Part 1|DF201|Question 5

A Clear understanding of the rural interest rate formation is at the heart of a successful rural credit and finance policy. Discuss.

Factors and Aspects of Rural Credit
1. Many peasant households live an insecure and precarious economic life. Thus it creates emergency aspects of borrowing that thus making interest rates inelastic on the demand side.

2. Thus a large percentage of loans are of present consumption and may be even due to the lack of investment opportunities. Lack of information may also lead to this market failure. Outreach programs may increase the knowledge base to create an enterprise mentality.

3. Cyclical nature of the farming. As crop harvest tends to be seasonal then liquid savings will also rise and fall as the harvest season is occurring. And this can be even compounded by community having this same cyclical manner-especially in regions of distinct seasons.

4. Lending tends to be short-term and less than a year. This tends to create higher interest rates since what are the holders of the capital to do with the assets during the other parts of the year?

5. And since the whole community will be facing the same general production and consumption factors then all in the community may have booms or busts that can stretch the savings pretty tight.

6. Informal Sector is composed of two sub-sectors: Commercial (people with excess liquidity-local merchants, landlords, input traders, crop buyers, wealthy individuals and professional money lenders) and Non-Commercial (Friends and Family-no interest on reciprocal basis).

7. Much criticism of professional money lenders for their exorbitant interest rates. But the fact that they remain around must signify some benefit of such arrangements. Some positive factors of non-institutional sources of rural credit are: proximity to and more intimate knowledge of borrowers (lower default risks); minimal protocol; easy access to and speed of operations; repayment flexibility; lower transaction costs and better rates of loan recovery, etc.

3.2 The Formal Sector
Commercial Banks even if mandated to build offices in rural areas have lack of penetration to the landless families and small peasant households. And the effectiveness in extending rural credit is widely disputed.

State Agriculture Banks have come under severe criticism and scrutiny as in:
1. Their large commercial farmer bias-less costly to administer and manage.
2. Their over-dependence on state resources.
3. The one way nature of their operations from the state to the rural sector-as opposed to intermediaries between rural savers and borrowers. But considering the cyclical nature of savings it may not even possible to do this.
4. Their susceptibility to political manipulation and personal favoritism.
5. Their high transaction costs and low recovery rates.

Cooperatives have many advantages over s-such as group lending resulting in lower transaction costs and better access to small farmers, for example. Despite this, however, the building up of effective cooperative movements has been fraught with difficulties.

1. lack of management expertise
2. political manipulation
3. insufficient supervision and auditing
4. top-down structures of credit delivery
5. low membership involvement and participation
6. poor loan recovery rates
Types: users' associations, credit unions, informal savings clubs, and Rotating Savings and Credit Associations (ROSCAs)!