Financing Smallholder Farmers and Rural Entrepreneurs in the Near East and North Africa Thierry Mahieux, Omer Zafar, and Mylène Kherallah

Session 3

Breakout session 4 Financing Smallholder Farmers and Rural Entrepreneurs through IFAD-

supported Operations in the Near East and North Africa1

Thierry Mahieux, Omer Zafar, and Mylène Kherallah2

Paper presented at the IFAD Conference on New Directions for Smallholder Agriculture 24-25 January, 2011

International Fund for Agricultural Development Via Paolo Di Dono, 44, Rome 00142, Italy

1 Copyright of the paper is reserved by IFAD. The paper may not be reproduced in part or in full and in any form without written permission of the Conference Organisers at IFAD (e-mail: at.rahman@ifad.org) 2 The Authors Respectively are Consultant, Country Programme Manager and Regional Economist at Near East and North Africa Division, IFAD.

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Financing Smallholder Farmers and Rural Entrepreneurs through IFAD-supported Operations in the Near East and North Africa

SUMMARY

This paper presents two models used by IFAD-supported projects for providing financial

services to small farmers and rural entrepreneurs in the Near East and North Africa. The first model, the sanduq, is a type of community-based saving and credit association which has been successfully evolving in Syria, with wide potentials for replication and scaling-up into more sophisticated financial institutions serving poor rural communities. The second model, is through the financing of value chains, which is currently being implemented in Yemen.

Through various contracting schemes between small farmers and processors or traders, the

farmers can access loans to finance their production and working capital. The paper also looks at the way forward in terms of innovative instruments to serve the various financial needs of small farmers and the rural poor in the region.

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Introduction

1. For more than 30 years, and given its focus on poor rural men and women, indigenous peoples and less privileged households, IFAD has concentrated on rural microfinance, with micro referring to the relative size of financial transactions and rural reflecting the location of entrepreneurs and small-scale agricultural and livestock producers that IFAD targets. 2. The provision of sustainable and adequate financial services to resource-poor rural households faces many challenges, including limited capacity of financial service providers and low level of client education. Most commercial banks are not interested in moving into the rural areas due to the low income levels, lack of scale economies, and poor infrastructure in the rural areas. Also few banks actually understand the most common economic activity in rural areas, i.e. agriculture, and those who do may be reluctant to serve the agricultural sector, given its seasonality and the inherent risks of farming. They also may be hesitant to finance rural micro- and small enterprises, given their difficulties to access markets, and the lack of experience and capacity of their promoters. Consequently, the absence of financial institutions in rural areas has often enticed governments to step in, particularly with state-dominated banks focused on agriculture. Many of these initiatives have failed, however, because they were too bureaucratic, too policy-oriented, too concentrated on risk to only one segment of the population, too weak in customer focus or suffering from too many political interferences either in their management or monitoring of their loan portfolio. In addition, clients consider these government-sponsored institutions to be instruments that provide grants; hence, the banks suffer from poor loan-recovery rates.

3. One of the most prominent gaps in developing banking services for rural areas is poor infrastructure - for example bad roads, erratic electricity supply, and lack of communications systems - which impedes effective outreach to customers. The legal environment in these rural areas is also suspect. Insecure property rights - especially land titles in rural areas - limit any bank’s collateral options; combined with poor contract enforcement opportunities, this takes away a bank’s incentive to provide credit, especially for long-term loans. The inefficiency of markets is also a barrier to developing rural financial services. Agricultural value chains are often poorly organized, lacking in transparent pricing, and fragmented in primary production - all of which results in high transaction costs. Taken together, these challenges increase the costs and risks of serving rural areas and require continuous attention and innovation. Furthermore, for cultural and social reasons, access to financial services may be in some countries even more cumbersome for women and may also require alternative approaches and long-term awareness-building.

4. In a changing global economy and in the context of an uncertain future for the financial sector, volatile food and agricultural commodity prices and perils of climate change, developing inclusive rural financial systems and fostering innovations to increase the access of resource-poor and marginalized women and men to a wide range of financial services is central to IFAD’s mandate. Approximately 20 per cent of IFAD’s investments are now focused on rural finance.

IFAD and rural finance

5. Given the many challenges inherent in remote, marginal areas, and in areas recovering from natural disasters, the development of innovative products and delivery mechanisms is critical to meeting the needs of IFAD’s target groups. IFAD intervenes at different levels of the financial sector:

• At the micro level: IFAD aims at enhancing the sustainability of financial service providers

while facilitating transparent information sharing on their financial and social performance

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management, including terms and conditions, particularly the effective interest rates/margins charged. With respect to its clients, IFAD aims to make them bankable by providing them with the necessary capacity building enabling them to implement, develop and manage their activity through provision of skill and management training, assistance to form sustainable producers’ associations, and assistance to access accurate market information.

• At the level of financial institutions: IFAD supports a wide range of financial institutions

through training and capacity building enabling them to provide better services to IFAD target groups and also second-tier organizations such as associations and apex institutions through advisory services, training and capacity building so that they can provide professional and cost-efficient financial and technical services to retail financial institutions and improve market transparency.

• At the policy and regulatory level: IFAD aims at improving enabling framework conditions for a

range of financial service providers to reach clients with low incomes with appropriate products and services, and to protect rural poor people’s savings and deposits.

6. In building inclusive financial systems, IFAD applies six guiding principles in its rural finance interventions:

(i) Support access to a variety of financial services, including savings, credit, leasing, equity

financing, venture capital financing, remittances and insurance, recognizing that rural resource-poor people and local entrepreneurs require a wide range of financial services;

(ii) Promote a wide range of financial institutions, models and delivery channels, tailoring each

intervention to the given location and target group;

(iii) Support demand-driven and innovative approaches with the potential to expand the frontiers of rural finance;

(iv) Encourage – in collaboration with private-sector partners – market based approaches that

strengthen rural financial markets, avoid distortions in the financial sector and leverage IFAD’s resources;

(v) Develop and support long-term strategies focusing on sustainability and poverty outreach, given

that rural finance institutions need to be competitive and cost-effective to reach scale and responsibly serve their clients; and

(vi) Participate in policy dialogues that promote an enabling environment for rural finance,

recognizing the role of governments in promoting a conducive environment for pro-poor rural finance.

7. These binding principles are applied at the micro level, working with retail rural finance institutions and beneficiaries; at the meso level, focusing on financial infrastructure, such as second-tier institutions, and technical service providers; and at the macro level, assessing the policy, legislative, regulatory and supervisory framework.

New Approaches in the Near East and North Africa – Examples from Syria and Yemen

8. Rural poverty in the Near East and North Africa (NENA) is linked to low natural resource endowments (especially water and arable land), low levels of human capital, weak infrastructure and basic services, poor governance, and lack of marketing or employment opportunities. In most countries, the inability of agriculture to provide sufficient incomes, and the absence of small and medium enterprises in rural areas, imply that the majority of rural households are largely dependent on

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the incomes obtained by their younger males through casual labour in urban areas. Insufficient agricultural income is increasing the importance of urban casual labour in household income; this is becoming the primary source of income for increasing numbers of rural households. The characteristics of rural poor households in the region can be summarized as follows:

Figure 3: Rural Poverty in the NENA - Characteristics Who are the rural poor?

landowners owning < 2 ha of rainfed or irrigated cultivable land; smallholders with very small holdings or without access to irrigation water; sharecroppers or tenants and their households; landless households dependent on livestock activities and/or casual labour; large farming households (usually consisting of extended families); households with high dependency ratios (e.g. adult unable to work or disabled); women-headed households; young women and men living in extended households.

Where are the rural poor? the rural poor are to be found throughout rural areas; located in areas of high population density and very small holdings; concentrated in dispersed settlements with inadequate access to services; found in remote inhospitable mountainous areas with steep watersheds; often dependent on seasonal or long-term migration to urban areas.

Why are they poor? subsistence focus; periodic drought and chronic water scarcity; inefficient use of irrigation water; inadequate access to knowledge and technology; poor/inconsistent quality and limited/unscientific application of inputs; inadequate access to financial services; difficult access to markets; weakness of local organisations, constraining collective action/negotiation; unfavourable tenure arrangements for sharecroppers and tenants; other social and non-economic aspects.

What are their coping strategies? out-migration (overseas; in-country); dependence on casual wage labour; borrowing from relatives and local traders; charity - further fuelling dependency; decapitalization.

9. As noted in the above table, most rural households in the Near East and North Africa (NENA) lack access to reliable and affordable finance for agriculture and other livelihood activities. Among the many problems faced by smallholders, micro-entrepreneurs and women are: a) lack of adequate assets that potential borrowers could use as collateral to secure their loans and to meet the lending banks requirements; b) limited or non-existing access to financial products and services due to an uneven distribution of financial points of services in rural areas; and c) limited or non-existing access to markets for smallholders’ production. On the one hand, commercial banks are reluctant to develop their outreach in rural areas mainly due to a wrong assessment of risks involved when lending in the agricultural sector, absence of products designed for rural and agricultural activities, collateral requirements, and inadequate capacity of staff to correctly assess rural/agricultural activities. On the other hand, commercial banks have sufficiently diversified financial resources to extend all types of loans needed by farmers/entrepreneurs such as: investment loans that are generally medium- or long-term loans requiring a payback period ranging from 3 to 7/8 years, and working capital loans, typically 12-month short-term loan. Leasing is extended by some financial institutions comprising of commercial banks and specialized institutions to an urban clientele only when a favorable and conducive environment is in place. These products are offered by commercial banks and bear an interest rate ranging from 7 to 20% in the region.

10. Microfinance institutions (MFIs), through their network of branches and points of services, have a greater outreach than commercial banks in rural areas, although just like elsewhere in the world, the majority of them are still focusing on urban areas. MFIs are facing two major problems: a/

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financial resources are generally of short-term maturity preventing them from extending investment loans, and b/ high transaction costs combined with high interest rates to cover their operating costs, especially in rural areas. Due to the rural network and microfinance philosophy of nearness and close monitoring, microfinance institutions bear operating costs that are significantly higher than those of commercial banks. Traditionally interest rates charged by microfinance institutions range from 20% per year to 3% per month for loan products that have a maximum 12-month maturity (average of 6 to 8 months to be in line with the agriculture production cycles).

11. The traditional IFAD approach of supporting MFIs has focused on extending their outreach through credit lines, investment grants/loans and technical assistance to fine tune their products and services to local population requirements. An alternative approach used by IFAD as well is based on traditional community-based organizations. These organizations are provided training, technical assistance and eventually seed capital, and are often turned into sustainable microfinance institutions. In most cases, traditional community-based organizations supported by IFAD are already undertaking financial activities (provisions of loans and mobilization of savings and deposits from their members).

12. Several models that have good prospects of long-term sustainability have been implemented by IFAD in the NENA region or elsewhere such as village savings and loan associations, self-help groups based on the Grameen Bank model, and village banks. This paper will focus on two main approaches which are currently being implemented in Syria and Yemen. These two countries are both low-income countries with a relatively large rural population (50% of the total population in Syria and 80% in Yemen), significant levels of rural poverty (15% of the rural population in Syria and 40% in Yemen), and where agriculture is a main source of income and employment generation.

13. Syria: A Rural Microfinance Innovation. Resource-poor Syrian households have limited access to sources of finance, because of high interest rates that moneylenders charge or lack of adequate physical collateral that traditional financial institutions require for any given loan. The objective of IFAD projects in Syria is to enable these resource-poor households to access different types of financial services and products in order to finance income generating activities that would increase their income and lift them permanently above the poverty line. The IFAD-supported projects have been focusing on strengthening the capacity of traditional financial institutions and on increasing their outreach towards the local rural population. This has been achieved by strengthening the managerial and financial capacities of traditional sanadiq (a local form of Credit and Savings Associations) and by linking them with the formal financial sector rather than assisting/financing financial institutions to extend their rural network without long-term perspective of growth, profit and sustainability. A sanduq (pl. sanadiq) literally means savings box and has been in use since ages by communities to help and assist each other in case of emergency and/or to develop their activity. The sanduq is an improved version of the savings and credit association while differing from it in the following aspects:

The sanduq requires mandatory membership and members cannot borrow until their shares are

fully paid; Once membership shares are paid, members can borrow from the sanduq even if they don’t

place their savings in the sanduq; All members regardless of whether they are active borrowers are entitled to receive annual

dividends based on their contributions to sanduq resources; and Seed capital is necessary during the first two/three years of sanduq operations as to avoid

placing a too heavy financial burden on the sanduq with operating expenses. Seed capital is provided as a loan to be paid back after 3 years.

14. Four principles are fundamental to the sanduq approach: self-reliance; autonomy; sustainability, and outreach to the resource-poor.

Self-reliance, in terms or mobilization and ownership of local resources, refers to: cultural self-reliance, based on the concept of the sanduq as an ancient community-based institution;

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organizational self-reliance, based on sanduq self-governance by local men and women through elected committees, and financial self-reliance, based on the self-financing of the sanduq through share capital paid up by members and retained earnings derived from adequate, non-subsidized financial margins and insistence on timely full repayment of loans;

Autonomy is based on self-selection of members-owners, in the choice of financial products and services offered by the sanduq to its members, in the determination of its lending decisions, and in the determination of its financial policy, especially margins charged by the sanduq;

Sustainability is based on the establishment of operationally and financially self-sufficient local financial institutions, together with a regional association. Future linkage with the financial sector will also enable sanduq to reach sustainability;

Outreach to the resource-poor is achieved through growth in the number of members, expansion in the number of sanadiq, growth of resources either internally (membership shares) or externally (financial link with commercial banks or microfinance institutions).

15. The sanduq start-up activity is financed by members share capital only. Whenever governance is appropriate and financial intermediation satisfactory, limited additional resources are injected from the IFAD project so as to increase the financial resources of the sanduq, hence increasing its attractiveness, its lending activity, the size of loans extended and their duration3. Injection of cash by the project is in the form of a medium-term loan and goes in parallel with training and sensitization of members on savings mobilization and implementation of attractive savings and deposits products.

16. Sanadiq are also focusing on women involvement. They constitute nearly 50% of the membership, have received more than one-third of the loans extended so far to establish their own business, such as sheep fattening, raising cows, opening petty trade shops and renting land to plant cash crops. Income generating activities are only financed on the basis of demonstrated access to market. Women interviewed acknowledge the easy access to loans from the sanduq especially because it doesn’t require any physical collateral (joint-liable borrowing group is the most common financing methodology applied but loans to individuals are also proposed by the sanduq once members have established a sound credit record). Additional income is used for business growth and family support.

17. So far IFAD has participated in the implementation and development of 76 sanadiq totaling around 13,500 members. Most of them have reached operational and financial sustainability. Close to 22 000 short-term loans have been extended under Islamic financing principles for an aggregate amount of USD 17 million. Repayment rate is above 99% and is closely monitored through an adequate management information and accounting system. A new IFAD-supported project will assist another 96 remotes villages to develop their own sanadiq.

18. IFAD is now engaged in the second step of its assistance to sanadiq consisting of the implementation of a sanadiq federation that will provide financial and non-financial services to each sanduq. Non-financial services mainly consist in training and capacity building of staff members and shareholders of each sanduq, representation and lobbying at regional and national level to influence the government microfinance policy, as well as accounting, supervision and internal audit services to ensure compliance with microfinance best practices. Financial services mainly consists, with the assistance of IFAD, of linking the association with the financial sector so as to increase the financial resources of each sanduq. Subsequently, for microfinance institutions such linkages represents a way to expand their outreach and activity as well as to increase their financial resources at a lower cost. The other main aspect of the IFAD-second step refers to membership and mobilization of additional resources. Specific training and advisory services are to be provided by the project for enlarging the scope of resources mobilized by developing and implementing new savings and deposits products based on real need and demand of the population. In parallel, the sanduq membership structure will become twofold: shares with voting rights and access to dividends and shares with no voting rights but access to dividends. This is mainly to encourage long-term injections of funds in the sanadiq by

3 Initial support to the sanadiq initiative in Syria was spearheaded by UNDP.

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better-of households and entrepreneurs as well as to safeguard the interest of resource-poor households in the dividend distribution.

19. The linkage between the Federation of sanadiq and commercial banks will definitely add more significant levels of complexity that would require technical assistance to review and update all procedures and training. Nevertheless, partnerships between federation and mainstream financial institutions can be beneficial if implemented incrementally. The simplest form of partnership will lie in banking the excess of sanduq’s savings and earn interest on these deposits. Then, once the financial institution has been able to assess the sanduq’s management of its own funds, it can extend small refinancing loans to sanadiq. However, significant external funds, apart from necessary seed capital that helps sanadiq to get their activity started, should be linked to the performance in managing their own resources (the portfolio at risk and the repayment rate at zero day and 90 days are among the most important performance indicators). External funding should be provided with care as it tends to have a negative impact on the mobilization of members’ savings.

20. The sanduq model has also been implemented in Sudan while in other countries, this model has been adapted: Associations de Services Financiers in Mauritania, Benin and Guinea; Village banks in Western Africa; Community Development Funds in Somaliland and Palestine. In other countries such as Morocco and Algeria, rural financial services components of IFAD-supported programmes have focused on assisting local microfinance institutions or commercial banks to expand their network in rural areas following the same principles and methodology as for community-based organizations. In Algeria, for example, IFAD-supported programmes aimed at developing village credit and savings institutions linked to the provincial and national Caisse Nationale de Mutualité Agricole (CNMA). 21. Community-based financial institutions are user-owned and -operated groups that mainly provide saving and lending services but might also provide other financial services such as insurance. Such institutions flourish among people who have limited or no access to banks and nonbank financial institutions. These independent organizations are based in local communities, with local governance and management. They can take several forms: informal and unregistered groups of a few people who save on a weekly basis small amounts of money that are then on-lent to group members; more formal groups of up to 50 people who have written by-laws, as well as small financial cooperatives.

22. In many developing countries, locally organized institutions such as rotating savings and credit associations (ROSCAs) or sanadiq, have served as financial intermediaries for their communities for generations. ROSCAs members save a predetermined amount of money regularly. At the end of each specific period, one member receives the total amount of funds collected in the form of a loan. Accumulated savings by members are used to finance small investments in agriculture or income generating activities, social and household needs. ROSCAs main drawback is that only one person at a time receives the accumulated funds which limits the attractiveness of the lending activity of such institutions.

23. Successful community-based financial institutions incorporate some basic principles: a/ social cohesion of group members; b/ focus on building up savings to fund loans rather than relying on external source of financing, and c/ an organizational structure that enables local governance and management by people who are often poorly educated and have little or no experience with financial management beyond managing their own households and economic activities.

24. Yemen: Financing Value Chain Development. IFAD is currently engaged in a long-term programme in Yemen valued at 150-200 million USD and co-financed with the Islamic Development Bank and the European Union. The programme consists of three projects in three specific sub-sectors: high-value agricultural commodities (coffee, honey, holticulture,etc.); fisheries; and rural non-farm employment. The overall approach focuses on creating economic opportunities for poor rural men and women within selected value chains. Each project is composed of three main components: (i) development of public-private partnerships; (ii) value chain financing and upgrading, and (iii) increasing microfinance outreach. The novelty of the Yemen programme is that financing

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smallholders’ production and working capital is made possible through the contracting systems within the value-chains.

25. Public-private partnerships (PPPs) enable the involvement of the private sector in the implementation and development of a programme. Various forms of PPPs implemented within the programme include:

Partnership with the private sector for better access of small producers to markets and enhancement of quality of production at grassroots level;

Partnership with the public sector to enforce the necessary legal framework and to develop the indispensable infrastructure;

Partnership with financial institutions inclusive of commercial banks, microfinance institutions and leasing companies to finance the needs of different stakeholders within value chains and service providers to the value chains;

Partnership with insurance companies to develop specific products aiming at mitigating risks for stakeholders and financiers;

Partnership with communities to strengthen their capacities to gradually own and operate productive assets and/or specifically created companies;

Partnership with local SMEs and entrepreneurs to develop services to value chain stakeholders like processing, storage facilities, transport, maintenance and repair, inputs supply.

26. Value chain upgrading and financing involve all stakeholders: producers, processors, exporters, intermediaries, service providers to value chain stakeholders. Upgrading value chains consists of providing financial and non-financial services to all stakeholders as illustrated in the figure below.

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Figure 1: Value Chain Upgrading and Financing

Financial services

Non-Financial Services

- Advisory Services - GGAP Certification

Financial Services (Equity and debt finance, leasing)

Market-derived Infrastructure

ForwardContracts

Agro-processingMarkets

(domestic; export)

Non-Financial Services

Business Services, Marketing support, ISO Certification

- Support to PA - Inputs - New Technologies - Business services

Primary Production

27. Financing small cash-crop farmers is made easier through a supply-chain approach. These smallholders are financed indirectly via contract farming with better rated processors. Under such schemes, the farmer commits to supply 100% of a particular crop to the processor, and this latter commits to buy 100% of the farmer’s production at a pre-determined price, subject to quality control. The price is paid partly to the farmer and partly to the bank for the repayment of the working capital loan extended by the financial institution to the farmer. Under this mechanism, the repayment risk to the individual farmers is converted into performance risk to both the farmer and the processor. In many cases, the cooperatives can play a facilitating role by being the counterpart of the processor and the borrower of the loan. A cross-liability system whereby the members guarantee one another’s loans could provide extra comfort to the bank. Also systems involving warehouse receipts can provide additional financing to this target group.

28. Emergent farmers, who have the potential to grow into commercial farming but lack the financing and farm-management expertise, justify an individual approach since they have the potential to develop into commercial or professional farmers with corresponding growth of financial services. Strict criteria are established regarding minimum size, sufficient entrepreneurial spirit, basic understanding of business planning, and farm-management skills. With a combination of financial services and technical support, these farmers stand a fair chance of success. Emergent farmers can be financed under the existing retail structure of a particular bank, but the local branches involved would need to hire and train agri-finance specialists who understand farming and have the ability to appreciate the particular risks associated with it. It is essential to form alliances with other stakeholders in the value chain who have also an interest in developing and investing in the farming sector (for example, farmers’ organizations, commodity exchanges, agri-input suppliers, and processors).

29. For both smallholders and emergent farmers, in addition to financing, non-financial services will be provided by external service providers or by other stakeholders from the value chains such as: support to producers’ associations; access to inputs and other agricultural supply through the cooperative and other stakeholders; access to new technologies; technical advisory services mainly to be provided by processors and other stakeholders, and access to markets including necessary certification and standards to enter export markets.

30. The selection of value chains to be assisted and strengthened by the programmes is based on their export potential; import substitution potential; production mainly carried out by smallholders or

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resource-poor households, and the demonstrated potential to organize value chain stakeholders and to engage in forward contracts. In its first programme, IFAD focuses its interventions on the coffee value chain (among some others) while in its second programme, the focus is to be put on the fisheries value chain.

Within the coffee value chain, the programme promotes operational linkages between exporters/processors and smallholders coffee producers consisting in the recruitment by exporters/processors of supply chain managers who provide technical assistance and advisory services to coffee producers in selected settlements/villages so as to increase the quality and the quantity of their production. Financing of agricultural inputs as well as investments resulting from the adoption of modern irrigation technologies (drip irrigation) is facilitated by forward contracts binding both producers and processors/exporters. Financial institutions use forward contracts as non-financial collateral and can extend their loans either to processors/exporters or to producers. As a complement to the direct assistance to coffee producers, the project also partners with communities and public sector to build/rehabilitate the necessary water-harvesting infrastructure and to gradually transfer their management to communities, and with public institutions vested with the responsibility of issuing health and production certificates necessary for export.

Within the fisheries value chain, the same methodology is applied. However, the project focuses more on the legal environment of the fisheries sector by assisting the Ministry of Fish Wealth to enforce the current laws and regulations; on its operational environment and long-term development by assisting fishers’ communities and public research institutes in determining new internal rules/regulations to protect and safeguard the future of natural resources, already seriously endangered of depletion.

31. Microfinance outreach. Since commercial banks are reluctant to invest in rural areas, the programme partners with a promising new microfinance institution on the basis of a minority equity participation in its share capital that gives the project a seat at the Board and the possibility to influence the poverty and gender focus of the institution, and of a long-term deposit as a shareholder the interest rate of which is negotiated among Board members outside regulations of the Central Bank. The equity participation finances part of the implementation costs of the rural network of the microfinance institution where growth and profit potential have been identified, as part of its long-term strategy and development plan, while the long-term deposit finances the incremental activity since current resources of that institution are too limited to face the additional demand resulting from the project.

32. For productive investments, the programme innovates by financing them through an adequate financial structure based on a joint-venture with producers’ organizations in specifically created limited liability companies (LLCs). Since producers’ organizations have limited financial resources, the project finances most of the LLCs’ share capital. Its shares are gradually bought back by producers’ organizations based on profit distributed. Venture capital mechanism ensures producers’ organizations full ownership over the medium-term.

33. Traditional IFAD target population are always the center of this new approach. Settlements/villages selected for the coffee production are mainly composed of smallholders owning less than 0.5 ha in coffee and 0.3 ha of other cash crops. Fishers’ organizations are selected based on the percentage of poor fishers in their membership. The programme assists them in accessing advisory services, enhancing the quality and increasing the quantity of their production, and to sustainably access financial resources and services through the rural network of microfinance institutions. Linkages with processors/exporters combined with higher productivity and certified quality result in a substantial increase of producers’ income and a sustainable lift above the poverty line.

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Way forward

34. Besides further development on above-mentioned financial instruments (such as financial linkages between savings and credit associations and commercial banks, or expansion of value chain financing), other financial instruments can be further developed in the NENA region. Three of these financial instruments include: (i) remittances as an alternative source of funds for rural financing; (ii) insurance and especially weather index-based insurance, as a mitigation tool for risks inherent to agriculture production, and (iii) leasing as an alternative to both debt financing and lack of proper collateral/guarantee.

35. Remittances. In 2006, remittances transfers all over the world represented over USD 300 billion. The countries of the NENA account for nearly 15% of that amount (especially Morocco, Algeria, Turkey, Lebanon). Average transfer per year per person represents USD 1 500 4. Specific products to use the surplus of remittances generally transferred in rural areas should be further developed in the design of projects within the NENA region. Based on lessons learnt and experiences in other regions, a Productive Investment Development Fund aiming at financing the creation of micro and small enterprises in rural areas could be implemented. The design of this Development Fund could be financed through the demand-driven funding facility established since 2005 by IFAD to promote innovative approaches to remittances in rural areas. This multi-donor facility provides seed funding to pilot innovative delivery mechanisms and money transfer products in rural areas. It will result in an increase in the outreach of financial services delivered to IFAD target groups.

36. Micro-insurance. Poor people in developing countries are vulnerable to a broad range of shocks that affect their livelihoods, including illness, accidents, and death as well as loss of assets such as animals, crops, and machinery. Given the rural character of poverty in many countries, poverty reduction remains strongly connected to agricultural development, and sustainable agricultural development depends on well-organized risk mitigation. One important tool for mitigating risk is micro-insurance.

37. One can define micro-insurance as insurance that is accessed by the low-income population, provided by a variety of different providers but run in accordance with generally accepted insurance practices. It differs from traditional insurance in that it is adapted to the circumstances of the poor: premiums are low, products have simple designs, it is offered through well-trusted and innovative channels, premium payments are flexible, and claims are settled promptly.

38. Micro insurance has the potential to enable the rural poor to mitigate the effects of shocks that threaten their lives, productivity, and assets. It can help prevent emergencies from depleting poor people’s savings and other assets. Furthermore, it allows households to invest in high-risk, high-return activities by securing the lending risk for agricultural and other investments. Financial sector reforms in many countries have begun to include insurance as an important pro-poor financial service along with other microfinance services such as savings, lending, and money transfers.

39. Providing micro-insurance in rural areas can be more difficult than in urban settings and requires some adaptations in terms of insurance products, risk carriers, delivery, and servicing. The characteristics of its market make sales and pricing more difficult. Low-income households’ financial capability is weaker. Affordability is another challenge because rural people rely on seasonal and generally low incomes. Demand is not known or understood, products are poorly designed, and if micro-insurance is available at all, the selection of policies is limited. Systems are not adapted to manage many small transactions for premium collection, back-office administration, and claims management. Population density is often low and distances are far, making it more difficult to reach scale. Distribution can suffer from the lack of channels like banking outlets. Risk assessment is difficult in rural areas and for agriculture-related activities. All these factors make underwriting more

4 Source : Sending Money Home - IFAD Publication - Dec. 2007.

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expensive, and therefore, the mostly urban-based insurers are not ready to serve rural low-income markets. Rural providers are often small and informal, with the inherent challenges of such organizational forms, such as weak governance or limited range of products.

40. Some micro-insurance schemes tailored to rural areas provide useful lessons. For example, a pilot project implemented in Rwanda and other Great Lake countries has been providing weather insurance for tomato, rice and maize small farmers to improve their access to credit. This micro-insurance scheme is based on a rainfall index. Payments are based not on individual loss adjustments, a costly undertaking not feasible in micro-insurance, but rather on whether rainfall measured at a local weather station reaches a certain threshold. The insurance contracts are linked to credit because the insurance secures repayment of the loans.

41. The pilot project strongly focused on raising awareness among potential beneficiaries, capacity building of banks and insurance companies staff, low premiums and quick payouts. High adoption rate among producers demonstrates the adequacy between the design of the product and the need expressed by farmers. At the outset, the project had to solve several problems like poor-quality weather data which required governmental contribution to finance necessary weather stations. Nevertheless, the Great Lake countries weather insurance market is growing strongly, and new micro-insurance providers are entering the market.

42. Developing effective and broad-based micro-insurance markets in the past few years requires to address some of the challenges still faced when extending micro-insurance in rural areas:

• Strategy and policy challenge: A holistic approach to improving the financial system addresses

the actors on three levels: it focuses simultaneously on framework conditions involving sector strategies, regulation, and supervision (macro level); service providers and public goods (meso level); and insurers, intermediaries, and customers (micro level). Rural development policies and financial sector development policies need to include micro-insurance.

• Underwriting challenge: Underwriting in rural areas faces higher risks and weaker

infrastructure, which requires special attention from policymakers and development organizations. Community-based and mutual types of underwriters are more common in rural areas than in urban areas, and they often require institution-building support.

• Delivery challenge: Delivery channels that are close and easy to use and support rural delivery need to be strengthened. These channels include micro-finance institutions, cell-phone banking and retail shops.

• Consumer challenge: Consumer-related challenges, such as affordability, insurance literacy, and consumer protection, need a special look. Affordability is more sensitive in rural areas than in urban areas because rural residents face higher cash-flow fluctuations in agriculture and generally have lower incomes. More investments are needed in insurance literacy. Consumer protection is a greater challenge in rural areas because the ombudsman and courts are often far away, and a claimant needs to finance travel costs.

• Agricultural insurance challenge: Although index insurance can potentially overcome many of the problems associated with traditional insurance, it requires improving the availability of high-quality weather data, creating awareness among farmers, achieving quick payouts, fine-tuning insurance products to take into account the different risks faced by farmers, and maintaining cost of premiums as affordable as possible for poor rural households.

43. Micro-insurance is an integral part of the financial sector and should be promoted as such. Rural finance and rural development policies should explicitly deal with micro-insurance, including

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agricultural micro-insurance. Coherence with other sector policies, such as agricultural development policy, social security policy, or consumer protection policy, results in more effective approaches.

44. In Yemen, the design of the programme related to agricultural value chains development has integrated a specific ‘weather index-based micro-insurance product’ component targeting coffee producers. Together with specialized service providers, the programme will promote two types of insurance services and products:

(a) products mitigating risks on households such as life insurance. Recent studies undertaken by

insurance companies in several countries in the NENA region show that less than 5% of the rural population has subscribed to a life insurance policy. In Algeria, the project proposed an improved version of life insurance product in which in addition to the pre-determined pay-out in case of death, an additional amount was to be paid by the insurance company compensating for the loss of revenue incurred by the household during one year after death. This product, mainly targeting micro and small entrepreneurs, prevented deceased’s relatives from selling at low price equipment and business to third parties. Rate of adoption was satisfactory. Such a product has also been tested by SIPEM, a non-mutual microfinance institution, in Madagascar with a high adoption rate among its members.

(b) products mitigating risks borne by a financial institution when lending to farmers including credit insurance and weather index-based insurance. Financial and technical feasibility and viability studies will be undertaken, their results discussed during a workshop with all stakeholders and proper design of insurance products will be jointly carried out by selected insurance companies, service providers and representatives of value chain stakeholders (including in priority coffee producers).

45. The main characteristics of insurance products to be developed by the programme consist of: (i) affordability: premiums should remain as low as possible; (ii) simplicity: products and related procedures should be well understood by the rural population, and (iii) efficiency: products should cover real risks faced by farmers , trigger factors should be easy to verify and claims should diligently be paid-out.

46. It is expected that approximately 10 000 coffee farmers supported by the programme will adopt weather index-based insurance in Yemen, as well as other insurance products. Al-Amal Microfinance Bank is already interested in integrating such insurance instruments in its loan products and in channeling them through its increasing rural network. Finally, local insurance companies have also expressed their interest in developing such products for coffee farmers but also for other cash-crop farmers as well as fishers.

47. Leasing. Investment loans in rural areas are difficult to access by smallholders and small entrepreneurs. As previously indicated, commercial banks have the financial capacity but lack a proper network of branches and willingness to finance rural areas and agricultural-related activities. On the other hand, MFIs which have a far better outreach in rural areas than commercial banks, lack long-term financial resources and consequently can only provide short-term working capital loans. Other sources of funds such as moneylenders, friends and relatives are used only for short-term credit or are too costly for investment financing. Leasing appears to be one solution for investors who want to modernize and develop or expand their operations.

48. Leasing is a contract between two parties, where the party that owns an asset (the lessor) lets the other party (the lessee) use the asset for a predetermined time in exchange for periodic payments. Lea sing separates use of an asset from its ownership. Two main categories of leasing exist in the market: financial leases and operating leases. In a financial lease, lease payments amortize the price of the asset. At the end of the lease period, the lessee can purchase the asset for a token price. The lessee is responsible for maintenance and risk of obsolescence of the asset. Because of the option to purchase the asset and the risks transferred to the lessee, the financial lease is a close substitute for a loan. Nearly all rural leases are financial leases. In contrast, operating leases do not include the option to

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purchase the asset. Maintenance costs and risk of obsolescence are borne by the lessor, and leases are cancelable.

49. Leasing offers several advantages. For traditional credit, farmers and rural enterprises are particularly constrained by a lack of assets that can be used as collateral. Leasing overcomes this constraint because it requires no collateral or less collateral than typically required by loans. Furthermore, ownership remains with the lessor and in case of default in the payment of monthly installments, the lessor can take back the asset without requiring a court decision. From the lessee’s perspective, not having to provide a collateral is particularly advantageous in a rural context.

50. The key features to be addressed in a financial lease contract include: (a) security: the primary security is the leased equipment; (b) insurance: the lessor insures leased assets with commercial insurance and includes the cost in the lease price; (c) lease term: lease terms range from two to seven years; (d) lease cost: it includes cost of insurance, operating cost, loss provision, and profit; (e) lease payment schedule: the payment schedule can be monthly, quarterly, half-yearly or annual in line with production and cash-flow cycles of the activity for which the equipment/asset has been leased, and (f) option to purchase: on completion of the lease payments, lessees have the option to purchase the leased assets/equipments at a certain predetermined percentage of their lease cost.

51. Leasing is a viable instrument to finance rural assets. The nature and capacity of existing financial institutions, the level of potential demand for investment finance in rural areas, and the level of development of the leasing industry should determine the mechanisms for supporting increased access to leasing for rural enterprises. Policy-level support will also be required in countries that do not have a clear legal and regulatory framework for leasing.

52. The existence of a well-functioning asset registry, the availability of insurance and maintenance services for equipment at a reasonable cost, and the existence of a good market for used assets are also necessary conditions for the development of the financial leasing industry. Institutional support may also be needed to develop the rural leasing sector. To successfully undertake financial leasing operations, organizations need not only well-trained staff, but also high-quality lease origination processes, accounting and internal control systems, and overall portfolio risk management.

53. Together with IFC, an IFAD-supported programme in Madagascar has promoted leasing as an alternative financing instrument for farmers. The programme and IFC have financed an awareness campaign for entrepreneurs and farmers; asset-registration offices in each province and sector; training and capacity building of banks and specialized institutions staff; technical assistance to adapt current leasing products to rural entrepreneurs and farmers requirements.

54. Based on the Madagascar experience, and considering that most commercial banks in the NEN region are reluctant to debt finance entrepreneurs in rural areas and farmers, new projects to be implemented in the NENA region should focus on and promote leasing as a substitute for debt financing. Many countries in the region have already adopted a favorable and conducive legal framework and regulations that make leasing more attractive for IFAD-supported projects’ target groups.

Conclusion

55. Within the framework of its mandate to alleviate rural poverty, IFAD has adapted its Rural Finance policy to the ever-changing needs of its target population. From financing smallholders and their production, IFAD is now engaged in multiple comprehensive financing packages including value chain development financing; equity participation in pro-poor financial institutions through adequate financial institutions; joint-venture with private entrepreneurs or resource-poor communities to develop small and medium rural enterprises that have market possibilities and that can create jobs for its target group; basic and more complex insurance products to mitigate risks taken by different

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parties; policy dialogue with local government to improve environment of rural finance; knowledge sharing and compliance with best practices.

56. Despite numerous success stories in the NENA region as illustrated by the two previously described examples, challenges are still ahead of IFAD in rural development and rural financing. New instruments and new approaches are still be required to target even more effectively and more efficiently resource-poor households in rural areas.

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Bibliography

Rural leasing: An alternative to loans in financing income-producing assets. Ajai Nair - IRAF - July 2010 - The World Bank - Agriculture and Rural Development Community-based financial organizations: Access to finance for the poorest. Anne Ritchie - IRAF - July 2010 - The World Bank - Agriculture and Rural Development