Financial services for next billion? [Part 4] – Managing large sums of money

I took a long time to write down the part 4 of my series – “financial services for next billion” as I was busy shifting from a co-living space to a studio apartment, so that I can better focus my energy towards my work as a hustler and not get distracted as well as overwhelmed by people. Though I must say, Tribe Theory hostel has given me a lot of great memories, pushed me to take my hustling journey and gave me tons of great friends.

Similar to my last post, in this one I have covered chapter 4 of the book – Portfolios of the poor in Q&A format, covering pieces around how poor people create and manage the large sums of money.

Do poor people hold long term debt or aim for long term asset?
“Unlike households in rich communities, the dairy households tend not to hold large long-term debt such as home mortgage. Nor are they building up formal retirement funds (especially outside of south Africa). Nor do young households deposit into long term education plans to see their children through college.”
“Seldom did we observe households converting these sums into a longer-term financial asset: they were built to be spent.”
“all families, even the poorest, attempted to accumulate lump sums of money over time through building up savings and paying off loans.”
“poor households tend to hold very little long term financial wealth. Making provision for old age just isn’t done directly by means of financial tools in our dairy households.” “many conversations with households suggest that desire for security in old age is often behind their financial transactions.”

What stops poor people to have long term assets?
“The financial capacity of the poor is constrained not just by low incomes but also by the characteristics of the instruments available to them today. New financial services may not be able to address low incomes, but they can do a lot by ensuring access to financial tools that provide the right doses of discipline, security, flexibility, and incentives.”

Do poor people leave room in the budget for financial transactions?
“In a 2007 paper, MIT economists Abhijit Banerjee and Esther Duflo report that surveys from around the globe show that the poor do no spend every available cent on food, leaving room in the budget for financial transactions that lead to larger expenses……most South African households spent no more than 75 percent of income on goods and services: the balance went toward financial intermediation such as insurance, savings or debt servicing.”

What are the categories of these lump sums?
“three very general categories of the uses of these lump sums. “Emergencies” include all sudden-onset occurrences that threatened life, health, or property. Under “life-cycle” uses we include household consumption, as well as expenditure on births, marriages, and deaths. “Opportunity” is the broadest class, broken down further in table 4.5.”

Primary use of large sums for opportunities

What is the life cycle uses in terms of lump sums of money allocation?
“poor households may use the short-term financial tools that are available to them to create stores of wealth as substitutes for the long-term financial tools, like pension plans, that aren’t available.”
“A very common use for lump sums is buying land, which we’ve classed as an opportunity… The precise motive for buying land can be influenced by cultural norms: one of the better-off households living in the slums ……. was clearly thinking about their last days when they told us they were investing all of their savings in the home they were building back.”
“land is seen with an eye toward future security”
“In Bangladesh and India urban households often sent funds, built through loans or through savings, back to the home village for investment in land or buildings.”
“In Bangladesh and India weddings were by far the most common expensive life cycle event.”
“expenses on religious and social event account for a large share of the expenses of poor households, and often require expenditures in large sums.”

How are emergencies managed?
“emergencies were met with a mosaic of smaller loans and savings combined with asset sales…. microcredit loans were seldom available for emergencies, because they were disbursed on an annual cycle, with prepayments (which would lead to the early release of a fresh loan) not allowed.”
“many saving clubs in all three countries pay out only at pre-specified times, leaving a saver with a sudden emergence unable to access funds.”

How are saving and borrowing are similar?
“Both involve steady, incremental pay-ins-saving week after week in small amounts, say or paying back loans week after week in small amounts.”
“saving and borrowing often share a very similar process: small sums are steadily set aside in return for a single large sum received at the appointed date.

What are accelerators?
“Loans are “accelerators” in the lump-sum-building process in more than one way. Obviously, they give households access to cash immediately rather than after a slow process of saving. But loans often have features that speed up the process even further. Price is one of them.”
“the pattern of borrowing at high cost even when adequate savings are in the bank is a regularity noted by economists working with data from low-income credit card holders in the United States. ”
“the truth of an odd-sounding paradox: if you’re poor, borrowing can be the quickest way to save.”
“though they also saved in informal clubs and other devices, for many of our South Asian diarists, borrowing proved the most manageable way to turn their capacity to set money aside into useful sums.”

What are accumulators?
The saving devices are called the accumulators.
“households using informal savings clubs, a very common accumulator throughout the developing world.”
“Why would Nomsa not bank this money for herself, avoiding the bother of the club (she has to attend its meetings) and its undoubted risks (what if the money is stolen from the secretary’s house?) Many South African diary households belonged to clubs of this sort, and their most common answer to this question was that club membership was the surest way to discipline themselves to save for a particular event.”
“You feel compelled to contribute your payment. If you don’t do that, [it] is like you are letting your friends down. So it is better because you make your payment no matter what.”
“The basic idea is that many people, both rich and poor, are often caught in a bind. They feel the need to put aside resources for the future, but they are also impatient to spend today. If impatience outruns concern for the future, little will be saved for later needs.”

What are the saving-up clubs?
“Usually, in a saving-up club, the fund builds up in the bank or in a member’s home and isn’t touched until an agreed term has finished- and very often the term is end just before a major expensive festival such as Christmas, Eid, or Diwali.”

What are RoSCAs or rotating savings and credit association?
“In a RoSCA, members save the same amount as each other every period- a month, say-and the total amount saved each period is given in whole to one of the members. This continues until everyone has received the “prize”, at which point the RoSCA comes naturally to a close-though of course its members may choose to start another cycle immediately or at any later time.”
“RoSCAs are flexible enough to accommodate almost any number of members, any interval between payments, and any value of pay in. They can also change all of their terms from cycle to cycle. On the other other hand, they impose strong discipline through their structured regularity.”

What are ASCAs pr accumulating savings and credit association?
“ASCA lends to fund in part to individual members (and in some cases to nonmembers), in varying amounts, charging interest on the loans and agreeing to a repayment schedule with the borrower. It may also accumulate any unlent part of the fund, storing it with the group’s treasurer or in the bank. “
“ASCAs….. are designed to help members profit from their savings.”

What are auction RoSCAs?
“RoSCA, where those members still eligible for for a prize bid for it, with the prize going to whoever puts in the biggest bid. The bid money is then distributed among the members equally, so that those willing to refrain from bidding until the later rounds, when bids are smaller, get a bigger than average prize for a smaller than average bid, as well as enjoying “interest” income from their share of the distributed bid money paid by others. “
“The money flows directly from savers to borrowers without any down time or middlemen to cream off their percentage.”
“auction RoSCAs could be considered the world’s most efficient intermediation system.”
“in India auction RoSCAs have developed into a licensed financial industry, known as “chit funds,” with tens of thousands of licensed chit fund managers running RoSCAs on behalf of their members, in return for a fee.”

How saving clubs are unreliable?
“Saving clubs, as powerful a savings device as they can be, are not always reliable. They may be unreliable in small ways – a member may not make the expected contribution at the exact time that you need the payout.”

How to manage the tension between discipline and flexibility?
“we all know we should save regularly, but we also know how difficult it is to carry out our good intentions. We seek external help – automatic payments, accounts with penalties for early withdrawal or missed payments – or we devise mental tricks, keeping the rent money in a special place (the teapot that belonged to grandma) and erecting taboos against dipping into it. These “mental accounts” have been subject of much recent enquiry.”
“In Bangladesh, to keep things simple, the microcredit lenders offered only one loan term- a year-and only one repayment schedule-equal invariable weekly instalments. Such a tight schedule is wonderful for discipline – but quite tough on borrowers with very small and very variable cash flows.”
“long term saving products could provide the foundations for creating secured loans – which use the savings deposits as collateral-with a potential for greater flexibility than the typical non-secured loans offered by micro-finance institutions.”

How saving clubs are too short-sighted?
“most informal savings devices are time-bounder, and a general rule is that the shorter their term the better their chances of working well. Saving-up clubs targeted at particular dates, like a major festival, last for a year or less. RoSCAs are by nature time-bound: their life quals the number of member multiplied by the interval between meetings , and most of those that work well are over and done with in a year, and often less, though of course they may chose to start another cycle.”
“A short-life span provides a regular test of the health of the device. When the scheme ends and the savings and profits are returned to the member, they either get paid in full or they don’t.”

How do poor households finance big things in life?
“The first answer is that they do so piecemeal. Large sums are cobbled together from smaller ones: loans are taken, gifts received, savings depleted. Financial tools capable of producing really big sums-simple and in a single place-are rarely there.”
“The second answer is that households use financial instruments to trap and hold the small amounts that they can squeeze out of a monthly budget.”

General insights
“micro-finance loans are cheaper than private money lender loans and are often used to pay off the latter[other debt]”
” we found several sums being used to actually pay down other debt.”
“common informal devices are designed, like the local savings and credit clubs…..it is similar to the way that many richer people pay for insurance or contribute to pensions. It is one of the features that microcredit pioneers adapted to form new innovations.”
“A study in the Philippines, for example, shows that bank customers save much more when offered a type of savings account that allows them to commit to making regular deposits at fixed intervals over a given period….richer households have many devices that do these job – like automatic salary deductions into retirement accounts. Poorer households usually have to rely on informal arrangement of their own making.”
“evolution of an almost endless number of different formats of savings clubs, as each tries to get ever closer to a perfect match between the lump-sum needs and the cash flows of its members.”
“clubs that continue for long periods are subject to many risks: members may move away, quarrel, or their circumstances may change so that they can no longer participate.”

I would like to hear more from you if you are using (or planning to use) these insights to build financial services for the next billion. Please do write to me at sagar@humane.network.

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