Poor Need More Financial Services than Rich

September 12, 2017

Why would that be the case?  The answer is risk.  Poor people (especially in developing countries) have a larger share of their assets at risk due to theft, a family illness, or funeral.  Thus, cash flow management is vital for survival for the poor.  The Enlightened Economist discusses a book called Portfolios of the Poor where Daryl Collins and three co-authors examine how the poor in India, Bangladesh and South Africa manage their money. The data the authors use is unique: weekly diaries kept by researchers who tracked these individuals and families. They found the following:

The first surprise is the extent to which poor people – living on or about the $2 a day threshold, or about 40% of the world’s population – use a wide variety of financial services, although many of them are informal. The reason is that such low incomes are typically extremely variable and so there is a more intense need than in the case of better-off people for financial management. Poor people have a greater demand for financial intermediation. Less surprising, perhaps, are the facts that poor people face much greater risks including the risk of theft or unanticipated life emergencies, and that their typical transaction is very small indeed…

The typical researchers’ focus on balance sheets will show that the kind of people who kept diaries for this research will see little change in their (tiny) level of assets from one year end to the next, but there will have been, relatively speaking, huge flows of cash in and out in between. Another insight is that a year is far too long a time horizon for financial decision making – and this includes assessing loan rates using APRs. Most of the time poor borrowers will want a loan for a very short period and may regard the (high) interest rate as a fee for a service.

Thus usurious interest rates may not be so high in levels if paid back quickly.   In other words, the high interest rate translate into a small interest payment for short-term loans, and thus the interest may just cover lenders’ high transaction cost of making such a short term loan.