The following material has been drawn, with permission, from DFID’s Sustainable Livelihoods Guidance Sheets.  For an introduction to the asset pentagon, change in asset status, and relationships within the framework (click here) 

What is Financial Capital?

Financial capital denotes the financial resources that people use to achieve their livelihood objectives. The definition used here is not economically robust in that it includes flows as well as stocks and it can contribute to consumption as well as production. However, it has been adopted to try to capture an important livelihood building block, namely the availability of cash or equivalent, that enables people to adopt different livelihood strategies.  There are two main sources of financial capital:

Available stocks: Savings are the preferred type of financial capital because they do not have liabilities attached and usually do not entail reliance on others. They can be held in several forms: cash, bank deposits or liquid assets such as livestock and jewellery. Financial resources can also be obtained through credit-providing institutions.

Regular inflows of money: Excluding earned income, the most common types of  inflows are pensions, or other transfers from the state, and remittances. In order to make a positive contribution to financial capital these inflows must be reliable (while complete reliability can never be guaranteed there is a difference between a one-off payment and a regular transfer on the basis of which people can plan investments).

Why is it important?

Financial capital is probably the most versatile of the five categories of assets:

• It can be converted with varying degrees of ease, depending upon Policy, Instructions and Processes into other types of capital.

• It can be used for direct achievement of livelihood outcomes for example when food is purchased to reduce food insecurity.

• Rightly or wrongly, it can also be transformed into political influence and can free people up for more active participation in organisations that formulate policy and legislation and govern access to resources.

• However, it is also the asset that tends to be the least available to the poor. Indeed, it is because the poor lack financial capital that other types of capital are so important to them. 

• There are, in addition, assets or desirable outcomes that may not be achievable through the medium of money (such as different components of well-being and knowledge of human rights).

What can be done to build financial capital for the poor?

Development agencies are not in the business of handing out money to poor people (direct support to financial capital). Access to financial capital is instead supported through indirect means. These may be:

• Organisational  increasing the productivity of existing savings and financial flows by helping to develop effective, tailored financial services organisations for the poor. So long as they are well-trusted, accessible and widely-known they may encourage people to save. Another option might be to help develop organisations that transit remittance income more efficiently to final recipients.

• Institutional increasing access to financial services, including overcoming barriers associated with poor people’s lack of collateral (either by providing some sort of umbrella guarantee or by identifying mechanisms that enable people’s existing assets to act as collateral).

• Legislative/regulatory working to reform the environment in which financial services operate or to help governments provide better safety nets for the poor (including pensions).

The issue of institutional sustainability is of particular importance in the area of micro-finance. Unless people believe that financial service organisations will persist over time, and will continue to charge reasonable rates of interest, they will not entrust their savings to them, or be reliable in making their loan repayments.

INSIGHT

Two important characteristics of savings are varying levels of:

Productivity (how much value do they gain when they are left untouched?)

Liquidity (how readily they can be turned into cash?).

Generally speaking, both are desirable characteristics, though liquidity also has a downside: the more liquid one’s savings, the more difficult it tends to be to defend them from claims from family members or others. There may also be trade-offs between liquidity and productivity as well as between productivity and risk.

Although financial capital tends to be quite versatile, it cannot alone solve all the problems of poverty. People may not be able to put their financial resources to good use because:  

• they lack knowledge (and cannot purchase this knowledge with small amounts of money); or

• they are constrained by inappropriate Policy, Institutions and Processes (e.g. under-developed markets, a policy environment that hinders micro-enterprise, etc.).

It is important to take these factors into consideration when planning support.  On the positive side, it is also important to be aware of the way in which existing social structures and relations (forms of social capital) can help facilitate group-based lending approaches. 

When savings are held in unconventional forms, particular to the needs and culture of owners, different modes of support may be appropriate.  For example, pastoralists may be more likely to benefit from improved animal health or marketing systems that reduce the risks associated with their savings (held in the form of livestock) than the establishment of a local bank.

Sustainable livelihoods objective: more secure access to financial resources... achieved through (for example):

Direct support to asset accumulation

Indirect support (through Policy, Institutions and Processes)

Feedback from achievement of livelihood outcomes 

None

Support to the development of financial services organisations (savings, credit, insurance)

Reform of financial sector legislation/regulation

Increased income increases the scope for saving

More sustainable resource management prolongs financial flows from natural capital

What kind of information is required to analyse financial capital?

• Which types of financial service organisations exist (both formal and informal)?

• What services do they provide, under what conditions (interest rates, collateral requirements, etc.)?

• Who, which groups or types of people has access? What prevents others from gaining access?

• What are the current levels of savings and loans?

Understanding the nature of savings behaviour requires finding answers to questions such as:

• In what form do people currently keep their savings (livestock, jewellery, cash, bank deposits, etc.)?

• What are the risks of these different options?  How liquid are they?  How subject to changes in value depending upon when they are liquidated?

In the past, the existence and effects of what can be quite sizeable flows of remittance income have often been over-looked.  To correct this, it is important to understand:

• How many households (and what type) have family members living away who remit money?

• How is remittance income transmitted?

• How reliable are remittances? Do they vary by season? How much money is involved?

• Who controls remittance income when it arrives? How is it used? Is it reinvested?