Development banking provides agricultural and rural sectors with more than credit, as it allows for technology and technical assistance in the country; however, is it really generating the impact that it looks for? ALIDE Technical Committee on Agricultural and Rural Financing examined this subject at the ALIDE 40th assembly (ALIDE 40) and synthesized some proposals.
In Latin American and the Caribbean countries (LAC), there is a low financial penetration, which is even lower within the rural area. Development financial institutions reach the rural sector to a greater extent; however, its penetration is not sufficient in order to meet the needs and to support the small-scale producer
By having difficulties to access the financial system, these small-scale producers have no other option but to turn to loan sharks, who charge them extremely high interests. This will prevent them from producing a surplus in order to move out of poverty and to improve their economic and social situation.
This is the vicious circle that characterizes the segment of the population with lower resources and was one of the topics addressed in the ALIDE Technical Committee meeting on Agricultural and Rural Financing, within the framework of ALIDE 40, in Fortaleza (Brazil).
In this meeting it was discussed that, although development banks have enough resources to guide and finance agricultural producers, they do not always meet the demand, as it is not effective but potential, as a great portion of producers are not considered eligible for credit, do not generate the sufficient production surplus to be located in the market and gradually become poorer. Even though credit is a powerful mechanism for development, they need to have access to technology, to generate incomes, to go into partnerships and to organize.
The phrase “they are not considered eligible for credit, therefore, they do not have access to the financial system” is commonly heard, so the logic question is: who does not consider them eligible for credit? Because they notice that rural producers are not considered eligible for credit by private banks, but by development banks, and those that are not considered eligible for credit by development banks, are considered eligible for credit by cooperatives or non-banking financial intermediaries.
This can indicate three points:
(1) that producers can be considered eligible for credit or not depending on the segment to which they belong or in which the financial entity specializes, and this is reflected on the type of client and the loan average amount;
(2) that technology, be it financial or activity-support ,used by financial entities is not appropriate to attend segments that are out of their scope of attention; and
(3) that there may be a lack of products adjusted to the demand or the need of those that are not considered eligible for credit yet. This may be due to the banking trend to focus, rather than on the design of the product, on interest rate, which although relevant, the important point is the opportunity offered by financing.
Attending the rural sector is very expensive, as they are very dispersed. Therefore, in some countries, transaction costs are subsidized, that is, a percentage of the costs is paid to the financial intermediaries (FI) if a credit granted to the rural sector is evaluated or an amount is paid for each new credit granted to this sector. The questions in this case are: Who pays the subsidy? and Where do the resources come from? Resources generally come from the budgets; Brazil, Chile, Colombia and Mexico are an example.
LACK OF GUARANTEES
Another obstacle in the agricultural and rural financing is the lack of guarantees and title documents. However, there are some leading countries in these processes, such as the case of Mexico, where Fideicomisos Instituidos en Relación con la Agricultura (Agricultural Trust Funds) (FIRA) and the Mexican government have different types and modes of guarantee funds for small-scale producers. However, when the small agricultural property can be used as a guarantee, financial entities do not accept it as such, as executing them is complicated and it is unlikely that justice shall favor them.
On the other hand, the law in Brazil does not allow small agricultural property to be used as a guarantee; and when financing is carried out through cooperatives, which receive resources from development banks; guarantees are not required since they use the joint and several guarantee system in the lending process. However, this model is not widespread in Brazil; it has not been developed in some states.
One of the most criticized problems around agricultural financing has been the generalization of subsidies to interest rates in development financial institutions (DFI).Both the large-scale and small-scale producer received subsidized credit. This policy has really changed, there are a large number of countries that use subsidies to induce financing to the agricultural and rural sector, but do not direct it to interest rates, but to technical assistance, agricultural insurance, etc.
So as not to jeopardize the sustainability of DFIs, it is recommended to eliminate the practice of debt relief or remission. If there were cases that justify it, this must be done with special or public budget resources that do not affect DFI balance. For example, in Brazil, the law does not contemplate remission of debt; instead, the debt term is extended.
In order to have a greater social impact and to bypass all these obstacles, a financial institution must diversify its risks, provide integral support to both agricultural and non-agricultural activities in the rural sector, and insist before the regulatory entities to reduce the excessively strict treatment of the sector, as there is still an excess of rules and regulations in the rural sector financing.
In the product and client portfolio of financial intermediaries (FI), rural credit competes with consumer, mortgage, corporative credit, and they lend the rural sector only if the business is as profitable as those in other sectors. FI prefers the most profitable business and not the rural sector, due to the market risk and price volatility.
Another great challenge is to have an agricultural risk management system, which includes, for example, agricultural insurance, catastrophic insurance, price coverage, although all the products do not have futures markets, and contract farming, in which large-scale companies contract producers and promise to buy the production at the end of the harvest at a specific and previously fixed price.
What should development banking do? Do more than just grant credit, but up to what extent? Even though the field of action is different in each country, it was pointed out that development banking could provide, besides credit, insurance, financial and environmental literacy, mechanisms for coverage, information, government supporting programs management and incentives management for the promotion of financial penetration in the agricultural and rural sector.
For this reason, it is advisable to design products that have demand, meet the needs and, at the same time, incorporate those that are not eligible for credit. In short, financial institutions with technology and ad-hoc products are required for the segment of those without access to credit.
To the extent that the DFIs achieve adequate administration and risk management, a revolution in the agricultural and rural financing will have taken place; furthermore, when the climate change is tangible and is affecting the activity of financial institutions. In addition, funding providers may soon start to request climate and environmental risks coverage. Therefore, climate change-derived risks must be added to the present risk management.