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Posted June 1997

Financing for Small Farmer Groups

by John Rouse
Senior Officer
Rural Institutions and Participation Service (SDAR)
FAO Rural Development Division
See also Special: Participation in practice - Lessons from the FAO People's Participation Programme

ACCUMULATION AND REINVESTMENT OF WEALTH are driving forces behind economic development. Financial institutions - such as banks, credit unions and informal savings societies - have, therefore, an important role to play in participatory projects: they provide a secure place for group members' savings, facilitate financial transactions and supply credit for investment in group activities.

In most developing countries, however, the rural poor have little, if any, access to institutional finance. This is partly because the rural poor lack the physical collateral normally required to qualify for bank loans. Another disincentive for banks is the high per unit cost of delivering financial services to the poor. Reaching and servicing large numbers of scattered and unorganized rural people is time-consuming, and the volume of their individual savings and loan operations is low. Dealing with the poor as individuals is simply not cost-effective for banks, nor is it profitable, given the interest rate ceilings under which most banks operate.

Subsidized credit is often seen as an effective means of reaching the poor. The idea has been that such credit would finance rapid adoption of new agricultural technologies, put high-interest moneylenders out of business and guarantee of high repayment rates. But a growing body of evidence suggests that low-cost credit programmes may do more harm than good. Low interest rate ceilings on loans limit the amount banks can earn from interest charges. Since lending to small farmers entails higher delivery costs, the banks often prefer to make high-volume loans to larger farmers. Low interest earnings also limit the banks' capacity to cover the higher unit costs of maintaining small farmer savings facilities and offering them more attractive dividends. Thus, cheap credit undermines the banks' ability to mobilize rural savings and retards rural capital formation.

Facilitating savings and access to credit

Given these constraints, the FAO People's Participation Programme (PPP) developed a set of financial strategies designed to improve the rural poor's access to essential financial services and promote their financial self-reliance. PPP projects introduce, on a pilot basis, new financial mechanisms and incentives that modify the existing rural financial environment: first, by reducing the cost to the banks of delivering savings and credit services to small farmers; and, second, by lowering the cost to project participants of gaining access to these services.

Although PPP financial approaches vary according to local conditions, all of them share five basic elements:

Financial arrangements

The success of a PPP project may depend, to a large extent, on the support of an existing rural financial institution. Selecting an appropriate institution during project formulation is, therefore, of the upmost importance.

There are several selection criteria. First, the institution should have a widespread network of branches in rural areas, and particularly in the project action area. Its management should be willing to introduce and test group approaches to delivering financial services to small farmers and should accept the concept of group-based social collateral. The institution should also agree to the establishment of the Credit Guarantee Fund. Finally, it should also be prepared to provide group-based or individual savings facilities for project participants and to introduce mechanisms to stimulate saving.

Once an appropriate banking institution has been selected, the next step is to negotiate the Credit Guarantee Fund agreement. In PPP's experience, negotiation of this agreement may take time and project activities may have to begin before the actual agreement is signed. Nevertheless, the proposed agreement with the selected institution should be made a part of the project document.

To ensure that the bank provides proper supervision and technical support to its new clients, CGF agreements usually call for the setting up of a small farmer finance management committee within the bank to monitor the implementation of the project's financial component. Representatives of the cooperating bank may also be asked to serve on local or national project coordinating committees.

The design and operation of the PPP financial component is tailored to conditions in individual countries. When the PPP project began in Ghana, for example, the country suffered from high inflation and a shortage of foreign exchange. To facilitate project operations, the guarantee fund was transferred into an Input-Import Fund held in convertible currency outside the country, while the Ghanaian Government allocated funds sufficient to cover most local currency costs. The collaborating bank received the inputs, which were then distributed to the participants on credit. The price of inputs in local currency was determined jointly by the government, the project and the bank.

In Sierra Leone, where the PPP project provided credit directly, a detailed system was developed to provide and recover loans in kind. In Zambia, credit is administered by a national cooperative organization. Other project-specific arrangements include group marketing of surplus in Ghana and the formation of local credit unions in Lesotho.


FAO is preparing a comparative study of savings arrangements of the rural poor in five countries: Zambia, Tanzania, Zimbabwe, Ghana and Sri Lanka, with a particular emphasis on PPP savings schemes. The study will assess the effectiveness and efficiency of these arrangements in terms of management of scarce resources and how social-cultural, economic and ecological conditions affect these arrangements. The study is a project formulation exercise in two ways: as a first step towards formulation of new research plans, and as a contribution to the preparation of policy guidelines for the design of improved savings approaches and a practical field guide on savings mobilization strategies for the rural poor. For details, see: "Savings forms of the rural poor".

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