The Economics of Microsavings

I have a confession to make. When I began composing this blog, I approached it with a fairly simple hypothesis:  Microfinance institutions (MFIs) that engage in large-scale deposit taking must likewise grow their loan portfolios. After all, deposits are a source of funding with high operational cost that must be appropriately offset by growing revenue, and only microfinance portfolios provide yields high enough to achieve that. And because many poor families have a higher demand for savings services than for credit, the resulting over-liquidity could push MFIs into unsustainable portfolio growth, eventually leading to the very credit bubbles that microsavings advocates are trying to avoid.

It seems a reasonable enough hypothesis, and sufficiently controversial to be interesting. Trouble is, it’s not true. Reality turns out to be more complicated. In this two-part blog series, I will explore the underlying economics behind microsavings.

Small savings, large costs
Microsavings is expensive. This is both intuitive to those familiar with microfinance operating costs, and is also borne out by the data. Simply put, microsavings faces the same dilemma as microcredit – using a high-touch process to handle low-value accounts.  

True, without the need for client evaluation, the degree of staff involvement in microsavings can be less than in microcredit, and the staff required is less costly (collectors are cheaper than loan officers).  However, the frequency of transactions is not necessarily lower, and for some products (with daily collections, for example) can even be higher than for most microcredit. Savings also presents increased scope for cost reduction through technology, including ATMs and various types of mobile banking. Still, no amount of technological innovation can replace the fact that the clientele served by MFIs operates in a cash-based economy,making costly cash-handling transactions unavoidable. As a result, there is simply no opportunity in any foreseeable future for MFIs to adopt the kind of technology-supported economies of scale enjoyed by developed-country banks.

Ok, so we know it’s higher than for banks, but what exactly is the cost of microsavings?  Some studies have examined the issue. A study of Latin American MFIs by the Inter-American Development Bank (IADB) found the average operating cost of microsavings accounts (<$100 average balance) to be in the range of 250-300% of the account value. In other words, such accounts cost several times more to operate than the amount of funding they actually bring in. And this isn’t some handful of portfolio outliers either. Such small saver accounts comprise 75% of total savings accounts in the 61 MFIs studied. At the same time, they provide less than 3% of the total savings collected.  

Microsavings as a service
It is readily apparent from these numbers that microsavings serve a purpose entirely separate from funding. And this is not only the case with the Latin American MFIs studied by IADB – similar patterns can be seen in MFIs in Indonesia, Africa, and elsewhere. Such accounts are also relatively active, with the IADB study finding an average of 1.7 transactions per month, while maintaining an average outstanding balance of only $12. Unfortunately, data on transaction volume is not provided, but it is reasonable to assume that the amount of funds rotated through these accounts far exceeds the outstanding balance. This assumption is consistent with Portfolios of the Poor, which found that poor families tend to be especially active users of financial vehicles, pushing through far higher transaction volumes than their average daily balance might imply.

The image created by these numbers suggests that it is more appropriate to view microsavings as a service than a funding source. But if funding isn’t the objective, then what is? Well, for one thing, providing microsavings has significant social returns, at least for those organizations that operate with a double-bottom line objective. It can also contribute to financial returns as well.  One recent CGAP study examined two MFIs with large microsavings portfolios and found their small savers to be a profitable segment. The CGAP study did not contradict the findings of the IADB study, since it also found that the operating cost of small accounts exceeded the total value of the accounts themselves. Instead, it argued that the provision of small savings should be regarded as part of a suite of financial services offered to poor clients, and then evaluated the overall profitability of the clients themselves.  

These clients are indeed profitable. Portfolios and other studies have demonstrated that poor savers are willing to pay for savings services through transaction fees or negative interest. Thus, it shouldn’t be a surprise that microsavings accounts can generate significant transaction fees, accounting for as much as 1/3rd of total client profitability at one MFI evaluated by CGAP. Nevertheless, the greater source of revenue still comes from lending. In the CGAP study, loans to microsavings clients were responsible for over half of the total revenue received from those individuals. And although not all savers were active borrowers at any given time (75% in one MFI, but only 15% in another), the yield generated from those who borrowed was substantial enough that, combined with fees from savings and other services (insurance, transfers, etc.), this client segment returned a profit margin of 26% and 58% at the two MFIs studied.  

One of the key reasons for this segment’s profitability is that the loan sizes of microsavings clients exceeded their outstanding savings balances by a factor of 70 or more. Thus, a saver with a deposit balance of $6 might take out a loan of $450, the latter being largely in line with the MFI’s overall loan portfolio. When compared with the larger loan amount, the high operating cost devoted to managing the savings account – about $42 from the IADB study – looks far more manageable. That is because the loan yield is high enough to cover both the loan and savings costs, as well as the costs of non-borrowing savers.

As it turns out, the need for a high yield loan portfolio is important not only to sustain microsavings, but to assure that deposits are a viable source of funding for MFIs. Part two of this blog series, will tackle this key – and often unrecognized – aspect of savings-driven microfinance.  

Daniel Rozas is a microfinance consultant based in Brussels. Previously he worked at the U.S. mortgage investment company, Fannie Mae.