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Entrepreneurial savings practices and reinvestment decisions

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Back in 2005, the International Year of Microcredit, it had already become clear that microfinance is much more than microcredit and that other financial services are as, if not even more, important for the poor.  There has been an increasing focus on microsaving products, with several recent studies gauging the effect of providing the poor with access to formal savings accounts.  Looking across the developing world, however, the large majority of the low- and even middle-income households continue to use different forms of informal saving channels. In a recent paper, we explore how these different savings practices are associated with the likelihood that a microentrepreneur reinvests her earnings into her enterprise.

We make use of a novel enterprise survey conducted at the MSE-level in Tanzania. The survey data was collected by the Financial Sector Deepening Trust Tanzania in 2010 from a nationwide representative cross-section of 6,083 micro- and small enterprises. The respondents of the questionnaire are entrepreneurs with an active business as of September 2010. The median initial capital is about 35 USD and average monthly sales are 149 USD. 50 percent of the entrepreneurs are female. More than three quarters of the entrepreneurs in the sample save for business purposes. However there is considerable heterogeneity among saving practices of Tanzanian entrepreneurs. Informal individual saving is the most popular practice among Tanzanian entrepreneurs. 75% of the savers save informal-individually (i.e. under the mattress), whereas around 13% of them save formally. The remainder save their funds via people outside the household such as members of ROSCAs and moneylenders or give them to household members for save-keeping.

Why would savings practices matter for reinvestment decisions?  In the absence of easy access to informal or formal credit, entrepreneurial savings might become important if liquidity needs arise.  However, the extent to which savings are channelled into the company might depend on the ease of access to these savings, where some informal practices (such as ROSCAS or saving with household members) might not offer as easy access as formal savings accounts or saving below the mattress.

What do we find?

Informed by a simple theoretical model that shows how the reinvestment probability of an entrepreneur can depend on the efficiency of the savings mechanism he has available, we relate the likelihood that a microentrepreneur reinvests her earnings to different savings practices. Our results can be summarized as follows:

  • The probability of reinvestment is higher for entrepreneurs who save than for those who do not. Specifically, entrepreneurs who save formally are nine percentage points more likely to reinvest and entrepreneurs who save informally are six percentage points more likely to reinvest than entrepreneurs who do not save.  This is of economic significance given that 76 percent of all entrepreneurs in our sample reinvest.
  • Within the group of savers, the probability of reinvestment is higher for entrepreneurs who keep their savings in a formal bank account than for those who save informally.  Specifically, the reinvestment probability is four percentage points higher for formal savers. This difference is driven by informal savers who save with others rather than under the mattress and who are nine percentage points less likely to reinvest.
  • The lower reinvestment probability of informal entrepreneurial savers is driven by entrepreneurs who save with other household members. There is a 12 percentage point difference in reinvestment likelihood between formal savers and those who save with other household members.

Obviously, these results might be driven by endogeneity, including reverse causation (entrepreneurs who want to reinvest choosing more effective savings practices) and omitted variable bias. We use two approaches to address this concern. First, we instrument the decision to save with a formal bank account with two (for the entrepreneur) exogenous variables: the geographic distance to nearest branch and the age of the entrepreneur.  While a shorter distance increases the likelihood of saving formally, a higher age first decreases and then (after age of 52 years) increases the likelihood to save formally.   Instrumenting savings patterns confirms our finding that formal savers are more likely to reinvest into their enterprise than within-household savers. Second, we explore whether the reinvestment gap between formal savers and within-household saver varies with specific entrepreneurial characteristics that might mitigate or exacerbate the negative effects from intra-household distributional challenges. We find that the reinvestment gap between formal savers and within-household savers is stronger for female than for male entrepreneurs and less strong for household heads.  These differential effects are in line with theory that predicts a stronger reinvestment gap for those household members with more limited intra-household negotiation powers.

What do we learn from this research?

Our findings suggest that the entrepreneurs who need to protect their savings from consumption commitments of other household members may benefit most from the introduction of formal saving instruments in low income countries. Therefore, from a development policy perspective, targeting entrepreneurs who have low decision power in the household and facilitating their access to formal saving instruments could be thought as a priority.

Note: This research was funded with support from the Department for International Development (DFID) in the framework of the research project `Co-ordinated Country Case Studies: Innovation and Growth, Raising Productivity in Developing Countries'


Thorsten Beck

Professor of Banking and Finance, Cass Business School

Haki Pamuk

PhD. student, Tilburg University

Burak Uras

Assistant Professor

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