Helping financial institutions to help poor people

The financial system could contribute more to the reduction of poverty. Action is needed to assist and enable banks and similar institutions to improve poor people’s access to financial services. More research is also needed on the links between finance and poverty reduction.

Financialservices allow poor people to convert savings into lump sums that can be usednot only for investment to generate income but also to reduce their vulnerability,cover life-cycle needs and acquire useful consumer durables and livelihoodassets. Business is made easier and more efficient. Financial services are importantalso in tackling the non-income dimensions of poverty, making it easier forpoor people to send their children to school or to health care providers and empoweringwomen through access to small loans.

Developingcountry financial sectors have to do a lot more to achievethis potential. Most poor families still have little or no access to financial services.A paper by two economists, written while they were working with the UK Department forInternational Development (DFID), reviews the potential of the financial sectorto help poor people, the reasons why it often fails to do so and suggestsactions that could improve its performance.

Thefinancial sector’s impact on poverty has not been studied sufficiently. TheInternational Monetary Fund and the World Bank identify financial sector weaknessesand actions for sector development, and monitor the implementation ofinternational standards and codes, but do not examine the relationship topoverty reduction.

Characteristicsof banks in developing countries that help explain their low impact are:

• smallness: domestic credit provided by the banking sector in low-incomecountries averaged only 43 percent of GDP in 1999, compared to 148 percent inhigh-income countries
• inefficiency: interest rate spreads are more than three times as large inlow-income countries compared to high-income countries
• vulnerability: in a sample of 50 countries over 20 years, developing countrieswere more than twice as likely to experience a banking crisis
• failure to engage with productive enterprises: banks toooften invest only in government securities.

Measuresto improve the access of poor people to financial services should address theroot causes of the problem, which are failures of both markets and governments.The suggestions for action in the paper include:

• increased land titling and the use of non-traditional means of providingcollateral for loans
• government support of research and development (R&D) on newtechnology in mobile banking and similar provision of small-scale financialservices at low cost
• international donor efforts to disseminate information about bestpractice in microfinance
• wider use of community and group based screening of loan applications andenforcement of loan repayments
• strengthened links between microfinance and the formalfinancial sector, for example through better prudential regulation andsupervision of microfinance institutions.