Bridging the Gap between Formal and Informal Finance

Abstract: Financial inclusion, defined as access and usage of formal financial services, has several positive micro and macro-level socio-economic implications. Due to decades of vigorous policies aiming at lowering barriers to formal finance, 80 percent of Indians now own a bank account. However, there is a significant gap between account take up and usage. One reason for low usage rate is persistent informal saving. The purpose of this thesis is to shed more light on what affects propensity to save formally and informally via different saving vehicles, namely bank accounts, gold, social networks and self-help groups (SHGs). By using a series of multivariate logistic regression models, this thesis analysed a comprehensive and recent household dataset from India. The main findings are: 1) women and men are as likely to save, but they have different saving preferences, 2) social networks play an important role in sustaining informal finance, 3) financial literacy does not have a statistically significant impact on savings, and 4) some financial inclusion policies have a negative effect on propensity to save formally. Since different saving vehicles carry multiple purposes, it might be difficult to fully substitute informal saving. For instance, the risk sharing and the social capital function of saving via social networks or the cultural dimensions of women owning gold cannot directly be substituted by formal finance. Our recommendation is to shift the focus to demand-side financial inclusion policies with special focus on women and economically vulnerable groups.