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)
RISK AND INSURANCE
Exposure to risk high in LIC esp rural areas
SOURCES OF RISK
1) AGGREGATE SHOCKS: affects all members of community, informal/formal insurance transfers needed from outside, droughts, rain, crop pest, input output price shocks
2) idiosyncratic shocks: affects individuals, insurance within community, crime, theft , job loss, illness
PROBLEMS OF POOR WITHOUT INSURANCE
- Decrease investment
- Households focus on income smoothing activities - reduce mean income- poverty trap
risk sharing
household insure each other by trading across, fpund among small knit gorups, less exploitation
SOCIAL PROTECTION
- Reduce need for savings precautions = increase investment
- decrease detrimental coping strategies ie taking kids out of school or selling producvie assets
issues of social protection:
who to target
solutions to social protection issues:
-SELF TARGETTING PROGRAMMES
PSND: Ethiopia, targets food insecure households, provides cash in exchange for participation in public service worl
MFIs
provide financial resources to those without access
-focuses on small loans for small enterprises
- uses group lending schemes- joint liability, collateral = peer pressure
-repayments increase by dynamic incentives: borrowers eligible for future loans if repaid
The Grameen Bank
-founded in Bangladesh
- joint liability
-weekly public repayment meetings
- increase in loan size conditional on prior repaymmnets
-intensive monitoring and screening by lenders
LIMITATIONS OF MFI
- poor described as reluctant entrepenuers- prefer secure jobs
- first repayment due soon after initial disbursement
- joint liability- investment in safe projects to avoid risk
