Barriers and Constraints to Risk Management and Savings

Whether the result of variable incomes, liquidity constraints or reduced access to formal financial services, poor households face unique financial constraints that undermine their ability to effectively guard against risk and accumulate meaningful savings. There’s been a lot of research into these questions in the last few years. Two important papers, “Barriers to Household Risk Management: Evidence from India” and “Savings Constraints and Microenterprise Development: Evidence from a Field Experiment in Kenya,” circulating for a few years have finally been published this month in the American Economic Journal: Applied Economics. Now that they’re “official” it’s worth revisiting them.

In “Barriers to Household Risk Management: Evidence from India” (ungated version), Shawn Cole, Xavier Giné, Jeremy Tobacman, Petia Topalova, Robert Townsend and James Vickery discuss the adoption of insurance schemes in rural India. They investigate why, contrary to what economic theory would predict, many rural households don’t purchase insurance designed to protect them against common risks. Through a randomized field experiment in the states of Andhra Pradesh and Gujarat, the researchers test two hypotheses that may account for the low adoption of an insurance product designed to protect households against rainfall variation during the monsoon season. First, they consider whether demand for the product is low because it’s simply too expensive relative to its value. Secondly, they look at whether non-price factors – such as difficulty raising sufficient cash to pay for a policy, ineffective product marketing, or a lack of trust or understanding about the product – might instead account for low adoption rates.

The researchers test these two theories by randomly varying the pricing of the product, the framing of the product, the educational component of the product, and the endorsement of the product by a trusted local agent. To test the role of credit constraints, they also randomly assign certain households positive liquidity shocks. The researchers find that demand for insurance is significantly price sensitive, but that non-price factors are also a large barrier to adoption. In particular, higher prices reduced product take-up, endorsements by a trusted third party dramatically increased take-up, product framing shifted demand, and education in the form of a household visit increased take-up. These results contribute to a growing body of literature about household finance and risk management and have important implications for the development and framing of insurance policies designed to help poor households effectively manage risk.

In “Savings Constraints and Microenterprise Development: Evidence from a Field Experiment in Kenya,” (ungated version) Pascaline Dupas and Jonathan Robinson explore a related theme: the extent to which inadequate access to formal financial services impedes the growth of microbusinesses in developing countries. They examine the impact of this potential savings constraint through a field experiment in rural Kenya in which they provide a randomly selected group of small business owners with access to formal savings accounts at a village bank. The bank accounts are interest-free and include substantial withdrawal fees, effectively resulting in a negative interest rate.

The experiment yielded a number of interesting findings. First, despite the negative interest rate, the bank accounts significantly increased the amount of money that female market vendors were able to save. Second, the bank accounts had a positive impact on the women’s business investments. Third, the daily private expenditures of the women in the treatment group were significantly higher than those of the women in the comparison group. And fourth, there was evidence to suggest that the accounts made female market vendors less vulnerable to illness shocks than their counterparts in the treatment group. Overall, these results suggest that women face negative returns on the money they save informally and that they would prefer to save in a formal account, even one with a negative interest rate. These findings are consistent with earlier studies that suggest that there exists a significant demand for formal saving services in developing countries.