Therefore, the weighted cost of subsidy is Cw = Z*C, where C is the actual cost of subsidy. When Cw < C, the society benefits from an enhanced social gain because of the greater allocation of subsidies to the lower income groups. Alternatively, the net cost of the subsidy to the society is lower. When Cw > C, the actual subsidy is higher and the net cost to society is higher. Thus, less lending reached the target segment of the population.

Although the OI can be used primarily for outreach measurement, it can also be adapted to other needs that reflect the government’s utility function (for example, if the goal is to target women, the portfolio could be divided by gender). Alternatively, the parameter L could be substituted for a different indicator that is not related to volume, such as the average spread of loan groups.

# **Applicability of SDI and OI to Different Types of DFIs**

The SDI and the OI can be used to assess the performance of different types of DFIs with a social objective.<sup>16</sup> Annex 2 presents a typology of DFIs that can be assessed while using such metrics. The typology is arranged along two axes:

1. _Service mechanism_ : It refers to whether the DFI provides services directly to final beneficiaries or acts as a second-tier institution. Additional care is needed when calculating the subsidy of a second-tier DFI to avoid either double counting of subsidies that in reality accrue only to the retail bank that the DFI serves or underestimating subsidies provided through such a bank.

2. _Product focus_ : It refers to whether the institution concentrates on lending activities. Although the earlier discussion uses mostly lending examples, in practice the SDI may illustrate the additional amount that a DFI would need to charge for any of its nonlending services in order to make the subsidy necessary.

# **4. Two Pilot Case Studies**

# **Banadesa**

# **Background and Setting**

Banadesa is the Honduran state agricultural development bank. It has approximately US$50 millions in assets (about 1 percent of the total assets in the Honduran financial system), representing one of the smallest DFIs in the region. It is among the smallest 5 in a set of 80 DFIs identified in LAC.<sup>17</sup> Banadesa’s performance reflects the characteristics of the old school of agricultural credit that reigned over development theories until the end of the 1980s. Those characteristics include (a) narrowly directed credit to agricultural producers—rather than to all other rural income–generating activities and rural consumption, (b) political intervention with respect to credit allocation and its terms, (c) poor financial discipline that eventually resulted in low loan recovery, (d) lack of comprehensive knowledge regarding the overall social cost of

> 16 As already mentioned, this paper does not consider publicly owned commercial banks that do not have a stated social objective because it would be meaningless to calculate the OI for those institutions. 17 The 2001 data were the latest available as of end-2004. The main sources were the websites of Alide and the Central Bank/Superintendency. The table includes only the first tier or mixed (first and second tier) DFIs, but data are available for second tier DFIs as well.

14