New Frontiers in Banking Services

New Frontiers in Banking Services Luisa Anderloni · Maria Debora Braga Emanuele Maria Carluccio (Editors) New Fronti...

Author: Luisa Anderloni | Maria Debora Braga | Emanuele Maria Carluccio

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New Frontiers in Banking Services

Luisa Anderloni · Maria Debora Braga Emanuele Maria Carluccio (Editors)

New Frontiers in Banking Services Emerging Needs and Tailored Products for Untapped Markets

With 20 Figures and 42 Tables

123

Professor Luisa Anderloni Milan State University Via Conservatorio, 7 20122 Milan Italy [email protected] Professor Maria Debora Braga University of Valle d’Aosta – Université de la Vallée D’Aoste Strada Cappuccini, 2A 11100 Aosta Italy [email protected] Professor Emanuele Maria Carluccio University of Valle d’Aosta – Université de la Vallée D’Aoste Strada Cappuccini, 2A 11100 Aosta Italy [email protected]

The research has beneﬁted by contribution of

Library of Congress Control Number: 2006935542

ISBN-10 3-540-46497-2 Springer Berlin Heidelberg New York ISBN-13 978-3-540-46497-6 Springer Berlin Heidelberg New York This work is subject to copyright. All rights are reserved, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilm or in any other way, and storage in data banks. Duplication of this publication or parts thereof is permitted only under the provisions of the German Copyright Law of September 9, 1965, in its current version, and permission for use must always be obtained from Springer. Violations are liable to prosecution under the German Copyright Law. Springer is part of Springer Science+Business Media springer.com © Springer-Verlag Berlin Heidelberg 2007 The use of general descriptive names, registered names, trademarks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. Production: LE-TEX Jelonek, Schmidt & V¨ ockler GbR, Leipzig Cover-design: Erich Kirchner, Heidelberg SPIN 11893509

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Preface

This book is devoted to an issue that is the subject of growing interest amongst policy makers, financial providers and academics. That issue is the problem of unbanking or underbanking in developed countries. The issue has arisen because, faced with an ever more sophisticated and efficient financial system, an increasing number of people have found themselves in danger of being excluded from it. The goal of the papers that follow is to draw attention, both through a theoretical framework and through field study, to the need for banks, financial institutions, public authorities and non profit associations to increase their efforts to understand the process of financial exclusion, so that they can develop approaches to help people on low to moderate incomes to gain access to the whole range of financial services, from payment to savings, and from loans to investment. Some farsighted banks and financial institutions have already developed strategies, and introduced new products and services, to promote financial inclusion in these untapped markets. The research group is international and multi-disciplinary. The authors are grateful to the Italian Ministry for University Research (MIUR) for financial assistance provided under the “PRIN 2003” programme. The volume has been produced thanks to support from the University of Valle d’Aosta – Université de la Vallée d’Aoste (Italy), which has an leading reputation for encouraging research on financial innovation aimed at marginalised groups. We would like to record our most sincere thanks to all those who have participated in the research project, and to all the bodies and institutes that have contributed to it. Luisa Anderloni Maria Debora Braga Emanuele Maria Carluccio Aosta, September 2006

List of Contributions

Introduction Benoît Jolivet…………………………………………………..……

1

Part I Access to Bank Accounts and Payment Services Luisa Anderloni and Emanuele Maria Carluccio................................

5

Access to Credit: the Difficulties of Households Laura Nieri………………………………………………………..…

107

Access to Investments and Asset Building for Low Income People Maria Debora Braga............................................................................

141

Appendix to Part I Methodological Notes to the Field Research in France, Italy and Spain…………………………………………………………………

183

Part II What Are the Specific Economic Gains from Improved Financial Inclusion? A Tentative Methodology for Estimating These Gains Philip Molyneux ………………………………………..…………..

191

From Financial Exclusion to Overindebtedness: the Paradox of Difficulties of People on Low Incomes? Georges Gloukoviezoff ……………………………….……………

213

The Role of German Savings Banks in Preventing Financial Exclusion Natalia Bresler, Ingrid Größl and Anke Turner ……………...……..

247

VIII

List of Contributions

Economic Growth and Financial Inclusion: the Case of Poland Ewa Miklaszewska ………………………………………………….

271

Italian Banks’ Credit Approach Towards Low-Income Consumers and Microenterprises: Is There a Bias Against Some Segments of Customers? Eliana Angelini……………………………………………………...

299

Banking the Poor: Policies to Bring Low- and Moderate-Income Households in the United States into the Financial Mainstream Michael S. Barr ……………………………………………………..

323

Migrants and Remittances Luisa Anderloni .................................................................................

353

Conclusions Benoît Jolivet………………………………………………………..

373

Contents

Preface List of Contributions Introduction

V VII 1

Part I 1 Access to Bank Accounts and Payment Services 1.1 Introduction: Financial Exclusion …………..……………………...... 1.2 Interests, Concerns and Possible Solutions ……………...………..…. 1.2.1 General Trends …………………………..………………....…. 1.2.2 Underbanked Individuals and Fringe Banks ……...….….……. 1.2.3 Over-Indebtedness …………………………...…...…………… 1.2.4 Financial Literacy …………………………..…………….…… 1.2.5 The Service of General Interest Mission and the CommunityBased Approach …………………………….………………… 1.2.6 Concerns and Possible Solutions ……………..……….……… 1.3 The Issue of Measurement and Comparative Analysis ….……...…… 1.4 Types of Response ………………….…….………….………………. 1.5 Case Studies………………………………..……………………...….. 1.5.1 Europe ………………………………………...………………. 1.5.2 The Situation Overseas ……………………….………………. 1.6 Result from a Survey in France, Italy and Spain .....…………………. 1.7 Conclusions and Future Perspectives ……….………….……………. 1.8 References …………………………………………………....……… 2 Access to Credit: the Difficulties of Households 2.1 Introduction …………………………….………………………….… 2.2 The Use of Credit by Households ...……………………………….…. 2.2.1 The Questionnaire Survey …………………..……………...…. 2.3 A Theoretical Framework for Credit Exclusion …….…………….…. 2.3.1 The Role of Credit to Overcome Social Exclusion ..……….…. 2.3.2 Economic Rationales for Credit Exclusion …………..…….…. 2.4 Beating Credit Exclusion ………………………………………….…. 2.4.1 Lending to Households: a Profitable Business Area .……….… 2.4.2 Reducing the Costs and Risks Associated with Households Loans.……………………………………………..……………

5 5 11 11 15 16 21 22 29 30 35 43 43 69 84 95 99 107 107 108 112 117 117 118 123 124 128

Contents

X

2.4.3 A Wider Scope for Not-For-Profit Intermediaries and Organizations ………………..…………………………..……. 132 2.5 Conclusions and Policy Implications ………………….………….…. 134 2.6 References ……………….…………………………………………... 137 3 Access to Investments and Asset Building for Low Income People 3.1 Saving and Asset Accumulation for LMIs: Theoretic Framework…... 3.2 The USA Experience with the Individual Development Accounts (IDAs) ..….………………………………………………….……….. 3.2.1 Features of the IDA Accounts/Programs ………………….….. 3.2.2 Stakeholders of the IDA Accounts/Programs ……………..….. 3.2.3 Funding of the IDA Accounts/Programs ………………..……. 3.3 Saving and Asset Accumulation with Tax Refunds ..….…………….. 3.4 The British Experience with the Child Trust Fund and the Savings Gateway …….………………………………………………….…….. 3.5 Conclusions …….……………………………………………………. 3.6 References and Bibliography …...……………………….…………… 3.7 Appendix - Comment on Data About the “Access to Investment Services” ……………………..………………………….……………

141 141 145 145 154 159 162 165 172 173 178

Appendix to Part I - Methodological Notes to the Field Research in France, Italy and Spain ……………………..……………………………….………… 183 Part II 4 What Are the Specific Economic Gains from Improved Financial Inclusion? A Tentative Methodology for Estimating These Gains 4.1 Introduction …….……………………………………………………. 4.2 Defining Financial Exclusion ...….…………………………………... 4.3 European Evidence on Exclusion …….……………………………… 4.4 Market Context and European Policy Responses …….…………….... 4.5 From Exclusion to Inclusion – Identifying the Costs and Benefits ..… 4.6 Measuring the Economic Gains from Improved Financial Inclusion ... 4.7 Conclusion ……………………………….…………………….….…. 4.8 References and Bibliography……………..……………….……..…. 5 From Financial Exclusion to Overindebtedness: the Paradox of Difficulties for People on Low Incomes ? 5.1 Introduction …….……………………………………………………. 5.2 A Definition of Financial Exclusion as a Social Phenomenon .……… 5.2.1 Return to the Definitions of Financial Exclusion ………….…. 5.2.2 Use Difficulties ……………….….……………………….…... 5.2.3 Financial Exclusion and Social Exclusion: Moving Towards an Overall Definition ……………….……………………….…… 5.3 Access and Use of Credit: the Importance of Social Constraints ……. 5.3.1 The Financialisation of Social Relations …….……………….. 5.3.2 Use of Credit as a Forced Response to Life Risks ……..….….. 5.4 The Mechanisms Underlying Access and Use Difficulties.…..……....

191 191 192 193 195 199 207 209 210 213 213 215 215 217 219 221 222 224 227

Contents 5.4.1 The Reasons for the Banking Relationship ……………….…... 5.4.2 The Need for Suitable Advice to Customers on Limited Incomes ………………………………………………….……. 5.4.3 Banking Imperatives Versus Customisation of the Service …... 5.4.4 Standardisation of the Service that Is the Source of Access and Use Difficulties, and Therefore of Overindebtedness ……...…. 5.5 Conclusion ………………………………………………….……..…. 5.6 References …………………………………………………...………. 6 The Role of German Savings Banks in Preventing Financial Exclusion 6.1 Introduction ……………………………………………………….…. 6.2 Savings Banks as a Part of the German Banking System ………...…. 6.2.1 The Three-Pillar Structure of the German Banking System .…. 6.2.2 Key Facts of the Sparkassen-Finanzgruppe……...……...….…. 6.2.3 Relationships Between Municipalities and the SparkassenFinanzgruppe …………………………………….……...….…. 6.2.4 Recent Developments Affecting the Sparkassen-Finanzgruppe 6.3 Is the Public Mandate of the Savings Banks Obsolete or a Successful Strategy to Prevent Financial Exclusion? …….……………………… 6.3.1 Stipulations of the Public Mandate of German Savings Banks.. 6.3.2 Provision of Basic Banking Services ………………...….……. 6.3.3 Nationwide Provision of Financial Services ….……...…….…. 6.4 Financing of Small and Medium-Sized Enterprises ……….…..….…. 6.5 Encouraging the Accumulation of Wealth and Financial Education .... 6.6 Future Outlook on the Sparkassen-Finanzgruppe ………………...…. 6.7 References …………………………………………...………………. 7 Economic Growth and Financial Inclusion: the Case of Poland 7.1 Introduction ……………………………………………………….…. 7.2 Transformation of the Polish Banking Sector and Provision of Banking Services ..……………………………………………..….…. 7.3 Provision of Banking Services to Households and Corporations ....…. 7.4 Models of Bank Services to SME ……………………………..….…. 7.5 Barriers to Providing Banking Services to SME: Results of Bank Surveys ……………………………………...……………………….. 7.6 Conclusions ………………………….…………………...……….…. 7.7 References …………………………….………………….……….…. 8 Italian Banks’ Credit Approach Towards Low-Income Consumers and Microenterprises: Is There a Bias Against Some Segments of Customers? 8.1 Introduction ……………………………………………………….…. 8.2 Methodologies of Credit Risk Measurement: Credit Scoring Models 8.2.1 The Choice of Highly Explanatory Variables ……………...… 8.3 Strengths and Weaknesses of Credit Scoring ……………………..…. 8.4 The Effects of the Adoption of Credit Scoring on a Marginal Borrower’s Credit Process………………………………………...….

XI 228 231 233 236 241 243 247 247 249 249 251 252 253 254 254 256 257 259 261 262 265 271 271 273 282 287 290 294 297

299 299 302 305 307 310

XII

Contents

8.5 The Experiences of Some Italian Banks ...………………………..…. 313 8.6 Conclusions ……………………………………….……...……….…. 318 8.7 References …………………………………………….….……….…. 319 9 Banking the Poor: Policies to Bring Low- and Moderate-Income Households in the United States into the Financial Mainstream 9.1 The “Unbanked” and the “Underbanked”……….….……………..…. 9.1.1 The Alternative Financial Sector ……...……………..…….…. 9.1.2 The Costs of Being Unbanked …………………...…..…….…. 9.2 The Banking Sector ………..………………………….……….….…. 9.2.1 Barriers to Banking the Poor ……………………………….…. 9.2.2 Governmental Policy and Private Sector Innovation ……....…. 9.3 Payments Systems and Distribution Networks ..………….……….…. 9.3.1 Checks and Debit Cards ……...………….……………………. 9.3.2 ATMs …...…………….………………………………………. 9.3.3 Direct Deposit and Bill Payment ………………….…………... 9.4 Transforming Financial Services for the Poor .…………….……...…. 9.4.1 A New First Accounts Tax Credit ………………….…………. 9.4.2 The Community Reinvestment Act ………………….………... 9.4.3 State Policies and Welfare Reform …………………..…….…. 9.4.4 Financial Education ...……………………………………....…. 9.4.5 Reforming the Alternative Financial Sector ……………….…. 9.5 Conclusion …..…………………………………………....……….…. 9.6 References ..…………………………………..………………………

323 323 324 326 327 327 329 333 333 335 337 339 339 344 345 345 346 349 350

10 Migrants and Remittances 10.1 Migration Phenomena: Modern-Day Elements of an Ancient Phenomenon ………………..………….…………………………… 10.2 The Risk of Financial Exclusion Within a Broader Perspective ….... 10.3 Migration Phases and Personal Variables as Key Elements of Financial Needs …………………..……………….....……………... 10.3.1 Demand for Financial Services Aimed at Immigrants ….…. 10.4 Migrant Remittance Behaviour ……………...……..……...……….. 10.5 Conclusions .………………...………………………......……….…. 10.6 References ………………………………………...…….……….….

353

356 357 365 368 370

11 Conclusions

373

Editors and Contributing Authors

377

353 355

Part I

Introduction

Benoît Jolivet The world of banking services is a fascinating but complex one. It is much more than simply an ideal place from which to observe the interplay of supply and demand for specific services. It is also a mixture of pure markets and of intermediaries, of banks regulated by both central banks in charge of monetary policies and by financial supervision authorities. Money remains something special, always including an element of public trust, and the high degree of information asymmetry calls for public intervention on the side of consumers and their protection. This new book attempts to shed some light on this world, which has rules of its own yet permanently interconnected economic, social, institutional and sociological aspects. New major concepts such as financial exclusion and inclusion, are clearly defined and show the interconnection with other aspects such as, for example, poverty. In this world of finance, so often seen in terms of technique and marketing, it is very helpful and positive to take into account the independent views of people with different academic perspectives. The first part of the book is dedicated to the issue of access to different types of financial services; and includes an analysis based on a wide ranging literature review and desk study of the most interesting examples of practice worldwide, as well as on specific research conducted in France, Italy and Spain. Access to banking accounts and to payment services is a most important issue today, because they are seen increasingly as a right and as a key to full citizenship. This is also why this right is increasingly enshrined in law or regulation despite the fact that the question of its status as a basic need or as a service of general interest is still a matter for debate in many countries. Without reasonable and affordable access to these two basic areas of services, however, the chances of participating in normal social life are reduced, leading to a greater risk of social as well as financial exclusion.

2

Introduction

Access to credit is important to develop the potential offered by employment. The issue is complicated by the fact that it is the responsibility of financial institutions to supply and price credit according to risk, which means denying credit to those who are at risk of not being able to pay it back. While there clearly may be no right to credit per se, turning down somebody who is solvent does present difficulties. In the banking world, solutions are linked with principles of segmentation, scoring methods and the awareness of the sub-prime market. This book gives an account of a whole range of new and interesting examples of work currently being developed in different countries that could lead to the adoption of new types of good practice. One of these types of practice is in facilitating access to investments and asset building for low-income people. Some examples that could lead to new ideas are presented here. The most advanced experiences and interesting solutions in this area come from the USA and the UK. The second part of the book presents different studies, all related to specific aspects or projects, showing that, from a theoretical as well as a pragmatic point of view, there is scope for products to meet new and emerging needs. This association of new elements of demand and supply, arising from untapped markets, should be to the benefit of all. The development of financial activities as an important part of the key services sector, should bring more activity and employment and therefore more economic growth. Focussed on encouraging financial inclusion, instead of simply fighting against financial exclusion, this development could also lead to improved social cohesion and specific economic gains. All the aspects developed here could herald new frontiers, new behaviours and new synergies between economy and finance that are of interest to all - citizens, bankers and decision-makers. For example, the ideas of «banking the poor», without necessarily having recourse to special institutions, or of bringing solutions to migrants wishing to make remittances, could open the door to new approaches, especially for those with an interest in sustainable development and corporate social responsibility. Some specific perspectives are also of considerable interest, for example on the prevention of over-indebtedness, financial exclusion, and the merits of micro-enterprises. The overall message conveyed by each of the authors of this book, the message that we are only at the very beginning of new developments and innovations in the world of financial services, especially ones that take into account new social needs, is an extremely encouraging and refreshing one.

1 Access to Bank Accounts and Payment Services

Luisa Anderloni and Emanuele Maria Carluccio

1.1 Introduction: Financial Exclusion The link between finance and growth has been thoroughly studied by several analysts from a macroeconomic perspective, with theoretical approaches, methodological issues and empirical analyses that are still being debated1. In relation to developing countries, the study of access to financial services by families and individuals is fairly recent. In this context, both private and social benefits have been shown to accrue from improving access to financial services, such as promoting economic growth and improving income distribution. In addition, it can play a key role in reducing risk and vulnerability2. In contrast, it is access to bank relations that has been more recently studied within developed countries3. Since the 80s, special attention has 1 For a wide overview of this debate, see Goodhart C.A. (2004), Levine R. (1997) and Levine R. (2005), in which the main focus is on aggregate growth. They consider the impact on real economy, namely on the development of the country’s economic activities in terms of several GNP configurations. The essential functions recognised by Levine for the financial system are described from a macroeconomic perspective and focus primarily on business activity. However, the most recent analysis and studies highlight new research perspectives on the relationship between finance, income distribution and poverty. Furthermore, recent studies on the link between finance and growth in the developed countries have tended to address the question of whether bank-based systems are superior to the market-based ones. 2 For all of them, see Beck T., A. Demirguc-Kunt and R. Levine (2004) as well as Honohan P. (2004). 3 A certain attention was given to all this in Europe in the sixties at the time of institutional reforms and/or interventions on territorial articulation and bank institutional structures. For example, in France, a set of measures paved the way

6

Luisa Anderloni, Emanuele Maria Carluccio

been devoted to the issue of financial exclusion, seen as part of the wider issue of social exclusion. This has been particularly true of the US, as well as some European countries – the UK and France in particular. The issues have proved to be multifaceted with a range of different solutions proposed. The experience of several countries in addressing these issues is described later in this chapter. Both theoretical and practical studies have been undertaken. At a theoretical level, studies have looked at the economic, sociological, institutional and behavioural reasons why some market segments have difficulty to accessing the financial system. They have also addressed the question of appropriate policy responses. From a practical point of view, the studies have looked closely at who exactly are having access difficulties, the reasons for these difficulties, possible solutions to meet at least the most basic needs, the types of institution most able to play a role in financial inclusion. Several trends in the banking system and, more generally, in the wider institutional framework have tended to exclude people with low-moderate incomes, who have tended to be increasingly lumped together with the poorest elements of the population. The analysis that follows looks at the debate about financial exclusion in several countries. Many stakeholders are involved: government, the financial services industry, related authorities and voluntary groups, consumer organisations and different academic interests. They have focussed on a number of aspects: -

-

from the social point of view, the importance of everybody being able to participate in financial processes and to benefit from the basic mechanisms that provide opportunities for economic independence4; from the point of view of society’s economic interest, individuals excluded from financial transactions and payment systems cause inefficiencies within the financial system that results in social costs5;

for a households’ higher level of access to bank services, which went up from 18% in 1966 to 99% nowadays. See Gloukoviezoff G. (2004c). 4 In this respect, Sinclair S.P. (2001), p. 14 states that people facing difficulties accessing banking services can be prevented from being able “to make an economic contribution to the community”. 5 So, as it was underlined, following the renewed interest for the access of retired people or the ones that receive subsidies of different kinds, in the US as well as in UK, the debate on financial inclusion and the offer of basic banking accounts to meet the life-line banking has been also stimulated by the need to reduce the administrative costs related to social subsides management. In this respect, it is the electronic forms of payment that have been promoted.

1 Access to Bank Accounts and Payment Services -

-

7

those who are financially excluded also risk being socially excluded and are not able to take part fully in the production of value, and to make a positive contribution to the system as a result; from a legal point of view – but with major social and economic implications as well – the debate is around the right to an account, a service that is an essential part of normal economic and social life, to be provided at a reasonable cost and quality6.

If the concept of financial exclusion is a multidimensional one7, what are its main elements? At least two possible definitions of financial exclusion are described in the literature. A wider definition focuses on financial needs. It refers to the difficulties experienced by low-income and socially disadvantaged people in accessing the financial system in all its forms in order to meet those needs. These needs include opening a bank account, to have the option of noncash payment services and to have access to affordable credit. The needs also include the opportunity to build up modest assets through appropriate savings and investment vehicles offering flexible terms and easy access to funds, and also take account of social security allowances and unstable work patterns. A rather more restrictive definition puts the emphasis on specific services and their absence. These services are sometimes described as “essential” and refer more to a certain notion of universal services, “services that do not have an impact on the households’ budget, but (they) represent at the same time essential elements for the individual’s life, subsistence, security and participation to the economic and social life”8. This definition is

On this debate in Europe, see following § 1.2.5. See Kempson E. and C. Whyley (1999) and several other authors that have further studied and confirmed this. 8 See Anderloni L. (2003a), Pesaresi N. and O. Pilley (2003) with a specific reference to State aids in this context. See also Pilley O. (2004) : “L’accès de tous aux comptes courants et aux moyens de paiement autres que l’argent en espèces, ne figure pas parmi les services essentiels (électricité, eau, chauffage, santé, éducation, justice et services publics et privés tels que la culture, le sport et les loisirs) auxquels doivent pouvoir accéder tous les citoyens européens en dépit de l’importance de cet accès pour un exercice plein de la citoyenneté dans une société de l’information. Par contre, le surendettement y figure. Il est explicitement reconnu que le surendettement peut conduire à une fracture sociale et, à ce titre, doit faire l’objet d’une prévention. Enfin la responsabilité sociale des entreprises est évoquée spécifiquement comme un moyen essentiel de mobilisation”. 6 7

8


usually used in the context of legislative measures to impose an obligation in terms of a universal service of essential or basic bank services. An additional dimension to financial exclusion also includes “underbanked” individuals who, while they do in fact have a bank account (they are not “unbanked”), use their account very little as they have a pattern of living in which they mostly use cash or prefer to use other channels outwith the mainstream financial system9. This dimension will also be discussed in later sections. In the light of these features, it seems appropriate to adopt a wider definition of financial exclusion, such as the following: “The inability to access necessary financial services in an appropriate form. Exclusion can come about as a result of problems with access, conditions, prices, marketing or self-exclusion in response to negative experiences or perceptions”10. The advantage of this definition is that it effectively encompasses both objective circumstances, “lack of access to financial services”, as well as specific assessments: whether, as a matter of fact, the services offered are appropriate to the needs. Furthermore, it also links the objective situation to various circumstances that, whether individually or jointly, lead to exclusion. These include both obstacles from the supply side as well as barriers from the demand side, such as lack of knowledge or awareness. In general, this concept of financial exclusion can be applied both to individuals and to communities, namely homogenous groups of individuals that live in the same context and share access difficulties. In general terms, financial exclusion amongst individuals and/or communities is due to In this respect, Barr M. (2004) uses the term “unbanked” to refer to “individuals that do not have an account (savings, checking, or otherwise) at a depository institution” and refers to the “underbanked” people as those with an account at a depository institute but who rely for their financial services providers (such as check cashers, payday lenders, auto title lenders, refund anticipation lenders, and rent-to-own companies) that largely serve low and moderate income neighborhoods”. Barr observes that the problems faced by the “unbanked” and “underbanked” overlap significantly but diverge in important aspects, which he further develops. 10 See Sinclair S.P. (2001). This notion is further accepted by Carbó S., E.P.M Gardener and P. Molyneux (2004). On the other hand, according to Gloukoviezoff G. (2004c), financial exclusion is the process whereby people encounter such access and/or use difficulties in their financial practices that they can no longer lead a normal social life in the society in which they belong. In other terms, he links the notion with the social implications these difficulties imply and clearly underlines that the social consequences that constitute it vary depending on the society under consideration as well as the status of the person concerned. 9


9

geographical location, low income, general conditions of poverty, age or disabilities, living in depressed urban areas or belonging to specific, often ethnic, groups. While earlier studies often focused on the geographical aspects of exclusion11, later studies have taken a broader perspective and have sought to explain wider underlying processes behind financial exclusion. Following a study supported by the Financial Services Authority in Britain in 2000, the following categories of causes/forms of financial exclusion have been identified and are widely accepted12: -

-

“geographical access”, referring to the existance of bank and counter services in particular goegraphical areas; “access exclusion”, referring to restricted access as a result of banks’ risk assessment processes; “condition exclusion”, the conditions relating to financial products offered mean that they fail to meet the needs of some groups of clients; “price exclusion”, charges associated with products or services that are too high for some individuals; “marketing exclusion”, some market segments are specifically excluded by the way marketing and sales are targeted; “self-exclusion”, referring the fact that some parts of the population refuse to approach banks, believing that any request for products or services would be turned down.

These main elements of financial exclusion have been further analysed and, depending on the perspective applied, grouped differently in particular cases13. See the experiences made in the UK and in the US in § 1.5. The classification Kempson E. and C. Whyley propose has been further addressed by Anderloni L. (2003a), Carbó S., E.P.M Gardener and P. Molyneux (2004). It is an importance reference for all the following studies. In fact, also G. Gloukoviezoff, while studying the issue of over-indebtedness, underlines that “the deprivation of all or part of financial services (from a bank loans and savings products) and over-indebtedness are two side of the same coin” and analyses financialisation of social relationship within modern societies. See his contribution (Chapter 5) to a more precise discussion of the aspects the various authors underline. 13 Beck T. and A. de la Torre (2006) distinguish 3 types: i) “geographic limitations”, referring, as example, to “the absence of bank branches or delivery points in remote and scarcely populated rural areas that are costlier to service”, ii) “socio-economic limitations when financial services appear inaccessible to specific income, social or ethnic group either because of high costs, rationing, 11 12

10


Another useful distinction, focussing on the causes of financial exclusion, explores concepts such as affordability and access, with an emphasis on economic variables, on the one hand and, on the other, on behavioural variables14. A further relevant distinction can be made between: i) access and the opportunity to use financial services and ii) the actual use of financial services15. In many cases, “alternative financial services providers” play an increasingly important role, especially payment services (exchange, cheques and transfer of remittances to the original country for migrants, and loans for immediate cash needs). In addition, there are also bank accounts that are opened but that are basically not used. So, within the category of selfexcluded people, there are also those that refuse any form of bank service16. This is linked sometimes to a certain resentment towards the system but, more often it is linked to the fact that the services offered are not financially accessible, fall short of what is needed, or because the potential user believes they would be rejected by the bank and see little point in making an approach in the first place. Difficulties of access and difficulties in using these services are closely linked to the behaviour of both providers and their customers. The above approach provides a useful tool to analyse the issues and to identify a wider range of interventions with the potential to facilitate financial inclusion.

financial illiteracy, or discrimination” and iii) “limitations of opportunity” when “talented new comers with profitable projects are denied finance because they lack fixed collateral or are not well connected. As a variant to the main abovementioned classification, Honohan P. (2005) explicitly proposes the following categories: i) “price barrier”, when service is available but too expensive, ii) “information barrier”, when poor household’s creditworthiness cannot easily be established, and iii) “product and service design”, when banks fail to offer the kind of services that would be most useful for poor households. The reason for these barriers, Honohan points out, may be technological, regulatory or market factors. 14 See Connolly C. and K. Hajaj (2001). 15 This position is shared by Gloukoviezoff G. (2005a) too. About this aspect, see also World Bank (2005), further developed in § 1.3 and the above-mentioned distinction between “unbanked” and underbanked,” proposed by Barr M. (2004). 16 These responses include the ideological position of refusing to interact with any banks. In this respect, see in §1.6 the results of the survey that has been carried out in France, Italy and Spain.


11

Table 1.1 Summary of different types of financial exclusion Difficulty of access Supply side Direct practices screening Indirect screening Demand side practices

Selfexclusion

Difficulty of use Supply side Customer practices profile scored “too costly to serve” Customer profile scored “too risky to serve”

Banking policies: refusal to serve customers on account of profile. Counters localisation policies in areas with no socio-economic degradation Marketing: adverts to profitable/ market segments only (marketing exclusion) Refuse to use some services

To force a deeper usage of services (policy of packaging, link some services to others, etc.) Higher fees and charges for those services that are more frequently used by undesired customers

To use penalty clauses and charge fees and commissions for non payment to improve profitability or to weed out customers that do not pay To take advantage of lack of knowledge of their rights from weak customers (undue foreclosure, dishonour of plans in cases of over-indebtedness) Demand Eschew Do not keep the bank informed about the side banking difficulties being experienced practices relationship To look for solutions from outside the banking relationship (revolving credit, undeclared work, etc.) Source: adaptation from Gloukoviezoff G. (2005).

1.2 Interests, Concerns and Possible Solutions 1.2.1 General Trends There are several reasons why growing sectors of the population are interested in having accessing financial services and why increasing attention is being given to the problem of financial exclusion. These include:

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Luisa Anderloni, Emanuele Maria Carluccio -

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an increased focus on all types of social exclusion and discrimination. In Europe, this interest has been encouraged by a number of leading countries (France, Great Britain and some Nordic countries) and has also been strongly supported by the European Union17. A major emphasis has been then put on measures to promote the social and economic potential of all to the full; the spread of social and economic organisational models over the past two or three decades that, on one hand, have made it more difficult to survive without contact with banks and other financial services providers and that, on the other, have increased socio-economic instability18. This instability has also made stable relationships with banks and other financial services providers more difficult and expensive and has widened the gap between the provision of necessities, on one side, and the accessibility of what is offered on the other; providers own policies may result in the neglect of clients considered marginal. In particular, cost based pricing and risk-based policies, with their corresponding techniques of measuring profitability and capital allocation can contribute to this. Growing pressures on banks for a higher manufacturing and distribution efficiency call for a stringent reduction in costs in search of greater profitability. This results in market segmentation policies with a preference for customers with greater financial resources, whereas those with more modest resources no longer benefit from cross-subsidies from other market segments. In fact, until recently, many basic banking services

In particular, the Lisbon European Council in March 2003 underlined the positive interaction between economic, social and employment policies, which aim to promote a model of sustainable development for the Union to raise all the European citizens’ lifestyle. This would be possible by linking economic growth, social cohesion and safeguard of the environment. This objective is pursued also by modernising the European social model, investing in people and fighting against social exclusion. 18 Some phenomena are mentioned, in particular: i) the employment market has become more flexible with more and more flexible working contracts, compared to the full-time open-ended jobs, ii) the traditional families have disappeared; see also the implications of ageing population, rising number of separations and divorces, diminution of marriages and, as a consequence of that, the rising number of cohabitations and children born to unmarried couples or raised by only one parent on the social integration solidity, iii) the development has geographically polarised, with major gaps between urban and suburban areas, economic and social wellbeing and degraded areas, iv) the speed gaps in the development of a knowledge society. 17


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were effectively cross subsidised by more profitable activities. Increasing competition and the emphasis on efficiency and profitability have conspired to eliminate these models. Automation and the spread of self-service banking, with low levels of interaction with bank staff, have also had a negative impact on access. More traditional users with lower technological and financial literacy and unwilling to use self-service banking, are penalised and do not benefit from the lower bank charges for self-service transactions; the transformation of the banking system. Many types of bank (such as mutual, co-operatives, previously public or, more rarely, private banks), have been privatised or taken over by commercial banks. The primary task of many of these banks in the past was to develop the local context and to support the poorest parts of the population, as well to encourage involvement in the local community; the rationalisation of the network of bank retail outlets as a consequence of the two above-mentioned factors19. Outlets are increasingly located in the most profitable areas and increasingly tend to avoid degraded urban areas and poorly populated rural ones20; measures both to combat money laundering and to combat the financing of terrorism bring a greater bureaucratisation of financial transactions in their wake and increase the importance of management and counter staff knowing more about their customers; finally, the increasing withdrawal of the state from the provision of social security means that there is a growing need for personal savings and more use of private sector provision to meet future needs, including the needs of those with the least financial resources.

People running the greatest risk of financial exclusion as a result of these trends share important common features even if their context is different. Evidence from different countries suggests that financial exclusion is concentrated among people with the lowest incomes and that unemployed people, those unable to work due to sickness or disability, and

19 It should be mentioned that the above-mentioned transformation process has often come along with concentration and revision processes, within a group perspective, with localisation of counters, closure of the ones that were overlapping in some areas and the ones whose profitability was considered not sufficient according to new profitability requirements and the new business’ mission. 20 This contributes to the concentration of multiple disadvantages in certain urban and rural communities and among some groups.

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lone parents are especially affected21. Indeed, many people either stop using, or close down a bank account and cancel insurance policies when they leave the labour market. Furthermore, it is the youngest and oldest parts of the society that have the most limited access to the bank services, though for different reasons. Young people on low incomes tend to have poor knowledge of financial services and, in addition, are more likely to have experienced financial difficulties because of a failure to respect their financial (and nonfinancial) commitments. Members of the oldest age groups on low incomes tend to have lived on a low income all their lives, never to have used financial services and to have only used cash. They tend to be highly resistant to change and prefer to continue the practice of carrying out their transactions solely in cash22. Recent immigrants and refugees face particular problems, partly through low income and partly through lack of appropriate documentation23. Cultural and religious factors can also have an impact24. In addition to this, migrants from some specific areas often have either a poor or even no knowledge of the banking system or have little trust in it. For this reason, they are reluctant to engage with banks. Together, ethnicity and low income can lead to geographical concentrations of serious financial exclusion. In drawing up a picture of factors that contribute to difficulty of access to the banking and financial services industries, there are three further issues that increase the risk of financial exclusion in the broad sense of the term: -

underbanked people and the use of fringe banks; over-indebtedness and payment incidents; financial illiteracy and other forms of misuse of the financial system.

See Anderloni L. (2003a), Bayot B. (2005), Kempson E., A. Atkinson and O. Pilley (2004), Gloukoviezoff G. (2005), Kempson E. and C. Whyley (1999), and § 1.6 in this chapter. 22 See Anderloni L. (2003a) pp. 58-96, GES (2000) and Kempson E., C. Whyley, J. Caskey and S. Collard (2000). 23 Permit to stay or identity documents. About the issue of migrant population’s access to financial services, see: Atkinson A. (2006), Anderloni L. (2003b), Anderloni L., E. Aro and P. Righetti (2005) and chapter 10 in this book. 24 In particular low-income Muslims living in a predominantly Christian often find that there are no Shariah-compliant financial services they can use. About Islamic finance, see Llewellyn D. and M. Iqbal (eds) (2002). 21


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1.2.2 Underbanked Individuals and Fringe Banks Though underbanked individuals formally have access to a bank account, for various reasons their needs are not satisfactorily met through their relationship with the bank and they remain then partially excluded from the banking system (for example they have no fiduciary instruments at their disposal, such as cheques or credit cards). Because of this they use alternative channels. To meet a need for immediate cash, for example cashing a cheque or other payment instrument, or a short-term loan, they address themselves to providers operating in areas of “grey regulation” often outwith the remit of consumer protection legislation. The underbanked individuals’ position can take different forms in different contexts. For example, in France where, for historical reasons, cheques still represent an important payment instrument, not having a chequebook puts one at a severe disadvantage; moreover, the widespread use of credit cards means that the failure to own one can reflect negatively on a person’s trustworthiness. In Sweden, internet banking is widespread and bank transactions at the counter are financially penalised and those without access to a computer and to the internet suffer. In some contexts, the fact that the unbanked or underbanked individuals use fringe banking services is a matter of some considerable concern since they tend to be associated with exorbitant costs and unfair conditions. The sector comprises both providers with a long tradition of meeting the needs of marginal customers (in particular the pawnshops that provide credit upon pledge, that experienced an exponential development in the 80s)25, as well as newcomers to the market (cheque cashing firms, pay-day loan firms, rent-to-owns and, more generally, finance and loan companies), who provide, immediate cash to this market segment. This case is forthcoming at the expense of very high charges, since they associate a high premium to the risk involved. This phenomenon is particularly widespread in the US26, in Canada27 and in the UK28. In these countries, increasing attention has come to be paid to these services and their impact on their customers – most of whom are economically fragile. In some other countries (for example in Italy and

Caskey J.P. (1994). See Caskey J.P. (1994), Fox C.J.A. (1998), Rhine S.L.W. et al. (2001), Arthi Varma (2004). 27 See Buckland J., M. Thibault et alia (2003) and (2005). 28 See Carbó S., E.P.M. Gardener and P. Molyneux (2004) and several articles on the daily press in 2004. 25 26

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Ireland29) there are signs that seem to indicate that these financial services have established themselves and are growing in importance. However, since the phenomenon has not been studied in detail, it is not really possible to get an accurate picture of its size, its ways of working and the dangers involved. The above-mentioned studies clearly show, however, the risks associated with the fringe banking sector, particularly for lowincome, socially and economically fragile customers. In fact, the sector encourages a vicious cycle where indebtedness grows, the costs of servicing debt increases, and the repayment arrangements become ever more demanding, with the result that the financial situation of those dependent on the sector becomes more and more difficult with an increased risk of poverty as a result. 1.2.3 Over-Indebtedness Over-indebtedness appears, at first sight, to be a paradoxical phenomenon. In fact, in addition to being associated with financial exclusion on account of difficulties in accessing the financial services market, modern economies also see financial exclusion resulting from exclusion from the market as a result of over-indebtedness, and when the situation has been faced in a way that is damaging30. At the same time there is another growing form of indebtedness. This is household indebtedness (to support consumption, to purchase the house, as a result of unforeseeable events, and so on) and it is a characteristic trend in modern economies: the over-indebtedness risk31 –

29 In particular, usury is mentioned, that is to say funding at so high rates that the loan will be ever redeemed, but it grows so massively to force the debtor to sell all his/her available goods, ask for the family’s help, and includes in some cases slavery and prostitution. These are of course illegal operations that remain out of the legal credit market and for which even the rules on threshold usury rates are ineffective. 30 On how the two phenomena are compatible, seen as two sides of the same coin, see G. Gloukoviezoff in this volume. 31 To underline the social implications of the phenomenon, the following definition is adopted: “over-indebtedness conditions are present when a private subject (a household) is incapable of facing the payment obligations in due time according to its current revenue. If it did it, its survival conditions would disappear”. See Anderloni L. (1997), p. 77. On the notion of over-indebtedness and, even more, on the modalities to measure this phenomenon, the literature’s debate is still open and there is no general agreement about how this is to be defined or measured.


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and, in particular, so-called “passive over-indebtedness”32 – is higher for the socially and economically fragile individuals. It should be remembered at this point that over-indebtedness can result not only from the need to keep up loan payments, but may also result from other commitments including rent, utilities, insurances, taxes and duties or cash advances within family structures. In fact, while over-indebtedness can affect all sections of the population, researches have shown that it is primarily related to low income. Besides lower incomes, separations and divorces are also often major factors. Over-indebtedness has, then, important and complex links with social and financial exclusion. While over-indebtedness is often a consequence of social exclusion it can also be a direct cause of exclusion, leading to exclusion not only from financial services, but also from other spheres of economic life such as telecommunications, housing or even employment. Problems of over-indebtedness mostly arise through changes in circumstances that give rise to an unexpected decline in income, making existing commitments unaffordable. This can include job loss, divorce and the onset of long-term sickness and disability. Some of these tend to be concentrated among young families. At the same time, it is important to note that people who are already socially excluded, and living on low income for long periods of time, also have a high risk of over-indebtedness, particularly taking into account all their household commitments rather than simply consumer borrowing.

This is distinguished, from a logical point of view, from active overindebtedness. “Active” over-indebtedness indicates the condition caused by the individual’s high tendency to spend (for consumption and/or investments) because he/she highly trusts his/her current and future revenue capacity. In other words, the individual’s economic and financial behaviour makes him/her underestimate his/her engagements’ size (entity and deadlines). Alternatively, he/she implicitly overestimates his/her income flows over time. “Passive” over-indebtedness indicates the condition that has been generated after indebtedness decisions, by unforeseeable factors that are generally independent from the individual’s will, job loss as an instance. In this context, there is no revenue (or parts of it) and the income flows has been interrupted or reduced; at the same time, some unplanned liabilities have emerged (diseases, disability, rising rent costs). These elements are more likely to occur within the economically and socially weakest and most vulnerable parts of the population and within the economic cycle’s phases that go towards recession. The distinction on the practical point of view is not always evident. It is clear that the lowest the individual’s current revenue is, the most frequently the “active over-indebtedness” will occur, for cultural and economic needs. 32

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The links between over-indebtedness and financial exclusion can thus be summarised as follows: -

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some studies have shown clearly that the people who are mostly subject to passive over-indebtedness (see definition above), have much in common with people who find it difficult to access the financial system and gain appropriate and mindful use of financial products and services33; payment and debt repayment difficulties resulting from overindebtedness often causes financial exclusion. For example, modern credit ratings techniques, allow personal information to be distributed through centralised credit reporting systems, so that someone with negative credit information such as a default can find themselves excluded in future from access to finance and, as mentioned above, also telecommunication or even employment; the means of preventing the risk of over-indebtedness occurring34 and the ways of dealing with it, once the difficulties have reached a climax35, are often the same as the ones that can be used to prevent the risk of financial exclusion and to help economically and culturally fragile people develop a relationship with the financial system.

Besides its links with financial exclusion in general, the issue of the financial exclusion of households has given rise to two particular concerns at EU level. On the extreme, it is the population with the highest revenues that most frequently face active “over-indebtedness”. In the countries where consumer credit is very widespread, people are becoming over-indebted simply through overborrowing. These people are not necessarily living on low incomes: indeed to obtain the levels of credit they have, they need to be in fairly secure jobs on middle incomes. They are people who are active consumers, who frequently aspire to a life style that they cannot afford on their income – consequently they live beyond their means by borrowing heavily. They also tend to be relatively young, since this is the time when household budgets are most limited and the need to borrow arises. 34 The most common initiatives to deal with problems of over-indebtedness are, on the demand side, programs for promoting financial literacy and to raise levels of financial capability, on the offer side, initiatives for promoting responsible lending by creditors, and on the institutional side, appropriate arrears recovery practices by creditors. 35 Ex post initiatives to deal with serious problems of over-indebtedness are both procedure for bankruptcy or “personal recovery” to deal with the most difficult, i.e. irreparable, situations, and provision of free debt advice for helping to draw a plan of reimbursement and provision of mediation services with the creditors in order to come to an agreement on a rescheduled plan of reimbursement. 33


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The first is the impact on consumers of the enlargement of the credit market, and increased competition and innovation. This is in the context of European Union moves towards a single harmonised market for financial services, progress with the Financial Service Action Plan36 and the proposal for modifying the Directive on consumer credit37. The priority is to find a balance between the goals of maintaining accessible and affordable credit together with the promotion of the internal market, while ensuring at the same time, a high degree of protection for consumers throughout the European Union. This debate highlights a discrepancy between the objective of offering financial service providers legislation to allow them to operate in the same way in all the Member States, through full harmonisation of key legislation and, at the same time, the goal of not reducing levels of consumer protection, leaving space for regional problems and combating the increase in over-indebtedness. A major concern is that, in some contexts, aggressive policies to promote the use of credit via revolving cards could lead to an intolerable increase in indebtedness, including over-indebtedness amongst those who are most economically and culturally fragile and who would be most exposed to the risk of taking on too big commitments too quickly. The increase in card-based payments undeniably presents a number of policy problems, the most serious of which is the likelihood that the use of cards will contribute to an unjustifiable level of consumer credit and that borrowing on the cards will contribute to an increase in the level of consumer bankruptcy38. Secondly, preventing and dealing with different forms of overindebtedness represents, in some countries, an important part of the common objective to fight against poverty and social exclusion. The Lisbon European Council has established a political framework, including the fight against exclusion in the Union’s overall strategy39. This is to be achieved through an open method of co-ordination combining national action plans and a Commission’s initiative for co-operation in that field. In accordance with its mandate, the Treaty of Nice endorsed the fight against See http://ec.europa.eu/internal_market/finances/policy/index_en.htm See Modified proposal for a Directive of the European Parliament and the council on credit agreements for consumers amending Council Directive 93/13/EC COM (2005) 483 final and the following Council of the European Union, DS258/06 of April 4th 2006. The importance to amend the Directive is reaffirmed in White Paper, Financial Services Policy 2005-2010. 38 Because increasing financial distress imposes externalities on the economies in which it occurs, the global rise of the credit card poses serious policy questions. 39 See Lisbon European Council, Presidency Conclusion, March 23rd and 24th, issue “Promoting social inclusion”. 36 37

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social exclusion and all forms of discrimination, within its European social agenda40. Furthermore, it has included the fight against exclusion within art. 137 of the Treaty establishing the European Community. Based on this, the Council has invited the Member States to elaborate a common approach by preparing two-year National Action Plans on Social Inclusion41. In this context it should be pointed out that, amongst initiatives aimed at preventing the risk of exclusion, several national plans have included specific initiatives to confront over-indebtedness and financial exclusion. In particular, as over-indebtedness has increased it has had unfavourable implications for poverty and exclusion amongst individuals and households (for example, they were discouraged from looking for or accepting a job)42. Initiatives taken to combat the rise in over-indebtedness include the promotion of information and the development of educational activities43. In addition, some countries44 have also adopted measures to improve access to banking services and to provide free financial advice services. On top of this, the reports presented by United Kingdom45, Netherlands, France, Finland, Belgium and Germany highlight the measures taken to combat financial exclusion, such as easier access to bank accounts, simplified soft See Nice European Council Meeting, December 7th, 8th and 9th 2000, Presidency conclusions, Annex I, European Social Agenda, III Fighting Poverty and all forms of exclusion and discrimination in order to promote social integration. 41 See NAPS/Inclusion 2003-2005 and updated reports on 2004-2006 NAPs/ Inclusion. 42 The situation and level of attention is different in the various countries, since there is no official or academic shared definition, it is difficult to compare the available data. This phenomenon seems to be relevant in Austria, Belgium, Germany, France, Ireland, Netherlands, the UK, Portugal where the NAP on Social Inclusion point out that the phenomenon has reached worrying levels and in Spain where a report of the Bank of Spain underlined the problem that 34.5% of the poorest families had debts which were three times more than their annual income. See Commission of the European Communities, Commission Staff Working Document, Implementation and update reports on 2003-2005 NAPS/Inclusion and update reports on 2004-2006 NAPS/Inclusion, COM (2006) 62 final. 43 Examples of that are Austria, Belgium, France, Luxembourg, Portugal that include these initiatives within the 2003-2005 NAPs on Social Inclusion. 44 France and Belgium in the first case, the UK in the second case. 45 The experience is particularly articulated in UK: generally, also afterwards, the government sets out the goal to reduce by 50% the number of people that do not have any bank account; to this purpose, it has created a special fund for financial inclusion. Some regions (Northern Ireland, Wales and Scotland) have taken specific initiatives. 40


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loans and face-to-face counselling to cater for the needs of people on low incomes. In these cases, financial exclusion is seen as part and parcel of social policies to fight poverty and promote social inclusion. Other initiatives taken to prevent and manage over-indebtedness include services that offer advice and guidance for people with debts46 and legislation on the regulation of debt47. 1.2.4 Financial Literacy The lack of financial understanding amongst consumers is a second major issue and surveys in a number of developed countries48 suggest that financial literacy levels are particularly low amongst the less educated, minorities and those on the lowest incomes. Financial literacy is increasingly important today for a number of reasons: -

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the wide range of financial products and services designed to meet a range of often sophisticated needs that are not easily understandable by the inexperienced user; the increasing complexity of financial products, with a very sophisticated range of options; combined with a time gap between the purchase of a financial product and its use to do what it is supposedly designed to do. Therefore, it is only at a later stage that it becomes apparent whether the original choice made was appropriate or not; the reduction in public pension provision and the need for the integration of public and private provision or the substitution of the latter for the former. The choices involved are complex ones, in which the risk tends to be transferred from the provider to the worker; the general growth in standards of living and therefore the increasing number of individual investors who have money saved that needs to be invested. At the same time, the increasing level of job insecurity in a more flexible labour market often make this saving essential to provide a buffer in the face of sudden changes of income; the trend towards the liberalisation of markets with a proliferation of providers and distribution channels, together with increasing product innovation, increases the risk of mis-selling and of consumers being actually “ripped off”.

See the experiences of Austria, Belgium, Germany, Finland, France, Hungary, Netherlands, Ireland and the UK. 47 With reforms introduced in Germany, France and presently under discussion in Belgium, Finland and Netherlands. 48 See US, the UK and Australia. 46

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Financial literacy and financial education initiatives49 are thus very important weapons in the fight against financial exclusion in its broadest sense, since access to appropriate financial services requires conscious and adequate choices on the part of consumers. 1.2.5 The Service of General Interest Mission and the Community-Based Approach Finally, mention should be made of the fact that, given crucial importance of suitable access to financial services – particularly to payment services – in many areas of social and economic life, a debate has developed in some countries about basic banking services as services of general economic interest. It is argued that they should be made accessible to all consumers and have a good price/quality ratio since they are indispensable for individual life, subsistence, and safety, as well as for involvement in economic and social life. Generally speaking, private sector providers perceive the possibility of imposing a requirement for the provision of services of general interest as a threat, especially if they are to receive no benefits to compensate for the costs of rendering services to unprofitable customer sectors50. At the same time, the granting of compensation benefits is also perceived as harmful by public authorities because of the risk of introducing bureaucratic mechanisms that compromise market competition. As far as individual countries are concerned, the obligation of universal service with regard to basic banking services has been discussed and introduced, through different forms and methods, in the UK, in France and in Belgium51. In other cases, such as Germany and Austria, it has been acknowledged that this function is effectively performed in the market, by The following definition is relevant here. “Financial education is the process by which financial consumers/investors improve their understanding of financial products and concepts and, through information, instruction and/or objective advice, develop the skills and confidence to become more aware of financial risk and opportunities, to make informed choices, to know where to go for help, and to take other effective actions to improve their financial well-being”. See OECD (2005). 50 The granting of compensation benefits is becoming increasingly difficult as a consequence of both the reluctance as regards direct or indirect government aid, and of the general reduction of public resources available to support the economy. At the same time, as already mentioned, competition erodes spaces for monopoly and use of cross-subsidies. 51 See § 1.5 below. 49


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some categories of banks or, as happens in Sweden, by a subsidiary of the postal service52. In order to understand the approach to the subject of services of general economic interest on a Community level, it is first of all necessary to consider the general framework of the debate over time and how the latter was supported by the discussion concerning the Services Directive proposed in January 2004 under Commissioner Bolkestein53. General economic interest missions were initially created by the Treaty of Rome as a means of justifying exceptions to competition, but later on they became a development and social concept (reflecting the shared values of the Union as well as playing a role in promoting social and territorial cohesion”)54. The Council of Nice approved a Statement on Services of General Economic Interest that shared the Commission’s view that “the scope of services of general economic interest should not remain fixed, but should reflect our rapidly changing economic, scientific and technological environment”. It also argued that the opening of some of them to the market could have a positive impact in terms of availability, quality and price55. As regards Communications56, the Commission issued a report to See Report of the European Commission to the Council of Ministers: Services of general economic interest in the banking sector, adopted by the Commission on 17 June 1998 and presented to the Ecofin Council on 23 November 1998. 53 The directive serves the purpose of making it easier for service providers to deliver services in other Member States, with the underlying assumption that liberalisation will lead to better quality services and lower costs. The proposal in its original form would have lumped together a vast range of services under the same umbrella: from financial services, employment agencies, to water, gas and social, education, health and housing services. 54 Thus in the new art. 16 of the Treaty signed on June 18th 1997. 55 Moreover it recognises their contribution to European competitiveness, as they serve specific purposes (protection of consumer interests, user safety, social cohesion and regional planning, sustainable development), reaffirms the importance of the principles of neutrality, freedom and proportionality, and underlines that the tasks performed by them should be carried out in such a way as to meet the legitimate expectations of consumers and citizens. In addition, it expresses a number of concerns related to the fact that application of internal market and competition rules should allow services of general economic interest to perform their task under conditions of legal certainty and economic viability which ensure - inter alia - the principle of equal treatment, quality and continuity of such services as well as the necessity of a regular assessment of the contribution made by services of general economic interest to economic growth and social well-being. See Nice European Council Meeting, 7th, 8th and 9th December, Presidency Conclusions. 52

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the Laeken European Council57 and the Green Paper on Services of General Interest58. The latter document built on the distinction between economic and non-economic services, and also highlighted the fact that “the range of services that can be provided on a given market is subject to technological, economic and societal change and has evolved over time”. As a consequence, the distinction between the two categories has been a dynamic and evolving one, and in recent decades more and more activities have come to have economic relevance. For an increasing number of services, the distinction has become blurred. As a consequence there has been a reluctance to draw up a definitive list of general interest services regarded as non-economic. Rather, in an attempt to paint a Community-wide picture of services of general interest, the Commission has identified a common set of types of provision that include the concept of universal service59. These should be provided in a continuous way, meet specific requirements in terms of quality and affordability, in order to be accessible for everybody, and comply with user and consumer protection standards. The general examples provided include network services (energy, transport, telecommunications) and, as far as non-economic services are concerned, justice, safety, national education and a compulsory basic social security scheme. Though the documents issued by the Commission frequently make a distinction between Services of General Interest (SGI) and

See “Services of general interest in Europe”, respectively OJ C 281, 28.9.1996, p. 3 and OJ C 17, 19.1.2001, p. 4. 57 See COM (2001) 598 final, 17.10.2001. 58 See Com (2003) 270 final where an effort is made to define and clarify terminology. 59 Mention should be made here of the definition of universal service contained in Green Paper: “the concept of universal service refers to a set of general interest requirements ensuring that certain services are made available at a specified quality to all consumers and user throughout the territory of a Member State, independently of geographical location, and in the light of specific national conditions, at an affordable price”. It has been developed specifically for some of the network industries (i.e. telecommunications, electricity, and postal services). The concept establishes the right for every citizen to access certain services considered as essential and imposes obligations on industries to provide a defined service at specific conditions, including complete territorial coverage. In a liberalised market environment, a universal service obligation guarantees that everybody has access to the service at an affordable price and that the service quality is maintained and, where necessary, improved. Reference to this concept has been made by some countries when underlining the need to impose on banks the obligation to supply basic banking services. 56


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Services of General Economic Interest (SGEI), there is no clear definition of either these terms60. From the evidence of Community documents, however, there are not many instances of the application of these concepts to the banking sector. When working documents mention sectors and services, this is usually done merely for the purpose of exemplification. The interpretative Communication of the Commission dated June 26th 1997 on the freedom of service provision and the general interest missions in the Second banking directive lays down the necessary criteria for a general interest measure to ensure that the set objective will be reached. The above mentioned Report to the Council of Ministers states that, with respect to the liberalisation of the market, the financial services sector has been the subject of Community legislation aimed at establishing fair and open competition and that the banking sector is already characterised by a satisfactory level of competition. Only overriding community interest could justify the placing of constraints on this. An investigation conducted by the Commission on services of general economic interest in the banking sector revealed that a certain number of Member States consider that a number of credit institutions fulfil specific tasks that constitute SGEI. The main ones are: i) promotion of small and medium sized enterprises, ii) granting or guaranteeing of export credits, iii) social housing loans, iv) municipal financing, v) financing of infrastructure projects and vi) regional development. In most cases these services are delivered by specialised credit institutions, especially established for that purpose, and in the vast majority owned by public authorities. Two member States61 consider the supplying by a certain group of credit institutions (namely the savings banks) of a comprehensive financial infrastructure providing territorial coverage as fulfilling the remit of a SGEI62. None of the Member States had given (until that time, i.e. 1998) the banking sector a duty to provide basic banking services. The Commission adopted a prudent attitude on the matter, deciding that this type of regime should be the object of an individual evaluation, on a case to case basis63. Thus the Committee on Economic and Monetary Affairs of the European Parliament in the Draft report on services of general interest of May 16th 2006. 61 They are Germany and Austria. Beside them the Swedish authorities obliged one credit institution, which offers banking services at the post offices, to provide a nation-wide payment service network. The credit institution receives compensation for costs incurred in delivering such services to sparsely populated areas where no other credit institution offer such services. 62 Also mentioned in paragraph 35 of the document “Com 2000 580 final”. 63 Some of these will be examined in detail later on. 60

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Most recently, the proposed amendment to the services directive on the one hand stipulates that SGEI fall within the scope of the directive because these services are of an economic nature64 and, on the other, excludes financial services – among numerous other exclusions – from its scope, arguing that these activities are the subject of specific Community legislation aimed at the same goals65. The solution mentioned above was adopted, despite some criticism that no specific consideration had been given to the concept of basic banking services. Finally, in order to gauge the role of the European Commission in this matter, we should bear in mind that, as the guarantor of the Treaty, it also has the task to monitor the compatibility of the provision of public services with the common market when they are provided by a company which, at the same time, is operating in the competitive sector. Various measures aimed at preventing or redressing financial exclusion have been notified to the Commission, which did not raise any objection66. These involved financing by the government of services of general economic interest (falling within the SGEI category) that offered deposit and payment services through the postal counter network covering the whole country and, in the specific cases presented to the Commission, serving citizens living in isolated regions or receiving social security benefits67. In the UK case, the authorities gave notice of an array of measures under the headline of “universal banking services”. As a part of the Government modernisation policy, the measures introduced the compulsory migration of the payment of social security benefits to automated credit transfer systems and were also aimed at facilitating access to a current account to those who were “unbanked”. The mechanisms were being put in 64 Following the amendments by Parliament, the revised text by the Commission reads as stated here, but also adds that the directive does not provide for their liberalisation or for the privatisation of public entities providing such services, nor does it deal with their funding or with state aids. Vice-versa services of general interest, which are not performed for an economic consideration, fall outside the scope of the directive. 65 This exclusion covers all financial services such as banking, credit, insurance (including reinsurance, occupational or personal pensions), securities, investment, funds, payments, investment advice and services listed in annex I to Directive 2000/12/EC. There is, as already mentioned, a large number of exclusions in a wide array of sectors; most importantly the exclusion covers all social and healthcare services, transport services and matters of electronic communication services. 66 Reference is made here to cases from different socio-economic contexts: Great Britain, Sweden and Ireland. 67 See Pilley O. (2005) and Pesaresi N. and O. Pilley (2003).


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place to ensure that the net cost of the services of general economic interest granted to Post Office Limited and the contributions to the new Post Office Card Account would not be overcompensated. These two measures did not involve any State resources. Therefore the Commission decided not to raise any objections to the notified proposal for universal banking services. In the Swedish case, the postal company, wholly owned by the State, was entrusted with a new universal basic cash service for which it receives an annual State compensation through a budget appropriation. In this case too, the Commission decided not to raise any objection as the measure did not involve any over-compensation. Finally, in the Irish case, the proposal was for a one-off equity injection to An Post aimed at enabling the redevelopment of the Post Office network, where the revenues to the postal counter network from the delivery of services of general economic interest (postal, financial and governmental) represent about 80% of turnover. As the compensation received is no higher than the extra cost of the related general economic interest service of the country-wide country cover, this transaction also got the green light. Another recent decision by the Commission concerns the creation and operation of the Postal Bank in France. The operation is complex: its aim is to split the banking and insurance activities of La Poste and entrust them to a subsidiary, Banque Postale, of which 100% was initially owned by La Poste, established as a joint stock company and with a credit institution statute. It is not possible here to go into detail about the implications of such an operation from the various viewpoints of Community law. Suffice it to say that the position taken by the European Court of Justice supported the view that La Poste has an important general economic interest role. More specifically, mention is made of its connection with the local area and service to the latter (“CRAT – Contribution à l’aménagement du territoire”) which, according to French authorities, falls within the scope of a SGEI68. The result is that there are complex methods for the allocation of the management costs for the counter network attributed also to financial services and therefore to Banque Postale. These are subject to validation and approval by the Commission to ensure that such methods are not in contrast with Community principles and do not involve Government aid. The situation is obviously complex and has economic relevance: suffice it to say that La Poste’s financial services account for The Government imposes on the French postal services two SIEG missions related to the density on contact points in the area: one is universal postal services, the other one “aménagement du territoire”. 68

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25% of turnover69 and the costs allocated to financial services include the share of structure services common to the group, taxes and the residual CRAT mentioned above, not compensated by the reduction of taxation. Based on the complex and articulated analysis by the Commission, the decision was taken not to raise any objection because the measures under examination do not involve economic advantages and could not therefore be regarded as Government aid70. It is worth mentioning here, however, that the importance of the distribution and convenience of retail outlets was acknowledged, since this enables them to provide services in areas with low population density or at an economic-social disadvantage. Finally, an indication as to how the Community has approached the topic of access to bank accounts and basic banking services is contained in the White Paper on Financial Services Policy 2005-2010 that paves the way for the development of Community activities as regards financial services for the current five-year period. There, the Commission, considering further actions that are needed to open up the fragmented retail financial services, mentions bank accounts. It points out that “accessing a bank account is the entry point for most consumers to financial services and markets and increasingly important for citizens to participate in the market and society”. It also calls attention to the fact that this is even more important when electronic payments are made within a Single Payment Area. The subsequent conclusion is that undue barriers associated with all types of bank accounts (current, savings, securities accounts) must be removed, that consumer choice must be widened and competition between service providers must be increased. In particular the Commission wished to identify existing problems associated with user mobility, that is to say opening accounts across-borders – including online – closing fees and transfers between banks. Moreover, the Commission has also put forward the idea of assessing the usefulness of an optional standard bank account, also in collaboration with experts chosen among the industry and users. While this proposal is actually driven more by a concern for the development of a borderless European market than by the a desire to promote social banking initiatives, it paves the way for a recognition of the central importance of banking services and accounts in the today’s social and economic context.

See C(2995) 5412 final, Mesures liées à la création et au fonctionnement de la Banque Postale. 70 See C (2005) 5412 final. 69


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1.2.6 Concerns and Possible Solutions From the above discussion, a wide range of factors contributing to financial exclusion emerges. They can be grouped into the following categories: -

macro environment (level of revenues, unemployment, social assistance, development’s geographical polarisation); personal features (education and culture, family structure and involvement in the local community); commercial context (bank, financial services, utilities and consumer goods).

In addition, factors contributing to difficulties of access or financial exclusion are to be found both in the supply side and the demand side. In fact, an examination of these factors can help point us in directions that can help remove obstacles and facilitate access and financial inclusion. The battle against financial exclusion should be fought, at several levels: the macroeconomic and the institutional one, with reference to support and care for those most in need, the offer side with appropriate structures supplying bank and financial products and services appropriate to lowmoderate income people, and at the level of the underlying philosophy and motivation underpinning the actions of providers. The approach certainly needs to be much more consistent and it is also important to establish policies that allow all aspects of financial exclusion to be monitored on a permanent basis and also allow intervention in areas not so acutely affected. Financial exclusion is not in its nature an absolute concept but a relative one, similar to that of the “poverty line”. As the level of financial inclusion improves, the focus of attention is likely to move. For example, it may move from the unbanked sector to the underbanked, so that the underbanked benefit as a result of the original intensive focus on the unbanked. While some gaps in access to financial services may be inevitable, if they go too far, the social implications can be considerable. For example, on one hand there is the gap between those prepared to enter into litigation and seek damages in societies where private insurance is the norm and, on the other hand, the decrease in the welfare state’s role in, for example, pensions, sickness and unemployment benefits, as they are replaced by insurance/financial products designed to meet these needs. A final further example: while nowadays, a lack of access to the internet (or not being able to use it) generally causes only minor problems in terms of being able to use a bank account, the day may well come when online

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management will become the rule, and lack of internet access will then become a source of exclusion from banking services.

1.3 The Issue of Measurement and Comparative Analysis As discussed above, measuring financial exclusion raises both conceptual and practical issues. The concept of financial exclusion is a multi-faceted one and there is a range of different types of difficulties involved in getting access to financial services. Such indicators are, however, useful in assessing the extent of the problem, in suggesting answers and in monitoring progress. They can also provide information to policymakers about the main barriers to access, to the private sector about market opportunities, and to researchers to provide data to inform policy recommendations. From a methodological point of view, at least four questions stand out: -

-

-

first, should a distinction be made between access to, and use of, financial services? secondly, with reference to what exactly should access be considered? Should it be considered with reference to financial institutions, to financial services, to functions performed by the latter, or to specific financial products? thirdly, should we take into account the types and levels of access. For example, are we talking about access to banks or quasi-banking institutions, with formal financial institutions or with informal financial operators? finally, should the measurement refer to individual adults or to the families and households?71

We could add to these, in respect of financial products, the question of which minimal product portfolio should be considered. Furthermore if, apart from the distinction between access and non-access we consider that there is a continuum of situations involving difficulty in use or sub-optimal use with respect to needs, the question arises as to whether to detail the precise range of difficulties involved in exclusion72. In other words, access to services can be analysed with reference to institutions, to needs satisfied, to specific products and can be measured both in absolute and relative terms, taking into account the reference framework The methodology problem was set out in these terms by the World Bank (2005). 72 See also Gloukoviezoff G. (2005b). 71


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and the distribution within the population of the financial integration/exclusion variable adopted. With regard to developing countries, simple sets of indicators have been drawn up which allow for an initial approximation, mainly serving the purpose of a comparison between different situations on an international level. The picture can be further improved if we adopt a functional perspective and focus on the kinds of financial services used. From this perspective we can consider: i) transactions or payments services, ii) savings (deposit) and investment services and iii) loan or credit services. Considering the European situation of EU15 (the member countries in the European Union prior to the accession of ten candidate countries on 1 May 2004) and if we adopt the “unbanked” as a proxy measure of financial exclusion, the main sources of data for international comparison are the Eurostat Eurobarometer73. At a national level, more detailed information can be obtained from regular surveys of household finances, including a wide range of questions on assets, debt, incomes, expenditure and other socio-economic variables relating to the household sector as well as bank account-holding74. Direct international comparisons are not possible, however, due to the lack of a standardised approach. That said, educated guesses about the level of financial inclusion of the general population in the different countries can be made, based on data about the availability of an account75. In commenting on comparisons of this international data it must be recognised that they can be no more than rough estimates76. That said, it is remarkable that the percentage of the unbanked (those without a deposit account that comes with a payment card or chequebook) varies so much 73 See Eurobarometer, Financial services, Europeans and financial services, various waves. 74 For example, in the US, the Survey of Consumer Finances; in Italy, Banca d’Italia, Asset and Liabilities of Italian Families, Biannual survey; in Spain Survey of Households Finances (EFF); in Great Britain, National Statistics and DWP, Family Resources Survey (annual); in France, Banque de France (number of account opened applying the right to hold a banking account). 75 Priority is given to the availability of accounts that perform monetary functions and provide payment services. 76 These comparisons should be treated with caution because they do not take into account the specific institutional contexts and market situations they refer to. Apart from the difficulty in comparing the data, there is also lack of information concerning access to the financial system. Some methods are therefore suggested in order to identify a set of proxy variables, available for a large number of countries, in order to produce approximate international comparisons that include both developed and developing countries. See also Peachey S. and A. Roe (2004).

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from countries where the situation seems to be very rare, from the Netherlands, Belgium, France and Germany (where the percentage of “banked” subjects is higher than 90%), to the most backward, including Italy, Spain, Ireland and Greece (see Figure 1.1). These are of course extremely general indications that need to be treated with great caution because they do not consider, among other things, the framework of banking services in the different countries. More specifically, there are bodies in some countries that provide an extensive network of other retail outlets of offering basic savings collection and investment services77, as well as others using of cash or “distance” postal payment mechanisms. The situation changes considerably when looking at the availability of accounts that pay interest but have no payment card or chequebook (see Figure 1.2). The availability of these accounts is lowest78 in Finland, France, Luxembourg, The Netherlands, Portugal and Italy. Another important element, mentioned earlier, is the use of mechanisms other than cash for transactions made, (see Figure 1.3). This highlights the fact that the relevance of exclusion is dependent on the norms that exist in particular contexts. Figure 1.1 Availability of a deposit account which comes with a payment card or a chequebook (%)

15 EU

E IR L G R

I

A

P

S

K

L

K FI N

U

D

F

D

B

N

L

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

Yes

No

Dnk

Source: Eurobarometer, Financial services, Europeans and financial services Wave 60.2, p. 21.

These are often organisations of a cooperative or mutual kind which, in some cases, are subject to special regulation. 78 Always with reference to EU15. 77


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Figure 1.2 Availability of a deposit account, which pays interest but has no payment card or chequebook 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% B

A

S IRL E

D DK GR UK FIN F

Yes

No

L

NL

P

I

EU 15

Dnk

Source: Eurobarometer, Financial services, Europeans and financial services Wave 60.2, p. 22. Figure 1.3 Preferred means of payment in own country 100% 80% 60% 40% 20% 0% F

S

NL

B

L

UK

D

DK FIN

I

A

P

IRL

E

GR

EU 15

Cash

Cheque

Credit card or bank card

Bank or postal transfer

Other

Do not know

Source: Eurobarometer, Financial services, Europeans and financial services Wave 60.2, p. 81.

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In other words, while some countries are increasingly oriented towards a cash-less society, others still use cash to a much larger degree79. Such profound differences can be explained both by strong historical traditions and habits, by the efficiency of the payment systems themselves, the costs involved in using them, and finally, by the presence of a “hidden” market where, as is well known, cash is the preferred form of payment. With regard to the perception that having an account is expensive, marked differences emerge not only from international comparisons but also within the same country. In a number of countries the ratio between the people take this view and those who do not is fairly balanced at 4060%. In others there is a strong prevalence on one side or the other. In the UK, the Nordic countries and Greece a large majority “do not see as any problem” in charges related to an account. Others, for example in Italy, express great concern about them80. There is therefore something of a paradox that the expected relationship between not having an account and the perception of its cost does not always seem to be borne out, as the cases of Greece, on the one hand, and Belgium on the other testify. The socio-demographic analysis carried out by the study suggests no significant variations in terms of gender or level of education; on the other hand there does appear to be a direct relationship between age and views about bank charges. Moreover, more than half of self-employed workers (57%) and the unemployed (52%) tend to agree with the statement that having a bank account is expensive. In the light of this discussion of the characteristics and scope of the financial exclusion, it might be useful to look at it from another perspective. As we have noted above, the concept of financial exclusion can encompass not only those who are unbanked, people who have no relationship whatsoever with banks, but also the underbanked, those who do have an account but either do not use it at all (the so-called dormant accounts) or use it only for very limited functions, (and perhaps in a way that is inappropriate). In some cases this may mean that access to account services is more apparent than real.

See also ECB (2006) and ECB (2005). See Eurobarometer, Financial services, Europeans and financial services Wave 60.2, p. 108. 79 80


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1.4 Types of Response As stated above, difficulties in accessing the banking system (i.e., the mainstream financial sector) may be due to a variety of factors. These include: -

financial exclusion; not having a bank account; being underbanked; that is, having a bank account but in fact not using it; resorting to fringe banks for immediate – but expensive – cash or funds; over-borrowing and not being able to deal successfully with the requirements of the credit system; and, in the worst cases blacklisting by mainstream providers following debt default.

Such problems are seen differently in different countries. Even within the so-called First World, there is considerable variation in the extent to which they occur, as well as in the importance accorded to them. Furthermore, the importance accorded is not always directly proportional to the seriousness of the problems, whether defined in terms of their extent or in terms of the consequences that they bring in their wake. In general, concern appears to be greatest in those cultures that give priority to combating exclusion in all its forms and to the prevention of new forms of poverty. As far as the classification of types of responses is concerned, it must be admitted that solutions appear difficult to classify schematically81. It is often the case that several kinds of financial products are simultaneously available in the same country, and choices are often influenced by historical factors that operate both within the institutional context and within the particular market. The solutions chosen in response to particular local needs seem to evolve constantly, becoming ever more refined and comprehensive. So there are no easy solutions or quick remedies. Furthermore, data that would allow an evaluation of the measures taken in response is not usually available on a large scale, since the available data is generally limited to reports of isolated pilot initiatives that have often not been taken beyond the pilot stage. This said, policy approaches to financial exclusion can be classified in three broad categories: market responses, self-regulation by a particular

See Anderloni L. (2003a) pp. 55-57, Carbó S, E.P.M Gardener and P. Molyneux (2005), pp. 106-110, Kempson E. (2006), pp. 9-12, Pollin P. and A. Riva (2002), pp. 227-235. 81

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sector, and initiatives supported by government whether through facilitation or legislation. On closer inspection, sector self-regulation may be seen as a form of market response, since self-regulation is in fact a specific market driven response made either by the financial market as a whole or by some of its most significant segments. For the present purposes, however, selfregulation will be treated as a separate category, for three reasons. First, it is a form of response found in other economic sectors as well, an alternative to regulations imposed ‘from above’ by the authorities that supervise the sector and that often validate and monitor self-regulation. Secondly, in some cases self-regulation policies have been adopted in response to the threat of legislation. Thirdly, as we shall see more generally, in some cases codes of self-regulation are in fact a dead letter, and not applied in practice, so it would be a contradiction in terms to list them as market responses. The apparent conflict between the free market model and a model focussing on the public good aspect of basic financial services has emerged as a major strategic policy challenge to the banking sector in recent years. In fact, while on the one hand one might focus on the hostile aspects of regulation, forcing inclusive behaviour upon banks, it is also possible to argue that it also offers the opportunity to develop new strategies to provide services to an otherwise excluded class of clients. For some banks, such strategies are very much a part of their role and mission, for example maintaining strong ties with the local area and meeting the needs of the local population, including lower-income families and customers with a lower degree of education (both in terms of general education and specific financial and economic education). Clearly, for such banks, giving attention to such ‘marginal’ market segments also means reaffirming their own mission. A description of the characteristics of each model is to be found in the following sections. Their application will also be analysed through case studies of practice in each country. As will become clear, the three response models are more often mutually inclusive rather than exclusive. That being said, it must be recognised that the unqualified adoption of another country’s model for handling financial exclusion may not be appropriate in the absence of a consideration of their respective institutional contexts. Market responses It is possible to identify two main types of market response: -

provision of financial services by niche providers, and


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development of services by mainstream financial providers targeted to those segments of the market that have special needs/difficulties in accessing the system.

With reference to niche providers, there is already a range of banks and credit institutions that have the provision of financial services to people on low-moderate incomes as part of their mission. Their approach is to pay great attention to the needs of disadvantaged or rural communities with limited access to financial services. They often operate only in a limited geographical area and are closely linked to the needs of that area, but are backed by a network providing expertise and professional management as well as a wide range of products to sell. They command financial and economic strength, IT infrastructure and access to payment circuits similar to those of the largest banks in the country. Sometimes they are also in a position to establish partnerships with other financial institutions outside their own natural network, in order to expand the provision of financial services while at the same time taking advantage of their geographical presence. These organisations include savings banks82, credit unions83 and other mutual or co-operative banks84, as well as Post Offices85. 82 Beside their historical mission (to promote savings among the lowest-income social classes), the broad network of savings banks is probably the most important element for their role in financial exclusion prevention. They are often located in marginalised urban areas, rural areas and locations with low population density. They are in a position to tackle geographical financial exclusion and reach communities with low-income levels and high unemployment rates. In addition, they are often involved in the governmental programs that facilitate subsidised mortgages. Their popularity and some characteristics of these institutions place them in a good position to face this challenge in countries like France, Spain and Germany. 83 Credit unions are widespread institutions in countries like the UK, Ireland and the US. They are mutual financial organisations that supply small scale savings and loans facilities to members, relying on common legally approved criteria. 84 These institutions are user-owned and include, other than the already mentioned credit unions, also co-operative banks, savings and credit networks and village banks. The role of co-operatives in financial inclusion is important, and it is sometimes more effective thanks to their link to the commercial sector. The performance of these institutions is highly dependent on their governance and increases its efficiency in terms of financial inclusion enhancement. 85 Here the experiences are widely diversified and the role of post offices in financial markets has undergone significant changes since the mid-1990s. Postal financial services were originally set up to provide financial services to those who

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Such organisations are usually rooted in the history of the area in which they operate, but in some cases they have undergone deep changes (loss of mutual or cooperative status, privatisation) which have sometimes led to a change in their historical mission, bringing it closer to that of commercial banks. In other cases, for the sake of ‘levelling the playing field’, there has been an erosion of those (tax, legal, or other) benefits that acted as compensation for the burden of serving ‘marginal’ market segments rather than just pursuing a profit. With reference to market responses by mainstream providers, in recent years there have been cases of mainstream providers developing products for people on low-to-middle incomes as part of their normal commercial business. Some banks, for example, have developed simple, low-cost accounts or specific products and services to meet the needs of migrants. The range of products aimed at people on low-to-middle incomes and with limited financial literacy includes not only saving accounts and bank accounts with payments facilities, but also personal loans, mortgages, insurance and various financial services. Some of these developments have involved partnerships with not-for-profit organisations or local government. One common example of partnership includes banks working with micro-credit organisations to widen access to affordable credit to promote opportunities for self-employment. Initiatives undertaken by mainstream providers can be summarised along the following lines: -

product design; reduction of barriers to access to services and the service delivery system; promoting initiatives to help the customer learn more about the banking system and about how the products on offer can help them meet their own needs.

had no other access to them and developed on the basis of the following factors: i) the perceived financial soundness of post offices with their implicit state guarantee, ii) the well-liked and trusted brand, iii) a range of simple products and services, appreciated by an unsophisticated segment of customers, iv) high accessibility through the omnipresence of the network and the informality of the relationship. In some countries, like France, the UK and Italy, they have the broadest office network among financial institutions and reach marginalized urban areas, rural areas and locations with low population density. This network is extensively used for basic financial transactions such as pension cashing, bill payments and other small payments. See Pilley O. and L. Anderloni (1999), Pollin J.P. and A. Riva (2002), Ruozi R. and L. Anderloni (2002).


39

Product design consists in designing an innovative range of products that can facilitate financial inclusion, by fulfilling two requirements: meeting basic financial needs, and reducing fixed operating costs and variable transaction costs. This applies both to the provision of basic money transfer facilities (for instance, bill payment), where, however, the bank will still take into account the risk of excessive overdrafts and failure to repay debt, and, in more general terms, to ensuring better transparency and designing products that are easier to use, including insurance and investment products. Innovations in the provision of credit deserve particular attention and prudence. On the one hand, the vast majority of low-income customers need access to credit in order to face unexpected outgoings or income shortfalls, even though they are unlikely to satisfy credit-scoring systems. On the other hand, a significant minority of low-income customers categorically refuse to borrow, and seek to have relationships with banks that preclude (even unintentional) overdrafts. The opportunities for innovation in this segment are thus considerable. In particular, it is worth noting here the unrelenting approach adopted by financial intermediaries and large scale players in the retail marketplace in promoting a range of revolving credit cards that encourages over-borrowing. In this context, customers seem particularly to favour short-term time limited credit facilities offering small, one-off, fixed-term loans rather than ongoing credit commitments such as credit cards or overdrafts and credit access offered without credit scoring. Moreover, the specific requirements of certain ethnic or religious migrant groups also offer opportunities for innovation, though the exact nature of these depend on the specific cultural context. As far as reduction of barriers to access is concerned, innovations include improved physical access (the use of intermediaries in addition to the telephone and computer based services, and the establishment of outlets and offices open to the public in deprived areas), partnership initiatives aimed at widening geographical access to those likely to be excluded86, the development of more precise risk assessment procedures (for example for workers without a fixed and reliable income) and the development of financial skills and use of technology facilities for financial purposes. Innovation in service delivery can also be achieved through the use of intermediary organisations (e.g. post offices, credit unions and housing associations) that have the advantage of being closer to low-income market segments as well as offering lower distribution costs as a result of lower expenditure on human resources and facilities, greater 86

A significant experience in this area is the British ‘universal bank account’.

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attention towards financial advice and support services, and the wellestablished practice of using electronic cards and electronic money transfers, since access to e-banking and phone banking is limited in this area87. To sum up, people at risk of financial exclusion need encouragement to develop confidence in the banking system and ensure that they are able to communicate adequately with financial intermediaries. A number of initiatives are currently being taken to tackle mistrust of many financial providers; targeting marketing and delivery at this market with easily understood, honest and comprehensive advertising and promotional material; providing no-frills banking services through post offices that facilitates access to benefit banking; and encouraging financial inclusion in other ways, (such as special terms on savings accounts, facilitating access to other products, cheaper payments and insurance options); and the promotion of free and independent information and advice services. In this area, voluntary charters and codes of conduct can contribute to consensus building. In addition, it is important to note that, while commercial banks, unlike community banks, are generally driven less by social responsibility than by a profit imperative, they are also driven by market opportunities. Moreover, corporate social responsibility has recently become an important part of the development, marketing and external communication strategies of profit-oriented institutions like commercial banks. As a result, a focus on marginal customers has become part and parcel of banks’ social responsibility agenda, with practical consequences both in the design of appropriate financial products to reach the financially excluded, and in the launch of initiatives to promote financial literacy. Sector self-regulation In some countries, pressure from both public opinion and from Government has encouraged the banking sector, particularly in the aggregate form of the banks’ trade associations, to become aware of, and to address, problems of financial exclusion and difficulties of access to the banking system. One kind of response has been the establishment of voluntary charters and codes of practice as evidence of a bank’s commitment to provide for this market segment, for example through ‘lifeline’ or ‘basic’ bank accounts. In many cases, these developments have

The American market is particularly advanced in technology in this area and rich in such initiatives. 87


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been prompted and encouraged by government initiatives aimed at increasing social inclusion88. In order to accurately assess the effectiveness of such self-regulation, we have to consider whether the expressed commitment meets local needs and demand, as well as the tone and extent of such commitment, and the measures available to ensure that commitments are honoured and to encourage changes to bring voluntary charters or codes of practices more in line with what is needed89. Government intervention As mentioned above, governments can intervene in two ways: as facilitators and as legislators. Government as facilitator In some cases, Governments have facilitated action on financial exclusion by promoting task forces to raise awareness. Several kinds of initiative have been involved: research projects investigating the causes of financial exclusion and recommending measures to combat them; verifying that the financial products created to promote inclusion are actually meeting the needs of the target population; and requiring scrutiny and approval of marketing material by an independent regulator, to ensure accessibility to the financially excluded. Other areas where Governments have taken action include: the promotion of existing government initiatives in financial services to facilitate and encourage savings. These include child tax credit; pensions and benefits; the provision of funds for not-for-profit organisations whose role is to meet the financial needs of people on low incomes (such as credit unions); the creation of new financial products (such as stakeholder pensions); and making it easier to access to the basic financial products provided by banks, through the post office network. National and local governments can also play an important role in improving the overall climate in which such activity takes place, by raising awareness and improving the image of financial products and services, especially among the target population. Examples include the launching of free publications, seminars at secondary and post-secondary level, and the development of creative approaches aimed at adults. These initiatives have As discussed in detail in the analysis of national experiences, this approach was first pursued in France (1992), then Germany (1995), Belgium (1997), and the UK. See also Riva A. (2003). 89 A good example in this regard is provided by the British Banking Code, which is periodically reviewed by an independent reviewer. 88

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had the aim of helping people develop financial skills, as well as promoting the use of technology, encouraging confidence in financial providers, and strengthening trust in networks closely linked to the public sector, for example postal banking or savings banks. In other cases, as mentioned above, Government action has been vital in encouraging banks and other financial institutions to develop voluntary charters or codes of practice and, more generally, encouraging banks to make a commitment to offering basic, affordable, accounts. Government as legislator Legislative action by government to promote financial inclusion can be grouped in three main areas: -

direct legislation, which imposes upon banks and other financial intermediaries an obligation to provide universal banking services; indirect regulation, designed to remove obstacles that reinforce financial exclusion; positive incentives to encourage the changes in the banking system to promote financial inclusion.

The first area typically includes a legal requirement that every citizen/resident should have access to specific basic banking services, as well as details of how they are to be guaranteed. These requirements usually apply either to specific categories of provider or to an entire range of banking institutions and financial intermediaries. The main purpose of such provisions is to define the types of services that make up the pool of ‘basic’ banking services, as well as pricing criteria and other requirements. The second area includes provision aimed at removing specific obstacles hindering the involvement of low-income customers with the banking system. Such obstacles can include ‘blacklists’ of people who have failed to repay their debts in the past, legal requirements concerning the verification of customer identity, as well as other procedures that may prove particularly problematic for people on low-incomes or individuals who find it difficult to meet the requirements for the verification of identity. Another example is the alleviation of the disproportionate impact of taxes on small transactions and the kind of transactions most frequently undertaken by those customers at risk of exclusion. The final area consists of positive action: incentives aimed at encouraging the use of banking and bank products by people at risk of exclusion. These generally fall within one of the following three categories: -

tax relief (products free of tax or with tax benefits);


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guarantees to reduce credit risk and therefore increase creditworthiness; occasionally monetary incentives (such as bonuses and premiums on under specific circumstances); incentives resulting from cooperation between public and private bodies, in which monetary incentives from the private the private organisation, usually a not-for-profit institution, are matched by tax relief from the public body90.

1.5 Case Studies 1.5.1 Europe France France was the first country in Europe to address the issue of financial exclusion. Legislation to this end dates from the bank reform of 1984, which confirmed the right to a basic account, a deposit account in which all transactions take place in cash91. In the two decades of the operation of this principle of the “right-to-an-account”, there have been a number of subsequent legislative interventions. Firstly, measures have been taken to combat the common practice of levying severe penalties for payment incidents, that occurred mostly to people with a low income, cultural level and poor socio-economic conditions. Secondly, legislation was introduced to modify the approved law of 1998 on the prevention of exclusion92 through tighter drafting and by extending the “right-to-an-account” not only to physical people but also to legal entities. Legislation also limited the conditions under which banks limit the opening of a bank deposit account to basic bank services. Moreover, it was decided that in the cases where the Banque de France had the right to designate a banking establishment with whom to open an account, the pricing of services would be postponed to the following decree. Furthermore, according the 99-532 law on saving and financial “security”, the “right-to-the-account” procedure is applied not only to the 90 It is easy to understand that, for reasons connected to the image of public policies, it is easier for public bodies to provide incentives in the form of tax relief (i.e., lower revenues) than as direct benefits (i.e., higher expenditure). 91 See art. 58 of Law n° 84-46 of January 24th 1984. 92 Law 98-657 of July 29th, in OJ of July 31st 1998, whose article 137 has paved the way for the new wording of art. 58 of the banking law.

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physical people resident in France but to all physical and juridical people that are established in France93. The following decree94 defined the range of services considered to be basic services. This was because the Charter on bank services established by the Comité Consultatif and signed by the Bankers’ Association in 1992, that had been intended to enhance the “right-to-the-account” law and integrate the previous law on a voluntary basis, was considered to be excessively vague. The basic services included are: i) account opening, maintenance and closure; ii) one change of place of residence per year; iii) issuing, upon request, of bank or postal identity document; iv) receiving bank or postal transfers; v) monthly statement of all transactions carried out on the account, sent to account holder’s address; vi) cash transactions; vii) collection of cheques or bank and postal money order; viii) deposit or withdrawal of cash at the counters of the bank where the account has been opened; ix) payments with withdrawal and use of inter-bank payment facilities or bank or postal money order; x) facilities for accessing details of balances at a distance; xi) a payment card requiring systematic authorisation (if provided) and, if not, a withdrawal card for weekly withdrawals at automatic teller machines of the bank where the account has been opened; xii) two bank cheques per month95 or equivalent payment mechanism providing the same service. The list of services included in the package is wide and comprehensive; fees are specified by decree for accounts set up by the Banque de France for people refused accounts96. The supervisory body is entitled to intervene to enforce the implementation of the right. However, evidence shows that appeals have been limited in number although the banks have applied severe conditions to other services related to these accounts. In particular so-called “payment incidents” have been penalised. To combat the extremes of this practice, a further decree has established a limit to the charges that can be imposed for modest bad cheques97. This was included within provision to improve the relationships between banks and customers. To this end, the applicable monetary See art. 83 of Law 99-532 of June 25th 1999. See Decree n° 2001–45 of January 17th 2001. 95 They are not ordinary cheques (due to the risk of overdraft), but only guaranteed cheques. 96 According to the “right-to-an-account” procedure, this legal package of services is to-day totally free of any charge or commissions for people having access to it. 97 Lower than 50 €. See Law 2001-1168 of December 11th 2001 portant mesures urgentes de réformes à caractère économique et financier, art. 15. 93 94


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and financial sections of the “Right to the account and relationship with customers” has been rewritten and the sale of financial services packages in particular has been regulated so that they can now be purchased separately. In 2005, debate on access to accounts began again. The Competition Council looked at the issue thoroughly, and also looked at experience abroad, and came to the following conclusions98. It must be remembered that the Competition Council is not formally asked to express any opinion on whether a right to a universal bank service is to be granted or not, since this right is given exclusively to the public authorities. However, it is important, on the one hand, to consider the most competition-oriented ones among the various possible options; on the other hand, it is important that mechanisms for funding the net costs to be debited to the issuing bank are completely transparent and not discriminatory, in other words unfair to the competition. The Competition Council concluded that although there were a large number of well-founded examples of practice, there was no one single universal service model that could be shown to be economically better. For this reason, the solutions to be adopted needed to be developed in an original way taking account of the actual market situation. In addition to this, while creating the National Council to combat exclusion in September 2005, the French Prime Minister announced his government’s commitment to the creation of a universal bank in 2006, together with tailored measures to accompany it99. This issue was put on the Financial Services Consultative Committee’s agenda (CCSF)100 in October 2005 and January 2006. An Action Plan was launched in 2006, designed to make access to all bank services possible101. In addition to this, a new decree will speed up the modernisation of payment mechanisms so as to make them accessible to individuals not in a fiduciary relationship. This plan has four main objectives: See Avis n° 05-A-08 of March 3rd 2005 on the Consumers, Housing and Life Conditions Union’s ("Cadre du vie") request on the conditions within which a basic bank service can be put in place. 99 The announcement has been welcomed enthusiastically by the consumers’ associations. Banks reacted with astonishment saying that this right already exists for the disadvantaged individuals. 100 This committee consists of representative of banks, family and consumer associations as well as public authorities. 101 See Plan d’Action 2006 pour l’access de tous aux services bancaires, that has been presented by the Ministry for Economy, Finance and Industry at the end of the CCSF gathering in October 2005. For a wider analysis of the French context see Gloukoviezoff G. (2004a) and (2004b). 98

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1. the right of access to an account for all; 2. access for all to a bank card and modern payment methods; 3. targeted communication with people who are not entitled to hold a cheque account; 4. the widespread acceptance of “modern payment methods” by public services in the local area. As to the first issue, the procedure to designate a banking establishment – that gives the right to an account to the people to whom this right has been denied – has been simplified. Now, any bank that has refused to open such an account has to undertake the formalities with the Banque de France and there is a stringent timescale for handling the procedure both by the bank as well as by the Banque de France. The client should be informed of the banking establishment nominated, within two days102. As to the second part of the 2006 Action Plan, individuals who are not considered sufficiently reliable and trusted to use fiduciary payment instruments which involve risk for the issuing bank (such as traditional credit cards, cheques etc) can now use alternative payment mechanisms without resorting to cash. These are payment cards with systematic authorisation103 and other alternative payment mechanisms whose introduction is being speeded up by the banks. These provisions became mandatory with the Decree of March 2006. The campaign to target people who are not entitled to a chequebook, aims to let them know about alternative payment instruments that require systematic authorisation104. In addition to this, the campaign is linked to an initiative to provide social support to people with difficulties, as a further measure to reduce financial exclusion. Finally, the public sector is encouraging the spread of these payment mechanisms by accepting them in the local area and, in addition, through an action plan to develop them that is headed by the Treasury in each

See in details CCSF of January 30th 2006 Banque de France and Federation Bancaire Française’s engagement (Schéma d’aménagement du dispositif de droit au compte pour les personnes physiques). Besides the subscription to the letter of commitment to activate the new procedure, the engagement includes training initiatives for the counter’s staff, communication campaigns organised by the Ministry for Economy addressed to the population, monitoring of the operation of the procedure as from the autumn of 2006. 103 Among the basic bank services the decree has introduced them in January th 17 2001. However, the supply was subject to the bank’s capacity to be equipped to make this offer available. 104 1,179,000 people (estimation) to be contacted in the first semester 2006. 102


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“Department”105. Besides this, the public sector is also providing financial support106. The above decree has encouraged the faster spread of cards requiring systematic authorisation by obliging all banks to be able to operate these cards by July 1st 2006. It has also given withdrawal cardholders the right to replace this card with a card requiring systematic authorisation also for distance payments, in line with the right-to-the-account provisions 107. As previously mentioned, France has also gone down the self-regulation route, with the government bodies acting in a promotional and mediating role. In fact, in 1992 the Comité Consultatif of that time (created within the Conseil National du Crédit, now CCSF) developed a Charter for basic bank services. It was supported by the Bankers’ Association as a means of facilitating relationships with the more deprived parts of the population. One attraction of the Charter for the Bankers’ Association was that it added a voluntary dimension to the right to an account sanctioned by the Banking Law. Rather than having the exact content of this right enshrined in law, the banks preferred to accept a voluntary agreement, which allowed some discretion and flexibility in terms of who exactly would benefit from the basic service as well as the exact nature of that service. This stance was considered by some to be vague and therefore inappropriate108. As mentioned earlier, the 2001 decree has legally formalised the provision of basic bank services. As far as the effectiveness of the “right-to-the-account” rules is concerned, evidence from one authoritative statistical survey shows that while In this respect, see the conventions undersigned between State, Association of French Municipalities and Assembly of French Departments. 106 The financial support consists of everlasting reduction by 50% of the bank charge on payments with bank card and charge of one third of the costs of the first 1,000 electronic payment terminals installed at the local administrations venues. 107 See Decree n° 2006-384 of March 27th 2006 on basic bank services (mentioned in art. D. 312-5 of the code monétaire et financier). 108 Here’s the engagement text: “Les établissements de crédit adhérant à la présente Charte s’engagent à offrir des services bancaires de base à tous, à des conditions qui en permettent l’accès aux personnes les plus modestes. En effet, il n’est apparu ni utile ni souhaitable de chercher des critères objectifs qui permettraient de déterminer, a priori, les particuliers qui relèveraient de services bancaires de base. ……”. “S’il doit en respecter la philosophie, cela ne signifie pas qu’il soit amené à offrir un “menu type” élaboré par le Comité. Les services bancaires de base peuvent être différents d’un établissement de crédit à l’autre, comme à l’intérieur d’un même établissement pour tenir compte de la diversité des besoins et des comportements, des technologies en place et des évolutions possibles dans ces deux domaines” . 105

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the population as a whole has not taken to the facility in large numbers, this opportunity is quite often used by segments of the population in a more precarious financial position, namely people benefiting from financial support from the state (the so-called “statutory minimum”) and members of social centres. Table 1.2 Refusal to open an account and closure of an account by the bank French population as a whole 2%

Beneficiaries of statutory minimum 8%

Refusal to open an account Closure of account 3% 7% Source: Credoc (2001), p. 57, Graphic n° 39.

Respondents in social centres 15% 14%

The survey on access to accounts and use of related payment services shows that the availability of post office accounts and bank-books is important in giving financially fragile individuals better access to the bank services (see Table 1.3). As a matter of fact, looking at the payment methods offered, it becomes clear that a large number of them are cash only and that the availability of a payment card – very popular in France – is rather rare among the beneficiaries of financial support109. Table 1.3 Types of account for the individuals with various forms of “statutory minimum” No account, no book Only a savings book Only a post account Only a bank account A post account and a savings book A bank account and a savings book A bank account, a post account and a savings book He/she prefers not to answer Total Source: DRESS (2004).

% of holders 2 4 19 43 7 21 3 1 100

Both the legislation introduced in recent years, and summarised in this chapter, as well as the debate on the right to the account that has developed in France, have improved access for people with difficulties. By the end of 109

See DRESS (2004).


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2005, over 26,000 accounts had been opened, almost ten times more that in 1995 (2,900). Table 1.4

Opening a bank account according to the right to the account

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Total Number 2,959 2,958 3,564 4,329 6,368 8,525 10,95511,73514,78419,42526,708 112,310 Variation 0.0% 20.5% 21.5% 47.1% 33.9% 28.5% 7.1% 26.0% 31.4% 37.5%

Source: Banque de France (2006).

Furthermore, France has focussed on the following issues: -

consumer protection, with wider scope, in terms of transparency, than provided for at Community level110; saving, and saver protection for investment products111; dealing with of over-indebtedness112.

Over-indebtedness occurs frequently in financially developed countries. This is only an apparent paradox, since these economies face a twofold problem. Difficulties in access to the banking system is to be found at the same time as an addiction to it and to the products it offers, resulting in frequent debt hangovers and resulting expulsion from the banking system altogether. In the US this problem is already very evident and is already being addressed. However, the French experience is certainly a most interesting one. In the late 1980s French legal system introduced a series of measures for dealing with the over-indebtedness of households, that is to say of physical people rather than those involved in a professional, handicraft, business or

See Law of December 11th 2001 on mesures urgentes de réformes à caractère économique et financier (MURCEF). This law introduces a set of measures to improve the relationships between banks and customers; the spreading of accounts conventions; the mediation for disputes settling; the prohibition to sell on-deposit services packages (with the exception of some explicit cases), the rules on premium sales. 111 See Loi du 1er août 2003 sur la sécurité financière. This law clarifies the rules on sale of financial products outside the banking promises, improves the savers’ and borrowers and enhances also the disposals on publicity and offer of consumer credit. 112 See Loi du 31 décembre 1989 relative à la prévention des difficultés liées au surrendettement des particuliers e des familles, the so-called Loi Neiertz, which establishes a «friendly» management procedure. See also the Decree of September 11th 2002 instituant un dispositif d’accès urgent aux sommes à caractère alimentaire figurant sur un compte saisi. 110

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economic activity113. Initially, legislation was supposed to deal with socalled “active” over-indebtedness, generated by the accumulation of excessive consumer credit or secured loans. It allowed a judge to reschedule repayment deadlines over 5 years (then 8 years after a change in the law114), reducing the rates of interest and residual debt following the realisation of available assets. However, along with the active over-indebtedness of the 80s, we have seen an increase in “passive” over-indebtedness, too. Passive overindebtedness arises not simply through the accumulation of debts, but also as a result of low and volatile incomes (unemployment or reduction of working time, diseases, divorce). As a result, many find it difficult to meet their financial and non-financial commitments, leading the way to a further spiral of social exclusion, so the above-mentioned measures gave only a temporary respite to the situation. Moreover, many people were never given permission to access these measures, because of the degree of their indebtedness and insolvency. A further measure has since been introduced: a new procedure to completely liquidate the debtor’s liabilities, with the possibly also of the discharge of the debt. This offers a different perspective, one that is founded on a rationale of social solidarity, and that offers a way out to those over-indebted debtors in an otherwise hopeless situation (see Law of 1st August 2003115) and should be available also to individuals who did not previously have access to the preceding procedure. In fact, under the new “rétablissement personnel” procedure (a sort of “personal recovery procedure”) the over-indebted person in a totally jeopardised financial situation can benefit from a debt discharge. In exchange, many of their assets are sold off, though there are some exceptions116. See Loi n°89-1010 of December 31st 1989 above mentioned. See Loi n° 98-657of July 29th 1998. 115 See the so-called Loi Borloo. It is important to remember that this is an orientation and programming law for town and urban regeneration. In 1998, the legislator, which had just introduced the possibilities to the over-indebtedness commissions to recommend, after 3 years moratorium, debts discharges. This measure has been applied only very little and in its framework, only some debts – particularly the fiscal ones – were excluded. On the contrary, this new law introduces some disposals to face totally jeopardised situations. 116 Some figures to give an idea of the frequency of this procedure: during the first year of application of the procedure – March 2004-April 2005, the overindebtedness commissions have received 219,049 requests and have decided, in agreement with the debtors, to orient 22,062 (11%) of them towards the so-called 113 114


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On the other side of the coin, as far as the promotion of financial literacy is concerned, there are no particularly noteworthy initiatives to which to draw attention. However, the country reveals an important culture of legislative and regulatory transparency as well as the widespread use of joint committees involving representatives of banks, consumers and households, and public authorities that play an important role in communicating with the media. They also promote and disseminate the measures introduced to improve market conditions. France has always been at the forefront of transparency in relations with consumers and the information given to promote responsible and aware behaviour amongst users and consumers has been both extensive and incisive. In the context of the abovementioned new provisions for dealing with the most serious cases of overindebtedness, preventative measures have also been strengthened, through restrictions on the way credit is promoted, in particular consumer credit and revolving credit vehicles. Issues such as use of credit records117 and proposals to rationalise the use of information, as well as what exactly the duties of credit issuers are, have also been addressed. In addition to this, a number of micro-credit initiatives, in particular in the area of social micro-credit, have been developed with the same goal of promoting financial inclusion118. Belgium The French experience has certainly been a good learning experience and an inspiration for Belgium, although the solutions that have been adopted in that country reflect the specific institutional, market and cultural context there. “rétablissement personnel” procedure (personal recovery). The related debts are modest (rarely over 15,000 €) and mainly are short term debts (revolving credit and bank overdrafts, outstanding rents and current expenses for consumptions and taxes). See Rapport du Comité (2005). 117 In France, there are three operational archives that are managed by the Banque de France: the Fichier Central des Chèques (FC), which assesses the payment incidents and the prohibitions as far as cheques are concerned, the Ficher National des Chèques Irrégulier (FNCI), which assesses appeals for losses and theft of cheques as well as payment refusals because of absent provision or account closure and the Fisher National des Incidents de Remboursement des Crédit aux Particuliers (FICP) for the payment incidents that are called “caractérisé” (habitual, within a second payment incident) and the registrations for procedures concerning the over-indebtedness management. 118 See in particular the recent launch of the Fonds de Cohésion sociale with the partnership of public and private banks and charitable organisations.

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Belgium has initially opted for self-regulation with the Charte de l’Association Belge des Banques relative à un service bancaire de base in 1997. According to this Charter, the banks that subscribed committed themselves to provide basic bank services to everyone with a legal domicile in Belgium. This service was then made available to physical individuals who could then access a current account which offered three basic functions: i) monetary, manual and electronic payments, ii) deposits and withdrawals, iii) account statements. While the relevant consumers’ associations approved this formula, they were also critical because the banks scarcely applied it to marginal clients at all, even though they had originally committed themselves to doing so. There has also been criticism because the evidence shows that accounts have tended to be opened not by people at risk of financial exclusion, but rather by people taking advantage of a product that is cheaper even though its functions are more limited. This criticism of self-regulation paved the way for the Loi instaurant un service bancaire de base, of March 24th 2003119. According to its provisions, all credit organisations have to offer a bank service, in the form of a current account. This requirement involves: i) opening, and closure of a current account; ii) transfer orders that can be carried out manually and payment of invoices; iv) the possibility to make deposits in Belgium; v) the facility to withdraw money in Belgium, either at retail outlets or electronically – depending on the bank’s view of what is needed, vi) the periodic mailing of account statements in Belgium. The account is accessible to people without any other bank relationship. Clients pay a yearly lump sum, in any case not more than 12 € per year. A compensation fund managed by the Belgian Central Bank and supplied with the bank system’s contributions, reimburses banks that open and manage a larger number of accounts than their own economic importance in the Belgian market would justify120. This law also provides sanctions for those that do not respect the rule. In addition, statistics on the number of basic bank accounts opened must be passed on to the National Bank of Belgium, so that the scheme can be monitored. The role of the Post Office in the financial sector should not be forgotten either: it acts as a “bank of the poor” with a simple and inexpensive product; in addition, via a 50% partnership with the Fortis 119 These criticisms have been enhanced also by the results of a mystery shopping survey, organised by the Test Achat and a study commissioned by the Ministry of Economic Affairs. See also Kempson E., A. Atkinson and O. Pilley (2004), pp. 24-26 and Bayot B. (2005), pp. 125-139. 120 According to two opinions of the Conseil de la Consommation (2002a) (2002b).


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Bank, it has enlarged the range of the services it offers through the postal counters’ network. Another aspect to be highlighted – common to both in the Belgian and French experience – is over-indebtedness. The issue is monitored by both the Observatoire du crédit et de l’endettement’s and through the records of a network of counters offering social and financial assistance. In addition, income (salaries, pension, unemployment benefit) that has been deposited for 30 days121 is declared not to be distrainable. The idea behind this is to encourage financially fragile individuals to access and use banks, which may be reluctant to open accounts for people in difficult situations fearing an impact on revenues. The United Kingdom Together with France, the United Kingdom is the European country with the most significant record in the promotion of financial inclusion and raising public awareness of the issue and with a proven capability to involve a range of diverse stakeholders in offering integrated solutions to the problem. In 1997, the Labour administration’s commitment get to grips with all forms of exclusion led to the creation of the Social Exclusion Unit122. The Unit’s first report123 prompted the government to establish 18 Policy Actions Teams (PATs) to analyse the various aspects of exclusion in depth. Financial exclusion was dealt with by PAT 14. Its report put forward the case for a basic bank account and set a time limit of one year within which all banks would be expected to make such accounts available. The government itself subsequently started to make oblique suggestions that it would itself impose a universal service obligation. At the same time, the Cruickshank Report on competition in the banking sector124, and the consultation paper on payment services, both highlighted the extent to which changes in the banking and postal systems were eroding the traditional functions of community based banks, thus increasing the risk of financial exclusion.

According to the “pay or play” model. The aim of the team, which includes officials, academics, businessmen and consultants and directly under the authority of the Cabinet Office was that of understanding the characteristics and reasons of exclusion, as well as developing a national response strategy to tackle it. 123 See SEU (1998). 124 See Cruickshank D. (2000). 121 122

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It should be noted here that financial exclusion was initially seen more as a locality based issue that was linked to deteriorating social and economic conditions in urban or remote rural areas. As a result, at first it did not attract attention in its own right, even though the proportion of totally unbanked British households was estimated at around 8% in 19951996, while about 20% of families did not hold a current account, i.e. a bank account granting the use of cheques or debit cards and access to electronic fund transfer systems125. The improvement of the situation since then is proof of the success of the initiatives taken. By 2004, for instance, both the proportion of the totally unbanked, and of those lacking a current account, had halved, to 4% and 10% respectively. Figure 1.4 Recent trend of the transition to the banking system in the United Kingdom 25 20 15 10 5 0 199596

199697

199798

199899

199900

Not having any type of account

200001

200102

200203

200304

200405

Not having a current bank account

Source: processing of National Statistics- DWP, Family Resources Survey data, various years.

Lack of access to banking therefore appears now to have limited reach, but it remains a matter of concern nevertheless. It also deserves attention Estimates vary significantly depending on the make-up of samples and the wording of the question on account ownership. See Anderloni L. (2003) p. 17 and FSA (2000), p. 21-29. 125


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because it is linked to social exclusion and to changes taking place in the banking and postal systems, that are leading to a reduction in the number of branches, especially in socially and economically disadvantaged areas. The fight against financial exclusion is therefore now seen as part and parcel of the wider fight against exclusion in general: - a priority for the British government, which has appointed a Social Exclusion Minister. The profile of the unbanked in Britain is fundamentally the same as in other countries. They are more frequently to be found in low-income households where a stable income may not be available due to the breadwinners’ illness or disability, or other hardships. Moreover, immigrants and the elderly are also more likely to be without a bank account. It should also be noted that stricter regulations to combat money laundering have made it more complicated for certain groups of people to access banking services, due to the difficulty of providing the necessary identification documents (such as a driving licence or passport). Several studies agree that such groups are also likely to show a tendency towards self-exclusion, perceiving a lack of interest within the banking sector in meeting their needs, and responding with a mistrust of the sector or by avoiding any contact with the sector at all in order to avoid possible rejection126. This practical example of ‘marketing exclusion’ shows how important it is to design effective marketing aimed at this segment. It should also be noted that the institutional context in the United Kingdom is particularly well suited to tackling the problems of the unbanked and underbanked. For example, two of the four elements of the remit of the Financial Service Authority (FSA), which supervises the banking system, relate specifically to consumers and the facilitation of access to banking relationships. The first of these is to raise public awareness and to promote public understanding of the financial system, and the second is consumer protection127. Similarly, the British Bankers’ Association also puts emphasis on its function as mediator between the banking industry as a whole and the market – more specifically, with consumers. Its website, for instance, devotes considerable space both to codes of practice, and to the BBA’s numerous publications devoted to raising consumers’ awareness about options in money management and in dealing with financial issues.

See, among others, Kempson E., A. Atkinson and O. Pilley (2004). For a wider analysis of the UK context see Carbó S., E.P.M. Gardener and P. Molyneux (2005) and Devlin J.F. (2005). 127 The other two (not only consumer-oriented) goals are the promotion of market confidence and the reduction of financial crime. 126

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In this context, several initiatives have been taken in order to facilitate financial inclusion and remove obstacles to access and to promote the use of banking services. The following are particularly worthy of note: -

promotion of the Universal Bank Offer and Post Office Account; adoption of the Banking Code and monitoring initiatives; initiatives aimed at combating social exclusion, of which financial exclusion is seen as an aspect; increased attention towards financial literacy.

The ‘Universal Bank Offer’ and the Post Office Account One important spur to account ownership amongst those without accounts was provided by the Treasury’s decision to pay all welfare subsidies, allowances, benefits and state pensions direct to beneficiaries’ accounts. Since the spring of 2003, this system has been progressively automated and has been closely tied to the Universal Bank, which in turn was the result of the joint action of three partners: the Treasury, the Post Office and the banking system. The Universal Bank is a scheme – jointly funded by the public and private sectors128 – by which any holder of a basic account with a major bank can use local post offices, (which may be closer to his/her home or workplace) for routine bank transactions such as withdrawals and cheque cashing, at no additional cost129. Furthermore, the postal system has itself developed a special kind of basic account offering an intentionally limited range of services, at a lower cost130. This product, called Post Office Card Account, consist in a card-based account to which only state benefits, subsidies and pensions, and no other kind of income, can be paid131. In a nutshell, it is a kind of electronic purse or prepaid stored value card, and has been popular with pensioners. The banking system contributed £ 182 million. Until 1990, the Post Office also offered banking services through the stateowned Girobank system, originally established as a part of the European ‘people banks’ network. Girobank was subsequently sold to the building society Alliance and Leicester and its productive structure therefore shifted into the private banking system, but, on the basis of commercial agreements and like other banks, it still uses the post office distribution channel. 130 Defined in the following way in the FSA glossary: “Offered by most of the largest banks/building societies. They give you a good range of services, such as a cash card. Most offer direct debit and standing orders, and are designed so that you cannot spend more than you have in the account”. 131 This account is now offered by Citibank International Plc through the Post Office Limited, and can only be used to receive state benefits (such as pensions, income support and tax credits). 128 129


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In all, 17 banks, including all major credit institutions, offer banking accounts that can be used at post offices. According to a survey commissioned by the British Bankers’ Association, 1,640,000 basic accounts had been opened under the Universal Banking convention between April 2003 and March 2006. Including other accounts with similar 'basic bank account' characteristics and basic accounts that can only be operated through bank branches, there were over 5.9 million basic accounts in operation132. Mystery shopping campaigns aimed at basic bank accounts, promoted by the Banking Code Standards Board and discussed in further detail later on in this chapter, have highlighted significant improvements over time, although there is still scope for further development. The range of provision thus appears extensive and diversified133. The Banking Code and monitoring initiatives It is useful to look at the provisions of the banking self-regulation code concerning customer relations and, particularly, relations with the family customer base, not only in the parts that make specific reference to basic bank accounts, but also as a whole. In the current version of the Code, issued in March 2005134, the issue of basic bank accounts is discussed in the sections about key commitments and the provision of support in choosing the products and services which best suit the customer’s needs. In the first section, though no specific commitment is set out to serve customers with basic knowledge and needs, the first two paragraphs of the section are clearly designed to meet the requirements of this market segment135. See http://www.bba.org.uk/bba/jsp/polopoly.jsp?d=145&a=6932&view=print See http://www.fsa.gov.uk/consumer/pdfs/bank_account.pdf for a synopsis of main characteristics of basic banking accounts offered in the UK. 134 It is the seventh edition, considering that the Code has been in force for fifteen years now. The Code is aimed at establishing good practice standards for financial institutions to follow when they are dealing with personal customers. It is complemented by a detailed Guide whose aim is to provide the signatories of the Banking Code with support in interpreting the norms and principles contained in the Code. The Banking Code has been undersigned by the British Bankers’ Association, the Building Societies Association and the Association for Payment Clearing Services. 135 They read, respectively: “We will make sure that our advertising and promotional literature is clear and not misleading and that you are given clear information about our products and services” and “ When you have chosen an 132 133

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In the same section, more explicit reference to basic accounts and their relation to needs is made. Paragraph 3.1. reads: “We will assess whether your needs are suited to a basic bank account (if we offer one) and if they are we will offer you this product”; also, “We will offer you a basic bank account if you specifically ask, and meet the qualifying conditions for one”. The following paragraph, 3.2. reads: “Where we offer basic bank accounts, we will tell you if they can be used at post office”. Furthermore, a clear definition of a basic bank account is provided in the Glossary: “A basic bank account will normally have the following features: -

Employers can pay income directly into the account. The Government can pay pensions, tax credits and benefits directly into the account. Cheques and cash can be paid into the account. Bills can be paid by direct debit, by transferring money to another account or by payment to a linked account. Cash can be withdrawn at cash machines. There is no overdraft facility. The last penny in the account can be withdrawn”.

It should be noted that the guide for subscribers to the Banking Code specifies that, if the customer has a history of fraud or unpaid debt, a subscriber is not bound to open an account, and also that “if the customer already holds a suitable account with the bank, a subscriber is not bound to open a bank account”. As already discussed in this chapter, one of the key issues about codes of practice and voluntary charters is ensuring that they are actually adhered to. In this regard, two initiatives are particularly noteworthy. They are both aimed at monitoring the adequacy and suitability of the Banking Code and are of special interest here, since they specifically refer to the provision of basic bank accounts as a means of meeting the needs of more marginal customers. The first initiative is a periodical review of the Code, carried out by an independent reviewer through extensive consultations with all stakeholders. During the second review process136, in spite of earlier modificaaccount or service, we will give you clear information about how it works, the terms and conditions and the interest rates which apply to it”. 136 See Kempson E. (2004). It should be specified that such review was carried out on the 2003 text.


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tions to the Code requiring the provision of information on basic accounts, the following shortcomings were observed: -

-

potentially interested customers did not receive extensive information about basic bank accounts, which were also poorly promoted; when a customer explicitly asked for a basic account, they were dissuaded from opening it and ‘sidetracked’ towards other types of accounts; customers in financial difficulty found it complicated to close more complex accounts in order to shift to a basic account, even when the latter had been advised by a money advice counselling structure.

This led the reviewer to suggest that both the wording of the Code and of the interpretation Guide be made more incisive. Other problems emerged as well: for instance, customers were not informed about the opportunity of using basic bank accounts at Post Office branches, and in certain cases found it difficult to prove their identity. While other difficulties outlined in the review do not directly refer to the market for basic bank accounts, they are nonetheless worth mentioning here as they did concern weaker categories of customers. Problems identified included the issuing and management of credit cards, the preparation of summary tables containing basic information about products such as credit facilities, current accounts, and savings accounts – similar outlines were already available for credit cards – and greater transparency on the clearing cycle of payment instruments. Banks accepted the reviewer’s criticism and agreed to take remedial action, including an amendment to the Code that reflected a commitment to make basic bank accounts more genuinely accessible to customers who needed them137. The second noteworthy initiative is the monitoring of basic bank accounts promoted by the Banking Code Standards Board, carried out through mystery shopping, with a view to establishing whether customers experienced difficulties in opening basic accounts138. Four mystery shopping campaigns have been completed to date. The July 2002 and July 2003 campaigns identified several areas where initiatives could be taken to ensure better services. These can be summarized as follows: i) financial service providers should produce separate brochures and literature for basic bank accounts, and make sure that they are placed in prominent positions at branch offices; ii) service providers should take greater care to honour the commitment provided for under the Code to offer customers 137 138

See BBA-BSA-APACS (2004a). See BCSB (2003).

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the products they need, not the products that would seem more suitable after a credit scoring analysis; iii) in the absence of primary sources for customer identification, alternative identification procedures should be developed; and lastly, iv) commission fees on overdue payments directly debited from basic bank accounts should be reduced and other methods of debt management should be considered in order to meet the needs of the market segment using basic accounts139. The 2004 monitoring survey140 outlined some general improvement of the mystery shoppers’ opinion about the results of their task, which consisted in collecting information on account types and inquiring about the opportunity of opening an account. The proportion of mystery shoppers who would recommend the bank they contacted consequently increased from 41% in 2003 to 57% in 2004. A similarly significant improvement emerged concerning access to information. The following four areas, however, were highlighted for improvement: 1. banks and building societies should make sure that literature about basic bank accounts is actually available at their counters; 2. if the customer’s needs are clear, simple and coherent and can be satisfied by basic bank accounts, staff should refrain from offering more complex products which may include financing instruments, the issuing of credit cards and chequebooks; 3. basic bank accounts do not imply credit facilities; it is therefore not necessary to resort to credit checks, it is sufficient to check whether the customer is entitled to vote (through a electoral register check); 4. current regulations on the identification of individuals, established to combat money laundering, still lead to difficulties for people wanting to open accounts. Front line staff should be better informed about alternative identification procedures and greater flexibility should be granted.

In 2003, the banks that had signed the Code jointly discussed this problem, which had already been highlighted in 2002. This led to commissions on overdue payments being set within a range between £25 and £38 for each transaction, amounts that still appear too large. 140 See BCSB (2004b). The analysis was carried out in the period between July and October 2004. A total of 396 mystery shops were done at different branches of Banking Code signatories offering basic bank accounts. The mystery shopping experiment consisted in prospective customers – each of them corresponding to one of 9 different profiles of ‘weak’ customers – asking to open an account and checking whether information was provided about basic bank accounts. For further details, see Appendix A. 139


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There were significant variations in the appraisal of the banks’ (or, more precisely, their tellers’) performance: different banks obtained different results141. However a general improvement has been noted over time. The latest review carried out by mystery shoppers in 2005142 looked not only at customers experience in attempting to open basic bank accounts and to obtain information about them but also, for the first time, included visits to the centralised account opening units of six providers to assess the effectiveness of identity verification and account activation procedures. The review highlighted further improvements that had taken place in the provision of basic bank accounts, following the strengthening of the Code in 2005143. However, in addition to the average improvement observed in the sector, the review also highlighted the fact that some banks still appeared to fall short of the standards enshrined in the Code. Overall, however, the Banking Code seems to be an effective instrument, partly thanks to the monitoring activities which, on the one hand, provide the opportunity for periodical updates of the banks’ commitments. At the same time, the presence of mystery shoppers provides a permanent incentive to tellers to apply the principles and procedures in the Code rigorously. The prominence given to the periodical review results and code updates, both by supervising authorities and by the mass media, has had the positive effect of raising public awareness about the products and principles covered by the Code. Finally, another survey commissioned by the British Bankers’ Association confirms that customers who had opened a basic bank account in the 12 months prior to the interview reported a fairly high level of satisfaction144.

141 On average, the behaviour of the 16 banks that signed the agreement was marked in the following, synthetic way: 3 banks were given the ‘red light’ – i.e., negative judgement due to serious shortcomings; 7 had the ‘orange light’, i.e., a few negative marks in a few areas, and 6 got the ‘green light’, i.e., were found to fully or mostly comply with the Code’s standards. 142 See BCSB (2005). 143 The proportion of mystery shoppers who would recommend a specific bank for opening a basic bank account has risen to 67% in 2005 from 57% in the previous year. Some improvement was also observed in the availability of literature and information, but this does not appear to apply uniformly to all providers; further progress is therefore necessary in this field. Moreover, in connection with antimoney-laundering norms and standards, customer identification problems still recur with some regularity, since bank staff do not often seem to be aware of the more recent agreements on alternative identification procedures. 144 See BBA-Millward Brown (2006).

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Initiatives aimed at combating social exclusion in general, including financial exclusion The British Government has clearly played a key role in promoting the above-mentioned initiatives. As mentioned earlier in this chapter, the Government has focussed increasingly on the problems of social exclusion and the lack of appropriate infrastructure in deprived urban areas and poorer rural communities since the mid-1990s. An analysis of the trends at work in the organisation and approaches of the banking system has followed as a natural consequence. Those who feared that privatisation would lead to the ‘homogenisation’ of provision, and result in the lowest market segment being deserted even by the post office system, were proved right. The same phenomenon of ‘levelling up’ the customer pool was also found to apply to several types of banks that had previously acted as financial points of reference for local communities145. In order to reverse this trend, the British Government has strongly supported the development of credit unions, i.e., cooperative banks whose mission is to operate on a local basis. As a measure of its concern, the British Government’s 2004 economic planning document, covering public expenditure plans146, reaffirmed its commitment to counter financial exclusion. It proposed responses in three main areas: i) access to banking services; ii) access to affordable credit; iii) access to face-to-face banking and financial advice and counselling free of charge147. In order to guarantee the practical application of the commitment, it was decided to establish a Financial Inclusion Task Force to monitor progress and suggest new governmental action, and a Financial Inclusion Fund to support initiatives aimed at tackling financial exclusion and, in particular, facilitating access to credit and financial advice148. The See HM Treasury (1999). On the same issue, see also Social Exclusion Unit cit. (SEU 1998), then the Cruickshank report on competition in the banking sector (Cruickshank D. 2000) and the consultation paper on payment services (HM Treasury 2000). 146 See HM Treasury (2004a). Chapter 5 (“A Fairer Society, with Stronger Communities”) of the planning paper for the 2005-2008 three-year period, entitled “Stability, security and opportunity for all: investing for Britain’s long-term future”, states that the goal of social inclusion should be pursued with a view to strengthening local communities and increasing service efficiency. 147 It may be worth repeating again that PAT 14 had already pressed banks to take all necessary measures so as to start offering basic bank accounts within one year from the report date. 148 In this respect, see also HM Treasury (2004b). 145


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Task Force works closely with consumer and bankers’ organisations to identify issues to be put on the policy agenda149. Both the Universal Bank initiative and the Financial Inclusion Task Force have adopted a public-private partnership model. In addition to actively involving all types of banking institutions and the not-for-profit sector, it has involved the Department of Trade and Industry for the provision of face-to-face money advice and the Department of Work and Pensions to support the coverage, capacity and sustainability of third sector lenders. Financial literacy and money advice Complementing the above-mentioned initiatives was the much heralded promotion of financial literacy, and of money advice and counselling. Financial literacy and money advice initiatives have taken place in a range of different contexts, both at the national and the local level, so it is therefore difficult to provide an exhaustive overview. The Financial Inclusion Task Force took upon itself the responsibility of promoting and funding community projects designed to provide and improve facilities to make financial services more accessible to all citizens including disabled people, as well as counselling services for people in financial difficulty, for example on account of job loss, divorce, illness, etc. It may be useful to emphasise once again the importance of the marketing strategy adopted by both the bankers’ associations and by the FSA, the authority supervising the banking and financial system: websites and simple easy to read leaflets and brochures have offered a simple and effective way to disseminate and promote awareness about financial products, their role in financial planning, and how to use them in a responsible way150. One particularly noteworthy initiative in the area of Financial Literacy is the FSA’s promotion of a baseline questionnaire to measure financial capability levels in the United Kingdom151. In this context, financial capability is defined in terms of four specific areas: “managing money”, “planning ahead”, “choosing products” and “staying informed”. The results of the survey, besides being interesting per se, are particularly useful in helping to identify different types of customer and their specific 149 For further detail, see Financial Inclusion Task Force (2006) and notes to meetings in http://www.financialinclusion-task force.org.uk/default.htm 150 By way of an example, two such leaflets are BBA and APACS (2005) “Financial Inclusion - access to advice, banking and credit” and BBA (2003), “Dealing with debt. How your bank can help”. 151 See FSA (2005), (2006a), (2006b) and (2006c).

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needs. This is a fundamental prerequisite in targeting financial literacy initiatives. Furthermore, as the survey can be repeated over time, progress can be monitored. The Financial Services Authority has also used it as a political tool to implement financial literacy development programs tailored to the specific needs of people who may be excluded from the financial system152. Besides collective action by the banking sector as a whole, there are several other initiatives that have been taken by individual banks. Prominent amongst these are interactive web pages that can be accessed by financial counsellors or by those acting as mediators in financial capacity promotion programs in the not-for-profit sector. Financial counselling or money advice falls within the scope of the Financial Inclusion Task Force153, among other institutions. Such type of activity has a long history in the United Kingdom and it has recently been specifically focussed on curbing over-indebtedness154 and illegal money lending. Italy The situation in Italy is an anomalous one. Although a significantly large number of people in Italy do not have a bank account (about 11% of the See FSA (2006d). The initiatives in this area have resulted in: i) regular monitoring of the levels of over-indebtedness (through quarterly surveys and the collection of a range of published statistics); ii) oversight of a new Consumer Credit Act; iii) changes to legal and bankruptcy procedures to make them more appropriate for people on low incomes; iv) changes to creditors’ codes of practice – covering responsible lending and responsible arrears management and recovery; v) the establishment of a 56 million Euro financial inclusion fund to expand the provision of affordable credit through not-for-profit organizations lending to people on low incomes; vi) the establishment of a 80 million Euro financial inclusion fund to expand the provision of debt advice to people who are financially and socially excluded; and vii) a pilot project to tackle illegal lending. 154 In 2000, the Government, through the Department of Trade and Industry (DTI), established an Over-indebtedness Task Force, which produced two reports for the Consumer Affairs Minister in 2001 and 2003. This was followed by the setting up of a Ministerial Committee, consisting of Ministers from the Legal, Consumer Affairs, Social Security and Finance Departments, supported by an advisory group of experts. See DCA (2004). The degree of attention raised by this phenomenon is further witnessed by DWP (2004) and the recourse to County Court Administration Order procedures among debtors, creditors and advisors as a post-hoc instrument to solve over-indebtedness cases. 152 153


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total population, while the European average is 8%155) and the charges connected with the use of bank accounts are comparatively high156, financial exclusion (in the two senses of being unbanked or underbanked) does not seem to have attracted particular attention. Organisations representing consumers have tended to focus more on highlighting market conditions that are unfavourable for consumers, while the social work sector has typically had other priorities on the agenda. Even social exclusion in general is not very often debated. Since cash transactions are still widely used in Italy, being unbanked is not equated with risking social exclusion 157. The charges connected with holding and using a bank account in Italy are certainly high, especially compared with other countries158. This is a result of several factors: firstly, the condition of the Italian banking system (inefficient production and distribution processes); secondly, ‘aggressive’ sales policies which target higher market segments for many financial services; thirdly, the lack of local competition; fourthly, the significant impact of taxes and stamp duties levied by the Treasury directly on account holders. The Bank of Italy has only occasionally analysed this issue, for instance by commissioning a survey whose results were published in its 2005 yearly report, but was not repeated the following year. According to the English translation of part of the results of the survey, “households lacking bank or postal deposits have socio-demographic and occupational profiles which differ significantly from those of other families: the breadwinner is usually older, has a lower educational level, and is more often jobless. The analysis of data related to the 1991-2002 period shows that, all other factors being equal, the probability that a 155 According to Banca d’Italia’s latest sample survey, 14.1% of breadwinners do not hold any deposit, either with banks or with the post office. See Banca d’Italia (2006) and for the trend Banca d’Italia (2004a) and (2002). For a wider analysis of the Italian context see Anderloni L. (2003a) and Anderloni L. (2005). 156 This applies to contracts under which transactions and services are paid separately, whereas more recent accounts offer ‘packages’ that allow the customer to save about 30% on individual service costs and up to 60% of the prices specified in transparency standards. See ABI, press release dated 19 January, 2005. 157 According to the latest sample survey on Italian households’ financial behaviour, receiving one’s wage or pension in cash is still preferred by as much as 20.7% of income earners (a decreasing figure: it was nearly 34% in 1995), while direct credit to a current account is used by 71.4% of respondents. 158 In 2006 the Italian Authority for Fair Competition and Market Conditions started an investigation on the price of banking services in Italy.

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given household holds a savings deposit or a current account increases by four percentage points if the breadwinner holds a University degree; the same probability decreases by eight percentage points if the family lives in Southern Italy, and by a further five percent if the breadwinners are jobless”. There are several reasons why an Italian household may decide not to have any kind of relationship with banks, and decide to open an account with the Post Office instead. Although Bancoposta accounts currently have functions similar to those of bank accounts, the Post Office still remains a ‘world apart’ from the banking system, as it targets a different market segment and is chosen by customers with different priorities and needs. The reasons against opening a bank account can be summarized as follows: first of all, the unbanked have a limited financial resources159; secondly, and as a consequence of the first reason, they do not find any economic advantage in opening an account, which involves costly taxes, fees and commissions. This basically confirms that Italian low-income families, besides being characterized by a general scarcity of financial resources and an economic-financial management style which does not require an account, show a tendency to prefer post office accounts or to carry out transactions at post offices; they also tend to make collective use of relatives’ personal accounts; additionally, they tend not to trust the banking system, as a result of concerns about security or privacy, because they are discouraged by bureaucracy or other complicating factors, or because they are afraid that their requests may be turned down160. Customers’ preference for Bancoposta postal accounts over bank accounts highlights concerns that include service cost and accessibility, the latter being both in terms of physical closeness and user-friendly account management. One initiative to encourage the unbanked to shift to using the banking system was launched by the Italian Bankers’ Association in February 2004, within the framework of the “Patti Chiari” consortium. It consisted in a new type of account, called ‘basic banking service’ (Servizio bancario This is actually the summary of two distinct types of responses: the first is worded more straightforwardly as “I cannot afford an account / My income is too low”, while the second hints more indirectly at the lack of resources, as in “I do not need an account”. See Anderloni L. (2003), Righetti P. (2005) and later on in this chapter. 160 Such motivations are essentially in line with the results of the survey carried out two years ago, although there were slight differences in percentages. See Righetti P. (2005). Similarly, the hierarchy of the reasons against banking relationships was also basically confirmed. See Anderloni L. (2003a), p. 69. 159


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di base), aimed at facilitating access to banking services by unbanked individuals and households. This initiative can be placed in the category of sector self-regulation. Participation is on a voluntary basis: the Patti Chiari charter is made up of single initiatives (i.e., it is not a ‘package’) and each bank is free to choose which initiatives it will take part in. Under the basic banking service initiative, all participating banks are required to offer a standard basic account (i.e., an account which has the same content across all banks)161, but each bank is also free to apply its own pricing policy. Italian basic bank accounts provide the following standard services: i) crediting of wages or pensions; ii) cash and cheque deposit; iii) cash withdrawal directly at the teller’s; iv) payment by bank transfer, both from and into the account; v) bill payment and other regular, recurrent payments; vi) use of a cash card to withdraw cash from all the issuing bank’s ATM facilities, or alternatively, a prepaid stored value card; vii) investment of savings through regular payments; viii) home and/or phone banking facilities to obtain information and manage transactions; ix) regular account statements. The basic banking service does not include a chequebook, credit card, any kind of loan or credit or the purchase of bonds. In compliance with antitrust regulations, each bank sets its own prices independently, having regard to its own sales policies and operational constraints. Consistent with the spirit of the initiative, charges should ideally be kept to a minimum and be divided into a flat rate for a fixed number of transactions, and individual commissions for each additional transaction above that ceiling. Overall, the range of charges and services available is wide and varied though, as already mentioned, stamp duties do have a particularly heavy impact on charges. Moreover, no statistical data is available on the actual spread of basic banking services; similarly, no ‘high visibility’ mass advertising campaign about basic accounts appears to have been launched in the Italian media, although such campaigns would be consistent with the aim of targeting customers with basic financial needs. It has already been pointed out that financial literacy promotion and over-indebtedness prevention seems to have failed to achieve a particularly high profile, either nationally or locally. This is despite the fact that recent financial scandals in Italy have shown that a significant number of The list of participating banks and individual descriptions of the services they offer are available at the website www.pattichiari.it, which also provides a useful ‘compare and contrast’ function. In June 2006 there were nearly 70 banks taking part in this initiative, with a few notable exceptions among major banks. 161

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households had invested their savings in corporate bonds without being fully aware of the risks involved. In this connection, the Patti Chiari consortium has recently signed a three-year agreement with the Italian Ministry of Education to provide educational programs covering basic information on economics, savings and banks. It should be noted, however, that, in contrast with the emphasis place on monitoring and evaluation in other countries, the few initiatives promoted by the Italian Bankers’ Association through the Patti Chiari consortium have not been followed up by independent monitoring or review activity. Spain Spain is worth considering here as an exception compared with other European countries, since financial exclusion – in its strictest sense – is particularly rare there. According to a sample survey, 97.7% of the Spanish population holds an account and/or a deposit with payment facilities. Similarly, over-indebtedness and difficulties in repaying debt with banks do not seem to be relevant. For Spanish-born citizens, while being unbanked is rather rare, being ‘under-banked’ is a more suitable concept. For it is more often the case that customers do not take full advantage of the financial services provided by their banks and, at the same time, there is often a mismatch between market demand and the products supplied by banks. However, situations such as families lacking a bank account or similar products, or experiencing difficulties in accessing the banking system, do not seem to be common in Spain. This seems to offer proof that, even if left unattended, the market is able to find adequate solutions for all kinds of customer. This includes the simple, unsophisticated requirements of customers who wish to keep costs down, who live in rural areas or urban peripheries, and whose needs are catered for by the savings bank system. Savings banks have adopted custom-made strategies to meet the needs of customers at risk of exclusion whom they recognise explicitly as a market segment of increasing importance. Strategies adopted include: initiatives aimed at countering geographic exclusion by opening branches and automated teller machines in isolated low-population-density areas162; the provision of products and customer relations approaches tailored to the Carbó S., F. Rodríguez and R. López del Paso (2000) showed that 3.5% of the Spanish population are “financially rescued” and restored to the banking system thanks to the branch or branches of a savings bank, the only kind of banking institution present in the local area. 162


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specific profile of customers liable to experience difficulties in accessing the banking system (which therefore counts as a way of preventing socioeconomic exclusion)163; and Government-subsidised low-rate mortgage schemes for low-income households, aimed at promoting home ownership. Other banks, too, contribute to the prevention of mortgage exclusion and offer micro-credit facilities, but savings banks are particularly active in this area. Moreover, savings banks play an important role in countering the exclusion of minority ethnic groups, offering special schemes and products for immigrants (savings accounts, special money transfer instruments, micro-credit facilities and other tailor-made services) and adopting targeted communication and delivery strategies164. In summary, from both the supply side and the demand side, underbanking and obstacles or barriers to financial access are not perceived as important, at least for obtaining basic banking services165. Access to savings bankbooks is perceived as largely unproblematic for immigrants as well. By way of conclusion, it should be noted that, starting from 2004, a group of banks have been offering current or deposit accounts that include additional services (such as a credit or debit card, or bank transfer facilities) covered by a single all-inclusive flat rate commission. The details of the product (called tarifa plana, ‘flat rate’) varies from bank to bank, but typically it consists of a package of services for which a fixed price is paid monthly or at other regular intervals. Some banks have also developed commercial products in which the customer uses certain categories of services free of charge, provided that they agree to build a closer relationship with the bank, particularly through the direct payment of their wage or pension into their account. 1.5.2 The Situation Overseas United States In the United States, financial exclusion has been perceived as a problem for longer than in any other country. This is due to two main reasons: on the one hand, several theoretical contributions from different disciplinary See Carbó S. and R. López del Paso (2002). Carbó S., E.P.M Gardener and P. Molyneux (2005), pp. 120 and Anderloni L., E. Aro and P. Righetti (2005). 165 Barriers or cases of discrimination are quoted as rare exceptions. See GES (2000), p. 26. 163 164

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areas have long since highlighted the links between economic growth and the development of the financial system, and the links between access to financial services and the reduction of poverty; on the other hand, the US has a deeply rooted tradition of fighting against all forms of discrimination and attempting to reduce social disadvantage. This has resulted in increased interest in access to financial services. As a result, the problem of the unbanked and underbanked has been carefully analysed and monitored. This has been done both directly, through an analysis of access to credit and financial services, and indirectly, within the broader framework of research into the financial behaviour, attitudes and needs of families or, more generally, consumers. It is a category of analysis that also includes difficulties in accessing the banking system. A reliable source of data in this respect is the Federal Reserve System’s periodical report on American families’ financial resources166. The proportion of households without a checking account (i.e., current account) fell constantly in the period between 1992 (16.6%), through 2001 (12.7%), to 2004 (10.6%). The profile of the average unbanked family was found to be as follows: annual income lower than $25,000, in 44.7% of cases lower than $10,000; the breadwinner is under 45 in 60.9% of unbanked families, under 35 in 35.6% of cases. 57.1% of unbanked individuals are non-white or Latino167. The reasons why people remain unbanked vary substantially, but they are mainly connected to low income and the resulting need to reduce costs; family financial resources are perceived to be too meagre to require a bank account to manage them168. ‘Strongly’ motivated refusal to interact with See the recent paper by Bucks B.K., A.B. Kennickell and K.B. Moore (2006), and Kennickell A.B., M. Starr-McCluer, and B.J. Surette (2000). For a diachronic literature review of surveys on bank account ownership, see Hogarth M. and H O’Donnell Kevin (1999), p. 461. 167 See Kennickell A.B., M. Starr, M. McCluer and B.J. Surette (2000). 166

168

Table 1.5 Distribution of reasons cited by respondents for their families’ not having a checking account, by reason Do not write enough checks to make it worthwhile Minimum balance is too high Do not like dealing with banks Services charges are too high Cannot manage or balance a checking account No banks have convenient hours or location Do not have enough money Credit problems Do not need/want an account Other Total

1989

1992

1995

1998

2001

2004

34.4 7.7 15.0 8.6 5.0 1.2 21.2 * * 6.8 100.0

30.4 8.7 15.3 11.3 6.5 8.0 21.2 0.7 3.2 1.9 100.0

25.3 8.8 18.6 8.4 8.0 1.2 20.0 1.4 4.9 3.5 100.0

28.4 8.6 18.5 11.0 7.2 1.2 12.9 2.7 6.3 3.1 100.0

28.6 6.5 22.6 10.2 6.6 0.4 14.0 3.6 5.1 2.4 100.0

27.9 5.6 22.6 11.6 6.8 1.1 14.4 2.4 5.2 2.4 100.0

Source: Federal Reserve Bulletin, Survey of Consumer Finances, various years.


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banks appears to be another important factor (22.2% of respondents indicated emotional factors as a reason against bank accounts, which makes this the second most frequent motivation after “not issuing enough cheques”, mentioned by 27.9% of respondents). A similar profile emerges from a survey carried out in New York and Los Angeles by the authority supervising State banks169. Unsurprisingly, the unbanked are, on average, younger and more often jobless or temporary workers than banked individuals, have lower educational degrees and incomes, and live in rented houses or apartments. Moreover, there is a higher concentration of unbanked people amongst the Latin American immigrant population170. The picture that emerges from responses about income collection and cheque cashing modes confirms the importance of fringe banks and cheque-cashing outlets (CCOs). The main reason for the unbanked resorting to non-banking services seems to be that banks often refuse to cash cheques if the payee does not hold an account with them, or, when they do offer cheque-cashing facilities for non-account holders, they suspend cashing procedures until they have established that the cheque has cleared, while the customer wants the funds now. Payees are therefore willing to pay a significantly higher commission for instant service. The unbanked pay their bills in cash (36.4%), money orders (28.6%) and special bill payment services (6.5%). It is interesting to note that the vast majority of money orders are made at cheque cashing points (60.1%), followed by post offices (19.8%), supermarkets (8.7%) and banks (2.6%)171. Cheque cashiers typically also offer bill payment services. The reasons for remaining unbanked illustrated by the respondents to the OCC survey are similar to those outlined in the Federal Reserve survey, with the exception that strong feelings against the banking system emerge less clearly. The cost of bank accounts appears to play an important role, albeit not the main one, in determining financial exclusion172. See OCC-Office of the Comptroller of the Currency (2002). The survey provides interesting answers to the following questions: i) how do unbanked individuals use basic bank services? ii) how does one become or remain unbanked? iii) what are the consequences of being unbanked? iv) what kinds of (public or private sector) initiatives are in place to improve the financial service offer aimed at the unbanked? The survey also provides a cross-section of American society that makes it possible to understand differences between the banked and the unbanked. 171 As opposed to, respectively and in the same order, 38.4%, 34.7%, 12.7% and 8.4% for banked individuals. 172 Another research – Caskey J.P. (1997) – indicates the following motivations: not needing an account 53.3%, high commission rates and bank fees 45.2%, wish 169 170

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Another factor, though one that was not explicitly stated by respondents, may be inclusion in the ChexSystem database, which includes all individuals and companies who have incurred serious debt repayment problems. Inclusion in the ChexSystem list means that individuals are considered to be unreliable customers by the entire banking system for a five-year period173. As regards awareness of basic bank accounts, as many as 76.65% of respondents stated that they know that low commissions are granted on special accounts with minimal deposits and a limited number of cheques issued. The main consequence of being unbanked is that people pay significantly more for services provided by fringe banks compared with the banking system. For a family with an income of $20,000, such costs are estimated at around $600 per year if payments are made through check-cashing outlets, whereas no bank would charge more than $100 for the same service, provided that all checks were honoured. Credit facilities, too, are significantly more expensive at fringe banks than at traditional banks174. However, the cost of commissions, fees and interest rates is not seen as a consequence of being unbanked. More frequently mentioned by respondents is the sense of insecurity generated by the unavailability of credit lines that could help in facing unforeseen expenses, or by the stressful routine of living hand-to-mouth off cashed paycheques. In other words, it is the inaccessibility of loans which might help deal with unforeseen expenses and urgent pecuniary needs that is seen as the main negative consequence of being unbanked175. Several initiatives have been taken, at federal and state level, in order to tackle financial exclusion and the consequent problems mentioned in the previous paragraphs.

to protect the privacy of personal data 21.6%, feeling uneasy with banks 17.6%, having been turned down by banks 9.5%, inconvenient location or opening hours of local bank branches 8.5%. Bank fees are divided into: monthly account fee (55.4%), bounced check fee (29.8%), per check fee (21.8%), fee for the use of other banks’ ATMs (16.9%), annual fee for ATM card (4.7%), other fees (24.2%). 173 See Belsky E. and A. Calder (2004). 174 Interest rates are estimated at 150% per year over loans of about $100 at pawnshops and as much as 300-500% with payday lenders. A lower interest rate, which however reaches 50-100% per year, is applied by small lending enterprises that supply minor loans, but carefully select more reliable customers. 175 As per Caskey J.P., C. Ruíz Durán, and T.M. Solo (2004) and Caskey J.P. (1997).


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The first of such initiatives is a legislative one. The Community Reinvestment Act (CRA), passed in 1977, is aimed at encouraging banks to meet the credit requirements of local communities176, including lowerincome households and individuals, within the constraints of banks solvency and reliability requirements. Over time, the CRA has undergone several fundamental amendments. Its current version requires banks to be subject to periodic reviews to ensure that they are abiding by the principle of local reinvestment, with specific reference to their performance in three areas: loan portfolio (especially mortgages for home ownership and loans to small businesses made available to members of the local communities in which they operate), investment in local development projects, and local provision of retail banking services. The last area is particularly relevant to access to banking services. Typically, banks are encouraged to open – or at least, not to close down – branches in disadvantaged areas that are at risk of socioeconomic deprivation. In addition to the CRA, various attempts have been made to pass other pieces of legislation that could require banks to supply low-cost basic bank accounts. While a consensus about this issue was never reached at the federal level177, some individual states have introduced state regulations providing lifeline bank services or basic accounts178. Further action has been taken by the US Department of the Treasury. In order to cut the administrative costs connected with public pension and benefit payments, the Treasury required to automate such payments, but could not do so since the vast majority of beneficiaries did not have a bank account. The Department therefore promoted the creation of a new type of bank account, called Electronic Transfer Account (ETA), offering banks $12.60 for each new account opened by a previously unbanked pension and benefit recipient. The Treasury also specified the minimum requirements that an account should have to qualify as a basic bank account and meet the needs of low-income customers requiring simple banking solutions. Such requirements are mainly: i) fixed account management charges Legislators mainly intended to prevent national credit institutions’ lending policies from having too much of a negative impact on specific geographical areas or social classes. In particular, the Act was aimed at restoring a well-balanced geographical distribution of both deposit collection and lending activities. 177 In 2002, President Clinton unsuccessfully suggested that the Federal Government encourage banks to create a ‘First Account’. 178 For further reference see Anderloni L. (2003a), where the following case studies are mentioned: Illinois (1986), Massachusetts, Minnesota (1995), New Jersey (1994), New York (1995), Rhode Island (1986) and Vermont (1987). The State of Pennsylvania used to have a basic-banking act, but repealed it in 1995. 176

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should not exceed $3 per month; ii) no commission should be applied on sums credited by the Federal government; iii) the bank should not require a minimal deposit and iv) should guarantee at least four cash withdrawals at no additional commission. Although several banks (including commercial banks, savings banks and credit unions) have agreed to offer ETA accounts, the use of such instruments still appears to be far from widespread. Another input in this respect is the support by governmental agencies and not-for-profit organizations for a category of commercial and savings banks known as ‘Community development financial institutions’, or CDFIs, whose institutional mission consists in promoting economic development in areas with a concentration of low-moderate income (LMI) individuals and families. To complete this overview of the legislative context, other pieces of legislation were passed aimed at controlling and setting a ceiling to the charges applied by fringe banks and moneylenders to marginal market segments. These charges are partly justified by higher costs, due both to the greater costs of small transactions, and to increased risk. Moreover, customers resorting to non-banking financial services typically have no other option, thus being at risk of falling victim to ‘loan sharks’. Two kinds of initiatives have been put in place. On the one hand, some State administrations have imposed an upper limit on commissions and interest rates at check-cashing points, pawnshops and payday lenders. Such ceilings, however, have not always proved effective, as they have often been set at very high levels that exceed market prices. On the other hand, and in some cases supplementary to the previous measure, some States have required non-banking financial providers to abide by certain standards of transparency of their terms and conditions and to offer easy access to dispute settlement processes, mediated by State agencies. Opinion is divided about these initiatives: for instance, some have commented that they are necessary responses to the failure of the market economy. The importance of financial literacy promotion, on the contrary, is a much less controversial issue. Financial literacy and personal financial education are the central banks’ favoured instrument for the prevention of financial exclusion, as witnessed by the large number of initiatives promoted over time both by the Federal Reserve System and by individual Federal Central Banks179. In recent years, legislators have played a particularly important role in this respect. In 2003, Congress established the Financial Literacy and Edu-

For a more detailed overview of such issues and a clear presentation of underlying aims, see Fox L. and J. Hoffmann (2004), pp. 447- 457. 179


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cation Commission180, whose task it was to “improve the financial literacy and education of persons in the United States through the development of a national strategy to promote financial literacy and education”. Across the United States, in fact, there are a number of ongoing financial education efforts, covering a wide variety of topics and audiences and employing various strategies to deliver financial education. They are sponsored by Federal, state and local government agencies, private entities, not-forprofit organizations and higher education providers, and respond to the needs of many different population segments. A national strategy in this area could therefore be to enhance the effectiveness of such initiatives. The Financial Literacy and Education Commission has noted that an effective national strategy should encompass four crucial areas: i) building public awareness of available resources, ii) developing tailored, targeted materials and dissemination strategies, iii) tapping into public-private and private-private partnerships; iv) research and evaluation of financial educational programs181. In general terms, the main focus of such initiatives is to find solutions to customers’ problems in accessing the banking system, helping them choose the right kind of product and understand how it works. On the credit front, the main goals of financial literacy programs are to provide consumers with a solid understanding of the credit system and its workings182 and the ability to select only reputable credit counselling services, and to raise the degree of financial awareness of those consumers facing serious financial problems that may otherwise lead to bankruptcy. Under the provisions of the new bankruptcy law these consumers are required to obtain credit counselling from a credit counselling agency approved by the U.S. Trustee within 180 days before they file for bankruptcy. The new law also provides for all bankrupt consumers to attend a personal financial instruction course as a condition of debt

See The Fair and Accurate Credit Transaction (FACT) Act of 2003 (P.L. 108-159), Title V – Financial literacy and education improvement. 181 See Financial Literacy & Education Commission (2006). The Commission’s work was carried out in ten distinct areas, as follows: i) general savings, ii) home ownership, iii) retirement savings, iv) credit, v) consumer protection, vi) taxpayer rights, vii) investor protection, viii) the unbanked, ix) multilingual/multicultural population, x) kindergarten-higher financial education. Additionally, the Commission also discussed academic research and program evaluation. 182 To this aim, the U.S. Department of the Treasury is setting up a multi-media campaign to improve credit literacy among consumers and to promote access to the MyMoney.gov website, through which Americans can learn more about credit history, credit reporting and credit scoring. 180

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discharge183. In such educational initiatives, however, over-indebtedness is not a key issue in itself; in fact, over-indebtedness prevention and management do not feature among the priorities of the National Strategy for Financial Literacy. Other notable initiatives have been taken by individual banks and can be grouped in the following categories: -

-

-

partnerships with check cashing outlets (CCOs); provision of simple accounts without chequebooks; issue of ATM cards without overdraft facilities which can be used to check one’s balance online; provision of small loans secured by deposits on account, which thus serve as collateral. This solution appears to be particularly appreciated by certain market segments, since it forces users to make disciplined use of savings and to repay their debts. Other forms of small loans are only granted after a certain probationary period (usually a few months), during which the customer has to prove their ability to keep their account constantly in credit through the systematic crediting of wages and benefits; development of specific automated cheque cashing and bill-paying facilities for unbanked customers184; issue of automated ‘payroll cards’, which make it possible for employers to pay unbanked workers electronically and thus avoid paycheques185; proposals about the issue of stored value cards and electronic purses for the unbanked.

While the press, particularly the local press, has publicised such initiatives186, it is difficult to judge their actual effectiveness, as they have usually taken the form of pilot projects carried out in small local contexts. An accurate assessment of their outcome will only be possible over the long term. In addition, close knowledge of the context in which they have The new provisions took effect on October 17th, 2005. See the Bankrupctcy Abuse Prevention and Consumer Protection Act of 2005. 184 An example of this is provided by the ‘Vcom kiosks’ available at nearly 1,000 of the 5,800 American outlets of the major retailer 7-Eleven. Among other services, such kiosks offer money transfer facilities through the ‘Quick Collect’ Western Union circuit. 185 Payroll cards are ATM debit cards on which wages can be directly credited; the pay money can be cashed at ATMs or used for online shopping. Costs are still high, but should decrease as technology progresses. 186 See in particular the press releases edited by Charles Klingman, an officer at the US Department of the Treasury. 183


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taken place is a precondition to fully appreciating their value and how consistent they have been with their original goals. Canada The discussion of the Canadian case is relevant here not so much because of the incidence of financial exclusion in its strictest sense, which is fairly infrequent, but because of two distinct emerging trends that deserve particular attention187. The first of these is the spread of fringe banks, offering a wide range of services and charging high commission fees on transactions188. The second alarming trend is for banks to follow commercial policies that lead them to discourage marginal customers from accessing banking services, because these market segments imply higher risks, greater costs and timeconsuming effort. The tendency to streamline bank’s branch networks has also raised concerns about economically and socially disadvantaged areas being left without banking services. Following the publication of the report of the Task Force on the Future of the Canadian Financial Services Sector189, the Canadian Federal government developed an action plan that, among other provisions, envisaged that the entire adult population should gain access to banking services, which in turn should be adequately promoted. In 2003 another regulation, titled “Access to Basic Banking Services Regulations”190, was issued with a view to giving all Canadian citizens the opportunity to open a bank account easily. Banking institutions are required to provide all applicants with personal accounts as well as to cash government-issued cheques free of charge (even if the payee does not have an account with them), on condition that customers comply with certain basic requirements. The Federal 187 In Canada, 3-4% of the total population is estimated to be unbanked, a figure that increases significantly (at around 8-10%) among the lower-income population. Such proportions seem to apply to Canadian-born citizens as well as immigrants. There are no official statistic data on the phenomenon; the estimates given here were produced by various organizations and disseminated by the press. 188 See Buckland J., M. Thibault et alia (2005) and (2003). 189 See Task Force on the Future of the Canadian Financial Services Sector (1998). On the evolution of the Canadian banking system and its implications for consumers, see also Barnes S. (2003), Department of Finance of Canada (2003), Bain&Company (2003), which express their concern that bankers might hurt certain vulnerable groups in society, including disabled persons, seniors and lowincome individuals. 190 See P.C. 2003-765, May 29th 2003, Access to Basic Banking Services Regulation.

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government has also urged banks to offer low-cost banking packages including a basic set of associated services. Additionally, eight Canadian financial institutions have signed an agreement with the Federal government, committing themselves to provide customers with low-cost accounts that meet the following guidelines: i) no charge for deposits; ii) a debit card; iii) a chequebook; iv) no commission on balance updates and entries; v) 8 to 15 debit transactions per month, at least 2 of which to be carried out in branch at traditional tellers’ counters; vi) a $4 ceiling on monthly commission, covering the agreed number of teller transactions and transactions on debit. Comparing the basic bank account characteristics across Canada, main features are: cost of the monthly commission on the account (ranging from $2.95 to $4), maximum number of debit transactions per month (8 to 15, occasionally with lower limits for transactions carried out at traditional tellers’ counters), whether a minimum monthly balance is required or not for monthly fees to be waived, and whether commission is charged on each transaction carried out with a teller’s assistance191. Individual banks are free to include other features in the basic account package: for instance, they may decide to apply some kind of incentive to encourage customers to have their incomes paid directly to their accounts. Overall, banks appear to be promoting the use of electronic distance banking and on-site self-service vehicles, in order reduce reliance on more costly traditional transactions carried out through tellers. Sector self-regulation is aided in Canada by legislative measures and mediation by Government. The Government has devoted much time and effort to analysing and countering the risk of financial exclusion through special commissions, regular surveys and meetings with bankers’ and consumers’ organisations. A special governmental body, the Financial Consumer Agency of Canada, actively promotes consumer interests and financial education programs, and also plays a crucial role contributing to the effectiveness of self-regulation by ensuring that financial institutions comply with their public commitments192. Interest in financial literacy and See http://www.fcac-acfc.gc.ca The FCAC monitors federally regulated financial institutions’ compliance with certain codes of conduct and public commitments that are designed to protect consumers’ interests. The FCAC reports to Parliament annually on the level of financial institutions’ compliance with these codes and commitments, and on all types and volume of complaints received. The 2004-2005 mystery shopping review, carried out at 17 Canadian banks, yielded positive overall results: success rates were, respectively, 91% for cashing cheques issued by the Government of Canada and 84% for opening basic bank accounts. Refusals to carry out such operations were mainly due to the teller’s inability to ascertain the customer’s 191 192


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the assessment and improvement of financial capability has recently been given further impetus by linking financial capability on the one hand, and social inclusion, increased economic efficiency and increased program effectiveness, on the other193. Australia As in Canada, the Australian case is of interest not so much because of the incidence of financial exclusion, but because of its social implications and the concern that recent changes in the banking system might lead to the progressive erosion of access by lower-income families and people living in isolated areas. Banking exclusion affects only a relatively small number of people in Australia. According to a recent survey, only around 3% of the population are unbanked194. The term ‘unbanked’ itself is not in common use; the most widely used term is ‘vulnerable’. More emphasis, however, is given to the ‘underbanked’, defined, as previously stated in this chapter, as people who do have a bank account, but do not exploit it to its full potential and use it mainly for cash transactions. The main focus in Australia therefore appears to be placed on ‘minimum access’ market segments, i.e. families and individuals who manage their payments exclusively through one facility alone195. This is partly due to the fact that financial exclusion is more frequent among Aboriginal communities. The adoption of the notion of relative exclusion places the emphasis on the impact that competition dynamics, the streamlining (i.e., reduction) of traditional branch networks, and identity, despite the Canadian law allowing tellers to use alternative instruments for identity verification, and even if the customer did produce some kind of documentation (even if not the ‘official’ one). In some cases, refusals were not provided and motivated in written form (which constitutes a violation of the law). 193 See Government of Canada (2006). It is interesting to note that 42% of the Canadian population read at or below A grade school level – which is considered Level 2 literacy, while most information in the financial marketplace is written at Level 3 literacy, or above. See Knight W. G. (2006). 194 See AC Nielsen-ANZ (2005a) and ANZ-Chant Link & Associates (2004). Such percentage is approximately the same as in the ANZ-Roy Morgan Research (2003). Among certain population groups, in particular Aborigines and Torres Strait Islanders, the proportion of unbanked individuals is reported to be higher, at around 10%. 195 About 6% of the total Australian population is estimated to be underbanked. This figure contrasts sharply with the average number of financial products held by each Australian household (6).

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the adoption of ICT can have on widening the gap between the general population and more marginal groups at risk of exclusion. The three main causes of financial exclusion in Australia are: i) the nearest bank office is too far to be conveniently reached, ii) commissions are too high, and iii) customer identification procedures are too complicated. The economic sustainability of bank accounts is a particularly relevant factor. Banks’ pricing policies tend to encourage self-service and distance banking facilities, making access more difficult for those who, for cultural or technological reasons, still prefer ‘traditional’ modes requiring close contact with staff who, from the bank’s point of view, are an expensive human resource. Several measures have been taken to counter the risk of financial exclusion, mainly in the fields of sector self-regulation and corporate social responsibility. In 1995, following a survey carried out by the Prices and Surveillance Authority, Australian banks promised the Treasury that they would start providing basic accounts. However, this commitment was never put into practice and, thinking that free competition and technological progress in themselves would prove sufficient stimuli for banks to find adequate solutions to reach all market segments, the new Government that was elected in 1996 dropped the previous Government’s attempt to pass a bill that would put banks under a legal obligation to provide such products. In 2002, the Australian Bankers’ Association put forward a proposal to the Australian Commission supervising competition and consumer protection. The proposal included a standard set of minimum requirements for basic bank accounts, to be offered at ten banks, but was turned down by the Commission since the requirements it envisaged were less favourable for consumers than the features of accounts already available at four Australian banks. The Commission therefore urged banks to follow the example of those institutions that already provided generic bank accounts meeting the needs of customers at risk of financial exclusion. All four major Australian commercial banks now provide basic accounts196. During the review process, a new section was added to the Australian Bankers’ Association’s Code of Banking Practice197 whereby the banks committed themselves to provide customers, especially those on lower ANZ, National Australia Bank, Commonwealth Bank and Westpac provide low-cost accounts with a limited number of transactions that may facilitate overdrawing, and free or flat-rate packages including a certain number of transactions. 197 See Australian Bankers’ Association (2004). 196


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income, with information about the account which most suitable to their needs198. The Code also placed special emphasis on the commitment to supply information on how accounts work and making sure that customers know that they should inform the bank promptly in the case of financial difficulty199. Other specific commitments undertaken by banks were to explain how cheques work200 and devote particular attention to the elderly and the disabled201. One issue that is still seen as a serious problem is the closing down of branches located in rural areas. Besides a commitment stated in an Australian Bankers’ Association’s protocol and referred to in the Code202, the Australian government has allocated a large proportion of the return generated by the sale of a part of its Telstra shares (Telstra is a telecommunication company) for the opening of bank branches in areas where no banks are currently present. New bank branches should consequently spring up in shopping malls and post offices, in cooperation with local municipalities. A special regulation was introduced to make it possible for Chief Executive Officers of the local councils to arrange for the issue of, and/or provide financial advice in relation to, certain basic deposit products issued by Westpac Banking Corporation203. In relation to providing banking services in remote areas, a number of commercial banks, such as Commonwealth Australian Bank (CBA), have set up joint partnerships with large-scale retail trade operators, with a view to opening branches at shopping malls located in rural areas. Some Section 14, titled “Account suitability”, reads as follows: “If you tell us that you are a low income earner or a disadvantaged person (regardless of whether you are an existing or perspective customer but not if you are a small business), we will provide you with details of accounts which may be suitable to your needs. We will also do this if you ask for this information or if, in the course of dealing personally with you, we become aware that you are in receipt of Entrelink or like benefits”. 199 See section 13, “Operations of accounts” and, particularly, 13.1. (e), “The advisability of you informing us promptly when you are in financial difficulty”. The same wording can also be found in section 10, “Terms and conditions”, paragraph 10.2.(v). 200 See paragraph 13.2 of the code. 201 See section 6, “Elderly customers and customers with disability”, which reads: “We recognise the needs of elderly customers and customers with disability to have access to transaction services, so we will take reasonable measures to enhance their access to those services”. 202 See section 32, “Bank closure protocol”. 203 See Class Order CO 05/844 of 11 August 2005, which applies to certain remote Northern Territory and Queensland communities. 198

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proximity banks close to their customers, such as Bendigo Bank, offer their logistics and financial advice to smaller-scale community banks with a narrower scope204. Much concern has been expressed that difficulties in accessing the traditional banking system might lead consumers to resort to fringe banks with high rates of commissions, and that cannot be fully controlled205. Following the British example, several measures have recently been taken to promote financial literacy and prevent household overindebtedness. Financial literacy work in Australia is situated within the wider framework of the promotion of adult literacy in general, including health literacy and family literacy. Adult literacy is seen as important in increasing the nation’s social and human capital, since it promotes psychological, economic, physical and social wellbeing. It therefore has a positive effect on the economy (and is much appreciated by employers) and on crime prevention206. To address the issue of financial literacy, the Australian government set up a Financial Literacy Task Force and a Consumer and Financial Literacy Task Force207. A number of studies have been conducted to assess the population’s level of financial capability, monitor changes over time and to look at the link with financial difficulty, in particular with loans. Financial literacy promotion campaigns have also been launched. Surveys have highlighted some progress (substantially more people knew how to use, and used, the newer payment methods in 2005 than in 2003)208, and although overall results confirm that the Australian population is financially literate, there are certain groups that present particular difficulties209 and are at risk.

See Cavell D. (2004). See ANZ (2004) and its references. 206 See Hartley R. and Horne J. (2005) and Hajaj K. (2002). See also Cota National Seniors (2004), where financial literacy is discussed in a broader literacy framework. 207 See, respectively, www.understandingmoney.gov.au and http://cfltask force.treasury.gov.au 208 See AC Nielsen-ANZ (2005a) and ANZ-Roy Morgan Research (2003). Methodologically speaking, the survey was conducted through interviews and divided into a quantitative phase (telephone interviews, n= 3,500) and a qualitative phase (face-to-face interviews, n=200) in order to examine those topics that could not be properly tested over the phone. 209 As one would expect, the lowest levels of financial literacy were associated with those having lower education levels (10 years or less), the jobless or unskilled workers, those with lower incomes (households income under $20,000), 204 205


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The survey questionnaire was divided into four main sections and included introductory items on the use of various types of product and on the ways people went about making financial choices. This made it possible to spot problem areas specific to each market segment, where remedial action could be taken. Amongst other initiatives to promote financial literacy, the following deserve particular attention: the “Saver Plus pilot program”, a financial literacy and matched savings programme210; the MoneyMinded programme set up by the ANZ group, which involves 15,000 Australians and has the aim of building up the financial skills, confidence and knowledge of lowincome earners, and the MoneyBusiness programme, promoted by the Australian government and aimed at indigenous communities211. Moving on to financial difficulties and the risk of over-indebtedness, it should be noted that in Australia, probably following the British case again, special indicators have been established to keep the situation under control and prevent emergencies from developing212. Surveys and other research findings agree that the problem of over-indebtedness and difficulty in repaying debt is not quantitatively important in Australia, since only a small number of consumers are in a vulnerable position, and the level of household debt has actually decreased over the last decade213. those with lower savings levels (under $5,000), singles and people at both extremes of the age profile (aged 18-24 years and 70 years and over). 210 See ANZ-RMIT University (2005). Savings incentives follow the model of the American IDA and the British Saving Gateway. On this issue, see Braga M.D. in this book. An interesting activity is the evaluation of the Saver Plus pilot phase 1, which is carried out by an independent body. 211 The Task Force conducted a preliminary stock-taking of consumer initiatives with a focus on financial education and found that over 700 initiatives were being produced by public, private and community sector bodies. The Task Force therefore concluded that there is no shortage of information available to assist Australians, but a good proportion of the materials is not known, not properly targeted or not used by Australians consumers. See Consumer and Financial Literacy Task Force (2004). 212 On this issue, see Cava G.L. and J. Simon (2005), Singh S., P. Myers, W. McKeown and M. Shelly (2005), Consumer Affairs Victoria (2006), Consumer and Financial Literacy Task Force (2004), AC Nielsen-ANZ (2005). 213 Statistics on personal non-business bankruptcies highlight that after the peak reached in 1998-1998 (nearly 21,500 cases throughout Australia) the phenomenon is on the decrease: today there are about 16,200 non-business bankruptcies. The bankruptcy rate, however, has not decreased if one considers other ways to manage indebtedness provided for under the Bankruptcy Act, such as debt agreements and assignments.

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This is probably due to the fact that much of the increase in household credit has been incurred by households who are financially able to support increased repayments, but it can also be interpreted as the result of the measures referred to earlier in this section, and proof of the success of the joint efforts of community organisations and mainstream providers. The Australian government, local communities and the banking sector itself therefore appear to be reaping the rewards of the preventative approach adopted. As further evidence of their commitment to fight against financial exclusion, they are also monitoring the activities of payday lenders and pawnbrokers, whose clients are mainly people living on welfare benefits. They are also looking at the growing practice of ‘booking up’, in which a store, taxi or another supplier may provide short term loans secured by the customer’s social security cheque, debit card and PIN, or signed blank withdrawal forms. This is a practice that mainly occurs in rural and marginal areas and is particularly prevalent in Aboriginal communities.

1.6 Results from a Survey in France, Italy and Spain214 The results of a study comparing practice in France, Italy and Spain may provide some insight into relationships with financial institutions and, in particular, into access to accounts and payment services215. With no claims to statistical significance, given the limited size of the samples and the way they were selected, the study suggests that the distribution of financial exclusion differs in the three countries. With equivalent interviewee target groups, Italy has the highest percentage of participants who have no bank relationship or, in other words who are unbanked216 (11.9% for natives and 40% for immigrants), compared to France (3.9% for natives and 6% for immigrants) and to Spain (only 0.7% for natives and 19.2% for immigrants). It is important to remember that the The authors wish to thank Marie Odile Pilley, for the useful ideas that have been given to prepare the research design, to carry out the research and for having given substantial support in the analysis of the results. 215 The study’s aims and methodologies are presented in the Appendix to Part I, while sample and data are described in detail in Anderloni L., M.D. Braga, E.M. Carluccio and L. Nieri (2006). 216 The term “bank relationship” indicates any account relationship, where an individual has an account with a bank or a post office. The term “unbanked” is used here to describe those who do not have an account or a savings book either at a bank, or at a post office. 214


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target group of participants was defined as living in conditions of socioeconomic difficulty, but not in poverty. Interviews covered three areas: access to accounts and payment services, credit, and investment and insurance services. In addition, for the immigrant segment, the area of remittances was also included. Because of the wide scope of the study, it would have been difficult to cover these areas without generating irritation in interviews with people in serious economic difficulty or poverty. Moreover, the aims of the survey, as illustrated in the appendix on methodology, were to gain a better understanding of features of bank relationships, as well as of difficulties in accessing financial services, uses of financial services, and of expectations held by those with low, unstable incomes (generally classified as low-moderate income earners in the United States). In this market segment of clients with limited economic means and precarious working conditions, the important role of the post office emerges, in Italy and in France, while in Spain this function is carried out largely by savings banks. This is even more true in the immigrant segment, although there are differing levels of integration in the three countries surveyed. Just under a third (29.7%) of native Italian survey participants had a post Office account and a further 6.3% declared, of their own accord, that they had recently closed a bank account and opened one at the post office. Another 4.4%, on their own initiative, stated that they intended to do so. An even larger proportion of immigrant participants in Italy had post office accounts: 41.7%, with another 11.7% who stated that they had moved from the bank system to the post office. In France, 21.8% of native participants and 42.9% of migrant participants had post office accounts. Another 17.7% and 7.9% respectively used both the post office and a bank, generally a current account, and a “Livret A” at the post office, a savings account that offers higher returns and tax benefits. In Spain the important distinction, in terms of type of intermediary preferred, was between banks and savings banks. However, it was not possible to actually measure a preference for either category, since this did not seem to be important to, or known by, many participants. To have asked the name of the bank was possibly important, but starting an interview with this question risked making it seem to be the beginning of an unduly personal survey into financial behaviour, rather than the intended study into participants’ opinions and expectations, so this option was rejected. According to whether participants were banked or unbanked, interviews continued down one of two possible routes. Unbanked participants were asked about their reasons for not having a bank account, about alternative means for satisfying some banking needs

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that are now routine (such as salary payment, benefits or other work payments, check payments and utilities payments), and about how strong these needs were. Banked participants were asked about whether they had a current account or savings account, or possibly both, about the perceived negative and positive aspects of their relationship with the bank, and about the services they used most. Participants were then asked to give their opinions about their relationship with the bank; they were asked about the quality of information provided in general terms and, specifically, about charges. Finally, in order to understand how effectively communications reach the low-moderate income market segment, knowledge of costs of loans was investigated, and, in France and in Italy, knowledge of basic bank accounts217. Further questions were asked about aspects of access to credit218, about investments, and about asset building instruments219. Motivation and behaviour of unbanked participants Reasons for not having a bank account were grouped in the following categories: -

very small income; not useful, given lifestyle and/or lack of economic means (this reason partially overlaps with the previous one); indefensible charges; bureaucratic difficulties opening an account, or self-exclusion by the participant; difficulties on the part of the bank, or refusal by the supplier; low trust in the system or perceived insecurity of accounts; account closure by the bank after problems; use of a family member’s account (in reality this reason is a logical consequence of the two preceding reasons).

In France the area is regulated by law, while in Italy there is a form of commercial self-regulation on the part of those banks which have joined a special initiative promoted by Consorzio Piatti Chiari, coordinated by ABI (the Italian Banking Association). In Spain, however, where there is a considerable range of “elementary” accounts and where bank-books with associated payment functions are widely used, the concept of basic bank service does not exist. The “tarifa plana” offer was just starting up at the time the study was being carried out, and it did not seem appropriate to compare it with Italian and French basic bank accounts. See previous section. 218 See Chapter 2, below. 219 See Appendix to Chapter 3, below. 217


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In Italy, results for native participants had some degree of significance, while in France and Spain the extremely low number of respondents220 made it difficult to generalise the results. Information from unbanked immigrants was analysed in Italy and Spain, while in France there were too few cases. In Italy, for native participants, the first reason given was insufficient income (36.7% of responses), followed by use of a family member’s account, then the high costs of holding an account (13.3% of responses), while other reasons given were marginal221. The results of the survey are not dissimilar to those from a previous study222. It should be noted that a large majority of cases (79.2%) were people who in the past had had accounts, but had closed them when their socioeconomic conditions changed223. Thus, it seems logical that 42% perceived an account to be “useful”, while 20.8% said that an account was “very useful”, and the same amount gave a “fairly useful” response. Nobody stated that an account was “not useful at all”. The lowest level of usefulness was “not very useful”, indicated by 16.7% of cases224. For the unbanked, methods of payment of salaries, benefits or other work payments were by cash (65.5%) or by cheque (27.6%). The frequency of the need to cash cheques among unbanked participants was low225. Cheques were cashed either by a family member (42.3%) or directly at the issuing bank which, when documents are presented and the cheque’s validity has been verified – generally after a few days – makes payment in cash. This indicates the importance of family networks in Italy, There were five in France, of whom two had had bank accounts closed by the bank because of payment incidents, the others essentially because of lack of sufficient financial resources to justify opening a bank account, and one case in Spain of totally insufficient income. 221 Only one participant referred to closure of an account by the bank because of problems that emerged. However, as seen below, in France some banked participants had accounts opened thanks to the “right-to-an-account” procedure and the systematic authorisation procedure for credit cards. 222 The study sample consisted of only unbanked participants, who were given both telephone and face-to-face interviews. See Anderloni L. (2003a), pp. 58-96. 223 Mainly job loss and more precarious situations, with temporary work, separation or divorce. 224 In Spain the only unbanked native participant stated that in their position an account would be “not very useful”, and similarly in France the rare cases gave responses of “not very useful” and “fairly useful”. 225 41.7% stated that this happens rarely, against 8.3% who stated that they are never in this situation and 20.8% generally once a month. There were fewer other cases, but they were not rare. 220

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together with the fact that family member accounts are often used (usually the spouse’s account, or the account of the parents of even fairly adult people). In France, too, native participants gave no indication that they used specialist agencies or shops to cash cheques from unbanked individuals, a practice which research has revealed to be deeply-rooted and growing in the United States, in the UK and in Australia. It is worth noting, moreover, that when participants in France were asked to assess the quality of their banking relationships, their responses giving positive (or, more often, negative or neutral) assessments stated that a current account is necessary in everyday life, and indeed essential for receiving wages and salaries. As regards payment of utilities by unbanked participants in Italy, the most frequent method was the post office bill (52%), or using cash to pay utilities or other banks directly (12% and 8%); a high percentage (28%) did not have to deal with these payments themselves. Here, however, it is important to point out that low-income banked participants indicated fairly frequently that they did not use bank bill payment services; by making the payment each time, it was easier to monitor the situation and postpone payments when necessary, or find help to meet payment dates. For immigrant participants, reasons for not having a banking relationship were more complex. In addition to income being so low that it did not justify the use of banking channels (33.3%, plus 25% who believed an account was not useful given their situation in Italy and 25% in Spain226), there were other reasons, such as difficulty understanding how accounts work (31.3% in Spain) and lack of residence permit documentation (14.6% in Italy and 18.8% in Spain). Motivation and behaviour of banked participants Moving on to look at the behaviour and expectations of banked participants, we see that in Italy the instrument most widely used was the current account, held by 91.6% of native participants and by 75% of immigrant participants (to which can be added respectively 17% and 3.3% who had both a current account and a bank-book). Post office accounts were more widespread in Spain, where 32.1% of native participants had them, and a further 17.2% had both a post office account and a current account. Just under half (49.2%) of the immigrant participants in Spain had them as a sole instrument and a further 13.6% together with a bank account. In It should be remembered that in France only 4 migrants were unbanked: the main reason is refusal by the banks, together with small size of income, and hence use of a family member’s account. 226


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France, 61% of native participants had only a current account and 4.1% had only a bank-book; for immigrant participants, the percentages are 60.3% and 9.5% respectively. Here in France, however, bank-books were generally used together with a bank account, and brought higher returns, thanks to tax benefits. This seems to reflect the varying incidence of non-cash methods of payment in the various countries, requiring a current account, and, as might be expected, emerges in answers about the bank services used, and assessments of banking relationships. In France, the native population used ATM for withdrawals (17% of replies), followed by cheques (16.6%), credit cards (14.6%), POS payments (11.1%) and other distance payment methods such as bank transfers (5.3%). Other traditional bank functions, such as savings deposits, finance and investments were used less (respectively 10.5%, 5.9% and 2.2%), while obtaining an account balance at ATMs accounted for 16.8% of responses. Direct payment of salaries or other work payments, as well as utilities payments, was not mentioned in this context, and was probably taken for granted here. The immigrant population in France gave the same order of importance, with priority given to payment instruments227. It should be noted that credit cards are considered important payment instruments in France and that often the cards issued use systematic credit card authorisation. Native participants in Spain also gave most importance to ATM use, at 25.3%, (without specifying, in this context, between withdrawal functions and other automatic teller functions) credit card use (20%), payment services such as transfers (19.6%), and cheques (6.2%). Credit was also important (16.3%) while savings deposits and investments were much less so (7.6% and 4.3%). As seen in France, for immigrant participants, although the use of ATMs (29.3%), bank transfers (21.0%) and credit cards (16.6%) were most important, though the importance of savings deposits (8.9%) and credit (10.2%) was beginning to grow. Moreover Spain was the country where, as we will see below228, banking channels were most used to make remittances (8.9% of responses). In Italy ATMs were of primary importance in their various functions, for cash withdrawal (25%), POS payments (13.5%), and the use of other functions (13.3%), in particular recharging cell phones. Credit card use Cheques 19.4%, ATM withdrawals 17.8%, other ATM functions 14.7%, credit card 13.2%, bank transfers and debit card use 6.6%. Amongst migrants, savings deposits are higher (12.0%), credit is lower (3.5%) and investment non existent, unlike deposits. 228 See Anderloni L., chapter 10 in this book. 227

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was 6.3%, with many participants reporting that they had sent back their credit cards because they made overspending too easy. Savings deposits and credit were less important, at 8.9% and 6.1%229. For immigrant participants in Italy, savings deposit services were the most important (32.8%), followed by the use of ATMs for cash withdrawals (24.8%) and credit (12.4%), in particular for mortgages to buy a house. The use of banking channels for making remittances was minimal (5.1%). Our survey also asked participants to assess positive and negative aspects of bank relationships: this made it possible to establish patterns of use and expectations, as well as difficulties of access, more clearly. In general, it seems clear that the French participants were, in a sense, more “mature” in their assessments. Their answers were very detailed, with evidence of serious reflection, and not infrequent references to the need to relate perceptions to particular situations. The Spanish sample seemed more restrained in their assessments, both positive and negative, while the Italian sample showed a tendency to be more immoderate, and in particular demonstrated less ability to justify responses. For native participants in Italy and France, usefulness and security were identified as the two top positive elements230, followed by direct debit payment of utilities. In the Spanish sample, this was given first place, while usefulness and security were placed second and third. Next, both in Italy and in France, came the traditional functions of access to credit and savings, which were preceded in Spain by direct salary payment into an account, mentioned by 47 respondents out of 134; credit and savings followed close behind. Towards the bottom of the list of positive elements, in the Italian sample (5.1% of responses, and around 10% of total respondents) we find “no positive element”, which is actually a negative assessment. In France, too, 6.9% of responses, or 14.6% of account-holders, gave no positive elements, but 5.4% of responses stated that they were generally fully satisfied (or “everything is OK”). In France, unlike the other countries, native participants also saw the attentiveness and politeness of staff, and their readiness to provide advice and help with specific problems, as important criteria in evaluating the relationship and these factors received a fair number of mentions, both positive (5.4%) and negative (4.1%). In addition, it is worth noting that a However, it should be pointed out that although the level of response is limited, the numbers are 51 participants for deposits and 35 for credit, out of a total of 178 banked participants. 230 Respectively 18.8% and 18.4% of responses in France, 23.9% and 22.5% in Italy and 18.4% and 18% in Spain. 229


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surprising number (6.5%) of responses referred to the fact that a bank account is really an absolute necessity in France. This makes it into something more like an obligation, rather than something that simply enhances everyday life. Almost nobody mentioned this point in Italy, and only a few in Spain. As far as negative aspects are concerned, cost – in the various forms of commissions, charges and expenses – took first place in all three countries although to differing extents: 48.5% of responses in Italy, 38.5% in France and a lower 28.5% in Spain. This was followed by “bureaucracy”, “transparency” and then “opening hours” for Italy and France, while in Spain the order was “transparency”, then “opening hours” and then “bureaucracy”. Next to the “strong” negative reasons, again positioned in the same order, but with differing weights in the three countries for native participants, we find difficulties in accessing credit, both in the direct question about accessing credit, and in the question related to requirements for guarantees; these cover not only credit transactions, but also in general, opening an account and the issuance of payment instruments based on trust231. It is interesting to observe how a number of specific elements emerge in the various countries. We have already mentioned the emphasis given to the quality of interaction with bank staff in France, the problem of queues in Italy, and clear preference for the post office in Italy because of lower prices, opening hours and locations. In Spain, some participants complained about excessive advertising placed by banks in the media, arguing that it was not of real interests of consumers, and inevitably had a knock on effect on costs. Moreover, it emerged to a certain extent that money deposited in current accounts no longer earned interest in any of the three countries and therefore such accounts do not, on their own, offer an accessible saving vehicle to those with limited funds. For immigrants in all three countries, usefulness and security also occupied the first two positions as far as the positive factors of the banking relationship were concerned232. In France and Italy the traditional function of collecting deposits and encouraging savings came next, followed by the payment of utilities (10%) in France and access to credit (11,8%) in Italy

231 In Italy guarantees and difficulty accessing credit account respectively for 5.4% and 3.8%. In France difficulty accessing credit accounts for 6% and guarantees 2.8%, while in Spain guarantees are 13.3% and access to credit less than 1%. 232 Respectively with percentage of mentions of 25% and 18% in France; 28.4% and 18.6% in Italy and 22.0% and 20.6% in Spain.

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whereas in Spain the priority was given to payment facilities (direct debit of salary, 17,0% and utilities payment, 16,3%). It is worth mentioning that a small number of respondents in Italy volunteered the view that they preferred to deal with post offices (6,9%). Only a few respondents in Italy and rather more in France said that there were no positive elements. A similar number said that everything was fine. Attentiveness and politeness of staff was given only a slightly higher score compared to the native respondents. As far as negative aspects are concerned, immigrants also rank “charges” in first place, though with different frequency233. As with native respondents, cost was followed by “bureaucracy” then “transparency” and then “opening hours”. Difficulties in getting access to credit (both in the form of guarantees 13,3% and directly 2,5%) were mentioned in Spain, while the negative elements with a lower rank are mixed. It is simply worth mentioning the lack of attention paid by banks to the personal relationship in France (5,5%). The survey also looked at two aspects of the quality of information provided: information relating to the functioning of the account generally, to contractual conditions and to periodic statements, and information provided about commissions and other charges and how they were applied. The responses often contained contradictory opinions about the two different areas. As regards the quality of information, native participants were generally satisfied: the assessment “good” (second in the descending scale, after “very good”), reached 60.2% in France, 51.1% in Italy and 45.5% in Spain where 5.2% also gave “very good”234. The worst assessment of quality of information went to Spain (10.4% “not good at all” and the same for “not very good”) while in Italy, 4.5% responded “not good at all” and 13.5% “not very good”. In France, revealing a situation perceived as better, only 3.3% responded “not good at all” and 8.1% “not very good”. Neutral evaluations (“fairly good”) accounted for between 20% and 30%. Opinions on information about charges were less uniform: many stated that the problem here was not so much one of information about charges, but more one of the actual level of cost, and the fact charges were associated with everything. With the exception of Spain, where judgments were evenly spread over the first four levels, in France and in Italy the

233 234

About 40% in Italy and Spain and 23,6% in France. In France 2.4% gave the response “very good”, and in Italy 4.5%.


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highest concentrations of judgements were “good”, with 30.9% and 38.2% respectively235. As well as asking participants to evaluate specific aspects of bank services, the study also enabled a number of problems to stand out more clearly. Many respondents were aware of the intrinsic difficulties involved in communication, and of making the technical aspects of banks’ services understandable to the lay person. Hence, the hope was expressed that banks would provide a better service in branches and provide simpler products, including payment functions that are now essential, such as POS, credit and debit cards. They could also adopt pricing policies that were not only more transparent, but that also had lower charges that were not subject to unexpected increases later on. It is clearly difficult to find a compromise between the alternatives of all-inclusive tariff policies (which some saw as too rigid, given differing incomes and hence also differing account use) and tariff policies which charge according to use, which have the advantage of not burdening the account down with fixed charges, but which can obviously become onerous as each transaction is charged for. Finally, as far as the quality of information is concerned, the immigrant population’s assessment was similar to that of native respondents as regards the functioning of the account, contractual conditions and periodic statements. On average, opinions were positive – good for 57.6% in Spain, 50.8% in France and 48.8% in Italy236 and neutral “fairly good” for 2025%. Opinions as regards charges were more critical. For the migrant population, if many pointed out bad surprises “ex post”, the main problem was not so much the lack of knowledge of charges but their “high” levels as well as the low level of account remuneration which fails to compensate for the charges levied. In view of the large number of negative assessments on charges, banks’ pricing policies for services aimed at low-income clients is clearly a question of fundamental importance. Finally it should be noted that the approaches to expressing an overall effective rate of interest for credit transactions are rather ineffective, as regards this segment of the market. The percentage of native participants who stated that they knew of the existence of these global rates was 32.8% in Spain (in France 24.4% and in Italy 20.8%), but many said that they had only heard about them and did not really understand what they were and In France: “not good at all” 8.9%, “not very good” 22% and “fairly good” 28.5%; in Italy “not good at all” 10.7%, “not very good” 12.45% and “fairly good” 23.6%. 236 To which have to added, respectively, 10.2%, 1.6% and 10% of “very good” assessment. 235

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how they worked. This means that for the large majority of native participants (67.2% in Spain, 75.6% in France, and 79.2% in Italy), this information, which is provided both at the level of commercial communication and as part of a contractual element, was ignored. In fact it may even worsen feelings lack of confidence and accentuate the sense of difficulty, in dealing with financial matters. This is even more true of a large majority of immigrant participants, (95% in Italy, 93.7% in France and 81.4% in Spain) for whom the methods of expressing an overall effective rate of interest charged for consumer credit, are not known and understood, even by those who have in fact had recourse to credit. Still on the marketing front, it should be noted in addition that the range of basic bank accounts on offer is not well known by the market segment which could use them: only 16.3% of participants in France, and 5.6% in Italy, had heard about them, percentages which are definitely too low to allow them to be considered to be really in this market at all237. Still lower is the proportion of immigrants who had heard of the basic banking account: 7.9% in France and 1.7% in Italy. It must be emphasized that, in the three countries studied, there were no significant differences between the assessments of the immigrant and native populations especially for those immigrants who had already lived a long time away from their home country. This suggests the need for undifferentiated products complemented by appropriate marketing in the native language. In conclusion, the survey of access to bank accounts by low-moderate income earners in precarious socio-economic conditions in France, Italy and Spain was carried out using small samples selected through reasoned choice sampling, and thus the results are not statistically significant. Nevertheless, the results provide interesting qualitative suggestions and pointers for combating financial exclusion and promoting a more inclusive financial system. While each country has its own particular banking and market characteristics that determine behaviours and needs. Nevertheless, some common points emerge: -

the primary importance given to payment services, and the need for access to tailored products that enable both for limited overdrafts and for sanctions in the event of possible involuntary payment incidents to be limited, thus reducing risk both for banks and for clients;

237

See note 217, with reference to Spain.


-

-

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the need for simple, basic packages with pricing policies that successfully bring together two opposing requirements: on the one hand, clarity about charges so that later surprises related to use of services, are avoided, and on the other hand control of fixed charges, so that lower users are not overburdened with charges: a seemingly impossible task, but there may be a solution; better communication of the criteria adopted to evaluate creditworthiness, both to support the management of credit relationships over time, and to combat a widespread belief that, while banks attempt to capture the savings of everybody, they are willing to lend only to the wealthy; for this particular market segment, paying greater attention to the effectiveness of consumer protection standards and criteria when offering tailored services so that they do not run the dual risks of being ignored, or of complicating the relationship with customers further, without additional benefits accruing.

In addition, as regards immigrants in particular: -

-

the importance of access to credit, for individuals who typically do not have a credit history or guarantees in the host country, especially if they have only recently arrived; the need for savings and investment instruments which are flexible and remunerative; the limited demand for remittance services from the banking sector, despite the fact that there is considerable market potential in this area, particularly in terms of an integrated range of services. These could gradually become more complex in the course of immigrant’s process of integration, and use effective technological solutions to ensure speed and security in remittance transmission.

1.7 Conclusions and Future Perspectives The theoretical analysis, supported by an overview of experience in several countries, both within Europe and further afield, together with the survey carried out in France, Italy and Spain, underlines the importance of an increased focus on financial exclusion and on access by low income people, and the difficulties in their relationships with banks. We have tried to show that, in modern economies, the risk of financial exclusion has a direct impact on social exclusion. Therefore, it is sensible to adopt the concept of relative exclusion – or inclusion – allowing the

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issue to be considered in a more dynamic way. Within cash-less societies and in contexts where relationships are highly “financialised”, being unbanked is a real handicap. This is the conclusion on the demand side. On the offer side, and taking a macro-perspective, the conclusion can only be that the existence of unbanked or underbanked people reflects a market failure. Despite this, it should not be forgotten that the market itself can be encouraged, on one hand, to identify the opportunities to meet the needs of people who are traditionally at its margin and, on the other hand, to find the most suitable opportunities from which to benefit. In this regard, technology and the low-cost online services it promises, through cards with incorporated microchips for example, offer opportunities for innovation. Moreover, it is almost certainly preferable to look at financial exclusion from a more positive perspective, in terms of financial inclusion rather than of financial exclusion. The advantage of this perspective is that individuals in the market are seen as having the potential to develop positive relationships, rather than focussing on a negative attitude of refusal and opposition. In order to see the issue in this wider context, a number of different approaches will be required, on the demand side, on the supply side and within the institutions involved. On the demand side, financial literacy and educational initiatives will need to be promoted: suitable advice and assistance initiatives are important in order help people solve temporary difficulties or misunderstandings concerning complex financial procedures quickly (i.e. clearing of payment instruments, insurance contracts, collective investments). Without this, major difficulties can occur. These initiatives will probably be more successful if they are seen as part of more general social initiatives integrated into programmes in the areas of education, skills training and family assistance, or into self-employment initiatives. On the supply side, the most “enlightened” and far-sighted banks and specialised institutions should be encouraged to look at this market segment with new eyes, and develop strategies focussing on the needs of low-income people. Our survey has also shown that unbanked or underbanked individuals constitute a very varied universe and within which several specific groups can be offered a range of targeted products and services. While this implies an essentially market-oriented rationale to deal with particular difficulties or risks, a number of external interventions will also be needed to ensure an economic fit between the needs of customers and the needs of potential providers, which can otherwise often appear distant from one another. External intervention can come from both the public sector (for example in


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the US and UK, where we have highlighted programmes including types of tax cuts, or tax incentives or public sector support of different kinds), as well as from the non-for-profit sector and, in particular, from the charitable arms of banks foundations (in the countries where they exist). As far as the context is concerned, it will be important to create the most suitable conditions to facilitate financial inclusion, but also to create effective mechanisms for monitoring and evaluation, so that the lessons learned can inform future practice. As to the nature of that context, no general answer has been found. While, in the different countries, unbanked people or the ones that try to have access or a relationship with banking system may have the same type of difficulties, each country has – despite being part of a single European common market – its own traditional way of working as regards bank relationships, assistance networks, moral suasion effectiveness and relations between social parties. Therefore, it would be wrong to think that any one solution, including solutions that have been worked in one country at a particular point of time, can be automatically and successfully transferred and implemented in other countries. On the contrary, the different solutions and modalities are often complementary, not so much alternative to one another but destined to evolve progressively in time. Wide ranging assessment of practice in different countries paves the way for the development both of new approaches and of improvements to existing ones. In general, however, access to financial services and the promotion of financial literacy should be integrated as a core element within welfare-to work strategies. There is no doubt that experience in the US and the UK has demonstrates the importance of government incentives as a catalyst to encourage efforts within the private and non-profit sectors to harness financial and technological developments to the service of greater access to financial services for LMI families. As far monitoring initiatives are concerned, they should be handed over to independent, external auditors, with the specific goal of suggesting how practice can be improved. Monitoring and evaluation should be applied to legislative initiatives, to the field of regulation, self-regulation with charters and voluntary codes, and within joint public-private initiatives, nonfor-profit initiatives, or independent initiatives of individual banks. As far as the last are concerned, it may be that only some positive expectations can be embraced, since they will be making the assessment themselves, and will be the only ones to know whether the initiatives taken reflect genuine strategies to approach that market segment or whether they are more in the nature of “window dressing”. Press and congresses aimed at a wide public often have an extraordinary impact on new initiatives in this

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respect. The consequence is also that an announcement can have a disproportionate impact on the market. The importance and necessity of regular assessment is therefore evident. There are, for example, indications that some of the regulations on consumer protection – well founded in theory – are not understood and therefore, not effective as consumer protection instruments. This implies a risk, namely that these instruments are not only useless but, also “harmful” since they will in any case include compliance costs that are related to production, distribution and the back office function. These costs inevitably have an impact on the market. Furthermore, this factor also risks increasing the complexity of financial transactions and thus fostering a vicious circle of mistrust, difficulties in building relationships and a sort of “financial ignorance” that is certainly not good for the system. Without concrete monitoring of their effectiveness and complementary initiatives to ensure that consumers understand consumer protection measures, they become futile. This is demonstrated, for example, by the results of the survey of consumers’ understanding of the global effective annual interest rate applying to consumer credit. From a standpoint of curbing the amount of regulation in comparison with how understood it is by its beneficiaries, it would be useful to set out periodic assessment levels of financial capability (see the UK and Australia with different goals). In general, this would help not only to link financial inclusion with a suitable level of financial awareness but it is also important in the present situation where all countries with advanced economies are facing a pensions crisis and are making a range of efforts (regulation, incentives, communication, and so on) to encourage a pension saving culture: low and moderate income individuals certainly have an interest in new pension schemes too. To conclude, a more inclusive approach is the key not only to promoting greater economic opportunities for low-income households but also to bringing financial transactions into the financial mainstream and preventing grey areas to emerge, namely in credit intermediation and the supply of financial services that, in the medium term, are useful neither to the users nor to the financial system as a whole.


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1.8 References AC Nielsen-ANZ (2005a), ANZ Survey of Adult Financial Literacy in Australia, November. AC Nielsen-ANZ (2005b), Understanding Personal Debt & Financial Difficulty in Australia, November. Anderloni L., E. Aro and P. Righetti (2005), Migrants and financial services in Spain, Mimeo. Anderloni L. (2005), L’exclusion financière en Italie: un phénomène encore diffus, in Gloukoviezoff G. (sous la direction de) “Rapport exclusion et liens financiers. L’exclusion bancaire des particuliers. Rapport du Centre Walras 2004”, Paris, Economica. Anderloni L. (2003a) (ed.), Il social banking in Italia. Un fenomeno da esplorare, Milano, Giuffrè. Anderloni L. (2003b), Flussi migratori e flussi finanziari: il social banking, in Secondo Rapporto Bocconi, DIA, DNA, UIC, Immigrazioni e flussi finanziari, Egea, Milano. Anderloni L. (1997), Sovraindebitamento delle famiglie e politiche di prevenzione e gestione: alcune esperienze estere e prospettive per l’Italia, in Porta A. and D. Masciandaro (eds.) “L'usura in Italia”, Egea, Milano. Anderloni L., M.D. Braga, E.M. Carluccio and L. Nieri (2006), Survey on LowModerate Income People and Access to Financial Services, Quaderno di Ricerca, Università della Valle d’Aosta. ANZ-Chant Link & Associates (2004), A Report on Financial Exclusion in Australia, November. ANZ (2004), Community Development Finance in Australia. A Discussion Paper, May. ANZ-Roy Morgan Research (2003), ANZ Survey of adult Financial literacy in Australia, ANZ Banking Group in co-operation with Roy Morgan Research, May. Arthi Varma (2004), A Survey of Check Cashers in the San Fernando Valley, Valley Economic Development Center, December. Atkinson A. (2006), Migrants and financial services: a review of the situation in the UK, Working paper, PFRC, University of Bristol, March. Atkinson A. (2004), Young people: Avoiding banking exclusion, Paper presented at the conference “Access to finance”, Brussels, 28-29 October. Australian Bankers’ Association (2004), Code of Banking Practice, May. Banca d’Italia (2006), I bilanci delle famiglie italiane nell’anno 2004, Supplemento al Bollettino statistico. Indagini campionarie, Anno XVI, n° 7, Gennaio. Banca d’Italia (2004a), I bilanci delle famiglie italiane nell’anno 2002, Supplemento al Bollettino Statistico, Anno XIV, n° 12, Marzo. Banca d’Italia (2004b), Relazione Annuale, Roma, 31 Maggio. Banca d’Italia (2002), I bilanci delle famiglie italiane nell’anno 2000, Supplemento al Bollettino Statistico, Anno XII, n° 6 , Gennaio.

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Bayot B. (2005), L’exclusion bancarie en Belgique, in Gloukoviezoff G. (sous la direction de) “Rapport exclusion et liens financiers. L’exclusion bancaire des particuliers. Rapport du Centre Walras 2004”, Paris, Economica, pp.125-138. Barr M. S. (2004), Banking the Poor, in “Yale Journal on Regulation”, vol. 21, pp. 121-237, Winter. BBA-BSA-APACS (2004), Review of the Banking Code 2004. Recommendations of the Independent Reviewer and the Initial Response on behalf of Subscribers to the Code, November. BBA-BSA-APACS (2003), The Banking Code. Getting standards for banks, building societies and other banking service providers, March. BBA-Millward Brown (2006), Understanding consumer Experience When Opening and Using Basic Bank Accounts, March. BCSB (2005), Survey of Subscribers Providing Basic Bank Accounts, Banking Code Standards Board, November. BCSB (2004a), Basic Bank Accounts – Room for further improvement, London, Press Release, November 18th. BCSB (2004b), Survey of Subscribers Providing Basic Bank Accounts, Banking Code Standards Board, November. BCSB (2003), Survey of Subscriber Institutions on Basic Bank Accounts, Banking Code Standards Board, July. Beck T., A. Demirguc-Kunt and R. Levine (2004), Finance, Inequality and Poverty, World Bank Policy Research Working Paper 3338. Beck T. and A. de la Torre (2006), The Basic Analytics of Access to Financial Service, paper presented at the Global Conference on Access to Finance, Access to Finance: Building Inclusive Financial Systems, World Bank, Washington, May 30-31. Belsky E. and A. Calder (2004), Credit matters: Low-Income Asset Building Challenges in a Dual Financial Service System, Joint Center for Housing Studies, Harvard University, Working paper series, BABC 04-1, February. Buckland J., M. Thibault et alia (2005), Fringe Banking in Winnipeg’s North End, Canadian Centre for Policy Alternatives, Ottawa Buckland J., M. Thibault et alia (2003), The Rise of Fringe Financial Services in Winnipeg’s North End: Client experiences, firm legitimacy and communitybased alternatives, Institute of Urban Studies, University of Winnipeg, August. Bucks B.K., A.B. Kennickell and K.B. Moore (2006), Recent Changes in the U.S. Family Finances: Evidence from the 2001 and 2004 Survey of Consumer Finances, in Federal Reserve Bulletin, vol. 92, February, pp. A1-A38. Carbó S., E.P.M. Gardener and P. Molyneux (2005), Financial Exclusion, Palgrave Macmillan. Carbó S. and R. López del Paso (2005), Cajas de Ahorros, Tecnología e Inclusión financiera, in "Cuadernos de Información Económica", nº 188, septiembreoctubre, pp. 105-112. Carbó S. and R. López del Paso (2002, La inclusión finanziera: un paso qualitativo más, in "Cuadernos de Información Económica", nº 170, septiembre-octubre, pp. 79-90.

1 Access to Bank Accounts and Payment Services 101 Carbó S., F. Rodríguez and R. López del Paso (2000), Las cajas de ahorros: algo más que instituciones financieras, in "Cuadernos de Información Económica", nº 158, septiembre-octubre, pp. 65-76. Caskey J.P., C. Ruíz Durán and T.M. Solo (2004), The Unbanked in Mexico and the United States, Paper presented at the conference “Access to finance. International Conference”, Brussels, 28-29 October. Caskey J.P. (2002), Bringing Unbanked Households into the Banking System, paper for the Brookings Institutions, Harvard University Joint Center for Housing Studies. Caskey J.P. (1997), Lower Income Americans, Higher Cost Financial Services, Filene Research Institute. Monograph series. Caskey, J. P. (1994), Fringe banking: check-cashing outlets, pawnshops, and the poor, Russel Sage Foundation, New York. Cava G.L. and Simon J. (2005), Household Debt and Financial Constraints in Australia, in “The Australian Economic Review”, n° 38, May, pp. 40-60. Cavell D. (2004), Bank Branch Transformation in the 21st Century. Winning Strategies from Across the World, Lafferty, London, Dublin. Collard S., E. Kempson and N. Dominy (2003), Promoting financial inclusion. An assessment of initiatives using selected committee approach, The Policy Press, London. Connolly C. and K. Hajaaj (2001), Financial services and social exclusion, Chifley research centre. Financial Services Consumer Policy Centre, University of New South Wales. Conseil de la Consommation (2002a), Avis sur le service bancaire de base (évaluation de la charte concernant un service bancaire de base et initiatives législatives en la matière), Bruxelles, 28 mars. Conseil de la Consommation (2002b), Avis sur la problématique de la protection de revenus susceptibles de saise ou de cession quand ceux-ci sont versés sur un compte en banque, Bruxelles, 4 décembre. Consumer Affairs Victoria (2006), The Report of the Consumer Credit Review, Supplementary Information, Consumers Affairs Victoria. Consumer and Financial Literacy Taskforce (2004), Australian Consumers and Money, Discussion Paper, July. COTA National Seniors (2004), Cota National Seniors response to the Consumer and Financial Literacy Taskforce discussion paper, July. Cruickshank D. (2000), Competition in UK banking: A report to the Chancellor of the Exchequer, Stationery Office. Devlin J.F. (2005), A Detailed Study of Financial Exclusion in the UK, in “Journal of Consumer Policy”, n° 28. DCA (2004), A Choice of Paths: better options to manage over-indebtedness and multiple debt, A Department for Constitutional Affairs Consultation Paper, July. DRESS (2004), Accès et utilisation des services bancaires par les allocataires de minima sociaux, in “Direction de la recherche des études de l’évaluation et des statistiques”, Novembre.

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DWP (2004), Characteristics of families in debt and the nature of indebtedness, Department for Work and Pensions, Research Report, n° 211. ECB (2006), Blue Book. Payment and Securities Settlement Systems in the European Union and in the acceding countries, March. ECB (2005), Blue Book. Payment and Securities Settlement Systems in the European Union, August. Eurobarometer (2004), Public Opinion in Europe: Financial Services – Report B., Wave 60.2, January. Eurobarometer (2001), Public opinion in Europe: views on financial services. Report prepared by C. Duflos, European Opinion Research Group for the Health and Consumer Protection Directorate-General, December 7th. Financial Literacy & Education Commission (2006), Taking Ownership of the Future, The National Strategy for Financial Literacy 2006. Fox L. and J. Hoffmann (2004), Federal Reserve Personal Financial Education Initiatives, in Federal Reserve Bulletin, Autumn. Fox C.J.A. (1998), The Growth of Legal Loan Sharking: a Report on the Payday Loan Industry, Consumer Federation of America. FSA (2006a) Levels of Financial Capability in the UK: Results of a baseline survey, n° 47, March. FSA (2006b) Levels of Financial Capability Baseline Survey: Methodological Report, n° 47a, March. FSA (2006c) Levels of Financial Capability Baseline Survey: Questionnaire, n° 47b, March. FSA (2006d), Delivering Change, March. FSA (2005), Measuring Financial Capability: an Explanatory Study, n° 37, June FSA (2003), No bank Account ? Why it could pay you to have one, May. FSA (2000), In or out ?, Financial exclusion: a literature and research review, Consumer Research, FSA, n° 3, July. GES (2000), Bancos e Inmigrantes. Informe español, Gabinet d’Estudis Socials, August. Gloukoviezoff G. (2005a), (sous la direction de) “Rapport exclusion et liens financiers. L’exclusion bancaire des particuliers. Rapport du Centre Walras 2004”, Paris, Economica. Gloukoviezoff G. (2005b), Peut-on Chiffrer l’exclusion bancaire ? in AA.VV. Rapport Moral sur l’Argent dans le Monde 2005, AEF, Paris. Gloukoviezoff G. (2004a), The “Caisse d’épargne” and households’ financial exclusion: Which actions should be taken and what are the prospects, Paper presented at “Access to finance. International Conference”, Brussels, 28-29 October. Gloukoviezoff G. (2004b) L’exclusion bancaire et financière des particuliers, in “L’Observatoire national de la pauvreté et de l’exclusion sociale, Les travaux de l’observatoire”, Paris, La Documentation Française, pp. 167-205. Gloukoviezoff G. (2004c), De la bancarisation de masse à l’exclusion bancaire puis sociale, in "Revue Française des Affaires Sociales", n.3-2004, La Documentation française, pp. 11-38.

1 Access to Bank Accounts and Payment Services 103 Goodhart, C.A.E. (ed.) (2004), Financial development and economic growth: explaining the links, Palgrave Macmillan. Hartley R. and J. Horne (2005), Social economic benefits of improved adult literacy: Towards a better understanding. Support document, Australian Government, National Centre for Vocational Education Research. HM Treasury (2004a), 2004 Spending Review, The Stationery Office, London, July. HM Treasury (2004b), Promoting Financial Inclusion, The Stationery Office, London, December. HM Treasury (2000), Competition in Payment Systems. A consultative document, The Stationery Office, London, December. HM Treasury (1999), Access to financial services, PAT 14, London. Hogarth J.M. and K.H. O’Donnell (1999), Banking Relationships of Lower-Income Families and the Governmental Trend towards Electronic Payment, in “Federal Reserve Bulletin”, July, pp. 459-473. Honohan P. (2004), Financial Development, Growth and Poverty: How Close are the Links ?, in Goodhart C. (ed.), Financial Development and Economic Growth: Explaining the Links, London, Palgrave. Honohan P. (2005), Measuring Microfinance Access: Building on Existing Crosscountry Data, World Bank Policy Research Working Paper 3606. Kempson E. (2006), Policy level responses to financial exclusion, in http://info.worldbank.org/etools/doc/library/232700/kempson_paper-final.rtf Kempson E. (2004), Independent Review of the Banking Code. Report to Code Sponsors, BCSB, London, September. Kempson, E., S. McKay and M. Willits (2004). Characteristics of the Households in Debt and Nature of Indebtedness. London, Department for Work and Pensions. Kempson E., A. Atkinson and O. Pilley (2004), Policy level response to financial exclusion in developed economies: lessons for developing countries, The Personal Finance Research Centre, March. Kempson E. (2001), L’exclusion bancaire: une comparaison internationale, in “Rapport Moral sur l’argent dans le Monde en 2001”, Association d’économie financière, Paris. Kempson E., C. Whyley, J. Caskey J. and S. Collard (2000), In or out ?, Financial exclusion: a literature and research review, Consumer Research, FSA, n° 3, July Kempson E. and C. Whyley (1999), Kept in or opted out? Understanding and combactin financial exclusion, Bristol, Policy Press. Kennickell A.B., M. Starr-McCluer and B.J Surette B.J (2000), Recent Changes in U.S. Family Finances: Results from the 1998 Survey of Consumer Finances, in “Federal Reserve Bulletin”, January. Knight W.G. (2006), Canada’s Access to Basic Banking Regulations, Notes for Remarks, Global Conference on Access to Finance, Washington, 31st May. Lawford J. (2003), Pragmatic solutions to payday lending: regulating fringe lending and “alternative” banking, Public Interest Advocacy Centre, Ottawa, November.

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Levine R. (1997), Financial Development and Economic Growth: Views and Agenda, in Journal of Economic Literature, Vol. 35, n. 2. Levine R. (2005), Finance and Growth: Theory and Evidence, in Aghion P., Durlauf S.N., Handbook of Economic Growth, Elsevier North Holland. Llewellyn D. Iqbal M. (eds) (2002), Islamic Banking and Finance, Edward Elgar, London. Lipman F.J. (2003), The working poor are paying for government benefits: fixing the hole in the antipoverty purse, in “Wisconsin Law Review”, n° 3. National Statistics–DWP (2003), Family Resources Survey. United Kingdom. 2002-03, in http://www.dwp.gov.uk/asd/frs/2002_03/pdfonly/frs_2002_03_report.pdf OCC (2002), Survey on financial activities and attitudes, http://www.occ.gov/SFAA/about.pdf OECD (2005), Improving Financial Literacy Analysis of Issues and Policies, OECD Publishing, Paris. Peachey S. and A. Roe (2004), Access to finance. A study for the World Savings Banks Institute, Oxford Policy Management, October. Pesaresi N. and O. Pilley (2003), Retail banking, social inclusion and public services, in “Competition Policy Newsletter”, n° 1, Spring, pp. 14-20. Pilley O. (2005), L’Union européenne et l’exclusion financière, in Gloukoviezoff G. (sous la direction de) « Rapport exclusion et liens financiers. L’exclusion bancaire des particuliers. Rapport du Centre Walras 2004”, Paris, Economica. Pilley O. (2000), Access to current account: issues raised by the UK debate, in “Lettera Newfin”, n° 2. Pilley O. and Anderloni L. (1999), European Post Offices in Financial Services. Competitors or Strategic Partners ?, Lafferty, Dublin Pollin J.P. and A. Riva (2002), Financial Inclusion and the Role of Postal Systems, in Ruozi R. and L. Anderloni (eds.), Modernisation and Privatisation of Postal System in Europe, Springer, Heidelberg New York. Rhine S.L.W., M. Toussaint-Comeau, J.M. Hogarth and W.H. Greene (2001), The Role of Alternate Financial Service Providers in Serving LMI Neighbourhoods, Policy Studies, Federal Reserve Bank of Chicago, April. Righetti P. (2005), Dalla bancarizzazione all’inclusione finanziaria: il paradosso della modernizzazione dei mercati e le iniziative di contrasto dell’esclusione, in Signori S., G. Rusconi and M. Dorigatti, Etica e Finanza, Franco Angeli, Milano. Riva A. (2003), Un tentativo di bilancio delle esperienze francese e britannica in materia di servizi bancari di base, in Anderloni L. (ed.), “Il social banking in Italia. Un fenomeno da esplorare”, Milano, Giuffrè. Ruozi R. and L. Anderloni (eds.) (2002), Modernisation and Privatisation of Postal Systems in Europe. New Opportunities in the area of Financial Services, Springer-Verlag, Berlin Heidelberg. SEU (1998), Bringing Britain Together, a National Strategy for Neighbourhood Renewal, Cabinet Office, June. Sinclair S.P. (2001), Financial exclusion: an introductory survey, Heriot Watt University, Scotland, Centre for Research into Socially Inclusive Services.

1 Access to Bank Accounts and Payment Services 105 Singh S, P. Myers, W. McKeown and M. Shelly (2005), Literature Review on Personal Credit and Debt in Australia. Families at Risk Deciding on Personal Debt, RMIT University, May. Task Force on the Future of the Canadian Financial Services Sector (1998), Canadians’ Expectations and Corporate Conduct, Background Paper n° 4, Department of Finance, Ottawa. World Bank (2005), Indicators of Financial Access – Household – Level Surveys. WSBI (2004), Access to Finance Resolution, Brussels, 27th October.

2 Access to Credit: the Difficulties of Households

Laura Nieri1

2.1 Introduction This chapter examines the issues concerning the access to credit by households and focuses on the difficulties encountered by certain societal groups in obtaining credit from mainstream institutions, such as banks and other regulated financial intermediaries. In recent years, concern for the inability to access mainstream credit or the inability to find credit at conditions and terms that suit the specific needs/features of certain households - especially those living on low income and with a poor financial culture - has grown in almost all financial developed countries (FSA, 2000; Gardener et al. 2005; Byrne et al. 2005; Anderloni, 2003, Kempson and Whiley, 1999, Caskey, 2002). Credit represents the main solution for bridging the gap between financial inflows – deriving mainly from income – and financial outflows, generated by everyday expenses, the purchase of durable consumer goods and of the house itself. Many households are also the owners and managers of a micro-enterprise and use credit to finance it. Thus, the lack of credit may hinder the start up and the development of a business and may prevent individuals from reaching higher living standards. The attention for the issue of credit access is justified not only by its economic and social significance, but also because of high-profile initiatives undertaken in many developing countries that have led to the establishment of financial intermediaries dedicated especially to those people who are usually rejected from mainstream financial institutions. The author is grateful to Luisa Anderloni, Paola Bongini and Emanuele Carluccio for their helpful comments on a previous version of the work and is thankful to Eliana Angelini and Luciana Lo Monaco for their help in data and information gathering. The author is solely responsible for the contents of the paper. 1

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The most famous example is that of Grameen bank in Bangladesh, the bank “owned by and created for the poor”, which grants micro-credit to groups of individuals who are mutually responsible for the loan. Concern for the issues relating to credit (in)access is also spreading in developed countries, especially in the US and UK where there is a growing number of people turning to non-status lenders, i.e. institutions or even private individuals such as pawnbrokers, moneylenders, payday-lenders, which operate outside the regulated financial system and provide credit at high interest rates, often against the provision of guarantees, and under penalizing conditions and terms (Peachey and Roe, 2004, FSA, 2000). Indeed, difficulties in getting credit is a facet of the broader problem of financial exclusion: this is why, from now on, we will use the term credit exclusion to identify those situations where people are not able to purchase from status-lenders those services necessary to fulfil their credit needs. Our purpose is to shed some light on this phenomenon by answering the following questions: who are the individuals excluded from mainstream credit, and why are they excluded? How is credit exclusion explained by the economic theory? What are the solutions adopted in different countries to tackle this problem? Lastly, given that credit exclusion may occur in different situations and may be caused by different reasons, the paper aims to identify the most effective solutions to prevent this phenomenon. The paper is structured as follows: paragraph 2.2 analyses the features of those households which encounter difficulties in accessing mainstream credit, identifies the reasons why these people are excluded from credit access and tries to evaluate the size of this phenomenon. Paragraph 2.3 contains a theoretical framework of credit exclusion and reviews the relevant literature. Paragraph 2.4 presents a classification of the main solutions so far implemented in financial developed countries, like USA, UK, France, Italy, and Spain, to reduce credit exclusion. Paragraph 2.5 presents the main conclusions and implications of this research.

2.2 The Use of Credit by Households During the last decade the use of credit by households has dramatically increased in almost all developed countries, both because of the growing number of households with outstanding liabilities and because of the growing amount of credit used by each household. Focusing on European countries, national statistics show that at the end of 2003 a high percentage of households held one or more credit products (see table 2.1). At the end of 2004 the amount of credit held by European households ranged from 39 thousand euros for Denmark to less than 5 thousand euros for Greek

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families (see Table 2.2). According to data in the Survey of Consumer Finance, the significance of debt is increasing also among US households, where, at the end of 2001 75% of families had a bank loan (Aizcorbe et al., 2003). Table 2.1 European Households’ debt Country Thousands Euros per inhabitant (2004) Denmark 39.79 The Netherlands 32.81 UK 25.95 Luxemburg 24.08 Ireland 22.68 Sweden 19.66 Germany 18.8 Austria 14.47 Spain 12.37 Finland 11.77 France 11.14 Belgium 10.94 Portugal 10.30 Italy 6.59 Greece 4.65 Source: Observatoire de l’Epargne Européenne (2005). Table 2.2 Use of credit by households (percentage of households declaring to use different type of credit) Country UK

Mortgage Loan lasting > 12 months to buy a car 33 13

Loan lasting > Overdraft Credit card 12 months to buy Facilities something else 15 48 57

France Germany Spain Italy Europe 15

15 10 25 10 19

9 8 7 6 9

13 10 10 8 11

60 36 9 12 35

75 26 48 38 45

(average)

Source: Standard Eurobarometer (2004) (data have been collected in November – December 2003).

Different countries are still characterized by a heterogeneous incidence of debt on households’ income or wealth, due to a traditionally different approach towards debt: typically, North-European and US households have a higher tendency to borrowing compared to South-European coun-

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tries. However, in recent years things have rapidly changed, on the one hand, because of a more positive attitude shown by households towards debt – partly justified by the low level of interest rates – and, on the other hand, because of the strong competition within the retail banking sector and the resulting product innovation. However, frequency in the use of credit appears positively correlated to the level of household income, which means that individuals living on higher incomes benefit more from the increasing availability of credit. This tendency is also confirmed by econometric test that prove that the demand for debt is positively associated with income, wealth and incomegenerating characteristics, such as home ownership, job status, education (Crook, 2001 and 2003; Cox 2002, Bridges and Disney, 2002). As a matter of fact, in addition to those households who go into debt in an attempt to maintain previous economic levels or prevent the slide into poverty, more and more choose debt as an alternative approach to the management of domestic consumption, savings and income. Although there are no official statistics available, factual evidence suggests that certain segments of the population, especially those living on low and moderate income, find obstacles in obtaining credit. Besides, it is highly probable that those people who have no access to basic financial services, such as a current account, and are therefore considered unbanked, are also excluded from mainstream credit. According to studies on financial exclusion (Anderloni, 2003; Devlin, 2005; Carbo et al. 2005; HM Treasury 2004), the higher percentage of people unbanked has to be found in specific societal groups, especially those who have a low income and a non regular and unstable job, those who are young, are part of an ethnic minority, those who live in suburbs or in agricultural areas, and those who have a low financial literacy. Among the same groups we could easily find people who have no access to mainstream credit. Usually, households ask for credit in order to fulfil the following needs: -

-

to buy household appliances, furniture or clothing they need to replace; to pay bills; to make ends meet; to meet the costs of discretionary items, such as Christmas, birthdays or other family events and, occasionally, to go on holiday (Kempson, 2003) and to buy a house.

Besides these reasons, a household may require credit also because it is self-employed or has set up a business activity. In these cases, credit also refers to the financial support needed by this micro-enterprise.

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There are various reasons for a household to be excluded from credit access; individuals may be excluded because: -

despite being in need, they have not requested credit as they are convinced that their application will certainly be turned down; the demand for credit has been rejected by credit institutions; even on finding an intermediary available to grant them credit, for several reasons they cannot or do not want to use this possibility.

The first situation concerns the so-called self-exclusion phenomenon. The decision on the part of a person needing credit not to apply for a loan is typically due to a lack of information regarding application procedures or a previous rejection. In such cases it is not the credit market which is unable to satisfy a demand for credit since the demand is unexpressed. The underlying reasons for this behaviour are mostly due to the limited, if not absent, financial culture of the individual, often exacerbated by the insufficient information regarding products and services that credit intermediaries provide these segments of the population. Secondly, an application can be rejected by the credit intermediary on various grounds: -

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difficulty on the part of the credit intermediary to assign an accurate credit rating. The conditions of many individuals belonging to the poor segments of the population, as well as of many small firms or micro-enterprises, are such that they represent a serious obstacle to the collection of sufficient and reliable information necessary for a correct evaluation of the risk incorporated in the applicant. This can occur, for example, in the case of the illegally employed, who have no income records; or in the case of an enterprise whose real income produced can be difficult, and therefore costly, to determine; or in the case of difficulties in evaluating the guarantees produced by the credit applicant. Consequently, the impossibility of concluding the preliminary phase in granting a loan represents a major obstacle; applicant’s perceived excessive level of risk. The credit intermediary may establish credit-risk levels beyond which it is judged uneconomical to grant loans. The individuals referred to in this paper often have societal, economic and legal features that expose them to high levels of insolvency risk. The refusal of credit by banks can lead to rationing, which as we will see in the next paragraph, is theoretically justified when the valuation of risk is performed correctly. With reference to the types of individuals exposed to the risk of credit exclusion, there is in fact the possibility that the poor informative transparency which characterizes them, as well as the adoption of inadequate

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screening techniques, can lead to evaluations that do not correspond to the real risk profile; limited “economic interest” by the intermediary in a specific customer segment. This happens both when the screening phase involves excessive costs in comparison to expected returns and when, more generally, the credit applicant, though having an acceptable credit risk profile, does not belong to the credit intermediary’s target customer segment. Commercial policies of banks and other credit intermediaries are increasingly focused on high worth customers with cross and/or up-selling potential. Clearly, comparatively low credit requests made by poorer citizens with limited openings for cross selling make such customers unattractive, which can, from this point of view, lead the intermediary to reject the credit.

The third and last situation of credit exclusion concerns those cases in which individuals who need credit decide not to finalize the credit contract, even if they have found an intermediary prepared to finance them. The underlying reasons of such behaviour can be: -

-

excessive cost of the loan. In line with the high risk correlated to the loan, the price of the loan can be so high that it cannot be met by the customer or, in the case of a productive investment on the part of an enterprise, is uneconomical. The widespread availability of more and more detailed scoring techniques increases the chances that a very risky borrower is actually obliged to pay a considerably higher rate than a more deserving borrower; contractual terms that are ill-suited to the applicant. Even though the price of the loan is satisfactory, which is more than likely in the current context of low rates, other aspects of the contract could on the other hand represent an obstacle. We could mention, for example, the repayment methods of the loan and its length, features that are decisive factor in quantifying the instalments. More generally, flexibility in contractual terms allows the borrower to optimize his/her financial management, whereas rigidity can be costly.

2.2.1 The Questionnaire Survey Given the general lack of data and information concerning credit exclusion, we have conducted a survey based on interviews among a sample of about 700 people - both native and migrant - living in France,

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Spain and Italy. The study’s aim and methodologies are presented in the Appendix to Part I2. The interviews were aimed at understanding: -

what percentage of people have applied for a credit and what their credit needs are; what type of institution (bank or another credit intermediary) people have applied to; how frequently the application has been rejected, and for what reasons; which factors are deemed to be important for a financial institution in order to lend money to a household.

As for the first question, data show that about half of the sample has never approached a bank or a credit institution for a loan; this percentage rises among migrant people (62% of the sample), especially those living in France (65%). The main reason people do not ask for credit is because they think they do not need it (64%); this position is more widespread among native people than among migrants and is quite frequent in France, where many households do not want to go into debt. Another explanation for not requiring credit is the fear that the application will be rejected (21%); this sort of self-exclusion is quite common especially among migrants (30%), who are conscious of the potential negative implications of their low income and of the unavailability of documents relating to their legal position (stay & residence permit). Only seldom, does the demand for credit remain unexpressed because of the difficulties associated with the application to the bank, though this problem seems to be more acute for migrants, for whom the language may be an obstacle as well as their low financial literacy. On the other hand, when people apply for credit they do so primarily because they want to finance the purchase of a house or another connected expense, such as the refurbishing or the renovation of the house or, sometimes, the purchase of furniture. This motivation is quite frequent in Italy and Spain (respectively, 44% and 51% of the credit applications). In France, the reasons why people ask for credit are more diversified and often refer to the purchase of a car and other vehicles (25%) and of other durable goods (26%). Another common reason among migrants for requiring credit is the financing of travel expenses to and from their country of origin, other expenses connected with reunion with relatives (children, spouse, parents) who still live in their country of origin. For all details relating to the sample and data see Anderloni L., M.D. Braga, E.M. Carluccio and L. Nieri (2006). 2

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Sometimes and especially among migrants, credit is also required to start a small business or to finance the purchase of instruments used by selfemployers. However, the percentage of loans concerned with a business activity is on average quite low (8%). This result may depend on a bias affecting our sample3, but can also mean that only a minority of people on low income are self-employed or think they can start an own business. This, in turn, may be due to a low level of education and to the lack of information concerning the subsidies offered by many national/local government and other associations. Banks represent the primary institution which households make their application to (77% of total applications). The development of banks in this business area is, however, constrained by the activity of specialized credit institutions whose role is quite important especially when the applicant is a migrant and especially in Italy, where these institutions detain almost one third of applications. The competition between banks and specialised credit intermediaries is confirmed also by the fact that 12% of households ask credit from both types of institutions. As for the result of applications, our data show that 84% of them have been accepted. However, one third of people who have received a loan have had difficulties in repaying it, though, many of them have eventually managed to pay it back fully. In the opinion of these people, repaying the loan was difficult because the “interest was too high or increased during he life of the credit contract” or because their income decreased, mainly as a result of the loss of job. On the other hand, those borrowers who did not encounter any difficulties in repaying the loan, state that this was because they had borrowed a small amount and the structure of the repayment schedule was adequate in terms of length and amount of each instalment. These data suggest that the contractual form used to grant credit is crucial for households, as well as a thorough understanding of their financial situation. Given the relatively low financial literacy of these people, advice from financial institutions about the most convenient type/amount of credit becomes an essential part of credit products and contributes to reducing what that can be identified as “difficulties of use”4 of credit services, and which are among the causes of credit exclusion. As previously stated, only a relatively small percentage of credit applications (16%) have been rejected: however, this percentage rises if we As explained in the Appendix, the sample is composed by people who frequently attend charity associations, centre for the unemployed or professional training centres. This may have reduced the share of the self-employed. 4 For a thorough analysis of difficulties of access and of use of financial services, see the following chapter by Gloukoviezoff. 3

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consider only migrants (26%), thus confirming that for this societal group it is more difficult to borrow money from mainstream institutions. The percentage of rejected applications varies also among the countries analysed: it is higher in Italy - where the incidence of credit denial is 20% for natives and 38% for migrants -, whereas it is relatively low in Spain – 8% for natives and 19% for migrants. This result, coupled with the information concerning the type of credit institution towards which the application has been addressed, demonstrated that there is not a strong link between type of credit intermediary and the probability of getting a positive answer: in Italy, where we found the highest number of people turning to specialised credit institutions instead of banks we also found the highest number of rejected applications. In a few cases, those interviewed have however admitted that they had turned to and obtained credit from a specialised credit institution after the refusal of a bank. Answers given to the question concerning “what kind of obstacles have prevented getting a loan” are not always clear and are occasionally even missing. This proves that sometimes people are not fully aware of the reasons why the bank or another intermediary have rejected their application and, more generally, it is proof of the problems of comprehension between these types of borrowers and the financial sector. The main obstacles encountered concern the unavailability of stable employment, the low level of income compared to the amount of credit, the lack of guarantees and collaterals, and – regarding credit applications to finance a business or a micro-enterprise - the negative evaluation about the economic perspectives of this business. Differences among the three countries are not significant, though Italian households appear to have more difficulties finding available property to pledge against the loan, whereas for Spanish and French households the presence of a stable employment and of a reasonable income is crucial. The comparison of the situation of migrants with that of natives shows that for the former group another important explanation for credit refusal is, besides the above mentioned factors, the lack of regular documents (residence permit). Unexpectedly, only a low percentage of respondents (9%) have pointed at the absence of a deposit account with the bank as a primary reason for credit denial. According to the literature on relationship banking5, the existence of a (long-term) relationship between credit institutions and their customers allows the former to overcome problems arising in the evaluation of credit risk. These problems are mainly due to the opaqueness of their counterparties and are deemed to be quite severe especially for certain groups of households. We would, therefore, have expected credit 5

See next paragraph.

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intermediaries to attach more importance to this feature of the potential borrowers in the decision process relating to a loan. Coherently with previous data, people interviewed say that the most important factors to obtain mainstream credit are the availability of a stable income and of adequate guarantees. Again, there is a limited perception of the importance of having a deposit account or another type of relationship with the credit institution, whereas for migrants being introduced to the bank by a native appears significant. On the whole, it seems that a number of respondents do not have a clear understanding of which factors are decisive in a successful application for credit, as is demonstrated by the large proportion of answers saying that almost all suggested factors are equally important. In conclusion, our survey allows us to make a few hypotheses concerning the incidence and significance of the phenomenon of credit exclusion. If we sum up those households who have not applied for credit because they were afraid to be rejected or because they find it too difficult to apply to those households whose applications have been rejected, we get an approximate estimate of the percentage of households who have no access to mainstream credit. According to our data, this percentage is roughly 22% of the total sample. Moreover, if we adopt a wider definition of credit exclusion that embraces not only difficulties in accessing credit, but also difficulties in using credit products, and if we assume that those people who had problems in repaying their loan did so because they did not receive proper advice and were sold products that were inappropriate or ill-suited to their needs, we should add another 12%, ending up with a final percentage of 34%. That is to say that about one third of people living on low income, being part of a minority and sometimes without a stable occupation face problems in accessing and using mainstream credit. The survey has also confirmed that difficulties in credit access are often due to an inadequate financial literacy. In fact, a limited understanding of technical characteristics of credit products and of the risk evaluation procedures followed by credit intermediaries may lead either to selfexclusion phenomena or to the choice of credit products which are inappropriate in terms of amount borrowed, price and other conditions. This latter consequence may, in turn, be the cause of the inability to repay the loan or the need to renegotiate the loan at a higher interest rate. Another effect of insufficient financial education may also be the inability of households to provide credit intermediaries with all the relevant information for the assessment of credit risk. Nonetheless, answers to our survey show that frequently the primary obstacle in obtaining credit is perception of the high risk embodied in unsecured loans granted to households with a very low income and/or an

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unstable occupation. This means that credit exclusion does not only result from a biased behaviour of credit institutions against a few segments of potential borrowers, but may also be the implication of the peculiarities of these borrowers.

2.3 A Theoretical Framework for Credit Exclusion 2.3.1 The Role of Credit to Overcome Social Exclusion The increasing importance attached by banks’ strategies to the retail sector, along with the growing tendency of households to use credit to finance their expenses, have led to a remarkable growth of the percentage of households using credit facilities. At the same time, this has increased concern for those households that have no access to credit. As mentioned in previous paragraphs, the probability to be excluded from mainstream credit is high for people on low incomes, such as young people living independently, single parents, people living in marginalised geographical areas or in suburbs, pensioners, and people without a permanent job. The number of people who are part of these categories is growing, mainly because of the ongoing trends relating to changes in demographic, social, and ethnic structures of population and in the labour market (FSA, 2000; Aizcorbe et al., 2003). In fact, credit unavailability represents a serious problem since it prevents lower-income people from reaching higher living standards and is somehow a reason for social exclusion (Caskey, 2002, Barr, 2002, Seidman and Tescher, 2004). Households require credit in order to fulfil basic needs of their daily life, or to overcome downturns – like a job loss, an illness or a divorce – or to purchase a house in order to solve the problems caused by the absence of rented houses and by high rents. Therefore, difficulties or even the impossibility to obtain basic credit products, such as a short-term overdraft, credit card and personal lending, as well as medium and long-term mortgages may worsen the economic, financial and social situation of these households. The problem of credit access seems even more crucial when it concerns households that are selfemployed or that wish to use credit to establish a business. The rejection of this type of credit application has a direct (negative) implication on the possibility for the household to earn an income or to increase its level. In fact, faced with the denial of mainstream credit institutions, lowerincome households have only two alternatives: either to ask for money from friends and relatives, or turn to non status-lenders. The former

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solution may be successful when the amount needed is not high; however, it is rather uncertain, since it depends on the financial availability of other households, which are usually not rich. On the other hand, non-status lenders often apply remarkably high interest rates and ask for guarantees such as a pledge on the borrower’s goods. The high cost of credit may lead to the inability of the borrower to repay the loan and, ultimately, to the repossession of the goods in case of default. The use of alternative credit providers, especially of those with a doubtful reputation, may be only a short-term and temporary solution for credit needs. But, in the medium term, it can turn out to be the first step towards situations of overindebtedness and can deprive the borrower of their property and other essential possessions (Kempson and Whiley, 1999). 2.3.2 Economic Rationales for Credit Exclusion In order to improve our understanding of credit exclusion and to find possible solutions to tackle this problem, we attempt to identify the economic rationales of this phenomenon. Our aim in doing so is to verify whether this sort of market failure – where part of the households’ demand for credit is not satisfied – is motivated by biased behaviour of credit institutions or whether it is justified by specific features of excluded households. Ultimately, this should provide us with insights into the most adequate and effective way to combat credit exclusion. If we analyse the reasons that underpin credit exclusion, three significant research approaches can be seen: -

The first, microeconomic, approach views credit rationing in a framework of information asymmetries; The second, known as information theory, focuses on the methods of credit provision in markets where information is incomplete; The third starts from a managerial approach and focuses on the creation of value and the maximization of shareholders’ wealth as banks’ primary objective6.

The first body of studies analyses the phenomenon of credit rationing, namely that situation in which a part of households’ demand for credit is unfulfilled at the market rate. Such rationing is a pertinent expression of credit exclusion. One of the major insights that this area of study provides is that there is a level of applicant riskiness beyond which it is not profitable for the bank to lend. When the risk threshold is crossed due to 6

For a similar approach, see Carbó et al. (2005).

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the expected costs of insolvency, the bank’s overall profit level drops. This explains why very risky individuals are excluded from access to credit (Hodgman, 1960). Furthermore, if we consider that lending is characterized by information asymmetries in which fund providers (banks, for example) are not able to know the exact riskiness of the borrower and/or cannot monitor variations in customer risk levels during the term of the loan contract, the interest rate applied to the loan is understood as a proxy of a borrower’s credit risk. Maximum interest rate levels are therefore set beyond which the bank has no intention of granting credit (Stiglitz and Weiss, 1981). This means that although those who request credit are willing to pay a remarkably high interest rate for a loan, they are not granted it. An individual is willing to pay high interest for potentially high return projects as he/she understands that high profit potential is intrinsically linked to high risk. The bank, consequently prefers on economic grounds not to grant the credit in such cases. This appears to explain why banks do not grant credit to high-risk customers even though they are willing to pay a high price for the loan. Under these circumstances, the granting of real or personal security by the potential borrower could reduce overall customer riskiness, and the bank could decide to grant the credit. However, individuals who are typically credit-rationed usually have neither the real property to provide under security nor the possibility to apply to other guarantors. Reduction of the risk can only be achieved via the participation of other institutions that shoulder a portion of the risk. The presence of incomplete information distributed asymmetrically between borrowers and fund providers – a crucial characteristic of information theory originally put forward by Sharpe (1990) - is also able to explain other reasons for credit exclusion. In fact, in a similar situation, it is expensive for the bank to acquire adequate information to value the riskiness of a potential loan and therefore to decide whether to grant the credit or not and if so at what price. The higher these charges are, the more difficult information retrieval concerning the applicant is, and the more complicated it is to check the reliability and truthfulness of information. This entails that, if the lender is not able to gather reliable information about the applicant or if its retrieval is too expensive7, there is no

In the field of consumer credit, banks in addition to information sourced directly from the customer often use information services provided by external companies. Such services represent an additional cost every time they are required. 7

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possibility to make an adequate risk evaluation, and so the granting of the loan is rejected. Many segments of individuals excluded from bank credit find themselves in such a position. A case in point are employees who receive no formal wage packet, or the self-employed who keep no formal bookkeeping records and make no tax returns. It is also clear why individuals who apply for credit of limited amounts and for which adequate information would be available cannot nonetheless receive funds as the costs relating to the credit-risk assessment are too high for the bank compared to the expected returns. In both cases, the elimination of the obstacles to credit access implies a greater availability of and accessibility to reliable information for the bank. This can at least partially be obtained when a bank has strong ties with the areas in which the applicants live and work. In these circumstances, the bank can build over a period of time a repository of shared information (for example, information about trends of the different economic sectors in the area, information about the potential borrower’s relatives, and so on) that reduces the opacity of these individuals. A similar result can also be achieved by the establishment of stable and lasting customer relations (Petersen and Rajan 1994 and 1995, Ongena and Smith 1997, Boot 2000). Such relations generate two positive externalities: on the one hand, over time information is stratified8, which provides the bank with a more detailed picture of the borrower, whilst on the other hand, the possibility to use information about the same customer more than once allows the bank to amortize over several years the costs of acquisition incurred – e.g. the costs of investigation. The above-mentioned advantages are extended if the bank is structured in a cooperative form, and therefore grants credit mainly to its members. In this case, lending risk is reduced – and with it the price of the credit – as instruments of social sanctions operate in favour of the bank. Such sanctions consist of peer monitoring – e.g. disapproval by the other members, who also belong to the same community – which encourages the borrower to fulfill his/her repayment commitment (Angelini et al. 1998, Banerjee et al. 1994). Therefore, information theory assumes that some types of banks are better at managing the problems linked to information asymmetries, provided the customer in question are those with non sporadic credit needs.

The fact that the borrower uses the bank to settle payments generated by the running of a business gives the bank access to important information represented by customer current account statements. 8

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The third approach identifiable in the analysis of credit exclusion is broader and wider ranging. Indeed, rather than representing a theoretical paradigm, the management approach is a set of best practices for the maximization of shareholder value. From the 1990s onwards, coinciding with the start of privatization, which affected most of the Western banking system, banks’ main mission has been the creation of shareholder value and the adoption of policies aimed at maximizing profitability, efficiency, adequate control of financial and non financial risks, and the prudential management of owners' equity. The pursuit of these objectives has meant adopting measures that may potentially exacerbate the problem of access to credit for some segments of the population. Below we report the main areas of interest concerning credit exclusion phenomena. -

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Credit rating procedures. As previously mentioned, in this field we can observe the spread of automated procedures, such as credit scoring, which, on the basis of standard information, allow the bank to obtain a rapid and reliable evaluation at low cost. The standardization of these procedures makes it impossible, or at least uneconomical, to analyze information which is not included in the evaluation checklist. Also excluded is so-called soft information; information which cannot easily be translated into the quantitative variables used in the scoring. Therefore, judgments based on scoring techniques may not reveal the real extent of a customer’s creditworthiness. A case in point is loans for small-scale business ventures in which repayment of the loan depends on the validity of the business plan, the evaluation of which is difficult only on the basis of scoring techniques. The same procedures also tend to exclude those who are unable to provide procedurally necessary information, such as wage packets in the case of craftsmen, or of those only partially in legal employment. For these reasons scoring techniques, increasingly used in the valuation of retail customers, may turn out to be ill-equipped to handle the specificities of the low-income segment. In fact, several studies (Schreiner, 2000, 2002) argue that, though automated techniques can leave out part of the so-called soft information, this kind of obstacle is widely offset by the benefits of using a screening method which provides rapid, uniform and constant evaluation of different types of applicants at a contained cost. Moreover, the use of automatic evaluation techniques for credit rating and the continuous improvement of screening procedures allow banks to achieve a segmentation of customers based on credit-risk levels and to price credit accordingly. It follows that, consistent with mana-

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gement principles, it is the marginal customers – often riskier or perceived as such – who must incur the higher borrowing costs. It is not a question of discrimination, but a tendency that is justified by correct management principles, whose results, however, can exacerbate the problem of access to credit for some individuals. Marketing focus on high worth customers, namely those able to acquire several bank services. In highly competitive markets, such as the financial services market, customer acquisition costs are high. Consequently, the main goal of banks’ marketing policies is to extend the duration of customer relations with the bank as well as to increase a bank’s share of the customer’s wallet through crosselling and/or upselling9. In fact, also advertising campaigns for different products are targeted to customer segments with these characteristics. This attitude on the part of many banks is the reason for limited interest in marginal customers, who are most exposed to credit/financial exclusion. The absence of advertising campaigns addressed to marginal segments of the population certainly does not contribute to increasing their level of financial knowledge and in fact heightens financial self-exclusion. On-line distribution of banking services. The increasing use of the Internet for the distribution of financial services represents a potential obstacle for access to the financial system on the part of some segments of the population that do not have ready availability to the Internet. Although the number of credit intermediaries that use solely the Internet in the distribution of credit products is still moderate and limited to Anglo-Saxon countries, the exclusion of this peculiar segment from the credit market can represent significant disadvantages due to the fact that the on-line market is characterized by high competition and consequently by more favourable prices than those offered in traditional segments of the credit market. Moreover, the Internet is increasingly the channel used for advertising campaigns and, more in general, for the disclosure of information about financial intermediaries: therefore the difficulty to access this media can increase the disinformation of those in need of credit. Product standardization. Widespread efforts to maximize operational efficiencies has led banks to standardize the underlying contracts of products and therefore to offer several products whose form and me-

I.e., the possibility of selling customers an increasing number of (value-added) products. A typical example is a young customer who takes out a mortgage, who will then be targeted for other products (payments, savings, insurance, etc.). See McKinsey & Company (2006). 9

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thod of use tend to be rigid and not always suitable for some customer segments. With reference to the credit needs of individuals living on low incomes and disadvantaged in terms of financial culture, different conditions (installments, repayment, etc.) from those applied to the majority of customers could turn out to be more appropriate. A useful example is represented by the structural characteristics typical of microcredit solutions: small loans; basic and easy-to-understand interest rates; repayment schedules based on regular and small installments which help the customer to manage his/her finances more effectively and so reduce the risk of falling behind in installment payments. Unwillingness by credit intermediaries to introduce greater contractual flexibility, though justified on the grounds of operational efficiency, can result in an inability on the supply side to satisfy the credit needs of some customer segments. The survey shows that credit exclusion is quite frequently caused by the behavior of credit intermediaries that deny credit to some segments of population. However, this behavior is theoretically at least, justified by particular operating conditions such as, for instance, incomplete disclosure of information or the cost associated with information processing. In other words, it seems that credit exclusion cannot be considered merely a form of discrimination carried out by intermediaries against some categories of households, but rather the inevitable consequence of how the financial system “normally” works. In the next paragraph we will analyze the experiences of some developed countries in attempting to tackle the problem of credit exclusion. We will also attempt to assess to what extent the solutions adopted are in line with the theoretical analyses presented as well as the extent of their success.

2.4 Beating Credit Exclusion Beating credit exclusion, as a means of tackling the broader problem of social exclusion, is an imperative aim for most Western countries. In almost all of these countries, steps to fight this phenomenon have been taken, both at the level of national and local governments and at the level of private associations. Despite the differences occurring among different methods and ways to address credit exclusion, they can be broadly grouped into the following three categories:

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1. initiatives aimed at making banks’ lending policies more supportive towards low income households’ credit needs, consistently with safe and sound management policies; 2. initiatives aimed at removing economic and “environmental” obstacles that prevent mainstream credit institution from lending to families who are usually excluded or credit constrained; 3. initiatives aimed at the development and the spreading of financial intermediaries whose primary mission involves not only the creation of value for shareholders, but also the provision of financial services to specific segments of population. In the remaining part of this chapter we will analyze each type of measure for beating credit exclusion and we will describe the most significant examples worked out in financially developed countries. 2.4.1 Lending to Households: a Profitable Business Area The most striking example of how it is possible to tackle credit exclusion by making banks pay more attention to segments of customers which are frequently rejected from mainstream credit is represented by the Community Reinvestment Act (CRA), issued in 199710 in the US. The Act encourages Federally insured banks and thrift institutions to meet the credit needs of the communities they serve, including low and moderateincome areas, consistently with safe and sound banking practices. Specifically, CRA is addressed to those households whose income is lower than 50 percent of the area median income and to small enterprises11. The observance of the law is checked on average every three years on the basis of a three-part test organized: lending test, investment test and service test12. The lending test, the results of which account for 50 per cent The CRA was reviewed in 1989, when credit ratings were made public (see infra), and in 1995, when the procedures of credit rating grants were modified. A discussion is currently in progress on the opportunity of “streamlining” such procedures, with particular reference to small-sized banks, for which the production of data needed for the checking by Federal agencies is costly. On this question, see Barr (2004), JCHS (2002). 11 Loans to small and medium-sized enterprises are loans of amounts below USD one million and/or loans granted to enterprises with a turnover below USD one million, or to enterprises located in low income areas. 12 For small-sized banks, the test is simplified and concentrates on lending activity. 10

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of the final judgement, takes into consideration the number and the amount of loans granted to borrowers living on medium-low incomes, as well as promoting the diffusion of innovative and flexible credit practices. The investment test measures the size of investments made by the bank within its operating area, and the service test evaluates factors such as branch network distribution, opening times, the range of services offered and their ability to meet the needs of low-income customers and, more generally, the degree of accessibility to bank services for various segments of the population. The evaluation result consists of a rating that expresses the actual capacity of an institution to meet the requirements of its own community13. Test findings are made available to the public, as well as a part of the analyses and evaluations that led the agency to grant its rating. Publication and communication of ratings, with the positive or negative reputational effects this has for banks, is a conduit for encouraging them to abide by the CRA. Rating is also carefully considered by Federal regulatory agencies in evaluating requests for branch openings or closures, mergers or acquisitions, and new business lines made by banks. A negative rating, or criticisms of a bank (so-called “CRA protest”) made by associations and/or bodies in defence of minority rights or in support of the growth of urban areas in which the bank is working, can lead to significant delays in the granting of authorisations or even the turning-down of an application. In these terms, non-observance of the CRA can prove costly for banks. Over the years the CRA has proved to be an effective instrument in reducing credit market failures which prevent low income segments of the community access to credit offered by the banking system. The main benefit produced by the CRA concerns the market of home mortgage loans and, consequently, the extension of home ownership levels. According to a survey carried out in 2000 by the Federal Reserve Board (Avery et al., 2000), 72% of the programmes specifically organized by the banks under the CRA concerns in fact the granting of home purchase loans. In particular, according to the data of the Joint Center for Housing Studies at Harvard University (JCHS, 2002), between 1993 and 2000, credit in support of home purchases by minorities rose by 94% for the black community, 140% for Hispanic groups and 92% for other minorities. The CRA’s effectiveness is proved by the fact that banks subject to its jurisdiction grant the largest share of loans to individuals at exclusion risk, The rating is expressed in four judgments: “outstanding”, “satisfactory”, “need to improve” and “substantial non-compliance”. In 1998, ratings were distributed as follows: 19.1% outstanding, 78.9% satisfactory, 1.8% needs to improve, 0.2% substantial non-compliance (Zinman, 2002). 13

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that is to say ethnic minorities, low-income individuals, residents in depressed areas and so on (Apgar and Duda, 2003). Yet, the gradual growth of shares of loans granted by institutions not subject to CRA oversight is proof of the increasing awareness of the importance of this business area. Benefits can also be found amongst small and medium-sized enterprises (SMEs). With reference to banks subject to CRA, there have been rises in both amounts lent and the numbers of SMEs accessing credit (Zinman, 2002). The attainment of the goals set by the CRA and the overcoming of the problems correlated to the financing of low-income individuals and areas have mainly been achieved thanks to: -

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using risk screening techniques that differ from those traditionally applied and which are more appropriate to this segment of individuals (Avery at al., 2000). For example, requests for higher amounts of debt are accepted, or; higher leverage level are accepted, or; promptness in payment of rents and utilities are taken into consideration instead of traditional credit histories, or the proportion of the total amount required to purchase goods is raised; starting marketing programmes in order to increase understanding of specificities of different urban areas and to work out loan programmes characterized by more flexible subscription and amortization techniques, as well as to increase the level of financial culture of the population (Barr, 2005); developing different forms of coordination between banks that work in the same areas in order to share information as well as to create a secondary market of CRA eligible loans14; the development of different kinds of partnership with organizations located in communities and the creation of community development financial institutions (CDFIs), whose task basically consists in providing a knowledge base of local areas, in supplying financial education and in assuming the risks considered excessive by the individual banks through the setting up of bank syndicates. In this connection, we can point out that 76% of specifically designed CRA-compliant loan programmes provides for the presence of third parties, such as non-profit organizations, local governments, civil services, credit institutions and so on (Avery at al., 2000). Their activity consists in

To comply with the CRA, loan valuations are applied not only to credits directly granted by each bank, but also to those acquired by other banks, so creating an incentive for a secondary loans market, which increases market liquidity. 14

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services such as borrowers’ financial education, identification of potential borrowers, execution of preliminary screening activities, as well as the provision of the first instalment of the loan repayment, or measures aimed at reducing the interest rate by the bank. A further aspect that proves CRA effectiveness concerns the profitability of loans granted to CRA-eligible individuals. More than 50% of banks subject to the CRA declare that CRA-related loans have the same profitability as other loans, and only 15% declare they do not break even (Avery at al., 2000). On the whole, the profitability of particular programmes, addressed to the business areas considered by the CRA, increases in time and indicates a kind of “learning effect” on the part of banks. We also have to point out that this particular credit activity involves greater risks, due to longer delays in the payment of instalments and higher insolvency costs. On the whole, home purchase loans, granted to households that are included in the CRA forecasts, involve a higher riskyield ratio in comparison to the same loan types granted to different individuals. This difference is, however, reduced in the case of small banks, which can probably exploit their strongholds in the area and their closeness to the community in order to carry out a more effective screening and monitoring activity. On the contrary, in the case of loans granted to small and medium-sized enterprises which are included in the CRA forecasts, there is a substantial alignment between this segment’s risk and yield values and those of SMEs in general. The observation that CRA loans have profit and risk profiles similar to other credits suggests that expanding loan activity to individuals often excluded from the credit system can represent a way of increasing the operational volumes, without damaging banks’ solvency and economic efficiency. When the reason for credit exclusion lies in the limited interest banks have in some customer segments and, to some extent, the possible prejudice these segments suffer, it is in fact possible to achieve a change in lending policy strategy which favours access to credit by those individuals originally considered to be unprofitable or at greater risk. Unlike the CRA case, where credit exclusion is addressed by externally-imposed rules on the banking system, there are also cases in which the incentive to favour access to credit on the part of poorer people is internal to the bank system itself. This is the case of the UK, where the banks, members of the British Bankers’ Association, have self-imposed the requirement to destine amounts to low income brackets and groups at risk

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of credit exclusion. In this case, reputational instruments are used to induce banks to adopt socially-responsible behaviour. A similar role is performed by the Social Statement, one of the main instruments used within the ambit of Corporate Social Responsibility. This document is intended to provide information about the reaching of pre-set social objectives and to demonstrate that the banks’ aim is not only to create profit, but also to provide added value for the community. To that end, included is also information concerning the different types of stakeholders in favour of which banks operate and grant credit. The examination of a sample of Italian banks’ Social Statements shows that credit assistance in favour of specific segments of the population at risk of credit exclusion is somewhat rare. In most cases help to the community consists in donations for social, cultural, sporting or scientific activities, in support namely of no-profit associations and organizations. In some cases, special-rate lending solutions for small businesses realized in collaboration with professional bodies or associations are provided, together with joint ventures to support the development of areas which, in many cases, correspond to banks’ main operating areas. The general impression drawn from these documents is that these are only isolated measures that aim at consolidating a bank’s image or reputation, rather than at defining a precise strategy regarding those segments of the population that are more vulnerable in terms of access to credit. 2.4.2 Reducing the Costs and Risks Associated with Households Loans The second class of solutions concerns the elimination of the obstacles that prevent banks from offering an economically effective solution for granting credit to low income households. As argued in the third paragraph, some families find it difficult to access credit because the risk of lending to certain households is deemed to be too high. Alternatively, credit intermediaries may not be able to assess potential borrowers’ credit risk due to the unavailability of reliable information about the borrower, or, more often, due to the level of costs associated with information gathering and processing, which are excessively high compared to the revenues that the bank may expect to gain from the loan. In both cases, it is improbable that the bank system is able to work out an “internal” solution to the problem of credit exclusion, and therefore external intervention is needed. An example of this is France, a country that has traditionally demonstrated considerable awareness of the problems

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involving the reintegration of people and households with financial difficulties both into work and into traditional credit circuits. Exclusion from traditional finance circuits is considered a reason for a further “impoverishment” of the weaker segments of the population because, denying these individuals the possibility of undertaking income-generating activities, they are denied the opportunity of social and financial reintegration. For this reason the main measures to facilitate access to credit are specially directed to the long-term unemployed, to the so-called “Rmistes”, who receive minimum unemployment benefit (RMI, Revenu Minimum d’Insertion15), and to people in temporary employment. The Borloo Law16 (“Law for the Planning of Social Cohesion”) specifically addresses these categories of people. The most significant aspect of this law is the establishment of a “Social Cohesion Fund” (FCS, Fond de Cohésion Sociale), which seeks to “guarantee loans granted with social aims to natural or moral persons, and loans granted to unemployed people and people receiving minimum unemployment benefits to create businesses17. There are two kinds of granted credits: credits for the creation or the recovery of a business (“crédit professionel”) and credits of a social nature, linked to small personal projects for individuals in difficulties (“crédit sociale”), intended to aid the process of social and professional inclusion for people living on low incomes or in conditions of financial instability. The loans in question generally involve small amounts of money – in fact they can be considered microcredits – and are distributed with the intervention of: -

“Accompanying organizations”, i.e. institutions/associations which support entrepreneurial initiatives and projects aimed at obtaining microcredits. This category includes Adie (Association pour le Droit à l’Initiative Economique), France Active, France Initiative Réseau, France Enreprendre and, albeit with a different role, Secours Catholique18. Their assets are provided by contributions from the Social Cohesion Fund, donations and other funds provided by private backers;

In 2005, the RMI consisted of a monthly benefit of € 425.40 per person (inclusive of a housing contribution), corresponding to a total of € 5,104.40 per year, and a benefit of € 638 per month for a couple, plus about € 113 for every child under the age of eighteen. 16 Borloo is the minister for Employment, Labour and Social Cohesion, who promulgated the law on the 18th of January 2005. 17 Art. 80-III of the Borloo Law. 18 Secours Catholique has created the so-called “social microcredit” for unemployed people, workers receiving low incomes and, more in general, for those who 15

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French banks – such as Caisse d’Epargne, Crédit Mutuel, Crédit Agricole, Crédit Coopératif – which distribute micro-credits according to partnership agreements with the supporting institutions.

The supporting organizations provide various services, for example, covering some of the costs of the preliminary phase – namely helping the applicant in preparing the necessary documentation; they also provide managerial and financial training services for borrowers, and they assume part of the credit risk of the loan19. In this way they help, on the one hand, in reducing the problems linked to limited information about the borrowers and, on the other, in limiting the risk for the lending bank. In this way the necessary conditions are put into place that enable banks to grant credit even to those customer segments that are usually excluded from mainstream credit, in a way which is consistent with the banks’ strategic objectives of creating value and stability. Similarly to what happens in France with the constitution of the “Fond de cohésion sociale”, at the end of 2005 the Italian Industry Ministry together with the Italian bankers’ Association (ABI) and the Italian Association of Consumer Credit and Mortgages Intermediaries (Assofin) promoted the creation of a guarantee fund “Fondo di garanzia per il credito al consumo” (FDGCC) to support the access of low income households to consumer credit. Specifically, the FDGCC guarantees up to 50% of consumer credit loans – each with a maximum amount of 3,000 euros granted to families whose income is lower than 15,000 euros per year. The residual risk is born by the banks and financial companies who have conceded the loan. The sponsors of the scheme hope that, by decreasing the risk associated with this type of loans, the number of families who have access to consumer credit should significantly increase. As for the informational problems concerning the assessment and management by financial intermediaries of credit risk associated with people living on the margins of society, an alternative solution to that tried out in France, and based on the support of a third party organization, may consist in improving the economic and financial literacy of these segments of population. As our survey also shows, quite often families have a poor knowledge not only about technicalities concerning credit products, but also of more general and ordinary issues relating to their financial situation, their credit needs and the ways to satisfy them. It is not surprising that many of the immigrants participating into our survey state have no access to the banking system. This type of microcredit is aimed at financing the purchase of personal goods, medical and educational expenses, etc. 19 In the case of Adie, for example, 70% of risk on the single loan is borne by the association and only 30% by the bank.

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that they finally succeeded in getting a loan only because they were supported by a native (i.e., their employee or a friend) who also accompanied them when their credit application was presented to the bank’s officer. A better understanding of economic and financial terms, as well as of the way to apply for and manage the repayment of a loan is deemed to be crucial in order to have one’s application for a loan accepted by credit intermediaries. This explains why in countries where the issue of financial exclusion has been pragmatically addressed, one of the solutions is represented by actions aimed at improving financial education. A significant example is given by the UK, where, at the end of 2003, the Financial Services Authorities (FSA)20 launched a new initiative to develop and implement a national strategy for financial capability (FSA, 2004). The aim of this initiative – which is financially supported by the Government, the FSA, the industry sector and charity associations - is to provide individuals with: education, delivered through schools and colleges or through alternative routes, such as the workplace or over the Internet; information – i.e., facts, data and opinion – and advice. Though the FSA plays a leading role, the project involves many other partners representing the other stakeholders, i.e. as the educational system, financial intermediaries, the UK Government, etc. In it first steps, the Financial Capability Steering Group has identified seven priorities - Schools, Young Adults, Work, Borrowing, Families, Retirement, Advice – that is to say, the key areas where it is crucial to strengthen financial capability. Increasing financial capability of people on low incomes has broader implications than those concerning risk assessment by banks. In fact, people who are aware of the implications of their personal financial choices will be better equipped to learn about and assess which financial products will be of benefit to them. They will also be less likely to use unsuitable credit products and be less likely to end up in financial difficulty or to be over-indebted. Banks and other mainstream credit institutions should also benefit from an increased financial capability, due to the lowering of costs associated with the risk assessment and choice of the credit product, and/or because of the reduced risk of default.

Amongst its statutory duties, the FSA has to promote public understanding of the financial system. 20

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2.4.3 A Wider Scope for Not-for-profit Intermediaries and Organizations A third solution to the risk of exclusion from the credit market highlights the contribution of institutions that do not follow exclusively profit objectives, but which also have an ethical or social commitment. Freed from the primacy of profit, obstacles such as high risk, high customer screening costs, and low profit levels on marginal customer segments can be overcome, so giving access to credit to those typically excluded by mainstream institutions. Indeed, until only a few decades ago, a large part of the financial system of many Western countries was made up of financial intermediaries whose primary goal was to satisfy the financial needs of the community where they operated. Savings & loans Associations and Mutual and Cooperative Banks represent an example of this type of intermediary. Yet, trends such as deregulation, competition and the consequent concentration of the financial sector, internationalisation and the increasing importance attached to creating shareholders’ value have increasingly reduced the scope for not-for profit financial intermediaries and for lending policies that do not fully respect the risk-reward paradigm. Many S&Ls and Cooperative banks have been acquired by commercial banks and have therefore lost their original features and many other institutions have been forced to reduce the resources initially addressed to people in need in favour of more profitable customers . Notwithstanding this, there still is a certain number of institutions whose primary goal is the provision of affordable financial services to their community, and especially to those individuals who are usually excluded from mainstream institutions. Many of these intermediaries are part of the so called “third sector” -or not-for-profit- such as the Community Development Credit Unions (CDCUs) in the US, the Community Development Financial Institutions (CDFIs) in the UK, and the Mag in Italy and a few Social Banks (HM Treasury, 2004; Tansey, 2001). These institutions are mostly cooperatively owned and are founded from a variety of sources including individuals and charitable foundations, as well as banks and government; a large number of their personnel is also made up by volunteers. To achieve their social and financial goals they grant credit to (disadvantaged) households and finance local community-owned or small business enterprises; moreover, they provide business training and support as an accompaniment of their investing. They are grounded in their local communities and this is the key element that allows these institutions to overcome problems associated with the opaqueness of borrowers and their

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riskiness. As such, the community-based intermediary works as a peerlender and benefits from the proximity to its customers (Tansey, 2001; NFCDCU, 2004). Another reason for the success of these institutions is the use of techniques and lending methods that suits the specific features of marginal borrowers. In detail, they may lend money by means of: -

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community loan funds, that is a ‘revolving’ fund which reuses the repaid money to finance new clients, or Community reinvestment trusts, which grant small loans to individuals for self-employment, for improving their housing, or to refinance other credit; micro-finance funds make very small loans to micro-entrepreneurs usually one-person businesses; common bonds used to save money which are then re-lent to members of the cooperative bank; pool of savings by the owners of small enterprises which are deposited in a bank in order to provide collective guarantees, making it possible to win better finance terms.

A common feature of loans provided by Community-based financial intermediaries is the structure of the repayment plan, made up by frequent and low-amount instalments. This makes it easier even for individuals with a poor financial education to manage their resources and respect the conditions set in the loan contract. Despite the role that these type of intermediaries may play in tackling credit exclusion, their actual contribution is, on the whole, rather limited given the small number of existing institutions, the inadequate amount of funds that they manage to raise and the inability to count on skilled staff. At the end of 2004, the number of members of the US National Federation of Community Development Credit Unions was only 222, with a higher concentration in the North-Eastern states like New York and Pennsylvania and in the South-West, in Texas and California. Likewise, in the UK there are over 500 Credit Unions, with a third located in Scotland. Another type of intermediary which has a similar mission to Community-based intermediaries is the Social bank. Social banks are forprofit financial service providers. They operate as mainstream banks, but have strict ethical policies and are dedicated to social or environmental objectives. One such example is Banca Etica, founded in Padua, Italy, in 1999, with the aim of providing support for not-for-profit organisations; directing savings to socially-useful initiatives; granting credits that are not solely asset.-backed but which also take into account the socio-economic and employment potential of the underlying business project. In line with these objectives, depositors accept lower-than-market savings rates in

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order to encourage access to credit for socially useful projects, particularly those presented by young business people and women. In some cases, depositors can also choose where their savings are destined as well as monitoring the observance of the ethical principles stated in the bank’s bylaws21. In the few years which Banca Etica has been operating, the bank’s full credit potential has however not been fully exploited, with lending concentrated towards third sector organisations rather than single families.In spite of a growing awareness of the phenomenon of credit and financial exclusion, in the light of our analysis it appears difficult to reconcile a social mandate with the financial objectives that typify forprofit companies. The same can also be said of initiatives launched by some commercial banks, such as dedicated credit funds for families in need and, more generally, for socially important objectives.

2.5 Conclusions and Policy Implications As more and more families resort to credit as a means of funding their spending choices, credit exclusion – the problem of obtaining credit at terms and conditions compatible with the financial and social characteristics of the applicant – is a problem that needs to be addressed. On the basis of a survey of around 700 people on low incomes resident in France, Spain and Italy, about a third is subject to credit exclusion. The problem is exacerbated by the fact that those most exposed are: families without regular sources of income, families belonging to ethnic minorities or immigrants, single-parent families, the young seeking firsttime employment, etc.. Exclusion from mainstream credit circuits can in fact lead to a worsening of the person’s economic and social position. Whilst the absence of a credit line may make it virtually impossible for a person to satisfy even the most basic of needs, the granting of credit at inappropriate conditions and prices may result in the use of non-status lenders (often of a dubious legal nature) and over-indebtedness. The negative implications that arise from difficulties in accessing credit are worse still when potentially life-style improving, income-generating micro-enterprise projects are blocked. What is apparent is that financial exclusion is closely related to, if not one of the causes of, social exclusion. The failure of the credit market in terms of its inability to satisfy the needs of low income families or those at risk of exclusion finds a theoreti21

www.bancaetica.it

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cal explanation in the problems relating to the presumed high credit risk levels present in low income segments, the costs incurred by financial intermediaries in scoring and screening these risks, and an increased strategic focus on creating shareholder value. In order to provide shareholders with attractive returns on investment, banks’ commercial policies have focused on medium/high-income customers who are able to purchase products at high added-value. In particular, this trend allied to the deregulation and liberalisation of financial services markets and the increasing importance of operational size in order to exploit economies of scale and scope has triggered off a process of M&A activity that has brought concentration and product standardisation. The declining importance of the social function of credit institutions – for instance the various types of savings & loans present in Western countries – and the gradual disappearance of mainstream institutions in low-income geographical areas, with the ensuing phenomenon of financial desertification, have heightened the problem of credit exclusion. Solutions adopted to address exclusion are often characterised by specificities relating to where and in what form the problem exists. Despite these differences, they can be broadly grouped into the following three categories: 1. initiatives aimed at making banks’ lending policies more supportive towards low income households’ credit needs, consistently with safe and sound management policies; 2. initiatives aimed at removing economic and “environmental” obstacles that prevent mainstream credit institutions from lending to families who are usually excluded or credit constrained; 3. initiatives aimed at the development and the spreading of financial intermediaries whose primary mission involves not only the creation of value for shareholders, but also the provision of financial services to specific segments of population. The three groups do not necessarily exclude one another nor does one solution appear better equipped to tackle exclusion than the others. Indeed, the effectiveness of each solution to include those segments at risk of exclusion from the credit market depends on its ability to remove/contain the underlying cause of exclusion. This means for instance that if some people are excluded from the credit system on the grounds of their high credit risk rating, solutions will probably be successful only in the short term as the credit-risk related cost could in the medium-long term generate system-wide instability. Ideally, in these cases a body outside the banking system such as the state could cover the costs (e.g. in France), providing

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the banking system with the necessary economic conditions in order to take part. Where on one hand no major obstacles prevent the supply of credit, a solution on the lines of that adopted in the US with the Credit Reinvestment Act can certainly be effective. Credit exclusion, as repeatedly shown, is a multi-faceted phenomenon which affects different social groups. Consequently, a multi-legged approach in the fight against exclusion is required. We should however point out that because credit exclusion is typically a social problem, the definitive solution must involve a wide range of players and cannot limit itself to behavioural changes alone on the part of the banking industry. To enable banks and credit intermediaries in general to extend credit to customer segments different from those normally targeted as economically attractive, an external body has to put into place operational conditions that make the low-income business area consistent with sound and profitable lending practices. This does not mean that nothing can be done to change financial intermediaries’ behaviour. Even respecting the objectives of maximization of value and so-called best practices, it is possible for credit intermediaries to adopt measures to reduce credit exclusion phenomena. An initial step lies in the reassessment of the economic importance of some customer segments and the possibility for intermediaries to obtain attractive economic returns on investments. To achieve such returns, banks and credit intermediaries in general should heighten their awareness of these customers’ needs and provide tailored products and services in addition to implementing operational changes where necessary. Such objectives could be reached, for example, by intensifying continuing relations with the social institutions that represent these segments of the population, and by creating appropriate channels of contact and distribution; for example, multi-ethnic counters with staff able to speak foreign languages and aware of different customs and traditions. Finally, a key role addressing the problem of credit exclusion and all forms of financial exclusion in general will be played by greater and more wide-ranging economic and financial knowledge.

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2.6 References Adie (1999), Etude sur le cadre réglementaire du microcrédit et du travail indépendant en France. Aizcorbe A.M., A.B. Kennickell and K.B. Moore (2003), Recent Changes in U.S. Family Finances: Evidence from 1998-2001 Survey of Consumer Finances, Federal Reserve Bullettin, January, pp. 1-32. Amihud Y. and G. Miller (eds.), 1998, Bank Mergers and Acquisitions, Kluwer Academic Publisher, Dornrecht. Anderloni L. (ed.) (2003), Il social banking in Italia: un fenomeno da esplorare, Giuffré, Milano. Anderloni L., M.D. Braga, E.M. Carluccio and L. Nieri (2006), Survey on LowModerate Income People and Access to Financial Services, Quaderno di Ricerca, Università della Valle d’Aosta. Angelini, P., R. Di Salvo and G. Ferri (1998), Availability and cost of credit for small businesses: customer relationships and credit cooperatives, in “Journal of Banking and Finance”, 22: 925-54. Apgar W.C. and M. Duda (2003), The Twenty-Fifth Anniversary Of The Community Reinvestment Act: Past Accomplishments And Future Regulatory Challenges, in “FRBNY Policy Review”, June, pp. 168-190. Association d’Economie Financière (2004), Rapport Moral sur l’argent dans le monde 2003-2004 : la finance pour quoi faire ? Atkinson A. (2004), Young people: Avoiding banking exclusion, Personal Finance Research Centre, University of Bristol, United Kingdom. Avery R.B., R.W. Bostic and G.B. Canner (2000), CRA Special Lending Programs, in “Federal Reserve Bulletin”, November, pp. 711-731. Banerjee A.V., T. Besley and T.W. Guinnane (1994), The Neighbourg’s Keeper: The Design of a Credit Cooperative with Theory and a Test, in “Quarterly Journal of Economics”, CIX (2), May, pp. 491-516. Baravelli M. and A. Omarini (2005), Le strategie competitive nel retail banking, Bancaria Editrice, Milano. Barbetta G.P. (2000), Il settore no-profit italiano, Il Mulino, Bologna. Barr M. (2004), Banking the Poor, in “Yale Journal on Regulation”, pp.21-121. Berger A.N. and G.F. Udell (2002), Small Business Credit Availability and Relationship Lending: The Importance of Bank Organizational Structure, in “The Economic Journal”, 112: F32-F53. Berger A.N., R. Rosenand and G.F. Udell (2002), The Effect of Market Size Structure on Competition: The Case of Small Business Lending, Federal Reserve Bank of Chicago Working Paper. Bitler M.P., A.M. Robb and J.D. Wolken (2001), Financial Services Used by Small Businesses: Evidence from the 1998 Survey of Small Business Finances, in “Federal Reserve Bulletin”, April. Boot A.W.A. (2000), Relationship banking: what do we know?, in “Journal of financial intermediation”, n 9, pp. 7-25. Bourguinat E. (2005) , Bâtir un secteur ouvert à tous , Paris, 20-21 giugno 2005.

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Bridges S. and R. Disney (2003), Use of credit and arrears on debt among low income families in United Kingdom, mimeo, School of economics, University of Nottingham. Bridges S. and R. Disney (2002). Access to credit, and debt, among low income families in the United Kingdom: an empirical analysis, mimeo, available at: http://www.nottingham.ac.uk/economics/ExCEM/publications/index.html Carbó S., E.P.M. Gardener and P. Molyneux (2005), Financial Exclusion, Palgrave Macmillan, UK. Caskey J.P. (2002), Bringing Unbanked Households into the Banking System, A Capital Xchange Journal Article Prepared for The Brookings Institution, Center on Urban and Metropolitan Policy, Harvard University, Joint Center for Housing Studies. Cosma S. and U. Filotto (2004), La formica e la cicala: Famiglie, credito e crisi,.in “IIX rapporto Fondazione Rosselli”, Bancaria. Cox P., J. Whitley and P. Brierley (2002). Financial pressures in the UK household sector: evidence from the British Household Panel Survey, in “Bank of England Quarterly Bulletin”, Winter, pp. 410-419. Crook J. (1996). Credit constraints and US households, in “Applied Financial Economics”, Vol. 6, pp. 477-485. Crook J. (2001). The demand for household debt in the USA: evidence from the 1995 survey of consumer finance, in “Applied Financial Economics”, Vol. 11, pp. 83-91. Crook J. (2003), The Demand and Supply for Household Debt: A Cross Country Comparison, Credit Research Centre, University of Edinburgh del Río A and G. Young (2005), The determinants of unsecured Borrowing: evidence from The British household Panel survey, Documentos de Trabajo N.º 0511, Banco de España. Devlin J. (2005), A Detailed Study of Financial Exclusion in the UK, in “Journal of Consumer Policy”, 28, pp. 75-108 DeYoung R., W.C. Hunter and G.F. Udell (2003), The Past, Present and Probable Future for Community Banks, Federal Reserve Bank of Chicago WP 2003-14 DeYoung, R, L.G. Goldberg and L.J. White (1999), Youth adolescence and maturity at banks: credit availability to small business in an era of bank consolidation, in “Journal of banking and finance”, 23, pp. 463-492 Financial Services Authority (2003), Towards a national strategy for financial capability, www.fsa.gov.uk/financial_capability Financial Services Authority (2004), Building financial capability in the UK, www.fsa.gov.uk/financial_capability. Financial Services Authority (2000), In or Out? Financial exclusion: a literature and research review, London. Guiso, L., P. Sapienza and L. Zingales (2002), Does Local Financial Development Matter?, CEPR Discussion Papers 3307, C.E.P.R. Discussion Papers. HM Treasury (2004), Promoting Financial Inclusion, Crown copyright 2004, Published with the permission of HM Treasury on behalf of the Controller of Her Majesty’s Stationery Office, London UK.

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Hodgman D. (1960), Credit risk and credit rationing, in “Quarterly Journal of Economics”, 74, pp. 258-278. JCHS (The Joint Center For Housing Studies) (2002), The Twenty-Fifth Anniversary Of The Community Reinvestment Act: Access To Capital In An Evolving Financial Services System, Harvard University. Kempson E. and C. Whiley (1999), Kept out or opted out? Understanding and combating financial exclusion, Bristol: Policy Press. Kempson E., S. Collard and K. Rowlingson (2003), Affordable credit for lowincome households, The Personal Finance Research Centre Working Paper, School of Geographical Sciences, Bristol University. Kennickell A. et al., (2000), Recent Changes in U.S. Family Finances: Results from the Survey of Consumer Finances, Federal Reserve Bulletin, Vol. 86, No. 1, January, pp. 1-29. La Croix, Ipsos (2004), Baromètre des finances solidaires , Finansol. Littlefield E., J. Morduch and S. Hashemi (2004), Is microfinance an effective strategy to reach the millennium development goals?, CGAP, Focus Note, World Bank, Washington. Mc Kinsey & Company (2006), Profiting from Proliferation, Mc Kinsey & Company, New York. Moro O. (2004), Il fenomeno del microcredito in Italia, Bancaria Editrice.. National Federation of Community Development Credit Unions (NFCDCU) (2004), 30th Anniversary Journal, www.cdcu.coop Nieri L. (2000), Domanda e offerta di servizi finanziari e strategie di crescita nei distretti industriali italiani del Centro-Nord, in “X Rapporto Cer-IRS”, Il Mulino, Bologna. Observatoire de l’Epargne Européenne (2006), L’endettement des ménages européens, Rapport réalisé pour le Comité consultatif du secteur financier. Ongena S. and D.C. Smith (1997), Empirical Evidence on the Duration of Bank Relationship, Working Paper n° 97-11, The Wharton School. Peachey S. and A. Roe (2004), Access to Finance. A study for the World Savings Banks Institute, Oxford Policy Management. Petersen M.A. and R.G. Rajan (1994), The Benefits of Lending Relationships: Evidence from Small Business Data, in “The Journal of Finance”, vol. XLIX, n° 1 March, pp. 3-37. Petersen M.A. and R.G. Rajan (1995), The effect of credit market competition on lending relationships, in “Quarterly Journal of Economics”, 110, pp. 407-443. Schena C. (2003), Il problema del finanziamento del terzo settore in Italia, Working Paper, n. 24, Università dell’Insubria. Schreiner M. (2000), Credit Scoring for Microfinance: Can it Work?, in “Journal of Microfinance”, Vol. 2, n. 2. Seidman E. and J. Tescher (2004), From Unbanked to Homeowner: Improving the Supply of Financial Services for Low-Income, Low-Asset Customers, BABC 04-4, Joint Center for Housing Studies Harvard University. Sharpe S.A. (1990), Asymmetric Information, Bank Lending, and Implicit Contract: a Stylized Model of Customer Relationship, in “Journal of Finance”, 32, pp. 1251-1266.

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Standard Eurobarometer (2004), Public Opinion in Europe: Financial Services Report B, European Opinion Research Group, European Commission, Bruxelles. Tansey C.D. (2001), Community Development Credit Unions:An Emerging Player In Low Income Communities, A Capital Xchange, Journal Article Prepared for The Brookings Institution Center on Urban and Metropolitan Policy, Harvard University. Viganò L. ( (2001), La banca etica, Bancaria Editrice. World Saving Banks Institute (2004), The Provision of Microfinance services by saving banks- Selected experiences from Africa, Asia and Latin America, Special edition, October 2004, Bruxelles. Zinman J. (2002), The Efficacy And Efficiency Of Credit Market Interventions: Evidence From The Community Reinvestment Act, The Joint Center For Housing Studies, Harvard University, Job Market Paper.

3 Access to Investments and Asset Building for Low Income People

Maria Debora Braga

3.1 Saving and Asset Accumulation for LMIs: Theoretic Framework This chapter addresses the specific issue of marginalisation risk for the economically and socially lower individuals, that concerns access to saving and asset accumulation. First of all, within a theoretical framework and for methodological sake, we will briefly analyse the considerations why saving and asset accumulation for the LMI people is important and why then some forms of support and encouragement as well as ad hoc products are to be created in order to meet these group of people’s needs. Secondly, our analysis will focus on some experiences that have been made in this context in Europe and USA. It is not difficult to observe that (financial or real) asset and saving accumulation are almost universally viewed as desirable goals by any family unit. These goals remain, in any case, rather prohibitive for the poorer or “marginal” part of the population, namely the ones that we call low moderate income people (LMIs). It is not easy nor natural for them to retain from their consumption a part of their current revenue, which may be also just close to their subsistence level, as their consumption marginal utility is high and their necessity to face emergencies and unforeseeable events is frequent. The social welfare policies and actions for these people have traditionally neglected the importance of saving accumulation to reach and sustain economic well-being. Typically, these policies’ structure rather aims at making LMIs less vulnerable in the economic sphere through cash and subsidies transfers. In fact, what these social actions lead to is to create better livelihood conditions because of the support given to the

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consumptions, namely the fact that the revenue is immediately available. This then means that the impact of this kind of social intervention is limited to the short term and is not far-sighted. In other words, traditional monetary subsidies can, in the short run, assuage some difficulties but they cannot, at the same time, avoid future difficulties to people that have unstable revenues and some saving potentials. This is not possible as the traditional monetary subsidies do not stimulate any prudent behaviour nor they promote a certain education to use poor resources, namely some saving to meet difficult situations, which would also give to the family, in the long run, a less precarious economic base. On the other hand, the development economy’s studies underline that goods and therefore also resources accumulation to be maintained over time and to be used to produce a certain revenue are the very base for a lasting well-being1. Saving is crucial because its increase makes the assets increase possible. This is what makes the difference between income or consumption-based policies and asset-based policies. The USA reality – where wealth is very much concentrated in a small part of the population and where ethnic, cultural and linguistic differences can considerably contribute to the introduction in a poverty cycle2 – shows that, as from the 90s, the idea of introducing LMIs as addressees of ad hoc asset-based policies is highly supported by the intellectuals and politicians. In this respect, Michael Sherraden is considered as one of the most important authors with this orientation: in his works, such as “Rethinking Social Welfare: Toward Assets” (1988) and “Assets and the Poor: A new American Welfare Policy” (1991), he already proposes a concrete application of the asset-based economic development theory, which will be dealt later in these pages. These preliminary remarks show that these policies presuppose that the population’s marginal families and people have a saving capacity. The various existing theories about the individual saving behaviour do not focus very much onto LMIs. For the neo-classical theory, saving is simply the amounts left after individuals have carried out their consumption decisions. These decisions are supposed to be taken by a rational individual, who has stable preferences and wants to avoid significant fluctuations in his/her consumption model within a context of perfect and

In this respect, see more authoritative texts of the development economy: Ray D. “Development Economics” (1998), Bardhan P., Udry C., “Development Microeconomics” (1999), Todaro M., Smith S., “Economic Development” (2003). 2 See Oliver M., Shapiro T. (1995), Bernheim B.D., Garrett D.M. (1996), Hurst E., Luoh M.C., Stafford F.P. (1998). 1

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always accessible markets3. The psychological/sociological theories invert the priorities order between consumption and saving. In other words, they state that individuals primarily define their goals in terms of goods acquisition and related savings to this purpose according to their own aspirations and perspectives – although these are influenced by economic and social circumstances. Mentally, individuals are more and more persuaded that they are not allowed to spend that amount and the consumption is then linked and determined by what is left after considering the saving intention4. For the behavioural theory, individuals may encounter major difficulties to resist to spending temptations even if they understand the saving value. In order to protect this value, individuals try to create their own incentives to keep and restrict the access to their own personal liquidity5. Finally, the institutional theory emphasises the role of institutional variables (rules, criteria), which can have an impact on individual saving attitudes. This gives then the institutions a role in the creation of saving mechanisms and incentives6. In the USA, the above briefly described theories have been the point of reference for identifying not a single factor but a set of factors that are responsible for the LMI people’s scarce or even absent capacity to retain and keep part of their own revenue. In this respect, a credible list of determining factors shall include: pressure coming from current consumption needs, lack of access to indirect saving and/or investments support (reductions/deferment of fiscal expenditures that are more accessible for the population’s medium-high social groups), fear of loosing possible social subsidies in case of resources conservation, psychological obstacles (feeling that an asset acquisition represents such a distant goal to be reached that it will be never reached), sociological obstacles (tendency to emulate or give in to other individuals’ pressures of the social network), link between low revenue and other impedimental factors to wealth accumulation (low education level, single parent condition, …)7. For more details, see Friedman M. (1957) and Modigliani F., Ando A.K. (1957). 4 This interpretation’s base on individuals’ saving attitude is to be found in Katona G. (1975). 5 In this respect, see Maital S., Maital S.L. (1994), Thaler R.H., Shefrin H.M. (1981) and Thaler R.H. (1990). 6 Among the supporters of this theory, Michael Sherraden, Professor of Social Development and Director of the Center for Social Development at Washington University. 7 A wide and interesting overview of possible answers to the question “Why Don’t the Poor Save?” is proposed by Shankar N. (2001). 3

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Furthermore, the above-mentioned theories do offer a support also while searching for a suitable answer to at least part of the causes of the LMIs’ low saving level. They orient the asset based policies towards the realisation and offer of specific and, by extension, asset based products whose design shall be able to bring down the saving’s received onerousness (deriving from the fact that consumption has been avoided), to relate saving to one or more specific purchasing goals, to include mechanisms allowing to avoid temptations not to address saving to prefixed destinations, to monitor the steps ahead towards the target, to generate a certain saving habit in the individual and a certain orientation towards not only very short term programs and goals. The USA reality is certainly the context in which the very first promising answer to the above-mentioned desires has been given. This is to be thanked to initially private and then also public forces. Accordingly, the LMIs have been given a product called IDA, Individual Development Account, whose working modalities fully satisfy the saving-accumulation and/or investment paradigm. The following pages of this chapter will go into further details about any interesting aspect of this product. So far, what is to be underlined once again is that within the asset-based policies perspective, the asset ownership is considered as the most trustworthy defensive weapon for the ones that risk to come to or to remain for indefinite time in a situation of relative poverty. In purely economic terms, the positive impacts associated to the asset ownership can be related to the following factors: bigger economic stability within the family, lesser vulnerability in case of economic crisis, smaller risk to transfer a condition of non economic selfsufficiency to the future generations. At the same time, several authors underline also major social/psychological effects (lesser risk of break-up of family units, stronger sense of civic participation, …) that can be considered as a sort of positive externality. Because of the increasing importance of the asset-building policy due to the impact it is able to have, this contribution will also consider the initiatives that intend to give an initial assets endowment to the youngest groups of the population, especially the ones that belong to low income families.


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3.2 The USA Experience with the Individual Development Accounts (IDAs) This paragraph aims at showing in details the IDA product’s efficacy, which certainly benefits from a preliminary statement on the logical category this product belongs to. In this respect, it shall be reminded that, nowadays, the IDA must be conceived as a promotion and social policy’s instrument and certainly not as a classical financial product that has been prepared by profitmaking intermediary subjects and financial markets. The reasons for this qualification are all to be identified in recurrent circumstances of the IDAs experience: -

-

firstly, the access to the asset building process through IDAs is limited to less well-off social groups; secondly, with public expenditure, the political stakeholders contribute to fund IDA program disbursement and management while being persuaded that they can generate a social return, namely the reduction of people living in poverty, including further positive effects both in terms of economic growth of a certain national reality as well as of natural reduction of common income supports for the future. It shall also be reminded that this qualification is supported by the leading role that non profit organisations have taken within the IDAs experience; thirdly, the IDA programs tend to mark a turning-point in the low income individual’s financial behaviour. That means that they push him/her to go for a medium - long term saving and, at the same time, he/she does not loose the reassurance deriving from the possibility of using that amount if he/she may need it. The IDA programs structure entails all this, namely both incentives (external integrations) to the individual’s savings as well as restrictive conditions for him/her to withdraw part of that sum from a reserve that is being accumulated.

It is then easy to imagine that, at this point, a much more detailed and precise study on this product needs to prove that the interpretation of this product is trustworthy. 3.2.1 Features of the IDA Accounts/Programs Both in the relevant literature as well as in the American economic press, the most recurrent definitions of IDAs – which are not that different one another – are the following ones: “matched saving accounts to help low

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income and low wealth persons”, “matched dedicated saving accounts” and “special purpose matched saving accounts”. Before going into further details about these definitions, it is important to point out that individuals become IDA’s owner by joining a corresponding program, namely the IDA program. To this purpose, a sort of tender or notice is launched and addressed to the potential “subscribers”. According to estimations of the CFED (Center for Enterprise Development - a nonprofit and non party-political organisation in Washington DC, which collaborates with the public authorities on economic development), already in 2002, that means even before the assessment of the American Dream Demonstration (ADD)8, the first experimental program, over 500 IDA programs were already available. To be entitled to an IDA program or to “be recruited” to take part to it, the eligibility requirements must be met. The reader already knows that the IDAs’ “targets” are the LMI people (as the preface as well as one of the mentioned definitions state); nevertheless, the analysis of these requirements can provide more precise information. As a matter of fact, this analysis shows that the IDAs primarily determine the possibility for individuals to participate according to their family’s income, expressed as percentage of the federal poverty level9. The participation to the program is mostly allowed if this percentage is not higher than 200%; in fewer cases, a set of values is chosen (typically 50% - 200% or 100% - 200%) to determine the eligibility. The participation to the IDA program is not necessarily limited to one single member of the family. In some other not less frequent cases, a further requirement must be met: the candidate shall not only meet the income criteria but also be (or is entitled to become) assignee of monetary subsidies and of other forms of support comprised in the TANF (Temporary Assistance for Needy Families) program for families with children. In general, according to the above-mentioned elements, the individual that participates to an IDA program is a subject that is not “at the last place” in a hypothetical income ranking of the population. Although he/she experiences the difficulties related to poverty as well as economic and social precariousness, he/she is not that needy that his/her saving capacity is completely impossible. This remark is further supported by the fact that, according to the 2003 Survey of IDA programs’ results – conducted by the CFED on slightly more than 300 programs - 75% of the IDAs participants has an income per family that ranges between 10,000 and 30,000 dollars. For a short analysis of the American Dream Demonstration, see box 1. The official level of poverty is fixed every year by the US Department of Health and Human Services. 8 9


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Coming back now to the initial definitions of Individual Development Accounts, first of all it is natural to qualify this financial instrument as saving account and/or deposit account at the financial institution the program indicates. This contractual instrument usually represents an elementary opportunity to be used the owner can benefit from at his/her best convenience. On the other side, an IDA accountholder will be obliged to periodically (mostly every month) deposit a minimal amount of his/her savings, which is already fixed from the beginning of the program and that can not be lower than the threshold fixed in the “tender”. The duration of the IDA accountholder’s engagement is fixed by contract and typically goes from 2 to 4 years. The IDA program’s saving account has the following basic features: -

-

it can generate a remuneration, in form of interest upon the deposited sums. These interests are equivalent to the ones that the financial institution gives to the owners of technically similar products that are not subject to the IDA program constraints. This confirms that this product is not perceived as the equivalent of a simple custody service of “forced stocks”; the management of this account and individual bank operations from this account will not be subject to any sort of charge.

All these elements clearly lead to state that the saving model followed by the IDA accountholder (although his/her initial independent deliberation to this purpose) is “rigid, strict and forced”. However, this description is not satisfactory not exhaustive yet. In fact, it shall be added that an IDA accountholder’s saving is a targeted saving. This is why the initial definitions entailed expressions such as “dedicated”, “special purpose” saving accounts! More precisely, this means that an IDA participant must immediately declare his/her saving goal, namely state for what type of investment he/she intends to accumulate financial resources. On this subject, it is important to point out that the decision concerning this goal can not be taken with full liberty. The reason for this is that any IDA program identifies possible destinations for the deposits accumulated within the IDAs and the individual participant will inevitably have to base his/her decision on them. In this respect, studies and investigations on this instrument often use the expression “Big Three assets” to typically indicate that these programs entail the obligation to use savings for the three following admitted purposes: -

first house purchase;

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payment of costs related to registration and/or school materials for post-university education or for training and apprenticeship; start-up or consolidation of a microenterprise.

This list not surprisingly leads to observe that the IDA programs’ structure is not functional for the “participants” to progressively approach investment solutions which may be incorporated into more sophisticated and complex financial instruments compared to the initial instruments (savings deposits). In fact, this list is consistent with the idea that the LMI people’s priority is the accumulation of: -

physical capital; human capital; business capital.

These elements lead to a suitable final phase where the participant can acquire, also with other sources of support and without assuming any further deliberations, real wealth and/or productive factors. This possession allows him/her to manage his/her life better in the short run and he/she will have a deeper awareness of his/her role in his/her personal economic development. This remark is not less valid in the cases of IDA programs that allow to use the deposited sums to renovate the house, buy computers or cars. If the Individual Development Accounts analysis could be over at this point, the prevailing identified feature would then be the obligation of saving that the program prescribes after voluntarily joining the program, as well as the inflexibility related to the use of this saving. This would most probably not facilitate the initial “getting closer” approach of many individuals to an asset-based product. In this respect, a clearly more incisive contribution is related to an IDA’s further feature, which has not been deeply addressed so far. To this purpose, some clarifications are needed about IDAs not only as saving account but rather as “matched” saving account. In fact, the IDA programs foresee also matching funds, which will be awarded to the ones that conclude successfully their program. These funds are basically additional financial resources, whose origin will be discussed in next paragraph. First of all, the matching funds the accountholder can be awarded are fixed by applying the so-called match rate indicated in the program. Some examples may be useful to understand this. Let’s suppose that an IDA accountholder has saved, by participating to the program, 2,000 dollars. If the match rate is 1:1, the accountholder will be awarded 2,000 dollars additional resources, so that the entire accumulated amount sums up to 4,000 dollars. If, on the other hand, the match rate is 2:1, the matching


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funds will sum up to 4,000 dollars and the entire accumulated resources will sum up to 6,000 dollars. At this point, it should not be forgotten that the matching funds per IDA accountholder can not raise in indefinite way consequently to the forecasted so-called match cap. This cap consists of a number representing a maximum threshold beyond which the matching funds can not go regardless the IDA accountholder’s saving capacity. It’s worth now going into further details with the match rate (and therefore also the matching funds) concept in order to interpret its role within the examined product and, more generally, within an asset based strategy. In this respect, it carries out a leverage action of his/her own means. In fact, it amplifies the assets deriving from a certain level of saving. Alternatively, we can state that it boosts the profitability of the resources the individuals have earmarked within the IDA. Contrary to what happens when some sorts of money transfers for social assistance purpose are made to LMIs, this financial instrument’s valuable and positive aspect is that it makes the access to matching funds depending on a concrete contribution, an effort made by the eligible person. According to these elements, it is certain that the match rate sets up an institutional mechanism that can have a major inclusive impact, namely a variable that can have an impact on the probability that an individual opts for saving through an IDA program. The match rates the IDA programs declare are usually comprised between 1:1 and 4:1. Furthermore, they are by and large higher when the accumulation aims at purchasing or contributing to the purchase of the first house. Moreover, if the match rate entails a strong incentive to saving10, it is legitimate to see somehow in the match cap the optimal amount of additional resources the participant can aim at as well as a useful instrument to indirectly calculate what he/she should periodically tries to save to be entitled to that amount. The following example should clarify this idea. A two years IDA program participant has taken the engagement to deposit not less than 25 dollars a month. The expected match rate is 2:1 and the match cap amounts to 1,800 dollars. With these parameters, it is evident that the above-mentioned individual must deposit 900 dollars out of his/her own resources to be awarded 1,800 dollars matching funds; he/she has then to try to invest 37.5 dollars a month, although 25 would be enough according to the program’s requirements. The previous example shows that the match cap, namely the maximum limit to the matching

It should not be forgotten that the matching funds are not subject to any taxation. 10

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funds can sometimes epitomise the IDA accountholder’s expectations and become a psychological goal. At this point of the analysis, it clearly emerges that an IDA program development involves financial resources of different origin: resources belonging to the participant and matching funds. Their management is then rather oriented to avoid they are somehow mixed, and this seems to be reasonable if you consider that you do not immediately have the certainty that the matching funds become the IDA accountholder’s property. These resources can be split by fixing that the IDA account the participant has opened at that financial institution can exclusively consist of the sums that are periodically deposited there to meet the program’s contractual obligations and the interests deriving from the accumulation of those sums. As already stated, this is a credit deposit account by definition. On the other hand, as to the matching funds, the same financial institution provides this time a master escrow account or master trust account. This account allows the program participants to carry out a centralised deposit of the matching funds at the “guardian” financial institution and to identify via “subaccounts” the amount to which the single participant will be entitled to if the IDA program “game rules” are respected. A further crucial aspect is the high control and monitor level an IDA program usually foresees while the IDA accountholder is getting closer to his/her personal goal fixed in his/her asset accumulation strategy and while he/she uses his/her own funds deposited in his/her saving account. This includes also the IDA accountholder’s obligation to disclose his/her periodic account statements to the subject which is responsible for the program’s operational management (typically a non profit organisation). This lack of confidentiality guarantees that the regular savings deposit operations’ schedule can be more easily controlled and that the minimum amount requested is concretely deposited. This account information jointly communicates the indication concerning the outstanding matching funds (although they are not owned by the accountholder). Secondly, it should not be forgotten that an IDA program hinders and discourages the IDA accountholder from withdrawing any fund from the saving account. In principle, the conversion of all savings and, at the same time, the release of the IDA account should occur at the program termination date. This would allow these amounts to contribute, with the matching funds, to the expected asset goal. Indeed, the IDA programs accept the deposited amounts liquidation (with access to the corresponding matching funds) also at an earlier date than the official termination date of the program, providing this comes after a first phase of variable extension during which no financial mean at all can be withdrawn from the saving account.


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On the contrary, an IDA program tries to hinder, also in the following step, any fund withdrawal for purposes different than the one that has justified the participation to the program. This result is reached by requesting that the specific form for withdrawals not only carries the interested person’s signature but also the approval of the organisation which is responsible for the program’s administration. This approval is then added only if the specific “Emerging withdrawals” line is provided, namely for emergency withdrawal (to cover abrupt medical expenses, to avoid a dispossession, …) in specific circumstances without jeopardising the matching funds allocation. However, if some withdrawals are made without the above-mentioned approval, the IDA accountholder will be excluded from the program and he/she will loose the fair matching fund for the existing accounting balance. It is worth reminding that these sanctions are applied also if the accountholder omits to credit the minimum amount required to his/her account and if, related to this, none of the notices of recall have not been answered and no date has been communicated for ensuring the due payment. The last remarks have underlined the different nature of the financial means involved in an IDA program and the technical and/or institutional solutions conceived to discourage a “fall of attention” to the realisation of an asset-based strategy, which is the reason for existence of an IDA product. In this phase, it can not be forgotten that this orientation lasts until the end of the program. As a matter of fact, this seems to be the basic reason why the USA active IDA programs opt to pay the “accrued” matching funds – after the saving plan has been completed, not directly to the IDA accountholder but rather to the seller or to the juridical entity that provides the good or the service originally identified as an asset goal. The analysis of the Individual Development Accounts has shown so far that, from one hand, the control of this product aims, without any easy derogation, at guaranteeing the effort to save and, on the other hand, it gives back a considerable benefit through matching funds. At this point, the only integral element of an IDA to be considered is related to the education and/or training dimension it entails11. In this respect, it should 11 The lack of financial education is largely recognised as one of the causes for mistrust and/or indifference shown by the socially and economically more vulnerable individuals vis-à-vis the financial products/services. For this reason, two supervisory authorities, the Financial Services Authority for UK and the Board of Governors of the Federal Reserve System for USA have been paying particular attention for two years to this and are directly involved into financial literacy initiatives.

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not be forgotten that one of the outputs expected from an IDA program is its participant improved financial literacy. This is a valuable fact per se, also because it seems to stimulate a bigger firmness and perseverance while the saving program is being developed. Practically, the above-mentioned element becomes reality by involving the program participants into two short education courses. According to the contents they develop, they can be described as follows: -

training in basic financial management; asset goal specific training.

The first course is general and, within its workshops, aims at transmitting basic concepts (saving, budget, …) in a simple and practical way in order to facilitate the development of skills as well as the determination the program requires. On the other hand, the second specific course can be compared to a sort of consulting and/or technical assistance. It can also be provided in form of one-to-one session according to the specific issues and/or problems it addresses as well as the perspectives deriving from a certain asset ownership goal. The importance these forms of financial education within an IDA program have on the IDA accountholder’s behaviour is proved by the fact that also when financial education obligations are not respected, the subject is generally expelled from the program and looses therefore his/her matching funds. As it emerges from this paragraph, IDAs mean at the same time a very varied product and strategy. In order to provide the reader a complete framework of reference, the contents have been illustrated in Figure 1, which summarises the main components that have been discussed so far. Figure 3.1 The constituent elements of an IDA account / program IDA ACCOUNT /PROGRAM

SAVING

ACCUMULATION

EDUCATION

To conclude this part, it is interesting to underline the LMI’s service capacity the IDA programs are presently able to show. In this respect, according to what emerges from the 2003 Survey of IDA programs, the IDA programs frequently serve rather wide geographical areas, that is to say with several towns or more counties; much more rarely the served area consists of a single town or even a single district.


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As to the number of accountholders per program, the average data (55) out of the 287 programs the CFED has taken into account leads to think that this is a rather small size12. However, the data obtained are reassuring if you consider that the IDA experience is rather recent. Nevertheless, there is no doubt that, nowadays, the IDA programs can not be considered yet as a large-scale product nor as a national product. Box 1 - American Dream Demonstration The American Dream Demonstration (ADD) is the first pilot project for the IDA product developed on large scale. From the research point of view, it has provided the first occasion for a systematic study of IDA accounts. The design and management of the demonstrative project shall be attributed to the Corporation for Enterprise Development (CFED) in co-operation with an academic Center of the Washington University at St. Louis, under the lead of M. Sherraden. The ADD was operational between 1997 and 2001; it has entailed 14 programs that have been conducted in 13 American States through 13 selected host organisations. Slightly more than 2,350 participants have taken part to this project. It should be added that the ADD project originates not only from a private initiative but also that it is financially sustained by private and not governmental financial resources. More precisely, 11 foundations have worked to provide financial resources both for matching funds as well as for operating funds. It makes no doubt that ADD can be considered as an important and persuading test of the feasibility of an asset building strategy as it already used to comprise all the structural elements: match rate, match cap, periodic (monthly) saving target, saving’s pre-destination and financial education. Nowadays, two considerable assessment studies on ADD have been carried out: Saving Performance in the ADD (2002) and Evaluation of American Dream Demonstration (2004). To summarise, the results of both studies show that an IDA program can have considerable favourable consequences, especially after a certain time rather than on the short term, on the LMIs’ asset building (increase of house ownership rate, increase of social security saving, …). The table below provides some details concerning the concrete destination given to the withdrawals made for purposes the ADD participants had been allowed. In particular, look at the rate of participants that have opted for each form of use, the rate of withdrawals for that purpose, the rate of the total amount of resources saved within the IDA which is absorbed by each form of use allowed and the same rate compared to the saved sums integrated to matching funds.

The first and not final data processing the CFED has colletected in the 2004 Survey of IDA programs, shows that out of 231 programs replying to the question on number of accounts, 142 have 0-49 accountholders; 33 programs have 50 - 99 acounts and, finally 56 programs have more than 100 accountholders. 12

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Table 3.1 Concrete destination given to the withdrawals by ADD participants Use

Participants N. of Withdrawals (%) (%)

Value

Home purchase Microenterprise Post-secondary Ed. Home Repair Retirement Job Training

28

21

23 21 18 8 2

Average Match Rate

(%)

Value + Match (%)

33

35

2.1 : 1

28 22

19 16

20 16

2.0 : 1 2.0 : 1

21 6 2

20 11 1

20 8 1

1.8 : 1 1.1 : 1 2.0 : 1

3.2.2 Stakeholders of the IDA Accounts/Programs The previous chapter has analysed in details the IDA product’s features, namely the solution that has been adopted to propose an asset building strategy to economically and socially weak individuals in USA, which have been the first ones to consider such a product for escaping from poverty. This paragraph aims at providing an overview of the stakeholders involved and of their role in the operational realisation of an asset building program. This will help understanding how the LMIs will have the possibility to benefit from this program itself, as it’s unlikely that these people will have a particularly enterprising and zealous attitude. Among the involved subjects within a typical IDA program, a special mention deserve the participants, one or more non-profit public and private bodies/institutions and a financial institution. This paragraph will not focus on the first ones since they have already been described in the previous pages. It is our duty to first refer about the non profit bodies/institutions given they are strongly involved in the preparation and development phase of an IDA. These are bodies and/or companies for social assistance and local communities’ development with a rather restricted range of action and renown. The perception of these subjects as stakeholders of the “IDA world’ is well founded. As it will clearly emerge, nowadays, with their action, they have compensated for what can be called a market failure or, in less drastic terms, at least some shortcomings related to the principle of the free market. In fact, it should not be forgotten that, without any similar product/strategy, the demand side, namely the LMIs, which are not intrinsically against the idea of saving, would feel some psychological


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barriers while independently and formally trying to establish a financial contact. From the offer side, namely the financial institutions, they would barely take the initiative to conceive any policies, which would specifically aim at reaching the LMIs according to the questionable argument that these individuals are generally not only non-creditworthy but neither savingsworthy. This argument is further supported by the fact that the above-mentioned organisations represent the individuals that carry out a feasibility study to sponsor an IDA program. This brings forward various and different assessments that can be simply summarised as follows: -

-

the confirmation that a certain (even not expressed) need exists and/or the premises for it. The same can be said about assets accumulation through the identification of worrying situations and up-grading spaces (comparison of the revenues’ distribution, employment rates and status, average education level in the non-profit body possible action field compared to the other territorial areas, counties, states or at national level); the estimation of the communities members’ desire of assetownership via the organisation and management of focus group for the individuals the IDA program would serve via informal conversations with the community’s members that already benefit from that body’s support.

After the possible positive outcome of this exploration, it should be reminded also that the non-profit associations play an equally crucial role in the project’s following phase, namely the phase that will end up with the formulation of the IDA program. This means that they are responsible for the decisions related to crucial aspects and issues, such as: -

-

to define the eligibility criteria to the program and the requirements to confirm the participation; to select the types of use the savings will be destined to (savings of the IDA account and matching funds related); to identify the suitable matching structure and therefore also the applicable match rates. To this purpose, an important point of reference is the estimation (not matters the fact that it is not very much precise) of the possible cost of each allowed type of use; to look for and/or to provide indispensable financial resources both for providing the matching funds as well as to cover the operational costs related to the realisation of the program itself.

The realisation phase of an IDA program requires further efforts to the sponsoring non-profit bodies and/or associations. As a matter of fact, this

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is a temporarily extended and rather labour intensive phase both from the administrative as well as the relational point of view. First of all, it should not be forgotten that the participants recruitment and, in a later stage, the management of them require extremely simple and essential procedures and/or forms, in order to document and shelve the participation requests, the emerging withdrawal requests and also the periodical updating of the participant’s personal situation. Furthermore, the IDA experience has shown that throughout the program the sponsors’ staff has the possibility to directly interact (on their own or others’ initiative) with the participants avoiding that they (clearly) perceive any psychological nor cultural difficulty/barrier because they are well rooted in the local communities and because then no excessive formalism with them is necessary. By doing so, the sponsoring institutes or bodies can raise the participants’ attention to the constant respect of the program’s obligations and discourage them to give in to any expenditure temptation when and if the IDA account’s institutional features themselves are not enough to discourage them to do so. In this phase of the program, the non profit bodies absorb human resources and make an effort in terms of relationships to be built, which become features that are also typical of the financial education activity. Sometimes, these bodies can also rely on the guests speakers’ (of the involved financial institution) partial contribution. Obviously, the non profit bodies’engagement in this context originates from a deep persuasion that the basic financial education can have an impact on the LMI’s behaviours and, in particular, can push them to develop their “saving capacity”, to get used to plan instead of making impulsive expenditures, to learn to weight their consumption decisions’ consequences. The financial institutions’ tasks are almost as important as the non-profit organisations/associations’ones. Nevertheless, they can be more easily summarised. In general, they are described in details in the framework of a formal agreement with the non profit partners (Financial Institution Partnership Agreement) as follows: -

to have saving accounts; to have match accounts to keep matching funds; to possibly contribute to matching funds and/or funding for operational costs; to support the financial education activity; to carry out various reporting and bookkeeping operations.

These functions are logically external to the IDA program operational management and marketing and are related to accounting and funding aspects.


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What has been worrying quite a lot in the USA already for a while is that very few financial institutions are involved in IDA programs, both as available institutions making IDA accounts as well as matching funds providers. Having said that, a special reflection deserves the cautious offer’s attitude in this field; furthermore, it is important to point out the elements that have presently encouraged a (even small) number of banks to promote this product among the LMI people. Considering the first issue, a special mention deserves the fact that for the intermediary it is difficult to perceive the asset-based products as being consistent with his/her own cost-performance model and with a profitability goal. In fact, it is evident that, at least on the short term, the participation to the IDA program cannot be considered as a source of potential profitability. The reason is that participating to an IDA program implies: -

the normal commissions are abrogated and therefore the positive revenue elements fall; additional costs are to be borne for keeping the accounts.

Moreover, the IDAs have additional characteristics compared to traditional products (i.e. forbidden withdrawal) and this leads to organise a separate accounting system even for the separate management of a often small number of IDA accounts. It is this circumstance that determines the various financial institutions to limit the IDA operations only at certain selected branches and therefore also to restrain the distribution channel. Although the IDAs are perceived as a scarcely appealing product for the above-mentioned reasons, a low number of financial institutions with a probably longer term vision, considers the participation to IDA programs as a useful instrument – after the accountholder has reached the saving goal – to promote new products and services among the participants while benefiting from an already consolidated relationship. In this case, the IDA’s involvement is the channel through which the financial institution attacks a new segment of customers. This is confirmed by the fact that some financial partners of the IDA programs decide to “soften” the lending rules after the program has been completed. They do this because they believe that is already an evidence of the subject’s trustworthiness. In this case, they speak of pre-qualification for loans. Moreover, although the analysis of profitability does not encourage to offer IDAs, the financial institutions, strictly speaking, should positively assess (at least from the management point of view) the circumstance that the matching funds coming from external individuals remain in the deposit for rather long periods.

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As to the cross-selling goal, the financial institution’s decision to operate with IDAs could be linked to the consideration of its own presence among the Community Reinvestment Act (CRA)’s examiners of its own compliance. In order to facilitate the CRA examination understanding and establish – or not – its “persuasive strengths”, this measure shall be examined in more details. The CRA, which was carried by the USA Congress in 1977 and revised later, states the obligation for the deposit banks with a FDIC (Federal Deposit Insurance Corporation) insurance to serve the needs of the community where their branches are located. The federal exam they have to make consists of 3 tests with various analysis perspectives (lending test, investment test and service test). If the federal examiners/inspectors do not globally give any positive assessment to the financial institution’s activities (such as service, lending and deposit-taking), then a sanction mechanism can be put in place against them. This means that the financial institution will not be allowed to carry out any expansion and/or consolidation operations (merges/acquisitions). It is then evident that, this is a poor threat during poorly intense activity in terms of redesigning the organisation and owners’ structure of banks. It should not be forgotten that the CRA’s composite grade, that is to say the global assessment of the federal exam can be satisfactory only if for the lending test a not lower than “low satisfactory” assessment has been given, regardless the way the other tests have been assessed. Moreover, a financial institution that has been assessed “outstanding” for the lending test, will be given a globally satisfactory assessment also if it is considered as not compliant for what concerns the other two components of the CRA examination. What is described above shows that the CRA’s examination primarily concentrates on the financial institutions’ lending activity; and this does not stimulate and discourages indeed any effort from their side to go for retail banking and saving accumulation activities for the community (i.e. IDA programs examined by the service test). If you then consider not only the service test’s reduced incidence and importance but also the ambiguity, uncertainty and vagueness of the rules the federal inspectors refer to while examining the IDA initiatives within the service test, you easily come to the conclusion that the Community Reinvestment Act has not presently facilitated the legitimatisation of this asset-based product and strategy for the financial community. Moreover, it has not attracted any newcomer, new financial institutions in the IDA world. Therefore, in order to increase the financial institutions’ interest for the IDAs, it is then desirable to overcome the service test weakness and to make the CRA credit, which is granted for offering such products, clearer and higher.


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3.2.3 Funding of the IDA Accounts/Programs The IDA accounts’ and/or IDA programs’ characteristics clearly show that the marginal customer will be more involved if there are funding sources available to draw matching funds from, or also the means to cover the program management’s operational costs. The experiences made so far have clearly shown that the non-profit organisations’ financial resources for the above-described goals are of two different origins: -

in most cases, public funding; in a lesser way, private financial resources. The first IDA programs have originated, in any case, from this second type of support.

The public resources disbursement to support asset building strategies in favour of poor individuals comes after the Federal Government or individual states have taken legislative measures and/or initiatives. On the first aspect, at present, there are two important measures to be pointed out. They are functional to the IDA programs funding and are called: Assets for Independence Act (AFIA) and Temporary Assistance for Needy Families (TANF). With the first measure, the Federal Government has created a funding solution, which is exclusively dedicated to the IDA programs. It is a federal agency, the US Department of Health and Human Services (HHS), that dedicates resources exclusively to the IDA programs. Contrary to the AIFA, the TANF sets up a legislative instrument for wider welfare programs. The TANF funds are of federal origin but are distributed by the US Department of Health and Human Services to the states that decide, in discretionary way, whether they are going to allow, among the various types of use, the creation and support of IDA programs. As from the 90s, the Federal Government has encouraged, though in a limited way, IDA programs with further instruments. In this respect, the Office of Refugee Resettlement (ORR)’s IDA initiative should be recalled. This is a federal program with which one of the US Department of Health and Human Services’ divisions, called the ORR, allocates federal funds to carry out IDA programs to people that are not only of low income but also refugees when they enter the program. Furthermore, a special mention deserves also the initiative to be attributed to the Community Development Financial Institutions (CDFI) Fund, directed by the Treasury and represented by the so-called Bank Enterprise Awards Program (BEA) with which, within a competition between banks belonging to the federal fund of deposits insurance, some prizes are awarded to some institutions for their contribution to the

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development of lending and investments policies in favour of local communities. These prizes can be used for funding IDA programs. To conclude, the Community Development Block Grants (CDBG) program should be mentioned: under the lead of a federal agency, the US Department of Housing and Urban Development, this program allocates the corresponding funds to various towns, cities and counties. For what concerns the funding sources that are controlled by individual states, three alternatives or complementary solutions can be identified. It is through them that individual national bodies support IDA programs: -

use of TANF funds of (above-mentioned) federal origin; use of part of public revenues to this purpose; forecasted tax credit in favour of private individuals that bring a donation/contribution of funds to an IDA program.

In most American States this is made possible by a corresponding national legislation on IDA programs; in fewer cases, this happens according to an administrative measure. The last point of the previous list is related to also private IDA programs supporters. This category not only comprises people that only want to be refunded of the above-mentioned tax credit but also enterprises that, with similar donations, aim at raising their visibility, and also philanthropic organisations for which this activity is to be considered as a mission, foundations and financial institutions (banks/ credit unions). To give a rough idea of the different levels of importance related to the various IDA funding sources, see in Fig. 3.2 the rate of programs that, out of 284 programs that are taken into account in the 2003 CFED survey, has benefited from various types of support. After this even short description of the IDA programs funding sources, some considerations can be proposed. First of all, it’s legitimate to interpret the public actor’s presence as willingness to create an institutional/formal mechanism for promoting a product, namely the IDA, aiming at facilitating the LMIs’ access to saving accumulation and following investment. However, the main involvement – as far as funding is concerned – of the highest political hierarchies (Federal Government and national governments) has not jeopardised the IDA programs’ local and community orientation. This feature is kept and you can see it very clearly in the program’s community-based fruition and working modality. In fact, both federal funds as well as national funds are allocated by the federal agency that is responsible for each state in a competitive way. This is organised via a tender and only non-profit associations/organisations, local bodies/institutions or partnerships among these subjects can participate. Since,


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to apply to this tender, the applicants are asked to provide numerous detailed information (organisational capacity, served area, program’s structure, …), it is evident that the project and proposal dimension (see paragraph 3.2.1) is not denied at all. Figure 3.2 Rate of IDA programs that have benefited from third parties funding as operating and matching funds

Educational Institutions 7%

Business/Corporations

11%

50%

Financial Institutions

Philantropy

57%

State and Local Government

57%

85%

Federal Government 0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Source: CFED, 2003 Survey of IDA programs.

Secondly, the IDA funding raises some worries, too. In fact, if, on one hand, the political intervention has provided a major visibility to IDAs at federal level, on the other hand, this has not been enough to ensure a real and wide penetration of it. This is due to two reasons: -

-

the dedicated resources are limited. Apart from the AFIA funds, the other public resources have no obligation to provide such allocations. In the future, agencies and States could prefer other destinations; the available public funds’ uncertainty and instability, not only for the aforementioned reason but also because of their inevitable exposure to fluctuations depending on the public revenues/expenditures dynamic or, in other words, on the public finances’ evolution.

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3.3 Saving and Asset Accumulation with Tax Refunds This contribution, as well as the USA economic and political context, takes into account some other initiatives than the IDAs, namely more low-cost solutions to support the LMIs within a saving-and-asset accumulation process. In particular, there is a certain interest in converting the tax refunds in savings. Before examining the implementation’s possible modalities, it is rather advisable to reflect upon the circumstances that encourage the adoption of such a solution. As a matter or fact, for several LMIs, the tax refund is the most substantial monetary flow throughout the year. Since it is also an irregular flow, it should be at least partially dedicated to different purposes than the ones the current revenues are destined to. In order to encourage to save the exceptional resources, a hypothesis belonging to behavioural theory underlines the importance of having a mechanism that is able to get these resources out of any expenditure instinctive temptation or impulse to spend them or to use them for hazardous financial choices13. This mechanism can opt for predetermining the irregular flow destination, namely towards prefixed purposes even before these sums are received, so that there is no need for specific decision concerning the flow distribution between expenditure and saving when the money is cashed. As to the flows for tax credits and the USA context, this mechanism can become a reality if the Internal Revenue Service (IRS)14 allows the tax refunds splitting to take predetermined financial accumulation forms as from the moment the credit is notified to the taxpayer. This would require an amendment to the present refunding procedure, as the latter exclusively entails a refund in form of lump sum. The American administration has already chosen to take and complete this engagement by fiscal year 2007. Also the results of the experimental programs that have been recently carried out on bench-scale may then have a positive impact on the development of such a political orientation. A special mention deserves the pilot initiative called Refund To Assets (R2A), an experiment made in 2004 and related to fiscal year 2003 in the Tulsa county (Oklahoma, USA). This experiment has involved a partnership consisting of the Community Action Project of Tulsa (CAPCT, care association), the Oklahoma bank, a private charitable foundation, the In this respect, see Shefrin H.M., Thaler R. (1992), Thaler R. (1994) and Thaler R., Benartzi S. (2004). 14 IRS is the US Treasury’s agency, which is responsible for tax collection and implementation of fiscal regulation. 13


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Annie E. Casey Foundation and the Doorways to Dream Fund (D2D Fund), a non profit organisation created under the initiative of P. Tufano, Professor of the Harvard Business School in the field of creation and validation of financial products and services for LMI families. Moreover, the tax refunds, for which the program wanted to check the possibility to convert them into an asset building vehicle, were related to the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC). This confirms that they used to be addressed to low gross income working people or families, mainly with dependant children of less than 17 years of age15. For implementing the program, the involved partners have planned: -

-

to offer, at the CAPTC sites, a free tax preparation service, to fill the forms related to fiscal credit calculation for the IRS and control of eligibility criteria; to give the possibility to open a saving account at the Oklahoma Bank already at the moment when and place where forms are filled; to provide information locally on the program and to underline the possibility to split and opt for an existing account or a new account; to make, after 10-15 days, a direct deposit of the saved amount onto the existing account at the Oklahoma Bank or onto a pre-existing account; for the remaining part of the amount to refund, a cheque will be sent soon afterwards.

The results of the R2A program are quite encouraging16. 27% of the respondents have expressed their intention to be involved in the program. Although the rate of real participation to the program has gone down to 15% because the requested criteria were not met, several signals show that tax refunds are perceived as an opportunity to retain resources. Furthermore, only 17% of the participants provide some indications for the accreditation of the whole tax credit. And all this leads to think that there is a concrete demand for a tax refunds splitting service. However, all these results are not enough to fully assess whether the pilot program has The Earned Income Tax Credit is a fiscal instrument to reduce the taxation of LMIs with a child younger than 19 years of age. The initially recognised credit increases proportionally to the revenue increase. It will reach a maximum threshold and will then decrease whenever a further amount is gained. The Child Tax Credit has been established in 1988 to help facing the child’s growth costs. If the families with a child younger than 17 years of age are entitled to CTC after paying their fiscal debts, the lowest amount of the followings is then recognised: the CTC amount and 10% of the revenue beyond a prefixed amount of 10,500 dollars. 16 For a detailed empirical analysis of the R2A program, see Beversly S., Schneider D. , Tufano P. (2005). 15

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reached the purposes for which it had been promoted. That is why the types of use the participants have planned while considering the possibility of multiple purposes cannot be neglected: 81% of the participants were pursuing a saving goal, 57% were forming monetary aggregates for immediate spending and 45% were creating the reserve to settle a past debt. This shows that a certain temptation to spend or to consume the tax credit is not rare. As to the individuals that would rather pursue a saving goal, the aforementioned survey considers also the account balance evolution and shows that 5-8 months after the deposited amount rapidly decreases and, in some cases, the saving account is even closed. This leads to think that saving was really dedicated to short term goals. And this shows that this asset building strategy has a very different timing than the IDA programs’ one. Via specific follow-up interviews to the participants with saving goals, the experimental R2A program has provided information on additional financial products towards which the tax refunds seem to possibly be destined to after the splitting. Among the preferred products, the basic financial products are mentioned, especially bank products (interest bearing deposit accounts, Certificates of Deposits), but also saving bonds. The sample is limited and therefore some reserves on this are justified. However, the expressed preferences lead to think that: -

-

the LMIs people rationally express their will to opt for financial accumulation by means of prudent and not risky solutions, which are the solutions a certain excitement or instinct may lead to if the tax refunds’ purpose had not been predetermined before. the LMI people seem to be ready to somehow give up to immediate liquidity while considering the indicated products.

To conclude, it’s worth pointing out that to take splitting to scale, some operational problems must be addressed. One must choose between two possible options: the accomplishement of tax refunds splitting “at the source” or “at the destination”. In the first case, the taxpayer, which is entitled to the fiscal refund, provides the necessary information for its splitting when he/she fills the request form; the IRS will simply observe these disposals. In the second case, the taxpayer has to ask the financial institution or the fiscal assistance agency to manage and monitor the refund and its manifold destinations after the IRS has received it. This solution is somehow like a contract with private individuals and there is no mechanism that generates marginalisation risk for many LMIs. For these reasons, the pilot program’s authors prefer the source-based solution while working with this type of asset building.


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3.4 The British Experience with the Child Trust Fund and the Savings Gateway In recent years, Michael Sherraden’s original definition of saving and asset accumulation as useful strategies for helping LMIs to get out of a poverty condition has reached Great Britain, too. In this country, political authorities and the government in force at that time have started to take initiatives to encourage a certain saving attitude. Consequently, contrary to what has happened in the USA, in Great Britain it’s the English welfare decision-makers that have moved to an asset- based approach17. Moreover, this approach does not represent the final point nor the official recognition of experiences that have been previously made in non-profit and/or care organisations. The strategy the British government has adopted in this context has paved the way for two concrete initiatives, called: -

Child Trust Fund (CTF) or baby bond; Savings Gateway.

As it will become clearer in the following pages, with these proposals, the British government has shown to be persuaded that the saving policies need to be progressive and therefore pursue their goal during the person’s entire life cycle and not only during adult age. This is the basic reason why the CTF has been created. In principle, this is somehow a long term saving account for children and teenagers. It is because the Savings Gateway’s initiative is easy to be understood as it has a corresponding form in the USA IDAs that we start from this. As a matter of fact, Savings Gateway is the name of the English pilot program for the development of a matched saving account for LMIs. The first experiences in this respect were made in July 2003 and involved approximately 1,500 accounts of this type that have “matured” between beginning of 2004 and 2005. The program has covered five communities18 and has involved people of active age and working people with low incomes19 or with no employment as well as tax credits or income subsidies holders. Concretely, the Government has assigned this program’s operational management to a department for education, the Community Finance and Learning Initiative. In all five areas, saving accounts have See box 1 on American Dream Demonstration. Tower Hamlets–East London, Gorton–East Manchester, Cumbria, Cambridgeshire and Hull. 19 Less than 11,000 pounds for one person and less than 15,000 pounds for families with children. 17 18

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been opened for all the participants exclusively by the Halifax Bank (now Halifax Bank of Scotland). For each saving account, the program was extended throughout 18 months, during which each participant has paid not more than 25 pounds monthly. Nevertheless, the fixed maximum threshold of 375 pounds for the balance of the account does not prevent from reaching that target even if the monthly maximum amount has not been transferred and just 20.83 pounds as monthly average have been deposited. As incentive, the British government has ensured a 1:1 match rate to be awarded at the end of the program according to the highest balance of the 18 months. After determining a maximum threshold of 375 pounds for the government’s integration (matching funds), in any case, the amount a participant has globally accumulated for the Savings Gateway will not be higher than 750 pounds. As it clearly emerges, the Savings Gateway pilot program and the USA IDA programs have several analogies in common. The author believes that the differences are even more interesting as they may let a different goal (a priority for both of them) emerge. The main differences are: -

-

-

there are no restrictions as to the use of both the paid funds into the savings accounts as well as the matching funds; the participation to financial education initiatives for the participants to the Savings Gateway is optional and/or voluntary; the matching funds are given all at once directly to the participant instead of – see IDAs – to be transferred to the good or service provider the funds are destined to; the personal funds in the saving account can be withdrawn at any time; in any case, the matching funds are adapted to the highest balance of account that has been reached at any moment during the project’s life; no remuneration will be paid as interest on the saving that has been accumulated in the account.

According to the above-mentioned list, it is possible to say that within the British experience, the public authorities have experienced the matched saving account as an instrument to encourage a regular saving behaviour, that is to say the habit to save without considering the use of the earmarked funds. Consequently, in the British experience, contrary to the American one, there is no tight evident complementarity and symbiosis between saving and asset accumulation. As a matter of fact, what emerges is the setting up of a liquidity reserve that guarantees a better financial security. It should be emphasised also that the program assessment report a group of the Personal Finance Research Centre’s researchers (Bristol University) has made on the behalf of the Treasury has reported the results of the


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interviews and surveys made with the accountholders at the end of the program. These results clearly show the accountholders’ availability to accept both a longer duration of the program as well as the presence of constraints when the amounts are withdrawn during the account’s life. While doing this, the integrated funds’ extremely encouraging effect is clearly to be considered, as well as the resistance vis-à-vis possible restrictions on the use of saved funds. It should not be forgotten that, in 2005, in the perspective of introducing a national program, the British government has launched a second pilot project called Savings Gateway 2. This project involves 6 local areas20 and aims at testing different match rates, different levels of allowed monthly contribution and, clearly also different match caps. The second initiative mentioned at the beginning of this paragraph, has a universal character and is not targeted to LMIs. In fact, all the new-born babies can benefit from social welfare (welfare state’s action) although people belonging to disadvantaged families do it more. Consequently to what has been previously said, the Child Trust Fund should be considered as the account that keeps and paves the way for increasing people’s financial availabilities before becoming adults. To open a Child Trust Fund account the government needs to recognise an initial monetary amount for each born baby, in form of a voucher that is given to the parents or to the tutor. This amount can only be changed for money with a simultaneous deposit at a CTF accounts provider21. The universally recognised voucher’s value amounts to 250 pounds and a similar amount is added if the children belong to families whose revenue is below a yearly determined threshold. Although the examined initiative is extremely recent (the issue of the first vouchers in January 2005 and the CTF accounts availability as from April 2005), the government has granted the right to all children born after the 1st of September 2002, living in the UK and not subject to any immigration control and to the children whose family receives the Child Benefit22. The capacity of the Child Trust Fund account to serve as a vehicle for accumulating savings is more evident while examining its working conditions and its specific features. Firstly, it’s worth noting that until the 20 These areas are: Cambridgeshire, Cumbria e North Lancashire, East Yorkshire, Manchester, East London and South Yorkshire. 21 The fact that an adult (parent, tutor) opens a CTF account at a provider’s does not mean that he/she is the owner of the deposited funds, which exclusively belong to the child. 22 The Child Benefit is a sort of social cheque for the ones that are responsible for the child’s growth and education.

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accountholder has reached the legal age of majority, parents, family and friends can contribute a further amount, which can not go beyond 1,200 pounds per year. Secondly, the paid amounts to the CTF account will be unavailable both for the person that has opened the account on the child’s name as well as for the nominee. In other words, a CTF account does not allow any withdrawal nor the debit of any operation. Thirdly, it should be reminded that for the examined account there is a mechanism of automatic redemption when the nominee is 18 years old. At that point, the nominee acquires the right to have access to the funds and he/she will be free to transfer them freely to a traditional account, or to use them to purchase consumption goods or investment forms. The government’s initial amount to open a CTF account clearly intends to play an incentive role. In order to avoid this amount to be jeopardised by an extremely rigid offer – with the risk for the CTF accounts provider to be obliged to keep completely static accounts open because of missing voluntary contributions –, in many cases three different CTF accounts have been made available: the CTF saving account, the CTF share account and the Stakeholder CTF account. To these types of offer correspond various forms of investment for the contributions to the account. This allows the person that opens the account for the newly born to have a certain flexibility in his/her financial choices. In particular, in the first case, the resources brought to the CTF account are subject to a monetary investment, while in the second case they are destined to a share investment. The investment option that is offered is more sophisticated in the case of the stakeholder CTF account as it paves the way for a life styling investing strategy. In fact, at first, the CTF account provider sets aside the account’s reserves to a presumed share market destination, typically via a common fund and, later, as from the nominee’s thirteenth year of age, they progressively move the share investment towards an investment in a liquidity fund. It’s worth noting that the stakeholder CTF account can be opened in the interest of the child not only on a voluntary basis but also peremptory by the HM Revenue and Customs (the English Treasury). This would happen if the nominee’s parents or tutor have not used the voucher one year after it has been issued. The Child Trust Fund initiative the government announced in UK in 2001, has encouraged various sponsors in the American context to produce similar ideas. Therefore, as to the Saving at birth, it’s the British experience that has a certain influence oversee. As a matter of fact, among the “emulative” programs, we can mention: the so-called Savings for Education, Entrepreneurship and Downpayment (SEED) Initiative as well as the proposal for an American Stakeholder Account (ASA). It is easy to


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understand that the common feature here is that all of them tend to go towards the setting up of an amount for the young population23. In the first case, the experiment’s design, co-ordination and funding are of private nature. In particular, the initiative’s sponsorship and management can be assigned to the CFED, which essentially addresses to community partners and foundations to raise funds. The experimental initiative has been started in 2003 and should be pursued until 2012 with the quantifiable goal to open up 1,200 accounts. This goal seems to be pursuable as already on June 30th 2005, 691 of them were already opened. A further encouraging signal to start a similar experiment is to be identified in the fact that, during 2005, 4 national States have concluded an alliance to set up, according to the law, a development action to create saving opportunities for young people. In the SEED Initiative there are various points that remind the British experience, namely the initiative’s general orientation for the newly born, a possible exogenous support and also the fact that the saving is not available until the adult age. Differently, the American Stakeholder Account (ASA) represents the ambitious goal of a legislative proposal (that is being under discussion since 2004), to set up a saving account prototype for each newly born in America24. The preparatory works and the political debate show that there are precise policies, which orient at creating a nation-wide system. In this respect, we have to stress the participation is universal and obligatory. In other words, the clear orientation is to give to all families with a new child, a public support to come to an asset building strategy, avoiding that it will be refused and without any necessary expressed option. It is evident that such a proposal should support the program’s take-up rate and allows that each American baby can grow and rely on account at his/her name he/she can use at the adult age. As to the funding mechanism, the saving account prototype the legislator is developing, should rely on a Federal Government’s initial input of resources that would sum up to 2,000 dollars, via a direct deposit. The solution that is being confirmed is then extremely practical compared to the possible alternatives such as the issue of vouchers (see English case) or the tax credit mechanism. In this respect, it should be underlined that the 23 To avoid any misunderstanding, it’s worth reminding that none asset building at birth initiatives are going to be set up on the base of bonuses for the babies, that are entailed in the Italian financial law for 2006 (Law nr 266/2005). This bonus consists of recognising the right to a family to receive a single lump sum for the baby’s birth. These initiatives are part of the income-based policies. 24 According to what has been done so far, the target should be each baby born in 2004. In this respect, see Cramer R. (2004).

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following hypothesis has already been taken into account: to ask for the return of the initial federal support after the adult account’s nominee has been given a stable job or has reached a self-sufficient economic position. By doing so, the government can recover the borne costs, although this will happen after a very long time. Although this would seem in contradiction to the spirit of the previous provision, it should be reminded that the ASA could benefit from further payments made by the government besides the one that is given soon after the child’s birth. In fact, some public additional payments are recognised. They are called merit deposits or merit contributions. The due sums will be credited depending on the young’s school career evolution. In other words, these contributions’ schedule will depend on the successful completion of kindergarten, primary and secondary school. To reach an asset building goal via the ASA, voluntary contributions are desirable and accepted (as in the English experience), no restriction is imposed upon parents, relatives and friends that can make them. In this respect, the modalities that could encourage the LMIs voluntary contribution are currently under discussion, namely: expansion of refundable tax credit provided that a corresponding sum is saved to an ASA, the possibility for the government to use a matching mechanism for annual private contributions. For this reason, a maximum threshold for voluntary contributions shall be fixed (so far, that could be between 1,000 and 2,000 dollars per year). By analysing the English CTF account and the American child account prototype, some differences emerge as to the use of kept funds. Both models opt for making the earmarked sums unavailable until the nominee has reached the legal adult age but they adopt completely different solutions as the use of them. As a matter of fact, United Kingdom’s model recognises full freedom whereas the American prototype, under the IDAs influence, prefers a model with some restrictions that recognises as investments only the uses that can make ”the difference” in the future material life conditions (education, house purchase, start up of microbusiness and so on). As to the ASA’s management, the prevailing orientation would rather suggest a centralised solution: that would mean that the administrative functions are directly assumed by the Federal Government, namely a federal body whose most likely name is ASA Fund. This body should provide financial support to the ASA system, manage the accounts and negotiate with the private financial sector for deciding who is going to manage the implementation of the proposed investment strategies. Once again the similarities and differences compared to the English case emerge. On one side, the American child account model would rather give the


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young people’s families (that are rather the accounts’ custodians and not the nominees), more investment options and, on the other side, they will not have to independently identify the account provider. The abovedescribed solution is certainly very practical especially for the families that have not developed any relationship yet with the financial services and that do not have any financial asset. However, it’s reasonable to think that, in this case, their financial inclusion in not encouraged. This is the reason why a further option has been taken into account during the debate: the governmental body can only temporarily intervene and the sums can be transferred to a private institution when the child has reached a certain age. At the end of this analysis of the main approaches to the creation of an account for children universal system, Table 3.2 summarises similarities and differences of models that have the same basic purpose. Table 3.2 Comparison between the British CTF and the American ASA CRITERIA FOR ANALYSIS

Incentives for LMI

Yes, by increasing the initial sum

Investment options for earmarked resources Forms of use of earmarked resources Accounts management

Several

ASA Universal Mandatory Child Adult legal age Accepted Initial seed deposit Yes, from the government Direct deposit to the account by the Federal Government Yes, by matching the LMI’s private contributions Several

No restriction

Prefixed and limited

At private providers selected by the child’s parents (or tutor) CTF account provider

At a federal body

Eligibility Participation Accountholder Funds availability Voluntary contributions Public contributions Merit contributions Modalities for assignment of public contributions

Investments management

CTF Account Universal Mandatory Child Adult legal age Accepted Initial seed deposit No Voucher issued

Contracts with private financial institutions

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3.5 Conclusions This contribution has deeply analysed, as announced in its preface, representative experiences on the concrete implementation of an assetbased approach to fight and/or prevent poverty. The defined approach is different than the classical income-based approach that intends to relieve the problem through economic aids supporting income and consumption. As a matter of fact, the asset-based approach rather aims at modifying and possibly resolving some poverty’s structural aspects. Such a goal is pursued by involving the LMIs within specific strategies leading to develop their saving capacity and a real and/or financial asset accumulation. These assets, that represent nontransitory but long-lasting endowments and capacities, help effectively fighting against economic and social exclusion. In particular, in the previous pages, three different strategies have been outlined: -

the development of matched saving accounts for LMIs; the development of universal saving accounts to start an asset accumulation process as from the birth; the offer of saving and asset accumulation vehicles via tax-based policies.

If these asset-based solutions are available, that means, as Michael Sherraden has repeatedly stated, that the LMIs are able to save. We should in any case never forget that, for this part of the population, saving and asset accumulation do not represent the ending point of an independent decision. In other words, the asset-based policies whose almost exclusive target are the population marginal groups do not assume that the individuals they are destined to first decide to save and then afterwards select the vehicles for their resources’ best allocation; they rather address themselves to the people for which saving can originate from a reaction to exogenous, very encouraging and persuading institutional and formal mechanisms. The examined experiences support this interpretation. In fact, their original contribution is not that they have brought real product innovations, namely new instruments that are based on new financial technologies. In fact, in the IDA, Savings Gateway and CTF experiences traditional financial products are involved, such as deposit accounts and mutual funds. The innovative aspect is that common products and institutional factors/working criteria have been successfully integrated in the aim of mitigating, with a proactive attitude, the problem of marginalisation of the LMIs’ access to investment services. These institutional factors include:

3 Access to Investments -

-

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use of saving for specific purposes (which introduces a constraint and does not permit to make a fully free choice, on the other hand it creates an expectation on the target to be reached); inclusion of match contributions that, by definition, encourage saving; prior definition of rules as to the contribution of monetary resources, withdrawals, outpayment of cumulated sums, which generates some trust in the adopted asset-based strategy.

A further characteristic which has emerged during the above-described experiences and that it’s worth reminding is the importance of having a supporting structure or subject at local level (often represented by nonprofit organisation) even when the strategy itself is inserted within a wider policy framework of reference. This presence will have a major impact on the asset-based strategy’s success. Because for LMIs, saving and asset accumulation do not correspond to the spontaneous research of various forms of satisfaction of personal preferences but are rather stimulated “phenomena”, the availability of not excessively formal places and points of reference is necessary so as to create more effective and credible possibilities of contact to encourage a persevering behaviour.

3.6 References and Bibliography Apgar W.C., Duda M. (2003), The Twenty-Fifth Anniversary of the Community Reinvestment Act: Past Accomplishments and Future Regulatory Challenges, FRBNY Economic Policy Review, June. Ashraf N., Gons N., Karlan D.S., Wesley Y. (2003), A Review of CommitmentSavings Products in Developing Countries, www.adb.org. Bardhan P., Udry C. (1999), Development Microeconomics, Oxford University Press. Bernheim B.D., Garrett D.M. (1996), The Determinants and Consequences of Financial Education in the Workplace: Evidence from a Survey of Households, National Bureau of Economic Research, Working Paper No. 5667. Bernheim B.D., Garrett D.M., Maki D.M. (2001), Education and Saving: The Long-term effects of High School Financial Curriculum Mandates, in Journal of Public Economy, 80-3. Bernheim B.D., Scholz J.K. (1993), Private Saving and Public Policy, Tax Policy and the Economy. Berry C. (2004), To Bank or not to Bank? A Survey of Low-Income Households, Joint Center of Housing Studies Working Paper Series, Cambridge, MA.

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Beverly S. (1997), How Can the Poor Save? Theory and Evidence on Saving in Low-Income Households, Center for Social Development, University of Washington in Saint Louis, working paper 97-3. Beverly S., Moore A., Schreiner M. (2001), A framework of asset-accumulation stages and strategies, Center for Social Development, Washington University in Saint Louis, Working Paper 01-1. Beverly S., Romich J.L., Tescher J. (2003), Linking Tax Refunds and Low-cost Bank Accounts: A social development strategy for Low Income Families?, Center for Social Development, Washington University in Saint Louis, October. Beverly S., Schneider D., Tufano P. (2005), Splitting Tax Refunds and Building Savings: An Empirical Test, HBS Finance Working Paper Series, August. Beverly S., Sherraden M. (1999), Institutional Determinants of Savings: Implications for Low-Income Households and Public Policy, Journal of SocioEconomics, vol. 28. Boshara R. (2003), American Stakeholder Accounts, New America Foundation, Issue Brief, June. Boshara R., Sherraden M. (2004), Status of Asset Building Worldwide, New America Foundation. Caskey J.P. (2002), Bringing Unbanked Households Into the Banking Systems, The Brookings Institutions, Center of Urban and Metropolitan Policy, January. CFED (2003), A Look at the Growing Individual Development Account Field – Results from the 2003 Survey of IDA Programs. CFED (2005), Assets Newsletter, 1. CFSI (2005), Breaking the Savings Barrier: How the Federal Government Can Build an Inclusive Financial System, February. Cheng L. (2003), Developing Family Development Accounts. Policy Innovation from Income to Assets, Center for Social Development, Washington University in Saint Louis. Clancy M., Grinsten-Weiss M., Schreiner M. (2001), Financial Education and Savings Outcomes in Individual Development Accounts, Center for Social Development, University of Washington in Saint Louis, June. Cramer R. (2004), Net Worth at birth: Creating a National System of Savings and Asset Building with American Stakeholder Accounts, New America Foundation. Cramer R., Parrish L. Boshara R. (2005), 2005 Federal Asset Policy Report and Outlook, New America Foundation, March. Emmerson C. Wakefield M. (2001), The Saving Gateway and The Child Trust Fund: Is Asset-Based Welfare “Well Fair”?, The Institute for Fiscal Studies, October. Federal Reserve Bank of San Francisco (2005), Community Investments – Special issue on building assets, May. Friedman M. (1957), A Theory of the consumption function, Princeton. Glen H., Skinner J. (1996), Assessing the effectiveness of saving incentives, Journal of Economic Perspectives.


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H.M. Treasury (2003), Details of the Child Trust Fund, London. Hubbard R.G., Skinner J., Zeldes S.P. (1995), Precautionary Saving and Social Insurance, Journal of Political Economy. Hurst E, Luoh M.C., Stafford F.P.(1998), The Wealth Dynamics of American Families, 1984-94, Brookings Papers of Economic Activity. Katona G. (1975), Psychological Economics, New York. Kempson E., McKay S., Collard S. (2005), Incentives to save: Encouraging saving among low-income households, Personal Finance Research Centre, University of Bristol, March. Kempson E., Whyley C. (1999), Kept out or opted out? Understanding and combating financial exclusion, Bristol, Policy Press. Kober C., Paxton W. (2002), Asset-Based Welfare and Poverty – Exploring the Case for and against Asset-Based Welfare Policies, www.ecpc.org.uk Loke V., Clancy M. (2005), Participants in SEED: A report from Account Monitoring Research, Center for Social Development, Washington University in Saint Louis, November. Maital S., Maital S. (1994), Is the Future What it Used to be? A Behavioral Theory of the Decline of Saving in the West, Journal of Socio-Economics, vol. 23. Marshall J.N. (2004), Financial Institutions in disadvantaged areas: a comparative analysis of polices encouraging financial inclusion in Britain and The United States, Environment and Planning. Midgely J. (1999), Growth, Redistribution and Welfare: Towards Social Investment, Social Services Review, 77. Mills G., Gale W.G., Patterson R. (2005), Effects of Individual Development Accounts on Household Saving Behavior: Evidence from a Controlled Experiment, http://elsa.berkeley.edu, April. Mills G., Patterson R., Orr L., DeMarco D. (2004), Evaluation of the American Dream Demonstration – Final Evaluation Report, www.abtassociates.com, August. Modigliani F., A.K. Ando (1957), Tests of the Life Cycle Hypothesis of Savings, Bulletin of the Oxford Institute of Statistics, vol. 19. Narayan S. (2001), Individual Development Accounts: A Social Insurance Perspective, Kennedy School Review. OCC (2005), Individual Development Accounts: An Asset Building Product for Lower-Income Consumers, www.occ.treas.gov, February. OECD (2003), Asset Building and the Escape from Poverty: a new Welfare Policy Debate, www.oecd.org Oliver M., Shapiro T.M. (1990), Wealth of a Nation: A reassessment of Asset Inequality in America Shows At Least One Third of Households are AssetPoor, The American Journal of Economics and Sociology, vol. 49. Oliver M. (1995), Shapiro T.M., Black Wealth/ White Wealth: A New Perspective on Racial Inequality, New York, Routledge. Page-Adams D. (2002), Design, Implementation, and Administration of Individual Development Account Programs, Center for Social Development, Washington University in Saint Louis.

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Parrish L. (2005), To save, or not to save? Reforming asset limits in public assistance programs to encourage low-income Americans to save and build assets, New America Foundation, Issue Brief, May. Ray D. (1998), Development Economics, Princeton University Press. Schreiner M. (2004), Asset-Building for Microenterprise through Matched Savings in Low-Income Countries, Center for Social Development, Washington University in Saint Louis, December. Schreiner M. (2004), Match rates, Individual Development Accounts, and Saving by the Poor, Center of Social Development, Washington University in Saint Louis, October. Schreiner M., Beverly S. (2003), Income and Saving Performance in Individual Development Accounts, Economic Development Quarterly, vol. 17 No. 1. Schreiner M., Clancy M., Sherraden M. (2002), Saving Performance in the American Dream Demonstration, Final Report, Center for Social Development, University of Washington in Saint Louis, October. Schreiner M., Guat T.N., Sherraden M. (2004), Cost-Effectiveness in Individual Development Accounts, Center for Social Development, Washington University in Saint Louis. Schreiner M., Sherraden M. (2005), Drop-Out from Individual Development Accounts: Prediction and Prevention, Center for Social Development, Washington University in Saint Louis, March. SEDI (2004), Savings and Asset-Based Policy in the UK, www.sedi.org, February. Seidman E., Tescher J. (2004), From Unbanked to Homeowner: Improving the Supply of Financial Services for Low-Income, Low-Asset Customers, Joint Center for Housing Studies Working Paper Series, February. Shapiro T.M., Wolff E.N. (2001), Assets for the Poor: The Benefits of Spreading Asset Ownership, New York, Russell Sage. Shefrin H.M, Thaler R.H. (1992), Mental Accounting, Saving, and Self Control, in G. Loewenstein and J. Elster eds.: Choice Over Time, (Sage Foundation, New York). Sherraden M. (2005), Inclusion in Asset Building, Testimony Senate Finance Committed, www.senate.gov, April. Sherraden M. (2002), Individual Development Accounts: Summary of Research, Center for Social Development, Research Report, September. Sherraden M. (1988), Rethinking Social Welfare: Toward Assets, Social Policy, vol. 18. Sherraden M. (1991), Assets and the Poor: A New American Welfare Policy (M. E. Sharpe, Armonk, N.Y.). Sherraden M., Schreiner M., Beverly S. (2002), Income, Institutions, and Saving Performance in Individual Development Accounts, Center for Social Development, University of Washington in Saint Louis, working paper 02-3, January. Stegman M.A., Faris R., Gonzalez O.U. (2000), The Impacts of IDA Programs on Family Savings and Asset Holdings, Center for Social Development, Washington University in Saint Louis, working paper 00-14.


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Stegman M.A., Kim P.H. (2004), Legitimizing Individual Development Accounts (IDA) Within Financial Institutions, www.cfed.org, August. Stuhldreher A. (2004), Tax Time: The Right Time: Federal Policy Recommendations to Help all Americans Save and Build Assets, New America Foundation, Issue Brief, December. Thaler R. H. (1990), Saving, fungibility and mental accounts, Journal of Economic Perspectives, 4(1). Thaler R. H. (1994), Psycology and savings policies, American Economic Review, 84 (2). Thaler R. H., Benartzi S. (2004), Save More Tomorrow (TM): Using behavioral economics to increase employed saving, The Journal of Political Economy, 112(1). Thaler R.H. (1981), Shefrin H.M., An Economic Theory of Self-Control, Journal of Political Economy, vol. 89, No. 2. Todaro M., Smith S. (2003), Economic Development, Longman. Tufano P., Schneider D. (2005), Reinventing Savings Bonds: a modest proposal, HBS Working Paper, September. Zdenek R.O., Stein B. (2003), “Recommendations from the Field: Individual Development Accounts as Part of a Universal Asset-Building System”, Center for Social Development, Washington University in Saint Louis. Ziliak J.P. (2003), “Income Transfers and Assets of the Poor”, Review of Economics and Statistics, Vol. 85, No. 1.

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3.7 APPENDIX COMMENT ON DATA ABOUT THE “ACCESS TO INVESTMENT SERVICES” This appendix aims at providing a summary as well as a comment on the results emerging from the questionnaire that has been carried out in Italy, Spain and in France on the LMIs’ access to investment services. In order to provide an easy and rational illustration, we have opted to distinguish between three different, interesting and pertinent areas most specifically related to: -

the overall capacity/ willingness/ possibility to draw resources from current consumption; the retirement saving; the insurance saving.

In the three above-mentioned European countries, as to the marginal client’s saving capacity, the interviews that have been carried out clearly let a worrying common situation emerge: this client is incapable and/or it is impossible for him/her to keep, that is to say not to spend part of his/her own monetary resources. This is what has emerged from over 30% of the native population, which is confronted with a risk of financial exclusion in Spain, France and Italy (in the latter, this rate is somewhat higher than 37%). More specifically on the respondents that have given a different answer to the question “Do you save or are you able to save?”, namely the ones that have given a positive answer to this question saying “yes” or, alternatively, “a little” (that means rarely or in a residual way), we can see a very different regularity and “premeditation” levels towards saving in the three above-mentioned countries. This is further proved by the fact that only 11% of the autochthonous population in Italy has opted for the first alternative (31% to the second one) versus over 33% of the interviewed French native population. Furthermore, Italy shows an extreme disparity compared to the collected data on immigrants (slightly over 48% of them are able to save). The questionnaire that has been proposed to the LMI people further aimed at checking the saving’s possible goals, if any. In this respect, we shall remind that the saving act is primarily motivated by the will to have monetary reserves to face unforeseeable situations and difficulties. Therefore, we can state that for most respondents saving has a precautionary function. This is quite reassuring. Nevertheless, for some


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aspects, this is also disappointing. As a matter of fact, this reality shows that frequently the (economically and socially) weak individual is not spontaneously capable of assuming any saving attitude on the medium and long term, namely to aim at creating a real and/or financial patrimony to structurally change his/her condition of poverty. This does not mean that in some situations saving has not been given – although quite rarely – a specific and not “immediate” purpose. For the native marginal population, this goal typically and primarily is the purchase of a house and, secondly the children’s education. As to the first answer, this is the position expressed by approximately 17% and 27% of the Italian and French respondents that have previously stated they are able to save or are able to do it rarely. For the immigrants, in all three countries, saving is frequently destined to constitute remittances in favour of their families that still live in the original country. Through the interviews, some other situations have also emerged, where life standard is apparently less hard and far-sighted. This can be a legitimate interpretation of those cases where saving is destined to travelling and holidays (in France, approximately 34% of the respondents pursue this goal). What has also been analysed are the types of financial instruments that are concretely used by the respondents to invest their saving. According to the modest entity of the saved amounts that have been kept and to the precautionary goal, the most used instruments emerged are the non negotiable instruments – within the category of bank deposit taking instruments –, with a certainly less strong investment function vis-à-vis the function of financial resources custody. Practically, we are talking here of current accounts and savings books. Other bank but more interest-bearing products such as certificates of deposit are more rarely used. The reason for that could be related to their holding period constraint. Nevertheless, the French case shows that the bank products are often open to stimulate saving through “attractive” remuneration. This is the case for the so-called LEP (Livret Epargne Populaire) and the CODEVI (Compte pour le Développement Industriel). They can be started up with small transfers (30 euro and 15 euro respectively) and can be further supplied with transfers (until the maximum threshold is reached) on which the matured interests will be not only attractive but, further more, free of taxation. A further aspect to be underlined is that these products do not place restrictions on when and how to use the account funds. The collected answers confirm the existence of few cases of saving and resources accumulation by means of marketable securities. Although the starting fragile economic situation would rather encourage to take a market risk but at least through diversification, the preference for investment in

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individual securities (non only State’s obligations but also equity shares) has not been less important than the one for investments in common funds! It should also be reminded that the respondents have sometimes declared that, in order to make these choices, they have relied on their friends that are active in the financial consulting areas. As far as the most important variables that are considered necessary to appreciate an investment solution, the respondents’opinions in all the three above-mentioned countries converge towards the “profitability-security” combination, with security meaning certainty of the performance. If these two elements have been chosen jointly, that would rather mean a scarce financial maturity as, according to a basic economic principle, you can exante have a legitimate higher profitability expectation only if you are ready to accept a higher risk level. The importance given to profitability is also proved by the fact that higher investments return is the most frequent answer given to the question: “If you could propose some innovations to the bank products to encourage saving, what would you suggest?”. The not strictly economic features, such as transparent conditions related to the financial contract and simple working modalities, seem to be not that important. As to retirement saving, some discouraging signals are to be found in relation to the basic social security issue as well as to the complementary social security one. On the first issue, the rate (at least 20% in all three European countries) of the ones that are not even presently acquiring the basic pension scheme is quite high. This is related to the respondent’s employment situation. As a matter of fact, in some cases, it is rather the independent worker and not the employee that do not pay social contributions as these are not automatically drawn by an employer at source; in other cases, this is the condition of irregular workers or unemployed. It goes without saying that, these individuals’ uncertainty as well as their economic difficulties seem to rather continue also at later age when, if the situation does not change, they risk not to benefit anymore from a pension scheme but only of a minimum social pension. Nevertheless, this perspective does not seem to constitute a valid encouragement to pay social contributions. This is due to a quite spread mistrust on the first pillar’s capacities or possibilities to ensure in the future a pension coverage also for the individuals that have acquired the right to it. As to the complementary social security, it’s easy to image that most respondents show a poor sensitiveness to it. As a matter of fact, many of them declare they have never thought to constitute an additional security through a voluntary pension scheme. As we have already said, this is an expected result: in fact, a complementary scheme would then presently


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require a saving capacity as it implies that some contributions – that are to be capitalised throughout the time – are paid. What is necessary also is a farsighted vision, which LMIs do not often have. Nevertheless, the local autochthonous Italian population has quite surprisingly shown to reserve a quite wide attention for the private welfare, although this has not been translated into a real use of social security instruments. The insurance saving draw a particular attention from the LMIs in France: in this country, a little more than 92% of the respondents of the autochthonous marginal population and approximately 85% of the respondents among the immigrants have signed an insurance police. Most of these policies recognise an insurance coverage in case of damages related to things or people. In particular, at least within the local population, most of the chosen policies are to ensure a protection against civil responsibilities risks, related to car driving. Further more, the French mostly sign policies while buying a house to the financial intermediate’s advantage as well as when they have the intention to rent the estate, provided the market asks for this coverage, as it usually happens. These insurance contracts are then followed by the policies that recognise a repayment for damages to the house, for cases of theft and work accidents. The above-described cases may lead to think that the respondents, in the insurance saving, primarily search for a repayment opportunity. Nevertheless, life policies, namely the insurance contracts where the financial component is stronger, is not that spread, but present anyhow. As a matter of fact, these contracts performs when an event concerning human life occurs but they also capitalize the sums that have been paid as insurance premium in order to constitute a capital and/or a future annuity. Differently than in France, in Spain and in Italy the rate of diffusion of insurance contracts within the marginal population is much lower. Further more, in both countries these are primarily policies to cover civil responsibility risks. With reference to the Italian reality, a sort of reversal is to be felt vis-à-vis the French reality: in fact, in Italy life policies are much more popular than voluntary damages policies (for thefts and work accidents). However, both types of policies are much less used than in France.

Part II

4 What Are the Specific Economic Gains from Improved Financial Inclusion? A Tentative Methodology for Estimating These Gains

Philip Molyneux

4.1 Introduction Financial exclusion has emerged as a concern for policymakers on both sides of the Atlantic in recent years. A broad definition of financial exclusion is 'the inability to access necessary financial services in an appropriate form. Exclusion can come about as a result of problems with access, conditions, prices, marketing or self-exclusion in response to negative experiences or perceptions' (Sinclair, 2001). In Europe, the widespread process of financial deregulation has increased the range of financial services and products for certain societal groups but it has also exacerbated for some others. The problem of financial exclusion is not marginal. The percentage of the adult population that does not even have access to a banking account in some countries appears high - Italy (22.4%), Greece (17.9%), Ireland (16.8%), Portugal (16.7%), Austria (13.5%) and UK (10.6%). Since financial exclusion is an important dimension of social exclusion it represents a key source of inequality that European policymakers (to varying degrees) have sought to address. The widespread process of financial services liberalization and the subsequent intensification of bank competition may, at least partially, explain why financial exclusion has become more visible over the last decade or so. Many of the strategies of financial intermediaries have resulted in a considerable segmentation of their products towards wealthier customers (flight to quality). Since most banks only seek to maximize profits or stock value, the implementation of standardised and rigid practices in screening customers (credit scoring) and formulating

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profitable financial contracts (loans, deposits) has made it difficult for certain population groups to access financial services, or, has caused the exclusion of those economic agents whose profile does not fit within the current standards (Boyce, 2001). This paper outlines the nature and causes of financial exclusion, briefly highlights the extent of exclusion across Europe and discusses the various policy / industry responses to tackling financial exclusion. We then move on to discuss a framework for measuring the impact of financial exclusion. This focuses on a framework that has recently been developed to analyse the impact of regulation on tackling financial exclusion (ex-post and exante) using both direct and indirect measures.

4.2 Defining Financial Exclusion Financial exclusion refers broadly to the inability (however occasioned) of some societal groups to access the financial system. It is part of the much wider concept of social exclusion and polarisation. Groups in society that are unable to access financial services are frequently unable to obtain other key social provision and financial exclusion can often exacerbate other kinds of social exclusion. Financial exclusion is invariably experienced by poorer members of society. Significant numbers of low income people are apparently excluded from financial services spanning a range of basic products that include credit, insurance, bill-payment services and deposit account facilities. Exclusion can come about as a result of a number of factors as explained in Chapters 1 and 5 of this text, to recap these include: access exclusion; condition exclusion; price exclusion; marketing exclusion; and self exclusion. Together, these different kinds of financial exclusion comprise a complicated collection of barriers to entry to mainstream financial services for various societal groups. Financial exclusion, then, appears to be the result of a complex, often interconnected set of factors. Socio-economic factors are clearly important. Concurrent developments in the financial services industry are also significant; financial exclusion has apparently been exacerbated by structural and strategic developments in the financial services industry. In particular, intensifying competition, the rise of ‘customer value’ concepts, increased customer segmentation and the pursuit of more affluent customers have been especially significant. Having said all this it should be clear that it is difficult to pinpoint and measure the precise determinants of financial exclusion. From one perspective it can be viewed as a consequence of market failure – excluded

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groups may just not have an appropriate choice of products available to meet their needs (e.g. sub-optimal choice) or it may not be worthwhile for banks to offer such services due to ‘apparent’ lack of consumer interest (e.g. reduced choice). Even if markets are efficient (e.g. no market failure) some groups may not be able to obtain adequate or affordable access to financial services. As such, financial exclusion can be regarded as both the consequence of market failure (sub-optimal and reduced choice of services) and also due to other factors that limit access to financial services in efficient markets.

4.3 European Evidence on Exclusion Financial exclusion from basic bank transaction accounts is often used as an indicator of financial exclusion in a country. Table 4.1 draws attention to several aspects of contemporary European access to basic bank accounts. Table 4.1 Availability of a personal current account, giro account or similar (%) Country

YES

NO

Not Country YES Known Belgium 92.7 5.1 2.2 Luxembourg 94.1 Denmark 99.1 0.7 0.2 Netherlands 98.9 Germany 96.5 2.9 0.6 Austria 81.4 Greece 78.9 17.9 3.2 Portugal 81.6 Spain 91.6 6.9 1.5 Finland 96.7 France 96.3 2.8 1.0 Sweden 98.0 Ireland 79.6 16.7 3.7 UK 87.7 Italy 70.4 22.4 7.2 EU 15 89.1 Source: Ruozi and Anderloni (Eds) (2002, Table 5.1, p. 219).

NO 3.9 0.5 13.5 16.7 1.5 1.6 10.6 8.6

Not Known 1.7 0.6 5.1 1.8 1.7 0.4 1.6 2.2

It can be seen that in the majority of European countries over 90% of the adult population have access to basic banking account facilities however, there are some noteworthy exceptions. Countries with an apparently high level (10 per cent or more of the population that do not have access to such accounts) include: -

Italy (22.4%) Greece (17.9%) Ireland (16.7%) Portugal (16.7%) Austria (13.5%) UK (10.6%)

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There is considerable variation among the countries listed in Table 4.1. Financial inclusion varies from 99.1% (Denmark) to 70.4% (Italy). One has to exercise certain care in interpreting these data, however, for example, payment systems in Europe differ markedly in many important respects. Nevertheless, they do confirm both the importance and heterogeneity of financial exclusion experiences across Europe. On the demand side, Pollin and Riva (2002) report on very much the same kind of socioeconomic characteristics of those excluded as found in similar surveys in the UK and US. These kinds of characteristics include a high proportion of those who are less well off, women, older and younger members of society, the less educated, ethnic minorities and the unemployed. Although financial exclusion is not a new problem, its consequences are perhaps nowadays more serious. Not having access to key financial products (a bank account, consumer credit, savings or insurance) can lead to many problems in a fast-changing, more demanding and competitive society. A lack of banking facilities is especially problematic in an environment where a growing volume of payments are made via a bank account. Research has found that one of the top priority products for the financially excluded is an account to receive income and make payments (Kempson and Whyley, 1999). Those without access to mainstream credit facilities may also face serious practical difficulties; credit needs cover both short-term facilities (to smooth peaks and troughs in household budgets) and different kinds of loans to buy larger items. As a result, the financially excluded are often incentivised to borrow from ‘non-status lenders’ who charge high (and even exorbitant) prices. Since these loans are often secured on the borrower’s property, the consequences of non-repayment are especially serious. Insurance exclusion becomes increasingly problematic as the range of risk cover possibilities extend. At the same time, the financially excluded are often most vulnerable to the kinds of risks that can be covered by insurance (ranging from home contents, mortgage protection to life cover and long-term sickness cover). The consequences of financial (and social) exclusion are, as a result, further heightened. The absence or inadequacy of pension provision also carries with it the obvious consequence of a greater risk of poverty and hardship in later years. The impact of exclusion from pensions is heightened since membership of private pension schemes is increasingly becoming the norm. The Joseph Rowntree Foundation Inquiry (1995, p.25) in the UK found that a ‘substantial minority’ of people were heavily reliant on the social security system. Those who are unable to manage on the income they receive in retirement face a very restricted range of available options.


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A number of consequences flow from not having savings. The most fundamental of these is the loss of security and flexibility that the majority of people take for granted. As with insurance, the awareness of having no safety net is an ongoing source of concern for these financially excluded persons. The preceding consequences of financial exclusion are not confined to individuals; they also impact on their communities. The withdrawal of financial services from certain localities (so-called ‘financial desertification’) has been associated with deterioration in the built environment, restricted economic growth and social problems. Leyshon and Thrift (1995, p.315) go on to suggest that….”rich areas tend to get richer and poor areas poorer because of the way in which the financial system discriminates between people and communities on the basis of risk”. A related issue is the practical relevance of local knowledge and presence by financial services firms. Without a local presence and the customer knowledge that accrues from such a presence, financial institutions may become more risk averse in their lending. This results from a greater reliance on national lending models where ‘qualitative’ and ‘softer information’ inputs on local and customer circumstances do not have such a weighting (if any). The marketing strategies of financial institutions based on the same geographical information systems may accelerate this ‘desertification’ of certain communities by mainstream financial providers (Thrift and Leyshon, 1997).

4.4 Market Context and European Policy Responses1 Financial exclusion appears to be exacerbated by the forces and ‘strategic mindset’ of financial services firms that are incentivised to maximize returns in an increasingly competitive and deregulating environment. Whilst the economic benefits of liberalisation and greater competition continue to be sought, the free market unaided does not appear capable of solving the financial exclusion problem. These free market desiderata can produce many desirable ‘economic goods’. A higher output of financial services, products tailored more closely to demand, higher rates of innovation, greater bank efficiency, lower prices and improved service quality, to name but a few of the targeted benefits. The overall ‘economic good’ at a macro level is that the economy can operate at higher investment levels and on investment sched1

Part of this section was adapted from Carbó, Gardener and Molyneux (2006).

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ules that carry higher risk (but better managed and hedged via a more efficient financial services sector). This is the economic model that is actively pursued in Europe via liberalisation, deregulation and globalisation of financial services sectors. In this operating environment, the so-called ‘shareholder value model’ pursued by financial sector firms appears to emphasise increasingly the ‘standard customer’ in more profitable customer segments. Marginal customers may become ever more excluded. For example, as financial services firms ‘desert’ particular geographical localities and customer segments, information for assessing respective risks is reduced; asymmetric information problems worsen. Concomitantly, the ‘risk pools’ for such marginalised groups may also reduce for individual financial services firms; risk becomes less predictable and less amenable to risk pooling. This is the contemporary and developing scenario that governments face. In one important respect, US experiences (and to a lesser extent, those of the UK) are especially germane in continental Europe. The U.S. system is in many respects the ‘pacemaker’ in the development of financial services. On the one hand, financial services are produced more efficiently than in many other countries and are particularly responsive to the ‘shareholder model’, the free market. On the other hand, this kind of model by itself appears to have a negative impact on financial exclusion. Both the US and UK financial sectors are probably the most deregulated and market-orientated in the world. In both countries, significant policy responses also characterise government action. Both the US and UK have seen strong Government action directed at tackling financial exclusion. Strong affirmative action in the US (via the Community Reinvestment Act) has not been replicated in the UK, but the UK Government has undoubtedly pursued a coercive and directing role. What is important in formulating a policy response to financial exclusion is the historic and contemporary institutional setting of the financial system. In the US, for example, ‘redlining’ led to apparent discrimination and resultant financial exclusion of some societal groups; this apparently required a strong affirmative response. In the UK, on the other hand, ‘redlining’ has not been a feature of the financial services industry. Financial services policy in the UK has more of a history of ‘coercion’ and ‘moral suasion’. The result is an emphasis on Government mediation, self-regulation (the financial services industry and its associations generally responding to the Government’s wishes) and public/private and private/private arrangements for tackling financial exclusion. These types of policy response may not always work in the way intended and may need to be complemented with stronger rules and guidelines, but they reflect the UK approach to tackling


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exclusion. Flexibility, responding to market pressures and a respect for Government aims are hallmarks of the British regulatory philosophy. In many European countries, the historic and institutional apparatus have emphasised more strongly ‘public models’ and social responsibility. The financial sector systems and strategic mindsets of many European bankers and politicians reflect these ideologies. They are not contrary in any way to UK and US approaches, but they have impacted on the development of European banking and regulatory thinking in different ways. In Europe, these kinds of models are embodied in political philosophies that are reflected in constitutional constraints like ‘solidarite’ (France), ‘mutuality’ (Italy) and the role of the ‘social state’ (Germany). These philosophies are reflected at many levels in the way the European banking and financial system has evolved. The role of publicly chartered banks, savings banks, regional and social banking reflect this ‘European philosophy’. The debate between ‘shareholder value maximization’ and ‘stakeholder value’ are other transparent aspects of the continental European approach2. In this connection, Schuster (2000, p.7) points out that in Europe: -

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90% of enterprises ‘pretend’ to be focused on the interests of shareholders, but only 34% of them use shareholder value techniques in planning, decision-making and communication; shareholder value plays a rather unimportant role in France, Belgium, Italy, Austria and Spain; ‘countries in transition’ that are increasingly adopting the entrepreneurial philosophy are Switzerland, Sweden and the Netherlands; shareholder value maximization is increasingly important in the US and UK.

Nevertheless, European banking has been ‘on the move’ throughout the 1990s and the banking industry’s strategic mindset has undoubtedly changed during this period: see Economic Research Europe Ltd (1997) and Gardener et al (2002). HĘrter (in Schuster [2000, p.13]) points out in this context: ‘Managers – especially those in continental Europe – who neglect shareholders’ financial interests have to be aware that their behaviour will no longer be tolerated. Capital is increasingly in the hands of powerful professional fund managers’. The HĘrter study is quite clear that shareholder value will increasingly drive European financial services firms: see Shareholder value maximization involves a corporate strategy that focuses on maximizing share price / owners returns. The broader concept of stakeholder value maximization involves maximising returns to all stakeholders in the firm including owners, employees and customers.

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also Gardener et al (2003). The implication is that financial exclusion is likely to become more widespread and thus will require a more concerted policy response throughout Europe. The various policy responses to tacking financial exclusion have already been outlined in detail in Chapter 1 of this text, broadly identifying five main approaches: -

the Market, but increasing Government and Private Sector Interest (Spain, Greece, Ireland and Italy); the Voluntary Role of Banks (Belgium, Finland, France, Germany and the Netherlands); the Government as Mediator: (UK and an attempt in France); Government as Legislator (France, Belgium, Portugal and Sweden); and Government Affirmative Action (US).

These ‘models’ are by no means mutually exclusive. In practice, a combination of approaches is often deployed. Where private sector response is not apparent and/or is not working, however, the likelihood and need for a stronger Government-led initiative seems apparent. It can be seen, however, that the general approach to tackling financial exclusion in Europe has been somewhat ad hoc. This, to a certain extent at least, reflects the disappointing role of the European Commission (EC) in dealing with financial exclusion issues. The EC have affirmed via the European Social Agenda the concept of a social policy that embraces increased inclusion as a major, ‘ongoing target’. Improved forms of governance that bring together the EU, member states, local and regional authorities, non-Governments organisations and enterprises of all kinds are seen as the way forward. Within the framework of market liberalisation, the ‘general economic interest missions’ are the means by which a balance may be struck between competition and protecting more vulnerable consumers. Nevertheless, the position of the EC remains imprecise, undeveloped and not altogether transparent on these general interest missions in the context of financial exclusion and areas related to it (like the provision of basic banking services and the development of regional financial infrastructure). The EU has done little regarding financial exclusion and what has been done is rather dispersed and disappointing. It is true that the industry is reluctant to a kind of (EU) regulation whereby banks are obliged to offer a "social" (bank) account for everybody3. In addition, European banks are A view aired by many bank participants at the WSBI-World Bank "Access to Finance" Conference, Brussels, October 2004.

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also concerned (and very reluctant) to have a kind of Community Reinvestment Act as the Americans have (see Peachey and Roe, 2006). Perhaps because of industry concerns European policymakers are hardly recognising financial exclusion as a policy issue. In the December 2005 Draft White Paper on Financial Services Policy 2005-2010 financial exclusion issues are mentioned once (p.14): "Accessing a bank account is the entry point for most consumers to financial services and markets and increasingly important for citizens to participate in the market and society; even more so within the context of using electronic payments within a Single Payments Area. Undue barriers associated with all types of bank accounts (current, savings, securities accounts) must be removed, consumer choice widened and competition between service providers improved". In a more recent presentation Charlie McCreevy, European Commissioner for Internal Market and Services, indirectly recognizes the problem of financial exclusion with regards to the opening of current accounts (especially by foreigners in EU member states) – he also emphasises the lack of integration of retail financial markets4. One criticism levelled at EU policy and the White Paper in particular is that it treats all types of banking firms as the same whereas it could be argued that many mutual banks place a greater emphasis on their commitment to financial inclusion (and local and regional economic development) compared with their larger private sector counterparts.

4.5 From Exclusion to Inclusion: Identifying the Costs and Benefits Despite the substantial literature on financial exclusion as far as we are aware there have not (as yet) been any studies that seek to measures the specific costs and benefits of financial exclusion. This is mainly due to the challenges posed in identifying an appropriate framework for measuring such things. Probably the best first step in identifying a measurement approach is to use methodologies that have been used in the past to

Presentation given by Charlie McCreevy on ‘Banking regulation: next steps’, to the French Banking Federation Conference, Paris 21st March, 2006.

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evaluate the impact of regulations5. Typically, studies that examine the impact of regulation focus on the improvements in the market environment and these can be: -

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ex-post analysis, here the aim would be to examine the impact of regulations that have been put in place to tackle financial exclusion, using various metrics to identify what has happened compared to the outcome if no regulation (the counterfactual) had occurred; or ex-ante analysis which requires the measurement of likely improvements (i.e. a reduction in the number of individuals financially excluded) that would occur if various initiatives to improve inclusion were put in place.

Figure 4.1 illustrates the sort of framework that can be used to investigate the impact of regulations (or other initiatives) aimed at tackling financial exclusion. The framework outlined in Figure 4.1 starts with identifying the area of policy concern – financial exclusion – and this identifies the problems associated with exclusion (as noted earlier in this chapter) and helps define the benefits associated with the reduction (or eradication) of financial exclusion. The identification of potential benefits associated with the reduction or eradication of financial exclusion could include such things as the value obtained by consumers from greater access to adequate and affordable financial services, improved choice of financial services, reduction of sub-optimal purchase decisions by consumers or (at a broader level and over a longer term) improved income distribution (individually and regionally). Once the benefits have been defined (as noted already, these may be partial e.g. a reduction of the number of people excluded, or maximal e.g. no individuals are financially excluded) then this helps identify possible policy action and what to measure. For illustrative purposes, previous studies that have sought to identify the impact of financial sector regulation, such as the EC’s work on the impact of the 1992 single market (see COEC 1988a, 1988b) have followed a similar approach to as above. In this case the benefits of the policy action (e.g. creation of the single market) were hypothesised to generate lower prices for financial services throughout Europe. Various hypothetical price scenarios were identified that would occur as a result of the Single market programme and the potential reductions in prices were converted into potential consumer surplus gains. These were idealised estimations based The following framework has recently been outlined in Oxera (2006) in the context of measuring the impact of regulation in the financial sector. This section applies the approach suggested specifically to financial exclusion. 5


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(some say) on heroic assumptions – nevertheless the analysis set the parameters for the expected potential price falls that may have occurred as a result of the EC’s 1992 programme in financial services. The same sort of setting can be suggested for the measurement of financial exclusion – e.g. identify the benefits associated with the total removal of financial exclusion and then see what effect policy initiatives have in getting closer to these benchmarks. Figure 4.1 Conceptual framework for measuring initiatives / regulations designed to tackle exclusion Potential outcome with initiatives / regulation

Outcome if no initiative/regulation

Financial exclusion

Potential benefits of no financial exclusion

Types of benefits realised Actual outcomes post-initiative

Initiatives to reduce exclusion Types of costs imposed What to measure

How to measure

Actual measurement of benefits of policies / initiatives designed to tackle exclusion

Source: Adapted from Oxera (2006), Table 2.1, p. 4.

Referring back to Figure 4.1, once the potential benefits (greater access to financial services, more choice, reduction in sub-optimal purchase of financial products) associated with the reduction or eradication of financial exclusion have been identified this suggests what to measure. As the main potential benefits of tacking financial exclusion relate to improved access to financial services, improved choice of products and a reduction in suboptimal choice of products (e.g. some consumers ‘mis-buy’ financial products from loan-sharks and other unofficial sources when they are not

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fully informed about conventional products available to them) this suggests various measurement indicators: -

improved access to financial services can be measured by identifying the value derived by consumers from better choice; improved choice can be measured by identifying the value derived from greater choice of financial services; and improved access to (adequate and affordable) financial services can be measured by identifying the value obtained from consumers from greater access.

These potential benefits focus primarily on individuals / consumers, but of course there may well be benefits accruing to banks such as access to new customers / markets (although the fact that individuals are excluded in the first place may suggest that these benefits are not apparent). In addition, there will be costs – the costs of implementing regulations / initiatives aimed at tackling exclusion and also the expenses borne by banks (and other financial service firms) in providing a wider range of financial services, information and literary programmes earmarked for the excluded. These costs also need to be borne in mind as ex-ante judgement about policy should always try and take account of the net benefits (gross benefits minus costs) of new regulation/initiatives. Having said this, however, greater weight should always be placed on the benefits of consumers compared with the increased costs incurred by producers and others especially if substantial broad economic and societal benefits are believed to flow from tackling the exclusion issue. There are two main ways in which the actual or potential benefits of policies aimed at dealing with financial exclusion can be measured: direct and indirect. Direct measurement requires information about the change in the relevant metric (e.g. change in the penetration of financial services, survey evidence on how much those that are excluded value increased or better choice of financial services). There are three main empirical approaches that can be used: -

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‘before – and – after’ comparison change in the relevant metric (e.g. change in the penetration of financial services). This can only be undertaken ex-post; survey based information can be used to gather subjective information of improvements in financial inclusion as a consequence of actual or possible regulation; international comparisons or other types of benchmarking approaches can be used to draw inferences about how regulations / initiatives impact on exclusion in different sectors or countries.


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Table 4.2 highlights various direct approaches that can be used to measure financial exclusion issues. Table 4.2 Measuring financial exclusion – Direct approaches Adverse impact of financial exclusion

Measures of benefits associated with reducing / eradicating financial exclusion Restricted access to Value derived by consumers affordable and from improved access to adequate financial financial services. services.

Limited choice of financial services.

Examples of measurement techniques

Ex post: - survey consumers to identify the value they place on increased penetration of financial services (and valuation of the change in regional or national income distribution). Ex ante and ex post: -international comparisons and other benchmarking exercises. Value derived from excluded Ex ante and ex post: consumers from increased - consumer surveys to choice (i.e. reduction in the establish ‘willingness-to-pay’ opportunity cost of not being for appropriate services (e.g. able to buy what could be maybe the difference between available). ‘loan-shark’ rates and official bank rates); - controlled experiments to establish what excluded customers purchased when faced with a greater choice and an evaluation of the value they derive from this greater choice. Ex post: econometric / statistical approaches to estimate the value of a new (or range of) products. (continued)

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Sub-optimal choice Value derived by excluded Ex ante and .x post: of financial services. consumers from better choice - consumer surveys to (i.e. more optimal fit between establish ‘willingness-to-pay’ what they buy and what in to avoid mis-buying or fact they need). willingness-to-accept compensation for mis-bought products and services; - controlled experiments as above. Ex post: - before and after analysis of consumer decisions (e.g. using surveys) to judge the actual increase in optimal purchases. Source: Adapted from Oxera (2006), Table 4.1, p. 15.

Before-and-after (event study) type approaches are clearly attractive to use if specific regulations or initiatives are identified and researchers can look for structural breaks or changes in behaviour around and after the date using various metrics. One problem with this approach of course, is that researchers have to be careful in screening out other factors that may impact on the measurement metric that may have nothing to do with the policy approach or initiative taking place. For example, if the policy runs concurrent with an increase in property prices in areas where exclusion is an issue then improved exclusion may be a consequence of rising house prices and not the policy in question. The before-and-after approaches to measuring financial exclusion are not relevant when one has to try and make predictions about policy choice and future policy impacts. Here one has to use measurement approaches that make ex ante judgements. A starting part could be to quantify the total negative effects of financial exclusion – this provides the upper bound for the potential benefits that could be obtained if exclusion was eliminated. As identified in Table 4.2 the main ways to measure ex ante effects of policies designed to eradicate or reduce exclusion include: -

consumer surveys – excluded consumers could be asked directly about the value they would attach to having access to affordable and adequate financial services, improved choice and better information to relevant services. These can be designed to identify the willingness to pay for the change or (maybe) the willingness to accept compensation if no changes take place. The problem with this sort of


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approach is that consumers often overstate their willingness to pay and also find it difficult to make other accurate judgements about possible future opportunities / regulatory outcomes; international comparisons – the first part of this chapter highlighted differences in financial exclusion across various countries. Looking at policy actions and their consequences from other countries makes it possible to do some sort of benchmarking exercise. Nevertheless, the quality of inferences obtained from such analysis depends on the ability to find suitable comparators. The same types of regulation designed to reduce financial exclusion may have a markedly different impact due to a whole host of factors – institutional and macroeconomic environment and so on. In general, while international comparisons may provide an indication of the sort of benefits that may result from various policies designed to tackle financial exclusion they are not too useful for helping researchers to quantify the specific impact of policy within a particular country. Benchmarking studies using similar earlier policies aimed at tackling the same sort of problems are more likely to yield better benchmarks.

So far we have discussed potential direct measures associated with policies designed to reduce financial exclusion. Often, however, it is difficult to obtain such measures and so researchers must choose indirect measures. Indirect measurement focuses on proxy metrics that provide an indication of the extent to which policy actions / initiatives deliver better outcomes (in terms of reduced exclusion). To develop indirect measures ‘requires the identification of the complete set of causal links between the direct impact of regulation and the desired market outcomes, and importantly, validating these in practice’ Oxera (2006 p. iii). As before, developing indirect (proxy) measures of the impact of policy requires researchers to first identify the problem (financial exclusion) and the potential benefits derived from eradicating the problem. The second step is to identify the mechanisms by which regulation delivers the improvement (reduced exclusion) and then identify and measure relevant proxy metrics. These then need to be validated linking proxy measures to the desired outcome (eradication or reduction of financial exclusion). Indirect measurement relates to quantifying intermediate improvements in the situation. Examples of possible indirect measures relating to financial exclusion are illustrated in Table 4.3.

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Table 4.3 Indirect measures of financial exclusion Adverse impact of financial exclusion Restricted access to affordable and adequate financial services.

Examples of proxy measures and / or measurement

- Participation rates (e.g. number of consumers without a particular type of financial service – basic bank account, pension, insurance); savings rates; average pension income in retirement; etc. Limited choice of financial - Products offerings and variety in market. services. - Survey of banks to ask which products they would/would not be supplying in the absence of regulation geared to tackling exclusion. - Surveys or experiments to asses how consumers deal with greater choice, whether a larger set influences decisions, whether consumers are likely to take up the new products or switch suppliers. - Surveys to assess confidence in banks / financial service firms and quality of products they offer. Revealed preference – how many consumers have taken up the new products (or ex ante, how many would take up the new product). Sub-optimal choice of - Survey of consumers to ask about degree of financial services. information problem: - information they seek or have access to; - the extent to which they make use of published information; - the degree to which they understand the information - Experiments to assess consumer recall or understanding of financial information. - Complaints to consumer bodies or other authorities about inappropriate products bought or offered. - Revealed preference – how many consumers have changed their behaviour after financial exclusion regulation / initiatives. Source: Adapted from Oxera (2006), Table 4.2, p. 24.

Indirect measures relating to financial exclusion can be ex post or ex ante. Of critical importance in identifying these indirect measures is that the intermediate effects (the causal links by which new regulations deliver change) hold in practice. If one can identify these causal links then the impact of regulation can be measured in an indirect fashion. Or to put another way, the impact of a policy designed to reduce financial exclusion, may be measured indirectly by looking at changes in participation rates


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(the take-up of financial services by the excluded) but it does not directly measure the precise impact on those that have been financially excluded.

4.6 Measuring the Economic Gains from Improved Financial Inclusion The analysis presented so far highlights various methodological issues associated with measuring financial exclusion, particularly in the context of policymaking. The focus has been on highlighting various direct and indirect measures of financial exclusion and these main measures can be summarised as follows: Direct Measures: a) Survey evidence of consumers aimed at identifying the value they place on increased penetration of financial services (and valuation of the change in regional or national income distribution). b) International comparisons and other national benchmarking exercises; c) Consumer surveys aimed at measuring the ‘willingness-to-pay’ for appropriate services (e.g. maybe the difference between ‘loan-shark’ rates and official bank rates). d) Controlled experiments to establish what excluded customers purchased when faced with a greater choice and an evaluation of the value they derive from this greater choice. e) Econometric / statistical approaches to estimate the value of a new (or range of) products. f) Consumer surveys aimed at establishing the ‘willingness-to-pay’ to avoid mis-buying or willingness-to-accept compensation for misbought financial services. g) Controlled experiments to measure the value consumers derive from purchasing appropriately priced financial services and products. h) Event studies (before and after analysis) of consumer decisions (e.g. using surveys) to judge the actual increase in optimal purchases. Indirect Measures: a) Participation rates (e.g. number of consumers without a particular type of financial service – basic bank account, pension, insurance); savings rates; average pension income in retirement, etc.

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b) Surveys of banks to identify products and services they would or would not supply in the absence of regulation geared to tackling exclusion. c) Surveys or experiments to asses how consumers deal with greater choice, whether a larger set influences decisions, whether consumers are likely to take up the new products or switch suppliers. d) Surveys to assess consumer confidence in banks / financial service firms and the quality of products they offer. e) Measures of revealed preference – how many consumers have taken up new products that aim to address exclusion issues (or ex ante, how many would take up the new products if these were available); or /and how many consumers have changed their behaviour after financial exclusion regulation / initiatives. f) Survey of consumers to identify if there are information problems regarding access, the extent to which they make use of published information relating to helping with inclusion and other financial matters and the extent to which they understand this information. g) Experiments to assess consumer recall or understanding of financial information. h) Measuring / monitoring complaints to consumer or other authorities about inappropriate products bought or offered. Considering the above measures of financial exclusion (and evidence presented elsewhere in this textbook on the extent of exclusion) it is apparent that direct measures of exclusion are relatively limited and the main measures of exclusion tend to focus on indirect indicators, particularly participation rates and revealed preference indicators (product take-up rates comparing pre- and post-regulation). (Note that survey evidence has been much more widely used in various countries in the area of SME financing to gauge small firm’s perceptions of product availability and to identify various financing gaps). In general, however, evidence on measures of individual financial exclusion is generally ad hoc, there is no systematic coverage over time, institutions or consumers. Typically, measures of participation rates and the take-up of new products (such as basic bank accounts) are used as the main (indirect) proxy measure. It can also be seen that the majority of measures also rely on survey evidence or experimental economics and these are both costly and time-consuming. This is probably the main reason for the paucity of systematic data on financial exclusion issues. While it is widely recognised that obtaining accurate information on financial exclusion, both within and across countries, is difficult to obtain, greater effort at governmental levels should be made to obtain this


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information. If we have no better measures of exclusion then it also makes it difficult to quantify the overall macro / societal impact of eradicating this problem. Financial exclusion is one major feature of both social and political exclusion and evidence points to the fact that it is most prevalent in the poorest families and most economically deprived regions. Reducing financial exclusion in the poorest areas could be expected to improve the well-being of these regions. This suggests that for measuring broader impacts of exclusion researchers could aim to measure changes in income distribution or income/ GDP per capita that may result from policies geared to addressing exclusion issues. It may also be possible to compare regions that have similar economic features but with different levels of exclusion – this could indicate potential distributional and wealth gains associated with the reduction or removal of exclusion. These are all challenging research agenda for the future.

4.7 Conclusion Although experiences with regard to tackling financial exclusion vary throughout Europe, there are somewhat marked differences in policy approaches by Governments and their respective relationships with banks. This mainly reflects the institutional structures of countries financial systems and their respective ‘political’ style / approach. It seems that there are apparently no easy solutions or ‘quick fixes’ to financial exclusion. The variation in experiences means that deriving benchmark indicators from the impact of heterogeneous policies on tackling financial exclusion is problematic. Probably researchers need to focus more on specific before-and-after type studies within countries using both direct and indirect measures to corroborate the influence of specific policies designed to tackle exclusion. From a policy perspective it is surprising that so much country-specific policy action has been taken aimed at addressing the exclusion issue when there is a dearth of empirical evidence on the subject. Possibly the difficulties (and expense) associated with undertaking a rigorous assessment of these issues – as highlighted in the discussion of different measurement approaches in this chapter – is one of the main reasons for this. There has certainly not been any great impetus from the EU to conduct any such study. This seems to be because, from a policy perspective, the EU appears to prefer national solutions to tackling financial exclusion and dealing with exclusion is not a key feature of its future plans (if the White Paper on EU Financial Services Policy 20052010 is anything to go by).

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In reviewing the available evidence, what is clear is that neither governments nor banks have the stomach for U.S style affirmative action. The offer of basic banking accounts lies at the heart of many countries’ efforts to increase financial inclusion and they are a common feature in Europe. Experiences in countries like France and Sweden, however, has exposed the problems of reconciling universal, non-discriminatory banking (a social objective) with the requirements of safe and sound banking (an economic objective) – although yet again no empirical work has really been done on this subject. There are clearly different ‘models’ for responding to financial exclusion in Europe and in all of these banks play an important function. Although as yet we really do not know how effective these policies are! Regional and social banking, together with the role of more socialorientated financial players like the savings and co-operative banks (as well as credit unions) are likely to be important participants in fostering financial inclusion in the future. In many countries, the increasing move by Governments towards using electronic methods to make benefits payments have helped to attenuate the need to tackle financial exclusion. French experiences (like those of the UK) have also indicated the potential important role of the Post Office in tackling financial exclusion. It seems inevitable that public policy towards tackling financial exclusion in Europe will continue on its piecemeal/ad hoc path. It would be a fruitful path if regulators pay more attention to measuring/quantifying the impact of their actions in the future!

4.8 References and Bibliography Boyce G. (2000), Valuing customers and loyalty : the rhetoric of customer focus versus the reality of alienation and exclusion of (devalued) customers, in “Critical Perspectives on Accounting”, 11, pp.649-689. Carbó S., E.P.M. Gardener and P. Molyneux (2005), Financial Exclusion, (Basingstoke, UK: Palgrave Macmillan). Carbó S., E.P.M. Gardener and P. Molyneux (2006), Financial Exclusion in Europe, Public Money and Management (forthcoming). Commission of the European Communities (1988a), European Economy: The Economics of 1992, (Directorate General for Economic Affairs). Commission of the European Communities (1988b), The Cost of Non-Europe in Financial Services, Research on the Cost of Non-Europe, Basic Findings, Vol. 9, (Brussels: Commission of the European Communities). Economic Research Europe Ltd (1997), The Single Market Review: Impact on Credit Institutions and Banking (Kogan Page: London).


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Gardener E.P.M., P. Molyneux and B. Moore (Eds) (2002), Banking in the New Europe: The Impact of the Single European Market Programme and EMU on the European Banking Sector (Basingstoke, UK: Macmillan). Gardener E.P.M., P. Molyneux and J. Williams (2003), Competitive banking in the EU and Euroland, Chapter 5 in Andrew W. Mullineux and Victor Murinde (Eds) (2003), Handbook of International Banking (Cheltenham: Edward Elgar). HĘrter S. (2000), Shareholder Value: Changing the Face of the European Financial Industry, Chapter 3, in Schuster, L. (2002) (Ed), Shareholder Value Management in Banking (Basingstoke, UK: Macmillan). Joseph Rowntree Foundation (1995), Inquiry into Income and Wealth (York: Joseph Rowntree Foundation Findings). Kempson E. and C. Whyley (1999), Kept out or opted out? Understanding and combating financial exclusion, (Bristol UK, Policy Press). Leyshon A. and N. Thrift (1995), Geographies of financial exclusion : financial abandonment in Britain and the United States, Transactions of the Institute of British Geographers, New Series, 20, pp.312-341. Oxera (2006), A Framework for Assessing the Benefits of Financial Regulation – Report Prepared for Financial Services Authority, June 2006, (Oxford: Oxera Consulting Ltd). Peachey S. and A. Roe (2006), Access to Finance – What Does It Mean And How Do Savings Banks Foster Access, World Savings Banks Institute (WSBI), (Brussels: WSBI). Pollin J.P and A. Riva (2002), Financial Inclusion and the Role of Postal Systems, Chapter 5 in Ruozi, R. and L. Anderloni (Eds) Modernisation and Privatisation of Postal Systems in Europe: New Opportunities in the Area of Financial Services (London: Springer), pp. 213- 252. Ruozi R. and L. Anderloni (Eds.) (2002), Modernisation and Privatisation of Postal Systems in Europe: New Opportunities in the Area of Financial Services (London: Springer). Schuster L. (2002) (Ed), Shareholder Value Management in Banking (Basingstoke, UK: Macmillan). Sinclair S.P. (2001), Financial Exclusion : an introductory survey, (Heriot Watt University, Scotland : Centre for Research into Socially Inclusive Services [CRSIS]). Thrift N. and A. Leyshon (1997), Financial desertification, in J. Rossiter (Ed), Financial Exclusion : Can Mutuality Fill the Gap (London : New Policy Institute), pp. 11-16.

5 From Financial Exclusion to Overindebtedness: the Paradox of Difficulties for People on Low Incomes?

Georges Gloukoviezoff

5.1 Introduction1 How is it possible that at the same time, in the same country2, people on low incomes have no access to credit while others with a similar profile find themselves weighed down with debts? Is that not a strange paradox? We do not think so. If there is a paradox, it is more due to the fact that a distinction is made between overindebtedness and financial exclusion, although this is only one of the aspects of the problem. While overindebtedness is generally considered a phenomenon separate from the rest of financial exclusion, this is mainly because of its visibility. The consequences of banking problems connected with a deposit account or non-cash means of payment are not as spectacular as those connected with credit can be. But the deprivation of all or part of financial services (from a bank account to loans and savings products) and overindebtedness are two sides of the same coin. These are components of the social phenomenon known as financial exclusion. Our hypothesis is that financial exclusion can be defined with regard to the social consequences of the banking problems of which it consists. From this viewpoint, overindebtedness is one of the consequences of banking problems which affect, in particular, but not only, people on low incomes. Likewise, difficulties in accessing various financial services lead to various social consequences which reinforce the process of social exclusion. However, on the one hand the banking difficulties that we are We would like to thank Jeanne Lazarus for her careful proofreading (of the French version). 2 Our analysis relates mainly to the situation in France. 1

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talking about are not limited only to difficulties of access but also include difficulties of use, and on the other hand, the consequences of these difficulties are broader than mere overindebtedness. The objective of this paper is to propose an analysis of financial exclusion for private individuals which structures these various types of problems and their consequences, and shows their similarities. To achieve this objective, we will firstly examine the main definitions of financial exclusion which have appeared over the last 15 years (§ 5.2). This analysis will enable us to highlight the aspects for understanding financial exclusion that are decisive but are frequently overlooked. This mainly concerns consideration of the difficulties in use along with difficulties in access, and the role of these difficulties in the development of the broader process of social exclusion. In fact financial exclusion is both cause and effect of social exclusion defined as “all the mechanisms of breakdown, both in symbolic terms (stigma or negative attributes) and from the viewpoint of social relations (a break in the various social links which bind people together). Exclusion is both a process and a state which enshrines a lack of integration”. (Loisy, 2000, p. 42). Then in order to go beyond certain fragmented analyses which treat overindebtedness as being merely the result of increased precariousness and poverty or poorly considered individual choices, we analyse financialisation of social relationships within modern societies. The fact that it is possible to talk today about financial exclusion is due to the unavoidable nature of these services for people to live a normal social life. Thus in France, to receive a salary and social benefits, it is necessary to have a bank account. With regard to credit, matters are less clear: recourse to credit is often presented as a choice (sometimes ill-considered), as much as a constraint. However, as for a bank account or means of payment, borrowing is partly linked to the organisation of social relationships. So to contend with the ups and downs of life or to fulfil certain aspirations, borrowing increasingly appears an essential resource (§ 5.3). Finally, based on the preceding elements, we shall endeavour to show that the constraints placed on customers with modest incomes by financial institutions contribute directly to financial exclusion. These various constraints, which we shall describe in detail afterwards, make the implementation of high quality financial services a particularly delicate matter, as they need to reconcile adequate access for the customer and profitable transactions for the bank. The modes of response chosen to deal with the constraints explain both the difficulties of access and the difficulties in use and therefore overindebtedness, so there is no paradox in these different situations occurring concurrently (§ 5.4).

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5.2 A Definition of Financial Exclusion as a Social Phenomenon In general, analyses concerning financial exclusion and overindebtedness are carried out separately. However, it appears that an examination of the main definitions of financial exclusion which have been produced over the last 15 years challenges the apparent relevance of this distinction. In fact the idea that financial exclusion corresponds only to finding oneself excluded from the banking system should be rejected. Of course that is the prime meaning of the term “exclusion”. However, it would conceal an essential part of the phenomenon if we were to restrict ourselves to issues of being unbanked or underbanked. Therefore it is essential in order to define financial exclusion to consider the role of difficulties of use alongside difficulties of access on the one hand, and on the other hand the social consequences of these difficulties. 5.2.1 Return to the Definitions of Financial Exclusion Leyshon and Thrift are generally considered to be the first to have proposed a definition of financial exclusion. In their opinion, it involves “those processes that serve to prevent certain social groups and individuals from gaining access to the financial system” (1995, p. 314). This definition emphasises the mechanisms that explain that a part of the population – people with limited incomes and certain disadvantaged social groups – are deprived of access to financial services. The authors explain this by the fact that these people and groups represent too high a risk level to be acceptable to financial institutions, which then decide not to move into certain geographical areas where these groups of the population live, in order to avoid having them as customers. So it is mainly problems of physical, geographical access which are criticised. While also adopting this approach which defines financial exclusion with regard to mechanisms explaining difficulties of access, Kempson and Whyley (1999) provide two additional factors which we believe are essential. First of all they emphasise the fact that one should not focus on the selection practices of banks to explain the difficulties of access. The mechanisms at work here go beyond the mere question of physical access. These new factors are confirmed and further explained by the work carried out by these two authors, Caskey and Collard (FSA, 2000). Thus five causes of access difficulties are added to the geographical exclusion put forward by Leyshon and Thrift.

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“Access exclusion: the restriction of access through the processes of risk assessment; Condition exclusion: where the conditions attached to financial products make them inappropriate for the needs of some people; Price exclusion: where some people can only gain access to financial products at prices they cannot afford; Marketing exclusion: whereby some people are effectively excluded by targeting marketing and sales; Self-exclusion: people may decide that there is little point applying for a financial product because they believe they would be refused. Sometimes this is a result of having been refused personally in the past, sometimes because they know someone else who has been refused, or because of a belief that “they don’t accept people who live round here”.

Together, these various forms of financial exclusion constitute a complex set of barriers to accessing and using mainstream financial services for many people with limited incomes” (FSA, 2000, p. 9). This work identifies an essential aspect of the mechanisms of financial exclusion; these various barriers lead to difficulties in accessing financial services as well as using them. That is what the final sentence of the previous quote emphasises. Therefore, studying financial exclusion presupposes consideration both of access difficulties and use difficulties, i.e. the mismatch between the way products are sold to customers or the characteristics of financial services and the needs of people. The second contribution of these studies (Kempson and Whyley 1999; FSA, 2000) is that they emphasise the causal link between financial exclusion and the broader phenomenon of social exclusion. This link had already been highlighted by Leyshon and Thrift (1995) who stressed the relevance of the concept of “financial citizenship”. However, this aspect is emphasised to a greater extent by the authors who came after them. Thus it is clearly highlighted that financial exclusion is a process that contributes to the development of social exclusion at individual as well as collective level. “Where whole communities have limited access to financial products, the process becomes self-reinforcing and an important contributor to social exclusion more generally” (Kempson & Whyley, 1999, p. 22). However, these authors do not base their definition on this aspect. Therefore it appears that at the end of the year 2000, researchers in the Anglo-Saxon world working on financial exclusion identified the various elements which make up this phenomenon. Sinclair (2001) emphasises this when he explains that financial exclusion can be defined in two ways:

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in a narrow sense, considering the difficulties in accessing a wide range of financial services or accessing them in an appropriate way. Therefore he considers both access and use difficulties; in a broader sense, considering the social effects of these banking difficulties, i.e. considering that financial exclusion corresponds to the fact that banking difficulties prevent those who face them from being able “to make an economic contribution to the community”. (Sinclair, 2001, p. 14).

However, despite this detailed knowledge of the various facets of financial exclusion, not all the lessons are drawn from it. However, it is necessary to go beyond the definitions based on identification of the various types of access difficulties and incorporate two factors. The former concerns the role played by use difficulties and the latter the social consequences of these various types of difficulties. 5.2.2 Use Difficulties Publications on financial exclusion now refer systematically to the fact that socially disadvantaged people or groups either do not have access or have insufficient access to financial services, or inappropriate access to these services. (Panigyrakis et al., 2002; Byrne et al., 2005; Devlin, 2005; Gardener et al., 2005). The inappropriate character of access to financial services corresponds simultaneously to the characteristics of the service (the way in which it is sold), and the lack of control by customers over their finances. So a loan may be sold with insufficient advice about the commitments that the customer is undertaking, with technical terms which are incomprehensible to anyone who is poorly informed, in branches that are geographically remote, with exorbitant charges, with interest rates which are difficult to calculate, etc. We group all these difficulties under the banner of “use difficulties”. Therefore they are not the responsibility only of the customers or the banks. The responsibility is shared. Despite this broad awareness, use difficulties are not considered as the only explanation of difficulties of access to mainstream financial services. In fact, according to these various authors, it is due to the mismatch of financial services offered by mainstream financial institutions with regard to their needs, that certain customers will not use these services or will prefer to use the services of fringe banks (Collard, 2005; Barr, 2005). We are not challenging the existence of this causal link – quite the opposite – however, even where they do not lead to access difficulties, use difficulties are behind economic and social problems which can contribute

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to the process of social exclusion in the same way as access problems. Therefore they are worth considering in their own right. It seems to us that two main reasons explain why use difficulties are not highlighted to a greater extent. The first relates to the way in which the issue of financial exclusion has been tackled. As we have already shown, the ground-breaking work by Leyshon and Thrift (1995) and Kempson and Whyley (1999) addresses this issue via its most visible manifestation: access difficulties. Financial exclusion was therefore defined with regard to the mechanisms that contributed to these difficulties in accessing financial services. It was only later that use difficulties were identified (FSA, 2000). Once identified, these use difficulties were considered only from the viewpoint of their responsibility in the development of access difficulties, which may be due to that fact that this research was carried out in the Anglo-Saxon world. That is the second explanation. The work on financial exclusion initially related to the Anglo-Saxon countries. In view of the normal practices in banking that prevail in these countries, it is entirely relevant to emphasise access difficulties rather than use difficulties. Indeed, in these countries where the percentage of the population who have a bank account is approximately 78% in the United States (Barr, 2005) and 85% in the United Kingdom (Collard, 2005), it is possible to live without a bank account despite the constraints this implies. This is mainly explained by the fact that Social Security benefits and salaries can be received in cash. This is not the case in a country like France, where in order to receive these funds, one must have a bank account. Moreover, and this is hardly surprising, the percentage of people with a bank account is much higher: 98% of households have a deposit account. In the Anglo-Saxon countries, if the services offered are unsuitable, the person may opt out of the mainstream banking system and make sporadic use of the services of occasional providers like the fringe banks. In the French case, a person cannot live without a bank account and therefore must bear the costs connected with the use difficulties involved. The choice is even more restricted due to the fact that there are no alternative service providers in France3. It is not a question of saying at this point that the situation in the AngloSaxon countries is better or worse than the French situation. Both situations generate surcharges that are difficult to bear for people on low incomes and which should be evaluated at individual and collective level. The main alternatives to retail banks are specialised credit institutions (SCI) that mainly offer revolving lines of credit and credit cards. However, their access to these institutions requires the user to hold a deposit account and therefore have a banking relationship. 3


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What we want to emphasise is that in the French case, use difficulties will result less systematically in access difficulties. Use difficulties are therefore an independent component of the phenomenon of financial exclusion. Moreover, it appears obvious that giving everyone access to credit would be disastrous. Use difficulties produce their own negative consequences – including overindebtedness4 – which contribute to the process of social exclusion. 5.2.3 Financial Exclusion and Social Exclusion: Moving Towards an Overall Definition While the consequences of banking difficulties are not the same from one country to the next, it is true nevertheless for these different countries that what justifies taking an interest in these difficulties is the fact that they produce social consequences. These consequences are an issue at individual and collective level in terms of economic development and social cohesion. The link between banking difficulties and social exclusion is emphasised in various studies cited previously (Leyshon & Thrift, 1995, 1996; Kempson & Whyley, 1999; FSA, 2000). However, despite taking this into account, the social consequences of these difficulties are not explicitly incorporated into the formulation of the definition of financial exclusion. Lets take an example to highlight how essential it is to take it into account. The fact that a young child can be refused the possibility of opening a bank account or receiving a loan does not mean that she/he is suffering from financial exclusion. In fact there are no social consequences connected with this refusal. Such a child can continue to live normally. On the other hand, a salaried adult living in France who is refused the possibility of opening a bank account would immediately be faced with the process of financial exclusion, and would be unable to receive his/her salary or make certain payments that cannot be made in cash. The social necessity of having an account is so great that French law acknowledges it explicitly via the “right to an account” which theoretically guarantees everyone who does not have one, the possibility of opening an account by applying to the Banque de France5. The inevitable nature of financial We will return to this aspect later. Since 1995, only 10 220 people per year have benefited from the procedure of the right to a bank account due to the complexity of its implementation and the lack of information from banks. This right, introduced by the banking law of the 24 January 1984, since amended and supplemented by decree of 17 January 2001, gives access to a deposit account to anyone who does not have one, and a basic 4 5

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services for leading a normal social life is amply emphasised by Leyshon & Thrift (1995) when they speak of “financial citizenship”. This social necessity of using financial services is both the cause and consequence of their wide distribution. Because the use of financial services is so widespread and leads to new practices in terms of payment and resource management, those who experience difficulties of access or use are confronted with negative social consequences. This is pointed out in the report by the FSA when it emphasises that “the problem of financial exclusion has, ironically, resulted from increased inclusion that has left a small minority of individuals and households behind”. (FSA, 2000, p. 11). Those who find themselves on the margins of the financial system encounter increasing difficulties as financial products become widespread. This process is also highlighted by Leyshon & Thrift (1996) when they compare financial exclusion with the phenomenon of financial “super inclusion”, which concerns the customers most sought after by financial institutions. It is just as relevant to deal with financial exclusion not by defining it by the mechanisms that produce it but in relation to the consequences it causes. This is what Servet emphasises (2000); while he does not ignore the causes of banking difficulties that part of the population encounter, he is more concerned with describing their social consequences. He identifies three main consequences: stigmatisation, exclusion and economic marginalisation. In the context of work carried out by the Observatoire national de la pauvreté et de l’exclusion sociale (National Poverty and Social Exclusion Observatory) we have worked on in-depth understanding of these consequences and how, in the French case, access and use banking difficulties can harm self-esteem, links to family and friends and participation in society, whether via employment or consumption, thus contributing to the process of social exclusion (Gloukoviezoff, 2004). Therefore, we feel that it is necessary to propose a definition of financial exclusion which takes account of the elements above. This is a definition of financial exclusion in a broad sense which is not limited to the issue of access. In our opinion, financial exclusion can be defined as the process whereby people encounter such access and/or use difficulties in their financial practices that they can no longer lead a normal social life in the society in which they belong. Financial exclusion therefore is only definable in relation to the social consequences of the difficulties that it entails. It can affect individuals or banking service which includes in particular bank cheques and a bank card with systematic authorisation. The right to an account and basic banking service is free of charge.


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entire groups. The social consequences that constitute it vary depending on the society under consideration as well as the status of the person concerned. Finally it is important to emphasise, although we will not develop this point further here, as it is completely undisputed, that social difficulties that make up the process of social exclusion also contribute to the process of financial exclusion. Thus unemployed people or single mothers have a greater risk of facing financial exclusion. Therefore it is simultaneously a cause and an effect of social exclusion. Our hypothesis is that, based on this definition, it is possible to consider overindebtedness as one of the consequences that make up financial exclusion. It results from access and use difficulties that certain people face in relation to credit. The only noteworthy difference is that overindebtedness is a much more easily identifiable consequence than those concerning access or use difficulties in relation to accounts or non-cash means of payment. Moreover, it is this high visibility as well as moral judgements that are frequently expressed about debt, which lead to it being considered an independent phenomenon.

5.3 Access and Use of Credit: the Importance of Social Constraints First and foremost we should specify what we mean by “overindebtedness”. Firstly, we will look at the definition of overindebtedness laid down in French law: “the situation of overindebtedness for natural persons is characterised by the manifest impossibility of the debtor meeting, in good faith, all his non-business debts due and falling due and the commitment that he gave to guarantee to pay off the debt of an individual entrepreneur or company where he was not, in law or de facto, a manager of that company.” (Art. L. 330-1 of the Consumer Code). The debts in question are not necessarily debts connected with credit. They can also concern arrears of current expenditure (unpaid rent, water bills, electricity bills, etc.). However, if we consider the overindebtedness cases in France (Banque de France 2005) only 3% of them consist solely of arrears of current expenditure. Loans are present in 97% of cases (87% consist of both loans and arrears of current expenditure) and in six out of ten cases, they represent at least 70% of the total amount of debt. Therefore if we settle for observing only the composition of the debt it is apparent, unsurprisingly, that credit is an essential feature of overindebtedness.

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However, writing that credit plays a key role does not mean that credit itself is a cause of overindebtedness. It is no more so than a bank account or a payment card and it is not responsible for the consequences that access or use difficulties can cause. As for other financial products, access or use difficulties that certain people encounter in relation to credit produce consequences – in this case overindebtedness – which contribute to the development of the process of social exclusion. Therefore it is important to consider the nature of the difficulties encountered and the reasons they produce such consequences, the main reason being the financialisation of social relations. 5.3.1 The Financialisation of Social Relations Although banking difficulties contribute to the process of social exclusion, this is because they occur in a society which has placed financial services at the heart of its operations. One of the key factors that enables us to understand this is what we call, following Servet (2004), the financialisation of social relations. The financialisation of social relations6 corresponds to the fact that the various connections that make up the social bond (self-esteem, links to family and friends, links to society as a whole (employment, consumption)) are increasingly expressed and constrained by the use of financial services. This results both from expressing social relationships in monetary terms (social relationships are expressed in monetary forms to an increasing extent) and from the percentage of the population who have an account (in societies that have a high level of bank accounts like France, monetary circulation practices imply the use of financial services). Two examples may make this very theoretical description more concrete. The first concerns child care and mainly illustrates what monetarisation is. Before the “three glorious decades” after the Second World War and the transition from an industrial society to a service economy, geographical mobility of workers was relatively low and fewer women were in paid employment. Young couples with children could either look after them 6 We do not use the term “financialisation” in the narrow sense of “financialisation of economies” which corresponds to their financing via the financial markets. In our opinion restricting the use of the term “financialisation” to the financial markets would be equivalent to misunderstanding or denying the diversity of finance. The merry-go-round (rotating savings and credit association) of a group of women in Senegal and the activities of Wall Street traders are two manifestations of financialisation of social relationships. Only the degree is different. For more details on this point see Gloukoviezoff (2005).


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themselves, or entrust them to grandparents who lived nearby. Child care was therefore based on a social relationship which did not involve money changing hands. Nowadays, geographical mobility is much greater mainly for reasons connected with work, and far more women are in paid employment. Therefore, looking after children more frequently involves using the services of a crèche or child minders at home, and these are services that are paid for. So marketable services expressed in monetary form have taken the place of links based on family solidarity7. This is monetarisation. The second example concerns the development of the welfare state and is a further illustration of financialisation. At the end of the Second World War, a series of regulations and social protection measures were set up, based on the development of the wage society. This protection against risks like illness, unemployment, etc. took the form of financial benefits paid by the State. They started by supplementing, and then taking the place of older forms of solidarity which had proven unsuitable for dealing with the requirements of a wage society. In France, from 1978 on, these benefits have been paid only by bank transfer; in other words, it became essential for the whole population to have a bank account to be able to benefit from these payments. So the expression of these social links in monetary form involved and still involves using financial services. The high level of bank accounts in France is the result as much as the cause8. However, an additional factor which has arisen in recent years makes this financialisation even more explicit. The decline of the welfare state, which has resulted in the reduction of the amount of social benefits or tightening of their access conditions, has led to an expansion of use of financial services and in particularly borrowing, to deal with the ups and downs of life. This is particularly true of the United States and the United Kingdom where this decline has been the most pronounced, and where access to credit is most highly developed (Ramsay, 2003). On the one hand, all the links established with crèches are not necessarily operated for profit. For example, those set up as subsidised crèches particularly for families on the lowest incomes are not of this kind. On the other hand, the substitution of monetary links for links of solidarity is not necessarily something negative. In this document we are not making any value judgement but we merely wish to illustrate the change in ways these needs are met and the growing role that money plays. 8 This change which encourages people to open bank accounts obviously adds to that concerning the way in which salaries are paid, which is the principal cause. Since 1968, salaries have been paid monthly and cannot be received without having a bank account. 7

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So to lead a normal social life, i.e. to meet the needs considered as normal in given society, or deal with the ups and downs of life (unemployment, divorce, illness etc.), it is now imperative to call on financial resources which can only be achieved via financial services. These services are therefore at the heart of the social life of individuals. Various facets of their life “transit” via the financial sector. In this way difficulties in the area of employment (unemployment) or in the family sphere (divorce), have consequences for the person’s banking situation (unpaid loan instalments, for example). On the other hand, banking difficulties will have negative effects on other spheres which make up the social life of individuals. It is for this reason that difficulties for access or use may potentially contribute to the process of social exclusion and it is therefore possible to speak of financial exclusion as a social phenomenon. 5.3.2 Use of Credit as a Forced Response to Life Risks While the application of the preceding reasoning to financial services like bank accounts and non-cash means of payment poses relatively few problems, the same cannot be said for credit. The value judgments about the use of credit are very frequently marked by moral judgements. So although it would never enter anyone’s head to consider that a bank account holder who encounters problems is naive and irresponsible, the same cannot be said about borrowing. In the latter case, the same user may be accused of the two previous faults in addition to the inability to resist the immediate temptations of the consumer society. The explanation of his/her difficulty and potential overindebtedness should be sought on an individual basis in the user in question. It should be pointed out the opposite excess is just as prevalent, and holds lenders as the only persons responsible for the bankruptcy of their customers. What we wish to stress here is that while borrowers and lenders obviously have responsibilities, these must be structured and set in context: a context of financialisation of social relations. Placing individuals’ borrowing practices in the context of highly financialised societies restores their meaning and avoids the excess of certain individualistic and psychological analyses. One of the first factors which allows us to challenge the unilateral responsibility of individuals in the situation of overindebtedness is provided by the analysis given by the Banque de France on this issue (Banque de France, 2005). It draws a distinction between two types of overindebtedness:

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active overindebtedness, which is explained by excess borrowing without any change in resources; passive overindebtedness, which is a result of an unforeseen change in the level of resources and/or expenditure due to an “accident” of life (unemployment, separation, illness, etc.).

It appears that in 73% of cases, overindebtedness is passive in nature. It is due to an exogenous shock. The responsibility of the “hedonistic” consumer (Ramsay, 2003) therefore cannot be criticised in almost three quarters of cases. Even when one considers the 27% of cases of overindebtedness that are considered active, the responsibility of hedonistic behaviour of individuals is certainly not obvious, quite the contrary. Ramsay (2003) shows that in the United States, this behaviour is only responsible for a very low percentage of overindebtedness cases, around 5.4% (Sullivan et al., 2000). This is also the theory that Duhaime (2003) supports when he describes as a complete fiction the vision according to which “the consumer is the king of the system, the master of the game since, in the final analysis, he is entirely free to sanction the behaviour of businesses by his decision whether or not to purchase the goods which are offered to him” (p. 38). Neither can we say, on the other hand, that the customer has no autonomy whatsoever, and is manipulated by vendors and lenders. The objective here is to underline that in order to understand overindebtedness, it is essential to consider the constraints affecting the decisions made about borrowing. These constraints correspond to a large extent to changes in the wage societies. The development of mass unemployment, job insecurity and the appearance of poor workers have profoundly destabilised the institutionalised solidarity links based on an open ended contract of paid employment. This new relationship to employment is not only reflected in impoverishment of the people concerned but also transfers “entirely to the employee the costs previously borne jointly with the employer, like insurance and pension schemes” (Duhaime, 2003, p. 15). This is also the conclusion reached by Ford (1988) in his study of the reasons for the development of overindebtedness in the United Kingdom, highlighting three main causes: -

the challenge to the Welfare State by the neo-liberal wave; the downgrading of public service; the restructuring of large companies to deal with the new economic relationships resulting from globalisation.

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It is these natural economic changes associated with the financialisation of social relations which lead people to make use of financial services (overdrafts, loans, etc.) to contend with short term cash flow requirements. This is what is emphasised by Sullivan et al. (2000, p. 137, quoted by Ramsay, 2003, p. 23): “Consumers now use credit cards to see them through a time of crisis for which public assistance is unavailable or inadequate. If they survive, as most do, they will pay high interest rates, but they will eventually get back on their feet. If they do not, they can nonetheless consume the goods and services they need and shuck the credit balances when the debt scheme eventually collapses”. In a way, as pointed out by Ramsay (2003), this borrowing leads, in the event of a failure and overindebtedness, to accusations aimed at the borrowers or lenders and to making this a private problem, without raising any questions about the role of job insecurity and the shortcomings of the social security system, which is a public problem. However, we should not make the opposite error and consider that overindebtedness is only the result of increasing precariousness in society and that in order to resolve the problem, all that needs to be done is to ask questions about how growth and employment rates can be improved. Although these questions need to be asked, we will be missing the point by failing to see that the problem that actually arises is more the following: how can the lender and borrower cope with these macroeconomic changes in such a way that neither of them suffers as a result? Before showing the mechanisms which are an obstacle to the previous question being resolved, we need to stress the fact that identifying the increasing precariousness in society as one of the causes of overindebtedness does not alter the fact that this is a consequence of financial exclusion. Quite the opposite. If one considers the profile of people who have difficulties in accessing an account or non-cash payment methods, it emerges that they largely belong to the same social groups that have to face overindebtedness. However, a slight distinction does need to be made. At least in France, it seems that those on lowest incomes (i.e. those with incomes below the RMI9) are proportionally less concerned by overindebtedness (Banque de France, 2005). This is explained by the difficulties they have in accessing borrowing. In other words, it is because they have access difficulties that they cannot encounter use difficulties in relation to borrowing and therefore be faced with overindebtedness. Notwithstanding this, it appears that it is inI.e. 433 euros per month for a single person and 909 euros for a couple with two children over 14 years of age. 9


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deed people with the same profiles who are the least attractive in commercial terms according to current banking criteria, who have access and use difficulties concerning the various types of financial services including borrowing, and who have to contend with overindebtedness. Once again what distinguishes overindebtedness from the other consequences of access and use difficulties is its visibility. Moreover, besides the simplicity of grasping this concept, the interest in overindebtedness is probably explained by two factors. On the one hand the amounts involved are high and the people concerned are very frequently in impossible situations. On the other hand, but here we will no doubt be described as cynical, unlike difficulties in accessing a bank account or means of payment, the customer is not alone in bearing the consequences of use difficulties relating to credit. Overindebtedness also means that creditors cannot recover the money lent. Perhaps that explains why financial institutions are more interested in this precise consequence of financial exclusion than others. So, after having highlighted: -

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that the use of borrowing like any other financial services largely mirrors macro-social reasons which we group together under the term financialisation of social relations; that this recourse to borrowing, which is partly forced, is a source of access and/or use difficulties; and that these difficulties produce social consequences, including overindebtedness;

it is necessary to consider the mechanisms which produce these difficulties and any similarities that they may have when they concern credit or other financial services.

5.4 The Mechanisms Underlying Access and Use Difficulties The definition of financial exclusion which we have put forward creates a link between banking difficulties and their social consequences. We have greatly emphasised the reasons for these consequences, particularly concerning the phenomenon of financialisation of social relations. It has emerged that on the one hand, overindebtedness is the result of banking difficulties linked to credit, and on the other hand the overall mechanisms which explained that the banking difficulties produce these consequences, were the same for various types of financial services. However, the other dimension of financial exclusion has not yet been studied. Nevertheless it

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is essential to be able to take account of this phenomenon and attempt to counter it. This concerns the causes of access and use difficulties. Our objectives in this last part are to identify these causes and to highlight their similarity for banking difficulties in relation to credit or to other products. 5.4.1 The Reasons for the Banking Relationship Why do we use financial services? What reasons encourage us to maintain a long-term banking relationship? Of course, as we have said, society is organised in such a way that it is not possible to live without these services. However, beyond that fact, the raison d’être of the banking relationship should be sought in the very nature of the services provided by banks. For this reason we have deliberately left aside definitions drawn from banking economics, which treat financial institutions as intermediaries between savers and borrowers, and are, in our opinion, too restrictive. By adapting the definition Gadrey (2003) gives of service provision in general to the banking situation, we can put forward the following definition: the provision of financial services corresponds to the fact that a bank which has or controls a technical capability (products which are accounts, non-cash means of payment, various forms of credit or statistical tools for risk assessment) and human capabilities (the skills of employees, mainly their advice) sells its personal customers the right to use those capabilities and skills for a certain period to produce useful effects on its customers’ budgets. These useful effects are: the retention and increase of their funds, putting them into circulation to make expenditures, the anticipation or funding of projects and prevention or curative action when faced with life risks. This definition is a research convention which is valid for a geographical area and a particular period of time. It enables us to describe a reality that exists nowadays in France. Thus although it is valid in France it probably applies to a very limited extent in India and would have to be adapted to a limited degree for the Anglo-Saxon countries. In fact in France, the banking model which predominates is that of the “universal bank” where customers deal with a single service provider for almost all the services they need. On the other hand the model present in the United States and the United Kingdom corresponds more to a model of “split bank” where customers consume financial services from a variable number of different providers and only the wealthiest customers are likely to have a relationship which is almost exclusive with a single bank. Having pointed this out, we should draw the basic lessons from this definition concerning the issue under examination, financial exclusion.


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Customers use financial services for two main reasons. The first is that they do not have the technical capacities to carry out the operations necessary for living in a highly financialised society. Therefore they are obliged to work via intermediaries that have these capabilities and are approved by a public authority10 to operate as banks. But these intermediaries do not only have technical capabilities; they also have skills, which is the second reason. Customers rarely have a thorough understand how all the financial services that are available work. Therefore they need the advice of the banker – the expert – to decide “in full knowledge of the facts” about what financial services they should use11. This need for advice may be manifested at the beginning of the banking relationship when the customer has a precise vision of certain plans he/she intends to finance (purchasing property, higher education, etc.) but usually it appears when the customer’s situation undergoes positive or negative change (first job or dismissal, marriage or divorce, etc.). The appearance of these new requirements during the relationship presupposes that the banker would be able to adapt the services provided to the new conditions. In other words it presupposes that they are able to customise the service to cope with changes that are very rarely foreseeable, in the customer situation, as well as the customer’s aspirations. The latter factor is essential for understanding the specific nature of banking activities in general and the provision of financial services in particular. The economic literature on banking talks about the presence of risk at great length. For a bank which provides financial products including credit, there is a risk that customers may not repay the amounts borrowed or that they will make unsuitable use of the products that they have. The banker must therefore evaluate the level of risk associated with the customer. We shall return to this point later. What concerns us at present is that one aspect that is systematically left out: the risk to which the customer is exposed when using financial products. When customers use financial services, they pay “so that it works”. It is important to customers that the bank should give them the best advice possible to meet their requirements, including by refusing access to certain services which could be dangerous for maintaining a balanced budget. That means on the one hand that the bank must espouse the customer’s interest and not restrict its analysis to upholding the bank’s interests, and secondly it must not give poor quality advice due to lack of time or This authority is the Comité des établissements de crédit et des entreprises d’investissement (Committee of lending establishments and investment companies). 11 French law imposes an obligation on bankers to advise their customers. 10

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through incompetence. To have access to appropriate advice, it is not enough merely to have access to a banker. Moreover, contrary to the hypotheses of the economic theory of banking, customers often lack knowledge concerning banking issues. Therefore they may be dependent on the advice that their bank gives, without being able to assess whether it is relevant. In this sense, the customer is also taking a risk by using financial services. To obtain high quality financial services, i.e. which meet as far as possible the interests of the customer and the bank, it is necessary for the two parties to work together. This is what Gadrey (1996) calls copiloting.12 Bankers cannot decide alone about the decisions to be taken, despite their expertise, in the way that a mechanic would decide about repairing an engine. They must take account of their customer’s aspirations, but for this co-piloting to be possible, it is necessary that the customer should be able to express these aspirations (contact the banker at a sufficiently early stage and in the event of problems, give the relevant information, etc.) and be listened to (the banker must have the time to devote to the customer, be interested, etc.). In other words, it is necessary for them to be able to develop a relationship with sufficient trust to be able to customise the service provided. This description that we are giving of provision of financial services can be criticised to the extent that co-piloting is not omnipresent in the relationship as experienced by the majority of customers. Moreover, in the Anglo-Saxon countries, this link to the bank advisor that we observe in France is probably less present due to the difference in banking model (universal bank verses split bank). However, the requirement for advice or for expertise which underpins our definition of financial services withstands these criticisms. On the one hand co-piloting is not always present; it is present in a particularly intense way when the customer’s situation changes (purchase of property, loss of a job, etc.). On the other hand, including in the Anglo-Saxon countries, customers as a whole, but to differing degrees, need advice in making their financial choices. Those who have the most acute requirements are of two types: customers who have sizable assets, who have asset managers available to them, and those who, on the other hand, have very limited resources, are faced with precariousness and are unaware of their rights and the way the banking system functions. For them establishing a high quality relationship proves more difficult.

For readers familiar with the work of Goffman (1968), the banking relationship as we describe it here is like a service relationship. 12


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5.4.2 The Need for Suitable Advice to Customers on Limited Incomes On the strength of this definition of financial service provision, we can now identify more simply the reasons for which customers are likely to encounter use difficulties. In other words, we can identify the reasons that customers may encounter financial problems even though they do have access to certain financial services. Whether with regard to credit or for other financial products, the requirements of customers on low incomes are broadly similar. They need to be able to control the instruments that come between them and their budget. This is not easy. In fact, some customers have no knowledge whatever about these products. Some do not understand the meaning of the terms "credit" and "debit" that appear on their monthly bank statement (Gloukoviezoff, 2003, 2004). Under these circumstances, how can they possibly manage their budget? Besides problems of limited knowledge, customers’ budgeting skills are sometimes challenged by the introduction of financial products. Dealing with coins and notes does not require the same skills as the dematerialised management induced by using a bank account, a cheque book, a charge card, etc. This change has often destabilised the budget management of people who were used to having a concrete, physical relationship with their spending and their budget (Kempson & Whyley, 1999; Pahl, 1999, Guérin, 2000). For example, some people were used to managing their budget with a system of envelopes allocated to different budget items. This enabled them to avoid accidentally dipping into the rent money when there was not enough to pay for another item of expenditure. The fact of paying all a customer’s money into an account makes it impossible to apply this know-how. The solution would be to withdraw the money from the bank, to return to a cash management system, but this would come up against the problem that certain payments can only be made using cheques or cards, and requires a certain balance to be kept in the account. Going beyond day-to-day management, longer-term budget control is also made problematic by purchases made with a credit card. This makes it difficult to understand the number of repayment instalments and their amount (Pahl, 1999). The problem that arises is not related to incompetence on the part of customers with low incomes, but rather a mismatch between their know-how and that required to use financial services. Finally, even if customers do have the knowledge and skills necessary to deal properly with financial products and remain in control of their budget, the quality of their decision-making can be affected by their social situation. A distinction must be made between two major types of

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situation: people living in precarious circumstances, and those who are having to contend with some mishap in life. The fact of living in a permanently precarious situation sometimes leads to developing budget management practices that Guérin (2000) calls "survival management". Being constantly faced by daily emergencies, whether it involves putting food on the table or paying the bill that arrived in this morning’s post, etc., leads people to develop a specific relationship to time. In these situations, which are also typified by poor career prospects, the short-term assumes disproportionate importance. In other words, the importance attached to imminent payment deadlines is overestimated in comparison with those which will arise later. An illustration of this management practice is given by some products that are sold by specialised lending establishments. Some revolving loans are offered with an extremely low or even zero rate of interest for the first three or four months. These customers are particularly receptive to this kind of argument since their need for money is solved by this type of credit, which apparently has a limited cost, and they can worry about paying the interest later13. This type of behaviour is explained by the fact that these people often have difficulty looking to the future, and are mainly concerned about solving problems as and when they arise. In these circumstances, it is extremely difficult to keep a balanced budget. Advice from the banker – if it is of good quality – can be precious in avoiding poor decisions when that is still possible. In the event of setbacks in life, the problem is not quite the same, although there are many similarities. In the event of losing a job, the people concerned see their decision-making mode disrupted by the emotions that they are feeling. This may seem anecdotal, but it is essential to realise that someone who loses their job, or is trying to cope with separation or being widowed, is not in an ideal state to keep a close eye on their budget. Thus people can feel such shame when they lose their job that they will avoid meeting their bank manager for fear of being "judged" (Gloukoviezoff, 2004). They will look for solutions that avoid this confrontation, particularly by using revolving loans14. Of course, not

13 This shows the subtlety of the "customer sociology" that these institutions have developed. 14 In the French case, the revolving loan is the main resource for those in difficulty (the secured loan offered by the Crédits Municipaux municipal banks is only available in some large cities). On the one hand, some customers have these credit lines, which were granted to them before the setback occurred, and are still available. On the other hand, the institutions that grant them are not always able to


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everyone finds themselves confronted permanently with financial difficulties. Some manage to keep their budget under control. If we refer to research carried out in the United Kingdom and the United States where more data is available, it appears that the diversity of reactions is reflected by the use that people make of their credit card: some people hand back their card, others stop using it except for emergencies, while on the other hand, some people use it heavily, to pay various expenses (Rowlingson & Kempson, 1995)15. But budget problems are far more likely to arise if people find it hard to adapt their standard of living to their new situation, and even find it hard to understand that their behaviour is leading them towards bankruptcy. Here once again, having a high quality relationship with a bank can be particularly valuable. Therefore it is essential in order for these customers to avoid having use difficulties that their bank should offer the customised services where the advice dimension is not overlooked. For customers on low incomes, this is only rarely the case. 5.4.3 Banking Imperatives Versus Customisation of the Service Why don’t banks offer a high level of advice to people on low incomes? After all, they always claim to want to meet their customers’ requirements. The explanation is due to the fact that while customer satisfaction is important, it is only a means, not an end. The ultimate aim for the banks which are profit-making bodies, is that their business should be profitable16. find out that these incidents have occurred, or know how much debt these people are in. In France, there are no positive databases or credit bureaus. We wish to stress the fact that revolving credit is not "bad" in itself. Merely, when it is used by people who do not understand how it works and its implications, do not realise how much it costs, or where it is used or granted in an inappropriate way (inadequate advice, accumulation of debts, etc.), it can be a major factor in making the situation worse. However, not all customers who use this kind of credit when they run into difficulties end up drowning in debt. Some of them – probably the majority – find it to be a solution to their problem, albeit an expensive solution. 15 In the French case, credit cards are far less widespread and it is mainly revolving credit lines that play this role. 16 This statement may seem rather simplistic. Some mutualised banks or the Postal Bank (Banque Postale) in France, credit unions in the Anglo-Saxon countries, combine profitability with other values. However, in the context of this article, due to the predominance of this value, and out of a concern for clarity, we shall treat the search for profit as being the objective of the banks.

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So the banks try to select and increase the loyalty of customers with whom they can have a commercially viable relationship. To do that, they will need to assess the needs of the customers and their level of risk, at the lowest possible cost. In other words, they must go beyond the asymmetry of information that exists between the banks and their customers. This issue is nothing new for the banks. What is new is the way that they have dealt with this issue for the last fifteen years. Particularly due to the changes in the context in which they operate (very high level of liberalisation of the banking industry due to standardisation of the banking regulations, opening up of markets to new entrants and foreign players), banks have undergone a dual revolution, affecting both the logic of their operations, and the way in which they are implemented. They have changed in just a few years from an activity based on local services where bank managers knew their customers well, and where the duration and stability of the relationship produced the demand from customers, to an activity based on proactivity by the banks, which have to stimulate the "needs" of customers, whom they only really know about from the information contained in the bank’s databases (Courpasson, 1995, 2000; Leyshon & Thrift, 1999). The advent of marketing and its tools (scoring, datamining) whose efficiency is unprecedented, has changed banking professionals’ understanding of the market considerably. In the past, it was branch managers who held the knowledge about customers, with whom they were in daily contact. Now it is computerised databases which store the "knowledge" that banks hold about their customers. Based on this data, customers are segmented by their risk level and their assumed requirements. Banking professionals have switched from knowledge and action based on "actual markets" (Courpasson, 1995), to knowledge and action based on "segmented markets"17 (Gloukoviezoff & Lazarus, 2006). These changes are based on at least two extremely strong beliefs. The first relates to the virtual certainty that the recommendations issued by scoring and datamining tools are sufficiently relevant to be sufficient in their own right. The second belief relates to the degree of autonomy of customers. While these beliefs have their limits, which are real, for the whole population, they particularly penalise customers on low incomes. Leyshon and Thrift (1999) explain that the underlying marketing hypotheses treat consumption as a "rational" act with "needs" that must be These changes are also accompanied by many changes in the way bank branch networks are organised, and human resources are managed, which we will not go into here, but which also constrains the action of bankers (Courpasson, 2000). 17


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met. These two authors call into question, by drawing on various studies (Miller, 1995; Bianchi, 1998; Levine, 1998), the rational nature of consumption, as well as the ability of marketing specialists to understand a priori the needs of customers. Therefore, it is highly unlikely that the statistical tools alone can guide the actions of the banks. This is confirmed by the observations of Rowe (1998), incidentally. They highlight that the recommendations by scoring tools are followed systematically where they concern customers who belong to the least commercially attractive customer segments, while they are often re-processed and invalidated when they concern wealthier customers. This clearly illustrates the fallible character of these tools and also leads us to consider a second contradiction within marketing hypotheses. Leyshon and Thrift (1999) emphasise that “the only ‘needs’ that the industry are really interested in providing for are those consumers whose custom will provide the firm profits. Knights et al. (1994) reveal that this requirement has caused some financial services firms to withdraw products from sale in the face of customer demand (‘need’) on the grounds that they were no longer profitable” (p. 439). Thus, and this aspect is of paramount importance, only profitable needs are satisfied. It appears that one of them, which is nevertheless essential to the quality of the service, is not considered as such by the banks when it concerns customers on low incomes: advice. Segmentation of the customer base and processing of data about customers enables banks to offer financial services that usually correspond to the customers’ requirements. The banks offer customisation which is close to "tailor-made services for the masses" (Bressand & Nicolaïdis, 1988). The higher the level of the segment, the greater the quality and variety of products and services that become accessible – this is the “super inclusion” to which Leyshon and Thrift (1996) referred. However, this definition of the financial supply also leads to the suggestion that the lower segments have less need for advice than the higher segments. The less commercially attractive customers are grouped into very large portfolios, and entrusted to bankers who are often very inexperienced, while attractive customers are put into more select portfolios, and entrusted to experienced bankers. Rowe (1998) also indicates that customers with modest resources are sometimes put into a portfolio assigned to multiple bankers, which has a negative impact on the quality of the follow-up. This poor or nonexistent advice for low-income customers is variable, depending on the banking networks, but can generally be explained by the hypothesis which is made about the autonomy of the customers. Thus, in banking reasoning, a customer is generally considered as responsible and sufficiently competent in financial matters to evaluate the relevance of his/her choices

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(Gloukoviezoff, 2004). We have already seen how questionable this claim is. However, behind this reasoning which justifies existing practices, the constraint of profitability is definitely present. Advice is an extremely expensive dimension to the provision of financial services, since it absorbs a large amount of time and the resource that is most expensive for a bank: staff. This is particularly true for customers on low incomes, who often have to deal with complex economic and social situations, a serious lack of knowledge about banking, and relatively low prospects of ever being profitable. Therefore, it is unsurprising that banks generally tend, instead of providing advice and recognising these customers as full participants in the banking relationship, to prefer to adopt procedures that protect themselves against the risk and expense associated with the absence of advice. Therefore, at present, the profitability of banking relationships established with these customers relies on the high level of charges in the event of incidents, if problems should arise. Likewise, responses contributed to the discussion about the battle against financial exclusion by the banks are limited, in France, to the introduction of a positive database18 so as to enable better evaluation of the risk taken by the bank, and adjustment of the (excessive) interest rate to be able to lend at a higher rate, thus improving the profitability of the transaction. Even though these arguments are far from irrelevant, it is also necessary to pose questions about the actual characteristics of the provision of financial services. These characteristics largely explain the access and use difficulties that customers on low incomes face. 5.4.4 Standardisation of the Service that Is the Source of Access and Use Difficulties, and Therefore of Overindebtedness To contend with the expensive needs of people on low incomes, the banks have come up with a standardised service provision which protects the banks as far as possible. However, this standardisation itself contains the seeds of access and use difficulties which customers face. Before making the causal connections that exist more explicit, two examples provide an illustration of the perverse effects.

This proposal is far from being unanimously supported, including within the banks. 18


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The first example concerns the effects of the lack of long-term monitoring for people in stable situations, but on low incomes. Provided that they have a regular income, various banking networks will automatically grant them an overdraft of 50% of that income. So a person who earns 1,000 EUR is "entitled" to a 500 EUR overdraft19. For some of these people, it appears that the overdraft, although expensive, is often a necessity to ease the constraints of an income that is structurally too low to meet their needs. Gradually, these people see their overdraft swell. They are operating their budget with a permanent debt that increases from 50 to 100 then 300 EUR and so on. This growth in the debt is gradual, with shorter or longer phases of stabilisation, but it inevitably moves towards the limit of 500 EUR. Throughout this trend, the bank does not receive any warning signs, since there is no sudden deterioration. However, once the overdraft exceeds 500 EUR, the automated procedure for dealing with incidents springs into action, with the associated charges. The customer is told to repay the debt and pay the charges that he or she owes to the bank. Unfortunately, it is extremely difficult for a person with a low income to repay a debt that is over 50% of that income. It is made even more difficult by the fact that the debt arose over a long period, and has become a means of managing their budget. It is unlikely that the people concerned will be able to find the right solution on their own. The close links between banking difficulties and social difficulties are obvious here. It is certain that in a situation of structurally low income, it would be desirable for social workers to intervene to perform a budget diagnosis and define any financial support necessary. However, the easy access to the overdraft, the absence of warning to the customer by the bank about the latent imbalance in his/her situation (a warning which, if given, is not always heeded), and the difficulties in accessing social services (ashamed to ask, eligibility criteria, etc.) are all factors that exacerbate the situation. So, for people with little knowledge about banking, who have to deal with an emergency, it may seem easier to use a revolving loan to repay these amounts (the amount of the overdraft plus the bank charges) than to take a really close look at their budget. The second example relates to situations where there is a sudden, unforeseeable destabilisation of the customer’s budget. This may be a 19 Several bankers from different networks confirmed these practices to us, stating that they allowed a 300 EUR overdraft for a fixed income of 600 EUR. However, in the latter case, some bankers did tell us that it was not always beneficial to the customers concerned. By way of comparison, it should be noted that the minimum income considered vital and to be retained in the case of overindebtedness is 433 EUR for a single person.

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major event like a setback in life, or a problem that appears to be much more controllable, such as a delay in payment of benefits. In this way a household with limited but stable income had 16 cheques bounced in two months, due to a delay in refunding substantial medical expenses. Each bounced cheque resulted in charges of about 64 €20, and they received a bill for 1 030 € in charges (Gueneau, 2000). The disproportionate amount demanded by the bank is largely explained by the totally automated processing of situations. Moreover, customers who are not sufficiently commercially attractive, and are dealing with a banker who has little time to devote to them will have great difficulty in persuading the banker that they are not responsible for the incident that has occurred (Gloukoviezoff, 2004). As in the previous example, similar mechanisms can kick in, leading customers to avail themselves of services that appear to offer solutions. But these services are often unsuitable and may, in the long term, be a factor that considerably aggravates the situation. If we leave the social difficulties aside for a moment, these two examples show that while customers do bear a share of the responsibility for the banking difficulties that arise, it remains true that this responsibility has to be shared with the bank, which offers inappropriate access to its services. In fact, the de-personalisation of the service, standardisation and automation of procedures make it particularly difficult to take account of career upheavals or the fact of living in long-term financial insecurity. So while one can criticise customers for not warning their bank early enough of the problems they are facing (dismissal, delays in payment, etc.), it is necessary to link this behaviour to the cause. Many customers prefer not to warn their bank out of fear that in order to protect itself, the bank may sanction them by withdrawing some of the services to which they do have access. This is not a matter of saying that if the bank provided more advice to these customers, that would suffice to solve all the banking problems that they encounter. Of course not. However, it would definitely make it possible to reduce the number of people facing these difficulties, as well as the amount of charges associated with incidents. The establishment of a de-personalised banking relationship leads to distrustful behaviour and reticence on the part of customers. They look for solutions outside the bank, and often these solutions are worse than the original problems. It is extremely For cheques of less than 50 €, the law (Article 23 of Law no. 2001-420 of 15 May 2001 on the new economic regulations (NRE)) provides for a cap on bank charges of 30 €. For cheques of higher amounts, the charges made vary from 7.5 € at the French Post Office to over 100€ at some other banks (most charge between 50 and 60 €.) 20


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difficult to implement the effective co-piloting of the service that we have seen is crucial to this type of service provision. The poor quality of the financial service provision is therefore an essential factor that contributes to use difficulties and therefore the development of overindebtedness. When faced with destabilisation of their budget or chronic lack of funds, some people turn to expensive loans where advice is virtually non-existent. They can also use cards or credit lines that have been granted to them before the difficulties arise, and which are not taken away from them afterwards. It is the lack of suitable alternatives in terms of product characteristics and advice that explains the worsening of these situations. We find a similar conclusion in Ford (1991): “The use of credit by low-income households is, however, currently problematic. Not on grounds of principle, but because the forms of credit available to them are restricted and costly” (p. 99). However, the point that we wish to emphasise at the end of this process of reflection, and which is the key point in our reasoning, is that while the poor quality of the banking relationship explains use difficulties and its consequences including overindebtedness, it explains access difficulties in a similar way. Two main causes of access difficulties have been identified: the direct (refusal) or indirect refusal (location of branches, charging practices or advertising) of the banks, and self-exclusion by customers (FSA, 2000; Gloukoviezoff, 2004). First, banks select their customers by virtue of their profitability constraint, which is due to risk and cost. However, as we have explained, the level of risk and cost is partly explained by the type of financial services that are on offer. Thus de-personalised and standardised service leads to a higher level of risk and cost for those customers who do not match the profile expected by the banks. In other words, it is the mismatch between the characteristics of customers and the banks’ expectations that explain that the banks refuse these customers access to their services. Another type of service, for example a more personalised service, could reduce the risk level of a part of these customers. The experience with micro-loans provides an example of this. Secondly, customers also self-exclude from the bank due to the poor quality of the relationship. In particular, it is because they expect to be rejected by the bank, that they consider that they will have difficulties in using some services, or that they have actually had difficulties, that they abstain from applying for these services (Gloukoviezoff, 2004). Therefore, access difficulties, in relation to either the selection practised by banks or self-exclusion by customers, can be explained by the mismatch in financial service provision offered to low income customers. The problem is that the

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unsuitable practices of customers justify a posteriori the practices of the banks: this is a vicious circle. Therefore there is no paradox in people who do not have access to a bank account or credit living alongside those who suffer from overindebtedness. The following diagram aims to illustrate this in a simplified way, via two possible routes – these are stylised examples which are by no means the only routes possible, or even the most common – following a setback in the customer’s life, leading in one case to access difficulties (no bank account or non-cash means of payment)21 and in the other to use difficulties (overindebtedness). Figure 5.1 Unforeseen destabilisation of the budget and possible outcomes Unforeseen destabilisation of the budget (Setback in life)

Bounced cheques

Overdraft limit exceeded and delays in payment

Automated processing

Automated processing

Prohibition by the bank (legal procedure call Interdiction bancaire)

Confiscation of cheque book and sometimes debit card

Closure of the account

(8 % of people whose account has been closed have no other account)

Accumulation of bank charges

Inappropriate use of revolving credit to repay overdraft

Overindebtedness

Interdiction bancaire : suspension of your banking privileges; an action which is communicated to all banks. 21


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5.5 Conclusion The initial question was whether there was a paradox in that difficulties in obtaining access to financial services are found alongside overindebtedness. There is no paradox. Access and use difficulties that people on low incomes experience (but they are not the only ones) have the same causes and the same consequences. They are the result of problems that banks and customers encounter in solving the challenge that faces them: incorporating into their banking relationship the economic and social constraints that affect each party, within highly financialised societies. The financialisation of social relationships results in financial services becoming a key factor in the life of citizens. It is essential to be able to use them in an appropriate way to lead a normal social life. But these services are offered by private-sector institutions that aim to make a profit on their business activities, i.e. they must control the risks they take and the costs they incur. The development of computerised tools has enabled these institutions to attain that objective very efficiently (the very low level of bad debts and the profitability of specialised lending institutions is evidence of that). However, the standardisation and automation of the service that currently accompanies the use of these tools results in financial services being offered that are not appropriate to the needs of at least a proportion of customers: those on low incomes or facing upheavals in their lives. This mismatch generates potential costs and risks for the bank. That is why, on the one hand, it selects its customers, prohibiting access to its services – or to some of its services – to a part of the population. On the other hand, it defines a service that guarantees as far as possible that the costs and risks of the relationship are borne not by the bank, or at least to the minimum extent possible, but by the customers themselves. This is a long way from the bank described by Okun (1981) offering its customers "an umbrella in bad weather". We are much closer to the maxim attributed to Mark Twain: "A banker is someone who lends you an umbrella when the weather is fine, and takes it away when it starts to rain". The strategy of the banks is to satisfy the requirements that they consider profitable for themselves. However, that profitability does not depend only on the characteristics of the customers, but also on those of the service itself, whether in terms of advice or the product characteristics. The choices that have been made by giving a crucial role to computerised systems to evaluate the needs and risks have proven detrimental to customers who do not match the profiles that the banks expect. That is

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partly linked to the systems themselves, as well as to the fact that these systems were not developed to meet the needs of customers. On the one hand, the gradual disappearance of interaction between bankers and customers is a factor that changes the nature of the relationship established. A relationship where trust could be built up over time, and rely on interpersonal relationships, is being replaced by a more functional, more contractual relationship, where the bank becomes more a technical operator that executes the instructions of autonomous customers. This is rarely the case with customers facing poverty or who have lost their job. The question that arises is how to re-structure these computerised systems and the expertise of banking advisers not only to help wealthy customers, but also those who are far less prosperous. Moreover, we find the distinction drawn by Leyshon and Thrift (1996) between those who are "super included", for whom a wide range of products has been developed, and the undesirables who receive no attention at all. While computerised systems can be used efficiently to identify the needs of wealthy customers, it is probable that they could be configured to detect deteriorating situations at an early stage. However, it is necessary that information should be used in a context that allows copiloting and does not just provide protection for the bank. Thus financial exclusion is an overall social phenomenon. The problems of access to an account or credit and overindebtedness are the consequences that feed into the process of social exclusion. We have emphasised this throughout, but it is essential to drive home this point: financial exclusion cannot be defined with regard to the responsibilities of the banks or customers, but in relation to the social consequences of access and use difficulties. However, to counter this phenomenon, it is important to understand the extent to which it is possible to reconcile the constraints of each party. Probably a proportion of customers currently ignored by the banks could be reached in a profitable way if the banks re-examined their conventional wisdom. The Community Reinvestment Act (CRA) that drew attention to markets totally ignored by the American banks until now reinforces our view on this point. However, broadening access cannot just be a question of the quantity of financial services available but is also a question of the quality of the service provided. This aspect makes this a very thorny issue, as advice and monitoring are very expensive activities for institutions subject to competition and profitability requirements. Nonetheless, the absolute necessity of using financial services in order to lead a normal social life means that it is not possible to dodge this issue. The very status of these services needs to be re-examined. Is it possible to entrust these services to


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establishments that are only governed by market forces? Should we not devise regulations allowing competitive freedom and social necessity to be accommodated? The CRA is probably one example of a possible response. Polanyi (1944) already considered the specific role of money and the dangers of regulating exchanges purely from the viewpoint of market forces. It is probably time to reconsider the arrangements for regulating trade in financial services.

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Gardener E., Molyneux P., & Valverde S. (2005), Financial Exclusion, London: Palgrave Macmillan. Gloukoviezoff G. & Lazarus J. (2006), La relation bancaire avec la clientèle de particuliers: sélection et captation du client bancaire, Revue de la littérature volet 2, Mission de la recherche de La Poste. Gloukoviezoff G. (2003), L’activité des agences bancaires en environnement sensible, study for the Caisse d’Épargne Rhône-Alpes Lyon and the Fédération Nationale des Caisses d’Épargne. Gloukoviezoff G. (2004), “De la bancarisation de masse à l’exclusion bancaire puis sociale”, Revue Française des Affaires Sociales, no. 3, Paris: La documentation française, pp. 11-38. Gloukoviezoff G. (2005), “Introduction générale”, in Gloukoviezoff G. (ed.), Exclusion et liens financiers. Rapport du Centre Walras 2005, Paris: Economica, pp. 15-29. Goffman E. (1968), Asiles, Paris: Les éditions de minuit. Gueneau C. (2000), Les besoins des personnes fragiles en matière de service bancaire, in “Revue d’Économie Financière”, no. 58, pp. 47-56. Guérin I. (2000), Pratiques monétaires et financières des femmes en situation de précarité, doctoral thesis in econmics Université Lumière Lyon 2. Kempson E. & Whyley C. (1999), Kept out or opted out? Understanding and combating financial exclusion, Bristol: The Policy Press. Knights D., Sturdy A., & Morgan G. (1994), The consumer rules? An examination of the rhetoric and “reality” of marketing in financial services, in “European Journal of Marketing”, no. 28, pp. 42-54. Levine D. P. (ed.) (1998), Subjectivity in Political Economy, London: Routledge. Leyshon A. & Thrift N., (1995), Geographies of Financial Exclusion: Financial Abandonment in Britain and the United States, in ”Transaction of the Institute of British Geographers”, New Series, no. 20, pp. 312-341. Leyshon A. & Thrift N., (1996), Financial exclusion and the shifting boundaries of the financial system”, in “Environnement and Planning A”, no. 28, pp. 11501156. Leyshon A. & Thrift N. (1999), Lists come alive. Electronic systems of knowledge and the rise of credit-scoring in retail banking, in “Economy and Society”, vol. 28, pp. 434-466. Loisy C. (2000), Pauvreté, précarité, exclusion. Définitions et concepts, in Observatoire national de la pauvreté et de l’exclusion sociale, Les travaux de l’Observatoire national de la pauvreté et de l’exclusion sociale, Paris: La documentation française, pp. 23-50. Miller D. (1995), Consumption as the vanguards of history: a polemic by way of an introduction, in Miller D. (ed.), Acknowledging Consumption, London: Routledge, pp. 1-57. Okun A. (1981), Prices and Quantities: a macroeconomic Analysis, Oxford: Basil Pahl J. (1999), Invisible Money. Family finances in the electronic economy, Bristol: Policy Press.


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Panigyrakis G. G., Theodoridis, P. K., & Veloutsou, C. A., (2002), “All customers are not treated equally: Financial exclusion in isolated Greek islands”, Journal of Financial Services Marketing, 7, pp. 54-66. Polanyi K. (1944), The Great Transformation, New-York: Rinehart. Ramsay I. (2003), Consumer Credit Society and Consumer Bankruptcy: Reflections on Credit Cards and Bankruptcy in the Informational Economy, in Niemi-Kiesiläinen J., Ramsay I., & Whitford W., Consumer Bankruptcy in Global Perspective, Portland: Hart Publishing, pp. 17-39. Rowe F. (1998), Formes de surveillance et relations de confiance dans les types de relation: l’impact de l’informatisation bancaire, in “Réseaux”, no. 91. Rowlingson K. & Kempson E. (1995), Paying with Plastic: A study of credit card debt, London: Policy Studies Institute. Servet J.-M. (2000), L’exclusion, un paradoxe de la finance, in “Revue d’Économie Financière”, no. 58, Paris: Montchrestien, pp. 17-28. Servet J.-M., (2004), Introduction générale, in Guérin I., Servet J.-M. (eds.), Exclusion et liens financiers. Rapport du Centre Walras 2004, Paris: Economica, pp. 4-20. Sinclair S.P. (2001), Financial Exclusion: an introductory survey, Edinburgh: Heriot Watt University / Centre for Research into Socially Inclusive Services (CRSIS). Sullivan T., Warren E. & Westbrook J. (2000), The Fragile Middle Class: Americans in Debt, New Haven: Yale University Press.

6 The Role of German Savings Banks in Preventing Financial Exclusion

Natalia Bresler, Ingrid Größl and Anke Turner

6.1 Introduction In today’s Germany, like anywhere in the world, the use of financial services is essential to participate in economic life. Bank accounts are needed to pay the rent or to receive income. The usage of loans and investment opportunities helps to manage income fluctuations, often caused by insecure employment situations or unplanned events such as divorce or illness. Life risks can be managed and minimized with insurance policies. Despite a rising financial inclusion of private households over the last decades, certain social groups and people in certain areas generally tend to be excluded from the access to financial services. For Germany, a comprehensive study of the level of financial exclusion does not exist. This can have several reasons. On the one hand, there might be no studies showing significant financial exclusion in Germany because financial exclusion simply does not exist or is not perceived as an important issue. On the other hand – assuming financial exclusion exists in Germany – defining and measuring financial exclusion is tricky. Statistics gathered by official German sources are not intended to answer questions about financial exclusion. From research of financial exclusion we know, the excluded groups are often characterized by low income, unemployment, lack of education or high crime environments, to name a few examples. Therefore, the financial exclusion debate is mostly associated with poverty problems1. However, for the purpose of this paper, we would like to include in the groups most For a discussion of financial exclusion see e.g. Claessens (2005); Anderloni (2003), p.10 ff; Sinclair (2001); Caskey, Collard, Kempson, Whyley (2000). 1

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likely to be financially excluded not only private households but also small enterprises. Small and medium sized enterprises (SME) play a vital role in economic development of Germany and their financial exclusion can have a significant effect on economic development of the country. There are numerous strategies possible to overcome financial exclusion2. For example, the government could regulate the financial industry. One advantage would be the enforceability of a specific right. High costs for control and bureaucracy could be counterproductive though. The industry could alternatively agree upon voluntary codes of conduct in order to avoid costly state regulation. The main risk of this strategy is that not all providers of financial services may adhere strictly to the codes. Another strategy could be that the financially excluded will find a way to organize themselves. The last strategy has a long tradition in Germany. In 1778, the “Ersparungsklasse” of the Allgemeine Versorgungsanstalt was founded in Hamburg as the first savings bank3. The first formations of savings banks by private associations were intended to decrease poverty and foster selfdirected life precautions through the means of savings. The industrial development in Germany around 1800 caused widespread poverty among small businesses in towns and among farmers. Starting in 1830, the establishment of savings banks by municipalities was aimed at the provision of credit to individuals as well as to small commercial and agricultural businesses4. In 1850, the Eilenberger Vorschußverein was founded by Hermann Schulze-Delitzsch in Delitzsch as a first example for a cooperative credit institution in towns. In rural areas, cooperative credit institutions were founded as “Darlehenskassenverein”, based on the ideas of Friedrich Wilhem Raiffeisen5. Today, the succeeding institutions are organized in the savings bank sector and in the cooperative bank sector. Looking at the balance sheet total of all banks6 on December 2005, these two pillars (out of three) account for 62 % of the German banking sector. From a more general perspective, Shleifer (2005) describes the different strategies of dealing with market inefficiencies from market-oriented selforganisation to public ownership, demonstrating theses strategies on the case of securities markets. 3 See DSGV (2006). 4 See Mura (1995), p. 78 ff. 5 See Aschhoff, Henningsen (1995), p. 18. 6 This number includes the private banking, the cooperative banking and savings banking sector. We didn’t include mortgage banks (“Realkreditinstitute”), building societies (“Bausparkassen”), and banks with special tasks (“Banken mit Sonderaufgaben”). Bundesbank (2006), pp. 10. 2

6 The Role of Savings Banks in Germany

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Today, German savings banks are acting like normal banks, serving all types of customers and not only those in need. But yet they are related to the promotion of public welfare by their public mandate (“Öffentlicher Auftrag”). This paper looks closer at the German savings banks and their role in preventing financial exclusion. Firstly, we start with a short overview of the German banking system, in particular its three-pillar structure. The focus is on the specific characteristics of the savings banks sector, e.g. the public ownership structure, the public mandate and the regional principle (“Regionalprinzip”) as well as on recent developments affecting the public-banking sector. Secondly, we examine the public mandate more closely. In the current economic and political debate, many discussants question the need for a public banking system in order to ensure the access to financial services. Our analysis indicates that, along with other measures to prevent financial exclusion, this instrument seems to work quite well until now. In the final chapter we discuss the rising pressure on savings banks to operate profitably and the potential impact on the public mandate and its efficiency as a means of ensuring access to financial services.

6.2 Savings Banks as a Part of the German Banking System 6.2.1 The Three-Pillar Structure of the German Banking System A particular feature of the German banking system is its universal character. In other words the majority of German banks conduct, to greater or lesser extent, every type of banking business, which legal definition is given in the Article 1 of the Banking Act. The group of all universal banks may be subdivided into three broad categories, often referred to as the three pillars of the German banking system: (1) privately owned commercial banks, (2) the credit cooperatives group, (3) savings banks group (“Sparkassen-Finanzgruppe”). This distinction is made in terms of ownership structure: while the private commercial banks are privately owned and the credit cooperative banks are member-owned, the financial institutions of the SparkassenFinanzgruppe are with a few exceptions state-owned and belong to the local municipalities or counties or to one of the states (“Bundesland”). Savings banks can be acquired solely by other member institutions of the Sparkassen-Finanzgruppe while mergers and acquisitions are not restricted

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for commercial banks and – assuming certain pre-conditions are met – even possible for credit cooperative banks7. But what is the weight of every pillar? According to 2004 data, Landesbanken and savings banks had the highest number of employees. The number of branches is about equally weighted among the pillars8. Comparing the number of banks and the number of branches it turns out that the local cooperative banks are relatively small. Table 6.1 Key Metrics of the German Banking System in 2004

Number of banks Number of branches Employees Loans to enterprises and consumers Deposits from non-banks Balance sheet total Net interest income Net commission income Operating result before valuation Earnings before tax Cost/income ratio

All banks*

Private commercial banks

Landesbanken and savings banks

Central cooperative banks and credit cooperatives

2,229 42,659

357 14,750

489 14,841

1,340 12,978

678,800 2,224,165 mio €

192,550 574,776 mio €

303,950 829,629 mio €

169,250 362,120 mio €

2,511,211 mio € 7,183,653 mio € 85,012 mio €

726,980 mio €

943,985 mio €

443,891 mio €

2,361,952 mio € 29,476 mio €

2,504,949 mio €

761,918 mio €

33,082 mio €

15,201 mio €

25,345 mio € 13,497 mio €

7,278 mio €

4,000 mio €

39,962 mio € 12,076 mio €

16,021 mio €

6,608 mio €

10,420 mio € - 337 mio €

4,938 mio €

3,173 mio €

65.5 %

73.5 %

53.5 % and 59.2 % and 64.9 % 68.7 % Return on equity 4.21 % - 0.41 % 1.07 % and 2.91 % and before tax 9.86 % 10.23 % *Including mortgage banks (“Realkreditinstitute”), building societies (“Bausparkassen”), and banks with special tasks (“Banken mit Sonderaufgaben”).

Source: Deutsche Bundesbank (2005a), pp. 15-30; Deutsche Bundesbank Zeitreihendatenbank. Dagott (2003), p. 160 mentions eight acquisitions of credit cooperative banks by savings banks between 1937 und 1987. 8 Starting in 2004, the former state owned Deutsche Postbank is included in the numbers of the private commercial banks. Deutsche Postbank is part of Deutsche Post, using its nationwide postal branch network. 7


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Landesbanken and savings banks have a substantially higher market share in terms of loans to enterprises and consumers as well as deposits from non-banks. With total assets of 2.5 trillion € the Landesbanken and savings banks are closely followed by the private commercial banks while the cooperative banking sector has substantially lower total assets of 762 billion €. In comparison, both the local savings banks and cooperative banks have the highest profitability. As wholesale banks, the Landesbanken not surprisingly show the most favourable cost-incomeratio since they don’t maintain an extensive branch network. Since World War II, the German economy didn’t suffer from a crisis in the banking system. Despite a difficult business environment for German banks due to the meltdown of the securities markets after 2000 combined with a general economic slump, the Deutsche Bundesbank asserts the stability of the German banking system.9 Comprehensive stress tests as conducted by the Deutsche Bundesbank in summer 2004 didn’t reveal exposures endangering the stability. Moreover, the regulatory solvency ratios of German banks are in line with international standards.10 6.2.2 Key Facts of the Sparkassen-Finanzgruppe The Sparkassen-Finanzgruppe encompasses regional banks (“Landesbanken”), regional building and loan associations (“Landesbausparkassen”), the central investment service provider DekaBank and a few other financial services companies as well as the local savings banks (“Sparkassen”). With 670 companies, 22,000 branches, a staff of approximately 390,000, the aggregated balance sheet total of 3.2 trillion € at the end of 2004, this financial institutions group, viewed as whole, is the largest banking group in the country and in the world.11 The cooperation inside the Sparkassen-Finanzgruppe is characterized by close interaction between all the structural levels of the Group. The local savings banks, constituting the first tier of the Sparkassen-Finanzgruppe, provide front office banking services for private clients, local companies and institutional customers while the Landesbanken are engaged in the both large-scale and international business, acting furthermore as bankers of the state governments. The latter build a link between the local savings banks and both national and international banking systems by providing a broad range of financial services that would remain precluded or too See Deutsche Bundesbank (2003), pp.5ff; Deutsche Bundesbank (2004a), p.5. See Deutsche Bundesbank (2004), p. 79; Sachverständigenrat (2004), p. 281f. 11 See Hoppenstedt (2005), p. 6. 9

10

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expensive in terms of production costs for the often too small local savings banks. Such services include primarily complex banking products, domestic and foreign payment transactions, centralized processing of securities business and liquidity management. Due to this subsidiary-like structure, which persists between all the associated companies of the Sparkassen-Finanzgruppe, even the smallest local savings banks are able to offer their customers a vast range of universal banking services. An important characteristic of the savings banks, which is stipulated in the savings banks laws and statues, is their devotion to serve the public interests (“Öffentlicher Auftrag”) by providing safe and interest-bearing investment opportunities and access to credit facilities primarily to the local population and small and medium-sized enterprises. Thus, the savings banks may be seen as a state instrument to foster and ensure the provision of financial services throughout the country. The legislative rules however oblige the savings banks to conduct their business economically and to fulfill their public mission out of their own profits. In accordance with their public mandate, savings banks also fulfill a sociocultural function acting as promoters and sponsors of social and cultural events, sports and arts. With donations of approximately 353 million € for art and culture in 2004, the Sparkassen-Finanzgruppe is indeed by far Germany's biggest non-government sponsor of culture and sport12. Thus the savings banks’ commitment to social welfare encompasses not only a financial but also a cultural aspect. The latter will not be discussed further as the aim of this paper is solely to assess the role of savings banks in preventing financial exclusion. 6.2.3 Relationships Between Municipalities and the Sparkassen-Finanzgruppe Owned by local municipalities or counties the savings banks are governed by the respective state savings banks law and are subject to a regional principle (“Regionalprinzip”), which restricts the business area of each savings bank to the geographical area of its owner. Due to this geographical restriction there is hardly any competition inside the Sparkassen-Finanzgruppe. The organizational structure of the Group thus resembles the multi layers structures of the big commercial banks. The main competitors of the savings banks in urban areas are the private commercial banks. In rural areas they compete typically with the cooperative banks, which also operate on the regional principle. 12

See DSGV (2005a), p. 13.


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The governance structure of the savings banks consists, similar to the commercial banks, both of an executive and a supervisory board. The major part of the supervisory board members has to be appointed by the owner of the bank, i.e. the local municipality or county. The chief executive officer has to be nominated by the supervisory board and reports to it in regular time intervals. Furthermore a supervisory board appoints a third governance tier, the credit committee, which is in charge of the important credit decisions. The state representatives have therefore a direct influence on the credit decisions of the savings bank. However, as Hackethal and Schmidt put it, “political interference does not seem to be a relevant factor”13. According to the state laws, the relevant regulatory supervision (“Staatsaufsicht”) is conducted by a state ministry. 6.2.4 Recent Developments Affecting the SparkassenFinanzgruppe Before July 2001, and until the Understanding about Landesbanken and savings banks has been fully implemented, the state guaranteed the maintenance and unlimited liability of both local and regional savings banks, thus making them to a subject of state aid. The maintenance guarantee (“Anstaltslast”) obliged the owners (or guarantors, “Gewährträger”) of the savings banks to equip their credit institutions with all the relevant means indispensable for the fulfillment of their tasks and to compensate possible financial gaps. While the maintenance guarantee defined the inside state aid provision, the assurance of the state aid provision towards the outside parties was provided by the liability guarantee (“Gewährträgerhaftung”). The latter is an unrestricted and unconditional obligation of public banks owners to fulfill every liability of the respective credit institutions14. First discussions between the European Commission and the German Government about the state guarantees to financial institutions already started in 1995. In 1999, the European Banking Federation filed a complaint against Anstaltslast and Gewährträgerhaftung. On 17.7.2001, the European Commission, the German government and the Deutscher Sparkassen- und Giroverband signed an understanding to change or to abolish both guarantees by July 2005. As a result, Anstaltslast had to be replaced by a relationship similar to a commercial ownership. Gewährträgerhaftung

13 14

Hackethal, Schmidt (2005), p. 15. See Moser, Pesaresi (2002), p. 5.

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had to be abolished after a transition period on 18.7.200515. While this agreement had raised the risk awareness of the whole SparkassenFinanzgruppe it had its major consequences for the Landesbanken, whose costs of capital have increased due to a subsequent inferior rating on the capital market. In 2003, the International Monetary Fund (IMF) issued a Financial Stability Assessment in which several concerns regarding the structure of the German banking system were raised. In its line of arguments, the IMF was emphasizing that following the phase out of the state guarantees, a more radical change in the public sector structure was needed16. It gave a rise to an intensive public and academic debate about the pro and cons of public ownership of the Sparkassen-Finanzgruppe.

6.3 Is the Public Mandate of the Savings Banks Obsolete or a Successful Strategy to Prevent Financial Exclusion? 6.3.1 Stipulations of the Public Mandate of German Savings Banks The merits of the public mandate of savings banks have been widely discussed over the past decades17. Critics argue that most of the tasks can be provided by the banking system itself without a publicly owned banking sector18. However, political decision makers on the state level still stress the importance of the public mandate. This could be observed in the legislative process of adapting the state laws according to the Understanding on Landesbanken and savings banks of 17.7.2001 between Germany and the EU. See Moser, Pesaresi (2002), pp. 9 ff. However, certain liabilities can be grandfathered until 2015. On 1.3.2002, an understanding on special credit institutions was concluded. These public sector banks still benefit from state guarantees for promotional tasks. As a consequence, several Landesbanken separated their promotional activities, only keeping their commercial activities. The public mandate of these development banks is commonly accepted. However, they don’t belong to the Sparkassen-Finanzgruppe. 16 See IMF (2004), pp. 59 ff. 17 See for example Sommerfeld (2005), p. 29-56; Klein (2003), pp. 98-111; Eichhorn, Schröder (2001), pp. 20-40; Größl (2001), pp. 139-160; Müller; Schrumpf (2001), pp. 25-27; Steiner (1994), pp. 77-88. 18 They claim that public ownership can only be justified by the existence of market inefficiencies. For example see Klein (2003), p. 98; IMF (2004); pp. 54 ff. 15


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The public mandate is governed by the respective state laws. While the majority of German States has a common understanding on how the public mission of the Sparkassen-Finanzgruppe should be carried out, there are differences in details. However, there has been no successful attempt to study whether these differences have an impact on how the public mandate is implemented in real life by the savings banks. All definitions of the public mandate in the state laws include the areawide provision of financial services to the local population, to local businesses and to public authorities19. Some states name certain kinds of financial services in addition to providing safe and interest-bearing investment opportunities and ensuring the access to credit. For example, the Savings Banks Act of the State of Rhineland-Palatinate (§ 2) explicitly names the improvement of equity resources of start-up companies as well as small and medium-sized companies as a public mandate. The Act on Savings Banks and on Savings Banks Associations of the State of North Rhine-Westphalia (§ 3) supports the access to credit for the economically weaker part of the population. However, the discussion concerning the provision of financial services, which will be carried out in the following chapter, will be focused on the geographical access to financial services, the access to basic banking services and the access to financing of small and medium sized companies. Except for the Free State of Bavaria and the State of Hesse, another dimension of the public mandate as stated in the state savings banks laws, is strengthening the competition among banks. Eleven states stress the importance of accumulation of private funds as a key dimension of the public mandate. Another five states name financial education as a part of the public mandate. Finally, in the State of Schleswig-Holstein, in the State of MecklenburgWestern Pomerania, in the State of Lower Saxony, and in the State of Baden-Wuerttemberg savings banks are obliged to support their owners See The Act on Savigs Banks and on Savings Banks Associations of the State of North Rhine-Westphalia § 3(1); The Berlin Savings Bank Act § 2(1); The Public-Sector Banking Act of The Free State of Saxonia § 2(1); The Savigs Banks Act of the Free State of Thuringia § 2(1); § 3 The Savings Banks Act of Bremen § 3 (1); The Savings Banks Act of the Free State of Bavaria § 2 (1); The Savings Banks Act of the State of Lower Saxony § 4(1); The Savings Banks Act of the State of Baden-Wuerttemberg § 6(1); The Savings Banks Act of the State of Brandenburg § 2 (1); The Savings Banks Act of the State of Hesse § 2(1); The Savings Banks Act of the State of Mecklenburg-Western Pomerania § 2(1); The Savings Banks Act of the State of Rhineland-Palatinate § 2(1); The Savings Banks Act of the State of Saarland § 2(1); The Savings Banks Act of the State of SaxonyAnhalt § 2(1); The Savings Banks Act of the State of Schleswig-Holstein § 2. 19

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in their economical, regional, social, and cultural activities. The cultural and social aspects of the public mandate are not discussed here because they don’t affect financial exclusion. The savings banks’ support of the regional, structural and business policy of their public owners will be covered somewhat along the lines with the support of small and mediumsized companies. 6.3.2 Provision of Basic Banking Services In Germany, the access to basic bank accounts is organized by a voluntary code of conduct since 199520. This code of conduct is a recommendation of the Zentraler Kreditausschuss21 suggesting to all associated banks to provide a current account to anyone without looking at the income situation (“Girokonto für Jedermann”). This voluntary code of conduct also names circumstances which make it unreasonable for a bank to offer a current account. If a bank wrongly refuses to open a current account, the concerned customer can file a complaint to one of the complaint offices (“Kundenbeschwerdestellen”) of the four major banking associations. However, a legal entitlement to open a basic current account at any bank doesn’t exist. Nevertheless, the public mandate to offer financial services is somewhat interpreted as an obligation for the savings banks to provide a current account22. To date, only the Savings Banks Acts of the State of RhinelandPalatinate (§ 2) and the Free State of Bavaria (§ 2) explicitly include a statement about the provision of current accounts (Rhineland-Palatinate) and the provision of payment services (Bavaria). However, according to Kaiser (2000), an explicit obligation to offer a current account can be derived from savings banks regulation in seven German states. Owing to the recommendation of the Zentraler Kreditausschuss, there shouldn’t be any hurdle for a private or commercial client to open and hold a basic banking account with any German bank. The German government regularly issues a report about the implementation of this voluntary code of conduct. According to the latest report (2004)23, it is not possible to accurately estimate the number of cases in which a current account was wrongly refused. A 2003 survey of the Arbeitsgemeinschaft SchuldnerSee Zentraler Kreditausschuss (2005). The Zentraler Kreditausschuss is a lobby organization of all German banking associations including the Deutscher Sparkassen- und Giroverband (German Savings Banks Association). 22 See for example Kaiser (2000). 23 See Deutscher Bundestag (2004). 20 21


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beratung der Verbände, a customer protection organization for indebted people, counted 2033 cases. Since only 8 % of the interviewed financial advisors for indebted people responded to the survey, they claim the real number of cases to be much higher. However, the regularly cited estimate of 500.000 cases from this organization is hard to verify. The Federal Financial Supervisory Authority (“Bundesanstalt für Finanzdienstleistungsaufsicht”) counted about 100 complaints per year. The Federal Employment Agency (“Bundesagentur für Arbeit”) charges recipients of unemployment benefits who don’t have a current account a fee for a money-order unless they prove that they had been wrongly denied a current account by a bank. As of September 2003, 103000 recipients of unemployment benefits and 34000 recipients of child benefits didn’t have a current account. Among those, 10920 recipients could prove that they didn’t have a current account without their fault. A survey of the Eurobarometer on the availability of a personal current account shows that ca. 3 % of the population doesn’t have an access to the basic banking facilities24. While this figure maybe interpreted as a hint on financial exclusion, compared to other EU 15 countries (i.e. 22 % in Italy) it is very low. The reason for its comparatively lesser extent may be found not only in the voluntary code of conduct but also in the public mandate of the savings banks. Giving the public mission of the savings banks, their high market share among retail customers, and their nationwide branch network, it is not surprising, that, as the Federal Savings Banks Association (“Deutscher Sparkassen- und Giroverband”) reports, 80 % of all welfare recipients – who are most likely to be financially excluded – hold a basic bank account with a savings bank25. 6.3.3 Nationwide Provision of Financial Services As to the physical access to financial services, new ways of physical access such as internet or telephone banking had been introduced during the new economy boom. With more people becoming technically savvy and security issues being tackled, these new access channels might overhaul the conventional structure of bank branches at some point in future years. However, as of today, retail networks are still the key method of assuring geographical access to financial services. A large part of the population is still slow to adapt the new technologies, especially the ones most likely to be financially excluded. Although many financial products 24 25

See Ruozi, Anderloni (1999). See DSGV (2005c), p. 6.

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can be standardized and distributed without financial advice, other products can not. For instance, the regulation for private provisions for retirement pension in Germany is extremely complex. To make a decision anyone, who is not a pension expert, needs specific additional knowledge and information, often provided by financial advisors of banks. The main indicator of geographical access is the density of retail branches per person. Depending on what sources one uses, different pictures of bank concentration emerge. According to the bank office statistics26 of the European Banking Federation, Germany had 0.55 branches per 1,000 persons in 2004. Among the EU 15 member states, only Luxembourg (0.56) and Spain (0.94) had more branches per 1,000 persons, well above the mean (excluding Germany) of 0.44. Not surprisingly, Germany shows low concentration. According to the IMF (2004) report, the lowest value for the Herfindahl concentration index was calculated for Germany, reflecting the high number of branches and employees of the local savings and cooperative banks27. In 2004, the Federal Savings Banks Association conducted an in-depth analysis of the regional distribution of the bank branch network28. As a result, even in economically underdeveloped regions and in the countryside, the access to bank branches is not an issue in Germany. The savings banking sector along with the cooperative sector are the two main driving forces behind this situation. While cooperative banks have a strong position especially in the southern part of former West Germany as well as in rural areas, savings banks can be found simply everywhere. In contrast to these two groups, the four main private banks in Germany focus on a few attractive regions, thus in fact ignoring 20 million persons29. In accordance with their public mandate the savings banks are therefore de facto preventing geographical causes of financial exclusion. See European Banking Federation (2004). See IMF (2004), pp. 49-50. The IMF also argues that the Herfindahl concentration index is distorted by the savings banks and the cooperative banks sector structure and thus not really reflecting the level of competition. In fact, within the savings and the cooperative banks sector there is hardly any competition. But for our purpose, showing the nationwide accessibility of financial services, this is an excellent indicator. 28 See DSGV (2004). 29 This survey ignores the influence of the stock exchange listed Deutsche Postbank AG, a former federal postal bank focused on retail activities. In 2004, the Deutsche Postbank had 9,707 branches whereas the four largest private banks had only 2.255 branches. However, the Deutsche Postbank has basically no impact on enterprise financing. Results similarly to this survey were found by Klein (2003), p.100. 26 27


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Emerging from the status quo analysis of the access to basic bank services in Germany there are no significant geographical barriers, which means that the banking structure, mainly thanks to savings and cooperative banks, doesn’t exclude economically underdeveloped regions or less wealthy people. Obliged by the state laws and statutes, savings banks are indeed committed to the development of the region in which they operate, by, in first place, providing local small and medium-sized enterprises and private customers with financial services. Hence all private and commercial clients who are actively willing to access the financial services in Germany have a physical possibility to do so.

6.4 Financing of Small and Medium-Sized Enterprises Most of the barriers to finance also apply for small and medium sized enterprises, esp. geographical barriers, lack of quality, and lack of affordability of financial services. However, one of the main issues for SME is the problem of attaining credit. Information asymmetries and moral hazard issues between lender and borrower get worse with the smaller size of a company. SME often don’t have the extensive documentation and the specific financial knowledge required by the banks. Assessing the risk for the bank is difficult and costly. The financing volume is comparatively low. These reasons make it difficult for a bank to benefit from economies of scale and economies of scope and induce a charge of a high risk premium which in turn may make the investment of the SME unprofitable. A look at the access to small and medium business finance reveals that starting in 2001, bank loans approvals to enterprises were declining. Only in the first quarter of 2005 a small recovery had been observed. What were the reasons for the decline? First, with the burst of the new economy bubble, the economy was suffering in general. The Sachverständigenrat zur Begutachtung der Gesamtwirtschaftlichen Entwicklung30 and Deutsche Bundesbank31 agree, that the decline was mainly due to less demand and not, as some were suspecting, due to structural problems in the banking sector. However, the Bank Lending Survey conducted by the Bundesbank revealed until the end of 2004, that banks - in preparation of Basel II were tightening their credit standards 32. German academics generally agree See Sachverständigenrat (2004), pp. 286 -289. See Deutsche Bundesbank (2005b), p. 29. 32 See Deutsche Bundesbank (2005b), p. 29. 30 31

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that a credit crunch, a form of credit rationing due to cyclical decline, was not observable33. Overall, there has been no evidence for credit rationing in Germany. This has been accredited to the tradition of relationship banking (“Hausbankprinzip”) which is the main way how enterprise financing is conducted in Germany34. In a survey in 1998, Elsas and Krahnen could demonstrate that the Hausbankprinzip has a positive impact on financing financial distressed enterprises in Germany35. If you look closer at the market share in enterprise financing, you will again find savings banks and cooperative banks as the main competitors. Against the general market decline, savings banks could even improve their position. Both their decentralized organization with a clear regional focus as well as their longterm relationships with clients (“Hausbankprinzip”) give them an edge over the private banks by decreasing information asymmetries. A banker who knows his region and the people faces smaller information asymmetries and might be more willing to offer financial services to this special group. Figure 6.1 - SME Financing Involvement in 2004 (Market Share in %) demonstrate that savings banks have a significant higher market share in SME financing, financing of tradespeople and in the distribution of KfW programs to SME.

33 See Deutsche Bundesbank (2005b); Detken und Lang (2003); Polleit (2003). Only Nehls and Schmidt (2003) observe characteristics of a credit crunch. Interestingly, especially among private banks they observe a reluctance of banks to offer loans to enterprises. 34 See Elsas, Krahnen (2004). 35 See Elsas, Krahnen (1998).


261

Figure 6.1 SME Financing Involvement in 2004 (Market Share in %)

Source: DSGV (2005a), p. 9.

6.5 Encouraging the Accumulation of Wealth and Financial Education The public mandate of fostering savings activities of the population has its roots in the formations of the first savings banks. Historically, the aim was to help especially the lower-income part of the population to take financial precautions and thus be able to manage their lives independently from municipal assistance. While over the past decades public welfare schemes might have reduced the importance of this task, we observe an increasing shift of financial risks from the state and from financial institutions to private households36. The most obvious example is the shift from defined benefit pension systems to defined contribution pension systems. As a result, more and more complex financial decisions are shifted to the individual. Therefore, another important aspect of financial exclusion, which is not necessarily restricted to poor people, is the ability of individuals to manage their financial needs. Irrational investor behavior – as observed by behavioral finance economists37 – is widespread. Studies show, that not only people with poor education lack the knowledge to manage their financial risks38. For 30 years, the Sparkassen-Finanzgruppe has been offering a service for schools (“Sparkassen-SchulService”) in order to promote the financial See IMF (2005), pp. 4-6. For a comprehensive overview see Barberis und Thaler (2002). 38 See for example see Reifner, Tiffe, Turner (2003). 36 37

262


education of young people. In 2005, the UNESCO recognized this service as an outstanding activity. The school service program is implemented by the local savings banks, covering 75 % of all 40,000 schools in Germany for the time being. Every year, savings banks spend four million € on teaching material provided by the school service program. In addition to the provision of class room material, the program includes a stock market educational game reaching 250,000 pupils. 20,000 high school students participated in a start-up business game organized by the SparkassenFinanzgruppe and the business consultancy firm McKinsey39. Founded in 1958, the consumer education program “Geld und Haushalt” of the Sparkassen-Finanzgruppe is a service for private customers covering household budgeting and money management topics. The service offers guidebooks, an online budgeting tool and a lecturing program where speakers can be booked for consumer-related financial topics40. These two comprehensive financial education programs of the Sparkassen-Finanzgruppe can easily be distributed through the nationwide branch network of the savings banks. Among the associations of the main competitors, the Association of German Banks (“Bundesverband deutscher Banken”, the association of private banks) also offers a financial education program “InfoDienst Schule/Bank” and a business education project “Jugend und Wirtschaft” for schools. On their websites, both the Association of German Banks and the Bundesverband der Deutschen Volksbanken und Raiffeisenbanken (the association of the cooperative banking sector) provide guidebooks for personal finance management41.

6.6 Future Outlook on the Sparkassen-Finanzgruppe The analysis in the preceding part leads to the conclusion that the public mandate does have some influence on the level of financial exclusion in Germany. However, gaps do exist which could be closed by savings banks by interpreting the public mandate more strictly or by extending the scope of the public mandate. The alternative (and common) approach to prevent financial exclusion would be to regulate the whole industry. For instance, in the case of basic bank services, there are regular attempts to introduce a law to substitute the current voluntary code of conduct42. See DSGV (2005b). See Sparkassen-Finanzgruppe Beratungsdienst Geld und Haushalt (2006). 41 See Bundesverband deutscher Banken (2006a, 2006b); Bundesverband der Deutschen Volksbanken und Raiffeisenbanken (2006). 42 See for example vzbv (2006). 39 40


263

The question remains whether savings banks can maintain any scope of public mandate while operating profitably. As stated above, a look at the legislative rules reveals that the obligation to serve the public welfare is accompanied by the demand to do so economically. Maximizing profits is therefore and has always been one of the business goals perceived by German savings banks. There is no doubt, that the savings banks sector is taking measures to further increase its efficiency and profitability. The savings banks sector (including Landesbanken and associated companies) has set its target return on equity rate before taxes at 15%43. According to Bundesbank statistics (see Table 6.2), savings banks were able to stabilize their net interest and net commission margin in relation to their total assets while private banks had to face an erosion of their margins. Moreover, together with the cooperative banks, savings banks were earning the highest margins in the industry. Looking at the return on equity before tax (9.86 % in 2004), there is still some way to go for the savings banks. But again, together with the cooperative banks, savings banks have a considerably higher return on equity than the average private bank. The strategy paper of the DSGV (2002) defines three areas of activity to improve the position of savings banks group: (1) exploit the earnings potential of the Sparkassen-Finanzgruppe, (2) cut costs, as well as (3) improve the cooperation in the Sparkassen-Finanzgruppe and give it a sharpened profile. If this strategy would result in a further closing of branches, in a rise of prices of financial services or a decrease in the quality of financial services, this could lead to increasing financial exclusion in Germany. The main sources of capitalization of savings banks are retained earnings. Traditionally, savings banks are also in an excellent market position to attract customer deposits, a comparatively cheap source of refinancing. The Landesbanken, by contrast, rely on capital market refinancing sources. Therefore, the changes of Anstaltslast and Gewährträgerhaftung forced the Landesbanken to find new business models while the savings banks for the most part were not affected by the change44. Nevertheless, the whole process made it clear that the European Community does not accept any hidden state aid in the public banking system disturbing the market. If in future the reliance on capital market financing of savings banks increases, they would have to deliver sound business results, otherwise the refinancing costs will sharply increase. One hint towards a more capital marketoriented approach is the assignment of a floor rating to the savings banks 43 44

See Bundesverband deutscher Banken (2006c), p. 2. See for example Moody’s (2006); Kleff (2005), p. 173.

264


sector. According to Moody’s in March 2006, the debt ratings of individual banks should not fall below A1. Rating agencies stress the importance of support mechanisms within the savings banks sector after the phase-out of the state aid45. Some savings banks have already undergone the individual ratings process46. Table 6.2 Net Interest Margins, Net Commission Margins and Return on Equity among the Three Banking Pillars (2000-2004) Year Net interest margin in % of total assets 2000 2001 2002 2003 2004 Net commission margin in % of total assets 2000 2001 2002 2003 2004 Return on equity in % (after tax) 2000

All Private LandesbankenSavings CooperativeCooperative Banks banks banks central banks banks 1.14 1.12 1.20 1.16 1.18

1.17 1.15 1.34 1.17 1.25

0.56 0.60 0.59 0.63 0.65

2.33 2.38 2.38 2.40 2.35

0.78 0.62 0.66 0.46 0.49

2.45 2.41 2.49 2.51 2.51

0.42 0.36 0.34 0.35 0.35

0.76 0.64 0.60 0.59 0.57

0.13 0.11 0.11 0.11 0.11

0.55 0.50 0.49 0.53 0.56

0.21 0.15 0.14 0.17 0.16

0.69 0.58 0.57 0.61 0.65

12.95 (8.84) 4.43 (2.74) 4.56 (4.95) 0.66 (2.30) 2.91 (3.97)

8.59 (4.09) 7.46 (4.41) 9.68 (6.60) 10.64 (5.24) 10.23 (5.12)

9.32 8.19 8.14 13.39 (6.09) (7.32) (4.22) (6.05) 2001 6.19 4.74 4.78 9.16 (4.57) (4.24) (4.01) (5.06) 2002 4.49 0.97 2.80 8.15 (2.91) (0.04) (1.94) (4.65) 2003 0.72 -6.24 -4.25 10.89 (-1.45) (-6.57) (-5.17) (4.00) 2004 4.21 -0.41 1.07 9.86 (1.94) (-1.39) (-0.83) (5.11) Source: Deutsche Bundesbank (2005a), pp. 30 and 33.

45 46

See Moody’s (2006); von Lüpke, Thomas (2006), p. B3. See Schröder, Gröschel (2006), pp. 115-125.


265

To date, the public mandate and the strong ties between the local government and its local savings bank ensure the access to financial services in the community. However, with increasing financial problems of local communities, some towns and municipalities might enforce dividend payouts of their local savings banks47 and thus increase the pressure to make profits on the expense of the public mandate. Given the public mandate had a positive impact on financial exclusion so far, the increasing pressure on profitability could weaken the savings banks ability to maintain their public mandate. If that was true, we will see an increase in financial exclusion in the future in Germany unless other measures, e.g. consumer protection laws, are taken.

6.7 References Anderloni L. (2003), Le istanze di social banking negli anni 2000: teoria ed evidenza empirica in Italia, in Anderloni, L. (ed). Il social banking in Italia. Un fenomeno da esplorare, pp. 3-133, Milano: Giuffrè. Ruozi, Roberto; Anderloni, Luisa (eds). (1999). Banking Privatisation in Europe The Process and the Consequences on Strategies and Organisational Structures. Berlin-Heidelberg: Springer. Aschhoff, Gunther; Henningsen, Eckart (1995). Das deutsche Genossenschaftswesen: Entwicklung, Struktur, wirtschaftliches Potential. Frankfurt am Main: Knapp. Barberis, Nicholas; Thaler, Richard H. (2002). A survey of behavioral finance. Cambridge, Mass.: NBER. Bundesbank (2006). Bankenstatistik, Stand 5.5.2006. Bundesverband der Deutschen Volksbanken und Raiffeisenbanken (2006). Kundeninformationen. Found at http://www.bvr.de on 1.6.2006. Bundesverband deutscher Banken (2006a) Geldinfos + Finanztipps. Found at http://www.bankenverband.de/geldinfos/channel/11101010/index.html on 1.6.2006. Bundesverband deutscher Banken (2006b) Schule + Bildung. Found at http://www.bankenverband.de/schule/channel/14101010/index.html on 1.6.2006. Bundesverband deutscher Banken (2006c). Stellungnahme zur Anhörung zum Antrag der SPD-Fraktion „Reform des Sparkassenrechts darf nicht zur Zerschlagung des Sparkassensystems in Nordrhein-Westfalen führen“, Düsseldorf, 26.1.2006. Claessens, Stijn (2005). Access to financial services: a review of the issues and public policy objectives. In World Bank Group (ed.), Washington: World Bank Group. 47

See for example Kleff (2005), p. 137.

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Dagott, Marc-Philipp (2003). Transsektorale Unternehmensverbindungen zwischen Sparkassen und Genossenschaftsbanken. Lüneburg: Universität Lüneburg, Wirtschafts- und Sozialwissenschaften. Detken, Annette; Lang, Frank (2003). Die Entwicklung der Kreditneuzusagen. In KfW Bankengruppe(Hrsg.), Droht eine Kreditklemme in Deutschland - was sagen die Daten? Frankfurt/Main. Demirgüç-Kunt, Asli; Huizinga, Harry Pieter (2000). Financial structure and bank profitability. Washington, DC: World Bank, Development Research Group, Finance. Deutsche Bundesbank (2003). Bericht zur Stabilität des deutschen Finanzsystems. Monatsbericht der Deutschen Bundesbank, pp. 5-53, December 2003. Deutsche Bundesbank (2004a). Bericht zur Stabilität des deutschen Finanzsystems. Monatsbericht der Deutschen Bundesbank, pp. 5-77, Oktober 2004. Deutsche Bundesbank (2004b). Stresstests bei deutschen Banken - Methoden und Ergebnisse. Monatsbericht der Deutschen Bundesbank, pp. 79-88, Oktober 2004. Deutsche Bundesbank (2005a). Die Ertragslage der deutschen Kreditinstitute im Jahr 2004. In: Monatsbericht der Deutschen Bundesbank, pp. 15-43, September 2005. Deutsche Bundesbank (2005b). Geldpolitik, Bankgeschäft und Kapitalmarkt. Monatsbericht der Deutschen Bundesbank, pp. 23-35, May 2005. Deutscher Bundestag (2004) Bericht der Bundesregierung zur Umsetzung der Empfehlung des Zentralen Kreditausschusses zum Girokonto für jedermann, Drucksache 15/2005, Berlin, 11.2.2004. DSGV (2004). Bankzweigstellen vor Ort – unverzichtbar für leistungsfähige Regionen, Berlin. DSGV (2005a). Financial data for 2004. Berlin, 15.6.2005. DSGV (2005b). Finanzerziehung in der Schule: Sparkassen-SchulService zum 30jährigen Jubiläum von der UNESCO ausgezeichnet. Berlin, 21.10.2005. DSGV (2005c). Sparkassen – Institute aller Bürgerinnen und Bürger, Berlin. DSGV (2006). History Timeline, found at http://www.dsgv.de/en/sparkassenfinanzgruppe/geschichte/zeitleiste/index_7024.html on 25.5.2006. Elsas, Ralf; Krahnen, Jan Pieter (1998). Is relationship lending special? Evidence from credit file data in Germany. Journal of Banking and Finance (22), pp. 1283-1316. Elsas, Ralf ; Krahnen, Jan Pieter (2004). The universal banks and relationships with firms. In Krahnen, Jan Pieter; Schmidt, Reinhard (eds). The German Financial System (pp.. 197-232). Oxford [u.a.]: Oxford University Press. Eichhorn, Peter; Schröder, Ernst-Jürgen (2001). Der Förderauftrag von Sparkassen angesichts globaler Wirtschaftsentwicklung. In: Eichhorn, Peter; Kirchhoff, Ulrich (eds). Öffentliche Banken, (pp. 20-40). Baden-Baden: Nomos. European Banking Federation (2004). General Statistics on the European financial sector as at 31.12.2003. Größl, Ingrid (2001). Wirtschaftspolitische Antworten auf Funktionsmängel im Finanzsystem. In: Hartwig, Karl-Hans; Vollmer, Uwe; von Delhaes-Guenther,


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Dietrich (eds). Monetäre Institutionenökonomik (pp. 139-160). Stuttgart: Lucius & Lucius. Hackethal, Andreas; Schmidt, Reinhard H. (2005) Structural change in the German banking system? Working Paper Series Finance and Accounting No. 147, Johann Wolfgang Goethe-Universität, Frankfurt am Main, January 2005. Hoppenstedt, Dietriech H. (2005). The Sparkassen-Finanzgruppe: a model for future competitive cooperation. Speech at the 10th Handelsblatt Conference “Radical Change for Banks” on 7.9.2005, Frankfurt am Main. IMF (2004). Germany: Article IV consultation – staff report. IMF Country Report No. 04/341, November 2004, Washington, D.C. IMF (2005). Global Financial Stability Report. Washington, DC. Kaiser, Sven. (2000). Der Kontrahierungszwang beim Girokonto in Europa – ein rechtsvergleichender Überblick, in: Verbraucher und Recht, 10/2000. Kempson, Elaine, Whyley, Claire, Caskey, John; Collard, Sharon (2000). In or out? Financial exclusion: a literature and research review. London: Financial Services Authority. Kleff, Volker (2005). Die Eigenkapital- und Ausschüttungspolitik deutscher Sparkassen. Mannheim: Universität Mannheim. Klein, Mikko (2003). Die Privatisierung der Sparkassen und Landesbanken: Begründungen, Probleme und Möglichkeiten aus ökonomischer und rechtlicher Perspektive. Frankfurt am Main: Lang. Moody’s (2006). Solidarity and strenght of the public-sector banks in Germany continue to underpin their credit quality. London, Frankfurt am Main, March 2006. Moser, Stefan; Pesaresi, Nicola (2002). State guarantees to German public banks: a new step in the enforcement of State aid discipline to financial services in the Community. In: Friess, Bernhard; Pesaresi, Nicola (eds). Competition Policy Newsletter No. 2. Mura, Jürgen (1995). Deutschland. In Wissenschaftsförderung der Sparkassenorganisation (ed), Europäische Sparkassengeschichte (Vol.I, pp. 77104). Stutgart: Deutscher Sparkassenverlag. Müller, Beate; Schrumpf, Heinz (2001). Sparkassen und Regionalentwicklung: eine empirische Studie für die Bundesrepublik Deutschland. Stuttgart: Dt. Sparkassenverl. Nehls, Hiltrud; Schmidt, Torsten (2003). Credit Crunch in Deutschland? - Ein empirisches Ungleichgewichtsmodell. In KfW Bankengruppe (ed) Droht eine Kreditklemme in Deutschland - was sagen die Daten? (pp. 21-31). Frankfurt/Main. Polleit, Thorsten (2003). The slowdown in German bank lending - revisited. In KfW Bankengruppe (ed) Droht eine Kreditklemme in Deutschland - was sagen die Daten? Frankfurt/Main. Reifner, Udo; Tiffe, Achim; Turner, Anke (2003). Vorsorgereport: Private Alterssicherung in Deutschland. Gütersloh: Verlag Bertelsmann Stiftung. Ruozi R. and Anderloni L. (eds). (1999). Banking Privatisation in Europe - The Process and the Consequences on Strategies and Organisational Structures. Berlin-Heidelberg: Springer.

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Sachverständigenrat zur Begutachtung der Gesamtwirtschaftlichen Entwicklung (2004). Das deutsche Bankensystem: Befunde und Perspektiven. In Sachverständigenrat zur Begutachtung der Gesamtwirtschaftlichen Entwicklung (ed) Jahresgutachten 2004/05: Erfolge im Ausland – Herausforderungen im Inland (pp. 272-303). Wiesbaden. Schröder, Gustav Adolf; Gröschel, Ulrich (2006). Ratings in der Zukunftsstrategie einer Großsparkasse. In Fischer, Thomas R.; Pape, Christoph (eds). Handbuch der deutschen Sparkassen, Frankfurt am Main: Frankfurter Allgemeine Buch, pp. 115-125. Shleifer, Andrei (2005). Understanding regulation. European Financial Management, 11(4), pp. 439-451. Sinclair S. P. (2001). Financial exclusion: an introductory survey. Edinburgh, Edingburgh College of Art, Center for Research into Socially Inclusive Services. Sparkassen-Finanzgruppe Beratungsdienst Geld und Haushalt (2006). Wir über uns. Found at http://www.geldundhaushalt.de/metanav/profil.html on 1.6.2006. Sommerfeld, Olaf (2005). Wettbewerb kontra Daseinsvorsorge: die Strukturmerkmale der kommunalen Sparkassen in Deutschland im Lichte des EGWettbewerbsrechts. Hamburg: Kovac. Steiner, Jürgen (1994). Bankenmarkt und Wirtschaftsordnung - Sparkassen und Landesbanken in der Privatisierungsdiskussion. Frankfurt am Main: Fritz Knapp Verlag. von Lüpke, Thomas (2006) Positive Ratingeffekte durch Verbundkonzepte. In Börsen-Zeitung Nr. 70, 8.4.2006, p. B3. vzbv (2006). Lob für Zypries: Hunderttausende Verbraucher sollen Anspruch auf Girokonto bekommen. Berlin, 24.1.2006. Zentraler Kreditausschuss (2005).Stellungnahme des Zentralen Kreditausschusses zum Expertengespräch im Ausschuss für Verbraucherschutz, Ernährung und Landwirtschaft des Deutschen Bundestages zum „Girokonto für jedermann“ am 16. März 2005, Berlin, 2.3.2005.

Cited Laws The Act on Savings Banks and on Savings Banks Associations of the State of North Rhine-Westphalia (Gesetz über die Sparkassen sowie über die Sparkassen- und Giroverbände für Nordrhein-Westfalen) as of 10.9.2004. The Berlin Savings Bank Act (Gesetz über die Berliner Sparkasse) as of 28.6.2005. The Banking Act (Kreditwesengesetz) as of 22.9.2005. The Public-Sector Banking Act of The Free State of Saxonia (Gesetz über das öffentlich-rechtliche Kreditwesen im Freistaat Sachsen) as of 13.12.2002. The Savigs Banks Act of the Free State of Thuringia (Thüringer Sparkassengesetz) as of 3.12.2002.


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The Savings Banks Act of Bremen (Bremisches Sparkassengesetz) as of 12.10.2005. The Savings Banks Act of the Free State of Bavaria (Sparkassengesetz Bayern) as of 1.10.2005. The Savings Banks Act of the State of Lower Saxony (Niedersächsisches Sparkassengesetz) as of 14.12.2004. The Savings Banks Act of the State of Baden-Wuerttemberg (Sparkassengesetz für Baden-Württemberg) as of 19.7.2005. The Savings Banks Act of the State of Brandenburg (Brandenburgisches Sparkassengesetz) as of 10.7.2002. The Savings Banks Act of the State of Hesse (Hessisches Sparkassengesetz) as of 13.12.2002. The Savings Banks Act of the State of Mecklenburg-Western Pomerania (Sparkassengesetz des Landes Mecklenburg-Vorpommern) as of 4.3.2004. The Savings Banks Act of the State of Rhineland-Palatinate (Sparkassengesetz von Rheinland-Pfalz) as of 22.12.2004. The Savings Banks Act of the State of Saarland (Saarländisches Sparkassengesetz) as of 27.11.2002. The Savings Banks Act of the State of Saxony-Anhalt (Sparkassengesetz des Landes Sachsen-Anhalt) as of 18.12.2002. The Savings Banks Act of the State of Schleswig-Holstein (Sparkassengesetz für das Land Schleswig-Holstein) as of 9.2.2005.

7 Economic Growth and the Financial Inclusion: the Case of Poland

Ewa Miklaszewska

7.1 Introduction The aim of this paper is to show that the market-oriented transformation initiated in 1989 has resulted in a rapid expansion and thorough modernisation of the Polish banking sector, and as a consequence has provided all parts of the Polish population with better access to banking services. However, as the Polish economy has been undergoing rapid transformation, not all of its segments have benefited from a better quality and wider range of products to the same extent, particularly in the countryside. Polish agriculture currently employs about 20% of the total workforce, but it contributes only in 3.4% to the GDP. Most farms have always been privately owned, but they remain small and fragmented. Out of 12.7 millions of employed in 2004, 2 millions are self-employed on small private farms, with low incentives to gain access to more sophisticated financial services. However, after accession to the EU, this sector benefits a great deal form agricultural transfers form the EU budget and exports of food products has been soaring. Table 7.1 Polish GDP and employment by sector of the economy Agriculture Industry Services 1999 2004 1999 2004 1999 2004 GDP 4% 3% 36% 31% 60% 66% Employment 18% 19% 31% 27% 50% 54% EU 25: employment 6% 5% 27% 26% 67% 69% Source: Analiza tendencji w gospodarce Ğwiatowej, Kwartalnik Statystyki MiĊdzynarodowej GUS 2/2005 (Central Statistical Office, International Statistics).

272

Ewa Miklaszewska

The paper analyses the long-term results of the transformation processes, particularly as measured by access to banking services in the current decade, a period of dynamic economic growth, connected with Polish accession to the EU in 2004 (Fig.7.1; preliminary data for GDP growth in the first quarter of 2006 is 5.2%). Currently Poland has a well developed banking system, which offers all major products and services. In the last few years, banks have particularly expanded household loans and services, benefiting from a consumer boom (Fig. 7.2), sometimes at the expense of servicing the corporate segment, particularly the SME (Small and Medium Enterprises). Consequently, the paper focuses on the remaining important gaps and niches not yet efficiently covered by banks, particularly on a relative discrimination against SME financing. Polish SME are largely microentreprises: 93% of them employ up to 6 people. Small size and short history have negatively influenced their access to financial services. However, they constitute a very important economic segment, contributing a great deal to growth, export and employment. Figure 7.1 GDP growth rate in Poland and EU 25 6 5,3

5 4

3,8 3,2

3

EU 25

2,4

2

1,9

1

1

1,4 1,2

Poland

1,6

1,2

0 2001

2002

2003

2004

2005

Source: Summary Evaluation of the Financial Situation of Polish Banks, 2005, NBP, Commission for Banking Supervision.

7 Economic Growth and Financial Inclusion in Poland 273 Figure 7.2 Banking loans to non-financial sector (billions of zá) 140

100 80

119,6

116,6

120 75,4

85,8

114,1

121,5117,6

96,2

60 40 20 0 2002

2003 household loans

2004

2005

corporate loans

Source: Summary Evaluation of the Financial Situation of Polish Banks, 2005, NBP.

7.2 Transformation of the Polish Banking Sector and Provision of Banking Services After 1989, the Polish banking market recorded a remarkable growth, due to liberalisation, privatisation, the inflow of foreign capital and regulatory reform. Initially, the dominant issues for most banks were those of expansion and restructurisation, and changes centred on the largest banks. Among the newly accepted EU members, Poland has the biggest banking sector in absolute terms. However, in comparing banking assets in relative terms, the picture is far less positive. The ratio of banking assets to GDP around 60% - has remained stable over the last few years and far below the EU averages (278% for EU15 and 80% for EU10 new members).

274

Ewa Miklaszewska

Figure 7.3 Banking sector assets growth (billions of zá) 700

10

600

9 8

400 300 200 100

4,2

5,3

5,0

4,6

5,3

7

5,8

%

bln zl

500

6 5

0

4 2000

2001

2002

2003

2004

2005

total assets share of the cooperative banks

Source: Summary Evaluation of the Financial Situation of Polish Banks, 2005, NBP.

Poland has currently over 60 universal banks, mostly foreign owned, and around 600 cooperative banks which, however, constitute only 5-7% of the banking sector’s total assets, deposits and loans. Due to the privatisation of the 1990s, the majority of banking assets belong to foreign owners: only 11 universal banks are controlled by Polish capital, including 4 banks directly controlled by the Treasury (Tables 7.2-3). Table 7.2 Bank ownership transformation in Poland 1993

1995

1998

2000 2002 2004 2005

Commercial banks, of which: a. Owned by Treasury

87

81

83

73

59

57

61

29

27

13

7

7

5

4

b. Privately owned c. Foreign owned d. Branches of foreign banks Cooperative banks Total credit institutions Source: Summary Evaluation NBP.

58 54 70 66 10 18 31 46 1653 1510 1189 680 1740 1591 1272 753 of the Financial Situation of

52 45 605 664 Polish

49 50 41 43 3 7 596 588 653 649 Banks, 2005,

7 Economic Growth and Financial Inclusion in Poland 275 Table 7.3 Structure of banking sector and its contribution to total available credit 1993 % of assets Commercial banks of which: a. State-owned

93.4

2000 2005 % of % of corporate assets loans 92.9 95.8

80.4

79.3

22.9

21.2

20.3

20.5

b. Privately owned

13.0

13.6

72.9

73.4

73.0

71.1

c. Foreign owned

2.6

2.7

69.5

70.2

69.0

68.4

d. Branches of foreign banks Cooperative banks 6.6

-

-

-

0.9

0.8

7.1

4.2

5.4

5.8

7.6

Total Credit Institutions 100%

100%

100%

100%

100 %

100%

% of % of corporate assets loans 94.6 94.2

% of corporate loans 92.4

Source: Summary Evaluation of the Financial Situation of Polish Banks, NBP, 2005.

The concentration of the banking market is close to the European average and the biggest 5 banks are losing market share to medium sized banks. However, the concentration may increase, as the second and third largest banks are likely to merge, as a result of their owners’ consolidation (UniCredit and HypoVereinsbank). When comparing Polish banking sector with other emerging markets’ systems (Table 7.4), the picture is positive, although “nothing to be proud of “ (The Economist, Survey of Poland, May 13, 2006). Table 7.4 Financial sector development indicators, 2003 Number ofBanks banks foreign owned Czech Rep.35 Estonia 7 Hungary 38 Latvia 23 Poland 58 Slovak 21 Rep.

26 4 29 10 46 16

Asset share of stateowned banks

Domestic credit to private sector (% of GDP)

EBRD index of banking reform

3.0 0.0 7.4 4.1 25.7 1.5

18 34 42 39 18 25

3.7 3.7 4.0 3.7 3.3 3.3

EBRD index of non-bank financial institution 3.0 3.3 3.7 3.0 3.7 2.7 (continued)

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Slovenia 22 6 12.8 43 3.3 2.7 Bulgaria 35 12 0.4 26 3.3 2.3 Romania 30 21 4.6 10 2.7 2.0 Source: Integration of European Banking: The Way Forward, CEPR, London 2005, p.41.

The strong presence of foreign capital is characteristic of almost all East-European countries and has been largely transition-related - by the need in the ‘90s to create an efficient, market-oriented banking system in a very short time. Lacking domestic financial sources and experience, the governments opted for the active involvement of foreign banks in the privatisation processes. However, although the majority of Polish banks are currently foreign owned, Polish customers in various surveys stress their attachment to Polish names and control (Fig. 7.4), which may explain why the biggest foreign owned banks have kept former Polish names and old logos. Only recently have some of them been slowly introducing their foreign brands, stressing their foreign affiliations (CitiHandlowy, ING Bank ĝląski, etc.). Figure 7.4 Why customers trust their banks? State-ow nership

54%

size

48%

tradition

41%

Polish ow nership

37%

financial data

26% 24%

bank quotation 16%

impressive building

12%

advertisment foreign name other

2% 6%

Source: J. Pietrzak, Czynniki przewagi konkurencyjnej na rynku bankowych usáug detalicznych, Univ. of GdaĔsk, GdaĔsk 2003, p. 183.

Since almost the beginning of the transformation processes, Polish commercial banks have fallen into three groups: -

the 10 largest banks, universal in nature; a group of about 20 medium-sized banks, mostly retail or specialised; a group of around 30-40 smallest banks, many of them with cooperative status.

7 Economic Growth and Financial Inclusion in Poland 277

Foreign capital inflow initially centred on the largest banks, and this has turned out to be a profitable long-term investment. For 2005, the average ROA of Polish banks was 1.7% and the ROE 20.8%, way above the Eurozone level, although less than for certain other East European countries, headed by Hungary (25% ROE)1. Poland thus found itself among the most profitable European banking systems. Local or specialised banks constitute only slightly above 5% of total assets, in contrast to other European countries (this figure exceeds 35% in Germany, France and Spain2) and non-banking financial firms are also underdeveloped. Thus the impact of global, foreign owned banks operating in Poland can be seen as positive, from the point of view of their contribution to competitive environment. They increase competitive pressure on regional and local levels and offer high quality financial services, although mostly for loanrelated products. Table 7.5 Structure of financial sector’s assets (2004) Institutions % Banks 74,4 Insurance 10,7 OFE (pension funds) 8,7 SKOKs (mutual banks) 0,6 Investment funds 5,2 Broking houses 0,4 Source: Summary Evaluation of the Financial Situation of Polish Banks, NBP, 2005.

The distance between the top and medium sized banks is diminishing, as the dynamics of growth are much stronger in the medium banks. For example, the strongest growth in revenues recorded in 2005 was in Euro Bank, Getin Bank and Santander Consumer Bank (above 70%), and the highest ROE was that of AIG Bank Polska (86%) and Lucas Bank (47%)3. The smallest bank group is also expanding, although less dynamically and is dominated by Polish-owned cooperative banks. The banking market has diversified also in terms of strategies.

The Report of the The Association of Polish Banks, BANK 04/2006. Dermine J., Bank Mergers in Europe, the Public Policy Issues, Journal of Common Market Studies, 2000. 3 50 najwiĊkszych banków w Polsce (50 Largest Polish Banks), BANK, May 2006. 1 2

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Figure 7.5 Balance sheet ratios for the Polish banks, 2004 Cost / Net Income Ratio Net Commissions & Fees / Net Income on Banking Activity Net Interest Income / Net Income on Banking Activity ROE Irregular Loans / Total Loans Portfolio Securities / Assets Interbank Deposits / Assets Interbank Loans / Assets small banks medium banks large banks

Deposits / Assets Loans / Assets 0,00 0,10 0,20 0,30 0,40 0,50 0,60 0,70 0,80

Source: E. Miklaszewska, K. Mikoáajczyk, own estimates.

As illustrated in Fig. 7.5, large banks are cost efficient, have the largest deposit base and are less dependent on loans and more on securities trading than other groups of banks. Medium banks had in 2004 a smallest deposit base, which resulted in their need to borrow on the interbank market, which allowed them to better control costs. Small banks were most traditional in nature and at the same time least cost-efficient. Currently, the inflow of foreign capital is centered on the middle banking group, where competition has become fierce, strategies are being reshaped and profitability is increasing. Typical of this group is AIG Bank Polska SA – the most profitable Polish bank in 2005 (ROA of 6.76% and RoE of 85.9%). Its strategy can be summarised as “lending to the poor and collecting deposits from the rich”4. Banks such as AIG base their strategies on entering profitable market niches, particularly in offering loan-related products to a more high-risk group of clients. They are able to carry this strategy due to better risk management models, low cost of delivery and stress on excellent marketing of selected, standardised

500 najwiĊkszych firm w Polsce (500 Largest Polish Firms), Rzeczpospolita, 26.04.2006, p.1330. 4


products, mostly consumer loans. Their other strong focus is on cost control – all banks in this group are leaders in cost control. The strategic transformation of the Polish banks can also be illustrated by the results of bank surveys, conducted by the author in the period 19952003 and summarised in Table 7.6 and Fig. 7.6. Table 7.6 Strategic goals of Polish banks: result of bank surveys (major answers, % of total) 2003 1998 1995 1. Strategic priorities: - maximising profitability 26 17 20 - improving quality of service 14 20 18 - expansion of scale 11 - cost control 11 17 5 - innovations (new products) 10 14 0 - looking for niches 8 - takeovers 5 6 9 - increase in capital 5 23 26,5 2. Strengthening competitive position by: - superior quality 33 38 37 - universalism 21 26 0 - specialisation 21 15 43 - product innovation 12 7 16 - low price of service 12 1 4 3. Reasons for introducing new products: - long term strategy 48 4 58 - expected profits 34 38 22 - reaction to competitors 17 58 10 No. of banks 27 29 49 Source: E. Miklaszewska, Deregulation and strategies of commercial banks, AE, Krakow 2004.

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Figure 7.6 Results of 2003 bank survey

Strategic priorities 14

Large banks Medium banks

12

Small banks

in points

10

8

6

4

2

other

new profile

share price

M&A

increase of capital

market niches

innovativeness

cost control

expansion

service quality

profitability

0

Sources of competitive advantages Large banks

25

Medium banks

in points

20

Small banks

15 10 5

Source: E. Miklaszewska, own database.

other

low price

innovativeness

specialisation

universalism

service quality

0


The analysis of bank responses to strategy-related questions in the period of 1995 – 2003 supports a positive picture of the transformation of the Polish banking industry. In 2003, top priorities for both large and medium banks were profitability, quality of service, expansion and cost control, although for medium banks product innovations, including expansion of internet banking, ATM machines, payment cards, etc. were sometimes more important that asset growth. The surveys support the observation of a strategic differentiation in the Polish banking market: in 2003, for the first time the medium sized banks emerged as a clearly defined group, focusing on introduction of innovative products in selected niches, which turned out to be a more promising strategy than following the large bank emphasis on universal bank model. Large banks have defined their strategy as being globally oriented and universal, although with less stress on investment banking or allfinanze than in their counterparts in Europe. Table 7.7 The largest Polish banks, 2005 Bank

Assets Loans (m zá) (m zá)

PKO BP SA 90 528 Bank Polska Kasa Opieki SA 61 972 Bank BPH SA 57 922 ING Bank ĝląski SA 42 268 Bank Handlowy w 32 915 Warszawie SA Bre Bank SA 32 817 Bank Zachodni WBK SA 28 183 Bank Millennium SA 22 152 Kredyt Bank SA 20 841 Bank Polskiej Spóádziel. SA 18 949 Bank Gospodarstwa 18 385 Krajowego Bank Gospodarki 16 627 ĩywnoĞciowej SA Raiffeisen Bank Polska SA 11 243 GE Money Bank SA 9127 Bank Ochrony ĝrodowiska 7 767 SA GETIN BANK SA 7 129 Fortis Bank Polska SA 6 363 Deutsche Bank Polska SA 6 193

Loans as % of assets

46 061 28 224 31 931 9 833 9 607

51 46 55 23 27

ROE C/I (%) ratio (%) 25 65 26 54 23 50 20 59 16 63

15 463 12 897 9 591 9 702 10 207 6 753

22 46 43 46 54 37

12 14 28 21 130 15

58 53 46 74 36

7 680

46

6

77

7 582 8 748 5 913

67 95 77

28 38 9

58 41 70

3 406 4 299 497

48 68 8

26 50 20 50 8 60 (continued)

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NORDEA Bank Polska SA 5 918 4 018 68 7 Lukas Bank SA 5 022 3 963 78 47 Deutsche Bank PBC S SA 4 702 1 648 34 -8 Rabobank Polska SA 4 249 1 135 26 4 Santander Consumer Bank 3 787 3 600 95 9 SA Gospodarczy Bank 3 760 982 26 10 Wielkopolski SA ABN AMRO Bank Polska 3 496 770 22 17 SA AIG Bank Polska S.A. 2 851 2 280 26 86 WestLB Bank Polska S.A. 2 420 601 25 6 BISE S.A. 2 343 1 162 50 4 Euro Bank SA 2 019 1 167 58 -10 Danske Bank Polska SA 1 939 1 175 61 10 Source: 50 Largest Polish Banks, BANK – Special Edition, May 2006.

74 41 60 74 62 71 76 23 70 70 45

7.3 Provision of Banking Services to Households and Corporations Most available sources typically analyse provision of banking services by segmenting the market into households (i.e. individuals, microfirms and small farmers) and corporations. In recent years, most dynamic growth has been that of household financing. For example, the number of bank accounts has dramatically increased, from 14.4 mln in 2000 to 24.7 mln in 2004. Consequently, today 70% of households have a bank account. However, when comparing the number of accounts per head of the population, Poland (0.58) still occupies one of the last places in Europe, followed only by Slovakia and Greece, while the EU-15 average is 1.385. Looking at banking data, the risk associated with corporate loans has been higher than that of consumer loans. Consequently, in the last 5 years there has been a rapid expansion in consumer credit (loans to households and mortgages) by banks and credit firms. As a result, household loans increased from 75 billion zá in 2002 to 121 billion zá in 2005, while corporate loans remained at around 117 billion in the same period. Unperforming loans have recently dropped for all groups of customers from a historically high level - over 20% of total loan portfolio to 14%, due to an improvement in the business cycle, but also due to liberalising

K. Pietraszkiewicz, XVI Annual Meeting of the Association of Polish Banks, 2005, www.zbp.pl 5


accounting rules, which were more restrictive in Poland than in the EU. However, they are still above the European average (2-6%, see Table 7.8). Table 7.8 Structure of problematic loans in 2004 Type of loan

Poland

The EU (15)

Consumer 9.7 6.0 Corporate 19.1 2.2 Total 14.2 3.1 Source: Banki 2004, ZBP (The Association of Polish Banks). Table 7.9 Non-performing loans as % of total credit portfolio Type of loan

2002

2003

Corporate loans 26 27 Consumer loans 14 13 Source: Banki 2004, The Association of Polish Banks (ZBP).

2004 19 10

Some barriers to household access to banking services, particularly in the countryside, may be due to a relative shortage of bank branches. The number of branches is increasing (Table 7.10); however, there are currently 17 banks and only 131 branches per 1 million of population in Poland, the latter constitutes one of the lowest rate in the EU. Table 7.10 Bank branches Commercial Banks Cooperative Banks No. of banks No. of branches No. of banks No. of branches 1996 81 1 580 1 394 502 2000 73 2 449 680 1 149 2004 57 3 705 596 1 298 2005 61 3 715 588 1 342 Source: Summary Evaluation of the Financial Situation of Polish Banks, NBP 2005.

The small number of branches is to some extent offset by a rapid expansion in internet banking, which is relatively well developed in Poland (4.6 millions customers). In almost all the top banks, opening an account gives automatic access to internet transactions. However, banks are not committed to educate and train customers how to use the new products. Bank surveys confirm that bankers are aware of a lack of knowledge and experience with more sophisticated products among the large part of their

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consumers. However, they are not doing much to promote new products and services. Bank services to corporations are more stagnant. Bank loans currently constitute 30% of the Polish GDP, while in the Eurozone this figure amounts to 130% GDP on average. However, this may be related to the fact that mostly large firms invest and it is commonly observed that there are no medium-sized firms in Poland - only very small self-financing microfirms and a small number of large corporations. Recently, there has been a tendency for a further increase in the contribution of smaller firms and decrease in medium ones. Table 7.11 Size of the corporate sector 1995 1998 2001 All enterprises registered 2 099 577 2 792 697 3 374 956 SME 1 093 148 2 786 462 3 368 366 Micro (0-5 till 1998, 0-9 later) 1 921 151 2 591 400 3 206 452 Small (0-49) 2 069 930 2 761 010 3 337 557 Medium (50-249) 23 218 25 452 30 809 Large (above 250) 6 429 6 235 6 589 All active firms 1 140 141 1 726 073 1 657 630 SME active 1 136 808 1 722 616 1 654 822 Small (0-49) 1 125 656 1 709 294 1 641 403 Medium (50-249) 11 152 13 222 13 419 Large (above 250) 3 333 3 457 2 808 Source: Polish Agency for Enterprise Development (PARP), Raport o stanie MSP in 2002-2003 (Report on the Conditions of the SME Sector in Poland).

Having 3.4 mln registered and 1.7 mln active SME, which generate 48% of GDP, 44% of exports and employing 7 million people (67% of workforce), the sector is vital to the Polish economy. However, most SME are small, on average much smaller than other European ones: 93% employ up to 6 people. The majority of Polish SME operate in trade, manufacturing, real estate and construction businesses6. They invest less than European firms and 70% of them finance investments from their own private sources. The majority of assets of Polish firms (56%) are owned by large corporations.

A detailed description of the SME sector contribution to the Polish economy can be found in the annual reports published by PARP: Raport o stanie MSP (Polish Agency for Enterprise Development: Report on Conditions of Small and Medium-Size Enterprise Sector in Poland). 6

7 Economic Growth and Financial Inclusion in Poland 285 Table 7.12 Contribution of firms to the Polish economy, 2001 All firms SME: Micro Micro and Medium Large firms total (0-9) small (50-249) (above 250) (0-49) % of GDP 68 48 31 39 9 20 Employment in 100 68 33 48 20 32 % Source: PARP, Report on the Conditions of SME Sector in Poland 2002-2003. Table 7.13 Polish enterprises asset structure, 2003 Total assets in billion zá 1 145 728

Total assets Small firms Medium Large in % 100 17 26 56 64 16 24 60

Total Long-term assets Short-term 417 36 19 29 51 assets Source: Central Statistical Office, Statistical Yearbook of Industry – Branch Yearbook, 2004.

In the structure of capital, external financing slightly dominates (55%) in all groups. However, bank loans (both long-term and short-term) constitute together only about 25% of external financing and about 13% of total capital of all firms. Table 7.14 Capital structure of Polish firms, 2003 All firms Small Medium Large billion zá %

billion zá %

billion zá %

Billion zá %

Total Capital 1 145 100 197 100 300 100 649 Own funds 520 45 76 39 144 48 300 External funds 626 55 120 61 156 52 349 Including: - LT Bank loans 86 7 19 9 19 6 47 - ST Bank loans 68 6 14 7 20 6 33 Source: Central Statistical Office, Statistical Yearbook of Industry – Branch Yearbook, 2004.

100 46 54 7 5

When analysing new investments, self-financing and reinvested profits dominate, constituting around 70% of SME investment funds. Venture capital financing is rare. Among external financing, the most popular

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Ewa Miklaszewska

sources, particularly for short–term financing, are trade credit and bank loans and less frequently factoring and leasing (Table 7.15). Table 7.15 Structure of liabilities of the Polish firms, 2003

All liabilities (m zá) Including:

Small firms (1049) L-T 20 436

Medium and large (above 50) S-T 64 836

L-T S- T 131 615 268 130

9 643 57 205 47 258 27 815 109 656 5 607 28 638 Source: Central Statistical Office, Statistical Yearbook of Industry – Branch Yearbook, 2004. -

13 833 loans trade credit accruals

In their offer to SME, banks have more sophisticated credit products, such as discounting of trade bills, factoring and leasing. However, access to those products is more difficult. The requirements are sometimes excessive and fees are high, so these products are infrequently used by SME. Leasing is potentially the best credit product for SME, but it is also less frequently used than in other European countries (Fig. 7.7). Figure 7.7 Value of leasing agreements as % of GDP, 2003 Czech Republic Slovenia Hungary Slovakia Portugal Italy Austria Germany United Kingdom Sw itzerland France Spain Sw eden Denmark Poland 0

1

2

3

4

5

6

Source: M. Groszek, Leasing jako instrument finansowania gospodarki, ZBP, Forum Bankowe 2005.


7.4 Models of Bank Services to SME Banks effectively offer basic, standardised products to SME. However, taking investment loans or asking for more sophisticated credit products – such as leasing, factoring, discounting of trade bills or conducting international, insured payments or hedging currency risk – is very expensive and less efficiently provided. A typical large bank, crediting SME generates most income from fees, 25% from loans and 25% from currency trading (Rzeczpospolita, 12.06.04). Many banks offer special terms for SME and both the product range and the prices of services respond positively to competitive pressures. Typical problems, specific to SME in their access to banking services, are inadequate credit history, lack of proper collateral and simplified accounting rules, which makes it difficult for a bank to use standard methods of loan assessment. Based on bank surveys, the major models of banks services to SME can be identified as follows7: -

Retail bank model

In this model, SME are one of many segments and are offered a wide range of products, but they are standardised and very basic in nature: transfer of funds, cards, overdrafts, internet banking. The main advantage of this model is accessibility of branches and the relatively low prices of services. The main disadvantage is the lack of flexibility and specialisation. This model can best be represented by major Polish banks. -

Stages of life model

This model is a version of the above, but with bank trying to assemble specialised packages for the same category of clients, but with different incomes and needs. BPH SA best exemplifies this model. For example, when servicing SME, the bank offers different types of account: Harmonium start, micro, basic, plus, pro – for every stage of a firm’s life. In 2004, BPH SA won the title for best bank servicing SME sector.

7 P. Kulawczuk, Modele bankowoĞci maáych i Ğrednich przedsiĊbiorstw w Polsce, Konkurs „Bank Przyjazny dla PrzedsiĊbiorców 2005”, Warszawski Instytut Bankowy oraz Polsko-AmerykaĔska Fundacja Doradztwa dla Maáych PrzedsiĊbiorstw, WWW.zbp.pl

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Table 7.16 BPH SA Bank Group BPH Bank Strategic companies

Retail, Private banking, SME, Corporate, Capital Markets, Cards BPH Bank Hipoteczny, BPH Leasing, PBK Inwestycje, PBK Property, Direct banking (Call Center) Commercial Union PTE CU WBK Source: www.bph.pl -

Multi-platform model

In this model a bank creates a multichannel and multiproduct model, focused on target customer groups, where separate units service different types of clients. Each platform has its own marketing and product strategies, and they all are supported by headquarters, which however, also conducts its own banking services. The best example is Polish BRE Bank S.A. Group. In this model different type of firms or clients may select different platforms, which correspond exactly to their needs. This is a very narrowly specialised model, which however, allows for high flexibility, efficient procedures and innovativeness. The main disadvantage is the possible cannibalisation and duplication of activities. Table 7.17 BRE Bank Group Structure – Business Areas Corporate Banking BRE Bank

- services

for corporations (Capital Groups) - services for large enterprises - SME services - FT financing

Strategic companies

- BRE Bank Hipoteczny - BRE Leasing - Intermarket Group (Intermarket

Bank, Polfactor, Transfinance, Magyar Factor) - Skarbiec Asset Management Holding - PTE Skarbiec Emerytura (pension

fund) Source: www.brebank.pl

Investment Retail Banking Banking - financial - mBank markets (internet banking) - treasury - project - MultiBank finance (retail) - financial - Private institutions Banking - proprietary investment - BRE - emFinance Securities - BRE Corporate Finace - BRE Finance France

7 Economic Growth and Financial Inclusion in Poland 289 -

Cooperative model

Small, locally licensed cooperative banks are very flexible and able to offer tailor-made products. The bank knows its customers well and is strong in relationship banking. Table 7.18 Comparison of major banking models for SME Retail model Multiplatform Cooperative High accessibility of branches Competitive prices Flexibility of offer Innovativeness

Transparent and simple procedures

yes yes -

yes yes yes

Yes, locally yes yes yes

Local focus Relationship banking Source: Own characteristics, based on Kulawczuk (2005).

yes yes

NBP Financial Stability Report for 2004 classifies SME as negative- neutral-or focused:

banks servicing

Table 7.19 Banks servicing SME – NBP survey Type of bank Attitude towards SME

No. of banks

% of assets

Universal

10

80

% of corporate loans 81

4

7

6

3

3 93

2 93

SME are one among many clients, with low priority Focused on SME

Small, 7 specialized Small, neutral SME serviced in a standard 12 way Small, negative Discouraging SME 13 Total 42 Source: NBP Financial Stability Report 2004.

Hence, 80% of loans to the SME sector are given by universal banks, operating on a retail model, which is not suited best for this segment, rather than by specialised banks, which focus strongly on SME. Other results of the NBP survey showed that most banks consider crediting SME as very risky and that the main problem in assessing SME loans was the lack of reliable data about firms.

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7.5 Barriers to Providing Banking Services to SME: Results of Bank Surveys The three largest Polish banks serve almost half of the Polish small and medium sized firms, according to business surveys. The extent of bank services to the SME can be only estimated, as banks use their own criteria for the SME sector and usually publish only aggregate data for households and corporate clients. However, this segment is attracting a lot of attention and is surveyed and analysed by almost all governmental and many private agencies, so some conclusions as to the barriers to satisfaction of SME from financial services can be formed indirectly on this basis. The major findings of the recent surveys are summed up in Table 7.20 : Table 7.20 The Results of SME-related surveys Survey

Year Target group

Objectives

Findings

Pentor Agency: Commercial 2005 Major Banking Audit Polish banks

Warsaw Banking Institute

Banks are most popular Attitude of customers’ among financial firms; towards banks however, knowledge of banking products is low. Most satisfied are large firms, least satisfied microfirms. SME awareness of Among SME, most 2005 Polish and satisfaction from popular are large firms banking products universal banks rather than local small cooperative ones 2005 Customers General attitude Negative attitude to towards banks credit and risk taking.

PBS: Polish Customer Survey Grant Thornton Polish and Competitive conditions Insufficient sources of and PARP: The 2002 European of European SME financing reported by European SME Polish SME Business Survey PARP Survey 2002- Polish SMEBarriers for SME SME finance 03 financing investment mostly from their own sources, but new investment spending is ncreasingly financed through external sources, including bank loans (continued)

7 Economic Growth and Financial Inclusion in Poland 291 NBP: Bank 24 largest Trends in SME loans Credit 2005 Polish Committees banks Periodic Reports City Council of 2004 SME in History, activities, Cracow: SME Cracow conditions of SME Survey area

Improving terms for SME loans, particularly short term ones Most SME are selffinancing, their owners are conservative, with low propensity for financial risk

Source: Author’s table, based on various bank surveys.

In researching SME needs for banking services, many surveys concentrate on their awareness of and satisfaction from banking products. SME survey conducted by the Warsaw Banking Institute8 showed that small and medium firms were aware of most banks names and products, however, used mostly the services of top universal banks. This feature of the Polish market, that even small firms have contacts mostly with large universal banks, is probably unique and creates a barrier in itself for their access to financing. In financial literature it is well documented that the bigger the bank, the more interest it places in transactional banking, rather than in relationship banking, so the relative discrimination against SME may be a side-effect of the scale of banks. Consequently, there is a lot of room for the expansion of small cooperative banks into local markets, particularly in servicing the SME sector. The European Business Survey9 published by Polish Agency for Enterprise Development, which analyze competitive conditions in European SME, gives also interesting results. When comparing with the European firms, the Polish ones complain about high financial costs, lack of access to new capital and the instability of legal and tax rules. However, in terms of the financial innovations, the picture is more positive: among European SME using internet banking, Polish firms are quite high placed, above Ireland (53%), France (24%) and Greece (21%).

Unpublished survey analysed with permission of the Institute. Europejski SondaĪ MSP, Grant Thornton and PARP 2002 (The European Business Survey). 8 9

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Table 7.21 European SME using internet banking % of total SME 96 91 82 81 79 76 73 65 64

Finland Holland Austria Belgium Denmark Spain Germany Norway Poland Source: EBS, p.51.

The expansion barriers analysed in the Report are summarized in Table 7.22. Table 7.22 SME – Barriers for expansion (% of firms) Euro zone average

UE (15) average

Poland

11 14 22 42

12 16 25 39

3 10 36 13

34

29

50

24 15

21 16

57 42

17 Management 26 Demand 30 Legal problems and taxation 18 Cost of capital 20 Lack of investment funds Access to new markets 29 7 R&D

19 27 26

9 59 44

16 18

44 42

28 7

47 16

Short-term barriers -

Production capacities Management Lack of orders Lack of skilled workers Legal problems and taxation Cost of capital Lack of working capital

Long-term barriers -

Source: EBS, 2001, p.38-41.


SME survey, conducted by Polish Ministry of Economy and Labour and Polish Agency for Enterprise Development (PARP) in 2002-0310 pointed to the positive tendencies in the firms’ environment – relatively high GDP growth and low inflation. New investment was financed by leasing (30%), particularly of transport equipment (83% of all leased assets) and bank loans. Most important barriers indicated in the survey were of a legal and economic nature (changes in law, high taxation, complexity and instability of regulations, high labour costs). The central bank (NBP) Bank Credit Committees Periodic Reports11 pointed out to an increasing number of new loan applications from SME and an increasing number of old loans repaid before a deadline - both tendencies also related to high economic growth. Secondly, banks reported a tendency to offer better terms for overdrafts or other short term loans for SME. In Commercial Banking Audit12, conducted by Pentor Agency in 2005, banks were described by customers as most popular and trusted among all financial firms. The corruption in banking was among the lowest. However, the survey reported that knowledge of banking services and willingness to learn and use banking products was low. Moreover, rising expectations on the part of clients were not matched with a flexible answer on the part of banks. The most dissatisfied customers were owners of micro firms, the most satisfied that of large firms. Table 7.23 Pentor banking survey Why there is a negative tendency to use banking products? -

Consumers

68 Unemployment Inaccessibility of banks for low income people 49 42 Lack of trust 37 High costs of banking services 22 Preference to keep cash at home 19 Lack of experience with banks 5 Lack of bank branches

Bankers 87 24 6 29 37 61 4

Source: Pentor: Commercial Banking Audit 2005, www.zbp.pl

The above table illustrates difference in perspectives in assessing financial barriers to SME: banks pointing to a lack of knowledge and

PARP, Report on SME in Poland, 2002-03. Available at www.nbp.pl 12 Pentor: Commercial Banking Audit 2005, www.zbp.pl 10 11

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experience on the part of the consumers, while customers stressing high costs of services and a lack of trust. Many reports point also to a conservative attitude towards financial risk on the part of both the general population and SME, suggesting some important psychological barriers to more aggressive loan taking13. For example, most SME in the Cracow area surveyed by the Cracow City Council14 declared that they borrow money only in extraordinary situations and 68% of them had not taken out any loans. The firms, when asked about sources of finance, pointed to their own profits and family loans and less frequently to bank commercial loans and instalment loans. Most of those firms were start ups (80%), and only 5% were inherited. 40% of owners declared a negative attitude towards risk and only 25% were open to new challenges, including risky financing. For them, the biggest opportunity was related to accession to the EU, good access to advanced technologies and skilled labour, while the biggest threats were related to bureaucracy and payment delays.

7.6 Conclusions Polish consumers and firms have frequently voiced their dissatisfaction with access to banking products and their cost. However, these complaints are not entirely supported by detailed analysis, including customer and bank surveys. In the last few years there has been an impressive expansion in household financing, which has resulted in a wider range of available products, including very popular internet banking or payment cards. Today, household loans carry an acceptable repayment rate and are easily available due to rapidly increasing competition in the servicing of this segment. This area is penetrated especially by the foreign owned banks. Corporate loans, which have a much worse repayment record, are more stagnant. However, large firms generally express their satisfaction with the scope and cost of bank services. The most dissatisfied group are micro firms, but their problems with access to bank services may be related to their characteristics: short history, simplified accounting and conservative attitude to risk. They are mostly serviced by large banks, with a retail model, and not more flexible specialised ones. However, cooperative Use of Financial Services – Polish Customer Survey, Pracownia BadaĔ Spoáecznych PBS i Konferencja PrzedsiĊbiorstw Finansowych, Sopot 2005. 14 Diagnoza, analiza i ocean kondycji sektora MSP w Krakowie, UMK 2004 (Report based on a survey of 404 SME active in the Cracow area). 13


banks, which used to be very inefficient, in the last few years have been recording very good results and are expanding their lending activities (Table 7.24), but mostly to private households and consumers. Table 7.24 Non-financial sector loans (% of assets) Banks: Total Commercial Cooperative 1993 30 30 32 1995 29 29 34 1998 37 37 43 2000 41 40 53 2002 40 39 52 2004 39 38 56 2005 (03) 38 37 52 Source: Summary Evaluation of the Financial Situation of Polish Banks, NBP 2005.

There is a view that corporate loans are relatively underdeveloped because of the high participation of foreign banks, which are considered to be interested in servicing high income, literate customers, rather than reaching relatively “excluded” segments, such as people on low incomes and small firms. However, some of the most profitable medium-sized foreign banks base their strategies on servicing low-income and more high-risk groups, which for them is profitable. Poland historically has been a cash economy, with low use of banking products. Those features are, however, changing. In 2005, there were over 30 mln bank accounts, many of them with an internet banking facility and 70% of households and 60% of people aged above 16 years had bank account. Currently, there are 8 500 ATM machines (up from 5000 in 2000), 140 000 points accepting payment cards and 20 million cards in circulation 15. Recently firms have also expressed the opinion that banks are more friendly, focusing not only on financing, but also on advising and interacting with firms. To conclude, it seems that the problem of financial exclusion – major barriers to use financial services in terms of access and cost, in the case of Poland is not absolute, but rather more relative in nature. Polish customers: firms and households, have access to all major products which are efficiently offered by a diversified and competitive banking structure. In terms of cost of basic basket of globally available banking products (global profile in tab. 25), Poland is below the European average, but slightly K. Pietraszkiewicz, Zrozumieü banki, Bank, 04/2006 (Rapport of the President of the Association of the Polish Banks). 15

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above in a locally adjusted basket (local profile). However, when comparing the prices of banking services to GDP per capita, Poland is closer to China than to the most effective EU systems. Table 7.25 Cost of core banking services (annual weighted prices, 2005 EUR) Country Switzerland Australia Italy Norway Germany US Poland France Spain Austria UE 2005 average Canada Portugal Czech Rep. UK Belgium Sweden Slovakia Ireland China Netherlands

Global profile 159 81 252 131 223 126 101 99 108 93 108

Local Profile 137 123 113 102 98 93 91 89 81 79 78

Local profile cost as % of GDP per capita 0.4 0.6 0.5 0.3 0.4 0.3 2.1 0.4 0.5 0.3 -

93 99 83 64 59 80 105 63 54 34

76 69 68 65 57 49 48 42 29 25

0.3 0.6 1.0 0.3 0.2 0.2 0.9 0.1 3.3 0.1

Source: World Retail Banking Report, Capgemini Analysis 2005, ww.capgemini.com

In the period before and after accession to the EU, the Polish economy has been dynamically growing. After slowing down in 2005, the first quarter of 2006 is characterised again by dynamic growth, led by exports and investment spending by firms (Fig. 7.8). This, together with the fact that unemployment is falling, due to massive employment opportunities in the EU, to which Polish workers have reacted very flexibly, creates a positive perspective for the future.

7 Economic Growth and Financial Inclusion in Poland 297 Figure 7.8 Dynamics of GDP Growth in real terms (constant prices, last year corresponding period = 100%)

110 108 106 104 102 100 98

I 03

II 03 III 03 IV 03 I 04

II 04 III 04 IV 04 I 05

II 05 III 05 IV 05 I 06

96 Individual Consumption

Outlays on Fixed Assets

Gross Domestic Product

Source: Central Statistical Office (GUS): National Accounts, www.stat.gov.pl

7.7 References PARP sources (Polish Agency for Enterprise Development) Raport o stanie sektora MSP w Polsce w latach 1999-2000; 2001-2002; 20022003 (Report on Conditions of Small and Medium-Size Enterprise Sector in Poland); MSP w Polsce 2003 (SME Sector in Poland in 2003); Europejski sondaĪ MSP, Grant Thornton and PARP 2002 (The European Business Survey, Grant Thornton and PARP); Finansowanie rozwoju MSP, 2000 (Financing of the SME sector) The Association of Polish Banks (ZBP) and Warsaw Banking Institute (WIB) Annual Report of ZBP: Banki 2004 Papers from the Annual Conference: Bank Forum 2005, www.zbp.pl National Bank of Poland General Inspectorate for Banking Supervision: Sytuacja finansowa banków 2005 (Summary Evaluation of the Financial Situation of Polish Banks, 2005) Raport o stabilnoĞci systemu finansowego 2004, 2005 (Financial Stability Report) Sytuacja na rynku kredytowym - 2004, 2005 (Situation in the Credit Market)

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Informacja o kondycji sektora przedsiĊbiorstw, 2005 (Information on the Conditions in the Enterprises’ Sector) GUS (Central Statistical Office) Statistical Yearbook of Industry 2004, Wyniki bilansowe przedsiĊbiorstw gospodarczych w 2003 r. (Balance Sheet Data for Industrial Enterprises, 2003). Books and articles BankowoĞü detaliczna, red. G. Rytelewska, PWE, Warszawa 2005. Chmiel J. (ed.), Stan sektora MSP w 2002 (SME in 2002), PARP, Warszawa 2004. Dermine J., Bank Mergers in Europe, the Public Policy Issues, Journal of Common Market Studies, 2000. Dziewulski P., GruziĔski W., Warchaáowski P., ElastycznoĞü krajowego sektora bankowego w finansowaniu MSP (The Flexibility of the Polish Banking Sector in Financing SME), BRE Bank – Case Papers no. 78, 2005. Integration of European Banking: the Way Forward, CEPR, London 2005. Józefowska M., Polityka banków komercyjnych w odniesieniu do sektora MSP (Banks’ Policy towards SME), in: Raport o stabilnoĞci systemu finansowego, NBP 2004. Kulawczuk P., Modele bankowoĞci maáych i Ğrednich przedsiĊbiorstw w Polsce, konkurs „Bank Przyjazny dla PrzedsiĊbiorców”(Bank Models for SME), Gdynia 2004, www.zbp.pl Miklaszewska E., Impact of Deregulation on Strategies of Commercial Banks, AE, Krakow 2004. Pietrzak J., Czynniki przewagi konkurencyjnej na rynku bankowych usáug detalicznych (Competitive Advantages in Retail Banking Market), Univ. of GdaĔsk, GdaĔsk 2003. Skowronek–Mielczarek A., MSP: ħródáa finansowania (SME: Sources of Financing), Beck, Warszawa 2005.

8 Italian Banks’ Credit Approach Towards LowIncome Consumers and Microenterprises: Is There a Bias Against Some Segments of Customers?

Eliana Angelini11

8.1 Introduction In Italy, the sensibility of banks for financial requirements of low-income consumers and microenterprises appears still rather limited. Low-income customers include salaried employees, farmers, pensioners, young people with temporary occupation (atypical workers) or unemployed, housewives and immigrants. Microenterprices, the smallest economic units that operate in any economy, include the self-employed as well as family-run enterprises. From corner grocery shops to tailors, they operate in just about any sector of the economy. While the financial needs of these segments are similar to those of other businesses and consumers, their personal and business characteristics, as well as the relative size of their operations, diverge significantly. Specifically, microentrepreneurs and other lowincome customers tend to operate on the margins of the formal economy and society, often without requisite permits and documentation. The microenterprises have few employees, other than the owner-operator. The enterprises and households usually have limited assets, particularly lacking fixed assets with formal titles that could serve as traditional collateral. Net incomes are on the lower end of the scale although operating margins for microenterprises in percentage terms can be significant. Formal records of sales, expenses and incomes are scarce and unreliable. Business and The author would like to thank Laura Nieri and Maria Debora Braga for the precious suggestions and Paola Assetta for the collaboration to the collection of data. Sole responsibility for the contents of this analysis rests with the author. 1

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household finances are mixed with income generated from diverse sources, such as multiple enterprises, farming and agricultural production activities, remittances, day labour and salaried employment2. Access to credit by this segments of customers is a common problems and tends to be especially acute in developing countries. There are many causes for this including the cost and difficulty of evaluating the credit worthiness. These customers, often defined "marginal", often create specific problems of evaluating and monitoring credit risk: lending is considered "vulnerable" for objective characteristics – linked, as an example, to aleatory activity practised from the borrower – or subjective characteristics, regarding customers (economic availability, the style of life, the low school – attendance index and the low level of socialeconomic insertion). Banks used credit scoring models to generate information about a borrower’s propensity to repay a loan. Credit scoring is a statistical technique that combines several financial characteristics to form a single score to evaluate a borrower’s credit worthiness. Credit scoring tool is utilised by most banks in their assessment and approval (or decline) of the vast majority of their loans; it is widely used in consumer credit markets to reduce the time and costs associated with loan evaluations but only recently have begun to be used for small business lending . As some banks became larger and as the number of their consumer credit applications grew, these banks needed to establish more systematic and efficient methods for evaluating which clients were good credit risk. Credit scoring is one such technique. Although no system is perfect, credit scoring methodologies can be at least as accurate as informal methods for granting credit because they treat all applicants objectively; with credit scoring lending decisions are likely to be more objective, faster and less costly than traditional "judgmental" decisions. Furthermore, another key to the acceptance of scoring in a bank organization is ease of use. This requires that scoring models be integrated into the existing management information system; a good scoring methodology allows a bank to continue with business as usual, but with the addition of quantitative estimates of risk. Banks measure the borrower’s creditworthiness against a representative database and use the resulting information to decide whether a loan should be made and on what conditions. Credit scoring is the process of assigning a single quantitative measure, or score, to a potential borrower representing an evaluation of the borrower’s future loan performance. A credit scoring model is a formula that puts on different features of a borrower, a lender, and a loan, and produces an estimate of the probability or risk that 2

See Viganò L. (2001), Anderloni L. (2003), USAID (2005).

8 Italian Banks’ Approach

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an outcome will happen. It uses quantitative measures of the performance and characteristics of precedent loans to predict the future performance of loans with similar features: scoring supposes that the performance of future loans with a given set of characteristics will be like the performance of past loans with similar description: if the future is not like the past, scoring will not work well. The weights of each characteristic in the scorecard are based on a statistical analysis of the relationship between the features and repayment in the lender’s historical database3. Credit risk estimates are based on information; this information is usually qualitative, informal and resides with group members or with loan officers. Credit scoring takes a different approach: it predicts risk based on quantitative information that resides in the management – information system of the lender. Can lending benefit from scoring and its formal, quantitative information? In other words, do credit scoring models have sufficient flexibility and accuracy to assess credit risk or is there a bias against some segments of customers? The objective of this chapter is to examine the characteristics of credit scoring approaches, their application and their predictive power to estimate the credit risk in lending decisions. In particular, it considers the main economic implications, generated by using these methodologies, in these areas: -

lending costs for banks or other credit institutions; credit assessments, quality and accuracy; loan pricing and credit availability.

This analysis proceeds as follows. § 8.2 provides background information on credit scoring models and describes highly predictive variables used in the model by lenders. § 8.3 discusses about opportunities and risks of these methodologies. The benefits of scoring can vary according to the type of loan and the nature of available data about borrowers and repayment experience. § 8.4 examines economic effects raised by the increasing in the use of scoring-based systems for lending, distinguishing between the To use scoring in daily work, the lenders might identify some policy ranges: super safe, regular, risky and super risky. Applicants with predicted risk in the super safe range are quickly accepted and may qualify for lines of credit or other special rewards. Applicants with predicted risk in the regular range are accepted. Applicants with predicted risk in the risky range receive extra attention from the loan officer and from the credit committee. The amount, term or guarantee specified in the contract may be adjusted for risky cases in an attempt to control risk. Finally, applicants with risk in the super risky range are suddenly rejected. See Schreiner M. (2002). 3

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effects of credit scoring on “marginal borrowers” and “non marginal borrowers”. § 8.5 presents the empirical results concerning a sample of Italian banks, operating in Abruzzo region, about their lending policies towards “marginal” segments of customers.

8.2 Methodologies of Credit Risk Measurement: Credit Scoring Models The range of theoretical models on the credit risk assessment is wide and has a strong differentiation in the conceptual presupposition. Lending decisions involve classifying a would-be borrower into the group of either acceptance or rejection for the loan. The traditional quantitative methods for this type of binary classification are credit scoring models4. Credit scoring methods can be utilised for all types of credit analysis, from consumer credit to commercial loans. The presupposition is essentially the same: pre-identify certain key factors that determine the probability of default and combine or weight them into a quantitative score. In some cases, the score can be literally interpreted as a probability of default; in others, the score can be used as a classification system: it places a potential borrower into either a good or bad cluster, based on a score and a cut-off point. The score can be used to classify individual borrowers or loans into risk categories. A credit score is a number that is intended to predict a borrower’s propensity to repay a loan; a loan score expands upon the credit score to include variables relating to loan characteristics – for example, the loan-to- vale- ratio for a home mortgage – to create a numerical indicator of the probability that a loan may default5. Credit scoring found its first applications in consumer lending. Starting in the 1960s, finance companies, followed by retailers and credit card companies, began to apply scoring-based system to assess potential customers and evaluate credit applicants6.

See Sironi A, Marsella M. (1999), Barontini R. (2000), De Laurentis G. (2002), Schreiner M. (2002), Caire D. and R. Kossmann (2003). 5 In addition to decisions regarding approval or disapproval of loan applications, credit scoring can be used for the following purposed: a) pricing loans based on degree of risk; b) differential landling of late payments; c) differential handling of collections based on outcome predictions; d) estimating the amount of profit an account is likely to generate; e) targeting prospective customers. See Barefoot A.S. (1996). 6 See Stanton T.H. (1999). 4


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Bankers employ the credit score as a guide in the credit decision process. It is important to note that, while the credit score can be used to auto-decision an application, scoring and auto-decisioning are not the same. It is helpful to view credit scoring as part of a continuum in the development of the credit decisioning process, where credit screening is the most basic, foundation approach and auto-decisioning the most complex (Fig. 8.1). Figure 8.1 Credit Scoring Development Credit screening An initial test to censure that the applicant meets the lender’s basic credit requirements. Performed either by the banker during the initial applicant interview or through an on line questionnaire.

Credit scoring A statistical technique that combines several financial characteristics to form a single score to represent a borrower’s credit worthiness. Derived from data provided on the applicant for credit as well as from outside sources (e.g., credit bureaus).

Auto-Decisioning An automated application decision based on the applicants credit score.

Source: Wendel C.B., Harvey M. (2006).

Several statistical models are used to develop credit scoring systems. The traditional scoring models can be subdivided in three main categories: -

models of linear discriminant analysis, in particular, Altman Z-score model7. The multivariate analysis, through a discriminating function, permit to synthesize the value of more variables in a single Z value that, compared with a Zc value (cut-off point) concurs to classify the loan applications into the groups of acceptance or rejection for the loan. The linear discriminant function is following: Z = O1x1 + O2x2 + .. + Onxn where xi represents indicators used as independent variables and Oi indicates discrimination coefficients;

-

7

models of linear regression: they identify, in a selected sample, some random variables (Xij); these variables reflect important information See Altman E.I. (1968) and Altman E.I. (1993).

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and they are used as independent variables in a linear regression in which the dependent variable is represented by the variable Z (that can assume 0 or 1 value alternatively). In this way, it identifies variables statistically meaningful in insolvency evaluating and it also estimate regression coefficients. In analytical terms: n

Zi

¦E

j

X i, j H i

j 1

where ȕj represents the importance of Xj variable in evaluating the past insolvency. This approach suffers from an important problem whenever the probability of default of one new borrower assumes external values to the interval (0;1); such problem is faced from the models logit and probit8; -

logit and probit model: the problem of linear model regarding the output not limited in interval (0; 1) is solved by the model of logistic regression (logit); it uses an exponential transformation and results of the regression analysis are included within this interval. We have the following equation:

F ( Zi )

1 1 e Z i

The expression provides the conditional probability of finding the borrower i in the group of insolvent customers. The probit model only differs from the logit model as far as concerns the hypothesis of the distribution: it assumes that the distribution is the standardized normal and therefore F (Z) represents the accumulated function of the normal distribution. In the logit model F (Z) indicates the accumulated function of the logistic distribution, characterized from thicker tails. In the application, it does not determine important differences between the two models if not there are numerous extreme cases in the reference sample. These methodologies suffers from important statistical restrictions. First, the distributions of discriminating variables must be jointly normally distributed. Second, the disturbance term of the discriminant function is assumed to be normally distributed with homoschedastic variance. These assumptions may cause problems for interpreting the results of empirical estimation and generating reliable forecasts.

8

See Altman E.I., Saunders A. (1997), Saunders A. (1999).


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The recent application of nonlinear methods, such as neural networks to credit risk analysis, shows promise of improving on traditional credit scoring models9. Neural networks: they differ from classical credit scoring systems, such as the Z-score model, mainly in their black box nature and because of they assume a non-linear relation among variables. They are considered black boxes, since, in general, it is not possible to extract symbolic information from their internal configuration. Neural networks are machine learning systems based on a simplified model of the biological neuron. In the same way as the biological neural network changes itself in order to perform some cognitive task (such as recognizing faces or learning a concept), artificial neural networks modify their internal parameters in order to perform a given computational task. The two main issues to be defined in a neural network application are the network typology and structure and the learning algorithm. The connections (links) among neurons have associated a weight which determines type and intensity of the information exchanged. The main advantages have to be found in their learning capabilities and in the fact the derived model does not make any assumption on the relations among input variables. Conversely, a theoretical limit of neural networks is that they are black-box systems and the extraction of symbolic knowledge is awkward. Moreover, design and optimization of neural network methodologies are almost all empirical, thus the experience and sensibility of the designer have a strong contribution in the final success. Nevertheless, with this work we show that some useful general design and parameters optimization guidelines exist.

-

8.2.1 The Choice of Highly Explanatory Variables The individualization of inputs in scoring systems is an extremely delicate and laborious task. The variables in the model can be: chosen discretionally by the “constructor” of the scoring model; characterized through appropriate statistical techniques10.

-

In the first case, it is spoken about “subjective” credit scoring models. The subjective term refer to the fact that the choice of variables is at the discretion of who elaborates the model, based on the own last experience 9

See Hykin S. (1999), McNelis P.D. (2005). See Sironi A. (2005).

10

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in credit management. In reference to second case, the “objective” credit scoring models, the individualization of variables and the weight of same are determined through statistical techniques applied on predefined sample of borrowers. For personal loan, main variables employed in scoring models are following: -

marital status, citizenship, age; type of occupation, main salary, added yields; duration of the working activity; house ownership, property of other assets (as an example the car); possession of telephone, possession of credit cards; credit history; eventual judgment of the Credit Bureaus.

The database included publicly available, governmentally supplied information, such as sex, citizenship, marital status, taxable income, taxable wealth, and variables reported by banks like the total number of inquiries made about an individual, the number of unsecured loans and the total amount of unsecured loans. For enterprises, the variables include information for the business, budgetary indices, major financial ratios and history of past back payment. Main explanatory variables are following: -

age of a firm since its establishment; total amount of loan requested; maturity of loans; total amount of existing credit obligations; total interest to cash flows ratios; net cash flow of the firm; debt to equity ratio; current assets divided by current liability; net income plus interest divided by total assets; sales to accounts receivables ratio; average turnover rate of receivables per annum; sales to total assets ratio; Credit Bureau information.

It’s possible to observe that statistical scoring requires a lot of data on each loan; anyway, almost borrowers are self-employed and have no formal credit record. Many of them are young, minorities, immigrants or members of ethnic groups that avoid use of the traditional banking system. Therefore, the best predictors of risk are not accessible. As it will be shown later, this is one of pitfalls of the scoring methodology.


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Credit bureaus are being established in more and more markets, selling more information on more people to more enterprises. Small businesses, low-income customers and salaried employees are the primary market segments that can benefit from the establishment and expansion of credit bureaus. Credit reference services allow people and firms to turn their reputations (credit and social history) into collateral for loans to finance businesses, home improvements, consumer purchases and to respond to other opportunities and needs that require financial services. Borrowers can use their credit reports as substitutes for formal financial statements and traditional collateral to access loans usually unavailable from the formal financial sector. Credit bureaus can help increase access to client information, thereby lowering costs on loan appraisal, collections and losses. They can increase competition for smaller borrowers, which expands access to credit and lowers costs on financial services for these traditionally underserved segments. A credit bureau report is not a perfect substitute for reference checks and other elements of credit analysis, but it can serve as a filter to reject unqualified clients, such as those a high level of arrears. Such screening mechanisms for bad loans free lenders to focus on other potential clients rather than wasting time searching for references and others information on applicants who clearly do not qualify. A credit bureau helps lowincome people who have developed a credit relationship with one institution signal their credit worthiness to the market, allowing them to access diverse sources of financing at competitive rates and terms.

8.3 Strengths and Weaknesses of Credit Scoring Banks’ credit managers have to understand the benefits and pitfalls of statistical credit scoring to get better its adoption in the credit administration and to improve management decisions11. As discussed, scoring reveals the links between risk and the features of the borrower, the loan and the lender. For example, the wisdom in microfinance is that woman repay better than man. For a given lender, scoring not only confirm or reject this wisdom but also reveals precisely how much gender matters. Scoring can also reveal, for example, how risk is related with past arrears, with the type of business and with adjustments, how loan officers would fare if they all managed an identical portfolio. In contrast, subjective scoring relates risks with characteristics based on 11

See Schreiner M. (2002).

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beliefs derived from experience and/or handed-down wisdom, but the beliefs and wisdom may be incorrect, or at least imprecise. Scoring uses statistics to derive this historical links between risk and features. In general, statistical scoring confirms the general direction of subjective judgement (for example, past arrears do signal greater risk of future arrears, and carpenters are indeed among the riskiest of borrowers), but statistical scoring, unlike subjective scoring, reveals the precise strength of the links. Another, statistical credit scoring reduces costs and time spent in collections12. Generally speaking, credit scoring models offer several potential benefits13: -

-

lower costs: evaluation systems such as credit scoring reduce the role of human evaluation, with the potential for reducing the cost of delivering credit; improved accuracy: as scoring systems evolve and improve they will be more effective at predicting actual loan performance; better products and marketing: credit scoring models allow lenders to tailor the marketing effort to meet the needs of market niches.

Credit scoring models have several potential risks, yet. Scoring is powerful, but its misuse can be very damaging. This methodology requires data on many loans and a lot of data on each loan. Predictive power increases with the number of features available. Some borrowers are self-employed and have no formal credit record. Thus, the best predictors of risk are not available; scoring must compensate for the lack of a few very strongly predictive characteristics with the use of a larger number of less-strongly predictive features, not only of the borrower but also of the loan and of the lender. Subjective scoring is indispensable for estimating those aspects of risk associated with characteristics and quality that are not (or cannot be) quantified and/or have not been recorded in an electronic data base. For credit-card loans to salaried people in highincome countries with comprehensive credit bureaus, a very large share of risk is related with quantified factors. For small loans to self-employed people in low-income countries without comprehensive credit bureaus, a much smaller share of risk is related to characteristics recorded in the database. The main difficulty is generating an adequate database on the performance and features of past loans, inserting scoring into the current Experiments in the poor countries (Bolivia and Colombia) suggests that scoring for microfinance can indeed improve the judgement of risk and thus cut costs. See Schreiner M. (1999a, 1999b, 2000). 13 See Barefoot A. S. (2006). 12


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loan – evaluation process. The database must be computerized, and it ideally would include both accepted and rejected applicants; it should also include a full range of characteristics of the borrowers, the lenders, and the loan, as well as data on the timing and length of each spell of arrears in each loans. Lenders score potential customers based on comprehensive credit histories from credit bureaus and on the experience and salary of the borrower in formal wage employment; however, most of their borrowers are poor and self-employed and much of the risk of micro-loans is unrelated to features that can be quantified inexpensively. Another difficulty is that a scoring model developed from the database of one lender will be much less powerful if applied to a second lender because of divergences in the lending technology, the clientele, the competition and the general economic environment. Another, all databases have some noise, if the inaccuracies or random value are too much, statistical scoring can generate erroneous links between the characteristics in the database and credit risk. An additional, among the most predictive characteristics for scoring are gender, marital status, age, place of residence, and ethnicity14. Borrowers, however, do not choose their gender, age or ethnicity and many may not have had must choice in their marital status or place of residence. All over the world, these recognized characteristics have been (and still are) used by lenders to oppress certain groups without any relation or associations with risk. Yet, these features are strongly associated with a plethora of other characteristics in a scorecard – whether chosen by the individual or imposed on the individual by society – that are in turn strongly associated with repayment risk; a lender with a strong sense of its social mission might sensibly use the information to make more careful and explicit trade-offs between social mission and profits. Finally, statistical scoring assumes the future will be like the past. Careful management must still adjust the use of scoring for changes in context, competition, or even in the lender’s own policies. Scoring cannot predict something that has not already happened many times and that has not been recorded in the data base. At the same time, even though things change, scoring usually continues to predict relative risk well, even though it may lose power in terms of absolute risk. While credit scoring have been used for some time to take decisions on consumer loans for autos, personal lines of credit, credit cards and residential mortgages, this methodology has only recently been applied to small commercial credits. This is because commercial loans were thought to be too heterogeneous and documentation was not sufficiently standardized ei14

See Schreiner M. (2000).

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ther within or across institutions15. However, credit analysts ultimately resolved that the personal credit history of small business owners is highly predictive of the loan repayment prospects of their businesses. The personal information used in small business credit scoring models may include the owner’s monthly income, outstanding debts, financial assets, employment tenure, home ownership, and previous loan defaults or delinquencies. Therefore, personal information is attained from a credit bureau and then improved with basic business - specific data collected by the bank16. In the long run, the use of credit scoring may help in the expansion of a secondary market for pools of small business debt, similar to the way in which consumer credit scoring helped in the development of secondary markets for consumer debt.

8.4 The Effects of the Adoption of Credit Scoring on a Marginal Borrower’s Credit Process Credit scoring models may modify small lending in these areas: -

lending costs for banks or other credit institutions; credit assessments, quality and accuracy; loan pricing and credit availability.

The adoption of credit scoring may change the way banks process information and make credit decision about loan applicants17. In this analysis is better to distinguish between the effects of small business credit scoring on “non marginal borrowers” – that would be approved for credit whether or not credit scoring is adopted – and “marginal borrowers” that gain or lose access to credit as a result of the adoption of credit scoring18. Non marginal borrowers, with the implementation of credit scoring models, may pay inferior prices for credit or face other contract terms that are less restrictive for at least three possible reasons. First, if the overall costs of lending (including due diligence, on-going monitoring, etc.) decrease, some of these cost savings may be passed on to the firm as lower See Rutherford R. (1994/1995). While some large banks have developed proprietary small business credit scoring, most have turned to models from provider of external models (e.g., Fair, Isaac and Company); today, there are alternative outside vendors that are typically also in the commercial credit information business (e.g., Dun & Bradstreet). 17 See Altman E.I., Marco G., F. Varetto (1994). 18 See Berger A.N., Frame S.W., Miller N.H. (2002). 15 16


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interest rates. Second, if the use of credit scoring improves the bank’s accuracy in evaluating the creditworthiness of some types of loans, then the price or other terms may also become more favourable because of reduced moral hazard or adverse selection problems19. Third, irrespective of any change in costs or accuracy, some borrowers may pay lower prices because they are evaluated as higher quality when scoring is used. Other “non marginal borrowers” may pay higher prices as a result of the adoption of scoring because the converse of these conditions may hold. That is, contract terms may worsen because bank costs could increase, accuracy could decrease, or the “new” information set suggest more risk than the “old” set for these borrowers. Although all of these effects may happen to some degree across different banks and different borrowers, it seems most likely that there would be a net reduction in average prices for “non marginal borrowers”, due to the overall improvements in lending costs and/or accuracy discussed above. Some “marginal borrowers” may gain access to credit for essentially the same reasons given above20. First, any cost savings from the use of scoring may transform some loans from negative net present value (NPV) investments into positive NPV investments and let the bank expand its lending reach into some pools of borrowers that were previously unprofitable to serve. Second, improved accuracy may permit the bank to expand its lending into pools of subjects that were previously too informationally opaque to be creditworthy, That is, the adoption of scoring may reduce moral hazard and/or adverse selection problems to the point where some loans are positive NPV rather than negative NPV investments. Third, irrespective of any change in costs or accuracy, some “marginal borrowers” may gain access to credit using scoring because these borrowers are evaluated as higher quality credits. Loans to these borrowers may be positive NPV investments using the “new” information, whereas these loans were negative NPV investments using the “old” information. The use of scoring may cause other “marginal borrowers” that would otherwise be granted credit to lose access to credit because 1) the costs of lending increase, 2) the bank’s accuracy decreases, or 3) the “new” information set is less favourable than the “old” information set21. Other “marginal borrowers” may also 19 The improved accuracy may permit the bank to eliminate some of the worst borrowers in their applicant pool (adverse selection) or to reduce the ability of borrowers to take on more risks after the loan is granted (moral hazard). 20 See Berger A.N., Frame S.W., Miller N.H. (2002). 21 Note that by assumption above, either (1) or (2) may be true, but they cannot both hold, since scoring would not be adopted and kept if both raised costs and was less accurate.

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lose access to credit because the adoption of scoring causes the bank to discontinue a lending technology under which these borrowers’ loans would be evaluated as positive NPV investments to a technology under which these loans are negative NPV investments. “Marginal borrowers” do not face price increases or decreases from the bank adopting scoring, since these borrowers simply either gain or lose access to credit; however, the addition to or subtraction of these firms from the pool of subjects receiving loan contracts from the adopting bank may have important effects on the average price paid for credit at the bank: marginal borrowers pay higher loan prices on average than non marginal borrowers because they generally have upper credit risk, greater informational opacity, and/or are more costly to serve than other borrowers that are not at the margin of acceptance/ rejection. In recent years, in US commercial banking industry, data suggest that the adoption of credit scoring is associated with expanded quantities, higher average prices, and greater risk for small business credits under $100,00022. These results are consistent with the hypothesis that a dominant effect of small business credit scoring is a reduction in lending cost and/or improved accuracy of credit assessments that allows banks to expand credit to some relatively risky “marginal borrowers” that would otherwise not obtain credit. These borrowers tend to pay relatively high prices, when they are funded because of higher risks, more informational opacity, or other associated costs of processing their loans. In general, the adoption of scoring is likely to have mixed effects on loan applicants: some are likely to face virtually no change in credit availability or terms, whereas some will likely gain or lose access to credit, and others will likely face higher or lower prices. The credit risks of the borrowers receiving credit may also change considerably as “marginal borrowers” are added and subtracted. Specifically, credit prices are likely Berger A.N., Frame S.W., Miller N.H. (2002), in their analytical framework provide an intuition for how the adoption of small business credit scoring (SBCS) may change the way banks process information and make credit decisions about small business loan applicants. Their empirical model compare the predicted quantities, prices, and risks ratings of small business credits for banks that did and did not adopt SBCS, controlling for other exogenous differences among the banks and their markets. They show how SBCS may act as a substitute for or complement to other lending technologies, and may result in reduced lending costs, improved accuracy in evaluating creditworthiness, or both. Other findings include that: 1) both bank-specific and industry wide learning curves are important; 2) the effects of SBCS differ according to the extent to which the bank adheres to “rules” versus “discretion” in using the technology, and 3) the effects of SBCS differ for slightly larger credits (between $100,000 and $250,000). 22


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to be lower on average for “non marginal borrowers” at banks that have adopted scoring relative to banks that have not adopted this technology. This is due to reduced bank lending costs and/or improved bank accuracy. It’s no possible to predict whether more “marginal borrowers” will gain versus lose access to credit, but it does predict that if there is a net gain (loss), this will tend to increase (decrease) the average prices and credit risks at the bank because of the relatively high prices paid by “marginal borrowers” and the relatively high credit risk when they receive credit.

8.5 The Experiences of Some Italian Banks In this section we indicate the main results obtained from interviews based on a questionnaire turned to a sample of banks operating in Abruzzo region. It concerns the technical aspects of lending decisions and the methodologies adopted by banks to an accurate credit risk estimation. In particular, the analysis is interested in the credit approach towards lowincomes (and/or devoid of guarantees) customers and microentreprises; that segments we have often called “marginal” customers. The credit institutions are following: Banca di Credito Cooperativo Abruzzese, Banca Toscana, Carichieti, Caripe, San Paolo IMI e Tercas. It is difficult, therefore, to make specific comments regarding the strategies and credit decisions being employed by the various banks. Some general points can, however, be made. -

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Banca di Credito Cooperativo (BCC) – whose social object previews the economic support to the little well-to-do families – doesn’t make any distinction of customers. The only distinction is between the status of “associate” and “nonmember”: the interest rates and the economics conditions satisfy the expectations of associates; the institutional objective is to favour the access to the financial services. Caripe – whose objective is to intensify the relationships with the greater possible number of customers, with the perspective of penetration in the local market and with a consequent increasing profit – it demonstrate that, for the agencies localized in the small centres of the province, is fundamental to entertain relationships of confidence with this target of customers. A “neutral” position is assumed by Carichieti and by Banca Toscana; they confirm that although this target is not the more interesting, under the economic profile, there are, as well, numerous customers such as retired people, housewives and students customers of the bank.

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San Paolo IMI : “marginal customer” doesn’t mean the young person with temporary occupation, the housewife, the retired person, the student, the no-profit organization or immigrants; in this definition are included customers who make few operations upon the account. Tercas: does not have “marginal customers” portfolio, for company policies. The excessive riskiness and the limited profit, motivate the bank to entertain relationships with companies with elevates yearly turnovers and/or with small enterprises already reliable and payable.

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Table 8.1 “Marginal” customers BCC Young people with temporary occupation, housewives, retired people, students, no – profit organizations, small producers, farm workers, immigrants. CARIPE Small producers, housewives, retired people and students.

BANCA TOSCANA Young people with temporary occupation, housewives, retired people, students.

CARICHIETI Especially retired people, but also housewives and students.

SAN PAOLO IMI TERCAS Small producers, that = operate upon the account little and immigrants.

Driven by internal and external factors, the reasons for granting credit to this segment of customers are diverse, ranging from motivations of pure profit to social objectives. Institutions have to possess a sound business reason; the declared, continued support of the bank’s board and a group of managers who are persistent in establishing and advancing this markets. Internal drivers must be matched by an environment favourable, with sufficient demand, freedom to set prices and reasonable regulations. Figure 8.2 Reason for granting credit: internal and external factors Internal Factors -

Profit Risk diversification Image Public relations Cross – marketing opportunities

External Factors -

Competition Large microenterprise and low – income market Regulations Market pressure on margins


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In the credit assessment, the external informative sources assume an important role. The motivations substantially concern the opportunity to take advantage of the economies of scale in the collection and elaboration of the information available and in the necessity to exceed the limits deriving from the absence of customers consolidates relationships. A solution – particularly diffused in the Anglo-Saxon systems, characterized by greater propensity to the indebtedness of the families – concerns the “esternalization” of preliminary investigation process: the collection of the information, their elaboration and often their evaluation are made by external specialist societies, i.e. credit bureaus, whose main function is to collect, to elaborate, to integrate “the raw” information. The existence of a credit bureau can provide additional support to the decision – making process by revealing a prospective borrower’s repayment history and level of indebtedness with other financial institutions. Although public and private credit bureaus are being established in a growing number of countries, in many cases they do not yet exist, are weak or lack data on micro-borrowers; development of full service credit bureaus that include on all micro-clients significantly facilitates market entry, reduces costs associated with credit analysis, and provides an incentive for repayment while improving risk management of lending. In Italy, the resource to the Credit Bureaus constitutes a more recent phenomenon even if in strong expansion; the main Credit Bureau is the C.RI.F (Centres of the Financial Risks) (see Table 8.2). Table 8.2 Evaluation of credit risk BCC External evaluation (CRIF) and credit scoring models.

BANCA TOSCANA Subjective and discretionary evaluation /external evaluation (CRIF) and credit scoring models. CARIPE SAN PAOLO IMI External evaluation Subjective and (CRIF) and credit scoring discretionary evaluation models. / credit scoring models. External evaluation (CRIF).

CARICHIETI Subjective and discretionary evaluation / credit scoring models. External evaluation (CRIF). TERCAS =

In the past, banks used credit reports, personal histories and judgement to formulate credit decisions. But over the past 20 years, credit scoring has become widely used in issuing credit cards and in other types of consumer

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lending; now, a growing number of Italian banks are using credit models also in their small-business lending operations. The first banks to use scoring for small-business loans were larger banks that had enough historical loan data to build a reliable model. To build a scoring model, banks analyze historical data on the performance of previously made loans to determine which borrower characteristics are useful in predicting whether the loan performed well. Information on borrowers is obtained from their loan applications and from credit bureaus. Data such as the applicant’s monthly income, financial assets, outstanding debts, net cash flow of the firm, whether the applicant has defaulted on a previous loan, whether the applicant owns or rents a home are all potential factors that may relate to loan performance. Statistical analysis relating loan performance to these variables is used to pick out which combination of factors best predicts the default, and how much weigh should be given to each of the factors. The weights give a measure of the relative strength of each factor’s correlation with credit performance. The main inputs regarding the borrowers are summarized in Table 8.3. Table 8.3 Main inputs used in the credit scoring models Individual characteristics Business characteristics Past arrears: number of spells of arrears days in arrears per payment longest spell of arrears in days Borrower demographics: - gender - age - marital status - education - number of household members Experience as a borrower: number of previous loans months since the first payment

Type of business years of experience in current type of activity number of employees monthly sales/expenses other business income/expenses household (non-business) income/ expenses monthly free cash flows inventory fixed assets other business assets (accounts receivable) accounts payable debts other liabilities

Other characteristics Presence of salaried job length of time at salaried job home tenure (owner, renter, other) length of time at current address


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The objective assessments offered by credit scoring systems should help lead to greater consistency in lending decisions. Scoring models use factors that have proven to be predictive of creditworthiness, as opposed to judgmental assumptions, and should lead to better lending decisions. For Italian banks, the benefits of credit scoring are: -

-

credit scoring models reduce the time needed in the loan approval process; this time savings means cost savings to the bank and benefits the client as well; credit scoring models improve objectivity in the loan approval process: this objectivity facilitates lenders ensure they are applying the same underwriting criteria to all borrowers regardless of race, gender, or other factors.

Nevertheless, many consumers, particularly those who have not been able to obtain their credit scores or useful information about how the scores were derived, have expressed concerns about credit scoring: not everyone agrees that the objectivity in scoring techniques will benefit minorities or low-income customers, who may have had limited access to credit in the past. It’s possible to argue that since these potential borrowers are not well represented in the loan data on which the scoring techniques have been built, the models are less accurate predictors of their loan performance. This is a legitimate concern: the accuracy of the scoring models for underrepresented groups is still an open question. Even a good scoring model won’t predict with certainty any individual loan’s performance, but it should give a fairly accurate prediction of the likelihood that a loan applicant with certain characteristics will default. To develop a good scoring technique, banks need sufficient historical data, which reflect loan performance in periods of both good and bad economic conditions. The accuracy of a credit scoring models will depend on the care with which it is developed. The data on which the system is based need to be rich sample of both well-performing and poorly performing loans. The data should be up to date and the methodologies should be reestimated frequently to ensure that changes in the relationships between potential factors and loan performance are captured. Determining which loan is appropriate depends on the definitions of the target market. The appropriate “packaging” will depend in large part on market segmentation. The medium amount of loans are heterogeneous, as evidenced in the following outline (Table 8.4):

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Table 8.4 Average amount of loans BCC € 10,000 CARIPE € 4,000/20,000

BANCA TOSCANA € 2,500/3,000 SAN PAOLO IMI € 7,500/ 30,000

CARICHIETI € 3,000/5,000 TERCAS =

Relatively to the conditions of interest rate, banks often recognize the application of penalizing interest rates. Market research shows that microenterprises and other low-income clients can and will pay higher prices for loans and other banking services. For these banks, collateral, especially real estate and salaried co-signers, plays an important role in lending process. However, many microborrowers lack acceptable security for loans, and when available, the costs of legally registering and executing such collateral are not justified by the loan size. In addition, it can be very difficult if not impossible to present a salaried co-signer. Banks make loans to groups that mutually guarantee the loans or focus on individual lending and do require collateral although its role is primarily for moral suasion rather than realizable security. Instead of relying on collateral, micro-lending primarily depends on good loan analysis of a client’s character and capacity to repay, positive incentive for on-time repayment and effective monitoring and collections procedures.

8.6 Conclusions This chapter has analyzed the effects of scoring adoption on lending decisions, especially for low-income consumers and microenterprises. These particular segments of customers, when gain access to credit, pay relatively high loan prices because they generally have upper credit risk, greater informational opacity, and/or are more costly to serve than other clients. It’s no possible to predict whether more “marginal borrowers” will gain versus lose access to credit, but it does predict that if there is a net gain (loss), this will tend to increase (decrease) the average prices and credit risks at the bank because of the relatively high prices paid by “marginal borrowers” and the relatively high credit risk when they receive credit. In practice, most credit scoring systems suffer from a sample selection bias because they are estimates from a sample of granted loans and the criteria by which applicants are rejected are not taken into account. Presumably, the main reason for this deficiency is the lack of publicly available data on rejected loan applicants. Anyway, the use of credit


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scoring models has allowed banks to reduce the costs associated with originating and underwriting loans. Account should be taken not only of the characteristics of customers who were granted credit but also of those who were denied. Otherwise, a “selection bias” in the loan approval process could lead to bias in the estimated weights in the scoring system. A good credit approach needs to make accurate predictions in good economic times and bad, so the data on which the model is based should cover both expansions and recessions. Moreover, the description of credit scoring methodologies could leave the impression that credit scoring models are essentially “black-boxes” that provide an answer to the user to accept on blind faith. More realistically, the effects of credit scoring approach differ for banks following “rules” versus exercising “discretion” in using the technology. When banks follow “rules”, substituting scoring for other technologies and putting very little effort into decision making (using automated price and approval/rejection decisions based on purchased credit scores), the purpose is more likely to reduce lending costs. When banks use more “discretion”, using the credit scoring as additional information to complement the use of other technologies (using other inputs in credit decisions), the purpose is more likely to improve accuracy in evaluating creditworthiness, although total cost of lending generally increases. Credit scoring is not necessarily seen as something that would, or should, replace the judgment exercised by the relationship/branch manager. Operating in this way, banks can avoid a bias against some segments of customers.

8.7 References Akhavein J., Frame W.S., White L.J. (2001), The Diffusion of Financial Innovations: An Examination of the Adoption of Small Business Credit Scoring by Large Banking Organizations, Working Paper Series, University of Pennsylvania. Altman E.I. (1968), Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy, in “Journal of Finance”, September. Altman E.I. (1993), Valuation, Loss Reserves and Pricing of Commercial Loans, in “Journal of Commercial Bank Lending”, August. pp.9-25. Altman E.I., Marco G., Varetto F. (1994), Corporate distress: Diagnosis: Comparisons Using Linear Discriminant Analysis and Neural Networks, in “Journal of Banking and Finance”, n.18. Altman E.I., Saunders A. (1997), Credit Risk Meausurement: Developments Over the Last 20 Years, in “Journal of Banking and Finance”, September. Anderloni L. (ed.) (2003), Il Social Banking in Italia: un fenomeno da esplorare, Giuffré, Milano.

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Barefoot A.S. (1996), Credit Scoring at a Crossroads, in “ABA Banking Journal”, June. Berger A.N., Frame S.W., Miller N.H. (2002), Credit Scoring and the Availability, Price, and Risk of Small Business Credit, Federal Reserve System, Washington. Barontini R. (2000, La valutazione del rischio di credito. I modelli di previsione delle insolvenze, Il Mulino, Bologna. Burgess R., Pande R. (2002), Do Rural Banks matter? Evidence from the Indian Social banking Experiment, Working Paper, Department of Economics, London School of Economics. Caire D., Kossmann R. (2003), Credit Scoring : Is It Right for Your Bank?, Working Paper, Bannock Consulting, London. De Laurentis G. (ed.) (2002), Rating interni e credit risk management. L’evoluzione dei processi di affidamento bancari, Bancaria Editrice, Milano. Evers J. (2000), Micro-lending as a Model for Efficient Commercial Small-Scale Lending and its Application in Banks, IFF, Hamburg. Evers J., Fisher T., Foschi L., Guene C., Jung M., Rodriguez M., Vandemeulebrouche V. (2001), Finance for Local development. New solutions for public-private action, New Economics Foundation, Evers& Jung, Fondazione Choros, INAISE. Evers J., Jack S., Loeff A., Siewwertsen H. (1999), Reducing Cost and Managing Risk in Lending to Micro Enterprises. Handbook for Micro-Lending in Europe, FACET, Netherlands and IFF, Germany. Frame W.S., Padhi M., Woosley L. (2001), The effect of Credit Scoring on Small Business Lending in Low and Moderate Income Areas, Working Paper Series, Federal Reserve Bank of Atlanta. Hykin S. (1999), Neural Networks: A Comprehensive Foundation, Prentice Hall International, Inc, second edition. McCorkell P. (1999), Credit Scoring 101, Presentation at a Federal Trade Commission Public Forum on “The Consumer and Credit Scoring”, download paper www.ftc.gov/bcp/creditscoring McNelis P.D. (2005), Neural networks in finance, Elsevier Academic Press. Mester L.J. (1997), What’s the Point of Credit Scoring ?, in “Business Review”, Sept-Oct., Federal Reserve Bank of Philadelphia. Peachey S., Roe A. (2004), Access to Finance. A study for the World Savings Banks Institute, Oxford Policy Management. Petersen M.A., Rajan R.G. (1994), The Benefits of Lending Relationships: Evidence from Small Business Data, in “Journal of Finance”, vol. 49. Rutherford R. (1994/1995), Securitizing Small Business Loans: A Banker’s Action Plan, in “Commercial Lending Review”, Vol. 10. Saunders A. (1999), Credit Risk Measurement, John Wiley & Sons, Inc., New York. Saunders A. (2000), Financial Institutions Management, Boston, Irwin McGrawHill.


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Schreiner M. (2002), Benefits and Pitfalls of Statistical Credit scoring for Microfinance, Working Paper, Microfinance Risk Management,

www.microfinance.com Schreiner M. (2000), Credit Scoring for Microfinance: Can it Work?, in “Journal of Microfinance”, Vol. 2, n. 2. Schreiner M. (1999a), The Risk of Exit for Borrowers from a Microlender in Bolivia, Center for Social Development, Washington University in St. Louis Version en castellano “El Riesgo de Desercion de Prestatarios de un Prestamista de Microcredito en Bolivia”, www.microfinance.it. Schreiner M. (1999b), A Scoring Model of the Risk The Risk of the Costly Arrears at a Microfinance Lender in Bolivia, Center for Social Development, Washington University in St. Louis Version en castellano “Un Modello de Calificacion del Riesgo de Morosidad para Credtos de una Organization de Microfinanzas en Bolivia”, www.microfinance.it. Sironi A., Marsella M. (eds.) (1999), La misurazione e la gestione del rischio di credito, Bancaria Editrice, Roma. Sironi A. (2005), Rischio e valore nelle banche, Egea , Milano. Stanton T.H. (1999), Credit Scoring and Loan Scoring: Tools for Improved Management of Federal Credit Programs, Working Paper, Center for the Study of American Government, Johns Hopkins University. USAID (United States Agency for International Development) (2005), Banking at the base of the pyramid, February. Viganò L. (1993), A Credit Scoring Model for Development Banks: An African Case Study, in “Savings and Development”, Vol.17, n.4. Viganò L. (2001), La banca etica, Bancaria Editrice. Wendel C.B., Harvey M. (2006), SME Credit Scoring: Key Initiatives, Opportunities, and Issues, Financial Institutions Consulting (FIC), Issue No.10.

9 Banking the Poor: Policies to Bring Low- and Moderate-Income Households in the United States into the Financial Mainstream1

Michael S. Barr

9.1 The “Unbanked” and the “Underbanked” Twenty-two percent of low- and moderate-income American families over 8.4 million families earning under $25,000 per year - do not have either a checking or savings account. Most of the unbanked are low- or moderate-income: 83% of the unbanked earn under $25,000 per year. Many of the “unbanked” as well as other households using alternative financial services - the “underbanked” - face high costs for basic financial services. I first explain the consequences of inadequate access to banking services. In § 9.2, I explore key barriers to banking the poor as well as nascent efforts to overcome these barriers. In § 9.3, I analyze changes in the electronic payment systems that hold out promise for banking the poor at lower cost and risk than in a checking account paradigm. In § 9.4, I propose fundamental reforms to transform financial services for the poor. I then conclude.

This paper was originally published in an extended format as “Banking the Poor” in the Yale Journal on Regulation, vol. 21:121 (2004), © 2004, Yale Journal on Regulation, and was published in approximately its current form as Banking the Poor: Policies to Bring Low-Income Americans into the Financial Mainstream, Brookings Institution Metropolitan Policy Program Policy Brief (September 2004).The article is reproduced and adapted here with permission. For full citations please see Yale Journal on Regulation. The issues raised here are further explored in a new survey the author has just completed of low-and moderate-income households, the “Detroit Area Household Financial Services Study,” see http://www-personal.umich.edu/~msbarr/. 1

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9.1.1 The Alternative Financial Sector In lieu of bank-based transaction, saving, and credit products, the unbanked and other low-income households often rely on the more costly alternative financial sector (AFS). AFS providers offer a wide range of services, including short-term loans, check cashing, bill payment, tax preparation and rent-to-own products, in low-income urban neighborhoods. These AFS providers are currently the only means available for many low-income persons to access basic financial services. Let me sketch, by way of example, three important AFS industries. Check Cashers For many years, check cashers have been used by low-income individuals to cash checks, pay bills and wire funds.. John Caskey referred to these customers as employing the “cash and carry” method of financial management2. Upon receiving a paycheck, they cash the check and pay their bills immediately. While check cashers offer essential services, the fees involved in converting paper checks into cash are high, relative to income, and relative to transactions middle and upper-income families usedepositing a check into a bank account, or electronic direct deposit. Check cashing fees vary widely across the country and between types of checks, but typically range from 1.5% to 3.5% of face value. The industry reports that it processes 180 million checks totaling $55 billion annually, generating $1.5 billion in fees. Almost all of these checks are low-risk payroll (80%) or government benefit (16%) checks. While even payroll checks are not without some credit and fraud risk, average losses from “bad” checks at check cashing firms are low. For example, Ace Cash Express (ACE) reports that 0.5% of the face value of checks bounce, but net losses after collection are 0.2%. By comparison, 0.64% of the face value of interbank checks were returned in 20003. Payday Lending Payday lenders provide short-term (usually two-week) consumer loans to low- and moderate-income working people who have bank accounts but lack credit cards, have poor credit history, or are tapped out on credit John Caskey, Fringe Banking: Check-Cashing Outlets, Pawnshops, and the Poor (1994). 3 Geoffrey R. Gerdes & Jack K. Walton II, “The Use of Checks and Other NonCash Payment Instruments in the United States,” 88 Federal Reserve Bulletin 360, 360, 364-65 (2002). 2

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limits. Payday loans carry high implicit annual interest rates, with an average APR of over 470%. At an average loan size of about $300, the average fee for the average loan is about $544. Many borrowers, moreover, take out payday loans repeatedly throughout the year, often because they cannot repay their earlier payday loan by their next payday. The typical payday loan customer takes out anywhere from seven to eleven loans per year, with added fees for each loan renewal or “rollover”. These borrowers can get caught in a “debt trap,” with payday lending fees eating up a significant portion of their income. Payday lenders annually make over 65 million loans totaling over $10 billion to 8-10 million households, earning revenue of over $2 billion. Tax Preparers and Refund Anticipation Lenders The federal earned income tax credit (EITC) is a wage subsidy provided to families who earn under about $35,000. The average family with children receiving the EITC earned a credit of nearly $1,800. Unfortunately, lowincome families, particularly those with low levels of education, or who do not speak English as their first language, may have difficulty understanding the refund process. In addition, households face conflicting and complex rules under different tax provisions for determining household status and dependents. Moreover, low-income families may worry about increased IRS audits of EITC claimants and IRS delays in issuing EITC refunds. As a result, about two-thirds of EITC claimants use commercial tax preparation firms. In addition to seeking help with return preparation and filing, many EITC recipients also use refund anticipation loans (RALs) facilitated by tax preparers. The RAL is repaid when the IRS issues the borrower’s expected refund. There are three main reasons why low-income households use RALs: First, banked customers receive cash proceeds from their loans 8-10 days sooner than with direct deposit. Second, RALs permit taxpayers without bank accounts to obtain their refunds without waiting approximately four to six weeks for a paper check from the IRS. Third, taxpayers who do not have the funds to pay for tax preparation services up front, find RALs and similar products necessary simply to pay preparers to file for their refund. Tax preparation fees are deducted from the proceeds of the RAL. Thus, the

Michael A. Stegman & Robert Faris, “Payday Lending: A Business Model That Encourages Chronic Borrowing,” 17 Economic Development Quarterly 8 (2003). 4

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desire to have returns professionally prepared itself drives some decisions to take out RALs independent of a desire to obtain a quicker refund. Tax preparation services and refund loans can consume a nontrivial portion of an EITC recipient’s refund. The purchase of a RAL for an anticipated $1,500 refund costs roughly $90. For EITC recipients filing electronically and choosing to take out a RAL, total fees would consume an average of 13% of the EITC or nearly 8% of the total refund from the EITC and other credits - totaling $1.75 billion in fees for low-income households. In addition, for the estimated 22% of EITC recipients who lack a bank account, or four million households, the additional fee to cash a $1,500 RAL check issued by the bank partner of the tax preparer would be at least $30 on average at a check casher, despite the low risk of the government checks5. 9.1.2 The Costs of Being Unbanked The high costs of alternative financial services raise several concerns. First, the costs of these basic financial transactions reduce take-home pay. A worker earning $12,000 a year would pay approximately $250 annually just to cash payroll checks at a check-cashing outlet, in addition to fees for money orders, wire transfers, bill payments, and other common transactions6. High cost financial services also reduce the effectiveness of federal income transfer programs such as the EITC and may undermine public initiatives to move families from welfare to work. Given the high cost of converting income from checks into liquid form in the alternative financial sector, promoting bank account ownership for the poor is probably more efficient than simply transferring income. The value of a government check is reduced by the cost of converting it to cash. In addition, one unit of in-kind assistance, in the form of sufficient governmental incentives to induce a bank to offer a bank account to a lowincome person, would provide the benefit of liquidity to all subsequent income transfers. Moreover, the government would save money by transferring EITC funds electronically, rather than by paper check.

5 Alan Berube et al., “The Price of Paying Taxes: How Tax Preparation and Refund Loan Fees Erode the Benefits of the EITC” (Brookings Institute & Progressive Policy Institute, 2002). 6 See Arthur B. Kennickell et al., “Recent Changes in U.S. Family Finances: Results from the 1998 Survey of Consumer Finances,” 86 Federal Reserve Bulletin 1, 9-11 (2000); Dove Consulting, U.S. Department of the Treasury, “Survey of Non-Bank Financial Institutions,” 34 fig. 6.5 (2000).

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Second, without a bank account, low-income households face key barriers to increased saving. Promoting low-income household savings is critical to lowering reliance on high-cost, short-term credit, lowering risk of financial dislocation resulting from job loss or injury, and improving prospects for longer-term asset building through homeownership, skills development, and education. Third, without a bank account, it is more difficult and more costly to establish credit or qualify for a loan. A bank account is a significant factor - more so, in fact, than household net worth, income, or education level in predicting whether an individual also holds mortgage loans, automobile loans, and certificates of deposit. Fourth, low-income families who cash their paycheck may face high risk of robbery or theft. By transitioning into bank accounts where they can store a portion of their earnings, withdraw funds in smaller amounts, pay for goods or services directly using debit, and withdraw funds outside of the concentrated time periods during which benefit checks and paychecks are commonly cashed, these families can decrease their exposure to risk of crime. Fifth, inefficiencies in the payments system impose costs on the national economy. Increasing the efficiency in the payments system for the poor could have modest positive effects on the economy as a whole. Because of positive network externalities, funds spent converting the poor to electronic payment might speed conversion to electronic payments more generally.

9.2 The Banking Sector 9.2.1 Barriers to Banking the Poor While the banking system works extraordinarily well for most Americans, many low- and moderate-income individuals face five key barriers to account ownership. First, regular checking accounts may not make economic sense for many low-income families. Consumers who cannot meet account balance minimums for an account at a bank often pay high monthly fees. In addition, nearly all banks levy high charges - averaging over $20 per item for bounced checks or overdrafts that low-income families with little or no savings face a high risk of paying and can ill-afford. Moreover, banks hold checks that are not “on us” for a matter of days before depositing funds, unlike check cashing outlets; for low-income customers, the few days wait

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may not be practical. The structure of these accounts is a key driver in keeping the unbanked out of the banking system. Banks doubt that accounts tailored to low-income individuals will be profitable. While a financial institution’s monthly costs for administering the account can likely be covered by low monthly fees, at this early stage in the evolution of research and development for low-income products, banks’ up front costs are likely to exceed what most unbanked households are willing to pay. Financial institutions may need incentives to pursue research and development on accounts for low-income customers, particularly for accounts based on electronic payments technology. A second barrier comes from difficulties that many unbanked persons may have in qualifying for conventional bank accounts because of past problems with the banking system. The CheckSystem, a private clearinghouse that most banks use to decide whether to open accounts for potential customers, records that nearly 7 million individuals have had their accounts closed for prior problems, such as writing checks with insufficient funds or failing to pay overdraft fees. While some individuals undoubtedly pose undue risk for account ownership, many potential customers could responsibly use electronic, no-overdraft bank accounts. Third, while many urban communities contain adequate numbers of banks, in some low-income neighborhoods, banks, thrifts, and credit unions are not as readily accessible to potential customers as such institutions are in higher-income areas. Fourth, for some low-income households, lack of financial education with respect to account ownership, budgeting, saving, and credit management is a significant barrier to personal financial stability. The need for financial education may be particularly acute among immigrants and other groups unfamiliar with American banking practices. The benefits of financial education are not likely to be fully captured by any one financial institution because an educated consumer will shop for financial services among competing providers. Thus, education at any scale will likely be under-funded without public or philanthropic subsidy. Lastly, immigrant communities may face difficulties regarding proper documentation for opening an account, either because they lack such documentation, or they fear that depositories will police immigration laws. While consular identification cards may now be used by banks, at their discretion, for checking accounts, an IRS-issued individual taxpayer identification number or a social security card is needed for interestbearing accounts. Moreover, the IRS will no longer guarantee that taxpayer information will not be shared with the Immigration and Naturalization Service.

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9.2.2 Governmental Policy and Private Sector Innovation Despite these barriers, the 1990s witnessed a period of strong economic growth and technological innovation that improved the prospects for banking the poor. During the latter part of the 1990s, governmental policy began to focus on expanding access to financial services for low-income persons, focused initially on recipients of federal benefits and later on lowincome persons more generally. In addition, financial institutions began to experiment more recently with products designed to help Hispanic and other consumers to send remittances to family members in other countries in competition with wire transfer services. Community development financial institutions have also experimented with new products to reach the unbanked. Electronic Transfer Accounts Under the Debt Collection Improvement Act of 1996, the United States Treasury launched an effort, known as Electronic Funds Transfer (EFT) ’99, to increase direct deposit of federal benefits and wages. For unbanked federal benefit recipients, Treasury designed an Electronic Transfer Account (ETA), a low-cost, electronically based bank account. The ETA carries a maximum fee of $3.00 per month and has no minimum balance. ETAs can be used for direct deposit of Social Security and certain other federal benefits. Under the program, Treasury provides financial institutions offering ETAs with a one-time payment of $12.60 per account to offset the costs of opening the accounts. Despite the relatively low reimbursement amount, as of May 2004, nearly 500 banks, thrifts, and credit unions were offering ETAs at almost 18,000 locations nationwide with a total of 98,000 accounts opened7. The ETA project revealed that banks are likely to need subsidies to cover the cost of initiating a program but could profitably offer electronically based accounts on a monthly recurring basis. Treasury analysis suggests that an all-electronic ETA account with a $3.00 monthly fee would produce pre-tax profit of $0.93 per month. Average account set up costs of $12.60 would take about one year to recover. In addition, Treasury estimated that ETA products could cost between $64,000 and $148,000 in research and product development for each financial institution. Even if a financial institution were to open 10,000 ETAs, product development would still cost between $6 and $15 per account. Moreover, marketing and consumer education expenses are likely also to Dove Associates & U.S. Department of the Treasury, “ETA Initiative, Final Report” (1998). 7

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be high, about $9-11 per account, as are the costs of training bank personnel about the product. Electronic Benefits Transfer The 1996 Welfare Reform law mandated that states convert from paying federal welfare benefits in the Temporary Assistance for Needy Families (TANF) program by check to making such payments electronically. State electronic benefit transfer (EBT) programs now cover not only welfare payments, but a host of other state programs as well, such as food stamps and state cash benefits8. Unfortunately, the way EBT has been set up in most states has minimized the extent to which electronic transfer could be utilized as an entry point to banking. Most states do not seek to establish bank accounts for benefit recipients, but instead use a contractor to provide debit cards to recipients to access funds held by the state government in a pooled account. Doing this allows states to have the benefit of the “float” on benefit funds before recipients withdraw the funds. In addition, most states hope to minimize administrative costs by having a single prime contractor deliver EBT services rather than seeking out all depositories in the state to offer EBT. States benefit in the short term, but this card-based approach has left most benefit recipients without access to a bank account. First Accounts At the end of the Clinton Administration, Treasury began a small pilot initiative, called First Accounts, to expand access to main stream financial services. The First Accounts initiative had four main components. First, Treasury would help to offset the costs financial institutions incurred in offering low-cost, electronic banking accounts to low-income individuals. Second, Treasury would help to defray the costs of expanding access to ATMs, POS, Internet, or other distribution points in low-income neighborhoods. Third, Treasury would support financial education for lowincome households. Fourth, Treasury would fund research into the financial services needs of low-income individuals and development of financial products designed to meet these needs. In 2001, the new Administration awarded $8.35 million to fifteen projects seeking to bring over 35,000 individuals into the banking system. Strategies, cost structures, other funding sources, the extent to which Barbara Leyser, “Selected Characteristics of State EBT Systems” (National Consumer Law Center, 2001); Federal Reserve System, “Retail Payments Research Project: A Snapshot of the U.S. Payments Landscape” (2002). 8

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capital outlays are included, and the intensiveness of financial education varied significantly across chosen programs. Given the small amount of funding available and the large number of organizations funded, Treasury will have difficulty determining from this pilot phase whether a given strategy is sustainable at scale. A more focused effort in a handful of metropolitan areas might have led to adoption of new technologies by major firms, and more useful data. Moreover, the Administration has not sought any new funds for First Accounts and asked Congress to rescind some appropriated funds. Yet only a sustained commitment would provide financial institutions with sufficient incentive to make the necessary investments in research, technology, training, marketing, and education to serve low-income households. Private Sector Innovation in Banking Products Partly in response to increased information about the unbanked and incentives created by EFT ’99, EBT, and First Accounts, a number of banks, thrifts, and credit unions have begun to experiment with products designed to serve the needs of low-income individuals. These efforts, though small in scale, suggest that the policies that I advocate here could plausibly be undertaken in the real world. Let me cite just a few examples: - Banco Popular has made great strides in reaching the 50% of Puerto Rican residents who are unbanked. Banco Popular’s Acceso Popular account has a $1 monthly fee, no minimum balance, free ATM transactions, and free bill payment. Acceso Popular has a savings “pocket” into which small sums (initially, $5 per month) are automatically transferred from the Acceso Popular transaction account. Banco Popular opened nearly 60,000 such accounts in 2001. Half of the account holders activated the savings “pocket” in their accounts; - ShoreBank worked with a local voluntary income tax assistance (VITA) organization to provide tax preparation advice to EITC filers in ShoreBank’s branches. EITC recipients filing through VITA offices do not face high tax preparation and filing fees, nor do they have an incentive to take out expensive refund anticipation loans to pay for tax preparation services. Moreover, ShoreBank offered low-income households the opportunity to open a bank account in order to save their refunds; - Fleet has also launched a debit product to move unbanked employees from payroll checks to bank accounts. The accounts carry no minimum balances, no monthly fees, permit no check writing and allow free ATM withdrawal from Fleet’s ATMs, as well as free POS withdrawal.

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Remittances and the Hispanic Market Remittances from the U.S. to Latin America and the Caribbean totaled $32 billion in 2002. Yet more than 40% of Hispanic immigrants lack a bank account, and most Latino immigrants send remittances back to their country of origin using wire transfer services, rather than banks9. The G-8 nations in their June 2004 summit meeting called for a greater focus on remittances as a development tool, and highlighted the need to reduce the costs of sending remittances. New ATM-based remittance products from Citibank, Wells Fargo, Bank of America and others are beginning to bring more Hispanics into the banking system and are lowering the cost of remittances. Enhanced competition from the banking sector has already helped to cut the cost of sending a remittance to Mexico in half. Still, bank penetration of the remittance market stands below 5%10. An impediment to greater competition in this market may be a lack of sufficient ATM and point of sale (POS) infrastructure to compete with Western Union’s strong penetration in recipient countries, although networks appear to be widely available in many parts of Mexico. More marketing and consumer education in the United States may also be essential to inducing consumers to switch from wire transfer to bank products. Progress on remittances is important for four reasons. First, given the high costs of sending remittances, ATM-based products can help to drive down transaction costs for millions of immigrants. Second, bank remittance products have the potential to bring more immigrants in the U.S. into the banking system. Given the costs of setting up each remittance transaction as a stand-alone proposition, bank costs could be reduced by establishing a bank account for these customers. In turn, account ownership would let immigrants convert income into cash, save, and pay bills - not simply send remittances. Third, strategies to reduce the costs of remittances have the potential to increase the flow of funds for development into Latin America. Lastly, new electronically based approaches developed for remittances may be adapted in ways that will help to open up the banking system to the unbanked more generally. 9 See U.S. Department of the Treasury, “Partnership for Prosperity: Report to President Vicente Fox & President George W. Bush,” 3-4, 9 (Mar. 22, 2002); Robert Suro et al., Pew Hispanic Center & Multilateral Investment Fund, “InterAmerican Development Bank, Billions in Motion: Latino Immigrants, Remittances and Banking,” 14 (2002). 10 Manuel Orozco, The Remittance Marketplace: Prices, Policy and Financial Institutions (June 2004), Georgetown University, Institute for the Study of International Migration.

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9.3 Payments Systems and Distribution Networks Payment and distribution systems significantly affect the cost and risk of providing financial services to low-income households. Thus, in this Part, I explore changes in the use of checks and debit cards, the expansion of ATM networks, and the potential for direct deposit and direct payment. Despite the potential of online debit, the widespread availability of ATMs, the increased penetration of direct deposit, and the emergence of direct bill payment, the expansion of these technologies to low-income communities may be slower than is socially optimal. At least in part, that is because payments systems are characterized by positive network externalities. Because public benefits to all users of the payment system exceed private ones to each participant the socially optimal mode of payment may not be adopted or may be adopted slowly. 9.3.1 Checks and Debit Cards Because payments systems produce network externalities, they often rely on a sponsoring entity to subsidize entry and set uniform rules and prices for network participants. The Federal Reserve Board sponsored and subsidized the check clearance process, beginning at the turn of the last century, helping to establish a nationwide means for transferring funds and ensuring the dominance for decades of check payments. Although they long remained the dominant form of retail payment, checks declined from 85% of non-cash payments in 1979 to 59% in 200111, and have declined to less than half of all such payments in recent years. Checks are costly to process, pose the risk of being overdrafted at high cost to consumers and financial institutions, and cause delay in the availability of funds. While checks continue to dominate, online debit cards – because they are low cost and low risk – hold out the most promise for expanding bank services to low-income households. Bank accounts with online debit access, but no checking, would provide a low-cost, lowrisk bank account for low-income households. Yet online debit cards have themselves not been adopted as rapidly as would be socially optimal because of the dominance of checks and off-line debit cards. Online debit cards can be used at an ATM, or at retail merchants with point of sale (POS) personal identification number (PIN) pads for purchases or to obtain cash back. Sales made with online debit generally cannot result in an overdraft, as funds transfer instantly through EFT 11

Federal Reserve Board, “Retail Payments Study” (2002).

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networks. Most banks do not charge their bank customers for using an online debit card at POS. Moreover, many retailers permit customers to get cash back using their online debit cards; these transactions are surchargefree, cost the merchant no more than a standard online debit transaction, and reduce merchant cash-handling costs. Because the transfer into their account is instantaneous, merchants lose no interest income from float and, unlike a credit card, the customer cannot revoke the transaction. By contrast, offline debit cards can be used for purchases where Visa or MasterCard are accepted by signing a receipt, do not allow cash back, are routed through Visa and MasterCard networks, and use the automated clearinghouse (ACH) network, which settles in one to three days. Offline debit presents a risk that the consumer will overdraft and requires the merchant to float the cost of sale for days. Offline debit fees paid by the merchant to the card issuer are significantly higher than for online debit. In sum, offline debit is higher cost and higher risk than its online counterpart. Despite the advantages of online debit, offline debit makes up two thirds of debit transaction volume in the United States. Moreover, less than onethird of merchants have online debit capacity. Offline debit is dominant in the United States, even though other advanced countries generally utilize the more efficient online debit. One important reason why is that online debit has had to compete with Visa and Mastercard’s entrenched credit card infrastructure, which they use to offer offline debit. As debit grew in importance in the 1990’s, Visa and MasterCard implemented “honor-all-cards” rules that required merchants who accepted Visa and MasterCard credit cards also to accept their debit cards. In addition, Visa and MasterCard imposed a “one price” policy that prohibited merchants from charging a differential fee to customers for using the more costly, offline debit. Lastly, the firms made their debit and credit cards physically indistinguishable. Because the higher interchange fees for offline debit could not be passed on to customers, they were indifferent to the form of payment, and the use of offline debit increased at an inefficient rate12. The honor-all-cards rules and the prohibition of surcharging offline debit usage can largely be understood as an effort by Visa and MasterCard to “sponsor” offline debit to extend their market power. The prohibition on surcharges prevented retailers from forcing consumers to internalize the cost of their offline debit usage, thereby dampening consumer demand for See David B. Humphrey & Allen N. Berger, “Market Failure and Resource Use: Economic Incentives to Use Different Payment Instruments,” in The U.S. Payment System: Efficiency, Risk and the Role of the Federal Reserve, 45, 45-46 (David B. Humphrey ed., 1990). 12

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POS terminals. The honor-all-cards rules, which effectively tied offline debit acceptance to credit card acceptance, effectively blocked retailers, whose customers demanded the availability of credit card usage, from refusing to accept offline debit. By maintaining a large base of retailers who accept the offline payment format, the incentive for a consumer to demand online debit was maintained at a low level. Visa and MasterCard essentially sought to postpone “tipping” to the more efficient online standard for as long as possible. Under network externality theory, setting network fees within a network for the same product is generally thought of as important to establishing a network. But letting one network set prices in another network can be anti-competitive and lead to sub-optimal outcomes. The tension came to a head with the antitrust suit led by Wal-Mart against Visa and MasterCard. The parties ultimately settled on the eve of trial. Visa and Mastercard agreed to eliminate the honor-all-card rules and to pay significant damages. Over time, the settlement has the potential to benefit the poor. The untying of credit and offline debit may result in lower interchange fees for offline debit as Visa and MasterCard seek to preserve their market share, and faster growth of its online counterpart as merchants seek cost savings. This, in turn, would lower the cost and risk of providing bank accounts to low-income households using online debit card access. Offline debit, however, has the infrastructure advantage and may continue to dominate for some time. 9.3.2 ATMs Transactions at ATMs are significantly less expensive than transactions with tellers, and the costs of ATMs are significantly lower than the costs of a bank branch. ATMs thus offer an opportunity to deliver financial services to the poor at lower cost than “bricks and mortar” branches. With the advent of surcharging, rapid expansion of ATM deployment in the late 1990s has dramatically increased the availability of ATMs to 324,000 nationwide. That growth is unlikely to continue as the market matures, but widespread ATM networks present possible distribution channels for expanded access to banking services for the poor. Given the economics of ATM placement and operation, which require high volumes of fee-driven transactions, a strategy for expanding access to banking for the poor using ATMs or POS, will likely require governmental incentives to be viable in some low-income areas with low penetration of these technologies. Moreover, further expansion of ATMs is contingent on surcharge income,

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but surcharging significantly increases the cost of using ATMs for lowincome persons13. Bank accounts and ATMs are complementary products that exhibit indirect network externalities. Increasing the penetration of bank accounts will increase the number of ATM users, giving banks a greater incentive to deploy more ATMs. Although ATM dispersal is quite broad now, and network effects from additional users are likely to be low, additional account holders from low-income communities with low ATM penetration would increase incentives to place ATMs in those locations. Moreover, where there is intense competition among ATM deployers, surcharging is more difficult to maintain because non-customers are more likely to be relatively close to an ATM owned by their own bank. Thus, surcharging is less prevalent in areas with higher ATM densities. Pointedly, ATM densities are lower and surcharging more prevalent in areas with higher concentrations of ethnic or racial minorities, and of elderly persons14. To avoid costly surcharging, low-income persons would need to establish bank accounts with banks that have high penetration of ATMs in communities near where they live or work. The need to use a bank with a strong local ATM presence would complicate efforts to bank the unbanked on a national scale. More importantly, the goal of avoiding surcharging conflicts with the goal of expanding deployment. ATMs require significant surcharge income to support themselves. The additional security costs associated with deployment of ATMs in high-crime areas would also complicate efforts to serve the poor. In addition to the basic functions of income deposit and withdrawal, ATMs could be used to provide a broader range of services, such as check cashing, issuing money orders, wiring funds, stamp vending, automatic bill payment, and replenishing prepaid cell phones. These advanced functions could help position ATMs as competitors to both banks and check cashers in providing financial services to low- and moderate-income customers. Now that Congress has enacted the Check Clearing for Twenty First Century Act, banks could deploy ATMs with check truncation technology permitting them to capture check information electronically. These ATMs could process checks without the need for daily physical transfers of checks, which would dramatically reduce the cost of providing deposittaking or check cashing capacity at off-premises machines. Tony Hayes et al., Dove Consulting Group & NYCE Corp., “ATM Deployer Study,” 56 (2002). 14 See Timothy H. Hannan et al., “To Surcharge or Not to Surcharge: An Empirical Investigation of ATM Pricing 1,” Federal Reserve Board, Finance & Economics Discussion Series 2001-38 (2000). 13

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In sum, the rapid growth in deployment of ATMs presents a real opportunity for the delivery of financial services to low- and moderateincome consumers. ATMs are far less expensive than bank branches and teller time. ATMs could potentially be used to make deposits of income, convert income to cash, and pay bills electronically or through disbursement of money orders. These three functions are critical financial services for the poor. Yet while advanced functions could one day prove useful to low-income ATM users, current practice suggests that day is a long way off. 9.3.3 Direct Deposit and Bill Payment Advances in the automated clearing house (ACH) system can make it easier and cheaper to offer banking products, such as direct deposit and bill payment, that could reduce reliance on more expensive comparable transactions conducted by low- and moderate-income households, such as cashing payroll checks and buying money orders. ACH already carries nearly $6 trillion in retail electronic payments, mostly payroll direct deposit, and also bill payments. Expanding ACH and lowering its price would make electronically based bank accounts more attractive to and useful for low- and moderate-income households. In contrast to issuing and cashing checks, direct deposit is lower cost to employers, employees, and banks. Direct deposit permits employees to get immediate access to their funds. Low-income persons who have access to direct deposit need not wait for a check to clear or visit a check casher. Direct deposit involves no risk of bounced, lost, or stolen checks. Banks that currently issue payroll checks for employers and switch to direct deposit services may see reduced lines at tellers on paydays as employees no longer wait to cash their employer’s check “on us” at the issuing bank. Payroll cards are designed for just that purpose, and are an important step toward banking. Moreover, direct deposit can facilitate saving. Direct deposit is already used by more than 100 million individuals in the U.S. and is offered by more than 80% of firms with more than 100 employees. Yet many low-income workers do not have access to or take advantage of direct deposit, in part because many of them do not have bank accounts. Low-income persons are more likely to work in smaller firms, which tend not to offer direct deposit, and to have sporadic, parttime, or multiple employment, which complicate direct deposit. The challenge is to bring direct deposit to more workplaces employing lowincome workers and to more low-wage workers – including part-time or temporary workers – wherever they work.

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Similarly, electronic bill payment could be more widely used by lowincome consumers - at lower cost and risk than checks or money orders. Direct bill payment eliminates the risk of late payment fees and interest charges, charges for checks, and postage expense. Direct payment is advantageous for the billing company as well, as it reduces the risk of nonpayment and late payment. Moreover, consumers using direct payments tend to maintain higher balances in their bank accounts and save more than consumers who do not use it. Direct bill payment may also increase one’s ability to establish a sound credit history because, unlike information about the payment of bills with cash or money orders, the bank processing the payment regularly captures information about direct bill payment. For most banked middle- and upper-income customers, however, checks remain relatively cheap and convenient, and electronic technology for bill payment may appear uncertain, effectively delaying deployment of the necessary infrastructure to reduce costs and increase availability of electronic payments. Moreover, businesses must overcome high initial costs, customer inertia, and the indirect network externality of consumers without bank accounts in order to expand direct bill payment. In addition, low-income persons may have a heightened need to control the timing of their bill payment – delaying payment on the phone bill to pay the rent, for example – given their low levels of liquidity. Thus, direct bill payment may make sense for only some low-income persons, or for only critical monthly bills, with discretion retained as to the timing in paying others. More widespread use of direct deposit and electronic bill payment would not only lower payment systems costs overall, but also reduce the need for low-income people to frequent high-cost alternative financial service providers to cash checks or pay bills. Given the positive externalities from adoption of ACH, ACH may be priced higher than is socially optimal by the Federal Reserve Board, which handles 80% of ACH transactions. Although ACH prices have been declining, data from 2000 shows that ACH services were still priced at least twenty-four percentage points too high relative to check services, if one simply measures the relative price to cost ratios15. This rather crude gauge does not take into account, on the one hand, the positive externalities from moving towards wider dispersion of ACH networks or, on the other, the difficulty of assessing price-cost ratios in two-sided networks and the

See Michael Herd, NACHA, “Federal Reserve Check Volume Decreases, ACH Volume Continues To Rise” (Press Release, August 2, 2001). 15

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concern that if the Board charged less for ACH services, private sector participants would likely lose the small market share they now have16.

9.4 Transforming Financial Services for the Poor I propose a cohesive strategy to increase bank account ownership among low- and moderate-income households: First, and most importantly, the U.S. Congress should enact a “First Accounts Tax Credit” to financial institutions to develop and deploy electronically based banking products for low-income households. Second, the federal banking regulators should use the Community Reinvestment Act to shed light on bank and thrift performance in meeting the financial services needs of low-income households. Third, states should shift their EBT programs to bring TANF recipients into the banking system. Fourth, Congress and Treasury should support financial education to help to change the financial services and savings behavior of low- and moderate-income households as part of an initiative to provide new financial services for the unbanked. Lastly, I propose a series of smaller steps to help to reform the AFS sector. 9.4.1 A New First Accounts Tax Credit Proposal To transform the market for low-income financial services, I propose a tax incentive for financial institutions to offer low-cost electronic accounts for low-income persons17. Financial institutions could receive a tax credit equal to a fixed amount per account opened. Roughly speaking, the amount of the credit would be calculated to cover the average administrative cost to an average bank of offering the account, taking into consideration research and product development, account opening and closing costs, marketing and financial education, and the training of bank personnel. Using Treasury’s analysis conducted for ETAs would suggest that the tax credit be set at an amount between $20 and $50 per account opened. An additional tax credit could also be provided to create a matched savings program, under which financial institutions are Federal Reserve Bank, “A Summary of Consumer and Business Attitudes on Direct Deposit and Direct Payment, A National ACH Market Research Study” (1998). 17 For an early proponent, see Michael Stegman, Savings for the Poor: the Hidden Benefits of Electronic Banking (Brookings Institute, 1999). 16

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reimbursed for the cost of matching customer’s deposits of savings into accounts. Banks, thrifts, and credit unions could, under the First Accounts Tax Credit, experiment with a wide variety of techniques to expand access to the unbanked and to provide an increasing range of services to the underbanked18. Banks could obviate concerns about individuals in the Chex system, or those with credit problems, by working with the private clearinghouses to better distinguish among types of past problems, by offering accounts contingent on completion of financial counseling, and by offering electronically based accounts that pose little risk of overdraft. Banks may experiment with accounts with savings features, including separate savings “buckets” within accounts. Similarly, banks could provide low-income individuals with a convenient and low-cost means of paying bills and wiring funds. Automated money orders, online bill payment, debit-card-based foreign country remittance, and other low-cost payment methods can help to reduce the cost of transactional services to the poor. Treasury estimated that adding a savings feature to an electronic account would cost approximately $0.06 per month. Adding ACH bill payment would cost $0.65 per month. Accepting direct deposits would decrease net costs by $0.11 per month because of added float income19. In addition, the First Accounts Tax Credit has the potential to help spur “leapfrogging” in technology for low-income financial services. To offer a few examples that could be subjected to the test of market feasibility: ATM networks and financial institutions could develop shared technological platforms to serve low-income households, reducing research and development costs for each firm. As access to the Internet expands in low-income communities through efforts to bridge the “digital divide,” e-finance can increasingly be made available to the poor at Internet or other kiosks. Companies that are exploring ways to expand the use of cellular phones to transact financial services for high-income clientele could be encouraged to focus attention on expanding bank Credit unions, which are not-for-profit corporations, could not directly take advantage of tax credits. It is possible to structure the tax credit so that for-profit subsidiaries or credit union service organizations could receive the tax credit for their services on behalf of the credit unions in offering the accounts. It would also be reasonable, however, to take the position that credit unions, which are tax exempt, 12 U.S.C. § 1768 (2000), because their mission is to serve “people of modest means,” 12 U.S.C. § 1751 (2000), should be able to pass on the benefits of tax exemption to low-income persons by offering accounts tailored to their needs. 19 Dove Associates & U.S. Department of the Treasury, “ETA Initiative: Optional Account Features, Economic Waterfall Analyses” (1998); Ed Bachelder & Isabelle Aguerre, Dove Associates., “ETA Conjoint Research,” 60 (1999). 18

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account access through pre-paid cellular phones commonly used by lowincome persons. Smart cards could be used by unbanked customers to conduct an increasing array of bank-like transactions at relatively low cost. A First Accounts Tax Credit for financial institutions could also help to spur employer-driven (or union-driven) strategies to expand access to banking services. Banks using the tax credit could market new, low-cost banking services to employers for the firm’s employees. Employer-driven strategies to bank the unbanked have three potential strengths: large-scale, consistent access to workers, a structure for providing regular savings through direct deposit, and the ability to offer financial education. Large employers can reap significant benefits from moving more of their workers to direct deposit. Direct deposit would drive down their payroll processing costs, increase the effective take-home pay of their workers, and reduce problems from theft or fraud associated with checks. Similarly, payroll cards might serve as a useful starting point towards providing an increasing range of financial services – including bill payment, savings, and bank accounts, – to low-income persons. Employers are increasingly moving towards the provision of electronically based payroll services. In one model, employees are given a smart card. Banked employees can direct deposit funds from their smart cards to their personal accounts; unbanked employees can simply withdraw funds through an ATM or POS. Employers could work with banks utilizing a First Accounts tax credit to make available all-electronic bank accounts through which they could use their payroll cards. Objections and Responses The tax credit proposal could be criticized in two layers. The top layer of potential criticism follows from the subsidy being a supply-side rather than demand-side mechanism to reach the poor with banking services. Supplyside approaches are preferable to demand-side efforts when efficiency in provision outweighs potential windfalls to suppliers and the costs of the mechanism. In the other layer of potential criticism, the tax credit proposed must be judged as an in-kind mechanism as opposed to a direct cash transfer. An in-kind approach will be warranted if consumption externalities outweigh the deadweight costs from substitution effects and the costs of administrating the program. I thus address the costs and benefits of this supply-side, in-kind subsidy. First, the relative efficiencies of demand compared with supply programs depend on the elasticity of supply in the sector. In the case of low-cost electronic banking accounts, it is reasonable to think that the supply of accounts is characterized by a single fixed cost for start-up and

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low marginal costs for additional accounts. Thus, after the provision of the tax credit, supply is likely to be highly elastic. If supply is perfectly elastic, there is no welfare difference in a supply-side subsidy or a demand voucher. Second, there is a danger that subsidies for the provision of low-cost banking accounts could provide a windfall to financial institutions who would offer such accounts without the tax credit. It is difficult to know the extent of this problem without more empirical evidence. There are some small-scale private sector initiatives in serving low-income customers, partly motivated by market analysis and partly by governmental and philanthropic programs. Network externalities may slow the adoption of technologies that would better serve the poor. To the extent that these tax credits are used to spur these technologies, the tax credits are less likely to result in windfalls rather than in internalizing some of those externalities. Third, one must consider the costs of demand compared with supply programs. I have proposed a supply-side subsidy rather than a demand-side subsidy because I believe that it is more likely to induce a change in the nature of financial services offered to low-income consumers at lower cost. If low-income consumers were given a voucher for financial services, they would need to invest in sufficient, costly information-gathering to be able to find an adequate banking product for their needs, and financial services are notoriously difficult to understand. Since the voucher would offset some of the costs of existing services, financial products might not evolve to meet the needs of other low-income persons. Without the development of new low-cost electronic banking accounts, the vouchers’ value would be limited to its face value. It is possible that a similar result to a supply-side subsidy could be obtained with vouchers, but the administrative costs of delivering the financial services voucher to millions of low-income households are likely to be much higher than the administrative costs of tracking account opening by a manageable number of financial institutions who already have established relationships for reporting to the IRS. Fourth, the subsidy is administered through the tax code, rather than as a grant program. Tax expenditures are not necessarily more or less efficient than grant programs. However, the fixed cost of tax administration by the IRS and of tax compliance by corporations is already in place and is unlikely to be affected in any significant way by the additional tax expenditure. I am proposing that the Treasury Department’s Financial Management Service (FMS) compute the amount of the tax reduction owed to each financial institution and administer the program because the FMS already has developed a system for tracking ETA accounts opened by financial institutions for federal benefit recipients under the EFT ‘99 program. This aspect of the tax expenditure, which replicates core

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functions of a grant program, is unlikely to be significantly different were the financial institutions to be given a grant instead of a tax credit. The alternative to some form of in-kind program is a direct cash transfer. There are three main critiques of in-kind transfers compared with cash transfers. First, generally speaking, in-kind subsidies are thought of as less efficient than cash subsidies because the recipient may only use the inkind subsidy for specified purposes. To the extent that the subsidy changes behavior, the subsidy does not increase the welfare of the recipient to the same degree as if the recipient had been able to use the funds to pursue her own preferences. Second in-kind plans are paternalistic in telling the heterogeneous recipients that they should derive utility in particular from the provision of the service for which the in-kind benefit is intended. Third, in-kind programs are often more administratively costly than direct transfers. The marginal cost to the government of increasing the dollar amount of income transfers to the poor, for example, through the EITC, is low. There are primarily two arguments that an in-kind benefit may be larger than an equivalent cash transfer. First, in-kind programs may generate “consumption externalities,” benefits accruing because the in-kind program exists. Here, the externality is the fixed investment leading to a new form of permanent low-cost electronic banking accounts. The tax credit would establish permanent access to low-cost banking, which would reduce the consumer’s costs of cashing all her income checks, would facilitate saving, and would provide a means to pay bills into the future. More pointedly, the argument in favor of income transfers as compared with in-kind subsidies breaks down when one analyzes how “income” gets transferred. The government does not transfer income as cash. Income can be transferred as a direct deposit to a bank account, to a debit or stored value card, or as a check. Transferring income through a government check not only costs the government more than an electronic transfer, but also transfers less value to low-income persons than a direct deposit of that income into the recipient’s bank account. Once established, these accounts provide a repository for the receipt of other federal or state transfers and private earnings in the future. The second reason why a cash transfer would be less efficient than this in-kind program involves screening and targeting. An in-kind program can screen in the optimal potential beneficiaries by providing what economists call an “inferior good,” a good to which a higher-income individual would not immediately be drawn. In the current market, such a goal would be achieved by offering a product that does not permit check writing. This result would not distort the quality of the goods that low-income individuals might choose for themselves. Moreover, the divergence in

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goods provided will differentiate the target audience, improving the effectiveness of the program. In sum, the tax credit would be more efficient than a grant program, a demand-side voucher, or a cash transfer. In addition, a tax credit to financial institutions is more likely to be politically feasible to enact in today’s environment, than cash assistance. Political feasibility, like other forms of feasibility, ought to be considered in weighing policy options.

9.4.2 The Community Reinvestment Act The Community Reinvestment Act (CRA) could also help to focus banks and thrifts on opportunities to provide bank accounts to low-income persons. Under CRA, federal regulators evaluate bank and thrift performance in serving their communities. As Michael Stegman has shown, the CRA service test, under which the regulators evaluate bank and thrift performance in meeting transaction, savings, and other community needs, has received perfunctory attention from examiners, with public evaluations containing little or no analysis of whether low-income consumers actually use bank or thrift products or services. Examinations under the service test could be vastly improved by taking three steps. First, examiners should evaluate the extent to which institutions offer low-cost accounts designed to meet the account needs of low-income individuals. Examiners should attempt to make a qualitative judgment about the range of product offerings of the institutions, based on lowincome consumer needs, and taking into account the costs to institutions of providing accounts and the requirements of sound banking practice. Second, banks and thrifts should be evaluated based on the number of low-income account holders at their institution. To reduce the data burden, the banking agencies might consider permitting institutions to use certain assumptions about their customers’ incomes based on the accounts offered, whether the account was opened at a branch in a low-income area, or held by a customer residing in a low-income census tract. Third, the agencies should give negative consideration to activities that undermine the provision of quality services to the poor. For example, participation by banks or thrifts in arrangements with affiliates or other parties that do not provide adequate consumer protection, or raise compliance, operational, or other risks, should receive negative consideration as part of the performance context under the service test.

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9.4.3 State Policies and Welfare Reform States should integrate access to financial services as a core element of welfare-to-work strategies. High cost alternative financial services undermine efforts to improve workforce participation by reducing effective take-home pay. Lack of structured savings mechanisms, such as direct deposit into a bank account, makes it less likely that new entrants into the workforce will save against liquidity crises from job loss, injury, or other family emergencies, and makes it more likely that such crises will push families back onto the welfare rolls. Moreover, lack of saving will reduce the ability of low-income families to save for homeownership, skills development, or their children’s education. States should encourage account ownership. First, states should shift EBT to individually owned accounts. With many contracts now up for renewal, there is a narrow window within which states could choose to restructure contracts to use EBT to develop banking relationships. States could move towards providing EBT through individually owned bank accounts and negotiate with networks for surcharge-free alliances for EBTcard holders. In so doing, states would be increasing the effectiveness of their welfare-to-work strategies by bringing low-income families into the banking system in preparation for their entry into the workforce. Second, states should permit former welfare recipients to retain accounts after they move into the workforce. This step may decrease the likelihood that new labor force entrants will turn to check cashing services once employed and increase the likelihood that they will arrange for direct deposit of their income. Given the high turnover rates of households on and off welfare, permitting families to retain EBT-issued bank accounts may be important to those families’ financial stability. Third, states should assist former welfare recipients to set up direct deposit of EITC and other tax refunds. Fourth, state welfare initiatives should increasingly include Individual Development Account (IDA) programs, and exempt the full array of IDA programs from state asset limits. As part of the federal reauthorization of the 1996 Welfare Reform law, Congress should make funds available to states for these financial services initiatives. 9.4.4 Financial Education Studies find that financial education can sometimes help to change the financial behavior of individuals, particularly low-income persons, if such education is combined with institutional support for the changed behavior.

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For example, financial education can be combined with new access to lowcost bank accounts that make financial sense for low-income families, together with saving plans at work or in the community. Financial education can focus on better financial management, reduced reliance on high cost credit, and increased participation in saving plans. The Treasury Department could support community-based financial education focused on account ownership and savings, building on the important work of the Consumer Federation of America in “America Saves”. In addition, workplace financial education could be funded as part of tax credits covering the administrative costs of setting up payroll direct deposit and savings plans for low- and moderate-income workers. 9.4.5 Reforming the Alternative Financial Sector Bringing low-income households into the banking sector is key to transforming financial services for the poor. Still, reform of the alternative financial services sector can help. In this section, I offer a few key reforms. Check Cashing Given the high cost structure of a paper- and labor-intensive industry, it is doubtful that costs of check cashing can be brought down significantly with existing technology. Reduced state regulatory barriers to entry, such as geographic restrictions, may help enhance competition - for example, Wal-Mart’s recent entry into check-cashing - if they are accompanied by consistent disclosure requirements and enforcement that would make it easier for consumers to shop for financial services. Some have suggested that banks themselves, with cheaper, direct access to the payments system, might effectively compete for check-cashing services. It would be cheaper and the services provided more useful, however, if banks were to compete with check cashers by offering electronically based banking services, instead of competing with them as check cashers. Advances in direct deposit, debit card infrastructure, and electronic bill payment will also be required to bring down the costs of income conversion. Payday Lending The Federal Reserve Board, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision have now shut down most bankpayday lender partnerships because of safety and soundness concerns; the FDIC has not yet followed suit, but should. At a minimum, the FDIC should use its authority under the Federal Trade Commission Act to take

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action against banks and thrifts that are engaged in “unfair and deceptive trade practices” in the course of payday lending activities. Regulators should pay particular attention to the problem of short-term balloon payments, repeated refinancing, and inadequate or misleading disclosures under the Truth in Lending Act (TILA). For example, if repeated payday loan rollovers indicate that the lender failed to underwrite the loan by determining a borrower’s ability to repay, contrary to safety and soundness guidelines, then the bank may have engaged in an “illegal credit practice” for purposes of the CRA. Such an illegal practice should adversely affect the bank’s CRA rating. Congress should also enact legislation mandating that payday lenders report borrowers’ performance to the credit bureaus, so that responsible borrowers have the opportunity to pursue alternative credit products based on their credit history. State regulation of payday lenders has been largely ineffectual to date, at least in part because payday lenders partnered with federally regulated banks and thrifts that could rely on federal pre-emption of state usury laws. Moreover, state rollover laws have been largely ineffective because they can be easily evaded. Thus, some states are now focusing on more effective legislation that would provide for longer minimum terms for payday lending to reduce the likelihood that short-term balloon loans that are repeatedly refinanced become a “debt trap”. Over the long term, there is room for greater private sector competition from the banking industry. Banks could compete with payday lenders by offering alternative, lower cost, longer term, and lower risk products. In principle, one such alternative might be bank overdraft protection. Although current disclosures are inadequate and costs are high, in theory overdraft policies could be provided at lower cost than payday loans because there is no need for face-to-face interaction. The transactions can take place automatically at low risk and cost to banks. Moreover, repayment of the overdraft could be scheduled so that regular minimum payments (through automatic debiting of the customer’s account) repay the overdraft over a reasonably long time period, rather than the current payday loan of two weeks or bank overdraft practice of thirty days. In addition, the Federal Reserve Board should go further than it did in its recent overdraft proposal. For example, overdraft protection fees should also be disclosed as an extension of credit using APRs and ATMs should not include overdraft limits as available balances. Refund Anticipation Lending The IRS, in responding to congressional pressure to increase e-filing and decrease EITC errors, has helped to create the market for RALs, by

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providing tax refund and offset information to preparers, and by delaying EITC refunds to conduct basic anti-fraud and error detection. The IRS now bears a special responsibility to help end RAL abuse. First, and most importantly, Congress should continue to simplify the EITC, for example, by altering the definition of qualifying children. Simplification should help to drive down costly error rates, and will help to diminish the need for expensive tax preparation services. Second, the IRS should expand free tax preparation and electronic filing. Greater availability of these services would diminish the need to take out RALs in order to pay for preparation services. The biggest barriers to an expansion of fee tax preparation services are lack of funds, lack of sites that provide for electronic filing, and, more critically, lack of effective ways to assure the quality of these tax preparation services. Third, since Treasury and the IRS have now indicated that the IRS will begin, in tax year 2007, permitting taxpayers to split their refunds to be directly deposited into more than one bank account. If refunds are permitted to be split into more than one account, tax preparers could compete by offering tax preparation services that are paid not out of the proceeds of RALs, but paid directly to them electronically out of tax refunds through direct deposit to them of a portion of the refund, diminishing the risk to the preparer and eliminating one reason to take out a RAL. If this reform is combined with public and private sector efforts to bring EITC recipients into the banking system, the remaining portion of the refund could be direct deposited into the client’s own bank account or other saving vehicles. Fourth, coupled with better error and fraud detection and prevention efforts, the IRS can speed up EITC refunds, and do more to encourage direct deposit of refunds into bank accounts, both directly and through employers, commercial preparers, and Volunteer Income Tax Assistance (VITA) sites. Only 41% of all tax refunds nationwide are direct deposited. The IRS could offer to directly deposit tax refunds into a default bank account for the “unbanked”. These tax refund bank accounts could be offered by a range of banks and thrifts willing to sign up with the IRS. Fifth, EITC recipients can become a central focus of efforts to bank the unbanked. Treasury should expand its Electronic Transfer Account (ETA) program to permit use of ETAs for EITC receipt. Congress should appropriate more funds for Treasury’s First Accounts program to support innovative efforts to reach EITC recipients without bank accounts. The IRS should establish partnerships with large employers to encourage employees to open bank accounts and establish direct deposit of paychecks and tax refunds. Moreover, the tax preparation firms themselves – as H&R Block has now begun to do in a recent pilot – should partner with banks to

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develop and offer individual, low-cost, electronically based bank accounts for their clients. Their clients could use the accounts to receive direct deposit of their income tax refunds, to withdraw funds at ATMs and POS using debit cards, to save, and for their other financial services needs throughout the year. The tax preparers would gain a new marketing tool and might see higher rates of client retention. Sixth, the IRS can use its oversight of e-file preparers to improve the market for EITC recipients. Towards this end, the IRS should make enforcement a priority; provide more detailed rules regarding nondeceptive advertising, including disclosures of how the offered product compares with the IRS’s current anticipated refund times; and force greater transparency in pricing, including by requiring that RAL funds be provided to EITC recipients in a form that does not require an additional cost to convert to cash. Lastly, if Congress wants the IRS to expand e-filing availability, and direct deposit of refunds, it should pay for expanding the private sector infrastructure necessary to implement it, rather than relying on RAL fees paid by low- and moderate-income tax payers to cover the tax preparers’ costs of implementing e-filing. Congress could appropriate funds for the purpose, or use an e-filing tax credit to offset the costs.

9.5 Conclusion Low- and moderate-income households who use alternative financial service providers pay a high price to convert their income into cash, pay their bills, and obtain credit, and they lack a regular means to save. The high cost of alternative financial services undermines key income redistribution policies for the poor, including the EITC. Existing banking products are often not well designed to meet the needs of the poor, and few banks compete with alternative financial services providers for lowincome customers, particularly in low-income neighborhoods. The cost to individual financial institutions of research, product development, account administration, staff training, marketing and financial education with respect to new financial products for the poor, relative to their expected financial return, means that the market is unlikely to change quickly on its own. In addition, network externalities in electronic payments systems and distribution networks suggest that net social benefit could be obtained through further expansion. Financial and technological innovation has been a hallmark of U.S. financial markets. Financial institutions can harness that innovation to

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meet the needs of low-income Americans. Governmental incentives appear to be important to catalyze private sector efforts to use financial and technological progress to expand access to financial services for low- and moderate-income families. By helping these families to enter the financial services mainstream, the policies outlined here can help to transform financial services for low-income persons. Such a transformation is a key to promoting greater economic opportunities for low-income households.

9.6 References Barr M. (2004), Banking the Poor, in “Yale Journal on Regulation”, vol. 21:121. Barr M. (2004), Banking the Poor: Policies to Bring Low-Income Americans into the Financial Mainstream, Brookings Institution Metropolitan Policy Program Policy Brief. Berube A. et al. (2002), The Price of Paying Taxes: How Tax Preparation and Refund Loan Fees Erode the Benefits of the EITC, Brookings Institute & Progressive Policy Institute. Caskey J. (1994), Fringe Banking: Check-Cashing Outlets, Pawnshops, and the Poor, Sage. Dove Consulting & U.S. Department of the Treasury (2000), Survey of Non-Bank Financial Institutions. Dove Associates & U.S. Department of the Treasury (1998), ETA Initiative, Final Report. Dove Associates & U.S. Department of the Treasury (1998), ETA Initiative: Optional Account Features, Economic Waterfall Analyses, Ed Bachelder & Isabelle Aguerre. Dove Associates (1999), ETA Conjoint Research. Federal Reserve Bank (1998), A Summary of Consumer and Business Attitudes on Direct Deposit and Direct Payment, A National ACH Market Research Study. Federal Reserve System (2002), Retail Payments Study. Federal Reserve System (2002), Retail Payments Research Project: A Snapshot of the U.S. Payments Landscape. Gerdes G.R and J. K. Walton II (2002), The Use of Checks and Other Non-Cash Payment Instruments in the United States, in “Federal Reserve Bulletin”. Hannan T.H. et al. (2000), To Surcharge or Not to Surcharge: An Empirical Investigation of ATM Pricing, in “Federal Reserve Board, Finance & Economics Discussion Series”. Hayes T. et al. (2002), ATM Deployer Study, Dove Consulting Group & NYCE Corp. Humphrey D.B. and A.N. Berger (1990), Market Failure and Resource Use: Economic Incentives to Use Different Payment Instruments, in “The U.S.

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Payment System: Efficiency, Risk and the Role of the Federal Reserve”, (David B. Humphrey ed.). Kennickell A.B. et al. (2000), Recent Changes in U.S. Family Finances: Results from the 1998 Survey of Consumer Finances, in “Federal Reserve Bulletin”. Leyser B. (2001), Selected Characteristics of State EBT Systems, National Consumer Law Center. Orozco M. (2004), The Remittance Marketplace: Prices, Policy and Financial Institutions, Georgetown University, Institute for the Study of International Migration, June. Stegman M.A. (1999), Savings for the Poor: the Hidden Benefits of Electronic Banking, Brookings Institute. Stegman M.A. and R. Faris (2003), Payday Lending: A Business Model That Encourages Chronic Borrowing, in “Economic Development Quarterly”. Suro R. et al. (2002), Inter-American Development Bank, Billions in Motion: Latino Immigrants, Remittances and Banking, Pew Hispanic Center & Multilateral Investment Fund. U.S. Department of the Treasury (2002), Partnership for Prosperity: Report to President Vicente Fox & President George W. Bush.

10 Migrants and Remittances

Luisa Anderloni1

10.1 Migration Phenomena: Modern-day Elements of an Ancient Phenomenon Migrations have been feature of the history of humankind and of the world. They range from the movement, in ancient times, of whole populations in search of new settlements in more fertile and wealthier areas, of movements to “newly-discovered” continents, to willing or enforced colonisation, from the eighteenth century, to the migrations of the contemporary age, including recent migrations affecting societies in both Europe and in the United States, in many ways. One only has to consider the management of arrivals and of residence permits, the impact on the dynamic of the job market, of the interplay between different cultures, religions, habits and lifestyles, the impact on school education, housing, medical assistance, as well public or private initiatives targeting specific social groups, often characterised by social fragility and/or low income. Current migrations are unique in terms of size, complexity and diversity and are simultaneously both a product of and a boost to the processes of globalisation. The international migration phenomenon has reached the top of the policy agenda in a large number of developed countries over the past decade because, due to an ageing population and a loss of interest in some sectors of employment by parts of the local population, there is expected to be a further increase in the demand for migrant workers in the near future.

The author’s thanks go to Marie Odile Pilley, Postal financial services expert, Universal Postal Union, specialised UN agency, for her contribution to financial practices research as an independent consultant before taking up her new role in the UPU. She has provided insightful suggestions. However, advice given reflects her own views and does not represent the UPU's position. 1

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Within this complex framework there are also questions related to the connection between migrations and finance, and between migrants and banks. It must be conceded that access to banking services by immigrant populations is not a priority compared to that of looking after other aspects, for example getting a residence permit, if they entered illegally, housing, employment, schooling of children and the reunion with family members living in the host country. It is also secondary to other aspects of social integration or, according to other approaches, to living together within a diversity of cultures and social traditions. However, interest in the issue has increased in importance, in recent years, especially with reference to: -

the role of remittances and the way they latter are made. This has obvious implications for the banking system2; the use of financial circuits in international flows and the counteracting of money laundering or money dirtying; the perception of the market potential by some banks and the development of various kinds of commercial initiatives (the offer of specific products and services, implementation of different styles of customer relations and communication or ad-hoc distribution channels) geared towards the immigrant population.

Moreover, as emphasised previously3, a focus on financial exclusion, and on initiatives aimed at promoting inclusion, has highlighted the fact that immigrants often find it difficult both to access the banking system and to establish wider relationships with banks.

The literature on remittances is a wide one that comes from different disciplines. In fact, the flows of remittances, as well as the widespread distribution of them, raise important questions about their economic impact, how they arrive in the home countries, and what are the most common spending practices among remittance receiving countries. Moreover, recently, the issues of reducing the transaction costs of remittances and of how to channel part of them to finance productive investments have emerged as on the political agenda. See CPSS–The World Bank (2006), IMF (2005), OECD (2005), Orozco M. (2005), Orozco M. and E. Hamilton (2005), Rapoport H. and F. Docquier (2005). 3 See Anderloni L. and E.M. Carluccio, in this volume. 2


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10.2 The Risk of Financial Exclusion Within a Broader Perspective Immigrants are often subject to social and financial exclusion. In many countries, most belong to the lowest income group, especially when the first arrive in a country. This is especially true of those belonging to ethnic groups that integrate less easily4. Social exclusion amongst immigrants increases the difficulties they have in accessing financial services. Unstable income and low savings mean that many banks see them as unexciting - if not undesirable – customers, associated with higher credit risks, higher operational costs and lower profit margins. At the same time, exclusion from financial services is also an obstacle to immigrants’ social and economic integration. Bank accounts can help build savings and make payments easier. Mortgages give immigrants opportunities to own property that not only can offer better living conditions, but that also can become useful collateral for future business loans. Loans to finance new businesses can help immigrants create new work and business opportunities, and thus provide them with more chances for economic and social integration. In many enterprises, wages are paid directly into employees’ bank accounts, so that bank accounts are necessary. Following a commercial logic, several banks have started to recognise the potential for business development presented by members of the immigrant population. An answer to the question of whether the immigrant population are seen to have specific financial needs that require a targeted and dedicated response, or whether they are to be seen as low priority customers for whom the cost of providing services is inadequately covered by earnings and risk coverage margins, can be found by looking at the issue from a perspective that includes the changing dynamics of needs how these change over time. An understanding of needs within this more dynamic context can help explain whether the limited financial inclusion of, possibly large, groups of immigrants may be due to the lack of, or at least limited extend of, needs that can be met by the banking system or, on the other hand, whether difficulties in access are rooted in cultural, linguistic factors, procedural aspects or assessments of cost, or even to other factors of individual psychology and views individuals have of banking relationships. It could also help understand whether, as an alternative or in addition to these See, with reference to the UK context, C. Pilley (2003) and, with reference to the Spanish reality, Anderloni L., E. Aro and P. Righetti (2005). 4

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shortcomings on the demand side, there might also be something lacking as regards what they are offered, either because products and services are unsuitable to their needs, or because the procedures, communication methods or pricing policies adopted have the effect of discouraging, whether by design or by chance, access to banking relations. Taking a dynamic approach and a longer term perspective opens the way to a modification of both views: on one side immigrants might appreciate the convenience of access to the banking system, on the other side the banks might see the benefits in targeting the immigrant market. As a result it might be easier for supply and demand to come together. Adopting this approach it might also make it easier to provide an accurate assessment of remittance services, which are specific and exclusive for the migrant population. In recent times they have been analysed on a number of occasions and from several viewpoints taking into account the connection this issue has with other macro and microeconomic questions. Remittances are a primary need, generally used recurrently by migrants, though remittance models vary depending on the reasons the person saves money to send it back home, on how long they have been living in the host country and on their plans for the future. An approach will be developed that looks at financial needs taking into account the phases of migration that mark stages in the life cycle and of immigrant’s actual plans. This makes it possible to provide a comprehensive assessment, based on individual personal variables (social, cultural and psychological characteristics) and to demonstrate that the range of products and services supplied is likely to become broader as the initial needs to access an account to pay in and use payment instruments and the need to make remittances comes to be accompanied by additional needs for increasingly complex services that are likely to be profitable.

10.3 Migration Phases and Personal Variables as Key Elements of Financial Needs Immigrant groups often show characteristics and attitudes typical of other socially excluded groups, such as low income, low skills levels, a lack of language knowledge and of technical knowledge – i.e. legal and financial, mistrust of suppliers, and psychological barriers including lack of confidence. These characteristics are partially related to what may be termed “migration phases” and the level of integration in the host country, and to their economic, social and educational level (since not all migrants


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have little or no education or training) as well as to the type of banking system that they were used to in their country of origin. In other respects, immigrant groups may differ from other socially excluded groups. In particular, second generation immigrants, immigrants in the last phases of their migration plans, or immigrants from certain ethnic groups, can gradually overcome an initial economic exclusion, as they obtain a regular job and a permanent place to live, and start saving and using bank services and products. Eventually they may become sought-after customers to be supplied by bank service providers with a range of services. However this is not the case for all immigrant groups. Thus, the migrant universe is a complex one, made up of various, very different, ethnic groups. Consequently, theoretical considerations may apply to one situation but not to another. Social and financial exclusion amongst immigrants also differs according to geographical context, with considerable variation to be found in Europe. Some countries, such as the United Kingdom, France and Germany, have experienced migration flows for many decades, and their “integration problems” are different from those experienced by countries with recent, more varied migration flows, such as Italy and Spain. Recent migration flows are much more mixed than those further in the past: in countries where migration is more recent, immigrants come from many different nationalities (from Asia, Africa, Eastern Europe and Latin America). Differences between countries also depend on ethnicity. In certain cases, immigrants speak the same language as the native population in their host country: South Americans in Spain; Indians and West Indians in the United Kingdom; Tunisians and Algerians in France; in the past, East Germans in Germany. Most countries also have very different approaches regarding initiatives to support financial literacy. 10.3.1 Demand for Financial Services Aimed at Immigrants In drawing up a theoretical framework based on variables that may influence immigrant demand for financial services and products in the host country, we should remember that financial needs are generally considered to be “secondary level” needs, rather than the “primary level” basic needs required for survival in a foreign country5. With this in mind, we need to consider the relationship between the following variables: 5

See below, and Anderloni L. ( 2003a) and Anderloni L. ( 2003b).

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migratory project (phase and goals of migration plan); priority of basic needs and resulting prioritisation of intervention by social and governmental institutions; structure of banking markets, extent of development of a cashless society in the host country.

The implementation of plans to move from one country to another can be divided into a succession of phases6, each of which has differing priorities in terms of basic needs and in terms of financial needs. The first phase is “initial settlement”, when immigrants first enter the host country. Basic needs in this phase relate to labour (finding a job or obtaining money for basic living needs), housing (finding a place to live, often shared with many other immigrants), and language. In this phase financial needs relate mainly to the use of money for survival. The key variable in the initial phase is the issue of legal or illegal entry, as this heavily influences immigrants’ way of life and the visibility of their activities. Whether immigrants have entered the country legally or not has implications for how easy it will be to find jobs and housing, both of which are very important basic needs in the initial phase. Generally illegal immigrants have no official access to the services provided by financial institutions7. It is practically impossible for immigrants to save money during this economically unstable first phase. Housing problems may lead to financial needs, such as the need to obtain a bank guarantee to rent a house, in cases where immigrants favour or are able to choose the legal approach and do not have to rely on the “irregular” rental market. More often, migrants share housing with friends, relatives or simply other immigrants from the same country or ethnic group. Illegal entry is, furthermore, often associated with incurring large debts to finance the journey. The second phase is characterised by the following basic needs: for illegal migrants, to obtain a regular residence permit; to have a regular job; and to work towards reuniting the family. This need shapes choices in different ways, depending on what their main goal in coming to a country has been. If the goal has been to stay permanently in the host country, immigrants often try to arrange for other family members to join them. If 6 See Sergi N. and F. Carchedi (1991), pp. 8-9 and Anderloni L. (2003b), pp. 163-164. 7 In reality, in most countries there are no legal restrictions because a valid passport suffices to open a bank account as a “foreigner”. However, these accounts have very high fees and costs. For commercial reasons, i.e. for internal policy reasons, banks often do not publicise this.


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they only want to stay on a temporary basis, they prefer to help the family while staying in the host country and will send them money for food, housing, education, and emergency medical services. In this phase, financial needs consist mostly in saving and transferring money abroad through remittances. How often they send money depends on how important an individual’s help is for the survival of their family in their country of origin and the amount will depend on how much they manage to save, given low salaries and high expenses8. Other financial needs may include personal loans or consumer credit to buy furniture or household appliances, or, micro-credit for the self-employed to purchase business equipment. Sometimes the demand remains only latent due to a failure to meet the requirements that banks generally stipulate in order to grant a loan in the first place. The third phase of “stable settlement” involves a greater degree of integration in the host country. Priorities may shift to setting up business or commercial activities (such as shops, restaurants, or small businesses in the services or industrial sector), to buying “superfluous” goods or services (such as a car, or more furniture, or entering into a rental agreement), and in certain cases even to buying a house. In this phase, saving is characterized by more medium-term goals, and immigrants look for basic savings products. As far as credit is concerned, demand will focus on micro or consumer credit, mortgages for house purchase, and business loans. The amount and frequency of remittances generally decrease as many immigrants now have a family living with them in the host country and prefer to invest most of their resources in improving their life in their adopted country. The exact features of the fourth phase of “consolidation” will depend on the original plan or model of migration9. If the plan follows the “transit” model, where the aim is to work abroad for a certain period of time, to save money for the family in the country of origin, to be able to buy, build, or refurbish a house and then return home, needs are similar to those in the previous phase. An untapped area of offer for this segment of immigrants may be that of savings and transferable pension schemes and the formation of deferred annuities. If the project follows the model of “final settlement and succeeding generations”, the financial needs will become more sophisticated, and Researchers have proposed various theories to explain remittance behaviour. See below. 9 Massey D.S. et al. (1993) and Schoorl J. (1995) show two different research approaches to international migration: studying why migration processes begin, and studying how the migration process continues over time. 8

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resemble those of people in the host country with the same characteristics. Remittance services become less important than in the previous phases. Further stages are those of second and succeeding generations. Only countries with a long tradition of incoming migrations (the US, the UK and France) have already experienced these stages. However, in all these phases, remittance is an important service for immigrant populations, even though its relative importance tends to decrease as other needs increase. Figure 9.1 Financial needs and migrant life cycle Stages

Initial stage

Second Stage

Third Stage

Fourth Stage

Further stages

Initial settlement

Legalisation

Stable settlement

Consolidation

?

Needs Survival

Remittances Remittances Savings products

Debt run Latent up dormant demand of consumer credit and micro credit

Payment services Loans for: -consumption -start up of economic activities (self-employment or microenterprise) -mortgages Non life insurance “basic damages”

Remittances (?) More sophisticated financial needs, including: -investments and asset management -life and non life insurances -pension schemes -loans -mortgages

Depending on Models: “Transit” versus “Final settlement”

Further stages Models “Transit” coming back to the country of origin If well marketed tailored products: Savings and transferable pension schemes Formation of deferred annuities

Source: adapted from Anderloni L. (2003 b).

“Final settlement” succeeding generation Similar, ceteris paribus, to those of the comparable local population


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As stated earlier, the demand for remittance services tends to vary over time and depends on possible different reasons for sending the money home in the first place. Economic research on motives for remittances has extensively investigated this area, and four approaches have been suggested10: - Altruism The altruism approach is based on the family economy. According to this view, immigrants send remittances back home because they care about the wellbeing of their family in the home country. Therefore, sending remittances gives satisfaction to migrants who are concerned with the welfare of their family. According to this model, remittances tend to decrease over time. One reason for this is that family attachment is more likely to decrease over the time which members are in different countries. Migrants may also plan to stay abroad for a long time period (possibly retiring there) and have their families join them. This, of course, will reduce remittances. On the other hand, if immigrants return home they can bring fresh capital with them, in the form of one extra large remittance. - Self-interest According to this approach, migrants are mainly motivated by economic and financial self-interest when sending remittances to the home country. The dynamic is as follows: migrants start saving after a while in the host country. The question then arises as to how and where to invest in order to build wealth, spreading investments between the host country and the country of origin, and an obvious place to consider investing at least some of these funds is in property, land, or financial assets in the country of origin. These assets may earn a higher rate of return than assets in the host country, although their risk profile may also be higher. In turn, pending immigrants return to their country of origin, the family can administer these assets on their behalf, acting as trusted agents. Another motivation in sending money home is the desire to receive inheritances from parents: family members that have contributed to increasing family wealth, for example by sending remittances, increase the likelihood of receiving inheritances in the future.

10

See Solimano A. (2003) and IMF (2005).

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- Implicit Family Contract I: Loan Repayment This approach also takes the family, rather than the individual, as the main unit of analysis. The theory assumes that there is a kind of implicit contract between family members who seek work abroad and those who stay at home. The implicit contract can cover a considerable time span and combines elements of investment and repayment. Families have invested in the education of immigrants and usually finance migration costs too. Repayment begins after immigrants have settled in the host country: once they find employment and have begun to bring in earnings, they start paying back the loan in the form of remittances home. The model predicts differing remittance time profiles depending upon the length of time it takes for immigrants to become established in the foreign labour market and also on the length of time spent abroad. The faster they enter the foreign labour market, the sooner remittances flow. The amount remitted will depend, among other things, on their income. Unlike the altruistic model, remittances do not necessarily decrease over time.

Implicit Family Contract II: Co-Insurance Another version of the theory of remittances as an implicit family contract between immigrants and those at home, relies on the notion of risk diversification. According to this model, sending a family member abroad - often the most educated one - as a migrant worker is a means of diversifying economic risk. Family members working abroad can help support fellow family members through difficult times at home. In the same way, families in the country of origin can provide security for family members who can sometimes have periods of difficulty in the host country. Under this model, migration becomes a co-insurance strategy, where remittances correspond to insurance premiums. Enforcement of contracts is not seen as a problem, due to the fact that they are agreements within the family, strengthened by the bonds of family trust and altruism. In this model, remittances vary over time and reflect the different economic and financial situation of family members abroad and in the country of origin. -

These different theories predict different flows of remittances over time. Therefore, considering that remittances are only one type of financial service a person may need, we should remember that immigrant demand for financial services and immigrant financial behaviours are also influenced by such factors as:

10 Migrants and Remittances -

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country of origin; personal attitudes; ethnic group.

One factor relating to the country of origin is the level of economic development in that country. In very poor countries, even very small remittances may be of major significance in the survival of the families of migrant workers. In these countries, too, relatively small savings in European terms may have much greater purchasing power locally. Medium-term saving may facilitate the creation of a business or house purchase on return to the home country. Furthermore, economic development in their home country also has an indirect effect on immigrants’ knowledge of the products, services and technologies normally available in the host country and may influence their lifestyle in the host country as soon as they start to work and earn income. This has an indirect effect on purchasing decisions, saving capacity, and also on access to financial services. The level of development of the banking systems in countries of origin also has an indirect effect both on the financial awareness of immigrants, since they may already know about certain banking products and services, and on their use of banking channels for services and for remittances. If in their country of origin the banking system is not well developed, with very few branches, it is more likely that immigrants will access non-banking channels in the host country to send remittances. The distance between the country of origin and the host country also has an influence on the channels used for remittances. If the country of origin is not far away from the host country, informal channels are more likely to be used. The characteristics of different ethnic groups, in terms of level of network cohesion and of social control, also play an important role in this case. If cohesion and social control are low, migrants from countries located near the host country prefer not to use informal channels. Individual immigrants’ own particular social, cultural, economic, and psychological characteristics have a strong impact on their access to financial services. Each person is an individual with his or her own ideas, behaviour and plans for the future. Furthermore their position on the labour market (employee or self-employed; open-ended or temporary contract) and social position in their home country can influence the economic activity undertaken in the host country. Level of education is an important factor: the ability to read and write, knowledge of a foreign language and knowledge of basic mathematical concepts, enable better integration and facilitate access to banking services in the host country.

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Psychological factors may include a perception of how immigrants are viewed in the host country, and consequently influence their behaviour in approaching host country institutions, particularly banks. If they sense that there is a hostile or discriminatory attitude towards foreigners (or immigrants, or non-Europeans), they may prefer to access non-banking institutions, especially if other immigrants run these. Another psychological factor is the extent of their attachment to their own ethnic community lifestyle and whether they are likely to develop a different lifestyle as time goes on: if they remain in areas with high concentrations of their compatriots and their working relationships restricted to members of that particular community, they are unlikely to access institutions in the host country since they will first turn to their own community to find solutions to financial problems. Ethnic group characteristics and initiatives play an important role in shaping immigrants’ access to financial services. The ability to act and communicate together is a very important variable. One important factor that influences aggregation and communication mechanisms is the degree of geographical concentration of immigrants’ homes and workplaces11. Ethnic associations and informal groups can help to facilitate access to financial services for their members12. Ethnic groups can also be channels of information facilitating bank credit analysis: they may know their members well, they understand the significance of the cultural factors in behaviour, and can then act as cultural mediators between banks and other immigrants. Community associations can also make agreements with banks to facilitate immigrants’ access to financial services. Price agreements are the most popular initiatives but agreements with cultural mediators or interpreters who can help immigrants when they enter bank branches are also common. Another important role played by ethnic associations is that of developing innovative approaches to the financial literacy of their member and in facilitating access to finance for their members, by, for instance, guaranteeing loans taken out by members.

11 When immigrants from the same country are concentrated in the same area it is easier to provide them with information and to launch initiatives in their favour, even if there is no institutional organization to act in this capacity. 12 For instance they can promote bank initiatives on products, and other financial institutions, and they can refer their members to a specific bank. In some cases these associations have been targeted by banks or financial institutions wishing to reach their members.


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10.4 Migrant Remittance Behaviour The study of access to bank services by low-income population segments, including immigrants, presented in Chapter 1, §1.6 that looked at access to bank accounts and payment services, also investigated the issue of remittances13. To respect time constraints in such a large study, the following areas were selected for investigation: -

whether remittances were made or not; frequency (regular or irregular) of remittance transmission; average size of sums sent; channels used; reasons for choice of channel.

For the last area, participants were asked to indicate elements considered important, identified on the basis of the results of previous studies14 and on the basis of testing and refining the questionnaire subsequently used. They were also invited to make suggestions for improvements in services. The frequency of remittances appears to confirm both assumptions advanced on a theoretical level and the results of other surveys: the greater the degree of integration in the host country in the early phases of arrival in the country, including the creation of a family unit, and the resolution of housing and work problems, the less likely it is that funds will be remitted to the country of origin. In Italy, 92% of respondents made remittances, in Spain 65.8% (attributable to the high number of recent immigrants) and in France 55.2% (attributable on the contrary to the greater age of immigrants there and their high level of social integration). The data relating to frequency (regular or irregular according to circumstances) seems to confirm the theoretical assumptions: a correspondence was noted between making (or not) remittances in the early phases of the migration life cycle and later phases. In Italy transmission tended to be regular, generally on a monthly basis; 68.5% of migrants who made remittances said they did this regularly. In Spain 60.4% of immigrants sent remittances regularly. In France 52.8% sent remittances on an irregular basis, and 42.3% on a regular basis, generally every 3-4 months. In Italy and Spain monthly transmission was more common. The average amount sent in regular See Appendix to part I for the study’s aims and methodology, more detailed discussion of the sample and data is to be found in Anderloni L., M.D. Braga, E.M. Carluccio and L. Nieri L. (2006). 14 See Anderloni L. (2003) and CECA (2002). 13

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transmissions tended to be generally limited: mainly in the bands between €50–100, €100-200 and €200-300, with the greatest frequency of the highest bands in Italy, and the lowest in France. It is worth noting the average amount sent for each transmission, as there are clear implications in terms of the proportion eaten up by commissions. Remittance service providers generally charge fixed commissions, which can weigh heavily in percentage terms on small remittances. For some immigrants, however, remittance transmission is a way of building savings and storing money, and hence the frequency of transmission of even small amounts meets this need, even if the cost is high. As regards the channels used to make remittances, banks and post offices do not play a major role in France and Italy, where specialist agencies are normally used. The extent to which they are used is very different in the two countries, however. In Italy money transfer agencies account for 64.2% of responses (followed by unofficial agencies or networks with 14.2%, relatives and friends with 6.6%, banks with 5.7%, and last of all post offices with 1.9%). In France agencies account for 35.3% of responses, followed by post offices with 29.4% and then banks with 17.6%15. In Spain, conversely, banks and post offices (respectively 36.2% and 25.9%) are top of the list, followed by official agencies (20.7%) and unofficial agencies (8.6%)16. Of the official agencies, Western Union dominates the market, although to a differing extent in the different countries. In France it is used by 94.4% of migrants sending remittances, in Spain by 47.4%, and in Italy by 40.4%. Their traditional competitor, Money Gram, is less used than other specialist agencies for Latin American countries; there are 4 or 5 main agencies in Italy and in Spain. As far as the reasons for choosing an agency are concerned, security, rapidity, ease of use and ease of access predominate in France, and economic considerations and ease of access in Spain. In Italy reasons given cover a wider range, including advice from friends, agency managed Relatives and friends play a more important role here; this can be explained by greater proximity to country of origin, given the different ethnic groups in the three countries. 16 This also seems to be the result of the strategies that the savings bank system has applied, of serving this market which in the past was dominated by remittance agencies, and by the fact that commercial banks in Spain have responded to competitive moves by savings banks in this segment, and are guided by an approach that takes account of immigrant life cycles and sees remittances as an opportunity to establish client relationships that over time can be enhanced through a wider range of services. 15


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by friends, and cost considerations which have led to regionally specialised agencies being preferred to Western Union. Participants were presented with factors that are traditionally seen as determining choice, such as efficiency, accessibility, security, cost, and ease of use, and were asked to rate the three most important in order of importance. Again participants in Italy and France gave similar responses, with, in order of importance, efficiency, security, accessibility ease of use and cost. In Spain, efficiency and security came first, followed by cost and then accessibility and ease of use. The cost element, in second position in terms of choice of channel, moves to first place in all three countries when respondents were asked to put forward suggestions for service improvement. However, in France the majority of respondents did not make suggestions (although this was not generally the case), suggesting that remittance transmission is less important there than other services. Many responses indicated that remittance services generally work well, but that costs are too high. Responses that suggested giving priority to speed and security of remittance transmission appear largely to be emphasising the importance of these elements, rather than putting forward concrete suggestions for improving the service17. In general, however, areas of access and method of remittance are seen as significantly less problematic than access to, and using, accounts, payment services and credit. Remittance services are seen as commodities, with a sufficiently wide and varied range of providers, and lacking barriers of prejudice or bureaucracy; they are seen as generally unproblematic, which is not the case in other services. The main complaint is about cost. The view amongst policy makers and international financial institutions and organisations suggests that cost reductions are possible provided actions are taken to remove inefficiencies18. The time is fast approaching In Italy, respondents sometimes called for remittance agencies to control their distribution networks better, both in Italy and in the country of origin, so as to prevent delays that were sometimes attributed to inefficiency or to “dodgy behaviour” in some provincial agencies. However, the network was seen as reliable, although there were some differences in treatment between different transmission points. 18 A task force consisting of representatives from international financial institutions involved in remittances and from central banks in both remittancesending and remittance-receiving countries prepared a Consultation document for the Committee on Payment and Settlement System and the World Bank. It identified five areas of possible market weakness: i) lack of transparency in the market and of understanding by users; ii) weaknesses in the infrastructure that is used to provide remittances services; iii) the possibility of adverse effects from 17

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when banks, post offices and other financial intermediaries will have to come up with innovations in the area of remittances, both in terms of products and processes. As mentioned in the introduction, the size of the sample does not enable statistical significance to be attributed to the results: nevertheless the suggestions that emerge seem sensible and constitute a useful point of departure for further reflection and research.

10.5 Conclusions Theory and evidence suggest that it would be useful for banks’ policies to target the immigrant population to took account of the needs identified in the different phases of the ”migrant life cycle” described earlier. Taking account of how needs develop over time, allows the potential demand – both qualitative and quantitative – to be highlighted and should facilitate a recognition of the potential that this market segment represents, given that, over time, remittances are only one out of many types of financial service that an immigrant may need. There is an opportunity for the most far-sighted banks to become the first to exploit these new market niches, which in the long run have great potential19. As regards the development of strategies by the banks to meet needs is concerned, two possible approaches emerge. These are to be found on the ground and were developed theoretically by some of the interviewees during the field surveys. While there is insufficient empirical evidence to suggest which is most appropriate, they are detailed with a view to encouraging reflection. poor or disproportionate regulation or weak legal framework; iv) lack of competitive market conditions and v) risk. Therefore it has assumed the following public policy objectives for the provision of international remittance service: “International remittances services should be safe and efficient. To this end, the markets for the services should be contestable, transparent, accessible and sound”. In order to achieve these objectives, the areas of intervention result to be: i) transparency and consumer protection, ii) payment system infrastructure, iii) the legal and regulatory environment, iv) market structure and competition, v) governance and risk management. 19 This happens in Spain where, saving banks in particular have played a pioneering role, but some commercial banks in search of new competitive opportunities have also adopted far-sighted strategies on the supply side, based on the consideration of the life cycle. See Anderloni L., E. Aro and P. Righetti (2005).


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The first approach consists in offering products and services that are not differentiated, but are similar to those provided to those local market segments with similar economic resources and needs. Some differences may be found, for example in specific services for fund transfers abroad related to remittances to the countries of origin, though the immigrant population tends to prefer specialised money transfer operations or informal networks and circuits that are regarded as more efficient than banking networks20. The second is a strategy that focuses on this specific customer segment. Products and services are targeted specifically at immigrant groups. This implies not only dedicated counters with suitably skilled staff and with specific commercial and legal marketing material, but also specific products and product packages aimed at the target market21. Under this approach, agreements or alliances could also be made with ethnic organisations22. Each of these approaches has advantages and disadvantages from a logical viewpoint, just as different elements become more or less important during the phases of the “migrant life cycle” described above. Suffice it to say here that, one of the advantages in the first approach is that it avoids creating ghettoes, and singling out immigrant customers; on other hand one of the disadvantages is the risk of appearing not to be interested in the segment and not offering suitable responses to its specific needs. As regards the second approach of specifically targeting this segment, the The trends emerging in Spain, however, seem to confirm the hypothesis that banking services targeted more towards the immigrant population could lead to shifting remittance services to the banking channel. The attention paid to this market by savings banks is confirmed in CECA (2002). 21 A number of projects of this kind have been successfully carried out in Spain, mainly by savings banks, but also by commercial banks such as Banesto (with “Tariffa Plana Welcome”) and BBVA (with “Cuantas claras international”), as well as by Banco Popular. See Anderloni L., E. Aro and P. Righetti (2005). In Italy, the first services offered include the “Extraordinario” account of Banca Popolare di Milano, the “People” account of Banca Intesa, the “Country” account of Popolare di Vicenza, the “Paschi senza frontiere” account of Monte Paschi Siena, the “Radici” account of Banca di Credito Cooperativo dell’Emilia Romagna. These were followed by a number of other proposals where the word “Welcome” is often used as an encouragement to start a banking relationship. 22 This type of alliance, can both provide a commercial boost, and can serve as a technical assistance and support service to help immigrants make appropriate choices, and promote financial literacy and education initiatives. It may even go as far as offering collateral guarantees for operations that banking institutions would otherwise be unable to sustain. 20

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opposite seems to be true: the advantage is that by being geared towards a specific segment there is a risk of creating ghettoes and promoting initiatives which, at the end of the day, are nothing more than window dressing23. At a more general level, “enlightened” policies by some of the most innovative banks should have a positive effect on society as a whole, since exclusion from official financial channels has the effect of encouraging people to resort to unofficial channels. These are not totally transparent and reliable which means that consumers get little protection and they can even be illegal or be supporting criminal activities. To the extent that the services offered by the financial system contribute to the development of individual economic potential, the failure to offer such services to specific segments, including those that are considered more difficult to approach, hinders the exploitation of that potential. For this reason, too, measures to extend access to banking services should provide dividends in terms of greater well being for the community as a whole.

10.6 References Anderloni L. (2003a) (ed.), Il social banking in Italia. Un fenomeno da esplorare, Milano, Giuffrè. Anderloni L. (2003b), Flussi migratori e flussi finanziari: il social banking, in Secondo Rapporto Bocconi, DIA, DNA, UIC, Immigrazioni e flussi finanziari, Egea, Milano. Anderloni L., M.D. Braga, E.M. Carluccio and L. Nieri (2006), Survey on LowModerate Income People and Access to Financial Services, Quaderno di Ricerca, Università della Valle d’Aosta. Anderloni L., E. Aro and P. Righetti (2005), Migrants and financial services in Spain, Mimeo. CECA (2002), Las remesas des emigrantes entre EspaĖa y latinomérica, CECA, Caja Murcia, Caja de Ahorros El Monte de Se villa, SADAI, Noviembre. Committee on Payment and Settlement System – The World Bank (2006), General principle for international remittance services, Consultative report, Bank for International Settlements-The World Bank, March. 23 This can happen in Italy, where in some cases there has been a mismatch between “commercial” communication or, more precisely image promotion, with some banking service packages being praised at conferences and debates and in the press, and comparable attention by the sales force at counter level. In many cases there has been a total lack of provision of information material at counters or the product is not even mentioned by staff.


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IMF (2005), Two Current Issues Facing Developing Countries, in “World Economic Outlook”, Cap. II, Avril 2005. Massey et al. (1993), Theories of international migration: A review and appraisal, in “Population & Development Review”. OECD (2006), International Migration Outlook, Sopemi, OECD Publishing. OECD (2005), Migration, Remittances and Development, OECD Publishing. Orozco M. (2005), Remittances, Competition, and Financial Intermediation for Unbanked Migrants, Paper presented before the Taskforce on Remittances and Development in the Inter-American Dialogue, September, 20th. Orozco M. and E. Hamilton (2005), Remittances and MFI Intermediation: issues and lessons, July. Pilley C. (2003), Immigrants and Financial Services: Literacy, Difficult of Access, Needs and Solutions. The UK Experience, IFF-FGDA, paper prepared for the research project, European Commission-General Directorate Employment and Social Affairs. Sergi N. and F. Carchedi (1991), L’immigrazione straniera in Italia. Il tempo dell’integrazione, ISCOS, Edizioni il Lavoro, Roma 1991. Solimano A. (2003), Workers Remittances to the Andean Region: Mechanisms, Costs And Development Impact, CEPAL. Schoorl J. (1995), Determinants of international migration: Theoretical approaches and implications for survey research, in R. van der Erf & L. Hgs (Eds), Causes of International Migration, NIDI. Rapoport H. and F. Docquier (2005), The Economics of Migrants’ Remittances, ISA, Discussion Paper Series, DP n° 1531, March.

11 Conclusions

Benoît Jolivet The financial and banking world is moving so fast that new real changes – sometimes with contradictory aspects – are appearing every day. These changes are all the more important since finance has an impact on economic activities at the same time as social relationships are increasingly being “financialised”. Together, the interplay of these factors generates a new landscape. Techniques and products in the financial world – markets, sectors, networks, and intermediaries – are increasingly sophisticated, and the development of hedge funds is just one example. There is a growing concentration of players, with fewer and fewer of them maintaining fierce competition with each other in each mature market. At the same time, there is increasing evidence of the development of a two-speed system: one for the more educated and one for those left behind, and frequently to be found on the margins of exclusion. An added element of this emerging landscape, though still relatively minor for retail banking, is the importance of cross-border or international financial relations. For these reasons, it is of crucial importance to understand the main characteristics and long term implications for economic and social life of all these changes, and to try to influence them in the most desirable way and by injecting a dose of idealism if necessary. For example, behind an appearance of saturated markets with banking penetration rates close to 100%, evolution towards “new frontiers” of activity is probably the most relevant feature in the medium term. The main “drivers” behind these new frontiers are extremely diversified in their range and their importance. The main one is probably changes due to ICT; for instance, we can be confident that a significant proportion of loans will be delivered through mobile phone technology within 5 years. Another driver is the ageing of the population, with many implications for savings and pensions products. The impact will be strongly influenced by societal changes:

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for the educated section of the population, it is clear that the new world of information, especially through the internet, will be a total revolution. For example, the boundaries of the industry will inevitably be redefined by the ability of individuals to have instantaneous access to all the possible data – without having resort to an intermediary; the organisation of the banking industry around the present principles of selection, segmentation, choosing (and therefore excluding) individual customers and companies using statistical techniques such as “scoring”, may become superseded as exclusion is increasingly replaced by a common interest in encouraging inclusion.

For me, one of the most important features of all these fascinating studies by distinguished and experienced academics is contained in their visions of the factors that are going to change the world. For example, I completely share the views expressed here that the most important change we are going to find is the emergence of new markets and products dedicated and tailored to answer new needs in today’s untapped markets. The idea that these developments will not automatically be driven by the intervention of the State or public institutions – except as facilitators – but rather by new elements of demand and supply, such as those addressing low income categories, younger people, new consumers in the recent EC member states, migrants and refugees, is also quite new. The exploration, in some of these studies, of alternative solutions offered to today’s unbanked or underbanked by mainstream or niche providers, opens up new areas for consideration based on the belief that these new solutions will build up additional wealth for consumers and producers. The overall welfare gain arising from the non-exclusion of consumers analysed by the different studies is certainly of great interest for the future. I hope that other studies will apply a similar perspective to other “vulnerable” categories such as disabled or ill people. To maximise the impact of new initiatives, other innovative aspects should also be taken into account. These include: -

-

a quality approach to new products rather than the lowest price-only approach. The emerging new needs also require to be clearly and deeply understood; the effective functioning of the sub-prime markets according to solvency criteria and the influence of external factors, such as regulation, usury rules, the impact of the credit reporting systems;

11 Conclusions

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complementing the phenomenon of growing over-indebtedness, already studied in this volume; the absolute necessity of improved financial education. The complexity of the subject (as can be seen from the different educational concepts, numeracy requirements, lack of clear information, misunderstanding and mis-use of the financial system etc) could be tackled by new academic studies looking at the collective benefits arising from this process (as already the case for computers and the Internet). The alternative is a heightened risk of ever-deeper exclusion; the role of the general interest approach as opposed, for example, to the exclusive insistence on shareholder value; the need for impartial advice, as opposed to a marketing-only approach, especially for those products aimed at this market. This is certainly a key to developing a good fit between the social demand and the products offered; new studies on the role of different financial risk concepts: for example, it may seem that nowadays the financial risk of banks has been substantially reduced, including the systemic risk, but at the cost of transferring those risks to other economic agents, in particular to end-users. They should look at what is considered acceptable in this area.

All these new studies and approaches converge – at least in Europe and in the US – despite major diversity in the various experiments. One conclusion might be that it would be premature and unwise to move to over-regulation. Another conclusion could be that it is essential for academics and practitioners to deploy the investigative tools at their disposal to identify the long term trends that are reshaping our financial and economic world. With this in mind, one of the most practical contributions we can bring to the present debate is to highlight and evaluate what we consider to be social and technical benchmark practices, applying them to other situations where appropriate.

Editors and Contributing Authors

Luisa Anderloni

Professor of Financial Intermediaries and Markets at Milan State University

Maria Debora Braga

Associate Professor of Financial Intermediaries and Markets at University of Valle d’Aosta - Université de la Vallée d'Aoste

Emanuele Maria Carluccio

Professor of Financial Intermediaries and Markets at University of Valle d’Aosta Université de la Vallée d'Aoste

Eliana Angelini

Researcher of Financial Markets and Intermediaries at University of Pescara – Chieti

Michael S. Barr

Professor of Law at the University of Michigan Law School

Natalia Bresler

PhD student at the University of Bayreuth


Researcher in Economics at the University of Lyon 2

Ingrid Größl

Professor of Economics at the University of Hamburg

Benoît Jolivet

Banking Ombudsman – France

Ewa Miklaszewska

Associate Professor at the Economic University of Kraków

Philip Molyneux

Professor of Banking and Finance at the University of Wales, Bangor

Laura Nieri

Associate Professor of Financial Markets and Intermediaries at the University of Pescara – Chieti

Anke Turner

PhD student at the University of Hamburg

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