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Posted November 1997

Participation in practice / 7
The financial component

Introduction | People's Participation Programme (PPP)| Project preparation | Forming groups | Group activities | Implementing agencies | Financial component | Group promoters | Participatory training | Monitoring and evaluation | Project sustainability | Costs and benefits | Replicating the PPP approach | Complete Special as a single 121K file

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.

Facilitating savings and access to credit

Savings first

PPP experience highlights the importance of "savings before credit" in group financial development. In Sri Lanka members of newly formed groups are asked to determine how much they will save each week, based on the capability of the poorest member. Savings come from weekly membership fees, profits on activities, and interest earned on emergency loans to members. Sums of $40 or less are usually kept by the treasurer; larger amounts are banked. The "savings first" philosophy has paid off: so far, the Sri Lanka groups have accumulated savings of $9,000, an average of $5 per member in areas where the poor earn less than $1 a day. Loans to individual members are channeled into a group account before being distributed. In this way, the group is made responsible for the entire loan. "We tell the groups that unless they are extremely sure of the creditworthiness of a member, they should not forward an application for that member," the project coordinator said.
Given these constraints, PPP has 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.

Adapting to local conditions

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.
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.

Finally, group promoters play a critical role in building up financial-self reliance among PPP groups. The GP must not only train members in basic financial skills, but assist the bank in recovering loans and building stronger links with the groups. As the groups reach maturity, however, this responsibility should be assumed gradually by inter-group federations. The federations thus complement - and help reduce the costs of - the bank's own supervisory and monitoring support.

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