Financial Policy and Access to Finance by the Poor

1
Financial Policy and Access to Finance by the
Poor

• Anjali Kumar Priya Basu
• Latin America Region South Asia Region
• The World Bank The World Bank

India, January 2005
2
Outline

• Why is access to finance relevant?
• What evidence on access do we have from the
  users side?
• What are the trends on the supply side?
• What is the situation regarding financial
  services for the poor in India?
• What can be learned from other country
  experiences?

3

• Why is Access to Finance Relevant?

4
There is close association between financial
system depth and long-term economic growth
And Countries with Deeper Financial Systems in
1960 Grew Faster for the Next 35 Years
Note These figures represent the average of
available dates in the 1990s for each of 87
countries. Source Beck, Demirguc-Kunt, and
Levine (BDL) database.
5
Moreover, financial depth helps growth, and
growth helps poverty alleviation

• Financial system depth and soundness has been
  causally linked to economic growth
• Economic growth has been causally linked to
  poverty reduction (e.g., Brazil)
• Furthermore, financial depth provides a cushion
  against poverty-exacerbating crises

Brazil Poverty and GDP, selected years 1988-1999
1988-93 Negative Growth, Increase in Poverty
1993-96 Positive Growth, Decrease in Poverty
1998-99 Stagnant, Increase in Poverty
Source World Bank, Brazil First Programmatic
Financial Sector Adjustment Loan, 2001 e.g.,
King, Levine (1993), Levine, Loyaza, Beck (2000)
6
Finance is a highly effective tool in spreading
economic opportunity and fighting poverty

• Broader access helps produce more and distribute
  it fairly
• Productivity Access to credit helps translate
  ideas into investments
• For producers, this enables an increase in
  production possibilities.
• For consumers, this raises welfare and can affect
  patterns of employment, occupational choice and
  economy-wide productivity and growth.
• Without access to credit, opportunities for self
  employment are far more limited.
• Insurance Access to savings helps protect
  against unexpected income fluctuations and
  maintain consumption standards
• Farmers save as insurance against common periods
  of drought or crop failure.
• Savings provides a vehicle for future
  expenditures (expected and unexpected).
• Education and Retirement Access to finance
  allows educational borrowing when young, and
  retirement savings when older
• Considerable empirical evidence and theoretical
  literature exists

Source Rajan Zinghales, 2003
7
Financial depth directly helps poverty reduction
by cushioning against economic crises

• Financial crises create huge fiscal costs
• These costs directly increase poverty and crowd
  out social spending
• Financial crises also lead indirectly to a
  one-off decline in the growth path, setting back
  poverty reduction for years
• Brazil crisis (1995) cost 13 of GDP
• Indonesia crisis (1999) cost 50 of GDP
• Significant increases in the incidence of
  poverty after crises in Venezuela (1994), Mexico
  (1995), and Ecuador (1998)

Source World Bank, Brazil First Programmatic
Financial Sector Adjustment Loan , 2001
8
New evidence suggests that financial development
may reduce income inequality

• Beck et al (2004) show that financial
  development improves income distribution Finance
  is not only pro-growth, but also pro-poor
• With better developed financial intermediaries
• Income inequality falls more rapidly (both Gini
  coeff. and st. dev.)
• The income of the poorest quintile grows faster
  than average income
• Private credit has been shown to have a direct
  positive impact on the income growth of the poor
• For example, Beck et al suggest that if Brazil
  had the same level of financial intermediary
  development as Korea, the average income of the
  poor in Brazil would have grown 2 instead of 0
  annually
• Additionally, countries with better developed
  financial intermediaries have seen larger
  reductions in infant mortality

Source Beck, Demirgüç-Kunt and Levine, 2004,
Finance, Inequality and Poverty Cross-Country
Evidence, draft.
9

• What Evidence on Access Do We Have From the
  Users Side?

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Access to financial services is lower in poorer
countries, but the relationship is not linear
Source Anjali Kumar et al Access to Financial
Services - What Do we Know Across Countries?
Preliminary Comparisons, World Bank Finance
Forum 2004
11
Even where banks exist, many unbanked perceive
their loan requests will be refused

• These perceptions translate into very low levels
  of demand by the poor only 10-15 of the
  respondents applied for loans
• Of those that applied, about a third were
  rejected
• Lack of income appears to the main perceived
  reason in Brazil
• However the lack of guarantees seems to be
  important in Colombia and Mexico can we explore
  these differences further?

Source Anjali Kumar et al Access to Financial
Services - What Do we Know Across Countries?
Preliminary Comparisons, World Bank Finance
Forum 2004
12
In fact, there may be more potential borrowers
compared to applicants among the poor
Evidence from Indonesia

• 1438 surveys taken by rural bank loan officers
  across Indonesia on behalf of researchers
• Probability of borrowing and saving relates to
  formal institutions
• After each survey, loan officers were asked
  Would this household be feasible to be granted a
  loan if needed?

Source Morduch, Jonathan, 2004, Microfinance
Transactions at the bottom of the pyramid, New
York University.
13
How much of a factor is demand when examining why
the unbanked do not bank?
percentage of total sample and not percentage of
total reasons

• Demand side lack of perceived need may be
  factor for the poorest
• Supply side bank barriers also a factor
  documentation, costs, minimum balances and
  unfriendly service
• However, country surveys are not standardized
  and comparisons are therefore difficult using
  this data

Source Anjali Kumar et al Access to Financial
Services - What Do we Know Across Countries?
Preliminary Comparisons, World Bank Finance
Forum 2004
14
The Financial Diaries of the poor show other
dimensions of access

• Financial diaries in South Asia
• Poor, very poor and near-poor households were
  surveyed in detail about finances over a year in
  small samples of 30-40 households
• Main findings
• Respondents manage assets and income streams
  using a wide array of informal, semi-formal and
  formal services and devices
• One sample of 42 households used 33 types of
  services during the year no household used less
  than 4, and one third used more than 10
• In Bangladesh, average households annually push
  or pull through financial services (839) equal
  to 2/3 annual cash income
• In India, households enter a fresh financial
  arrangement every two weeks
• Examples are moneylenders, money guards, savings
  clubs, or formal provider
• Microfinance is 10-15 of capital of households
  surveyed (USAID AIMS project)
• Poor households actively manage cash flow to turn
  small flows to large lumps, and to smooth income
  and consumption
• There is room for greater access to financial
  services that fit the earning and portfolio
  profiles of poor households at reasonable cost

Source Murdoch, 2004, based on Rutherford, 2000.
15
Access has a quality dimension and the design
of tools and mechanisms is important

• Financial access is not just a yes/no question
  (i.e., whether some people have access and others
  dont)
• Quality matters current access to a bank does
  not mean satisfactory access to banking
• The real issue Do households have access to a
  reliable, reasonable quality set of tools and
  mechanisms?
• What kind of services are needed to improve the
  quality of access?
• Reliable
• Convenient
• Continuous
• Flexible range of services
• Frontiers have not been reached deeper outreach
  is possible, perhaps on a commercial basis
• Need mechanisms tailored to cash flows, that fit
  into household portfolios

Source Morduch, Jonathan, 2004, Microfinance
Transactions at the bottom of the pyramid, New
York University.
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• What Are the Trends on the Supply Side?

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Microfinance is a growing industry
Source Microcredit Summit
18
But microfinance remains limited in most
countries
MFI Penetration Rates Top Countries (borrowing
clients as of population)
Source Honohan, 2004, based on Daley-Harris,
2003.
19
Credit reach of alternative financial
institutions is also limited
Borrowing Clients at Alternative Financial
Institutions (borrowing clients as of
population)
Note Alternative Financial Institutions include
MFIs, financial cooperatives, rural and/or local
banks, state agricultural and development banks,
postal savings banks institutions that focus on
extending finance outreach to people not normally
served by banks.
Source Honohan, 2004, based on Christen, et al,
2004.
20
Micro-insurance services are just developing

• Some insurance products emerging
• Life (e.g., Philippines, Sri Lanka)
• Rainfall (e.g., Morocco, India, Mongolia)
• Health (e.g., India)
• Catastrophe risk (e.g.,Turkey)
• Sustainability is a major issue
• Appropriate regulation needs to be developed.
• Better data infrastructure (mortality, health,
  weather, etc) will facilitate development of
  insurance markets
• Financial education is necessary
• More ways for practitioners to share good
  practices/failures

21
Challenge Increase the financial reach of
institutions in ways compatible with needs of poor
Source Scaling up access to finance On the
critical path to the MDG, WB 2003
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The landscape of financial service providers is
changing to respond to this challenge

• Institutions with strong models emerging and
  scaling up
• Recognition of major returns to scale
• Experimentation with increasing range of savings
  and lending products geared toward increased
  flexibility
• Some generate good returns, but a large number of
  financial service providers remain unsustainable
• What is a reasonable stance on subsidies?
• More public-private solutions and private capital
  interest
• Emerging infrastructure on credit information and
  ratings
• Growing need for viable entry and prudential
  regulation
• Must nurture growth to scale and diversity
• Need for consistent information and data to track
  outreach, diversity of institutions, and impact

Source Based on Financial Sector Assessments of
44 countries, The World Bank, 2004, WB assisted
projects, CGAP.
23

• What is the Situation Regarding Financial
  Services for the Poor in India?

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Low access to formal finance in India, and the
poor are particularly underserved
70 of poorest households dont have a bank
account 87 have no access to credit
Note Marginal farming householdslandholdinglt1
acres Small1 to 4 acres Large farmersgt4acres
Commercial households with or w/o land but with
income from non-farm sources exceeding half of
total household income Othersmixed households
with land and non-farm commercial incomes but the
latter being less than half of their total
household income.
Source India Scaling up access to finance,
P. Basu et al
25
Among the sources of formal finance in India,
commercial banks are the main source
Source India Scaling up access to finance,
P. Basu et al
26
High transaction costs / collateral requirements
make banking unattractive for the poor
Source India Scaling up access to finance,
P. Basu et al
27
Why are the poor unattractive clients? Volatile
incomes / expenditures, repayment uncertainties

• Problems of uncertainty about the repayment
  capacity of poor rural borrowers, and their
  irregular/volatile income streams and expenditure
  patterns
• In the absence of credit information, these drive
  up default risk
• Exacerbated by lack of collateral, and/or
  difficulties in contract design and enforcement

Source India Scaling up access to finance,
P. Basu et al
28
Who is providing informal credit to the poor?
Evidence in Rural India

• Moneylenders 56
• Family and friends 31
• Landlord 8
• For what?
• Family emergencies 29
• Social expenditures 19
• Invest in land, building 13

Source India Scaling up access to finance,
P. Basu et al
29
Indias rural poor rely heavily on informal
finance
Note Marginal farming householdslandholdinglt1
acres Small1 to 4 acres Large farmersgt4acres
Commercial households with or w/o land but with
income from non-farm sources exceeding half of
total household income Othersmixed households
with land and non-farm commercial incomes but the
latter being less than half of their total
household income.
Source India Scaling up access to finance,
P. Basu et al
30
New providers of finance to the rural poor
include the SHG-bank linkage program
Collective action Self help groups (SHGs) of
15-20 with savings linkages with local bank,
which lends using group savings as
collateral Scale gt 1M SHGs linked by 2004 gt 16M
deposit accounts estimated 3-6M active loan
accounts, concentrated in Indias south

• Repayment rate About 95
• Targeting 90 women reaches households in two
  quintiles above the poorest
• Impact Studies show a positive impact on asset
  creation, savings, employment and poverty, as
  well as social impact/empowerment
• Challenge Expansion while enhancing viability
  and ensuring sustainability
• More attention to group quality
• Strengthening the capacity of group promoter
  institutions
• More attention by banks to financial
  sustainability (rates that cover costs)

Source India Scaling up access to finance,
P. Basu et al
31
Other delivery channels are being used in India

• Micro Finance Institutions (MFIs) Growth
  potential (small and region specific)
• Outstanding loans of US52M reaching about 1M
  borrowers at 95 repayment rate
• Select MFIs have scaled up, but regulatory,
  equity capital technical support issues
• Portfolio of Grameen Bank exceeded all of India
  by a factor of five in March 2003
• Financial service provider models used by new
  generation banks/insurers
• Banks lend to MFIs who on-lend
• lt0.1 of banks balance sheets banks typically
  lend to 5-10 MFIs
• ICICI Bank securitizes MFI portfolios and
  partners where ICICI bears credit risk, but
  origination, recovery business development done
  by MFIs and other agents
• Mutual funds/banks increasingly using the postal
  network (156,000 branches)
• Insurers piloting new products through MFIs/NGOs
  and banks to reach out to the poor
• Kisan Credit Cards (KCCs) commercial,
  regional rural, and cooperative banks
• 41.4M users by Mar 2004, though access for
  marginal farmers needs to be improved
• Lower transaction costs (e.g., bribes) and
  improved access through pre-approved limits

Challenge in all cases is of increasing scale and
depth of financial service provisionwhile
preserving viability of operations
Source India Scaling up access to finance,
P. Basu et al
32

• What Can be Learned from Other Country
  Experiences?

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Some examples that address

• What policies have been used in some countries to
  spur access?
• What have been the role of public and the private
  sector?
• What has been the role of the international
  community?

34
In Bolivia, BancoSols conversion to a commercial
bank and regulatory reforms spurred microfinance
Source Superintendencia de Bancos de Bolivia, WB
staff estimates
35
In Brazil, legal and interest rate reforms
facilitated the growth of private microfinance
Source BNDES, WB staff estimates
36
Kenya and Uganda are good examples of
microfinance development in Africa

• Kenya
• Kenyas K-rep pioneered transformation of MFIs
  into regulated institutions creating K-REP Bank
  in the mid 1990s.
• A few large savings and credit cooperatives
  (SACCOs) in Kenya are individually larger than
  many banks
• Uganda
• In Uganda, legal reforms in 2003 led to the
  transformation of unregulated MFIs into regulated
  institutions
• This has helped Ugandas sustainable outreach
  expansion by improving ability to leverage,
  credibility, and operations
• The quality of regulation is important in the
  decision to formalize
• Four major MFIs are becoming regulated thus
  increasing the borrower-client base in the
  supervised sector by 72 percent
• These four institutions, accounting for 14 of
  all deposit accounts in the regulated sector, are
  now able to expand deposit taking

37
Growth of Bangladesh microfinance made possible
by massive donor support and little regulation
First donor funding
Massive TA and donor support
Source WB estimates. Includes main MFIs (BRAC,
GRAMEEN and ASA)
38
ASA (Bangladesh) and Compartamos (Mexico) focused
on sustainability, cost control and innovation
Source Data from ASA and Compartamos
39
BRI Unit Desas (Indonesia) and CrediAmigo
(Brazil) built sustainable program using existing
public bank infrastructure
Both institutions benefited from donor funding
Source World Bank, BRI, CrediAmigo
40
Public-private solutions in reform Mexicos
BANSEFIs investments to facilitate scale

• Legal and regulatory reform in 2001 regulated
  savings and credit institutions (mainly financial
  cooperatives)
• Creation of BANSEFI as the central vehicle to
  coordinate the transformation of the
  semi-informal s/c institutions
• Linked BANSEFI to the distribution of government
  programs
• Creation of a commercial alliance between BANSEFI
  and other financial institutions to achieve more
  than 5,000 points of access, 50 in rural areas.
• Public investments to achieve scale
• - Technical/service assistance to about 400
  retail institutions and their federations to meet
  new standards and strengthen institutions.
• - Comprehensive technological platform to
  integrate La Red de la Gente.

41
Other public-private solutions to overcome scale
economies and coordination

• Correspondent banking with existing postal
  infrastructure
• Post offices in Brazil
• Auctioned exclusive right to distribute financial
  services through post offices in 2001, large
  private bank was winner
• Post office in 1,738 out of gt5,000 municipalities
  without bank outlet
• Post offices in South Africa
• E-finance services
• Platform to apply for loans from any bank
• Nafins internet-based market for receivables in
  Mexico
• Reverse factoring links many small suppliers
  with few large credit-worthy buyers
• Subsidized overhead costs
• Lower costs and increased transparency for SME
  working capital
• Credit scoring
• Requires information on many performing,
  non-performing and rejected loans might be too
  costly for one institution
• Encourage cooperation without collusion

Source Beck and de la Torre, The Analytics of
Access to Finance Introducing the Access
Possibilities Frontier, 2004
42
How to scale up access and develop an inclusive
financial sector Some conclusions

• There is room for public-private solutions that
  overcome scale economies and coordination and
  enhance market information
• Entry and interest rate policies that allow
  innovation and opportunities to grow and realize
  economies of scale
• Appropriate regulatory frameworks and effective
  supervision forms that respond to an evolving
  industry can have an energizing impact on
  growth and development of a diverse set of
  institutions
• Donor and public support for technical assistance
  to institutions, financial infrastructure, and
  financial education
• International and national efforts to provide a
  better database on access to finance and more
  effective analysis of cost benefit of subsidies
  and impact