Tailoring Formal Financial Products for the Poor
In our last post, we shared findings from the South African, Bangladeshi and Indian Financial Diaries that built the case for formal and informal financial services serving different purposes in the portfolios of the poor. We found that the two should be viewed as complements rather than alternatives to each other. For example, informal borrowing can be quite flexible and is accessible readily, whereas formal credit may provide larger loan amounts, and has the added benefit of privacy. Now, we’d like to delve deeper into our findings to help formal financial providers tailor and target their offerings to fit the broad financial needs of the poor. To see all the details across three countries and three products, download the deck. Let’s take a look at insurance and savings products in particular.
Surprisingly, we found that most of the low income South African households sampled usually hold two types of insurance products -- informal and formal. Both types of insurance offer similar value and households spent about the same amount on each type (see figure below).
Given the transaction time and costs, why aren’t people using just one insurance policy, either formal or informal? Our findings show that each type of product serves a distinct function within portfolios. For example, informal burial societies provide physical and emotional support during funerals. Even wealthier people, who use a number of sophisticated formal financial tools, contribute to burial societies as a way of staying connected to their communities, particularly in rural areas. However, the payout from an informal burial society is not nearly enough to cover all the costs of a funeral and therefore users need to manage several different funeral insurances.
Formal funeral policies have their drawbacks as well; their transaction time is unexpectedly high. They are paid by debit order from a bank account. However, many low income people withdraw all their money from bank accounts all at once when they receive salaries or government welfare payments so they have to go back to the bank to stand in a line and re-deposit money before the debit order is released. Clearly, formal insurers should make paying premiums more convenient through easy payment systems done at grocery stores or via a cell phone. Also, households perceive higher risk of loss in formal funeral schemes than in informal ones. Many respondents in the Financial Diaries sample households experienced a lower-than-expected payout from their formal plans, creating this high perceived loss. Making sure that funeral plan terms are communicated well and easy to understand is not only good consumer protection but good business.
Formal and informal savings instruments in South Africa in almost every dimension of cost (see figure below). Overall, even when taking transaction and travel time into account, banks are more expensive than informal savings services. Bank accounts incur both monthly service fees and high transaction fees, along with long transaction times. Informal instruments, usually savings clubs, incur negligible fees, but the real costs come in both risk and transaction time (meetings can last several hours). Many households have lost money in savings clubs, often at the end of the term when the entire lump sum is to be paid out. While there is reported risk in banks as well, the amounts are much smaller and are usually due to a misunderstanding of the fees.
Our return to South African Financial Diaries households also allowed us to compare household savings patterns during a time between 2004 and 2009 when the Financial Sector Charter pushed branches and ATMs closer to low income neighborhoods and the no frills Mzansi account was introduced. Over this period, travel time to a banking services decreased by 44% and transaction times decreased by 25% for our South African sample. Although one would imagine that savings at the bank would increase as a result, we found no change in savings patterns. Given the comparisons above, perhaps Mzansi’s fees were still too high and travel costs among our particular sample were never really a barrier to savings. However, we also found a substantial increase in the direct deposit of salaries and grants, which corresponded significantly to an increase in bank savings as a share of financial assets. This suggests that it is not only the decrease in time and expense of travel, but the convenience of direct deposit and other electronic mechanisms that could encourage behavior change.
There are two main conclusions to be drawn here. Firstly, one real benefit of bank savings is the link to a direct deposit service (i.e. not have to wait in line). Secondly, another benefit is a reliable, low-risk service. An additional benefit would be for fees to come down, as $18 is a huge leap from $4 in a budget of $730 per month.
Extending the analysis to South Asia
So far, these insights have been gleaned from South Africa, where we had the best data, but we also did some exploration of India and Bangladesh. “Lump sums” (amounts about the size of one month’s income) were raised mostly with loans in our Bangladesh and Indian Financial Diaries households, compared to our South African households where lump sums were mostly raised by savings.
What can financial providers in Bangladesh and India do to attract more business with low income clients? The deck suggests that the cost of transaction times is much higher in formal and MFI-provided services than informal ones, and the risk of formal services is several times higher than risk experienced in informal products. The message reached for formal providers in South Africa – to improve convenience and demonstrate reliability – goes double for South Asia.
The bottom line
In summary, we find that there is no natural competition between formal and informal financial products. Formal products, like credit and insurance, certainly offer larger sizes, but informal instruments can fill other needs such as flexibility, immediacy and links to the community. Formal sector providers can offer low-income clients both lower transaction times and more reliable services. Our South African data suggests that marginal reductions in cost and time may not have a large impact. A dramatic change in convenience though technology like cell phones that can drastically reduce transaction time and eliminate travel time are increasingly looking to be a necessary ingredient to change behavior. Additionally, if they ensure that consumers are well informed about product risks and fees, consumer protection can become effective marketing.
We are looking forward to comparing these results to the new sets of financial diaries currently underway across Kenya, Mexico, the U.S., South Africa and India.
------- Daryl Collins leads research at Bankable Frontier Associates, and is especially interested in demand-side work. Claudia McKay is a Financial Sector Specialist at CGAP.