SAVINGS AND THE
FINANCIAL SYSTEM
Chapter 8
1
Saving plays a key role in determining growth.
It is also important to know how saving behavior is
conditioned in order to explore the implications of
macroeconomic policy and the impact of changing
government policies
Chapter 8.1
SOME SAVINGS MODEL 2
Total saving is the sum of government, business, and private savings.
In developing countries, most savings are accumulated by private households and the
unincorporated business sector.
There have been two major developments in the theory of personal consumption and
saving
Irving Fisher (1930) and Frank Ramsay (1930)
Keynesian Model (1936)
Chapter 8.2
KEYNESIAN AND INCOME CONSTRAINED 3
MODELS
These models start with the simple observation that consumption
may depend upon current income.
This model was overtaken by more plausible theories in the 1960s
and 1970s that allow for consumption and income smoothing
overtime - that is, borrowing to smooth consumption so that it does
not depend completely on the current level of income.
Chapter 8.2.1
INCOME SMOOTHING MODELS: THE PERMANENT INCOME 4
AND LIFE CYCLE HYPOTHESES
These are models that allow for consumption smoothing over some time
horizon without constraint.
The time horizon in these models can be a person’s lifetime or a longer
(sometimes infinite) time horizon.
Chapter 8.2.2
5
DETERMINANTS OF SAVINGS
Real Interest Rates Level of Income
Chapter 8.2.3
Role of the Government Terms of Trade
Growth in Income Degree of Financial
Liberalization and
Population age structure Stability
Real Interest Rates 6
- Higher interest rates stimulate saving by offering higher financial returns for
abstaining from consumption through the substitution effect.
Role of the Government
-If the government raises taxes, incomes will decline, and private savings can
also be expected to diminish, other things being equal.
Growth in Income
-If workers believe that a change in income is permanent, in an LCH/PIH world,
consumption would be adjusted upward accordingly, and the current saving rate
could fall.
Chapter 8.2.3
Population age structure 7
- LCH implies that the age structure plays an important role in saving behavior.
Level of Income
-If LCH and PIH are correct, then saving should not be related to current income.
Terms of Trade
-The terms of trade effect works through an unanticipated and transitory
increase in income by an improved trade balance.
Degree of Financial Liberalization
-A general rule of thumb regarding saving would be that financial stability and
liberalization are positively related to the rate of private saving, other things being
equal.
Chapter 8.2.3
8
9
Gross Domestic Savings Rate as %
1990-2006 2006-2023
Source: World Development Indicators
Chapter 8.3
10
DETERMINANTS OF SAVING Per-capita income
IN DEVELOPING COUNTRIES - has a non-linear effect: its impact on
saving diminishes as income increases.
Variables affecting savings in
Current-account surplus/GDP
developing countries:
Chapter 8.3.1
- reflects the impact of foreign
• rate of growth of GDP savings/transfers on domestic savings
• terms of trade - an increase in foreign saving equal to
• per-capita income 1% of GDP reduces the national saving
• total wealth rate by about 0.4% points.
• dependency ratio
Wealth
• current-account surplus/GDP
- wealthier populations tend to have
higher saving rates.
11
DETERMINANTS OF SAVINGS IN ASIA
Focus on saving behavior in high- and medium-income
developing Asian countries.
Chapter 8.3.2
Core sources: Masson et al. and Harrigan (1998).
Key determinants analyzed:
income growth
dependency ratios
fiscal policy
12
COMMON DETERMINANTS IN ASIA
Variables explaining savings in Asia align with those in
other developing countries.
Chapter 8.3.2
Bivariate analysis confirms:
Income growth
Foreign Saving
Dependency Ratio (esp. youth)
13
COUNTRY-SPECIFIC EVIDENCE
Korea (Dowling, 1984): Impact of income and
demographics.
Chapter 8.3.2
Philippines (Nam, 1989): Confirmed demographic
importance.
Southeast Asia (Harrigan, 1998): Key conclusion—“Trinity”
of growth, fiscal balance, and demographic shift promotes
savings.
14
Chapter 8.3.2
DETERMINANTS OF SAVINGS IN ASIA
14
HARRIGAN (1998) FINDINGS
Positive determinants: Negative Determinants:
GNP growth (short and Decline in agriculture’s share
Chapter 8.3.2
long run) of income
Favorable terms of trade Inflation (short-term negative
impact)
Financial liberalization and
stability Young age dependency
(strong impact)
Higher real interest rates
DEPENDENCY RATIO EFFECTS 15
Youth dependency has a Declining agriculture share
strong negative effect on linked to lower saving rates.
savings
Possible reasons:
Chapter 8.3.2
Elderly dependency has little Agricultural income variability
to no effect. = stronger saving motive.
Drop in youth dependency = Shrinking agriculture sector =
boost in private savings more consumer credit → less
saving.
AGRICULTURE AND SAVINGS
16
POLICY IMPLICATIONS
Growth and macroeconomic stability crucial.
Financial market development encourages savings.
Chapter 8.3.2
Demographic transition plays a key role.
Structural transformation must consider savings
behavior.
17
CONCLUSION
Savings in Asia are shaped by multiple,
interconnected factors.
Chapter 8.3.2
Core takeaway: Rapid growth, sound fiscal policy,
and reduced youth dependency drive higher
savings.
Policy must balance economic transformation with
incentives for private saving.
18
INTRODUCTION TO THE FINANCIAL SYSTEM
The financial system is an integral component of modern
Chapter 8.4
economies.
In most Asian countries, commercial banks constitute the
primary component of the financial system. However,
informal financial institutions also play an important role.
19
8 . 5 BANKING AND FINANCIAL SYSTEM
The banking and financial system in the
developing economies in Asia evolved from
systems that were in place during the colonial
period.
20
8 . 5 . 1 FINANCIAL REPRESSION
These various controls and schedules interacted,
resulting in a financial system that did not allocate
credit to the public in an efficient manner, and the
banking sector played a smaller role than it could
have in a more competitive and free environment.
21
8 . 5 . 2 FINANCIAL LIBERALIZATION
How then were “miracle” economies of East
Southeast Asia able to develop such dynamic
economies?
Financial liberalization is designed to remove all the
restrictions that characterize financial repression.
22
8 . 5 . 3 ASIAN EXPERIENCE OF
FINANCIAL LIBERALIZATION
In the 1960s and 1970s, the commercial
banking system was tightly controlled by
the government in almost all Asian
countries.
23
8 . 5 . 4 MEASURES OF FINANCIAL REPRESSION
Substantial evidence of financial repression remained in
several countries.
One such widely used measure of financial repression and
financial liberalization is the ratio of money plus quasi money
(M2) to GDP/GNP.
The ratio rises with liberalization and falls with financial
repression.
24
25
8 . 6 FINANCIAL LIBERALIZATION IN THE
DEVELOPING COUNTRIES
Asian countries initially succeeded in financial liberalization, avoiding the
inflation and fiscal crises seen in Latin America. Strong fiscal policies and
capital controls helped manage risks.
However, unresolved weaknesses and reliance on foreign capital led to the
1997 Asian financial crisis, as liberalization outpaced institutional reforms.
As financial liberalization advanced, loans were issued without proper risk
assessment and competition was weak. Financial systems struggled with rapid
capital inflows and growing risks, especially in banking and real estate.
26
8 . 7 THE FINANCIAL CRISIS OF 1997
Asian Financial Crisis of 1997: Triggered by underlying financial
vulnerabilities (moral hazard, asset bubbles) exposed by stock
market crashes and currency drops. Key issues: poor lending, high
corporate debt. Solutions proposed: better regulation, market
development.
Post-crisis: financial and corporate restructuring.
27
8 . 8 INFORMAL FINANCE
Informal finance plays a significant role in developing
countries where many people lack access to formal
financial institutions. However, it often operates
without proper regulation and faces challenges like
limited capital, high transaction costs, information gaps
about borrowers, and difficulties in assessing
creditworthiness.
28
8.8.1
A RATIONALE FOR INFORMAL FINANCE AND A SIMPLE
TAXONOMY OF INFORMAL FINANCIAL INSTITUTION
Informal finance is important because many in developing Asia, especially the poor
and those in rural areas, face significant barriers to accessing formal financial
services. These barriers include:
1. Limited access to banking facilities in rural and slum areas.
2. Banks prioritizing investment over consumption loans.
3. High transaction and appraisal costs discouraging small loans.
4. Lack of creditworthiness information on potential borrowers.
5. Borrowers often lack sufficient capital for credit reports.
6. Borrowers being too poor to repay at commercial interest rates.
29
8 . 8 . 2 GROUP FINANCE
Group finance involves individuals forming groups to access loans,
where members often guarantee each other's loans. Rotating
savings and credit associations ("roscas") are a common example,
where members contribute regularly to a pool, and the total sum is
given to a member in rotation.
This system helps those excluded from formal finance access funds
and encourages repayment through peer pressure and social
capital.
30
8 . 8 . 3 MONEY LENDERS, LANDLORDS,
AND PAWNBROKERS:
These informal lenders cater to borrowers who lack
access to formal credit. Money lenders typically charge
high interest rates to compensate for the higher risk and
transaction costs. Landlords may also act as lenders,
often tying credit to tenancy. Pawnbrokers provide loans
secured by personal assets.
31
8.8.4 NON-GOVERNMENT
ORGANIZATIONS (NGOS)
NGOs can work outside the formal banking system or join
it later. They play a key role in providing financial
services, especially in rural areas where access to banks is
limited.
32
8.8.4 GRAMEEN BANK IN
BANGLADESH
The Grameen Bank is one of the most successful NGOs, focusing on rural
banking. It is unique because it is owned by the people who borrow from it (the
depositors), making it a cooperative.
The bank does not require collateral; instead, it relies on borrowers’
commitment to repay, supported by peer pressure within groups. Loans are
small, and borrowers’ repayment records determine their eligibility for future
loans. Groups are responsible for ensuring everyone repays, and if one person
defaults, the group covers it.
Grameen Bank operates with minimal enforcement costs, as risks are shared
within groups.
33
8 . 8 . 4 BANK GADANG BALI IN
INDONESIA
This started as a small lending business by a local shoemaker and grew into a
successful local bank.
It focuses on small loans and uses mobile bank-vans to collect deposits and loan
repayments in rural areas.
Like Grameen Bank, the bank benefits from borrowers’ similar social and
economic backgrounds, which reduces credit appraisal costs.
Peer pressure also helps ensure repayment.
34
8 . 8 . 5 HOW LARGE IS THE INFORMAL
FINANCE SECTOR IN DEVELOPING ASIA?
The informal finance sector, such as money lenders, has historically played a big
role in providing credit in rural areas.
In the 1980s, a large portion of household debt came from informal sources.
Over time, this has decreased due to more formal credit options, fewer people
living in poverty, and rural areas shrinking.
35
BOX 8.2 GRAMEEN BANK
The Grameen Bank (GB) started in 1976 as a project in one village and
became a bank in 1983 under a law.
It is owned primarily by the poor, especially women, who are also the
bank's borrowers.
The government owns a small part, but the majority of the bank’s stock is
held by borrowers.
36
BOX 8.2 GRAMEEN BANK
Growth and Impact
GB serves over 40,000 villages with more than 1,000 branches and over 10,000
staff.
The bank has distributed over 150 billion Tk (Bangladeshi currency), with a
repayment rate of around 98%.
It has become less reliant on donations and now funds most of its loans from its
own savings and depositors (83% of whom are borrowers themselves).
It has been profitable in all but three years since it began.
37
BOX 8.2 GRAMEEN BANK
Loan Types
Income-generating loans (higher interest rates) for business purposes.
Housing and education loans at lower interest rates for borrowers and their
children.
Scholarships and higher education loans for students, especially for
females.
Loans for cell phones, helping borrowers set up telecom businesses in rural
areas.
38
BOX 8.2 GRAMEEN BANK
Services
A life insurance program is provided to members, with no premiums
required, as they are covered by being shareholders.
Over 40% of Grameen borrowers’ families have moved out of poverty, and
many others are seeing steady income growth.
Social and Economic Impact
GB has improved education and literacy levels and helped integrate
borrowers into their communities.
Its success model has been copied in other countries, including China and
some parts of Latin America.
39
BOX 8.2 GRAMEEN BANK
Challenges and Criticism
The bank's success relies heavily on trust within small groups of women, making
it difficult to expand to larger or more diverse groups.
GB has faced criticism for relying on donations, despite its high repayment
rates.
Some critics argue that loans are sometimes misused for personal consumption
rather than business, with women often acting as intermediaries for their
husbands.
Advantages
GB’s simple structure and decentralized decision-making help reduce costs.
The reliance on local community meetings to enforce loan repayment reduces
overhead and administrative costs.
40
8.8.6 ESTABLISHING LINKAGES BETWEEN
INFORMAL FINANCE AND THE BANKING SECTOR
Banks and informal financial groups can cooperate without changing their current systems.
Banks can lend to NGOs, which then provide financial support to small borrowers.
Example: Grameen Bank started with the support of formal banks.
In Nepal, a proposal involved Roscas (savings groups):
-Instead of distributing funds directly to members, the money would be saved in a bank as collateral.
-The bank could lend more funds to the group based on this collateral.
-The Rosca would then lend the money to its members.
Banks can offer similar services to informal lenders:
Example: In the Philippines, the PCIB bank set up "moneyshops" in markets in the 1970s.
-Gave small daily loans to vendors.
-Collected payments daily in the market.
-Helped increase deposits and lower informal interest rates.
After interest rate deregulation in the 1980s:
-Banks focused on larger, riskier loans.
-Smaller borrowers were mostly left out.
41
8.8.7 INFORMAL FINANCE AND MONETARY POLICY
Monetary policy mainly affects informal finance through inflation (the
"inflation tax").
People involved in informal finance are usually poor and:
-Have little to no savings.
-Keep their assets in cash or goods, not in interest-earning investments.
Because of this, they are more hurt by inflation than wealthier
individuals.
Informal finance is less sensitive to changes in monetary policy
compared to formal banking.
To support the poor, monetary policy should prioritize price stability
(controlling inflation).
42
GLOBAL FINANCIAL CRISIS OF 2008/2009 AND
8.9 ITS IMPACT ON ASIAN FINANCIAL MARKETS
Previous Stability and Preparedness
Asian financial markets were relatively stable at the onset of the 2008 global financial crisis.
Reforms after the 1997 Asian financial crisis strengthened bank balance sheets and reduced
non-performing loans (NPLs).
Exchange rates became more flexible, reducing reliance on a rigid U.S. dollar peg.
Short-term overseas borrowing practices were reduced to mitigate risks.
Financial Stress and Market Decline
The crisis in late 2008–early 2009 added pressure to financial systems.
Stock markets declined significantly due to reduced industrial production and lower exports.
The fall in stock prices reflects the outflow of portfolio investments.
Foreign direct investment remained more stable compared to short-term capital movements.
43
GLOBAL FINANCIAL CRISIS OF 2008/2009 AND
8.9 ITS IMPACT ON ASIAN FINANCIAL MARKETS
Government Stimulus Measures
Singapore: Announced a US$13.5 billion package to preserve jobs, stimulate bank lending,
and enhance competitiveness.
China: Launched a US$586 billion infrastructure investment program (6% of GDP) for low-
income housing, rural development, environmental protection, and innovation.
Other countries in the region also introduced stimulus measures to counter economic
downturns.
Future Outlook
Despite reports of increasing NPLs in some countries (e.g., Korea and Vietnam), the financial
sector is unlikely to face the same crisis levels as in 1997.
Government interventions are expected to stabilize financial markets and support economic
recovery.
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