Portfolio Balancing:Rethinking our assumptions about the benefits and costs of financial products for the poor            ...
Objective: Understand consumer logic on financial choices to offerbetter products and improve portfolios as a wholeFaulty ...
Underlying analytical insight: Full costs of financial services includetime and risk, not just monetary costs             ...
Methodology: Financial portfolios of Indian, Bangladeshi,and South African householdsCGAP commissioned Bankable Frontiers ...
We start with South Africa, where we have the largest sampleand diversified portfolios       # of households              ...
Clarifying what we mean by formal and informal    BORROWING                INSURANCE               SAVINGSFormal          ...
Borrowing: If we use a product-centric view, i.e. comparingproduct to product on annualized terms, formal looks muchcheape...
For a true cost/benefit evaluation, we must switch from aproduct-centric view to a portfolio-centric viewIllustration of a...
When assessing costs on a portfolio-centric view, the pooractually spend much less on informal loan instruments on amonthl...
How does this inform our perspective on formal andinformal borrowing options? Additional non-cost considerations:         ...
Clarifying what we mean by formal and informal    BORROWING                INSURANCE               SAVINGSFormal          ...
Insurance: South African formal and informal funeralinsurance are very different; but costs are nearly equal.      Cost co...
Formal funeral insurance offers the same value as burialsocieties, but premiums and payouts are on a higher (but stillaffo...
How does this inform our perspective on formal and informalinsurance?Additional non-cost considerations:Formal Insurance  ...
Clarifying what we mean by formal and informal    BORROWING                INSURANCE               SAVINGSFormal          ...
Savings: Informal savings is much cheaper than formal, eventhough risk is high and privacy low    Cost comparison within a...
Simply lowering travel time does not increase savings Policies targeting travel time and fees alone did not make a differe...
Automation results in increased savings Higher direct deposit rates resulted in increased savings in banks.           Only...
Savings: Formal instruments are still perceived asrisky for the userTwo examples of frequently used financial instruments:...
How does this inform our perspective on formal andinformal savings?Additional non-cost considerations:Formal Savings      ...
What if we broaden the view beyond South Africa?• In South Africa, there is a tilt in balances towards savings – this  see...
Who did we interview?                                South Africa           Bangladesh                  India        # of ...
Bangladesh and India rely heavily on debt to form“lump sums”* while South Africa depends on savings                       ...
In pure monetary flows in South Africa, the outflows attributed tosavings every month are still higher than those for debt...
…But in Bangladesh, it’s the opposite – outflows for debt andinsurance are higher than savings.35%    South Africa and Ban...
The cost of time is even higher in India andBangladesh  3.0%                  Total transaction costs for South Africa, In...
There is an even greater emphasis on the need for    more reliable services                                               ...
Conclusions and next steps• When judged on portfolio-centric merits, there is no natural advantage  of formal products ove...
Advancing financial access for the world’s poor                 www.cgap.org           www.microfinancegateway.org
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CGAP BFA Portfolio Balancing September 2012

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CGAP BFA Portfolio Balancing September 2012

  1. 1. Portfolio Balancing:Rethinking our assumptions about the benefits and costs of financial products for the poor September 2012
  2. 2. Objective: Understand consumer logic on financial choices to offerbetter products and improve portfolios as a wholeFaulty assumption:Over time, take up of Increased access to Increased formal Decreased informalformal products will formal financial financial usage financial usagenaturally eradicate the toolsneed for informalproducts.Instead, we suggest aparadigm shift: Increased access Increased Usage depends to formal financial financial options on current tools to consider financial needs Availability of formal financialTherefore, a completely services adds more options, rational and informed which often have safer decision may be to elements, but rarely offer an continue using informal improvement over informal financial instruments in devices in every way. combination with formal instruments. Result: Rather than weighing the merits of formal versus informal products, see both as complements in satisfying the complex financial needs of the poor.
  3. 3. Underlying analytical insight: Full costs of financial services includetime and risk, not just monetary costs Definition Main Finding Any fees, interest or premiums Monetary associated with the transaction Monetary costs comprise the largest portion of the transaction costs Financial cost of transportation to the costs place of transaction. associated with formal savings. • Time required to complete transaction at the place it is made Time spent completing transactions is Time costs • Amount of time spent on travelling to more costly than travel time. the place of transaction. • Likelihood and amount lost in the Formal Instruments are not risk-free in Risk past 10 years. eyes of the users.
  4. 4. Methodology: Financial portfolios of Indian, Bangladeshi,and South African householdsCGAP commissioned Bankable Frontiers Associates to revisit the households from Portfolios of the Poor to understand changes in portfolio mix:1. Leverage existing data on portfolios of financial instruments over time: Orlanda Ruthven, Stuart Rutherford and Daryl Collins collected data about how much households used financial instruments and what they paid in fees with the Indian, Bangladeshi and South African households that were the subjects of Portfolios of the Poor.2. Gather new data: In 2010, we revisited the same households, updated our knowledge of their financial status and asked more detailed questions about loss and transaction costs.3. Calculate: Fully loaded costs of using financial services (including travel and transaction time and costs) RESULT: Concrete, detailed lens of the costs of financial services within complex portfolios 4
  5. 5. We start with South Africa, where we have the largest sampleand diversified portfolios # of households Share of households that have at least in original SA 152 one… sample Formal 74% # of households 125 Bank account 74% in 2010 SA sample* Formal loan 22% % rural 39% MFI loans or savings - Average per capita monthly income $152 Credit arrangement* 41% (US$)** Formal insurance 52% Median per capita Informal 100% monthly income $104 (US$)** Savings club 65% *We lost 19% of urban sample and 17% of rural Saving in the house 89% sample. **Converted to US$ at current market rates. One-on-one borrowing 73% Informal insurance 66% *Refers to credit cards (including store-specific cards), and credit at a store (general or for a specific good, like hire-purchase) 5
  6. 6. Clarifying what we mean by formal and informal BORROWING INSURANCE SAVINGSFormal Formal Formal• Bank • Life insurance • Fixed deposit• MFI • Medical insurance account• Credit union/ • Vehicle insurance • Private long term cooperative • Funeral insurance investment• Credit card • Crop insurance • Bank account• Store card • Credit union account• Paying on installments Informal Informal Informal• Family and friends • Savings group (with or without • Burial society • Savings in the house interest) • Money guard• Moneylender
  7. 7. Borrowing: If we use a product-centric view, i.e. comparingproduct to product on annualized terms, formal looks muchcheaperSimpleAPR costcomparison:Common conclusionChoose formal options: The overwhelmingeconomic cost is the main problem withinformal instrumentsBut this fails to consider other costs /benefits which differ across loan types:• ESPECIALLY LOAN SIZE• But also duration• Frequency• Transaction costs• Other factors difficult to quantify (e.g. So, we present a more likelihood that a loan will be given ) appropriate comparison in the next few slides…
  8. 8. For a true cost/benefit evaluation, we must switch from aproduct-centric view to a portfolio-centric viewIllustration of a South Africa Financial THE TYPICAL PORTFOLIO ISDiaries budget: Expenditure over 4 DIVERSIFIED ACROSS TIME:months (in $)* …WOULD contain a formal credit card/line of credit. 41% of the sample had formal credit, with an Avg. Jan.- Avg. % of avg. of one credit to pay off (avg.debt size: $270, avg monthly repayment $27, duration: 8 months). Apr. Income ….would NOT contain a formal bank loan. Only 22%Income 730 of the sample had a formal bank loan (avg size: $540, duration: 2 years).Store card 30 4% ….WOULD contain a one-on-one loan. 73% of the sample had one-on-one loans, with an average of 3Bank loan -- -- loans per year(avg. size: $4, duration: 15 days).One-on-one loans 2 0.3% …..would only contain sporadic moneylender loans. Only 26% of the sample had a moneylender loan, on average 1 per year (avg. size: $28, duration: 42 days).Moneylender loans 5 0.6% Diversification is often necessary: formal satisfies larger loan requirements, whereas informal can help during short term and small funding gaps. * Figures in the table above are illustrative and based on calculated averages across the entire sample.
  9. 9. When assessing costs on a portfolio-centric view, the pooractually spend much less on informal loan instruments on amonthly basis Cost comparison within an average monthly budget of $730: Formal Informal Debt repayment, $5.41 Cost per month: $5 Cost per month: $37Informal options impose no travel and transaction costs and have lower interestcosts. The few informal loans that charge interest are paid back within a month.Note: This slide is not comparable to the previous slide because it compares full debt repayment and not interestcost alone. Our respondents were often unable to tell us how much of their payments were interest versusprinciple, particularly in a credit transactions. However, we feel this view better reflect the debt burden onhouseholds because it takes account of the fact that household repay debt in very different time frames - fromone day to one year.
  10. 10. How does this inform our perspective on formal andinformal borrowing options? Additional non-cost considerations: Formal Informal • Is not instantaneously accessible • Usually is instantaneously (except for credit cards, once given) accessible* • Is more private • Is NOT private • Is not flexible • Can have flexible payments Rational Decision for Consumers? • Borrow informally until you need size (e.g. more than 1/3 of monthly income**); until then, the associated transaction costs and the availability of flexible payments make informal the better choice. Lesson for Formal Lenders? • For clients, knowing how much they will be approved to borrow ahead of time is very useful • Ease repayment transaction time *Knowing that they will be able to receive a certain amount is one of the key reasons why households reported they borrowed from moneylenders. **This is the average size of formal loan to income for those who have formal loans
  11. 11. Clarifying what we mean by formal and informal BORROWING INSURANCE SAVINGSFormal Formal Formal• Bank • Life insurance • Fixed deposit• MFI • Medical insurance account• Credit union / • Vehicle insurance • Private long term cooperative • Funeral insurance investment• Credit card • Crop insurance • Bank account• Store card • Credit union account• Paying on installments Informal Informal Informal• Family and friends • Burial society • Savings group (with or without • Savings in the house interest) • Money guard• Moneylender
  12. 12. Insurance: South African formal and informal funeralinsurance are very different; but costs are nearly equal. Cost comparison within an average monthly budget of $730: $47 per month $43 per month Informal options and formal options have similar transaction time costs. Note: Average portfolio has one funeral policy and one burial society.
  13. 13. Formal funeral insurance offers the same value as burialsocieties, but premiums and payouts are on a higher (but stillaffordable) scale Funeral Insurance Burial Societies (Formal) (Informal) • Avg. coverage per dollar • Avg. coverage per dollar contributed (i.e. VALUE)= contributed (i.e. VALUE)= $683= $12,980 payout for a $683 = $3,620 total payout for $19 monthly premium a $5.30 monthly premium • Funeral insurance covers an • Burial societies cover an average of 4 family members, average of 7 family members, or $3,245 per funeral. or $517 per funeral. While average coverage per dollar is equal for formal and informal insurance, the coverage per funeral is much greater for formal funeral insurance than for informal burial societies.
  14. 14. How does this inform our perspective on formal and informalinsurance?Additional non-cost considerations:Formal Insurance Informal Insurance• More difficult/concerning to claim • Easier, more confident in claiming• Money might not come when • Helping hands at the funeral itself neededRational Decision for Consumers?• Treat formal and informal as complements: Informal insurance provides immediate support, while formal insurance provides greater coverage (once received).Lesson for formal insurance?• Need to offer size (i.e. be able to insure for more than 75% monthly income*)• Must promote credibility• Must make it easy to claim and easy to pay premiums – note that it takes just as long to do a premium payment as it does to attend a burial society meeting, but the meeting is with your friends! *This is the average total payout over income for those who have formal insurance.
  15. 15. Clarifying what we mean by formal and informal BORROWING INSURANCE SAVINGSFormal Formal Formal• Bank • Life insurance • Fixed deposit• MFI • Medical insurance account• Credit union / • Vehicle insurance • Private long term cooperative • Funeral insurance investment• Credit card • Crop insurance • Bank account• Store card • Credit union account• Paying on installments Informal Informal Informal• Family and friends • Burial society • Savings group (with or without • Savings in the house interest) • Money guard• Moneylender
  16. 16. Savings: Informal savings is much cheaper than formal, eventhough risk is high and privacy low Cost comparison within an average monthly budget of $730: $18 per month $4 per month 74% of households use banks 89% of the sample save in the house and save an average 22% of 66% of households use savings clubs and their financial wealth there. save an average of 30% of their financial wealth there. Note: Average savings flow/month: formal instruments (8%); informal instruments (12%)
  17. 17. Simply lowering travel time does not increase savings Policies targeting travel time and fees alone did not make a difference in bank savings. With more ATMs and But savings in With Mzansi, ledger branches, transaction times banks stayed the fees were dropped dropped same Financial Sector Charter required branches to be within 20 km from low income areas. Result: Transaction times decreased by 25% and travel time to the bank decreased by 44%.
  18. 18. Automation results in increased savings Higher direct deposit rates resulted in increased savings in banks. Only when direct deposit Financial options to rates increased consider Increase in direct deposit of salary and grant from 29% to 43% of income.* Conclusion? Automation matters as much as economic costs. *The increase in direct deposit of salary and grant was not a result of income fluctuations.
  19. 19. Savings: Formal instruments are still perceived asrisky for the userTwo examples of frequently used financial instruments:Savings clubs: High Actual Losses Banks: High Perceived LossesHigh loss: 6% of users lost an average of High loss: 6% of users lost an average of$346 in the past decade $145 in the past decade.Money “lost” = Money “lost” =– Other members don’t contribute their – There was less money in the account payments than expected (due to monthly charges)– Borrowers don’t repay the club– Money is robbed at the time of Bottom line: If banks improve distribution consumer awareness of rules and fees, this perceived risk couldBottom line: Effective savings decline dramatically.mechanism but very real potentialfor loss
  20. 20. How does this inform our perspective on formal andinformal savings?Additional non-cost considerations:Formal Savings Informal Savings• When using formal savings, the time • When using informal savings, time making the transaction means making a transaction means being in waiting in line a meeting, usually with friends• Doesn’t impose the same level of • Savings clubs have a huge advantage inflexibility as savings clubs in commanding discipline from membersRational Decision for Consumers?• Use savings clubs to “save up”, use bank accounts to receive payments; use savings clubs as much as possible to realistically reach savings goals; use bank accounts to receive and manage incoming funds.Lesson for formal providers?• Convenience and low transaction times• Improve reliability AND ensure that clients understand how the products work• Commitment savings is valued – beyond risk and beyond cost
  21. 21. What if we broaden the view beyond South Africa?• In South Africa, there is a tilt in balances towards savings – this seems to be one of the benefits of having such high participation in savings clubs• In Bangladesh and India, there is a tilt towards debt – in the Bangladesh case this might be due to the higher presence of larger MFI debt to be paid off over a longer period• The result is that the same challenges remain for these portfolios, which the formal sector might be able to address: ▫ Lower transaction times ▫ If properly explained, lower risk
  22. 22. Who did we interview? South Africa Bangladesh India # of households 152 42 48 in original samples # of households 125 34 36 in 2010 samples* % rural 39% 59% 68% Average per capita monthly income $152 $28 $36 (US$)** Median per capita monthly income $104 $23 $17 (US$)**From each of these households, we’ve collected a total of some 3000 datapoints over the past decade – a small sample, but deep data.*In Bangladesh, lost only 1 rural household, but one third of the urban sample. In India, lost 4 out of 28 ruralhousehold, but 40% of urban sample. In South Africa, lost 19% of urban sample and 17% of rural sample.**Converted to US$ at current market rates.
  23. 23. Bangladesh and India rely heavily on debt to form“lump sums”* while South Africa depends on savings Percentage of total lump sums 100% 90% 80% 70% 60% Insurance 50% Loans 40% Savings 30% 20% 10% 0% Bangladesh India South Africa *Total number of sums: Bangladesh (94), India (139), South Africa (65).
  24. 24. In pure monetary flows in South Africa, the outflows attributed tosavings every month are still higher than those for debt payments,fees and premiums, but by a slim margin… Percent of monthly average budget (% of monthly income, US$ above columns) 30% $197 25% $153 20% $134 Formal devices 15% 10% Informal devices $44 $44 5% $22 0% Food Savings outflow Fees, premiums Transport Energy Telephone and debt payment
  25. 25. …But in Bangladesh, it’s the opposite – outflows for debt andinsurance are higher than savings.35% South Africa and Bangladesh comparative financial outflows (% of monthly income)30%25%20%15% Informal Formal and MFI10%5%0% South Africa Bangladesh South Africa Bangladesh savings savings fees, premiums, fees, premiums, and debt and debt payments payments
  26. 26. The cost of time is even higher in India andBangladesh 3.0% Total transaction costs for South Africa, India and Bangladesh 2.5% (% of monthly income) 2.0% 1.5% 1.0% 0.5% 0.0% Formal Informal Formal MFI Informal Formal MFI Informal Bangladesh South Africa India Travel costs Implied transaction time* Implicit risk cost** Time costs are highest for MFIs, which are not as prevalent in South Africa.
  27. 27. There is an even greater emphasis on the need for more reliable services Implicit cost of risk 0.60% (% of monthly income) In Bangladesh, lo In South sses* in 0.50% informal Africa, losses* in In informal India, losses instruments 0.40% instruments are * in informal are nearly nearly the same instruments 4 times 0.30% as the losses in are losses formal 3 times in formal/MFI instruments losses in instruments 0.20% formal /MFI instruments 0.10% 0.00% South Africa India Bangladesh Formal MFI Informal*During the interviews on transaction costs, respondents were asked about money lost through financial instruments in the last ten years. Households couldname as many losses as they had. The rate of incidence is the number of losses divided by the number of users of each type of instrument. Incident rate andaverage loss were combined by dividing the rate of incidence by the number of months in 10 years (120) then multiplying by the average amount lost in eachinstrument. These amounts were then divided by average income in each country to get a percent of income per month number. The ratio of losses ininformal instruments compared to formal instruments is simply the ratio of the risk percentage of monthly income for informal instruments over formalinstruments. In India and Bangladesh, formal instruments includes MFIs, weighting by use of MFIs versus formal instruments. WARNING: THESE NUMBERSNEED TO BE TAKEN AS INDICATIVE AS THESE ARE VERY SMALL SAMPLES AND MANY LOSSES HAPPENED EARLY DURING THE 10 YEAR PERIOD!
  28. 28. Conclusions and next steps• When judged on portfolio-centric merits, there is no natural advantage of formal products over informal product ▫ Informal products often fill a need in portfolios (although not perfectly) that formal products do not• What formal service providers can do to improve their offering and help build better portfolios is to: ▫ Ensure greater reliability across all products ▫ Ensure more efficient transactions across all products ▫ Offer size in insurance and loans ▫ Offer commitment in savings• Next steps – data from financial diaries in other countries will broaden our evidence base: ▫ Mexico ▫ Kenya ▫ U.S.
  29. 29. Advancing financial access for the world’s poor www.cgap.org www.microfinancegateway.org
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