The Performance of Banks in Rural Financial Markets

Abstract

In the 1960s and 1970s national policymakers charged many rural banks with the provision of cheap credit to small farmers, small fishermen, or broadly speaking, rural households with small-scale enterprises. The performance of these institutions and the programs, projects and schemes they supported, however, remained below expectations. A new thinking about rural finance and its role in development, based on the concept of the Rural Financial Market (RFM), clearly demonstrated the shortcomings of the cheap credit policy. It enabled a more balanced understanding of the roles of rural banks, informal intermediaries and their (potential) clients in the supply of and demand for financial services (Adams 1983; Donald 1976; Von Pischke 1981). The new thinking also resulted in a growing recognition that governments should refrain from direct participation in banking and concentrate on policies that establish and maintain confidence in financial institutions. Such a new role of government in finance is a pre-condition for the provision of sustainable financial services by banks. Of course, this is not the only issue. Various studies have explored other factors that strongly affect the provision of rural banking services (Binswanger and Rozenzweig 1986; Schmidt and Kropp 1987; Von Pischke 1991). This paper focuses on the costs of financial intermediation and its relation to the scale of operation. The calculation and monitoring of costs is of central importance when rural banks2 pursue the socially desirable objective of providing financial services to new clients. Emphasis on reaching new clients without due attention to costs, and the control of costs in particular, leads invariably to operating losses which sooner or later result in a reduction or termination of services provided. From a long-term perspective, the objective to reach new clients should thus necessarily be linked with attention to costs, or in broader terms: with the objective to operate on a financially viable basis. Rural banks trying to achieve these two objectives simultaneously are faced with a host of questions regarding the demand for various types of financial services by their new clients, and their own organizational, operational and financial capabilities to meet this demand. Answering these questions requires analysis, followed by experiments to explore the feasibility of new organizational approaches and new methods of operation. The discussion of lending costs should therefore be part of evaluation of existing banking services and of planned experiments to widen to scope of services.