Better Financial Tools for the Poor
by David Levine, President & CEO
Jonathan Morduch is a professor at NYU who directs the Financial Diaries Project. I’ve written about the Diaries Project before in my weekly updates.
The Diaries Project looks at the daily income and expenses of 200+ low-income households nationwide. One key conclusion of the Diaries Project is that unexpected volatility in income and expenses is a reality for most of these households. This volatility makes any long-term planning — such as for budgeting, savings, and investment — difficult if not downright impossible.
In his article in the Stanford Social Innovation Review, Dr. Morduch offers some additional insights on low-income households. In particular, he notes that low-income households and neighborhoods have access to credit that is defined to be “informal.” This “informal” credit might be borrowing from family and friends rather than a “formal” line of credit from a lending institution like a bank.
The problem is that “informal” credit is unreliable and comes with limitations. For example, as Dr. Morduch notes, “There is no guarantee that a neighbor will have money to lend when you need it; nor is it always possible to say no to a sister’s request for a loan, even when you know it is not likely she’ll repay it.”
Moving these communities to access formal lines of bank credit is not an answer. Too many barriers exist in formal credit rules, including the fine print in the application terms and the applicant’s income, work history and credit score.
Financial tools targeting the poor and low-income communities should have old-fashioned virtues of reliability and transparency. The answer might be microcredit lending facilities, where small loans at reasonable interest rates can be offered to poor households. It could include loans that can be longer-term and fixed rate (forget the adjustable-rate teaser loans!)
His insights really show what kind of credit can work in these neighborhoods.