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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

Client Profile

Successful provision of financial services to the poor requires a clear picture of who the “poor” are. But generalizations are hard to make. Conditions of the poor in Latin America or Central Asia are quite different from those in South Asia or Africa. Hence, the nature of the constraints and the best approach for tackling them depend on the characteristics of the target population. Approaches that work in one region may not be readily transplanted to another, and services that successfully address the demand of one type of clientele - poor agricultural traders, for example - may fail to address those of another type - semisubsistence farmers in the same region. Inadequate understanding of the conditions of the client population or the context within which policy decisions are made often leads to tension among policy-makers, donors, and managers about what is the best way to support financial services for the poor. With this in mind, some major characteristics of the poor and their participation in formal and informal financial markets in rural areas of Africa and Asia are identified here. The data for the analysis are derived from nine household surveys conducted by IFPRI, that collected detailed data on credit market participation.1 Here the focus of the intercountry comparisons is not so much the nature of credit transactions themselves (as conditions among countries vary greatly), but the differences between the poor and the nonpoor within countries. The “poor” are defined here as the bottom one-fourth of the sample households when ranked by per capita household income levels.

The extremely limited resource base of the poor in Asia and Africa is evident in Table 1. The majority of the poor lack basic education, are primarily dependent on agriculture for their livelihood, own extremely small amounts of land for cultivation, and support large families at low average per capita income levels. Further, since rural areas are not as well serviced as urban centers by physical and social infrastructure such as roads, schools, telephones, radio, shops, and health clinics, their capacity to take advantage of market opportunities is severely curtailed. Households belonging to the lowest income quartile spend as much as 91 percent of their consumption budget on food (Figure 1). Even so, because their earnings are so low, they sometimes go hungry.2 As a result, the consequences of a drop in their earnings or the need to finance unexpected expenditures such as medical expenses could be quite serious. The cycle of borrowing during adverse times or during planting seasons and saving or repaying loans after harvest or when earnings are good is an integral part of the livelihood system of the poor. This is evident in IFPRI studies in Pakistan, Madagascar, and Nepal. In Nepal, an overwhelming majority of the poor, about 72 percent, engaged in some form of financial transactions. In Madagascar, nearly half of the poor households reported that loans were used to cope with household emergencies when they occurred. In Pakistan, a 1985 rural credit survey conducted by the government of Pakistan indicated that nearly 40 percent of poor households engaged in credit transactions.3

Table 1 - Selected household characteristics, by country


Bangladesh

Cameroon

China

Egypt

Ghana

Madagascar

Malawi

Nepal

Pakistan

Indicator

Poor
(P)

Nonpoor
(NP)

P

NP

P

NP

P

NP

P

NP

P

NP

P

NP

P

NP

P

NP

Mean household size, number of people

5.4

5.0

8.5

6.0

4.8

4.4

7.7

6.2

8.4

6.8

6.8

5.3

5.3

4.0

6.3

7.5

11.2

8.4

Years of education of household head (percent)a



















None

73.3

49.3

36.9

33.9

17.1

9.3

56.2

39.2

29.3

20.9

13.0

21.6

30.0

27.0

93.1

93.3

64.2

59.6


Under five years

21.3

20.4

52.8

58.8

42.4

42.0

15.0

13.6

10.6

4.6

67.4

53.6

51.0

39.0

2.3

3.7

0.0

0.0


Five to eight years

3.3

14.2

8.3

8.2

32.5

38.1

12.9

16.1

14.6

7.9

17.4

13.5

18.0

29.0

4.5

2.6

29.0

24.2


Nine or above

2.0

16.0

0.0

4.2

7.7

10.3

16.0

30.9

45.4

66.9

2.2

11.2

1.0

5.0

0.0

0.6

6.8

16.3

Percent of household heads reporting self-employed farming as principal occupationb

16.0

44.6

69.4

62.0

91.1

81.2

23.4

27.3

76.0

63.0

76.6

81.0

80.0

59.0

n.a.

n.a.

42.0

58.1

Mean land ownership
(hectares)

0.2

0.6

2.5

4.3

2.0

2.0

0.4

0.8

2.6

3.4

2.1

3.3

1.5

1.7

0.5

1.5

1.5

4.9

Mean annual income per household member, US$

108.6

232.2

179.1

357.2

74.1

204.62

236.3

641.5

82.8

217.2

86.6

223.9

32.7

61.0

90.0

118.5

216.6

407.2

Source: IFPRI research on rural finance (see note 1).

Notes: P = poor. The poor belong to the lowest quartile of income (or consumption expenditure) in their respective countries.

NP = nonpoor. The nonpoor are the three other quartiles.

The time periods of the surveys are: Bangladesh, 1994; Cameroon, 1992; China, 1994; Ghana, 1992-93; Madagascar, 1992; Malawi, 1995; Nepal, 1991-92; Pakistan, 1986-91; Egypt, 1997.

n.a. is “not available.”

a “Household head” refers to the major family laborer. For years of education of household head, the category “none” refers to the percentage that are illiterate; “under five years” to those who had at most some primary education; “five to eight years” to those who completed some junior level school; and “nine or above” to those who completed some senior level school.

b Household heads working principally as daily laborers in agriculture account for an additional 37.6 percent for the poor and 10.1 percent for the nonpoor.


Figure 1 - Percent of consumption budget allocated to acquiring food

Source: IFPRI research on rural finance (see note 1).

The average cumulative yearly amount borrowed by poor households from the formal and informal sectors ranges from about US$4 in Malawi to US$80 in Bangladesh to US$133 in Cameroon. The samples drawn are not nationally representative; with the exception of China, Egypt, and Pakistan, they are concentrated in areas and in villages where formal financial institutions are placed. For this reason, reported levels of borrowing are likely to be higher than national averages. Nevertheless, Figure 2 shows that the nonpoor households (the upper three quartiles of household income) borrow much more than the poor, with the exception of Ghana.4 Moreover, the loan amount shown in Figure 2 is not available to the borrower throughout the year, but only for several weeks or months. This is because most informal loans are given for only a few days or weeks. Even many formal loans obtained by the sample households are seasonal loans for agriculture or rural micro-enterprises. The smallest amount borrowed is in Malawi, a very poor country with a relatively inactive informal credit market.


Figure 2 - Average amount borrowed from formal and informal rural financial sectors per household per year

Source: IFPRI research on rural finance (see note 1).

Informal lenders - friends, relatives, neighbors, informal groups, or moneylenders - provide the bulk of the loans in every country except Ghana and Malawi (Figure 3). In Pakistan and Cameroon, for example, less than 5 percent of the amount borrowed by poor rural households was obtained from formal lenders. In this report, formal lenders consist of state and agricultural development banks and new microfinance institutions. The latter group includes credit unions and cooperatives, group-based programs run by government agencies or nongovernmental organizations, and village banks. The new member-based microfinance institutions successfully reach the poorest income quartile in Bangladesh and Malawi.

The poor obtain a smaller share of their loans from the formal sector than the non-poor in six countries (China, Egypt, Madagascar, Malawi, Nepal, and Pakistan), about the same in one country (Cameroon), and a larger share in two countries (Bangladesh and Ghana) (Figure 3). Even in a country like Egypt that has a relatively dense coverage of formal financial institutions, the role of informal lenders remains important. In Bangladesh, member-based credit programs run by NGOs now play a significant role in providing credit to the rural poor. In Ghana, the villages selected for the survey benefited from rural banks and NGO-assisted credit programs, the latter targeting poor female-headed households.


Figure 3 - Share of different sources of loans to poor and nonpoor, by country

Source: IFPRI research on rural finance (see note 1).
Note: Green = poor; Black = nonpoor

Figure 4 indicates how households spent their loan money. About one-half to almost nine-tenths of the loans obtained from the formal and informal sectors combined went to consumption-related purchases. In Pakistan, more than 80 percent was spent on consumption, food and nonfood combined. Moreover, in six out of eight countries, with Malawi and Nepal the exceptions, loans for consumption are more important for the poorest quartile than for the nonpoor. In every country, the share of loans used for consumption was higher for informal loans than for formal loans.5 In Malawi, only a small share of loans was used for consumption because the Malawi Rural Finance Company, the major rural lender, provides all loans in kind in fertilizer and seeds.


Figure 4 - Stated use of formal and informal loans by the poor and nonpoor, by country

Source: IFPRI research on rural finance (see note 1).
Note: Green = poor; Black = nonpoor

Why do more loans finance consumption activities than production or investment activities? First, the main suppliers of credit, informal lenders, are generally ill-equipped to finance substantial, long-term investments since they rely on their personal funds. The average duration of informal loan periods was, for example, 86 days in Bangladesh and 65 in Madagascar.6 The characteristics of informal loans make them more useful for financing short-term activities such as consumption stabilization and providing working capital for off-farm enterprises. Formal loans, which are larger in amount and longer in duration, are more useful for financing seasonal inputs and investments.

Second, in poor households the spheres of consumption, production, and investment are not separable in the sense that consumption and nutrition are important to a household’s ability to earn income. If a laborer does not have enough to eat, he may be too weak to work productively. In general, family labor is by far the most important production factor, and the maintenance and enhancement of labor productivity is central for securing and increasing income.

Once minimum requirements for a healthy and adequate diet have been met, additional consumption does not generate further increases in labor productivity. Many view such excess consumption as a luxury and see no social benefit in financing it through publicly supported programs. Yet, it is fair to say that luxurious or excessive consumption is extremely rare among the rural poor. Thus, in considering policies for providing banking for the poor, consumption loans spent mostly on foods needed to obtain a balanced diet or to improve the health of family labor should be seen as productive loans because the loan enhances the family’s ability to earn.

Bankers in particular frequently argue against consumption loans on the grounds that loans should finance activities that generate income for repaying the loan. In actuality, however, the current practice of lending only for narrowly defined productive activities seldom prevents rural households from diverting borrowed funds from production to consumption needs, since lenders rarely have the resources and time to supervise loan use.7 Only when loans are given in kind - in seeds or fertilizer, for example, instead of cash - do farmers have difficulty in diverting the loan to consumption uses. The data show that the share of loans used for consumption borrowed from the formal sector is lower than the consumption share of informal loans, but it still ranges from 9 percent in Ghana to 54 percent in Nepal for all households. The Nepal study indicates that borrowers often take advantage of the fungibility of financial instruments to divert investment-tied loans to finance consumption expenditures that, in the household’s own calculation, offer greater returns. But just because a loan is used for consumption purposes does not imply that repayment will falter. Consumption loans in Cameroon and Madagascar were found to have the same or even higher repayment rates than production loans.8

What about the adequacy of rural financial services? In spite of the vibrant informal markets that can be observed in many countries, financial services for the poor remain inadequate.9 In countries as diverse as Bangladesh, Ghana, Madagascar, Malawi, and Pakistan, access to credit and savings facilities is severely limited for small farmers, tenants, and entrepreneurs, particularly women. A useful way of examining household access to financial markets is to examine credit limits imposed on them by lenders.10 In Bangladesh the median formal credit limit is $50 and the informal limit is $13. The ability to borrow is significantly more restricted in Malawi, where the median formal credit limit is zero and the informal limit is US$3.

Such low credit limits mean that while some households frequently are unable to borrow enough to meet their needs, other households simply do not apply for a loan at all because of the expectation that they will be denied. In Madagascar, for example, about 50 percent of loan applicants received less than they asked for or nothing from formal and informal lenders alike.11 In Ghana, Madagascar, and Pakistan, IFPRI studies show that a significant proportion of the poor who do not apply for loans are discouraged from applying by the strict collateral requirements and high transaction costs frequently involved in doing business with formal institutions. There is some variation in the percentage of discouraged nonborrowers by country; it is highest in Ghana and lowest in Madagascar (Figure 5). Given such widespread credit-rationing, it is entirely possible that even households with average annual incomes above the poverty line may not be able to avoid transitory food insecurity when faced with an adverse shock such as a bad harvest or serious illness of a family member.


Figure 5 - Self-reported reason for households not borrowing, by country

Source: IFPRI research on rural finance (see note 1).

While these figures describe the extent of inadequate access to credit, one must not assume that all households who do not borrow lack access to credit. In fact, Figure 5 shows that the share of voluntary nonborrowers ranges from 11 percent in Ghana to nearly 59 percent in Madagascar. Among the most important reasons cited for not borrowing were adequate liquidity within the household, lack of profitable investment opportunities that could carry the cost of the loan, and inability or unwillingness to carry the risks of indebtedness.

Three important implications may be drawn from the information presented here about clients:

· A significant number of poor households in developing countries experience real constraints in the financial market in the sense that they are unable to borrow as much as they would like at the prevailing transaction terms. Given that most of the poor attempt to borrow in order to finance consumption of food and other basic goods that enhance health and labor productivity, such constraints may force poor households to eat less food or cheaper foods with lower nutritional value. Also, when consumption levels are already precariously low, they may be forced to cancel or postpone profitable investments or sell off assets - sometimes at a substantial loss - to meet irreducible consumption needs. This may lead to greater impoverishment in the long run.

· Because the cost of failure can be very high at extremely low incomes, poor households are likely to be particularly risk averse and sensitive about the kinds of projects that they choose for financing. Access to credit and savings options may enhance their capacity to bear risks and therefore indirectly foster technology adoption and asset accumulation.

· Poor households in Africa and Asia face complex, multiple constraints on earning opportunities. They often lack education, markets, and other essential services. Hence, the impact of financial services on welfare is likely to vary with accessibility to complementary inputs such as irrigation, education, and market services. In some environments or for some socioeconomic groups, access to micro-finance may do no good, while in other regions or for other groups, it can make an important difference.