The Role of Financial Institutions
This note reviews risks and problems that financial institutions (FIs) face in trying to provide rural and agricultural financial services. It highlights new approaches and mechanisms to mitigate credit risk and improve profitability of rural lending.
The note discusses the potential for historically urbanized MFIs to provide services in rural areas. It identifies the following constraints to provision of financial services by FIs:
- Higher transaction costs;
- Seasonality of agriculture;
- Loan collateral issues;
- Asymmetry of information;
- Legacy of failed state-subsidized credit programs for agriculture;
- Covariant risk.
The paper states that FIs have significant financial resources and range of financial products that can serve all clients. Donors must recognize that working with FIs in rural areas is a long-term strategy that requires commitment. The paper lists the following ways in which donors are encouraging FIs to enter the rural market:
- Supporting expansion of MFIs into rural areas;
- Developing new bank and non-bank financial institution products for lending to agriculture and agri-business;
- Renewing interest in state agricultural banks;
- Addressing policy issues that focus on profitability of agriculture.
