BSP-UP Professorial Chair Lectures

19-20 October 2015

Bangko Sentral ng Pilipinas
Malate, Manila

Lecture No. 8

Financial Inclusion Through Expanding Housing

Finance Services: Insights and Options from the
Behavioral Economics Literature

by

Dr. Toby Melissa C. Monsod

BSP UP Centennial Professor of Money and Banking
Expanding the frontiers of housing finance: Insights from the behavioral economics literature
and considerations for financial inclusion initiatives
(Revised, 10/22/2015)

Toby C. Monsod 1
University of the Philippines School of Economics

I. Motivation

The symptoms of the housing problem can be summed up as follows2: First, formal housing
production has been unable to keep up. Informal housing arrangements, substandard
structures, and congestion characterize the urban housing problem in the Philippines.
Second, formal housing supply has limited reach. Informal housing is populated not only by
the poor but by the non-poor. Third, public housing interventions for the very lowest income
households are limited. Budgets for sites upgrading, core shelter, and other social housing
assistance are restricted; delays in mass housing programs are well known.

Logically, if formal housing solutions are not available for middle income groups, then the
housing problems of the lowest income households cannot be solved [Hoek-Smit 2015]. To
this end, rigidities in the real sector – dysfunctional land markets, incoherent transportation
infrastructure, and outdated planning and building standards which drive the unit price of
housing up – must be addressed. Additionally, end-user finance must be assured. On a very
practical level then, a key policy challenge has to do with moving the frontiers of mortgage
finance and non-mortgage housing finance down-market and expanding their scale. When
private capital is better leveraged for the middle income sectors, scarce public subsidy
resources can be optimized for the lowest income sector.

It is this challenge - how to expand the reach the housing finance – that motivates this paper.
There are many parts to this puzzle. On the mortgage lending side alone, many models exist
and the use of one or more of those systems depends on the stage of development of a
country’s markets as well as government policies [Lea 2009]. To my knowledge, the last
comprehensive look at our mortgage system was in the late 1990s and it seems like the
prerequisite infrastructure to an efficient primary mortgage market identified then, e.g.
professional appraisal services, credit bureau information, are still absent now (e.g. see Llanto
2015). This state of affairs is confirmed by the 2009 Consumer Finance Survey which
indicates that owned-housing is still largely self-financed or directly financed: of the 68.8
percent of households who own or co-own their house/house and lot, 64.8 percent acquired
the property through cash payment while 29.6 percent acquired the property though

1 Associate Professor and BSP Professorial Chair for Money and Banking. This revision benefitted from
helpful comments received during the 2015 BSP-UP Professorial Chair Lectures on October 20, 2015.
2 Hoek-Smit [2015] discusses the challenge of mass housing and mass housing finance common to

developing and emerging market economies. I adopt her summary here.

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inheritance or gifts.3 Only 6.7 percent borrowed money to acquire the property, of which just
9.3 percent borrowed from banks. 4 Needless to say this is an inefficient situation.
“Dependence on direct finance results in cities that are built as they are financed, with a
considerable and visible proportion of self-construction and slum proliferation.” [Lea 2009]
Mortgage markets grow with and support efficient and inclusive urbanization. But relative to
countries at the same level or lower levels of urbanization, our mortgage system is “tiny”
(Figure 1)

Figure 1

Source: Hoek-Smit, 2015 (http://unhabitat.org/mass-housing-requires-mass-housing-finance-marja-hoek-smit-wharton-

scool-university-of-pennsylvania/)

Notwithstanding the slow progress on primary mortgage market infrastructure, banking

regulations have created a space for stretching the frontiers of housing finance by enabling
housing microfinance (HMF). HMF is not a substitute for affordable long-term mortgages but,
in the context of a comprehensive country-level housing finance strategy, can play a vital role
in reducing qualitative shortages [Daphnis 2009]. More importantly for our purposes, the roll-
out of HMF may be accompanied by product or process innovations that can spillover for
application in mortgage markets.

Interestingly, given both observed housing shortfalls and the banking sector’s experience in
micro-enterprise lending, the uptake of HMF has been slower than expected. 5 To explain this
puzzle, some insight may come from the behavioral economics literature which highlights
psychological influences that constrain ‘optimal’ decision-making by economic agents. The
objective of this paper is to explore what this literature has to say.

3 The survey may be downloaded at http://www.bsp.gov.ph/downloads/publications/2012/cfs_2012.pdf

4 Including commercial, rural/cooperative, and thrift banks. A bigger percentage of households from
areas outside NCR (at 18.6 percent) than from NCR (at 5.1 percent) sourced from banks.
5 Microfinance has been a recognized as a legitimate banking activity to be supervised by the BSP since

2001. During the 2002 to 2013 period, microfinance loans rose constantly from P2.6 billion ($85.79
million) to P8.7 billion ($196.73 million), equivalent to an 11.6% compound annual growth rate. See
Llanto [2015] for a historical account of microfinance in the Philippines.

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I proceed as follows. In the next section I provide more context on the housing supply
challenge and HMF. In the third section, I discuss Behavioral Economics and its key insights
and, in the fourth section, considerations for the Philippine case.

II. Context and challenge

Despite decades of public sector housing programs, there is a significant unmet need for
improved and additional housing in the Philippines. Using the Census 2010, HUDCC
estimates an accumulated ‘backlog’ of 1.225 million units as of January 2011 (Table 1). Of this,
787,731 units are attributed to households in ‘unacceptable housing’ – in marginal/makeshift
housing or dilapidated/condemned housing – and another 437,612 units to households in
doubled-up but acceptable housing. On top of the backlog, HUDCC also anticipates a ‘future
need’ of 2.25 million for new household formation and 1.93 million for inventory losses over
the period 2011-2016 (Table 2). Households under the former category are “likely to afford to
own or rent” acceptable housing units.

Table 1: Accumulated Housing Need (based on Census 2010 or as of January 1, 2011)

Doubled-up HH
marginal/ dilapidated/
Region in acceptable Total
makeshift+ condemned++
units+++
PHILIPPINES 700,239 4,799 437,612 1,225,343
NCR 163,094 2,122 118,651 292,234
CAR 5,098 705 5,052 10,861
Region 1 18,026 2,566 34,633 55,312
Region 2 13,012 3,171 13,983 30,323
Region 3 53,408 5,528 41,909 101,441
Region 4A 72,364 6,253 55,914 135,068
Region 4B 21,656 2,962 4,285 28,931
Region 5 46,001 6,423 9,203 61,738
Region 6 58,533 8,968 17,772 85,425
Region 7 53,237 6,751 19,417 79,815
Region 8 27,806 6,557 6,667 41,081
Region 9 22,153 4,198 11,964 38,322
Region 10 30,250 4,657 17,147 52,094
Region 11 41,594 4,981 19,345 66,099
Region 12 35,459 4,242 14,634 54,442
CARAGA 17,048 3,483 9,014 29,572
ARMM 21,501 2,871 38,024 62,584
Source: HUDCC

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 + Includes informal settlers (or households living on lots without consent of property owners), households living
in structures that are made of makeshift/salvaged materials or predominantly of makeshift/salvaged materials,
as well as households living in quarters not intended for human habitation. Other ‘informal settlers’ include
households living in danger areas, areas for government infrastructure projects, protected/forest areas (except
for indigenous peoples), areas for Priority Development (APDs), and other lands/facilities not intended for
human habitation. However these households are not included in the count for lack of data.
++ Households occupying structures that are beyond repair, constructed of substandard materials/procedures,
or are structurally defective.
+++ Estimated number of dwelling units shared by two or more households.

Table 2. Future Needs

CY2011 CY2012 CY2013 CY2014 CY2015 CY2016 Total
Replacement of Inventory
306,515 312,338 318,273 324,320 330,482 336,761
losses 1,928,689
New HH formation (likely
to afford to own/rent 358,522 365,334 372,275 379,348 386,556 393,901
acceptable HU) 2,255,936
Source: HUDCC

Supply shortfalls in affordable and quality housing are not uncommon in low-middle income
countries like the Philippines. Housing conditions are a reflection of the level of economic
development, i.e. higher incomes associated with economic development permit greater
spending on housing, which is reflected in better housing [WB 1993]. However, poor housing
is likely to be as much the result of housing policy – the combination of policies and
regulations that determine the efficiency and responsiveness of housing supply – as it is
income levels per se [WB 1993]. This is especially applicable in urban conurbations like
Metro Manila where bottlenecks in urban land markets figure greatly in explaining the
relatively high costs and poor conditions of housing [Strassman and Blunt 1993; Ballesteros
2000].

The point that informal and substandard housing conditions are not due to low incomes alone
is illustrated in Table 3 which presents housing by tenure type and the share of income poor
households in those types.6 Across the country, just 35 percent of households in informal
housing are income poor while 65 percent of households are not poor. In NCR, only 8 percent
of households in informal housing are income poor while 92 percent of households are not
poor. Table 4 presents tenure against income class and likewise shows how lower-middle and
middle income households swell the numbers in informal housing. Table 5 tabulates
households by quality of housing: of households in substandard housing, 50 percent are non-
poor. In NCR, 80 percent are non-poor 7

6 Households are identified as income poor by region using 2012 regional poverty thresholds produced
by the Philippine Statistical Authority.
7 HH prioritize the quality of roofing over walls. Using quality of walls as an indicator would therefore

provide a more conservative estimate of substandard housing.

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 Table 3: Households by tenure type and poor households, all Regions and NCR (2012)
All Regions NCR
Tenure Type HH Poor HH % Poor HH Poor HH % poor
Formal 15,536,041 3,240,800 20.9 2,044,459 66,640 3.3
Informal, with
3,847,917 1,432,807 37.2 258,189 21,895 8.5
consent
Informal, without
649,112 141,262 21.8 250,895 16,344 6.5
consent
Base data: FIES 2012. See Annex Table 1 for breakdown

Table 4: Households by reginal income class and tenure type, all Regions and NCR (2012)
All Regions NCR
LOW MID HIGH LOW MID
(1st-3rd (4th -8th (9th-10th (1st-3rd (4th -8th HIGH (9th-
Tenure Type decile decile) decile) deciles) deciles) 10th deciles)
Formal 4,100,671 7,824,559 3,610,811 546,165 1,034,208 464,086
Informal, with
consent 1,648,708 1,847,261 351,949 102,794 123,338 32,056
Informal, without
consent 262,288 341,359 45,465 117,792 118,520 14,584
Base data: FIES 2012

Table 5: Households by quality of house, All Regions and NCR (2012)

All Regions NCR
Walls HH Poor HH % poor HH Poor HH % poor
Strong 15,351,993 2,451,993 16.0 2,443,848 85,118 3.5
Light 4,422,804 2,252,858 50.9 82,132 13,118 16.0
Makeshift 232,619 116,938 50.3 29,186 6,003 20.6
Base data: FIES 2012

The housing policies that have contributed to these outcomes have long been discussed [WB
1997, Llanto and Orbeta 2001, Monsod 2011]. Suffice to say, government’s (default) strategy
of choice – which has been to maximize the output of new houses and sites for sale at below
market prices – has been fundamentally flawed, treating symptoms rather than fundamental
causes of housing system failures.8 This is borne out by the repeated episodes of insolvency or
illiquidity of government housing finance corporations, low disposition rates at resettlement
sites, and distributional inefficiencies in the incidence of implicit and explicit public
subsidies. Non-market pricing and subsidized lending in the primary mortgage market are

8 Symptoms are excessively high unit costs of land and housing. Fundamental causes are rigidities in
land and input markets, poor transportation infrastructure, construction and subdivision restrictions on
the real side, and primary mortgage market system failures on the housing finance side.

5
also suspected to have generated other perverse results, such as the ‘crowding-out’ rather than
the ‘crowding-in’ of private finance and other ancillary services. PagIBIG, a mandatory
housing provident fund, is the biggest single source of home financing in the country,
accounting for about 39 percent of the aggregate portfolio for residential real estate loans as of
September 2014. 910

The outcome on the housing finance side is a rather small primary mortgage market, with
very limited reach. Tables 6 and 7 provide a rough and optimistic picture of the current reach
of mortgage finance, both state subsidized and market-sourced. It is an optimistic picture
because it is based on average monthly family income alone and whether or not the
amortization due for select home loan packages will be below the average percentage
allocated to housing expenditures, by decile. It does not take into account savings/wealth, the
regularity of income flows, the availability of collateral and other pre-requisites for qualifying
for a home mortgage. Nor does it take into account any funding constraints which would
apply to government funding windows. In short, ‘reach’ does not mean that all households in
each decile may qualify for nor access loans. Actual recipients are only a small proportion of
households in each decile.

Table 6: Current reach of mortgage system, all Regions

Income Decile, All Regions
1st 2nd 3rd 4th 5th 6th 7th 8th 9th 10th
Market finance
Home Mortgage +
Housing Microfinance ++
Subsidized finance+++
PagIBIG Home Loans
Group mortgages (lots)
Group mortgages (high
density housing)
Base data: Annex Table 2
+ Most liberal package from a website survey of 11 commercial banks
++ Package for long-term construction and acquisition loan based on BSP Circular 678, s. of 2010
+++ Packages under the Community Mortgage Program (for lots) and the Socialized Housing Finance Corporation (for
high density housing)

9This figure is from PagIBIG, although its components are not clear. It may be higher.
10Yet PagIBIG enjoys significant legal and regulatory privileges under the law (R.A. 9670), such as
mandatory contributions, the privilege to deduct loan payments from salaries, tax exemptions,
exemption from the Maceda law, and a general government guarantee, among others. The continuing
challenge to PagIBIG is whether and to what extent it has encouraged (or deterred) the down-market
penetration of private mortgage finance.

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 Table 7: Current reach of mortgage system, NCR
Income Decile, NCR
st nd rd th
1 2 3 4 5th 6th 7th 8th 9th 10th
Market finance
Home Mortgages+
Housing Microfinance++
Subsidized finance+++
PagIBIG Home Loans
Group mortgages (lots)
Group mortgages (high
density housing)
Base data: See Annex Table 3
+ Most liberal package from a website survey of 11 commercial banks
++ Package for long-term construction and acquisition loan based on BSP Circular 678, s. of 2010
+++ Packages under the Community Mortgage Program (for lots) and the High Density Housing program of the
Socialized Housing Finance Corporation

A few things can be highlighted. First, commercial home mortgages reach only the 9th decile
on the overall and the 6th decile in NCR. PagIBIG caters to the same market but reaches 4
deciles lower on the overall and 3 deciles lower in NCR. That said, both effectively reach only
individuals with regular income flows, that is, the wage/salary-employed. 11 This means just
between 27.2 and 33.4 percent of households per decile for the 4th to 8th decile.12

Second, it is more than likely that middle and lower-middle income decile groups who
cannot access formal housing solutions are spilling over and availing of subsidized group
mortgage programs offered by government. But these programs are funded by general
appropriations and have extremely tight budget constraints. Therefore, when there are
‘leakages’ to middle income and lower-middle households in this manner, it can only be that
poor households for whom social housing assistance is intended are (inadvertently) displaced.

The challenge is to move formal housing supply to the broad middle income groups so that
social assistance can be better targeted to (and accessed by) the poor. Expanding housing
supply down-market will require the availability of end-user financing however (apart from
other land and other real side requirements), which in turn may require some product
innovation. This is because housing finance for middle-income and lower-income groups may

11 Which implies that when PagIBIG home loans are not market-priced, or if the portfolio is of poor
quality (e.g. default rates are relatively high), lower-income self-employed member-savers who are not
able to avail of housing loans are effectively ‘subsidizing’ higher income members by less than optimal
returns to their provident fund contributions.
12 For whole Philippines in 2009, where percent employed was 55.1 to 59.6 percent. In NCR, percent

employed per decile ranged from 41.8 to 51.4 percent for the 4 th to 8th decile. Wage/salaried was 30 to
37.4

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be less of a problem of inadequate incomes per se and more of a problem of irregular income
flows, lack of wealth/saving, uncertain collateral, and neighborhood risks [Hoek_Smit 2015]

In this regard, HMF is an innovation. HMF involves “the application of microfinance

principles to the provision of housing finance and consists mainly of loans to existing clients
of microfinance institutions and other poor and low-income households. With adequate and
appropriate risk management measures, the product will enable institutions to appropriately
service the housing needs of those who are unable to access traditional housing finance.” (BSP
Circular 678, s. of 2010) It was motivated by the observation that microfinance, a regulated
financial product since 2001, had been confined to mean financing for microenterprises or
small livelihood activities. However, “it has been proven… that clients of microfinance also
need a wide range of financial services including housing finance... it is typical that some
microfinance clients also use their access to credit for their homes.” [ibid]

The HMF product shares the characteristics of the microfinance product. However, HMF
innovates on microfinance by allowing longer term loans (up to 15 years for house/lot
acquisition or house construction) and a larger maximum loanable amount (up to P300,000
from P150,000 for microfinance). Moreover, and most critically, other forms of secure tenure
and property right – specifically usufruct, lease, freehold, and right to occupy and/or build –
are recognized and corresponding instruments may be used as collateral for house/lot
acquisition and house construction loans.

Innovations notwithstanding, the uptake of HMF by the market has been slower than
anticipated. As of the end of 2014, less than 10 percent of banks with microfinance portfolios
also had a HMF portfolio and HMF borrowers constituted less than 2 percent of microfinance
borrowers (Table 8).13 The average HMF loan size suggests that loans were primarily for
home improvement, implying a relatively simple extension of microfinance business
processes (Table 9). However, in the last two years, more banks have exited rather than
entered the HMF ‘industry’ (Table 10)

Table 8 Microfinance portfolio of Banking Sector and relative size of the Housing Microfinance (HMF) portfolio,
2011-2014
Microfinance Microfinance % % %
participating portfolio (in million Microfinance engaged portfolio to borrowers
banks pesos) borrowers in HMF HMF with HMF
2011 189 7,567.6 1,005,750 6.9 1.9 1.6
2012 187 8,413.5 1,137,813 9.6 2.9 2.3
2013 182 8,701.2 1,049,988 8.8 3.0 1.6
2014 176 11,372.8 1,229,825 9.1 2.9 1.4
Base data: BSP

13It is likely but cannot be assumed that HMF borrowers are also microfinance borrowers. Rules allow
for new borrowers who would normally be eligible for microfinance loans as well as borrowers who
have qualified for the Credit Surety Fund enhancement program (Circular 678, s. of 2010)

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 Table 9 Housing Microfinance Portfolio, 2011-2014
HMF HMF portfolio System
participating (in million HMF average bank average bank average
banks pesos) borrowers HMF loan loan (min) loan (max)
2011 13 141.3 16,239 8,704 6,177 1,032,420
2012 18 241.8 26,255 9,209 4,844 1,475,097
2013 16 262.8 16,694 15,739 3,931 1,827,180
2014 16 334.5 17,263 19,374 4,730 3,202,217
Base data: BSP

Table 10 Flow of banks in HMF sector, 2011-2014

enter exit re-enter Net

2011 13 13
2012 8 3 18
2013 3 5 16
2014 2 3 1 16
Base data: BSP

In the face of observed housing shortfalls, it is not clear what accounts for this slow uptake.
On the demand side, traditional economic theory would suggest that consumers in inadequate
housing are either (i) not fully informed about the availability of the product, (ii) informed
but not qualified to avail of the product, or (iii) informed and qualified but have determined
that the marginal cost of using the product (i.e. borrowing) outweighs its marginal benefit.
Solutions would have to do with changing incentives, making benefits greater or costs lower,
or providing more information so people better understand the costs and benefits. On the
supply side, traditional theory would suggest that non-adoption could be due to risks and
opportunity costs that are too high and expected financial returns that are too low for profit-
maximizing banks [Daminger et. al. 2014]. Solutions would involve addressing market
failures which squeeze private financial returns, if any, and/or providing incentives to
encourage adoption by banks if housing microfinance at scale promises compensating social
returns.

In any case, behavioral economics may have something to say. Behavioral economics (BE)
takes a more refined view of the consumer (and, by extension, of decision-makers in banks)
recognizing that psychological and social influences affect behavior and decision making. Key
principles would include, among others, that while consumers try to choose the best feasible
option, they don’t always succeed, e.g. many people prefer a 6 percent income raise when
there is 4 percent inflation over a 3 percent raise with no inflation [WB 2015]; that there is a
gap between good intentions and actions, e.g. people often plan to save for retirement – or
plan to exercise, or diet - but renege at the last second [Laibson and List 2015]; that These
behaviors occur for a number of reasons but the important observation is that implications for

9
market transactions are not trivial and can help explain sluggish adoption, poor usage, or
limited derived benefits from an innovation [Daminger et. al. 2014].

III. Insights from behavioral economics

If you want to get from Chicago to the bleachers of Fenway Park to watch the Boston Red Sox, standard
economics will get you to Cambridge, or even Boston University (which is adjacent to Fenway), but you may
need behavioral economics to take the final steps and find your seat in the bleachers. [Laibson and List
2015]

Behavioral economics is a series of amendments to traditional economics, an augmentation of

standard economic analysis, which develops and refines core principles of economics
(optimization and equilibrium) to make them more empirically accurate [Laibson and List 2015].
“Behavioral economics uses variants of traditional economic assumptions (often with a
psychological motivation) to explain and predict behavior, and to provide policy
prescriptions.” [ibid: 385] 14

Also, standard economic theory makes two big behavioral assumptions with respect to
consumer choice. First, that people take full account of all information available to them and
act according to this information and their preferences in an unbiased manner. Second, that
once a person decides to do something, his or her actions naturally follow from that decision
[Daminger et. al. 2014].

In contrast, a more behavioral model of decision-making recognizes that, one, people tend to
think ‘automatically’, evaluating alternatives quickly, based on what automatically comes to
mind, rather than ‘deliberately’ [WB 2015].15 Automatic thinking is effortless, fast, and largely
out of voluntary control; deliberate thinking is effortful, reflective and cognitively taxing.16
The automatic system is used routinely, without much oversight from the deliberative
system, and especially when people are under financial distress or time pressure, which
results in systematic behavioral biases such as loss aversion (the tendency to feel losses more
acutely than gains of equal magnitude), status quo bias (tendency to stick with current
choices or default options), framing effects (tendency to assess factually equivalent
information differently depending on how it is framed), and present bias (tendency to prefer
short-term gratification over longer term returns). A more behavioral model also recognizes
that people have bounded willpower – self-control problems [Laibon and List 2015]) - leading

14 Laibson and List [2015] cite Daniel Kahneman and Amos Tversky (1979) as the ‘big bang’ for
behavioral economics but also reiterate that psychological assumptions “are as old as economics itself”,
e.g. Adam Smith wrote about the psychology of decision-making, including the tension between a
person’s “passions” and their rational deliberations.
15 This paragraph and the next two draw heavily from WB 2015. Unless otherwise stated, quotations

are from this reference.

16 Like when solving a difficult math problem or when resisting temptation to cheat on a diet.

10
to a consistent failure to carry out plans. In traditional theory, there is no such intention-
action divide. 17

To provide more detail:

Loss aversion. People care (in part) about how their circumstances compare to reference
points and it matters whether a person is losing or gaining relative to their reference point
[Laibson and List 2015]. It turns out people suffer from a loss about twice as much as they
benefit from a gain of equal absolute magnitude. This leads people to shy away from
investment opportunities that are profitable over time, on average, but that might expose
them to a loss at any given time [WB 2015] Loss aversion is related to the disposition effect -
the tendency to continue holding assets that have dropped in value and sell those that have
increased in value - as well as to the endowment effect - the tendency of individuals to place
a higher price or value on an object if they own it than if they do not [Chuah and Devlin
2010]. In the long run, returns are likely to be higher if people dispose of ‘losers’ and keep
‘winners’. But people are so averse to actually realizing losses that they do the opposite.

Loss aversion may explain an entrepreneur’s reluctance to invest in a new income-enhancing

technology, a household’s reluctance to use property as collateral, a bank’s reluctance to adopt
a new product line which would involve reputational risk. Loss aversion may also apply to
macroeconomic policy-making, e.g. industries suffering losses are more likely than others to
receive trade ‘protection’ [WB 2015]. In this case, the prospect of losing tens of thousands of
jobs in old sectors may loom much larger than the prospect of creating many more jobs under
free-market policies in new sectors. 18

Status quo bias.19 Rather than make a conscious choice, people tend to stick with current
choices or patterns of behavior or, when no status quo has been established, stick with the
default option.

An example of the status quo bias is as follows; when a University added some new options to its
employment- based healthcare plan, faculty joining after this point understandably took advantage of most of

17 Aside from thinking ‘automatically’, WB [2015] discusses how people also think ‘socially’ and ‘with
mental models’. The former implies that, apart from being influenced by external material incentives
(prices), behavior is also influenced by “social expectations, social recognition, patterns of cooperation,
care of in-group members, and social norms”, explaining observed collective patterns of, say, trust, that
are desirable, or corruption, that is destructive. The latter has to do with what individuals perceive and
how they interpret what they perceive. Many mental models are useful but some are not, contributing
to the intergenerational transmission of poverty.
18 Understanding of loss aversion can also help influence behavior however. This was demonstrated in

an experiment involving teachers, who were paid a bonus at the beginning of the school year, in
advance, but were told they would lose it if students did not meet a threshold level of achievement by
the end of the school year [WB 2015]. These teachers expended a significantly greater effort than did
teachers who were otherwise similar except that they could receive the bonus only at the end of the
year. The potential loss of the bonus was more salient than the potential gain of the bonus.
19 Unless otherwise indicated, this section draws from Chuah and Devlin 2010

11
 the options. However, faculty previously employed (who of course had the right to take advantage of the new
options) chose to participate in the new options to a far lesser degree. They exhibited a strong preference
for sticking with the status quo. [Chuah and Devlin 2010]

This bias explains why marketing ‘opt outs’ - the offer of a ‘free subscription’, say of a
magazine or software application, for a fixed period which then reverts automatically to a full
payment contract unless the customer decides to actively cancel the subscription – are such a
success (subscriptions are rarely cancelled).

Defaults are particularly important in an individual’s portfolio allocation decisions. While

investors may have all the information necessary to make a rational, informed choice, in
practice they often opt for the default option provided, or they may employ simple rules of
thumb, or heuristics, to simplify the process of choice. For instance, investors have a
tendency to follow what is known as the 1/n rule.20

Framing. Factually equivalent information can provoke a very different response when
framed in a different manner [Chuah and Devlin 2010]. People have a preference for positive
rather than negative frames for instance (consistent with loss aversion). In choosing cancer
treatment, 82% of patients preferred surgery over radio therapy when surgery was described
as having a 90% survival rate. Only 56% preferred surgery over radio therapy when it was
described as having a 10% mortality rate. The anchoring effect is a type of framing effect
where the appraisal of options is affected by an original starting value (or anchor) even if the
anchor is arbitrarily chosen.

People tend to frame financial decisions in a narrow way rather than consider their overall
financial situation [WB 2015]. This is associated with mental accounting - i.e. when
individuals compartmentalize funds into mental categories, say categories of spending (funds
for food vs funds for school supplies) or categories by source (business income vs.
gifts/transfers), and are reluctant to mix, combine or spend from one account to another - a
violation of the standard economic assumption that money is “fungible” [Chuah and Devlin
2010]. The behavior of people who have some low-interest saving but still borrow at higher
rates to repay expensive loans is a demonstration of narrow framing [WB 2015]. The
(anecdotal) reluctance of households to borrow for housing, which does not produce its own
income stream, is another. It is possible to work with mental accounting however, as
demonstrated in a saving intervention in Kenya:

20The example given by Chuah and Devlin (2010) is of academics in the US who, for a period, could
choose between two funds as part of their defined contribution pension plans. One invested exclusively
in fixed interest securities and bonds. The other invested mainly in company shares, or equity. Well
over half of investors in the plan chose to allocate their contributions 50:50 between the two choices.
However, given historical precedents, such an allocation is likely to bring a significantly lower rate of
return than an allocation which favors shares to a greater degree. Therefore, the rule of thumb of
splitting allocations equally between alternatives may not be the most appropriate strategy.

12
 In Kenya, many households report a lack of cash as an impediment to investing in preventive health
products, such as insecticide-treated mosquito nets. However, by providing people with a lockable metal box,
a padlock, and a passbook that a household simply labels with the name of a preventive health product,
researchers increased savings, and investment in these products rose by 66–75 percent…. What was
important about the metal box, the lock, and the labeled passbook was that it allowed people to put the
money in a mental account for preventive health products. [WB 2015: 4]

Framing has a crucial role to play in financial services more generally. For instance, a fee or
rate of return expressed as a percentage versus one expressed in absolutely monetary terms
may provoke significantly different behavioral responses [Chuah and Devlin 2010]. The
typical customer would take a very different view of being told that he/she is paying a 3% up-
front charge as opposed to P3000 when deciding whether or not to invest P100,000 in an
investment product. The claim that “the number of successful investments increased by 150
percent” also conveys very different information from the claim that “the number of
successful investments increased from two in a thousand to five in a thousand.” [WB 2015]
Timescale used in past performance presentation can influence investment decisions, or
whether data is presented in a line graph or as a bar chart [Chuah and Devlin 2010].

The power of (re)framing is demonstrated in a field trial in the US which tested an

intervention that presented the cost of payday borrowing (small, short term, unsecured loans
with high interest costs) more transparently.

A control group received the standard payday loan company envelope with the cash and the paperwork for
their loan (Figure A). Another group received a cash envelope that showed, in addition, how the fees
accumulate when a loan is outstanding for three months, compared to the equivalent fees for borrowing the
same amount on a credit card (Figure B). The envelopes provided some anchoring to help borrowers
evaluate the cost of payday loans and incorporated insights about cognitive biases. The result: compared to
the control group, individuals who received the envelope with the “dollar anchor” were 11 percent less likely
to borrow from the payday lenders in the four months that followed the intervention. If the field test on payday
lending had been an actual policy change in the way information was presented, then individuals would have
been exposed to the more informative envelopes every time they visited a payday store and the effects
probably would have been even stronger [WB 2015: 31-33, abridged]

Figure A

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 Figure B

Present bias. A major tendency accounting for the underutilization of financial products is
present bias [WB 2015]. Present bias leads decision makers to shift good experiences
(consumption) toward the present and bad experiences (say, difficult decisions about how
much to save) toward the future, leading to overconsumption and procrastination. This is best
illustrated in the following stylized accounts:

Mila, a typical school teacher, participates in a savings scheme in her barangay that specified monthly
contributions. She accepts these contribution amounts without much thought. The school where she works is
now offering a subsidized savings account at the local bank for all employees. Mila must decide how much to
save and put in the bank account. When the accounts were offered, Mila resolved to make her savings
decisions in the next few weeks. After a year and a half, Mila has still not made the time to decide. [WB
2015:114, abridged]

Ruth, just built a house and is considering insuring her property. When she finds time to look into the details
of the insurance, she finds that there are many different contracts. She also finds that comprehensive
coverage involves significant monthly costs and that for some insurance, she would have to provide
documentation on her valuables, which will require more time. She decides to wait a bit and spend more time
thinking about what she should do.[WB 2015:114, abridged]

What is known as the intention-action divide is rooted in present bias. In a study of business
school students, students received payment for participating in a survey and could choose
between receiving the payment immediately after the survey or receiving a much larger
payment two weeks later [WB 2015]. Many students chose the immediate payment,
indicating strong impatience. However, many did not cash their checks until four weeks
after; some waited as long as 30 weeks. Those who initially indicated a strong preference for
immediate payment were also more likely to delay cashing their checks.

The upshot is people strive for simplification and process only the information that is most
salient to them [WB 2015]. This may lead them to gloss over key information and overlook

14
critical consequences. People will also rarely, if ever, evaluate all alternatives. And people
will have commitment issues. Hence the observed (large and costly) errors in critical
decisions such as the “poor financial decisions and the failure to adhere to health regimens,
take health precautions, and adopt income-increasing techniques after receiving new
information” [WB 2015: 29].

Biases are particularly acute in financial decision-making because financial decisions are –
simply – very difficult to make. Financial decision-making involves great uncertainty about
the future (incomes, cash flows, interest rates) and requires individuals to understand the
future cost of money, assess gains and losses evenhandedly, avoid procrastinating, resist the
temptation to consume too much [WB 2015]. The complexity of managing day-to-day
finances has been compared to changing oil in a car: with some skill and instruction, it can be
managed, but “there is a good chance that we’ll end up with a big mess of black gunk
everywhere.” [Schoar and Tantia 2014] For people in poverty, or on the edge of poverty, who
lack a margin for error, the consequences of systematic biases in financial decision-making
can be profound [WB 2015: 112].

IV. Implications and considerations for current financial inclusion initiatives

The preceding insights have some immediate implications for resolving the ‘puzzle’ of
housing microfinance and for the design of related financial inclusion ‘products’ (saving,
deposit accounts) and strategies.

First, if individuals are subject to loss aversion, framing and other effects, then “better”
decisions on household finance may be obtained by adjusting what information is provided in
relevant products and the format in which it is provided – as illustrated in the mental
accounting and reframing examples above. Better decisions are decisions people would have
made if the deliberative system rather than the automatic system had been activated.

Second, the incorporation of commitment devices in products and processes could be welfare
improving. More generally, strategies which focus on helping people take action (e.g. on
saving, on housing microfinance) may be far more salient for financial inclusion than
strategies which seek to provide people with ever more information, especially in the context
of what appears to be the already vast intention-action divides among Filipino adults: 21

 97% of adults believe that it is important to save money and to have the means to
save money and 80% adults express desire to save in formal financial institutions.
Yet only 44 adults out of 100 are currently saving. Moreover, among the 56 who
are not currently saving, only 3 say it is because they do not need to save.

21From the National Baseline Survey on Financial Inclusion 2015. Available at

http://www.bsp.gov.ph/downloads/publications/2015/NBSFIFullReport.pdf

15
  90% of adults agree that insurance is important to them and that it benefits their
families. However of the 78 (out of 100) adults who are aware of health insurance,
only 31 actually have coverage; of the 67 (out of 100) adults who are aware of life
insurance, only 14 actually have coverage, and of the 60 (out of 100) adults who
are aware of accident insurance, only 12 actually have coverage

Two local examples demonstrate how commitment devices are likely to have strong and
positive impacts on behavior. One is due to a field trial by Ashraf, Karlan and Yin [2006]
which offered saving accounts in a local CARAGA bank without the option of withdrawal for
six months.22 There was a large demand for such accounts and a take-up rate of nearly 30
percent. After one year, individuals who had been offered and had used the accounts
increased savings by 81 percent more than a control group, and this saving did not crowd out
savings held outside of the participating bank. Over the longer term of two and a half years
however, the savings impact was still positive but smaller in magnitude (34%) and statistically
insignificant. One of the things posited was the possibility that while the commitment
account may have caused a deviation from a low-savings equilibrium, sustained interventions
may be necessary to help clients reach a new equilibrium. This was an argument for greater
proactivity on the bank’s side (e.g. by asking clients for an active decision to renew or
through interventions that automatically defaulted clients into depositing into the accounts).
It was suggested that if proactivity is not profitable (given that it would be directed at small
depositors), it may need to be subsidized.

The benefit of proactivity is demonstrated in the second example involving a behavioral

design project undertaken to improve savings outcomes of clients of CARD Bank [Fiorillo,
Potok and Wright 2014]. Originally thought to be an uptake problem, a diagnosis revealed
the problem to be usage (e.g. 58% of new 34,175 accounts under a new savings product had
no transactions). Moreover, the challenge was not how to change people’s minds or create
new intentions – clients did have a desire and broad intention to save in their accounts - but
rather how to get people to take action to meet their own goals. Based on behavioral
bottlenecks identified 23, an intervention package was designed, which included a simpler
account opening form (to choose a savings account, plan to make the first deposit, and sign up
for regular savings collection), a printed savings plan (to be co-signed with a savings officer)
and a savings calendar. The treatment led clients to make larger opening deposits (by 15%),
transact more frequently (but in smaller amounts), and build higher savings balances (by
37%) compared to the control group over the 8-week pilot.24

22The product was a SEED (Save, Earn, Enjoy Deposits) account with the Green Bank of Caraga. It
required that clients commit not to withdraw funds that are in the account until they reach a goal date
or amount but did not explicitly commit the client to deposit funds after opening the account.
23
Behavioral bottlenecks included required weekly deposits and minimum opening deposits that were
anchoring clients to lower deposit amounts; new accounts that were being opened without an
intention or plan about how to use them; clients who were overlooking the option to enroll in a free
regular savings collection service; savings goals which were abstract, or not strongly felt on a day-to-
day basis.
24 The study did not provide information on the cost side of the treatment.

16
Third, given the importance of heuristics and salience, and following from the cases above,
financial education programs may be more successful in improving outcomes if these are
simplified and targeted and, more importantly, bundled with personalized add-ons such as
goal-setting and individualized counseling [Fiorilla et. al. 2014, Carpena et. al. 2015, WB
2015]. Notwithstanding having the motivation to learn and the tools to make informed
financial choices, individuals face multiple behavioral constraints in converting knowledge
into concrete action [Carpena et. al. 2015] Goal setting and counselling enable individuals to
bridge that gap leading to meaningful impacts on saving, budgeting, opening bank accounts,
and, to some degree, insurance adoption [ibid].

Fourth, it could very well be that the opportunity costs and/or the financial, regulatory or
reputational risks involved in the scaling of housing microfinance products are too high
(making profitability too low) for mainstream (large) banks to deal with. However, if housing
microfinance promises significant social value at scale, it would be in the state’s interest to
intervene and make it economically worthwhile for banks and other private stakeholders to
engage. A first step in this regard would be for regulators to assess regulations for unintended
or unforeseen bottlenecks that hinder scaling. Another action would be for government and
funders to support the testing of new behaviorally-informed innovation ideas from banks (e.g.
savings product innovation tests, housing microfinance product innovation tests, bank-MFI
partnership innovation tests) [Daminger et. al. 2014]. Apart from reducing the financial risk
for large banks, meaningful research along the lines of the field trials and rigorous data
analysis undertaken by CARD and Green Bank generates information on impact and costs
that are necessary to support business decisions.

17
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