rura107078_fm.qxd 5/17/05 3:33 PM Page i Meeting Development Challenges RenewedApproaches to Rural Finance Agriculture and Rural Development Department World Bank rura107078_fm.qxd 5/17/05 3:33 PM Page ii rura107078_fm.qxd 5/17/05 3:33 PM Page iii Table of Contents Acknowledgments v Acronyms and abbreviations vii Executive summary ix 1. Introduction 1 · Objective of the paper 1 · Why rural finance? 2 · Bank approach to rural finance 2 · Special challenges of rural finance 4 · Special challenges of rural finance within the World Bank 4 · Focus of the approach paper 5 · Methodology and organization of the approach paper 6 2. The three pillars of rural financial sector development 7 · Government policies and the legal, regulatory and supervisory framework 7 · Financial sector and real sector infrastructure 8 3. Grants and subsidies 13 · Appropriate subsidies to support rural finance goals 13 · Grants versus credit--subsidies to the poor for asset acquisition 15 4. Delivery channels and models for rural financial services 17 · Overview 17 · Potential areas of intervention for the World Bank 17 · Success factors for financial institutions in rural areas 18 · Commercial banks and rural finance 19 · Models for commercial banks entering rural markets 21 · Areas for possible Bank interventions 24 · Donor credit lines to commercial banks 24 · State-owned Agricultural and Rural Development Banks 25 · Areas for possible Bank interventions 28 · Specialized rural microfinance institutions 28 · Cooperative financial institutions 30 · Informal village-based models 33 · Community-driven development and rural finance 35 iii rura107078_fm.qxd 5/17/05 3:33 PM Page iv 5. Special-purpose institutions and products 37 · Leasing, a source of investment capital for rural areas 37 · Guarantee institutions and guarantee funds 39 · Supply chain financing 39 6. Cross-cutting issues of risk management, technological innovation and specialized collateral arrangements 43 · Technological innovations to reduce transaction costs and to achieve greater outreach for financial institutions 43 · Risk management instruments for financing for agriculture 45 7. Pulling it all together: a practical approach to strategy formulation 49 · Step 1: Preparation of a country diagnostic matrix 50 · Step 2: Formulation of core strategic focus 50 · Step 3: Prioritising the options and coming to a decision 52 · Conclusion 55 Appendix 1 Rural finance portfolio analysis at entry 2004 and 2003 57 Appendix 2 Diagnostic matrix: Rural financial sector development-- An example from a developing country--Uganda 67 Endnotes 69 Bibliography 73 iv Table of Contents rura107078_fm.qxd 5/17/05 3:33 PM Page v Acknowledgments This paper was prepared by Renate Kloeppinger- Ajai Nair, Korotouma Quattara, Parmesh Shah, Todd, Rural Finance Adviser, Agriculture and Rural Harideep Singh, and Liza Valenzuela. Background Development Department, with significant support papers were prepared by Ajai Nair, Harideep Singh, from Anne Ritchie, Senior Financial Sector Spe- and Rabobank International Advisory Services. cialist, Financial Sector Department. It builds on Thoughtful comments from a number of Bank rural finance work done in the past within the Bank colleagues as well as external persons are reflected and international experience worldwide. in this paper. Reviewers and advisers in the Bank The paper's starting point is the publication included Benoit Blarel, Hoonae Kim, Bikki "Rural Financial Services" (World Bank 2003d) Randhawa, David Scott and Biff Steel. Mark that outlines the Bank's strategy for rural finance Wenner from the Inter-American Development within the framework of Reaching the Rural Poor, Bank also provided valuable insights. the World Bank's rural development strategy. World The team appreciated the support and encour- Bank staff and consultants contributing to this agement of management and the financial support paper included, notably, Henry Bagazonzya, of the Government of the Netherlands through the Eustacius Betubiza, Juan von Buchenau Ulrich Bank Netherlands Partnership Program. Hess, Sabine Keinath, Cornelis van der Meer, v rura107078_fm.qxd 5/17/05 3:33 PM Page vi rura107078_fm.qxd 5/17/05 3:33 PM Page vii Acronyms and Abbreviations ALCU Association of Lithuanian Credit Unions ARB Association of Rural Banks ARD Agriculture and Rural Development Family of the World Bank ASCA accumulating savings and credit associations ATM automatic teller machine BAAC Bank for Agriculture and Agricultural Cooperatives BANSEFI Banco del Ahorro Nacional y Servicios Financieros BRAC Bangladesh Rural Advancement Committee BRI Bank Rakyat Indonesia CARD Center for Agriculture and Rural Development CAS Country Assistance Strategy CDD community driven development CECAM Caisse d'Epargne et de Credit Agricole Mutuel CGAP Consultative Group to Assist the Poorest CLUSA Cooperative League of USA CRMG Commodity Risk Management Group CVECA Caisses Villageoises d'Epargne et de Credit Autogérées DFCU Development Finance Corporation (Uganda) EBRD European Bank for Reconstruction and Development EU European Union FAO Food and Agriculture Organization of the United Nations FFI formal financial institution FI financial institution FMO Netherlands Development Finance Company (FMO) FSAP Financial Sector Assessment Papers GoB Government of Bangladesh GTZ Gesellschaft fuer Technische Zusammenarbeit IFAD International Fund for Agricultural Development IFC International Finance Corporation IGVGD Income Generation for Vulnerable Groups Development Program IMF International Monetary Fund IPC Internationale Projekt Consult IT information technology ITC Indian Tobacco Company KAFC Kyrgyz Agricultural Finance Corporation KfW Kreditanstalt fuer Wiederaufbau KPI key performance indicator vii rura107078_fm.qxd 5/17/05 3:33 PM Page viii LAAD Latin America Agribusiness Development Corporation LCCU Lithuanian Central Credit Union MIS management information system NBFI nonbank financial institution NGO non-governmental organization NLC Network Leasing Corporation (Pakistan) NMB National Microfinance Bank (Tanzania) OED Operations Evaluation Department PDA personal digital assistant PEP Private Enterprise Partnership PFCCO Philippine Federation of Credit Cooperatives PoS point of sale PRSP Poverty Reduction Strategy Papers RCSS Rural Savings and Credit Cooperatives ROSCA rotating savings and credit associations SME Small and medium sized enterprises TA Technical assistance UMU Uganda Microfinance Union WBI World Bank Institute viii Acronyms and Abbreviations rura107078_fm.qxd 5/17/05 3:33 PM Page ix Executive Summary The majority of the world's poor live in rural areas. the Bank's rural finance portfolio over the past It is clear that the Bank will not be successful in three years show that there are very few stand- achieving its overall poverty reduction objective alone rural finance projects that aim to increase unless it addresses rural poverty and helps to create access to financial services on a comprehensive broad-based economic growth in rural areas. basis. Most rural finance projects are components Rural finance is a necessary ingredient for rural of larger projects and contribute to the solution of economic growth. It makes a significant contribu- specific, narrowly defined problems, mostly credit tion to increasing incomes for farmers and other for project target groups through the provision of rural entrepreneurs and their employees; it helps credit lines. create opportunities for self-employment; and it re- duces the vulnerability of the poor to economic swings by offering opportunities to save in good What needs to be done times and to borrow in hard times. to realize the potential? There is a need to address the lack of financial ser- The potential of rural finance vices in the rural areas of most countries head-on. has never been better The time has passed to just add credit lines and a bit of technical assistance to rural and multi-sector The approach to rural finance developed over the projects and expect that this will result in the sus- past decade within the international community, tainable provision of financial services to rural including the World Bank, emphasizes the im- households and enterprises. portance of creating sustainable financial institu- This approach paper provides practical guidance tions providing a range of financial services that to Bank staff that are willing to take on that chal- are based on client demand. This approach offers lenge. It is not only meant to assist staff to knowl- the opportunity to make a lasting contribution to edgeably choose the appropriate design for rural the reduction of rural poverty, because people need finance projects but also, maybe even more impor- access to financial services on a permanent basis in tantly, to enable them to provide advice and guid- order to manage their financial affairs, including ance to World Bank country directors and counter- the growth of their economic activities. While there parts in Ministries and elsewhere in the partner are still many unresolved issues, especially with re- country. It also provides practical information to gard to financing for agriculture, diverse institu- Bank staff working on multi-sector projects tions in a number of countries are now providing a where access to finance in rural areas can only be broad range of people in rural areas with access to a component. appropriately designed financial products. Innova- The primary target audience of the approach tions that increase the efficiency of these institu- paper is task team leaders who are nonfinancial tions, and thus make the provision of financial ser- sector specialists working on rural development, ir- vices to rural people more attractive, are well rigation and other programs and projects where ac- beyond the pilot stage in many cases. cess to finance is an issue. Financial sector special- However, the World Bank, in its rural activities, ists without a comprehensive background and has not yet fully realized this potential. Reviews of exposure to rural finance might also find it useful. ix rura107078_fm.qxd 5/17/05 3:33 PM Page x What are the basic interest rate subsidies, caps on interest rates and credit forgiveness measures undermines efforts to underpinnings of a achieve sustainable rural finance. comprehensive approach to rural finance? How can the World Bank The development of a well-functioning rural fi- nance system rests on three pillars: good policies intervene? including an enabling legal, regulatory and super- Areas for Bank interventions exist at many points visory framework; financial sector and real sector along the continuum, depending on the specific infrastructure; and strong financial institutions. In- conditions and requirements of a particular coun- terventions on all three levels, appropriately se- try, or region of the country. A focus on policy dia- quenced, achieve the best results. Nevertheless, logue with respect to good policies and creation of there are potentially many activities on the institu- an enabling environment for rural finance is needed tional level that can be undertaken to increase ac- to support interventions at the institutional level. cess to financial services, even if the enabling envi- Therefore, close consultation and cooperation ronment is not fully supportive. Institution building between rural staff who are responsible for design- measures include technical assistance to help finan- ing and implementing projects that focus on the cial institutions develop appropriate products, sys- specific issues of rural finance and financial sector tems and service delivery strategies that will enable staff who are working on general financial sector them to profitably serve a rural clientele. issues in support of such projects is strongly Financial services are delivered to rural popula- recommended. tions by institutions that exist along a continuum Promising areas for World Bank interventions to from formal to informal. Formal institutions in- support rural finance are commercial banks looking clude public and private commercial banks, state- for new markets, select state-owned agricultural owned agricultural and rural development banks, and rural development banks that can be reformed cooperative banks, microfinance banks and special or restructured, specialized rural microfinance in- purpose financial institutions such as leasing, hous- stitutions, cooperative financial institutions, and ing and consumer finance companies. Informal community-based financial organizations. The providers of financial services include small groups same basic success factors apply to most types of that rotate internally generated savings as loans to financial institutions and include good governance members, money lenders, pawn shops, and busi- and management, appropriate credit technology, ef- nesses that provide financing to their customers. In ficient internal processing and controls, portfolio between stand the semiformal institutions such as diversification, and sound accounting and manage- NGOs and small financial cooperatives. All these ment information systems. The Bank has knowl- institutions have a role to play in rural finance. edge and experience in all these areas, so should be able to provide appropriate technical support. How- ever, the challenges are quite significant, as capac- What is the role ity building often requires a longer time frame than of government? a typical World Bank project. This implies that the way projects in rural areas are measured and evalu- There is a significant role for government. How- ated within the Bank should be refocused, so as to ever, the role of government should be limited to set the right incentives for Bank staff. creating good macroeconomic policies and an ap- Special purpose products offer additional oppor- propriate regulatory and legal framework, support- tunities. Leasing provides medium- to long-term ing the creation of appropriate financial and real funding for agricultural machinery and other pro- sector infrastructure, and funding technical assis- ductive assets. Guarantee mechanisms, when prop- tance that supports the efforts of rural financial in- erly designed, offer the opportunity to reduce stitutions to achieve sustainability. Direct govern- specific credit risks for financial institutions that ment intervention in rural credit markets through would otherwise not provide services in rural areas. x Executive Summary rura107078_fm.qxd 5/17/05 3:33 PM Page xi Appropriate design and a focus on minimizing some cases, a portion of an investment can be fi- moral hazard are essential here as in all other inter- nanced with a grant and the balance by a loan from ventions. In most developing countries, supply a financial institution. chain financing that provides the largest amount of financing for agriculture is a private sector activity that operates without much support from interna- Pulling it all together: tional institutions. A question that remains to be an- swered is whether and how the Bank can intervene a practical approach to in this area, in order to increase financing options strategy formulation on the for smallholder farmers and to encourage proces- country level sors to provide credit to farmers in regions that are without access to credit. Rural finance is a complex subject that requires Risk management instruments for financing for specialist knowledge. In order to help Bank task agriculture and technological innovations that en- managers decide on an appropriate set of interven- able financial institutions to reduce transaction tions from among all the options, a three-step ap- costs and increase portfolio quality present addi- proach to strategy formulation has been developed. tional opportunities. Knowledge about these excit- In the first step, information on the key elements of ing developments (as well as their limitations) the policy context, enabling environment, and fi- needs to be made available to task team leaders nancial institutions are collected and analysed, and become part of the tool box for design of rural along with information on the characteristics and finance projects. structure of the real sector. The findings from this Grants and subsidies are needed in many cases to analysis are then coupled in the second step with an support rural finance interventions. Bank policy on analysis of the demand for financial services in the financial intermediary lending (OP8.30) allows the proposed project area. A typology of countries has useofsubsidiestocreatetheconditionsthatmakeac- been developed that provides a framework that cess to financial services to underserved populations should enable task managers to compare the strate- possible.Appropriate subsidies include technical as- gic approach contemplated for the project under sistance to financial intermediaries to improve sys- design with that of similar countries. Taken to- tems that enhance efficiency; to develop and intro- gether, this analysis should enable the principal duce demand-responsive products on a pilot basis; to strategic focus of the project to be developed. The develop new or revised service delivery mechanisms third step concludes the analysis with the identifi- to enable larger outreach into rural areas than the fi- cation and prioritisation of intervention options. nancialinstitutionwouldattemptontheirown;andto This three-step process is obviously a simplifica- cover a portion of the cost of establishing new tion of the project design process; the intent is to branches in areas that do not have financial interme- provide a structure that will guide task managers diaries that serve the rural poor. Subsidies are also and help to ensure that all important elements are relevantforthedevelopmentoffinancialandrealsec- considered. tor infrastructure, as well as development of the en- This paper has attempted to create awareness of abling legal and regulatory environment. the complexities of rural finance and its relevance Very poor populations who lack access to eco- for rural development, and to explain the principal nomic opportunities and are too vulnerable to take methods and solutions that have been successful. risk can in some cases be assisted with matching Many of the challenges that have confounded ef- grants that enable them to acquire income generat- forts to increase the access of rural populations to ing assets. These assets can kick-start an activity sustainable financial services have now been over- that will result in future income generation. How- come in a number of countries. Over the years, the ever, such grants must be carefully targeted to World Bank has been an integral part of the inter- avoid capture by elites, have a match from the ben- national effort that has led to the current state of eficiary to ensure real ownership, and be accompa- knowledge. It is now time to increase that effort as nied by other types of support, such as training. In an indispensable part of the fight against poverty. Executive Summary xi rura107078_fm.qxd 5/17/05 3:33 PM Page xii 1 Introduction This paper is one in a series of sector papers elab- improvement of the living situation of the rural orating the implementation of the Bank's rural poor on a sustainable basis. Access to financial ser- development strategy "Reaching the Rural Poor."1 vices is an important ingredient to achieve this It builds on rural finance work done in the past2 overall objective, and makes a meaningful contri- within the Bank and on international experience bution if implemented well. The purpose of the worldwide. Its starting point is the publication rural finance approach paper is, therefore, to pro- "Rural Financial Services"3 that outlines the Bank's vide practical guidance to Bank staff who design strategy for rural finance within the framework of and implement rural finance projects. It is meant "Reaching the Rural Poor." not only to assist staff to knowledgeably choose the The range of topics related to finance in rural appropriate design for rural finance projects but areas is extensive, ranging from the financing of also, maybe even more importantly, to enable them rural development and infrastructure, to financing to provide advice and guidance to their counter- agricultural growth and private sector develop- parts in partner countries. The primary target ment, to the sustainable provision of financial ser- audience of the paper is task team leaders who are vices to rural populations. All of these topics are nonfinancial sector specialists working on rural important with respect to the Bank's rural develop- development, irrigation and other programs and ment strategy. Moreover, they are all within the projects where access to finance is an issue. mandate of the Bank's Agriculture and Rural Financial sector specialists without a comprehen- Development Department. However, in order to sive background and exposure to rural finance keep this approach paper to a manageable size that might also find it useful. is practical to use, the decision was made to limit Within the context of this paper, rural finance is the paper to the internationally accepted definition the provision of financial services such as savings, of rural finance. Rural finance for the purposes of credit, payments and insurance to rural popula- this approach paper is defined as the provision of a tions by organizations that exist along a continuum range of financial services to rural individuals, from formal to informal, ranging from commercial households, and enterprises, both farm and non- banks to informal village-based savings groups. This farm, on a sustainable basis. includes financing for agriculture, agro-processing and other rural enterprises, from part-time income Objective of the paper generating activities to full-time micro-enterprises to small and medium size (SME) enterprises. The overall objective of the Bank's rural develop- Rural finance projects, which are based on the ment strategy "Reaching the Rural Poor" is the Board-approved rural development strategy, can 1 either be comprehensive stand-alone projects, or pursue economic opportunities as well as manage rural finance components of rural development their household finances. projects. Credit lines for rural projects, where the end-user receives funds in the form of a loan and is · Reduction of vulnerability to economic, physical required to pay it back, regardless of the institu- and other shocks tional arrangements, are also considered rural The poor in general have few resources and are finance components for the purposes of this paper. vulnerable to even small swings in income or unex- In the past, it has often been the case that rural pected expenses due to illness, death of a family finance components were developed as an after- member, seasonal liquidity problems related to the thought, once it became obvious that stated project agricultural calendar, and a wide variety of other objectives could not be achieved without support- factors. The ability to save even small amounts ing access to financial services. This paper will during good times and keep these sums safely provide rural staff with knowledge of the success locked away until they are needed is essential. factors for rural finance, gained from international Another financial product that is important to poor as well as Bank experience, and a tool to make rural populations is the ability to receive remit- design decisions based on a systematic and trans- tances reliably and at a low cost from migrant parent process. workers, especially in rural areas that have poor prospects for economic growth and income generation. Why rural finance? While there is no conclusive proof that access to financial services has a significant impact on From the standpoint of rural development and poverty reduction, there is substantial field-based poverty reduction, as supported by the World Bank, evidence pointing to the importance of rural finance three strategic goals are central,4 and rural finance, for economic development.5 Most households with when properly implemented, makes a contribution economic activities above the consumption level to all three of these goals: and most enterprises in rural as well as urban areas need access to financial services in order to grow · Achievement of economic growth and generate income, be they agriculture-based6 or off-farm. Access to finance is also needed for Access to a range of financial services is necessary improvements in rural infrastructure such as in order to achieve economic growth, including telecommunications, energy, irrigation and water- growth in rural areas. Growth in agriculture as well shed management, all of which have an impact on as other rural economic activities can be substan- the improvement of people's lives. tially enhanced if there is reliable and sufficient financing, and sustainable financial intermediation, in addition to many other factors. Bank approach to · Inclusion and participation of all members of rural finance the rural population in economic development For many years, rural finance was defined as the In many countries, poor rural populations do not provision of credit to special target groups, mainly have access to financial services even if there is farmers. International donors, including the World access for wealthy persons, larger farms and larger Bank, supported this approach through the provi- rural enterprises. The microfinance "revolution" sion of funds for international and domestic credit has demonstrated conclusively that financial inter- lines. By the early 1990s, it became apparent mediaries that serve the poor, as well as better-off that many such credit lines had low recovery rates, populations and enterprises, can be successful. were implemented by unsustainable institutions, Access by the poor to financial services provides and did not achieve the intended purpose of in- them with some of the resources they need to creasing rural livelihoods, except for those few 2 Meeting Development Challenges: Renewed Approaches to Rural Finance farmers, often the more wealthy ones, who directly for institution-building are thus essential project benefited from the limited funding and inefficient features, rather than simply support for credit distribution structures.7 Consequently, significant lines. The long-term sustainability of financial analytical work was done within the Bank and institutions requires access to reliable sources of the international community to analyze the issues funding for their credit business. Savings, properly involved and to develop alternative approaches.8 safeguarded by means of supervision and possibly Donor agencies began to shift their approach away deposit insurance arrangements, are a first choice. from a focus on agricultural credit towards a wider Therefore, savings should be regarded as not only a view of rural finance, characterized by a broad product demanded by customers, but also a strategic range of financial services, rather than credit only; priority for a financial institution's sustainability. provision of financial services to all rural dwellers, Access to domestic and possibly international bond not just farmers; use of market interest rates; and markets are another potential source of funding in the operational efficiency and financial viability of more developed financial markets and could well be rural financial institutions.9 supported. One example is International Finance Rural finance for rural development in the Corporation's (IFC) recent partial guarantee of current context of the World Bank is based on a bond issue for Compartamos, a Mexican rural the following principles: microfinance institution.10 · Demand-responsive approach to financial · Clearly defined role for government services access There is a significant role for government in rural Rural populations demand a range of financial finance. But this role should be limited to the cre- services, depending on their current economic de- ation of good macroeconomic policies, an appro- velopment, potential for future development, and priate regulatory and legal framework, and funding ability to take advantage of opportunities within for technical assistance to rural finance institutions. their existing environment. In many cases, credit is Direct interference in rural credit markets through not the most appropriate product. In fact, savings interest rate subsidies, caps on interest rates and and payment services might initially be more rele- credit forgiveness measures undermine efforts to vant for poor rural populations, enabling them to achieve sustainable institutions. State ownership of accumulate assets and to smooth uneven income rural financial institutions has in the past often not flows. Consequently, the design of programs that resulted in achieving sustainable access to financial support rural financial intermediaries has shifted services and should therefore not be promoted, from a focus on credit only to a better understanding except under exceptional circumstances and as of the demand by rural populations, including the outlined in Chapter 4. poor, for all financial services, including savings, in- surance, payments and remittances, as well as credit. · Holistic approach Efforts to achieve access to financial services need · Sustainability of access to financial services to be complemented by other interventions that Sustainable access to demand-responsive financial support the sustainable development of rural eco- services is critical for the economic development nomic activities. Access to financial services is of rural areas and contributes to the reduction only one of the factors influencing rural economic of vulnerability of poor populations. It is there- development. For example, access to quality agri- fore now seen as the primary objective of rural cultural inputs, access to agricultural extension finance. Within this context, helping rural finan- services, access to markets and market informa- cial institutions--all along the continuum from tion, and access to physical and communication formal to informal--to achieve long-term institu- infrastructure are all important, and should be tional sustainability is paramount. Support for the investigated as complementary measures in order creation of an enabling environment and support to achieve best results. Introduction 3 Special challenges answers on how the proposed actions tackle the problem structure arising from the specific circum- of rural finance stances of the particular country. The establishment of viable rural financial systems encompasses many specific challenges, in addition to the challenges inherent in the development of Special challenges of countrywide financial systems. Low population rural finance within the density and difficult to reach remote areas in many countries translate into high transaction costs for World Bank financial institutions contemplating an entry into Bank lending for lines of credit these areas. Limited economic opportunities in many rural areas result in small transactions, Credit lines are often part of rural development further increasing overall transaction costs. projects. They fulfill a useful function in those The heavy concentration on agriculture and countries where there is a demonstrated lack of agriculture-related activities in rural areas exposes liquidity or long-term funding in the financial farmers and their lenders to multiple risks. Some markets, or where funding is not available for rural of these risks are idiosyncratic, affecting a single lending, and where there are institutions available household, whereas others are covariant in nature that have the capacity to implement a credit line. and affect an entire region or country. Weather risk They are also beneficial when financial institutions is probably the single most important risk influenc- that do not have access to commercial sources of ing the outcome of a farmer's investment. This risk funding are supported in their early stages. This is also affects associated economic activities such as especially important in those Bank member coun- agro-processing. Price risk can also be quite sub- tries that are reluctant to borrow for technical assis- stantial, especially for products that are sold in very tance to establish new institutions or to strengthen competitive international markets. existing financial institutions, but can be convinced For financial institutions, in addition to the risks to do so if the technical assistance funds are com- inherent in financing agriculture and agriculture- plemented by a line of credit. related activities, there are risks associated with the Over the past few years, credit lines within the concentration of portfolios on the agricultural ac- Bank have been subjected to close scrutiny, includ- tivities that are most prevalent in a particular rural ing development of a Bank policy on credit lines, area; this makes risk reduction through portfolio OP8.30, in 1998,11 and an Operations Evaluation diversification in rural areas difficult if not impos- Department (OED) review of Bank lending for credit sible to achieve. On top of this, the risk of political lines in 2003/4.12 This review included rural finance intervention can strongly influence the overall risk operations. The main findings were that (i) imple- from the perspective of the intermediaries, as pay- mentation of Bank guidelines for lines of credit has ment morale can be completely undermined by been poor, (ii) outcomes are poor, (iii) cancellation debt forgiveness granted at the government's insti- rates have been high, and (iv) better outcomes are gation and interest rate caps can eliminate what associated with stable macroeconomic conditions, may already be very slim margins. stronger financial sectors, use of clear eligibility All three factors together--high transaction criteria for the selection of participating financial costs, high risks, and the possibility of political institutions, and use of private sector financial inter- interference--constitute a problem structure for mediaries. One lesson learnt is that rural credit lines rural finance which has to be well understood and usually perform better if they are designed as part of taken into account in strategy formulation. This a comprehensive rural finance project rather than as a combination of factors can render rural finance an short-term solution to credit needs in a general rural unattractive proposition for many financial institu- development operation. As a result of the OED re- tions, especially those that have well-established view,theBoardhasmadeapolicydecisiontohaveall and profitable business lines and no mandate to proposed credit lines reviewed by financial special- serve the rural sector. This clearly implies that any ists reporting to the financial sector board regarding strategy for rural finance has to provide clear-cut their adherence to the principles of OP8.30. 4 Meeting Development Challenges: Renewed Approaches to Rural Finance According to this policy, institutions that do support for service provision, where credit is the not have strong institutional capacity can become predominant service being provided (14 projects eligible for Bank credit lines if they develop and out of 20 in FY04 and 13 out of 17 in FY03). In implement an institutional strengthening plan. both years, only two projects are stand-alone rural Funds must be used for the increased production of finance projects that aim to increase access to fi- goods and services, and appraisal must determine nancial services in rural areas on a comprehensive if the operation can achieve its desired objective basis. In FY04, 10 projects were initiated by the with due regard to the sustainability of the financial agriculture and rural development sector, four by sector. On-lending terms must be set within the the financial and private sectors, and two each by context of a country's interest rate structure and infrastructure and social protection. must provide financial institutions with adequate The annual review of approved rural finance pro- margin to cover all their costs, including credit and jects, as well as the OED review of credit lines, in- other risks, and an adequate profit margin. Thus, cluding credit lines to rural financial institutions, OP8.30 provides space for rural finance operations demonstrates clearly that rural finance within the in areas with weak financial institutions, provided World Bank has not yet taken on the full role it that they explicitly address the weaknesses of these needs to play to support rural development. Rural institutions. finance project components contribute to the solu- The definition of credit line for the purpose of tion of specific, narrowly defined problems, mostly the OP8.30 review includes any project that chan- credit for project target groups. They rarely com- nels Bank funds to households or businesses with prehensively address the issues that constrain an obligation to repay, regardless of what entity is access to finance by rural populations, and conse- intermediating the funds (financial institution, gov- quently have only modest impact. The scarcity of ernment department, nonfinancial company, etc.) such operations, regardless of sector attribution, and regardless of what it is called (loan, cost recov- points to either insufficient resources, lack of ery of grants, reimbursable assistance, revolving knowledge about rural finance and its relevance fund or other terms). Thus, grants made by pro- for rural development, or other priorities within the jects, especially Community Driven Development regional departments and their partner countries. (CDD) projects, to communities that lend these The potential contribution of rural finance to funds to their members, must be reviewed. rural development warrants a far more substantial approach. Status of rural finance within the World Bank's rural Focus of the approach paper development operations This paper builds on the three pillars of rural finan- The Agriculture and Rural Development Depart- cial sector development; namely, government poli- ment conducts annual reviews of rural finance cies and the enabling regulatory and legal environ- projects approved in a given year that are either ex- ment, infrastructure for the financial and real clusively focused on rural finance or have compo- sectors, and financial institutions. The major focus nents or activities directly related to rural finance. of this paper is on the third pillar, the institutional In FY04, there were 20 projects with a volume of level, for the following reasons: $241 million, and in FY03, 17 projects with a volume of $666 million.13 The difference in volume · Rural finance is a subsector of the country's is explained by one large adjustment project financial sector, and many of the issues concern- ($506 million) in FY03. The analysis revealed that ing government financial sector policies and the designs of most projects are based on good the regulatory framework are better addressed practice for the chosen approach and that several through country-level financial sector work. projects have outstanding innovative features. Interventions on that level are therefore only However, the majority of rural finance projects are covered in this paper insofar as they apply to components of larger projects and tend to focus on specific rural circumstances.14 Introduction 5 · Considerable research work on cross-cutting Methodology and organization issues, for example, on credit information sys- of the approach paper tems, remittances, and the use of postal systems for improved access, is being done by other parts The approach paper has five major thematic blocks. of the Bank and should not be duplicated.15 The Chapter 2 provides an overview of the main issues cross-cutting issues covered in this paper relate restricting the development of rural finance on the directly to rural finance; this includes risk man- three levels of policy, enabling environment and in- agement instruments for financing agriculture stitutional capacity. Chapter 3 discusses the issues and innovations that will enable rural finance of appropriate subsidies and the use of grants institutions to cover their costs. versus credit. Chapters 4­6 analyze the delivery · The institutional level is the area of greatest de- channels and models for supporting rural finance, mand for advice, as most rural finance projects including special purpose institutions and products, within the Bank concentrate on this level. and an overview of several cross-cutting issues. Chapter 7 develops a practical approach to the References are provided throughout the text on formulation of a country-specific rural finance where to look for further information on topics strategy. mentioned in the text. 6 Meeting Development Challenges: Renewed Approaches to Rural Finance 2 The three pillars of rural financial sector development Provision of financial services in rural areas re- developing economies where financial markets in mains a challenge. During the last ten years, the general and rural financial markets in particular adoption of the financial systems approach--that are often weak, fragmented and cater only to the is, the financing of economic activities in rural least-risk and higher-value customers, including areas as part of a comprehensive financial sector the government itself. Government policies can be development strategy--has led to significant break- erratic and opportunistic, responding more to throughs in increasing the outreach of financial political than economic considerations. Issues that services and the performance of financial interme- frequently have a major impact on rural finance are diaries. However, many rural areas worldwide still highlighted in the sections below. lack an adequate supply of formal financial ser- The three pillars of rural financial sector devel- vices; even the strong expansion of microfinance opment are: 1) government policies and the legal, has not changed this significantly, especially with regulatory and supervisory framework, 2) financial regard to financing for agriculture. Government sector and real sector infrastructure, and 3) finan- policies in many countries hinder rather than sup- cial institutions. port the development of financial markets that provide access to the majority of the population. In the case of rural financial markets, there are often Government policies and additional issues related to government policies the legal, regulatory and to subsidize farming and farmers. In the ideal case for agricultural and rural devel- supervisory framework opment, rural financial markets are efficient and Policy level issues afford access to all population groups for their financing needs, including agriculture, and offer · Crowding out of private sector customers demand-responsive products and services tailored through large government borrowings from the to the requirements of their diverse customers. banking sector, as government bonds offer finan- Macroeconomic policies are favorable as is the cial institutions less risky and often shorter-term legal and regulatory environment, and there is suf- investment opportunities than the financing of ficient financial and real sector infrastructure to small farmers and rural entrepreneurs. support the development of efficient financial insti- · Monetary policies leading to high uncertainty tutions. However, this is not the case even in highly and the unwillingness of investors to provide developed countries; much less in transition and mid- and long-term domestic funding. 7 · Tendencies of governments to please potential markets in more mature markets, and often have voters in the short run by providing inappro- limited growth potential.18 priate subsidies to the detriment of longer-term · Shortage of institutional capacity in bank sustainable financial sector development. Caps supervision. on interest rates that can be charged by financial Supervising financial institutions is costly and institutions also deter financial institutions from resource-intensive. This is especially true for entering or staying in those markets where there smaller institutions in rural areas. Solutions such are higher costs and/or credit risks. as delegated or auxiliary supervision are being used for cooperative financial institutions in Issues in the legal, regulatory some countries and could be an example for other networks of nonbank financial institutions.19 and supervisory framework · Missing or inappropriate laws on property, especially land, but also other kinds of physical Financial sector and real property, and their use as collateral; and lack of efficient bankruptcy laws. sector infrastructure Especially in rural areas, the role of secure Financial sector infrastructure property rights, i.e. land rights, are of great importance, both for credit purposes and as an · Lack of training institutes, industry associations, incentive for people to invest in the development and information agencies, including credit and of that land.16 They need to be administered and collateral registries. enforced by institutions that have both legal Credit registries allow a borrower to establish backing and social legitimacy and are accessible a credit history, an important factor in a bank's by and accountable to the holders of property decision to grant a loan. Collateral registries rights. However, not just property rights, but also allow financial institutions to collect on collat- land transactions such as rentals and sales are eral without having to go through often lengthy important to realize full benefits. Most financial court processes. Other financial sector infra- institutions will not provide credit without col- structure such as training institutes and industry lateral, meaning in most cases land or the right to associations increase the professionalism of fi- use land. However, land as collateral by itself is nancial institutions' management and staff. Fi- only valuable if it can be collected, or if the nancial institutions that are staffed with educated threat of collection contributes to credit disci- people that receive ongoing professional training pline. Efforts to support land titling as well as the are likely to be better managed and better able to establishment of property registries can make a calculate risks, than institutions with less-devel- significant contribution to access to credit for oped staff. rural populations17 as can efforts to establish For a real reduction of critical transaction efficient markets for land. costs, best results are achieved when all relevant · Lack of enforcement capabilities or willingness issues are addressed. The establishment of credit to take action against offenders, even if there is information registries, adequate creditor rights an appropriate legal framework. in secured transactions, and efficient bankruptcy · Issues with the regulation of the financial sector. laws all work together to facilitate access to These issues range from inadequate regula- credit. Information sharing allows creditors to tion to excessive regulation, and disagreements distinguish good clients from bad clients, while on which institutions should be defined as being legal rights enable claims enforcement in the part of the financial sector, and therefore subject event of default. to supervision. Usually, unsupervised financial · Lack of agricultural risk management institutions are not allowed to collect deposits, so instruments. as to provide protection to depositors. These Weather and prices both pose great risks institutions are thus likely to depend on govern- for farmers. Instruments to manage such risks ments or donors for refinancing, or on capital have been developed and are available to farmers 8 Meeting Development Challenges: Renewed Approaches to Rural Finance in developed countries. New ways are being A lack of paved roads in rural areas, unreliable sought to apply these instruments to develop- electricity and an inadequate telecommunica- ing countries and to smallholders. Chapter 6 tions infrastructure all increase costs for busi- takes a closer look at such instruments and their nesses and financial intermediaries. Overcoming potential. serious deficiencies will have a very positive · Payment systems that need to be modernized. impact on the development of a rural financial In many developing countries, payment sys- system. As these statements are simple, com- tems are woefully inadequate, slow, expensive to monsense observations, not much literature is access, and with limited outreach to rural areas. available here. Small rural banks might be excluded from check · Lack of market information such as current clearing by large urban banks; access to cash prices for basic commodities. might be sporadic, resulting in the rural popula- · Lack of processing facilities for local value- tion being forced to carry much larger amounts adding. of cash for purchases than would be advisable · Lack of competent business development ser- for security reasons. Migrant remittances to vices that could assist farmers and other rural rural areas are also expensive. These issues can enterprises with informed decision-making and be addressed by a combination of measures, as the acquisition of management skills and sup- demonstrated by the Ghana Rural Financial Ser- port them in developing business plans that vices project outlined in Box 1 below. would enable them to better approach financial · Lack of facilities such as deposit insurance that institutions. would safeguard and encourage savings. · Stifling bureaucracy in the registration of In many rural areas, savings are collected businesses. through informal or semiformal savings groups where members know each other and savings are Addressing macro-level monetary policy and finan- safeguarded through the group process. Mobi- cial sector issues is obviously outside the scope of lization of savings on a larger scale might be ac- Bank agriculture and rural development activities companied by some kind of protection scheme, in a given country. Instead, a close coordination such as a fund set up by the members of a finan- with the International Monetary Fund (IMF) and cial network, for example, cooperative financial Bank departments working on such issues at the institutions. Deposit insurance within the formal country level could be beneficial for the develop- financial sector is a complex issue and is not ment of rural finance over the long run. Supporting likely to be addressed in a rural finance project.20 the development of a suitable legal and regulatory framework, financial and real sector infrastructure, and an enabling environment for economic activi- Real sector infrastructure ties can, however, be an important part of rural de- · The impact of inadequate infrastructure on the velopment projects.This should only be considered if development of rural enterprises can be massive. the project team contains, or can acquire, the required BOX 1 Rural Financial Services Project (RFSP), Ghana RFSP supported the establishment of an apex bank for developed; this is a network linking all rural banks to the network of rural banks in Ghana. The Association the Apex Bank for fund transfers. The ARB Apex of Rural Banks (ARB) Apex Bank is undertaking sev- Bank's regional branches also supply bank notes to eral measures to increase access to countrywide pay- the rural banks on short notice and without charge. ment systems. It supports the individual rural banks in their check clearing efforts so that rural bank checks Source: R. Kloeppinger-Todd and P. Mensah, The World Bank, are now accepted across the country. Apex-link was Personal Communications, March 2005. The Three Pillars of Rural Financial Sector Development 9 technical expertise. Otherwise, the principle of "Do In many countries, one of the biggest problems No Harm" should be followed. Task team leaders in rural finance is that there are not a sufficient who are looking for further information on the issues number of financial institutions operating in rural highlighted in this section should refer to the refer- areas, or there are not enough institutions serving ences provided throughout the paper. low-income customers and farmers. Many World Bank projects have used various kinds of incen- Financial institutions tives, especially credit lines, to stimulate the entry At the core of rural finance are the financial inter- of financial intermediaries that can help to close mediaries that deliver financial services within these gaps, as well as to provide longer-term fund- rural areas. In the end, all other aspects of rural fi- ing to rural businesses. The recent OED review of nancial sector development are no more and no less the performance of Bank credit lines has revealed a than necessary or desirable elements that ultimately substandard performance across the portfolio in- support the development of institutions that can de- cluding rural credit lines; this has resulted in closer liver financial services in rural areas on a sustain- oversight at entry and a focus on better reporting of able basis. It is important to stress this point: one performance. The real issue, however, is not only key consequence of the financial systems approach the performance of credit lines but also the useful- which has evolved over the last 10­15 years is that ness of providing such funding at all, especially to it is not primarily target group outreach which financial institutions that in many cases do not have determines the success of a project, but equally the institutional capacity and strategic motivation important--or even more important--whether or to serve the new clientele after the project has not services can be delivered to the target group on ended. The lack of access to financial services a sustainable basis. Reaching a specific target other than credit is not addressed by this instrument group once or even a couple of times cannot in the either. end be considered as any success at all, if the fun- In many of the Bank's partner countries, lack of damental need for sustainable financial services financing in rural areas and specifically financing has not been satisfied or if it comes at the expense for agriculture is not due to a general lack of liq- of other clients. Almost all businesses and house- uidity in the country, but rather to lack of suitable holds need an extensive set of financial services financial institutions and the high risks, perceived that enable them to actively manage their financial and real, in entering such markets. Therefore, pro- resources; these include access to savings, credit, viding liquidity in the form of a credit line does not insurance and payments systems, including the solve the problem in most cases; it provides only ability to send and receive remittances. temporary funds to borrowers and may not meet The financial systems approach has necessarily their needs for other financial services. An excep- shifted the focus from target groups to suppliers of tion is those situations where there is no long-term financial services, since only well-managed finan- lending available in a country, even in the face of cial intermediaries can guarantee the provision of high short-term market liquidity. In those situa- financial services to rural customers over the long tions, a Bank credit line directed towards longer- term. This has huge implications for project design, term investment lending could well complement as not only are the availability of funds and the institution-building measures. capacity to reach rural customers, including farm- Institution-building measures would include ers and the rural poor, important, but also the sus- technical assistance to help financial institutions tainability of the financial intermediaries that serve develop appropriate products, systems, and service these customers. Therefore, complex issues of delivery strategies that would enable them to prof- ownership, governance, management, systems, and itably serve a rural clientele.Although this approach service delivery structures have to be analyzed so can be easily formulated, the challenges are quite as to ensure that partner institutions are financially significant, as capacity building often requires a sound and have a business strategy which allows long time frame. Significant outreach results should them to extend financial services in rural areas on a not be expected quickly, as it takes time to build sustainable basis. strong structures and systems. This implies that the 10 Meeting Development Challenges: Renewed Approaches to Rural Finance way projects in rural areas are measured and evalu- Unless these arrangements are designed from the ated within the Bank should be refocused, so as to beginning to link clients to existing financial inter- set the right incentives for Bank staff. mediaries or to develop these structures into viable The lack of financial institutions in rural areas financial intermediaries, with the appropriate assis- is often the reason that projects channel credit tance for institution-building, sustainability cannot lines through a variety of other institutional be achieved and rural populations will be left once arrangements, including community groups, project again without financial services after the project implementation units and government departments. ends. The Three Pillars of Rural Financial Sector Development 11 3 Grants and subsidies Grants and subsidies are an important topic in rural and especially prior to elections. These and similar development; while strictly speaking, this topic is measures, however, prevent the development of outside the narrow focus of rural finance, the use of sustainable rural financial markets by crowding out grants and subsidies strongly influences the out- or preventing the entry of private financial institu- come of rural finance activities, so the topic needs tions, introducing moral hazard and contributing to be addressed in this paper. Project teams some- to a bad credit culture.Therefore, they should not be times provide subsidies and grants, rather than ad- supported.There are, however, many types of subsi- dressing the issue of lack of access to financial ser- dies that can contribute to the goals of rural devel- vices, especially if there are few suitable opment and poverty reduction without distorting institutions that could be qualified partners right the development of sustainable rural finance. This from the start. This approach can lead to the well- could include helping financial institutions to be- demonstrated effects of capture by elites, lack of come more cost-effective and by fostering competi- access to necessary financial services after the pro- tion, thus motivating them to lower interest rates. ject ends, and market distortions that undermine the efforts of others, who are working on promoting more sustainable arrangements. Appropriate subsidies to Therefore, it needs to be clearly stated that the support rural finance goals World Bank adheres to and promotes the financial systems approach to finance, including rural finance. These subsidies can be divided into three cate- The ultimate goal of this approach is the develop- gories: subsidies for (i) financial intermediaries, ment of financial institutions operating profitably (ii) financial infrastructure, and (iii) economic and on a commercial basis and offering products and social infrastructure. Each of these categories is services demanded by a wide range of clients covered briefly in the sections below. The general including the poor. This means that the financing of rule is that subsidies should be time-bound, limited agriculture and rural development needs to be in nature, and decreasing over time. structured in such a way that it doesn't distort or inhibit the growth of financial markets, but instead Subsidies for financial contributes to their development. intermediaries Interest rate subsidies and caps, directed credit, forgiveness of farmers' debts following bad har- Bank policy on financial intermediaries (OP8.30) vests, and government-subsidized crop insurance allows the use of subsidies to create the condi- are always hot topics for Ministries of Agriculture tions that make access to financial services to 13 underserved populations possible. Subsidies to sustainable financial institutions, not only in rural financial intermediaries must be: areas (see Box 2). Significant leverage can be achieved from the investment of relatively small · transparent, targeted, and capped; amounts that would benefit a range of institutions. · funded explicitly through the government bud- Time-bound subsidies may be appropriate to: get or other sources subject to effective control and regular review; · create capacity within regulatory and supervi- · fiscally sustainable; sory bodies; · fair, not giving an unfair advantage to some · support the creation of industry associations; intermediaries vis-à-vis other qualified and di- and rectly competing institutions; and · develop training institutes and credit informa- · economically justified. tion agencies. Subsidies for financial intermediaries that cannot Subsidies for economic and comply with standard eligibility criteria, such as social infrastructure profitability, must be accompanied by an institu- tional development plan. Monitoring should in- Appropriate investments in economic and social clude sectoral, financial and institutional variables. infrastructure can raise the productive potential of Key performance indicators (KPIs) should include the community. They do not in themselves generate the quality of earnings and assets. income, but rather facilitate the carrying out of Appropriate subsidies could: income-generating activities. Examples of economic infrastructure that directly raise income earning po- · provide technical assistance to financial inter- tential include small-scale irrigation, market facili- mediaries to improve systems that enhance effi- ties, a harbour or cold storage for fishing, and even ciency, such as management information systems; a building and safe for a community-based savings · develop and introduce demand-responsive prod- and credit association. Income-earning potential is ucts on a pilot basis; also increased indirectly by investments in social · help develop or improve service delivery mecha- infrastructure that raise the productivity of labor, nisms that enable greater outreach into rural such as clean water, education and health facilities. areas; and Subsidies can also be used to help develop local or- · cover a portion of the cost of establishing new ganizations that can facilitate input supply, storage, branches in areas that do not have financial inter- and marketing, either directly or in partnership with mediaries that serve the poor. other private firms. In all cases, subsidies should: Subsidies for financial · decline over time, as the local organizations build up capacity to cover costs through user fees; and infrastructure · include a match from the beneficiaries, prefer- Appropriate financial sector infrastructure is a ably in cash but also in kind, depending upon the necessary prerequisite for the development of beneficiaries' economic circumstances. BOX 2 Example: Subsidies for the Creation of Microfinance Banks in Eastern Europe, the Caucasus and Africa. IFC, in cooperation with other investors such as Eu- sistance funds for management contracts, as well as ropean Bank for Reconstruction and Development funds to cover start-up costs for the initial two years (EBRD), Kreditanstalt fuer Wiederaufbau (KfW), a of operation, decreasing to zero after some additional Netherlands Development Finance Company (FMO) years. Source: E. Wallace, EBRD, 2003, Personal and private investors, has provided investment funds Communication, S. A. Ahmed, IFC, 2003, Personal for the creation of microfinance banks. The European Communication. Union (EU) and other donors provided technical as- 14 Meeting Development Challenges: Renewed Approaches to Rural Finance Grants versus credit-- In these cases, the use of grants can be consid- ered. However, since grants cannot be considered a subsidies to the poor source of sustainable financing, their use should be for asset acquisition limited in time and amount. They may be useful to kick-start an economic activity by providing the During the early stages of the "microfinance revo- very poor with an income-generating asset, but lution" in the 1980s, the provision of credit to poor must be followed by measures that help people population groups was indeed a revolution. The graduate to sustainable sources of financing. Fur- strong repayment of loans by both the urban and thermore, extremely poor and vulnerable people rural poor who had previously been considered may need a package of assistance, including train- "unbankable," the ability of clients of microfinance ing, if they are to earn income from an economic organizations to save, and the development of activity on a sustainable basis. An example of an in- methodologies that enabled these organizations to tegrated approach is BRAC Bangladesh's IGVGD cover their costs demonstrated clearly that the pro- program shown in Box 3. vision of financial services can be done on a sus- Some general guidelines for grants for economic tainable basis. At that time, credit programs were activities include the following: targeted primarily to the economically active poor, who were expected to use the funds to develop their livelihoods and earn an income that would support · Grants for economic activities should be limited to (i) very poor people who are too vulnerable to their families. take on the risk of a loan, (ii) poor people living in Subsequent efforts to deepen the outreach of communities that are beyond the reach of finan- microfinance to ever poorer populations have had cial institutions that are willing and able to extend mixed results, however. Potential borrowers need to services to the poor, and (iii) poor people that achieve a certain level of economic capacity before have some assets and earning capacity but could they are able to effectively utilize loans for income not earn enough from the activity to pay off the generation. Those who are extremely poor, living in investment cost within a reasonable time frame. a post-conflict or emergency situation, or ill with life-threatening diseases, may not be able to prof- · Grants must be carefully targeted with strong eligibility criteria to avoid capture of benefits itably manage an economic activity. Hence, the by elites. provision of credit for such people may not result in the improvement of their economic situation and a · Grants should be made on a matching basis; beneficiaries' contributions should be in cash if reduction in vulnerability; on the contrary, it may possible. In-kind contributions would only be leave them indebted and without the means to repay appropriate in situations such as emergency or the loan. BOX 3 Social Safety Net Linkage Programs: BRAC's IGVGD Program Realizing that their microfinance programs did not going skills training in areas such as poultry and reach the ultra-poor, the Bangladesh Rural Advance- livestock raising. Participants are also required to ment Committee (BRAC) developed the Income save and are eligible for two consecutive loans from Generation for Vulnerable Groups Development Pro- BRAC. After successful completion of IGVGD and gram (IGVGD). IGVGD combines existing social repayment of the loans, participants can graduate to safety net programs such as the World Food Pro- BRAC's regular microfinance program. IGVGD has gram and Government of Bangladesh (GoB) food reached approximately one million very poor grain assistance with skills training, savings and women in the 10 years from 1988/89 to 1998/99, credit services. The program thus addresses immedi- two-thirds of whom were able to graduate to BRAC's ate consumption needs while laying the basis for regular microfinance program. viable income generating activities. Participants re- ceive time-bound food grain assistance while under- Source: CGAP 2001; and information at www.brac.net. Grants and Subsidies 15 post-conflict, where the majority of participants savings and a loan from a financial institution could not be expected to have been able to save should be considered. There should be a strict for the cash contribution. separation between the financial intermediary · So as to ensure that beneficiaries value and care that is issuing the loan and the body that is issu- for the assets financed by the grant, they should ing the grants, even if the funding is held in the contribute as high a percentage as is reasonable, same financial institution. This way, it can be given their overall economic circumstances. This made clear to the beneficiary that the loan com- should be at least 10% of total cost, and in many ing from a financial institution or other body is cases, a much greater percentage. indeed a loan and needs to be paid back. If both · Developing a cost recovery mechanism can help sources of funding appear to come from the ensure that only people with serious intentions same organization, confusion among beneficia- receive grants. One possibility would be to es- ries is likely to result in poor repayment and tablish local savings and credit associations that damage to the local credit culture. The example would capture recoveries and hold beneficiary in Box 3 outlines how such a separation can be savings. The recoveries would help capitalize the implemented. entities for future lending within the groups. · Grants for income-generating activities should · Grants are sometimes made to groups to finance in many cases be combined with training in expensive assets that can't be provided by grants economic activity selection, planning and man- to individuals. However, project teams should agement. World Bank Institute (WBI) has an es- be aware that conflicts can arise from group tablished Grassroots Management Training pro- ownership of an asset. If group ownership does gram, which includes household management, not have clear advantages that significantly business skills, and financial skills. These im- outweigh these potential conflicts, it might be prove the ability of targeted groups (especially preferable to provide grants to carefully targeted rural women) to manage their income-earning individuals. activities and finances, often obviating the need · For poor people who have some assets and in- to seek credit and making them more successful come earning capacity, financing a portion of the when they do. Such programs are sometimes investment with a grant and the remainder with linked with literacy and health programs. 16 Meeting Development Challenges: Renewed Approaches to Rural Finance 4 Delivery channels and models for rural financial services Overview where there are no formal providers of financial services. They offer a range of services, from This chapter provides an overview of delivery safeguarding of savings to short-term loans to channels and models for rural financial services, domestic and even international transfer services explores their suitability under different circum- for remittances. These entities are often not con- stances, and identifies key success factors. sidered to be part of the financial sector by fi- Financial services are delivered to rural popu- nancial sector specialists and are thus often not lations by organizations that exist along a contin- included in discussions about financial sector de- uum from formal to informal. The boundaries velopment, even in rural areas. However, they are between these categories are often blurred, but in included in this approach paper, given their im- general formal financial institutions (FFIs) are portance to poor people in rural areas, especially licensed banks or nonbank financial institutions those areas not served by formal or semiformal that are regulated and supervised by a central au- institutions. thority or authorities. They include public and private commercial banks, state-owned agricul- tural and rural development banks, cooperative banks, microfinance banks and special purpose Potential areas of intervention financial institutions such as leasing, housing for the World Bank and consumer finance companies and providers of payment services. Informal providers of finan- There are several areas of intervention that apply to cial services include small groups that rotate in- most delivery channels. Establishing and maintain- ternally generated savings as loans to members ing a policy dialogue about rural finance and its im- and that are not licensed, regulated or supervised plications for government policy could well be the in most countries. They also include money first step in the development of a rural finance pro- lenders, pawn shops and businesses that provide ject. The range of issues that might apply in a par- financing to their customers. In between stand ticular country is outlined in Chapter 2. Establish- the semiformal institutions such as non-govern- ment of financial sector infrastructure such as mental organizations (NGOs) and small financial credit information agencies, industry associations, cooperatives. These entities have a legal structure training institutions and activities related to land and are licensed, but have not typically been sub- registration and land titling are also relevant no ject to banking regulation and supervision. matter which approach is finally chosen. Areas of In many countries, informal providers of fi- intervention related to a specific delivery channel nancial services can be found in rural areas will be outlined in the relevant sections of this 17 chapter as well as Chapter 5. The matrices in Chap- Appropriate management structure ter 7 provide a road map for decision-making. and staff incentives in order to attract and retain competent management and staff Success factors for financial Performance-related compensation that is based institutions in rural areas on fair and measurable indicators, transparent pro- The following success factors suggest ways that motion procedures, intensive training, and efforts financial institutions can orient their operations to to create a "corporate we" have been shown to work profitably in rural areas. increase staff motivation and loyalty. Portfolio diversification Appropriate credit technology for different lines of business A financial institution is able to significantly reduce its portfolio risk through geographic diversifica- Different lines of business require different tion, customer diversification and product/service methodologies, know-how and staffing. Financial diversification. However, for this to work success- institutions are therefore well advised to acquire or fully, economies of scale in sub-markets need to be develop the right employee skill mix and to install achieved. Otherwise, there is the risk that the insti- workable and efficient systems (see Box 4). For ex- tution is spreading itself too thin. Diversification ample, in lending for agriculture, loan officers need only works if the institution invests in understand- to be knowledgeable about agricultural products ing the needs of its new clientele, develops prod- and markets and understand how to structure dis- ucts that respond to those needs, and installs sys- bursements and repayments within the agricultural tems for efficient processing and monitoring. If this timetable. Typical corporate banking does not re- is not done, higher rather than lower risk could be quire this particular skill set. Lending to small and the result. micro businesses again requires a different ap- proach. The microfinance experience has shown that high repayment can be achieved on loans, Development and marketing of when methodologies include alternatives to land demand-responsive products collateral, and repayments are based on household The experience of successful microfinance institu- cash flows, rather than cash flows from the eco- tions demonstrates that even poor rural clients are nomic activity alone.21 Group-based lending in able and willing to pay for financial products that rural areas can decrease the transaction costs and meet their requirements in terms of convenient ac- risks of providing very small loans to poor clients, cess and quick turnaround as well as the features of if coupled with the promise of repeat loans for cus- the products themselves. Deposit services are espe- tomers that pay on time. Individual loans secured cially valued if there is fast and inexpensive access by guarantors and household assets might be suit- in case of emergency cash needs. Undertaking mar- able for customers with larger credit needs. keting campaigns to inform potential clients about the products and services that the institution offers Installation of efficient internal is an important activity that is often overlooked. processing, control and management information systems Good governance and management A reliable management information system (MIS) Good governance and management are major providing timely information for decision-making, requisites for any financial institution that intends and knowledge of its uses and limitations, is critical to stay in business for the long haul. Transparent for the success of any financial institution. Up-to- decision-making procedures based on pre-agreed date information on clients' repayments and on de- rules, enforcement of these rules, and committed velopments in the markets for the principal agricul- management from the top on down are key. tural products financed by the bank is especially 18 Meeting Development Challenges: Renewed Approaches to Rural Finance BOX 4 Appropriate Credit Technologies Credit technologies vary according to a financial insti- client's repayment performance. This technology has tution's client group, the business sector, and the pos- been successfully implemented by IPC in many dif- sibilities of obtaining and enforcing loan securities. ferent regions. Group lending technologies were pioneered by the Latin America Agribusiness Development Cor- Grameen Bank in Bangladesh, and are now being poration SA (LAAD) provides loans to medium used by numerous microfinance institutions all over sized agribusiness and agricultural enterprises in the world. Group lending technologies replace the several Latin American countries. The specializa- need for collateral from individual borrowers with tion has enabled LAAD to build up considerable peer pressure of the group by making the entire group expertise in agricultural lending and knowledge of liable for the repayment of individual loans. The its inherent risks. The corporation follows a client- credit program is usually supported by mandatory ed- centered approach, building long-term client rela- ucation and training programs for members, as well tionships with contract terms adjusted to the client's as by obligatory savings, and is suitable for very poor cash flow requirements, backed up by enforceable borrowers who cannot offer collateral. collateral. LAAD takes a long-term view of agri- International Projekt Consult (IPC), a private con- cultural finance and is willing to restructure loans sulting firm, has developed credit technologies for based on risk assessments. LAAD's loan portfolio individual loans that emphasize the importance of the is well diversified in terms of sectors and countries, clients' ability to repay from income received from a and thus allows the corporation to fill a market variety of sources over the ability to offer collateral. niche hardly serviced by commercial banks in Latin Loan officers develop a strong business relationship America. with the client and are responsible for the same client over the lifetime of the loan. Salaries are performance Sources: Grameen profile at www.grameen-info.org, IPC profile based, ensuring a loan officer's vital interest in each at www.ipcgmbh.com; LAAD 2004 and 2005. important in a high-risk sector such as agriculture. Commercial banks Investments in technologies that enable the institu- and rural finance tion to more efficiently process transactions, con- trol repayments, and more effectively reach out to In most countries, commercial banks represent the customers will result in lower costs that may make largest part of the financial sector and offer a diver- the provision of services to rural and low-income sified set of services that are unparalleled by any clients more attractive (see Box 5). other institutional form. They are more suitable for the provision of financial services to small and Access to appropriate risk medium enterprises (SMEs), including farm enter- management products for prises, than to the very poor, who might operate part-time seasonal activities and can be more effec- agricultural lending tively served in many cases by semiformal and Lending for agricultural or livestock production informal institutions. entails nonfinancial risks that often prevent In order to evaluate and best work with commer- lenders from entering this market. The major risks cial banks within the framework of development are unpredictable weather and strong price swings goals in rural finance, a closer look at the objectives, for commodities traded in international markets. purposes and motivation of such institutions is in Pilot efforts are underway to assess the feasibility order. In general, commercial banks, in contrast to of risk management instruments to reduce some state-owned development banks, have the one over- of these risks. However, it is too early to predict riding objective of achieving profits for their share- if these can become commercially viable (see holders. Social development objectives, such as Chapter 6). deeper outreach into poorer population groups and Delivery Channels and Models for Rural Financial Services 19 BOX 5 Using Palm Pilots to Speed Transaction in Ecuador Banco Solidario in Ecuador has introduced Palm by shifting time from administrative work to client Pilots to enable loan officers to process transactions follow-up, responding more quickly to loan appli- immediately in the field and transfer data to the cants, and realizing substantial savings on office sup- center. The software used integrates field based and plies. Banco Solidario plans to introduce credit scor- central data collection and processing into a compre- ing to the rural sector once sufficient historical data hensive management information system (MIS). This has been collected. The Palm Pilot software and technology has supported the introduction of credit credit scoring system were developed by ACCION scoring systems for client selection, segmentation International. Other MFIs in Latin America, for ex- and payment collection in the urban sector. Scoring ample Mibanco in Peru, are now introducing mobile uses past performance to predict future behavior and phones for similar purposes. consequently, helps loan officers structure loans. The technology enabled the bank to improve its efficiency Source: Barton, S. and del Busto, C., 2004. remote geographical areas that are underlying the micro-entrepreneurs and farmers, have in general World Bank's rural development strategy, are not, not resulted in sustainable access to such financing. for the most part, on their radar screens, and will be Many such credit lines are not even successful in the embraced if, and only if, there are other benefits that short-term, as evidenced by cancelled credit lines outweigh the financial disadvantages. These bene- and underutilized credit lines.25 fits include access to new markets with profit poten- However, one trend is emerging that might moti- tial, or access to government subsidies. There is, in vate commercial banks to extend their services to a general, a significant conflict of objectives between low-income or more rural clientele. In nearly all commercial banks seeking to maximize profits and World Bank partner countries, international banks donor institutions such as the World Bank that sup- have established a strong presence over the past port social as well as economic goals. In order to be decade, competing with domestic banks for their successful, interventions need to start with an align- best corporate customers. Local banks are losing ment of interests and provide the tools to achieve some of these clients, so are increasingly being such alignment. Far too often, funds for refinancing forced to examine their competitive position and to are provided to commercial banks who are eager to look for other, untapped markets, where they are accept them and use them once or twice to make better able to compete.26 These untapped markets loans to underserved groups, but who do not de- include the rural areas of most countries and low- velop a credit technology that will enable them to income people who have been unable to access lend profitably to these groups over the long term. formal financial services. Farsighted international commercial banks, such as Governments and donors can achieve sustainable those adhering to the Equator principles,22 realize results by aligning their development interests with that adhering to a double or triple bottom line23 pro- the self-interest of commercial banks, i.e., helping vides for low-cost public relations and other bene- commercial banks to achieve their objectives. This fits, like increased customer or shareholder loyalty means, for example, assisting them to improve the or gaining a new clientele. In many developed and profitability of existing rural financial services or most developing countries, and especially in rural supporting their expansion into rural markets with areas, such benefits have not yet become obvious technical assistance and know-how.27 In general, it and accepted, and should not be counted upon is recommended that World Bank programs and as significant motivators.24 For these reasons, at- projects select those rural financial institutions for tempts by governments and donors to motivate com- partners, where there is a strong alignment of inter- mercial banks (often strong-arming them) through est in serving those segments of the rural population special credit lines to provide financing, often that are currently underserved, especially farmers assigning quotas for special groups outside their and low-income populations, and where services core business, such as small business owners, can be provided on a sustainable basis. 20 Meeting Development Challenges: Renewed Approaches to Rural Finance Concerns of financial institutions about the prof- mitigate risk, reduce transaction costs and increase itabilityofmovingintoruralareasandespeciallyinto the portfolio quality of financial institutions. Last- agricultural loans are valid and need to be addressed. ing results can be achieved best if deficiencies are These include high transaction costs due to small addressed on all three levels rather than rather than loan sizes and large geographic spread, systemic risk working on one level only. regarding financing for agriculture and agriculture- related ventures, little knowledge of rural customers and their business dynamics and high costs to obtain Models for commercial banks suchknowledge,lowequitybaseandfrequentlackof entering rural markets collateral of the clients to be financed making them There are a number of models that a bank can rather risky business prospects, insufficient credit choose when contemplating entry into rural mar- know-how of banks in those countries where invest- kets. The choice depends on the importance of this ments in government securities are or were in the past the investment of choice,28 lack of efficient market within a bank's overall strategic plan, the available business opportunities, the resources it is management information and portfolio management willing to invest and its appetite for risk. Some ini- systems, unclear property rights and lack of collat- tiatives undertaken by commercial banks over the eral enforcement rights, government and donor- past decade are outlined below. influencedcultureofnon-performingloans,unfavor- able government policies such as overly large government borrowing that crowds out smaller bor- Integrating rural finance rowers, interest rate caps, and interest rate subsidies. and financing for agriculture These weaknesses are often exacerbated by low into a commercial bank's institutional capacity, weak or corrupt management, mainstream business and poor organization of the institutions. As outlined in Chapter 2, these concerns can be This approach is usually chosen by a financial insti- addressed on three levels: the policy level, includ- tution that realizes that its traditional mainstay ing the development of a favorable macro- business is getting increasingly competitive, and economic, legal, and regulatory environment; the consequently has made the strategic decision to enabling environment, which includes the creation focus on new markets in order to survive or to in- and/or improvement of credit information systems, crease profitability. This business reorientation can industry associations, and training institutes that take place in farsighted institutions, without donor offer business development services to improve support as outlined in Box 6 below. borrowers' ability to manage their businesses; and In other cases, however, support from donors is the institutional level, including instruments to instrumental.Traditionally donors and governments BOX 6 Banco del Pichincha Banco del Pichincha in Ecuador has developed a ment services. One of these services is the handling strong rural finance program framed in that bank's of payments to the small farmers supplying inputs to overall strategy of becoming the country's leading re- the industry by depositing such payments into sav- tail banking institution. To achieve this goal, Banco ings or checking accounts. The bank has been able to del Pichincha has established a network of over 220 learn through the management of these accounts branches serving even remote villages. In 2001, Pich- about the small farmers' income level and cash flow incha was providing almost 20,000 small loans to pattern and has tailored specific loan products for peasants and rural dwellers with an arrears rate of them, which allow a better utilization of the bank's only 5%. The bank's relation to the farmers has been costly rural infrastructure. the result of its engagement with agro-processing in- dustries, to which the bank provides cash manage- Source: Buchenau, J. et al., 2003. Delivery Channels and Models for Rural Financial Services 21 support interested banks through special-purpose unit as a profit center and allowing it to develop a credit lines and technical assistance. In many cases, distinct culture and business model can be a good however, it has been the experience that banks con- solution. This model has been used successfully by tinue to focus on the supported markets after project the EBRD to introduce SME lending to commer- end only if the owners and top management of the fi- cial banks in Kazakhstan (Box 8). Another example nancialinstitutionarehighlysupportiveandconsider is Kingdom Bank in Zimbabwe, which has estab- it to be in their own interest. The example in Box 7 lished a separate microfinance division with the below demonstrates how significant donor involve- assistance of ACCION International. mentandaninnovativethree-partyapproachresulted in increased lending for agricultural equipment. Establishing and spinning off a separate unit to serve rural markets Establishing a separate unit within a and low-income populations bank to serve non-priority markets This approach goes one step further than the estab- with lending products lishment of a separate unit; there is the goal of Many commercial banks are quite interested in spinning off the unit once it has demonstrated its entering new markets such as agri-business and profitability. Financial Bank is using this model in SME lending, while staying focused on their exist- West Africa, with the goal of establishing a network ing core business. In this case, setting up a separate of small special purpose banks (Box 9). BOX 7 Lending for Agricultural Equipment, The German Romanian Fund in Romania In Romania, farmers often lack financial resources to framework cooperation contract, and then, for each buy equipment, while commercial banks lack secure loan, a credit contract guaranteed by a buy-back clause financial products and procedures to reach these rural is signed by the three parties (bank, client and sup- clients. Guaranteeing equipment loans is the main plier).All three parties benefit: i) the banks, who reach issue because banks do not want to take pledges on a new clientele and do not have to deal with the equip- equipment they would have to sell in case of client de- ment in case of default; ii) the equipment suppliers, fault, and farmers do not have collateral. The German who can sell more equipment and who are very inter- Romanian Fund, a program implemented by Horus ested, if necessary, in buying back the equipment at a Development Finance in Romania, offers a solution to price lower than the market price; and iii) the rural both farmers and commercial banks: an innovative clients, who have access to financial resources to buy product consisting of a bank equipment loan with a new as well as second hand equipment. buy-back clause from the equipment supplier. The commercial bank and the equipment supplier sign a Source: Horus Development Finance, 2004. BOX 8 EBRD SME Lending Program in Kazakhstan The major commercial banks in Kazakhstan that qual- consultants who installed all the systems and proce- ified under the EBRD guidelines were provided with dures and provided training to bank staff. Based on the significant technical assistance to set up a separate de- success of the Kazakhstan project, EBRD expanded partment with separate staff, credit procedures and the program to other CentralAsian countries, in coop- management, often located in a separate building. In eration with IFC. the early stages of the project, the SME financing units were managed and tightly controlled by international Source: Wallace, E., 2003; and S.A. Ahmed, 2003. 22 Meeting Development Challenges: Renewed Approaches to Rural Finance BOX 9 Financial Bank of Benin and Chad Financial Bank (Benin, Chad) is an example of a bank main agricultural area of Chad. Many of the women forming a microfinance unit within the bank with the micro-entrepreneur clients of Finadev have, in addi- objective of spinning it off once it has achieved out- tion to their business, a cereal storage activity. A reach, sustainability and profitability. The spun-off study is presently being conducted to develop a units, called Finadev, are private commercial microfi- small agricultural equipment-financing product. Col- nance institutions, with a banking group as the main laboration with an agricultural development program sponsor and shareholder, international financial insti- would certainly help Finadev to develop appropriate tutions as shareholders and partners, and a technical products. partner (Horus) directly involved through equity Finadev Chad intends to be, within a few years, capital and technical assistance. strong enough to serve other types of customers in Finadev Benin and Finadev Chad are freestanding rural southern Chad. Important economic reforms are microfinance units focusing on low-income cus- underway to strengthen the private sector in this re- tomers. They currently target three customers seg- gion, and these reforms require that new intermedia- ments, presently all urban: (i) women micro- tion mechanisms be available to finance agricultural entrepreneurs, especially active in trade, (ii) SMEs; production and rural activities. This will only be pos- and (iii) employees in the formal sector, with loans sible if a sustainable and professional financial insti- used mainly to fund housing improvement work or an tution exists. informal business. Finadev Chad already has a branch in Moundou, Source: C. Falgon, Horus Development Finance, Personal Com- the second city of the country, which is located in the munication, 2004. Establishing a separate unit back-office processing and administrative struc- managed by a service company tures. This model has numerous advantages: it does not require a financial institution license, initial Service companies are nonfinancial companies that capitalization is very small as it does not need loan originate and service loans on behalf of a bank, for funds, and it uses many parts of the bank's existing a fee (see Box 10). Loans are booked on the bank's infrastructure, thus reducing costs. ACCION Inter- balance sheet but all staff are employees of the national has worked with banks in Haiti (Soge- service company. The service company identifies bank), Ecuador (CrediFe) and Brazil (Banco Real) customers and initiates transactions, while taking to establish service companies. advantage of the bank's funds, as well as its BOX 10 Sogebank, Haiti Sogebank, Haiti's largest locally owned commercial the management contract of the company in 2004. As bank, launched its microcredit program in 2000, after of June 2004, Sogesol has established nine branches a change in legislation made such operations possi- in the capital and secondary cities in Haiti, serving ble. Sogebank established Sogesol (Societe Generale over 6400 clients with an average loan size of approx. Haitienne de Solidarite), an independent non-bank US$900.00. Its portfolio quality remains a challenge microlending company, as its service company. due to political unrest and hurricane damages that Sogesol provides loan origination and administration affect the repayment capacities of its clients. services to Sogebank, which issues the loans. ACCION International is a shareholder of Sogesol, Source: www.accion.org/about_where_we_work_program. has provided technical assistance and has taken over asp_Q_T_E_17. Delivery Channels and Models for Rural Financial Services 23 Linkages and agency arrangements Areas for possible Bank with third parties interventions Linkages or agency arrangements with microfi- Support to commercial banks entering rural areas nance institutions, NGOs or village organizations can take many forms, apart from activities related are another way for commercial banks to penetrate to good policies and the enabling legal and regula- remote rural areas. This model enables the bank to tory environment that were outlined earlier in this avoid high start-up costs for infrastructure, and chapter. The boxes in this section on commercial takes advantage of the expertise of existing organi- banks provide examples of interventions ranging zations. Banco Solidario of Ecuador is utilizing ex- from technical assistance to the financing of out- isting rural credit cooperatives as agents to serve side management contracts to the provision of tech- rural areas that are outside of its established mar- nologies, including installation or improvement of ket.29 Rural post offices can also serve as agents to communication and computer systems. Support for provide financial services, especially for the collec- the training of bank management and staff, as well tion of savings. India is a case in point, where sig- as access to firsthand information about successful nificant savings are collected by the post in rural operations through exposure visits, staff exchanges areas.30 and on-site demonstrations is often invaluable. The provision of credit lines is another intervention that Establishing mobile branches is outlined below. to extend rural outreach Mobile banking allows commercial banks to re- Donor credit lines to duce the transaction costs of servicing rural areas. commercial banks Although initial capital investment in mobile of- fices is substantial, these costs need to be seen in The recent OED review32 of Bank credit lines from relation to those of establishing and maintaining a 1993­2002 reveals that many projects did not fixed delivery mechanism. The partner bank for the achieve the stated project objectives with regard to World Bank's Rural Finance Project in Vietnam has the project credit lines or were not in a position to been effective in reaching over 315,000 people in measure the results. Specifically, it noted that re- remote areas through mobile units, and these units ceiving banks were in many cases not sufficiently have proved to be much more profitable than estab- strong, there was insufficient supervision, and lack lished branches.31 The case of Kenya's Equity of meaningful information on performance. The Bank, outlined in Box 11, demonstrates important recommendations reiterate that projects must success factors such as use of secure vehicles and comply with the Bank's policy on financial inter- access to strong communication lines. mediary lending (OP8.30); key provisions of this BOX 11 EBS of Kenya Equity Bank, originally Equity Building Society high security. The convenience of access to the (EBS) of Kenya, a mortgage lender, decided to re- mobile branches resulted in many new customers focus its business on low- and moderate-income and also helped reduce branch congestion by at- borrowers and customers in rural areas. While tracting existing customers to the units. By the end some new branches were opened in more populous of 2002, EBS was successfully operating 10 rural areas, creating permanent branches in remote branches in the largely rural Central Province and areas was not a financially viable solution. EBS reaching 21 isolated communities via mobile purchased mobile branch vehicles with special fea- banking units. tures, including all-terrain driving ability, constant voice and data communication, power back up and Source: CGAP, 2003. 24 Meeting Development Challenges: Renewed Approaches to Rural Finance policy are that interest rates to the end-customers profitably--or at least recovering their costs--and should not be subsidized, and that the project must supporting the government in achieving social establish eligibility criteria for banks that include development goals (double bottom line33). In the commercially oriented governance, adequate 1970s and 1980s, state banks were established in profitability and portfolio quality, and appropriate many countries, often with donor support, with staff capacity for sub-loan appraisal and monitor- high hopes of establishing permanent access to ing. Banks that do not meet these criteria may be credit in underserved areas, especially for agricul- supported, provided that they agree to an institu- ture. Subsequently, in many cases, these institu- tional development plan that includes a set of time- tions neglected, or were forced by governments to bound performance indicators. In order to imple- neglect, the first objective. This translated many ment such an action plan, many banks would need times into decision-making by and for special inter- technical and/or management assistance. Signifi- est groups, high transaction costs, high loan losses, cant funding in the form of matching grants and a and corruption. As a result, many of these institu- multi-year time horizon are likely to be necessary tions were closed or privatized in the late 1980s and for such interventions to be successful. early 1990s, with the expectation that the private A specific issue that needs to be addressed is sector would pick up the pieces. the provision of credit lines denominated in hard However, in many cases, rural branch networks currencies, such as the dollar or the euro. Govern- contracted following privatization, the private sec- ments often pass the foreign exchange risk on to tor did not step in, and in some cases, financial the participating bank, with a number of potentially institutions completely disappeared in rural areas undesirable effects. Foreign currency refinancing when state banks closed.34 Consequently, new of local currency loans often results in highly risky thoughts have begun to emerge about the potential foreign exchange exposures. To avoid this risk, the of such institutions for rural finance. While the local bank pushes it on to the end-clients, who are shortcomings of state-owned banks are well known usually the weakest link in the chain and the least and have been extensively documented,35 the disad- able to carry such a risk. Their foreign currency vantages of their disappearance have also now been loans will have to be repaid from their local cur- recognized. As a result, quite a few Bank client rency earnings. If there is significant currency countries are looking anew at setting up such insti- depreciation and clients do not have foreign cur- tutions and are asking the Bank for guidance and rency earnings to repay the principal and interest, support. loan defaults are often the result, with rather un- By virtue of their often significant equity base, pleasant consequences for both the clients and the existing infrastructure in rural areas, and banking banks, which have to cover the losses from their experience, state banks focusing on the financial own funds. It is therefore recommended that for- needs of rural populations offer the potential to ex- eign currency funding only be provided if thorough tend a whole array of financial services into rural analysis indicates that local banks and their cus- areas, to an extent and scale that most commercial tomers can easily carry the exchange rate risk. Hard banks and other financial service providers are not currency credit lines could be appropriate if the able to match. This alone would not justify a special economy is mostly hard currency based, the major- focus by the Bank on such institutions, especially ity of the envisioned end-clients have hard currency given the extensive negative experiences. However, earnings that enable them to avoid exchange rate there are now a number of state-owned banks that losses, or hedging instruments are available. have been able to provide financial services in rural areas on a sustainable basis and at a significant scale. There are three distinct ways that this has State-owned agricultural and been done: (i) reformation or turn-around of exist- rural development banks ing development banks, (ii) start-up of new bank or nonbank financial institutions, and (iii) specialized State-owned agricultural and rural development micro or rural finance units within existing state- banks have the dual objectives of operating owned banks. Delivery Channels and Models for Rural Financial Services 25 BOX 12 Agricultural Bank of Mongolia After overcoming initial strong opposition from the products based on extensive market research and multilateral financial institutions including the World many other good practices. It decided to extend its al- Bank, the government of Mongolia obtained support ready extensive network from 250 to 350 branches. A from bilateral donors to turn-around the loss-making key success factor was an experienced hands-on inter- Agricultural Bank of Mongolia (AgBank, renamed national management team, free from loyalties to spe- Khan Bank in 2004).39 Over a two-year time period, cial interest groups in the country and backed by the the bank was restructured, based on sound banking government and generous donor support.40 Following principles, while keeping to its mission of providing privatization in early 2003, there was the general an- financial services in rural areas. AgBank is one exam- ticipation that the new private owners would refocus ple of a privatized bank that recognized significant the bank away from rural activities. This did not take business opportunities in rural areas and took advan- place, as the new farsighted owners are well aware of tage of its competitive position as the only bank with AgBank's strong position and earnings potential in an extensive branch network. AgBank was able to in- rural Mongolia. crease its rural penetration by following a well- thought out strategy of offering demand-responsive Source: Dyer, J. et al, 2004; also CGAP, 2004b. Reformation or turn-around of Start-up of a new agricultural bank existing development banks or nonbank financial institution Restructuring a poorly managed state bank requires Creating a new institution might be the approach of significant resources and political will from all choice in those countries where there are no finan- stakeholders, and close cooperation and alignment cial institutions in rural areas that could be turned of objectives. In several countries, mostly in Asia, around, or the existing institutions are beyond turn- the existing large state banks were neither priva- around aspirations. This has been the case in most tized nor closed down, but rather reformed to better countries of the former Soviet Union where, with meet their stated objectives. A case of a reformed few exceptions, the former state-owned agricul- institution is BAAC Thailand,36 which has huge tural banks were liquidated, leaving a void that has outreach, providing insurance, savings and credit not been filled by private sector institutions as an- services to nine out of ten farming households. Re- ticipated. The World Bank has been instrumental in formation of BAAC has been strongly supported by establishing two agricultural finance institutions in the government and donors, who have provided this region, the Agricultural Development Bank of technical assistance in a variety of areas, including Latvia, which has been successfully privatized, and new product development and implementation. An- the still to be privatized Kyrgyz Agricultural other case is the National Microfinance Bank Finance Corporation (KAFC), which is profiled in (NMB) of Tanzania that is in the process of being Box 13 on page 27. privatized after a management-led turnaround that also benefited from donor support. NMB has a Specialized micro or rural strong network of rural branches and is focusing on finance units within an existing the savings business, with lending being introduced on a very cautious basis.37 The case of the Agricul- state-owned bank tural Bank of Mongolia is highlighted in Box 12 A specialized department focusing on rural clients, above. It is interesting to note that these quite large that can be isolated from political pressures and institutions with significant rural outreach report a has the organizational independence to follow best higher demand for savings than for credit. A net practices, might be the preferred solution in those transfer of funds from rural into urban areas at a countries where there is an existing state-owned ratio of one to two is taking place.38 institution that is focusing on a different market 26 Meeting Development Challenges: Renewed Approaches to Rural Finance BOX 13 KAFC of Kyrgyzstan The Kyrgyz Agricultural Finance Corporation serving mainly small clients with an average loan (KAFC) was established in 1997 under the Bank- size of US$1,400. KAFC has also started to lend to financed Rural Finance Project as a nonbank financial micro-credit organizations, and had financed nine institution serving farmers and rural entrepreneurs. such organizations by 2003. KAFC has applied for a KAFC was designed to operate on a commercial banking license in order to extend services to include basis--extending credit based on rigorous financial deposit and payment facilities. The Bank assisted in appraisal, taking full collateral, and fully covering its establishing an enabling environment, providing costs through its on-lending rates. The bank's loan funds for on-lending, obtaining donor support for recovery rate reached approximately 98% in 2004. technical assistance and early stage operating ex- KAFC offers individual collateralized loans and penses, and ring-fencing the new institution from po- social collateral-based group loans on a short- and litical influence. medium term basis. KAFC supplies 90% of all agricultural and livestock lending in Kyrgyzstan, Source: Broka, S., 2004. BOX 14 CrediAmigo CrediAmigo is a micro lending initiative of Banco size of US$211, and just under 50% women bor- do Nordeste, a regional state-owned development rowers. CrediAMIGO entered into a cooperation bank dedicated to stimulating economic develop- program with the Mexican MFI Compartamos in ment in Brazil's poorest region. In 1997, Banco do order to improve its outreach in rural areas. A key Nordeste approached ACCION for help in design- success factor has been strong and patient support ing a microcredit program. The program, called from the World Bank and highly professional tech- CrediAmigo, began in five pilot branches and nical assistance from an international microfinance quickly expanded to 51 branches in 1998. While network. While in the past CrediAmigo focused on CrediAmigo is managed by Banco do Nordeste, it nonagricultural loans in densely populated areas, it has separate staff and offices adjacent to the bank's plans to enter more remote rural areas, again sup- branches. This pre-existing infrastructure has facili- ported by technical assistance. tated CrediAmigo's expansion at a low cost. In 2003, it served 118,000 active borrowers through a Source: The MIXMarketWeb site: the global information exchange network of 165 branch offices with an average loan for the microfinance industry. Accessible at www.MixMarket.org and doesn't need a turn-around. Indonesia's state- · Clear separation of banking operations and owned Bank Rakyat (BRI) is a case in point.41 Its decision-making from government influence, and local micro and rural finance units were established strong political will from all parties for an inde- to operate completely independently of the parent pendent institution, including sanctions against institution and to provide financial services to political actors who attempt to use their influ- the rural population on a sustainable basis. The ence to interfere; strength of this system was demonstrated during · Appropriate governance structure including a and in the aftermath of the Asian financial crisis. majority of private sector representation on the The case of CrediAmigo in Brazil is highlighted in board, political independence of the board and Box 14 above. managing director, overlapping terms of ap- In addition to the success factors for financial in- pointed officials with the electoral cycle, and a stitutions outlined earlier in this chapter, the state- non-removal clause for the managing director owned banks cited above consistently made use of except for proven malfeasance, corruption and the following success factors: incompetence; Delivery Channels and Models for Rural Financial Services 27 · Consistent government policies concerning the tablished under a country's laws as a non-profit development of a sustainable rural financial sec- society or trust with charitable objectives. The tor; e.g., no debt-forgiveness, interest rate subsi- NGO's capital comes mainly from donors, because dies or interest rate caps; they are unable to raise capital through issuing · Sufficient, no-strings-attached funding by gov- shares or mobilizing deposits. Many microfinance ernment and/or donors for expert international NGOs began life as organizations with the mission technical assistance to build the institution's sys- of alleviating poverty through multifaceted enter- tems and products; prise development (Box 15). Over time, many · Ability of the institution to charge full cost- began to realize that their clients particularly valued recovery interest rates (net of time-bound subsi- easy, flexible and continuous access to financial ser- dies for technical assistance (TA) and initial op- vices, and that the interest from loans could cover erating expenses); the NGOs' costs, provided that the organizations · Access to local currency funding through deposit had sufficient scale and efficient methodologies. mobilization or credit lines; Consequently, starting in the late 1980s and early · Long-term approach that recognizes that progress 1990s, many of these organizations began to shift might be slow and initially not spectacular. from a social approach to a business approach, fo- cusing on the sustainability of the organization as well as the sustainability of clients' businesses. The Areas for possible Bank borrower gained recognition as a valued client interventions (rather than a "beneficiary") with diverse and con- tinuous needs for financial services--not just loans. The areas for possible interventions to support With their new orientation as sustainable finan- commercial banks equally apply to state-owned cial businesses serving a low-income clientele, mi- banks. An additional area of intervention at the crofinance NGOs needed to grow the liabilities and policy level is dialogue on the strict separation of capital side of their balance sheets, so they would banking decisions from government influence. have the scale to become financially viable and Supporting the start-up of specialized rural finan- have sufficient funds to serve new clients as well as cial institutions, such as KAFC, through a range of old ones. However, their status as NGOs made this activities on all three levels (policy, enabling regu- difficult. They couldn't raise capital because they latory and legal framework, and institutional devel- weren't shareholding entities. They couldn't raise opment) is also a possibility that could be explored deposits, except in some cases small savings from if there are no other suitable existing institutions their members that served to partially guarantee a that could be supported. loan. These savings could not be intermediated because the NGOs were not licensed as financial institutions and had no shareholders who could Specialized rural recapitalize the institution in the case of loss. They also had great difficulty accessing commercial microfinance institutions bank loans because of their lack of owners and per- Specialized rural microfinance institutions can take ceived status as charitable non-profit organizations. the form of NGOs, commercial finance companies In many cases, this status also created difficulties or specialized financial institutions operating under with the tax authorities. the supervision of the banking authorities. Despite the constraints noted above, NGOs play a valuable role in the provision of financial services to poor populations, providing outreach that other- NGOs and microfinance wise would not be possible. However, unless the NGOs have played a leading role in the develop- NGO focuses on provision of financial services, or ment of the microfinance industry over the past strictly separates its financial and nonfinancial ac- 25 years. NGOs have an ownership structure totally tivities, there can be significant problems, includ- different from companies or cooperatives; in fact, ing client confusion between cost-covering finan- they do not have real owners. They are usually es- cial services and subsidized social services. 28 Meeting Development Challenges: Renewed Approaches to Rural Finance BOX 15 CARD: From NGO to Bank The Center for Agriculture and Rural Development experienced "donor fatigue" and needed to access fi- (CARD) was established in the Philippines in 1987 nancial services from the market.The regulatory envi- with the vision to create a bank owned and managed by ronment allowed for a feasible organizational form, rural landless women. CARD launched its credit pro- the rural bank, with lower capital requirements than gram in 1990, and initiated scaling up in 1995, commercial banks.Technical assistance supported the accessing commercial funding and charging fees for organizational transformation. And lastly, the man- its services. CARD Rural Bank started operating in agement team was strongly committed to the "double 1997. Several factors contributed to the transforma- bottom line" of social mission and financial viability. tion from NGO to bank: CARD NGO experienced pressure from donors to scale up its work and to offer Sources: Bergmann, N., 2004; and information at www. savings services to its clients.At the same time, CARD cardbankph.com. Specialized financial institutions stitutions in these networks are urban-based, there and commercial finance companies is a growing interest in expansion into rural areas.42 Other networks have been set up by international In order to overcome the constraints outlined organizations that have provided technical support above, some microfinance NGOs have undertaken to microfinance institutions in a large number of an ownership transformation from NGO to com- countries. Examples include Women's World Bank- pany with share capital. This change has enabled ing, Opportunity International, ACCION Interna- them to attract shareholders, access capital mar- tional (see Box 16) and IPC. Most of the networks kets, become licensed as banks or nonbank finan- receive donor funding for various purposes and can cial institutions, and offer new products to their potentially be valuable partners for the Bank in clientele, including deposit products. However, ex- rural finance. The institutions participating in these perience has shown that transformation is a diffi- networks have a wide variety of institutional types: cult and lengthy process, involving not only major NGOs, nonbank financial institutions, banks, and changes in ownership and governance, but also cooperatives. acquisition of a whole new set of skills, such as the management of deposits and the production of timely and consistent information for regulatory Areas for possible Bank bodies. An alternative from transformation is for interventions in rural microfinance these organizations to become agents of main- stream financial institutions; the NGO benefits The Bank can support the development of effi- from bank funding and the bank benefits from the cient microfinance institutions in rural areas in a NGO's capacity to reach a poor clientele. variety of ways, ranging from provision of advice As a result of the accumulated lessons and con- on legal and regulatory issues, to support for straints, many institutions specializing in micro and transformation from an NGO to a shareholding rural finance that have recently been created by company structure, to funding for capacity build- innovators like International Projekt Consult (IPC) ing. Technical assistance for the development of and ACCION began life not as NGOs, but as products and services, creation of transparent ac- licensed and regulated financial companies. counting and management information systems, and acquisition of technologies that will create ef- ficiencies are all possible interventions. In addi- Microfinance networks tion, partial funding of microfinance ratings or as- Over the past decade, many national and regional sessments can help well-performing organizations networks have been established by the financial to obtain commercial funding.43 For those institu- entities that are focused on providing financial tions that receive a low rating, the advice given in services to the poor. While most of the financial in- the assessment can provide useful guidance that Delivery Channels and Models for Rural Financial Services 29 BOX 16 The Role of ACCION International ACCION International has been an important innova- Shareholders include bilateral and multilateral tor. In Nigeria, ACCION has formed a microfinance institutions, including IFC, as well as private investors. bank with other institutional shareholders and in Zim- Recognizing the limitations of the NGO institutional babwe and Brazil, it has established microfinance divi- form, ACCION has also pioneered the transformation sions within a bank. In Haiti, Ecuador and Brazil, it has of NGOs into regulated financial intermediaries, formed service companies with major banks. In 2003, including BancoSol in Bolivia, Mibanco in Peru, based on the success of an earlier smaller investment Finamerica in Columbia and Compartamos in Mexico. fund,ACCION established an international investment company for investment in its microfinance affiliates. Source: Profile at www.accion.org. will help move these institutions closer to eligibil- be reinforced through the installation of more pro- ity for commercial funding. Credit lines can be fessional management.45 While even small volun- justified when institutions are performing well, teer-managed cooperatives need to have a transpar- but cannot yet obtain commercial funding. Credit ent structure, good accounting and sound criteria lines should be priced at the market rate, so that for decision-making, this is even more important they do not distort incentives for seeking commer- when the cooperative grows and paid management cial funding. They should be accompanied by takes on the functions previously performed by capacity-building assistance to help the institu- members. Many financial cooperatives become or- tions overcome their deficiencies, so that the ganized into federations so as to obtain services credit line can be replaced with domestic funding such as external audit and training that enhance ac- when it becomes due. countability and professionalism (see Box 17). Credit unions are a type of financial cooperative. They are based on a common bond, often occupa- Cooperative financial tional, and often serve a primarily urban and institutions44 middle-class clientele. Examples are teachers, gov- ernment workers, farmers and corporation-based Cooperative financial institutions range from for- credit unions including the Bank's own Bank-Fund mal cooperative banks to semiformal financial staff credit union. Credit unions can be small cooperatives and credit unions to informal village- village-based entities or larger, more professional based savings and loan associations. The main organizations that are federated (Box 18). characteristics include ownership of the entity by Cooperative banking networks consists of pri- members (or member cooperatives in the case of a mary financial cooperatives, often in the form of federation or a bank), the provision of financial community banks, with an apex institution owned services to members, and governance by elected by the member cooperatives and providing services representatives of the owners/members. Members to them. There may also be parallel independent are usually people with a common bond, either ge- apex institutions responsible for supervision and ographic or occupational. Membership can in some auditing of the member institutions. This model cases be purchased for a token amount while in had its origins in central Europe in the early 1800s, other cases significant involvement of the member with the idea of encouraging poor people and small is required, as well as a savings history, before he or groups to pool their financial resources for mutual she becomes eligible for loans. benefit. Membership was open to everyone, with Small primary cooperatives may be managed by special emphasis on lower-income groups. Over members on a volunteer part-time basis, with low the years, these European cooperatives have grown operating costs and close contact with their into major participants in the financial markets of customers. Once an institution grows above a cer- their respective countries as well as internationally. tain number of members, the social cohesion found Rabobank, DZ Bank, Credit Agricole, Raiffeis- in small cooperatives is not sufficient and needs to senbank46 and Desjardins are all full service banks 30 Meeting Development Challenges: Renewed Approaches to Rural Finance BOX 17 Setting Up Financial Cooperatives in Russia In Russia, the first Rural Savings and Credit Coopera- source of credit for the rural population, farming fam- tives (RSCCs) were established in 1996, in the midst ilies and rural small businesses. Repayment rates are of the Russian banking crisis that led to the closure of impressive with over 99%. International technical as- many rural banks and branches.The sector operates as sistance is directed at all three levels, with emphasis on a three-tier structure with local credit cooperatives, re- the development of an enabling regulatory framework gional and federal level federations, and apex institu- and sector development at local and regional levels. tions such as training institutes. The Central Bank is responsible for supervision. The RSCCs are the main Source: Armbruster, P. G., 2004. BOX 18 Credit Unions in Lithuania The first credit union in Lithuania was founded in unions, including the administration of a stabilization 1995, after a new law on credit unions was passed in fund, a liquidity fund, and credit and deposit facili- the midst of the 1994­1996 banking crisis. In 1997, ties. While the Central Bank retains supervision au- 11 credit unions formed the Association of Lithuan- thority, LCCU provides supplementary supervision ian Credit Unions (ALCU). ALCU provides training, services to its members. The sector has shown im- technical assistance, lobbying and financial services pressive growth since its establishment. Growth ac- to its members. In order to separate financial from celerated after a modification of the law in 2000 and technical functions, an apex bank, the Lithuanian the closing of rural branches of commercial banks. Central Credit Union (LCCU), was established in 2002. LCCU provides financial services to credit Source: Lietvos Centrine Kredito Unija (undated). owned by their member community banks. This Success factors model is also found in countries like Argentina, Despite their often dismal history, financial cooper- Uruguay, Chile, Brazil and West Africa. atives represent an important area of intervention in In developing countries, cooperative financial rural finance, due to their comparatively low costs institutions have had a mixed history in terms of fi- and huge potential for massive outreach to the rural nancial performance, governance and sustainabil- poor. However, there is also considerable risk of ity. Problems have occurred at all levels. One of the failure, especially if donors' and governments' ob- major reasons that rural financial cooperatives have jectives are not aligned with the institutions' objec- failed so often over the last three decades has been tives. Success factors include attention to all the the involvement of governments and donors, who following areas: have used cooperatives to channel cheap credit, and undermined the savings-based character of these organizations.47 In addition, lack of transparency in · Policy and enabling environment. Political will is decision-making, poor financial management and required at the policy level to develop an enabling the inability of board members to provide effective legal, regulatory and supervisory framework.48 oversight have been extremely damaging. Those · Governance. Transparent structures and trans- cooperatives that succeed in overcoming these parent decision-making processes on all levels issues face the problem that all small financial in- of the institution from board and management to stitutions face; namely, the difficulty of providing loan officers are critical for the cooperatives' a full range of banking services and obtaining sustainability. Strong governance is also the first reliable refinancing facilities. Belonging to a feder- line of defense against those who try to use fi- ation can help to alleviate these difficulties. nancial cooperatives for political influence and Delivery Channels and Models for Rural Financial Services 31 personal gain. A strong governance structure influence the capacity to provide a wide range of could include political independence of the services to members, which in turn can strongly board and management, overlapping terms with influence the achievement of profitability. the electoral cycle and others. · Defining the role of the federation. A clear dis- · Professional management and staff. tinction between financial functions such as · Recognizing the important role of member sav- funding, supervisory functions and support ings. Savings, as well as equity participation, functions such as promotion and training is provide members with a strong sense of owner- needed in order to avoid conflicts of interest. ship of the cooperative, which should motivate · Developing more effective regulatory and super- them to demand transparency and accountability visory structures.49 In many countries, financial from the governing body as well as management. cooperatives are regulated and supervised by External funding, whether it is from govern- institutions such as Cooperative Ministries or ments or donors, can diminish the incentives for Departments that typically lack specialized good governance and management unless the technical expertise to supervise financial institu- savings focus can be maintained. This being tions. Direct supervision through the Central said, for larger financial cooperatives, the issue Bank is often not possible, except in the case of of sufficient capitalization is a major one and cooperative banking networks, due to the costs cannot be solved through member savings and of supervising a large number of small institu- equity holdings alone. tions that are geographically dispersed. Other · Strong systems. This includes products, service methods of supervision such as auxiliary super- delivery structure, accounting and financial vision and delegated supervision are now being management systems. tried in some places. For a further discussion on · Affiliation with a federation of financial coopera- the features, advantages, and disadvantages of tives.Thisiscriticalforaprimarycooperativethat the various models see Arzbach 2004. aims to provide a range of financial services to its · Independent auditing of primary cooperatives members. The degree of federation can strongly and their federations. BOX 19 Cooperative Reforms Since 2001, Mexico has restructured its "popular" In the Philippines, the 30-year-old credit union savings and credit sector, comprising financial insti- movement has had weak structures, with many inac- tutions providing rural, SME and microfinance. At tive unions, and others that are financially unstable the macro-level, a new sector law defines and regu- with high default rates. The credit unions have also lates the institutions within a three-tier structure of been used as a conduit for cheap credit. The credit retail institutions, their federations and confedera- union federation, PFCCO, has been underfunded and tions. The law defines regulatory standards (including not been able to provide technical services to its accounting and prudential standards), and identifies members. At the end of the 1990s, the government the supervision authority and mechanisms. At the initiated a reform program with international techni- meso-level, the Mexican government provides tem- cal assistance, with the objective of establishing porary infrastructure support and technical assistance model cooperatives, turning them around from loss- to the sector through the newly established state- making entities into independent profit oriented owned development Bank, BANSEFI, and through unions, adhering to strict prudential standards and newly established second-tier federations of financial emphasizing savings mobilization. Results for the institutions. At the institutional level, the reform first batch of model credit unions have been impres- package provides technical assistance for a transition sive, with default rates declining from 63% to 7% in process, which requires relicensing of all financial in- 2002. New business plans and marketing strategies stitutions of the popular savings and credit sector. Fi- have quadrupled the membership. nancial assistance is available for restructuring, and Sources: Ito, L. et al. 2003; Klaehn, J., 2004; and Singh, H. Per- for temporary liquidity problems. sonal Communication, 2004; World Bank, September, 2004. 32 Meeting Development Challenges: Renewed Approaches to Rural Finance · Eliminating the use of cooperatives to promote areas.Traditionalinformalsavingsandcreditgroups political goals or to benefit powerful local indi- exist virtually everywhere, and have proved to be re- viduals or companies. Governments need to markably resilient over time, with features that have establish enforceable policies and procedures to made them indispensable to the financial manage- prevent interference and influence peddling. ment activities of the rural poor. Their resilience of- fers a contrast to the failures of many other models. The examples in Box 19 on page 32 describe Manymicrofinancebestpracticeshaveevolvedfrom two successful programs for cooperative reforms in the lessons learned from traditional group mecha- different parts of the world. nisms. Hence, it is important to understand this dimensionofruralfinance.Informalfinancialgroups Areas for possible Bank can be broadly divided into two categories: interventions · Rotating savings and credit associations Strengthening financial cooperatives requires a (ROSCAs) are unregistered, time-bound groups dramatic shift in the priorities of governments and whose members deposit a fixed amount of donors. In particular, they should not provide credit money each period. One member receives all the lines to cooperatives unless there is a strong institu- funds collected during that period. The group tional structure, including effective governance, a stays in existence until each member has re- substantial savings base, and strong financial man- ceived a payout. ROSCAs enable their members agement including loan losses of less than 5%. to receive usefully large sums of money and are Experience in a wide range of countries has shown simple and easy to manage. However, they are that external financing damages these institutions inflexible: members can't deposit and withdraw by changing them from savings-driven institutions funds as needed, so they are not suitable for to borrower-driven institutions. emergencies or for occasions such as festivals Many of the success factors listed above repre- when all members need money at the same time. sent areas of possible interventions for the World Amounts saved are usually quite small so they Bank. Successful interventions usually address is- are not generally adequate for the financing of sues at all three levels of intervention in a carefully small economic activities. planned sequence, starting with policy dialogue, · Accumulating savings and credit associations advice on an enabling legal and regulatory frame- (ASCAs) are unregistered, time-bound groups work, technical assistance and possibly refinancing whose members deposit a fixed sum each period. on the institutional level. Rather than disbursing the funds in rotation, ASCAs loan money to members with interest. At Informal village-based models the end of the predetermined cycle, members re- ceive a return on their investment. ASCAs are In many countries today, neither banks nor special- more flexible than ROSCAs but require greater ized microfinance institutions (MFIs) nor coopera- management skills.As amounts saved are usually tive networks have reached the majority of villages small, funds available for lending are also small. in the rural areas. Even those MFIs that have devel- oped methodologies that enable them to reach the Success factors that have contributed to the poor are seldom able to reach clients in rural vil- widespread development of ROSCAs and ASCAs lages beyond secondary towns. This is particularly by communities in many parts of the world include: true in countries with dispersed rural populations, due to high transaction costs coupled with small · a common bond that creates pressure for mem- transaction size. However, financial service pro- bers to honor their commitments, whether that viders do exist in villages, including the ubiquitous be to continue saving until all members have moneylenders and a variety of informal groups. received an equal share (ROSCAs) or to repay Informal and semiformal village-based models, loans within the agreed time period (ASCAs). including thoseusingaCDDapproach,holdthemost · Members save and, in the case of ASCAs, lend promise at the present time in most countries for pro- their own money so they have a vested interest in vision of financial services to people in remote rural protecting their savings and recovering loans. Delivery Channels and Models for Rural Financial Services 33 · Because the organizational structure is imper- and commitment are critical to the long-term sus- manent, and the amounts of money generally tainability of these organizations. small, these groups do not need sophisticated The creation and/or strengthening of second-tier accounting and management skills. Periodic federations of small village-based organizations can paybacks of capital and earnings that reset the help these entities receive important institution- balance sheet to zero has proven to be one effec- building services that they cannot avail on their own tive way for non-literate or semi-literate groups and link them with the formal financial sector (see to manage their finances by themselves. Box 20). Federations can help their members to set performance standards and monitor performance Some countries and organizations have devel- against the standards. Once standards have been de- oped models that are essentially revised versions of fined and monitored, creating links to banks for refi- the basic ASCA. For example, CARE International nancing facilities becomes easier. Federations can has implemented a Village Savings and Loan also provide a link to national and international model50 in several African countries that retains sources of best practice training and networking. many of the features of ASCAs, but seeks to im- prove the prospects for long-term sustainability Areas for possible Bank through training of groups in organizational devel- interventions opment topics such as ownership structure, gover- nance, internal rules and financial management. Informal village-based models are best supported by Technical assistance and training is provided providing funding for technical assistance institu- through local facilitators, keeping expenses to a tions that can demonstrate a proven track record of manageable level. In India, informal and unregis- successful work with such models. In particular, the tered self-help groups (SHGs) have been linked to model must be shown to be very low-cost; otherwise, banks, dramatically increasing the number of poor the costs will outweigh the benefits in terms of num- villagers who have been able to access services ber of people served. Funding for the development of from the formal financial system. training materials for non-literate or semi-literate Factors for success of these semiformal models people is important, as is the training and equipping include the common bond and peer pressure so of local people who can become para-professionals, important for informal ROSCAs and ASCAs. In thus continuing the dissemination of the model after addition, strong governance structures that limit the an initial phase. Efforts to link such groups to com- ability of any subgroup to dominate, clearly defined mercial banks may start with the opening of accounts policies and procedures, strong internal controls for the safekeeping of savings. Further information and financial management are paramount. In par- can be found on the website of the Rural Finance ticular, the members' strong sense of ownership Learning Center, a joint undertaking of Food and BOX 20 CVECAs of Mali The Self-Managed Village Savings and Credit Banks including auditing services and management train- (Caisses Villageoises d'Epargne et de Credit Auto- ing. Unlike traditional cooperative second-tier orga- gérées, CVECAs) have been established in Mali nizations, the CVECA federations have no office since the 1980s as small, locally-managed savings structure and do not provide technical services di- and credit associations. The CVECAs have formed rectly, but through outsourcing. The federations are regional federations with technical functions such as district-based, ensuring local solidarity. The model self-regulation through peer monitoring, and they act has been replicated in several regions within Mali, as as financial intermediaries between the National well as in other African countries such as Burkina Agricultural Development Bank (BNDA) and the vil- Faso, Gambia, Madagascar and Benin. lage units. The profits from these operations are used to contract technical services for member units, Source: Chao-Beroff, R., 1999. 34 Meeting Development Challenges: Renewed Approaches to Rural Finance Agriculture Organization of the United Nations revolving loan funds. A recent OED review of mi- (FAO), Gesellschaft fuer Technische Zusammenar- crofinance credit lines52 including revolving funds beit (GTZ), World Bank and International Fund for showed that such funds within World Bank projects Agricultural Development (IFAD).51 have generally not performed well. It is an open Financial assistance in the form of credit lines or question whether or not this trend can be reversed. revolving funds is best avoided. However, learning from the experience of informal models, it can be hypothesized that success factors include: Community-driven · Development of a strong local institution owned development and rural finance by community members rather than "the commu- nity." The ownership structure could be either a Village-based models are relevant for Bank com- cooperative or company model in which mem- munity-driven development (CDD) projects, espe- bers buy shares. These members then have a cially if they focus on member savings and bank vested interest in the success of the institution. linkage rather than external grants. CDD is an ap- They should be in control of policies and proach that treats poor people and their institutions processes, including rules on membership, focus as partners in the development process. CDD pro- on collective versus individual production, risk jects strive to devolve control of decisions and re- management strategies, and setting interest rates. sources to community groups, which work in part- · Provision of grants for revolving loan funds only nership with government and support institutions after members have saved their own money over such as NGOs. Many CDD projects have an "open a substantial time period and demonstrated an menu" which enables communities to decide how to ability to rotate these savings in the form of spend project resources. Typical investments in- credit to members. clude community infrastructure such as schools, · Strong technical assistance to build transparent health clinics and improved roads. However, many and accountable governance, management and communities decide that income-generating activi- financial systems. ties are a key priority for villagers. If they cannot ac- cess funding from banks or MFIs, they sometimes Box 21 provides an example of a CDD project use project resources to set up community-managed that has made use of these lessons. BOX 21 Using the CDD approach in Andhra Pradesh, India The World Bank's Rural Poverty Reduction Project themselves. Well-managed SHGs are often able to ac- (RPRP) and District Poverty Reduction Initiative Pro- cess loans from local banks, sometimes with funding ject (DPIP) inAndhra Pradesh, India illustrate the po- from NABARD, the National Bank for Agriculture tential for institutional strengthening, scaling up and and Rural Development. RPRP and DPIP support the linkage of informal institutions to the formal financial development of SHGs and their federations, Village sector within a project using a CDD approach and hav- Organizations (VOs) and Mandal Samakiyas (MSs). ing grant funds. Andhra Pradesh (AP) has a well-de- VOs are federations of SHGs in a village or cluster of veloped microfinance industry with a variety of insti- villages, whereas MSs are federations of VOs in a tutional models: licensed nonbank microfinance Mandal, the sub-district administrative unit inAP.The institutions such as Basics, Share and SKS, financial success of the bank linkage is evidenced by the linkage cooperatives and self-help groups (SHGs). SHGs are of 231,336 SHGs to banks from 2002 to 2004. Since small groups of 15­20 members coming together to each SHG has about 15 members, over 3 million saveandlendamongthemselves;theyaresignificantly women have been able to access bank credit. Repay- different from groups using the Grameen model, in ment rates are just below 100%. that SHGs are not just solidarity groups receiving fi- nancial services but are financial intermediaries Source: Kumar, V. and P. Shah, 2005. Delivery Channels and Models for Rural Financial Services 35 5 Special-purpose institutions and products There are several special-purpose institutions and collateral needs to be registered. The lessor is the products that are quite suitable for financing rural owner, not just the financier, and the equipment enterprises and farms, especially larger ones. They can quite easily be recovered from a lessee who is are also relevant for small farmers but to a lesser remiss in paying the lease obligations. Leases extent. The most important are outlined below. typically have lower down payments than loans, making them more accessible to lower income peo- ple. In a Bank survey of ten leasing companies in Leasing, a source of 2003,54 the surveyed companies indicated that they investment capital for require down payments of 15% to 25% as com- rural areas pared to 30% to 40% required by banks in those countries for equipment financing. These advan- In many countries, lack of access to long-term tages not only result in faster processing but lower financing for capital investments is one the most overall transaction costs. pressing issues in rural areas.53 Leasing has long IFC has often initiated the establishment of been recognized as one solution, as it allows the cir- leasing companies in countries where financial cumvention of such financial market imperfections market conditions do not allow for long-term bank as lack of a collateral registry and collection en- financing on commercial terms or where there forcement mechanism, two of the major obstacles are no suitable commercial banks. In more devel- in equipment financing (see Boxes 22, 23, and 24). oped financial markets, commercial banks often Leasing is a financing tool where the provider establish leasing subsidiaries to provide long-term (lessor) owns the equipment and permits the client financing which are considered too risky for regular (lessee) to use it in exchange for periodic payments bank financing. There is experience, though lim- (lease payments). Leases are also a means of even- ited, in micro-leasing and leasing for agricultural tually acquiring equipment (and not just its use), as equipment.55 ownership is generally transferred to the lessee at In general, less rather than more regulation is the end of the lease period, either automatically or useful. There should be clear regulations that at a token price. classify leasing companies as non-deposit-taking fi- Leasing is likely to be more accessible and nancial institutions that are not subject to the affordable to rural enterprises than credit. Farmers restrictions of banking laws, including reserve and rural enterprises are particularly constrained by and liquidity requirements. An enabling legal the lack of assets that can be used as collateral. framework includes equally clear definitions for the Leasing overcomes this constraint, because no legal ownership of leased assets, repossession of 37 BOX 22 Network Leasing Corporation Pakistan Network Leasing Corporation (NLC) in Karachi and equipment can be leased. NLC includes life insurance Lahore, Pakistan predominantly serves small and for the lessee in the contract in addition to coverage of micro businesses. NLC innovated the leasing process the leased assets. NLC has launched a program to in- by introducing post-dated checks as a secure payment crease its business in rural areas in the northwestern method and required clients to open bank accounts for provinces of Pakistan with international assistance. this purpose. Payment patterns can vary according to the lessee's cash flow patterns and secondhand Source: Havers, M., 2003. BOX 23 DFCU Leasing The Development Finance Corporation of Uganda the company has tried to reach more small and micro (DFCU) has pioneered leasing activities in Uganda. businesses by introducing a pilot scheme for bee- DFCU also allows the leasing of secondhand equip- keepers and mushroom growers in rural areas, and ment and uses post-dated checks to ensure payment. opening regional offices. DFCU uses in-house engineers to monitor proper maintenance of leased equipment. DFCU's main clien- tele are small and medium size urban enterprises, but Source: Kisaame, J. 2004. BOX 24 CECAM Madagascar In Madagascar, the Caisse d'Epargne et de Credit machines. Payment schedules are adapted to the crop Agricole Mutuel (CECAM), a cooperative for agri- cycle, and local member groups monitor the security cultural finance, has introduced hire-purchase for a of the hired items. range of assets including farm implements, dairy cows, artisanal equipment, bicycles and sewing Source: Fraslin, J.-H., 2004. leased assets in case of default, and liability in case nical assistance and training to develop a skill mix of third-party losses. Leasing regulations are in gen- among employees that includes technical knowl- eral quite simple and uncontroversial, and thus offer edge about new equipment, assessment of used a good opportunity for fast action by policy makers equipment and residual values, in addition to motivated to support rural development. Desirable general credit skills, would also present a valuable but not required features include a functioning mar- contribution from international donors. ket for secondhand equipment and affordable and Potential World Bank interventions to support accessible repair and maintenance facilities. leasing should take advantage of IFC's experience in this area. In order to achieve maximum impact, Areas for possible Bank interventions should be coordinated with IFC and possibly complemented by an IFC investment. A interventions possible model is IFC's Private Enterprise Partner- Since special-purpose leasing companies are not ship (PEP) initiative, a multi-donor-funded and licensed to take deposits, they need to develop IFC-managed effort in countries of the former other reliable sources of refinancing, preferably in Soviet Union. PEP provided in-country support to local currency. Credit lines from banks or interna- introduce enabling legislation and direct technical tional donors are quite often utilized and could support to leasing companies. In some cases, there present an opportunity for Bank intervention. Tech- was also an investment by IFC, but this was not PEP's 38 Meeting Development Challenges: Renewed Approaches to Rural Finance focus. Based on its good experience with PEP in the There is a wealth of experience available to countries of the former Soviet Union, IFC has de- underline that this approach is fraught with danger. cided to extend PEP toAfrica and in late 2004 estab- However, there is a place for carefully designed lished a PEP office in Johannesburg as a first step. guarantees that serve as policy instruments to reduce the credit risk for financial institutions inter- Guarantee institutions ested in providing loans for agriculture, when the attendant risks can be reduced. The IFC, for exam- and guarantee funds ple, has developed a partial guarantee instrument Loan guarantees are a financial instrument used to for portfolios of SME loans.57 move all or part of the credit risk of a specific loan The most important success factors include the or a predefined group of loans from the underwrit- following: ing institution, usually a commercial bank, to a · The underwriting institution, usually a commer- guarantee fund or institution. The borrower is cial bank, should always hold a significant por- charged guarantee fees, in addition to interest costs. tion of the risk as a first loss to be carried before Guarantees have long been used to motivate finan- the guarantee can be called; usually this first loss cial institutions to provide credit to special groups, provision is no less than 5%. The remaining risk including farmers and SMEs that are considered should be shared based on a pre-agreed for- too risky to be creditworthy on their own merit. mula.The benefit of a first loss provision is that In some countries, such as Turkey, special loan the bank incurs losses of its own before receiv- guarantee institutions have been set up; in other ing any reimbursement from the guarantee; this cases, a loan guarantee fund may be housed in a re- helps to ensure that a thorough credit screening gional development agency or other body. Germany, takes place and mitigates the moral hazard risk. for example, has a whole system of regional guaran- · All loans in a category must be put in the guar- tee banks in each state that provide guarantees antee portfolio to avoid cherry picking, again for small business loans and that have been used ex- mitigating the moral hazard risk. tensively since reunification. Internationally, loan · Early-warning monitoring procedures and strict guarantee institutions and funds were seen as quite reporting requirements should be in place and negative for some time, for the following reasons:56 closely followed. · Moral hazard risk on the side of the borrowers Since IFC has experience in issuing partial guar- who may not feel a strong motivation to repay antees on portfolios of small loans, it is advisable the loans, especially if they consider them to be that Bank efforts in that area be coordinated with another type of government grant; IFC and focus on those countries and rural areas · Moral hazard risk on the side of the financial where IFC may not be able to directly invest. institutions that might finance good credit risks without guarantees, and use the guarantees to Supply chain financing underwrite loans with a high default risk ("cherry-picking") without proper evaluation Supply chain financing generally refers to the pro- and safeguards; vision of short-term, seasonal credit to farmers by · Additional transaction and guarantee costs on private firms such as input suppliers and processors. top of interest, making a guaranteed loan quite Typically, farmers receive inputs from the processor, expensive for borrowers, and in many cases not or credit for inputs through a banking relationship economically feasible; established by the processor. Some arrangements · Rapid depletion of loan guarantee funds as high- provide additional credit to finance household risk loans are foreclosed and the guarantee is needs until the harvest. Once the products are ready called; for sale, they are delivered to the processor, who · Lack of sustainability of the guarantee institu- deducts the credit from the value of the products. tions over the long term because they are often The farmer receives the surplus, if any, in cash. not able to charge high enough fees to cover all There usually is an established business rela- transaction costs, in addition to the credit risk. tionship between the parties, facilitated by mutual Special-Purpose Institutions and Products 39 knowledge, while collateral constraints are limited financial institutions providing agricultural loans, it by linking credit with sale of the product financed. is the only game in town. Both parties gain through the transaction: the Supply chain financing has taken place over farmer by obtaining working capital financing, a many years and in all regions, usually without donor guaranteed market for his product, and technical support and as an entirely private sector activity. advice in some cases to ensure that quality stan- Only recently58 has there been donor interest in sup- dards are met; the processor by securing a reliable porting such activities as a way to increase financing source of product for his operation. for agriculture. There are several different ways to Nevertheless, supply chain arrangements can be provide financing through the agricultural supply quite risky for both parties.The risks for the farmers chain. All of them are directed at commercial, pro- are that the agreed-upon price at contract time might fessional farmers who are able to earn sufficient be lower than the market price at harvest, even amounts from their farming activities to repay the though it will be sufficient to cover loan and interest loans. In order for supply chain financing to be fea- repayments. This can provide farmers with an in- sible, a sufficiently large volume of outputs needs to centive for side-selling; i.e., selling the products to be generated so that transaction costs for processors another party at a higher price, repaying the loan do not become overly burdensome. However, this from the proceeds and keeping the surplus, unless does not mean that supply chain financing is limited there are incentives to refrain from doing so.The re- to large farmers only. Small family farmers in many verse risk applies to the processors who are commit- countries have been able to organize input supply ted to purchase at an agreed-upon price, even if the and marketing cooperatives that allow them to market price at harvest is lower. Processors also run achieve sufficient economies of scale and some the risk of not being able to obtain sufficient product level of bargaining power for their member farmers due to side-selling by farmers, and poor quality of in relation to processors and traders. the product supplied. Consequently, these relation- ships are rarely without hitches. Characteristics of supply chains Credit from formal financial institutions with specialized knowledge of agricultural financing Supply chains range from rather loose to very tight is preferable to supply chain financing, because ties and interrelationships. This is often determined farming households usually need a wide variety of by the economic power of the participants within the financial products, rather than credit for one crop supply chain. Tight supply chains bind both parties only (Box 25). Supply chain financing should, closely to each other, through enforceable contrac- therefore, be considered a second-best solution to tual arrangements, as well as through business real- the lack of credit for agriculture in a given country. ities and incentives. Loose supply chains are often Often, however, in markets where there are no non-binding, there are opportunities to circumvent BOX 25 Supply Chain Financing through Small Farmer Producer Organizations in Mozambique In Mozambique, small farmers have established self- While out-grower schemes are well established, par- managed out-grower schemes with assistance of the ticularly in the cotton and tobacco sectors, more Cooperative League of USA (CLUSA) program. The loosely organized marketing arrangements are preva- program established a two-tier organization of pro- lent for the cashew, groundnuts, sesame, sunflowers, ducer organizations and their regional associations. and maize sectors. At the end of 2002, the program The producer organizations serve as the intermediary had established over 840 producer organizations in- between the individual farmer and the agribusi- volving approximately 26,000 farmers. Repayment nesses/processors that provide short-term production reached 96%. The program has been handed over to a credit and purchase the produce. The producer orga- local NGO, OLIPA. nizations also provide extension services to the farm- Sources: Phillips, R. et al., 1999; and project information at ers to improve farming methods and quality of the CLUSA International Program Web resource at www.nbca.coop/ produce, and provide storage and transport facilities. clusa.cfm. 40 Meeting Development Challenges: Renewed Approaches to Rural Finance the arrangements, and the relationship is maintained supply chain, they have a significantly better bar- mostly through mutual business interests. gaining position. Very tight supply chains leave little room for variant actions. These arrangements, often referred Specialty arrangements to as either coordinated supply chains or integra- Agro-service centers tion contracts, are durable arrangements between producers, processors and buyers about what and In a number of Bank partner countries, large how much to produce, time of delivery, quality, international input suppliers such as Monsanto safety conditions and price.59 Contract farming is and Novartis have established distribution net- one example of such a relationship. In this case, the works, which deliver their inputs to farmers on farmer utilizes some of his own inputs (premises, conditional sales of the crops, both in-kind and land, labor, etc.) while other inputs are supplied at predetermined prices. This solution, which is im- by the contract partner. In return, there are rela- perfect from the farmers' standpoint, allows the tively assured income streams if the agreed upon companies to sell their products to farmers who production goals are met. Examples are the poultry have little bargaining power, as they have no other industry in Brazil, where the farmer supplies labor financing alternative. and buildings, but all other inputs are supplied by the processor; sugar beet growers in Poland; and Pre-financing of international commodity sugar cane growers in Brazil as outlined in Box export trade 26.60 This approach is extensively and successfully Pre-export financing is mainly done for non- used in transition economies (Box 27). perishable commodities like cereals, coffee, and Other supply chains are organized much more cotton (Box 28). It only works for clients, such loosely, with the respective bargaining powers of as well-managed cooperatives and commodity the partners based on economic realities. If farmers boards, that have an excellent export performance have opportunities to profitably sell outside the track record. BOX 26 Supply Chain Financing in the Sugar Industry in Brazil Sugar mills in Brazil offer integration contracts to final prices for the end products, sugar and ethanol, sugar cane farmers in order to secure access to their are known. The advances are interest free, and allow produce. Farmers who enter the annual contracts re- farmers to smooth annual cash flows. ceive three payments, the first at contract entry, the second upon delivery of the product to the mill, and the final payment at the end of the season after the Source: Rabo International Advisory Service, 2004. BOX 27 Supply Chain Financing in Kazakhstan In Kazakhstan, commercial banks provide credit accounts to the processor's account, up to the value of lines to processors of cotton, soy, and wheat. The the loan. In reality, since the markets for the these processors then provide loans to their potential sup- commodities are quite transparent, there is little ad- pliers for agricultural inputs, rental of equipment, etc. vantage to farmers'side-selling, not repaying the loan Farmers producing these commodities have access to and thus risking the receipt of loans in subsequent market information and are contractually free to sell years. Consequently, within this supply chain, there is their harvest to any party of their choice. However, a lasting client-customer relationship. all participating farmers are required to maintain accounts at the lending bank and the bank has the authority to transfer funds from the borrowers' Source: Kloeppinger-Todd, R., Personal Communication, 2004. Special-Purpose Institutions and Products 41 BOX 28 Pre-Export Financing through Price Risk Management in Tanzania Tanzanian coffee cooperatives were restricted in their the banks with more certainty with respect to the ability to obtain bank credit due to the risk of varia- cash flow of coffee growers, resulting in increased tions in international commodity prices that could credit to the cooperatives, which in turn extended compromise their ability to repay loans. Rabobank loans to their members. International developed a put-option for the coffee cooperatives, which assured the cooperatives a mini- mum price for their future produce. This provided Source: Rabo International Advisory Service, 2004. BOX 29 Supply Chain Lease Contracts in Russia The Agricultural Finance Company (AFC) in Russia back agreements with AFC in case of repossession of provides farm equipment leasing contracts to farmers equipment due to default.The contract is advantageous in the dairy sector in the Moscow region. The dairy for all parties involved: the processors secure their processor selects the farmers eligible for AFC leasing inputs from the farmers, the farmers obtain medium- contracts. Farmers make down payments and agree to term finance for capital goods, and the equipment ven- the processor's withholding the balance of the lease dors increase their market through this arrangement. contract.The processor transfers the payments directly to AFC. Equipment suppliers have entered into buy- Source: Rabo International Advisory Service, 2004. Medium-term supply chain financing ° If the bank is providing the funding to the end- through the banking system client under a tied arrangement with the processor, the support could be in the form of A bank or other financier can play an important role technical assistance to install monitoring and in setting up a market-oriented supply chain, for the control systems within the bank or the proces- benefit of all segments and participants, by organiz- sor's specialized credit department. ing a tailor-made credit line that connects the dif- Financial assistance in the form of a credit ferent segments (Box 29). ° line, where appropriate (see section on credit lines in Chapter 3), or a guarantee arrange- Areas for possible Bank ment could also be envisioned. interventions · In order to facilitate the participation of small farmers in a supply chain financing arrange- Historically, supply chain financing has taken place ment, support to create and strengthen small in developing countries as a response by processors farmers' associations or cooperatives that would and traders to a lack of credit for farmers. It has act as direct partners for processors and other usually been done on a fully commercial basis, purchasers. These associations, which would without donor involvement or support. However, represent a number of farmers, would enable the supply chain financing as a tool to increase the sup- processors to lower their transaction costs. ply of credit to farmers offers several opportunities for Bank involvement: Setting up an arrangement for long-term financing · On the legal and regulatory level, assistance to requires the strong involvement of private sector develop transparent and enforceable contract law. agribusinesses and financial institutions, so is prob- · Since all suppliers of credit to farmers need refi- ably outside the scope of most Bank-supported nancing themselves, support to commercial banks rural finance projects. However, there is a signifi- to motivate them to undertake such financing. cant role for IFC. 42 Meeting Development Challenges: Renewed Approaches to Rural Finance rura107078_ch06.qxd 5/17/05 12:20 PM Page 43 6 Cross-cutting issues of risk management, technological innovation and specialized collateral arrangements There are many cross-cutting issues that fall into mobile banking units, and internet banking.63 Use the area of general financial sector development of many of these technologies for rural finance is but that are also important for rural finance. For still in the design or pilot stage, so the suitability the purposes of this approach paper, only those has not yet been proven; however, there are some cross-cutting issues that are crucial for the de- promising developments. velopment of sustainable rural finance or that Technologies for rural areas in developing coun- apply specifically to financing for agriculture are tries need to be adapted to the respective envi- covered.61 ronment. Transferring solutions from developed countries with strong communication networks to developing countries with limited infrastructure Technological innovations to may result in expensive yet unsustainable applica- tions. The following principles are good bench- reduce transaction costs and marks: simple and easy to use, wireless, low power, to achieve greater outreach durable, reliable, with a low cost through shared for financial institutions access, low maintenance, or high volume. Examples of rural finance institutions and com- High transaction costs are one of the major factors panies in supply chains developing and implement- limiting the expansion of rural financial services. ing innovative technologies include Mongolia's Most financial institutions, even if interested in Khan Bank, Uganda's Microfinance Union, and increasing outreach to rural areas, would be dis- India's ITC (Box 30). suaded by the high cost of processing a large num- Lessons learnt so far include the following:64,65 ber of generally small transactions in villages across a broad geographic area, and the challenge · Information technology (IT) does not replace of maintaining the quality of such a portfolio. poor management in financial institutions. On Small transactions in general require nearly as the contrary, good management practices must much oversight as larger ones, while providing a be followed in order to apply and extract the much smaller return. value of technology solutions. Some commercial banks, as well as microfi- · Deploying technology successfully involves nance institutions, have developed technology- much more than simply acquiring the technol- based solutions.62 These technologies range from ogy; it requires a clear set of business goals, debit and credit cards, to personal digital assistants objectives and strategies in order to establish (PDAs), to new delivery channels such as ATMs, resource priorities and requirements. 43 rura107078_ch06.qxd 5/17/05 12:20 PM Page 44 BOX 30 Three Institutions using technological innovations Khan Bank of Mongolia tion in Uganda with Uganda Microfinance Union (UMU).The system enables transactions to be made in Increased security and ease of access through an rural locations at a much lower cost than equipping extensive network of computerized branches and operating a branch office. Agents with liquidity Mongolia is a large country with vast and thinly pop- management skills and fixed locations in rural com- ulated rural areas traversed by nomadic herders. Khan munities are provided with a wireless PoS device that Bank has a branch network of nearly 400 branches, of has an 11-hour battery, smart cards, and a web-based which 76 are currently online. They are working to transaction management application that can handle bring the remainder of the branches online over the savings deposits, loan payments, withdrawals, and next few years. Historically, nomadic herders have not fund transfers.Transactions are transferred through the used banks, relying instead on a barter system for local mobile phone infrastructure to UMU's manage- payment from customers. Through favorable interest ment information system.Transactions are uploaded at rates on savings, the extensive branch network and least once a day, but can be sent more often depending targeted marketing, Khan Bank has drawn herders on airtime charges and the volume of transactions. The into their customer base. These nomadic herders have application provides customers with longer hours of discovered the convenience, security and power of de- service than a bank, reduces the distance that cus- positing their money into the Bank at one location, tomers must travel from 20 km to less than 5 km, thus then following their regular seasonal patterns of reducing both transaction cost and risk, and creates movement across the country and being able to access more incentives to save.The system creates a customer their deposits from other branches of the bank. The payment history that can then be used for credit deci- bank has now provided herders with nearly 30,000 sions, risk modeling and product development. loans as well as deposit accounts. Source: Africap, 2004. Cross-border debit cards The Indian Tobacco Company In October 2004 Khan Bank began offering debit cards to cross-border traders traveling to China. His- The Indian Tobacco Company (ITC) realized that the torically the traders would receive a loan from Khan long supply chain for agricultural produce resulted in Bank in the Mongolian currency, the togrog. Carry- inefficiencies for ITC and high transaction costs for ing the cash long distances, they would exchange the the farmers. In order to shorten the supply chain, ITC loan into Chinese yuan near the border, then purchase introduced its e-choupal initiative in 2000, setting up the goods and travel back to Mongolia to sell them computer terminals and internet connectivity in for togrog and repay their loan. Khan Bank now co- villages (choupal means "village meeting place" in operates with the Agricultural Bank of China, the Hindi), to enable farmers to access information about fourth largest bank in China, to accept Khan Bank prices, weather, farming methods and soil testing, as debit cards at ATMs and point of sale (PoS) devices, well as to order agricultural inputs. The terminals are enabling cashless travel and transactions for the operated by one elected farmer per village, the san- traders, who thereby have a greatly reduced risk of chalak, who earns a commission on each completed theft of funds. This in turn reduces Khan Bank's risk transaction. Farmers receive instant quotes for their of theft-related default. The bank is planning to offer produce, and instant payments for their sales after the reverse opportunity for Chinese traders and to transporting it to ITC collection centers. This tech- replicate the services along the Russian border. nology enables ITC to reduce its handling costs by 30% and farmers to reduce their tranaction costs by Source: www.khanbank.com, and Morrow, P., Personal Commu- up to 68%. Farmers also benefit from better availabil- nication, March, 2005. ity of inputs, increasing productivity. As of December Uganda Microfinance Union 2004, ITC has reached over 3 million farmers, creat- ing links to companies, government departments and Using technology-equipped agents to create low-cost universities. Trials are underway to offer insurance access to services in rural areas products and agricultural credit. The Microdevelopment Finance Team led by Hewlett Packard is testing a point of sale (PoS) payment solu- Source: India Today, December 13, 2004. 44 Meeting Development Challenges: Renewed Approaches to Rural Finance rura107078_ch06.qxd 5/17/05 12:20 PM Page 45 · A centralized, reliable and robust management large amounts have been borrowed from a financial information system provides vast amounts of institution that need to be repaid following the har- data. Learning how to analyze the data and use vest, but the harvest fails. Nor do they protect a fi- the resulting information for business decisions nancial institution that has made many loans for is in many cases a major challenge. that crop. · Leadership within an institution is critical. Key Governments in developed and developing decisions regarding technology strategy and ini- countries have attempted to manage these risks for tiatives must be made by senior executives, not their rural populations by establishing commodity left to the IT manager. price guarantees, buffer stocks or stabilization · Strategic partnerships with experienced technol- funds, and providing crop insurance in case of nat- ogy providers are critical in making technology ural disasters. These efforts have had mostly nega- initiatives affordable. In many cases, shared in- tive results, such as huge inefficiencies and costs to frastructure is a decisive element needed to re- the government budget, with a paltry payout for in- duce costs and make services affordable. dividual farmers. Moral hazard and adverse selec- · Significant funding for quality technical assis- tion are also major factors, since these measures tance is imperative, so as to leverage the exper- provide the same kind of protection to honest and tise of those who have gained experience doing dishonest and good and bad farmers alike. It is now this type of project, whether the services are Bank policy to discourage partner countries from procured from the vendor, a third party provider, adopting such policies, and the Bank is actively ex- or another financial institution that has been in- ploring other, private sector-based ways to manage volved in a similar undertaking. agricultural risks. Supporting financial institutions to pilot innova- Price risk management instruments tive technology solutions that enable them to reach rural customers at a reasonable cost might present for commodities an area of intervention for the Bank, especially Strong price fluctuations for internationally traded when there are strong private sector partners and commodities such as coffee, cotton, and maize significant potential for scaling up. can be managed through the purchase of hedging instruments that are available in international financial markets. However, derivatives contracts, Risk management instruments futures and options are not traded for all commodi- for financing for agriculture ties. For many products such as sesame and cashew, there are no contracts traded on international and Farmers (and their lenders) are exposed to risks that local exchanges, and therefore, no price risk man- are in addition to those facing other credit clients. agement instruments available. Even when price Some of these risks are idiosyncratic risks that af- risk management instruments are available on in- fect a single household, while others are covariant ternational exchanges, the movements of prices on in nature and affect an entire region or country at these markets may not be an accurate reflection of the same time. Weather risk is probably the single price movements in local markets. This disjuncture most important risk influencing the outcome of between local and international markets, called a farmer's investment. Price risk, especially for "basis risk," often makes contracts traded on inter- internationally-traded commodities, can also be national markets inappropriate as instruments for quite substantial. managing price risks in local markets. On an individual level, farmers have always de- If a price risk management instrument is avail- veloped risk management strategies, ranging from able, it might be quite expensive, so a financial in- crop diversification, adoption of low-risk and stitution would need to go through a series of steps low-yield crops and production patterns, to self- in order to determine the suitability of using it. The insurance through extended family relationships institution would first need to determine the nature, and use of money lenders in an emergency. How- level and timing of its primary risks. Once this ever, these strategies do not protect a farmer when has been done, and the financial institution has Cross-Cutting Issues of Risk Management 45 rura107078_ch06.qxd 5/17/05 12:20 PM Page 46 determined that a market-based price risk manage- the level of rainfall to harvest success. Insurance ment instrument is the best way to manage that risk, can then be written against lack or excess of rain- the institutional capacity of the bank is the key to fall. Index-based weather insurance solutions can successful implementation. Success factors include protect financial institutions that are exposed to the following: weather risks against declines in repayment rates in the case of severe weather events and protect the · The financial institution should have a sig- farmers who have taken out loans. nificant commercial stake in the use of the Risk management products based on weather instrument; events and indices such as area yields avoid the · The hedging instrument should cover significant problems of traditional crop insurance because they volumes of loans; rely on objective observations of specific events · Top management should provide strong support; that are outside the control of either farmers or in- and surance companies. They are also less costly to ad- · Managers and staff should receive in-depth minister because they do not require individual training. contracts, on-field inspections and loss adjust- Although this approach has only limited applica- ments. These contracts are written as insurance or tions for financing for agriculture within rural de- derivatives and rely on the close correlation be- velopment, it can represent a breakthrough for tween the farmers' exposure, such as yields, to an some of the Bank's partner countries, and pilots index, such as cumulative rainfall per season. The have been supported by Agriculture and Rural De- contract payouts are therefore not settled on the velopment Department's (ARD) Commodity Risk basis of actual losses incurred, but on the basis of Management Group (Box 31).66 the index, which makes payouts more timely and objective. However, index-based contracts intro- Index-based weather risk duce basis risk; that is, the potential mismatch between payouts and actual losses. management instruments The development of weather risk management Index-based weather insurance is based on objec- programs generally entails the following: tive, easily verifiable data. It uses official measur- ing stations to measure levels of annual or seasonal · Identification and quantification of weather-re- rainfall over time and determines the correlation of lated risks and correlation with production losses. BOX 31 Price Risk Management in Tanzania Lending for primary commodities in Tanzania has instruments in order to manage their exposure and faced traditional obstacles such as a lack of collateral, their clients' exposure to price risk. The bank be- price and weather volatility, and often times poor man- lieved that by using price risk management instru- agement by borrowers. In the late 1990s, as a result of ments as well as collateral risk management, they these constraints, an agricultural lending institution would be able to better manage their exposure to which was the third largest bank inTanzania was faced commodity risk. To do this, CRMG helped train their with the prospect of withdrawing much of their lend- staff on how to use these instruments and provide risk ing to the coffee and cotton sectors. To overcome its management services to their customers. In 2004, a exposure to weather risk, the bank used collateral man- large ginner located in the northwestern cotton grow- agement. But even with collateral management, the ing area, purchased a price risk management contract bank remained exposed to significant price volatility. in order to protect itself against a fall in the cotton In order to continue lending and to protect itself price. During the 2005 crop season, the bank plans to against price risk, the bank began working with the introduce this product to additional customers. Commodity Risk Management Group at the World Source: Bryla, E., Personal Communication February, 2005.66 Bank to learn more about price risk management World Bank forthcoming a 46 Meeting Development Challenges: Renewed Approaches to Rural Finance rura107078_ch06.qxd 5/17/05 12:20 PM Page 47 · Assessment of the meteorological infrastructure. before such programs can be extended to other This is key, since good weather data and analysis regions on a large scale. that enable correlation of weather events to Insurance premiums, coupled with the interest crop losses are central to the success of such charged by financial institutions on their loans programs. might well make a farmer's investment unprofitable · Design and pricing of prototype insurance except for high return crops. In addition, the ability contracts that compensate for losses. and willingness of local lending banks to recognize · Explanation and testing of contracts with the risk reduction for individual agricultural loans, users/beneficiaries. and reward this risk reduction through a reduction · Identification of institutions that are involved on in the interest rate charged to the client is quite un- the supply side of weather-based insurance, par- clear. Recent experience on lenders' willingness to ticularly insurance companies and international reduce interest rates, based on the reduction of risk re-insurance companies. from credit guarantee mechanisms, suggest that this could be difficult.68 The Bank, through CRMG, has supported a successful pilot project in India, as outlined in Box 32.67 Specialized collateralized lending There is significant interest world-wide in this Traditional bank lending always requires collateral. product. Evidence from India, where self-help The underlying collateral of a bank loan is, how- women's groups have purchased the insurance, in- ever, only considered as a secondary source of re- dicates that even smallholder farmers are willing payment, to be mobilized in case of default. The and able to shoulder the costs of insurance premi- first source will be the enterprise's operating per- ums as well as interest charges on loans, if the cost formance, i.e. revenue earned. In contrast, in spe- of self-insurance through techniques such as well- cialized arrangements, specific goods are dedicated digging or over-diversification are clearly greater. as collateral and secured for the use of the financial The mainstreaming and scaling-up of the weather institution at the time the loan becomes due. The insurance product for India for the 2005 and 2006 creditor has no right to other assets of the borrower. monsoon seasons is expected to demonstrate the These arrangements considerably reduce the risks applicability of this instrument to a wider market. to the bank if the goods given as collateral are eas- However, pilots in other regions are needed, and is- ily identifiable, there are officially recognized qual- sues such as the affordability of insurance premi- ity standards, the goods can be securely stored, title ums and basis risk have to be better understood to the goods can be assigned fast and at low cost, BOX 32 Weather Risk Management in India In 2003, BASICS, a microfinance organization in As a result, both BASICS and the farmers had a Andhra Pradesh, India whose principal customers are mutual interest in the development of a product that small rural farmers, introduced the first index-based would protect them against this risk. In conjunction weather insurance program in the developing world, in with a large insurance company that was looking to ex- collaboration with a local insurance company. The pand its outreach into the rural sector, BASICS devel- farmers who borrow from BASICS are affected every oped an index-based rainfall insurance product. This year by monsoon rains. When faced with excess rain- insurance product triggers an insurance payment to fall, they lose their groundnut crop.This risk has impli- farmers when the amount of monsoon rains rises sig- cations for farmers even in years when monsoon rains nificantly above the mean. These insurance contracts are good, because they worry about the adverse effects were sold to farmers in the rural sector, protecting both of a bad monsoon and alter their production patterns to the farmer and the lender against bad monsoon rains. be less risk adverse. BASICS faces the same negative Source: Hess, 2003. impacts of the monsoon due to increased defaults. World Bank forthcoming b Cross-Cutting Issues of Risk Management 47 rura107078_ch06.qxd 5/17/05 12:20 PM Page 48 and there is a ready market for sale of the goods. Warehouse receipt financing and repurchase One such arrangement of special relevance for agreements allow farmers to choose the timing of rural finance with regard to financing for agricul- their sales; as a result, they often obtain better pric- ture is warehouse receipts.69 ing than would be possible at harvest time. This In warehouse receipts financing, the underlying type of collateralized financing is used extensively collateral is a commodity such as grain, cotton, cof- in developed countries; in developing countries, fee, cocoa and vegetable oil, to name a few. The there are often significant obstacles that need to be process works as follows. After harvest, the goods overcome.70 are graded and stored in a warehouse. The farmer receives proof of ownership and proof that he can- Possible areas for not access the goods without release from the bank. Bank interventions With these instruments, he can then apply for credit from a bank against the stored goods. The amount All three cross-cutting issues outlined above offer of the loan depends upon the value of the underly- areas for Bank interventions. Since the enabling ing collateral, the transaction costs that the bank legal and regulatory framework is often the deci- will incur when selling the commodities in case of sive factor in the success of such an approach, loan default, and the potential decrease in value due interventions at that level are desirable. to price fluctuations. At a later time, presumably A second important area of intervention is ca- when the price level is more favourable to the pacity building within local banks. Instruments farmer than right after harvest, the farmer sells the such as weather insurance, hedging instruments for coffee to a trader or processor. The purchaser pays price risk management and specialized collateral off the loan plus interest and obtains release of the are fairly complicated and sometimes counter- coffee from the warehouse by showing proof of intuitive. Local banks need to learn about these ownership of the coffee (provided by the farmer) instruments, preferably firsthand. Once a decision and payment of the loan (provided by the bank). has been made to utilize one of these instruments, A specialized form of warehouse receipt are re- procedures for approval, monitoring, and collection purchase agreements (repos), where the financial need to be developed and installed, and manage- institution actually purchases the goods and obtains ment and staff need to be trained. Information and clear title, while at the same time signing a repur- training need to be provided to the farmers and chase agreement with the seller, obligating him to other stakeholders as well, in order for them to repurchase the goods at a certain point in time at a make informed decisions. pre-agreed price reflecting the costs of the funds The Bank could conceivably take on a role to advanced to the farmer. Repurchase agreements kick-start the development of such mechanisms in are advantageous in environments with inadequate selected countries, in cooperation with private sec- laws and regulations, or weak enforcement with tor partners. Once a pilot demonstrates the merits regard to registration of pledges and foreclosure of such an undertaking, the private sector actors mechanisms. would carry it forward. 48 Meeting Development Challenges: Renewed Approaches to Rural Finance rura107078_ch07.qxd 5/13/05 4:26 PM Page 49 7 Pulling it all together: a practical approach to strategy formulation The preceding chapters have discussed the three It is therefore suggested that all project teams pillars of rural financial sector development: policy, include an experienced rural finance specialist. infrastructure and the development of financial Failure to identify the need for rural finance dur- institutions. The success factors related to many ing project design can lead to the belated design delivery channels have been outlined and models of "a credit patch" that does not lead to the cre- discussed that could potentially be relevant for ation of sustainable institutions. The matrices might Bank programs. The use of products such as leas- be helpful in such a situation, as well as in post- ing, guarantees and financing through supply conflict, post-disaster situations where there is a chains have also been covered. How, then, can task political mandate "to do something now," i.e. with- managers decide on a set of interventions for a out systematic analysis and transparent process. rural finance program or component from among However, the limitations of this type of use must all these options? be recognized. The following matrices were developed as This chapter outlines a three-step approach decision tools for both stand-alone rural finance to strategy formulation. In the first step, informa- projects and for project components. They provide tion on the key elements of the policy context, the framework for a first and preliminary analysis, enabling environment and financial institutions are allowing an informed stop-go decision. If the deci- collected and analysed, along with information on sion is made to go ahead, then the matrix will guide the characteristics and structure of the real sector. in the choice of delivery channel. The budget for The findings from this analysis are then coupled in the analysis, as well as complexities within a coun- the second step with an analysis of the demand for try and availability of other relevant studies, will financial services in the proposed project area. determine the level of analysis. This could range Taken together, this analysis should enable the prin- from a two-week consulting assignment for a desk cipal strategic focus of the project to be developed. study that seeks to inform the design of a project The third step concludes the analysis with the iden- component, to an in-depth analysis that uses the tification and prioritisation of intervention options. matrices as a roadmap to develop a rural finance This three-step process is obviously a simplification strategy for a country. of the project design process; the intent is to provide As rural finance is a complex subject, design a structure that will guide task managers and help to and implementation requires specialist knowledge. ensure that all important elements are considered. 49 rura107078_ch07.qxd 5/13/05 4:26 PM Page 50 MATRIX 1. Country diagnostic matrix: rural financial sector development Real sector Policy and enabling environment Financial sector Geographic and climatic aspects Policy and enabling environment Banking sector · Population density · Macro economy · Financial sector · Mix of cities, towns and · Political stability depth/breadth villages in rural areas · Direct participation of · Financial institutions · Influence of disasters, government in the rural efficiency/soundness epidemics, etc. financial sector · Presence of larger banks, · Soil fertility · Subsidies that distort rural including state-owned · Rainfall financial markets banks, in rural areas and · Presence of credit information the extent to which they registries, training institutes, and serve farmers and other financial sector low-income people infrastructure Infrastructure Legal (real economy) Nonbank financial institutions · Transportation · Creation of laws for (NBFIs) · Communication secured transactions · Presence and composition · Water and sanitation · Bankruptcy laws of NBFIs in rural areas · Electricity · Leasing laws (finance companies, · Market infrastructure · Land rights cooperatives, MFIs, etc.) · Availability and affordability · Degree of enforcement of · Depth and breadth of of high-quality inputs above laws outreach to farmers and low-income people · Efficiency/soundness · Grants and subsidies that may create an uneven playing field Production and processing Regulatory and supervisory Products and services (financial sector) · Agriculture production · Availability of and access structure · Banking regulation in general to household saving · Structure of supply chains · Regulation and supervision facilities · Level of know-how of nonbank rural finance · Supply chain financing · Market penetration institutions · Rural leasing products (commercialisation) · Analysis of above with respect · Risk management · Degree of specialization, to expansion of access to instruments maturity of rural economy financial services · Warehouse financing · Prevalence of rural facilities non-farm private enterprises, including agribusinesses and processors · Access to agricultural extension and business support services Rural finance, relevant Rural finance, relevant donor-financed Rural finance, relevant donor- donor-financed activities and activities and projects on the macro financed activities and projects projects in the real sector and meso levels at the institutional level Source: Project team. 50 Meeting Development Challenges: Renewed Approaches to Rural Finance rura107078_ch07.qxd 5/13/05 4:26 PM Page 51 Step 1: Preparation of a For all three categories, relevant donor activities should be identified, as proposed strategies should country diagnostic matrix build on these or at least guarantee consistency. Strategy formulation starts with data collection and analysis. The country diagnostic matrix (Matrix 1) provides an overview of all relevant aspects of the real economy, as well as the policy context, Step 2: Formulation of core enabling environment, and financial sector of a strategic focus country, including the financial institutions that provide services to rural residents. The range of This step adds an assessment of the demand for topics in this matrix is a fairly complete list and financial services to the information gathered could be narrowed depending upon the context and within the country diagnostic matrix. Based on this the available resources. information, a first assessment of the nature and Within the real sector, the current production extent of the problems that the project wishes to structure and the potential for farming and non- tackle can be made, as well as a preliminary identi- farming private enterprises should be analysed, fication of the main strategic focus. along with relevant aspects of geography, climate "Effective demand" is defined as demand from and infrastructure. In addition, existing support people who would be willing and able to utilize services such as extension services or business and pay for the financial services demanded. In development services should be identified. rural areas with high effective demand, many The data gathering for the financial sector commercially-oriented farmers operate and the includes information on all types of financial in- nonfarm rural sector is dynamic. At the other ex- termediaries, from commercial banks to nonbank treme are rural areas where farmers produce crops financial institutions to semiformal and informal primarily for household consumption and there are financing mechanisms. It should include supply few nonfarming economic activities. In the middle chain financing, which quite frequently is at the are rural areas that have characteristics containing core of the financial services supply for rural elements of both of these more extreme cases: producers. The availability of risk management many small farmers have commercial activities, instruments should also be evaluated. As rural and the nonfarm sector is a mix of medium and finance is an integral part of the country's finan- small companies, as well as family-based micro cial sector, a special effort should be made to enterprises. understand the strengths and weaknesses of the Each of these scenarios for effective demand financial sector overall, as well as the rural finance requires a different set of interventions. For exam- subsector. The extent to which the various types ple, in a country, or region of a country where of financial intermediaries serve farmers and effective demand is low because most farmers are low-income people, including those in remote producing crops primarily for household con- rural villages, should be analysed as well as the sumption and there is a low level of economic features of the products and services that are activity not related to agriculture, it would be provided. difficult for most formal financial institutions to The laws governing the real economy and the cover the cost of extensive rural outreach due to a financial sector, as well as the meso-level institutions small customer base with small financial require- that support them, drive the analysis of the policy ments. In such a situation, encouraging banks to and enabling environment. This analysis covers the reach out to the rural areas might not be the best macroeconomic situation, regulatory framework, intervention. Instead, a program might focus on supervisory structures, and laws that affect financial activities that would translate potential demand transactions, including the level of enforcement of into effective demand. This could include creating these laws. Initiatives that could at least partially awareness of economic opportunities, providing compensate for a poor legal environment should be extension services to farmers and building essen- analysed as well. tial economic infrastructure, such as farm to Pulling It All Together: A Practical Approach to Strategy Formulation 51 rura107078_ch07.qxd 5/13/05 4:26 PM Page 52 market roads. Over time, such assistance would task managers with a framework that enables them lead to the creation of economic opportunities for to compare the strategic approach contemplated households, small entrepreneurs and smallholder for the project under design with that of other farmers who only then would be in a position to similar countries. The typology is a matrix that actively demand and utilize a broad range of outlines seven different combinations of interven- financial services. tions that could form the core strategic focus of a The critical determinants for the evolution of project with differing levels of demand for and the supply of financial services are the regulatory, supply of financial services, as well as differing legal, and enabling environment, as well as the levels of development of the policy and enabling level of government intervention. As with demand, environment. the supply side can be subdivided into three broad The seven different country typologies are categories. The first category comprises rural finan- shown in Matrix 2. There are seven typologies cial sectors that show very promising developments rather than nine, because the two extreme cases in the supply of financial services, such as success- will hardly be found in reality. In each case, a ful reforms of publicly-owned rural banks; pri- different emphasis and focus should be applied vately-owned commercial banks with innovative when strategies are formulated. For example, if a delivery channels for rural clients; microfinance in- country performs poorly at the macro and en- stitutions that are expanding into rural areas; and/or abling environment levels but demand is already rural financial cooperatives that are profitable and evolving and financial intermediaries are provid- have strong governance and management systems ing some services to farmers and low-income that are likely to be operating within a supportive people, policy dialogue and enabling environment regulatory, legal, and enabling environment. The obstacles could be emphasized. If the macro second is defined by some deficiencies in the envi- and enabling environments are moderately accept- ronment that have constrained the number of finan- able, addressing the needs of financial inter- cial intermediaries that are operating profitably and mediaries could be the cornerstone. But if low are interested in serving farmers and low-income effective demand is combined with strong defi- clients. The third has such a poor environment that ciencies that distort the development of financial the development of the rural financial sector is very markets, normally only state-owned banks and difficult. informal/semiformal financial providers could be Although it goes without saying that countries, expected to provide services to small farmers and and regions within countries, when analysed in low-income villagers. Under such circumstances, detail, are rather different from each other, a ty- the strategy should focus on measures that support pology can be developed that categorizes coun- effective demand, such as infrastructure improve- tries, or specific regions within countries, accord- ments and production-enhancing technologies, as ing to the level of development of these related well as policy dialogue. factors. A typology has been developed to provide 52 Meeting Development Challenges: Renewed Approaches to Rural Finance rura107078_ch07.qxd 5/13/05 4:26 PM Page 53 f- of and and poor and poor y y oducing orf on can pr erv and mal can ucture and ucture village erv y health, y focus and that (e.g. as yb health, demand; and that (e.g. as yb vironment semifor FIs mainl polic FIs en gies infrastr s ementsv roads, such vironment infrastr gies such and in roads, en opportunities ling ements;v vironment social associations) acquisition vironment acquisition farmer wef w-cost enhanced mal social w-cost lo en ling enab technolo impro issues technolo lo en impro and rigation, to rigation, to ir institutions loan asset and with and enab infor yek ir institutions asset FIs for for of and ements;v of stabilization associations) on gue; demand; ucture y vices scale vices activities vironment w-demand vironment w-demand loan ser demand, en economic assistance lo lo vings rantsg gue dialo impro assistance en economic ser rantsg small-scale in iciencf sa y small in and dialo consumption infrastr elopmentv ling edv as ef de channels y edv as ectivef orf Enhanced olicP ling ucture ef economic Production-enhancing xtensione Enab Impro such education echnicalT y vings operate membership-based village Matching ocusf erv Macroeconomic olicP enab Impro such education Production-enhancing xtensione echnicalT operate membership-based sa Matching w ops · · · · · · · · · · · Lo cr farm ocus:F vings; economic sa ocus:F vings; infrastr sa deli gic tea a to and str range mation outreach mation ability dna ucture vices mation e con- FI y health, mal loan of supports financial ser h infor and & infor polic infor cor y infrastr such mix hic broaden ementsv xpande and vironment infor activities in roads, of a w icientf and reduce and ementsv to to to en and vings ef ets vity Demand ops, FIs iciencf impro ets vity social ets vity sa FIs have ef impro ling issues s cr and to people rigation, esv mal mark economic ationsv to products demand; mark enab yek and ir mark institutions cial to producti to producti vide uralr to producti channels on xamplese farmer inno mer demand; vironment mer pro gue, y scale f-farm demand of mer semifor costs en vironment gue enhanced vironment cooperati commer of access arf assistance access arf assistance yl erv gical set en dialo en economic access arf and and of (FIs) edv ling edv y deli small dialo demand: and ling set y edv edv ling as education mal Enhanced products Enhanced enab profitab mal financial Impro Increased echnicalT of echnoloT transaction Impro Increased echnicalT broader olicP ements;v to a Enab olicP enab Impro such and Impro Increased Membership-based as Infor roupsg wingo · · · · FIs; · · · · · · · · · · Evolving sumption gr ocus:F institutions ocus:F of ocus:F impro semifor countries) to FIs; elopv to access of to within (FIs) y de ev yl vices FIs f-farm and uments ementsv credit of to costs to ser people man including instr ationsv as impro outreach impro profitab and gionser and s inno to uralr to such products institutions and of y vironment systems demand: assistance products, assistance set gical transaction credit en (or farmer FI financing ability products activities anced of vironment management m ementsv ectivef cial financial iciencf en ling mation anced Adv ter Ef vide ef echnicalT adv risk echnoloT reduce Lines to ling echnicalT xpande broader pro a Enab impro infor · · · · · High commer economic ocus:F icientf ef ocus:F enab countries of s y al rur but in wef se and in farmer and y s within financial eas ar to s ypologT of diver people man onment, s al a onment, financial financial lingb farmer people vir rur deficiencies vir farmer people of 2. s to en videro in services en of s to team. ena deficiencies onment, lingb pr vidingo of w-income e lo vir videro pr lingb TRIX w-income eas videro w-income Good en pr services lo ar Some ena some services not angr Project and Significant ena pr services lo MA ylppuS Source: rura107078_ch07.qxd 5/13/05 4:26 PM Page 54 Step 3: Prioritising the rural finance and their content can be made avail- able to a wider audience. options and coming to However simple the decision matrix structure a decision may be, following the procedure helps create a cer- tain degree of transparency, as priorities have to be The country diagnostic matrix and the typology of made explicit from among the range of possible countries provide the basic information that allows interventions. In addition, it forces analysts to be for a formulation of a rural finance strategy for a systematic and to ensure that all important ele- specific country. Once the core strategic focus has ments are considered. Even if most cases will be been identified, intervention options can be listed more complex than what can be captured within and prioritized, according to the broad categories this three-step process, this approach to strategy already defined within the country diagnostic ma- formulation provides a logical and straightforward trix: the real sector, the financial sector and the pol- basis for decision taking. icy and enabling environment. For a relatively transparent process of prioritization, a simple deci- Conclusion sion matrix as shown in Matrix 3 can be applied according to the following three criteria: proposed This paper has attempted to create awareness of output or results of a specific intervention, compar- the complexities of rural finance and its relevance ative advantage of the Bank, and level of resources for rural development, and to explain the principal required. methods and solutions that have been successful. The assessment should in all cases take into Many of the challenges that have confounded account the status of existing or planned projects efforts to increase the access of rural populations of other donors, government priorities, and the to sustainable financial services have now been respective Country Assistance Strategy (CAS) and overcome in a number of countries. Over the Poverty Reduction Strategy Paper (PRSP). In addi- years, the World Bank has been an integral part of tion, Financial Sector Assessment Papers (FSAP), the international effort that has led to the current which have very restrictive confidentiality require- state of knowledge. It is now time to increase that ments and often do not focus on rural finance, can effort as an indispensable part of the fight against be useful for those countries where they include poverty. MATRIX 3. Decision matrix Competitive Option Output Advantage of Resources Priority the Bank Level of Intervention Real Sector Policy/Macroeconomics Enabling Environment Financial Sector/Supply Source: Project team. 54 Meeting Development Challenges: Renewed Approaches to Rural Finance rura107078_app1.qxd 05/11/2005 10:31 PM Page 57 Appendix 1 Rural finance portfolio analysis at entry 2004 and 2003 Rural finance lending FY2004--a desk review This note presents the results of a desk review space. However, only two projects are stand-alone of 20 World Bank projects approved in FY2004 projects that aim to increase access to financial that either exclusively focused on rural finance services. The remaining projects are multi-sector or had components/activities/conditionalities di- projects that have a component that aims to in- rectly relevant for rural finance (hence referred to crease access to a one (mostly credit) or few as RF projects). Two groups of projects that have financial services, or those that use financial in- an indirect impact on rural finance are included struments to deliver other services. The number of under this review. These are projects that aim RF projects is higher in FY2004 compared to to strengthen the financial sector in general and FY2003 although RF portfolio is lower. Portfolio projects that improve access to land and property for to rural finance could only be disaggregated rights. for 12 projects, and this was estimated to be $288 The objective of this review is to identify key million.72 elements of the project/component design and as- sess the quality of sector assessment, strategy, and Projects with rural finance monitoring framework (of the component). Good components, activities, and/or practices, innovations, and practices to avoid are identified. The review primarily involved review benchmarks of the key project document (Project Appraisal Document, Program Document, etc.) and inter- 25 views with task managers where necessary. The 20 20 review does not include any analysis of implemen- 17 tation or impact. Projects 15 of 10 Number 5 Overview 0 Twenty FY2004 projects included a component 2003 2004 or activity related or benchmark (policy-lending Fiscal Year project) related to rural finance. This was approx- Source: Ajai Nair, Project Team imately one out of ten FY2004 projects in the rural 57 rura107078_app1.qxd 05/11/2005 10:31 PM Page 58 The higher portfolio in FY2003 was primarily Sector board distribution because of a large adjustment project (US$506 million).73 In terms of sector boards, ten projects are rural sec- tor operations, five are finance and private sector operations, two are social protection, and one each Volume of rural finance lending is infrastructure, social development and public sector development operations respectively. The large number of non-rural sector board operations 800 indicate the need for a Bank-wide approach to rural 666 Millions finance. 600 US$ in 400 Distribution of rural finance lending 288 by managing sector board Amount 200 0 Lending Sector Boards 2003 2004 Public Sector Management Fiscal Year Social Development 1 Source: Ajai Nair, Project Team 1 Social Protection 2 Agriculture and Rural Finance Sector Regional distribution Development 2 10 SAR had both the largest number of projects (six) Private Sector and the largest share of the FY2004 rural finance Development lending (55%). As in FY2003, most of the lending 3 Infrastructure volume comprises a small number of projects; 1 three projects make up 86% of the estimated rural The Numbers = the Number of Projects finance lending amount. Source: Ajai Nair, Project Team Regional distribution of rural finance lending, FY04 Targeting Most projects do not target any particular economic sector or population group. Among those that have Africa South Asia 5 sector targeting, two projects, both in China, target 6 agriculture and two projects target infrastructure, supporting renewable energy development. Only one project has a population targeting, that of pro- Middle East and viding support for savings and credit groups among North Africa East Asia and the very poor. 1 the Pacific 4 Latin America and the Caribbean Europe and 3 Central Asia Financing scale 1 Three projects support small-enterprise finance, six The Numbers = the Number of Projects projects support both microfinance and small- enterprise finance, and the remaining 11 support Source: Ajai Nair, Project Team only microfinance. 58 Appendix 1 rura107078_app1.qxd 05/11/2005 10:31 PM Page 59 Activities supported of credit services. Less than half the number-- five--projects support development of savings ser- This analysis and the next two sets of analyses are vices. Among these only two involve supervised fi- done only for 15 projects for which most of the re- nancial institutions; others are considered to quired information are available. The major activity support savings services because these projects in- supported continues to be delivery of financial ser- volve development of savings and credit groups. vice at the retail level. An activity is defined to Only one project supports the development of pay- fall into this category if a credit line or revolving ment services. The far fewer number of projects funds are being used to support it. Eleven projects supporting the development of savings and pay- support this activity. The other retail-level activity ment services is of concern since it is increasingly supported is creating effective demand for financial recognized that these services are equally or per- services. An activity is defined as doing this if it haps more important than credit services. It is involves support to entrepreneurs for preparing notable that none of the projects support the business proposals or if it involves technical sup- development of insurance services, perhaps the port for development of community-based finan- most important financial service, given the role it cial organizations. Five projects do this. Market plays in income protection. facilitation activities are meso-level interventions that support the development of financial markets in rural areas. These include support for setting up Financial services supported by credit bureaus, property registries, retail and apex service providers, industry associations, industry rural finance lending, FY04 standards, etc. It is a welcome feature that a signif- icant number--eight--of projects support this crit- 20 ical but often neglected activity. However, only one 15 project supports macro-level activities that create 15 an enabling environment for the development of Projects rural financial markets. These involve activities that of 10 involve legal, regulatory, and policy reforms. 5 5 Number 1 0 Activities supported by rural 0 Credit Savings Payment Insurance finance lending, FY04 Source: Ajai Nair, Project Team 12 11 10 8 8 Service-providers supported Projects of 6 5 4 A wide variety of providers are supported. Five Number projects support MFIs, four each involve financial 2 1 cooperatives and savings and credit groups, and 0 three projects involve banks or nonbanking finan- Service Market Demand Enabling Provision Facilitation Development Environment cial institutions. The last category contains the Source: Ajai Nair, Project Team most rigorously regulated institutions. This also ex- plains the very low number of projects supporting services other than credit because provision of all other services are normally permitted only by regu- lated institutions in most countries. The predomi- Financial services supported nance of unregulated institutions supported is also Provision of credit is the predominant service being of concern from the perspective of sustainability of supported. All 15 projects support the development financial services supported. Rural Finance Portfolio Analysis at Entry 2004 and 2003 59 rura107078_app1.qxd 05/11/2005 10:31 PM Page 60 Service providers supported by the use of credit-guarantees. The large number of rural finance lending projects using revolving funds is an area of con- cern, particularly so when provided without ade- quate capacity building. 6 5 5 4 4 4 Innovative practices Projects 3 of 3 Practices identified in this section reflect relatively 2 new approaches. It is expected that identifying these Number 1 would encourage innovations in general and also 0 flag them for future assessments for effectiveness. Microfinance Savings and Financial Banks/ Institutions Credit Cooperatives Non-bank Groups Finance Supporting technology Institutions development for enhancing quality Service Provider of services and reducing Source: Ajai Nair, Project Team transaction costs The US$160 million Savings and Rural Finance (BANSEFI) Phase II Project in Mexico74 funds Instruments used the initial costs (US$56 million) to set up a tech- It is a welcome feature that the largest proportion nology platform for savings and credit institutions of projects--10--involve capacity building in the in Mexico. The activities financed include hard- form of technical assistance or training. Start-up ware costs, software development, and technical grants, either for operations or technology im- assistance. The platform would be at the national provement, are still a relatively less used nonfinan- level, rather than at the savings and credit institu- cial instrument. Only two projects use this instru- tion level or at the level of the federations, for ment. Among financial instruments, four projects economies of scale reasons and because it would use revolving funds (three other projects not in- make monitoring and learning across the supported cluded in the 15 analyzed here also mention revolv- entities feasible. The supporting entities are ex- ing funds as an activity that while six projects use pected to bear part of the installation costs and all traditional credit-lines. Two projects are piloting the operational costs. Additionally, it is expected that the national support agency can charge reason- able license fees from the supported entities after Instruments used to support rural two years of installing the platform. Supporting the finance lending, FY04 development of a modern technology platform to be used by a wide variety of independent savings and credit institutions is an innovative practice. 12 10 The project expects the platform to significantly 10 enhance the quality of services delivered by the 8 supported institutions and reduce the transaction Projects 6 of 6 costs of providing the services. 4 4 2 2 Number 2 Start-up grants for small business 0 enterprises to leverage credit Capacity Credit Revolving Start-up Credit Building Line Fund Grants Guarantee The US$19 million Village Investment Project in Instrument Kyrgyz Republic provides start-up grants for new business enterprises. These grants are provided by Source: Ajai Nair, Project Team local governments based on project proposals that 60 Appendix 1 rura107078_app1.qxd 05/11/2005 10:31 PM Page 61 have been independently appraised by established evaluation component. This component finances lenders such as commercial banks and MFIs and for independent household surveys, case studies, and which they have committed credit financing. The institutional performance assessments, as well as grant is expected to be a small portion of the total evaluation of project outcomes to be carried out project costs (a maximum of $1000 per proposal) internally. The significant investment envisaged for with the major portion expected to be from credit Monitoring and Evaluation (M&E) studies is justi- financing. Other requirements for release of the fied by the innovative nature of the project and its grants include legal registration of the group (coop- expected sector-wide impact. erative, company, partnership, etc.) and their having obtained adequate training in business planning and Combining grants and loans without management by a recognized institution. These re- creating perverse incentives for quirements reduce the likelihood that grants are pro- vided for proposals that are not commercially viable. lenders and borrowers Start-up grants that only fund a small portion of the Two FY2004 projects use innovative means to project costs is also in contrast to funding of produc- combine grants and loans for final clients while tive activities under most CDD projects where the minimizing the risks of creating perverse incen- grants fund up to 90% of project costs. While start- tives such as reduced incentive for lenders to enter up grants to help small urban businesses have been the market and reduced incentive for borrowers used for a long time in developed economies, their to repay loans. The $27 million Rural Power use to encourage enterprise development in rural Projects in Philippines includes a credit line that areas is relatively new and innovative. provides loans to financial intermediaries for on- lending to renewable energy technology (RET) suppliers and users. The project also provides Good practices grants to technology suppliers and users to reduce The review identifies the following projects on the cost of the systems. However, neither recipient of basis of specific features in project design or imple- the grant and loan receive them from the same en- mentation arrangements that are generally con- tity. Provision of the grant and loan from separate sidered a good practice in microfinance and rural entities prevents the borrower from considering the finance literature. loan as grant, an issue typical in several projects where both the loan and the grant are provided by Public-private partnership to increase the same entity. The grants provided by the US$19 million Village Investment Project in Kyrgyz access to credit in rural areas Republic are also unlikely to create perverse in- The US$258 million Second Poverty Alleviation centives for the same reasons (see under innovative Fund in Pakistan is a good example of public- practices for project modalities). private partnership. While the government sponsors the project implementation agency by providing eq- Practices to avoid uity and borrowing from the World Bank on its be- half, the organization board has majority of members These practices could adversely affect effectiveness from the private sector. The implementation is car- of rural finance activities in World Bank operations. ried out by MFIs and NGOs who are provided with both a credit line and significant technical assistance. Lending to local governments and government-controlled cooperatives Stand-alone monitoring & for on-lending evaluation component to evaluate The Jiangxi Integrated Agricultural Moderniza- outcomes in an innovative project tion Project and Gansu & Xinjiang Pastoral The Savings and Rural Finance (BANSEFI) Development Project in China envisage providing Phase II Project in Mexico includes a large loans to farmers for various farm-related invest- (US$7.5 million) stand-alone monitoring and ments. However, the institutional arrangements for Rural Finance Portfolio Analysis at Entry 2004 and 2003 61 rura107078_app1.qxd 05/11/2005 10:31 PM Page 62 this do not follow the recommended good practices infrastructure. Recommendation: Sector-work for rural financial institutions. The project envisages that investigates demand and supply of financial the loans to be provided either by local government services for agriculture and rural infrastructure departments or by the rural credit cooperatives. should be carried out. In economies where supply There is little evidence globally of successful man- constraints are established, further investigations agement of loans by government departments or can be carried out on possible reasons and means agencies. The rural credit cooperatives are still ef- to address these. Based on such studies, projects fectively state-controlled organizations and man- can experiment with financial and nonfinancial agement of loans by such organizations too do not instruments to address the constraints. have a history of success. The project appraisal doc- 2. Issue: Many multi-sector projects that include ument (PAD) also does not provide any information rural-finance components or activities do not on why this approach has been adopted, what--if include a rural-finance specialist in the project any--is the strategy to ensure successful manage- preparation team. Recommendation: All projects ment of the credit line, and does not include any that have rural finance components or activities indicators to monitor the repayment performance of should have specialists with rural finance exper- loans to farmers. tise in the project preparation team. As a rule of thumb, if the component is considered too small Providing revolving funds to to justify having a specialist, it is unlikely to be community groups without significant enough to be included in the project. adequate support for institutional 3. Issue: Most multi-sector projects that have a rural finance component or activity do not development and capacity building give the rationale for including the component/ The US$89 million Uttaranchal Decentralized activity or for using the particular project im- Watershed Management Project in India and the plementation mechanism being adopted. This US$81 million Second North-East Irrigated makes it difficult to understand whether a strong Agriculture Project envisage providing revolving rationale exists for inclusion of the component funds for community groups without adequate and whether alternative implementation mecha- technical assistance arrangements. Available evi- nisms were explored. Recommendation: Multi- dence for the performance of community-managed sector projects should provide clear rationale for revolving funds suggest that external capital is inclusion of the rural finance component/activity likely to be beneficial only when they are provided in the project and for the mode of its implemen- in combination with adequate technical assistance. tation. Additionally, where the component is relatively significant, projects could also include an annex that provides a rural finance sector as- Recommendations sessment and explains how the rural finance strategy being adopted by the project fits in with General national strategy (if this exists). 1. Issue: Only four out of 20 FY2004 RF projects 4. Issue: Most RF projects do not include well- focus on specific sectors--two on agriculture and specified outcome and output indicators in the two on infrastructure; other projects either focus project results-monitoring framework. Recom- broadly on enhancing access to finance for the un- mendation: All RF projects should include RF derserved or focus on enhancing access to credit well-specified output and outcome indicators in for specific population groups such as women the results-monitoring framework. When provi- or the very poor. While having a broader rural sion of credit is supported (through credit lines or finance approach (in contrast to single-sector, revolving loan funds), include key indicators such credit-only projects) is in keeping with the con- as loan repayment performance is critical to esti- sensus about the need for a financial system ap- mating the performance of the component/activity. proach, it is unknown if this approach addresses 5. Issue: Projects that support provision of finan- the financial needs (particularly credit) of key cial services in both rural and urban locations sector in rural areas, particularly agriculture and (typically finance sector projects) do not include 62 Appendix 1 rura107078_app1.qxd 05/11/2005 10:31 PM Page 63 output and outcome indicators that are disaggre- 2. Issue: In multi-sector projects, implementation gated geographically (rural/urban). Recommen- of rural finance activities are often carried out dation: Projects that support provision of finan- by project implementation units or local govern- cial services in both rural and urban areas should ments that do not have adequate rural-finance disaggregate outputs and outcomes indicators expertise. Recommendation: Multi-sector pro- geographically (rural/urban). PADs should also jects having rural finance components should clearly indicate how rural/urban locations are contract out implementation of rural finance defined. activities to institutions with the required spe- cialist expertise. If this is not feasible, it should Project design be ensured that adequate expertise in rural- 1. Issue: Some projects provide revolving funds for finance expertise is ensured at all levels of community groups without also providing the re- implementation. quired technical assistance to ensure effective use 3. Issue: Supply of financial services by government of the funds and their sustainability. Recommen- departments or agencies have traditionally not dation: Globally, available evidence indicates that been successful. Yet, some projects continue to groups that receive external capital assistance support this means of delivering financial services, tend to have higher failure rates when compared to particularly credit. Recommendation: Support projects that only receive support for group mobi- should primarily be provided for supply of finan- lization, provide training, and offer advisory ser- cial services by specialized organizations such as vices. Projects should provide revolving-funds banks, MFIs, financial cooperatives, and savings only when a strong justification for the need is and credit groups. If supply by an organization (in- made and is accompanied by institutional devel- cluding any of the types just referred to) in which opment and capacity-building support. It should governments have an ownership-stake is sup- also be ensured that the recipient of the revolving ported, it should be ensured that the ownership- funds have ownership structures that have stake is not likely to translate into interference in incentives to ensure the sustainability of the fund management and operational decisions. This is and the project design does not introduce rules or critical to ensure effectiveness and sustainability incentives that operate in the reverse. of interventions supported by the project. Rural finance lending FY2003--a desk review This note presents the results of a desk review of 17 mid-1900s. The average number of projects per year World Bank projects approved in FY2003 that ei- during the period FY 1992-2000 was 19 and the ther exclusively focused on rural finance or had lending was $630 million.76 The number of projects components or conditionalities directly relevant for in FY2003 is lower than the averages for the last rural finance. The objective of the review was to decade and the last two FYs, but the volume is capture nature of support and identify innovations, slightly higher. good practices, and practices to avoid. The analysis focuses solely on design elements and not on imple- Trends in number and volume mentation or impact. The review draws on informa- tion in project documents and on interviews with In FY2003, 12 investment projects supported project task managers. activities aimed at increasing access to financial services in rural areas. Five adjustment projects Overview had conditionalities or benchmarks connected to rural finance. Among these 17 projects, portfolio After significantly declining in the 1980s and early for rural finance could not be disaggregated for 1990s, rural finance lending75 started increasing in the three adjustment projects and one investment Rural Finance Portfolio Analysis at Entry 2004 and 2003 63 rura107078_app1.qxd 05/11/2005 10:31 PM Page 64 Trends in rural finance lending gets agriculture, two target infrastructure sector (energy production) and 15 do not target any Lending particular sector.78 Twelve projects focus on micro- 25 666 700 23 finance while one focuses exclusively on small en- 630 628 Amount ergy enterprises. Four projects support both micro- 22 600 20 finance and small enterprise financing. Projects of 19 500 in 17 US$ 15 What is being supported? 440 400 Millions Number The major activity supported continues to be ser- 10 300 vice provision. Five projects each support creation 1992­2000 2001 2002 2003 of an enabling environment, market facilitation, and Fiscal Year support for creating effective demand for financial Number Volume ($ million) services. Enabling environment involves support for legal, regulatory, and policy reforms. Market facili- Source: Ajai Nair, Project Team tation involves support for asset registries and credit bureaus. Support for creating effective demand in- project. In the remaining 13 projects, the rural fi- volves financial counseling services and support to nance portfolio is estimated to be $666 million.77 enterprises for preparation of credit proposals. As in the past years, AFR has the largest number of projects. The largest share of the portfolio is in Activities supported LAC (the two projects in Mexico make up over Among the projects involving support for service 90% of the total FY2003 portfolio). provision, credit is the predominant service being provided. This could be because provision of other Regional distribution of projects services involves significant regulatory constraints. Ten projects exclusively target rural areas and However, inadequate recognition of the importance seven have no targeting. Two projects work exclu- of other financial services (especially savings and sively with women and two have explicit poverty insurance) by project teams could also explain the targeting. As for sector targeting, one project tar- predominance of credit. A wide variety of providers are involved in Regional distribution of rural service provision. Three projects each involve microfinance organizations and community-based finance lending, FY03 organizations, and two each involve state-owned South Asia 1 Activities supported by rural Middle East and North Africa finance lending, FY03 2 Africa 14 13 8 Latin America 12 and the Caribbean 3 10 Projects 8 of Europe and 6 5 5 5 Central Asia 4 1 East Asia Number and the Pacific 2 2 0 Service Enabling Market Demand The Numbers = the Number of Projects Provision Environment Facilitation Development Source: Ajai Nair, Project Team Source: Ajai Nair, Project Team 64 Appendix 1 rura107078_app1.qxd 05/11/2005 10:31 PM Page 65 banks, commercial banks, and cooperatives. It is What are the innovations? not, however, clear if all these institutions are envisaged to be sustainable. Practices identified in this section reflect relatively new approaches. It is expected that iden- tifying these would encourage innovations in Financial services supported by general and also flag them for future assessments rural finance lending, FY03 for effectiveness. · The Rural Finance Sectoral Adjustment Loan 12 11 in Mexico supports creation of a non-deposit 10 taking, state-owned bank focusing exclusively 8 on lending to middle-income rural producers. Projects of 6 While the state ownership of the bank does raise 5 concerns on its ability to operate on commercial 4 basis, not having the ability to mobilize deposits Number 2 1 1 and being required by charter to maintain the 0 real value of its assets is more likely to make it Credit Savings Insurance Others do so. Source: Ajai Nair, Project Team · It is generally agreed that sustainability of mi- crofinance institutions is critical. The Andhra Pradesh Rural Poverty Reduction Project in How is the support being India envisages this by supporting the develop- provided? ment of federations of community-based organi- zations and specialized second-tier microfinance More projects involve start-up funds for service organizations. providers, technical assistance, and training than do · As was mentioned earlier, most projects focus on those that involve a credit line or revolving funds. provision of credit services. In contrast, the The higher focus on nonfinancial instruments, Third Malawi Social Fund Project focuses on rather than financial instruments, is welcome since supporting community groups that provide sav- in most situations the absence of an enabling pol- ing opportunities. The groups are not envisaged icy environment, institutional capacity of service as clients for lending by banks or microfinance providers, and capacity of clients is more limiting a organizations (they are, however, expected to constraint than is the absence of finance. lend their savings among their members). · Inadequate capacity of entrepreneurs to submit Instruments used to support rural bankable proposals is one of the several con- finance lending, FY03 straints that limit poor people's access to finan- cial services. The Savings and Credit Sector pro- ject in Mexico and Small-scale Commercial 9 8 Agriculture Development Project in Bosnia have 8 sub-components that support the provision of 7 6 6 technical support for this purpose. 5 5 · Commercial financing of rural infrastructure is Projects 4 of 4 expected to enhance creation and improve main- 3 3 tenance of such infrastructure. The Off-grid 2 Number Rural Electrification Project in Nicaragua and 1 Decentralized Rural Electrification Project in 0 Guinea envisage bank financing of small energy Technical Training Start-up Credit Revolving Assistance Grants Line Fund projects and household electrification. Instrument · Financial services aligned with social and cul- tural contexts have relevance in areas with lim- Source: Ajai Nair, Project Team ited economic activity. The Matruh Resource Rural Finance Portfolio Analysis at Entry 2004 and 2003 65 rura107078_app1.qxd 05/11/2005 10:31 PM Page 66 Management Project in Egypt has a microfi- supports capacity building for such an institu- nance component that supports credit financing tional framework. in `in kind' (not cash) and in keeping with · Linkages with mainstream financial institutions Islamic financing principles. can provide sustainability to community-based financial institutions. The Andhra Pradesh Rural Poverty Reduction Project in India envisages What are the good community-based organizations using funds practices? provided by the project to leverage additional investment funds from banks. Most of these are design features in projects that are generally considered a good practice in microfi- nance and rural finance literature. What are the practices · In the Third Kecamatan Development Project to avoid? in Indonesia, support for revolving fund These include practices that could adversely affect management units (UPKs) of the subdistricts effectiveness of rural finance activities in World (Kecamatans) is based on the assessment of Bank operations. their viability potential and classification into four categories. This helps the project to provide · Most projects do not report a microfinance com- need-based support to the UPKs, including ponent under the relevant sector code. Not doing support for termination of operations when so makes identification of the rural finance port- necessary. folio a cumbersome process. · Several multi-sector projects are contracting out · One project supports formation and strengthen- implementation of the microfinance compo- ing of community-based organizations that pro- nents. This is a good practice because project vide microfinance services in rural areas, but implementation units of multi-sector projects does not classify this support under a microfi- usually do not have the capacity to implement nance component or subcomponent. Doing so microfinance activities. The Small-scale Com- makes identification of the component and ade- mercial Agriculture Development Project in quately monitoring it difficult. Bosnia and Herzegovina goes one step further · Credit lines or revolving funds need to be and contracts out supervision of the microfi- avoided under budget-support loans. When re- nance organizations supported. quired, these are best provided under investment · Well-functioning industry associations of micro- projects. finance organizations facilitate the development · Two projects have microfinance components that of a robust microfinance sector. The Savings and are too small to make a significant impact or be Credit Sector Strengthening and Rural Microfi- monitored effectively. nance Capacity Building Project, Mexico and · Implementation of microfinance activities are Competitiveness and Enterprise Development best carried out by specialized institutions rather Project, Burkina Faso support such associations. than by project implementation units or local · Appropriately regulated and supervised savings governments. Yet, several projects continue to and credit institutions can have a significant have microfinance components implemented or role in providing financial services in rural areas. supervised by project implementation units or The Mexico Savings and Credit Sector Project local governments. 66 Appendix 1 rura107078_app2.qxd 05/11/2005 09:09 PM Page 67 Appendix 2 Diagnostic matrix: Rural financial sector development--An example from a developing country--Uganda Real sector Political and enabling environment Financial sector Geographical/climatic aspects Macroeconomic and policy Banking sector environment · Shallow banking sector · Macroeconomic stabilization (200,000 persons per since 1987; strong growth during branch; very low ratio of last ten years loans to private sector/ · GoU reduced its participation GDP; dominated by four within the financial sector nearly foreign-owned banks) completely · Some large loans for · Acceptable environment commodity processing firms or large exporters are available · Leasing is available (DFCU, new entrants expected) · Checking, savings and deposit services in rural towns · Some banking services for MFI available Infrastructure/human capital Legal (real economy) Nonbank financial sector · Deficient infrastructure · Strong land tenure problems · Dominated by NGOs, · Unreliable electricity · Lack of possibility to mortgage SACCOs and DFCU, Ltd. · Deficient market land · 4­7 stronger NGOs, up to 5 infrastructure · Poor legal contract enforcement in transformation process · Lack of qualified personnel (especially in rural courts) · Clients: mostly small-scale traders in peri-urban areas · SACCOs: some loan extension to farmers, rural traders (continued) 67 rura107078_app2.qxd 05/11/2005 09:09 PM Page 68 Real sector Political and enabling environment Financial sector Production structure Legal/administrative (financial sector) Trade finance; buyer and · Agriculture still dominant · Adequate regulatory environment supplier credit (80% of workforce) · Adequate access of NGO to · In-kind and suppliers · Around 60,000 farmers and formal financial sector credits for buyers, sellers fishermen operate commer- · Improving supervision and farmers throughout the cially (the basic need is · Minimum deposit requirements production marketing chain term finance, which is not available; leasing,) · Semi-commercial farmers with similar needs as the commercial farmers but on a smaller scale · Subsistence farmers and villagers Availability of support services Information sharing Risk management · A market information service · Access to savings products (Foodnet) sponsored by the in small rural towns avail- government is in place (future able; however: very limited funding insecure) branch network · Information sharing systems are · Hedging possibilities for not in place price risks are not available · Generally: lack of information on investment opportunities Rural finance, relevant GTZ/SIDA financed financial Projects by USAID and donor-financed activities, and sector project with focus on MF; probably GTZ/Kf W are in projects in the real sector implementation of adequate preparation supervisory mechanisms for NBDI 68 Appendix 2 rura107078_end.qxd 5/17/05 12:17 PM Page 69 Endnotes 1World Bank. 2003a. $43.4 million) for Compartamos, a major microfinance 2See for exampleYaron, J. et al., 1997;Yaron, J., 1994; Von institution in Mexico. 11 Pischke, J. D., 1991; and Von Pischke, J. D. et al., 1983. World Bank, 1998. 3 12 World Bank, 2003d. World Bank, 2005a. 4 13 World Bank, 2003a. WorldBank,2005c.SeeAppendix1forthecompletetext. 5 14 For an overview of the role of finance in economic Regulatory environment for cooperative financial development see for example Caprio G. and Honohan P., institutions, for example, is of specific concern to rural 2001 and Hermes, N. et al., 1996. finance, since financial cooperatives and credit unions are 6Butzer, R. et al., 2002. often regulated by bodies outside the general financial 7 sector, often by Departments of Agriculture. Rural finance used to be defined as agricultural finance 15 by donor agencies and governments for much of the See for example Miller, M., 2003; and Maimbo, Samuel period from the 1950s to the 1980s. Donor agencies M., 2003. 16 provided resources for agricultural finance, often through Deininger, Klaus, 2003. subsidized credit lines for state-owned agricultural 17The World Bank's Integrated Development Program for development banks. In the 1950s and 60s, projects tended Irrigated Agriculture in Mauritania supports the expanded to promote the adoption of productivity-increasing and transparent registration of land in order to assist technologies and methods, often following a one-model- farmers to be eligible for long-term investment credit. By fits-all approach. The 1960s and 1970s also saw a trend in the end of the first phase of the project in 2004, approx. development thinking emphasizing industrial over 36,000 hectares have been registered. The project also agricultural development, resulting in increasing biases provided technical assistance and a credit line for against, and deteriorating terms of trade of, the UNACAEM, the National Union of Agricultural and agricultural sector. Given deteriorating agricultural prices, Credit Cooperatives, which is now able to provide short-, subsidized finance was seen as the only means to induce medium- and long-term credit for all agricultural farmers to adopt new technologies. FAO/GTZ, 1998. activities, year-round. For details see World Bank, 2005d. 8Von Pischke, J. D. et al., 1983; Yaron, J. et al., 1997; See also Deininger, Klaus, 2003. Yaron, J., 1994; Gonzales-Vega, C., 1994. 18For example, cooperative financial institutions and credit 9The concurrent decline in agricultural credit programs unions in many countries are not counted as part of the has also led to a decline in available finance for financial sector. agriculture. For example, World Bank lending for 19One can distinguish direct and indirect supervision agriculture in the 1990s represents only one-third of the systems. Direct supervision systems are those where all volume of agricultural lending of the 1980s (FAO/GTZ, supervision tasks are carried out by the agency 1998). This statement is corroborated by the Bank's responsible for the oversight of financial institutions, such "Reaching the Rural Poor" strategy which states that as the central bank. Indirect supervision systems involve "lending for agricultural activities declined dramatically designated agencies, such as specialized government from about 31% in 1979­81 to less than 10% in FY 00 agencies, audit firms or federation networks, in all or and FY01." The largest declines occurred inter alia in the some supervisory tasks. Within the indirect systems, one sector of agricultural credit, because of the shift away can further distinguish auxiliary and delegated from commodity targeted credit. (World Bank, 2003b; supervision. The term auxiliary supervision is usually p. 15) However, rural finance lending started increasing in used to indicate a supervision system where the primary the mid 1990s, after large declines in the 1980s and supervisor, such as the Central Bank, retains most of the early 1990s. (World Bank, 2003c; Appendix 3 Rural sanctioning powers while only using the supervisory agent Finance, p. 28) to undertake routine supervisions­both off-site and 10In July 2004 IFC closed on a 34% Partial Credit on-site. In contrast, the term delegated supervision is used Guarantee to the bond issue of 500 million pesos (approx. to indicate a system where the supervisory agent has 69 rura107078_end.qxd 5/17/05 12:17 PM Page 70 significant powers of sanction also, although the ultimate 27IFC, with its 2001­2002 initiative "How to make small power of closure and liquidation of a financial institution business finance profitable for financial institutions," is retained by the primary supervisor. For more details on initiated an international discussion focused on such an the advantages of the different systems see Kumar, A. approach. In order to tap new markets in an increasingly et al., forthcoming, p. 11ff. competitive environment, financial institutions can expand 20Deposit insurance programs might help in promoting "downwards" to reach smaller businesses and rural savings in rural areas where the confidence of potential enterprises. This requires a shift in emphasis away from clients in formal financial institutions is low. In order to delivering credit to individual clients to providing a full mitigate the moral hazard problem, a deposit insurance package of financial services to mass customers. The new scheme would need to be designed in such a way that approach requires the development of new products and participating financial institutions are screened for the use of new or improved financial information and financial strength, standardized procedures, etc. This communication technologies. Examples include the use would, however, give the participating institutions an of multiple channels for service delivery, such as mobile additional competitive advantage. Schemes can also be phones and mobile branches, as well as the introduction adapted to the type of participating institution. In the USA of credit scoring technologies for managing a large for example, the deposit insurance differs for commercial portfolio (see Box 5 for a brief explanation of scoring). banks or credit unions. See Carter, M. et al., 2004. The IFC has launched two new facilities, the Global 21Cash-flow lending based on household income refers Microfinance Enhancement Facility and the Global SME to credit technologies which tie the repayment schedule Enhancement Facility, which provide credit guarantees to the borrower's expected cash flow from a variety and technical assistance to banks trying to expand into of sources, rather than simply the cash flows from the these sectors. See IFC, 2001. activity financed. This method is being used by 28An example are Ghana's rural banks that in the past microfinance institutions in many countries. For example, functioned essentially as deposit collection institutions. commercial rural banks in the Philippines have adopted As a result of macroeconomic policies, government cash-flow lending through participation in an institution securities were by far the most lucrative investments, building assistance program. See for example Campion, effectively crowding out loans to customers. Therefore, et al., 2003. the banks never had to develop a credit system that 22In 2003, a group of commercial banks agreed to adopt enabled them to service retail and corporate clients. Their the IFC environmental and social safeguards as their most urgent task is now to develop the appropriate credit guidelines for project finance in emerging markets. The technology for different lines of business. guidelines, or Equator principles, include issues of 29See World Bank, 2005b. environmental assessments, natural habitats, involuntary 30World Bank, Forthcoming. resettlement, indigenous people and child labor, and 31World Bank, 2004c. apply to projects above US$ 50 million. As of January 32Yaron, J., 2003. 2005, 28 private banks have adopted the Equator 33See endnote 23 on double bottom line objectives for principles. Critics point out that attempts to set financial institutions. See also CGAP, 2004a. international industry standards are laudable, but that 34 the principles do not include mechanisms for external Seibel, H. D., et al., 2005, show that private providers, monitoring and enforcement. particularly microfinance organizations, could not replace 23 the vast branch network that many agricultural The "double bottom line" refers to business objectives development banks had. Microfinance providers, such as that include social as well as financial objectives. The NGOs, do furthermore often show an urban bias, with "triple bottom line" includes environmental protection. credit technologies adopted to the urban environment, The triple bottom line has been incorporated by many but not necessarily suitable for agricultural finance. The financial institutions, such as the Equator principle banks closures of agricultural development banks particularly (see endnote 22), and has for example led to the in Latin America and West Africa therefore left the publication of annual sustainability reports in addition to rural populations without formal financial services. annual business reports. For a good overview of current A case in point is the Banco Agricola del Peru, which thinking see Bouma, J. et al., 2001. An example for an was closed in 1991, and where no private providers have annual sustainability report can be found at Rabobank's filled the gap. For more details on this case see Vogel, website at http://www.rabobank.com. R. C. et al., 1997. 24The Economist, 2005. 35See for example Adams, D. W. et al., 1984. 25World Bank, 2005a. 36See CGAP, 2004c. 26Valenzuela, L., 2002. 70 Endnotes rura107078_end.qxd 5/17/05 12:17 PM Page 71 37NMB currently does not publish any financial and 55For a detailed discussion see Nair, A. et al., 2004. business data because of its upcoming privatization which 56See Nair, A. et al. Forthcoming. is expected to be completed in mid-2005. However, 57See for example Myer, R. et al., 1996; and Navajas A.R., according to the Parastatal Sector Reform Commission in 2001. Tanzania, the National Microfinance Bank (NMB) was the 58Risk Sharing Facilities for SME Financing, internal IFC largest bank in Tanzania in terms of customer deposits and publication, contact Peer Stein. In July 2004 IFC closed in terms of branch network. As of December 2003, NMB on a 34% Partial Credit Guarantee to the bond issue of comprised four agencies and 104 branches. Its deposits 500 million pesos (approx. US$43.4 million) for stood at approx. US$361 million. DAI has estimated the Compartamos, a major microfinance institution in loan portfolio at US$61 million (see http://www.dai.com Mexico. for details). The ratio of savings to loans thus stood at 59 approx. six to one. See World Bank, 2004c, Module 7, Agricultural Investment Note on Production Credit from Input 38BRI in Indonesia and AgBank of Mongolia have the Suppliers, Processors and Buyers. same experience; see Robinson, M. S., 2001; and 60 Agricultural Bank of Mongolia (undated). van der Meer, K., 2004. and Swinnen, J.F.M., 2005. 61 39GTZ, 2002, and also IFC internal appraisal report Rabo International Advisory Services (RIAS), 2004. 62 of AgBank, 2003 (unpublished). World Bank, Forthcoming a. 40 63 See http://www.khanbank.com and http://www.dai.com/ IFC, 2001. work/practice_detail.php?pid=4 and also CGAP, 2004b. 64For more information see Africap, 2004; and Profund, 41Robinson, M. S. 2001. 2003. 42 65 See World Bank, 2004c; and. Manndorff, H., 2004. CGAP, undated; Frederick, L. I., 2003; Littlefield, E. 43CGAP has established a rating fund that provides partial et al., 2004; Salazar, D. G., 2003; Whelan, S., 2003a, funding for ratings of microfinance institutions. The 2003b, 2003c; and Waterfield, C. 2003. 66 website of the fund http://www.ratingfund.org provides The Commodity Risk Management Group (CRMG) general information on the rating process and rating and provides technical assistance to lenders and other farmer assessment agencies. risk-exposed institutions in developing countries to bridge 44An ESW on cooperative financial institutions is being the gap between supply and demand of market-based prepared by FSE. In addition, in 2004, the World Bank risk management instruments. See http://www.itf- organized a series of conferences on Strengthening of commrisk.org. 67 Cooperative Financial Institutions. These were held in World Bank, Forthcoming a. Washington, DC; Recife, Brazil; and Baku, Azerbaijan. 68Hess, U., 2003. Proceedings of these conferences are available on the 69IFC experience in SME lending. Bank's Rural Finance website. 70Another specialized collateralized financing 45See World Bank, 2004a. arrangement is factoring, whereby an enterprise sells its 46A profile or history of most of these institutions can be accounts receivable to a specialized financial institution. found on their respective websites: For Rabobank, see Factoring is a popular financing mechanism in developed http://www.rabobank.com; for DZ Bank, see countries because the credit risk can be diversified from http://www.dzbank.de; for Raiffeisenbank, see the single credit risk of the original borrower to the credit http://www.vr-networld.de; and Credit Agricole, see risks of multiple customers. In spite of these advantages, http://www.credit-agricole.fr. factoring has rarely been introduced in developing 47Balkenhol, B., 1999. countries and is not of any great relevance in rural 48See World Bank, 2004b. finance. 71 49Arzbach, M., 2004. For further information see Counter, J. et al., 2005. 72 50Arzbach, M., 2004; see also World Bank, 2004b. The rural finance lending volume is an approximation. In most multi-sector projects, such as CDD projects, the 51See Allen, H., 2002. project appraisal documents (PADs) do not provide 52http://www.ruralfinance.org. costs for sub-components with rural finance lending 53Rosenberg, R., 2004. activities. In finance sector projects, the PADs do 54See FAO/ GTZ, 1998. "Financing Longer-Term disaggregate the project clientele by their geographic Investments in Agriculture" is the title of the ongoing location. Hence, the volume was arrived at through FAO/GTZ research project that publishes the AFR series. discussion with task managers. The following Details are available at http://www.FAO.org. methodology was used for estimating RF lending volume. Endnotes 71 rura107078_end.qxd 5/17/05 12:17 PM Page 72 · When the project is an exclusively rural finance project, regimes (land titling), restructure the banking system, and the WB share in total project cost is taken as the RF provide grant funds for income generating activities--are amount. not included. Some state-bank privatization/restructuring · When only a component is for rural finance, WB share projects might have implications for rural finance if the in the component costs was estimated using the WB state-banks concerned had significant rural lending. This share in total project cost. is often not obvious from the PADs. Policy measures such · When no separation of rural finance component is made as creation/reform of deposit insurance and credit bureaus but a portion of project beneficiaries are located in rural supported by some projects can have positive implications areas, the share of such beneficiaries was used to for rural finance in the long run. estimate the RF amount. 76Includes agricultural finance, microfinance and SME · In projects where ex-ante estimate of rural/urban projects with a rural focus. beneficiary distribution is not possible or the project is 77When the project is an exclusively rural finance project, of a budget support nature--multi-sector adjustment the share of IDA/IBRD in the whole project is taken as loans and PRSCs, the projects are identified but the portfolio. When only a component is for rural portfolio amount devoted to rural finance is not finance, the share of the IDA/IBRD component in the estimated. whole project is used to estimate the IDA/IBRD share in 73The US$506 million Rural Finance Sector Adjustment the component. When no separation of rural finance Loan. component is made but a portion of project beneficiaries 74The first phase of this project, the Savings and Credit are located in rural areas, the share of such beneficiaries Sector Strengthening and Rural Microfinance Capacity was used to estimate the rural finance IDA/IBRD portfolio Building Project, was among the most well-designed amount. In the case of projects where such estimation is not rural finance projects approved in FY2003. possible (ex-ante estimate of rural/urban beneficiary 75Only projects that have a direct impact on rural finance allocation is not possible or the project is of a budget are included. These are defined as investment projects or support nature--multi-sector adjustment loans and budget support projects that included activities aimed at PRSCs), the projects are identified but portfolio amount creating an enabling environment for financial services, devoted to rural finance is not estimated. 78 supporting financial service provision, development of However, it is not possible to say if this indicates low market facilitating institutions, or development of viable financing for agriculture since the credit going to the proposals in rural areas. Projects that could have an agriculture sector from general microfinance and indirect impact--projects that improve property right enterprise finance is not known ex-ante. 72 Endnotes rura107078_bib.qxd 5/17/05 1:10 PM Page 73 Bibliography ACCION International. 2004. http://www.accion. Buchenau, Juan and Andrés Hidalgo. 2003. "Servicios org/about_where_we_work_program.asp_Q_T_E_17. 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