How moving money to the bank helps the poor
There is enormous latent demand for formal financial services among the poor
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Ever since the high-denomination currency was withdrawn from circulation, there has been a spotlight on the possible impact of this move on the economic lives of the poor. Many economists have pointed out correctly that at least in the short run, disruption of the informal economy could impose costs on the poor. Those who support the move point out the long-term benefits to the poor which could result if the additional revenue that the government is likely to earn is transferred to them directly or indirectly. However, the first-order impact of nudging the poor to shift their savings from home to a bank account has not received much attention. This article reviews careful research published in top economic and finance journals on the subject. A key finding is that moving money from home to a bank may have enormous first-order benefits for the poor: The benefits would include increase in income, business investment and health spending, among other things.
Pascaline Dupas and Jonathan Robinson conducted an experiment in western Kenya where they offered access to non-interest-bearing savings accounts to a group of randomly selected self-employed women. Of course, as in any scientific investigation, they selected a control group, which did not get this access. They found that the self-employed women who were provided with access to bank accounts (treated group henceforth) used the accounts actively and consistently increased savings. No such impact was found in the group that was not given access. More importantly, they found that within a short span of four-six months, the business investment of the treated group was higher by 38-56% when compared to the control group. What is remarkable about their study is that 81% of the selected women actually opened the savings account despite the account being non-interest-bearing. The authors conjecture that women have difficulty in protecting their savings from demands placed by relatives and social contacts but, at the same time, face barriers ranging from unfamiliarity to distance in opening a bank account. Therefore, an act of nudging them to open a bank account could have dramatic real impact on future savings, investments and consumption.
Silvia Prina conducted a similar field experiment, closer home, in Nepal. Her subjects were slum dwellers in Nepal. She provided an option to randomly chosen poor households to open a savings account, which did not charge any fee. The account offered a nominal interest rate much below the Nepalese inflation rate. Within a short span, the households that had been given access randomly to savings accounts had increased their monetary savings by 25%, total assets by 12% and, more importantly, these increases did not come at the cost of other non-monetary assets such as livestock and durables. Crucially, the treated group increased spending on education by 20%, spending on rich food by 15%, and showed increased resilience in terms of stability of income even when hit by a health shock.
Simone Schaner offered a short-term subsidy for opening bank accounts in Kenya for a randomly chosen group of married couples. Although the subsidies, in the form of higher interest rates, were withdrawn within six months, the treated group continued to save and earn more when compared to the control group even after 2.5 years. The author conjectures that entry into the formal financial system reduces systematic biases, increases the salience of savings and also boosts the spirit of entrepreneurship among the poor.
Studies that have used the Indian economic setting have also seen similar results. For example, Robin Burgess and Rohini Pande show that bank branch expansion is associated with significant decline in poverty in India. Manju Puri, Jörg Rocholl and Sascha Steffen show that maintaining an active savings bank account helps the borrower obtain loans at favourable terms. It is well known that poor borrowers borrow at atrociously high rates from informal lenders. Therefore, a nudge towards formal banking is also likely to bring down the cost of borrowing for the poor significantly.
The bottom line of all these research findings is easily summarized. There is enormous latent demand for formal financial services among the poor. However, frictions such as distance, fee, minimum balance requirement, lack of trust and social customs, among other issues, keep the poor away from formal savings instruments. However, once nudged into the formal financial system, the poor not only actively transact but also reap real benefits in terms of additional savings, investments and income.
A number of researchers have looked at the issue of how best to nudge the poor into the formal financial system. Shawn Cole conducts experiments in India and Indonesia and finds that mere imparting of financial literacy does not lead to active participation. He notes that some sort of financial incentive for participation does help. Our own initial analysis of Pradhan Mantri Jan Dhan Yojana data reveals that when nudged into the formal financial system, the poor indeed transact actively.
It is crucial to note that most of the experiments, although internally valid, may not be fully generalizable for other contexts. Moreover, in most cases, the beneficiaries were inducted into the system by offering positive incentives. The present situation is different. Therefore, scepticism about the applicability of these results to the present situation is not only valid but also welcome. However, the fact that experiments conducted in several parts of the world have consistently produced directionally similar results should help to assuage these concerns.
If the findings of these studies play out, then there is a case to be made that formalization of the economy may lead to significantly higher benefits for the poor that are independent of likely transfers from the government due to revenue gains.
Prasanna Tantri is senior associate director at the Indian School of Business.