Focus No. 15 M a y 2 0 0 0 Raising the curtain on the `microfinancial services era' From the `agricultural credit era' sense of what `financial services' mean (1950s­1970s) through the `microenter- for poor households? `Complexity' and prise era', institutional arrangements and `variety' are words that threaten to lead C G A P product designs that characterised away from, rather than towards, con- financial services to the poor were under- ceptual clarity. pinned by a dominant image of the The Focus Series is poor. First, the image of the poor as We can already appreciate that savings CGAP's primary vehicle and insurance services, as well as credit, for dissemination to small and marginal farmers drove the will feature in the new complexity. So governments,donors, disbursement of agricultural loans from and private and special, often governmental, institutions it looks as if `agricultural credit' and financial institutions using foreign grants and soft loans. `microenterprise credit' are certain to on best practices in Subsequent views of the poor as lose their old monopoly on our imagi- microenterprise finance. women entrepreneurs resulted in nation, and simple uniform products like a `hybrid wheat package' or the Please contact FOCUS, the delivery of increasingly large work- Grameen's one-year business loan are CGAP Secretariat with ing capital loans by mostly voluntary comments, contributions, organisations to poor women organised about to be dethroned. and to receive other notes into groups offering joint liability. in the series: But what will appear in their place? How Whatever the strengths and weaknesses can we come up with products that 1818 H Street NW, of these approaches ­ and experience address poor people's myriad uses for Washington DC 20433 has taught us many lessons ­ the arguments financial services, which are easy to Tel: 202. 473 9594 which supported them were clear, even understand and deliver, and with institu- though they may now appear simplistic. tions that can keep tabs on these prod- Fax: 202. 522 3744 Farmers need crop loans. Poor business- ucts and recover their costs from the e-mail: women need a steady supply of easily re- margin? This note begins to answer the CGAP@Worldbank.org paid loans which grow with their businesses. first of these questions, namely, about product design. WWW: C o m p l e x i t y a n d v a r i e t y http://www.cgap.org The function of financial services: As we move into the `microfinancial M a n a g i n g m o n e y services era' and begin to deal with `vulnerable households with complex It is the function of financial services ­ livelihoods and varied needs'1, do we seen from the point of view of the user ­ have a clear idea about the kinds of fi- to help manage money. This is their pri- nancial products that will be required mary task, and this is how people actu- or of the institutions that are going to ally use them. In the eras of agricultural deliver them? Do we have even a real and enterprise credit, we overlooked the C G A P T H E C O N S U LT A T I V E G R O U P T O A S S I S T T H E P O O R E S T [ A M I C R O F I N A N C E P R O G R A M ] fact that borrowers have many other money management needs besides financing their cash kept aside from regular expenditure crops or businesses. Financial services allow people to reallocate expenditure across time. This means simply that if you don't have the ability to pay for things now, out of current income, you can pay for them out of past income or future income, or some combination of both. Because our income does not arrive in exact rhythm with our outflow of expenditure, we all need this facility. The poor need it no less than other groups of people. Indeed, they may need it more. This is not just because regular expenditure their incomes are uncertain and irregular from current income (which is often true), but because the abso- lute amounts of cash they deal with are very small. As a result, anything more than the tiniest expenditures will require sums of money greater than they have with them at the time ­ in their pocket, purse or home. "large" expenditure made from cash kept Expenditure of almost any kind can require back from future income: saving down them to look for a way of financing the expenditure, or part of it, out of yesterday's or tomorrow's income. Note that I am referring to expenditure of any kind, and not just for farming inputs or microenterprises. Life cycle events, such as birth, schooling, marriage, home-making, retirement and death, emergencies including personal ones like illnesses and accidents and impersonal ones like cyclones, fires, floods How do poor people tap into past and present and droughts, all require the expenditure income to finance this wide and constantly of sums bigger than those available on an pressing range of expenditures? They do it in everyday basis. Besides needs, there are op- many ways, but it helps if we group them into portunities ­ opportunities to invest in land, three main strategies which I call `saving up', business, buildings and comforts like fans and `saving down' and `saving through'. They are TVs. These too involve spending sums that illustrated in the chart. Let us consider each in force the poor to look for ways of using past turn, from the point of view of a poor house- and future as well as presently available income. hold in the developing world. C G A P T H E C O N S U LT A T I V E G R O U P T O A S S I S T T H E P O O R E S T [ A M I C R O F I N A N C E P R O G R A M ] C H A R T 1 : S AV I N G D O W N , S AV I N G T H R O U G H A N D S AV I N G U P "large" expenditure made from cash kept back "large" expenditure made from cash from both past and future income: saving through kept back from past income: saving up In this and all other charts, the horizontal axis represents time, and the vertical axis values of cash. S a v i n g u p Saving up ­ keeping back cash now so that it can cash. Formal opportunities to do so ­ at banks be spent in the future--is hard for poor people. and the like--are rarely accessible. Cash kept at Strange as it may seem, this is not primarily be- an insecure slum or village home can be stolen, cause they have little or nothing to save (though lost, burnt, blown or washed away. It can be cap- that may also be true). The difficulty comes not tured by mothers-in-law with hard voices, visiting so much with finding the resources from which relatives with hard-luck stories, and alcoholic hus- to save, as with the practical problems of saving bands with hard knuckles. How do you keep even up. It is very hard to find a safe place to store a few cents back when the children are hungry? C G A P T H E C O N S U LT A T I V E G R O U P T O A S S I S T T H E P O O R E S T [ A M I C R O F I N A N C E P R O G R A M ] C H A R T 2 : S AV I N G U P W I T H A D E P O S I T C O L L E C T O R the deposit collector takes her fee by deducting it from the lump sum at the end a regular flow of small savings (cash held back from expenditure) transformed into a usefully large lump sum at the end of a set period Because holding cash is so hard, savings I pay ­ to save cash. This high price is ex- created by not spending all of yesterday's pressed in two ways ­ high levels of risk income are often kept in kind ­ in livestock, and low, or even negative, interest rates. tin roofing sheets, and even trees. Such All round the world the poor entrust their methods of saving have some advantages: savings to people and institutions that are the piglets may produce young, the tree less than fully reliable. `Money guards' like may mature into something worth many relatives, employers, and shopkeepers hold times its original value as a sapling. But vast sums of the poor's cash ­ and some- there are disadvantages, too. The piglet times cheat them. Tens of thousands of may die. The tin sheets rot. Above all, when informal savings clubs of all kinds spring you need to realise the value of these `in up daily round the world, and too many of kind' savings, it is bothersome. You can sell them are inefficiently or fraudulently run. a piglet in order to have cash to buy some Yet poor people persevere with these high- medicine, but it may be a bad time of the risk methods, for lack of better alternatives. year for piglet prices, and what are you Most vulnerable are the poorest ­ those going to do with the ten dollars left over most likely to be illiterate and powerless. when you've bought the medicine? Spend it, perhaps, if you don't have a good place A good safe place to save money can be to save cash. There is also the problem of expensive. Deposit collectors ­ people how you keep the rain out if you sell the tin whose job it is to collect and store savings sheets. Finally and crucially, how and where from their poor clients ­ do the same job do you save up the cash to buy the tin sheets as a savings bank, but most charge for the in the first place? service, rather than pay interest. In West Africa it is common for deposit collectors These disadvantages force the poor to pay a to collect savings on a daily basis, and to high price ­ very much higher than you and charge one day's savings per month. C G A P T H E C O N S U LT A T I V E G R O U P T O A S S I S T T H E P O O R E S T [ A M I C R O F I N A N C E P R O G R A M ] C H A R T 3 : S AV I N G D O W N W I T H A N U R B A N M O N E Y L E N D E R the moneylender takes his fee by deducting it from the lump sum at the beginning a regular flow of small savings (cash held back from expenditure) given in return for a usefully large sum provided by the moneylender at the start of a set period S a v i n g d o w n for households that resorted to saving down precisely because saving up was so hard in Not surprisingly, when a marriage contract the first place. for the daughter is suddenly proposed, or ill- ness strikes, or the opportunity to buy a cheap The costs of using a moneylender are usually rickshaw unexpectedly occurs, few poor greater than a deposit collector, but it's not households have got enough cash saved up hard to see why. The moneylender, unlike the to manage the required outlay. They may then deposit collector, has to provide the capital try to tap future income ­ by saving down. To for the lump sum in the first place. He also do that, they need to find someone or some bears the risk of the contract not being institution willing to give them a cash advance honoured, whereas in the case of the deposit against part of their future income. They often collector it is the client who takes that risk. start with friends or neighbours who may be in Finally, the moneylender has to acquire the a position (by having some funds saved up) to information that will enable him to decide make them a loan. Such loans may be offered how much he can risk advancing to his client, without interest if there is an assumption that while the deposit collector simply returns the borrowing household will reciprocate the whatever the client managed to save, and the favour on some other occasion. With or with- client has to try to find out whether the de- out interest, the loans will be repaid by with- posit collector has a safe pair of hands. holding a part of future income. Some lenders will be happy to get their money back in small S a v i n g s a s t h e b a s i s o f a l l installments, and in that case the borrower can f i n a n c i a l s e r v i c e s repay as and when they can keep cash back from everyday expenditure. Many loans in the The fact that deposit collectors and urban informal world, however, are repaid in a single moneylenders offer fundamentally similar, `balloon' repayment. In that case the borrower though mirror-imaged, services is not just has got to find a way to save up the full a matter of aesthetic interest. It drives home amount of the loan ­ by definition difficult the point that the money deposited with the C G A P T H E C O N S U LT A T I V E G R O U P T O A S S I S T T H E P O O R E S T [ A M I C R O F I N A N C E P R O G R A M ] C H A R T 4 : S AV I N G T H R O U G H I N A R O S C A a regular flow of small savings (cash held back from expenditure) is made over an extended period of time, and at some point in that period a usefully large sum is taken in exchange deposit collector and the money repaid to many times as there are members, say twelve, the moneylender come from exactly the same as in Chart 4. At every meeting everyone source: cash held back from regular day-to-day brings along a fixed sum of money, say $1. expenditure by an act of will. This is a pretty On each occasion one of the twelve mem- good definition of savings, and savings is ex- bers walks away with all $12 contributed actly what these deposits and repayments are. that day. After twelve meetings everyone has put in twelve lots of $1 and come away with Deposit taking and lending are alternative one usefully large lump sum of $12. The ways of managing savings. Both transform order in which the lump sum is taken can a series of savings into a lump sum large be decided by agreement, by chance (drawing enough to pay for the daughter's wedding, lots), or by auction. or bury grandfather or buy a rickshaw. A good definition of financial services for the Because there are usually no charges in- poor is that they are `money management volved, the simple function of this device services that help the poor turn their savings stands out clearly: it turns a series of savings into usefully large lump sums'. into a lump sum ­ some of the savings are made before the lump sum arrives, and some This definition puts saving at the centre of after (unless you are the first or last taker). financial services, rather than seeing it as a Perhaps more importantly, `saving through' somewhat overlooked alternative to loans. features in some kinds of insurance, such as health and property insurance. We can see S a v i n g t h r o u g h this in the simple case of vehicle insurance. When you insure your car, you make a series This may become clearer as we investigate of regular small savings ­ perhaps annually `saving through'. To illustrate saving through, or monthly ­ in the form of `premium' we turn to a service the poor can and often payments. When you crash your car into a do set up for themselves ­ savings clubs. One lamppost, the insurance company pays out a particular kind of savings club is known as the usefully large amount2 ­ large enough to ROSCA, for rotating savings and credit asso- repair the car, with luck ­ after which you ciation. In such a club, members agree to go on paying your premiums until the next meet on a periodic basis, say weekly, for as need for such a sum arises. C G A P T H E C O N S U LT A T I V E G R O U P T O A S S I S T T H E P O O R E S T [ A M I C R O F I N A N C E P R O G R A M ] C o n c l u s i o n : D e f i n i n g g o o d m i c ro f i n a n c e p r o d u c t s Turning savings into usefully large lump people have fluctuating amounts of cash sums is what financial services do, for no available to save, it makes sense to accept, matter what use, over no matter what time- wherever possible, any value of deposit (in- scale, in no matter what value, and in any cluding tiny sums). However, there are some one or any mix of three major strategies circumstances in which fixed-value deposits for effecting the swap: saving up, saving make sense, both from the point of view of down and saving through. the user and the institution, because they promote discipline. In that case, the deposits The first requirement of a good financial should be small (so that very poor people can service product, therefore, is that it makes reach them) but capable of being deposited it easy to deposit the savings (remembering in multiples, so that those able to afford more that `savings' can take the form of loan re- than the minimum can do so. For example, payments or insurance premium payments in the marriage funds of South India, users as well as `savings' as generally understood). pay a fixed sum each week, which must be a Easy deposit systems are those that are multiple of ten rupees (about 20 cents US). close-at-hand, regular, frequent, quick, safe, In many ROSCAs, better-off members can flexible and affordable. An ideal would be have several `names' in the scheme, enabling a neighbourhood-based collector who calls them to deposit and take out larger sums. every day without fail and can accept deposits on the spot with a minimum of paperwork The fourth requirement is to offer a wide but with complete assurance that the de- range of time scales for the savings-to-lump- posit will be properly credited to the client's sum swap. Like anyone else, poor people account. need to be able to finance tomorrow's gro- ceries as well as next year's school fees and The second requirement of a good financial next century's retirement costs. For longer- service product is that it makes it easy to take term swaps some users may express a prefer- out the lump sum (again remembering that ence for illiquidity. That is, they may prefer accessing the lump sum may take the form to protect the savings from the temptation of a savings withdrawal, or a loan, or an in- to withdraw and use them until a certain surance pay-out, depending on the strategy being employed). Such a system would have period of time has elapsed or until a certain unambiguously clear rules, so that accessing event has occurred. This preference needs the lump sum would be as mechanical as to be recognised and accommodated. extracting cash from an ATM with a debit The fifth requirement is to offer a full range card. It should also be close at hand, available of swap strategies. People need to be able to at convenient hours, and unencumbered draw on both previous and future savings, with complex paperwork or waiting time. so they need to save up, save down and save The third requirement is to accept a wide through. Without this, they are unlikely to range of values of deposits. Since poor be able to maximise their savings potential. C G A P T H E C O N S U LT A T I V E G R O U P T O A S S I S T T H E P O O R E S T [ A M I C R O F I N A N C E P R O G R A M ] For example, if they are offered only loans (savings-down facilities) they may be unable to exploit their capacity to make occasional low-value sav- ings, especially if the loan has a fixed or infrequent repayment schedule. The five key requirements I have listed are all matters of product design. Other sets of requirements ­ those that have to do with the institutions that are to deliver such products, and with the legal, regulatory and eco- nomic environment in which such institutions can flourish ­ will be impor- tant to the microfinancial era of the twenty-first century. But until we are clear about the kind of products we want to deliver, and why, our specifica- tions for the design and support of sustainable MFIs will be premature. 1 From Matin, I., D. Hulme and S. Rutherford. 1999. Financial Services for the Poor and the Poorest: Deepening Understanding to Improve Provision. Finance and Development Programme Working Paper Series, Institute of Development Policy Management, University of Manchester, UK. Available on-line at: http://www.man.ac.uk/idpm/idpm_dp.htm#F_DWP 2This article does not distinguish between arrangements (such as ROSCAs) where pooled savings are returned to their savings in proportion to each individual's contribution, and other arrangements (found in many forms of insurance) where pooled savings are distrib- uted unequally between savers, according to the losses they suffer. A brief discussion of the two can be found in Stuart Rutherford, The Poor and Their Money (Oxford University Press, India, 2000). An earlier version appeared as a Working Paper from the Institute for Devel- opment Policy and Management, University of Manchester, in 1999. This Focus Note was written by Stuart Rutherford of SafeSave. 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