rural finance experts

rural finance experts

Innovations in Rural Finance: A Comprehensive Guide for Experts

1. Introduction to Rural Finance

This volume presents a comprehensive framework for innovations in rural finance. It highlights the urgency of redesigning the rural financial system, which has acted as a discriminatory and exclusionary institution serving the needs mainly of the urban areas and the relatively poor. The enormous number of people living in the rural areas of developing countries face an array of constraints that prevent them from accessing the range of services used by the wealthier or more secure, often urban, population. If the lives of the rural poor are to be improved, then facilitating the establishment and growth of a dynamic informal sector will do much to improve the long-term welfare of the rural population.

Many of the financial policy innovations discussed in this volume are new, although some of the practices already exist in parts of Latin America, other parts of the Third World, and in the United States. The changes emphasized require not only an expansion of the physical network of rural financial institutions; progress will demand also a fundamental shift in the public policies which have tended in the past to obstruct or discourage the involvement of financial markets with the world of the poor.

2. Challenges and Opportunities in Rural Finance

Rural finance is the provision of financial services in rural areas, including those related to agriculture, to people with a lifestyle and often livelihood different from that of people in urban areas. Several aspects are particularly critical to understanding and defining rural financial markets. It is well-understood, for instance, that lender motives and objectives differ in rural markets from those in urban areas, and in particular that rural finance does not operate in the same way as urban finance. People in rural areas have different preferences, schemes of time preference, and attitudes towards risk and uncertainty. The financial products for rural areas should also be different. The evidence that motivated this report emerges from the very limited understanding of the financial sector in rural areas due to the lack of comprehensive publications on diagnostics, innovative efforts to increase access to financial services, and improved commercial performance.

This report provides a comprehensive account of innovations and lessons learned in the provision of financial access to rural people in developing countries. Critically, beyond lessons, the report provides experts and professionals involved in rural finance with a roadmap on diagnostics and analysis tools, innovative measures, and operational recommendations. These can help in treating rural financial markets instrumentally, wanting to go beyond the stakeholders’ arguments in the sense that an enabling environment is a sufficient condition to attract the lower-income segment to the formal financial sector. The idea for this report “Innovations in Rural Finance: A Comprehensive Guide for Experts” emerged from the limited understanding of the financial sector in rural areas, due to the lack of comprehensive publications from which diagnostics, access improvement, or commercial improvement could be drawn.

3. Innovative Approaches and Best Practices

Traditionally, banks have not been effective in serving the capital needs of the agricultural sector, particularly underdeveloped regions of Latin America. Banks generally lack the expertise to quickly and appropriately evaluate investment projects in rural finance, and they often set very high borrowing requirements, as assessing rural portfolio risk with normal lending technology usually requires very high collateral requirements. The Bank’s rural portfolio investment criteria formalize this problem because they introduce state-of-the-art international credit risk assessments (which have assessment costs) for what might turn out to be the local small farmer who actually has evaluations that make use of easily observed inputs with very low capitalization. Although the Bank has devised an intricate method to provide loans to small farmers who do not meet international credit standards, the processes and costs inherent in obtaining an ITD (internal target rating) for software procurement management are substantial and reflect the same institutional risk aversion that leads banks to underweight the rural portfolio in the first place.

The Bank is not the only institution facing these problems. The Inter-American Dialogue’s Basic Education Program for Rural Latin America is attempting to assist institutions in six countries to obtain seed capital and the design of rural loan programs suitable for risks assumed by local stakeholders while discovering household production and income objectives in the process. Rural banking design workshop participants acknowledge most of these constraints and offer solutions for specific project components. They design programs that: a) provide local control for risk assessment and repository/collateral enforcement; b) obtain the majority of the return from planting credit through local provision of information lessening project vulnerability to adverse selection; c) collect ratings through community-restricted certified loan agents who receive a percentage of the loan (convex sharing rule and constant absolute risk aversion utility a la Rothschild-Stiglitz); and d) use a group loan approach (stronger monitoring and more collateral available under group lending, Rosett) for part of the portfolio.

4. Case Studies and Success Stories

Introduction The following case studies provide examples of how innovative rural financial services are being developed and implemented throughout the world. These examples highlight many aspects of the supply of financial services in rural areas, including the interests of farmers and nonfarm rural residents, the roles played by the private sector, cooperatives, and other indigenous organizations, and the interest of government and donors in building sustainable financial systems. A broader range of financial products is emerging, including innovative delivery channels designed to reduce transaction costs, the development of new financial institutions, new strategic roles for governments and donors, innovative partnerships, and an emerging international consensus on both the need for and the way to bring about sustainable financial systems. In Chapter 6, we highlight specific innovations. Chapter 7 provides conclusions and recommendations on how to achieve the goal of a well-functioning, sustainable rural financial system that includes a full range of financial products and services.

Financing Small Enterprise: Group Lending in Tanzania By David Chetham, Research Officer DFID’s Workshop on Microsavings, Lilliput to London: Household Finance at the Grassroots, 21-22 July 1999 The role that women’s informal savings and credit groups play in the personal and professional economic life of women has been well researched in many countries. Active participation in informal savings groups leads to a sense of mutual obligation to the other participants. Activities such as this that build the community spirit and confidence are especially important in meeting the needs of women living in poverty. These groups can be utilized further as a loan window if there is adequate capital available for both saving and credit. To be successful, a savings and credit model must recognize the importance of decision-making, participation, and flexibility, and it must give power to the poor to negotiate their own development strategies according to their own aspirations and ideas to utilize the poor in their own economic development.

5. Future Trends and Recommendations

Finance and financial services are no magic formula for reducing poverty and accelerating development – they are only a beginning. But they are an essential foundation whose capacity to support rural development has often been overlooked. This guide clearly demonstrates that rural financial services have now entered an exciting period of change. Policy makers, field workers, and financial institutions all need to be aware of global trends and national experiences in order to assist their clients or beneficiaries to make informed choices.

In these rapidly changing circumstances, putting pressure on the level of savings seems to be one of the major challenges facing rural finance institutions. The guide recommends two easy entry points: allowing banks to issue certificates of deposit and promoting postal savings. Other key challenges concern improving the quality of services and developing products more in harmony with rural development objectives. At present, many rural finance institutions are still organized around regulatory and product delivery issues, with their objectives primarily to maximize resource inflow to the disadvantage of resource outreach. A shift in focus away from financial self-sufficiency toward rural development objectives seems to be essential. To change the savings culture, rural finance institutions are advised to consider the following: diversifying into microfinance, deposit guarantees, special outreach strategies, and delivery channels.