For government financial intermediaries, management considerations begin with the essential requirement of autonomy. Government interference in the operations of these intermediaries, for political reasons and in the name of advancing social objectives, has caused huge difficulties in

122. Ibid.

123. Several of these options are adapted from FAO, 2001.

124. This section provides a brief review of management issues. For the reader interested in more detail on setting up and managing microfinance institutions in particular, very useful references are B. Klein, et al. (1999), J. Ledgerwood (1999) and Robert Peck Christen, Banking Services for the Poor: Managing for Financial Success, Accion International, Somerset, MA, USA, and Washington, DC, USA, February 1997.

their operations and has made them unsustainable. Yaron et al. state the case clearly:

The financial performance of virtually all government-owned rural financial institutions has usually been extremely poor. Most rural financial institutions have remained highly subsidy-dependent. In India arrears as a proportion of amounts due and overdue hover at around 50 percent in most states. The recovery rate of Mexico's BANRURAL was around 25 percent in the late 1980s (ignoring recoveries from the loss-making national agricultural insurance company). Recoveries for the Small-Scale Agricultural Credit Agency in Malawi plummeted from almost 90 percent during the most recent elections; the agency was subsequently declared insolvent. Inflation eroded the real value of the equity of government-owed rural financial institutions throughout Latin America during the 1980s because of poor loan collection and agricultural on-lending rates that failed to keep pace with inflation.

The economic cost of this dismal performance has been enormous and has often put macroeconomic stability at risk. For example, agricultural credit subsidies totaled 2.2 percent of Brazil's GDP in 1980, and 1.7 percent of Mexico's GDP in 1986 In several cases, the subsidies could not even be measured because of poor accounting practices. .. .

The reason for the poor performance is evident: the interventions invariably have been, and generally still are, characterized by a lack of managerial autonomy for the rural financial institutions and by poor operating procedures.125

As a result of these problems, most government-owned rural financial institutions are playing a much smaller role in the sector than they were in the 1970s. There are a few exceptions. They are those government institutions that have attained the greatest degree of operational autonomy, such as the Bada Kredit Kecamatan (BKK) and the Bank Rakyat Indonesia (BRI) in Indonesia and the Bank for Agriculture and Agricultural Co-operatives (BAAC) in Thailand.

7.6.2 Interest Rates and Lending Policies

Interest rate policies have been discussed throughout this chapter. Suffice it to say here that the management of rural financial institutions should follow a flexible, market-oriented interest rate policy and not attempt to subsidize rates for borrowers. Excessively high rates bring with them the danger of adverse selection of clients, as mentioned previously, but lending rates should be high enough to cover deposit rates plus intermediation margins (including profits), and modest provisioning in the form of a risk reserve, especially at the beginning of operations. Establishing the most appropriate set of rates may take time, depending on the results of pilot efforts in savings mobilization. After the introduction of savings deposits in an institution:

interest rates on loans may have to be changed to ensure that the spread between interest rates for loans and deposits is sufficient to cover all costs and return a profit. . .. adjusting the interest rates requires some experimentation.126


Microenterprise programs can charge much more than formal financial institutions and still underprice informal-sector alternatives. Moreover, studies have shown that microenterprise borrowers are far more sensitive to the availability and convenience of credit than to the

125. J. Yaron, M. P. Benjamin and G. L. Piprek, 1997, pp. 25-26 [emphasis added].

126. Joyita Mukherjee, 'Introducing Savings in Microcredit Institutions: When and How?', Focus, Note No. 8, The Consultative Group to Assist the Poorest, Washington, DC, USA, April 1997, pp. 2-3. [This note is a synopsis of Marguerite S. Robinson, 'Introducing Savings Mobilization in Microfinance Programs: When and How?', Harvard Institute for International Development, Cambridge, MA, USA, 1995 or 1996.]

interest rate (Christen, 1989127). The nonfinan-cial transaction costs borrowers normally face dwarf interest costs.128

Innovative lending policies have permitted the authorization of unsecured loans. They include criteria for borrower eligibility, incentives for repayment and techniques of monitoring borrower behavior. These new policies represent responses to the three basic problems faced by lenders in rural credit markets, as described in Section 7.1 above: screening potential borrowers, providing incentives for compliance with the conditions of the loans, and enforcing repayment obligations.

Group lending is at the heart of the new lending techniques. In part, this approach is designed to overcome the common problem of asymmetric information between lenders and borrowers, for screening potential clients, but it also deals with the problems of incentives and enforcement. 'If clients have better information about each other's investments than the lender has about them, and the clients can engage in cooperative behavior, [then] interlinked contracts based on mutual guarantees can result in better loan terms for the clients with no reduction in expected income for the lenders. This is so because the co-guarantees can lead to higher effort levels and lower default rates on loans'.129

The Grameen Bank of Bangladesh pioneered a scheme in which borrowers are asked to form groups of five persons, each of whom will guarantee the loans of all of the others in the group. In the first stage, loans are made only to two of the five, and extending loans to others in the group depends on the performance of the first two borrowers. A similar approach was developed even earlier in Mexico for small-scale rural credit programs, under the name of grupos solidarios. An extreme case of the approach of mutual lia bility is found in Albania, where 'if a borrower fails to repay a loan, the line of credit to the borrower's entire village may be suspended'.130

Among other distinctive features, these group approaches may be considered to substitute social collateral, or peer monitoring, for more tangible forms of collateral. There are two alternative ways to implement this concept:

The two most common means of providing group accountability are (a) joint and several liability and (b) limited liability. Joint and several liability encourages extremely careful selection of members because any member can be held liable for the defaults of others. It may, however, deter the comparatively wealthy from joining the group, since they have more to lose. In rural Zimbabwe, schemes based on joint and several liability worked well in times of average production but fared worse than other schemes in the same area in times of drought and low production. The threat of default led farmers to withhold repayment and hope for a general amnesty, since they would be, in any event, accountable for other members' debts.

Group lending schemes based on limited liability are more common. In Malawi and Nepal borrowers are required to put part of their loans in a fund that would be forfeited if any member defaulted. If all members repay their loans, these deposits are returned. This practice has resulted in a good record of repayment. In Malawi, where 10 percent of loans was held as security, 97 percent of seasonal credit disbursed between 1969 and 1985 was recovered. In Nepal's Small Farmer Development Program, which required security deposits of 5 percent, the repayment rate in 1984 was 88 percent. These rates compare favorably with other small-borrower credit programs.131

127. Robert Peck Christen, 'What Microenterprise Credit Programs Can Learn from Moneylenders', Discussion Paper Series No. 4, Accion International, Cambridge, MA, USA, 1989.

129. J. Yaron, M. P. Benjamin and G. L. Piprek, 1997, p. 78.

The Grameen Bank's approach to group lending is somewhat different:

The bank's customers, who are restricted to the very poor, are organized into five-person groups, and each group member must establish a regular pattern of weekly saving before seeking a loan. The first two borrowers in a group must make several regular weekly payments on their loans before other group members can borrow.. . . the Grameen Bank has experienced excellent loan recovery. As of February 1987 about 97 percent of loans had been recovered within one year after disbursement and almost 99 percent within two


A cautionary note is in order about the degree of local participation in the way in which the schemes are organized:

Groups often have been created at the initiative of governments or private development agencies. This top-down approach means that a scheme can be extended rapidly, but it may undercut the force of local sanction (ibid.).

The Juhudi Credit Scheme in Kenya organizes clients into associations of thirty members known as KIWAs. 'Savings begin before lending. After eight weeks of uninterrupted savings by each KIWA, eighteen members qualify for loans. The remaining twelve members in the KIWA qualify for loans after the first eighteen repay at least four installments without fail, and all KIWA members continue contributing toward the group savings fund without interruption. Once members repay current loans, they qualify for repeat loans, provided the other KIWA members continue to meet their obligations'.133

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