shocks that could severely depress earnings performance and the more cross-subsidization can occur. High-margin financial products— such as consumer finance and urban microfinance—can compensate for lower profit margin products, such as agricultural loans. Excessive provisioning: The last line of defense is called


“loan loss provisioning,” meaning an internal absorption of credit risk. Adequate provisioning according to a risk-classification scheme helps to protect the intermediary from liquidity and capital adequacy crises. Some leading agricultural lenders in Latin America, for example, provision from 121 to 260 percent of doubtful loans. Heavy provisioning, however, clearly constrains the volume of lending, ability to make a profit, and client outreach potential.


Implications for managers of financial institutions and public policymakers


There are numerous implications of these credit risk-management techniques. First, the credit risk evaluation systems are labor intensive with high costs, which, in turn, contribute to high lending interest rates. Public-sector policymakers need to understand this, so they avoid imposing interest rate ceilings or forcing publicly owned banks to charge interest rates that are lower than their true operating costs because results would then be counterproductive. Additionally, fewer intermediaries would be willing or able to serve the sector. Therefore, both policymakers and managers should focus on developing and implementing institutional innovations—such as credit bureaus, applications of information and communication technology, and delegated agent models of service delivery—that will reduce overall operating costs. Second, agricultural lending cannot be the primary type


of lending unless robust risk-transfer techniques (for example, insurance, futures, and securitization) become more commonplace. In place of land, alternative forms of collateral—including warehouse receipts, accounts receivable, equipment, and standing crops or livestock—should be more widely accepted. Improved contract enforcement should be aggressively promoted as well. These developments would all serve to lower lender risk. Many of these innovations and institutional developments require legal and regulatory reforms, modernization of property registries, investments in information infrastructure, and massive education efforts. Third, the majority of institutions involved in agricultural


lending are small and unregulated. They are using adapted microcredit-lending technologies that do not fully meet the needs of farmers, especially those needs regarding loan term and repayment frequencies. These shortcomings pose default risks in and of themselves. The larger institutions that have the scale and scope tend not to enter into agricultural lending because they do not have the strategic commitment, proper staff, or branch networks. Donors and governments can play a vital role in assisting these smaller institutions to grow, consolidate, and eventually merge. They can also help rural financial intermediaries with liability


diversification through mobilization of savings, access to capital markets, and the provision of long-term lines of credit that could facilitate more term lending. Nevertheless, donors and governments must price the discount line of credits in a manner that will not undermine savings mobilization.


Conclusion


In short, risk management needs to improve dramatically so that agricultural finance can flourish. Strides have been made in recent years in reducing information problems and transaction costs through, respectively, peer-group lending and a greater reliance on information and communication technology. Uncontrollable risk, however, continues to be a major impediment to the development of more efficient rural financial markets. Renewed private–public sector efforts and higher amounts of investments will be required at various levels to address these issues. At the farmer level, governments need to spur the rebuilding of farm extension services, while farmers need to become more financially literate and save more so they can retain some of the risks. Governments, donors, and insurance companies need to collaborate in the development of yield-insurance products that are inexpensive, sustainable, and appropriately designed. Governments, commodity exchanges, and financial institutions likewise need to collaborate in developing futures, structured finance products, and other hedging instruments to reduce price risk. At present, the lack of high-quality weather data, inadequate distribution of weather stations, limited supply of people with risk- modeling capabilities and expertise in agricultural risk management, small capital markets, and weaknesses in regulatory and legal infrastructure hamper the pace of progress. Since the depth and efficiency of financial markets are highly correlated with the speed of overall economic development, innovative methods of improving rural financial services will be critical in facilitating and sustaining any marked improvement in rural welfare. n


For further reading: H. Bhattacharya, Banking Strategy, Credit Appraisal and Lending Decisions: A Risk-Return Frame- work, (New Delhi, India: Oxford University Press, 1996); J. B. Caoutte, E. I. Altman, and P. Narayanan. Managing Credit Risk: The Next Great Financial Challenge, (New York: John Wiley and Sons, Inc., 1998); C. Trivelli, and A. Tarazona, Riesgo y Portafolios Agropecuarios: Lecciones desde la Expe- riencia de Instituciones Financieras de América Latina, Docu- mento de Trabajo 151 (Lima, Perú: Instituto de Estudios Peruanos, 2007), www.iep.org.pe/textos/DDT/DDT151.pdf; M. Wenner, S. Navajas, C. Trivelli, and A. Tarazona, Manag- ing Credit Risk in Rural Financial Institutions in Latin America, Sustainable Development Department Best Practices Series MSM 139 (Washington, D.C.: Inter-American Development Bank, 2007); World Bank, Doing Business database, www. doingbusiness.org/economyrankings.


Mark D. Wenner (markw@iadb.org) is a lead financial specialist in the Capital Markets and Financial Institutions Division of the Inter-American Development Bank.


INTERNATIONAL FOOD POLICY


RESEARCH INSTITUTE Supported by the CGIAR


www.ifpri.org


sustainable solutions for ending hunger and poverty Supported by the CGIAR


www.worldbank.org Copyright © 2010 International Food Policy Research Institute and the World Bank. All rights reserved. Contact ifpri-copyright@cgiar.org or pubrights@worldbank.org for permission to republish.


Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15  |  Page 16  |  Page 17  |  Page 18  |  Page 19  |  Page 20  |  Page 21  |  Page 22  |  Page 23  |  Page 24  |  Page 25  |  Page 26  |  Page 27  |  Page 28  |  Page 29  |  Page 30  |  Page 31  |  Page 32  |  Page 33  |  Page 34