Who Pays for Free Trade?: How FTAs Affect the Unbanked

This post originally appeared on the SPINNAKER Network.

Two weeks ago, President Obama announced Congress’s approval of three long-awaited trade deals with Colombia, Panama, and South Korea. They have been both hailed and rejected by the usual suspects, but the debate has centered largely on employment and labor issues. However, there’s also something to say about what these deals mean for financial inclusion, specifically with regards to mobilizing savings for the poor.

The financial services section of the Colombia and Panama agreements both state that each party must provide “treatment no less favorable than that it accords its own financial institutions” (Article 12.2.2). This phrase is found verbatim in several free trade agreements (FTAs) around the globe, but also in the World Trade Organization’s General Agreement on Trade in Services (Article XVII). In a bilateral agreement, the phrase makes sense if the purpose of an FTA is to spur competition and a free flow of goods and services across borders. However, the real issue here is that the agreements say nothing about giving foreign entities more favorable treatment than domestic ones.

For countries with large income disparities, such as the US and Colombia, the unequal treatment of banks adversely affects the poor because the benefits of an FTA are starkly different for each party. For the US, FTAs create new and lucrative export markets. But for the lower income country, the goal is to attract foreign direct investment, and in order to do this, poorer nations must first attract foreign financial institutions by providing incentives not afforded to domestic banks.

A 2009 study of the India-European Union FTA shows how this issue directly affects domestic banks and the unbanked. In this case, the main incentive provided exclusively to foreign banks is that they are exempt from regulations intended to promote financial inclusion. Unlike domestic banks, foreign entities are not required to open less profitable rural branches. Out of the top nine European Union based banks operating in India, not one has opened a single rural branch. In addition, the central bank requires 10% of domestic bank lending go to those below the poverty line while foreign banks are off the hook. As a result, domestic banks simply cannot compete in their own markets while providing efficient services for the poor.

With the Indian government essentially subsidizing foreign banks, the only way for domestic institutions to compete involves moving upmarket. As for state mandated financial inclusion? It still exists, but without a market incentive to engage deposits from the poor, innovation in the field remains stifled. As domestic banks move to attract higher income clients, they cut costs by providing the bare minimum required by the state, with no incentive to actively market products that are legitimately accessible to the poor.

Take, for example, savings for the poor in Mexico. In compliance with the 2007 Law of Transparency, Mexico’s commercial banks must offer basic, fee-free deposit accounts. Yet, according to Bankable Frontier Associates’ GAFIS project, “customers subsequently find the account unsuitable or difficult to use” (3). The project’s goal is to work at this issue and find ways to make basic deposit accounts viable and accessible, but the problem seen here is similar to that faced in India. It’s possible that this is a result of NAFTA, the FTA between Mexico, Canada, and the United States, but further analysis is necessary to make a definite conclusion.

The goal of this piece is not to conclude that free trade is bad for the poor, but instead it should fuel the debate over questions such as “can the market work for the poor?” and “can we make the market for the poor?”. In addition, it is a reminder that macro-level financial and economic liberalization may cause very real micro-level problems.