Despite decades of funding support from donors and development finance institutions (DFIs) to build financial systems that work for low-income populations and micro and small enterprises, sizeable gaps in financial inclusion remain. During this time, DFIs were powerful actors investing primarily in building financial service providers’ (FSPs) capacity and financing their growth. Given persistent market gaps and suboptimal functioning of many financial systems, it is time for DFIs to adopt an alternative approach to financial inclusion that prioritizes needed market changes. A shift to a market systems approach (also referred to as a market development approach) addresses this need and requires that DFIs carefully analyze each market to determine the key gaps, underlying causes, critical actors, and theory of change for bringing about sustainable market development.
Our research, including interviews with over 40 industry experts, supports the concept that DFIs can be an even more powerful actor in driving market change. It also provides evidence that several DFIs have already made investments with overlapping elements to a market development framework. The paper features these in five mini case studies that help illustrate the market change process. The paper also proposes a framework for DFIs to evaluate whether and how their new investments might affect market change and satisfy financial return expectations.
Shifting to a market development approach will present challenges to DFIs. This paper outlines core requirements and makes several recommendations. Areas covered include the role of technical assistance, the power and credibility of DFIs to influence local policy and regulations, and the structures that allow for increased risk and flexibility.
As DFIs consider their market development mandate from their government stakeholders, CGAP’s “New Funder Guidelines: Market Systems Approach to Financial Inclusion” and this paper will better equip DFIs to optimize their contribution to the development of inclusive financial markets.