1 - Structural Barriers to Financial Inclusion in Emerging Markets
1.1 - Inefficiencies in financial services
A range of inefficiencies inherent in the structure of financial services mars lending. Each stage of the lending and securitization process necessitates multiple layers of intermediaries and administrative oversight, including custody, trustee services, reconciliation, and compliance. Though essential to current systems, these roles often act as rent-seeking layers, driving up costs for consumers, originators, and investors.
Asset-backed financing—an essential driver for credit expansion—is especially riddled with high expenses and inefficiencies. The procedure encompasses numerous phases, all of which saddle significant costs that are disproportionately burdensome for minor entities. Prime factors contributing to the costs include:
Warehousing Costs: Loans are aggregated by warehouse lenders, requiring multiple audits to ensure compliance and accuracy. Each re-audit adds significant expense.
Special Purpose Vehicle (SPV) Formation: Loans are transferred into an SPV or trust to isolate financial assets and enhance creditworthiness. This step involves legal and trustee fees.
Auditing and Underwriting Fees: Independent auditors validate loan pools, while underwriters re-evaluate loans to ensure conformity with original policies. Each stage incurs additional costs.
Rating Agency Fees: To attract investors, securitized products are rated by agencies that conduct thorough risk assessments for a fee.
These costs amount to around 1% of total loan value but include fixed costs, making securitization only economically viable for large-scale loan books. Regardless of securitization, many asset classes suffer from opaque practices and illiquidity, leading to elevated transaction costs and risk premiums. The net effect is a significant reduction in capital availability and increased credit costs for borrowers.
1.2 - Amplified inefficiencies in emerging markets
The underdeveloped financial infrastructure and fragmented ecosystems in most emerging markets magnify inefficiencies in financial services. A lack of standardized methods for value assessment, high operational costs, and limited access to reliable credit data exacerbate the problem. Traditional financial institutions often perceive these markets as high-risk, deterring investments due to counterparty risks, payment rail challenges, and operational hurdles.
These challenges contribute to billions of people remaining unbanked or underbanked in emerging markets. According to the World Bank, approximately 1.4 billion adults globally were unbanked as of 2021, with the majority concentrated in emerging markets across regions like Africa, South Asia, and Latin America. These populations face exorbitantly high interest rates, lack of established credit histories, and inefficient lending processes that exclude them from formal financial systems
The high costs and inefficiencies of securitization are significant barriers to improving access to credit in these markets. Smaller loan sizes and the smaller loan books of emerging market fintech generally make securitization unfeasible. As a result, small businesses and individual borrowers struggle to secure affordable credit, which stifles entrepreneurship, economic expansion, and financial inclusion.
1.2.1 - The Untapped Potential of Emerging Markets
Unlocking access to credit in emerging markets could yield significant economic benefits. The International Finance Corporation (IFC) and the SME Finance Forum estimate that the global credit gap for micro, small, and medium enterprises (MSMEs) in developing countries is approximately $5.2 trillion annually. Closing this gap could significantly boost these markets' economic growth and job creation. Furthermore, expanding financial inclusion by integrating the unbanked into the formal economy could lift millions out of poverty and significantly increase economic activity. Achieving full financial inclusion could boost the GDP of emerging economies by $3.7 trillion by 2025, lifting 95 million people out of poverty and generating substantial additional revenue for financial service providers, according to a report by McKinsey Global Institute
The economic potential extends to broader societal impacts. Improved access to credit enables small businesses to grow, creates jobs, and drives infrastructure development. It also empowers individuals by facilitating access to education, healthcare, and housing, all contributing to long-term economic stability
1.3 - Emerging market fintechs are growing rapidly but struggle with access to credit
The fintech landscape in the Global South is expanding rapidly, driven by high mobile penetration, digital payment adoption, and a large unbanked population:
Africa: Home to over 2,600 fintech companies, concentrated in markets like Nigeria, Kenya, South Africa, and Egypt. Fintech adoption rates are around 50%, and the sector is expected to grow thirteenfold to $65 billion by 2030, significantly increasing financial access.
Latin America: The Fintech industry is thriving, particularly in Brazil, Mexico, and Colombia. With adoption exceeding 60%, the market is projected to grow 12.5 times by 2030, driven by digital banking and payments.
Southeast Asia: The broader region hosts nearly 5,900 fintech companies, including key markets like Indonesia, Vietnam, and the Philippines. With 76% adoption of digital financial services, the area is a global leader in fintech innovation.
South Asia: India and Bangladesh are at the heart of South Asia’s fintech expansion. India’s fintech ecosystem is expected to grow more than 35% annually, reaching over $190 billion in revenue by 2030, contributing 13% to the global fintech revenue.
Collectively, fintech companies in emerging markets already serve hundreds of millions of users, and adoption is expected to double by 2030. This expansion presents a unique opportunity to drive financial inclusion and economic growth.
These companies are pivotal in expanding access to financial services, particularly in regions with underdeveloped traditional banking infrastructure. However, they face significant challenges that hinder their ability to scale and effectively raise credit.
1.3.1 - Barriers to Debt Capital for Emerging Market Fintechs
Despite their rapid growth, fintechs in emerging markets encounter significant challenges when attempting to securitize their debt books and access credit from U.S. and other global investors. High costs, fragmented ecosystems, and the absence of standardized credit evaluation make these processes viable only for the biggest companies. Compounding these issues, investors perceive emerging market debt as high-risk, reducing access to critical capital despite these markets' attractive yields.
The challenges of raising debt capital constrain the growth of emerging market fintechs, limiting their ability to scale lending and expand financial access to local communities. Without trusted financial reporting, streamlined investment mechanisms, and accessible funding channels, originators struggle to attract institutional capital, often relying on expensive, short-term funding that drives up borrowing costs.
1.4 - Challenges for U.S. Investors in Emerging Markets
While emerging markets present attractive opportunities for high-yield debt investments, U.S. investors face challenges that hinder participation:
Audit and Legal Challenges: Fragmented loan data, lack of standardization, and re-audit requirements create costly and time-consuming barriers. Legal exposure in less predictable bankruptcy courts and the lack of backup servicing mechanisms also heighten operational risks.
Issuer and Systemic Risks: Limited transparency from debt issuers and weaker legal frameworks increase the likelihood of defaults and fraud. Broader macroeconomic risks, including currency volatility and political instability, compound the challenge of investing in these markets.
Inefficient Payment Rails: Outdated and fragmented payment infrastructure complicates cross-border transactions, and high costs, scalability limitations, and settlement delays affect cash flow predictability.
1.4.1 - Removing Barriers to High-Yield Investment Opportunities
The PACT protocol offers a transformative approach that makes it significantly easier for global investors to access high-yield debt opportunities in emerging markets by reducing risks, increasing transparency, and streamlining operational processes:
On-Chain Auditability: Enabling real-time visibility into loan books, reducing audit complexity and costs.
Improved Transparency: Providing standardized data and enhanced reporting to mitigate counterparty risks.
Seamless Payment Integration: Leveraging blockchain technology to facilitate efficient, low-cost cross-border transactions.