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Financial Services to the Micro, Small and Medium Enterprises Dean Karlan Yale University Innovations for Poverty Action

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Presentation on theme: "Financial Services to the Micro, Small and Medium Enterprises Dean Karlan Yale University Innovations for Poverty Action"— Presentation transcript:

1 Financial Services to the Micro, Small and Medium Enterprises Dean Karlan Yale University Innovations for Poverty Action

2 Two Themes Apply Behavioral Economics to product design Find win-win evaluation strategies: – Measure social impact AND – Improve operations

3 Behavioral Economics

4 Assumptions of Behavioral Economics Humans vs. Econs Bounded Rationality – including bounded attention Bounded Willpower Bounded Self-interest


6 Escalator Lesson People are complicated. No one model predicts a persons behavior. Design matters

7 Suppose you received one of these letters: What would be most important to you?

8 Direct Mail Lesson The normal things economists look at arent always the drivers. Behavioral economics has expanded the standard set of behavior drivers…

9 Behavioral Economics Theoretical behavioral economics: – Tries to understand, develop models, etc. to predict behavior better (and heterogeneity) Applied behavioral economics: – Tries to figure out how to use behavioral economics to make the world a better place

10 Nudges Anyone who designs the environment in which people make choices is a choice architect – Menus – Store layouts – Organ donorship – Retirement savings plans – One last amusing one, and then banking

11 Urinal, Amsterdam Airport

12 Applications in Banking Commitment contracts – Savings Reminds to save – Increased savings by 6% in three country study! But also.. – Smoking – Weight loss

13 Goals and Commitment Three truths for most if not everyone: – You have set goals for yourself in the past. – You have not achieved every one of those goals. – You regret not having achieved some of them.

14 Commitment Contracts Make your vices more expensive Make your virtues cheaper The obvious: – Savings – Weight loss – Smoking – Exercise

15 Philippines: Savings SEED for the Green Bank of Caraga in Mindanao Simplest commitment: no withdrawals until goal amount or date is reached No increase in interest rates for illiquidity 28% opened an account 300% increase in savings for those who opened an account Similar to Christmas Clubs in the USA, popular in the past

16 Philippine: Smoking C ommitted A ction to R educe and E nd S moking Minimum deposit of 50 pesos ($1.25) CARES lock box to help clients save daily No access to the money in the account for 6 months No interest-bearing Weekly deposit collection service (the service stops if the client fails to deposit for 3 consecutive weeks) Must pass a urine test within 1 week of the 6 month maturity date in order to gain access to the money in the account

17 Philippine Smoking: Results 83 out of 781 (11%) individuals offered CARES signed a contract. 29 of 83 passed at 6 months Of the 29 who passed at 6 months: 14 passed and 15 failed at 12 months Of the 54 who failed at 6 months: 7 passed and 47 failed at 12 months 30 percentage points more likely to stop smoking

18 Mexico: Corporate Employee Wellness Program Contracts for employees – Lose weight – Stop smoking – Read more – Play more – Complete tasks on time for work No financial incentives But psychological commitment And public visibility

19 Behavioral Economics: Conclusions Humans are imperfect. We need all need help. We can improve choices without restricting options. Nudges can work.

20 Part II: Win-Win for Social Impact Many ways to improve programs Evaluation, done well – Looks forward, Not backwards – Is an investment, not a cost – Helps improve profits, not merely prove impact

21 Outline Four specific projects to describe – Reminders to save – Small/medium enterprise mentoring/consulting Mexico – Price: expanding access to credit South Africa and Mexico – Credit scoring to measure impact of loans Philippines and South Africa

22 Reminders to Save: Peru, Bolivia & Philippines Attention problem: Savings is salience- disadvantaged relative to debt Do the poor save everything they can? Or does attention to needs influence savings? Three country study Impact: – Increase savings by 6% with monthly reminder – Increased likelihood of reaching goal by 3 percentage points

23 Mentoring/Consulting Project Run by Mexican state government Firms apply for grants for consultants/mentors from consulting firms in Puebla Limited supply of grants for eligible firms – Thus randomization good for two reasons: 1) Helped solve political problem, by choosing randomly no complaints of favoritism when allocating a scarce resource 2) Provides powerful impact evaluation by independent researchers to help strengthen future policy discussions Fairly small sample, 433 firms

24 Results After one year Monthly firm sales & profits up 78% and 110% respectively Productivity increased – Productivity defined as profits unexplained by assets

25 Demand Elasticities Large-scale experiment in Mexico, Compartamos Bank Randomized over branches spread throughout entire country Incorporates general equilibrium effects

26 Price Huge variance in rates around the world Huge variance in depth of outreach Significant debate, especially in high rate countries Two sides to the calculation – Costs – Demand Most of the data/analysis/discussion is on costs For years, World Bank (CGAP) and others pushed to raise rates, to get to sustainability

27 Compartamos experiment Randomization at branch level Data collected over 19 months Two take-up sets of data – Specific face-to-face marketing – Natural over time process, i.e., branch level outcomes with normal marketing, growth, gossip and general equilibrium effects

28 Experimental Design Crédito Mujer village banking loan product only for women Bank branches grouped into 80 geographic clusters across Mexico – Half assigned high rate – Half assigned low rate Difference of 10% (0.50% per month)

29 Branch Locations Final sample included 132 branch offices in 80 geographic clusters across Mexico high rate low rate

30 Results: More Clients

31 Results: Larger Loan Portfolio

32 All together for Compartamos Compartamos is a for-profit Impact on society important Promise to investors of course is that helping society can be profitable. Revenues increased by about 11% Costs did too Net impact on profits: up about 3% – Statistically same as before

33 Measuring Social Impact with Credit Scoring Credit scoring – Difficult for SME sector – Even more difficult for nicroentrepeneurs – Much to be learned about optimal system How to balance hard and soft information How to build incentives for long term client loyalty How to maintain safe banking principles

34 Experiments to measure impact Impact studies of microcredit have been done – and done and done and done… – Questions linger regarding identification Basic selection problems: – Who chooses to borrow? Entrepreneurial spirit? Resourceful individuals? – Who do MFIs agree to lend to? – Program placement: MFIs target growing areas

35 Microcredit Randomized Trials Now we are beginning to see a wave of them – South Africa: urban/peri-urban, for-profit, individual lending, formal sector employed individuals (Karlan and Zinman, 2008) – Philippines: urban Manila, for-profit, individual lending (Karlan and Zinman, 2009) – India: Spandana, urban Hyderabad, for-profit, group lending (Banerjee, Duflo, Glennerster and Kinnan, 2009) – Peru: Arariwa, rural, village banking, non-profit (Karlan and Zinman, 2010?) – Mexico: Compartamos, peri-urban/urban, village banking, for-profit (Angelucci, Conley, Karlan and Zinman, 2011?) – Morocco: Al-Amana, rural, village banking, non-profit (Crepon, Duflo and Pariente, 2010?) – Philippines: FICO and First Valley (getting under way, 2012?) – Bosnia: for-profit, individual liability, urban and rural (Augsburg, de Haas, Hamgart and Meghir, 2011?) – Mongolia: group liability, rural, Attanasio et al

36 Simple but critical test One theory: markets are actually complete. High prices for informal credit – Incomplete credit markets? – Or higher price for better service? Will increased loans higher debt or change in debt composition? If so, prima facie evidence for credit constraints

37 Basic Methodology 1.Lender randomizes marginal loan applicants: 100-point credit scorecard based on applicants: 1 – 30 Auto reject 60 – 100 Auto approve 31 – 45 Randomly approve 60% 46 – 59 Randomly approve 85% Business capacity Personal financial resources Outside financial resources Personal and business stability Demographic characteristics

38 Basic Methodology 2.Follow-up with household survey that measures: Borrowing, broadly defined Business income, expenses, and profits Investments, broadly defined Psychological and political outlook Surveyors completed 1,114 of 1,601 in sample for 70% response rate. Number of days between treatment and follow-up: MeanMedianStandard Dev

39 Why did the bank do this? Weekly credit committees: slow, costly, subject to inconsistencies of subjective scoring. Computerized credit scoring fast (loan decision in 1 hour!) and quantitatively-based. Future scorecard revision requires data points on below the line applicants.

40 Market Settings Small-business Microloan market in Philippines: For-profit rural bank Regulated but no viable credit bureau Unsecured Individual liability High-risk Short-term (13 weeks), fixed repayments Expensive by many international standards (63% APR)

41 Results Loan use increases: 9.6% more likely to have a loan – Evidence of market failure being solved

42 Impacts Key results: – Profits go up for men, but not women (consistent with de Mel et al capital drop experiment in Sri Lanka) – Cut back in firm investments and cutback in formal insurance – Increased education for families of male borrowers – Increased access to informal credit – Increased trust in community – Increased stress (consistent finding in South Africa)

43 South Africa Similar study Consumer lending Found increase in employment after getting a loan Net impact: 8 percentage point reduction in poverty headcount ratio

44 Further research What are patterns of impact? When should credit be increased? Who should lenders (and their funders) target? Replication needed to further answer these questions. No one study can satisfy the policy questions being posed. – Need varying competitive settings – Need varying cultural and economic conditions.

45 Five ideas SME – Give a choice to a microentrepreneur Job Or Microenterprise – What will she choose? – What are constraints? Managerial capital? Finance? Both together? Credit scoring Electronic/mobile banking linkages to savings accounts Savings – Behavioral Economics applications Integration of health into banking – CARES

46 Thank you!

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