One of the most important roles of a financial intermediary is to facilitate consumption transformation, which enables the purchase of goods to be rearranged over time. People and firms need to be able to keep surpluses safely until they are required. Many studies have shown how important saving is, even to the poorest people.
From an institutional point of view, being able to mobilise deposits from people enables the whole process of intermediation to take place, as the funds can be lent to people who have a spending opportunity that they cannot satisfy from their immediate resources. There is an important obligation on intermediaries, however, to ensure the safety of deposits and in most countries legislation is in place to control deposit-taking institutions and protect people’s savings.
Insurance is a risk management strategy. Loans may help a household to increase its income but they do not reduce the household's vulnerability or exposure to risks. Easily available savings may help to address this need as households can build reserves from which they can draw in emergency or to smooth cash flow imbalances. However, this still does not help if they are exposed to risks which cause losses that are beyond their means. Insurance products enable the risks faced by households to be pooled and thus provide protection against larger losses.
This paper has been written primarily for managers and directors of microfinance institutions that either offer insurance or plan to develop an insurance product for low-income households. It suggests that the provision of insurance might create a win-win situation where clients experience a reduction in vulnerability to risk and MFIs benefit from an improved bottom line. Key points are:
- insurance is a promising response to risks which cause losses that are beyond the means of the poorest and pools the risks faced by low-income households,
- in the drive for sustainability or profitability, MFIs are diversifying their lines of financial products and insurance has the potential to improve profitability by reducing loan losses and replacing clients' need to draw down savings for emergencies,
- MFIs can benefit from an additional source of capital for lending or fee-based income as agents.
The paper is divided into three main sections:
- The first chapter examines risks faced by low-income households, e.g., life cycle needs, death, property, health,disability and mas, covariant risks. A framework is developed which classifies the risks on the basis of degree of uncertainty and relative size of loss.
- The second chapter reviews potential risk management strategies, including informal individual and group based coping strategies and formal credit, savings and insurance products.
- The third chapter looks at insurance from the provider's perspective, including matching supply and demand and the different types of insurance products.
The paper concludes that insurance involves pooling risk over a number of participant groups and is not like a savings product. Insurance may be secondary to saving enough money to protect from economic shocks and is most appropriate for uncertain and expensive losses. Developing insurance products should involve experts.
Leasing is a medium term financing instrument which can be used for financing fixed and moveable assets, such as farm machinery, equipment, buildings, land, means of transport, etc. The core principal of leasing is the separation of ownership and use of a productive asset: The owner (lessor) hands the asset over to the lessee for an agreed period of time against a periodic payment which covers capital costs, depreciation and a profit margin.
The key benefit of leasing is the relaxation of collateral requirements because the leased asset itself stands as main security. A second advantage relates to the in-kind disbursement mode which avoids the risk of diversion of funds. However, rural lessors face high transaction costs for supervision of lessees, a lack of secondary markets for repossessed equipment, of appropriate insurance products and awareness amongst all stakeholders about the legal and operational features of leasing.
Loans are borrowed funds with specified terms for repayment. When there are insufficient accumulated savings to finance an activity and when the return on borrowed capital exceeds the interest rate charged on the loan, it makes sense to borrow rather than postpone the investment until sufficient savings can be accumulated. Loans are also an important means of solving imbalances between household income and expenditure, provided income flows in the future are sufficient to meet the repayments. Credit is used widely as a poverty alleviation tool as it can enable people to start or improve enterprises but usually it is not a sufficient solution on its own. There is a wide variety of loan products for a financial institution to consider.
In traditional banks payment services include cheque cashing and cheque writing privileges for customers who maintain deposits. Payment services also include the transfer and remittance of funds from one area to another. There has been a great increase in people migrating to find work in recent years and it is becoming clear that a significant portion of the subsequent remittance flows go to poor and low income families in rural areas. Thus microfinance institutions, rural based banks and credit unions are all looking at money transfer services as a potential part of their business.
The scale, growth and importance of remittances to developing countries cannot be understated. The Inter-American Development Bank (IDB) estimates that $32 billion in remittances was sent to the LAC region in 2002, and it represents "the single most valuable source of new capital for Latin America and the Caribbean.... more important for the region's economic and social development than foreign direct investment, portfolio investment, foreign aid or government and private borrowing" (Inter-American Dialogue, 2004).
This World Council of Credit Unions (WOCCU) Technical Guide provides a useful introduction to the methods of how money crosses international borders, such as cash-based electronic transfers, card-based transfers, informal mechanisms and account-to-account wire transfers. It discusses the current operating environment for remittances, provides an overview of WOCCU's International Remittance Network (IRnet) and details how WOCCU has facilitated mass remittance distribution through credit unions by partnering with money transfer operators (MTOs). This system enjoys the advantages of both the credit unions' proximity to clients in the receiving countries and the MTO's transferring experience and dense network in the sending countries.
The entrance of credit unions and commercial banks into the remittance market has put pressure on MTOs to lower prices and become more competitive. Receiving institutions are seeing the potential of attracting unbanked clients as credit union members and future savers, borrowers and insurance policyholders. For example, some initiatives are underway in both
The Guide stresses a number of critical factors that affect the success of the remittance service operations and provides a number of illustrative case studies. The success factors include:
- the number and location of points of service in both the sending and receiving countries
- the quality and security of service and
- the need to comply with government legislation on control of illicit money transfers and money laundering.
Finally, the Guide looks at the future of remittance transfers and the task ahead, in particular, the need to extend the outreach and improve the shared branching network of credit unions in order to continue the provision of low-cost remittance services.
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