Reading time: 3 – 5 minutes

I was reading The Economist a couple of weeks back and one article really struck me.  The article was entitled “Smooth Operators” and it started off talking about how the worlds poor (roughly speaking, those that live on less than $2 per day) save their money. You might think they simply use savings accounts like people in developed countries do but that isn’t fully correct.  Generally the worlds poor are “unbanked” meaning that they are ineligible for even the most basic financial services you and I take for granted (e.g. savings accounts, loans, etc.). This is exactly why Muhammad Yunus developed what we now know as microfinance.

Microfinance started off as a loan program where a microfinance institution (MFI) would disburse and administer very small loans to poor people who would then take those loans and build businesses that would sustain them and their families.  Microfinance has come a long way since then and now a lot of large MFIs provide many other services to their clients.

However, savings is still an issue.  This is especially true in places where microfinance (including the micro savings account piece of microfinance) has not been fully developed. This is where the innovation mentioned in The Economist article comes in.

It turns out that some poor people in the developing world actually pay someone to look after their deposits.  Yes, you read right.  They pay “interest” on their savings at rates that equate to roughly -30% (India) and -40% (West Africa) interest rates in some cases. While this may strike the developed world as very odd this system works much better than the alternative (i.e. no savings accounts).

One of the main issues the worlds poor face is that of uneven cash flow.  Since these people generally have incomes that are low while also being unpredictable and erratic they need to control their cash flows and smooth them out.  This is what economists call “consumption smoothing,” a term that refers to spreading spending out in such a way that what one consumes today isn’t determined by what they earned that day or the day before.

What is fascinating about all of this is that, of the poor people surveyed in the new book “Portfolios of the Poor,” hardly anyone lived “paycheck to paycheck” because of their use of a combination of savings and loans.  This is clearly evidence that poor people are fairly sophisticated financially.  They also appear to be very aware of common psychological issues that cause all of us, poor or rich, to run into financial issues.

The example the Economist article brings up relating to psychology is our tendency to do what our peer group does (i.e. peer pressure).  Knowing that peer pressure exists some people in developing nations (even those with bank accounts) have begun to form “savings clubs” where the combined peer pressure of the group keeps everyone honest about their savings.  This same principle is also something that Muhammad Yunus used when he started giving small loans to the poor in the 1970s. Yunus had lendees form groups so that peer pressure would keep everyone honest in terms of paying back their loans.  This system has worked incredibly well over the past 30 years as can be seen in the repayment rates of most MFIs.

The worlds poor have proven time and time again to be very creative in solving their financial problems even though they don’t have access to all of the sophisticated financial instruments and technologies the developed world has access to.  Sure, in some cases they use unorthodox methods like paying for things that people in developed countries get for free or get paid to use (e.g. savings accounts) but the flip side to that coin is that small businesses are created (e.g. the people who charge to safeguard the savings of others), which also help to boost the local economy. All in all, it appears that the poor are much more sophisticated than people in developing nations generally think.