Building Financial Resilience: Do Credit and Finance Schemes Serve or Impoverish Vulnerable People?

© The Author(s) 2018

Jerry BucklandBuilding Financial Resiliencehttps://doi.org/10.1007/978-3-319-72419-5_1

1. Introduction

Jerry Buckland¹ 

(1)

International Development Studies, Menno Simons College, Canadian Mennonite University, & University of Winnipeg affiliate, Winnipeg, MB, Canada

This book examines if credit and finance schemes that span the globe such as microcredit, payday lending, and financial literacy education build financial resilience of vulnerable people. By building financial resilience is meant improving and making more durable an individual’s and community’s income and assets. By vulnerable people is meant people who struggle with material and/or psycho-social poverty so that a temporary or permanent decline in their income and/or assets would have disastrous consequences.

Microcredit is a product (and possibly a movement) associated with development and non-profit agents largely based in the Global South. It has been highly praised in much of the literature and is popular among practitioners and in society more broadly. There are detractors among those who have carefully examined its impact, but they are in the minority. Payday lending, on the other hand, is a commercial product that is common in Anglo-American nations and increasingly in other parts of the world such as Eastern Europe and South Africa. It has been widely criticized, and yet where it operates it attracts a strong and loyal (some say this is based on creating a dependency) following. Financial literacy education, also more common in the Global North, comes in many forms and through many organizations and is premised on the idea that increasing consumers’ knowledge will protect and empower them.

The stories associated with microcredit tend to play up the borrowers who use the loan in a way that boosts their resilience through higher and more durable income which then enables them to repay the loan, a kind of virtuous cycle. Muhammad Yunus’s story of his first loan is an exemplar of this. As he was investigating the micro-economy of poor people in Chittagong District in Bangladesh , he met a basket weaver who had to take out a loan from a money lender at a very high interest rate, perhaps over 100%, in order to purchase the inputs to weave the baskets. He found that by providing her a lower interest rate loan she was able to increase her profits and improve her livelihood. But there are also the bad news microcredit stories in which borrowers are unable to make a good investment and end up being unable to repay their loan, sometimes needing to sell off assets to repay it.

However the bad news stories tend to be more commonly associated with payday lending. One payday loan client I recently met in a focus group discussion about payday lending noted that he regularly got into a debt cycle with payday loans. In his most extreme case he reported that he had ten payday loans simultaneously and was unable to pay them off. He eventually required his spouse to take out loans in order to pay his off. This family’s finances are becoming less resilient and payday loans seem to be part of the reason why. Less commonly do we hear the good stories about payday loans. In the same focus group discussion another person used payday loans, just occasionally, and to pay for unexpected expenses, in order to not draw down her savings. The payday loan created the external discipline to pay it off without requiring her to reduce her savings. The other types of financial programs that will be discussed in this book—asset building, cash transfers, financial literacy—all have similar good and bad news stories but they tend to get less media interest. But these stories give a sense of the types of challenges and opportunities that financial products present people.

The book focuses its analysis on a set of common credit and finance schemes. Microfinance, mobile phone-based banking, and financial inclusion are examples of these in the Global South , and asset-building and financial literacy programs are examples from the Global North. It is assumed that underlying the expansion of these schemes is the process of financialization, often defined as the rising influence of financial motives and growth of financial services in society. Financialization is a deep and challenging process that affects many aspects of modern life and is closely tied to neoliberal policies that promote markets and new technologies to foster change that affects us all at a deep socio-cultural level. Financialization has become intertwined in complex ways with development actions. This book considers how these credit and finance schemes affect the poor and vulnerable—people who experience poverty in one or more of its complex manifestations, including material poverty (a gap between material needs and their being met) and psycho-social poverty (gaps in esteem and control).

A note on terminology: financialization refers to the increase of finances in daily life, through the expanding availability of financial products and the growing demand for them. Financial exclusion refers to the situation faced by persons who have insufficient access to mainstream—that is, banks—financial services. Sometimes this is broken down into categories of complete financial exclusion, being unbanked or being under-banked, having insufficient bank financial services. In either case—whether un- or under-banked—the consequence is that the person is reliant on alternative sources for financial services, such as informal providers or fringe banks. Informal providers include corner stores that might cash one’s cheque or a family member who might loan one some cash. Fringe banks are semi-formal operations set up to provide financial services such as pawnshops and payday lenders. Financial inclusion is the process whereby financially excluded people become integrated into the mainstream banking system for all of their financial service needs.

General Approach

This book draws on and extends popular finance theory (Aitken 2007; van der Zwam 2014) and examines the literature, discussed below, and in the cases of payday lending and mobile banking draws on primary research, on a variety of credit and finance schemes from around the world to learn how they affect the financial resilience of vulnerable people. Since we rely heavily on academic and policy literature, rather than primary data, we depend on the indicators (e.g., of financial resilience) used in these studies. An ideal indicator, but one that is not always available, is whether and to what extent vulnerable people themselves value the change. Everyday financialization is an important lens to assess credit and finance schemes because it focuses on the vulnerabilities of ordinary people, people who only recently have been brought into the financial world. But this lens is inadequate to assess finance and credit schemes of vulnerable people because it does not provide a framework to assess the impact on human well-being. What is needed for this is a theory of human well-being, and for this purpose we draw on the work by Goulet (1995) and human capabilities of Sen (1999) and Nussbaum (2006). Financialization proponents might argue that more (money, credit, income, etc.) is better, but scholars of human well-being understand that financialization is only a means but that the end is human improvement. Credit and finance schemes need to be assessed within that lens.

This book argues that finance and credit schemes can help vulnerable people in a limited capacity if they are carefully constructed, but they can also not help and sometimes harm people. This is because, by definition, vulnerable people have limitations and weaknesses that finance and credit providers may be ignorant and/or disinterested in. Moreover, without a clear understanding of the relationship between finances and human well-being, these schemes may not achieve valued outcomes.

Primary research has been completed by the author and colleagues on microcredit, payday lending, and mobile banking over the past several years, and results are published elsewhere. The relevant literatures on credit and finance schemes are dispersed across different disciplines and approaches, including economics, geography, and sociology. This book brings together elements of these literatures, as each contains insights that are useful to understand the others, and by looking at the forest, one can better understand the individual trees.

The ethical approach taken in this book is that poverty and excessive inequality harm people who are poor and relatively marginalized and this harms wider society. Credit and finance schemes that reduce poverty and inequality add to the common good, while those that increase poverty and inequality undermine it. A critical assumption that guides this analysis is that finances need to be constructed to build financial resilience, not the other way around. Financial services and technologies do not necessarily foster financial resilience, and in fact they can counteract it. That is why the services and technologies need to be designed with the end user in mind, which includes poor people and communities.

This book presents a critical and constructive perspective regarding these credit and finance schemes. It critiques the changes associated with this process while at the same time not idealizing past development practices or socio-economic realities. As a critical analysis, it endeavors to cast particular light on the problematic consequences for poor and marginalized people. In addition, where possible, the analysis identifies and explores constructive responses to these problems.

In terms of political-economic theory, the book is rooted in a reform market approach. That is to say, given that markets are currently the most prominent way to organize the economy but often fail to deliver on important human outcomes, a strong state and civil society response is needed. State and social actors’ roles are critical to ensure that adequate market regulations are in place and enforced and that community needs are identified and planned for.

Because credit and finance schemes directed at vulnerable people are now a global phenomenon, this book examines them from a global perspective. This process has become intertwined in complex ways with development actions in what is known as the Global South—a rich and varied grouping of relatively poorer and geographically more southern nations of Africa, Asia, Latin America, and the Middle East. Here these schemes are manifested through activities such as microfinance, mobile phone-based banking, and financial literacy education. The book also takes into account the Global North—a relatively smaller and richer set of nations in Europe, part of North America, Japan, Australia, New Zealand, and most recently a diversity of other countries (e.g., South Korea, Singapore, the Gulf States). Here, prominent schemes include asset-building programs and financial literacy programs. The grouping of countries into Global South and North offers some assistance in our understanding, but it also blurs important changes such as the meteoric rise of China and India, to name two particularly important nations, in economic and banking terms.

Even though there are important similarities between finance schemes in the Global South and North, the contexts vary substantially between and within the Global South and North, so that outcomes vary. The rise of microcredit and mobile banking in the Global South, as compared with the Global North, is partly explained by the relative lack of formal financial infrastructure, so that lower-cost institutions (like microfinancial institutions) and technologies (like mobile phones) are more rapidly embraced in the South as compared with the North. Microcredit is often upheld as a powerful development approach in the Global South, whereas payday loans are generally vilified in the Global North. These are very different products with respect to duration and fees but have enough similarities to make it surprising that popular perception is so different. The rise of payday lending presents a parallel situation (to microcredit’s rise in the South) in the North, but its rise relates to infrastructure gaps for certain groups within countries rather than for an entire country. Payday lending and other fringe banks have met an infrastructure gap for poor people in the North, but they have done so by charging high fees.

Actors Engaged in Credit and Finance Schemes

This book is organized by the key actors involved in credit and finance schemes, starting with an introduction to financialization and financial inclusion (Chap. 2) and then examining the commercial banking sector (Chap. 3), the consumer and finances (Chap. 4), civil society and banking (Chap. 5), and the state and financial inclusion (Chap. 6). The interconnections between these topics are depicted in Fig. 1.1. Chapter 3 looks at the commercial sector’s role in credit and finance schemes by considering its history and the range of actors and products commonly available to poor consumers. Of particular interest in this chapter is payday lending and mobile banking. Chapter 4 examines studies of consumer behavior with respect to finances. Chapter 5 focuses on social sector engagement with credit and finance schemes and considers microcredit, cash transfers, asset building, and non-formal financial education. Chapter 6 examines state programs and regulations that directly relate to financial inclusion, such as postal banking and formal financial education.

Fig. 1.1

Financialization flowing from different sectors

Some of these programs straddle more than one sector. For instance, commercialized microcredit flows from both the social and commercial sectors. Conditional cash transfers involve the state and the social sectors. Semi-commercial microcredit, asset building, and financial education straddle the state, the commercial, and the social sectors.

The credit and finance schemes considered in this book, by definition, draw vulnerable people into financial services. This is the process of financial inclusion. But financial inclusion is born out of the problem of financial exclusion, which is the situation in which a person is unable or unwilling to access financial services from a formal sector financial institution like a bank. The consequence is that person likely spends more on informal financial services that are often of lower quality than the formal sector alternative.

There are a variety of ways to think about financial exclusion. Buckland (2012) mapped different theories onto a two-dimensional space, with one axis representing competing assumptions about human rationality and the other axis representing competing assumptions about the role of institutions. Some theories (e.g., neoclassical economics) assume that humans are rational and operate within frictionless markets, so that institutions do not play a role in how society operates. Behavioral economics is silent about institutions—this point is discussed in Chap. 5—but assumes humans are bounded (limited) in their rationality. There are a number of more institutionally oriented theories (e.g., institutional theory of savings) that assume that institutions matter and that humans have bounded rationality. Finally there are theories that embrace human rationality but find that institutions also matter (e.g., post-Keynesian theory).

Responses to financial exclusion can be similarly mapped onto the human rationality –institution space by activating the variable and adding the adverb more: that is, more rational humans, more effective structures, and so on (Fig. 1.2). Common types of responses to financial exclusion include more and/or different government regulation, government nudging, corporate social responsibility, and citizen financial literacy. The first two—government regulation and nudging—are both a form of regulation but coming from different starting points. Traditional government regulation is premised on the idea that citizens are rational but not necessarily fully informed and/or markets are not frictionless. Placing a cap on chargeable interest rates or requiring lenders to use fair fee disclosure is a regulation flowing from this analysis. However, if people are bounded in their rationality, then interest rate caps and disclosure requirements may not be sufficient. Imperfectly competitive firms may not compete on price, and the cap may lead all remaining firms to raise their fees to the cap. Disclosure requirements such as the annual percentage rate (APR) may simply be ignored by customers. Thus work on behavioral economics, such as Thaler and Sunstein’s (2008) Nudge, calls for the government to put in place programs that encourage people to make the best decision.

Fig. 1.2

Responding to financial exclusion

It is relatively easy to categorize different theories within the rationality–institution space but more difficult to synthesize a fully accurate theory. Each theory has its strengths and weaknesses. Neoclassical economics offers theoretical simplicity and elegance but this limits its ability to model the full complexity of the social world.¹ Behavioral economics opens up the simplifying human rationality assumption but fails to address the limiting assumptions in neoclassical theory regarding institutions. Institutionally based theories like institutional savings and post-Keynesian approaches offer insights about the impact of institutions but are sometimes so complex that it is difficult to determine recommendations for policy and practice.

Bibliography

Aitken, Rob. 2007. Performing Capital. 1st ed. New York: Palgrave Macmillan.

Buckland, Jerry. 2012. Hard Choices: Financial Exclusion, Fringe Banks, and Poverty in Urban Canada. Toronto: University of Toronto Press.

Goulet, Denis. 1995. Development Ethics. 1st Publ. ed. New York: Apex Press.

Nussbaum, Martha C. 2006. Frontiers of Justice: Disability, Nationality, Species Membership. Boston: Harvard University Press.

Sen, Amartya. 1999. Development as Freedom. New York: Alfred A. Knopf Inc.

Thaler, Richard H., and Cass R. Sunstein. 2008. Nudge: Improving Decisions about Health, Wealth, and Happiness. New Haven and London: Yale University Press.

van der Zwan, Natascha. 2014. Making Sense of Financialization. Socio-Economic Review12 (1): 99–129.

Footnotes

1

Neoclassical economic theory was formed in the late nineteenth century by various people including Alfred Marshall, Stanley Jevons, and Léon Walras and rooted in the eighteenth-century work of classical political economists such as Adam Smith, David Ricardo, and Robert Thomas Malthus. One might argue that the classical political economy school was broader in scope than later neoclassical theory, perhaps the classical approach—to use a contemporary term—was almost interdisciplinary in nature. Classical political economy took a broad-brush theoretical approach and studied how countries grew economically (e.g., through economic specialization or international trade) and how they declined (e.g., through unregulated population growth). By contrast, the neoclassical school narrowed the scope of study to more particular issues, today referred to as the efficient allocation of scarce resources. Basically neoclassical thought shifted the focus to how markets could be structured so that buyers and sellers mutually benefit and that resources—land, labor, and capital—are used efficiently. The shift from classical to neoclassical thought moved the analysis from factors explaining the rise and fall of nations to examining the relationship between suppliers and buyers in markets. This also meant a methodological shift from broad analysis to a focused model-based analysis. The scope of neoclassical analysis is quite sharp, examining the allocation of resources such as labor, land, and capital. This is generally done by creating models of suppliers and demanders using mathematical equations, determining the equilibrium conditions, and then testing the model using relevant data via econometric analysis.

© The Author(s) 2018

Jerry BucklandBuilding Financial Resiliencehttps://doi.org/10.1007/978-3-319-72419-5_2

2. Financial Inclusion and Building Financial Resilience

Jerry Buckland¹ 

(1)

International Development Studies, Menno Simons College, Canadian Mennonite University, & University of Winnipeg affiliate, Winnipeg, MB, Canada

This chapter opens with a discussion of the 2007 subprime mortgage crisis, as an extreme example of financial change gone awry. This leads into a general discussion of financialization which was introduced in Chap. 1 and analyzed more fully in this chapter. The discussion then moves to the popular concept of financial inclusion which is followed by a discussion on the evidence for the expansion of financialization and financial inclusion. Since the book examines the impact of credit and finance schemes on vulnerable people, the chapter then moves into a discussion of the relationship between poverty and financial inclusion. Finally, anticipating Chap. 3’s focus on commercial banking, the chapter presents a brief history of money and banking and identifies how major actors’ roles have changed in the last century.

One of the most severe financial crises in recent times was the US-based subprime financial crisis of 2007 through 2010. In the period leading up to the crisis, financial markets in the United States and elsewhere had been deregulated and new financial products were being created. This process was encouraged by neoliberal policymakers, who believe that markets are largely self-governing and that markets and innovation are the root of economic growth. The crisis was linked with two types of financial devices: asset-based securities and subprime mortgages. These products were designed and primarily implemented in the United States; however, the asset-backed securities became popular with banks and governments across the Global North. Asset-backed securities were bundled assets sold to investors. The troublesome versions of these securities were bundled with subprime mortgages. Subprime mortgages were mortgages that were designed to bring into the mortgage market non-traditional home owners, but these mortgages had problematic features, such as teaser interest rates. These were starter rates that were close to the prime lending rate but would, after a short period of time, automatically rise. This would raise the cost of servicing one’s debt, particularly problematic for many modest income Americans.

Problems occurred when housing prices stopped rising or started to decline and when the teaser interest rate period ended so that mortgage interest rates on the subprime mortgages jumped. This made servicing the mortgages by many mortgage holders unsustainable and might actually drop the value of the house so that it is lower than the value of the mortgage. Many subprime mortgage holders lost their homes. The value of the subprime mortgages in the securities dropped as did the value of the securities. So that security holders found that the value of their assets declined. In some extreme cases this led to bankruptcy. Security holders were found across the Global North so that indirect effect of the subprime mortgage crisis went global. Moreover, as an engine of the global economy, when the United States economy went into recession, this dampened its trade and investment with the rest of the world. The consequence of the crisis was a major global recession. Remarking on the outcome, George Soros noted:

The human suffering caused by the housing crisis will be enormous. There is significant evidence that senior citizens are disproportionally defaulting on their mortgages. Communities of color are also disproportionately affected. Given that home ownership is a key factor in increasing wealth and opportunity in the United States. Upwardly mobile young professional of color will be particularly hard hit. (Soros 2009, p. 149)

This is an extreme case in which financial innovation did not build the common good and, in fact, did the opposite and caused considerable harm. And the global capitalist system is vulnerable to financial crises like the Great Depression of the 1930s.¹ Subprime mortgage holders, their neighbors, their communities, businesses, workers, and governments in the United States and around the world were harmed by the misapplication of these devices in relatively unregulated financial markets. This is not to say that financial innovation cannot improve the common good. Financial devices are powerful and their relationship to human well-being or development is multifaceted. Undergirding the drivers of the subprime financial crisis is the process of financialization, introduced in Chap. 1, discussed further now.

Financialization

Views about Financialization and the Financialization of the Everyday

Academics and popular thinkers generally agree that economies of the Global North in particular as well as economies around the world are financializing. This means that finances are playing a larger role in virtually all walks of life, from banking through consumption to human motivation. A common definition of financialization, discussed in Chap. 1, is the growing integration of financial motives and the proliferation of financial devices in the socio-economy (Epstein 2005).² Measuring human motivation can be difficult, but there are many indicators regarding the rise of financial devices.

However, academic views about the causes and effects of financialization are mixed. Hudson (2015) provides a helpful rubric to understand the different views in the academy about the relationship between finances and development. He argues that there are four basic views about how finance effects economic development: neoliberal, liberal institutional, critical reformist, and radical (Hudson 2015, p. 49). The neoliberal view, advanced by people such as Milton Friedman and Paul Krueger, finds that money is a commodity that enables the economy to move to equilibrium, a metaphor for the economy finding a state of dynamic health, in that market prices are set so that resources, including labor, are fully employed. The liberal institutionalists including Dani Rodrik and William Easterly argue essentially the same thing—that money and markets lead the economy to a healthy state, but this process requires institutions such as the legal system and a transparent and accountable state to ensure that this process happens, that is, markets are necessary but insufficient. Hudson considers the neoliberal and liberal institutional approaches are orthodox, in the sense that they form the basis for policy making in the Global North and much of the Global South. The market is central and, at most, the state must support the market.

Heterodox approaches include the critical reform and radical approaches. Critical reformist such as Ha-Joon Chang and Robert Wade argue that the market does not on its own or with a few institutions automatically move to equilibrium. This is because uncertainty about markets, including financial markets, can lead them into disequilibrium which is associated with unhealthy outcomes associated with unemployed resources including high level of unemployment. Finally, radicalism, associated with Karl Marx and Andre Gunder Frank , is the view that markets and states in the rich countries and regions systematically exploit poor countries and regions and that finance is one means through which this exploitation takes place.

While Hudson (2015) identifies broad approaches taken with respect to the relationship between finances and development, Van der Zwan (2014) offers a synthesis on theories of financialization that leads her to identify three main types of financialization theories: financialization as a new regime for accumulation, financialization associated with the ascendancy of the shareholder value concept, and the financialization of the everyday. The first approach, advanced by people such as Krippner (2005) and Lapavitsas (2009), argues that finances have become a new and important source of accumulation on the part of finance and non-finance corporations (Van der Zwan 2014). This is because the internationalization of production has led these firms to search for alternative means to accumulate surplus and thus a growing reliance on finance. The shareholder value approach to financialization, embraced by Boyer (2005), shares with the previous approach recognition of the growing reliance of the corporation on finances but it differs in that its focus is on how it affects the corporation internally, particularly focusing on shareholder benefits to managers and employees.

But the approach to financialization probably of greatest interest to this study of credit and finance schemes for vulnerable people is the financialization of the everyday (Van der Zwan 2014; Roy 2010). This approach focuses on the fact that financialization has made possible the extension of financial products to a large part of the population including modest and vulnerable people who were previously by-passed by the process. Roy (2010) argues that everyday-styled financialization, like that associated with Bangladesh-inspired microcredit, democratizes capital and, by extension, human well-being and development.

Theorists such as Aitken (2007) and Montgomerie (2006) argue that the consequences of the deeper reach of finance, including consumer credit, have both material consequences and consequences for the subjective understanding of financialization (Van der Zwan 2014). These analyses focus less on global elites and more on the non-elite everyday consumer of finances and find that they may lack the financial literacy to handle sophisticated and rising financialization (Van der Zwan 2014). Since this study seeks to explore the character and impact of credit and finance schemes on vulnerable people, this approach to financialization offers important insights.

Van der Zwan (2014) argues that the financialization of the everyday has facilitated the decline of the welfare state that previously provided cradle to grave services and has linked vulnerable people with capital markets in order to enable them to protect themselves from life’s uncertainties (Van der Zwan 2014, p. 111). Financialization of the everyday scholars are concerned that this substitution involves risks for vulnerable people as commercial credit and debt are not a perfect substitute for a stream of income from the state.

Causes and Effects of Financialization

Lapavitsas and Powell (2013), drawing on the new regime of accumulation school, enlarge on the expansion of financial devices by identifying three tendencies associated with financialization: (1) the increased engagement by non-financial firms into finances, (2) increasing dependence of banks on lending to individuals and households, and (3) increasing dependence of individuals on financial service providers to make their basic needs, including pensions, housing, education, and health care. Innovation and extension of information technology have enabled finances to reach the everyday level (Van der Zwan 2014). Some additional indicators, correlates, and consequence of financialization noted in the literature include the following:

increasing share of the financial sector of the economy

rise in importance placed on shareholder value

growth of public and private debt

growth in income inequality, and

increased instability of financial markets

The effect of financialization varies around the world and even within relatively homogeneous countries such as countries of the Global North. One study found, based on a series of indicators, that the United States and United Kingdom have been more affected by financialization, Germany and Japan less affected, while France falls between these two groups (Lapavitsas and Powell 2013, pp. 375–76).

When there is a relative balance between the powers of actors involved in a market transaction then there is the scope for a mutually beneficial transaction, that is, synergies or win–win outcomes. This may be more the case when financial service companies are providing services for middle- and upper-income people. However, this book focuses on how certain manifestations of financialization, that is, credit and finance schemes, affects poor people. This is a particularly challenging dynamic because it brings together very large and powerful actors, such as banks, with poor people. This creates a classic development challenge associated with asymmetric power dynamics, in which one group is more powerful, wealthy, and organized than the other. The outcome of this type of relationship is likely to be tilted in the former group’s favor.

What is driving financialization? There are a variety of factors driving financialization including the rise of select institutions such as banks, the liberalization/deregulation of markets, changing information and communications technology, and rising financial motivations on the part of consumers. Markets, financial markets included, have been liberalized through structural adjustment programs (SAPs) in poor countries and through general neoliberal ideology and reforms in rich countries. The subprime mortgage