WORLD BANK TECHNICAL PAPER NO.

499
Europe and Central Asia Environmentally and Socially Sustainable
Development Series

Financial Markets,
Credit Constraints,
and Investment
in Rural Romania

Rodrigo A. Chaves
Susana Sanchez
Saul Schor
Emil Tesliuc
The World Bank
Washington, D.C.
Copyright © 2001
The International Bank for Reconstruction
and Development/THE WORLD BANK
1818 H Street, N.W.
Washington, D.C. 20433, U.S.A.

All rights reserved

Manufactured in the United States of America
First printing April 2001
1 2 3 4 04 03 02 01

Technical Papers are published to communicate the results of the Bank's work to the development
community with the least possible delay. The typescript of this paper therefore has not been prepared in
accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no
responsibility for errors. Some sources cited in this paper may be informal documents that are not
readily available.
The findings, interpretations, and conclusions expressed in this paper are entirely those of the
author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations,
or to members of its Board of Executive Directors or the countries they represent. The World Bank does
not guarantee the accuracy of the data included in this publication and accepts no responsibility for any
consequence of their use. The boundaries, colors, denominations, and other information shown on any
map in this volume do not imply on the part of the World Bank Group any judgment on the legal status
of any territory or the endorsement or acceptance of such boundaries.
The material in this publication is copyrighted. The World Bank encourages dissemination of its
work and will normally grant permission promptly.
Permission to photocopy items for internal or personal use, for the internal or personal use of
specific clients, or for educational classroom use, is granted by the World Bank, provided that the
appropriate fee is paid directly to Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA
01923, U.S.A., telephone 978-750-8400, fax 978-750-4470. Please contact the Copyright Clearance Center
before photocopying items.
For permission to reprint individual articles or chapters, please fax your request with complete
information to the Republication Department, Copyright Clearance Center, fax 978-750-4470.
All other queries on rights and licenses should be addressed to the World Bank at the address above
or faxed to 202-522-2422.

ISBN: 0-8213-4928-7
ISSN: 0253-7494

Rodrigo A. Chaves is a lead financial economist in the Europe and Central Asia Region at the World
Bank. Susana Sanchez is a financial specialist in the Latin America and the Caribbean Region at the
World Bank. Saul Schor is an operations analyst in the Europe and Central Asia Region at the World
Bank. Emil Tesliuc is an economist in the Europe and Central Asia Region at the World Bank.

Library of Congress Cataloging-in-Publication Data

.
Financial markets, credit constraints, and investment in rural Romania / Rodrigo Chaves --- [et al.]
p. cm. — (World Bank technical paper ; no. 499. Europe and Central Asia environmentally
and socially sustainable development series)
Includes bibliographical references.
ISBN 0-8213-4928-7
1. Rural credit—Romania. 2. Financial institutions—Romania. 3. Investments—Romania.
I. Chaves, Rodrigo, 1961- II. World Bank. III. World Bank technical paper. Europe and Central Asia
environmentally and socially sustainable rural development series.
HG3729.R62 F56 2001
332.7’0948’091734—dc21 2001023605
CIP
 iii

Contents
Foreword..................................................................................................................................vi

Abstract...................................................................................................................................vii

Acknowledgements ................................................................................................................viii

Currency Equivalents..............................................................................................................ix

Abbreviations and Acronyms..................................................................................................ix

Executive Summary and Introduction..................................................................................... x

A. Executive Summary .......................................................................................................... x
B. Specific Objectives, Methodology, and Data ................................................................ xxxi
C. Organization of the Study ........................................................................................... xxxiv
Chapter I: The Rural Economy and its Economic Agents ..................................................... 1
A. The Rural Economy within the Aggregate Economy ......................................................... 1
B. Agricultural Sector Policies During the Transition............................................................. 3
C. Rural Employment ............................................................................................................ 4
D. Rural Households and their Economic Activities ............................................................... 5
E. Rural Enterprises ............................................................................................................... 8
Chapter II: Rural Financial Intermediaries, Market Shares, Credit Products, and Deposit
Services.................................................................................................................................... 13
A. The Financial Sector........................................................................................................ 13
B. The Banking Sub-Sector.................................................................................................. 14
C. Mutual Rural Financial Intermediaries............................................................................. 18
D. Distribution Network of Financial Services ..................................................................... 19
E. Market Shares in Rural Financial Markets ....................................................................... 23
F. Distribution of the Flow of Credit Among Borrowers and Lender Preferences ................. 25
G. Characteristics of Credit Products.................................................................................... 26
H. Participation of Rural Enterprises and Households in Financial Markets as Depositors and
Savers ................................................................................................................................... 32
Chapter III: Limited Access to Loans: Weak Supply of and Weak Demand for Loans..... 35
A. Participation of Economic Agents in the Market for Loans.............................................. 35
B. Weak Supply of Credit .................................................................................................... 36
C. The Demand for Loans: An Econometric Model............................................................. 48
Chapter IV: Credit Constraints and Rural Investment ....................................................... 55
A. The Extent of Credit Constraints in the Rural Sector ....................................................... 55
B. Credit Constraints at the Level of Rural Households........................................................ 57
iv

C. Credit Constraints at the Level of Rural Enterprises......................................................... 58

D. Investment Levels: Is It Where You Are and What You Have or What You Do With It? 64
Chapter V: Policy Options and Possible World Bank Support ........................................... 78
A. General Strategy and Emphasis ....................................................................................... 78
B. Government Credit Lines ................................................................................................ 79
C. Improving the Legal and Institutional Environment for Financial Transactions................ 82
D. Improving the Legal and Institutional Environment for Using Land as Collateral ............ 84
E. Retail Lending ................................................................................................................. 86
F. Regulatory Concerns Regarding Chartered Non-Bank Mutual Financial Intermediaries ... 88
G. Market Development, Balanced Rural Development, and Privatization ........................... 92
H. Policy Coordination ........................................................................................................ 92
References ............................................................................................................................... 95

List of Tables

Table 1 Consolidated Financial Performance of Rural Enterprises in 1997............................... 11

Table 2 Consolidated Financial Performance of Rural Enterprises in 1997 (Adjusted by
Inflation)................................................................................................................................... 12
Table 3 Composition of the Romanian Banking Sector, 1996-2000.......................................... 16
Table 4 Non-performing Loans, Provisions, and Capital Adequacy Ratio (1996-2000) ............ 17
Table 5 Consolidated Loans, Deposits, and Loan-to-Deposit Ratios by Agro-region and
Population ................................................................................................................................ 22
Table 6 Market Shares of Credit Products ................................................................................ 23
Table 7 Distribution of Loan Amount Disbursed to Rural Enterprises by Type of Lender ........ 25
Table 8 Use of Loans by Type of Lender and Borrower ........................................................... 27
Table 9 Collateral Use by Type of Lender (% of Amount Lent to Households and Enterprises)28
Table 10 Shares of Savings Accounts of Rural Households by Type of Instrument .................. 33
Table 11 Average Amount and Maturity of Deposit Instruments of Rural Households ............. 34
Table 12 Participation in the Market for Cash Loans................................................................ 36
Table 13 Structure of Effective Nominal Interest Rates on Loans for Different Agricultural
Activities according to the 1998 Ordinance on Providing Finance for Crop Planting,
Maintenance, and Harvesting, and for Livestock Raising and Feeding ...................................... 39
Table 14 Demand for Loans by Rural Households (Probit Model) ........................................... 50
Table 15 Demand for Loans by Rural Enterprises (Probit Model) ............................................ 52
Table 16 The Extent of Credit Constraints ............................................................................... 56
Table 17 Rural Households: Credit Constraints (Ordered Probit Model) .................................. 69
Table 18 Rural Households: Supply of Loans by Type of Lender (Multinomial Logit Model).. 70
Table 19 Rural Enterprises: Supply of Loans (Ordered Probit Model)...................................... 71
Table 20 Rural Households: Investment Decision and Investment Outlays............................... 72
Table 21 Rural Households: Effect of Removing Credit Constraints on Investment Decisions
and Investment Opportunities ................................................................................................... 73
Table 22 Rural Households: Investment Decisions for Borrowing and Non-Borrowing
Households ............................................................................................................................... 74
Table 23 Decomposition of Investment Decisions between Borrowing and Non-Borrowing
Rural Households ..................................................................................................................... 74
 v

Table 24 Rural Enterprises: Investment Opportunities and Investment Levels.......................... 75

Table 25 Rural Enterprises: Estimated Effect of Removing Credit Constraints on Investment
Decisions and Investment Levels .............................................................................................. 76
Table 26 Rural Enterprises: Investment Decisions for Borrowing and Non-Borrowing
Enterprises................................................................................................................................ 77
Table 27 Rural Enterprises: Decomposition of Investment Decisions between Borrowing and
Non-Borrowing Enterprises ...................................................................................................... 77
Table 28 Romania: Summary Matrix for a Proposed Transitional Directed Credit Program for
the Rural Sector (2000-2003).................................................................................................... 81

List of Figures

Figure 1 Change in GDP and Agricultural GVA ........................................................................ 1

Figure 2 GDP and Agricultural GVA Growth Rate .................................................................... 2
Figure 3 Rural Households by Farm Size ................................................................................... 7
Figure 4 Credit from Deposit-taking Banks to the Private Sector, 1998 (as percent of GDP) .... 13
Figure 5 Credit to the Private Sector: Transition Economies and Rest of the World, 1998 (as
percent of GDP)........................................................................................................................ 15
Figure 6 Population per Bank Branch....................................................................................... 20
Figure 7 Percentage of Localities with Financial Outlets across Population Brackets ............... 20
Figure 8 Average Speed of Disbursement of Loans by Lender Type ........................................ 29
Figure 9 Repayment Problems on Cash Loans ......................................................................... 30
Figure 10 Percentage of Households with Savings Accounts by Per Capita Income Quartile.... 32
Figure 11 Commercial Lending Interest Rate vs. T-Bill Rate vs. Inflation................................ 37
Figure 12 Investment Decisions by Credit Constraints ............................................................. 60
Figure 13 Romania by Agro-Region ........................................................................................ 94
vi

Foreword

Romanian policy makers are justifiably concerned with the performance of financial
markets in rural areas because these markets have an important impact on rural growth and
poverty. In the absence of sufficient investment capital, the rural economy has experienced
difficulty in adjusting to the major policy reforms of recent years, the aftermath of the exchange
rate crisis of early 1997, and the strong depreciation of the Leu that has occurred since early
1999. These events require rural enterprises and households to adjust factor proportions, modify
output mixes, change their scale of operations, and invest in new technologies. Their success in
this endeavor, which depends on the performance of all factor markets, has been hindered by the
observed poor performance of financial markets.

This report is intended to assist Romanian policy makers as they seek to formulate and
implement a market-based rural sector strategy that aims to render rural areas internationally
competitive with significantly less incidence of poverty through the establishment of effective
private financial markets and intermediaries which will provide access to investment capital and
safe deposit services to all segments of the rural population, especially individual farmers, rural
microentrepreneurs, and small and medium businesses.

The report is the latest addition to a long and growing series of World Bank publications
on the former socialist countries of Europe and Central Asia. The unique features of all these
publications is their reliance on first-hand empirical information collected through extensive
surveys of rural constituencies. Analysis of survey findings enables the World Bank to base its
policy dialogue with governments in the region on empirical fact, rendering the Bank’s
recommendations more credible and relevant. The new findings for Romanian rural financial
markets contained in this report will provide a solid platform for policy discussions with the
Government of Romania and supply the many international donors active in the country with
essential information for the design of their strategic programs.

Laura Tuck
Sector Manager
Environmentally and Socially Sustainable Development
Eastern Europe and Central Asia Region
 vii

Abstract

This report assesses the performance of financial markets in rural areas of Romania based
on three (rural household, rural enterprise, and financial intermediary) surveys carried out in
1998, and on other official statistical data covering 1997. The study finds that rural financial
markets perform rather poorly in three key dimensions, namely: (a) the degree of access to
financial services by rural economic agents (enterprises and households) is very limited; (b) this
limited access hinders the ability of these agents to take advantage of the investment
opportunities available in rural areas; and (c) these markets failed to allocate (very scarce) flows
of credit to those agents with the most profitable investment opportunities. This poor
performance is caused by an unfortunate combination of short term circumstances (including
high and volatile inflation rates), structural factors (such as an inadequate legal and institutional
framework), and government policies and interventions (such as subsidized credit programs for
agriculture). In particular, the degree of access to credit services by rural agents is very low
because several factors have combined to weaken both the supply of and demand for rural credit.
The report presents empirical evidence indicating that this constrained access to credit markets
negatively influences the investment behavior of households and enterprises. The report
suggests a detailed government strategy to correct the observed shortcomings of rural financial
markets and identifies new challenges likely to appear. In particular, the Government could
assist in increasing the availability in rural areas of viable, competitively priced, and untargeted
credit (and deposits) by improving: (a) its own policies and interventions in financial markets;
(b) the legal and institutional environment for financial transactions; and (c) the ability of the
financial sector to provide retail financial services.
viii

Acknowledgements

This report was written by Rodrigo Chaves (Lead Financial Economist, ECSSD), Susana
M. Sánchez (Financial Economist, LCSFP), Saul Schor (Operations Analyst, ECSSD), and Emil
D. Tesliuc (Economist, ECSPF) on the basis of background papers written by Rodrigo Chaves,
Heywood Fleisig (consultant), José Pagán (consultant), Nuria de la Peña (consultant), Susana M.
Sánchez, Saul Schor, and Emil D. Tesliuc. Peer reviewers of this report were J. Luis Guasch
(Sector Manager, LCSFR), Paul Holden (Principal Economist, on leave from the LAC Region),
and Jacob Yaron (Senior Advisor, RDV). The report benefited greatly from the comments of
Marcelo Bueno (consultant), Kevin Cleaver (Sector Director, ECSSD), Farid Dhanji (Lead
Economist, ECSPE), Henry Gordon (Senior Sector Economist, ECSSD), John Kendall
(consultant), Kaled Sheriff (Lead Country Economist, ECSPF), Laura Tuck (Sector Manager,
ECSSD), and Andrew Vorkink (Country Director, ECC05). The National Commission for
Statistics (NCS) contributed significantly to the sample design of the surveys and to the
collection of data used in the report.
 ix

Currency Equivalents
Currency Unit = Leu
US$1 = 8,477 Lei (May 1998)
US$1 = 26,160 Lei (January 2001)

Abbreviations and Acronyms

BIR - International Bank of Religion

CAR - Casa de Ajutor Reciproc
CC - Credit Cooperative
CENTROCOOP - National Cooperative Union
CREDITCOOP - House of Credit Cooperatives
FEDERALCOOP - National Federation of Cooperatives
MOAFF - Ministry of Agriculture, Food and Forestry
MFI - Mutual Financial Intermediary
MOPF - Ministry of Public Finance
NBR - National Bank of Romania
NCS - National Commission of Statistics
SAPARD - Special Accession Program for Rural Development
SFI - Survey of Financial Intermediaries
SRB - Small Regional Bank
SREFS - Survey of Rural Enterprises and Financial Services
SRHFS - Survey of Rural Households and Financial Services
TFI - Technology of Financial Intermediation
UNCAR - Uniunea Nationala a Caselor de Ajutor Reciproc
 Executive Summary and Introduction
A. EXECUTIVE SUMMARY

The Key Findings

This study assesses the performance of financial markets in rural areas of Romania based
on three (rural household, rural enterprise, and financial intermediary) surveys carried out in
1998, and on other official statistical data covering 1997.1 The performance of these markets is
evaluated in the following dimensions: (a) the degree of access to financial services by rural
economic agents (enterprises and households); (b) the influence of this access (or lack thereof)
on the ability of these agents to take advantage of the investment opportunities available in rural
areas; and (c) the effectiveness of financial markets in allocating (very scarce) flows of credit to
those agents with the most profitable investment opportunities.

The study finds that rural financial markets perform rather poorly in each of these
dimensions and that this poor performance is caused by an unfortunate combination of short term
circumstances (including high and volatile inflation rates), structural factors (such as an
inadequate legal and institutional framework), and government policies and interventions (such
as subsidized credit programs for agriculture).

In particular, the degree of access to credit services by rural agents is very low because
several factors have combined to weaken both the supply of and demand for rural credit. Lenders
avoid rural credit and comparatively few rural agents demand credit (Chapter III). The net result
was that about 80 percent of rural enterprises and 80 percent of rural households did not incur
any form of debt (loans or suppliers’ credit) from formal or informal lenders during the period
covered by the surveys which form the basis of this study (see page xxxi for a description of
these surveys). The incidence of borrowing from the banking sector was particularly low as only
one percent of households and 14 percent of enterprises borrowed from commercial banks. These
enterprises and households operated in all sub-sectors of the rural economy, including
agriculture, industry, trade, and services.

The study presents empirical evidence indicating that constrained access to credit markets
negatively influences the investment behavior of households and enterprises. The presence of

1 The definition of “rural” used in this study corresponds to the legal definition used in Romania, which is an

administrative definition. In this sense, the rural areas are comprised of all localities which have not attained the
status of “urban.” A law is required to grant urban status to a locality. This somewhat arbitrary convention implies
that it is possible to find urban localities with, say, 10,000 inhabitants while some rural localities have up to 80,000
inhabitants. In practice, rural areas are comprised of the entire country minus 200 (mostly large) localities which
have been granted urban status by legislative action. References throughout the report to households and enterprises
should be understood as rural households and rural enterprises. The report’s empirical findings are based on
statistically representative surveys of rural households and enterprises conducted in late spring of 1998 as well as on
disaggregated data on the country’s banking sector covering 1997. Thus, the figures contained in the report
correspond to those years, unless otherwise indicated. The data sources are fully described below.
Finanacial Markets, Credit Constraints, and Investment in Rural Romania xi

such constraints reduces both the number of agents that invested and the amounts they invested.
The effect is especially negative at the enterprise level. The bottom line is that profitable
investment opportunities are not pursued because of limited access to credit markets. This
situation is detrimental because these forgone investment opportunities are among the very few
available in rural Romania, an environment not particularly conducive to productive investments
anyway.

Financial markets fail to allocate credit to the best alternative uses within the rural
economy. Lenders allocate significant portions of rural credit to enterprises (as opposed to
households) which experience negative net incomes (losses) and which have negative gross cash
flows. About a third of all credit went to enterprises with negative profits and about 40 percent to
enterprises with negative cash flows during the period covered by the surveys. A related and
worrisome finding is that rural enterprises that borrow are not able, in the aggregate, to service
their existing debt (see chapter III section B). Moreover, the agricultural and services sub-
sectors need to incur additional debt to service interest payments and amortize the principal
amount of their outstanding loans. State-owned enterprises contribute most to this situation in
that the negative balances on their consolidated cash flow is large enough to wipe out the net
cash surplus generated by the private sector.

Romanian policy makers are justifiably concerned with this poor performance of rural
financial markets because it has had a negative impact on rural growth and poverty. In the
absence of sufficient investment capital, the rural economy has experienced difficulty in
adjusting to the major policy reforms of recent years, the aftermath of the exchange rate crisis of
early 1997, and the strong depreciation of the Leu that has occurred since early 1999. These
events require rural enterprises to adjust factor proportions, modify output mixes, change their
scale of operations, and invest in new technologies. Their success in this endeavor, which
depends on the performance of all factor markets, has been hindered by the observed poor
performance of financial markets.

Finally, Romanian rural agents have been, and will continue to be, at a disadvantage when
competing with counterparts in European Union countries and the United States where rural
enterprises and households have much better access to far superior financial services. Clearly,
these problems are not limited to the rural economy. All sectors are likely suffering similar
problems because the impediments to efficient financial intermediation identified in this study
are common to all financial transactions, regardless of economic sector.

The study suggests a detailed government strategy to correct the observed shortcomings of
rural financial markets and identifies new challenges likely to appear (Chapter V). In particular,
the Government could assist in increasing the availability in rural areas of viable, competitively
priced, and untargeted credit (and deposits) by improving: (a) its own policies and interventions
in financial markets; (b) the legal and institutional environment for financial transactions; and (c)
the ability of the financial sector to provide retail financial services. These three elements should
be the core of the short term strategy because they would augment the supply of credit by
reducing credit risk and the transaction costs of rural lending.

The empirical findings of the study provide strong support for policies aimed at: (a)
integrating households into markets and allowing consolidation of land holdings; (b) formulating
xii Executive Summary and Introduction

balanced rural development policies (in contrast to focussing on agriculture only); (c) privatizing
state enterprises; and (d) privatizing state banks. These findings show that household investment
opportunities are positively associated with the degree of connection to markets. Further,
enterprises more likely to invest are, everything else the same, in sectors other than agriculture
and are totally private. Finally, private banks are more amenable to financing productive
investments than are their state-owned counterparts.

The next generation of public policy relevant issues on rural finance will likely include two
additional elements. (Chapter V provides detailed policy recommendations to deal with them.)
The first element will be a likely reduction of the network of bank branches. This reduction may
result from the expected privatization or divestiture of the state banks which owned 87 percent of
all bank branches. The presence of a network of retail finance will be required to allow for the
large redeployment of resources that need to occur for the rural economy to adjust to the policy
reforms of the recent years.

The second element will be the provision of an appropriate regulatory framework for the
estimated 1,400 independent mutual financial intermediaries registered under Law 109/1996. A
majority of these intermediaries are domiciled in rural areas. The reasons for concern are that the
Government may have assumed important contingent liabilities by chartering them, and that they
may constitute a regulatory hazard because they can be used to profitably avoid banking sector
prudential regulations. The vacuum that may be left by a retiring state banking sector introduces
the risk that these unregulated intermediaries will increase their share of deposits. The three
state-owned banks expected to be privatized soon held 80 percent of the deposits of the rural
population during the period covered by the surveys.

The remainder of this executive summary puts rural financial markets in the context of the
rural economy and provides the empirical evidence supporting the above conclusions. The
summary follows the same sequence of the five chapters included in the main body of the study.
The last two sections of the Executive Summary and Introduction describe the statistical and
econometric analyses of the data collected in the three surveys conducted specifically for the
study. Chapter I examines the Romanian rural economy and provides a profile of economic
agents in rural areas and the context in which rural financial intermediaries operate. Chapter II
describes financial intermediaries, their market shares, and their financial products in rural areas.
Chapter III examines the roles of demand and supply factors in explaining the limited use of
credit services. Chapter IV measures empirically the influence of credit constraints on the
investment strategies of households and enterprises. Finally, Chapter V draws conclusions and
specific policy recommendations to improve the performance of financial markets in rural areas.

The Rural Economy and its Economic Agents

Rural areas are important within the Romanian economy. More than half of total
employment and roughly a fifth of all incorporated business are domiciled there. The sector is a
dual economy in that a formal sector coexists with a large informal economy. The formal sector
consists of about 80,000 incorporated businesses, most of which were created after the fall of the
centrally planned regime. The informal sector consists mainly of small-scale, subsistence-based
farm households which conduct a handful of other informal business activities. The economy of
Finanacial Markets, Credit Constraints, and Investment in Rural Romania xiii

these rural households is highly autarchic, is based on low-input production technology, and is
largely directed towards self-consumption.

Rural households. Most rural households operate with limited integration into market
activities and primarily engage in agricultural activities. About 61 percent of rural households
were self-sufficient farm households, during the period covered by the surveys, in that they did
not: (a) sell any outputs; (b) buy any inputs; (c) hire labor; or (d) rent or buy fixed assets.
Seventeen (17) percent had some marginal involvement in markets (less than US$20 of monthly
sales), 12 percent had substantial market involvement, five percent had non-farm entrepreneurial
activities, and the remaining five percent relied entirely on wages and pension benefits.

Farm households. Most farms are small and fragmented. The average farm had 2.1
hectares during the period covered by the surveys, and was subdivided into 3 or 4 plots. In fact,
35 percent of households operated more than four farming plots. About a fifth of all households
operated a portion of their landholdings through family associations (17 percent) and very few
through agricultural associations (4 percent).

Non-farm households. Non-farm entrepreneurial activities are very limited among rural
households. Only five percent of households had members who were entrepreneurs outside
agriculture during the period covered by the surveys. These members accounted for about two
percent of the economically active rural population. Non-farm entrepreneurs had (mostly very
small) businesses in all economic sectors (25 percent in trade, 23 percent in the processing
industry, 21 percent in transportation, 15 percent in construction, and 10 percent in services).
Their business activities tend to be small and informal. In fact: (a) 75 percent employ one or no
workers at all; (b) 75 percent had an endowment of assets in their business of less than
US$1,775; (c) their average monthly income was US$139, which was higher, nevertheless, than
farm entrepreneurs; (d) 40 percent were not registered nor had licenses; and (e) only 27 percent
kept formal accounting records of their activities.

The formal enterprise sector. The rural economy contained about 80,000 enterprises during
the period covered by the surveys.2 The large majority of them were engaged in trade and
commerce (62 percent). Agriculture was the main activity for six percent of them. The remaining
enterprises were evenly divided between the service sector (15 percent) and in industry and
construction (16 percent).

Agriculture was the sub-sector which had the majority of assets (57 percent by book
value). Trade and industry followed with 21 and 18 percent of assets, respectively. The services
sub-sector was the smallest and had the remaining three percent of the consolidated book value
of enterprise assets.

The large majority of rural enterprises (98 percent of them) were in the private sector and
were totally private. These private enterprises were basically small and medium size businesses.

2 This figure includes businesses legally incorporated and which are domiciled in rural areas. It excludes all: (a)
enterprises with operations in rural areas but with headquarters in urban areas and Regies Autonomes; (b) enterprises
not legally incorporated; (c) branch offices of financial institutions, public administration offices; (d) educational
institutions; and (e) health care units. Therefore, some large enterprises which have operations in rural areas but are
domiciled in urban localities were not included in the sampling universe for the study.
xiv Executive Summary and Introduction

In fact, the average private enterprise had US$11,900 of assets at book value and 80 percent of
them had less than 5 employees.

The participation of the state in terms of the value of enterprise assets was very significant,
however, as the two percent of enterprises that had some degree of state ownership controlled
more than half of the aggregate book value of the assets of all rural enterprises. This large
incidence of state ownership is due mostly to the fact that the state partly owned about a fifth of
agricultural businesses and that these agricultural state enterprises were particularly large.
Agricultural state enterprises accounted for about one percent of all rural enterprises but
controlled about 43 percent of their assets.

The aggregate profitability indicators of rural enterprises are rather weak. The aggregate
return on equity (ROE) and return on assets (ROA) of Romania’s rural enterprises in 1997 were
much lower than inflation (18 percent and 9 percent, respectively, against an annual inflation rate
of 155 percent). This poor aggregate performance was mostly caused by the state-owned
enterprises which had a negative ROE of 9 percent and of which 53 percent reported losses. In
contrast, the consolidated ROE of private enterprises was 69 percent and the share of them which
reported losses was 29 percent.3 By sector, agricultural enterprises reported losses while the
remaining sectors generated aggregate profits. The trade sub-sector was by far the most
profitable in terms of ROE.

Cash flow analysis confirms that rural enterprises have, in the aggregate, a profitability
problem. The value of the sales (products and services), during the period covered by the
surveys, of the entire rural enterprise sector was not sufficient to cover production costs and
operational expenses. The state-owned enterprises contributed most to this situation, as their
negative cash flow balances were large enough to wipe out the net cash surpluses generated by
the private sector.

A worrisome implication is that rural enterprises are not able, in the aggregate, to service
their existing debts. Moreover, the agricultural and services sub-sectors need to incur additional
debt to service interest payments and amortize the principal amount of their outstanding debts.
Indeed, banks lent 45 percent of all new credit flows to state enterprises with negative cash flows
during the period covered by the surveys. Again, state enterprises were the primary cause of this
situation. A likely outcome of lending to state enterprises with negative cash flows is that these
loans will have to be assumed by the Government or the banking system. The likelihood of these
enterprises returning to a positive cash flow under state ownership is minimal, and privatizing
them will be difficult while they have a large debt overhang.

Rural Financial Intermediaries and their Market Shares

The banking sub-sector. As of 1998, there were 45 banks licensed by the National Bank of
Romania, of which 35 were open to the public and operating normally, three had their operations

3 The consolidated financial statements of enterprises were adjusted according to International Accounting Standard
(IAS) No. 29 to account for high inflation in the period under analysis. The adjusted financial statements indicate
that the consolidated ROE for rural enterprises was 2.4 percent. Private sector enterprises had a consolidated ROE
of 16 percent while their state-owned counterparts had a ROE of negative six percent.
Finanacial Markets, Credit Constraints, and Investment in Rural Romania xv

effectively suspended by the regulatory authorities pending reorganization or liquidation, and

seven (mostly foreign-owned) were preparing to initiate operations. These banks had about US$
14 billion in assets (123,744 billion lei). The system was dominated by state banks which
accounted for 71 percent of total banking assets and 81 percent of total bank deposits in national
currency.

Mutual financial intermediaries. As of 1998, there were 840 credit cooperatives that were
members of the National Cooperative Union (CENTROCOOP), which operated at the comuna
level with a membership of about 1.8 million farmers, professionals, and self-employed
individuals. These credit cooperatives had about US$92 million in assets (1,000 billion Lei) and
were comparatively small financial intermediaries. The average credit cooperative in Romania
had assets of US$110,000 and 3.5 employees. There were also about 4,600 Casa de Ajutor
Reciprocs (CARs), of which 400 were in rural areas. These are mutual financial organizations
that primarily serve employees of rural enterprises, commercial societies, and state-owned
companies. Finally, it is estimated that there were about 600 independent mutual financial
intermediaries (Banca Populara) for which information was not available.

The distribution network of financial services. Romania possesses an extensive network of

retail financial outlets in both rural and urban areas. As of the period covered by the surveys,
there were 4,076 retail outlets, 3,156 bank branches, and 840 credit cooperatives for which data
were available. this network was also dominated by the state-owned banks, which owned 87
percent of all bank branches in the country. The ownership of the private branches was also
highly concentrated in that two banks owned 86 percent of them.

Who gave rural credit? Financial markets in rural areas are basically segmented. Friends,
relatives, and the semi-formal sector serve households, while the formal financial sector and
suppliers of inputs give credit to rural enterprises. Cash-loan transactions are the most important
credit product available. For households, these loans accounted for 88 percent of the number of
transactions and for 85 percent of the total amount of credit during the period covered by the
surveys. For enterprises, cash loans accounted for 48 percent the of number of transactions and
for 50 percent of the amount.

Romanian rural households rely significantly less than their counterparts in other
developing countries on the informal sector. Commercial credit transactions and forward sales
are a comparatively small source of credit, accounting for 13 percent and 2 percent of the volume
of credit disbursed, respectively during the period covered by the surveys. This scarcity of
commercial credit and forward sales is consistent with households’ low levels of market activity
and lack of linkages with traders. Commercial and supplier credit played an important role
among rural enterprises, accounting for 41 percent of the amount disbursed and 40 percent of the
number of credit transactions.

The banking sector had a three percent share of the number, and a 16 percent share of the
amount, of the transactions involving households during the period covered by the surveys. The
banking sector’s share of credit to enterprises was significantly larger. Banks were the lenders in
31 percent of the number of transactions and allocated 50 percent of the amounts of credit
received by enterprises. State banks allocated five times more credit to rural enterprises than
private banks.
xvi Executive Summary and Introduction

Who obtained the rural credit actually available? The agricultural sector received 61
percent of the total amount allocated during the period covered by the surveys, while the service
sector received 3 percent. Industry and trade received, respectively, 19 and 16 percent. This
allocation of credit tracked very closely the shares of these sectors in the aggregate book value of
assets owned by rural enterprises. Contrary to the generalized perception in Romania, private
banks did not discriminate against agriculture. Indeed, 65 percent of their disbursements went to
agriculture − slightly higher than the share of credit that public banks allocated to agriculture (62
percent). Agriculture was also the sector which received the largest share of subsidized credit,
obtaining 90 percent of all preferential lending.

The private sector received 57 percent of all credit and 45 percent of subsidized loans.
State enterprises received the difference, namely, 43 percent of all credit and 55 percent of
subsidized loans.

Characteristics of the Credit Services Available

Amounts. By source of credit, banks provided the largest loans in rural credit markets
during the period covered by the surveys. The average bank loan to enterprises (US$17,875) was
almost 16 times larger than the average loan disbursed by the informal sector (US$1,137). A
similar situation occurred with the credit allocated to households. The average bank loan to
households (US$797) was eight times larger than the average loan allocated by friends and
relatives (US$173) and about seven times larger than the average loan disbursed by credit
cooperatives and CARs (US$99).

Maturity of cash loans. The large majority of loans received by rural borrowers were short-
term loans. In fact, 93 percent of the loan transactions entered into by households had to be
repaid in less than a year. The corresponding percentage for enterprises was 85 percent. Bank
loans had the longest average term to repayment at 16 months. This average increased to 20
months when weighted by amount, as larger bank loans tended to have longer terms.

Use of loan proceeds. Most of the enterprise loans were reported to have financed working
capital (87 percent) and most of the household loans were reported to have financed consumption
and household durable assets (53 percent). By amount, 29 percent of the loans received by
enterprises were used to finance investments, while the equivalent percentage of the loans
received by households was 17 percent.

Collateral and guarantees. Romanian rural financial markets rely significantly on real
assets as collateral for loans. Naturally, there is a large number of small loans guaranteed only by
fiduciary contracts and verbal promises. These loans accounted for about a third of the aggregate
amount and were granted by the informal and semi-formal sectors during the period covered by
the surveys. The remaining two thirds of the value of rural loans were secured with tangible
assets by pledges on movable assets, mortgages on real state, or both. Indeed, about half of the
amount of secured loans was guaranteed by a pledge on movables and a mortgage
simultaneously.

When tangible assets are used as collateral for loans, the ratio of the market value of the
pledged assets to the amount of the loans (collateral/loan) is very high. The average value of
Finanacial Markets, Credit Constraints, and Investment in Rural Romania xvii

these assets was four times the amount borrowed during the period covered by the surveys. This
seemingly excessive protection of loans was due in part to the costly and lengthy processes
involved in repossessing assets pledged as collateral and to the lack of liquidity of rural real
estate.

The use of farm land to secure loans is also extremely low. The use of land as collateral
was impossible during the period covered by the surveys because, until late 1998, transactions
with restituted agricultural land were prohibited. More than 90 percent of the country’s land was
under this regime. Recently, there has been an increase in land transactions − mostly in land
leases however. Thin farm land markets combined with the structural features of land ownership
(fragmentation, incomplete titling, poor registration) make land mortgages risky collateral.
Limited mortgage lending should not be surprising, therefore.

Repayment problems of cash loans. The number of enterprise loans that fell in arrears (15
percent) was almost three times that of households (5 percent) during the period covered by the
surveys. The loans that enterprises reported in arrears were very large. These loans accounted for
43 percent of the aggregate amount received by the sector. In contrast, delinquent household
loans were slightly below the average size and delayed payments represented 4 percent of the
aggregate amount.

There is a significantly higher incidence of arrears on the loans received by state

enterprises relative to the loans received by their private counterparts. About 52 percent of the
amount of loans to public enterprises fell in arrears during the period covered by the surveys,
while the equivalent percentage for private enterprises was 12 percent. The incidence of arrears
was very similar when measured by number of transactions (as opposed to amounts) as 59 and
12 percent of the number of loans obtained by public and private enterprises, respectively, fell in
arrears.

Arrears are a more serious problem for state-owned banks than for private banks. Sixty
percent of the amount of the loans disbursed by state banks fell in arrears during the survey
period − more than twice the arrears of private banks (25 percent). Delinquency on subsidized
government credit lines was significant when state banks were the lenders (about 35 percent of
the amount disbursed). In contrast, when private banks allocated subsidized credit, the
delinquency reported was about 3 percent.

Commercial credit. Credit received in kind, such as commercial and supplier credit,
represents a significant source of financing for the rural economy. It accounted for 9 percent of
all credit transactions and for about 20 percent of the flow of credit to rural households and
enterprises during the period covered by the survey.

Commercial credit was particularly important for enterprises. It was a source of financing
for about 9 percent of them, accounted for 40 percent of the number of their credit transactions,
and represented 23 percent of the total amount they borrowed in the period, including all other
forms of credit. The 2 percent of enterprises owned by the state received 34 percent of the
aggregate amount of credit disbursed under this modality. Households, on the other hand, used
commercial credit less often and mostly to purchase durable goods and appliances. This type of
credit was a source of financing for 2 percent of households, accounted for 7 percent of
xviii Executive Summary and Introduction

household credit transactions, and represented 13 percent of the total amount borrowed by
households.

Deposits and Savings

Rural enterprises make intense use of the banking sector to manage their cash and to make
and collect payments. Virtually all rural enterprises had sight deposits and/or checking accounts
during the period covered by the surveys. About 80 percent of these accounts were in state banks
while the remaining 20 percent were in private banks. Less than one percent of these enterprises
had certificates of deposit or similar financial instruments.

About 36 percent of rural households had financial savings during the period covered by
the surveys. The highest incidence of households that save is among the well-off. While only 11
percent of the households belonging to the poorest income quartile save, the participation rate
approaches one half for households in the two richest quartiles. Savings accounts are the most
common deposit instrument held by rural entrepreneurs. They represented 69 percent of the
number of accounts and 64 of the amounts deposited. Three state-owned banks – Savings Bank,
Banca Agricola, and Banca Comercial_ Român_ – held more than 80 percent of the savings of
rural inhabitants.

Limited Access to Loans: Weak Supply of and Weak Demand for Loans

Overall access to loans by rural households and enterprises is limited. In fact, the
percentage of households and enterprises that used loans to finance consumption, working
capital, or investments was only 20 percent during the period covered by the surveys. This
observed scarcity of credit transactions in rural areas is caused by numerous factors which have
weakened both the supply and demand for rural credit. Lenders avoid rural credit and few rural
agents demand credit. Worse, the supply and demand do not match in that those agents which
demand credit do not correspond to those to which lenders want to lend. Most likely, the other
sectors in the economy also suffer from limited access to credit because the majority of these
problems are common to all financial transactions in Romania.

Weak supply of rural credit. The financial sector, especially the banking industry, supplies
very limited amounts of loans to the productive sectors of the economy. This weak supply results
not from lack of liquidity, but from an unfortunate combination of the short-term circumstances
and structural factors analyzed below. These factors combine to make the returns to rural lending
(adjusted by risk and transaction costs) unattractive relative to alternative investments available
to lenders.

Government macroeconomic policies. The Government is crowding out the enterprise

sector from bank lending portfolios. For significant periods over the last few years, it has been
more profitable and less risky for banks to invest their liquidity in inter-bank lending and
government securities than in credit to enterprises or individuals. Treasury bill yields have been
consistently above the rates on commercial loans. In January 1998, the yield on treasury bills
was about 4,400 basis points above the rate at which banks reported lending to their prime
borrowers.
Finanacial Markets, Credit Constraints, and Investment in Rural Romania xix

Government policies and participation in rural financial markets. The Government is also
crowding out private lenders from rural credit markets and hinders the private supply of rural
credit. Private lenders have not been in a position to compete with a poorly run government bank
which was not subject to a budget constraint (Banca Agricola), and with numerous directed
credit lines that financed rural loans at subsidized rates with a high probability of debt-
forgiveness. Debt forgiveness programs (implicit or explicit) have promoted strategic defaults
and created obvious credibility problems for all rural entrepreneurs as viable borrowers.

The institutional and legal framework for financial transactions. Some of the features of
the legal and institutional framework have made credit transactions riskier and more costly than
necessary, diminishing, therefore, the inclination of lenders to lend to all applicants, especially
small and medium businesses and informal entrepreneurs.

First, the majority of assets in the sector could not be effectively pledged as collateral for
loans during the period covered by the surveys. Land and buildings accounted for 42 percent of
the aggregate book value of the assets owned by rural enterprises and were by far the single most
important component of the wealth endowments of rural households (57 percent). Nonetheless,
agricultural land was not acceptable as collateral because transactions involving restituted
agricultural land remained prohibited until late 1998. More than 90 percent of the country’s land
is under this regime. Land markets have remained thin, in part due to lack of viable long term
financing. Thin markets combined with the negative structural characteristics of land ownership
such as fragmentation, incomplete titling, and poor registration make land too risky as collateral.

Second, movable assets (equipment, machinery, inventories, livestock, and accounts

receivable) had very limited capacity to carry debt during the period covered by the surveys
because of imperfections in the legal regime.4 These assets represented about 48 percent of the
aggregate book value of assets of rural enterprises. The legal regime for securing transactions
with movables: (a) limited the creation of security interests on inventory, accounts receivable,
leases, fixtures, and chattel paper; (b) did not provide a unified and easily accessible system for
publicly registering and ranking the priority of a lender to collect against the property of a
debtor; and (c) implied that repossession and sale of goods in which a lender had a security
interest simply took too long (sometimes years), exceeding the economic life of an important
portion of movable property. The net result was that moveable property as collateral was not
valued, and borrowers offering movable property as collateral got no better terms than did those
who offered nothing, nor were they more likely to be given credit.

When real estate and movable assets were used to secure debts, the ratios of collateral
value to loan amount were extremely high to protect lenders against the above imperfections. For
the average bank loan, the assets securing repayment were four times more valuable than the
amount borrowed. Hence, the real estate and movable assets in the hands of the enterprise sector

4 The Government of Romania passed Law No. 99 of 26 May 1999, published in Monitorul Oficial 236 of 27 May

1999 "Law Regarding Some Steps to Speed Up Economic Reform, TITLE VI. The Legal Status of the Security
Interests in Personal Property." Shortly thereafter the Government issued the regulations for this Law. Preparation of
the law and regulations was supported by the World Bank, which is also supporting the creation of an electronic
filing archive for security interests. This archive will stand among the most modern in the world. The archive is
presently under development and should begin operating during first quarter 2001. It is expected that this new
framework will correct the deficiencies mentioned above.
xx Executive Summary and Introduction

(90 percent of the aggregate book value of assets) could be used to secure credit transactions
worth about 22 percent of the value of such assets. In countries with well-functioning collateral
systems, assets carry about four times more debt than in Romania. For instance, in the United
States loans guaranteed by mortgages normally finance up to 90 percent of the value of the real
estate pledged while loans secured with movables normally finance up to 95 percent of the goods
pledged.

Third, other financing instruments such as warehouse receipts and leasing are, and
continue to be, unavailable. The legal environment for warehouse receipts is inappropriate in that
the rights, liabilities, and duties of each party to a warehouse receipt (e.g., producer, bank,
warehouse) are not clearly defined or enforceable. In practice, receipts are not freely transferable
by delivery or endorsement. In addition, potential lenders have no way to determine if there are
competing claims on a given stock of commodities. There are no performance guarantees for
warehouses. Farmers and traders are reluctant to store crops and banks are not willing to accept
receipts as collateral because there is significant uncertainty as to whether the goods exist in the
quantities specified by the receipt or whether the quality is the same or worse than that noted on
the receipt. Lack of performance guarantees is worsened by the lack of independent inspection
and licensing of warehouses. The storage industry is not competitive and remains dominated by
the state. The excessive prices charged by elevators and the probability of receiving different
amounts and qualities of commodities than originally stored make it unattractive for farmers and
traders to store their products.

Leasing has been rendered an unprofitable business by uncertainty and inappropriate rules
on depreciation, accounting, and taxation of fixed assets. The law does not provide clear
definitions for financial and operational forms of leasing and is unclear on: (a) the differing tax
and accounting treatments accorded to each of these two arrangements; (b) how leased goods
must be treated in the balance sheets; and (c) who (lessor or lessee) can claim credit on
depreciation and rental payments under each type of leasing. Also, there is enforcement
uncertainty because the law does not assign priority to lessors over leased assets in the case of
the bankruptcy or reorganization of the lessee and because recovery of leased assets upon default
by the lessee involves complicated, expensive, and time-consuming judicial procedures.

The depreciation schedules allowed by law on fixed assets are too long compared with the
normal life of a leasing contract. When such long depreciation schedules are applied to
equipment leases, the lessor has to report artificially-high net taxable profits because current
period costs are not being matched with current period expenditures. The Government is taxing
the difference between the historical value of assets and their current replacement cost (in
nominal Lei).

Also, according to Romanian accounting law, all assets must be booked at their historical
value and their revaluation is not allowed. This rule implies that, in the presence of inflation,
depreciation expenditures are underestimated causing, again, artificially high taxable profits and
low equity ratios for firms. The net effect is equivalent to a tax on investment in capital goods.

Romanian law does not permit tax payers to deduct from their taxable income losses
incurred when selling assets below their book value. Book value losses are unavoidable for
Romanian leasing companies because of the very long depreciation schedules imposed by law
Finanacial Markets, Credit Constraints, and Investment in Rural Romania xxi

and the comparatively short leasing periods, typically 3 to 4 years. In most cases, this
combination causes the market value of fixed assets to be below their book value. Losses occur,
therefore, when leased assets are sold. This practice gives leasing companies an unduly large tax
burden.

The customs duties and value added tax (VAT) on equipment leased from a foreign leasing
company are deferred until the end of the lease period and are calculated on the residual value of
the assets. These practices favor cross-border leasing and make it difficult to lease Romanian-
made assets. In fact, the Romanian leasing association estimates that 99 percent of outstanding
leasing contracts in the country are cross-border leasing. The practice also makes leasing a
comparatively easy mechanism to avoid custom duties and the VAT on imported assets.
Industrial companies could profit from establishing wholly owned leasing companies in foreign
countries for the sole purpose of leasing their fixed assets from these companies and reduce,
thereby, the amounts paid on custom duties and VAT.

Retail lending capacity. Another factor contributing to the weak supply of credit is that the
country’s banking industry does not have the interest or the capacity to serve retail clients as
evidenced by an almost negligible share of loans to households and to small businesses in the
portfolios of banks. Successful financing of rural areas will require the ability of the financial
sector to supply retail and micro-finance services profitably because the large majority of
potential clients are small. Small and medium businesses are predominant in the enterprise
sector. The average rural private enterprise had US$11,900 of assets while 80 percent of them
had less than 5 employees. Households, on the other hand, were even smaller clients as their
average monthly income was US$67 per month and the average value of their assets was
US$1,564.

Several elements suggest that the financial sector will continue to be reticent about retail
and micro-finance in the medium term. First, the methods or technologies of financial
intermediation used by the country’s banks render retail lending unprofitable because: (a) they
imply high fixed costs (expensive physical infrastructure, numerous employees) that could not be
supported by the comparatively small volume of operations in retail and rural markets; and (b)
the methods used to screen loan applicants imply costs that render small loans non-economical.

The second factor that may weaken retail lending even more is that the network of bank
branches may shrink significantly after the expected privatization or divestiture of state banks.
In this case, a retail network would be required to lend to small and medium businesses and
farmers because small credit transactions are highly elastic with respect to transaction costs,
which are large in the absence of a point of sale in the locality of residence of borrowers.

The network of bank branches may shrink because it is likely that struggling state banks
will downsize by closing branches and that large state commercial banks will close many
existing branches after privatization as they adopt strategies focussed on the corporate portion of
the market. This tendency, which characterizes the behavior of the banking sector in most
countries in Central and Eastern Europe, is already occurring in Romania where, for instance,
Banca Agricola closed the majority of its branches during the process leading to its planned
privatization. Privatized banks may also close existing branches as macroeconomic stability
reduces the profitability of “deposit-only” branches. These branches have been used to arbitrage
xxii Executive Summary and Introduction

on the lack of access of the population to government securities. Banks have enjoyed
disproportionately high margins from collecting retail deposits to finance portfolios of
government securities which, under macroeconomic stability, will produce much lower yields
than those obtained over the last few years. A reduction of the yields on government securities
will render many “deposit-only” branches unprofitable.

The weak demand for rural credit. The empirical findings of this study dispute the
commonly held belief that the unwillingness of the banking sector to lend to rural agents is the
(only) factor contributing to insufficient credit flows to rural areas. A weak demand for loans is a
very important determinant of the limited participation of rural agents in credit markets. Only 31
percent of households with farm and other entrepreneurial activities, and about 50 percent of all
rural enterprises, reported having a demand for loans during the period covered by the surveys.

The demand for loans at the household level is associated with highly inelastic
consumption needs, rather than with investment opportunities. Households that have access to:
(a) bigger endowments of assets and wealth, including larger landholdings; and (b) sources of
liquidity, including bank deposits and sales revenues, were more likely to report that they had no
demand for loans during the period covered by the surveys. Indeed, 44% of the households
which reported no demand for loans belonged to the top quartile in terms of the value of assets
owned. It is reasonable to conclude, therefore, that households preferred internal sources of
funding over external borrowing.

One consequence of the very high observed collateral requirements is that the demand for
loans decreases as large numbers of otherwise creditworthy borrowers opt out of credit markets.
Peculiar collateral requirements, together with the shortcomings of the legal framework, could
make borrowers' cost of defaulting disproportionate to the amount borrowed. Rural areas have
no functioning mechanisms with which to auction property given as collateral and to ensure that
any amount remaining after lenders have been fully compensated will be returned to the
borrower. Hence, those potential borrowers that would be required to pledge collateral may face
an artificially skewed risk-return distribution for their investments. Indeed, 27 percent of rural
entrepreneurs and 8 percent of rural enterprises did not request loans during the period covered
by the surveys because they considered borrowing too risky for this reason.

There are also underlying profitability problems in the rural sector which imply low values
for sector-specific assets, notably land. These low values restrict the demand for credit. As
mentioned above, the profitability indicators of the enterprise sector were rather weak during the
period covered by the surveys. In addition, the sector’s demand for credit was also weak because
limited investment took place during the period. Investment outlays tended to be lumpy and
required liquid resources. Thus, access to external credit may assist households and enterprises to
take advantage of profitable investment opportunities. Availability of internal financing was not
necessarily synchronized with investment opportunities. A comparatively limited number of
rural households and enterprises made investments in capital goods. Only 28 percent of rural
households and 26 of enterprises made some type of investments.

Macroeconomic uncertainty is a significant concern of potential rural borrowers. Most

borrowers must borrow at variable rates of interest, as 87 and 75 percent of all bank loans
granted to enterprises and households, respectively, during the period covered by the surveys had
Finanacial Markets, Credit Constraints, and Investment in Rural Romania xxiii

rates of interest adjustable with respect to some market index. Borrowers can go bankrupt when
interest costs rise relative to their enterprise earnings, especially for households which have very
limited access to markets or enterprises in non-tradable sectors, because of difficulties in hedging
against devaluation of the Lei. Another related factor that weakens the effective demand for
credit is the high levels of ex-ante real interest rates on loans − whether denominated in Lei or in
hard currency (taking into account expected devaluation). High real rates require investments to
have very high marginal productivity. Smaller enterprises with low capital/labor ratios are more
willing, everything else equal, to borrow at the prevailing high real rates, while larger and more
capital intensive businesses cannot afford such rates. In Romania there may be an unfortunate
mismatch in which smaller businesses which demand credit even at high rates are not being
served by banks, while larger enterprises which banks are willing to serve are not demanding
credit at high (real) rates.

Credit Constraints and Rural Investment

This study answers two key questions resulting from the empirical evidence of weak
supply of, and demand for, credit, namely: Does the limited supply of loans relative to existing
demand result in significant numbers of households and enterprises not taking advantage of the
profitable investment opportunities that may be present in rural areas because of constrained
access to credit markets? And if so, how much larger would rural investment be in the absence
of credit constraints? Answering these questions required determining whether the agents which
have a positive demand for loans are able to borrow the amounts they desire, that is, whether
rural agents are credit constrained.

Being “credit constrained” is necessarily a relative concept resulting from the comparison
of an agent’s demand with the supply of credit to which it has access. An agent which does not
have a demand for credit could not be credit constrained by definition. In terms of credit
constraints, every agent must, therefore, belong to one and only one of the following four groups:
(a) agents which do not have loans because they do not demand loans may be called
unconstrained non-borrowers; (b) agents which do not get loans although they demanded
credit correspond to totally constrained non-borrowers; (c) agents which receive loans for
exactly the amount they request may be called unconstrained borrowers; and (d) agents who
receive loans for less than the amount they want to borrow. This last group represents
constrained borrowers.

Only 6 percent of households and 8 percent of enterprises were able to borrow the amounts
that they wanted to borrow during the period covered by the surveys. Enterprises reported that
they were totally credit constrained three times more often than households. This greater
incidence among enterprises results because they had a stronger demand for loans. Among
households, 10 percent reported being totally credit constrained and 14 percent were partially
credit constrained. Among enterprises, 29 percent reported being totally constrained while 12
percent reported that they were partially constrained.

Credit constraints at the household level. Unconstrained and partially constrained

households (i.e., those which borrowed) were similar among themselves, but tended to be very
different from their totally credit constrained counterparts. After controlling for numerous other
variables, totally credit constrained households were more likely (with statistical significance)
xxiv Executive Summary and Introduction

than their borrowing counterparts to: (a) be headed by unmarried individuals; (b) be less
educated; (c) have more members; (d) have less members working in the non-agricultural sector;
(e) have smaller endowments of non-financial movable assets; (f) receive smaller amounts of
fixed incomes such as salaries and pensions; (g) have smaller real estate holdings; (h) live in
localities where there are more farmers relative to total population; and (h) live in localities
where there are more branches of state-owned banks.

The study also estimated, as a function of observable variables, the probability of a

household being: (a) totally credit constrained; (b) a borrower from the informal sector; or (c) a
borrower from the formal sector. The results indicated that there was a matching of borrowers
and lenders in that (among those who had borrowed) the better-off individuals with access to
financial markets obtained their loans from the formal sector, while worse-off and economically
isolated individuals resorted to borrowing mostly from friends and relatives. Regression results
confirmed that one reason why few Romanian rural households participated in credit markets is
because there was a limited coincidence between those which wanted loans (the aggregate
demand) and the willingness of all potential lenders to lend to them (the aggregate supply). In
fact, a majority of characteristics that made households more likely to demand loans also made
lenders less willing to grant loans to them.

Credit constraints at the rural enterprise level. The enterprises that were partially credit
constrained or unconstrained were statistically similar and, as a group, differed significantly from
their totally unconstrained counterparts. In a sense, lenders to rural enterprises based their
decisions to allocate any amount of credit (the amount actually requested or less) on basically the
same criteria.

Lenders were more likely, everything else the same, to have received and to have approved
credit applications from enterprises which: (a) were managed by older and less educated
individuals; (b) were operating in sectors other than industry and were incorporated as stock
corporations; (c) were large in terms of the value of their gross sales and the value of their assets;
(d) were very large enterprises in the agricultural sector; and (e) were domiciled in localities in
which there were many branches of state-owned banks. That is, enterprises with these
characteristics were less likely to be totally credit constrained and more likely to be either
unconstrained borrowers or constrained borrowers.

The bottom line effect of credit constraints on rural investment. The study finds strong
empirical evidence that credit constraints influence negatively the investment behavior of
households and enterprises. In particular, such constraints reduce the number of agents that
invest and the amounts they invest. The effect is especially negative at the enterprise level. Thus,
profitable investment opportunities are not pursued as a result of limited access to credit markets.
This situation is very negative for rural Romania because there are few such opportunities
relative to the size of the sector.

Investments. The study examines the investments made by households and enterprises.
Investments are defined as the expenditures incurred in acquiring capital goods including
buildings, equipment, tools, machinery, vehicles, livestock, and land. A comparatively limited
number of rural households and enterprises made investments during the period covered by the
surveys. About 27 percent of rural households and about 26 percent of enterprises made some
Finanacial Markets, Credit Constraints, and Investment in Rural Romania xxv

type of investment. The amounts actually invested were small relative to the income of rural
enterprises and households. In the aggregate they invested 4 and 6.5 percent of their gross annual
incomes, respectively. The value of physical investment as a percentage of GDP in the EU and
the OECD was 22 and 25 percent, respectively. Although the Romanian, EU, and OECD
statistics are not directly comparable because of measuring methodologies, the absolute
differences in magnitude are sufficient to indicate low levels of investment relative to income in
rural Romania.

Investment opportunities and the effects of removing credit constraints. The study
estimated how much more investment would have occurred in rural Romania during the period
covered by the surveys had credit constraints been removed − that is, how many more agents
would have invested, and how much more they would have invested, had they been able to
borrow as much as they wanted under the prevailing conditions during the period. The results
follow.

Investments by households. Investment opportunities at the household level: (a) were

negatively related to the age of the household head; (b) increased with the number of household
members who were pensioners, mostly because of stability of cash flows; (c) were basically in
consumer goods; (d) were positively related to the number of household members; (e) were more
likely for households which hold bank deposits; (f) were more frequent for households with
larger housing units, again associated with durable consumer goods; (g) were positively
associated with the degree of connection to markets as proxied by the share of the value of
agricultural sales in total household income − in fact, 45 percent of farm households with
substantial market involvement made investments during the period covered by the surveys,
compared to only 24 percent of farm households which consumed their production; and (h)
varied significantly by region in that there were more frequent opportunities in Moldova de
Podis, Subcarpati de Sud, and Oltenia de Sud, and less frequent opportunities in Campia Dunarii
de Jos and Campia Romana Centrala. A significant portion of the investments made were in
consumer durables.

The amounts invested by households that perceived profitable opportunities tended to be

larger for households: (a) headed by younger, female, and less educated individuals; and (b)
with more pensioners. Some of the characteristics of the entrepreneurial activities influenced the
amounts invested as well. The households which invested larger amounts had: (a) more
fragmented landholdings; and (b) more market involvement as indicated by the shares of their
income originated in labor and output markets (farm and non-farm). Finally, households in: (a)
agrarian localities, as proxied by the ratio of farmers to population; and (b) Subcarpatii de Sud
and Oltenia de Sud, tended to invest lower amounts.

Removing credit constraints at the household level. The key policy issues regarding the
relationship between investment and access to credit at the household level are: (a) the set of
investment opportunities available to rural households is rather limited; (b) lack of financing
(debt or equity) under the conditions prevailing during the period covered by the surveys was not
a bottleneck to investment in the sense that most of the households which had investment
opportunities actually took advantage of them; (c) mitigating credit constraints by providing
additional credit at the prevailing conditions would have a limited impact on the number of
households which would have invested and on the aggregate amount of household investments
xxvi Executive Summary and Introduction

In terms of numbers of households, had there been no credit constraints for households
during the period covered by the surveys, 29 percent of households would have invested. This is
an increase of only 2 percent from the 27 percent of households which actually made
investments. The aggregate amount invested by households in the absence of credit constraints
would have been 10 percent above the amount actually invested. This increase would have
placed household investment levels at about 7.2 percent of their aggregate income instead of the
6.5 percent actually observed.

Investments by enterprises. Everything else the same, the enterprises more likely to invest
during the period covered by the surveys: (a) had younger managers; (b) were in sectors other
than agriculture with the exception of large agriculture enterprises which were also more likely
to invest; (c) were private in that the state had no participation in their ownership; (d) had high
volumes of sales; (f) were those which did not have large numbers of owners managing the
enterprise nor working in it, as measured by the share of members in the total work force; and (g)
were located in more densely populated regions. Enterprises in the regions of Moldova Deal and
SAI were less likely to invest.

The amounts invested by enterprises were statistically independent of economic sectors,

legal status of incorporation, ownership, and economic conditions of the locality where the
enterprises were located. The amounts invested were higher for enterprises with more: (a)
assets; (b) gross value of sales; and (c) leverage, as measured by their debt-to-asset ratios. The
amounts invested by enterprises in the regions of Subcarpatii de Sud and Moldova de Podis
tended to be smaller.

Lack of financing represented a significant impediment for rural enterprises to take

advantage of the investment opportunities available in that a considerably larger number of them
would have made investments had credit constraints not been present. In particular, the
econometric analysis estimated that, in the absence of credit constraints, about 37 percent of
enterprises would have invested versus the 26 percent that actually did invest (an increase of 41
percent) during the period covered by the survey. The aggregate amount invested in the absence
of credit constraints would have been about 57 percent greater than the amount actually invested.

Policy Options

General strategy and emphasis. Deepening financial markets in rural areas and increasing
their outreach requires stronger credit supply and demand. While the problem must be tackled
simultaneously from both sides (supply and demand), efforts to shift the supply curve of rural
credit to the right would probably yield results faster than interventions in the demand side.
Significant increases in the demand for credit to finance investments will occur only after the full
implementation of appropriate policies (privatization of state enterprises, land titling) and the
development of infrastructure (warehousing system) in rural areas.5

5 An important exogenous factor that may increase the demand for private investments and for rural credit is the

Special Accession Program for Agriculture and Rural Development (SAPARD). This program will be financed by
the European Union. SAPARD will allocate a significant portion of _ 150 million per year during the period 2000-
2006 in grants to finance eligible private sector investments in rural areas. These grants will finance up to 50 percent
of eligible investments. The remaining 50 percent of the value of these investments will need to be financed by
Finanacial Markets, Credit Constraints, and Investment in Rural Romania xxvii

The core of the short term strategy should, therefore, be to augment the supply of credit by
increasing the returns to rural lending, adjusted by risk and transaction costs. An increased
supply of credit would translate into lower total cost of borrowing, including lower and less
volatile effective rates of interest, transaction costs of borrowing, and collateral requirements.
Better conditions on credit would be followed by an increase in the amount of credit demanded
in the form of a movement along the existing demand curve (as opposed to a shift in the demand
curve).

In practice, this challenge requires: (a) removing the unfair competition between the state
and the private sector for (i) controlling productive rural assets, (ii) collecting savings from the
public, and (iii) allocating credit; (b) improving contract enforcement; and (c) increasing
competition in the supply of deposit services and funding to private rural clients of which the
large majority are farmers and micro, small, and medium enterprises.

The following is a summary of the options available to the Government to implement a

program aimed at meeting the above challenge.6 Some of these policies have already been
adopted by the Romanian authorities, as indicated below.

Government credit lines. The government has realized that directing and subsidizing credit
in the face of existing high costs, risks, and distortions will only perpetuate the existing problems
by crowding out private lenders. The Ministries of Agriculture and Finance have agreed to the
dissolution of all subsidized credit programs and all government funds financing rural and
agricultural credit, including Ordinance 36/99 (Support for Farm Equipment Purchases) and
Ordinance 165/98 (Ordinance for Providing Finance for Crop Planting). It is expected that the
Government will issue this Ordinance at the end of 2000. The elimination of directed subsidized
credit to the sector constitutes one of the conditions for a proposed World Bank loan, which will
finance the implementation of a project to develop rural financial markets in Romania.

Improving the legal and institutional environment for using movable assets to secure
transactions. There has been significant progress in passing legislation that will allow for greater
and more effective use of movable assets as collateral most notably, farm equipment, inventories,
accounts receivable, and consumer goods. In particular, the Government passed Law No. 99 of
26 May 1999, published in Monitorul Oficial 236 of 27 May 1999, "Law Regarding Some Steps
to Accelerate Economic Reform, TITLE VI. The Legal Status of the Security Interests in
Personal Property." Preparation of the law and its regulations was supported by the World Bank
as preparation for the above-mentioned rural finance project. The Romanian authorities are

beneficiaries either with their own resources or with debt. There may be, therefore, a “step” increase in the demand
for rural credit from the private sector to finance the counterpart funding requirements to obtain SAPARD grants.
Clearly, financial rates of return on private investments will increase because of the grants.
6 The benefits for the development of financial markets of conducive macroeconomic conditions in the form of low

and predictable inflation rates and exchange rate stability are obvious. It should suffice to mention, as an example,
that an improved fiscal balance would allow the government not to crowd out the private sector in financial markets.
Policy recommendations to achieve macro stability are, however, beyond the scope of this study. While recognizing
that such stability is a necessary (albeit not sufficient) condition for the development of rural financial markets, this
chapter focuses on possible government interventions that may be required to achieve other necessary conditions for
the improved performance of these markets.
xxviii Executive Summary and Introduction

creating, with World Bank support, an electronic filing archive for interests interest secured with
movable assets. It is expected that the archive will begin operations before the end of 2000.

The legal environment for warehouse receipts will improve when Law 99 above becomes
effective with the launching of the archive. This law clarified and defined clearly the rights,
liabilities, and duties in each party to a warehouse receipt (e.g., producer, bank, warehouse) by
making receipts freely transferable by delivery or endorsement. In addition, potential lenders will
be able to use the new security interest electronic archive to determine if there are competing
claims on a given stock of commodities. Three actions are still required to develop a fully
effective warehousing framework. First, independent inspection and licensing of warehouses
should be established. Second, a system of performance guarantees for warehouses should be
developed, including establishing an indemnity fund and/or requiring mandatory insurance
among licensed warehouses. Third, more competition should be introduced in the storage
industry which remains dominated by the state.

There has been important progress in establishing a western-style leasing system with the
“Law on Amending Ordinance No. 51/1997.” Nonetheless, the problems in the accounting and
fiscal treatment of leasing and, more generally, of depreciable fixed assets, remain. Leasing
should not be expected to grow because investment in the types of assets that are typically leased
is taxed excessively. Specific recommendations include: (a) allow for shorter depreciation
schedules on fixed assets; (b) allow reasonable revaluation of assets over their historical book
values to compensate for inflation; (c) allow tax payers to deduct from their taxable income
losses incurred when selling assets below their book value; (d) finish leveling the playing field
between domestic and cross border lessors in terms of the value added tax (VAT) on equipment
leased; and (e) eliminate the customs duties incentives on assets to be leased, namely, total
exemption of import tariffs, duties, and customs guarantees because these incentives have only
increased inter-company leasing as a means of avoiding customs duties, and not the growth of
real leasing transactions.

Improving the legal and institutional environment for using land as collateral. There are
obvious benefits for rural finance of well-defined property rights and secure title to real estate,
namely, the ability to use land as collateral which both enhances financial market development
and promotes greater investment. In particular, titled land which has secure registration generally
has a much higher market value. While this is not sufficient for a well functioning financial
system, insecure property rights unambiguously reduce the development of financial markets,
especially in rural areas where farm land represents an important portion of all assets.

The following are recommendations for a successful titling and registration system: (a) do
not use titling and registration programs to collect additional taxes; (b) invest in making property
rights and property boundaries clearly recognizable and easily definable; (c) hire and train
qualified survey and registry staff to ensure their suitable competence; (d) improve the ability of
the court system to enforce and protect property rights; (e) decrease the degree of regulation of
land sales and make zoning regulations more transparent while the procedures for zoning
changes should be simpler and less expensive; (f) reduce the statutory costs of property
transactions, as well as those related to the transfer and registration of title.
Finanacial Markets, Credit Constraints, and Investment in Rural Romania xxix

Retail lending. Successful financing of rural areas will require the ability of the financial
sector to supply retail and micro-finance services profitably because the large majority of
potential clients are small. Section B of Chapter III argues, however, that the supply of retail and
micro-finance services is likely to remain weak. Government support may be justified to provide
technical assistance to private lenders to accelerate their understanding of the rural sector, of how
to evaluate business plans from new private farms and rural businesses, of how to use and value
rural assets that might be pledged as security, of how to dispose of such assets, and so forth.
Financial and technical assistance should also be provided to non-profit organizations to support
the provision of micro-credit to the poorest segments of the rural population, i.e., those which
will not be reached by the banking sector. The Government could also assist in the development
and introduction of technologies and institutional arrangements that could reduce costs and risks
of retail banking and micro-credit in the rural areas (e.g., character based lending, credit
bureaus).

Government support for these activities is justified from a public policy point of view.7 The
development of sustainable technologies for delivering financial services to retail and micro
rural clients requires extensive local experimentation. The problem is that the investment in
experimentation may be inadequate unless the Government provides the necessary stimulus.
Since no single lender can capture a significant portion of the social value of improved lending,
the rational strategy is to wait for someone else to assume the risks and costs of experimentation
and, in the case that the technologies are successful, to copy them. It is also justifiable for the
Government to invest in this experimentation because past government interventions in financial
markets have been extremely costly. Any future mistakes are likely to also be expensive. Hence,
limited support to private intermediaries that will avoid future direct involvement by the
Government may be a good policy. Micro-finance, on the other hand, has proven to be a cost
effective and sometimes sustainable instrument to deal with the rural poor.

Regulatory concerns regarding chartered non-bank mutual financial intermediaries. As

argued in section F of Chapter V, the stability of the overall financial sector and the protection of
the savings of the population may be threatened by the operations of an estimated 1,400
independent mutual financial intermediaries (MFIs) registered under Law 109/1996 and of which
a majority are domiciled in rural areas.

The elimination or management of the risks imposed by MFIs will not be a simple task.
The authorities have taken the important initial step of suspending the licensing of new MFIs.
The challenge of what to do with the existing ones remains, however. Two options have been
proposed in Romania, namely: (a) bring the system under the supervision of the NBR; or (b)
introduce self-regulation by requiring individual MFIs to join second-tier groups such as
federations of credit cooperatives, which would supervise their members. Neither option may be
suitable, however. The first may strain the supervisory capacity of the NBR as it would increase
the number of intermediaries it currently supervises from 45 commercial banks to more than
1,400 in one single step. The second option has significant shortcomings, including: (a) the
federations (the supervising entities) would be owned and controlled by MFIs (the supervised
entities) − the managers of more tightly-run federations could be replaced by laxer management

7 Chapter V: Policy Options and Possible World Bank Support provides an outline of an operationally feasible way

for the Government to support these efforts.

xxx Executive Summary and Introduction

teams; and (b) federations and MFIs would be private entities, allowing MFIs to choose to
exercise their constitutional right of free association by either moving from tightly-run
federations to lax federations or to no federation at all – the Government may not be able to
condition the existence or functioning of a MFI on belonging to a federation.

A third option seems to be required. The following sequence of actions may represent a
viable option to ameliorate the risks entailed in the operations of MFIs: (a) maintain the status
quo, leaving existing MFIs outside NBR’s regulatory authority and supervisory responsibility;
(b) pass legislation, possibly by amending Law 109/1996, so that (i) MFIs are no longer allowed
to use the word “bank” in their names (e.g., Banca Populare), (ii) MFIs are obliged to register
with the NBR with the (sole) purpose of establishing a complete inventory of them, (iii) NBR
has the authority to request some basic financial data on MFI performance, including external
audits for MFIs above certain asset thresholds, (iv) NBR has the authority to regulate the “act” of
financial intermediation rather than specific financial intermediaries (e.g., bank charter only),
allowing NBR to take discretionary actions with respect to selected MFIs without acquiring the
obligation of supervising all MFIs; (c) pass new, or amend existing, legislation that would allow
for the creation of a totally new financial intermediary charter such as a “small regional bank”
(SRB) charter which would be subject to a complete regulatory framework (see details in
Chapter V); (d) NBR would undertake immediate efforts to develop its capacity to enforce SRB
compliance with the above prudential norms, including a well staffed unit devoted to this
purpose, an early-warning system based on data reported by SRBs, and on-site supervision
necessary to undertake inspections that, because of their nature, cannot be performed by an off-
site analysis; (e) existing MFIs would be eligible to be licensed under the new regulations under
a “fast track” procedure for a period of, say, 12-18 months; (f) MFIs that would opt to comply
with the new regulations and get licensed under the new framework would be provided technical
assistance to meet the new regulatory standards; and (g) existing MFIs that refuse to migrate to
the new charter and to comply with the new regulatory framework would remain unregulated
informal financial intermediaries and the NBR may consider the possibility of making the public
aware of the risks involved in maintaining deposits in such intermediaries by publicizing their
status.

Market development, balanced rural development, and privatization. The empirical

findings of the study provide strong empirical support to the claim that the following actions
would contribute to increased investment in rural areas:

(a) Integrating households into markets and allowing concentration of land holdings.
Household investment opportunities are positively associated with the degree of
connection to markets as proxied by the share of the value of agricultural sales in total
household income and negatively associated with the age of the heads of households. In
fact, 45 percent of farm households with substantial market involvement made investments
during the period covered by the surveys, in contrast with only 24 percent of the farm
households which consumed their production. In turn, market involvement requires
eliminating the restrictions for exiting agriculture faced by the large numbers of elderly
landowners who have small-scale operations and lack agriculture equipment. These
farmers created by the land reform process will remain engaged in subsistence farming and
will remain disconnected from markets.
Finanacial Markets, Credit Constraints, and Investment in Rural Romania xxxi

(b) Formulating balanced rural development policies (in contrast to focussing on

agriculture only) and privatizing state enterprises. The enterprises more likely to invest
were, everything else the same, in sectors other than agriculture and were private in that
the state had no participation in their ownership. Everything else the same, the probability
that an enterprise in the industry, trade, and service sectors had a demand for loans was,
respectively, 36, 32, and 30 percentage points higher than the probability of an agricultural
enterprise reporting a demand for loans.

(c) Privatizing state banks. Private banks were more amenable to financing investments
than their state-owned counterparts. Private banks allocated 80 percent of their loans to
borrowers who reported having made investments in the period in which they received the
loan, while the equivalent share allocated by state banks was 55 percent.

Policy coordination. Rural finance in Romania is a very complex multi-sector subject with
important policy and political implications. It is an issue with multiple influences on the
economy ranging from macroeconomic stability to impact on rural poverty. A consistent set of
policies towards rural financial markets is a vital concern, therefore. A steering committee
should coordinate general policies and, maybe, guide the reform of specialized government
institutions and programs. This committee should consist of representatives from the government
agencies involved, including the Ministry of Agriculture, Food and Forestry, the Ministry of
Public Finance, and the National Bank of Romania.

B. SPECIFIC OBJECTIVES, METHODOLOGY, AND DATA

The objective of this study is to address public policy questions relevant to rural finance.
What is the impact of the widely perceived limited access to credit on growth, efficiency, and
poverty in rural areas? What are the roles of demand and supply factors in explaining limited
access to rural credit? Does access to credit influence the investment strategies of rural
entrepreneurs and rural enterprises? What determines the extensive geographical coverage of the
banking sector? Is this coverage efficient, especially in the case of public banks? What would be
the profitability of rural bank branches if they not only collected deposits but also allocated
credit to rural households and enterprises? What should be the government strategy to increase
the availability of financial services, especially credit, in rural areas? Who would be the winners
and losers of reforming the sector?

In short, the study provides the data and analytical tools needed to design rural financial
markets polices and to support the dialogue between the Government of Romania and the World
Bank. The study provides an empirical basis for a government strategy to increase the
availability of financial services in rural areas and for the World Bank to fine tune its possible
support in the endeavor. The approach used was to: (a) assess the performance of the markets;
(b) identify the causes of any identified deficiencies in performance; and (c) design the
minimum-cost policy instruments to bring about improvement.

The research focuses on entrepreneurs and enterprises and the financial transactions and
capital investments in which these agents participated. Entrepreneurs and enterprises are defined
as any physical or legally incorporated persons engaged in an economic activity and whose
xxxii Executive Summary and Introduction

earnings depend on the differences between uncertain incomes and contractual costs. The agents
under study are, therefore, the residual claimants of the cash flows of an economic activity.

Three kinds of credit products or services are considered in this study, namely: (a) cash
loans, which are credit transactions disbursed and repaid in cash; (b) commercial credit, which
includes all credit provided in kind and paid back in cash; and (c) forward sales or sales with a
down payment, which consist of payments received by the borrower in exchange for the future
delivery of products and services. Deposits in financial institutions and investments in securities
are also considered.

All types of lenders and their services are also considered. Lenders are classified as formal,
semi-formal, or informal, according to whether they have a government-granted license to
provide financial services or operate under the auspices of specific legislation. The formal sector
includes commercial banks or deposit-taking institutions supervised by the National Bank of
Romania. The semi-formal sector includes chartered non-bank financial intermediaries and other
registered institutions providing credit products − mostly credit cooperatives and Mutual Aid
Intermediaries (CARs).8 Informal lenders consist of: (a) moneylenders, who provide cash loans
in exchange for explicit interest payments; (b) friends and relatives, who provide cash loans
without explicit pecuniary compensation; and (c) traders, merchants, and processors, who engage
in commercial credit or sales with a down payment as defined above.

The analysis in this study relies intensively on statistical and econometric analysis of the
data collected in three surveys conducted specifically for the study.9 A brief description of these
surveys follows.

Survey of Rural Households and Financial Services (SRHFS)

This survey was conducted in Spring of 1998. The sampling universe corresponded to
households located in Romania’s rural areas, as defined by the National Commission of Statistics
(NCS). A total of 2,420 households were selected using a two-stage selection scheme. The first
stage used the Master Sample of Census Tracts (referred to by its Romanian acronym, EMZOT)
to select 242 census tracts.10 In the second stage, a total of 2,420 households were randomly

8 There are few Non-Governmental Organizations providing financial services in rural areas. The scale of their

operations is very small and of limited geographical scope.

9 The technical aspects of this study are presented in detail in each of the annexes to the study. Annex 5 presents the

complete sample design of the household and enterprise surveys. These annexes are available on request through
Rodrigo Chaves or Saul Schor.
10 NCS uses a master sample of census tracts to carry out all of its household surveys. This master sample of census
tracts, which was built using the 1992 population and housing censuses, contains 242 census tracts and 107,662
dwellings according to the latest update in 1995. These 242 census tracts were selected using a spiraling selection
scheme from a total of 93,037 census tracts in the Romanian territory.
Finanacial Markets, Credit Constraints, and Investment in Rural Romania xxxiii

selected from the pool of households that had not been selected for other NCS surveys.11 Data
were collected on a total of 7,098 individuals belonging to sampled rural households.

The household survey provided data on individual labor market decisions, household
demographic characteristics, and basic socio-economic data on household members. In addition,
the survey collected detailed information on agricultural and non-agricultural activities
undertaken by the household. The data set provides previously unavailable information regarding
the use of credit and savings products, investment activities, and the extent of credit constraints.
The survey considered three kinds of credit products: cash-loans, trade-credit, and sales with
advances.

Survey of Rural Enterprises and Financial Services (SREFS)

This survey was also conducted during Spring of 1998. The sampling universe
corresponded to enterprises domiciled in rural areas. The survey excluded, therefore, all
enterprises with operations in rural areas but with headquarters in urban areas and Regies
Autonomes, enterprises not legally incorporated, branch offices of financial institutions, public
administration offices, educational institutions, and health care units. The sampling frame was
constructed using a farm enterprise survey conducted in 1997 and the REGIS registry.12 The
frame included 4,238 agricultural enterprises and 75,516 non-agricultural enterprises. A total of
900 rural enterprises of which 390 were agricultural enterprises were sampled using stratified
sampling. Four strata were constructed on the basis of the value of annual sales.

The enterprise survey provided data on financial statements, financial transactions,

characteristics of enterprise managers, investments, and problems affecting the enterprise. The
survey is unique in its collection of rarely available data – namely, the characteristics of loan and
savings products and the extent of credit constraints.

Survey of Financial Intermediaries (SFI)

This survey was conducted in 1998 and gathered information at the locality level on the
number of financial outlets, amount of deposits and loans outstanding and number of employees
per branch. Responses were obtained from 5 state-owned banks and 11 private banks. Aggregate
data for all individual credit cooperatives was also obtained. The surveyed banks accounted for
more than 70 percent of the assets in the banking sector at time.13

11 This procedure does not introduce a bias in the selection of the SRHFS because a random process was used to
select the households for the other surveys. To account for non-responses, a total of 14 households per census tract
were sampled, but only 10 were actually surveyed.
12 The REGIS registry is the most comprehensive list of enterprises in Romania. It is updated monthly with entries
from the Trade Registry, the Fiscal Registry, and the National Commission for Statistics.
13The banks which responded to the survey were Banca Internationala a Religiilor (International Bank of
Religions), Bankcoop, Banca Turco-Romana (Turkish-Romanian Bank), Banca Franco-Romana (French-Romanian
Bank), Casa de Economii si Consemnatiuni (Savings Bank), Banca Romaneasca, RoBank, ABN AMRO Bank,
Daewoo Bank, Demir Bank, Ion Tiriac Bank, Bucharest Bank, BancPost, and Banca Agricola.
xxxiv Executive Summary and Introduction

Additional Data

The survey data are complemented with information collected by the National
Commission of Statistics (NCS) on Romanian localities for the year 1997. This NCS locality
database contains information regarding numerous variables disaggregated at the locality level,
including employment, population demographics, and educational enrollment.

C. ORGANIZATION OF THE STUDY

This study is organized in five chapters that summarize the findings and analysis of five
detailed annexes to the study. These annexes are available upon request at the World Bank
through Rodrigo Chaves or Saul Schor. Chapter I examines the Romanian rural economy to
illustrate the profile of economic agents in rural areas and the context in which rural financial
intermediaries operate. Chapter II describes the financial intermediaries existing in Romania’s
rural areas, their market shares, and their financial products. Chapter III examines the roles of
demand and supply factors in explaining the limited use of credit services. Chapter IV illustrates
the influence of credit constraints on the investment strategies of households and enterprises.
Finally, Chapter V draws some conclusions and policy recommendations to improve the
performance of financial markets in rural areas, before closing with a look at the challenges
forthcoming in the future.
 Chapter I: The Rural Economy and its Economic Agents
The focus of this report is the performance of Romania’s rural financial markets, which are
intrinsically connected with the performance of product, input, and others factor markets. The
first part of the chapter (sections A and B) introduce the reader to the main features of rural
Romania, describing the characteristics and policies that affect its economic activity.14 Section A
establishes that Romania has a large and diverse rural economy, predominantly agricultural, with
a low-educated and aging labor force. The major “reforms” implemented during the transition
period that dramatically modified the rural economic landscape are presented in section B: (a)
the land reform in 1991; (b) the interventionist agriculture and agricultural credit policies
implemented during 1993-96; and (c) the hesitant reforms of 1997-98. Section C summarizes the
characteristics of rural employment.

The second part of this chapter (sections D and E) examines rural entrepreneurs and
enterprises. Section D presents the characteristics of rural entrepreneurs. Most are farmers who
emerged as a result of the 1991 land reform, but whose potential was stifled by almost a decade
of inappropriate policies. The section describes the diversity of farm entrepreneurs, including
non-agricultural entrepreneurs, who run informal family-owned businesses. Finally, section E
describes the main characteristics of the formal rural enterprise sector.

A. THE RURAL ECONOMY WITHIN THE AGGREGATE ECONOMY

Romania ranks as a mid-sized European country, with a population of 22.5 million, an area
of 238,391 km2 , and a GDP of
Figure 1 Change in GDP and Agricultural GVA US$31.8 billion (1997). Romania
belongs to the group of lower
160.0 middle-income countries, with a
140.0 GDP per capita of US$1,410
120.0 (US$4,270 at purchasing power
100.0 parity).
80.0
60.0 Transition to a market
40.0 economy has occurred gradually
20.0 and the results of the transition
- have been less than encouraging.
1990 1991 1992 1993 1994 1995 1996 1997 1998
In 1993, GDP had contracted to
Change in GDP Change in Agricultural GVA 76 percent of its 1989 level. State
Source: National Commission of Statistics. intervention briefly restored some
GDP growth at the cost of serious

14This chapter provides required background to the study’s empirical findings on rural financial markets. The
chapter attempts to provide the most succinct possible information. Hence, readers familiar with the sector may skip
some sections accordingly, while those totally unfamiliar with the subject may benefit from reading Annex 1 which
contains more complete and detailed information on Romania’s aggregate and rural economy.
2 Chapter One:

macroeconomic imbalances. These imbalances triggered a new period of recession from 1997
through 1999, when GDP declined back to its 1993 level. In contrast, agricultural gross value
added (GVA) was higher than its 1989 level throughout the transition period.

Poverty is a widespread and severe problem in Romania. In 1998, roughly 44.5 percent of
Romanians were living on less than $4 of purchasing power parity (1996 PPP) a day with per
capita consumption falling 25 percent short of the poverty line (World Bank, 2000). Poverty is
greater and deeper among the approximately 10 million people who live in rural areas (45
percent of population).

The definition of “rural” used in this study corresponds to the legal and administrative
definition used in Romania, which is an administrative definition. Under this definition, rural
areas are comprised of all
Figure 2 GDP and Agricultural GVA Growth Rate localities which have not
achieved the status of
30 “urban”. This status
25 requires a law. This
Annual Growth Rate (%)

20 somewhat arbitrary
15 custom implies that it is
10
possible to find urban
5
towns with, say, 10,000
-
(5)1990 1991 1992 1993 1994 1995 1996 1997 1998
inhabitants, while some
(10)
rural villages may have,
(15) say, 20,000 inhabitants.
(20) In practice, therefore,
rural areas are comprised
GDP Growth Rate Agricultural GVA Growth Rate
of the entire country
Source: National Commission of Statistics. minus 200 (mostly large)
localities which have been
granted urban status by legislative action.

More than half of total employment is located in rural areas (52 percent in 1997), and
roughly a fifth of all incorporated business are headquartered in rural areas.

Rural inhabitants are spread out among 2,686 communes (the smallest administrative unit),
which contain 13 thousand villages spread over 89 percent of the country’s surface. Population
density is comparatively high.

Primary productive activities prevail in rural areas. The typical occupations are farming,
forestry, fishing, and extractive industries, and most of the economically active population in
rural areas are self-employed farmers.

The educational level in rural areas is lower than in urban regions. Individuals over 15
years of age with no formal schooling or only primary education make up 27.6 percent of rural
inhabitants. The same group corresponds to 2.6 percent in urban locations, while 90 percent of
high school graduates are concentrated in urban areas.
The Rural Economy and its Economic Agents 3

Rural areas are heterogeneous, made up of both small human settlements and larger
communities, densely populated areas and isolated villages and hamlets, and rich and poor
communities. Some large rural communities are comparable in size to towns (up to 30 thousand
inhabitants), while smaller communities may have a little over one hundred residents.

Three main trends have shaped rural Romania and its villages over the past 30 years
(Chirca and Tesliuc, 1999). First, population decreased by almost 20 percent due to a
combination of migration, low birth rate, and high mortality. Those leaving the villages for
towns were basically young high-school graduates. The out-migration of rural youth caused the
aging of the rural population and contributed to increasing the educational differences between
rural and urban areas. The beginning of the transition found an aged rural population occupied
mostly in the agriculture sector, which was totally dominated by the State and collectivization

B. AGRICULTURAL SECTOR POLICIES DURING THE TRANSITION

There were three phases of agricultural sector reforms with the greatest impact on rural
markets during the transition period: (a) a period of heavy structural changes between 1990-91,
triggered by the land reform; (b) a period of heavy interventionist agricultural policies between
1992 and 1996; and (c) a recent period of hesitant liberalization of rural markets. A common
feature of these policies was their “stop-and-go” nature, with liberalization followed by measures
aimed at counteracting their perceived negative effects.

Land Reform

In 1991, the Government undertook a land reform program that dramatically changed rural
areas. The land reform restituted 9.25 million hectares of land to private agents.15 This land
accounted for 73 percent of total arable land or 63 percent of total agricultural land in the
country. Consequently, the share of private land increased from 12 percent in 1989 to 70 percent
in 1992. Second, peasant farms and small informal and formal associations of farmers replaced
the traditional state and cooperative farms that existed during the communist era.

By design, the land reform created the largest class of entrepreneurs in Romania – the
farmer. These new entrepreneurs, however, are elderly and uneducated landowners who have
small-scale operations and lack agriculture equipment. They engage mainly in subsistence
farming disconnected from markets.

To date, one in five farmers does not possess legal title to their land due to delays in the
implementation of land titling. Moreover, the Government banned sales of restituted land until
August 1998 when the restrictions were removed. These two events have had serious
consequences for the development of land markets needed to consolidate private farms and
provide farmers with incentives to invest. The lack of an effective rural land market in Romania
has posed a significant constraint on the access of farmers to credit (see below).

15Land was restituted to those individuals that were forced to put their land under collective control during 1949-
1962.
4 Chapter One:

The new land ownership and tenure did not match the previous arrangements for input
procurement or output marketing, requiring adjustments across all segments of the chain.
Changes in land tenure made established distribution channels in input and product marketing
unsuitable for a very small and dispersed clientele. A rapid organizational solution was needed in
response to these changes in order to re-establish marketing and credit chains for small farmers
and family associations. The Government, however, failed to recognize this, and opted instead to
maintain the status quo. The immediate effect was a severe drop in input use, followed by a
notable reduction in output 1992-1993 − the largest in two decades.

The Heavy Hand of the State

Faced with a substantial reduction in agricultural output in 1991-92, the authorities decided
to replace the “invisible hand” of market forces with the “heavy hand” of the State in agriculture,
which delayed the adjustment to a market economy and created open ended large public
liabilities. The agricultural policy implemented between 1992 to 1996 had two pillars: (a) to use
the financial sector to allocate subsidies to agriculture in which bankers were dictated to whom
to lend and at what rates; and (b) to use the procurement, marketing, and credit arrangements of
the communist era to implement administratively set prices for the inputs and outputs of main
agricultural products, namely (i) ROMCEREAL, a parastatal controlling the country’s entire silo
capacity under a single management and (ii) the network of state-owned animal breeding
facilities.

These massive interventions have been extremely costly for the Government (about 20
percent of agriculture value added) and have had negative consequences for the development of
financial markets. State farms, storage and marketing agents (ROMCEREAL and later NAAP),
and the processing industry, which accounted for 20 percent of the gross agricultural output,
received 80 percent of agricultural-directed subsidies during 1992-1996. Private lenders have
been crowded out from rural credit markets, while lenders with no access to cheap resources to
subsidize their loans and permit arrears were out-competed. The repayment culture was
shattered, and as a consequence of the misallocation of resources, growth potential in rural areas
has ultimately been hampered.

Recent Liberalization in Agriculture

In 1997, the Government adopted an agricultural reform strategy supported by a structural

adjustment loan financed by the World Bank. The strategy covered four areas: (a) agricultural
incentives and credit; (b) operation of land and grain markets; (c) privatization of state-owned
farms and storage operators; and (d) adoption of a new mandate of the agricultural
administration. Although the reform was originally scheduled to be implemented over the period
of May 1997 to June 1998, there were significant delays, and full implementation was still
uncertain as of Fall 2000.

C. RURAL EMPLOYMENT

The rural labor market is virtually mono-sectoral with more than 70 percent of the labor
force in agriculture and mono-occupational and 65 percent of employment in farming. Rural
The Rural Economy and its Economic Agents 5

areas have a dual economy in which a commercial sector coexists with a large informal sector.
The commercial sector consists of about 80 thousand incorporated business, most of which were
created after the fall of the centrally planned regime. The informal sector consists, in large part,
of small-scale farms and a handful of other businesses, and is dominated by small-scale,
subsistence-based farms. The economy of these rural households is highly autarchic, is based on
low-input production technology, and is largely directed toward self-consumption.

With a working age population exceeding 8.2 million, the household survey shows that 72
percent of adults (15 years or older) were economically active, compared to 59.3 percent in
urban areas during the period covered by the survey. The age-labor force participation profile is
concave and peaks for the group of individuals in their forties. About 24 percent of adults were
wage earners, 27 percent were entrepreneurs (self-employed or employers), and 21 percent were
non-paid family labor. The majority of entrepreneurs (about 92 percent) were engaged in farm
activities and, compared to western economies, the extent of non-farm entrepreneurial activities
is minimal.

Gender differences in labor force participation are significant but small, with 75 percent of
males employed and only 67 percent of females holding any type of job during the period
covered by the surveys. However, the survey shows substantial differences in the types of jobs
between the genders. For example, 29 percent of males were employed as farm entrepreneurs,
compared to 20 percent of females. Moreover, family labor was more predominant among
females (29 percent) than among males (11 percent).

Labor markets show some differences among agro-regions. Farm entrepreneurs accounted
for 36 percent of adults in Moldova de Podis, but for only 14 percent in SAI. The proportion of
pensioners, which is only 5 percent in Moldova de Podis, is as high as 23 percent in Campia
Romana Centrala.

D. RURAL HOUSEHOLDS AND THEIR ECONOMIC ACTIVITIES

Most rural households operate with limited integration into market activities and primarily
engage in agricultural activities. About 61 percent of rural households were self-sufficient farm
households, according to the survey data, in that they did not: (a) sell any outputs; (b) buy any
inputs; (c) hire labor; or (d) rent or buy fixed assets. Seventeen (17) percent had some marginal
involvement in markets (less than US$20 of monthly sales), 12 percent had substantial market
involvement, 5 percent had non-farm entrepreneurial activities, and the remaining 5 percent
relied strictly on wages and pension benefits.

This limited market integration may reflect the comparative isolation of households from
large towns and market centers. About 52 percent of surveyed households lived 27 kilometers or
more from a town and 42 percent lived 11 kilometers or more from a railway station. Rural
households are headed by older men. Almost half of household heads were 60 years old and
older, and about three-quarters (74 percent) of them were males.
6 Chapter One:

Household Income

Average per capita monthly income of households was US$67 (567,980 lei) during the
period covered by the survey, which was about 60 percent of monthly per capita GDP and 50
percent of the average net wages at the national level. Household income was computed in four
categories: sales of agricultural products, sales of non-agricultural products, imputed value of
monthly self-consumption, and periodic income, such as wages and pension benefits.16 For the
average household, wages and pension benefits were the most important sources of household
income (58 percent), while agricultural and non-agricultural sales represented the least
significant sources, 6 percent and 5 percent, respectively. The imputed value of self-consumption
accounted for 30 percent of income.

The distribution of monthly per capita income is skewed, as 52 percent of income went to
the top quartile of households. The bottom quartile of the distribution earned 9 percent of the
total. In this way, households in the richest per capita income quartile earned six times more than
those in the poorest income quartile.

Household Wealth

The per capita wealth endowment of households had a market value of US$1,564
(13,261,300 lei) during the period covered by the survey.17 Agricultural land and housing
constituted the main assets of rural households for 25 percent and 32 percent of household
wealth, respectively.

The household survey shows that the distribution of wealth endowments is a bit more
skewed than that of income. About 59 percent of aggregate total wealth was owned by the top
wealth quartile. Moreover, households in the lowest wealth quartile had 12 times fewer assets
than households in the richest quartile.

Farm Households

Most farms are small and fragmented. The average farm had 2.1 hectares, and was
subdivided into 3 or 4 plots. In fact, 35 percent of households operate more than four farming
plots. About a fifth (17 percent) of all households operate a portion of their landholdings through
family associations and a very few (4 percent) in agricultural associations.

Almost all farms are for self-subsistence production (68 percent during the period covered
by the survey), are based on the labor input of household members (99 percent during the period
covered by the survey), and use very simple technologies. The typical farm is one where two
adults work and occasionally hire one paid worker during the peak planting or harvesting season.
Most farmers use their own seeds to grow grains and their own livestock to raise animals. About

16 This last category includes wages, pensions, social aid and other protection benefits, plus annual incomes from
land leased, dividends, and asset rentals.
17Household wealth includes the imputed value of buildings, agricultural land, houses, equipment, livestock, and
agricultural stock. Annex 1 provides a detailed description of the method used to estimate the value of these assets.
The Rural Economy and its Economic Agents 7

half of farmers utilize fertilizers but only a small percentage apply pesticides or other intensive
inputs. Most farmers rent machinery or animal-traction to plough and harvest.

Larger farms are the exception. Less than 17 percent of farms earned an income higher
than the economy-wide average wage during the period covered by the survey. Only one percent
of farms had one or more permanent paid worker and only 8 percent operated more than 5
hectares. There are significant regional differences in the size of farms. Farms located in
Transylvania, Western Plain and
Southern Sub-Carpathia earn
Figure 3 Rural Households by Farm Size
higher incomes and are
wealthier. These areas are also
5 Has or more Landless the ones where farm
(8%) (12%) entrepreneurs hire permanent
workers and where there is a
2 - 5 Has higher incidence of seasonal
(28%) workers. Farms located in
< 1 Ha (30%)
Transylvania are the largest and
are more fragmented on average.

Although GDP declined

1- 2 Has dramatically in 1997, most farm
(22%)
households perceived that their
activities were the same in 1996
Source: Survey of Rural Households and Financial Services, 1998. as in 1997 (42 percent). Only 21
percent considered that
economic conditions declined in 1997, while the remaining 34 percent reported that 1997 was
better than 1996. Among those farm households reporting 1997 as their worst year, 90 percent
attributed their situation to low income levels resulting from such causes as low levels of
production.

Non-Farm Households

Non-farm entrepreneurial activities are very limited among rural households. Only 5
percent of households had members who were entrepreneurs outside agriculture during the
period covered by the surveys. These members accounted for about two percent of the
economically active rural population. Non-farm entrepreneurs had (mostly small) businesses in
all economic sectors with 25 percent in (mostly small) trade, 23 percent in the processing
industry, 21 percent in transportation, 15 percent in construction, and 10 percent in services.

Whether measured by number of employees, value of assets, non-farm income, or

accounting practices, the business activities carried out by non-farm households tend to be small
and informal. In fact: (a) 75 percent employed one or no workers at all during the period
covered by the survey; (b) 75 percent had an endowment of assets in their business of less than
US$1,775; (c) their average monthly income was US$139, which was higher than farm
entrepreneurs, nevertheless; (d) 40 percent were not registered nor had licenses; and (e) only 27
percent kept formal accounting records of their activities. These small and micro rural businesses
were comparatively young and depended mostly on local markets. More than half had been in
8 Chapter One:

business for less than five years, while only about a tenth of them sold their products or services
outside their immediate community.

E. RURAL ENTERPRISES

As of 1997, the Romanian rural economy contained about 80,000 rural enterprises.18 The
large majority of them were engaged in trade and commerce (62 percent). Agriculture was the
main activity for 6 percent of them. The remaining enterprises were evenly divided between the
service sector (15 percent) and industry and construction (16 percent).

Private sector enterprises dominate the sector in terms of number of enterprises (98 percent
were totally private during the period covered by the survey). However, the participation of the
state in terms of the value of assets was very significant and disproportionately large. The two
percent of enterprises that had some degree of state ownership controlled more than half of the
aggregate book value of the assets of all rural enterprises. The incidence of state ownership is
highest in agriculture, where about a fifth of agricultural businesses were owned partly by the
state during the period covered by the survey. These state enterprises in agriculture were
particularly large. They accounted for about one percent of all rural enterprises, but controlled
about 43 percent of their assets.

The private enterprise sector is basically composed of small and medium size businesses.
In fact, the average private enterprise had US$11,900 of assets at book value, and 80 percent had
less than 5 employees during the period covered by the survey.

Most firms are owned by few individuals, as 93.2 percent had less than five partners or
shareholders during the period covered by the survey. In agriculture, however, the situation is
reversed as 74 percent of businesses had more than 5 partners or shareholders.

The average age and years of experience of managers of agricultural-related businesses is

higher than the average for the rural sector (48 years of age with 15.4 years of experience in the
case of agricultural managers, and 42 years of age with 8 years of experience for the whole
sector during the period covered by the survey). About half of the managers of private sector
enterprises were under 40 years of age, while less than 20 percent of state enterprises had
managers under 40.

Table 1 presents the consolidated balance sheet for the rural enterprise sector in 1997. The
sector was dominated by agriculture in terms of activity and by the state in terms of ownership.
Agriculture accounted for 57 percent of total assets while the state controlled about half of all
assets. Dominance of agriculture resulted because the book value of land and buildings
accounted for 42 percent of total assets in the hands of rural enterprises, of which three quarters
were devoted to agricultural production. The value of land in agriculture, however, represented a
smaller percentage of total assets than that normally observed in countries with developed

18This figure excludes all: (a) enterprises with operations in rural areas, but with headquarters in urban areas, and
Regies Autonomes; (b) enterprises not legally incorporated; (c) branch offices of financial institutions, public
administration offices; (d) educational institutions; and (e) health care units.
The Rural Economy and its Economic Agents 9

agriculture. For instance, in the United States real estate has represented roughly from 70 to 80
percent of aggregate agricultural assets over the last 30 years.

A combination of the following two elements may explain the deviation of Romanian
agriculture from the international norm. First, land markets in Romania have not worked well
which has led to low land values. Second, Romanian accounting norms do not allow revaluation
of fixed assets. The upper bound for the share of real estate in the market value of total assets in
the sector was 72 percent. This ratio results from adjusting the consolidated financial statements
of enterprises according to International Accounting Standard (IAS) No. 29 (see Table 2) to
account for high inflation in the period under analysis. This share is considered an upper bound
because it is unlikely that the market value of land adjusted at the same pace as inflation.

Rural enterprises in the aggregate financed 52 percent of their assets with debt. The most
indebted sub-sector was trade and commerce, with a debt to assets ratio of 72 percent.
Agriculture was the least indebted with a corresponding ratio of 43 percent.

This level of indebtedness is at the lower end of the debt to assets ratios of non-financial
sector enterprises in industrialized countries. These ratios varied from 51 percent in the United
States to 80 percent in Japan.19 However, the capacity of the rural sector to carry debt is a matter
of policy concern. There is a potential problem because illiquid assets, especially land, dominate
the sector’s balance sheet. The capacity of assets to carry debt is directly related to their liquidity.
This problem may be particularly serious for Romanian agriculture. Debt levels are already high
in the sub-sector. The 43 percent debt to assets ratio of Romanian agricultural enterprises
contrasts sharply with the equivalent ratios for agriculture in the United States, which varied
from about 12 to 16 percent over the last 30 years.

The profitability indicators of the enterprise sector are rather weak. These indicators vary
significantly between private and state enterprises and across sub-sectors. The aggregate return
on equity (ROE) and return on assets (ROA) of Romania’s rural enterprises in 1997 were much
lower than inflation (19 percent and 9 percent, respectively, against an annual inflation rate of
155 percent). The ROE of private enterprises was 69 percent and that of state owned enterprises
was negative 9 percent. The share of state enterprises which reported losses was 53 percent,
while the equivalent share among private ones was 29 percent. The aggregate of agricultural
enterprises reported losses. The remaining sectors generated aggregate profits. The trade sub-
sector was, by far, the most profitable in terms of ROE.20

Cash flow analysis confirms the above findings (see Table 1). The value of the sales
(products and services) of the entire rural enterprise sector was not sufficient to cover production
costs and operational expenses in 1997. The gross net cash from operations was negative at the

19 The corresponding ratios for selected countries are 56 percent for the United Kingdom, 57 percent for France, 60
percent for Germany, 72 percent for Switzerland, and 76 percent for Italy. The consolidated debt ratio of Romanian
rural enterprises, calculated on the basis of their financial statements adjusted by inflation, is 25 percent (see
table1.A).
20The financial statements adjusted for inflation indicate that the consolidated ROE for rural enterprises was 2.4
percent. Private sector enterprises had a consolidated ROE of 16 percent while their state-owned counterparts had a
ROE of negative six percent.
10 Chapter One:

consolidated level and for all sub-sectors with the exception of trade. The net cash from
operations was made (barely) positive by significant non-operational income, namely financial
and exceptional revenues.

A worrisome implication from Table 1 is that rural enterprises are not able, in the
aggregate, to serve their existing debt. In particular, the agricultural and services sub-sectors
need to incur additional debt to serve interest payments and amortize the principal amount of
their outstanding debts. The table also shows that the state-owned sub-sector was the cause of
this situation, as the negative balance on its net cash flow in 1997 was large enough to wipe out
the net cash surplus generated by the private sector. Interestingly, the enterprise survey shows
that the banking sector allocated 45 percent of all new credit flows to state enterprises with
negative cash flows.

The capacity of the sector to carry debt and its efficiency in allocating credit flows to the
best alternative uses is analyzed in detail in Chapter IV. Nonetheless, it should be noted that a
likely outcome of lending to state enterprises with negative cash flows is that these loans will
have to be assumed by the Government or by the banking system, as the likelihood of these
enterprises returning to a positive cash flow under state ownership is minimal and privatizing
them will be difficult while they have a large debt overhang.

Among private enterprises, the agricultural sub-sector is the least profitable with a ROE of
8 percent in 1997. Private enterprises in all sub-sectors, except trade, also had operating and
production expenses above the value of sales. Thus, in the aggregate their gross cash from
operations was negative. The difference was that private enterprises had more miscellaneous
revenue and lower financing costs relative to assets. This situation allowed them to serve their
existing debts without additional injections of external funding.
The Rural Economy and its Economic Agents 11

Table 1 Consolidated Financial Performance of Rural Enterprises in 1997

Economic Sector Ownership Type

Industry &
(in billion Lei) Total Agriculture Construction Trade Services Public Mixed Private
Balance Sheet (yearly avg.)

Fixed assets 8,291 5,936 1,441 669 245 1,075 4,678 2,539
Current assets 7,094 2,760 1,412 2,691 231 301 1,767 5,027
Other assets 367 258 61 40 8 3 77 287
Total Assets 15,752 8,954 2,914 3,399 485 1,378 6,522 7,852

Equity 7,446 5,137 1,114 948 247 833 3,988 2,625

Provisions & others 59 18 37 4 0 0 18 41
Liabilities 8,178 3,788 1,752 2,425 213 545 2,489 5,144
Other Liabilities 69 11 12 22 25 0 27 42
Total liabilities & equity 15,752 8,954 2,914 3,399 485 1,378 6,522 7,852
Income Statement
Total revenue 33,464 8,564 7,121 16,370 1,408 753 5,227 27,484
Total expenses 30,939 8,748 6,958 13,932 1,300 780 5,588 24,570
Net Income (Loss) before taxes 2,525 -184 163 2,438 108 -27 -361 2,913
Net Income (Loss) 1,398 -278 70 1,526 79 -40 -395 1,834
Financial Ratios (%)
Debt Ratios
Liabilities / Assets 51.9 42.3 60.1 71.3 43.9 39.6 38.2 65.5
Liabilities / Equity 109.8 73.7 157.4 255.7 86.2 65.4 62.4 196.0
Bank Loans / Liabilities 72.3 83.0 60.0 64.2 74.5 93.0 85.6 63.6
Assets / Equity 211.6 174.3 261.7 358.4 196.3 165.4 163.5 299.1
Profitability Ratios
Return on Equity 18.8 -5.4 6.3 160.9 32.1 -4.9 -9.9 69.8
Return on Assets 8.9 -3.1 2.4 44.9 16.4 -2.9 -6.1 23.4
Profit Margin on Sales 4.7 -4.5 1.1 9.4 6.6 -7.1 -10.9 7.2
Statement of Cash Flowsa
1 Cash from Sales 21,003 3,118 3,516 13,409 959 522 1,358 19,123
2 Cash Production Costs -18,408 -3,105 -3,378 -10,921 -1,003 -425 -1,604 -16,378
3 Gross Cash Margin (1+2) 2,595 13 137 2,488 -44 97 -246 2,744
4 Cash Operating Expense -2,736 -1,098 -562 -897 -179 -165 -500 -2,070
5 Gross cash from operations (3+4) -141 -1,084 -425 1,591 -223 -69 -747 674
6 Miscellaneous Cash Income 2,439 1,351 734 159 195 168 833 1,439
7 Taxes paid -1,209 -157 -105 -905 -43 -32 -63 -1,114
8 Net Cash from Operations 1,089 110 205 846 -71 68 23 998
(5+6+7)
9 Financing Costs and Exceptional -1,161 -816 -205 -120 -20 -180 -480 -501
Costs
10 Net Cash Income (8+9) -71 -706 1 725 -91 -113 -456 498
11 Net capital expenditures -911 88 -310 -572 -117 -19 219 -1,111
12 Financial Surplus (Requirements) -982 -618 -309 153 -208 -132 -237 -613
(10+11)
13 External Financing 1,209 634 382 -26 220 152 233 824
14 Cash and Deposits after 227 16 72 127 12 20 -5 211
Financing (12+13)
15 Actual Change in Cash and -227 -16 -72 -127 -12 -20 5 -211
Deposits
a
Excludes those enterprises for which the cash flow statement did not balance (about 15 percent of observations)
Source: Survey of Rural Enterprises and Financial Services, 1998.
12 Chapter One:

Table 2 Consolidated Financial Performance of Rural Enterprises in 1997 (Adjusted by Inflation)

Economic Sector Ownership Type

Industry &
Agri- Construc-
(billion Lei) Total culture tion Trade Services Public Mixed Private
Inflation Adjusted Balance Sheet (yearly avg.)
Fixed Assets 19,919 14,976 3,205 1,236 502 2,670 12,011 5,238
Current Assets 12,625 5,373 2,076 4,813 363 511 3,639 8,475
Other assets 372 264 60 39 8 3 81 288
Total assets 32,915 20,613 5,341 6,089 872 3,183 15,731 14,001

Equity 24,440 16,660 3,512 3,633 635 2,634 13,099 8,707

Provisions & others 61 19 37 4 0 0 19 42
Liabilities 8,366 3,924 1,785 2,443 214 549 2,587 5,229
Other liabilities 49 11 7 8 24 0 27 23
Total Liabilities & Equity 32,915 20,613 5,341 6,089 872 3,183 15,731 14,001
Inflation Adjusted Income Statement
Total revenue 49,954 19,647 9,412 19,111 1,783 2,524 13,915 33,515
Total expenses 48,244 20,269 9,468 16,787 1,719 2,593 14,636 31,015
Net Income (loss) before 1,710 -621 -56 2,324 64 -69 -722 2,500
Taxes
Net Income (loss) 583 -715 -149 1,412 35 -82 -755 1,420
Financial Ratios (%):
Inflation Adjusted Financial Ratios
Liabilities / Assets 25.4 19.0 33.4 40.1 24.5 17.3 16.4 37.3
Liabilities / Equity 34.2 23.6 50.8 67.3 33.7 20.9 19.8 60.1
Assets / Equity 134.7 123.7 152.1 167.6 137.5 120.9 120.1 160.8
Return on Equity 2.4 -4.3 -4.2 38.9 5.5 -3.1 -5.8 16.3
Return on Assets 1.8 -3.5 -2.8 23.2 4.0 -2.6 -4.8 10.1
Net income / Sales 2.0 -11.5 -2.4 8.7 2.9 -14.5 -20.8 5.6
Sales / Avg. Assets 90.1 30.1 114.5 265.5 137.1 17.8 23.1 181.9
Source: Survey of Rural Enterprises and Financial Services, 1998.
 Chapter II: Rural Financial Intermediaries, Market
Shares, Credit Products, and Deposit Services
This chapter describes the Romanian financial sector in general and the providers of
financial services in rural areas. In particular, the chapter analyzes financial service providers’
distribution network, market shares, preferences in lending, and the characteristics of the
financial services that they provided to their clienteles. This information is necessary background
for the study’s findings on the performance of rural financial markets and for the design of
government interventions and policies to improve such performance. 21

Figure 4 Credit from Deposit-taking Banks to A. THE FINANCIAL SECTOR

the Private Sector, 1998 (as percent of GDP)
Traditional measures of financial
A ZE 3.3% market development, such as broad money
K AZ 6.2% to GDP, market capitalization to GDP, or
UKR 7. 6%
outstanding private sector credit to GDP
ARM 8 .6%
show that the financial sector in Romania
L TU 11.3%
is shallow and underdeveloped compared
BUL 12.7%
to other countries in the region, as well as
RO M 12.7%
other countries with similar levels of
RUS 12.9%
income per capita.22
L AT 14.1%

M OL 14.4%
Further, financial sector
POL 19.6%
development in Romania is taking place in
H UN 23.3%
an environment where lenders and
EST 25 .3%
borrowers must contend with
S LO 32.9%
macroeconomic instability, an uncertain
CRO 40. 9%
and insecure legal environment, and a
S VK 45.9%
taxation regime which is not friendly to
CZE 58.0%
financial intermediaries and transactions.
0% 20% 40% 60% 80% Figure 4 shows that Romania’s financial
Per cent of GDP sector ranks near the bottom among
Central and Eastern European countries in
Source: Eichengreen and Rühl, 2000. terms of financing of private sector

21 The chapter attempts to provide the required information as succinctly as possible. Readers familiar with the
sector may skip some sections accordingly. Those unfamiliar with the subject may benefit from reading Annex 2 of
this study, which contains more detailed information on Romania’s financial sector.
22Sections A and B of this Chapter are drawn largely from Chapter 5 (“Financial Sector Development”, Chaves,
2000) of the Romania Country Economic Memorandum (CEM), the publication of which is forthcoming.
14 Chapter Two:

activities.

The role of market-based financial intermediation (enterprise finance provided through

stock markets or other security markets) in Romania is even smaller than that of the banking
sector, implying that the financial sector remains dominated by bank-based intermediation.23
Credit markets, in turn, are dominated by the banking industry, because the size and presence of
non-banking sector lenders, including leasing and financial companies, are negligible.

B. THE BANKING SUB-SECTOR

The number of banks has moderately increased in Romania (see Table 3) since the early
1990s after the mono banking system was abandoned, and the number of commercial banks has
remained stable over the last few years. By mid-2000, 42 banks operated in Romania, including
7 subsidiaries of foreign banks.

Overall, Romania remains severely “undermonetized” and “underbanked”. It is

undermonetized both in terms of the ratio of domestic credit from deposit-taking institutions to
GDP and in terms of asset size (see Figure 4, Figure 5, and Table 3). It is underbanked in the
sense that the absolute size and number of assets in the banking system is small relative to the
existing number of banks, bank branches, and bank personnel. Total assets in the banking sector
reached 192 trillion Lei in September of 2000 (about $7.6 billion), which is less than the assets
of a medium-sized German bank.

The banking system is dominated by state banks, which accounted for 71 percent of total
banking assets and 81 percent of total bank deposits in national currency during the period
covered by the surveys. Private banks are becoming important players in the capitalization of the
banking system, however. Their share in the system’s capital increased by 10 percentage points
to well above 40 percent from 1994 to 1996 (Davis Hare, 1997).

State-owned, private, and foreign banks have traditionally specialized in different market
niches in the aggregate economy24. State-owned banks have specialized in servicing state
enterprises and the agricultural sector. The subsidiaries of international banks have been mainly
interested in servicing multinational and corporate clients.

23Because securities markets play such a limited role in Romanian financial markets, they are not discussed here. A
detailed discussion of Romanian securities markets is presented in Chapter 5 (“Financial Sector Development”,
Chaves, 2000) of the Romania Country Economic Memorandum (CEM), 2000.
24The market shares of each type of bank and the kinds of clients to which they lent in rural areas are presented in
detail in section D of this Chapter.
Rural Financial Intermediaries, Market Shares, Credit Products, and Deposit Services 15

Figure 5 Credit to the Private Sector: Transition Economies and Rest of the World, 1998 (as
percent of GDP)

100%

90%

80%

70%

60% Non-transition economies

CZ
SEE
50%
SVK CE and Baltics
CR
40% CIS
SLO
30%
HU
EST
20% FYRM
BEL
MOL BUL LAT PL
RUS
10% UKR
RO
ARM KYR LIT
KAZ
AL AZ
0%
0 5000 10000 15000
Income per capita at Purchasing Power Parity

Source: Romania: Country Economic Memorandum, publication forthcoming.

While the ownership structure of the banking sector is still behind other European
transition economies in terms of the share of private banks, it has improved over the last few
years. This is due to privatization efforts (Bank Post and the Romanian Development Bank), but
even more so to the closure of the largest state-owned bank, Bancorex, in 1999. Improvements
in the composition of the bad loan portfolio in commercial banks can be traced to the same cause
(see Table 4): (a) the clean up of 1998 and 1999, when Bancorex was first put under special
administration and then liquidated; and (b) the neutralization of Banca Agricola through its
takeover by an NBR-sponsored management team. These events restricted Banca Agricola’s
activities (in particular, by not allowing it to engage in any new lending and investment
operations) and enhanced provisioning and capital adequacy ratios across the board.
16 Chapter Two:

Table 3 Composition of the Romanian Banking Sector, 1996-2000

1996 1997 1998 1999 2000:I
Number of Commercial Banks 35 37 45 41 42
Of which:
Romanian incorporated banks 29 31 36 34 35
State-owned 7 7 7 4 4
Private 22 24 29 30 31
Of which joint venture with foreign 8 11 15 19 22
Branches of foreign banks 6 6 9 7 7
Banks under special treatment* 1 1 3 3 3
Share of Total Banking Sector Assets
All commercial banks 100 100 100 100 100
Of which:
Romanian incorporated banks 96.1 93.4 94.3 92.9 92.5
State-owned 77.8 74.7 71.0 46.8 44.3
Private 18.4 18.7 23.3 46.2 48.2
Of which joint venture with foreign 4.3 6.4 10.4 40.5 44.1
Branches of foreign banks 3.9 6.6 5.7 7.1 7.5
Banks under special treatment 3.7 1.7 2.5 1.8 2.0
* Suspended, special administration, in court, etc.
Source: National Bank of Romania and International Monetary Fund, 2000.

Table 4 shows that there is no room for complacency. The aggregate balance sheet of
Romania’s commercial banks, with more than one third classified as non-performing (doubtful
and loss), remains one of the worst in the entire region. The improvements in loan loss
provisioning and capital adequacy are in part (in the case of loan loss provisions) due to
improved supervision and regulation or (in the case of capital adequacy) to an increased capital
adequacy requirement (from 9 to 12 percent in 1999). They are, however, also partially the result
of the large transfers of non-performing assets to the newly established asset recovery agency
AVAB (Agentia de Valorificae a Activelo Bancare) that took place in 1999 as part of World
Bank conditionality. Moreover, though the amount of non-performing assets in state-owned
banks largely reflects past years’ exposure to political pressure to engage in directed lending, a
factor which influenced the lending practices of these banks and exacerbated the bad loan
problem, there is increasing evidence that private banks are getting into difficulties, and these
difficulties are due to more complex and market-related factors.

As in other transition economies, the banking sector does not have access to long-term
funding and thus cannot provide the medium- and long-term credit which would be required to
finance the long-term investments that bring about growth. After a prolonged period of high
inflation, neither assets nor liabilities are available on maturities in excess of one year. In fact,
the bulk of bank liabilities tend to be sight deposits that could be withdrawn at call. Although
banks have invested these liabilities in mostly short-term assets, there is a maturity mismatch,
because the weighted maturity of assets exceeds the maturity of liabilities. This maturity
mismatch, the result of the lack of long-term funding makes long-term loans risky, because
banks may experience operational losses if market interest rates increase.

Banking supervision improved following a re-organization of the National Bank of

Romania (NBR) which, in September 1999, consolidated on- and off-site supervision with bank
Rural Financial Intermediaries, Market Shares, Credit Products, and Deposit Services 17

rating and early warning functions in a new Supervision Department. Another new Department,
the Financial and Banking Policies Department, is responsible for licensing, formulation of
prudential regulation, and the like. The frequency and coverage of on-and off-site supervision
have also improved, and the current bank rating and early warning system is based on
international standards. In practice, however, the NBR does not have a good track record in
banking and financial market supervision, as the continuing difficulties in the banking sector
(where several insolvent banks have remained active and are awaiting some sort of resolution for
years) demonstrate.

Table 4 Non-performing Loans, Provisions, and Capital Adequacy Ratio (1996-2000)

1996 1997 1998 1999 2000:I
Share of Non-Performing Loans
All commercial banks 100 100 100 100 100
Of which:
Romanian incorporated banks 47.2 52.6 58.5 35.4 35.4
State-owned 43.0 51.1 52.9 32.3 36.2
Private 63.3 60.1 73.9 37.5 34.8
Of which joint venture with foreign 24.1 56.2 45.1 26.0 34.2
Loan Loss Provisions: Share of Actual to Required
All commercial banks 100 100 100 100 100
Of which:
Romanian incorporated banks 64.5 73.1 73.8 102.7 94.4
State-owned 59.2 74.5 72.3 114.5 91.2
Private 79.0 57.0 77.4 94.6 96.9
Of which joint venture with foreign 40.3 56.0 57.6 90.7 97.3
Capital Adequacy Ratio of the Banking System
All commercial banks 14.0 13.6 10.3 17.5 21.4
Of which:
Romanian incorporated banks 14.0 13.6 10.3 17.5 21.4
State-owned 13.2 12.0 10.3 17.5 20.4
Private 18.4 22.0 10.0 17.5 22.1
Of which joint venture with foreign 22.2 34.7 36.6 27.0 22.2
Source: National Bank of Romania and International Monetary Fund, 2000.

Despite recent regulatory reforms, the state of the Romanian banking system remains
uncertain and lags behind other transition economies (Davis and Hare, 1997; Meyer et. al, 1997;
Schrieder and Heidhues, 1997). Unfortunately, government-mandated lending programs where
banks had limited authority to decide on the allocation of credit persisted up to 1997 (Schrieder
and Heidhues, 1997). The ability to appraise loans has been acquired only gradually, and other
banking skills and business methods are still in their formative stages. Chronic asset quality
problems, political interference in lending, shortage of liquidity, poor capitalization, burdensome
non-performing loans, poor management, and lack of transparency are among the main issues
that have negatively affected the performance of the banking sector. A volatile macroeconomic
environment and the poor financial performance of enterprises in general have contributed to this
adverse state of affairs.

Substantial restructuring and privatization of state banks will be necessary to build a strong
banking system. The privatization of Romanian Development Bank and of Banc Post in 1998,
18 Chapter Two:

the divestiture of Bancorex, and the recent decision to place Banca Agricola under special
administration are a step forward in reducing political interference and ensuing credit losses in
the system. Still, however, there will be a strong need to significantly improve the scope and
quality of banking services, especially at the retail level.

C. MUTUAL RURAL FINANCIAL INTERMEDIARIES

This section presents data on credit cooperatives (CCs) and Casa de Ajutor Reciprocs
(CARs) which are non-bank mutual financial intermediaries.25 These intermediaries date back to
the mid-1800s and are owned by their members who are also depositors and borrowers. During
the communist era, CARs were taken over by the labor unions of state enterprises and were
merged with credit and consumer cooperatives. Since 1989, credit cooperatives and CARs have
been classified as separate entities and have provided simple savings and loan services to their
members independently.

Credit Cooperatives

Credit cooperatives are organized in a three-tiered system. There were 840 credit
cooperatives operating at the comuna level, with a membership of about 1.8 million farmers,
professionals, and self-employed individuals in 1998. These cooperatives were organized in 41
federations comprised of the credit cooperatives and consumer cooperatives that operate in each
judet (FEDERALCOOP). There were from 15 to 20 credit cooperatives in each judet. At the
national level, credit cooperatives are affiliated with an apex institution (CREDITCOOP). Lastly,
the federation of credit unions is associated with the consumer cooperatives’ network, forming
the National Cooperative Union (CENTROCOOP).

As of December 1998, credit cooperatives had about US$92 million (1,000 billion Lei) in
assets and US$63.1 million (688 billion Lei) in deposits from members. The value of their
portfolio of outstanding loans was about US$69 million (750 billion Lei). While most credit
cooperatives operate in rural areas, loans to agricultural activities accounted for only 10 percent
of outstanding loans during the period covered by the surveys. These are small financial
intermediaries, therefore. The average credit cooperative in Romania had assets of US$110,000
and 3.5 employees during the period covered by the surveys.

The supervision of credit cooperatives rests with the House of Credit Cooperatives
(CREDITCOOP). However, this responsibility is delegated at the judet level to Territorial
Houses of Credit Cooperatives. The National Bank of Romania (NBR) has never supervised
credit cooperatives.

CREDITCOOP and the Territorial Houses are so involved in the lending process that, in
practice, numerous credit cooperatives behave as branches, rather than as independent

25There are an estimated 1,400 independent mutual financial intermediaries (MFIs) registered under Law 109/1996.
The information presented in this section corresponds to the CCs and CARs affiliated with national systems. There
was no information available on other non-affiliated MFIs, most notably Banca Populara. Chapter V addresses the
regulatory hazards implied by the functioning of numerous unregulated MFIs, and provides possible options to
ameliorate such risks.
Rural Financial Intermediaries, Market Shares, Credit Products, and Deposit Services 19

intermediaries. Small loans under US$350 (3 million Lei) are approved by credit cooperatives
themselves. Loans up to about US$825 (7 million Lei) must be approved by the corresponding
Territorial House of Credit Cooperatives. Larger loans must be approved by CREDITCOOP.

Casa de Ajutor Reciprocs

Casa de Ajutor Reciprocs are mutual financial organizations that primarily serve workers
of rural enterprises, commercial societies, and state-owned companies. CARs are also organized
in a tiered system. Casa de Ajutor Reciprocs are the units at the comuna level. There are unions
at the judet level, while the Uniunea Nationala a Caselor de Ajutor Reciproc (UNCAR) includes
all the CARs in the country.

As of March 1999, there were about 4,600 CARs out of which 400 were in rural areas.
Membership was about 1.8 million individuals, outstanding loans amounted to US$70 million
(767 billion Lei). The average loan outstanding loan was for US$192.

CARs seem to have simple but strict loan underwriting standards, requiring a combination
of cosigners and collateral. Various studies report that CARs experience virtually no loan losses
(Meyer 1997).

D. DISTRIBUTION NETWORK OF FINANCIAL SERVICES

This section describes the Romanian distribution network of retail finance and the services
it provides. The objective is to examine the ownership structure of this network and the role it
plays in providing access to financial services, if any, especially in rural areas. In particular, the
following questions are answered. First, who owns the distribution network of retail financial
services? Second, which localities are more likely to have financial outlets and which specific
economic and demographic factors are related to the presence (or absence) of financial outlets?
Third, which factors are related to the total number of financial outlets in the different localities?
Fourth, which economic and demographic factors explain the ratio of loans to deposits in
branches located in different communities?

While the financial sector in Romania is still relatively underdeveloped, the country
possesses an extensive network of retail financial outlets in both rural and urban areas. This
network is dominated by state banks and by unregulated mutual financial intermediaries (mostly
credit cooperatives).

The country had 3,156 bank branches and 840 credit cooperatives for a total of 4,076 retail
outlets during the period covered by the survey. There was one retail outlet for every 58 km2 and
for every 5,597 inhabitants, which indicates that the banking network is particularly dense. As
shown in Figure 6, while the industrialized countries have more bank branches per capita, few
developing countries have more bank branches per capita than Romania. An exception is India
with 4,000 inhabitants per bank branch. Mexico is an example of the other extreme, with 28,000
per bank branch.
20 Chapter Two:

There are four types of bank retail outlets. Full branches (sucursula judetana), sub-branches
(sucursula), agencies (agenties), and offices (point du lucru). Branches and sub-branches are very
similar in terms of loan and
deposit services offered to
Figure 6 Population per Bank Branch
customers. However,
Romania
branches are located in the
Spain capital of each judet. Most
United States decision-making is
Canada conducted at the
Britain branch/sub-branch level.
Germany
Agencies and offices do not
France
process or approve loan
Italy
applications. Instead, they
Japan

India
remit all loan applications to
Australia
the main branch in the
Argentina locality, or directly to
Brazil headquarters. Nonetheless,
Mexico approved loans are
- 5,000 10,000 15,000 20,000 25,000 30,000 disbursed and recorded at
the agency level after
Source: International Bank for Settlements, 1999.
upstream approval.
Agencies accounted for 61
percent of outlets, branches and sub-branches for 34 percent, and offices for four percent during
the period covered by the survey.

The banking sector’s distribution network was dominated by state banks which owned 87
percent of all retail outlets. Of the 3,156 bank retail outlets, 2,749 were owned by state banks.
Private banks owned the remaining 407 outlets. This large network is concentrated in only a few
banks, however. For instance, the Savings Bank (CEC) owned 1,970 outlets, which accounted
for 60 percent of the total, while 86 percent of private outlets belonged to two private banks,
which had 348
outlets between
Figure 7 Percentage of Localities with Financial Outlets across them.
Population Brackets
% locality bracket Slightly more
100
90 than half of all
80
All Localities financial outlets
70
54
59 Up 2 thou were located in
60
50
2-3.5 thou rural areas during
3.5 -5 thou
40 30
5-8 thou
the period covered
30
>8thou by the survey (52
20
9 percent). State
10
0 owned banks were
with State-owned with Private banks with Credit with any financial
banks cooperatives outlet
the predominant
institutions in rural
Source: Survey of Financial Intermediaries, 1998. areas (they owned
94 percent of
Rural Financial Intermediaries, Market Shares, Credit Products, and Deposit Services 21

outlets in such localities). This dominance resulted because state banks not only had about five
times more outlets than private banks, but also located 52 percent of them in rural areas. Private
banks, in contrast, had 23 percent of their (fewer) outlets in rural areas.

About 60 percent of the country’s localities had at least one financial retail outlet (either a
bank office or a credit cooperative) during the period covered by the survey. State banks had
established financial outlets in 54 percent of the country’s localities, private banks in about 9
percent, and cooperatives in 30 percent. Naturally, bank outlets tended to be concentrated in
localities with more population. Only 25 percent of localities with 2,000 or less inhabitants had
an outlet. In contrast, 95 percent of localities with more than 8,000 inhabitants had a branch (see
Figure 7).

Other regional and demographic variables are related to the likelihood of a locality having
at least one outlet. An econometric model of the factors that explain the presence or absence of at
least one financial outlets was applied to the data.26 The model showed that there were
substantial differences across agroregions.27 Localities in Campia Romana Centrala and in
Campia Dunarii de Jos were more likely to have outlets with statistical significance. All other
agro-regions were less likely to have outlets.

The econometric results also indicate that, everything else the same, localities more likely
to have at least one outlet were those with: (a) larger population; (b) higher average education of
population; and (c) higher share of professionals (doctors and teachers) and of farmers.

There were statistically significant differences in the preferences for location of outlets
between private banks and public banks. Private banks were more likely, everything else the
same, to have branches in Campia de Vest, Subcarpati de Sud, and SAI. State-owned banks
behaved in the opposite way. They were less likely to have established branches in these three
localities. State-owned and private banks had a statistical preference for establishing outlets in
Campia Dunarii de Jos and Campia Romana Centrala. State banks were also less likely to open
outlets in Moldova de Podis and Moldova Deal.

The presence of outlets at the locality level, albeit necessary, is not sufficient to guarantee
retail customers effective access to financial services. The data presented below focus on the
ratio of loans to deposits in these outlets and on whether there were systematic differences
between public and private banks and between large and small localities.

26 A probit model explains a dichotomous dependent variable that takes the value of one when there is one or more
outlets in a locality, and of zero when there is no outlet, on the basis of a vector of observable characteristics of the
locality in question.
27 Romania can be divided into nine agro-regions: Transilvania, Campia de Vest, Moldova de Podis, Moldova Deal,
Subcarpatii de Sud, Campia Dunarii de Jos, Oltenia de Sud, Campia Romana Centrala, and SAI (where Bucharest is
located). An agro-region is composed of various judets with a similar pattern of land use. The groupings were
determined using multivariate cluster analysis by finding the regions which minimize the variance of patterns of
land use within all of Romania’s 41 judets.
22 Chapter Two:

Table 5 Consolidated Loans, Deposits, and Loan-to-Deposit Ratios by Agro-region and Population
All Localities All Banks Private Banks Only State Banks Only All Banks -CEC Credit Coop
Loans 15,490,.25 2,430.49 12,612.92 15,222.44 446.83
Deposits 21,580.74 2,746.88 18,629.41 16,429.56 204.46
Loans/Deposits Ratio 0.72 0.88 0.68 0.93 2.19
Agroregions
Transilvania
Loans 4,679.81 546.07 3,993.48 4,61839 140.26
Deposits 6,957,.7 727.54 6,156.37 5,536.05 73.46
Loans/Deposits Ratio 0.67 0.75 0.65 0.83 1.91
Câmpia de Vest
Loans 1,334.83 216.14 1,055.63 1,317.48 63.07
Deposits 1.334,83 216.14 1,055.63 1,660.91 29.88
Loans/Deposits Ratio 0.64 0.58 0.62 0.79 2.11
Moldova de Podiº
Loans 1,276.23 290.86 949.50 1,261.01 35.88
Deposits 1,459.46 232.30 1,213.50 1,075.76 13.66
Loans/Deposits Ratio 0.87 1.25 0.78 1.17 2.63
Moldova Deal
Loans 1,373.85 188.84 1,152.79 1,335.63 32.23
Deposits 1,963.05 239.65 1,708.33 1,446.59 15.07
Loans/Deposits Ratio 0.70 0.79 0.67 0.92 2.14
Subcarpa?ii de Sud
Loans 2,719.50 408.87 2,233.17 2,665.43 77.46
Deposits 4,421.91 520.03 3,868.02 3,230.37 33.87
Loans/Deposits Ratio 0.62 0.79 0.58 0.83 2.29
Câmpia Dunãrii de Jos
Loans 1,492.02 188.12 1,269.95 1,469.46 33.94
Deposits 1,932.17 220.11 1,699.84 1,449.29 12.22
Loans/Deposits Ratio 0.77 0.85 0.75 1.01 2.78
Oltenia de Sud
Loans 1,158.23 265.09 859.65 1,112.79 33.49
Deposits 1,416.85 252.15 1,152.66 1,041.57 12.04
Loans/Deposits Ratio 0.82 1.05 0.75 1.07 2.78
Câmpia Românã
Centrala
Loans 1,434.28 315.58 1,088.20 1,420.78 30.50
Deposits 1,226.41 155.81 1,056.33 884.67 14.26
Loans/Deposits Ratio 1.17 2.03 1.03 1.61 2.14
SAI
Loans 21.49 10.93 10.56 21.49 0.00
Deposits 104.35 29.80 74.55 104.35 0.00
Loans/Deposits Ratio 0.21 0.37 0.14 0.21
Population Categories
< 2,000
Loans 4.94 0.00 3.83 2.36 1.11
Deposits 48.84 0.00 48.37 3.92 0.48
Loans/Deposits Ratio 0.10 - 0.08 0.60 2.33
2,000 – 3,500
Loans 57.49 3.99 37.24 37.30 16.27
Deposits 435.59 2.46 425.84 78.34 7.29
Loans/Deposits Ratio 0.13 1.62 0.09 0.48 2.23
3,000 – 5,000
Loans 104.07 20.71 52.25 74.00 31.11
Deposits 648.14 12.86 620.73 95.50 14.55
Loans/Deposits Ratio 0.16 1.61 0.08 0.77 2.14
5,000 – 8,000
Loans 391.26 85.29 252.11 348.64 53.86
Deposits 1,249.90 89.28 1,134.74 468.13 25.88
Loans/Deposits Ratio 0.31 0.96 0.22 0.74 2.08
>8,000
Loans 14,932.48 2,320.50 12,267.50 14,760.14 344.49
Deposits 19,198.27 2,642.27 16,399.73 15,783.67 156.27
Loans/Deposits Ratio 0.78 0.88 0.75 0.94 2.20
Source: Survey of Financial Intermediaries, 1998.
Rural Financial Intermediaries, Market Shares, Credit Products, and Deposit Services 23

As presented in Table 5, the consolidated ratio of loans to deposits for all bank outlets was
0.72 during the period covered by the survey.28 The consolidated loan portfolio of private banks
as a share of their deposits (0.88) was greater than that of state banks (0.68). Removing the
Savings Bank brings the ratio for state banks to 0.98. Interestingly, the data suggest that private
banks lend more than what they collect in deposits in small localities. Private banks had
outstanding loans worth 1.61 times the amount of deposits in localities with less than 8,000
inhabitants. In larger localities with more than 8,000 inhabitants, the ratio decreased to 0.78. In
short, private banks are net lenders in small localities and net borrowers in larger localities. In
contrast, state banks are net borrowers in all ranges of locality size. This behavior persisted even
after removing the Savings Bank, which is a net borrower by design, from the data. State-owned
banks (without the Savings Bank) had less loans than deposits. Their loans to deposits ratio was
particularly low in small localities.

E. MARKET SHARES IN RURAL FINANCIAL MARKETS

This section summarizes the market shares of the different credit products that were
available in rural areas and the different types of lenders that allocated credit during the period
covered by the surveys.29 The shares considered in Table 6 correspond to the flow of credit
during the period
Table 6 Market Shares of Credit Products rather than to the
amounts
Households Enterprises
outstanding. That is,
% % these market shares
% amount outstanding % amount outstanding
reflect the allocation
% trans disbursed amounts % trans disbursed amounts
of credit transactions
Formal Sector 3.5 16.6 14.6 23.1 68.7 71.0
State Banks 1.6 9.6 6.1 16.1 55.7 56.1 entered between
Private Banks 1.9 6.9 8.5 7.0 13.0 14.9 rural agents and
Semi-formal Sector 37.4 39.6 38.3 0.4 0.1 0.3 lenders during the
CAR 28.2 21.5 19.5 - - 0.1 period covered by
Cooperatives 9.2 18.1 18.9 0.4 0.1 0.2
the survey,
Informal Sector 59.1 43.8 47.0 76.5 31.2 28.7
Moneylender & Others 0.7 1.9 3.6 0.8 0.1 3.6
regardless of the
Friends & Relatives 46.7 26.9 24.2 20.2 3.1 - term to maturity of
Commercial Credit 7.1 12.8 18.8 41.6 22.9 25.1 each credit
Forward Sales 4.6 2.2 0.4 13.9 5.1 - transaction. Hence,
Total 100.0 100.0 100.0 100.0 100.0 100.0 loans granted prior
Total Cash-Loans 88.3 85.0 80.7 44.5 72.0 74.9
to the period under
Source: Household and Enterprise Surveys , 1998.
consideration and

28 Banks do not only finance their operations with deposits. In Romania there were numerous government-financed
directed credit lines and inter-bank borrowing which financed, along with banks’ own resources, the banking
sector’s portfolio of loans. The ratio presented above is a proxy intended to capture whether certain types of outlets
were more likely to have more loans relative to deposits.
29 Chapter IV provides empirical support to the prevalent perception that there are relatively too few credit
transactions in rural areas. It should be kept in mind that this section presents the shares of different credit products
and lenders in very thin markets.
24 Chapter Two:

still outstanding at the time of the survey are not considered, while some short term loans granted
− but already canceled − during the period under study are considered.

The household and enterprise surveys gathered information on three kinds of credit
products: cash-loan, commercial or trade credit, and forward sales. Cash-loans are defined as
credit transactions disbursed and repaid in cash, commercial credit as transactions extended in
kind and repaid in cash, and sales with advances as credit extended in cash/kind and repaid in
kind.

The surveys also collected data on the credit and loans disbursed by three types of lenders,
namely, formal, semi-formal, and informal. The main difference is whether they had a
government license to provide financial services or whether they operated under the auspices of
specific legislation. The formal sector includes any deposit-taking intermediary supervised by the
NBR, mostly commercial banks, of which only seven had a significant presence in rural areas
(see Annex 1). The semi-formal sector includes credit cooperatives and mutual help cooperatives
(CAR), which are the only institutions with a significant presence in rural areas.30 Informal
lenders consist of: (a) moneylenders, who provide cash loans in exchange for explicit interest
payments; (b) friends and relatives, who provide cash loans without explicit pecuniary
compensation; and (c) traders, merchants, and processors, who engage in commercial credit or
sales with a down payment as defined above.

The market shares of the credit products and of the lenders which granted them were
estimated in terms of the total number of transactions and the total amount disbursed to rural
households and enterprises. Individual transactions provided information on financial sector
coverage and access. The consolidated amount of credit determined the weighted characteristics
of the supply of credit available and the allocation among different agents.

Table 6 summarizes the market shares. Financial markets in rural areas seem basically
segmented. Friends, relatives, and the semi-formal sector serve households, while the formal
sector and commercial suppliers give credit to rural enterprises.

Cash loan transactions are the most important credit product. For households, these loans
accounted for 88 percent of the number of credit transactions and for 85 percent of the total
amount of credit disbursed during the period covered by the surveys. For enterprises, cash loans
accounted for 48 percent the of number of transactions and for 50 percent of the amount
disbursed.

Romanian rural households rely significantly less than their counterparts in other
developing countries on the informal sector. Commercial credit transactions and forward sales
are a comparatively small source of credit, accounting for 13 percent and two percent of the
volume of credit disbursed, respectively, during the period covered by the surveys. This scarcity
of commercial credit and forward sales is consistent with the low levels of market activity and
the lack of linkages with traders enjoyed by households.

30There are some rural NGOs in Romania which provide credit. Nonetheless, their scale of operations is very small.
Their operations were not reported with sufficient frequency to make any inference about their market shares.
Rural Financial Intermediaries, Market Shares, Credit Products, and Deposit Services 25

Commercial credit plays a more important role among rural enterprises. It accounted for 41
percent of the amount disbursed and 40 percent of the number of credit transactions during the
period covered by the surveys.

The banking sector had a three percent share of the number of transactions and a 16
percent share of the amount of transactions involving households. The banking sector’ share of
the enterprise market niche is significantly larger. Banks participated in 31 percent of the number
of transactions and allocated 50 percent of the amounts of credit received by enterprises. State
banks dominate the enterprise segment. These banks allocated five times more credit to rural
enterprises than private banks during the period covered by the surveys.

F. DISTRIBUTION OF THE FLOW OF CREDIT AMONG BORROWERS AND

LENDER PREFERENCES

The data in Table 7 indicate the sectors and enterprises which obtained the flows of rural
credit allocated during the period covered by the surveys. The agricultural sector received 61
percent of the total amount, while the service sector received only 3 percent. Industry and trade
received 19 and 16 percent, respectively, of the total credit allocated. This allocation of credit
tracked very closely the shares of these sectors in the aggregate book value of assets owned by
rural enterprises. Somewhat surprisingly, private banks did not discriminate against agriculture.
Indeed, they granted to agriculture 65 percent of the total amount of rural credit they disbursed.
This share is actually slightly higher than the share of credit that public banks allocated to
agriculture (62 percent of their disbursements).

Agriculture is also the sector which receives the largest share of subsidized credit. It
obtained 90 percent of all preferential lending during the period covered by the surveys. State
enterprises active in the agricultural sector captured about 55 percent of subsidized loans.

Table 7 Distribution of Loan Amount Disbursed to Rural Enterprises by Type of Lender

Total Banks Semi-Formal Informal Subsidized
Loans
State Private Credit Money- Other No Yes
% of Loan Amount Disbursed Banks Banks Cooperatives lenders Sources
Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Economic Sector
Agriculture 61.0 62.4 65.4 - - 18.1 52.3 89.7
Industry & Construction 19.2 19.8 19.7 - - 7.3 23.0 6.7
Trade 16.5 15.5 9.3 100.0 100.0 61.9 20.5 3.6
Services 3.2 2.3 5.6 - - 12.7 4.2 -
Type of Ownership
Public 43.1 46.3 38.6 - - 0.3 39.5 55.3
Private 56.9 53.8 61.4 100.0 100.0 99.7 60.5 44.7
Net Income (Loss)
Negative 30.2 31.3 29.2 - 100.0 7.9 29.6 32.4
Positive 69.8 68.7 70.8 100.0 - 92.1 70.4 67.6
Made Investments
No 40.7 44.4 19.5 17.4 - 52.0 40.3 41.9
Yes 59.3 55.6 80.5 82.6 100.0 48.0 59.7 58.1
Source: Survey of Rural Enterprises and Financial Services, 1998.
26 Chapter Two:

Lenders in rural areas allocated significant portions of credit to enterprises (as opposed to
households) which experienced negative net incomes (losses) and which had negative gross cash
flows. About a third of all credit went to enterprises with negative profits and about 40 percent to
enterprises with negative cash flows. State and private banks behaved similarly in terms of
granting credit to money-losing enterprises. Close to 30 percent of their loans (by amount) went
to borrowers who reported losses in the same accounting cycle in which they received the loan.
About half of the borrowers (by number of individual credits) which received loans from private
banks did report losses. The equivalent percentage for state banks was 29 percent.

Table 1 in Chapter I shows that the state-owned sub-sector caused the negative balance on
the aggregate net cash flow of rural enterprises. Also, the enterprise survey shows that the
banking sector allocated 45 percent of all the new flow of credit to state enterprises with negative
cash flows. A likely outcome of lending to state enterprises with negative cash flows is that these
loans will have to be assumed by the Government or by the banking system, since the likelihood
of these enterprises returning to a positive cash flow under state ownership is minimal and
privatizing them will be difficult while they have a large debt overhang.

In the aggregate, lenders granted about half of the loans (by number of transactions) and
more credit (by amount) to borrowers who made investments in the period in which they
received credit. About 60 percent of the aggregate amount of credit went to such borrowers.
Private banks allocated to borrowers who reported investments 80 percent of the amount of loans
they granted, while state banks allocated 55 percent.

G. CHARACTERISTICS OF CREDIT PRODUCTS

This section examines the characteristics of the credit products received by rural agents
during the period covered by the surveys. Special attention is given to the amount, maturity, use
of credit, collateral requirements, speed of disbursements, transactions costs, and repayment
problems.

Cash Loans

Amounts. By source of credit, banks provide the largest loans in rural credit markets. The
average bank loan to enterprises (US$17,875) was almost 16 times higher than the average loan
disbursed by informal sector (US$1,137) and 26 times larger than the average loan allocated by
credit cooperatives and CARs (US$693) during the period covered by the survey. A similar
situation occurred with the credit allocated to households. The average bank loan to households
(US$797) was eight times larger than the average loan allocated by friends and relatives
(US$173) and about seven times larger than the average loan disbursed by credit cooperatives
and CARs (US$99).

Credit cooperatives allocate significantly larger loans than CARs. For instance, 60 percent
of the loans they granted to households during the period covered by the survey exceeded
US$500. In contrast, 85 percent of loans made by CARs were below US$500. Finally,
moneylenders and friends and relatives allocate very small loans. The evidence is that 66 percent
Rural Financial Intermediaries, Market Shares, Credit Products, and Deposit Services 27

of the loans made by moneylenders and 80 percent of the ones made by friends and relatives
during the period covered by the survey were below US$100.

Maturity of cash loans. The large majority of loans received by borrowers in rural areas are
short term loans of less than 12 months maturity. In fact, 93 percent of the loan transactions
entered by households during the period covered by the survey had to be repaid in less than a
year. The corresponding percentage for enterprises was 85 percent. Bank loans had the longest
average term to repayment at 16 months. This average increased to 20 percent when weighted by
term. Clearly, the larger loans granted by banks also tended to have longer terms.

Reported use of loan proceeds. Households and enterprises were asked what type of
expenditures they financed with the proceeds of the loans they received. Their responses are
summarized in Table 8. Most of the enterprise loans were used to finance working capital (87
percent) and most of the household loans were used to finance consumption activities and
household durables (53 percent).31 Loans reported to have financed investments accounted for
23 percent of the number of loans and 29 percent of the amount borrowed by enterprises.
Households reported that 7.3 percent of loans financed business investments and that such loans
accounted for 17.1 percent of the amounts of loans they obtained. Households were more likely
to use loans from the formal sector to finance business investments than loans obtained from
semi-formal and informal lenders. While only 8.4 percent of the total number of loans were used
to finance business-related investments, 40 percent of the loans taken from formal sector were
used for this purpose (see Table 8).

Table 8 Use of Loans by Type of Lender and Borrower

Total Formal Semi-formal Informal
% % % % % % % %
Used Loan for: trans amounts trans amounts trans amounts trans amounts
Rural Enterprises
Investment 23.4 28.6 27.0 28.6 - - 17.7 46.6
Working Capital 87.0 78.7 81.7 78.7 100.0 100.0 96.3 94.1
Rural Households
Business Investment 7.3 17.1 39.5 37.3 9.1 16.4 3.5 6.4
Business Working Capital 11.5 7.8 4.8 8.5 10.8 8.4 12.6 6.7
Household Investment or Consumption 59.3 57.0 59.6 56.0 83.2 81.8 40.4 23.3
Note: Totals in each category exceed 100 percent due to multiple responses.
Source: Survey of Rural Households and Financial Services, 1998; Survey of Rural Enterprises and Financial Services, 1998.

Collateral and guarantees. The survey revealed that Romanian rural financial markets rely
significantly on real assets as collateral for loans (see Table 9). Naturally, there are a large
number of small loans guaranteed only by fiduciary contracts and verbal promises. These
unsecured loans represented about a third of the aggregate amount of loans and were made
almost entirely by the informal and semi-formal sectors during the period covered by the survey.

31 These results should be interpreted with caution, however, because they do not necessarily reflect the activities
actually financed at the margin. Given that money is fungible, it is possible, for instance, that a loan actually
invested in the hosuehold’s economic activity may have also allowed consumption to increase because a portion of
rural entrepreneurs’ equity − which in the absence of the loan would have been invested in the rural enterprise −
could instead have been used to finance consumption. Nonetheless, the results are interesting inasmuch as they seem
to reflect general patterns of loan investment.
28 Chapter Two:

The remaining two thirds of the value of rural loans were secured with tangible assets by
pledges on movable assets, mortgages on real estate, or both. Indeed, about half of the amount of
secured loans was guaranteed by a pledge on movables and a mortgage simultaneously.

When tangible assets were used as collateral for loans, the ratio of the market value of the
pledged assets to the amount of the loans (collateral/loan) was very high. This ratio had an
average of 4 for bank loans. That is, the assets securing repayment of the average bank loan were
four times more valuable than the amount borrowed. The ratio for private banks was lower than
that of state-owned banks (3.2 times versus 4.2 times).

This seemingly excessive protection of loans was due, in part, to the costly and lengthy
processes involved in repossessing assets pledged as collateral and to the lack of liquidity of
rural real estate (see Chapter III, page 42). One consequence of excessive collateral is that the
demand for loans decreases. Large numbers of otherwise creditworthy borrowers may opt out of
credit markets. Peculiar collateral requirements together with the shortcomings of the legal
framework could make borrowers' cost of defaulting disproportionate to the amount borrowed.
Rural areas had no functioning mechanisms with which to auction property given as collateral
and to ensure that any amount remaining after lenders have been fully compensated will be
returned to the borrower. Hence, those potential borrowers that would be required to pledge
collateral may face an artificially skewed risk-return distribution for their investments. Indeed
the enterprise survey indicates that 27 percent of rural entrepreneurs and 8 percent of rural
enterprises did not request loans because they consider borrowing too risky for this reason.

Table 9 Collateral Use by Type of Lender (% of Amount Lent to Households and Enterprises)
Pledges and
No Collateral Pledges Mortgages Mortgages Total
Shares on Lending Volumes by Type of Collateral
State banks 0.7 18.2 24.2 57.0 100.0
Private banks 9.8 18.1 24.8 47.4 100.0
Semi-formal 49.0 38.9 5.4 6.7 100.0
Informal 96.2 0.1 - 3.7 100.0
Total 32.9 20.1 14.6 32.4 100.0
Shares of Lending Volumes by Type of Lender
State banks 0.9 38.5 70.4 75.1 42.6
Private banks 3.5 10.7 20.0 17.3 11.8
Semi-formal 39.2 50.8 9.6 5.4 26.2
Informal 56.5 0.1 - 2.2 19.3
Total 100.0 100.0 100.0 100.0 100.0
Source: Survey of Financial Intermediaries, 1998.

The combination of lenders’ strong appetite for collateral, the regime for secured
transactions, and the functioning of rural real estate markets pushed a wedge between demand
and supply by making borrowing too risky as explained above (weakening the demand for loans)
and by reducing the capacity of the rural sector to carry debt (weakening the supply of loans). In
practice, the only rural real estate accepted as collateral for loans was non-residential buildings.

The number of rural loans secured with residential real estate was negligible. The study’s
analysis of the rural housing market revealed factors that explain the extremely limited use of
housing as collateral. The price of houses located more than 10 km from an urban center was
Rural Financial Intermediaries, Market Shares, Credit Products, and Deposit Services 29

about 25 percent of the construction costs of an equivalent unit. This may explain the high
collateral to disbursement ratios, on one hand, but also the reluctance of owners to risk their
house in pursuing entrepreneurial activities.32

The use of farm land to secure loans is also extremely low. The use of land as collateral
was impossible during the period covered by the survey because transactions with restituted
agricultural land were prohibited until late 1998. More than 90 percent of the country’s land is
under this regime. Recently there has been an increase in land transactions, but mostly in land
leases. Thin farm land markets combined with the structural features of land ownership
(fragmentation, incomplete titling, poor registration) make land mortgages risky collateral.
Limited mortgage lending should not be surprising, therefore.

Transaction costs of obtaining loans. Borrowers care about the total cost of loans and
about the timeliness of disbursement. The total cost of borrowing includes the financial expenses
and the costs required
Figure 8 Average Speed of Disbursement of Loans by Lender Type to complete the
Days
transaction. Timeliness
45
41 is especially important
40 38
when: (a) cash needs
35
30 are urgent and
30 27
24
unexpected; and (b)
25
19
liquidity needs are
20 17
seasonal (e.g., planting
15 11
season for farmers,
10
3
Christmas for
5 1 2
-
merchants). Thus,
State Banks Private CAR Credit Moneylender Friends &
transaction costs and
Banks Coops Relatives the timeliness of
Enterprises Households disbursement greatly
affect the demand for
Source: Survey of Financial Intermediaries, 1998.
loans. For instance, 13
percent of households
declared that, although they wanted loans during the period covered by the survey, they did not
apply for them because of high transaction costs.

The speed of loan disbursement is measured as the time elapsed between loan application
and actual disbursement. This speed is positively related to the size of the loans (see Figure 8).
Lenders which provide the smaller loans disbursed faster. Moneylenders took about one to two
days, and friends and relatives took about three days during the period covered by the survey.
More formal lenders, such as banks and cooperatives, took between 17 and 41 days.

32 These results are based on actual transactions which occurred in villages. There is a high variance in the price of
rural residential real estate that is not explained by the characteristics of the house or its location. While high
variance may reflect numerous unknown factors, including distressed sales, it indicates with certainty a high risk of
lending against an asset whose value upon repossession is difficult to predict.
30 Chapter Two:

Borrowing from lenders which are slow to disburse also entails higher transaction costs.
These costs were proxied by the sum of fees and commissions on the loan plus the costs of
visiting the lender (number of trips times their cost). These costs were correlated with the amount
borrowed.

Repayment problems of cash loans. The survey collected data on the repayment of loans to
determine the extent to which borrowers were able to serve their loans. The results are
summarized in Figure 9. The percentage of loans (in terms of the aggregate amount and total
number) that experienced repayment problems was used as a proxy indicator of delinquency.33

The number of enterprise loans that fell in arrears (15 percent) was almost three times that
of households (5.5 percent). The loans that enterprises reported in arrears were very large. These
loans accounted for 43 percent of the aggregate amounts received by the sector. In contrast,
delinquent household
Figure 9 Repayment Problems on Cash Loans loans were slightly
below the average size
70 as 5.5 percent of loans
60 with delayed payments
50 represented 4 percent of
40 the total amount.
30

20
The survey
10
results indicate that
arrears are a more
0
State Banks Private Mtual Help Credit Moneylender Friends &
serious problem for
Banks Coops Coops Relatives state-owned banks than
Households Enterprises, Not Subsidized Enterprises, Subsidized for private banks. The
share in the amount of
Source: Survey of Financial Intermediaries, 1998. the loan portfolio
disbursed by state
banks with repayment arrears was about 60 percent during the period covered by the survey,
which was more than twice that of private banks (25 percent).

Delinquency on subsidized government credit lines was significant when state banks were
the lenders (about 35 percent of the amounts).34 In contrast, when private banks allocated
subsidized credit, the delinquency reported by borrowers was about 3 percent.

33 Two caveats apply to this measure. First, the information was collected from the borrowers themselves who, for
various reasons, may underreport delinquency. Second, the measure used may overstate arrears problems because
the amounts used correspond to the original amount of the loan and not to the outstanding balance at the time of the
repayment problem. The resulting information can be used to study systematic differences in repayment across
groups of borrowers and lenders, nonetheless.
34The survey documented three mechanisms by which the Government subsidized rural credit: (a) direct rebates to
borrowers on the interest paid; (b) credit at preferential rates below market rates; and (c) rebates on principal paid to
borrowers upon canceling on time. The principal amount of these subsidized loans represented 23 percent of the
amount received in loans by the entire rural sector during the period covered by the survey. State banks allocated 86
Rural Financial Intermediaries, Market Shares, Credit Products, and Deposit Services 31

Commercial Credit

Commercial credit is defined, for purposes of the study, as credit received in kind.
Examples include suppliers credit and the inputs advanced to farmers by processing firms or
traders. This form of credit represents a significant source of financing for the rural economy. It
accounted for 9 percent of all credit transactions and about 20 percent of the flow of credit to
rural households and enterprises between June 1997 to May 1998.

Commercial credit is particularly important for enterprises. It was a source of financing for
about 9 percent of enterprises, accounted for 40 percent of the number of their credit
transactions, and represented 23 percent of the total amount they borrowed during the period
covered by the survey, including all other forms of credit.

Households use commercial credit less often and mostly to purchase durable goods and
appliances. Commercial credit was a source of financing for 2 percent of households, accounted
for 7 percent of household credit transactions, and represented 13 percent of the total amount
borrowed by households.

Private enterprises are the main supplier of commercial credit transactions. They granted
77 percent of commercial credit transactions with enterprises as debtors and 60 percent with
households. State-owned enterprises were the creditors in about a fifth of transactions with
enterprises and in 23 percent of transactions involving households.

The debtor was a private company in 96 percent of all commercial credit transactions
involving enterprises. Nonetheless, the 4 percent of transactions which involved state companies
accounted for 34 percent of the aggregate amount of credit disbursed under this modality.
Enterprises fully owned by the state and mixed enterprises accounted for two percent of
enterprises, had 50 percent of all assets, and generated 18 percent of aggregate revenues in the
sector.

The incidence of commercial credit among households is highest among those which have
non-agricultural entrepreneurs and commercially oriented farmers. These households accounted
for 83 and 14 percent of transactions, respectively, during the period covered by the survey.

Commercial credit finances almost exclusively working capital for enterprises and
consumption for households. Enterprises used virtually all commercial credit for working capital,
while for households 96 percent of the aggregate value was made of durable goods, special
celebrations, and housing improvements.

Commercial credit transactions tend to be smaller and have shorter terms to repayment
than bank credit. For enterprises, the average commercial credit transaction (US$5,100) was for
less than a third of the average bank loan amount during the period covered by the survey. The
average term to repayment of commercial credit (4 months) was a fourth of the average maturity

percent of all subsidized loans. Private banks allocated the remaining 14 percent. Chapter II presents details on
subsidized credit.
32 Chapter Two:

of bank loans. The average commercial credit transaction in which a household was the borrower
was for US$300 and had a term of seven months.

Commercial credit is granted mostly on the basis of trust, rather than on the basis of legal
contracts or collateral. Households obtained 86 percent of their commercial credit transactions
without pledging collateral (not even the goods acquired on credit) during the period covered by
the survey. About half of the 48 percent of the transactions were based solely on the verbal
promise of the debtor. Naturally, larger transactions used authenticated notarized contracts (15
percent of the aggregate amount) and real assets as collateral. Interestingly, a combination of
mortgages and pledges on movables secured 45 percent of the aggregate amount of commercial
credit. Co-signers assumed fiduciary responsibility for 35 percent of commercial credit
transactions (45 percent of the aggregate amounts).

Commercial credit in which enterprises are the debtors is not secured with real assets
either, and was rather informal as well. More than 90 percent of these transactions did not
involve pledging assets, and about half of them were based solely on the verbal promise of the
debtor during the period covered by the survey. However, there were significant differences by
enterprise ownership type. State-owned enterprises were able to obtain credit without pledging
guarantees or notarizing contracts in all transactions. Private enterprises, in contrast, had to
provide stronger assurances. Two thirds of the aggregate amount they received were secured
with collateral, cosigners, and notarized contracts.

H. PARTICIPATION OF RURAL ENTERPRISES AND HOUSEHOLDS IN

FINANCIAL MARKETS AS DEPOSITORS AND SAVERS

Rural enterprises make intense use of the formal financial sector to make and collect
payments. Virtually all rural enterprises (99.9 percent) had sight deposits and/or checking
accounts during the period covered by the survey. Most of these accounts had been opened in
state banks (80 percent).
Figure 10 Percentage of Households with Savings Accounts by The remaining 20 percent
Per Capita Income Quartile of accounts were in private
banks. Few rural enterprises
50
45
had made investments in
40 financial instruments. Less
35
30
than one percent of them
25 had certificates of deposit
20
15
or similar financial
10 instruments.
5
-
Lowest income 2nd income 3rd income Highest income
About 36 percent of
quartile quartile quartile rural households had
quartile

Source: Survey of Rural Households and Financial Services, 1998. financial savings. The
highest incidence of
households that saved was among the well-off, farming households with more than two hectares
of land, households practicing commercially-oriented agriculture, and households of which the
head had higher levels of education. Regionally, the highest incidence of households with
Rural Financial Intermediaries, Market Shares, Credit Products, and Deposit Services 33

savings was found in Subcarpa_ii de Sud (51 percent). The lowest incidence was in the area
surrounding the capital city Bucharest (14 percent).

Not surprisingly, income is a powerful predictor of the participation in the rural savings.
While only 11 percent of the households belonging to the poorest income quartile saved during
the period covered by the survey, the participation rate approached one half for households in the
two richest quartiles.

Table 10 Shares of Savings Accounts of Rural Households by Type of Instrument

Sight Term
Deposits Deposits
Commercial Banks 44.0 93.4
State Banks 42.4 88.6
CEC 30.0 48.5
Banca Agrícola 4.9 22.7
Banca Comerciala Romana 5.2 10.4
Private Banks 1.6 4.9
Credit Cooperatives 7.8 4.6
Casa de Ajutor Reciprocs (Mutual 47.9 1.8
Help Cooperatives)
Others 0.3 0.1
Total 100.0 100.0
Row Percent 31.5 68.5
Source: Survey of Financial Intermediaries, 1998.

There is not much diversity in the instruments used by rural households to save or make
payments. Savings accounts are the most common deposit instrument held by rural
entrepreneurs. They represented 69 percent of the number of accounts and held 64 of the
amounts deposited during the period covered by the survey. Current accounts and sight deposits
held the remaining amounts.

Three state-owned banks – Savings Bank, Banca Agricola, and Banca Comercial_ Român_
– kept more than 80 percent of the savings of rural inhabitants during the period covered by the
survey. One reason for this dominance is that these three banks have a vast network of retail
outlets (see section III.E, page 25). Table 10 presents the estimated market shares by type of
instrument and intermediary. The three large state banks accounted for about 42 percent of sight
deposit accounts. The rest of the accounts were kept primarily in Casa de Ajutor Reciprocs
(Mutual Help Cooperatives), which had 48 percent of total number of rural sight deposits, and
credit cooperatives which had 8 percent.

Second, the average size of deposits is small relative to the average annual income in rural
areas. Table 11 presents the average size and term to maturity of the deposits that were held by
different intermediaries during the period covered by the survey. There was no variation in the
nominal interest rate offered by banks to depositors, controlling for type of deposit and time.
34 Chapter Two:

Table 11 Average Amount and Maturity of Deposit Instruments of Rural Households

Sight Deposits Term Deposits
Amount Amount Maturity
(US$) (US$) (Months)
State Banks 524 451 10
Private Banks 489 1,186 7
Mutual Help 50 14 12
Cooperatives
Credit Cooperatives 112 575 6
Source: Survey of Financial Intermediaries, 1998.

Proximity to the intermediary was cited by half of the survey respondents as an important
reason in the selection of intermediaries in which to open accounts. Only 22 percent of
respondents, with the exception of private banks’ clients, mentioned higher interest rates as a
main reason for choosing a financial institution. For the clients of the private banks, high interest
rates seems to be the most important reason in choosing the depository institution, as
acknowledged by 76 percent of them.

The clients with the largest amounts of savings choose their deposit-taking institution
primarily on the basis of trust. About 73 percent of the total amount invested belonged to
households which considered the degree of trust as the most important reason to have opened an
account in a given intermediary.
 Chapter III: Limited Access to Loans: Weak Supply of
and Weak Demand for Loans
This chapter provides empirical support to the prevalent perception that there are too few
credit transactions in rural Romania. Policy makers are justifiably concerned with this situation
because credit constraints  unsatisfied demand for credit at current market conditions  could
have a very negative impact on agricultural growth and rural poverty. Credit constraints affect
not only the output and efficiency of rural households, but also their capacity to adjust to the
major policy reforms of recent years and the aftermath of the exchange rate crisis of early 1997.35
Rural households may require adjusting their scale of operations, investing in new technologies,
or initiating new activities. Their investment behavior  and therefore their growth potential 
can be diminished by credit constraints. This has serious consequences for rural development,
since rural households operate entirely out of retained earnings, saved assets, remittances, other
businesses’ income, and sales of animals. Moreover, access to credit services affects rural
households’ investment and risk management decisions, and thus differential access to these
services could widen income disparities over time by having a long-term effect on asset
accumulation and poverty (Chaves and Sánchez, 1998; Jalan an Ravallion, 1999). Finally,
Romanian rural entrepreneurs are at a disadvantage when competing with counterparts in
countries such as the members of the European Union or the United States, where more than 95
percent of rural entrepreneurs have access to credit from the formal sector.

This chapter provides evidence that rural households and enterprises have limited use of
loans, raising two questions. The first question is whether the supply of loans has been limited,
resulting in households and enterprises experiencing an unsatisfied demand for loans. The
second question is whether the scarcity of loans is linked to weak demand arising from, for
example, the lack of profitable investment opportunities. It is found that the observed scarcity of
credit transactions in rural areas has been caused by numerous factors which have weakened both
the supply of and demand for rural credit. Lenders avoid rural credit and few rural agents
demand credit anyway. Worse, the supply and demand do not match in that those agents which
demand credit do not correspond to those to which lenders want to lend.36

A. PARTICIPATION OF ECONOMIC AGENTS IN THE MARKET FOR LOANS

The overall access to loans by rural households and enterprises was limited. Table 12
shows that the percentage of these agents that used loans to finance consumption, operations, or
investments was only 20 percent. Predictably, the incidence of borrowing was not uniform and

35Main reforms include restitution of all cooperative land under the land reform of 1991, removal of price controls
and subsidies on staple products, privatization of state-owned enterprises, and tax policies.
36It is most likely that all other sectors of the economy have suffered from limited access to credit because the
majority of these problems are common to all financial transactions in Romania, regardless of economic sector.
 36 Chapter Three:

varies across agro-regions and economic sectors.37 For instance, 26 percent of households in the
region of Subcarpatii de Sud had access to credit, which was better than the access enjoyed by
their counterparts in Oltenia de Sud, where only seven percent received loans in the period.
Further, households whose income originated mostly from wages and pensions had the highest
incidence of borrowing (29 percent), followed by self-sufficient farm households (21 percent),
and non-farm households (20 percent).

The participation of rural enterprises in credit markets was 32 percent in Campia Dunarii
de Jos, while in Campia de Vest it was only 18 percent. Agricultural enterprises ranked first in
their use of loans (49 percent), while industrial and trade enterprises ranked second and third
with rates of participation of 26 percent and 17 percent, respectively. Public enterprises had a
much higher rate of participation in credit markets (54 percent) than their private counterparts
(20 percent).

B. WEAK SUPPLY OF CREDIT

The household and enterprise surveys show that the financial sector, especially the banking
industry, supplied very limited amounts of loan capital to the productive sectors of the rural
economy (households and
enterprises).
Table 12 Participation in the Market for Cash Loans
Households Enterprises Rather than from lack of
(%) (%) liquidity, this weak supply resulted
Borrowers from: 20.2 from an unfortunate combination of
20.3
Formal lenders 1.1 14.4
short-term circumstances and
State banks 0.5 10.9
structural factors, namely: (a)
Private banks 0.6 4.1
Government macroeconomic
Semi-formal lenders 10.1 0.4
policies; (b) Government policies
Credit Cooperatives 2.9 0.4
CARs 7.8 -
and participation in rural financial
Informal Lenders 9.9 markets and the rural economy; (c)
6.1
Moneylender 0.1 the institutional and legal
0.2
Friends & Relatives 9.8 framework
5.8 for financial
Other transactions; (d) the existing debt
Non-borrowers 79.8 79.7 overhang that limits the rural
Source: Surveys of Rural Households and Enterprises, 1998. sector’s capacity to carry additional
liabilities; (e) the lack of capacity or
interest of the country’s banking industry to serve retail clients; and (f) missing input and output
markets. These factors combined to make the risk-adjusted returns to rural lending unattractive
relative to alternative investments in other sectors of the economy.

37The country can be divided into nine agro-regions: Transilvania, Campia de Vest, Moldova de Podis, Moldova
Deal, Subcarpatii de Sud, Campia Dunarii de Jos, Oltenia de Sud, Campia Romana Centrala, and SAI (where
Bucharest is located). An agro-region is composed of various judets with a similar land use pattern. The groupings
were determined using multivariate cluster analysis by identifying those regions with minimal variance in land use
patterns for all of Romania’s 41 judets.
Limited Access to Loans: Weak Supply of and Weak Demand for Loans 37

Government Macroeconomic Policies

The financing of both unprofitable productive activities in state-owned industries and

social expenditures has led the Government to compete with the productive sector in attracting
funding. In fact, the
Figure 11 Commercial Lending Interest Rate vs. T-Bill Rate vs. Government has
Inflation crowded out the
140
enterprise sector from
bank lending
120
portfolios. For
100 significant periods
80 over the last few
%

60 years, it has been

40
more profitable and
less risky for banks to
20
invest their liquidity in
0 inter-bank lending and
8

9
98

99
7

9
98

99
98

99

government securities
r-9

-9

r-9

-9
-9

-9

-9
g-

g-
ct

ct
n-

n-
b-

b-
ec

ec

ec
Ap

Ap
Au

Au
O

O
Ju

Ju
Fe

Fe
D

D
than in credit to
Lending (to non-banks) T-Bills Inflation enterprises or
individuals (see
Source: National Bank of Romania. Figure 11). Treasury
bill yields have been
consistently above the rates on commercial loans. In January 1998, the yield on treasury bills
was about 4,400 basis points above the rate at which banks reported lending to their prime
borrowers.

The Government’s open market policies made investment in short-term and low-risk
government securities and NBR deposits significantly more attractive than longer term and
riskier loans to the real sector. Naturally, the banking system reacted by increasing their portfolio
of government securities during 1997 and 1998 (World Bank, 1999). In 1997, outstanding
government securities increased by 262 percent in nominal terms and by 44 percent in real terms.
In 1998, outstanding government securities rose again by 101 percent in nominal terms and 43
percent in real terms.38

Government Participation in Rural Financial Markets

The Government has competed successfully with the private sector in lending to rural
borrowers. Massive government interventions in the sector hindered the private supply of rural
credit. Private lenders were not in a position to compete with a poorly run government bank
(Banca Agricola), which was not subject to a budget constraint, and with numerous directed

38The fact that banks prefer to lend to the Government rather than raising the rates charged to the private sector is
common in high-inflation environments. In Brazil, for example, the Government consistently paid interest rates that
were substantially above those paid by the private sector. Lenders feared that charging private enterprises these
same rates would result in adverse selection and skew their loan portfolios towards unacceptably risky borrowers.
As a result there was little or no lending to companies during the high inflation period.
38 Chapter Three:

credit lines that financed rural loans at subsidized rates with a high probability of debt
forgiveness. Naturally, these interventions crowded out private lenders from rural credit markets.
Lenders with no access to subsidized funding to enable them charge borrowers rates below
market and to permit arrears were at a competitive disadvantage.

Debt forgiveness programs (implicit or explicit) have promoted strategic defaults and
created obvious credibility problems for all rural entrepreneurs as viable borrowers. Rural
lending has become (or at least is widely perceived as) an unattractive market niche for the
banking sector to invest their resources − especially for emerging private banks. For example, a
Government Ordinance issued in the spring of 1996 required banks (mainly Banca Agricola) to
provide loans to delinquent borrowers and to borrowers without appropriate collateral. Strategic
default became widespread. In 1997, the Government cleaned up Banca Agricola’s loan portfolio
by converting delinquent loans into public debt. The amount involved in this de facto debt
forgiveness program was equivalent to about half of the outstanding loans in Banca Agricola’s
portfolio.

Subsidized credit was a significant share of the total supply of rural credit. It accounted for
about a quarter of the aggregate amount of credit received by the rural economy in the surveyed
period. In 1997, the Government attempted to phase out directed credit programs and to make all
subsidies transparent by putting all credit ordinances in the national budget.

Budgeted credit programs to finance agriculture and agricultural machinery persist, but
their costs remain in question. Even when these programs are successfully implemented, their
benefits concern macro-economic aspects and transparency in the allocation of quasi-fiscal
transfers. Although the objectives of these programs are well-intended, the programs still have
negative effects on the development and efficiency of financial markets in rural areas.

The Government’s main rural credit instrument, the Ordinance on Providing Finance for
Crop Planting, Maintenance and Harvesting as well as for Livestock Raising and Feeding,
created a permanent revolving fund (the Fund) which will be part of the regular administrative
structure of the Ministry of Agriculture, Food and Forestry (MOAFF) rather than a transitory
mechanism. The budgetary costs and real amount of subsidies in the ordinance are not
transparent. The ordinance does not specify: (a) the interest rates payable by final borrowers and
intermediary banks; (b) the amount of credit being made available; and (c) estimated
disbursement schedules. These three variables together with inflation and treasury bill rates will
determine the actual budgetary cost of the credit scheme.

The Ordinance continues to distort rural financial markets by establishing a bonus for
borrowers who repay their loans punctually. This rebate is 25 percent of principal regardless of
the maturity and nominal interest rate on the loan. The ordinance also includes a “bonus on
advanced payment” of 5 percent of principal for borrowers who repay their loans at least 20 days
prior to maturity of their loans.

The effects of these provisions are illustrated in Table 13. They include: (a) distortion of
investment decisions by the establishment of different effective interest rates and, thus, different
relative profitability for different crops; (b) the possibility of profitable opportunistic behavior on
the part of borrowers − among others, there will be strong incentives to arbitrage across the
Limited Access to Loans: Weak Supply of and Weak Demand for Loans 39

effective interest rates charged for different activities or to divert subsidized loans to financial
investments;39 (c) the impossibility of determining, ex-ante, the true budgetary costs to
government because these costs will depend on the turnover of the credit fund (i.e., “lending
rounds”) − an allocation with a larger share of short-term livestock loans will be more expensive
to the Government than another allocation with a larger share of long term wheat loans.

Table 13 Structure of Effective Nominal Interest Rates on Loans for Different Agricultural
Activities according to the 1998 Ordinance on Providing Finance for Crop Planting, Maintenance,
and Harvesting, and for Livestock Raising and Feeding
Annualized Effective
Term to Total Annualized Effective Rate After Bonus on
Repayment for a Interest Interest Paid Minus Rate After Bonus on Principal and Early
Given Activity Paid Bonus on Principle Principal Payment Discount
(days) (Lei) (Lei) (percent) (percent)
Case A: Contractual rate 80 percent p.a. on a Lei 100 loan
360 80.00 55.00 55.00 48.22
340 75.55 50.55 53.33 46.24
305 67.77 42.77 50.48 44.58
245 54.44 29.44 43.25 31.98
210 46.66 21.66 37.13 23.15
Case B: Contractual rate 40 percent p.a. on a Lei 100 loan
360 40.00 15.00 15.00 8.22
340 37.77 12.77 13.52 6.24
305 33.88 8.88 10.48 4.57
245 27.22 2.22 3.62 - 8.01
210 23.33 - 1.27 - 2.86 - 16.04
The following is the formula used to calculate the above annual effective rates (AER).
AER=(Annual contractual rate)-[(360/Days to repayment)*(Bonuses as percentage of principal)]
The following are the maturities of loans intended to finance different products:
a. 360 days for winter wheat, rye, barley, and two-row barley crops
b. 340 days for vineyards, orchards, and vegetables
c. 305 days for sugar beats
d. 245 days for summer two-row barley
e. 210 days for livestock
Source: Author’s calculations

An additional concern raised by the ordinance has to do with the incentives to commercial
banks to disburse credit to agriculture in the form of a 4 percent disbursement fee and a 6 percent
bonus on principal amounts recovered. This structure of incentives for banks has two negative
effects: (a) it contributes to the difficulty of estimating the budgetary cost − for the same reason
above; and (b) it provides banks with behavioral incentives similar to those of borrowers.

This last point deserves further analysis. The opportunities for borrowers to profit by
obtaining, and for banks by granting, a series of short term loans under the ordinance are very
significant. Should borrowers obtain credit simply to, say, invest the proceeds in financial
markets, then each lending round would bring the following net profits free of risk: (a) for the
borrower, (30 percent bonus on principal) + (interest earned on back-to-back deposit in lending
bank) - (interest paid on loan); and (b) for intermediary banks, (10 percent bonus on principal) +
(intermediation margin).

39 Clearly, it is better to obtain two consecutive “livestock loans” to finance winter wheat than to get a winter wheat
loan.
40 Chapter Three:

The upper bound or theoretical limit to these risk-free profits is the sum of the bonuses
collected by banks and borrowers on a sequence of, say, one day loans. Bonuses such as those
proposed in the ordinance allow strong incentives for collusive opportunistic behavior, therefore.
In fact, the potential profits are large enough to expect that any amount allocated under the
ordinance will be disbursed and repaid. Repayment is almost assured by the expectation of future
access to similar loans. Repayment is more profitable than default.

The survey results are consistent with this possibility. The share of rural loans
contaminated with delinquency in the overall rural portfolio of private banks was about 25
percent and only 3 percent for the sub-set of the rural portfolio financed by government-
subsidized credit lines. Although with less dramatic magnitudes, equivalent differences were
observed in state banks where 60 percent of the overall rural portfolio was contaminated while
only 35 percent of the subsidized portfolio suffered contamination.

Inadequate Legal Framework for Financial Transactions: Collateral Issues

This section summarizes the main findings of Annex 3, “Romania: How Problems in the
Framework for Secured Transactions Limit Access to Credit”, which presents a detailed analysis
of the legal framework for transaction secured with movable assets in Romania.

There are significant structural impediments to financial transactions that have minimized
the supply of credit, especially to the agricultural sector, small businesses, and individuals. The
following features of the country’s legal and institutional framework have made credit
transactions in Romania riskier and more costly than necessary, diminishing, therefore, the
inclination of lenders to lend to all applicants, especially small and medium businesses.

The flow of credit to the rural economy during the period covered by the surveys was
insufficient in part because the majority of assets in the sector could not be effectively pledged as
collateral for loans. Lenders care significantly about recovering their debts, and collateral is the
most widely used instrument to insure repayment. In fact, two thirds of the value of rural loans
were secured with tangible assets by pledges on movables, mortgages on real estate, or both.
Indeed, about half of the amount of these secured loans was guaranteed by a pledge on movables
and a mortgage simultaneously.

When tangible assets were used as collateral for loans, the ratio of the market value of the
pledged assets to the amount of the loans (collateral/loan) was very high. This ratio had an
average of 4 for bank loans. That is, for an average bank loan the assets securing repayment were
four times more valuable than the amount borrowed. Hence, the real estate and movable assets
which represented 90 percent of the aggregate book value of assets in the hands of the enterprise
sector in rural areas could be used effectively to secure credit transactions worth at most 22
percent of the sector’s assets. In countries with well-functioning collateral systems, assets carry
about four times more debt than in Romania. For instance, in the United States loans guaranteed
by mortgages normally finance up to 90 percent of the value of the real state pledged while loans
secured with movables normally finance up to 95 percent of the goods pledged.

The combination of lenders’ strong appetite for collateral, the regime for secured
transactions, and the functioning of rural real estate markets pushed a wedge between demand
Limited Access to Loans: Weak Supply of and Weak Demand for Loans 41

for, and supply of, loans by making borrowing too risky as explained above (weakening the
demand for loans) and by reducing the capacity of the rural sector to carry debt (weakening the
supply of loans). In practice, the only rural real estate accepted as collateral for loans was non-
residential buildings.

Land. Land and buildings accounted for 42 percent of the aggregate book value of the
assets owned by rural enterprises and were by far the single most important component of the
wealth endowments of rural households (57 percent) during the period covered by the surveys.
Nonetheless, agricultural land was not acceptable as collateral because transactions involving
restituted agricultural land remained prohibited until late 1998. More than 90 percent of the
country’s land is under this regime.

Land markets have remained thin, in part due to lack of viable long term financing.40 Thin
markets combined with the negative structural characteristics of land ownership such as
fragmentation, incomplete titling, and poor registration make land too risky as collateral.41

The survey finds that basically only urban non-residential real estate was accepted by
lenders as collateral should not be surprising under these circumstances. There are many reasons
for this finding including the uncertain state of property rights in many parts of the country,
difficult verification of previous liens and encumbrances, difficulties of repossession, the high
transactions costs associated with valuing and recording fragmented property holdings, and the
low value of agricultural land in rural areas that are remote from larger towns and cities. In the
case of default, there is a procedure for banks to seize property. After three months of non-
payment the financial institution can commence court proceedings. While in principle these
procedures should be complete within a few months and the property repossessed and sold, in
practice there are many opportunities for the defaulter to delay the process so that it can easily
take several years.

Additionally, effective use of land as collateral requires land markets to work. For land
markets to work, titling and registration institutions should allow for secure holdings and the
inexpensive transfer of ownership. In Romania these criteria are not being met. Problems exist in
several areas, but are centered around two particular issues. First, the institutions that are
involved in titling are inadequate, and second, the process is costly by international standards.

Romania’s property institutions do not work effectively. The Land Book offices (land
registries) attached to the courts are poorly equipped, understaffed, and have inadequately paid
personnel. More specifically: (a) the documents are stored under inadequate conditions that
result in their deterioration so that the older records are degenerating badly; (b) personnel in the
Land Book offices are either badly trained, unmotivated, or both, and all entries are made by

40In a sense, there is a simultaneity issue here. The lack of financing leads to thin markets and thin markets, in turn,
reduce the amount of financing available.
41 Under Law 18 of 1991, restitution takes place through restitution commissions which operate at the local
government level and which include the mayor as president, local residents, and a representative from the local
cadastre and the agricultural cadastre offices. The restitution process is largely complete, but many disputes remain
to be resolved. These are now being adjudicated by the courts, which adds further to the congestion of the legal
system and to the delays in titling and registration.
42 Chapter Three:

hand and are illegible, leading to errors; (c) there are insufficient personnel to handle the volume
of transactions that are occurring as long backlogs have developed so that delays of 12 months or
more to complete registration are common; (d) disputes resulting from documentation not being
checked thoroughly are accumulating, adding to the delays; (e) the system is time consuming in
that users have to complete many steps, adding to the cost of the process; and (f) the various
steps in the process raise costs substantially above those required to ensure widespread titling
and registration and are well above those in countries where the process has been well designed
and is efficient.

The actual object of registration is referred to as an “immobile” or parcel, which is a piece

of land either with or without a building on it. Land is classified as either Intravilan or
Extravilan. The latter classification means that no permanent buildings may be erected on this
type of land. Intravilan land may be either for agricultural use or may be built on. All land, both
Intravilan and Extravilan is classified by the Ministry of Agriculture, Food and Forestry. If land
owners wish to change the use, they must apply to the Ministry of Agriculture, Food and
Forestry for permission to do so. Law 51 of 1991 provides that a fee of up to 8 times the price of
land must be paid for this conversion. The Ministry of Agriculture, Food and Forestry has the
power to change the classification, which often leads to a lowering of the multiple that must be
paid for conversion to about three times the sales price. Apart from applications for conversion
for construction purposes, enforcement of the classification system appears to be lacking.
However, uncertainty about future enforcement is ever-present.

Movable assets. Equipment, machinery, inventories, livestock, and accounts receivable

represented about 48 percent of the aggregate book value of assets of rural enterprises during the
period covered by the survey. These movables assets had very limited capacity to carry debt
because of imperfections in the country’s legal regime, which severely limited the creation,
perfection, and enforcement of security interests in moveable property, as follows. 42

The framework failed to contemplate most important economic transactions by limiting the
creation of security interests on inventory, accounts receivable, leases, fixtures, and chattel
paper. Therefore, most formal lenders demanded additional security for loans in the form of a
mortgage or fiduciary contract.

The framework did not provide a unified and easily accessible system for publicly
registering and ranking the priority of a lender to collect against the property by debtors
(perfection of security interests). Lenders, consequently, ignored whether other lenders and
creditors might have had prior claims against goods offered as collateral.

The enforcement of security interests – the repossession and sale of goods in which a
lender has a security interest – takes years in Romania, exceeding the economic life of an

42 The Government of Romania passed Law No. 99 of 26 May 1999, published in Monitorul Oficial 236 of 27 May
1999 "Law Regarding Some Steps to Speed Up Economic Reform, TITLE VI. The Legal Status of the Security
Interests in Personal Property." Shortly thereafter, the Government issued the regulations for this Law. Preparation
of the law and regulations was supported by the World Bank, which is also supporting the creation of an electronic
filing archive for security interests. This archive will stand among the most modern in the world. The archive is
presently under development and should begin operating before the end of 2000. It is expected that this new
framework will correct the deficiencies mentioned above.
Limited Access to Loans: Weak Supply of and Weak Demand for Loans 43

important portion of movable property. The result is that moveable property as collateral is not
valued and borrowers offering movable property as collateral get no better terms than do those
who offer nothing.

In short, the Romanian framework did not meet certain minimum conditions that render a
system for security interests economically useful. These conditions are: (a) the law must provide
for creating an enforceable security interest against all property and this must be inexpensive; (b)
enforcing the security interest must be inexpensive; (c) the security interest must produce real
commercial value for the lender when enforced; (d) the lender must be able to determine before
the loan is made, with certainty and at little cost, whether any other lender has a superior claim to
the collateral; and (e) the secured lender must be protected from claims of third parties, including
secured and unsecured creditors, a trustee in bankruptcy, or some purchasers of the collateral.

Warehouse receipts. The rural sector did not have access to warehouse receipts (also called
warrants) to finance inventories of commodities during the period covered by the survey. These
are legal documents stating the ownership of a specific amount of a commodity or good with
specific characteristics stored in a specific warehouse. These receipts play a key role in
agricultural financing and marketing in countries where they are backed by a legal and
institutional framework that allows their value to be used as collateral. In most developed
countries, warehouse receipts can be pledged as collateral for loans, traded, sold, swapped, or
used for delivery against a derivative instrument, such as a futures contract. The overall
efficiency of financial and agricultural markets is greatly enhanced by the ability to convert
agricultural commodities into tradable securities. Warehouse receipts do not work well in
Romania because of the following reasons.

The legal environment is inappropriate in that the rights, liabilities, and duties in each party
to a warehouse receipt (e.g., producer, bank, warehouse) are not clearly defined or enforceable.
In practice, receipts are not freely transferable by delivery or endorsement. In addition, potential
lenders have no way to determine if there are competing claims on a given stock of commodities.

There are no performance guarantees for warehouses. Farmers and traders are reluctant to
store crops and banks are not willing to accept receipts as collateral because there is significant
uncertainty on whether the goods exist in the quantities specified by the receipt or whether the
quality is the same or worse than that noted on the receipt. Lack of performance guarantees is
worsened by the lack of independent inspection and licensing of warehouses.

The storage industry is not competitive and remains dominated by the state. Breaking
Romcereal into Comcereals and Cerealcoms simply divided a large state monopoly into a
collusive organization of local monopolies (still controlled by the state) without any positive
impact on their operations. Anecdotal evidence suggests that the excessive prices charged by
these elevators often makes it unattractive for farmers and traders to store. It is also argued that
the elevators often return different amounts and qualities of commodities than originally stored.
Even if an appropriate legal framework were passed, enforcement would remain a serious
impediment in the presence of an oligopoly of state-controlled storage facilities.
44 Chapter Three:

Leasing. Leasing has been rendered an unprofitable business by uncertainty and

inappropriate rules on depreciation, accounting, and taxation of fixed assets.43 Hence, Romania
has had an experience with leasing that contrasts with that of other countries in which leasing is
widely used to finance individuals and small, and medium sized companies. According to the
Romanian Leasing Association, outstanding leasing contracts amounted only to about US$ 270
million during the period covered by the survey. These contracts were highly concentrated in a
few large lessees, mostly in the industrial sector.

The law does not provide clear definitions for financial and operational forms of leasing
and it is unclear about the: (a) differing tax and accounting treatments accorded to each of these
two arrangements; (b) how leased goods must be dealt in the balance sheets; and (c) on whom a
lessor or lessee can claim credit on depreciation and rental payments under each type of leasing.

Also, there is enforcement uncertainty because the law does not assign priority to lessors of
leased assets in the case of bankruptcy or reorganization of the lessee, and because recovery of
leased assets upon default by the lessee involves complicated, expensive, and time consuming
judicial procedures. The Romanian Leasing Association reported that recovery of assets
normally took more than six months of litigation, when successful, during the period covered by
the survey.

The depreciation schedules allowed by law on fixed assets are still too long compared with
the normal life of a leasing contract. When such long depreciation schedules are applied to
equipment leases of, for example three years, the lessor must report artificially-high net taxable
profits because current period costs are not being matched with current period expenditures. This
excessive taxation limits the ability of leasing companies to replace leased assets. In practice, the
Government is taxing the difference between the historical value of assets and their current
replacement cost (in nominal Lei).

According to Romanian accounting law, all assets must be booked at their historical value
and their revaluation is not allowed. This rule implies that, in the presence of inflation,
depreciation expenditures are underestimated causing, again, artificially high taxable profits and
low equity ratios for firms. The net effect is equivalent to a tax on investment in capital goods.

Romanian law does not permit tax payers to deduct from their taxable income losses
incurred when selling assets below their book value. Book value losses are unavoidable for
Romanian leasing companies because of the very long depreciation schedules imposed by law
and the comparatively short leasing periods, typically 3 to 4 years. In most cases, this
combination causes the market value of fixed assets to be below their book value. Losses occur,
therefore, when leased assets are sold. This practice gives leasing companies an unduly large tax
burden.

The payment of customs duties and value added tax (VAT) on equipment leased from a
foreign leasing company are deferred until the end of the lease period and are calculated on the

43 The following codes and ordinances constitute the legal framework for leasing in Romania: (a) Commercial Code
of 1897 and its reforms of 1923; (b) Code of Civil Procedures of 1897 and its reforms of 1923; (c) Depreciation
Law; (d) Tax Code; (e) Accounting Law; and (f) Ordinance 51 of August 1997 as amended in 1998.
Limited Access to Loans: Weak Supply of and Weak Demand for Loans 45

residual value of the assets. These practices favor cross border leasing and make it difficult to
lease Romanian-made assets. In fact, the Romanian leasing association estimates that 99 percent
of outstanding leasing contracts in the country are cross-border leasing. The practice also makes
leasing a comparatively easy mechanism to avoid custom duties and the VAT on imported
assets. Industrial companies would find it profitable to establish wholly-owned leasing
companies in foreign countries for the sole purpose of leasing their fixed assets from these
companies and reduce, thereby, the amounts paid on custom duties and VAT.

The Capacity of the Rural Sector to Carry Additional Debt (Overhang)

Rural enterprises, in the aggregate, had financed 52 percent of their assets with debt during
the period covered by the survey. The most indebted sub-sector was trade and commerce with a
debt to assets ratio of 72 percent. Agriculture was the least indebted with a ratio of 43 percent
(see Table 1).

The capacity of the rural sector to carry additional debt should be a matter of policy
concern. The problem is that illiquid assets, especially land, dominate the sector’s balance sheet.
The capacity of assets to carry debt is directly related to their liquidity. The problem seems
particularly serious for Romanian agriculture because debt levels are already high in the sub-
sector. The 43 percent debt to assets ratio of Romanian agricultural enterprises contrasted sharply
with the equivalent ratios for agriculture in the United States, which have varied from about 12
to 16 percent over the last 30 years.44

Cash flow analysis confirms that the sector would have problems servicing new flows of
debt. The value of the sales (products and services) of the entire rural enterprise sector was not
sufficient to cover production costs and operational expenses (see section II.E, page 8 ). The
gross net cash from operations was negative at the consolidated level and for all sub-sectors with
the exception of trade. The net cash from operations was made (barely) positive by significant
non operational income, namely financial and exceptional revenues.

One implication is that rural enterprises were not able, in the aggregate, to serve their
existing debt. In particular, the agricultural and services sub-sectors needed to incur additional
debt to serve interest payments and amortize the principal amount of their outstanding debts. The
state-owned sub-sector was the culprit of this situation as the negative balance on its net cash
flow was large enough to wipe out the net cash surplus generated by the private sector.
Interestingly, the banking sector allocated 45 percent of all the new flow of credit to state
enterprises with negative cash flows.

44 One caveat applies to this measure. Romanian accounting and taxation laws do not allow revaluation of assets in
the presence of inflation. Thus, these ratios may overestimate the debt burden as market values may be above their
historic book values. The resulting information may be used to detect systematic differences across sectors.
Comparisons across countries should be done with care, but could still be useful because it is unlikely that the
market value of farm land has adjusted significantly to inflation because of the poor functioning of land markets.
46 Chapter Three:

Retail Lending Capacity in the Banking Industry

The Romanian banking sector has not developed the capacity to profitably provide retail
credit. The weak supply of these services is reflected in the fact that the share of loans to
households and to small businesses in the portfolios of banks is almost negligible. Development
of private financial markets in rural Romania requires the ability of the financial sector to supply
retail and micro-finance services profitably. This necessity results form the fact that, by and
large, rural clients demand very small transactions. Small and medium enterprises dominate the
enterprise sector as the average rural private enterprise had US$11,900 of assets and the large
majority (80 percent) had less than 5 employees. On the other hand, households are also small
clients. The average monthly household income was US$67 per month and the value of
household assets was US$1,564 (see Chapter I for details on enterprises and households).

Several factors suggest that the supply of retail and micro-finance services will continue to
be weak in the medium term in the absence of Government policy intervention. First, the
methods or technologies of financial intermediation (TFI) used by the country’s banks render
retail lending unprofitable. These technologies are important in that they represent the methods
used by banks to: (a) raise funds and (b) to allocate and recover loans. This methods include: (a)
business components such as (i) branches and points of sale, (ii) management information
systems, (iii) internal control procedures, and (iv) asset and liability management techniques; and
(b) an information component comprising (i) screening of loan applicants, (ii) monitoring of
borrowers, and − to certain extent − (iii) enforcing credit contracts. These two types of
components determine the fixed cost structure of a bank branch and the average cost of
providing financial intermediation services, respectively.

The TFIs used by the large majority of Romanian banks are inappropriate to provide retail
financial services because: (a) they imply high fixed costs (expensive physical infrastructure,
numerous employees) that could not be supported by comparatively small volumes of operations
in retail and rural markets; and (b) the TFI’s information component (e.g., screening of loan
applicants using feasibility studies or audited financial statements) implies costs of lending that
render small loans (the majority of the potential demand) non-economical.

The second factor that suggests that the supply of retail services will continue to be weak
or actually weaken further is that the network of bank branches may shrink significantly during
and after the expected privatization or divestiture of state-owned banks (see Chapter II). It is
likely that struggling state banks will downsize by closing branches and that large commercial
banks will close a significant number of existing branches after privatization as they adopt
strategies focused on the corporate portion of the market. This tendency, which characterizes the
behavior of the banking sector in most countries in Central and Eastern Europe, is already
occurring in Romania where, for instance, Banca Agricola has recently closed more than a third
of its branches.

Another reason to expect a reduction in the number of bank branches is that a significant
portion of the existing branches are not adequate to provide retail services, especially in rural
localities. Many existing branches have fixed costs structures that are not sustainable in rural
markets characterized by comparatively small populations which conduct mostly small
Limited Access to Loans: Weak Supply of and Weak Demand for Loans 47

transactions. Reasonable intermediation margins may not be enough to sustain the high fixed
costs of the existing network.

Finally, privatized banks may close existing branches as macroeconomic stability would
reduce the profitability of “deposits-only” branches. These branches have been used by the
Government (in the case of CEC) and by other banks to arbitrage on restricted access, on the part
of the population, to Government securities. Banks have enjoyed disproportionately high
margins from collecting retail deposits to finance portfolios of such Government securities (see
fig. 9). Macroeconomic stability would reduce the rather large yields on Government securities
of the last few years, rendering many deposits-only branches unprofitable.

There may be a need, therefore, to induce private banks to increase their presence in the
retail portion of the market. In the first instance, this presence would be required to provide safe
deposit services to large portions of the population which have bank deposits (see Chapter II).
These services should be provided mainly by regulated intermediaries. The vacuum that may be
left by a retiring state-owned banking sector introduces the risk of unregulated intermediaries
increasing their share of the deposits of the population. As indicated in Chapter II, three state-
owned banks held 80 percent of the deposits of the rural population.

An appropriate distribution network will also be required to lend to small and medium
businesses, including those in rural areas and farmers. Small credit transactions are highly elastic
with respect to transaction costs, which are reduced in the presence of a point of sale in the
locality of residence of borrowers. The presence of a network of retail finance will be required to
allow for the massive redeployment of resources expected to occur in the rural economy.

International experience attests that retail rural lending could be a profitable market niche
for banks, provided they use appropriate methodologies. These methods require banks to: (a)
sell few and simple credit products; (b) have low branch fixed costs; (c) use of local information
to screen and monitor borrowers; (d) implement conducive incentive schemes for branch
managers; and (e) deploy adequate internal control mechanisms.45 The irreversible trend of banks
in economies with developed financial markets is to aggressively compete for the retail portion
of the market. In Romania, increased availability of retail credit in rural areas may take a long
time to develop if left solely to the market. In fact, there is a significant risk that the banking
sector will reduce its retail network in rural areas after privatization, as indicated above.

Missing Input and Output Markets

The weak supply of informal sector credit to rural households may result from missing
input and output markets. The overall scarcity of forward sales and inter-linked credit
transactions contrasts with the stylized facts that characterize rural credit markets in other
regions, notably Asia and Latin America. In countries with well developed input and output
markets, traders are important agents in the financing of household productive activities.

45These elements are common to some very successful rural financial intermediaries whose experiences are well
documented in the professional literature (Chaves and Gonzalez, 1996).
48 Chapter Three:

The new land ownership and tenure system does not match the previous centrally planned
arrangements for input procurement or output marketing, requiring adjustments across all
segments of the chain. Changes in land tenure made established distribution channels in input
and product marketing unsuitable for a very small and dispersed clientele. The dominance of the
state in agricultural output and input markets prevented the development of innovative financial
arrangements in the input and output markets. In 1992, the Government established a parastatal −
the regie autonome RomCereal − to manage the country’s entire silo capacity. RomCereal acted
as the sole provider of agricultural inputs and the sole buyer of grain and oilseeds in the country.
RomCereal operated until 1996, when it was replaced by the National Agency for Agricultural
Products (ANPA). Although some planned reforms of the agricultural marketing system should
allow competitive informal credit markets to flourish, the process will take a long time. The
informal sector may require a long time to fill the vacuum left by retiring state-owned
institutions.

C. THE DEMAND FOR LOANS: AN ECONOMETRIC MODEL

The empirical findings of this study dispute the commonly held belief that the
unwillingness of the banking sector to lend to rural agents (i.e., a weak supply) is the (only)
cause of insufficient credit flows to rural areas. In the case of Romania, weak demand for loans
was a very important determinant of the limited participation of rural agents in credit markets.
The survey data show that the incidence of economic agents reporting a demand for loans in
rural areas was rather limited, as only 31 percent of households with farm and other
entrepreneurial activities and half of all rural enterprises reported having a demand for loans.

Naturally, the demand for loans was not uniform, but varied by key characteristics of the
agents such as size (measured as assets or revenues), economic sector, ownership, and agro-
region.

For example: (a) the 50 percent of enterprises reporting that they had a demand for loans
controlled 82 percent of total assets and generated 62 percent of total revenues of the rural
enterprise sector; and (b) rural enterprises owned by the public sector were more likely to
respond that they had a demand for loans (71 percent) than their private counterparts (51
percent).

Examples of the variation of demand for loans continue with substantial regional
differences as: (a) the proportion of households demanding loans in the case of Oltenia de Sud is
20 percent, while in Subcarpatti de Sud the equivalent percentage is 39 percent; and (b) 78
percent of enterprises in rural Campia Romana Centrala reported loan demand while the
equivalent percentage in the case of Campia de Vest was 37 percent.

This variation of the reported demand for loans with various observed characteristics of
rural agents made it necessary to use econometrics to isolate key variables. A probit model was
used to separate the correlation between demand for loans and the characteristics of economic
Limited Access to Loans: Weak Supply of and Weak Demand for Loans 49

agents.46 The results follow, first for the model applied to the data on households and then to the
data on enterprises.

Household Demand for Loans

A probit model of which the dependent variable is whether or not the household reported a
demand for loans was estimated. A total of 28 observed explanatory variables were used. These
variables measured different characteristics of sampled households in four dimensions: socio-
demographic, entrepreneurial activity, conditions in the locality of residence, and agro-region of
residence. The results of the regression and the complete list of explanatory variables are
presented in Table 14. The table also presents the results of three specifications of the model,
which confirm that its results are robust.

The following variables were found to be related, with statistical significance at

conventional levels of confidence, to the likelihood of a household reporting a demand for loans.
In terms of demographic characteristics the households more likely to have reported a demand
for loans, everything else the same: (a) were headed by younger individuals; (b) were more
numerous; (c) had more members who were pensioners; and (d) had a larger number of members
working outside the agricultural sector.

In terms of entrepreneurial and financial characteristics, the households less likely to have
reported a demand for loans were those which, everything else the same: (a) had higher amounts
of assets excluding land and financial deposits; (b) had more liquid financial assets in the form of
bank deposits; (c) had higher levels of income generated by sales of agricultural and non-
agricultural products and services; (d) self-consumed less of their own production; (e) had larger
endowments of land; and (f) hired less workers.

Finally, in terms of the characteristics of their locality of residence, the households more
likely to have a demand for loans were those which, everything else the same, lived in localities:
(a) that were more highly populated; (b) in which there were many farmers relative to
population; and (c) that were located farther from large urban centers.

46 A probit model fits a dichotomous dependent variable that takes the value of zero when there is a lack of demand
for loans and the value of one when there is a demand for loans against a vector of observable characteristics or
explanatory variable. Annex 2 presents the details of the probit model used.
50 Chapter Three:

Table 14 Demand for Loans by Rural Households (Probit Model)

Regression Results Regression Results Regression Results
Explanatory Variables Coeff. S.D. Mean Xs Partials Coeff. S.D. Partials S.D. t-stat Prob Mean Coeff. S.D. Partials
Constant -2.2284 0.7841 *** -0.7578 -2.3210 0.7658 *** -0.7911 0.2604 -3.0380 0.0024 -2.0684 0.7521 *** -0.7068
Sociodemographic variables
Age of household head -0.0141 0.0024 *** 58.2769 -0.0048 -0.0140 0.0024 *** -0.0048 0.0008 -5.7950 0.0000 58.2769 -0.0134 0.0023 *** -0.0046
Marital status (1=married) -0.1427 0.1020 0.6870 -0.0485 -0.1525 0.1013 a -0.0520 0.0345 -1.5070 0.1319 0.6870 -0.1487 0.1004 a -0.0508
Gender (1=male) 0.0943 0.1066 0.7538 0.0321 0.0868 0.1059 0.0296 0.0361 0.8200 0.4122 0.7538 0.0864 0.1048 0.0295
Nationality (1=Romanian) -0.0794 0.1089 0.9045 -0.0270 0.0065 0.0982 0.0022 0.0335 0.0660 0.9475 0.9045 0.0537 0.0959 0.0183
Max education by HH member -0.0021 0.0201 4.0523 -0.0007 0.0004 0.0198 0.0001 0.0068 0.0200 0.9837 4.0523 -0.0026 0.0193 -0.0009
Family size 0.0922 0.0209 *** 2.9319 0.0314 0.0885 0.0207 *** 0.0302 0.0071 4.2720 0.0000 2.9319 0.1034 0.0199 *** 0.0353
Adults working in non-agriculture 0.1453 0.0468 *** 0.4666 0.0494 0.1407 0.0464 *** 0.0480 0.0158 3.0360 0.0024 0.4666 0.1219 0.0434 *** 0.0417
Number of pensionersin HH 0.1173 0.0540 ** 0.3117 0.0399 0.1218 0.0529 ** 0.0415 0.0180 2.3040 0.0212 0.3117 0.1185 0.0521 ** 0.0405
Characteristics ofEntrepreneurial Activity
Log (assets,excluding land and deposits) -0.0266 0.0222 9.6296 -0.0091 -0.0398 0.0210 * -0.0136 0.0072 -1.8930 0.0584 9.6296 -0.0368 0.0201 * -0.0126
Log (deposits) -0.0204 0.0085 ** 2.7066 -0.0069 -0.0149 0.0084 * -0.0051 0.0029 -1.7730 0.0763 2.7066
Log (monthly agricultural sales) -0.0380 0.0136 *** 1.4296 -0.0129 -0.0389 0.0135 *** -0.0133 0.0046 -2.8910 0.0038 1.4296
Log (monthly non-agricultural sales) -0.0421 0.0218 ** 0.2883 -0.0143 -0.0419 0.0217 ** -0.0143 0.0074 -1.9280 0.0538 0.2883
Log (monthly non-agricultural sales) -0.0094 0.0240 6.2475 -0.0032 -0.0009 0.0236 -0.0003 0.0081 -0.0400 0.9682 6.2475
Log (monthly self-consumption) 0.0209 0.0220 5.5538 0.0071 0.0365 0.0210 * 0.0124 0.0072 1.7390 0.0820 5.5538
Land holdings (Ha) -0.0704 0.0217 *** 1.8454 -0.0239 -0.0908 0.0211 *** -0.0309 0.0072 -4.3200 0.0000 1.8454 -0.0991 0.0206 *** -0.0339
Number of plots 0.0122 0.0117 3.3383 0.0042 0.0144 0.0112 0.0049 0.0038 1.2800 0.2007 3.3383 0.0168 0.0111 a 0.0057
Number employees (ag and non-ag) 0.0106 0.0108 3.6787 0.0036 0.0175 0.0106 * 0.0060 0.0036 1.6510 0.0988 3.6787 0.0115 0.0100 0.0039
Economic Conditions in the Locality
Log (population) 0.2099 0.0792 *** 8.3835 0.0714 0.2169 0.0760 *** 0.0739 0.0259 2.8550 0.0043 8.3835 0.1869 0.0754 *** 0.0639
Log (population density per hectare) -0.0138 0.0579 -0.4953 -0.0047 0.0131 0.0529 0.0045 0.0180 0.2480 0.8040 -0.4953 0.0073 0.0526 0.0025
Owners of agricultural land /inhabitants (%) 0.6941 0.2313 *** 0.4256 0.2360 0.7999 0.2242 *** 0.2726 0.0764 3.5700 0.0004 0.4256 0.8005 0.2229 *** 0.2735
Log (Kms to nearest town) 0.1594 0.0441 *** 2.7481 0.0542 0.1601 0.0436 *** 0.0546 0.0148 3.6810 0.0002 2.7481 0.1558 0.0432 *** 0.0532
Agroregion Dummies
Campia de Vest 0.0105 0.1155 0.1038 0.0036
Moldova de Podis 0.0856 0.1284 0.0872 0.0291
Moldova Deal 0.0835 0.1242 0.1038 0.0284
Subcarpatii de Sud 0.3455 0.1037 *** 0.2159 0.1175
Campia Dunarii de Jos 0.0381 0.1310 0.0706 0.0129
Oltenia de Sud -0.0649 0.1291 0.0872 -0.0221
Campia Romana Centrala 0.1043 0.1254 0.0872 0.0355
SAI -0.3290 0.2314 0.0249 -0.1119
Number of observations 2,409 2,409 2,409
Chi-squared 276.4580 250.9545 232.8266
df = 29 21 16
McFadden's Pseudo-R2 0.0933 0.0847 0.0786
Proportion YD=1 0.3047 0.3047 0.3047
a/*/**/*** significant at the 85%, 90%, 95%, and 99% confidence intervals,respectively
Source : Author's calculations.

Enterprise Demand for Loans

A similar exercise was conducted for rural enterprises. Also a total of 28 observed
variables were used to explain enterprises’ demand for loans. These explanatory variables
measured characteristics of sampled enterprises regarding their managers, economic sector, legal
status and governance structure, financial indicators (e.g., assets, profitability, turnover), and the
economic conditions in the locality where they are located.

The results of the regression and the complete list of explanatory variables used in the
model are presented in Table 15. The table also presents the results of three specifications of the
model which confirm that its results are robust. The model indicates that the enterprises more
likely to have reported a demand for loans:

(a) Had a younger manager, which could be explained by several possibilities

including that younger managers (i) may be less risk averse on the average, (ii) more able
Limited Access to Loans: Weak Supply of and Weak Demand for Loans 51

to identify investment opportunities, and (iii) more familiar with the procedures to obtain
banks loans than their older counterparts.47

(b) Were in sectors other than agriculture. Everything else the same, the probability
that an enterprise in the industry, trade, and service sectors reported a demand for loans
was, respectively, 36, 32, and 30 percentage points higher than the probability of an
agricultural enterprise reporting a demand for loans.

(c) Were bigger in terms of the book value of their assets and were within the group
of very large enterprises those in agricultural are more likely to report demand than their
(also) big counterparts in other sectors.

47 The model applied to the data on households found that households headed by younger individuals are also more
likely to report a demand for loans. The “appetite” for debt of farming households, the large majority of Romanian
rural households, seems to be highly influenced everywhere by life cycle patterns. In the United States, for instance,
debt to assets ratios are highest in the younger age classes and decline steadily as age increases (Barry). Clearly, a
life cycle argument for firms based on the age the enterprise’s manager does not hold.
52 Chapter Three:

Table 15 Demand for Loans by Rural Enterprises (Probit Model)

Regression Results Regression Results Regression Results
Mean
Explanatory Variables Coeff. S.E. Values Partials Coeff. S.E. Partials Coeff. S.E. Partials
Dependent Variable: 0=No Demand 1=With Demand for Loans
Constant -0.3221 1.5240 -0.1146 0.9280 1.0437 0.3304 -0.1271 1.4798 -0.0453
Manager of the Enterprise
Log(age) -0.6128 0.2403 *** 3.7915 -0.2179 -0.6354 0.2390 *** -0.2263 -0.6225 0.2392 *** -0.2216
Education Index 0.0208 0.0319 5.6581 0.0074 0.0236 0.0317 0.0084 0.0136 0.0315 0.0049
Economic Sector
Industry Dummy 1.0066 0.3617 *** 0.1152 0.3580 0.9795 0.3596 *** 0.3488 0.8923 0.3518 *** 0.3177
Trade Dummy 0.8876 0.3241 *** 0.3239 0.3157 0.8672 0.3224 *** 0.3088 0.7727 0.3125 *** 0.2751
Services Dummy 0.8371 0.3621 ** 0.0730 0.2977 0.8252 0.3596 ** 0.2938 0.7252 0.3519 ** 0.2582
Legal Status and Ownership
Agricultural Stock Enterprise (1=yes) -0.4363 0.2770 a 0.1575 -0.1552 -0.3998 0.2761 a -0.1424
Non-Agricultural Stock Enterprise (1=yes) -0.4745 0.4609 0.0166 -0.1687 -0.5139 0.4607 -0.1830
Private Owned Dummy 0.0233 0.2801 0.8860 0.0083 0.0383 0.2788 0.0136
Characteristics of Firm Activity
Log ( years in business) -0.0469 0.1365 1.5849 -0.0167 -0.0467 0.1349 -0.0166 0.0360 0.1305 0.0128
Log (total assets in 1996) 0.2188 0.0609 *** 4.1549 0.0778 0.2232 0.0606 *** 0.0795 0.2024 0.0582 *** 0.0721
Log (total assets in 1996)*Agricultural Sector
Dummy 0.1859 0.0754 *** 2.7799 0.0661 0.1731 0.0744 ** 0.0617 0.1499 0.0668 ** 0.0534
Fixed assets/total assets in 1996 -0.0335 0.2042 0.3487 -0.0119 -0.0337 0.2027 -0.0120 -0.1655 0.1924 -0.0589
Bank deposits/total assets in 1996 -0.6834 0.3041 ** 0.0766 -0.2431 -0.6858 0.3027 ** -0.2442 -0.7075 0.3028 ** -0.2519
Log (turnover) -0.0249 0.0394 4.8102 -0.0089 -0.0209 0.0392 -0.0074 -0.0160 0.0388 -0.0057
Turnover/employees -0.0005 0.0008 33.1162 -0.0002 -0.0005 0.0008 -0.0002 -0.0004 0.0008 -0.0001
Associate members working in
enterprise/employees 0.1947 0.1503 0.3676 0.0692 0.1971 0.1487 0.0702 0.2697 0.1434 * 0.0960
Economic Conditions in the Locality
Log (population) 0.1338 0.1302 8.3983 0.0476 0.1223 0.1295 0.0436
Log (population density per hectare) 0.0977 0.1166 -0.4950 0.0348 0.1010 0.1160 0.0360
Agricultural employment ratio 0.2443 0.3204 0.4227 0.0869 0.2293 0.3193 0.0817
Log (Kms to nearest town) 0.0323 0.0789 3.0749 0.0115 0.0349 0.0785 0.0124
Agroregion Dummies
Campia de Vest -0.0691 0.1849 0.1280 -0.0246 0.0000 0.1797 0.0000 -0.0677 0.1842 -0.0241
Moldova de Podis 0.5630 0.2862 ** 0.0653 0.2002 0.7216 0.2599 *** 0.2570 0.5591 0.2850 ** 0.1991
Moldova Deal 0.2688 0.2252 0.0794 0.0956 0.3870 0.2136 * 0.1378 0.2555 0.2244 0.0910
Subcarpatii de Sud 0.0825 0.1743 0.1895 0.0293 0.1837 0.1598 0.0654 0.0699 0.1740 0.0249
Campia Dunarii de Jos -0.0620 0.2132 0.1050 -0.0220 0.0342 0.1990 0.0122 -0.0631 0.2122 -0.0225
Oltenia de Sud 0.3917 0.2440 a 0.0832 0.1393 0.5110 0.2217 ** 0.1820 0.3685 0.2419 a 0.1312
Campia Romana Centrala 0.2507 0.1990 0.1306 0.0892 0.3391 0.1896 * 0.1208 0.2222 0.1976 0.0791
SAI -0.7596 0.3214 ** 0.0359 -0.2701 -0.5846 0.2888 ** -0.2082 -0.7612 0.3217 ** -0.2710
Number of observations 781 781 781
Chi-squared 169 165 164
df = 28 24 25
McFadden's Pseudo-R2 0.1666 0.1633 0.1619
Proportion YD=1 0.6492 0.6492 0.6492
a/*/**/*** significant at the 85%, 90%, 95%, and 99% confidence intervals, respectively
Source : Author's calculations

Other interesting findings include that: (a) although simple cross-tabulations show that
public enterprises demanded and, in fact, got more loans than private firms, once other variables
are controlled for − government ownership by itself is not correlated with reporting a demand;
(b) locality-level variables do not influence demand among enterprises; and (c) there were
substantial differences in reported demand across agro-regions. Points (b) and (c) are in direct
contrast with the corresponding findings of the model when applied to the data on households.

Weak Demand for Credit

The regression results on the household data suggest that, by and large, the demand for
loans at the household level was associated with highly inelastic consumption needs rather than
with investment opportunities and by absence of alternative financing means to loans. In short,
Limited Access to Loans: Weak Supply of and Weak Demand for Loans 53

the demand for loans in rural areas seems to have been exercised along the “inelastic” portions of
the demand curve – when liquidity was badly needed and when there were no substitutes for
loans to obtain the required liquidity. The justification of this inference follows.

Everything else the same, larger families have more cyclical (e.g., beginning of the school
year, Christmas) and unexpected (e.g., medical emergencies) consumption needs. This feature
may trigger recurrent demand for loans to finance household consumption. In fact, 53 percent of
the households which had access to credit declared that they used it to finance consumption
activities. Households with more pensioners were not only older on average, but also may be
more likely to finance medical expenditures and to have sticky nominal incomes. Although their
incomes have deteriorated in real terms, they are predictable enough to allow servicing of debts.
Households with a greater involvement in non-agricultural activities tend to have higher wages
and more stable income levels and are, thus, better positioned to trade present consumption for
future income flows.

On the other hand, households residing in comparatively large communities dedicated

intensely to farming and which were distant from urban centers reported were more likely to
have a demand for loans. In such an environment, local aggregate levels of economic activity
were highly dependent on systemic factors such as weather or specialization in few regional
crops, which may trigger simultaneous need for outside funding.

Finally, households who had access to: (a) bigger endowments of assets and wealth,
including larger landholdings; and (b) sources of liquidity, including bank deposits and sales
revenues were more likely to report that they had no demand for loans. Indeed, 44% of the
households which reported no demand for loans belonged to the top quartile in terms of the value
of assets owned. It is reasonable to conclude, therefore, that households prefer internal sources of
funding over external borrowing.

One consequence of the observed excessive collateral requirements is that the demand for
loans decreases. Large numbers of otherwise creditworthy borrowers may opt out of credit
markets. Peculiar collateral requirements together with the shortcomings of the legal framework
could make the borrowers’ cost of defaulting disproportionate to the amount borrowed. Rural
areas have no functioning mechanisms with which to auction property given as collateral and to
ensure that any amount remaining after lenders have been fully compensated will be returned to
the borrower. Hence, those potential borrowers who would be required to pledge collateral may
face an artificially skewed risk-return distribution for their investments. Indeed the survey
indicates that 27 percent of rural entrepreneurs and 8 percent of rural enterprises did not request
loans because they considered borrowing too risky for this reason.

Clearly, there are also underlying profitability problems in the rural sector. Low
profitability in the sector implies low values for sector specific assets, notably land. These low
values restrict the demand for credit. As detailed in Chapter I section E, the profitability
indicators of the enterprise sector were rather weak during the period covered by the survey.
Although indicators varied significantly between private and state enterprises and across sub-
sectors, the aggregate return on equity (ROE) and return on assets (ROA) of Romania’s rural
enterprises were much lower than inflation in 1997 (19 percent and 9 percent, respectively),
against an annual inflation of 155 percent.
54 Chapter Three:

In addition, the sector’s demand for credit was also weak because limited investment took
place during the period covered by the survey. The link between credit and investment is
intuitively straightforward. Investment outlays tend to be lumpy and require liquid resources.
Thus, access to external credit may assist households and enterprises to take advantage of
profitable investment opportunities. Availability of internal financing is not necessarily
synchronized with investment opportunities. Efficient credit markets could be accessed when
opportunities appear. The data indicate that a comparatively limited number of rural households
and enterprises made investments in capital goods during the period for which data was
collected.48 About 28 percent of rural households made some type of investment, of which 74
percent invested in productive activities (mostly agriculture) and 36 percent in housing and
household durables.49 About 26 percent of enterprises invested in the period, of which 57
percent were in equipment and machinery.

Macroeconomic uncertainty probably remains a significant concern of potential rural

borrowers who must borrow at variable rates of interest – 87 and 75 percent of all bank loans
granted to enterprises and households, respectively, had rates of interest adjustable with respect
to some market index. Borrowers could go bankrupt when interest costs rise relative to their
enterprise earnings, especially for households which have very with limited access to markets or
enterprises in non-tradable sectors because of difficulties in hedging against devaluation of the
Lei.

Another factor that may be weakening the effective demand for credit is the high levels of
ex-ante real interest rates on loans, whether denominated in Lei or in hard currency (taking into
account expected devaluation). High real rates require investments to have very high marginal
productivity. Smaller enterprises with low capital/labor ratios would be more willing, everything
else equal, to borrow at the prevailing high real rates, while larger and more capital intensive
businesses would not be able to afford such interest rates. In Romania, there may be an
unfortunate mismatch in which smaller businesses which would demand credit even at high rates
are not being served by banks, while larger enterprises which would be served by banks are not
demanding credit at high (real) rates.50

48Clearly, it is difficult to separate causality in this case. Limited demand for investment certainly implies weak
demand for loans. On the other hand, limited investment may have been caused by limited access to loans. Chapter
V separates empirically these effects, and also provides details on the measurement of investment outlays.
49 These figures do not add to 100 percent because some households invested in both productive and household
activities.
50 Of course, borrowers who intend to get away with default are not concerned about the real interest rates on their
loans.
 Chapter IV: Credit Constraints and Rural Investment
The previous chapter provided evidence that the observed limited flow of loans to rural
households and enterprises during the period covered by the surveys was caused by a limited
supply of credit in the whole economy, which was probably worse for the rural sector, and by a
weak demand for rural credit under the conditions at which loans were available at the time. This
chapter addresses the relevant public policy questions that arise from this evidence. How much
of this limited flow of loans was due to weak supply of credit and how much was due to a weak
demand for credit? In particular, was the demand weak because there were only a few profitable
investment opportunities or because households and enterprises had sufficient internal funding
relative to their needs. Equivalently, did the limited supply of loans relative to existing demand
result in significant numbers of households and enterprises not taking advantage of the profitable
investment opportunities that may have been present in rural areas because of constrained access
to credit markets? If so, how much larger would rural investment have been in the absence of
credit constraints?

This chapter is organized in four sections. The first section presents the working definition
of credit constraints and the empirical methodology used to assess the determinants of credit
constraints in the rural sector. Then, the results are evaluated for the sample of households and
enterprises in the following next two sections. The last section presents the effect of credit
constraints on rural investments.

A. THE EXTENT OF CREDIT CONSTRAINTS IN THE RURAL SECTOR

The previous chapter identified empirically the households and enterprises that reported a
demand for loans under the conditions they perceived the market would lend to them. Prevailing
conditions included dimensions such as interest rate, collateral requirements, and transaction
costs required to complete a credit contract.

This section takes the analysis further by determining whether the agents which had a
positive demand for loans were able to borrow the amounts they desired. That is, whether rural
agents were credit constrained.51 Being “credit constrained” is necessarily a relative concept
resulting from the comparison of an agent’s demand for credit with the supply of credit to which
it has access. An agent which does not have a demand for credit can not be credit constrained by
definition.

Consequently, rural agents could be classified by comparing their self-reported demand

with the actual amounts of loans they received during the period under analysis. In terms of

51 Credit constraints relative to demand for credit and credit rationing is an issue widely discussed in the economics
literature (e.g., Milde and Riley, 1988; Gale and Hellwing, 1985). Credit rationing is explained as an equilibrium
outcome under various circumstances such as interest rate restrictions or subsidized credit policies (e.g., Gonzalez-
Vega, 1984), imperfect information and profit maximizing behavior of lenders (e.g., Stiglitz and Weiss, 1981), and
enforcement difficulties and ensuing opportunistic behavior of borrowers (e.g., Bell 1988).
56 Chapter Four:

credit constraints, every agent must, therefore, belong to one and only one of the following four
groups.

The first group includes those agents which were not interested in borrowing at the
prevailing conditions. These agents did not have loans simply because they did not want loans,
and may be called unconstrained non-borrowers. The second group corresponds to agents that
did not get loans although they wanted credit. This group includes agents whose loan
applications were denied and agents which did not apply for loans because of their (correct)
perception that their applications would have been rejected, at least with high likelihood. This
group corresponds to totally constrained non-borrowers.

The third group of agents consists of those that received loans for exactly the amount they
wanted under the prevailing conditions. These agents may be called unconstrained borrowers.
The fourth and last group
Table 16 The Extent of Credit Constraints corresponds to those agents that
received loans for less than the
Households Enterprises amount they would have wanted to
(%) (%) borrow at the conditions prevailing
Credit Constrained 24.3 41.1 at the time. This group is termed
Constrained borrowers constrained borrowers.
(partially constrained) 13.8 12.0
Constrained non-borrowers Table 16 summarizes the
(totally constrained) 10.5 29.1 incidence of credit constraints in
Credit Unconstrained 75.7 58.9 rural Romania. The survey data
Unconstrained borrowers 6.4 8.3 show that the incidence of credit
Without loan demand 69.3 50.5 constraints is significant. Only a
Total 100.0 100.0 small percentage of rural agents
Source: Surveys of Households and Enterprises, 1998.
reported being unconstrained
borrowers. Six percent of
households and 8 percent of
enterprises were able to borrow the amounts that they wanted to borrow. The prevalence of credit
constraints among rural enterprises doubled that of rural households. Enterprises reported that
they were totally credit constrained three times more often than households. This greater
incidence among enterprises resulted because they had a stronger demand for loans. Among
households, 10 percent reported being totally credit constrained and 14 percent were partially
credit constrained. Among enterprises, 29 percent reported being totally constrained, while 12
percent reported that they were partially constrained.

Credit constraints resulted from the interaction of demand and supply factors. Hence, it is
necessary to separate the influence of demand and supply to assess the performance of rural
credit markets. An ordered probit econometric model was applied to the data on those agents
which had a positive demand for loans. The model determines the probability of an agent being a
totally constrained, partially constrained, or an unconstrained borrower as a function of
observable variables. These variables influence both the demand for, and supply of, loans
available to each agent and include specific observations related to lending costs (e.g., the
number of financial services retail outlets in the locality).
Credit Constraints and Rural Investment 57

Table 17 and Table 19 present the estimated coefficients and the marginal effects of the
explanatory variables on the above probabilities for rural households and enterprises,
respectively.52

B. CREDIT CONSTRAINTS AT THE LEVEL OF RURAL HOUSEHOLDS

As presented in Table 17 the ordered probit model shows that unconstrained and partially
constrained households (i.e., those which borrowed) tend to be similar among themselves and
tend to be very different from their totally credit constrained counterparts. After controlling for
numerous other variables, totally credit constrained households are more likely (with statistical
significance) than their borrowing counterparts to: (a) be headed by unmarried individuals; (b)
be less educated; (c) have more members; (d) have less members working in the non-agricultural
sector; (e) have smaller endowments of non-financial movable assets; (f) receive smaller
amounts of fixed incomes such as salaries and pensions; (g) have smaller real state holdings; (h)
live in localities where there are more farmers relative to total population; and (h) live in
localities where there are more branches of state-owned banks.

The (aggregate) supply of loans faced by households is very diverse as it ranges from
altruistic friends and relatives to credit cooperatives owned by the credit applicants themselves to
for-profit money lenders. Clearly, each type of lender imposes different conditions on its loans
and has diverse criteria to approve requests for credit. Hence, the analysis of the supply of loans
available to households should differentiate between informal sector lenders (mostly friends and
relatives) and formal sector lenders (commercial banks and non-bank intermediaries such as
credit cooperatives and Casa de Ajutor Reciprocs, CARs). 53

The probability of an agent being: (a) totally credit constrained; (b) a borrower from the
informal sector; or (c) a borrower from the formal sector as a function of observable variables
should complement the analysis above. A multinomial logit was applied to the data set of
households with positive demand to find the variables that determine the probability of a rural
household to obtain a loan from a particular type of lender or no loan at all. The results of the
regression and the complete list of explanatory variables used in the model are presented in
Table 18. These results expose the differences in the motivation and approval criteria between
the formal sector and friends and relatives when lending money to households.

52 Annex 2, “Credit Constraints and Investment Behavior of Households and Enterprises in Romania’s Rural Areas:
An Empirical Analysis”, presents the theoretical and technical aspects of the simple and ordered probit models
applied to the data. The ordered probit measures the aggregate supply of loans faced by an agent relative to the
agent’s total demand. It does not distinguish among different possible lenders. Another econometric model, whose
results are presented below, calculates the probability that an agent with positive demand obtained a loan from a
given type of lender. Annex 2 also provides statistical demonstration that the particular application of the ordered
probit models yields good econometric fits to the data (e.g., χ2 and pseudo-R2 measures). It also shows that there are
no sample selection problems in applying the ordered model only to the observations of households and enterprises
that reported a demand for loans (Greene, 1997).
53 The market shares and the characteristics of the loans granted by each type of lender in rural Romania are
summarized and described in great detail in Annex 1. The market shares as a percentage of the number of loans to
households (as opposed to amounts lent) of moneylenders and commercial banks are very limited (0.7 percent and 4
percent, respectively).
58 Chapter Four:

Formal lenders (mostly credit cooperatives and CARs) were more likely, everything else
the same, to have received and to have approved credit applications of households which: (a)
were headed by married, female, and more educated individuals; (b) had fewer members; (c)
were wealthier with higher values of movable and real estate assets and financial deposits; (d)
had access to predictable and verifiable flows of income as indicated by higher levels of wage
and pension incomes; (e) were more integrated into markets as suggested by more people
working outside agriculture, lower levels of self-consumption of their production, less
fragmented landholdings, residence in localities with a lower proportion of farmers, and being
closer to a town or city.

In contrast, the informal sector (mostly friends and relatives) were more likely, everything
else the same, to have received requests for credit from, and granted credit to, households which:
(a) were headed by younger and male individuals; (b) did not have alternative sources of
liquidity in the form of bank deposits or the possibility of borrowing from a credit cooperative;
and (c) were less integrated into markets as indicated by more members working in agriculture,
fragmented agriculture with numerous plots, and living farther from a town or city. Statistically
speaking, informal lenders, which comprise mostly friends and relatives, as a group were not
concerned with wealth and income variables.

These results strongly suggest that there was a matching of borrowers and lenders in that
(among those who had borrowed) the better-off individuals with access to markets obtained their
loans from the formal sector while comparatively worse-off and economically isolated
individuals resorted to borrowing mostly from friends and relatives. Formal lenders provided 56
percent of their loans and 68 percent of their total amount of credit to households in the two
richest asset quartiles.

Additionally, the fact that households located in localities with a larger number of state
bank branches were more likely to be totally credit constrained suggests that state banks not only
grant few loans to households, but that their branches are possibly crowding out credit
cooperatives and CARs which, in order to lend to households, need to compete in mobilizing
savings with the state. Backing from the state gives state-owned banks an advantage in
mobilizing savings over those lenders which did grant loans to households, albeit to the richest
ones.

In general, the regression results confirm that one reason why few Romanian rural
households participate in credit markets is because there was a limited coincidence between
those which want loans (the aggregate demand) and the willingness of all potential lenders to
lend to them (the aggregate supply). In fact, a majority of characteristics that made households
more likely to demand loans (see Table 18) also made lenders less willing to grant them loans.

C. CREDIT CONSTRAINTS AT THE LEVEL OF RURAL ENTERPRISES

Table 19 presents the results of two specifications of the ordered probit model applied to
the enterprise survey data. The table presents the signs, magnitudes, and statistical significance
of the estimated parameters and marginal effects that each of the variables has on the probability
Credit Constraints and Rural Investment 59

that an enterprise had been totally constrained, partially constrained, or unconstrained at the time
of the survey54.

The results indicate that enterprises that were partially credit constrained or unconstrained
tended to be statistically similar and that, as a group, they differ significantly from their totally
unconstrained counterparts. In a sense, lenders to rural enterprises based their decisions to
allocate any amount of credit (the amount actually requested or less) on basically the same
criteria, as follows.55

Lenders were more likely, everything else the same, to have received and to have
approved credit applications from enterprises which: (a) were managed by older and less
educated individuals; (b) were operating in sectors other than industry and incorporated as stock
corporations; (c) were large in terms of the value of their gross sales and the value of their assets;
(d) were in the agricultural sector, but only among the very large enterprises; and (e) were
domiciled in localities in which there were many branches of state-owned banks. That is,
enterprises with those characteristics were less likely to be totally credit constrained and more
likely to be either unconstrained borrowers or constrained borrowers, as indicated in the table.

So What? The Effect of Credit Constraints on Rural Investment

This section presents empirical evidence that credit constraints influence negatively the
investment behavior of households and enterprises. In particular, such constraints reduce the
number of agents that invest and the amounts they invest. The effect is especially negative at the
enterprise level. Thus, credit constraints matter from a public policy point of view, because
profitable investment opportunities are not pursued as a result of limited access to credit markets.
This situation is very negative for rural Romania because there are few such opportunities
anyway.

The analysis that follows predicts the share of households and enterprises which would
have invested during the period covered by the surveys, and the amounts of such investments, in
the absence of credit constraints. The analysis also determines the characteristics of agents which
were statistically related to their likelihood of investing and to their expected amounts of

54 The second specification (Model II) excludes the agro-region dummies to test whether the number of financial
outlets in the locality may be related to regional differences captured already by the dummies. A likelihood test
indicates that these dummies are not statistically significant determinants of the borrowing status of enterprises.
Hence, the results summarized here correspond to the variables that were found to be statistically significant in both
models. Variables that were significant at 85 percent in one model had to be significant at least at 90 percent in the
alternative specification to be reported in the text.
55 The banking sector allocated to enterprises 99.5 percent of the amount of loans and about 70 percent of the
number of transactions they received during the period. This concentration makes the supply of loans available to
enterprises rather homogeneous. There is no need, therefore, to study the supply of loans independently as was the
case at the household level where it was much more heterogeneous. While political considerations may result in
differences in the lending behavior of state or private banks, and thus, in the probability of a rural enterprise
obtaining loans, the majority of enterprises that received loans did so from state banks (88%). Thus, the results of
the ordered probit are highly influenced by the lending criteria of state banks. On the other hand, private banks that
are lending directed credit lines to rural enterprises may also be subject to political pressures.
60 Chapter Four:

investments. These results allow for estimation of the costs of credit constraints. They also
outline areas for fruitful policy intervention.

The link between credit and investment is intuitively straightforward. Investment outlays
tend to be lumpy and require liquid resources. Thus, access to external credit may assist
households and enterprises to take advantage of profitable investment opportunities. Efficient
credit markets can be accessed when opportunities appear. In contrast, availability of internal
financing is not necessarily synchronized with investment opportunities.

The analysis begins by looking at the investments made by households and enterprises.
Investments are defined as the expenditures incurred in acquiring capital goods including
buildings, equipment,
tools, machinery,
Figure 12 Investment Decisions by Credit Constraints vehicles, livestock, and
land.56
Total

Credit unconstrained
A comparatively
limited number of rural
Partially credit constrained households and
Borrowers e n t e r p r i s e s m ade
investments in capital
Without demand
goods during the period
Totally credit constrained
Enterprises
for which survey data
Non-borrowers Households was collected (see
Figure 12). About 28
0 5 10 15 20 25 30 35 40 45 50
percent of rural
Source: Survey of Rural Households and Financial Services, 1998; Survey of households made some
Rural Enterprises and Financial Services, 1998. type of investment, of
which 74 percent
invested in productive activities (mostly agriculture) and 36 percent in housing and household
durables.57 About 26 percent of enterprises invested, of which 57 percent was in equipment and
machinery.

The data also show that the amounts actually invested were very small relative to the
income of rural enterprises and households. In the aggregate, they invested 4 and 6.5 percent of
their gross annual incomes, respectively.58 The value of physical investment as a percentage of
GDP in the EU and the OECD was 22 and 25 percent, respectively. Although Romanian, EU,

56 Inventory accumulation (a form of investment) was not included in the definition of investment used in the
analysis. The poor performance of input and output markets in rural Romania does not allow for the distinction
between inventories as investments and as storage of production that could not be sold. Investments in research and
development, another form of investment, were not observed in rural Romania.
57 These figures do not add to 100 percent because some households invested in both productive and household
activities.
58 Enterprise income is equivalent to the aggregate value of gross sales. Household income includes the gross value
of sales of agricultural and non agricultural products and services, the gross value of wages, and the imputed value
of self-consumption of agricultural products.
Credit Constraints and Rural Investment 61

and OECD statistics are not directly comparable because of different measuring methodologies,
the absolute differences in magnitude are sufficient to indicate low levels of investment relative
to income in rural Romania.

Figure 12 also illustrates substantial differences in investment decisions between the agents
which borrowed and the ones which did not. About 38 percent of the households which
borrowed made investments compared to 26 percent for their non-borrowing counterparts. For
enterprises, the percentages are 44 percent for the ones which borrowed and 20 percent for the
ones which did not. The main message is that the incidence of investments is positively
correlated with access to loans. Totally credit constrained households and enterprises show lower
incidence of investments when compared to the agents that borrowed.

The remainder of this section is aimed at providing answers to the following questions: (a)
What were the determinants of investment opportunities and the amounts of investments? (b)
Would increasing access to loans also increase the incidence and amounts of investment? (c)
Where would public policies have the greatest impact in improving the overall investment
environment or in transferring assets among economic agents, including expenditures in
technical assistance and training?

What were the Determinants of Investment Opportunities and Amounts of Investments?

The analysis estimated how much more investment would have occurred in rural Romania
during the period covered by the surveys had credit constraints been removed, that is, how many
more agents would have invested, and how much more, had they been able to borrow as much as
they wanted at the prevailing conditions at the time. Two approaches were used in this study to
empirically measure the influence that credit constraints had on investments.

The first approach entailed dividing the data into the following two groups. The first group
contains the households and enterprises for which it can be ascertained whether or not they had
investment opportunities. This group includes agents which invested and agents which did not
invest. Obviously, any agent which invested in the period had an investment opportunity. For the
agents in this group which did not invest, the reason that prevented them from doing so was lack
of opportunity and not lack of financing. Empirically, this group includes the observations of (a)
all agents which invested, (b) all unconstrained borrowers, and (b) all agents with no demand for
loans.

The second group contains the agents which did not invest and for which the causes of the
observed lack of investment could not be clearly ascertained. For these agents, lack of
investment may have occurred because: (a) lack of investment opportunities; or (b) lack of
funding to take advantage of opportunities; or (c) both. Empirically, this group includes all
agents which did not invest and which were credit constrained.59

59This separation of the observations to study investment behavior follows the logic of the Theory of Revealed
Preference used in empirical demand analysis. Individuals who purchase a basket of goods prefer that basket and
have the budget required to purchase it. Individuals who do not purchase any given basket within their budget set do
not prefer such basket. Finally, no direct inference could be made about the individual’s preference over baskets
outside her budget. The separation above divides the sampled rural agents into those for which direct similar
62 Chapter Four:

To understand investment decisions and amounts, a reduced-form equation was applied to

the subset of households and enterprises for which there was no ambiguity regarding availability
(or lack thereof) of investment opportunities (the first group above). The empirical model
estimates two equations simultaneously: (a) one to analyze the decision to invest (yes or no, type
of decision); and (b) another to analyze the amount of the investments made by those which
actually invested.60

The estimated coefficients from these two equations were applied to the group of agents
for which the reason for their lack of investment could not be inferred directly (the second
group). The result of this exercise is the predicted probability that these agents had an investment
opportunity and, if so, the expected value of the amount that they would have invested had they
had access to funding.

These predictions are, therefore, a function of the behavior of group one (estimated
coefficients) and the observed characteristics of group two.61

Investments by Households

Table 20 presents the explanatory variables and regression results for two specifications of
the model.

Table 21, on the other hand, presents the summary of the predictions made by the model
about the effects that removing credit constraints would have on: (a) the number of households
which would have invested; and (b) the amounts they would have invested. The base line for
these predictions is the actual levels of investment during the period covered by the survey.

The first table shows that household investment opportunities: (a) are negatively related to
the age of the household head; (b) increase with the number of household members who are
pensioners, mostly because of stability of cash flows and basically on consumer durables; (c) are
positively related to the number of household members; (d) are more likely for households which
hold bank deposits; (e) are more frequent for households with larger housing units, again
associated to durable consumer goods; (f) are positively associated with the degree of connection
to markets as proxied by the share of the value of agricultural sales in total household income −
in fact, 45 percent of farm households with substantial market involvement made investments,

inferences about their availability of investment opportunities could be made and those for which no direct inference
could be made because they did not have an investment “budget.”
60 Annex 2 presents the theoretical and technical details of the methodology used. Both equations are estimated
simultaneously to maximize the efficiency of the estimated parameters. The method of estimation was maximum
likelihood.
61 The most commonly used method to analyze empirically the effects of credit constraints on investment decisions
is a switching regression model where investment equations are fitted to two groups that differ only in terms of their
excess demand for loans. An alternative approach had to be devised to be used here because of the impossibility of
separating agents in two mutually exclusive categories on the basis of their excess demand for loans. In Romania
and during the period covered by the survey, the investment behavior of households and enterprises varied
dramatically with the degree of credit constraints (see Annex 2). The traditional switching regression model was
applied to the data with poorer results in terms of fit to the data, robustness, and appropriateness of the signs.
Credit Constraints and Rural Investment 63

compared to only 24 percent which consumed their production; and finally (g) vary significantly
by regions, namely more frequent opportunities in Moldova de Podis, Subcarpati de Sud, Oltenia
de Sud, and less frequent opportunities in Campia Dunarii de Jos and Campia Romana Centrala.

The second part of Table 20 indicates that the amounts invested by households that
perceived profitable opportunities tended to be larger for households: (a) headed by (i) younger,
(ii) female, and (iii) less educated individuals; and (b) having more pensioners. Some of the
characteristics of the entrepreneurial activities influenced the amounts invested. Indeed the
households which invested larger amounts had: (a) more fragmented landholdings; and (b) more
market involvement as indicated by the shares of their income originated in labor and output
markets (farm and non-farm). Finally, households in agrarian localities, as proxied by the ratio of
farmers to population and in Subcarpatii de Sud and Oltenia de Sud tended to invest lower
amounts.

Table 21 sheds light on the following key policy issues regarding rural households: (a) the
set of investment opportunities available to rural households is rather limited; (b) lack of
financing under the conditions prevailing at the time of the survey (debt or equity) was not a
bottleneck to investment in the sense that most of the households which had investment
opportunities actually took advantage of them; (c) mitigating credit constraints by providing
additional credit under the (same) prevailing conditions would have a limited impact on the
number of households which would have invested and on the aggregate amounts of household
investments.

In terms of numbers of households, according to the econometric analysis, had there been
no credit constraints for households during the period covered by the survey, 29 percent would
have invested. This is an increase of only 2 percent from the 27 percent of households which
actually made investments. Still according to the analysis, the aggregate amount invested by
households in the absence of credit constraints would have been 10 percent higher than the
amount actually invested. This increase would have placed household investment levels at about
7.2 percent of their aggregate income instead of the 6.5 percent actually observed.

Investments by Enterprises

Table 24 presents the explanatory variables and regression results for two specifications of
the model applied to the enterprise survey data.

Table 25 presents a summary of the predictions made by the model about the effects that
removing credit constraints would have on: (a) the number of enterprises which would have
invested; and (b) the amounts they would have invested. The baseline for these predictions is the
actual levels of investment during the period covered by the survey.

The results suggest that the enterprises more likely to invest: (a) had younger managers;
(b) were in sectors other than agriculture with the exception of large agriculture enterprises
which were also more likely to invest; (c) were private in that the state had no participation in
their ownership; (d) had high volumes of sales; (e) were those without large numbers of owners
managing or working in them, as measured by the share of owners or members in the total work
64 Chapter Four:

force; and (f) were located in more densely populated regions. Enterprises in the regions of
Moldova Deal and SAI were less likely to invest.

The second part of Table 24 indicates that the amounts invested were statistically
independent of economic sectors, legal status of incorporation, ownership, and economic
conditions in the locality where the enterprises were located. The amounts invested were higher
for enterprises with more: (a) more assets; (b) gross value of sales; and (c) leverage, as measured
by their debt-to-asset ratios. The amounts invested by enterprises in the regions of Subcarpatii de
Sud and Moldova de Podies tended to be smaller.

Table 25 indicates that lack of financing under the conditions prevailing at the time of the
survey (debt or equity) represented a significant impediment for rural enterprises to take
advantage of the investment opportunities available. There would have been considerably more
enterprises taking advantage of investment opportunities if credit constraints had not been
present. Mitigation of credit constraints would have an especially significant impact on the
aggregate amount of investments made by rural enterprises.

In particular, the econometric analysis predicts that, in the absence of credit constraints,
about 37 percent of enterprises would have invested during the period covered by the survey.
This is an increase of 41 more than the 26 percent of enterprises which actually made
investments. The aggregate amount invested in the absence of credit constraints would have been
about 57 percent greater than the amount actually invested.

D. INVESTMENT LEVELS: IS IT WHERE YOU ARE AND WHAT YOU HAVE OR

WHAT YOU DO WITH IT?

The design of policies to improve rural financial markets could be refined still further by
better understanding the way in which access to credit affects investment. The facts are that
about 40 percent of borrowing households made investment outlays during the survey period,
while only 24 percent of their non-borrowing counterparts did. About 37 percent of the
enterprises that borrowed invested. The incidence of investment among enterprises that did not
borrow was about half (only 20 percent).

Obviously there is a difference between borrowers and non-borrowers in their investment

decisions. This section aims to answer the relevant policy question that arises from this
observation. Suppose that it is possible to give credit to agents (households or enterprises) which
did not have credit before without changing their productive characteristics or their location.
Would those agents invest more? If so, how much more?

The following approach to estimating the effect that access to credit had on investment
decisions is based on examining the difference in the propensity to invest of borrowers and non-
borrowers. These differences are influenced by observable and unobservable factors. For any
agent (household or enterprise) in either group (borrowers or non-borrowers), the decision to
invest, Ii, is a function of: (a) observable productive characteristics (number of employees, years
in business, total assets, bank deposits, location); (b) the effect that each of these characteristics
has on the agent’s decision to invest, β; and (c) a residual, ε, that captures all things that cannot
be observed and that are specific to that particular agent. In a simple equation.
Credit Constraints and Rural Investment 65

• I * i = X i β + εi Ii = 1 if Y*i > 0 (the agent made an investment)

Ii = 0 otherwise
The equation captures a simple fact. When two individual agents make different
investment decisions, it must be because: (a) they have different productive characteristics, ∆X -
for example, level of assets or locality of residence; or (b) they have different structural factors,
∆β for example, entrepreneurial abilities, skills, and risk preferences, or (c) both. Statistically,
differences in unobserved structural variables show up as different returns to observed
productive characteristics.

It follows that aggregate differences in the investment decisions made by borrowers and
non-borrowers could be explained by aggregate disparities in endowments and differences in
structural factors. If so, borrowers and non-borrowers invest differently because they are located
in different places, have different endowments of productive characteristics, and use their
endowments and their location differently.

The strategy for the analysis is as follows. First, an agent’s investment decision is modeled
as a dichotomous dependent variable (yes or no type of decision) using a probit specification.
Second, the model is estimated separately for borrower and non-borrower samples to analyze
differences in their investment behavior.62 Third, the observed differences in investment
decisions between borrowers and non-borrowers are decomposed using the method below,

I B − I NB = [Φ ( X B βˆ B ) − Φ ( X NB βˆ B )] + [Φ ( X NB βˆ B ) − Φ ( X NB βˆ NB )]

where I represents the percentage of households or enterprises that made investments

among borrowers (B) and among non-borrowers (NB), X is the vector of the average values of
the explanatory variables posited to influence investment decisions, and the β‘s are the estimated
coefficients capturing the structural factors that affect investment decisions.63

The first term on the right-hand side of this equation captures the effect of borrowers and
non-borrowers having different endowments of assets and being in different localities. It
represents the difference between the actual investment decisions made by borrowers and the
(predicted) investment decisions they would make if they had the asset endowments and locality
of residence of non-borrowers. In short, this first term captures how much of the difference in
investment is due to having more or less assets, more or less bank deposits, living in different
places, etc.

The second term of the equation captures the effect of the difference in investment
decisions between borrowers and non-borrowers that is due to structural factors such as abilities
and entrepreneurial capacity. It represents the difference between the (predicted) investments that

62 A likelihood ratio test was used to investigate the possibility of sample selectivity bias from classifying agents in
the categories of borrowers and non-borrowers. The test rejected the bias on the basis a bivariate probit, that
included a probit model of investment decisions and a probit model of being a borrower.
63 This method was first proposed by Jones and Makepeace (1996). Pagán and Tijerina (1999) provides an example
of this separation and other technical details.
66 Chapter Four:

would have been made by borrowers if they had the assets and they lived in the localities of non-
borrowers.

These results can be used to estimate what percentage of the households and enterprises
that did not have credit would have invested had they been given credit. In other words, would
credit have changed the investment decisions of those agents which did not have credit? The
results of this exercise follow, first for rural households and then for enterprises.

Rural Households

Table 22 presents the list of explanatory variables and estimated coefficients for (a) all
sampled households, (b) borrowing households only, and (c) non-borrowing households only.64

Differences in investment decisions between borrowers and non-borrowers. All

households, regardless of whether they borrow or not, invest more when they are headed by
younger individuals. For borrowers, higher levels of education are positively related to the
propensity to invest, while for non-borrowers education does not influence investment decisions.
For non-borrowers, households headed by males and non-Romanians are more likely to invest.
Family size and the number of pensioners in the household increase the likelihood that non-
borrowers will invest, consistent with the results obtained in the previous approach.

For borrowers and non-borrowers, investment decisions are positively related to dwelling
size. Interestingly, farm size does not affect the likelihood of investment. Borrowers are less like
to invest if they live in agrarian localities with low population densities. Plausibly, they borrow
basically to smooth consumption. The availability of liquid assets in the form of bank deposits
make it more likely for non-borrowers to invest, naturally. Non-borrowers who are integrated to
output markets are also more likely to invest, especially those which have non-agriculture
enterprises.

There are substantial regional differences in the decisions to invest between households
which borrow and those which do not. Borrowing households located in Moldova de Podis and
SAI are more likely to invest than borrowing households situated in other regions. Significantly
lower investment propensities in Campia Dunarii de Jose, Campia Romana Centrala, and SAI are
found among non-borrowing households.

Decomposing the differences in investment decisions between borrowers and non-borrowers.

Table 23 reports the results of decomposing the differences in the investment decisions
between borrowing and non-borrowing households. Remember that about 40 percent of
borrowing households made investment outlays, 24 percent of their non-borrowing counterparts
invested, and that the share of all households which invested was 27 percent.

The probit model predicts that 31 percent of non-borrowing households would have
invested if they had had access to credit, instead of the 24 percent that actually did invest, under
the assumption that they had the structural factors. More investment by those which did not
borrow would imply that, in the aggregate, 33 percent of all households would have invested

64 The Χ2 and Pseudo-R2 measures indicate that the regressions fit the data on households quite reasonably.
Credit Constraints and Rural Investment 67

rather than the observed 27 percent for the entire population. This alternative estimation method
predicts a larger effect on investment levels at the household level due to access to credit than the
effect predicted by the previous section.

The question remains as to why households which had access to credit were almost twice
as likely to invest (40 percent) than households which did not borrow (24 percent). The model
indicates that differences in the endowment of productive characteristics and in the localities
between the two groups account for 54 percent of the incidence of investment decisions. The
remaining 46 percent of the difference should be attributed to differences in structural factors
across groups.

Rural Enterprises

Table 26 presents the estimated coefficients for all observations, borrowing enterprises,
and non-borrowing enterprises for the same set of explanatory variables used for the model in the
previous section.65

Differences in investment decisions between borrowers and non-borrowers. The results of

the model applied to the entire data set of enterprises (whether they borrowed or not) indicate
that the decision to invest was associated with statistical significance to six variables, namely:
(a) economic sector − enterprises in the agricultural sector were less likely to invest than those in
the other sectors; (b) private sector ownership − private enterprises invested more often than their
state-owned; (c) liquidity − those with more money deposited in banks invested more; (d) sales −
larger turnovers where associated with higher frequency of investments; (e) separation of
ownership and workforce − enterprises in which numerous owners or members were also
employees were less likely to invest (e.g., family associations); (f) density of population −
enterprises located in densely populated areas were more likely to invest; and (g) primary sector
− those enterprises located in agrarian localities, measured as the share of farmers in the
population of the locality, were less likely to invest.

The model applied to the data set of enterprises that borrowed during the period indicates
that the decision to invest among such enterprises is related to mostly the same variables above.
The difference with respect to the whole set of enterprises is that more of those with higher
financial leverage were less likely to invest and that the share of owners who act as employees
and density of population are not statistically significant for the enterprises which borrowed.

The investment decisions of the group of enterprises which did not borrow were influenced
by the same set of variables found to be associated with the investment behavior of the whole set
of enterprises, with the addition of: (a) the age of the business as younger business were more
likely to invest more often; and (b) more levered enterprises were less likely to invest.

Decomposing the differences in investment decisions between borrowers and non-borrowers. As

shown in,

65 Note that the Χ2 and Pseudo-R2 also indicate that the regressions have a reasonable fit to the enterprise data.
68 Chapter Four:

Table 27 the model predicts that the incidence of investment among non-borrowers would
have been 33 percent, instead of the observed 20 percent, had they borrowed. Overall, the
percentage of rural enterprises that made investments would have been 34 percent, rather than
the 26 percent that actually did, in a situation in which non-borrowers would have had access to
credit.

In the case of enterprises, structural factors are the main cause of the different incidence of
investment between non-borrowers and borrowers. Such factors account for 74 percent of the
difference. In turn, differences in the productive characteristics between borrowing and non-
borrowing enterprises accounted for only 26 percent of the differences in investment decisions.
When it comes to enterprises and the decision to invest, it is not what they have and where they
are but what they do with what they have. Entrepreneurial capacity seems to be less uniformly
distributed among enterprises than among households, as the latter were basically made farm
entrepreneurs by the land reform process (see section II.E).
Credit Constraints and Rural Investment 69

Table 17 Rural Households: Credit Constraints (Ordered Probit Model)

Regression Results Marginal Effects (evaluated at mean values) Regression Results
Explanatory Variables Coeff. S.D. Ptotally constrained Ppartially constrained P unconstrained Coeff. S.D.
Constant -1.5779 1.3817 0.5852 -0.2364 -0.3487 1.5109 1.3608
Sociodemographic variables
Age of household head -0.0036 0.0040 0.0013 -0.0005 -0.0008 -0.0043 0.0039
Marital status (1=married) 0.4381 0.1699 *** -0.1625 0.0657 0.0968 0.4266 0.1664 ***
Gender (1=male) -0.2321 0.1841 0.0861 -0.0348 -0.0513 -0.2339 0.1810
Nationality (1=Romanian) 0.0985 0.1808 -0.0365 0.0148 0.0218 0.1433 0.1612
Max education by HH me mber 0.1115 0.0332 *** -0.0414 0.0167 0.0246 0.1089 0.0329 ***
Family size -0.0930 0.0327 *** 0.0345 -0.0139 -0.0206 -0.0882 0.0313 ***
Adults working in non- agriculture 0.2028 0.0712 *** -0.0752 0.0304 0.0448 0.2012 0.0696 ***
Number of pensioners in HH -0.1170 0.0885 0.0434 -0.0175 -0.0259 -0.1094 0.0856
Characteristics of Entrepreneurial Activity
Log (assets, excluding land and deposits) 0.1088 0.0362 *** -0.0404 0.0163 0.0241 0.1036 0.0351 ***
Log (deposits) 0.0108 0.0149 -0.0040 0.0016 0.0024 0.0104 0.0146
Log ( monthly agricultural sales) -0.0173 0.0235 0.0064 -0.0026 -0.0038 -0.0171 0.0231
Log ( monthly non-agricultural sales) -0.0588 0.0377 a 0.0218 -0.0088 -0.0130 -0.0563 0.0362 a
Log ( monthly non-agricultural sales) 0.1699 0.0442 *** -0.0630 0.0255 0.0375 0.1635 0.0432 ***
Log ( monthly self-consumption) -0.0014 0.0385 0.0005 -0.0002 -0.0003 0.0028 0.0372
Land holdings (Ha) 0.1266 0.0403 *** -0.0470 0.0190 0.0280 0.1321 0.0386 ***
Number of plots -0.0095 0.0211 0.0035 -0.0014 -0.0021 -0.0164 0.0208
Number employees (ag and non-ag) -0.0194 0.0163 0.0072 -0.0029 -0.0043 -0.0177 0.0158
EconomicConditions in the Locality
Log (population) 0.0168 0.1411 -0.0062 0.0025 0.0037 0.0252 0.1365
Log (population density per hectare) 0.1162 0.0918 -0.0431 0.0174 0.0257 0.1128 0.0840
Owners of agricultural land /inhabitants (%) -0.8844 0.4207 ** 0.3280 -0.1325 -0.1955 -0.8995 0.4081 **
Log (Kms to nearest town) -0.0326 0.0833 0.0121 -0.0049 -0.0072 -0.0311 0.0811
Agroregion Dummies
Campia de Vest 0.1219 0.1899 -0.0452 0.0183 0.0269
Moldovade Podis 0.2924 0.2051 -0.1084 0.0438 0.0646
MoldovaDeal 0.1607 0.1980 -0.0596 0.0241 0.0355
Subcarpatii deSud 0.0162 0.1555 -0.0060 0.0024 0.0036
Campia Dunarii de Jos -0.0767 0.2036 0.0284 -0.0115 -0.0170
Oltenia de Sud -0.2544 0.2436 0.0944 -0.0381 -0.0562
Campia Romana Centrala 0.2736 0.1990 -0.1014 0.0410 0.0605
SAI -0.0748 0.7855 0.0277 -0.0112 -0.0165
Number of Financial Outlets of:
State-owned bank branches -0.2257 0.0863 *** 0.0837 -0.0338 -0.0499 -0.2275 0.0821 ***
Private-owned bank branches -0.0449 0.2463 0.0166 -0.0067 -0.0099 -0.0678 0.2370
Credit cooperatives -0.1123 0.1096 0.0416 -0.0168 -0.0248 -0.1271 0.0982
Moneylenders 0.0147 0.0165 -0.0055 0.0022 0.0033 0.0179 0.0156
Threshold Parameter
ThresholdParameter (µ) 1.4691 0.0732 *** 1.4583 0.0723 ***
Number of observations 734 734
Chi-squared 209.8130 200.4
df= 33 25
a/*/**/*** significant at the 85%, 90%, 95%,nd a 99% confidence intervals, respectively
Source: Author's calculations
.
70 Chapter Four:

Table 18 Rural Households: Supply of Loans by Type of Lender (Multinomial Logit Model)
Regression Results Marginal Effects (evaluated at mean valu es)
P semi-formal / P totallyconstrained P informal / P totally constrained P totally onstrain
c ed P semi-formal P informal
Explanatory Variables Coeff. S.D. Coeff. S.D. Coeff. S.D. Coeff. S.D. Coeff. S.D.
Constant -5.5883 3.5052 a -5.3059 3.1824 * 1.3089 0.6779 ** -0.6243 0.6138 -0.6846 0.6350
Sociodemographic variables
Age of household head -0.0027 0.0097 -0.0132 0.0087 a 0.0021 0.0018 0.0006 0.0017 -0.0027 0.0017 a
Marital status(1=married) 1.4534 0.4601 *** 0.3870 0.3438 -0.2077 0.0763 *** 0.2492 0.0851 *** -0.0415 0.0746
Gender (1=male) -1.2127 0.4928 *** 0.4266 0.3879 0.0731 0.0832 -0.2734 0.0912 *** 0.2004 0.0840 **
Nationality (1=Romanian) 0.6796 0.4598 a -0.0034 0.3672 -0.0725 0.0821 0.1326 0.0820 a -0.0602 0.0749
Max education by HH member 0.3241 0.0802 *** 0.1110 0.0738 a -0.0496 0.0157 *** 0.0534 0.0140 *** -0.0038 0.0144
Family size -0.3137 0.0819 *** -0.1213 0.0661 * 0.0499 0.0145 *** -0.0505 0.0147 *** 0.0006 0.0137
Adults working in non-agriculture 0.3491 0.1816 ** -0.1500 0.1756 -0.0174 0.0373 0.0811 0.0313 *** -0.0637 0.0335 *
Number of pensioners ni HH -0.2910 0.2102 -0.3930 0.1992 ** 0.0838 0.0410 ** -0.0223 0.0376 -0.0615 0.0405 a
Characteristics of Entrepreneurial Activity
Log (assets, excluding al nd and deposits) 0.2943 0.0951 *** 0.1071 0.0805 -0.0459 0.0171 *** 0.0479 0.0174 *** -0.0020 0.0169
Log (deposits) 0.0569 0.0357 a -0.0675 0.0364 * 0.0029 0.0074 0.0170 0.0062 *** -0.0199 0.0071 ***
Log (monthly agricultural sales) -0.0148 0.0580 -0.0711 0.0520 0.0111 0.0112 0.0033 0.0102 -0.0144 0.0103
Log (monthly non-agricultural sales) -0.0952 0.0859 -0.0353 0.0793 0.0149 0.0170 -0.0155 0.0148 0.0005 0.0154
Log (monthly non-agricultural sales) 0.8277 0.1736 *** 0.2357 0.0850 *** -0.1203 0.0236 *** 0.1406 0.0304 *** -0.0203 0.0203
Log (monthly self-consumption) -0.1276 0.0903 0.0545 0.0937 0.0064 0.0189 -0.0296 0.0158 * 0.0232 0.0184
Land holdings(Ha) 0.3616 0.1075 *** 0.1603 0.1015 a -0.0602 0.0222 *** 0.0564 0.0173 *** 0.0038 0.0185
Number of plots -0.0609 0.0528 0.0483 0.0462 0.0001 0.0104 -0.0161 0.0087 * 0.0160 0.0086 *
Number employees (agand non-ag) -0.0866 0.0470 * 0.0553 0.0404 0.0019 0.0091 -0.0217 0.0078 *** 0.0198 0.0076 ***
Economic Conditions in the Locality
Log (population) -0.1979 0.3533 0.1953 0.3311 -0.0049 0.0699 -0.0556 0.0617 0.0605 0.0655
Log (population density per hectare) 0.2793 0.2325 0.3248 0.2191 a -0.0734 0.0456 a 0.0260 0.0412 0.0474 0.0441
Owners of agricultural land/inhabitants (%) -1.4799 0.9685 a 0.4999 0.8680 0.0920 0.1847 -0.3319 0.1721 ** 0.2399 0.1745
Log (Kms to nearest town) -0.3643 0.1989 * 0.2785 0.1896 a 0.0019 0.0399 -0.0953 0.0345 *** 0.0934 0.0370 ***
Agroregion Dummies
Campia de Vest -0.0476 0.4970 0.7315 0.4211 * -0.0927 0.0935 -0.0732 0.0862 0.1659 0.0828 **
Moldovade Podis 0.6115 0.5303 0.6533 0.4505 a -0.1529 0.1007 a 0.0620 0.0911 0.0910 0.0874
MoldovaDeal 0.7074 0.4852 a -0.4012 0.4854 -0.0223 0.0999 0.1728 0.0835 ** -0.1506 0.0955 a
Subcarpatii de Sud 0.2948 0.3965 -0.2435 0.3786 0.0009 0.0787 0.0787 0.0699 -0.0796 0.0758
Campia Dunarii de Jos -0.1634 0.5522 -0.1253 0.4458 0.0343 0.0985 -0.0209 0.0997 -0.0134 0.0921
Oltenia de Sud -0.5915 0.6067 -0.6619 0.5011 0.1519 0.1088 -0.0573 0.1103 -0.0946 0.1043
Campia Romana Centrala -0.0193 0.5324 0.4612 0.4473 -0.0596 0.0996 -0.0441 0.0927 0.1037 0.0882
SAI 0.2624 1.2440 1.4836 1.0582 -0.2265 0.2417 -0.0786 0.2065 0.3051 0.1969 a
Number of Financial Outlets of:
State-owned bankbranches -0.2398 0.2087 -0.2512 0.1872 0.0593 0.0402 a -0.0247 0.0365 -0.0346 0.0372
Private-owned bank branches -0.1109 0.5812 -0.0427 0.5645 0.0176 0.1206 -0.0179 0.0967 0.0003 0.1071
Credit cooperatives 0.1591 0.2724 -0.5020 0.2495 ** 0.0500 0.0528 0.0749 0.0475 a -0.1249 0.0498 ***
Moneylenders 0.0429 0.0438 0.0406 0.0331 -0.0100 0.0076 0.0048 0.0079 0.0052 0.0069
Number of observations 734
Chi-squared 374.7346
df= 66
a/*/**/*** significant at the 85%, 90%, 95%, and 99% confidence intervals, respectively
Source : Author's calculations.
Credit Constraints and Rural Investment 71

Table 19 Rural Enterprises: Supply of Loans (Ordered Probit Model)

Model I Model I
Regression Results Marginal Effects (evaluated at mean values) Regression Results Marginal Effects (evaluated at mean values) Regression Results
Explanatory Variables Coeff. S.E. Mean X P P P Coeff. S.E. P P P Coeff. S.E.
totally constrained partially constrained unconstrained totally constrained partially constrained unconstrained
Dependent Variable: 0=Totally constrained,1=Partiallyconstrained, 2=Unconstrained
Constant -2.5648 1.8974 -2.5929 1.8276 -2.7391 1.2164
Manager of the Enterprise
Log(age) 0.5800 0.2826 ** 3.7879 -0.2262 0.0759 0.1504 0.5142 0.2754 * -0.2007 0.0662 0.1345 0.4981 0.2738
Education Index -0.0609 0.0362 * 5.9606 0.0237 -0.0080 -0.0158 -0.0564 0.0355 a 0.0220 -0.0073 -0.0148 -0.0533 0.0344
Economic Sector
Industry Dummy -0.5697 0.3902 a 0.1124 0.2222 -0.0745 -0.1477 -0.6637 0.3781 * 0.2591 -0.0855 -0.1736 -0.6802 0.3696
Trade Dummy -0.3571 0.3583 0.2643 0.1393 -0.0467 -0.0926 -0.4495 0.3482 0.1755 -0.0579 -0.1176 -0.4484 0.3422
Services Dummy -0.4935 0.4167 0.0611 0.1925 -0.0645 -0.1280 -0.5516 0.4075 0.2153 -0.0710 -0.1443 -0.5477 0.3975
Legal Status and Ownership
Agricultural Stock Corporation (1=yes) -0.3246 0.2678 0.1953 0.1266 -0.0425 -0.0842 -0.4002 0.2634 a 0.1562 -0.0515 -0.1047 -0.3831 0.2627
Non-agricultural Stock Corporation (1=yes) -1.1422 0.4616 *** 0.0178 0.4455 -0.1494 -0.2961 -1.0884 0.4478 ** 0.4249 -0.1402 -0.2847 -1.0736 0.4312
PrivateOwned Dummy 0.0828 0.2705 0.8580 -0.0323 0.0108 0.0215 0.0598 0.2622 -0.0233 0.0077 0.0156 0.0718 0.2603
Characteristicsof FirmActivity
Log ( years in business) -0.0285 0.1286 1.6254 0.0111 -0.0037 -0.0074 -0.0528 0.1226 0.0206 -0.0068 -0.0138 -0.0573 0.1223
Log (total assets in 1996) 0.2685 0.0674 *** 4.7770 -0.1047 0.0351 0.0696 0.2745 0.0666 *** -0.1072 0.0353 0.0718 0.2709 0.0648
Log (total assets in 1996)*(AgriculturalSector
Dummy) -0.1545 0.0752 ** 3.4235 0.0603 -0.0202 -0.0401 -0.1649 0.0732 ** 0.0644 -0.0212 -0.0431 -0.1676 0.0721
Fixed assets/total assetsin 1996 -0.0582 0.2549 0.3808 0.0227 -0.0076 -0.0151 -0.0405 0.2478 0.0158 -0.0052 -0.0106 -0.0611 0.2453
Bank deposits/total assetsin 1996 0.6255 0.4585 0.0510 -0.2440 0.0818 0.1622 0.6007 0.4307 -0.2345 0.0773 0.1571 0.5827 0.4211
Log (turnover) 0.1656 0.0414 *** 5.2447 -0.0646 0.0217 0.0429 0.1650 0.0405 *** -0.0644 0.0213 0.0432 0.1653 0.0402
Turnover/employees -0.0006 0.0010 33.6736 0.0002 -0.0001 -0.0001 -0.0007 0.0009 0.0003 -0.0001 -0.0002 -0.0008 0.0008
Associatemembers working in
enterprise/employees 0.0554 0.1807 0.3699 -0.0216 0.0072 0.0144 -0.0069 0.1738 0.0027 -0.0009 -0.0018 0.0030 0.1660
Economic Conditions inthe Locality
Log (population) -0.0789 0.1735 8.4102 0.0308 -0.0103 -0.0205 -0.0488 0.1661 0.0191 -0.0063 -0.0128
Log (population densityper hectare) 0.2162 0.1433 a -0.5006 -0.0843 0.0283 0.0561 0.0886 0.1285 -0.0346 0.0114 0.0232
Agricultural employment ratio -0.0285 0.3594 0.4453 0.0111 -0.0037 -0.0074 -0.0267 0.3035 0.0104 -0.0034 -0.0070
Log (Kms to nearest town) 0.1008 0.0890 3.0885 -0.0393 0.0132 0.0261 0.0839 0.0812 -0.0328 0.0108 0.0220
Agroregion Dummies
Campia de Vest 0.1952 0.2226 0.1183 -0.0761 0.0255 0.0506
Moldova de Podis -0.1809 0.2786 0.0848 0.0706 -0.0237 -0.0469
Moldova Deal -0.2057 0.2284 0.0848 0.0802 -0.0269 -0.0533
Subcarpatii deSud -0.3617 0.2178 * 0.1755 0.1411 -0.0473 -0.0938
CampiaDunariide Jos -0.0644 0.2531 0.1065 0.0251 -0.0084 -0.0167
Oltenia de Sud -0.0538 0.2621 0.1006 0.0210 -0.0070 -0.0139
CampiaRomana Centrala -0.1290 0.2204 0.1479 0.0503 -0.0169 -0.0334
SAI -0.6228 0.5817 0.0197 0.2429 -0.0814 -0.1615
Number of Financial Outlets of:
State-owned bank branches 0.1718 0.1079 a 0.7002 -0.0670 0.0225 0.0446 0.1794 0.1030 * -0.0700 0.0231 0.0469 0.1881 0.0947
Private-owned bank branches 0.0440 0.2142 0.0789 -0.0172 0.0058 0.0114 0.0113 0.2084 -0.0044 0.0015 0.0030 0.0285 0.1987
Credit cooperatives 0.0549 0.1252 0.4221 -0.0214 0.0072 0.0142 0.0712 0.1225 -0.0278 0.0092 0.0186 0.0766 0.1183
Threshold Parameter
ThresholdParameter(µ) 1.1406 0.0736 *** 1.1268 0.0723 *** 1.1259 0.0722
Number of observations 507.0000 507.0000 507.0000
Chi-squared 143.0559 134.6758 133.4069
df= 31.0000 23.0000 23.0000
a/*/**/*** significant at ht e 85%, 90%, 95%, and 99% confidence intervals, respectively
Source : Author's Calculations.
72 Chapter Four:

Table 20 Rural Households: Investment Decision and Investment Outlays

Model I Model II
Explanatory Variables Coeff. S.D. Coeff. S.D.
Dependent Variable: 1=Investment Opportunity 0=No Investment Opportunity
Number of Observations: 2,005
Constant -0.9599 0.8728 -0.6545 0.8100
Sociodemographic variables
Age of household head -0.0144 0.0029*** -0.0135 0.0028***
Marital status (1=married) 0.1200 0.1325 0.0717 0.1197
Gender (1=male) 0.1382 0.1402 0.1542 0.1265
Nationality (1=Romanian) -0.2152 0.1200* -0.0808 0.1106
Max education by HH member 0.0200 0.0238 0.0299 0.0224
Family size 0.0957 0.0253*** 0.0845 0.0237***
Adults working in non- 0.0552 0.0541 0.0376 0.0516
agriculture
Number of pensioners in HH 0.1557 0.0604*** 0.0662 0.0562
Characteristics of Entrepreneurial Activity
Dwelling size (mts2) 0.0035 0.0020* 0.0014 0.0018
Land holdings (Ha) 0.0460 0.0469 0.0521 0.0448
Land holdings ( H a ) -0.3338 0.4388 -0.4117 0.4284
Squared/100
Number of plots 0.0095 0.0123 0.0100 0.0123
Number employees (ag and 0.0069 0.0119 0.0177 0.0110 a
non-ag)
Log (deposits) 0.0254 0.0090*** 0.0254 0.0086***
Share of agricultural sales in 0.8817 0.4542** 0.5278 0.4687
monthly income
Share of non-agricultural sales -0.3484 0.3572 -0.5319 0.3286 a
in monthly income
Share of salary income in 0.0917 0.1840 -0.0548 0.1719
monthly income
Economic Conditions in the Locality
Log (population) 0.0054 0.0919 -0.0142 0.0835
Log (population density per -0.0798 0.0698 0.0259 0.0634
hectare)
Owners of agricultural land 0.1362 0.2680 0.4205 0.2495*
/inhabitants (%)
Log (Kms to nearest town) 0.0811 0.0501ª 0.0617 0.0443
Agroregion Dummies
Campia de Vest 0.1913 0.1214ª
Moldova de Podis 0.9373 0.1335***
Moldova Deal 0.0481 0.1447
Subcarpatii de Sud 0.2493 0.1177**
Campia Dunarii de Jos -0.9675 0.2106***
Oltenia de Sud 0.4574 0.1315***
Campia Romana Centrala -0.6244 0.1707***
SAI -0.2769 0.2467
Dependent Variable: Log (Investment) for those that invested
Number of Observations: 653
Constant 7.0910 1.5786*** 7.4166 1.6547***
Sociodemographic variables
Age of household head -0.0243 0.0053*** -0.0343 0.0057***
Marital status (1=married) 0.1261 0.2426 0.2247 0.2491
Gender (1=male) 0.4529 0.2519* 0.3464 0.2682
Nationality (1=Romanian) -0.0790 0.2122 -0.3791 0.2225*
Max education by HH member 0.1308 0.0410*** 0.1298 0.0444***
Family size 0.0794 0.0428* 0.0682 0.0449a
Adults working in non- 0.0847 0.0889 0.1192 0.0960
agriculture
Number of pensioners in HH -0.2383 0.1030** -0.1268 0.1115
Credit Constraints and Rural Investment 73

Model I Model II
Explanatory Variables Coeff. S.D. Coeff. S.D.
Characteristics of Entrepreneurial Activity
Dwelling size (mts2) 0.0067 0.0034** 0.0095 0.0036***
Land holdings (Ha) 0.0484 0.0898 -0.0164 0.0928
Land holdings ( H a ) 0.1532 0.9043 0.7905 0.8774
Squared/100
Number of plots 0.0401 0.0224* 0.0683 0.0249***
Number employees (ag and 0.0570 0.0202*** 0.0643 0.0222***
non-ag)
Log (deposits) 0.0151 0.0154 0.0216 0.0166
Share of agricultural sales in 2.3411 0.8270*** 2.5940 0.8689***
monthly income
Share of non-agricultural sales 1.5312 0.7800** 1.3419 0.8239*
in monthly income
Share of salary income in 0.5682 0.3175* 0.8442 0.3312***
monthly income
Economic Conditions in the Locality
Log (population) -0.2259 0.1623 -0.2546 0.1699a
Log (population density per -0.1049 0.1412 -0.2159 0.1309*
hectare)
Owners of agricultural land -0.8807 0.4367** -1.0543 0.4644**
/inhabitants (%)
Log (Kms to nearest town) 0.0365 0.0908 -0.0325 0.0933
Agroregion Dummies
Campia de Vest 0.1726 0.2065
Moldova de Podis -0.2896 0.2632
Moldova Deal 0.2175 0.2577
Subcarpatii de Sud -0.4615 0.2297**
Campia Dunarii de Jos -0.5135 0.4709
Oltenia de Sud -0.8654 0.2716***
Campia Romana Centrala -0.4993 0.2945*
SAI -0.1349 0.5060
_ 1.5478 0.0885*** 1.7636 0.1023***
Rho 0.8510 0.0363*** 0.8733 0.0296***
Log likelihood Function -2076.7 -2219.6
Chi-squared
a/*/**/*** significant at the 85%, 90%, 95%, and 99% confidence intervals, respectively
Source: Author’s calculations

Table 21 Rural Households: Effect of Removing Credit Constraints on Investment Decisions and
Investment Opportunities
Model I Model II
Decision to Invest
Actual 27.1% 27.11%
Predicted 29.4% 29.27%
Log (investment), for investors
Actual 7.172 7.167
Predicted 7.181 7.199
Effect of Removing Credit Constraints
Additional households that would 2.32% 2.16%
invest
Investment outlays would increase by: 9.63% 11.53%
Source: Estimated with regression results of Table 20.
74 Chapter Four:

Table 22 Rural Households: Investment Decisions for Borrowing and Non-Borrowing Households
All Households Borrowing Households Non-Borrowing Households
Explanatory Variables Coeff. S.D. Mean Xs Coeff. S.D. Mean Xs Coeff. S.D. Mean Xs
Constant -0.4576 0.8002 0.7749 1.8067 -0.5387 0.9245
Sociodemographic Variables
Age of householdhead -0.0102 0.0026 *** 58.2769 -0.0189 0.0062 *** 51.3203 -0.0077 0.0029 *** 59.9144
Marital status (1=married) 0.1868 0.1101 * 0.6870 0.2035 0.2825 0.8083 0.1616 0.1232 0.6585
Gender (1=male) 0.1417 0.1162 0.7538 -0.2008 0.3101 0.8519 0.2190 0.1291 * 0.7308
Nationality (1=Romanian) -0.2182 0.1115 ** 0.9045 -0.2175 0.2597 0.9194 -0.2595 0.1254 ** 0.9010
Max education by HH member 0.0237 0.0210 4.0523 0.0966 0.0447 ** 4.8322 -0.0016 0.0247 3.8687
Family size 0.0653 0.0219 *** 2.9319 0.0214 0.0458 3.5403 0.0788 0.0259 *** 2.7887
Adults working in non-agriculture 0.0986 0.0486 ** 0.4666 0.1265 0.0936 0.8170 0.0555 0.0605 0.3841
Number of pensioners in HH 0.1281 0.0551 ** 0.3117 0.1779 0.1370 0.2505 0.1140 0.0616 * 0.3262
Characteristics of Entrepreneurial Activity
Dwelling size (mts 2) 0.0044 0.0018 *** 39.9705 0.0060 0.0037 * 42.7495 0.0051 0.0021 ** 39.3164
Land holdings (Ha) 0.0772 0.0425 * 1.8454 0.1476 0.1169 1.4906 0.0756 0.0471 a 1.9289
Land holdings (Ha) Squared/100 -0.5109 0.3957 0.0747 -1.5012 1.2254 0.0567 -0.4693 0.4316 0.0789
Number of plots 0.0100 0.0117 3.3383 0.0251 0.0249 3.0131 0.0057 0.0138 3.4149
Number employees (ag and non-ag) -0.0003 0.0106 3.6787 -0.0096 0.0231 3.8105 -0.0032 0.0123 3.6477
Log (deposits) 0.0307 0.0084 *** 2.7066 -0.0111 0.0203 2.4712 0.0419 0.0095 *** 2.7620
Share of agricultural sales in monthly income -0.2191 0.3106 0.0457 0.4166 1.0491 0.0241 -0.3277 0.3369 0.0507
Share of non-agricultural sales in monthly income 0.8680 0.4491 ** 0.0117 0.3522 0.9790 0.0122 1.0227 0.5196 ** 0.0115
Share of salary income in monthly income 0.0468 0.1644 0.5760 0.0652 0.4035 0.6365 -0.0446 0.1851 0.5618
Economic Conditions in the Locality
Log (population) -0.0812 0.0834 8.3835 -0.1202 0.1893 8.4555 -0.0878 0.0966 8.3666
Log (population density per hectare) -0.0534 0.0616 -0.4953 -0.2531 0.1302 ** -0.3925 0.0076 0.0730 -0.5195
Owners of agricultural land /inhabitants (%) -0.1315 0.2414 0.4256 -1.1198 0.5645 ** 0.4166 0.0549 0.2784 0.4278
Log (Kms to nearest town) 0.0444 0.0445 2.7481 0.0546 0.1034 2.7350 0.0426 0.0506 2.7511
Agroregion Dummies
Campia de Vest 0.1844 0.1158 a 0.1038 0.0442 0.2593 0.1002 0.2125 0.1314 a 0.1046
Moldovade Podis 1.0208 0.1259 *** 0.0872 1.1565 0.2794 *** 0.0980 0.9816 0.1443 *** 0.0846
MoldovaDeal 0.0692 0.1300 0.1038 0.0838 0.2611 0.1242 0.0492 0.1539 0.0990
Subcarpatii de Sud 0.2256 0.1075 ** 0.2159 0.2370 0.2230 0.2810 0.2247 0.1257 * 0.2005
Campia Dunarii de Jos -0.9186 0.1801 *** 0.0706 -0.7561 0.3553 ** 0.0545 -0.9918 0.2166 *** 0.0744
Oltenia de Sud 0.5123 0.1239 *** 0.0872 0.3402 0.3456 0.0436 0.5449 0.1369 *** 0.0974
Campia Romana Centrala -0.6223 0.1539 *** 0.0872 -0.0126 0.2951 0.0828 -1.0139 0.2131 *** 0.0882
SAI -0.1571 0.2445 0.0249 1.3373 0.5400 *** 0.0196 -0.6313 0.3279 ** 0.0262
Number of observations 2409 459 1950
Chi-squared 372.44 84.17 316.06
df= 29 29 29
2
McFadden Pseudo-R 0.1323 0.1362 0.1469
Mean dependent variable 0.2711
a/*/**/*** significant at the 85%, 90%, 95%, and 99% confidence intervals, respectively
Source : Author's calculations

Table 23 Decomposition of Investment Decisions between Borrowing and Non-Borrowing Rural

Households
Mean Shares
Borrowing Rural Households (XBBB) 0.4009
Non-borrowing Rural Households 0.2405
(XNBBNB)
Predicted Shares
For non-borrowing Rural Households 0.3141
(XNBBB)
Differences in Investment Decisions 0.1604
Due to X's 0.0868 54%
Due to betas 0.0735 46%
Source: Author’s calculations
Credit Constraints and Rural Investment 75

Table 24 Rural Enterprises: Investment Opportunities and Investment Levels

Model I Model II
Explanatory Variables Coeff. S.D. Coeff. S.D.
Dependent Variable: 1=Investment Opportunity 0=No Investment Opportunity
Number of Observations: 483
Constant 1.2645 2.4408 1.1495 2.3696
Manager of the Enterprise
Log(age) -0.6714 0.3442** -0.6485 0.3285**
Education Index 0.0397 0.0518 0.0454 0.0495
Economic Sector
Industry Dummy 1.6195 0.5565*** 1.5171 0.5149***
Trade Dummy 1.1340 0.5284** 1.0896 0.4945**
Services Dummy 0.9460 0.5722* 0.9532 0.5320*
Legal Status and Ownership
Agricultural Stock Corporation -0.3907 0.4084 -0.3402 0.3835
(1=yes)
Private Owned Dummy 0.6679 0.3895* 0.7284 0.3570**
Characteristics of Firm Activity
Log ( years in business) -0.2847 0.2329 -0.3369 0.2122a
Log (total assets in 1996) 0.1067 0.0915 0.1201 0.0859
Log (total assets i n 0.1837 0.1061* 0.1667 0.0963*
1996)*Agricultural Sector
Dummy
Log (Bank deposits), in 1996 0.1102 0.0660* 0.1073 0.0615*
Log (turnover), in 1997 0.1757 0.0680** 0.1684 0.0634***
Fixed assets/employees -0.0001 0.0057 0.0001 0.0053
Turnover/employees -0.0002 0.0013 -0.0004 0.0010
Debt/total assets, in 1996 -0.1758 0.4467 -0.1323 0.4173
Associate members working in -0.4977 0.2504** -0.5025 0.2371**
enterprise/employees
Economic Conditions in the Locality
Log (population) -0.1318 0.2080 -0.1493 0.1939
Log (population density per 0.3991 0.2061** 0.2511 0.1636a
hectare)
Agricultural employment ratio -0.6290 0.4855 -0.7300 0.3844*
Log (Kms to nearest town) 0.0360 0.1290 0.0280 0.1125
Agroregion Dummies
Campia de Vest -0.0573 0.2747
Moldova de Podis -0.2883 0.3857
Moldova Deal -0.8505 0.4032**
Subcarpatii de Sud -0.2433 0.2738
Campia Dunarii de Jos -0.1120 0.3207
Oltenia de Sud -0.2362 0.3227
Campia Romana Centrala -0.2896 0.2991
SAI -0.7695 0.4589*
Dependent Variable: Log (Investment) for those that invested
Number of Observations: 206
Constant 13.1255 4.0655*** 12.7442 3.6670***
Manager of the Enterprise
Log(age) -1.2367 0.6033** -1.3006 0.6049**
Education Index -0.0410 0.0910 -0.0478 0.0890
Economic Sector
Industry Dummy 1.4994 1.0106a 1.4635 0.9976a
Trade Dummy 0.4419 0.9521 0.4895 0.9489
Services Dummy 0.9628 1.0414 1.1742 1.0348
Legal Status and Ownership
Agricultural Stock Enterprise 0.3504 0.6660 0.3314 0.6394
(1=yes)
Private Owned Dummy 0.3832 0.6618 0.4272 0.6597
Characteristics of Firm Activity
76 Chapter Four:

Model I Model II
Explanatory Variables Coeff. S.D. Coeff. S.D.
Log ( years in business) -0.2587 0.3985 -0.2208 0.4185
Log (total assets in 1996) 0.3236 0.1374** 0.3340 0.1353***
Log (total assets i n 0.0637 0.1667 0.0706 0.1626
1996)*Agricultural Sector
Dummy
Log (Bank deposits), in 1996 0.2058 0.1289a 0.2169 0.1251*
Log (turnover), in 1997 0.2312 0.1173** 0.2029 0.1294a
Fixed assets/employees 0.0081 0.0084 0.0059 0.0079
Turnover/employees 0.0021 0.0018 0.0017 0.0018
Debt/total assets, in 1996 0.8837 0.8433 1.1095 0.8207
Associate members working in 0.3962 0.5557 0.3560 0.5567
enterprise/employees
Economic Conditions in the Locality
Log (population) -0.3690 0.3757 -0.2900 0.3394
Log (population density per 0.4614 0.3597 0.1432 0.2738
hectare)
Agricultural employment ratio -0.7506 0.8811 -1.0327 0.7990
Log (Kms to nearest town) 0.2304 0.2251 0.1678 0.2058
Agroregion Dummies
Campia de Vest 0.2771 0.4214
Moldova de Podis -1.3046 0.5906**
Moldova Deal -0.7202 1.1352
Subcarpatii de Sud -0.6815 0.4108*
Campia Dunarii de Jos -0.4094 0.5179
Oltenia de Sud -0.0137 0.6549
Campia Romana Centrala -0.0327 0.4859
SAI -0.5540 0.7686
_ 1.5299 0.2217*** 1.5198 0.2303***
Rho 0.6705 0.2496*** 0.5721 0.3420*
Log likelihood Function -590.7674
a/*/**/*** significant at the 85%, 90%, 95%, and 99% confidence intervals, respectively
Source: Author’s calculations.

Table 25 Rural Enterprises: Estimated Effect of Removing Credit Constraints on Investment

Decisions and Investment Levels
Model I Model II
Decision to Invest
Actual 26.4% 26.4%
Predicted 37.4% 37.3%
Log (investment), for investors
Actual 10.2329 10.2329
Predicted 10.3343 10.3296
Effect of Removing Credit Constraints
Additional enterprises that 11.0% 10.9%
would invest
Investment levels would 56.9% 57.1%
increase by:
Source: Author’s calculations.
Credit Constraints and Rural Investment 77

Table 26 Rural Enterprises: Investment Decisions for Borrowing and Non-Borrowing Enterprises
All Enterprises Borrowing Enterprises Non-Borrowing Enterprises
Explanatory Variables Coeff. S.D. Mean X Coeff. S.D. Mean X Coeff. S.D. Mean X
Dependent Variable: 0=No Invested 1=Invested
Constant -1.0896 1.6156 -0.4049 2.7354 -1.8055 2.1797
Manager of the Enterprise
Log(age) -0.1946 0.2580 3.7915 -0.4167 0.4774 3.8114 -0.0339 0.3218 3.7797
Education Index 0.0288 0.0359 5.6581 0.0980 0.0616 a 6.2295 0.0101 0.0469 5.3170
Economic Sector
Industry Dummy 1.4238 0.4089 *** 0.1152 1.7240 0.7371 ** 0.0993 1.8240 0.6221 *** 0.1247
Trade Dummy 1.1011 0.3794 *** 0.3239 1.5660 0.6679 ** 0.2021 1.3412 0.5959 ** 0.3967
Services Dummy 1.0821 0.4289 *** 0.0730 1.9772 0.7982 *** 0.0377 1.2202 0.6420 * 0.0941
Legal Status and Ownership
Agricultural Stock Corporation (1=yes) -0.1480 0.2673 0.1575 0.0369 0.3850 0.2363 -0.4193 0.4117 0.1104
Private Owned Dummy 0.8187 0.2708 *** 0.8860 0.6462 0.3907 * 0.8151 1.2078 0.4573 *** 0.9284
Characteristics of Firm Activity
Log ( years in business) -0.1631 0.1490 1.5849 0.2717 0.2865 1.6941 -0.3542 0.1928 * 1.5197
Log (total assets in 1996) 0.0456 0.0623 4.1549 -0.0400 0.1077 5.6838 0.0156 0.0879 3.2420
Log (total assets in 1996)*Agricultural Sector Dummy 0.1245 0.0731 * 2.7799 0.1073 0.1212 4.3266 0.2968 0.1298 ** 1.8563
Log (Bank deposits), in 1996 0.1540 0.0468 *** 1.1030 0.1960 0.0652 *** 1.6152 0.1318 0.0741 * 0.7972
Log (turnover), in 1997 0.1941 0.0492 *** 4.8102 0.2017 0.0949 ** 6.1606 0.1469 0.0606 ** 4.0038
Fixed assets/employees -0.0013 0.0017 9.3653 -0.0003 0.0023 16.8130 -0.0038 0.0073 4.9180
Turnover/employees 0.0000 0.0008 33.1162 0.0023 0.0017 41.3321 -0.0003 0.0010 28.2102
Debt/total assets, in 1996 -0.3668 0.2695 0.1275 -0.6637 0.3566 * 0.2753 -1.6717 0.9202 * 0.0392
Associate members working in enterprise/employees -0.4352 0.1679 *** 0.3676 -0.1283 0.2804 0.3217 -0.6312 0.2211 *** 0.3951
Economic Conditions in the Locality
Log (population) -0.1574 0.1371 8.3983 -0.1742 0.2291 8.4208 -0.1835 0.1851 8.3848
Log (population density per hectare) 0.1930 0.1139 * -0.4950 -0.1580 0.1995 -0.5261 0.3760 0.1517 *** -0.4764
Agricultural employment ratio -0.8875 0.3028 *** 0.4227 -1.3696 0.4780 *** 0.4582 -0.7721 0.4311 * 0.4016
Log (Kms to nearest town) 0.0629 0.0857 3.0749 -0.0859 0.1395 3.0804 0.1515 0.1170 3.0717
Number of observations 781.0000 292.0000 489.0000
Chi-squared 200.7169 105.4657 107.1425
df= 20.0000 20.0000 20.0000
2
McFadden Pseudo -R 0.2227 0.2741 0.2187
Mean dependent variable 0.2638
a/*/**/*** significant at the 85%, 90%, 95%, and 99% confidence intervals, respectively
Note: The hypothesis of sample selection was tested and it was rejected
Source : Author's calculations.

Table 27 Rural Enterprises: Decomposition of Investment Decisions between Borrowing and Non-
Borrowing Enterprises
Mean Shares
Borrowing Rural Enterprises (XUBU) 0.3699
Non-borrowing Rural Enterprises (XCBC) 0.2004
Predicted Shares
For non-borrowing Rural Enterprises (XCBU) 0.3265
Differences in Investment Decisions 0.1695
Due to endowments 0.0433 26%
Due to structural factors 0.1261 74%
Source: Author’s calculations.
 Chapter V: Policy Options and Possible World Bank
Support
A. GENERAL STRATEGY AND EMPHASIS

The shortcomings of rural credit markets identified in this study are due largely to the
country’s institutional underdevelopment and to massive interventions in the rural economy.
These problems can be overcome if the Government formulates implementable strategies for
dealing with them. In particular, the Government's objective should be to increase the availability
in rural areas of viable, competitively priced, and untargeted credit (and deposits). This effort
would increase overall access to rural financial markets and change the composition of credit
market participation by including more agents currently not interested in borrowing and more
agents to whom lenders would not currently serve.

Deepening financial markets in rural areas and increasing their outreach requires stronger
credit supply and demand. Removing the main causes of the current low intensity of both is a
necessary condition to attain these objectives, therefore.

While the problem must be attacked simultaneously from both sides (supply and demand),
it should be noted that efforts to shift the supply curve of rural credit to the right would probably
yield results faster than interventions in the demand side. In Romania, an upward shift of the
demand curve for credit would require increased demand for rural investment. Significant
increases in the demand for investment will occur − with a time lag − following the full
implementation of appropriate policies (privatization of state enterprises, land titling) and
developing of infrastructure (warehousing system) in rural areas. While these actions are beyond
the strict scope of financial markets, they are key determinants of the demand for capital because
they would enlarge the set of investment opportunities, lengthen planning horizons, and reduce
uncertainty in performance of contractual obligations.66

The core of the short term strategy should, therefore, be to augment the supply of credit by
increasing the returns to rural lending, adjusted by risk and transaction costs. The ingredients are
reduction of the credit risk and of the transaction costs of lending. An increased supply of credit
translates into a lower total cost of borrowing, including lower and less volatile effective rates of
interest, transaction costs of borrowing, and collateral requirements. Better conditions on credit
will be followed by an increase in the amount of credit demanded in the form of a movement
along the existing demand curve (as opposed to a shift in the demand curve).

66 An important exogenous factor that may increase the demand for private investments and for rural credit is the
Special Accession Program for Agriculture and Rural Development (SAPARD). This program will be financed by
the European Union. SAPARD will allocate a significant portion of _ 150 million per year during the period 2000-
2006 in grants to finance eligible private sector investments in rural areas. These grants will finance up to 50 percent
of eligible investments. The remaining 50 percent of the value of these investments will need to be financed by
beneficiaries either with their own resources or with debt. There may be, therefore, a “step” increase in the demand
for rural credit from the private sector to finance the counterpart funding requirements to obtain SAPARD grants.
Policy Options and Possible World Bank Support 79

The objective of reducing credit constraints (especially for rural enterprises) cannot be
attained by allocating larger amounts of subsidized credit. In the presence of credit rationing,
interest subsidies do little to improve access to credit. Interest rate subsidies primarily reduce re-
borrower payments. However, rationing exists because banks may perceive insufficient credit
worthiness of borrowers − not because borrowers’ cannot pay high market interest rates. In
contrast, improving the regime for secured transactions primarily raises the lender’s return
adjusted by risk. Hence, increasing the returns to lenders (adjusted by risk and transaction costs)
is much more effective than subsidies in reallocating credit to a target group which is credit
rationed.

The challenge is to create the conditions, mechanisms, and institutions that will allow new
resources to flow to the rural economy and to re-deploy existing rural assets to better uses. In
practice, this challenge requires: (a) removing the unfair competition between the state and the
private sector for (i) controlling productive assets, (ii) collecting savings from the public, and
(iii) allocating credit; (b) improving contract enforcement; and (c) increasing competition in the
supply of deposit services and funding to private rural clients of which the large majority are
farmers and micro, small, and medium enterprises. There are not many policy instruments
available to the Government. The following is a sketch of the most important and urgent options
available to the Government to implement a program aimed at meeting the above challenge.67

B. GOVERNMENT CREDIT LINES

It cannot be emphasized enough that lending government money in the face of existing
high costs, risks, and distortions will only perpetuate the existing problems. If credit resources
must be directed to the sector, then credit lines should be: (a) transitory with a well defined
ending period; (b) well targeted; (c) appropriately priced to cover all risks and costs to avoid
hoarding, rent seeking, and distortions in the allocation of resources; (d) well-designed in terms
of recovery incentives for participating intermediaries to begin introducing the repayment
discipline so desperately needed in the sector; and (e) allocated competitively among interested
intermediaries and final borrowers. The basic elements of a transitional program of directed
credit for agriculture consistent with these principles is outlined below. Its implementation would
allow the Government to meet its policy objective of progressively lowering directed credit to
the sector through mechanisms that minimize market distortions.

The objective should be to phase out directed credit as rapidly as possible (say, over two to
three years) by establishing a series of monitorable policy targets to insure that: (a) the key
variables involved in agricultural directed credit steadily approach market levels; (b) there would
be a smooth transition towards an ideal situation of sufficient market-based credit flows to

67 The benefits, for the development of financial markets, of conducive macroeconomic conditions in the form of
low and predictable inflation rates and exchange rate stability are obvious. It should suffice to mention as an
example that an improved fiscal balance would allow the Government not to crowd out the private sector in
financial markets. Policy recommendations to achieve macro stability are, however, beyond the scope of this study.
While recognizing that such stability is a necessary (albeit not sufficient) condition for the development of rural
financial markets, this chapter focuses on possible government interventions that may be required to achieve other
necessary conditions for improved performance of these markets.
80 Chapter Five:

agriculture; and (c) the distortions in the functioning of rural financial markets are minimized in
the meanwhile.

Under such a program, sensible targets would be established for the following variables
(see Table 28): (a) the amount, in real terms, of subsidized directed credit allocated to the sector;
(b) the cost of funds to participating banks; (c) the interest rates charged to final borrowers; (e)
rebate payments to borrowers on the interest they would pay on loans; (f) rebate payments to
participating banks on the amount of loans allocated to the sector; and (g) limits in the amount of
credit granted to a single borrower with program resources.

Ideally, the program would be implemented under a single Government Ordinance on

Directed Credit. One single Ordinance for the entire period, as opposed to issuing several
ordinances every year for the financing of different investment activities (e.g., harvesting,
machinery), has the advantage of allowing participants in rural financial markets to better plan
their credit needs and sources of finance. In contrast, the current situation of yearly Ordinances
imposes uncertainty in the planning process of banks and potential rural borrowers.68

68 During the discussions of the preliminary results of this study and during the preparation of a World Bank
financed rural finance project (see below), the Ministries of Agriculture and Finance have agreed in writing to
prepare and submit to the Government a new Ordinance on Agricultural Credit. The objective of this Ordinance,
which is an agreed condition for the World Bank Loan, is the dissolution of all subsidized credit programs and all
Government funds financing rural and agricultural credit, including Ordinance 36/99 (Support for Farm Equipment
Purchases) and Ordinance 165/98 (Ordinance for Providing Finance for Crop Planting).
 Rural Sector (2000-2003)
Table 28 Romania: Summary Matrix for a Proposed Transitional Directed Credit Program for the

Policy Options and Possible World Bank Support

Quantitative Targets b
Policy variable and actions a 2000 2001 2002 2003
Amount of subsidized directed credit allocated to the sector. Total phase-out over a period of base 66% of 33% of no
three years. Under the program, budgeted allocations to directed credit would decline in real terms amount base base subsidized
by 33 percent per year with respect to the amount allocated in 2000 until subsidized directed credit amount amount directed
would be totally phased out by 2003. Since the proposed reductions are in real terms the nominal credit
amounts may actually increase depending on inflation.
Cost of Funds to Participating Banks. Determined based on a market and observable rate of 85% of 95% of 100% of N.A.
interest such as BUBOR or the cost of deposits for the banking system. The cost of funds for banks cost of cost of cost of
should reach market levels over the life of the program. To reduce uncertainty, possibilities to “lock- deposits deposits deposits
in” rates at the time of disbursement or to set “caps” for the life of the loan should be analyzed. The
illustrative targets provided next are based on average cost of deposits for the banking system. These
possibilities would require comparatively short term repayments for loans of one year maximum.
Interest rate charged to final borrower. Negotiated by participating banks and borrowers N.A. N.A. N.A. N.A.
according to market conditions and borrower specific risks. This pricing policy implies that margins
for participating banks are completely liberalized reducing, thereby, biases against smaller loans.
Interest rebates to final borrowers. Incentives to final borrowers, if any, should be in the form of a initial 66% of 33% of N.A.
rebate on the amount of interests paid. For example, upon repayment borrowers would be refunded a rebate on initial initial
percentage of the amount of interest repaid. Rebates ought to decline over the implementation of the interest rebate rebate
program. For example if the rebate for 2000 is 25 percent of interest paid the rebates for 2001 and paid
2002 would be, respectively, 16.5 and 8.25 percent.
Cost rebates to banks. Cost rebates for banks could be paid as a percentage of the principal initial 66% of 33% of N.A.
amount of the loan. The rebates ought to be proportional to the term of loans (e.g., a six month loan rebate on initial initial
would accrue 1/2 the cost rebate of a year loan) and would be collected by participating banks when loans rebate rebate
disbursing the loans. Banks would return the corresponding proportion of the rebate on any loans disbursed
that are repaid prior to their maturity. The rebates ought to be declining over the implementation of
the program as banks learn to lend to agriculture and provide repeated loans to borrowers with good
repayment performance.
Limits in the amount of credit to a single borrower. Credit to the sector would be better targeted initial 66% of 33% of N.A.
by establishing limits in the amount of credit granted to a single borrower. These limits would be maximum initial initial
declining over time by, say, 33 percent annually. To allow better planning for borrowers and banks, amount maximum maximum
these limits may be denominated in US dollars. To illustrate, if the maximum amount of credit that amount amount
could be granted to a single borrower in 2000 is, say, the equivalent in Lei of US$ 250,000; then the
limits for 2001 and 2002 would be of the equivalent in Lei of US$ 165,000 and US$ 82,500,
respectively. Among other positive features, the proposed limits would (a) reduce the ability and
incentives to capture subsidies by hoarding credit at below market rates and (b) may induce banks to
supplement budgeted credit allocations with their own resources to fulfill large credit applications
from worthy clients.
a
This matrix is intended only as a basis of discussion between the Government of Romania and the World Bank.
b
Clearly, this study could not provide specific and definite suggestions for quantitative targets at this time. The World Bank would respond positively to any
request by the Government to assist in fine-tuning a similar program. The targets provided above are mostly intended to illustrate the design of a transitional

81
program.
Source: Author’s calculations.
82 Chapter Five:

C. IMPROVING THE LEGAL AND INSTITUTIONAL ENVIRONMENT FOR

FINANCIAL TRANSACTIONS

Movable Assets as Collateral

There has been significant progress in passing legislation that may correct the
shortcomings analyzed in Section B of Chapter III. This legislation will allow for greater and
more effective use of movable assets as collateral, most notably, farm equipment, inventories,
accounts receivable, and consumer goods.

In particular, the Government passed Law No. 99 of 26 May 1999, published in Monitorul
Oficial 236 of 27 May 1999m "Law Regarding Some Steps to Accelerate Economic Reform,
TITLE VI. The Legal Status of the Security Interests in Personal Property." Preparation of the
law and its regulations was supported by the World Bank, which is also supporting the creation
of an electronic filing archive for security interests. The legal framework and the archive will
stand among the most modern systems of securing transactions with movable assets in the world.
The archive is presently under development and should begin operations during first quarter
2001. It is expected that this new framework will correct the deficiencies mentioned in Chapter
III allowing, therefore, effective use of movable assets as collateral

Two actions still need to be undertaken to fully reap the benefits of the new secured
transactions system. First, implementation of a registry for security interests in movable goods
should continue. Second, the mechanisms for expeditious recovery of collateral included in the
legislation should be implemented without hindrances as assets pledged as security in the rural
and agricultural sectors tend to have a comparatively short life span.

These are important elements because, on the one hand, they will reduce credit risk for
lenders, thus increasing their risk adjusted return on lending. On the other hand, they will also
increase the capacity to carry debt of movable assets, which is tantamount to reducing the
average ratio of collateral values to the amounts of loans. The quantity demanded of credit
should increase as large collateral to loan amount ratios were found to be a significant element in
reducing the demand for credit (see Chapter III).

Warehouse Receipts

The legal environment for warehouse receipts was also improved by Law 99 above. This
law clarified and defined the rights, liabilities, and duties of each party to a warehouse receipt
(e.g., producer, bank, warehouse) by making receipts freely transferable by delivery or
endorsement. In addition, potential lenders will be able to use the new security interest electronic
archive to determine if there are competing claims on a given stock of commodities.

Two actions are still required to overcome the shortcomings of the warehousing
framework described in Chapter IV. First, independent inspection and licensing of warehouses
should be established. Second, a system of performance guarantees for warehouses should be
developed, including establishing an indemnity fund and/or requiring mandatory insurance
among licensed warehouses. Farmers and traders will be reluctant to store crops, and banks will
Policy Options and Possible World Bank Support 83

not be willing to accept receipts as collateral unless there is significant certainty on whether the
goods exist in the quantities specified by the receipt and on whether the quality is the same as
that noted on the receipt.

More competition should be introduced into the storage industry, which remains
dominated by the state. Breaking Romcereal into Comcereals and Cerealcoms simply divided a
large state monopoly into a collusive organization of local monopolies (still controlled by the
state) without any positive impact on their operations. Anecdotal evidence suggest that the
excessive prices charged by these elevators often makes it unattractive for farmers and traders to
store. It is also argued that the elevators often return different amounts and qualities of
commodities than originally stored.

Leasing and Investments on Depreciable Assets

Priority should also be given to solving the remaining problems in the accounting and
fiscal treatment of leasing and, more generally, of depreciable fixed assets (see Chapter IV).

There have been important steps in establishing a western-style leasing system. Late in
1998, the Government passed the “Law on Amending Ordinance No. 51/1997.” This law is an
important step in that it corrects problems in the previous regime. In particular, this new law: (a)
provides clear definitions for financial and operational forms of leasing and clarifies the differing
tax and accounting treatments accorded to these two arrangements;69 and (b) decreased the
disadvantages for Romanian leasing companies vis a vis cross border lessors by unifying imports
tariffs and customs guarantees. The Law on Amending Ordinance No. 51/1997 and Law 99 (see
above) also provide enforcement certainty by: (a) assigning priority to lessors over leased assets
in case of bankruptcy or reorganization of the lessee; and (b) by simplifying the procedures for
repossessing leased assets upon default.

Significant problems remain, however. As long as Romanian depreciation and accounting

procedures do not embrace generally accepted principles in the treatment of depreciable fixed
assets, leasing will not fully develop. Leasing is merely one of several instruments to finance
investments in such assets. In other words, one should not expect leasing to grow because
investment in the types of assets that are typically leased is taxed excessively. Specific
recommendations follow.

(a) Allow for shorter depreciation schedules on fixed assets. The current schedules
are too long compared with the normal life of a leasing contract. When such long
depreciation schedules are applied to equipment leases of, for example three years, the
lessor would have to report artificially high net taxable profits because current period costs
are not being matched with current period expenditures. This excessive taxation limits the
ability of leasing companies to replace leased assets. In practice, the Government is taxing
the difference between the historical value of assets and their current replacement cost (in
nominal Lei).

69 This law introduced a clear distinction between the treatment of financial leasing and operational leasing with
specific regulations on: (a) how leased goods must be dealt in the balance sheets; and (b) on who can (lessor or
lessee) claim credit on depreciation and rental payments under each type of leasing.
84 Chapter Five:

(b) Allow reasonable revaluation of assets over their historical book values to
compensate for inflation. According to current Romanian accounting law, all assets must
be booked at their historical value and their revaluation is not allowed. This rule implies
that, in the presence of inflation, depreciation expenditures are underestimated causing,
again, artificially high taxable profits and low equity ratios for firms. The net effect is
equivalent to a tax on investment in capital goods.

(c) Allow tax payers to deduct, from their taxable income, losses incurred when
selling assets below their book value. These deductions are not permitted. Book value
losses are unavoidable for Romanian leasing companies because of the very long
depreciation schedules imposed by law and the comparatively short leasing periods
(typically 3 to 4 years). In most cases, this combination causes the market value of fixed
assets to be below their book value. Losses occur, therefore, when leased assets are sold.
This practice gives leasing companies an unduly large tax burden.

(d) Finish leveling the playing field between domestic and cross border lessors. The
payment of value added tax (VAT) on equipment leased from a foreign leasing company is
still deferred until the end of the lease period and is calculated on the residual value of the
assets. These practices favor cross-border leasing and make it difficult to lease Romanian-
made assets. In fact, the Romanian leasing association estimates that 99 percent of
outstanding leasing contracts in the country are cross-border leasing.

(e) Eliminate the customs duty incentives provided by the Law on Amending
Ordinance 51/99 namely, total exemption of import tariffs, duties, and custom guarantees
on assets to be leased. This regime has resulted mainly in an increase in the number of
inter-company leasing arrangements as a means of avoiding customs duties, and not in the
growth of real leasing transactions.

D. IMPROVING THE LEGAL AND INSTITUTIONAL ENVIRONMENT FOR USING

LAND AS COLLATERAL

There are many economic benefits that result from well-defined property rights and secure
title to real estate that go beyond financial markets. These benefits include: (a) greater incentives
for the maintenance of and investment in property as well as the reduced probability of long-term
environmental degradation as generally secure rights tend to be associated with more intensive
farming and with a stronger commitment to preserve the integrity of natural resources; and (b)
reallocation of land to those who have both the ability and the resources to use land most
productively.

There are also obvious advantages for rural finance; namely, the ability to use land as
collateral which both enhances financial market development and promotes greater investment.
In particular, titled land which has secure registration generally has a much higher market value.
While this is not sufficient for a well functioning financial system, insecure property rights
unambiguously reduce the development of financial markets, especially in rural areas where
farm land represents an important portion of all assets.
Policy Options and Possible World Bank Support 85

Rights in fixed property have, as their foundation, an effective legal system. Without
effectively functioning laws, records, and enforcement mechanisms, property rights will not be
secure. This, in turn, will hamper the development of property markets.

The features of a good system of fixed property are: (a) it secures ownership and property
rights; (b) it develops and encourages a system which supports property transactions; and (c) it
allows for the mortgaging of property.

In turn, the following are the conditions necessary for a successful titling and registration
system. These elements should be at the center of effective government action:

(a) Acquire support from land and property owners who wish their titles to become more
secure. Unless there is demand for land registration from this group, a successful program
will be difficult to implement. The way property owners perceive the system of titling and
registration is therefore critical. If, for example, titling and registration programs are
viewed as an attempt to collect additional taxes, widespread support is unlikely. Similarly,
if the process is perceived to be corrupt or unduly subject to political influence, it will not
be widely used.

(b) Invest in making property rights and property boundaries clearly recognizable and
easily definable. Otherwise, the land registration system will become bogged down by
disputes. Records on ownership need to be easily accessible and accurate.

(c ) Hire qualified survey and registry staff and train these staff to ensure they are suitably
competent. The public must have faith in the titling and registration process.

(d) Improve the ability of the court system to enforce and protect property rights. This
requires both the appropriate laws, strong institutions involved in titling and registration,
and the appropriate enforcement mechanisms, as well as courts that are able to render
judgment without undue delay.

(e) Decrease the degree of regulation of land sales. While zoning regulations are
probably unavoidable, the rules should be transparent and the procedures for applying for
zoning changes should be simple and relatively inexpensive. Rules regarding uses to which
agricultural land must be put or restrictions on the size or ownership of holdings have a
negative effect on efficiency.

(f) Reduce the statutory costs of property transactions, as well as those of private agents
involved in the transfer and registration of title should be low so as to keep the prices for
the buyer and the seller as close together as possible. If these margins are high, transactions
that could enhance efficiency and improve the utilization of property will not take place.
This applies not only to the first registration but to all subsequent transactions.
International experience has shown that even if the first registration is inexpensive, if
property transactions are costly, registries are not used, many transactions go unrecorded,
and the registry information quickly becomes outdated so that the value of the initial
efforts are severely reduced.
86 Chapter Five:

E. RETAIL LENDING

Development of private financial markets in rural Romania requires the ability of the
financial sector to supply retail and micro-finance services profitably. This necessity results form
the fact that by and large rural clients demand very small transactions (see Chapter II). Section B
of Chapter III argued, however, that the supply of retail and micro-finance services will continue
(at best) to be weak in the absence of Government policy intervention. While the irreversible
trend for banks in economies with developed financial markets is to aggressively compete for the
retail portion of the market, in Romania increased availability of retail credit in rural areas may
take a long time to develop if left alone to the market. In fact, it is likely that the banking sector
will reduce their retail network in rural areas after privatization.

There may be a need, therefore, to induce private banks to increase their presence in the
retail portion of the market. In the first instance, this presence would be required to provide safe
deposit services to large portions of the population which have bank deposits (see Chapter II).
These services should be provided mainly by regulated intermediaries. The vacuum that may be
left by a retiring state banking sector introduces the risk of unregulated intermediaries increasing
their share of the deposits of the population. As indicated in Chapter II, three state owned banks
held 80 percent of the deposits of the rural population at the time of the survey.

An appropriate distribution network will also be required to lend to small and medium
businesses, including those in rural areas, and farmers. Small credit transactions are highly
elastic with respect to transaction costs, which are reduced in the presence of a point of sale in
the locality of residence of borrowers. The presence of a network of retail finance will be
required to allow for the massive redeployment of resources expected to occur in the rural
economy.

Government support may be required to provide technical assistance to private banks to

accelerate their understanding of the rural sector, of how to evaluate business plans from new
private farms and rural businesses, of how to use and value rural assets that might be pledged as
security, of how to dispose of such assets, and so forth. Financial and technical assistance should
also be provided to non-profit organizations to support the provision of micro-credit to the
poorest segments of the rural population (those which will not be reached by the banking sector).

The Government could also assist in the development and introduction of technologies and
institutional arrangements that could reduce the costs and risks of retail banking and micro-credit
in the rural areas (e.g., character based lending, credit bureaus). These instruments are
particularly important for small and medium enterprises. The idea is that the Government could
fund experiments in developing sustainable technological packages for delivering retail and
micro-credit in rural localities. The objective is to establish general guidelines for providing
financial services to small, medium, and micro entrepreneurs by adapting to Romanian
conditions the experience of successful rural financial in other countries.

International experience attests that rural retail lending could be a profitable market niche
for banks, and that micro-finance could be a sustainable activity to non-profit organizations,
provided that they use appropriate methodologies. These methods require banks and NGOs to:
(a) sell few and simple credit products; (b) have low branch fixed costs; (c) use local information
Policy Options and Possible World Bank Support 87

to screen and monitor borrowers; (d) implement conducive incentive schemes for branch
managers or credit agents; and (e) deploy adequate internal control mechanisms.70

Government support for these activities is justified from a public policy point of view.71
The development of sustainable technologies for delivering financial services to retail and micro
rural clients requires extensive local experimentation. The problem is that the investment in
experimentation may be inadequate unless the government provides the necessary stimulus.
Since no single lender can capture a significant portion of the social value of improved lending,
the rational strategy is to wait for someone else to assume the risks and costs of experimentation
and, in the case that the new technologies were successful, to copy them. It is also justifiable for
the Government to invest in this experimentation because past government interventions in
financial markets have been extremely costly. Any future mistakes are likely to also be
expensive. Hence, limited support to private intermediaries that will avoid future government
direct involvement may be a good policy. Micro-finance, on the other hand, has proven to be a
cost effective and sometimes sustainable instrument to deal with the rural poor.

There is credible empirical evidence that the necessary conditions exist in Romania for
rural bank branches to operate profitably by allocating retail credit and to collecting deposits, and
for NGOs to allocate micro-loans in a sustainable manner. The Technical Annex to this study
analyzes the potential profitability of providing retail financial services in rural areas of Romania
through the introduction or modification of specially designed rural bank branches and micro
credit programs. The analysis was conducted on the basis of conservative assumptions and
parameters derived from the survey and other official data. The annex suggests that such a
branch or program could begin to generate operational surpluses early in its operations if it
adopts best practices which ensure its ability to control the overall cost of operations, in
particular loan losses and administrative overheads.72

70These elements are common to some very successful rural financial intermediaries whose experiences are well
documented in the professional literature (Chaves and Gonzalez, 1996).
71The next section on possible World Bank support provides an outline of an operationally feasible way for the
Government to support these efforts.
72 The study is based on the results of a computerized financial projection model used to project the potential
profitability of a new rural bank branch and a new micro credit program in Romania. The model results are based
on a set of conservative assumptions and parameters derived from official survey and other data on the lending and
saving behavior of individuals, households, and enterprises in rural Romania, the macroeconomic environment, size
and make-up of the market area to be covered by a new branch or program in terms of potential clients, interest rates
at which a new branch or program will mobilize and lend funds, types and characteristics of financial products to be
offered, loan portfolio performance, existing banking regulation, start-up costs, and operating expenses.
88 Chapter Five:

F. REGULATORY CONCERNS REGARDING CHARTERED NON-BANK MUTUAL

FINANCIAL INTERMEDIARIES

The Problem

The stability of the overall financial sector and the protection of the savings of the
population are paramount ingredients in the development of financial markets in rural areas. The
estimated 1,400 independent mutual financial intermediaries (MFIs) registered under Law
109/1996, most notably Banca Populara, and Credit Cooperatives should be a matter of concern
in this regard. A majority of these intermediaries are domiciled in rural areas. The reasons for
concern are that the Government may have assumed important contingent liabilities by
chartering MFIs and that they may constitute a regulatory hazard because they can be used to
profitably arbitrage on the general regulation of the banking sector.

MFIs have large numbers of depositors and their operations take place outside the
regulatory authority of the National Bank of Romania (NBR). The Government may be unable to
credibly commit not to bail them out in case of financial difficulty. This implicit deposit
insurance would only make incentive problems implicit in their governance rules (see below) all
the worse and may contribute further to their instability. The failure of individual MFIs would
endanger the deposits made by largely unsophisticated and poor rural households.

The biggest risk posed by MFIs, however, is that they could be used to profitably arbitrage
on the general regulation of banking sector. This opportunity arises because their activities are
not supervised and because they have the ability to: (a) provide basically all credit and deposits
services allowed to commercial banks; (b) lend to other MFIs; and (c) invest in the equity of
other MFIs and commercial banks. These elements make the growth of a network of related
MFIs with negligible capital possible. This growth may occur exclusively on the basis of
deposits when members of the network use debt to finance equity investments in other members
of the group (i.e., “cascading” or “pyramiding” of capital). The financial statements of any MFIs
in the group would reflect “healthy” leverage ratios when analyzed individually. The
consolidated system, however, could have negligible or no equity at all.

MFIs have caused disruption in the financial markets of other countries for diverse
reasons. Their failure has resulted in the loss of deposits and/or expensive bailouts by tax payers
in numerous countries including the United States (Savings and Loans), Mexico (Uniones de
Crédito), and France (Credit Agricole System). Credit Cooperatives have experienced recent
problems in numerous Latin American countries such as Costa Rica, Colombia, Panama, and
Argentina.

Romanian credit cooperatives and Banca Populara have a governance structure stipulated
in Law 109/1996 which makes their regulation more difficult than that of private banks. The
governance structure includes the following principles: (a) ownership by depositors and
borrowers; (b) one-man-one-vote with simple majority rules; and (c) open doors for admission
and withdrawal of members.

These rules may allow the individuals in control of these organizations to become residual
claimants of their profits but not of their losses. This situation is known as borrower
Policy Options and Possible World Bank Support 89

domination.73 Based on a one-man-one-vote and simple majority rules, decisions such as interest
rates, collateral on loans, enforcement of credit contracts are made by members who may have a
clear conflict of interest by acting simultaneously as borrowers and owners.

The international experience with these governance rules has been mixed even in countries
with well-developed cooperative structures, legal and institutional frameworks, and bank
supervision capacities. Credit cooperatives have been financially unstable, more susceptible than
other intermediaries to (minor) changes in their environments, and with few exceptions unable to
capitalize significant subsidies, special tax treatments, and regulatory forbearance that donors
and governments have given them. In particular, they: (a) have been borrower dominated; (b)
have been created with significant subsidies from donors and governments; (c) are normally
undercapitalized by their owners; and (d) have been particularly difficult (more so than other
intermediaries) to regulate and supervise. 74

Current Proposals May not Remedy the Problem

Clearly, the elimination or management of the risks imposed by existing MFIs in Romania
is not a simple task. The authorities have taken the initial important step of suspending the
licensing of new MFIs. The challenge of what to do with the existing ones remains, however.
Two options have been proposed in Romania, namely: (a) bringing the system under the
supervision of the NBR; and (b) introducing self-regulation by requiring individual MFIs to join
second-tier groups such as federations of credit cooperatives which would supervise their
members.

Neither option may be suitable, however. The first may strain the supervisory capacity of
the NBR, as it would increase the number of intermediaries it currently supervises from 45
commercial banks to more than 1,400; in one single step. The second option has significant
shortcomings, including: (a) the federations (the supervising entities) which would be owned
and controlled by MFIs (the supervised entities) – the managers of a tightly-run federation may
be replaced by a laxer management team; and (b) federations and MFIs would be private entities
and thus, MFIs may choose to exercise their constitutional right of free association by either
moving from tightly-run federations to lax federations or to no federation at all. The Government
may not be able to condition the existence or functioning of a MFI on belonging to a federation.

73Borrower domination occurs when members acquire control of a client-owned intermediary, such as a credit
cooperative, with the purpose of seizing private benefits generated at the expense of the organizations financial
health. Examples of such practices adopted by borrower dominated intermediaries are weak collection of loans and
low interest rates.
74There is a significant body of literature which documents this performance, including the following examples: (a)
Black, H. and R. Dugger. (1981) “Credit Union Structure, Growth, and Regulatory Problems.” The Journal of
Finance 2:529-538; (b) Bonus, H. and G. Schmidt. (1990). “The Cooperative Banking Group in the Federal
Republic of Germany: Aspects of Institutional Change.” Journal of Institutional and Theoretical Economics
146:180-207; and (c) Porter, P. and Scully G. (1987). “Economic Efficiency in Cooperatives.” Journal of Law and
Economics 30:489-512. The most notable exceptions to this general pattern of financial instability are the
Cooperative Banking Group in Germany and the Credit Union financial intermediaries in the United States.
90 Chapter Five:

A Third Option Seems to be Required

The following sequence of actions may represent a viable option to ameliorate the risks
involved in the operations of MFIs:

(a) Maintain the status quo, leaving existing MFIs outside NBR’s regulatory authority
and supervisory responsibility.

(b) Pass legislation, possibly by amending Law 109/1996, so that: (a) MFIs are no longer
allowed to use the word “bank” in their names (e.g., Banca Populare); (b) MFIs be obliged
to register with the NBR with the (only) purpose of establishing a complete inventory of
them; (c) The NBR has the authority to request some basic financial data on MFI
performance, including external audits for MFIs above asset thresholds; (d) NBR has the
authority to regulate the “act” of financial intermediation rather than specific financial
intermediaries (e.g., bank charter only) allowing the NBR to take discretionary actions
with respect to selected MFIs without acquiring the obligation of supervising all MFIs.

(c ) Pass new, or amend existing, legislation that would allow for the creation of a totally
new financial intermediary charter. This “small regional bank” (SRB) charter would be
subject to a complete regulatory framework which would correct the governance problems
detailed above.75 The new legislation would allow the NBR to define whether the proposed
SRBs would be subject to the same prudential standards applicable to commercial banks or
whether there should be specific standards for them. Prudential norms appropriate for
commercial banks may not necessarily be appropriate for the proposed SRBs. Examples of
the norms that ought to be specifically defined for these banks and which may need to be
different from those applied to commercial banks include: (a) maximum levels of exposure
to the risks of financial intermediation (e.g., interest rate and liquidity risks); (b) rules
about their ability to make equity investments in other organizations; (c) capital adequacy
ratios; (d) investments in non-financial activities; (e) risk weighted provisioning against
loan losses, and (f) nature and legal character of their owners. The general principle
suggested is that the prudential norms may have to impose different norms on different
types of intermediaries if and only if required to reduce risks. There may be valid
justifications for different norms to account for differences in: (a) the environment in
which intermediaries operate; (b) the size and characteristics of the market niches they
serve; and (c) their institutional design and governance structure.76 For example, SRBs
would have lower minimum capital requirements to be licensed (consistent with the size of
the markets they would serve), but they should also be subject to stricter capital adequacy
ratios than those of normal commercial banks and should not be allowed to take foreign
exchange risks or take equity positions in other entities. In general, the prudential norms
for SRBs would be stricter than those applicable to commercial banks.

75 The positive experience of small regional banks in Indonesia (Badan Perkreditan Rakyat ) prior to the late 1990’s
crisis encourages the possibility of passing a “small bank law.”
76 Institutional design refers to the property rights and rules of control over the organization's assets. For example,
as mentioned above cooperatives are controlled by a one-man-one-vote rule, while commercial banks are controlled
by a one-share-one-vote rule.
Policy Options and Possible World Bank Support 91

(d) The NBR would undertake immediate efforts to develop its capacity to enforce SRB
compliance with the above prudential norms. These efforts should include establishing a
well-staffed unit devoted to this purpose. The NBR would need to design indicators to
measure risks, to monitor and analyze the impact that external events might have on the
performance of SRBs, and to make sure that the data reported by SRBs are accurate. The
surveillance of SRBs would have the following two basic components of banking
supervision:

(i) An early-warning system based on data reported by SRBs. This would be the
off-site component of the supervisory structure. Its purpose would be to provide a
frequent depiction of the financial health and risks of each one of the SBR
supervised. This system would use standardized computer models to identify SRBs
likely to experience financial distress.77 Off-site supervision would be used to set
priorities regarding the more expensive on-site inspection and would entail
specialized computer software to periodically process the returns submitted by the
SRBs, a scoring method to rank them, and “industry” standards to assess their
individual performance.

(ii) On-site supervision necessary to undertake inspections that, because of

their nature, cannot be performed by an off-site analysis (e.g., quality of internal
control) and to verify that the data fed to the off-site surveillance system are correct.

(e) Existing MFIs would be eligible to be licensed under the new regulations under a
“fast track” procedure. This special procedure would be available for a limited period, say
12-18 months. During this period existing MFIs that would opt to comply with the new
regulations and get licensed under the new framework would be provided technical
assistance to meet the new regulatory standards, including the adoption of charts of
accounts, management information systems, and reporting requirements. The NBR would
give preference in licensing to MFIs willing to merge with others. The new regulations
would include provisions to facilitate mergers and to insure that the resulting SRBs would
become the legal successors to the previous MFIs.

(f) Existing MFIs that refuse to migrate to the new charter and to comply with the new
regulatory framework would remain unregulated informal financial intermediaries. The
NBR could consider the possibility of making the public aware of the risks involved in
maintaining deposits in such intermediaries by publicizing their status.

The development of a system of SRBs with disparate minimum initial capital requirements
should not cause regulatory apprehension in itself. These banks should be subject to sound

77 Most of these models are based on multivariate discriminatory analysis using a series of financial ratios as
predictive variables. These methods, although sophisticated, are not particularly difficult to implement and, when
properly applied, can be very efficient in predicting the failure of intermediaries. In effect, the specialized literature
reports that these models are almost as effective in such predictions as the more expensive bank supervisor visits.
For instance, the off-site supervision methods used by the United States regulatory agencies signaled financial
instability in 96 percent of the 347 cases of bank failure occurred between January 1989 and August 1990. The
early warning system used, denominated CAMEL (i.e., capital adequacy, asset quality, management, earnings, and
liquidity), gives banks a composite grade from 1 (best) to 5 (worst).
92 Chapter Five:

prudential norms such capital adequacy requirements in the form of minimum solvency or
maximum leverage ratios. This practice represents sound regulation. In contrast, capital
requirements in the form of an absolute minimum amount of capital needed to enter the industry
are, conceptually, anti-competitive regulation. The justification for this latter type of regulation is
the practical difficulty of supervising potentially large numbers of intermediaries with small-
scale operations. Numerous such intermediaries already exist and actions to ameliorate the
implied risk must be taken sooner rather than later.

G. MARKET DEVELOPMENT, BALANCED RURAL DEVELOPMENT, AND

PRIVATIZATION

The empirical findings of the survey provide strong support to the claim that the following
actions would contribute to increasing investment in rural areas: (a) integrating households into
markets and allowing concentration of land holdings; (b) formulating balanced rural
development policies (in contrast to focussing on agriculture only); (c) privatizing state
enterprises; and (d) privatizing state banks.

For instance, Chapter IV found that household investment opportunities are positively
associated with the degree of connection to markets as proxied by the share of the value of
agricultural sales in total household income and negatively associated with the age of the heads
of households. In fact, during the survey period, 45 percent of farm households with substantial
market involvement made investments, in contrast with only 24 percent of the farm households
which consumed their production. In turn, market involvement requires eliminating the
restrictions for exiting agriculture faced by the large numbers of elderly landowners who have
small-scale operations and lack agriculture equipment. These farmers created by the land reform
process will remain engaged in subsistence farming and will remain disconnected from markets.

The results in Chapter IV indicate that the enterprises more likely to invest were,
everything else the same, in sectors other than agriculture and were private in that the state had
no participation in their ownership. These results are also consistent with those of Chapter III,
which show that, everything else the same, the probability that an enterprise in the industry,
trade, and service sectors had a demand for loans was respectively, 36, 32, and 30 percentage
points higher than the probability of an agricultural enterprise reporting a demand for loans.

Finally, private banks were more amicable to financing investments that their state-owned
counterparts. During the survey period, private banks allocated 80 percent of their loans to
borrowers who reported having made investments in the period in which they received the loan,
while the equivalent share allocated by state banks was 55 percent.

H. POLICY COORDINATION

Rural finance in Romania is a complex multi-sector subject with important political

implications. It is an issue with multiple influences on the economy ranging from
macroeconomic stability to impact on rural poverty. A consistent set of policies towards rural
financial markets is a vital concern, therefore. A steering committee should coordinate general
policies and, maybe, guide the reform of specialized government institutions and programs. This
Policy Options and Possible World Bank Support 93

committee should consist of representatives from the government agencies involved, including
the Ministry of Agriculture Food and Forestry, the Ministry of Public Finance, and the National
Bank of Romania.
94 Chapter Five:

Figure 13 Romania by Agro-Region

 References

Adam, Christopher S. (1999). “Assets Portfolios and Credit Rationing: Evidence from
Kenya.” Economica, 66, 97-117.
Arrow, K. J. (1971). Essays in the Theory of Risk Bearing. Chicago: Markham.
Barry, Peter. (1995). The Effects of Credit Policies on U.S. Agriculture. American
Enterprise Institute Press, Washington, D.C.
Bell, Clive, T.N. Srinivasan, and Chritopher Udry (1997). “Rationing, Spillover, and
Interlinking in Credit Markets: The Case of Rural Punjab.” Oxford Economic
Papers, 49, 557-585.
Benjamin, McDonald and Joanna Ledgerwood (1999). The Dominican Republic –
ADEMI. Case Studies in Microfinance. Sustainable Banking with the Poor (SBP)
Project. The World Bank, Washington, D.C.
Brunetti, Aymo and Beatrice Weder (1998). “Investment and Institutional Uncertainty: A
Comparative Study of Different Uncertainty Measures.” Weltwirtschaftliches
Archiv 134 (3), App: 514.
Carter, Michael (1989). “The Impact of Credit on Peasant Productivity and
Differentiation in Nicaragua.” Journal of Development Economics, 31, p.13-36.
Chaves, Rodrigo A. and Claudio Gonzalez-Vega (1996). “The Design of Successful
Rural Financial Intermediaries: Evidence from Indonesia.” World Development,
24, 65-78.
Chaves, Rodrigo and Susana M. Sánchez (1998). “Poverty, Entrepreneurs, and Financial
Markets in the Rural Areas of Mexico.” In Ramón López and Alberto Valdés
(eds.), Rural Poverty in Latin America, forthcoming.
Chaves, Rodrigo and Susana M. Sánchez. (August 25, 1995). “Mexico: Rural Financial
Markets.” Green Cover Report No. 14599-MX, Latin America and the Caribbean
Regional Office, Country Department II, Natural Resources and Rural Poverty
Division. The World Bank, Washington, D.C.
Chirca C., Tesliuc E. (1999). “From Rural Poverty to Rural Development.” National
Commission for Statistics, Bucharest.
Chung, Inuk (1995). “Market Choice and Effective Demand for Credit: Roles of
Borrower Transaction Costs and Rationing Constraint.” Journal of Economic
Development, 20 (2), 23-44.
Claessens, Stijn (1997). “Banking Reform in Transition-Countries.” Unpublished
Manuscript. The World Bank.
Cleary, Sean (1999). “The Relationship between Firm Investment and Financial Status.”
Journal of Finance, 54 (2), 673-692.
96 References:

Cleary, Sean (1999). “The Relationship between Firm Investment and Financial Status.”
The Journal of Finance, 54 (2), 673-692.
Conning, Jonathan (1996a). “Mixing and Matching Loans: Credit Rationing and
Spillover in Rural Credit Markets in Chile.” Unpublished manuscript.
Conning, Jonathan (1996b). “Financial Intermediaries, Rationing an Spillover in a Rural
Credit Market in Chile: A Theoretical and Empirical Analysis.” Center for
Institutional Reform and the Informal Sector, Working Paper No. 1994. The
University of Maryland at College Park.
Davis, Junior R. (1997). “Access Constraints, Debt or Profitability? Are These Mutually
Exclusive Elements of Romanian Rural Finance?” Paper prepared for the
Romania: Rural Financial Market Development for the Small Private Sector
Workshop, May 7-8, 1998.
Davis, Junior R. and Paul G. Hare (1997). “Reforming the Systems of Rural Finance
Provision in Romania: Some Options for Privatisation and Change.” Centre for
Economic Reform and Transformation Discussion Paper No. 97/13, Department
of Economics, Heriot-Watt University, Edinburgh: Scotland.
Davis, Junior R., Angela Gaburici, and Paul G. Hare (1998). “What’s Wrong with
Romanian Rural Finance? Understanding the Determinants of Private Farmers’
Access to Credit.” Centre for Economic Reform and Transformation Discussion
Paper.
DeYoung, Robert, Lawrence G. Goldberg, Lawrence J. White (1999). “_outh,
Adolescence, and Maturity of Banks: Credit Availability to Small Business in an
Era of Banking Consolidation.” Journal of Banking and Finance, 23, 463-492.
Ducan, John V. and Stuart S. Rosenthal (1993). “Borrowing Constraints, Household
Debt, and Racial Discrimination in Loan Markets.” Journal of Financial
Intermediation, 77-103.
Economist Intelligence Unit (1999). Romania 1999-00. Country Profile, London:
Economist Intelligence Unit.
Fafchamps, Marcel and John Pender (1997). “Precautionary Saving, Credit Constraints,
and Irreversible Investment: Theory and Evidence from Semiarid India.” Journal
of Business & Economic Statistics, 15 (2) 180-194.
Feder, Gershon, Lawrence J. Lau, Justin Y. Lin, and Ziaopeng Luo (1991). “Credit’s
Effect on Productivity in Chinese Agriculture.” Policy, Research, and External
Affairs Working Paper 571, The World Bank, Washington, D.C.
Gale, Douglas and Martin Hellwig (1985). “Incentive Compatible Debt Contracts: The
One-Period Problem.” Review of Economic Studies, 72, 1151-1157.
Gorton, Gary and Andrew Winton (1998). “Banking in Transition Economies: Does
Efficiency Require Instability?” Journal of Money, Credit, and Banking, 30 (3),
621-656.
Guariglia, Alessandra (1999). “The Effects of Financial Constraints on Inventory
Investment: Evidence from a Panel of UK Firms.” Economica, 66, 43-62
Financial Markets, Credit Constraints, and Investment in Rural Romania 97

Hauge, Soren (1998). “The Hidden Costs of Rationing in a Chilean Rural Credit
Markets.” Unpublished manuscript. University of Wisconsin-Madison.
Heidhues, F., Schrieder, F., Gaburici, M. Constantin, M. Comsa, A. P.Hare, and J.Davis
(1998). “Romania: Rural Financial Market Development for the Small Private
Farm Sector.” Report No. P95-2170-R, ACE-Phare95, Bucharest: Romania.
Heidhues, Franz (1995). “Romania Rural Financial Market Development for Small
Private Farm Sector.” University of Hohenheim.
Hubbard, Glenn R. (1998). “Capital-Market Imperfections and Investment.” Journal of
Economic Literature, 36, 193-225.
Jaffe, Dwight M. and Franco Modigliani. “A Theory and Test of Credit Rationing.” The
American Economic Review, 59 (5), 850-872.
Jaffee, Dwight M. and Stiglitz, Joseph (1990). “Credit Rationing.” In Friedman, B.M. and
F.H. Hahn (eds) Handbook of Monetary Economics, Volume II, Elsevier Science
Publishers B.V.
Jalan, Jyotsna and Martin Ravallion (1999). “Are the Poor Less Well Insured? Evidence
on Vulnerability to Income Risk in Rural China.” Journal of Development
Economics. 58, 61-81.
Jayaratne, Jith and John Wolken (1999). “How Important are small banks to small
business lending? New Evidence from a Survey of Small Firms.” Journal of
Banking and Finance, 23, 427-458.
Jones, David R., and Gerald H. Makepeace (1996). “Equal Worth, Equal Opportunities:
Pay and Promotion in an Internal Labor Market.” The Economic Journal, 106,
401-409.
Kochar, Anjini (1997). “An Empirical Investigation of Rationing Constraints in Rural
Credit Markets in India.” Journal of Development Economics, 53, 339-371.
Ledgerwood, Joanna (1998). Microfinance Handbook. An Institutional Financial
Perspective. Consultative Group to Assist the Poorest (CGAP). Washington,
D.C.: The World Bank.
López, Ramón, and Tim Thomas (1999). “The Underlying Factors of Poverty in Rural
Romania: Access to Productive Assets and Asset Productivity.” Unpublished
manuscript. University of Maryland at College Park.
Maddala, G.S. (1983) Limited-Dependent and Qualitative Variables in Econometrics.
Cambridge: Cambridge University Press, Econometric Society Monograph No. 3.
Maddala, G.S. and Forrest D. Nelson (1974). “Maximum Likelihood Methods for Models
of Markets in Disequilibrium.” Econometrica, 42 (6), 1013-1030.
Meyer, Richard L., Douglas H. Graham, and Geetha Nagarajan (1997), “Small Business
Finance in Romania: Banks, Business an Business Centers in a Transition
Economy.” Study prepared for the Bureau for Europe and the NIS of the U.S.
Agency for International Development under Grant Number EPE-0023-G-00-
5116-00.
98 References:

Milde, Hellmuth and John Riley (1988). “Signalling in Credit Markets.” Quarterly
Journal of Economics, 102, 101-129.
Ministry of Agricultural and Food (1997). “Changes in the Romanian Agricultural and
Food Sector.” 1997 Annual Report, Bucharest.
Ministry of Agricultural and Food, European Union, and the World Bank (1997).
“Private Agriculture in Romania.” Unpublished manuscript.
Nabi, Ijaz (1989). “Investment in Segmented Capital Markets.” The Quarterly Journal of
Economics, 104 (3) 453-462.
Pagán, José A., and José A. Tijerina. (1997). “Increasing Wage Dispersion and the
Changes in Relative Employment and Wages in Mexico’s Urban Informal Sector:
1987-1993.” Ensayos y monografías #82 (noviembre), Unidad de Investigaciones
Económicas, Universidad de Puerto Rico, Recinto de Río Piedras.
Perez, Stephen (1998). “Testing for Credit Rationing: An Application of Disequilibrium
Econometrics.” Journal of Macroeconomics, 20 (4), 721-739.
Raturi, Mayank and Anand V. Swamy. (1998). “Explaining Ethnic Differentials in Credit
Markets Outcomes: Evidence from Zimbabwe.” Unpublished manuscript. The
World Bank and University of Maryland at College Park.
Sánchez, Susana M. and Arianna Legovini (1999). “Guatemala: Rural Financial
Markets.” Report No. 18853-GT, Finance Private Sector and Infrastructure,
Central America Country Management Unit, Washington, D.C.: The World Bank.
Sánchez, Susana M., Carlos Cuevas, and Rodrigo Chaves (April 10, 1998). El Salvador:
Rural Finance Performance, Issues and Options. Gray Cover Report No. 17689-
ES. Finance, Private Sector & Infrastructure, Central America Department, Latin
America and the Caribbean Region, The World Bank, Washington, D.C.
Schiantarelli, Fabio (1998). “Financial Factors, Investment, and Firm’s Performance:
Issues, Results, and Data Requirements.” Document prepared for the workshop
“Firm Analysis and Competitiveness Survey (FACS): December 14-15, 1998.”
The World Bank, Washington, D.C.
Schreiner, Mark (1996). “Discrimination in Installment Lending by Retailers of
Consumer Durables in Apartheid South Africa.” Unpublished manuscript.
Stiglitz, Joseph, and Andrew Weiss (1981). “Credit Rationing in Markets with Imperfect
Information.” American Economic Review. 71 (3), 393-410.
Tesliuc, Emil (1998). “Agricultural Finance: An Assessment of the Costs and Implicit
Transfers Associated with the Current System of Agriculture Finance.”
Tybout, James (1983) “Credit Rationing and Investment Behavior in a Developing
Country” The Review of Economics and Statistics, 65 (4), 598-607.
Vogel, Robert and Dale W. Adams (1996). “Rural Finance in Romania.” Unpublished
manuscript, IMCC, Washington, D.C.
Financial Markets, Credit Constraints, and Investment in Rural Romania 99

Von Pischke, J.D. (1991). Finance at the Frontier. Debt Capacity and the Role of Credit
in the Private Economy, EDI Development Studies, The World Bank,
Washington, D.C.
World Bank (1997). “Aide-Memoire”. The World Bank.
World Bank (forthcoming). “Romania: Country Economic Memorandum”, Europe and
Central Asia Region. Washington, D.C.
World Bank (1999). “Romania: Financial Sector Review.” Private and Financial Sector
Development Department, Europe and Central Asia Region. March 1999. The
World Bank: Washington, D.C.
World Bank (1999b). “Report and Recommendation of the President of the International
Bank for Reconstruction and Development to the Executive Directors on a Private
Sector Adjustment Loan in the Amount of US$300 million.” Report No. P7313-
RO.
World Bank and National Commission for Statistics (1999). “From Rural Poverty to
Rural Development.” July 1999. Unpublished manuscript.
World Bank (2000). “Making Transition Work for Everyone: Poverty and Inequality in
Europe and Central Asia.”
Yaron, Jacob, McDonald Benjamin, and Gerda L. Piprek (1997). “Rural Finance: Issues,
Design, and Best Practices.” Environmentally and Socially Sustainable
Development Studies and Monographs Series: No. 14.” The World Bank:
Washington, D.C.
Yaron, Jacob, McDonald Benjamin, and Stephanie Charitonenko (1998). “Promoting
Efficient Rural Financial Intermediation.” The World Bank Research Observer,
13, 147-70.
Yaron, Jacob (1992). “Successful Rural Finance Institutions.” Working Paper 150. The
World Bank, Washington, D.C.