Renewed Approaches to Rural Finance · Renewed Approaches to Rural Finance Agriculture and Rural...

Meeting Development ChallengesRenewed Approaches to Rural Finance

Agriculture and Rural Development DepartmentWorld Bank

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Acknowledgments v

Acronyms and abbreviations vii

Executive summary ix

1. Introduction 1• Objective of the paper 1• Why rural finance? 2• Bank approach to rural finance 2• Special challenges of rural finance 4• Special challenges of rural finance within the World Bank 4• Focus of the approach paper 5• Methodology and organization of the approach paper 6

2. The three pillars of rural financial sector development 7• Government policies and the legal, regulatory and supervisory framework 7• Financial sector and real sector infrastructure 8

3. Grants and subsidies 13• Appropriate subsidies to support rural finance goals 13• Grants versus credit—subsidies to the poor for asset acquisition 15

4. Delivery channels and models for rural financial services 17• Overview 17• Potential areas of intervention for the World Bank 17• Success factors for financial institutions in rural areas 18• Commercial banks and rural finance 19• Models for commercial banks entering rural markets 21• Areas for possible Bank interventions 24• Donor credit lines to commercial banks 24• State-owned Agricultural and Rural Development Banks 25• Areas for possible Bank interventions 28• Specialized rural microfinance institutions 28• Cooperative financial institutions 30• Informal village-based models 33• Community-driven development and rural finance 35

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Table of Contents

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iv Table of Contents

5. Special-purpose institutions and products 37• Leasing, a source of investment capital for rural areas 37• Guarantee institutions and guarantee funds 39• Supply chain financing 39

6. Cross-cutting issues of risk management, technological innovation and specialized collateral arrangements 43• Technological innovations to reduce transaction costs and to achieve

greater outreach for financial institutions 43• Risk management instruments for financing for agriculture 45

7. Pulling it all together: a practical approach to strategy formulation 49• Step 1: Preparation of a country diagnostic matrix 50• Step 2: Formulation of core strategic focus 50• Step 3: Prioritising the options and coming to a decision 52• Conclusion 55

Appendix 1 Rural finance portfolio analysis at entry 2004 and 2003 57

Appendix 2 Diagnostic matrix: Rural financial sector development—An example from a developing country—Uganda 67

Endnotes 69

Bibliography 73

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This paper was prepared by Renate Kloeppinger-Todd, Rural Finance Adviser, Agriculture and RuralDevelopment Department, with significant supportfrom Anne Ritchie, Senior Financial Sector Spe-cialist, Financial Sector Department. It builds onrural finance work done in the past within the Bankand international experience worldwide.

The paper’s starting point is the publication“Rural Financial Services” (World Bank 2003d)that outlines the Bank’s strategy for rural financewithin the framework of Reaching the Rural Poor,the World Bank’s rural development strategy. WorldBank staff and consultants contributing to thispaper included, notably, Henry Bagazonzya,Eustacius Betubiza, Juan von Buchenau UlrichHess, Sabine Keinath, Cornelis van der Meer,

Ajai Nair, Korotouma Quattara, Parmesh Shah,Harideep Singh, and Liza Valenzuela. Backgroundpapers were prepared by Ajai Nair, Harideep Singh,and Rabobank International Advisory Services.

Thoughtful comments from a number of Bankcolleagues as well as external persons are reflectedin this paper. Reviewers and advisers in the Bankincluded Benoit Blarel, Hoonae Kim, BikkiRandhawa, David Scott and Biff Steel. MarkWenner from the Inter-American DevelopmentBank also provided valuable insights.

The team appreciated the support and encour-agement of management and the financial supportof the Government of the Netherlands through theBank Netherlands Partnership Program.

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Acknowledgments

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ALCU Association of Lithuanian Credit UnionsARB Association of Rural BanksARD Agriculture and Rural Development Family of the World BankASCA accumulating savings and credit associationsATM automatic teller machineBAAC Bank for Agriculture and Agricultural CooperativesBANSEFI Banco del Ahorro Nacional y Servicios FinancierosBRAC Bangladesh Rural Advancement CommitteeBRI Bank Rakyat IndonesiaCARD Center for Agriculture and Rural DevelopmentCAS Country Assistance StrategyCDD community driven developmentCECAM Caisse d’Epargne et de Credit Agricole MutuelCGAP Consultative Group to Assist the PoorestCLUSA Cooperative League of USACRMG Commodity Risk Management GroupCVECA Caisses Villageoises d’Epargne et de Credit AutogéréesDFCU Development Finance Corporation (Uganda)EBRD European Bank for Reconstruction and DevelopmentEU European UnionFAO Food and Agriculture Organization of the United NationsFFI formal financial institutionFI financial institutionFMO Netherlands Development Finance Company (FMO)FSAP Financial Sector Assessment PapersGoB Government of BangladeshGTZ Gesellschaft fuer Technische ZusammenarbeitIFAD International Fund for Agricultural DevelopmentIFC International Finance CorporationIGVGD Income Generation for Vulnerable Groups Development ProgramIMF International Monetary FundIPC Internationale Projekt ConsultIT information technologyITC Indian Tobacco CompanyKAFC Kyrgyz Agricultural Finance CorporationKfW Kreditanstalt fuer WiederaufbauKPI key performance indicator

vii

Acronyms and Abbreviations

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LAAD Latin America Agribusiness Development CorporationLCCU Lithuanian Central Credit UnionMIS management information systemNBFI nonbank financial institutionNGO non-governmental organizationNLC Network Leasing Corporation (Pakistan)NMB National Microfinance Bank (Tanzania)OED Operations Evaluation DepartmentPDA personal digital assistantPEP Private Enterprise PartnershipPFCCO Philippine Federation of Credit CooperativesPoS point of salePRSP Poverty Reduction Strategy PapersRCSS Rural Savings and Credit CooperativesROSCA rotating savings and credit associationsSME Small and medium sized enterprisesTA Technical assistanceUMU Uganda Microfinance UnionWBI World Bank Institute

viii Acronyms and Abbreviations

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ix

The majority of the world’s poor live in rural areas.It is clear that the Bank will not be successful inachieving its overall poverty reduction objectiveunless it addresses rural poverty and helps to createbroad-based economic growth in rural areas.

Rural finance is a necessary ingredient for ruraleconomic growth. It makes a significant contribu-tion to increasing incomes for farmers and otherrural entrepreneurs and their employees; it helpscreate opportunities for self-employment; and it re-duces the vulnerability of the poor to economicswings by offering opportunities to save in goodtimes and to borrow in hard times.

The potential of rural financehas never been betterThe approach to rural finance developed over thepast decade within the international community,including the World Bank, emphasizes the im-portance of creating sustainable financial institu-tions providing a range of financial services thatare based on client demand. This approach offersthe opportunity to make a lasting contribution tothe reduction of rural poverty, because people needaccess to financial services on a permanent basis inorder to manage their financial affairs, includingthe growth of their economic activities. While thereare still many unresolved issues, especially with re-gard to financing for agriculture, diverse institu-tions in a number of countries are now providing abroad range of people in rural areas with access toappropriately designed financial products. Innova-tions that increase the efficiency of these institu-tions, and thus make the provision of financial ser-vices to rural people more attractive, are wellbeyond the pilot stage in many cases.

However, the World Bank, in its rural activities,has not yet fully realized this potential. Reviews of

the Bank’s rural finance portfolio over the pastthree years show that there are very few stand-alone rural finance projects that aim to increaseaccess to financial services on a comprehensivebasis. Most rural finance projects are componentsof larger projects and contribute to the solution ofspecific, narrowly defined problems, mostly creditfor project target groups through the provision ofcredit lines.

What needs to be doneto realize the potential?There is a need to address the lack of financial ser-vices in the rural areas of most countries head-on.The time has passed to just add credit lines and a bitof technical assistance to rural and multi-sectorprojects and expect that this will result in the sus-tainable provision of financial services to ruralhouseholds and enterprises.

This approach paper provides practical guidanceto Bank staff that are willing to take on that chal-lenge. It is not only meant to assist staff to knowl-edgeably choose the appropriate design for ruralfinance projects but also, maybe even more impor-tantly, to enable them to provide advice and guid-ance to World Bank country directors and counter-parts in Ministries and elsewhere in the partnercountry. It also provides practical information toBank staff working on multi-sector projectswhere access to finance in rural areas can only bea component.

The primary target audience of the approachpaper is task team leaders who are nonfinancialsector specialists working on rural development, ir-rigation and other programs and projects where ac-cess to finance is an issue. Financial sector special-ists without a comprehensive background andexposure to rural finance might also find it useful.

Executive Summary

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x Executive Summary

What are the basicunderpinnings of acomprehensive approachto rural finance?The development of a well-functioning rural fi-nance system rests on three pillars: good policiesincluding an enabling legal, regulatory and super-visory framework; financial sector and real sectorinfrastructure; and strong financial institutions. In-terventions on all three levels, appropriately se-quenced, achieve the best results. Nevertheless,there are potentially many activities on the institu-tional level that can be undertaken to increase ac-cess to financial services, even if the enabling envi-ronment is not fully supportive. Institution buildingmeasures include technical assistance to help finan-cial institutions develop appropriate products, sys-tems and service delivery strategies that will enablethem to profitably serve a rural clientele.

Financial services are delivered to rural popula-tions by institutions that exist along a continuumfrom formal to informal. Formal institutions in-clude public and private commercial banks, state-owned agricultural and rural development banks,cooperative banks, microfinance banks and specialpurpose financial institutions such as leasing, hous-ing and consumer finance companies. Informalproviders of financial services include small groupsthat rotate internally generated savings as loans tomembers, money lenders, pawn shops, and busi-nesses that provide financing to their customers. Inbetween stand the semiformal institutions such asNGOs and small financial cooperatives. All theseinstitutions have a role to play in rural finance.

What is the roleof government?There is a significant role for government. How-ever, the role of government should be limited tocreating good macroeconomic policies and an ap-propriate regulatory and legal framework, support-ing the creation of appropriate financial and realsector infrastructure, and funding technical assis-tance that supports the efforts of rural financial in-stitutions to achieve sustainability. Direct govern-ment intervention in rural credit markets through

interest rate subsidies, caps on interest rates andcredit forgiveness measures undermines efforts toachieve sustainable rural finance.

How can the World Bankintervene? Areas for Bank interventions exist at many pointsalong the continuum, depending on the specificconditions and requirements of a particular coun-try, or region of the country. A focus on policy dia-logue with respect to good policies and creation ofan enabling environment for rural finance is neededto support interventions at the institutional level.Therefore, close consultation and cooperationbetween rural staff who are responsible for design-ing and implementing projects that focus on thespecific issues of rural finance and financial sectorstaff who are working on general financial sectorissues in support of such projects is stronglyrecommended.

Promising areas for World Bank interventions tosupport rural finance are commercial banks lookingfor new markets, select state-owned agriculturaland rural development banks that can be reformedor restructured, specialized rural microfinance in-stitutions, cooperative financial institutions, andcommunity-based financial organizations. Thesame basic success factors apply to most types offinancial institutions and include good governanceand management, appropriate credit technology, ef-ficient internal processing and controls, portfoliodiversification, and sound accounting and manage-ment information systems. The Bank has knowl-edge and experience in all these areas, so should beable to provide appropriate technical support. How-ever, the challenges are quite significant, as capac-ity building often requires a longer time frame thana typical World Bank project. This implies that theway projects in rural areas are measured and evalu-ated within the Bank should be refocused, so as toset the right incentives for Bank staff.

Special purpose products offer additional oppor-tunities. Leasing provides medium- to long-termfunding for agricultural machinery and other pro-ductive assets. Guarantee mechanisms, when prop-erly designed, offer the opportunity to reducespecific credit risks for financial institutions thatwould otherwise not provide services in rural areas.

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Appropriate design and a focus on minimizingmoral hazard are essential here as in all other inter-ventions. In most developing countries, supplychain financing that provides the largest amount offinancing for agriculture is a private sector activitythat operates without much support from interna-tional institutions. A question that remains to be an-swered is whether and how the Bank can intervenein this area, in order to increase financing optionsfor smallholder farmers and to encourage proces-sors to provide credit to farmers in regions that arewithout access to credit.

Risk management instruments for financing foragriculture and technological innovations that en-able financial institutions to reduce transactioncosts and increase portfolio quality present addi-tional opportunities. Knowledge about these excit-ing developments (as well as their limitations)needs to be made available to task team leadersand become part of the tool box for design of ruralfinance projects.

Grants and subsidies are needed in many cases tosupport rural finance interventions. Bank policy onfinancial intermediary lending (OP8.30) allows theuse of subsidies to create the conditions that make ac-cess to financial services to underserved populationspossible.Appropriate subsidies include technical as-sistance to financial intermediaries to improve sys-tems that enhance efficiency; to develop and intro-duce demand-responsive products on a pilot basis; todevelop new or revised service delivery mechanismsto enable larger outreach into rural areas than the fi-nancial institution would attempt on their own; and tocover a portion of the cost of establishing newbranches in areas that do not have financial interme-diaries that serve the rural poor. Subsidies are alsorelevant for the development of financial and real sec-tor infrastructure, as well as development of the en-abling legal and regulatory environment.

Very poor populations who lack access to eco-nomic opportunities and are too vulnerable to takerisk can in some cases be assisted with matchinggrants that enable them to acquire income generat-ing assets. These assets can kick-start an activitythat will result in future income generation. How-ever, such grants must be carefully targeted toavoid capture by elites, have a match from the ben-eficiary to ensure real ownership, and be accompa-nied by other types of support, such as training. In

some cases, a portion of an investment can be fi-nanced with a grant and the balance by a loan froma financial institution.

Pulling it all together:a practical approach tostrategy formulation on thecountry levelRural finance is a complex subject that requiresspecialist knowledge. In order to help Bank taskmanagers decide on an appropriate set of interven-tions from among all the options, a three-step ap-proach to strategy formulation has been developed.In the first step, information on the key elements ofthe policy context, enabling environment, and fi-nancial institutions are collected and analysed,along with information on the characteristics andstructure of the real sector. The findings from thisanalysis are then coupled in the second step with ananalysis of the demand for financial services in theproposed project area. A typology of countries hasbeen developed that provides a framework thatshould enable task managers to compare the strate-gic approach contemplated for the project underdesign with that of similar countries. Taken to-gether, this analysis should enable the principalstrategic focus of the project to be developed. Thethird step concludes the analysis with the identifi-cation and prioritisation of intervention options.This three-step process is obviously a simplifica-tion of the project design process; the intent is toprovide a structure that will guide task managersand help to ensure that all important elements areconsidered.

This paper has attempted to create awareness ofthe complexities of rural finance and its relevancefor rural development, and to explain the principalmethods and solutions that have been successful.Many of the challenges that have confounded ef-forts to increase the access of rural populations tosustainable financial services have now been over-come in a number of countries. Over the years, theWorld Bank has been an integral part of the inter-national effort that has led to the current state ofknowledge. It is now time to increase that effort asan indispensable part of the fight against poverty.

Executive Summary xi

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This paper is one in a series of sector papers elab-orating the implementation of the Bank’s ruraldevelopment strategy “Reaching the Rural Poor.”1

It builds on rural finance work done in the past2

within the Bank and on international experienceworldwide. Its starting point is the publication“Rural Financial Services”3 that outlines the Bank’sstrategy for rural finance within the framework of“Reaching the Rural Poor.”

The range of topics related to finance in ruralareas is extensive, ranging from the financing ofrural development and infrastructure, to financingagricultural growth and private sector develop-ment, to the sustainable provision of financial ser-vices to rural populations. All of these topics areimportant with respect to the Bank’s rural develop-ment strategy. Moreover, they are all within themandate of the Bank’s Agriculture and RuralDevelopment Department. However, in order tokeep this approach paper to a manageable size thatis practical to use, the decision was made to limitthe paper to the internationally accepted definitionof rural finance. Rural finance for the purposes ofthis approach paper is defined as the provision of arange of financial services to rural individuals,households, and enterprises, both farm and non-farm, on a sustainable basis.

Objective of the paperThe overall objective of the Bank’s rural develop-ment strategy “Reaching the Rural Poor” is the

improvement of the living situation of the ruralpoor on a sustainable basis. Access to financial ser-vices is an important ingredient to achieve thisoverall objective, and makes a meaningful contri-bution if implemented well. The purpose of therural finance approach paper is, therefore, to pro-vide practical guidance to Bank staff who designand implement rural finance projects. It is meantnot only to assist staff to knowledgeably choose theappropriate design for rural finance projects butalso, maybe even more importantly, to enable themto provide advice and guidance to their counter-parts in partner countries. The primary targetaudience of the paper is task team leaders who arenonfinancial sector specialists working on ruraldevelopment, irrigation and other programs andprojects where access to finance is an issue.Financial sector specialists without a comprehen-sive background and exposure to rural financemight also find it useful.

Within the context of this paper, rural finance isthe provision of financial services such as savings,credit, payments and insurance to rural popula-tions by organizations that exist along a continuumfrom formal to informal, ranging from commercialbanks to informal village-based savings groups. Thisincludes financing for agriculture, agro-processingand other rural enterprises, from part-time incomegenerating activities to full-time micro-enterprises tosmall and medium size (SME) enterprises.

Rural finance projects, which are based on theBoard-approved rural development strategy, can

1

1

Introduction

either be comprehensive stand-alone projects, orrural finance components of rural developmentprojects. Credit lines for rural projects, where theend-user receives funds in the form of a loan and isrequired to pay it back, regardless of the institu-tional arrangements, are also considered ruralfinance components for the purposes of this paper.In the past, it has often been the case that ruralfinance components were developed as an after-thought, once it became obvious that stated projectobjectives could not be achieved without support-ing access to financial services. This paper willprovide rural staff with knowledge of the successfactors for rural finance, gained from internationalas well as Bank experience, and a tool to makedesign decisions based on a systematic and trans-parent process.

Why rural finance?From the standpoint of rural development andpoverty reduction, as supported by the World Bank,three strategic goals are central,4 and rural finance,when properly implemented, makes a contributionto all three of these goals:

• Achievement of economic growth

Access to a range of financial services is necessaryin order to achieve economic growth, includinggrowth in rural areas. Growth in agriculture as wellas other rural economic activities can be substan-tially enhanced if there is reliable and sufficientfinancing, and sustainable financial intermediation,in addition to many other factors.

• Inclusion and participation of all members ofthe rural population in economic development

In many countries, poor rural populations do nothave access to financial services even if there isaccess for wealthy persons, larger farms and largerrural enterprises. The microfinance “revolution”has demonstrated conclusively that financial inter-mediaries that serve the poor, as well as better-offpopulations and enterprises, can be successful.Access by the poor to financial services providesthem with some of the resources they need to

pursue economic opportunities as well as managetheir household finances.

• Reduction of vulnerability to economic, physicaland other shocks

The poor in general have few resources and arevulnerable to even small swings in income or unex-pected expenses due to illness, death of a familymember, seasonal liquidity problems related to theagricultural calendar, and a wide variety of otherfactors. The ability to save even small amountsduring good times and keep these sums safelylocked away until they are needed is essential.Another financial product that is important to poorrural populations is the ability to receive remit-tances reliably and at a low cost from migrantworkers, especially in rural areas that have poorprospects for economic growth and incomegeneration.

While there is no conclusive proof that accessto financial services has a significant impact onpoverty reduction, there is substantial field-basedevidence pointing to the importance of rural financefor economic development.5 Most households witheconomic activities above the consumption leveland most enterprises in rural as well as urban areasneed access to financial services in order to growand generate income, be they agriculture-based6 oroff-farm. Access to finance is also needed forimprovements in rural infrastructure such astelecommunications, energy, irrigation and water-shed management, all of which have an impact onthe improvement of people’s lives.

Bank approach to rural financeFor many years, rural finance was defined as theprovision of credit to special target groups, mainlyfarmers. International donors, including the WorldBank, supported this approach through the provi-sion of funds for international and domestic creditlines. By the early 1990s, it became apparentthat many such credit lines had low recovery rates,were implemented by unsustainable institutions,and did not achieve the intended purpose of in-creasing rural livelihoods, except for those few

2 Meeting Development Challenges: Renewed Approaches to Rural Finance

farmers, often the more wealthy ones, who directlybenefited from the limited funding and inefficientdistribution structures.7 Consequently, significantanalytical work was done within the Bank andthe international community to analyze the issuesinvolved and to develop alternative approaches.8

Donor agencies began to shift their approach awayfrom a focus on agricultural credit towards a widerview of rural finance, characterized by a broadrange of financial services, rather than credit only;provision of financial services to all rural dwellers,not just farmers; use of market interest rates; andthe operational efficiency and financial viability ofrural financial institutions.9

Rural finance for rural development in thecurrent context of the World Bank is based onthe following principles:

• Demand-responsive approach to financialservices access

Rural populations demand a range of financialservices, depending on their current economic de-velopment, potential for future development, andability to take advantage of opportunities withintheir existing environment. In many cases, credit isnot the most appropriate product. In fact, savingsand payment services might initially be more rele-vant for poor rural populations, enabling them toaccumulate assets and to smooth uneven incomeflows. Consequently, the design of programs thatsupport rural financial intermediaries has shiftedfrom a focus on credit only to a better understandingof the demand by rural populations, including thepoor, for all financial services, including savings, in-surance, payments and remittances, as well as credit.

• Sustainability of access to financial services

Sustainable access to demand-responsive financialservices is critical for the economic developmentof rural areas and contributes to the reductionof vulnerability of poor populations. It is there-fore now seen as the primary objective of ruralfinance. Within this context, helping rural finan-cial institutions—all along the continuum fromformal to informal—to achieve long-term institu-tional sustainability is paramount. Support for thecreation of an enabling environment and support

for institution-building are thus essential projectfeatures, rather than simply support for creditlines. The long-term sustainability of financialinstitutions requires access to reliable sources offunding for their credit business. Savings, properlysafeguarded by means of supervision and possiblydeposit insurance arrangements, are a first choice.Therefore, savings should be regarded as not only aproduct demanded by customers, but also a strategicpriority for a financial institution’s sustainability.Access to domestic and possibly international bondmarkets are another potential source of funding inmore developed financial markets and could well besupported. One example is International FinanceCorporation’s (IFC) recent partial guarantee ofa bond issue for Compartamos, a Mexican ruralmicrofinance institution.10

• Clearly defined role for government

There is a significant role for government in ruralfinance. But this role should be limited to the cre-ation of good macroeconomic policies, an appro-priate regulatory and legal framework, and fundingfor technical assistance to rural finance institutions.Direct interference in rural credit markets throughinterest rate subsidies, caps on interest rates andcredit forgiveness measures undermine efforts toachieve sustainable institutions. State ownership ofrural financial institutions has in the past often notresulted in achieving sustainable access to financialservices and should therefore not be promoted,except under exceptional circumstances and asoutlined in Chapter 4.

• Holistic approach

Efforts to achieve access to financial services needto be complemented by other interventions thatsupport the sustainable development of rural eco-nomic activities. Access to financial services isonly one of the factors influencing rural economicdevelopment. For example, access to quality agri-cultural inputs, access to agricultural extensionservices, access to markets and market informa-tion, and access to physical and communicationinfrastructure are all important, and should beinvestigated as complementary measures in orderto achieve best results.

Introduction 3

Special challenges of rural financeThe establishment of viable rural financial systemsencompasses many specific challenges, in additionto the challenges inherent in the development ofcountrywide financial systems. Low populationdensity and difficult to reach remote areas in manycountries translate into high transaction costs forfinancial institutions contemplating an entry intothese areas. Limited economic opportunities inmany rural areas result in small transactions,further increasing overall transaction costs.

The heavy concentration on agriculture andagriculture-related activities in rural areas exposesfarmers and their lenders to multiple risks. Someof these risks are idiosyncratic, affecting a singlehousehold, whereas others are covariant in natureand affect an entire region or country. Weather riskis probably the single most important risk influenc-ing the outcome of a farmer’s investment. This riskalso affects associated economic activities such asagro-processing. Price risk can also be quite sub-stantial, especially for products that are sold in verycompetitive international markets.

For financial institutions, in addition to the risksinherent in financing agriculture and agriculture-related activities, there are risks associated with theconcentration of portfolios on the agricultural ac-tivities that are most prevalent in a particular ruralarea; this makes risk reduction through portfoliodiversification in rural areas difficult if not impos-sible to achieve. On top of this, the risk of politicalintervention can strongly influence the overall riskfrom the perspective of the intermediaries, as pay-ment morale can be completely undermined bydebt forgiveness granted at the government’s insti-gation and interest rate caps can eliminate whatmay already be very slim margins.

All three factors together—high transactioncosts, high risks, and the possibility of politicalinterference—constitute a problem structure forrural finance which has to be well understood andtaken into account in strategy formulation. Thiscombination of factors can render rural finance anunattractive proposition for many financial institu-tions, especially those that have well-establishedand profitable business lines and no mandate toserve the rural sector. This clearly implies that anystrategy for rural finance has to provide clear-cut

answers on how the proposed actions tackle theproblem structure arising from the specific circum-stances of the particular country.

Special challenges ofrural finance within the World Bank

Bank lending for lines of creditCredit lines are often part of rural developmentprojects. They fulfill a useful function in thosecountries where there is a demonstrated lack ofliquidity or long-term funding in the financialmarkets, or where funding is not available for rurallending, and where there are institutions availablethat have the capacity to implement a credit line.They are also beneficial when financial institutionsthat do not have access to commercial sources offunding are supported in their early stages. This isespecially important in those Bank member coun-tries that are reluctant to borrow for technical assis-tance to establish new institutions or to strengthenexisting financial institutions, but can be convincedto do so if the technical assistance funds are com-plemented by a line of credit.

Over the past few years, credit lines within theBank have been subjected to close scrutiny, includ-ing development of a Bank policy on credit lines,OP8.30, in 1998,11 and an Operations EvaluationDepartment (OED) review of Bank lending for creditlines in 2003/4.12 This review included rural financeoperations. The main findings were that (i) imple-mentation of Bank guidelines for lines of credit hasbeen poor, (ii) outcomes are poor, (iii) cancellationrates have been high, and (iv) better outcomes areassociated with stable macroeconomic conditions,stronger financial sectors, use of clear eligibilitycriteria for the selection of participating financialinstitutions, and use of private sector financial inter-mediaries. One lesson learnt is that rural credit linesusually perform better if they are designed as part ofa comprehensive rural finance project rather than as ashort-term solution to credit needs in a general ruraldevelopment operation. As a result of the OED re-view, the Board has made a policy decision to have allproposed credit lines reviewed by financial special-ists reporting to the financial sector board regardingtheir adherence to the principles of OP8.30.


According to this policy, institutions that donot have strong institutional capacity can becomeeligible for Bank credit lines if they develop andimplement an institutional strengthening plan.Funds must be used for the increased production ofgoods and services, and appraisal must determineif the operation can achieve its desired objectivewith due regard to the sustainability of the financialsector. On-lending terms must be set within thecontext of a country’s interest rate structure andmust provide financial institutions with adequatemargin to cover all their costs, including credit andother risks, and an adequate profit margin. Thus,OP8.30 provides space for rural finance operationsin areas with weak financial institutions, providedthat they explicitly address the weaknesses of theseinstitutions.

The definition of credit line for the purpose ofthe OP8.30 review includes any project that chan-nels Bank funds to households or businesses withan obligation to repay, regardless of what entity isintermediating the funds (financial institution, gov-ernment department, nonfinancial company, etc.)and regardless of what it is called (loan, cost recov-ery of grants, reimbursable assistance, revolvingfund or other terms). Thus, grants made by pro-jects, especially Community Driven Development(CDD) projects, to communities that lend thesefunds to their members, must be reviewed.

Status of rural finance withinthe World Bank’s ruraldevelopment operationsThe Agriculture and Rural Development Depart-ment conducts annual reviews of rural financeprojects approved in a given year that are either ex-clusively focused on rural finance or have compo-nents or activities directly related to rural finance.In FY04, there were 20 projects with a volume of$241 million, and in FY03, 17 projects with avolume of $666 million.13 The difference in volumeis explained by one large adjustment project($506 million) in FY03. The analysis revealed thatthe designs of most projects are based on goodpractice for the chosen approach and that severalprojects have outstanding innovative features.However, the majority of rural finance projects arecomponents of larger projects and tend to focus on

support for service provision, where credit is thepredominant service being provided (14 projectsout of 20 in FY04 and 13 out of 17 in FY03). Inboth years, only two projects are stand-alone ruralfinance projects that aim to increase access to fi-nancial services in rural areas on a comprehensivebasis. In FY04, 10 projects were initiated by theagriculture and rural development sector, four bythe financial and private sectors, and two each byinfrastructure and social protection.

The annual review of approved rural finance pro-jects, as well as the OED review of credit lines, in-cluding credit lines to rural financial institutions,demonstrates clearly that rural finance within theWorld Bank has not yet taken on the full role itneeds to play to support rural development. Ruralfinance project components contribute to the solu-tion of specific, narrowly defined problems, mostlycredit for project target groups. They rarely com-prehensively address the issues that constrainaccess to finance by rural populations, and conse-quently have only modest impact. The scarcity ofsuch operations, regardless of sector attribution,points to either insufficient resources, lack ofknowledge about rural finance and its relevancefor rural development, or other priorities within theregional departments and their partner countries.The potential contribution of rural finance torural development warrants a far more substantialapproach.

Focus of the approach paperThis paper builds on the three pillars of rural finan-cial sector development; namely, government poli-cies and the enabling regulatory and legal environ-ment, infrastructure for the financial and realsectors, and financial institutions. The major focusof this paper is on the third pillar, the institutionallevel, for the following reasons:

• Rural finance is a subsector of the country’sfinancial sector, and many of the issues concern-ing government financial sector policies andthe regulatory framework are better addressedthrough country-level financial sector work.Interventions on that level are therefore onlycovered in this paper insofar as they apply tospecific rural circumstances.14

Introduction 5

• Considerable research work on cross-cuttingissues, for example, on credit information sys-tems, remittances, and the use of postal systemsfor improved access, is being done by other partsof the Bank and should not be duplicated.15 Thecross-cutting issues covered in this paper relatedirectly to rural finance; this includes risk man-agement instruments for financing agricultureand innovations that will enable rural financeinstitutions to cover their costs.

• The institutional level is the area of greatest de-mand for advice, as most rural finance projectswithin the Bank concentrate on this level.

References are provided throughout the text onwhere to look for further information on topicsmentioned in the text.

Methodology and organizationof the approach paperThe approach paper has five major thematic blocks.Chapter 2 provides an overview of the main issuesrestricting the development of rural finance on thethree levels of policy, enabling environment and in-stitutional capacity. Chapter 3 discusses the issuesof appropriate subsidies and the use of grantsversus credit. Chapters 4–6 analyze the deliverychannels and models for supporting rural finance,including special purpose institutions and products,and an overview of several cross-cutting issues.Chapter 7 develops a practical approach to theformulation of a country-specific rural financestrategy.


Provision of financial services in rural areas re-mains a challenge. During the last ten years, theadoption of the financial systems approach—thatis, the financing of economic activities in ruralareas as part of a comprehensive financial sectordevelopment strategy—has led to significant break-throughs in increasing the outreach of financialservices and the performance of financial interme-diaries. However, many rural areas worldwide stilllack an adequate supply of formal financial ser-vices; even the strong expansion of microfinancehas not changed this significantly, especially withregard to financing for agriculture. Governmentpolicies in many countries hinder rather than sup-port the development of financial markets thatprovide access to the majority of the population. Inthe case of rural financial markets, there are oftenadditional issues related to government policiesto subsidize farming and farmers.

In the ideal case for agricultural and rural devel-opment, rural financial markets are efficient andafford access to all population groups for theirfinancing needs, including agriculture, and offerdemand-responsive products and services tailoredto the requirements of their diverse customers.Macroeconomic policies are favorable as is thelegal and regulatory environment, and there is suf-ficient financial and real sector infrastructure tosupport the development of efficient financial insti-tutions. However, this is not the case even in highlydeveloped countries; much less in transition and

developing economies where financial markets ingeneral and rural financial markets in particularare often weak, fragmented and cater only to theleast-risk and higher-value customers, includingthe government itself. Government policies can beerratic and opportunistic, responding more topolitical than economic considerations. Issues thatfrequently have a major impact on rural finance arehighlighted in the sections below.

The three pillars of rural financial sector devel-opment are: 1) government policies and the legal,regulatory and supervisory framework, 2) financialsector and real sector infrastructure, and 3) finan-cial institutions.

Government policies andthe legal, regulatory andsupervisory frameworkPolicy level issues• Crowding out of private sector customers

through large government borrowings from thebanking sector, as government bonds offer finan-cial institutions less risky and often shorter-terminvestment opportunities than the financing ofsmall farmers and rural entrepreneurs.

• Monetary policies leading to high uncertaintyand the unwillingness of investors to providemid- and long-term domestic funding.

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The three pillars of rural financial sector development

• Tendencies of governments to please potentialvoters in the short run by providing inappro-priate subsidies to the detriment of longer-termsustainable financial sector development. Capson interest rates that can be charged by financialinstitutions also deter financial institutions fromentering or staying in those markets where thereare higher costs and/or credit risks.

Issues in the legal, regulatoryand supervisory framework• Missing or inappropriate laws on property,

especially land, but also other kinds of physicalproperty, and their use as collateral; and lackof efficient bankruptcy laws.

Especially in rural areas, the role of secureproperty rights, i.e. land rights, are of greatimportance, both for credit purposes and as anincentive for people to invest in the developmentof that land.16 They need to be administered andenforced by institutions that have both legalbacking and social legitimacy and are accessibleby and accountable to the holders of propertyrights. However, not just property rights, but alsoland transactions such as rentals and sales areimportant to realize full benefits. Most financialinstitutions will not provide credit without col-lateral, meaning in most cases land or the right touse land. However, land as collateral by itself isonly valuable if it can be collected, or if thethreat of collection contributes to credit disci-pline. Efforts to support land titling as well as theestablishment of property registries can make asignificant contribution to access to credit forrural populations17 as can efforts to establishefficient markets for land.

• Lack of enforcement capabilities or willingnessto take action against offenders, even if there isan appropriate legal framework.

• Issues with the regulation of the financial sector.These issues range from inadequate regula-

tion to excessive regulation, and disagreementson which institutions should be defined as beingpart of the financial sector, and therefore subjectto supervision. Usually, unsupervised financialinstitutions are not allowed to collect deposits, soas to provide protection to depositors. Theseinstitutions are thus likely to depend on govern-ments or donors for refinancing, or on capital

markets in more mature markets, and often havelimited growth potential.18

• Shortage of institutional capacity in banksupervision.

Supervising financial institutions is costly andresource-intensive. This is especially true forsmaller institutions in rural areas. Solutions suchas delegated or auxiliary supervision are beingused for cooperative financial institutions insome countries and could be an example for othernetworks of nonbank financial institutions.19

Financial sector and realsector infrastructureFinancial sector infrastructure• Lack of training institutes, industry associations,

and information agencies, including credit andcollateral registries.

Credit registries allow a borrower to establisha credit history, an important factor in a bank’sdecision to grant a loan. Collateral registriesallow financial institutions to collect on collat-eral without having to go through often lengthycourt processes. Other financial sector infra-structure such as training institutes and industryassociations increase the professionalism of fi-nancial institutions’ management and staff. Fi-nancial institutions that are staffed with educatedpeople that receive ongoing professional trainingare likely to be better managed and better able tocalculate risks, than institutions with less-devel-oped staff.

For a real reduction of critical transactioncosts, best results are achieved when all relevantissues are addressed. The establishment of creditinformation registries, adequate creditor rightsin secured transactions, and efficient bankruptcylaws all work together to facilitate access tocredit. Information sharing allows creditors todistinguish good clients from bad clients, whilelegal rights enable claims enforcement in theevent of default.

• Lack of agricultural risk managementinstruments.

Weather and prices both pose great risksfor farmers. Instruments to manage such riskshave been developed and are available to farmers


in developed countries. New ways are beingsought to apply these instruments to develop-ing countries and to smallholders. Chapter 6takes a closer look at such instruments and theirpotential.

• Payment systems that need to be modernized.In many developing countries, payment sys-

tems are woefully inadequate, slow, expensive toaccess, and with limited outreach to rural areas.Small rural banks might be excluded from checkclearing by large urban banks; access to cashmight be sporadic, resulting in the rural popula-tion being forced to carry much larger amountsof cash for purchases than would be advisablefor security reasons. Migrant remittances torural areas are also expensive. These issues canbe addressed by a combination of measures, asdemonstrated by the Ghana Rural Financial Ser-vices project outlined in Box 1 below.

• Lack of facilities such as deposit insurance thatwould safeguard and encourage savings.

In many rural areas, savings are collectedthrough informal or semiformal savings groupswhere members know each other and savings aresafeguarded through the group process. Mobi-lization of savings on a larger scale might be ac-companied by some kind of protection scheme,such as a fund set up by the members of a finan-cial network, for example, cooperative financialinstitutions. Deposit insurance within the formalfinancial sector is a complex issue and is notlikely to be addressed in a rural finance project.20

Real sector infrastructure• The impact of inadequate infrastructure on the

development of rural enterprises can be massive.

A lack of paved roads in rural areas, unreliableelectricity and an inadequate telecommunica-tions infrastructure all increase costs for busi-nesses and financial intermediaries. Overcomingserious deficiencies will have a very positiveimpact on the development of a rural financialsystem. As these statements are simple, com-monsense observations, not much literature isavailable here.

• Lack of market information such as currentprices for basic commodities.

• Lack of processing facilities for local value-adding.

• Lack of competent business development ser-vices that could assist farmers and other ruralenterprises with informed decision-making andthe acquisition of management skills and sup-port them in developing business plans thatwould enable them to better approach financialinstitutions.

• Stifling bureaucracy in the registration ofbusinesses.

Addressing macro-level monetary policy and finan-cial sector issues is obviously outside the scope ofBank agriculture and rural development activitiesin a given country. Instead, a close coordinationwith the International Monetary Fund (IMF) andBank departments working on such issues at thecountry level could be beneficial for the develop-ment of rural finance over the long run. Supportingthe development of a suitable legal and regulatoryframework, financial and real sector infrastructure,and an enabling environment for economic activi-ties can, however, be an important part of rural de-velopment projects. This should only be considered ifthe project team contains, or can acquire, the required

The Three Pillars of Rural Financial Sector Development 9

BOX 1 Rural Financial Services Project (RFSP), Ghana

RFSP supported the establishment of an apex bank forthe network of rural banks in Ghana. The Associationof Rural Banks (ARB) Apex Bank is undertaking sev-eral measures to increase access to countrywide pay-ment systems. It supports the individual rural banks intheir check clearing efforts so that rural bank checksare now accepted across the country. Apex-link was

developed; this is a network linking all rural banks tothe Apex Bank for fund transfers. The ARB ApexBank’s regional branches also supply bank notes tothe rural banks on short notice and without charge.

Source: R. Kloeppinger-Todd and P. Mensah, The World Bank,Personal Communications, March 2005.

technical expertise. Otherwise, the principle of “DoNo Harm” should be followed. Task team leaderswho are looking for further information on the issueshighlighted in this section should refer to the refer-ences provided throughout the paper.

Financial institutions

At the core of rural finance are the financial inter-mediaries that deliver financial services withinrural areas. In the end, all other aspects of rural fi-nancial sector development are no more and no lessthan necessary or desirable elements that ultimatelysupport the development of institutions that can de-liver financial services in rural areas on a sustain-able basis. It is important to stress this point: onekey consequence of the financial systems approachwhich has evolved over the last 10–15 years is thatit is not primarily target group outreach whichdetermines the success of a project, but equallyimportant—or even more important—whether ornot services can be delivered to the target group ona sustainable basis. Reaching a specific targetgroup once or even a couple of times cannot in theend be considered as any success at all, if the fun-damental need for sustainable financial serviceshas not been satisfied or if it comes at the expenseof other clients. Almost all businesses and house-holds need an extensive set of financial servicesthat enable them to actively manage their financialresources; these include access to savings, credit,insurance and payments systems, including theability to send and receive remittances.

The financial systems approach has necessarilyshifted the focus from target groups to suppliers offinancial services, since only well-managed finan-cial intermediaries can guarantee the provision offinancial services to rural customers over the longterm. This has huge implications for project design,as not only are the availability of funds and thecapacity to reach rural customers, including farm-ers and the rural poor, important, but also the sus-tainability of the financial intermediaries that servethese customers. Therefore, complex issues ofownership, governance, management, systems, andservice delivery structures have to be analyzed soas to ensure that partner institutions are financiallysound and have a business strategy which allowsthem to extend financial services in rural areas on asustainable basis.

In many countries, one of the biggest problemsin rural finance is that there are not a sufficientnumber of financial institutions operating in ruralareas, or there are not enough institutions servinglow-income customers and farmers. Many WorldBank projects have used various kinds of incen-tives, especially credit lines, to stimulate the entryof financial intermediaries that can help to closethese gaps, as well as to provide longer-term fund-ing to rural businesses. The recent OED review ofthe performance of Bank credit lines has revealed asubstandard performance across the portfolio in-cluding rural credit lines; this has resulted in closeroversight at entry and a focus on better reporting ofperformance. The real issue, however, is not onlythe performance of credit lines but also the useful-ness of providing such funding at all, especially tofinancial institutions that in many cases do not havethe institutional capacity and strategic motivationto serve the new clientele after the project hasended. The lack of access to financial servicesother than credit is not addressed by this instrumenteither.

In many of the Bank’s partner countries, lack offinancing in rural areas and specifically financingfor agriculture is not due to a general lack of liq-uidity in the country, but rather to lack of suitablefinancial institutions and the high risks, perceivedand real, in entering such markets. Therefore, pro-viding liquidity in the form of a credit line does notsolve the problem in most cases; it provides onlytemporary funds to borrowers and may not meettheir needs for other financial services. An excep-tion is those situations where there is no long-termlending available in a country, even in the face ofhigh short-term market liquidity. In those situa-tions, a Bank credit line directed towards longer-term investment lending could well complementinstitution-building measures.

Institution-building measures would includetechnical assistance to help financial institutionsdevelop appropriate products, systems, and servicedelivery strategies that would enable them to prof-itably serve a rural clientele. Although this approachcan be easily formulated, the challenges are quitesignificant, as capacity building often requires along time frame. Significant outreach results shouldnot be expected quickly, as it takes time to buildstrong structures and systems. This implies that the


way projects in rural areas are measured and evalu-ated within the Bank should be refocused, so as toset the right incentives for Bank staff.

The lack of financial institutions in rural areasis often the reason that projects channel creditlines through a variety of other institutionalarrangements, including community groups, projectimplementation units and government departments.

Unless these arrangements are designed from thebeginning to link clients to existing financial inter-mediaries or to develop these structures into viablefinancial intermediaries, with the appropriate assis-tance for institution-building, sustainability cannotbe achieved and rural populations will be left onceagain without financial services after the projectends.

The Three Pillars of Rural Financial Sector Development 11

Grants and subsidies are an important topic in ruraldevelopment; while strictly speaking, this topic isoutside the narrow focus of rural finance, the use ofgrants and subsidies strongly influences the out-come of rural finance activities, so the topic needsto be addressed in this paper. Project teams some-times provide subsidies and grants, rather than ad-dressing the issue of lack of access to financial ser-vices, especially if there are few suitableinstitutions that could be qualified partners rightfrom the start. This approach can lead to the well-demonstrated effects of capture by elites, lack ofaccess to necessary financial services after the pro-ject ends, and market distortions that underminethe efforts of others, who are working on promotingmore sustainable arrangements.

Therefore, it needs to be clearly stated that theWorld Bank adheres to and promotes the financialsystems approach to finance, including rural finance.The ultimate goal of this approach is the develop-ment of financial institutions operating profitablyon a commercial basis and offering products andservices demanded by a wide range of clientsincluding the poor. This means that the financing ofagriculture and rural development needs to bestructured in such a way that it doesn’t distort orinhibit the growth of financial markets, but insteadcontributes to their development.

Interest rate subsidies and caps, directed credit,forgiveness of farmers’ debts following bad har-vests, and government-subsidized crop insuranceare always hot topics for Ministries of Agriculture

and especially prior to elections. These and similarmeasures, however, prevent the development ofsustainable rural financial markets by crowding outor preventing the entry of private financial institu-tions, introducing moral hazard and contributingto a bad credit culture. Therefore, they should not besupported. There are, however, many types of subsi-dies that can contribute to the goals of rural devel-opment and poverty reduction without distortingthe development of sustainable rural finance. Thiscould include helping financial institutions to be-come more cost-effective and by fostering competi-tion, thus motivating them to lower interest rates.

Appropriate subsidies tosupport rural finance goalsThese subsidies can be divided into three cate-gories: subsidies for (i) financial intermediaries,(ii) financial infrastructure, and (iii) economic andsocial infrastructure. Each of these categories iscovered briefly in the sections below. The generalrule is that subsidies should be time-bound, limitedin nature, and decreasing over time.

Subsidies for financialintermediariesBank policy on financial intermediaries (OP8.30)allows the use of subsidies to create the condi-tions that make access to financial services to

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Grants and subsidies

underserved populations possible. Subsidies tofinancial intermediaries must be:

• transparent, targeted, and capped;• funded explicitly through the government bud-

get or other sources subject to effective controland regular review;

• fiscally sustainable;• fair, not giving an unfair advantage to some

intermediaries vis-à-vis other qualified and di-rectly competing institutions; and

• economically justified.

Subsidies for financial intermediaries that cannotcomply with standard eligibility criteria, such asprofitability, must be accompanied by an institu-tional development plan. Monitoring should in-clude sectoral, financial and institutional variables.Key performance indicators (KPIs) should includethe quality of earnings and assets.

Appropriate subsidies could:

• provide technical assistance to financial inter-mediaries to improve systems that enhance effi-ciency, such as management information systems;

• develop and introduce demand-responsive prod-ucts on a pilot basis;

• help develop or improve service delivery mecha-nisms that enable greater outreach into ruralareas; and

• cover a portion of the cost of establishing newbranches in areas that do not have financial inter-mediaries that serve the poor.

Subsidies for financialinfrastructureAppropriate financial sector infrastructure is anecessary prerequisite for the development of

sustainable financial institutions, not only in ruralareas (see Box 2). Significant leverage can beachieved from the investment of relatively smallamounts that would benefit a range of institutions.Time-bound subsidies may be appropriate to:

• create capacity within regulatory and supervi-sory bodies;

• support the creation of industry associations;and

• develop training institutes and credit informa-tion agencies.

Subsidies for economic and social infrastructureAppropriate investments in economic and socialinfrastructure can raise the productive potential ofthe community. They do not in themselves generateincome, but rather facilitate the carrying out ofincome-generating activities. Examples of economicinfrastructure that directly raise income earning po-tential include small-scale irrigation, market facili-ties, a harbour or cold storage for fishing, and evena building and safe for a community-based savingsand credit association. Income-earning potential isalso increased indirectly by investments in socialinfrastructure that raise the productivity of labor,such as clean water, education and health facilities.Subsidies can also be used to help develop local or-ganizations that can facilitate input supply, storage,and marketing, either directly or in partnership withother private firms. In all cases, subsidies should:

• decline over time, as the local organizations buildup capacity to cover costs through user fees; and

• include a match from the beneficiaries, prefer-ably in cash but also in kind, depending upon thebeneficiaries’ economic circumstances.


BOX 2 Example: Subsidies for the Creation of Microfinance Banks in Eastern Europe,the Caucasus and Africa.

IFC, in cooperation with other investors such as Eu-ropean Bank for Reconstruction and Development(EBRD), Kreditanstalt fuer Wiederaufbau (KfW), aNetherlands Development Finance Company (FMO)and private investors, has provided investment fundsfor the creation of microfinance banks. The EuropeanUnion (EU) and other donors provided technical as-

sistance funds for management contracts, as well asfunds to cover start-up costs for the initial two yearsof operation, decreasing to zero after some additionalyears. Source: E. Wallace, EBRD, 2003, PersonalCommunication, S. A. Ahmed, IFC, 2003, PersonalCommunication.

Grants versus credit—subsidies to the poor for asset acquisitionDuring the early stages of the “microfinance revo-lution” in the 1980s, the provision of credit to poorpopulation groups was indeed a revolution. Thestrong repayment of loans by both the urban andrural poor who had previously been considered“unbankable,” the ability of clients of microfinanceorganizations to save, and the development ofmethodologies that enabled these organizations tocover their costs demonstrated clearly that the pro-vision of financial services can be done on a sus-tainable basis. At that time, credit programs weretargeted primarily to the economically active poor,who were expected to use the funds to develop theirlivelihoods and earn an income that would supporttheir families.

Subsequent efforts to deepen the outreach ofmicrofinance to ever poorer populations have hadmixed results, however. Potential borrowers need toachieve a certain level of economic capacity beforethey are able to effectively utilize loans for incomegeneration. Those who are extremely poor, living ina post-conflict or emergency situation, or ill withlife-threatening diseases, may not be able to prof-itably manage an economic activity. Hence, theprovision of credit for such people may not result inthe improvement of their economic situation and areduction in vulnerability; on the contrary, it mayleave them indebted and without the means to repaythe loan.

In these cases, the use of grants can be consid-ered. However, since grants cannot be considered asource of sustainable financing, their use should belimited in time and amount. They may be useful tokick-start an economic activity by providing thevery poor with an income-generating asset, butmust be followed by measures that help peoplegraduate to sustainable sources of financing. Fur-thermore, extremely poor and vulnerable peoplemay need a package of assistance, including train-ing, if they are to earn income from an economicactivity on a sustainable basis. An example of an in-tegrated approach is BRAC Bangladesh’s IGVGDprogram shown in Box 3.

Some general guidelines for grants for economicactivities include the following:

• Grants for economic activities should be limitedto (i) very poor people who are too vulnerable totake on the risk of a loan, (ii) poor people living incommunities that are beyond the reach of finan-cial institutions that are willing and able to extendservices to the poor, and (iii) poor people thathave some assets and earning capacity but couldnot earn enough from the activity to pay off theinvestment cost within a reasonable time frame.

• Grants must be carefully targeted with strongeligibility criteria to avoid capture of benefitsby elites.

• Grants should be made on a matching basis;beneficiaries’ contributions should be in cash ifpossible. In-kind contributions would only beappropriate in situations such as emergency or

Grants and Subsidies 15

BOX 3 Social Safety Net Linkage Programs: BRAC’s IGVGD Program

Realizing that their microfinance programs did notreach the ultra-poor, the Bangladesh Rural Advance-ment Committee (BRAC) developed the IncomeGeneration for Vulnerable Groups Development Pro-gram (IGVGD). IGVGD combines existing socialsafety net programs such as the World Food Pro-gram and Government of Bangladesh (GoB) foodgrain assistance with skills training, savings andcredit services. The program thus addresses immedi-ate consumption needs while laying the basis forviable income generating activities. Participants re-ceive time-bound food grain assistance while under-

going skills training in areas such as poultry andlivestock raising. Participants are also required tosave and are eligible for two consecutive loans fromBRAC. After successful completion of IGVGD andrepayment of the loans, participants can graduate toBRAC’s regular microfinance program. IGVGD hasreached approximately one million very poorwomen in the 10 years from 1988/89 to 1998/99,two-thirds of whom were able to graduate to BRAC’sregular microfinance program.

Source: CGAP 2001; and information at www.brac.net.

post-conflict, where the majority of participantscould not be expected to have been able to savefor the cash contribution.

• So as to ensure that beneficiaries value and carefor the assets financed by the grant, they shouldcontribute as high a percentage as is reasonable,given their overall economic circumstances. Thisshould be at least 10% of total cost, and in manycases, a much greater percentage.

• Developing a cost recovery mechanism can helpensure that only people with serious intentionsreceive grants. One possibility would be to es-tablish local savings and credit associations thatwould capture recoveries and hold beneficiarysavings. The recoveries would help capitalize theentities for future lending within the groups.

• Grants are sometimes made to groups to financeexpensive assets that can’t be provided by grantsto individuals. However, project teams shouldbe aware that conflicts can arise from groupownership of an asset. If group ownership doesnot have clear advantages that significantlyoutweigh these potential conflicts, it might bepreferable to provide grants to carefully targetedindividuals.

• For poor people who have some assets and in-come earning capacity, financing a portion of theinvestment with a grant and the remainder with

savings and a loan from a financial institutionshould be considered. There should be a strictseparation between the financial intermediarythat is issuing the loan and the body that is issu-ing the grants, even if the funding is held in thesame financial institution. This way, it can bemade clear to the beneficiary that the loan com-ing from a financial institution or other body isindeed a loan and needs to be paid back. If bothsources of funding appear to come from thesame organization, confusion among beneficia-ries is likely to result in poor repayment anddamage to the local credit culture. The examplein Box 3 outlines how such a separation can beimplemented.

• Grants for income-generating activities shouldin many cases be combined with training ineconomic activity selection, planning and man-agement. World Bank Institute (WBI) has an es-tablished Grassroots Management Training pro-gram, which includes household management,business skills, and financial skills. These im-prove the ability of targeted groups (especiallyrural women) to manage their income-earningactivities and finances, often obviating the needto seek credit and making them more successfulwhen they do. Such programs are sometimeslinked with literacy and health programs.


OverviewThis chapter provides an overview of deliverychannels and models for rural financial services,explores their suitability under different circum-stances, and identifies key success factors.

Financial services are delivered to rural popu-lations by organizations that exist along a contin-uum from formal to informal. The boundariesbetween these categories are often blurred, but ingeneral formal financial institutions (FFIs) arelicensed banks or nonbank financial institutionsthat are regulated and supervised by a central au-thority or authorities. They include public andprivate commercial banks, state-owned agricul-tural and rural development banks, cooperativebanks, microfinance banks and special purposefinancial institutions such as leasing, housingand consumer finance companies and providersof payment services. Informal providers of finan-cial services include small groups that rotate in-ternally generated savings as loans to membersand that are not licensed, regulated or supervisedin most countries. They also include moneylenders, pawn shops and businesses that providefinancing to their customers. In between standthe semiformal institutions such as non-govern-mental organizations (NGOs) and small financialcooperatives. These entities have a legal structureand are licensed, but have not typically been sub-ject to banking regulation and supervision.

In many countries, informal providers of fi-nancial services can be found in rural areas

where there are no formal providers of financialservices. They offer a range of services, fromsafeguarding of savings to short-term loans todomestic and even international transfer servicesfor remittances. These entities are often not con-sidered to be part of the financial sector by fi-nancial sector specialists and are thus often notincluded in discussions about financial sector de-velopment, even in rural areas. However, they areincluded in this approach paper, given their im-portance to poor people in rural areas, especiallythose areas not served by formal or semiformalinstitutions.

Potential areas of interventionfor the World BankThere are several areas of intervention that apply tomost delivery channels. Establishing and maintain-ing a policy dialogue about rural finance and its im-plications for government policy could well be thefirst step in the development of a rural finance pro-ject. The range of issues that might apply in a par-ticular country is outlined in Chapter 2. Establish-ment of financial sector infrastructure such ascredit information agencies, industry associations,training institutions and activities related to landregistration and land titling are also relevant nomatter which approach is finally chosen. Areas ofintervention related to a specific delivery channelwill be outlined in the relevant sections of this

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Delivery channels and models for ruralfinancial services


chapter as well as Chapter 5. The matrices in Chap-ter 7 provide a road map for decision-making.

Success factors for financialinstitutions in rural areasThe following success factors suggest ways thatfinancial institutions can orient their operations towork profitably in rural areas.

Portfolio diversificationA financial institution is able to significantly reduceits portfolio risk through geographic diversifica-tion, customer diversification and product/servicediversification. However, for this to work success-fully, economies of scale in sub-markets need to beachieved. Otherwise, there is the risk that the insti-tution is spreading itself too thin. Diversificationonly works if the institution invests in understand-ing the needs of its new clientele, develops prod-ucts that respond to those needs, and installs sys-tems for efficient processing and monitoring. If thisis not done, higher rather than lower risk could bethe result.

Development and marketing ofdemand-responsive products The experience of successful microfinance institu-tions demonstrates that even poor rural clients areable and willing to pay for financial products thatmeet their requirements in terms of convenient ac-cess and quick turnaround as well as the features ofthe products themselves. Deposit services are espe-cially valued if there is fast and inexpensive accessin case of emergency cash needs. Undertaking mar-keting campaigns to inform potential clients aboutthe products and services that the institution offersis an important activity that is often overlooked.

Good governance and managementGood governance and management are majorrequisites for any financial institution that intendsto stay in business for the long haul. Transparentdecision-making procedures based on pre-agreedrules, enforcement of these rules, and committedmanagement from the top on down are key.

Appropriate management structureand staff incentives in order toattract and retain competentmanagement and staffPerformance-related compensation that is basedon fair and measurable indicators, transparent pro-motion procedures, intensive training, and effortsto create a “corporate we” have been shown toincrease staff motivation and loyalty.

Appropriate credit technologyfor different lines of businessDifferent lines of business require differentmethodologies, know-how and staffing. Financialinstitutions are therefore well advised to acquire ordevelop the right employee skill mix and to installworkable and efficient systems (see Box 4). For ex-ample, in lending for agriculture, loan officers needto be knowledgeable about agricultural productsand markets and understand how to structure dis-bursements and repayments within the agriculturaltimetable. Typical corporate banking does not re-quire this particular skill set. Lending to small andmicro businesses again requires a different ap-proach. The microfinance experience has shownthat high repayment can be achieved on loans,when methodologies include alternatives to landcollateral, and repayments are based on householdcash flows, rather than cash flows from the eco-nomic activity alone.21 Group-based lending inrural areas can decrease the transaction costs andrisks of providing very small loans to poor clients,if coupled with the promise of repeat loans for cus-tomers that pay on time. Individual loans securedby guarantors and household assets might be suit-able for customers with larger credit needs.

Installation of efficient internalprocessing, control andmanagement information systemsA reliable management information system (MIS)providing timely information for decision-making,and knowledge of its uses and limitations, is criticalfor the success of any financial institution. Up-to-date information on clients’ repayments and on de-velopments in the markets for the principal agricul-tural products financed by the bank is especially

Delivery Channels and Models for Rural Financial Services 19

BOX 4 Appropriate Credit Technologies

Credit technologies vary according to a financial insti-tution’s client group, the business sector, and the pos-sibilities of obtaining and enforcing loan securities.

Group lending technologies were pioneered by theGrameen Bank in Bangladesh, and are now beingused by numerous microfinance institutions all overthe world. Group lending technologies replace theneed for collateral from individual borrowers withpeer pressure of the group by making the entire groupliable for the repayment of individual loans. Thecredit program is usually supported by mandatory ed-ucation and training programs for members, as wellas by obligatory savings, and is suitable for very poorborrowers who cannot offer collateral.

International Projekt Consult (IPC), a private con-sulting firm, has developed credit technologies forindividual loans that emphasize the importance of theclients’ ability to repay from income received from avariety of sources over the ability to offer collateral.Loan officers develop a strong business relationshipwith the client and are responsible for the same clientover the lifetime of the loan. Salaries are performancebased, ensuring a loan officer’s vital interest in each

client’s repayment performance. This technology hasbeen successfully implemented by IPC in many dif-ferent regions.

Latin America Agribusiness Development Cor-poration SA (LAAD) provides loans to mediumsized agribusiness and agricultural enterprises inseveral Latin American countries. The specializa-tion has enabled LAAD to build up considerableexpertise in agricultural lending and knowledge ofits inherent risks. The corporation follows a client-centered approach, building long-term client rela-tionships with contract terms adjusted to the client’scash flow requirements, backed up by enforceablecollateral. LAAD takes a long-term view of agri-cultural finance and is willing to restructure loansbased on risk assessments. LAAD’s loan portfoliois well diversified in terms of sectors and countries,and thus allows the corporation to fill a marketniche hardly serviced by commercial banks in LatinAmerica.

Sources: Grameen profile at www.grameen-info.org, IPC profileat www.ipcgmbh.com; LAAD 2004 and 2005.

important in a high-risk sector such as agriculture.Investments in technologies that enable the institu-tion to more efficiently process transactions, con-trol repayments, and more effectively reach out tocustomers will result in lower costs that may makethe provision of services to rural and low-incomeclients more attractive (see Box 5).

Access to appropriate riskmanagement products foragricultural lendingLending for agricultural or livestock productionentails nonfinancial risks that often preventlenders from entering this market. The major risksare unpredictable weather and strong price swingsfor commodities traded in international markets.Pilot efforts are underway to assess the feasibilityof risk management instruments to reduce someof these risks. However, it is too early to predictif these can become commercially viable (seeChapter 6).

Commercial banks and rural financeIn most countries, commercial banks represent thelargest part of the financial sector and offer a diver-sified set of services that are unparalleled by anyother institutional form. They are more suitable forthe provision of financial services to small andmedium enterprises (SMEs), including farm enter-prises, than to the very poor, who might operatepart-time seasonal activities and can be more effec-tively served in many cases by semiformal andinformal institutions.

In order to evaluate and best work with commer-cial banks within the framework of developmentgoals in rural finance, a closer look at the objectives,purposes and motivation of such institutions is inorder. In general, commercial banks, in contrast tostate-owned development banks, have the one over-riding objective of achieving profits for their share-holders. Social development objectives, such asdeeper outreach into poorer population groups and


remote geographical areas that are underlying theWorld Bank’s rural development strategy, are not,for the most part, on their radar screens, and will beembraced if, and only if, there are other benefits thatoutweigh the financial disadvantages. These bene-fits include access to new markets with profit poten-tial, or access to government subsidies. There is, ingeneral, a significant conflict of objectives betweencommercial banks seeking to maximize profits anddonor institutions such as the World Bank that sup-port social as well as economic goals. In order to besuccessful, interventions need to start with an align-ment of interests and provide the tools to achievesuch alignment. Far too often, funds for refinancingare provided to commercial banks who are eager toaccept them and use them once or twice to makeloans to underserved groups, but who do not de-velop a credit technology that will enable them tolend profitably to these groups over the long term.Farsighted international commercial banks, such asthose adhering to the Equator principles,22 realizethat adhering to a double or triple bottom line23 pro-vides for low-cost public relations and other bene-fits, like increased customer or shareholder loyaltyor gaining a new clientele. In many developed andmost developing countries, and especially in ruralareas, such benefits have not yet become obviousand accepted, and should not be counted uponas significant motivators.24 For these reasons, at-tempts by governments and donors to motivate com-mercial banks (often strong-arming them) throughspecial credit lines to provide financing, oftenassigning quotas for special groups outside theircore business, such as small business owners,

micro-entrepreneurs and farmers, have in generalnot resulted in sustainable access to such financing.Many such credit lines are not even successful in theshort-term, as evidenced by cancelled credit linesand underutilized credit lines.25

However, one trend is emerging that might moti-vate commercial banks to extend their services to alow-income or more rural clientele. In nearly allWorld Bank partner countries, international bankshave established a strong presence over the pastdecade, competing with domestic banks for theirbest corporate customers. Local banks are losingsome of these clients, so are increasingly beingforced to examine their competitive position and tolook for other, untapped markets, where they arebetter able to compete.26 These untapped marketsinclude the rural areas of most countries and low-income people who have been unable to accessformal financial services.

Governments and donors can achieve sustainableresults by aligning their development interests withthe self-interest of commercial banks, i.e., helpingcommercial banks to achieve their objectives. Thismeans, for example, assisting them to improve theprofitability of existing rural financial services orsupporting their expansion into rural markets withtechnical assistance and know-how.27 In general, itis recommended that World Bank programs andprojects select those rural financial institutions forpartners, where there is a strong alignment of inter-est in serving those segments of the rural populationthat are currently underserved, especially farmersand low-income populations, and where servicescan be provided on a sustainable basis.

BOX 5 Using Palm Pilots to Speed Transaction in Ecuador

Banco Solidario in Ecuador has introduced PalmPilots to enable loan officers to process transactionsimmediately in the field and transfer data to thecenter. The software used integrates field based andcentral data collection and processing into a compre-hensive management information system (MIS). Thistechnology has supported the introduction of creditscoring systems for client selection, segmentationand payment collection in the urban sector. Scoringuses past performance to predict future behavior andconsequently, helps loan officers structure loans. Thetechnology enabled the bank to improve its efficiency

by shifting time from administrative work to clientfollow-up, responding more quickly to loan appli-cants, and realizing substantial savings on office sup-plies. Banco Solidario plans to introduce credit scor-ing to the rural sector once sufficient historical datahas been collected. The Palm Pilot software andcredit scoring system were developed by ACCIONInternational. Other MFIs in Latin America, for ex-ample Mibanco in Peru, are now introducing mobilephones for similar purposes.

Source: Barton, S. and del Busto, C., 2004.

Concerns of financial institutions about the prof-itability of moving into rural areas and especially intoagricultural loans are valid and need to be addressed.These include high transaction costs due to smallloan sizes and large geographic spread, systemic riskregarding financing for agriculture and agriculture-related ventures, little knowledge of rural customersand their business dynamics and high costs to obtainsuch knowledge, low equity base and frequent lack ofcollateral of the clients to be financed making themrather risky business prospects, insufficient creditknow-how of banks in those countries where invest-ments in government securities are or were in thepast the investment of choice,28 lack of efficientmanagement information and portfolio managementsystems, unclear property rights and lack of collat-eral enforcement rights, government and donor-influenced culture of non-performing loans, unfavor-able government policies such as overly largegovernment borrowing that crowds out smaller bor-rowers, interest rate caps, and interest rate subsidies.These weaknesses are often exacerbated by lowinstitutional capacity, weak or corrupt management,and poor organization of the institutions.

As outlined in Chapter 2, these concerns can beaddressed on three levels: the policy level, includ-ing the development of a favorable macro-economic, legal, and regulatory environment; theenabling environment, which includes the creationand/or improvement of credit information systems,industry associations, and training institutes thatoffer business development services to improveborrowers’ ability to manage their businesses; andthe institutional level, including instruments to

mitigate risk, reduce transaction costs and increasethe portfolio quality of financial institutions. Last-ing results can be achieved best if deficiencies areaddressed on all three levels rather than rather thanworking on one level only.

Models for commercial banksentering rural marketsThere are a number of models that a bank canchoose when contemplating entry into rural mar-kets. The choice depends on the importance of thismarket within a bank’s overall strategic plan, theavailable business opportunities, the resources it iswilling to invest and its appetite for risk. Some ini-tiatives undertaken by commercial banks over thepast decade are outlined below.

Integrating rural finance and financing for agriculture into a commercial bank’smainstream businessThis approach is usually chosen by a financial insti-tution that realizes that its traditional mainstaybusiness is getting increasingly competitive, andconsequently has made the strategic decision tofocus on new markets in order to survive or to in-crease profitability. This business reorientation cantake place in farsighted institutions, without donorsupport as outlined in Box 6 below.

In other cases, however, support from donors isinstrumental.Traditionally donors and governments


BOX 6 Banco del Pichincha

Banco del Pichincha in Ecuador has developed astrong rural finance program framed in that bank’soverall strategy of becoming the country’s leading re-tail banking institution. To achieve this goal, Bancodel Pichincha has established a network of over 220branches serving even remote villages. In 2001, Pich-incha was providing almost 20,000 small loans topeasants and rural dwellers with an arrears rate ofonly 5%. The bank’s relation to the farmers has beenthe result of its engagement with agro-processing in-dustries, to which the bank provides cash manage-

ment services. One of these services is the handlingof payments to the small farmers supplying inputs tothe industry by depositing such payments into sav-ings or checking accounts. The bank has been able tolearn through the management of these accountsabout the small farmers’ income level and cash flowpattern and has tailored specific loan products forthem, which allow a better utilization of the bank’scostly rural infrastructure.

Source: Buchenau, J. et al., 2003.


support interested banks through special-purposecredit lines and technical assistance. In many cases,however, it has been the experience that banks con-tinue to focus on the supported markets after projectend only if the owners and top management of the fi-nancial institutionarehighlysupportiveandconsiderit to be in their own interest. The example in Box 7below demonstrates how significant donor involve-mentandaninnovativethree-partyapproachresultedin increased lending for agricultural equipment.

Establishing a separate unit within abank to serve non-priority marketswith lending productsMany commercial banks are quite interested inentering new markets such as agri-business andSME lending, while staying focused on their exist-ing core business. In this case, setting up a separate

unit as a profit center and allowing it to develop adistinct culture and business model can be a goodsolution. This model has been used successfully bythe EBRD to introduce SME lending to commer-cial banks in Kazakhstan (Box 8). Another exampleis Kingdom Bank in Zimbabwe, which has estab-lished a separate microfinance division with theassistance of ACCION International.

Establishing and spinning off aseparate unit to serve rural marketsand low-income populationsThis approach goes one step further than the estab-lishment of a separate unit; there is the goal ofspinning off the unit once it has demonstrated itsprofitability. Financial Bank is using this model inWest Africa, with the goal of establishing a networkof small special purpose banks (Box 9).

BOX 7 Lending for Agricultural Equipment, The German Romanian Fund in Romania

In Romania, farmers often lack financial resources tobuy equipment, while commercial banks lack securefinancial products and procedures to reach these ruralclients. Guaranteeing equipment loans is the mainissue because banks do not want to take pledges onequipment they would have to sell in case of client de-fault, and farmers do not have collateral. The GermanRomanian Fund, a program implemented by HorusDevelopment Finance in Romania, offers a solution toboth farmers and commercial banks: an innovativeproduct consisting of a bank equipment loan with abuy-back clause from the equipment supplier. Thecommercial bank and the equipment supplier sign a

framework cooperation contract, and then, for eachloan, a credit contract guaranteed by a buy-back clauseis signed by the three parties (bank, client and sup-plier).All three parties benefit: i) the banks, who reacha new clientele and do not have to deal with the equip-ment in case of default; ii) the equipment suppliers,who can sell more equipment and who are very inter-ested, if necessary, in buying back the equipment at aprice lower than the market price; and iii) the ruralclients, who have access to financial resources to buynew as well as second hand equipment.

Source: Horus Development Finance, 2004.

BOX 8 EBRD SME Lending Program in Kazakhstan

The major commercial banks in Kazakhstan that qual-ified under the EBRD guidelines were provided withsignificant technical assistance to set up a separate de-partment with separate staff, credit procedures andmanagement, often located in a separate building. Inthe early stages of the project, the SME financing unitswere managed and tightly controlled by international

consultants who installed all the systems and proce-dures and provided training to bank staff. Based on thesuccess of the Kazakhstan project, EBRD expandedthe program to other Central Asian countries, in coop-eration with IFC.

Source: Wallace, E., 2003; and S.A. Ahmed, 2003.


Establishing a separate unitmanaged by a service companyService companies are nonfinancial companies thatoriginate and service loans on behalf of a bank, fora fee (see Box 10). Loans are booked on the bank’sbalance sheet but all staff are employees of theservice company. The service company identifiescustomers and initiates transactions, while takingadvantage of the bank’s funds, as well as its

back-office processing and administrative struc-tures. This model has numerous advantages: it doesnot require a financial institution license, initialcapitalization is very small as it does not need loanfunds, and it uses many parts of the bank’s existinginfrastructure, thus reducing costs. ACCION Inter-national has worked with banks in Haiti (Soge-bank), Ecuador (CrediFe) and Brazil (Banco Real)to establish service companies.

BOX 9 Financial Bank of Benin and Chad

Financial Bank (Benin, Chad) is an example of a bankforming a microfinance unit within the bank with theobjective of spinning it off once it has achieved out-reach, sustainability and profitability. The spun-offunits, called Finadev, are private commercial microfi-nance institutions, with a banking group as the mainsponsor and shareholder, international financial insti-tutions as shareholders and partners, and a technicalpartner (Horus) directly involved through equitycapital and technical assistance.

Finadev Benin and Finadev Chad are freestandingmicrofinance units focusing on low-income cus-tomers. They currently target three customers seg-ments, presently all urban: (i) women micro-entrepreneurs, especially active in trade, (ii) SMEs;and (iii) employees in the formal sector, with loansused mainly to fund housing improvement work or aninformal business.

Finadev Chad already has a branch in Moundou,the second city of the country, which is located in the

main agricultural area of Chad. Many of the womenmicro-entrepreneur clients of Finadev have, in addi-tion to their business, a cereal storage activity. Astudy is presently being conducted to develop asmall agricultural equipment-financing product. Col-laboration with an agricultural development programwould certainly help Finadev to develop appropriateproducts.

Finadev Chad intends to be, within a few years,strong enough to serve other types of customers inrural southern Chad. Important economic reforms areunderway to strengthen the private sector in this re-gion, and these reforms require that new intermedia-tion mechanisms be available to finance agriculturalproduction and rural activities. This will only be pos-sible if a sustainable and professional financial insti-tution exists.

Source: C. Falgon, Horus Development Finance, Personal Com-munication, 2004.

BOX 10 Sogebank, Haiti

Sogebank, Haiti’s largest locally owned commercialbank, launched its microcredit program in 2000, aftera change in legislation made such operations possi-ble. Sogebank established Sogesol (Societe GeneraleHaitienne de Solidarite), an independent non-bankmicrolending company, as its service company.Sogesol provides loan origination and administrationservices to Sogebank, which issues the loans.ACCION International is a shareholder of Sogesol,has provided technical assistance and has taken over

the management contract of the company in 2004. Asof June 2004, Sogesol has established nine branchesin the capital and secondary cities in Haiti, servingover 6400 clients with an average loan size of approx.US$900.00. Its portfolio quality remains a challengedue to political unrest and hurricane damages thataffect the repayment capacities of its clients.

Source: www.accion.org/about_where_we_work_program.asp_Q_T_E_17.


Linkages and agency arrangementswith third partiesLinkages or agency arrangements with microfi-nance institutions, NGOs or village organizationsare another way for commercial banks to penetrateremote rural areas. This model enables the bank toavoid high start-up costs for infrastructure, andtakes advantage of the expertise of existing organi-zations. Banco Solidario of Ecuador is utilizing ex-isting rural credit cooperatives as agents to serverural areas that are outside of its established mar-ket.29 Rural post offices can also serve as agents toprovide financial services, especially for the collec-tion of savings. India is a case in point, where sig-nificant savings are collected by the post in ruralareas.30

Establishing mobile branches to extend rural outreachMobile banking allows commercial banks to re-duce the transaction costs of servicing rural areas.Although initial capital investment in mobile of-fices is substantial, these costs need to be seen inrelation to those of establishing and maintaining afixed delivery mechanism. The partner bank for theWorld Bank’s Rural Finance Project in Vietnam hasbeen effective in reaching over 315,000 people inremote areas through mobile units, and these unitshave proved to be much more profitable than estab-lished branches.31 The case of Kenya’s EquityBank, outlined in Box 11, demonstrates importantsuccess factors such as use of secure vehicles andaccess to strong communication lines.

Areas for possible BankinterventionsSupport to commercial banks entering rural areascan take many forms, apart from activities relatedto good policies and the enabling legal and regula-tory environment that were outlined earlier in thischapter. The boxes in this section on commercialbanks provide examples of interventions rangingfrom technical assistance to the financing of out-side management contracts to the provision of tech-nologies, including installation or improvement ofcommunication and computer systems. Support forthe training of bank management and staff, as wellas access to firsthand information about successfuloperations through exposure visits, staff exchangesand on-site demonstrations is often invaluable. Theprovision of credit lines is another intervention thatis outlined below.

Donor credit lines tocommercial banksThe recent OED review32 of Bank credit lines from1993–2002 reveals that many projects did notachieve the stated project objectives with regard tothe project credit lines or were not in a position tomeasure the results. Specifically, it noted that re-ceiving banks were in many cases not sufficientlystrong, there was insufficient supervision, and lackof meaningful information on performance. Therecommendations reiterate that projects mustcomply with the Bank’s policy on financial inter-mediary lending (OP8.30); key provisions of this

BOX 11 EBS of Kenya

Equity Bank, originally Equity Building Society(EBS) of Kenya, a mortgage lender, decided to re-focus its business on low- and moderate-incomeborrowers and customers in rural areas. Whilesome new branches were opened in more populousrural areas, creating permanent branches in remoteareas was not a financially viable solution. EBSpurchased mobile branch vehicles with special fea-tures, including all-terrain driving ability, constantvoice and data communication, power back up and

high security. The convenience of access to themobile branches resulted in many new customersand also helped reduce branch congestion by at-tracting existing customers to the units. By the endof 2002, EBS was successfully operating 10branches in the largely rural Central Province andreaching 21 isolated communities via mobilebanking units.

Source: CGAP, 2003.

policy are that interest rates to the end-customersshould not be subsidized, and that the project mustestablish eligibility criteria for banks that includecommercially oriented governance, adequateprofitability and portfolio quality, and appropriatestaff capacity for sub-loan appraisal and monitor-ing. Banks that do not meet these criteria may besupported, provided that they agree to an institu-tional development plan that includes a set of time-bound performance indicators. In order to imple-ment such an action plan, many banks would needtechnical and/or management assistance. Signifi-cant funding in the form of matching grants and amulti-year time horizon are likely to be necessaryfor such interventions to be successful.

A specific issue that needs to be addressed isthe provision of credit lines denominated in hardcurrencies, such as the dollar or the euro. Govern-ments often pass the foreign exchange risk on tothe participating bank, with a number of potentiallyundesirable effects. Foreign currency refinancingof local currency loans often results in highly riskyforeign exchange exposures. To avoid this risk, thelocal bank pushes it on to the end-clients, who areusually the weakest link in the chain and the leastable to carry such a risk. Their foreign currencyloans will have to be repaid from their local cur-rency earnings. If there is significant currencydepreciation and clients do not have foreign cur-rency earnings to repay the principal and interest,loan defaults are often the result, with rather un-pleasant consequences for both the clients and thebanks, which have to cover the losses from theirown funds. It is therefore recommended that for-eign currency funding only be provided if thoroughanalysis indicates that local banks and their cus-tomers can easily carry the exchange rate risk. Hardcurrency credit lines could be appropriate if theeconomy is mostly hard currency based, the major-ity of the envisioned end-clients have hard currencyearnings that enable them to avoid exchange ratelosses, or hedging instruments are available.

State-owned agricultural andrural development banksState-owned agricultural and rural developmentbanks have the dual objectives of operating

profitably—or at least recovering their costs—andsupporting the government in achieving socialdevelopment goals (double bottom line33). In the1970s and 1980s, state banks were established inmany countries, often with donor support, withhigh hopes of establishing permanent access tocredit in underserved areas, especially for agricul-ture. Subsequently, in many cases, these institu-tions neglected, or were forced by governments toneglect, the first objective. This translated manytimes into decision-making by and for special inter-est groups, high transaction costs, high loan losses,and corruption. As a result, many of these institu-tions were closed or privatized in the late 1980s andearly 1990s, with the expectation that the privatesector would pick up the pieces.

However, in many cases, rural branch networkscontracted following privatization, the private sec-tor did not step in, and in some cases, financialinstitutions completely disappeared in rural areaswhen state banks closed.34 Consequently, newthoughts have begun to emerge about the potentialof such institutions for rural finance. While theshortcomings of state-owned banks are well knownand have been extensively documented,35 the disad-vantages of their disappearance have also now beenrecognized. As a result, quite a few Bank clientcountries are looking anew at setting up such insti-tutions and are asking the Bank for guidance andsupport.

By virtue of their often significant equity base,existing infrastructure in rural areas, and bankingexperience, state banks focusing on the financialneeds of rural populations offer the potential to ex-tend a whole array of financial services into ruralareas, to an extent and scale that most commercialbanks and other financial service providers are notable to match. This alone would not justify a specialfocus by the Bank on such institutions, especiallygiven the extensive negative experiences. However,there are now a number of state-owned banks thathave been able to provide financial services in ruralareas on a sustainable basis and at a significantscale. There are three distinct ways that this hasbeen done: (i) reformation or turn-around of exist-ing development banks, (ii) start-up of new bank ornonbank financial institutions, and (iii) specializedmicro or rural finance units within existing state-owned banks.



Reformation or turn-around ofexisting development banksRestructuring a poorly managed state bank requiressignificant resources and political will from allstakeholders, and close cooperation and alignmentof objectives. In several countries, mostly in Asia,the existing large state banks were neither priva-tized nor closed down, but rather reformed to bettermeet their stated objectives. A case of a reformedinstitution is BAAC Thailand,36 which has hugeoutreach, providing insurance, savings and creditservices to nine out of ten farming households. Re-formation of BAAC has been strongly supported bythe government and donors, who have providedtechnical assistance in a variety of areas, includingnew product development and implementation. An-other case is the National Microfinance Bank(NMB) of Tanzania that is in the process of beingprivatized after a management-led turnaround thatalso benefited from donor support. NMB has astrong network of rural branches and is focusing onthe savings business, with lending being introducedon a very cautious basis.37 The case of the Agricul-tural Bank of Mongolia is highlighted in Box 12above. It is interesting to note that these quite largeinstitutions with significant rural outreach report ahigher demand for savings than for credit. A nettransfer of funds from rural into urban areas at aratio of one to two is taking place.38

Start-up of a new agricultural bankor nonbank financial institutionCreating a new institution might be the approach ofchoice in those countries where there are no finan-cial institutions in rural areas that could be turnedaround, or the existing institutions are beyond turn-around aspirations. This has been the case in mostcountries of the former Soviet Union where, withfew exceptions, the former state-owned agricul-tural banks were liquidated, leaving a void that hasnot been filled by private sector institutions as an-ticipated. The World Bank has been instrumental inestablishing two agricultural finance institutions inthis region, the Agricultural Development Bank ofLatvia, which has been successfully privatized, andthe still to be privatized Kyrgyz AgriculturalFinance Corporation (KAFC), which is profiled inBox 13 on page 27.

Specialized micro or rural finance units within an existingstate-owned bankA specialized department focusing on rural clients,that can be isolated from political pressures andhas the organizational independence to follow bestpractices, might be the preferred solution in thosecountries where there is an existing state-ownedinstitution that is focusing on a different market

BOX 12 Agricultural Bank of Mongolia

After overcoming initial strong opposition from themultilateral financial institutions including the WorldBank, the government of Mongolia obtained supportfrom bilateral donors to turn-around the loss-makingAgricultural Bank of Mongolia (AgBank, renamedKhan Bank in 2004).39 Over a two-year time period,the bank was restructured, based on sound bankingprinciples, while keeping to its mission of providingfinancial services in rural areas. AgBank is one exam-ple of a privatized bank that recognized significantbusiness opportunities in rural areas and took advan-tage of its competitive position as the only bank withan extensive branch network. AgBank was able to in-crease its rural penetration by following a well-thought out strategy of offering demand-responsive

products based on extensive market research andmany other good practices. It decided to extend its al-ready extensive network from 250 to 350 branches. Akey success factor was an experienced hands-on inter-national management team, free from loyalties to spe-cial interest groups in the country and backed by thegovernment and generous donor support.40 Followingprivatization in early 2003, there was the general an-ticipation that the new private owners would refocusthe bank away from rural activities. This did not takeplace, as the new farsighted owners are well aware ofAgBank’s strong position and earnings potential inrural Mongolia.

Source: Dyer, J. et al, 2004; also CGAP, 2004b.


and doesn’t need a turn-around. Indonesia’s state-owned Bank Rakyat (BRI) is a case in point.41 Itslocal micro and rural finance units were establishedto operate completely independently of the parentinstitution and to provide financial services tothe rural population on a sustainable basis. Thestrength of this system was demonstrated duringand in the aftermath of the Asian financial crisis.The case of CrediAmigo in Brazil is highlighted inBox 14 above.

In addition to the success factors for financial in-stitutions outlined earlier in this chapter, the state-owned banks cited above consistently made use ofthe following success factors:

• Clear separation of banking operations anddecision-making from government influence, andstrong political will from all parties for an inde-pendent institution, including sanctions againstpolitical actors who attempt to use their influ-ence to interfere;

• Appropriate governance structure including amajority of private sector representation on theboard, political independence of the board andmanaging director, overlapping terms of ap-pointed officials with the electoral cycle, and anon-removal clause for the managing directorexcept for proven malfeasance, corruption andincompetence;

BOX 14 CrediAmigo

CrediAmigo is a micro lending initiative of Bancodo Nordeste, a regional state-owned developmentbank dedicated to stimulating economic develop-ment in Brazil’s poorest region. In 1997, Banco doNordeste approached ACCION for help in design-ing a microcredit program. The program, calledCrediAmigo, began in five pilot branches andquickly expanded to 51 branches in 1998. WhileCrediAmigo is managed by Banco do Nordeste, ithas separate staff and offices adjacent to the bank’sbranches. This pre-existing infrastructure has facili-tated CrediAmigo’s expansion at a low cost. In2003, it served 118,000 active borrowers through anetwork of 165 branch offices with an average loan

size of US$211, and just under 50% women bor-rowers. CrediAMIGO entered into a cooperationprogram with the Mexican MFI Compartamos inorder to improve its outreach in rural areas. A keysuccess factor has been strong and patient supportfrom the World Bank and highly professional tech-nical assistance from an international microfinancenetwork. While in the past CrediAmigo focused onnonagricultural loans in densely populated areas, itplans to enter more remote rural areas, again sup-ported by technical assistance.

Source: The MIXMarket Web site: the global information exchangefor the microfinance industry. Accessible at www.MixMarket.org

BOX 13 KAFC of Kyrgyzstan

The Kyrgyz Agricultural Finance Corporation(KAFC) was established in 1997 under the Bank-financed Rural Finance Project as a nonbank financialinstitution serving farmers and rural entrepreneurs.KAFC was designed to operate on a commercialbasis—extending credit based on rigorous financialappraisal, taking full collateral, and fully covering itscosts through its on-lending rates. The bank’s loanrecovery rate reached approximately 98% in 2004.KAFC offers individual collateralized loans andsocial collateral-based group loans on a short- andmedium term basis. KAFC supplies 90% of allagricultural and livestock lending in Kyrgyzstan,

serving mainly small clients with an average loansize of US$1,400. KAFC has also started to lend tomicro-credit organizations, and had financed ninesuch organizations by 2003. KAFC has applied for abanking license in order to extend services to includedeposit and payment facilities. The Bank assisted inestablishing an enabling environment, providingfunds for on-lending, obtaining donor support fortechnical assistance and early stage operating ex-penses, and ring-fencing the new institution from po-litical influence.

Source: Broka, S., 2004.


• Consistent government policies concerning thedevelopment of a sustainable rural financial sec-tor; e.g., no debt-forgiveness, interest rate subsi-dies or interest rate caps;

• Sufficient, no-strings-attached funding by gov-ernment and/or donors for expert internationaltechnical assistance to build the institution’s sys-tems and products;

• Ability of the institution to charge full cost-recovery interest rates (net of time-bound subsi-dies for technical assistance (TA) and initial op-erating expenses);

• Access to local currency funding through depositmobilization or credit lines;

• Long-term approach that recognizes that progressmight be slow and initially not spectacular.

Areas for possible BankinterventionsThe areas for possible interventions to supportcommercial banks equally apply to state-ownedbanks. An additional area of intervention at thepolicy level is dialogue on the strict separation ofbanking decisions from government influence.Supporting the start-up of specialized rural finan-cial institutions, such as KAFC, through a range ofactivities on all three levels (policy, enabling regu-latory and legal framework, and institutional devel-opment) is also a possibility that could be exploredif there are no other suitable existing institutionsthat could be supported.

Specialized rural microfinance institutions Specialized rural microfinance institutions can takethe form of NGOs, commercial finance companiesor specialized financial institutions operating underthe supervision of the banking authorities.

NGOs and microfinanceNGOs have played a leading role in the develop-ment of the microfinance industry over the past25 years. NGOs have an ownership structure totallydifferent from companies or cooperatives; in fact,they do not have real owners. They are usually es-

tablished under a country’s laws as a non-profitsociety or trust with charitable objectives. TheNGO’s capital comes mainly from donors, becausethey are unable to raise capital through issuingshares or mobilizing deposits. Many microfinanceNGOs began life as organizations with the missionof alleviating poverty through multifaceted enter-prise development (Box 15). Over time, manybegan to realize that their clients particularly valuedeasy, flexible and continuous access to financial ser-vices, and that the interest from loans could coverthe NGOs’ costs, provided that the organizationshad sufficient scale and efficient methodologies.Consequently, starting in the late 1980s and early1990s, many of these organizations began to shiftfrom a social approach to a business approach, fo-cusing on the sustainability of the organization aswell as the sustainability of clients’ businesses. Theborrower gained recognition as a valued client(rather than a “beneficiary”) with diverse and con-tinuous needs for financial services—not just loans.

With their new orientation as sustainable finan-cial businesses serving a low-income clientele, mi-crofinance NGOs needed to grow the liabilities andcapital side of their balance sheets, so they wouldhave the scale to become financially viable andhave sufficient funds to serve new clients as well asold ones. However, their status as NGOs made thisdifficult. They couldn’t raise capital because theyweren’t shareholding entities. They couldn’t raisedeposits, except in some cases small savings fromtheir members that served to partially guarantee aloan. These savings could not be intermediatedbecause the NGOs were not licensed as financialinstitutions and had no shareholders who couldrecapitalize the institution in the case of loss. Theyalso had great difficulty accessing commercialbank loans because of their lack of owners and per-ceived status as charitable non-profit organizations.In many cases, this status also created difficultieswith the tax authorities.

Despite the constraints noted above, NGOs playa valuable role in the provision of financial servicesto poor populations, providing outreach that other-wise would not be possible. However, unless theNGO focuses on provision of financial services, orstrictly separates its financial and nonfinancial ac-tivities, there can be significant problems, includ-ing client confusion between cost-covering finan-cial services and subsidized social services.

Specialized financial institutionsand commercial finance companiesIn order to overcome the constraints outlinedabove, some microfinance NGOs have undertakenan ownership transformation from NGO to com-pany with share capital. This change has enabledthem to attract shareholders, access capital mar-kets, become licensed as banks or nonbank finan-cial institutions, and offer new products to theirclientele, including deposit products. However, ex-perience has shown that transformation is a diffi-cult and lengthy process, involving not only majorchanges in ownership and governance, but alsoacquisition of a whole new set of skills, such as themanagement of deposits and the production oftimely and consistent information for regulatorybodies. An alternative from transformation is forthese organizations to become agents of main-stream financial institutions; the NGO benefitsfrom bank funding and the bank benefits from theNGO’s capacity to reach a poor clientele.

As a result of the accumulated lessons and con-straints, many institutions specializing in micro andrural finance that have recently been created byinnovators like International Projekt Consult (IPC)and ACCION began life not as NGOs, but aslicensed and regulated financial companies.

Microfinance networksOver the past decade, many national and regionalnetworks have been established by the financialentities that are focused on providing financialservices to the poor. While most of the financial in-

stitutions in these networks are urban-based, thereis a growing interest in expansion into rural areas.42

Other networks have been set up by internationalorganizations that have provided technical supportto microfinance institutions in a large number ofcountries. Examples include Women’s World Bank-ing, Opportunity International, ACCION Interna-tional (see Box 16) and IPC. Most of the networksreceive donor funding for various purposes and canpotentially be valuable partners for the Bank inrural finance. The institutions participating in thesenetworks have a wide variety of institutional types:NGOs, nonbank financial institutions, banks, andcooperatives.

Areas for possible Bankinterventions in rural microfinanceThe Bank can support the development of effi-cient microfinance institutions in rural areas in avariety of ways, ranging from provision of adviceon legal and regulatory issues, to support fortransformation from an NGO to a shareholdingcompany structure, to funding for capacity build-ing. Technical assistance for the development ofproducts and services, creation of transparent ac-counting and management information systems,and acquisition of technologies that will create ef-ficiencies are all possible interventions. In addi-tion, partial funding of microfinance ratings or as-sessments can help well-performing organizationsto obtain commercial funding.43 For those institu-tions that receive a low rating, the advice given inthe assessment can provide useful guidance that


BOX 15 CARD: From NGO to Bank

The Center for Agriculture and Rural Development(CARD) was established in the Philippines in 1987with the vision to create a bank owned and managed byrural landless women. CARD launched its credit pro-gram in 1990, and initiated scaling up in 1995,accessing commercial funding and charging fees forits services. CARD Rural Bank started operating in1997. Several factors contributed to the transforma-tion from NGO to bank: CARD NGO experiencedpressure from donors to scale up its work and to offersavings services to its clients.At the same time, CARD

experienced “donor fatigue” and needed to access fi-nancial services from the market.The regulatory envi-ronment allowed for a feasible organizational form,the rural bank, with lower capital requirements thancommercial banks.Technical assistance supported theorganizational transformation. And lastly, the man-agement team was strongly committed to the “doublebottom line” of social mission and financial viability.

Sources: Bergmann, N., 2004; and information at www.cardbankph.com.


will help move these institutions closer to eligibil-ity for commercial funding. Credit lines can bejustified when institutions are performing well,but cannot yet obtain commercial funding. Creditlines should be priced at the market rate, so thatthey do not distort incentives for seeking commer-cial funding. They should be accompanied bycapacity-building assistance to help the institu-tions overcome their deficiencies, so that thecredit line can be replaced with domestic fundingwhen it becomes due.

Cooperative financialinstitutions44

Cooperative financial institutions range from for-mal cooperative banks to semiformal financialcooperatives and credit unions to informal village-based savings and loan associations. The maincharacteristics include ownership of the entity bymembers (or member cooperatives in the case of afederation or a bank), the provision of financialservices to members, and governance by electedrepresentatives of the owners/members. Membersare usually people with a common bond, either ge-ographic or occupational. Membership can in somecases be purchased for a token amount while inother cases significant involvement of the memberis required, as well as a savings history, before he orshe becomes eligible for loans.

Small primary cooperatives may be managed bymembers on a volunteer part-time basis, with lowoperating costs and close contact with theircustomers. Once an institution grows above a cer-tain number of members, the social cohesion foundin small cooperatives is not sufficient and needs to

be reinforced through the installation of more pro-fessional management.45 While even small volun-teer-managed cooperatives need to have a transpar-ent structure, good accounting and sound criteriafor decision-making, this is even more importantwhen the cooperative grows and paid managementtakes on the functions previously performed bymembers. Many financial cooperatives become or-ganized into federations so as to obtain servicessuch as external audit and training that enhance ac-countability and professionalism (see Box 17).

Credit unions are a type of financial cooperative.They are based on a common bond, often occupa-tional, and often serve a primarily urban andmiddle-class clientele. Examples are teachers, gov-ernment workers, farmers and corporation-basedcredit unions including the Bank’s own Bank-Fundstaff credit union. Credit unions can be smallvillage-based entities or larger, more professionalorganizations that are federated (Box 18).

Cooperative banking networks consists of pri-mary financial cooperatives, often in the form ofcommunity banks, with an apex institution ownedby the member cooperatives and providing servicesto them. There may also be parallel independentapex institutions responsible for supervision andauditing of the member institutions. This modelhad its origins in central Europe in the early 1800s,with the idea of encouraging poor people and smallgroups to pool their financial resources for mutualbenefit. Membership was open to everyone, withspecial emphasis on lower-income groups. Overthe years, these European cooperatives have growninto major participants in the financial markets oftheir respective countries as well as internationally.Rabobank, DZ Bank, Credit Agricole, Raiffeis-senbank46 and Desjardins are all full service banks

BOX 16 The Role of ACCION International

ACCION International has been an important innova-tor. In Nigeria, ACCION has formed a microfinancebank with other institutional shareholders and in Zim-babwe and Brazil, it has established microfinance divi-sions within a bank. In Haiti, Ecuador and Brazil, it hasformed service companies with major banks. In 2003,based on the success of an earlier smaller investmentfund,ACCION established an international investmentcompany for investment in its microfinance affiliates.

Shareholders include bilateral and multilateralinstitutions, including IFC, as well as private investors.Recognizing the limitations of the NGO institutionalform, ACCION has also pioneered the transformationof NGOs into regulated financial intermediaries,including BancoSol in Bolivia, Mibanco in Peru,Finamerica in Columbia and Compartamos in Mexico.

Source: Profile at www.accion.org.

owned by their member community banks. Thismodel is also found in countries like Argentina,Uruguay, Chile, Brazil and West Africa.

In developing countries, cooperative financialinstitutions have had a mixed history in terms of fi-nancial performance, governance and sustainabil-ity. Problems have occurred at all levels. One of themajor reasons that rural financial cooperatives havefailed so often over the last three decades has beenthe involvement of governments and donors, whohave used cooperatives to channel cheap credit, andundermined the savings-based character of theseorganizations.47 In addition, lack of transparency indecision-making, poor financial management andthe inability of board members to provide effectiveoversight have been extremely damaging. Thosecooperatives that succeed in overcoming theseissues face the problem that all small financial in-stitutions face; namely, the difficulty of providinga full range of banking services and obtainingreliable refinancing facilities. Belonging to a feder-ation can help to alleviate these difficulties.

Success factorsDespite their often dismal history, financial cooper-atives represent an important area of intervention inrural finance, due to their comparatively low costsand huge potential for massive outreach to the ruralpoor. However, there is also considerable risk offailure, especially if donors’ and governments’ ob-jectives are not aligned with the institutions’ objec-tives. Success factors include attention to all thefollowing areas:

• Policy and enabling environment. Political will isrequired at the policy level to develop an enablinglegal, regulatory and supervisory framework.48

• Governance. Transparent structures and trans-parent decision-making processes on all levelsof the institution from board and management toloan officers are critical for the cooperatives’sustainability. Strong governance is also the firstline of defense against those who try to use fi-nancial cooperatives for political influence and


BOX 18 Credit Unions in Lithuania

The first credit union in Lithuania was founded in1995, after a new law on credit unions was passed inthe midst of the 1994–1996 banking crisis. In 1997,11 credit unions formed the Association of Lithuan-ian Credit Unions (ALCU). ALCU provides training,technical assistance, lobbying and financial servicesto its members. In order to separate financial fromtechnical functions, an apex bank, the LithuanianCentral Credit Union (LCCU), was established in2002. LCCU provides financial services to credit

unions, including the administration of a stabilizationfund, a liquidity fund, and credit and deposit facili-ties. While the Central Bank retains supervision au-thority, LCCU provides supplementary supervisionservices to its members. The sector has shown im-pressive growth since its establishment. Growth ac-celerated after a modification of the law in 2000 andthe closing of rural branches of commercial banks.

Source: Lietvos Centrine Kredito Unija (undated).

BOX 17 Setting Up Financial Cooperatives in Russia

In Russia, the first Rural Savings and Credit Coopera-tives (RSCCs) were established in 1996, in the midstof the Russian banking crisis that led to the closure ofmany rural banks and branches. The sector operates asa three-tier structure with local credit cooperatives, re-gional and federal level federations, and apex institu-tions such as training institutes. The Central Bank isresponsible for supervision. The RSCCs are the main

source of credit for the rural population, farming fam-ilies and rural small businesses. Repayment rates areimpressive with over 99%. International technical as-sistance is directed at all three levels, with emphasis onthe development of an enabling regulatory frameworkand sector development at local and regional levels.

Source: Armbruster, P. G., 2004.


personal gain. A strong governance structurecould include political independence of theboard and management, overlapping terms withthe electoral cycle and others.

• Professional management and staff. • Recognizing the important role of member sav-

ings. Savings, as well as equity participation,provide members with a strong sense of owner-ship of the cooperative, which should motivatethem to demand transparency and accountabilityfrom the governing body as well as management.External funding, whether it is from govern-ments or donors, can diminish the incentives forgood governance and management unless thesavings focus can be maintained. This beingsaid, for larger financial cooperatives, the issueof sufficient capitalization is a major one andcannot be solved through member savings andequity holdings alone.

• Strong systems. This includes products, servicedelivery structure, accounting and financialmanagement systems.

• Affiliation with a federation of financial coopera-tives.This is critical for a primary cooperative thataims to provide a range of financial services to itsmembers. The degree of federation can strongly

influence the capacity to provide a wide range ofservices to members, which in turn can stronglyinfluence the achievement of profitability.

• Defining the role of the federation. A clear dis-tinction between financial functions such asfunding, supervisory functions and supportfunctions such as promotion and training isneeded in order to avoid conflicts of interest.

• Developing more effective regulatory and super-visory structures.49 In many countries, financialcooperatives are regulated and supervised byinstitutions such as Cooperative Ministries orDepartments that typically lack specializedtechnical expertise to supervise financial institu-tions. Direct supervision through the CentralBank is often not possible, except in the case ofcooperative banking networks, due to the costsof supervising a large number of small institu-tions that are geographically dispersed. Othermethods of supervision such as auxiliary super-vision and delegated supervision are now beingtried in some places. For a further discussion onthe features, advantages, and disadvantages ofthe various models see Arzbach 2004.

• Independent auditing of primary cooperativesand their federations.

BOX 19 Cooperative Reforms

Since 2001, Mexico has restructured its “popular”savings and credit sector, comprising financial insti-tutions providing rural, SME and microfinance. Atthe macro-level, a new sector law defines and regu-lates the institutions within a three-tier structure ofretail institutions, their federations and confedera-tions. The law defines regulatory standards (includingaccounting and prudential standards), and identifiesthe supervision authority and mechanisms. At themeso-level, the Mexican government provides tem-porary infrastructure support and technical assistanceto the sector through the newly established state-owned development Bank, BANSEFI, and throughnewly established second-tier federations of financialinstitutions. At the institutional level, the reformpackage provides technical assistance for a transitionprocess, which requires relicensing of all financial in-stitutions of the popular savings and credit sector. Fi-nancial assistance is available for restructuring, andfor temporary liquidity problems.

In the Philippines, the 30-year-old credit unionmovement has had weak structures, with many inac-tive unions, and others that are financially unstablewith high default rates. The credit unions have alsobeen used as a conduit for cheap credit. The creditunion federation, PFCCO, has been underfunded andnot been able to provide technical services to itsmembers. At the end of the 1990s, the governmentinitiated a reform program with international techni-cal assistance, with the objective of establishingmodel cooperatives, turning them around from loss-making entities into independent profit orientedunions, adhering to strict prudential standards andemphasizing savings mobilization. Results for thefirst batch of model credit unions have been impres-sive, with default rates declining from 63% to 7% in2002. New business plans and marketing strategieshave quadrupled the membership. Sources: Ito, L. et al. 2003; Klaehn, J., 2004; and Singh, H. Per-sonal Communication, 2004; World Bank, September, 2004.

• Eliminating the use of cooperatives to promotepolitical goals or to benefit powerful local indi-viduals or companies. Governments need toestablish enforceable policies and procedures toprevent interference and influence peddling.

The examples in Box 19 on page 32 describetwo successful programs for cooperative reforms indifferent parts of the world.

Areas for possible BankinterventionsStrengthening financial cooperatives requires adramatic shift in the priorities of governments anddonors. In particular, they should not provide creditlines to cooperatives unless there is a strong institu-tional structure, including effective governance, asubstantial savings base, and strong financial man-agement including loan losses of less than 5%.Experience in a wide range of countries has shownthat external financing damages these institutionsby changing them from savings-driven institutionsto borrower-driven institutions.

Many of the success factors listed above repre-sent areas of possible interventions for the WorldBank. Successful interventions usually address is-sues at all three levels of intervention in a carefullyplanned sequence, starting with policy dialogue,advice on an enabling legal and regulatory frame-work, technical assistance and possibly refinancingon the institutional level.

Informal village-based modelsIn many countries today, neither banks nor special-ized microfinance institutions (MFIs) nor coopera-tive networks have reached the majority of villagesin the rural areas. Even those MFIs that have devel-oped methodologies that enable them to reach thepoor are seldom able to reach clients in rural vil-lages beyond secondary towns. This is particularlytrue in countries with dispersed rural populations,due to high transaction costs coupled with smalltransaction size. However, financial service pro-viders do exist in villages, including the ubiquitousmoneylenders and a variety of informal groups.

Informal and semiformal village-based models,including thoseusingaCDDapproach,holdthemostpromise at the present time in most countries for pro-vision of financial services to people in remote rural

areas.Traditional informal savings and credit groupsexist virtually everywhere, and have proved to be re-markably resilient over time, with features that havemade them indispensable to the financial manage-ment activities of the rural poor. Their resilience of-fers a contrast to the failures of many other models.Many microfinance best practices have evolved fromthe lessons learned from traditional group mecha-nisms. Hence, it is important to understand thisdimensionofruralfinance.Informalfinancialgroupscan be broadly divided into two categories:

• Rotating savings and credit associations(ROSCAs) are unregistered, time-bound groupswhose members deposit a fixed amount ofmoney each period. One member receives all thefunds collected during that period. The groupstays in existence until each member has re-ceived a payout. ROSCAs enable their membersto receive usefully large sums of money and aresimple and easy to manage. However, they areinflexible: members can’t deposit and withdrawfunds as needed, so they are not suitable foremergencies or for occasions such as festivalswhen all members need money at the same time.Amounts saved are usually quite small so theyare not generally adequate for the financing ofsmall economic activities.

• Accumulating savings and credit associations(ASCAs) are unregistered, time-bound groupswhose members deposit a fixed sum each period.Rather than disbursing the funds in rotation,ASCAs loan money to members with interest. Atthe end of the predetermined cycle, members re-ceive a return on their investment. ASCAs aremore flexible than ROSCAs but require greatermanagement skills.As amounts saved are usuallysmall, funds available for lending are also small.

Success factors that have contributed to thewidespread development of ROSCAs and ASCAsby communities in many parts of the world include:

• a common bond that creates pressure for mem-bers to honor their commitments, whether thatbe to continue saving until all members havereceived an equal share (ROSCAs) or to repayloans within the agreed time period (ASCAs).

• Members save and, in the case of ASCAs, lendtheir own money so they have a vested interest inprotecting their savings and recovering loans.



• Because the organizational structure is imper-manent, and the amounts of money generallysmall, these groups do not need sophisticatedaccounting and management skills. Periodicpaybacks of capital and earnings that reset thebalance sheet to zero has proven to be one effec-tive way for non-literate or semi-literate groupsto manage their finances by themselves.

Some countries and organizations have devel-oped models that are essentially revised versions ofthe basic ASCA. For example, CARE Internationalhas implemented a Village Savings and Loanmodel50 in several African countries that retainsmany of the features of ASCAs, but seeks to im-prove the prospects for long-term sustainabilitythrough training of groups in organizational devel-opment topics such as ownership structure, gover-nance, internal rules and financial management.Technical assistance and training is providedthrough local facilitators, keeping expenses to amanageable level. In India, informal and unregis-tered self-help groups (SHGs) have been linked tobanks, dramatically increasing the number of poorvillagers who have been able to access servicesfrom the formal financial system.

Factors for success of these semiformal modelsinclude the common bond and peer pressure soimportant for informal ROSCAs and ASCAs. Inaddition, strong governance structures that limit theability of any subgroup to dominate, clearly definedpolicies and procedures, strong internal controlsand financial management are paramount. In par-ticular, the members’ strong sense of ownership

and commitment are critical to the long-term sus-tainability of these organizations.

The creation and/or strengthening of second-tierfederations of small village-based organizations canhelp these entities receive important institution-building services that they cannot avail on their ownand link them with the formal financial sector (seeBox 20). Federations can help their members to setperformance standards and monitor performanceagainst the standards. Once standards have been de-fined and monitored, creating links to banks for refi-nancing facilities becomes easier. Federations canalso provide a link to national and internationalsources of best practice training and networking.

Areas for possible BankinterventionsInformal village-based models are best supported byproviding funding for technical assistance institu-tions that can demonstrate a proven track record ofsuccessful work with such models. In particular, themodel must be shown to be very low-cost; otherwise,the costs will outweigh the benefits in terms of num-ber of people served. Funding for the development oftraining materials for non-literate or semi-literatepeople is important, as is the training and equippingof local people who can become para-professionals,thus continuing the dissemination of the model afteran initial phase. Efforts to link such groups to com-mercial banks may start with the opening of accountsfor the safekeeping of savings. Further informationcan be found on the website of the Rural FinanceLearning Center, a joint undertaking of Food and

BOX 20 CVECAs of Mali

The Self-Managed Village Savings and Credit Banks(Caisses Villageoises d’Epargne et de Credit Auto-gérées, CVECAs) have been established in Malisince the 1980s as small, locally-managed savingsand credit associations. The CVECAs have formedregional federations with technical functions such asself-regulation through peer monitoring, and they actas financial intermediaries between the NationalAgricultural Development Bank (BNDA) and the vil-lage units. The profits from these operations are usedto contract technical services for member units,

including auditing services and management train-ing. Unlike traditional cooperative second-tier orga-nizations, the CVECA federations have no officestructure and do not provide technical services di-rectly, but through outsourcing. The federations aredistrict-based, ensuring local solidarity. The modelhas been replicated in several regions within Mali, aswell as in other African countries such as BurkinaFaso, Gambia, Madagascar and Benin.

Source: Chao-Beroff, R., 1999.

Agriculture Organization of the United Nations(FAO), Gesellschaft fuer Technische Zusammenar-beit (GTZ), World Bank and International Fund forAgricultural Development (IFAD).51

Financial assistance in the form of credit lines orrevolving funds is best avoided.

Community-drivendevelopment and rural financeVillage-based models are relevant for Bank com-munity-driven development (CDD) projects, espe-cially if they focus on member savings and banklinkage rather than external grants. CDD is an ap-proach that treats poor people and their institutionsas partners in the development process. CDD pro-jects strive to devolve control of decisions and re-sources to community groups, which work in part-nership with government and support institutionssuch as NGOs. Many CDD projects have an “openmenu” which enables communities to decide how tospend project resources. Typical investments in-clude community infrastructure such as schools,health clinics and improved roads. However, manycommunities decide that income-generating activi-ties are a key priority for villagers. If they cannot ac-cess funding from banks or MFIs, they sometimesuse project resources to set up community-managed

revolving loan funds. A recent OED review of mi-crofinance credit lines52 including revolving fundsshowed that such funds within World Bank projectshave generally not performed well. It is an openquestion whether or not this trend can be reversed.However, learning from the experience of informalmodels, it can be hypothesized that success factorsinclude:

• Development of a strong local institution ownedby community members rather than “the commu-nity.” The ownership structure could be either acooperative or company model in which mem-bers buy shares. These members then have avested interest in the success of the institution.They should be in control of policies andprocesses, including rules on membership, focuson collective versus individual production, riskmanagement strategies, and setting interest rates.

• Provision of grants for revolving loan funds onlyafter members have saved their own money overa substantial time period and demonstrated anability to rotate these savings in the form ofcredit to members.

• Strong technical assistance to build transparentand accountable governance, management andfinancial systems.

Box 21 provides an example of a CDD projectthat has made use of these lessons.


BOX 21 Using the CDD approach in Andhra Pradesh, India

The World Bank’s Rural Poverty Reduction Project(RPRP) and District Poverty Reduction Initiative Pro-ject (DPIP) inAndhra Pradesh, India illustrate the po-tential for institutional strengthening, scaling up andlinkage of informal institutions to the formal financialsector within a project using a CDD approach and hav-ing grant funds. Andhra Pradesh (AP) has a well-de-veloped microfinance industry with a variety of insti-tutional models: licensed nonbank microfinanceinstitutions such as Basics, Share and SKS, financialcooperatives and self-help groups (SHGs). SHGs aresmall groups of 15–20 members coming together tosave and lend among themselves; they are significantlydifferent from groups using the Grameen model, inthat SHGs are not just solidarity groups receiving fi-nancial services but are financial intermediaries

themselves. Well-managed SHGs are often able to ac-cess loans from local banks, sometimes with fundingfrom NABARD, the National Bank for Agricultureand Rural Development. RPRP and DPIP support thedevelopment of SHGs and their federations, VillageOrganizations (VOs) and Mandal Samakiyas (MSs).VOs are federations of SHGs in a village or cluster ofvillages, whereas MSs are federations of VOs in aMandal, the sub-district administrative unit in AP. Thesuccess of the bank linkage is evidenced by the linkageof 231,336 SHGs to banks from 2002 to 2004. Sinceeach SHG has about 15 members, over 3 millionwomen have been able to access bank credit. Repay-ment rates are just below 100%.

Source: Kumar, V. and P. Shah, 2005.

There are several special-purpose institutions andproducts that are quite suitable for financing ruralenterprises and farms, especially larger ones. Theyare also relevant for small farmers but to a lesserextent. The most important are outlined below.

Leasing, a source ofinvestment capital forrural areasIn many countries, lack of access to long-termfinancing for capital investments is one the mostpressing issues in rural areas.53 Leasing has longbeen recognized as one solution, as it allows the cir-cumvention of such financial market imperfectionsas lack of a collateral registry and collection en-forcement mechanism, two of the major obstaclesin equipment financing (see Boxes 22, 23, and 24).Leasing is a financing tool where the provider(lessor) owns the equipment and permits the client(lessee) to use it in exchange for periodic payments(lease payments). Leases are also a means of even-tually acquiring equipment (and not just its use), asownership is generally transferred to the lessee atthe end of the lease period, either automatically orat a token price.

Leasing is likely to be more accessible andaffordable to rural enterprises than credit. Farmersand rural enterprises are particularly constrained bythe lack of assets that can be used as collateral.Leasing overcomes this constraint, because no

collateral needs to be registered. The lessor is theowner, not just the financier, and the equipmentcan quite easily be recovered from a lessee who isremiss in paying the lease obligations. Leasestypically have lower down payments than loans,making them more accessible to lower income peo-ple. In a Bank survey of ten leasing companies in2003,54 the surveyed companies indicated that theyrequire down payments of 15% to 25% as com-pared to 30% to 40% required by banks in thosecountries for equipment financing. These advan-tages not only result in faster processing but loweroverall transaction costs.

IFC has often initiated the establishment ofleasing companies in countries where financialmarket conditions do not allow for long-term bankfinancing on commercial terms or where thereare no suitable commercial banks. In more devel-oped financial markets, commercial banks oftenestablish leasing subsidiaries to provide long-termfinancing which are considered too risky for regularbank financing. There is experience, though lim-ited, in micro-leasing and leasing for agriculturalequipment.55

In general, less rather than more regulation isuseful. There should be clear regulations thatclassify leasing companies as non-deposit-taking fi-nancial institutions that are not subject to therestrictions of banking laws, including reserveand liquidity requirements. An enabling legalframework includes equally clear definitions for thelegal ownership of leased assets, repossession of

37

5

Special-purpose institutions and products

leased assets in case of default, and liability in caseof third-party losses. Leasing regulations are in gen-eral quite simple and uncontroversial, and thus offera good opportunity for fast action by policy makersmotivated to support rural development. Desirablebut not required features include a functioning mar-ket for secondhand equipment and affordable andaccessible repair and maintenance facilities.

Areas for possible BankinterventionsSince special-purpose leasing companies are notlicensed to take deposits, they need to developother reliable sources of refinancing, preferably inlocal currency. Credit lines from banks or interna-tional donors are quite often utilized and couldpresent an opportunity for Bank intervention. Tech-

nical assistance and training to develop a skill mixamong employees that includes technical knowl-edge about new equipment, assessment of usedequipment and residual values, in addition togeneral credit skills, would also present a valuablecontribution from international donors.

Potential World Bank interventions to supportleasing should take advantage of IFC’s experiencein this area. In order to achieve maximum impact,interventions should be coordinated with IFC andpossibly complemented by an IFC investment. Apossible model is IFC’s Private Enterprise Partner-ship (PEP) initiative, a multi-donor-funded andIFC-managed effort in countries of the formerSoviet Union. PEP provided in-country support tointroduce enabling legislation and direct technicalsupport to leasing companies. In some cases, therewas also an investment by IFC, but this was not PEP’s


BOX 22 Network Leasing Corporation Pakistan

Network Leasing Corporation (NLC) in Karachi andLahore, Pakistan predominantly serves small andmicro businesses. NLC innovated the leasing processby introducing post-dated checks as a secure paymentmethod and required clients to open bank accounts forthis purpose. Payment patterns can vary accordingto the lessee’s cash flow patterns and secondhand

equipment can be leased. NLC includes life insurancefor the lessee in the contract in addition to coverage ofthe leased assets. NLC has launched a program to in-crease its business in rural areas in the northwesternprovinces of Pakistan with international assistance.

Source: Havers, M., 2003.

BOX 23 DFCU Leasing

The Development Finance Corporation of Uganda(DFCU) has pioneered leasing activities in Uganda.DFCU also allows the leasing of secondhand equip-ment and uses post-dated checks to ensure payment.DFCU uses in-house engineers to monitor propermaintenance of leased equipment. DFCU’s main clien-tele are small and medium size urban enterprises, but

the company has tried to reach more small and microbusinesses by introducing a pilot scheme for bee-keepers and mushroom growers in rural areas, andopening regional offices.

Source: Kisaame, J. 2004.

BOX 24 CECAM Madagascar

In Madagascar, the Caisse d’Epargne et de CreditAgricole Mutuel (CECAM), a cooperative for agri-cultural finance, has introduced hire-purchase for arange of assets including farm implements, dairycows, artisanal equipment, bicycles and sewing

machines. Payment schedules are adapted to the cropcycle, and local member groups monitor the securityof the hired items.

Source: Fraslin, J.-H., 2004.

focus. Based on its good experience with PEP in thecountries of the former Soviet Union, IFC has de-cided to extend PEP toAfrica and in late 2004 estab-lished a PEP office in Johannesburg as a first step.

Guarantee institutions and guarantee fundsLoan guarantees are a financial instrument used tomove all or part of the credit risk of a specific loanor a predefined group of loans from the underwrit-ing institution, usually a commercial bank, to aguarantee fund or institution. The borrower ischarged guarantee fees, in addition to interest costs.Guarantees have long been used to motivate finan-cial institutions to provide credit to special groups,including farmers and SMEs that are consideredtoo risky to be creditworthy on their own merit.

In some countries, such as Turkey, special loanguarantee institutions have been set up; in othercases, a loan guarantee fund may be housed in a re-gional development agency or other body. Germany,for example, has a whole system of regional guaran-tee banks in each state that provide guaranteesfor small business loans and that have been used ex-tensively since reunification. Internationally, loanguarantee institutions and funds were seen as quitenegative for some time, for the following reasons:56

• Moral hazard risk on the side of the borrowerswho may not feel a strong motivation to repaythe loans, especially if they consider them to beanother type of government grant;

• Moral hazard risk on the side of the financialinstitutions that might finance good credit riskswithout guarantees, and use the guarantees tounderwrite loans with a high default risk(“cherry-picking”) without proper evaluationand safeguards;

• Additional transaction and guarantee costs ontop of interest, making a guaranteed loan quiteexpensive for borrowers, and in many cases noteconomically feasible;

• Rapid depletion of loan guarantee funds as high-risk loans are foreclosed and the guarantee iscalled;

• Lack of sustainability of the guarantee institu-tions over the long term because they are oftennot able to charge high enough fees to cover alltransaction costs, in addition to the credit risk.

There is a wealth of experience available tounderline that this approach is fraught with danger.However, there is a place for carefully designedguarantees that serve as policy instruments toreduce the credit risk for financial institutions inter-ested in providing loans for agriculture, when theattendant risks can be reduced. The IFC, for exam-ple, has developed a partial guarantee instrumentfor portfolios of SME loans.57

The most important success factors include thefollowing:

• The underwriting institution, usually a commer-cial bank, should always hold a significant por-tion of the risk as a first loss to be carried beforethe guarantee can be called; usually this first lossprovision is no less than 5%. The remaining riskshould be shared based on a pre-agreed for-mula.The benefit of a first loss provision is thatthe bank incurs losses of its own before receiv-ing any reimbursement from the guarantee; thishelps to ensure that a thorough credit screeningtakes place and mitigates the moral hazard risk.

• All loans in a category must be put in the guar-antee portfolio to avoid cherry picking, againmitigating the moral hazard risk.

• Early-warning monitoring procedures and strictreporting requirements should be in place andclosely followed.

Since IFC has experience in issuing partial guar-antees on portfolios of small loans, it is advisablethat Bank efforts in that area be coordinated withIFC and focus on those countries and rural areaswhere IFC may not be able to directly invest.

Supply chain financingSupply chain financing generally refers to the pro-vision of short-term, seasonal credit to farmers byprivate firms such as input suppliers and processors.Typically, farmers receive inputs from the processor,or credit for inputs through a banking relationshipestablished by the processor. Some arrangementsprovide additional credit to finance householdneeds until the harvest. Once the products are readyfor sale, they are delivered to the processor, whodeducts the credit from the value of the products.The farmer receives the surplus, if any, in cash.

There usually is an established business rela-tionship between the parties, facilitated by mutual

Special-Purpose Institutions and Products 39

knowledge, while collateral constraints are limitedby linking credit with sale of the product financed.Both parties gain through the transaction: thefarmer by obtaining working capital financing, aguaranteed market for his product, and technicaladvice in some cases to ensure that quality stan-dards are met; the processor by securing a reliablesource of product for his operation.

Nevertheless, supply chain arrangements can bequite risky for both parties. The risks for the farmersare that the agreed-upon price at contract time mightbe lower than the market price at harvest, eventhough it will be sufficient to cover loan and interestrepayments. This can provide farmers with an in-centive for side-selling; i.e., selling the products toanother party at a higher price, repaying the loanfrom the proceeds and keeping the surplus, unlessthere are incentives to refrain from doing so. The re-verse risk applies to the processors who are commit-ted to purchase at an agreed-upon price, even if themarket price at harvest is lower. Processors also runthe risk of not being able to obtain sufficient productdue to side-selling by farmers, and poor quality ofthe product supplied. Consequently, these relation-ships are rarely without hitches.

Credit from formal financial institutions withspecialized knowledge of agricultural financingis preferable to supply chain financing, becausefarming households usually need a wide variety offinancial products, rather than credit for one croponly (Box 25). Supply chain financing should,therefore, be considered a second-best solution tothe lack of credit for agriculture in a given country.Often, however, in markets where there are no

financial institutions providing agricultural loans, itis the only game in town.

Supply chain financing has taken place overmany years and in all regions, usually without donorsupport and as an entirely private sector activity.Only recently58 has there been donor interest in sup-porting such activities as a way to increase financingfor agriculture. There are several different ways toprovide financing through the agricultural supplychain. All of them are directed at commercial, pro-fessional farmers who are able to earn sufficientamounts from their farming activities to repay theloans. In order for supply chain financing to be fea-sible, a sufficiently large volume of outputs needs tobe generated so that transaction costs for processorsdo not become overly burdensome. However, thisdoes not mean that supply chain financing is limitedto large farmers only. Small family farmers in manycountries have been able to organize input supplyand marketing cooperatives that allow them toachieve sufficient economies of scale and somelevel of bargaining power for their member farmersin relation to processors and traders.

Characteristics of supply chainsSupply chains range from rather loose to very tightties and interrelationships. This is often determinedby the economic power of the participants within thesupply chain. Tight supply chains bind both partiesclosely to each other, through enforceable contrac-tual arrangements, as well as through business real-ities and incentives. Loose supply chains are oftennon-binding, there are opportunities to circumvent


BOX 25 Supply Chain Financing through Small Farmer Producer Organizations in Mozambique

In Mozambique, small farmers have established self-managed out-grower schemes with assistance of theCooperative League of USA (CLUSA) program. Theprogram established a two-tier organization of pro-ducer organizations and their regional associations.The producer organizations serve as the intermediarybetween the individual farmer and the agribusi-nesses/processors that provide short-term productioncredit and purchase the produce. The producer orga-nizations also provide extension services to the farm-ers to improve farming methods and quality of theproduce, and provide storage and transport facilities.

While out-grower schemes are well established, par-ticularly in the cotton and tobacco sectors, moreloosely organized marketing arrangements are preva-lent for the cashew, groundnuts, sesame, sunflowers,and maize sectors. At the end of 2002, the programhad established over 840 producer organizations in-volving approximately 26,000 farmers. Repaymentreached 96%. The program has been handed over to alocal NGO, OLIPA.

Sources: Phillips, R. et al., 1999; and project information atCLUSA International Program Web resource at www.nbca.coop/clusa.cfm.

the arrangements, and the relationship is maintainedmostly through mutual business interests.

Very tight supply chains leave little room forvariant actions. These arrangements, often referredto as either coordinated supply chains or integra-tion contracts, are durable arrangements betweenproducers, processors and buyers about what andhow much to produce, time of delivery, quality,safety conditions and price.59 Contract farming isone example of such a relationship. In this case, thefarmer utilizes some of his own inputs (premises,land, labor, etc.) while other inputs are suppliedby the contract partner. In return, there are rela-tively assured income streams if the agreed uponproduction goals are met. Examples are the poultryindustry in Brazil, where the farmer supplies laborand buildings, but all other inputs are supplied bythe processor; sugar beet growers in Poland; andsugar cane growers in Brazil as outlined in Box26.60 This approach is extensively and successfullyused in transition economies (Box 27).

Other supply chains are organized much moreloosely, with the respective bargaining powers ofthe partners based on economic realities. If farmershave opportunities to profitably sell outside the

supply chain, they have a significantly better bar-gaining position.

Specialty arrangements

Agro-service centers

In a number of Bank partner countries, largeinternational input suppliers such as Monsantoand Novartis have established distribution net-works, which deliver their inputs to farmers onconditional sales of the crops, both in-kind andat predetermined prices. This solution, which is im-perfect from the farmers’ standpoint, allows thecompanies to sell their products to farmers whohave little bargaining power, as they have no otherfinancing alternative.

Pre-financing of international commodityexport trade

Pre-export financing is mainly done for non-perishable commodities like cereals, coffee, andcotton (Box 28). It only works for clients, suchas well-managed cooperatives and commodityboards, that have an excellent export performancetrack record.

Special-Purpose Institutions and Products 41

BOX 26 Supply Chain Financing in the Sugar Industry in Brazil

Sugar mills in Brazil offer integration contracts tosugar cane farmers in order to secure access to theirproduce. Farmers who enter the annual contracts re-ceive three payments, the first at contract entry, thesecond upon delivery of the product to the mill, andthe final payment at the end of the season after the

final prices for the end products, sugar and ethanol,are known. The advances are interest free, and allowfarmers to smooth annual cash flows.

Source: Rabo International Advisory Service, 2004.

BOX 27 Supply Chain Financing in Kazakhstan

In Kazakhstan, commercial banks provide creditlines to processors of cotton, soy, and wheat. Theprocessors then provide loans to their potential sup-pliers for agricultural inputs, rental of equipment, etc.Farmers producing these commodities have access tomarket information and are contractually free to selltheir harvest to any party of their choice. However,all participating farmers are required to maintainaccounts at the lending bank and the bank has theauthority to transfer funds from the borrowers’

accounts to the processor’s account, up to the value ofthe loan. In reality, since the markets for the thesecommodities are quite transparent, there is little ad-vantage to farmers’ side-selling, not repaying the loanand thus risking the receipt of loans in subsequentyears. Consequently, within this supply chain, there isa lasting client-customer relationship.

Source: Kloeppinger-Todd, R., Personal Communication, 2004.

Medium-term supply chain financingthrough the banking system

A bank or other financier can play an important rolein setting up a market-oriented supply chain, for thebenefit of all segments and participants, by organiz-ing a tailor-made credit line that connects the dif-ferent segments (Box 29).

Areas for possible BankinterventionsHistorically, supply chain financing has taken placein developing countries as a response by processorsand traders to a lack of credit for farmers. It hasusually been done on a fully commercial basis,without donor involvement or support. However,supply chain financing as a tool to increase the sup-ply of credit to farmers offers several opportunitiesfor Bank involvement:

• On the legal and regulatory level, assistance todevelop transparent and enforceable contract law.

• Since all suppliers of credit to farmers need refi-nancing themselves, support to commercial banksto motivate them to undertake such financing.

° If the bank is providing the funding to the end-client under a tied arrangement with theprocessor, the support could be in the form oftechnical assistance to install monitoring andcontrol systems within the bank or the proces-sor’s specialized credit department.

° Financial assistance in the form of a creditline, where appropriate (see section on creditlines in Chapter 3), or a guarantee arrange-ment could also be envisioned.

• In order to facilitate the participation of smallfarmers in a supply chain financing arrange-ment, support to create and strengthen smallfarmers’ associations or cooperatives that wouldact as direct partners for processors and otherpurchasers. These associations, which wouldrepresent a number of farmers, would enable theprocessors to lower their transaction costs.

Setting up an arrangement for long-term financingrequires the strong involvement of private sectoragribusinesses and financial institutions, so is prob-ably outside the scope of most Bank-supportedrural finance projects. However, there is a signifi-cant role for IFC.


BOX 28 Pre-Export Financing through Price Risk Management in Tanzania

Tanzanian coffee cooperatives were restricted in theirability to obtain bank credit due to the risk of varia-tions in international commodity prices that couldcompromise their ability to repay loans. RabobankInternational developed a put-option for the coffeecooperatives, which assured the cooperatives a mini-mum price for their future produce. This provided

the banks with more certainty with respect to thecash flow of coffee growers, resulting in increasedcredit to the cooperatives, which in turn extendedloans to their members.


BOX 29 Supply Chain Lease Contracts in Russia

The Agricultural Finance Company (AFC) in Russiaprovides farm equipment leasing contracts to farmersin the dairy sector in the Moscow region. The dairyprocessor selects the farmers eligible for AFC leasingcontracts. Farmers make down payments and agree tothe processor’s withholding the balance of the leasecontract. The processor transfers the payments directlyto AFC. Equipment suppliers have entered into buy-

back agreements with AFC in case of repossession ofequipment due to default.The contract is advantageousfor all parties involved: the processors secure theirinputs from the farmers, the farmers obtain medium-term finance for capital goods, and the equipment ven-dors increase their market through this arrangement.


There are many cross-cutting issues that fall intothe area of general financial sector developmentbut that are also important for rural finance. Forthe purposes of this approach paper, only thosecross-cutting issues that are crucial for the de-velopment of sustainable rural finance or thatapply specifically to financing for agriculture arecovered.61

Technological innovations toreduce transaction costs andto achieve greater outreachfor financial institutionsHigh transaction costs are one of the major factorslimiting the expansion of rural financial services.Most financial institutions, even if interested inincreasing outreach to rural areas, would be dis-suaded by the high cost of processing a large num-ber of generally small transactions in villagesacross a broad geographic area, and the challengeof maintaining the quality of such a portfolio.Small transactions in general require nearly asmuch oversight as larger ones, while providing amuch smaller return.

Some commercial banks, as well as microfi-nance institutions, have developed technology-based solutions.62 These technologies range fromdebit and credit cards, to personal digital assistants(PDAs), to new delivery channels such as ATMs,

mobile banking units, and internet banking.63 Useof many of these technologies for rural finance isstill in the design or pilot stage, so the suitabilityhas not yet been proven; however, there are somepromising developments.

Technologies for rural areas in developing coun-tries need to be adapted to the respective envi-ronment. Transferring solutions from developedcountries with strong communication networks todeveloping countries with limited infrastructuremay result in expensive yet unsustainable applica-tions. The following principles are good bench-marks: simple and easy to use, wireless, low power,durable, reliable, with a low cost through sharedaccess, low maintenance, or high volume.

Examples of rural finance institutions and com-panies in supply chains developing and implement-ing innovative technologies include Mongolia’sKhan Bank, Uganda’s Microfinance Union, andIndia’s ITC (Box 30).

Lessons learnt so far include the following:64,65

• Information technology (IT) does not replacepoor management in financial institutions. Onthe contrary, good management practices mustbe followed in order to apply and extract thevalue of technology solutions.

• Deploying technology successfully involvesmuch more than simply acquiring the technol-ogy; it requires a clear set of business goals,objectives and strategies in order to establishresource priorities and requirements.

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Cross-cutting issues of risk management,technological innovation and specialized

collateral arrangements

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BOX 30 Three Institutions using technological innovations

Khan Bank of Mongolia

Increased security and ease of access through anextensive network of computerized branches

Mongolia is a large country with vast and thinly pop-ulated rural areas traversed by nomadic herders. KhanBank has a branch network of nearly 400 branches, ofwhich 76 are currently online. They are working tobring the remainder of the branches online over thenext few years. Historically, nomadic herders have notused banks, relying instead on a barter system forpayment from customers. Through favorable interestrates on savings, the extensive branch network andtargeted marketing, Khan Bank has drawn herdersinto their customer base. These nomadic herders havediscovered the convenience, security and power of de-positing their money into the Bank at one location,then following their regular seasonal patterns ofmovement across the country and being able to accesstheir deposits from other branches of the bank. Thebank has now provided herders with nearly 30,000loans as well as deposit accounts.

Cross-border debit cards

In October 2004 Khan Bank began offering debitcards to cross-border traders traveling to China. His-torically the traders would receive a loan from KhanBank in the Mongolian currency, the togrog. Carry-ing the cash long distances, they would exchange theloan into Chinese yuan near the border, then purchasethe goods and travel back to Mongolia to sell themfor togrog and repay their loan. Khan Bank now co-operates with the Agricultural Bank of China, thefourth largest bank in China, to accept Khan Bankdebit cards at ATMs and point of sale (PoS) devices,enabling cashless travel and transactions for thetraders, who thereby have a greatly reduced risk oftheft of funds. This in turn reduces Khan Bank’s riskof theft-related default. The bank is planning to offerthe reverse opportunity for Chinese traders and toreplicate the services along the Russian border.

Source: www.khanbank.com, and Morrow, P., Personal Commu-nication, March, 2005.

Uganda Microfinance Union

Using technology-equipped agents to create low-costaccess to services in rural areas

The Microdevelopment Finance Team led by HewlettPackard is testing a point of sale (PoS) payment solu-

tion in Uganda with Uganda Microfinance Union(UMU). The system enables transactions to be made inrural locations at a much lower cost than equippingand operating a branch office. Agents with liquiditymanagement skills and fixed locations in rural com-munities are provided with a wireless PoS device thathas an 11-hour battery, smart cards, and a web-basedtransaction management application that can handlesavings deposits, loan payments, withdrawals, andfund transfers. Transactions are transferred through thelocal mobile phone infrastructure to UMU’s manage-ment information system. Transactions are uploaded atleast once a day, but can be sent more often dependingon airtime charges and the volume of transactions. Theapplication provides customers with longer hours ofservice than a bank, reduces the distance that cus-tomers must travel from 20 km to less than 5 km, thusreducing both transaction cost and risk, and createsmore incentives to save. The system creates a customerpayment history that can then be used for credit deci-sions, risk modeling and product development.

Source: Africap, 2004.

The Indian Tobacco Company

The Indian Tobacco Company (ITC) realized that thelong supply chain for agricultural produce resulted ininefficiencies for ITC and high transaction costs forthe farmers. In order to shorten the supply chain, ITCintroduced its e-choupal initiative in 2000, setting upcomputer terminals and internet connectivity invillages (choupal means “village meeting place” inHindi), to enable farmers to access information aboutprices, weather, farming methods and soil testing, aswell as to order agricultural inputs. The terminals areoperated by one elected farmer per village, the san-chalak, who earns a commission on each completedtransaction. Farmers receive instant quotes for theirproduce, and instant payments for their sales aftertransporting it to ITC collection centers. This tech-nology enables ITC to reduce its handling costs by30% and farmers to reduce their tranaction costs byup to 68%. Farmers also benefit from better availabil-ity of inputs, increasing productivity. As of December2004, ITC has reached over 3 million farmers, creat-ing links to companies, government departments anduniversities. Trials are underway to offer insuranceproducts and agricultural credit.

Source: India Today, December 13, 2004.


• A centralized, reliable and robust managementinformation system provides vast amounts ofdata. Learning how to analyze the data and usethe resulting information for business decisionsis in many cases a major challenge.

• Leadership within an institution is critical. Keydecisions regarding technology strategy and ini-tiatives must be made by senior executives, notleft to the IT manager.

• Strategic partnerships with experienced technol-ogy providers are critical in making technologyinitiatives affordable. In many cases, shared in-frastructure is a decisive element needed to re-duce costs and make services affordable.

• Significant funding for quality technical assis-tance is imperative, so as to leverage the exper-tise of those who have gained experience doingthis type of project, whether the services areprocured from the vendor, a third party provider,or another financial institution that has been in-volved in a similar undertaking.

Supporting financial institutions to pilot innova-tive technology solutions that enable them to reachrural customers at a reasonable cost might presentan area of intervention for the Bank, especiallywhen there are strong private sector partners andsignificant potential for scaling up.

Risk management instrumentsfor financing for agricultureFarmers (and their lenders) are exposed to risks thatare in addition to those facing other credit clients.Some of these risks are idiosyncratic risks that af-fect a single household, while others are covariantin nature and affect an entire region or country atthe same time. Weather risk is probably the singlemost important risk influencing the outcome ofa farmer’s investment. Price risk, especially forinternationally-traded commodities, can also bequite substantial.

On an individual level, farmers have always de-veloped risk management strategies, ranging fromcrop diversification, adoption of low-risk andlow-yield crops and production patterns, to self-insurance through extended family relationshipsand use of money lenders in an emergency. How-ever, these strategies do not protect a farmer when

large amounts have been borrowed from a financialinstitution that need to be repaid following the har-vest, but the harvest fails. Nor do they protect a fi-nancial institution that has made many loans forthat crop.

Governments in developed and developingcountries have attempted to manage these risks fortheir rural populations by establishing commodityprice guarantees, buffer stocks or stabilizationfunds, and providing crop insurance in case of nat-ural disasters. These efforts have had mostly nega-tive results, such as huge inefficiencies and costs tothe government budget, with a paltry payout for in-dividual farmers. Moral hazard and adverse selec-tion are also major factors, since these measuresprovide the same kind of protection to honest anddishonest and good and bad farmers alike. It is nowBank policy to discourage partner countries fromadopting such policies, and the Bank is actively ex-ploring other, private sector-based ways to manageagricultural risks.

Price risk management instrumentsfor commoditiesStrong price fluctuations for internationally tradedcommodities such as coffee, cotton, and maizecan be managed through the purchase of hedginginstruments that are available in internationalfinancial markets. However, derivatives contracts,futures and options are not traded for all commodi-ties. For many products such as sesame and cashew,there are no contracts traded on international andlocal exchanges, and therefore, no price risk man-agement instruments available. Even when pricerisk management instruments are available on in-ternational exchanges, the movements of prices onthese markets may not be an accurate reflection ofprice movements in local markets. This disjuncturebetween local and international markets, called“basis risk,” often makes contracts traded on inter-national markets inappropriate as instruments formanaging price risks in local markets.

If a price risk management instrument is avail-able, it might be quite expensive, so a financial in-stitution would need to go through a series of stepsin order to determine the suitability of using it. Theinstitution would first need to determine the nature,level and timing of its primary risks. Once thishas been done, and the financial institution has

Cross-Cutting Issues of Risk Management 45



BOX 31 Price Risk Management in Tanzania

Lending for primary commodities in Tanzania hasfaced traditional obstacles such as a lack of collateral,price and weather volatility, and often times poor man-agement by borrowers. In the late 1990s, as a result ofthese constraints, an agricultural lending institutionwhich was the third largest bank in Tanzania was facedwith the prospect of withdrawing much of their lend-ing to the coffee and cotton sectors. To overcome itsexposure to weather risk, the bank used collateral man-agement. But even with collateral management, thebank remained exposed to significant price volatility.

In order to continue lending and to protect itselfagainst price risk, the bank began working with theCommodity Risk Management Group at the WorldBank to learn more about price risk management

instruments in order to manage their exposure andtheir clients’ exposure to price risk. The bank be-lieved that by using price risk management instru-ments as well as collateral risk management, theywould be able to better manage their exposure tocommodity risk. To do this, CRMG helped train theirstaff on how to use these instruments and provide riskmanagement services to their customers. In 2004, alarge ginner located in the northwestern cotton grow-ing area, purchased a price risk management contractin order to protect itself against a fall in the cottonprice. During the 2005 crop season, the bank plans tointroduce this product to additional customers. Source: Bryla, E., Personal Communication February, 2005.66

World Bank forthcoming a

determined that a market-based price risk manage-ment instrument is the best way to manage that risk,the institutional capacity of the bank is the key tosuccessful implementation. Success factors includethe following:

• The financial institution should have a sig-nificant commercial stake in the use of theinstrument;

• The hedging instrument should cover significantvolumes of loans;

• Top management should provide strong support;and

• Managers and staff should receive in-depthtraining.

Although this approach has only limited applica-tions for financing for agriculture within rural de-velopment, it can represent a breakthrough forsome of the Bank’s partner countries, and pilotshave been supported by Agriculture and Rural De-velopment Department’s (ARD) Commodity RiskManagement Group (Box 31).66

Index-based weather riskmanagement instrumentsIndex-based weather insurance is based on objec-tive, easily verifiable data. It uses official measur-ing stations to measure levels of annual or seasonalrainfall over time and determines the correlation of

the level of rainfall to harvest success. Insurancecan then be written against lack or excess of rain-fall. Index-based weather insurance solutions canprotect financial institutions that are exposed toweather risks against declines in repayment rates inthe case of severe weather events and protect thefarmers who have taken out loans.

Risk management products based on weatherevents and indices such as area yields avoid theproblems of traditional crop insurance because theyrely on objective observations of specific eventsthat are outside the control of either farmers or in-surance companies. They are also less costly to ad-minister because they do not require individualcontracts, on-field inspections and loss adjust-ments. These contracts are written as insurance orderivatives and rely on the close correlation be-tween the farmers’ exposure, such as yields, to anindex, such as cumulative rainfall per season. Thecontract payouts are therefore not settled on thebasis of actual losses incurred, but on the basis ofthe index, which makes payouts more timely andobjective. However, index-based contracts intro-duce basis risk; that is, the potential mismatchbetween payouts and actual losses.

The development of weather risk managementprograms generally entails the following:

• Identification and quantification of weather-re-lated risks and correlation with production losses.


• Assessment of the meteorological infrastructure.This is key, since good weather data and analysisthat enable correlation of weather events tocrop losses are central to the success of suchprograms.

• Design and pricing of prototype insurancecontracts that compensate for losses.

• Explanation and testing of contracts withusers/beneficiaries.

• Identification of institutions that are involved onthe supply side of weather-based insurance, par-ticularly insurance companies and internationalre-insurance companies.

The Bank, through CRMG, has supported asuccessful pilot project in India, as outlined inBox 32.67

There is significant interest world-wide in thisproduct. Evidence from India, where self-helpwomen’s groups have purchased the insurance, in-dicates that even smallholder farmers are willingand able to shoulder the costs of insurance premi-ums as well as interest charges on loans, if the costof self-insurance through techniques such as well-digging or over-diversification are clearly greater.The mainstreaming and scaling-up of the weatherinsurance product for India for the 2005 and 2006monsoon seasons is expected to demonstrate theapplicability of this instrument to a wider market.However, pilots in other regions are needed, and is-sues such as the affordability of insurance premi-ums and basis risk have to be better understood

before such programs can be extended to otherregions on a large scale.

Insurance premiums, coupled with the interestcharged by financial institutions on their loansmight well make a farmer’s investment unprofitableexcept for high return crops. In addition, the abilityand willingness of local lending banks to recognizethe risk reduction for individual agricultural loans,and reward this risk reduction through a reductionin the interest rate charged to the client is quite un-clear. Recent experience on lenders’ willingness toreduce interest rates, based on the reduction of riskfrom credit guarantee mechanisms, suggest thatthis could be difficult.68

Specialized collateralized lendingTraditional bank lending always requires collateral.The underlying collateral of a bank loan is, how-ever, only considered as a secondary source of re-payment, to be mobilized in case of default. Thefirst source will be the enterprise’s operating per-formance, i.e. revenue earned. In contrast, in spe-cialized arrangements, specific goods are dedicatedas collateral and secured for the use of the financialinstitution at the time the loan becomes due. Thecreditor has no right to other assets of the borrower.These arrangements considerably reduce the risksto the bank if the goods given as collateral are eas-ily identifiable, there are officially recognized qual-ity standards, the goods can be securely stored, titleto the goods can be assigned fast and at low cost,

Cross-Cutting Issues of Risk Management 47

BOX 32 Weather Risk Management in India

In 2003, BASICS, a microfinance organization inAndhra Pradesh, India whose principal customers aresmall rural farmers, introduced the first index-basedweather insurance program in the developing world, incollaboration with a local insurance company. Thefarmers who borrow from BASICS are affected everyyear by monsoon rains. When faced with excess rain-fall, they lose their groundnut crop.This risk has impli-cations for farmers even in years when monsoon rainsare good, because they worry about the adverse effectsof a bad monsoon and alter their production patterns tobe less risk adverse. BASICS faces the same negativeimpacts of the monsoon due to increased defaults.

As a result, both BASICS and the farmers had amutual interest in the development of a product thatwould protect them against this risk. In conjunctionwith a large insurance company that was looking to ex-pand its outreach into the rural sector, BASICS devel-oped an index-based rainfall insurance product. Thisinsurance product triggers an insurance payment tofarmers when the amount of monsoon rains rises sig-nificantly above the mean. These insurance contractswere sold to farmers in the rural sector, protecting boththe farmer and the lender against bad monsoon rains. Source: Hess, 2003.World Bank forthcoming b


and there is a ready market for sale of the goods.One such arrangement of special relevance forrural finance with regard to financing for agricul-ture is warehouse receipts.69

In warehouse receipts financing, the underlyingcollateral is a commodity such as grain, cotton, cof-fee, cocoa and vegetable oil, to name a few. Theprocess works as follows. After harvest, the goodsare graded and stored in a warehouse. The farmerreceives proof of ownership and proof that he can-not access the goods without release from the bank.With these instruments, he can then apply for creditfrom a bank against the stored goods. The amountof the loan depends upon the value of the underly-ing collateral, the transaction costs that the bankwill incur when selling the commodities in case ofloan default, and the potential decrease in value dueto price fluctuations. At a later time, presumablywhen the price level is more favourable to thefarmer than right after harvest, the farmer sells thecoffee to a trader or processor. The purchaser paysoff the loan plus interest and obtains release of thecoffee from the warehouse by showing proof ofownership of the coffee (provided by the farmer)and payment of the loan (provided by the bank).

A specialized form of warehouse receipt are re-purchase agreements (repos), where the financialinstitution actually purchases the goods and obtainsclear title, while at the same time signing a repur-chase agreement with the seller, obligating him torepurchase the goods at a certain point in time at apre-agreed price reflecting the costs of the fundsadvanced to the farmer. Repurchase agreementsare advantageous in environments with inadequatelaws and regulations, or weak enforcement withregard to registration of pledges and foreclosuremechanisms.

Warehouse receipt financing and repurchaseagreements allow farmers to choose the timing oftheir sales; as a result, they often obtain better pric-ing than would be possible at harvest time. Thistype of collateralized financing is used extensivelyin developed countries; in developing countries,there are often significant obstacles that need to beovercome.70

Possible areas forBank interventionsAll three cross-cutting issues outlined above offerareas for Bank interventions. Since the enablinglegal and regulatory framework is often the deci-sive factor in the success of such an approach,interventions at that level are desirable.

A second important area of intervention is ca-pacity building within local banks. Instrumentssuch as weather insurance, hedging instruments forprice risk management and specialized collateralare fairly complicated and sometimes counter-intuitive. Local banks need to learn about theseinstruments, preferably firsthand. Once a decisionhas been made to utilize one of these instruments,procedures for approval, monitoring, and collectionneed to be developed and installed, and manage-ment and staff need to be trained. Information andtraining need to be provided to the farmers andother stakeholders as well, in order for them tomake informed decisions.

The Bank could conceivably take on a role tokick-start the development of such mechanisms inselected countries, in cooperation with private sec-tor partners. Once a pilot demonstrates the meritsof such an undertaking, the private sector actorswould carry it forward.



The preceding chapters have discussed the threepillars of rural financial sector development: policy,infrastructure and the development of financialinstitutions. The success factors related to manydelivery channels have been outlined and modelsdiscussed that could potentially be relevant forBank programs. The use of products such as leas-ing, guarantees and financing through supplychains have also been covered. How, then, can taskmanagers decide on a set of interventions for arural finance program or component from amongall these options?

The following matrices were developed asdecision tools for both stand-alone rural financeprojects and for project components. They providethe framework for a first and preliminary analysis,allowing an informed stop-go decision. If the deci-sion is made to go ahead, then the matrix will guidein the choice of delivery channel. The budget forthe analysis, as well as complexities within a coun-try and availability of other relevant studies, willdetermine the level of analysis. This could rangefrom a two-week consulting assignment for a deskstudy that seeks to inform the design of a projectcomponent, to an in-depth analysis that uses thematrices as a roadmap to develop a rural financestrategy for a country.

As rural finance is a complex subject, designand implementation requires specialist knowledge.

It is therefore suggested that all project teamsinclude an experienced rural finance specialist.Failure to identify the need for rural finance dur-ing project design can lead to the belated designof “a credit patch” that does not lead to the cre-ation of sustainable institutions. The matrices mightbe helpful in such a situation, as well as in post-conflict, post-disaster situations where there is apolitical mandate “to do something now,” i.e. with-out systematic analysis and transparent process.However, the limitations of this type of use mustbe recognized.

This chapter outlines a three-step approachto strategy formulation. In the first step, informa-tion on the key elements of the policy context,enabling environment and financial institutions arecollected and analysed, along with information onthe characteristics and structure of the real sector.The findings from this analysis are then coupled inthe second step with an analysis of the demand forfinancial services in the proposed project area.Taken together, this analysis should enable the prin-cipal strategic focus of the project to be developed.The third step concludes the analysis with the iden-tification and prioritisation of intervention options.This three-step process is obviously a simplificationof the project design process; the intent is to providea structure that will guide task managers and help toensure that all important elements are considered.

49

7

Pulling it all together: a practical approach to strategy formulation



MATRIX 1. Country diagnostic matrix: rural financial sector development

Real sector Policy and enabling environment Financial sector

Geographic and climatic aspects• Population density• Mix of cities, towns and

villages in rural areas• Influence of disasters,

epidemics, etc.• Soil fertility• Rainfall

Policy and enabling environment• Macro economy• Political stability• Direct participation of

government in the rural financial sector

• Subsidies that distort ruralfinancial markets

• Presence of credit informationregistries, training institutes, andother financial sectorinfrastructure

Banking sector• Financial sector

depth/breadth• Financial institutions

efficiency/soundness• Presence of larger banks,

including state-ownedbanks, in rural areas andthe extent to which theyserve farmers and low-income people

Source: Project team.

Infrastructure• Transportation• Communication• Water and sanitation• Electricity• Market infrastructure• Availability and affordability

of high-quality inputs

Production and processing• Agriculture production

structure• Structure of supply chains• Level of know-how• Market penetration

(commercialisation)• Degree of specialization,

maturity of rural economy• Prevalence of rural

non-farm private enterprises,including agribusinessesand processors

• Access to agriculturalextension and businesssupport services

Rural finance, relevant donor-financed activities andprojects in the real sector

Legal (real economy)• Creation of laws for

secured transactions• Bankruptcy laws• Leasing laws• Land rights• Degree of enforcement of

above laws

Regulatory and supervisory(financial sector)

• Banking regulation in general• Regulation and supervision

of nonbank rural financeinstitutions

• Analysis of above with respectto expansion of access tofinancial services

Rural finance, relevant donor-financedactivities and projects on the macroand meso levels

Nonbank financial institutions(NBFIs)

• Presence and compositionof NBFIs in rural areas(finance companies,cooperatives, MFIs, etc.)

• Depth and breadth ofoutreach to farmers andlow-income people

• Efficiency/soundness• Grants and subsidies that

may create an unevenplaying field

Products and services • Availability of and access

to household savingfacilities

• Supply chain financing• Rural leasing products• Risk management

instruments • Warehouse financing

facilities

Rural finance, relevant donor-financed activities and projectsat the institutional level


Pulling It All Together: A Practical Approach to Strategy Formulation 51

Step 1: Preparation of acountry diagnostic matrixStrategy formulation starts with data collection andanalysis. The country diagnostic matrix (Matrix 1)provides an overview of all relevant aspects ofthe real economy, as well as the policy context,enabling environment, and financial sector of acountry, including the financial institutions thatprovide services to rural residents. The range oftopics in this matrix is a fairly complete list andcould be narrowed depending upon the context andthe available resources.

Within the real sector, the current productionstructure and the potential for farming and non-farming private enterprises should be analysed,along with relevant aspects of geography, climateand infrastructure. In addition, existing supportservices such as extension services or businessdevelopment services should be identified.

The data gathering for the financial sectorincludes information on all types of financial in-termediaries, from commercial banks to nonbankfinancial institutions to semiformal and informalfinancing mechanisms. It should include supplychain financing, which quite frequently is at thecore of the financial services supply for ruralproducers. The availability of risk managementinstruments should also be evaluated. As ruralfinance is an integral part of the country’s finan-cial sector, a special effort should be made tounderstand the strengths and weaknesses of thefinancial sector overall, as well as the rural financesubsector. The extent to which the various typesof financial intermediaries serve farmers andlow-income people, including those in remoterural villages, should be analysed as well as thefeatures of the products and services that areprovided.

The laws governing the real economy and thefinancial sector, as well as the meso-level institutionsthat support them, drive the analysis of the policyand enabling environment. This analysis covers themacroeconomic situation, regulatory framework,supervisory structures, and laws that affect financialtransactions, including the level of enforcement ofthese laws. Initiatives that could at least partiallycompensate for a poor legal environment should beanalysed as well.

For all three categories, relevant donor activitiesshould be identified, as proposed strategies shouldbuild on these or at least guarantee consistency.

Step 2: Formulation of corestrategic focusThis step adds an assessment of the demand forfinancial services to the information gatheredwithin the country diagnostic matrix. Based on thisinformation, a first assessment of the nature andextent of the problems that the project wishes totackle can be made, as well as a preliminary identi-fication of the main strategic focus.

“Effective demand” is defined as demand frompeople who would be willing and able to utilizeand pay for the financial services demanded. Inrural areas with high effective demand, manycommercially-oriented farmers operate and thenonfarm rural sector is dynamic. At the other ex-treme are rural areas where farmers produce cropsprimarily for household consumption and there arefew nonfarming economic activities. In the middleare rural areas that have characteristics containingelements of both of these more extreme cases:many small farmers have commercial activities,and the nonfarm sector is a mix of medium andsmall companies, as well as family-based microenterprises.

Each of these scenarios for effective demandrequires a different set of interventions. For exam-ple, in a country, or region of a country whereeffective demand is low because most farmers areproducing crops primarily for household con-sumption and there is a low level of economicactivity not related to agriculture, it would bedifficult for most formal financial institutions tocover the cost of extensive rural outreach due to asmall customer base with small financial require-ments. In such a situation, encouraging banks toreach out to the rural areas might not be the bestintervention. Instead, a program might focus onactivities that would translate potential demandinto effective demand. This could include creatingawareness of economic opportunities, providingextension services to farmers and building essen-tial economic infrastructure, such as farm to



market roads. Over time, such assistance wouldlead to the creation of economic opportunities forhouseholds, small entrepreneurs and smallholderfarmers who only then would be in a position toactively demand and utilize a broad range offinancial services.

The critical determinants for the evolution ofthe supply of financial services are the regulatory,legal, and enabling environment, as well as thelevel of government intervention. As with demand,the supply side can be subdivided into three broadcategories. The first category comprises rural finan-cial sectors that show very promising developmentsin the supply of financial services, such as success-ful reforms of publicly-owned rural banks; pri-vately-owned commercial banks with innovativedelivery channels for rural clients; microfinance in-stitutions that are expanding into rural areas; and/orrural financial cooperatives that are profitable andhave strong governance and management systemsthat are likely to be operating within a supportiveregulatory, legal, and enabling environment. Thesecond is defined by some deficiencies in the envi-ronment that have constrained the number of finan-cial intermediaries that are operating profitably andare interested in serving farmers and low-incomeclients. The third has such a poor environment thatthe development of the rural financial sector is verydifficult.

Although it goes without saying that countries,and regions within countries, when analysed indetail, are rather different from each other, a ty-pology can be developed that categorizes coun-tries, or specific regions within countries, accord-ing to the level of development of these relatedfactors. A typology has been developed to provide

task managers with a framework that enables themto compare the strategic approach contemplatedfor the project under design with that of othersimilar countries. The typology is a matrix thatoutlines seven different combinations of interven-tions that could form the core strategic focus of aproject with differing levels of demand for andsupply of financial services, as well as differinglevels of development of the policy and enablingenvironment.

The seven different country typologies areshown in Matrix 2. There are seven typologiesrather than nine, because the two extreme caseswill hardly be found in reality. In each case, adifferent emphasis and focus should be appliedwhen strategies are formulated. For example, if acountry performs poorly at the macro and en-abling environment levels but demand is alreadyevolving and financial intermediaries are provid-ing some services to farmers and low-incomepeople, policy dialogue and enabling environmentobstacles could be emphasized. If the macroand enabling environments are moderately accept-able, addressing the needs of financial inter-mediaries could be the cornerstone. But if loweffective demand is combined with strong defi-ciencies that distort the development of financialmarkets, normally only state-owned banks andinformal/semiformal financial providers could beexpected to provide services to small farmers andlow-income villagers. Under such circumstances,the strategy should focus on measures that supporteffective demand, such as infrastructure improve-ments and production-enhancing technologies, aswell as policy dialogue.


MA

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team

.



Step 3: Prioritising theoptions and coming toa decisionThe country diagnostic matrix and the typology ofcountries provide the basic information that allowsfor a formulation of a rural finance strategy for aspecific country. Once the core strategic focus hasbeen identified, intervention options can be listedand prioritized, according to the broad categoriesalready defined within the country diagnostic ma-trix: the real sector, the financial sector and the pol-icy and enabling environment. For a relativelytransparent process of prioritization, a simple deci-sion matrix as shown in Matrix 3 can be appliedaccording to the following three criteria: proposedoutput or results of a specific intervention, compar-ative advantage of the Bank, and level of resourcesrequired.

The assessment should in all cases take intoaccount the status of existing or planned projectsof other donors, government priorities, and therespective Country Assistance Strategy (CAS) andPoverty Reduction Strategy Paper (PRSP). In addi-tion, Financial Sector Assessment Papers (FSAP),which have very restrictive confidentiality require-ments and often do not focus on rural finance, canbe useful for those countries where they include

rural finance and their content can be made avail-able to a wider audience.

However simple the decision matrix structuremay be, following the procedure helps create a cer-tain degree of transparency, as priorities have to bemade explicit from among the range of possibleinterventions. In addition, it forces analysts to besystematic and to ensure that all important ele-ments are considered. Even if most cases will bemore complex than what can be captured withinthis three-step process, this approach to strategyformulation provides a logical and straightforwardbasis for decision taking.

ConclusionThis paper has attempted to create awareness ofthe complexities of rural finance and its relevancefor rural development, and to explain the principalmethods and solutions that have been successful.Many of the challenges that have confoundedefforts to increase the access of rural populationsto sustainable financial services have now beenovercome in a number of countries. Over theyears, the World Bank has been an integral part ofthe international effort that has led to the currentstate of knowledge. It is now time to increase thateffort as an indispensable part of the fight againstpoverty.

MATRIX 3. Decision matrix

Level of Intervention

Option

Real Sector

Policy/Macroeconomics

Enabling Environment

Financial Sector/Supply

OutputCompetitiveAdvantage of

the BankResources Priority

Source: Project team.


This note presents the results of a desk reviewof 20 World Bank projects approved in FY2004that either exclusively focused on rural financeor had components/activities/conditionalities di-rectly relevant for rural finance (hence referred toas RF projects). Two groups of projects that havean indirect impact on rural finance are includedunder this review. These are projects that aimto strengthen the financial sector in general andprojects that improve access to land and propertyrights.

The objective of this review is to identify keyelements of the project/component design and as-sess the quality of sector assessment, strategy, andmonitoring framework (of the component). Goodpractices, innovations, and practices to avoid areidentified. The review primarily involved reviewof the key project document (Project AppraisalDocument, Program Document, etc.) and inter-views with task managers where necessary. Thereview does not include any analysis of implemen-tation or impact.

OverviewTwenty FY2004 projects included a componentor activity related or benchmark (policy-lendingproject) related to rural finance. This was approx-imately one out of ten FY2004 projects in the rural

57

Appendix 1

Rural finance portfolio analysis at entry 2004 and 2003

Rural finance lending FY2004—a desk review

space. However, only two projects are stand-aloneprojects that aim to increase access to financialservices. The remaining projects are multi-sectorprojects that have a component that aims to in-crease access to a one (mostly credit) or fewfinancial services, or those that use financial in-struments to deliver other services. The number ofRF projects is higher in FY2004 compared toFY2003 although RF portfolio is lower. Portfoliofor to rural finance could only be disaggregatedfor 12 projects, and this was estimated to be $288million.72

25

2003

Fiscal Year

2004

17

2020

15

Num

ber

of P

roje

cts

10

5

0

Source: Ajai Nair, Project Team

Projects with rural financecomponents, activities, and/orbenchmarks

rura107078_app1.qxd 05/11/2005 10:31 PM Page 57

The higher portfolio in FY2003 was primarilybecause of a large adjustment project (US$506million).73

800

2003

Fiscal Year

Len

ding

Am

ount

in U

S$

Mil

lion

s

2004

600

400

200

0

666

288

Sector board distributionIn terms of sector boards, ten projects are rural sec-tor operations, five are finance and private sectoroperations, two are social protection, and one eachis infrastructure, social development and publicsector development operations respectively. Thelarge number of non-rural sector board operationsindicate the need for a Bank-wide approach to ruralfinance.

Social Development1

Social Protection2

Finance Sector2

Private SectorDevelopment

3Infrastructure

1

Public Sector Management1

Agricultureand Rural

Development10

Sector Boards

The Numbers = the Number of Projects

58 Appendix 1



Regional distribution SAR had both the largest number of projects (six)and the largest share of the FY2004 rural financelending (55%). As in FY2003, most of the lendingvolume comprises a small number of projects;three projects make up 86% of the estimated ruralfinance lending amount.

South Asia6

Middle East andNorth Africa

1

Latin America andthe Caribbean

3

Africa5

East Asia andthe Pacific

4

Europe andCentral Asia

1



TargetingMost projects do not target any particular economicsector or population group. Among those that havesector targeting, two projects, both in China, targetagriculture and two projects target infrastructure,supporting renewable energy development. Onlyone project has a population targeting, that of pro-viding support for savings and credit groups amongthe very poor.

Financing scaleThree projects support small-enterprise finance, sixprojects support both microfinance and small-enterprise finance, and the remaining 11 supportonly microfinance.

Volume of rural finance lending

Regional distribution of ruralfinance lending, FY04

Distribution of rural finance lendingby managing sector board


Activities supportedThis analysis and the next two sets of analyses aredone only for 15 projects for which most of the re-quired information are available. The major activitysupported continues to be delivery of financial ser-vice at the retail level. An activity is defined tofall into this category if a credit line or revolvingfunds are being used to support it. Eleven projectssupport this activity. The other retail-level activitysupported is creating effective demand for financialservices. An activity is defined as doing this if itinvolves support to entrepreneurs for preparingbusiness proposals or if it involves technical sup-port for development of community-based finan-cial organizations. Five projects do this. Marketfacilitation activities are meso-level interventionsthat support the development of financial marketsin rural areas. These include support for setting upcredit bureaus, property registries, retail and apexservice providers, industry associations, industrystandards, etc. It is a welcome feature that a signif-icant number—eight—of projects support this crit-ical but often neglected activity. However, only oneproject supports macro-level activities that createan enabling environment for the development ofrural financial markets. These involve activities thatinvolve legal, regulatory, and policy reforms.

12

ServiceProvision

MarketFacilitation

DemandDevelopment

EnablingEnvironment

11

8

5

1

10

8

Num

ber

of P

roje

cts

6

2

4

0

of credit services. Less than half the number—five—projects support development of savings ser-vices. Among these only two involve supervised fi-nancial institutions; others are considered tosupport savings services because these projects in-volve development of savings and credit groups.Only one project supports the development of pay-ment services. The far fewer number of projectssupporting the development of savings and pay-ment services is of concern since it is increasinglyrecognized that these services are equally or per-haps more important than credit services. It isnotable that none of the projects support thedevelopment of insurance services, perhaps themost important financial service, given the role itplays in income protection.

20

Credit Savings Payment Insurance

15

5

10

10

15

Num

ber

of P

roje

cts

5

0

Rural Finance Portfolio Analysis at Entry 2004 and 2003 59



Financial services supportedProvision of credit is the predominant service beingsupported. All 15 projects support the development

Service-providers supportedA wide variety of providers are supported. Fiveprojects support MFIs, four each involve financialcooperatives and savings and credit groups, andthree projects involve banks or nonbanking finan-cial institutions. The last category contains themost rigorously regulated institutions. This also ex-plains the very low number of projects supportingservices other than credit because provision of allother services are normally permitted only by regu-lated institutions in most countries. The predomi-nance of unregulated institutions supported is alsoof concern from the perspective of sustainability offinancial services supported.

Activities supported by ruralfinance lending, FY04

Financial services supported byrural finance lending, FY04


Instruments usedIt is a welcome feature that the largest proportionof projects—10—involve capacity building in theform of technical assistance or training. Start-upgrants, either for operations or technology im-provement, are still a relatively less used nonfinan-cial instrument. Only two projects use this instru-ment. Among financial instruments, four projectsuse revolving funds (three other projects not in-cluded in the 15 analyzed here also mention revolv-ing funds as an activity that while six projects usetraditional credit-lines. Two projects are piloting

12

CapacityBuilding

RevolvingFund

Start-upGrants

CreditGuarantee

10

4

Instrument

2 2

10

8

Num

ber

of P

roje

cts

6

2

4

0CreditLine

6

the use of credit-guarantees. The large number ofprojects using revolving funds is an area of con-cern, particularly so when provided without ade-quate capacity building.

Innovative practicesPractices identified in this section reflect relativelynew approaches. It is expected that identifying thesewould encourage innovations in general and alsoflag them for future assessments for effectiveness.

Supporting technologydevelopment for enhancing qualityof services and reducingtransaction costsThe US$160 million Savings and Rural Finance(BANSEFI) Phase II Project in Mexico74 fundsthe initial costs (US$56 million) to set up a tech-nology platform for savings and credit institutionsin Mexico. The activities financed include hard-ware costs, software development, and technicalassistance. The platform would be at the nationallevel, rather than at the savings and credit institu-tion level or at the level of the federations, foreconomies of scale reasons and because it wouldmake monitoring and learning across the supportedentities feasible. The supporting entities are ex-pected to bear part of the installation costs and allthe operational costs. Additionally, it is expectedthat the national support agency can charge reason-able license fees from the supported entities aftertwo years of installing the platform. Supporting thedevelopment of a modern technology platform tobe used by a wide variety of independent savingsand credit institutions is an innovative practice.The project expects the platform to significantlyenhance the quality of services delivered by thesupported institutions and reduce the transactioncosts of providing the services.

Start-up grants for small businessenterprises to leverage creditThe US$19 million Village Investment Project inKyrgyz Republic provides start-up grants for newbusiness enterprises. These grants are provided bylocal governments based on project proposals that

60 Appendix 1


6

MicrofinanceInstitutions

Savings andCreditGroups

FinancialCooperatives

Service Provider

Banks/Non-bankFinance

Institutions

5

4 4

3

2

4

5

3

Num

ber

of P

roje

cts

1

0


Service providers supported byrural finance lending

Instruments used to support ruralfinance lending, FY04


have been independently appraised by establishedlenders such as commercial banks and MFIs and forwhich they have committed credit financing. Thegrant is expected to be a small portion of the totalproject costs (a maximum of $1000 per proposal)with the major portion expected to be from creditfinancing. Other requirements for release of thegrants include legal registration of the group (coop-erative, company, partnership, etc.) and their havingobtained adequate training in business planning andmanagement by a recognized institution. These re-quirements reduce the likelihood that grants are pro-vided for proposals that are not commercially viable.Start-up grants that only fund a small portion of theproject costs is also in contrast to funding of produc-tive activities under most CDD projects where thegrants fund up to 90% of project costs. While start-up grants to help small urban businesses have beenused for a long time in developed economies, theiruse to encourage enterprise development in ruralareas is relatively new and innovative.

Good practicesThe review identifies the following projects on thebasis of specific features in project design or imple-mentation arrangements that are generally con-sidered a good practice in microfinance and ruralfinance literature.

Public-private partnership to increaseaccess to credit in rural areas The US$258 million Second Poverty AlleviationFund in Pakistan is a good example of public-private partnership. While the government sponsorsthe project implementation agency by providing eq-uity and borrowing from the World Bank on its be-half, the organization board has majority of membersfrom the private sector. The implementation is car-ried out by MFIs and NGOs who are provided withboth a credit line and significant technical assistance.

Stand-alone monitoring &evaluation component to evaluateoutcomes in an innovative projectThe Savings and Rural Finance (BANSEFI)Phase II Project in Mexico includes a large(US$7.5 million) stand-alone monitoring and

evaluation component. This component financesindependent household surveys, case studies, andinstitutional performance assessments, as well asevaluation of project outcomes to be carried outinternally. The significant investment envisaged forMonitoring and Evaluation (M&E) studies is justi-fied by the innovative nature of the project and itsexpected sector-wide impact.

Combining grants and loans withoutcreating perverse incentives forlenders and borrowersTwo FY2004 projects use innovative means tocombine grants and loans for final clients whileminimizing the risks of creating perverse incen-tives such as reduced incentive for lenders to enterthe market and reduced incentive for borrowersto repay loans. The $27 million Rural PowerProjects in Philippines includes a credit line thatprovides loans to financial intermediaries for on-lending to renewable energy technology (RET)suppliers and users. The project also providesgrants to technology suppliers and users to reducecost of the systems. However, neither recipient ofthe grant and loan receive them from the same en-tity. Provision of the grant and loan from separateentities prevents the borrower from considering theloan as grant, an issue typical in several projectswhere both the loan and the grant are provided bythe same entity. The grants provided by the US$19million Village Investment Project in KyrgyzRepublic are also unlikely to create perverse in-centives for the same reasons (see under innovativepractices for project modalities).

Practices to avoidThese practices could adversely affect effectivenessof rural finance activities in World Bank operations.

Lending to local governments andgovernment-controlled cooperativesfor on-lendingThe Jiangxi Integrated Agricultural Moderniza-tion Project and Gansu & Xinjiang PastoralDevelopment Project in China envisage providingloans to farmers for various farm-related invest-ments. However, the institutional arrangements for



this do not follow the recommended good practicesfor rural financial institutions. The project envisagesthe loans to be provided either by local governmentdepartments or by the rural credit cooperatives.There is little evidence globally of successful man-agement of loans by government departments oragencies. The rural credit cooperatives are still ef-fectively state-controlled organizations and man-agement of loans by such organizations too do nothave a history of success. The project appraisal doc-ument (PAD) also does not provide any informationon why this approach has been adopted, what—ifany—is the strategy to ensure successful manage-ment of the credit line, and does not include anyindicators to monitor the repayment performance ofloans to farmers.

Providing revolving funds tocommunity groups withoutadequate support for institutionaldevelopment and capacity buildingThe US$89 million Uttaranchal DecentralizedWatershed Management Project in India and theUS$81 million Second North-East IrrigatedAgriculture Project envisage providing revolvingfunds for community groups without adequatetechnical assistance arrangements. Available evi-dence for the performance of community-managedrevolving funds suggest that external capital islikely to be beneficial only when they are providedin combination with adequate technical assistance.

Recommendations

General

1. Issue: Only four out of 20 FY2004 RF projectsfocus on specific sectors—two on agriculture andtwo on infrastructure; other projects either focusbroadly on enhancing access to finance for the un-derserved or focus on enhancing access to creditfor specific population groups such as womenor the very poor. While having a broader ruralfinance approach (in contrast to single-sector,credit-only projects) is in keeping with the con-sensus about the need for a financial system ap-proach, it is unknown if this approach addressesthe financial needs (particularly credit) of keysector in rural areas, particularly agriculture and

infrastructure. Recommendation: Sector-workthat investigates demand and supply of financialservices for agriculture and rural infrastructureshould be carried out. In economies where supplyconstraints are established, further investigationscan be carried out on possible reasons and meansto address these. Based on such studies, projectscan experiment with financial and nonfinancialinstruments to address the constraints.

2. Issue: Many multi-sector projects that includerural-finance components or activities do notinclude a rural-finance specialist in the projectpreparation team. Recommendation: All projectsthat have rural finance components or activitiesshould have specialists with rural finance exper-tise in the project preparation team. As a rule ofthumb, if the component is considered too smallto justify having a specialist, it is unlikely to besignificant enough to be included in the project.

3. Issue: Most multi-sector projects that have arural finance component or activity do notgive the rationale for including the component/activity or for using the particular project im-plementation mechanism being adopted. Thismakes it difficult to understand whether a strongrationale exists for inclusion of the componentand whether alternative implementation mecha-nisms were explored. Recommendation: Multi-sector projects should provide clear rationale forinclusion of the rural finance component/activityin the project and for the mode of its implemen-tation. Additionally, where the component isrelatively significant, projects could also includean annex that provides a rural finance sector as-sessment and explains how the rural financestrategy being adopted by the project fits in withnational strategy (if this exists).

4. Issue: Most RF projects do not include well-specified outcome and output indicators in theproject results-monitoring framework. Recom-mendation: All RF projects should include RFwell-specified output and outcome indicators inthe results-monitoring framework. When provi-sion of credit is supported (through credit lines orrevolving loan funds), include key indicators suchas loan repayment performance is critical to esti-mating the performance of the component/activity.

5. Issue: Projects that support provision of finan-cial services in both rural and urban locations(typically finance sector projects) do not include

62 Appendix 1


output and outcome indicators that are disaggre-gated geographically (rural/urban). Recommen-dation: Projects that support provision of finan-cial services in both rural and urban areas shoulddisaggregate outputs and outcomes indicatorsgeographically (rural/urban). PADs should alsoclearly indicate how rural/urban locations aredefined.

Project design

1. Issue: Some projects provide revolving funds forcommunity groups without also providing the re-quired technical assistance to ensure effective useof the funds and their sustainability. Recommen-dation: Globally, available evidence indicates thatgroups that receive external capital assistancetend to have higher failure rates when compared toprojects that only receive support for group mobi-lization, provide training, and offer advisory ser-vices. Projects should provide revolving-fundsonly when a strong justification for the need ismade and is accompanied by institutional devel-opment and capacity-building support. It shouldalso be ensured that the recipient of the revolvingfunds have ownership structures that haveincentives to ensure the sustainability of the fundand the project design does not introduce rules orincentives that operate in the reverse.

2. Issue: In multi-sector projects, implementationof rural finance activities are often carried outby project implementation units or local govern-ments that do not have adequate rural-financeexpertise. Recommendation: Multi-sector pro-jects having rural finance components shouldcontract out implementation of rural financeactivities to institutions with the required spe-cialist expertise. If this is not feasible, it shouldbe ensured that adequate expertise in rural-finance expertise is ensured at all levels ofimplementation.

3. Issue: Supply of financial services by governmentdepartments or agencies have traditionally notbeen successful. Yet, some projects continue tosupport this means of delivering financial services,particularly credit. Recommendation: Supportshould primarily be provided for supply of finan-cial services by specialized organizations such asbanks, MFIs, financial cooperatives, and savingsand credit groups. If supply by an organization (in-cluding any of the types just referred to) in whichgovernments have an ownership-stake is sup-ported, it should be ensured that the ownership-stake is not likely to translate into interference inmanagement and operational decisions. This iscritical to ensure effectiveness and sustainabilityof interventions supported by the project.


Rural finance lending FY2003—a desk review

This note presents the results of a desk review of 17World Bank projects approved in FY2003 that ei-ther exclusively focused on rural finance or hadcomponents or conditionalities directly relevant forrural finance. The objective of the review was tocapture nature of support and identify innovations,good practices, and practices to avoid. The analysisfocuses solely on design elements and not on imple-mentation or impact. The review draws on informa-tion in project documents and on interviews withproject task managers.

OverviewAfter significantly declining in the 1980s and early1990s, rural finance lending75 started increasing in

mid-1900s. The average number of projects per yearduring the period FY 1992-2000 was 19 and thelending was $630 million.76 The number of projectsin FY2003 is lower than the averages for the lastdecade and the last two FYs, but the volume isslightly higher.

Trends in number and volumeIn FY2003, 12 investment projects supported

activities aimed at increasing access to financialservices in rural areas. Five adjustment projectshad conditionalities or benchmarks connected torural finance. Among these 17 projects, portfoliofor rural finance could not be disaggregated forthe three adjustment projects and one investment


project. In the remaining 13 projects, the rural fi-nance portfolio is estimated to be $666 million.77

As in the past years, AFR has the largest numberof projects. The largest share of the portfolio is inLAC (the two projects in Mexico make up over90% of the total FY2003 portfolio).

Regional distribution of projectsTen projects exclusively target rural areas andseven have no targeting. Two projects work exclu-sively with women and two have explicit povertytargeting. As for sector targeting, one project tar-

14

ServiceProvision

EnablingEnvironment

MarketFacilitation

DemandDevelopment

13

5 5 5

12

10

8

Num

ber

of P

roje

cts

6

2

4

0

South Asia1

Middle East andNorth Africa

2

Latin Americaand the Caribbean

3

Europe andCentral Asia

1

Africa8

East Asiaand the Pacific

2


gets agriculture, two target infrastructure sector(energy production) and 15 do not target anyparticular sector.78 Twelve projects focus on micro-finance while one focuses exclusively on small en-ergy enterprises. Four projects support both micro-finance and small enterprise financing.

What is being supported?The major activity supported continues to be ser-vice provision. Five projects each support creationof an enabling environment, market facilitation, andsupport for creating effective demand for financialservices. Enabling environment involves support forlegal, regulatory, and policy reforms. Market facili-tation involves support for asset registries and creditbureaus. Support for creating effective demand in-volves financial counseling services and support toenterprises for preparation of credit proposals.

Activities supportedAmong the projects involving support for serviceprovision, credit is the predominant service beingprovided. This could be because provision of otherservices involves significant regulatory constraints.However, inadequate recognition of the importanceof other financial services (especially savings andinsurance) by project teams could also explain thepredominance of credit.

A wide variety of providers are involved inservice provision. Three projects each involvemicrofinance organizations and community-basedorganizations, and two each involve state-owned

64 Appendix 1

Source: Ajai Nair, Project Team Source: Ajai Nair, Project Team

25

1992–2000 2001Fiscal Year

630 628

440

666

17

23

22

19

2002 2003

15

Num

ber

of P

roje

cts

20

10

700

500

400

600

300

Number Volume ($ million)

Lending A

mount in U

S$ M

illions


Trends in rural finance lending

Regional distribution of ruralfinance lending, FY03

Activities supported by ruralfinance lending, FY03


banks, commercial banks, and cooperatives. It isnot, however, clear if all these institutions areenvisaged to be sustainable.

8

9

TechnicalAssistance

Start-upGrants

Instrument

CreditLine

RevolvingFund

7

6

5

4

Num

ber

of P

roje

cts

3

1

2

0

3

4

Training

5

6

8

What are the innovations?Practices identified in this section reflectrelatively new approaches. It is expected that iden-tifying these would encourage innovations ingeneral and also flag them for future assessmentsfor effectiveness.

• The Rural Finance Sectoral Adjustment Loanin Mexico supports creation of a non-deposittaking, state-owned bank focusing exclusivelyon lending to middle-income rural producers.While the state ownership of the bank does raiseconcerns on its ability to operate on commercialbasis, not having the ability to mobilize depositsand being required by charter to maintain thereal value of its assets is more likely to make itdo so.

• It is generally agreed that sustainability of mi-crofinance institutions is critical. The AndhraPradesh Rural Poverty Reduction Project inIndia envisages this by supporting the develop-ment of federations of community-based organi-zations and specialized second-tier microfinanceorganizations.

• As was mentioned earlier, most projects focus onprovision of credit services. In contrast, theThird Malawi Social Fund Project focuses onsupporting community groups that provide sav-ing opportunities. The groups are not envisagedas clients for lending by banks or microfinanceorganizations (they are, however, expected tolend their savings among their members).

• Inadequate capacity of entrepreneurs to submitbankable proposals is one of the several con-straints that limit poor people’s access to finan-cial services. The Savings and Credit Sector pro-ject in Mexico and Small-scale CommercialAgriculture Development Project in Bosnia havesub-components that support the provision oftechnical support for this purpose.

• Commercial financing of rural infrastructure isexpected to enhance creation and improve main-tenance of such infrastructure. The Off-gridRural Electrification Project in Nicaragua andDecentralized Rural Electrification Project inGuinea envisage bank financing of small energyprojects and household electrification.

• Financial services aligned with social and cul-tural contexts have relevance in areas with lim-ited economic activity. The Matruh Resource


12

Credit Insurance Others

10

8

Num

ber

of P

roje

cts

6

2

4

0

11

Savings

5

11



How is the support beingprovided?More projects involve start-up funds for serviceproviders, technical assistance, and training than dothose that involve a credit line or revolving funds.The higher focus on nonfinancial instruments,rather than financial instruments, is welcome sincein most situations the absence of an enabling pol-icy environment, institutional capacity of serviceproviders, and capacity of clients is more limiting aconstraint than is the absence of finance.

Financial services supported byrural finance lending, FY03

Instruments used to support ruralfinance lending, FY03


Management Project in Egypt has a microfi-nance component that supports credit financingin ‘in kind’ (not cash) and in keeping withIslamic financing principles.

What are the good practices?Most of these are design features in projects thatare generally considered a good practice in microfi-nance and rural finance literature.

• In the Third Kecamatan Development Projectin Indonesia, support for revolving fundmanagement units (UPKs) of the subdistricts(Kecamatans) is based on the assessment oftheir viability potential and classification intofour categories. This helps the project to provideneed-based support to the UPKs, includingsupport for termination of operations whennecessary.

• Several multi-sector projects are contracting outimplementation of the microfinance compo-nents. This is a good practice because projectimplementation units of multi-sector projectsusually do not have the capacity to implementmicrofinance activities. The Small-scale Com-mercial Agriculture Development Project inBosnia and Herzegovina goes one step furtherand contracts out supervision of the microfi-nance organizations supported.

• Well-functioning industry associations of micro-finance organizations facilitate the developmentof a robust microfinance sector. The Savings andCredit Sector Strengthening and Rural Microfi-nance Capacity Building Project, Mexico andCompetitiveness and Enterprise DevelopmentProject, Burkina Faso support such associations.

• Appropriately regulated and supervised savingsand credit institutions can have a significantrole in providing financial services in rural areas.The Mexico Savings and Credit Sector Project

supports capacity building for such an institu-tional framework.

• Linkages with mainstream financial institutionscan provide sustainability to community-basedfinancial institutions. The Andhra Pradesh RuralPoverty Reduction Project in India envisagescommunity-based organizations using fundsprovided by the project to leverage additionalinvestment funds from banks.

What are the practicesto avoid?These include practices that could adversely affecteffectiveness of rural finance activities in WorldBank operations.

• Most projects do not report a microfinance com-ponent under the relevant sector code. Not doingso makes identification of the rural finance port-folio a cumbersome process.

• One project supports formation and strengthen-ing of community-based organizations that pro-vide microfinance services in rural areas, butdoes not classify this support under a microfi-nance component or subcomponent. Doing somakes identification of the component and ade-quately monitoring it difficult.

• Credit lines or revolving funds need to beavoided under budget-support loans. When re-quired, these are best provided under investmentprojects.

• Two projects have microfinance components thatare too small to make a significant impact or bemonitored effectively.

• Implementation of microfinance activities arebest carried out by specialized institutions ratherthan by project implementation units or localgovernments. Yet, several projects continue tohave microfinance components implemented orsupervised by project implementation units orlocal governments.

66 Appendix 1


67

Appendix 2

Diagnostic matrix: Rural financial sector development—An example from a

developing country—Uganda

Real sector Political and enabling environment Financial sector

Geographical/climatic aspects

Infrastructure/human capital• Deficient infrastructure • Unreliable electricity• Deficient market

infrastructure• Lack of qualified personnel

Macroeconomic and policyenvironment

• Macroeconomic stabilizationsince 1987; strong growth duringlast ten years

• GoU reduced its participationwithin the financial sector nearlycompletely

• Acceptable environment

Legal (real economy)• Strong land tenure problems• Lack of possibility to mortgage

land • Poor legal contract enforcement

(especially in rural courts)

Banking sector• Shallow banking sector

(200,000 persons perbranch; very low ratio ofloans to private sector/GDP; dominated by fourforeign-owned banks)

• Some large loans forcommodity processingfirms or large exporters areavailable

• Leasing is available(DFCU, new entrantsexpected)

• Checking, savings anddeposit services in ruraltowns

• Some banking services forMFI available

Nonbank financial sector• Dominated by NGOs,

SACCOs and DFCU, Ltd.• 4–7 stronger NGOs, up to 5

in transformation process • Clients: mostly small-scale

traders in peri-urban areas• SACCOs: some loan

extension to farmers, ruraltraders

(continued )


68 Appendix 2

Real sector Political and enabling environment Financial sector

Availability of support services

Rural finance, relevant donor-financed activities, andprojects in the real sector

Information sharing• A market information service

(Foodnet) sponsored by thegovernment is in place (futurefunding insecure)

• Information sharing systems arenot in place

• Generally: lack of information oninvestment opportunities

GTZ/SIDA financed financialsector project with focus on MF;implementation of adequatesupervisory mechanisms for NBDI

Risk management• Access to savings products

in small rural towns avail-able; however: very limitedbranch network

• Hedging possibilities forprice risks are not available

Projects by USAID andprobably GTZ/Kf W are inpreparation

Production structure• Agriculture still dominant

(80% of workforce)• Around 60,000 farmers and

fishermen operate commer-cially (the basic need isterm finance, which is notavailable; leasing,)

• Semi-commercial farmerswith similar needs as thecommercial farmers but ona smaller scale

• Subsistence farmers andvillagers

Legal/administrative (financial sector)• Adequate regulatory environment • Adequate access of NGO to

formal financial sector• Improving supervision • Minimum deposit requirements

Trade finance; buyer andsupplier credit

• In-kind and supplierscredits for buyers, sellersand farmers throughout theproduction marketing chain


1World Bank. 2003a.2See for example Yaron, J. et al., 1997; Yaron, J., 1994; VonPischke, J. D., 1991; and Von Pischke, J. D. et al., 1983.3World Bank, 2003d.4World Bank, 2003a.5For an overview of the role of finance in economicdevelopment see for example Caprio G. and Honohan P.,2001 and Hermes, N. et al., 1996. 6Butzer, R. et al., 2002.7Rural finance used to be defined as agricultural financeby donor agencies and governments for much of theperiod from the 1950s to the 1980s. Donor agenciesprovided resources for agricultural finance, often throughsubsidized credit lines for state-owned agriculturaldevelopment banks. In the 1950s and 60s, projects tendedto promote the adoption of productivity-increasingtechnologies and methods, often following a one-model-fits-all approach. The 1960s and 1970s also saw a trend indevelopment thinking emphasizing industrial overagricultural development, resulting in increasing biasesagainst, and deteriorating terms of trade of, theagricultural sector. Given deteriorating agricultural prices,subsidized finance was seen as the only means to inducefarmers to adopt new technologies. FAO/GTZ, 1998.8Von Pischke, J. D. et al., 1983; Yaron, J. et al., 1997;Yaron, J., 1994; Gonzales-Vega, C., 1994. 9The concurrent decline in agricultural credit programshas also led to a decline in available finance foragriculture. For example, World Bank lending foragriculture in the 1990s represents only one-third of thevolume of agricultural lending of the 1980s (FAO/GTZ,1998). This statement is corroborated by the Bank’s“Reaching the Rural Poor” strategy which states that“lending for agricultural activities declined dramaticallyfrom about 31% in 1979–81 to less than 10% in FY 00and FY01.” The largest declines occurred inter alia in thesector of agricultural credit, because of the shift awayfrom commodity targeted credit. (World Bank, 2003b;p. 15) However, rural finance lending started increasing inthe mid 1990s, after large declines in the 1980s andearly 1990s. (World Bank, 2003c; Appendix 3 RuralFinance, p. 28)10In July 2004 IFC closed on a 34% Partial CreditGuarantee to the bond issue of 500 million pesos (approx.

$43.4 million) for Compartamos, a major microfinanceinstitution in Mexico.11World Bank, 1998.12World Bank, 2005a.13World Bank, 2005c. SeeAppendix 1 for the complete text.14Regulatory environment for cooperative financialinstitutions, for example, is of specific concern to ruralfinance, since financial cooperatives and credit unions areoften regulated by bodies outside the general financialsector, often by Departments of Agriculture.15See for example Miller, M., 2003; and Maimbo, SamuelM., 2003. 16Deininger, Klaus, 2003.17The World Bank’s Integrated Development Program forIrrigated Agriculture in Mauritania supports the expandedand transparent registration of land in order to assistfarmers to be eligible for long-term investment credit. Bythe end of the first phase of the project in 2004, approx.36,000 hectares have been registered. The project alsoprovided technical assistance and a credit line forUNACAEM, the National Union of Agricultural andCredit Cooperatives, which is now able to provide short-,medium- and long-term credit for all agriculturalactivities, year-round. For details see World Bank, 2005d.See also Deininger, Klaus, 2003.18For example, cooperative financial institutions and creditunions in many countries are not counted as part of thefinancial sector.19One can distinguish direct and indirect supervisionsystems. Direct supervision systems are those where allsupervision tasks are carried out by the agencyresponsible for the oversight of financial institutions, suchas the central bank. Indirect supervision systems involvedesignated agencies, such as specialized governmentagencies, audit firms or federation networks, in all orsome supervisory tasks. Within the indirect systems, onecan further distinguish auxiliary and delegatedsupervision. The term auxiliary supervision is usuallyused to indicate a supervision system where the primarysupervisor, such as the Central Bank, retains most of thesanctioning powers while only using the supervisory agentto undertake routine supervisions–both off-site andon-site. In contrast, the term delegated supervision is usedto indicate a system where the supervisory agent has

69

Endnotes

rura107078_end.qxd 5/17/05 12:17 PM Page 69

significant powers of sanction also, although the ultimatepower of closure and liquidation of a financial institutionis retained by the primary supervisor. For more details onthe advantages of the different systems see Kumar, A.et al., forthcoming, p. 11ff.20Deposit insurance programs might help in promotingsavings in rural areas where the confidence of potentialclients in formal financial institutions is low. In order tomitigate the moral hazard problem, a deposit insurancescheme would need to be designed in such a way thatparticipating financial institutions are screened forfinancial strength, standardized procedures, etc. Thiswould, however, give the participating institutions anadditional competitive advantage. Schemes can also beadapted to the type of participating institution. In the USAfor example, the deposit insurance differs for commercialbanks or credit unions. See Carter, M. et al., 2004.21Cash-flow lending based on household income refersto credit technologies which tie the repayment scheduleto the borrower’s expected cash flow from a varietyof sources, rather than simply the cash flows from theactivity financed. This method is being used bymicrofinance institutions in many countries. For example,commercial rural banks in the Philippines have adoptedcash-flow lending through participation in an institutionbuilding assistance program. See for example Campion,et al., 2003.22In 2003, a group of commercial banks agreed to adoptthe IFC environmental and social safeguards as theirguidelines for project finance in emerging markets. Theguidelines, or Equator principles, include issues ofenvironmental assessments, natural habitats, involuntaryresettlement, indigenous people and child labor, andapply to projects above US$ 50 million. As of January2005, 28 private banks have adopted the Equatorprinciples. Critics point out that attempts to setinternational industry standards are laudable, but thatthe principles do not include mechanisms for externalmonitoring and enforcement. 23The “double bottom line” refers to business objectivesthat include social as well as financial objectives. The“triple bottom line” includes environmental protection.The triple bottom line has been incorporated by manyfinancial institutions, such as the Equator principle banks(see endnote 22), and has for example led to thepublication of annual sustainability reports in addition toannual business reports. For a good overview of currentthinking see Bouma, J. et al., 2001. An example for anannual sustainability report can be found at Rabobank’swebsite at http://www.rabobank.com.24The Economist, 2005. 25World Bank, 2005a.26Valenzuela, L., 2002.

27IFC, with its 2001–2002 initiative “How to make smallbusiness finance profitable for financial institutions,”initiated an international discussion focused on such anapproach. In order to tap new markets in an increasinglycompetitive environment, financial institutions can expand“downwards” to reach smaller businesses and ruralenterprises. This requires a shift in emphasis away fromdelivering credit to individual clients to providing a fullpackage of financial services to mass customers. The newapproach requires the development of new products andthe use of new or improved financial information andcommunication technologies. Examples include the useof multiple channels for service delivery, such as mobilephones and mobile branches, as well as the introductionof credit scoring technologies for managing a largeportfolio (see Box 5 for a brief explanation of scoring).The IFC has launched two new facilities, the GlobalMicrofinance Enhancement Facility and the Global SMEEnhancement Facility, which provide credit guaranteesand technical assistance to banks trying to expand intothese sectors. See IFC, 2001.28An example are Ghana’s rural banks that in the pastfunctioned essentially as deposit collection institutions.As a result of macroeconomic policies, governmentsecurities were by far the most lucrative investments,effectively crowding out loans to customers. Therefore,the banks never had to develop a credit system thatenabled them to service retail and corporate clients. Theirmost urgent task is now to develop the appropriate credittechnology for different lines of business. 29See World Bank, 2005b.30World Bank, Forthcoming.31World Bank, 2004c.32Yaron, J., 2003. 33See endnote 23 on double bottom line objectives forfinancial institutions. See also CGAP, 2004a. 34Seibel, H. D., et al., 2005, show that private providers,particularly microfinance organizations, could not replacethe vast branch network that many agriculturaldevelopment banks had. Microfinance providers, such asNGOs, do furthermore often show an urban bias, withcredit technologies adopted to the urban environment,but not necessarily suitable for agricultural finance. Theclosures of agricultural development banks particularlyin Latin America and West Africa therefore left therural populations without formal financial services.A case in point is the Banco Agricola del Peru, whichwas closed in 1991, and where no private providers havefilled the gap. For more details on this case see Vogel,R. C. et al., 1997.35See for example Adams, D. W. et al., 1984.36See CGAP, 2004c.

70 Endnotes


37NMB currently does not publish any financial andbusiness data because of its upcoming privatization whichis expected to be completed in mid-2005. However,according to the Parastatal Sector Reform Commission inTanzania, the National Microfinance Bank (NMB) was thelargest bank in Tanzania in terms of customer deposits andin terms of branch network. As of December 2003, NMBcomprised four agencies and 104 branches. Its depositsstood at approx. US$361 million. DAI has estimated theloan portfolio at US$61 million (see http://www.dai.comfor details). The ratio of savings to loans thus stood atapprox. six to one.38BRI in Indonesia and AgBank of Mongolia have thesame experience; see Robinson, M. S., 2001; andAgricultural Bank of Mongolia (undated).39GTZ, 2002, and also IFC internal appraisal reportof AgBank, 2003 (unpublished).40See http://www.khanbank.com and http://www.dai.com/work/practice_detail.php?pid=4 and also CGAP, 2004b.41Robinson, M. S. 2001. 42See World Bank, 2004c; and. Manndorff, H., 2004.43CGAP has established a rating fund that provides partialfunding for ratings of microfinance institutions. Thewebsite of the fund http://www.ratingfund.org providesgeneral information on the rating process and rating andassessment agencies.44An ESW on cooperative financial institutions is beingprepared by FSE. In addition, in 2004, the World Bankorganized a series of conferences on Strengthening ofCooperative Financial Institutions. These were held inWashington, DC; Recife, Brazil; and Baku, Azerbaijan.Proceedings of these conferences are available on theBank’s Rural Finance website.45See World Bank, 2004a.46A profile or history of most of these institutions can befound on their respective websites: For Rabobank, seehttp://www.rabobank.com; for DZ Bank, seehttp://www.dzbank.de; for Raiffeisenbank, seehttp://www.vr-networld.de; and Credit Agricole, seehttp://www.credit-agricole.fr. 47Balkenhol, B., 1999. 48See World Bank, 2004b.49Arzbach, M., 2004.50Arzbach, M., 2004; see also World Bank, 2004b.51See Allen, H., 2002.52http://www.ruralfinance.org.53Rosenberg, R., 2004.54See FAO/ GTZ, 1998. “Financing Longer-TermInvestments in Agriculture” is the title of the ongoingFAO/GTZ research project that publishes the AFR series.Details are available at http://www.FAO.org.

55For a detailed discussion see Nair, A. et al., 2004.56See Nair, A. et al. Forthcoming. 57See for example Myer, R. et al., 1996; and Navajas A.R.,2001. 58Risk Sharing Facilities for SME Financing, internal IFCpublication, contact Peer Stein. In July 2004 IFC closedon a 34% Partial Credit Guarantee to the bond issue of500 million pesos (approx. US$43.4 million) forCompartamos, a major microfinance institution inMexico.59See World Bank, 2004c, Module 7, AgriculturalInvestment Note on Production Credit from InputSuppliers, Processors and Buyers.60van der Meer, K., 2004. and Swinnen, J.F.M., 2005.61Rabo International Advisory Services (RIAS), 2004.62World Bank, Forthcoming a.63IFC, 2001. 64For more information see Africap, 2004; and Profund,2003.65CGAP, undated; Frederick, L. I., 2003; Littlefield, E.et al., 2004; Salazar, D. G., 2003; Whelan, S., 2003a,2003b, 2003c; and Waterfield, C. 2003.66The Commodity Risk Management Group (CRMG)provides technical assistance to lenders and other farmerrisk-exposed institutions in developing countries to bridgethe gap between supply and demand of market-basedrisk management instruments. See http://www.itf-commrisk.org.67World Bank, Forthcoming a.68Hess, U., 2003. 69IFC experience in SME lending.70Another specialized collateralized financingarrangement is factoring, whereby an enterprise sells itsaccounts receivable to a specialized financial institution.Factoring is a popular financing mechanism in developedcountries because the credit risk can be diversified fromthe single credit risk of the original borrower to the creditrisks of multiple customers. In spite of these advantages,factoring has rarely been introduced in developingcountries and is not of any great relevance in ruralfinance.71For further information see Counter, J. et al., 2005.72The rural finance lending volume is an approximation.In most multi-sector projects, such as CDD projects, theproject appraisal documents (PADs) do not providecosts for sub-components with rural finance lendingactivities. In finance sector projects, the PADs dodisaggregate the project clientele by their geographiclocation. Hence, the volume was arrived at throughdiscussion with task managers. The followingmethodology was used for estimating RF lending volume.

Endnotes 71


• When the project is an exclusively rural finance project,the WB share in total project cost is taken as the RFamount.

• When only a component is for rural finance, WB sharein the component costs was estimated using the WBshare in total project cost.

• When no separation of rural finance component is madebut a portion of project beneficiaries are located in ruralareas, the share of such beneficiaries was used toestimate the RF amount.

• In projects where ex-ante estimate of rural/urbanbeneficiary distribution is not possible or the project isof a budget support nature—multi-sector adjustmentloans and PRSCs, the projects are identified butportfolio amount devoted to rural finance is notestimated.

73The US$506 million Rural Finance Sector AdjustmentLoan.74The first phase of this project, the Savings and CreditSector Strengthening and Rural Microfinance CapacityBuilding Project, was among the most well-designedrural finance projects approved in FY2003.75Only projects that have a direct impact on rural financeare included. These are defined as investment projects orbudget support projects that included activities aimed atcreating an enabling environment for financial services,supporting financial service provision, development ofmarket facilitating institutions, or development of viableproposals in rural areas. Projects that could have anindirect impact—projects that improve property right

regimes (land titling), restructure the banking system, andprovide grant funds for income generating activities—arenot included. Some state-bank privatization/restructuringprojects might have implications for rural finance if thestate-banks concerned had significant rural lending. Thisis often not obvious from the PADs. Policy measures suchas creation/reform of deposit insurance and credit bureaussupported by some projects can have positive implicationsfor rural finance in the long run.76Includes agricultural finance, microfinance and SMEprojects with a rural focus.77When the project is an exclusively rural finance project,the share of IDA/IBRD in the whole project is taken asthe portfolio. When only a component is for ruralfinance, the share of the IDA/IBRD component in thewhole project is used to estimate the IDA/IBRD share inthe component. When no separation of rural financecomponent is made but a portion of project beneficiariesare located in rural areas, the share of such beneficiarieswas used to estimate the rural finance IDA/IBRD portfolioamount. In the case of projects where such estimation is notpossible (ex-ante estimate of rural/urban beneficiaryallocation is not possible or the project is of a budgetsupport nature—multi-sector adjustment loans andPRSCs), the projects are identified but portfolio amountdevoted to rural finance is not estimated.78However, it is not possible to say if this indicates lowfinancing for agriculture since the credit going to theagriculture sector from general microfinance andenterprise finance is not known ex-ante.

72 Endnotes


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