FINANCIAL SERVICES FOR THE POOR AND POOREST: DEEPENING
UNDERSTANDING TO IMPROVE PROVISION
Imran
Matin, David Hulme and Stuart Rutherford
CONTENTS
Summary
1 Introduction: Points of Departure
2 The Poor and Financial Services
2.1 The Economic Environment of the Poor:
the
Savings, Credit and Insurance Nexus
2.2 The Money Management of the Poor:
Towards
a Typology
2.3 Conclusion
3 The Providers and Their Provision
3.1 An Overview
3.2 The Informal Providers and Their
Provision
3.3 The Formal Providers
3.4 Microfinance: Providers and Promises
4 The Impact Pathways: Not One but
Many
5 Conclusion
Notes
References
Summary
In the last fifteen years,
we have made significant advances in both the understanding of the needs of the
poor for financial services and in how to provide them. This has been
accompanied by a change in our image of the poor. Previously, we saw the poor
as small or marginal (male) farmers needing subsidised agricultural credit. As
the ‘microfinance’ revolution spread, our image changed, and we came to see the
poor as (largely female) micro-entrepreneurs with no collateral to pledge but
with a business world to conquer with the help of microcredit. Now a new
understanding is emerging: the poor are diverse group of vulnerable households
with complex livelihoods requiring a full set of microfinancial services.
Such financial services help
the poor maintain and improve their livelihoods, not merely by giving them
access to credit to start or run a business, but also by offering them savings
and insurance services that help them maintain and improve their human and
social capital throughout their lives.
This paper reviews the achievements
of the ‘microfinance revolution’ at the end of the twentieth century, through
reference to the now extensive literature. It finds that there are many
opportunities to improve and innovate. To illustrate this finding, the paper
concentrates on examining what we need to know to design and deliver better
financial products to the poor, especially the poorest. It argues that
financial services for the poor are essentially a matter of helping the poor
turn their savings into sums large enough to satisfy a wide range of business,
consumption, personal, social and asset-building needs. The range of such
‘swaps’ needs to be wide enough to cater for short, medium and long-term needs,
and they need to be delivered in ways which are convenient, appropriate, safe
and affordable.
Providing poor people with
effective financial services helps them deal with vulnerability and can thereby
help reduce poverty. However, the relationship is driven by complex livelihood
imperatives and is not simple. Microfinance is not a magic sky-hook that
reaches down to pluck the poor out of poverty. It can, however, be a
strategically vital platform that the poor can use to raise their own prospects
for an escape from poverty.
This paper aims to assist in the design and
construction of such platforms.
1 INTRODUCTION: POINTS OF DEPARTURE
This
paper is written on the premise that despite important recent advances in
providing financial services to the poor, there are still many opportunities to
improve practice. In particular we maintain that a better understanding of the
financial service preferences and behaviour of the poor and poorest is
important for expanding the scope of microfinance initiatives. This is crucial
in order to address emerging concerns about microfinance and the poor and
poorest (Morduch, 1998; Matin, 1998; Matin and Sinha, 1998; Rahman, 1998; Ito,
1998; Zaman, 1998; Gulli, 1998).
Our
understanding of the role offinancial services, and of the ways of providing
them to those not-served by conventional financial systems, has passed through
its ,intellectual adolescence. After an initial wave of faith that
state-mediated and subsidised credit expansion could massively reduce poverty,
countered by a second wave during the 1980s of belief that state withdrawal
would suffice, there is growing evidence of a ‘new wave’ of microfinance
experiences that have been more successful (Lipton, et. al., 1997, Rogaly et
al., 1997). This ‘new wave’, sometimes known as the ‘microfinance movement’,
has generated considerable enthusiasm among academics, donors and development
practitioners of diverse intellectual persuasion (Montagnon, 1998; Dichter,
1997). This is reflected in the figure that the microfinance industry at last
count had extended around US$ 7 billion in loans to more than 13 million
individuals around the world (World Bank, 1996).
The
logic underpinning much of the recent innovation in microfinance starts from a
set of beliefs about the financial service needs of the poor. The focus has been mostly on the design and
institutionalisation of a microcredit ‘template’ – a delivery model that is
believed to best answer those needs.
Millions of poor households around the world now benefit from this
model. However, more useful and varied
financial products can be developed if a fuller understanding of the existing
money-managing efforts of the poor informs practice. This paper attempts to
begin that task.
Debates about finance and poverty-reduction
have been shaped by changing conceptualisations of who the poor are and the
nature of poverty. During the
subsidised agricultural-credit era[1](1950s
to 1970s), the poor were seen as small
or marginal farmers, usually male, whose poverty could be overcome by
credit-induced increases in productivity. From 1980 to 1995 they were seen as mostly
female micro-entrepreneurs with no
assets to pledge (but a world to conquer with microcredit financed investment
that would raise their incomes). Recently, they have become a diverse group of vulnerable households with complex
livelihoods and varied needs. From such a perspective, microfinance is seen
as a mechanism that can reduce vulnerability (i.e. a sudden drop in income,
consumption or assets) and/or reduce income poverty. We are now entering the ‘microfinancial
services era’.
This
paper is structured as follows. The first section does two things. It draws
from the theoretical and empirical literature on the ways financial markets
work when markets are missing and/or imperfect. Such a perspective highlights
the interconnectedness of savings, credit and insurance - the three main
elements of financial services. Second, it provides a ‘financial service
anatomy’ through which various money-managing efforts of the poor may be
understood. Besides being a useful organising structure, such an exercise helps
us to see the relationship between informal financial services and the more
recent initiatives to deliver microfinancial services.
The
second section discusses contemporary knowledge of pro-poor financial service
provision in terms of a three-by-three matrix in which one axis comprises the
financial service components (the classical three: savings, credit and
insurance) and the other axis comprises the providers (the informal, the
formal, and ‘new wave’ of semi-formal providers). Various issues are addressed
here: the concerns with existing approaches, possible ways forward, and
questions that need to be examined and assessed to push forward our
understanding of better service provision for the poor and poorest.
The
third section concludes with a summary of the arguments.
2 THE
POOR AND FINANCIAL SERVICES
2.1 The Economic Environment of the Poor: the Savings, Credit and Insurance Nexus
The
economic environment of the poor has two features that have particular
significance in shaping their use of financial services. The first is that they operate in a
mini-economy in which production, consumption, trade and exchange, saving,
borrowing and income-earning occur in very small amounts. The effect of this is that transaction costs
tend to be high as the ‘unit’ of transaction is generally minuscule. This has important implications for the use
of formal sector institutions where the charging of any standardised
administrative cost will commonly make transactions unattractive to the poor.
The
second characteristic is that there are high levels of insecurity and
risk. These arise because flows of
income and expenditure commonly do not coincide, because of household-specific
factors (loss of earnings because of sickness, urgent medical expenses, premature
death, theft, insecure conditions of employment, difficulties of contract
enforcement), and because of broader
environmental factors (natural hazards, harvest failure due to drought or
flooding, national economic crisis). The co-variant nature of the risks
associated with this latter group are particularly problematic as they weaken
the capacity of community-based social security networks to provide support.
These
characteristics have a number of consequences.
(i) They limit the interactions of poor
people with formal sector institutions.
(ii) They foster strategies of risk-spreading by the poor:
these encourage diversification of economic activities and the development of
financial relationships with networks of individuals, groups and agencies.
(iii) They lead to the use of savings and credit mechanisms by
the poor as substitutes for insurance (Platteau and Abraham, 1984; Alderman and
Paxson, 1992; Fafchamps, 1992) so that savings, credit and insurance have to be
treated in a unified way.
Demand
for financial services from poor households calls for short and long term
credit lines for financing inputs and investments in both physical and human
capital, and for provision of savings opportunities with different rewards and
maturities. In general, the poorer the household the greater the need to use
savings and credit as insurance substitutes.Thus the contributionof financial
services to coping with risks (the ‘protective’ role of financial services)
becomes more important than the expected return of the financial service alone
(the ‘promotional’ role of financial services)[2].
2.2 The Money Management of the Poor: Towards A Typology[3]
Historically
(and contemporarily, as well) the provision of financial services to the poor
has often been seen as means to achieve some other ‘greater’ end. Such ambitions have included rescuing people
from the exploitation of moneylenders, rehabilitation in the wake of natural
disasters, promotion of co-operation among villagers, teaching people the
virtues of thrift, poverty alleviation, the adoption of HYV technologies or
empowerment. McGregor (1991) rightly points out that when colonial governments
introduced rural credit projects, their intentions were often more moral and
didactic than financial. Recently, Zeller (1993) argues that the past focus of
agricultural economics on the farm rather than on the household, may have lead
to a narrow definition of financial services for the poor as inputs for
financing production rather than broadly defined financing for all aspects of
household investment, including maintenance and formation of human capital and
off-farm income generation activities. But despite convincing arguments
supporting a broader agenda which considers financial services to the poor as
an important issue in its own right, this emerging consensus is often not
translated into practice. A number of
misconceptions still shape much external intervention in the financial markets
of the poor.
In
order to get to grips with the ways in which financial services for the poor
are provided and might be innovated upon, it is useful to construct a
simplified typology of such provision, drawing from both informal and more
formal experiences.
One
of the most prevalent misconceptions about the poor is that they do not and/or
cannot save. This perception is so pervasive that it demands elaboration as it
is difficult to get an understanding of the money management efforts of the
poor without confronting it. As we shall see later, the need and ability of the
poor to save lies at the heart of innovative microcredit products.
Two
images underlie the view that the poor do not save. One construes the poor as ‘wasteful , immoral and irrational’.
This is seen as a cause of their misery and also helps to ‘explain’ their
failure to better their lot[4].
While we recognise (and have witnessed) the problems that can arise from
alcoholism and gambling our experience is that the vast majority of poor people
are actively seeking to improve their personal and household circumstances. Consequently, we do not pursue this image of
the poor as feckless. The second image
holds that the poor cannot save because: “ The poor spend all their income and
still don't get enough to eat, so how can they save?”. Paradoxically, it is precisely because of
such survival uncertainties that the poor need to and do save, though in ways
that are not self-evident, at least according to the conventional understanding
of savings as income surplus after consumption. Such an image, as we shall see
below, has two consequences: (a) it gives rise to the widespread view that the
poor in general cannot save, and (b)it over-emphasises the promotional role of
financial services as credit for investment. These lead to a lack of research
into the financial service preferences of the poor and the actual ways they
engage in money management, and result in the design of products that are
either ill-suited to their needs and/or excludes them.
People
(and not just the poor) may save money as it goes out (keeping a few coins back from the housekeeping money) as well
as when it comes in (deducting
savings at source from wages or other income). Even the poorest have to spend
money to buy basic items like food and clothing, and each time they do so there
is the opportunity to save something, however tiny. Many poor housewives try to
save in this way, even if their working husbands fail to save anything from
their income[5].
That they sometimes succeed is shown by their habit of lending each other small
amounts of money (as well as small amounts of rice or kerosene or salt). This
‘reciprocal lending’ is very common and makes up the bulk of financial
transactions for many poor people (Matin and Sinha, 1998; Dreze, 1997). Such
arrangements depend primarily on the poor’s capacity and willingness to save.
Given
the interconnectedness of the roles of savings, credit and insurance (discussed
above) the motivation behind savings can be expected to be diverse. These
motivations can be viewed as the need for large lump-sums[6]
of money that people (including the poor frequently) need for a variety of
reasons. We can categorise these needs into three main groups.
Life-cycle needs: In South Asia, the dowry system makes marrying
daughters an expensive matter. In parts of Africa, burying deceased parents is
very costly. These are just two examples of ‘life-cycle’ events for which the
poor need to amass relatively large lump sums. Other such events include
childbirth, education, home-building, widowhood and old-age generally, and the
desire to bequeath a lump sum to heirs. There are also recurrent festivals like
Eid, Christmas, or Diwali. In each case the poor need to be able to access sums
of money which are much bigger than the amounts of cash which are normally
found in the household. Many of these needs can be anticipated, even if their
exact date is unknown. The awareness that such outlays are looming on the
horizon is of great anxiety for many poor people.
Emergencies: Emergencies that create a sudden and unanticipated
need for a large sum of money come in two forms - personal and impersonal.
Personal emergencies include sickness or injury, the death of a bread-winner,
the loss of employment, and theft. Impersonal
ones include events such as war, floods, fires and cyclones, and - for slum
dwellers - the bulldozing of their homes by the authorities. Each creates a
sudden need for more cash than can normally be found at home. Finding a way to insure
themselves against such events could help millions of poor people.
Opportunities: As well as needs
for accessing large sums of cash, there can be opportunities when such access is important. There may be
opportunities to invest in an existing or new business, or to buy land or other
productive assets. The lives of some poor people can be transformed if they can
afford to pay a bribe to get a permanent job (often in government service). One
opportunity– the setting up of a new business or expanding an existing one -
has recently attracted a lot of attention from the aid industry and from the
new generation of banks that work with the poor. But business investment is in
fact just one of many needs and opportunities that require the poor to access
lump sums of cash at short notice.
How
do the poor get access to the lump sums they so often need? Apart from gifts or
charity - which cannot be relied on - there are only three common methods. The
first is to sell assets they already hold (or expect to hold); the second is to
take a loan by mortgaging (or ‘pawning’) those assets. The third is to turn
their many small savings into larger lump sums.
The
first method - the sale of assets - is usually a straightforward matter that
does not ordinarily require any ‘financial services’. However, poor people
sometimes sell, in advance, assets that they do not currently have but expect
to hold in the future. The most common example is the advance sale of crops.
These ‘advances’ are a form of financing, since the buyer provides, in effect,
a loan secured against the yet-to-be harvested crop. The advance may be spent
on financing the farming costs required to provide that crop. But they may
equally be used on any of the other needs and opportunities identified earlier.
The
second method - mortgage and pawn - enables poor people to convert assets into
cash and back again. It is the chance
(not always realised) to regain the asset that distinguishes this second method
from the first. As with the straightforward sale of assets, such services
require the user to have a stock of
wealth in the form of an asset of some sort. They allow the user to exploit
their ownership of this stock of wealth by transforming it temporarily into
cash. The most common examples are the pawn shop in urban areas and mortgaging
land in the countryside.
Whereas
these first two methods require that the users have assets, the third method
enables poor people to convert their small savings into lump sums. This
requires the users to have a flow of
savings, however small or irregular. It allows them to exploit their capacity
to make savings through a variety of mechanisms by which these savings can be
transformed into lump sums. The three main mechanisms are:
·
Savings deposit, which allow a lump sum to be
enjoyed in future in exchange for a series of savings made now
·
Loans which allow a lump sum to be
enjoyed now in exchange for a series of savings to be made in the future (in
the form of repayment instalments), and
·
Insurance, which allows a lump sum to
be enjoyed at some unspecified future time in exchange for a series of savings
made both now and in the future
The problematic that needs to be addressed in order to
provide each of these services is different. For savings services, the concerns
are about the costs and legality of deposit mobilisation and about deposit
protection. For credit and insurance services, the issues are about how to
address adverse selection and moral hazard problems while minimising client
transaction costs.
Thinking about financial services for the poor as a
matter of providing ways of turning small amounts of savings into larger useful
lump sums - a ‘turning mickles into muckles[7]
perspective - helps us to understand the wide variety of informal arrangements
that the poor themselves innovate and use. The nature of the financial service
used varies, depending on local knowledge, history, context and need, but the
essence of such arrangements is similar: turning small amounts of savings into
usefully large lump sums.
Interestingly, the current microcredit focus on loans
that are repaid in small, regular instalments is a good example of such a
perspective, since such loans are in many ways an ‘advance against future
savings’ contract between the borrower and the lender. This is yet another
example of the interconnectedness of saving and credit.
2.3 Conclusion
In this first section we drew attention to the facts
that the economic transactions of the poor occur in very small amounts, and
that they occur in an environment characterised by high levels of insecurity
and risk. A result of the first, the
poor enjoy limited access to formal financial service providers. As a result of the second, the poor develop
strategies which emphasise the diversification of economic activity and the
development of informal networks of financial relationships. In these relationships, the distinction
between savings, credit and insurance breaks down, with credit often pressed
into service as a substitute for insurance.
The difficulties associated with managing such strategies are likely to
be more acute for the poorest households.
We also provided a simple typology of financial
service from the user’s perspective, in which the principal role of all three
kinds of financial service is to build usefully large lump sums out of the
pool’s capacity to save. This is useful
framework for looking at financial service innovations in various sectors
The upshot of the arguments of this section is that
the design of financial service for the poorer households would need to pay
attention to the protective aspect of financial service provision, in addition
to the conventional emphasis on its promotional role. Poor households throughout the world face twin disadvantages. The
first is difficulty in generating regular income while the second is
vulnerability to economic, political and physical downturns. Harder still, the
two disadvantages reinforce each other: poverty is a source of vulnerability
and repeated exposure to downturns reinforces poverty.
Financial services in their broadest sense can play an
important role in enabling poor households cope with these twin disadvantages.
For financial services to play such a role, however, we need to take the issue
of vulnerability as seriously as poverty and refocus financial service
innovations on that issue. To do that, we need a better understanding of when,
how and why poor and very poor households manage to convert their capacity to
save into usefully large sums of cash. We can start by looking at what is
already in place.
3 THE PROVIDERS AND THEIR PROVISION
3.1 An Overview
This section examines the various providers of
financial services to the poor and discusses the nature of their provision. The
providers are categorised as informal providers, formal providers and
semi-formal microfinance institutions (MFIs). The provisions are classified as
savings, credit and insurance. For each of the cells in this three by three
matrix, certain questions are addressed. These are:
·
what
do we know of the existing approaches?,
·
what
are the main concerns with these approaches?,
·
what
are the possible ways forward? and
·
what
questions need examination to encourange innovations?
It is important to clarify a few definitions. The
conventional provider categories of informal and formal has been complicated by
the recent entry of the semi-formal sector of the microfinance institutions
(MFIs). The rationale behind the entry of this sector has ostensibly been the
desire to address the twin failures of the market and the state, the bite of
which is particularly acute for the poor.
Further complexity has been added recently because
several semi-formal providers have formally registered themselves as banks
(BancoSolIn Bolivia , BRAC Bank in Bangladesh, etc).
In the context of financial services, there has been
little explicit attempt to define the underlying characteristics based on which
the distinction between different providers may be made[7]. The
traditional distinction has been between institutional and non-institutional
finance, implicitly encompassing both the nature of the providers and of the
provisions. For instance, ‘institutional credit’ referred to legally-recognised
banks as providers and to loans that are relatively large and are based on
collateral and explicit contract. The informal sector was loosely viewed as
non-institutional sources of credit, such as moneylenders and traders. Such a
distinction however ignored other types of financial service that the poor
themselves made as a part of their wider money management efforts, including
savinds clubs such as RoSCAs rotating savings and credit associations and
ASCrAs accumulating savings andcredit associations).
For the purpose of this paper, we shall refer to
formal providers as those who are subject to banking laws of the country of
operation[8],
provide conventional retail facilities to customers and engage in diversified
financial intermediation. Semi-formal providers are MFIs that are mostly
registered NGOs or banks with a special charter (such as the Grameen Bank). The
informal sector captures the residual providers - money lenders, traders,
RoSCAs, ASCrAs, deposit-takers and non-bank pawnbrokers.
We acknowledge that this categorisation does not take
into account the dynamics by which informal providers become semi-formal (such
as where managed RoSCAs are registered as Chit
Funds in India) and semi-formal become formal (such as BancoSol and Kenya’s
K-REP,two ‘MFIs’that have chosen to register as formal banks). Within this
framework, it could also be difficult to classify NGO-sponsored self-help
groups, such as those in India, who are largely autonomous of the sponsoring
NGO in their operations. Again, ‘reverse’ dynamics are also observed where
formal financial institutions create microfinance windows like the BRI Unit
Desas in Indonesia[9],
or where the formal banks in Sri Lanka offer pawn shop services on a large
scale. Such dynamics are important research areas, especially with respect to
their implications for designing the right kinds of network for pro-poor
financial structures. For instance, an interesting hypothesis could be that
semi-formal providers are better able to do pro-poor financial innovation but
that mass outreach requires some degree of formalisation.
Despite these limitations our
formal/semi-formal/informal classification does succeed in capturing a wide
gamut of providers and wherever qualification is necessary, it will be done.
For the purpose of historic continuity[10], we discuss
the providers in the following order: informal, formal and finally semi-formal.
3.2 The Informal Providers and Their
Provisions
Unlike the semi-formal (microfinance) and formal providers,
the informal providers do not constitute a neat category. More importantly, the
distinction between informal providers
and their users is often fuzzy since
they may constitute the same group. This often results in a relatively
localised scale of financial intermediation. In constructing a typology of
financial service provision drawing primarily from the informal sector
experiences, Rutherford (1998) refers to such intermediation as ‘basic personal
financial intermediation’. The conventional image of the informal provider is
of the moneylender[11].
However, the range of informal providers and their provision is in fact far more diverse[12]. The
fuzziness of the savings-credit-insurance nexus is most evident in the informal
financial service provisions.
For a variety of reasons, our knowledge of informal
financial service providers is relatively sketchy. These providers do not
usually operate out of offices, they maintain few records and more importantly,
many such arrangements are time-bound[13]. In some
countries, such as Indonesia, such services are illegal - though quite common. As the loans extended tend to be relatively small,
financing mainly consumption smoothening and working capital needs, informal
finance is not very visible, despite its ubiquity (Ghate 1988). Moreover, the
sensitivity that attaches to financial transactions, on the part of both
borrowers and lenders, makes it a particularly difficult subject for empirical
research. The sheer diversity of informal arrangements and the heterogeneity of
the providers frustrate generalisation.
The main providers of informal financial credit
services are illustrated in Figure 1. According to this schema, a distinction
is made between five broad categories: (i) lending by individuals on a
non-profit (and often reciprocal) basis; (ii) direct but intermittent lending
by individuals with a temporary surplus; (iii) lending by individuals
specialised in lending, whether on the basis of their own funds or
intermediated funds; (iv) individuals who collect deposits or ‘guard’ money;
and (v) group finance.
A preliminary distinction which is more important in
informal than formal finance is between credit extended by individuals to other
entities and credit extended within mutually organised groups. A second
distinction among informal lenders who lend to other entities, can be made
between regular and intermittent lenders. The latter extend credit
intermittently, although not necessarily infrequently, whenever they have a
temporary surplus of funds. More often than not, such lenders become borrowers,
when the need arises. Such role reversals form the basis of informal insurance
networks that have been examined seriously by researchers (Morduch, 1997;
Fafchams, 1995; Udry, 1994). Regular lenders, on the other hand, remain net
lenders over a period of time.
Among regular lenders, a major distinction arises
between those who ‘tie’ lending to other market transactions, and those who
extend ‘untied’ credit. A distinction
that cuts across both tying and non-tying lenders is that between lending out
of lenders’ own funds (also referred to as ‘direct financing’) and lending
based on funds borrowed as deposits when the lender acts as a financial
intermediary. Intermittent lenders by definition rely on one or the other of
the two sources, or sometimes on both, apart from on-lending borrowed funds
from the formal sector. In group finance, intermediation can be thought of as
taking place between members of the group.
Importantly, many of the transactions, which on the
surface appear as credit, are on a deeper analysis, very closely linked to
savings and insurance. Udry (1994), based on his study of credit transactions
in Nigeria, has described much of such transactions as ‘insurance substitutes’,
Fafchams (1995) refers to them as ‘quasi-credit’ and Rutherford (1999) as
‘advances against future savings’. Several researchers also point out that such
fuzzy financial transactions are more important for the poor[14] (Matin and Sinha, 1998; Morduch, 1997). Most
intermittent lending (which is often reciprocal) and mutual group finance falls
under this category.
Figure 2: Major Types of Informal Finance
Source:
Adapted from Ghate (1988:24)
Credit
The credit function of informal finance has received
the most widespread attention. These services are extended by intermittent or
regular lenders, though as discussed above, much intermittent lending is
motivated by reciprocal arrangements and serves as a substitute for insurance[15].
Moreover, loans from such intermittent sources tend to account for an important
share of the volume of informal finance and an even higher share of the number
of loans, since such loans are relatively (and often absolutely) small. Lund (1996) provides empirical evidence that
informal loan exchange in the rural Philippines is in fact used by households
to pool risks.
However, informal credit is also important as a source
of initial working capital for micro enterprises[16].
Intermittent and sometimes reciprocal lending for businesses also takes place
between households and can help to smooth out the short-term cash flow problems
and also to ease longer-term credit constraints. This is important in financial markets for the small enterprises
of the non-poor. The size of this
market in India is estimated to be equivalent to 13 to 25 percent of total bank
credit to industry (Ghate,1988:25). Wholesalers and other firms in the textile
and foodgrain distributive trades also actively borrow from each other, seeking
short-term accommodation (Murshid, 1990).
Getting access to a useful lump sum through building
mutual savings is most evident in informal group finance schemes. In such
arrangements, groups of individuals pool their savings and lend primarily to
each other or to persons outside the group. The two most common types are
referred to as RoSCAs and ASCrAs. In
the former, the equal periodic savings of every member are pooled and given to
each member in turn: there are therefore as many as such poolings as there are
members and the cycle comes automatically to an end when each member has taken
her ‘prize’. In an ASCrA by contrast,
the pooled savings of the members may accumulate until such time as one or more
members are willing to take them on loan.
The device is therefore not time-bound in the same was as ROsCAm though
many groups limit the life of their ASCrA in order to ensure a satisfactory
outcome the saved capital is returned to the members and interest earned on the
loans can be distributed. The widespread use of such mutual finance ‘templates’
across time and space has generated a lot of interest and careful study.[17]
These arrangements have been shown, in the extensive field literature, to exist
in developing and developed countries in both rural and urban areas, among both
females and males and among all classes including the poor[18].
The basis and the gains to members that such
arrangements offer is predicated on the difference in preferences (in terms of
current and future consumption) that might exist among the participants at any
particular point in time. Besley et. al. (1992) argues that RoSCAs are
predominantly means of acquiring indivisible consumer durables. As such, RoSCAs
are often classified under informal credit (Besley, 1995). However, in a recent
article, Calomiris and Rajaraman (1997) argue that the insurance motive[19]
also plays an important role, especially in bidding RoSCAs[20]. The
continuing prevalence (and rise) of these arrangements have often intrigued
researchers. Part of the reason could be simply due to the inability of the
participants to access other formal sources, but recent research shows (Brink
and Chavas, 1997) that these institutions are built on solid microeconomic
foundation[21]
- one of several reasons that explain their continued popularity throughout the
world.
Savings
Credit extended by intermittent lenders and group
finance arrangements like RoSCAs and ASCrAs are
essentially hybrid financial products, incorporating savings mobilisation and
insurance functions. This becomes an even more important finding given the fact
that the poor households tend to use these forms of financial services to a
greater extent that the non-poor. The building up of small amounts of savings
and innovatively intermediating it across a network (see Rutherford, 1998, for
ingenious examples) is the basis of the informal financial services that the
poor predominantly use.
The savings contribution of the informal sector is
often discussed in the context of deposit mobilisation. However, when savings
are viewed as deferred consumption, it is seen that the informal sector
provides opportunities for saving both through direct lending and
intermediation. A large part of informal credit is from friends, relatives and
neighbours deferring current consumption to lend to others directly. In fact
the bulk of rural credit consists of direct finance, with lenders using their
own funds built up over a period of time.
The type of informal finance that makes the greatest
contribution to additive savings (that is savings that would not have been
mobilised anyway by the formal sector in the absence of the informal) is mutual
finance – group-based or reciprocal financial services of one kind or another,
including savings cclubs. The major attractions of such arrangements as a means
of savings are: (i) Reciprocity, or the in-built provision of borrowing at
short notice, especially for the bidding varieties of ROSCAS. This serves as a
kind of access to a liquidity-guaranteeing function which is especially
important to business. (ii) Being able to save in small instalments, which is
particularly attractive to the poor.
(iii) The provision of a disciplined environment in which to save, once
the initial decision to join a club has been made. (iv) Convenience and absence
of formalities, and (v) Meeting illiquidity preferences by permitting savings
to be hidden away from the demands of friends and relatives.
Savings and Credit: Informal Financial Intermediation
It has been asserted by some that – outside the mutual
devices such as RoSCAs and ASCrAs - intermediation I soften either absent or
very localised in the case of informal finance. Binswanger et. al. (1985)
observes that the traditional moneylender relies on his own funds and does not
accept deposits. He gives three reasons for this. First, the seasonality and synchronic timing of agriculture means
that if depositors and borrowers are both engaged in cultivation, depositors
will want to withdraw deposits exactly when borrowers want to borrow - at the
beginning of the production season. Similarly, depositors will want to make
deposits exactly when borrowers will want to make repayments - after harvest.
Second, the covariance of yield risk in agriculture leads to covariance of
default and to covariance of income between depositors and borrowers. After a
bad harvest a depositor may want to withdraw deposits to cushion shortfall,
exactly when borrowers are least in a position to repay. Unless the moneylender
has a very high level of reserves, he may not be able to repay depositors[22].
Third, since the information gap between a depositor and a lender both engaged
in the same occupation is likely to be smaller than would be the case were they
engaged in different occupations, the possibility of direct lending places a
limit on the difference between borrowing and lending rates the moneylender can
charge. Since he must have a high reserve ratio if he accepts deposits, and
only the lent-out part of his funds earn interest, he is not in a position to
offer depositors a good enough return to prevent them from lending to borrowers
directly[23].
Yet another reason is the limited number of borrowers that the moneylender can
possess information on. This limits the size of his market to a small number of
borrowers, to whom he can usually cater with his own funds.
Despite such arguments, the volume of intermediation
in some rural areas by informal institutions has been reported to be high. This is especially in areas with diversified
agriculture and a well developed non-agricultural sector. For example, the
volume of intermediation is reported to be high in Kerala (Ghate,1988). It is
conducted by large number of finance companies and trusts that often have
several partners and employ staff to appraise loans. They take advantage of
diversification of Kerala’s agriculture, with its large variety of commercial
crops which reduces the severity of seasonality and covariance of risk and
income. Moreover, the importance of deposits from non-agricultural sources,
such as remittances from abroad, greatly increases the possibilities of
intermediation by increasing the heterogeneity of depositors and borrowers. In
some cases informal clubs have evolved into credit unions or village banks (Box
1).
Box 1: Credit Unions and
Village Banks
Most informally-run savings and loan clubs, such as
ROSCAs and ASCrAs, run for a fixed duration (as in a ROSCA) or for a period of
a few years or less (as in most ASCrAs). There are good reasons for this, which
have to do with the difficulties that low-income groups have in maintaining
books, avoiding disputes and fraud, storing excess cash in their often insecure
environments, and escaping the notice of more powerful predators. ROSCAs and
ASCrAs can be said to have adopted a strategy of ‘impermanence and
re-iteration’ to reach millions of people, as opposed to the strategy of
‘permanence and growth’ adopted by the conventional banking industry and now
being widely recommended to MFIs.
Small informally run savings and loan clubs at village
or slum level that do try to become
permanent institutions have a hard time and fail more often than not. One
exception is the Credit Union (or Thrift and Credit Co-operative). A Credit
Union is essentially an ASCrA that has chosen to adopt principles that have
been worked out by the Co-operative movement over the last 130 years since its
early days in Western Europe. These principles are designed to counter the
difficulties mentioned in the previous paragraph. They include, essentially,
some kind of affiliation to a supervisory body (or ‘apex’ institution) that can
sort out disputes, audit the books, offer a home for excess cash, provide loan
insurance (sales of insurance are often a way of securing income for the
supervisory body), intermediate resources between its member Unions, and represent
its members’ interests to government and others. Traditionally used by
middle-income rather than low-income groups, Credit Unions have recently begun
to seek ways of increasing their membership among the poor.
The term ‘Village Banks’ has been used in several
experiments, but the best known is the system devised by John Hatch and others
in Latin America two decades ago. The system involves using NGOs to introduce a
high level of regularity and discipline into what are basically ASCrAs. Groups
of villagers are invited to form a ‘Bank’. The sponsoring NGO provides
resources that allow the members to take a series of nine successive loans that
rise in value by a fixed amount. All members borrow and repay at the same time,
usually in weekly instalments (see the box on the Grameen Bank) for sixteen
weeks for each loan. Meanwhile, they are coached by their sponsoring NGO in
business skills, and make savings which also rise in value each cycle so that
by the time the nine ‘external loan’ cycles are complete the members’ ‘Bank’
holds enough resources to continue indefinitely as a locally-owned autonomous
financial institution. In practice this has rarely happened – for the reasons
laid out in the first paragraph of this box – and by the mid 1990s many sponsoring
NGOs had given up the ideal of
promoting village-level self-help institutions. Instead, they have
become permanent providers of financial services to the member-clients of the
Village Banks they set up.
In Bangladesh, it has been found that commission
agents financing paddy and jute marketing accept deposits from friends and
relatives on a profit sharing basis and sometimes also borrow from moneylenders
(Murshid, 1990). In this case, the seasonality of agriculture works in favour
of deposit taking - deposits from farmers are most likely to be forthcoming
when traders need funds for crop purchases. Harriss (1981) also found that
paddy traders in South India accept small deposits, which farmers make
primarily for safekeeping[24].
The examples in this section so far are all from
Asia. In many countries of Africa,
above all in West Africa, itinerant deposit collectors collect savings from
their customers and charge a fee for the service. They may also lend the proceeds back to their customers Box 2
describes an operator from Nigeria.
|
Gemini News reported in 1995 that one consequence of
Nigeria’s current political difficulties is a drop in public confidence in
formal banks. This has allowed an old
tradition to flourish again -alajos,
or peripatetic deposit takes. Idowu
Alakpere uses a bicycle to go door-to-door round his outer suburb of Lagos
where he has 500 customers who save about 10 or 15 naira cash with him (about
50 to 75 cents US) on each daily visit.
Customers withdraw whenever they like, and Idowu charges them one
day’s savings pr month, which he deducts from the withdrawal. Since deposits are made evenly over the
month, the negative interest rate for one-month deposits is 1/15, or 6.6% a
month, an APR of 80%. some alajos,
including Idowu, store the cash in a reliable bank, others use it to make
loans. The Gemini reporter found many
local people telling her that they trusted those alajos more than banks. When it was pointed out that some alajos
are dishonest, they retorted that so are many banks. |
|
Box 2:
An Itinerant Deposit Collector in Nigeria |
There are itinerant deposit takers in Asia (see Rutherford 1998 for an
example from Vijayawada in southern India) but their prevalence is low compared
to Africa. One reason suggested to
explain this is that in Asia it is more often the case that the poor turn their
savings into lump sums through money lenders who offer to let them repay in
small regular installments.
Insurance
The insurance role of informal finance has already
been discussed above[25].
It has been pointed out that extension of credit more often than not serves as
insurance substitutes. However most
empirical studies haveshown that the scale and effectiveness of most informal
insurance are narrow. A substantial number of households, especially the most
poor, appear ill-equipped to handle even small scale, localised risks (Alderman
and Paxson, 1994; Morduch, 1995)[26]. Most informal insurance arrangements work on
the basis of self-enforcement, as, for example, when slum shopkeepers set up a
fund to spent in the case of a fire or a bull-dozing. It tends to operate best when participants have a cushion from
poverty. Thus theory suggests that such informal arrangements may be more
effective for slightly better-off amongst the poor (Coate and Ravallion,
1993). More importantly, many of these
mechanisms are costly. In risk prone rural India, for example, households may
sacrifice as much as 25% of average income to reduce exposure to shocks. Third,
informal insurance mechanisms appear to be particularly fragile when needed
most – for poor people during widespread covariate and repeated shocks.
Nevertheless, some specific risks appear to be well-covered
by informal insurance devices in some localities. Buriesl or funeral funds were found by Rutherford and Arora(1996)
to be working well in the slums of the southern Indian city of Cochin, and
reaching the very poor in greater numbers than most other informal
schemes. There are reports of similar
devices in southern and western Africa.
Related schemes such as marriage funds - where parents save small sums
regularly in order to enjoy a substantial sum when their child marries - are
also common in southern India and elsewhere.
Typically, the choice for policy makers looking at
insurance for low-income groups has been between three imperfect options:
fostering government-provided safety nets, private insurance markets or
existing informal insurance mechanisms. The choice may be a false one, however.
The most promising policy option may be a fourth option (Morduch, 1997): the
promotion of new market-based institutions that substitute for both failed
insurance markets and failed informal insurance mechanisms. An important and
promising example of this fourth option would be fostering easier, more flexible
ways to save (and possibly borrow) in small amounts. The idea is to help
develop markets that span the failed markets but which themselves are not as
prone to failure.
To carry our understanding of the limitations and
possibilities of informal financial arrangements forward we would need
information on the extent of consumption volatility and the major insurance
mechanisms used by households. The absence of institutions needs to be assessed
and reasons researched. A related research area should focus on the economics
of household savings. Why are households unable to save enough to protect
themselves against insurable downturns? Can savings-focussed innovations make a
dent? Can informal arrangements like RoSCAs and ASCrAs be built upon? Is it
possible to increase savings mobilisation without broader financial reform?
3.3 The Formal Providers
There is a plethora of studies evidencing the failure of the formal financial sector in serving the poor. The existence of capital market imperfections in the rural areas of developing countries has engaged the attention of economists, social scientists and policy makers for decades. (Griffin, 1979; Ladman and Adams, 1978; Lipton, 1976; Ruttan, 1986; Braverman and Guasch, 1986; Eswaran and Kotwal, 1986). An important feature of this market is t