BEYOND MICROCREDIT P.V. Viswanath Learning Goals BOP customers need saving, insurance and other financial services in addition to credit. Why do individuals save and what are the obstacles to their saving? What are the traditional solutions to these obstacles? What are the microfinance solutions to these obstacles? What micro-insurance products have been developed and what are their characteristics? Can microfinance increase financial risk for its clients? Microsaving The financial needs of the BOP go beyond microcredit. Unfortunately, many NGOs are not able to accept savings deposits from their clients, though many can lend, and even at a profit. First of all, savings and credit both help smooth consumption over time and hence are substitutes. Even though savings might be cheaper than credit, there are behavioral problems that might make savings difficult in the absence of proper savings institutions. People have problems with self-discipline. Hence expensive credit can be used as a incentive to accelerate savings. Rotating Savings and Credit Associations (ROSCAs) can also serve this purpose, since they are simultaneously borrowing and saving devices. Why save? Saving is not only for business uses. A 2001 survey of BRI clients in Bangladesh found that only 16% used their savings for business uses. 35% (about twice the number using it for business purposes) used it for nonbusiness consumption. In this category, school fees (14%), household consumption (13%), medical expenses (3%) and religious holiday needs (3%) were paramount. 6% also used it buy nonbusiness assets (land, house). 39% used it for other purposes. The point is that savings are used for a variety of purposes. Low Frequency Saving Savings can be low-frequency (steady, long-term accumulation) or highfrequency (to fund short-term investments. According to the neo-classical lifetime consumption model, people save when they are in their high-earning years and then use those savings during retirement. Pension funds are usually not available to BOP families. Retirement needs are often taken care of by individuals in traditional countries by intergenerational support. Parent spend on their children’s education when their earnings are high, and their children support them in their old age. Furthermore, in multigenerational family units, retirement is funded on a pay-as-you-go model like Social Security. The reason is that “standard” saving for retirement requires the availability of pension funds. “Mechanisms matter.” However, such mechanisms don’t work perfectly. And with the move to nuclear families, there is more need for retirement savings alternatives. As Families Change, Korea’s Elderly Are Turning to Suicide, NY Times, Feb. 16, 2013 High-frequency savings The Collins et al. Portfolios of the Poor diaries showed that BOP families had high cash turnover, that is the ratio of cashflow (cash moving in and out of savings devices) to average assets is high. The high variability and uncertainty of cashflows for BOP families (particularly for those without stable jobs) implies a need for highfrequency savings. Households need to, and are eager to save in the face of recurrent shocks. However, they face many problems in accomplishing such savings. These savings constraints reduce the level of consumption growth for lowincome families, but not so much for higher-income families – even those in low-income areas. Since appropriate financial solutions are not available to them, families must often insulate themselves by modifying real decisions. Thus, households might try to smooth income by making more conservative agricultural choices rather than riskier but more profitable high-yielding crop varieties. Taking Constraints Seriously Savings constraints mean that sometimes families are not able to consume out of future income and must suboptimally reduce current consumption. In rural China, Jalan and Ravallion (1999) found that the bottom ten percent of households can protect themselves from only 60% of adverse income shocks, while the top ten percent can protect themselves from 90% of shocks. But sometimes, families are not able to save and must consume more today than they would like. Such forced second-best solutions may be playing a role in keeping BOP households poor. The importance of savings vs credit Some argue that BOP families are very poor and savings is irrelevant for these families. Most poor families are not at subsistence level, though at many times during the month/year, their incomes dip to subsistence level. Hence it is crucial that they be able to save from their slightly-above-subsistence level incomes at other times in order to be able to survive at other times. Others argue that families have other informal methods of saving – ROSCAs, etc. But these informal methods are very costly and insecure. Savings through traditional mechanisms may not always work. Informal risk-sharing agreements are subject to moral hazard problems – neighbors may assert that they are in need and lay claim to others’ surpluses. Households are willing to pay in order to be able to save in a secure manner. Cf the case of Jyothi’s clients who pay her 30% a year to be able to save with her. Why do families use such services? Why not just keep the money under a pillow? Impatience and Hyperbolic Discounting People behave differently about choices that matter today compared to choices about allocations at some future date. For example, when offered the choice between $50 now and $100 a year from now, many people will choose the immediate $50. However, given the choice between $50 in five years or $100 in six years almost everyone will choose $100 in six years, even though that is the same choice seen at five years' greater distance. In hyperbolic discounting, valuations fall very rapidly for small delay periods, but then fall slowly for longer delay periods. This contrasts with exponential discounting, in which valuation falls by a constant factor per unit delay, regardless of the total length of the delay Individuals using hyperbolic discounting reveal a strong tendency to make choices that are inconsistent over time – they make choices today that their future self would prefer not to make, despite using the same reasoning. Villagers who exhibit present bias save less and borrow more – and they are more likely to seek out disciplining devices. Commitment Devices Faced with a conflict between their present and future selves, people can tie their hands to avoid temptations. The SEED (Save, Earn, Enjoy Deposits) account developed in the Philippines is a commitment savings product. A SEED account required individuals to restrict their right to withdraw any funds in their own accounts until they reached a selfspecified and documented goal. Once the decision was made it could not be changed, and the clients could not withdraw funds from the account until they met their chosen goal amount or date. Karlan et al. studied randomly assigned some MFI members to a group that was offered the opportunity to open a SEED account; the control group was not offered such an account. After twelve months, average bank account balances increased by 80 percent on average for all who were assigned to the treatment group compared to those assigned to the control group. Further, the study shows that women who demonstrate a desire to save but a difficulty in doing so (indicating hyperbolic discounting according to answers on a survey) are significantly more likely than others to open such an account. There is no similar effect among men. Reminders to Save and Mental Accounts The other reason why people don’t save enough is that present needs may be more salient than future needs. Karlan et al. (2009) in a study sent reminders to save to some randomly selected bank clients and not to others. Such reminders led to a 6% increase in the total mount of money saved. Mental accounting is the tendency to treat funds differently based on their source and intended use. Savings accounts (or ROSCAs) earmarked for a particular purpose (such as tuition fees) may be treated differently from other monies. Mental accounting might work by making the intended use more salient. Other reasons why saving is costly When people save, they have to trust their bankers. This may be difficult when the bank is an outside institution. Transactions costs per dollar are high for small deposits; this may cause banks not to want to get into the deposit-taking business, especially if there are usury laws. In order to offset these costs, banks might impose restrictions on withdrawals. But this reduces the convenience of the product. Convenience and flexibility seems to be much more important to BOP customers than the interest rate on deposits. Microinsurance Insurance also has the moral hazard and adverse selection problems associated with providing credit. Transaction costs are high and contract enforcement can be difficult for the policy-holder. However, for BOP clients, catastrophic events such as illnesses can destroy their lives. Life insurance can be useful when the breadwinner leaves behind a family, or for funeral expenses (esp in South Africa) MFIs can collaborate with an insurer who can take care of the technical details, such as actuarial tables and can spread the risk across many people to reduce cost. Life insurance tied to microcredit can also reduce the cost to the MFI of providing such credit and can reduce the cost of providing loans. Health insurance can work in the same way and can be low cost if coverage is restricted to a small list of important diseases and contract provisions are simple and standardized. Rainfall Insurance A key element in insurance can be the cost of verifiability of the event, for example, in crop insurance. Index insurance ties coverage to the occurrence of a more easily verifiable event that is highly correlated with the event to be insured. In the case of crop insurance, that could be the amount of rainfall in the district where the field is located. Furthermore, moral hazard is reduced because farmers have no control over the rainfall. However, any other index could be used. For example, payout could be tied to the average crop yields in a region. Furthermore, index insurance can be purchased by non-farmers, as well, who might have an interest in the harvest, e.g. shopkeepers, craftsmen, traders and others whose livelihoods depend upon the weather and on the local economy. Livestock insurance (KGFS, India)and property insurance (SEWA, India) are some of the other products that have been developed for BOP use. Microloans and Risk Sometimes microloans may make things worse. Microcredit as the solution to one problem (low earning power) may worsen the other problem suffered by BOP families (vulnerability). Loans are not gifts and produce obligations. Individuals might fall into over-indebtedness. Microfinance providers, in trying to keep costs low, have often been rigid, which can exacerbate the situation for borrowers (in contrast with moneylenders, who are often more flexible). More recently, Grameen II provides flexi-loans; SKS Microfinance provides interest-free emergency loans. Group lending also exposes borrowers to risk of default by other group members. On the other hand, microloans can allow customers to diversify income streams and thus to reduce exposure to income fluctuations.