2 0 FOCUS 2 18 0 71071 InnovatIons In RuRal and agRIcultuRe FInance EDITED BY REnaTE KloEppIngER-ToDD anD ManohaR ShaRMa FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT InnovatIons In RuRal and agRIcultuRe FInance FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT Focus 18 • IntroductIon • July 2010 Most rural households lack access to reliable and affordable finance for agriculture and other livelihood activities. Many small farmers live in remote areas where retail banking is limited and production risks are high. The recent financial crisis has made the provision of credit even tighter and the need to explore innovative approaches to rural and agricultural finance even more urgent. Rural and agricultural finance innovations have significant potential to improve the livelihoods and food security of the poor. Although microfinance has been widely studied, a large knowledge gap still exists on the nuts and bolts of expanding access to rural and agricultural finance. IFPRI’s 2020 Vision Initiative approached the rural finance team of the Agriculture and Rural Development Department of the World Bank to conceptualize and assemble this collection of briefs to narrow the knowledge gap by examining innovations in providing financial services to rural households. They, in turn, asked leading experts around the world to share their perspectives and experiences, focusing on issues related to implementation and operations. Together with a companion set of briefs—Innovations in Insuring the Poor (2020 Focus 17) edited by Ruth Vargas Hill and Maximo Torero—this series contributes to the knowledge pool on innovative tools for effectively managing the risks faced by the rural poor. This set of briefs clearly points out the importance of business realities faced by small farmers, including low education levels, the dominance of subsistence farming, and the lack of access to modern financial instruments. These conditions mean that new and innovative institutions are required to reach small farmers. Emerging communication technologies provide new opportunities for rural banking by reducing business costs and alleviating information asymmetries. New financing instruments, such as weather index-based insurance and microinsurance, also have great potential for managing the risks faced by small farmers. In addition, bundling financial services with nonfinancial services like marketing and extension services offers new opportunities for small farmers to increase their productivity and incomes. Finally, an enabling policy environment and legal framework, enforcement of rules and regulations, and a supportive rural infrastructure all contribute immensely to making sustainable access to finance a reality. We are grateful to Renate Kloeppinger-Todd and Manohar Sharma for their work in bringing together these important briefs, to the brief authors for their analyses and insights, to the reviewers for their constructive comments, to Heidi Fritschel and Ashley St. Thomas for editorial assistance, to Shirong Gao for design, and to Djhoanna Cruz for coordination assistance. We hope that the findings and recommendations presented here will contribute to policy changes that enhance poor people’s access to financial services in ways that increase their livelihoods and improve their lives. Shenggen Fan Juergen Voegele Rajul Pandya-Lorch Director General Director, Agriculture and Rural Development Head, 2020 Vision Initiative IFPRI World Bank IFPRI The International Food Policy Research Institute (IFPRI) is one of several international research centers supported by the Consultative Group on International Agricultural Research (CGIAR). “2020 Vision for Food, Agriculture, and the Environment� is an initiative of IFPRI to develop a shared vision and consensus for action on how to meet future world food needs while reducing poverty and protecting the environment. IFPRI gratefully acknowledges the generous unrestricted funding from Australia, Canada, China, Denmark, Finland, France, Germany, India, Ireland, Italy, Japan, the Netherlands, Norway, the Philippines, South Africa, Sweden, Switzerland, the United Kingdom, the United States, and the World Bank. The views expressed in these 2020 Focus briefs are those of the authors and are not necessarily endorsed by or representative of IFPRI or its supporting organizations. In collaboration with colleagues in the Sustainable Development Network and across the World Bank, the Agriculture and Rural Development Department (ARD) of the World Bank works to reduce poverty through sustainable rural development. To this end, ARD provides analytical and advisory services to the Bank’s regions on a wide range of agricultural and rural development topics. These services include the preparation and implementation support of the World Bank’s Agriculture Action Plan, monitoring of the World Bank’s portfolio of agriculture and rural projects, and promoting knowledge sharing among agriculture and rural development practitioners, inside and outside the World Bank, in order to continually improve the World Bank’s activities in rural areas. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. DOI: 10.2499/0896296687 ISBN 10-digit: 0-89629-668-7 ISBN 13-digit: 978-0-89629-668-8 InnovatIons In RuRal and agRIcultuRe FInance Overview FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT Renate KloeppingeR-todd and ManohaR ShaRMa Focus 18 • BrIeF 1 • July 2010 E verywhere in the world, small agricultural producers are entrepreneurs, traders, investors, and consumers, all rolled into one. In all these roles, small agricultural households agricultural finance, used good banking practices, and above all drawn on knowledge of agriculture to enter and succeed in this market. Many of these new approaches show great promise, but no constantly seek to use available financial instruments to improve single approach works for all situations. Rather, organizations have their productivity and secure the best possible consumption and the most success when they are nondogmatic, apply comprehensive investment choices for their families. But the package of financial risk-management strategies and tools, retain the ability to pick and services available to small farmers in developing countries is choose their clients rather than having the government do so, and severely limited, especially for those living in remote areas with no are innovative and pragmatic. access to basic market infrastructure. This set of briefs explores how rural and agricultural finance When poor people have limited saving or borrowing options, can be profitable, without high levels of government subsidies, by their investment plans are stifled and it becomes harder for them to examining a selection of successful interventions—out of the many break out of poverty. If households have no access to insurance and being implemented in the developing world—and highlighting the are unable to accumulate small savings that enable them to pay for lessons learned. household and business expenses, especially during lean seasons, The briefs fall into four thematic areas: addressing the business they are forced to limit their exposure to risk, even if high returns reality of small farmers in developing countries, using modern are expected, once again making the pathway out of poverty more communication technology to overcome the tyranny of distance and arduous than necessary. Inadequate access to financial services is information bottlenecks, managing risks at the farm and household thus part of what is often called the “poverty trap.� level, and bundling financial services with nonfinancial services to address the multiple constraints faced by most small farmers. Microfinance and agriculture finance In the 1980s and 1990s the deleterious impact of limited financial Addressing the business reality of small farmers access caught the attention of many academics, policymakers, Most small farmers in developing countries have little education donor agencies, and development practitioners, who generated an and limited exposure to modern financial instruments. Further, outpouring of new thinking and new ideas. Innovative concepts many of these small farmers have only recently transitioned from such as group liability, village banking, microinsurance, and index- subsistence to commercial farming, and their contact with the cash based insurance were tested in new and emerging microfinance economy and experience in cash management is limited. Hence, in institutions. But progress on expanding agricultural finance—as Brief 2 Monique Cohen addresses the issue of financial literacy and opposed to nonagricultural microenterprise finance—lagged. explains why the poor may need some coaching on how modern Donors and governments that had invested heavily in agricultural financial instruments can better their lives. development banks and agricultural credit in the 1980s and early Additionally, many small farmers in developing countries 1990s found that these efforts did not produce the expected results live in remote rural settings, where urban-based retail banking is and withdrew their support. It was hoped that private commercial unavailable. In Brief 3 Anne Ritchie describes two operational models banks would step in, but for the most part they did not. used by community-based financial organizations and explains Financial institutions have demonstrated a lack of interest how community banking enables the unbanked rural poor to serve in agriculture finance for four reasons. First, many agricultural themselves, with or without links to the formal financial sector. households were located in remote parts of the country and As rural banking takes hold in developing countries, it has also were often so widely dispersed that financial institutions found attracted the attention of institutions in developed countries that it challenging to provide cost-effective and affordable services. have traditionally served farmers. The Netherlands-based Rabobank, Second, big swaths of the agricultural population were subject to for example, has made investments in countries as varied as China, the same weather and climate risks, making it hard for providers Paraguay, and Zambia. In Brief 4 Gerard van Empel describes of financial services to hedge risks or operate profitable insurance Rabobank’s use of a supply-chain approach to address key gaps in pools. Third, service providers, mainly urban-based, simply did not rural banking in many developing-country contexts. know enough about the business of agriculture to devise profitable Ghana’s network of rural and community banks represents a financial products. Fourth, most small agricultural producers in unique approach to generating access to financial services across developing countries had little education and little knowledge of the rural areas of a whole country. In Brief 5 Ajai Nair and Azeb how modern banking institutions work. Fissha describe their business model, their services, and their financial performance. The brief discusses the challenges facing the Recent progress in rural finance network and its apex institution in becoming financially sustainable Since the early 2000s a number of organizations have developed and competitive and draws lessons that are applicable elsewhere. innovative approaches to financing agriculture. They have The financing of productive assets requires access to medium- sometimes adapted microfinance concepts to the provision of term loans and usually significant collateral, neither of which are available in most rural circumstances. In Brief 6 Ajai Nair describes based on extreme El Niño events that create catastrophic flooding leasing as an alternative to credit, which can help ease the provision resulting in significant consequential losses and extra costs for a of credit for investments in movable assets in rural areas. The brief wide range of stakeholders in northern Peru. describes the benefits of leasing to the client and the provider and Microinsurance has been developed as a risk management tool identifies lessons on how to manage and support financial leasing in only recently. In addition to being more expensive to administer rural areas. than savings and loan services, microinsurance schemes are plagued Finally, a key issue in financial service delivery is how to by more severe levels of adverse selection and moral hazard, which effectively increase repayment rates. In Brief 7 Yanyan Liu and makes them challenging to provide on a sustainable, full-cost- Klaus Deininger discuss this issue in the context of self-help groups recovery basis. Brief 12 by Martina Wiedmaier-Pfister and Brigitte (SHGs) in India. Their analysis of the factors affecting repayment Klein surveys key experiences in providing insurance in rural areas, performance among low-income SHGs shows that effective including important issues related to regulating microinsurance. application of rules pertaining to loan terms is more important than group characteristics in improving repayment performance. Bundling financial and nonfinancial services In addition to financial constraints, small farmers in developing Using modern communication technology countries also face market constraints in acquiring needed inputs Recent advances in communication technology affect rural banking (such as fertilizer, seeds, and extension services). Returns to financial in two key ways. First, by facilitating electronic payment systems services are thus highly conditional on access to other nonfinancial and branchless banking, this technology can significantly slash services. Brief 13 by Vijay Mahajan and K. Vasumathi describes how transaction costs for both service providers and consumers. Second, BASIX in India provides services such as soil testing and health using portable smart technology to establish identification and monitoring of livestock, along with credit, to farmers in a way that monitor clients can significantly alleviate information asymmetries maximizes returns to credit services. and help improve repayment rates. Brief 14 by Jonathan Campaigne and Tom Rausch describes In Brief 8 Susie Lonie describes how the cell phone–based a similar approach used by the DrumNet project in Kenya. In payment service M-PESA now serves more than 9 million clients contrast to BASIX, however, the DrumNet project uses information throughout Kenya, enabling them to remit money, make bill and technology to link key actors along the supply chain to farmers. loan payments, make cell phone–based payroll payments, and use banking services. The way forward In Brief 9 Xavier Giné describes the results of an experiment This set of briefs seeks to initiate discussions among stakeholders to assess the impact of using biometric technology to monitor by disseminating information on a selection of innovative, on- repayment performance of individuals in rural Malawi. This the-ground initiatives designed to improve financial access for experiment showed that repayment rates increased by 40 percent poor small farmers. All of these initiatives hold promise, but they for groups with a high default risk, and the benefits of improved also face challenges, and in the end some may not be suitable repayment outweighed the cost of implementing the new technology. for a massive scale-up or for use in all country settings. Yet such initiatives demonstrate that it may be possible to eventually provide Managing risk at the household and farm level financing for agriculture on a sustainable basis at a reasonable cost. The management of risk is the key issue for financial institutions Many of these initiatives are based on the premise that there is that finance agriculture, as well as for rural populations in a supportive policy environment that allows innovation to flourish. general. In Brief 10 Mark D. Wenner analyzes various approaches The gravest risks to sustainable financing for agriculture often to managing risk in financing agriculture. Index-based insurance come not from inherent business risks or the inability of financial schemes are one approach that has been implemented on a pilot institutions to design profitable financial products for the rural basis in several countries. Such schemes use an easily observable population, but rather from misguided government interventions index that is not subject to tampering. The index is correlated such as subsidized interest rates and lack of or non-enforcement with the underlying risk and used to make decisions on insurance of appropriate rules and regulations. Conversely, an enabling payouts, thus eliminating the cost of verification as well as environment and legal framework, enforcement of regulations, and incentives to misrepresent losses. In Brief 11 Jerry Skees and a supportive rural infrastructure would eventually lead to lower but Benjamin Collier describe an ongoing pilot project in Peru that sustainable interest rates by reducing transaction costs and risks insures firms (such as microfinance institutions or firms in the value and increasing competition. All this would contribute immensely to chain) serving smallholder households. The insurance pays out making sustainable access to finance a reality. n Renate Kloeppinger-Todd (rkloeppingertodd@worldbank.org) is rural finance adviser in the Agriculture and Rural Development Department of the World Bank. Manohar Sharma (msharma5@worldbank.org) is senior poverty specialist in the Poverty Reduction and Economic Management Unit, East Asia Region of the World Bank. INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance Financial Literacy FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT Monique Cohen Focus 18 • BrIeF 2 • July 2010 T he global financial crisis has intensified the problems of over- indebtedness, especially for the poor. In this context, the microfinance industry is giving more attention to building delivery channels to reach them. Identifying the most appropriate “teachable moments� for financial education—for example, when someone first opens a bank account, starts a business, or makes a their customers’ financial capabilities, designing products that transition to technology-enabled banking—makes the education respond to their needs and preferences, and ensuring their relevant and reinforces behavior changes since people have an protection as consumers. opportunity to apply what they learn in the context of real life. In a world where financial products and institutions are expanding rapidly, deciding which services to choose and how to How can financial education use them is an increasing challenge. That challenge is especially be successfully delivered? great for customers who are poor and have limited experience in An important debate among practitioners is how financial education the formal financial sector. While money-management strategies can be delivered most effectively. Channels range from public can be innovative, the financial choices they make are defined by campaigns and mass media to face-to-face communication and environments where informal financial practices are dominant and personal counseling, from small-group seminars to classroom-style the consumer is often uncertain about commercial products and workshops. Innovative delivery channels also include cell phones services. In increasingly complex and competitive financial markets, and other electronic media. consumers with low levels of financial literacy lack the information Experience has shown that there is no best way to deliver and tools necessary to make informed decisions. Building financial financial education; it depends on the target group, objectives capabilities can help people move from being overwhelmed by their of a financial-literacy initiative, and available resources. Mass financial options to being empowered by them. media—including television, street theater, call-in radio, or printed materials, such as posters and comics—is being used increasingly to Why is financial education important? expose poor and often illiterate people to key financial messages. People at all income levels may have different resources and Its primary impact is to spread awareness, whereas the purpose opportunities, but they still typically share common goals: They of face-to-face training and counseling is to provide participants seek to put food on the table, educate their children, own a home, with hands-on experience, particularly with banks, which they tend and plan for the future. To set aside even small amounts of money, to distrust and fear. More fundamental changes in attitudes and low-income families need to be careful spenders as well as skilled behaviors require reinforced messaging over time. money managers. Providers of financial education have differing interests, which Financial education provides a foundation for managing translates into a diversity of delivery approaches. Central bankers money, which is an indispensable skill in a world where microfinance or regulators who wish to protect consumers from fraud and abuse products and services are proliferating at the same time that overly tend to give priority to public campaigns focused on consumers’ aggressive financial services providers are ever ready to pressure rights and responsibilities. Financial institutions that aim to increase the consumer. Building consumers’ financial capabilities is about adoption and use of their products and services may choose to doing more with the little at hand, readying the unbanked (people integrate financial-education messages into their marketing without access to conventional banking services) to enter the agendas. Community-based organizations wishing to promote formal financial system and enabling the underbanked (people with livelihoods and asset building for the poor may integrate financial limited access to conventional banking services) to do more with education into a range of activities, including extension services, the financial services at their disposal. It is also about improving health education, business-development training, or mentoring. the performance of financial services providers. Findings from a Consumer-protection organizations may embrace financial randomized impact evaluation found that Self-Employed Women’s education as part of social-marketing campaigns, community-based Association clients who attended financial literacy classes took training, or one-on-one counseling at debt advisory centers. out twice as many loans as women who did not (Pande, Field, and The choice of delivery systems is very much a question of Jayachandran 2009). resources. While tangible, direct training is expensive on a large scale, bundling delivery channels—for example, combining radio How does financial education work? with some direct training offers—can help strike a balance between Financial education is the process of building knowledge and skills achieving both broad and focused impacts. to enable people to make more effective financial decisions while changing behaviors to build confidence in financial empowerment. Outcomes and impact The core of a financial-education agenda includes budgeting, saving, Controversy surrounds the issues of what and how to measure and managing debt. It also involves managing financial products the outcomes and impact of financial education. (See Figure 1 in such as insurance or remittances and making use of bank services. Appendix A for one such approach.) Designing a financial-education program begins with a good Currently, quantitative evidence of the positive outcomes understanding of the market. This means knowing the financial- and impacts of financial education is limited. This contrasts with literacy levels of the target population and the most effective affirmative anecdotal evidence from learners. Meanwhile, research shows that financially literate clients make better financial decisions on particular financial products (including insurance, remittances, and maintain a better overall financial well-being (Cole and and housing loans), specific target groups (for example, adolescent Fernando 2008). girls) and consumer protection. By leveraging partnerships and Recent research linking financial education to behavior using scalable delivery channels, Microfinance Opportunities is changes among low-income microfinance clients in Bolivia and achieving significant levels of outreach; in less than three years, Sri Lanka provides insights into these contradictory impact-related more than 500,000 consumers have received direct training. This observations. Two years after receiving financial education, clients figure does not include the enormous outreach achieved through increased their knowledge of loan products and debt capacity. the viral spread and adaptations of the MFO curriculum using mass Positive changes in savings behaviors included reducing expenses media. For example, Makutano Junction, a televised series in East as well as recognizing the value of saving three times the amount Africa, has incorporated the key messages into several episodes. Its of monthly income for emergency purposes. Those given budgeting viewers are in the millions. training identified the primary function and different parts of a budget and were able to work within their own budgets. However, Where do we go from here? putting debt-management and savings behaviors into practice Financial education is beginning to get the visibility and interest it during the food and financial crises that affected these countries deserves. Attention is moving beyond the implementation of small- was a challenge. The new savings behaviors translated into reduced scale initiatives to the development of national financial-literacy vulnerability (Gray et al. 2010). strategies that straddle financial and social policies. Integration of To assess the outcomes of financial education, researchers must financial education into cash-transfer programs and branchless look beyond indicators of behavior change. They must recognize banking are other emerging programmatic areas. Measuring how that financial behaviors are influenced by the context in which and when financial education translates into financial-behavior people live—both inside and outside the household—and thus are change remains difficult, but, among learners, it is valued and ever changing. According to Gray et al. (2010), the five elements of has emerged as a key—although often overlooked—component of effective financial education are economic empowerment. • quality and frequency of education, Some see the challenge of scalability as an obstacle to a meaningful impact of financial education. It need not depend • relevance of the education to the target population, on stakeholders’ objectives for financial education. Everyone • opportunity to use the education, can benefit from financial education: the banked, unbanked, or underbanked. Technology offers just one avenue to send key • context in which people can exercise their new financial messages to large numbers of people; its spread therefore must behaviors, and not be restricted to users of formal financial services. Building • appropriateness of the financial products offered. financial capabilities among the low-income population is a win– win situation for the financial sector because it creates better- Developing a financial education agenda informed consumers. Financial education need not be a stand-alone Since 2002, Microfinance Opportunities (MFO) has sought to put activity. It is very effective when combined with other development financial education on the agenda of microfinance institutions interventions aimed at reducing vulnerability and food insecurity and other development organizations seeking to improve the and expanding opportunities for the poor. n financial lives of the poor. To this end, MFO partnered with Freedom See more information at www.microfinanceopportunities. from Hunger to develop a global financial-education curriculum org. that is targeted at those just above and below the poverty line in developing countries. Developed in partnership with nearly For further reading: S. Cole and N. Fernando, “Assessing 20 microfinance service providers, the curriculum currently the Importance of Financial Literacy,� ADB Finance for the addresses ten themes. The core topics are budgeting, saving, Poor Vol. 9 (No. 3): 2008; B. Gray, J. Sebstad, M. Cohen, and managing debt, negotiating financial transactions, and using bank K. Stack “Can Financial Education Change Behavior?: Les- services. Each theme includes (1) a content note that provides a sons from Bolivia and Sri Lanka,� Working Paper 4 (Micro- topic overview, (2) a trainer’s guide with step-by-step instructions finance Opportunities, Washington, D.C.: 2010); C. Nelson and A. Wambugu, Financial Education in Kenya: Scoping for conducting each learning session, and (3) a “training of trainers� Exercise Report (Financial Sector Deepening Kenya, Nairobi, manual to prepare financial-education trainers. Kenya: 2008); A. Klincic, “Case Study of Opportunity Bank The trainer’s guide, the cornerstone of the curriculum, has of Malawi� (Microfinance Opportunities, Washington, D.C.: proven itself a valued reference tool. The curriculum itself is flexible Forthcoming); R. Pande, E. Field, and S. Jayachandran, Busi- and readily adaptable to longer or shorter learning activities, ness Training and MFI Client Behavior: Findings from a Ran- different contexts, and target populations, including people who are domised Impact Evaluation in Ahmedabad, Gujarat (Institute illiterate (Nelson and Wambugu 2008). The base curriculum has been for Financial Management and Research (IFMR) Centre for expanded to encompass a number of specialized modules focused Micro Finance, Chennai, India: 2009). Monique Cohen (moniquec@mfopps.org) is the president of Microfinance Opportunities. INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance Community-Based Financial Organizations: Access to Finance for the Poorest FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT anne RitChie Focus 18 • BrIeF 3 • July 2010 C ommunity-based financial organizations (CBFOs) are user- owned and -operated groups that provide mainly saving and lending services but may also offer other financial services such adopted lessons from the efforts of poor local women to save in this large, poor, sparsely populated country. Since then, CARE and other nonprofit development agencies have spread the model to as insurance. These independent organizations are based in local 39 countries, the vast majority in Africa. VSLA groups, consisting of communities, with local governance and management. CBFOs range between 10 and 30 members, have simple rules that govern their in size. They can take the form of informal and unregistered groups savings and lending activities. Each member saves on a regular of five to seven people, usually women, who meet weekly to save basis, and this money is then lent out at an interest rate and on loan small amounts of money that they then lend to each other and terms decided by the group. Loans may be made to both members possibly to other members of the community. They also include and nonmembers. Indeed, many members save but do not borrow larger, slightly more formal groups of up to 40 people who have and earn a good return on their investment through the interest written by-laws, and they include small financial cooperatives. CBFOs charged to borrowers. At the end of a given period, usually a year, flourish among people who have poor access to banks and nonbank the savings and the interest the VSLA earned are distributed to the financial institutions such as microfinance institutions (MFIs). members, and a new cycle begins. The distribution feature of this model keeps the amounts of money that the members must manage Market niche at a level commensurate with their financial literacy. It also enables The market niche served by CBFOs is the unbanked poor. In many all members to receive a lump sum on the same date, often one that countries, locally organized CBFOs, such as rotating savings and coincides with most members’ need for funds, such as an annual credit associations (ROSCAs), have served as financial intermediaries festival, the start of the planting season, or the date that school for their communities for generations. ROSCA members save a fees must be paid. VSLAs do not generally link with banks or MFIs predetermined amount of money regularly. In each period, one because experience has shown that members’ savings are generally member of the ROSCA receives the funds collected. ROSCAs thus sufficient to meet their credit needs, and injection of external loan allow people to accumulate, through small regular savings, a large funds has caused many groups to fail. lump sum that is available for investments, such as creation or The self-help group (SHG) model, begun in India several expansion of small businesses, children’s education, and home decades ago, has become the dominant microfinance model in that improvement. The main drawback of ROSCAs is that the money may country, especially for the rural poor. SHGs usually have between not be available when needed because only one member collects the 10 and 20 members who save regularly and lend the money out to funds at one time. members only. The funds saved are not distributed back to members, Although MFIs formed over the past four decades have done a but, rather, grow over time. SHGs in India often receive small great deal to make financial services available to the unbanked poor, amounts of seed capital from government or donors. They usually they have not, for the most part, been able to reach the poorest have an explicit goal of bank linkage, which has been facilitated people, especially those who live in remote rural areas. The poorest by the high density of banks in rural areas and by a government are able to save and borrow only very small amounts of money, policy stipulating that banks’ portfolios must include rural loans. making it too costly for banks and MFIs to serve them. In remote Many SHGs belong to federations that provide them with access to rural areas with widely dispersed populations, banks and MFIs often external capital, technical assistance in areas such as accounting, cannot cover the costs of an extension agent or a branch office, and greater bargaining power with government and banks. As of even if they use modern technologies to reduce costs or group 2007, India had approximately 69,000 SHG federations. people together to achieve economies of scale. Thus, MFIs have The principal differences between the models are the following: been successful in broadening the number of people served but less • VSLAs are self-contained at the village level, whereas SHGs link successful in reaching the poorest. with banks and form federations with other villages. • VSLAs distribute all savings and earnings back to members at Successful models the end of the year, whereas SHGs add new savings to existing Experience has shown that successful CBFO models must savings with no automatic distribution mechanism. This incorporate a number of basic principles: social cohesion of group difference makes VSLAs easier for nonliterate people to manage members, a focus on building up savings to fund loans rather than but allows SHGs to accumulate more capital for lending. relying primarily on external sources of funds, and an organizational structure that enables governance and management by people who are often poorly educated and have little or no experience with Matching CBFO models with communities’ needs financial management beyond managing their own households and The design of a CBFO program should be responsive to prevailing economic activities. Two models in particular appear to work well on local conditions. A number of factors should be taken into a large scale and have good prospects for long-term sustainability. consideration, including the demand for financial services and the One model is the village savings and loan association (VSLA) proximity of banks and MFIs. In poor rural areas with weak local model. Started in Niger by CARE International in 1991, the VSLA economies dominated by subsistence farming and few new business opportunities, VSLAs can provide an effective way for households relationships with CBFOs, which provide banks with easy access to a to manage their financial resources. Savers are able to earn a return large number of rural customers. In some cases, the banks have sent on their investment by making their capital available to those with their representatives to the villages to open the bank accounts. Such viable businesses. If banks and MFIs are distant, as in the rural areas confidence-building measures can, over time, lead to a willingness of many African countries, attempting to foster bank linkage may be on the part of the bank or MFI to extend credit to either the CBFO more expensive than is warranted by the limited demand for loans. (for on-lending to its members) or to individual members who have In areas with more vibrant economies and greater population viable business plans. density, the bank linkage and federation aspects of the SHG model enable groups to draw on external funds for the growth The way forward of members’ businesses. Federations can help SHGs with financial The ability of CBFOs to govern themselves effectively and to management and may also offer training aimed at strengthening manage their operations so that savings are secure and loans are the SHGs. However, because both the bank linkage and federation repaid is paramount for their long-term sustainability. Donors aspects of the SHG model add significant levels of complexity, and government can add value by funding programs that train external support from a technical-assistance provider may be local people to develop viable groups and by providing technical required for a long period of time. assistance for the development of simple governance, operational, Both VSLAs and SHGs are initially formed and nurtured by and accounting systems that can be implemented locally. trained extension agents. Experience with both models has shown Donors and governments should also fund program that once the model has been established in a particular area, evaluations, using performance criteria that allow comparison setting up new groups can be less expensive because members of across programs and models. The single most important existing groups can spread the model to other communities through performance indicator is repayment performance—that is, the informal linkages between communities or through the formation ability of CBFOs to get borrowers to repay their loans in a timely of associations of trainers who are themselves group members. way. Nonrepayment of loans is the greatest threat to the financial sustainability of any financial organization, including CBFOs. This Leveraging finance and partnerships threat is increased by the tendency of donors and governments to with mainstream financial institutions provide CBFOs with large loan funds that are beyond their capacity The question of external financing has generated great debate. Many to manage effectively. Significant amounts of external funding— CBFOs have failed following the infusion of donor or government beyond small seed funds that help groups get started—should be funds into fragile young organizations lacking the skills to manage linked to their performance in managing the group’s own funds. This this money. External credit may also draw into the membership careful approach will enable CBFOs to develop a strong foundation people whose main objective is to obtain a slice of donor largesse that enhances their prospects for long-term sustainability. n rather than to contribute to the slow but steady buildup of the group through its own efforts. Yet it is precisely these efforts that For further reading: J. Murray and R. Rosenberg, Commu- are needed to build effective governance and management. nity-Managed Loan Funds: Which Ones Work? Focus Note No. 36 (Washington, DC: Consultative Group to Assist the Nevertheless, partnerships between CBFOs and mainstream Poor, 2006), www.cgap.org/p/site/c/template.rc/1.9.2577/; financial institutions can be beneficial, especially if implemented A. Ritchie, Community-Based Financial Organizations: A incrementally. In the simplest form of partnership, CBFOs may Solution to Access in Remote Rural Areas? Agriculture bank their excess savings and earn interest on these savings. As the and Rural Development Discussion Paper 34 (Washington, relationship develops, the bank or MFI is able to assess the capacity DC: World Bank, 2007); APMAS, www.apmas.org/; Gemi of the CBFO to manage its own funds. In a World Bank–supported Diriya Foundation, www.gamaneguma.lk/sub_link_view. project in Sri Lanka, rural banks have been eager to develop php?doc=19; VSL Associates, www.vsla.net/. Anne Ritchie (AnneFRitchie@aol.com) is a World Bank microfinance consultant. INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance Rural Banking in Africa: The Rabobank Approach FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT geRaRd van eMpel Focus 18 • BrIeF 4 • July 2010 M any people in the vast rural areas of Africa lack access to financial services, and most commercial banks are not interested in moving into these areas due to their low income levels, years ago. In order to achieve its mission of providing access to financial services to those in rural areas of developing countries, RD participates in financial institutions and provides management lack of scale economies, and poor infrastructure. Also, few banks services and technical assistance. It has made investments in actually understand the most common economic activity in rural Tanzania, Zambia, Mozambique, Rwanda, Paraguay, Brazil, and areas: agriculture. China. RD also works with cooperative “enterprises� and financial Consequently, the absence of financial institutions in rural institutions that want to increase their own access to financial Africa has often enticed governments to step in, particularly with services. While RD focuses on investments, Rabo International state-dominated banks focused on agriculture. Many of these Advisory Services (RIAS) provides technical assistance. RIAS has initiatives have failed, however, because they were too bureaucratic, a 20-year history in consultancy services mainly to financial too policy oriented, too concentrated on risk to only one segment institutions and cooperatives in emerging markets. of the population, or too weak in customer focus. In addition, Rabo Development has made investments in some existing clients considered these government-sponsored institutions to be financial institutions with the objective to transform these instruments that provided grants; hence, the banks suffered from organizations into leading banks with a rural orientation. Financial poor loan-recovery rates. participation is limited to minority stakes (variation between While microfinance institutions have made some inroads 10 and 45 percent); the majority of shares are locally owned, thereby into rural Africa with the financial backing of international retaining the status of a local bank. This allows customers to better nongovernmental organizations and other sponsors, their identify themselves with the institution and appeals to national pride. sustainability is questionable. They tend to lack banking licenses and Financial investment demands a shared vision of the future therefore have a very limited product range, and they cannot afford development of an institution, so stakeholders should agree on modern technology-based distribution systems. a mission and business plan, which are likely to entail servicing new customer segments, including rural clients (mainly farmers), Key gaps in rural banking in Africa and developing a broader product base. In order to assist implementation, Rabo Development not only provides capital but One of the most prominent gaps in developing banking services for also management services, technical assistance, and representation rural Africa is poor infrastructure—for example, bad roads, erratic on the board of directors. At present, Rabo Development has four electricity provision, and lack of communications systems—which investments in banks in Africa, which have a total of more than impedes effective outreach to customers. 3 million customers collectively. The legal environment in these rural areas is also suspect. There is no standard recipe for exactly how capacity should be Insecure property rights—especially land titles in rural areas—limit built because it very much depends on each individual institution’s any bank’s collateral options; combined with poor contract- stage of development and the country concerned. In any case, enforcement opportunities, this takes away a bank’s incentive however, special attention should be given to getting the product to provide credit, especially for long-term loans. Proper land distribution strategy of the institution right. To distinguish customer registration and enforceable mortgage systems are important issues segments and develop their value propositions, it is pivotal to for rural development. organize an efficient outreach, using both physical channels (such The inefficiency of markets is also a barrier to developing as branches) and virtual channels (such as ATMs, mobile banking, rural financial services. Agricultural value chains are often poorly and Internet banking). organized, lacking in transparent pricing, and fragmented in primary production—all of which results in high transaction costs. In many Lessons learned cases, the banking environment is distorted by stakeholders— These lessons have been learned by Rabo Development’s work in including donors, governments, and development banks—who do developing countries and emerging markets. not always regard agriculture as an economic activity, but rather as a social problem. These stakeholders provide subsidized funding • Banks with a rural orientation still need a strong urban to farmers or cooperatives, which means private banks often lack presence, as most banking assets are concentrated in urban a level playing field. Poor financial literacy rates, especially among areas. New distribution concepts, such as mobile banking and small farmers, and a limited understanding of banking requirements products, are also normally piloted in urban areas. also pose a problem. • Banks need to service all client segments with the appropriate mix of products (including microloans) in order to effectively Rabo Development use the branch network and establish a well-balanced portfolio, In an effort to serve the financial needs of emerging markets and thereby reducing the concentration of risks. developing countries, Rabo Development (RD) was created with a • Financial institutions that want to practice rural finance mission similar to that of its parent organization, Rabobank, which need to be committed to this segment and need specialized was created by farmers in the Netherlands more than one hundred knowledge-based departments, including agriculture and small and medium enterprises (SMEs), in order to be effective to money directly to the bank, thereby allowing a direct repayment. these target groups. Political pressure has forced institutions in Under these structures, the repayment risk to the individual farmers some countries to provide rural financial services, but, with no is converted into performance risk to both the farmer and the commitment, results are poor. off-taker. In many cases, cooperatives can play a facilitating role • Sufficient scale and market share is essential for banks with a by being the counterpart of the off-taker and the borrower of rural orientation. the loan. A cross-liability system whereby the members guarantee one another’s loans could provide extra comfort to the bank. • Client linkage to corporate governance—for example, rural Also, systems involving warehouse receipts can provide additional and urban client shareholders or client panels—can positively financing to this target group; they have been used effectively by influence performance and safeguard the rural mission of the banks that Rabo Development has invested in. an institution. Emergent farmers justify an individual approach since they • Clear client segmentation linked to products and distribution have the potential to develop into commercial or professional channels is essential to effectively delivering products in the farmers with corresponding growth of financial services. Strict rural environment. criteria need to be established regarding minimum size, sufficient entrepreneurial spirit, basic understanding of business planning, and • Direct product distribution channels—including mobile-phone banking, ATMs, and electronic point-of-sale devices—are farm-management skills. With a combination of financial services becoming increasingly important for rural finance delivery. A and technical support, these farmers stand a fair chance of success. modern and up-to-date IT system is crucial to these services. Emergent farmers can be financed under the existing retail structure of a particular bank, but the local branches involved • Rural banks in Africa need to focus on both sides of the balance would need to hire and train agrifinance specialists who understand sheet (that is, offer an appropriate mix of savings and lending farming and have the ability to appreciate the particular risks products). Due to a lack of well-operating markets, they need associated with it (including, among others, climatic, disease, and to be largely self-financing. price risks). It is essential to form alliances with other stakeholders • Policy instruments based on risk or cost sharing can be in the value chain who also have an interest in developing and effective but need to be based on clear client segmentation. investing in the farming sector (for example, farmers’ organizations, In cases of sufficient payment capacity, they can be used commodity exchanges, agri-input providers, and off-takers). to overcome the lack of enforceable collateral or to make The main obstacles to financing agriculture are unpredictable the credit itself more enforceable. Clients with insufficient or erratic government behavior and interference in the agricultural payment capacity can only be assisted through income-support sector. This is especially the case in cash crops like coffee, which mechanisms, meaning grants not loans. are often important sources of hard currency, and in grains, of which African countries are often net importers. In several coffee- The Rabobank approach to financing agriculture exporting countries, the coffee export is not free but rather Among the most important lessons Rabo Development has regulated through auctions with only a limited number of private learned about building sustainable agrifinance in Africa is that exporters licensed. In grains, prices are often regulated by the segmentation of farmers is essential. In general, a small group of government to safeguard food security. This comes often at the commercial farmers is responsible for a large part of a country’s expense of local farmers who are struggling to break even, and it is agriculture production and exports, and often these farmers are aggravated by relatively high transaction costs and the weak market the only ones with access to financial services. A large group position of African farmers. of subsistence farmers who lack sufficient repayment capacity for bank loans resides at the bottom of the pyramid. The group Conclusion between the subsistence farmers and the commercial farmers The Rabobank approach is strongly focused on the value chain, as consists of both farmers of small cash-crops (for example, coffee, ultimately the farmer—who runs the price risk, to a large extent— cotton, or cocoa) with a low annual marketable surplus and so- will only be able to get a fair price when the whole chain operates called “emergent� farmers. The latter group has the potential to effectively. The success of agricultural development depends on the grow into commercial farmers but lacks both the financing and creation of a large group of professional local farmers producing farm-management expertise. high volumes of marketable output at a consistent quality. This will Financing small cash-crop farmers is only feasible through have a positive effect on reducing the transaction costs throughout a supply-chain approach. These smallholders should be financed the whole value chain. It is also imperative that all those involved indirectly via contract farming with better-rated “off-takers� (or share a common vision on development and contribute in effective, processors). Under such schemes, the farmer commits to supply constructive, and committed ways. n 100 percent of a particular crop to the off-taker, and the off-taker commits to buy 100 percent of the farmer’s product but pays that See more information at www.rabobank.com. Gerard van Empel (g.j.j.m.empel@rn.rabobank.nl) is general manager of Rabo International Advisory Services and director of Rabo Development. INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance Rural Banking: The Case of Rural and Community Banks in Ghana FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT ajai naiR and azeb FiSSha Focus 18 • BrIeF 5 • July 2010 B efore the late 1970s, rural dwellers in Ghana had almost no access to institutional credit for farm and nonfarm activities, and in many rural communities, secure, safe, and convenient savings of GHc 3.8 million (US$2.4 million), although values of the three indicators vary significantly among RCBs. Community ownership and governance. RCBs are fully and payment facilities hardly existed. In response to this situation, owned by shareholders who are residents of communities in which the Government of Ghana took several measures to increase access they operate. Each rural or community bank has a board of directors to credit in rural areas, including facilitating the establishment of that is responsible for its strategic governance. Boards are elected rural and community banks (RCBs). This brief discusses the history by owners/shareholders during annual general meetings. Election of RCBs, their business model, their services, and their financial criteria are normally based on reputation in the community and performance. It then draws some lessons relevant for others professional expertise, but experience in banking is extremely limited. involved in or planning similar initiatives. Professional management and staff. The core management As a network, RCBs are the largest providers of formal financial staff of a typical RCB is composed of a chief executive officer who is services in Ghana’s rural areas. By the end of 2008, Ghana had in charge of the daily management of the bank; an internal auditor, 127 RCBs with a total 584 service outlets, representing about half of responsible for internal control measures; a finance officer; and the total banking outlets in the country. The RCB network reaches credit and project officers. Many of the personnel are recruited from about 2.8 million depositors and 680,000 borrowers. Although the local communities. service delivery performance of the RCB network has been strong, Strategic alliance. Since 2002 the ARB Apex Bank has its financial performance has been mixed. The profitability and net provided specialized services essential to improving the quality worth of the network have grown, but the financial performance of and scope of products offered by RCBs, and it performs important some members has been poor, and a small number are insolvent. supervisory functions delegated by the Bank of Ghana. Among the main services offered by the Apex Bank are check clearing, specie The creation and evolution of the RCBs supply, treasury management, loan fund mobilization, and domestic The first RCB was established in a farming community in the Central and international money transfers. The Apex Bank provides most of region of Ghana in 1976. Several others were established in rapid these services on a fee basis. succession, and by 1984 the number of RCBs reached 106. By the Legal and regulatory framework. RCBs are incorporated early 1980s, however, the financial performance of many RCBs as limited liability companies and licensed by the Bank of Ghana started to decline for several reasons, including a 1983 drought, within the framework of the Banking Act. The minimum level of weak governing ability, conflicts within boards of directors, and capital required by RCBs is GHc 150,000 (US$116,135). RCBs whose ineffective management in many RCBs. capital falls below this minimum are not allowed to pay dividends The Bank of Ghana, the Ghanaian central bank, undertook or open new branches or agencies until they attain the minimum several reforms to curb the deteriorating situation. Exposure to level of capitalization. risky sectors (mainly agriculture) was limited, distressed banks were closed, supervision was strengthened, and RCB managers and Products and services boards of directors were offered training. Between 1989 and 1994 Savings. RCB savings products include savings accounts, current the Government of Ghana, with the support of the World Bank, also accounts, susu deposits (small savings collected daily from clients by implemented the Rural Finance Project, aimed at providing targeted individual collectors going door to door), and fixed or time deposits. support to the RCBs. The project contributed to an improvement in In a sample of 12 RCBs, regular savings deposits account for about RCB performance. 58 percent of the total number of clients and 57 percent of the total Nevertheless, several RCBs remained weak, and in 1998, the deposit balance. These accounts are small in size and short term. Bank of Ghana liquidated 23 RCBs. The Government of Ghana, with Susu is the second-largest account type, representing the support of the World Bank and other donors, implemented a 21 percent of total clients, but its share of total deposits is only follow-up project—the Rural Financial Services Project—between 11 percent because of the small size of each account. Fixed and 2001 and 2007 to help further strengthen the RCBs. This project special deposits that offer higher interest rates with long-term provided extensive training to RCBs and supported the establishment deposit contracts represent only about 1 percent of total clients. and strengthening of the Association of Rural Banks (ARB) Apex Credit. The credit products offered by RCBs include Bank, as a bank to the RCBs. (The Association of Rural Banks had microfinance loans, personal loans, salary loans, susu loans, and been established in the early 1980s as a networking forum for RCBs overdraft facilities. In a sample of 12 RCBs, salary loans amount to and later started providing training to member RCBs.) 33 percent of total advances, followed by personal loans (24 percent) and microfinance (20 percent). In terms of number of Business model borrowers, microfinance accounts for 31 percent of total borrowers Small asset base. RCBs are relatively small financial institutions followed by personal loans (26 percent) and salary loans with average share capital of GHc 136,526 (US$105,263), average (22 percent). RCB loans are used for agriculture, cottage industries, deposits of GHc 2.3 million (US$1.77 million), and average assets and trading. Money transfers and payments. RCBs participate in local • Small local financial institutions often cannot easily procure and international money transfers, and government agencies use needed technical support (such as training and specialized the RCB service outlets for salary and pension deposits. Clearing of technical assistance for product development and setting up checks for cocoa purchases is also an important service provided of operational systems) from the market. Hence, initiatives under the payment category. to build local financial institutions must support the creation of strategic alliances that can either provide such services or Performance facilitate their cost-effective provision. Apex institutions can Steadily increasing outreach and service delivery. Between 2000 play a crucial role in providing technical and financial services and 2008 the number of depositors in RCBs grew at an average to small financial institutions. annual rate of 14 percent, and the number of borrowers grew at an • Apex institutions may find it difficult to achieve financial average annual rate of 27 percent. The RCB network reaches about sustainability by providing services to members alone. Such 2.8 million depositors and 680,000 borrowers, making RCBs the institutions may have to also provide services to the public, largest group of licensed financial service providers in rural areas. including general commercial banking services. Care must be Clients of RCBs consist mostly of farmers, government employees, taken, however, to ensure that the business model adopted and small and micro-entrepreneurs. does not compromise the original mission—in this case, to Mixed financial performance. The profitability and net worth increase sustainable provision of financial services in rural areas. of the RCB network steadily increased from 2000 to 2008. Network- • The regulator needs to have the necessary skills, political wide capital is well above the minimum 10 percent required by the autonomy, and financial resources to effectively regulate and Bank of Ghana. In 2008, however, seven RCBs were insolvent, and supervise a large number of small financial institutions that the continued operation of poorly performing RCBs is a key issue are geographically dispersed. Often the central bank does not facing the network. The relatively high ratio of nonperforming loans have the skills to undertake this task directly, and alternative is another major factor affecting financial performance. In the models of supervision may have to be adopted. Even in the sample RCBs, for example, the proportion of the loan portfolio that best circumstances, however, a certain number of institutions was in default for more than 30 days was 16 percent, compared will fail, and the regulatory system needs to have the capacity with 3 percent for banks in their global peer group. to respond quickly to protect depositors and to prevent failure from lowering confidence in other institutions. Donor Lessons on rural banking funding cannot sustain a supervisory regime in the long run, The case of rural banking in Ghana points to the following lessons: and recovery of all supervision costs through fees from the • Although community-based financial institutions such as supervised institutions may not be a feasible option. Under these the RCBs can play a key role in increasing access to financial circumstances, adequate government funding for supervision services in rural areas, their small size can also make it would be critical for ensuring sustainable service delivery. n challenging for them to become financially sustainable and compete with other financial institutions that enter the rural financial market. To be successful, they should be able to For further reading: A. Nair and A. Fissha, “Rural Banking: respond dynamically to changes in the business environment. The Case of the Rural and Community Banks in Ghana,� These responses may include building linkages, being open to Agriculture and Rural Development Discussion Paper No. 48 mergers, and bringing in external investors, if necessary. (Washington, DC: World Bank, 2010). Ajai Nair (anair@worldbank.org) is program coordinator of the Agriculture Finance Support Facility in the Agriculture and Rural Development Department of the World Bank. Azeb Fissha (afissha@worldbank.org) is a consultant with the Agriculture and Rural Development Department of the World Bank. INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance Rural Leasing: An Alternative to Loans in Financing Income-Producing Assets FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT ajai naiR Focus 18 • BrIeF 6 • July 2010 C redit for investments that pay back in the medium to long term (three to five years or longer) is in short supply in rural areas. Credit unions and microfinance institutions (MFIs), which Box 2—Key features of a financial lease contract • Security: The primary security is the leased equipment. In some generally have better outreach than commercial banks in rural cases a small amount of cash or other asset owned by the areas, typically provide only short-term credit. Credit available from lessee may be taken as additional security. informal sources (such as moneylenders, family, and friends) is • Insurance: The lessor insures leased assets with commercial usually both short term and too costly for investment financing. For insurance and includes the cost in the lease price. rural enterprises seeking to acquire equipment—a typical investment need—to modernize production and thereby increase productivity, • Lease term: Lease terms range from two to five years. one solution may be financial leasing. • Lease cost: It includes cost of insurance, operating cost, loss Leasing offers several advantages. For traditional credit, provision, and profit. farmers and rural enterprises are particularly constrained by a lack • Lease payment schedule: The payment schedule can be monthly, of assets that can be used as collateral. Leasing overcomes this quarterly, half-yearly, or annual. constraint because it requires no collateral or less collateral than • Option to purchase: On completion of the lease payments, typically required by loans. Because leases also often require lower lessees have the option to purchase the leased assets at a down payments than the equity required for loans, they are more certain percentage of the lease cost. affordable for rural enterprises that have limited funds and little access to borrowed funds. Figure 1—Financial lease transaction From the lessor’s perspective, not having to obtain collateral is particularly advantageous in a rural context. Although the 8 difficulties involved in creating, perfecting, and enforcing security 3 are applicable in both urban and rural contexts in most developing Supplier Lessor 7 countries, they are more severe in rural areas where enterprises 5 are less likely to hold titles to their assets, asset registries are less likely to be functional, and judicial processes are likely to be slower. Lessors are also likely to benefit from not being restricted by interest 4 rate ceilings and sector-specific credit allocations—factors that have 6 7 1 2 traditionally constrained rural lenders. Boxes 1 and 2 explain key 9 features of a leasing contract, and Figure 1 shows a typical tripartite financial lease transaction involving an equipment supplier, a lessor, and lessee. Lessee 1. Initial negotiations about model, specification, price, Box 1—What is a financial lease? discounts, warranty, delivery, etc. At this time the method of payment for the asset may not have been discussed. 2. Request for a leasing quotation (the supplier may also Leasing is a contract between two parties, where the party that provide quotations on behalf of lessors). owns an asset (the lessor) lets the other party (the lessee) use the asset for a predetermined time in exchange for periodic payments. 3. Purchase contract agreement signed between lessor and Leasing separates use of an asset from ownership of that asset. supplier based on information supplied by the lessee to There are two main categories of leasing: financial leases and include those issues in (1) and also payment terms. operating leases. 4. Lease contract signed and downpayment paid by lessee. In a financial lease, lease payments amortize the price of the 5. Invoice created by supplier giving title in asset to lessor asset. At the end of the lease period, the lessee can purchase the (assuming full payment received by supplier). asset for a token price. The lessee is responsible for maintenance and risk of obsolescence of the asset. Because of the option 6. Asset delivered to lessee. to purchase the asset and the risks transferred to the lessee, a 7. Delivery and acceptance notice (protocol) signed by financial lease is a close substitute for a loan. Nearly all rural leases supplier and lessee. are financial leases. In contrast, operating leases do not include the option to 8. Supplier’s invoice paid by lessor. purchase the asset. Maintenance costs and risk of obsolescence are 9. Regular lease repayments paid. borne by the lessor, and leases are cancelable. Source: IFC (International Finance Corporation), Leasing in Development: Guidelines for Emerging Economies (Washington, DC, 2009). Rural leasing initiatives A good legal framework for leasing includes (1) clear definitions of a lease contract, leased assets, and responsibilities and rights of A 2006 World Bank case study of three profitable providers of the parties to a lease contract; (2) clarity in allocating responsibility leasing in rural areas showed that in all three cases the rural for liability for third-party losses arising out of the operation of portfolios were as profitable as their urban portfolios. Arrendadora leased assets; (3) stipulation of the priority of a lessor’s claim over John Deere, the largest provider of farm machinery leases in Mexico, a leased asset; and (4) a framework for easy and fast repossession had nearly US$63 million in farm equipment leases. DFCU Leasing, of leased assets. The use of internationally accepted accounting the largest provider of leases in Uganda, had a US$5 million lease standards and an unbiased tax code enhance the development portfolio in rural areas. Network Leasing Corporation Limited, a of the leasing sector. The existence of a well-functioning asset leading micro-leasing provider in Pakistan, had a lease portfolio of registry, the availability of insurance and maintenance services for more than US$2.4 million in rural areas. Low lease losses, strong equipment at a reasonable cost, and the existence of a good market client demand for asset financing, and a favorable legal and policy for used assets are also necessary for the development of the environment made rural leasing a profitable business for these financial leasing industry. companies. For clients, access to finance at a reasonable cost, low or Targeted institutional support may also be needed to help no collateral requirements, quick processing, and easy access to the develop the rural leasing sector. As shown in Boxes 1 and 2 and provider appear to be significant benefits. Figure 1, financial leasing is a relatively complex transaction. To Drawing on the experiences of the providers studied, the World successfully undertake financial leasing operations, organizations Bank study identified the following lessons on managing financial need not only well-trained staff, but also high-quality lease leasing in rural areas. origination processes, accounting and internal control systems, • Rural leasing is a means to acquire productive assets. and overall portfolio risk management. Types of institutional- All rural leases provided by the three leasing companies are level support that can help include (1) subsidies for startup costs financial leases and were used to finance the acquisition of of leasing operations to help offset the higher transaction cost assets (in contrast to renting of assets). and risk of operating in rural areas; (2) funding to establish links • Rural enterprises of different sizes benefit from leasing, between commercial providers and community-based or nonprofit but a provider may not be able to equally serve all organizations to increase scale; (3) technical support to leasing enterprises. Providers are limited because of differences in the companies; and (4) provision of equity, loans, or guarantees to skills and capacities required to effectively serve enterprises of expand rural outreach. varying sizes. A wide range of organizations—leasing companies, banks, financial cooperatives, microfinance organizations, and equipment- • Nonfarm enterprises account for a significant proportion selling companies—could benefit from such support. Institutional- of rural leases. level support can include capital support when access to long- • Rural leasing can be profitable, but jump-starting rural term funds is a critical constraint. Capital support combined with leasing will require government and donor support. All technical assistance can help leasing firms develop access to three firms studied benefited from access to government or sustainable sources of capital. n donor funds, particularly in expanding their rural operations. • A rural-only leasing company may not be viable. Because leasing is a specialized financial activity, economies of scale, cost, and risk factors may require that, in most economies, For further reading: IFC (International Finance Corpo- leasing companies have larger urban operations. ration), Leasing in Development: Guidelines for Emerging Economies (Washington, DC, 2009), available at www.IFC. org; A. Nair and R. Kloeppinger-Todd, “Buffalo, Baker- The challenge: Supporting increased availability ies, and Tractors: Cases in Rural Leasing from Pakistan, of leasing in rural areas Uganda, and Mexico� (Washington, DC: World Bank, Leasing is a viable tool to finance rural assets. The nature and 2006), available at www.worldbank.org/rural; A. Nair, R. capacity of existing financial institutions, the level of potential Kloeppinger-Todd, and A. Mulder, “Leasing: An Underuti- lized Tool in Rural Finance,� World Bank Agricultural and demand for investment finance in rural areas, and the level Rural Development Discussion Paper No. 7 (Washington, of development of the leasing industry should determine the DC: World Bank, 2004), available at www.worldbank.org/ mechanisms for supporting increased access to leasing for rural rural; G. D. Westley, Equipment Leasing and Lending: A Guide enterprises. Policy-level support will be required in countries that do for Micro-Finance, Best Practice Series (Washington, DC: not have a clear legal and regulatory framework for leasing. Such Inter-American Development Bank, Sustainable Develop- support must be sectorwide and not restricted to rural leasing. ment Department, 2003). Ajai Nair (anair@worldbank.org) is program coordinator of the Agriculture Finance Support Facility in the Agriculture and Rural Development Department of the World Bank. Azeb Fissha, consultant, provided research and editorial support. INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance Determinants of Microcredit Repayment in Federations of Indian Self-Help Groups FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT YanYan liu and KlauS deiningeR Focus 18 • BrIeF 7 • July 2010 S ince the establishment of the Grameen Bank in Bangladesh in 1976, microfinance has boomed. As of December 31, 2007, 3,552 microcredit institutions had reached 154 million clients ensure that public programs reach the poor. Although IKP program funds were initially made available to SHGs, they were shifted to village organizations and later to county organizations as soon as worldwide, about 106.6 million of whom were among the poorest these were established. when they took their first loan. Such expansion can be at least partly attributed to the widely adopted practice of group lending The survey in microfinance programs. In contrast to individual lending, group Data for this study come from a survey of 299 village organizations lending (or joint liability) grants a loan to a group of borrowers, conducted by the World Bank in 2006. This brief investigates and the whole group is liable for the debt of any individual member 3,350 expired loans made to members of 2,147 SHGs. In the survey, in the group. This practice allows microfinance programs to rely all loans taken by each member SHG in the village organizations mainly on accountability and mutual trust among group members between June 2003 and June 2006 were recorded from account rather than financial collateral to insure against default. Given that books of each organization. The study period started after the the poor often lack appropriate financial collateral, group lending majority of village organizations were formed and coincided with programs offer a feasible way of extending credit to poor people a major drive for SHG formation. Of the 40 million rupees (about who are usually kept out of traditional banking systems. US$1 million) of aggregate loan principal, about 60 percent of the There is considerable debate about whether such groups can be funds were provided by the IKP program, with the rest of the funds sustainable, achieving sound repayment performance while serving coming from banks, SHGs, and other sources. Only 63 percent of poor borrowers. The factors affecting repayment performance are loans from the IKP program were fully repaid, compared with thus of great policy relevance. This brief examines whether and 87 percent repayment for bank loans and 89 percent repayment for how much repayment is affected by three factors: the source of internal loans. the loan, groups’ provision of public goods in the form of insurance The survey provides information on loan terms (size, substitutes, and the monitoring and repayment rules of the source, length, interest rate, and repayment frequency), SHG federations of groups. The data come from more than characteristics (size, age, and membership composition), and village 2,000 self-help groups (SHGs), federated in 299 village organizations organizations’ monitoring and repayment rules. These rules differ in the Indian state of Andhra Pradesh. The SHGs under study were in four key dimensions: supported by a large World Bank program called the Indira Kranti • Delinquency management policies. These policies include fees Patham (IKP) program, with a cost of US$260 million. The program to SHGs that miss an installment and loan recovery committees has been replicated in other states in India and may be replicated to monitor SHGs’ creditworthiness (through a rating system, for in other countries. A better understanding of factors influencing example). Both would likely increase repayment probability. repayment will therefore help improve the performance and advance of the program. • Monitoring of SHGs’ financial affairs. Here, the study looks at three variables: whether the village organization (1) regularly Background of the IKP program inspects member SHGs’ books at monthly meetings; (2) employs a trained bookkeeper; and (3) regularly audits members’ books. Building on Andhra Pradesh’s tradition of SHGs, the IKP program Again, all of these steps should help reduce defaults. was launched in October 2000 to promote the formation of new groups and to strengthen existing ones. A typical program SHG • The extent to which the village organization provides public consists of 10–20 women members who meet regularly to discuss goods. The study considers whether in-kind rice credit and social issues and engage in social activities. During these meetings marketing services are provided. The in-kind rice credit is a each member deposits a small thrift payment into a joint bank program whereby the village organization acquires subsidized account. Once enough savings have been accumulated, group rice in bulk under the public distribution scheme and makes it members can apply for internal loans that draw on accumulated available to SHG members as an in-kind credit, with any savings savings at an interest rate to be determined by the group. Once from the bulk purchase passed on to members in the form of the group establishes a record of internal saving and repayment, lower prices. Marketing services are the collective activities that it becomes eligible for loans through a commercial bank or IKP help SHG members gain access to markets—for example, buying program funds. and selling in bulk to obtain more favorable prices or to reduce An important component of the program is to support the transaction costs. Because such benefits can be cut off in case federation of SHGs at the village and mandal (block/county) of default, they should enhance repayment incentives, especially level through formation of village organizations and county when alternative sources for these benefits are unavailable. organizations. The purpose of federation is to capitalize on • The extent to which SHGs are required to deposit regular economies of scale in capacity building, credit, and insurance and to thrift payments with the village organization. The village organizations’ collection of thrift from member SHGs provides very poor members would reduce full repayment by only cash collateral that can be withheld in case of default and thus 1.7 points. Here the trade-off between sustainability and service to should increase repayment incentives. the poorest is much smaller than suggested by some other studies. In the sample of 299 village organizations, 36 percent applied Neither caste composition nor homogeneity has a significant a sanction for SHGs that miss an installment, 41 percent had a impact on repayment. loan-recovery committee, 35 percent provided in-kind consumption credit, 25 percent provided marketing services, 47 percent Summary and policy implications collected thrift from their member SHGs, 82 percent employed In contrast to most existing literature that studies the effects of trained bookkeepers, 37 percent of the SHGs in the sample were group and individual attributes on loan repayment in microcredit regularly audited, and 23 percent presented their books at village groups, this study investigates the effects of exogenous monitoring organization meetings. and loan recovery arrangements, together with loan and group characteristics. Because banks and others can provide microfinance Factors influencing loan repayment institutions with additional resources contingent on adoption of The model used to estimate the effects of various factors on certain minimum rules, the findings from this study could be of repayment shows that monitoring and loan recovery arrangements great practical relevance. The results highlight the following four are highly significant, both statistically and economically. Regular policy implications: audits, checking of SHG books at village organization meetings, 1. Repayment rates are significantly lower on loans originating and depositing of SHG savings with the village organization in externally provided grant resources managed by village are estimated to increase the probability of full repayment by organizations. This finding highlights the need for further 8.3, 9.5, and 20 percentage points, respectively. Although the inquiry on why this is the case and how to improve the village organization’s involvement in marketing has no impact on repayment performance of loans from grant resources. repayment, in-kind consumption credit is predicted to increase the 2. Among SHGs, external management policies (such as regular probability of full payment by 12.7 points, suggesting that non- monitoring and audits and in-kind consumption credit) and economic benefits from credit groups increase repayment incentives. loan terms (group savings deposits with the lender, frequency This finding also implies that village organizations are better of repayment) appear far more important to full repayment positioned to help smooth consumption and address credit market than group characteristics such as the poverty level of imperfections than to intervene in output markets. members. This result suggests that, in this context, even The results also suggest that SHGs are more likely to fully repay groups composed of very poor borrowers can achieve high loans from banks—by 18.6 points according to the estimate—than repayment rates if village organizations adopt proper rules loans from the IKP program. The program’s lower repayment rate and management practices. Furthermore, SHG federations and points to limits in village organizations’ credibility, possibly because other external group supervisors should consider implementing of their relatively recent establishment. High installment frequency the management policies that can encourage full repayment. has an almost equally large effect (15 points), consistent with the notion that frequent small installments enhance repayment 3. Third, the results suggest that the optimal size of a group is performance for households with credit constraints. As have other about 14 members. This finding can provide some guidance in studies, this study found that full repayment is less likely for loans group formation. n with longer duration and, less significantly, higher interest. For further reading: C. Ahlin and R. M. Townsend, “Using Other studies have found mixed evidence on the impact of Repayment Data to Test across Models of Joint Liability group characteristics, but the results of this study suggest that Lending,� Economic Journal 117, no. 2 (2007): F11–51; R. Cull, the probability of repayment increases with the size of the group A. Demirguc-Kunt, and J. Morduch, “Financial Performance up to about 14 members and decreases thereafter. In contrast, and Outreach: A Global Analysis of Leading Microbanks,� the probability of repayment decreases with the length of time Economic Journal 117, no. 2 (2007): F107–33; M. Sharma and the group has been in operation up to about five years. Although M. Zeller, “Repayment Performance in Group-Based Credit groups with a high percentage of poor individuals show lower rates Programs in Bangladesh: An Empirical Analysis,� World of full repayment, the magnitude is small: a 10-point increase in Development 25, no. 10 (1997): 1731–42. Yanyan Liu (y.liu@cgiar.org) is a research fellow in the Markets, Trade, and Institutions Division of the International Food Policy Research Institute (IFPRI). Klaus Deininger (kdeininger@worldbank.org) is a lead economist at the World Bank. This brief is based on Klaus Deininger and Yanyan Liu, “Determinants of Repayment Performance in India Microcredit Groups,� World Bank Policy Research Working Paper No. 4885 (Washington, DC: World Bank, 2009). INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance M-PESA: Finding New Ways to Serve the Unbanked in Kenya FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT SuSie lonie Focus 18 • BrIeF 8 • July 2010 O ver the past three years, payment strategies for emerging markets have been revolutionized by the advent of a simple cell-phone-based payment service in Kenya called M-PESA (“M� two years, M-PESA had become the most frequently used money- transfer mechanism (see Figure 1 in Appendix A). The need for fast, safe money transfers, particularly to those for “mobile� and “pesa� for “money�). From a small-scale pilot in rural communities, is obvious; and the benefits have been program in 2006, M-PESA has become an outstanding success in much reported in the Kenyan press and by nongovernmental Kenya; customer response has been unprecedented. Currently, more organizations. However, by extending functionality and thinking than 9 million Kenyans use M-PESA to perform tens of millions of laterally, M-PESA has been expanded to further serve the unbanked transactions every month throughout the country. Although this of Kenya. success has led to new opportunities, it has also brought about many unforeseen challenges. Bill payments The option for customers to pay their bills via cell phone was What is M-PESA? recently added to the M-PESA menu. Designed to allow people to Vodafone, the world’s leading international mobile communications pay their regular bills—such as utilities, school fees, and rent—this group, based in the United Kingdom, originally developed M-PESA feature has become a means of payment collection for many other with funding from the Department for International Development businesses as well. Of particular relevance to rural communities, (DFID) as a pilot program to extend the growth of financial markets even the provision of clean drinking water has been improved to the unbanked (people without access to conventional banking through the use of M-PESA. Grundfoss, a Danish company, services) in East Africa. In March 2007, M-PESA was launched developed an entrepreneurial solar-powered metering system to in Kenya in partnership with Safaricom, Kenya’s leading mobile pump clean water from boreholes into rural areas. Pumps can be telecommunications company. It quickly became clear by the paid for by a “smart card� (a prepaid card with a memory chip), but demand from the unbanked that this cell-phone-based, money- finding means to apply credit to these smart cards in the rural areas transfer business was a welcome commercial opportunity across where water pumps were situated was a problem—until M-PESA Africa and elsewhere. arrived. Customers sent money to Grundfoss using the “Pay Bill� In emerging economies, it is common for some wage earners feature, and their smart card was automatically credited and ready to work away from home and send domestic remittances back to use. This payment system is now available wherever Grundfoss to their extended families in rural areas. The initial focus of water pumps are deployed. M-PESA, therefore, was to enable these workers to send money Additionally, several microfinance institutions (MFIs) are now home via faster, safer, and more affordable means than those using M-PESA’s bill-paying feature for loan repayment collection. previously available to them. M-PESA allows customers to send This eliminates the time loan recipients used to spend travelling money home (and make a variety of other payments, described to urban areas to deposit cash into their MFI bank accounts; this below) without a bank account. People can begin using the time can now be better spent attending to their farms or small system simply by registering for free at certified M-PESA agents, businesses. Similarly, insurance and microinsurance premiums can which include retailers such as supermarkets, gas stations, and now be paid using M-PESA. shops that sell prepaid airtime cards. In fact, several banks have even become M-PESA agents. Customers can use cash to “buy� Business payments electronic money (e-money) from an agent, then use their phones The “Business Payments� feature allows a business to pay a number to perform financial transactions (for example, to send money to of customers or employees through their M-PESA accounts. This another person or buy additional airtime). The e-money can also be service was originally introduced at the request of Safaricom’s converted into cash by selling it back to an agent. Agents are paid temporary staff working in rural areas. These low-income workers a commission for providing cash-in and cash-out services and for previously had to travel to a Safaricom office in the nearest town to registering customers. pick up their paychecks and deposit them into bank accounts; it was Transaction values are typically low; M-PESA moves smaller a time-consuming activity at best. Now they receive their wages amounts of money than banks would normally service. As M-PESA directly through their M-PESA accounts. It has proven so popular gains acceptance, however, it is also becoming attractive to people that the organization recruited to provide M-PESA training to new who already have bank accounts as a way to pay out wages to, agents around Kenya actually started to use the payment feature for example, tradesmen and household staff—who are, of course, for its own staff expenses. Many other companies are now using M-PESA’s targeted customers. M-PESA to pay field operatives working remotely from regional offices. Safaricom also recently offered shareholders the opportunity M-PESA: Beyond “sending money home� to receive their annual dividend payments via M-PESA; many There is no doubt that giving M-PESA customers the ability to send thousands of Kenyans—who had become first-time shareholders money home was a feature that filled a gap in the market. Within when Safaricom issued public shares in 2008—accepted the offer. Agent management tools of person-to-person money transfer, and subscriber numbers grew In rural areas, the only suitable outlets to become M-PESA agents well beyond projections. Initial predictions estimated 320,000 users are often small family-run stores. While it is not commercially in the first year of trading: Nine months after launch, M-PESA feasible for M-PESA to have a direct business relationship with registered its one millionth customer. It was an exciting success. As thousands of “Mom-and-Pop� shops across Kenya, a partnership with any new business that unexpectedly finds itself growing much of some kind would be advantageous to all parties. To resolve this faster than anticipated, however, there were numerous implications, conundrum, M-PESA created the aggregator model in which a each with significant costs. distributor is appointed to recruit and manage agents in these small • Budget flexibility: The rapid growth required a significantly stores and in return gets a share of the M-PESA commission earned reworked budget. For example, customer acquisition costs by that store. money because agents have to be paid to register customers, To further accommodate the growing system, M-PESA had to and the cost of new SIM cards—which are free to new address the issue that when an agent runs out of “float�—either customers—needs to be covered. It takes time for new customers e-money or cash—they cannot service their customers. With the to become mature users and start generating revenue, so huge expansion, getting more e-money into the system was a signing up more than 10,000 new customers per day had a requirement and, oftentimes, a challenge since conventional serious impact on cash flow in the early life of the product. banking takes some time to clear deposits before new e-money • Customer support: M-PESA needed a significantly larger call can be issued, during which time an agent who has run out cannot center and a lot more customer service representatives than offer M-PESA. To reduce this problem, larger agents rich in cash or were originally anticipated. e-money were given the ability to act as agents to smaller shops. Thus, a smaller outlet can now buy or sell e-money from one of • System capacity: At the time of M-PESA’s launch, the system these larger, richer “super agents.� Float management is a particular had a technical design that could cope comfortably with problem in rural areas where agents tend to net more withdrawals the original business case plus a sensible safety margin; than deposits, or, in other words, they tend to be e-money rich but this capacity was rapidly exceeded and had to be regularly cash poor. The capability of these super agents has helped speed up expanded to include new features at significant expense. the turnaround of e-money and cash, allowing small agents to have • Managing agent demand: A sufficient number of agents had less money tied up in M-PESA and yet still have more float available. to be sought out, enrolled, and trained. As retailers and outlets Bank branches that were reluctant to become regular M-PESA came to understand the business opportunity, however, the agents for customers conducting small transactions have been happy situation reversed; their demand was such that the Safaricom to act as super agents for businesses operating with larger sums. sales office had to cater to the crowds of would-be agents. This also gives these banks the opportunity to promote and sell their Extra staff members were also required to process applications banking services to more businesses. Many small business owners and provide ongoing agent training. acting as M-PESA agents now have their first ever bank account. Conclusion Banking services As problems go, those associated with rapid growth are the best M-PESA is now giving cell-phone users access to formal banking kind to have, but they are challenging nonetheless. Substantial costs services. In May 2010 Safaricom and Equity Bank, a leading bank were incurred far earlier than anticipated, pushing back the expected in Kenya, launched an initiative to offer every M-PESA user the break-even date. Working on the basis that budget shortfall would opportunity to open a savings account. Customers use M-PESA to soon be forgotten while unexpected customer growth would both deposit money into and withdraw money from their savings be remembered for years to come, M-PESA managed to secure accounts. Called M-KESHO (kesho is Swahili for “tomorrow�), this additional funds. Now, alongside increasing demand, a critical mass service effectively gives millions of rural Kenyans access to banking of mature customers is growing to support the need for revenue. services for the first time. There is still much to do, but as M-PESA approaches its third birthday in Kenya, it is well prepared to tackle whatever comes next. n M-PESA: Perks and pitfalls It became clear soon after M-PESA’s launch that the service See more information at www.safaricom.co.ke/index. provided an effective and convenient means of making any sort php?id=745. Susie Lonie (Susie.Lonie@vcontractor.co.za) is a mobile commerce expert and currently the executive head of financial services at Vodacom (Pty) managing the rollout of M-PESA in South Africa. Lonie managed the design, piloting, and implementation of M-PESA in Kenya. INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance Biometric Technology in Rural Credit Markets: The Case of Malawi FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT XavieR giné Focus 18 • BrIeF 9 • July 2010 I dentity theft is a common crime the world over. In developing countries, the damage caused by identity theft and identity fraud goes far beyond the individual victim, however, and ultimately applied for an agricultural input loan in 2007. Farmers in the study were randomly allocated to either a control group or a treatment group; each member in the latter group had a fingerprint collected creates a direct impediment to progress, particularly in credit as part of their loan application and an explanation that this would markets. Recent research reveals that biometric technology can help be used to determine their identity on any future applications. reduce these problems. (Fingerprint recognition was used instead of face, iris, or retina A biometric is a measurement of physical or behavioral recognition because the technology has been commercially available characteristics used to verify or analyze identity. Common since the early 1970s, and there is a highly competitive market for biometrics include a person’s fingerprints; face, iris, or retina it. Therefore, it is inexpensive, well known, and widely used.) Both patterns; speech; or handwritten signature. These are effective treatment and control groups were given a training session on the personal identifiers because they are unique and intrinsic to each importance of credit history in ensuring future access to credit. person, so, unlike conventional identification methods (such as The study shows that within the subgroup of farmers who had passport numbers or government-issued identification cards), they the highest ex ante default risk, fingerprinting led to increases in cannot be forgotten, lost, or stolen. repayment rates of about 40 percent. By contrast, fingerprinting had Recent advances in recognition technology coupled with no impact on repayment for farmers with low ex ante default risk. increases in both digital storage capacity and computer processing These higher repayment rates are due to fingerprinted borrowers speeds have made biometric technology (for example, ocular or requesting smaller loan amounts to ensure they would be able to fingerprint scanners) feasible in many applications, from controlling repay them and devoting more land and inputs to paprika, thus restricted building access to allowing more effective delivery of diverting fewer resources to other crops; the same cannot be said targeted government programs with large-scale identification for their nonfingerprinted counterparts. systems, such as those being implemented in India by the Unique A rough cost–benefit analysis of the pilot experiment suggests Identification Authority of India. that the benefits from improved repayment greatly outweigh the Biometric technology can also improve access to credit costs of biometric equipment and fingerprint collection, which and insurance markets, especially in countries that do not have accounts for basic training and the time it takes credit officers a unique identification system, where identity fraud—the use to collect biometric data. These costs, however, do not include of someone else’s identity or a fictitious one—to gain access to a full implementation plan, which would likely require software services otherwise unavailable to an individual is rather common. integration, expanded data-storage facilities, upgraded equipment, For example, lenders in Malawi describe past borrowers who and more in-depth staff training. purposefully defaulted then tried to obtain a fresh loan from the same or another institution under a false identity. And, although Challenges in the implementation less common in developing countries because markets are less of biometric systems developed, the potential for sick individuals without healthcare Despite the encouraging results from the pilot in Malawi and coverage to use the insurance policy of a friend or relative does the success of biometric technology in controlled laboratory exist. The response of lenders and insurance companies has been to environments, there are still concerns and challenges when restrict the supply of such services to the detriment of the greater collecting and using such information in real life and when trying to population, not just those people committing identity fraud. establish an identification system at a national level. In the case of credit, biometric technology can make the idea of • Not everyone can participate in a fingerprint-based future credit denial more than an empty threat by making it easier identification system. Fingerprints can be unrecognizable for financial institutions to withhold new loans from past defaulters due to cuts or burns. In addition, older individuals may have and reward responsible past borrowers with increased credit. As a fingerprints that have worn with age, and the operation of result of this inability to “cheat the system,� individuals may take fingerprint readers may be jeopardized due to arthritis. In some out smaller loans that they are able to repay or avoid borrowing areas, especially those with past or present conflict, individuals altogether if they cannot pay back any debt. Borrowers may have may lack fingers altogether. In the most comprehensive study greater incentives to ensure that production is successful, either by to test the process and customer attitude during the recording exerting more effort or choosing less risky projects, and—whenever of biometric information, the United Kingdom passport service production could cover the loan repayment—borrowers may be less trial reports an enrollment success rate of 100 percent for the likely to default intentionally or opportunistically. 9,250 nondisabled participants and 96 percent for the To look at the impact of biometric technology, Giné, Goldberg, 750 disabled participants. In Malawi, only about 2 percent of and Yang (2009) implemented a field experiment using the sample of 1,600 fingerprinted farmers had to have their 3,200 smallholder paprika farmers in four locations in Malawi who left thumbprint recorded when the scanner failed to capture the required right thumbprint. This is surprising, as it turns out, Economics and Political Science found that the government because many Malawian farmers grow tobacco, which requires underestimated the implementation of the Identity Cards the heavy use of fingertips in the transplant of seedlings. Over Bill. The report suggests that the ten-year rollout would cost the years, their fingerprint ridges may become too worn to be between 10.6 billion and 19.2 billion pounds (compared to the read or captured by a fingerprint scanner. government estimate of 5.84 billion pounds over the same • The accuracy of biometric technology remains, to a large period), excluding public- or private-sector integration costs. extent, untested. Biometric companies report very high • Biometric technology is not infallible. While biometric accuracy rates from highly controlled trials that typically use identification systems can help combat identity theft, fraud, artificially generated data. However, because the performance and money laundering, they are essentially technological of a technology depends greatly on the context in which it applications and, as with any other technology, can be hacked is used, trials using real-life data are far less impressive. For or infiltrated. These systems therefore run the risk of having example, the United Kingdom passport service trial reports data fall into the wrong hands. Since biometric technology that only 80 percent of the participants could be correctly is only being piloted on a large scale in some pockets of the verified by their fingerprints, and younger individuals were world at present, legitimate concerns on privacy do arise. For more successfully identified than older ones. In Malawi, example, it is possible to imagine that identification-database however, everyone selected during demonstration sessions was workers will be threatened, blackmailed, and possibly corrupted. correctly identified. After all, the perpetrators of 80 percent of all computer security • Individuals may have a negative attitude toward providing their lapses are not hackers, but employees. biometrics. People may be reluctant to place their fingers on • It is important that a common platform be used if biometric scanners due to hygiene concerns. More importantly, there is data are merged with other datasets. Biometric data are stored the widespread public perception that fingerprinting is linked in formats that may not be compatible with the information to the criminal justice process. Therefore, in conflict-affected systems of other government agencies, so an effort must be countries that are stricken by ethnic infighting, individuals made to have compatibility if biometrics are to serve as the may refuse to provide biometrics for fear of persecution by basis for a national identification system. authorities or others who could gain illegal access to such biometric records. The parliamentary debates concerning the United Kingdom’s identification cards bill revealed that Conclusion 55 percent of poll respondents thought the collection of Despite these concerns, biometric technology presents an exciting biometric information was an infringement of civil liberties. The and innovative opportunity for increased access to financial markets authors did not encounter any such resistance from farmers in and better delivery of social assistance programs such as conditional Malawi, perhaps because the technology was very novel. cash transfers, aid distribution, or subsidized inputs or commodities. • The cost of collecting biometrics can be high. The estimates Whether it can be scaled up effectively and used to resolve are sparse, and detailed cost–benefit analyses have not been identification and authentication issues is a challenge that requires systematically conducted. However, the costs of using different more research. n types of biometric technology—from basic fingerprinting For further reading: X. Giné, J. Goldberg, and D. Yang, techniques to voice- and iris-recognition software—can be “Identification Strategy: A Field Experiment on Dynamic prohibitively expensive. In India there are legitimate concerns Incentives in Rural Credit Markets,� mimeo (Washington, that the costs of rolling out biometric technology may mean a D.C.: World Bank, 2009); U.S. General Accounting Office, huge opportunity cost for more than 700 million Indians living Using Biometrics for Border Security (Washington, D.C.: in poverty to receive social benefits. In the United Kingdom, a 2002); London School of Economics and Political Science critical report by several researchers at the London School of (LSE) Identity Project, www.identityproject.lse.ac.uk. Xavier Giné (xgine@worldbank.org) is a senior economist in the Research Development Group at the World Bank. INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance Credit Risk Management in Financing Agriculture FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT MaRK d.WenneR Focus 18 • BrIeF 10 • July 2010 A griculture is an inherently risky economic activity. A large array of uncontrollable elements can affect output production and prices, resulting in highly variable economic returns risk to third parties through, for example, portfolio securitization or credit insurance, which were common in mortgage and consumer finance markets in developing countries prior to the 2008 financial to farm households. In developing countries, farmers also lack crash. If more farm borrowers held agricultural insurance policies, access to both modern instruments of risk management—such as this could serve to reduce credit risk for financial institutions, agricultural insurance, futures contracts, or guarantee funds—and but agricultural insurance markets are grossly underdeveloped ex post emergency government assistance. Such farmers rely in middle- and low-income countries. For example, agricultural on different “traditional� coping strategies and risk-mitigation premiums totaled US$18.5 billion worldwide in 2008, but the techniques, but most of these are inefficient. Formal and semiformal United States and Canada accounted for 62 percent of the premium arrangements—such as contract farming, joint-liability lending, and volume. Latin American, Asian, and African regions, home to most of value-chain integration—have arisen in recent decades, but they the lower-income countries, accounted for 21 percent, or too are limited and can be very context sensitive. One consequence US$3.88 billion. Moreover, the leading countries in terms of of inadequate overall financial risk management is that farmers in agricultural insurance development—the United States, Canada, general face constrained access to formal finance. The smaller the and Spain—all depend on heavily subsidized schemes that would be net worth of the farm household, the worse the degree of exclusion. difficult to replicate in other places. Formal lenders avoid financing agriculture for a host of Thus, most of the strategies available to financial intermediaries reasons: high cost of service delivery, information asymmetries, lack in developing countries involve coping with and absorbing of branch networks, perceptions of low profitability in agriculture, credit default risk. There are two broad means of evaluating lack of collateral, high levels of rural poverty, or low levels of farmer creditworthiness: appraisal of repayment capacity and asset- education and financial literacy. But, predominantly, bank managers backed lending. The former approach focuses on analyzing the around the world say they will not finance agriculture because debt-paying capacity of a potential borrower using either human of the high degree of uncontrolled production and price risk that experts or statistical models, while the latter focuses on the quality confronts the sector. A farmer can be an able and diligent manager and quantity of assets that can be pledged as collateral and how with an excellent reputation for repayment, guaranteed access to quickly that collateral can be liquidated in the event of a default. a market, and high-quality technical assistance, but an unexpected Since titled assets are scarce outside of large farms and extensive drought or flood can force him or her to involuntarily default. In databases on farm enterprises rarely exist in developing countries, emerging countries with fair to high levels of agricultural market the following represent the four credit risk-management techniques and trade integration, large commercial farmers may escape this used successfully by rural financial intermediaries. predicament because they have the ability to purchase insurance, Expert-based credit evaluation systems: Trained credit engage in price hedging, obtain financing overseas, or liquidate officials conduct financial analysis of the client, focusing on assets quickly in the event of a default. Consequently, formal household cash flow, market situation, assessment of managerial lenders tend to overemphasize the use of immoveable collateral as or entrepreneurial ability, and reputation. Institutions can have the primary buffer against default risk, which means they provide centralized or decentralized systems to approve client requests services to a limited segment of the farm population. Small- and as long as both systems include performance incentives for and medium-sized farmers, who constitute the vast majority of farm investments in staff members, who should be recruited from the operators, often do not have secured-title land, which is the region of operations. To quickly determine client willingness to repay preferred type of collateral; if they do, its value may be insufficient loans, staff members need access to credit bureaus or borrowers’ to cover the loan in question. Even if farmers have sufficient titled utility bill payments. Agriculture requires a wide range of experts land to collateralize loans, they may refuse low-interest formal loans since it is such a heterogeneous field; therefore, an expert-based and assume high-interest informal ones that have no collateral evaluation system is expensive to both develop and maintain. requirements instead. They may also use savings to finance Portfolio diversification: In order to dilute risk, intermediaries agricultural production because they are averse to risking their most consciously seek to diversify the agricultural loans approved prized possession—land. The result is limited supply or access to by geographic region, commodity, and type of household. This formal agricultural financing, even though much of the population technique can be implemented only by large institutions that of Sub-Saharan Africa and South Asia is rural and depends on operate in more than one agroclimatic zone, however. agriculture and livestock rearing for their main livelihood activities. Portfolio exposure limit: Because agricultural lending is risky and expensive, high-performing financial intermediaries tend to limit Typical risk-management mechanisms in rural exposure to agriculture in their loan portfolio. For example, recent financial intermediaries survey data in Latin America found that the average share is less In developing countries, formal and semiformal rural financial than 40 percent. The smaller the share agriculture has in a total loan intermediaries have limited or nonexistent means to transfer credit portfolio, the less vulnerable the institution is to systemic external shocks that could severely depress earnings performance and the diversification through mobilization of savings, access to capital more cross-subsidization can occur. High-margin financial products— markets, and the provision of long-term lines of credit that could such as consumer finance and urban microfinance—can compensate facilitate more term lending. Nevertheless, donors and governments for lower profit margin products, such as agricultural loans. must price the discount line of credits in a manner that will not Excessive provisioning: The last line of defense is called undermine savings mobilization. “loan loss provisioning,� meaning an internal absorption of credit risk. Adequate provisioning according to a risk-classification Conclusion scheme helps to protect the intermediary from liquidity and capital In short, risk management needs to improve dramatically so that adequacy crises. Some leading agricultural lenders in Latin America, agricultural finance can flourish. Strides have been made in recent for example, provision from 121 to 260 percent of doubtful loans. years in reducing information problems and transaction costs Heavy provisioning, however, clearly constrains the volume of through, respectively, peer-group lending and a greater reliance on lending, ability to make a profit, and client outreach potential. information and communication technology. Uncontrollable risk, however, continues to be a major impediment to the development Implications for managers of financial of more efficient rural financial markets. Renewed private–public institutions and public policymakers sector efforts and higher amounts of investments will be required There are numerous implications of these credit risk-management at various levels to address these issues. At the farmer level, techniques. First, the credit risk evaluation systems are labor governments need to spur the rebuilding of farm extension services, intensive with high costs, which, in turn, contribute to high lending while farmers need to become more financially literate and save interest rates. Public-sector policymakers need to understand this, more so they can retain some of the risks. Governments, donors, so they avoid imposing interest rate ceilings or forcing publicly and insurance companies need to collaborate in the development owned banks to charge interest rates that are lower than their true of yield-insurance products that are inexpensive, sustainable, and operating costs because results would then be counterproductive. appropriately designed. Governments, commodity exchanges, and Additionally, fewer intermediaries would be willing or able to serve financial institutions likewise need to collaborate in developing the sector. Therefore, both policymakers and managers should focus futures, structured finance products, and other hedging instruments on developing and implementing institutional innovations—such to reduce price risk. as credit bureaus, applications of information and communication At present, the lack of high-quality weather data, inadequate technology, and delegated agent models of service delivery—that distribution of weather stations, limited supply of people with risk- will reduce overall operating costs. modeling capabilities and expertise in agricultural risk management, Second, agricultural lending cannot be the primary type small capital markets, and weaknesses in regulatory and legal of lending unless robust risk-transfer techniques (for example, infrastructure hamper the pace of progress. Since the depth and insurance, futures, and securitization) become more commonplace. efficiency of financial markets are highly correlated with the speed In place of land, alternative forms of collateral—including warehouse of overall economic development, innovative methods of improving receipts, accounts receivable, equipment, and standing crops or rural financial services will be critical in facilitating and sustaining livestock—should be more widely accepted. Improved contract any marked improvement in rural welfare. n enforcement should be aggressively promoted as well. These developments would all serve to lower lender risk. Many of these For further reading: H. Bhattacharya, Banking Strategy, innovations and institutional developments require legal and Credit Appraisal and Lending Decisions: A Risk-Return Frame- regulatory reforms, modernization of property registries, investments work, (New Delhi, India: Oxford University Press, 1996); J. in information infrastructure, and massive education efforts. B. Caoutte, E. I. Altman, and P. Narayanan. Managing Credit Third, the majority of institutions involved in agricultural Risk: The Next Great Financial Challenge, (New York: John lending are small and unregulated. They are using adapted Wiley and Sons, Inc., 1998); C. Trivelli, and A. Tarazona, microcredit-lending technologies that do not fully meet the Riesgo y Portafolios Agropecuarios: Lecciones desde la Expe- riencia de Instituciones Financieras de América Latina, Docu- needs of farmers, especially those needs regarding loan term and mento de Trabajo 151 (Lima, Perú: Instituto de Estudios repayment frequencies. These shortcomings pose default risks in Peruanos, 2007), www.iep.org.pe/textos/DDT/DDT151.pdf; and of themselves. The larger institutions that have the scale and M. Wenner, S. Navajas, C. Trivelli, and A. Tarazona, Manag- scope tend not to enter into agricultural lending because they ing Credit Risk in Rural Financial Institutions in Latin America, do not have the strategic commitment, proper staff, or branch Sustainable Development Department Best Practices Series networks. Donors and governments can play a vital role in assisting MSM 139 (Washington, D.C.: Inter-American Development these smaller institutions to grow, consolidate, and eventually Bank, 2007); World Bank, Doing Business database, www. merge. They can also help rural financial intermediaries with liability doingbusiness.org/economyrankings. Mark D. Wenner (markw@iadb.org) is a lead financial specialist in the Capital Markets and Financial Institutions Division of the Inter-American Development Bank. INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance New Approaches for Index Insurance: ENSO Insurance in Peru FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT jeRRY R. SKeeS and benjaMin CollieR Focus 18 • BrIeF 11 • July 2010 T he El Niño Southern Oscillation (ENSO) is a climate event associated with warming sea surface temperatures in the Pacific Ocean. In years of extreme El Niño events, areas in northern number of individuals must suffer losses at the same time. Given that many individuals suffer a loss at the same time, risk aggregators will also suffer serious losses. Thus, correlated losses from natural Peru experience catastrophic flooding. As of 2010, it is possible disasters constrain the development of credit markets for the rural for stakeholders in northern Peru to purchase a new form of poor, particularly for those involved in agriculture. Lenders cannot insurance that pays out just as flooding begins and stakeholders absorb the risk exposure of a large number of borrowers who may be begin incurring extra costs and consequential losses. Given the high unable to pay off loans after a major natural disaster. basis risk associated with selling index insurance to households, Likewise, an insurer deciding to write any form of insurance this insurance is designed for firms and institutions that serve against extreme weather events must have a means to transfer these households that are highly exposed to El Niño. ENSO insurance risks—generally through a global reinsurer. Insurers in developing is sold by a Peruvian insurance company, and a major global countries often find obtaining access to reinsurance markets reinsurer carries most of the risk. This new insurance product is difficult. If the index being used is fully transparent, the global the first insurance to use sea surface temperature as the proxy reinsurer is more likely to feel comfortable with the systems used to for catastrophic losses and also the first regulated “forecast index estimate the index. This is certainly the case for ENSO measurements, insurance� product in the world. This innovation could enhance which have been developed over more than 50 years by the U.S. progress in developing index-based insurance products for extreme National Oceanic and Atmospheric Administration (NOAA). weather events. Extreme weather events such as drought and flooding can also Recent years have seen a growing number of pilot tests have associated consequential losses that extend beyond traditional of index insurance for weather risk, motivated by an increased crop insurance, which pays for losses of a specific crop. For example, understanding of how natural disasters affect developing countries. in a number of African countries, where owning livestock is a form Beyond immediate suffering (including deaths, destroyed assets, and of savings, extreme droughts compel large numbers of farmers to lost income), disasters have troublesome indirect effects: economic sell their livestock at the same time. Distressed sales of livestock growth can be disrupted, the poor are thrust into permanent on local markets depress local prices, compounding losses. Floods poverty traps, and the mere presence of these risks constrains access and droughts also generally influence the quality of crops, not just to financial services and causes many decisionmakers to pursue low- yields. Moreover, risk-management strategies to diversify cropping return, low-risk strategies that impede economic progress. enterprises can quickly prove ineffective if droughts or floods Much of the development of index insurance focuses on negatively affect all of the crops at the same time. agriculture, because activities associated with agriculture remain the primary livelihood strategies for the rural poor in developing ENSO insurance as a form of business- countries. Thus far, most index insurance pilots have involved interruption insurance products targeted at households—that is, micro-level products. In Peru, where ENSO insurance is being tested, the consequential Index insurance uses an objective measure (an index) of a natural losses and problems associated with extreme rainfall and event known to cause losses (such as excess rain, high river levels, or catastrophic flooding are enormous—crops are lost, trees die, soils extreme sea surface temperatures). Using an index as the proxy for wash away, transportation systems break down, incidence of disease loss dispenses with expensive loss assessments. Furthermore, use of (such as malaria) increases, and markets are destroyed. When an index diminishes moral hazard and adverse selection, problems individuals and local markets suffer in this fashion, firms in the that plague traditional forms of insurance. Given these advantages, value chain and the financial sector also suffer. index insurance may be well suited to developing countries where In the extreme El Niño years 1983 and 1998, the volume of data are sparse and delivery of financial services to smallholder water in the Piura River was about 40 times greater than normal. households increases the per-unit cost of traditional insurance. Although Piura was among the worst-affected areas, a number of Despite the promise of index insurance, uptake by smallholder other regions in northern Peru were also severely affected. In 1998, households is slow. Presently, index insurance may be better with a clear indication that El Niño was coming, farmers simply did suited for risk aggregators—that is, groups or institutions that not plant crops, resulting in a 27 percent drop in fertilizer sales in aggregate the risk of households either through the services northern Peru. Agricultural lending was growing at a significant they provide or through informal risk-sharing arrangements (for pace before the 1997–98 El Niño, but that growth came to a halt example, agricultural lenders, firms in the value chain, and farmer after the event. Microfinance institutions (MFIs) had a significant associations). Focusing first on risk aggregators should also help increase in problem loans. Because of the 1998 El Niño, the default build linkages and sustainable products that will directly serve rate on agricultural loans increased from about 8 percent of all smallholder households. agricultural loans to more than 18 percent for MFIs operating in the region of Piura. Loan default is defined as loans that were 60 days Index insurance and correlated losses late or more in payments. Once loans fall into this category, the As a precondition of index insurance, losses created by the natural probability of collection is nearly zero. Additionally, member deposits disaster to be insured must be strongly correlated—that is, a large and savings—the major sources of capital for the MFIs— declined by roughly 15 percent as people withdrew funds to cope with the drainage systems will clog. Lenders are interested in using payments problems created by the event. It took at least three years to recover to ease the liquidity crisis and associated cost. Those in the value from the compounded problems of loan defaults, loan restructuring, chain are interested in smoothing their losses and maintaining their and savings and member deposit withdrawals. specialized workforce when revenues are temporarily low because ENSO insurance was presented to the Peruvian insurance of El Niño. Finally, ENSO insurance is also being offered to local regulators as a form of business-interruption insurance designed and regional governments to provide ready cash to mitigate some to pay for consequential losses and extra costs linked to extreme problems associated with catastrophic flooding. flooding, which is highly correlated with ENSO. ENSO insurance To begin, the insurance company is offering ENSO insurance fits well in a class of insurance called “contingency insurance.� only to highly exposed risk aggregators. Demand from other firms Contingency insurance is intended to protect policyholders against and institutions that are exposed to El Niño risk will then drive the a variety of consequences associated with a specific event; these expansion of this market. Anecdotal evidence points to substantial consequences can include loss of assets, losses in normal business interest in ENSO insurance. After some initial press releases on the revenues, and increased costs associated with addressing the event. product, the insurer was inundated with calls from a variety of Experience in Peru suggests that formulating index insurance as firms and institutions interested in the product. At this stage, ENSO contingency insurance against a natural disaster has potential insurance is not being made available to smallholder households. applications in many regions of the world highly exposed to severe The product can, however, be tied to other financial services in a weather risks such as drought or flood. fashion that gives smallholders greater access to these services at The ENSO insurance uses the monthly sea surface temperature better prices. for ENSO Region 1.2 (0–10° South, 80–90° West), measured and reported by the NOAA Climate Prediction Center. The basis for Conclusion payment is the average of two months—November and December. El Niño events affect many regions of the world. The most dramatic Three contracts are available with three different thresholds where effects probably occur in Peru and Ecuador, but El Niño affects payments begin (23.4, 24.0, and 24.5 degrees Celsius); each of other countries in South, Central, and North America as well these contracts reaches a maximum when the measure reaches as in Southeast Asia and East Africa. In some regions, El Niño 27 degrees. The payout function is linear. Indemnity payments is associated with flooding, and in others it is associated with are made in early January, just as flooding begins, and flooding drought. Although no other region may have as strong a correlation continues from February to April. between sea surface temperature and flooding as northern Peru and Indemnity payments are made by multiplying the payout rate southern Ecuador, this project may increase awareness and lead to times the sum insured, which is selected by the insured party. A risk new thinking and opportunities regarding the potential for forecast assessment that estimates the largest losses that may occur under index insurance and the relationship between natural disaster risk the worst flooding event is likely the best starting point for selecting and oceanic oscillations such as ENSO. n a sum to be insured. Prudent buyers of insurance will be more likely to select a value that is less than these estimates, given the expense of this type of insurance and the fact that they have other For further reading: J. R. Skees, J. Hartell, and A. Murphy, risk-management mechanisms that can be blended with the ENSO “Using Index-based Risk Transfer Products to Facilitate insurance in an optimal fashion. Micro Lending in Peru and Vietnam,� American Journal of Since the ENSO insurance pays before the catastrophe, Agricultural Economics 89 (2007): 1255–61; J. R. Skees, “Chal- educational efforts have focused on helping people in the target lenges for Use of Index-based Weather Insurance in Lower- markets understand how to use the extra cash to mitigate the Income Countries,� Agricultural Finance Review 68 (Spring impending crisis. Farmers’ associations in remote regions of Piura have 2008): 197–217; J. R. Skees and B. J. Barnett, “Enhancing expressed an interest in using the funds to clear drainage systems Micro Finance Using Index-based Risk Transfer Products,� because heavy rains associated with ENSO increase the likelihood that Agricultural Finance Review 66 (2006): 235–50. Jerry R. Skees (jskees@uky.edu) is president of GlobalAgRisk and the H. B. Price professor of policy and risk in the Department of Agricultural Economics at the University of Kentucky. Benjamin Collier (benjamin@globalagrisk.com) is an employee of GlobalAgRisk and a PhD candidate in the Department of Agricultural Economics at the University of Kentucky. INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance Microinsurance Innovations in Rural Finance FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT MaRtina WiedMaieR-pFiSteR and bRigitte Klein Focus 18 • BrIeF 12 • July 2010 P oor people in developing countries are vulnerable to a broad range of shocks that affect their livelihoods, including illness, accidents, and death as well as loss of assets such as animals, crops, is difficult because of a lack of mortality and morbidity data. All these factors make underwriting more expensive, and therefore, the mostly urban-based insurers are not ready to serve rural low- and machinery. The poor are still predominantly rural, and their income markets. Rural providers are often small and informal, with vulnerability is even higher than that of their urban peers. Health the inherent challenges of such organizational forms, such as weak facilities are less available and less well equipped in rural areas; governance or limited range of products. water, sanitation, roads, and telecommunication are less developed; and people are less educated and not as aware of risk-mitigation Experiences in providing microinsurance mechanisms. Given the rural character of poverty in many countries, to the rural poor poverty reduction remains strongly connected to agricultural Some microinsurance schemes tailored to rural areas provide development, and sustainable agricultural development depends on useful lessons. For example, a pilot project in India, set up by the well-organized risk mitigation. One important tool for mitigating risk microfinance institution BASIX and a commercial insurer with the help is microinsurance. of the World Bank, has been providing weather insurance for small The International Association of Insurance Supervisors (IAIS) farmers to improve their access to credit. This microinsurance scheme defines microinsurance as “insurance that is accessed by the low- is based on a rainfall index. Payments are based not on individual loss income population, provided by a variety of different providers adjustments—a costly undertaking not feasible in microinsurance—but but run in accordance with generally accepted insurance practices rather on whether rainfall measured at a local weather station reaches (including the IAIS Insurance Core Principles).� It differs from a certain threshold. The insurance contracts are linked to credit traditional insurance in that it is adapted to the circumstances of the because the insurance secures repayment of the loans. poor: premiums are low, products have simple designs, it is offered At the outset, the project had to solve several problems like through well-trusted and innovative channels, premium payments poor-quality weather data. Furthermore, the insurance provider are flexible, and claims are settled promptly. strongly focused on raising awareness, capacity building, continuous Microinsurance has the potential to enable the rural poor to product improvement, and quick payouts. Certain elements remain mitigate the effects of shocks that threaten their lives, productivity, unresolved, such as basis risk (which occurs when the actual loss and assets. It can help prevent emergencies from depleting poor does not match the benefit because a payout is triggered but people’s savings and other assets. Furthermore, it allows households there is no loss or vice versa), high premiums, clients’ difficulties to invest in high-risk, high-return activities by securing the lending understanding this complex product, and low demand due to these risk for agricultural and other investments. factors. Nevertheless, the Indian weather insurance market is growing Financial sector reforms in many countries have begun to strongly, and new microinsurance providers are entering the market. include insurance as an important pro-poor financial service along Innovations are also taking place in the policy area. Insurance with other microfinance services such as savings, lending, and regulators across the globe are working to create an enabling cashless payments. According to a study by the International Labour framework for insurance products, delivery channels, and new Organization, microinsurance in Africa almost doubled from 2006 providers. Brazil and Ghana are among the countries changing their to 2009. The survey shows that half of the schemes were growing regulations, and South Africa aims to integrate thousands of existing faster than 30 percent a year between 2007 and 2008. Data on informal burial societies into the mainstream insurance sector. growth in rural areas, however, are not available. The Philippines has already made such a regulatory move. In 2006 the Insurance Commission of the Philippines issued Insurance Microinsurance in rural areas Memorandum Circular No. 9-2006, which provided a definition of Providing microinsurance in rural areas can be more difficult than in microinsurance and spelled out the requirements for registering a urban settings and requires some adaptations in terms of insurance microinsurance mutual benefit association. As a result, by the end of products, risk carriers, delivery, and servicing. The characteristics 2009, microinsurance mutuals covered 2 million policyholders. Now of its market make sales and pricing more difficult. Because the Philippine government is pursuing a wider approach that aims to educational levels are usually lower in rural areas, low-income increase access to microinsurance products and services by including households’ financial capability is weaker. Potential customers different kinds of actors. The country’s National Microinsurance often distrust insurance. Affordability is another challenge because Strategy and regulatory framework focus on increasing private- rural people rely on seasonal and generally low incomes. Demand sector participation in the provision of microinsurance and the is not known or understood, products are poorly designed, and if mainstreaming of informal insurance. microinsurance is available at all, the selection of policies is limited. Another groundbreaking example of dedicated microinsurance Systems are not adapted to manage many small transactions regulation can be found in India. India was the first country to pass for premium collection, back-office administration, and claims regulations covering microinsurance products and agents in 2005. management. Population density is often low and distances are In addition, India made it compulsory for all insurers to provide far, making it more difficult to reach scale. Distribution can suffer microinsurance to the rural and social sectors (the “social sector� from the lack of channels like banking outlets. Risk assessment includes the unorganized sector, informal sector, economically vulnerable or backward classes, and other categories of persons in 4. The consumer challenge: Consumer-related challenges, such as both rural and urban areas). affordability, insurance literacy, and consumer protection, need Although the evidence on requiring insurers to provide a special look. Affordability is more sensitive in rural areas than microinsurance is mixed (as insurers may consider the penalties in urban areas because rural residents face higher cash-flow a cost of doing business), this approach has stimulated a large fluctuations in agriculture and generally have lower incomes. number of pilot projects and provided useful lessons for the More investments are needed in insurance literacy. Consumer industry and for policymakers. protection is a greater challenge in rural areas because the Today, insurance supervisors all over the world are expressing ombudsman and courts are often far away, and a claimant strong interest in sharing experiences and understanding the needs to finance travel costs. dynamics of an enabling regulatory and policy environment. 5. The support structure challenge: Service providers in In response to this interest, the IAIS, in partnership with the microinsurance are often not active in rural areas and not Consultative Group to Assist the Poor, the International Labour equipped to transfer the required know-how and systems to Organization, the German Federal Ministry for Economic Cooperation their clients, the intermediaries, and insurers. Training courses and Development, and Finmark Trust, created the global “Access for rural staff of insurers are more costly to organize. Service to Insurance Initiative� (www.access-to-insurance.org) to foster providers often face higher costs to assess demand or establish capacity development and standard setting for insurance supervisors. risk data for remote areas and therefore neglect rural areas. Key challenges for the development 6. The agricultural insurance challenge: Although index insurance of microinsurance markets in rural areas can potentially overcome many of the problems associated with traditional insurance, it requires improving the availability of Much has been learned about developing effective and broad-based high-quality weather data, creating awareness among farmers, microinsurance markets in the past few years, but a number of achieving quick payouts, and dealing with basis risk due to challenges still face efforts to extend microinsurance in rural areas: conditions that might affect farmers but are not incorporated 1. The strategy and policy challenge: A holistic approach to in the index (such as soil composition or uneven terrain). improving the financial system addresses the actors on three Conclusion levels: it focuses simultaneously on framework conditions involving sector strategies, regulation, and supervision (macro Rural microinsurance products and their sales strategies require level); service providers and public goods (meso level); and huge investments in product innovation, literacy work, and insurers, intermediaries, and customers (micro level). Rural establishment of sound providers and intermediaries. In addition, development policies and financial sector development policies regulatory dedication and innovation are required to spur the need to include microinsurance, and public resources need to provision of rural microinsurance by motivating and formalizing be made available. rural providers and developing adequate customer protection. Microinsurance is an integral part of the financial sector 2. The underwriting challenge: Underwriting in rural areas faces and should be promoted as such, through an “access to finance higher risks and weaker infrastructure, which requires special strategy.� Rural finance and rural development policies should attention from policymakers and development organizations. explicitly deal with microinsurance, including agricultural Community-based and mutual types of underwriters are more microinsurance. Coherence with other sector policies—such as common in rural areas than in urban areas, and they often agricultural development policy, social security policy, or consumer require institution-building support. International development protection policy—results in more effective approaches. n cooperation agencies can help by supporting capacity building and investment. For further reading: German Federal Ministry for Economic 3. The delivery challenge: Delivery channels that are close and Cooperation and Development (BMZ), Security at Little easy to use and support rural delivery need to be strengthened. Cost: Microinsurance in Financial Systems Development (Bonn, 2009), www.bmz.de/en/service/infothek/fach/konzepte/ These channels can include cell-phone banking and retail shops. konzept179.pdf; Lloyd’s and the Microinsurance Centre, Community-based organizations play an important role in Insurance in Developing Countries: Exploring Opportunities in providing microinsurance in rural areas, and these organizations Microinsurance (London and Appleton, WI, 2009); M. Mc- are often the risk carriers. This situation is suboptimal because Cord and J. Roth, Agricultural Microinsurance: Global Prac- of their limited reserves and management skills. Converting tices and Prospects (Appleton, WI: Microinsurance Centre, them from insurers to delivery channels could mitigate many of 2008), www.microinsurancecentre.org/UI/DocAbstractDe- these problems. tails.aspx?DocID=660. Martina Wiedmaier-Pfister (wiedmaier-pfister@t-online.de) is a consultant on financial systems development for German Technical Cooperation (GTZ) and the German Federal Ministry for Economic Cooperation and Development (BMZ). Brigitte Klein (Brigitte.Klein@gtz.de) heads the sector project Financial Systems Development on behalf of BMZ. INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance Combining Extension Services with Agricultural Credit: The Experience of BASIX India FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT vijaY Mahajan and K.vaSuMathi Focus 18 • BrIeF 13 • July 2010 I ndia has nearly 90 million farm households. More than 80 percent of these farmers operate on a small or marginal scale, farming less than two hectares of land. They also usually have one or two (cotton, groundnut, soybean, pulses, paddy rice, chilies, vegetables, mushrooms, and lac [a form of organic resin]) and two livestock products (dairy and meat [sheep and goat]). Nonfarm business buffaloes or cows, reared for milk and dung. Most of these small development services are also provided in selected activities like and marginal farmers fall below the poverty line. To reduce overall tailoring, woodworking, bamboo work, and retail stores. poverty in India, it is important to enhance the incomes of small and marginal farmers. One way to do that is to provide credit so they How are services delivered? can get access to yield-enhancing inputs like seed, fertilizer, and BASIX works in more than 25,000 villages through a network of cattle feed, as well as acquire irrigation pumps and crossbred cattle. 150 branches, each with five field executives under a team leader. But these kinds of investments alone will not raise farmers’ incomes. Each field executive supervises five livelihood service advisers Agricultural and livestock development services are also crucial to (LSAs), who each cover about 10 villages, originating credit, selling give farmers knowledge of improved practices and strengthen their links to markets. insurance, and collecting repayments. The LSAs also sell AGLED BASIX is an Indian livelihood promotion institution working Services. BASIX has more than 3,000 LSAs. with more than a million poor households. Its mission is to promote BASIX field executives identify and select villages or clusters sustainable livelihoods for a large number of rural poor people of villages to receive these services. A cluster is a group of and women. When it started in 1996, BASIX’s primary focus was villages within a radius of 6 to 8 kilometers—a size that includes delivering microcredit to its customers. In 2001, however, BASIX a reasonable customer base for delivering services effectively and asked the Indian Market Research Bureau to carry out an impact efficiently. The branches start enrolling customers for services in assessment, and the results were rather disappointing. Only those villages where there are at least 30 existing borrowers for 52 percent of the customers, who had received at least three rounds either crop or livestock activity. of microcredit from BASIX, showed a significant increase in their BASIX has built a cadre of nearly 1,000 livelihood services income (compared with a control group); 25 percent reported no providers (LSPs). LSAs function as BASIX salespeople, whereas LSPs change in income level; and 23 percent reported a decline in their are similar to extension agents. An LSP works with BASIX on a income level. BASIX then carried out a detailed study of those who regular basis and is typically a high-school graduate with training had experienced no increase or a decline in income and found that as a para-extension worker or a para-veterinarian. He or she covers the reasons for these results could be grouped into three factors: 200–400 customers for one crop or activity. BASIX distributes product brochures in regional languages telling customers what 1. unmanaged risk; 2. low productivity; and Table 1—Services included in the BASIX livelihood triad 3. unfavorable terms in input and output market transactions. Agricultural, Livestock, and Enterprise Development Institutional Development This analysis made clear the need for Financial Inclusion Services Services Services productivity enhancement, risk-mitigation • Savings (directly in districts • Productivity enhancement: • Individual-level awareness services, and market linkages, as well as the where BASIX has a banking through increased yields, use building, skill enhancement, need for rural producers to come together license, and through other of improved seed varieties or and entrepreneurship to amass greater bargaining power in banks elsewhere) practices development the marketplace. In 2002, therefore, • Credit: agricultural, allied, and • Productivity enhancement: • Formation of groups, BASIX revised its strategy to provide a nonfarm, short and long term reduction in costs federations, and cooperatives comprehensive set of livelihood promotion of producers services to poor rural households. This • Insurance for lives and • Risk mitigation (other than • Functional training in livelihood triad strategy includes provision livelihoods, including weather insurance), such as livestock accounting and management index-based crop insurance vaccinations information systems, using of financial inclusion services; agricultural, information technology livestock, and enterprise development services; and institutional development • Money transfer, for migrant • Local value addition, such as • Building collaboration to workers processing cotton into lint deliver a wide range of services (Table 1). before selling services What services are provided? • Experimental products: • Alternative market linkages: • Sector and policy work: micropensions, warehouse input supply and output sales analysis and advocacy for Under Agricultural, Livestock, and receipts, etc. changes and reforms Enterprise Development (AGLED) services, Source: BASIX. BASIX currently provides services to farmers growing nine types of crops services they will receive and when. Customers pay Rs 450 (US$10), to more precise and economical application of fertilizers. In the including services tax, for a year of AGLED services. case of dairy animals, simple practices like vaccination and periodic deworming were more cost-effective than procurement of high- Achievements yielding crossbred animals. In 2009 BASIX had nearly half a million customers for AGLED Based on such experiences, BASIX staff learned how to services. About half of these customers were using agriculture customize AGLED services for different agroclimatic zones, which and livestock services, and the rest were using services related to enhanced the farmers’ willingness to pay for these services. nonfarm activities. The details are as follows: Customer satisfaction surveys conducted by independent audit • Agriculture: AGLED provided soil-testing service to more teams found that the satisfaction level was nearly 80 percent, with than 20,000 farmers, integrated pest management (IPM) or the main cause of dissatisfaction being inadequate visits of the LSPs. integrated nutrient management (INM) services to nearly To improve service, field executives introduced tighter monitoring of 75,000 crop customers, and field surveillance to more than service delivery, but this practice turned out to be expensive. BASIX 30,000 farmers. It connected most customers to markets for is now pilot testing mobile phone–based monitoring of service inputs (seed, fertilizers, pesticides, and bio-inputs such as delivery through which farmers will be able to report incidents of no vermicompost and organic pesticides) and outputs. Weather visit or poor service. index-based crop insurance was provided to more than 10,000 farmers for different crops and in different agroclimatic Sustainability and future plans zones, in collaboration with private insurance companies. The income from AGLED services in 2009 was nearly Rs 145 million • Livestock: BASIX AGLED services conducted health checkups of (US$3 million), and BASIX made a modest profit of nearly nearly 440,000 animals, vaccinated nearly 165,000 animals, and Rs 22 million (US$450,000) providing these services to nearly dewormed 125,000 animals. It trained more than half a million customers. With more and more LSPs reaching the 36,000 customers on feed and fodder and better dairying breakeven number of customers, profitability is likely to improve. practices. More than 60,000 farmers were linked to milk BASIX also plans to move some basic facilities like soil-testing labs marketing chains of cooperatives or private dairy companies. and artificial insemination centers under its own control to improve Livestock insurance was provided for more than 120,000 animals, its service to farmers. in collaboration with private insurance companies. Although BASIX agricultural credit operations are aimed at small and marginal farmers, the organization plans to extend AGLED services to larger farmers (to whom BASIX does not extend credit) Lessons learned in the same villages. These farmers’ enhanced yields will generate It has taken BASIX about six years to reach the scale described, additional output as well as employment opportunities for the and it has learned many lessons along the way. In the initial two landless poor—outcomes that are in line with the BASIX mission. years, the main emphasis was on market research to identify So far BASIX has worked mainly in poorer dryland districts, but it which services farmers needed. This research, conducted through is also considering providing AGLED services in irrigated districts a large number of field visits and group interactions with farmers, where it has no credit operations. With these changes, BASIX is showed that small farmers preferred cost-saving and risk-reducing confident of reaching 2 to 3 million farmers with AGLED services in interventions over yield-enhancing interventions requiring greater the next five years. n cash outlays. It also showed that it was not possible to handle these interventions for a large number of crops, so BASIX focused on a For further reading: BASIX, www.basixindia.com; few crops grown by a large number of farmers, such as groundnut P. Chandra Shekara, Status of Private Extension in India (Hy- in southern Andhra Pradesh, cotton in northern Andhra Pradesh, derabad: National Institute for Management of Agricultural and soybean in western Madhya Pradesh. Extension [MANAGE], 2002); R. Sulaiman and V. V. Sada- The next step was designing the service offerings. For example, mate, Privatising Agricultural Extension in India, Policy Paper 10 (New Delhi: National Centre for Agricultural Economics enhancing productivity could mean increasing the yield or reducing and Policy Research [NCAP], 2000); S. K. Datta, A Perspec- the cost for the same output. Local agricultural universities and tive on Farmer-Market Interface: Results of a Revisit to Selected research stations made available many packages of practices for Villages from West Bengal, Gujarat, and Maharashtra (Ahmeda- increasing yields, so BASIX decided to focus more on cost reduction. bad: Indian Institute of Management, 1999); V. Mahajan, One successful example of this approach was stem application of “From Micro Credit to Livelihood Finance,� Economic and pesticide in cotton, which reduced pest multiplication and thereby Political Weekly 40, no. 41 (2005): 4416–19; V. Mahajan, Be- reduced the need to undertake a large number of pesticide sprays yond Microfinance, in C. Moser, ed., Reducing Global Poverty later. Another example was introduction of soil testing, which led (Washington, DC: Brookings Institution, 2007). Vijay Mahajan (vijaymahajan@basixindia.com) is founder and chief executive officer of the BASIX Group. K. Vasumathi (vasumathi@basixindia.com) is associate vice president, Agricultural, Livestock, and Enterprise Development (AGLED) services, BASIX Group. They are based in Hyderabad, India. INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance Bundling Development Services with Agricultural Finance: The Experience of DrumNet FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT jonathan CaMpaigne and toM RauSCh Focus 18 • BrIeF 14 • July 2010 A griculture is the largest economic sector in most African countries and remains the best opportunity for economic growth and poverty alleviation on the continent. Yet, sadly, the (ICTs) across the platform makes the process efficient, cost-effective, and practical in the African context. The process begins when farmers (organized into farmer sector has been in decline over the past 40 years, and poor farmers groups) sign a fixed-price purchase contract with an agricultural have largely remained poor. This failure is due to many factors, buyer. The contract allows farmers to approach a partner bank, including collapsed agricultural development banks, corruption, obtain credit, and get farming inputs from a local, certified retailer. inadequate infrastructure, and poor soils and seeds. It has also At harvest, the contracted produce is collected, graded, and sold to occurred because smallholder farmers lack access to critical the buyer at designated collection points. A successful transaction information, market facilitation, and financial intermediation services. triggers a cashless payment through a bank transfer. DrumNet This brief reviews the DrumNet Project and its approach to serves as the intermediary in the flow of payment to ensure that improving farmers’ access to finance in Kenya. The project has found credit is repaid before earnings reach farmers’ accounts. A master that financing small-scale farmers is challenging given the cost and contract governs the entire process, and DrumNet’s information risk associated with serving rural, relatively isolated clients. Lending technology (IT) system monitors compliance. becomes increasingly feasible, however, in a supply-chain approach The process creates an enabling environment for agricultural in which farmers are connected to a formal network of buyers, finance in several ways. First, banks are assured at the time of retailers, and financiers. lending that farmers have a market for their produce and the means to adequately serve that market—two building blocks of a healthy The DrumNet Project revenue stream. Second, banks minimize the problem of loan diversion by offering in-kind credit to farmers for inputs and directly Financing farmers is a difficult proposition in Africa. African paying certified (and monitored) input retailers after distribution of farmers tend to be geographically dispersed, resource poor, and the inputs. Finally, cashless payment through bank transfers reduces undereducated—all traits that amplify the costs and risks involved strategic default, since farmers cannot obtain revenue until their with lending. Other characteristics related to the agricultural outstanding loans are fully repaid. sector, such as unpredictable weather patterns, long crop cycles, DrumNet has piloted its approach in Kenya’s horticultural and irregular market access, and volatile or high farm input costs, make oilseed sectors, serving more than 3,000 farmers across five provinces. the proposition even more unappealing to financial institutions. Consequently, agricultural lending constitutes less than 1 percent of Lessons learned, challenges faced the commercial lending taking place on the continent. The DrumNet Project has operated in Kenya since 2005 Since its start in 2005, the DrumNet Project has learned many and employs proven microfinance principals and a supply-chain lessons and undergone continual testing and redesign. DrumNet has approach to promote agricultural lending (Figure 1). The project found that by bundling services at various stages in the supply chain, establishes relationships with key actors along a supply chain—a its approach can enhance efficiency and build trust between actors buyer, a bank, and several farm input retailers—and links them to in the chain. Together, that efficiency and trust help resolve many of smallholder farmers through a dedicated transaction platform and a the problems that historically discourage smallholder financing. fully integrated finance, production, delivery, and payment process. At the same time, DrumNet has encountered many The targeted use of information and communication technologies challenges during implementation, particularly related to partner noncompliance and poor agricultural yields. In both situations, the Figure 1—DrumNet farm input loan and payment flow outcome has been a substantial number of farmer loan defaults that eroded the interest of DrumNet’s crop-buying partner and the goodwill of its banking partner. These remaining challenges show Bank Farm group that the package of services must be adjusted and enhanced as the project moves forward. Input retailer Buyer Partner noncompliance For this approach to function properly, each supply-chain partner must abide by an established set of procedures and rules. Therefore, supply-chain actors must find value in and benefit from the Flow of produce payment Flow of farm inputs arrangement at all times. In theory, this is the case. Farmers get Flow of farm input loan to produce goods under structured agreements and obtain inputs that help them boost farm productivity. The buyer receives greater Source: Authors. quantities of higher-quality product with limited field mobilization. Input retailers realize increased sales without taking on the burden of offering credit themselves. And the bank captures a new be directly tied to input sales or incorporated into production customer market with minimal risk, adding to its loan portfolio and contracts. Farmers would receive not only a guaranteed deposit base. produce purchase price, but also guaranteed reimbursement or DrumNet has, however, experienced its share of replacement of inputs. noncompliance. Farmers have opted to side-sell produce outside • Soil analysis. A soil analysis service would provide farmers buyer agreements to attain quick cash or evade loan obligations. with precise recommendations on how best to restore fertility Buyers have at times failed to honor contract terms, and input to their soils and, accordingly, improve land productivity. A retailers have engaged in dishonest practices as well. Even fertilizer matching component—matching the right fertilizers to banks have strayed from the program by delaying payments and a farmer’s particular soil composition—would make the analysis introducing unexpected fees to farmers. even more effective. The analysis could be offered by input It is crucial to resolve the issue of partner noncompliance retailers, thereby generating greater trust between farmers, because the benefit any one actor accrues from DrumNet depends retailers, and DrumNet. on other partners’ faithful completion of their functions in an agreed-upon manner. In other words, once one actor fails to comply • Payment systems. Advances in electronic payment options because he or she does not find value in the arrangement, the should also play an important role as DrumNet moves into the overall value of the supply-chain approach is lost. future. Payment systems like M-PESA, ZAP, and MobiCash can increase the timeliness of transactions between supply-chain Low agricultural yields partners and move cash points closer to rural-based farmers. These payment solutions, together with the increasing number Farmers’ inability to attain sufficient crop yields has also negatively of bank products available in the market, will reduce the hassles affected the project and its overall service package. In many farmers now incur when receiving payment. instances, poor yields have resulted from poor weather conditions. Kenya has experienced several years of irregular and insufficient rain, DrumNet is now commercializing its operations through the especially in the eastern portion of the country. Consequently, many formation of a private company in Kenya. The products and services farmers have produced only small or extremely stunted harvests. described in this brief, along with others, are being incorporated Soil conditions in Kenya have also diminished farmers’ into the new company’s platform. In addition, the company plans productivity. Because of population pressures, intensified to upgrade DrumNet’s existing IT system, building a more robust agricultural activities, and low fertilizer use, many Kenyan famers and expandable system that is accessible to rural-based partners. have exhausted their soils. With such soil conditions, even the best The system will be modular in structure, so users with different agronomic practices result in disappointing yields, low returns on requirements can select and use different components. Furthermore, farm investments, and consequently further soil degradation from the system’s functionality will be matched by its simplicity—it will season to season. The use of poor seed varieties has exacerbated easily plug in to the way users already conduct business. the problem. To mitigate risk on a larger scale, comprehensive and commonly accepted standards for communication, financing, information, and The way forward exchange must be applied across different agricultural supply chains in Africa. It is in everyone’s interest to facilitate and enforce the To address these challenges and others, DrumNet has identified development of these standards to ensure that all agricultural actors products and services that can be bundled with or added as and initiatives operate under a single preferred paradigm. n supplements to the supply chain: • Performance rating. DrumNet is devising a performance rating system that will be integrated into DrumNet processes to For further reading: X. Giné, “DrumNet Case Study� allow good and bad performers to be identified, thus creating (World Bank, Washington, DC, 2005), siteresources. an incentive for better partner behavior and commitment and worldbank.org/DEC/Resources/DrumnetCaseStudy.pdf; distinguishing especially competent, reliable actors over time. S. Arnquist, “In Rural Africa, a Fertile Market for Mobile Simple credit ratings could also serve as helpful indicators for Phones, New York Times, October 6, 2009, www.nytimes. banks as they assess potential borrowers’ creditworthiness. com/2009/10/06/science/06uganda.html; The Economist, “Security for Shillings: Insuring Crops with a Mobile Phone,� • Crop insurance. A dedicated crop insurance product that March 11, 2010, www.economist.com/business-finance/ insures farmers’ inputs against drought or other acts of displaystory.cfm?story_id=15663856; The Economist, “Dial God would reduce the weather risk inherent in agricultural M for Money: Beating Banks at Their Own Game,� June 28, financing, win further buy-in from farmers, and fill a crucial 2007, www.economist.com/business-finance/displaystory. gap in this bundled, supply-chain approach. The product could cfm?story_id=9414419. Jonathan Campaigne (jfc@prideafrica.com) is executive director of PRIDE AFRICA. Tom Rausch (trausch@prideafrica.com) is PRIDE AFRICA’s regional director for East Africa. INTERNATIONAL FOOD POLICY RESEARCH INSTITUTE sustainable by the CGIAR Supportedsolutions for ending hunger and poverty www.ifpri.org Supported by the CGIAR www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. InnovatIons In RuRal and agRIcultuRe FInance APPENDIX A: Supplementary Material Brief 2, “Financial Literacy,� by Monique Cohen Figure 1—Impact framework for financial education Inputs Outputs Outcomes Impacts CLIENT-LEVEL INDICATORS: • Increased assets Design and delivery INDICATORS: • Reduced vulnerability of financial education • Improved financial • SHORT TERM: INDICATORS: Improved financial well-being knowledge, attitudes, • Quality of training and skills • Number of participants • LONG TERM: FINANCIAL Financial learning INSTITUTION–LEVEL Improved behaviors experience INDICATORS: and financial outcomes • Improved financial performance • Improved responsiveness Source: B. Gray et al., “Can Financial Education Change Behavior?: Lessons from Bolivia and Sri Lanka,� Working Paper 4 (Microfinance Opportunities: Washington, D.C.: 2010). Brief 8, “M-PESA: Finding New Ways to Serve the Unbanked in Kenya,� by Susie Lonie Figure 1—FinAccess reports on how people in Kenya send money First study prior to launch of M-PESA (multiple responses possible). Second study conducted two years post launch. money transfer other other service 18% 13% 9% by hand 32% by hand post office / 58% money order 24% M-PESA 46% by bus by bus 9% 27% Source: FinAccess 2006 Source: FinAccess 2009 2 FOCUS 0 2 0 18 July 2010 InnovatIons In RuRal and agRIcultuRe FInance Edited by Renate Kloeppinger-Todd and Manohar Sharma Introduction • Shenggen Fan, Juergen Voegele, and Rajul Pandya-Lorch 1. Overview • Renate Kloeppinger-Todd and Manohar Sharma 2. Financial Literacy • Monique Cohen 3. Community-Based Financial Organizations: Access to Finance for the Poorest • Anne Ritchie 4. Rural Banking in Africa: The Rabobank Approach • Gerard van Empel 5. Rural Banking: The Case of Rural and Community Banks in Ghana • Ajai Nair and Azeb Fissha 6. Rural Leasing: An Alternative to Loans in Financing Income-Producing Assets • Ajai Nair 7. Determinants of Microcredit Repayment in Federations of Indian Self-Help Groups Yanyan Liu and Klaus Deininger 8. M-PESA: Finding New Ways to Serve the Unbanked in Kenya • Susie Lonie 9. Biometric Technology in Rural Credit Markets: The Case of Malawi • Xavier Giné 10. Credit Risk Management in Financing Agriculture • Mark D. Wenner 11. New Approaches for Index Insurance: ENSO Insurance in Peru Jerry R. Skees and Benjamin Collier 12. Microinsurance Innovations in Rural Finance • Martina Wiedmaier-Pfister and Brigitte Klein 13. Combining Extension Services with Agricultural Credit: The Experience of BASIX India • Vijay Mahajan and K.Vasumathi 14. Bundling Development Services with Agricultural Finance: The Experience of DrumNet • Jonathan Campaigne and Tom Rausch Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish. International Food Policy Research Institute 2033 K Street, NW • Washington, DC 20006-1002 USA Phone: +1-202-862-5600 • Skype: ifprihomeoffice Fax: +1-202-467-4439 • Email: ifpri@cgiar.org www.ifpri.org FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT