Rural Banks

International experience in the microfinance field emphasizes the need for credit programs to move to higher levels of self-sufficiency, essentially to become banks. However, in the meantime most of them are limited in scale and in financial terms their clients are small in scale. The credit needs of many farms, even those in the small- to medium-size range, usually exceed the lending limits or capabilities of most microfinance institutions. In this regard, millions of farms find themselves in the same situation that growing non-farm micro-

enterprises are in, i.e. of being too large to be clients of these institutions and yet too small to borrow from commercial banks:

Too big for credit programs that provide only short-term working capital, yet still too small to meet the minimum loan amounts or collateral requirements of formal financial institutions, these enterprises find their growth curtailed by lack of credit available in amounts and terms that meet their expanding needs. Growing microenterprises find that 'their success has made them too steep a risk for both the informal and formal finance sectors. They are lost in the gray area, a true structural gap in which thriving businesses stagnate, their potential for generating further income and employment curtailed'.107

In many countries, the credit requirements of farmers have become even more urgent as State-owned agricultural development banks have been closed. As useful as the growing microfinance movement is for meeting the financial needs of many rural families, it does not represent a complete solution for financing agricultural development. A more complete response to this need can be developed by complementing the microfinance approach with the creation of private banks that emphasize lending to agriculture. A few examples exist - Bancafé and Banco del Occidente in Honduras and the Banco Ganadero in Colombia may be mentioned - but they are not very numerous. As noted earlier, no commercial bank can afford to specialize entirely in agricultural lending, owing to its greater riskiness, but it is possible to devote a significantly larger share of the portfolio to agriculture than most commercial banks do.

For a bank to emphasize agricultural operations and still be viable it needs to be large enough to cover geographically dispersed areas, in order

107. H. P. Martinez, 'The gray area in microenterprise development', Grassroots Development, 14(2), 1990, p. 33, cited in Larry R. Reed and David R. Befus, 'Transformation Lending: Helping Microenterprises Become Small Businesses', in M. Otero and E. Rhyne (Eds), 1994, p. 185.

to reduce covariant risk. Other requirements include:108

• Implementation of a policy of flexible interest rates, so that the higher risk in agricultural lending can be offset by higher interest margins. In the same spirit, link interest rates to a farmer's credit history.

• Adoption of some of the techniques of microfinance institutions for selecting clients and creating incentives for repayment. The formation of groups of farmers, making them jointly responsible for repayments, or making lending to some depend on the prior repayment record of others. Even more applicable for the case of agriculture may be a policy of progressive lending, explicitly making eligibility for future loans dependent on the timeliness of repayment of the present one.

• Decentralization of loan decision-making as much as possible to rural branches, even forming loan committees composed of local citizens, to take advantage of local knowledge of production conditions and clients.

• Development of modern information systems so that loan officers can follow up with clients if loan payments are even a day late.

• Consideration of innovative forms of collateral, such as antichresis and movable property, as mentioned above.

• Improvement of staff training and provision of incentives to loan officers for good client selection and loan recovery rates.

• Provision of additional basic financial services to the rural population.

In addition to efforts to encourage better lending practices for agriculture, it is becoming apparent that an appropriate regulatory framework is needed for agricultural finance, and not only for microfinance, as suggested by the observations of Michael Fiebig cited in Section 7.4 above. This issue is discussed further in the concluding section of this chapter.

In most cases, it is not realistic to expect to persuade existing commercial banks to take on greater volumes of agricultural lending, in place of their relatively more secure investments in urban properties and government bonds. An alternative is to create separate, agriculturally oriented banks, but the initial capital requirements for the formation of a bank may be daunting for even a large group of interested farmers. Both Bancafe and the Banco Ganadero were transformed from government institutions into private ones. In the case of the latter, some of the shares were purchased by Colombian ranchers over a period of many years via a special levy on livestock herds.

Another alternative would be to seek external sources of funding in order to found such institutions and begin operations, as most of the microfinance programs have done, with an agreement that share capital would be purchased over time by local farmers and other private domestic investors. In such a case, the path followed to self-sufficiency could be very similar to that followed by those programs. The difference is that the clientele would be of varying sizes, in financial terms, and the average loan size would be larger than is the case for the microfinance programs. Another difference would be relatively greater emphasis on agricultural lending.

Additionally, rural microfinance institutions can expand their operations through alliances with existing banks:

Another alternative to special licensing of MFIs is to have unlicensed MFIs take advantage of someone else's license. NGO MFIs have teamed up with existing banks or credit unions, in effect using the latter institution's license to increase services to the NGO's target clientele. The NGO Freedom from Hunger has such arrangements with financial cooperatives or rural banks in Burkina Faso, Ghana, Mali, Madagascar, and the Philippines.

108. See B. Klein, R. L. Meyer, A. Hannig, J. Burnett and M. Fiebig (1999) for a very useful discussion of recommended practices for agricultural lending.

. . . There is room for a lot of creativity in structuring a bank/NGO relationship, including some options that could preserve the NGO's control over the lending, including methodology, loan sizes/terms, and the choice of clients.109

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