SUSTAINABILITY OF RURAL FINANCE: PROBLEMS AND PROSPECTS

DAMYAN DIMITROV KIRECHEV

UNIVERSITY OF ECONOMICS – VARNA, VARNA, BULGARIA

DEPARTMENT OF AGRICULTURAL ECONOMICS

University of Economics - Varna, 77 Knyaz Boris I Blvd., 9002 Varna, Bulgaria

Phone: +359 899 825519, E-mail: dkirechev@abv.bg

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 Abstract

The inability of farmers households and enterprises to access capital on competitive

terms to undertake profitable investments, or take advantage of market opportunities, means

that incomes and growth are lower than they need be. Without market instruments to insure

against risk, farmers households and enterprises may even retreat from profitable projects for

which they have adequate liquidity.

Main objective of this study is to identify unique features of the agricultural sector and

the rural economy that present challenges formal of rural finance; to look at how these affect

the provision of sustainable rural financial services and, thus, determine the key elements of a

strategy for successful and sustainable rural and agricultural finance. Other goals are defined

as: to overcome the existing structural obstacles of financial markets for efficiency of

agricultural lending and utilization of improved financial technologies; to suggest a strategies

and recommendation to government policy for efficient and sustainable rural and agriculture

financial sector.

Key words: rural finance; micro financing; agricultural lending; sustainability.

Introduction

In today’s economic situation the main priorities in rural development are the establishment of

a competitive agricultural sector, conservation and environmental protection, promoting employment

and improving the quality of life in rural areas. The most important engine of the rural economy is

agriculture, and the diversification of economic activities through the creation of small enterprises, the

development of alternative agricultural activities are the main prerequisites for promoting

employment, increasing income, reducing poverty, and improving the infrastructure.

The development of rural financial markets significantly contributes to achieving economic

growth of businesses, increasing the income of the population and reducing poverty in rural areas. The

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effective provision of financial services allows for the flourishing of entrepreneurship, innovation and

production in rural areas. The improvement of the access to finance facilitates the introduction of

modern agricultural technologies and production models to improve the possibility of agriculture to

produce more goods and to avoid environmental degradation.

The main purpose of this article is by identifying certain characteristics of the agricultural

sector and rural economy and the current challenges facing rural finance, to find out what are the

impacts that will ensure the sustainability of rural finances and financial services, and to determine key

elements of the strategy for successful development of sustainable agricultural and rural finance. Other

objectives of the study are: to overcome the existing structural barriers and problems in the financial

markets to ensure the efficiency of agricultural credit and use to the same degree of technology

specific to financial markets; to offer views on the state policy in achieving effective and sustainable

rural finance and agricultural financial sector.

Characteristics of rural finance and challenges to its development.

Rural finance includes the full range of financial services offered and used by people in rural

areas, at all income levels. They are the specific element of the countries’ financial sector. These

include agricultural finance, aimed at providing funds for financing agriculture-related activities in

manufacturing, supply, distribution, trade and marketing of agricultural produce. Another key element

is the microfinancing, the provision of related financial services to people in rural areas, including

lending, savings and insurance services, etc. The modern concept of microfinance comprises also

economic and social aspects. It is seen as a tool to combat poverty and unemployment in rural areas, a

means of financing young entrepreneurs, a means to develop alternative activities and to build

sustainable enterprises in rural areas. Figure 1 is an attempt to illustrate the relationships involved in

the different concepts.

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 Financial sector
Rural finance

Agricultural Micro-
finances financing

Fig. 1. Relationship between different terms

Currently in many countries, including Bulgaria, it is very difficult to differentiate a clearly

defined and functioning financial market in rural areas. Higher transaction costs, uneven distribution

of the population, underdeveloped market and social infrastructure, risk factors inherent in agrarian

development hamper the provision of financial services in rural areas. Often financial services are

provided to households and industry in rural areas without taking into account their needs, capacities

and capabilities.

The difficult access of households and businesses in rural areas to capital at competitive terms

and the lower return on investment does not allow them to undertake profitable investments or to take

maximum advantage of market opportunities, leading to a reduction of revenue and growth

opportunities. Without market instruments to protect against risk, rural households and enterprises may

not even realize the potential projects, even if they are able to provide liquidity. Underdeveloped

financial services in rural areas lead to diminished opportunities for saving and borrowing, which

limits their liquidity and growth opportunities. In this sense, the expansion of the provision of financial

services to rural households and businesses can be a good opportunity for promoting growth and

reducing poverty in rural areas. Taking into account the fact that the rural population is poor, the

growing inequality between urban and rural communities and their market opportunities, the

deteriorating rural infrastructure, and the greater vulnerability of the population of the villages, it can

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be concluded that it is worth talking a more profound look at their problems, in order to stimulate

development and solve financial problems.

Common problems in rural finance development.

The effective functioning of rural finances requires clarification of their characteristics and the

related problems. Rural financial markets do not always function efficiently because of the high

production and price risk, the existence of asymmetric information between subjects and the high level

of transaction costs. Offering some tools, such as subsidizing part of the interest on agricultural loans

and the lack of proper understanding on the part of financial intermediaries of the characteristics of

rural financial markets, restrict the access of small and medium-sized companies and make them

undesired customers.

One of the primary reasons for the poor functioning of rural credit markets is the combination

of high levels of production and price risks and limited opportunities for mitigation. For example, by

assuming financial obligations farmers and small entrepreneurs become subject to constant change,

which can lead to unintentional non-compliance in relation to loans. In the lack of adequate tools to

reduce risk (eg through guarantees, insurance, futures, etc.) financial intermediaries are forced to

withdraw from rural areas or to develop a mechanism to solve their problems by other means (eg by

contracts allowing sharing of responsibilities or by providing loans to groups of farmers or

entrepreneurs). However, this may increase the cost of loan financing.

Another important reason for the underdevelopment of rural financial markets is the

asymmetric information. Asymmetric information occurs when the two contracting parties do not have

the same quality and quantity of information. The high cost of information as a resource in some cases

does not allow farmers and entrepreneurs to acquire it, and this is reflected in the valuation and risk

management. At the same time, very often in rural areas there is no background information of

economic entities receiving loans, which complicates the assessment of their loan capacity.

A third reason lies in the high transaction costs arising from the physical and institutional

environment. Rural areas are characterized by high levels of poverty, spatial fragmentation of

production, seasonality in the realization of income from economic activity, lower degree of legal

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enforcement of contracts, underdeveloped infrastructure, low levels of education and culture of the

population, etc. These features increase the transaction costs for both parties.

To some extent these common problems of rural finance indicate that financial intermediaries

are not so willing to be present in rural areas. This explains also the fact that even in a highly

competitive financial market, small farmers and entrepreneurs are less undesired as clients compared

to those with high incomes, large-scale activity, credit history, providing traditional collateral.

Specific issues in the development of rural finance.

The study of the development of rural finance allows to identify several problems with a

specific character, namely: there is limited access to short-term loans, there is market segmentation

and lack of competition, there is limited supply of medium and long term loans, a relatively limited

range of financial services is available.

The limited access to short-term loans can be explained by several factors, namely: low

profitability of many farming and other entrepreneurial activities carried out in rural areas; the fact that

land is not accepted as collateral in case of insufficient liquid assets; less developed and often costly

formal mechanisms for implementing agreements and commitments; lack of awareness of businesses,

etc. Rural businesses that do not generate sufficient reserves to cover their financial obligations are of

little interest to credit institutions. Low prices for agricultural products, along with deteriorating

infrastructure, low level of technical equipment and technology and higher marketing costs limit the

profit margin. The lower competitiveness of production (especially in agriculture) in international

markets and the insufficient subsidies to local farmers reduce the profitability of economic activity and

slow down the turnover of capital. Last but not least, the high costs of financial intermediaries to

gather information and credit history is a serious constraint affecting mostly small farmers and small

entrepreneurs.

The segmentation of the rural financial market includes most often a model whereby the

major financial institutions (banks, insurance and leasing companies) tend to serve well equipped

customers with a high degree of credibility, while intermediaries relying on informal connections

(some finance houses, credit cooperatives, etc.) target customers with lower incomes and fewer

opportunities for providing collateral. The lack of sufficient competition and the manifestation of less

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interest on the part of a specific group of intermediaries, especially as regards micro-loans, can lead to

the exercise of monopoly power, which can render the provided financial services significantly more

expensive. Thus, customers with the same demand for credit and the same risk profile can benefit from

different terms of financing, depending on their source of funds. Causes of such segmentation can be

found in the gaps in the legislation relating to lending activities, as well as in the limited opportunities

for introducing innovations in the sector.

The limited supply of medium and long term loans is slowing the economic development of

businesses in rural areas, particularly farmers. The cultivation of perennial crops, livestock,

construction of irrigation facilities and the purchase of technical equipment requires substantial

investment, long payback period, which increases the risk of credit institutions, especially in the

absence of appropriate tools for its management. This naturally leads to a decrease in the desire for

medium and long term lending. This fact is reinforced in times of economic crises and macroeconomic

instability associated with rising inflation and interest rates in the economy. Medium and large

producers and processors in rural areas have greater flexibility with regard to medium and long-term

credit financing, but most do not have opportunities to benefit from joint funding or bonding. At the

same time making long-term investments by small farmers and entrepreneurs is significantly narrower,

which prevents the introduction of new technologies, modernization of equipment and provision of

greater opportunities for profit. Thus the growth of the most popular forms of businesses in rural areas

is inhibited, which are expected to be a major generator of employment. It should be noted that

microfinancing can have a lower technological capabilities to solve the problem of offering long-term

loans mainly because of the lower fixed-term savings base. However, a consistent state policy on

agriculture and rural areas may to some extent overcome the problem of lower demand for long-term

financing. The implementation of plans for rural development and the investment of significant

resources from the Cohesion Funds of the European Union in recent years has shown that access to

long-term financing is expanding for a wide range of economic entities operating in rural areas. Banks

get greater collateral. Farmers and entrepreneurs have the opportunity apart from developing their

economic activities also to implement projects for the diversification of their activities, for the

environment preservation, for improvement of the quality of life, etc.

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 In rural areas there is limited supply of other financial services, including deposit operations,

insurance, leasing and other activities which hinders the ability of economic agents operating in them

to effectively manage risk and liquidity. Often customers from the villages are forced to use loans as

an expensive substitute for missing opportunities to use insurance or liquid savings. This results in

reduced welfare and restrictions in business development. The reasons for the insufficient

development of this type of financial instruments in rural areas can be found in the absence of legal,

institutional and economic conditions. Recent innovations in financial services are credit cards, loans

against pledge of securities, development of the lease system. Offering this innovative range of

financial services in rural areas, however, is limited because of the high costs associated with their

sale.

Prospects for development and sustainable rural finance

In order to improve the functioning of rural finance may recommend activities in three main

groups:

I. Implementation of policies aimed at creating a more conducive environment for rural

financial intermediation, including:

- Maintenance of prudent fiscal, monetary and trade policy reduces the macroeconomic and

sectoral risk for financial intermediaries and clients;

- Improving the profitability of rural activities through implementation of appropriate

sectoral policies, promote investment in rural infrastructure, improving social services;

- Limiting the legal impediments to the financial activity and performance of contract;

- Improving the quality and quantity of information and awareness of the rural population

through the expansion of information network and market information.

II. Increasing the retail capacities of financial intermediaries in rural areas by:

- Expansion of financial intermediation including pore participants – private commercial

banks, credit unions and cooperatives, insurance companies, government agencies and others;

- Strengthening the links between financial intermediaries.

III. Promoting the establishment and offering more financial services and innovation other

than credit, and improving the financial literacy of client, including:

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 - Development of the deposit instruments and services;

- Encouragement and development of trade credit between enterprises;

- Development of insurance and hedging instruments and increase the insurance culture of

the population and businesses in rural areas;

- Encouragement and development of the leasing services;

- Improvement of electronic customer services in rural areas.

Measures to achieve sustainability or rural finance, the place of their occurrence:

I. Public conditions and prerequisites for development of rural finance, including:

- Confidence of macroeconomic and social level;

- Make a reasonable production initiatives, and behavior of economic agents aim to

achieve sustainable performance over the long term the desire to take advantage of certain subsidies to

a point;

- Development of competitiveness of financial markets;

- Achievement confidence and trust in contracts and legal incentives about it.

II. Rural preconditions for sustainable rural finance:

- Achievement of profitability of production – sufficiency of the companies that operate in

rural areas;

- Development of integration processes, including partnership, cooperation, integration and

more – to reduce costs for farmers and entrepreneurs and to improve their access to credit;

- Achieve and maintain efficiency in resource and carrying costs;

- Implementation of adequate logistics system to manage stocks and transport links;

- Presence of sustained market demand.

III. Financial preconditions for sustainability of rural finance:

- Improving the geographical and spatial access to credit institutions;

- Expanding the information base for the risk;

- Adequacy and quality of activities related to the leasing;

- Better structuring of loans;

- Financial support to all economic agents that are connected by supply chain or network.

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REFERENCES

1. Agricultural Finance and Credit Infrastructure in Transition Economies , focus on the South East

Europe Region (2001), OECD

2. Boevsky, I., Importance of Microfinancing for the Struggle with Poverty and for the Development

of Rural Regions (2007), Economy and management of agriculture, Vol. 5, pp. 18-23.

3. Gozabie, G (2009). Sustainable rural finance: Prospects, challenges and implications, International

NGO Journal Vol. 4 (2), pp 012-026

4. Innovation in Rural and Agriculture Finance (2010), Focus 18, World Bank

5. Nikolov, D. E. Ivanova, Analysis of Non-Banking Microfinancial Services in Rural Areas (2007),

Economy and management of agriculture, Vol. 3, pp. 52-61.

6. Rural Finance Strategy (2001), Inter-American development Bank,

7. Rural Finance, Policy (2009), IFAD

8. Rural Financial Services, Implementing the bank strategy to reach the rural poor (2003), Report No

26030, The International Bank for Reconstruction and Development.

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