The role of microfinance in rural microenterprise development

Agriculture is an important engine for economic growth in developing countries. Rural microenterprise is critical to that growth. The microenterprise sector (small farmers, small-scale traders, artisan producers) needs access to financial services, including credit and savings products, which should be provided through a professional and dynamic microfinance sector. The Small and Medium Enterprise (SME) sector is essential in both connecting urban and rural economies and industries of different types and sizes. It needs a very specific blend of financial instruments and business support.

 

Microfinance is the provision of a broad range of financial services such as deposits, loans, payment services, money transfers, and insurance to poor and low-income households and their microenterprises¹. In contrast to microcredit (i.e. loans), microfinance addresses a wider range of financial services. Microfinance services are provided by three types of sources¹:

 

It has proven to be difficult to provide sustainable microfinance services to remote rural clients in developing countries. Lack of information on borrowers' credit history, insufficient collateral, and the presence of a high degree of covariate risk due in particular to weather and market prices for farmers' produce, among other factors, make lending and other financial services risky and often unprofitable. In addition, high levels of transaction and supervisory costs contribute to the absence of functioning rural financial markets and institutions in many countries. The table below lists the limitations in extending rural financial services from the supply and demand perspective. The challenge for rural financial institutions is to develop low-cost ways of reaching farmers (especially smallholders) and to better manage risks involved in loans, insurance and other services.

 

 

Financiers: The Supply Side

Microenterprises: The Demand Side

Small size average farm, low population density, higher loan servicing costs due to limited volumes and high information costs. Lack of collateral or adequate security. Risk correlation when lending to farms: all borrowers are affected by the same risk, such as low market prices and reduced yield due to weather. High transaction and supervisory costs due to the particular risk, nature, and characteristics of the rural sector (e.g. it requires pre-harvest financing to buy inputs that can only be repaid after harvest and show much more uneven cash flows than urban borrowers, leading to repayment in less frequent installments, which increases the risk and monitoring costs for financiers). No branches or limited network in rural areas, thus difficult to reach farms. Underdeveloped communication and transportation infrastructure.

Agribusinesses suffer from poor, insufficient collateral and non enforceability of security due to lack of land and property rights, high costs, and lengthy or lacking registration and foreclosure processes. Low affordability for farmers of market interest rates Insufficient cash flow planning; farms are not obliged to keep accounts or financial statements; cash flows are hard to assess when clients sell directly to consumers. Repayment schedules are often difficult for the clients to meet; standard repayment schedules are not adapted to seasonality of the business. Lack of legal education at the farmers' level. Lack of initiative and articulated demand for finance by agribusinesses.

History has shown that regardless of ownership, type of institution, and rural or urban sphere of operation, to be sustainable microfinance institutions ultimately have to

 

Read the Seibel Report “The Role of microfinance in Rural Microenterprise Development”. This report focuses on the microfinance industry and its role in servicing the rural micro-enterprise sector, by Professor Hans Dieter Seibel of the University of Cologne, a specialist in rural microfinance.

 

 

 

 

 

 

 

References:

¹Finance for the Poor: Microfinance Development Strategy, 2000. Asian Development Bank.

²Rural Finance Innovations: Topics and Case Studies, 2005. The World Bank Agriculture and Rural Development Department, Report No. 32726-GLB.