Precautionary Wealth of Rural Households: Is it Better to Hold it at the Barn or at the Bank?

This paper examines how greater access to deposit facilities affects the level and composition of the precautionary wealth of credit-constrained rural households. The paper states that:

• In the rural areas of developing countries, the high cost of access to deposit facilities for financial savings prevents households from using them as instruments to store precautionary wealth.
• Gaining greater access to deposit facilities is significant especially for households that face credit constraints.

The authors solve a dynamic stochastic model on wealth portfolio decisions, in which households make three decisions:

• How much to consume?;
• How much to save to deposit in a bank?;
• How much livestock to keep in the barn?

The authors state that these portfolio decisions depend on the rates of return for each type of asset, the correlation of these returns with systemic shocks, the volatility of income, the probability of bank bankruptcy, and transaction costs for depositors. They find that:

• Potential depositors in the rural areas of developing countries are discouraged from depositing by prohibitively high transaction costs;
• Effective financial regulation and supervision and robust financial institutions create an environment conducive to holding a greater share of precautionary wealth in the form of financial assets;
• These holdings reduce the costs of risk management for households while they increase the volume of financial intermediation;
• Growing financial intermediation leads to additional valuable services for the rural population.