2.2 How do the poor manage their money?
All people, regardless of where they live, their wealth or their livelihood, can benefit from a range of financial services to enable them to manage their household finances in the most efficient way. Obviously the types of financial services that will be most useful will vary from situation to situation, but generally speaking poor people can benefit from being able to access funds to invest in productive or income-earning activities, and to help them through times when their income is inadequate to meet their expenses, be those daily expenses or larger one-off expenses.
According to Collins et al (2009), there are three different types of financial management that all people need to take care of:
- Managing basics: cash-flow management to transform irregular income flows into a dependable resource to meet daily needs. In economics terminology this is known as 'consumption smoothing'; ensuring that you are able to buy what you need to consume on a daily basis even if your income is inadequate or irregular.
- Coping with risk: dealing with the emergencies that can derail families with little in reserve. These types of emergencies are often described as 'shocks' to household economies.
- Raising lump sums: seizing opportunities and paying for big-ticket expenses by accumulating usefully large sums of money.
(Collins et al 2009 p. 18)
Although the details differ from place to place – for example, one study found that only 11% of the rural poor in East Timor were in debt, compared with 96% in Pakistan (Bannerjee and Duflo 2007) – generally speaking, the poor make use of a myriad of informal financial services, and even occasionally formal financial services.
At the individual or household level, there are numerous ways in which poor people manage their finances, planning so that they can meet their daily needs, be able to cope with any larger expenses, unexpected or otherwise, and, hopefully, to invest in better livelihood options in the future, for their children if not for themselves (for example, through education). Poor people save money at home, save in kind, or purchase assets such as livestock or jewellery that can be sold in times of need. We often imagine that poor people are simply too poor to save but, in fact, poor people have been found to save larger percentages of their incomes than rich people. They save because they have to; their lives often depend upon it.
There are also numerous informal financial systems in place through which poor people co-operate to help each other manage their finances better; in ways that fit the more standard definition of financial intermediation. Relatives, friends and neighbours frequently help each other out, sharing each other’s financial resources – lending a little today on the understanding that they will be helped out when they need something extra. Sometimes they spread the risk among a group. Informal savings and loans groups of various kinds are commonly found in rural areas, groups that pool their funds and allocate them to different members at different times, depending on how the system works.
We discussed above how efficient financial intermediation is limited by information asymmetries; the fact that the people providing the service and the potential users of those services often do not know enough about each other to risk entering into financial transactions with each other (lenders might not trust clients to repay their loans, savers might not trust those taking deposits to keep their money safely).
The informal systems described here overcome the problems of information asymmetries and transactions costs extremely effectively, as the transactions are between people who live close to each other, who know each other well, and who know very well the nature of each other's livelihood activities.
These communal methods of mutual support have been described as a 'moral economy', referring to the responsibility people feel for and take for each other, even if it has a negative impact on their own economic status. Helping a neighbour or relative out may, of course, also be seen as a self-interested strategy, if that person will then help you in time of need.
Poor people also make use of individual informal financial service providers. These can range from friends, relatives or neighbours who provide each other with fairly informal loans, with or without interest, depending on the nature of the relationship. There are also people who specialise in providing loans, be they specialised moneylenders, or shopkeepers, traders or landlords. These people are usually able to provide larger loans than those available from friends or relatives, or through group-based systems. There are also individuals who provide savings services, collecting regular deposits from clients and keeping them safe until the client wants to access them. There is often a small charge for this service.
We usually think of the various financial services that can be made available as discrete products and used for specific purposes, for example, taking a loan to invest in a business, saving up money for a child's wedding, or buying health insurance in case a family member falls ill. In practice, however, poor people do not separate the way that they use financial services into neat categories. They may have forms of insurance, but at the same time rely on loans or savings to help in times of need, and they may borrow and save at the same time in order to come up with the money they need when they want it. Again, these practices are not unique to poor people; most of us combine our use of financial services to meet our needs; saving for one purpose (education perhaps) while taking a loan for another (buying a house), or combining insurance payouts and savings to make up for losses (buying a new car).
Saving up and saving down
We tend to think of different forms of financial management as quite different from each other (savings versus loans for example), but it is possible to think of most forms of financial management in terms of savings. One of the benefits of doing this is that it emphasises the common, overarching goal of protecting basic consumption needs whilst responding to requirements for irregular sums of money, whether planned (investments) or unplanned (shocks).
- Loans - a lump sum to be enjoyed now in exchange for a series of savings to be made in the future in the form of repayment instalments. We can think of this as 'saving down'.
- Savings - creating a lump sum to be enjoyed at some point in the future, when the need arises, by making a series of savings deposits now. We can think of this as 'saving up'.
- Insurance – creating the possibility for a lump sum to be received at some unspecified time(s) in the future, if needed as a result of a particular shock. This is done by making a series of savings deposits regularly, both now and in the future. We can think of this as ‘saving through’, as the deposits continue both before and after any claims.
- Pensions - creating a lump sum to be enjoyed in the distant future by making a series of savings deposits now.
- Remittance transfer - enabling migrants to save money and send that money home, to be saved there either in the form of cash or assets or to meet ongoing or emergency household expenses.
Limits to informal financial management systems
Although the informal financial services that poor people use are an essential component of their livelihoods, they do have serious limits. They are limited in the amount of funds they have available and they are usually only helpful for relatively small, short-term financial needs. The resources available from family and friends are often not enough to cope with the many serious financial crises that poor people find themselves in. However, the larger sums of money that may be available from moneylenders are usually very expensive.
While poor people are able to save much more than is commonly thought, the fact that they are poor means that they only have access to limited resources. It also means that there is only so much they can do to help each other out, even when they are affected by shocks at different times. Mutual support systems thus tend to benefit the better off proportionately more; poorer people are likely to have less reliable support networks and thus tend to be hit harder when problems strike.
Access to financial services that enable the poor to manage their finances without having to rely on insecure or expensive forms of saving, asset sales, and unreliable loans can enable poor people to maintain a more stable and secure flow of income, and build up assets in the future.