Posted June 1997
Financing for Small Farmer Groups
by John Rouse
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:
- Savings first. Groups are encouraged to initiate group-based
savings schemes prior to applying for bank loans. Progress in mobilizing
group savings provides a measure of members' commitment to the group enterprise
and their loan repayment capacity.
- Group savings and credit. Delivery of financial services to participatory
groups, rather than individuals, carries cost advantages for both banks
and the poor. For example, a joint loan application submitted by a group
of 10 farmers reduces the bank's loan administration costs by a factor of
10. Group saving offers similar reductions in deposit account maintenance
costs. Transactions costs are also lower for the group members: they need
to prepare only one loan application and make a single trip to their local
- Credit Guarantee Fund. To encourage an interested institution
to lend to participatory groups, each PPP project provides a special Credit
Guarantee Fund (CGF) to cover losses resulting from loan defaults. The fund,
held in an interest-bearing account at the institution, is governed by a
written agreement that sets out conditions under which loans are to be granted
from the bank's own capital, as well as procedures to be followed in case
of non-repayment of loans.
- Linking savings with credit. Through the CGF agreement, the cooperating
bank also requires that groups open a joint savings account and make regular
deposits for a specified period before becoming eligible for loans. Some
projects limit the maximum amount that a group can borrow to a multiple
of the amount in the group's savings account, or require the group to deposit
part of its loan as savings.
- Loans based on social collateral. In PPP projects, the cooperating
bank is encouraged to relax requirements for physical collateral and use
"social collateral" in its place. Members of borrowing groups
are held jointly responsible for the repayment of their group loan. Should
one member of the group fail to repay his or her portion of the loan, the
entire group loan is considered delinquent and all group members are barred
from obtaining credit until it has been repaid. (This mechanism is partly
responsible for the PPP loan recovery rate of 80-90%, roughly double the
rate achieved by most small farmer credit schemes.)
- Group training in financial self-reliance. An essential element
of PPP is the training of group members and leaders in the importance of
achieving financial self-reliance. Groups are encouraged to exercise discipline
in the use of savings and credit in order to maximize the income-generating
potential of their activities, to accumulate wealth and to build credit-worthiness.
The group promoter plays an important role in this education process and
serves as a link between the group and the cooperating bank.
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
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
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".