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Opinion - Farm credit
Agri-Biz & Commodities - Insight
Directed lending — a new approach

A. R. Patel

Rather than mandating farm credit targets, an enabling environment must be created so as to motivate Rural Financial Institutions to widen credit outreach.

Time was when the Agricultural Credit Policy would stipulate that not less than 18 per cent of commercial bank net credit should go to accelerate the process of Green Revolution.

Now, with financial sector reforms robbing the significance of such directions, the Reserve Bank of India must create an enabling environment (rather than setting mandatory farm credit targets and sub-targets) for Rural Financial Institutions to deepen and widen credit outreach covering small/marginal/tenant farmers, share croppers and landless labourers.

Since the early 1950s, governments and donors have spent large amounts on agricultural credit programmes in developing countries. The World Bank alone committed over $16 billion to these efforts from the mid-1950s to the late 1980s; other donors also have spent substantial amounts.

In several countries, such as Brazil, India, Indonesia, Mexico and Sri Lanka, supply-led and directed credit programmes were used extensively to spur agricultural development till the 1990s.

Liquidity constraints

The assumption of these efforts was that farmers faced liquidity constraints that limited their ability to make investments and bring to use modern inputs. Providing them with loans was thought to be an easy way of stimulating agriculture investments, boosting the use of modern inputs and augmenting farm production.

The proponents of the directed credit approach assign many tasks to financial markets, but pay little attention to creating an enabling environment to boosting the sustainability of the rural financial intermediaries or creating and maintaining rural infrastructure.

In contrast, the new market approach assigns a more modest role to financial markets, and stresses the importance of the processes of financial intermediation.

Resource allocation

The main goal of improving this process is to enhance the efficiency of resource allocation in the economy.

This is done by efficiently mobilising deposits from savers who, otherwise, have only low-return options, and then efficiently allocating funds to creditworthy borrowers who have too few funds to capitalise on viable investment opportunities.

The users of financial services in a system strongly influenced by directed credit tend to be borrowers rather than depositors; the system is borrower dominated. By contrast, the new approach is to mobilise local deposits and efficiently intermediate between savers and borrowers.

While commercial and regional rural banks can mobilise savings, Primary Agricultural Credit Societies cannot, not even from their borrowers. Yet, neither the commercial nor the regional rural banks have developed savings instruments/products for the rural areas, as, for instance, Bank Rakhyat Indonesia has done.

Typically, the volume of information associated with directed credit programmes is substantial. Managers of directed credit programmes are able to provide detailed information or data required by funds providers but are unable to generate critical up-to-date management information, such as the status of loan recovery. While banks in India have to collate, compile and furnish data under agricultural credit programmes in the form of several returns periodically (leaving practically very little time for business development) the return on recovery of loans is an annual exercise that does not provide the status of recovery/overdue at any point of time.

Credit impact studies

To justify the subsidies associated with directed lending programmes, it is common to do credit impact studies. These studies usually require collection and analysis of primary data not ordinarily assembled by lenders. The cost of managing the volume of information generated raise the loan transaction cost, for both the lender and the borrower.

In contrast, the new approach is to generate limited but more useful data. The absence of numerous directed credit lines eliminates the need to process data for each sub-programme and makes available staff for development of business including recovery, mobilisation and impact assessment.

Managing financial intermediaries

The essence of data collection and processing under the new approach is to manage financial intermediaries efficiently and prudently. The performance of the financial institution is measured by such indicators as deposit mobilisation, transaction cost, loan recovery, number of clients, and financial and operational sustainability.

The support for these traditional directed agricultural credit efforts began to wane in the 1980s and by the end of the decade most donors and some governments sharply reduced their support to agricultural credit. In part, the waning decline in support was due to the unsatisfactory performance of these efforts. Critics increasingly argue that while relatively very few poor rural households secure credit, resourceful clients got a lion's share of the directed agricultural credit.

Subsidised credit

Besides, subsidised and directed credit had limited impact on farm production and investment. Serious and chronic loan recovery problems, dependence on outside funding and overall costs eroded these efforts.

Poor performance and falling donor and government support led to the collapse of many public sector agricultural development banks and government-supported rural cooperatives in the 1980s.

In some countries such as Peru and Bolivia traditional agricultural banks were closed. In other countries such as Gambia and of the former USSR where all or part of the development banks were sold or privatised.

In some other countries these development banks and rural credit cooperatives persist but their financing activities have been sharply reduced, as in Guatemala, Nicaragua and Uganda.

In India, where directed credit and government sponsored programmes still persist, commercial/cooperative and regional rural banks faced serious problems of recoveries and had to be re-capitalised whereas co-operative banks are now being considered for re-capitalisation.

What is most important is to cover progressively all poor rural households in each and every village that have so far not been able to access the credit rather than targets of direct and indirect agricultural credit.

(The author, based in the US, has extensive experience in rural development and banking in India.)

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