This week the Fridays Academy series falls on a Saturday (sorry for the delay)
From Raj Nallari and Breda Griffith's lecture notes:
Policy Measures to Increase Access to Financial Services
Although, as we have seen, financial services can have very beneficial effects, usage of financial services in developing countries is far from universal, as Claessens (2005) discusses. Instead, financial systems are often skewed towards the better off, catering mainly to large enterprises and wealthier individuals, and allocated on the basis of connections and non-market criteria. Often, many segments of the enterprise and household sectors suffer from lack of access to finance at reasonable cost, hindering growth. Claessens finds that for most developing countries, basic bank account usage does not exceed 30 percent of households, and in the lowest-income countries, usage is less than 10 percent.
Although low usage levels may reflect lack of demand rather than lack of access, Claessens argues that this is unlikely to be the case in many developing countries, simply because usage is so low. If supply of financial services is limited, as appears to be the case, is this because banks are unwilling to supply financial services because of the perceived poor quality of many customers? Or are there barriers to supply and, if so, can these be removed? Or is there some form of “market failure” that government intervention can address?
Lack of demand can arise if financial services are too costly and not well tailored to customer needs. If this is the case, households and firms may rely instead on informal forms of finance. But there are some grounds for hope here. For instance, in 2004 in South Africa, the country’s major banks launched a low-cost bank account aimed at extending banking to low-income households. Reportedly, initial take up has been very high. The sharp drop in the costs of international remittances also suggests that banking services are being extended at a more reasonable cost to wider segments of the population.
Turning to supply barriers, we will shortly discuss micro-finance developments, the main movement towards extending the provision of credit in developing countries. Also on the supply side, in developing countries the use of savings and payments services can be provided through postal and saving banks.
More generally, for a sample of more than 90 countries, Beck, Demirguc-Kunt and Soledad Martinez Peria (2005) show those countries with better developed financial systems have services that are more evenly distributed among banking clients. This suggests that the overall institutional environment can play a role in the supply of banking services. It has also been shown that the quality of legal systems, property rights, and the presence of reliable information mechanisms are especially important for the supply of credit to small firms. Banking system regulations can also hinder usage. For instance, interest rate or legal lending restrictions can make it difficult for financial services providers to offer profitable saving or lending instruments.
Against this backdrop, better legal, information, payments systems, distribution and other infrastructures appear to be needed in many developing counties. Many of these reforms are, however, difficult and time-consuming. To complement these policies, Honohan suggests that another important way to enhance access—and one that is often easier than improving the institutional environment—is to improve competition in banking systems. For instance, smaller and non-bank financial institutions (including department stores) can be allowed greater use of existing financial networks. Allowing greater entry by foreign banks can further enhance competition and access to banking services by the population at large. Claessens cites the example of Mongolia where the failed government-owned Agricultural Bank was sold to a Japanese investor and became a highly successful bank providing far greater access to the population at large than previously. Foreign ownership can also induce greater financial stability and improve the overall efficiency of financial intermediation.
Whether universal usage should be a public policy goal is, however, an open question. The fact that the poor do not use financial services may be more a problem of poverty than a problem of access. Also, there is as yet insufficient knowledge at the micro-level of what the benefits and impacts of finance are. For example, access to credit may be a problem when it leads to over-indebtedness, as poor can be uninformed and overborrow, often at unfavorable terms. General public interventions can nevertheless be useful in some cases, but will need to be carefully introduced. Governments can try to make social security, tax and other payments in such a way as to encourage more bank access, by making them electronic to the extent feasible. Authorities can also mandate banks to provide minimum banking services for otherwise excluded segments of the market.
Next week: A Brief History of Financial Sector Reform in Developing Countries