Digital finance offers hope of internationalising emerging markets

International financial institutions are examining the potential of the ongoing revolution in digital money to enable emerging markets and developing countries to participate more in both local currency and international capital markets

THE GLOBAL FINANCIAL system is undergoing a profound transformation: rapid technological innovation is ushering in a new era of digital money. This is reshaping economic activity, shrinking the role of cash and spurring new digital forms of money. Just as consumers have found it easier to buy a coffee with a swipe of a card, phone or watch than scrabble around for notes and coins, so national policy-makers and regulators in emerging markets and developing economies are waking up to the potential of digitalised monetary systems to further connect them to global capital markets.

They are looking at the role of digitalised monetary systems in reshaping areas such as payments, lending, insurance and wealth management — a process that the Covid-19 pandemic accelerated.

For multilateral organisations that have staffed the sentry posts of the international financial system since the end of the second world war, this rise in the digitalisation of money poses a profound paradox.

On one hand, increased adoption of digital money by emerging economies can foster greater efficiency and financial inclusion. On the other, it poses significant challenges and risks.

The potential benefits are clear. Payments will become easier, faster, cheaper, more accessible and will cross borders swiftly. These improvements could improve efficiency and inclusion, with major benefits for all.

But to reap the full benefits and manage risks, policy-makers must step up as the implications and risks are wide-ranging and profound.

Multilateral development banks, such as the Inter-American Development Bank (IDB) and World Bank, and financial watchdogs, such as the International Monetary Fund, are alert to the need to formulate a strategic response to the rapid and widespread transformation related to digital forms of money.

They have two compelling reasons for doing so. First, digitalisation can offer EMDCs an opportunity to accelerate their entry into international capital markets. Second is the potential these tools have for helping to tackle wider goals that are central to development banks’ mandates, such as increasing financial inclusion.

‘Blue ocean’ of opportunity

Emerging markets and developing countries, which collectively account for 84% of the world’s population but only 37% of its gross domestic product, have made major advances in the last two decades to close the gap with advanced countries in terms of their engagement with global capital markets and payments systems.

However, there is more ground to cover. One metric is market capitalisation of listed domestic companies as a share of GDP. While the global ratio was 133% in 2020 — meaning the market value of these companies is a third higher than global annual economic output — this spikes to 150% for members of the Organisation for Economic Co-operation and Development but slumps to just 78.6% for low- and middle-income economies, according to World Bank data.

EMDCs can close this gap by increasing the depth of their markets and opening up to a larger investor universe. As Diego Herrera, financial markets lead specialist at the IDB, said: ‘We’re talking about a myriad — a huge blue ocean — of opportunities in terms of expanding the capital markets now.’

For instance, the ratio for market capitalisation in his region, Latin America and the Caribbean, is just 50% for active exchanges. Even that masks wide regional variations with Brazil and the Pacific Alliance countries of Chile, Colombia, Mexico and Peru making up some 96% of the total market capitalisation of the region.

Digitalisation, financing for micro-, small- and medium-sized enterprises, and the mobilisation of resources are key parts of the IBD’s Vision 2025. Other international financial institutions have the digital transition in their crosshairs: it is one of three overarching goals of the European Bank for Reconstruction and Development’s 2021-25 strategic and capital framework.

Plumbing needed

The potential is huge. But before considering how the benefits can be realised, experts believe that the first step is to use digitalisation to improve the plumbing of the financial system.

Over the last couple of decades, technology has revolutionised how investors access financial markets. That will deliver higher marginal gains for EMDCs whose financial systems are not as developed as advanced economies.

But there is an array of technologies that have been used to raise the efficiency of capital markets operations. Herrera identified four: cloud computing, artificial intelligence, blockchain and open architecture.

Traditionally, central data repositories have been used to store transaction data. Blockchain uses distributed ledger technology that enables computers in separate locations to validate transactions and update records simultaneously across a network.

Blockchain consists of a block of transaction details like the seller, buyer, price, contract terms and other relevant details. A copy of the database is saved in different locations, called nodes, which validate new transactions.

This decentralisation of finance can help EMDCs create markets and foster market making for primary dealers. This may provide a solution for issuance of public and private debt by tracing bonds, gathering information and enabling payment of taxes.

The overall impact on market liquidity should not be overestimated, however. Detailed data on transactions are usually not publicly available and post-trade public reporting is usually aggregated.

Artificial intelligence allows for buying and selling financial assets in an automatic and more efficient way. Cloud computing can support the integration of markets that on their own might be too small. Herrera pointed to Colombia, Chile and Peru that are integrating their exchanges and possibly their central securities depositories. The IDB has co-operated with governments integrating financial markets.

Markets including Brazil and Colombia are offering investors an open architecture protocol. Both local and international investors can access protocols where they can deliver orders and modifications of orders to a system with a capacity of around 10m orders per day.

Investors can apply AI to these protocols and do algorithmic or high frequency trading. That creates an incentive for investors to invest both nationally and internationally. It creates an opportunity for supervisors and financial regulators as they can use those protocols to access data in real time.

Countries in EBRD regions have sizable alternative finance markets
Average peer-to-peer lending and crowdfunding, % of GDP, 2016-20

Source: EBRD (2021) Transition Report 2021-22

IFI mandates

The falling costs caused by the move to digital technology have increased the ability of individuals and firms to access payment instruments previously used only by financial institutions.

Emerging markets stand to gain the most from this dramatic shift, which moves it to the centre of IFIs’ attention, given their mandates of promoting sustainable growth and fostering economic stability.

Arif Ismail, deputy division chief for payment and infrastructure at the IMF, said digitalisation is a very important tool for IFIs. It provides new opportunities, including the emergence of new products and services, the potential for the realisation of efficiency gains from peer- to-peer lending and credit scoring based on artificial intelligence.

‘The thing that makes it exciting is that for the first time in history, not only is the data available, but we also have the ability to use tools like AI, robotics and  machine learning to crunch the data, using cloud computing as the backbone for scale,’ Ismail said.

Against this backdrop, IFIs see three roles for themselves. First is to support the foundations of digital finance, both physical, such as supporting the roll-out of 5G broadband, and intangible, such as helping policy-makers devise the regulatory systems to support digital finance. Second is helping governments and private finance adapt to the technologies that have sprung up. Third is to foster innovation to enable EMDCs to leapfrog older systems in terms of the development of financial products.

Jacek Kubas, head of digital at the EBRD, sees the benefit of digitalisation in bringing down transaction costs as key to making it easier for issuers and investors to come to EMDC markets. ‘If the capital markets are more internationalised and so, to an extent, also more integrated, that means that a larger pool of investors will come because it will be much easier for them to access those markets that will do it normally,’ he said.

The EBRD’s area of operation includes many small countries with similarly small capital markets, whose market capitalisation makes it hard to attract international investors focused on larger capital markets and hard currencies.

To counteract that, the EBRD has been looking to help integrate capital markets in Estonia, Latvia and Lithuania, to create a pan-Baltic capital market, which will be more attractive to international investors looking at benchmark issuance of €250m or more.

To this effect, in 2017 the three states, in co-operation with the EBRD and European Union, drew up a memorandum of understanding to create a pan-Baltic capital market.
This was followed by another memorandum in 2020, signed by the central banks of the three countries, to develop a regional market for commercial paper, short-term unsecured promissory notes issued by companies with a fixed-term maturity and used to address short-term liquidity or working capital needs.

‘The world is changing around us, we are becoming more digital and capital markets are also becoming much more digital,’ Kubas said.

Private finance in front

For now, digitalisation is more evident among private financiers in EMDCs. This is often the result of national central banks and governments introducing regulations that enable fintechs to experiment.

A number of the economies where the EBRD invests – again most notably the Baltic states — are taking a leading role in the global digital revolution. The central bank of Lithuania has created a regulatory sandbox to test their new digital solution within a safe environment.

Digitalisation has enabled the emergence of a broad range of alternative finance models, which involve internet-based financial channels and instruments falling outside of the traditional financial system.

The Baltic states are particularly advanced in terms of online peer-to-peer consumer lending platforms, with examples including Estonia’s Bondora, Lithuania’s Savy and Latvia’s Mintos and Twino. These have developed into international marketplaces for consumer loans and also operate in other transition economies such as Armenia and Georgia.

As an IFI, the EBRD invested €28m in the first ever covered bond issued in the Baltic states to support the establishment of a new capital market instrument in this region. Luminor Bank issued five-year bonds for €500m, initially secured with Estonian mortgages. Almost all of the orders originated from institutional investors outside of the Baltics, with close to 80 investors from 18 different countries.

Kubas said that thanks to digitalisation, investors that might not normally come to the region could see a collateral security network, adherence to international standards and data about the assets in the bond.

The EBRD has also partnered up with Wise Guys, a fintech accelerator that brought 10 companies through an eight-month programme with financing of up to €100,000 each. Kubas said that the programme not only helped accelerate the companies’ development of financial products but helped plug the gap in terms of capital funding.

Meanwhile, the European Investment Bank has used its boost Africa initiative to work with the European Commission and the African Development Bank to support the development of a dynamic venture capital and private equity ecosystem in Africa.

In Latin America, the IDB funds FintechLAC, a regional public goods initiative consisting of a group of financial regulators, supervisors and fintech associations from 15 countries but with access to the whole region. According to its research with Cambridge University’s centre for alternative finance, the last two years have seen significant growth of the alternative finance ecosystem in Latin America and the Caribbean.

The region reached $5.3bn in originations in 2020, representing a growth of 9.1% when compared to 2019 ($4.8bn) but a stunning 191% when compared to 2018 ($1.8bn).

Within that, the share of business finance rose to 86% in 2020 from 60% in 2018. Debt-based models explain most of this behaviour, accounting for a total volume of $4.5bn and a growth rate of more than 177% since 2018.

‘Crowdfunding is showing the potential to close the financing gap for micro firms and SMEs by changing local markets, enabling investors, both institutional and retail, and enabling ways of creating new markets,’ Herrera said.

Growth and regional divergence in digital financial inclusion
Regional averages for digital financial inclusion index, sample sizes in brackets

Source: WP/21/90 working paper Measuring Digital Financial Inclusion in Emerging Market and Developing Economies: A New Index

IFIs then governments?

One area where EMDCs have made advances — albeit not a capital market product — is digital currencies. Over the last two years, the debate over digital sovereign currencies has moved from the theoretical to the practical.

According to a survey of its country mission chiefs by the IMF in February 2021, central bank digital currencies were being closely analysed, piloted or likely to be issued in around 111 — or 70% — of the 159 countries surveyed.

One interesting feature to emerge is that while advanced economies seem quite ambivalent about digitalising their currencies, emerging markets are much more motivated.

The Bank of England said in November 2021 that a UK CBDC — inevitably dubbed ‘britcoin’ — was unlikely to arrive until at least 2025, while the US Federal Reserve has taken no position on the ultimate desirability of a dollar CBDC. Australia sees ‘no strong public policy case’ to move in that direction.

The handful of nations that have gone ahead are all emerging economies. So far, the only CBDCs to be launched are the Bahamas’ sand dollar in 2019 and the eNaira from the Central Bank of Nigeria, along with a pilot for the Eastern Caribbean Central Bank’s DCash blockchain-based version of the East Caribbean dollar.

John Rolle, governor of the Central Bank of the Bahamas, told OMFIF’s Digital Monetary Institute Symposium in 2021 that he wanted to ensure that, as it introduces new connected services providers and pushes the digital transition in terms of financial services, providers operate in an interoperable environment.

‘From my point of view, identifying central bank digital currency as a means of providing the interoperability was an easy solution for the Bahamas, particularly to make certain that there is a transmission channel for financial services, so that wherever a person resides in the Bahamas, they can use that medium to access other banking products and services.’

Others are still waiting and watching. Palau, a dollarised Pacific island nation, is working with Ripple, the digital payment network. The initial focus of the partnership will see the development of a dollar-backed digital currency to help facilitate cross-border payments for the nation.

‘The project is to develop a national stablecoin, which will be pegged to the dollar and has lots of interesting use cases around that,’ James Wallis, vice-president of central bank engagements at Ripple, told an OMFIF podcast.

This addresses the issue of financial inclusion, which is a core mandate for IFIs. The Bank for International Settlements’ Innovation Hub has conducted over 20 workshops with more than 30 participating organisations in a project with Australia, Malaysia, Singapore and South Africa.

This has seen six months of collaboration with central banks, commercial banks and technology solution providers to gain a better understanding of the critical challenges of onboarding onto a common CBDC platform and to understand the nuances of access, governance, security and other functional and non-functional requirements.

In October 2021, the BIS Innovation Hub co-hosted a roundtable with Queen Máxima of the Netherlands and central bank governors from EMDCs, along with other stakeholders such as the Alliance for Financial Inclusion, Consultative Group to Assist the Poor, IMF and World Bank to explore the potential of CBDCs to address financial inclusion.

‘Financial inclusion is an important issue not only for the Innovation Hub, but for the BIS more broadly,’ said Ross Leckow, senior adviser, fintech  – strategy and legal at the Innovation Hub. ‘We think the lessons that people may learn from our projects may be of assistance to them, particularly on the retail side.’

Yet to materialise

Aside from CBDCs, development banks say the potential of digitalisation in financial services and payment systems as a platform for governments to take advantage of global capital markets has not yet materialised.

‘Almost across the board, the take-up in digital payment has increased substantially,’ said Cyn-Young Park, director of the regional co-operation and integration division of the economic research and regional co-operation department at the Asian Development Bank. ‘But it’s not really through the digital currencies. It’s just the digitalisation of the payments system through a variety of methods such as digital wallets, quick response codes and payment links.’

This highlights a divide between products that target a domestic retail audience and those aimed at international investors.

In the first sphere are innovations such as M-Akiba, a local currency retail bond issued by the government of Kenya to fund infrastructure and sold through a mobile phone app. In Thailand, the public debt management office raised ฿200m by selling local currency savings bonds to the public with a face value of one baht ($0.03) and a minimum subscription of ฿100, rather than the usual ฿1,000 denomination, selling out within hours through Krungthai Bank’s e-wallet.

The success of these issues — enabling and encouraging people in EMDCs to use digital apps to invest — could provide a platform for the development of more sophisticated products, such as pensions. ‘Could there be positive spill over effects from having these e-wallets and digital wallets to produce other products?’ asked the IMF’s Ismail. ‘The answer is yes, we are beginning to see that. Digitalisation brings mobile wallets and introduces micropayments, but the process doesn’t end there. It starts to create the opportunity for more and more products to be digitally introduced.’

Anderson Caputo Silva, practice manager, long term finance at the World Bank Group, said that digital technologies will lower costs of entry so that pension funds and life insurers will see an opportunity that previously did not seem profitable. ‘You now increase the target population, there’s more incentive for intermediaries to think of products that initially they would not have thought of, because they didn’t have anybody to offer them to,’ he said.

The next step in this evolution will be for EMDC public issuers to be able to take advantage of the potential that digital technology offers. The World Bank believes that when the technology and regulatory systems are available to all, the marginal gains will be greatest for those countries with the most difficulties in terms of financial market infrastructure, attracting capital and access to investors.

There is a substantial amount of funding in international markets but that is currently highly concentrated in a few of the largest emerging markets such as Brazil and India. The potential transaction volume in these markets is sufficient to justify the costs such as developing a connection with the international central securities depositories like Euroclear or Clearstream, having local custodians or buying foreign exchange hedges.

The challenge is to ensure that a larger range of countries benefit from these capital flows. But while these economies need the capital to flow in, their relatively small size acts as a deterrent.

New digital plumbing has the potential to make it easier for small economies to connect to international capital markets at a fraction of the investment costs they face today.

‘What we are thinking about is whether with digital ledgers and other technology you can replace those old frameworks with something much simpler and much less expensive that could really facilitate the interconnection between small domestic markets and the rest of the world,’ said Silva.

However, fixing the plumbing is just one of the many challenges faced by small markets eager to be more connected to international capital markets. Others include the scope of regulation, tax treatment and currency conversion, that new technology will not be able not solve by itself.

Crowdfunding in Latin America thriving
Alternative finance volumes in Latin America and the Caribbean, $bn

Source: CCAF (2021) The 2nd Global Alternative Finance Market Benchmarking Report

Preparation is key

But IFIs themselves are playing a key role in using digital technology to issue financial products such as bonds.

In 2018, the World Bank launched bond-i, the world’s first bond to be created, allocated, transferred and managed throughout its life cycle using distributed ledger technology. The two-year bond raised A$110m and investors in the bond include seven major Australian banks and state treasuries.

The following year, secondary market trading recording was enabled on blockchain for bond-i. The issue was also re-opened the same year with broadened market participation.

Last year, the EIB launched a digital bond issuance on a blockchain platform, deploying DLT for the registration and settlement of digital bonds, in collaboration with Goldman Sachs, Santander and Société Générale.

The €100m two-year bond, placed with key market investors, represents the market’s first multi-dealer led, primary issuance of digitally native tokens using public blockchain technology.

The next stage would be for national governments and debt management offices to get in on the act in the form of digitally enabled issuance of products such as local currency bonds on global capital markets.

There is evidence that within public finance, governments are making investments to digitalise their financial systems. Benin, for example, worked with Estonia’s information technology provider to develop an e-government interoperability framework, review the legislative framework so that it corresponds to the needs of a digital society and conduct an inventory of existing public sector information systems and databases.

Development banks are also interested in the environmental, social and governance sphere. Blockchain can play the role of an auditor to make sure that the proceeds of green or social bonds are actually going towards green or social projects.

According to the IDB there was $30bn of issuances for green and sustainable bonds in Latin America and the Caribbean, most of them focused on international investors.

The IMF is keen to point out that EMDCs must invest in providing the underlying conditions needed for financial development. This includes access to electricity, mobile networks and internet coverage, as well as online, financial and digital literacy.

If tech giants, smaller fintechs or even incumbent firms are using data, regulators must prevent biases emerging through AI or other technologies that exclude particular ethnicities, races or genders.

There is also a systemic risk that financial regulators in less developed countries may not have a full picture of the size of financial transactions and capital flows during a shock.

The IMF recommends that EMDCs looking to embrace digital finance as a route to gaining greater access to international investors should ensure all parties are engaged and, where appropriate, take advantage of innovation hubs and regulatory sandboxes.

‘It requires a significant amount of energy, leadership and commitment at the right levels,’ said the IMF’s Ismail. ‘I often say the capital piece, the financing piece is the last of the hurdles. The most important one is how to bring the right stakeholders together and commit. It has to be around public private partnerships.’

At the World Bank, Silva is also cautious about the ability of EMDCs to harness digital finance. Technological innovation is unlikely to immediately remove the hurdles that EMDCs face in accessing international capital markets compared with their advanced counterparts. When the World Bank engages with EMDCs, it often finds that technology issues are not usually the most important ones.

However, for economies that are determined to make all the changes to domestic regulations and systems that are needed to attract foreign investors, digital technology will make it a bit easier to achieve this objective.

One long term option would be for technology to merge both the corporate and sovereign bonds of a number of smaller countries into single instruments that would then be attractive to international investors due to their size and inherent diversity. ‘We are really going to the moon right now. but maybe I see more potential there,’ the World Bank’s Anderson said.


Emerging markets and developing countries account for 84% of the world’s population but only 37% of its gross domestic product.


Around 70% of countries surveyed by the IMF were experimenting with CBDC.


The EIB two-year bond in 2021 was the first primary issue of a digitally native token using public blockchain technology.

What the experts say

‘We’re talking about a myriad — a huge blue ocean — of opportunities in terms of expanding the capital markets now’

Diego Herrera
Financial markets lead specialist


‘The project is to develop a national stablecoin, which will be pegged to the dollar and has lots of interesting use cases around that’

James Wallis
Vice-president of central bank engagements


‘Financial inclusion is an important issue not only for the Innovation Hub, but for the BIS more broadly’

Ross Leckow
Senior adviser, fintech – strategy and legal

BIS Innovation Hub

‘There’s more incentive for intermediaries to think of products that initially they would not have thought of, because they didn’t have anybody to offer them to’

Anderson Caputo Silva
Practice manager, long term finance

World Bank

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