Exclusion and Financial Services

The IDB in action

Financial exclusion refers to the processes that impede the access of different population groups to the financial system. The key financial services that can be provided by formal and semiformal institutions include deposit accounts, credit accounts, transaction services, and private insurance products.[1] Although a wide variety of institutions and products are available in Latin America and the Caribbean, large shares of the population continue to conduct personal and business transactions through informal channels, using cash for their transactions.[2]

The benefits of financial inclusion are many. Access to savings products can help families smooth consumption and avoid the limitations inherent in depending on cash flow alone.[3] Maintaining cash in a wallet or under a mattress often presents challenges because of intrahousehold allocation conflicts, self-commitment difficulties, inflation, or high exposure to theft. Access to transaction services such as debit cards, ATM cards, and checking accounts can produce large savings in time and opportunities for better control of funds. These services facilitate drawing funds or making payments. The electronic management of funds through computers, cellular telephones, and other devices can have large returns for entrepreneurs, who can also access relevant business information in a timely manner. Access to credit is critical for increasing the productivity of home businesses, farms, and small and medium-sized enterprises. Entrepreneurs and farmers may also invest in higher-return projects when they can purchase insurance against idiosyncratic or aggregate risks.

It is well recognized that the poor face higher risks for job loss, health crises, and even climatic and natural disasters. While economic theory suggests that more vulnerable populations should have higher rates of precautionary savings, empirical studies have found just the opposite: analysis of household survey data suggests that only 15 percent of poor households in Latin America and the Caribbean have savings accounts, whereas the rate is twice as high for nonpoor households (Tejerina and Westley, 2007).[4] Although the poor may attempt to save by investing in their homes or saving “in kind,” these informal methods are not sufficiently liquid, and these assets can lose value during times of covariate (economy-wide) shocks, precisely at the time of greatest need (Sadoulet, 2006).

Table 11.1 shows the percentage of households reporting credit or savings through any source (formal, semiformal, or informal), and Table 11.2 shows the percentage only for those with credit or savings through formal or semiformal institutions, based on a review by Tejerina and Westley (2007).[5] According to their classification, the “formal and semiformal institutions” category includes regulated financial institutions, such as banks, as well as unregulated financial institutions, which in most cases refers to different types of credit unions and nongovernmental organizations. The “informal” category includes all sources of credit that are not considered financial institutions, such as rotary savings and credit associations (ROSCAs), moneylenders, and relatives. Tejerina and Westley’s information is based on national household surveys which inquire about savings accounts and loans obtained in the preceding year.

Even if the least restrictive definition is used as in Table 11.1, less than one-quarter of households declare holding savings or credit, according to the weighted average. Dropping the informal providers as in Table 11.2 reduces the levels of the “banked” populations, particularly in the case of the households reporting that they have obtained a loan in the preceding year.

Much variation is observed across countries and socioeconomic groups. Of the twelve countries included in Tejerina and Westley’s (2007) study, Jamaica, Panama, and the Dominican Republic have the highest coverage of savings accounts, but only in Jamaica do more than 50 percent of households have an account. In Peru, Paraguay, Nicaragua, and Bolivia, by contrast, fewer than 10 percent of households report having savings accounts. However, the gap between the poor and the nonpoor within each country is striking, as are the gaps between rural and urban households. Across the twelve countries, 28.3 percent of the nonpoor report holding savings, whereas only 10.0 percent of the poor report having them. In their extensive analysis of survey data, Tejerina and Westley find that the gaps in savings between the poor and the nonpoor are larger than the gaps in use of credit. The urban-rural gap in the use of financial services is also important. Use of formal or semiformal credit in rural areas is 3.8 percent compared to 7.4 percent in urban areas, and use of formal or informal savings is 8.4 percent in rural areas compared to 22.2 percent in urban areas.

Most empirical work in this area struggles with the problem of assessing access to financial products rather than usage of the products, a very different concept. This is particularly challenging in regard to measuring access to formal credit, since individuals may have the ability to secure credit but may not have considered the possibility of doing so or may have considered it but decided against pursuing it. Various techniques have been developed to measure access to credit, including direct elicitation, a series of objective and hypothetical questions based on self-reported status, and key informant methodology. The pivotal challenge, however, remains. Empirical estimates suggest that access to financial markets remains a challenge for large sectors of Latin America and the Caribbean, most notably poor rural households. For large shares of the population, financial transactions take place with only minimal involvement of formal and semiformal financial institutions, with individuals relying on extremely informal arrangements rather than deposit and credit accounts.

A variety of factors, from both the supply and demand sides, explain these low participation rates. High minimum balances, monthly fees, and transaction fees deter the participation of low-income clientele in semiformal and formal institutions. The annualized estimated cost of maintaining a deposit account in Brazil and Mexico in 2004 was estimated at US$50 and US$400, respectively, based on a modest set of transactions (Ketley, Davis, and Truen, 2005). A lack of trust in financial institutions is typically a main reason provided by respondents who do not have a bank account. The pervasive fear that savings will be confiscated by authorities on either a permanent or temporary basis was unfortunately given credence during economic crises in Brazil and Argentina. The concern that inflation may erode balances is also a common concern. Strict requirements regarding documentation are also an important barrier to participation. Banks commonly require proof of address in the form of utility bills and proof of steady employment in the form of a series of wage receipts. A formal address and a steady or formal job are common eligibility requirements for opening deposit accounts in the region, according to research by Ketley, Davis, and Truen (2005). The extralegal nature of unplanned communities, established without municipal plans, can contribute to financial exclusion, since dwellings in these communities often lack official addresses as well as formal connections to utility services.[6] Workers in the informal sector and in particular industries are less likely to be able to provide proof of steady salary and employment sufficient to open a deposit account at an institution that requires such proof. Based on a survey of the five largest formal banks in fifty-eight countries, Beck, Demirgüç-Kunt, and Martínez Pería (2006) report that the requirements of a formal sector job and a physical address effectively exclude the majority of the population from opening accounts in developing countries. Ketley, Davis, and Truen (2005) find that the requirements for opening a deposit account in Mexico and Brazil are more exclusionary than those in Kenya or South Africa, primarily because of the required proof of salary income.

Financial literacy and cultural preferences also play an important role, leading less- advantaged individuals to prefer alternative savings instruments such as investing in their home (“saving in bricks”) or through informal savings clubs (ROSCAs). Although these alternatives provide some opportunities for consumption smoothing, they do not provide the full benefits of financial inclusion.

The lack of interest in opening a bank account is a serious deterrent to expanding financial participation. Household survey data in Brazil indicate that one-third of households that do not have bank accounts do not want one (Kumar, 2005).

In terms of supply factors, the higher administrative costs associated with screening and monitoring clients who may lack traditional inputs such as credit histories or collateral lead to higher fees for services. ATMs may not be placed at the same concentration in high-crime areas, potentially disadvantaging low-income populations.

The legal and regulatory environment in a country provides important incentives for lenders. In most countries in the region, it is not legal to use inventories (movable products) as collateral, only real estate or new automobiles (Fleisig, Safavian, and de la Peña, 2006). Countries without a secure transactions environment in which repossession of collateral can be conducted in a timely fashion provide poor incentives for loans to be broadly extended. The lack of developed credit registries further restricts offers of credit to a select set of clients with outstanding records in regard to business transactions (Galindo and Miller, 2001). Moreover, information on bank account features, charges, and costs of borrowing money may not be widely disseminated in accessible language. The degree of discretionary authority loan officers have in approving or denying loans to applicants provides an opportunity for discrimination and favoritism to enter decision making. Audit studies in which demographic characteristics vary across applicants with matched eligibility characteristics provide the best way of measuring these costs of exclusion (Yinger, 1986; Neumark, 1996), but these are only beginning to be conducted in the region and would be difficult to conduct in tightly knit communities where it would be unlikely for strangers to apply for credit.

DIRECT AND INDIRECT INTERVENTIONS TO EXPAND PARTICIPATION IN FINANCIAL SERVICES

Concern about welfare consequences resulting from exclusion from the banking sector has led some governments to promote the extension of banking services, particularly to the rural poor (Besley, 1995). In 2001, Mexico launched a $150 million program to expand banking institutions in rural areas (Taber, 2004). The National Savings and Financial Services Bank (Banco del Ahorro Nacional y Servicios Financieros, or BANSEFI) has two main objectives: (a) to mobilize savings deposits, particularly in areas previously unserved by banks, and (b) to help popular savings and credit institutions meet licensing requirements through technical assistance and a one-time subsidy for upgrading.[7] Banking fees are intentionally kept at a minimum, with no transaction fees charged and only a minimal service fee (about US$5) charged to open an account (Taber, 2004). The BANSEFI program has successfully extended banking services to the unbanked population, with the number of savings accounts in Mexico increasing from 850,000 in 2001 to 3.3 million five years later. By May 2006, there were 523 BANSEFI branches, one-half located in areas unserved by commercial banks (Gavito Mohar, 2006). A full 70 percent of BANSEFI’s customers are women, with average savings balances of US$150.[8]

The explosion of microfinance institutions in the region is often described as a response to the high transaction costs of banking with formal institutions. While these institutions have been extremely successful in extending access to credit to small businesses and the moderately poor, success in reaching the most marginalized populations has been more mixed (Hashemi and Rosenberg, 2006; Copestake et al., 2005; Hulme and Mosley, 1996). A private sector institution in Bolivia, the Promotion and Development of Microfinance (PRODEM), uses technology to overcome many of the most challenging barriers to financial access. The institution has sixty-five branch offices located in rural communities lacking reliable communications infrastructure. PRODEM offers deposit and credit accounts to rural communities through a specialized network of ATMs. The ATMs extend to “unconnected” communities using electronic smart cards in which are embedded the account information and biometrics of the client. The rural branches can communicate digitally with the central office and can rely on hard electronic media when telecommunications services are limited. Along with geographic barriers, PRODEM addresses cultural barriers and low levels of financial literacy through its specialized technology. According to PRODEM estimates, 27 percent of its customers are illiterate and therefore unable to read standard instructions for financial transactions (Bazoberry, reported in Hernández and Mugica, 2003). To overcome this obstacle, a series of interactive transactions has been modified to be voice-activated in Bolivia’s three main languages (Spanish, Quechua, and Aymara), using a simple series of color-coded touch screen transactions. A fingerprint identification system eliminates the need for clients to self-identify regularly using a long account number, which may be merely a hindrance for some customers and for others a cultural affront. PRODEM does not charge a fee for each smart card transaction, instead collecting a modest annual fee (about US$7).[9] By 2006, 255,966 customers had savings accounts and 77,476 customers had active loans (Microfinance Information Exchange, 2006). Although the smart card is activated by fingerprint identification, it is important to note that opening an account requires a valid national identity card.[10]

Land-titling programs, inspired by the seminal work of Hernando de Soto (2000), have proliferated in the region, with the promotion of access to credit as a primary objective. The theory behind these programs is that once families can provide collateral to a bank in the form of the title to their property, the bank will be willing to extend them credit. Impact evaluations of various land-titling programs have shown mixed results with respect to the effect of titling on leveraging credit. Research by Galiani and Schargrodsky (2005) in Argentina found that even when they received title to land (in a quasi-experimental situation), most residents did not satisfy other requirements for obtaining loans, such as formal employment status and personal documentation. Having a title to land was not, therefore, a sufficient condition for increasing access to credit. Evaluations of land-titling programs in Peru and Uruguay have yielded similar results. Boucher, Barham, and Carter (2007) found that the land-titling program in Peru has reduced the share of households that describe themselves as quantity-rationed (defined as lacking collateral). However, they also found that the inability to reduce exposure to risks remained the primary constraint to rationing credit in Peru, with the increase in risk-rationed households muting the effect of titling. In his evaluation of land-titling programs in Uruguay, Gandelman (2007) also found that property ownership did not increase access to the formal banking system or less formal financial institutions. Of households who had requested credit in the preceding year, 93 percent were required to show personal identification and 74 percent were required to show documentation of their wages, whereas only 4 percent were asked to present home ownership documents. The emerging literature thus suggests that personal identification is an important binding constraint for accessing credit, whereas the possession of a property title is required less often.

Other interventions in the region have important implications for expanding financial access to excluded populations, even if increasing such access is not the primary objective of the programs. Many social programs in the region, including conditional cash transfer programs, have shifted to electronic payment of benefits rather than distributing cash to beneficiaries (Duryea and Schargrodsky, 2006). The previous system of distributing cash through administrative offices typically resulted in long lines, and allegations of kickbacks to administrative officers and political bosses were not uncommon.

Although providing subsidies through electronic intermediaries is becoming increasingly common in Latin America and the Caribbean, the services offered and the flexibility provided by the different programs ranges widely. In many countries, including Argentina and Brazil, beneficiaries can only withdraw money from the beneficiary account; they cannot deposit additional funds. The Oportunidades program in Mexico, in contrast, allows beneficiaries to deposit other funds in the beneficiary accounts, and a new option is available to apply for loans (Ayala Consulting, 2006). Although distributing program benefits through banks may encourage some subsidy program participants to open deposit accounts, a more comprehensive intervention such as that in Mexico provides more services to beneficiaries and includes more users in the financial system. As of May 2006, 1.2 million savings accounts had been opened for Oportunidades beneficiaries.

How do beneficiaries view these new payment systems? In an evaluation of the shift to debit cards for the transfer of benefits in a welfare program in Argentina, Duryea and Schargrodsky (2007) found that beneficiaries report high levels of satisfaction with the new system, with 87 percent rating the new debit card system as more efficient.[11] The high levels of satisfaction are highly correlated with savings of time. Moreover, the time saved in retrieving benefits is associated with an increase in hours of work. Beneficiaries also reported fewer problems meeting medical expenses after receiving the debit cards, suggesting that the electronic system provided an instrument to smooth consumption. Although only a small proportion of beneficiaries (4 percent) reported that they had been paying kickbacks on their benefits, this fell to 0.03 percent when the payments were made electronically to the accounts. The survey results also suggest that each household individual gains independence in the use of his or her own money under the system of payment by ATM. The percentage of households surveyed that declare that the household head and his or her spouse decide the use of their own money independently from one another increased from 6 to 12 percent. The results of the evaluation in Argentina regarding time use and autonomy have particularly important implications for women, who tend to bear the time-intensive burdens imposed by the obligations of cash transfer programs.

The design of the electronic transfer card itself can promote social inclusion. In the case of the Jefes and Jefas program in Argentina, as well as the follow-up program Plan Familias, the debit cards were designed to have exactly the same appearance as bank cards held by high-income individuals, so as not to stigmatize beneficiaries as welfare recipients. The debit cards complemented a tax rebate policy implemented by the Argentine government aimed at drawing more expenditure into the formal economy. Under this policy, the country’s value-added tax is reduced by 15 percentage points, from 21 percent to 6 percent, for program participants for purchases made using the debit cards issued by the program. The tax savings is returned to the debit or credit account.

Although the quality and variety of products sold at formal establishments in Argentina is higher on average than that of products available through informal shops, low-income families typically face high effective prices at these establishments, because they do not have a bank card and therefore cannot take advantage of the associated rebate. [12] Evaluation of the modification in the program revealed that beneficiary families shifted their purchases to more formal establishments, making 10 percent more of their monthly expenditures in these establishments after receiving the debit card.[13] Beneficiaries clearly take advantage of the additional opportunity to shop in places typically frequented by higher-income clientele. Thus the country’s new approach to distributing benefits in welfare programs has assisted the government’s efforts to shift expenditures to the more formal economy, potentially increasing the tax base for social policy.

Permitting the deposit of funds from other soures into individual electronic accounts originally designed for a single social program requires a particular administrative framework for the accounts, but this flexibility can be important for promoting savings. After the second monthly payment under the Oportunidades program, 94 percent of beneficiaries hold accounts with positive balances. After the fifth cash payment, 5 percent of beneficiaries make deposits into the account from other sources of income (Gavito Mohar, 2006).

An inclusive financial sector allows poor and marginalized populations to access a broad range of financial services, such as credit, savings, mortgages, and insurance. Financial inclusion can be promoted through larger-scale reforms of the financial sector, including legal reforms that broaden the definition of collateral to movable inventories and strengthen a secure transactions environment as well as support for credit registries. However, inclusion can also be accomplished through well-designed interventions that lie outside the immediate realm of the financial sector. Extending identity documents at both the personal and residential levels has important implications for access to financial services. Social programs that distribute benefits in the form of electronic payments can be structured to promote beneficiaries’ inclusion and expansion into different financial products. New technologies applied to completing transactions, such as cellular telephones, have shown tremendous potential for reducing physical barriers to access. Microfinance institutions have demonstrated that doing business with the nonrich can be profitable; the next challenge is to expand this success to the remaining unbanked. Improving financial access should help families reduce their vulnerabilities to shocks and smooth consumption as well as enable them to respond to better investments.