The Nature of the Problem

The antiquity of agricultural lending practices cannot be doubted. The second book of the Bible provided rules related to loans in kind: 'When a

Agricultural Development Policy Concepts and Experiences. R. D. Norton

© 2004 Food and Agriculture Organization of the United Nations

ISBNs: 0-470-85778-1 (HB) 0-470-85779-X (PB) FAO Edition: 92-5-104875-4

man borrows a beast from his neighbor and it is injured or dies while its owner is not with it, the borrower shall make full restitution' (Exodus 22:14). The cuneiform texts of the early Sumeri-ans described the penalties associated with default on loans: 'Landless peasants .. . sometimes sold themselves as slaves simply for meals and a place to sleep. ... A man in desperate financial straits might turn over his entire family - himself included - to a creditor for an agreed-upon time in satisfaction of his debts'.1

While the early rules had to do with financial transactions between individuals, governments eventually came to be concerned about agricultural credit as a matter of policy. Ensuring that farmers receive sufficient credit has been taken as a serious challenge by virtually all governments in our era. The extent of policy influence on credit differs by country, but every government in the world has intervened in the rural financial sector.2 Governments in the developing world have justified their measures by the perception of inadequate volumes of commercial bank lending to agriculture, and of excessive interest rates and limited amounts of loanable funds in the informal credit market.

For many decades now, those interventions in credit markets have tended to be direct, usually taking the form of directed allocations of loans, subsidized interest rates and State ownership of banks. 'In the later 1970s, for example, the central bank in Indonesia administered nearly 200 directed credit lines, many of which were aimed at agricultural activities, and most of which were subsidized In Thailand . .. during the 1970s and 1980s the government required all banks to lend an increasing percentage of their total loan portfolio to farmers'. In addition 'in several countries such as the Philippines, major segments of the rural financial system were attached to crop production programs. In other countries such as

Egypt and Brazil large subsidized credit efforts were justified on the basis of compensating farmers for other . .. distortions in the economy, such as food price controls or over-valued foreign exchange rates'.3

Enough experience with such interventions has been accumulated that the results are now in: they have failed to meet their objectives and have become an unsustainable fiscal burden. As a result, the real amount of formal credit available to agriculture has declined in the last two decades in most regions of the developing world. How to satisfy the credit needs of a growing agriculture in a viable way has therefore become a central issue of agricultural development policy. The crisis in the traditional approach was well articulated by Jacob Yaron:

Generally, the past performance of State- or donor-sponsored rural finance operations has fallen substantially short of expectations. Many of the institutions established or supported primarily for delivering credit programs have not developed into self-sustained rural finance institutions. The programs have reached a minority of the rural population, often resulting in benefits in the form of negative [real] on-lending interest rates which become an unintended 'grant element,' captured by wealthy and influential farmers. The maintenance and continued operation of many of the credit programs has turned into an extremely costly drain on government budgets. . . . Administrative interventions have retarded the promotion of efficient financial markets and have had an adverse impact on the development of other sectors of the economy, mainly by depriving them of loanable funds and increasing their borrowing costs. Many of the large rural financial institutions have been associated with heavy losses generated by either

1. The Age of God-Kings, Time-Life Books, Alexandria, VA, USA, 1987, p. 27.

2. J. Yaron, M. P. Benjamin, Jr and G. L. Piprek, Rural Finance: Issues, Design and Best Practices, Environmentally and Socially Sustainable Development Studies and Monographs Series, No. 14, The World Bank, Washington, DC, USA, 1997, p. 20.

3. Elizabeth Coffey, Agricultural Finance: Getting the Policies Right, Agricultural Finance Revisited No. 2, FAO and GTZ, Rome, June 1998, pp. 2-4.

inadequate indexation in a highly inflationary environment (Brazil, Mexico) or by dismal loan collection in a stable economy (India and Bangladesh).4

State-owned agricultural banks that masked their administrative shortcomings with repeated infusions of capital from the government budget have found that they can no longer count on funds from the national treasury indefinitely. Throughout the world, many of them have closed or scaled down their operations drastically. The closure of these banks has stranded large numbers of small- and medium-scale producers without access to institutional credit, even though many of them had solid credit histories. The loss of these financial relationships and the associated information which had accumulated over time represents a loss to the economy.5

At the other end of the spectrum, large numbers of small rural credit organizations that depended on donor funding have folded as the programs that sustained them came to an end. These difficulties experienced by agricultural credit institutions have given rise to a search for approaches that will be sustainable as well as ensuring that sufficient volumes of credit are available:

ongoing market reform and privatization have not yet produced appreciable improvements in the provision of agricultural support services. Nor have they increased farming profitability. If anything, small farmers often have less access to rural banking and institutional agricultural lending facilities than before. A major reason is the absence of an adequate rural and agricultural finance policy framework.6

A considerable amount has been learned in recent years about how to make small-scale financial institutions sustainable, and the number of successful microfinance organizations has increased rapidly. These institutions are responding to part of the need for production credit in agriculture, but their contribution in that regard remains small in comparison with the needs. The following is one of many commentaries along these lines:

In view of the difficult experience with agricultural credit, development aid shifted towards supporting microfinance institutions (MFIs). These institutions predominantly grant small and short-term loans to marginal clients. .. . However, it becomes evident that microfinance institutions mostly focus on urban and periurban areas. In addition, they predominantly grant loans for non-agricultural purposes such as trading activities. Thus the financing requirements for on-farm production of small farm households remain largely unsatisfied.7

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