Millions of people in the developing world's rural areas are poor not because they cannot manage money, but because they have too little of it. While studies show that rural micro-entrepreneurs produce high rates of return on the capital they invest, the problem is they lack access to sufficient funds, which means their aggregate return remains low, thus perpetuating a life in poverty.
A key objective of rural finance is to provide those people with the funds and financial services they need to multiply their earnings and build a more prosperous future. The United Nations International Year of Microcredit 2005 has provided an opportunity for dialogue among financial institutions, development banks, governments and donors on the role and potentials of rural finance - what it can do, who it can reach and why it has still not reached many of the rural poor.
New focus. In the past, "rural finance" and "agricultural credit" were used interchangeably. Today the focus has broadened: the future of rural poverty alleviation is investment in all aspects of rural development, not only agriculture. More business in rural areas generates the economic incentive to improve infrastructure, which boosts the competitiveness of production. But development can only occur when a rural area is able to attract and sustain rural investment, through a conducive operating environment, suitable financial products and services, and attractive returns.
Efforts to make financial services accessible to poor rural households must overcome several key constraints. First, rural incomes are highly susceptible to systemic risks, such as bad weather and disease, and cyclical and seasonal fluctuations in prices of agricultural commodities. Any loss of expected income has significant impact, and reduces savings and borrowing capacity.
For providers of financial services, the rural sector is particularly risky. Returns on investment capital are low and profit margins are often very low. Operating costs are high in isolated areas and, since collateral is often unavailable, lenders face greater risks from loan defaults. The low level of skills reduces the capacity for adopting new technologies, affecting both productivity and competitiveness in the marketplace. Social exclusion also limits constrains production and marketing efficiencies.
Despite these constraints, micro-finance institutions (MFIs) have introduced innovations - mainly in urban areas but also in the rural sector - that are realizing the potentials of microfinance in many countries. Small working capital loans for petty trade, artisanal production and microbusiness are a growing part of MFI portfolios, while rural savings products have also filled an important need. Microfinance has been instrumental in recognizing the multiplicity of both household finance needs - not only for production credit, but equally so for school fees, health costs and housing, and for services such as remittances, accessible savings outlets and insurance.
Microfinance has often led the way in addressing social, gender and ethnic equity issues which hold families in poverty. In countries where subsistence agriculture predominates, improving women's access to rural finance has favoured empowerment, equality and better lives for those women and their families.
A vision for the future. The importance of rural finance in poverty alleviation and achievement of the Millennium Development Goals means that it will remain a high priority for governments, donors and, of course, rural households. Based on current trends, we can expect major changes in provision of products and services over the next decade.
In countries where microfinance and retail finance institutions have been operating for a long time, there will be increasing consolidation in the sector, and a marked tendency toward full service provision: single loan products and the credit-only services of agricultural banks will be replaced by savings options, remittances and insurance. Since very few providers can offer efficiently a full set of services, institutions will need to link up with specialized companies (for insurance, leasing, venture capital, etc.) and with "niche" organizations such as NGOs and self-help groups that facilitate their outreach in rural areas. Effective use of financial services will also require stronger ties to training, technology, marketing and business services.
Donor capital for lending will become relatively insignificant. Retail finance institutions will be funded largely by client savings, with investment funds, securitization and bonds also growing in importance. Subsidized finance will mostly disappear. Increased vertical integration of production and marketing, coupled with improved information systems and better regulation, will mean greater inclusion and understanding of trade-linked finance. The use of contract farming, inventory credit, forward contracting and leasing can be expected to grow. Risk management will remain a major issue, but it will also improve, through portfolio and client diversification, and improved analysis and information tracking. The use of insurance products will make the systemic and unique risks of rural finance less hazardous.
"Bankable"clients. The Year of Microcredit has helped dispel the notion that the poor are "irresponsible with money". Indeed, it has confirmed that they are not only "bankable" clients, but a very important and largely untapped financial market. Despite their lack of traditional sources of collateral, micro-entrepreneurs demonstrate that "peer group pressure", as well as self-interest in a lasting source of funds, are usually sufficient to ensure very high repayment rates.
FAO and other development partners stand behind rural and microfinance organizations that wish to make a difference in poverty alleviation, economic growth and social empowerment. Such partnership requires transparency and accountability, standardization in reporting and shared learning. The vision for the future is one of hope - rural finance and the other tools that make a difference exist and are continually being refined and improved. Together we can make the vision become reality.
See also Spotlight: Agribusiness and small farmers and Contract farming in Asia
Find out more about FAO's programmes on Rural finance
Published November 2005