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Module 8 - Investments in Rural Finance for Agriculture


Providing financial services to households and agribusiness in poorer and marginal rural areas remains a challenge for the World Bank and other funding agencies. The adoption of a financial systems approach and the expansion of the microfinance sector have led to significant breakthroughs in performance, outreach, and lending volumes. Such breakthroughs rarely have extended to more marginal rural areas dependent on agriculture, however. Even so, some progress has been made recently in providing financial services to poor rural households with diversified nonfarm sources of income or income from nonseasonal agricultural activities.

Several factors heighten the costs and risks of financing agriculture and cause financial service providers to regard investment in agriculture as unattractive (box 8.1). However, recent efforts by the World Bank and other organizations are starting to bear fruit in the form of emerging models and successful approaches. Rather than recapitulating the comprehensive and well-documented treatments of the challenges and failures of agricultural finance (World Bank 2003; IADB 2001; Yaron, Benjamin, and Piprek 1997), this module explores promising new directions in rural finance for agriculture and identifies lessons for policy and lending.

Within the current financial systems approach, financing for agriculture is seen as part of a comprehensive rural finance strategy. The terms “rural finance for agriculture” and “financing for agriculture” are used interchangeably throughout this module to define all financial services provided to those engaged in the agricultural sector.

Box 8 .1 Challenges of providing financing for agriculture

  • High, interrelated covariant risks: Owing to variable rainfall (especially for nonirrigated crop production); pests and diseases; price fluctuations; and constrained smallholder access to inputs, advice, and markets.
  • Dispersed demand for financial services: Owing to low population densities; small size of individual transactions.
  • High information/transaction costs for service providers: Owing to the remoteness of clients and heterogeneity among communities and farms. This challenge creates the potential for information asymmetries and moral hazard risks.
  • Seasonality of agricultural production (crop production in particular): Leads to a lag between investment needs and expected revenues, and consequent liquidity management challenges.
  • Lack of usable collateral: Owing to ill-defined property and land-use rights, costly or lengthy registration procedures, and social constraints to foreclosure.

Source: Authors

 The module focuses on the provision of financial services for agricultural activities and to agriculturally dependent households, though most services do not exclusively provide financing for agriculture. They also provide financial services to nonagricultural rural and, in some cases, urban communities. Service providers include formal, semiformal and informal institutions, ranging from full-service banks to specialized agricultural finance institutions, microfinance institutions (MFIs), financial cooperatives), credit unions, savings and loan associations, traders, and processors.


 

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