Research Proposal

Title:                Better Practices for Scaling-up Rural Microfinance in Tajikistan

General

The question of how to best develop an effective rural financial system has been much debated over the past three decades. A significant evolution in agricultural and rural development strategies has taken place over the last decade. This evolution represents a shift away from supply-led and interventionist policies towards a more liberal, market-oriented approach. Liberalization of the financial sector includes the elimination of regulated interest rates and directed credit programs, and the restructuring or liquidation of state-owned agricultural development banks.

Lack of access to formal credit and to full financial intermediation services impedes agricultural development and hampers the efforts to alleviate rural poverty. However, new initiatives are being undertaken to meet the demand for rural credit. They include the reform of agricultural development banks, enabling them to pursue a market approach in the delivery of credit services to small and medium-sized rural clients.

Two recent developments have influenced these initiatives. The first one has been the adoption of a “financial systems” development approach. This emphasizes the need for an integrated approach to financial market development and the provision of competitive and durable financial services in local financial markets. A clear understanding of both client demand and existing informal financial services providers is required. In fact, over the last decades, development agencies, NGOs, practitioners and researchers have accumulated substantial experience in operating financial services for rural clients.

The second development has been the emergence of specialized microfinance institutions. Microenterprise credit programs were initiated to address the unemployment problems that are associated with the vast rural-urban migration in developing countries. Initially, they targeted the promotion of self-employment and income-generating activities for the urban poor. The evolution in microfinance, like the earlier one in rural finance, has been affected by the principles of financial systems development. Attention is on developing financial institutions that target low-income clients while pursuing commercial viability.

Although today only a few microfinance institutions have achieved full financial independence, many more use innovative credit technologies and have developed organizational structures that produce positive results. These initiatives illustrate the potential to overcome the financial barriers that commercial banks traditionally face when they try to lend to low-income clients.

The goal of this research will be to identify those lending practices that are able to address the challenge of financing small farmer clients. Within the framework of rural financial markets, the text concentrates on the specific issues of lending to agricultural producers. The lessons that can be learned from microfinance will be reviewed and an assessment will be made of the possibility of transferring successful microcredit practices to agricultural lending. In addition, the experiences and the strategies of three micro and rural finance institutions doing agricultural lending will be examined in greater detail.

The research work will be divided into four chapters.

I. The Rural Microfinance: Markets, Costs and Risks   

Chapter 1 will give a brief overview of agricultural finance and highlights its unique features. The detailed analysis of the characteristics of agricultural lending also will be presented in this chapter. In research work these features will be examined, with regard to the implications they have on the management of the costs and risks faced by agricultural lending institutions.

Agricultural lenders face distinct challenges that are related to the specific nature of farm production. Particular attention in this chapter will be given to the factors that affect the design of agricultural lending products.

Firstly a summary will be given of the past agricultural credit policies including the shift from supply-led and directed agricultural credit programs towards rural financial market development. In the current prevailing market environment in developing countries, major attention is now given to the assessment of the effective demand for financial services.  The unique features of agricultural lending also will be outlined in this chapter. Major attention will be given to an assessment of the specific cost and risk barriers that formal lenders face in agricultural lending.

II. Lessons from Rural Microfinance: Cost Reduction and Risk Management Strategies

Chapter 2 will summarize the main lessons that have been learned from microcredit. It presents the approaches that successful microlenders follow in managing their costs and risks in lending. The chapter concludes by indicating the main limitations that the microcredit lessons have for agricultural lending.

During recent years, financial services have been provided to an increasing number of low-income people and microentrepreneurs because of innovative developments in “microfinance”. Microfinance refers to that part of the financial sector that responds to the financial demand of low-income households. Until now, microfinance institutions have operated mainly in urban areas. They provide small and short-term loans predominantly for trading, services and microenterprise activities. The lessons learned from the failures of the earlier directed agricultural credit projects plus the principles of the new financial systems development approach have been particularly influential in microfinance. Important progress has been made in the areas of institutional and organizational set-up and operational strategies. New lending technologies have been designed for low-income clients.

In this chapter, the key lessons that have emerged as the “best practices” in the field of microfinance will be examined. The chapter will review the supply and demand features of microcredit and will examine some key factors, which have emerged from the cumulative experiences of microcredit. Particular attention will be given to the review of the microcredit technologies and the contribution that they make towards managing the costs and risks of small loans. The main limitations that are encountered in transferring the microcredit practices to agricultural lending also will be highlighted in this chapter.

III. Rural Microfinance and Agricultural Lending: Lessons from the Field

Three field experiences in agricultural lending will be reviewed in Chapter 3. The objective of this chapter is to assess the innovations that have enabled the case study lending institutions to meet the challenges that are traditionally associated with the granting of rural and agricultural credit. Particular attention will be given to those aspects that facilitate a better cost and risk management in agricultural lending.

There are the examples of a number of successful agricultural development banks. Although there are few microfinance institutions currently engaged in agricultural lending, some of them have broken new ground. Their experiences are worthy of study and important lessons can be learned.

The three case studies that have been selected for this study are: Grameen Bank in Bangladesh, FINCA Kyrgyzstan in Kyrgyzstan and Development Fund in Tajikistan.

These institutions have widely different ownership structure, institutional and organizational set-up, duration of operations, size, credit technologies and type of clientele. They have also quite different backgrounds and mandates.

Grameen Bank started in Bangladesh to assist the rural poor. Small amounts are loaned, mostly to women, without collateral and without guarantors. So far loans have been made to more than 600,000 people. Even though money is lent without collateral, the Grameen Bank reports a 98% repayment rate, far in excess of most conventional banks.

FINCA Kyrgyzstan started in 1995 with funds granted by USAID. Now FINCA Kyrgyzstan is the leading MFI in Kyrgyzstan, serving over 30,000 clients. FINCA Kyrgyzstan is also one of the premier MFIs in the NIS, with its profitability and asset quality exceeding industry standard.

Development Fund in Tajikistan is the local NGO doing agricultural and rural lending from 1999. Loans are made for production and processing of agricultural products to the groups without collateral and to the individuals with collateral. Fund’s goal is to provide farm households with access to agricultural credit and other financial services on a nationwide basis.

These organizations employ a different agricultural lending technology and have distinct institutional structures and operate in different environments. They represent successful urban microlenders which are expanding their operations into rural areas. They illustrate the adaptation of urban microcredit technology to the specific demand features of a rural clientele. They have developed credit technologies that deal with the high costs and risks that are associated with lending to small farm households.

This chapter focuses on those factors that are especially relevant to the management of costs and risks in agricultural lending. The first section of the chapter provides a brief overview of the institutional profile, the clientele served and the performance of each of the three case studies. The second section examines the strategies that are used to reduce the costs and to manage the risks in agricultural lending.

IV. Summary and Conclusions

Chapter 4 will summarize conclusions and highlight the remaining challenges in agricultural lending. This research will examine the challenges that agricultural lenders face in designing and operating demand-oriented lending services. These systems should be widely accessible to small farm households and durable. Based on the preliminary guiding principles that will be developed for agricultural lending, a summary presents the main lending strategies. These methods can be used to reduce the high costs and risks of lending to small farmers. Selected annotations also will be provided for a number of key aspects.