Rural Finance: Issues, Design, and Best Practices

This paper traces developments in rural credit systems, especially the intervention models used by governments in the last five decades. The paper argues that the outcomes from these interventions have largely been unsatisfactory because of the following reasons:

• Using concessional interest rates;
• Favoring agricultural rather than rural operations;
• Ignoring or oppressing the creation of savings deposits;
• Implementing costly and inefficient service delivery mechanisms.

The paper lists the challenges faced in rural financial intermediation:

• Macroeconomic policies, which include distorted financial policies and market rigidities alongwith legal and regulatory constraints;
• Urban-biased policies;
• The nature of rural markets, which are characterized by poverty, low population density, isolated markets, highly covariant risk, and seasonality.

Describing the traditional approach to rural finance, the paper details the new approach that is gaining ascendancy and focuses on:

• Income Expansion;
• Poverty Reduction.

The paper proposes the following interventions to strengthen rural financial markets:

• Creating a favorable policy environment;
• Improving the legal and regulatory framework;
• Deciding performance criteria for rural financial intermediation;
• Building institutional capacity.

Discussing three success stories, the paper concludes by identifying areas for future research.