Challenges in Rural Finance

Vulnerability constraints include systematic risk, market risk and credit/financial risk. Let us examine these risks closer.

Severe weather conditions significantly impact rural areas. This makes the provision of financial services is risky. Weather is the most uncontrollable risk and often devastating on rural households, farmers etc. Plague, fungus, insects are similarly important and can have the same devastating effects as the bad weather conditions have. This is especially true for very poor farmers who can not afford crop protection against pests. Failures in agriculture affect farmer households as well as rural non - farm economies that are involved in the production chain and dependent on those income flows. Failures related to weather conditions affect market linkages established within households and communities minimizing available income. Due to the above discussed risks, farm credit is difficult to provide.

Examples of Systematic risks are: Weather floods, draught, hail, frost, plagues, diseases, fungus, and insects.

In developing countries, markets are especially risky because there are both cyclical and seasonal price fluctuations of agricultural commodities. These fluctuations are not only due to local production variation but also affected by "outside forces" such as political price and exchange controls, subsidies and globalization. Some examples of market risks are prices, level of production and access to markets.

One of the greatest challenges in rural finance is minimizing Credit/Financial risk. These risks are related to useable collateral, family needs such as payment of school fees, HIV/AIDS, health etc. The creditor is challenged with minimizing all those risks. Collateral, especially mortgage, is a missing element in many rural finance interventions hence increasing the risk of the lender. Similarly collateral substitutes may be costly in both financial terms as well as in social terms as with. Other support services and information networks such as credit bureaus are often not available to help lower the risk.

A financial gap risk between sources and uses of funds poses another risk constraint.

The list below includes elements that can reduce the risk for lenders:

• Credit guarantees
• Currency stabilization or guarantees
• Staff and management training
• Inventory credit development
• Credit bureau development

What are the Elements for Successful Credit Delivery?

• Loan products should be demand driven
• Innovative guarantees
• Lower transaction costs to the client
• Risk management is critical - portfolio, financial and systemic
• Good governance is a key to sustainability
• Financial systems and good MIS are critical
• Prompt and strict delinquency management is required

Operational constraints include investment returns, low investment and assets and geographical dispersion.

Providers of rural finance are challenged by areas that are characterized by a low density of population and high dispersion, which is coupled with a relatively low market potential. The low market potential is usually accompanied by poor services that make access and communication difficult and hence cause high costs of operation for both production and marketing and for access and delivery of services. Many rural areas have no existing road network hence reaching markets is very difficult.

Geographical dispersion contributes to relative poverty in rural areas. Due to no or lack of access to markets rural poor are unable to generate significant income and accumulate assets. Therefore small household crises become major crises due to the lack of asset "cushion." Any loss of expected income through sickness or production losses cause significant impact. In compensation, traditional networks and production risk minimization become more important than profit maximization. The small asset base also reduces savings and borrowing capacity, thus constraining economies of scale in the use or provision of services.

Some exampled of Low Assets and Investment are lack of business investment, low use of capital. Rural capital revolves slowly, with often one or less frequently two crops per year. For investment capital the returns are even slower and in spite of that are often faced with very low profit margins. Hence the margins for error are much less than for example in commerce or most microfinance which tend to have high returns per unit of funds invested and higher profit levels.

Many rural areas have low growth potential; low velocity of capital; non-competitive technologies or no technology at all; lack of market integration; low efficiencies of business operations and high production costs.

Capacity constraints include Infrastructural capacity, technical capacity and training, social exclusion, institutional capacity

Poor communication, pitiful roads, unequipped schools and missing social and health services decrease efficiency of operations, discourage new services and increase the outflow of the most talented and resourceful persons and a reluctance of educated families to live in rural communities.

Relatively unskilled rural population reduces opportunity for ready access and adaptation to new technologies and employment. The lack of capacity affects not only the productivity and competitiveness in the changing marketplace but also the ability to find trained staff for service provision.

Cultural, linguistic, gender, racial, religious and educational constraints affect market and financial integration. Such barriers reduce production and marketing efficiencies. These are required in order to compete effectively in the marketplace and thereby generate income and levels of assets needed to reduce poverty and vulnerability. HIV/AIDS makes this even worse in many countries.

While there is an abundance of organizations in rural areas, the capacity is often lacking. This includes management and technical capacity, economies of scale competitive viability and often risk-bearing capacity. Even when urban based institutions have the capacity to reach into rural areas, there is little incentive to do so. At the micro level, the the social fabric is often strong and can be sufficient for small, simple levels of operations typically undertaken. With sufficient organization and experience these groups may also form linkages with intermediaries of higher institutional capacity.

The last major constrains are political and regulatory constraints, these include political interference; NGO "donation" competition; cultural and gender constraints, land tenure laws, financial regulations, Inept justice system and tax policies.

Loans can be forgiven, savings can be withheld, interest rates can be capped, mortgages can be rendered useless and payments can be suspended due to decree. Even danger is not uncommon; hence uncertainty can become an insurmountable hurdle.

Regulations and/or a lack of enforcement of them hinder rural as well as urban environments. Land tenure regulations, banking laws, exchange rate manipulation and tax considerations are examples of such constraints that destabilize and/or hinder viability of business and financial operations in rural areas.