Rural Financial Services in Central and Eastern Europe and the Newly Independent States

T H E M A T I C E V A L U A T I O N

September 2005

Enabling poor rural peopleto overcome poverty

International Fund for Agricultural DevelopmentVia Paolo di Dono 4400142 Rome, ItalyTel +39 06 54592048Fax +39 06 54593048E-mail: evaluation@ifad.orgwww.ifad.org/evaluation

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Document of the International Fund for Agricultural Development

Rural Financial Services in Central and Eastern Europe and the Newly Independent States

Thematic Evaluation

September 2005 Report No. 1645

Photo on cover page: Georgia: Agricultural Development Project

Elizbar Tatarashivili cultivates grapes to eat and make wine in his farm in Missaktsieli village. With a small loan he was able to hire help to cultivate his crops. IFAD Photo by Robert Grossman

Rural Financial Services in Central and Eastern Europe and the Newly Independent States

Thematic Evaluation

Table of Contents

Abbreviations and Acronyms iv Map v Agreement at Completion Point ix Executive Summary xv I. INTRODUCTION 1 A. Goal and Objectives of the Study 2 B. Approach 3 C. Key Questions and Issues to be Addressed 4 II BACKGROUND 5 A. Eastern Europe 15 Years after the Collapse of Communism 5 B. IFAD Regional Strategy Statement on Rural Finance 6 C. IFAD Portfolio – Four Country Case Studies 7 D. Learning from Other Experiences – Similar Regional Learning Initiatives 8 III. COUNTRY RURAL FINANCE EVALUATION SUMMARIES 9 A. General 9 B. Albania – Creating a New Financial Institution to Consolidate the IFAD Rural

Finance Portfolio in Mountain Areas 9

C. Georgia - Support for Establishment of Credit Unions 11 D. Moldova - Support to Savings and Credit Associations and SME Credit Line through

Commercial Banks 12

E. Romania - Credit Line through Commercial Banks 14 IV. RURAL FINANCE DEVELOPMENT AND POVERTY ALLEVIATI ON:

POLICIES AND PERSPECTIVES 14

A. Poverty Status 14 B. Rural Finance Development and Poverty Alleviation 16 C. Perspectives 18 V. MAIN ISSUES IN CAPACITY BUILDING AND INSTITUTION AL

DEVELOPMENT FOR IFAD SUPPORTED RURAL FINANCE INSTIT UTIONS 19

A. Types of Financial Institutions, Legal Forms, Governance 19 B. Pro Poor Orientation 22 C. Loan Portfolio Quality 23 D. Deposit Mobilisation 25 E. Other Financial and Non-financial Services 26

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VI. VILLAGERS’ VIEWS: DEMAND SIDE OF RURAL FINANCE 29 A. Approach and Rationale 29 B. Socio-Economic Settings 30 C. Perceptions of Change since Collapse of Communist System 32 D. Access to Credit and Borrowing Patterns 32 E. Access to Deposit Services and Savings Patterns 34 F. Household Income and Asset Structures 34 G. Gender Perspectives 36 H. Views on Investing in Village Economies 37 VII. IMPACT ON PEOPLE’S LIVES AND PRODUCTIVE ASSETS 37 A. Impact on Physical and Financial Assets 37 B. Impact on Human Assets 38 C. Impact on Social Capital and Empowerment 38 D. Impact on Food Security 38 VIII INSIGHTS GAINED 39 A. General 39 B. Financial Systems Development 40 C. Performance of Partnering Financial Institutions 42 D. Emerging Impact for the People and Rural Economies 43 IX. THE WAY FORWARD: CONCLUSIONS & RECOMMENDATIONS 44 A. No Way Back for the New Rural Poor 44 B. From Plan Allocated Credit Distribution to Functioning Rural Finance Systems 44 C. Role of Donors in Institutional Development for Rural and Microfinance 45 D. Rural and Microfinance Strategies and Operations 45 E. Monitoring and Supervision 45 F. Savings and Credit Performance Enhanced through Training and Non-Financial

Services 46

G. Promising Practices in Rural Finance Development for CEN Region 47 H. Policy Role for IFAD in Rural Finance and Poverty Alleviation 48 Appendix: Bibliography 49 Annexes – Country Case Studies* Albania Romania Georgia Moldova

*Annexes are available upon request from IFAD’s Office of Evaluation (evaluation@ifad.org)

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CURRENCY EQUIVALENTS

FOREIGN EXCHANGE RATES (end period)

DATE LEK GEL/1 MDL ROL

USD USD USD USD

31/12/1998 142.00 1.39 8.30 11040.00

31/12/1999 135.70 2.02 11.6 18335.00

31/12/2000 143.65 1.98 12.4 25940.00

31/12/2001 141.73 2.06 13.1 32778.00

31/12/2002 138.77 2.19 13.4 34438.00

31/12/2003 129.42 2.19 13.3/2 40146.32

/1: GEL 1998 1999 figures annual average as per EIU Country Profile, 2002 /2: MDL figures for 2003 as of 30-09-2003, IMF Country Report No. 4/39 Republic of Moldova 2003 Article IV Consultation IMF Staff Report 02-2004

Fiscal Year for All Four Countries Concerned

1 January to 31 December

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Abbreviations and Acronyms

AB Administrative Bank ADF Albanian Development Fund ADP Agricultural Development Project (Georgia) AMZ Apuseni Mountain Zone (Romania) ARD Agency for Rural Development (Romania) BA Bank of Albania (central bank) BP British Petroleum CGAP Consultative Group to Assist the Poorest CEN Central and Eastern Europe and the Newly Independent States CEO Chief Executive Office CI Cooperating Institution CLP Core Learning Partnership CPM Country Programme Manager (IFAD) COSOP Country Strategic Opportunities Paper CU Credit Union CUDC Credit Union Development Centre (Georgia) EBRD European Bank for Reconstruction and Development EUR Euro currency FSU Former Soviet Union GEL Georgian Lari (national currency) GOA Government of Albania GOG Government of Georgia GOM Government of Moldova GOR Government of Romania GPRS Growth and Poverty Reduction Strategy GRF German Romanian Fund GTZ German Technical Cooperation Agency HH Household IAS International Accounting Standards IDA International Development Agency IFC International Finance Corporation IMF International Monetary Fund IPC Interim Poverty Reduction Strategy KFW Kreditanstalt f. Wiederaufbau, since November 2003 renamed as KfW

Banking Group (German Commercial & Development Bank) LEK Albanian Lek (national currency) MADA Mountain Areas Development Agency MAFF Mountain Areas Financing Fund MDL Moldovan Lei (national currency) MEB Micro Enterprise Banks (KfW and IFC promoted domestic commercial banks,

now re-branded as ProCredit Banks) MFI Microfinance Institution MoAF Ministry of Agriculture and Food MSME Micro, Small and Medium Enterprise MTR Mid-Term Review NARD National Agency for Regional Development NBG National Bank of Georgia (central bank) NGO Non Governmental Organisation OE Office of Evaluation (IFAD) PCU Project Coordinating Unit PIU Project Implementation Unit

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PRSP Poverty Reduction Strategy Paper RCB Rural Commercial Bank RDC Rural Development Centre (Moldova) RFC Rural Finance Corporation (Moldova) RFF Rural Finance Fund RFI Rural Finance Institution ROL Romanian Lei (national currency) ROSCA Rotating Savings and Credit Association SAPARD Special Accession Programme for Agriculture and Rural Development (EU) SCA Savings and Credit Association SDC Swiss Agency for Development and Cooperation SFA Subsidiary Financing Agreement SME Small and Medium Enterprise UNDP United Nations Development Programme UNICEF United Nations Children’s Fund USD United States Dollar VCC Village Credit Committee (of VCF) VCF Village Credit Fund

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Rural Financial Services in Central and Eastern Europe and the Newly Independent States

Thematic Evaluation

Agreement at Completion Point

I. BACKGROUND AND INTRODUCTION

1. IFAD has been involved in the Central and Eastern Europe and Newly Independent States (CEN) region since the early 1990s, following the start of the political and economic transition process which continues to characterise the region to this day. This is demonstrated by the 18 projects for a total value of approximately USD 192 million1 which have been approved and are being implemented. The establishment and promotion of rural financial services initiatives, including the provision of credit, savings and other associated services has figured heavily in the IFAD programme in CEN countries. 2. Given the relative importance of the rural financial services activities, the decision was taken to carry out a Thematic Evaluation of the rural finance activities financed by IFAD in the Region. Four of the eight countries with active programmes in the Region were selected, taking into account the nature of the portfolios, including the weight of financial services components, implementation status, and highly concessional borrowing status: Albania, Georgia, the Republic of Moldova and Romania. 3. The main objectives of the Thematic Evaluation were to: (i) thoroughly analyse the demand and supply sides of rural finance in the specific context of IFAD projects in four of the eight countries in the CEN Region; (ii) assess the relevance and effectiveness of IFAD’s approach in support of financial services in these countries; and (iii) based on this analysis, on the IFAD Strategic Framework 2002-2006 and the Sub-Regional Strategy for the CEN Region, formulate recommendations for strategy, design and implementation of future IFAD-financed interventions in the rural finance sector in CEN countries. 4. This Agreement at Completion Point (ACP) is a distillation of the main findings and recommendations of the Evaluation, and has been agreed by the members of the CLP2.

II. OVERVIEW OF MAJOR FINDINGS 5. The findings of the Thematic Evaluation are reflected through: (i) the four Country Background Reports that contain a relevant analysis and primary data collected by the missions which visited the four countries; and a (ii) Synthesis Report which contains the major findings, conclusions and recommendations made by the Thematic Evaluation.

1 Approved IFAD financing. 2 The Core Learning Partnership was composed of: Mr Arben Jorgji, Executive Director of the Mountain Areas Financing Fund, Albania; Mr Noe Khozrevanidze, Programme Director of the Rural Development Programme for Mountainous and Highland Areas, Georgia; Mr Ion Russu, Project Director of the Rural Finance and Small Enterprise Development Project, Moldova; Mr Stefan Petrescu, Director General, Ministry of Public Finance, General Department for External Public Finances, Romania; Mr Henning Pedersen, Country Programme Manager for Albania, Near East and North Africa Division (PN), IFAD; Mr Abadalla Rahman, Country Programme Manager for Georgia, PN, IFAD; Mr Pietro Turilli, Country Programme Manager for Moldova and Romania, PN, IFAD; Ms Mylene Kherallah, Regional Economist, PN, IFAD; Mr Henri Dommel, Technical Adviser on Rural Finance, Technical Advisory Division, IFAD. Dr Mona Bishay, Deputy Director, Office of Evaluation, IFAD, was in charge of the evaluation.

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6. Evolution in the nature of the IFAD portfolio . There is a clear evolution in the nature of the IFAD portfolio in the Region, with early interventions co-financed in partnership with the World Bank being gradually replaced by a second generation of IFAD-initiated and financed projects, with an increasingly focused development orientation to meeting the needs of the rural poor. The second generation projects also show, on average, a sharpened focus on rural financial services development and delivery. 7. Partnerships. As mentioned in paragraph 6 above, IFAD’s first generation projects were co-financed almost exclusively with the World Bank, while follow-up projects have been co-financed with a variety of international agencies and bilateral donors, including the OPEC Fund, DfID, SIDA and SNV (the Netherlands). This does not include a variety of potential co-financing partners currently operating in the region. IFAD has not, for example, partnered with other organisations that have been prominent in the development and/or reform of the formal financial sector, including EBRD and KfW. This is, partly at least, the result of the vastly different funding cycles, operating modalities and strategic focus of these institutions. 8. Institutional Options . The work of the Thematic Evaluation has illustrated the three broad categories of institutional options for rural financial services development in the Region: (i) formal financial sector – commercial banks; (ii) non-banking financial institutions; and (iii) member-owned institutions. 9. Commercial Banks offer the advantage of being well-established, usually with an extensive branch network and subject to central bank supervision. They are also in a position to provide, in addition to access to loans, a full range of financial services, ranging from money transfers to current accounts and cheque facilities, which are often of great importance to rural customers. Furthermore, lending products can be easily diversified by commercial banks with access to different terms and foreign exchange as well as domestic currency facilities, making it possible to offer different customers financial products well suited to their specific needs. The disadvantages to working with commercial banks relate to the relatively high operating costs and especially to the difficulty to ensure a focus on the traditional IFAD target group of the rural poor. 10. Non-bank financial institutions (NBFIs) is a broad category covering institutions that could graduate to commercial bank status in the future (an example would be the IFAD-financed Mountain Areas Finance Fund – MAFF – in Albania) as well as ‘financial service’ providing NGOs and microfinance institutions. Member-owned institutions are member-owned and governed institutions that are usually proximity based, offering a decentralised management structure, and tend to be smaller institutions based on a participatory grassroots approach to the provision of small-scale financial services (the development of the Savings and Credit Association – SCA – network in Moldova being a prime example). 11. NBFIs and member-owned institutions face a number of similar opportunities and challenges. They offer relatively similar services, usually starting out through the provision of small-scale loan programmes and gradually developing a series of complementary services for their client base, with both institutional types relying on a proximity based, low-cost operating structure. The main drawback for these institutions is the nature of the legal framework, which either does not exist or is incomplete, making it difficult, if not impossible, for these institutions to develop over the short to medium term. 12. Given the instability of the financial sector early in the transition period and the immense losses which the general population was forced to bear following bank collapses (the Albanian pyramid schemes being the one example), central bank regulators often remain very hesitant to allow these types of institutions the ability to mobilise savings. Being barred from attracting savings makes it difficult for them to become self-sustaining, and forces them to rely on regular capital injections (on

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either a grant or heavily subsidised basis) from donors and revolving credit funds as quickly as possible to ensure some level of profit-making. 13. Project management and supervision issues. A development oriented rural finance initiative requires monitoring and evaluation of relatively few key performance indicators: disbursement performance vis-à-vis the target group, repayment/arrears performance (including ageing), service costs for the institution and transaction costs for clients. A portfolio management system based on these indicators should provide the input for supervision of the implementation of the rural financial services activities foreseen at project level. A basic set of key performance indicators, as well as other major issues of importance to IFAD (including gender, targeting and outreach) should be spelled out clearly at design of the M&E systems and agreed upon with the Cooperating Institution and built into the TORs of supervision missions. The RIMS system adopted recently by IFAD will go a long way in achieving this. 14. Development of relevant lending products for the IFAD target groups. Broadly speaking, short-term credit is readily available through a variety of institutional mechanisms through the CEN region. What is clearly lacking however, are adequate medium and long-term loan products, which would help meet one of the greatest needs of the poor rural population – access to financial services which would allow them to recapitalise firms and modernise infrastructure which have suffered from over a decade of inadequate investment. 15. Collateralisation of lending. The need to develop medium and long-term lending products is also tied to the complex issue of collateralisation of lending, and especially to the difficulties in the valuation of land for use as collateral. Along with private commercial banks’ perception of rural lending as inherently risky, this is probably one of the most serious constraints to the development of longer term financial products more in line with the needs of the IFAD beneficiary group.

III. RECOMMENDATIONS 16. Enhancing partnerships. Efforts should continue to be made to widen the scope of partnerships and co-financing arrangements with other stakeholders involved in rural financial services activities in the Region. Communications between IFAD and prominent regional institutional players in rural finance need to be enhanced, and PN (possibly in collaboration with PT) should explore potential for establishing learning and partnership links with active donors, commercial banks, microfinance institutions, NGOs and CSOs. PN should continue to focus on expanding partnership and co-financing arrangements with international and bilateral donors, as well as with NGOs and CSOs in the region. Follow-up action – PN Division. 17. Improving implementation performance. As highlighted above, the effectiveness of monitoring and evaluation as an important management tool for improved implementation would be heightened with the inclusion of a standard set of key performance indicators in all projects. This should implemented in all Subsidiary Financing Agreements, as well as being integrated as a standard review activity in all CI supervision missions. Furthermore, performance should be evaluated by the Borrowing Government and IFAD through Project Units, supervision and follow-up mission, A set of key performance indicators should be included in all M&E systems as well as Subsidiary Financing Agreements and as a standard review activity in all CI supervision mission. Adequate sanctioning mechanisms for participating financial institutions (PFIs) non-performance should be built into the Subsidiary Financing Agreements. Follow-up action – PN and OL, with collaboration of PIUs and CIs.

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18. Providing financial services relevant to the entire rural economy supply chain while continuing to support smallholders. While it is clear that the development of a sustainable rural financial services institutional network in the CEN region will require developing financial products and providing both technical and financial support throughout the entire supply chain – from smallholder to agro-processing units to marketing channels – IFAD must maintain as its main foci the emphasis on supporting the rural poor. This will entail ensuring that, suitable products targeting the rural poor and smallholders are developed within the context of IFAD country programmes in the region. This also requires IFAD to support the development of medium and long term financial products to help capitalise firms and replace obsolete infrastructure and machinery in rural firms. IFAD should continue to focus on smallholder lending for its traditional target group, along with developing medium and longer term financial products for other beneficiary groups, within an overall strategy to support (both technically and financially) critical actors and activities throughout the entire supply chain in support of rural poverty reduction, in line with its sub-regional strategy. Follow-up action: PN, with collaboration of PIUs, PFIs and CIs 19. Ensuring impact of larger SME loans. In line with the sub-regional strategy, the IFAD-financed portfolio in the region is increasingly supportive of medium sized loan products targeting the rising dynamic elements which will form the backbone of the rural economy, generating employment and on and off-farm income generating activities with direct link to the rural poor. Given the uneven capacities in the financial institutions in the region, all SME loan products should be implemented by financial institutions which IFAD is satisfied have the professional skills to assess the loan applications. IFAD should provide, in the context of its projects and programmes, support to develop capacities of participating financial institutions in this respect. In supporting critical actors and activities throughout the entire supply chain with the ultimate aim of rural poverty reduction, IFAD should carefully assess the capacities of participating financial institutions and provide capacity building technical assistance as necessary. Follow-up action: PN, PIUs, CIs and PFIs 20. IFAD specific concerns. There has been a steady improvement in terms of the IFAD-financed projects’ focus on participatory development processes, gender sensitive implementation and pro-poor orientation with the evolution of the IFAD programme in CEN countries. A fundamental element which should receive more attention in the development and design of future projects and programmes is the need to develop a thorough understanding of social conditions in rural areas. This is especially important in the design of small-scale financial services products (as highlighted in paragraph 18 above). This will improve design and help avoid the implementation of ‘blueprint’ approaches which are not always well-tailored to local community needs and realities. Small-scale financial services need to be designed following an in-depth analysis of prevailing economic and especially social conditions at the local level. Follow-up action: PN 21. Technical assistance. There is a need to provide focused technical assistance to build capacities in the formal financial sector in the region. However, Governments in the region have been hesitant to finance any sizeable technical assistance programmes through loan funds, even if their importance to project implementation is well understood. In this regard, and in line with the recommendation made regarding partnerships (as noted in paragraph 16 above), PN should enhance its efforts to attract grant-financed technical assistance from like-minded donors, complementing IFAD loan funds and improving implementation performance. Every effort should be made to attract grant financed technical assistance and/or improve donor coordination to ensure that IFAD-financed loan funds are used for productive investments, while

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at the same time providing for the technical assistance required to enhance project implementation and build capacities at project level. Follow-up action: IFAD, National Governments 22. Learning and innovation. IFAD (as all other donors) has been involved in the CEN region for a relatively short time and PN needs to focus on feeding lessons learned from project implementation into the future project design. The specific conditions faced in the region also reflect similarities to some of the challenges faced in a number of other IFAD regions. PN needs to enhance and strengthen its knowledge sharing capacities both within the Division, in IFAD as a whole, and with other interested stakeholders. Information and lessons learned from project implementation experience must be distilled and reapplied in new project design, both within the Division and in IFAD as a whole. A focused learning group bringing together all PN CEN region CPMs and representatives from concerned IFAD divisions (including PMD, OL, FC/L and OE) as well as the CI should be formed to carry out this task. Follow-up action: PN, concerned divisions, CI

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Rural Financial Services

in Central and Eastern Europe and the Newly Independent States

Thematic Evaluation

Executive Summary1

I. CHALLENGES 1. The fall of the communist system in Eastern Europe and the former Soviet Union brought about a dramatic transformation of the overall socio economic framework and people’s expectations as to how life would be in a free market and politically pluralistic society. The advent of new realities in the post-communist period found the rural population particularly unprepared, above all, those at the geographic edges mountain areas, or other remote agricultural or forest regions. 2. Specific features of poverty in Eastern Europe and the former Soviet Union. Under the equality-focused communist system, rural poverty was not a widespread phenomenon. A separate and identifiable segment of ‘the poor’ was not part of the rural social structure. The withdrawal of the social services and safety nets familiar to villagers after decades of communism added to the hardship of rural families, as the market system became established, with its focus on the costs and benefits of social services. The transition process also affected rural women and kept some of them at home sometimes against their will, further constricting household incomes and cash flows. 3. As they were faced with their new economic and living conditions, rural societies had little defence mechanisms at hand to face their new difficult realities. In Eastern European villages where the concept of private farming was almost forgotten the challenge of helping oneself out of a difficult situation through taking up new jobs or running an own micro business was little known. 4. Institutional development on the fast track. With the old system disappearing and nothing at hand to replace it, success had to come fast, and there was simply no time or patience among any of the major stakeholders involved in rural finance development in Eastern Europe (such as farmers and the wider rural population, governments, politicians and other key decision-makers) to let systems evolve over time. This also made it more difficult for people-based rural finance − systems such as village savings and credit associations, thrift and credit cooperatives, or small single-unit village banks – to grow step-by-step, and in tune with gradually increasing savings, business volumes and membership figures. 5. Lack of trust in the financial system and its institutions. The hardship suffered by millions of depositors who put their savings into established and seemingly trustworthy banks in all states constituting the former Yugoslavia, and the former Soviet Union could not be forgotten. Losses by Azerbaijani depositors resulting from the collapse of the Sper Bank amount to more than USD 1 billion, 30 per cent more than the entire loan portfolio outstanding in the country to date. In Albania, with the collapse of the pyramid schemes in the late nineties, the higher risk nature of the institutions involved was at least more visible, but this offers little comfort to rural families who lost all their savings, pensions and rainy-day funds as a result of the bankruptcy of these financial institutions.

1 The thematic evaluation missions were composed of: Dr Rauno Zander, mission leader and rural finance

specialist; Ms Paivi Pylkkanen, socio-economist; Ms Sandra Romboli, IFAD Associate Professional Officer and institutional specialist; Ms Helen Lackner, sociologist; Ms Lea Joensen, IFAD Associate Professional Officer; and Ms Ranjanai Murthy, sociologist. Dr Mona Bishay, Deputy Director of the Office of Evaluation, supervised the evaluation. The field work of the evaluation covered four countries: Albania, Georgia, Moldova and Romania.

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6. Legal and supervisory sector conditions. Compounding this loss of faith in financial systems is a legal and supervisory framework that remains still ineffective in many cases, and unsupportive of sound, non-corrupt and well-functioning rural financial systems and institutions. In order for financial institutions (including rural and microfinance institutions) to thrive, governments need to establish an appropriate regulatory framework, supervising agencies with the capacity to oversee larger numbers of dispersed institutions operating with smaller credit volumes. 7. External establishment and de facto ownership. A further challenge faced by external promoters of rural and microfinance institutions in the Central and Eastern Europe and the Newly Independent States (CEN) region has been the establishment of a clear legal ownership regime for rural finance mechanisms. Governance structures of various institutional models – ranging from large commercial to small specialized and single-unit banks, village banks and savings and credit cooperatives – are all based on the privilege of clearly defined owners who ultimately influence, control and oversee the affairs of ‘their’ institution. Where donor money comes in without making local people responsible and part of the process, externally established institutions are in danger of being used to extract money and resources, rather than have their resources used for sustainable institutional growth. 8. Credit-led institutional development. The absence of general financial intermediation between depositors’ excess liquidity and borrowers’ effective credit requirements under the communist system, combined with a generalized lack of trust in banks and other financial institutions, have created a climate in which small farmers may be ready to take out a loan, but much less likely to put their own savings into a financial institution. Loans represent a temporary transfer of resources in farmers’ favour but savings are a de facto transfer of control of their resources to an external institution. Trust is required to ensure that savings, once deposited, can safely be withdrawn. 9. Centralized credit procedures and corporate-only lending. In all four countries surveyed (Albania, Georgia, Moldova and Romania) banks were part of the institutional infrastructure of small towns in rural districts (raions or judhetes). These banks distribute pensions and transact inbound money transfers from wealthier regions or relatives working abroad. They are not normally authorized to lend to private farmers and other non-corporate borrowers, nor do they have a credit officer in place in these branches to support a lending function. Branch managers have either no credit-granting capacity at all or only very limited scope for lending. Loan applicants from rural districts have to deal directly with the head office in the capital, often many hours journey away. Credit analysis and approval are centralized and loans to rural loan applicants are granted only by head office staff. Finally, most of the old-style banks in the region still do not lend to non-corporate borrowers (legal entities versus individuals).

II. RURAL FINANCE IN IFAD’S CEN SUBREGIONAL STRATE GY 10. The overall development goal of IFAD is to contribute to the reduction and eventual eradication of poverty in rural areas. IFAD’s Strategic Framework 2002-2006: Enabling the Rural Poor to Overcome their Poverty translates this goal into three main objectives.

� Human and social assets: strengthening the capacity of the rural poor and their organizations; � Productive assets and technology: improving equitable access to productive natural resources

and technology; and � Financial assets and markets: increasing access to financial services and markets.

11. With these three strategic objectives the Fund specifically promotes income-earning and employment-generating activities among lower-income farmers and other households in rural areas in the eight countries in the CEN region where it currently operates (Albania, Armenia, Azerbaijan, Bosnia and Herzegovina, Georgia, the Republic of Moldova, Romania and The Former Yugoslav

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Republic of Macedonia). Access to affordable and reliable financial services is seen as an important factor in harnessing local resources and rendering the skills, land and productive assets of the rural poor more productive. 12. The IFAD CEN subregional strategy specifically stresses the need for a wide variety of rural financial institutions in the CEN region. These should be supported both in their short-term supply of seasonal credit and in their provision of long-term and investment loans for agriculture and rural development. To this effect, IFAD promotes the integration of rural microfinance into national anti-poverty strategies and operations. In the Caucasus and Albania, IFAD has focused specifically on more remote mountain areas.

III. THE SITUATION TODAY 13. Throughout the CEN region, poverty among farmers and in rural economies continues to persist at a wide scale. Constant high levels of migration from farmlands to urban and semi-urban areas are similarly continuing. 14. IFAD portfolio and approach in the CEN region. Against this background, the rural microfinance activities of IFAD in the CEN region were assessed. A survey at the outset of this study indicated that, out of a total of USD 140 million in IFAD loan proceeds for interventions in these countries, USD 65.7 million was used for rural microfinance activities, either in the form of sub-loans or non-repayable grants for capacity-building or institutional development. 15. Altogether, IFAD’s approach to rural finance in the region is characterized by a proactive learning process and the selective transfer of successful technologies from other regions and countries. These ‘first-generation’ projects with rural finance activities were often implemented in partnership with the World Bank as the initiator. With portfolio experience building up and a better understanding as to how to specifically support the rural poor, the Fund proceeded to prepare a ‘second generation’ of IFAD initiated programmes with improved targeting mechanisms, specifically targeting poor segments of the rural population who had income-earning potential but were experiencing problems of access to markets and production factors. These second-generation projects are usually IFAD-initiated. Often, but not always, they focus on mountainous regions. The promotion of credit, savings and other essential financial services plays a major role in the current portfolio of IFAD-initiated and financed programmes. 16. What have financial systems and institutions contributed to rural development? More than a decade after these profound changes, the supply of rural financial services is still uneven. Donors and external support agencies have had a major influence on the rural finance sector and there is better access to rural finance where donor programmes and initiatives have been more successful, for instance in the farmlands of the Republic of Moldova, in rural Kosovo and in the highlands of Albania. In a few parts of Eastern Europe, traditional rural banks have survived, but are mostly ailing. 17. The presence of rural lending institutions is still rather irregular. The evaluation indicates that whereas in Albania’s highlands, all banks and other financial institutions in the district centres have stopped lending and only the IFAD-supported Mountain Areas Finance Fund (MAFF) and a couple of small, local donor funds give credit to farmers, the Moldovan countryside has been transformed by the operations of about 500 savings and credit associations (SCAs) spread throughout the country.

IV. BENEFICIARY PERSPECTIVE 18. The thematic evaluation focused specifically on the views of the people for whom the IFAD programmes were designed – small farmers and other lower and low-income rural people with productive potential, but with a dearth of capital constraining their income-generating possibilities.

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Insights from the field are encouraging. For members of the Moldovan SCAs, incomes have increased as a consequence of borrowing for small productive purposes. The extent of the increase ranged from 5 to 60 per cent over the pre-loan period. Also cited as encouraging was the collective impact of new and democratic governance patterns on these savings and credit associations. Elections in these SCAs are conducted democratically and with a secret ballot. 19. In Georgia, members of successfully operating credit unions reported considerable increases in household food security, income and sometimes also employment. Such gains are irrespective of gender since about half of the credit union members are women. 20. The evaluation described IFAD projects in Albania as having a significant impact on rural poverty reduction. However, with the stabilization of the political and economic situation, there is now a trend towards more individualized production. As a consequence, small individual loans are more in demand than group-based delivery structures. Similarly, where land titles are safely secured, production and marketing are conducted individually. 21. Comparatively speaking, the project financial services with the least beneficial impact were noted in Romania. Existing legislation for commercial banks results in collateralization of very small loans, comparatively high interest rates and complicated loan application and analysis procedures. Small farmers complained that, for loans as small as USD 2 000 to USD 5 000 equivalent, the entire real estate of the farm was blocked as collateral (farm buildings and plots valued at between USD 20 000 and USD 100 000) and required loan documentation as costly to obtain and unnecessary.

V. AVAILABLE OPTIONS

22. The regional evaluation illustrated that institutional options for rural finance development in Eastern Europe and the former Soviet Union basically consist of three alternatives: 23. Commercial Banks (and Non-Bank Financial Companies that could graduate into banks at a later stage) can provide the full range of financial services to their customers. Money transfer, current account and cheque facilities may be as important to an emerging small farmer or micro entrepreneur as access to loans. Types of loans can be more easily diversified by a commercial bank with access to funds with different terms and foreign exchange as well as domestic currency facilities. A bank can grow with the client, establish a relationship through loans when the farmer is still small, and then grow to a full service provider later on. In the evaluated programmes, banks were used mostly as providers of large scale investment loans, partly financed by IFAD (Moldova and part of the Romania portfolio) and partly financed by other sources (World Bank in Georgia). The NBFC established by IFAD in Albania, MAFF also offers the entire range of lending services, from small working capital loans to large SME investment finance, the latter without any competitor in rural Albania and with a comparatively high first mover advantage in a traditional society like Albania where relationships, once established, are maintained as a question of honour. 24. Thrift and credit cooperatives and credit unions. These member-owned and member-governed institutions are proximity-based and offer physical accessibility for rural people as their main plus point. This type of decentralized financial institution was the prime model for promotion of rural finance in the four countries covered by the regional evaluation, but the success in introducing these networks of small rural finance institutions was uneven. While they emerged as the most important retail finance providers in rural areas of the Republic of Moldova, their success in countries such as Georgia fell short of expectations. 25. Financial and General Purpose NGOs with financial services have an overall good outreach covering not only small towns, but also more rural and agricultural areas. These microfinance institutions (MFIs) are more mature and have been operating longer in the CEN region than in other

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parts of the developing world. Many of these operators (often with eight to ten years of operational experience) have separated from their international parent NGO and recommenced as local domestic microfinance institutions with their own board and domestic management staff. After extensive support with non-repayable grants, these institutions have reached a level of maturity that permits them to seek commercial sources of funds and to lend commercially. None of the four countries studied for this regional evaluation had such MFIs included in their projects. More recently designed IFAD programmes in Armenia, Azerbaijan and Georgia have begun to cooperate with NGO-type MFIs.

VI. ADVANTAGES AND DISADVANTAGES OF THE THREE OPTI ONS 26. Banks and non-bank financial companies such as the IFAD initiated MAFF in Albania can offer a full range of financial services and grow with the initially small client. However, in the CEN region the ownership and governance structure of commercial banks remains in some cases unclear. In the case of state-owned banks, the real decision-makers and their motives for action are sometimes not easily identifiable. Equally, in the case of some privately-owned banks, the ubiquitous syndicates of private business people holding shares can mean myriad objectives and strategies for the business and strategic development of a commercial bank that may not be fully understood by project designers. More generally, commercial banks are also disadvantaged in rural finance development by their lack of experience in the specific products and lending technologies of agricultural finance, their reluctance to reach out to non-corporate, small, single-proprietor businesses without audited accounts or a credit history, and the high costs and perceived high risks of lending to lower income and smaller credit applicants. A new type of microfinance bank operating in ten countries in the CEN region has however illustrated the potential of a licensed commercial bank to operate profitably with an exclusively small and microentrepreneur clientele. 27. Thrift and credit cooperatives, credit unions and other forms of mutualist and proximity-based finance institutions operate close to village and small-town economies and can operate profitably even in remote and difficult-to-access regions. Their democratic governance structure and voting procedures ensure that this type of rural finance institution is member-owned and member-governed. 28. On the other hand, thrift and credit cooperatives are more vulnerable than other forms of rural finance to political interference and take-over by rural elites or representatives of village power structures. The country studies undertaken in the context of the thematic evaluation have reiterated the crucial importance of the initial and founding phase of a credit union. Where future credit union managers select the credit union members themselves, chances are that the change-oriented and business-minded part of the rural population will not be fairly represented. Where, however, villagers form a group on their own initiative, look into the potential of the thrift and credit cooperative model for their village and then choose leaders from among the community, it is much more likely that a sustainable and well-managed village credit union has been established. 29. Financial NGOs, when new or only recently established, have a high overhead cost structure and initially concentrate solely on lending in urban environments. Caution is needed in approaching situations where ownership is still vested in the international support institution and the MFI concerned is an affiliate rather than an independent local body. Similarly, where microfinance operations are still functionally linked to the other humanitarian activities of an international NGO, the possibilities for partnering are limited for a larger-scale donor like IFAD, with no possibilities for direct funding to support programme operations.

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VII. COSTS OF EACH OPTION 30. Commercial banks constitute the highest-cost option if they are newly established, as in the case of the ProCredit Banks in Eastern Europe (a network of ten microfinance institutions). In this case, a proven partnership among different international financial institutions capitalizes these banks and also raises the initial loan funds. As illustrated by the IFAD-established MAFF in Albania, capitalization on the basis of past credit portfolios bears its own risks since the valuation of these portfolios at the time of asset transfer may be overly optimistic. All the same, MAFF is a case where a non-bank financial institution was created as a new bank-like operator with reasonable amounts of capacity-building and establishment funds. 31. Without donor support, thrift and credit cooperatives/credit unions are normally the cheapest form of rural finance institution. In Georgia, the IFAD initiative of establishing a countrywide network of rural credit unions provides a typical example. A group, ranging between 10 and 50 members, forms the institution and registers and/or licenses it as required. The institution may then be staffed initially on a part-time or purely volunteer basis and staff levels may increase only in response to increased business revenues. As the work of the Irish League of Credit Unions in several countries in the CEN region shows, this is a slow process that can easily take up to a decade. External donor and support agencies with their three- to five-year project implementation horizons do not allow for such a time frame. For this reason, the creation of credit unions is catalysed with external establishment grants of usually between USD 3 000 and USD 5 000 per credit union, plus the sourcing of external loan funds. The organic growth of a credit union led by a gradual increase of member deposits and lending solely out of internally mobilized funds cannot be accomplished within a two- to four-year period. In countries such as Albania, Kosovo and the Republic of Moldova, the savings and credit associations operate on a group basis but exclusively with externally sourced loan funds without mobilizing any internal deposits at all. 32. Financial NGOs (such as Agricultural Cooperative Development International/Volunteers in Overseas Cooperative Assistance (ACDI/VOCA), the Foundation for International Community Assistance (FINCA), Mercy Corps, World Vision and World Relief). Differences among these operators in terms of cost of operations and overheads are considerable, largely due to widely differing salary structures for international and local staff, different levels of grants for operating costs during the establishment and consolidation phase, and different delivery mechanisms. Quite often, a localized MFI operation with fully capitalized head office costs and some grant or concessional funding for onlending in the balance sheet from its start-up phase is in a good position to borrow on commercial or semi-commercial terms from an international financial institution or out of rural finance project funds.

VIII. RECOMMENDATIONS AND OTHER INSIGHTS GAINED 33. Detailed recommendations are contained in the final section of this study, as well as the final sections of the country studies for Albania, Georgia, the Republic of Moldova and Romania. They are summarised below:

A. Design Recommendations 34. Design recommendations in rural finance need more adjusted flexibility during implementation due to the fast changing conditions in the CEN region. Mechanisms have to be found to shift some of the design resources into the implementation phase to cope with the need for re-design while implementing a programme (as in the case of the Republic of Moldova project). 35. Appraised and selected partner institutions should be more diverse in the future. At the time of the evaluation in the country studied, IFAD supported mainly credit union-type networks (Georgia,

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Moldova, and earlier in Albania) and larger volume SME credit lines through commercial banks (Albania and the Republic of Moldova). However, banks in the CEN region can also transact small-scale loans with microentrepreneurs and small farmers with average loan amounts of between USD 1 000 and USD 5000. IFAD should make more use of this conduit, and collaborate more with financial NGOs. Some such NGOs have been operating for more than five years and have reached an institutional development path that would permit them to lend on commercial or near commercial terms, rather than being the passive recipients of grants and non-repayable contributions or consulting services.

B. Targeting 36. Poverty impact of large-scale SME loans. In Albania, IFAD consolidated three project credit portfolios and established MAFF as an institution providing small retail and large SME loans of up to USD 100 000. This example has shown the difficulty in achieving a poverty impact through a ‘trickle down’ of large loans. Field interviews conducted with large borrowers showed that it is generally difficult to make the case for large rural SME loans as an effective poverty-reduction mechanism unless clear proof can be given as to the direct and/or indirect employment generations of these loans. Since these loans are already offered by institutions such as the European Bank for Reconstruction and Development (EBRD), the German Credit Institution for Reconstruction (KfW) and the World Bank, a partnering with these institutions (possibly also through parallel financing) and a freeing of IFAD resources for more direct strikes on poverty should be considered. 37. Results in all four countries show that the poorest members of village communities are unlikely to benefit directly from IFAD lines of credit or IFAD-financed institutions with a wider range of services. Very poor rural people first need assistance to reach a situation where they can profitably absorb credit. For this reason, a more proactive inclusion of the very poor, and in particular women, would require a front-loaded social and community mobilization component.

C. Institutional Capacity 38. The study has revealed the extent to which rural financial systems and institutions in all of the sampled countries had collapsed. To its credit, IFAD-supported rural finance systems in Albania, Georgia, the Republic of Moldova and, to a large extent, also Romania constitute the only credit and deposit mechanisms for large parts of the rural population. This considerable institutional gap has been addressed through IFAD-supported interventions that establish, consolidate and scale up innovative types of institutions, such as MAFF in Albania, the SCAs in the Republic of Moldova and credit union networks in Georgia. Two particular challenges in this context were ensuring outreach of these institutions to rural low-income households, and finding an institutional development path with concrete prospects of reaching operational and financial sustainability in the medium term. In this area IFAD has succeeded to a large extent. 39. The service capacity of existing rural banks for credit operations has to be critically assessed in situ. Wherever a significant expansion of branch credit portfolios is being planned, the ‘without project’ situation has to be professionally analysed, and technical assistance offered for training and skills development of the credit officers to be deployed in rural branches. 40. The study also showed that three out of four rural finance programmes supported by IFAD promoted the development of new institutions. Far from being an exception, the development of new financial institutions (called by KfW the ‛greenfield approach’) has fared comparatively well in the CEN region and in the IFAD portfolio. Too many old or existing financial institutions, from the public and private sector alike, operate with non-transparent owner and stakeholder arrangements and can be plagued by sudden frauds, illegal transactions and so on. This is a positive achievement for IFAD that has to continue in the future.

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41. The example of Romania shows that: (i) a single bank selected for onlending of IFAD funds may use its monopsony position for the interest of the institution rather than the poverty-reduction programme; a pool of banks with flexible disbursements and other programme support in line with programme performance ensures better services; (ii) partner financial institutions should be selected as part of project design and appraisal; the Romanian situation, where no partner financial institution could be identified for a programme that was basically financial services-driven, should be avoided; and (iii) subsidized interest rates for loans as part of IFAD appraisal recommendations requires critical review. 42. Other operators – such as microfinance NGOs, national credit union networks or NBFCs – have limited capacity to absorb loan funds for poverty reduction. Even though capacity may be built up over time and with complementary technical assistance, an average sized microfinance NGO may not be able to absorb more than USD 500 000 of additional loan funds that would recycle within the institution profitably. Such unit sizes for refinancing funds are too small for most international financial institutions. IFAD is more flexible in this respect and should wield this flexibility as the first mover in providing loan funds on commercial or near-commercial terms to rural MFIs.

D. Monitoring and Supervision 43. Monitoring indicators should focus more on social and general impact. In particular, SME lines with loans up to USD 100 000 have to have a good tracking and monitoring system to measure whether incremental income and employment have been created for the IFAD target group. Likewise, the creation of more than 160 credit unions through an IFAD-cofinanced project in Georgia, without providing for the monitoring of social, physical and human assets, and social capital development, seems to fall short of the desired objectives.

E. Policy Dialogue and Involvement in Ongoing Poverty Assessment Processes 44. In Romania, IFAD’s position as an international financial institution with onlending funds actually taken up and utilized could have been used for a process of joint learning and policy adjustments. In particular, collateral requirements for small and retail loans would require review. Coordination with other donors (such as those operating the German-Romanian Fund) would have improved the prospects of involving other commercial banks in agricultural lending in the project area. 45. In Georgia, better identification of constraints to credit union formation and development particularly in the field of policy and institutional framework could have assisted in directing IFAD’s efforts in policy dialogue. This would also have addressed practical issues of great relevance to small rural credit unions in mountain areas, such as tax exemption, which is the norm for thrift and credit cooperatives in other countries. Other issues, such as a relaxation of the rather high minimum requirement of 50 members to form a union, also needed to be addressed. As the regulatory authority, the central bank has signalled its interest in receiving and reviewing this type of proposal to ensure that Georgian credit unions remain open to small operators in future. 46. In the Republic of Moldova, and to an extent also in Albania, policy dialogue and proactive involvement in ongoing poverty assessment processes would have resulted in a clearer strategy for institutional growth and a valid direction of development for both the Moldovan SCAs and Albania’s MAFF. 47. The emerging rich and multifaceted experience of IFAD in rural finance development for poverty reduction should be made available more proactively throughout the donor community, and among domestic and international decision-makers. In particular, IFAD should be more engaged in the participation process that precedes the drafting of poverty reduction strategy papers (PRSPs). Comparing the sections of PRSPs, such as those for Albania and Georgia, that describe concrete

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emerging experiences and lessons learned from IFAD rural finance development illustrates that IFAD has a lot to offer in formulating concrete recommendations for rural finance development strategies and activities in the CEN region.

Rural Financial Services

in Central and Eastern Europe and the Newly Independent States

Thematic Evaluation

I. INTRODUCTION 1. Early after the fall of the Communist system in the countries of Eastern Europe, the Caucasus and Central Asia, IFAD became engaged in the region. With its specific development mandate of alleviating the poverty of rural poor people with productive potential, IFAD was soon approached by Governments to apply its experience in rural and microfinance also in Eastern Europe and the former Soviet Union. However, mindful that its core competence at the time was built up primarily in the Near East and North Africa, Asia, Latin America and other regions in the Southern hemisphere, the Fund applied a cautious approach of partnering with larger institutions and only responding to specific government requests in the period soon after the breakdown of previous Communist systems. With portfolio experience building up and a better understanding as to how specifically support rural poor people, the group of specific interest to IFAD and its development mandate, the Fund then prepared a second generation of programmes. These more recent IFAD interventions are characterised by a process of targeting poor segments of the rural population with income earning potential but access barriers to markets and production factors. Often, but not always, these second generation projects focus on mountainous regions. Both in the first generation of largely co-financed programmes, and in the current portfolio of IFAD initiated and financed programmes the promotion of credit, savings and other essential financial services usually play a major role. 2. Mindful of the importance of rural finance promotion in the region and IFAD’s emerging role in this process and of the need to continuously feed back lessons from experience into programme design and implementation, IFAD’s operational division for the region, IFAD-PN of the IFAD Programme Management Department requested the IFAD Office of Evaluation (IFAD-OE) to undertake a Thematic Evaluation of IFAD’s Approach to Rural Financial Services in Central and Eastern Europe and the Newly Independent State1. The Study was implemented in four countries of the region with ongoing IFAD financed activities in rural finance development, Albania, Georgia, the Republic of Moldova and Romania. The four country cases were mainly selected based on the importance of rural finance in the overall project cost table. 3. Dr. Mona Bishay, IFAD’s Senior Evaluator, coordinated, guided the work of the different missions and provided leadership in managing the process of launching, carrying out and synthesising mission findings. A consultant, Mr R. Zander, was the team leader of the four different missions and compiled the four country reports and the regional study synthesis. 4. After the compilation of an Approach Paper for the Evaluation that circulated within all concerned operational, policy and other concerned IFAD divisions, the first mission visited Albania in November 2002. Georgia was then visited in January 2003, Moldova in February and Romania in March 2003. 5. In addition, the mission was invited to join the kick-off workshop for a similar regional study in South Eastern Europe. This financial sector symposium was held by the German KfW Banking Group in Berlin in November 2002.

1 Central and Eastern Europe and the Newly Independent States - a regional grouping known in IFAD as CEN. CEN countries encompass Poland, the Czech Republic, Slovakia, Hungary, Estonia, Latvia, Lithunia, Belorussia, Ukraine, Moldova, Romania, Slovenia, Croatia, Bosnia Herzegovina, Serbia and Montenegro, Macedonia, Albania, Bulgaria, Georgia, Armenia, Azerbaijan, Kazakhstan, Kirgizstan, Uzbekistan, Tajikistan. The IFAD portfolio includes eight countries of the CEN region.

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6. The process of joint learning from each others’ experience both IFAD-internally and with government and other key stakeholders was set in motion through creating a Core Learning Partnership (CLP) group in October 2002. Members are listed in footnote 2 of the ACP. They include IFAD management, responsible country programme managers and representatives from IFAD Cooperating Institutions. CLP members received the relevant country case study documentation generated by the mission and gave valuable feed-back to the different missions. 7. Following the Agreement at Completion Point, it is proposed to convene a workshop bringing together all involved IFAD departments and divisions, practitioners from partnering rural finance institutions, governments and other interested donors active in the field in order to validate elements of a new strategy for rural finance on the basis of insights gained and recommendations made during this mission. In the course of this workshop, this report will be discussed and finalised.

A. Goal and Objectives 8. Goal: This study-cum-evaluation was conducted with the overall purpose of reviewing the experiences gained in the IFAD regional portfolio in Eastern Europe and the countries of the former Soviet Union, within the emerging context of the rural financial sector in CEN countries, analysing successes achieved, constraints encountered and identifying options for improvements and lessons learnt. 9. Objectives: The five specific objectives of this regional evaluation were to:

a) examine IFAD’s approach to Rural Financial Services in the region and the extent to which it took into account institutional, policy and socio-economic differentiation among countries;

b) assess the main features of the implementation experience so far and the relevance of projects’ objectives given the changing socio–economic and policy conditions during implementation;

c) analyse in selected projects the achievements in reaching the rural poor through financial services and to the extent possible the degree to which the objectives of these projects are likely to be met;

d) identify and scrutinize the major cross-cutting issues and emerging constraints in IFAD’s experience with special reference to IFAD’s influence on rural financial services policies at country level; IFAD’s catalytic role in providing replicable models for upscaling; as well as options for improvement with respect to ongoing operations and for future policies and strategies of rural financial services in the region;

e) extract lessons learnt for project design and implementation and for current and future policies and strategies.

10. The Evaluation was desk and field based and conducted within an overall participatory framework. The approach consisted of the following main steps:

(i) A desk review of design and implementation documents to identify issues as a starting point for the evaluation and of existing literature and knowledge sources on rural finance in the CEN region.

(ii) An in depth study of four countries with the most relevant IFAD portfolio experience selected

on the basis of defined criteria for detailed field analysis. These focused on policy and financial sector perspectives, the main features of IFAD’s approach to rural financial services in the region, the supply perspective of rural financial institutions, and the demand perspective of the ultimate users of financial services, the clients of rural finance institutions. Details of the analytical approach are contained in box 1 below.

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BOX 1: Evaluation Focus of In-country Institutional and Client Level Analysis

� Reviewing policy and financial sector issues related to rural financial services for the rural poor; � Reviewing the main features of IFAD’s approach to rural financial services in these countries and

the extent to which it manages in practice to target rural poor people; � Reviewing the supply side of rural and agricultural finance institutions, in particular their

performance and development whilst partnering with IFAD in investment projects, the extent of their poverty orientation and institutional capacity to reach rural poor people and the efficiency of their delivery function;

� Field analysis of the demand side of financial services through structured interviews and other survey methods with the sub-borrowers, the final beneficiaries of IFAD projects.

Field work in the four countries will be concluded with a local workshop/extended meeting with the partners/stakeholders, to share and discuss the results of the study and draw lessons learned from the experience.

11. The evaluation focus combines the supply and demand perspectives rather than just analysing rural financial institutions (RFIs) without also focusing on the people whom these institutions and services are meant to service.

B. Approach 12. Participatory Approach to Learning and Distilling I nsights Gained in Practice – the IFAD Core Learning Partnership: In line with IFAD’s wider approach to evaluating and gaining insights relevant as elements for future policies, strategies and programme implementation, this regional study brought together all relevant in-house and in-country stakeholders. This approach with close collaboration between all departments and functional units concerned represents an important inclusive approach to evaluation and joint learning from experience. 13. Country Studies: Conducting country specific studies with data collection at institution and client level constitutes another element of the approach. Supervision documentation, baseline studies and other material were useful in forming a larger picture. But talking and learning directly from the concerned institutions, clients and borrowers through interviews and surveys gave the possibility for an immediate feed-back of field experience to the study team. 14. Follow-up and Insights Gained: The main findings and results of this evaluation are presented in the final part of the report. They are presented in a format that permits for adaptation in project design and implementation and for current and future policies and strategies. 15. Focus on Rural Finance: IFAD has traditionally supported rural finance institutions and services. In the period prior to the mid 1990s, when microfinance was carved out as a discreet poverty alleviation activity2, IFAD with its focus on rural poverty alleviation had launched or supported a number of different institutions that would be termed microfinance institutions to date, such as the Grameen Bank, rural thrift and credit cooperatives in Sri Lanka and the Philippines, the P4K project in Indonesia, etc. In all these cases, rural finance encompasses both the financing of agricultural as well as off-farm activities.

2 IFAD was instrumental in this orientation towards microfinance as a launch donor of the Consultative Group to Assist the Poorest (CGAP), host of the second meeting of this donor consortium in its early and formative phase, and secondment of an IFAD staff member to the CGAP secretariat.

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Box 2: MFIs and Poverty Levels

Lower Middle Income

Economically active poor

Very Poor

Poverty Line

Destitute

Commercial Banks

Credit Unions

Financial NGOs

Grants

Lower Middle Income

Economically active poor

Very Poor

Poverty Line

Destitute

Commercial Banks

Credit Unions

Financial NGOs

Grants

Source: Consultative Group to Assist the Poorest (CGAP) 16. Definition of Microfinance : The Asian Development Bank has defined microfinance as: “The provision of a broad range of financial services that includes services such as deposits, loans, payment services and insurance to poor and low income households and their micro enterprises.” (ADB, 2000). Typically, microfinance services are provided through three sources: 1) commercial banks; 2) credit unions, thrift and credit co-operatives and similar; and 3) NGOs, both financial and multi-purpose NGOs. Microfinance institutions are defined as those "whose major business is the provision of microfinance services.” (Ibid.) 17. Microfinance and Rural Finance in CEN Region: Box 2 tries to assign the main financial institutions, banks, credit unions and NGOs to different poverty levels. These different types of institutions are all present in rural Eastern Europe and the countries of the former Soviet Union. As the remainder of this study will illustrate, most of the reviewed rural finance institutions – the Banca Comerciala Romana and their larger scale individual loans to IFAD project participants apart – would classify both rural as well as microfinance service providers. In sum, microfinance institutions insofar as they operate in rural areas, constitute a sub-group of rural finance institutions. In practice however, microfinance institutions above all of the specialised and financial NGO type are generally located in urban and semi-urban areas and provide short term working capital loans to micro and small entrepreneurs with good market access in towns and cities. Specific lending technologies for agricultural credit are largely unknown in microfinance institutions in the CEN region.

C. Key Questions and Issues to be Addressed 18. A set of 17 main questions to be considered by this study is contained in the preparatory Approach Paper. They concern four different levels of analysis: (i) the financial sector and macro-economic framework conditions; (ii) the rural finance institution as the supplier of services; (iii) rural borrowers and savers on the demand side of financial services; and (iv) IFAD, other donors and financing sources and the project management level. Chapter VIII of this study provides a summary of the responses and insights gained on the 17 initial questions. 19. The other chapters of this synthesis report are organised as follows: Chapter III introduces the readers to the main findings of the four thematic country evaluations. Chapter II and IV give an overview of the key sectoral and systemic issues at play in rural finance development as a tool for poverty alleviation. Chapter V focuses on the rural finance institutions studied, while chapters VI and

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VII analyse in detail the demand side of rural finance and the impact of rural financial services on the lives of rural people. Chapter VIII distils the key insight gained from this thematic evaluation and chapter IX contains some observations for the way forward and the challenges ahead.

II. BACKGROUND

A. Eastern Europe 15 Years after the Collapse of the Communist System 20. Changes in Central and Eastern Europe and the Newly Independent States (CEN) since the collapse of the former Communist system have been rapid and profound. Subsequent economic reforms and development of a market economy have left many countries with new challenges to face. One of these has been the development of robust financial systems that are accessible to all and contribute to supporting a functioning micro-, small- and medium enterprise sector, including privately operated farms. 21. An efficient financial sector is seen as a prerequisite for economic growth and development. However, the first ten years of transition have been characterised by financial crisis and a low level of financial intermediation. In particular, credit to the new private sector is still in short supply and accordingly perceived as an important development bottleneck in the CEN region. Accordingly, there have been numerous attempts to alleviate or overcome this bottleneck by providing credit lines to micro and small enterprises.

Table 1: Gross National Product and Per Capita Income in Transitional Economies with IFAD Active Portfolio

GNP (USD bn.) Per Capita Income (USD) Country

1990 1999 1990 1999 Albania 2.11 3.11 845 870Armenia 3.97 1.90 2 168 490

Azerbaijan 9.84 3.70 1 351 460

Bosnia & Herzegovina 10.60 4.52 1 980 1 147Georgia 8.82 3.41 1 967 620

Republic of Moldova 10.58 1.50 1 056 410

Romania 38.46 34.14 1 585 1 520

Former Yug. Rep. of Macedonia 2.56 3.30 1 195 1 690

* Atlas Method (constant prices) Source: Regional Strategy Paper, Central and Eastern Europe and the Newly Independent States, IFAD 03/2002.

22. Governments and donors started to complement sector interventions with institutional capacity building and community development programmes as it became apparent that market reform and private sector development did not automatically trickle down and enhanced the welfare of the poorer segments of the population. 23. Against this background, a wide array of financial sector, rural and agricultural finance projects are being promoted in the CEN region. These projects range from the restructuring of state owned commercial banks and specialised agricultural credit institutions to the establishment of thrift and credit co-operatives (“credit unions”), licensing and start-up of entirely new microfinance banks and support to specialised microfinance or multipurpose NGOs. In several countries, different types of priority sector funds (focusing on a specific area e.g. agriculture) were put in place and lend to domestic financial institutions.

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Table 2: IFAD Rural Finance Portfolio in CEN Region

Country/Project

IFAD Loan Amount

% of IFAD loan amount allocated to Credit/RFS

% of total project costs allocated to Credit/RFS

Loan Disburse-ment rate (%) (09/10/02)

% of Credit/RFS allocation disbursed

Azerbaijan: Farm Private. Proj. (447-AZ) 9.30 64% 47% 100% 100% Azerbaijan: Rural Dev. Progr. (542-AZ) 9.00 44% 40% 31% 100% Georgia: Agricultural Dev. Proj. (450-GE) 6.57 69% 77% 84% 77% Georgia: Rural Dev. Progr. (543-GE) 8.00 26% 24% 31% 0% Bosnia & Her.: Livest. & Rural Fin. (562-BA)

12.00 19% 9% 26% 0%

Armenia: North-West Agricul. Serv.(455-AM)

12.96 35% 29% 100% 100%

Armenia: Agricultural Services (561-AM) 15.51 36% 31% 98% 25% Moldova: Rural Finance (527-MD) 8.00 89% 93% 84% 37% Romania: Apuseni Dev. (485-RO) 16.46 97% 90% 36% 0% Macedonia: S&E Rural Dev. (428-MK) 8.14 91% 87% 81% 46% Albania: North Eastern Dist. RDP (347-AL) 11.60 53% 34% 100% 62% Albania: Small Scale Irrigation (372-AL) 9.02 20% 17% 100% 55% Albania: Mount. Area Dev. Progr. (526-AL) 3

13.22 17% 17% 75% 0%

TOTAL 139.78 Source: PPMS and LGS (various reports, PIM020, PRT 110, ADM040, date: 29/12/2004, all amounts in USD ‘000)

24. The poverty situation in the CEN region presents unique challenges summarised in a recent IFAD strategy paper for the region4: widespread poverty is a relatively new phenomenon with a rapid increase in rural poverty throughout the region. Urban – rural inequalities are steadily increasing. The impact of the first decade of economic transition has been severe and individual incomes and output levels have not managed to bounce back to levels last seen during the former Communist system. Table 1 taken from the IFAD Regional Strategy Paper for Central and Eastern Europe and the Newly Independent States illustrates the impact of the Eastern European transition on GNP and Per Capita Income. 25. IFAD’s portfolio in the CEN region pertaining to Credit /Rural Financial Services comprises 13 projects with a total approved assistance volume of USD 140 m. Table 2 gives an overview of the IFAD portfolio in rural finance in the CEN region. It also shows the size of the financial services portfolio in relation to the overall project cost and the IFAD loan amounts, as well as the disbursement rate of the rural finance component.

B. IFAD Regional Strategy Statement on Rural Finance 26. A separate strategy related to rural finance in the CEN region has not yet been formulated. Strategic statements concerning rural and microfinance are contained in the IFAD Regional Strategy for Poverty Reduction in Eastern Europe and the Newly Independent States of March 2002:

“IFAD will continue to give high priority to the development of rural financial services as a fundamental precondition for sustainable economic growth… Future projects, therefore, will work with private banks and other service providers to develop seasonal credit and

3 This project has an IFAD grant of 440 000 USD (465-AL) (not included above). 4 Regional Strategy Paper – Central and Eastern Europe and the Newly Independent States, IFAD PN – Programme Management Department, March 2002.

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long-term investment facilities and to build necessary support for enabling legal reforms. IFAD has considerable experience with different approaches to rural credit and will continue to use various mechanisms to target specific beneficiary groups…Within this context, the Fund will emphasize new channels of credit distribution targeting not only individual family farmers but also commodity traders, agricultural service providers, agro-processors and other rural entrepreneurs” (pp.10-11)

27. These strategic statements contain three main thrusts. First, and similar to other regions in which the Fund operates, rural finance is seen as an important tool for poverty reduction and consequently, it will have a major role also in future IFAD operations in the region. This seems useful since it builds on one of IFAD’s perceived core competencies. 28. Second, IFAD supports a wide variety of different types of rural finance institutions in the region. Instead of having one institutional champion such as commercial banks5, IFAD supports different institutions, a fact well reflected in the four countries covered by this thematic evaluation. 29. The reference to “new channels of credit distribution” suggests that IFAD would also experiment with new and less conventional institutional options for the delivery of financial services. In the context of this regional evaluation, probably the most unusual of the institutions analysed is the Mountain Areas Financing Fund (MAFF). Similarly, Savings and Credit Associations in Moldova constituted a novel and untested way when they were introduced. Both have stood the test of time, and IFAD would also in future remain open and actively supportive of new types of agricultural and rural finance institutions in the region.

C. IFAD Portfolio - Country Case Studies 30. The four countries selected for this Thematic Evaluation represent a cross-cutting sample of the countries of Eastern Europe and the former Soviet Union:

• IFAD Portfolio Experience: Each of the four selected countries had IFAD rural finance components operating for a sufficiently long time to draw relevant conclusions. The benchmark set by IFAD-OE was a disbursement rate for rural finance and related components of at least 70% of total allocated IFAD funds.

• FSU and Non FSU Countries: The Republic of Moldova and Georgia represent countries

from the former Soviet Union, while Romania and Albania were countries outside of the Soviet Union sphere of influence, representing Eastern Europe (Romania) and the Balkans (Albania).

• Rural-Urban Mix : The four selected countries represent a broad mix of current and future

population trends. The reference year in Table 3 is 2015, the benchmark year for reaching the U.N. Eight Millennium Development Goals.

Table 3: Percentage of Rural Population in Sampled Four Countries, 2001 and 2015

Percentage 2001 Percentage 2015 Albania 57,1% 48,1% Georgia 50,5% 43,5% Rep. of Moldova 64,2% 58,3% Romania 53,8% 44,7% Source: UNDP Human Development Report 2003 – Millennium Development Goals – a Compact among Nations to End Human Poverty, pp. 250.

5 As in the case of the European Bank for Reconstruction and Development (EBRD)

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D. Learning from Other Experiences – Similar Regional Learning Initiatives

31. World Bank Study on Microfinance in Central Asia (Final Version, February 2004) The World Bank recently finalised a study on microfinance issues and options in central Asia6, a region where donor initiatives in rural and microfinance have been much more cautious than in the Western ex-Soviet Union and the Caucasian countries. 32. The study focuses specifically on microfinance operations, and contains cautious notes on applying microfinance practices in non-urban areas (box, p.12). Limitations identified for introducing or increasing the supply of microfinance comprise (i) a policy, legal and regulatory financial sector framework that is not conducive to microfinance operators, (ii) institutional gaps in microfinance operators and services in the region, (iii) the problem of very limited market coverage of the existing NGO type of microfinance institutions, (iv) limitations in the products and services offered by these MFIs, and (v) inefficiencies and other institutional shortcomings of existing operators. 33. Against this background of existing supply - the demand side was not researched or documented in this regional study – the World Bank study makes the following recommendations for next steps of the donor community in the five central Asian ex-Soviet Union countries: (i) to focus on operational and financial standards of microfinance institutions, (ii) to diversify the products and services of existing MFIs (iii) to strengthen MFIs and link them to formal financial institutions, and finally (iv) to concentrate on the “localization of the microfinance market development”. The latter is explained in the World Bank study as “facilitating the transfer of ownership to local NGOs with a focus on building local capacity”. In addition, various types of technical assistance activities are proposed. The World Bank has both grant facilities for these TA measures, but also a specifically adjusted loan type, the “technical assistance loan”7 to support this type of non-repayable capacity building activities. 34. KfW Banking Group, Matthäus-Maier, J.D. Von Pischke: The Development of the Financial Sector in Southeast Europe - Innovative Approaches in Volatile Environments. Berlin 2004): The KfW Banking Group called together this symposium with key practitioners and donors to take stock of their three different institutional approaches to financial sector development in Eastern Europe and former Soviet Union countries. First, together with IFC and the European Bank for Reconstruction and Development (EBRD), KfW had a lead in incorporating new full service commercial banks with micro and small entrepreneurs as their prime clientele (greenfield approach). These new banks have sometimes very low average transaction sizes – at least in their initial and consolidation stage – and in some cases grew to be the largest actor in the market place (Kosovo). In other countries such as Serbia, the microfinance banks built up a loan portfolio of USD 30 million in less than three years of operations. 35. KfW Banking Group and EBRD also pursue another strategy for supporting the financial sector, the so-called downscaling approach. In this case, the capacity of existing commercial banks with significant growth potential is built up through technical assistance focusing specifically on SME lending, and this is combined with major lines of credit and sometimes equity stakes8.

6 World Bank, Central Asia – Microfinance and the Poor, Microfinance Study Team ECSSD, Washington, D.C. 2003. 7 These loans are however rare in the World Bank portfolio. An example for a TAL is the Pension Reform Loan for the FYRO Macedonia. A more detailed comparison of all major types of financial instruments currently employed by bi- and multilateral agencies worldwide, see Zander, R. GTZ Preparatory Study for Formulation of New Financial Sector Policy of German Ministry for Development Cooperation (BMZ), 2003. 8 EBRD employed this approach mainly in the Russian Federation with selective existing banks there.

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36. Typically for Eastern Europe and the former Soviet Union, the informal financial sector is considered to be so small and insignificant, that there is no scope in this region for the upscaling approach, bringing informal finance systems to a level where they can operate in a formal financial environment. 37. The symposium concluded that it would be useful to establish an umbrella financial institution for the network of microfinance banks9, that some of the downscaling approaches were fraught with considerable difficulties, and that in some cases, sub-borrower investments were promoted that did not yield a robustly positive return on investment. Lessons learned include that banking development should be ambitious and not focus on the existing “mini banks” typical of many FSU countries without adequate growth potential and not in a position to raise the capital up to internationally acceptable levels.

III. COUNTRY RURAL FINANCE EVALUATION SUMMARIES

A. General

38. The four country studies conducted for this thematic evaluation are attached to this report. This chapter highlights the most important general findings of the four studies. Details on supply (chapter 5), demand (chapter 6) and impact (chapter 7) follow.

B. Albania – Creating a New Financial Institution to Consolidate IFAD’s Rural Finance Portfolio in Mountainous Areas

39. IFAD´s Albania country portfolio10 comprises three projects. The North Eastern District Rural Development Project (347-AL) was implemented from 1994 to 2002. The main project objectives included the promotion of small-scale credit and micro-enterprise development in order to develop livestock and off-farm income-generating activities. More than half of IFAD´s loan proceeds were allocated to rural financial services. The credit delivery mechanism under this project has evolved over the project implementation period. In the absence of any formal credit institution in the mountainous project area of North Eastern Albania, the credit programme was managed for most of the active implementation period by the World Bank initiated Rural Finance Fund (RFF). The project credit retailing mechanism provided for the establishment of some 200 informal VCFs to be managed by Village Credit Committees (VCCs). These VCCs received their on-lending funds as loans from RFF. After the retreat by RFF from mountainous areas and the consolidation of World Bank financed VCFs in the Albanian lowlands, IFAD transferred the implementation of the project credit activities to the newly established Mountain Areas Finance Fund (MAFF). 84 percent of total IFAD loan proceeds were disbursed as of December 2002. 40. The Small Scale Irrigation Project (372-AL) has been in operation for more than eight years. Project objectives in support of small-scale irrigation development foresaw provision of essential rural infrastructure and associated services, including credit and institutional support. A commercial bank was selected by IFAD as the implementing agency for project financial services. After its liquidation, activities under the credit component commenced only after the establishment of MAFF11. 98 percent of IFAD funds were disbursed as of November 2002, when the evaluation mission was fielded. 41. The most recent Mountain Area Development Programme (526-AL) represents an ambitious development programme with four interrelated components: Together with the establishment of a new

9 The re-branding of the microfinance banks as ProCredit Banks is a major step towards streamlining the different microfinance banks and bring them under the umbrella of a Frankfurt based apex bank. 10 The Thematic Evaluation Mission visited the country from 10 to 22 November 2002. 11 See below

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and independent institution to provide credit to rural people, the Mountain Areas Finance Fund, the programme also financed the establishment of a Mountain Areas Development Agency (MADA), plus rural infrastructure and agricultural production activities. MAFF began operations on 1 July 2000. The programme comprises all northern, eastern and central districts covered by the first two IFAD investments with financial services. Additional districts in the South of the country have also been included: Korce, Tepelene, Permet and Kolonje. In addition to disbursing unutilised balances for credit components of IFAD´s earlier two projects, MADP disbursed 11 percent of IFAD programme funds up to December 2002. 42. Table 4 below summarises details on the IFAD portfolio and rural finance activities in Albania:

Table 4: IFAD Rural Finance Portfolio in Albania

Project IFAD Loan Amount (in USD ‘000)

% allocated to Credit/ RFS

Credit/RFS in % of total project costs

%Disbursed/*

347-AL 11.60 53% 34% 100% 372-AL 9.02 20% 17% 100% 526-AL12 13.22 17% 17% 75% TOTAL 33.84

/*as of 29 December 2004 43. All IFAD rural finance operations in Table 4 had been consolidated under one umbrella, the Mountain Area Financing Fund. At the end of September 2002, MAFF had a current outstanding loan portfolio of 3 437 loans with an increasing trend since inception of the institution. After a period of less than 30 months of operations MAFF had a total of USD 2.96 million in loans outstanding to 3437 borrowers. The average loan balance amounts to USD 861 (data as of end September 2002). 44. MAFF offers three types of loans. VCF Loans follow the methodology applied by IFAD since 1995 in rural Albania. A committee of village officials (“Village Credit Committee”) helps in establishing an informal group and loans are then sanctioned to members of these groupings, called Village Credit Funds. Whilst in the original design of the first IFAD project (347 AL) village officials appraised and sanctioned loans, MAFF upgraded the procedures. MAFF loan officers are now chiefly responsible for loan appraisal, but they take into account the advice of the Village Credit Committee where appropriate. Contract parties to VCF type of loans are individual village borrowers and MAFF. These small loans are paid out solely on the basis of group guarantee without any tangible security. The VCF portfolio has seen a gradual decline in performance because of declining demand and perhaps also as a result of changes in land tenure systems. VCF as delivery vehicles for small loans are not actively promoted by MAFF management any more. 45. Small Individual Loans were introduced as a response to demand; they are similar in size and target clientele to VCF loans, but granted to villagers without the VCF umbrella. Individual loans are better documented than the original VCF loans. They are collateral free, but without involving the village community as collateral substitutes. These loans are also more flexible in maximum loan terms and monthly instead of six monthly instalments. 46. Small and Medium Enterprise Loans: The third loan type targets better-off rural entrepreneurs. These so-called small and medium enterprise (SME) loans are much higher in value. Repeater loans can reach amounts of over USD 70 000 equivalent. Loans are collateralised, and MAFF uses the services of a specialised assessor to derive at collateral values. MAFF makes some

12 IFAD grant of 440 000 USD (465-AL) is not included above

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effort to monitor and assess the income and employment generating effects of SMEs on poor fellow villagers. 47. The indicative breakdown of loan types of the portfolio (end September 2002) amounts to VCF loans 51%, individual loans 14% and SME loans 35% (volumes of funds). 48. Noteworthy for all three types of loans is the fact that terms of more than one year are granted also to first-time borrowers. From the outset MAFF and its predecessor RFF did not restrict the portfolio to very short term and seasonal loans. The development impact of a loan increases with terms adjusted to net cash flow patterns of the financed investments, not only with lower interest rates. The term portfolio of MAFF can be sustained as long as matching fund inflows of donors keep on forthcoming and portfolio quality does not further deteriorate.

C. Georgia – Support for Establishment of Credit Unions

49. In Georgia13, IFAD has financed two projects. The Agricultural Development Project (450-GE) has been implemented since 1997 with an extension up to April 2004. IFAD is co-financing two components of this World Bank initiated project, the credit unions development and land registration components. The total cost of the credit union component amount to USD 7.5 million., with IFAD financing USD 6.57 million. Objectives of the credit union development component as stipulated at appraisal included the development of a network of 120 rural credit unions that would mobilise deposits and provide loans to small farmers. The component would also support the establishment of the Credit Union Development Centre, a training, refinancing and regulatory body for associated credit unions. Each new credit union would receive tranched grant payments of up to USD 3 000 equivalent to cover start-up and initial administrative costs and a balance amount of USD 2 000 to cover depositors of CUs to be liquidated. A loan fund for borrowing credit unions equalling USD 4.52 million was originally budgeted. Withdrawals for the loan fund from the project special account have been held in an administrative bank (TBC Bank) and managed by a credit committee consisting of CUDC, MoF and MoA. This complex structure resulted in disbursement delays and temporary total suspensions of lending to credit unions.

Georgia-Agricultural Development Project Arcena Eliashvili cuts roses in his small farm in Giorgi Tsminda village. As a member of the credit union, he received a loan to buy fertiliser. IFAD Photo by Robert Grossman 50. Project implementation of GE-450 has not met expectations. By 31 December 2002, 164 credit union had been established, of which only 16 were performing and reporting on time. A further 50 credit unions were believed to be functioning, but were late in reporting. About 100 credit unions established with project assistance were no longer functioning: 31 were liquidated, the remainder defunct with court cases against them to enforce repayments of loans from CUDC.

13 The Thematic Evaluation Mission visited the country from 11 to 28 of January 2003.

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Georgia-Agricultural Development Project Elizbar Tatarashivili cultivates grapes to eat and make wine in his farm in Missaktsieli village. With a small loan he was able to hire help to cultivate his crops. IFAD Photo by Robert Grossman

51. The Rural Development Programme for Mountainous and Highland Areas (543-GE) became effective in September 2001. Project objectives in support of microfinance development foresee the establishment of credit unions in the project target areas, together with provision of a line of credit. CUDC would be involved in the execution of the USD 2 million microfinance support activities in its capacity as technical services provider. A separate microfinance window was proposed to be set up at appraisal within CUDC, and a National Federation of Credit Unions was to be established. Similar to an IFAD project in Azerbaijan, project implementation was sub-contracted to MADI, an international NGO14. The target group for this programme is focused on the specific type of mountain areas and are defined by the two key characteristics of mountain terrain, altitude and slope. The programme includes districts in which more than 50% of the population live at altitudes above 500 meters. Priority is given to communities located at altitudes of 1000 m and above. The target group comprises active small private farmers who have less than 1 ha of homestead, crop land and hay meadows, and own less than 3 milking cows and less than 10 ewes. Targeting focuses on the growing number of women who are presently carrying the entire burden of farm and family. Other specific target groups comprise: a) new families established since privatisation that lack land and have only a few livestock; b) large families for whom resource constraints are particularly acute as land was allocated on a household basis irrespective of household size; and c) families who received marginal land in the privatisation process. 52. At the time of the mission visit, no activities had yet been initiated under the microfinance component. Disbursements under the USD 2 million rural finance component are scheduled to pick up in 2004 and after a re-design of financial services arrangements through a special programming mission in December and January (2003 and 2004).

D. Moldova – Support to Savings and Credit Associations and SME Credit Line through Commercial Banks

53. The Rural Finance and Small Enterprise Development Project (MD-527) is IFAD’s first investment project in the Republic of Moldova15. The project objective is to generate sustainable increases in household incomes among the target population in rural areas during the transition. Investments “will aim at (a) facilitating the participation of the rural poor in the commercialisation of agricultural and rural development, and (b) contributing to the establishment of a responsible institutional framework for rural financial services delivery.” 14 With a project structure and proposed activities similar to the IFAD Rural Development Project Mountainous and Hilly Areas (RDPMHA) in Azerbaijan. 15 The Thematic Evaluation Mission visited the country from 10 to 26 February 2003.

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54. Different from Georgia and Albania, this first IFAD project in the country is not co-financed with the World Bank. Instead it constitutes a de facto parallel financing arrangement whereby IFAD funds cover one region in Moldova with an approach that is broadly similar to World Bank financing in other parts of the country. The prime focus of project activities are the establishment and financing of community credit organisations, referred to as Savings and Credit Associations (SCAs) primarily in the region (“judete”) of Ungheni in the West of this small country. Through the operations of SCAs the financial constraints preventing the new smallholders from developing their agriculture within the market economy were planned to be addressed. 55. For SME loans of the Small-Scale Enterprise Development Fund (SEDF) through accredited commercial banks the stipulated target group are small private farmers who have withdrawn their land from the cooperative and who are not part of ‘associations’ created to preserve previous forms of management and control. 56. For the SCAs, targeting was less restrictive and membership open to all small private landowners. SCA members de facto originate from all sections of village society. Consequently, the IFAD Appraisal Report provides no numbers concerning the target group nor does it give any socio-economic definition in terms of income or poverty or household typology. 57. The project became effective in December 2000. Total project costs amount to USD 15.06 million, of which IFAD provided a loan of USD 8.0 million or 53.12%. Designated co-financing in the amount of USD 4.34 million from the American NGO Citizen’s Network for Foreign Affairs (CNFA) was not forthcoming and is not expected to realise up to the end of this project. 58. Institutional support of the project supports the formation of 40 SCAs. A provision was also made to establish a deposit insurance scheme and a deposit insurance agency to serve the SCAs, but no activities were initiated in this regard by the time the thematic evaluation mission was fielded. Other project rural finance activities include capacity building for two financing institutions for SCAs, the World Bank supported Rural Finance Corporation and SSB, a local NGO. 59. Two Revolving Credit Funds provide refinancing to the two separate and unconnected target groups of the project, small farmers organised in SCAs, and the so-called Small-scale Enterprise Development Fund (SEDF) for lending to SMEs with their specific and larger credit requirements (USD 3.3 million). 60. The final project component, a Post-Mid-term Review Project Development Fund constitutes the financing of project activities after mid term review. This “component” had a volume of USD 7.2 million and was originally proposed to be financed mainly from contributions of the American NGO CNFA (USD 4.341 mn.) and IFAD (USD 2.898 mn.). In the absence of co-financing from CNFA as originally committed to, the project financing plan up to loan closing will have to make do without grant-based co-financing. 61. Numerical progress in the establishment of SCAs in the country, including the Ungheni district is impressive with 483 SCAs created and about 52 000 members. 62. The IFAD financed SME lending programme through commercial banks had provided 60 loans through five commercial banks by February 2003. Initially, the credit ceiling was set at the local currency equivalent of USD 30 000. Since April 2002, loans of up to USD 100 000 are accepted in exceptional cases. It appears that the exception is fast becoming the norm. There is need for a procedure regulating access to large sized loans and to ensure that these are only provided exceptionally and where high income and employment generating effects for poor rural people can be expected and effectively monitored.

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E. Romania – Credit Line through Commercial Bank 63. The IFAD supported Apuseni Development Project (0839-RO) is designed as a line of credit to be retailed by commercial banks to farmers and rural off-farm enterprises as working capital and investment loans. The project area consists of 121 districts in the six counties that cover the Apuseni Mountain Zone in Western Romania. 64. The project consists of two components: (a) A revolving fund was supposed to be drawn upon by several commercial banks for on-lending (USD 15.98 million USD IFAD contribution); and (b) complementary institutional support to strengthen rural development services at head office and project area level (USD 415 800). 65. Total project costs including contingencies amount to USD 34.1 million, financed by an IFAD loan of USD 16.4 million, co-financing of USD 5.1 million, Government contribution of USD 0.4 million equivalent, selected banks’ contribution of USD 7.0 million equivalent and beneficiary contribution of USD 5.2 million equivalent in the form of equity contributions to loan-financed investments. 66. The project was implemented at the time of fielding the study mission by only one partner bank, the Banca Comerciala Romana or BCR. After an initial focus on the county of Alba, the five other Western Romanian counties of Arad, Bihor, Cluj, Hunedoara, Salaj had been included as well. 67. The project was burdened with major obstacles from the start. The IFAD Appraisal Report recommended subsidised interest rates for lending operations. The resulting margins for any participating bank were thus reduced to a level that made participation of all but one, the only major universal state owned bank, impossible. Policy dialogue from the Romanian side corrected the subsidy orientation of the lending operations, and lending started on a larger scale only during financial year 2002. 68. As of 1 February 2003, the number of borrowers grew to 243 and the aggregate loan amounts approved stood at USD 2.588 million. A further 13 loan applicants were approved up to end February 2003. Because of the considerable delays during the first phase of the project, a portion of the IFAD funds had to be cancelled after the mission was fielded. 69. The participation of only one and state owned bank with an uncertain future because of impending privatisation, lack of sharing of credit processing and other process data, and the largely unsuccessful collaboration with GTZ that decided to run a parallel agricultural development project in the Apuseni area rather than a coordinated joint initiative between IFAD and the German Technical Corporation Agency are the main shortcomings experienced in this project. “When Life Pushes You, You Have to Learn Farming” (Naber Milaev, Meshkit Turk, Subsistence farmer, Expelled from Uzbekistan in 1990, Refugee and former sales manager in state wine company in Tashkent, October 2003)

IV. RURAL FINANCE DEVELOPMENT AND POVERTY ALLEVIATI ON: POLICIES AND PERSPECTIVES

A. Poverty Status

70. The countryside in the CEN Region acts both as a reservoir of people who emigrate or migrate to urban areas, but less visibly also as a refuge of people who lost out in the economic transition process. Once employment is found or adult children have the possibility again to take the elderly villagers, people will move away from their small rural homesteads that they currently inhabit with

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hardly any economic activity but home gardening or subsistence farming on small and un-irrigated plots. 71. To date, some agricultural regions that used to thrive are all but deserted, while other areas closer to the towns and with functioning land registration and real estate cadastres see people move back to the villages from towns and cities. Internally displaced people (the entire Caucasus region, but also the Southern Balkans) as well as refugees from other countries are likewise settled in new or reclaimed agricultural plots in the countryside. For many of these most vulnerable groups, farming is a mere survival strategy and done only on small horticultural plots around the homesteads. Others, in many cases ex-Kolkhoz and Sovkhoz managers and accountants and economists, the previous rural elite, have early understood the mechanisms of land distribution and privatisation and have long since consolidated their land holdings and farm on large, irrigated and commercially structured farming enterprises. 72. Table 3 presented the population percentages in the four countries that live in rural areas. Table 5 now illustrates the considerable share of poor people currently living in the countryside and generally below the poverty line in the four selected countries.

Table 5: Percentage Population below Poverty Line Nationally and in Rural Areas

Country % Rural Population below Poverty Line

% Population below Poverty Line

Country HDI Ranking (2003)

Romania 27.9% 21.5% 72 Georgia 9.9% 11.1% 88 Albania n.a. n.a. 95 Moldova 26.7% 23.3% 108

Source: United Nations Development Programme: Human Development Report 2003 73. Table 6 from the same source supplies income data per head and in USD (see also table 1 for introductory income data p.c. income data from the 1990s). The table contains both gross national income and the adjusted national income following the UNDP purchasing power parity method. In order to put the poverty and income levels of the selected CEN countries into perspective, the table also includes the data for the two largest developing economies in Asia (India and PR China), as well as data on the poorest economy in Latin America, Bolivia.

Table 6: Gross National Income and PPP in Comparison

Country Gross National Income per Head

in USD (2001) PPP Gross National Income

in USD (2001) Romania 1,720 5,780 Georgia 590 2,580 Albania 1,340 3,810 Moldova 400 2,300 PR China 890 3,950 Bolivia 950 2,240

Source: United Nations Development Programme: Human Development Report 2003 74. In sum, all four countries sampled and visited by this mission are grouped as medium level human development countries according to HDI ranking. Poverty looms larger in rural areas, in particular where climatic conditions do not favour subsistence agriculture. Comparisons with income levels of other developing economies demonstrate that most countries of the CEN Region are on a comparable level on average, while some countries such as Moldova are significantly poorer than large Asian economies like China, and have only half the income of the poorest Latin American country, Bolivia.

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75. These figures dispel any notion that the eastern part of the European continent had just a temporary growth problem after the fall of the iron curtain and that the macro figures have sufficiently picked up again. On the contrary – small countries in the “European backyard” such as the Republic of Moldova have less than half the incomes per head as compared to China and Bolivia. Equally, even the purchasing power adjusted income puts them only on par with Bolivia and significantly below China. 76. What follows is a short country-by-country overview of the poverty situation, strategies for poverty alleviation and the role of rural finance in poverty reduction strategies. What emerges from this analysis is that – generally – the link between economic, financial and rural finance policy and poverty reduction is not yet sufficiently researched at country level and should receive greater focus. As they stand in national government poverty reduction documents, poverty analysis and subsequent policy recommendations require a better link to avoid the mistakes of the past where economic and financial sector policies in some cases worsened the poverty situation in the long term instead of reducing it. On the other hand, the contribution of rural finance not just to general economic development, but specifically to rural poverty reduction is now increasingly being included in the sectoral analysis of some of the PRSPs reviewed.

B. Rural Finance Development and Poverty Alleviation 77. Albania: Detailed and recent data on rural poverty or a ranking according to the UNDP poverty index are not available in recent Human Development Reports. It is however clear that the basic dichotomy between the more remote and agricultural mountain areas of the country, and the generally more productive and economically vibrant lowlands of the country persists. 78. The Albania PRSP (on page xiv, see next paragraph) quotes an earlier national survey with a data base of 1997 to provide its poverty data. Considering that these data pre-date the second wave of civil unrests, they can only be taken as rough and preliminary indicators of poverty in the country. The PRSP states that measured in relative terms, 29.6 percent of the Albanians were poor in 1997, while half of them lived in the category of extreme poverty; in absolute terms, 46.6 percent of the Albanians were below the poverty line of USD 2 per capita a day, while 17.4 percent were below the poverty of USD 1 per capita a day. In addition, it was observed that almost one in seven children under 5 (14 percent) was malnourished at the time of data collection and that illiteracy has increased (only 88 percent of the population aged over 15 were able to write and read). 79. Albania’s Growth and Poverty Reduction Strategy for the years 2002 - 2004, the National Strategy for Socio-economic Development (Government PRSP) aims at providing a concrete path towards achieving among other things i) growth of GDP in real i.e., inflation adjusted terms, ii) reduction of the population living below the poverty line, iii) reduction of infant and maternal mortality and disease rates. The development of rural finance systems and here in particular of Savings and Credit Associations in the lowlands are viewed as a primary tool to poverty alleviation. IFAD’s approaches and lessons learned in the more poverty stricken mountainous areas of Albania where MAFF operates are not a focus of this document. 80. Georgia: IFAD’s strategy in Georgia from 2002 to 200516 emphasises the development of the agricultural economy in mountainous areas in the face of high mobility within the country, new and stricter taxation laws and inadequate results of credit union development through the Agricultural Development Project17. The last Human Development Report for Georgia was compiled in 1999 and

16 Finalised in a workshop in Tbilisi in November 2002 with participation of the Dy. Minister of Agriculture and Food, the Head of the Mountainous Committee of Parliament and the IFAD Country Portfolio Manager and Deputy Head of the Department of MAF to present the Ministry of Agriculture and Food’s position on the Georgia Poverty Reduction Strategy, Tbilisi 14 November 2002. 17 see chapters below for details.

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published as the Georgia 2000 Human Development Report. The income analysis as a database for household income and poverty reduction calculation was rather thorough. The HDI highlights that when monetary and non-monetary income (subsistence farming, bartering, reciprocity of services) is taken into account, then the overall income situation in Georgia shows a small but steady upward trend since 1996. These tendencies are however observed in an environment of salaries below the poverty line, and increasing arrears in pensions and salaries. Typically for CEN economies in transition, the number of self-employed people had overtaken the number of employed people. These self-employed are often the new rural and urban poor. In rural areas, they have turned to subsistence agriculture without economic growth potential because of the lack of finance for investments and working capital; and in the cities, these entrepreneurs have turned to the informal sector for a much needed lifeline to make ends meet.

Georgia-Agricultural Development Project Tsiuri Oniani picks beans In her family farm in the Gardabani Raion. Her family also cultivates beans, corn, cherries, strawberries, tomatoes, cucumbers, onions, potatoes, garlic, peppers, carrots and grapes for wine. IFAD Photo by Robert Grossman 81. GoG released a first PRSP Document in June 2003. In Georgia, it is termed the Economic Development and Poverty Reduction Programme (EDPRP) and is based on an interim poverty reduction strategy from December 2000. Usefully, the government proposes an annual Economic Development and Poverty Reduction National Conference. The document was drafted under the responsibility of a Presidential Advisor and also focuses on the role of financial services for poverty alleviation. The document proposes attracting a higher share of financial resources available in the country into the banking

system, reducing the real interest rates which are high when compared to inflation, and introducing modern mechanisms and technologies. A subsequent assessment document of the poverty reduction efforts observes that the real spreads between deposit rates of interest (between 5 and 14%) and interest rates for loans (between 20 and 30%) remain too high. The IMF also recommends to consolidate the banking sector through mergers and the raising of minimum capitalisation for commercial banks to USD 5 million. 82. Moldova: The latest National Human Development Report for Republic of Moldova was compiled in 2000. It contains little economic, fiscal, financial sector or rural finance recommendations. Instead, the document represents a thoughtful example for critically reviewing the major social and human issues associated with the process of economic transformation that has left many in the country worse off than under the previous system (see tables 1 and 6). It highlights the unfavourable environment for business in Moldova, in particular the legal framework and regulatory methods related to SMEs (regulation, licensing, taxes and inspection), the unfavourable climate for investments, the limited access to bank credits, and weakness of business infrastructure. If anything, then these trends will have exacerbated since the drafting of the report and the advent of a Government with a pro-Communist platform sceptical of free market orientation and business. 83. A draft PRSP document was seen by this mission in February 2003. Up to mid November 2003, this draft was not followed by a first final version of a poverty reduction document of the Government. The rural development part of the strategy focuses on promoting the diversification of

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income streams in rural areas, and to render village economies less vulnerable to cyclical economic downturns and natural disasters. 84. With regard to rural finance, the draft highlights that availability of credit in rural Moldova is poor with only 6% of formal institutional lending going to agriculture. 25% of rural communities have access to Savings and Credit Associations. 85. Romania: The latest in a series of seven National Human Development Reports provides a detailed account and look back at the experience of Romania as a transition country. The transition in Romania was accompanied by an explosive increase in poverty. In 1989, an estimated 7% of the population was poor. By 1994, the poverty rate ranged, depending on the methodology employed, between 22%-39%. A second wave of impoverishment began in 1997 and by 1999 the poverty rate had reached 42% (an increase of more than 60% over the 1995 rate), while extreme poverty doubled over the same period. With Romania’s preparations for EU accession and considerable funding going to the Romanian countryside out of European Union funds, the second wave of poverty has been reduced again and reached 21.5% at the end of 2001. The IFAD COSOP identifies the main vulnerable groups in rural areas as small landowners, the landless poor, rural people in upland and mountainous areas and rural women.

C. Perspectives 86. Albania: Earlier than in most other countries of Eastern Europe, rural finance development was recognised as an important tool for alleviating poverty. Village Credit Funds (VCFs), and more recently, Savings and Credit Associations (SCAs) in the lowlands, and the IFAD supported Mountain Area Financing Fund (MAFF) underline the still prevailing focus on rural finance for poverty alleviation. On one hand, the very low level of financial deepening in general, and of penetration of financial services outside of the major Albanian cities makes this focus on rural finance for poverty alleviation relevant. On the other, truly impoverished, civil war ravaged and remote village economies may have growth requirements different from just access to credit. Training, awareness and skill building may have to precede the offering of financial services. Mission findings probing evidence of exclusion of women and very poor rural mountain households as borrowers indicate that these particularly vulnerable groups require non-financial services first before they reach a level where they can usefully be serviced with loans and micro deposit services. This plea for a frontloading of selective non-financial services to particularly poor or vulnerable groups is also captured in the afore captioned box 3 on microfinance client profiles. 87. Georgia: The country requires investments in the cash starved agricultural and livestock systems. Poor self-employed people (MSMEs) should be assisted as well as small farmers, by targeting rural and semi-urban micro and small entrepreneurs. Business development and financial services then have the potential to bring micro entrepreneurs out of the shadow economy and to have them contribute to economic growth through regular channels. Contributions of a competent and inclusive financial sector to the support and growth of micro and informal entrepreneurs can be major, as the successful microfinance banks in the CEN region, but also downscaling programmes for existing commercial banks have illustrated. For this reason, the PRSP devotes one chapter exclusively to the support for micro and small enterprises (MSMEs) as a strategy against poverty reduction. Measures proposed in the PRSP and follow up documentation mainly aim at the introduction of a credit bureau, a deposit insurance and similar secondary measures. These may have an indirect effect on the functioning of rural financial markets. Direct attacks on poverty through financial services are not considered in the PRSP. Georgian banks need more assistance to update their micro and small enterprise finance skills. Equally important are banking skills specifically for agricultural finance. In particular, the absence of any leasing facility constitutes a gap for agricultural producers and processing facilities. The uneven utilisation of tools and equipment over a full annual cycle, and the higher risk of lending to agricultural producers would make it likely that specialised leasing and hire-

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purchase companies already exist in the country. This is not the case, but it is understood that one of the large private banks, the TBC Bank is planning to establish the first leasing subsidiary in the country within the next 18 months. 88. Moldova: As far as the promotion of rural financial services and institutions is concerned, the draft rural development strategy recommends the further development of Savings and Credit Associations and its apex organisation. A legal framework for credit and insurance co-operatives and unions will be created. The draft PRSP demands more flexible lending services through SCAs or commercial banks in terms of loan amounts and timescales of loans. Information and advice on credit applications should be made freely available. 89. Romania: Romania is classified as a middle-income country by the World Bank Group and not eligible for highly concessional loans. No PRSP has been prepared by the Government18. IFAD’s Strategy in Romania emphasizes rural poverty alleviation through rural and agricultural development primarily in mountainous areas. The Country Strategic Opportunities Paper (COSOP) contains the Fund’s poverty reduction strategy. IFAD’s strategy for Romania is focused on developing rural institutions that enable the rural poor to benefit from new economic opportunities and that provide them with a voice in policy articulation. The proposed thrust of future IFAD operations in Romania is to create new opportunities for small landowners and other vulnerable groups to participate in the commercial economy through farmer organisations with access to markets. This would include working in close cooperation with Government, other donors and non-governmental organizations (NGOs) to improve the overall institutional framework and ensure a policy environment that helps promote pro-poor growth and development. 90. The European Bank for Reconstruction and Development sets out the key challenges for the outstanding parts of the reform agenda of the Romanian financial sector as follows: “Enhanced supervision and regulation of the financial sector, together with the privatisation of the remaining state owned banks, are central to secure financial stability and discipline. Two World Bank Private Sector Adjustment Loans (PSAL I and II) have specifically focused conditionality on the privatisation the largest bank still owned by the state, the Banca Comerciala Romana (BCR) – the Participating Financial Institution in the IFAD project. However it remains to be seen whether BCR will indeed be privatised by end 2003 as foreseen in PSAL II. V. MAIN ISSUES IN CAPACITY BUILDING AND INSTITUTION AL DEVELOPMENT

FOR IFAD SUPPORTED RURAL FINANCE INSTITUTIONS

A. Types of Financial Institutions, Legal Forms, Governance 91. The three main types of rural finance institutions, (i) commercial banks, (ii) cooperative financial institutions including credit unions, and (iii) financial and multi-purpose NGOs are faced with different issues with regard to a pro-poor institutional development and governance. 92. Commercial Banks – Issues and Options: In the four visited countries, IFAD collaborated with commercial banks in two out of four cases. Considering also MAFF in Albania, which is a special case but should be seen as on the way to being a commercial bank (see table 6 below), the number of corporate types of partners would raise to three out of four possible countries. The wider IFAD portfolio in the CEN region confirms this trend: commercial banks are partners in Macedonia, Armenia and Bosnia & Herzegovina (private commercial banks), while a majority public owned bank, the Agroprombank, partnered with the World Bank and IFAD in Azerbaijan. 93. Typical structural and governance issues that commercial banks in the four sampled countries face are fragmentation and small overall balance sheet and business operations. This is the result of 18 PRSPs are a requirement for lending on IDA terms by the World Bank group.

20

minimum capitalisation requirements significantly below international standards. Moldova and Georgia should be mentioned in this regard. Minimum capital to license a commercial bank is as low as USD 2 million and as a consequence, the small financial markets are crowded with tiny banks. While IFAD cannot actively participate in capital increases of rural based private commercial banks, institutional appraisal at Formulation should ensure that an adequate risk adjusted capital base exists for a potential partner bank to absorb additional loan funds from IFAD. 94. Albania – The Special Case of MAFF: The Mountain Areas Financing Fund constitutes a novelty in IFAD rural finance operations in the CEN region since a new and specialised financial institution was created specifically for the purpose of servicing the IFAD target group. 95. The Non-Bank Financial Company (NBFC) licensing regime as set by the central bank of Albania defines capital requirements for different types of financial business of NBFCs as outlined in table 7 below:

Table 7: NBFC Capitalisation Requirements in Albania for Different Types of Financial Activities

NBFC Financial Activity Required Incremental

Capital (LEK) Required Incremental Capital (USD eq.)

Credit granting 100 million 727 273 Cash transactions 30 million. 218 183 Current account, cheque facilities 100 million. 727 273 Dealing and brokerage 10 million. 72 727 Leasing 100 million. 727 273 Guarantees 100 million. 727 273 Capital Req. for All Activities 440 million 3 200 000 Memo Item: bank capital requirem. 700 million. 5 090 909

IFAD Thematic Evaluation Mission 96. These figures illustrate a well balanced and layered approach to financial institutions licensing that should be considered exemplary also for other countries in the CEN region. MAFF is currently licensed as a non-bank financial institution and registered as a Foundation with different government agencies as trustees. The biggest drawback of this type of licensing is that with its current license as a Foundation and a USD 2 million capital base, MAFF is legally barred from mobilising deposits. Only financial institutions licensed as commercial banks (USD 5 million capital) are permitted to mobilise deposits in Albania. 97. Unlike in the case of other newly established microfinance banks in Eastern Europe and the Balkans, in MAFF there is as yet no clearly defined ownership of capital and as yet, governance strategies including a shareholding company with owners participating in the business risk in the form of a public private ownership have yet to be defined. As per its standard practice, IFAD or UNOPS as the Cooperating Institution do not participate in the MAFF Board. However, IFAD financed most of MAFF capital and available credit funds for on-lending through its projects (see the Thematic Evaluation Report for Albania for details). 98. Credit unions, savings and credit associations and credit cooperatives: These member-owned and usually member managed institutions are proximity based and offer closeness to the rural people as their main plus point. While this mode of decentralised financial institution was the prime model for promotion of rural finance in the sampled four countries, legal and governance issues still need to be resolved.

21

99. Surprisingly at first sight, Georgia with fully-fledged credit unions that combined deposit mobilisation from members with lending to the same pool of members, fared comparatively least successful. Out of more than 160 credit unions established from scratch through the Agricultural Development Project, only 15 were assessed to be sustainable in the medium to long term, and only 32 received a license from the central bank, in many cases in spite of them not fulfilling some of the criteria at the time of licensing19. 100. In Moldova and Albania on the other hand, where financial groups were likewise established in the villages, but only to retail credit funds that were received from apex lending institutions, the system seems to have fared better. This applies above all to rural Moldova, where farmers and small entrepreneurs have little alternatives to their loans from SCAs and where establishment, consolidation and the process of wholesale lending is carefully managed by a financing institution: RFC in the case of Moldova, and the Rural Finance Fund RFF in Albania. 101. In spite of success in repayments and institutional growth and coverage all over the country, the legal form of these mutual institutions was left open for too long. In Albania, a law that governs SCAs was enacted as recently as in Georgia, where the credit union law was passed only in 2002 and some regulations are still in the process of finalisation. The situation was better managed in Moldova, where SCA Guidelines were in place as early as 1998. 102. Subtler is the aspect of ownership and shareholding. In Albania, Moldova, and also in Azerbaijan, the share capital contribution from credit union members is raised not through documented and paid in capital payments. Instead, it is either accumulated through additional levies on credit interest rates, or through other similar means. Only in Georgia did the central bank as the supervisory agency insist on a net additional lump sum cash payment of GEL 50 or about USD 22 per member. The experience in this country indicates that even though there may be initial resistance against cash payments for shares on the grounds that these are too high for poor members, the capital can usually be raised, and the resulting share in the institution provides a clearly defined ownership certificate for a member. This can be sold and redeemed upon leaving the credit union. It should not be withheld in the case that a member leaves an SCA as is the case in Albania since the capital then takes the form of a membership fee rather than an owning share. 103. In sum, equity stakes in community financial institutions should consist of real and net additional equity to be paid by the owners of these institutions, the rural people. If a member leaves, her or his share is sold and the balance amount remitted by the institution to the ex member. 104. Microfinance and other NGOs: Ownership and governance issues are probably most complex in this latter type or rural finance institution. Since none of the projects in the four countries supported rural finance intermediation through NGOs, the discussion of this type of institution will be only short. Schmidt and Zeitinger raised the major governance issues of credit granting NGOs as early as the mid 1990s20. They concern the lack of a clearly defined ownership of NGOs, deficits in financial management and a legal form that would permit an NGO to sue and be sued, accept deposits and operate for profit. 105. In the meantime, many microfinance NGOs in the CEN region have successfully mastered their initial and fledgling institutional phase. INGOs like ACDI VOCA, FINCA, Mercy Corps and other generally U.S. American operators also localised their operations and spun off their financial services or microfinance operations from the business of the larger NGO (World Vision, Mercy Corps). The debate as to whether these operators require grants (CGAP) or whether the more mature of these institutions can deliver also commercial financial relations and borrow those funds that are on-lent to

19 A period of 12 months was granted by the central bank for these credit unions to achieve compliance with central bank regulations. 20 Schmidt, R.H. and C.-P Zeitlinger. Critical Issues in Small and Microbusiness.

22

sub borrowers is still ongoing (IMF as a proponent for grant funds at establishment and then a phase back subsequently). In IFAD a first commercial collaboration with an NGO is proposed in a new IFAD project in Azerbaijan. 106. The Special Case of SCAs in Moldova – A Hybrid between NGO and Credit Union Type of Operation: Savings and Credit Associations constitute a group based decentralised financial institution at village level. SCAs are initially dependent on outside support through NGOs for establishment and initial training and management development support. SCAs grew out of World Bank supported rural finance projects and initial collaboration with French NGOs (FIDES in Albania and Moldova, ADIE in Kosovo). As they operate at present, SCAs constitute a hybrid between the more conventional donor supported group based rural finance systems, and decentralised credit unions, which are member owned and member governed, but take a much longer time to consolidate than an IFI donor time frame would permit. NGO features include i) high set up costs, in Moldova between USD 5 000 and more than USD 8 000 for a single SCA; ii) little practical emphasis on financial controls; iii) centralised loan approval; iv) inflow of below-market rate donor funds that crowds out locally mobilised deposits; and v) intensive training and start-up support of SCA office bearers. Credit union features – on the other hand – include the governance structure with a general assembly of members, management and supervisory committee, and the exclusive access of members to financial services. Other important organisational features constitute a mix between the two models: while there is equity placed in SCAs, members do not manage the affairs of an SCA on account of their equity placement, but simply as members of an institution. Equally, while it is possible for the General Assembly to elect members of the Board and also substitute salaried staff (the manager called “director” and accountant) that do not perform, the latter is rarely done in practice. Instead, financial and non-financial apex institutions undertake supervisory tasks and may initiate the exchange of staff if required. As a result of their dual institutional features, SCAs combine advantages of the NGO model, in particular high repayment performance during the active project implementation period with the member based ownership and governance structure that characterises credit unions or thrift and credit co-operative societies.

B. Pro Poor Orientation 107. The degree to which rural finance institutions orient their business in an inclusive way that also reaches out to lower income households and producers depends on a few key exogenous and endogenous variables. 108. Environmental and sector conditions that influence the pro-poor orientation of rural finance institutions include first the degree of segmentation of income brackets in rural areas of Eastern Europe and the FSU. In the first years after the collapse of the previous system, poverty was still universal in the countryside, and the few that were quick and agile enough to get access to newly available resources of land and capital were the same rural elites that prevailed as Kolkhoz managers under the previous system. In such an environment, it is comparatively easy to target poor people, since the wide majority of potential clients fall into the poor or very poor income bracket. This situation continues up to the present day in countries like Moldova, parts of rural Azerbaijan, the South and East of Romania, the Eastern part of Georgia and the high altitude villages of central and Northern Albania. 109. Equally important when it comes to poverty reach is the degree of readiness or responsiveness of impoverished but productive people to seek the credit and deposit services on offer. Even a poverty sensitive institution like the Albanian MAFF with adequate staff and policy orientation can only service those villagers who come to the institution and apply for a loan. Why do the other villagers not come? The answer lies partly in the different risk profile of impoverished and small-scale farmers. Household interviews in the four countries confirmed time and again that for them a loan is sometimes considered more of a threat than a help and that non-repayment would be a

23

very serious breakdown of the low level but hitherto stable financial balance of this household. The lack of awareness about the development potential of credit and/or the missing technical or managerial skills that make poor people cautious about taking out a loan can more easily be tackled in an integrated programmatic rural finance development approach. This would combine non-financial and training services first with the possibility to seek financial services later on. This approach of bringing very poor people up to a level first where they can take out a loan constitutes and important part of capacity building and training efforts. In Georgia where the establishment of credit unions must be considered a failure in numerical terms – 30 out of more than 160 credit unions survived only two to three years after their establishment – the frontloading of a training and awareness programme about credit unions and their development possibilities would have made a decisive difference in the crucial start-up stage of credit union development. 110. Impoverished but productive farmers or rural off farm micro entrepreneurs will only take out a loan, if there is scope for a financially robust investment or utilisation of additional loan financed working capital. The internal rate of return of a loan financed investment or working capital supplement depends on a number of factors, and this issue has been discussed at length elsewhere. The standard constraints include lack of market and production input access and a better branded, standardised and dependable supply of the same goods from other parts of the country or from abroad. On the other hand, even in marginal and remote areas there are in many cases activities with sufficiently high returns on investments. These may be seed potatoes in very remote areas of the Northern Albanian Highlands, plum cultivation for liquor production, agro-tourism in Georgia or herbal and medical plant cultivation in Moldova. In general, there is considerable scope in the remote and more mountainous areas of the CEN region for certified seed production and the breeding of high performance livestock such as pigs, fattened cattle and poultry. But if an impoverished farmer does not see a possibility to make a loan at market rates of interest work for himself, then it is entirely rational for her or him not to seek a loan in order to further develop the farm. 111. To conclude, individual poverty targeting may become more important in the CEN region in future, when income levels and social status become more segmented than in the past, when everybody was equally poor in the countryside. This individual targeting is more expensive for a rural finance institution and generally, this task is best accomplished by specialised microfinance NGOs. However, with the present high rates of interest for loans in general in all four countries surveyed21 and the limited skills and awareness of some of the potential poor rural people, the extent to which incremental funds for rural finance lending can be productively absorbed should be viewed realistically.

C. Loan Portfolio Quality 112. Albania: The main areas of concern related to MAFF and its operations include a slow but noticeable decline in loan portfolio quality, not just for its historic portfolio of VCC loans but also for more recently granted small individual loans disbursed by MAFF itself and not predecessor structures. The larger SME loans continue to perform without portfolio infections. Loan loss provisioning and reporting of portfolio at risk does not comply with international standards. Notably, as of December 2002 not a single non-performing loan was written off, even though some of the historic loans from the VCF portfolio have been in arrears for years. Strategic planning should be introduced. In the absence of a business plan for MAFF containing the necessary financial projections and targets for portfolio quality and loan write offs, this function has to be created from scratch for MAFF. 113. Georgia: IFAD co-financed the credit union development component. The ambitious numerical target of creating 120 credit unions during the active project period was exceeded and more than 160 credit unions were formed through the project. 21 Details on nominal and real spreads and benchmark rates are contained in the respective country reports.

24

114. All but two dozen credit unions at the maximum were weak or in the process of failing at the time of fielding this mission. Many credit unions initiated through the project failed or are failing because of low recovery performance. The comparatively high incidence of low or non-performing credit unions could probably have been reduced by placing more emphasis on the early phases and start-up of a credit union, and by a closer and pro-active involvement in the initial stages of developing a pool of potential founding members of a new village savings and credit cooperative. In the less successful credit unions, the credit union manager chose the members, and not the other way around. As a consequence of this and a generally low understanding of general credit union principles among CU members, the segment of a village, which is progressive and change oriented was sometimes left out of the initial formation process. In other cases, only members of a single extended family had effective access to the services of a credit union. In addition, the absence of effective financial controls and outside supervision coupled with the inflow of external grant and often also external loan fund resources into a new credit union increased unreasonably the moral hazard and incentives for default. 115. Moldova: Both the speed of creation, the number of Savings and Credit Associations created and the overall recovery performance of these SCAs has been impressive. 116. At the end of September 2002, when the most recent figures are available, 483 SCAs operated throughout the Republic, 341 of which were members of the National Federation. This network comprised a total of 52 028 members, and an equally impressive 37 648 borrowers. About 90 percent of outstanding loan balances financed short-term loans, whilst term loans of more than 12 months are gaining in importance. Loan officers of RFC directly sanction these loans of more than one year duration. Risk fund balances (loan loss provisions) in the network more than double the delinquent principal and interest of loans outstanding. Total assets of the system amount to 125 853 400 MDL or USD 8 862 915. Capital is comprised of initial minimum share per member (MDL equivalent of USD 579 850) and considerable retained earnings (MDL equivalent of USD 1 119 217). 117. Romania: In this project with the Banca Comerciala Romana as the only partnering bank and considerable initial delays in sub-loan disbursements due to re-design of essential elements as compared to the Appraisal Report, most sub-loans are in their early phase of repayment or still under grace period, too early to realistically assess the portfolio performance. However, given the high level of collateral required and the generally very low levels of default in the Romanian banking system, plus the de facto maintenance of the credit fund in hard currency, the project credit funds are expected to be maintained up to the time when repayments of GoR to IFAD commence. 118. The case of Romania and its banking system with an excessive bias on collateral needs to be highlighted in some more detail in order to track interrelations between the asset based lending approach and volumes and quality of the loan portfolio. Present regulations by the central bank strictly impose an asset-based lending focus on Romanian commercial banks. There are no exceptions to this and the IFAD project is bound to the same regulations without exception. Only the networks of credit cooperatives can substitute the asset-based lending by loan securities through guarantors, but loans still have to be secured and loan sanctions are made solely dependent on this security cover. The targeted sub-borrowers under the IFAD project were generally not aware of the 130 to 150% collateralisation requirements under the IFAD project. Table 8 provides the breakdown of the portfolio in individual (farmer) and legal entity and corporate borrowers. It also indicates a large differential between loan applicants initially identified and considered appropriate for loan appraisal and borrowers actually receiving loans. Different from other countries this is mainly due to the fact that targeted sub-borrowers lose their interest in borrowing from the IFAD facility once it is clear to them that their small loans of about USD 5 000 require full collateral back up. The dynamics are discussed in detail in the Romania Country Report.

25

Table 8: IFAD Project Credit Portfolio in Romania – Breakdown by Borrower Legal Status (01-2003)

Identified for Appraisal Approved and Disbursed Individuals

Amounts (USD) 1 774 939 930 174 No. of Loans 325 184 Average Loan Size (USD) 5 461 5 055

Companies Amounts (USD) 3 200 181 1 657 771 No. of Loans 102 59 Average Loan Size (USD) 31 374 28 098

D. Deposit Mobilisation

119. Institutional Perspective: The case for the mobilisation of savings together with lending has been forcefully made in rural finance since the 1970s. With the demise of most of the old-style agricultural credit institutions in the 1970s and 1980s, the realisation grew that internally mobilised resources make financial institutions more robust and less dependent on donor or other external funding. In 1984, Vogel then coined the phrase of “savings as the forgotten half of rural financial development”. 120. Client Perspective: Similarly, for the clients of savings and microsavings services, the case for integrating the mobilisation of small-scale deposits into any sustainable pro-poor oriented rural finance institution is obvious. Recently, this case has been most pointedly made by Rutherford and his publications. His book “The Poor and their Money” states: Three facts and a conclusion. Fact one: poor people can and do save, even if the amounts are often small and irregular. Fact two: poor people need usefully large lump sums of money from time to time, for many different purposes. Fact three: for most poor people, those ‘usefully large lump sums’ have to be built, somehow or other, out of their savings - because there is no other reliable way to get hold of them. Conclusion: financial services for poor people are largely a matter of mechanisms that allow them to convert a series of savings into usefully large lump sums. 121. Realities in the Countries of the Former Soviet Union and the Balkans: Severe banking crises in the former Soviet Union, the Russian Federation shortly after it came into being, but also in the countries that made up the former Yugoslavia had strong implications for the rural population. Entire lifetime savings for old age were lost. In the former Yugoslavia, retail foreign currency deposits were frozen in 1992 by the Milosevic regime and not repaid. The remainder of the decade – not surprisingly – was then characterised by a process of considerable financial disintermediation: loans from the banking system were still in demand, but nobody put his deposits any more into a system that just took them away with official blessing in 1992. 122. The scenario in the former Soviet Union countries differed insofar, as the banking collapses appeared to be corporate failures rather than politically engineered events. But the effects were equally drastic. A recent IFAD Formulation mission in Azerbaijan found that the collapse of the old Soviet Savings or Sper Bank led to losses of deposits of more than one billion USD. This sum then compares to the entire outstanding loans position of the financial sector of that country to date (September 2003), USD 600 million. More drastically, household surveys of the mission similar to the ones undertaken for the Thematic Evaluation study found that the household financial position had suffered losses of financial assets due to bank collapses a decade ago that have been larger than the entire sum total of assets created by these rural households in the decade thereafter. In other words, until today, rural savers as an aggregate have not been able to compensate the financial losses incurred as a consequence of bank collapses.

26

123. Alternative Approaches to Asset Creation: Instead of financial savings, poor people sometimes invest their savings in livestock or other productive assets. The four household surveys and related borrower interviews indicate that this strategy increases in popularity the weaker or more unstable the banking system is perceived to be. Refusing to save is not always the result of lacking access to a safe, rewarding, inflation-proof place, but in the CEN region rather an expression of mistrust in the financial institutions of the country and/or the prevailing local currency. 124. It is not surprising therefore that only in Romania, a country outside of the old Soviet Union and not plagued by collapses of financial pyramid schemes like Albania, domestic deposits are very successfully mobilised in Romanian urban as well as rural areas.

E. Other Financial and Non-financial Services

125. Other Financial Services – Leasing: Through leasing, farmers or rural micro entrepreneurs gain access to short- and medium-term capital for fixed assets. The lease is usually granted based on an enterprise’s cash flow rather than on its credit history. The risk involved is reduced because property ownership is not transferred to the enterprise until the lease term is completed; this provides the lessor with collateral—the leased item—that can be repossessed in the event of loan default. European leasing legislation differentiates between operate and finance leasing. One constitutes a de facto rental contract for an agricultural equipment asset; the other includes the possibility to transfer ownership to the leasing farmer, based on the value of the equipment at the end of the leasing term. 126. Among the many advantages of leasing arrangements is that it keeps the balance sheet of the leasing enterprise short, which has tax and licensing advantages. It is the lessor as the proprietor of the item that maintains the value of the equipment in its possession. In agricultural finance where certain equipments are used very unevenly over a 12 months period, leasing arrangements provide access to equipment when it is required, but shifts it to other purposes or production types when it is not required. A tractor would be withdrawn when not required and could operate for construction or transport. Some Eastern European economies with reasonably advanced financial sectors (Georgia) do not have specialised legislation and leasing companies. Others still at the very beginning of financial sector development after the collapse of the Soviet Union such as Uzbekistan already have a comparatively flourishing leasing sub-sector22. 127. Insurance Services: “Insurance” refers to a financial service that uses risk pooling to provide compensation to individuals or groups that are adversely affected by a specified risk or event. Risk pooling involves collecting large groups, or pools, of individuals or groups to share the losses resulting from the occurrence of a risky event. Persons harmed by such an event benefit from the contributions of those who are not affected and, as a result, they receive compensation that is greater than the amount they have invested in the insurance policy. Thus, products which only allow an affected individual to receive up to the amount they have contributed are considered savings products, not insurance.

22 Established through technical assistance/joint ventures of EBRD.

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Box 3: Decision-Tree for Micro- and Insurance Product Development

Source: Warren Brown, 2001

128. Box 3 contains the necessary decision steps in order to assess the viability or otherwise of introducing an insurance product into the operations of a financial institution. 129. The box contains two messages that are in tune with current thinking on micro insurance. First, these services are better provided through partnerships with professional insurance companies. These corporate partners can structure the products and provide the high quality market intelligence required to assess whether it makes commercial sense to enter the market with insurance products or not. Second, professional and sustainable insurance services need to be backed up with considerable funding. If this cannot be brought in through the partnership with an insurer, then other possibilities would have to be identified prior to start promoting insurance products. 130. To conclude, the time may be right for promoting a more diversified product range of financial services in rural finance institutions of the CEN region. On the other hand, the results of this study and of other similar efforts for promoting rural and microfinance in the CEN region illustrate that rather than trying to service every client requirement and promoting different types of innovative financial services through complex institutions and services, a sustainable, self propelled and profitable financial institution as a result of a donor initiative or start-up support constitutes enough of a challenge in itself in many countries of Eastern Europe and the former Soviet Union. 131. Non-financial Services - Training and Capacity Building for Rural People: The point is made elsewhere in this regional synthesis paper that training and awareness building prior to providing financial services brings with it the possibility to reach out to lower income and very poor population segments. These services should however not be offered directly by the rural finance institutions, but be outsourced to specialised domestic service providers, possibly initially guided by international expertise and through train the trainer activities. 132. For credit union or SCA type of decentralised financial institutions, start-up training is obviously essential to the long-term success of these institutions. The Rural Development Centre (RDC) in Moldova constitutes an interesting and successful example in this regard. RDC was set up with World Bank funding and expertise, and is run by a young and competent local manager. There is agreement that the success of the Moldovan type of SCAs is in no small measure due to the training and capacity building support received through RFC. Table 8 shows the breadth and depth of the training syllable. This emphasis on training and capacity building assistance to the whole gamut of members in credit unions would have been useful also in Georgia, where the CUDC only trained managers of credit unions, and this training was largely focused on financial management and accounting issues.

Are clients interested in insurance protec tion and is this

protecti on the most mos t-effecti ve risk-managing

solution?

YES

Consider Consider Developing Developing Alternative Alternative

RiskRisk--Managing Managing Financial Financial ServicesServices

Potential Market?

Potential Market?

Solicit Insurer Partnership

Solicit Insurer Partnership

NO

Negotiate Partnership

Negotiate Negotiate PartnershipPartnership

Not Found

Defer Product Development

Defer Product Development

Consider Starting with Simple Types of

Coverage

Consider Starting with Simple Types of

Coverage

Consider Alternative Risk-Managing

Financial Services

Consider Alternative Risk-Managing

Financial Services

Found

Are clients interested in insurance protec tion and is this

protecti on the most mos t-effective risk-managing

solution?

YES

Consider Consider Developing Developing Alternative Alternative

RiskRisk--Managing Managing Financial Financial ServicesServices

Potential Market?

Potential Market?

Solicit Insurer Partnership

Solicit Insurer Partnership

NO

Negotiate Partnership

Negotiate Negotiate PartnershipPartnership

Not Found

Defer Product Development

Defer Product Development

Consider Starting with Simple Types of

Coverage

Consider Starting with Simple Types of

Coverage

Consider Alternative Risk-Managing

Financial Services

Consider Alternative Risk-Managing

Financial Services

Defer Product Development

Defer Product Development

Consider Starting with Simple Types of

Coverage

Consider Starting with Simple Types of

Coverage

Consider Alternative Risk-Managing

Financial Services

Consider Alternative Risk-Managing

Financial Services

Found

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Table 9: Rural Development Centre – Training Syllabus for Savings and Credit Associations (SCAs)

Accounting Business Planning Co-operatives Credit Marketing Organisational Behaviour

Risk Management Savings

Accounting Principles The Legal Environment Cooperative Principles

Principles of Lending

Key Considerations The Nature of Organisations

Types of Risk Savings Products

Ledgers used in SCA Accounting

Establishing an Enterprise Organisation and Ownership

RFC Products and Regulations

Consumer Needs Identification

Diversity and Individual Difference

Main Forms of Risk Control

Pricing Savings

Double Entry Accounting

Business Basics Members’ Rights and Obligations

Issues to be Considered

Consumer Analysis – Segmentation

Motivation Credit Risk Management

Managing the Liquidity

The Audit Trail – Vouchers/Receipts

Making Business Decisions

Transparency and Confidentiality

Screening – Client Capacity Appraisal

Consumer Analysis – Marketing Research

How Groups Work Pricing Risk Incentives to Savings

The Balance Sheet Financial Ratios Conditions for Membership

Appraising the Business Plan

Competitive Environment

Managing Organisations

Funding and Liquidity

Savings Mobilisation

The Income Statement Assessing Past Performance

Election of Officials

Approval and Documentation

Marketing Plan Organisational Politics

Managing Interest Risk

The Cash Flow Statement

Analysing the Market The General Assembly

Contracts and their Content

Marketing Mix Leadership Managing Portfolio Exposures

Sources and Uses Statement

Applying SWOT Analysis The Board and its Role

Disbursement and Control

Communication

Software for SCA Accounting

Formulating Strategies Capital Creation and Growth

Monitoring and Supervision

Decision Making

Financial Reporting for SCAs

Forecasting Future Business

Managing Variation Conflict and Negotiation

Establishing the Assumptions

Collection and Recovery of Loans

Projecting Financial Outcomes

Managing the Portfolio - MIS

Preparing the Business Plan

Assessing and Evaluating Impact

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Georgia-Agricultural Development Project Beans collected by Tsiuri Oniani in her family farm in the Gardabani Raion. Her family also cultivates beans, corn, cherries, strawberries, tomatoes, cucumbers, onions, potatoes, garlic, peppers, carrots and grapes for wine. IFAD Photo by Robert Grossman

“During the Soviet Period, we were occupied, had something to do. Now we wake up in the morning and know that there will be nothing” (Mr. Jafarov Jafar, former Kolkhoz tractorist, January 2003) VI. VILLAGERS’ VIEWS: DEMAND SIDE OF RURAL FINANCE

A. Approach and Rationale

133. Household Surveys for Members of Mutualist Financial Institutions : In Albania, Georgia and Moldova, where IFAD supported the establishment of credit unions or Savings and Credit Associations (SCAs), household surveys were conducted in villages covered by IFAD rural financial services activities. The objectives of the survey were (i) to establish an indicative picture of the social and economic setting of project rural finance participating households, and, through a control group, of those not participating; (ii) to obtain indicative data on household income and asset/liability status for average project participants following IFAD project support, and to compare these with non-participating households; (iii) to assess the degree of involvement of target group households in rural financial services (within and outside the project), and the need for such services; and (iv) to review participants own perceptions of the benefits and constraints of rural financial services initiated and supported by IFAD. 134. Borrower Interviews for Credit Lines from Commercial Banks (incl. MAFF): In Albania, Moldova and Romania, a different approach was selected to get the demand side view of borrowers from larger sized SME credit lines or the agricultural credit line in the Romanian case. Out of a list of borrowers, samples of 10 to 20 respondents were selected randomly and visited at their farm or enterprise. 135. The rationale for conducting these surveys and interviews at all, and for not sub-contracting these outside of mission members has been to get the first hand account of the people for whom IFAD financial services activities have been conceived. In line with IFAD rural finance approaches that consider institutional development not as an end in itself but as a means to an end, to better service

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rural poor people in need of these services, these interviews occupied a major amount of mission time and human resources during the four country studies. Reference is made to the country studies where all the primary data are presented in a processed format, and discussed in more detail for the specific country case than is possible in the context of this synthesis report.

B. Socio-Economic Settings

136. Core households consisted of about 4 to 5 family members. Typically for the countryside in the CEN region, these families live in rather large houses, surrounded by home gardens around the residential plot that result in a considerable overall size of the dwelling. These houses have 6 rooms on average with 3.5 sleeping rooms. In all four countries, the vast majority of houses had outdoor toilets, usually not connected to the local sewage system. Most households visited in the four countries had electricity supply, even though sometimes only erratic. Phones lines were functioning in only a few of the premises. Very few in rural Moldova and Romania, 40% of all households interviewed in Georgia. In Albania, cell phones reach high into the mountain ranges and have taken the place of land lines in a few of the visited households. 137. Farm sizes are small on average, but still contribute significantly to overall household cash incomes. 138. Land titling has been completed in most of the four countries. Wherever this titling was not based on quality cadastral data or maps, and where possibilities for appealing against titling procedures and results were limited and centralised in the capital, frustration among villagers has been considerable. The most agile previous leaders of Kolkhozes and Sovkhozes managed to secure access to high quality lands. In other cases, they accumulated large private farms through leasing of state owned lands at a time, when nobody in the village was aware that these leasing arrangements even existed. 139. The case of Albanian highlands where group lending was still implemented up to recently in IFAD projects seems to indicate that land-titling patterns also influenced the types of borrowings of the villagers. Wherever land titling was not yet completed and the farmers had to do without ownership certificates for the only major asset in their possession, the need for solidaric action and community based activities was felt more acutely. In these areas one can find the few still functioning Village Credit Funds (VCFs) in the mountains, non-formal credit mechanisms that lent to a group of villagers on the basis of joint liability. Wherever, on the other hand, individual land titles had been secured and were not disputed by neighbours, the borrowing pattern shifted towards a demand for small individual loans. This corresponds with observations from the Kosovo and Serbia: group lending in a European context works best with more destitute people without a large personal asset base, such as Roma people on the town market in Prizren, South Kosovo, or small highland farmers from Albania. When these borrowers have secured their own and individual asset base, the appetite for joint liability loans that may result in the loss of assets as a result of somebody else’s failure to repay a loan is considerably reduced. 140. Educational Attainment: Education standards in all four countries visited were uniformly high among respondents in the countryside. The case of Georgia illustrates this point, and is similar in the other three countries, even though overall level of schooling of adults in Romania lagged slightly behind. 141. The educational level of the household heads and their spouses in Georgia is depicted in table 10. Among household heads, just one had only 7 years of education, and he was older and a full time farmer. Otherwise, the lowest educational level found was 10 years of schooling (i.e. full secondary education), and 20 or (50%) of the sample of household heads had higher education in technical institutes or up to 5 years at university. The same situation was found with respect to their spouses.

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Where these were present (36 cases), 18 had been involved in higher education for up to 5 years after secondary school. All children of school age in respondent households are attending school, with no difference between boys and girls.

Table 10: Educational Attainment of 40 Sampled Households in Georgia

<10 years 10 years >10 years Interviewee 1 20 19 Spouse 2 16 18 TOTAL 3 36 37

142. Mobility has been relatively limited. Since the interviews were conducted in the villages, those who have moved to the towns or abroad were not captured and only those remaining could be surveyed. 143. Taken together, the general and non-income related socio-economic conditions remain favourable for rural finance interventions. Villagers still benefit from high levels and good quality education that was promoted during the Communist period. The withdrawal of these and other social services, such as Kindergartens, pre-schools and rural health stations after the collapse of the previous system is a source of major concern and dissatisfaction, voiced most strongly in Albania and the Republic of Moldova. Mobility is limited. Whoever wanted to leave to the towns or foreign countries has done so by now, and in countries such as Albania and Moldova, returnees that have to be integrated back into the village society are becoming a new phenomenon. For rural finance institutions, these returnees with their plans to start up new business in the countryside should also be a prime client segment to be newly developed. 144. Problems and Constraints: The main problems facing people in their daily lives seem to be broadly the same in the four countries. They are largely associated with the fallout from the collapse of the Soviet Union. Unemployment was mentioned most frequently as the main problem of contemporary life. Inadequate infrastructure, mainly roads and transport problems were also considered important. 145. Directly agriculturally related constraints concern mainly the only limited availability of irrigated land plots (Moldova, Georgia), the lack of marketing facilities (Albania, Romania) and the lack of accessible financial services. Credit and deposit services are by no means the only major constraint for productivity increases in the countryside. On the other hand, travelling major parts of rural Moldova, Georgia and Albania it is clear that these areas are cash starved and in need of investments, either in agricultural or in off farm enterprise investments.

Georgia-Agricultural Development Project Farmers meet and discuss business in a greenhouse that they own collectively in Saguramo village, Mtskheteta Raion. IFAD Photo by Robert Grossman

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C. Perceptions of Change since Collapse of Communist System 146. Looking at changes since independence, people’s attitudes were mixed. In a country like Georgia, the wealthiest country in the Southern Soviet Union, and more recently falling behind slowly but steadily, with respect to changes in the past 3 years, 3 out of 40 respondents considered that living conditions have worsened, 12 that there has been no change and 25 (a majority) that things have improved. Improvements ranged from increased availability of electricity and better roads and infrastructure, to improvements in agriculture through financial services, marketing and availability of inputs, higher agricultural production. An impact of the fledgling credit union network can be identified here. 147. Looking at changes in the past 10 years, or roughly since independence, the 40 respondents had a very different view. The majority (23) consider that the situation has worsened significantly in the last 10 years, pointing to a long term deterioration of infrastructure and services, the late payment of salaries and pensions and the overall worse economic and cultural situation. Five respondents considered there was no change and nine that the situation had improved, mentioning reduced criminality, safety, and possibilities of travelling abroad, starting micro enterprises and taking loans being among the stated improvements. This situation also reflects the facts in Albania and Moldova. Perceptions of change have been slightly more favourable in rural Romania. In addition to domestic policy achievements, this may be due to large inflows of European Union money (SAPARD Programme) in preparation for possible accession of this country into the European Union.

D. Access to Credit and Borrowing Patterns

148. In Albania, an ordinary household had practically no access to financial services before the IFAD funded projects in mountainous Albania. This situation continues and at the time the mission was fielded, no other source of credit but MAFF provided loans in the Albanian mountains. Loans from VCFs constituted the first and only source of formal credit to sampled borrowers. The first loans date back from 1996, while the most recent ones in the sample are not more than few months old. All previous VCF borrowers from the mid 1990s with fully repaid loan history have borrowed at least once more. One successful female trader had entered up to her fourth lending cycle. Borrowers recalled terms and conditions of their loans immediately, even if the loan was taken some time back and varied over time. With regard to repayment periods, these varied considerably between the borrowers even when loans were for similar activities. MAFF needs to apply more uniform and consistent procedures in this regard. Overall, the recorded repayment times would vary between 6 and 36 months. Notably, repayment periods for livestock investments had a wide range starting from 6 to 36 months, while loans for trading spanned from 12 to 36 months. With loan appraisal initially left to village credit committee members not trained for this job, there was little consistency between grace periods for similar kind of activities. With MAFF credit officers now responsible for loan appraisal and determining repayment schedules, terms and conditions for similar loans appear to become more similar again. 149. Informal borrowing and lending among friends and kin, and loans from urban based moneylenders and pawnshops constitute the only alternative non-institutional sources of loans. Group based informal rotating savings and credit schemes (“ROSCAs”), were not reported at all. Significantly, the non-borrowing control group in the sample had not taken any loans from any source. 150. In Georgia, the credit union model provides the only integrated donor promoted rural borrowing and deposit institution in the sampled four countries. Among the interviewees, attitudes to savings and borrowing appear to be fairly positive. Of the 40 respondents, 21 consider borrowing to be a form of investment to improve the long-term living conditions of the household; only 7 see it as a means to solve immediate cash flow problems and 12 borrow only when there is no alternative.

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151. Non-members of Georgian credit unions stressed that had not heard of the credit union in their village and were not familiar with the credit union concept. Among those who had heard of the credit union, in two villages people mentioned that the ‘credit union is not for ordinary people, but for the richer and more influential’, indicating its association with the former and current power structures and the greater involvement of less poor people in the communities. Members and non-members alike stressed the twofold need for loans in their villages: small and quickly repayable working capital loans, but also larger investment loans for agricultural production or off-farm investments. 152. In Moldova, the sampled SCA members had a positive opinion of the credit facilities offered by SCAs. Given high interest rates charged by village moneylenders, members and non-members rarely borrowed from them for agriculture or other productive purposes, but only for emergencies. Few members and non-borrowers had accessed loans through commercial banks. Thus the SCAs had significantly expanded the access of Moldovar villagers to credit, and at interest rates lower (typically 18% to 22.5%) than those charged by private moneylenders. 153. The demand for credit varies across economic background of households, which can be divided into three categories: very poor defined in this study as those with a food insecurity for 2-6 months a year, poor (food insecurity for a month or less) and less poor with no current food insecurity, but without adequate buffers for the future. Very poor households (including elderly without children, landless young couples without parents and with no migrating members abroad) demand small amounts of credit (150 to 500 MDL, or USD 10.5 to 35.0) as emergency loans for consumption and health care expenditures. They are either too old or too scared of taking loans for livestock or trade and prefer to borrow from shopkeepers and relatives, and have little collateral to offer. Poor households typically have small plots of cultivable land (1 hectare and below) and expressed demand for loans between 1 000-3 000 MDL (USD 70.4 to 211.2) for meeting costs of agriculture inputs, purchasing livestock, tiding over consumption needs during lean periods, marriage of children, as well as financing the costs of migration (abroad) of an adult member. Less poor households require loans larger than 3 000 MDL for replanting of farm vineyards and small investment loans. The poor and less poor households take loans from private moneylenders at 120% for health emergency needs and for legally sending children abroad. 154. In Romania, there are two types of loans offered through the IFAD line, working capital and investment loans. In reality, only the latter category is in demand. These investment loans can be granted for up to five years with a maximum of one-year grace. They have to be fully secured with movable or immovable collateral. A minimum of two (and up to four) guarantors with regular incomes have to provide a loan cover additional to the collateral. These securities determine loan amounts. Cash flow based lending techniques and dynamic loan appraisals are not applied. Most borrowers paid an interest rate of 6.79 percent for loans paid out in Lei and indexed to the USD. Interest rates are periodically adjusted. 155. Small farmers, shepherds and rural producers begin to fully understand the implications of the stringent collateral and guarantee procedures of the Romanian banking system only after having gone through much of the loan appraisal process. With average loan sizes of about USD 5 000, these borrowers were obliged to secure these small loan amounts with collateral often twice and three times the value of the loan. On the small farms that these typical IFAD target group borrowers possess, there is normally nothing else to pledge as a collateral than the farm dwelling. The collateral value of these residential properties varies between USD 8 000 and USD 50 000. The value of this property has to be assessed and the full costs of this (between USD 200 and 500) be borne by the loan applicant. In addition to a full collateral cover, the required two guarantors are often difficult to find for small and remote mountain farmers. Insurance cover for any collateral item is mandatory, further increasing the non-interest costs of the loan. Even though project credit procedures explicitly permit the hypothecation of the investment item (the credit-financed item itself is taken as security) and other less strict collaterals than residential property, in the concrete reality of small farmers dealing with

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their BCR branch, most of the sampled individuals ended up pledging residential property. This structure of the project supported sub-loan therefore turned out to be so unattractive upon closer inspection by small-scale loan applicants that many small people originally interested - and also considered creditworthy by the bank - decided not to take the loan after all.

E. Access to Deposit Services and Savings Patterns 156. In Albania and Moldova, no deposit promotion programme accompanied the credit delivery system through MAFF, the SCAs or the SME loans for larger rural business people. Only the SME borrowers with the five selected partner banks for the SME line in Moldova were free to put their deposits in the same bank that also lent the IFAD funded SME loans to them. But this was nowhere promoted. In the case of MAFF and SCAs, these institutions did not offer any deposit services at all. 157. In Georgia, credit union members recognised the different advantages of having access to a deposit-taking institution in the village. 19 out of 40 respondents consider cash saving to be important to plan the future, and 7 as a means to finance investments and emergency needs. Only 1 thinks that saving cash is useless due to the low interest rates while 4 prefer to keep gold as savings and 9 consider livestock to be the most convenient and effective means of saving. Both gold and livestock were stated to be superior forms for savings as they are easily convertible to cash when required. 158. In Romania, the partner bank BCR is very active in mobilising corporate and small scale deposits. The area in and around Alba Julia is the most active deposit mobilising area in the whole country apart from the capital. The Alba Julia branch of BCR managed to mobilise the Lei equivalent of USD 600 million by end 2002, as against outstanding loan balances of USD 300 million equivalent. Against these figures, the outstanding balance of loans refinanced from IFAD amounted to only a paltry 1.2 million A closer look at the account opening procedures in BCR for IFAD sub-borrowers shows that an opportunity has been lost to graduate the one-time loan transaction into a more durable and deposit based relationship with this bank. IFAD clients are usually new clients to BCR. They have to open two accounts when the sub-loan is disbursed, a designated credit account only for loan repayments and a current account for financial transactions associated with loan utilisation. The credit account closes automatically once the loan is fully repaid. The current account could have served as a basis for a more sustained client relationship beyond the repayment of the loan. But this account, opened generally only after considerable effort and documents produced by the sub-borrower, also closes automatically six months after full sub-loan repayments. This in spite of attractive and competitive deposit products of BCR, a fixed deposit range from 1, 2, 3, 6 and 9 up to 12 months at competitive interest rates, and with a minimum amount of USD 1 000 equivalent. 159. Considering this, it is not surprising to learn from the 11 interviews with a sample of sub-borrowers that they keep their savings for unforeseen emergencies or for a rainy day in their house, where it is not safe and does not generate returns for the depositor.

F. Household Income and Asset Structures 1. Household Incomes 160. Albania: Table 11 below contains the cash income structure of households borrowing from IFAD project resources, in the form of individual or group loans (“village credit funds”). The table consolidates the aggregate income structure and size of loan client and non-client households within a 12 months period. The definition of income relates to net cash incomes after subsistence and deducting production and other costs from gross cash income.

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Table 11: Structure of sampled household incomes (average per hh in brackets)

Clients Non-Clients

Lek % Lek % Farm related income 4 285 000

(194 773) 32 275 000

(55 000) 11

Off-farm income generation 6 574 900 (298 859)

49 1 067 000 (213 400)

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Salaries and all other income (incl. transfer payments)

2 470 300 (112 286)

19 1 129 600 225 920)

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TOTAL NET INCOME 13 330 200 (605 918)

100 2 471 600 (494 320)

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161. The table provides insights into the income structure and relative importance of different income sources in rural mountainous Albania. Sub-borrowers from IFAD lines have higher incomes from farming (crops and livestock) than the non-borrowing control group. It seems that these households finance working capital and investments primarily from remittances sent from family members working abroad. It is equally important to note that the control group has a little less than half of total household incomes deriving from remittances, whilst project supported borrowers had much less remittances to draw from. It is interesting to note that even after remittance inflow, project supported households command higher average incomes than non-borrowing households. A positive impact of recent farming activities (including those financed by IFAD resources) can be established. 162. Finally, the importance of off-farm income generation even for remote villagers in agricultural mountain locations becomes apparent. People that decided to stay and not emigrate from the village could make a living mainly by diversifying their income sources away from pure cropping and livestock rearing. This illustrates that micro and small enterprise loans are a source of household income not only for peri-urban and highly skilled borrowers. 163. Georgia: The Georgian farming households had an annual average cash income of GEL 3322.4 per household. Only the bartering and subsistence farming complements explain how these households can survive and why rural poverty levels are not higher than those captured by UNDP26. Out of the 40 rural households interviewed, none (!) derived any income from off farm SME type of activities. Cash incomes from farming contributed about 20%, while remittances raised 9% of total household cash incomes. The balance is due to wages, salaries and pensions. 164. In Moldova, incomes of 32 sampled households had the highest share of agricultural income in percent of total. Wage labour on other people’s farms and to a limited extent also genuine SME activities contributed to total incomes. Salaries and wages, but also remittances figured much less importantly than in Georgia. 2. Household Assets, Liabilities and Financial Status 165. As the respective tables in the country reports illustrate, the similarities in financial status and household net worth between the sampled countries are striking. First, land and property constitutes the most important single asset, followed by livestock and agricultural equipment. Financial assets in the form of deposits or loans to others do not play any role. It should be kept in mind however that these assets are in many cases notional rather than real. In some countries, a price tag is put on titled agricultural or residential land plots. In the absence of a functioning land market and mostly no demand for agricultural lands from any body, the price tag expressed in current market value is difficult to assess. Some banks in the region do not accept any farm or residential plots at all as

26 cf. UNDP National HDR 2000 for methodological explanations and a discussion of the Georgian Household Income and Labour Survey results.

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collateral, but only property in the capital (Azerbaijan) or in provincial capitals (Romania, Uzbekistan) as well. 166. Second, borrowers from IFAD credit facilities in all four countries have little to no alternative sources of credit. In Albania and Georgia, there is some limited activity of village-based moneylenders; in Moldova and Romania informal finance arrangements are criminal and a punishable offence. There are therefore no senior claims against which outstanding balances of IFAD sub-loans to be repaid have to compete. The main risks of non-repayment are the typical agricultural risks worldwide: climatic, insufficient insurance cover and marketing gaps or failures. 167. As a result of this overall minimal penetration of the formal financial sector into areas where IFAD financed credit activities were carried out, households have no debts to repay, and have a small but always positive financial net worth. 168. To conclude, the uncertain asset base and valuation make it seem recommendable to base lending decision on the net cash flows of the loan financed investments. Income movements, if they are complete and not hidden in the form of multiple bank accounts, dual income statements and balance sheets, etc., constitute a good indicator of overall creditworthiness. 169. These assessments do not require fancy business plans that are either time consuming (if done themselves) or expensive (if done by an outside company), but skilled and experienced credit officers or credit union staff. 170. Providing financial services to rural people below the small wealthy and entrepreneurial successful bracket will in the foreseeable future mean cash flow based lending with the requisite appraisal skills by financial institutions in rural areas of Eastern Europe and the former Soviet Union.

G. Gender Perspectives 171. In Georgia, the gender distribution of members in the surveyed credit unions appears to be reasonably balanced, at least in the CUs for which such data are available, with 55% of loans given to women and 45% to men. Women are the main borrowers for personal and commercial loans, while men are the main borrowers for agricultural and livestock activities. Repayment rates are generally better for women. Women are also active in credit union management with women managers in three of the seven functioning credit unions visited. 172. In the course of formal and informal meetings, there was no suggestion of any problems for women either in joining credit unions or in obtaining loans. Insofar as the collateral used for credit union loans up to now has been mainly livestock, gold and household goods, the issue of whether land titles are in the names of men or women has not arisen as an important issue with respect to securing loans with land titles. The current situation appears to require no specific intervention for improving the gender balance as it appears to be well balanced. It would be necessary to have data on all credit unions and on all loans to be able to confirm these mission findings that are based only on a sample. 173. In Albania, despite the fact that Albanian women increasingly entered the paid labour force during the last 50 years, traditional gender roles particular in rural families are still preserved. This came out in group sessions conducted by the Albania mission and is in line with a recent UNICEF national study on the subject. The majority of women indicated that their husbands held a strong belief in the traditional culture that dictates the submission of women to men. On the contrary, most of the women did not favour the traditional gender roles. Women expressed their desire to be equal to their husbands. But still, the traditional gender roles are difficult to be broken down, as resulted from the women’s statements. “Equal rights between men and women have never existed in Albania, nor do they exist nowadays. The main factor leading to this situation is the inherited mentality, which

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considers the woman a household property”. In sum, a special emphasis on women borrowers and ensuring their equal access to financial services would have been called for given that the project aimed at providing equal access to loans for all rural low-income borrowers in needs of these loans, and also considering that as of to date, there are still serious imbalances in the decision making power and control over resources in rural Albanian families. 174. In Moldova, no gender inequalities were observed with respect to access to primary education, access to food, access to markets, work force participation, wage levels and control over household income. However, inequalities still prevail with respect to legal ownership of homestead plots (with these being largely owned by men) and access to leadership positions in village councils. On the other hand, as far as access to project supported financial services from SCAs is concerned, women accessed almost an equal number and proportion of loans in the sampled SCAs. Spouses of borrowing members were aware of the loan taken by their husbands or wives, and took part in decisions on whether and how much to borrow, and use of income generated from it. 175. Finally, the random sampled borrowers in Romania consisted of 36.6% women borrowers. Not surprisingly, the collateral orientation of the Romanian banking system meant that only women in control of household assets and productive resources such as widows and other female-headed households were in a position to borrow from the bank.

H. Views on Investing in Village Economies 176. Views from the four countries are similar. Agricultural areas and rural economies are cash starved in all these countries bar Romania. For this reason, small loan amounts up to USD 1 000 would be used for working capital expenditures, specifically for agricultural inputs and requirements for livestock production. 177. Comparatively larger loan amounts would likewise mainly finance agricultural and livestock related re- or new and additional investments. Details are contained in the processed data tables of the country reports, but a picture emerges: New opportunities exist within the agricultural sectors of these countries that have been neglected for more than a decade and may likely meet adequate demand for its produce. This holds true in particular for the classical countries with high quality agricultural produce such as Moldova and Georgia.

VII. IMPACT ON PEOPLE’S LIVES AND PRODUCTIVE ASSETS

A. Impact on Physical and Financial Assets 178. In the absence of an impact-oriented monitoring system in the projects visited, reliable and robust statements about movements of physical and financial assets over time cannot be made. The spot surveys conducted by this mission focused only on one point in time, the interview date, with only limited attempts of scaling variables over a time line. In any case, these attempts would have been subjective, since farmers do not remember gross or net incomes of 12 or 24 months ago with any certainty. Against this background, the statements in this section should be considered merely as related to one point in time, based on interviews and site visits usually not exceeding 90 minutes. 179. Physical Assets: The key event in the household balance sheets of the four countries over the past years has been the assignment of individual land titles and a valuation going with this process in most of the cases. Growth in livestock and agricultural equipment appears a better indicator of overall project impact, albeit not just of the sub-loans since effects from borrowing can not be separated from other income effects generated by the projects such as extension and grants (attribution problem). The trend in all the four countries is upwards with regard to accumulation of non-financial assets.

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180. Financial Assets: Monetary deposits and accounts receivable from other parties constitute negligible positions, and can not be used as an indicator of impact of projects in this part of the world. Indications from Albania detailed above show however that the impact of agricultural finance on the overall income status of loan-financed farmers has been positive.

B. Impact on Human Assets

181. Aspects Related to the Quality of Health and Related Services and Indicators: Changes in potable water supply, disease prevention and basic health services, maternal mortality and HIV infection are noticeable in the CEN countries and also specifically in the four countries visited by this mission. No link or interrelation to project supported financial services could however be established. For the IFAD supported credit activities, the above indicators constitute exogenous variables.

C. Impact on Social Capital and Empowerment 182. The possibility of accessing loan funds in cash starved environments like rural Moldova or the Albanian highlands changes the quality of life and the comparative advantages of the rural location vis-à-vis other and likely urban settings. The dependability of this access to financial services has been demonstrated in Albania and Moldova through institutions that have been operating already for some years in the current or previous forms (VCFs instead of MAFF in Albania). The outlook of rural people to rural organisations and institutions is likely to be influenced to a large degree by the experience of credit unions, VCFs and SCAs. The message that also in free market systems, solidaric and group based action can reap rewards for all individuals involved will be with these farmers also for the future, when group based marketing or political organisation and expression will become more common. 183. Access of women to loan resources appears to have been satisfactory in the more group based credit union arrangements in Georgia and Moldova, and less so in Albania and Romania, where a bank (Romania) or bank-like financial institution (Albania) took the lead as the credit institution. Where access to financial resources is equal, such as in Georgia and Moldova, an impact can be made on women’s empowerment and the equal and gender neutral build up of social capital.

D. Impact on Food Security 184. In all the four countries, more than 50% of the farming produce went into subsistence and was consumed or bartered without entering formal market channels. Wherever farming systems permitted only perennial crops or other farming systems without a subsistence element for the family, cash incomes increased markedly, but the overall poverty situation was worse rather than better since all household food items had to be bought on the local markets against cash. This applies to the high mountain ranges of the Apuseni mountains in Romania, where only transhumance and livestock keeping is possible above a certain altitude, but also to the Albanian highlands. In Moldova, a certain diversification along ethnic lines was observed in the project judet of Ungheni. Azeri farmers raised sheep and grew potatoes on their small farming plots, Ukrainian and Russian farmers grew winter wheat and perennial fruit trees (apples), while Moldovan farmers concentrated on wine production and vegetables for subsistence production in their home gardens. 185. In Georgia, all the households met rely heavily on their own production and sell little or no farm produce. Of the 36 rural households, 12 (33%) found their home produce sufficient to cover all their household food needs last year, while 20 stated that their home produce fed them for 6 months a year or less, meaning they were in food deficit. Cash for food and other expenses come from state salaries and pensions for 12 households, from a combination of state and private income for 13 households, and entirely from private enterprise for 12 more respondents; three respondents did not answer that question. The very limited sales of agricultural produce reflect the reversal to subsistence

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agriculture, though the inability to fully satisfy their needs throughout the year also reflects the small size of the land plots as well as the limited animal resources of the new farmers. 186. In view of the mixed nature of farming in the country, the average diet is generally quite appropriate. In winter it appears to consist mainly of dairy products and bread (from maize and wheat) as well as beans with some meat, while in summer, vegetables are added to these produce. The wide availability of home produced or cheap dairy products as well as the availability of poultry and eggs from home production ensures a healthy diet. Although not mentioned, fruit, salads, and nuts are also very widely consumed either fresh or preserved at home.

VIII. INSIGHTS GAINED

A. General 1. Poverty Levels, IFAD’s Targeting Approaches and the Need to Re-Focus 187. More than a decade after the fall of the previous systems, average monthly wages in the region remain precariously low. In the Republic of Moldova, these ranged between USD 29 and USD 40 per wage earner between 1999 and 200127. These levels of poverty are on par with some of the poorest countries in the world. Recoveries from income poverty domestically but also in rural areas has been much slower in many countries than envisaged. In the comparatively differentiated rural social profiles 15 years after the collapse of the Soviet Union, IFAD may therefore consider to either refine the targeting criteria in order to better reach pockets of poor people within societies that have moved on, or to still apply area targeting only in the more remote and underdeveloped areas for poverty reduction impact. 188. Experience from the four countries studied varies widely. Albania and Georgia with the IFAD positioning in the more remote and poorer mountain regions would still justify an area based targeting, even though this is no more the case in Albania and the most recently added districts that are outside of mountain areas and with a larger share of non-poor population and the need to define target areas better. The problem in Georgia is rather that in two of the four districts selected for the IFAD Mountain Area Development Project, the potential for initiating or strengthening economic activities is very minor, compared to other mountain regions. In Romania, the entire project area selected by the IFAD design team was misplaced. Not only is the area around Alba Julia among the wealthiest in Western Romania, but the rural poverty incidence can not be compared to other parts of the country as well. The reason for this is quite simple. In the Apuseni Mountains, farmers were permitted to keep their farm land as private property also under Communist rule. Other than the collectivised farms in the lowlands, the Apuseni farmers were known throughout the country as small but comparatively well off. 189. Both the targeting concept and the type of targeting should in future be based in the region on project design inputs similar to those applied by IFAD in other regions of the world. Socio-economic and production surveys are usefully phased between inception and formulation missions, thus equipping a project preparation team with the sociological, socio-economic and targeting information required for a poverty reduction initiative. None of the projects reviewed conducted an exercise of this kind, even though when World Bank projects were co-financed (“first generation projects”), the World Bank conducted its own social information exercises as part of project preparation (Albania, Georgia).

27 IMF Republic of Moldova 2002 Article IV Consultation, Staff Report

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2. Rural Finance Development and Donor Collaboration 190. Broadening of Partners for Rural Finance Development: Up to now, IFAD co-financed mainly projects of the World Bank in the four countries studied. Other IFIs with relevant complementary experience in rural finance promotion such as the European Bank for Reconstruction and Development (EBRD), the German KfW Commercial and Development Banking Group (including DEG, the equity finance provider of the Group), and smaller bilaterals were not approached for co-or parallel financing. This is in spite of the fact that a wide range of different support and development agencies pursues the support of rural finance institutions in the CEN region. In addition to the Multilateral Financial Institutions that operate with loans and through Governments (IFAD, WB, Regional Development Banks, Islamic Development Bank), there are bilateral and multilateral grant and technical assistance agencies plus organisations that are funded by the private sector (Soros Foundation, BP Foundation, etc.). For IFAD as an organisation without direct country presence and with loans to governments as its principal instrument, development partners would ideally have the following characteristics (i) local presence and domestic knowledge base in financial sector and rural finance (ii) grant, technical assistance and other capacity building instruments (iii), and with possibilities to directly work with the private sector. These three features would usefully complement the IFAD instruments for development of rural financial systems and institutions. Future partnering should therefore be broader based and oriented towards partners with proven successful interventions and experience in poverty-inclusive financial institutions development in the CEN region. 3. Conducive Policies and Enabling Environments 191. Similar to other developing regions world wide, the Poverty Reduction Strategies, in interim or final form, have very recently emerged as a key standardised instrument for policy formulation and medium to long term strategies for combating poverty. Where governments have taken these instruments seriously, such as in Albania, ownership was nested in the dealing government departments almost from the outset, and recommendations in different fields, including rural finance development, receive considerable attention. In other countries, such as Georgia or Moldova, the PRSP approach has not taken off or yielded many tangible results on the ground. 192. Experience with rural finance as a tool for development that IFAD interventions have generated, have up to now not adequately been reflected in PRSPs. The Fund should pro-actively advise on its experience and guidance for future roles and directions in rural finance development as a means for poverty alleviation.

B. Financial Systems Development 1. Specific Rural Finance Development Constraints and Opportunities in the CEN Region 193. The study has revealed the extent to which rural financial systems and institutions in all of the sampled countries had collapsed. Until now, IFAD supported rural finance systems in Albania, Moldova, Georgia and to a large extent also Romania constitute the single and only source of credit and place for deposits for large parts of the rural population. This considerable institutional gap has been turned into a challenge through IFAD supported interventions: to establish, consolidate and scale up new and hitherto untested institutions such as MAFF, SCAs in Moldova and networks of credit unions in Georgia. In particular the challenges concerned two areas, outreach of these institutions to truly rural and low-income households, and an institutional development path that would show concrete prospects of reaching operational and financial sustainability in the medium term. 194. Demand side surveys of this study have confirmed that overall satisfactory progress was made on this challenge of filling institutional and service gaps that left large parts of the rural population outside the reach of conventional financial institutions. Poor people were reached in their rural micro economies and credit-only (Albania, Moldova) or savings and credit services (Georgia, Romania)

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provided to them. On the latter challenge, the institutional development paths towards sustainability reached varying degrees, depending largely on the quality of project design, and of domestic executive management staff. The purely IFAD supported MAFF in Albania is doing well on both challenges, whilst most of the more than hundred World Bank and IFAD supported Georgian credit unions do not have a future28. In Moldova, SCAs perform better in their day-to-day business, but there is a medium term sustainability issue here as well. In Romania, sustainability prospects of the IFAD supported credit line appear intact in the strict sense. There are however major question marks related to the future of the only partnering bank there, the Banca Comerciala Romana that is in the process of privatisation. 195. However, the long-term impact of institution building for rural finance development in the CEN region remains an open issue. Too much depends on the larger political and financial sector stability as well as endogenous variables such as ownership strategies, technical and banking skills and management capacity of domestic executives. A transfer into private hands with a mixed domestic and international private ownership in these institutions appears the best strategy against future instability or lack of sustainability. 2. IFAD Appraisals of Partnering Rural Finance Institutions 196. The study showed that the quality of rural finance recommendations at appraisal stage in general, and specifically, the appraisal of financial institutions as partnering institutions for IFAD in particular require improvements in future. 197. The Case for Better Quality Financial Institution Appraisals: In Romania, IFAD appraisal recommendations foresaw a subsidized supervised credit programme more typical of earlier periods of rural finance development. With this package only one bank, the state owned Banca Comerciala Romana could be persuaded to join. In this case, no appraisal of this institution was made at all. Absorptive and service capacity in the project area, and the probability of privatisation and subsequent closing of rural branches and phase out of rural lending were not considered. In Albania, IFAD supported rural finance operations were delayed considerably after a bank that was appraised to be fit for collaboration with IFAD went bankrupt shortly after project start-up. 198. The Case for Better Appraisals of Rural Finance Components in IFAD Supported Programmes: The first two IFAD financed Albania Appraisal reports required major shifts of the rural finance components during implementation. The last one proposes a new financial institution, but does not contain the minimum corporate guidance such as a business plan for this institution. In the case of Georgia, assumptions for sustainability of credit unions and their servicing institution CUDC quickly turned out to be unrealistic, and in the absence of any prospect to cover CUDC expenses out of membership fees, the future of this project initiated umbrella institution remains unclear. Romania with its subsidized credit operations and major role foreseen for another donor (GTZ) that never took on the tasks envisioned was mentioned above. Finally, the IFAD Appraisal of its Moldova Project best exemplifies the need for better appraisals. Project implementation was planned for only half of the project (up to mid term review), and the latter half of the project was left open and to be designed by an MTR mission. Major implementation responsibilities were assigned to a small I-NGO that never came up with the agreed counterpart funds or took up its responsibilities under the project.

28 See Georgia Country Report of Thematic Evaluation for detailed analysis. In sum, the failure of Georgian credit unions can be attributed to inadequate monitoring and supervision of project activities, insufficient attention paid to capacity building, training and management development, as well as inverse incentives caused by credit union installation grants. The fact that lending to credit unions had to be interrupted for more than a year because of project internal problems did not help to build up trust in the system either.

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199. Alternative: Shift of Appraisal Financial Resources to Programme Implementation: The case of Moldova could also be considered differently however. In a rapidly changing rural and macro-economic environment, it may be more opportune to shift design of the tail ends of projects to implementation. In this case however, the attendant funds and budgets would need to be amended in tune with this shift and more resources made available to IFAD or its Cooperating Institutions in future. 3. Mainstreaming Approaches 200. The study showed that three out of four rural finance programmes supported by IFAD largely supported the development of new institutions. In the case of Albania, MAFF operates as a non-bank financial institution licensed by the central bank, the Bank of Albania and is treated as an NBFC without any exemption criteria. 201. In Georgia, the central bank now requires a formal registration of each credit union. This could be interpreted as a step to integrating these institutions into the formal financial mainstream. On the other hand some of the registration criteria, here in particular the minimum capitalisation for each credit union have led some of their members to believe that the central bank criteria are too stiff and more accommodating to the urban middle class than to rural small people. 202. In Moldova, the registration of SCAs is kept simple, while in Romania, some of the rural based thrift and credit cooperative societies there have proved so robust that they had survived more than two generations of Communist and centralised rule. 203. The programme with the largest potential for mainstreaming, the Apuseni Programme in Romania, had the least to show in this respect. The essential credit and operating procedures of this only partnering bank were never assessed. Neither did the bank make their credit guidelines for IFAD project lending available to the Fund or UNOPS, the Cooperating Institution. Without a knowledge of existing procedures for rural and retail finance, and the insistence of the bank not to disclose lending procedures to IFAD as the funding agency for this project, the degree of mainstreaming of IFAD lending procedures for small and agricultural loans into the main operations of the business can only be guessed. And this guess would realistically be set rather low. 204. In sum, the three new institutions in Albania, Georgia and Moldova are well integrated into the formal financial mainstream. In Romania, the IFAD financed small-scale loans to agricultural producers and rural based SMEs will likely have had no significant impact on the general business of the partnering bank.

C. Performance of Partnering Financial Institutions 1. Recovery Performance, Target Group Reach, Capacity Building 205. In all four countries, the IFAD rural finance portfolio performed satisfactorily in terms of portfolio at risk. In the case of the Albanian MAFF, a transfer to international accounting practices, including procedures for loan write-offs would reveal the real portfolio at risk. Shortcomings relate to an overly numerical target setting for the establishment of credit unions in Georgia, and the inadequate selection and collaboration procedures with the commercial bank in Romania. 206. Target group reach in the present portfolio is an issue mainly in the SME credit lines financed by IFAD in Albania through MAFF and in the Republic of Moldova. In both cases, a better monitoring of income and employment effects to small scale rural farmers and other low income segments of the rural population are required to assess whether these credit lines have a trickle down effect strong enough to justify IFAD financing. In all likelihood, a strict poverty reduction oriented

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SME finance portfolio would be smaller than the present exposures in IFAD projects in Albania and Moldova. 207. Capacity building efforts for rural finance institutions would be considered positive in three out of the four countries, Romania being the exception.

D. Emerging Impact for the People and Rural Economies 1. Beneficiary Demand Patterns and Service Requirements 208. Depending on the degree of crisis in the village economies and opportunities to make a living in the countryside, the demand for financial services varied among beneficiaries in the four countries studied. In post-conflict scenarios quick access to loan funds is required for the returning population. If the Albanian mountain areas would have had to do without the quick loan facilities of the type offered by VCFs, some of the young people farming there today would have migrated to the large cities in the lowlands. Similarly, in Moldova with its precarious and persisting poverty levels, the SCAs with their current credit only service function may have filled a need. While short term and seasonal loans were offered by all the rural finance institutions in the four countries, investment finance for the small farmer or rural entrepreneur was found to be in rather short supply in all of the four countries studied. 209. It is simply incorrect to state that only large farmers and SMEs in the countryside have an effective demand for investment finance. Small farmers and micro entrepreneurs equally do, but their required loan volume may range from just USD 2 000 equivalent to USD 10 000 and 15 000 at the most. – Far from the USD 100 000 loans currently traded as small farm and SME loans in the Eastern European countryside. It is this client bracket between the small and short term loans and the few large farmers and rural SMEs that have largely gone unserviced. In Romania, where it was possible in the IFAD project for a small farmer to borrow for a USD 5 000 investment, this loan was usually secured with USD 50 000 collateral in the form of the entire current real estate value of the farm. The Albanian MAFF has gone the longest way in providing loan sizes for small scale investments of a relevant size and tenor in its individual small loan product. The SMEs loans up to USD 100 000 are way beyond the reach of average or moderately larger sized farmers or SMEs in the Albanian countryside. 210. The lack of financial services other than loans remains the biggest shortcoming from the client point of view, as far as the Moldovan SCAs and the Albanian MAFF is concerned. In Romania, no attempt was made to utilise the many openings created through the IFAD project for a structured deposit mobilisation initiative. Only in Georgia, deposit mobilisation was considered from the outset as the natural complementary activity to provision of loans through the Georgian credit union network. 2. Access to Assets, Income and Investments 211. The four country examples all indicated that access to credit funds has been generated. In Albania, Moldova and Georgia on a sustainable basis, but in the latter country this can only be said for the less than three dozen CUs that are still in existence out of more than 200 founded through the project. The extent to which loans to small farmers and rural SMEs have generated assets and income depends on the quality and direction of loan utilisation. In cases where the risk adjusted financial rate of return for loans was analysed in more detail (SME loans in Albania, Moldova and Romania), most investment and working capital activities financed by loans had a large enough margin to generate net income after loan repayments. Assets were mostly created in the form of livestock or agricultural equipment. Plot amelioration would also count, where perennial plantations were upgraded through irrigation or new and high yielding variety plants.

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3. Other Pro-Poor Impacts at Household Level 212. Community and group based institution building that works for the people in the countryside is probably the biggest non-monetary achievement of the projects in Moldova and Georgia. Analysis of this evaluation above all in Albania with its prolonged period of internal upheavals and destitution show that IFAD loans for livestock made a difference to highland villagers.

IX. THE WAY FORWARD: CONCLUSIONS & RECOMMENDATIONS

A. No Way Back for the New Rural Poor 213. The poverty situation in the former Soviet Union and other countries of the CEN region has forced people to adapt. There is simply no way back to the old and in some ways protective and comfortable system that was ready to subsidise rural families. Trying to tackle the “New Poverty” in Eastern Europe and the former Soviet Union means building awareness first that the way is forward with new services, institutions and development perspectives for the villages. With capital in many cases in shorter supply than other production factors and financial institutions or semi-formal credit providers not at hand, the development of rural financial services and institutions is a process that will go hand in hand with a general recovery of rural landscapes. This process of guiding poor people to look forward and search for hope and opportunities not in the past, but in the new free market economies, will need to be built up.

B. From Plan Allocated Credit Distribution to Functioning Rural Finance Systems 214. Initial expectations in the speed of transfer from guided credit institutions under the old Soviet system to self sustained providers of savings and credit services proved to be unrealistic. In the first years after the collapse of the Communist system, farmers and rural poor people targeted by NGO microfinance institutions had not yet developed their credit culture and defaulted in the face of economic hardship. The old and failed institutions were then liquidated and from the mid 1990s onwards, in countries as diverse as Romania, Azerbaijan and Georgia, new and privately owned financial institutions, and community based financial institutions in the countryside began to emerge together with a new clientele of business minded private entrepreneurs and small farmers. To date, this process of liquidation, transfer and consolidation is basically completed satisfactorily in some of the countries. The Republic of Moldova possesses a small but effective commercial banking sector that reaches out also to rural areas and is open to innovative retailing arrangements through refinancing of SCAs there. In other countries such as the Belorus and Uzbekistan, some of the structural elements of banking in the former Soviet Union remain in place up to this day: non-convertible domestic currency, cash plans for entrepreneurs and liquidity steering for commercial banks, and the use of rural finance institutions to obtain information for tax authorities and deduct taxes directly from the bank account of an overdue farmer or small entrepreneur. 215. In sum, large differences between individual countries and the degree to which they have developed their commercial and rural finance institutions remain and should be recognised as such by project designers. In some countries such as Serbia and Russia, these institutions continue to exist side-by-side. In others such as Romania, self sustained thrift and credit cooperatives for proximity financing have survived the entire Communist era and continue to function after almost hundred years of existence. Again other countries have not taken the challenge of reforming their financial sector and making it more accessible also to smaller clients (Belorus, Azerbaijan, Uzbekistan, Turkmenistan). Others have completed their sector and financial institution restructuring and are ready for an energetic outreach through rural and microfinance institutions in future (Albania, Kosovo, Kazakhstan, Republic of Moldova). 216. For this reason, the sizes and entry rationales of IFAD rural finance operations into countries with as yet unreformed financial sectors and only a few and scattered rural and microfinance

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institutions present, should be more critically considered in future. Absorptive capacities of banks and other rural financial institutions in rural finance environments that are not fully reformed need to be assessed on site. They will likely be smaller than initial rural finance design may have suggested.

C. Role of Donors in Institutional Development for Rural and Microfinance 217. In the 1990s, access to grant funds and technical assistance constituted the most common route for establishing new types of financial institutions. More recently, the necessity of a long-term sustainable development of these institutions, ownership and management by local people and an exit strategy for grants and donations to the financial business of these institutions has increasingly been advocated. For newly established institutions such as those reviewed by this study in the former Soviet Union and Eastern Europe, considerable start-up grant funding and international technical assistance appears the most promising way to sustainability. In a second phase after institutional consolidation, it is then necessary to phase down technical assistance and non-repayable grants to avoid long-term structural damage for the rural or microfinancial institutions and moral hazards, as well as reverse incentives. 218. The Microfinance Banks29 in most countries of Eastern Europe and the former Soviet Union constitute a promising example in this regard. Capitalised initially by the KfW Banking Group, and usually the European Bank for Reconstruction and Development, IFC and international commercial banks, these specialised banks for micro and small entrepreneurs have become the fastest growing commercial banks in many countries, and the largest ones in others. Only 2 to 4 years after their establishment, grants, technical assistance and other forms of subsidies to their commercial operations are phased back. In less than five years from their inception, these banks are planned to be financially and operationally self sustainable and locally managed.

D. Rural and Microfinance Strategies and Operations

219. Microfinance interventions, if they are located in rural areas, constitute a sub-set of rural finance operations. However, the differing objectives, emphases in institutional capacity building, and differing loan-grant mixes to get these programmes off the ground would make it advisable to clearly separate between microfinance and rural finance objectives and activities. Any overlap between rural and microfinance should be clearly defined at the outset in order to manage expectations later on.

E. Monitoring and Supervision

220. All three major types of financial institutions offering rural financial services, banks, credit unions and NGOs would be expected to possess the adequate skills for progress and financial monitoring. On the other hand capacity in the project office is required for impact monitoring. This should build on socio economic surveys and baseline studies. Partnering institutions in IFAD first generation projects did not place the same emphasis on tracking the physical and social progress of targeted rural families. The two Georgia investments constitute an example in this regard. While baseline data and subsequent monitoring of development progress of targeted rural people was absent in the first Agricultural Development Project, the Rural Development Programme for Mountainous and Highland Areas (RDPMHA) operations were based on an elaborate baseline study30 and monitoring by the project office now includes gender disaggregated and impact monitoring.

29 Those established by the German Consulting Company IPC as the Managing Entity, are now re-branded as ProCredit Banks (Albania, Kosovo, Serbia, Bosnia and Montenegro, Bulgaria, Republic of Macedonia, Moldova, Romania, Ukraine, Georgia) 30 Institute for Polling and Marketing Georgia – The Baseline Study as Part of the RDPMHA, May 2002 (www.ipm-georgia.com)

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221. Large Loans to Individual Borrowers for Poverty All eviation? Three out of four countries visited permit the granting of SME loans of up to USD 100 000, either on a restricted basis (Moldova, Romania) or as part of the main lending business (Albania, MAFF SME loans). In view of this mission, it would neither be useful to continue with the current practice of issuing large loans under a poverty alleviation context. Nor would it be justified to exclude the granting of large loans altogether. This mission recommends to continue with very large loans only under the following conditions:

• Granted by an IFAD supported institution, but not out of IFAD loan funds. • If granted out of IFAD loan funds, then a special and separate impact monitoring function

needs to be exercised. This would not be done by the concerned bank or financial institution, but by the project office. Impact monitoring resources should monitor and quantify income and employment effects that large loans have on small farmers or poor landless households in non-urban areas. It is encouraging to note that MAFF in Albania takes a broadly similar stance and attempts to monitor the broader income and employment effects of its large SME loans. However, this effort needs to be streamlined and applied to all larger borrowers uniformly.

• If granted out of IFAD loan funds, any loans larger than USD 40 000 would have to be accounted for a special case with a separate justification as part of the loan documentation. The case of Moldova indicates that special procedures need to be put in place to prevent that a pro forma exceptional loan size does not over time become the commonplace procedure.

222. The case of Moldova provides good pointers for a future positioning of IFAD SME loan funds. Following the IFAD Thematic Evaluation mission visit to the country that pointed first to the problem of special arrangements for large sized SME loans, the PIU immediately

• stiffened the access criteria for SME loans higher than USD 30 000 • pays special attention to monitoring the impact of loan financed investments on employment

creation, increase of employee income in addition to SMEs net sales and profit margins • in addition, each year the project office now conducts a Beneficiaries’ Evaluation Study

analysing the evolution of financed enterprises and progress on key impact indicators obtained.

223. As a result, the weight of loans larger than USD 30 000 has decreased from 62% at the time of fielding the thematic evaluation mission to 17.7% in 2004.

F. Savings and Credit Performance Enhanced through Training and Non-Financial Services 224. Frontloaded non-financial and business development services should figure more prominently in some of the rural finance components. In Albania, field surveys indicated that poorer and very poor villagers would have been reached if some investment in upgrading skills and entrepreneurship awareness were made. In Romania as well it was obvious that entrepreneurial performance of economic actors could have been performed through:

- awareness and guided self-analysis - stimulating enterprising behaviour - the build up of business competencies

225. Many training programmes have the objective of transferring needed skills and know how, with the result that knowledge is acquired but there is very little subsequent application, because of the absence of working on the motivation to act, the strengthening of capabilities to act and the testing of the capabilities in "real-life simulation exercises". This is particularly the case with lower income target groups whose experience and exposure to more formal business situations such as applying for

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a loan from a bank, precludes their competence in handling the rigours of a sophisticated business environment that comes together with growth.

G. Promising Practices in Rural Finance Development for CEN Region 226. There is no single institutional model that emerges as the clear “winner” in promoting rural finance in the CEN region. A wider look also including other countries in Eastern, South Eastern (Balkan), Caucasus and Central Asian ex Soviet Union countries leads this study to conclude the following: (i) Commercial Banks and Non-Bank Financial Institutions: Institutions emanating out of

programmes for establishing new banks and NBFCs are usually robust and solidly established in their chosen market niche. Near term exit strategies for international financial institutions holding the capital and appointing the management of these institutions are the most often cited issue with these institutions. This exit strategy still needs to be defined for MAFF. Wherever financial services activities are channelled through existing banks in the CEN region, more caution has to be exercised than in other regions. De facto governance and priorities of owners require careful analysis. For example, a bank that operates as a de facto finance department of a large corporation would not be a good partner for a development project. For this reason, the practice of professional commercial bank appraisals that are conducted by other IFI donors should be exercised by IFAD as well. The fact that a partner bank in Romania did not even undergo the most essential appraisal checks is worrying. Equally, the fact that even an elementary due diligence control of this bank can not be carried out at mid term review is worrisome as well. Considering the impending privatisation of this bank, lending on this weak basis constitutes a high-risk strategy for an International Financial Institution like IFAD, even if repayments are backed up by sovereign guarantee. Future partnerships with commercial banks in the region should be based on a professional appraisal and realistic expectations on the partnership on both sides.

(ii) Credit Unions, SCAs and Thrift and Credit Cooperative Societies: In the CEN region more

than in other parts of the world, donors reacted to the de-capitalisation of the countryside by introducing group based decentralised finance systems with many features that resemble credit unions (and in the case of Azerbaijan, these institutions also carry the name credit union), but without any deposit mobilisation at all from members (not to mention the general public). It is a fact confirmed by this Thematic Evaluation that the SCA systems in particular in Moldova without internal deposit mobilisation have outperformed those in Georgia with internal mobilisation of deposits. Still, it is likely that with general development and growing income levels in the countryside, deposit services will become more and more important. Once market surveys indicate a demand for savings mobilisation, then this service should be introduced without delay by the SCAs. On the other hand, this study also indicated that gender equal access to financial services is best ensured through decentralised and credit union type of financial institutions. This is a big plus of credit union type institutions and not yet sufficiently highlighted in the literature.

(iii) NGOs: These often internationally steered operations cover small loan amounts to mostly urban

poor people that characterise microfinance. Without their incorporation and integration into the formal financial mainstream of the Eastern European and FSU countries, these institutions often provide a service parallel to already existing banks or non-bank financial companies, but to a poorer and more informal economic clientele. Requirements of new or fledgling NGOs are naturally for grant funds, both for on-lending and for capacity building. A forward looking school that acknowledges the institutional maturity of some of these Eastern European iNGOs that have been in the market for sometimes more than a decade is in line with IMF thinking on

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the subject31: grant funds for on-lending to these NGOs are considered appropriate only in the early and consolidation phase. Subsequently, where funds are on lent, they should be raised commercially or through donors providing loans and not grants. The KfW Banking Group pioneered this approach in Kosovo already in 1999, together with high calibre technical assistance to the three selected NGOs32. However, a few key benchmarks have to be set and followed in this type of collaboration: Loans to iNGOs must be short to maximum medium term in the light of their weaker corporate identity and the higher “address risk”. Domestic and forex inflow have to be carefully blended and a thorough risk and liquidity assessment for both future forex and domestic currency positions made. And finally, the final layer spread for the iNGO (meaning the locally incorporated independent institution that emerged out of initial iNGO operations in the country) needs to reflect the higher costs of NGO operations as compared to other institutions in the financial sector.33

227. In sum, banks can be the intermediary of choice in reasonably robust banking environments such as most countries of the Balkans in particular Slovenia, some of the Eastern European countries, and the emerging private banks in the Russian Federation. In these countries, competition between banks forces them to open up to new client segments. Where population densities are adequately high and distances can be easily travelled (such as in Croatia, Serbia, Azerbaijan or even the Republic of Moldova), banks will be more interested to develop their non-corporate retail and SME segment. Credit unions require strong external supervision. Donor initiated notions of internal or self-supervision as the driving modus operandi remain elusive for institutions especially if they mobilise public deposits or transact higher volumes of loans to their members. NGOs and iNGOs are the likely partner of choice in urban or semi-urban environments, but also in rural areas where the population has no access to financial services. Small sized and quickly repayable loans that characterise microfinance transactions provide an adequate impetus in the form of working capital additions to the local rural economy. Sustainability prospects for a potential partner NGO need to be professionally and realistically assessed.

H. Policy Role for IFAD in Rural Finance and Poverty Alleviation 228. The visibility of the Fund in the process of formulating, monitoring and fine-tuning the essential strategic documentation for poverty alleviation and donor initiatives in Eastern Europe, the Poverty Reduction Strategy Papers (PRSPs) of the IMF could be strengthened in some of the countries visited. IFAD lessons learned and insights from financial services operations in areas most affected by poverty and deprivation such as the mountainous areas of Albania and Georgia should flow in as guideposts to rural finance parts of the PRSP country strategy formulation against poverty. 229. In the absence of any sector intervention of the Fund and its limited principal instrument of loans to governments, one key role in influencing policy and having other stakeholders in Eastern Europe benefit from the Fund’s experience in rural finance and poverty alleviation, is a much more pro-active stance in PRSP formulation, execution and monitoring. IFAD’s Country Strategic Opportunities Paper (COSOP) and the way in which they are formulated in close collaboration with domestic decision makers in agriculture, finance and others are the essential IFAD statement in this regard. Semi-annual or annual updating of COSOPs could be considered, possibly in joint or coordinated missions with the IMF PRSP assessment missions.

31 Hardy, D.C., Holden, P. and Vassili Prokopenko: Microfinance Institutions and Public Policy, IMF Staff Working Paper WP/02/159, International Monetary Fund, Washington, D.C. 2002 32 It is understood that some of the NGOs have developed so professionally as a consequence that they have become take over targets of international commercial financial institutions aiming to build up an efficiently managed pro poor portfolio. 33 These recommendations on NGOs reflect the experience of the author in 10 countries of the CEN Region, and are not specific to the four selected projects where NGOs played no role as retail financial institutions.

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Appendix

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Rural Financial Services in Central and Eastern Europe and the Newly Independent States

T H E M A T I C E V A L U A T I O N

September 2005

Enabling poor rural peopleto overcome poverty

International Fund for Agricultural DevelopmentVia Paolo di Dono 4400142 Rome, ItalyTel +39 06 54592048Fax +39 06 54593048E-mail: evaluation@ifad.orgwww.ifad.org/evaluation