Financial Shock

In order to improve global economic equality, and even lift whole populations from poverty, international financial experts and banking institutions are pinning their hopes on something called “financial inclusion.” They want to extend formal and regulated financial tools — such as bank accounts, credit cards, mobile money, and insurance — to the two billion people around the world who still do not have access to such services.

Economists at the World Bank and other international institutions assert that access to such services plays a critical role in alleviating extreme poverty, providing economic stability for individuals, families, communities, and countries. They say it facilitates investment in education, adequate nourishment, improved health care, and even starting or expanding a business. In theory, someone who is financially included would also be well equipped to face and manage a financial emergency when it arises.

In 2014, the World Bank commissioned a survey, called the Global Findex, to take measure of the financial health of people and countries worldwide. Among the questions asked were a set that focused on whether respondents would be able to access money in an emergency, and if so, how. For those who said they would be able to find the money, family and friends were cited as the most common source, followed by personal savings.

Data analysis is a big part of our unique reporting process at Orb. For this story, we correlated four variables — level of education, income, gender, and participation in the formal financial structures — with one’s ability to find emergency funds. By aggregating those correlations at the country level, we estimated what proportion of respondents from each country would likely be able to come up with emergency money. We then compared those numbers to actual responses in the Global Findex. That enabled us to find those countries with the largest discrepancies — where the predicted results differed most markedly from the actual responses. Based on what we learned, we selected four countries — Brazil, Cambodia, the United States and Myanmar — to look more closely at how people cope with a financial emergency. In doing so, Orb developed a unique lens through which to view and evaluate the efficacy of financial inclusion as an instrument to support financial resilience and alleviate extreme poverty.

It really doesn’t matter who you are or where you live; the question isn’t if you’ve faced a financial emergency but when — and when you did, how you managed it. Some describe it as the hardest times they have faced in their lives — a moment that challenges us as individuals both financially and emotionally.

HOW ABOUT YOU?

FINANCIAL SHOCK

Karen Oliver, 60, nestles into the comfort of her beige couch one last time. In 15 minutes, a young woman and her boyfriend will carry it out of Karen’s townhouse in West Arlington, Virginia, an affluent suburb of Washington, DC. Karen will use the USD$200 she receives from the sale to help her aging mother pay medical bills.

By every measure, Karen has done well. She has a secure, high-paying job in the U.S. federal government. Over the years, she built up a nest egg of savings while also saving for her retirement. Yet, here she is, selling off her household belongings.

Why? Because Karen was ill-prepared to take on the financial responsibilities of family members who were not as conscientious. In effect, she’s become the money lender for the rest of her family. As a result, her savings have dried up. Now she’s selling off assets to pay for things her salary will not cover. An emergency of her own, like an accident or health crisis, could put her over the financial edge — even after all her years of good planning.

While financial emergencies are often the result of health or medical problems, they can also be triggered by being laid off from your job, losing your livestock, or experiencing a costly but necessary repair to your home.

Global Findex respondents were asked if they would be able to find a certain amount of money within 30 days to combat a hypothetical emergency. Only 31 percent of Global Findex respondents said it would be very possible or somewhat possible to find money if they faced a financial emergency; 22 percent said it would be impossible. Clearly, we as a global population are teetering on the edge.

WHERE TO TURN

Respondents were then asked a follow-up question: “If you could get the money, where or how would you get it?”

Thirty-eight percent of those who said they are financially prepared for an emergency said they would turn to family or friends and 35 percent indicated they would dig into personal savings. Others cited a range of other sources: salaries, advances from their employer, credit cards or loans from a private lender, pawnshop, or formal institution.

The insight that emerged from conducting the Global Findex survey paved the way in 2015 for a World Bank initiated project called Universal Financial Access 2020 (UFA2020). The program seeks to provide adults everywhere with access to formal accounts and transaction services, with a focus on 25 specific countries where 73 percent of the world’s remaining two billion “unbanked” people reside.

Banks, credit card companies, microfinance institutions, multilateral agencies, and telecommunications companies have joined UFA2020 to execute the strategy with the goal of bringing those two billion unbanked into the financial fold.

Says World Bank Group president Jim Yong Kim: "Access to financial services can serve as a bridge out of poverty. We have set a hugely ambitious goal — universal financial access by 2020."

However, over the course of Orb’s reporting on how people manage financial emergencies, we began to wonder whether providing access to those financial services is — in and of itself — as strong an instrument for lifting people from poverty as its proponents assert.

The world’s two largest credit card companies, Visa and MasterCard, have signed on as partners in the UFA2020. Together, the companies are hoping to put credit and payment cards in the hands of more than one billion new customers. However, credit card debt remains a big concern among economists who embrace financial inclusion — especially in the wake of what has happened in places like Brazil, an early adopter of financial inclusion thinking.

As the economy in Brazil grew and a new middle class emerged in the early years of the new millennium, the Central Bank of Brazil (BCB) took its own initiative to bring more of the country’s unbanked into the formal financial sector. In 2009, the BCB launched a forum on Financial Inclusion in the city of Salvador. In a display of its commitment to these new efforts to bring financial services to its previously unbanked citizens, Brazil became a founding member of the Alliance for Financial Inclusion in 2010, a consortium of like-minded countries and their banking organizations trying to reach the unbanked.

As a result of these efforts in Brazil in 2014, 68 percent of adults reported to Global Findex surveyors that they have bank accounts or access to formal financial services. But, only 12.3 percent said it would be “very possible” to access money in an emergency. What’s most troubling? A whopping 44.2 percent said that they would not be able to come up with the money at all. How is that possible in a country that seemed to be moving in the right direction, with better access to banks and greater prosperity for everyone?

One of the main culprits is obvious almost anywhere you look in Brazil. Throughout the country, plastered on nearly every shop window, billboard, and signage are advertisements for credit cards.

In 2009, when the project to increase Brazil’s financially included population was launched, the middle class was growing, buoyed by higher wages and more job opportunities. People who had previously lived very sparingly were ready to spend on a more lavish style of living, too. Sensing opportunity, credit card companies extended their plastic to just about anyone who reached for it. But without either a meaningful financial education to understand how credit works or the tight regulation of interest rates, Brazil’s new middle class swiped its way to record-level debt, borrowing to pay for everything from televisions to toilet paper. The economy was growing and no one seemed to be thinking about what would happen when the bills came due. When they did, many cardholders defaulted. Interest rates skyrocketed. In September 2015, the average Adjustable Percentage Rate (which can fluctuate monthly) on credit cards reached 414.3 percent.

In fact, in the Findex, the majority of Brazilians cited revolving debt — using one loan to pay off another — as one of the main reasons why they could not access money in an emergency.

This lack of savings paired with the accumulated debt in both the United States and Brazil may be a cautionary tale worth heeding as a similar story is starting to play out in Myanmar, where more than 150 microfinance companies have set up shop in recent years. Farmers, laborers, and small business owners operating on very thin margins have taken out multiple loans from unregulated microfinance institutions. Many people have even signed over the deed to their home as collateral for these loans. If they can’t pay off their debts, these individuals and families could well lose the roof over their head.

Once a person becomes stuck in a cycle of debt, it becomes nigh impossible to save money. And, when a person who is paying astronomical interest rates has no more lines of credit available, if money is needed in a financial emergency the only option becomes unregulated, even predatory, lenders.

According to the World Bank’s Douglas Pearce, the UFA2020 partners have agreed to prioritize transaction accounts — accounts that can be used to make and receive payments and safely save money — in order to assure that financial inclusion brings true benefits to those it’s meant to serve. But greater access to credit cards and the presence of unregulated and even predatory microfinance companies in countries slated for expanded financial inclusion efforts could open the door to debt issues similar to those that have plagued Brazil. Microfinance institutions have joined Visa and MasterCard in the World Bank’s list of partners in the UFA2020.

Favelas flow up and down hills, around rivers and bays, occupying the most marginal lands around Brazil’s cities, both large and small. Millions of lower and middle class Brazilians call the favelas home. But the favelas all have something important in common: they lack traditional, brick-and-mortar banks. The same can be said about Brazil’s vast and far-flung rural regions. Especially in the country’s impoverished North and Northeast.

These areas are virtual banking deserts.

But Brazil isn’t alone. Banking deserts are something of a global phenomenon.

Banks rarely set up operations in shantytowns or remote rural areas — and for for-profit banks there are a host of good reasons. It costs a lot of money to build and staff a bank branch or financial office. If the clientele is rural and geographically scattered, you’d need to build more branches that would serve fewer people. Particularly in rural areas, poor transportation infrastructure means accessing them is laborious and they often lack adequate technology, which makes the transfer of money difficult. In some urban slums, security can be an additional issue. Additionally, profit margins for banks in such communities may be too low to make operations viable. The modest or marginal economic status of local residents makes extending credit to them risky. And to top that all off, many who live in rural or slum areas may not have the proper documentation, such as government-issued ID cards, which most banks require to open an account.

Many of the people who live in rural areas or our world’s slums and favelas work in the informal, “gray” economy. And the massive scale of the gray economies — where transactions are conducted off the books — presents a huge challenge to those seeking to extend access to formal financial services to the “unbanked.”

Around the world, the informal sector makes up a large portion of the overall economy. In North Africa, 48 percent of non-agricultural jobs are in the informal economy. In Latin America, it is 51 percent and in Asia, 65 percent. In developing countries, the informal economy contributes up to 40 percent of GDP according to the World Bank. The people who make up the informal sector oftentimes include day laborers, housekeepers, childcare providers, and street vendors. Even if this population can save money, unless banks change their policies, these workers won’t be able to open an account and hence, will have no regulated and safe place to store it. The only way for them to weather a financial emergency will still be to crack open the piggy bank or go into debt.

FINANCIALLY ILLITERATE

Understanding basic financial concepts is a struggle for billions of adults. While the Global Findex was being conducted in 2014, McGraw Hill Financial and Gallup created the Standard & Poor’s Ratings Services Global Financial Literacy Survey to conduct its own study. The S&P survey found that two-thirds of the world’s population is functionally financially illiterate.

Experts say financial literacy is a critical component in extending the benefits of financial inclusion to the world’s unbanked. Basic financial literacy — understanding how bank accounts and interest rates work — is fundamental to responsibly using the access to credit delivered by financial inclusion. Without it, access to credit can land people in debt rather than make them more resilient and prepared for a financial emergency.

For-profit financial partners emphasize advertising their services over educating their clients on financial matters. In the U.S., for example, financial services companies spend 25 times more on marketing their products than on customer education, according to the Consumer Financial Protection Bureau, the federal regulatory agency set up in the wake of the 2008-09 financial crisis.

There’s a profound disconnect. Unless ordinary citizens know how to save money, invest prudently, and borrow responsibly, financial inclusion is much less likely to achieve the UFA2020 objectives. Many officials see expanded access to credit without a parallel effort to educate consumers on the dangers of debt especially troublesome.

So why isn’t there more emphasis and investment in financial education to ensure this new access to financial services is a life saver, not an anchor pulling people down?

TRUST IS THE MOST IMPORTANT COLLATERAL

Myanmar is emerging from a half-century of international isolation, military dictatorship, and more than a dozen ethnic-fueled insurgencies. In the absence of a formal banking system, a network of informal lenders has thrived and is estimated to be as large as the formal sector.

Myanmar is still very much an agrarian society. Only about 20 percent of the population lives in major cities. The country’s population also has one of the lowest rates of participation in the formal financial system. So, how is it that 40.6 percent of Myanmar citizens say they can very easily come up with funds in an emergency?

Myanmar offers a case study in the genius and creativity of human beings when they are forced to devise solutions with limited resources. In the case of Myanmar, a network of informal local lenders and pawn shops sprouted up in the absence of formal banking institutions. Similar systems have emerged in developing countries around the world, such as Cambodia and Niger.

Money lenders provide the most streamlined way for people to get the funds they need when facing an emergency. The lenders are well known in their communities and they, in turn, know their clients well and what a client’s particular financial circumstances might be. This local knowledge proves decisive for a system in which trust is the only collateral. Ethical lenders know when a client is seeking a loan too big to repay. As a result, clients typically borrow modest sums and default rates are among the lowest in the world. But because there is no collateral, the loans come with a hefty price tag, usually around 30 percent interest per month.

Village pawn shops are also a popular alternative for unbanked people in need of cash. Like local lenders, pawn shop operators know their clients, too. But since they take personal property as collateral — a motorbike, an appliance, gold jewelry, or even clothing may be exchanged for money — a pawnshop’s interest rates are much lower, around 3 percent per month.

As the World Bank and its UFA2020 partners seek to expand financial inclusion, they might want to take a cue from the informal lenders who bring trust and a personal knowledge to the relationships they sustain with their clients.

KEEPING MONEY LOCAL

To address the lack of financial access for impoverished families in Northeastern Brazil, Banco Palmas opened shop in 1998 in the city of Fortaleza. The idea was to create an informal bank run by the community for the community. While this “bank” isn’t regulated and people who have accounts there are not considered “financially included,” it was developed specifically to serve the community — especially individuals without access to formal bank accounts.

Banco Palmas bank officials and community organizers developed a local currency that can be redeemed for goods and services within Fortaleza. In this way, money generated within the community stays in it and contributes to a gradual buildup of local wealth, allowing more people access to credit at affordable rates.

Banco Palmas has emerged as a model for more than 150 other community banks that have sprouted up around the country. Banco Verde is one of those. A bank with a unique approach, at Banco Verde recyclable plastic is redeemed for a local currency that — like Banco Palmas’ currency — can be traded for food and other basic household items.

The community banks are not recognized as part of the formal banking system. But the Central Bank of Brazil does believe the community banks are meeting a fundamental need among populations who remain unserved by the formal financial institutions. Instead of legislating to remove them, the Central Bank of Brazil monitors their success. By providing easy access to credit at low interest rates, community banks offer citizens a safety net that hasn’t previously existed for surviving financial shocks.

CHANGING GLOBAL FINANCIAL BEHAVIOR

More than three-quarters of the global adult population have no savings at all; even though 62 percent have an account at formal financial institutions. So, a bank account does not equate to saving money.

In fact, most of us are doing the exact opposite of saving; we are overextending ourselves on credit. We are taking on more debt than we can pay back, then taking on more debt to pay for that debt, which leaves few options when emergencies arise. While financial responsibility ultimately lies with the borrower, practically speaking, people are failing to save and live on the financial edge — for a variety of economic and social reasons. But whatever those reasons, the reality is that most people leave themselves few options in a financial emergency.

This alarming state of affairs is leading some economists to call for beefed-up efforts to include financial education as a critical component in the campaign to extend formal financial services to the world’s two billion unbanked people. However, some studies suggest that financial education goes in one ear and out the other. That could be one of the reasons why financial literacy receives so little attention. A recent progress report on the UFA2020 initiative issued by the Center for Financial Inclusion concludes that financial literacy is getting short shrift, leaving customers with little understanding of how to manage their finances. The Center says that UFA2020 financial literacy efforts should include an emphasis on practical tips for good banking behaviors.

Extending credit to a financially illiterate society can be seen as letting the fox in the hen house. Concerned economists point to a rapid expansion of foreign-owned superstores in Cambodia, a country with only 18 percent financial literacy among adults. The stores offer everything from rice to flat-screen televisions and they provide customers easy access to microfinance credit to buy luxury items, leaving the customers potentially vulnerable to spiraling debt.

In practice, financial literacy isn’t a clear priority for the UFA2020 partners. The metric of success is getting people accounts, not educating them about using those accounts.

In addition to concerns about our ability to save and our financial literacy, the regulation of financial services, interest rates, and consumer protections vary tremendously. While organizations like the World Bank can make recommendations, national governments have the ultimate responsibility for regulating formal financial services. But regulation is a tricky affair, particularly when it comes to a rapidly evolving industry, with new technologies speeding the development of and access to new financial products.

Overextended borrowing and revolving debt not only cripple a family’s ability to overcome a financial emergency, they also threaten the long-term viability of lenders — be they microfinance companies, banks, or credit card companies.

The World Bank’s core objective is to alleviate extreme poverty by helping people achieve financial resilience. Pairing access to financial services with the knowledge of how to manage finances and the consequences of taking on debt supports any individual overcoming financial shock. Financial education should be the cornerstone of the World Bank’s successful development of financially resilient societies.

Orb’s reporting has uncovered concerns and contradictions regarding how the UFA2020 partnership is rolling out the financial inclusion project. The World Bank’s overall objectives of eradicating extreme poverty and promoting economic equality are laudable. Their plan to provide access to secure and affordable financial services would seem to create a pathway out of poverty while bolstering peoples’ resilience to financial shock. But that pathway has its own obstacles.

Our inquiry raises questions about whether the World Bank and its partners can achieve their stated goals. After studying the World Bank’s Findex data and looking specifically at where people around the world find it easiest to get money in a financial emergency, we realized that many people who can get money in an emergency reside in countries with low levels of financial inclusion. Many of those countries are also among the world’s poorest. So, being “financially included,” in and of itself, might not provide the key to successfully managing a financial shock or alleviating poverty.

Brazil and the United States offer cautionary cases in point. Easy access to credit and, particularly, Brazil’s high interest rates, leave the financially included even more vulnerable to financial shock. 

As they seek to alleviate poverty by bringing every adult in the world into the financial inclusion tent, the World Bank and its partners could better emphasize financial education and client protection. Partners in the UFA2020 as well as their clients would benefit from recognizing and implementing the multiple aspects of achieving vibrant financial health. Those aspects would include: access to safe, reliable ways to save money and conduct financial transactions; financial education around managing accounts and taking on debt; consumer protections; and careful regulation of lenders and the interest rates they charge. Last, but not least, they should find ways to mimic the personal touch and local knowledge that informal lenders bring to their business as a way to provide a check on individuals becoming overextended.

Only once this full suite of tactics is applied will the World Bank and its UFA2020 partners succeed in alleviating the greatest of all financial emergencies — extreme poverty.

WE’RE ASKING YOU