Financial Services in Rural Areas

Under the traditional policy conception, the only role of credit in agriculture was to increase output. Credit was viewed as a production input, one that is necessary in order to acquire other inputs, and it was thought it had to originate largely from outside the sector. The need for financial services for poor rural families was ignored.19 In light of the widespread failure of programs of directed credit in agriculture, that view is being abandoned in favor of a broader vision of the role of financial services in rural areas.

The principal orientation in rural finance reform is shifting away from a sole emphasis on the channeling of production credit to agriculture to one of strengthening rural financial intermediation in general. In addition to the above-mentioned financial services required by rural households, Dale Adams has commented on the need for mechanisms of financial transfers (for example, for sending payments to a child studying in a city and for receiving remittances), for long-term finance for fixed investments, and for mechanisms for more efficient allocation of investment funds among competing alternatives. Within rural areas there are opportunities for reallocating funds from households that save to those that invest.

Stuart Rutherford has observed recently that:

Financial services allow people to reallocate expenditure across time. This means simply that if you don't have the ability to pay for things now, out of current income, you can pay for them out of past income or future income, or some combination of both .. . The poor need [this facility] no less than other groups of people. Indeed, they may need it more. This is not just because their incomes are uncertain and irregular (which is often true), but because the absolute amounts of cash they deal with are very small. As a result, anything more than the tiniest expenditures will require sums of money greater than they have with them at the time____20

From the viewpoint of rural financial intermediaries, an institution that can provide a variety of needed services will have additional sources of fee income, and it can earn greater loyalty from its clientele, thereby increasing the possibilities for a high rate of loan recovery.

18. Maria Otero and Elisabeth Rhyne, 'Introduction', in M. Otero and E. Rhyne (Eds), 1994, pp. 4-5.

19. Manfred Zeller, Gertrud Schreider, Joachim von Braun and Franz Heidhues, Rural Finance for Food Security for the Poor, Food Policy Review 4, International Food Policy Research Institute, Washington, DC, USA, 1997, p. 1.

20. Stuart Rutherford, 'Raising the Curtain on the "Microfinancial Services Era"', Focus, Note No. 15, Consultative Group to Assist the Poorest (CGAP), Washington, DC, USA, May 2000, pp. 3-4.

The gamut of institutions that provide loans and some of these other financial services is wide, including commercial banks, investment banks, credit unions or co-operatives, small rotating savings and credit associations (ROSCAs), NGOs, input suppliers, agroproces-sors and marketing agents, retail businesses, friends and neighbors and moneylenders, among others.21 On the basis of studies in five Asian countries, the World Bank has underscored the diversity of the informal financial sector and its importance and operational advantages, pointing out that professional moneylenders account for only a small proportional of total informal credit.22

Additional testimony to the cost-effectiveness and sustainability of informal, indigenous financial institutions is found in a landmark study of monetary and banking policy in developing countries by Maxwell J. Fry:

[There are] four characteristics that explain why indigenous banks exhibit lower transaction costs than modern banks. First, indigenous bankers know their clients better than commercial banks. This reduces information costs. Second, administrative costs are lower for indigenous banks than for modern banks because their employees are paid less (and are less educated), the establishment is less elaborate, and the paperwork simpler. . .. Third, indigenous bank interest rates are not regulated and can therefore adjust fully to market forces. Nonprice competition [for loans] is thereby kept down to an optimum level. Fourth, indigenous banks are not subject to the reserve requirements that are imposed on modern banks.23

Informal credit can be productive as well:

In the broadest, albeit necessarily incomplete, survey of indigenous financial institutions in developing countries, Wai (1977, p. 301)24 reports that 55-60 percent of the demand for noninstitutional credit is for purely productive purposes, a finding that differs from the commonly held belief that high-interest informal lending is invariably used to finance consumption expenditure.25

Some of the informal financial institutions are not capable of taking deposits or offering transfer services over long distances. In addition, their lending practices are based more on knowledge of borrowers than on collateral, a characteristic that restricts their scope for expansion at the same time that it improves their effectiveness in managing risk.

Nevertheless, these institutions clearly are vital to the agricultural sector and to microenterprise in general. An appropriate policy framework for the rural financial sector must reach beyond banking institutions per se and facilitate the participation of many kinds of agents.

21. A more extensive list of both formal and informal financial institutions is found in Richard L. Meyer and Geetha Nagarajan, An Assessment of the Role of Informal Finance in the Development Process', in G. H. Peters and B. F. Stanton (Eds), Sustainable Agricultural Development: The Role of International Cooperation, Proceedings of the 21st International Conference of Agricultural Economists, Tokyo, 1991, Dartmouth Publishing Company, Aldershot, UK, 1992, p. 646. See also the comprehensive treatment in Joanna Ledgerwood, Microfinance Handbook: An Institutional and Financial Perspective, The World Bank, Washington, DC, USA, 1999.

23. Maxwell J. Fry, Money, Interest and Banking in Economic Development, 2nd Edn, The Johns Hopkins University Press, Baltimore, MD, USA, 1995, p. 346. In this case, Fry cites work by Thomas A. Timberg and C. V. Aiyar, 'Informal credit markets in India', Economic Development and Cultural Change, 33(1), October 1984, pp. 43-59.

24. U Tun Wai, 'A Revisit to Interest Rates Outside the Organized Money Markets of Underdeveloped Countries', Banca Nazionale del Lavoro Quarterly Review, No. 122, September, 1977, pp. 291-312.

Sometimes the potential for non-financial institutions to provide loans to farmers is inhibited by the existing regulatory framework:

. . . dealers in feed, fertilizer, insecticides and machinery. . . . often. . . are willing to extend credit without collateral. However, because they lack the deposit base of banks, they must be able to borrow themselves in order to offer credit. In a well-functioning system of secured transactions, such credit sellers could use their inventories and accounts receivable to secure loans from the formal sector to extend more credit. But herbicide dealers in Bulgaria, equipment dealers in Uruguay and Argentina, and insecticide andfer-tilizer dealers in Bangladesh have all reported that they have been unable to do so. The absence of a good framework for secured transactions can break any possible link between rural supplier credits and urban formal sector lending.

In this way defects in the secured transactions system reduce the availability of credit to those who borrow in small amounts or who cannot provide land as collateral ( from J. Yaron, M. P. Benjamin and G. L. Piprek, 1997, p. 57).

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