Expanding the Frontier in Rural Finance: Financial Linkages and Strategic Alliances - Softcover

Pagura, Maria

Softcover

ISBN 10: 1853396664 ISBN 13: 9781853396663

Publisher: Practical Action Publishing, 2008

Synopsis

This book shows how formal financial institutions and companies use a variety of less formal, often rural, organizations to overcome the information and enforcement problems of serving rural clients and is of interest to al involved in rural development, financing economic development, and innovation.

About this title

About the Author

MARIA PAGURA is a Rural Finance Offi cer at FAO, Rome; she has 16 years’ experience in rural and microfi nance and small enterprise development in Africa and Asia.

Excerpt. © Reprinted by permission. All rights reserved.

Expanding the Frontier in Rural Finance

Financial Linkages and Strategic Alliances

By Maria E. Pagura

Practical Action Publishing Ltd

Copyright © 2008 FAO
All rights reserved.

ISBN: 978-1-85339-666-3

Contents

Preface, vii, 
Acknowledgements, ix, 
Tables, x, 
Figures, xiii, 
Boxes, xiv, 
Acronyms and abbreviations, xv, 
Contributors, xxi, 
1 Introduction: Linkages between formal and informal financial institutions, 1, 
2 Strategic alliances for scale and scope economies: lessons from FADES in Bolivia Claudio Gonzalez-Vega and Rodolfo Quirós, 11, 
3 Institutional transformation to create linkages that enhance rural access to financial services: the case of the Fundación Integral Campesina in Costa Rica Rodolfo Quirós and Claudio Gonzalez-Vega, 27, 
4 Opportunities for the creation of linkages and alliances to expand the supply of rural financial services: the José María Covelo Foundation and its partners in Honduras Mayra Falck, Rodolfo Quirós and Claudio Gonzalez-Vega, 55, 
5 ICICI Bank partnership linkages in India Malcolm Harper and Marié Kirsten, 85, 
6 A case study of AVIVA Life Insurance and its linkage with microfinance institutions Nilotpal Pathak, 97, 
7 Indonesia: A Regional Development Bank linked with village-based non-bank financial institutions Iketut Budastra, 113, 
8 The rich variety of microfinance linkages in Indonesia John D. Conroy and Iketut Budastra, 133, 
9 Self-reliance vs. donor dependence: linkages between banks and microfinance institutions in Mali Hans Dieter Seibel, 147, 
10 Partnership to expand sources of funds for rural microfinance in Peru: the case of Confianza Janina León, 169, 
11 Financial linkages in the Philippines: constraints and success factors Benjamin R. Quiñones, Jr, 187, 
12 Extending the outreach of Rwandan People's Banks to the rural poor through village savings and credit associations Chet Aeschliman, Fiacre Murekezi and Jean-Paul Ndoshoboye, 201, 
13 Linking with savings and credit cooperatives (SACCOs) to expand financial access in rural areas: a case study of CRDB Bank in Tanzania Gerda Piprek, 217, 
14 Conclusions, 247, 
Index, 275, 

CHAPTER 1

Introduction: Linkages between formal and informal financial institutions

Access to a broad range of rural financial services can have a significant impact on people's ability to weather economic shocks, make investments and build up financial and physical assets. But, supplying financial services in rural areas continues to be a formidable endeavour. Faced with high costs and risks of doing business in harsh economic and physical environments, most financial institutions are reluctant to enter rural markets. In their absence informal financial institutions emerge, but typically they are only able to offer a narrow range of financial services in a small geographic area. Through strategic partnering formal and informal financial institutions are finding new ways of establishing a presence in rural markets. As the cases presented in this book reveal, strategic partnerships and alliances allow them to surmount many of the cost and risk obstacles that preclude them from expanding financial services at and beyond the rural market frontier. However, although conceptually valid, establishing and maintaining such linkages in practice may be harder than it looks.

In this book we examine eleven financial linkage cases from Africa, Asia and Latin America. The cases were funded by the Ford Foundation with additional contributions from the Food and Agriculture Organization (FAO) of the United Nations. Over a period of 18 months one country overview and 11 case studies were conducted from late 2004 to early 2006. The aim of the study was to evaluate the degree to which financial linkages increase the supply of a broad range of financial services, not just credit, in rural areas. We defined a 'financial linkage' as a mutually beneficial arrangement between formal (commercial, state, apex banks, etc) and semi and informal financial institutions (microfinance institutions, NGOs, credit cooperatives, village banks, self-help groups, etc.). The linkages were considered successful when based on market principles and resulting in sustainable expanded access to financial services for new segments of the rural population not traditionally served, broadening the variety of products and services already offered and/or creating quality improvements of current products through better terms and conditions.

The rationale for linking is based on the premise that natural complementarities exist between the formal and informal financial sectors that, when joined, reduce the costs and risks in supplying services in rural areas. The complementarities principle is derived from modern economic theory that attempts to explain information, incentive and contract enforcement problems of credit markets and how they result in a mismatch of resources and abilities between formal and informal lenders (Armendáriz de Aghion and Morduch, 2005; Bell, 1990; Fuentes, 1996; and Varghese, 2005). On the one hand, formal financial institutions have extensive infrastructures and systems, access to funds and opportunities for portfolio diversification, permitting them to offer a wide range of services. However they are usually at a distance from rural clients, making obtaining adequate information and enforcing contracts difficult. In contrast, informal financial institutions operate close to rural clients, possess good information and enforcement mechanisms and are typically more flexible and innovative. However, constrained by regulation (e.g. not authorized to take deposits) and a lack of resources and infrastructure, informal financial institutions are only able to offer a narrow range of services in a small geographic area (Figure 1.1). In theory linkages between formal and informal financial institutions appear to have much potential in overcoming the persistent difficulties in supplying rural financial services.

A variety of institutions exists to enable the transmission of financial information and transactions (Johnson, 2005). According to Johnson all the institutions along this continuum represent 'solutions' to the problem of financial intermediation – how to match the supply and demand of funds. Not only the institutions, but the relationships between them as well are designed to address information asymmetries, resolve enforcement problems and reduce the cost associated with the transaction. In essence, linkages afford the players, both formal and informal, the opportunity to overcome a weakness in what they can achieve on their own.

Since a wide variety of formal, semi-formal, and informal financial institutions exists, the possible financial linkages between actors along the chain are numerous. In Figure 1.2 we have illustrated this concept as a continuum of formality, with more formal institutions on the left side of the diagram on down to those institutions that are less formal on the right side. It is helpful to conceptualize linkages using a continuum of formality principle, especially since the meaning of 'formal', 'semiformal' and 'informal' varies widely across countries. In this way, it is helpful to think of linkages as mutually beneficial partnerships between upstream (more formal) and downstream (less formal) institutions. This includes linkages between institutions that are more towards the centre of the continuum, as well as those at the extreme ends.

Using case studies we employed a common research framework to answer the following questions below.

• What was the main motivation behind the development of the financial linkage?

• What were the main preconditions for the linkage to emerge, such as a senior management buy-in, shared vision on financial service provision, minimum levels of institutional capacity, etc?

• What were the key design factors and processes that led to the success of the linkage?

• How did linkages impact the financial organizations that were linked together?

• In what way did linkages improve access to rural financial services for rural small-holders and micro-entrepreneurs?

• In what ways did the legal and/or regulatory framework help or hinder the establishment of the financial linkage?

The case studies

In the following chapters, we present one country overview and eleven cases that met most of the following selection criteria:

• demonstrated success in expanding access to underserved rural market segments;

• were based on cost-covering principles, or had clear exit strategies if they were externally supported;

• had been in existence for two or more years;

• added to the diversity of linkage types reviewed.

The selected cases fell into four broad categories:

(i) Cases that are strategic in nature and driven by the informal institution;

(ii) Cases that are strategic in nature and driven by formal bank/insurer;

(iii) Cases in which mentoring and/or capacity building of informal institutions is a key component;

(iv) Cases that are externally driven by a third party (e.g. donors, governments), but that demonstrated a certain level of formal sector openness to engage with the informal sector.

The cases under each category are highlighted below.

Strategic – informal sector driven linkage

Under this category we highlight two informal institutions that successfully established linkages with a range of financial and non-financial partners in order to expand their service offerings and/or to establish more stable sources of funds.

In Chapter 2, we present the case of Fundácion para Alternativas de Desarrollo (FADES), a Bolivian non-regulated MFI specializing in the supply of financial services with significant outreach in rural areas. This is an interesting story of an informal financial institution's explicit strategy of increasing its supply of a wide range of non-traditional financial services by establishing a 'multiplicity' of inter-institutional linkages with financial and non-financial partners. This story highlights several lessons learnt about the benefits and costs of establishing and maintaining a multiplicity of linkages. The authors end the Chapter with insightful recommendations on the importance of picking the right partners, persuading staff of new partnership benefits, and knowing how to manage a set of inter-institutional linkages.

In Chapter 10 we present the case of Confianza, a regulated MFI in Peru with significant outreach in rural areas. This is a story about a newly regulated MFI, formerly an NGO, and the impact of its new regulatory status on the ability to source funds from a range of commercial and non-commercial providers. Tradeoffs emerge for the organization in choosing the right mix of partners that is most appropriate for its long-term strategic interests. However, the author questions the impact of the institution's new regulation and interaction with commercial partners on rural outreach. She considers the possibility that Confianza, in an attempt to cut costs and meet prudential requirements, relies more on increasing financial services in urban rather than rural areas. The data presented for recent years supports this view.

Strategic – formal sector driven linkages

In this grouping we describe two commercial banks and one insurer using linkages to reach rural markets. What may have begun as acts of corporate social responsibility and/or a response to priority sector targets soon became absorbed for these commercial actors into their mainstream business and long term corporate strategies.

In Chapter 5 we present the case of a now well-known private bank in India, ICICI Bank. Motivated by an internal drive to 'be a leader in every field of banking' and a belief that new micro clients will grow into mainstream banking clients, ICICI developed a unique model to tap into rural markets. The case describes the innovative 'outsourcing' model and provides two 'linkages in action' sub cases depicting the spillover effects of the ICICI linkage on two partner organizations and their sponsored SHG (self-help group) members. Although the authors state that ICICI Bank is no doubt demonstrating its effectiveness in profitably serving the rural poor, they are cautiously optimistic about the future and highlight some concerns for consideration. In fact, in February 2007 after the completion of the field study, ICICI Bank had to temporarily suspend its main partnership model with microfinance institutions (MFIs) because the Reserve Bank of India said that it was not meeting the 'know your customer' requirements through the partnership model. Since the suspension, ICICI Bank has worked with its partners to overcome this challenge by upgrading data systems to enable them to meet the requirements, but many MFIs, especially those that depended heavily on ICICI Bank for their funds, are still feeling the pain of suspension.

In Chapter 6 we present a second case from India about Aviva, a large private life insurer, and its unique approach of responding to priority sector requirements of the Indian government. This is a unique story about a massive international insurer's effectiveness in supplying life insurance products in remote rural markets. As with ICICI Bank, serving the rural poor became a long-term corporate business strategy and not just a 'requirement'. The author provides a good overview of the insurance market in India, including an historical review of the Insurance Regulatory and Development Authority (IRDA) and its regulatory norms. He highlights the challenges and successes Aviva faces in setting up 'tailor made' business models with an MFI and a trade union. The first case demonstrates the numerous advantages of working with a well-qualified local partner while the second tells the story of Aviva's success in beating out the competition to win over the business of a large trade union with over 500,000 members.

In Chapter 13 we present the case of CRDB Bank, the fifth largest commercial bank in Tanzania, and its desire to do 'something positive' about the majority of Tanzanians alienated from the commercial banking sector. The author describes CRDB's corporate vision to successfully serve the broader Tanzanian market commercially. Although this appears to be a story about CRDB's level of corporate social responsibility, it may have more to do with a smart, forward-thinking bank preparing for what they feel will eventually be a saturated urban banking market. The author describes CRDB's strategy of linking with Savings and Credit Cooperatives (SACCOs) as a way to cost-effectively increase the supply of financial services in the rural countryside.

Mentoring – capacity-building driven linkages

It is not surprising that in all of the cases that we studied formal actors met severe difficulties in partnering with local organizations because of their low level of institutional capacity. What is interesting, however, is the way in which formal actors chose to deal with this problem. The cases presented under this category exemplify a range of strategies that different formal actors have undertaken. We feel the contrasts among the cases are striking and provoke much reflection and debate on how to tackle what will continue to be a long-term challenge in our field.

In Chapter 3 we present a case about FINCA/Costa Rica, a non-financial NGO with linkages with local and regional financial NGOs operating in rural areas. Originally, FINCA/Costa Rica was established as a village banking programme with a resource intensive model of creating and funding village banks on a continual basis. In the late 1990s/early 2000s, faced with chronic problems of financial self-sufficiency, an inability to secure loanable funds and an inefficient MIS system, FINCA/Costa Rica made a radical decision to close its financial operations and specialize completely in the creation of incorporated village banks, otherwise known as communal credit enterprises (CCEs). The authors provide a wealth of information about FINCA/Costa Rica's institutional transformation that strengthened financial linkages and enhanced rural access to financial services. Anyone interested in a story about a courageous local organization willing to rethink and adjust an international programme's 'one size fits' all model should read this chapter. Lessons abound on the flexibility to adjust, the dangers of conditionality, the challenges of scaling up and the importance of institutional strengthening.

In Chapter 4 we illustrate a unique case about the José María Covelo Foundation in Honduras. This is an interesting story of the foundation's evolution from a typical second-tier organization providing capacity building training and funding to private development finance organizations (PDOs) to one of a highly sophisticated holding company offering financial, human resource management, administrative systems, marketing and organizational services to the six organizations in the holding group. The study focuses on a multiplicity of intra- and extra-group linkages with a range of financial and non-financial actors. The authors examine market-deepening linkages for rural finance and provide in-depth analysis of two local organizations and their linkages with Covelo Group among others. This case is rich in detail and at times complex, but for those interested in exploring a new way of building local capacity, it is essential reading.

(Continues...)

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Edition details

• Publisher: Practical Action Publishing
• Publication date: 2008
• Language: English
• ISBN 10: 1853396664
• ISBN 13: 9781853396663
• Binding: Paperback
• Number of pages: 320