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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

Introduction

The myth that poor households in developing countries, who often earn less than a dollar a day, are not creditworthy or able to save has been firmly put to rest in recent years. Poor households, it has been found, place special value on reliable and continued access to different types of financial services, available at reasonable cost and catering to their specific needs. Credit and savings facilities can help poor rural households manage and often augment their otherwise meager resources and acquire adequate food and other basic necessities for their families. Credit facilities enable them to tap financial resources beyond their own and take advantage of potentially profitable investment opportunities. Well-managed savings facilities provide incentives for households to build up funds for investment or future consumption. Credit and savings facilities enable farmers to invest in land improvements or agricultural technology such as high-yielding seeds and mineral fertilizers that increase incomes (while sustaining the natural resource base). For rural households who do not own land, credit and savings facilities can help establish or expand family enterprises, potentially making the difference between grinding poverty and an economically secure life. Short-term borrowing or savings are often used to maintain consumption of basic necessities when household incomes decline temporarily - after a bad harvest or between agricultural seasons, for example.

The task of providing financial services at a reasonable cost to those who have limited assets has not been easy, however. Until the 1980s in many developing countries, state-run agricultural development banks took the lead in establishing formal credit markets in rural areas. However, the shortcomings of the banking principles that they were based on - collateralized lending, an organizational setup without any incentives to do business with the poor, excessive dependence on government funding, and pervasive political patronage - severely handicapped their performance. The provision of savings services was also largely neglected because the importance of providing deposit services to the poor was not appreciated and because donor finance was available on attractive terms. Distributing loans at subsidized interest rates was emphasized. And it was all too easy for the socially powerful and the wealthy to preempt most of the benefits of the subsidized distribution of credit. Moreover, in some countries, political leaders found it to their advantage to resist any moves to collect long-outstanding debts from subsidy recipients, and in many cases leaders periodically announced loan amnesty or interest remission programs in order to attain political objectives. These types of actions greatly eroded borrower discipline and loan arrears ballooned. Not only did the banks fail to serve the poor who were unable to pledge collateral, they also became chronically dependent on larger and larger infusions of subsidy money, quickly sliding beyond any prospect of long-term financial sustainability. Many of them, in effect, degenerated to costly and inequitable income transfer programs.

In the past 15 years, support for state-sponsored agricultural banks has greatly declined, and the need for financial market reforms to rectify distortions caused by past government policies is now almost universally acknowledged. However, governments, donors, and nongovernmental organizations (NGOs) continue to look for alternative models for extending financial services to the rural poor in an effective and economically sustainable way. Typical questions asked are what types of financial services are demanded by the poor? How does access to credit affect the welfare of the poor? How can rural financial institutions more effectively reduce poverty? What kinds of innovations in institutional design are called for and how can they be generated? What is the role of government in this process? The solutions proposed in answer to these questions are often confusing and conflicting, frequently the result of taking extreme positions on some issues or generalizing from a narrow context. This report attempts to provide a balanced discussion of the underlying issues, giving due attention to competing claims and points of view.