What’s Keeping Us From Innovating in Rural Finance?

Formal financial services in rural areas have long been underdeveloped.  This is due to a combination of factors – dispersed clients, low levels of financial literacy among rural households, the high cost of delivering services (especially low-value transactions), and the perceived high repayment risk associated with lending to agri-dependent households, which make up the majority of households in rural areas. 

Besides a few cases in South and Southeast Asia, where in some places, rural population densities are high and supportive government policies and investments helped improve prospects for rural financial intermediation, most rural financial institutions in other developing regions over the last thirty to forty years have struggled to achieve scale and strong profitability, and to deliver a complete suite of financial services. 

Two women husking paddy harvested from the fields. Two women husking paddy harvested from the fields.
 Photo Credit: Mohammad Moniruzzaman

A recent exception has been the success of M-Pesa in Kenya, where the application of mobile communication technology has dramatically reduced costs and broadened access to payment services for rural as well as urban customers.

Even though 55% of the world’s population is rural, 70% of the world’s poor are concentrated in rural areas, and agriculture is the main livelihood activity of the majority of rural households, investments in agricultural and rural development have generally lagged. Public expenditures on agriculture as a share of GDP tend to be far less than proportionate given the real economic importance of agriculture in the economy. Meantime, empirical evidence indicates that agricultural growth is 3.2 times more effective in reducing poverty than growth in non-agricultural sectors. 

More evidence exists that clearly links greater financial depth and greater financial market efficiency to higher levels of economic growth and income equality. 

Today national policymakers and development agencies have shown renewed interest in agricultural and rural development.  They are responding to a confluence of interrelated opportunities and challenges.  On the positive side, incomes are rising in most regions and with it the demand for more food.  The global sourcing of horticultural produce and the growing popularity of high value organic food along with the improvement in logistical management and the application on new technology are creating attractive business opportunities. 

On the negative side, agricultural commodity price volatility, poor infrastructure in many regions, the lack of adequate policies and robust institutions, and the growing negative effects of climate change on agricultural productivity, among others, present challenges.

The question is how can formal financial services in general and agricultural credit in particular be successfully extended in a sustainable manner to rural areas? Clearly, agriculture is heterogeneous and complex.  The errors of directed, subsidized credit experiences of the 1960s and 1970s loom large and should be avoided. A new consensus is emerging on how to proceed.

Know your client

First, rural households have to be segmented and their desires, resources, constraints, and capacities well understood.  The financial services on offer have to provide a value to clients equal to or superior to informal mechanisms currently used, and they should be sustainable over time to permit continued benefits.   Rural households demand a range of products—payments, transfers, savings, credit, and insurance. To achieve strong uptake and scale economies, the products have to match household capabilities and needs, including variability of cash flows. During “lean times,” for example, households can seek loans, withdraw savings, liquidate assets, or reduce consumption.

For example, commercially oriented smallholders that have been integrated into higher-value agricultural markets and have a certain profile -- for example, those with proximity to a growing market, minimum farm size, use of irrigation or greenhouse technologies, improved input packages, forward contracts, or participation in tightly organized value chains including those with organic certification may represent  “low hanging fruit” for financial intermediaries interested in extending production credit. They will be much more attractive than subsistence oriented farmers who produce little or no marketable surplus.  On the other hand, households that are subsistence oriented but produce a surplus of staple food items that are sold on “open spot markets” may be attractive as clients of commitment savings and payment products but may be very risky as loan clients. 

Lower costs

Serving a large number of clients demanding small valued transactions due to limited income and scale of business operations implies high operational costs for financial intermediaries.  Therefore, innovations in both institutional arrangements (correspondent banking, value chain approaches, and other partner agent models) and the use of computer and informational technology (including fully digitalized management information systems, mobile telephony, tablets, geographical information systems, GPS mapping and tracking) are critical for making a difference in outreach and scale.  The high cost of delivering services, the riskiness of the environment, and the lack of competition tend to contribute to high loan interest rates, especially in Latin America and Sub-Saharan Africa.  Successful approaches to cost minimization and greater efficiencies should contribute to lower financial charges.

Manage risk aggressively 

Risk management is of preeminent importance in agriculturally dependent households. It can take many forms.   An integrated and layered approach that depends on good agricultural practices (GAP) as well as risk transfer mechanisms should be pursued to achieve sustainability. To date a host of pilots on weather based index insurance are underway, and a critical task is how to lower basis risk and overcome high startup costs.   Moreover, value chain development approaches that reduce marketing risk and product quality assurance through the provision of technical assistance services and intensive monitoring are proliferating.

In short, the view of rural finance as an extremely inhospitable and unprofitable area of development finance is melting as the willingness to understand the inner dynamics of rural households and rural economies increase.  Nonetheless, many challenges and information gaps remain and much work still has to be done to apply these insights and improve outreach and the depth of rural financial markets.


------ Mark Wenner works with the Capital Markets and Financial Institutions Division of the Inter-American Development Bank and has published numerous articles on rural finance topics and participated in a number of financing operations involving rural and microfinance organizations.


15 October 2012 Submitted by Peter van Dijk (not verified)

The main issues that are holding back the integration of the poor rural masses into sustained growth in agriculture and economy have no direct link with Finance; it is about land ownership, limiting the power and scale of huge land owners, water management, physical infrastructure (roads, transport, schools, hospitals). Obviously changing these issues demand important changes in culture and in politics. The world's development finance institutions could have a role in change in the above areas. But until now they support the continued focus and dependence on socio-political Microcredit for the poor and display banking intellect by explaining issues on client, cost and risk management.

15 October 2012 Submitted by Milford Bateman (not verified)

You talk about 'sustainable' rural finance and also note 'The errors of directed, subsidized credit experiences of the 1960s and 1970s loom large and should be avoided'. This sounds like reflexive support for IDB's tired mandate to promote neoliberalism in all its work, because it is a statement that is simply not based on any real independent evidence. Check out Ha-Joon Chang's work for FAO on, among other things, the crucial role of subsidies in agriculture at
I also discuss the issue, in the latest issue of Journal of Agrarian Change, which has a special feature on rural finance, of how it was that the international development community's hatred of subsidies came about, and I pointed out that it was largely because of (neoliberal) ideology that subsidies were criticised rather than because subsidies (a.k.a. 'investment') don't work to create a successful agricultural sector. The western economies all used subsidies to create successful agricultural sectors and the mere fact that SOME subsidy schemes did not work, as many insist on pointing out, does not invalidate the model of subsidised rural finance - see ...…

18 October 2012 Submitted by Imaduddin (not verified)

A have been keen observer of rural dynamics since last few decades and over one decade is directly involved & responsible in development of access to finance to rural / deprived strata of Pakistani population. Intervention started from introduction of Microfinance in formal sector by developing enabling legal, regulatory environment and from last almost 5 years designing and implementation of agri. finance products, enabling policy interventions.

In my humble view i agree that subsidized credit has not given the desired results as usually in 3rd world countries, developing countries we cannot simply regulate flow of funds its proper / appropriated utilization and channelization of cheap money into targeted population has also not worked due reasons known to us but practically most of checks & balance put in place were counter productive. So putting in public money without desired economic returns is not desirable, however, in my view we can do a lot with lot lesser money if investing on designing smart interventions eg sustainable & cost effective farmer financial literacy programs, product development, Crop insurance ( Loan insurance to encourage health financial habits), designing innovative products and its introduction through pilots, awareness and capacity building programs etc.

In my view financial institutions are no more comfortable in lending in rural/agri customers due to ill perceived risks to change that we need to:
1) Sensitize & orientation of banks, financial institutions management that lending to rural/ agriculture sector is not riskier that any other business segment provided that we do it right .
2) Create clear understanding that this is not charity but core business activity where you need to see business relationship rather than the loan part i.e. deposit, financing, remittance, insurance etc.
3) Designing of comprehensive & structured training programs for officers, management and staff of financial institutions. Refreshers to reinforce.

The very approach needs to be changed we need to give due respect to farmers by referring to them as ENTERPRENEUR this will be step towards integration of rural population into mainstream.

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