Practicum

Issues and Challenges in Providing Rural Finance
Services in Harmenistan

Learning Objective:

• To increase the awareness of risks and challenges associated with agricultural lending and the issues you will have to take into consideration when starting an agricultural lending program.

You are a newly assigned manager of Microfinace Association of Harmenistan (MAH), Harmenistan that has distinguished itself as a profitable, diversified provider of individual loans in the highly competitive Harmenistanian microfinance market. After inheriting a three-year-old urban lending portfolio from the parent organization (Ilend) in 1995 the MFI wanted to expand its portfolio and target group.

In the beginning you were not sure how to expand MAH's portfolio but after a few months of working in Harmenistanian environment you decided that you would like to expand the operations to rural areas as well as to add agricultural loans to MAH's portfolio. The Board has approved your idea; however your task showed not to be as easy as you thought and you faced a spectrum of challenges.

Harmenistan environment: In spite of regional financial instability starting in the mid-1990s and a recession that began in 1999, MAH and the regulated Harmenistanian microfinance industry as a whole continued to flourish through 2003, and those institutions with a substantial rural portfolio fared noticeably better than their exclusively urban counterparts. The period from 1998 to 2002 saw a significant decline in the country's formal banking sector, with a 33% decrease in lending, an arrears rate three times higher than that during the previous three years, and gross losses. Political uncertainty and borrower protests in urban areas accounted for much of this decline.

Rural environment: Harmenistan has a natural advantage in the diversification of agricultural risk: its array of altitudes and microclimates even within small areas help protect against widespread crop loss. Moreover, most rural families in Harmenistan engage in two to five different income-generating activities, as compared to urban citizens who typically have only one or two income sources

Key facts about MAH

• MAH opened in Marane the capital city of Harmenistan in 1995 and it has distinguished itself from its competitors with a different approach: individual lending (as opposed to solidarity group loans).


• Enormous swaths of the largely rural country were not being reached by banking services at all. Since the failure and departure of state-owned agricultural banks in the 1980s, only a few MFIs had ventured into this arena due to its real and perceived risk, leaving an enormous, untapped market.


• MAH is hoping that rural expansion would help diversify its portfolio while also deepening its mission of improving living standards by providing financial services to the poor.


• MAH established its first rural office in 1996 in Punana, a small town in the relatively well-populated agricultural department of Crechena. MAH's Punana office made loans to local farmers who possessed a diverse set of income sources Ð mdash;a potato farm, dairy cows and migrant wage labor, for example.

While introducing the agricultural lending you found out that:

• Reaching clients in less populated areas was considerably more expensive than it had been in urban areas. Not only were the dispersed clientele more difficult to reach, but the nature of their businesses also required more sophisticated and time-consuming appraisal processes.


• Your loan officers had to visit potential borrowers' fields to assess crop investments, and detailed information had to be gathered on numerous household income sources.


• Moreover, the seasonality of agricultural lending made for a higher cost of funds since the bulk of the rural loans were disbursed at the beginning of the planting season, and principal was not repaid until after harvesting.


• Even though you operate in an environment where agricultural activities dominated the local economy, you realized that agriculture was seen as a risky investment. Your loan portfolio was threatened by natural disasters (drought or unseasonable weather, pests, and other natural disasters) which posed grave threats to repayment capacity as well as the fluctuations in the prices for agricultural products


• Your urban lending methodology could only go so far in informing MAH's work in rural areas.


1. Collateral: Many of your potential rural clients did not possess sufficient assets or even registered land titles, and Harmenistanian law prevented many small farmers from using their land as collateral.


2. Appraisal, disbursement and repayment: Your loan applications did not suffice the needs of agro—businesses.


3. Quick turnaround times: Your loan process was not fast enough for agricultural lending.


4. Communication and accessibility: You found out that many of your rural clients not only had lower education levels than their urban counterparts, but also spoke only indigenous languages specific to a confined area.


• You are faced with new borrower-related risks as you entered rural areas.


• There is a rampant culture of non-repayment in rural Harmenistan (legacy of the socially driven state-owned development banks, which had previously provided subsidized credit to agricultural producers).


• Many farmers' only experience with credit involved unsustainable rates and terms, and ready loan forgiveness—neither of which you could afford to offer.