Rural Finance System

History of Rural Economy

Even in recent time, third world countries were believers in industry based development. This policy of
development benefited the urban dwellers relatively more because much of the industry grew up
infrastructure developed cities and their metropolises. This uninterrupted policy did cause prosperity in
rural areas as such rather the economic condition of the region was deteriorating gradually.

In such condition, the World Bank advised the third world countries to implement overall
development planning based on rural area. The World Bank gave strong advice on implementation
of overall development planning by coordinating various sectors of rural economy. This
development strategy is called as multi-sectoral rural development strategy. In the multi-sectoral
development strategy, production sector has been joined not only with service sector but also with
infrastructure development sector.

Production sector can be divided into poultry, livestock, fisheries, handicraft, small business etc.
besides crop production. Other than these, health, family planning, education, communication,
good provision of housing and entertainment may seem like to include in service sector for the time
being.

Actually in the final analysis, the development of all these sectors contributes greatly to the growth of
productivity of developing financial sector. Similarly, development of infrastructure for example roads
and highways, markets etc. in a planned way accelerates the development of production sector.

There is no doubt that the mentioned multi-sectoral development strategy will be able to improve the
economic condition of rural people. However, implementation of all these projects will require huge
amount of money which is impossible for rural people to supply. So, there requires invention of
successful organizations that shall have abundant deposits and high number of branches present
everywhere and above all of them shall be operated with clearly defined policy and strategy and by
keeping achievable goals in front and above all by favorable well-trained workforce.
Credit in Rural Economy
Without adequate capital investment is a dream to rural development. For any kind of economic
development planned capital investment is essential. Only capital investment is not the mean of rural
development, there must be need development of social infrastructure. But this infrastructure
development needs adequate investment. This investment may be private or public. From the experience
it is seen that in capital and mixed economies government spend necessary capital for development of
social infrastructure but for economic activities it spends less. On the other hand in social economy in
both the factor govt. spends all the necessary investment.
Generally govt. invests for rural infrastructure development by its financial budget. On the other hand in
this type of economy agriculture, industry, business etc, private investors invest by savings. Rural people
can collect money from three sources for economic activities. They are
1. Savings from past income
2. Sale revenue from present assets
3. Loan from other persons
Money collect from sale of assets do not bring additional money. Because is the transfer of resources
from on surplus family to other surplus family. It is a temporary action. For this reason to develop the
rural people and their life we need collection of deposit from rural, sub-town and town and invest this
deposit effectively and efficiently.

Necessary to collect money other than family source

In the third world country like Bangladesh inevitable fund is very limited. Because their income is low
that’s why savings is also low. To convert the ancient period agriculture method to modern method here
also need adequate investment example: machinery, hybrid seeds, more fertilizer, water, and insecticide
using we can more crop pre acre from before production. More than half of the landless people also live
in rural area, for upgrading their life it would be essential to popular them the cottage business and the
small business. To perform this we need adequate capital but here is also the short of capital.
Historically, Bangladeshi rural people suffering for necessary capital. There are only 5 to 10% people can
save. The remaining people depends on loan from others or sale of assets. Majority of the rural people are
living by borrowing money from others. So for the development of the rural people there need adequate
capital to upgrade the life of rural people

Rural Banking in Rural Development

Like other loan term the rural loan also the same. Here also one party gives loan to another party by
consuming less or sale of the assets. When one party need any asset or consumable think then other help
this family. This help can be monetary or non monetary. So which goods, money or technology not in the
hand of any rural people, they avail it with an agreement to back it is called the rural loan.

Essential Characteristics of Effective Rural Credit System

Properly planned and managed rural credit system can do well both for the lender and borrower.
Characteristics that are to be followed for the effective rural credit system are:
1) Credit in accordance with usage time should be comparatively long termed.
2) Credit cost of the lender and borrower should be comparatively minimum.
3) Adequate security must be ensured.
4) At the time of economic depression loan installment and other conditions of
repayment should be flexible on the basis of the borrower’s income and capacity.
5) Efficient and trained loan officers should maintain credit system.
Suggestions for effective and proper credit system
1) Rural credit system should be concerned with national policy.
2) Institutional rural credit must be proper alternative of non institutional rural credit.
3) Institutions engaged in rural credit must have adequate fund.
4) Loan officers of those institutions should be properly trained and cordial.
5) Not only the movable and immovable properties at present but also the assets or
goods that will be produced in future by using the loan should be considered as collateral.
6) Financial cooperation amongst rural villagers should be developed through the
system.
7) Proper monitoring must be ensured.
8) Institutions must be cautious about legal needs and interests of the borrowers.
9) Institutions involved with rural credit must be granting loan in a preplanned way
all areas, villagers (landless/marginal farmers, agricultural labor, small, medium, large
farmers, cottage industry labor and rural businessman) and economic sectors with
prefixed amount and speed.
10) Training related to motivation and change of mind setting should be given to the
employees of the institutions.
11) Risk should be minimized and for this rural credit insurance system should be
inaugurated.
12) In proper time loan application granting and disbursement should be done.
13) Granted loan amount should be sufficient for proposed work.
14) Loan repayment scheduled should be considered flexible for the villagers who are
very much lagging behind.
15) Importance should be posed on financial results of the purpose of the proposed
loan rather than collateral.
16) Training to the borrower about advantages of proper usage and timely repayment
 of loan should be given.
17) Concise application and less formalities, documents should be maintained for loan
granting.
18) Short and long term credit should be granted considering the loan applicant’s
current production cost and comparatively long term investment.
Demand and Supply of Rural Credit
It is necessary to have the similar knowledge about the demand and supply of rural credit as the other
goods demand and supply. The supply should be as per the demand. If the supply of rural credit is more
or less than the demand of rural credit then there would be a mismatch in the rural economy. So, it should
be the goal of the planned economy of balanced demand and supply of rural credit. The indicators of
demand and supply are discussed below:
Demand of Rural Credit
It should be aim of developing country to fulfill the demand and creating extra demand of rural credit.
The demand indicators are:
Consumers constructional power
Possibility of increasing the production
Production procedure
Crop/production mixture
Use of innovational power
Use of developed technology
Limit of machineries
Change of seasons
Required skills and labor expend
Loan expenditure
Collateral for the loan
The consumers behavior
Government’s behavior on providing loan in rural economy
The risk of using credit
Monitoring the uses of credit
The behavior and attitude of the credit granting institution’s employees
Position of developed market
Expand of infrastructure development
Receiving of raw materials in production
Difference between application for loan and time of receiving the loan
 Number of economical market and their position, capital and skill
Probability of getting subsidy from the government
Skill and training of the loan users
Determinants that have special impact on demand of rural credit
In case of growing crops
Duration of irrigation;
Area of cultivable land;
Nature of land fertility;
Nature of density of farming crop;
Potentiality of adopting associate profession;
Extent of promptness of government agriculture employee.
In case of cottage and handicraft industry
Quantity of Supply of entrepreneur;
Certainty of market for produced goods;
Condition of supply of skilled technicians;
Potentiality of export market for produced goods.
In case of cattle rearing
Quantity of entrepreneurs in cattle rearing;
Nature of demand of cattle and animal milk;
Nature of demand of cattle and animal meat;
Potentiality of gathering high-class cattle and animal assets etc.

Supply of Rural Credit

Supply of rural credit depend upon the following matters on the basis of economic activities or sources of
credit:
1) Attitude of government in developing financial condition of rural people;
2) The central bank’s attitude and organizational skill to provide the rural credit;
3) Government monetary and fiscal policy for rural economy;
4) Extent and quantity of institution or individual involved with supply of credit;
5) Credit policy and skillness of institutions in supplying credit;
6) Adequacy of fund of institutions involved with supply of credit;
7) Adequacy of collected rural deposit by the institutions of credit provider;
 8) Attitude/adequacy of refinancing by the central bank;
9) Disparity of cost for credit providing and operation of business;
10) Interest rate paid on credit;
11) Intensity of risk in providing loan;
12) Potentiality of rural savings for present and future;
13) Method of supplying raw materials, seeds, fertilizer, and other equipments to use credit;
14) Attitude of borrower for payment of loan;
15) Economic, political and social stability;
16) Limit of decentralization of power for providing credit in lower level
17) Training and attitude of employees engaged in institutions that provide loan.

Competency of Getting Loan of Rural Credit Seeker

It is a conventional technique of institutional loaner to justify the competency of getting credit. It is not
right that any individual or society will get loan against their application.
Loan is provided to those people who are abiding by the disciplines and regulations of credit
management. On the other hand non-organizational loaner also justify competency of loan seeker directly
or indirectly or explicitly or inexplicitly. But non-institutional loaner emphasis on security of recovery of
loan amount with interest. But institutional loan provider also considers the benefits of credit seeker
besides appropriate conditions.
It is worth mentioned that as commercial or industrial loan seeker are rich, educated and aware about
knowledge of business competency of getting loan of those people is measured tightly.
Measurement of credit competency of those people is very important as each of them apply for a lump
sum amount of loan which is equivalent to or more than one thousand rural credit applicant.
However, the factors considered in granting credit by the institutions that worked in rural area are as
follows:
i) Objective of loan
ii) Stability of loan applicant in rural area
iii) Competency and good reputation of loan applicant
iv) Capability of giving collateral for the loan amount that has applied for
v) Potentiality of financial benefits of loan applicant by using loan
Discussions of above points are given below:
i) Objective of loan /Purpose of the credit proposal:
In rural areas the credit institutions do not give loan for all purposes, especially for consumption
purpose. On the other hand, loans are not sanctioned for all financial transactions, such as loan for: loan
sanctioning to others with interest, speculation business etc. Bangladesh Bank or Head offices of that
institutions specify the purposes for which loan will be sanctioned (before loan sanctioning).
Example: Loan for cropping, poultry firm, cattle breeding, fisheries, handicrafts. Loan is not sanctioned
except for the above purposes, normally.
ii) Stability of loan applicant in rural area /Applicant’s performance in rural area:
Generally people who do not have houses, land property or business property do not
get loan. Applicants who are guests, beggars, travelers do not get loan.
iii) Competency and good reputation of loan applicant /Applicant’s reputation and usability of loan:
It must be ensured, that applicant is trustworthy and will use the loan properly,
through loan application or interview or from his/her neighbors.
iv) Capability of giving collateral for the loan amount that has applied for / Collateral:
This is wanted to ensure recovery of loan. Example of collateral: mortgage property,
valuable ornaments or personal guarantee of any powerful man.
v) Potentiality of financial benefits of loan applicant by using loan / Financial benefit
from loan usage:
How much net income will exist after meeting all the expenditures for the purpose for
which loan is wanted, should be examined. For landless and marginal farmers: how
long s/he will be engaged in work using the loan-is the consideration.
Mostly all rural credit institutions consider the above points. Moreover, cooperatives and many other
institutions look for the past repayment history

Difference between rural loan and agricultural loan

Rural loan is wider than the agricultural loan which they can use for any purposes. So rural loan can be 3
types and they are:
i. productive agriculture, small cottage and small business
ii. consumption of goods or any type of arrangement such as marriage purpose
iii. Infrastructure development such as road, school. Hospital mosque madrasha, culvert
On the other hand agricultural loan means for agricultural investment purpose investment in seeds,
fertilizer, machinery, insecticides etc. with a view to increase the production. The difference between
rural and agricultural loan is given below:
SL. Rural Loan Agricultural Loan
1. Rural loan is a wider term than the Agricultural loan is used only for agricultural
agricultural loan. Rural loan is used for purpose. Agricultural loan is used in animal
agricultural, industry and business, and husbandry, poultry, fishing, forestry etc.
social purpose etc.
 2. Rural loan can be used in land based or Agricultural loan is used land, pond and
non land based. poultry.
3. Rural loan can be disburse in any time ofAgricultural loan disbursed only in agricultural
the year season.
4. Mortgage can be land or any other property
Only land can be used as mortgage.
5. Landless or marginal farmer can be taken Landless or marginal farmers cannot take the
the rural loan. agricultural loan
6. Since the rural loan is disbursed all theSince agricultural loan is given on the seasonal
year that’s why the loan risk is low. basis the risk is high because of natural
calamities can be affected in agriculture.
7. Rural loan is not only used in small But by taking agricultural loan is take time to
business but also can be used in cottage income generating as a result the recovery of
industry as a result much income can be agricultural loan beginning lately.
generated.

In which persons or institutions give money to purchase the above things and collect that money with the
interest is called the bankers or Banks. For this which activities are taken by the bank is totally called the
rural banking. But interest collect is depending on the bank.
Industry VS Agriculture and Rural loan
The concept of agricultural and rural loan is much more new concept than the industry loan. Because the
importance of rural development is not heard by so many people before they heard the industry loan. Now
the difference among Industry vs. Rural and agricultural loan is given below:
SL Industry loan Agricultural Loan/rural loan
1. Industry loan is used only for the industry Rural loan is given for all the rural development
and based on the town and sub-town basis activities based only the rural basis.
2. Industry loan is given on long term basis This type of loan is given on medium and short
term basis.
3. Most of the loan amount is used for On the other hand this type of loan is used for
collecting machinery product. purchasing input.
4. This loan amount is relatively large and the Loan amount is relatively small but the
borrowers are comparatively few. borrower number is comparatively high.
5. This type of loan sanction is depending on This type of loan is disbursed all around the
the new entrepreneur come to this sector. year.
6. Interest rate is high Interest rate is relatively low.
7. Without sufficient collateral the loan amount Some of agricultural and rural loan is given
is not sanctioned. without collateral.
 8 Supplier of this type of loan is large financial The source of this type of loan is almost the
institutions. non-organizational institution.
9. The loan amount is determined by the The amount is determined by the money needed
capacity of the financial institution. of the borrower.
10. In case of industry loan there follow the In case of this type of loan the project appraisal
certain method, project appraisal and and valuation is not done.
valuation.
11. This type of loan is renewable. This type is not renewable.
12. Industry loan is given in domestic as well as Agricultural and rural loan is always given in
foreign currency domestic currency

The Market Makers/Intermediaries in Rural Financial Markets

Rural finance comprises formal and informal financial institutions, small and large, that provide small-
size financial services to the rural poor, as well as larger size financial services to agro-processing and
other small and medium rural enterprises.

Rural finance also covers a wide array of micro-finance institutions (MFIs), ranging from indigenous
rotating savings and credit associations and financial co-operatives to rural banks and agricultural
development banks.

Rural finance is a vital tool in poverty reduction and rural development. It plays a catalytic role in
bringing together the elements of production for increased output and improvement of the recipients'
resources and livelihood in rural areas.

Although the supply of finance to rural areas is limited now and there is a general imbalance between
supply and demand in rural capital markets at present, buyers and sellers of financial assets did exist in
rural economies in the past.

The market makers/intermediaries in rural financial markets are rural individuals, households, and farm
and non-farm enterprises. The market makers/intermediaries in rural financial markets are
Rural individuals, households, and
Farm and non-farm enterprises
Such classification of rural finance markets is based on the specific sources of funds, which vary widely
in organization, management, terms and conditions and lender-borrower relationships.
Rural Financial Strategy
The heterogeneity of the socio-economic status of the rural people and the diverse nature and scale of
their economic activities would imply that the demand for financial services by the rural people may not
be met by a unique financial institution or a uniform approach.
The institutional mix, the product variety and the operational approaches must be compatible with the
characteristics of different socio-economic categories if their demands for financial services are to be met
satisfactorily.
However, owing to high costs and risks associated with the early stages of rural financial market
development, private financial institutions are unlikely to voluntarily play a major role in this process.
Rural financial market development cannot therefore be left entirely to market forces, although the
ultimate objective is to develop a market-driven financial system. The government also has an important
role to play in the process.
A well-formulated rural financial market development strategy is required to ensure that rural financial
market development activities of different groups, particularly the potential small borrowers, government
agencies, private sector, NGOs and the donors are carried out within a coherent framework with clearly
defined objectives.
Rural Financial Markets
Broadly, three types of institutional models can be identified in the operation of rural financial markets:
i. Formal financial institutions including commercial banks,
ii. Specialized financial institutions;
iii. Semi-formal institutions including NGOs; and
iv. The traditional informal sources such as: friends and relatives, suppliers and moneylenders,
which fall outside the legal and regulatory banking framework.
Formal Financial Institutions
The banking system is probably the only model capable of offering both credit and savings services to
MEs because of its developed institutional structure and widespread branch network. The formal rural
financial institutions are dominated by public sector banks. However, their programmes have failed to
reach the majority of the rural people.
1. The institutional or formal sources of rural finance
The sources of funds in the formal part of rural finance markets are mainly:
(a) Co-operatives that meet the needs of short, medium and long-term credit;
(b) Commercial, cooperative and specialized banks;
 (c) micro-finance institutions (MFIs) and NGOs conducting micro-finance operations;
(d) Agro-product marketing associations; and
(e) Land mortgage banks, and various government agencies including those established for
agricultural development.
The operations of financial institutions in formal rural financial markets are typically heavily regulated,
and the nature and extent of formalities, as well as the interest rate structure, usually make access to credit
from this market restricted to limited segments of the rural population.
2. Semi-Formal Financial Institutions
There has been considerable interest around the world in bridging the formal sector banks with the semi-
formal sector NGOs exploiting the comparative advantages of each. The informal and semi-formal
sectors have a comparative advantage over the banks in lending small loans without collateral or in
"relending" to women and poor borrowers. NGOs mobilize savings from their members but not from non-
members which deny them access to large savers. They are therefore in a position to lend more than they
can mobilize as deposits. Creating a link between NGOs and banks therefore ensures the comparative
advantage of both sectors.
The ME schemes run by semi-formal institutions represent an arrangement which offers a link to the
formal banking system. At least three different linkage patterns can be seen in operation.
First is a model in which NGOs function as intermediaries, taking on themselves the resulting loan
losses. An example of this linkage is found in the IFAD-financed Oxbow Lakes Small Scale Fishermen
Project with BKB on lending funds through BRAC. The Bangladesh Bank provides IFAD funds to BKB
at 6% and the ultimate borrower paying 15%. The interest spread of 9% is shared by BKB (2%) and
BRAC (7%).
Under the second model, the bank lends directly to borrower groups. NGOs assist borrowers with
paperwork, analysis of proposals and so forth. They also "retail" loans from banks to beneficiaries, either
charging the borrower a fee or receiving a subsidy for this service from the government.
The third model operates with the NGO itself as a bank. Grameen Bank started as NGOs but now
operate as banks under special charters. Agha Khan
Foundation has recently proposed a rural development bank under the Agha Khan Rural Support
Programme.
There are several reasons for NGOs opting for banking charter. It would allow them
(a) To obtain refinance from the central banks on the same terms as the commercial banks,
(b) To mobilize deposits from non-members, and
(c) To utilize members' savings for loans to other members, on a sufficient legal basis.
3. Informal Sources
Informal finance includes a heterogeneous set of individual and group financial arrangements. Most fall
outside the scope of government support and regulation, although some countries have usury and other
laws intended to cover them.
Informal financial markets do exist in urban areas, but are more prominent in rural areas where
institutional sources of finance are either absent or insufficient to cater to the needs of funds of local
professionals of different categories.
Informal rural finance markets enable flow of funds and transfer of rural financial assets through
relatively localized transactions in money, and real goods and services among friends, relatives, kin-
members, landlords, neighbors, shopkeepers, farmers, artisans, itinerant traders, marketing intermediaries,
village mahajans (moneylenders), and other local income groups.
These sources are particularly important for business start-up capital. Moneylenders, pawnbrokers,
suppliers and traders are also important sources of credit because they are close to the borrower and offer
small sums of money mostly for short-term and immediate disbursement. The speed and ease of access to
these sources are cited as the reason for dealing with them despite higher interest rates. In addition, the
credit services of informal lenders are often linked to other services such as supplying raw materials or
finished products for sale or marketing.
The sources of informal rural finance in most developing countries include
(a) Professional moneylenders;
(b) Agricultural moneylenders;
(c) Commission agents;
(d) Relatives and friends,
(e) Different associations of rural professionals/self-help groups;
(f) Well-to-do rural people;
(g) Shop-keepers, and
(h) Marketing intermediaries and proprietors.
Contrary to formal rural finance, the informal segment of rural financial markets is not subject to
regulation.
The informal sector serves a smaller, segmented market with almost negligible transaction costs. The
personal nature of transactions alleviates informational problems that formal institutions face and the
threat of sanctions discourages default.
The drawback of informal credit, despite its usefulness for some purposes, is its high cost and lack of
dependability. The linkage with other services such as marketing frequently channels the benefits of
increased production to the moneylender.
Few informal sources provide savings facilities. Participation in these institutions does not link
microentrepreneurs directly to the mainstream banking institutions. Also the amount of credit available
from these sources is limited and generally for short-term. Microentrepreneurs with good prospects of
expansion must look elsewhere for larger, less costly and longer-term loans.
Attributes of informal finance
Meyer and Nagarajan (1992) list several attributes of informal finance:
1) Heterogeneity - informal finance includes a wide variety of institutional forms and a variety of
financial contracts between savers and borrowers can be found within any one type. Informal financial
institutions are used almost exclusively to finance household consumption, investment or very small-scale
business enterprises (Fry, 1988). Informal finance offers both loans and savings, unlike supply-lending
finance institutions which often ignore savings. Many types of informal finance institutions also offer
marketing and other services.
2) Specialisation - some informal financial arrangement serves a broad clientele, but information
problems often encourage specialisation. For example, money keepers, moneylenders and trade lenders
often provide only one type of financial service that is limited to those clients of whom the supplier has
good information.
3) Collateral - very few loans involve collateral. However, in the extreme end collateral substitutes are
used to enforce repayment in the informal credit market (Esguerra & Meyer, 1992). The informal
financial sector has developed effective collateral substitutes through interlinked contracts, peer
monitoring and group lending (Meyer & Nagarajan, 1992). Other forms of collateral substitutes used in
some developing countries include -:
•third party guarantees ("sureties") where the loan is given on the strength of a guarantee provided by a
third person, usually someone with the means to pay the loan if the original borrower defaults,
•linked markets/contracts or tied contracts where the loan is given on the promise or agreement that
the lender will be the sole buyer of the produce at a mutually acceptable implicit interest rate. The
mortgaging of tenancy or cultivation rights which affords the mortgagee to derive actual and beneficial
use of the land which yields him returns over and above the earnings derive from the principal, and
•threat of loss of future borrowing opportunities which for as long as it represents a credible threat is
an effective means to keep the integrity of the loan contract (Llanto, 1990).
4) Interest rates - money lenders have often been criticised for charging exploitative interest rates on
loans, but at the other edge of the scale, some other types of informal lenders, such as friends and
relatives, often charge no interest at all. Fry (1988) pointed out that informal finance is characterised by
higher lending rates than formal finance. However, non interest costs of borrowing from the banks are
often substantial (e.g. transaction costs), whereas they are virtually nonexistent in informal financial
markets.
5) Relatively low transaction cost to savers and borrowers because of close proximity; a minimum of
formal procedures (Meyer & Nagarajan, 1992); better knowledge concerning their clients (and thus, lower
risk) on the part of lenders, and thus the minimum information costs; no regulation of interest rates and
therefore an ability to adjust fully to market forces;
6) Reserve requirements - Informal finance is not subject to the reserve requirements that are imposed
on formal institutions (Fry, 1988).
7) Deposits mobilization - Informal lenders have not been able to mobilize financial deposits on a large
scale because their deposit facilities are inadequate, unsafe, untrustworthy, or less remunerative (Von
Pischke et al, 1983). The informal credit market is fragmented, imperfect and isolated (Desai, 1976).

Rural financial markets in Bangladesh:

History: Formal financing through institutional sources evolved in Bengal during the British period. The
Hindustan Bank was established in Calcutta in 1700. The Bengal Bank, established in 1784, is considered
to be the first British-patronised modern bank in India to start trading in credit and money. The 14
prominent banks operating in Bengal during the British period were located in Dhaka, In addition to these
bank offices, 17 loan offices were established which operated throughout the Bangladesh region between
1850 and 1894. These loan offices extended their lending activity to the rural areas and gave short,
medium and long-term credits. Provincial co-operative banks were established in 1912 under the Co-
operative Society Act that was passed and enacted in the same year. The Bengal Co-operative Societies
Act 1940 was enacted to allow the formation of co-operative societies.
Following the Partition in 1947, Pakistan inherited a banking and credit structure from the British regime
consisting of 631 bank offices belonging to both local and foreign banks. Of these offices, only 159 were
in rural areas. The State Bank of Pakistan, the central bank of the country, came into being in 1948 and
attempted to strengthen the country's credit system through setting up new branches of commercial banks
and other types of credit institutions in rural areas. In addition to the progress achieved in commercial
banking, other credit institutions had also been established to satisfy the need for medium and long-term
credits for rural trade, agriculture, industry, and housing . Among credit institutions, the Agricultural
Development Bank of Pakistan had its branches in the rural areas of both the provinces.
Bangladesh on independence inherited a weak banking system. Then Bangladesh had 12 banks1, with 130
branches altogether. Between 1971 and 1976, Bangladesh Krishi Bank (formerly the Agricultural
Development Bank) and the co-operatives were the two institutions that were meeting the need of
agricultural credit. To increase the flow of credit for agriculture, the government inducted the NCBs in the
field of agricultural credit in 1976 under a new programme called Special Agricultural Credit Programme
(SACP) which was designed to cater to all seasonal crop loans. Rural branches of NCBs are now engaged
in agricultural credit.
The 968 branches of Bangladesh Krishi Bank (BKB) and 357 branches of Rajshahi Krishi Unnayan
Bank (RKUB) are engaged in providing agricultural credit.
Other major institutions providing rural finance in Bangladesh are: Bangladesh Samabaya Bank Ltd
(BSBL), the apex institution of all central cooperative societies, co-operative land mortgage banks, central
sugarcane growers associations and thana co-operative societies. Any of the above societies can be a
member of the Samabaya Bank Ltd, Despite the significant increase
in the amount of total agricultural credit in the country during the last two and a half decades, NCBs,
BKB and the RKUB together cater to only 50% of the total agricultural credit at present. The rest is being
provided by the informal money market. A Lead Bank Scheme is in operation for co-ordinated
distribution of agricultural credit throughout the country. Under this scheme, each of the branches of
NCBs, and BKB was allocated one or more of the Unions for servicing agricultural credit so that the
NCBs, together with BKB and RKUB, could cover the entire country. For each financial year, the central
bank of the country (Bangladesh Bank) formulates and promulgates the agricultural credit policy
according to which banks and other institutions operate their agricultural credit-giving activities.
Moreover, the recovery rate of agricultural credit in the country is now only around 42%, which is a
heavy barrier to its expansion.
The NGOs operating in the country with microcredit programmes also constitute a major group of formal
institutions providing rural finance. They work with the rural poor who are largely bypassed by the
banking system and other credit-giving agencies. But Rural finance is just one of the many important
intervention variables. Its impact is fully felt only when conducive policies are in place, markets are
functioning, and non-formal services are available. The very poor, ie, those without income may be more
effectively reached through direct micro-enterprise promotion, income transfer, safety nets and improved
infrastructure.
The state-owned banks have been playing leading role in rural finance. Meanwhile, all scheduled banks
including private and foreign banks operating in Bangladesh have been brought under the agricultural
credit scheme. The government has simplified the Agricultural Credit Distribution Policy and in many
cases the scheme is being implemented through some NGOs including BRAC under a linkage
programme. The involvement of banks in poverty alleviation programme through micro-credit scheme
has increased significantly.
Beside the banks, the government managed Palli Karma Sahayak Foundation' (PKSF) and NGOs have
been playing a significant role in alleviating poverty through micro-credit scheme.
Thus, the rural financial markets in Bangladesh comprises are as follows:
1. Rural branches of nationalized commercial banks,
ii. Rural branches of Private banks,
iv. Cooperative banks and societies and
v. Specialized banks such as the Bangladesh Krishi Bank and the Rajshahi Krishi Unnayan
Bank (RAKUB)
vi. Government institutions and programmes such as:
a. Bangladesh Rural Development Board (BRDB),
b. Bangladesh Small and Cottage Industries Corporation, (BSCIC),
c. ntegrated Rural Development Programme (IRDP), and
d. Swanirvar Bangladesh Programme,
e. Non-government organizations (NGO)
f. Traditional institutions like local moneylenders and friends and relatives also
contribute significantly as sources of informal rural finance in the country.

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THE STATE OF RURAL FINANCIAL MARKETS

This section briefly reviews the current state of rural financial markets. It discusses the extent and
structure of rural financial markets (RFM) in Bangladesh and the existence and nature of unmet demand
for financial services by rural households. It complements existing data and knowledge with findings
from a survey conducted as part of this study. The primary purpose of the survey was to address a
number of empirical issues relating to the performance and efficiency of formal and informal
RFMs, to increase our understanding of their behavior.

A. Market Structure
2.3 RFMs in Bangladesh can be technically classified into three sectors: formal, semi-formal and
informal. The formal sector includes regulated financial institutions. The semi-formal sector includes
micro-credit institutions and programs, mostly organized by non-governmental organizations (NGOs) and
some by government organizations (GOs), e.g., Swanirwar. The informal sector includes private
transactions falling outside the regulated banking framework. Informal sources include moneylenders,
traders and dealers in agricultural markets, shopkeepers, landlords, friends and relatives.

2.4 The formal sector comprises of the public sector banks, specifically two agricultural banks (AGBs)
and rural branches of three nationalized commercial banks (NCBs); the largely member owned Grameen
Bank (GB)6; two cooperative networks (COOPs) and, to a very limited extent, private banks.7 The
Grameen Bank began as the Grameen Project, an NGO, in 1976 and was formally established as a bank
with a special charter in 1983. It is administratively autonomous and uses the group lending model
developed under the Grameen Project and now used by most NGO's in Bangladesh. Thus, operationally
GB resembles the semi-formal sector, but technically and legally it is a formal bank.

2.5 The RFM participants are broadly classified into three categories: public sector institutions (PSI,
including AGBs, NCBs, and COOPs); member based institutions (MBIs), including GB and the
semiformal institutions; and informal intermediaries (IFI). This is done to reflect the functional and
operational characteristics of the intermediaries for analytical purposes.

Market share: Past studies have documented the domination of the informal sector in rural
Bangladesh (see, e.g., Maloney and Ahmad, 1988, and Murshid and Rahman, 1990). In the early-mid
80's, the share of IFIs was estimated at two-thirds of total rural credit and the share the MBIs was
estimated at below 4% (Rural Credit Survey, 1987; Rahman, 1992). Aggregate data suggest that the role
of MBIs has changed significantly since. In 1993-94, MBIs advanced at least Tk. 1660 crores (with GB
alone advancing Tk. 1240 crores).i On the other hand, the PSIs advanced Tk. 1100 crores as "agricultural
credit" and Th. 11 crores under their various poverty alleviation programs.
2.7 Results from the survey carried out for this study (hereafter referred to as the survey) generally
conform to this picture with the exception of the role of MBIs: 44% of households had borrowed in the
past two years (of the sample of 1044); of these, 56% had borrowed from IFIs, 44% from PSIs and 10%
from MBIs.9 There appears to be little overlap among sectors with only 8% borrowing simultaneously
from public and informal sectors, and 1.7% from both informal markets and member-based institutions. It
should be reiterated that the sample was restricted to close proximity to a bank branch. Hence, the shares
of MBIs and IFIs are likely to be underestimates. The data confirm this; even within the sample at hand,
the PSI share falls and IFI share rises with the distance of sample households from bank branches.

2.8 Outreach: Total rural households are estimated at 16.26 million. Total PSI "agricultural loans"
outstanding at the end of FY95 were 7.7 million. A rough estimate of annual loans is obtained using data
from the two agricultural banks who made about 578,000 new loans in FY94. Assuming identical loan
size for NCBs, total loans by PSIs for FY94 is estimated at 863,000.10 Thus, assuming one loan per
household, this suggests a little over 5% of rural households are currently being serviced annually, despite
the large number of rural branches of PSIs.
2.9 The performance of MBIs is much better. At the end of 1994, GB had over 2 million members,
with 1.86 million borrowers, 95% of whom were women. There are no comparable statistics for the
semiformal sector; individually, BRAC has over 1 million members and the participating organizations
(107 in 1995) of the Palli Karma Sahayak Foundation (PKSF) have another 1.5 million. A vast majority
of these too are women. The numbers of MBI borrowers at the end of 1994 is estimated to be at least 4.9
million. Again, assuming one borrower per household, this suggests that MBIs reached over 25% of all
households.

2.10 Distribution: A majority of the (survey) landless borrowers obtained finance from IFIs (69%),
while PSIs and MBIs each extended loans to 19%. At the other extreme, 89% of households with over 0.5
acre obtained loans from PSIs and 26% from IFIs. Among the small and marginal farmers (0.5-2.5 acres),
IFIs provided the majority of loans (57%), but PSIs provided loans to 49% of the borrowers. Across
occupational groups, PSIs financed a major share only for big businesses and salaried households. The
pattem among farmers is the same as with land holding classes but the proportion of small and marginal
farmers borrowing from PSIs falls to 42%. Thus, subject to the sample selection caveat, the data show
that the PSI bias against the landless continues, but the disparity among other groups appears to have
narrowed. IFIs still dominate the RFM.

2.11 Deposit Mobilization: The total (rural and urban) deposits by PSIs increased 3 times (Tk. 103.9
billion to Tk. 309 billion) between 1986 and 1994. Of this, 10% originated in the "agriculture and
fisheries" sector (Bangladesh Bank, 1994). Data from the two AGBs show a four fold increase in deposits
(Tk. 4.3 billion to Tk. 17.1 billion) between 1986 and 1994. In contrast, member deposits of Grameen
Bank increased 47 times (from Tk. 0.19 billion to Tk. 9 billion) over the same period.

Public Sector Institutions

2.13 Two specialized agricultural banks, Bangladesh Krishi Bank (BKB) and Rajshahi Krishi Unnayan
Bank (RAKUB), three nationalized commercial banks (Sonali, Janata and Agrani), and the cooperative
networks, the traditional cooperatives under the Registrar of Cooperative Societies (financed by
Bangladesh Sambaya Bank Ltd., BSBL) and the two-tier (Comilla model) cooperatives under Bangladesh
Rural Development Board (BRDB) (financed by Sonali Bank), comprise the public sector."2 Of the 5762
total bank branches (as of March 31, 1994), over two-thirds are located in rural areas. This large rural
presence of PSIs is a result of the rapid expansion of the banking sector under the Special Agricultural
Credit Program started in 1977. 13
2.14 Deposits originating in the rural sector were Tk. 6863 crores, or 22% of total (private sector)
deposits of PSIs, while the outstanding advances were Tk. 5459 crores, or 19% of the national aggregate
on March 31, 1994 (Bangladesh Bank, 1994). The deposits originating in the agriculture and fishing
sector was Tk. 2388 crores (or 10% of the total). In contrast, for FY94 disbursement of agricultural credit
was Tk. 1100 crores and agricultural GDP was Tk. 31,494 crores, about 30% of the national GDP.
2.15 After years of stagnation, disbursements have increased over the past five years reaching Tk. 1480
crores in FY95 (see Appendix Table 1).14 Of this, over 47% was for crop loans (Appendix Table 2). The
AGBs (BKB and RAKUB) dominate, contributing about 65% of the total disbursements to the sector.15
Lending by BSBL cooperatives continues to be negligible, while BRDB cooperatives' share went up to
4.4% of total disbursements in FY95 after several years of a virtual standstill.

Member based Institutions

A rapidly growing segment of RFMs in Bangladesh are the member based institutions. The largest
MBI is the Grameen Bank (GB), the only formal institution of its type. All others are NGOs, biggest
amongst them being BRAC, ASA and Proshika.26 Credit Development Forum (CDF)27 estimates over
1000 NGOs offer credit services. Most MBIs, including the GB, have an explicit social agenda to cater to
the poorest sections of the non-agricultural population, with women making up a majority of their
clientele.
2.30 A major institutional innovation in Bangladesh is the Palli Karma Sahayak Foundation (PKSF).
The foundation is an autonomous institution that lends funds to credit MBIs for on-lending. Established
and funded by GOB, the foundation's policy has been gradual expansion and capacity building of its
Partner Organizations (PO). It seeks to encourage innovation and to learn from and diffuse knowledge
through a program of evaluation and research. It has a strict set of criteria that POs need to satisfy to be
eligible to borrow funds and it closely monitors their financial and accounting practices.29 In the past,
however, PKSF has concentrated on lending and monitoring activity and has paid relatively less attention
to capacity building or financial development of new or currently ineligible POs.
2.35 The group methodology for crop lending is also being developed by the Grameen Krishi
Foundation (GKF), a spin-off of Grameen Bank. The project aims to provide credit and non-credit
services to agricultural producers. It provides credit in kind and collects repayments in kind. GKF also
stands ready to buy the entire crop, providing an important marketing service, and provides extension
services to farmers, especially for the new and diversified crops that it actively promotes. The project is
bold and innovative, but it is too early to assess its sustainability as it is still evolving and needs to be
refined. The recovery rates so far have reportedly been around 100% indicating initial success in using the
group methodology for crop lending, but the project continues to incur losses (largely due to the non-
profitable deep tubewell operations it inherited).
The Informal sector
2.36 The informal sector continues to be the main source of credit for a majority of the population and a
lender of the last resort for many. Households without access to, or those rationed (totally or partially) by
other lenders, turn to informal sources to borrow. IFIs are widely perceived to function efficiently, with
low defaults and low transaction costs. Personalized transactions alleviate information problems (for
screening and monitoring borrowers); geographical proximity makes lenders more accessible; flexibility
in terms and conditions allows customizing loans to borrowers' needs; and the threat of monetary and
social sanctions creates strong dis-incentives to default.
Also contrary to popular opinion, informal markets are not dominated by unscrupulous moneylenders.
Past studies have shown that a majority of transactions are among friends and relatives at
zero or nominal interest rates. Survey data confirm this: 55% of IFI transactions, uniformly distributed by
loan sizes, were reported at zero interest rates.36 Loan sources were diversified with a majority of loans
fromneighbors (37%), relatives (16%), and friends (26%). Although there were no reported transactions
with 'professional moneylenders' per se, with 59% of loans from neighbors, 30% from friends and 27%
from relatives carrying positive interest rates, there appears to be substantial moneylending activity. The
average interest rate was 48% per year, increasing to 106% for interest bearing loans. Interest free loans
reflect the existence of social safety nets based on reciprocity and hence entail a future cost (i.e., future
income opportunities).
A potentially important source of credit are traders and dealers, as in non-agricultural rural
industries( generallya s supplier-cum-buyear rrangements). In agriculture, dadon (or forward sale) has
traditionally financed paddy and jute marketing, and continues to finance over half of the transactions in
upper levels of marketing chains for foodgrains. At the retail level, this interlinkage is now almost
nonexistent in advanced areas, although it still prevails in the more backward and remote areas (Hashemi,
1988; Sen, 1988; Crow and Murshid, 1994). In general, given the advantages of trade credit in reducing
transactionc osts and in diffusingr isk, with increasingc ommercializationo f agriculture,t rade credit was
expected to increase (e.g, as in the case of India and the Phillipines, see Ghate, 1992). One problem
appears to be access to finance by itinerant traders who in tum are unable to finance farmers (Chowdhury,
1994).

B. Demand for Financial Services

2.45 For policy purposes it is important to establish if there exists any unmet demand for financial
services; for appropriate policy design, it is crucial to identify the nature of the demand. In a low income,
low productivity and high risk environment, the basic financial services most demanded are savings
facilities, investible resources and insurance against uncertainty (i.e., natural, business and personal
risks).Policy makers have traditionally been pre-disposed to believe the only demand that exists is for
credit.
However, there is sufficient evidence available to show that the demand for other services, particularly
deposit facilities, is often greater but is rarely recognized.
2.46 There is significant evidence showing that rural households in all income classes can and do save
non-trivial amounts (see, e.g., Maloney and Ahmad, 1988, on Bangladesh, and Adams and Fitchett, 1992,
for other countries). Survey results indicate that on average households save over 22% of their incomes.
Although not all households are able to save (27% were deficit households), a large proportion of the
population does so in various forms. These alternative forms are often inefficient as they incur significant
transaction costs and risk capital losses. Over the past decade, the success of MBIs in raising deposits
from assetless households demonstrates the thrift that the poor are capable of.38 This potential for deposit
mobilization, however, remains largely unexploited.
2.47 There are currently no risk or insurance markets in rural areas of Bangladesh and their absence
continues to be a major market failure. Self insurance via savings can substitute for the absence of
contingent markets; however, risk aversion will continue to entail productivity cost unless the income and
consumption of households can be perfectly smoothed. Social networks at the local and familial level are
able to provide a limited safety net, although they are unable to overcome covariant shocks. For reasons
discussed later, this issue has not been addressed in this study.
2.48 The importance of savings services and insurance notwithstanding, a more direct way of
influencing productivity growth is timely access to resources for investment. The primary concem,
therefore, is whether the lack of access to credit is constraining growth. Rigorous estimation of credit
constraints is beyond the scope of this study. Identification problems, self-selection and non-price
rationing make it difficult to establish whether the problem is due to the lack of effective demand or
whether there is insufficient supply. Direct elicitation is also problematic in a non-competitive
environment (with distorted interest rates, non-price rationing and a non-credible threat of enforcement)
making it difficult to distinguish between legitimate demand and a demand for grants.
2.49 In principle, potential demand for loans depends simultaneously on the existence of profitable
investment opportunities and on the willingness to borrow at a given price. It is informative, therefore, to
look at indirect evidence on available opportunities, the pattem of past investment and the revealed
willingness to borrow by rural households which might suggest possible constraints.
2.50 Evidence shows that the role of RFMs in financing productive investment in Bangladesh has been
limited thus far. Given the strategic importance of minor irrigation, the financing of irrigation equipment
is a case in point. The 'engine' of growth of the late 1980's was the rapid spread of shallow tube wells
(STWs). There is strong evidence showing that this was largely equity-financed, with the contribution of
both PSIs and IFIs being conspicuously low. 3 9 The 1991 Census of Lift Irrigation revealed that banks
financed 13.8% of then existing equipment, mostly in the early part of the 80's (AST-MOA, 1991). Over
80% were financed from own resources (including relatives and disinvestment of other assets).

3. ISSUES IN IMPROVING RURAL FINANCIAL MARKETS

3.1 The RFMs in Bangladesh are inefficient and incomplete.
The PSIs have limited outreach and their persistent arrears are clearly unsustainable.
MBIs have been successful in reaching the poor, but they offer a limited range of financials services
making them ineffective for intermediation. Their services are targeted at a specific segment of the rural
population and a vast majority of MBIs are critically dependent on grants or subsidized funds. The
informal sector, while providing much needed credit in areas untouched by the other two sectors, remains
segmented( and hence inefficient and non-competitive) and is also constrained by limited resources.

3.2 To improve their functioning, it is essential to address the issues in areas of strategic importance
for the future development of RFMs. Accordingly the purpose of this part of the report is to analyze the
issues impeding the efficiency and expansion of financial services in rural areas

3.3 The first aspect relates to the central role of the banking sector in a financial system. By virtue of
its economies of scale, the potential to mobilize resources with appropriate prudential oversight and to
intermediate and pool risks over geographical areas, the banking sector constitutes the backbone of the
financial infrastructure. At present, only public sector banks operate in the rural areas.

3.4 The second aspect is the lack of access to credit, especially by the rural poor. Even established
NGOs are unable to secure loans against their reputation or accounts receivable. A number of seemingly
innocuous legal, regulatory and institutional barriers in framework for secured transactions significantly
affects the efficiency of rural financial markets and restricts the flow of funds to rural areas. They limit
private sector participation by significantly increasing the costs and risks associated with financial
contracts, and prevent the participation of otherwise creditworthy borrowers with little real estate to offer
as collateral.

3.5 The third aspect is the effective delivery of credit and savings services to the rural poor, reflecting
a systemic failure to intermediate efficiently. The RFMs are currently fragmented with the formal,
semiformal and informal sectors operating in isolation. Given the comparative advantages of each sector
in the process of financial intermediation it seems prudent to integrate the three segments to allow the
system as a whole to intermediate. In the short run, this would provide an effective mechanism to reach
small borrowers including the small and marginal farmers, and in the long run, it would promote the
provision of financial services on a commercial basis.
3.6 The problems and issues associated with each of the three aspects are discussed in the three
following sub-sections. The first section analyzes the issues concerning the formal sector institutions. It
focuses on agricultural banks -- BKB and RAKUB -- to identify issues related to public sector banks, and
briefly discusses issues concerning agricultural cooperatives. The second section discusses the problems
with the current framework for secured transactions. Finally, the third section addresses the issues of
linking formal sector banks with semi-formal and informal sector intermediaries.

A. Problems with Formal Rural Financial Institutions

3.7 This section focuses on the problems facing PSIs and COOPs. The discussion does not include the
Grameen Bank as it has been well studied (see Khandker, et. al., 1995) and does not warrant further
examination. Within PSIs, the first part of the analysis is based on a diagnostic review of Bangladesh
Krishi Bank (BKB) and Rajshahi Krishi Unnayan Bank (RAKUB). Resource constraints and lack of
detailed information on the rural-urban breakdown of the operations prevented a similar analysis of the
Nationalized Commercial Banks (NCBs). In general, the problems facing the NCBs rural portfolios are
similar in nature but probably more severe in magnitude. 45 Nevertheless, the agricultural banks are
presuned to be representative of the sector. Their problems are symptomatic and illustrate the issues quite
well. The second part of the analysis deals with COOPs.
Agricultural Banks
3.8 In general, (non-specialized) public commercial banks are able to lower their operational costs, and
hence raise profitability, because of their urban and industrial operations. In Bangladesh, however, the
AGBs are found to be 'technically' more efficient than NCBs in rural credit operations while the NCBs are
more efficient in deposit mobilization (Khalily, et. al., 1994). These comparative advantages reflect the
better perfonmance of BKB in loan recovery (although RAKUB's perfornance has been worse) while
NCBs have generated more deposits, even in rural areas.
3.9 BKB and RAKUB have not been affected by the financial sector reforms underway since 1990.6
Both have nevertheless classified their loan portfolios according to the latest Bangladesh Bank (BB)
guidelines. Most issues covered by the reforms are equally relevant to the rural financial sector. Important
among these are: removal of interest rate restrictions; replacement of refinance facilities (still open to
AGBs and COOPs) with a re-discount window as for other banks; strengthening the monitoring and
supervisory capabilities of BB to deal with both the banking and non-bank rural financial institutions; and
expediting legal reforms for loan recovery, especially strengthening and extension of the court system in
rural areas. These issues are well understood and are not elaborated upon further.
3.10 To put the analysis in perspective, financial services provided by BKB and RAKUB are discussed
first, followed by an analysis of their performance and a discussion of the main issues.

Financial Services: Trends and Composition

3.11 Credit trends: Annual disbursement by BKB, in nominal terms, stagnated from FY86 through
FY93 (fluctuating around Tk. 4 billion), and has since increased sharply to Tk. 7.6 b in FY95. RAKUB's
lending similarly fluctuated around Tk. 0.4 b though FY91, increasing sharply to Tk. 1.9 b in FY95. Both
experienced declines in FY90 and FY91 due to mounting overdues, tighter lending criteria and funding
constraints. Despite recent growth, disbursements in FY94 as a proportion of total assets averaged only
22% for BKB and 7% for RAKUB. They fell short of loan collections representing a withdrawal of funds
from the rural economy in FY87, FY88 & FY90-93.
3.12 BKB's average loan size has increased almost 50% to Tk. 15,120 between FY87 to FY94 and
RAKUB's almost doubled to Tk. 8,200, partly due to higher per acre norms. BKB's borrowers went up
from 372,000 to 407,000 between FY87 to FY94 and RAKUB's from 100,000 to 170,000 between FY88
to FY94. Both experienced a sharp decline in FY91 caused by GOB's loan waiver program.
3.13 Borrower mix: The majority of recorded loans are for less than Tk. 10,000 targeted at small
farmers (for FY94, these constituted 81 % by number and 29% by volume of lending for BKB and 79%
by number and 53% by volume for RAKUB). Banks' statistics also suggest that the programs are targeted
on small farmers with 71% by number and 31% by volume of loans by BKB and 61% by number and
53% by volume of loans by RAKUB going to households owning less than 2.5 acres.4
3.14 Although relatively better recoveries may have contributed to the increased concentration in
shortterm loans, pressure to meet disbursement targets and expectations of loan forgiveness appear to be
the major factors. As for targeting, bank staff could not confirm this to be the true picture. Apparently,
recorded land holdings do not constitute total land holdings of borrowers.
3.15 Quality: For FY94, the outstanding loan portfolio was 83% and 80% of the total assets of BKB
and RAKUB, respectively; arrears amounted to 48% and 54% of total assets (57% and 57% of total loan
portfolios), respectively, reflecting very poor loan recovery. Total loan recoveries were 27% and 16% for
BKB and RAKUB at the end of FY94, although current recoveries of 78% and 71%, respectively,
indicate significant improvement since FY93. About 78% and 77% of the arrears, and 48% and 51% of
total outstanding loans, are over 3 years old for the two banks, respectively, reflecting past practices.
3.16 The recent improvement is a result of concerted efforts, especially by BKB, to improve recovery.
Significant among these is an incentive scheme for staff to meet recovery targets. Although interest
remissions and waivers have marginally helped recovery in particular years, they have had adverse effects
in later years by creating expectations for further remissions. Political loan forgiveness programs have
been most damaging, while lack of political will and ineffective legal enforcement have prevented the
banks from pursuing defaulters. For FY94, only 1.9% of total overdues (by volume) were filed as
certificate cases; of these less than 5% have been disposed off and less than 9% of the amount recovered.
About 42% of the cases have been pending from four to ten years.
3.17 Diversification: Portfolio diversification has declined for both BKB and RAKUB over time with
concentration in short-term loans (76% and 84%, respectively, of lending in FY94), particularly for crop
production (27% and 74% of lending by BKB and RAKUB, respectively) 49. Medium-term loans for
draught cattle constituted 7.6% of total FY94 lending for both banks and long-tern loans for irrigation
equipment went down to 1.1% for BKB and 0.6% for RAKUB. These trends reflect past experience;
bothbanks have been particularly vulnerable to defaults in lending for these purposes as is evident from
the dominant share of these loans in overdues (39% for BKB and 53% for RAKUB).
3.18 The unsatisfactory past experience with diversification, particularly for agro-industry and
medium/long tern loans, has made the banks reluctant to diversify. As a result, the current portfolios have
become excessively risky, and both banks face significant potential losses due to covariant fluctuations in
specific sub-sectors (crop production for RAKUB, and crop and tea production for BKB). Geographically
localized, RAKUB is especially susceptible to exogenous fluctuations.
3.19 The problems underlying previous experience, however, continue unaddressed. These include,
pressure to meet pre-determined disbursement targets, low quality of appraisal, underfinancing and
untimely provision of loans, poor monitoring, inexperience in lending for different activities, unskilled
staff and external influences in loan decisions.
3.20 Resource mobilization: Both banks currently face a severe liquidity crisis. Poor recoveries and
inadequate deposit mobilization are the major contributory factors. Their main sources of funds are BB
refinance (35% for BKB and 28% for RAKUB in FY94), loan recoveries (42% and 41%) and equity
(15% and 14%). The dependence of both banks on BB has increased over time, with refinance accounting
for 45% of BKB's and 71% of RAKUB's disbursements for FY94. Deposits provide only 5% and 6% of
funding, respectively. Although total deposits have increased over the past four years at a seemingly good
annual average rate of 20% and 24% for BKB and RAKUB, respectively, about 50% of the increase is
reported to be due to interest accumulation in savings accounts. Fixed deposits accounted for 64% of total
deposits of BKB in FY94 which has raised its average cost of funds.'°
3.21 Both banks lack a consistent funding strategy, reflecting their orientation as 'lending institutions'.
Although BKB has taken steps recently to expand deposit mobilization through its staff incentive scheme,
these efforts are ad hoc in the absence of a coherent medium or long term financial plan for sustainable
growth. The institutional objectives prevent these banks from behaving and operating as financial
institutions; consequently there is little incentive to reduce reliance on BB refinance by improving deposit
mobilization or to substantially increase lendable equity resources.

Performance Evaluation

3.22 Performance has been assessed by two measures: outreach and sustainability. Three indicators are
used to measure outreach: market expansion in terns of number of clients in relation to total rural
population; market penetration to find out the proportion of small farmers reached; and market
diversification to see the diversity of services provided by the banks. Sustainability is assessed as both the
financial and economic viability of these institutions.
3.23 To evaluate the performance of BKB and RAKUB, where possible the analysis is supported by a
comparison with two successful rural banks - Bank for Agriculture and Agricultural Cooperatives
(BAAC) of Thailand and Bank Rakayat Indonesia (BRI) Unit Desa System (see Box 1 for a brief
descriptive background on BRI and BAAC).

3.24 Market Expansion: In terms of number of loanees reached, BKB and RAKUB have perfonned
very poorly, covering less than 1% of farming households. They have failed to reach a significant
proportion of their target population despite the heavy losses they have incurred over the years due to
subsidized interest rates and high arrears. BAAC (77%) and BRI (34%) demonstrate a significant level of
outreach. These impressive figures are reinforced by their low arrears (9% and 5.4%, respectively)
compared to 57% for BKB and 66% for RAKUB. The continuing growth of BRI's borrowers
demonstrates the willingness of its clients to pay high real interest rates (23%) for access to the high
quality service.
3.26 Market Penetration: In the absence of other direct measures, market penetration is best
demonstrated by considering indirect indicators such as average loan size. The average size of loans by
BKB (US$486) and RAKKUB(U S$538) is less than others (BRI - US$494 and BAAC - US$829), but
overall compares reasonably well. The smaller loan size of BKB and RAKUB is partly the result of
giving short-term loans without collateral to farmners with land holdings less than 2.5 and partly due to
the lower loan ceiling imposed by funding constraints. Field observations, however, indicate that a large
proportion of the clients of BKB and RAKUB are well-to-do farmers (with more than 2.5 acres).
3.27 Since the country circumstances differ widely, a comparison is made between the average loan size
with GNP per capita in that country. The ratio for BKB (221%) and RAKUB (245%) is much larger than
BAAC (39%) and BRI (67%) suggesting that BKB and RAKUB tend to serve a narrower segment of the
population, not reaching households at the lower end of the income distribution.

3.28 Market Diversification: BRI has the most diversified loan portfolio and savings services. BAAC
is diversified in terms of funding sources but its loan portfolio is concentrated in agriculture. RAKUB is
restricted to Rajshahi division and geographic concentration is unavoidable. Like BKB, it has chosen to
concentrate current lending for crop production, while BKB also has a high concentration in tea loans.
BKB and RAKUB have most of their deposits in fixed term and a minor proportion in demand balances
and are heavily dependent on the central bank for funds.
3.29 A bank's behavior is largely determined by the objectives enshrined in its charter. BKB and
RAKUB are mandated to provide credit for agriculture and for the development of cottage and other
allied industries. BAAC is authorized to provide financial assistance to agricultural producers while BRI
is to provide credit and savings facilities for rural small income activities.

3.30 Financial Performance: An adequate level of profit is needed to provide an appropriate return to
shareholders; to reassure depositors that business is sound and competently managed; and to maintain and
expand its capital base to satisfy prudential criteria and facilitate growth. The adequacy of earnings is
measured by two indicators: operating ratio, i.e., operating income as a ratio of operating costs including
provision for loan losses; and return on assets, i.e., the ratio of net profit after tax to average total
assets.52
3.31 Both BKB and RAKUB have incurred losses each year since FY92, the year they started to
classifv and provision for their portfolios under the new system. Current losses are estimated at 4.0% and
4.9% of their average total assets, respectively. BRI (1.8%) and BAAC (0.96%), on the other hand, are
generating a positive return on their assets.

Critical Issues

3.41. Both BKB and RAKUB are unsustainable and have failed to deliver adequate financial services,
both qualitatively and quantitatively. The analysis above identifies a number of problems, resolving
which requires squarely addressing critical issues affecting performance of these banks.

3.42 Sustainability: Adequate interest margins, control of arrears and reducing administrative costs are
key to sustainability. The banks have little control on interest margins as they face interest ceilings. High
and effective interest rates are the most important variable for the success of rural finance institutions.
Loan recoveries are hampered by frequent and blanket loan forgiveness programs, pressure to meet
disbursement targets, ineffective legal framework to enforce repayments and inadequate incentives for
prompt repayment. Administrative costs can be traced to inappropriate technologies for lending and
deposit mobilization and organizational and structural inefficiency.

3.43 Governance: Owned by GOB, the AGBs fall under the administrative control of the Ministry of
Finance. As financial institutions, they come under the supervision of BB. The autonomy and discretion
of the banks is severely curtailed by formal and informal government interference. Thus, despite the poor
financial condition of the banks, GOB continues to use them as conduits for political and social transfers.
The predominance of official representatives on the Board of Directors discourages commercial
orientation, with development objectives over-riding efficiency and viability. The present condition of the
banks reveals the weakness and inability of BB to supervise and control the rural banking operations.

3.44 Institutional culture: Although established as banks, the mission of BKB and RAKUB is
perceived to be disbursement of subsidized agricultural loans rather than to function as autonomous
financial institutions. Managing Directors (MD) have historically been selected from among senior civil
servants, with the only (recent) exception of the current MD of BKB, who is a professional banker.
Financial viability has often been compromised in favor of socio-political objectives. In line with civil
service norms, the MDs are also frequently transferred severely affecting policy and management
stability.
The bureaucratic set up of the institutions has created the perception that financial services, primarily
credit, are an entitlement and that the borrowers are "beneficiaries". This identity crisis propagates the
treatment of loans as grants amongst borrowers. The inability, or more accurately, the unwillingness to
pursue repayment has reinforced this perception.
3.45 Management systems: Strategic planning is non-existent, with business and financial plans
projected on an annual basis. Budgeting is also on an annual basis making it difficult to moritor
performnanceo n a quarterly or semi-annual basis to identify emerging problems. Information flows of
basic financial ratios lack consistency, accuracy and timeliness making control functions difficult and
limiting management's ability to identify critical areas and take timely action.
3.46 Incentive structures: The bureaucratization of the institutions has created adverse incentives,
both for the institution and staff. There is little incentive for managers or staff to pay attention to branch
viability or portfolio quality without accountability for performance and effect on their compensation or
tenure. BKB and RAKUB have recently introduced an incentive scheme based on established targets for
disbursement, recovery and deposit mobilization. The scheme is a good start and has already yielded
positive results. Its design needs to be re-evaluated, however, to focus on full recovery and savings
mobilization. 56
3.47 Range of services and products: The banks offer a very limited range of products and services
using technology that has failed to work in the past. They are also mandated by their charter to restrict
lending to agricultural activities and cottage and allied industries. Both are currently over-exposed to risks
in particular sectors, especially crop production. The banks also offer very limited savings services, while
it is well demonstrated that more people demand savings services than loans.
3.48 Human resource management: The rapid expansion of the late 70s and early 80s has left an
overstaffed and poorly trained bureaucracy. The recruitment freeze has for several years prevented fresh
ideas and blood to come into the banks. Banking is a highly competitive service industry and depends on
highly qualified and motivated personnel. The civil service pay scales, promotion policies and
qualification requirements are inappropriate for bank sevice.

B: Constraints on Access to Credit: The Framework for Secured Transactions

3.55 Access to credit is one of the key constraints in rural finance. Farmers and rural entrepreneurs
appear to have projccts with high rates of return, yet they are either unable to obtain finance, or when they
do, the loan sizes thcy arc offered or interest rates they face make otherwise attractive investments
unprofitable. The GOB has unsuccessfully tried to stimulate these investmcnt opportunities by lowering
the pricc of credit. The PSis have failed to reach the small borrower.
3.56 The fundamental problems in RFMs are information and the inability to enforce contracts. A
lender often has little or no knowledge about the borrower. Faced with uncertainty about the borrower's
intcnt to repay, and without an cffectivc mcchanism to recover the loan, commercial transactions are
forced to be conducted strictly on non-credit basis. Buyers thus have to rely on own savings or loans from
friends and relatives. Solc rcliance on internal financing severely limits economic activity, especially
lumpy investmcnts. Onc rcsponsc to these problems has been group lending that has succeeded in
effectively reaching thosc with few assets. A majority, however, have to rely on reciprocal arrangements
or on limited sources of a segmented informal market to meet their financing needs.
3.57 The rolc of trade and supplier's credit has remained minor in Bangladesh, and may in fact be
declining. Private rural lending remains largely in the hands of those who are able to enforce repaymnents
through social pressure. These agents have not succeeded in linking with banks, with non-bank lenders
(e.g., finance and leasing companies), or with non-financial creditors (e.g., equipment and input
suppliers).
Nor have such financial intermediaries established themselves in rural areas. Bangladesh's NGO solidarity
group lenders have achieved world renown. Yet, on the one hand, even their operations in rural areas are
limited and they are rcluctant to fund larger investments needed by many farms and rural businesses. On
the othcr, they have difficulty in obtaining refinance from formal banks. On net, the situation in rural
Bangladesh is that many high return projects remain unfunded.
3.58 This section discusscs the legal, regulatory, and institutional problems that contribute to the high
cost and limited loan sizes confronting the small borrower in Bangladesh. It discusses options that would
pcrmit expandcd access to crcdit by the poor and help NGOs to lower their costs and expand their
financing base. The suggested changes would provide a framework in which private lenders and sellers-
oncredit could profitably expand their rural operations, and provide conditions under which even state
operated lenders would be able to collect their loans were they inclined to do so.

Problems In Laws And Regulations

3.59 Several features of the Bangladeshi legal and regulatory system limit access to credit in rural areas.
The principal difficulty is the inability to use collateral for loans. Rural borrowers have limited ability to
provide a mortgage on their land that would satisfy a private lender. The borrower's have no effective
ability to use movable property -- equipment, supplies, livestock - as collateral.
3.60 Consequently, private lending in rural areas depends entirely on non-collateral enforcement systems
-- how well the lender knows the borrower and how likely the lender perceives the borrower as being
willing and able to repay. These information and monitoring costs are high; the result, compared with
collateral based systems, is smaller loans and higher interest rates. 3.61 For movable property, the
primary problem arises from a defective framework for secured transactions. This makes it difficult for
private lenders to make loans secured by movable property – for equipment, supplies, and livestock.
These same defects limit non-financial creditors who might provide supplemental financing through
natural conduits of rural credit, especially dealers and suppliers of farm inputs. It further makes it difficult
for non-financial creditors themselves to get access to credit from the formal financial sector. These same
defects limit the ability of NGO lenders to refinance their portfolios of loans with private formal sector
lenders.
3.62 These defects arise from: gaps and problems in the laws, which often fail to cover important
financial transactions; from problems in enforcing laws, that arise from long delays in the courts and
difficulties in obtaining official assistance in enforcing court judgments; and finally from problems in
institutions, such as registries, which work slowly and expensively and, therefore, discourage many types
of lending that require registration. These problems arise in three areas:
Creation of security interests: many economically important types of security interests -- types
of loans against movable property -- cannot easily be created in Bangladesh.
Perfection: the key action of publicizing the existence of loan contracts to make them safer for
lenders could be simplified, made less expensive, and more secure.
Enforcement: the process of seizing and selling the collateral that backs the security interest is
slow, expensive, and unpredictable; it relies on court procedures and government actions that
cannot be depended on to produce timely results.
3.63 For real estate, the problems arise from difficulties in registration systems that make mortgages
riskier than they should be; slow court procedures make it expensive to repossess and sell mortgaged
property; and the impact of the law's homestead provisions (discussed below). For example, although
taking "charges" on real estate or movable property are heavily regulated by statutes, the associated
risks are high. This is due to the technical inadequacy of land registries. Multiple agencies can issue
certificates making it difficult to establish if the title is good or whether there exist prior charges against
the property (Bhuiya, 1994).
3.64 Many other legal and regulatory issues also raise the cost of supplying rural credit, limit loan sizes
and access to credit. Of these, the most important are: homestead and exempt property provisions prevent
small holders, preeminently the poor, from using their holdings as collateral or purchasing equipment on
credit. Usury laws drive informal lenders underground, so that rural borrowers fail to get the benefit of
competition or proper regulation of lending practices. The age of majority of 18 makes it impossible for a
large number of married poor and heads of households under that age to sign lawful contracts to borrow."

Problems In Institutions

3.65 Besides the legal system, certain institutional features limit access to credit in rural Bangladesh.
3.66 Legal registries are expensive to search, they are not sufficiently open to public access, and are
technically weak. This makes it expensive to register security interests in small real estate holdings,
movable property, accounts receivable and chattel paper. Such registration is essential to open channels of
credit to rural borrowers. Where land holdings are small and of low value, these costs make registration of
mortgages prohibitively expensive and drive the poor out of the credit market. It often takes over a year
for a Land Registry Office to register a transfer or conveyance of property. It becomes difficult, therefore,
to prove title even though the purchaser has registered the sale. These delays lead to problems where the
purchaser wants to mortgage his property by depositing title deeds.
3.67 Credit reporting systems are just starting for large industrial bank loans. In general, lenders have
no system for basing credit decisions on past repayment performance of borrowers. Hence, borrowers
who are unknown outside their area, especially the poor, have no way to gain access to credit by
publicizing a strong repayment record. For agricultural credit, the banks have a pass-book system, but
with inefficient information sharing among banks it fails to be an effective signaling system. Non-bank
lenders and creditsellers have no access to even this rudimentary system.

ANOTHER PDF -
RURAL FINANCE & DEVEOPMENT
’… poverty is not the result of rapacious financiers exploiting the poor. It has much more to do with the
lack of financial institutions, with the absence of banks, not their presence. Only when borrowers have
access to efficient credit networks can they escape from the clutches of loan sharks, and only when savers
can deposit their money in reliable banks can it be channelled from the idle to the industrious or from the
rich to the poor.’
Source: Ferguson (2009) p. 13.
Do you agree with the statement above?

Finance and individual livelihoods

In the past, people trying to understand the problem of poverty used to think mainly in terms of income
and consumption. Poverty was measured by a lack of income or food, which could be resolved by raising
their income through getting better jobs, or through increasing the amount of food available. While this
idea of poverty is not exactly wrong, it does not capture the much more complex reality of the lives of
poor people. Efforts to help people out of poverty have to take this complexity into account, otherwise
they risk failing to address their underlying problems.
The idea of a livelihood, which comes from an old English word meaning ‘a means of keeping alive’
captures the complex reality of poor peoples’ lives more than just a job, or an income. For example, in
reality, many people, and most poor people, do not make a living through a single source of income – or
‘livelihood strategy’. They may produce some of their own food or other things that they consume, and
they almost always rely on multiple sources of income at any one time. The reasons why the poor are
poor, and why they stay poor, are much more complicated than a lack of jobs. We need to understand the
constraints they face in getting and keep jobs or other sources of income. We also need to understand
issues of vulnerability; poverty is not just about lack of income, it is about unpredictability of income and
lack of assets (both material and social) to fall back on.
The idea of sustainable livelihoods was developed in the early 1990s in an effort to capture all of this
complexity, and is now widely used in understanding and formulating responses to poverty in developing
countries. We talk about sustainable livelihoods to capture the importance of a livelihood being one that
can sustain itself in the long term, even in the face of shocks, and that does not compromise the access of
others in the world, or of future generations to the resources they will need to survive.
This comprehensive definition of a sustainable livelihood was developed in a seminal paper on the
subject:
‘A livelihood comprises the capabilities, assets (stores, resources, claims and access) and activities
required for a means of living: a livelihood is sustainable which can cope with and recover from stress
and shocks, maintain or enhance its capabilities and assets, and provide sustainable livelihoods
opportunities for the next generation; and which contributes net benefits to other livelihoods at the local
and global levels and in the short and long term’ Source: Chambers and Conway (1991) p. 6.

Livelihood vulnerability and financial services

Many better-off ‘modern’ people have only one means of living. This is their job, or a business that they
own and manage. It is fairly unusual for one person to have more than one significant livelihood.
Think about yourself, for instance; do you earn significant amounts of money, or other benefits, from
more than one source? Do you intend in the future to do so, to diversify your sources of income, or do
you envisage that you will progress from one job to another, within the same institution or in different
ones, and that increases in your total income will come from higher earnings from your principal activity,
or livelihood?
Now think about the household to which you belong. Do all its members depend on one earner, perhaps
you, for their livelihoods, or do different members of the household have different livelihoods, whose
earnings or other benefits are (partially or fully) pooled for their common good?

Using the table below, make a note of your household’s approximate total annual income, insofar as you
know it. Include income in cash or in kind (such as the value of free or low-cost housing, or health
benefits, or other non-cash remuneration). How many different sources are there which account for 10%
or more of the total? If there is more than one income in the household, make a separate column for each
of them.
Look again at the figures and rank them high (H), medium (M) or low (L) in the ‘vulnerability’ column
according to their vulnerability. By this we mean how secure are the various incomes? How likely is each
income stream to disappear or to be substantially reduced?
Make a very rough estimate in per cent of the likelihood of each income source being eliminated (50%
meaning there is a 50:50 chance of it being lost in a given year, 10% meaning that there is a one in ten
chance, and so on), and multiply this by the income to get the corrected income in the last column. (A
completed example is shown below but be sure to use or estimate your own figures).

Now consider what sources of ‘fallback’ funds you or the main breadwinner have. This means where you
could raise cash if you need it unexpectedly; say if someone in your family got sick, a storm damaged the
roof of your house, or your car was damaged in an accident. Fallback funds might also be needed for
happier reasons; your daughter might announce that she has met her ideal partner and wants you to pay
for her impending wedding. So think about ways in which you can pay for such things. Do you have
insurance? Items you could sell to raise money? Pension funds? Support from other family members?
What have you learned from this exercise about the ways in which financial services can help us
manage our livelihoods?
We all need access to financial services at different times in our lives. Even those of us who have
relatively secure sources of income cannot be entirely sure that they will last into the future, and
unexpected expenses, or ‘shocks’, can happen to anyone. Financial services are absolutely key to
enabling us to manage uncertainties and shocks, even if we sometimes have to compromise on the value
of the funds we have available.

1.3 Market failures; information asymmetries and transaction costs

In an ideal world, banks and other providers of financial services would emerge wherever the need arose
to provide those services, and those financial services would be so efficient that everyone who needed
services would get them when they needed them. People who wanted to save their money would be able
to open a savings account, people who wanted to take a loan would be able to take credit, and people who
wanted to insure themselves would find an insurance product that would address their particular risk.
Free market theorists believe that in a perfectly functioning free market, where a service is in demand, the
supply will arise to meet it. According to this theory, the balance between savings and loans will be
maintained through the use of interest rates. The theory goes as follows:
 When there are more opportunities for productive investments in an economy, there will be a higher
demand for credit, as people look for money to start businesses.
 In order to raise funds to lend to potential borrowers, banks will raise interest rates to encourage more
people to save (they will save more because they will get more profit on the money they save).
 As the banks will be paying more to savers, they will need to charge higher interest rates on the loans
that they give, to cover the costs of the interest paid to savers, their administrative costs, and their profits.
Borrowers will be willing to pay these higher rates for loans because they can use the money productively
to earn enough profit to cover their costs, make a profit for themselves and pay back the loan with
interest.
 In case demand for goods and services in the economy goes down, and there are less opportunities for
investment, so banks will lower interest rates, which means that people will still be able to borrow money
and start businesses, even though their expected profits are not as high.

Market failures
In practice, letting banks set their own policies, including setting interest rates, does not always produce
desirable results. If the market is left to itself, many people do not get access to the financial services that
they could benefit from; most often it is the poor, particularly the rural poor, who have the least access of
all. One of the reasons for this is that the connection between interest rates and savings is not as clear as it
might seem. Increased interest rates do not always lead to higher savings rates. Savings are not
determined simply by the profit that can be earned; they also depend on how much income someone has.
Higher interest rates may, in some cases, lead to lower savings rates as people can reach their target
savings goal more quickly. Also, with the development of other types of financial intermediaries,
particularly insurance companies, people may choose to save less if they know they are protected against
future risks (Pagano 1993). We cannot assume, therefore, that financial markets can ‘self-regulate’ to
maximum efficiency through adjusting interest rates.
There is another even more important reason why financial markets, left to themselves, will not
necessarily result in the most efficient allocation of resources. This is because of what are known as
market failures. Market failures refer to situations when the market alone does not produce the most
efficient outcome.
Market failures arise for a number of reasons. These include, among others:
 when there is not perfect competition (which of course is much of the time)
 when human beings do not behave as purely rational agents seeking to maximise their interests (which
also, of course, happens much of the time)
 when there are externalities. This means when there is a cost to something that nobody pays for, such
as keeping the air free of pollution or the roads well maintained
 when there are high levels of risk
 when there are high transaction costs
 when there are what are known as information asymmetries
The most significant reasons for financial services not being provided to everyone who could make use of
them are the interrelated problems of information asymmetries and high transaction costs.
Information asymmetries refer to the fact that, in the real world, information does not flow smoothly.
Some people have access to information that others do not. In the case of financial services, this means
that those providing the financial service do not always know as much as they would like to know about
the person to whom they are providing the service. When lending money it is important to know
something about the person borrowing, to make sure that they spend the money in such a way that they
will be able to repay the loan, and to keep track of them and make sure they don’t run away without
repaying. Because of this, they do not provide financial services to everyone that needs them. That is,
even though they might have enough funds at their disposal, they choose not to disburse them to potential
borrowers whom they don’t know enough about, especially when it is too expensive to get the
information they need. Thus we have credit rationing, even without any government intervention (Stiglitz
and Weiss 1981).
The two most important results of asymmetric information relevant to financial services are known as
moral hazard and adverse selection.
Moral hazard can arise when someone’s behaviour changes based on their access to financial services.
For example, a business person may make a riskier investment after taking a loan with a high interest rate
(to try to get a higher rate of profit and so repay the loan more easily). So, in this case, high interest rates
can cause risky behaviour. Another example is when a person who has taken out insurance against their
car being damaged will drive less carefully because they know they will not have to pay for it in case of
an accident. Those providing the financial services have to work out ways to prevent the users of the
service acting in this way. They may require other information about the clients that can reassure them
that they will not do risky things, they may require certain forms of assurance (for example, collateral for
loan takers, or a deductible for someone taking insurance) or they may simply decide not to lend to
certain clients about whom they are not confident.
Adverse selection refers to the fact that it is often people whose activities are particularly risky who take
high interest loans, or buy insurance. As it is not possible for lenders or providers of insurance to be sure
how risky their customers’ behaviour is, they have to use various mechanisms to screen potential
borrowers. These methods are inevitably imprecise, which means that some potentially sound customers
are rejected.
List one example each of moral hazard and adverse selection that you are familiar with. How might banks
or insurance providers try to reduce the likelihood of these particular things happening?
Answer
Moral hazard: a homeowner does not bother to install smoke detectors because they have insurance in
case their house burns down. The insurance provider can offer cheaper premiums to people who can
prove they have smoke detectors installed.
Adverse selection: a person who knows that early fatal heart attacks run in their family buys a life
insurance policy to ensure that their family will be financially secure in case of their death. An insurance
provider can require medical records and make those with illnesses running in the family pay higher
premiums.
In practice, it is often poorer and less-well-connected people who are not given the financial services, as
lenders or insurance providers will prefer to lend to or insure those who have more money to start with,
and those who can provide collateral. They also prefer to lend to those about whom they can easily collect
information. Often this means they lend to people who are ‘like them’ and so they feel they know better,
or those with whom they actually have personal connections. They ‘trust’ such people more and, in
financial service provision, when there are no formal systems in place to verify someone’s honesty, then
trust becomes central to any transaction.
Another reason why poor people, particularly the rural poor, might not be provided with financial services
is because they demand services on such a small scale, be those savings deposits or loans. It is more
difficult for those providing the services to make a profit on such small transactions, because each
transaction has an administrative cost. The rural poor often live in areas with poor transport and
communications infrastructure, where it is particularly expensive for both service providers and the poor
themselves to reach each other, and is also particularly difficult and expensive for financial service
providers to get the information they need about potential clients to provide them with services. These are
what are known as high transaction costs.
Given information asymmetries and high transaction costs, the best allocation of resources may only
come about through some type of government or other external intervention. Governments are responsible
for putting infrastructure in place that will reduce the transaction costs associated with providing services
in rural areas. Governments can also take risks that private lenders may not to ensure that everyone who
can make good use of financial services gets access to those services, or they can put regulations in place
that make sure the services are made available to those who need them.
Any type of government intervention is of course only as good as the government making that
intervention; while the private sector has its limitations, the track record of governments in providing the
appropriate interventions has not always been very good. The challenge in providing all those who need
them with financial services is to work out what type of intervention will help, rather than hinder, in the
goal of providing services both efficiently and equitably.
There are also important ways in which private financial service providers can adapt the way they provide
services and so reduce the problems of information asymmetries and high transaction costs. Increasingly,
innovative financial services providers are learning from, and building on, the traditional systems of
financial intermediation that exist in poor communities. This allows them to reduce information
asymmetries, so as to provide financial services to people previously not reached by formal providers.

2.0 FINANCE FOR THE POOR

Section Overview
In this section we will home in on the financial service needs of the poor. We will discuss the
characteristics of the livelihoods of the poor, and consider the ways in which they need to manage their
money to survive. We will begin to think about the systems that poor people already make use of, and
their strengths and weaknesses. Finally, in light of these considerations, we will define ‘rural finance’ as
we will examine it in the remainder of the module.

2.1 Understanding the livelihoods of the poor

We will now apply the same exercise that we did in Section 1.2, thinking about our own finances, to a
poor household, so that we can be clear about the particular challenges that poor people face.

Think of a typical poor household in a country with which you are familiar; as best you can, try to go
through the same exercise for its livelihood strategies. Choose either a rural or an urban household. Our
focus in this module is rural poverty, but if you are more familiar with urban poverty then use an urban
example for now; you will have many more opportunities in later units to think about rural livelihoods.
There are more similarities than differences between rural and urban poverty, and the function of this
exercise is to enable you to understand aspects of poverty that affect all poor people, wherever they live.
Now consider what sources of ‘fallback’ funds such a family might have, such as selling livestock, or
mortgaging or leasing out land, or getting or extending the duration of credit from the local shopkeeper or
moneylender, or getting an advance from a buyer of crops or from the landowner for a sharecropper, or
even ‘selling’ a family member’s labour in advance.
(a) Which household has the highest earnings?
(b) Which household has the most sources of income (ie the number of different sources each contributing
10%+ of total household income)?
(c) Which household loses the highest proportion of the value of its assets if they have to be realised at
short notice?
(d) Which household’s realised value from its assets is the highest multiple of its annual income?
Answer
(a) almost certainly your own household
(b) probably the poor household
(c) the poor household
(d) your own household’s
What are the implications of these conclusions for any attempts to improve poor households’
livelihoods?
Answer
– Poor households have more diverse sources of incomes or livelihood strategies.
– Poor households NEED more diverse sources of income, because each source is more vulnerable than
better-off people’s incomes.
– Having to juggle a range of income sources probably means not being able to specialise in any one of
them, so missing out on a chance to achieve higher returns to labour over time.
– Poor people need more protection from reductions in income, but generally have less protection, in that
they lose more if they have to sell assets to finance consumption.
How could access to financial services help the poor rural household that you used in your example
to protect themselves better from the risk of reductions in their income? What sort of financial
services would help them?
Answer
– savings: to build up savings over time to make use of in case of emergency
– credit: to take a loan when the need for cash arises, rather than having to sell a valuable asset
– insurance: to set up an insurance policy to cover, for example, health expenses in case of illness

2.2 How do the poor manage their money?

All people, regardless of where they live, their wealth or their livelihood, can benefit from a range of
financial services to enable them to manage their household finances in the most efficient way. Obviously
the types of financial services that will be most useful will vary from situation to situation, but generally
speaking poor people can benefit from being able to access funds to invest in productive or income-
earning activities, and to help them through times when their income is inadequate to meet their expenses,
be those daily expenses or larger one-off expenses.
According to Collins et al (2009), there are three different types of financial management that all people
need to take care of:
 Managing basics: cash-flow management to transform irregular income flows into a dependable
resource to meet daily needs. In economics terminology this is known as ‘consumption smoothing’;
ensuring that you are able to buy what you need to consume on a daily basis even if your income is
inadequate or irregular.
 Coping with risk: dealing with the emergencies that can derail families with little in reserve. These
types of emergencies are often described as ‘shocks’ to household economies.
 Raising lump sums: seizing opportunities and paying for big-ticket expenses by accumulating usefully
large sums of money. (Collins et al 2009 p. 18)
Although the details differ from place to place – for example, one study found that only 11% of the rural
poor in East Timor were in debt, compared with 96% in Pakistan (Bannerjee and Duflo 2007) – generally
speaking, the poor make use of a myriad of informal financial services, and even occasionally formal
financial services.
At the individual or household level, there are numerous ways in which poor people manage their
finances, planning so that they can meet their daily needs, be able to cope with any larger expenses,
unexpected or otherwise, and, hopefully, to invest in better livelihood options in the future, for their
children if not for themselves (for example, through education). Poor people save money at home, save in
kind, or purchase assets such as livestock or jewellery that can be sold in times of need. We often imagine
that poor people are simply too poor to save but, in fact, poor people have been found to save larger
percentages of their incomes than rich people. They save because they have to; their lives often depend
upon it.
There are also numerous informal financial systems in place through which poor people co-operate to
help each other manage their finances better; in ways that fit the more standard definition of financial
intermediation. Relatives, friends and neighbours frequently help each other out, sharing each other’s
financial resources – lending a little today on the understanding that they will be helped out when they
need something extra. Sometimes they spread the risk among a group. Informal savings and loans groups
of various kinds are commonly found in rural areas, groups that pool their funds and allocate them to
different members at different times, depending on how the system works.
We discussed above how efficient financial intermediation is limited by information asymmetries; the
fact that the people providing the service and the potential users of those services often do not know
enough about each other to risk entering into financial transactions with each other (lenders might not
trust clients to repay their loans, savers might not trust those taking deposits to keep their money safely).
The informal systems described here overcome the problems of information asymmetries and transactions
costs extremely effectively, as the transactions are between people who live close to each other, who
know each other well, and who know very well the nature of each other’s livelihood activities.
These communal methods of mutual support have been described as a ‘moral economy’, referring to the
responsibility people feel for and take for each other, even if it has a negative impact on their own
economic status. Helping a neighbour or relative out may, of course, also be seen as a self-interested
strategy, if that person will then help you in time of need.
Poor people also make use of individual informal financial service providers. These can range from
friends, relatives or neighbours who provide each other with fairly informal loans, with or without
interest, depending on the nature of the relationship. There are also people who specialise in providing
loans, be they specialised moneylenders, or shopkeepers, traders or landlords. These people are usually
able to provide larger loans than those available from friends or relatives, or through group-based
systems. There are also individuals who provide savings services, collecting regular deposits from clients
and keeping them safe until the client wants to access them. There is often a small charge for this service.
We usually think of the various financial services that can be made available as discrete products and
used for specific purposes, for example, taking a loan to invest in a business, saving up money for a
child’s wedding, or buying health insurance in case a family member falls ill. In practice, however, poor
people do not separate the way that they use financial services into neat categories. They may have forms
of insurance, but at the same time rely on loans or savings to help in times of need, and they may borrow
and save at the same time in order to come up with the money they need when they want it. Again, these
practices are not unique to poor people; most of us combine our use of financial services to meet our
needs; saving for one purpose (education perhaps) while taking a loan for another (buying a house), or
combining insurance payouts and savings to make up for losses (buying a new car).
Reflecting on your own knowledge and experience, what are some of the financial management
methods and informal services that the poor use?
Answer
You might have included the following in your list, and you may have thought of others that are not
included here. The point to take away from this is that the poor already have use of a myriad of financial
management methods and informal services even if they do not have access to formal service providers:
– saving money in the home
– purchasing assets such as livestock or jewellery
– saving and borrowing through informal mutual financial mechanisms such as savings clubs
– saving with individual savings collectors who come around and take deposits P528 Rural Finance Unit
– taking loans from family, from friends or neighbours, from local shopkeepers or moneylenders or other
people with whom they have some sort of relationship
– giving loans to friends or relatives; helping someone out but also a form of savings in itself, provided
the money is returned at some point. Giving loans to friends or relatives is a form of insurance; it may
mean that they can fall back on those people for help should the need arise
– investing accumulated savings with the local shopkeeper
Saving up and saving down
We tend to think of different forms of financial management as quite different from each other (savings
versus loans for example), but it is possible to think of most forms of financial management in terms of
savings. One of the benefits of doing this is that it emphasizes the common, overarching goal of
protecting basic consumption needs whilst responding to requirements for irregular sums of money,
whether planned (investments) or unplanned (shocks).
 Loans – a lump sum to be enjoyed now in exchange for a series of savings to be made in the future in
the form of repayment installments. We can think of this as ‘saving down’.
 Savings – creating a lump sum to be enjoyed at some point in the future, when the need arises, by
making a series of savings deposits now. We can think of this as ‘saving up’.
 Insurance– creating the possibility for a lump sum to be received at some unspecified time(s) in the
future, if needed as a result of a particular shock. This is done by making a series of savings deposits
regularly, both now and in the future. We can think of this as ‘saving through’, as the deposits continue
both before and after any claims.
 Pensions – creating a lump sum to be enjoyed in the distant future by making a series of savings
deposits now.
 Remittance transfer– enabling migrants to save money and send that money home, to be saved there
either in the form of cash or assets or to meet ongoing or emergency household expenses.

Limits to informal financial management systems

Although the informal financial services that poor people use are an essential component of their
livelihoods, they do have serious limits. They are limited in the amount of funds they have available and
they are usually only helpful for relatively small, short-term financial needs. The resources available from
family and friends are often not enough to cope with the many serious financial crises that poor people
find themselves in. However, the larger sums of money that may be available from moneylenders are
usually very expensive.
While poor people are able to save much more than is commonly thought, the fact that they are poor
means that they only have access to limited resources. It also means that there is only so much they can
do to help each other out, even when they are affected by shocks at different times. Mutual support
systems thus tend to benefit the better off proportionately more; poorer people are likely to have less
reliable support networks and thus tend to be hit harder when problems strike.
Access to financial services that enable the poor to manage their finances without having to rely on
insecure or expensive forms of saving, asset sales, and unreliable loans can enable poor people to
maintain a more stable and secure flow of income, and build up assets in the future.

2.3 Livelihoods and finance in rural areas

Think about a ‘typical’ rural poor person. What sort of person are you thinking of? When you
think of how the rural poor make a living, what first comes to your mind?
Answer
The first thought that might have come to your mind was of a farmer, someone who lives off the land. Or,
depending on where you live or where you have worked, you might have thought of a poor landless
person, working as a wage labourer on someone else’s land. Or you might have thought of a pastoralist,
someone who raises livestock for a living. None of these are wrong, but at the same time none of them are
exactly right. It is true that the livelihoods of the rural poor vary widely depending on where they live, but
one thing that is common to most of the rural poor is that they, and their families, do not engage in a
single activity, but rather a whole range of different activities to make a living.
Farming lies at the core of the economy of most rural areas in developing countries, but many, many
people, particularly the poorest, are not farmers because they are landless. Even where the rural poor own
land, they often own so little land, or such unproductive land, that they cannot produce enough food to
sustain themselves through the year, and so supplement their farming with other activities. When we talk
about rural economies, we are not talking simply about farming.
Farming is important because many of the poor work on other people's farms, have some land of their
own, work in activities related to farming, or find ways to earn money in the off-farm sector which is
affected by the productivity of and wealth created by farming. But many, if not most, of the rural poor
will not benefit directly from interventions that aim to increase incomes from farming. It is important to
keep this in mind when we consider what types of financial services will help the rural poor. Also, many
rural households survive through income from migration to urban areas, which is important to keep in
mind when designing financial services.
Regardless of their livelihoods, rural populations need financial services just like any other people
anywhere else.
Consider the three different types of financial management: managing basics, coping with risk and
raising lump sums. Suggest examples of each of these requirements for the ‘typical’ rural poor person
whom you thought of just now.
Answer.
– Managing basics: cash-flow management to transform irregular income flows into a dependable
resource to meet daily needs. The incomes of many rural people are highly irregular, due to the
seasonality of agricultural production and hence also the demand for other goods and services that is
derived from agricultural incomes. Cash flow management tools are required so that incomes received
predominantly in the month or two after harvest can be converted into basic consumption flows
throughout the year.
– Coping with risk: dealing with the emergencies that can derail families with little in reserve. Rural
households are subject to numerous ‘shocks’, from weather, illness and disease (human or livestock),
theft, conflict and even market fluctuations.
– Raising lump sums: seizing opportunities and paying for big-ticket expenses by accumulating usefully
large sums of money. Whilst free education is returning in many countries, school fees (uniforms, books,
other contributions) remain a big expense for many poor households. Weddings (including dowries) and
funerals are also major expenses. New couples aspire to have and furnish their own house; existing
households to upgrade theirs. Then, of course, rural households aim to invest in their productive
capacities. A bag of fertiliser can account for a significant share of annual household income for a poor
household. Others aspire to acquire livestock, ploughing equipment or a means of transport. Smoothing
consumption to ‘manage the basics’ is vital, but, without investment, many poor households do not
generate enough income each year to provide even the very basics. Hence, they go hungry for several
months or get trapped in a cycle of debt.
As you will have realised, there are some important characteristics of rural economies that present
particular financial management challenges to poor people living in rural areas. The biggest of these is the
fact that farming is a seasonal and highly risky economic activity. Even where the rural poor are not
farmers, all rural populations are affected by what is going on in the farming economy.

2.4 Defining ‘rural finance’

Given the importance of investment finance (loans) to strategies for raise the productivity and profitability
of smallholder agriculture, some people in governments and development agencies might in practice (if
not in theory) define rural finance as:
‘Credit to poor rural people for farming’.
Do you think this definition is a good one or a bad one? Make a note of what you like about it and
what you don’t like about it. Is it too broad, or too narrow? Why?
Answer
We shall argue that:
– Finance means financial services of all sorts; savings, insurance, transfers as well as loans. Because we
are interested in how to provide services to people, we will focus on activities that take place between two
or more people.
– Rural means affecting rural people, whether or not the financial transaction takes place in a rural area or
is carried out by a rural institution.
– The livelihood to which the finance relates need not be farming, or livestock. It can be for any activity
which affects rural people, such as a shop or a factory or an internet café, and it can take place in a non-
rural place, or in an another country; what matters is that it affects rural people.
– The institution which provides a financial service need not be a registered financial institution; it can be
an input supplier, or a processing or marketing business, and it can be informal, a money lender or money
guard, a local shop or a friend or relative.
– Our main concern is with poor people, because they need to improve their welfare, but the people who
are directly involved in a financial transaction need not be poor; what matters is that the transaction
affects poorer people.
It follows from this that ‘credit to poor rural people for farming’ is not a useful definition of rural finance.
CGAP (The Consultative Group to Assist the Poor)’s offers the following more useful and broader
definition
‘The provision of financial services for rural farming and non-farming populations at all income levels.’
Source: Microfinance Gateway (2013)
This specifically includes non-farm activities, and both rich and poor people, and, because it uses the
broad term ‘financial services’ rather than ‘credit’ and does not mention any particular types of
institutions, we can probably accept it.
In this module, when we talk about ‘finance’ or ‘financial services’ we will usually be referring to
transactions between two or more people. As discussed above, the ways people manage their finances by
themselves are crucial and must be understood. When we talk about financial services, however, we are
talking about services that can be offered to enable people to manage their finances better through
transacting with someone else.
Finally, in this module, we shall be ‘institution neutral’; what matters is the suitability of the service for
its intended task, and we recognise that village money lenders and money guards, family members, local
fertiliser dealers, and other less familiar and more informal sources of financial services may be the
optimum suppliers of certain financial services in some circumstances.

SUSTAINABLE LIVELIHOODS – THE LIMITS TO FINANCIAL CAPITAL

3.1 The sustainable livelihoods framework
The sustainable livelihoods framework in 3.1.1 is an effort to conceptualise livelihoods in a holistic way,
capturing the many complexities of livelihoods, and the constraints and opportunities that they are
subjected to.
These constraints and opportunities are shaped by numerous factors, ranging from global or national level
trends and structures over which individuals have no control, and may not even be aware of, to more local
norms and institutions and, finally, the assets to which the households or individual has direct access. For
now, we will use the household as a unit of analysis, but as we will discuss in later units, it is important to
recognise that not all individuals within a household have equal decision-making power, or benefit
equally from household assets or income.
The vulnerability context in 3.1.1 refers to the external environment in which people live. This includes
trends (such as national or international economic trends, changes in available technology, political
systems), shocks (such as illness or death, conflict, weather), and seasonality (of prices, production cycles
and so on). The vulnerability context is important because the three factors have a direct impact on the
possibilities that poor people have to earn a living now and in the future. Wider economic conditions can
create more or fewer opportunities; an illness in the family can deprive a family of an important source of
income and can force them to sell important assets that they have built up. Seasonal shifts in prices,
production and employment opportunities are one of the most enduring sources of hardship for poor
people all over the world.
The ‘transforming structures and processes’ box refers to the institutions and policies that affect poor
peoples’ lives, from public and private entities to national policies and local culture. All of these can
change both the vulnerability context and the assets to which poor people have access.
The idea of assets is central to the sustainable livelihoods approach. Rather than understanding poverty as
simply a lack of income, the sustainable livelihoods approach considers the assets that poor people need
in order to sustain an adequate income to live.
Based on those assets, and shaped by the vulnerability context and the transforming structures and
processes, poor people are able to undertake a range of livelihood strategies – activities and choices – that
ultimately determine their livelihood outcomes. As we discussed earlier, poor people are usually obliged
to combine a range of strategies in order simply to survive; individuals may engage in multiple activities,
and the different members of a household may live and work in different places. The outcomes that they
may achieve, all being well, could include more income, increased well-being, reduced vulnerability and
greater food security. Sometimes one outcome can negatively affect another; for example, when poor
people engage in less risky, and hence lower income activities, in order to be less vulnerable to shocks.
Five types of assets, or capital as they are described in the literature, have been identified that we all, not
just poor people, need in order to make a living. These are the following:
 Human capital: skills, knowledge, the ability to work and good health. Good health is not simply a
means to earning a livelihood; it is of course an end in itself.
 Social capital: the social resources that people draw on to make a living, such as relationships with
either more powerful people (vertical connections) or with others like themselves (horizontal
connections), or membership of groups or organisations. Generally relationships of trust, reciprocity and
exchange that the poor can draw on in times of need, and that lower the costs of working productively
together. Like human capital, social capital has an intrinsic value; good social relationships are not simply
a means, they are an end in themselves.
 Natural capital: the natural resource stocks that people can draw on for their livelihoods, including
land, forests, water, air and so on.
Physical capital: the basic infrastructure that people need to make a living, as well as the tools and
equipment that they use. For example, transport and communication systems, shelter, water and sanitation
systems, and energy.
Financial capital: savings, in whichever form, access to financial services, and regular inflows of
money.
The more assets any household has access to, the less vulnerable they will be to negative effects of the
trends and shocks as described above, or to seasonality, and the more secure their livelihood will be.
Often increasing one type of capital will lead to an increase in other amounts of capital, for example, as
people become educated (increase in human capital) they may get a better job which earns more money
(increase in financial capital) which in turn means that they are able to upgrade their home and facilities
(increase in physical capital). Sometimes, however, one form of capital decreases as another increases.
This could be true, for example, where a person or household sells their land to migrate to a city.

Critiques of the sustainable livelihoods framework

In recent years the prominence of the five capitals has been criticised by development practitioners for
focusing too much on the micro-level and neglecting the 'higher' levels of governance, the policy
environment, national and global economic growth and so on. This has led, for example, to a limited
understanding of how markets work; how processes far from the lives of poor people nonetheless
have an enormous impact on the possibilities that exist for them to earn a secure income. These
issues are of course captured in the wider sustainable livelihoods framework, within the transforming
structures and processes and the 'vulnerability context' but, in practice, many people have used the idea of
the five capitals more than they have the linkages between those and the wider environment in which
people live. It is very important to keep in mind that the wider environment affects not only the assets to
which people have access, but also what can be achieved with those assets.
The sustainable livelihoods framework has also been criticised for failing to take power dynamics into
consideration, as it relates to gender, for example. Again, while such dynamics are included in the
framework, in practice, they have been neglected. In particular, social capital has often been seen as
simply 'a good thing' whereas, in reality, social networks can be both inclusive and exclusive, with often
the weakest and most vulnerable excluded. They also often involve hierarchical and coercive relationships
that limit options for those at the lower levels, and even when relationships are more horizontal than
vertical, the obligations that reciprocal relationships involve can be onerous.
All of the criticisms and limitations of the sustainable livelihoods approach outlined above are certainly
valid. The approach attempts to summarise in a single set of diagrams and connected terms the extremely
complex and diverse reasons for poverty and the possibilities for addressing it. Inevitably, when used in
practice it is unwieldy and certain elements will be highlighted more than others depending on the
interests of the users. Nonetheless, it remains very useful for our purposes in this module, both for
considering the very micro-level details of poor people's livelihoods and for considering the wider context
in which those livelihoods operate.

KEY TERMS AND CONCEPTS

adverse selection
refers to the fact that it is often people whose activities are particularly risky who take high interest loans,
or buy insurance, which means that financial service providers may end up with a set of particularly risky
clients
coping with risk
dealing with emergencies that arise through life. These types of emergencies are often described as
‘shocks’ to household economies
credit rationing
refers to situations when banks do not meet the demand that exists for loans. Some argue that this occurs
only when interest rates are set by the government and the market is unable to balance itself. Credit
rationing can, however, also occur due to information asymmetries and transaction costs
finance the ways that people manage their money, and the systems that exist to enable them to do that
effectively
financial capital
savings, in whichever form, access to financial services, and regular inflows of money
financial intermediaries
individuals or institutions whose business it is to act as the middleman between those who want to save
and those who want to invest, or to be the point person for many people who want to reduce their risks
financial intermediation
the process through which resources are channelled from those who have a surplus to those who do not
have enough to carry out an activity, in order that the activity can be carried out
human capital
skills, knowledge, the ability to work, and good health. Good health is not simply a means to earning a
livelihood; it is also an end in itself
information asymmetries
refer to the fact that, in the real world, information does not flow smoothly. Some people have access to
information that others do not. In the case of financial services, this means that those providing the
financial service do not always know as much as they would like to know about the person to whom they
are providing the service, and may therefore not provide the service, even if they have the funds available.
Moral hazard and adverse selection arise because of information asymmetries
managing basics
household cash-flow management to transform irregular income flows into a dependable resource to meet
daily needs. In economics terminology this is known as ‘consumption smoothing’; ensuring that you are
able to buy what you need to consume on a daily basis even if your income is inadequate or
irregularmarket failures
situations when the market alone does not produce the most efficient outcome. Then some sort of
government regulation or direct intervention may be necessary to produce that outcome, rather than just
leaving it to the market
moral hazard
is when someone’s behaviour changes based on their access to financial services which makes them more
of a risky client. For example, a business person may make a riskier investment after taking a loan with a
high interest rate (to try to get a higher rate of profit and so repay the loan more easily), or a person who
has taken insurance against their car being damaged may drive less carefully because they know they will
not have to pay for it in case of an accident
natural capital
the natural resource stocks that people can draw on for their livelihoods, including land, forests, water, air
and so on
physical capital
the basic infrastructure that people need to make a living, as well as the tools and equipment that they use.
For example, transport and communication systems, shelter, water and sanitation systems, and energy
raising lump sums
seizing opportunities and paying for big-ticket expenses by accumulating usefully large sums of money
rural finance
‘the provision of financial services for rural farming and non-farming populations at all income levels’
(Fernando 2007)
saving down
saving later after taking a lump sum now, for example, taking a loan and repaying it over time
saving through
saving consistently to have a lump sum when the need arises, for example, paying regular insurance
premiums
saving up
saving now to have a lump sum later
social capital
the social resources that people draw on to make a living, such as relationships with either more powerful
people (vertical connections) or with others like themselves (horizontal connections), or membership of
groups or organisations. Generally relationships of trust, reciprocity, and exchange that the poor can draw
on in times of need, and that lower the costs of working productively together. Like human capital, social
capital has an intrinsic value; good social relationships are not simply a means, they are an end in
themselves