Financing Rural Finance Institutions in Mexico

This paper begins by highlighting the significant development challenge of financing rural enterprise. It notes the difficulties resulting from relatively high transaction costs, volatile agricultural commodity markets and poor infrastructure that contribute to the development of inefficient rural financial systems to the detriment of all business activity, but in particular to low income, small and medium enterprises. The paper does note, however, that unlike many developing countries, Mexico has relatively deep and sophisticated financial markets, strong savings instincts, and a plethora of financial institutions operating in rural and semi-rural areas. Nevertheless, despite the presence of financial institutions in rural Mexico, the demand for financial products and services – especially by small rural enterprises – remains largely unmet. While there has been much public sector bank and government financial support to rural areas, most of it has favoured large rural enterprises (e.g., commercial farms, processors, wholesalers, or exporters) over small enterprises. These initiatives have also been heavily subsidised and poorly managed, creating a culture of non-repayment. This has resulted in limited sustainable access to appropriate financing for small and micro rural enterprises.

The paper suggests that the advent of microfinance and increasing pressures on state banks for demand driven and sustainable programs is beginning to erode this culture. While rural financial markets remain far from efficient, advances in banking technology, risk management methodologies, and competitive pressure among private financial institutions have encouraged some interest in rural financial markets. Small, non-collateralised working capital loans to off-farm enterprises, for example, are proving to be profitable in high to medium density rural areas. Short-term, crop lending is also relatively low risk and profitable. However, medium term, non-working capital loans to low income farmers or entrepreneurs in rural areas still remains the frontier of rural finance as are long-term production loans (e.g., orchards, water and soil conservation or management, etc.).

This paper discusses the similarly difficult issue of financing RFIs that serve these markets, focusing on Mexico. It notes that whilst many would prefer to fund themselves through deposits, very few achieve this, and where deposits may be significant enough for financing, their contract structure is often one year or less and so financing medium or long-term assets remains a critical challenge in rural areas where the need for long-term loans is structurally very strong. As a result, the paper reports that most RFIs rely to varying degrees on state bank finance, much of which is available over the medium term (two to five years). This is better than short-term finance, but it does not resolve matching problems for longer term lending required for many agricultural needs. Collateral requirements from state banks can also complicate access to long-term funding unless RFIs have solid and liquid collateral (i.e., not a loan portfolio).

After analysing how a sample of Mexican RFIs source their portfolio funding the paper discusses strategic considerations for RFI financing and looks at deposits, term deposits, international funds, access to capital markets, structured finance instruments and securitisations.

The paper then elaborates on how financing success lies in strategy and concludes with the view that examples from around the world show how concerted and dedicated finance strategies can improve an institution’s long-term funding base, contributing to profitable and scalable rural financial institutions.

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