Precautionary wealth of rural households: Is it better to hold it at the barn or at the bank?

1
Precautionary wealth of rural households Is it
better to hold it at the barn or at the bank?

• Franz Gomez-Soto
• Claudio Gonzalez-Vega
• International Conference on Rural Finance
• Food and Agricultural Organization
• March 20th, 2007

2
Motivation

• Precious little is known on how the rural poor
  use money and other financial instruments. More
  work is needed so that adequate savings
  instrument can be provided.
• Fafchamps, 2003

3
How do rural households cope with risk?
Shock
t-1
t1
t

• Ex-ante (Income smoothing)
• Diversification
• Crops, plots
• Farm and off-farm
• Production choices
• Low return, low variability
• Strategic migration

• Ex-post (Consumption smoothing)
• Temporary changes in labor supply
• Child labor
• Transfers
• Extended family
• The use of Precautionary Wealth (PW)

4
Assets held as Precautionary Wealth (PW)

• Livestock
• Bullocks
• Stocks of grain
• Land
• Durable goods
• Jewelry
• Cash

• 1. What is the problem with them?
• High covariance with income!
• 2. Why not deposits?
• More liquid and presumably safer
• But High transaction costs !
• 3. Do deposits break the covariance problem?
• It depends
• Large, more diversified, regulated institutions
• Small, local, less diversified, unregulated
  institutions

5
Research Questions

• 1. Does increased access to deposit facilities
  affect the level and composition of PW held by
  rural households?
• 2. Do changes in the level and/or composition
  of PW affect rural households capacity to
  smooth consumption against income shocks?

6
Effects of increased access to deposit
facilities on PW

• 1. Composition (positive)
• PW Portfolio composition effect (positive)
• Level (ambiguous)
• Strategy substitution effect (positive)
• Melting effect (negative)
• 2. Protection is less costly ? More protection

7
Method

• Dynamic Stochastic Model
• Insights from a Two Period Model.
• PW can be held as
• Case I Only livestock (risky asset)
• Case II Livestock (risky asset), and Deposits
  (risk-free asset), with transaction costs
  attached

8
Main Results

• The model shows that rural households have a high
  willingness to pay to have access to deposits in
  a bank as a means for holding PW
• If transaction costs are not prohibitively high
• Households, in the model, always hold at least
  half of their PW in the form of deposits.
• Households welfare is greater when PW is
  diversified by adding deposits.

9
Policy Implications

• Poor rural households do accumulate PW !
• They are willing to incur in high transaction
  costs in order to hold deposits as major
  component of their PW.
• Reducing depositor transaction costs in the rural
  areas may be welfare improving.
• Micro Rural households are able to smooth their
  consumption better
• Macro More efficient use of resources

10
Questions for Policymakers and Practitioners

• What kinds of innovations are being successful in
  reducing the transaction costs of depositors?
• What kind of regulatory framework would be most
  appropriate for the expansion of deposit
  facilities in poor rural areas? 
• How could the expansion of credit and insurance
  services complement the availability of
  deposit-taking instruments to facilitate
  household management of risk?