Financial Services and Consumption Smoothing
As Zeller (1999) observed, there is more focus on the role of microfinance for consumption smoothing but less so in respect of micro-credit and micro-insurance and micro-savings other than their role in “mobilizing capital”. The vulnerable are subjected to two risks: income smoothing and consumption smoothing. It is difficult for vulnerable households to smooth income risks as they are subjected to adverse income fluctuations and in many instances have little savings to manage their income fluctuations. As the same time, they have heightened vulnerability as again vulnerable groups may not have the luxury of risk management choice either through insurance through their networks or insurance to enable stable consumption patterns (Morduch 2004).
It is clear that what is important to enable a household’s ability to smooth income and consumption is not only access to specific services (formal and informal) but also risk-bearing capacity. In this respect, attention should be paid to financial services, that is, the provision of microinsurance (Morduch 1999, 2006), micro-savings and micro-credit.
There are three key ways to develop service infrastructure for the vulnerable:
- 1. Savings build for consumption smoothing (community banking)
- 2. Credit build for current expenditure and investments (microfinance instruments)
- 3. Savings through regular payments to a pool or a fund (micro-insurance)
Rutherford (1998) points out that the poor often pay heavily for the chance to save (the problem with informal loans, which can be very expensive). Furthermore, microfinance does not always reach the poorest or the most vulnerable (Scully 2004; Simanowitz 2001). However, there are three key problems for financial service providers:
• The first problem is the existence of moral hazard (Linnerooth-Bayer and Mechler 2009), where collaterals may be ineffective (Bond and
Rai 2002); there may be collusion (Bond and Rai 2002; Valenzuela 1998; Counts 1997); and a high degree of moonlighting might exist.
- • The second problem is that financial institutions have to deal with the paradox of adverse selection in their portfolios for demonstrating social justice (Stiglitz 1990; Varian 1990; Wydick 1996; Van Eijkel et al. 2007).
- • The third problem is that trying to smooth consumption and income can be costly (Morduch 2004; Rosenzweig and Binswanger 1993) as vulnerable households have a high exposure to risk and a low riskbearing capacity.
In reality there are a number of problems that the vulnerable suffer in accessing financial services, even though there may be opportunities to access these services.