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close this bookRural Finance and Poverty Alleviation - Food Policy Report (IFPRI, 1998, 32 p.)
View the document(introduction...)
View the documentPreface
View the documentIntroduction
View the documentClient Profile
View the documentCommitting Public Resources to Rural Finance
View the documentInformal Markets: What Lessons Can We Learn from Them?
View the documentPublic Policy: Supporting Institutional Innovation
View the documentConclusions
View the documentNotes

Public Policy: Supporting Institutional Innovation

To reach the majority of the poor, institutional innovations are needed that enable services to be expanded, while substantially reducing the transaction costs for both the financial institutions and the clients. Long-term support of institutional innovations in the rural financial sector may be the most promising direction for public policy to take. Both governments and donors must encourage institutional innovation and development, not micromanage banks and other organizations, or initiate short-term projects that have no bearing on institution building.

The Institutional Framework

In general, transaction costs can be brought down by improving infrastructure such as roads, schools, and communications; by titling property so that it can serve as collateral; or by improving institutions.33 While infrastructure development and land titling may prove politically or economically feasible only in the long run, institutional innovations can be fostered through public action, through the concerted efforts of donors, governments, nongovernmental organizations, communities, and households.

Successful outreach requires institutional innovations that reduce the risks and costs associated with lending and depositing small amounts of money. Many of the transaction costs arise from the need to acquire information about the market partner. Obtaining such information for small loans can be prohibitively costly if the bank agent is asked to do this. Traditional banking techniques, such as judging the loan application based on written information, are either not feasible because of illiteracy or too costly to administer. Yet, information about the creditworthiness of a loan applicant is readily available within the local community through neighbors and other peers.34 Such information can be obtained at less cost if networks or institutions are based at the community level.

While there are several different forms that institutional innovations in rural finance can take, all of the innovations build on locally available information and exploit the cost advantage of informal monitoring and enforcement systems. Within such systems, the functions of information acquisition and monitoring and enforcement of financial contracts are largely transferred from the bank to a group of borrowers and savers. The group members share a common interest in gaining access to credit and savings services, and they also possess enough low-cost information to adequately screen each other and apply sanctions to those who do not comply with the rules. The major difference between traditional and innovative banking for the poor is that in traditional banking, the agent of a rural bank branch directly negotiates savings or loan contracts between the retail banking institution and the individual. In innovative approaches, on the other hand, a local institution mediates between the bank and the individual and assumes many of the screening, monitoring, and enforcement functions that are too difficult or too costly to be executed by a bank agent.

Yet, differences in culture and socioeconomic systems do not allow for institutional blueprints. While the principle of harnessing locally available information and sanctioning and enforcement mechanisms is central to institutional innovations in rural finance, the practical challenge lies in finding how best to build and adapt these local community- and member-based institutions and to link them with other institutions in the formal banking system. So far, most institutional innovations in microfinance have been generated by NGOs that do not have commercial profit as their principal objective. By taking fresh approaches, these new microfinance institutions have penetrated rural financial markets and serviced an underclass of borrowers in a way that was unimaginable some 20 years ago.

In 1988, IFPRI published one of the most detailed studies then available of the innovations in group-based banking introduced by the Grameen Bank of Bangladesh, which has provided credit to 2.1 million women in 36,000 villages. Since then, IFPRI has examined the experiences of other institutions, including member-owned village banks in Madagascar; other large-scale, group-based credit programs in Bangladesh and Malawi; and savings and credit cooperatives in Cameroon. Table 3 outlines some of the more important features of these institutions. Some key common characteristics have been instrumental to the success of most of these programs, and lessons for new program designs can be derived from them:35

· Savings arrangements are a prominent part of sustainable financial programs for the poor. All of the innovative rural finance institutions in Table 3 have some type of savings scheme. Savings schemes must take into account that clients, especially the poorer ones, are motivated to save, among other reasons, as a precaution against future risks. Therefore, it is important that products be differentiated with respect to maturity, liquidity, and return to reflect this concern.

· Group approaches have shown clear potential for reaching poorer participants of financial markets, who either do not possess suitable collateral or who cannot provide such collateral at reasonable transaction costs for the lender. Most schemes make members jointly liable for the repayment of loans and give subsequent credit only if the group has fully repaid. The threat of losing access to future credit exerts pressure on members to perform various tasks, including screening of loan applicants, monitoring the individual borrowers, and enforcing repayment of their peers’ loans.

· Demand-oriented financial services are essential for wide outreach. The scope of lending services offered to rural households must address not only production- and income-generating activities but also consumption needs such as health, education, and social obligations. Rural financial institutions should also be able to put in place innovative refinancing and repayment procedures that are flexible enough to accommodate unanticipated events affecting a household. This may require unbureaucratic access to emergency loans or the buildup of emergency funds by member-based financial institutions, which could possibly be pooled through a regional or national second-tier institution.

Table 3 - Structure of innovative rural financial institutions for the poor: Some examples from Africa and Asia

Institution

Percent of female members

Minimum balance/membership fee

Type of collateral requirement

Subsidization

Covering administrative costs

Percent of loan recovery

Length of operation

Growth (number of members)








(years)


Nonbank rural financial institutions

Bangladesh Rural Advancement Committee (BRAC)

80

Membership in a group. Regular savings requirement

Group liability, fraction of loan must be deposited as savings

Yes, but moderate. Many donors

Yes

95 to 100, over the years

26

121,000
707,000 (1992)
Over 1 million (1998)

Association for Social Advancement (ASA), Bangladesh

96 (1997)

Same as BRAC

Same as BRAC

Yes, in new donor-supported branches

Yes

99.9 (1997)

20

800,000 (1997)

Cooperative Credit Union League (CamCCUL), Cameroon

25

One membership share mandatory

Savings deposit with leverage 1:5, peer pressure

Yes, technical assistance

Yes

74 (1991)

20

50,000 (1983)
72,000 (1989)

Mutual Assistance Credit Groups (MCAGs), China

Household is member

Admission fee ($2 to $20) or equivalent in grain

Savings with leverage 1:4, social capital as collateral substitute

Yes, state and relief funds

Covered mostly by members

n.a.

Since 1992

About 170,000 MCAGs nationwide (1995)

Rural Credit Cooperatives (RCC), China

n.a.

Must buy shares

Savings, social capital as collateral substitute

Yes, state funds

Covered mostly by members

85 (1994)

Since late 1950s. Separated from Agricultural Development Bank in 1994

RCC located in 96 percent of counties

Mutual credit and savings groups (CECAM), Madagascar

About 10

Yes, 1-5 times the daily wage (decided by members themselves)

Savings deposits with leverage 1:10/social capital

Yes, by international donors

Covered mostly by members

Above 90

8

Started 1990. 7,200 members in 90 villages (1997)

Member-Managed Village Banks (AECA) in Madagascar (also in Cameroon, Mali, The Gambia)

About 30

Yes, decided by members

Member/village solidarity. Various loan sizes in relation to savings deposit applied (varies with village bank)

Yes, technical assistance (by French NGO)

Covered by members

Close to 100

7

Started 1991. 1,830 members in 38 village banks (1997)

Village Development Funds, Segou, Mali

n.a.

No

Village savings fund for lending, leverage 1:10

Establishment assistance by BNDA

n.a., but financial success

100 (1988)

Start 1984

85 villages (1988)

Malawi Mudzi Fund (MMF)/Rural Finance Company (MRFC), Malawi

n.a.

No, but opportunity costs of time for group training/formation

Savings with leverage ratio 1:10. Social capital as collateral substitute

Yes

No

More than 90; during 1990s, below 90%

12

About 5,000

Promotion of Micro-entreprises for Rural Women (PMERW), Credit Program, Malawi

100

No, but must save and be trained before any credit is given

Savings, loan sizes fixed. Social capital as collateral substitute

Yes, technical assistance and credit guarantee for commercial bank

No (subsidized)

More than 90 (1995)

4

600 (1996)

Banking institutions (serving poor clientele)

Grameen Bank, Bangladesh

90

Membership in a group. Regular savings payment

Savings/loans extended to groups under joint liability, fixed loan sizes

Yes, moderate, through grants and low-interest loans from donors

Yes, in old branches, but not in new ones

98 (1995)

First branch office in 1978

58,000 (1985)
250,000 (1986)
660,000 (1990)
2.07 million in 1,055 branches (1995)

Bankya Rakyat Indonesia unit network (BRI-UD)

About 25

No

Physical guarantee (land, vehicle, savings), therefore do not reach the poorest

No (Subsidy Dependency Index - 40%, i.e. BRI makes profit)

Yes

More than 95

Founded in 1970 (to expand Green Revolution) between 1970-84 highly subsidized

Reorganized since 1984, 16.2 million depositors and 2.5 million borrowers in 3,512 units

Note: n.a. means not available