Small Farmers Development Bank

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SMALL FARMERS DEVELOPMENT BANKA. Background1. The Agricultural Development Bank Limited (ADBL)started the Small Farmers

Development Program (SFDP) in 1975 to extend credit tosmall and marginal farmers. UnderSFDP, small and marginal farmers were organized intogroups of 57 individuals to borrowfrom ADBL based on the group guarantee. SFDP was carriedout through its subprojectoffice (SPO), which promoted village level committees andwas facilitated by a grouporganizer. Groups were formed based on the communitymembers common socioeconomic

status, such as having income below the poverty threshold,being from a common locality,and having citizenship certificates. Separate male andfemale groups were organized. Loansunder SFDP were subject to the ceiling of NRs30,000 perindividual group member. Loansgenerally started at lower levels, with members graduatingto larger loans based onexperience and satisfactory repayment performance. In

addition to the financial operations tosupport SFDP, ADBL has assumed responsibility for groupmobilization and group training.2. Following resounding success in the pilot sites of SFDP,the number of groups hasmultiplied rapidly since 1980. Some aid agencies, includingthe International Fund forAgriculture Development and the Asian Development Bank,funded SFDP1on a large scale.

However, as the number of SPOs increased rapidly in all thedistricts of the countryreaching 452 by 1990the performance of SFDPprogressively deteriorated due to (i)


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mounting political interference, (ii) soaring overhead costs,(iii) ineffective loan appraisal andportfolio management, (iv) deliberate default, and (v) rapidand alarming decline in recovery

rates. The supply of aid agency funds encouraged ADBL topass down inflated loandisbursement targets to SPOs. As a result, lendingaccelerated and became moreindiscriminate, leading to even more widespread defaults. Inthe early 1990s, with theemergence of many microfinance nongovernmentorganizations, the aid agencies stoppedfunding SFDP due to its worsening performance, and startedchanneling funds to

nongovernment organizations.3. This declining performance led to the restructuring ofSFDP. In 1987, the InstitutionalDevelopment Program (IDP) was initiated with the assistanceof German developmentcooperation through Gesellschaft fr TechnischeZusammenarbeit (or the German

Technology Corporation). IDP was a 5-year program totransform SPOs into Small Farmers

Cooperative Limited (SFCL), registered under theCooperative Act. Under IDP, SPOs werefederated into inter-groups, which were federated furtherinto the main committee. A SFCL iscomposed of 915 inter-groups. The conversion of SPOs toSFCL was preceded byinstitutional development to improve their performance tomake them eligible for conversion.Each SPO was required to improve the loan repayment rateto more than 70%, overdueloans against the total loans to below 10%, and interestarrears to less than 15%. As of July2005, 200 SFCL had been established.4. For SFDP restructuring, ADBL established a separate andindependent Small


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Farmers Development Bank (SFDB) owned jointly by ADBL,the Government, two privatebanksNepal Bank Limited and Nabil Bankand SFCL. Thefunction of SFDB is to provide

wholesale lending to SFCL. SFDB, which was registeredunder the Company Act of 1991,conducts its business under the Development Bank Act1996. In connection with the

1ADB. 1970. Report and Recommendation of the President

to the Board of Directors on a Proposed Loan to theKingdom of Nepal for the Agricultural Credit Project. Manila.ADB. 1974. Report and Recommendation of the President to

the Board of Directors on a Proposed Loan andTechnical Assistance to the Kingdom of Nepal for the SecondAgricultural Credit Project. Manila.ADB.1990. Report and Recommendation of the President tothe Board of Directors on a Proposed Loan and

Technical Assistance Grants to the Kingdom of Nepal for theThird Small Farmers Development Project.Manila. 2 Supplementary Appendix Denactment of the Banks and Financial Institutions Ordinance,

2the umbrella act for financial

institutions, SFDB also will be licensed as a financialintermediary.B. Performance of SFDB5. SFDB, which started operations as an independent bank in2002, makes loans foragriculture and livestock investments through SFCL. Itsoutstanding loans totaled NRs476.5million in 2005, comprising loans for (i) crop and cropservices, (ii) forestry and fishing, (iii)livestock and livestock services, (iv) agricultural machinery,(v) other agricultural and agroservices, and (vi) teaproduction. SFDBs performance, outreach, and impact onthe rural


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finance sector have been limited relative to its resources andmarket potential. Concernsabout SFDB focus on its scale of operations, loan portfoliomanagement, and weak

institutional capacity. SFDBs viability is also weak. Thereturn on assets and on equity in theaudited accounts is very low, and falls into deficit when thefinancial statements are restatedto take suspense interest into account. Interest expense hasgrown much faster thanandnow exceedsinterest income. Nonperforming loans are notwritten off the balance sheetregularly. Thus, new arrears are added to unrecoveredarrears of the previous year. Unpaid

interest is not moved to suspense as required by the centralbank. The financial performanceof SFDB is summarized in Tables D.1 and D.2.

Table D.1: Small Farmers Development Bank, Profit and Loss(NRs million)Item FY2003 FY2004 FY2005IncomeInterest Income 27.01 73.44 74.44

Less: Interest Expenses 17.31 56.79 67.95

Net Interest Income 9.71 16.65 6.49Fees, Commissions, and Brokerage 3.92 9.63 6.69Other Operating Income 0.00 0.04 0.06

Total Operating Income 13.60 26.30 13.20

ExpensesStaff Cost 2.75 4.64 6.26Other Administrative Expenses 2.01 3.35 4.19Provisions Against Nonperforming Advances 7.28 16.37 0.98

Total Operating Expenses 12.04 24.35 11.43

Net Operating Profit 1.58 1.96 1.81Other Income Depreciation, Other Charges, and Other Provisions (0.84)(1.20) (1.11)Profit Before Tax 0.75 0.76 0.70


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Tax Provision (0.24) (0.24) (0.22)Profit After Tax 0.51 0.53 0.48 = not available, ( ) = negative.Note. Unaudited financial statements. The profit and loss

statement does not include suspenseinterest as required by the central bank.Source: Small Farmers Development Bank, Nepal.

2Enacted in February 2004 to support of the Poverty

Reduction and Growth Facility of the InternationalMonetary Fund. It unifies five banking laws, and strengthensNepal Rastra Banks supervisory powers over thefinancial sector. Supplementary Appendix D 3

Table D.2: Small Farmers Development Bank, Key RatiosItem FY2003 FY2004 FY2005Profitability (%)Return on Assets 0.15 0.22 0.29Return on Equity 0.44 0.55 0.51

Operating Efficiency (%)Net Interest Margin 1.69 1.89 1.08Net Operating Profit to Total Assets 0.15 0.22 0.29

ProductivityReturn on Staff Costs (%) 57.45 42.24 28.91Return per Staff Member (NRs 000) 14.60 -Intermediation Costs (% of Assets)Staff Costs 0.27 0.53 1.01Other Administrative Costs 0.20 0.38 0.68Loan Loss Provisions 0.71 1.86 0.16Total 1.17 2.77 1.84 = not available.Source: Small Farmers Development Bank.6. The portfolio quality raises concern about the viability ofSFDB. The repayment ofloan principal by SFCL has been poor, as a substantialnumber of loans have been


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rescheduled and nonperforming loan amounts areincreasing. The collection of loan interestis equally poor, and continues to decline. In FY2003, onlyNRs27 million of the NRs66 million

in interest due for payment, including NRs22 million chargedfor the year, was collected.Similarly, only NRs74 million of the NRs124 million in interestdue in FY2004, includingNRs81 million charged for the year, was collected.7. At SFDB, loans totaling NRs97.8 million were rescheduleduntil FY2004. The mainreason for such a high level of rescheduling was the difficultySFCLs had in meeting interestpayments. SFDB grants the extension of repayment schedule

without examining the needforor the viability ofthe SFCL making the requests. Muchof the rescheduling has beendone in the eastern and central regions of Nepal. Thecollection details of SFCL indicate thatit has been making repayments on the SFDB loans from itsown loan and interestcollections, not from capital and deposits of members. Thissuggests growing concern for

future repayments. With nearly 90% of SFCL loans tomembers concentrating on livestockand agro-services, which have poor repayment histories,SFDB is susceptible to seriousdamage if the subsector performance deteriorates further.

The level of nonperforming loansfor livestock and agro-services is high, and crop servicesrepresent 39% of nonperformingloans (Table D.3).

Table D.3: Small Farmers Development Bank, Classificationof Subsector Loans(NRs million)SubsectoraPass Substandard

Doubtful Loss Total % of


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NPLaCrop and Crop Services 7.03 0.66 0.16 3.73 11.92 38.67Forestry, Fishing, Animal

Slaughter0.99 0.12 0.02 0.21 1.34 26.12Livestock and Livestock Services 36.88 3.16 1.07 14.0555.15 33.15Agricultural Machinery 0.77 0.02 0.16 0.95 18.95Other Agricultural and AgroServices62.23 5.44 1.52 16.18 85.37 27.11

Tea 3.16 0.04 0.02 0.10 3.32 4.82Total 111.06 9.44 2.79 34.43 158.05

= not available.

aThe percentage of nonperforming loan out of the total loans

in the subsector.Note. For FY2004 under the Nepal Rastra Bank subsector

category.Source: Small Farmers Development Bank. 4 SupplementaryAppendix D8. The organizational and administrative structure of SFDB isnot consistent with ones

for a financial intermediary. SFDBs operational approachwhich recover loans throughrebates rather than filed pursuit, and select clients byexisting SFCLs discretion rather thanproactive effort from SFDBis an indication of weakoperational capacity. The current staffincentive system does not distinguish between good andpoor performance. SFDB does nothave the policies needed to ensure that basic risks in areassuch as credit portfoliomanagement and cash management do not harm the banksliquidity. The portfolio auditsuggests passivity in servicing loans risk. SFDB does nothave a reliable managementinformation system, which is required for timely andaccurate information for portfolio


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management.C. SFDB Institutional Reform and Strengthening9. SFDP generally has contributed positively to enhancingincome-generating activities

and employment opportunities through expanded ruralfinance outreach to poor smallfarmers, who otherwise would have been outside the reachof institutional financial services.As of July 2005, SFDP had 65,589 members, including 23,830women. In addition toreceiving tangible economic benefits, SFDP members havebenefited from leadershipdevelopment, group solidarity, empowerment, financialliteracy, and skills development.

Some of the SFCL members are emerging as viable creditcooperatives and replicatinginstitutional development processes on their own. SFCL andSFDB are likely to play asignificant role in reducing rural poverty. Thus, broad-basedinstitutional reform is crucial totransform them into autonomous and viable financialinstitutions that can continue to provideaffordable financial services to small and marginal farmers.

10. The operational and portfolio review of SFDB, conductedunder technical assistanceprovided by the Asian Development Bank,3identified several key operational issues and

outlined strategies for SFDB reform. The Government andSFDB agreed to initiate thereform process based on (i) expanding and strengtheningsystems and controls for greatertransparency; (ii) building a structure with greater businessautonomy, and ensuringfunctional relationships of departments; (iii) improving thecredit culture in SFDB and SFCLby re-emphasizing viability and the borrowers sustainablecapacity to generate income


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sufficient to maintain the society and service debt; (vi)building a viable and balancedportfolio in which nonperforming loans are minimized; (v)upgrading the management

information system to cover all aspects of the banksoperations; and (vi) adopting practicesthat ensure accounting records and financial statementsgive an accurate picture of thefinancial health of SFDB and SFCL.

Documents

Small Farmers Development Bank