Financial Services for Lower-Income Individuals Remarks Prepared for the Conference on Access to Financial Services Bo

1. 1 Financial Services for Lower-Income IndividualsRemarks Prepared for theConference on Access to Financial ServicesBogot�, ColombiaNovember 9 & 10, 2006John P. CaskeySwarthmore College

2. 2 I. Introduction I focus on access to traditional deposit-taking institutions. Emphasis is on access to payments and savings, not access to credit. No discussion of remittances. Examples from the U.S., Mexico, Brazil, and Colombia. Looking for common themes across countries that are very different.

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4. 4 II. What is the Problem? Many people are �unbanked�

5. 5 Who are the Unbanked? Lower-income households, e.g. 25% of households in lower 20% of U.S. income distribution are unbanked Also linked to factors correlated with income and social exclusion: Education Age Minority or disadvantaged ethnic status

6. 6 Why Don�t People Have Bank Accounts? In urban areas, across countries, most common two explanations are: Don�t have enough money to want or need a bank account Bank fees/minimum balance requirements are too high Other relatively more minor reasons Desire for privacy or don�t trust banks Banks won�t let me open an account Don�t have necessary identification Not comfortable in banks or can�t manage account

7. 7 Rarely given reason for being unbanked in an urban area Banks are not conveniently located Conclusion: At least in urban areas, principal barrier is not physical access. It is financial access.

8. 8 Example from a Survey in the U.S.

9. 9 Example from Mexico City Survey

10. 10 Example from Survey in Brazil (urban areas)

11. 11 How do the unbanked obtain financial services and what is the problem? Savings services Vast majority of the unbanked have almost no month-to-month financial savings. Short-term savings are generally held as cash. Some use of jewelry, lay-away plans for purchases, and, in Latin America, informal savings groups (tandas, clubes, or cajas de ahorro)

12. 12 Associated problems Such informal savings are not secure. In Brazilian survey, 66% of the unbanked said that they would like to have an account and the primary reason given was �security.� Living without financial savings is very stressful. Always one small step from a financial crisis. In some countries, bringing informal savings into the banking system could promote productive investment and growth

13. 13 Payment Services In the U.S., the unbanked need to cash paychecks and pay utility bills (water, electric, cable television, etc). Cash checks at banks on which they are drawn or pay a fee at a commercial check-cashing outlet. Buy money orders or pay agent in order to pay utility bills. In Mexico, unbanked cash paychecks at banks on which they are drawn. Pay bills at banks or utility payment offices.

14. 14 In Colombia, unbanked receive income in cash. Pay utility bills at banks. In Brazil, the unbanked can pay utility bills at a Caixa Lot�rica, a lottery store associated with Caixa Econ�mica Federal, or other �bank correspondent� sites.

15. 15 What problems are associated with these arrangements? In some countries the unbanked pay significant fees fees for payment services. (In the U.S., regular users of check-cashing outlets spend about 3 to 4% of their incomes on payment services) In some countries, the unbanked spend much time traveling and waiting to make payments (particularly pronounced in Mexico City). Unbanked must carry cash, exposing them to risk or crime.

16. 16 Credit Services Unbanked are largely excluded from bank loans for two reasons. (1) Bank account is a prerequisite. (2) They have bad credit histories. They get credit from department stores (Latin America) for purchases, payday lenders (U.S.), rent-to-own/lease purchase (U.S.), pawnshops, money lenders, family and friends. Banco Azteca lends to unbanked, but at rates typical for consumer finance companies.

17. 17 The problem is that such sources of credit can be expensive and/or unreliable with few consumer protections. Two conceptually separate issues: (1) The lack of a bank account, (2) The lack of any month-to-month financial savings.

18. 18 III. Strategies to Bring the Unbanked into the Banking System Rationale: Lower cost of payments. Make savings secure. Help the unbanked to build financial savings.

19. 19 Implementation Countries are using political pressure or regulatory power to ensure that banks are physically and financially accessible. Acknowledge that it has been unprofitable to provide a traditional bank account to someone living paycheck to paycheck. Banks responded with minimum balance requirements and fees. Look to technology or flexible service platforms to make serving the unbanked profitable. Some banks and nonbanks see big �niche� segmented market.

20. 20 U.S. example Many banks, in response to political/ regulatory pressures or for internal reasons, offer low-cost low-minimum balance deposit accounts. Some make these profitable with overdraft fees. Others use on-line debit and restricted direct banks access to keep costs low. Growing use of payroll cards. Employer push. Rapid growth in pre-paid debit cards. Some use of bank/nonbanks partnerships to deliver basic saving and payment services.

21. 21 Mexico Use of payroll cards is growing rapidly, esp. for unionized workers. Government is working to improve supervision of �popular� financial institutions and to encourage them to offer low-cost savings and payment services. BANSEFI Government has encouraged chartering of new banks seeking to serve moderate-income households. Banco Azteca example.

22. 22 Comparison of Bank Fees

23. 23 Brazil Extensive use of debit/ATM cards. Since 2000, government has made it easier for banks to work with nonbank correspondents to deliver basic payment and deposit services. Government had banks bid to operate correspondent sites in post offices. 2003 National Monetary Council resolution called on banks to provide a no-fee sight deposit account. Allows 4 withdrawals and deposits per month. Free withdrawals are by card only.

24. 24 Conclusions Progress to date is small but the momentum is strong. Trend appears to be unstoppable. An optimistic conclusion: Clearly technology and flexible delivery platforms will lower costs of serving unbanked. Percentages of unbanked will fall. A somewhat pessimistic conclusion: Bringing people without month-to-month savings into the banking system benefits them modestly. But there is no firm evidence that simply having an account helps people to build savings. Figuring out how to help the poor build savings is harder, and it is not clear that technology will be much help.

25. 25 IV. Strategies to Help Lower-Income Households Build Savings Examples from the U.S. Personal Financial Management Education Rationale: The unbanked may be able to build savings if they are taught to comparison shop, shown how small savings accumulate over time, and taught behavioral tricks that help one avoid unnecessary expenditures or to isolate longer-term savings.

26. 26 Implementation Is it working? Flaws in existing evaluation studies Need for random assignment studies

27. 27 Provide institutional support at �savable� moments Rationale: It is difficult to save out of regular income unless the saving is predetermined, automatic and isolated. May be easier to save from lump-sum payments, and to isolate this savings. What creates lump-sum transfers to lower-income U.S. households?

28. 28 Implementation Two small-scale trials involving tax refunds and the opening of bank accounts in Tulsa and Chicago. Is it working? Most accounts were depleted rather rapidly. A small minority of participants may have been helped to build medium- or long-term savings.

29. 29 Improve financial incentives to save Rationale: In the U.S., people who save in approved ways receive subsidies through tax reductions. Since the poor owe no federal income taxes or face very low marginal tax rates, they have a much smaller financial incentive to save. Perhaps they would save more if they received similar financial incentives as middle- and high-income households.

30. 30 Implementation Individual Development Account (IDA) trials of the late 1990s. H&R Block experiment with opening retirement savings accounts in 2005. Is it working? In the IDA trials, 56% of the participants built savings of $100 or more. But in the one random assignment study, no statistically significant change in net worth.

31. 31 H&R Block results for low-income individuals

32. 32 V. Conclusions A somewhat pessimistic conclusion A rather optimistic conclusion

33. 33 Sources for Data Caskey, John. �"Can Personal Financial Management Education Promote Asset Accumulation by the Poor?" Networks Financial Institute Policy Brief No. 2006-PB-06, March 2006. Caskey, J.P., Duran, C.R. and Solo, T.M. (2006) �The Urban Unbanked in Mexico and the United States,� World Bank Policy Research Working Paper 3835, February 2006 Duflo, Esther, William Gale, Jeffrey Liebman, Peter Orszag, and Emmanuel Saez. �Saving Incentives for Low- and Middle-Income Families: Evidence from a Field Experiment with H&R Block,� NBER Working Paper #11680, September 2005. Klaehn, Janette, Brigit Helms, and Rani Deshpande. �Mexico: Country Level Savings Assessment,� March 2006. Kumar, Anjali. Access to Financial Services in Brazil (Washington, D.C.: The World Bank) 2005 Solo, Tova Maria and Astrid Manroth. Access to Financial Services in Colombia: The �Unbanked� in Bogota,� World Bank Policy Research Working Paper 3834, February 2006.