Chapter 2 main post: How the Other Half Finances

February 17, 2009

Aside from the “bookend” chapters (now there’s an odd metaphor), this book is really a series of perspectives on microfinance: the historian’s perspective, the microfinance manager’s perspective, the economist’s perspective, and so on. The first perspective, in chapter 2 (.doc .pdf), is that of poor clients. To borrow the title of Stuart Rutherford’s great book, it is about the poor and their money.

Aware of the potential presumptuousness of a white American seeing the world through the eyes of billions of poor people, I begin by inventorying how I use financial services, and inviting you to do the same. I then use this as a point of departure to talk about how the financial challenges and strategies of the poor compare and contrast with those of the rich, whom I define to include the materially comfortable global middle class. I argue that poor people want financial services for the same broad reasons as rich people: not only investing (in microenterprises), but also transferring money, managing consumption, attaining ownership of houses and other assets. But the financial challenges for poor households are qualitatively tougher because most poor people do not have jobs. They tend to diversify across several economic activities, often deliberately refraining from investing too much in any one. In general, because of the unpredictability of their financial circumstances, poor people actually need financial services such as savings, credit, and insurance more than the rich–but can access them less.

The chapter closes with a survey of the role of financial systems in economic development, suggesting that the greatest contribution of finance to poverty reduction may lie in supporting the growth of formal, job-creating enterprises.

Do these ideas make sense to you? What seems wrong? Post comments on chapter 2 as comments on this blog entry.

Thanks to Mai Pham and Anna Rain for edits on earlier drafts.

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1. Asif Dowla Says:
   February 22nd, 2009 at 5:33 pm

   David:

   Congratulation on getting out the drafts. If you want the book to be of general interest, you should shun using big words. Whenever you use jargon, make sure you have defined it at least once. I am afraid, the chapter reads like an academic tome. I know how hard it to break out of academic mode to write for general readers. If you want to hold the readers interests, you have to break down the narrative with stories. You have done some in this chapter. But the stories should be a means to get to bigger and important point without using jargon. You can cut down extended quotes from other studies.

   I suggest you read Stuart financial diary stuff (A multi-country study of financial diary will soon be published by Princeton University Press under the title The Portfolio of the Poor). You will find that the poor conduct complicated and complex financial transactions. Stuart found out that the members of Grameen Bank, in addition to borrowing and saving with the bank was participating in ROSCAS and lending and borrowing from other sources as well. The difference is that the amount transacted is rather small and quite frequent. The latter is a way of coping with the day to day vulnerability of life.

   I hope you find the comments useful.

2. Ben Elberger Says:
   February 22nd, 2009 at 7:45 pm

   David, great chapter. It raises a really interesting question: given the poor’s rapacious demand for savings services, is it ethical for microfinance institutions to charge fees to deposit funds and offer no interest (effectively a negative rate of return)?

3. Debbie Says:
   February 26th, 2009 at 3:43 pm

   Hi David,
   I have been involved in micro-financing through KIVA for 3 years. Instead of withdrawing money as it’s paid back, I prefer to reinvest it (using credit accrued from loan repayments) to help finance other loan requests. My initial 4 or 5 loans have increased to 45, in different stages of repayment. There has only been one default.

   Three years ago, the interest charged by a number of field partners was quite low (3-7%). Recently, it’s not uncommon to see rates as high as 58%. I just noticed one (on KIVA) that was 37%. I feel that is still too high. Even though these rates are lower than the local money lenders are charging, it still has to be more of a burden for the person trying to repay the loan.

   If I search long enough, I can usually find a low rate. But it can be quite frustrating. What has changed? And what rate do you feel is too high? Thanks, Debbie

4. Charles Belanger Says:
   March 21st, 2009 at 4:53 pm

   Hi David, excellent chapter, too bad I can’t quote you.

   I am a graduate student at the University of Toronto. I write my major paper on the impact of microfinancing methods on the Microfinance Institutions.

   I have one (empirical) question for which I haven’t found information anywhere: depending on the context, what is the number of client a MFI should have before offering microsaving services? This question is based on the assumption that, usually, with the exception of certain region of Africa, the MFIs usually start with microcredit before offering microsaving.

   Thank you to give me the answer, or to let me know where you think I could find the answer,

   Looking forward to buy your book,

   Charles

5. David Roodman Says:
   March 22nd, 2009 at 7:32 am

   Hi Charles. Readiness to take savings depends on a lot more than numbers. The big issue is that organizations that are entrusted to take other people’s money generally need to be much more tightly regulated than ones that just give credit. So usually they have to be *banks*. I touch on these issues in my Microfinance as Business report and I am sure you could find much more on it, e.g., at the CGAP website (look for “transformation” and “savings”).

6. Uzma Qureshi Says:
   March 26th, 2009 at 5:26 pm

   David, when I first read your inventory of financial services in Table 1, I got the mistaken idea that it was kind of a preference ranking of services. Then I reread it and understood that it was just a list and that the reader was supposed to pick one that she prized the most and your pick was life and health insurance.

   The idea to get the readers to evaluate their relative need for different financial services is a really clever one because it focuses our attention much more clearly on why we demand these services—much more so than if we were to just focus on the various transactions that are facilitated by these services. One can view the list in Table 1 from either a supply or a demand standpoint. In terms of supply, of course, the list shrinks as fewer options are available to the poor, with payday lenders often replacing bank accounts, as you yourself point out. What is also interesting, however, is the demand side. If we were to have a theoretical experiment where these services were available to the poor, how would they rank them? Would the poor agree with you that buying life and health insurance was dearer to them than having access to a savings account? More often than not, even the rich in poor countries, who have access to both savings and to credit, do not carry health insurance. Is that simply a supply problem? Even the MFIs, when offering some rudimentary life or health insurance, often make the insurance mandatory, instead of letting clients select it voluntarily. Research that sheds more light on how the poor rank these financial services would be a critical input in evaluating how well financial institutions are serving the needs of the poor when they do offer only a curtailed set of services.

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