Thematic evaluation ¹

Challenges

The fall of the communist system in Eastern Europe and the former Soviet Union brought about a dramatic transformation of the overall socio economic framework and people’s expectations as to how life would be in a free market and politically pluralistic society. The advent of new realities in the post-communist period found the rural population particularly unprepared, above all, those at the geographic edges mountain areas, or other remote agricultural or forest regions.

Specific features of poverty in Eastern Europe and the former Soviet Union. Under the equality-focused communist system, rural poverty was not a widespread phenomenon. A separate and identifiable segment of ‘the poor’ was not part of the rural social structure. The withdrawal of the social services and safety nets familiar to villagers after decades of communism added to the hardship of rural families, as the market system became established, with its focus on the costs and benefits of social services. The transition process also affected rural women and kept some of them at home sometimes against their will, further constricting household incomes and cash flows.

As they were faced with their new economic and living conditions, rural societies had little defence mechanisms at hand to face their new difficult realities. In Eastern European villages where the concept of private farming was almost forgotten the challenge of helping oneself out of a difficult situation through taking up new jobs or running an own micro business was little known.

Institutional development on the fast track. With the old system disappearing and nothing at hand to replace it, success had to come fast, and there was simply no time or patience among any of the major stakeholders involved in rural finance development in Eastern Europe (such as farmers and the wider rural population, governments, politicians and other key decision-makers) to let systems evolve over time. This also made it more difficult for people-based rural finance − systems such as village savings and credit associations, thrift and credit cooperatives, or small single-unit village banks – to grow step-by-step, and in tune with gradually increasing savings, business volumes and membership figures.

Lack of trust in the financial system and its institutions. The hardship suffered by millions of depositors who put their savings into established and seemingly trustworthy banks in all states constituting the former Yugoslavia, and the former Soviet Union could not be forgotten. Losses by Azerbaijani depositors resulting from the collapse of the Sper Bank amount to more than USD 1 billion, 30 per cent more than the entire loan portfolio outstanding in the country to date. In Albania, with the collapse of the pyramid schemes in the late nineties, the higher risk nature of the institutions involved was at least more visible, but this offers little comfort to rural families who lost all their savings, pensions and rainy-day funds as a result of the bankruptcy of these financial institutions.

Legal and supervisory sector conditions. Compounding this loss of faith in financial systems is a legal and supervisory framework that remains still ineffective in many cases, and unsupportive of sound, non-corrupt and well-functioning rural financial systems and institutions. In order for financial institutions (including rural and microfinance institutions) to thrive, governments need to establish an appropriate regulatory framework, supervising agencies with the capacity to oversee larger numbers of dispersed institutions operating with smaller credit volumes.

External establishment and de facto ownership. A further challenge faced by external promoters of rural and microfinance institutions in the Central and Eastern Europe and the Newly Independent States (CEN) region has been the establishment of a clear legal ownership regime for rural finance mechanisms. Governance structures of various institutional models – ranging from large commercial to small specialized and single-unit banks, village banks and savings and credit cooperatives – are all based on the privilege of clearly defined owners who ultimately influence, control and oversee the affairs of ‘their’ institution. Where donor money comes in without making local people responsible and part of the process, externally established institutions are in danger of being used to extract money and resources, rather than have their resources used for sustainable institutional growth.

Credit-led institutional development. The absence of general financial intermediation between depositors’ excess liquidity and borrowers’ effective credit requirements under the communist system, combined with a generalized lack of trust in banks and other financial institutions, have created a climate in which small farmers may be ready to take out a loan, but much less likely to put their own savings into a financial institution. Loans represent a temporary transfer of resources in farmers’ favour but savings are a de facto transfer of control of their resources to an external institution. Trust is required to ensure that savings, once deposited, can safely be withdrawn.

Centralized credit procedures and corporate-only lending. In all four countries surveyed (Albania, Georgia, Moldova and Romania) banks were part of the institutional infrastructure of small towns in rural districts (raions or judhetes). These banks distribute pensions and transact inbound money transfers from wealthier regions or relatives working abroad. They are not normally authorized to lend to private farmers and other non-corporate borrowers, nor do they have a credit officer in place in these branches to support a lending function.

Branch managers have either no credit-granting capacity at all or only very limited scope for lending. Loan applicants from rural districts have to deal directly with the head office in the capital, often many hours journey away. Credit analysis and approval are centralized and loans to rural loan applicants are granted only by head office staff. Finally, most of the old-style banks in the region still do not lend to non-corporate borrowers (legal entities versus individuals).

Rural finance in IFAD’s CEN subregional strategy

The overall development goal of IFAD is to contribute to the reduction and eventual eradication of poverty in rural areas. IFAD’s Strategic Framework 2002-2006: Enabling the Rural Poor to Overcome their Poverty translates this goal into three main objectives.

• Human and social assets: strengthening the capacity of the rural poor and their organizations;
  
• Productive assets and technology: improving equitable access to productive natural resources and technology; and
  
• Financial assets and markets: increasing access to financial services and markets.

With these three strategic objectives the Fund specifically promotes income-earning and employment-generating activities among lower-income farmers and other households in rural areas in the eight countries in the CEN region where it currently operates (Albania, Armenia, Azerbaijan, Bosnia and Herzegovina, Georgia, the Republic of Moldova, Romania and The Former Yugoslav Republic of Macedonia). Access to affordable and reliable financial services is seen as an important factor in harnessing local resources and rendering the skills, land and productive assets of the rural poor more productive.

The IFAD CEN subregional strategy specifically stresses the need for a wide variety of rural financial institutions in the CEN region. These should be supported both in their short-term supply of seasonal credit and in their provision of long-term and investment loans for agriculture and rural development. To this effect, IFAD promotes the integration of rural microfinance into national anti-poverty strategies and operations. In the Caucasus and Albania, IFAD has focused specifically on more remote mountain areas.

The situation today

Throughout the CEN region, poverty among farmers and in rural economies continues to persist at a wide scale. Constant high levels of migration from farmlands to urban and semi-urban areas are similarly continuing.

IFAD portfolio and approach in the CEN region. Against this background, the rural microfinance activities of IFAD in the CEN region were assessed. A survey at the outset of this study indicated that, out of a total of USD 140 million in IFAD loan proceeds for interventions in these countries, USD 65.7 million was used for rural microfinance activities, either in the form of sub-loans or non-repayable grants for capacity-building or institutional development.

Altogether, IFAD’s approach to rural finance in the region is characterized by a proactive learning process and the selective transfer of successful technologies from other regions and countries. These ‘first-generation’ projects with rural finance activities were often implemented in partnership with the World Bank as the initiator. With portfolio experience building up and a better understanding as to how to specifically support the rural poor, the Fund proceeded to prepare a ‘second generation’ of IFAD initiated programmes with improved targeting mechanisms, specifically targeting poor segments of the rural population who had income-earning potential but were experiencing problems of access to markets and production factors. These second-generation projects are usually IFAD-initiated. Often, but not always, they focus on mountainous regions. The promotion of credit, savings and other essential financial services plays a major role in the current portfolio of IFAD-initiated and financed programmes.

What have financial systems and institutions contributed to rural development? More than a decade after these profound changes, the supply of rural financial services is still uneven. Donors and external support agencies have had a major influence on the rural finance sector and there is better access to rural finance where donor programmes and initiatives have been more successful, for instance in the farmlands of the Republic of Moldova, in rural Kosovo and in the highlands of Albania. In a few parts of Eastern Europe, traditional rural banks have survived, but are mostly ailing.

The presence of rural lending institutions is still rather irregular. The evaluation indicates that whereas in Albania’s highlands, all banks and other financial institutions in the district centres have stopped lending and only the IFAD-supported Mountain Areas Finance Fund (MAFF) and a couple of small, local donor funds give credit to farmers, the Moldovan countryside has been transformed by the operations of about 500 savings and credit associations (SCAs) spread throughout the country.

Beneficiary perspective

The thematic evaluation focused specifically on the views of the people for whom the IFAD programmes were designed – small farmers and other lower and low-income rural people with productive potential, but with a dearth of capital constraining their income-generating possibilities. Insights from the field are encouraging. For members of the Moldovan SCAs, incomes have increased as a consequence of borrowing for small productive purposes. The extent of the increase ranged from 5 to 60 per cent over the pre-loan period. Also cited as encouraging was the collective impact of new and democratic governance patterns on these savings and credit associations. Elections in these SCAs are conducted democratically and with a secret ballot.

In Georgia, members of successfully operating credit unions reported considerable increases in household food security, income and sometimes also employment. Such gains are irrespective of gender since about half of the credit union members are women.

The evaluation described IFAD projects in Albania as having a significant impact on rural poverty reduction. However, with the stabilization of the political and economic situation, there is now a trend towards more individualized production. As a consequence, small individual loans are more in demand than group-based delivery structures. Similarly, where land titles are safely secured, production and marketing are conducted individually.

Comparatively speaking, the project financial services with the least beneficial impact were noted in Romania. Existing legislation for commercial banks results in collateralization of very small loans, comparatively high interest rates and complicated loan application and analysis procedures. Small farmers complained that, for loans as small as USD 2 000 to USD 5 000 equivalent, the entire real estate of the farm was blocked as collateral (farm buildings and plots valued at between USD 20 000 and USD 100 000) and required loan documentation as costly to obtain and unnecessary.

Available options

The regional evaluation illustrated that institutional options for rural finance development in Eastern Europe and the former Soviet Union basically consist of three alternatives:

Commercial Banks (and Non-Bank Financial Companies that could graduate into banks at a later stage) can provide the full range of financial services to their customers. Money transfer, current account and cheque facilities may be as important to an emerging small farmer or micro entrepreneur as access to loans. Types of loans can be more easily diversified by a commercial bank with access to funds with different terms and foreign exchange as well as domestic currency facilities. A bank can grow with the client, establish a relationship through loans when the farmer is still small, and then grow to a full service provider later on. In the evaluated programmes, banks were used mostly as providers of large scale investment loans, partly financed by IFAD (Moldova and part of the Romania portfolio) and partly financed by other sources (World Bank in Georgia). The NBFC established by IFAD in Albania, MAFF also offers the entire range of lending services, from small working capital loans to large SME investment finance, the latter without any competitor in rural Albania and with a comparatively high first mover advantage in a traditional society like Albania where relationships, once established, are maintained as a question of honour.

Thrift and credit cooperatives and credit unions. These member-owned and member-governed institutions are proximity-based and offer physical accessibility for rural people as their main plus point. This type of decentralized financial institution was the prime model for promotion of rural finance in the four countries covered by the regional evaluation, but the success in introducing these networks of small rural finance institutions was uneven. While they emerged as the most important retail finance providers in rural areas of the Republic of Moldova, their success in countries such as Georgia fell short of expectations.

Financial and General Purpose NGOs with financial services have an overall good outreach covering not only small towns, but also more rural and agricultural areas. These microfinance institutions (MFIs) are more mature and have been operating longer in the CEN region than in other parts of the developing world. Many of these operators (often with eight to ten years of operational experience) have separated from their international parent NGO and recommenced as local domestic microfinance institutions with their own board and domestic management staff. After extensive support with non-repayable grants, these institutions have reached a level of maturity that permits them to seek commercial sources of funds and to lend commercially. None of the four countries studied for this regional evaluation had such MFIs included in their projects. More recently designed IFAD programmes in Armenia, Azerbaijan and Georgia have begun to cooperate with NGO-type MFIs.

Avantages and disadvantages of the three options

Banks and non-bank financial companies such as the IFAD initiated MAFF in Albania can offer a full range of financial services and grow with the initially small client. However, in the CEN region the ownership and governance structure of commercial banks remains in some cases unclear. In the case of state-owned banks, the real decision-makers and their motives for action are sometimes not easily identifiable. Equally, in the case of some privately-owned banks, the ubiquitous syndicates of private business people holding shares can mean myriad objectives and strategies for the business and strategic development of a commercial bank that may not be fully understood by project designers. More generally, commercial banks are also disadvantaged in rural finance development by their lack of experience in the specific products and lending technologies of agricultural finance, their reluctance to reach out to non-corporate, small, single-proprietor businesses without audited accounts or a credit history, and the high costs and perceived high risks of lending to lower income and smaller credit applicants. A new type of microfinance bank operating in ten countries in the CEN region has however illustrated the potential of a licensed commercial bank to operate profitably with an exclusively small and microentrepreneur clientele.

Thrift and credit cooperatives, credit unions and other forms of mutualist and proximity-based finance institutions operate close to village and small-town economies and can operate profitably even in remote and difficult-to-access regions. Their democratic governance structure and voting procedures ensure that this type of rural finance institution is member-owned and member-governed.

On the other hand, thrift and credit cooperatives are more vulnerable than other forms of rural finance to political interference and take-over by rural elites or representatives of village power structures. The country studies undertaken in the context of the thematic evaluation have reiterated the crucial importance of the initial and founding phase of a credit union. Where future credit union managers select the credit union members themselves, chances are that the change-oriented and business-minded part of the rural population will not be fairly represented. Where, however, villagers form a group on their own initiative, look into the potential of the thrift and credit cooperative model for their village and then choose leaders from among the community, it is much more likely that a sustainable and well-managed village credit union has been established.

Financial NGOs, when new or only recently established, have a high overhead cost structure and initially concentrate solely on lending in urban environments. Caution is needed in approaching situations where ownership is still vested in the international support institution and the MFI concerned is an affiliate rather than an independent local body. Similarly, where microfinance operations are still functionally linked to the other humanitarian activities of an international NGO, the possibilities for partnering are limited for a larger-scale donor like IFAD, with no possibilities for direct funding to support programme operations.

Costs of each option

Commercial banks constitute the highest-cost option if they are newly established, as in the case of the ProCredit Banks in Eastern Europe (a network of ten microfinance institutions). In this case, a proven partnership among different international financial institutions capitalizes these banks and also raises the initial loan funds. As illustrated by the IFAD-established MAFF in Albania, capitalization on the basis of past credit portfolios bears its own risks since the valuation of these portfolios at the time of asset transfer may be overly optimistic. All the same, MAFF is a case where a non-bank financial institution was created as a new bank-like operator with reasonable amounts of capacity-building and establishment funds.

Without donor support, thrift and credit cooperatives/credit unions are normally the cheapest form of rural finance institution. In Georgia, the IFAD initiative of establishing a countrywide network of rural credit unions provides a typical example. A group, ranging between 10 and 50 members, forms the institution and registers and/or licenses it as required. The institution may then be staffed initially on a part-time or purely volunteer basis and staff levels may increase only in response to increased business revenues. As the work of the Irish League of Credit Unions in several countries in the CEN region shows, this is a slow process that can easily take up to a decade. External donor and support agencies with their three- to five-year project implementation horizons do not allow for such a time frame. For this reason, the creation of credit unions is catalysed with external establishment grants of usually between USD 3 000 and USD 5 000 per credit union, plus the sourcing of external loan funds. The organic growth of a credit union led by a gradual increase of member deposits and lending solely out of internally mobilized funds cannot be accomplished within a two- to four-year period.  In countries such as Albania, Kosovo and the Republic of Moldova, the savings and credit associations operate on a group basis but exclusively with externally sourced loan funds without mobilizing any internal deposits at all.

Financial NGOs (such as Agricultural Cooperative Development International/Volunteers in Overseas Cooperative Assistance (ACDI/VOCA), the Foundation for International Community Assistance (FINCA), Mercy Corps, World Vision and World Relief).

Differences among these operators in terms of cost of operations and overheads are considerable, largely due to widely differing salary structures for international and local staff, different levels of grants for operating costs during the establishment and consolidation phase, and different delivery mechanisms. Quite often, a localized MFI operation with fully capitalized head office costs and some grant or concessional funding for onlending in the balance sheet from its start-up phase is in a good position to borrow on commercial or semi-commercial terms from an international financial institution or out of rural finance project funds.

Recommendations and other insights gained

Detailed recommendations are contained in the final section of this study, as well as the final sections of the country studies for Albania, Georgia, the Republic of Moldova and Romania. They are summarised below:

Design recommendations

Design recommendations in rural finance need more adjusted flexibility during implementation due to the fast changing conditions in the CEN region. Mechanisms have to be found to shift some of the design resources into the implementation phase to cope with the need for re-design while implementing a programme (as in the case of the Republic of Moldova project).

Appraised and selected partner institutions should be more diverse in the future. At the time of the evaluation in the country studied, IFAD supported mainly credit union-type networks (Georgia, Moldova, and earlier in Albania) and larger volume SME credit lines through commercial banks (Albania and the Republic of Moldova). However, banks in the CEN region can also transact small-scale loans with microentrepreneurs and small farmers with average loan amounts of between USD 1 000 and USD 5000. IFAD should make more use of this conduit, and collaborate more with financial NGOs. Some such NGOs have been operating for more than five years and have reached an institutional development path that would permit them to lend on commercial or near commercial terms, rather than being the passive recipients of grants and non-repayable contributions or consulting services.

Targeting

Poverty impact of large-scale SME loans. In Albania, IFAD consolidated three project credit portfolios and established MAFF as an institution providing small retail and large SME loans of up to USD 100 000. This example has shown the difficulty in achieving a poverty impact through a ‘trickle down’ of large loans.

Field interviews conducted with large borrowers showed that it is generally difficult to make the case for large rural SME loans as an effective poverty-reduction mechanism unless clear proof can be given as to the direct and/or indirect employment generations of these loans. Since these loans are already offered by institutions such as the European Bank for Reconstruction and Development (EBRD), the German Credit Institution for Reconstruction (KfW) and the World Bank, a partnering with these institutions (possibly also through parallel financing) and a freeing of IFAD resources for more direct strikes on poverty should be considered.

Results in all four countries show that the poorest members of village communities are unlikely to benefit directly from IFAD lines of credit or IFAD-financed institutions with a wider range of services. Very poor rural people first need assistance to reach a situation where they can profitably absorb credit. For this reason, a more proactive inclusion of the very poor, and in particular women, would require a front-loaded social and community mobilization component.

Institutional capacity

The study has revealed the extent to which rural financial systems and institutions in all of the sampled countries had collapsed. To its credit, IFAD-supported rural finance systems in Albania, Georgia, the Republic of Moldova and, to a large extent, also Romania constitute the only credit and deposit mechanisms for large parts of the rural population. This considerable institutional gap has been addressed through IFAD-supported interventions that establish, consolidate and scale up innovative types of institutions, such as MAFF in Albania, the SCAs in the Republic of Moldova and credit union networks in Georgia. Two particular challenges in this context were ensuring outreach of these institutions to rural low-income households, and finding an institutional development path with concrete prospects of reaching operational and financial sustainability in the medium term. In this area IFAD has succeeded to a large extent.

The service capacity of existing rural banks for credit operations has to be critically assessed in situ. Wherever a significant expansion of branch credit portfolios is being planned, the ‘without project’ situation has to be professionally analysed, and technical assistance offered for training and skills development of the credit officers to be deployed in rural branches.

The study also showed that three out of four rural finance programmes supported by IFAD promoted the development of new institutions. Far from being an exception, the development of new financial institutions (called by KfW the ‛greenfield approach’) has fared comparatively well in the CEN region and in the IFAD portfolio. Too many old or existing financial institutions, from the public and private sector alike, operate with non-transparent owner and stakeholder arrangements and can be plagued by sudden frauds, illegal transactions and so on. This is a positive achievement for IFAD that has to continue in the future.

The example of Romania shows that: (i) a single bank selected for onlending of IFAD funds may use its monopsony position for the interest of the institution rather than the poverty-reduction programme; a pool of banks with flexible disbursements and other programme support in line with programme performance ensures better services; (ii) partner financial institutions should be selected as part of project design and appraisal; the Romanian situation, where no partner financial institution could be identified for a programme that was basically financial services-driven, should be avoided; and (iii) subsidized interest rates for loans as part of IFAD appraisal recommendations requires critical review.

Other operators – such as microfinance NGOs, national credit union networks or NBFCs – have limited capacity to absorb loan funds for poverty reduction. Even though capacity may be built up over time and with complementary technical assistance, an average sized microfinance NGO may not be able to absorb more than USD 500 000 of additional loan funds that would recycle within the institution profitably. Such unit sizes for refinancing funds are too small for most international financial institutions. IFAD is more flexible in this respect and should wield this flexibility as the first mover in providing loan funds on commercial or near-commercial terms to rural MFIs.

Monitoring and supervision

Monitoring indicators should focus more on social and general impact. In particular, SME lines with loans up to USD 100 000 have to have a good tracking and monitoring system to measure whether incremental income and employment have been created for the IFAD target group. Likewise, the creation of more than 160 credit unions through an IFAD-cofinanced project in Georgia, without providing for the monitoring of social, physical and human assets, and social capital development, seems to fall short of the desired objectives.

Policy dialogue and involvement in ongoing poverty assessment processes

In Romania, IFAD’s position as an international financial institution with onlending funds actually taken up and utilized could have been used for a process of joint learning and policy adjustments. In particular, collateral requirements for small and retail loans would require review. Coordination with other donors (such as those operating the German-Romanian Fund) would have improved the prospects of involving other commercial banks in agricultural lending in the project area.

In Georgia, better identification of constraints to credit union formation and development particularly in the field of policy and institutional framework could have assisted in directing IFAD’s efforts in policy dialogue. This would also have addressed practical issues of great relevance to small rural credit unions in mountain areas, such as tax exemption, which is the norm for thrift and credit cooperatives in other countries. Other issues, such as a relaxation of the rather high minimum requirement of 50 members to form a union, also needed to be addressed. As the regulatory authority, the central bank has signalled its interest in receiving and reviewing this type of proposal to ensure that Georgian credit unions remain open to small operators in future.

In the Republic of Moldova, and to an extent also in Albania, policy dialogue and proactive involvement in ongoing poverty assessment processes would have resulted in a clearer strategy for institutional growth and a valid direction of development for both the Moldovan SCAs and Albania’s MAFF. 

The emerging rich and multifaceted experience of IFAD in rural finance development for poverty reduction should be made available more proactively throughout the donor community, and among domestic and international decision-makers. In particular, IFAD should be more engaged in the participation process that precedes the drafting of poverty reduction strategy papers (PRSPs). Comparing the sections of PRSPs, such as those for Albania and Georgia, that describe concrete emerging experiences and lessons learned from IFAD rural finance development illustrates that IFAD has a lot to offer in formulating concrete recommendations for rural finance development strategies and activities in the CEN region.

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1/ The thematic evaluation missions were composed of: Dr Rauno Zander, mission leader and rural finance specialist; Ms Paivi Pylkkanen, socio-economist; Ms Sandra Romboli, IFAD Associate Professional Officer and institutional specialist; Ms Helen Lackner, sociologist; Ms Lea Joensen, IFAD Associate Professional Officer; and Ms Ranjanai Murthy, sociologist. Dr Mona Bishay, Deputy Director of the Office of Evaluation, supervised the evaluation. The field work of the evaluation covered four countries: Albania, Georgia, Moldova and Romania.