Farm credit and microfinance – is there a critical mismatch?

“New paradigm” micro-finance has largely replaced old style rural finance, which was mainly subsidised low-cost farm credit. The “old paradigm” rural development finance institutions have in some cases disappeared, and in others they have been converted into what are effectively specialist micro-finance institutions (MFI). This article asks if new paradigm micro-finance effectively address the needs of farmers.

The author constructs an interesting table which compares the features of five possible uses of credit in a rural household – health needs, petty trade, milking cows, crop loans and minor irrigation – with the characteristics of typical microfinance loan products. He concludes that there is an increasing mismatch in suitability as one moves from health needs and petty trade to crop loans and irrigation. He then goes on to examine one particular feature in more detail – the mismatch of microfinance interest rates with on-farm rates of return.

Professor Harper believes that MFIs should consider their clients’ rates of return as well as their own costs when setting interest rates. He argues that if interest rates are higher than the clients’ returns, the long-term impact will be to impoverish them and not to enrich them. Studies of many microenterprises have established that their rates of return can be very high. One study of 215 microenterprises produced an average annual return of 847% (see online lesson number 2 in the RFLC for an explanation of rates of return). However, examination of limited data about returns for farm investments showed the highest figure was 160% and most were below 100%.

To conclude the article the author asks if the low or negative margin between the cost of micro loans and returns from farm investments matters. He cites arguments for and against the issue being a problem and explores some trends which may help to render microfinance products more suitable for farmers, notably the increasing competition amongst MFIs and from commercial banks which will help to drive interest rates down. Microfinance staff seem largely unaware of the potential unsuitability of their products for farming and the author recommends that those who advise, finance and train MFIs should encourage their staff to investigate the situation and address the problem if there is one.

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