**Policy Research**

## **Agricultural Policies**

# WPS 875

- This paper a product of the Agricultural Policies Division, Agriculture and Rural Development - Department is part of a larger eftbrt in the department to define appropriate modes of Bank ac0ivities in the areaof rural finance. Copies of the paperare available free from the World Bank, 1818 H Street NW, Washington, DC 20433. PIlease contact Cicely Spooner, room N8-037, extension 30464, or through electronic mail (March 1992, 25 pages).

The establishment of fonnal agricultural credit systems in most developing countries in recent decades has been motivated by the belief that widespread shortages of short- and long-terrn finance have arrested agricultural growth and development. The lack of affordable formal credit has been blamed for delaying, if not preventing, the timely adoption of new production technology and intensive nonlabor inputs.

Commercial lending institutions generally focus on large-scale farmers and ignore smallscale farners because of the significant cost of processing and servicing unsecured small loans and the prevalent belief that small entrepreneurs represent a greater risk than large ones. The shortage of strong formal credit markets has caused informal credit institutions to flourish in many developing countries. These infonnal institutions disburse funds rapidly, and the transaction costs for borrowers are low.

Many specialized agricultural credit institutions have suffered from design deficiencies. They often were not expected to function as true financial intenmediaries that mobilize deposits to make loans. Instead, they have merely channeled government-supplied funds to rural borrowers. Making external funds continuously available at below-market interest rates has not obliged rural financial institutions to operate under constraints of financial viability. That -ogether with the lack of competition and limited accountabilityhas led to bad loans, inefficient operations, patronage, and irregularities.

Arrangements such as lending groups and credit cooperatives could rcducc both transaction costs and the risks involved in lending to small farners. Successful group lending programs have shown the importance of such factors as homogeneous borrowing groups that are jointly liable and themselves assume some of the managerial and supervisory responsibilities. Fact,,s attributed to the success of credit cooperatives include bottom-up institutional development, extensive training at all levels, reliance on mobilized savings and equity contributions rather than extemal funds, prudent expansion of cooperative activities, strict monitoring and auditing, and adequate incentives to staff and clients.

For a rural financial institution to become viable, state or donor support should focus on institution-building and development. Targeted credit without institution-building is almost always a recipe for prolonged dependenec on donor or state funds and bailouts. Attention to institution-building often makes the difference between a rural financial institution that can be self-sustaining after a few years of support during its startup period and one that continues to depend on public support.

ThePolicy RescarchWorking PaperScriesdisseniinatcs the findingsof work undcr way in the Bank. Anobjectivcof thcscries is to get thcsc findings out quickly, cven if prcsentations are Icss than fully polished. The findings, interpretations, and conclusiorns in thesc papers do not necessarily reprc.;cnt ofrficial Bank policy.

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