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Saving investment and the financial system test 20

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WEALTH CREATION THROUGH INVESTMENT RARITIES

Chapter 22a test bank. Chapter 27a test bank. When a country saves a smaller portion of its GDP, it will have a. What are the two basic categories of financial institutions? Which of the following is not a nonsensical headline? British perpetuities about to mature. Government bonds currently pay less interest than corporate bonds. A certificate of indebtedness that specifies the obligations of the borrower to the holder is called a a.

All of the above are correct. Rudolph has the choice of two bonds, one that pays 5 percent interest and the other that pays 10 percent interest. Which of the following is most likely? The 10 percent bond is less risky than the 5 percent bond b. The 10 percent bond has a shorter term than the 5 percent bond c.

The 10 percent bond is a U. The 10 percent bond is a corporate bond, and the 5 percent bond is a municipal bond. Harcourt, Inc. People who buy stock in a corporation such as Maytag become a. Stock indexes are a.

The dividend yield on this stock is a. A mutual fund a. Which of the following equations represents national saving in a closed economy? In a closed economy, national saving equals a. Suppose that in a closed economy GDP is equal to 9,, taxes are equal to 1,, Consumption equals 6,, and government expenditures equal 2, What are private saving and public saving? A budget surplus is created when the government a. None of the above is correct.

The source of the demand for loanable funds a. The supply of loanable funds slopes a. Saving for Development pp Cite as. In advanced economies, the vast majority of savings are intermediated through formal financial instruments. This intermediation can take one of three forms: direct financing, with individuals holding instruments issued directly by firms or the government; through institutional investors who then invest in those instruments; or through formal financial intermediaries such as banks.

By contrast, in Latin America and the Caribbean, much of the savings of households does not go through the formal financial system. Some households—typically the less wealthy—keep savings in unregulated institutions, buy durables or other assets as a means to save, or simply stash their cash in the proverbial mattress.

Others—typically more wealthy households—hold assets abroad or invest in real estate, bypassing the domestic financial system entirely. Latin American and Caribbean financial systems lack depth and pose serious constraints to access credit. This chapter focuses on financial intermediation and mainly on the fourth role: to mobilize and pool savings. It asks why in Latin America and the Caribbean, the financial system has done a poor job in this role.

An efficient financial system should promote savings by providing easy and convenient access to appropriate savings instruments offered by high-quality, trustworthy institutions at reasonable cost. Clearly, there is no single optimal design for a financial system; many potential instruments and structures of financial systems may be equally efficient. In some systems such as the United States and the United Kingdom , direct financing through capital markets is relatively more important.

Firms issue equities and bonds, which are bought by individuals or by institutional investors that pool the savings of individuals. In other countries, such as Germany and Japan, financial intermediaries, including banks, are relatively more important. They offer savings accounts and provide financing to firms. Banks play a critical role in allocating capital and in guiding the corporate governance of firms through representation on boards.

In Latin America and the Caribbean, banks have tended to dominate the financial landscape, although capital markets have been growing. Most individuals do not buy equities or bonds directly, but rather hold them indirectly through mutual funds, pension funds, or insurance companies. The size of these institutional investors in the region has increased, and they are now very significant players in some countries.

Note: Data on assets rather than liabilities are used for mutual funds and pension funds, as these are the data available on a comparative basis. The figures have been adjusted for double-counting as mutual funds, pension funds, and insurance companies may hold bank deposits, and banks may purchase mutual funds as data sources allow, although it is possible that some may remain.

For details, see Bebczuk b. For example, in Brazil, the mutual fund industry has grown considerably and has assets under management approaching total banking sector deposits. In Chile, pension fund assets exceed bank deposits, and the sum of insurance company and mutual fund assets is close behind.

Mexico has a large corporate bond market. These assets are typically held by pension funds and mutual funds, which together rival the amount held in bank deposits. And in Colombia, pension fund assets under management are almost comparable to the deposits of banks. How are financial systems in the region likely to change as capital markets grow? On the other hand, they may also promote greater instability.

Writing in before the global financial crisis about a similar phenomenon in continental Europe, Rajan and Zingales warn about this trade-off. Still, Latin America and the Caribbean has experienced significant economic instability in its past, despite having a more bank-based financial system; indeed, as a result, the region has improved banking and capital market supervision and has been extremely conservative in its regulation of more exotic financial instruments.

This approach surely helped the region survive the recent global financial crisis relatively well Powell, It may also allow the region to transition to a more market-based system while maintaining financial stability. A related question is whether as capital markets grow they will take over from intermediaries—or, in other words, whether capital markets are substitutes or complements to financial institutions.

A novel analysis suggests that for Latin America and the Caribbean—as for the rest of the world—banks and capital market institutional investors are complements, rather than substitutes. Capital markets are not taking over from banks, although both grow more quickly in some countries than others. The region appears to be no different from the rest of the world in this regard.

For capital markets to grow, ultimately outside investors must feel comfortable either buying debt-type instruments or investing in equity issued by firms. In turn, this requires a set of conditions to be met. Rating agencies should be operating effectively; this saves individual investors the work of analyzing every firm, which would be prohibitively costly. Corporate governance should be effective so that outside equity or bond investors do not feel they will be taken advantage of by an inside group of equity holders.

Latin America and the Caribbean typically scores rather poorly on these important aspects of what might be referred to as the plumbing that allows finance to flow freely from investors to users. This may be one reason why financial markets have remained small to date, and why financial intermediaries, particularly banks, continue to dominate. But in order to do this, they must build solid reputations so that investors feel comfortable entrusting them with what may be their life savings.

They must also offer convenience and appropriate instruments with a reasonable return. Large financial systems have two very important advantages. The first is economies of scale, which allow large banks to operate with low margins.

The second advantage is that such systems can mobilize large amounts of financing for big projects; they can overcome problems of indivisibility. Large projects may require considerable financing, which may be a constraint in some countries that lack large financial intermediaries. How financial intermediaries operate determines not only the quantity of savings, but also the quality.

This ensures that the savings are allocated efficiently, which in turn allows them to offer better returns. Institutions should also be regulated appropriately and should have a high standard of corporate governance so that capital can be allocated efficiently. Note: All measures are simple country averages.

Where does the rest of the savings go? A fraction is channeled through informal financial institutions. Most countries have a large number of small, cooperative-type financial institutions. On top of this, other types of institutions, including nongovernmental organizations NGOs , provide financial services. Microfinance institutions have grown considerably in several countries of the region, and some of them also offer deposit-like instruments Trujillo and Navajas, If savings are highly dispersed—in either small formal or informal financial institutions—and not pooled, then they may not be allocated in the most efficient manner.

In turn, the returns offered to savers may be low, reducing the total amount of savings. Notes:Panel a: vertical axis shows percentage of total. Figures inside first column show savings as percentage of GDP, simple average across countries in the region.

Figures inside second column show the total number of institutions. Panel b: Bubble size illustrates the average of savings as percent of GDP, simple average across countries. Bahamas and venezuela excluded due to lack of complete data. In addition, households may be saving in the form of non-financial assets, ranging from jewelry and consumer goods, such as refrigerators and cars, to houses and other property.

They turn to these alternatives for a number of reasons. They may lack documentation to open an account; they may live far away from a financial institution; opening or servicing an account may be too expensive; or they may simply lack information or trust in financial institutions.

In countries where people tend to mistrust the financial system—either because a history of relatively high inflation has eroded the real value of savings, or banking crises have wiped out financial savings—savers may seek to protect the real value of their savings by investing in assets with a better track record as a store of value. Saving in real estate is more common among high-income households.

The use of these mechanisms is especially common among households that in turn are more likely to be excluded from formal financial systems. Again, while these forms of saving may not constitute a large part of total national savings, they can be an important component of the savings portfolio of individual households.

In Mexico and Peru, 20 percent and 33 percent of all surveyed households report saving through a variety of informal mechanisms, while 14 percent and 30 percent of them save using bank accounts, respectively. In Brazil, on the other hand, the saving rate is low irrespective of the instrument: only 4 percent of the surveyed households save informally, while 10 percent of them do so formally.

Preliminary evidence from Colombia reveals a pattern similar to that in Mexico and Peru: 18 of the First, the vast majority of surveyed households that save informally in these three countries do so mostly through family, friends, savings groups, or loans to others, and much less by buying assets for the home or business. Second, households that save formally use saving accounts and employee paycheck accounts, but not other financial instruments that can provide higher long-term returns, such as fixed-term deposits and mutual funds the total share of long-term saving instruments among households saving formally is less than 0.

Third, households that save using both formal and informal instruments are the smallest group of savers in each country. In the context of high macroeconomic volatility, residential real estate has been a popular investment for savers. After the financial crisis of —02, in which the government and many private institutions restructured debts, and many financial contracts were switched from dollars to pesos, Argentines increasingly channeled their savings toward real estate. Flows into real estate only pertain to the City of Buenos Aires, while the increase in time deposits corresponds to the whole banking sector of the country.

All figures are in constant dollars. Moreover, the real estate market absorbed 27 percent more square meters comparing the decade from — with that of to How did the real estate market react? Cruces finds that real rental rates fell significantly to adjust supply and demand: the net rental rates fell from an average of 7. At the end of the sample, the net rental yield was just 1. The net rental yield on housing can be compared to the returns on alternative investments to estimate the efficiency loss opportunity cost from the money sunk in real estate.

The higher end of this range amounts to a loss of 2. The pattern of saving choices among households in Latin America is very different from a textbook model whereby households save, deposit those savings in banks or other financial intermediaries, which in turn allocate those savings to those in the economy that need the funds to invest.

But how different is Latin America from other regions in this respect? In order to address this question, the flow of funds of households in a subset of countries in Latin America and in a comparator group of developing countries outside the region was tracked.

Notes: Computed as simple averages by country over the period — Panel b shows the distribution of total net acquisition of financial assets. This category includes direct ownership of family firms, which is a non-intermediated financial asset, and which makes up the bulk of the account in those countries for which there are data. The regional averages, however, hide much heterogeneity across countries. For example, in Chile, which has the deepest financial system in the region, 50 percent of funds are channeled into financial deposits and other financial instruments, while only 9 percent goes toward equity.

In Ecuador, which has a smaller financial system relative to the size of its economy, only 25 percent of funds are channeled into financial instruments, and 32 percent go into equity assets. More funds appear to be intermediated in Chile than in other countries in the region, where funds tend to be used more for direct investments. Chile more closely resembles a country like the Republic of Korea in the comparator group.

For the other four Latin American countries, a significantly smaller fraction is intermediated through financial deposits and other financial instruments. Mexico provides an interesting country to analyze in more detail. National saving as a percent of GDP is reasonably high given income per capita, and household savings constitute some 50 percent of the national total. The household saving rate defined as a residual between disposable incomes and consumption increases from 8.

A high share of savings that is not channeled through an integrated formal financial system suggests that resources are being poorly allocated. An interesting question is why these savings are not intermediated. This chapter focuses on the issue of lack of supply, or access. If many households live far from a formal financial institution, then factoring the costs of travel and time may encourage each individual household to save in an informal instrument even if that instrument pays little in terms of private returns.

That informal saving instrument may have very little social return as well, as it may not lead to a very productive investment opportunity. In this case, if a sudden change in access occurs—for example, a local bank branch opens or mobile banking becomes available—then informal savers may switch instruments and the social return from the extra dollar of savings the difference between the new return and the previous very low return might be very high.

A complementary explanation for low intermediation relates to the high informality in labor markets in Latin America and the Caribbean. McKenzie and Woodruff find that in Mexico self-employed poor individuals receive above market rates of return for very small capital investments. Not surprisingly, these self-employed individuals tend to reinvest heavily in their own family business, buying goods such as refrigerators, trucks, or any other type of durable good that could simultaneously satisfy a consumption need for the household and serve as a capital good for their home business.

Thus, these small capital investments may make sense for self-employed individuals or households but are an inefficient use of savings from an aggregate, economy-wide perspective. While no similar estimates of individual returns are available for other countries in the region, clearly Mexico is not the only country in the region with a large percentage of self-employed, informal entrepreneurs in the economy. Informality in labor markets also creates a potential barrier to access formal financial instruments because labor income from informal sources is more volatile and is more likely to be paid out in cash.

Evidence from surveys conducted in Brazil, Mexico, and Peru supports these patterns. A higher proportion of households working in the formal economy have access to formal saving instruments, while a higher proportion of informal workers save using informal instruments. In Mexico, 11 percent of households working in the informal labor market save formally compared to 34 percent of households working in the formal economy. In Peru, the gap is even larger: 16 percent versus 49 percent. In Brazil, this gap is negligible: 10 percent versus 11 percent.

Much has been written on the potential obstacles to accessing credit while the potential problems of accessing formal financial savings instruments have been less studied. One interesting finding is the importance of cost and distance as significant deterrents to opening or using a bank account. Stronger institutions and greater equality are associated with a higher percentage of individuals with accounts in financial institutions.

Thus, whether a person has a bank account or not can be looked at as a function of individual as well as country level characteristics. Individual characteristics such as age, income, gender and the level of education are all significant determinants of whether an individual has a financial account see Powell, Women are significantly less likely to have a formal financial account than men, while richer individuals are more likely to have one.

The level of education turns out to be highly significant: individuals with secondary and tertiary education are much more likely to have an account. Note: The figures illustrate that the probability of having a bank account falls sharply for lower income groups as inequality rises while inequality has little effect on rich households. The estimates known as margins plots stem from the estimates of a probit regression and use Findex microdata for the dependent variable the probability of having an account in a financial institution, post office or microfinancial institution.

The explanatory variable in each case is the country Gini coefficient a measure of inequality and a set of micro and macro controls. This result is consistent with an explanation that factors in the behavior of banks and other financial institutions.

If there is a fixed cost for using formal financial institutions for savings, then only people with sufficient resources will use those services. Banks will tend to open branches in communities where richer households will use banking services. If entry barriers to banking are high, the combination of fixed costs and economic inequality may limit the size of banking systems. The result is a financial system that remains relatively small and inefficient and caters largely to wealthier households.

Regional inequalities may exacerbate this pattern. In a larger country, banks will naturally locate in areas where richer households reside.

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Chapter Saving, Investment, and the Financial System 1. Bond markets allow firms to pursue. The four categories of expenditures that make up GDP are consumption,. Which of the following would be counted as a private investment expenditure in the national income accounts? Households make their savings available to borrowers through. What is the price of funds in the loanable funds market?

Assuming the economy is in equilibrium, use the following information to determine the amount of funds supplied to the loanable funds market. The supply of loanable funds curve is upward sloping because a rise in the interest rate. When interest rates rise, the quantity of loanable funds demanded by. If taxes are reduced with no change in government spending, and people spend all the money from the tax cut on consumption. Basically, wants are all those little extras you spend money on that make life more enjoyable and entertaining.

This includes adding money to an emergency fund in a bank savings account, making IRA contributions to a mutual fund account, and investing in the stock market. You should have at least three months of emergency savings on hand in case you lose your job or an unforeseen event occurs. After that, focus on retirement and meeting other financial goals down the road. If emergency funds are ever used, the first allocation of additional income should be to replenish the emergency fund account.

Savings can also include debt repayment. While minimum payments are part of the "needs" category, any extra payments reduce the principal and future interest owed, so they are savings. Americans are notoriously bad at saving, and the nation has extremely high levels of debt. The personal savings rate in was 7. The rule is intended to help individuals manage their after-tax income, primarily to have funds on hand for emergencies and savings for retirement. Every household should prioritize creating an emergency fund in case of job losses, unexpected medical expenses, or any other unforeseen monetary cost.

If an emergency fund is used, then a household should focus on replenishing it. Saving for retirement is also a critical step as individuals are living longer. Calculating how much you will need for retirement and working towards that goal, beginning at a young age will ensure a comfortable retirement. Saving is difficult, and life often throws unexpected expenses at us.

By following the rule, individuals have a plan with how they should manage their after-tax income. Life should be enjoyed, and it is not recommended to live like a Spartan, but having a plan and sticking to it will allow you to cover your expenses, save for retirement, all at the same time doing the activities that make you happy.

Retirement Savings Accounts. Personal Finance. Financial Planning. Retirement Planning. Your Money. Your Practice. Popular Courses. Table of Contents Expand. Importance of Savings. The Bottom Line.

HOW TO REMOVE INVESTMENT FROM CASTINGS DEFINITION

Harcourt, Inc. People who buy stock in a corporation such as Maytag become a. Stock indexes are a. The dividend yield on this stock is a. A mutual fund a. Which of the following equations represents national saving in a closed economy? In a closed economy, national saving equals a. Suppose that in a closed economy GDP is equal to 9,, taxes are equal to 1,, Consumption equals 6,, and government expenditures equal 2, What are private saving and public saving?

A budget surplus is created when the government a. None of the above is correct. The source of the demand for loanable funds a. The supply of loanable funds slopes a. A lower interest rate induces people to a. If the current market interest rate for loanable funds is below the equilibrium level, then the quantity of loanable funds a. If the inflation rate is 3 percent and the real interest rate is 9 percent, then the nominal interest rate is a. Promises of future payments have the largest present value when interest rates are a.

What would happen in the market for loanable funds if the government were to decrease the tax on interest income? The supply of loanable funds would shift right. The supply of loanable funds would shift left. The demand for loanable funds would shift right.

The demand for loanable funds would shift left. If Congress raised the tax on interest income, investment a. Which of the following is incorrect? Taxes on interest income do not substantially decrease future payments from current saving. American families save a smaller fraction of their incomes than their counterparts in many other countries such as Germany and Japan. A change in the tax law that encouraged greater saving would reduce interest rates.

Suppose that Congress were to institute an investment tax credit. On the other hand, they may also promote greater instability. Writing in before the global financial crisis about a similar phenomenon in continental Europe, Rajan and Zingales warn about this trade-off. Still, Latin America and the Caribbean has experienced significant economic instability in its past, despite having a more bank-based financial system; indeed, as a result, the region has improved banking and capital market supervision and has been extremely conservative in its regulation of more exotic financial instruments.

This approach surely helped the region survive the recent global financial crisis relatively well Powell, It may also allow the region to transition to a more market-based system while maintaining financial stability. A related question is whether as capital markets grow they will take over from intermediaries—or, in other words, whether capital markets are substitutes or complements to financial institutions. A novel analysis suggests that for Latin America and the Caribbean—as for the rest of the world—banks and capital market institutional investors are complements, rather than substitutes.

Capital markets are not taking over from banks, although both grow more quickly in some countries than others. The region appears to be no different from the rest of the world in this regard. For capital markets to grow, ultimately outside investors must feel comfortable either buying debt-type instruments or investing in equity issued by firms. In turn, this requires a set of conditions to be met. Rating agencies should be operating effectively; this saves individual investors the work of analyzing every firm, which would be prohibitively costly.

Corporate governance should be effective so that outside equity or bond investors do not feel they will be taken advantage of by an inside group of equity holders. Latin America and the Caribbean typically scores rather poorly on these important aspects of what might be referred to as the plumbing that allows finance to flow freely from investors to users.

This may be one reason why financial markets have remained small to date, and why financial intermediaries, particularly banks, continue to dominate. But in order to do this, they must build solid reputations so that investors feel comfortable entrusting them with what may be their life savings. They must also offer convenience and appropriate instruments with a reasonable return. Large financial systems have two very important advantages. The first is economies of scale, which allow large banks to operate with low margins.

The second advantage is that such systems can mobilize large amounts of financing for big projects; they can overcome problems of indivisibility. Large projects may require considerable financing, which may be a constraint in some countries that lack large financial intermediaries. How financial intermediaries operate determines not only the quantity of savings, but also the quality. This ensures that the savings are allocated efficiently, which in turn allows them to offer better returns.

Institutions should also be regulated appropriately and should have a high standard of corporate governance so that capital can be allocated efficiently. Note: All measures are simple country averages. Where does the rest of the savings go? A fraction is channeled through informal financial institutions. Most countries have a large number of small, cooperative-type financial institutions.

On top of this, other types of institutions, including nongovernmental organizations NGOs , provide financial services. Microfinance institutions have grown considerably in several countries of the region, and some of them also offer deposit-like instruments Trujillo and Navajas, If savings are highly dispersed—in either small formal or informal financial institutions—and not pooled, then they may not be allocated in the most efficient manner.

In turn, the returns offered to savers may be low, reducing the total amount of savings. Notes:Panel a: vertical axis shows percentage of total. Figures inside first column show savings as percentage of GDP, simple average across countries in the region.

Figures inside second column show the total number of institutions. Panel b: Bubble size illustrates the average of savings as percent of GDP, simple average across countries. Bahamas and venezuela excluded due to lack of complete data. In addition, households may be saving in the form of non-financial assets, ranging from jewelry and consumer goods, such as refrigerators and cars, to houses and other property. They turn to these alternatives for a number of reasons.

They may lack documentation to open an account; they may live far away from a financial institution; opening or servicing an account may be too expensive; or they may simply lack information or trust in financial institutions. In countries where people tend to mistrust the financial system—either because a history of relatively high inflation has eroded the real value of savings, or banking crises have wiped out financial savings—savers may seek to protect the real value of their savings by investing in assets with a better track record as a store of value.

Saving in real estate is more common among high-income households. The use of these mechanisms is especially common among households that in turn are more likely to be excluded from formal financial systems. Again, while these forms of saving may not constitute a large part of total national savings, they can be an important component of the savings portfolio of individual households.

In Mexico and Peru, 20 percent and 33 percent of all surveyed households report saving through a variety of informal mechanisms, while 14 percent and 30 percent of them save using bank accounts, respectively. In Brazil, on the other hand, the saving rate is low irrespective of the instrument: only 4 percent of the surveyed households save informally, while 10 percent of them do so formally. Preliminary evidence from Colombia reveals a pattern similar to that in Mexico and Peru: 18 of the First, the vast majority of surveyed households that save informally in these three countries do so mostly through family, friends, savings groups, or loans to others, and much less by buying assets for the home or business.

Second, households that save formally use saving accounts and employee paycheck accounts, but not other financial instruments that can provide higher long-term returns, such as fixed-term deposits and mutual funds the total share of long-term saving instruments among households saving formally is less than 0.

Third, households that save using both formal and informal instruments are the smallest group of savers in each country. In the context of high macroeconomic volatility, residential real estate has been a popular investment for savers. After the financial crisis of —02, in which the government and many private institutions restructured debts, and many financial contracts were switched from dollars to pesos, Argentines increasingly channeled their savings toward real estate.

Flows into real estate only pertain to the City of Buenos Aires, while the increase in time deposits corresponds to the whole banking sector of the country. All figures are in constant dollars. Moreover, the real estate market absorbed 27 percent more square meters comparing the decade from — with that of to How did the real estate market react?

Cruces finds that real rental rates fell significantly to adjust supply and demand: the net rental rates fell from an average of 7. At the end of the sample, the net rental yield was just 1. The net rental yield on housing can be compared to the returns on alternative investments to estimate the efficiency loss opportunity cost from the money sunk in real estate. The higher end of this range amounts to a loss of 2.

The pattern of saving choices among households in Latin America is very different from a textbook model whereby households save, deposit those savings in banks or other financial intermediaries, which in turn allocate those savings to those in the economy that need the funds to invest. But how different is Latin America from other regions in this respect? In order to address this question, the flow of funds of households in a subset of countries in Latin America and in a comparator group of developing countries outside the region was tracked.

Notes: Computed as simple averages by country over the period — Panel b shows the distribution of total net acquisition of financial assets. This category includes direct ownership of family firms, which is a non-intermediated financial asset, and which makes up the bulk of the account in those countries for which there are data.

The regional averages, however, hide much heterogeneity across countries. For example, in Chile, which has the deepest financial system in the region, 50 percent of funds are channeled into financial deposits and other financial instruments, while only 9 percent goes toward equity.

In Ecuador, which has a smaller financial system relative to the size of its economy, only 25 percent of funds are channeled into financial instruments, and 32 percent go into equity assets. More funds appear to be intermediated in Chile than in other countries in the region, where funds tend to be used more for direct investments.

Chile more closely resembles a country like the Republic of Korea in the comparator group. For the other four Latin American countries, a significantly smaller fraction is intermediated through financial deposits and other financial instruments. Mexico provides an interesting country to analyze in more detail.

National saving as a percent of GDP is reasonably high given income per capita, and household savings constitute some 50 percent of the national total. The household saving rate defined as a residual between disposable incomes and consumption increases from 8. A high share of savings that is not channeled through an integrated formal financial system suggests that resources are being poorly allocated. An interesting question is why these savings are not intermediated. This chapter focuses on the issue of lack of supply, or access.

If many households live far from a formal financial institution, then factoring the costs of travel and time may encourage each individual household to save in an informal instrument even if that instrument pays little in terms of private returns. That informal saving instrument may have very little social return as well, as it may not lead to a very productive investment opportunity.

In this case, if a sudden change in access occurs—for example, a local bank branch opens or mobile banking becomes available—then informal savers may switch instruments and the social return from the extra dollar of savings the difference between the new return and the previous very low return might be very high. A complementary explanation for low intermediation relates to the high informality in labor markets in Latin America and the Caribbean.

McKenzie and Woodruff find that in Mexico self-employed poor individuals receive above market rates of return for very small capital investments. Not surprisingly, these self-employed individuals tend to reinvest heavily in their own family business, buying goods such as refrigerators, trucks, or any other type of durable good that could simultaneously satisfy a consumption need for the household and serve as a capital good for their home business. Thus, these small capital investments may make sense for self-employed individuals or households but are an inefficient use of savings from an aggregate, economy-wide perspective.

While no similar estimates of individual returns are available for other countries in the region, clearly Mexico is not the only country in the region with a large percentage of self-employed, informal entrepreneurs in the economy.

Informality in labor markets also creates a potential barrier to access formal financial instruments because labor income from informal sources is more volatile and is more likely to be paid out in cash. Evidence from surveys conducted in Brazil, Mexico, and Peru supports these patterns.

A higher proportion of households working in the formal economy have access to formal saving instruments, while a higher proportion of informal workers save using informal instruments. In Mexico, 11 percent of households working in the informal labor market save formally compared to 34 percent of households working in the formal economy.

In Peru, the gap is even larger: 16 percent versus 49 percent. In Brazil, this gap is negligible: 10 percent versus 11 percent. Much has been written on the potential obstacles to accessing credit while the potential problems of accessing formal financial savings instruments have been less studied. One interesting finding is the importance of cost and distance as significant deterrents to opening or using a bank account.

Stronger institutions and greater equality are associated with a higher percentage of individuals with accounts in financial institutions. Thus, whether a person has a bank account or not can be looked at as a function of individual as well as country level characteristics. Individual characteristics such as age, income, gender and the level of education are all significant determinants of whether an individual has a financial account see Powell, Women are significantly less likely to have a formal financial account than men, while richer individuals are more likely to have one.

The level of education turns out to be highly significant: individuals with secondary and tertiary education are much more likely to have an account. Note: The figures illustrate that the probability of having a bank account falls sharply for lower income groups as inequality rises while inequality has little effect on rich households. The estimates known as margins plots stem from the estimates of a probit regression and use Findex microdata for the dependent variable the probability of having an account in a financial institution, post office or microfinancial institution.

The explanatory variable in each case is the country Gini coefficient a measure of inequality and a set of micro and macro controls. This result is consistent with an explanation that factors in the behavior of banks and other financial institutions. If there is a fixed cost for using formal financial institutions for savings, then only people with sufficient resources will use those services. Banks will tend to open branches in communities where richer households will use banking services.

If entry barriers to banking are high, the combination of fixed costs and economic inequality may limit the size of banking systems. The result is a financial system that remains relatively small and inefficient and caters largely to wealthier households.

Regional inequalities may exacerbate this pattern. In a larger country, banks will naturally locate in areas where richer households reside. Financial institutions may steer clear of poorer areas, leaving poorer households to travel larger distances and face even higher costs in order to be banked.

The location decision of banks, coupled with fixed and variable transport costs and economic inequality, leads to a banking sector focused on wealthier households of limited size and hence of higher costs, concentrated in specific geographic locations. A large share of poorer households are left with no banks nearby and are very likely unbanked. Typically, empirical work suggests that saving is determined by a set of country-level variables and individual or household characteristics.

This type of analysis suggests that saving is low in the region due to macroeconomic uncertainty, weak institutions, or low household income, for example. Without finer, withincountry information, it is impossible to tease out the nature of the link between the two. It is generally assumed that financial access is driven by the same factors that also govern savings. At the other extreme, a body of literature considers specific interventions that frequently involve improving access to financial services.

Note: Territorial shading illustrates the number of bank branches per 10, inhabitants at the municipal level in Mexico. The cut-off points were obtained by generating quartiles according to the distribution, excluding the municipalities that do not have a bank branch. Banks will naturally tend to open where they expect to find a market for their services. The number of financial institutions increases in municipalities with fewer poorer households.

Moreover, crime rates seem to be positively related with financial institution presence. One explanation may be that in high crime areas, it is more important to keep savings safe in a bank rather than at home. Interestingly, the presence of a high school is associated with a larger bank presence. Not every municipality in Mexico has a high school. Municipalities are generally keen to obtain such an honor, which may be awarded by the state or federal authorities.

One explanation for this relationship is that more people circulate in municipalities with high schools; parents transport their children back and forth to school, and teachers and other personnel come and go to work. Thus, placing a branch in an area with a school rather than one without a school brings greater convenience to a larger number of people. The decision as to where schools are located is not automatic; location decisions appear to be driven as much by politics as by any other factor.

These considerations potentially make school location a useful variable to explain financial presence that is not directly related to savings. How does financial presence affect savings decisions? To research this question, several years of household surveys and information regarding financial presence were matched at the municipality level.

A difficulty is that banks will locate where they think households will use their services. Hence, the measures of financial presence are not used directly. Rather what is used is the estimated financial presence using the preferred proxy: namely, high school presence. As the location of high schools is unrelated per se to savings behavior directly but is a good predictor of bank presence, it appears to be a valid instrument for this analysis. In theory, the effect could go either way.