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Rural Finance

It is estimated that more than a billion people lack access to the basic financial services which are essential for them to manage their precarious lives. Rural finance can be considered as one of the tools in poverty reduction and rural development.

The Consultative Group to Assist the Poor (CGAP) defines rural finance as “financial services offered and used in rural areas by people of all income levels”, including farm and non-farm population. It encompasses diverse types of products and services, such as loans, deposits, insurance, remittances,...

Rural finance is a sub-sector of the financial sector and includes agricultural finance, which is dedicated to financing agricultural related activities such as input supply, production, distribution, wholesale, processing and marketing. It also includes microfinance, which provides financial services for poor and low income people by offering smaller loans and savings services, while accepting a wider variety of assets as collateral, or lending without any collateral at all.

Rural financial markets tend to be fragmented and work through a variety of institutions and organizations, including formal (such as banks and regulated microfinance institutions), semiformal (such as self-help groups, NGOs and cooperatives) and informal (such as rotating and non-rotating or accumulative savings and credit groups, village money lenders, shop owners, friends and relatives) institutions.

On the whole, high transaction costs associated with dispersed populations and inadequate infrastructure, along with the particular needs and higher risk factors inherent in agriculture result in an under-provision of financial services in rural areas.

This was particularly true in Eastern Europe and Central Asia (ECA) countries during the transition from the former Soviet Union system.

In centrally planned economies, one of the predominant monetary policy instruments was credit allocation and lending at negative interest rates. Moreover, banks had a fiscal rather than an economic function: they distributed subsidies and supported production plans.

With the transformation of centrally planned economies into market economies, credit costs rose and terms of trade deteriorated as a result of price liberalization, falling domestic and international demand, reduced domestic subsidies, and the breakdown of the former trading system. In addition to this general set of problems, rural financial institution-building faced specific obstacles including difficulties in the provision of credit collateral due to an unclear land property situation; the relatively high transaction costs related to supplying financial services to small enterprises; the still prevalent misuse of the financial sector to supply subsidies to bankrupt state-owned enterprises and the related poor financial discipline and credit repayment behaviour. The consequence was the development of weak financial intermediaries with large portfolios of non-performing loans.

This lack of access to credit caused a high level of rural unemployment and poverty. Traditional forms of collateral often being not available, new forms of financing and security were required that took into account the value of agricultural products and the strengths of agricultural value chains and those involved in them. For example, Structured Finance (SF), which comprises, among others, warehouse receipts, forward contracting and loan guarantees, was developed precisely for using such non-conventional types of collateral.

Sources: EastAgri; FAO; IFAD; The Rural Finance Learning Centre; CGAP.

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