The Importance of distinguishing between Savings and Deposits in microfinance

Peter van Dijk

By Peter van Dijk,

Microfinance Focus , May 05, 2010 : As with many financial terms “Savings” and “Deposits” are often mixed and inappropriately used by all kinds of Microfinance practitioners; public authorities, donors, aid agencies, experts, MFI managers and even by financial authorities. In this article I want to explain why a correct use of these terms is important for achieving the objectives of Microfinance.

When I first worked in Africa, in June 1995, when representing the World Savings Banks Institute (WSBI), a central bank authority and a youth representative tried to convince me that in Africa most people are too poor to save. This immediately and since then always makes my neck hair stand up in frustrating unbelief. For me it was always evident that especially poor people need to save; they should avoid “living from hand to mouth”. Poor people regularly face many of life’s worse challenges at the same time: the sickness of a child, too many children and large families, problems with giving birth, accidents, criminality and violence. At the same time the poor live in instability, insecurity, often despair of work and income. But they obviously have the same needs and objectives as non-poor, “normal people” have: health, education, shelter, food, hygienic water, clothing, child care, old people’s care, safety, transport, stability, to be able to organise their lives and that of their loved ones. This means obviously that they need to be more careful with the little money they depend on for day-to-day life; that they need to plan more and manage better their finance than non-poor people have to.

Since the new millennium more and more Microfinance organisations and specialists have researched the actual financial behaviour of low-income households, poor citizens and micro-enterprises, concluding that they all do indeed save, but they do not call it that. In a study done in South Africa during my work there, Cape Town University published in 2005 a study based on long-term findings and interviews called “Financial Diaries of the Poor”. Recently similar studies have been done in several countries. The studies found that many poor people often have a dozen or so different ways by which they set aside money for different purposes: many participate in savings and credit groups, others participate in accumulating savings groups for specific future events such as weddings or funerals, others set aside money for school fees or plant crops which they can sell around the time the fees are due, and again others buy and collect bricks to prepare for building a house. In some countries I found that staff, even on management level, of commercial banks and even of central banks do not have a bank account, and in some countries informal savings groups mobilised member contributions that together represented more money than fixed term deposits in a large bank put together.

But these informal or semi-formal ways of setting aside money have drawbacks that frustrate the specific financial planning by the poor and that even undermine building inclusive financial sectors. Firstly, as I explained in general terms, cash money (or other easily liquidating valuables) is always at risk in an informal, unstable, insecure, poor environment. There are no controls, no legal address when money goes missing, no real insurance, no regular security control, no safe transport, in an environment where many people need money urgently for life’s basic needs, all the time. Again, it is my experience that there where there is an opportunity for poor people to steal money and get away with it, they will, despite a highly religious culture. Secondly, when people’s excess liquidity is not collected by financial professionals, by bankers, such bankers cannot invest these funds in economic growth or lend it to people for consumption smoothening or for urgencies as a part of their daily work, their profession. In a publicly regulated manner, and possibly with effective supervision (added in the aftermath of the USA sub-prime lending crisis), banks and other financiers have a key role in supporting asset growth, economic growth, job creation (sustainable business creation and growth) and they help households to better manage their money. And thirdly, when poor people do not save for a specific purpose with financial professionals, they will never structurally improve their money management skills and they will not earn interests on the money they agreed on to set aside with a banking organisation whilst normal “deposits” might cost time and money.

It is at this point where I would like to explain the basic legal difference between “Savings” and “Deposits”. Depositing money means what it says: a person just puts money somewhere, which s/he can do for different purposes. In a bank it can mean putting money on a current (checking) account, to make a payment, to make a transfer or to put it on a fixed term and specific purpose account. The latter can be an investment account, an insurance product or a savings account. All these different products and services have different legal conditions, terms and prices. In particular, the depositors must pay for most of these deposits. In the case of Savings products, the interest of the banker to attract specific, stable, long-term, predictable deposits from a massive number of ordinary clients shifts the economic accent in favour of the client. That is why banks offer an interest rate to specific depositors/ savers and waiver costs they often charge customers. When a client agrees to have a specific savings account, with a minimum deposit, with conditions on withdrawals, with an agreed (fixed) term, and sometimes for a future specific service which can also be a loan (as for mortgages for instance, or for pension or education), the bank ensures paying a specific interest rate each year to the saver. Such savings are the backbone of retail banking in modern societies; public deposits are the most reliable, stable, and cheapest funds on any (developed and underdeveloped) financial market in the world.

Then many will riposte that collecting excess liquidity from poor people, in the areas they live and when managing many small sums of money, is costly, not cheap. There are indeed challenges, often due to underdeveloped infrastructure, education, transport, management and education, but experience in most countries play evidence that these challenges can successfully be met in order to continue arguing that public deposits, also from poor people are indeed the cheapest and most reliable for a bank. Since the 1960ies, development finance institutions help countries with massive poverty to overcome such challenges, with heavy priorities on infrastructure development, transport and education. Ignoring these basic facts is the cause for many debates that go on and on, run in circles, pop up again and again, on how to get interest rates down for MFIs that focus on credit.  Such organisations “buy” their money from government, aid agencies, donors, NGOs etceteras who, all of them raise concerns about the sustainability of the lending programs, of the services for the poor people they set out to help. This dependency is not cheap and this strategy literally blocks a mutual long-term process to evolve between communities and “their” bank around trust and business. In such a customer relationship interest rates setting can become optimal for both parties. MFIs and their supporters are wasting time and other resources when they themselves try to overcome physical, non financial, challenges they are not responsible for. They should mobilise attention and further support that government authorities, where possible in collaboration with local businesses, resolve those challenges and be accountable for resolutions and for failures. MFIs need to be part of the communities, rich and poor, public and private, they aim to help in a structural, sustainable manner. MFIs should not be part of a separate social safety net. Such social safety net is indeed also necessary but that is not the job of an institution that aspires to undertake finance as a business and who considers also poor people as part of their business.

If poor people are part of business and of the entire community they live in, then they also have the right to effective protection. This is what regulated MFIs give them and this is what savings contracts give them, on the condition of course that MFIs again work effectively with public authorities to solve all challenges so that also poor consumers who, when successful, become less and non-poor in the future, have effective access to rights and protection. Every reader easily comprehends and appreciates that such a process means that both parties, MFI and client, need to precisely understand products, contracts and their consequences and processes. This is an ongoing process also in the world’s wealthiest and most inclusive countries. Consumer protection is relatively new everywhere and demands high investments from public authorities, involvement of civil society, technical support by academics, regular public debates, and in fact the concrete commitment to let every voice be heard, which is really what democracy is all about, by any standard and in any culture. And this thus also means that the terms “deposits” and “savings” need to be clearly distinguished, understood and applied by all stakeholders in Microfinance.

It is I think important to finally add that religious opinions do not need to oppose the objective of developing deposit and savings products for poor people and MFIs. All major religions have their roots before money and banking became necessary for the functioning and advancement of society. Often they condemned “making money with money” and put such people in a vulnerable position (nevertheless close to state and religious leaders to be of assistance in case of need). Jews, Christians and Muslims prohibited “fixed term interest” for a long time to their “own” people but what they in fact wanted to fight is the same as is now the case, namely abusive practices. In fact the English term “Usury” comes from the Latin word “Usura” that exactly means “(fixed) interest (rate)”. Since the end of the seventeenth century governments in Christian cultures transformed the “fixed interest rate” prohibition in effective and detailed Usury Laws to combat abusive practices. The current interest in “Islamic Banking” where most promoters state that Islam prohibits “fixed interest rates” do not find arguments either in the holy Qu’ran or in the Hadith (narrative of the words and deeds of the prophet Mohamed, MBUH). The Arabic term “Riba” seems to mean more like the modern interpretation of the English word “usury” as explained above. The third caliph Usman (who had the Qu’ran written down for the first time) stated that it is unclear what the prophet meant in verse 2:275, expressed just before his passing on, where God allows trade but forbids “Riba”. Some say that the Sharia (Islamic law, which interpretation varies depending on schools of thought) clearly states that “Riba al Nasiah” – interest on giving a loan and (just) “waiting” for repayment is forbidden. That clearly ignores inflation, competition of different investment opportunities at different risk levels and the fact that financial intermediation has become one of the most important economic professions that justifies remuneration as all work does. As the term is mentioned in the same sentence as “Trade” it might justify an interpretation in the line of “Riba af Fadl” – where an exploitative increase in the price of trade is forbidden. Such an interpretation would certainly agree with some of the Hadith. Consequently, Islamic Banking should in my view not be isolated from the universe of global banking and be limited to sharing profits made on risk- and asset sharing. The crisis made clear the risks of betting on real estate (such as in Dubai) and on the cash-flows that such real estate may create; that looks to me as being very similar to greedy speculation as is done in other parts of the world.

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About the Author

Peter van Dijk, Microfinance Consultant| Indonesia

Peter van Dijk is a lawyer by training who entered the financial sector in January 1994 working for five years with the World Savings Banks Institute responsible for promoting the interests of savings banks in Africa and Asia. Mr. van Dijk worked from 2000 to end 2002 with the Central Bank and the Finance Ministry in Uganda on one of the world’s first laws that supported the integration of Microfinance Institutions into the banking sector. From January 2003 to end 2004 he worked with the International Monetary Fund (IMF) in developing a Microfinance Policy and in its West African Technical Assistance Centre West Afritac, he advised 10 Francophone countries on Microfinance policy development, regulation and supervision. End 2004 Peter moved to South Africa on the invitation of its Microfinance regulator to provide advice and he undertook the first study on Financial Services for Poor Households on behalf of the Finance Ministry. In South Africa he was also a member of the organizing committee of the African Microfinance Conference in Cape Town end August 2005 and during that year he advised the United Nations on its “Year of Microcredit, Building Inclusive Financial Sectors”. Since January 2006, Peter is an independent consultant in Microfinance and Financial Sector Development and he has undertaken technical assistance projects in several African and Asian countries. In recent projects, he worked with several central banks (Cambodia, Laos, Madagascar, Nigeria, and Pakistan) on reviewing policies, regulations and on strengthening the capacities of Microfinance regulators, managers and trainers. He provided training on Legal Issues in Microfinance with the International Development Law Organisation (IDLO) and with the Frankfurt Bankakademie. Last year he published an article on Public Policy Issues to make Financial Sector Cooperatives Work.

Send your comments to the Author : petrusvandijk@yahoo.com

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