Bridging the savings gap4 min read . Updated: 20 Aug 2014, 06:26 PM IST
Considerable gaps exist between human intention and action, and decisions around savings are no different
Kamala earns her living as a domestic worker, and her husband as a rickshaw puller. In spite of their limited earnings, they are determined that their child attend private school, which they hope will secure better job opportunities for him. Their child is due to start school in a few months, when a lump-sum amount has to be paid as admission fees. As such fees are high—almost as much as their joint monthly earnings—Kamala and her husband decide to put aside money every month. Yet, when the fees is due, they find that their money has been spent on other things such as festival purchases and house repairs. They regret this very much, as their only recourse now is to borrow informally from a moneylender at high interest rates.
Kamala’s story is similar to many you frequently hear. Like others across the world, the poor in India wish to save for their future. Yet, why do they save less in formal institutions than their means allow and often less than they intend?
The Reserve Bank of India’s (RBI’s) vision to expand financial inclusion by providing every adult with a bank account is laudable. Prime Minister Narendra Modi’s recent announcement of the ‘Sampoorn Vittiyea Samaveshan,’ (SVS, Comprehensive Financial Inclusion) scheme provides added impetus to this goal. However, will increased access translate to greater inclusion?
While the experiences with savings programmes for the poor in other parts of the world have been positive, the impacts are conditional on people using the bank account: recent randomized evaluations of savings interventions in the Philippines, Malawi and Kenya, implemented by Innovations for Poverty Action (IPA), a non-profit research organization that seeks to expand financial inclusion for the poor through rigorous research, indeed show significant welfare impacts from increased take-up of formal savings accounts. However, the RBI report on financial inclusion and the proposed SVS scheme are guilty of not incorporating knowledge from the latest behavioural economics research to ensure that expanded access to bank accounts translates into sustained usage.
What we now know from behavioural economics—a branch of study that tests insights from psychology as they relate to economic behaviours—is that there are considerable gaps between human intention and action, and decisions around savings are no exception. Behavioural issues such as limited self-control, which this article discusses, as well as information and knowledge gaps and inattention to long-term goals, can act as barriers to financial inclusion. Emerging lessons from behavioural economics, combined with the power of rigorous randomized evaluations, increasingly used in international development to provide credible answers on programme effectiveness, can improve financial product design and promote take-up and usage of these products by the poor, thereby leading to financial inclusion.
To go back to Kamala’s story, although she wants to save for the school admission fees because she values her child’s future education, she spends her money today on consumption goods offering more immediate value. Placing different values on current versus future consumption is termed as having “time-inconsistent preferences". Insights from behavioural economics show that understanding how time-inconsistent preferences affect savings behaviour is essential for increasing savings.
An extreme form of time-inconsistent preferences is a problem of “self-control". Research shows designing savings products that take self-control tendencies into consideration can increase usage of savings accounts. Commitment savings products, such as the SEED (Save, Earn, Enjoy Deposits) account that restricts access to savings until a goal date or goal amount is reached, have been shown to successfully address self-control problems, including for the poor. A randomized evaluation in the Philippines showed that the offer of the SEED account increased savings significantly. However, take-up of these accounts was not universal and varied depending on the design and features of the product, and individual user characteristics and preferences, indicating there is no one-size-fits-all solution.
While such products can be viewed as “hard" commitment products, “softer" alternatives that require a lower level of obligation have also proven effective. These products factor in behaviour termed “mental accounting" in behavioural economics, which refers to the tendency where resources for different spending needs, such as for business investment or education, are viewed as being in different accounts and not interchangeable, even though the available money is fungible. Therefore, policy interventions that aim to address particular self-control problems and increase savings for specific purposes can involve clients labelling accounts for education, health, etc. For example, a recent randomized evaluation in Kenya showed that providing simple savings products earmarked for health expenditures increased the amount spent on preventative health investments, and helped individuals better manage health shocks.
New research using behavioural analysis and randomized evaluations substantially enriches the understanding of savings decisions. Given the new government’s and RBI’s vision to aggressively expand financial inclusion, significant reforms in the design of financial products and services that extend beyond overdraft protection and accident insurance should be forthcoming. Thus, there can be no better time than now to consider these new insights. Surely Kamala and other Indian poor deserve not only access to traditional financial accounts, but also financial products that take the newest wisdom into consideration.
Ruchira Bhattamishra is an independent consultant.
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