Savings for Low-Income Households An Asset Liability Management Perspective on Low-Income Savings Dr. Joachim Bald Frankfurt School of Finance & Management Phone: © F r a n k f u r t – S c h o o l. d e International Advisory Services Fund Management Academic Programs Executive Education Research

2 © F r a n k f u r t – S c h o o l. d e  My panel contribution proposes to look at low-income savings from an institutional perspective and in their aggregate, i.e. as a class of liabilities on the balance sheet.  How do aggregate low-income savings behave in terms of:  liquidity risk,  interest rate risk and  their profitability contribution?  Are there product features that can maximize the utility of the savings liabilities to the institution while meeting the needs of low-income clients? Low-income savings products must make business sense for the institution Asset Liability Management Perspective on Savings

3 © F r a n k f u r t – S c h o o l. d e Liquidity Implications of Small Retail Deposits Asset Liability Management Perspective on Savings Contractual Maturity Gap Report, ProCredit Bank, Kosovo:  Extreme liquidity risk? Quite the opposite: ProCredit has a large, atomistic retail deposit base - the cheapest, most stable, long term funding there is.

4 © F r a n k f u r t – S c h o o l. d e Financial Supply DriversQualitative / Service Supply Drivers Own Rates & Fees Competitor Rates Alternative Investment Opportunities & Yields (stock market, real estate etc.) Macroeconomic Context: disposable incomes, inflation etc. Customer Expectations / Motives Product Features / Service Quality Marketing / Branding / Perception of Corporate Culture Modeling Retail Deposit Supply: It ain’t easy …. … … Complex Influences on Supply Behavior of Particular Deposit Product Supply Behavior of Other Deposit Products Asset Liability Management Perspective on Savings

5 © F r a n k f u r t – S c h o o l. d e  Annualized Volatility based on daily aggregate balance observations:  STDEV( ln(Balance t+1 / Balance t ) ) *250^0.5 Deposit Behavior: Volatility of Small Balance Deposits, CGAP Study Asset Liability Management Perspective on Savings

6 © F r a n k f u r t – S c h o o l. d e Using Volatility in Forecasting Deposit Supply  Equity Bank, Kenya. USD Savings Supply. Actual Observations, long run exponential trend line and 95.4% forward confidence interval (2 STDV). Asset Liability Management Perspective on Savings

7 © F r a n k f u r t – S c h o o l. d e  Time horizon: reputational stress event starts today and lasts for 3 months.  Voluntary retail deposits run off by 30% over 3 months.  Large time deposits run off by 50% over 3 months.  Unused overdraft lines of credit are canceled by your correspondent banks within first month  Unsecured overdraft utilizations must be paid back within 3 months.  No new long-term borrowing, scheduled fresh draws on existing funding lines are being delayed by counterparts and do not become available during the 3 months. Example of Stress Test Assumptions (1) Asset Liability Management Perspective on Savings

8 © F r a n k f u r t – S c h o o l. d e  Maximum stand-by facility from parent network is drawn after four weeks.  New lending is limited to prolongations for core clients only. No new borrowers accepted.  Collection ratio declines from 95% to 80%.  Calculate coverage ratio of 3-month assets to liquidating liabilities based on these assumptions.  Better even, do a detailed cash-flow forecast as per the institutional liquidity management model with the above stress assumptions. Example of Stress Test Assumptions (2) Asset Liability Management Perspective on Savings

9 © F r a n k f u r t – S c h o o l. d e Liquidity Risk Run on Mortgage Bank Northern Rock, September 2007 Asset Liability Management Perspective on Savings

10 © F r a n k f u r t – S c h o o l. d e Seasonality of Deposit Supply : Example of Allied Bank, Pakistan Asset Liability Management Perspective on Savings

11 © F r a n k f u r t – S c h o o l. d e Asset Liability Management Perspective on Savings Small Savings and Interest Rate Risk Re-pricing Gap Report, ProCredit Bank, Kosovo:  A liability-sensitive balance sheet?  No, the opposite. Consider experiential prolongation and repricing behavior!

12 © F r a n k f u r t – S c h o o l. d e A bank has two transactions on its books, a four-year home improvement loan for $10,000 at 8.5% and a $10,000 time deposit for one year at 5.5%. Net interest margin is 3%. The graph shows the decomposition of the total 3% margin along the yield curve constructed from the wholesale investing and funding opportunities actually available to the institution. Profitability Management: Matched Maturity Transfer Pricing Gross contribution margin of the retail deposit Asset Liability Management Perspective on Savings

13 © F r a n k f u r t – S c h o o l. d e Savings Product Design from ALM Perspective Asset Liability Management Perspective on Savings  Discourage mere overnight safekeeping of cash, offer lock-box rentals, instead.  No proliferation of products. There are really only three basic products: demand savings, installment savings plans, time deposits.  Don’t confuse savings themes with savings products.  Encourage transactions on savings accounts, particularly in other products offered by the institution.  Counter-intuitively, the more transaction opportunities and the cheaper and more convenient it is to withdraw funds, the smaller (and more frequent) the actual withdrawals and the higher the average balance.  Go easy on savings interest: interest rate is not the client’s primary concern on demand savings. Why pay 2% p.a. if you can get away with 1%?  Rather pay very competitive rates on savings plans and time deposits, where the rate paid is highly visible and the main driver in client retention.