Financial inclusion, financial literacy, and financial education in Georgia

Babych, Yaroslava; Grigolia, Maya; Keshelava, Davit Working Paper Financial inclusion, financial literacy, and financial education in Georgia ADBI Working Paper, No. 849 Provided in Cooperation with: Asian Development Bank Institute (ADBI), Tokyo Suggested Citation: Babych, Yaroslava; Grigolia, Maya; Keshelava, Davit (2018) : Financial inclusion, financial literacy, and financial education in Georgia, ADBI Working Paper, No. 849, Asian Development Bank Institute (ADBI), Tokyo This Version is available at: https://hdl.handle.net/10419/190270 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/3.0/igo/ ADBI Working Paper Series FINANCIAL INCLUSION, FINANCIAL LITERACY, AND FINANCIAL EDUCATION IN GEORGIA Yaroslava Babych, Maya Grigolia, and Davit Keshelava No. 849 June 2018 Asian Development Bank Institute The Working Paper series is a continuation of the formerly named Discussion Paper series; the numbering of the papers continued without interruption or change. ADBI’s working papers reflect initial ideas on a topic and are posted online for discussion. Some working papers may develop into other forms of publication. Suggested citation: Babych, Y., M. Grigolia, and D. Keshelava. 2018. Financial Inclusion, Financial Literacy, and Financial Education in Georgia. ADBI Working Paper 849. Tokyo: Asian Development Bank Institute. Available: https://www.adb.org/publications/financial-inclusion-financial-literacy- and-financial-education-georgia Please contact the authors for information about this paper. Email: [email protected], [email protected], [email protected] Yaroslava Babych is assistant professor of economics at the International School of Economics of Tbilisi State University, ISET Policy Institute. Maya Grigolia is a senior researcher and Davit Keshelava is a researcher, both at the ISET Policy Institute. The views expressed in this paper are the views of the author and do not necessarily reflect the views or policies of ADBI, ADB, its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms. Working papers are subject to formal revision and correction before they are finalized and considered published. Asian Development Bank Institute Kasumigaseki Building, 8th Floor 3-2-5 Kasumigaseki, Chiyoda-ku Tokyo 100-6008, Japan Tel: +81-3-3593-5500 Fax: +81-3-3593-5571 URL: www.adbi.org E-mail: [email protected] © 2018 Asian Development Bank Institute ADBI Working Paper 849 Babych, Grigolia, and Keshelava Abstract In this paper, we provide a comprehensive overview of the current state of financial inclusion and financial literacy in Georgia based on the latest literature, statistical evidence, and recent surveys. The paper reviews current government policy initiatives and strategy documents aimed at improving financial access of SMEs and households; analyzes the state of the regulatory framework in Georgia; focuses on the causes behind the current low levels of financial inclusion and financial literacy among the young, the poor, and the rural population; and provides policy recommendations to comprehensively address the financial inclusion problem in Georgia. Keywords: economic development, financial stability, financial literacy, financial inclusion, financial education JEL Classification: G20, G21, G23, G28 ADBI Working Paper 849 Babych, Grigolia, and Keshelava Contents 1. INTRODUCTION ......................................................................................................... 1 2. OVERVIEW OF THE GEORGIAN FINANCIAL SYSTEM ........................................... 2 2.1 Sources of Financial Services for Individuals and SMEs ................................ 2 2.2 Deposits .......................................................................................................... 3 2.3 Lending ............................................................................................................ 4 2.4 Insurance ......................................................................................................... 6 2.5 Pensions Services ........................................................................................... 6 2.6 Capital Markets ............................................................................................... 6 2.7 Remittances .................................................................................................... 7 2.8 Technologies Driving Financial Sector Development ...................................... 8 2.9 P2P Lending and Crowdfunding and Cryptocurrencies ................................... 9 3. STATUS OF FINANCIAL INCLUSION FOR INDIVIDUALS AND SMES .................. 10 3.1 Access Indicators .......................................................................................... 10 3.2 Usage Indicators ........................................................................................... 12 3.3 Financial Inclusion of SMEs .......................................................................... 15 3.4 Summary ....................................................................................................... 16 4. BARRIERS TO FINANCIAL INCLUSION .................................................................. 16 4.1 Supply Side Barriers ...................................................................................... 16 4.2 Demand Side Barriers ................................................................................... 18 5. REGULATORY FRAMEWORK AND FINANCIAL INCLUSION ................................ 20 5.1 Regulatory Framework and Policies to Promote Financial Inclusion for SMEs and Households ............................................................................. 20 5.2 Structure of Regulatory Framework............................................................... 22 5.3 New Regulations Affecting Consumer Protection and Access to Finance .... 22 6. FINANCIAL EDUCATION AND FINANCIAL LITERACY IN GEORGIA: WHAT DO WE KNOW? ............................................................................................ 23 6.1 Financial Literacy .......................................................................................... 24 6.2 Financial Attitudes and Behavior ................................................................... 24 6.3 Financial Education Strategy of Georgia ....................................................... 27 7. CONCLUSIONS AND RECOMMENDATIONS ......................................................... 28 7.1 Main Takeaways from the Study ................................................................... 28 7.2 Recommendations ........................................................................................ 29 REFERENCES ..................................................................................................................... 31 ADBI Working Paper 849 Babych, Grigolia, and Keshelava 1 1. INTRODUCTION Financial inclusion, broadly defined as the access of households and firms (in particular low income and SMEs) to financial services,1 has become one of the most important issues in modern development discourse. While cross-country studies can offer a bird’s-eye view of the general patterns that are common across countries, each developing country has its unique set of problems related to the financial inclusion of vulnerable households and small/medium size businesses. In this respect Georgia offers an interesting case study. Georgia is a country of 3.7 million,2 situated in the South Caucasus, bordering the Russian Federation, Turkey, Azerbaijan, and Armenia. After gaining independence in 1991, the country experienced the deepest economic collapse among the transition economies, exacerbated by several wars and refugee crises. Following the Rose Revolution of 2003, the country’s economy and in particular its financial system has also undergone deep structural transformations, increasingly attracting foreign capital participation.3 The National Bank of Georgia (NBG) managed to establish and maintain a rather strong micro and macro-prudential regulatory system, slowly restoring trust in commercial banks. 4 The structural transformation of the banking system implied consolidation, reducing the number of players on the market.5 At the same time, the number of people serviced by the commercial banks was rising continuously as well.6 In this respect, Georgia’s indicators outperformed the average for Europe and Central Asian countries (excluding the high-income countries). Despite impressive progress in financial access across several dimensions, Georgia remains one of the countries with the highest poverty rates in the region.7 Various surveys, including the quarterly Business Confidence Index run by ISET-PI, also indicate that access to finance remains one of the biggest obstacles to doing business for SMEs. Thus, the question of whether the poorest population and small businesses remain underserved by the financial system, and what are the obstacles to greater financial inclusion for these groups remains open. One possibility is that access to finance is impeded by low incomes of households and low profitability of small businesses. In this regard, the question is whether policy-makers have access to 1 N. Yoshino and P. Morgan, Overview of Financial Inclusion, Regulation and Education, Working Paper No, 591, ADBI Working Paper Series, 2016. 2 National Statistics Office of Georgia (Geostat). Population statistics, 2017 http://www.geostat.ge/ index.php?action=page&p_id=152&lang=eng 3 In 1995, just three out of 211 banks were foreign-controlled, while in 2016 the vast majority (11 out of 19 commercial banks) had 50% or more foreign capital participation. 4 While NBG tightly controlled commercial banks, the non-bank financial institutions were much less regulated until recently. The details of the regulatory environment will be discussed in Section 6 of the paper. 5 The number of banks operating in Georgia reduced from 211 in 1995 to just 19 in 2016, with the two largest banks currently controlling 60% of the total assets of the banking system. 6 For example, the number of borrowers from commercial banks per 1,000 adults grew from 32 in 2004 to 680 in 2015, and the number of commercial bank branches per 100,000 adults rose from 9.3 to 31.9 during the same period. 7 Poverty rates have been coming down substantially in recent years (Ref: World Bank, World Development indicators). Despite this, the country’ poverty headcount ratio at $3.10 per day substantially exceeds the corresponding rates for the whole region (25.27% of the population in Georgia, vs. 6.24% in ECA countries) and even for the neighboring countries, such as Armenia (14.62% of the population in Armenia). ADBI Working Paper 849 Babych, Grigolia, and Keshelava 2 medium-term solutions to this problem, and whether greater financial literacy levels could improve the situation for poorer households and small firms. This paper provides an overview of the current financial sector situation in Georgia and investigates the obstacles to financial inclusion based on an analysis of the available statistical data, the most recent studies and reports on the subject, as well as the results of the most recent surveys. 2. OVERVIEW OF THE GEORGIAN FINANCIAL SYSTEM 2.1 Sources of Financial Services for Individuals and SMEs In the last 27 years, the Georgian financial system has undergone substantial structural changes. The level of financial access for individuals and SMEs has also changed quite dramatically. Despite the fact that between 1996 and 2017 the number of banks in the country decreased from 174 to just 16, access to banking services via bank service points (branches) increased more than three times (from 242 bank branches in 1996 to 826 in 2016). The number of registered microfinance organizations increased drastically from two in 2004 to 81 in 2016. Unfortunately, until 2013 no data was gathered by NBG on non-regulated financial lending institutions, such as pawnshops. The first survey of pawnshops in 2013 accounted for 1,307 organizations around the country8. Currently (2016 and 2017), financial services in Georgia are provided by 16 banks, 11 non-bank depository corporations (e.g. credit unions), 14 insurance corporations, of which two are private pension schemes, 81 microfinance organizations, 1,307 pawnshops, 9 the stock exchange, six brokerage companies (securities dealers), 124 money remittances units, and 1,200 active foreign exchange bureaus. The overall size of the financial sector in Georgia has grown quite impressively. In 2000 total assets of financial corporations accounted for 31.8% of GDP, in 2016 this share was already 127.4% of GDP. The most rapid growth spurt occurred between 2005 and 2007 (total financial sector assets grew 1.4 times in absolute terms, increasing from 38.5% to 63% of GDP). Since the growth spurt, financial sector assets grew at a steady pace of 17% per year on average.10 The total assets of microfinance organizations in particular grew from 0.02% of GDP to 8.03% of GDP in just 10 years (between 2006 and 2016). Despite the impressive growth in the microfinance sector in recent years, the financial system remains largely dominated by commercial banks. They account for 70% of the financial sector’s total assets. 11 Other financial corporations, like insurance companies, microfinance organizations, and pawnshops account for about 8% of total financial sector assets. Of these, 80% are controlled by microfinance organizations. 8 Pawnshop Survey. National Statistics Office of Georgia, 2013. http://www.geostat.ge/cms/site_images/ _files/english/finance/Pawnshop%20survey%20results.pdf 9 2013 survey data. 10 Excluding the year of the financial crisis, 2009. 11 NBG, 2016 data. ADBI Working Paper 849 Babych, Grigolia, and Keshelava 3 Figure 1: Share of Financial Sector Assets Controlled by Different Financial Organizations in Georgia Source: NBG. 2.2 Deposits The market for deposits in the country is also dominated by commercial banks. Non-bank depository institutions, such as credit unions, account for a tiny proportion (0.0326%) of the total deposits in the economy. The value of total deposits in commercial banks (both in domestic and foreign currency) amounted to GEL18.7 billion ($7.75 billion) by the end of Q3 2017, the same variable for non-bank depository institutions amounted to only GEL6.1 million ($2.5 million). Other financial institutions, such as microfinance organizations, are barred by law from taking deposits. However, they are allowed to enter into loan agreements with private individuals and firms. Such loan agreements typically offer significantly higher interest rates on both foreign and domestic currency than regular bank deposits.12 In the last 12 years, the number of commercial bank deposit accounts per 1,000 adults has been growing steadily; in 2005 there were 366 household deposit accounts per 1,000 adults, in 2016 this figure already reached 1,798 – a five-fold increase. The indicators of access to deposit accounts have shown improvement over the years, but more so for households than for SMEs. As the figures above indicate, outstanding deposits of SMEs with commercial banks, as a share of GDP, remained flat for the last 8 years (at the level of 3.1% to 3.7% of GDP), while household deposits grew impressively from 6.02% to 21.28% of GDP. While it is difficult to pinpoint the exact reason for this phenomenon, the low level of financial literacy may play a role here. Another concern is that remaining in the “shadow” of mainstream economic activity is still the preferred way of doing business for SMEs. 12 Since July 2017, microfinance organizations can only enter into such loan agreements with customers if the amount of funds loaned exceeds GEL100,000 or an equivalent in US dollars. This regulation helped move large amounts of de-facto deposits from microfinances to commercial banks. For microfinances it means that they will increasingly rely on commercial bank loans for liquidity. ADBI Working Paper 849 Babych, Grigolia, and Keshelava 4 Figure 2: Outstanding Deposits with Commercial Banks, % of GDP (Total, Household, SMEs) Source: IMF Financial Access Survey (FAS). 2.3 Lending Commercial banks in Georgia also dominate the market in the total amount of loans issued. The amount of loans granted by banks to non-government, non-financial sector, and households is roughly 13 times the amount of loans granted by the microfinance institutions.13 Overall, microfinance organizations lent GEL1.4 billion by the end of 2016 (equivalent to $0.59 billion14), while the commercial banks’ total nonfinancial sector loans amounted to GEL18.9 billion ($8.0 billion). In absolute terms, banks dominated the market in lending to households. By the end of 2016 the microfinance organizations’ loan portfolio was about GEL1.4 billion (the vast majority of these loans are to households and small business clients), while the commercial banks’ household lending was GEL8.9 billion ($3.76 billion). In relative terms, commercial banks’ loans to households comprise just above 50% of their total loan portfolio. In contrast, the microfinance organizations’ portfolio consists almost entirely of household and small business lending. The figures on micro lending presented here do not include pawnshops. The pawnshops are periodically surveyed by the National Bank of Georgia,15 which allows us to judge the relative size of the pawnshop lending market. For example, in the 2013 survey pawnshops had in total GEL310 million ($186 million) in outstanding loans, whereas the microcredit institutions in 2013 had about twice as much – GEL620 million (or $373 million). 13 For example, at the end of 2016 the total loans of the commercial banking sector amounted to GEL18.9 billion, while the loans of microfinances amounted to GEL1.4 billion. 14 GEL amounts converted to dollars at the average annual exchange rate for the corresponding year. 15 The pawnshop survey is scheduled to be repeated in 2017–2018. ADBI Working Paper 849 Babych, Grigolia, and Keshelava 11 Figure 5: Branches of Commercial Banks per 100,000 Adults in the South Caucasus Source: Financial Access Survey, WB. Figure 6: The Number of ATMs per 100,000 Adults in the South Caucasus Countries Source: Financial Access Survey, WB. Other indicators of financial access have also been evolving quite rapidly. For example, the number of POS terminals has increased three-fold in the last 5 years. The number of branches of Payment Service Providers (PSP) has also increased quite dramatically, from 641 to 1,769 in 5 years. ADBI Working Paper 849 Babych, Grigolia, and Keshelava 12 3.1.2 Geographic and Demographic Outreach One of the first indicators of geographic outreach in financial services is the number of bank branches and ATMs available outside the major cities (Tbilisi, Batumi, and Kutaisi). The data shows a clear improvement in the absolute number of ATMs and bank branches available in the regions (the number of ATMs outside the three major cities rose from just 31 in 2005 to 674 in 2016; the number of bank branches grew from 141 in 2005 to 427 in 2016). Yet, a significant share of the population in the regions of Georgia remains underserved. According to the latest (2014) Census figures, the Georgian population in the three largest cities accounts for 36.5% of the total population. In the same time, the bulk of access to financial services was concentrated in the largest cities. This can be illustrated by the simple fact that the share of ATMs in the three largest cities compared to the total number of ATMs in the country was about 70% in 2016, much higher than the share of the population living in these cities. The share of ATMs in the three largest cities was even higher in 2005, reaching 83% of the total. Similarly, the share of bank branches in the three largest cities is about 56% of the total, although, as mentioned earlier, the share of the population living in the largest cities is about 36.5%. 3.2 Usage Indicators 3.2.1 Deposit or Savings Accounts Table 1 below gives a snapshot of the deposit/savings account access status for the adult population in Georgia, 2014, in comparison with the ECA region and lower middle-income countries. Table 1: Select Financial Inclusion Indicators for Georgia, 2014 Financial Inclusion Indicators for Georgia (2014) Country Data Europe and Central Asia All Lower Middle- Income Countries Accounts (% age 15+) All adults 39.7 51.4 42.7 Women 39.8 47.4 36.3 Adults belonging to the poorest 40% 28.6 44.2 33.2 Young adults (% ages 15–24) 9.9 35.6 34.7 Adults living in rural areas 40.1 45.7 40.0 Source: Global Financial Inclusion Survey, WB. The most striking feature of financial inclusion in Georgia is the extremely low percentage of young adults with deposit or savings accounts (9.9%, as compared to 35.6% in the ECA region). This result is likely driven first by the low rate of economic activity among youth (57.6% of the 20–24 age cohort in 2016 were economically active) and high rate of unemployment in this cohort (30% in 2016). Secondly, lack of economic independence leads to the lack of financial inclusion among the youth. As the data in Table 1 indicates, adults belonging to the poorest 40% of the population are also underserved compared to the regional average and to the indicator for lower middle-income economies. On the other hand, the share of women with deposit or savings accounts in Georgia is about 39.8%. This number is higher than in other low middle-income countries (36.3% of the population), but still lower (by about seven percentage points) than in the ECA region. ADBI Working Paper 849 Babych, Grigolia, and Keshelava 13 3.2.2 Credit Usage Indicators In terms of access to credit, Georgia is one of the countries with the greatest ease of access in the South Caucasus.37 Figure 7: Getting Credit: Distance from the Frontier in the South Caucasus Countries Source: G-20 Financial Inclusion Indicators. Figure 8: Borrowers from Commercial Banks per 1,000 Adults Source: IMF Financial Access Survey (FAS). 37 According to G-20 Financial Inclusion Indicators, the Getting Credit indicator measures “the strength of credit reporting systems and the effectiveness of collateral and bankruptcy laws in facilitating lending. Measured as ‘distance to frontier’... This measure shows the distance of each economy to the WBG Doing Business ‘frontier,’ which represents the best performance observed on each of the indicators across all economies in the sample since 2005…. An economy’s distance to frontier is reflected on a scale from 0 to 100, where 0 represents the lowest performance and 100 represents the frontier. For example, a score of 75 in DB 2015 means an economy was 25 percentage points away from the frontier constructed from the best performances across all economies and across time.” Source: G-20 Financial Inclusion Indicators note, GPFI Global Partnership for Financial Inclusion. Retrieved January, 2018 from http://datatopics.worldbank.org/g20fidata/home#void ADBI Working Paper 849 Babych, Grigolia, and Keshelava 14 Georgia is ahead of Azerbaijan and some Central Asian countries on the number of borrowers from commercial banks per 1,000 adults. Yet, in recent years the indebtedness of households (measured by principal payments to income ratio) grew rapidly. In 2015, the debt service to income ratio reached 12.8%. The debt service to income started declining in 2015–201638 only to increase again following another round of GEL depreciation reaching a record high of 13.6% in the third quarter of 2017. Figure 9: Household Debt Service: Principal Payments to Income Ratio Source: NBG. In addition, the amount of real estate and movable property repossessed by microfinance firms has increased very sharply in 2013 and then again in 2015 (from GEL2.5 million in Q1 2013 to GEL16.7 million in Q3 2017 – more than 6.5 times). The rapid increase of defaults was most likely due to the fact that most of these loans were denominated in US dollars, creating currency mismatch problems for indebted households. Despite the fact that household finance indicators showed clear signs of stress, in particular after Q1 2015, non-performing loans (NPL) as a share of the total loans of commercial banks remained quite low and stable (the average NPL was 7.6% between Q1 2015 and Q2 of 2017, based on the more conservative NBG methodology for tracking NPLs. According to the IMF methodology the NPL share was just 3.3% on average in the same period). This discrepancy suggests that financially vulnerable groups of population still remain outside the realm of bank lending. Thus, in Georgia the rapid growth in consumer credit prompted concerns about the sustainability of credit expansion. Georgia’s main financial concern was not so much about access to credit, but about making sure that borrowers were protected and were making informed decisions. Since then, the government of Georgia and the NBG called for stronger consumer protection measures, pushed for rapid de-dollarization of small and medium-size loans and stepped up the efforts to promote financial literacy. Sections 5 and 6 of the paper examine these issues in greater detail. 38 Most likely the decline was caused by the fact that fewer households qualified for loans from banks in that period. ADBI Working Paper 849 Babych, Grigolia, and Keshelava 15 3.3 Financial Inclusion of SMEs As mentioned earlier, while the financial access indicators for households were growing rapidly, the same indicators for SMEs stayed largely the same. According to the World Bank Enterprise Survey 2013 data, 20.4% of SMEs identified finance as a major constraint (in the ECA region this figure for SMEs is 16.4%). Outstanding loans to SMEs accounted for only 7.5% of GDP in 2016, while outstanding loans to households account for 26% of GDP in the same year. The share of SMEs with a bank loan or line of credit constituted 30.3% of the firms, the same percentage as in the ECA region and 2 percentage points higher than the world average. This indicates that while receiving a loan per se may not be a problem for SMEs in Georgia (as compared to the ECA region and other countries), securing the desired amount of funding may be problematic. From the table one can see for example that only 7.2% of SMEs reported their recent loan application rejected, while the figure is much higher, 14.6%, in the ECA countries. Table 2: Enterprise Survey for Georgia, 2013 Indicators, Enterprise Survey, 2013 Georgia All Firms Georgia SMEs Europe & Central Asia SMEs All Countries, SMEs Percentage of firms with a bank loan/line of credit 35.8 30.3 32.7 28.3 Proportion of loans requiring collateral (%) 95.6 97.9 75.7 77.3 Value of collateral needed for a loan (% of the loan amount) 223.3 232 197.9 217.5 Percentage of firms whose recent loan application was rejected 4.6 7.2 14.6 14.9 Percentage of firms using banks to finance investments 22 15.3 22.3 23.2 Percentage of firms identifying access to finance as a major constraint 18.3 20.4 16.4 27 Source: World Bank Group. Finally, an important indicator of financial access for both households and firms is the cost of funds, in Georgia’s case the cost of funds is largely determined by interest rates on loans charged by different financial institutions. Figure 10 below indicates that real interest rates on loans have been on a declining trajectory since 2012.39 Real interest rates went up again briefly in 2015 following the regional crisis and devaluation of GEL, then started falling again from September 2016, when the currency value stabilized. From January 2017 a new law prohibited the issue of loans in foreign currency for loan amounts below GEL100,000 (this was part of the de-dollarization campaign by NBG and the government). Since most banks and microfinance organizations raise funds in US dollars, the cost of financing lari loans has increased. According to interviews with bank and MFI executives the cost of hedging the currency risk on a lari loan increased from 3–4% to over 10%. Part of these cost increases could be passed on to the consumers in the form of higher interest rates, although some financial institutions opted to keep lending interest rates at about the same level in 39 The prominent dip and a sharp rise in real interest rates during the years after the financial crisis of 2008–2009 was largely driven by the behavior of the inflation rate, which fell in September 2009 and rose sharply again until May 2011. ADBI Working Paper 849 Babych, Grigolia, and Keshelava 16 order to avoid raising the risk of their customer pool. The interest rates on loans in foreign currency, on the contrary, decreased. Figure 10: Market Real Interest Rates on Loans in National Currency, by Category Source: NBG. 3.4 Summary To summarize the results of this section, Georgia has been improving rapidly on a number of financial inclusion indicators, in particular in the access to payments systems, new financial technologies, number of savings/deposit accounts, and credit to households. For households, the main concern is not so much the access to credit, but rather low levels of income, low levels of savings, provision for retirement, and low levels of financial literacy. The SMEs in Georgia report problems with access to finance. According to the data, access to deposit and savings accounts is high for SMEs, but in fact SMEs save very little. Moreover, while the number of SMEs with loans and lines of credit from the bank is reasonable (on a level with the world and regional average), SMEs may be credit constrained in the sense that the amount of funds they can secure from banks is seen as insufficient for the development of the business. Interviews with commercial bank and MFI executives point largely in the same direction – many SMEs would like to borrow more than their financial situation could allow. 4. BARRIERS TO FINANCIAL INCLUSION 4.1 Supply Side Barriers The supply side barriers to financial inclusion refer to the factors which limit the ability of financial institutions to extend deposit, savings, and/or credit to households and businesses. Among them the literature distinguishes between market driven, regulatory, and infrastructure-related barriers. ADBI Working Paper 849 Babych, Grigolia, and Keshelava 17 Among the main markers of market-driven barriers to financial inclusion identified in the literature are: • relatively high maintenance costs of small deposits and loans; • high costs of providing financial services in small towns and rural areas (e.g. transport-related problems); • information asymmetry on the market (lack of credit data about the clients and/or lack of usable collateral); • lack of convenient access points to financial services. Among the markers for regulatory barriers are: • strict requirements for opening branches and ATMs; • strict identification requirements which can limit access of poor households; • restrictions on foreign ownership may restrict the entry of financial institutions, including MFIs. The infrastructure barriers could be inferred from: • lack of reliable payments and settlements system; • limited availability of phone access (either fixed or mobile phones); • lack of convenient transport to ATMs; • lack of reliable internet connection. From the data presented in the previous section, small town and rural areas in Georgia may indeed be underserved in terms of access to financial infrastructure, such as ATMs, bank branches, etc. Georgia is behind the regional average (Europe and Central Asia) in access of rural, and particularly poor households to financial services, such as deposit accounts.40 The existing data, unfortunately, does not provide a clear answer as to the drivers behind low financial inclusion figures. We have conducted a series of interviews with the executives of large commercial banks and MFIs in Georgia to better assess the issue of supply-side barriers. According to the interviews, the cost of servicing small loan and deposit accounts is not the main obstacle to financial inclusion. The costs of providing services outside major cities and servicing the lower-income population may indeed be higher, especially for MFIs which mainly serve households, including lower income households. For MFIs, about 6 percentage points of the interest rate on household loans are due to operational cost requirements. Thus, the operational costs are estimated to contribute about one-quarter to the total cost of credit. This includes the need to maintain and train staff (one of the large MFIs with a loan portfolio of GEL150 million maintains 50 branches around the country and a staff of around 800 employees). 40 Table 1 indicates that 28.6% of adults belonging to the poorest 40% of the population have deposit accounts, which is about 5 percentage points lower than in other lower middle-income countries, and 16 percentage points lower than in the ECA region. About 40% of adults in rural areas are served with deposit accounts, which is 4 percentage points lower than in the ECA region, but the percentage of the rural population served is about the same in other lower-middle income countries. ADBI Working Paper 849 Babych, Grigolia, and Keshelava 18 Informational asymmetry is less of a problem for MFIs, who adhere to a relationship-based banking model. Even commercial banks in Georgia have largely avoided this problem thanks to the credit database maintained and shared among the financial institutions. The subscribers to the database can see whether a particular physical person or a company has ever defaulted, the number of defaults, and the size of defaults. The presence of a customer’s name in the database is not an automatic reason to disqualify a loan application, and financial institutions look at the pattern of defaults or amount of defaults to assess the client’s creditworthiness.41 Transport and access to financial services is not a major problem, considering that large MFIs and the commercial banks oriented on servicing small deposits and loans (e.g. Liberty Bank, which services government-provided pension plans for the elderly population) have already established extensive networks outside of the major cities, relying on the so-called mobile branches to reach their client base. The regulatory barriers to access in Georgia are probably least problematic, as there are no strict requirements on operating branches and ATMs, and no restrictions on foreign ownership for financial institutions (which could limit the amount of foreign funds entering the market). The current regulations on identification requirements are indeed cited by the banks as one of the problems for increasing financial access. According to regulations, opening a bank account requires the physical presence of a customer (business or a household client) in the branch to sign the required documents. Although e-signature technology is available, it cannot be used at present to open a deposit account. The infrastructure barriers, such as poor internet connection, lack of phone (mobile or landline) network, transport, etc. are not a major concern for the financial institutions. The number of mobile subscriptions in Georgia is quite high – 129 per 100 persons in 2016, which is higher than in other countries of the South Caucasus and higher than in the region (Europe and Central Asia’s average is 125 per 100 persons). Internet coverage is available throughout the country, although internet usage in Georgia is not as widespread as mobile phone usage. According to World Bank data only 50% of the population in Georgia use the internet, as compared to 73.9% in the ECA region, 62% in Armenia, and 78.2% in Azerbaijan. While the use of mobile or internet banking may not be widespread, the usage is rapidly improving, suggesting that there is large potential for including a larger share of the population in the financial services. 4.2 Demand Side Barriers Demand side barriers to financial inclusion consist of all the factors that can limit the demand of households for financial services. The major factors include but are not limited to the following aspects: • low income levels of the population; • lack of knowledge (low levels of financial literacy); • lack of trust towards financial institutions; • institutional aspects, for example, bankruptcy law, assessment of creditworthiness, etc. 41 See Section 5 for more information on CreditInfo, the private credit bureau in Georgia. ADBI Working Paper 849 Babych, Grigolia, and Keshelava 19 The demand side barriers to financial inclusion are indeed very prominent in Georgia. In particular, the low income levels of the population can be named among the most important barriers. One piece of evidence in this regard is the high share of the population in Georgia living on less than $3.10 per day. The share of the population below this threshold in Georgia was 34.8% on average between 2005 and 2015. In 2015, the rate was 25.3% 42 ). Such high poverty rates are not common in other countries in the region. Armenia, for example, has a comparable GDP per capita,43 but the share of the population living on less than $3.10 per day was on average 20% in the same period of time, and only 13.5% in 2015. Several surveys44 which touched upon the savings behavior of households in Georgia reveal that only a small share of the population manages to save money in some form (the estimates in different years range from as low as 16% in 2011 to 37.9% in 2016). In addition, the surveys reveal (OECD/INFE survey) that 61% of Georgians were unable to make ends meet at least once in the last 12 months, and 45% resorted to borrowing. The Savings Behavior Survey (2011),45 which makes a distinction between rural, urban, and Tbilisi responses, showed that in villages the percentage of household who currently had savings was lower (12% vs. 16% overall). The same survey revealed that people with a monthly family income of GEL700 (about $424 at the time) were three times more likely to save money than people with income below that level. Low financial literacy is another serious barrier which is discussed in more detail in Section 6 of the paper. Lack of trust towards the financial system is not a big problem in Georgia. The country enjoys high levels of popular trust in banks, which is confirmed in several surveys. For example, according to the ISET-PI/TBC survey of financial literacy, 79% of the surveyed population unconditionally trust the banks with their money, while 85% of the population would not entrust their money to other financial institutions (e.g. credit union or microfinance). This result is corroborated by evidence from the World Gallup Poll (2013)46 which showed that in Georgia 62% of respondents reported to have confidence in the banks. In fact, Georgia’s trust in banks was 5th highest among European countries. One survey result that stands apart from these findings is the Caucasus Research Resource Center (CRRC) poll Caucasus Barometer of 2015. In the survey one of the questions people were asked was “how much you trust or distrust Georgian banks?” As many as 34% of respondents fully or somewhat distrusted Georgian banks. The reasons for this result are discussed in more detail in the financial literacy section of the paper. 42 World Bank data. 43 According to World Bank data, $3,606 in Armenia to $3,853 in Georgia in 2016 44 Among them: Saving Behavior Assessment Survey in Georgia, 2011, ACT Research, Saving Banks Foundation for International Cooperation, January and February 2010–2011, Tbilisi, Georgia https://nbg.gov.ge/cp/uploads/research/sbfic.pdf ; ISET-PI and TBC Bank Financial Literacy Survey in Georgia, 2016 (available only in Georgian); Georgian National Public Opinion on Remittances, EBRD-ETC initiative, January 2007. OECD/INFE International Survey of Adult Financial Literacy Competencies, OECD 2016, Financial Literacy and Financial Inclusion Study, NBG and EFSE DF, November 2016, Georgia 45 Savings Behavior Assessment Survey in Georgia. Tbilisi, Georgia: ACT Research, 2011. 46 http://news.gallup.com/poll/162602/european-countries-lead-world-distrust-banks.aspx ADBI Working Paper 849 Babych, Grigolia, and Keshelava 20 The institutional aspects, such as adequate bankruptcy law, assessment of creditworthiness, etc. do not feature very prominently and are largely overshadowed by the other factors (low incomes and low financial literacy levels). Interviews conducted in the course of this study with microfinance organizations suggested that microfinances do not automatically exclude people from borrowing on the basis of low credit score and tend to look at the entire credit history and current circumstances of the household before making a decision on lending. 5. REGULATORY FRAMEWORK AND FINANCIAL INCLUSION 5.1 Regulatory Framework and Policies to Promote Financial Inclusion for SMEs and Households Currently in Georgia there is no official document outlining the country’s financial inclusion strategy. Greater financial access to SMEs, however, is a stated priority for the government in several strategic documents, such as Georgia 2020 Socio-economic Development Program,47 and in SME Development Strategy of Georgia 2016–2020.48 According to the SME development strategy document, improving access to finance for SMEs would be achieved via the following policy actions: • improving financial literacy among SMEs • training to help SMEs conduct financial reporting and meet the IFRS requirements • increase knowledge of fundraising among SMEs • attract SME-oriented private equity funds to Georgia • via existing programs, like “Produce in Georgia” enhancing existing schemes of SME financing via commercial banks and MFIs • Improve SME financing through grants. Currently, the government program that is specifically aimed at SMEs is the Micro and Small Business Support Project of Enterprise Georgia. 49 The project offers financial assistance to startups as well as expanding companies in the form of grants between GEL5,000 and GEL15,000. The project started in 2016, and in total 5,313 entrepreneurs were supported by an average grant of GEL7,276 per project.50 47 Social-economic Development Strategy for Georgia “Georgia 2020”, Government of Georgia, 2016 http://www.mrdi.gov.ge/sites/default/files/socialeconomic_development_strategy_of_georgia_georgia_2020.pdf 48 SME Development Strategy for Georgia 2016-2020, Government of Georgia, 2016 http://www.economy.ge/uploads/files/2017/ek__politika/eng_sme_development_strategy.pdf 49 Enterprise Georgia is a government agency established under the Ministry of Economy and Sustainable Development. It is mandated to facilitate private sector (and in particular SME) development through a variety of financial and technical support mechanisms, as well as export support. 50 A different program, “Produce in Georgia,” that is aiming at financial, technical, and infrastructural support of enterprises covers SMEs only partially. The requirements of the program apply mostly to medium and large size companies. The program has three main components: (i) access to finance component (co-financing the loan interest and supporting with the secondary collateral); (ii) technical support (supporting the enterprise with training and consultations); and (iii) infrastructural component (transfer state property to the beneficiary for GEL1). ADBI Working Paper 849 Babych, Grigolia, and Keshelava 27 make ends meet, deeply in debt), Enjoy spending (11% – live for today only, focus on short-term goals) or Shopaholics (5% make spontaneous financial decisions). People in these categories had the lowest financial literacy scores ranging from 57.7% (burdened by debt category) to 49.2% (enjoy spending category). As these surveys show, Georgia has a long way to go to reach the level of the OECD average in financial literacy, behavior, and attitudes. To this end, the National Strategy for Financial Education in Georgia71 has been developed by the NBG and has been implemented since 2016. In the following section of the paper we will summarize the main points of the strategy. 6.3 Financial Education Strategy of Georgia Besides the goal of the overall improvement in financial well-being of the Georgian population, the strategy’s aim is to protect consumers’ rights. The following are three strategic focus points to help achieve the goals of financial education: • Raise awareness of the benefits of financial education – by enhancing awareness of the importance of financial education in society, and stimulating a greater demand for and use of financial education initiatives; • Enhance coordination and collaboration among stakeholders by optimizing resources for achieving synergy, extending the impact and reach of education initiatives, sharing experience and good practice; • Extend opportunities to learn – by encouraging life-long learning of financial matters, starting from an early age, and making financial education initiatives available through diversified venues, settings, and languages. To coordinate this effort, the NBG established a Steering Committee comprised of different types of stakeholders including the financial institutions (banks and MFIs), universities, Civil Society, and other government entities for the implementation of the strategy. The Committee’s goal is to evaluate existing and future programs, raise initiatives, and provide advisory, financial, and technical assistance. According to the Strategy, the high-need, vulnerable segments were identified: • The young generation – pupils and students; • Unemployed population; • People employed in large companies and organizations;72 • Rural population; • People facing special life events (such as the birth of a child, wedding, university education, etc.) The guideline for activities under the Strategy for 2017–2019 has been drafted, but is not yet enforced. The activities include training, awareness raising campaigns, and communication using various channels. It is planned to integrate financial literacy topics in the national curriculum in schools (in math classes and in civil education classes). The pilot of the program, “school-bank,” is already in action and NBG is delivering training for pupils, as well as trainings for teachers in 11 public schools. 71 http://nbg.gov.ge/cp/uploads/stategy/FinLit_Strategy_ENG.pdf 72 Arguably, these people are not financially vulnerable, but are easy to target by financial education programs at low cost. ADBI Working Paper 849 Babych, Grigolia, and Keshelava 28 7. CONCLUSIONS AND RECOMMENDATIONS 7.1 Main Takeaways from the Study 7.1.1 Adequate Access, but Low Usage of Financial Services in Georgia On a number of financial inclusion indicators, Georgia is outperforming the ECA developing countries cohort (in particular in terms of access indicators, such as the number of ATMs, bank branches, POS terminals). Yet, in terms of usage of financial products and technologies, Georgia is still very much behind the peer group of countries. Strikingly, the percentage of young adults with deposit or savings accounts is very low compared to the regional average (only 9.9%, as compared to 35.6% in the ECA region). This result is likely driven by the low rate of economic activity among youth and a high rate of unemployment in this cohort. The lack of economic independence leads to a lack of financial inclusion among the youth. The same factors are likely to be responsible for the low usage of financial technologies, such as internet and mobile banking. Once the current youth cohort becomes integrated into the economic life of the country, the usage of modern financial technologies is expected to increase. 7.1.2 Poor Households Remain Underserved Despite rapidly growing indicators of access to financial services (such as deposits and credit), a significant cohort of the population remains underserved. This concerns mainly poor and to some extent rural populations. Only 29% of poor adults have a deposit or savings account as opposed to 40% of adults overall. The rural population has adequate (country average) indicators of usage, but is much more likely to be engaged in low-income subsistence agriculture, less likely to have accumulated savings, and have lower financial literacy scores. In addition, rural inhabitants dominate the segment of the population that can be described as “financially fearful,” according to the NBG financial literacy survey. 7.1.3 Access to Credit has been Growing Rapidly for Households, but Not SMEs Indicators of financial access among SMEs have remained largely the same since 2012. At the same time, credit to households, in particular credit secured by real estate, has been expanding rapidly in the past few years. Indebtedness of households has been growing rapidly as well. While the ratio of non-performing loans to total loans in commercial banks remained stable, the data from microfinances is different – the value of repossessed property increased sharply around the time of the lari devaluation73. This suggests that the financial strain was experienced mostly by households who did not, for various reasons, qualify for a loan from a commercial bank. In addition, credit score distribution data from the country’s only credit bureau, which covers 88.6% of the adult population, indicates that the distribution is skewed towards the high-risk category. There are notably more MFI clients in the E3 category than bank clients, as banks have much stricter requirements for giving credit. Rapid growth in consumer credit prompted concerns about the sustainability of credit expansion. Thus, the government of Georgia and the NBG called for stronger consumer protection 73 NBG Statistics. Assets and Liabilities of Micro Financial Organizations. https://www.nbg.gov.ge/ index.php?m=304 ADBI Working Paper 849 Babych, Grigolia, and Keshelava 29 measures, pushed for rapid de-dollarization of small and medium-size loans and stepped up efforts to promote financial literacy. 7.1.4 Financial Literacy Levels can be Described as Inadequate for the Given Level of Financial Sector Development In Georgia, the financial sector has been developing and growing quite rapidly. Yet, various financial literacy indicators show that the majority of the population is only familiar with basic financial concepts, like simple interest, inflation, risk and return, etc. Yet, slightly more complicated questions about calculating a simple interest on a deposit or detecting the effect of compounding remain challenging. There is evidence that Georgians choose financial products without “shopping around,” and are in many cases unaware of various financial products available to them. 7.1.5 Low Levels of Financial Literacy in Conjunction with Low Incomes are Among the Main Obstacles to Greater Financial Inclusion Financial literacy and financial inclusion go hand in hand. People with higher levels of financial literacy tend to save more, are more aware of various financial products, are more responsible borrowers. The data we have analyzed for the purposes of this study points to the conclusion that financial literacy is correlated with income and education levels. While there may be a causal relationship in the direction from financial literacy to income level (as financial literacy may proxy ability), one can imagine the reverse causation as well: low income levels may be in part responsible for low levels of financial inclusion and thus, indirectly, lead to lower levels of financial literacy. 7.2 Recommendations The analysis of various financial inclusion indicators and financial sector policies in Georgia leads us to conclude that the country’s problems with financial inclusion of the poor, young, and rural population stem from low income levels as well as low levels of financial literacy. As the Georgian authorities navigate different policy options to improve financial inclusion for households and SMEs, they have to keep in mind that financial literacy, general education, and income levels are interrelated concepts, and it will not be possible to fully address one aspect of the problem (e.g. financial literacy) without simultaneously addressing the issues related to general education and the lack of stable incomes. The government needs to develop a comprehensive national strategy for financial inclusion of the population (currently lacking) which will address different aspects of this problem, including consumer protection, education, employment opportunities, and, last but not least, financial literacy. In particular, promoting employment among youth could go a long way towards their greater financial integration and more responsible financial behavior in the future. Greater financial access for SMEs remains a challenge. SMEs face a chicken and egg problem, where they find it hard to grow without greater access to finance, while banks are reluctant to lend in excess of what the financial situation of these firms would currently allow. The solution to this problem could be to experiment with different approaches, which do not necessarily imply interest rate subsidies or collateral pledges. Education programs and training for SME entrepreneurs may be a way to solve the problems of low financial reporting standards as well as other structural problems that plague the SME sector. ADBI Working Paper 849 Babych, Grigolia, and Keshelava 30 As far as regulatory issues are concerned, the recent steps by the government to promote consumer protection, de-dollarize the economy, and increase the level of financial literacy are adequate and timely. Policy-makers, however, need to be cautious about changes that can affect both consumers and providers of financial services. Financial inclusion is driven by both demand and supply factors – thus, the efforts to de-dollarize lending to households can also create a higher cost of hedging instruments for banks and MFIs, higher domestic currency interest rates, and, consequently, less affordable loans for households. Finally, policy-makers need to stay vigilant and informed about the new financial technologies that appear on the market that can potentially affect vulnerable population groups. In this respect, the recent changes in the Civil Code to keep effective interest rates capped were an adequate response to rapidly growing predatory lending practices. Yet, policy-makers need to develop the means to keep an eye on various segments of the financial market, not just commercial banks or microfinances, in order to detect problems before they arise. One of the instruments employed could be more frequent surveys about lending, borrowing, and savings behavior and practices of households and SMEs. 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