Why do poor people so often take on more debt than they can handle? Often, it begins out of sheer necessity: debt is taken on to make ends meet, but most income is spent on paying it off, leaving no choice but to incur even more debt to cover daily expenses. This “debt cycle” leaves people unable to save any money and unable to improve their circumstances. But behavioral economics research has shown that low income alone does not explain this debt trap. Lack of self-control and unrealistic planning are also important factors. These problems shared by people at all income levels, but their consequences may be particularly damaging for those whose income is low to begin with.
ideas42 approached this problem with the idea that if low-income families could forgo borrowing in the first place, they could save the interest they would have paid on the loan as well as the resulting interest on these savings; these combined earnings should remove the need for borrowing in the future. The household would thus enter a “savings cycle” in which they would gradually accumulate savings, spend the accrued savings on necessary purchases, and put away a small part of their income from which to draw more savings. For this idea to work, the design would have to address the human fallacies of planning and self-control , and incorporate features to help avoid those pitfalls.
ideas42 partnered with the Centre for Innovative Financial Design (CIFD) and Shashtradhara Kshetriya Gramin Financial Services (SKGFS) in India to design and pilot a debt-to-savings product called the Poultry Loan. The product had two parts: a loan that allowed borrowers to set up their own backyard poultry farming unit as a means of making extra money, and a loan repayment structure that automatically placed part of the payment into savings. The idea was that the proceeds from selling the poultry would cover the cost of the original loan and some day-to-day expenses, and any money left over would automatically be allocated to a savings account. Aligning the automatic savings with the loan repayment acted as a commitment device for the borrowers: they had to pay back their loans, and the transfer to savings happened at the same time with no extra effort on their part. The poultry farms served as a new supply chain that allowed us to create a liquidity moment and trap savings at the point of payment.