m5101: prof. heidhues + tom · 2009. 4. 14. · m5101: prof. heidhues + tom 2 universität...
TRANSCRIPT
M5101: Prof. Heidhues + Tom
1
Universität Hohenheim, Institut 490a 1
Rural Finance
Thomas Dufhuesand
Prof. Franz Heidhues
Universität Hohenheim, Institut 490a 2
WS 2003/04 Rural Finance: Thomas Dufhues and Prof. Franz Heidhues
Structure of the lecture
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal credit
2. New Institution Economics (NIE) aspects in rural finance
3. Financial services3.1 Credits
- Traditional agricultural credit- „Micro finance revolution“
3.2 Savings3.3 Insurances3.4 Safety net of MF
(credits, savings, insurances)4. Financial innovations
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Universität Hohenheim, Institut 490a 3
WS 2003/04 Rural Finance: Thomas Dufhues and Prof. Franz Heidhues
Government, Central Bank
Financialmarketpolicy
Monetarypolicy
Tradepolicy
Exchange rate
relations
Rural infra-
structure
Agriculturalsector
Extensionsystem
Off-farmactivitiesFormal
Semi-formal
Informal
Insured party
BorrowerSaver
Rural financial market
Financial intermediaries
The rural financial subsystem
Source: Adapted from Buchenrieder, Heidhues, and Dung (2000)
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
Universität Hohenheim, Institut 490a 4
WS 2003/04 Rural Finance: Thomas Dufhues and Prof. Franz Heidhues
Regional transformationSectoral transformationSocial transformation
Size transformationTime transformation
Information transformation
Risk transformation
Intermediation
Financial assettransformation
Financial DepthWidth of financial instruments
Diffusion Promotion of financial asset accumulation
Effects:Functions:
Increase in theefficiency of resource
allocation
Promotion offactor mobility
Provision of afinancial
infrastructure
Setting monetary policy
Enforcement of financialdiscipline in the
enterprise sector
Framework for structural adjustment
Economicstability
Form of Implication:
Major functions of theformal financial system
Source: Adapted from Geis (1975)
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Universität Hohenheim, Institut 490a 5
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The traditional reason forformal agricultural credit
Traditional approach towards agricultural credit
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
S
Y
P
I
Vicious cycle of capital formation- A descending spiral -
Source: Heidhues and Schrieder (1999)
Y = Yield/income
S = Savings
I = Investment
P = Productivity
Universität Hohenheim, Institut 490a 6
WS 2003/04 Rural Finance: Thomas Dufhues and Prof. Franz Heidhues
Y
S P
I Traditional approach towards agricultural credit
The rising cycle of capital formation- An ascending spiral -
The traditional reason forformal agricultural credit
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Who are the informal intermediaries?
Definition of formal finance:
Formal financial intermediaries (FFI)?
• All intermediaries under control of the central bank
• Usually all banks and institutions which are collecting savings
• Family members or friends
• ASCAS/ROSCAS
• NGOs
• Traditional money lenders
• Deposit collectors
• Pawnbrokers
} Non-profit segment
} Profit segment
Forward1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
Next
Universität Hohenheim, Institut 490a 8
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Rotating savings & credit associations(RoSCAs):
Note: All RoSCA members contribute the same amount at their periodic group meeting (Four members: A, B, C and D)
RoSCA members and their contribution
A B C D Σ of individual contributions
50505050
50505050
50505050
50505050
200200200200
Σ of contributions received by individual member
200 200 200 200
Σ of net loan received by individual member
150 100 50 0
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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RoSCAs and ASCAs pros and cons
- generally relatively short-term oriented
- cumulative credit needand no interregionalinter-mediation (fragmentation)
- operating outside governmental/central bank policy
+ low cost+ high repayment rates+ need orientation+ unbureaucratic, quick
loan decision process+ no collateral+ mutual insurance
system
conspros
Back
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
Universität Hohenheim, Institut 490a 10
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Credit worthiness
Credit disbursement is the process of the temporary allocation of resources (financial means) with the expectation that they will be repaid.
Collateral Character Capacity to repay
Goods
Freedom/obligationto select
Credit worthiness(3 essential Cs)
Persons Credit history
Personal background
Income streams
Legal obligations
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
Invest-ment
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• Past repayment record
• Social status
• Acquaintance
• Employment status
• Guarantee
• Recommendation
• Collateral
Borrower evaluation ofinformal credit markets
Borrower evaluation offormal credit markets• Collateral
• (Guarantee)
• (Past repayment record)
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Cost of credit extension (formal)
For the credit institution For the borrower
• Costs of finance: costs of procurement of funds
• Transaction costs− staff remuneration− material costs− reserves
= Total costs for the credit institution
+ profit margin
= Market rate of interest (including fees etc.)
• Costs of finance: interest payment to the credit institution
• Transaction costs− transport− opportunity costs of
time− costs of advice and
procurement of information
− securities, guarantees− certificates (certificate
of residence, employment, good standing etc.)
= Total costs for the borrower
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Cost of credit extension (informal)
For the credit institution For the borrower
• Costs of finance: costs of procurement of funds
• Transaction costs− staff remuneration− material costs− reserves
= Total costs for the credit institution
+ risk margin+ profit margin
= Market rate of interest (including fees etc.)
• Costs of finance: interest payment to the credit institution
• Transaction costs− transport− opportunity costs of
time− costs of advice and
procurement of information
− securities, guarantees− certificates (certificate
of residence, employment, good standing etc.)
= Total costs for the borrower
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
Universität Hohenheim, Institut 490a 14
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Informal vs. formal finance
Informal financial sector Formal financial sectorAdvantages Disadvantages Disadvantages Advantages
Informal financial sector
• closeness toclients/members
• little bureaucracy• flexibility• low TCs
• short-term financialproducts
• savings eventuallyinsecure
• low, locally limitedcapital mobilization,fragmentation
• little cost efficiency• little closeness toclients
• political influencepossible
• bureaucraticprocedures
• monetarisation, i.e.systemic savingsmobilization
• economicdevelopment
• High volume andlong-term loanspossible
Formal financial sector
Advantage economic organizational / institutional
Disadvantage organizational / institutional economic
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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1. Are the services provided by informal lenders "valuable" for their clientele?
The answer is a strong “yes“.
2. Are the services provided by informal lenders "sufficient," from the perspective of their clientele?
Under many circumstances, the answer in this case is possibly “no“.
3. Are informal financial services "efficient" from an economic perspective?
The answer here is a strong “no“.
4. Can informal financial transactions be replaced and/or complemented with formal financial intermediation?
The answer is “potentially yes“, but the task is not easy at all.
The efficiency of informal finance
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Definition of Transaction Costs (TCs)• The cost that arise when individuals exchange property
rights (PR) to economic assets and enforce their exclusive rights.
• TCs include all expenses and opportunity costs, fixed and variable, which arise in the exchange of PRs, except the price of the PR itself.
• TCs decrease the efficiency of exchange relationships. The regulatory framework of institutions shall reduce TCs and raise the efficiency of exchange.
• In New Development Economics,TCs are considered to be of substantial interest for development finance.
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
Importance of TCs in Development(Micro)-finance
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Arising beforethe transaction
Mostly related to searching for and
screening ofpotential trading
partners andobtaining price
information
Arising duringthe transactionIncluding costsof arranging the
transactions,physically
transferring theproduct or
service, anddrawing upcontracts
Arising afterthe transactionIncluding costs
of monitoring theterms of the
transaction andenforcing liability
MFIs
Clients
Informationcosts
Negotiationcosts
Enforcementcosts
Classification of TCs
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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• Financial services contracts are relational contracts• The transaction takes place over a long period of time • Transaction is based on the promise of the two contract
partners• Trust is an important factor in relational contracts
• One party to an agreement has better information on the matter of contract then the other
TCsMFIs HHs
Information cost
Relational contracts
Information asymmetry
• All relational contracts are hit by information asymmetry• The costliness of information is the key to the costs of
transaction. Thus, reducing the cost of information means reducing TC.
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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• Adverse selection means that one party to a contract is unable to measure accurately certain valued human qualities or attributes of non-human resources that he or she seeks to acquire.
Adverse selection
• Moral hazard occurs, e.g. when a party to an insurance contract changes his behavior after the purchase of insurance in that way that the change increases the likelihood that policy holders will collect insurance indemnities.
Moral hazard 1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
adverse selection moral hazardex-postex-ante
Tran
sact
ion
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Source: Buchenrieder, Heidhues, and Dung (2003)
Financialmarket
Credit Savings
Insurance
The product triangle of rural finance
Financialmarket
Credit Savings
Insurance
The product triangle of rural finance
Vogel‘s (1984)forgotten half of microfinance in the 1980s
Financialmarket
Credit Savings
Insurance
The product triangle of rural finance
Vogel‘s (1984)forgotten half of microfinance in the 1980s
Zeller et al. (1997) termed insurance as the forgotten third in the 1990s
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Key features of the traditional agricultural credit extension
1. External (to the rural sector) financing by government
and external donors
2. Production credit (supervised credit, targeted credit)
3. Strong focus on credit; no savings mobilization
4. Subsidized credit (low interest rate)
5. Collateral to overcome information asymmetry1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Why was the traditional agricultural credit approach not successful?
No capital mobilization (savings)lack of independenceGov. influence undermines institutional independence
Uncertainties of external funding (government, donors)
Linkage between government funding and repayment performance
Did not reach the target group
Distortions caused by subsidized credit
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Effects of low interest rate policy
1. Weakening of rural finance institutions
2. Adverse allocation effects
4. Distribution effect, regressive
5. Low savings interest rate(often negative, below inflation)
economic andpolitical power
lower cost/larger loans
3. Non-market (non-price) rationing
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
Forward
Next
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Misallocation of funds
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
i
i*
i**
i* = market interest ratei** = subsidized interest rate
Investments
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Adverse employment effects
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
Lopt
Labor
CapitalCopt
Isoquante
Iso-cost-function
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Adverse employment effects
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
Lopt
* = subsidized interest rate
Labor
CapitalCopt
Lopt*
Copt*
Back
Iso-cost-function*
Isoquante
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average transaction cost per lent unit of money
averagecost per loan
small-scale-farmers medium-size-farmers large-scale-farmers
Selection of borrowerstowards bigger farmers
Back
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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S
D
i
Credit
i*
i**
S** D**i* = market interest ratei** = subsidized interest rateE* = equilibrium
E*
Effects of an imbalancein supply and demand
Back
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Nominal and real rate of interest
100111
×
−
++
=pir
Example: i=18%, p=12%
%36,5100)10536,1(
100112,118,1
=×−=
×
−=r
The real rate of interest is equal to the nominal rate of interest minus the effects of inflation.
The real rate of interest (r) is derived from the nominal rate of interest (i) and the inflation rate (p) according to the following formula:
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
Universität Hohenheim, Institut 490a 30
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“As a rule, lending to agriculture is more expensive than lending to commerce and industry and lending to small farmers is more expensive than lending to others”
1. Riskier because of relatively undiversified loan portfolio, mainly agriculture
2. Riskier because of the productive risk of agriculture, droughts, floods, diseases etc.
3. Usually thinly populated areas with bad infrastructure
4. Small amounts of loans are required (see page before)
Reasons for high costs inagricultural lending
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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The new approach to rural finance- The microfinance revolution -
1. Financially sustainable and independent financial organizations
2. Ensure outreach to the whole spectrum of the rural population
3. Implementation of client adapted financial services (see last chapter)
4. Implementation of savings instruments
5. New forms of collateral, e.g. group credit, savings, leasing...
Forward
Forward
Forward
Forward1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
Next
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1. Sustainability Back
Why sustainability? • The poor value secure but more expensive access to credit
higher then cheap but uncertain access• Unsustainable FFI are a drain of public resources• Non-performing loans leaving behind a burnt soil for any
viable rural financial intermediationHow to achieve sustainability?• Savings collection for being independent from external
funds which tend to end at some point of time• Covering costs is essential:
a) cost covering interest rate, b) full/high repayment rate, andc) organizational efficiency (low hierarchies, de-central decision making)
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
BUT: Despite best practice, the vast majority of MFIs (95-99%) does not meet the criteria for sustainability (financial oreven operational)
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2. Outreach
• supports rural growth and food security
• it improves an equitable income distribution
• it enhances portfolio diversification of the rural finance institution and reduces risk
• Depth of outreach: high share of women, poorest, ethnic minorities etc.
• Breadth of outreach: reaching huge numbers of target group people
While outreach is used from the perspective of the financial program and access is used from the point of view of the potential client, they both refer to the same thing: who is getting the credit (Vaessen 2001).
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Targeting - Exante• Potential clients are assessed ex ante, e.g. by living
standard or farm sizeProblemUsually quite expensive and time consuming, as every new customer has to be assessed Potentially open to corruption
Product design• Designing of financial services exactly tailored to the
needs of the target group and thus, are not demanded by other groups of the population
• This requires extensive market research before the product designProblemCritics say, that with product targeting alone the very poor can not be reached
2. Outreach - How to reach the target group?
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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• Some theorists argue there is a trade-off between sustainability and outreach
the costly information collection on the credibility of potential clients and long distances in sparsely populated regions
• Counter example: e.g. BRI (Bank Rakyat Indonesia) has an enormous outreach and is covering its operational costs
• Sustainability enables rural MFIs to serve significant/more numbers of low-income clients over time
• MFIs try to operate in a so called ‘win-win pro-position’: The poor benefit from the financial services provided, willingly to pay high interest rates/fees to obtain them, which permits the MFIs to provide the services on a sustainable basis.
• Sustainability is based on the reasoning that sustainability today will mean more outreach and impact tomorrow
2. Outreach vs. Sustainability Back
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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4. Reasons for MFI to offer savings Back
• Achieving independence from external funds
• Improving the internal organizational efficiency
• Close contact to the target group
• Gathering of relevant information for granting credits
• Improving outreach
• Collateral
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Why are banks asking for collateral?• Relational contracts, information asymmetry, moral
hazard problem• Collateral insures the lenders’ loan portfolio in case of
borrowers’ default. It represents an incentive of the borrowers’ willingness to repay.
Traditional collateral• Land titles, mortgages, wages, capital assets• FFIs typically resort to legal options, such as seizing
property or garnishing wages directly from the employer.
• MFIs lend to low-income clients who usually have very few assets. Consequently, traditional collateral is often not available.
5. Collateral
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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The mechanism of collateral• Often, simply the risk of legal repression is enough to
encourage repayment.• Regardless of the actually value of the asset, the act
of pledging assets and the consequent realization that they can be lost causes the client to repay the loan.
• Even if the collateral is almost never collected, this does not signal its lack of importance. Few instances when collateral is actually collected are sufficient.
Back5. CollateralSubstitutes of traditional collateral• Joint liability groups• Compulsory savings• Social collateral or character-based lending• Assessment of the investment• Credit history• Any kind of property, e.g. animals, furniture
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Reasons for households to save
1. Income smoothingSafeguards against uneven income streams due to seasonal variations
2. InsuranceProvisions against disability, disease, retirement, sudden income losses and other contingencies
3. Wealth accumulationFinancing household’s long-term goals (social and religious purposes, heritage, consumer durable)
4. Future investments
5. Financial reciprocity or social reciprocityThe possibility of using savings to gain access to credit or other services
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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The need for income smoothing
Cash flow within the lunar year of anethnic minority in Northern Vietnam
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1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
ExpenditureIncome
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Formal and informal savingsFormal savings
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
• Bank accounts• Certain insurances• StocksInformal savingsIn kind:• Animals (cows, goats, pigs, chickens etc.)• Grain (maize, rice etc.) and commodities (beans,
coffee etc.)• Construction materials (bricks, wood, etc.) • Jewelry or goldIn cash:• Money collectors• Reciprocal lending (e.g. RoSCAs)• Under the pillow
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1. Transaction costsTCs incurred on transforming available surplus into a specific savings option or on liquidating it
2. LiquidityTime of liquidating the saving option in case of need
3. Real interest ratesRemunerations of the saving option
4. DivisibilityPossibility of parting of the savings in different sizes
5. SafetyHow secure are the savings stored?
6. Trustworthiness and confidence
7. Piggy bankLocking money away from relatives and friends
Decision parameters for choosing asaving option
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Importance of savings
“For the poor, access to saving products may be more important then credit (Zeller 2001).”
“In institutions which offer unbiased savings and credit services, the number of savers exceeds the number of borrowers by a wide margin (Seibel 1999).”The most successful saving product:
- voluntary- close proximity to the clients- positive real interest rates- (quickly accessible in case of need)
BUT: Locking away of savings in formal deposits may decrease the depositor’s access to financial support from the social environment in times of scarce resources. Social cohesion as well as individuals’ safety nets may be disrupted
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Micro-Insurance“Many households borrow, more save, and all insure (Zeller 2000).”
• Formal insurance schemes in most developing countries not available, particularly not for the rural population
• Particularly poor households enter into various forms ofinformal self-insurance or co-insurance arrangements
• Informal insurance arrangement are important but at the end not sufficient
Insurance in rural finance:• Relatively new product in rural finance• During the 80s many experiments in developing countries
with crop insurance schemesBUT: All failed and immense public resources were wasted
• Today many MFIs also offer micro-insurances, e.g. live insurances, disability insurance, health insurances
• MFIs sometimes offering a compulsory investmentinsurance to secure their portfolio
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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• Moral hazard problems, particular for property insurances and crop insurances
• Totally different business compared to credit and savings• Danger of bankrupting an MFI in a single catastrophic event• Professional expertise from insurance companies is
inevitable• The absence of insurance possibilities limits the households’
ability to reduce consumption fluctuations, but this does not necessarily imply that the most effective intervention would be to set up insurance programs
• Providing open access to savings and (emergency) loans may be a preferable method for helping clients to manage risk.
• If potential MFI‘s clients do not yet have access to flexible savings and credit, providing insurance may be premature.
Challenges of micro-insurance in MF
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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The safety net of microfinance
• Open access savings and emergency loans act as a form of insurance
• Credit and savings products cannot provide complete protection against risks resulting in a loss greater than what a household can save or repay
at this point, insurance becomes a more effective method of risk management
• Some risks cannot be insured and there are some risks where insurance is technically possible but may not be the most appropriate tool
• Different risks require different financial services with specific features:There is no „one fits all“ solution!!!
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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‘ Saving down’
‘ Saving up’
‘ Saving through‘
Pay
- out
Pay
- inCash flows of different financial products
Source: Rutherford (2000)
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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„The Schumpeterian qualification, that innovation must be cost reducing, separates change from innovation (Von Pischke 1995
p.121).“
Categories of financial innovations
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
1. Innovations in the macro-financial system
2. Innovations at the level of the financial intermediary
3. Innovations in organizing financial intermediation
4. Financial product innovations
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• Innovations at this level change the system as a whole.• They may contribute to the outreach of financial
intermediation and are generally applied at the policy level.
Examples: ⌦ Changes in the legal and regulatory framework
⌦ Establishment and acceptance of new organizational forms of financial intermediaries
Innovations in the macro-financial system allowed NGOs to take up financial intermediation activities in many countries which was illegal before
(1) Innovations in the macro-financialsystem
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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• Innovations at the level of the financial organization refer to changes in their legal form or organizational form.
• These innovations may increase access to financial services through economies of scale and specialization; mistrust may be reduced through a better organizational compatibility with existing organizational forms.
Examples: ⌦ Transformation of an informal into a registered or formal financial organization
⌦ Changes in the hierarchical structure, decentralization
⌦ Market differentiation through the creation of specialized outlets which, e.g. cater particularly to SMEs
(2) Innovations at the level of thefinancial organization
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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• Innovations in the areas of administration, monitoring, and management of financial contracts may increase efficiency through a reduction of transaction costs.
• Often, technical progress plays a role when adoptingproductivity increasing innovations.
Examples: ⌦ Monitoring Software specifically for small-scale clientele
⌦ Simplification of used forms⌦ Participatory marketing
approach
(3) Innovations in organizing financialintermediation
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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• Innovative financial products reflect new or modified products.
• They may improve the operational and financial sustainability of the financial intermediary and may be better adapted to the demand of the clientele.
• Gaining new market segments and improving outreach
Examples: ⌦ different forms of savings contracts
⌦ supply of insurance contracts⌦ consumption loans, input loans,
loan volume and time horizon of loans according to market rates
Rural Credit Project of the Bangladesh Rural Advancement Committee (BRAC) offers life insurance policies
(4) Financial product innovations
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
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Building of rural financial markets Dos
(innovative approaches)Don'ts
1. Mobilization of savings; savings as collateral
2. Implementation of alternative forms of collateral, e.g. joint-liability groupsCredit/saving allocation at the local level (decentralization)
3.
4. Integration of women (outreach)5. Building of guarantee and
emergency funds 6. Unconventional enforcement of
repayment (exclude group from access to further loans, seizing of group savings, etc.)
7. Cover costs (sustainability)8. Credit/savings/plus approach, i.e.
offering of agricultural extension in addition to savings and credits
1. Start from the beginning with cold money, i.e. (exclusively) funds by the government or international donors
2. Subsidizing of interest rate(but support of institution building often indispensable)
3. Credit as appendage to a production project
4. Politically motivated debt relieve
5. Use of extension workers as debt collectors
1. Rural financial system1.1 Formal1.2 Informal1.3 Formal vs. informal2. NIE in rural finance3. Financial services3.1 Credits
- Agricultural credit- Micro finance
3.2 Savings3.3 Insurances3.4 Safety net of MF4. Financial innovations
Market research9.Integration or connection to the formal financial market
10.
6. Do not use blue prints, especially not from other countries
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Recommended literature for first steps inthe field of rural (micro) finance
Ledgerwood,J. 1999. Sustainable banking with the poor - Microfinance handbook - An institutional and financial perspective, Washington DC, USA: The World Bank.
Robinson, M.S. 2001. The microfinance revolution - Sustainable finance for the poor. Washington DC, USA: The World Bank and Open Society Institute.
Rutherford, S. 2000. The poor and their money. New Delhi, India: Oxford University Press.
Pischke, von, J.d. 1991. Finance at the frontier – Debt capacity and the role of credit in the private economy. EDI Development Studies. Washington DC, USA: Economic Development Institute and The World Bank.
Pischke, von. J.D, Adams, D.W. and G. Donald. 1983. Rural financial markets in developing countries. EDI Series in Economic Development. Washington DC, USA: Economic Development Institute and The World Bank.
http://www.cgap.org/
http://www.microfinancegateway.org/
http://www.alternative-finance.org.uk/en/
http://econ.worldbank.org/
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Literature used for this lectureBuchenrieder, G., Heidhues, F., and P.T.M. Dung. 2000. Rural finance and sustainable rural development in
Northern Vietnam - Research proposal submitted to Deutsche Forschungsgemeinschaft (DFG). Stuttgart, Germany: University of Hohenheim, The Uplands Program.
Buchenrieder, G., Heidhues, F., and P.T.M. Dung. 2003.Risk management of farm households in Northern Vietnam. Research proposal submitted to Deutsche Forschungsgemeinschaft (DFG). Stuttgart, Germany: University of Hohenheim, The Uplands Program.
Geis, H.G. 1975. Die Rolle der finanziellen Infrastruktur bei der Kapitalbildung. In: Priebe, H. (ed.): Eigenfinanzierung und Entwicklung. Berlin, Germany: Duncker und Humboldt.
Heidhues,F. and G.Schrieder. 1999. Rural financial market development. Research in Development Economics and Policy Discussion Paper No 1. Stuttgart, Germany: Grauer Verlag.
Pischke, von, J.D. Analytical and public policy issues in promoting innovation in rural financial markets. In Special issue: Innovative approaches to rural financial market development. (ed Heidhues, F). Quarterly Journal of International Agriculture 34 (2): 121-131
Rutherford,S. 2000. Raising the curtain on the 'microfinancial services era'. Small Enterprise Development11 (1): 13-25.
Seibel, D. 1999. Outreach and sustainability of rural microfinance in Asia: Observations and recommendations. Rural Finance Working Paper No A5. Rome, Italy: International Fund for Agriculture Development (IFAD).
Vaessen,J. 2001. Accessibility of rural credit in Northern Nicaragua: The importance of networks of information and recommendation. Savings and Development 25 (1): 5-32.
Vogel, R., 1984. Savings mobilization, the forgotten half of rural finance. In: Adams, D. W., Graham, D., Von Pischke, J. D. (Eds.): 248-265. Undermining rural development with cheap credit. Boulder, USA: Westview Press.
Zeller, M. 2001. Promoting institutional innovation in microfinance - Replicating best practices is not enough. Development and Cooperation (1): 8-11.
Zeller,M. and M. Sharma. 2000. Many borrow, more save, and all insure: Implications for food and microfinance policy. Food Policy 25 (2): 143-167.
Zeller,M., Schrieder,G., Braun von,.J., and F. Heidhues. 1997. Rural finance for food security of the poor: Concept, review, and implications for research and policy. Food Policy Review No 4. Washington DC, USA: International Food Policy Research Institute (IFPRI).
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FinancialMarket
Credit Savings
Insurance
Steps to select a topic for a seminar paper:1. Germans select a country (developing or transition) of their choice,
all others should take their home country2. You may select a rural financial service (see rural finance triangle) or an
FFI of the country3. Select the sector (formal or informal) and/or specific financial institution4. Discuss strengths and/or weaknesses of sector and/or financial institution5. Use the templates of the institute6. Not more then five pages (incl. tables, figures & references)
Assessment of strengths & weaknessesof selected rural finance issues:Implications for the future
Source: Buchenrieder, Heidhues, and Dung (2003)
If you have questions while preparing the seminar-papers you can contact me under:[email protected] can find me in the office of Dr. Gertrdu Buchenrieder.