1.1 What is specific about agricultural finance? The financing of agricultural activities reflects specific characteristics and constraints – factors that explain the difficulty microfinance institutions have in meeting this demand. Family farms need to innovate, modernize and improve their productivity constantly. Their financial needs, therefore, involve various types of loans, both shorter and longer term:
The financing of agriculture is characterized by a high level of risk, both climatic and economic (price fluctuations, difficulty in selling harvests, etc.). These risks are often covariant, in that they affect all borrowers in a given zone at the same time (drought, floods, epizootic diseases, etc.). Covariant risks are therefore harder to manage through the usual mechanism used in microfinance to secure loans, that of solidarity groups. All these constraints are intense in the areas where IFAD is typically present, namely disadvantaged areas without staple food crops and where infrastructure and markets are often underdeveloped. Another factor differentiating agricultural finance is that farm budgets are closely integrated with household budgets, and financing for agricultural and non-agricultural activities, consumption and household investments are closely linked. Among a household’s various economic activities, agricultural activities are often less profitable and more risky than non-agricultural activities. In most countries, agricultural finance has mainly focused on export crops. The liberalization of agricultural economies has led to a reduction in the amount of credit available for agriculture, and microfinance institutions have often been called upon to fill the gap. Financial services for farming households also need to include not only savings products that allow farming households to develop their farms’ self-financing capabilities, but also simple insurance services. 1.2 What Does Microfinance Contribute to Agricultural Finance Today?
Microfinance loans are mostly short term, while the supply of medium- and long-term loans is generally insufficient to meet demand. There are several reasons for this shortfall, including that the profitability of the activities financed may be insufficient to cover the cost of the loan (for example, this is often the case with purchase of animal traction in staple crop farming); microfinance institutions (MFIs) lack access to stable medium- and long-term funds and prefer to secure a return on their funds through rapid rotation as short-term loans; and MFIs do not have the appropriate technology to track and support medium- and long-term loans. Yet, innovations are being introduced, such as mutualist rent-to-own systems and equipment loans guaranteed within production sectors (see Appendix 3). No one MFI model is better suited to agricultural lending than any other, but systems that foster feelings of ownership among their members (such as credit unions (CUs), cooperatives and village banks) enjoy a higher success rate than others, and contribute most strongly to agricultural financing. This derives from closeness to their members. A number of CUs and cooperatives were created by farming populations in order to meet their financing needs (e.g. Federation of Agricultural Savings and Credit Unions in Benin; Kafo Jiginew in Mali), and the decentralized loan disbursement and monitoring procedures make it possible to know borrowers well and treat applications individually. However, such MFIs, especially when they are small and very local, remain highly vulnerable to covariant risks. Conversely, entrepreneurial MFIs are less present in the agricultural field. Certain innovations in securing agricultural loans seem promising, including agricultural warrants, loan delegation, jointly managed guarantee funds and mutual guarantee associations. These security mechanisms make use of new types of contracts between the various partners in agricultural activities: producers, farmer organizations, processors, traders, etc. Today, microfinance experiments that significantly finance agriculture tend to be concentrated on production in secure areas (often irrigated areas). Some services developed to meet agricultural finance needs have been successfully provided by MFIs. However, they are usually focused on specific activities that bring strong added value to producers, and are being used in contexts where the predictability of incomes derived from such agricultural activities is quite high (cash crops in irrigated areas). For example, post-harvest credit provided by CU networks in Madagascar has helped producers to almost double the value of their crop by enabling them to store it for sale three to four months after the harvest season. Due to the profitability of this service to their clientele, those CUs have been able to provide this financial service at market cost (including the refinancing costs from local commercial banks, plus the operating margin of the CU and loan provision). This is one example of a very profitable agricultural microfinance service provided by CUs operating in rural areas, which brings strong value to their clients. The issue of agricultural finance has also been raised to meet needs in staple crop production areas. In those areas, the basic rule should be to focus on the overall funding needs of the many household activities (which permits more effective risk mitigation) and not to fund only specific agricultural investments, due to the risks involved. This rural finance approach is also more likely to meet the needs of the rural poor, as it enables them to use microfinance services flexibly, helping to diversify their sources of income and cope better with adverse circumstances. In general, agricultural finance could be developed by MFIs on a larger scale only if farming itself became a more profitable and safer economic activity. Beyond the need for certain predictability regarding the income generated from the agricultural activity (e.g. the need to be cautious in funding staple production in rainfed areas), it is also important to assess the safeguards that exist for the economic activities themselves, such as price policies and organization of markets and producers. Taking the same example of the CUs in Madagascar, very wide fluctuations in the price of rice have occurred there, due in large part to massive imports from Asia in recent years. The absence of a strong national market and producer associations, combined with loose import policies, have made the funding of rice production by CU networks much more risky for the farmers. To mitigate risk implies coordinating policies and donor actions, as well as forging new alliances between the various rural stakeholders, including farmer organizations, MFIs and support services. 1.3 Recommendations for Increasing the Microfinance Institution Contribution to Agricultural Finance A number of steps can be taken to improve both the quantity and quality of financial services to the agricultural sector. 1.3.1 Meet solvent demand The general recommendation to “meet solvent demand” is particularly appropriate in agricultural financing. Credit can only provide effective economic leverage if the activities financed are profitable. Credit should be used very prudently (and alternative interventions considered) in areas where agriculture is based exclusively on staple food crops, with rainfed practices, where market integration is low, and non-agricultural activities are not very well developed. 1.3.2 Improve the microfinance institution’s knowledge of agricultural activities As MFIs become more professional, they often hire specialized staff who lack detailed knowledge of the agricultural sector. To develop the appropriate financial services and adequate loan portfolio monitoring capabilities, detailed knowledge is needed of the characteristics and constraints of agricultural activities. This knowledge must include both technical aspects (production systems, farmers’ practices, etc.) and a clear understanding of local economic and social realities. This knowledge then helps to identify the most suitable financial services, develop guarantee systems that are as effective as possible, and identify any potential for systemic failure. In addition to the knowledge requirement, an information system is also needed to monitor changes in local agricultural activities. Creating and maintaining systems of this sort within MFIs can be costly. Contracting with other institutions active in the area (farmers’ organizations, development programmes, support services, etc.) can provide more effective sharing of costs and further encourage exchange of information. 1.3.3 Diversify loan portfolios MFIs that fund exclusively agricultural portfolios are extremely vulnerable to external shocks. Loan portfolio diversification strategies, therefore, need to be developed to mitigate this risk. A diversified credit portfolio and a wider range of products would, moreover:
This implies that MFIs need to:
MFIs’ own funds are often insufficient to cover agricultural needs. Links with the formal financial sector can provide specific solutions (improve the volume of funds available, the availability of long-term funds, etc.). This is highlighted in the example of Madagascar, where CU networks used commercial loans to fund post-harvest loan campaigns in favour of small-scale rice producers. 1.3.6 Disconnect financing from agricultural support and supervision To a large extent, the failures of past agricultural financing systems can be attributed to the strong ties that existed between the two functions of funding and of agricultural technical support, encouraging lessened entrepreneur responsibility and a low level of specialized skills among MFI agents. Today, it is clearly acknowledged that MFIs should not provide agricultural support and supervision to their clients. Technical support, however, can make agricultural loans more profitable for farmers and safer for MFIs. One approach is to seek to develop contractual relationships with other organizations active in rural areas and that could provide such support (support services, non-governmental organizations (NGOs), etc.). 1.3.7 Disconnect financing from farmer representation This recommendation concerns more specifically MFIs that have emerged from the agricultural sector (CUs, cooperatives). Combining farmer representation with financial services can precipitate governance failings and management problems. Consensus is progressively building on the need to make the financial role autonomous through specialized institutions (MFIs) that are independent of the founding farmer organizations. However, such autonomy raises the issue of a possible “financial mission drift” by the MFIs, away from the farmer organizations that initially created them. Innovations exist in this field to preserve farmers’ representation in the supervision of MFIs: through representation on the Board of Directors, for example, using the college of administrators principle (see Appendix 4). Within such a supervision structure, however, it is important that a judicious balance be maintained between the representations of borrowers and of savers. Borrower domination may entail some risks, including practices that may benefit borrowers in the short term, while jeopardizing the MFI’s longer-term sustainability (such as lower interest rates on loans, or larger loan amount compared with the saving requirement). 1.3.8 Strengthen ties between microfinance institutions and farmer organizations Where MFIs do not grow directly from an agricultural environment, relationships between MFIs and farmer organizations can be marked by little mutual knowledge of each other’s activities and roles, and a high level of distrust, with loan interest rates often focal points of contention. Strengthening ties between these institutions – MFIs and farmer organizations – can help match services more closely to local needs and can improve loan security. Diverse approaches may be used: exchanges fostering better knowledge of each other and each others’ approaches, use of MFI services by farmer organizations, joint participation in a credit bureau, etc. Beyond the local level, ties should also be strengthened among the various bodies in charge of elaborating agricultural and financial policies. 1.4 Internet Resources for Further Reading
2. Financial sector reform and the implications for rural finance programmes: the role of state-owned banks 2.1 IFAD and state-owned banks - current status Most of the generic recommendations below will also apply to private commercial banks as potential partners for IFAD’s rural finance programmes. However, they are not specifically mentioned here, since most private commercial banks in developing countries have limited branch networks in rural areas and so far have not been important partners for IFAD.
This general withdrawal from operations with state-owned banks on the part of IFAD, apart from very specific contexts, is understandable, as these banks in general have failed to reach the Fund’s target groups in a sustainable manner. Subsidized credit has focused the supply of loans to well-off farmers, as borrowing conditions and collateral requirements have excluded the poor, and the type of services offered were frequently inappropriate to the needs of the rural poor. As a result, the IFAD’s rural finance policy rightly argues against providing large credit lines to those institutions. Despite these shortcomings, state-owned banks may, in principle, offer comparative advantages for reaching very large numbers of poor people in a cost-effective manner. These banks generally have large retail networks in rural areas, with trained staff, fund-transfer facilities and the ability to mobilize savings. Carefully designed pilot programmes for technical assistance and capacity building could help harness those comparative advantages, and reach the rural poor with financial services on a sustainable basis. Such pilot programmes will typically be based on the provision of technical assistance, and should not presume any large credit line (due to the reasons mentioned above, and since such a facility would have no added value and relevance in that context). However, IFAD needs some guidelines for identifying the circumstances under which it might work with state-owned banks. The first step should be to recognize that the Fund does not usually have the capacity, political clout or mandate to support large-scale reforms of state-owned banks. The corporatist interests ingrained in these institutions, and their monopoly in providing funds and subsidies for the agricultural sector, make it unrealistic for a donor such as IFAD to be the prime partner or driving force for creating institutional changes in these banks. The World Bank may be better placed to assume this role. Having said that, it may be possible to set up a ‘space’ within state-owned banks where pilot experiences could be launched to test a new rural finance approach, based on sound microfinance practices. The key challenge, though, will be to attract the interest and support of senior bank management for piloting such approaches. Two steps will be needed:
2.1.1 Assess the state-owned bank’s financial situation and performance The following indicators should be examined to evaluate the bank’s financial position and their capacity to reach IFAD’s target group:
2.1.2 Assess the conditions that influence state-owned bank activities and that may be conducive to improving their operations
2.1.3 Assess alternative rural finance options
2.2 IFAD’S potential work with state-owned banks Once the above general review has been carried out, IFAD has two main options: assess the possibility of developing a retail capacity within a state-owned bank (through a pilot rural finance programme), or consider the wholesale function. The following analysis underlines optimum conditions to start a pilot retail programme with a state-owned bank. What are not reflected, however, are some specific constraints in certain countries or contexts in which IFAD intervenes, and where a more incremental approach may need to be adopted. 2.2.1 The state-owned bank as retailer This section draws heavily on the general guidelines in the Consultative Group to Assist the Poorest working paper “Should Your Commercial Bank Do Microcredit”? 2.2.1.1 Political commitment An essential condition for pilot testing a microfinance programme with a state-owned bank will be that the chief executive officer and senior management, as well as executive board members, where relevant, are deeply committed to the process of exploring microfinance. Their commitment can be judged through discussions in the programme identification and formulation process, assessing their readiness to modify the bank structure were the pilot trial to be implemented. One issue that should be checked is the tenure of top management and board members, as many senior positions in state-owned banks are often filled by civil servants, whose tenures may be short. Short tenures militate against longer-term planning, weakening the ability to secure the right support. The degree of commitment may also be measured by the resources the state-owned bank will contribute to fund the pilot experience, including readiness to assign promising young managers to take charge of the pilot programme, and to delegate an adequate number of qualified staff for programme implementation. Typically, in a microfinance pilot programme, at least six capable managers are needed, namely a general manager, plus managers covering operations; MIS; human resources; credit; product development; and marketing management. 2.2.1.2 Critical prerequisites for a pilot microfinance experiment The strong political support from top management should be reflected in the agreement to secure minimum, essential conditions for the pilot operations (these have been essential factors in successful pilot experiences with state-owned banks). Requirements include:
2.2.1.3 The need for autonomy and direct accountability within the structure of the state-owned bank Microfinance operations have their own dynamics. They need to be able to process vast amounts of information quickly, to decentralize virtually all operational decisions, and to have a different type of loan officer and a more friendly client interface and accountability. These characteristics distinguish microcredit from most other banking operations. This implies that microfinance must be able to operate with a high degree of autonomy within the structure of a state-owned bank, and be administered separately from other banking services. Although microfinance services may be extended through the existing retail network of state-owned banks, they would most probably require separation in terms of staff, MIS, operating policies and organizational structure. Above all, a successful microfinance operation will require that staff be held directly and immediately accountable for their individual performance (loan repayment, growth in client and loan volume, profitability of branch-level operations, and generation of savings in those cases where this is appropriate). Suitable accountability mechanisms will include paid incentives, connected to base pay; indirect incentives, such as staff travel and training; promotion; and, ultimately, the ability to sanction non-performers. 2.2.1.4 Various scenarios for the internal organization of microfinance operations A microfinance pilot experiment can be organized in different ways – as a division within the bank, as a product line with its own staffing, as a loan processing subsidiary, or as an entirely separate entity. Whatever the structure adopted, however, the state-owned bank’s MIS system must be able to track and report on the activities and results of the microfinance unit separately from other bank activities. 2.2.1.5 The need to set high performance standards The microfinance pilot programme, if it is to succeed, will need to set high standards in terms of loan portfolio quality and profitability. This means that the programme must aim at full cost recovery, implying charging interest rates that are typically higher than the rates of any of the bank’s other loan products. An important issue in this context is whether or not the government and the bank’s political supervisors will allow such policies, once the programme becomes publicized. The danger is that the programme could be disrupted because of political pressure. 2.2.1.6 Time frame for the pilot experiment before considering scaling up within the institution Most successful MFIs have learned the elements that are critical to their success through trial and error. State-owned banks should follow a process of experimentation, adjustment and repeated trials before launching microfinance services system-wide. This means that the bank should allow the microfinance programme at least two, if not three, years of operation for design, testing, adjusting and re-testing, before considering large-scale implementation. 2.2.1.7 Conclusion Finally, the successful introduction of microfinance technology and capacity within a state-owned bank may have a major impact in terms of increasing access to financial services for poor people in rural areas. Bank Rakyat Indonesia changed from an inefficient state-owned bank in 1983-84 to a national network of village units that services millions of clients in rural areas. Other programmes, including the Bank for Agriculture and Agricultural Cooperatives in Thailand, and, more recently, Banco do Nordeste in Brazil, are also displaying very strong potential. However, experience shows that only a very small minority of state-owned banks may be ready to experiment with microfinance and rural finance on basis discussed above. Establishing a priori very clear and strict criteria, based on the above considerations, should be seen as a prerequisite by IFAD before considering any such programme. Otherwise, there is a real danger that IFAD could duplicate past flaws in its programmes with state-owned banks, and repeat past mistakes. 2.2.2 The state-owned bank acts as a financial intermediary In other contexts, IFAD might consider working with state-owned banks on a wholesale basis alone, and avoid involving them as financial retailers. This could be a valid approach when:
However, caution should be used in reviewing this refinancing need, and the following factors should be taken into account:
Specific issues will need to be taken into account when considering such refinancing. For example, the pricing of loan capital should be higher than the cost for the MFI to mobilize savings (interest rate plus related administrative costs). Also, a major increase in the MFI loan portfolio (as a consequence of external funding) may tip the MFI’s governance in favour of borrowers against savers: the potential consequence of this evolution will also need to be carefully monitored. Many savings-based institutions have been badly damaged, and sometimes destroyed in their structure and operations, by the massive injection of external capital from donors. IFAD’s potential role within such an approach could be to strengthen the understanding and trust between the two institutions. This can be achieved by providing technical assistance and training, preparing market surveys, assisting in the preparation of business plans, and providing some limited resources – seed money as a loan or small grant – at the initiation of the partnership. 2.3 Internet Resources for Further Reading
3. The role of participation in rural finance operations 3.1 Participation modes
Client participation contributes to RFI sustainability by:
While client participation and support to the RFI is crucial to its ultimate success, there are certain drawbacks inherent in such participation, which can negatively affect both the RFI itself and the clients themselves. These drawbacks include:
Hence, promotion of participation should be addressed within the larger context of good governance, in order to ensure appropriate supervision of RFI management and operations, and help preclude the development of negative aspects of participation. 3.3 Promoting Suitable Participation that Strengthens Rural Finance Institutional Sustainability In IFAD’s rural finance programmes, focus should be placed on promoting client participation, while taking into account client interest in, and ability to benefit from, such participation. One should keep in mind that sustainable access to financial services, both credit and savings, that are designed specifically to meet their needs is very often a primary objective for those clients, an objective that participation should help to achieve. That being said, the degree of participation will depend on the:
The type and scope of participation should always be adapted to each specific situation, to the capacity and will of local actors, and to the institutional setting of rural finance partners (CU, financial NGO, non-bank financial institution, etc.). Regardless of the context and system chosen, client participation in defining products and financial services always seems to be both feasible and desirable as it ensures that supply closely matches demand, and that products will be adjusted to clients’ potential and constraints. Client participation in management should only be envisaged when it corresponds to an expressed desire (for example, request from a farmer organization) and is within the capabilities of the membership to provide. Moreover, it must have the specific aim of limiting the system’s intermediation costs, therefore making it possible to extend outreach to very poor and remote areas. Client participation in equity financing or debt mobilization undeniably increases the sense of ownership and responsibility vis-à-vis the system, and is to be encouraged where and when financially feasible. The debate remains open, however, with regard to the potential problems generated as a result of conflict of interest deriving from clients’ dual roles – as both shareholders and service users – especially if the shareholder role allows them to influence the system’s operational decisions (e.g. interest rates, conditions, modalities). In designing and implementing microfinance programmes, IFAD should always endeavour to optimize the potential provided by the constructive and voluntary participation of beneficiaries. This should help ensure that needs of the target populations are met, while helping prevent the development of any flaw in the sustainability process that could be attributable to artificial and forced participation. The link between participation and empowerment may be further investigated in the context of IFAD rural finance programmes. Empowerment of the poor may be achieved by their participation in operational responsibilities at the local level in certain contexts (very decentralized systems), although such participation might also be seen in other contexts as a constraint, with a high opportunity cost (time, absence of remuneration, etc.). Empowerment can also be strengthened by a sense of ownership in the RFI, thereby ensuring that the RFI is managed for their long-term benefit. This can happen not only with mutualist systems, but also with financial NGOs that have been transformed into licensed institutions. In these cases, part of the equity (from donors) could be transferred to clients, through an appropriate holding structure (such as those used by the Association of Cambodian Local Economic Development Agencies or by the Center for Agriculture and Rural Development in The Philippines). Finally, the empowerment gained through access to appropriate financial services will be reflected in many aspects of local social organization, and through strengthened negotiation capacity vis-à-vis external actors. This aspect of empowerment may be assessed through impact studies, and the AIMS tool proposes a specific instrument for that purpose. 3.4 Internet Resources for Further Reading
4.1 Preconditions for Savings Mobilization Before embarking on savings mobilization, some preconditions should be met concerning the socio-economic environment. These include: overall security in the area; a low and steady inflation rate (to avoid the risk of negative real interest rates being offered on deposits); and a reasonable level of monetization in the economy, thereby permitting savings in monetary instruments. Once the socio-economic preconditions are met, other preconditions need to be considered. These concern the MFI itself and its capacity to mobilize savings safely, including:
Finally, the need for effective supervision from regulatory authorities needs to be assessed.
4.2 Design of Demand-Driven Savings Products Traditionally, group lending methodology implies some form of compulsory savings from the client, while the individual lending methodology requires compulsory savings less frequently. Compulsory savings, when required, are contributed either prior to loan disbursement or subtracted from the loan capital, or as sums deposited on a regular basis after disbursement. Often, 10% of the loan amount is required as mandatory savings and is supposed to guarantee loan repayment. Questions are now being raised about whether, in the long run, compulsory savings serve either the client or the MFI. The compulsory savings approach to savings is not conducive to encouraging a savings habit among clients. They simply consider it as one of the requirements for accessing loans, and not part of their own saving strategy. As they rarely contribute more than the minimum amount required, savings mobilization usually does not progress over time, and such savings are frequently withdrawn at the earliest possible opportunity. Paradoxically, the same clients often continue to save outside the system, either in rotational savings and credit associations (ROSCAs) or in kind, yet saving in kind can be very risky. Experience has shown that it is the mobilization of voluntary savings that can have the strongest impact on the lives of poor people. It is also the best approach for providing the MFI with a significant amount of funds to diversify its resources, and contribute to financial sustainability. To mobilize voluntary savings, however, the MFI has to design products that fit client demands. In order to design attractive savings products, the MFI will need to:
Typically, a savings product designed to meet client satisfaction will reflect:
Poor clients are usually not very sensitive to interest rate incentives, especially in places where alternative savings services are not available to this segment of clientele. Some informal savings systems actually charge clients for the services they offer, since clients value security over earnings. Nevertheless, there may be some trade-offs between safety, flexibility and accessibility when operating in a very decentralized situation, especially when there are no banks nearby in which MFIs can deposit their extra liquidity. In these cases, the MFI may choose to offer a less flexible product (term-deposit, for instance), which is easier to manage and may be partially transformed into loans locally, in order to avoid a surplus of cash in local safes at certain periods of the year (e.g. harvest time). 4.3 Implication of Savings Mobilization: Recommendations for IFAD Supporting RFIs to mobilize deposits carries high risks and is a serious matter. The donor doing so assumes at least a moral responsibility of assuring the poor that their savings are secure. This gives IFAD a moral obligation to verify that the RFIs it supports have the necessary managerial and technical skills to operate effectively, and also to meet the criteria mentioned earlier, such as in Section 4.1. Hence, RFIs need to be carefully selected and assessed before entering into partnership with them. Few donors are equipped to support savings mobilization initiatives. In comparison with supporting credit programmes alone, savings mobilization requires closer and more intensive monitoring, together with understanding of a set of entirely different dynamics. Consequently, donors involved in supporting savings mobilization should have both the structure and the capacity to:
Regarding possible entry points for supporting savings mobilization, IFAD’s involvement might imply active intervention in several areas.
4.4 Remittances In some disadvantaged areas, emigration remittances are a major source of income for households. There are both seasonal emigration patterns, to nearby regions and towns, and the more long-term emigration to foreign countries. Transfer back home of money from long-term emigrants is a very valuable financial service and it can add up, in many cases, to a large volume and number of transactions. In countries where banks are present in all major towns, transfers can be made effectively, even if at a high cost. In countries where banks are concentrated in the capital cities and postal banks are not operational, there are no such services to meet the needs of emigrants, who want to send their money back home while avoiding excessive transfer costs to families. For those MFIs operating in remote rural areas, this represents a very meaningful and lucrative market if they can establish an attractive transfer service for emigrants. It represents a way to attract new rural clients, and will encourage the development of new savings products for this category of wage earners and their families. Additionally, it will boost and diversify the sources of revenue for the institution through service charges while contributing to the economic development of poor rural areas by converting local-external resources into productive investment in the local economy. Providing appropriate solutions for this demand is definitely a major challenge for RFIs operating in poor regions everywhere. However, with a creative approach – possibly including partnerships with banks in the various countries, local transfer mechanisms, and specially designed long-term savings products – the remittances from emigrants can have a substantial impact on the underlying performance of the RFIs and their clients. While the benefits to both the RFI and the client base can be substantial, the risks and requirements associated with handling this service must be very carefully assessed before an RFI enters this market, addressing legal status, security and transport of funds, management and staff capacity, internal control, MIS, etc. 4.5 Internet Resources for Further Reading
5. How far can IFAD extend the frontier of its Rural Finance interventions in rural areas?
It is very difficult to generalize with regard to the conditions necessary for sustainability in remote rural areas because microfinance promoters maximize their chances of success on a case-by-case basis. They do this by judiciously combining the various local factors that have been identified for reducing costs and increasing revenues, while maintaining reliable, high-quality operating systems. So as to minimize the recurrent costs associated with the constraints faced in remote areas, innovations are crucial in order for RFIs to achieve sustainability. Based on experience, a number of practical recommendations can be drawn up regarding (i) minimum conditions required for a successful rural finance intervention, as evaluated in prefeasibility studies; (ii) adaptability of services, defined in feasibility studies; and (iii) innovations to be promoted with action-research programmes. 5.1 How Can IFAD Assess the Minimum Conditions Required to Justify Rural Finance Interventions? What Are the Main Constraints Facing Rural Finance in Remote Rural Areas? 5.1.1 General prerequisites for microfinance There are some general prerequisites for implementing microfinance programmes in any given country. These include basic political and macroeconomic stability (absence of very high inflation); basic security (enabling relatively safe transportation and use of funds); a minimum degree of monetization of the local economy; and a minimum population density to support a viable RFI. The feasibility of any rural finance intervention should be carefully assessed in the light of the presence or absence of the above preconditions. In that context, the decision to fund a rural finance intervention should be based on a clear prospect for the rural finance partner to be able to reach – within the agreed time frame – the twin objectives of outreach and sustainability. 5.1.2 The main constraints for microfinance in remote and disadvantaged areas There are typically four main constraints.
5.1.3 Analysis of geographical and economic conditions Microfinance clearly is not the solution to problems in areas where monetary transactions are scarce and where access to capital is not an appropriate response to people’s most urgent needs. Three types of surveys should help provide a better understanding of the issues involved:
5.1.4 Social and cultural conditions In poor and isolated areas, social mobilization and well-respected cultural values can be drawn upon to minimize costs and accelerate implementation. It is essential, therefore, to accurately identify the social and cultural assets of an area at the outset, implying:
In order to assess these cultural assets, in-depth studies need to be conducted at village and group levels.
5.2 How Can Rural Finance Institutions Adapt their Operations to Reach their Target Client Groups in Remote Rural Areas? In remote areas, not all approaches necessarily produce convincing and sustainable results. Various components influence the success or otherwise of a rural finance programme, and therefore need to be decided upon on an individual basis. 5.2.1 Methodology It is strongly recommended that, at some stage, future and potential clients become involved in selecting the methodology to be utilized, at least in order to be sure that it suits their needs and is capable of providing the clients with the appropriate services. Experience has shown that, in these types of remote contexts, MFIs need to:
5.2.2 Selecting the right rural finance institution operator, and designing an appropriate partnership The success of overall rural finance operations calls for a certain level of skills and experience, so that the MFI can manage its affairs and produce innovative ideas with a high degree of confidence. It is better to abandon an attempt to create or support a RFI than to launch one in a difficult area with an unqualified partner or operator. Clearly, the rural finance partner should not be chosen solely on the grounds of prior presence in the area, but rather on the basis of convincing results that demonstrate its ability to conduct microfinance activities professionally under such conditions. In the absence of a professional rural finance operator in the area, IFAD will have to find incentives to induce the chosen operator to consider extending activities to the area in question. IFAD should consider assigning the task of conducting the feasibility study to the rural finance partner, so as to build commitment to the programme. This study will serve both to compile information for relevant decision-making, and to establish the contractual basis for partnership. After an appropriate level of review, the study could form the basis of a long-term commitment from both sides. The establishment of mutually agreed performance and activity indicators will provide the basis for evaluating progress towards the sustainability objectives. 5.2.3 Resources to be made available In remote and vulnerable regions, the progress of rural finance programmes from start-up to full sustainability can take ten years or more. In certain circumstances, where positive factors compensate for other shortcomings, this process may take eight years. The need to spread support over two programme phases should be anticipated, with care taken to ensure that there is no interruption between phases. The expected duration should be incorporated in a ‘generic contract’ even if administrative procedures do not allow donors to commit financially beyond a certain statutory period. Investing in remote areas also requires larger financial outlays. Additional training needs to be provided, while more time is needed for developing tools and approaches suited to the environment. Moreover, the equipment and hardware need to be sturdier in order to withstand the more challenging climatic and environmental conditions. A posteriori calculations by CIDR show that the cost of establishing a rural finance network in a remote area is likely to be about 80% higher than establishing such a network in more accessible regions. Donors can play a major role in supporting the establishment of such RFIs by setting up appropriate financial tools to provide longer-term support, such as the “funds for securing loans that can be transformed into capitalization funds” approach developed by Appui au développement autonome – a Luxembourg-based NGO with the Réseau des caisses populaires de Burkina Faso network, and described by Adams (1998) in La garantie bancaire dans le contexte des caisses populaires et des caisses villageoises au Burkina-Faso. 5.2.4 Services to reach target groups in remote rural areas Diversifying services and financial products helps RFIs to spread their risk while serving a broader range of clients in the target group. Diversification can be obtained by some combination of:
Such diversification, however, necessitates changes in operating procedures and, often, improvement in the agents’ ability to analyse risk. Hence, any diversification strategy must be supported by appropriate staff training. An important step in this process is pilot testing of financial services before rolling them out on a larger scale. This should help ensure that they are well suited to the requirements of the RFI client base, as well as to the RFI itself. Savings are likely to be particularly important in rural areas and so the associated demand for savings-related services should be carefully assessed, as discussed later, in Section 12. 5.3 Innovations Rural Finance Institutions Might Consider for Interventions in Remote Rural Areas to be Sustainable The are three major areas of innovation that can be explored by RFIs seeking to reach sustainability in remote rural areas, namely outreach mechanisms, management, and governance. These are briefly analysed below. 5.3.1 Outreach mechanisms
5.3.2 Management
5.4 Internet Resources for Further Reading
6. Balancing the pros and cons: providing loan capital versus funding capacity building and technical assistance
The appropriate balance between, on the one hand, institutional strengthening and technical assistance and, on the other, loan capital, should also be defined in the context of building strong partnerships with RFIs, whereby IFAD’s support mix would be provided based on the RFIs’ own development plans, and would reflect their commitment to meet mutually agreed minimum performance benchmarks. IFAD support should also reflect, whenever possible, close donor partnerships, where each party would seek to maximize the impact of their respective intervention, such as the ability of bilateral donors to provide grant funding to support rural finance institutional strengthening. 6.1 Microfinance institution needs according to maturity The general phases of development for most MFIs are start up; growth; and maturity and institutionalization. The needs of MFIs vary, though, at each stage and according to their level of maturity and development. These phases and the types of assistance required are discussed below. 6.1.1 Start-up phase During their early years, MFIs need grants, above all, so as to be able to build their capacities, develop their organizations, perfect their products and services, and install the tools and functions required for efficient operation. Even if they mobilize client savings, they usually also need capital – in the form of grant funds or loans at low rates – to strengthen their loan resources. At this stage, however, specialized technical assistance is the decisive factor in providing young structures with the basic knowledge they need for sustainable growth. 6.1.2 Growth phase During the growth period, MFIs extend their outreach, widen their geographical coverage, and increase their transaction volumes. Grants become crucial for developing and equipping new branch offices, training new agents, and acquiring the appropriate MIS technology. Since the MFI is not able to cover its full operating costs through the income generated by its portfolio, subsidies to cover these costs are still very much justified. Loan capital requirements are considerable during this stage, and may be fulfilled in different ways. Some MFIs may fund most of their growth by mobilizing savings (e.g. CUs), or may need to combine internal and external resources. In this case, access to external capital should be facilitated while taking into account (i) its impact on the MFI’s strategy to mobilize savings, (ii) its cost and impact on MFI profitability, and (iii) the long-term funding of the MFI loan portfolio. Point (iii) raises the following issue: If loan capital is provided from donor funding (or from a subsidiary loan agreement between the government and the MFI, in the case of IFAD), then the availability of such funding in the long term needs to be assessed. The repayment schedule of the subsidiary loan from the MFI to the government must be harmonized with the mobilization of alternative resources (through equity, savings or other sources) in order to avoid disruption in the funding of the loan portfolio. A powerful incentive would be to transform a government subsidiary loan into equity, based on the MFI’s ability to meet minimum performance standards, such as in terms of client outreach, portfolio quality and operational self sufficiency. This equity would be subscribed in the name of local stakeholders (clients, or MFI staff, for example), as a way to strengthen local ownership, and should obviously not be used to increase government equity participation in the MFI. During this growth phase, some MFIs may become sufficiently strong to start accessing loan capital from banks on a commercial basis. This scenario may require support from donors (or specialized entities) in the form of guarantees, to facilitate refinancing relationships between commercial banks and the MFIs. However, this approach needs to be considered with caution, since overall donor experience with guarantee funds has been rather negative, as it can encourage moral hazard on the part of the lending banks. 6.1.3 Maturity and institutionalization phase At the institutionalization stage, the MFI has achieved the necessary economies of scale for long-term sustainability, and has developed a successful business model. At this stage, institution-building support is a fundamental intellectual input to guide its choices, upgrade procedures, adopt the most appropriate legal vehicle, review its overall internal organization, and to prepare for transformation. This transformation may require strengthening the MFI equity base by bringing in new shareholders or investors, who also could provide additional technical expertise. At this stage, dependence on donor loan capital should end, since the newly matured MFI has the possibility of raising financial resources in the local financial markets (debt or equity), or through deposit mobilization. Overall, keeping the right balance between funding capacity building and the provision of loan capital is a great challenge, especially for IFAD, whose principal funding instrument has been long-term lending to governments. The ideal option would be to maintain a certain flexibility in supporting an MFI, without strict earmarking of funds towards capacity building and loan capital, but rather to identify several minimum performance criteria that will condition continuation of support from IFAD to this MFI. The inclination for governments to use IFAD resources for extending loans to MFIs for on-lending (as opposed to providing technical assistance) is real and may be understandable. However, this approach should be challenged, by emphasizing the following arguments:
6.2 What Does Capacity Building Include? Capacity building and institutional strengthening can comprise several forms of support, covering human resources development, operations, methodologies and product development. 6.2.1 Human resources
6.2.3 Methodologies and tools
6.2.4 Product development
6.3 Appropriate Technical Assistance and Skill Transfer Contracts Each stage of MFI development necessitates a differentiated approach to capacity building, but such support and advice should not be provided by generalists, and even less so by local, non-specialized NGOs. Reliance on short, generalist visits with no continuity is likely to increase confusion about focus, accumulate incoherent tools, and retard progress towards growth and institutionalization. In that context, IFAD should make use of specialized and experienced technical assistance whose expertise is proven and acknowledged internationally. Technical assistance may be provided either by a specialized consultant through short field visits, or by the long-term local presence of a technical adviser. The consultant or adviser might be hired by IFAD directly, or work for a specialized organization (consulting firm, specialized NGO), or they could be external contractual operators hired for the development of a new rural finance network. Finally, use could also be made of in-house advisors from an existing RFI or bank who can provide the additional skills needed for the development of the structure. Faced with the challenge of helping to build new rural finance networks or strengthen local or nationwide RFIs, IFAD may need to recruit a national, regional or international rural finance partner (operator) to assume local responsibility. In this situation, it is important to set the right selection framework to attract the best expertise, and make the rural finance partner accountable for the results. Where tendering is used for such recruitment, the following framework of a request for proposals could be used – adapted as needed – for selecting potential applicants. Such a request for proposals needs to address both technical and financial dimensions. The technical proposal submitted by applicants should include:
In order to rank the proposals for final selection, a scoring methodology might be used. On the basis of a scale of 100 points, each proposal could be evaluated as follows, although the number of points given in the example below are illustrative, and are intended to illustrate how the relative weight and importance of each section may be defined when reviewing a proposal:
In addition to the above-mentioned scoring approach, the financial effectiveness of the proposal should be evaluated. In order to introduce incentives for cost-effectiveness, proposals should also be ranked financially, but experience has shown that it is advisable to give more weight to the quality of the technical proposal presented, rather than simple cost. What should be carefully assessed in that context is the volume of total assets planned at programme conclusion (loan portfolio, number of staff trained, physical rural finance infrastructure set up) as well as the loan portfolio quality, the programme efficiency (portfolio per loan officer, etc.) and the range of services provided. These are compared to the cost of the proposal. The loan portfolio projections, however, need to be treated with strong caution, as requests for proposals may project results that are unrealistic given the known operating environment, in order to render the proposal more attractive. The financial proposal may account for 30% of final grading, while the technical proposal may count for 70%. All applications from entities that do not have experience as microfinance operators or practitioners, or that have not developed specialized microfinance departments, should be excluded. In order to avoid prolonged technical assistance due to insufficient transfer of skills to local stakeholders, the transfer stages and indicators should be contractually binding and monitored. 6.4 How to Address Different Country Perceptions Regarding the Need to Fund Capacity Building In some countries, governments clearly recognize a very strong need for MFI capacity building, and may be ready to allocate a large part of their rural finance programme budgets to fund both capacity building and technical assistance. In these cases, IFAD could launch its projects and programmes to interdigitate with and complement the local thrusts. In other countries, however, governments may hesitate to allocate substantial resources to capacity building, especially when they fund their rural finance programmes through donor loans. In such cases, IFAD may want to condition the commitment of its resources to its ability to mobilize additional grant funds from other donors to cover the capacity building and technical assistance needs of recipient RFIs. 6.5 Internet Resources for Further Reading
7. Policy issues Policy issues relating to rural finance are of major importance to IFAD, for many reasons:
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Contrary
to preconceived notions, microfinance, in all its diversity, already contributes
substantially to the financing of agricultural activities (see 
IFAD’s
experiences with state-owned banks with a mandate as commercial and agricultural
development banks differ among the various regions. The Fund has moved
away from state-owned banks in Eastern and Western Africa because of poor
project performance and the closing of most of these institutions. In
state-controlled environments, such as China, state-owned banks remain
major partners within the rural context, where there is little alternative.
In North Africa, the Near East and Latin America, cooperation still exists,
but is progressively declining. 
Participation,
in the present context, usually refers to client involvement in the operation
of RFIs at various levels of intensity and complexity, according to the
type of model under consideration, and so client participation usually
falls into one of four forms.
Recent
research has confirmed that savings are key financial services for the
poor in general, and for the rural poor in particular. In this regard,
both researchers and practitioners have specifically noted that:
This
section draws largely on a 1999 study commissioned by the United Nations
Capital Development Programme from the International Centre for Development
and Research (CIDR) on How to push the frontiers of microfinance into
remote rural areas.
For
a considerable period, IFAD’s lines of credit for the rural poor
focused on financing agricultural production and purchasing capital equipment.
These lines of credit were channelled through banks or through integrated
rural development projects. The repayment rates and social impact of those
instruments have been very mixed, causing the Fund to revise its approach.
Today, IFAD places more emphasis on strengthening the capacities of autonomous
MFIs in rural areas and, hence, faces the challenge of adjusting its financial
tools accordingly. This change of tack begs the question of what are the
needs at each stage of the MFI’s development cycle regarding institutional
strengthening and loan capital, and what portions of programme budgets
might be envisaged for each type of support.