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Transcript of Delien Hans
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CHAPTER 2
SAVINGS AND RURAL DEPOSIT MOBILIZATION
The objective of this chapter is to develope a conceptual framework to analyze determinants of
rural deposit mobilization. The chapter is divided into five parts. The first part reviews the role of
finance in economic development, and it surveys traditional views regarding rural financial markets.
The second part focuses on the importance of financial intermediation for the economy as a whole and
on the importance of deposits for financial markets, and it evaluates past policy designs and their
impact on financial markets. The fourth part analyzes the problems in achieving a cost-effective
deposits mobilization in less-developed regions and risky environments, and it reviews the efforts to
improve the regulatory framework needed to achieve safe deposit taking. The fifth part examines the
determinants of deposit mobilization, and it highlights theories of savings behavior for credit
constrained households in developing countries.
2.1 Finance and Economic Development
Finance plays a vital role in economic development. Since the late 1950s several authors
already underscored the role of finance in economic development (Tobin, 1965, Patrick, 1966, Gurley
and Shaw, 1967). It was not until the publication of the work of McKinnon and Shaw argued that
financial repression for a small size of the financial sector, for keeping the rates of return on money too
low, and for inhibiting economic growth. Financial repression results mainly from four kinds of direct
controls :
(a) the control of aggregate bank liquidity and credit,
(b) the control of interest rates,
(c) qualitative controls of band credit,
(d) foreign exchange controls.
These controls distort financial prices and reduce the real size of the financial system.
Strategies of financial repression gravely retarded economic development in many countries.
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Techniques of financial repression have included low and even negative lending interest rates,
high reserve requirements, the use of selective credit policies through specialized financial institutions,
and controls that result in high intermediation costs (Fry, 1981)
The dependency of rural financial markets on cheap funds through rediscount mechanisms
discourages intermediaries from aggressively mobilizing rural deposits (Vogel, 1980, Adams, 1984).In the absence of attractive deposit services, most of the accumulated rural savings are dept in non-
financial forms (e.g, gold, land), or are invested in assets generating low marginal rates of return
(Gonzalez-Vega, 1985).
Efficient rural financial markets draw resources from unproductive investments, particularly
inflation hedges, by offering positive real rates of interest on deposits (Vogel, 1984 ; Bhatt and
Meerman, 1978). In turn, rural financial markets allocate these command over resources toward the
most productive investments.
2.2 Importance of Financial Intermediation
Surplus units posses a comparatively ample endowment of own resources which, when applied
to their own productive opportunities, render low marginal rates of return. Deficit units possess few
resources in comparison to their productive opportunities and as a result their marginal rates of return
are relatively high. Surplus units have comparatively more resources than opportunities, while the
opposite is true for deficit units. In general, differences in marginal rates of return are a signal of
opportunities to increase the efficiency of resource allocation in the economy (Gonzalez-Vega, 1984)
Direct financing (transactions between surplus units may charge interest rates higher than the
marginal rates of return they would obtain from alternative investments. In turn, the inflow of
resources allows deficit units to engage in projects with marginal rates of return high enough to pay the
principal and rate of interest on the loan.
Although direct finance improves the welfare of both types of units, the process is costly.
Double coincidence of interests is necessary to close the transaction: surplus and deficit units must
agree on loan size, maturity and interest rate. When they have limited information about each other,
transaction costs are bid up. Because of the high transaction costs involved, many surplus and deficit
units may be unwilling to participate in financial markets, which narrows the scope of direct financing.
In contrast, indirect financing allows financial transactions between surplus and deficit units
through specialized intermediaries such as banks. Hanks provide deposit facilities to surplus units
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which are more attractive than the alternative investment opportunities they may posses. Intermediaries
also offer more flexible terms and conditions to borrowers than individual surplus units do.
Informal or non-institutional forms of direct financing preceded formal indirect financing
through the banking system. In effect, moneylending activities have taken placed for centuries in risky
environments. In most cultures , however, moneylenders have been characterized as evil. This biasagainst money lenders has influenced the authorities in attempts to reduce the range of action of
moneylenders, especially in rural areas.
In the 1980s, the criticism against moneylenders was challenged on the grounds that :
(a) there is free entry and exit into money lending activities and, therefore, monopoly
profits are likely to be eroded away by newcomers,
(b) the interest rates changed usually reflect the opportunity cost of money,
(c) interest rates incorporate lender transaction costs and a premium for risk, and
(d) policymakers have ignored that consumption purposes, such as weddings and illness,
can also explain the demand for loans ( Bottomly, 1983, and Singh, 1983)
Moneylenders have satisfied many demands for loans of the population has also found informal
alternative forms of holding accumulated savings (livestock, inventories, jewelry) or informal
arrangements such as savings clubs, cooperatives or rotating savings
agreements, which have been present to fulfill many of their demands. Informal markets,
however, have also left many demands for financial services unsatisfied (Gonzalez-Vega and Graham,
1995)
In attempts to displace the moneylenders, development finance efforts had focused almost
exclusively on the provision of credit. During the past decade, however, the introduction of deposit
facilities tailored to the requirements of small savers has become an important topic in development
finance. Deposit mobilization was called the forgotten half of financial development, due to the almost
exclusive prior attention to credit (Vogel, 1984)
The new view has emphasized the social and private benefits of deposits. Social gains arise
from the reallocation of resources for investment, transferring them from relatively low-return uses to
high-return alternatives through financial intermediaries. The improvement of resource allocation
reduces the dispersion of marginal rates of return in the economy (McKinnon, 1973). Private gains are
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enjoyed by depositors, borrowers, and financial intermediaries. Depositors may find in financial assets
safer, more liquid, and profitable forms to store wealth. Their risks are reduced and their earnings
increased by access to deposit facilities. Borrowers benefit from the expanded availability of loanable
funds for investment projects and from lower transaction costs.
Intermediaries also benefit from deposit mobilization. First, deposits represent a more stablesource of funds for intermediaries than reliance on loans from the government or donor funds. Hence,
independence in the formulation of credit policies and less donor and government intervention are
possible. Second, deposit services reduce risks of adverse selection and of default, due to valuable
information obtained through the deposit behavior of the clients. Finally, the combination of credit
and deposit activities may generate economies of scope for the intermediary as well as for the clients.
2.3 Faulty Assumptions and Rural Development Policies
Traditionally, the complexity of the rural sector in developing countries was ignored or
underestimated. Faulty assumptions underpinned the views that :
(a) only the activities of farmers are important and need to be promoted,
(b) farmers are so poor that they are not able to save, and
(c) farmers are inefficient in the allocation of their resources, due to lack of knowledge and
the use of traditional techniques.
These beliefs have been challenged by many authors. Meyer and Alicbusan (1984), for
instance, mentioned at least four sources of heterogeneity which contour the complexity of the rural
sector :
(a) the wide range of economic activities in which farmers and non-farmers are engaged,
(b) differences among farmers in both access to resources and investment opportunities.
(c) different patterns of cash flows that lead to continuous shifts from a deficit position to a
surplus position, and
(d) differences in family life cycles.
As a result of this heterogeneity among farmers, credit and savings activities in rural areas are
common and have a long history. Many authors have documented informal arrangements in rural
areas. Adams (1983), for instance, documented rotating savings and credit associations in Asia and
Latin America. Bouman (1983) and Holst (1985) reported ablut indigenous banks, credit societies, and
rotating savings. Several studies reported in Adams and Fitchet (1992) and in Bouman and Hospes
(1994) further documents these activities.
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The traditional view of rural finance led to policies that reduced the viability of financial
institutions ad retarded deposit mobilization efforts. Adams (1985) argues that because of the flows of
cheap refinance and rediscount funds, bank managers pay less attention to deposit mobilization. Cheap
credit forces bankers to offer low interest rates on deposits, which in turn discourages depositors.
2.4 Costs of Deposit Mobilization
Schmidt and Zeitinger (1994) summarized the importance of deposit services and deposit
mobilization, First, financial intermediaries provide deposit facilities to the relevant target group (e.g,
the poor) and mobilize funds that they employ in their lending business. Deposit mobilization enables
financial institutions to lend without being overly dependent on foreign financing and on money
creation by the central bank. Second, there is a demand for deposit facilities in any economy. In strict
contrast to what many experts long believed, poor people demand deposit facilities. If there is an
institution accessible to them, such as development banks, the empirical evidence suggests that
deposits can be mobilized. Third, financial institutions that have no access to other sources of funds,
because they are not integrated to the financial system of the country and thus cannot borrow from
other institutions, have to mobilize deposits in order to undertake their lending activities.
Schmidt and Zeitinger (1994) raised several questions, however, about the importance that all
financial institutions must at all times provide to the target grout deposit facilities and mobilize the
bulk of the funds for their lending business from depositors (p.86). The first argument these authors
raise is that the target group of small entrepreneurs already have more easy access to deposits facilities
than they have to credit services. Thus, when one looks at the demand side, there is less justification to
develop deposit facilities designed for the target group than there is for promoting credit services for
small and micro entrepreneurs. If there are other institutions in the financial system that already
provide adequate deposit facilities, this may be a good reason for an institution specialized in lending
activities for the poor to focus on this mission.
The second question raised by these authors is how important is the mobilization of deposits
from the target group of the poor for the operations of specialized financial institutions. Will deposit
mobilization enable the institution to become self-sufficient and achieve significant growth ? More
important, how expensive is it to mobilize deposits ? These questions do not have easy answers.
Schmidt and Zeitiger (1994) consider the arguments of positive synergies between credit and
deposit businesses, which presumably improve borrower willingness to repay, unconvincing in the
case of poor clientele. Further, the assumed moral and political obligation of development finance
institutions to instill a spirit of prudence into their poor customers is considered as inappropriate.
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The argument that deposits should be offered because there is a genuine demand for such
services is valid, but the deposit mobilization experiences analyzed by the authors (BancoSol, Bolivia ;
Cajas Municipales, Peru; and BKK, Indonesia) indicate that deposit mobilization is an extremely
expensive undertaking. Lepp (1994) reached also similar results. Therefore, it is important to consider
in each individual case whether there are other financial institutions in the domestic financial systemthat could provide this service to the target group. This is frequently the case, at least in urban areas.
The authors find the concept of an inter-sector full-service bank more reasonable from an
economic point of view than the intra-sector full-service bank concept. Intra-sector banks are
institutions that mobilize deposits from and lend to the same target groups (g. g, the poor). In contrast,
inter-sector banks attract depositors from some sector (the middle class) to lend to another sector (the
poor). The deposit-taking institution, however, incurs high costs of funds when mobilizing deposits
form middle and low-income savers. Not only must it pay high interest rates on deposits and incur in
considerable administrative costs, but the institution must also offer a broader diversity of financial
products such as credit cards, currents accounts, and other services to meet the demands from the new
clientele. This could ultimately induce a gradual shift away form its target group (the poor)
Schmidt and Zeitinger (1994) also show that an important proportion of the deposits in the
microfinance institutions studied came from a few medium-size depositors and from big institutional
depositors, which combined held more than 60 percent of the deposit volume. These clients usually
prefer short-term time deposits rather than long-term time deposit contracts. This might have adverse
consequences on the institution, because of the high volatility that such deposits tend to exhibit,
creating a high degree of liquidity risk.
Thus, the inter-sector full-service bank concept proves difficult to implement in an
economically-sound basis in the case of microfinance. The question raised by the authors is, therefore,
why an intermediary which is specialized in lending operations for the poor and which is already
attempting to develop a market that is difficult and expensive to serve should be expected to deliver
deposit facilities also, which are difficult and extremely expensive to provide and which can endanger
the successful efforts on the lending side ?
2.5 Some Principles of Prudential Supervision in Microfinance Programs
The expansion of the supply of deposit facilities by several microfinance institutions in Latin
America and other developing countries has significantly increased the volume of their liabilities. In
the microfinance world, however, there are many badly-run and financially-weak semi-formal
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institutions that mobilize deposits or require their borrowers to keep compensatory deposits as a
condition for their loans. An important policy issue is how to protect the deposits of the poor in these
institutions.
Although financial liberalization has expanded the range and volume of lending and deposits
activities, often this expansion has been accomplished without improvements in prudential regulationand supervision. Recently, several authors have focused on regulation and supervision issues (Vogel,
1994 ; Chaves and Gonzalez-Vega, 1994).
Vogel (1994) points to two forces propelling successful microfinance programs towards some
kind of formalization deposit mobilization and leverage. This author also lists two key features of
microfinance programs that need to be considered in any regulation and supervision scheme. First, loan
delinquency in successful microfinance programs is lower than in commercial banks, but it can be
more volatile. When a microfinance intermediary faces high levels of delinquency, it can lose a higher
percentage of its equity than a bank with a similar level of delinquency. This may be due to the
absence of tangible guarantees and to the short-term maturity of the loans.
Second, the potentially greater volatility of delinquency rates with a greater threat to equity
suggests the need for more frequent reporting for microfinance institutions than for banks. This author
argues that microfinance programs are highly sensitive to institutional failures. These failures may
generate a run on deposits resulting in the collapse of the whole microfinance system. In addition,
many microfinance programs have limited capacity to increase their levels of capitalization. In the
event of a run on deposits, institutions have no clear and solvent owners who can rescue the program
with inflows of additional capital. Therefore, examiners may need to the specially alert in determining
the actual and potential capital adequacy of a microfinance program. For this, examiners need to have
special skills and attitudes. Similarly, agencies dedicated to the supervision of microfinance institutions
need to have a special orientation. Therefore, a common supervisory agency for both banks and
microfinance programs is still an issue of debate.
In order to achieve a safe and sound microfinance system, a technical paper of FAO (1995)
remarked, that, in addition to a prudential regulation and supervision scheme, it is important to provide
facilities of a lender of last resort to prevent temporary liquidity problems. This paper also discusses
the moral hazard problems of deposit insurance systems. Arguing that under these schemes depositors
have less incentive to choose more
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Stable financial institution and that financial intermediaries have less incentive to abide by the
discipline of the market, the paper highlighted that deposit insurance can only provide adequate
protection, if :
(a) the microfinance system has access to at least a fairly stable banking system,
(b) the microfinance system is covered by an adequate prudential regulation andsupervision mechanism, and
(c) the microfinance system exhibits a willingness to adequately fund a deposit insurance
scheme.
Chaves and Gonzalez-Vega (1994) discussed some principles of prudential regulation and
supervision for microfinance programs. These authors argue that :
(a) regulation should not introduce competitive biases among financial intermediaries,
(b) the negative effects of regulation on the efficiency of the financial system should be
minimized,
(c) regulation of financial markets should not be used to promote the achievement of social
objectives, and it must rely as much as possible on the self-interest of economic agents
(incentive compatibility),
(d) the purpose of regulation and supervision should not be to avoid bank failures at all
costs, and
(e) the regulatory framework should be flexible enough to attempt to regulate different
intermediaries in a different manner when necessary
As noted by several researchers, deposit mobilization is of a paramount importance for the
financial system and for financial intermediaries, but one must be cautious and analyze first the relative
advantages of each institution, the organization of the financial system, as well as the maturity of the
financial market before engaging in serous efforts to promote full-service microfinance institutions.
2.6 Determinants of Savings and Deposits
Savings are generally defined as the excess of current income over current expenditures.
Savings are also defined as the change in net worth resulting from the change in physical asset holding
plus the change in financial assets minus the change in financial liabilities during a given period. There
is a close relationship among the flows of income, consumption, and savings. Households make
intertemporal decisions between consumption now or consumption in the future through savings and
investment.
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The postponement of consumption leads to the accumulation of the stock of wealth (net worth).
Wealth comprises both financial and non-financial assets. Non-financial assets in agriculture typically
include land, irrigation, facilities and other improvements, buildings and equipment, inventories, and
livestock. Gold and other non-productive assets are also held in some countries as precautionary
reserves and inflation hedges. Financial assets include cash, deposits and other financial instrumentssuch as government securities or bonds. Deposits are one type of financial assets, and financial assets
are a component of total wealth.
Alternative theories have been developed to explain the relationship among income,
consumption and savings and the extent to which some variables, such as interest rates, affect savings
and deposits.
Keynes (1936) awoke a great interest in the analysis of the consumption function. National
income data and cross-sectional analysis confirmed the hypothesis that consumption is a positive but
decreasing function of income, so that the marginal propensity to consume is lower then the average
propensity to consume. The opposite is true for savings function. In the early 1930s, high
unemployment, deflation and high real interest rates had a significant impact on Keynesians, who did
not consider savings as important as investment for the reactivation of the economy. In their view,
investment should be encouraged through a reduction in interest rates and growth promoted by higher
levels of government expenditures.
Kuznets (1960) found that the average propensity to consume is constant in the long run. The
idea that savings is a fixed proportion of output was generally accepted in most of the earlier growth
models. When these models where used in developing countries, it was argued that low income
implied low absolute and relative savings in comparison to developed countries.
Later formulations of the savings function developed by Friedman and by Modigliani and Ando
shared a common microeconomic point of view. These researchers focused more on individual
behavior than on macroeconomic relationships. Friedman (1957) introduced the interest rate in the
consumption function to allow for individual borrowing and lending decisions. In rural areas, the
distinction made by Friedman between permanent and transitory income called the attention of
researchers, due to the variability of farm income. Modigliani and Ando (1963) introduced interest
rates to discount the income stream generated during the life cycle of consumers. In both cases,
however, the existence of efficient capital markets was assumed, and interest rate changes were
supposed to be known in advance and incorporated into expected income streams.
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The life cycle hypothesis attracted attention on the influence of dependency ratios on savings
patterns. Some authors found in high dependency ratios a partial explanation for low savings ratios in
developing countries (Leff, 1968). Other authors rejected these results, arguing that the cur-off age for
dependency must be low, especially in rural settings (Gupta, 1970).
Theoretical and empirical studies have thus singled out a group of variables that presumablyinfluence savings. Income, family size, wealth, interest rates, returns on physical assets or alternative
investments, transaction costs, and the size of the financial system are among these variables.
A number of studies provide evidence of a strong relationship between income levels and
savings levels. There are three main theories of savings and income: the absolute income theory, the
relative income theory, and the permanent income theory.
The absolute income theory states that the level of income determines the level of savings. It
further indicates that savings increase with each rise in income at an increasing rate (Gilboy, 1968).
The relative income theory states that in the long run the aggregate savings ratio is independent
of absolute income and that in the short run it is contingent upon the relationship between current
income and previous peak income. Very few researchers have attempted to test this hypothesis
(Chauhan, Mundle and Jadhav. 1972).
Friedman (1957) classifies income into permanent and transitory income. According to the
permanent income hypothesis, permanent income and permanent consumption are positively
correlated, and there is no correlation between transitory income, and that the elasticity of savings with
respect to transitory income is unity.
Friedman argues that consumption is determined by long-term considerations, so that any
transitory changes in income lead primarily to additions to accumulated balances or to the use of
previously accumulated balances rater than to corresponding changes in consumption. Furthermore,
this hypothesis states that the relationship between permanent income and permanent consumption is
proportional. Thus, an increase in permanent income will cause a proportionate increase in permanent
consumption, suggesting that the relationship between permanent income and permanent savings is
also proportional.
In a rural economy, the permanent income hypothesis seems to explain the influence of income
on household savings better than the absolute income hypothesis because of the typical variability of
rural household income. In addition to savings out of permanent and transitory income for
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Vogel and Buser (1976) also reviewed the experience of Latin America and found evidence
supporting the positive elasticity of financial asset holding to higher returns on financial assets.
Evidence that deposits respond to higher interest rates is also indicated by the growth of parallel
financial sectors in countries with repressed financial systems. Depositors are attracted to unregulated
intermediaries whenever these are able to offer depositors interest rates that compensate for both
inflation and the greater risk of depositing with non-regulated intermediaries (Gonzalez-Vega andZinser, 1987).
Savings and deposits are affected by inflation. Increases in the price level have two effects.
First, an increase in prices raises nominal consumption expenditures. Second, inflation increases
nominal income. Farmers may derive benefits from inflation, if the increases in the prices for their
products are greater than the increases in the prices of their inputs and vice-versa. Wage earners
usually suffer the most from price increases.
Different studies show both a positive and a negative relationship between savings and
inflation. Diwan (1968) found an inverse and significant relationship between savings and the price
level in India, while in Bangladesh. If real interest rates are negative as a consequence of inflation, the
demand of deposits is reduced.
The returns on alternative investments and transaction costs are two other variables that
influence the level of deposits. The magnitude of the relationship between interest rates and deposits
may be influenced by the rates of return on alternative investments. Several studies in India show that
rural investments in irrigation, land, and dairy farms are highly profitable (Rajagopalan and
Krishnamurty, 1969, Desai, 1981, Krishnamurty and Raychaudhuri, 1980). The existence of profitable
investment opportunities that are more attractive than the interest paid by banks induces households to
invest in alternative businesses rather than to keep their purchasing power in deposit accounts. Adams
(1983) and Burket and Vogel (1987) found a significant negative relationship between returns on
physical capital and financial savings.
High transaction costs reduce the net return to depositors and have a negative impact on
deposits. Transaction costs include explicit costs of travel and other incidental expenses and the
implicit coat of the time spent in maintaining accounts. Transaction costs influence both non-interest
bearing deposits and time deposits. Such costs are reduced by proximity to bank branches, financial
innovations, and the expansion of roads and vehicles.
Depositors may also be discouraged from holding wealth in financial instruments by the same
reasons potential borrowers are rationed when they apply for loans. For depositors and borrowers, the
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costs of meeting bank requirements result in too high total costs of loans or too low net returns on
deposits. Small depositors, in particular, are screened out by large requirements of initial amounts, high
service charges, or simply by limiting branch expansion to important urban or rural areas (Gonzlez-
Vega and Poyo, 1986 ; Burket and Vogel, 1987)
In rural areas where people have little understanding and confidence on banking, depositmobilization may depend largely on the quality of the services of bank employees, where frequent
interaction may increase peoples confidence. Furthermore, the existence of bank branches has positive
effects by lowering transaction costs and increasing awareness about banking. In Bangladesh, for
example, policies for deposit mobilization encompass personal contact of employees with potential
depositors and large-scale publicity. These policies are observed to be effective in deposit mobilization
particularly in urban areas (Kahlily, 1987). Earlier studies did not include quality of service as a
variable that affects deposit mobilization. The omission of this variable may have infalted the effect of
interest rates on deposits.
Von Pischke (1978) and Mauri (1983) argued that the demand for deposits is largely influenced
by education, Yet, the evidence on the elasticity of deposits with respect to education levels is quite
conflicting. While Koropecky (1984) found a significantly positive relationship between literacy and
rural deposits in Bangladesh, Vasquez (1986) found a negative elasticity of rural deposits with respect
to education levels in Dominican Republic. Educated depositors avoided financial assets which earned
negative real rates of return.
It has been evident from the experience of Grameen Bank in Bangladesh and in other places
that linking future loans with deposits induces households to demand deposit facilities. The linkage
between loans and deposits may allow financial institutions to get more information about potential
borrowers, reducing potential default rates (Meyer, 1985).
Among other authors, Mauri (1983) argued that not only economic factors influence the
decision to demand deposits. Safety considerations are also an important factor that Positively affects
deposit mobilization. This is particularly true where law and order are precarious.
Wai (1972) developed a conceptual framework to study savings behavior. According to this
author, three sets of factors determine the decision to save:
(a) The ability to save, which is a function of variables such as income, dependency rations,
and wealth levels.
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(b) The willingness to save, determined by variables such as interest rates, the stage in the
life cycle of the household, and cultural factors.
(c) The opportunity to save, where the supply of financial services and the marginal
efficiency of capital are determinant factors according to wai.
With regard to deposit mobilization, Wai argued that the variables that can be more easily
influenced in order to increase deposits are interest rates and the degree of financial intermediation. In
contrast, a reduction in dependency ratios, for instance, can come along only after a slowdown in the
rate of population growth, and it cannot be changed in the short ruin. Finally, other variables affect
deposit behavior in opposite ways, and thus their effect at the aggregate level may cancel out. This is
the case, for instance, of the stage in the life-cycle of the household.
In some models, Wai used as a proxy for the aggregate ability to save the rate of growth of per
capita income; for willingness to save, he used various proxies of the degree of financial
intermediation, such as branch/population ratios and the growth of financial assets held by the private
sector. For developing countries, Wai found evidence to support the positive effect of growth in
income per capita and of financial intermediation on savings as a well as the negative influence of
capital inflows and of inflation.
A newer approach to the relationship between savings behavior and income in developing
countries was initiated in the late 1980s. This approach falls into two categories. The first category
includes studies that investigate how well households smooth consumption for a given income level,
but abstracts from issues of production (Deation, 1991). The second category includes a small but
growing literature that studies the inter-linkages between savings, credit constraints, and production
decisions (Rosenzweig, 1992; Paxson, 1992; Udry, 1993).
Deaton (1990) constructs a model of savings that includes several special characteristics to
reflect better the environment in developing countries. First, a model of savings for developing
countries will not consider retirement savings, because of the internal transfers from children to
parents, which occur when parents reach low-productivity ages. Second, income derived from
agriculture is uncertain, and poor consumers are more risk averse. Risk aversion has important
implications for the shape of the consumption function. The marginal disutilities of losses in
consumption near subsistence levels is greater than the marginal utilities of gains in times of
abundance. Individuals will therefore give up consumption (save) when it is possible so as to prepare
of possible disasters, even if those disasters are few and far between.
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The econometric results together with descriptive statistics by wealth level of the rural and
urban households shed some light on their savings and deposit patterns.
7.1 Determinants of Saver Status
For the model for urban areas, the sector of economic activity in trade, agriculture, and services
as well as education are significant variables in explaining the probability of being a saver. This result
reflects the greater demand for transaction balances and inventories in trade and service activities andthe lack of synchronization of earnings and expenditures in agriculture, which requires the
accumulation of assets.
In contrast, being a male head of household has a negative effect on the probability of being a
saver. This unusual result refers, however, to the higher probability of being a saver among female
heads of household and not a women in general. The dependency ratio also has a negative impact on
the probability of being a saver. Wealth, on the other hand, is not significant. Ceteris paribus, there are
no significant differences in the probability of being a saver according to wealth: both the rich and the
poor save.
For the model for rural areas, education, wealth level, and being a bank and a cooperative
borrower have a positive effect on the probability of being a saver. The different sectors of economic
activity did not have a significant impact on the probability of being a saver. Wealth may reflect more
binding constraints on the ability to save in rural areas, while being a borrower suggests a positive
impact of financial intermediation on savings behavior.
7.2 Determinants of Bank Depositor Status
In urban areas, earning of monthly income has a positive effect on the probability of holding a
bank deposit. Heads of household with monthly earnings in urban areas prefer to hold their money
balances in a safe place, such as a bank deposit. In urban areas, education is not a significant
determinant of the probability of being a bank depositor, while in rural areas education does have a
positive significant effect on this outcome. This might reflect the fact that in rural areas over 40 percent
of the populations has no schooling at all. Higher levels of education may enable heads of household to
initiate a relationship with a bank.
Among the most important determinants of the probability of being a bank depositor are the
existence of bank-client relationships and perceptions about the transaction costs of being a depositor.
Being a bank borrower has a positive significant effect on the probability of having a bank deposit
account in both urban and rural areas. This result suggests that borrowers are more integrated to the
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may offer higher rates of return are added to the households portfolio of wealth, as predicted by
Deaton (1991) and others.
Although deposits are liquid and a close substitute of cash at home, they are not widely held in
rural areas, most likely because of deficiencies in the supply of deposit facilities. This is reinforced by
the negative and significant effect of occupation in agriculture on the probability of holding bankdeposits over cash at home. The relative low rates of interest offered by banks can be a disincentive for
potential depositors, particularly if transaction costs are high. The significance of the impact of
education in rural but not in urban areas suggests that differences in schooling levels in the two areas
and familiarity with banking procedures may also explain this result.
Bank transaction costs have a significant effect on the probability of holding bank deposits over
only cash at home in rural areas, but they are not significant in urban areas. This result was expected,
and it suggests that although transaction costs may not be a significant determinant of the net return on
deposits in urban areas, they indeed are in rural areas. This reflects the urban bias of financial
development. Given a strong preference for liquidity in rural areas, in the absence of deposit facilities,
the alternative to costly deposits is cash at home. If, in addition, the transaction costs of cooperative
deposits are perceived as being low, the probability of being a bank depositor declines, as shown by
the corresponding significant coefficient. The reduction in transaction costs for depositors in
cooperatives may thus imply a substitution effect on bank deposits.
Being a borrower in a cooperative has a positive significant has a positive significant effect on
the probability of holding cooperative deposits over cash at home only in both urban and rural areas.
This result shows that loans from cooperatives are closely associated with a deposit account at the
same institution, in reflection of the institutional requirement in cooperatives to open a deposit account
before obtaining a loan. Similarly, being a bank borrower has a positive significant effect on the
probability of holding bank deposits over cash at home, but only in rural areas.
7.4 Policy Implications
The financial sector plays an important role in economic growth and development especially in
rural areas. Credit-constrained households are not able to borrow during adverse shocks. To face these
shocks, they need to keep precautionary reserves. reserves. The absence of deposit facilities eliminates
a most attractive means of holding these reserves.
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A deepening in the outreach of rural financial intermediation would allow these households to
keep precautionary deposits and to borrow when necessary. This will reduce their risk aversion and
would free resources for productive investment that otherwise are kept hostage to guarantee a secure
minimum standard of consumption. Therefore, the improvement and expansion of credit and deposit
facilities will have an important impact on the investment behavior of rural households.
The results of this thesis have several policy implications for government intervention in rural
financial markets. First, it is important to recognize that, despite its importance, deposit mobilization in
rural areas is more complex and costly than is traditionally believed. Low levels of wealth imply small
deposit accounts. This increases the cost per dollar of handling deposit accounts. Further, the
geographical dispersion of rural households makes it more costly for financial institutions to mobilize
deposits. The low density of population reduces the size of the market and prevents the exploitation of
economies of scale to dilute the fixed costs of branches. The same circumstances increase the
transaction costs of depositors.
Second, high levels of illiteracy in rural areas are strongly correlated with poverty. Both
significantly reduce the probability of being a depositor. Illiteracy should be reduced as an important
strategy to reduce poverty. Improvement in education will improve the probabilities of future
generations of breaking away from the perennial condition of poverty suffered by most rural
households.