Bringing Formal Credit to Informal Households

Low-income individuals in developing economies face barriers that limit access to banking. In some countries, a common requisite of banks is that would-be borrowers must have official proof of income. However, this requirement excludes from the banking system all the informal households whose members work in activities that are not registered with the government, and who, due to the nature of their occupations, lack income documents. A case in point is that of Mexico. In this middle-income country, informal households represent more than half the population.

In Mexico, banks have been hesitant to lend to informal clients since they are considered riskier and less profitable. Nevertheless, and although they find it difficult to obtain credit from traditional banks, informal households tend to be active borrowers with alternative suppliers. Informal borrowers rely heavily on loans from relatives and friends, and on more expensive credit suppliers, such as pawn shops and moneylenders.

In a recent paper, I studied the impact of expanding access to bank credit to informal households on their decisions and welfare.¹ To do this, I analyzed the opening of Banco Azteca, the first bank in Mexico to extend loans to households employed in the informal sector.

In October 2002, Banco Azteca opened more than 800 branches across the country. At the time, these branches accounted for 15 percent of the supply of bank branches in Mexico. This new bank eliminated the proof of income requirement, allowing all Mexicans from the informal sector to obtain bank credit for the first time. Different from traditional banks, Azteca’s loans were collateralized by households’ appliances; the bank accepted its clients’ refrigerators or televisions as valid collateral. In terms of costs for borrowers, Azteca’s annual percentage rate (APR) was significantly higher than that of traditional banks: its APR in 2005 was 130 percent compared with 40 percent for regular banks. Nevertheless, it was lower than its competitors; in that same year, pawn shops charged on average an APR of 220 percent.

Using panel data at the household level, which provides information for the same households across several years, I started by analyzing their saving and consumption patterns before and after the entrance of the bank.

The household data consisted of two waves that were collected in 2002 and 2005. By the time of the first wave, Banco Azteca had not opened its branches; but by 2005, Banco Azteca’s presence varied across municipalities. I exploited this variation over time and across municipalities of Azteca’s branches to compare household outcomes before and after the entrance of Banco Azteca.

From this exercise, I found that households whose members were employed in the informal sector had significant changes in their saving and consumption patterns after an Azteca branch appeared in their municipality. Formal households, however, did not change their behavior with the entrance of Azteca, which is consistent with the fact that Azteca was targeting the informal population.

I found evidence that, relative to households from municipalities where the bank did not open, informal households in Azteca municipalities were more likely to borrow from banks, less likely to obtain loans from pawnshops, and less likely to hold liquid savings. While this last result might sound surprising to some, it provides evidence of the existence of precautionary savings among Mexican informal households: in an uncertain economic environment and lacking other financial instruments (such as credit) individuals set aside a precautionary cushion of savings to protect themselves from a bad outcome tomorrow. It is not too surprising to find that when households have other means to protect against shocks, their need to hold liquid savings decline.

In addition, with the opening of this bank, the fraction of informal households owning durable goods increased as did the value of these goods. Moreover, in municipalities where Azteca entered, informal households were more likely to increase their consumption during difficult economic times, such as illness of family members, unemployment, or failure of the family business.

Following this exercise, I developed and estimated a dynamic model of household choices in which Banco Azteca selected the municipalities for branch openings. There are two main reasons for using this structural approach. First, since the entry of Azteca in a given municipality is unlikely to be exogenous, estimating its impact on households’ welfare is difficult. The model deals with this issue by endogenizing the location decisions of the bank. Thus, the estimated model allows me to quantify the impact of the expansion of credit caused by the entrance of Banco Azteca. Second, the model can be used to evaluate alternative policies aimed at extending access to credit. In the paper, I evaluate the effect of a regulation that would cap the interest rate that this new bank charged.

Several policy makers have suggested that this measure would make loans more affordable for more people. However, as capping the interest rate would alter Azteca’s expected profits, this policy could have the unintended consequence of forcing Azteca out of municipalities where it is no longer profitable to maintain a branch. My results suggest that if the government were to cap Azteca’s APR at 40 percent, more households would obtain bank loans and the average size of these loans would be larger. However, in some municipalities this increase in demand would not compensate for the reduction in APR, and the bank would exit from 14 percent of the currently covered municipalities. Importantly, the likelihood of losing a branch would be higher in municipalities with lower per capita income and smaller population size.

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¹ Claudia Ruiz, 2012 — From Pawnshops to Banks — UCLA Working Paper.