FINANCIAL SYSTEMS Flashcards
Functions of a financial system
- allows individuals to decouple income and consumption
- so they can smooth consumption even when income is volatile
When can consumption smoothing occur:
- short term (bank accounts)
- long term (savings/credit)
Financial systems in developing countries: CHALLENGES
1) MACROECONOMIC VOLATILITY: fluctuating exchange rates, inflation, political stability
2) WEAK FINANCIAL INSTITUTIONS (Limited access to banking services)
3) WEAK FINANCIAL REGULATION
developing countries: market imperfections:
1) savings contraints
2) credit constraints
Why is savings important?
1) Life cycle consumption smoothing (too old to work)
2) finance lumpy expenditures (school fees, medical fees)
3) build up assets for collateral to obtain collateral / respond to income shocks, risk retention
Limitations to savings:
1) FINANCIAL COSTS: savings accounts offered free of set up costs, no min deposits, no withdrawal costs, demand is hgih. interest rates also affect
2) Financial literacy impacts behaviour
3) SOCIAL CONSTRAINTS: spousal control- women less savings abiltiies. household wealth (kinship network) pressure to share wealth instead of save or invest
Informal savings
way to avoid constraints of fomral saving
Examples of informal savings
1) Buffer stocks
2) ROSCAS
Buffer stock
when income volatile and moentary savings problematic build up assets in the form of buffer stocks to smooth consumption.
purchase asset when income high, sell when low
LIMITATIONS OF BUFFER STOCK
- consumption can decline when it runs out
if assets productive, short term gain but long term loss
ROSCAS
- pool fixed savings amount by each member
- pool of funds allocated on a rotating basis
- at least 1 participant receives pool for any purpose
- form of credit
- enforcement through social sanctions
- provides funds faster than indivual savings
-often used by women avoid pressure from husbands
ADVANTAGES OF ROSCAS
- simple accounting
- dont have to store large amounts of money
DISADVANTAGES OF ROSCAS
- contribution fixed
-pot size fixed
-cant mobilise funds from outside the community
Why is access to credit important?
1) Consumption smoothing- access to credit prevent shocks to income where savings ineffcient. important in dev countries, income irregular
2) Investment: invest in income generating activities, setting up business/buy productive assets
women face barriers to financial reosurces, credit increases financial independence
CHALLENGES OF CREDIT FOR POOR
- info problems, risky projects
- no collateral (lack assets)
- enforcement of repayments (weak financial regulation and institutions)
