Theme 3: Managing Credit Risk in Rural Financial Institutions in Latin America

Topic :

Taking credit risk is part and parcel of financial intermediation. Yet its effective management within financial intermediaries is critical to institutional viability and sustained growth. Failure to control risks, especially credit risk, can lead to insolvency. However, too often, the mere perception of high credit risk can serve to dissuade financial intermediaries from entering into a particular market segment when a large and contributing factor may be lack of adequate credit risk evaluation and management techniques. This seems to be the case with rural finance, especially lending to small- and medium-scaled agricultural producers. If financial institutions do enter rural areas, they tend to limit exposure to agricultural finance and to favor clients with established credit histories and significant collateral. As a result, a relatively small number of financial intermediaries have a presence in rural markets and an even smaller number have significant agricultural lending portfolios. This limited presence of financial intermediaries in rural areas and the bias against agricultural lending creates access and segmentation problems.

The purpose of this paper is to review common credit risk management techniques used in a sample of Latin American financial institutions with agricultural portfolios, identify the factors that contribute successful credit risk management as measured by asset quality maintenance, portfolio growth, and profit margins in order to assist the donor organizations and national governments in designing better interventions aimed at strengthening rural financial institutions and ultimately deepening rural financial markets.

Section 2 reviews and explains the types of risks financial institutions face, common approaches used to analyze credit risk, and common portfolio risk management strategies. Section 3 examines the results obtained from a survey of rural finance institutions in Latin America. Section 4 highlights in-depth and detailed financial analysis of four intermediaries. Finally, Section 5 makes conclusions and recommendations as to how to design better rural finance projects and interventions.

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