INTERNATIONALBANK FOR WORLD BANK R E T C N O E N STRUCTION PM AND DEVELO September 2005 No. 77 A regular series of notes highlighting recent lessons emerging from the operational and analytical program of the World Bank`s Latin America and Caribbean Region FINANCIAL EXCLUSION: A NEW ANGLE TO URBAN POVERTY IN LATIN AMERICA Tova M. Solo Background countries are dramatically different. Not surprisingly, the unbanked in all countries show other characteristics of marginality ­ low incomes, low levels of education, and, in developed countries, high rates among minority and The majority of the urban population in immigrant populations. Latin America is unbanked and the ma- jority of the unbanked are hard core Financial exclusion hinders economic poor. development at both macro and micro levels Seen from an urban development focus, financial exclu- Data gathered dur- sion limits possibilities ing studies con- for private investment ducted over the past in low-income com- four years in munities, driving up Mexico City, responsibilities and Mexico (Distrito costs for the public Federal); Bogotá, sector. The unbanked Colombia, and in are doubly disadvan- several Brazilian taged, first in terms of cities suggests that asset-building and in these countries second in qualifying somewhere be- for loans. While finan- tween 65 and 85 cial institutions are re- percent of house- luctant to lend to the holds are unbanked, depositors "unbanked", those and account-holders who do not hold any are better positioned kind of deposit or to negotiate invest- transaction account ments insofar as sav- in any formal sector fi- Source: Mexico - INEGI survey [Sample Size: 1198 respon- ings can serve not nancial institution.1As dents]; Brazil - World Bank 2002; Colombia DANE/World Bank only as collateral, but also as Figure 1 shows, the pro- Survey 2002; USA-Consumer Finance survey 1998; Germany, a demonstration of income ­ Dr. Peter Langkamp, 2004; Spain, A. Chueca Mora, 2004. portions in developed and of financial discipline. It 1 is no accident that Community Development Corpora- lenders to the unbanked), money lenders and pawn tions in the United States frequently begin their strategies shops charge from 10 percent/month to 35 percent with the courting of local banks to establish branches in per month (150 percent to over 400 percent per their neighborhoods. year.) compared to current active annual bank interest rates of around 17 In macro-economic terms, percent in Mexico and Co- financial exclusion means lombia. a loss of system efficiency and inequities. Several re- Interest by Both cent World Bank docu- Parties to Explore ments have discussed the effects of financial exclu- New Options sion on a national The unbanked want de- economy.2 A large posit accounts but face unbanked population can several obstacles - Survey mean a loss in aggregate data confirms that the saving3 , inefficiencies in unbanked do mobilize consid- transaction costs,4 and erable resources and save in systemic inefficiencies re- cash, non-cash, and informal sulting from investments in systems7 and that they rec- less than optimal choices.5 Finally, the concentration of ognize - and desire - the benefits of formal bank bank accounts can be seen as a factor in the regressive accounts.8 In the same surveys, the unbanked pointed to redistribution of national income, since the earnings on financial obstacles such as high initial deposits, minimum government papers held by banks and the regulatory balances and fees, among other discouraging factors costs borne by government benefit the wealthiest 35 ­ 15 such as paper work,9 lack of convenient locations and percent of the population. condescending attitudes from bank employees. Bank regulators from all three countries confirm that most On a micro-economic level, the unbanked pay a high banks require proof of income and minimum deposits cost for not having formal financial services.6 equal or above the legal monthly minimum wage. The Unbanked households spend an estimated 2.5 - 20 first tends to disqualify informal sector workers and the percent of income on financial costs, considering: second tends to discourage families earning below · Costs of making payments. Meeting monthly bills median income. for water, electricity, sanitation, telephone, for health insurance (required by law in Colombia ) and for Many financial institutions are interested in trying schools ­ for parents - means a day off work and a out the new markets. Several commercial banks in trip downtown with a wad of bills. Mexico, Brazil and Colombia have begun to test the · Costs of getting paid. A full 85 percent of Mexico's waters, reaching down scale. At the same time, the non- "unbanked" are paid by check. Between trips to the bank financial institutions (NBFIs) including non-govern- banks tha have issued the checks, to check cashing mental organizations (NGOs) and micro-finance institu- outlets, commercial stores and commissions, they tions (MFIs), which traditionally focus only on low pay anywhere from 5-10 percent of the face value income groups with credit products, are looking into to cash in their earnings. broad-based banking to increase funding sources. Both · Costs of savings. In Mexico and Colombia, where banks and non-banks point to regulatory obstacles, short term deposits pay a real return of about 2 however, that limit their opportunities to opening new percent, informal savings, in the form of cash held at branches, particularly in low income areas which are home, represent an opportunity cost in earnings, and perceived as insecure, and, in the case of NBFIs that a potential loss from robbery. limit options for receiving deposits. · Costs of sending and receiving money. For the 5 percent who receive income contributions through What can be done to bring banking to the national or international remittances, costs of send- unbanked - and vice versa?: Five cases ing and of receiving can run to 20 percent of the from the region remitted amount. · Costs of borrowing. Commercial stores (the main Measures to reduce financial exclusion focus on three 2 targets: (i) the financial institutions themselves, helping to income persons, the Cajas will now be able to offer overcome obstacles of location and culture and to savings and credit services as well. In preparation for the develop new and appropriate products; (ii) the unbanked project, the government carried out surveys of financial populations, through financial education and grant pro- products and costs (under the Superintendencia grams; and (iii), on governments to promote new pro- Bancaria) and of household use of financial service grams and new technologies to monitor information and (under the Department of National Administration of regulate new institutions. Currently, several teams in Statistics, or "DANE", household surveys.) The resulting Latin America and the Caribbean (LAC) are discussing baseline information will be useful to track future trends or have developed projects or components that address in the cost of savings products, and in the number and financial exclusion. percentage of unbanked. The Nicaragua Broad Based Access to Finance In Mexico, the National Savings and Financial Project focuses on increasing the number of points of Services Bank (BANSEFI for its acronym in Spanish) service to remote and unattended communities through projects help to promote new service providers with support to three levels of the financial system: (i) state of the art technology and regulatory services. financial service providers, (ii) financial institution super- Two World Bank loans are being implemented by visors, and (iii) rural households and businesses. The BANSEFI to support the sector by: (a) providing techni- project offers technical assistance and incentives, such cal assistance through consultants to work with the as matching grants, to help supervised financial institu- sector entities to prepare them for certification, or tions develop a broader range of products, including low- merger/liquidation, under the new Law; (b) establishing a cost attractive savings. The project also provides assis- technology platform focused on banking-related pack- tance to improve internal controls, loan portfolio manage- ages, hardware, data centers, and connectivity services; ment, and audits, as well as financing legal advice and (c) expanding and deepening the outreach of the financial other capacity building requirements to help transform institutions to the remote and underserved population in MFIs into regulated full financial service institutions. The seven marginal regions; and (d) establishing a baseline of project supports the Superintendent of Banks and Other rural financial sector attributes, and focusing on areas of Financial Institutions to establish norms, supervision further study to inform policy and strategy relating to this arrangements and consumer protection for financial sector. At the same time, the government is financing service clients. To encourage rural savings, the project some thirty thousand "points of service" for credit, debit supports capacity building for financial cooperatives, and stored value cards. while building the legal framework and national capacity to supervise and regulate these institutions. To ensure The Guatemala Community Infrastructure Project improved service for clients, and a broader menu of proposes a credit guarantee incentive for banks that financial services (including savings), the project also offer affordable savings products. The Bank is finances household surveys to measure impact on the currently discussing an operation with the Guatemalan unbanked population. government that would expand the existing mortgage insurance programs to cover commercial bank lending The Colombia Business Productivity and Efficiency for a broad range of community services. The proposal is Development Policy Loan (DPL) also emphasizes very attractive to commercial banks, such that dialogue increased service points through regulatory reform. has focused on requiring or encouraging participating The Colombia policy based loan promotes a regulatory banks to offer savings products affordable to the ultimate reform to reduce the risks and costs faced by commer- beneficiaries of the infrastructure loans ­ incidentally cial banks offering services to low-income communities facilitating their payment of service fees. by permitting banks to open branch offices inside public buildings (thus helping to overcome cultural and security Brazil's government has developed alternative ser- issues that come into play in low-income neighborhoods vice payment systems and regulations to encourage or remote areas). Another reform supports the develop- access to savings. Measures taken by the government ment of a regulatory framework to permit the "Cajas de in 2004, at the time that the Bank's studies on Access to Compensación" to offer financial services to their affili- Finance in Brazil were being carried out, follow a model ates. The "Cajas" are corporate-based social service based on the U.S. Community Reinvestment Act in organizations, financed through company and employee requiring Bank disclosure of location and income levels contributions. After forty years of providing health, of clients. At the same time, the government has education, and recreation services to middle and low introduced certain regulatory requirements to encourage 3 the offering of affordable savings accounts, to extend information gathering and public disclosure. Tracking the micro-credit, and initiate a housing subsidy credit-linked availability and costs of financial service products and scheme to reduce the risk that banks perceive in working making this information public, tracking and publicizing with the poor, while working with the judiciary to enforce profits from the retail banks, and finally, monitoring the legal dispositions to customers of all income classes.10 use of financial services as part of household and These efforts follow the government's long-standing individual census activities can lead to greater competi- service of receiving utility payments in "lottery shops" and tion (efficiency), stability and access in financial mar- postal outlets, a measure that offers an important payment kets. service, albeit at a high transaction cost, to the unbanked. Recent improvements were reached with the use of 1 i.e. institutions regulated by government for receiving banking services in the administration of conditional cash- deposits from the public, as in commercial banks, "social grants (e.g Bolsa Familia and Bolsa Escola), whereby interest" banks, cooperatives, credit unions, etc. families below a certain income level receive monthly 2 See Beck, et.al, World Bank Working Paper 3338, allowances provided their children attend school regularly, 2004 and Holden and Propenko, IMF Working Paper, get vaccinated, etc. These grants, targeting women in 2001. particular, are dispensed through very simple ATMs that 3 In simpler terms, savings under the mattress ­ which do not require literacy skills, much less previous banking do not get reinvested in productive purposes. experience. They, however, have a tremendous impact 4 Studies from the Mexican Central Bank point out that on increasing the familiarity of the population in using cash transactions are 5 times costlier than transactions banking technology and improving their self esteem and by check, which are, in turn, 15 time costlier than sense of social and economic inclusion. electronic transactions. 5 Families who cannot afford a financial savings account Further possibilities invest in less productive substitutes - a frequent observation by visitors to slum communities. Programs in developed countries have focused on the 6 See World Bank, AccessFinance, Volume 3, February, unbanked populations with financial education programs 2005 and incentive programs to help the unbanked to save and 7 In Colombia and Mexico 60 percent and 63 percent accumulate assets. In a similar vein, the regulatory respectively of the unbanked own their own homes, an agencies in developed countries also actively promote the impressive indication of capacity for investment. development of new products, technological advances 8 A quick calculation based on the Mexico survey and increased services for low income groups among suggests that on the order of US$ half a billion is saved bank and non-bank institutions.11 Development policy at home in Mexico City alone. lending offers the possibility of rewarding such incentive 9 In particular, requirements of wage and employment programs through output based lending linked to increased verification, tax returns, commercial and personal "first-time saver" accounts and financing incremental references. government expenditures, such as increased supervisory 10 See Housing Programmatic Loan (Report 31756-BR, activities, deposit insurance and incentive programs. Talks May 11, 2005) with the World Bank's Operational Policy and Country 11 In addition to meetings and incentives designed for Services (OPCS) Department representatives suggest banks,USregulatorsarenegotiatingwiththeorganizations that such a program could be feasible, depending, on representing "check cashing outlets" and pawn shops as careful calculations of government costs. service providers for the unbanked encouraging them to lower costs and improve services. The Government's role in supporting access to financial services About the Authors At a recent meeting with the World Bank, James Carr, Vice President of the Fannie Mae Foundation, stated that This note was prepared by Tova Solo, Senior Urban "No country has achieved widespread financial services, Specialist in the Latin America and Caribbean region however profitable and sustainable, without government of the World Bank. intervention at the outset." A review of developed country policies, which paralleled the studies carried out in Mexico About "en breve" and Colombia, tends to confirm this declaration. It also Subscribe to "en breve" by sending an email to suggests that the most important task for government is en_breve@worldbank.org 4