Rural finance Challenges

A large proportion of the population of developing and transition economy countries and three-quarters of the developing world's poor people live in rural areas. Sustainable livelihood development in rural communities is, thus, an important process and requires efforts to help people improve their social and financial assets.

Financial assets enable households to make better use of other assets, such as their land, labour and skills. Financial services help people to build their financial assets and can also help to facilitate their transactions, solve cash flow problems and manage risk.

Rural finance is, therefore, about the development of financial services in rural areas. The rural environment does have a number of particular problems, e.g.

A lower spatial density of clients, compared with urban areas, and therefore higher transaction costs; A mix of economic activities in which agriculture (including livestock and fisheries) is often very important, with consequent higher levels of risk from uncontrollable factors and irregular cash flows from seasonal production; A tendency towards lower levels of human capital, especially literacy and numeracy, with women often being disadvantaged; A history of poorly conceived, sometimes politically-driven, rural lending that has left a residue of bad debts, weak portfolios and borrowers unaccustomed to strict interest and repayment practices; Poor infrastructure and long distances from markets, which limits economic opportunities and debt capacity.

These issues require close attention to policies, to the operations of financial institutions, to improving the design of projects and to finding ways of improving capacity building so that best practices are followed wherever possible. Interesting Article .... Examining Design and Innovations in Rural Finance For Addressing Current and Future Challenges By Calvin Miller FAO Rural Finance Workshop: SEEP Pre-Event October 26, 2004 Twelve Key Challenges in Rural Finance Rural finance has been recognized as an important element and catalyst to rural development. Millions of dollars have poured into rural finance, especially agricultural credit, in the past and yet rural communities have little to show for it. Donors, governments and bankers became disillusioned with the results. Today there is renewed interest to learn from the past and experiment for the future to meet the seemingly illusive goal of increasing rural farm and non-farm investment and assets through the ready access of appropriate and sustainable financial services to all households. In addition, rural finance has begun to be seen in a broader spectrum than agricultural and farm credit but is rightly now being defined as farm credit and non-farm credit, savings, insurance, transfers, clearing, equity finance, etc. and is not restricted to institutional lines of finance. Twelve key challenges for achieving this goal are laid out below. Even so, these are challenges as seen by rural finance specialists. While these are recognized obstacles to overcome, are they the most important questions? What are the root causes and with which ones can we have the most impact? What is missing? What is not important? Should we focus more on adapting products to fit the constraints or on addressing the constraints? How must the responses to the key issues fit together in order to be effective. Key challenges for rural financial service provision Vulnerability Constraints Systemic Risk – rural incomes, especially among the agriculturalists, are highly susceptible to similar risks at the same time. Weather is the most uncontrollable and often devastating risk but disease and plagues are similarly important. Failures in agriculture affect not only the farmer households and the production and marketing linkages but also the rural non-farm economies that revolve around and depend upon those income flows. Even so, the most problematic is farm credit because of higher risk. Market Risk – especially in developing countries, there both cyclical and seasonal price fluctuations of agricultural commodities, not only due to local production variation but also affected by “outside forces” such as political price and exchange controls, subsidies and globalization. Credit Risk – collateral, especially mortgage, is a missing element in most rural finance hence increasing the risk of the lender. Similarly collateral substitutes may be costly in both financial terms as well as social stigma risk terms as can be the case with peer lending. Other support services and information networks such as credit bureaus are often not available to help lower the risk. For term lending, a financial gap risk between sources and uses of funds poses another risk constraint. Operational Constraints Investment Returns – rural capital revolves slowly, with often one or less frequently two crops per year. For investment capital the returns are even slower and in spite of that are often faced with very low profit margins. Hence the margins for error are much less than for example in commerce or most microfinance which tend to have high returns per unit of funds invested and higher profit levels. Low Investment and Assets – the relative poverty in rural areas causes common crises to become major crises due to the lack of asset “cushion.” Any loss of expected income through sickness or production losses cause significant impact. In compensation, traditional networks and production risk minimization become more important than profit maximization. The small asset base also reduces savings and borrowing capacity, thus constraining economies of scale in the use or provision of services. Geographical Dispersion – rural areas are characterized by low density of population and high dispersion, which is coupled with a relatively low market potential. with a relatively low market potential make access and communication difficult and hence high costs of operation for both production and marketing and for access and delivery of services. Capacity Constraints Infrastructural Capacity – poor communication, pitiful roads, unequipped schools and missing social and health services decrease efficiency of operations, discourage new services and increase the outflow of the most talented and resourceful persons and a reluctance of educated families to live in rural communities. Technical Capacity and Training – a relatively unskilled rural population reduces opportunity for ready access and adaptation to new technologies and employment. The lack of capacity affects not only the productivity and competitiveness in the changing marketplace but also the ability to find trained staff for service provision. Social Exclusion – cultural, linguistic, gender, racial, religious and educational constraints affect market and financial integration. Such barriers reduce production and marketing efficiencies. These are required in order to compete effectively in the marketplace and thereby generate income and levels of assets needed to reduce poverty and vulnerability. HIV/AIDS makes this even worse in many countries. Institutional Capacity – while there is an abundance of organizations in rural areas, the relative capacity is lacking. This includes management and technical capacity, size/economies of scale competitive viability, economic integration and often risk-bearing capacity. Even when urban based institutions have the capacity to reach into rural areas, there is little incentive to do so. An exception to the capacity constraint is at the micro level where the social fabric is able strong and is sufficient for the level of operations undertaken and may also form linkages with intermediaries of higher institutional capacity. Political and Regulatory Constraints Political and Social Interference – loans can be forgiven, savings can be withheld, interest rates can be capped, mortgages can be rendered useless and payments can be suspended due to decree. Even danger is not uncommon; hence uncertainty can become an insurmountable hurdle. Regulatory – regulations and/or a lack of enforcement of them hinder rural as well as urban environments. Land tenure regulations, banking laws, exchange rate manipulation and tax considerations are examples of such constraints that destabilize and/or hinder viability of business and financial operations in rural areas. Examples of responses to these challenges are being discussed, researched and/or tested throughout the world. Today we will learn about progress being made on some of these development fronts. Development is a collaborative effort and each one of our contributions is important. What steps can we take toward that end? Key Challenges Affecting Rural Finance Category of Challenge Constraints and Issues Response Approaches for Rural Development (What are priority issues to address?) Vulnerability Systemic risk Market risk Credit/financial risk Weather Plagues, diseases Prices Production Useable collateral Demand preferences Health and family needs Operations · Profitability/ investment returns · Poverty/lack of assets · Low-density dispersion Low growth potential Low velocity of capital Non-competitive technologies Lack of market integration · Lack or quality of roads and communication · Low efficiencies of business operations · High operating costs Capacity · Infrastructural capacity · Technical skills and training · Social exclusion · Institutional competency · Lack of business investment · Lack of competitive technologies · Lack of roads · Lack of communications · Lack of education · Lack of technical and management skills · Lack of institutional capacity · Lack of social representation(civil society) Political and Regulatory · Political and social interference · Regulations, policies and their application · Political interference · NGO “donation” interference · Cultural and gender constraints · Land tenure laws · Financial regulations · Tax policy Key Challenges Affecting Rural Finance Category of Challenge Constraints and Issues Designing to Fit (What is appropriate for addressing given constraints) Rural Finance Delivery Approaches and Methodologies Appropriate Products and Services Vulnerability · Systemic risk · Market risk · Credit/financial risk · Weather · Plagues, diseases · Prices · Production · Useable collateral · Demand preferences · Health and family needs Key Challenges Affecting Rural Finance Category of Challenge Constraints and Issues Designing to Fit (What is appropriate for addressing given constraints) Rural Finance Delivery Approaches and Methodologies Appropriate Products and Services Operations · Profitability/ investment returns · Poverty/lack of assets · Low-density dispersion · Low growth potential · Low velocity of capital · Non-competitive technologies · Lack of market integration · Lack or quality of roads and communication · Low efficiencies of business operations · High operating costs Key Challenges Affecting Rural Finance Category of Challenge Constraints and Issues Designing to Fit (What is appropriate for addressing given constraints) Rural Finance Delivery Approaches and Methodologies Appropriate Products and Services Capacity · Infrastructural capacity · Technical skills and training · Social exclusion · Institutional competency · Lack of business investment · Lack of competitive technologies · Lack of roads · Lack of communications · Lack of education · Lack of technical and management skills · Lack of institutional capacity · Lack of social representation(civil society) Key Challenges Affecting Rural Finance Category of Challenge Constraints and Issues Designing to Fit (What is appropriate for addressing given constraints) Rural Finance Delivery Approaches and Methodologies Appropriate Products and Services Political and Regulatory · Political and social interference · Regulations, policies and their application · Political interference · NGO “donation” competition · Cultural and gender constraints · Land tenure laws · Financial regulations · Tax policy