Thursday, September 1, 2011

Incentivizing savings habit among the poor

The government of India have initiated a Total Financial Inclusion (TFI) program to ease formal institutional credit constraints and expand their ability to manage their finances more optimally. However, while the policies under implementation may achieve success with the former, the later remains a much more formidable challenge.

The prevailing set of policies, revolving around the TFI program and door-step banking through business correspondents, will deliver a savings bank account to every citizen. It is also being suggested that the Aadhaar number and Aadhaar-linked savings bank bank accounts could provide the ideal platform to implement the proposed cash transfer schemes to deliver subsidies. All these will still not address the ultimate objective of getting people to optimally utilize their savings bank account to manage their finances efficiently. The challenge will be all the more bigger in promotion of savings among those poor who are more acutely present-biased (or have greater self-control problems).

Promotion of savings habit among the poor has been an area of interesting research in recent years, driven mostly by trends and developments in behavioural economics. Economists like Sendhil Mullainathan have expanded on Richard Thaler's mental accounting framework to explain how people's subliminal predisposition to categorize and evaluate savings and spending decisions can be invoked to nudge people into managing their finances more optimally.

I had blogged earlier about the merits of a system which divides income into separate, end-use based mental accounts.

"It helps people manage their finances more effectively in two ways. One, people are inclined to save if they are aware of what they are saving for. For example, a "car account" is a strong nudge to get people to save for purchasing a car. Two, separation of expenditure heads with pre-defined allocations help in effective management of expenditures."

Based on the mental accounting framework, I have also blogged about the merits of use-directed multi-tier accounts to nudge people into saving for specific purposes.

In this context, the most recent research paper (pdf here) on incentivizing savings among the poor come from an experiment among the rotating savings and credit associations (ROSCAs) of Kenya by Pascaline Dupas and Jonathan Robinson. They provided members of 113 ROSCAs in Kenya with different household and ROSCA savings instruments (like individual lock and key boxes and ROSCA health pot) to save for health and other contingencies and found that it could "substantially increase investment in preventative health, reduce vulnerability to health shocks, and help people meet their savings goals".

They also found that providing people with a designated safe place to keep money was sufficient to overcome the common barriers to savings - transfers to other people and "unplanned expenditures" on temptation goods - through a mental accounting effect ("The money put into the box was seen by respondents as 'for savings' and was therefore less likely to be spent on luxuries or given away to others").

The find strong evidence that use-directed commitment savings products can be effective in promoting savings even among the more present-biased individuals. The ROSCA health pot was a commitment savings approach wherein a sub-group in a ROSCA could agree on a health product and provide additional contribution (over and above their ROSCA contribution), which could be redeemed each month to purchase the particular health product for one member at a time. They write about the present-biased members of the ROSCA,

"The enthusiasm that led them to sign up for the Health Pot tied their hands not only to spend the money a certain way, but also to continue to save on a regular basis (i.e., at each ROSCA meeting). This strong social commitment feature is the only one that enabled present-biased individuals in our sample to overcome their barriers to savings."

They point to an earlier study by the same authors from the same area in Kenya which found that providing simple bank accounts to wmone who run small vending businesses had substantial savings impact only on about 40% of them. They write,

"Since the bank accounts did not provide any form of earmarking or a strong commitment feature, their primary function was likely to provide a designated place to save. The present study suggests that more sophisticated devices that include stronger commitment features might be better suited for some of those individuals who did not use the simple savings account. For others, it appears that a less sophisticated but more easily accessible device such as a Safe Box would be better suited to save small sums on a regular basis."


Anil Nilugonda said...

This is an interesting blog, when my mother used to save all the coins she accumulate and drop it in a pot money saver and then She uses it to buy some useful things. Thanks Sir.

Anil Nilugonda said...

This is an interesting blog, when my mother used to save all the coins she accumulate and drop it in a pot money saver and then She uses it to buy some useful things. Thanks Sir.