Twenty-seventh FAO Regional Conference for the Near East

Doha, Qatar, 13 - 17 March 2004

The Role of Micro-Finance in Sustainable Agricultural Development

Table of Contents






1. Although the Near East region is witnessing the highest urbanization growth in the world, the rural population still predominates in non-oil producing countries in the region, averaging 60 percent of the total population. In addition, the agriculture sector employs 60 to 80 percent of the labour force on average in the region and constitutes the biggest share of Gross National Product (GNP) (Mustafa, 1999). A significant portion of the agricultural output is produced by small and medium producers, which constitute between 50 to 80 percent of the farmers. Given the size and importance of this sector, agricultural investments remain a valid policy objective in the Near East. In particular, the development of sustainable financial institutions that offer both working capital and investment loans at competitive rates and provide safe and secure deposit facilities for farmers remains critical for achieving continued economic growth in the region. However, the Near East, like many other regions in the world, is haunted by a past of underperforming public agricultural development banks, with heavy government intervention and a limited outreach to small farmer clients.

2. In general, small farmers and rural enterprises have limited access to formal financial services. Appropriate financial products and viable and sustainable financial institutions to deliver them are scarce. This situation results from: high transaction costs associated with small loan amounts, highly segmented financial markets, and the provision of credit services to risky agricultural economic activities. Other impediments that restrict the supply of agricultural finance include: inadequate access of farmers to profitable market outlets for their farm produce and a lack of conventional bank collateral by small scale farmers. This situation is accentuated in particular by the high, covariant risks in agriculture without adequate mechanisms to manage and minimize these risks. Macroeconomic distortions and political intrusions into rural financial markets reduce the viability, credibility and sustainability of formal public financial institutions. Inadequate and non-enforceable legal systems are not conducive to the development of lending and other financial services that serve large proportions of the rural population. Adoption of supply driven credit rather than demand based financial services is a restricting factor.

3. Over the last twenty years the performance of agricultural development banks has gradually declined in the Near East region, resulting in a dramatic reduction of formal credit to small and medium scale farmers. This has constricted farm development and hampered the economic growth of the agriculture sector. A growing concern about the limited supply of agricultural finance has re-emerged as an important development issue among researchers, practitioners, donors, and policy makers (Gonzalez-Vega, 2003). At the forefront of this concern is the question of who is going to fill the supply gap of financial services to the rural population, in particular small scale farmers. Microfinance, given its demonstrated success in lending to micro-enterprises in many parts of the world is often considered as one of the more favoured strategies.

4. This document tries to shed some light on issues related to micro and rural finance. At the outset, a brief overview of the role of microfinance in expanding the supply of agricultural credit is presented. This is followed by a discussion of the microfinance realities in the Near East region. The paper ends with recommendations for policy makers and donors on the development of rural and microfinance in the Near East region.


5. Microfinance is an important strategy in increasing access of low income people to financial services. Microfinance services permit clients to accumulate assets, smooth consumption and invest in urban and rural (on and off farm) businesses. Primarily offering micro-loans and some savings products, Microfinance Institutions (MFIs) can be grouped in the following manner: solidarity group lending systems, based on joint liability; individual loan programs; savings and loan mutualist/cooperatives; and self-managed village bank systems which are based on local community realities.

6. Innovative microfinance institutions have successfully dealt with some of the most challenging issues of offering financial services to low-income people. Their strategies include but are not limited to the following: (i) solving the problem of the lack of conventional collateral by using group-based and character-based collateral substitutes; (ii) instilling high loan repayments and recovery rates through frequent and regular repayment collections, the use of social and peer pressure, and the promise of repeat loans; (iii) reducing high transaction costs by transferring some of the appraisal and supervision expenses down to group level and by increasing the outreach of services; (iv) designing staff incentives to achieve greater outreach and high loan repayment; and (v) providing savings and other demanded services that meet the needs of small clients.

7. In several areas regional and national microfinance associations (MFAs) are established to represent the collective interests of the industry vis vis donors and governments. For example, the Africa Microfinance Network (AFMIN) is a newly established regional network of national-level microfinance associations in Africa. AFMIN’s purpose is to support the African microfinance industry, enabling practitioners to exchange experiences on better practices, use common performance standards and influence policies that facilitate the growth of microfinance in Africa.

8. Although most of the microfinance experience has occurred in urban areas where opportunities for diversified income scope and outreach are more readily present, some microfinance institutions, such as credit unions and private rural and village banks, have successfully served rural clients. With innovative microfinance products and services adapted to the rural realities, these MFIs have overcome the information, incentive, and contract enforcement challenges intrinsic in most financial transactions (Gonzalez-Vega, 2003). Up until now, however, microfinance institutions operating in rural areas have limited their agricultural lending operations given the inherent riskiness of these activities (Gonzalez-Vega, 2003). Rural lending requires more effort and technical know how than urban lending given the greater complexity of rural firm-households, which are characterized by diverse and volatile sources of income (Buchenau, 2003).

9. Due to lack of experience in agricultural lending of most microfinance institutions the role of microfinance in the expansion of agricultural finance must be addressed with much caution. Designing appropriate macroeconomic policies and establishing a sound legal and regulatory framework are necessary precursors for fostering an efficient financial sector equipped to serve rural clients. An expansion of the supply of agricultural credit by microfinance institutions will succeed only if it is accompanied by other financial services and embedded in a strategy that improves the overall performance of rural financial markets in general (Gonzalez-Vega, 2003). Once these reforms are underway, only the most robust microfinance institutions, those that have demonstrated they can successfully manage urban microlending portfolios of agricultural loans, will gradually expand their outreach to the rural sector.


10. A World Bank study2 on microfinance reveals that the Near East region faces many challenges in developing a healthy microfinance industry. MFIs in this region lack experience and general exposure to worldwide microfinance best practices, constraining their ability to learn from others’ experiences. Political and macroeconomic instability in some countries has limited the development of the industry. Social, cultural, and religious barriers, such as the problem of charging interest rates for lending, a violation of the sharia, the basic Koranic code of law, also presents a challenge for the industry. The lack of adequate infrastructure, in particular in rural areas, presents another obstacle for the microfinance industry in the region. The legal and regulatory framework does not appear to be a major impeding factor to the development of the industry in most countries as laws, such as restrictions on NGO activities, interest rate ceilings, and loan size restrictions, are rarely enforced. However, there does appear to be a large need to revise the current regulatory framework in most countries to foster the development of a vigorous microfinance industry.

11. The World Bank study reveals that MFIs in the region present a wide variety of institutional forms, such as NGOs, non-profit micro-credit entities, government owned banks, and commercial banks with microfinance subsidiaries. Egypt has the biggest and most developed microfinance industry as its outstanding loan portfolio and number of borrowers, account for 57 percent and 66 percent respectively, of the total regional microfinance market. There is also much scope for expansion in the region, since the supply of microfinance only covers 2.4 percent of the actual demand. Most MFIs in the region offer only lending services with some compulsory savings, or loans are part of an overall package of charitable activities. Group joint liability is the dominating lending technology in most countries in the region, with the exception of Egypt and Tunisia where individual loans are offered as well. Most MFIs target both men and women; however, some focus solely on women to promote their participation in economic development.

12. Sustainability continues to be the biggest challenge for most MFIs in the Near East. Only three out of the 60 MFIs reviewed have achieved the first level of sustainability, covering all operational costs. Sustainability is constrained by poor loan portfolio quality, inefficient lending systems and procedures, and excessive donor reporting requirements. Portfolio quality is compromised by lax loan collection resulting in very high delinquency rates, as much as 70 percent in some MFIs in Jordan. In addition, some MFIs subsidise their interest rates and grant long grace periods, which drain capital funds over the long-term. Most MFIs are institutionally weak lacking a clear mission statement, qualified board members, staff knowledgeable in microfinance, and management information systems that provide timely and accurate information for monitoring and evaluating the MFI’s progress and overall financial health. In addition, most microfinance institutions do not have internal control systems or staff incentive schemes, while loan granting decisions are centralized and burdened by bureaucratic procedures.

13. The World Bank study reveals that microfinance best practices are not followed, resulting in an extremely weak institutional capacity of most institutions in the region. This weakness highlights the need for investments in human capital and systems development if microfinance is to play a role in the region’s economic activities. MFIs in the region have much to learn from successful best practices worldwide.


(i) Member Countries are called upon to consider:
14. First, emphasis should be place on developing an enabling environment that focuses on the development of stable macroeconomic policies and a favourable business climate that fosters investment opportunities for small farmers. Macroeconomic policies should focus on, in particular, control of government budget deficits and inflation, elimination of the distortions in exchange rates, liberalization of import and export trade, domestic market and price liberalization, and development of an adequate legal and regulatory framework (Roberts and Hannig, 1998).

15. In the Near East Region strong government interventions still exist in different economic sectors. Therefore, special attention is needed to foster private business development and the agricultural sector; policies should focus on making farming more profitable. Appropriate policies and investment in essential infrastructure and production support services, such as roads, markets, storage, research and extension services are critical to making agriculture more profitable (Coffey, 1998).

16. Rural financial policy in general should promote the development of a variety of financial intermediaries to meet the specific demands of a broad spectrum of clients, such as farmers, agribusiness entrepreneurs, and other rural people. In particular, support could be given to the experimentation and promotion of innovative and appropriate financial technologies and products for rural clients. In the case of agricultural finance, non-financial intermediaries such as input and equipment suppliers, warehouse operators, traders and agribusiness can play an important role in the finance of farm production and governments may want to facilitate the development of contract farming and other interlinked trade/ credit arrangements by bringing together agribusiness and small farmers organizations.

17. In the area of regulation and supervision of financial institutions, bank regulators in Near East should develop special licenses and a framework for non-bank financial institutions. This will allow smaller and innovative financial intermediaries to operate in and develop products for market segments that are not well served by commercial banks. Other innovative ideas in this area should include: repealing counterproductive regulations; incorporating measures by which regulation and supervision can be enhanced by using market forces to promote accountability; and increasing the number of well trained supervisory staff.

(ii) FAO and other Donors are called upon to consider:
18. Investments in capacity building, with an emphasis on using microfinance best practices, are needed to foster the growth and development of the microfinance industry in the region. Capacity building should focus on assisting MFIs in (i) selecting qualified board, management and staff members; (ii) defining clear mission statements that strive towards sustainability and outreach; (iii) training in financial management and accounting with a strong emphasis on adhering to prudential ratios; (iv) establishing effective information management systems; (v) developing new services and products, especially those targeted to rural clients; (vi) and setting up staff incentive systems to foster effective loan collection practices.

19. Capacity building of local training providers in the area of microfinance is needed.

“The absence of local microfinance training capacity has contributed to the lack of management capacity in most microfinance institutions in the NENA region. Existing materials on best practices in microfinance should be translated into Arabic and French and disseminated. And these materials should be adapted to the local market needs (Brandsma and Chaouali, 1997). ”

20. New microfinance institutions, especially those targeted at disadvantaged groups that are underserved, such as women and other rural poor clients, should be created. Successful group loan programs in Gaza should be replicated within the country and in other countries within the region (Brandsma and Chaouali, 1997). Also worldwide best practices of village banks, savings and credit associations, community revolving funds and social funds should be followed when developing new financial programmes that service women and other rural poor.

21. The creation of national and regional microfinance associations (MFAs) will help promote the development of the microfinance industry in the region. These MFAs should foster the exchange of information and experiences as well as carrying out joint activities of mutual interest. Key areas that these MFAs should focus on are: (i) setting industry standards; (ii) developing best practice strategies appropriate for the region; (iii) organizing field visits to successful MFIs within and outside the region; (iv) advocating microfinance with local and national governments; (v) facilitating experimentation of new products and services, especially those targeted to small farmers and other rural, low-income people; and (vi) organizing technical workshops on key microfinance topics.

22. Commercial and agricultural development banks, particularly those that have been reformed, can play an important role in expanding the supply of effective financial services to rural clients. Formal banks can create linkages with other rural and microfinance institutions by providing them with resources for on-lending to their respective client-members. With this strategy banks are able to increase their outreach and scope in a cost-effective manner. In addition, banks can downscale their products and services by creating a specialised rural and microfinance department within its structure to directly serve rural clients, such as small farmers, micro entrepreneurs, agro-processing firms, input suppliers, wholesalers, and warehousing agents. Initiatives, such as downscaling, increase the financial intermediation potential for banks that are willing and able to expand into this market (Klein et al., 1999).


Brandsma, J. and R. Chaouali (1997). Making Microfinance Work in the Middle East and North Africa. The World Bank, Washington, D.C.

Buchenau, J. (2003). “Innovative Products and Adaptations for Rural Finance.” Paper for “Paving the Way Forward: An International Conference on Best Practices in Rural Finance.” Washington, D.C., 2-4 June 2003.

Coffey, E. (1998). Agricultural Finance: Getting the Policies Right. FAO/GTZ Agricultural Finance Revisited (AFR) Series: No. 2. Rome, Italy.

Gonzalez-Vega, C. (2003). “Deepening Rural Financial Markets: Macroeconomic, Policy and Political Dimensions.” Paper for “Paving the Way Forward: An International Conference on Best Practices in Rural Finance.” Washington, D.C., 2-4 June 2003.

Klein, B. et al. (1999). Better Practices in Agricultural Lending. FAO/GTZ Agricultural Finance Revisited (AFR) Series: No. 3. Rome, Italy.

Mustafa, M.R. (1999). Some Features of Rural Finance in the Near East and North Africa Region: Studies and Remarks. NENARACA. Amman, Jordan.

Roberts, R.A.J. and A. Hannig (1998). Agricultural Finance Revisited: Why. FAO/GTZ Agricultural Finance Revisited (AFR) Series: No. 1. Rome, Italy.

1 The information in this section has been drawn heavily from a World Bank study on microfinance in the NENA region: Making Microfinance Work in the Middle East and North Africa. World Bank, 1997.

2 This study reviewed 60 MFIs in Algeria, Egypt, Iran, Jordan, Lebanon, Morocco, Tunisia, Syria, The West Bank and Gaza, and Yemen, representing 90 percent of the region’s microfinance activities.