admit to paying bribes to local officials in order to access their benefits fell from 3.6% to 0.3% after the Ministry of Social Development moved to electronic payment cards. (2) A study by the World Economic Forum indicates that leakage affects 5%-25% of total benefits and accounts for 75% of total losses. (3) Government disbursement through digital money, arguably, has the potential for higher social impact.

Benefits for Business
Digital money adoption provides the opportunity for efficiency gains in terms of the reduced costs of handling cash along with new revenue upside due to higher spending from existing consumers and access to new customers.

A recent study by The Fletcher School at Tufts University (4) estimates the cost of cash to U.S. businesses – as a result of theft, transit, security costs – to be USD $55 billion annually; McKinsey estimates the efficiency gains from digitization to be approximately USD $340 billion in the U.S. That amounts to anywhere from 0.4% to 2.3% of United States GDP. Anecdotally, the cost of the end-to-end cash collections cycle to a corporation can be 2%-5%, based on internal studies that Citi has done.

Revenue gains can also be substantial. Earlier in the report, we discussed innovations such as mPoS (mobile Point of Sale) that allow smaller retailers to accept card payments thus unlocking higher revenues. According to a recent survey by WorldPay (5), the uplift can be 20% or higher increase in sales for small and medium retailers if they accept electronic card payments. Moody’s Analytics studied 56 countries that make up 93% of world gross domestic product, over a five-year span–2008 to 2012 and found that greater usage of electronic payment products added $983 billion in real (U.S.) dollars to GDP in the countries studied.(6)

Within the broader purview of ‘Benefits for Business’, we analyzed the specific benefits for Financial Services institutions. According to our estimates, a 10% increase in digital money readiness score and commensurate increase in adoption for the countries included in the index, can help [up to] an estimated 220 million individuals enter the formal financial sector. As these individuals start to formulate banking relationships, we estimate that the financial services industry stands to witness an USD $80–$100 billion increase in deposits and a USD ~$70-$90 billion increase in loans.

Once a mobile money account is seeded, it often converts into a formal bank account down the road. Beyond this, it is possible for Financial Institutions to sell incremental services to the beneficiaries of digital money. According to work done by the Gates Foundation, revenue from such incremental services can be sizable – almost 2-5 times the core financial services revenue.

Benefits for the Consumer
It makes intuitive sense that the citizens of a jurisdiction that is implementing a digital money initiative should benefit if the initiative succeeds. Many individuals in the informal economy have to pay high rates for credit; they lack safe means of savings and investment and many face security concerns in handling cash. Access to financial services can be a key element in overcoming these stubborn realities. Not only does it help consumers accumulate, increase, and protect their money, it also allows them to weather financial shocks. At a minimum their life has become more convenient as some of the friction associated with a transaction is eliminated. There are several examples of the citizens of a country benefiting from mobile money due to reduced corruption.

Conclusion
Over the past few years, anecdotal evidence of the benefits of digital money adoption has grown. We believed there was an opportunity to formally quantify what the full impact of this trend could be, for governments, corporations and individual consumers. According to our estimates, digital money adoption could enable as many as 220 million individuals to enter the formal financial sector. This could result in over USD $1 trillion moving to the formal economy from the informal economy.

However, realizing these benefits requires a clear strategic intent and sustained execution, often at a local level, against a clearly understood roadmap. Our work provides a platform to develop actionable plans that enable progress against the digitization journey. It is also clear that there are several complex, interrelated factors at play and unique situations will require tailored solutions.

We will be the first to acknowledge that this is an arduous process and we do not have all the answers. However, our findings thus far support our conviction that a scientific approach to the problem of digital money readiness (and adoption) is not only possible, but also necessary in order to drive actionable solutions.

Digitization in general and adoption of digital money solutions in particular, is not a question of ‘if’, but ‘when’. Doing nothing simply means allowing the system to develop dysfunctionally, in fits and starts. It also means delaying the tremendous socio-economic benefits that adoption can bring. Inaction is not an option. There is too much at stake.

Note: The Digital Money Readiness Index was developed through a joint venture between Citi and Imperial College Business School London. Special thanks go to Llewellyn D W Thomas, Antoine Vernet and Professor David Gann, CBE for their contributions.

(1) R-squared of 0.62; R-squared is obtained by regressing cashlessness over our index.

(2) “Financial Services for the Poor: Welfare, Savings and Consumption”. IADB, 2007.

(3) “Galvanizing Support: The Role of Government in Advancing Adoption of Mobile Financial Services”, WEF, 2012

(4) “The Cost of Cash in the United States”. Bhaskar Chakravorti and Benjamin D. Mazzotta, Tufts University’s Institute for Business in the Global Context, 2013.

(5) Based on a survey of 5,000 consumers in the UK by WorldPay

(6) “The Impact of Electronic Payments on Economic Growth’, Moody’s Analytics, 2013