The financial inclusion challenge as an information revolution

The notion that we cannot count on brick-and-mortar investments to massively expand access to finance in developing countries is now widely accepted. We need to go branchless, and to do so safely we have an opportunity to leverage mobile phones that are increasingly ubiquitous. That’s clear at an infrastructure level, but I don’t think there is much understanding of what that means at the service level. Let me paint the picture as I see it, at the risk of sounding all high-level and new agey. 

For me the starting point is recognizing that financial services are primarily about information.  Mechanically, financial services are about recording a bunch of credits and debits: how much you’d like to transfer to whom, how much you have, how much you owe, how much you’ll be owed if certain events occur. More fundamentally, financial services are about trusting or being trusted, and that’s a function of the information you have on the other party . . . 

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The True Costs of Joining the Formal Financial System

What products are “right” for people who are outside of the formal financial system and/or poor? It’s a question as relevant in developed economies as in developing ones. During the housing bubble in the US, financial inclusion was often a justification for what in retrospect looks more like predatory behavior. It’s difficult to tell in the moment, though, the difference between a product priced appropriately (for cost of delivery, value to the consumer, and risk among other factors) and one that is predatory when those customers are almost entirely outside the existing formal system. 

The financial crisis extended the debate in the US from payday loans to mortgages and now to checking accounts, debit cards and credit cards via regulatory changes that have changed how providers charge for these services. These changes, in general, have made it much more explicit that the cost of basic financial services for the poor or those who do not manage their money carefully are much higher than for others. 

Along with driving some people away from some products—fewer people can get a credit card for instance—there is some innovation happening, particularly around alternatives to checking accounts . . . 

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Part 2: High yield loans: the lynchpin of deposit-driven microfinance

Part 1 ("The Economics of Microsavings") of this brief exploration into the economics of savings-driven microfinance looked at the role of microsavings at microfinance institutions. In one large study, poor borrowers, despite accounting for 75% of active accounts, only contributed 3% of total deposits mobilized, mainly because they maintain low balances. However, poor savings clients carry out frequent transactions, for which they have well-demonstrated willingness to pay relatively large fees. These and other fees can be a major source of revenue on its own. However, many savings clients are also borrowers, and it is through the combination of fees, high yield microcredit loans, and other services (insurance, transfers, etc.) that microsavings clients can be truly profitable.

That raises a question: if small savers are indeed profitable without providing significant funding, then where does the funding of deposit-driven MFIs come from? 

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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 . . . 

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Sanjay Sinha: A Rough Year for Microfinance

The microcredit movement is premised on the idea that access to capital will be liberating, empowering, and profit-making. But as the Indian microfinance sector closed out another year, it’s hard to be so ebullient.

The Indian microfinance crisis continued through 2011, and we now have good data and the distance to get a clearer perspective. More than anything else, the data show disturbingly high levels of debt pushed into communities. While the government blames microfinance institutions for excessive lending, government-sponsored self-help groups turn out to have contributed to a large share of the problems . . . 

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Freedom to Default: dealing with overindebtedness when all else fails

If there’s one microfinance word that rose above all others in 2011, it’s overindebtedness. As of the time of writing, it racks up the highest count on CGAP blog’s tag cloud (not counting generic terms like “microfinance”).  It seems fitting, then, to start 2012 with a blog post on this very subject. 

When we talk about overindebtedness, it usually comes for the perspective of the industry’s responsibility, whether the MFI, funders, or regulators. Prevention of overindebtedness came up as the most widely evaluated client protection principle in the Smart Campaign’s survey of social rating agencies and microfinance investors.  

This is, of course, all right and proper. It is the industry’s job to practice responsible lending, and avoiding overindebting clients deserves a place at the top of that agenda. But no matter the level of diligence on the part of lenders and financial education provided to clients, some borrowers will still become overindebted – be it because of bad business decisions, destabilizing macroeconomic shifts, or simply a string of bad luck. So what becomes of clients that, despite best efforts, still become overindebted?  

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From Financial Literacy to Financial Action

Expanding financial access can be a beautiful thing, but how people understand and make use of financial tools deeply matters, too. Acknowledging the importance of financial literacy has become quite the trend in microfinance circles, even if folks aren’t entirely sure of how best to approach the subject.

Jonathan Morduch and I recently wrote a white paper for the McGraw-Hill Research Foundation about the state of financial literacy—and attempts to improve it—in the U.S. While the consumer finance landscape is, of course, quite different in the U.S. than it is in the developing world, many of the lessons we draw are applicable to other pockets of the world. After all, if people in a country where high-quality, low-cost financial products tend to be plentiful so often make foolish decisions about money management and financial planning, there clearly must be more complicated dynamics at play . . . 

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Timothy Ogden: The Year in Financial Access

Since the assignment for a round-up of the year from my perspective was broad, I’m going to take full advantage, stretching this to financial access from microfinance and adding a few things which have a somewhat tenuous connection to this year. I’ve tried to mainly stick with writing about events, rather than events themselves (no doubt revealing my personal biases), but a few events snuck through.

1.    Due Diligence: Could anything other than David Roodman’s multi-year, incredibly thorough and supremely careful public examination of microfinance top this list? While he began writing before 2011 and the book won’t be published for another month or so (though you can order it at a 25% discount now), this is unquestionably the writing that happened this year that will be remembered and referred to longest. Due Diligence is already part of the canon in the field. Like Portfolios of the Poor, I don’t think anyone who hasn’t read Due Diligence can legitimately claim a serious interest in microfinance . . . 

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Jake Kendall: The Year in Microfinance

What has been the biggest event in the financial inclusion space over the last year? 

The shift in the field’s thinking to recognize the poor’s deep need for payments capabilities on par with other financial needs.

A year or two ago, had you polled the financial inclusion field and asked whether they thought that a person to person money transfer service (like M-PESA) would have a significant welfare benefit for poor households, on par with credit, savings or insurance, the majority would have said “no.” Most would have said that a mobile money type service is important for the potential to enable the other financial services, and may be somewhat useful to the extent it lowers the cost of moving money around, but would have said it’s not likely to be all that effective in improving household welfare in meaningful ways . . . 

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Mary Ellen Iskenderian: The Year in Microfinance

As CEO of a global microfinance network I spent much of 2010 answering questions about the crisis in India and advocating for the continued relevance of microfinance as a model. This year’s challenges, however, gave me an opportunity to talk about theessential role of transparency and good governance and the importance of building on a deep understanding of client needs to tailoring products to fit those needs.

While the crisis dominated the media for much of the year, it would be regrettable if we didn’t acknowledge some of the important positive developments in the last 12 months. As an organization focused on increasing women’s access to financial services, we at Women’s World Banking (WWB) have a few things to cheer . . . 

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Susan Davis: The Year in Microfinance

Critics of microfinance have knocked down an army of straw men in recent years, and 2011 was no different. But it’s high time for microfinance practitioners to stop being defensive. We know enough about the perils and potentials of poverty-focused microfinance to address the real needs of the poor. 

Early champions, including Sir Fazle Hasan Abed of BRAC, Mohammad Yunus of Grameen and Ela Bhatt of India’s Self-Employed Women’s Association, recognized that financial services alone would not be sufficient to break the bonds of poverty. Critics of microfinance became more shrill in 2011, but as a recent article in The New Republic points out, “the growing backlash is in danger of overcorrecting.” 

Going into 2012, the microfinance field faces three key challenges . . . 

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Elisabeth Rhyne: The Year in Microfinance

I for one am glad this year is over.  Maybe, as the Washington Post suggested today, first prize for the worst year goes to the U.S. Congress, or maybe it goes to the government of Greece. But it was no picnic for microfinance. This was the worst year for microfinance since forever – at least since it was called microfinance.

This year the microfinance sector got hit with three whammies. The first was the crisis in Andhra Pradesh, where rapid loan growth created overindebtedness that triggered a political backlash that is still sending ripples through microfinance in India and beyond. The second was the news from impact research challenging the efficacy of microcredit in moving people out of poverty. The third whammy is the rise of “financial inclusion” making electronic payments innovations and mobile banking the new darling of donors and policy makers, and relegating microfinance to the status of legacy.

I watched the industry coming to terms with these challenges throughout 2011 . . . 

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Can the expansion of microfinance add up to macro impacts?

High quality evidence on the state of financial access around the world is advancing rapidly. A happy consequence of increasing knowledge is the ability to better recognize what we don’t yet know. That's why FAI launched a series on the ten questions, some micro, some macro, that need answers if we are to make informed decisions on how to improve financial access.This is the seventh installment of the 10 Research Questions on Improving Financial Access series.

Question 7: Can the expansion of microfinance add up to macro impacts?

The most basic question is the micro one: whether microfinance typically yields notable impacts on the lives of low-income families. The logical follow-on is, to the extent that micro impacts emerge, how do those impacts add up?  Is there a reasonable case that expanding microfinance can make a dent in regional or national economic growth rates? In national-level poverty rates?

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Making RCTs Better

This is the third (and I hope final for a while) post in a series on the standard critiques of randomized control trials (RCTs). The first post examined the External Validity Critique; the second took on the Transcendental Significance Critique. In both, I suggested that while the critiques aren’t invalid they are typically overblown and rarely acknowledge that other evaluation approaches carry the same or similar challenges.

In this post, I want to lay out what I think the advocates of RCTs, including myself, could be doing better to maximize the short and long-term impact of RCT-based studies and of the movement itself.

First is to dial up the humility. I’ve argued elsewhere that the greatest threat to aid and charity is overpromising and inflated expectations . . . 

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The SME Initiative and What We Don't Know

Last week, Innovations for Poverty Action’s SME Initiative brought together researchers and practitioners to discuss recent research on SMEs (Small and Medium Enterprises), mostly in the developing world.

Why the growing interest in SMEs? Partly it’s a reaction to the murky results on the impacts of microfinance. Evidence is increasingly suggesting that microenterprises do not tend to grow much and their impacts on income and consumption are up for debate. Against that, supporting SMEs may be a more effective way to provide jobs and reduce poverty.

Given that, what struck me most about the conference is not what was discussed, but what was not discussed. Many big-picture questions that underlie the focus on SMEs were not explicitly raised . . . 

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When and How does Financial Literacy Really Matter?

The evidence on financial education has, to date, not been encouraging. As Cole and Zia write in Chapter 14, being financially literate clearly helps, but the value of financial education is a different question. We know the desired outcome (literacy) but not a reliable way to get there enough of the time, nor is it clear that literacy is enough. Behavioral economics teaches us that consumers also need ways to implement ideas, especially when temptations and distractions are difficult to keep at bay.

Intuition that improved financial decision making through training would have powerful effects is strong, and there’s some evidence in that line (e.g., Karlan and Valdivia 2011). So where exactly are existing financial literacy programs going off track? Is it curriculum? Is it delivery? Is it context? 

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Are Borrowing and Saving Complements or Substitutes?

In developed economies, households often use both savings and borrowings to produce large amounts of capital to buy fixed assets like houses and vehicles. House buyers, for example, make a down-payment from their savings and borrow the rest. Saving and borrowing are thus complements in this context.  

Behavioral economics provides another mechanism through which saving and borrowing act as complements: for households that are loathe to draw down their hard-earned savings, the ability to borrow–and thus to leave their stash of savings untouched—can function as a helpful way to maintain accumulations. Were households more confident in themselves, or if they had better mechanisms to achieve discipline, “borrowing to save” would be less useful, but in an imperfect world it can be the best of an array of imperfect strategies (Morduch 2010). 

In other contexts, borrowing and saving are depicted as alternative activities . . . 

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Which financial services are most valuable to the poorest?

Credit is just one useful financial service, but credit has been the first focus of microfinance institutions because there’s a business model that makes lending possible, not because it is necessarily most important for customers. Customers pay handsomely for access to credit. Regulations also often make it much easier to lend than to take deposits (since the risk rests with the lender).

Saving programs have emerged, and some advocates now claim that deposit services deserve claim to being the most fundamental need for poor families – and for the poorest specifically. But the picture developed by Collins et al (2009) pushes against that view. We argue that a range of financial devices are sought and used together, with different degrees of substitution and complementarity. None have clear primacy . . . 

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Is SME finance an alternative strategy to microfinance?

If micro-businesses tend to stay micro, perhaps there are better options?  Critics of the hoopla around microcredit suggest that job creation is better done by larger enterprises (e.g., Karnani 2007). The rush to support small and medium enterprises (SMEs) has been given attention by the G-20 countries and is tied in part to the idea that SMEs can contribute to the goal of poverty reduction by employing low-skilled workers. But can they? It’s an empirical question which has been met with little evidence so far.

Bauchet and Morduch investigate data on the employees of SMEs supported by BRAC Bank in Bangladesh. Their conclusion is that these employees are far more educated and skilled than microcredit borrowers; in line with this, SME employees come from households that are considerably less poor on average. And they tend to be men, while microcredit borrowers in Bangladesh are mainly women. In sum, the two groups – SME employees and microcredit borrowers – look very different in the Bangladesh surveys. Will these kinds of results hold up elsewhere, particularly in Latin America and Eastern Europe where the gender and education profiles of microcredit borrowers is different from that in South Asia?

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