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Chapter 1
Introduction to Rural Credit
Rural credit is any type of lending program or line of credit that is aimed at
impacting a rural population in some manner. There are banks and cooperatives
that specialize in extending this type of credit to farmers and others engaged in the
agricultural task. Depending on the nature of the organization, credit plans may
focus on providingmortgageassistance, securing new equipment, or even funds to
support research into various aspects of land development within a rural
community.
Individuals have access to rural credit options under certain circumstances. For
example, novice farmers and ranchers may be granted a loan or line of credit to
manage the acquisition and upgrade of an existing farm operation, or the
establishment of a new one. Farmers and ranchers are sometimes extended credit of
this type when some sort of natural disaster has ruined crops and threatens the
ongoing operation of the ranch or farm. Some lendersspecialize in farm loans that
offer highly competitive fixed and variable mortgage rates which make it possible
to refinance a farming operation for the purpose of acquiring new machinery or
meet some other pressing need relevant to the operation.
Businesses can also secure rural credit under specific situations. This includes theacquisition or establishment of a commercial farming operation, or a commercial
ranch. A business may also obtain funds earmarked for development, assuming that
the project concerned will benefit the rural community where it is based.
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In many countries, rural credit is extended under the auspices of national
government programs. Often, these programs are focused on enhancing the
agricultural effort within the country as a means of bolstering the economy. With
government sponsorship, farmers and ranchers can often obtain resources that
make it possible to sustain their productivity through growing seasons, than repay
the loans once livestock and crops are sold. It is not unusual for rural credit of this
type to be extended as a means of keeping a balance between imports and exports,
by assuring that a certain percentage of crops and other rural products are produced
domestically.
Along with government funded programs, rural credit is sometimes obtained from
organizations that are founded by and for farmers, ranchers, and dairy operators.
Local cooperatives often provide much-needed credit to farmers and others,
allowing them to receive what they need to operate theirfarms, effectively running
a tab until the current round of crops are sold. Banks created to assist rural
communities will often underwrite loans that can be used for everything from
building improvements to purchasing large quantities of seeds or other elements
required to produce a substantial crop. As with any type of credit option, anyone
who wishes to obtain rural credit must meet the basic criteria of the lender, and
demonstrate a reasonable ability to repay the amount of the loan or the funds
borrowed on a line of credit.
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Agricultural Credit:-
Agricultural credit is a financial term that refers to loans and other types of credit
extended for agricultural purposes. Many regions have agricultural credit systems
that promote the expansion and continued survival of farm &livestockoperations.
In some cases, agricultural credit can be used by farmers to purchase non-farm
items, such as housing and infrastructure.
Providing food is one of the major pursuits of any successful country; a country
that cannot feed itself is eternally dependent on external sources which may cost
more and may plunge a region further into debt. In recognition of the valuable and
critical work done in the agricultural industry, many governments oversee
special credit divisions that deal solely with farming and related pursuits. India,
Russia, most European nations, Canada, and the United States all have long
histories with agricultural credit systems.
Depending on the region, there are several different types ofagricultural
credit available. Some loans are geared specifically toward new farmers and
ranchers that are opening a new farming business and need start-up capital for land,supplies, and wages. Others are meant for established agricultural businesses that
are looking to expand on the present level of operations.
Some agricultural credit loans are emergency loans extended after natural disasters
to help make fast repairs and restore a farm or ranch to operating conditions. Loans
may also be available to young farmers, or those considered socially disadvantaged
due to racial or gender prejudice.
There are necessary requirements that must be met for agricultural credit extension,
just as with any loan. Borrowers agree to a repayment length, must make regularly
scheduled payments, and usually pay an interest rate on the loan. Since
these credit programs exist to help farmers continue to grow and succeed and are
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usually in the interest of the region, interest rates on agricultural loans may be
lower than on loans from private banks. Information and forms for agricultural
credit application can usually be found on government agricultural websites.
In the days of an expanding global community, many non-profit and government
organizations are attempting to spread the idea ofagricultural credit to developing
nations. By helping a poor nation improve farming and infrastructure, starvation
levels may go down, employment rates may increase, and developing regions may
become more self-sufficient. Often, these subsidies and loans come with certain
requirements, such as adherence to labor practices and environmental standards.
Some non-profits have even set up programs known as micro loans, which allow
wealthier donors to loan a specific amount of money to a farmer in a developing
nation for a short period of time.
Evolution of the Rural Credit System in India:-
Rural financial market development is a complex process .The creation of the
formal credit structure for financial agriculture and other rural activities
commenced in India in the early part of this century with the introduction of co-
operatives. It received a big push during the plan era. The All India Rural Credit
Survey Committee (AIRCS) 1954 forms the edifice for the policy towards the
development of the Institutional credit structures. The committee highlighted the
awful inadequacy in the supply of institutional credit to the rural sector and
proposed an integrated scheme of reorganization many more committees and
recommendations. Priority sector lending, lead bank scheme, services area
approach, setting up of NABARD, are some of the outcomes of the repeated
scrutiny of the system.
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Coming to the recent committees, the Agriculture Credit Review Committee
(ACRC) 1989 examined the existing rural credit system in detail. It highlighted the
yawning gap between income generated and costs incurred by rural credit
institutions, necessitating external assistance. The committee recommended greater
autonomy for commercial banks; the weakness of RRBs were seen as endemic to
the system with non-viability built into them. Co-operatives were sought to be
strengthened through thrust on deposit mobilization and reduction of political
interference. The Narsimham Committee on Financial Sector Reforms 1991,
among other things, recommended a redefinition of priority sector, gradual phasing
out of directed credit programmes to 10% of aggregate bank credit and
deregulation of interest rates.
Looking at the situation today, the exercise seems to have resulted in a scenario
where "an imposing superstructure of credit institutions has been built which one
committee after another has kept reshuffling or adding to" (Dandekar, 1993).
Commenting broadly on the exercise in developing countries (to which the India
experience seems to be no exception), Braveman and Guasch, 1986, see most ofthe changes in institutional design as largely superficial, window dressing type
rather than substantial. "The institutions have been perceived more like a welfare
agency than a commercial undertaking. There seems to be little effort to integrate
deposit taking activities or to generate saving mobilization-a vital activity for the
long run success of a credit institution. No provisions were made to deal with non-
compliance, or to implement a reasonable system of incentives to both lenders and
borrowers to induce the desired objectives."
The major problems of the rural credit system thus evolved are as follows:
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1. It has not produced desired results in terms of the direction, quantum and
quality of the flow of credit.
2. It is afflicted by alarming high overdue, bad debts, loan defaults,
unavailability, low profitability, overburdening of staff, declining control and
deteriorating customer services. It is estimated that the over dues of credit
institutions have increased from Rs. 2,818 crores to Rs. 9,661 crores during 1983-
93.
3. The complex tiring of funds through RBI-NABARD-Commercial Banks-
State Cooperative Banks (SCBs)-District Co-operative Banks (DCBs)-Primary
Agricultural Credit Societies (PACS), has tended to unduly increase the cost of
banking.
4. Features of rural credit markets in developing countries may be understood
as responses to the problems of adverse selection, moral hazard and enforcement.
Imperfect information in this sense creates problems from the perspective of
constrained Pareto efficiency. In Indian case too, information imperfections have
contributed to inefficiencies like high transaction costs and low recycling of credit.
5. From the institutional perspective, role of an appropriate institution as an
enforcer and transmitter of incentives and motivator and inducer of saving is
essential for development. The institutional design should serve to promote and
facilitate functioning at the levels of both the leaders and borrowers. This factor
seems to have been largely overlooked in the Indian case. Motivating to perform
has not been given due importance.
6. Directed credit program and subsidized lending have badly affected viable
functioning of credit disturbing units. The entire exercise has largely come to be
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characterized by tiring of funds from above to borrowers who often tale as a gift
that need not be returned.
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Chapter 2Rural financial services
PURPOSE
The purpose of this chapter is to examine the particular features of rural financial
services that need to be considered in deciding what forms of, and approaches to,
decentralization may be appropriate.
KEY POINTS
Credit is a private good but the fact that it involves an exchange of access to
resources now for an undertaking to repay in the future makes it different to
other services. This generates screening, incentives and enforcement
problems for those supplying loans.
Centralized and directed credit provision was based on the misconceptions
that the priority need for rural borrowers was to finance agricultural
production and that farmers were too poor to pay market rates for credit.
The new paradigm advocates the development of rural financial systems and
the decentralization of rural credit provision through a variety of institutional
and organizational devices.
An important policy setting and regulatory and promotional role remains for
central government.
The most far-reaching objective of decentralization of rural financial
services is to mobilize the potential of rural financial markets.
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The nature of rural financial services
The risks of credit provision
Rural financial services are nowadays concerned with a variety of services
including not only agricultural lending but lending to farm households for non-
agricultural production and consumption purposes, loans made to non-farm rural
firms, rural savings deposit services and other financial services such as insurance.
However, this Chapter mainly focuses on the provision of agricultural credit.
Broadly speaking, the provision of credit in the form of loans allows uneven
income and expenditure streams to be smoothed out. Credit provision is a private
good as it is excludable and rivalrous. However, it is a different type of service to
others discussed in this Sourcebook as a loan involves an exchange of access to
resources now for an undertaking to repay at some future date. In effect, a property
right in current consumption is exchanged for a property right in future
consumption. From the lenders point of view this involves two risks, namely, that
the borrower will be unable to repay (the use made of the funds is less productive
than anticipated perhaps due to unfavorable weather or lower market prices) or that
they will be unwilling to repay (opportunistic behavior due to asymmetric
information).
In total, the lending activity entails:
a. Exchange of consumption today for consumption in a latter period
b. Protection against default risk
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c. Information acquisition regarding characteristics of loan applicants
(the screening problem)
d. Measures to ensure that borrowers take those actions that make repayment more
likely (the incentives problem)
e. Actions to increase the likelihood of repayment by borrowers who are able to do
so (the enforcement problem).
This risk of non-repayment means that the private sector is usually unwilling to
provide credit unless collateralis available or the lender has particular ties to the
borrower. The high transaction costs associated with imperfect information (search,
monitoring and enforcement), and risk, increase the costs of credit transactions and
lower the effective demand. The dispersed nature of rural populations increases the
transaction costs of servicing rural areas compared to urban areas for many credit
providers. In principle, the government should be a more willing lender than the
private sector as it is less risk-averse and has greater powers of coercion and hence
ability to obtain repayment. However, it is generally disadvantaged relative to the
private sector in terms of local knowledge and loyalty from borrowers, leaving it
exposed to an adverse selection problem and unwillingness by borrowers to repay
loans.
The demand for and supply of rural financial services
The effective demand for rural credit
Many of the problems relating to rural financial services have derived from a
misunderstanding of the nature of the effective demand for these services. The first
misconception was that farmers and other rural dwellers mainly needed credit for
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agricultural production purposes. In fact, an effective demand for credit, backed up
by a willingness and ability to pay, can exist to smooth out a variety of situations
where income and consumption streams are poorly phased. Credit for non-
agricultural purposes may be as important as agricultural loans. Indeed, for many
rural dwellers the most important reason for demanding credit is as a consumption
loan to meet the costs of living in the months before the next harvest is due, not to
purchase inputs to raise agricultural productivity. The second misconception was
that the majority of poor farmers were too poor to pay for credit, which is, there
was a need for credit but little effective demand. The evidence now is that poor
households are both willing and able to service loans if they borrow for their own
perceived needs and are adequately screened and monitored.
The paradigm of directed credit provision
These misconceptions led to agricultural credit policies during the 1960s and 1970s
that were based on a paradigm summarized in. The policy implications of the
paradigm were that:
It was the function of the central government (normally of the Ministry of
Agriculture, or those acting on delegated authority to government-owned
financial institutions) to decide:
- What farmers should do with credit?
- What the cost of credit to rural borrowers should be
- Who should actually benefit from the loans?
- What the total amount of agricultural credit should be.
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It was the central government function to provide:
- Savings mobilization mechanisms in rural areas
- lending facilities on a subsidized basis.
Responding to farmers demand for credit for other purposes than
agricultural production was not a government priority.
The paradigm of centralized and directed agricultural credit policies
Agriculture is a major source of livelihood and the main engine of economic
growth in developing countries therefore the development of agricultural
production is a public priority
Technology innovations and more input use are essential to increase
production
Farmers need more financial resources to adopt technology innovations
Most farmers are poor, hence there is a gap in cash resources which blocks
the adoption of new technologies and credit is needed to fill the gap
Agricultural production is a risky business; returns in agriculture are less
than in the other sectors of the economy
Market interest rates reflect opportunities in other sectors: the market cost of
money is too high for farmers to borrow for productive purposes
Government must intervene with subsidized lending (seeking no profit,
amortizing high transaction costs, spreading the risk on a national basis)
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Subsidies are justified if loans aim at specific government objectives
Therefore agricultural loans must be targeted to selected crops and
technologies of interest to government
Loan repayment capacity is shown by viable crop/farm budgets models
To extend subsidized credit for specific purposes, specialized government
financial institutions must be established and financed with public funds
Specialization advises that the savings collection and the lending function of
financial intermediation are kept distinct
Since most borrowers in rural areas are small farmers (i.e. poor), low cost
credit responds to poverty alleviation considerations as well
Subsidized credit also compensates farmers for high taxation of agriculture
(such as price control on basic grains, export taxes, artificial exchange rates,
etc.).
The supply of rural financial services
Unique problems of supplying agricultural finance
FAO/GTZ (1998b) discusses a series of special factors that are likely to influence
the supply of agricultural finance. These include:
The high financial transaction costs of attending dispersed and small farm
households
The seasonality and the importance of opportune timing of on-farm finance
for cultivation practices, input application, harvesting (and related output
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marketing), the heterogeneity in farmers lending needs (seasonal and term
lending) and the relative long duration of agricultural lending contracts
The dependence on sustainable natural resources management and the
relative low profitability of on-farm investments
The various weather and other production risks, together with marketing
risks related to agriculture, that require appropriate risk management
techniques, both for producers and financial intermediaries
The limited availability of conventional bank collateral that farm households
can offer, that highlights the need to increase the security of existing loan
collateral or develop appropriate collateral substitutes
The reality that farm households are confronted with emergency needs and
that their loan repayment capacity is highly dependent on consumption and
social security contingencies
The need for adequate training of both bank staff and farmer clients.
The formal sector
In most developing countries there are typically two types of suppliers or financial
intermediaries. The formal sector consists of bank and non-bank financial
institutions that provide intermediation services between depositors (or the
government) and borrowers and, as they fall under the banking law, are regulated
and supervised. As noted above, in the past these typically charged relatively low
rates of interest that were usually subsidized by the government. The flow of funds
in a typical centralized and directed agricultural credit system is shown. In many
cases little attention was paid to voluntary savings mobilization in rural areas as
small farmers, being poor, were considered to have a low propensity to save.
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The informal sector
The informal sector typically comprises private individuals - professional
moneylenders, traders, commission agents, landlords, friends and relatives - who
lend money generally out of their own equity and are not regulated or supervised
by the national monetary authorities. One of the major differences between these
two types of supplier is the mechanisms used for dealing with the screening,
incentives and monitoring problems with the informal sector relying much more
heavily than the formal sector on their intimate knowledge of their clients toovercome these problems.
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The flow of funds in the centralized and directed agricultural credit system
Crowding out the informal sector
Informal financial markets have always existed in rural areas, but were ignored by
government policy for a very long time. The agricultural credit paradigm (Box 8.1)
excludes informal markets from playing a role on two grounds. First, that the
operators in informal financial markets do not share the same commitment as
government to promoting agricultural production. Second, they would charge
exorbitant interest rates which, allegedly, agricultural producers could not afford to
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pay. In many countries and for almost 30 years, governments hindered the
spontaneous development of informal financial intermediaries by occupying,
through subsidized operations, the market space that informal operators could have
exploited and developed. This has been defined as the crowding out effect of
government agricultural credit policy.
Appropriate forms of decentralization
Introduction
With few exceptions, the consequences of the centralized and directed approach to
agricultural credit were catastrophic. A fair number of agricultural credit banks
were liquidated during the 1980s and early 1990s across the world, when it became
clear that governments could not afford to:
Continue to subsidize low interest lending rates
Make good poor loan recovery
Compensate for very high operating costs and overheads.
In addition, the results achieved in terms of impact on agricultural production were
rather modest. This situation has prompted the elaboration of alternative policies
based on a very different paradigm. Liberal economics and decentralization
principles inspire the reform of the rural financial sector. Box 8.2 briefly states the
new paradigm.
The major objectives of decentralization of rural financial services are to:
Bring about closer links between service providers and beneficiaries
Respond to the demand for a variety of financial services by the rural people
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Improve the transparency and accountability of financial institutions dealing
with rural people
Reduce the high costs and risks of financial transactions in rural areas.
The paradigm of decentralized rural financial services
Demand for credit is one thing, demand for agricultural technology is
another: they may or may not coincide for individual borrowers
Borrowers are willing to service loans if they borrow for their own perceived
needs
Banks must lend to creditworthy clients responding to clients independent
assessment of their own requirements and preferences
Only those loan officers who know their clients well can effectively identify
creditworthy borrowers
Market-determined interest rates ration the demand for credit and provide
incentives for savings deposits
Competition among financial services providers improves efficiency and
lowers the cost of lending
Access to local financial services/institutions reduces transaction costs to
clients and improves lenders contacts with clients
Sustainable banking is based on savings mobilization
Financial institutions that offer local savings facilities at competitive and
appropriate conditions are more likely to mobilize enough deposits to support
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a sound lending policy
Financial institutions which lend to creditworthy clients recover all the loans
made, and can earn enough interest to cover their cost hence they are
sustainable
Sustainable institutions will grow in the course of time
Sooner or later, non-sustainable institutions will fail completely
Prospects of profitability and sustainability and growth encourage private
and voluntary sector enterprises to develop financial service institutions.
Reform of government-owned institutions
Two approaches to decentralization of rural financial services can be distinguished.
One approach involves a drastic reform or restructuring of government-owned
financial institutions operating in rural areas, by shifting power away from the
centre and changing responsibility and accountability systems through a
combination of deconcentration and devolution measures.
Diversifying ownership
The other approach aims at diversifying the ownership of the financial institutions
operating in rural areas. This objective can be achieved in three major ways:
Changing the capital structure of government-owned agricultural
development banks by selling a controlling interest to the private sector
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Encouraging the development of private banks and by eliminating subsidies
and liquidating, restructuring or reducing the scope of operations of banks
retained in the public sector
Promoting and regulating the emergence of new types of grassroots-based
rural financial intermediaries.
Naturally, all these ways of diversifying ownership can be implemented at the
same time. When many service providers operate in capital markets a multiplicity
of services delivery channels, distributing the power and influence associated with
the control of financial flows, is created. Competition and a variety of policies, new
financial technologies and products are introduced.
Each of these approaches will be considered in the ensuing sections.
The new role of central government
Different strategies, different actors
In rural areas, the starting point for elaborating the policy implications of the new
paradigm is a clear separation of the agricultural credit and the extension functions.
Promoting the adoption of new agricultural technologies is the task of extension,
not of credit. There is a strong case for governments to decentralize their rural
financial services, let rural financial services develop in the private and non-profit
mutualistic sectors and, where and when appropriate, reduce the overwhelming
presence of public financial institutions. Decentralized and private and voluntary
sector financial institutions are better placed to respond to peoples preferences, to
identify creditworthy borrowers, and to introduce effective mechanisms for savings
mobilization. The new role of government is thus support of institutional
development, rather than promotion of targeted incremental crop production
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through financial intermediation. This new role embraces the setting of a
favorable environment, the introduction of appropriate legislation, a regulatory role
and, perhaps, financial and technical support to promote new organizations.
Regulation of rural MFIs
As the importance of rural micro-finance institutions (MFIs) in the local capital
markets increases , their functions become diversified and not directly connected
with agricultural production. The need then arises for government to deal with
them in similar terms to those used for formal institutions. The monetary
authorities thus increasingly assume responsibility for the supervision of theiractivities, with a view to sound management of money, rather than Ministries of
Agriculture whose primary interest is agricultural production.
The promotion of rural MFIs raises questions such as:
What rules should govern the operations of decentralized rural financial
institutions?
What form, content, and degree of control should apply to ensure that the
rules are respected?
Who should exercise the control?
Regulation and supervision may cause more problems than those they are intended
to overcome. For example, regulations related to registration, licensing, and
inspection may offer opportunities for interference and corruption and supervisors,
in addition to their task of overseeing banks, may not devote enough staff and time
to inspect adequately a large number of new types of small rural financial
institutions. Rules and controls of financial institutions normally:
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Concern the technical aspects of national money management
Are designed to establish good governance in the institutions
Aim at sound and prudent banking practices and respect, by the
management, of the law and of the by-laws of the institutions as set by the
shareholders.
Such rules deal with problems common to all financial institutions, and must be
respected by all. Detailed regulations, however, differ depending on the nature of
the regulated institutions. The main objectives of the monetary authorities control
over financial intermediaries are to:
Manage the national money supply: this requires the continuous verification
of the level of the financial aggregates such as money in circulation and
volume of credit, and taking measures to influence their trend
Protect the interest of depositors and the stability of the overall national
financial system: this requires ensuring that the administrators of financial
institutions act in accordance with the law and with sound banking practices
Promote efficiency in the national financial markets.
Accordingly, the main objectives of the rules and controls over decentralized rural
financial institutions should be to ensure that:
The decision-making and accountability procedures of the organizations are
in accordance with the law and with the by-laws of each organization and
that management follow them properly, for instance, ensuring that accurate
and timely banking records are kept, etc.
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Accounting and audit procedures are transparent, adequate, properly and
timelessly followed by the management, and that shareholders have access
to independent internal and external audit reports.
Lending and savings mobilization policies, procedures, and management are
conducive to financial sustainability, and minimize the risk of fraud and loan
delinquency.
Responsibility for regulation
The elaboration of such rules, and the controls required for their enforcement, is
not in the field of competence of Ministries of Agriculture, but is in the naturaldomain of the monetary authorities. Rules need to be established centrally, whereas
controls can either be centralized or delegated. One option is for the central
monetary authorities to take over direct responsibility for inspections of rural
MFIs, as they do in the case of banks and other formally-established financial
intermediaries. Another option is to delegate the control of decentralized financial
service institutions to the apex body of cooperatives or MFIs. The latter would, in
turn, be directly controlled by the monetary authorities, and would be responsible
to them for controlling their member MFIs. A special opportunity for delegation is
presented when MFIs are promoted and supported by a commercial or a
development bank. In these cases, the commercial or development bank, which is
under the control of the national monetary authorities, will supervise in its own
interest the operations of the MFIs that they help to develop.
Financial support
Expenditure of public money may be necessary to support new institutions of the
cooperative bank type, which emerge in the private or non-profit or mutualistic
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sector. Subsidies would assist primarily with capacity building aimed at increasing
the staff and managerial skills of the new institutions. These subsidies may be
justified on the grounds that institutional development and diversification of
service providers are public goods that help to deal with financial market failures.
They are not intended to fill gaps in operating income or interfere with interest
rates and the free play of market forces. Support activities eligible for subsidies
would include:
The initial help to groups wishing to start a savings and loans association
(spontaneous groups animation, market studies, help to define by-laws, help
with registration procedures, etc.)
Experimentation/adoption and training in new financial technologies and
products and better banking practices for financial officers of emerging
institutions
Initial assistance in keeping adequate accounts and drafting balance sheet
and income statements
Initial free assistance in routine inspection and audit of accounts.
Loans, but not grants, at market or near market terms to the new rural financial
institutions, may also be justified (providing banks follow normal risk assessment
practices in making loans) with a view to expanding their operations beyond the
resources that they are able to mobilize by way of savings deposits.
Governments may also support the start-up process of designing innovative creditguarantee approaches for banks (FAO, 1998b). However, banks ought to assume a
good share of the risk in order to ensure that they assess their clients effectively.
Sustainability requires financial institutions, irrespective of their size and nature, to
respect sound banking practices. They should not borrow funds that they may not
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be able to remunerate at market rates of interest. The market will determine to what
extent MFIs are sufficiently creditworthy customers for higher level and larger
financial intermediaries to lend money to them.
Diversifying ownership
Privatization of agricultural banks
Several new liberal governments have tried to privatize government-owned
agricultural banks. In practice, there have been many difficulties due to the
problem of capital valuation and to the poor expectations of profit from future
operations. Short of outright fraud, government banks are in financial trouble for
two main reasons:
Excessive operating costs (overstaffing, unprofitable branches, low staff
productivity, wrong personnel policies, inadequate spread between active
and passive interest rates, etc.)
The poor quality of their portfolio (high loan delinquencies).
Excessive operating costs can eventually be corrected by new management,
provided labour legislation does not impose too much rigidity, but the poor quality
of the loan portfolio may often be difficult to remedy in the short- to medium-term.
Thus governments are unlikely to find a buyer for take-over unless they clear the
portfolio of bad loans. In some cases, the bulk of bad loans are held by bankrupt
government enterprises. However, buying out delinquent debtors is a poor solution,
because it does not establish an encouraging environment for making new loans.
Transferring non-performing assets to a separate company responsible for
recovering them has also been tried, but it did not always ensure the financial
recovery of the original lender.
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Liberalization of the formal financial market
The second option involves the liquidation of non-viable government banks,
coupled with allowing the entry of foreign capital and the encouragement of local
private groups to form joint ventures with foreign banking groups. Naturally,
private investors, particularly foreign capital, tend to be cautious given past
experiences with nationalization and political interference with staffing and lending
policy. However, in the short term, this option may not be a solution for rural areas
because private enterprises usually invest in commercial banking in urban areas
before expanding to rural areas. However, an important effect in rural areas would
be to restore lending to viable crop purchasing, equipment and input trading
enterprises. Part of the finance made available to input suppliers and traders is
likely to be passed on to farmers in the form of suppliers credit.
Micro-finance institutions
The most far-reaching objective of decentralization of rural financial services is to
mobilize the potential of informal rural financial markets and to rationalize their
operations. The operators in the informal market include all those intermediaries
who are not subject to the regulations and supervision of the monetary authorities,
such as money lenders, ROSCAS (rotating savings and credit associations),
informal savings groups, informal safe-deposit providers, village level savings and
loans associations, etc.
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The third option, then, is to encourage the expansion of MFIs in the voluntary or
mutualistic sectoras rural financial intermediaries. The common feature of mutual
or cooperative financial institutions is that their members own them. Members
savings are mobilized and people appointed and controlled by members oversee the
use of these savings. The cooperative nature of these institutions improves the
chances that loans respond to the borrowers requirements. Moreover, the loans are
made to borrowers who are well known to the institution and whose
creditworthiness most members of the institution can easily assess. In this case,
loan delinquency tends to be limited, since the social pressure to repay results from
lending the members own hard-earned savings. Safeguarding of ones own money
is a much stronger incentive for repayment than a generic sense of duty or interest
in becoming eligible for an additional loan. The social pressure for loan repayment
in classical group-lending schemes of agricultural development banks, where it was
the governments (or the donors) external funds rather than the members own
money that was loaned, in general has not worked. Experience suggests, however,
that even with own funds the group liability mechanism tends to weaken whenever
the local financial institution becomes too large or a large share of loan resources is
obtained from outside sources.
The role of NGOs
NGOs have played a significant role in promoting the development of informal
rural financial services. Although NGOs continue to play an important role in
promoting micro-finance in many developing countries, during the 1990s the
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growth of decentralized financial systems has evolved far beyond what NGOs
initiated. Professionalization and new actors coming into the picture have become
determining features. Some NGOs play a role in implementing a deliberate rural
financial services decentralization policy within the framework of more articulated
initiatives promoted by private banks, local interest groups, governments and
donors. The provision of both financial and non-financial support services, by the
same or by different organizations, as well as sustainability of the provided
services, has become main concerns. There are a wide variety of new approaches,
policies, objectives, and actors. Broadly speaking, four types of actors promote the
development of rural MFIs, besides NGOs acting on their own initiative:
Government agricultural development banks
Specialized cooperative finance development organizations of foreign origin,
contracted by donors or governments
Private commercial banks
Donor/government special programme units.
A well-established network of micro-finance cooperative institutions can change
the flow of financial resources in a very significant way. Figure 8.2 describes, in a
simplified manner, the transfer of resources and of decision-making power in
financial intermediation in the cooperative banking sector. The differences between
the flow shown in & that of should be evident.
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The flow of resources in a cooperative banking system
Apex organizations
The apex organizations of MFIs play a very important role. Accordingly,
encouraging the emergence of such organizations is an important component of
decentralization policy in rural financial markets.
Apex organizations help to provide a unified culture within member institutions,
which is a feature of social cohesion and a factor of success. They also provide
valuable technical support in the form of accounting, auditing, training and a
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central liquidity facility. They assist in securing lines of credit from commercial or
development banks and manage the liquidity requirements by transferring funds
from member MFIs with surplus deposits to member MFIs with an excess of
effective credit demand. Last but not least, they can join together with other apex
organizations to lobby politicians and influence government policy.
Conclusions
The paradigm of agricultural credit has changed fundamentally from a policy that
promoted centralized and directed agricultural credit to one that supports
decentralized rural financial services and rural financial markets and systemsdevelopment. The new paradigm emphasizes the distinction between the supply-
led finance of new agricultural technologies and the effective demand by rural
households for credit that can be used for their own perceived needs. It advocates
the decentralization of credit provision, the encouragement of competition between
loan services providers to lower the costs and risks of lending, and the use of
market rates of interest as a rationing device for credit allocation. It recognizes also
the importance of mobilizing local savings through offering competitive interest
rates and a variety of savings products and flexible procedures. In the new
paradigm the role of the government is to support institutional development, rather
than the promotion of targeted incremental crop production through involvement in
direct financial intermediation.
Support to institutional development and decentralization involves reformingpublic development banks, privatizing institutions that can perform better in the
private and mutualistic sectors, encouraging the growth of financial markets and
the development of sustainable rural financial services. Subsidies can be justified
for capacity building to increase competition. There are two approaches to
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decentralizing financial services in rural areas. One approach involves a drastic
reform or restructuring of government-owned development financial institutions
operating in rural areas. The other is to diversify the ownership and governance
structure of rural financial institutions by changing the capital ownership of
existing government institutions and/or by promoting the development of a
multiplicity of financial services providers belonging to different owners. This
includes the encouragement of the expansion of MFIs in the mutualistic sector.
The most far-reaching objective of decentralization of rural financial services is to
mobilize the potential of informal rural financial markets and to rationalize their
operations. This may lead to a fast growth of micro- financial institutions in the
rural areas and it is important to find effective ways of regulating them. Providing
appropriate methods are followed, considerable gains can be expected from
decentralization and a sustainable network of rural financial services providers may
emerge.
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Chapter 3
RURAL BANKING
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INTRODUCTION
Rural banking in India started since the establishment of banking sector in India.
Rural Banks in those days mainly focused upon the agro sector. Today,
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commercial banks and Regional rural banks in India are penetrating every corner
of the country are extending a helping hand in the growth process of the rural
sector in the country.
BANKS: FUNCTIONING FOR THE DEVELOPMENT OF RURAL AREAS
The area of operation of a majority of the RRBs is limited to a notified area
comprising a few districts in a State.SBI have 30 Regional Rural Banks in India
known as RRBs. The rural banks of SBI are spread in 13 states extending from
Kashmir to Karnataka and Himachal Pradesh to North East. Apart from SBI, there
are other few banks which functions for the development of the rural areas in India.Few of them are as follows.
Haryana State Cooperative Apex Bank Limited
NABARD
Sindhanur Urban Souharda Co-operative Bank
United Bank of India
Syndicate Bank
Co-operative bank
CO-OPERATIVE BANKS AND RURAL CREDIT
The Co-operative bank has a history of almost 100 years. The Co-operative banks
are an important constituent of the Indian Financial System, judging by the role
assigned to them, the expectations they are supposed to fulfill, their number, and
the number of offices they operate.
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Their role in rural financing continues to be important even today, and their
business in the urban areas also has increased phenomenally in recent years mainly
due to the sharp increase in the number of primary co-operative banks.
Co-operative Banks in India are registered under the Co-operative Societies Act.
The RBI also regulates the cooperative bank. They are governed by the Banking
Regulations Act 1949 and Banking Laws (Co-operative Societies) Act, 1965.
Co-operative banks in India finance rural areas under:
Farming
Cattle
Milk
Hatchery
Personal finance
Institutional Arrangements for Rural Credit (Co-operatives)
Short Term Co-operatives
Long Term Co-operatives
Short Term Co-operatives
|
District Central Co-operative Banks
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|
State Co-operative Banks
|
Primary Agriculture Credit Co-operative Societies
|
Branches
Long Term Cooperatives
|
State Agriculture & Rural Development Banks
|
Primary Agriculture & Rural Development Banks
|
Branches
Primary Agricultural Credit Societies (PACSs)
An agricultural credit society can be started with 10 or more persons normally
belonging to a village or a group of villages. The value of each share is generally
nominal so as to enable even the poorest farmer to become a member. The
members have unlimited liability, that is each member is fully responsible for the
entire loss of the society, in the event of failure. Loans are given for short periods,
normally for the harvest season, for carrying on agricultural operation, and the rate
of interest is fixed. There are now over 92,000 primary agricultural credit societies
in the country with a membership of over 100 million.
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The primary agricultural credit society was expected to attract deposits from
among the well to-do members and non-members of the village and thus promote
thrift and self-help. It should give loans and advances to needy members mainly
out of these deposits.
Central Co-operative Banks (CCBs)
The central co-operative banks are located at the district headquarters or some
prominent town of the district. These banks have a few private individuals also
who provide both finance and management. The central co-operative banks have
three sources of funds,
Their own share capital and reserves
Deposits from the public and
Loans from the state co-operative banks
Their main function is to lend to primary credit society apart from that, central
cooperative banks have been undertaking normal commercial banking business
also, such as attracting deposits from the general public and lending to the needy
against proper securities. There are now 367 central co-operative banks.
State Co-operative Banks (SCBs)
The state Co-operative Banks, now 29 in number, they finance, co-ordinate and
control the working of the central Co-operative Banks in each state. They serve as
the link between the Reserve bank and the general money market on the one side
and the central co-operative and primary societies on the other. They obtain their
funds mainly from the general public by way of deposits, loans and advances from
the Reserve Bank and they are own share capital and reserves.
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COMMERCIAL BANKS AND RURAL CREDIT
The commercial banks at present provide short term crop loans account for nearly
45 to 47% of the total loans given and disbursed by the commercial banks. Term
loans for varying periods are given for purchasing pump sets, tractors and other
agricultural machinery, for construction of wells and tube well, for development of
fruit and garden crops, for leveling and development of land, for purchase of
ploughs, animals, etc. commercial banks also extend loans for allied activities viz.,
for dairying, poultry, piggery, bee keeping, fisheries and others. These loans come
to 15 to 16%.
Commercial Banks and Small Farmers
The commercial banks identifying the small farmers through Small Farmers
Development Agencies (SFDA) set up in various districts and group them into
various categories for credit support so as to enable them to become bible
cultivators. As regard small cultivators near urban areas and irrigation facilities,
commercial banks can help them to go in for vegetable cultivation or combine it
with small poultry farming and maintaing of one or two milch cattle.
IRDP and commercial banks
Since October 1980, the Integrated Rural Development Programme (IRDP) has
been extended to all the blocks in the country and the commercial banks have been
asked by the government of India to finance IRDP. The lead banks have to prepare
banking plans and allocate the responsibility of financing the identified
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beneficiaries among the participating banks. Commercial banks have been asked to
finance all economically backward people identified by government agencies.
REGIONAL RURAL BANKS AND RURAL CREDIT
The Narasimham committee on rural credit recommended the establishment of
Regional Rural Banks (RRBs) on the ground that they would be much better suited
than the commercial banks or co-operative banks in meeting the needs of rural
areas. Accepting the recommendations of the Narasimham committee, the
government passed the Regional Rural Banks Act, 1976. The main objective of
RRBs is to provide credit and other facilities particularly to the small and marginalfarmers, agricultural laborers, artisans and small entrepreneurs and develop
agriculture, trade, commerce, industry and other productive activities in the rural
areas.
The progress of RRBs in the initial stage was quite rapid. For instance, the Sixth
Five-year plan (1980-85) had envisaged the setting up of 170 RRBs covering 270
districts by the end of March 1985.The target was exceeded. There are now 196
RRBs in 23 states of the country with 14,200 branches.
Structure of regional rural bank
The establishment of the Regional Rural Banks (RRBs) was initiated in 1975 under
the provisions of the ordinance promulgated on 26.9.1975 and thereafter Section
3(1) of the RRB Act, 1976. The issued capital of RRBs is shared by Central
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Government, sponsor bank and the State Government in the proportion of 50%,
35% and 15% respectively.
RRBs established with the explicit objective of:
* Bridging the credit gap in rural areas
* Check the outflow of rural deposits to urban areas
* Reduce regional imbalances and increase rural employment generation
Micro-Finance
Micro-finance is a novel approach to "banking with poor" as they attempt to
combine lower transaction costs and high degree of repayments. The major thrust
of these micro-finance initiatives is through the setting up of Self Help Groups
(SHGs),Non-Governmental organizations(NGOs),Credit Unions etc.
Kisan(Farmers') Credit Card
Another notable development in recent years is the introduction of Kisan Credit
Cards(KCC) in 1998-99.The purpose of the Kisan Credit Cards(KCC) scheme is to
facilities short term credit to farmers. The scheme has gained popularity and its
implementation has been taken up by 27 commercial banks, 187 RRBs and 334
Central cooperative banks.
Agricultural Insurance
As Agricultural is highly susceptible to risks such as drought, flood, pests etc. It is
necessary to protect the farmers from natural calamities and ensure their credit
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eligibility from the next season. Towards this purpose, the Government of India
introduced a comprehensive crop insurance scheme through the country in 1985
covering major cereal crops, oilseeds and pulses. Among commercial crops, seven
crops viz., sugarcane potato, cotton, ginger, onion, turmeric and chillies are
presently covered.
MARKETING OF MUTUAL FUND UNITS - RRBS
With a view to expanding the scope of business of RRBs and considering that
marketing of Mutual Fund (MF) units provides a profitable avenue for banks, it has
been decided by RBI on 17th May 2006 to allow Regional Rural Banks (RRBs) to
undertake marketing of units of Mutual Funds, as agents.
Accordingly, RRBs may, with approval of their Board of Directors, enter into
agreements with Mutual Funds for marketing their units subject to the following
terms and conditions:
* The bank should only act as an agent of the customers, forwarding applications
of the investors for purchase / sale of MF units to the Mutual Fund / Registrar
Transfer Agents.
* The purchase of MF units should be at the risk of customers and without the bank
guaranteeing any assured return.
* The bank should not acquire such units of Mutual Fund from the secondary
market.
* The bank should not buy back units of Mutual Funds from their customers.
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* The bank holding custody of MF units on behalf of their customers should ensure
that its own investment and investments belonging to their customers are kept
distinct from each other.
* Retailing of units of Mutual Funds may be confined to some select branches of
the bank to ensure better control.
* The bank should comply with the extant KYC/ AML guidelines in respect of the
applicants.
* The RRBs should put in place adequate and effective control mechanisms in
consultation with their sponsor banks.
CONCLUSION
RRBs' performance in respect of some important indicators was certainly better
than that of commercial banks or even cooperatives. RRBs have also performed
better in terms of providing loans to small and retail traders and petty non-farm
rural activities. In recent years, they have taken a leading role in financing Self-
Help Groups (SHGs) and other micro-credit institutions and linking such groups
with the formal credit sector.
RRBs should really be strengthened and provided with more resources with which
they can undertake more of these important activities. And most certainly they
should be kept apart from a profit-oriented corporate motivation that would reduce
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their capacity to provide much needed financial services to the rural areas,
including to agriculture. Ideally, the best use of the resources raised by RRBs
through deposits would be through extensive cross-subsidisation. This, in turn,
really requires an apex body that would cover and oversee all the RRBs, something
like a National Rural Bank of India (NRBI).
The number of rural branches should be increased rather than reduced; they should
be encouraged to develop more sophisticated methods of credit delivery to meet
the changing needs of farming; and most of all, there should be greater
coordination between district planning authorities, panchayati raj institutions and
the banks operating in rural areas. Only then will the RRBs fulfill the promise that
is so essential for rural development.
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4. Role of NABARD in Rural Credit
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ROLE OF NABARD IN RURAL CREDIT:-
NABARD is set up by the Government of India as a development bank with the
mandate of facilitating credit flow for promotion and development of agriculture
and integrated rural development. The mandate also covers supporting all other
allied economic activities in rural areas, promoting sustainable rural development
and ushering in prosperity in the rural areas.
With a capital base of Rs 2,000 crore provided by the Government of India and
Reserve Bank of India, it operates through its head office at Mumbai, 28 regional
offices situated in state capitals and 391 district offices at districts.
It is an apex institution handling matters concerning policy, planning and
operations in the field of credit for agriculture and for other economic and
developmental activities in rural areas. Essentially, it is a refinancing agency for
financial institutions offering production credit and investment credit for promoting
agriculture and developmental activities in rural areas.
NABARD today
Initiates measures toward institution-building for improving absorptive capacity
of the credit delivery system, including monitoring, formulation of rehabilitation
schemes, restructuring of credit institutions, training of personnel, etc.
Coordinates the rural financing activities of all the institutions engaged in
developmental work at the field level and maintains liaison with the government of
India , State governments, the Reserve Bank of India and other national level
institutions concerned with policy formulation
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Prepares, on annual basis, rural credit plans for all the districts in the country.
These plans form the base for annual credit plans of all rural financial institutions
Undertakes monitoring and evaluation of projects refinanced by it
Promotes research in the fields of rural banking, agriculture and rural
development
Functions as a regulatory authority, supervising, monitoring and guiding
cooperative banks and regional rural banks
Credit functions of NABARD:-
NABARD's credit functions cover planning, dispensation and monitoring of credit.
This activity involves:
Framing policy and guidelines for rural financial institutions
Providing credit facilities to issuing organizations
Preparation of potential-linked credit plans annually for all districts for
identification of credit potential
Monitoring the flow of ground level rural credit
Developmental and Promotional function:-
Credit is a critical factor in development of agriculture and rural sector as it enables
investment in capital formation and technological upgradation. Hence
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strengthening of rural financial institutions, which deliver credit to the sector, has
been identified by NABARD as a thrust area. Various initiatives have been taken
to strengthen the cooperative credit structure and the regional rural banks, so that
adequate and timely credit is made available to the needy.
In order to reinforce the credit functions and to make credit more productive,
NABARD has been undertaking a number of developmental and promotional
activities such as:-
Help cooperative banks and Regional Rural Banks to prepare development
actions plans for themselves
Enter into MoU(Memorandum Of Understandings) with state governments
and cooperative banks specifying their respective obligations to improve the
affairs of the banks in a stipulated timeframe
Help Regional Rural Banks and the sponsor banks to enter into MoUs
specifying their respective obligations to improve the affairs of the Regional
Rural Banks in a stipulated timeframe
Monitor implementation of development action plans of banks and
fulfillment of obligations under MoUs
Provide financial assistance to cooperatives and Regional Rural Banks for
establishment of technical, monitoring and evaluations cells
Provide organization development intervention (ODI) through reputed
training institutes like Bankers Institute of Rural Development (BIRD),
Lucknowwww.birdindia.org.in, National Bank Staff College,
Lucknow www.nbsc.in and College of Agriculture Banking, Pune, etc.
Provide financial support for the training institutes of cooperative banks
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Provide training for senior and middle level executives of commercial banks,
Regional Rural Banks and cooperative banks
Create awareness among the borrowers on ethics of repayment through
Vikas Volunteer Vahini and Farmers clubs
Provide financial assistance to cooperative banks for building improved
management information system, computerization of operations and
development of human resources
Supervisory functions:-
As an apex bank involved in refinancing credit needs of major financial institutions
in the country engaged in offering financial assistance to agriculture and rural
development operations and programmes, NABARD has been sharing with the
Reserve Bank of India certain supervisory functions in respect of cooperative
banks and Regional Rural Banks (RRBs).
As part of these functions, it
Undertakes inspection of Regional Rural Banks (RRBs) and Cooperative Banks
(other than urban/primary cooperative banks) under the provisions of Banking
Regulation Act, 1949.
Undertakes inspection of State Cooperative Agriculture and Rural Development
Banks (SCARDBs) and apex non-credit cooperative societies on a voluntary basis
Undertakes portfolio inspections, systems study, besides off-site surveillance of
Cooperative Banks and Regional Rural Banks (RRBs)
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Provides recommendations to Reserve Bank of India on issue of licenses to
Cooperative Banks, opening of new branches by State Cooperative Banks and
Regional Rural Banks (RRBs)
Administering Credit Monitoring Arrangements (CMA) in SCBs and CCBs.
Core Functions
NABARD has been entrusted with the statutory responsibility of conductinginspections of State Cooperative Banks (SCBs), District Central Cooperative
Banks (DCCBs) and Regional Rural Banks (RRBs) under the provisions of Section
35(6) of the Banking Regulation Act (BR Act), 1949. In addition, NABARD has
also been conducting periodic inspections of state level cooperative institutions
such as State Cooperative Agriculture and Rural Development Banks (SCARDBs),
Apex Weavers Societies, Marketing Federations, etc., on a voluntary basis.
Current Focus :-
Under the revised strategy, a sharper focus of the NABARDs inspection was
given on the core areas of the functioning of banks pertaining to Capital Adequacy,
Asset Quality, Management, Earnings, Liquidity, Systems and Compliance
(CAMELSC). Thus, NABARDs focus in its statutory on-site inspections is on
core assessments leaving the collateral appraisals to banks. The micro level aspects
are to be taken care of by the banks themselves by way of internal inspections or
by other agencies such as auditors. In this direction, through a series of workshops
and meetings held with the Chief Executives and the Chief Auditors of cooperative
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banks, NABARD has been attempting to ensure that the other areas, particularly
relating to the internal checks and controls, revenue and income realization by way
of interest on loans and advances, investments and other routine features of
carrying out general banking transactions were suitably taken care of by the banks
and their concurrent/statutory audit systems.
Institutional Building:-
Help cooperative banks and RRBs to prepare development actions plans for
themselves
Enter into MoU with state governments and cooperative banks specifying
their respective obligations to improve the affairs of the banks in a stipulated
timeframe
Help RRBs and the sponsor banks to enter into MoUs specifying their
respective obligations to improve the affairs of the RRBs in a stipulated
timeframe
Monitor implementation of development action plans of banks andfulfillment of obligations under MoUs.
Provide financial assistance to cooperatives and RRBs for establishment of
technical, monitoring and evaluations cells.
Provide organization development intervention (ODI) through reputed
training institutes like Bankers Institute of Rural Development (BIRD),
Lucknow, National Bank Staff College, Lucknow, College of Agriculture
Banking, Pune, etc.
Provide financial support for the training institutes of cooperative banks
Provide training for senior and middle level executives of commercial banks,
RRBs and cooperative banks
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Create awareness among the borrowers on ethics of repayment through
Vikas Volunteer Vahini/farmer's clubs
Provide financial assistance to cooperative banks for building improved
management information system, computerization of operations,
development of human resources, etc.
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Chapter 5
Case Study on Rural Credit
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CONCLUSION ON RURAL CREDIT
Rural credit given by bank is still not familiar with the farmers and also
accustomed to lending money without security. Rural clearly started to grow after
bank nationalization and it has been growing since then. Over the years there has
been a significant increase in the access of rural cultivators to institutional credits
and simultaneously the role of formal agencies, including money lender as source
of credit has declined.
A review of performance of agricultural credit in India reveals that though the
overall flow of institutional credit has increased over the years, there are several
gaps in the system like inadequate provision of credit to small and marginal
farmers, medium and long term lending and limited deposit mobilization and heavy
dependence on borrowed funds by major agricultural credit purveyors. These have
major implications for agricultural development as also the well being of the
farming community, Efforts are therefore required to address and rectify these
issues.