Rural finance in developing countries

The establishment of formal agricultural credit systems in most developing countries in recent decades has been motivated by the belief that widespread shortages of short- and long-term finance have arrested agricultural growth and development. The lack of affordable formal credit has been blamed for delaying, if not preventing, the timely adoption of new production technology and intensive nonlabor inputs. Commercial lending institutions generally focus on large-scale farmers and ignore small-scale farmers because of the significant cost of processing and servicing unsecured small loans and the prevalent belief that small entrepreneurs represent a greater risk than large ones. The shortage of strong formal credit markets has caused informal credit institutions to flourish in many developing countries. These informal institutions disburse funds rapidly, and the transaction costs for borrowers are low. Many specialized agricultural credit institutions have suffered from design deficiencies. They often were not expected to function as true financial intermediaries that mobilize deposits to make loans. Arrangements such as lending groups and credit cooperatives could reduce both transaction costs and the risks involved in lending to small farmers. For a rural financial institution to become viable, state or donor support should focus on institution-building and development.