NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

This is part three of a three-part series; you can read the first part here and the second part here.

Recently, I had the opportunity to have a discussion with David Roodman, who works at the Center for Global Development where he spends most of his time trying to understand the ins and outs of microfinance. He is trying to take a rigorous look at the space to understand what works, what doesn’t and how microfinance can be improved. David is best known for his blog posts about Kiva and about a potential repayment problem at Grameen. David Roodman is writing a book on microfinance which is likely to be published in the fall.

In part one of the series, David and I discussed the importance of credit bureaus and the phenomenon of multiple borrowing. In part two, David described ways in which technology might allow MFIs to reduce interest rates on their loans. In part three we discuss how other financial tools can be used to help those at the base of the pyramid.

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Bryan Farris, NextBillion.net: In your blog and in books like Portfolio’s of the Poor, it is theorized that cash flow is perhaps the bigger issue for the poor then their total level of income. Given that, can you outline some of the types of financial tools that you believe need to be established?

David Roodman: A point that Stuart Rutherford, who is one of the authors of Portfolios of the Poor, has made better than anyone is that financial services such as credit and savings are quite similar.

I tend to think of credit and savings as being opposite. But they are quite similar in that you can save up to start a business or borrow to start a business. You can save up to buy a TV or borrow to buy a TV. In both cases you’ll probably be putting small amounts of money into an account each month or week and then occasionally taking out large lump sums, whether it be the dispersal of a new loan or money taken out of your savings account to buy something big. The same thing goes for insurance: you pay premiums every month which are relatively small over a year and then if something insurable happens you get a large payout.

While the public perception of microfinance has mostly been about credit, it doesn’t mean that that’s actually what’s best for the poor. Many people would prefer to save instead of borrow to serve the same ends -whether to start a small business or pay their kids’ school fees. You can’t get into trouble by saving too much, assuming that there is no fraud and that you really can get your money back when you need it; on the other hand, you can get into trouble by borrowing too much. Therefore, the service that has been emphasized is one that is arguably most dangerous for the poor. It’s not obvious that it’s a good thing to put poor people in debt.

NextBillion.net: Sure. Then what are, in your view, the reasons why credit has been emphasized?

David Roodman: There are good practical reasons for the emphasis on credit, which are not easily overcome. One is that it’s much easier for a start-up organization like the Grameen Bank when it was ne to start making loans to people than it is for it to take their savings. We don’t want just any fly-by-night operation popping up and taking people’s savings.

NextBillion.net: Just driven by trust?

David Roodman: Yes, we need savings institutions to be regulated and monitored so that people don’t lose their savings. That is an important step to earning trust, which takes time. Another issue is that credit can be mass produced as we discussed earlier; you can set up a system with group credit where everybody takes the same loan on the same day. They pay back for a year in 50 equal installments then they take the next loan. It’s sort of streamlined mass production of credit. Savings would be much more of a custom service where I want to put in 10 this week and I want to take out 5 this weekend. All of that activity increases the administrative cost and if you’re not careful it can cost more to process these tiny savings than the savings themselves are worth.

It is easy to say that we need more savings and insurance but it’s still a big challenge to do it. I don’t think it’s an insurmountable challenge; there are encouraging examples of both of insurance and savings being done in poor countries, but it’s an uphill battle.

NextBillion.net: I am curious to hear what your perspective is on informal savings clubs, and whether you think a new entity could replicate something like that to provide a more flexible product. As you mentioned, there’s the risk that it becomes too costly but I’d love to hear your thoughts on how an organization might replicate savings clubs and whether that would require any third party regulatory entity like the credit bureaus that we were discussing before.

David Roodman: Well there is a whole spectrum of possibilities here. It’s true that for centuries people have come up with informal ways to help each other save. In the United States, we used to have Christmas clubs where people would agree to save up week by week as Christmas approached. In many poor countries people have created Rotating Savings and Credit Associations or ROSCAs, where %7e15 people get together and each will put, for example, $10 into a pot each week, and they take turns collecting the pot. So you put in 10 every week and every 15 weeks you get $150 out. This is a way of helping people discipline themselves to save. One of the nice things about ROSCAs is that you don’t even have to worry about where to store the money because it instantly gets transferred to whoever gets the next payout.

One approach that’s been getting more attention in the last few years is the Village Savings and Loans Association. It was developed by CARE and it’s been popularized by several other groups. Basically it involves training very poor people to do a more complicated version of a rotating savings club. To do this, they bring in a box with several locks on it and a different person has the key to each lock. As a group they save up and once they’ve got a certain amount of money, they can turn around and lend it to each other or maybe to other people outside the group. All that the external agent is doing is helping set up these groups and training people to operate them. The system requires minimal involvement, which is appropriate when you’re trying to reach the truly poor like in rural Niger. The poorer the people and the smaller their transactions, the more you need to cut costs to serve them sustainably. Here there is essentially no long-term cost.

The other extreme is to provide something much more like a formal savings account like we have in America. Given the option, that is what most people would prefer. They would rather have their money safely in a bank where they can take it out and have more whenever they want, secure that the government is in fact insuring their money. The various informal systems that people develop are less safe. For instance, when an individual enters a ROSCA, they have to put in $10 each week. If they’re the last person who gets the pot, they’re participating on faith. They’re betting that after 14 weeks of you putting in their money, on the 15^th week everyone else will ante up. There’s no guarantee; these things do fall apart and people do lose their money.

There is a spectrum where the higher the quality of service, the more it costs to provide it and the larger amounts of money need to be involved in order to make it economical. As a result it is the richer people who are targeted for those services.

There is always a hope that high technology will reduce costs so that you can provide higher quality service at lower costs than you once incurred.

NextBillion.net: Sure. I’m not quite sure how it would look, but do you think that there is room for an organization similar to Kiva or the other the number of the other similar sites that would be focused on connecting people to encourage saving or insurance?

David Roodman: I think it’s definitely worth exploring. There was a discussion panel here in Washington about matching savings programs (A video of the panel is featured on the New America Foundation site here). The speaker was Daryl Collins, one of the authors of Portfolio’s of the Poor, and she had some rather interesting critical thoughts about the system and the limitations of it. I can’t recite them for you right now but it’s an interesting idea to explore and like everything else it’ll have its strengths and weaknesses. I am very intrigued by it and I love the idea of matching the savings of the poor people to encourage them to save.

NextBillion.net: David, Thank you for taking the time for this discussion. This has really been fascinating for me and very enlightening for the NextBillion community.