Informal networks in developing countries provide an important means by which individuals and households share risk. However, this coverage is not always 100% comprehensive. Economists find that one of the reasons why this happens is transaction costs. Literally, the costs of transferring resources between individuals. The expansion of mobile money in developing countries has had a dramatic impact in the way people at the base of the pyramid transact with each other, but most importantly it has allowed for the expansion of access to one of the most basic financial services- the ability to smooth risk.
In a recent paper, Tavneet Suri from MIT and Bill Jack from Georgetown explore this issue focusing on customers using M-PESA, the most widely adopted mobile money service in the world. M-PESA is used mostly for p2p transfers and understanding its role in allowing households to better smooth risk is essential. To study how mobile money has affected risk sharing, they compared changes in consumption in response to shocks across M-PESA users and non-users by analysing data from a large household panel survey in Kenya that was designed and collected between 2008 and 2010.
The authors find convincing evidence that mobile money has had a significant impact on the ability of households to spread risk, and attribute this to the associated reduction in transaction costs. The results show that households which do not use mobile money suffer a 7% drop in consumption when hit by a negative income shock. These finding are especially important in the context of a country like Kenya, where a large proportion of the population lives close to subsistence. The benefits from smoothing down risk are much larger than in developed countries given household vulnerability to risk has a direct impact on poverty levels. The results also highlight the important role of remittances or P2P transfers in improving risk. When faced with a shock, households which use mobile money are not only more likely to receive a remittance, but the number of remittances and their amounts tend to be larger. “Mobile money appears to increase the effective size of, and number of active participants in, risk sharing networks, seemingly without exacerbating information, monitoring, and commitment costs”.
You can download a full version of the report from the MMU document library or the author’s webpage.