The Political Economy of Specialized FarmCredit Institutions in Low-income Countries

SWP446World Bank Staff Working Paper No. 446

April 1981

Prepared by: J. D. Von PischkePeter I. Heffeman and Dale W. Adams (Consultants)Agriculture and Rural Development Department

Copyright ® 1981The World Bank1818 H Street, N.W.Washington, D.C. 20433, U.S.A.

The views and interpretations in this document are those of the authorsand should not be attidbuted to the Wod Bank, to its affiliated

organizations, or to any individual acting in their behalf. _

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Contents

Page

The Political Economy of Specialized Farm Credit Institutions

in Low-Income Countries

Summary i

Organization and Operation of Specialized Farm Credit Institutions 1

A Conceptual Basis for a Performance Paradigm 3

Interaction of Interest Rates and Access 6

SFCI as a Response to Credit Rationing by Commercial Criteria 9

Effects of One-Sided Intervention in Rural Finance 10

Credit Rationing by Specialized Farm Credit Institutions 12

Repercussions of Poor Loan Discipline 17

The Utility of the Paradigm and of Lagg-ing Perfortmance 20

The Future of the Public Sector Farm Credit Complex 23

References 25

Annex 1 - Schematic Representation of the Specialized Farm Credit

Institution Performance Paradigm 28

Annex 2 - Nine Country Case Studies 31

Bangladesh 34

Tunisia 40

Jamaica 46

Philippines 54

Bolivia 62

Nigeria 68

India 74

El Salvador 82

Malaysia 89

SUMMARY

This paper outlines a pattern of specialized farm credit institution

performance in low-income countries. Specialized farm credit institutions

(SFCI) are defined as government institutions or credit programs which offer

farmers loans but no other significant financial services. Many countries

have such institutions, and among these certain common problems consistently

appear. These problems are seen in their faltering financial performance and

in limitations on their ability to provide an expanding array of services to an

expanding number of clients.

Their establishment often reflects a peculiar view of farmers,

finance and agricultural progress, and is usually associated with advocacy of

cheap credit for farmers. SFCI operate in two important environments because

of their functions and ownership. One environment is political, the other is

financial. The political context consists of SFCI design characteristics

including target group specification, concern about interest rate levels, and

limitations on and intervention in SFCI operations. The financial context

includes credit rationing strategies, access to market information, methods of

raising capital, loan collection performance, and relationships between SFCI

costs and revenues. The interaction of these contexts determines SFCI

performance.

The pattern outlined here is presented as a paradigm. It begins

with a situation in which it is felt in political circles that insufficient

credit is available for a certain agricultural purpose or group, who are

considered poor and unable to achieve an acceptable rate of progress without

access to cheap credit. It is further assumed that in this situation commercial

lenders are hesitant about venturing into rural lending, especially small

scale rural lending, because of the low returns envisaged from this type of

business.

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In response to the lack of rural financial services, the political

decision is taken to establish a specialized farm credit institution. This

institution is government owned and supported by the national treasury,

generally with the assistance of external donors. Credit programs for specific

agricultural purposes are designed by or for the institution, and constitute the

principal and perhaps sole service offered to clients.

Because of the narrowness of its functions, the SFCI fails to

mobilize rural savings and does not have access to sufficient information about

the rural economy to permit it to function dynamically or to gain credibility in

the eyes of the rural people it was designed to serve.

These difficulties are compounded by the emphases incorporated in

credit program design, which tend to result in large amounts of credit

being concentrated in the hands of relatively few prospective innovators, or

else spread widely in small amounts for political reasons. The result is

easily widespread default, manifested in delinquency in repayment, diversion

of loan funds to purposes not specified in loan contracts, and deceit on the

part of borrowers. These problems also result in the inadequate stimulation

of the agricultural production upon which the institution and specific

programs were initially justified.

Specialized farm credit institutions have limited scope for internal

reform because of their political nature. It is difficult to enforce loan

discipline in a political atmosphere. The continuation of poor loan recovery

performance entails certain negative secondary effects which are anti-develop-

mental. These include the discouragement of other financial intermediaries

from undertaking rural business, adversary relationships between rural people

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and government agencies, weakened contract enforceability, and increased

vulnerability by the SFCI to political interference.

The circle illustrated by the paradigm is completed by impaired

SFCI development, both in financial terms and in terms of its ability to

achieve its service objectives, and its continued dependence on the national

treasury and external donors.

The paradigm is presented in "worst case" terms for analytical

convenience. It is not meant to imply that all SFCI are doomed to follow this

extreme course. Rather, the paradigm identifies certain inherent weaknesses

in SFCI. It suggests that common problems experienced to some extent by most

SFCI in low-income countries can be related in a systematic framework. The

usefulness of the paradigm is not limited to pointing out weaknesses, however.

Within this framework, cause and effect are linked, offering an analytical tool

for remedial or institution-building initiatives. The paradigm's analytical

power is also demonstrated by the development of strong, independent financial

intermediaries in rural financial markets, when these institutions reflect

policies which depart from the consistent suboptimality contained in the basic

statement of the paradigm.

This paper contains in an annex nine country studies selected to

demonstrate the usefulness of the paradigm. These cases are drawn from the

credit literature, and were edited and cross referenced for this presentation

by consultants from the Ohio State University.

THE POLITICAL ECONOMY OF SPECIALIZED FARM CREDIT INSTITUTIONSIN LOW-INCOME COUNTRIES

by J.D. Von Pischke

1. Why are specialized farm credit institutions founded in low-income

countries, and why do they frequently founder? This phenomenon of development

finance may be explored and portrayed by a paradigm, or pattern, incorporating

financial logic and elements of political economy. The paradigm accepts

technical aspects of agriculture as given and ignores effects of inflation. It

demonstrates major causal links which produce typical patterns of institutional

performance.

Organization and Operation of Specialized Farm Credit Institutions

2. Specialized farm credit institutions (SFCI) primarily engage in the

provision of loans to farmers and others undertaking agricultural production.

Their names, while not invariably an accurate guide in terms of this strict

functional definition, include Agricultural Development Bank, Agricultural

Finance Corporation, Rural Development Bank, Agricultural Credit Corporation,

Supervised Credit Agency, Land Bank, and similar titles containing "agricultural"

and "fund." Their distinguishing features are a loan portfolio consisting

almost entirely of agricultural loans, and a narrow range of financial services

This publication is a result of research undertaken in the Economics andPolicy Division of the Agriculture and Rural Development Department. Helpful

comments offered by colleagues in the World Bank and by participants in the

Workshop on Rural Financial Markets and Institutions, sponsored by theOverseas Development Institute and the Ohio State University, which met in

June 1979, at Wye College, England, are gratefully acknowledged.

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offered. For example, SFCI do not on any significant scale accept deposits,

provide money transfer services, store valuables for safekeeping, or serve

as fiduciaries, except when these functions are required in the processing of

loan applications and in loan administration.

3. SFCI are established by governments in low-income countries to

provide financial assistance for agricultural production (FAO, 1973, 1974,

1975). They may cater to specific agricultural subsectors of farm sizes or

crops, and they may be linked with land tenure classifications or reforms.

Their services may be directed towards beneficiaries of agricultural, settle-

ment or rural development projects. These institutions are expected to

stimulate agricultural innovation and to promote certain social aspects of rural

development policy, often in the small-farm subsector.

4. Development assistance agencies often play an important role in

the design, establishment, financing and staffing of specialized farm credit

institutions, and in their reorganization and rehabilitation. Cumulative

World Bank lending for farm credit approximated the equivalent of

US$2.4 billion by 1979 (World Bank, 1979). The combined commitments by OECD

donors and regional development banks would probably be somewhat larger.

Much of this assistance has been directed towards SFCI rather than towards

enhancing the agricultural lending of diversified financial institutions

such as commercial banks and deposit-taking cooperative banks.

5. Specialized farm credit institutions in low-income countries have

a checkered record as financial intermediaries (Donald; Masini). Their

efforts to achieve institutional and £inancial viability and to expand their

clientele encounter more complications than those of diversified lenders

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because of the vagaries of agricultural production and prices, and also

because a certain portion of their activities have more in common with re-

search and development activities than with commercial practice. However,

losses appear to be larger than would be expected from credit institutions.

These lenders often find it difficult to achieve loan recovery levels suffi-

cient to break even financially before the allocation of administrative

expenses (Donald). Miracle (1973) estimated that approximately one third

of the funds loaned to farmers in the programs described in the 20-volume

Spring Review of Small Farmer Credit were unrecoverable. Others have noted

that SFCI provide services of low quality (Adams, 1977; Rice).

A Conceptual Basis for a Performance Paradigm

6. This paper attempts to explain why specialized farm credit insti-

tutions are created and why they and their programs frequently fail to

become viable. The point of view taken is that rural development requires

widespread access to resources to ensure that benefits of change are spread

broadly among target populations (Lele, 1975). Good financial performance

by lenders, permitting internally generated growth, is viewed as essential

to ensuring that access to credit is broadly based. It can be achieved

only when loan losses are minimized. 1/

7. The presentation which follows outlines typical defects in SFCI

performance. While the analysis is undertaken at the institutional level,

it also applies to farm credit units or components included in larger

1/ The criterion of good financial performance is based on the lack of areasonable alternative: subsidy is by definition limited by budgetaryconstraints and fiscal implications in low-income countries.

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development projects or loan portfolios. The basic statement of the para-

digm abstracts through the consistent selection of suboptimal alternatives.

The suboptimality of any single decision in the sequence may not be extreme

or obvious. As each decision sets in motion forces which lead to succeeding

decisions, however, the cumulative result is the opposite of the stated

objective towards which decision makers are initially oriented. That objec-

tive is the creation of a viable farm credit system or intermediary capable

of providing an increasingly wider array of services of an acceptable

standard to an expanding clientele of farmers. The paradigm demonstrates

how situations tend to develop perversely unless checked by departures from

the sequence, and identifies the types of costs encountered as the unfortu-

nate progression unfolds (Von Pischke, 1974).

8. The paradigm incorporates two types of influences on SFCI perform-

ance. The first is political, which stems from government's interest in

rural development, in agricultural production and in the use of political

power to benefit or to be seen to be benefiting various groups (FAO/CARIPLO).

The second type of influence is financial, comprising the inexorable mathe-

matics of the operation of financial markets and aspects of relationships

forged in these markets. Political decisions affect financial market vari-

ables, while the performance of financial markets provides grist for the

political mill. Interaction of these influences largely determines the

lagging performance of many SFCI.

9. The paradigm begins with the assumptions that the economy or the

relevant subsector is not served by a specialized farm credit institution,

and that most rural families, or a target group in question, do not have

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direct access to financial services provided by formal sector institutions.

It is assumed that the formal financial market, although not highly developed,

is loss avoiding, rational and workably competitive. 2/ A third assumption

is that policy makers believe that supplying credit for agricultural purposes,

or for the relevant subsector, cultivators or target group would be advanta-

geous. This belief, "the public sector farm credit complex," consists

of four related assumptions or ways of viewing rural people, the state of

agriculture, the requisites of rural development and the role of government.

The first is that "farmers are poor." Of all target group characteristics,

poverty is singled out as of primary interest. The second, "the farm credit

need creed," holds that little agricultural innovation or progress along

desired lines can occur without access to credit (Adams, 1971; Von Pischke,

1976a). The need creed is in harmony with concern for the poverty of farmers.

The third is the axiom that government should promote rural development or

target group welfare. The fourth is that supply-leading finance can stimulate

agricultural and rural development and contribute to target group productivity.

This term, evidently coined by Patrick (1966), suggests the antithesis of Mrs.

Robinson's observation that, "where enterprise leads, finance follows"

(Robinson, p. 86). Supply-leading finance consists of providing funds in

2/ Models of market perfection are inappropriate for the analysis of finan-

cial markets because of the role of risk in financial intermediation and

because of the contradictions in assuming access to a single price by

primary sellers and ultimate buyers in markets made by intermediaries.

No conceivable functioning financial market would refrain from using

nonprice criteria in allocative decision making (Clark, 1940, 1961;

Myrdal; Shaw; Stigler).

-6-

advance of demand 3/ in an effort to stimulate enterprise-- i.e., risk taking by

borrowers--in a socially useful manner. In agriculture it is based on the

assumption that credit tied to an innovation, such as improved inputs or a new

crop, will accelerate the adoption of the innovation by the target group of

intended borrowers.

10. The public sector farm credit complex defines the rural development

problem in terms of the poverty of farmers and their lack of access to credit

for specified purposes, finds the problem one which ought to be solved through

public sector intervention, and specifies credit as a medium through which

political initiative may be exercised. Supply-leading finance responds to the

perceived poverty of farmers as well as to the belief that they must have

access to credit before an acceptable rate of material progress will be

achieved. 4/

Interaction of Interest Rates and Access

11. The public sector farm credit complex produces advocacy of cheap

farm credit. Proponents note that credit should be provided at a "reasonable"

rate of interest for purposes which are considered socially and economically

imperative, and for target groups viewed as poor and having little alternative

but to use credit if they seek to progress (Donald). Since informal sector

3/ Schatz (1965, 1970) states that aggregate loan applications convey a"false demand for capital" and that the actual demand for credit con-sists of the volume of loan applications based on viable investmentproposals.

4/ Supply-leading agricultural credit is frequently linked with other meas-ures to stimulate rural development, such as extension. These ancillaryfactors are not crucial to the development of the relationships exploredhere.

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interest rates, except on some kinship and friendship loans, are high com-

pared to those found in formal markets, the possibility of involving informal

lenders in the solution to the problem defined by the public sector farm

credit complex is not seriously considered and would not be feasible within

the low interest rate structure proposed (Bottomley).

12. What constitutes a "reasonable" rate depends upon local circumstances,

but approximate parity with commercial bank loan rates to commerce and industry

is often advocated (Donald). One argument against higher rates for agriculture

contends that it is objectionable to charge a high rate to disadvantaged

elements in society. A similar position is that low rates of interest help to

compensate farmers for losses of income from government produce price ceilings

and other controls. The usual result is nominal agricultural interest rates

below or roughly equal to the going nominal rates on loans to other major

sectors, or to individuals not dependent upon agricultural incomes. The point

of analytical interest is that potential agricultural borrowers currently

without access to formal sector credit are to be accommodated under an interest

rate structure not significantly different from that applied to present

borrowers in other sectors (McKinnon).

13. Low formal sector interest rates on the types of loans most useful

to rural people tend paradoxically to restrict their access to formal sector

financial services (Adams, 1971; Adams, Davis and Bettis; Gonzalez-Vega;

Von Pischke, 1978). Rural customers at low levels of financial activity are

a costly market to serve (Adams, 1971). They tend to deal in small trans-

actions, which are relatively costly for formal financial institutions to

process. They frequently are scattered geographically in areas with poor

-8-

communications, making loan administration difficult. These factors preclude

economies of scale because of the small size of the market around a rural

office. Rural people may not be accustomed to modern commercial practice

and not so concerned about loan due dates as other customers, which raises

the lender's costs of loan and liquidity portfolio management. For deposit-

taking institutions, a clientele of small depositors who conduct business

in cash rather than by some form of payment order requires that offices main-

tain relatively high levels of cash. Cash kept to meet depositors' demands

earns no interest, adding to the costs of serving these clients.

14. The rural economy fluctuates more widely than many other types of

financial activity. The marketed or cash-generating portion of agricultural

output is subject to even greater uncertainty as a residual after relatively

constant subsistence requirements are satisfied (Allan). Variability in

income tends to reduce lenders' evaluation of the debt capacity of the target

group (Von Pischke, 1976b), which in effect is based on that portion of

expected future resources that would be available for loan repayment in

situations of reasonably expected adversity. Such situations include poor

harvests due to natural factors, low prices and failures in the marketing

system's capacity to absorb produce. Lenders' rationale rests on the require-

ment to meet the demands of their depositors and other creditors. An unpredict-

able stream of loan collections increases lenders' liquidity requirements,

raising costs and reducing the supply of loanable funds.

15. Uncertainty concerning the amount of a borrower's future cash flow

available to service debt is viewed by the lender as a credit risk. One

determinant of willingness to bear this risk is the interest and other income

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expected to be realized from the class of transaction concerned. Loans

involving substantial degrees of uncertainty tend to be avoided by lenders.

When interest rates (used here to denote all charges levied by lenders) are

kept low, lenders are not encouraged to expand their markets into activities

which incur higher costs, including the costs of greater uncertainty (Shaw).

Institutional factors inhibit lenders from raising rates selectively to

offset the costs of accommodating more risky loan applicants. These include

usury laws, the danger of increased political exposure, the size of the

increases required, possible losses in economies of standardized lending

terms, and the costs of obtaining the information and expertise necessary to

contain the risks of marginal business. Low rates encourage lenders to

perpetuate the status quo. Lenders stringently ration credit according to

commercial criteria of creditworthiness in low interest rate regimes, ceteris

paribus.

SFCI as a Response to Credit Rationingby Commercial Criteria

16. Stringent credit rationing by lenders such as commercial banks

results in severely restricted rural access to financial services. This

is seen in the paucity of rural offices of banks, in loan security demands

beyond the capacity of most households, in minimum transaction sizes and

minimum deposit account balance requirements which are high relative to

transactions and incomes normal for rural areas, and in other arrangements

imposing transactions costs on those seeking access to formal sector finan-

cial services. Adherents to the public sector farm credit complex perceive

this situation as grounds for remedial intervention by establishing a

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specialized farm credit institution (Reserve Bank of India; Tardy). This

new lender is intended to overcome alleged weaknesses in market performance

and is therefore not designed to be dependent upon market resources (World

Bank, 1975). It is funded through the national treasury, frequently with

support from external nonmarket sources such as aid agencies. 5/

17. By definition, a specialized farm credit institution is highly

selective in the types of financial services it provides, operating on only

one side of the rural financial market. Credit access is considered the

primary problem, and deposit-taking and money transfer services are typically

not developed. Rural savings capacities and liquid resources are usually

thought to be small (CARIPLO). Institutions already in place, such as post

office savings banks or commercial banks and cooperatives, may be thought to

be providing adequate financial services outside the credit sphere. Policy

makers may not see any advantages in replicating facilities or stimulating

competition for rural deposits or money transfers. In addition, these ser-

vices require managerial and accounting performance of a higher order than

those of loan disbursement, and there are merits in opting for simplicity

initially.

Effects of One-Sided Intervention in Rural Finance

18. Intervention solely on the side of the rural financial market which

issues loans has consequences which are frequently overlooked. It tends

to fragment these markets further. Credit channels are unrelated to savings

channels and make little direct contribution to stimulating rural savings.

5/ SFCI are good foreign exchange earners, opening new avenues of access togrants and loans from donors. Th_is may help to explain their popularityin low-income countries.

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Such intervention may encourage a popular belief that formal sector credit

is essential, or at least the most feasible means of progress (Lele, 1973;

Schatz, 1965; Vasthoff). This may occur at the expense of the tradition of

self-help and self-finance, and of the development of informal financial

mechanisms such as rotating savings and credit associations. 6/

19. Most importantly, dependence upon the national treasury and external

donors limits SFCI access to market funds and information. Lack of such

access results in alienation of the institution. Alienation stems from

inability to act as a rural financial institution intermediating between rural

savers and borrowers rather than merely serving as a link between the govern-

ment and the rural sector. Rural people are not regarded by SFCI as a market

to be developed but rather as poor, exploited or economically incompetent

people requiring assistance (Kratoska). Rural people, in turn, do not view

SFCI as something of their own, but rather as benevolent intrusions to be

exploited. In these circumstances a specialized farm credit institution

does not have access to the depth of information about rural financial flows,

behavior and priorities which is available to those who enjoy sufficient

confidence to operate on both sides of rural financial markets as deposit

takers, lenders and money transfer agents. Denied such information and

insight, and divorced from the context required to view finance broadly or

creatively, SFCI management can develop only limited decision-making

expertise (Von Pischke, 1974). SFCI are not in a position to be stimulated by

the discipline imposed and opportunities offered by market forces.

6/ Bouman (1977) notes that some government officials and development

specialists have a negative view of these associations in any case.

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20. Lacking essential information and limited by budgetary and operating

constraints imposed by government sponsors, specialized farm credit institu-

tions generally are forced to ration credit stringently. This stringency is

different from that based on commercial criteria applied by other formal

sector intermediaries such as commercial banks. It is based on considerations

which are fundamentally political. Political criteria, broadly defined, are

inherent in farm credit programs designed by governments and development

assistance agencies seeking to promote the welfare of target groups selected

on extra-market criteria.

Credit Rationing by Specialized Farm Credit Institutions

21. Credit rationing by SFCI tends to take two forms. These depart

from a financial optimum at which the borrower's level of indebtedness is

matched with his repayment capacity in such a way that enterprise is stimu-

lated. These two forms may be termed intensive and extensive. Intensive

credit rationing involves identification of a relatively small target group,

and the provision to members of that group of amounts of credit which are

large in relation to the existing scope of their operations. For example,

a farmer with two local cows may be given a loan to buy several grade or

exotic cows. A small farmer planting local varieties and using only a

little organic fertilizer may be issued credit, possibly in kind, to plant

the entire holding with high-yielding varieties nourished by chemical

fertilizers. A farmer using bullocks for draft power may be accorded a

loan to purchase a tractor. Smallholders without a cash crop may receive

tobacco planting materials on credit plus a loan to construct a curing shed.

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22. Intensive credit rationing has features attractive to aid agencies,

and it is often found in externally funded SFCI activities. The usual objec-

tive of intensive credit rationing is to increase agricultural production and

the incomes of borrowers through technological innovation. Because the size

of the loan is such that borrowers could not reasonably be expected to repay

from their pre-loan cash flow, loan repayment must come from the incremental

cash flow to be generated by the loan-supported investment. Credit alloca-

tion under these circumstances tends to be quite selective, and elaborate

access mechanisms using farm budgets are frequently employed by lenders

(Adams and Nehman; Gittinger).

23. An assumption underlying intensive credit rationing is that lack of

finance is a binding constraint to increased production and augmented farm

incomes. This implies that all other elements essential to the realization

of these objectives, including the borrower's ability to accommodate the

uncertainties involved, are in place or can be provided as an adjunct to

credit and rendered operative by finance. Intensively rationed credit

is supply-leading finance par excellence.

24. Extensive credit rationing is motivated by considerations of access

as well as of production, and access mechanisms are simple. Credit is

rationed extensively to large numbers of farmers in broad target groups. For

example, all members in good standing of a cooperative may have access to

seed and fertilizer loans. All commercial growers of wheat having land

titles may be eligible for production loans.

25. Within SFCI budget or balance-sheet constraints, broad access

implies relatively small loans to numerous borrowers. Loan limits under

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extensive rationing are frequently specified in terms of rules of thumb

or standard amounts per hectare of credit-supported enterprises, in contrast

to the more complicated derivation of loan limits from farm budgets used for

intensive credit rationing. Extensive rationing is most frequently found

in seasonal input credit. Small amounts are issued to each borrower, satisfy-

ing the production-oriented bias of program planners and inspiring broad appeal

which is politically desirable. Programs using extensive rationing are usually

funded by governments without support from donors, except in donor-supported

area development projects, certain aid for cooperatives, and farm credit systems

funded through centralized rediscounting agencies.

26. Each variety of stringent credit rationing under political criteria

contains the seeds of its own financial destruction. These seeds take root

to the extent that politics produces extremes in credit rationing which

overwhelm financial considerations. Programs with highly intensive or extensive

rationing self-destruct most rapidly, other things being equal.

27. Intensively rationed credit attempts to perform the function of

equity or ownership capital in absorbing the impact of uncertainty. The

borrower's return consists of a residual after permitting a steady flow

of resources back to the lender according to agreed loan terms. As a residual,

the return to equity is variable, reflecting the impact of uncertainty on

a borrower's overall financial situation. Intensively rationed loans are

large relative to the financial status of the borrower, impose relatively

large debt service burdens, and change the on-farm factor mix significantly

through the addition of higher levels of technology. Such loans may push the

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borrower's finances beyond his managerial and risk-bearing capabilities, 7/

especially during the critical initial period of adaptation to credit-

supported change. Adversity may be reasonably anticipated in agriculture and

in the implementation of new technologies. In periods of adversity, borrowers

may find it difficult to meet debt-servicing obligations (Von Pischke, 1976b).

The new activity may not generate sufficient cash flow to repay the loan which

permitted its adoption. Delinquency in repayment easily results. Borrowers

may not regard transgression of SFCI loan contracts very seriously: they

accept the public sector farm credit complex and view the lender as an alien

institution with access to the tremendous resources of government. In addition,

they may have relatively little of their own resources sunk in the loan-supported

investment, which tends to lessen their commitment to its successful performance.

28. Extensive credit rationing can also lead to financial problems.

In promoting access, lenders offer credit to some borrowers who are not in

a position to use it wisely, or who have little intention of repaying, or

who are so exposed to uncertainty or so close to subsistence that even small

repayment obligations assume major proportions. In these cases, accumulation

of arrears on the lenders' books is probable. For others who borrowed with

the expectation that their agricultural incomes would be increased, extensively

rationed small loans may pose certain difficulties. Prescribed husbandry

practices which lenders intend to support may be subject to indivisibilities

far beyond the average loan size. For example, the loan may be small compared

to the financial requirements of improved input packages, which may lead to

7/ Bouman suggests that the impersonal aspect of formal sector finance may

increase the willingness to go into debt by removing from loan trans-

actions the influence of cultural norms, such as the obligation to re-

ciprocate, which limit informal indebtedness. Low interest rates exert

a similar influence.

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incomplete adoption of the package with disappointing results. Improved seeds

without fertilizers, for example, may not perform much better than traditional

varieties. Even if all inputs are provided in kind, the new grower may not use

them in prescribed proportions for reasons of risk aversion or poor information.

In these cases the borrower may not produce incremental cash flow sufficient

for loan repayment. Access to extensively rationed credit does not necessarily

stimulate adoption, and loans may be too trifling to engender commitment to

either their productive use or repayment.

29. Stringent rationing by political criteria easily leads to poor

loan discipline, defined to include delinquency, deceit and diversion. All

constitute default according to technical usage indicating any breach of a

loan contract. Delinquency denotes the failure to pay on time, and inability

and unwillingness to repay as credit rationing becomes increasingly intensive

or extensive. Deceit arises because borrowers have an incentive to circumvent

the rules of the game, especially rules made by a lender alien to them and

thought to have huge financial resources rationed according to political

criteria. Incentives to build a good credit rating are lacking, especially

in the early years of an institution when its permanency and efficiency

have yet to be demonstrated.

30. One means of circumventing loan limits per hectare under extensive

rationing is to apply for credit for a larger area than will be cultivated,

or to borrow simultaneously under different names. Another is to borrow

using a different name each season. If loan repayments are deducted at

source from delivery proceeds, there is an incentive to borrow and deliver

-17-

under different names, or to use others as delivery agents. These tactics

are often successful when loan supervision and records are not finely tuned.

31. The relatively large size of intensively rationed loans may tempt

the borrower to divert a portion for purposes not envisaged by the lender,

especially if the borrower is not entirely comfortable with the leap in

uncertainty and managerial demands which agreed loan use involves. Loan-

supported purchases or disbursements in kind may be resold for immediate cash,

or fictitious invoices may be submitted by accommodating suppliers. Diversion

is probably even more common under extensive rationing, especially when

loans are disbursed in cash.

32. While possibilities of abuse are found wherever credit exists,

stringent credit rationing under political criteria creates incentives for

abuse. Under the terms on which credit is extended, rational behavior and

responsible behavior on the part of the borrower as specified in the loan

contract do not coincide.

Repercussions of Poor Loan Discipline

33. Poor loan discipline impairs SFCI development. Funds which would

have become available for relending, as outstanding loans mature, are locked

up as arrears. As arrears accumulate, SFCI resources fail to revolve full

circle. Potential new borrowers may find their access to credit delayed,

restricted or denied because of the declining liquidity of the lender.

Intensively rationed credit becomes available to fewer new borrowers when

funds available for lending decline. Lenders may restrict access further

by increasing the average loan size for economy in loan administration,

catering to an increasingly select group of relatively low-risk, large

-18-

borrowers. Lenders of extensively rationed credit may maintain broad

access by reducing average loan size. Causes of arrears are fortified as

extensively rationed loans become increasingly trivial, especially in real

terms when inflation raises the costs of modern husbandry.

34. Arrears have an opportunity cost. Day-to-day collection problems

consume the lender's scarce managerial resources, often at the expense of

activities requiring a long time horizon such as planning, staff training,

development of management information systems and designing more effective

services for rural people. The accumulation of arrears and associated poor

financial performance may demoralize staff having a financial or accounting

outlook, making it even more unlikely that the institution could become

financially efficient.

35. As damaging as these effects are within SFCI, they may be small

relative to external effects. Rural access to financial services provided by

lenders other than specialized farm credit institutions may be retarded by

poor SFCI performance. Dismantling the tradition of poor loan discipline of

government lenders has a cost, and diversified loss-avoiding intermediaries

outside the state sector may be deterred from serving the poor because of

that cost. They may be increasingly reluctant to extend credit in experi-

mental or innovative ways because of the heightened political sensitivity

surrounding the enforcement of rural loan contracts.

36. Achievement of development targets may be hindered by poor loan

discipline. Defaulters, originally considered as poor farmers deserving

financial assistance, are placed in an adversary position against their

financial partner in development. The flow of communication between borrower

and lender is constricted. A basis for distrust is created between borrowers

-19-

and rural development administrators, extension agents and SFCI staff. Dis-

trust raises the costs of promoting rural development by making consensus

more difficult to achieve, or by requiring greater coercion for the successful

implementation of programs involving rural participation. One attempt to

reduce these costs is to accord SFCI extra-legal administrative recourse

against defaulters. However, this power increases the probability of arbitrary

action against rural people.

37. Widespread default demonstrates to rural people that government

is not able or not willing to enforce contracts, in this case the loan document

to which an official institution is a party. Cases taken to court by SFCI

may strain the ability of courts to dispense justice, especially if defaulters

are numerous (Lele, 1975). The efficiency of legal administration may decline

as the increased queue of litigants makes it difficult for the courts to

deal promptly with routine cases, such as boundary disputes, inheritance claims

and cattle theft. The legal force of other contracts may be compromised by

situations created by loan defaults, retarding the contribution which commerce

and commercial practice make to rural development.

38. Accumulation of arrears also makes SFCI more vulnerable to political

interference. Those who formed the institution to assist the rural poor

are seldom enthusiastic about seeing their creation expropriate rural property

or construct a black list of defaulters to be denied further credit. Inter-

ference may be across the board, permitting all defaulters to take a longer

free ride, or selective, favoring certain groups or individuals. Default

may also be a source of conflict among rural people. Defaulters who are not

apprehended may incur the animosity or envy, or both, of borrowers who strain to

-20-

repay and of defaulters who are caught. The selective nature of credit access

may be magnified by default and by uneven efforts to enforce loan discipline.

To the extent that the pattern of default favors the rural power structure,

equity is violated by collection activities manipulated by that power struc-

ture. Thus, the initial concern for access, expressed through an inappropriate

medium, ends by violating the parallel concern for equity (Blair).

39. As the development of this paradigm suggests, the public sector

farm credit complex does not contain the basis for the correction of the many

unfortunate direct and indirect consequences it so easily engenders. In

addition, the tradition of poor loan discipline which it spawns tends to be

self-perpetuating (Rice). Arrears remain on the books for a very long time,

debilitating the lender. It may be argued, but not within the scope of this

paper, that lagging SFCI performance requires much more time and effort to

correct than the faltering or ineffective performance of an extension service

or input supply or produce marketing system. It may also be argued that the

costs of lagging SFCI performance are higher, from almost any perspective

except political expediency, than those associated with the poor performance

of most development activities undertaken by government.

The Utility of the Paradigm and of Lagging Performance

40. The paradigm describes the types of problems which to some degree

affect most SFCI in low-income countries. In situations in which the basic

statement of the paradigm appears not to offer a valid analytical approach,

several factors may be at work. However, these factors vindicate the

-21-

analytical framework it provides. 8/

41. The most positive vindication of the paradigm in cases in which it

appears not to apply is found when policy or institutional design departs from

the assumptions of the public sector farm credit complex. For example, rural

people may be viewed as a largely untapped, potential market for formal

sector financial services, and initiatives to tap this market may be oriented

towards cost-effectiveness. Likewise, low interest rate policies may be

abandoned in moves towards financial liberalization in efforts to enhance the

quality as well as the quantity of the financial sector's contribution to

development. In these cases reality may unfold in a manner consistent with the

paradigm but opposite to its basic statement. The result is the development

of strong, independent intermediaries and greatly expanded rural access to

financial services (Von Pischke, 1978).

42. The model may also appear superficially not to apply when government

or donor assistance enables a specialized farm credit institution to become

larger and serve more people in spite of itself. Arrears may not impede

new lending while funds pour in as subsidies, debt and equity capital. In

cases of poor SFCI performance overwhelmed by access to new funds, the paradigm

is still useful. It provides a systematic basis for identifying the costs of

those policies and activities which require outside support to keep the lender

liquid.

43. But why would new funds continue to be provided? A weak loan

recovery record may very well reinforce the public sector farm credit complex:

not only are rural people poor, they are too poor to repay their loans.

8/ Like the cobweb theorem, the paradigm can yield cycles of expansion as wellas of contraction, depending upon the assumptions used.

-22-

Disappointing performance may actually increase the institution's ability to

raise funds in the short run and need not place it at any real disadvantage

in relation to its sponsors. Assistance agencies are often eager to shore up

the operations of their clients so that program continuity is maintained and

country relationships solidified, and so that more farmers may be helped.

Past losses or failures may be viewed as sunk development costs contributing

to expectations of greatly improved performance in the future.

44. At some point, SFCI rehabilitation and reorganization may be neces-

sary because of decapitalization from bad loan losses and lending rates which

do not cover administrative and other costs. This admission on the part of a

government provides the possibility for increasing donor leverage, accompanied

by substantial infusions of new funds. Skillful governments may attempt to

create competition among donors to offset demands for increased controls,

tighter performance commitments or more flexible interest rate policies. In

any event, support is usually forthcoming: more funds enable more farmers to

receive loans.

45. Lagging farm credit operations may also be used to raise the institu-

tional stakes in rural development. Poor performance can be attributed to any

number of shortcomings and conditions judged worthy of remedial intervention.

Agricultural extension and farmer education are frequently invoked palliatives,

as are the formation of credit groups or cooperatives (Kratoska; Reserve Bank

of India). Some donors may be attracted by proposals for remedial ventures

considered innovative or experimental, such as loan insurance.

-23-

The Future of The Public Sector Farm Credit Complex

46. In view of the problems which plague specialized farm credit insti-

tutions in low-income countries, what is their future course? One certainty

is that they will continue to receive large amounts of funds from their sponsor

governments and donors because of their political appeal and thirst for

resources. Less certain is the survival of the public sector farm credit com-

plex, which faces four major challenges. First, the complex will be rendered

irrelevant in some countries by measures going far beyond intervention in rural

finance. Centralized control of agricultural production and of rural people,

and the transformation of the formal financial sector into a set of accounts

for the planning authority, eclipse the concerns raised by the paradigm.

Second, rural development breakthroughs not involving supply-leading finance

will divert attention from the complex. Arguably the most captivating recent

breakthrough of this nature has been the training and visit system (Benor and

Harrison) popularized in India and elsewhere with World Bank support, which

has obtained substantial yield increases by effectively packaging and market-

ing extension assistance to small farmers.

47. The third and fourth threats come from rural financial markets

themselves. The complex will be eroded by recent trends in rural financial

market research. Assumptions which are increasingly challenged by empirical

data are that rural people are unable to save, that rural financial liquidity

is negligible, that the informal credit market is characterized by "usurious"

rates of interest and that specialized farm credit institutions and low formal

sector interest rates are relatively low-cost interventions serving the best

interests of rural people. Finally, the complex is undermined by the

-24-

operations of farm credit suppliers which operate effectively in financial

terms on bases which are at odds with the complex. These include aggressive

voluntary efforts to mobilize target group deposits, and techniques of support

which concentrate on building viable financial institutions rather than on low

interest rates for target groups. In circumstances where research and financial

market performance constitute the main challenges to the public sector farm

credit complex, the institutional variable of greatest interest may be the

length of the lag between the realization that present systems are often based

on inappropriate assumptions and the development of new responses by rural

developers.

-25-

REFERENCES

Adams, D.W. (1971) Agricultural Credit Policy in Latin America: A Critical

Review of External Funding Policy. American Journal of Agricultural

Economics, 53, 163-172.

. (1977) Policy Issues in Rural Finance and Development. Con-

ference on Rural Finance Research, San Diego, California, 1.

Adams, D.W. and Nehman, G.I. (1979) Borrowing Costs and the Demand for

Rural Credit. Journal of Development Studies, 15, 165-176.

Adams, D.W., Davis, H. and Bettis, L. (1972) Is Inexpensive Credit a Bar-

gain for Small Farmers? Economics and Sociology Occasional Paper 58.

Department of Agricultural Economics and Rural Sociology, The Ohio

State University.

Allan, W. (1967) The African Husbandman. Edinburgh: Oliver & Boyd.

Benor, D. and Harrison, J.Q. (1977) Agricultural Extension: The Training

and Visit System. Washington, D.C.: The World Bank.

Blair, H.W. (1973) The Distribution of Agricultural Credit and Benefits:

Political Economy and Small Farmers in Less Developed Countries.

Small Farmer Credit Analytical Papers. AID Spring Review of Small

Farmer Credit, 19.

Bottomley, A. (1962) Credit Expansion and Growth in Underdeveloped Rural

Areas. The Indian Economic Review, 6, 125-143.

Bouman, F.J.A. (1977) Indigenous Savings and Credit Societies in the Third

World: A Message. Savings and Development, 1, 4, 181-219. (See also

Development Digest, 16, 3, 36-47.)

CARIPLO. (1971) The Mobilization of Savings in African Countries. Milan:

Cassa di Risparmio delle Provincie Lombarde (CARIPLO).

Clark, J.M. (1940) Towards a Concept of Workable Competition. American

Journal of Economics, 30, 241-256.

. (1961) Competition as a Dynamic Process. Washington, D.C.:

The Brookings Institution.

Donald, G. (1976) Credit for Small Farmers in Developing Countries.

Boulder, Colorado: Westview Press, Inc.

-26-

Donaldson, G. and Von Pischke, J.D. (1973) Survey of Farm Credit in Kenya.Small Farmer Credit in Kenya. AID Spring Review of Small FarmerCredit, 7.

FAO. (1973) Agricultural Credit in the Near East and Mediterranean Basin.Rome: Food and Agriculture Organization of the United Nations (FAO).

. (1974) Agricultural Credit in Africa. Rome: Food and Agri-culture Organization of the United Nations (FAO).

. (1975) Agricultural Credit in Asia. Rome: Food and Agricul-ture Organization of the United Nations (FAO).

FAO/CARIPLO. (1976) Agricultural Credit for Development. Milan: Cassa diRisparmio delle Provincie Lombarde (CARIPLO).

Gittinger, J.P. (1972) The Economic Analysis of Agricultural Projects.Baltimore: The Johns Hopkins University Press.

Gonzalez-Vega, C. (1976) On the Iron Law of Interest Rate Restrictions:Agricultural Credit Policies in Costa Rica and Other Less DevelopedCountries. Ann Arbor, Michigan: University Microfilms (77-7092).

Kratoska, P. (1975) The Chettiar and the Yeoman. Singapore: Institutefor Southeast Asian Studies.

Lele, U.J. (1973) Role of Credit and Marketing Functions in AgriculturalDevelopment. Prajnan, 2, 125-162.

. (1975) The Design of Rural Development: Lessons from Africa.Baltimore: The Johns Hopkins University Press.

Masini, M. (1977) Development Choices, Banking and Personal SavingsMobilization. Savings and Development, 1, 4, 220-237.

McKinnon, R.I. (1973) Money and Capital in Economic Development.Washington, D.C.: The Brookings Institution.

Miracle, M.P. (1973) Notes on Developing Small Farmer Credit Institutionsin Third World Countries. Small Farmer Credit Analytical Papers,AID Spring Review of Small Farmer Credit, 19.

Myrdal, G. (1968) Asian Drama: An Inquiry into the Poverty of Nations.New York: Pantheon, 3.

Patrick, H.L. (1966) Financial Development and Economic Growth in Under-developed Countries. Economic Development and Cultural Change,14, 174-189.

-27-

Reserve Bank of India. (1954) All India Rural Credit Survey: The

General Report, 2. Bombay.

Rice, E.G. (1973) Summary of the Spring Review of Small Farmer Credit.

Small Farmer Credit Summary Papers, AID Spring Review of Small

Farmer Credit, 20.

Robinson, J. (1952) The Rate of Interest and Other Essays. London:

Macmillan & Co. Ltd.

Schatz, S.P. (1965) The Capial Shortage Illusion: Government Lending

in Nigeria, Oxford Economic Papers, 17, 309-317.

_ (1970) Economics, Politics and Administration in Govern-

ment Lending: The Regional Loans Boards of Nigeria. Ibadan:

Oxford University Press.

Shaw, E.R. (1973) Financial Deepening in Economic Development. New York:

Oxford University Press.

Stigler, G.J. (1967) Imperfections in the Capital Market. Journal of

Political Economy, 75.

Tardy, L. (1938) Report on Systems of Agricultural Credit and Insurance.

Geneva: League of Nations.

Vasthoff, J. (1968) Small Farm Credit and Development: Some Experiences

in East Africa with Special Reference to Kenya. Munich: Weltforum

Verlag.

Von Pischke, J.D. (1974) Farm Credit in Kenya: The Poor Farmer Paradox.

Studies in Employment and Rural Development, 5, 2, Washington, D.C.,

The World Bank.

_ (1976a) A Critical Survey of Approaches to the Role of

Credit in Smallholder Development. Discussion Paper 233, Institute

for Development Studies, Nairobi, Kenya. (Edited version appeared

in 1978 as When is Smallholder Credit Necessary?, Development Digest,

16, 3, 6-14.

. (1976b) The Quantification of Farm Debt Capacity. Washington,

D.C.: Economic Development Institute of the World Bank.

. (1978) The Political Economy of Farm Credit in Kenya.

Ann Arbor, Michigan: University Microfilms (78-70,027).

World Bank. (1975) Agricultural Credit Sector Policy Paper. Washington,

D.C.

_ (1979) Annual Report. Washington, D.C.

-28-ANNEX 1

THE POLITICAL ECONOMY OF SPECIALIZED FARM CREDIT INSTITUTIONSIN LOW-INCOME COUNTRIES

SCHEMATIC REPRESENTATION OF THESPECIALIZED FARM CREDIT INSTITUTION

PERFORMANCE PARADIGM

1. Figure 1 presents the specialized farm credit institution (SFCI)

performance paradigm in schematic form. The schematic is presented in four

columns portraying the stages in the development of the paradigm. The first

contains those factors which are present when there is no SFCI to cater to the

perceived "needs" of a particular group of farmers. The second deals with SFCI

design and establishment, while the third outlines SFCI lending strategies and

borrowers' reactions to them. Column four presents the unfortunate results of

perverse SFCI development produced by the paradigm.

2. Horizontally superimposed on the columnar classification are the

dynamics determining SFCI development. The upper portion of the diagram

contains those points in the paradigm which reflect the political dynamics of

SFCI performance. These include (a) the peculiar view characterized as the

"public sector farm credit complex," and the resulting cheap credit bias,

(b) SFCI establishment by the State with the collaboration at some point of

external assistance agencies, and (c) negative side effects and political

repercussions which result from the perverse developments sketched by the

paradigm. The lower portion of the diagram contains those factors which

reflect the financial dynamics of SFCI operation. These include (a) interest

rates and credit rationing strategies, (b) SFCI institutional development and

impact on rural financial markets, and (c) the financial implications of poor

loan collection performance.

-29-

3. The schematic presents the paradigm in simple form. It ignores the

secondary or indirect linkages among points contained in the paradigm. For

example, restricted rural access to financial services, at the bottom of the

first column, is reinforced by the impaired SFCI development noted at the

bottom of the last column. SFCI alienation could contribute to poor loan

discipline and poor loan collection performance even without stringent credit

rationing based on political criteria. The separation of rural saving from

rural credit could contribute directly to poor SFCI loan collection performance

because SFCI have no opportunity to excercise the right of offset under which

commercial banks, for example, are able to block deposit balances of borrowers

in arrears and apply them to the reduction of arrears. Yet another example is

provided by the extent to which impaired SFCI development reinforces the public

sector farm credit complex. Numerous other secondary or indirect relationships

could be cited, based on the observation that the financial and political

dynamics which determine SFCI performance constitute a system involving a

complex set of variables and relationships.

Figure 1. A Paradigm of the Political Economy of Specialized Farm Credit Institutions (SFCI) in Low-Income Countries

B. SFCI Establishment C. SFCI Lending StrategiesA. Situation without SFCI and Status and Borrower Response D. Paradigm Results

The Public Sector -- Establishment of a Political repercussionsFarm Credit Complex specialized farm of enforcing loana. Farmers are poor credit institution discipline

Q b. Farm credit need creed (SFCI)c. Government should l Negative side effects

stimulate rural 4 a. Discourages otherdevelopment SFCI dependence on intermediaries

Ca d. Supply-leading finance Tesr&exrnlb. Adversarystimulates rural funds o sfterms relationshipsfunds on soft termsdevelopment c. Impairs contracto I I d. enforceability

l d. SFCI vulnerabilityto political 0

Cheap farm credit policy Farm credit program interferencedesign

Continued dependence

on Treasury & donors

Low interest rates Separation of rural Stringent credit rationing Poor loan collectionsaving from by political criteria performance

1 rural credit

Ei Unattractive returns onnon-prime lendingE sv dSCS~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Exesv ImntensiveCLimited SFCI access I edeSpCn

,-1 I to market funds Subsitution development

Stringent credit rationing I of debt Inadequateby commercial criteria for equity stimulation

I SFCI alienation of production

.. l1'Restricted rural access ___ Poor loan disciplineto financial services (delinquency, deceit, diversion)

-31-

ANNEX 2

THE POLITICAL ECONOMY OF SPECIALIZED FARM CREDIT INSTITUTIONSIN-LOW INCOME COUNTRIES:

NINE COUNTRY CASES

C O N T E N T S

Page

Introduction 32

"Rural Financial Markets in the Development of Bangladesh,"by Dale W. Adams and G. 0. Nelson 34

"Regional Agricultural Planning - Le Kef: Evaluation of PresentAgricultural Development Institutions and Programs"by F. Bouman 40

"Recent Economic Growth and Rural Financial Markets in Jamaica:Analysis of Performance, Problems and Recommendations"

by Douglas H. Graham, C. Bourne and G. Begashaw 46

"Rural Financial Markets in the Philippines: Case Study"by Evangeline P. Javier 54

"Credit Policies and Rural Financial Markets in Bolivia"by Jerry R. Ladman and Ronald Tinnermeier 62

"Credit in Rural Development: An Appraisal of the SupervisedCredit Scheme for the Settlers in Western Nigeria"

by S. A. Oni 68

"Rural Credit in Uttar Pradesh"by P. S. Saxena and B. B. Lal 74

"The Supervised Credit Program in El Salvador: 1961 to the Present"by R. A. Vasquez, G. Solis, and D. E. Weisenborn 82

"An Input Credit Program For Small Farmers in West Malaysia"by R. J. G. Wells 89

-32- ANNEX 2

THE POLITICAL ECONOMY OF SPECIALIZED FARM CREDIT INSTITUTIONSIN LOW-INCOME COUNTRIES:

NINE COUNTRY CASES

Introduction

1. This appendix consists of excerpted and lightly edited presentations

from the farm credit literature which to varying degrees support principal

arguments presented in the main text of this paper. Each of the works contained

in this appendix was written independently. They were not commissioned by the

Bank or any other agency or individual seeking support for the position taken in

the main text. Most of the writers of works excerpted in this appendix were

unfamiliar with the paradigm developed in the main text or with the author's

earlier materials on the subject.

2. Mr. Peter J. Heffernan prepared this appendix under the direction

of Professor Dale W Adams of the Department of Agricultural Economics and

Rural Sociology at the Ohio State University. Preparation consisted primarily

of selecting, excerpting and editing cases, and preparing cross-references to

relate the points made in these selections to the arguments developed in the

main text.

3. The criteria for selection included geographical coverage and relevance

to the paradigm presented in the main text. The cases, with one exception,

are from English language sources. They treat specialized farm credit institu-

tions (SFCI) in nine countries: Bangladesh, India, Malaysia, and the Philippines

in Asia; Nigeria and Tunisia in Africa; and Bolivia, El Salvador and Jamaica

in the Latin American/Caribbean region.

4. The cases deal with-different types of specialized farm credit

institutions. Some reflect the definition proposed in paragraph 2 of the

-33-

main text. These financial intermediaries provide loans without engaging

to any significant extent in the provision of other financial services.

However, the case studies also include examples of SFCIs which correspond to

the expanded definition suggested in paragraph 7 of the paper. These are not

separate entities or institutions, but are loan programs operated by non-

financial organizations such as ministries of agriculture or settlement

authorities, or agricultural lending operations of diversified intermediaries.

5. The extent to which credit operations discussed in these materials

conform to the paradigm varies, and in all cases the confirmation provided for

the paradigm is only partial. It was felt that the absence of complete and

consistent confirmation was not a great disadvantage in the context of the

social sciences, and that using existing and independent observations was more

rigorous than commissioning a number of case studies designed specifically to

support the arguments presented in the paradigm.

6. Annotated references to relevant portions of the main text are given

in each of the works presented in this appendix. These references are denoted

by lettered footnotes listing by number the correlative paragraph of the main

text. In most cases a brief explanation is given of the relationship between

the point made in the case and the point made in the main text.

7. The authors of the materials included in this appendix bear no

responsibility for the paradigm or its presentation. The selection of cases

for this appendix does not signify that their authors are in agreement with

arguments upon which the paradigm is based. Likewise, the World Bank and the

author of the main text of this paper assume no responsibility for the accuracy

of information provided in these cases or for the views or interpretations

presented by their authors.

-34-

EXCERPTS FROM

RURAL FINANCIAL MARKETS IN THE DEVELOPMENT OF BANGLADESH

Dale W. Adams and G. 0. Nelson

Problems and Issues of Agricultural Credit and Rural FinanceBangladesh Bank

DaccaSeptember 1979

While Bangladesh was part of Pakistan, agriculture was assigned

less priority than the industrial sector. It was not until the late 1960s

that policymakers focused attention on increasing production in agriculture

(A). This was done mainly by increasing the supply of chemical fertilizers

and pesticides, and expanding the number of tubewell or low lift pumps for

irrigation in the dry season. Physical inputs and credit were regularly

supplied at concessionary or subsidized rates (B). The overall productioneffect of these activities was positive. The increase in agricultural outputduring the 1960s nearly kept pace with the increase in population growth. The

strategy also had negative effects, however, as larger farmers, because oftheir better access to credit and modern inputs, benefited considerablymore than smaller farmers and the landless (C).

The structure of rural financial markets (RFMs) in Bangladesh is the

result of a good deal of evolution interrupted by politcal intrusions. Prior

to 1900 almost all credit in rural areas in East Bengal was provided by

informal lenders. Occasional distress credit known as taccavi loans, author-ized by the Agricultural Loan Act of 1885, were distributed from government

funds. These loans, however, have most often been treated by both giver andreceiver as relief payments rather than as loans to be repaid (D). Post

Office Savings Banks were also opened in some areas in the late 1880s. In

1905 the British began to introduce village level credit cooperatives in many

parts of the subcontinent. These cooperatives were largely aimed at substitu-

(A) See 3, 10. Agricultural development policies often involve technological

innovation. Credit is frequently an important vehicle for politicalintervention aimed at enhancing agricultural production.

(B) See 11. The public sector farm credit complex leads to the provision ofcredit at concessionary rates.

(C) See 8, 13-15. Financial considerations of viability and risk overcamepolitical concerns for equitable distribution of benefits derived from

the programs.

(D) See 35, 37. The government's lax approach to recovery of taccavi loans

inadvertently fostered a default mentality toward government loans in

rural areas.

-35-

ing for informal lenders who were thought to exploit the rural poor (E). By1947 there were 26,664 rural credit cooperatives scattered around East Bengal.Because of World War II, the Great Famine of 1943, and the effects of partition-ing, most of these coops were liquidated by 1957, however. A few survivingcredit cooperatives along with other new cooperatives and some post savingsfacilities provided almost all the formal financial services in rural areasuntil the late 1950s (F). Informal lenders continued to provide a very largepart of all credit in rural areas. A national study completed in 1956 showedthat less than 15% of the rural borrowers obtained loans from government orcooperative source. It is very doubtful if this percentage is much highercurrently.

As might be expected, the depression of the 1930s, World War II,and the formation of India and a two-part Pakistan caused extensive turmoil inrural financial markets through 1947. Loan repayment problems were severe.Many formal debts were restructured or essentially canceled by politicalaction during this period (G). In addition, many of the non-Muslim money-lenders left East Bengal as a result of partitioning. This further disruptedinformation portions of the RFMs.

In 1948 the East Pakistan Provincial Co-Operative Bank was organized.This was followed by gradual liquidation of almost all village-based creditcooperatives and their replacement by a three tier system with about 4,000union-based cooperative societies. Although multipurpose in name, most ofthese societies mainly provided loans (H). The formal RFM was further supple-mented by the formation of an Agricultural Development Finance Corporation in1951 and the Agricultural Bank of Pakistan in 1957. These two institutionswere merged in 1961 to form the Agricultural Development Bank of Pakistan.After the civil war this bank was renamed the Bangladesh Krishi Bank (BKB).

(E) See 11, 45. The concerns which motivate the public sector farm creditcomplex usually assume exploitation by private lenders and seek tocircumvent them rather than attacking directly the labor causes of ruralindebtedness judged excessive.

(F) See 16. The limited financial services available to Bangladesh's RFMs andthe highly fragmented nature of those available created a situationconducive to government intervention.

(C) See 35. An environment condoning default, created by a history of distressloans, political intrusions into the repayment process, and disruptionsassociated with war led to the establishment of poor loan disciplineamong borrowers.

(H) See 17. Credit access is considered the primary constraint on productivityand development of the rural sector. Financial services other than thoseassociated with lending are typically neglected.

-36-

As mentioned earlier, a substantial part of the cooperative system

has gone through still another major transformation during the 1970s (I). Atwo-tier cooperative system has been developed as part of the Integrated Rural

Development Program (IRDP). This includes Village Agricultural Coopera-tive Societies (KSS) and Thana level Cooperative Associations (TCCA). Creditallocation and savings mobilization are important parts of these cooperatives'activities. In many areas the KSS and TCCA's are substituting for the earlier,formed, union cooperatives. In other cases the older cooperatives exist along

with the new cooperative system.

Shortly after the Civil War which resulted in the independence ofBangladesh, most commercial banks were nationalized. Six state-owned commer-cial banks emerged from a consolidation of these banks in 1972. These

six commercial banks have been strongly encouraged to service rural needs by

opening up branches in rural areas, providing loans directly to cooperatives,and also expanding their direct loans to agricultural producers (J). Overall,the commercial banks and BKB increased the number of bank branches in the

country from a total of 1,148 in December, 1971 to 2,742 in June, 1978.In mid-1972 only 414 bank branches were in rural areas, but the numberincreased sharply to 1,594 by mid-1978.

In nominal terms the overall supply of formal agricultural credit inBangladesh expanded erratically from about 95 million Taka in 1960-61 to about865 million in 1976-77. The Civil War and substantial amounts of politicalintrusion caused substantial fluctuations in nominal credit supplies. Very

strong inflation pressures since 1970 also have eroded a good deal of thepurchasing power of the formal credit supply -- in 1976-77 total purchasing

power of the formal loans disbursed was only three-quarters of the pre-war

1969-70 period (K).

As mentioned earlier, a substantial part of the cooperative systemhas gone through still another major transformation during the 1970s (I). A

(I) See 44. The poor performance and resulting decapitalization of the oldsystem forced reorganization. The new system is established along thesame line as its predecessor, with little consideration for the causes ofpast failure, because of the strength and convenience of the publicsector farm credit complex.

(J) See 14-16. Commercial lenders are hesitant to provide financial servicesin rural areas given the riskiness of the largely agricultural economywhich exists there. As a result, lending is limited and highly selective,

and there is little market incentive to branch into rural areas. Hence,government pressure was used to push the banks into rural areas.

(K) See 33. The problem of decapitalization of the credit system due toarrears is accentuated by inflation, which accelerates the erosion of

capital. In addition, inflation can contribute to the arrears problem,particularly in the case of extensively rationed credit. Loans, alreadyreduced in size by default problems, become increasingly trivial in in-

flationary environments.

-37-

proportion of credit to rural areas (L). In late 1972 approximately 16% of the

total value of outstanding balances on loans made by banks in Bangladesh were

for agricultural purposes. In late 1976 this had slipped to less than

9%. The 100 Crore Taka Agricultural Credit Program initiated in early 1977

started to reverse this trend.

In addition to the overall supply issue, several other unsatisfactory

performance dimensions in RFIs can be readily identified, although not adequate-

ly documented. In part, the overall supply of formal rural credit has failed

to grow rapidly because of loan repayment problems (M). Policymakers and aid

agencies are slow to push more funds into a credit system which does not

retrieve a large part of the money lent (N). Bangladesh's history of making

distress "loans," political intrusions into the repayment process, and the

disruption caused by the Independence War caused very serious repayment

problems from 1970 to 1973. BKB recovered only 53% of the value of its loans

which fell due in 1970-71, and only 35% of those falling due in 1971-72.

Equally serious repayment problems were experienced in the cooperative system.

Since 1973 both the BKB and the cooperative system have improved their loan

recovery records. The IRDP Cooperatives, however, continue to recover only

two-thirds to three-quarters of the total amount they lend. Part of the

improved BKB recovery in recent years is the result of repayment of loans

which have been overdue for several years. Improved BKB repayment percentages

are also likely due to changes in its lending portfolio. In 1975-76, more

than 85% of the value of all loans made by BKB went to tea producers and

farmers purchasing livestock. These loans were typically well-secured and

less risky than loans for rice or jute production (0). It is still an open

question whether formal RFMs can substantially increase loans for production

of those commodities typically raised by small farmers and small tenants and

also maintain satisfactory repayment records (P).

(L) See 15, 39. Concessionary interest rates do not allow lenders to accom-

modate perceived higher levels of risk associated with the variabilityfound in agriculture. Poor performance by lenders tends to be self-

perpetuating.

(M) See 33. Default of interest and principal repayments restricts the pool

of loanable funds available to the system. Without government subsidy,

the amount of credit available would have been further reduced.

(N) See 43. (This situation is the opposite of that sketched in the text,

where the flow of resources is not necessarily affected adversely by

poor performance records.)

(0) See 14, 15. Subject to concessionary interest rates, lenders ration

credit stringently according to commercial criteria. As a result,

lending institutions seek clientele offering greater security and less

risk.

(P) See 21-26. Credit rationing by political criteria may threaten the

financial viability of credit programs.

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As suggested earlier, income distributions can be strongly affectedby formal loan allocation. Although difficult to pin down with availabledata, it appears that relatively little of the funds handled by formal RFMs inBangladesh has flowed to the rural poor. In 1975-76, for example, theAnnual Report of the BKB showed that less than one-quarter of the total valueof loans made by the BKB went to farmers who owned less than three acres.This proportion was down significantly from the one-third lent to this groupin 1971-72. It is likely that similar distribution patterns occur on loansmade by the various cooperatives. The lament that local elites receive amajority of the loans made by cooperatives can be heard throughout Bangladesh

(Q).

A few countries like Japan, Taiwan and South Korea have been quitesuccessful in mobilizing savings through RFMs. Unfortunately, it is difficultto document the amount of voluntary savings deposits which originate in ruralareas in Bangladesh. The sketchy information which is available suggests atthe end of 1976 only 11% of the deposits in the entire banking sector were inrural branches of the banking system. At the end of 1976 the BKB had savingsand fixed deposits which amounted to one-third of the total new loans it madeduring 1976-77. The cooperative system had an even lower savings-deposit-to-loan ratio. As suggested earlier, formal RFMs in Bangladesh largely viewthemselves as retail outlets for money provided by the Central Bank (R).

Formal RFMs in Bangladesh also appear to be imposing relativelyhigh user costs on some actual as well as potential users of deposit and loanservices. In the early 1960s, Shahjahan conducted a study which reported onborrowing costs incurred by various classes of borrowers in Bangladesh whoreceived loans from the Agricultural Development Bank of Pakistan. During theperiod of the study the bank charged borrowers a uniform 7% nominal interestrate on all loans. In addition to interest payment, however, many borrowerswere required to pay application fees, filing fees, loan registration fees,and also visit the bank a number of times to negotiate the loan. For new andsmall borrowers these additional loan transactions made up a large part oftotal borrowing costs (S). On an annualized basis, small borrowers were found

(Q) See 38. This situation alienates further the financial institutions fromthe clientele they are intended to serve. Large farmers and local elitesare able to garner the benefits of default without the threat of sanctionsdue to their political influence.

(R) See 18, 19. By intervening primarily on the lending side of the RFMs theinstitutional framework tends to fragment these markets. Furthermore,this one-sidedness limits the amount and quality of information availableto the institution and its management to develop an effective full-servicefinancial system, and is associated with poor loan collection performances.

(S) See 13, 15. Low interest rates on loans did not allow institutions asufficient operating margin to accommodate the higher expense associatedwith lending to small and new borrowers. To overcome this, additionalfees were initiated, which raised borrowing costs and restricted smallfarmer access to credit.

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to incur borrowing costs, as a percent of total amounts borrowed, which weresimilar to "high" interest rates charged by informal lenders.

The expansion of financial facilities into new areas in Bangladeshduring the past few years has undoubtedly reduced the time and travel expensesinvolved for many rural people who use formal financial services. Some bankshave also reduced the number of bank visits required by borrowers and or reducedborrower paperwork. A few banks have also used mobile banking facilities tobring financial services closer to users. Despite these improvements, new andsmall borrowers still complain about the time and effort associated withgetting small loans.

In summary, several laudatory aspects of RFMs in Bangladesh can benoted. Most importantly, the rapid expansion of financial outlets in ruralareas is a very important step forward. Also the increasing flexibility andwillingness of policymakers to discuss and experiment with RFM programs andpolicies is a very hopeful sign. Despite these bright spots, the performanceof RFMs in Bangladesh appears to suffer in many of the same ways that can benoted in all too many other low-income countries. With significant amounts ofinflation and relatively inflexible nominal interest rates, Bangladesh hasnot been able to maintain the purchasing power of its formal agriculturalcredit portfolio. Despite nationalization of most banks, relatively little ofthe formal credit in the country is going to agriculture and the rural poor.Repayment performance, while improving, still is unsatisfactory. It is alsoobvious that the average term structure of agricultural loans must be length-ened substantially if rural financial needs are to be more adequately met. Italso is apparent that RFMs in Bangladesh are mobilizing too little savingsand also imposing too many loan and deposit transaction costs on the ruralpoor.

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EXCERPTS FROM

PLANIFICATION AGRICOLE REGIONALE - LE KEF: EVALUATION DES INSTITUTIONSET DES PROGRAMMES ACTUELS DE DEVELOPPEMENT AGRICOLE

(Regional Agricultural Planning - Le Kef: Evaluation of PresentAgricultural Development Institutions and Programs)

F. Bouman

Unpublished paper, Department of Agrarian Law of Non-WesternCountries, Agricultural University, Wageningen, Netherlands

October 1974

The Banque Nationale de Tunisie (BNT) is not a typical commercialinstitution; its purpose is to foster agricultural development through credit

(A). To achieve this aim it has available to it, in addition to its own

capital, special funds provided by the State and external agencies. Itissues short term credit from its own funds, but uses the special funds formedium and long term lending. BNT acts as the administrator of the special

funds, without itself running any risk of nonpayment (B).

In 1973 BNT made a total of 1,180 loans in Le Kef, 330 of themshort term and 850 medium or long term. The bulk of BNT's short term lendinggoes to the large farms of over 100 ha. Certain large scale farmers have bothshort and long term credit.

In 1971 there were only 526 loans made: 330 short term and 196

long term. Hence, total loans made doubled over a period of two years.

However, this was entirely due to the expansion of long term credit: 196

operations in 1971 against 850 in 1973 (C). Short term credit -- seasonal orproduction credit for about one year -- remained at precisely the same level,

330 loans. In 1971, the short term side overshadowed the long as regards bothnumber of borrowers and volumes, whereas in 1973 it was the other way round.

Seasonal credit, therefore, has stagnated instead of expanding: Why?

Long term lending is based on special funds provided by theState and external aid agencies. Where these funds go is not solely the

decision of BNT, but rather a question of national agricultural policy (D).

(A) See 3. BNT has the social mandate characteristic of a specialized farmcredit institution (SFCI).

(B) See 1, 4, 15. Foreign assistance agencies play an important role infinancing of agricultural development, as does the Government. Thespecial funds are in effect specialized farm credit institutions.

(C) See 42. The expansion of BNT's long term portfolio is dependent upongovernment and external funds. It is, therefore, not entirely dependent

on turnover of past loans to maintain and expand its activities.

(D) See 8. As an instrument of national policy, BNT, through its long termloan portfolio, is subject to political as well as financial considerations.

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Borrowings through FOSDA (Fonds Special pour le Developpement Agricole, by far

the largest fund) have increased considerably over recent years, especially

in the livestock sector. Applications for credit from this fund are screened

by the Ministry of Agriculture and at the local level by the technical staff

of the Comissariat Regional de Developpement Agricole (CRDA), with a final check

through the National Commission in Tunis.

Short term credit, however, is financed out of BNT's own funds

(capital plus third party deposits) and BNT is very prudent in its lending

policy (E). Production credit is furnished mostly for cereals, for which

there is an optimum guarantee system.

The final decision on production loans lies with the head office in

Tunis. Although the local manager is clearly the best acquainted with local

circumstances and the situation of his clients, he only serves as a channel

for information (F).

It is not therefore surprising that, with all the restrictive

conditions involved, short term credit is granted almost exclusively to the

large farmers, who represent the least risk for BNT. A sample survey of 50

such loans in 1973 at the Le Kef agency produced the following breakdown: 48

of the farmers had more than 100 hectares and in fact averaged over 500 ha,

while the other two had 99 ha and 80 ha. These two received only D 300 and

D 250 respectively, while the average for the others was over D 2,000 each. 1/

Since the number of farmers in Le Kef governorate with over 100

ha is about 600, nearly 50% of them have access to BNT credit. Add to this

other sources such as the Cereals Board, COCEBLE, commercial banks and direct

credit in Tunis, and it can confidently be assumed that all the large farmers

have access to institutional agricultural credit without problems. BNT has

frequently been criticized for this policy of concentrating its lending on

cereal crops and the "safe" large farmers, because the bank is supposed to

have a development function and this function ought not be limited to

large scale enterprises (G).

BNT's view, on the other hand, is that farmers with less than

40 ha can apply to the Caisse Locale de Credit Mutuel (CLCM), which is

(E) See 14, 15. The volatile nature of the agricultural economy it is

intended to serve forces BNT to ration its own short term lending to the

least risky operators.

(F) See 19. Centralized decision making tends to deny the institution

information and insight into the situation and tends to alienate BNT from

its rural clientele.

(G) See 15. BNT uses commercial criteria to ration its own funds. As a

result, large farmers are favored.

1/ 1973 exchange rate: US$1 = D 0.44.

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especially concerned with the interests of the small farmer. These localinstitutions are supervised by BNT, but BNT does not participate in theircapital.

As regards production credit, the position is clearly one ofstagnation. Long term credit is different, because it is granted out ofspecial funds guaranteed by the State, without risk to BNT.

The number of BNT beneficiaries in Le Kef rose from 196 in 1971to 850 in 1973. The increase was most marked in the stock raising sector:61 beneficiaries in 1971 against 590 in 1973. A drop in the average loanamount per borrower from D 800 in 1981 to D 450 in 1973 accompanied this tenfold increase in the number of borrowers. There was also an increase, al-though a smaller one, in the irrigation sector: from 59 borrowers in 1971to 103 in 1973, with the average loan amount also dropping from D 1,000 toD 480. It can therefore be deduced that medium and long term credit is nowgoing more to small farmers (H).

The going price in the governorate at the beginning of 1974 wasbetween D 20 and D 23 for a ewe, and between D 23 and D 25 for a ewe withlamb. In theory, the borrower is expected to put down about 20%, but inpractice the amount of self-financing is over 50% (I). Experience showsthat many small farmers buy only half the number of sheep they are supposedto, without putting down any of their own money (J). It is also a factthat many farmers sell their sheep shortly after receiving them, withoutbothering about repayment of the loan (K). They will often have to wait ayear for the loan, which exhausts their patience (L). In other casestheir fodder position is hopelessly inadequate. Thus the percentage ofoverdue repayments is apparently much higher for FOSDA loans than forproduction credit: about 20%.

As regards loan procedure, BNT forwards applications for FOSDAloans to the CRDA in Le Kef. The CRDA then asks the local extension staff

(H) See 20. BNT uses political criteria to ration credit supported by fundsfrom government and assistance agencies. As a result, a portion ofthese funds are lent to small farmers.

(I) See 24. Under extensive credit rationing, small loans are extended tolarge numbers of individuals.

(J) See 30. Rationing credit extensively using low loan limits per animaleasily induces deceit.

(K) See 28, 31. Extending loans to larger and larger numbers of farmersinvolves lending to some who are not in a position to use credit wisely.For others, the loans are too small to be taken seriously as means ofaccess to improved breeds or practices. Those farmers who are notcommitted to productive use of credit are likely not to take theirrepayment obligation seriously.

(L) See 33. Delay may to some extent result from the impact on the lender

of poor loan discipline which shows portfolio turnover.

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to verify the data given, which they do by means of a farm survey, after

which the completed survey form and the opinion of the subdivision chief are

sent back to the CRDA. The head of the Agricultural Production Service

then adds his opinion and forwards the application to Tunis where the National

Commissibn has the final say. Here, too, as for short term credit, the

final decision is centralized in Tunis, and not in BNT but the National

Commission.

This complicated procedure is the reason why more than a year

can elapse between submission of an application and finalization of a loan.

Irrigation loans take even longer because technical research takes considerable

time and a backlog of pending applications has developed (M).

The following question then arises: how can a commission in

Tunis judge the accuracy of survey data from Le Kef? These local surveys are

often extremely superficial. On the one hand, farmers are trying all the

time to pull the wool over the extension officers' eyes to get loans by

false representations. On the other, the extension staff do not have the time

or the transport to do the job thoroughly. Sometimes they simply question the

farmers in their offices. A lot of farmers make a game of putting in one

application after another. Some figures: in 1973 the CRDA received a total

of 1,153 applications for FOSDA loans, i.e., 40 per extension officer. Add to

these the verifications to be made under other programs (SIDA, OEP, Rural

Development, etc.) and the total quickly becomes 80 verifications to be made

per officer. It is not surprising that the head of the Agricultural Production

Services is more of a bureaucrat than a technical specialist and is hardly

able to perform his real function of extension (N).

One of the conditions of proper functioning of agricultural credit

,is that the granting of credit must be accompanied by complementary measures

at the supply and marketing levels (0). Without these complementary measures

the effect of credit will remain limited. The recipients then become frustra-

ted and try every trick they can to avoid repaying their loans. Add to this

insufficient control over the use of the credit and an extension service so

snowed under with paperwork that it is unable to get down to its real job, and

agricultural credit will not show the dividends expected.

(M) See 19. BNT lacks information concerning the rural clientele they are

intended to serve. Under such conditions an institution is unable to

develop expertise in dealing with its clientele, which results in

customer alienation. This is demonstrated by the credit decision

mechanism employed by BNT and the resulting behavior of borrowers.

(N) See 9, 36, 39. Credit access is more important, according to the public

sector farm credit complex, than technical assistance to farmers.

Involvement of extension staff in credit activities can easily have

dysfunctional side effects.

(0) See 14. Limitations in the effectiveness of the marketing system contri-

bute to the variability of agricultural income. Shortcomings in the

system may prevent borrowers from receiving expected returns, and contri-

bute to stringent credit rationing by lenders.

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The BNT agency in Le Kef has a staff of five, that in Siliana three.The total number of loans granted in 1973 was 1,180, i.e., 147 per staff memberper year. Here it is a matter of low intensity of lending and relativelyhigh administrative costs. On the other hand, the average amount per loan isquite high, about D 2,000 for short term credit and D 900 for long. However,BNT would be in a very bad financial position, in view of the high proportion ofdefaults and delinquency, if it were not able to fall back upon state guaran-tees for medium and long term loans (P).

According to what we are told, the number of deposits has remainedfairly stable over recent years, with a slight upward trend. The figureD 800,000 has been reached in Le Kef, while Siliana was unable to provide dataon deposits (Q). The (large) farmers tend to spread their savings overseveral banks so that they will not appear to be well off -- and to avoidhaving to repay loans.

There are not, therefore, extensive grounds for optimism regardingclientele-Bank confidence; the number of stories told about how the farmerstry to fool the Bank is legion. These stories are heard not only from thebank employees, Arab notaries, extension staff, etc., but also from thefarmers themselves. It has, so to speak, become a national pastime (R).Some examples are: borrowing from several institutions at the same time, inone's own name or those of family members; exaggerating areas to be sown (toget a bigger loan or to qualify for fuel price relief) or else underreportingthem (to evade taxes); applying for a loan for the sole purpose of convincingthe tax authorities that one is short of cash; asking cheikhs to certifyfictional areas, for tractor loans, for instance; borrowing livestock from aneighbor to prove solvency; selling stock and then asking a veterinarian tocertify that they died of disease; selling fertilizer obtained on credit toother farmers at bargain prices; and a postal employee who owns no land at allobtaining an agricultural loan for the purchase of a moped (S).

But farmers have their gripes, too. According to the overallsurvey, 27% of the farmers in Zone A complain about credit constraints ingeneral, 32% of those in Zone B and 25% in Zone C. On occasions BNT's creditpolicy is specifically mentioned: smallness of loans (based on the scale of

(P) See 42, 43. Continued access to new funds prevents the contraction ofBNT's portfolio. Weak loan recovery reinforces the farm credit complexand maintains the flow of new funds.

(Q) See 34. Poor data may reflect internal problems at BNT, possibly suggest-ing allocation of manpower to arrears recovery rather than to financialhousekeeping.

(R) See 35, 36. An external effect of poor loan discipline and lack ofconfidence in BNT is the development of a default mentality.

(S) See 29, 30. The rationing of credit by political criteria provides incentivesfor poor loan discipline. Creative attempts by borrowers to circumventthe rules are not uncommon.

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D 10-15/ha for cereal crops and the FOSDA scales for livestock) (T); disburse-

ment of short term credit in three installments instead of one (defended by

BNT as a device to enable farmers to pay for compulsory insurance, which is

primarily a guarantee for BNT, and lessens the real amount of the loan even

further); advance withholding of interest, which reduces the loan proceeds

yet further; high insurance premiums (4-7% of the amount to be insured), which

are a particular burden for small farmers who borrow from the CLCMs (U).

The above apply primarily to large farmers. Small farmers' complaints

are different, because they have next to no access to BNT credit. One hears

from them that BNT credit is too dear or that the Bank insists on certain

mortgages or pledges as guarantees. However, BNT's interest rate is low, 6% for

short term credit, and is even lower for most long term loans (V). As regards

property titles, the customary Arab title is accepted while for sharecropping

and rental contracts a minimum duration of three years is required. However,

BNT's chief condition is in respect of solvency and creditworthiness and this is

precisely the prime constraint for small farmers. Giving credit to farmers

whose creditworthiness is inadequate would ipso facto be evidence of an unsound

credit policy, as would refusal to grant credit to progressive farmers whose

creditworthiness is solid. The impression is gained that a large number of

farmers who complain about the credit restrictions do not in fact possess the

necessary ability to repay. This is not to say that such creditworthiness could

not be developed. It is precisely this development function which has been

formally assigned to BNT, but which it has not to date been performing at all

energetically (W).

(T) See 28, 33. Stringent extensive credit rationing weakens farmers' commit-

ments to productive loan use and to repayment. (See K above.)

(U) See 19. These complaints and the items listed suggest that BNT may not

have used a marketing approach in its dealings with farmers.

(V) See 11, 12. Consistent with the paradigm, BNT loans are extended at

concessionary rates of interest. Advocacy of cheap credit is fostered by

the development priority assigned the agricultural sector, and by social

considerations for the rural poor. As Bouman notes, however, the poor do

not have effective access to BNT credit.

(W) See 8. The conflict between political and financial influences, within the

constraint imposed by a low lending rate, is evidenced by two aspects of

BNT's operations. The first is its stringency in rationing short term loans

for which it bears risk, using commercial criteria. The second consists of

problems associated with credit issued by BNT from special funds for which

it bears no default risk. These funds are rationed according to political

criteria.

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EXCERPTS FROM

RECENT ECONOMIC GROWTH AND RURAL FINANCIAL MARKETS IN JAMAICA:ANALYSIS OF PERFORMANCE, PROBLEMS AND RECOiMENDATIONS

Douglas H. Graham, C. Bourne and G. Begashaw

Report for USAID Mission JamaicaOctober 1978

The Jamaica Development Bank (JDB) was established in 1969 to assistin financing economic development. It was empowered to provide loans, equityparticipation, and loan guarantees, and to encourage capital market development.The target groups of its activities were statutorily defined to be in industry,tourism and agriculture.

Incorporation of agriculture among the Bank's concerns reflected animportant shift in governmental policy. JDB's predecessor, the DevelopmentFinance Corporation, was conceived purely as an instrument for industrialdevelopment. Governmental credit facilities to agriculture prior to theestablishment of JDB were located in the Agricultural Credit Board - a smalland largely inefficient organization catering primarily to small farmers.Provision for an agricultural credit window in JDB represented an attempt toaccelerate the development of agricultural credit facilities and to cater tothe long-term investment opportunities on medium to large farms (A).

A significant development was the transfer of the Self-SupportingFarmers Development Program (SSFDP) from the Agricultural Credit Board to theJDB in 1974. This program is designed for medium and small farmers. Itsincorporation in JDB meant that JDB was establishing a small farmer creditwindow and thereby broadening the range of its clientele in the agriculturalsector. It also signified some reservations about the efficiency of the ACBas the agency formerly responsible for processing SSFDP loans (B).

JDB and the Availability of Credit

JDB loans to agriculture expanded rapidly between 1970 and 1977 interms of values and number of new approvals and the value of loans outstanding.In 1970, the first full year of its operations, JDB made 13 loans, valued at

(A) See 2, 10, 16, 17. Government's shift in policy and subsequent establish-ment of an agricultural credit window in JDB is consistent with "the publicsector farm credit complex," particularly that tenet specifying directpublic sector intervention as the most appropriate means of ensuring theprovision of a desirable service to farmers. The JDB agricultural creditwindow functions as a specialized farm credit institution (SFCI).

(B) See 44. Reorganization of poorly performing SFCI is not uncommon.

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$0.7 million. 1/ From this point until 1977, approvals grew at an annual

average rate of 53% in current values, and at a rate of 34% in 1970 prices.

The number of loans made each year also increased rapidly, at a rate of

approximately 48% per annum. Expansion was even more rapid for loans outstand-

ing.

The major spurt in JDB agricultural lending took place after 1972.

Since there have been no clear directives to the Bank, one can only surmise

about the reasons for this acceleration. Significant explanatory factors no

doubt include the increasing emphasis being placed on agricultural development

and diversification by the new government which took office in 1972.

Another reason for the growth in JDB credit was the increasing

desire of international funding agencies to finance development by allocating

resources to directly productive enterprises. By 1970, aid institutions had

become at least a little disenchanted with the possibilities for, and the

benefits of rapid industrial development. Moreover the limiting effect of low

rural incomes and productivity on industrial development was abundantly clear

to many scholars. Simultaneously the urgency of the social problems posed

by widescale rural poverty was increasing appreciably. As a result, greater

stress was placed on rural development by multi-lateral and national funding

agencies.

JDB dependence on foreign agencies for its loanable funds meant that

the sectoral preferences of those agencies would be reflected in its portfolio

structure. The World Bank, the Inter-American Development Bank and the

Caribbean Development Bank (CDB) make agriculture sector-specific loans to

JDB (C). The percentage shares of foreign resources in loan approvals through

the commercial window averaged 45% between 1970 and 1977. Local resource funds

were obtained in the form of share capital subscriptions from the Government

and the Bank of Jamaica, and in the form of loans from local commercial banks,

other local financial institutions, and governmental agencies such as the

Jamaica National Investment Corporation, which invests the proceeds of the

levy on bauxite production.

In 1977 and 1978, lending for agriculture declined significantly

in nominal terms, and even more sharply in real terms. In 1977, only 84

commercial window loans were made compared to 136 in the previous year. These

amounted to $8.6 million in nominal terms and to $2.7 million in 1970 prices.

It is estimated that loans approved between January and July 1978 have not

(C) See 4. Development assistance agencies often play an important role in

financing specialized farm credit institutions.

1/ References to currency units in this paper are expressed in Jamaican

dollars. The exchange rate between Jamaican and US dollars was

J$1.00 = US$1.20 in 1970, and J$1.00 = US$1.10 in 1977. After 1977 the

rate changed greatly against the Jamaican dollar.

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exceeded $0.5 million in current values. The fall off is attributable to whatmay be a temporary halt in funding by the World Bank and by the CDB, causedby their dissatisfaction with JDB's loan recovery rate and their correspondinginsistence on certain organizational improvements being effected (D).

The cutback from external agencies comes at a time when the domesticsources from which the JDB mobilizes funds are contracting under the generalbudgetary and credit squeeze associated with the economic package agreed uponwith the International Monetary Fund in May, 1978. The decline in fundingunderscores the vulnerability of national credit programs which are dependenton externally provided financial resources (E). It also underlines the impor--tance of good collection performance. The $3.8 million in arrears at December31, 1977, if recovered, would have substantially moderated the depressingeffect of shortfalls in foreign funding (F).

JDB through its commercial window has substantially expandedthe volume of credit available to agriculture. JDB commercial window credithas increased rapidly as a proportion of total credit outstanding. Itsshare was 0.2% in 1970 and rose to 16% in 1977. To some extent, the share ofthe JDB is biased downwards since 1975 as a result of a reclassification ofcommercial bank loans which resulted in an upward shift in the latter'sagricultural loans as recorded in the total agricultural credit series.

Borrowing costs incurred by a JDB customer may be regarded as com-prised of direct charges imposed by the Bank, and of other costs incurredin negotiating and finalizing the loan. To the lending institution, thelatter are implicit and might be ignored, but to the borrower they are oftenquantitatively or psychologically important and are not usually ignored. Thereare four elements in the direct costs of a JDB agricultural loan. The mostobvious is the coupon or quoted interest rate charged on the loan. This ratehas varied with the source of funding. Loans made under projects supported bythe World Bank carry an interest rate of 10% per annum, those from CDB notmore than 10%, and loans from local resources not less than 11% per annum.These nominal rates of interest compare favorably with those imposed byprivate credit sources (G). For example, commercial banks' prime loan ratesranged between 8% and 11% over the period under study. Actual commercial bankloan rates are much higher. The weighted average loan rate ranged between13.5% and 14% between 1975 and 1977, that is, 2 1/2% to 3% higher than prime.

(D) See 44. Performance problems in activites dependent on external fundingcan lead to pressure from donors for remedial measures.

(E) See 19. Dependence on external funding may divert an institution fromraising funds locally and establishing a dynamic presence in ruralfinancial markets.

(F) See 33. Growing arrears restrict an institution's operation by reducingthe supply of funds available for relending.

(G) See 11, 12. The public sector farm credit complex advocates the provisionof credit at a "reasonable" rate of interest, with reasonableness definedin terms of prevailing levels of formal sector lending rates.

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Since 1973 JDB loan rates of interest have usually been less thanthe rate of inflation, yielding negative real rates of interest. Implicitly,JDB has been conferring a sizeable credit subsidy on the agricultural sector.JDB loan charges have been relatively rigid, and have not been adjustedsufficiently to take account of the increasing cost of operations in aninflationary environment. It now appears that the inflexibility of these ratesthreatens to undermine the financial viability of the institution.

The second direct cost is the evaluation fee of one-half of 1% imposedon all commercial window borrowers. Third, JDB sometimes charges a commitmentfee of one-half of 1% on the undisbursed amounts of loans. Together, these add1% to the quoted interest rate on loans. It is the view of at least one comment-ator within JDB that the evaluation and commitment fees sometimes prove onerousto borrowers, and result in delays between loan application, loan approval, andacceptance of the loan. Of major significance is the fourth cost element,namely the exchange rate adjustment to the principal in order to maintain theU.S. dollar value of loans made from World Bank resources. 2/ Though probabi-listic in nature, adjustment costs have been large within recent years owing tolarge and frequent devaluations of the Jamaican dollar. Between January andApril 1978, the currency was devalued by 13.9%, and by year-end is expected tohave been devalued by 50% in total.

The main indirect costs faced by borrowers are those associated withwaiting time (or production time lost) while the loan is being negotiated.For commercial window credit, the period between application and approval iscommonly four months. Another indirect cost results from the requirement thatborrowers purchase life insurance sufficient to cover the principal of the loan.Insurance premiums are borne by the borrower. In the Jamaican situation wherefarmers are quite old (50 years on average), insurance coverage must be expen-sive and difficult to obtain. JDB has discovered that the life insurancerequirement is a cause for delay between approval and acceptance of loans.

Term Structure

JDB has greatly lengthened the term to maturity of agriculturalcredit in Jamaica. The World Bank sets a maximum period of 10 to 15 yearsinclusive of grace period. The actual term varies with the type of activitybeing financed, as does the grace period. The CDB stipulates a maximum of 12years. Local resource commercial window loans cannot exceed 15 years' maturity.Data for 1977 suggests that over 50% of JDB commercial window loans havematurities between 5 and 10 years. In terms of values, 44% are in the 5-10 yearcategory and 52% in the more than 10 year category.

The commercial window does not provide loans for working capital.Its loan contracts with funding agencies explicitly forbid working capital

2/ Passing on to farmers the foreign exchange risk of externally funded creditprograms is an unusual feature of JDB's operations (ed).

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loans . 3/ Underlying such restrictions is the notion that investment capital

needs are the most pressing ones which the private financial system is least

likely to satisfy (H). There may also be an implicit assumption that working

capital requirements can or should be met out of own internal cash flows, and/

or private sector credit. These assumptions are debatable. Most farmers seem

to face serious liquidity problems, arising out of their crop cycles and out

of the small scale of their operations which do not generate a large margin

between revenue and expenditures. Furthermore, private financial institutions,

notably commercial banks, are reluctant to finance small to medium scale farms

and activities other than export crops, poultry, pigs and cattle which have

well organized marketing outlets and reasonably stable prices (I). A policy

against the financing of working capital can be debilitating to agricultural

development. It deprives farms of access to working capital when needed, and

may prevent successful implementation of a farm development plan and contribute

to difficulties in repaying investment loans (J).

JDB lends directly to private individuals and companies as well as

to statutory bodies, for example the Banana Board, which onlend to their

constituents. Private customers of the Bank can be classified into part-time

and full-time farmers. It would appear that slightly more than half of

JDB loans are to part-time operators. Thirty-seven percent of commercial

window loan recipients in 1976 were professionals and an equal percentage

businessmen. It would be surprising if the business and professional clients

were not strongly represented in the higher size categories (K).

The substantial proportions allocated to part-time farmers of

professional and business backgrounds imply that the Bank's resources are not

fully satisfying the objective of assisting those whose livelihood is mainly

(H) See 22, 23. Intensive credit rationing schemes allocate relatively

large loans and are quite selective. They exemplify supply-leading

finance par excellence.

(I) See 14. The variability of agricultural income makes commercial

lenders particularly selective in financing rural production.

(J) See 19, 20. By virtue of their dependence and isolation, SFCI may not

be in a position to view finance and potential markets dynamically.

(K) See 22. To the extent that large loans are intensively rationed, lender

selectivity may be reflected in a preference for borrowers with non-

agricultural incomes.

3/ These restrictions apply to specific projects underwritten by donors and

do not inhibit JDB from extending working capital credit outside these

projects (ed).

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dependent on farming (L). Moreover, it is possible that global output mightbe less than if the funds were deployed entirely to full-time operators.Efficiency levels may be lower among part-timers if they are new and in-experienced in farming; if their level of commitment to agriculture is lower;if their absence from the farm results in weaker management control andinto work avoidance by hired labor. The incentive to efficiency may also belower if losses incurred in agriculture can be written off against taxliabilities on incomes accruing from off-farm activities. Against thesenegative conjectures must be set the positive ones that new farming recruitsfrom the business and professional classes have higher educational levels thanthe farm population, might be more prone to experiment with new techniques ofproduction and new products, and can subsidize or augment their investment inagriculture by funds derived from their non-agricultural activities.

Financial Viability

The continued viability of JDB as well as its ability to securefurther injections of foreign capital depends upon the repayment performanceof its clients (M). Commercial window arrears have been increasing rapidly.In 1974, arrears by commercial borrowers amounted to $163,100. In 1976,arrears were $1.6 million. They more than doubled to $3.8 million in 1978.Although some of the loans were technically in arrears but only overdue by afew days or weeks, a large proportion of the loans in arrears were generallyso for more than sixty days. As many as 60% of the loans in arrears weremore than three months overdue.

The time series on arrears has to be related to some other variableto shed light on the severity of the problem. Since data were not availableon payments due on commercial window loans as a whole, arrears as a percentageof loans outstanding were used as a rough index of the behavior of the arrearsratio over time (N). These estimates indicate that the severity of theproblem has indeed been increasing greatly over the recent past. Dataon one of the foreign source lines of credit through the commercial windowalso reveal that between December 31, 1976, and June 30, 1978, arrears wereapproximately 82% of payments due. In the absence of more detailed knowledgeit appears that the arrears problem is a generalized phenomenon within the JDBcommercial window agricultural loan portfolio.

(L) See 13. Low interest rates and the circumstances they easily create tendto result in credit access limitations for large numbers of rural people.

(M) See 43 - 45. This view of the role of official foreign assistancechallenges several possibilities outlined in the presentation of theparadigm. However, the reported unwillingness of donors to provide morefunds to JDB may be a temporary phenomenon, and the changes in JDBperformance required to obtain more foreign assistance may not be sufficientto liberate it from the dynamics of the paradigm.

(N) See 34. Arrears may divert an SFCI from the development of managementinformation systems.

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Overall Assessment

JDB has substantially improved the quantity and quality of credit

provided to the agricultural sector. The initial narrowness of its activities

was deliberately relaxed as the Bank obtained funds which were not circumscribed

in the types of agricultural enterprises they could finance.

Nominal credit costs to JDB customers have not been expensive.

In real,terms, JDB has been subsidizing agricultural development through its

de facto negative interest rate policy. Loan pricing policy is resulting in

a deterioration of the Bank's net cash flow and operating margins under rapid

domestic inflation. With agricultural product prices on the upswing, a case

can be made for higher real rates of interest.

JDB, and especially its funding agencies, need to reconsider the

policy of financing only fixed investment. Though its efforts in this area

have been directed towards an important bottleneck, some broadening of its

activities to attempt to relieve the additional bottleneck of insufficient

working capital seems warranted both from the point of view of social develop-ment and from the point of view of enlightened self-interest by the Bank (0).

Credit resources have been concentrated on larger farmers, a large

proportion of whom are part-timers with primary occupations in professionaland business fields. This feature of its operations tends to concentrate

rural wealth even further and to be contrary to the objective of improving the

well-being of full-time farmers. However, no overall judgement can be made on

She distribution characteristics of the loan portfolio without solid evidence

on the comparative productivities of small and large, full- and part-time

farmers, and on the differential effects of the structure of JDB credit on

farm incomes, net worth and employment.

The arrears problem is very serious, even when one accounts for

massive and repeated devaluations, and for drastic cutbacks on foreign

exchange allocations - all of which have seriously affected the viability of

many of JDB's customers and might have pushed arrears above the norm. The

gravity of the arrears situation has disturbing implications not only for the

Bank's cash flows and operating margins (P). Its capital structure might also

be impaired since the economic depression has reduced the market values of

collateral and therefore the amounts of principal that could possibly be

recovered through default procedures. In development banking, one should

anticipate some costs arising through loan delinquency and administrative

requirements, since the credit system is being deliberately widened to cater

to new forms of credit, longer maturities, and producers with little or no

(0) See 26. The viability of credit programs exhibiting extremely intensiveor extensive credit rationing is threatened more than is the viability of

those exhibiting moderation in their rationing strategies.

(P) See 33. Repayment problems impair SFCI development.

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previous credit experience. An important objective of the Bank's operationwould be to inculcate proper attitudes towards credit and farm management

and thereby improve the credit rating of small, medium and large farmers.This "credit-teaching" role would take time to pay off, and is undoubtedlyexpensive. It is also useful to realize when evaluating the operational

efficiency of the credit program that the benefits are in part externalitiesto the Bank, but are important internalities to the credit system (Q). None-theless, the arrears ratio need not continue to be so high as it has been sofar. Considerable improvement can be effected by better loan administra-tion. JDB is aware that it needs to upgrade its procedures and practices, andalready seems to have started doing so.

The governmental and political system can be of some help.It is widely believed that legal supports are required, especially in terms ofthose rules which in their present form make it difficult, costly, and cumber-some for the Bank to take legal action against defaulters (R). It is'alsowidely believed that a "grants mentality" is fostered by the political systemin its approach to financial assistance whether for agriculture or industry(S). It needs to be emphasized that if a "grants" attitude towards governmentmoney pervades society, whether on the side of government or borrowers, publicdevelopment banking as an instrument of policy is not viable.

(Q) See 35. Credit programs have important externalities.

(R) See 36. Extra-legal administrative powers are often accorded SFCI's toenable them to circumvent the "cumbersome" features of civil justice.

(S) See 37, 39. Widespread default and lack of legal action against defaultersdemonstrates government's unwillingness or inability to enforce loancontracts. The tradition of poor loan discipline tends to be self-perpetuating.

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EXCERPTS FROM

RURAL FINANCIAL MARKETS IN THE PHILIPPINES: CASE STUDY

Evangeline P. Javier

ADB-DSE-SEARCA Regional SeminarLecture on Agricultural Credit,Los Banos, Laguna, Philippines

November-December 1976

The history of agricultural financing in the Philippines is markedby limited amounts of institutional credit flowing to the agricultural sector.

Some indicators of credit movement reveal a strong downward trend in therelative and real amounts of agricultural credit from 1960 to 1973. Forinstance, the ratio of agricultural loans to total loans granted to the private

sector declined from .16 in 1960 to .08 in 1973. The rise in the index of thereal value of agricultural loans in the 1960s was offset by a noticeable wane atthe start of the seventies. A similar trend may be noted in the relativeperformance of agricultural loans outstanding. Hence, the apparent continuedrise in the absolute amount of agricultural credit from 1960 to 1973 seems ratherillusive.

Preliminary figures for 1974 and 1975 seem to indicate a strengthen-ing of institutional agricultural credit supply. The index of the real value

of agricultural loans granted and the ratio of agricultural loans granted tonet value added from agriculture exhibit fair improvements compared to the1973 levels. However, the ratio for agricultural loans granted to total loansgranted remained at .08 in 1974 and 1975. This implies that the increasein agricultural loans during these years was part of a parallel increase inall the other types of loans granted by the financial institutions. In otherwords, there was no clear shift in emphasis towards agricultural loans.

The appreciable rise in the absolute amount of institutional agri-cultural loans in 1973 and 1975 may be attributed to the liberalization ofcredit under the four production programs of the government and partly tothe implementation of Presidential Decree No. 717 or the 25% agriculturalloan quota. The latter, however, should be taken in its proper perspectiveconsidering that the financial institutions have the option to buy governmentsecurities in compliance with the requirement of Presidential Decree No. 717.As of December 31, 1975 only about 17% of the total amount that should bechanneled to agrarian reform beneficiaries 1/ was lent out directly to farmer-borrowers. The rest, or 83%, was used to purchase government securities (A).

(A) See 15. Inhibited by low interest rates, lenders choose the lower riskalternative of investment in government securities.

1/ Ten percent of the 25 percent of financial institutions' loanable fundsmust be channeled to agrarian reform beneficiaries.

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The ratio of the agricultural loans granted to the total loansgranted of each institution reflects the institution's extent of exposure to

the agriculture sector. From 1960 to 1975 this ratio averaged .81 for the

rural banks (RMs), .34 for the development banks, .12 for the commercial banks

and .03 for the other financial institutions. The relatively heavy exposure of

the RBs is not at all surprising since they were established primarily to

participate in rural activities.

In a review of agricultural credit allocation, Sacay 2/ noted that

only about one fifth of total agricultural credit in 1967 was enjoyed by small

farmers. The small farmer category was defined in this study as those farmers

with farms of fewer than 10 hectares. This group constitutes about 95% of the

total farmer population and tills about 70% of the cultivated farm area. Theinequality in credit distribution is magnified by the observation that farmerswith farms of fewer than 3 hectares and with no collateral to offer shared only

1.6% of total production credit. This group was estimated to constitute about73% of the total farmer population, tilling 30% of the country's cultivated

area (B).

The liberalized extension of credit under the Masagana 99 Program

which was launched in 1973 may have improved the situation. However, statistics

reveal that less than 50% of the 3.5 million palay farmers in the country have

been covered by the Program. Furthermore, the number of farmers enjoying

Masagana 99 financing has started to decline, i.e. from 855,000 in 1975 to

only about 400,000 in 1976 (C). Unfortunately, the size and composition of

these Masagana 99 farmer-borrowers could not be determined presently. Thus,it is rather difficult to claim that the Masagana 99 Program has effectively

reached the small farmer sector of the country.

The loanable funds of financial institutions consist partly of

internally-generated resources such as deposits and capital accounts and

partly of borrowings from other banks and the Central Bank (CB). Borrowingsfrom the Central Bank usually take the form of rediscounting of eligible loanpapers and bills. Selectivity in the rediscounting structure is often used to

direct the flow of credit resources to preferred economic activities.

(B) See 14. Given the variability of the largely agricultural economy in

rural areas, credit institutions are extremely selective in rationingcredit. Their selectivity is intensified by low interest rates, andresults in very little credit flowing to small farmers.

(C) See 33. High arrears accumulated during this period contributed to thisdecline.

2/ Dr. Orlando J. Sacay, "Small Farmer Credit in the Philippines," Small FarmerCredit: Country Papers, USAID Spring Review of Small Farmer Credit, 13

(February 1973), p. 8.

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The funds being used by the Central Bank for rediscounting purposes

come from the issuance of Central Bank Certificates of Indebtedness (CBCIs).

The CB pays a nominal interest rate of 9% on these CBCIs with a tax exemptionguarantee costing approximately 3.15% (35% of 9%). Thus, the CB pays an

effective interest rate of 12.15%. On the other hand, the CB charges only 1%

for rediscounting agricultural loan paper under the supervised credit programsand 5%-8% for rediscounting paper under non-supervised credit programs. In

effect, the CB shoulders a cost burden of 11.15% for the supervised credit

program and 4.15%-7.15% for the non-supervised credit programs (D).

The Central Bank uses several funds under the so-called Special

Financing Program for funding special time deposits (STDs). 3/ Some of thesefunds have existed since 1965. The funds are used to finance mono-crop

projects which include rice, corn, tobacco, vegetables, cattle, poulty, hogs,

ducks and fish. The funds usually originate from contributions of governmentagencies and loans granted from foreign institutions.

The U.S. Agency for International Development (USAID) has been a major

contributor in five of these Special Financing Program Funds, i.e. the Agri-cultural Credit Fund, the Agricultural Guarantee and Loan Fund, the SpecialAgricultural Loan Funds, the Agricultural Loan (Calamity) Fund and The Acceler-ated Rice Production Fund (E).

Apart from USAID, a number of multilateral and other bilateralsources of development assistance lend support to the agricultural credit

pograms of the country (F). From 1965 to 1975 an approximate amount of $116

million in development loan assistance was channeled to some of the country's

agricultural credit programs. The multilaterial sources, i.e., the World Bankand the Asian Development Bank (ADB), accounted for about 66% of total external

funds. The World Bank granted a total of $71.7 million for medium and long

term relending in agricultural credit programs. The World Bank extended three

rural credit project loans to the CB which were in turn relent by some Rural

Banks to small landholders to finance farm machinery development of small

(D) See 11, 16. Subsidized interest rates are one means of making farm

credit appear cheap. Specialized farm credit institutions are not

designed to be dependent upon market resources. Instead, they areassisted by official sources of funding, in this case the Central Bank.

(E) See 16. The public sector farm credit complex tends towards interventionthrough specialized credit schemes to correct alleged deficiencies

in financial market performance.

(F) See 4. Foreign donors frequently assist in the funding of farm credit

institutions.

3/ Special time deposits are placed by the Central Bank with other financialinstitutions to support priority lending by these institutions.

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irrigation schemes and fish ponds. Likewise ADB's credit line to the PrivateDevelopment Corporation of the Philippines is being used partly for relendingfor deep-sea fishing, livestock, poultry and bananas.

Among the bilateral sources, USAID has been the main source of fundsfor relending purposes. Apart from the loans channeled through the CBDepartment of Rural Banks and Savings and Loan Associations, USAID alsogranted some loans for relending through the Agricultural Credit Administra-tion and for acquisition of irrigation pumps through the Farm Systems Develop-ment Corporation. The Spanish and Danish governments also extended assistancein kind to support the pump distribution project of the National IrrigationAdministration.

The previous discussions manifest the proliferation of both externaland internally-generated government funds intended for agricultural relending.These cheap sources of funds are designed to induce financial institutions tochannel credit to the agricultural sector. However, most financial institutionsare overly dependent on these funds, and the build-up of their market resources,particularly the mobilization of potential savings in the rural areas, issomehow neglected (G). The resulting weakness in the institutions' financialbase aggravates their hesitance to expose their resources to the risk inherentin agricultural lending (H).

The growth trends and composition of the financial resources of thecountry's rural banking system may give an indication of the possible adverseimpact of government intervention in the agricultural credit market. Therural banking system was established primarily to improve the productiveactivities of the rural areas. As of December 1975, 768 rural banks hadbeen established throughout the country.

The total resources of the rural banking system rose fromP105 million in 1961 to P2,749 million in 1975, 4/ registering an annnualcompound growth rate of 26.2%. This seemingly impressive record is marred bya disturbing trend in the composition of the RB's resource structure. In1961, 45% of the RB's total resources were accounted for by capital, 18% byborrowings and 32% by deposits. In 1975, the composition was reversed asfollows: 15% capital, 54% borrowings and 25% deposits. Over a 15 yearperiod, the RB's resource structure was characterized by a declining share ofcapital and deposits and by a steady expansion in the share of borrowings.These borrowings came mostly from the RB's lending privileges from the CentralBank. The RB's borrowings registered a noticeable acceleration starting in

(G) See 17. Credit access is considered the primary problem and savingsactivities are typically not stressed.

(H) See 16. Stringent credit rationing reinforces the rationale for specialprograms.

4/ 1975 exchange rate: US$1 = P7.024.

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1973 when the RBs were blest with considerable Central Bank rediscountingprivileges and STDs for the food production programs (I).

A gloomy picture is painted by the deceleration in the growth rateof RB's savings deposits in 1974 and 1975. The share of savings depositsto total resources dropped from 30% in 1961 to 20% in 1975. To some extent,RB efforts were lacking in the aspect of savings mobilization in the ruralareas (J).

The agricultural loans granted by the rural banking system averagedan annual compound growth rate of 27% from 1961 to 1975. The number of farmersserved expanded by an annual rate\of only 16% during the period (K).

On the whole, it seems that the rural banking system is becomingmore dependent on the Central Bank rather than on the potential resourcesthat can be tapped in the rural areas. It appears also that they have beenvery conservative in their role as credit conduits to small farmers. Thisbehavior is partly due to their inability to mobilize inherent rural resourceswhich can strengthen the foundation of their financial survival.

The high incidence of arrears in agricultural lending has contributedto the hesitance of financial institutions to voluntarily channel credit tothe agricultural sector (L). Many financial institutions have suffered fromserious agricultural loan delinquencies in spite of the presence of heavycollaterals. Unfortunately, published data on repayment aspects especiallyduring the pre-Masagana 99 period are quite scanty.

Currently, the repayment problems under the Masagana 99 and MasaganangMaisan Programs have threatened the viability of many cooperating financialinstitutions. The first two phases of Masagana 99 exhibited fair amounts ofrepayment, registering rates of 85% and 81%, respectively, as of March 1976.However, from phase III on to phase VI repayment rates have declined tremendously.A similar picture is presented by the Masaganang Maisan Program. In theprocess, a good number of farmers have fallen out of the two programs and many

(I) See 42. Poor performance on the part of financial institutions may bemasked when continuous assistance by government and donors allows thesystem to expand in spite of itself.

(J) See 17. The "public sector farm credit complex" views the primaryproblem as one of credit access and does not stress savings.

(K) See 21, 33. The expansion of lending at a more rapid pace than theexpansion in the number of borrowers suggests intensive credit rationing.

(L) See 35. Poor performance by farm credit programs provide little incentivefor other lenders to enter the market.

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RBs have alarming amounts of overdue loans with the Central Bank as a resultof their STD and rediscounting availments (M).

The arrears problem may be attributed to multiple factors operating notonly at the farmer level, but also at the financial institution and administra-tive levels. A number of studies traced the causes of the arrears to naturalcalamities, burden of other debts of farmers, diversion of funds by farmers (N),and weaknesses of the selda (group loan) system. The financial institutions werealso partly responsible considering their indiscriminate loan disposal and otherunrecorded malpractices. Likewise, the crash implementation of the Masagana foodprograms contributed to the extent of the problem. The Masagana 99 Program, forinstance, tried to cover extensively the palay crop areas in the country. This metwith the problem of inadequate supply of qualified production technicians. Thus,production and loan utilization were not properly supervised. Even non-viablefarm operations obtained financing from the Program. These were justifiedex-post as supportive of social welfare objectives of the government (0).

In many instances, the non-repayment problem is viewed as a grossincome transfer to the farm population. Some quarters claim that with thesuccess of the production aspect of the Masagana 99 Program, the unrepaidloans may be charged as the cost of importation which the economy shoulderedannually before the implementation of the Program. Granting that small farmersbenefit from the income transfer, should the banking institutions share the costof the social welfare objectives? Can the credit system remain continuouslyviable if the farmers who need to be subsidized participate in formal credittransactions? (P)

While the prevailing nominal interest rates for agricultural creditwere 12% for secured loans and 14% for unsecured loans, the average real ratesof interest ranged from a positive 11% to a negative 43% from 1960 to 1975.Negative average real interest rates prevailed after 1970 and became especially

(M) See 33. A high incidence of arrears reduces the funds available forrelending which further restricts access to credit.

(N) See 31, 32. Credit program design may encourage diversion.

(0) See 29. The political nature of credit rationing by specialized farmcredit schemaes easily leads to poor loan discipline.

(P) See 35. A tradition of poor loan discipline, established by government'sreluctance to enforce loan contracts, can threaten the viability of thoseinstitutions involved and create a disincentive for others to enter therural financial market.

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noticeable in 1974, at the height of a critical inflation (Q). It may be notedthat most indicators of the extent of agricultural credit began to decline in1970, a probable behavioral response to negative real interest earnings.

The above-mentioned real rates of interest are admittedly way belowthe opportunity cost of capital which is estimated to be within the order of15%. 5/ Apart from the opportunity cost of capital, loan administrationnaturally entails administrative costs and risk. The sum of these costfactors varies according to size of loans and creditworthiness of borrowers.Since the banks operate within an interest rate ceiling, rational economicbehavior forces them either to minimize any of the cost factors or imposenon-interest charges. This line of reasoning partly explains their preferencefor large farmer-borrowers who represent less risk compared to small farmerborrowers (R). It also explains the other fees and charges they impose toraise their earnings from loan administration. For most short term agriculturalloans, banks charge an additional service fee of 2% per annum. Most banks alsocollect the total interest charges upon partial or full release of the loans,thus raising the effective interest charges. To further lighten the cost sideof the banks, part of the risk premium is shouldered by the government throughvarious preferential treatment and subsidies both to the banks and the farmer-borrowers.

Concessional interest rates have always been justified by the followingarguments: (a) low interest rates will relieve the small farmers of theexorbitant charges of private moneylenders, (b) low interest rate is amechanism for income transfers to small farmers, and (c) subsidized creditwill induce farmers to use modern inputs (S). Previous observations seem toindicate that low interest rates serve as a hindrance to the flow of institu-tional credit to small farmers (T). The economic response of banks to lowinterest rates seems to have even encouraged the continuance of dualism in thecredit market. Furthermore, it is doubtful whether the liberalization ofcredit under the Masagana Program has reduced substantially the role of

(Q) See 12. "Reasonable" rates of interest defined by the public sectorfarm credit complex may in fact be negative in real terms.

(R) See 15. Low and inflexible interest rates limit the ability of lendersto accommodate various levels of risk associated with different borrowers.Under such conditions, the rational lender seeks the lower risk alternativesand rations credit stringently.

(S) See 9, 12. Supply-leading finance at low rates of interest is a manifestationof the public sector farm credit complex.

(T) See 13.

5/ ILO, Sharing in Development: A Program of Employment, Equity and Growthfor the Philippines (Geneva: International Labor Office, 1974), p. 240.

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private moneylenders. Most survey studies on Masagana 99 borrowers noted that

the burden of the other debts of the borrowers contributed to their arrears

problem. As regards the argument on income transfer, the negative real rates

of interest signify a large amount of income transfer to the agriculture

sector. Previous discussions again point to the relative edge of large

farmer-borrowers compared to small farmer-borrowers as beneficiaries of this

income transfer (U). Some studies confirm that the availability of credit

facilitates the adoption of modern technology by farmer-borrowers. However,

cheap credit also leads to diversion of funds to non-productive activities or

consumption goods whose real cost is relatively higher compared to the real

cost of credit. This practice has contributed to the arrears problem of the

Masagana food production programs (V).

(U) See 38. Rural credit policies should not be viewed as independent of the

rural power structure.

(V) See 32. Credit rationing by political criteria, particularly under

concessionary interest rate schemes, creates incentives to circumvent the

terms of the loan contract.

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EXCERPTS FROM

CREDIT POLICIES AND RURAL FINANCIAL MARKETS IN BOLIVIA

Jerry R. Ladman and Ronald Tinnermeier

American Journal of Agricultural EconomicsVolume 59, No. 5, pp. 962-966

December 1977

Prior to the 1952 Revolution, Bolivia had little need for well-developed rural financial markets (A). Apart from a strong tin mining industry,the country had progressed little since colonial times. Political instabilityreigned; little manufacturing existed; and most of the population was Indian,living on large estates in the high mountain plains and valleys as traditionalpeons or farmers of small plots. Commercial agriculture was not widespread,and the country imported basic food stuffs and exported virtually no agri-cultural products. After the Revolution the major tin mines were nationalized,and the large landed estates were broken up and parceled out to the campesinos(peasaAts) under an extensive land reform program. A major program waslaunched to develop the sparsely populated tropical plains east of the Andes(the Oriente) where petroleum and tropical hardwoods were located and fertilesoils offered potential for agricultural and livestock activities. Consider-able foreign economic and technical assistance poured into the country,especially that of the U.S. Agency for International Development (USAID).

The government established major goals of import substitution ofbasic food-stuffs and higher incomes for the beneficiaries of land reform (B).Although offices were established within the Ministry of Agriculture for thestandard activities of extension, research, etc., these programs had difficultiesdue to lack of financial support and trained personnel. Agricultural creditwas considered to be a main policy instrument, and the Agricultural Bank ofBolivia (BAB) was the main source (C).

Because of the reorganization associated with the land reform and theuncertainty and consequent instability associated with the new leftward leaninggovernment, it was not until the 1970s that the agricultural sector began to growrapidly. Growth rates of 2.1%, 3.9% and 6.7% were observed for 1973, 1974 and

(A) See 9. Following the Revolution, the semi-feudal conditions which hadexisted in Bolivia's rural sector were dismantled by extensive agrarianreform. Prior to the Revolution little official credit was availableto small scale operators.

(B) See 3. As the model suggests, the establishment of a specialized farmcredit institution (SFCI) may be linked to a land reform program and isintended to increase agricultural production as well as promote socialwelfare.

(C) See 9. BAB is the institutional expression of the "public sector farmcredit complex."

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1975, respectively. A number of factors contributed to this growth. Perhaps

the most important was the military coup of 1971, which established a conserva-

tive but progressive-minded government that created an ambiance of political

stability. Second, by this time the Oriente flourished under rice, sugar and

livestock production and also entered a favorable cotton export market. Third,

the land reform program was consolidated so that many of these farmers were

in a position to enter commercial production. Fourth, considerable foreign

assistance was directed to the sector -- in 1971-73 it accounted for 30% of the

agricultural budget.

Agricultural credit facilitated this expansion, and the development

of more extensive RFMs has been observed since 1967. The real value of the

annual flows of agricultural credit from the Bolivian banking system grew 4.6

times during 1967-75. In 1967 BAB accounted for over 90% of this credit,

but by 1975 the percentage had fallen to 54, indicating absolute and relative

increases by the commercial banks. (In 1975 about 28% of total agricultural

credit was extended by the government's State Commercial Bank and 18% by

several private banks.)

In spite of this impressive increase and structural change, there are

a number of indicators that Bolivian RFMs were not performing the previously

specified major roles well. First, there is little evidence that rural savings

are effectively being mobilized, particularly among small farmers. Although

Bolivia experienced an eight-fold increase in real savings deposits in banking

and nonbanking institutions during 1966-75, most institutions and offices are

located in major urban centers. Apart from some relatively minor cases they

cater almost exclusively to urban clientele. It is expected, however, that

medium- and large-scale farmers have savings accounts in the cities (D).

Second, credit was being distributed disproportionately to the

Oriente and to medium and large-scale farmers rather than to the campesinos in

the high plains and mountain valleys. Almost all private bank credit and 70%

of the loan volume under the USAID financed rediscount program (FRA-1) went to

the Oriente, while three-fourths of BAB credit during 1964-74 went to that

region (E).

(D) See 16 - 18. Rural access to financial services is restricted. BAB,

consistent with the SFCI definition, is primarily concerned with credit

access, and savings activities have not been developed. The result of

such reasoning is fragmented development of RFMs.

(E) See 13, 14. Concentration of credit in the Oriente, where large farmers

predominate, illustrates the impact of concessional interest rates on

small farmer access to credit. The response of lenders to this interest

rate policy was to extend credit to the larger, more commercially oriented

farmers who are viewed as less risky and less costly to serve than smaller

operators.

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Third, Bolivian RFMs do not have strong linkages with domestic andforeign financial markets except those that are forged by the Central Bank andforeign aid. Monetary savings are not being extensively generated, andcommercial banks tend to steer away from agricultural loans. Agriculturallending would likely be considerably reduced were it not for foreign aidearmarked for that purpose. However, most foreign assistance must be usedto cover the decapitalization created by the severe delinquency problem experi-enced by all banks (F).

The average annual delinquency rate for BAB between 1972 and 1975was 44.5%. If a number of previously delinquent loans had not been refinanced,the rate would have been even higher. In the same period the State Bank and theprivate banks were experiencing rates of 30% to 50%. In fact, primarily due todelinquency problems, the State Bank decided to withdraw from agriculturalcredit in 1976 (G).

Credit Policy and Its Effectiveness

As noted previously, prior to 1967 Bolivian agricultural creditpolicy used BAB to finance agriculture. This bank was established in 1942 andin 1954 received its first foreign loan from USAID. In the 1960s it was thebeneficiary of several other USAID, Inter-American Development Bank, and WorldBank loans aimed at increasing domestic production of basic food-stuffs (H), andalso borrowed from the Banco de Brazil. Concessional interest rates havecharacterized BAB's operation, as well as those of the Central Bank withrespect to agricultural lending by the commercial banks (I).

In 1967 the Central Bank established a policy to force commercial bankcredit into agricultural and other productive activities (J). It required each

(F) See 42, 43. Foreign assistance may continue to flow to farm credit institu-tions in spite of their poor financial performance.

(G) See 15. Following commercial criteria the State Bank returned to itsstatus quo ante position of not directly financing agricultural production.

(H) See 4, 44. Since its establishment in 1942, BAB has undergone severalreorganizations due principally to pressures exerted by foreign assistanceagencies.

(I) See 11, 12. The public sector farm credit complex advocates credit toagriculture at low interest rates.

(J) See 8, 15, Low interest rates provide little incentive for commerciallenders to expand services. Unable to accommodate greatly differentlevels of perceived risk among present and prospective borrowers, lenderscontinue to ration credit stringently.

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bank to allocate at least 70% of its loan portfolio to productive sectors by1971. To facilitate this requirement the Central Bank expanded an existingprogram of special rediscount credit lines for agricultural loans. Foreignaid played an important role through the Special Fund for Economic Developmentand the FRA-1 and the FRA-2 programs financed by USAID in 1967, 1972 and 1975,respectively. Loans refinanced by these special lines accounted for much ofthe increase in agricultural lending after 1967 in the State Bank, BAB, andcommercial banks. How have these operations and policies contributed to theperformance of Bolivian RFMs?

Delinquency is perhaps the most threatening problem to the agri-cultural banking system in Bolivia. Not only does it decapitalize the financialinstitutions and increase their reliance on foreign assistance, but it alsodiscourages lending to agriculture (K). The present-day Bolivian problem inmany respects is due to crop failures and unfavorable prices reflecting thelack of supportive infrastructure, appropriate technology and an adequatemarketing system. Another major reason is the lack of absorptive capacity bythe credit institutions to appropriately administer the large volumes of newagricultural loans under the special lines of credit. It is little wonderthat the State Bank experienced so many loan failures when that institutiondid not have adequate professional staff to properly analyze and supervisecredit (L).

Bolivia also suffers from a nonrepayment mentality (M). Bankers andborrowers alike accept the slightest pretext for farmers' not repaying.Unfavorable natural conditions and poorly designed loans feed this attitude.Historically loans have often been made, especially to larger farmers, on apolitical basis. In many such cases the borrower has almost assumed he hadthe right not to repay because he knew that legal pressure would not bebrought against him. In recent years this has been especially prevalent in theOriente for cotton and soybean loans, which account for a very significantportion of the delinquent portfolio (N). A factor that accentuates this

(K) See 33, 43. Given this fact of financial life, governments may use othermeasures to force lenders into priority sectors which are unremunerativefor lenders.

(L) See 19, 34. The State Bank's difficulties may have been aggravated by aninability to establish expertise in agricultural lending consistent withits one-sided intervention in the market. Such a situation is conduciveto demoralization of the staff of an institution and possibly contributedto the State Bank's move away from agricultural lending.

(M) See 35-39. Poor loan discipline has many social costs, and tends to beself-perpetuating.

(N) See 29, 38. The large farmers in the Oriente take liberties with theirrepayment obligations, which in effect extracts a subsidy from the farmcredit system.

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practice is the concessional interest rate policy, which encourages borrowersto seek credit for ostensibly agricultural purposes but which in fact isdirected to other activities or investments (0). This situation is exacerbatedwhen, due to high rates of inflation such as Bolivia experienced from 1972to 1974, the real rate of interest is negative and results in an incometransfer to borrowers. Clearly, policy has not mitigated but rather worsenedthe repayment problem.

Bolivia has few policy instruments designed to mobilize ruralsavings. BAB does not have a savings window (P), and most commercial bankingis confined to urban centers. Most cooperatives have not been successful ingenerating savings, and credit unions are only beginning to move into ruralareas. Other case studies show that small farmers hold cash reserves and alsohave relatively liquid investments in livestock. Few, however, know anythingof formal savings institutions. The Central Bank has had a minimum nominalinterest rate policy on commercial bank time deposits of about 10% over thelast 10 years. Given inflation and the opportunity cost of money it might beargued this rate is too low; however, the recent large increase in savings inthe urban centers suggests that other factors are also important. In ruralareas an important constraining factor is the lack of an institutional structureto encourage savings.

The Bolivian government, in its efforts to reduce agriculturalimports and to take advantage of the favorable world cotton market, made theconscious decision to direct the bulk of credit to the Oriente region. Nodoubt it reasoned this was the most rapid and least costly way of obtainingadditional output. If the RFMs were functioning correctly, this would meanresource productivities were higher in this region. Data are not available tomeasure this. Nevertheless, it does appear that existing governmental policyhas created some inequities in the system. Certainly concessional rates ofinterest, especially in periods of high inflation, have biased credit towardscapital-intensive investments leading to regional and on-farm misallocationof resources from a social perspective. Furthermore, these rates encourageagricultural illusion, which leads to intersectoral and regional misallocations,as illustrated by the observation that many of the cotton and soybean loans inthe Oriente are believed to have been used for other purposes, includingforeign investment (Q).

(0) See 29, 32. The design of farm credit schemes can actually encouragediversion of loan funds by borrowers.

(P) See 17 - 19. BAB's performance suggests it is alienated from itsclientele and lacking in financial expertise, which may be linked toits operating as a loan window rather than intermediating rural financialflows.

(Q) See 29, 32, and (0) above.

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Import substitution and export policies also exacerbated theregional distributional disparities, since the activities supported by thesepolicies are heavily concentrated in the Oriente. This is a paradoxicalresult for Bolivian agriculture and illustrates conflicts among policy goals,since credit was not directed in the main to the beneficiaries of land reform(R).

There has been considerable rhetoric about financing campesinos,but the evidence shows, both in terms of numbers and volumes of loans, thatmost credit has gone to medium- and large-scale farmers, much of it in theOriente but also to these same select groups in the mountain valleys. Thebulk of the small farmers who live in the altiplano and mountain valleyregions were untouched. Nevertheless, it is now recognized that, for thelong run interest of social and economic development, credit and otherresources must be directed toward this large mass of farmers. To this endBolivia, with USAID's encouragement and funding, developed two small farmercredit programs in 1974 (S).

One, FRA-2, was for a special line of credit to be rediscounted tothe commercial banks and BAB for loans to small farmers. The second was asmall farmer supervised credit program administered by BAB. In 1975, USAIDfunded a program for developing credit cooperatives among small farmers. Atthis point the programs appear to have been relatively successful in providingcredit to these farmers. Delinquency has not been a major problem to date.The programs would appear, however, to involve high transactions costs for bothfarmers and banks (T).

(R) See 8, 13. Politics and financial considerations resulted in theallocation of credit to large-scale operators.

(S) See 43. The failure of the institutional credit system in Boliviato accomplish the goals set by government has reinforced the "complex."The response has been to implement two additional programs under the sameenvironmental conditions, without addressing the shortcomings of theoriginal system, which was unable to achieve established policy goals.

(T) See 13. If forced to operate under the same interest rate constraintsimposed on other institutions, the programs may encounter difficulty inmaintaining their viability without considerable subsidy.

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EXCERPTS FROM

CREDIT IN RURAL DEVELOPMENT: AN APPRAISAL OF THE SUPERVISEDCREDIT SCHEME FOR THE SETTLERS IN WESTERN NIGERIA

Dr. S. A. Oni

Proceedings of the 1972 Annual Conference of theNigerian Economic SocietyDepartment of Economics

University of Ibadan, Ibadan, Nigeria

In 1960, the Western Nigerian government formally launched a farm

settlement scheme. The background was that of widespread unemployment among

primary school leavers, the existence of little used areas in the riverain

provinces, and the desire to pioneer new systems of farming involving new

techniques and the use of government supervised credit (A). The farm settle-

ments were to be operated on the working principles of the Israeli Moshavinwhere farms are owned and operated individually but with some centralized

services owned and operated cooperatively.

The main objectives of the settlements were listed as follows: 1/

(a) To test and later demonstrate carefully planned farming systems

designed to attract young educated persons to take up farming as a

satisfying and lucrative livelihood.

(b) To demonstrate that, by careful planning, farms can be established

and operated by young, educated farmers with reasonable assistance

in the form of advice and loans from the government or other

sources, and that these farms will provide a comfortable standard

of living for the owners, comparable with or higher than that

gained by persons of their own status in other forms of employment.

(c) To mitigate against an unfavorable land tenure system, with no legal

boundaries and no security of tenure, which deprives the farmers of

an asset against which to invest in long term improvements.

(d) To solve partially the unemployment problem of school leavers who

cannot be absorbed by higher educational institutions or industry.

(A) See 3. Implementation of settlement schemes is frequently linked to a

specialized farm credit institution. The agency is intended to foster

the adoption of innovative agricultural practices as well as to achieve

certain social objectives.

1/ Land Settlement Scheme Farm Settlement para. 14, Ministry of Agriculture

and Natural Resources, Western Nigeria (June 1960).

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(e) To develop another extension method with a view to acceleratingagricultural development in the region. It is planned that develop-ing widely scattered "areas of concentration" will serve as examplesto the rest of the country and enable experience to be gained by thestaff in the operation of a supervised credit scheme which canlater be applied to individual farms (B).

Three types of settlements exist in the Western State at present.Type A settlements are arable crop settlements where maize, cotton, rice,cassava, melon and yams are grown in conjunction with some livestock farming(pigs, cattle and poultry). Ogbomosho and Ilora Settlements fall under thiscategory.

Type B settlements are tree crop settlements where cocoa, oilpalm,rubber, citrus and coffee are grown with some subsidiary backyard poultryenterprises. At present about seventeen settlements can be classified as TypeB settlements. Type C settlements are those established under rural integratedschemes. They grow arable crops and some economic trees like teak in additionto their petty poultry farming. Our appraisal of the credit scheme focusesattention mainly on settlement Types A and B.

Government expenditures on settlements can be broadly grouped intotwo categories: non-refundable and refundable.

Non-Refundable Expenditures

These consist of outright expenditures disbursed as aid to thescheme with no expectation of repayment by the settlers. They cover prelimi-nary investigations; temporary and traverse surveys; compensation for land andcrops; general establishment including tree cutting, fencing, roads, bridges,temporary buildings; permanent village site clearing; supply, free board andlodging, Shasha training and Institute training; heavy equipment such astractors and silo engines; motor vehicles and first aid boxes; soil surveyand tree crop nursery establishment (C). Between 1959 and 1970, governmentgrants for non-refundable expenditures on the Types A and B settlementsamounted to i2,759,039, 2/ concentrated in the period between 1960 and 1963.

(B) See 9. "The public sector farm credit complex" advocates the use ofsupply-leading finance to promote rural development. The design of thesettlement scheme conforms to this approach.

(C) See 35. The large investment in non-refundable expenditures, while notdirectly contributing to poor loan discipline, may inadvertently create asituation in which the entire program is viewed by settlers as a governmentgrant. Such a situation could conceivably lead to misunderstanding ofthe terms of the project and result in poor loan repayment overall.

2/ 1970 exchange rate: Nigerian 11.00 = US$2.80.Nigerian I1.00 = 20 shillings (20/-).

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Refundable Expenditures

Refundable expenditures include outlays regarded as loans tothe settlers, for which the settlers are directly liable. They include thecosts of: communal and residential buildings; fertilizers; seedlings;cover crops; livestock; motor vehicle, tractor, heavy and light equipmentrunning costs; spraying chemicals; furniture; jute sacks and packing materials;tools and settlers' pocket money. For the period under review, refundableexpenditures increased from I4,847 in 1960 to a cumulated amount of E2,965,295by the end of the 1970 financial year. Refundable expenditures exclude theinterest on borrowed capital. Government has been unable to charge interestbecause the settlers did not sign any loan agreement before receiving theseloans; and there is therefore no legal basis to institute such charges (D).

The viability of any credit scheme can be assessed by a comparisonof its repayment schedule with its loan maturity schedule. The aggregateloans given to farm settlements between 1959 and 1971 has been estimated atL2.97 million. Out of this loan only L189,018 has been repaid, giving anaverage repayment rate of about 6% for the entire period under review. Thearable crop or Type A settlements have the highest rates of repayment. Infact the highest rate of repayment, 14.2%, was found at Ilora settlement, butafter about 12 years of operations, most of the tree crops settlements havenot paid more than 6% of the loans due (E).

If the present trend continues it will take almost a century torepay the total loan, in which case such loans cannot be repaid during thelifetime of the average settler (F). However, Ministry officials are not sopessimistic. They have been encouraged by repayments of over L51,000 duringthe last two financial years (1969-70 and 1970-71). There is a hope that thezeal and enthusiasm lately demonstrated will continue.

(D) See 37. On the assumption that the omission of a loan agreement was anoversight, it can be argued that the lack of a sound loan contractdemonstrates the government's inability to establish or enforce responsi-ble loan behavior on the part of borrowers. This omission retards thedevelopment of sound commercial practice and inhibits the full realizationof benefits to be derived from the settlement scheme and from the financialsystem.

(E) See 27. Given the intensive rationing of settlement credit, farmers mayexperience considerable difficulty, because of adverse weather or choiceof production methods, in generating cash flow sufficient to meettheir loan commitments.

(F) See 33. Slow collection of outstanding loans restricts the flow of fundsto the settlement authorities, and slows the expansion of settlement schemesor makes such expansion more costly to the public purse.

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It is interesting to consider how much has been repaid per settler.In Type A settlements an average of L473 has been repaid by each settler outof a total loan of L3,764. In tree crop settlements an average of onlyE176 out of a total loan of L3,291 has been repaid.

The average repayment for both arable and tree crops settlementshas been about Ib202 out of an estimated loan of L3,323 per settler, leaving adebt of over L3,000 per settler. The general conclusion that can be drawn fromthis analysis is that the rate of repayment has been very discouraging. Whyis this so?

To answer the above question a field survey was carried out amongthe settlements between July and November, 1971. Six settlements were selected.These included Ilora and Ogbomosho which are type A settlements; and Onishere,Ago-Owu, Orin-Ekiti and Oshun which are Type B settlements. About 80 settlerswere interviewed with the aid of a prepared questionnaire. Because of someseeming conflicts in the answers of three settlers, the sample actually analyzeddecreased from 80 to 77.

The plausible hypothesis to be tested is that repayment activitieshave been constrained by a large number of settlers' defaulting particularlybecause they lack the funds to repay. This hypothesis was tested in twostages. The first stage was to find out from the settlers whether they haveever repaid any loan since the inception of the scheme. It was found that 35%of the settlers interviewed have not repaid any loan since the beginning ofthe scheme. A closer look at these defaulters reveals that lack of funds hasbeen cited as the main reason for default. Over 80% of those who defaultedreportedly did so for lack of funds to meet their repayment schedules (G).

The most significant aspect of the farm settlement scheme is its"supervised credit" system. Credit is usually given in kind or in cash. Thegovernment ensures that the credit is used in accordance with the recommendedfarm management practices under the guidance of the settlement officer.

A settler who needs credit makes his request first to the settlementofficer who then refers this to the headquarters. The farm settlement divisionof the Ministry of Agriculture and Natural Resources is responsible fordisbursing the loan. There is generally no security or collateral required,but the settler signs for the receipt of the credit. It should be noted thata signature for receipt of credit cannot be equated with a formal loan agreement(H). This is a significant weakness in the administration of the creditscheme. There have been instances in which settlers disappeared after receipt of

(G) See 29, 32. Lacking details of any tests in research design for theverification of settlers' responses, it may be argued that their answersand their loan repayment behavior probably involved elements of deceit,and that such deceit was a rational response to the settlement creditsystem.

(H) See 29. The political basis of rationing settlement credit, coupled withinappropriate loan agreements, fostered poor loan discipline.

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some credit and no legal actions could be taken. In fact, since theinception of the scheme, over 76% of the settlers admitted having left the

settlements for one reason or another, and the Ministry has not been able to

institute any litigation against them. The rationale for this lack of

legal action has been that new settlers are easily recruited to inherit the

assets and liabilities of those who dropped out (I).

The credit given in cash consists mainly of about L115 per annumgiven as living allowance to each settler. At the peak season when specific

requests for credit to hire labor are made, most of the requests are disallowed.

Even when they are approved, there usually is a long delay in approval and

disbursement. Such a delay may slow down the rate of returns and result in an

uneven flow of cash for the development of the scheme (J).

In general it should be noted that the government controls laborrecruitment into the settlement. The Government hires labor for the settlers

at 6/3d per day when the settlers could hire the same labor for 4/- or at most

5/-. The weakness of such a policy is that it has led to a considerable in-

crease in the cost of establishing each settler and has at the same timereduced some settlements to a "dumping ground" for redundant governmentlaborers.

Credit in kind is given in the form of seedlings, fertilizers, chemi-

cals, feedstuffs, tractor services, birds and miscellaneous items. The main

weakness of this type of credit is the delay encountered between applicationand receipt. Because of the red tape and financial instructions followed by

government officials, some of the credit has been received at a time when it

could not be used to generate an optimum return from the farm business (K).

One of the main reasons for the low rate of credit repayments has

been the wrong selection policy of the State government. Tempting though it

may have been politically to seek this way out of the difficult problem of

employment for school leavers, it is a basic mistake to entrust the farms

created and capital invested primarily to immature boys, whose interest hasprobably turned from farming to other pursuits (L). The results have been a

(I) See 38, 39. The environment of poor loan discipline created by the publicsector farm credit complex is self-perpetuating. The government'srationale and its consequent reluctance to chase defaulters reinforces

poor loan discipline among borrowers.

(J) See 19, 36. Government, using procedures removed from the situation of

the settlers, is unable to develop insight or garner information about theopportunities and difficulties faced by the settlers. Alienation results,leading to deficiencies in cooperation between the settlers and their

benefactor, affecting production adversely.

(K) See 5, 19, 34. Disbursement lags tend to reduce the returns the farmeris able to generate, further contributing to the arrears situation.

(L) See 20. Political criteria for credit allocation are inherent in

government farm credit schemes.

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poor production performance and an amazingly high rate of drop-out. This

selection policy needs to be changed and it is gratifying to note that theerror of taking in boys as settlers appears to be fully appreciated by otherstates. For instance, in the Mid-West, a report on the farm settlement scheme

has put the position very clearly: "The minimum age of 18 years should belifted to 24 and the maximum age should be extended to 30 years instead of 27.

This will provide settlers with sufficient physical strength and experience."

An additional problem of considerable importance is the fantastic

amount of loans that have to be repaid by each settler. The estimated cost of

establishing each settler was E6,468, of which I3,323 was classified as aloan (M). This loan is far too prohibitive and it points to the fact that thescheme as a whole has been conceived on a lavish scale. Not only is it

improbable that these sums can ever be recovered by the government (partlybecause of the very poor selection of settlers), but also the magnitude of such a

liability can act as a deterrent to prospective and vigorous settlers and may

even accelerate the rate of drop-outs among the settlers (N).

(M) See 27. The large amount of credit extended to each settler attemptsto take the place of equity capital. Intensively rationed loans oftenexceed the borrower's debt capacity, making it difficult to service loanseven under relatively favorable circumstances.

(N) See 32. To the extent that taking on such a liability would constituteirrational financial behavior on the part of prospective settlers,

intensive credit rationing could act as a deterrent to participation.Accelerated drop-out rates could result as well, since settlers havecomparatively little of their own capital at stake and the threat ofsanctions for nonrepayment is remote.

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EXCERPTS FROM

RURAL CREDIT IN UTTAR PRADESH

P. S. Saxena and B. B. Lal

Eastern EconomistVol. 65, No. 16October 1975

Cooperation and cooperative methods are at present in use in almostevery country, but the way they function is fashioned by circumstancesin each country. The movement has taken strong roots in our country but weshould not be complacent about the achievements we have made in the variousfields of cooperative activity. The Royal Commission on Agriculture rightlyremarked: "If cooperation fails, there fails the best hopes of rural India."This statement still holds so true that it led the Rural Credit SurveyCommittee to remark, "Cooperation has failed but cooperation must succeed."It is a movement not only towards better social organization but also towardsimproved business.

It is wrong to believe that "Cooperation is a panacea for alleconomic ills and can cure a sinking patient." Rather, cooperation is a tonicfor the weak to give him strength. The movement was thus initiated by thegovernment as a measure to relieve the rural peasantry from the crushingburden of indebtedness and to foster thrift among the masses (A). Unfortunatelycooperative movement has been dogged by several ills, and the review of thecooperative movement in India has highlighted some of these.

In the beginning local people organized cooperative societies withoutany financial help by the government. After a period the government changedits policy and permission was given to local governments to advance a sum notexceeding Rs 2000 to rural societies. The government also provided guaranteesof interest on debentures.

In 1954, the Rural Credit Survey Committee felt that the State'shelp to the cooperative movement up to that time had been to "over administerand under finance." To reduce the influence of moneylenders and traders, thecommittee felt that the State should be a major partner in cooperative institu-tions at all levels in credit, processing and marketing societes (B). Withthe recommendation of the Rural Credit Survey Committee, the state became amajor partner of the cooperators in various fields. Such relationship was

(A) See 3, 16. Farm credit institutions are often established by governments toimprove agricultural production and provide a measure of relief for the

rural poor.

(B) See 8, 11. The performance of a specialized farm credit institution isinfluenced by both political and financial considerations. The publicsector farm credit project leads to measures designed to circumvent orweaken existing rural lenders in the.informal sector.

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direct at the apex level, while at intermediate and primary levels thisrelationship was to be indirect.

A special fund, to be known as the National Agricultural Credit(Long-term Ration) Fund, was suggested as the state governments were notcapable of rendering sufficient help (C). Further, the formation of twospecial funds, viz., the National Agricultural Credit (Stabilization) Fund formedium term loans and the National Agriculture Credit (Relief and Guarantee)Fund were suggested by the committee. At present the government is renderingthe following aids to cooperative societies: (a) state partnership in the sharecapital of cooperative societies including marketing societies, (b) loans tosocieties, (c) subsidies and grants, (d) guarantees, (e) contribution to riskfunds, (f) tax concessions, (g) legal sanctions, (h) training and education,(i) help through the Reserve Bank of India, (j) help through the State Bank ofIndia.

In Uttar Pradesh the expansion of cooperatives is in the areas ofcredit, marketing supply and stock arrangements, milk production, cooperativefarming and cold storage. Laborers, artisans and persons having limited meanshave also been benefited. Some of the societies working in the cooperativefield in the State are Uttar Pradesh Cooperative Bank, Uttar Pradesh StateCooperative Development Bank, Uttar Pradesh Cooperative Federation, UttarPradesh Consumers Cooperative Federation, State Cooperative Development BankUttar Pradesh Cooperative Federation, Uttar Pradesh Consumers CooperativeFederation, State Cooperative Milk Federation, Uttar Pradesh Cooperative Union,Uttar Pradesh Jute and Sanhemp Cooperative Federation, Uttar Pradesh StateWare Housing Corporation and Uttar Pradesh Housing Cooperation Federation.These societies have made a significant impact on the state's economy. Coopera-tive societies have not only arranged agricultural finance but also havehelped to increase the income of the farmers by marketing their agricultural

products (D).

There is an important program under the cooperative movement for thedistribution of credit, through medium, short term, mid term and long termloans. For this purpose there are cooperative societies at three levels. Atthe village level there are service cooperative societies and regional coopera-tive societies. At the district level there are 56 district cooperative banks andtheir 526 branches at various places. At the state level comes the UttarPradesh Cooperative Bank.

(C) See 16. Non-market sources are used to fund specialized farm creditschemes.

(D) See 14. The establishment of an effective marketing system servesto reduce the variability in income experienced in economies which arepredominantly agricultural. In this way, borrowers' repayment capacitymay be improved.

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As in other parts of the country, in Uttar Pradesh the cooperativemovement was started with a view to providing cheap credit to agriculturistsin order to free them from the clutches of the rapacious moneylenders (E).Most of the farmers require loans for machines, seeds, new methods of farming,food and other agricultural products. Primary agri-credit societies are themain source of agricultural finance.

Though there are joint stock banks in rural areas, it must be noted thattheir business is confined to big merchants and industrialists. Joint stock bankswere not interested in extending small loans. Therefore primary non-agriculturalcredit societes were formed (F).

After the initial increase in the number of societies up to 1960-61the number has shown a decreasing trend. This is due to the government'srevised policy to reorganize societies. The membership and coverage have grownenormously. Almost all the villages are covered but the percentage of thepopulation covered is low (G). A discouraging fact is that the amount of loansoutstanding and of overdues has been increasing continuously (H).

(E) See 11. Concessionary interest rates are one element of the public sectorfarm credit complex.

(F) See 16. As a result of credit rationing by commercial criteria, ruralaccess to financial services is limited. Specialized farm credit institu-tions are established to overcome this problem.

While village cooperatives in India accept deposits from their members, thebulk of their resources usually come from other sources. Although in nominalterms they may not be strictly specialized farm credit institutions, theirfunctions closely approximate those of specialized farm credit institutions,as suggested by the authors' emphasis on their lending activities ratherthan on their financial services in general. In recent years commercialbanks in India have increasingly expanded their services to rural people inresponse to Government policy. Documentation of this new emphasis is foundin several publications in the Domestic Finance Studies series of theDevelopment Policy Staff of the World Bank. These include: V. G. Patel,"Innovations in Banking: The Gujarat Experiments," No. 51; N. K. Thingalaya,"Innovations in Banking: The Syndicate's Experience," No. 46; and in studiesentitled "Innovations in Banking: The Indian Experience," undertaken by theIndian Institute of Management with some World Bank support: C. Rangarajan,"Part I: Impact on Deposits and Credit;" Paul Mampily, "Part II: Cost andProfitability of Commercial Banking."

(G) See 19. Low levels of participation suggest that these institutionsremain somewhat alien in the rural environment and in the perceptions ofrural people.

(H) See 20, 26. Credit societies in India tend to ration credit extensively,and arrears are likely to result, according to the paradigm, from institu-tional alienation and the financially suboptimal credit rationing which itproduces.

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This problem of mounting overdues has assumed disturbing proportions

in recent years. The Study Team on Overdues in Cooperative Credit Institutions,

conducted under the chairmanship of Dr. Datey, submitted its report in 1974.

The study team has viewed with concern the high levels and increasing trends

of the overdues of primary agricultural credit societies in the country.

The overdues of the primary societies exceed their own funds and

deposits put together. Overdues amounted to Rs 469.5 million 1/ as of June 30,

1972, forming as much as 51% of the outstanding loans. The proportion of

overdues of loans outstanding has been growing even faster. If the trend

continues then there is a danger of the societies becoming defunct (I).

An analysis of the data collected by the study team shows that small,

medium or large farmers behaved more or less alike in the matter of repayment

of their dues. Overdues were traced to the defective lending policies pursued

by the cooperatives, to the apathy of managements in taking quick action against

recalcitrant members (J) and above all, to the absence of a favorable climate

due to the attitude of the state governments, resulting in willful default on

a large scale (K). This holds true in the case of Uttar Pradesh also. The team

has recommended creation of stabilization funds to give relief to the borrowers

affected by successive or frequent natural calamaties and a program of rehabili-

tation by way of relief in respect to short and medium term agricultural

loans for those who are not willful defaulters. For these purposes the study

team has recommended important measures to be undertaken by the Reserve Bank

of India (L).

The report of the Datey Committee contained some very valuable re-

commendations including legislative amendments, administrative and management

changes and structural reforms. It singled out that lack of will and discipline

among the cultivators was primarily responsible for the prevalence of over-

(I) See 33. Growing arrears reduce the amount of funds available to relending,

further restricting credit access. When the arrears situation becomes

severe the financial viability of the program is threatened.

(J) See 19. Alienation of specialized farm credit institutions tends to

limit management development and adaptation to changing conditions.

(K) See 35, 37. An environment condoning default, created by government

unwillingness to enforce loan contracts, inhibits the development of the

financial system in rural areas.

(L) See 45. Arrears and the institutional debilitation they cause provide

an opportunity and perhaps also an incentive for advocates of the public

sector farm credit complex to raise the institutional stakes in rural

development by creating new funds, agencies and laws.

1/ Exchange rate in 1972: US$1.00 = Rs 7.28.

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dues (M). It took to task the state governments for their failure to createa favorable climate for the recovery of dues. It is not known what stepshave been taken to implement the recommendations of the Datey Committee (N).

The Reserve Bank has tried to bring about some improvement in thecooperative credit structure by earmarking credit for small and weak farmers,providing credit separately for kharif and rabi crops, with a view to introducingseasonality in the lending operations of cooperative banks and encouraging loansin kind to the maximum extent feasible. It is too early to assess the impact ofthese steps on the cooperative credit structure. It is, however, clear thatunless vigorous corrective measures are taken to rationalize loan policies, tostrengthen the supervisory staff for proper utilization of credit, and to maketimely recovery of loans, the future of the cooperative movement will be en-dangered (0).

Although all the villages in Uttar Pradesh are covered, still about60% of the rural population is not getting the benefit from cooperatives.This is the reason the role played by the mahajans and the agricultural money-lenders has not been curbed. About 65% to 70% of small farmers, harijanand adivasi households in the rural areas are steeped in debt and are at themercy of village moneylenders (P).

One of the major hurdles faced by the states in tackling this crucialproblem in the villages is the lack of precise and up-to-date data. Since theAll-India Rural Credit Survey conducted by the Reserve Bank of India in 1960-61,no comprehensive official study has been undertaken on the subject. The surveyshows that while cooperative credit organizations and commercial banks havemade considerable headway in providing institutional credit to agriculturists,they have yet to go a long way and private moneylenders and traders continue toprovide about 70% of the credit requirements of the villagers. The percentageof loans given by the primary agricultural credit societies was 29.5 in 1960-61and 30.5 in 1970-71. In between 1960-61 and 1970-71 the average percentage of theloans was only 14.04. It is obvious that when such a low percentage of loans isprovided by the cooperatives the area covered by mahajans and agricultural

(M) See 36. Poor loan discipline places farmers and government lenders in anadversary relationship, as suggested by the Datey Committee's view ofcultivators.

(N) See 38. A situation of increasing default rates subjects the creditcooperatives to continued political interference.

(0) See 33, 34. Poor loan discipline impairs the development and dynamismof the lender.

(P) See 33. Arrears reduce the funds available for relending, restrictingthe proportion of the rural population the system can serve.

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moneylenders will certainly be large. Further, a large amount of the credit

provided by the cooperatives goes to the richer section of the society (Q).

According to the survey conducted by the Reserve Bank of India to

ascertain the status of the borrowers of cooperative credit societies, the

13.3% of the total households having assets amounting to Rs 10,000 and over

obtained 55% of the credit given by the credit cooperatives whereas the 53% of

total households with assets below Rs 2,500 got only 10.8% of such loans.

According to the second survey nearly 15% of the cooperative credit has been

utilized by those who had holdings of five acres or less, 39% by those having

holdings between 5 and 10 acres and 46% by those having over 10 acres of

land.

It need hardly be emphasized that the cooperative credit institutions

should not only provide timely and easy credit, they should also stimulate

thrift and mobilize household savings, particularly from rural areas. They

should also be able to build up their own resources and thereby progressively

reduce their dependence on outside agencies, particularly the Reserve Bank of

India, and improve their operational efficiency. The extent to which coopera-

tives have been able to mobilize savings of the community in the form of

deposits may be taken as one important index of their efficiency and progress

(R). However, it is evident that in this country cooperatives could not

increase the savings of the rural population. The average deposits per member

for the country was as low as Rs 17 and for Uttar Pradesh it was still lower.

The cooperatives thus have to depend almost entirely on outside sources for

their working capital. That is why the state's contribution has been increas-

ing in their share capital.

It was assumed that the government's share would decrease as the private

shareholders increased their contribution. This has not happened. Now coopera-

tion has become a departmental activity of the government. The Reserve Bank

and the State Bank are maintaining the cooperative structure in the country (S).

Taking an overall view, the performance of the cooperative credit

institutions in mobilizing deposits during the period 1961-72 appears to be

encouraging but this performance is attributed largely to the good work done

by these institutions in three states, viz., Maharashtra, Gujarat and the

Punjab. Even within these states, a few banks account for the bulk of deposits.

(Q) See 38. Credit rationing becomes more selective when the institution

experiences increasing default rates. When both access and default favor

large farmers, the program's original concern for rural poor is compromised.

(R) See 19. Providing services on both sides of rural financial markets can

reduce the alienation of specialized farm credit institutions.

(S) See 42. Specialized farm credit institutions are able to continue operations

despite crippling arrears due to continuous government subsidization. Also

see footnote (F) above.

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Barring these states, and with the exception of a few banks in other states,the performance of cooperative banks in mobilizing deposits is poor (T).

The cooperative movement depends for its success to a considerableextent on the attitude of the government towards it. The movement cannotaltogether do without the help of the state. Yet its very existence isendangered if there is excessive government interference.

The Rural Credit Survey Committee has focused the attention ofthe state on the financial stringency of the movement and recommended --besides huge financial assistance in varying forms -- that the state shouldtake an active part in the movement in the interest of developing the ruraleconomy on cooperative lines. The government and the general body of coopera-tors have somewhat blindly accepted the view of the Rural Credit SurveyCommittee which is contrary to the basic principle of self-reliance (U).

There is no doubt that there has always been a chronic shortage offinancial resources in the cooperative movement, which can be relieved by thehelp made available by the government. But the overall impact of this situationis not likely to be beneficial to the cooperating public, except that it willprovide temporary relief to the movement in the matter of finance. As to thecooperative institutions already depending on the financing agencies, thefacility will provide an opportunity to fall back on the government's resources.This will perpetuate the dependence of the movement on governmental assistanceinstead of replacing it (V). In spite of the liberal assistance from thegovernment and the Reserve Bank, such as loans at 2% interest, subsidies andgrants, and exemptions from certain duties and taxes, the movement has notdeveloped sufficient strength to stand on its own feet. Further assistance fromthe government may dissuade cooperative institutions from either attractingdeposits or promoting thrift (W).

The shortcomings of the cooperative movement are too well known tobe stressed. Despite all-out assistance by the government and the ReserveBank of India, especially after the publication of the Rural Credit Survey

(T) See 17. Problems of credit access are the primary concern of special-ized farm credit institutions and savings mobilization is often neglected.

(U) See 44. Decapitalization of lenders leads to increased commitments ofgovernment funds.

(V) See 19. Assistance from the government allows specialized farm creditinstitutions to operate on only the lending side of the RFM. As such,the institute is denied access to market funds and information whichmight enable it to develop into a more efficient system.

(W) See 18. One-sided intervention in the RFMs perpetuates the fragmentationof these markets. Formal sector credit is viewed as the most promisingmeans of development and programs of self-help and self-finance areneglected.

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Report, cooperatives have remained, in large parts of the country, an ineffectivecredit agency. In fact, poor deposit base, lack of trained personnel, dominationby vested interests, lop-sided development, increasing political in-fighting,parochial outlook, communal leanings, and, last but not the least, mountingoverdues are some of the grave problems plaguing the cooperative movement.The cooperatives are also proving a burden on the state's limited financialresources.

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EXCERPTS FROM

THE SUPERVISED CREDIT PROGRAM IN EL SALVADOR: 1961 TO THE PRESENT

R. A. Vasquez, G. Solis, and D. E. Weisenborn

Small Farmer Credit in Mexico and Central America

AID Spring Review of Small Farmer CreditVol. 1

Washington, D.C., Department of State

February 1973

In early 1960, the Ministry of Agriculture (MAG) in El Salvador

established a committee of five credit experts to study the credit problems of

producers with less than 30 hectares of land. This committee recommended that

El Salvador establish a supervised credit agency, and the United States Agency

for International Development (USAID) provided a supervised credit advisor to

assist in the preparation of plans to establish such an agency. In 1961 the

Administracion de Bienestar Campesino (ABC) was created as an autonomous

government agency.

ABC began operations in 1962. Its initial capital was $665,826 from

a PL 480 loan. It had 10 supervised credit agents who were new graduates of

the National Agricultural School and had no field experience. In 1964 ABC

received $5,254,820 from a USAID loan of which $5 million was to be for making

new loans and $254,820 for purchase of equipment. ABC has also received opera-

ting grants from the Government of El Salvador (GOES) and has had access to

Central Bank special funds (A).

ABC's charter called for a national program of loans to producers

with 30 or less hectares who lived on the farm. These requirements were

removed in 1968, allowing ABC to loan to absentee producers and to large

farmers which, in part, defeated the earlier purpose. Policy changes in 1972

further encouraged large loans, and the number of field offices was reduced

from 31 to 15. It now appears that ABC will be reorganized into an agricultural

bank (B).

At the time that ABC was formed, there were three other institutions

through which the PL 480 funds could have been channeled. These were the

(A) See 3, 4. Specialized farm credit institutions (SFCI) are frequently

initiated to increase agricultural production and improve social condi-

tions in rural areas. Foreign assistance agencies often participate in

the establishment and maintenance of these institutions. It is interest-

ing to note that the agency established as a result of the recommenda-

tions of the expert committee on credit was named the Peasant Welfare

Administration, implying functions considerably broader than rural

lending.

(B) See 7. Initial SFCI objectives often cannot be realized.

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Banco Hipotecario, the Instituto Salvadoreno de Fomento de la Produccion, andthe Federacion de Cajas de Credito. While none of these three agencies had asupervised credit program, each was making loans to small and medium scaleagricultural producers. In a comprehensive credit report conducted by a GOESstudy group, USAID was accused of forcing the creation of ABC without adequate-ly evaluating the capacity of these three agencies. This report also statedthat the problems of ABC in the first three years of operation reflected pre-mature creation and a general lack of planning. This report would lead oneto believe that ABC was imposed upon an existing institutional structure andthat the funds could have been more effectively channeled through an existinginstitution (C).

The traditional export crops in El Salvador -- cotton, coffee, andsugar -- are generally produced by large producers. Due to their importance tothe national economy they have received the bulk of the institutional credit.There have also been substantial research efforts in these crops and therehave been large increases in productivity over time. The basic grains andother crops in El Salvador are produced by the small and medium scale farmers.Very little institutional credit reaches these producers and the developmentand adoption of new technology has been very slow (D).

The original objectives established for ABC were as follows:

1. Through a broad supervised credit program, increase agriculturalproduction and provide higher incomes and a better standard ofliving for agricultural producers.

2. Convert the agricultural producer into an effective manager ofhis own enterprise, an active worker of the land and an effectiveproducer by providing the necessary technical assistance andsocial and economic orientation to supplement his credit program.

3. Improve land tenure systems by granting loans with the provisionthat borrowers' rights be expressly guaranteed in the land leasethat they enter into with the landholders. This will also helpincrease, to the extent possible, the number of rural owners.

4. Encourage plans for land development reclamation, soil conserva-tion, and improved methods of operation, in order to adequatelyand effectively use the land.

5. Grant loans for the cancellation of existing debts which are detri-mental to the operation and maintenance of the farm and home,

(C) See 4, 9, 16. Foreign assistance is often directed toward creating newinstitutions to provide greater target group access to credit rather thantoward developing existing financial institutions for the same purpose.

(D) See 14. The uncertainties of agricultural production make leaders hesitantto extend credit to small farmers, viewed as being subject to high risk.

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provided that the loan granted for this purpose is not specifically

for the cancellation of the debt but is also made to improve the

borrower's existing operation.

6. Finance and give technical assistance for the development

or improvement of agricultural industries.

7. Provide funds and technical assistance to agricultural

cooperatives and associations, by promoting their creation with

emphasis on multi-purpose cooperatives. This will be done in

collaboration with other agencies of the government which have

the same objectives.

8. Help improve the marketing of agricultural products by provid-

ing funds and technical assistance for the establishment of

rural markets (E).

The major focus of the ABC program has been on loans for productive

inputs to individual farmers. Production of credit financed crops and livestock

must be for commercial purposes rather than for home consumption.

More than 90% of ABC loans have been short term (less than 18 months).

However, the percentage of funds used for short term loans decreased from 87.3%

in 1966 to 72.8% in 1971. Policy changes in 1972 which emphasize large loans

in 1972 will result in even less funds for short term loans on a percent-

age basis.

There was a reorganization of the agency in 1972 which included a

reduction in field offices from 31 to 15, due, in part, to the need to reduce

operating expenses and desire to move to larger, minimum supervision type

loans (F). The change also expanded the authority of field offices to make

loans.

In order to qualify for a loan a farmer must be 21, capable of

managing a farm, be a small or medium size farmer (less true now than in the

past when there was an upper limit of 30 hectares), have a good reputation,

and obtain ABC approval of his farm plan. Lending terms are uniform among

borrowers but may differ depending on type of project.

At the end of each agricultural year, a review is made of each

loan, and causes of poor performance or default are analyzed. If the problem

(E) See 10, 11. The objectives of ABC reflect the basic elements of the

"public sector farm credit complex." Objective 5 implies a policy of

cheap credit.

(F) See 8. The shift towards larger loans and away from supervised credit

suggests that financial considerations related to the institution's

viability overcame political concern for providing credit to small

farmers.

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was a result of the producer not following recommendations of the agent incharge, he will be eliminated from the program (G). If his failure was aresult of circumstances beyond his control, i.e., weather, markets, etc., hecan be considered for another loan.

ABC does not have a graduation policy, but this does not necessarilyindicate a lack of desire to graduate borrowers. Any agency plagued by highdefault rates and operational costs which were not being adequately subsidizedwould try to develop a core of reliable borrowers. The lack of a graduationpolicy most probably reflects the lack of an alternative for successfulborrowers. The commercial banking system has not expressed any interest intaking successful borrowers from ABC, and its collateral requirements arebeyond the means of most ABC borrowers, only 35% to 40% of whom are landowners (H). Land owners are generally the larger farmers in the ABC program.In 1971, 36% of the borrowers were land owners and they represented 67% of thetotal hectares financed.

ABC began operations in 1962 and built up to 3,345 loans for atotal amount of $2,698,000. However, the collection record was so poor in1963, 1964 and 1965 that ABC was actually forced to reduce operations in 1966(I). Following 1966 ABC has gradually increased its activities. It made morethan $5 million in loans in 1971. This was a result of a better collectionrecord, increased use of USAID loan funds, and a substantial increase in theuse of Central Bank lines of credit (J).

More than 70% of ABC loans were for less than $400. However, onlyabout 15% of the total amount loaned was for loans under $400, which aregenerally the type and size demanded by small producers in El Salvador (K).

The original charter of ABC specified that interest rate policywould be set by the Board of Directors but that interest rates could notexceed 8% per year. This compares with a market rate of usually 12% per year(L). The present ABC rate is 8% with a 2% service charge. The only exceptions

(G) See 36. Poor loan discipline can create distrust and dislike, rather thancooperation, between borrower and lender.

(H) See 15, 16. Commercial lenders are selective in terms of the clientelethey are willing to serve. Advocates of the public sector farm creditcomplex see this as grounds for intervention in rural financial markets.

(I) See 33. High default rates restrict funds available for relending.

(J) See 42-44. Poor SFCI performance may not reduce its access to funds fromdonor agencies and domestic official sources.

(K) See 13. Low interest rates may not offset the expense involved in servingsmall borrowers at low levels of financial activity. The move to larger,minimum supervision loans may be a response to this predicament.

(L) See 11. Advocates of the public sector farm credit complex suggest that

credit should be provided at "reasonable" rates of interest.

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to this rate involve cooperatives which pay 6% plus the 2% service charge for

working capital, and loans for equipment and machinery from a Central Bank

fund which are made at 6 1/2% to 8%. Inflation has not been a major problem

in El Salvador since ABC began operations.

ABC's borrowers must provide one of the following forms of collateral:

(1) a chattel mortgage on crops or livestock, (2) a co-signer, (3) a land mortgage,

or (4) a combination of the other three. The basic requirements have not

changed, but due to heavy default rates in the early years of operation, ABC

has become.more selective (M). This is especially true with chattels on crops

or livestock and with co-signers, since they are more risky than a land

mortgage. Although data are not available, it would appear that the combina-

tion category has been used more since the early years.

Until recently the commercial law required that a loan not exceed

75% of the value of the chattel mortgage. The new limit is 90%.

GOES has continued to subsidize the operating costs of ABC as a

result of the heavy expenses involved with providing supervision of loans.

Without this subsidy, continuation at present interest levels would not have

been possible without depleting capital available for lending (N).

The first step in the loan approval process involves an interview

of the prospective borrower by the ABC agent. If the borrower seems to

fulfill the basic requirements, he is asked to complete an application form.

He provides basic biographic data, personal and business references, and names

of friends who are ABC borrowers. If the information provided on the applica-

tion appears to be satisfactory, the agent assists the farmer in developing a

preliminary farm plan. He determines such factors as tenure arrangements,

family labor availability, tool and equipment availability, access to markets,

and many others. From this he prepares a budget, specifies the borrower's

contribution, and estimates the loan amount and the technical assistance

needed.

The next step is to obtain approval from the field committee. This

committee is composed of the chief of the field office, the agents involved,

and one other agent. If the application and preliminary farm plan are approved,

the agent makes his first farm visit to verify the information and to prepare

a more detailed final plan.

If the loan is rejected by the field committee (or is in excess

of $4,000), it is sent to the Central Office Committee for review. At this

level it can reverse the field decision, and grant or reject the loan. A

(M) See 33. Poor loan discipline may lead to a contraction in credit access

and concentration of lending to fewer and fewer farmers.

(N) See 42. Despite heavy losses and the expense of the program, ABC has beenable to expand its operation because of the continued availability of new

funds from government and donor agencies.

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rejection (or a loan in excess of $2,000) requires consideration by the Boardof Directors. At this point, a rejection by the field and central officecommittees can be reversed or upheld. There are no data to determine thenumbers of rejected field loans which are granted in the central office or bythe board (0).

ABC has experienced considerable problems with collection, especiallyduring the period 1963-65. Poor recoveries may have been due to the agency'scollection methods, but it was more likely a result of the screening proceduresused. There was also a drought which affected the ability of borrowers torepay. In 1965 about 29% of the loan funds granted were not repaid. Following1965, ABC has shown steady improvement. The rate in 1970 was only 3.1%. ABCpersonnel have broken past due accounts into two categories: past due butbelieved to be collectible, and past due but believed to be uncollectible. Theyinclude about 30% in the latter category, but in reality the percentage islikely to be much higher.

Collections are generally made by the field agent responsiblefor supervising the loan. However, the producer may come to the ABC fieldoffice to make his payment. Field office personnel issue receipts for thefunds collected and deposit them in the local bank accounts of ABC. Paymentmay be made only in cash.

The operating cost of the ABC program in 1971 was $938,198. The majoritems are salaries, services (including rent), vehicle maintenance, publicity,supplies and materials, and interest on money borrowed from USAID and theCentral Bank. The average cost per dollar loaned has been reduced from $.47in 1966 to $.18 in 1971. This is a result of several factors such as combiningfield offices with MAG extension offices, a reduction in field office numbers,more efficient use of personnel, etc. However, the biggest item, and the onewhich in a sense is defeating the original purpose, is the increase in loan sizeas a result of serving larger producers (P).

ABC does not include a savings program and any influence of ABCon savings would be indirect (Q). For example, agents encourage producersto save in order to reduce their future needs for operating credit or topurchase capital items for which they cannot obtain credit. There is noevidence to suggest that the ABC interest rates have discouraged savings usein the rural sector. This is not to say, however, that higher interest rateswould not draw out more savings for use as a credit replacement.

(0) See 34. The development of management information systems may be impededby the accumulation of arrears, which may pre-empt scarce managerialresources and demoralize staff.

(P) See 33. Low interest rates and poor performance of the institutionundermined the effort to provide assistance to small farmers and forcedstringent rationing of credit toward larger borrowers who could be servedat lower unit costs.

(Q) See 18. One-sided intervention further fragments rural financial markets(RFMs).

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The institutional image of ABC has been less than favorable, although

the program has matured and is functioning smoothly now. Heavy default rates

and losses in the early years did not help the situation (R). Many fail to

realize that a supervised credit program is expensive and that at subsidized

interest rates the agency could not be self-sufficient even under ideal

conditions.

Given the attitudes which prevail within the private credit system

in El Salvador, it appears that future credit for small farmers will have to

come largely from public institutions. Any new major influx of funds for this

purpose will have to be tied to improved technological packages to provide the

incentive to risk-taking on the part of small producers (S).

All things considered, the ABC program has been generally successful

in reaching and improving small farmers in El Salvador, but the scale has been

so small that the overall impact has not been highly visible (T).

(R) See 35. The poor performance of ABC may have an additional impact

on the RFI4. That is, the tradition of poor loan discipline retards

commercial development of the clientele as well as inhibiting other

financial institutions from serving rural areas.

(S) See 9, 16, 45. ABC's experience is interpreted by the writers as

reinforcing the public sector farm credit complex and as a basis for

extending the system to embrace more new technologies.

(T) See 5, 39. ABC apparently failed in its first decade of existence

to become dynamic and viable financially, capable of rapid self-

sustained growth.

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EXCERPTS FROM

AN INPUT CREDIT PROGRAM FOR SMALL FARMERS IN WEST MALAYSIA

R. J. G. Wells

Journal of Administration OverseasVol. 17, No. 1January 1978

This paper evaluates a crop-based production input credit schemeoperating in selected rice growing areas of West Malaysia by the AgriculturalBank of Malaysia. The program objectives, organizational structure andinterest rate policies adopted are examined; an assessment of the scheme'sprogress is made and several factors inhibiting its effectiveness are identified.

The Agricultural Bank of Malaysia (Bank Pertanian Malaysia) is aGovernment capitalized bank designed to provide short, intermediate andlong term credit to the smallholder agricultural sector and to act as thenucleus of Malaysia's institutional agricultural credit system. Its formationin April 1969 followed the pattern that had been established in many otherparts of Asia, viz., the attempted institutionalization of rural credit by thecreation of Government sponsored and capitalized banks specializing in providingcapital inputs to small-scale agricultural producers.

The rationale behind the formation of such specialized agencies isnot difficult to detect: with the increased attention applied to ruraldevelopment programs and in particular, the effort being made to modernizethe small farm sector, there arose a concomitant perceived need to enlarge thesupply of institutional agricultural finance (A). The importance of increasingthe supply of production credit assumed a greater urgency in West Malaysia,following the advent of short term, high yielding padi varieties and anextensive investment in large scale irrigation and drainage schemes in the"rice bowl" areas of the country. These developments not only permitteddouble cropping to be undertaken on a greatly increased scale but also offeredconsiderable potential for securing a rapid increase in rice production.

An important requirement of the program aimed at rapidly increasingrice output and augmenting farm incomes was the need to ensure that a lack offinance and complementary inputs and services did not hamper the implementationof double cropping or result in a failure to maximize the socio-economic bene-fits from the highly capital intensive irrigation investments (B). The newly

(A) See 9. One of the elements of "the public sector farm credit complex"is the belief that farmers need credit to undertake innovation. A frequentgovernmental response to this perceived need is to intervene in an attempt toincrease the supply of agricultural credit.

(B) See 3. Innovation in agriculture and social aspects of rural developmentpolicy are common elements in the formation of specialized farm creditinstitutions (SFCI).

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formed Agricultural Bank thus had as its first priority the operation of a

padi production input credit program in order to assist on-farm capital

formation and stimulate technological change in padi farming (C).

The policy of creating a new specialized institution clearly pre-

supposed that there was a significant void in the existing organized rural

credit structure and, moreover, implicitly assumed that institutions already in

existence could not be reorganized in order to fill the-credit gap (D). The

fragmentary empirical evidence available strongly supported the view that a

"bottleneck" existed within the institutional supply of capital. In particular,

private banking institutions had displayed a reluctance to finance smallholder

agricultural production (E). It was acknowledged that many primary producers

had received a relatively elastic supply of loanable funds from non-institu-

tional sources but on disadvantageous terms (F). In the longer established

double cropped rice-growing areas there was limited evidence to suggest that

the private sector had provided inputs on credit and at lower costs than in

the single cropped areas of the country. Nevertheless, the lowest interest

rates charged by private lenders were thought to vary between 30% and 40% per

annum. 1/

While smallholder credit cooperatives had operated in the rural

credit market since the early 1920s, their past record was not highly regarded

by policymakers. This was made explicit by the formation of directly competi-

tive multi-purpose farmers' associations which were intended to usurp many of

(C) See 4. Development assistance agencies frequently participate in the

establishment of specialized farm credit institutions, and the establish-

ment of a production input credit scheme was recommended by the World

Bank. A credit scheme -- with provisions for future extended geographical

coverage -- was subsequently designed by a team of consultants engaged by

the Malaysian Government; this, subject to certain modifications, became

the basis for the production input credit program. See Central Bank of

Malaysia, Quarterly Economic Bulletin, Vol. 2, No. 1, March 1969, pp

29-32.

(D) See 4. Foreign assistance is often directed at initiating new, specialized

farm credit institutions rather than building on the strengths of the

existing institutional framework in an effort to serve rural target groups.

(E) See 16. The public sector farm credit complex is reinforced by the lack of

financial services available from commercial sources in rural areas.

(F) See 11. "High" interest rates in the private market are a frequently

cited justification for formation of an SFCI.

1/ Central Bank of Malaysia, Quarterly Economic Bulletin, Vol. 2, No. 1,

March 1969, pp. 29-32.

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the cooperatives' former roles. The inexperience of farmers' associations andthe past record of the cooperatives meant that the producers' organizationswere discarded as a suitable mechanism for financing the "green revolution" inWest Malaysia. The establishment of the Agricultural Bank thus represented aninstitutional innovation designed to remedy that situation, by providing an"adequate" volume of credit at "reasonable" cost to padi farmers and otherrural producers (G).

Program Objectives

Since February 1970, the Bank has operated a production input creditscheme aimed at small rice farmers who met the Bank's basic criteria of credit-worthiness. The coverage of the scheme is determined in the first place bythe availability of adequate water supplies and infrastructure. Initially,this meant that geographical coverage was restricted to the Muda River IrrigationProject Area in the states of Kedah and Perlis but this coverage has beenprogressively widened to include other double cropped areas of high agriculturalpotential in Selangor, Kelantan, Trengganu and Krian, Perak. From the point ofview of the bank the individual farmer-borrower is required to have an adequateland base and judged to be in a position to have the ability to repay theloan.

The basic goals of the program are to make production credit avail-able to individual farmers to aid the acquisition of the production inputsnecessary for increased productivity and to increase net farm incomes.Sub-goals include the need to provide an economical credit system which willstimulate the flow of credit into padi production by utilizing agencies inboth the public and private sectors to operate as distributors of credit andsuppliers of inputs. A further requirement is that there should be adequatesurveillance over the use of credit in order to facilitate the prompt repaymentof loans and to limit abuses in transactions between farmers, stockists andcredit agencies.

Under the scheme, short term production loans are extended over apadi season, i.e., a period of about 6 1/2 months, for specified nurseryfertilizers, field fertilizers and insecticide, mechanized plowing servicesand for (hired) labor expenses incurred in transplanting and harvesting. Loandisbursement is by way of printed coupons validated for recommended inputsconsidered optimum for padi cultivation by the Department of Agriculture.Coupons are issued at the commencement of the season and are exchanged byfarmers for inputs from official suppliers within a prescribed time period;the only exception to this procedure is in the case of labor coupons where cashpayments to the farmers are made by local credit centers.

(G) See 10, 11. SFCI are implemented to improve conditions of access tocredit in rural areas. Government intervention in the rural financialmarket is judged the appropriate avenue by which the supply of credit torural areas in general and small farmers in particular may be increased.

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Organizational Structure

The bulk of the funds in the credit program are extended by way of

two-step lending. The Bank lends through a network of intermediary institutions

called local credit centers 2/ which act as agents, as well as directly through

its branches. Viable institutions and private sector agents operating in the

rice-growing areas are appointed, after screening, to organize local credit

centers. An interesting feature of the scheme is that agencies from both

the public and private sectors are utilized as channels for credit distribu-

tion. 3/ The public sector representatives are producers' organizations (rural

cooperatives and farmers' associations), while the private sector is represented

by rice millers, licensed padi buyers, merchants and shopkeepers who possess

facilities for padi collection and marketing and have storage for farm inputs.

Local credit centers are responsible for the initial screening of loan applica-

tions and also undertake to disburse the input credit and secure recovery of

loans.

Given the time constraints under which the Bank had to operate --

the production input credit scheme had to be operational for the first padi

season in 1970, for instance -- clearly full use had to be made of those

organizations which had successfully operated at ground level. Private

retailers and padi agents were financially strong and possessed intimate

knowledge of the socio-economic conditions prevailing in the padi areas; and thus

were in a good position to adequately screen loan applications and judge the

creditworthiness of potential beneficiaries. Conversely, selection of the

producers' organizations had to be restricted to those that were financially

viable and operationally efficient if the goals of the scheme were to be

2/ Approved local credit centers (LCCs) are required to forward a bankers

guarantee to the Bank and complete an agreement form to ensure contractor

compliance with contract terms. Legally, loan collection is the direct

responsibility of LCCs. In practice the Bank is reluctant to undertake

legal action against delinquent members of farmers' organizations. LCC

operations tend to be restricted geographically to cover part or all of a

Mukim (a local administrative area); the number of LCCs to be found within

a Mukim depends primarily on the level of institutional development in the

locality. In Mukim Langar, Kedah -- an area in which the author carried

out a cross section study -- there were two cooperatives, two farmers'

associations and a private agent operating as LCCs. In theory, farmers

have a choice as to which LCC they patronize, although in practice the

majority of farmers who are members of a farmers' institution would be

encouraged to secure credit from such an organization, while non-members

would resort to private traders. A few farmers who are members of farmers'

organizations obtain credit from private LCCs largely because of long

established patronage with such dealers.

3/ A similar reliance has been placed on a mix of private sector agencies and

cooperatives and other public institutions in the factor market, to import,

produce and distribute the manufactured technical inputs used in the program.

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realized. The network of farmers' associations had largely developed onlyduring the course of the Bank's operations, while the rural cooperatives weresubjected to severe screening in view of their past record. A further limita-tion was that producers' organizations only serviced their members.

Loan repayment under the scheme is through deductions from thevalue of padi sales. Licensed padi dealers, coupled with those producers'organizations with a proven marketing capability, provided the obvious mediumfor collection in kind.

There are significant variations in the loan appraisal procedures oflocal credit centers. The credit investigation procedure of the private sectoragents is highly informal; the majority of the prospective loanees are customerswell known to the agent. Detailed knowledge of individual applicants enablesthe private sector agents to make a quick assessment of the farmer's characterand creditworthiness (H). As a further guide, the borrower is also requiredto complete a loan application form on which details of his present land base,previous production and loan repayment records, and farm and non-farm incomeare stated.

Farmers' associations, on the other hand, have a much more formalizedloan appraisal procedure. Initial interviews and the completion of the loanapplication form are undertaken at the Small Agricultural Unit (SAU) level. 4/Loan applications and reports are forwarded to the area farmers' associationoffice where they are scrutinized by the general manager before submission tothe Members' Credit Standing Committee. This committee normally comprises thechairman of the board of directors, the general manager, the chief of thecredit section and a representative of the Small Agricultural Unit. TheSAU representative will indicate to the committee his views concerning thecreditworthiness of the applicant; and recommendation or rejection of the loanapplication will be decided by the committee.

Various forms of credit limit are imposed by farmers' associations.Credit is not given for labor expenses involved in transplanting and harvesting,and the total credit sanctioned is in relation to the value of the applicant'sshare capital holding in the farmers' association.

Rural cooperatives operate a less systemized and less uniformscreening procedure than the farmers' associations. Loan applications frommembers are scrutinized by a loan committee which comprises a varying number of

(H) See 19. Private loan agents have better market information than special-ized farm credit institutions because of their multifaceted relationshipwith their customers.

4/ A Small Agricultural Unit is a village level sub-unit of an Area Farmers'Association. An Area Farmers' Association usually includes at least six SmallAgricultural Units.

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office bearers; explicit attention is paid to the loan repayment record of theapplicant. In the case of members applying for the loan for the first time,the officials' knowledge of the member and, in particular, their judgement ofhis character, form the basis for assessing his creditworthiness. Whenavailable, land grants are retained and most rural cooperatives also requirethat two sureties be provided from fellow members.

Credit limits are imposed although there is no uniform set of criteriaemployed: some impose minimum acreage requirements, others dictate limits asto the total amount of credit that can be disbursed. Cooperatives similarlyvary in their attitudes towards credit coupons for labor expenses -- somerefuse to extend credit, others pare down applications, and some are preparedto grant the maximum permissible for such purpose.

Interest Rates

At the inception of the scheme the Agricultural Bank had two basiclending rates: 12% per season (about 6 1/2 months) for secured loans and 9% perseason for unsecured loans. In August 1972 these rates were lowered to 9% and6%, respectively, and a penal charge of 1% per month on overdue principalamounts was instituted.

Interest is computed for each season on the total seasonal creditallocation. Thus the effective interest rates are very much higher than thenominal rates: in the case of the harvesting labor coupons where credit isoutstanding for only 2 1/2 to 3 months, the effective rate on this portion ofunsecured loans at a contractual rate of 9% per season amounts to between 36%and 45%.

The scheme was designed on the premise that a land title would beprovided as the main form of collateral. However, few tenant farmers havecollateral acceptable to the Bank, and even in the case of owner-occupiers, theprovision of collateral is rarely available. Administrative and legal problemsinvolved in land charging and stamp duties are so cumbersome and expensive thatneither the farmers nor the local credit centers are prepared to undertake theexercise. In consequence nearly all loans are granted on an unsecured basis.

Legal restrictions on the sale, mortgage and transfer of land,inspired to prevent the alienation of land to moneylenders, also greatlycomplicate the lending procedures of institutions established to preventfarmers from seeking financial accommodation from informal credit sources.The dearth of suitable security caused the Bank in September 1973 to abolishthe interest rate distinction between unsecured and secured loans. At thesame time the rate was lowered to only 4.25% per crop season, although thepenal rate of 1% on overdue principal was maintained (I).

(I) See 11. The public sector farm credit complex leads to advocacy of"reasonable" interest rates. As the program expanded its coverage it becamepolitically expedient to reduce the lending rate. Between mid-1972 and late1973 the rate per season fell from 12% to 4.25%.

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There is a strong case for the lending rate structure to provide asufficient margin above deposit rates to cover program costs and enable

reserves to be built-up in order that delinquent loans can be accommodated.

The dramatic reduction in rates, however, conflicted with a major aim of thecredit scheme which was to disburse economically sound loans and was by implica-

tion not designed to provide an overt income subsidy to farmers (J). The

program involves indirect subsidization as lender operating costs are not fullycovered and the scheme is internally subsidized from the profits of other loan

programs. The operating costs of the scheme have been estimated to exceed

income by about 2% each production cycle (K). 5/

It must remain doubtful whether production credit is the most suitable

avenue for subsidy transfers to farmers: low interest rate policies discriminate

in favor of program users and encourage credit institutions to select applicants

with large operational land holdings (L). Such a concentration of concessionally

priced credit in the hands of large farmers would appear to negate the political

advantages of cheap credit as an easy means of securing political support,since a numerically larger group of farmers suffers relative deprivation compared

to the beneficiaries of such policies. The economic case for realistic pricing

of production credit is if anything even more powerful than arguments based on

political self-interest: low nominal rates and what are usually negative real

interest rates make lender attainment of profits virtually impossible,result in a failure to cover program cost and cause allocative difficulties.

Moreover, low loan rates imply a low interest rate on deposits and a discourage-

ment to rural savings (M). 6/

(J) See 8. This situation illustrates the interaction between the political

and financial influences exerted on specialized farm credit institutions.

(K) See 16. Programs of the type often undertaken by SFCI are not intended

to be dependent on market resources, and are subsidized by government andforeign donors.

(L) See 13. Low interest rates intended to aid poor farmers tend in fact torestrict small farmer access to formal credit.

(M) See 17. SFCI are primarily concerned with credit access, and savingsmobilization is not stressed.

5/ Agricultural Bank of Malaysia, Short-Term Production Credit Scheme in the

Muda Irrigation Project Area of Malaysia, Kuala Lumpur, 1972 (Mimeographed),

p. 48.

6/ Johnston and Kilby have pointed out how in Taiwan realistic interest rates

helped ensure that capital was employed in its most productive uses and

helped provide adequate incentives for voluntary savings. See, Bruce

F. Johnston and Peter Kilby, Agriculture and Structural Transformation,

Oxford University Press, 1975, p. 314.

-96-

Evaluation

The scale of lending under the scheme in its first five years ofoperations has risen perceptibly in both monetary and real terms from themodest initial level of operations. The number of borrowers and the double

cropped paddy acreage covered have increased rapidly. The Bank has widenedits short term financing commitments to a variety of crops such as tobacco,

groundnuts, and tapioca, but padi still remains the largest single financing

activity in dollar terms. Since its inauguration in 1969, the Bank has

become the major supplier of institutional credit to padi farming and aided

the adoption by participating cultivators of high yielding seed varieties

and complementary inputs.

In the five areas of its operations the Bank is beginning to make an

impact in the credit market as its coverage expands at a fairly rapid pace. The

concentration of credit activity in specific geographic areas where large-scale

irrigation facilitites have been provided and where there is considerable

potential for augmenting production, and the limitation of the credit base to

viable farmers, are probably inevitable for an organization designed to function

on commercial criteria. One distinct trend, however, is that credit is mainly

disbursed to those farmers operating relatively large farms: the average acreage

per farmer covered by the scheme is considerably above the average padi farm size

in the country. 7/ The fact that local credit centers are, in principle, held

responsible for loan recovery and repayment, suggests that many exercise caution

in screening applications and tend to equate creditworthiness with size of

operational landholdings (N).

There are several impediments which restrict the Bank's coverage in

its areas of operations. The inability to recruit a sufficient number of

acceptable local credit centers is one such impediment; future expansion incoverage will almost certainly necessitate an enlarged branch network in order

to obtain an increase in direct lending and the continued evolution of a

viable network of producers' organizations (0). A further problem resultsfrom the considerable degree of under-utilization of credit: apart from the

(N) See 15. Low and inflexible interest rates foster stringent credit rationing

by lenders.

(0) See 16. Low interest rates tend to restrict institutional credit opera-

tions in rural areas, especially by institutions operating on a commercial

basis.

7/ For West Malaysia, the average padi farm size in 1970 was estimated at 3.1

acres; 68% of padi farms are below 4 acres in size. See S. Selvadurai, Padi

Farming in West Malysia, Kuala Lumpur, 1972, p. 26.

-97-

initial pilot project in 1970, amounts disbursed have remained below 65% ofamounts sanctioned (P).

It is interesting to compare utilization levels according to typesof local credit centers. Among the non-Bank group the private sector has ahigher rate of credit utilization -- as a proportion of credit sanctioned --than the producers' organizations. The utilization of the credit sanctionedby the private sector has also for some seasons even exceeded that of the Bankgroup. This would tend to suggest that the Bank's controversial decision toutilize the private trading network has been vindicated, for not only has itsutilization level been higher but its repayment record is also generallysuperior to that of the producers' organizations (Q). Private sector localcredit centers have also provided access to production credit for non-membersof producers' organizations -- a substantial proportion of the nation's padifarmers.

Incorporation of traditional rural lenders in the credit schemeprovided an economical mechanism for stimulating the flow of productioninput credit into padi farming, for otherwise if the same degree of function-al coverage were to be achieved, additional resources would have had to bedevoted to expanding the network of public sector credit centers. Thiswould almost certainly have raised the real costs of retailing credit toproducers and have led to increased potential for default (R).

The Agricultural Bank faces formidable handicaps which militateagainst the disbursement of funds. There is the prudent need for rigidloan appraisal procedures to ensure that loan delinquencies are minimized.Moreover, as a financing agency designed from the outset to function onbanking lines, it is operating in an environment in which traditional formsof security are either not available or not easily charged. Althoughrepayment capacity rather than emphasis on tangible collateral is the moreappropriate criterion for the assessment of creditworthiness, unsecuredlending increases risk.

Other factors which result in an underutilization of credit derivefrom the income inadequacy of many padi farmers: this necessitates borrowingfor consumption which acts as a deterrent to their making use of the facili-

(P) See 28. Incomplete credit use may signify incomplete adoption of creditsupported technology, which may imply diminished borrower cash flow and con-tribute to arrears.

(Q) See 19. Private loan agents have better market information than special-ized farm credit institutions because of other multifaceted relationshipwith their customers.

(R) See 41. The paradigm is also useful in cases in which it appears not toapply. In this case government intervention was less than total, asprivate loan agents were used.

-98-

ties of a production credit delivery system. 8/ It is not, of course, only

the low absolute levels of income that cause borrowing for consumption

purposes but also the "lumpiness" of income receipts. The majority of padi

planters who double crop receive the bulk of their farm income on two

occasions, at the time of sale of their main and off-season crops. Their

ability to stagger the sale of their produce is impeded by the fact

that they lack on farm storage capacity and also may have to sell their

crop at harvest time in order to repay debt obligations (S).

There are also problems which rely for their solution more on an

intensification of agricultural extension than on the provision of production

credit. This is reflected in the marked variations in the utilization levels

of the various inputs: coupons for plowing services and for field fertilizers

have a high utilization, while farmers exhibit a considerable reticence to use

credit coupons for nursery inputs and precautionary inputs such as insecticides.

Empirical evidence suggests that padi planters are reluctant to accept the

necessity for the application of such inputs since little or no visible effects

can be seen from their usage. 9/ From this we may infer that if potential

credit needs are to be translated into effective demand, a greater degree of

coordination between credit and extension services will be necessary and

farmers will need to be convinced of the long term benefits to be derived

from adequate and timely plant protection methods (T). 10/

(S) See 18, 19. A specialized farm credit institution has limited access to

market information, which inhibits the institution's ability to serve its

clientele effectively. Savings facilities would be one means of helping

farmers over the income lumpiness problem, but low interest rates may

foreclose this possibility. Storage loans appear to offer another possi-

bility for service to customers.

(T) See 45. Lagging credit performance, in this case the uneven utilization of

the input package, provides a basis for increasing the scope of intervention.

In this case an appeal for more intervention is made even though there is

no evidence that borrowers are behaving irrationally in their technology

adoption patterns, or that social optimality differs from private optimality.

8/ The possibility exists that credit for production inputs may be diverted to

consumption.

9/ Agricultural Bank of Malaysia, Short-Term Production Credit Scheme in the

Muda Irrigation Project Area of Malaysia, Kuala Lumpur, 1972, p. 58.

10/ This is not to imply that socio-cultural resistance or other non-economic

impediments to the adoption of new inputs are necessarily more significant

than farm-level economic considerations such as the profitability of the

innovation and the asset position of the farm firm. Nevertheless, there

are instances in which the economic advantages of using precautionary

inputs are not immediately clear but, with suitable extension advice,

adoption can be accelerated; in short, technical assistance needs to

accompany the technology if adoption is to be speeded.

-99-

The Bank is also faced with the problem of a relatively high rateof defaults and late repayment of loans. For the first season of 1971, theratio of recoveries at the conclusion of the production loan cycle period --this is about one month after the completion of the harvest -- was 77.7%.For the same season in 1972, the ratio had increased slightly to 78.9% andby the first season in 1974 the recovery rate improved further to 82%. Anoverdues rate of nearly 20% in what is in some respects a supervised creditprogram can hardly be deemed satisfactory (U). In such schemes fidelity inloan repayments cannot just be assumed, as is indicated by the fact thathigh loan delinquency rates of the order of 20 to 30% are frequentlyencountered in small farmer credit programs in other developing countries. 11/It could be argued, of course, that some delinquency in loan repaymentsis not incompatible with a successful loan program if cognizance is takenof the wider socio-economic benefits arising from the infusion of productioncredit to small farmers. The increased costs involved in loan collectionand loss occasioned by bad debts may be offset by increased farm incomesthrough reduced indebtedness with higher priced informal credit sources andby progress towards other credit policy goals. Nonetheless, delinquencyrates remain an important quantitative indicator of program problems andusually require reducing if a psychology of default is not to be engendered(V).

The overdue rate facing the Bank suggests that it could experiencedifficulties in the future in reconciling the need for increased coveragewith the program goal that only economically sound loans be disbursed. Asubstantial increase in lending commitments poses dangers of an accumulationof "sour" loans and a depletion of resources, eventually necessitatingeither a reduction in loan commitments and no graduation to potentialborrowers or further infusions of external capital (W).

(U) See 33. High arrears limit the institution's ability to expand or evenmaintain its lending operations.

(V) See 39. A tradition of poor loan discipline tends to be self-perpetuating.

(W) See 42. Infusion of external funds allows institutions to continuetheir operations in spite of failure to attain a level of performancesufficient to be financially self-sustaining.

ll/ Ronald Tinnermeier and Chris Dowswell, "Small Farmer Credit," Research andTraining Network Workshop Report, No. 1, Agricultural Development Council,New York, March 1973, p. 6.

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