Savings:

Owned by keithwoodlock (Unlicensed)
Last updated: Mar 27, 2013
5 min read

Introduction

Savings mobilization is a demand-driven activity. Any savings institution,whether a bank, credit union, or other type of microfinance institution (MFI), must offer savings products that meet the demands of existing and potential clients. A savings institution asks savers to place their funds within its care taking and then uses those funds to finance its loan portfolio.

This relationship reverses the traditional power dynamic between clients and MFIs in which borrowers approach the institutions to ask for loans. In this new dynamic, a savings institution must market and sell itself to clients; it must convince savers that their savings will be safe and well managed.

A savings institution will be successful only if it can demonstrate to clients that it is safe and secure.Secondly, savers look for convenience: access and liquidity. They want to be able to access their funds whenever they need or desire them. Thirdly, savers look for a positive return on their savings. Savers place priority in this order: safety, convenience, and return.

These priorities shape the way savings programs are developed with savings products being tailored to meet client demands. Building a safe and sound savings institution involves establishing sound financial disciplines that will protect the value of savings. The effective design and management of savings products provides savers the convenience and return they seek.

Once a savings institution designs products to meet the local demand, it must effectively manage those products. Savings policies define the products offered and outline the procedures by which their liquidity, pricing, and transactions are managed. Savings policies should be updated regularly in response to market demand in order for products to remain competitive in the marketplace.

Interest rates determine the returns savers will receive on their deposits. To mobilize savings on a large scale, savings institutions must offer attractive rates. When setting interest rates, savings institutions

should pursue three general principles:

  1.  market-driven, competitive rates;
  2.  cost-based rate setting; and
  3.  real return on savings.

In addition to these principles, institutions should also consider the core characteristics of each product, together with the associated transaction costs, so that savings products are cost-effective for the institution, as well as gainful for the saver.

For institutions that have not offered savings services previously, the introduction of a savings program presents a new set of risks. Savings institutions should establish policies and procedures for liquidity management, cash management, and implementation of internal controls to address the new risks.

Savings Products

Savings products are built in three ways. Products are designed to balance the trade-off between liquidity (access) and return (compensation). Savings products are tailored to respond to the demands of particular market niches; for example, farmers who save in large amounts after a harvest and withdraw savings gradually through the year, or youth who save in small amounts due to limited incomes. Products are adapted to the purposes for which clients save; for example, to pay education fees or to purchase large expense items such as appliances or homes. In any case, products should be designed to satisfy local client demands for savings services.

Savings products exist along a continuum of trade-offs between liquidity (access) and return (compensation). Some products offer complete access to deposits (withdrawals whenever the saver wishes) with relatively low returns. Other products restrict liquidity (withdrawals), but offer higher returns.

Savings Products Matrix

The base rate mentioned in 'interest rate' column is the minimum rate offered by savings institute.

Product CharacteristicsCommentsAdvantages & Disadvantages
Passbook Savings
  • Targeted at micro and small savers
  • Interest rate is 'base rate' but can be setup to increase with increasing account balance
  • Zero or low minimum required opening deposit
  • Zero or low minimum passbook balance (before accruing interest)
  • Unlimited/fully liquid withdrawals

Some credit unions establish a minimum passbook balance before interest can accrue.

Accounts below the minimum balance do not earn interest. This allows an institution to offset the maintenance costs of smaller accounts, where transaction costs are high relative to the balance of the account. At the same time, it offers the smallest savers a store of value for their savings as well as the opportunity to build their accounts over time from small amounts to larger ones that do earn interest.

 

Withdrawal policy. As fully liquid products, passbook accounts generally allow unlimited withdrawals. Some credit unions have experimented with semi-liquid variations of passbook accounts that limit the number of withdrawals per month or charge fees for withdrawals over a certain number. Such limited passbook accounts have proven to be less popular than basic passbook products;

Advantages:The advantages of the passbook account for the client are twofold:

  1. it provides easy access for withdrawals,and
  2. it offers a market return on savings.

For the savings institution, the passbook savings product can be an abundant and low-cost source of funds. It is also the master account that supports other financial services and products. For instance, passbook accounts can serve as the crediting accounts for loan disbursements, as the receiving accounts for wire transfers, or for the liquidation of fixed-term certificates of deposit when they mature.

Disadvantages:

The drawbacks of this account for a savings institution are:

  1. high transaction costs when the balances are low or when withdrawals are frequent,
  2. high operating costs to administer transactions and calculate interest in non-computerized institutions, and
  3. volatility of deposits and withdrawals. These factors can complicate daily and weekly cash flow management and therefore command disciplined savings management.
    

Fixed-Term

Certificates of Deposit

  • Net savers who seek to maximise returns
  • Interest rate is higher than base rate (2-3%) and even higher for longer terms / higher deposits
  • High minimum opening deposit required
  • Minimum balance is define at opening of account
  • Withdrawals typically only when reaching maturity

Interest rate: The interest rate is set when the certificate of deposit is signed. The interest is paid upon maturity for all fixed-term products. To compensate the saver for sacrificing liquidity, these accounts offer higher rates of return than other products. Fixed-term funds tend to be interest rate sensitive. As fixed-term deposits come to maturity, clients will renew the certificates or move them elsewhere, according to where they find the best returns.

Withdrawal policy. As a general rule, fixed-term deposits may not be withdrawn until the date of maturity. In some cases, however, the early withdrawal of some or all funds may be approved, but the client pays a penalty for early withdrawal.

Advantages: For the client, fixed-term certificates of deposit offer higher interest rates than other savings products. Fixed-term savings can also serve as security for loans.

The primary advantages of fixed-term products for a savings institution are in cash flow and liquidity management. Since both the price and the term of the product are fixed through a contract at the outset, the savings institution can use the funds in fixed-term accounts to finance longer-term loans or investments. Fixed-term products have lower administrative costs, with only one initial deposit transaction and one withdrawal transaction upon maturity.

Disadvantages: The higher financial cost of funds from fixed-term accounts is the primary disadvantage for the savings institution. Another drawback is that there is no guarantee of renewal upon maturity of the term, as renewal decisions are sensitive to interest rates.