The grain banking model

Table of contents

List of abbreviations

List of figures

List of tables

Acknowledgements

Abstract

1 Introduction
1.1 Limited access to micro finance institutions
1.1.1 Rural client dispersion
1.1.2 Profitability and risks of on-farm lending
1.1.3 Loan collateral
1.2 Limited access to informal credit
1.3 Limited access to markets
1.4 Problem statement
1.5 Objectives of the study

2 Financial cooperatives
2.1 Conceptualized framework
2.1.1 Information asymmetry
2.1.2 Transaction costs
2.2 Importance of financial cooperatives
2.2.1 Decrease in information asymmetry and transaction costs
2.2.2 Decrease in administrative and financial costs of funds
2.2.3 Decrease in loan default and collateral substitute
2.3 Limitations of financial cooperatives
2.3.1 Limited access to input and output markets
2.3.2 Covariant risks and capital constraints
2.3.3 Limited skill transfer

3 The integrated approach

4 The grain banking model
4.1 Group formation
4.2 Products
4.2.1 Savings products
4.2.2 Credit products
4.2.3 Business development support services
4.3 Benefits
4.3.1 Access to input and output markets
4.3.2 Skill transfer and appropriate technology
4.3.3 Decrease in covariant risk and capital constraints
4.4 Hypotheses
4.5 Limitations
4.5.1 Group heterogeneity
4.5.2 Profit for sponsor and farmer
4.5.3 Input availability

5 Intermediate result

6 Description of the case
6.1 Ghana
6.2 The Northern Region
6.3 The Centre for Agriculture and Rural Development (CARD)
6.3.1 Background and mission statement
6.3.2 Farm management department and agro service centre
6.3.3 Savings and loan department
6.3.4 Grain banking cycle
6.3.5 Financial performance
6.3.6 Outreach
6.3.7 Sustainability
6.3.8 Weaknesses and threats

7 Empirical data
7.1 Research methodology
7.2 Socio economic characteristics of clients
7.3 Satisfaction with services received
7.4 Hypothesis 1
7.5 Hypothesis 2
7.6 Hypothesis 3

8 Recommendations

9 Conclusion

Appendix 1 – T-test

Appendix 2 – Linear regression

Bibliography

Internet sources

List of abbreviations

illustration not visible in this excerpt

List of figures

Figure 1: Traditional value chain

Figure 2: Information asymmetry

Figure 3: Market failures

Figure 4: Problems of rural finance

Figure 5: Minimalist and integrated approach

Figure 6: Core processes of a grain banking scheme

Figure 7: Structure of the grain bank

Figure 8: Modern value-chain

Figure 9: Poverty trends in Ghana in the 1990’s

Figure 10: Average monthly price trends of maize in Ghana

Figure 11: Ghana

Figure 12: Organizational structure of CARD

Figure 13: Tally card

Figure 14: Grain banking cycle

Figure 15: Financial performance of CARD

Figure 16: Satisfaction with inventory credit

Figure 17: Satisfaction with input credit

Figure 18: Satisfaction with storage possibilities

Figure 19: Satisfaction with training methods

Figure 20: Advantages for the farmer

Figure 21: Problems within the grain banking scheme

Figure 22: Effects of CARD on clients

Figure 23: Linear regression – SPSS output

List of tables

Table 1: Role and type of institutions

Table 2: Criteria of financial cooperatives

Table 3: Cost range of different funds

Table 4: Mitigations through the grain banking model

Table 5: Financial institutions and their contribution to the rural sector

Table 6: Sources of rural finance in Ghana

Table 7: Date of deposit

Table 8: Storage

Table 9: Sale

Table 10: Loan and repayment (a)

Table 11: Conditions of different loan products

Table 12: Loan and repayment (b)

Table 13: Changes in percent

Table 14: Outreach

Table 15: Sustainability

Table 16: Socio economic characteristics – Gender

Table 17: Socio economic characteristics – Age

Table 18: Socio economic characteristics – Education

Table 19: Socio economic characteristics – Product of cultivation

Table 20: Mean comparison

Table 21: Correlation coefficients

Table 22: Linear correlation

Table 23: Coefficients for CARD

Table 24: T-test (a) – SPSS output

Table 25: T-test (b) – SPSS output

Table 26: Variables entered – SPSS output

Table 27: Anova– SPSS output

Acknowledgements

The participation of the Ghanaian farmers is gratefully acknowledged. They willingly provided useful information about their livelihoods by taking part in the survey.

In Ghana the research benefited from the institutional support of the German Agency for Technical Cooperation (GTZ) and the “Rural Finance Project, Ghana” headed by Wolfgang Heupel.

A considerable debt is also owed to Clara Fosu, who enabled the access to detailed information of different Ghanaian microfinance institutions.

The help of the Centre for Agriculture and Rural Development (CARD) in Ghana which freely provided operational data of their smallholder farming operations, is also acknowledged with gratitude.

Abstract

The rural sector in development countries is characterized by high covariant risk, high client dispersion and lack of suitable collateral. These problems lead to high information asymmetry within the agricultural lending process. Because information is incomplete agricultural lending is costly. Consequently many micro finance institutions (MFIs) have concentrated their branches and activities in urban areas. Therefore scepticism is growing about their role in mobilising rural savings and offering rural lending services.

Financial cooperatives demanding compulsory savings and enforcing group lending schemes are able to reduce information asymmetry and hence transaction costs of agricultural lending. Since the financial cooperative follows a minimalist approach, it does not offer non-financial services such as storage facilities, training in farming techniques or the treatment of agricultural produce. In order to enhance clients’ ability to utilize credit, and thereby to improve their repayment rates, an MFI should follow the integrated approach. The MFI with an integrated approach offers credit combined with non-financial services.

The grain bank is seen as a financial institution which links products and services of the financial cooperative with those of the integrated approach. The grain bank replaces physical cash with grains and farm inputs. Six main products are offered by the grain bank: savings in grain, input credit, inventory credit, household food security loan, storage services and training services. Further the grain bank provides access to input and output markets otherwise not available for the farmer.

The Ghanaian “Centre for Agriculture and Rural Development” (CARD) is such a grain bank. The results show that CARD has a better financial sustainability than other Ghanaian MFIs not operating as a grain bank. Although the study reveals that the outreach of CARD is not as encouraging as assumed, the clients seem to be satisfied with the services received by CARD. At the same time the results of the econometric analysis indicate that the provision of credit supplied by CARD increases farmer’s output with potential effects on income.

1 Introduction

Microfinance institutions have shown the potential to reach people who live below the poverty line. MFIs lend small amounts of working-capital to those who do not have access to credit facilities. However many of the rural smallholders still remain excluded. The development of rural financial systems is hampered by the high cost of delivering financial services to small, widely dispersed customers. The rural economy is further characterised by high covariant risk, missing markets for inputs and agricultural produce as well as lack of suitable collateral. Attempts to improve the provision of rural finance have often focused on supply-side interventions, including government and donor-funded credit programmes. However, scepticism is growing about their role in mobilising rural savings and in providing adequate agricultural lending technologies.¹

The grain banking scheme is considered as a positive move towards reducing these entry barriers by linking financial services with non financial services. The grain bank’s main obstacle is to overcome the various problems of farmers. That is why first of all these problems will be introduced in more detail within the following chapters.

1.1 Limited access to micro finance institutions

The economy of Ghana is highly dependent on the agricultural sector. This sector alone employs about two-thirds of the population and contributes about 40 percent to the GDP. 60 percent of the poor live in the rural areas and are self-employed in agriculture.²

Although the importance of the agricultural sector in Ghana is recognized, Ghanaian MFIs, have concentrated their branches and activities in the urban areas for obvious reasons: rural client dispersion, profitability and risks of on-farm lending and the problem of missing loan collateral.

1.1.1 Rural client dispersion

Obtaining information required to appraise loan proposals of farmers tends to be difficult and lengthy.³ Rural borrowers are difficult to contact and hard to trace. It is costly for lenders to obtain and verify information from rural applicants because they are spread over large geographical areas.⁴ Traditional banking techniques, such as judging the loan application based on written information is not feasible because of high illiteracy rates among farmers.⁵ The staff devotes even more time to the applicants who cannot speak the business language of the country.⁶ As a result MFIs usually lack essential information on the credit history of rural clients, and on the farmer’s repayment capability.⁷

Given that farmers running a micro-business mostly ask for small loan sizes, financial transaction cost per credit unit delivered is high.^{8 9}

1.1.2 Profitability and risks of on-farm lending

The cash inflows and cash outflows of rural households are greatly influenced by the heterogeneity in farmers’ production, trading and consumption. Consequent peak-load demands are made on the MFIs for speedy disbursements during the lean season. Farmers often repay agricultural credits in “lumpy” instalments only after harvest.¹⁰ These are one or two loan repayments rather than regular weekly or monthly instalments common for micro finance provided in urban areas. This irregular pattern implies more difficult monitoring of repayment capacity and willingness.¹¹ Moreover, the uneven distribution of the agricultural lending operations over the year increases the fixed costs of human resources. The earnings from lending may not sufficiently cover these costs.

Liquidity requirements in periods of high seasonal loan demand also increase the price of loanable funds. In times of low demand, excess liquidity needs to be invested in low or non-earning assets. This will increase the opportunity costs of these funds.¹²

The risks of agricultural production are unfavourable weather (drought, hail, and floods), diseases or pest damage and uncertain market prices of agricultural produce. As a result, the rural borrower may not be able to repay the loan.¹³ The fact that these risks often affect a large number of loan recipients simultaneously makes it very difficult for rural based MFIs to diversify their portfolio against external shocks.¹⁴

Since the probability of loan default increases, the financial self-sufficiency of the MFI is in question. Financial self-sufficiency is a prerequisite for making financial services widely available to rural smallholders.¹⁵

1.1.3 Loan collateral

Consequently to the above, lenders perceive rural borrowers as risky. The risk profile of the borrower is unknown and he lacks collateral or access to cosignatories to guarantee the loans.¹⁶

Loan collateral is important in order to screen potential clients, to monitor and enforce loan contracts. The preferred forms of loan collateral are tradable assets, like mortgage on real property. Developing countries often lack clear land titles and an appropriate mortgage registration.¹⁷

Group lending schemes based on group control and joint liability are suitable forms of collateral substitutes. It may be effective if groups are homogenous in their composition, interests and objectives. However, in many countries, groups of farmers may not easily meet these criteria. Moreover, successful experience with group lending is chiefly for non-

agricultural purposes.¹⁸ In order to overcome the problem of missing collateral informal money lenders tie credit transactions to transactions in land and labour markets.¹⁹ Large landholders or traders secure access to labour in the peak season in return for earlier loan advances to labourers.²⁰ Money lending is seldom their main source of income.^{21 22}

1.2 Limited access to informal credit

However, innovative and useful as the informal financial sector may be, it frequently runs up against severe constraints. Informal credit markets typically consist of a single village or community. Therefore the supply of informal loans decreases significantly with the number of people earning income and with the number of wholesale buyers coming to the village.²³ The access to informal financial markets is dependent on external factors the farmer cannot influence.

Informal lenders seldom manage to offer saving services. As a result, the supply of credit is limited, resulting in either severe credit rationing or extremely high interest rates.²⁴ Interest rates to be paid to informal lenders range from 5 to 7 percent per month.^{25 26} Limited competition is seen as an important determinant for the high interest rates in rural financial markets.²⁷ Zeller and Diagne found that the informal market provides very little input financing. The financing of adequate fertilizer and good quality seeds is increasingly important for rural smallholders.²⁸ On average, the farmers spend 78 percent of the borrowed amount on farm inputs.²⁹

1.3 Limited access to markets

For rural smallholders not only the access to financial sources is limited but also the access to markets. The markets lack basic storage and transport infrastructure.³⁰ Due to the lack of transparent price systems, most farmers are unable to obtain remunerative producer prices.^{31 32}

Usually the farmer sells part of the goods remaining after self consumption to a buyer coming to his village. After transactions in multiple spot markets involving multiple intermediaries and margins, the goods reach the final consumers in urban areas. The farmer has little or no information about the prices offered by urban consumers.³³

illustration not visible in this excerpt

Figure 1: Traditional value chain

Source: Chowdhury, S., Negassa, A. and Torero, M. 2005: 17.

In part, due to natural variation, the quality of rural products differs.³⁴ Farmers do not benefit from a system of grain standardization and inspection that would enable trade with distant buyers. The lack of easily measurable quality standards allows unknown traders to cheat the farmer on prices and weight.^{35 36} Therefore, farmers trade only with partners linked either through ethnic group or other social and family relationships.³⁷ Consequently, the market access for agricultural produce is limited.

1.4 Problem statement

Handling the problems of limited access to financial sources and limited market access requires institutional innovation.

It is necessary to have institutions that involve components of the following: social capital as security for credit; clients’ participation in management to promote a sense of ownership; products that take into account the seasonality of agricultural production; extension as well as marketing components which improve productivity.³⁸

The grain banking scheme may be an institution whose structure and financial products might be beneficial to the smallholders. Consequently, the question to be examined is as follows:

Is the grain banking scheme a viable means of financing for small rural businesses in Ghana?

Is the grain banking scheme a viable means of financing for small rural businesses in Ghana?

1.5 Objectives of the study

It remains to be examined whether the grain banking scheme is a viable means of financing for small rural businesses in Ghana. This should be established through the research case of the Ghanaian Centre for Agriculture and Rural Development (“CARD”).

Therefore, the study seeks to describe the structure of CARD. It also examines the impact of CARD`s services on clients and the effect on the area of land which farmers cultivate. Increased acreage cultivated could be a reflection of farmers’ increased income, since marketing is linked to production. Based on the case study of CARD, the specific objectives of this thesis are to:

1. Determine the level of client satisfaction with existing products offered by CARD.
2. Examine changes in clients` production levels since joining the CARD program.

Apart from cooperative elements, the grain banking scheme is integrated into the social life and the financial needs of clients. Therefore, an analysis of the financial cooperative business model as well as of the integrated approach is necessary. Chapter 2 begins with a presentation of a conceptualized framework of cooperatives and then identifies their benefits and limitations. Chapter 3 analyses how the integrated approach works. Chapter 4 introduces the grain banking model and explains how it is able to overcome the problems of cooperatives by following the integrated approach. The theoretical findings regarding the grain banking model are summarized in Chapter 5. The research area and structure of the grain bank CARD are described in Chapter 6. Chapter 7 looks at the hypotheses and the research methodology. Finally Chapter 8 discusses the results of the study, while Chapter 9 concludes the study.

2 Financial cooperatives

2.1 Conceptualized framework

The second part of this thesis introduces the theoretical findings explaining the problems identified above. The two major factors for limited credit access and limited market access are: information asymmetry and high transaction costs.

2.1.1 Information asymmetry

Information asymmetry means that the MFI lacks essential information on the willingness and the ability of the farmer to repay the loan. Information asymmetry may lead to adverse selection and moral hazard.³⁹

illustration not visible in this excerpt

Figure 2: Information asymmetry

Source: Own representation.

In general, there are three problems within the scope of information asymmetry: hidden information, hidden action and hidden characteristics. Hidden information means the MFI is not able to differentiate between farmers repaying the loan and those who do not. As a result, the MFI may charge higher interest rates to offset the loss of the loans that may default. Rising interest rates may motivate farmer “A” to invest in riskier projects. The riskier project has a higher payoff when successful and hence may offset the higher costs of the higher interest rate charged. On the other hand, a farmer “B” might be unwilling to invest in riskier projects. He may choose not to borrow at higher interest rates. Therefore, the average risk of the loan portfolio will increase. As the higher risk is combined with a lower probability of success, the rate of credit default will increase. Consequently, the MFI will raise interest rates again. In the end, only farmers “A” stay with the MFI, leading to a high loan default rate. This situation is called adverse selection resulting from hidden information.⁴⁰

Moral hazard means that the farmer “A”, willing to pay a higher interest rate, accepts more risk than he prefers normally.⁴¹ Within the scope of information asymmetry this is called hidden action. Again, the probability of loan repayment decreases. Besides the investments in riskier projects the farmer may simply refuse to repay, which is called hidden characteristics. Moral hazard of this kind is partly due to failed subsidized credit programs.⁴² “Borrowers, who have witnessed the emergence and demise of lending institutions, have been discouraged from repaying their loans.”⁴³

As a response to an expected decrease in returns resulting from adverse selection and moral hazard, the MFI may choose to keep interest rates low enough to avoid a high-risk profile and may ration available loan funds. If credit is rationed, loans are denied to applicants who are observationally indistinguishable from those who receive credit.⁴⁴

The probability of adverse selection, moral hazard and credit rationing can be reduced by: signalling, screening and self selection. Signalling describes certain actions by the farmer that would reveal private information. For example, by providing collateral for the loan the farmer signals his credit worthiness. The MFI can screen the farmer by inquiring after his education, family size and social environment. Self-selection means that the farmer can choose, e.g. between two loan contracts. Within the first contract he will pay lower interest rates but has to report regularly the progress of his project. Within the second contract the farmer pays higher interest rates, but does not have to report regularly. If the farmer chooses the first contract the MFI will conclude that the farmer is sure that the regular reporting will not reveal his inability to repay the loan.⁴⁵ The solution of hidden information, hidden characteristics and hidden action is to ensure as far as possible the provision of a reliable monitoring system.⁴⁶

2.1.2 Transaction costs

Because information is incomplete, transaction costs are high. Transaction costs arise from the decentralized coordination of exchange among market actors.^{47 48} Transaction costs are the costs the farmer bears to search for a trading partner, the costs of obtaining information on market prices,⁴⁹ the costs of screening potential buyers to ascertain their trustworthiness,⁵⁰ the costs of negotiating with the potential buyer about a market price,⁵¹ and the costs of monitoring the agreement to ensure that the farmer receives his money.^{52 53} These costs include cost of transporting the produce to the market or the buyer’s home.^{54 55}

With the pioneering work, “The Nature of the Firm” Coase presented a possibility to minimize transaction costs by the establishment of institutions. He explains that products can be sold centrally by a market institution. Market institutions emerge to economize on the transaction costs of the decentralized market exchange.⁵⁶

The work of Williamson on the economics of organization and contracts follows Coase’s line of thinking. Williamson has combined the concepts of bounded rationality and opportunistic behaviour.⁵⁷

Figure 3: Market failures

illustration not visible in this excerpt

Source: Williamson, O. E. 1975: 40.

Opportunism and bounded rationality of farmers amidst a complex and uncertain environment increase transaction costs. Bounded rationality means that the farmer chooses a trading partner on the basis of only partial information. The farmer does not know prices on distant markets because he can not afford to travel to these markets. The market institution can reduce bounded rationality and hence the transaction costs for the farmer.⁵⁸ E.g. the market institution may afford a telephone and may call different markets in order to receive necessary information.

Opportunism is characterised by dishonesty of the economic actors. They can lie, cheat and steal. The buyer may cheat the farmer by pretending that the quality of the grains is low. Hence the buyer may demand a lower price than the price corresponding to the real quality of the grain to be sold.

A repeated market transaction among a small number of participants allows an immense scope for opportunistic behaviour.^{59 60} With large numbers of buyers, the farmer could avoid those who cheat. However, the farmer is forced to sell his grain to the same wholesale buyer visiting his village because he cannot afford to travel to distant markets. Therefore, the farmer is unable to avoid being cheated by the same wholesale buyer several times.

Therefore, Williamson argues that transactions have to be organized “in such a way as to economize on bounded rationality while simultaneously safeguarding those transactions against the hazards of opportunism.”⁶¹

How the elements of chapter 1 and 2.1 can be seen in interrelation is presented in the following overview.

illustration not visible in this excerpt

Figure 4: Problems of rural finance Source: Own representation.

2.2 Importance of financial cooperatives

Transaction costs arise from the decentralized coordination of market exchange. In order to reduce transaction costs the shift from decentralized market coordination to a centralized coordination through a market institution is advised by Williamson. Table 1 puts forth some of the roles and types of market institutions that are appropriate to reduce information asymmetry and transaction costs.

illustration not visible in this excerpt

Table 1: Role and type of institutions

Source: Adapted from Chowdhury, S., Negassa, A. and Torero, M. 2005: 15; Zeller, M. 1996: 3.

Experiences gained in developing countries have revealed that especially vertical integration and cooperatives have the potential to reduce information asymmetry and hence transaction costs.^{62 63} 62As stated by Zeller and Lapenu, cooperatives are the most important source for loans and savings mobilization within the rural sector.⁶⁴

Forming a cooperative represents an agreement among a group of farmers to save collectively and to loan the collectively saved money to the group’s members. Cooperatives are owned and managed by their members. In cooperatives, all members have an equal right to participate in decision making. Members’ participation leads to their overall control over the affairs of their organization and the promotion of their interest.⁶⁵

As cooperatives achieve a certain size, they can no longer be managed by their members. A specialized management staff has to be hired.⁶⁶ This requires establishing an official organization like the financial cooperative.⁶⁷ Table 2 summarizes important features characterizing the financial cooperative.

illustration not visible in this excerpt

Table 2: Criteria of financial cooperatives

Source: Adapted from Zeller, M. and Lapenu, C. 2001: 16.

As it can be seen in table 2, its nature as self managed and democratic institution sets the financial cooperative apart from other microfinance institutions, which often operate as privately owned institutions.⁶⁸

The lending operations of the financial cooperative are based on the members' savings received.⁶⁹ Members who save subsidize those who borrow. Consequently, saving services as well as credit services are constrained to the cooperative’s members.⁷⁰

2.2.1 Decrease in information asymmetry and transaction costs

Farmers become members of a financial cooperative by applying and paying compulsory savings.⁷¹ Compulsory savings represent funds that must be paid to participate and gain access to credit.⁷² Compulsory savings cannot be withdrawn by farmers as long as they are members of the cooperative.⁷³ Compulsory savings serve as collateral substitute.⁷⁴ By demanding compulsory savings, financial cooperatives can screen the farmer’s creditworthiness. The farmer is explained that he is only able to withdraw the compulsory savings if he has reimbursed his outstanding loan. Thus, by paying the compulsory saving, the farmer signals his willingness for full loan repayment. In addition to the signalling process by the borrower the adverse selection problem is further directed by a complementary screening process of the credit officer. The credit officer aims to generate as much information about the borrower’s repayment capacity as possible. As a result only borrowers whose investment project promises a high probability of success are selected.⁷⁵

As introduced, the financial cooperative is a group-based institution. The functions of screening, monitoring and enforcement of repayment are transferred to the group members. It is argued that group members can obtain information better than distant credit agents.⁷⁶ Since the financial cooperative is usually limited to a small geographic area, such as a village, actual and potential members know each other’s habits, character, and abilities.⁷⁷ Farmers screen and monitor each other in order to prevent each other from moral hazard behaviour. Village members receive early information if one farmer faces a problem in his business.

The incentives to screen and monitor each other arise from joint liability of repayment.^{78 79} Joint liability means that the whole credit group is considered as being in default if one borrower rejects to repay his share of the loan. As a result the whole group looses access to future loans. This encourages the group either to repay for the delinquent partner, or to exert social pressure on him. As a consequence, the financial cooperative is able to achieve loan repayment with high probability.⁸⁰

The main argument is that, compared to socially and physically distant credit agents, group members obtain information at a lower cost.^{81 82} This is because the farmer members can screen other members as part of their daily activities.⁸³ One French visitor refers to these small villages as places “where one’s eyes are so attentive to what occurs among the neighbours.”⁸⁴

2.2.2 Decrease in administrative and financial costs of funds

Additionally to a decrease in information asymmetry and transaction costs financial cooperatives are able to mobilize cheap funds for lending. Vogel argues that because of the heterogeneity of rural households some units will at times have savings which others wish to borrow.⁸⁵ A farmer “A” may be able to produce more income than farmer “B”, although the environmental conditions (e.g. agricultural land size, weather conditions) are the same for both farmers. This may be due to farmer “A” working part time as a driver or having better knowledge of agricultural production than farmer “B”. Hence farmer “A” may have a surplus to save while farmer “B” is looking for support in order to buy agricultural inputs.

Savings as a source of loanable funds can have considerable advantages over other funds accessible to a MFI. Apart from equity funds the MFI generally has three fundraising possibilities: commercial borrowing, subsidized credit lines and deposits.

Commercial borrowing implies low administrative costs, since there are no detailed report requirements for each credit. Costs for external auditing and disclosure of information required by creditors are lower than the report requirements of subsidized credit lines. However, the market-based interest rate costs of these funds are usually high.⁸⁶

Interest costs of subsidized credit lines are quite cheap. Contrary the administration and risk management costs of subsidized credit lines may be rather expensive.⁸⁷ Usually, the subsidies are granted for a specific purpose. Therefore, the proper use has to be reported regularly increasing administrative costs. Furthermore product related and target group related guidelines may compromise the mission of the MFI. E.g. the donor guideline is to support women cultivating tomatoes. Contrary women within the community of the MFI are competent in producing maize. Since they do not know how to grow tomatoes loan repayment rates may be endangered. Interest costs of deposits are also usually low, and reflect the administrative costs incurred by lending these deposits. Short-term deposits earn lower deposit interest rates than long-term deposits. The reason for that is the lack of planning reliability to refinance loans. For instance, farmer “A” deposits his money for one month, while farmer “B” receives a loan for three months. After one month the financial cooperative has to look for other funds in order to refinance the loan of farmer “B” and hence enable farmer “A” to withdraw his deposit. The searching for new funds incurs transaction costs and hence lower interest rates for short-term deposits.

Additionally, there is evidence that savers accept real negative interest rates on their deposits. They are willing to pay for safekeeping of their money,⁸⁸ explaining the low range of financial costs for deposits in table 3.⁸⁹

Within table 3 financial costs refer to interest costs. Administrative costs refer to the costs of raising and handling funds including risk management costs.

illustration not visible in this excerpt

Table 3: Cost range of different funds Source: FAO, GTZ 1999 (b): 46 and 23.

The wide range of administrative costs of deposits in table 3 results from fixed costs. By increasing the number of savers, fixed costs decrease due to economies of scale. If it is not possible to realize economies of scale, administrative costs of deposits may be quite high.⁹⁰

As can be seen in table 3, deposits are altogether cheaper funds for lending than commercial funds or subsidized credit lines.⁹¹ However 69 percent of the total funding from present MFIs comes from donors.⁹² Therefore, it can be assumed that a financial cooperative has a better financial sustainability than MFIs which do not use saving deposits for refinancing.

2.2.3 Decrease in loan default and collateral substitute

The financial sustainability of a financial institution also depends on a low loan default rate. Financial cooperatives may have a comparative advantage in the enforcement of loan repayment. Whereas the distant credit agent has limited means to compel repayment from delinquent borrowers, group members have the potential to employ social sanctions. Since the group members of a financial cooperative share the risk of default under joint liability,⁹³ they appear to be in a better position to assess the reason for default and to offer insurance services to the members experiencing a shock beyond their control.⁹⁴ Let us give an example. Farmer “A” has worked hard in order to increase his agricultural production. However, because of a high hospital bill for his ill child he may not be able to repay the loan. In that case group members will support farmer “A”. At the same time they will force farmer “B”, being lazy, to work harder, by excluding him during daily meetings, which has previously been defined as social sanction.

Wenner shows that 75 percent of the sample groups in Costa Rica had members defaulting on their loan, but more than half of these groups managed to fully repay the loan to the financial institution by using group savings or by forcing the co-signers of the loan to repay for the defaulter. ⁹⁵ Bratton analyzes the repayment record of credit groups in Zimbabwe. He states that group loans performed better than individual loans in years of good harvest, but worse in drought years.⁹⁶ This problem arises from the joint liability mechanism. If the group members are unable to repay the loan of one defaulting member, the whole group is excluded from further loans. Consequently all group members do not repay their loans, because all members will be excluded irrespective of their individual ability to repay their own loan.⁹⁷

Such domino-like effects are mitigated within a financial cooperative by using the required compulsory savings to reschedule default loans.⁹⁸ Therefore, most loans are limited to a multiple of a member’s savings, so that at least a part of the loan is guaranteed by the savings balance.⁹⁹

Because of the peer pressure under joint liability and the compulsory savings serving as collateral substitute, it is assumed that the loan default rate within a financial cooperative is low increasing financial sustainability.

2.3 Limitations of financial cooperatives

2.3.1 Limited access to input and output markets

Financial cooperatives, however, do not solve the problem of limited access to markets. In Africa, fertilizer was distributed by the government in the past. Structural adjustment programs enforced the abolishment of governmental subsidization of fertilizer. Since the farmer does not receive credit, he cannot afford to buy fertilizer. Consequently, the incentives for the private sector to establish a commercial fertilizer distribution are limited.¹⁰⁰ Furthermore, small-scale farmers are often constrained in what they can produce by limited marketing opportunities. Farmers will not cultivate unless they are sure that they can sell their surpluses.¹⁰¹

The financial cooperative is unable to overcome the lack of both reliable and cost-efficient inputs such as fertilizers, and guaranteed profitable markets for the farmers’ surplus.¹⁰²

2.3.2 Covariant risks and capital constraints

Another issue connected with financial cooperatives is how to recover from losses as a result of covariant risk factors. Farmers often have homogeneous economic activities. Hence, it is often more difficult for agricultural MFIs to diversify their risks.¹⁰³ Lariviére and Martin argue that especially financial cooperatives may not have the facility to diversify their portfolio.¹⁰⁴

One of the stiffest challenges facing cooperatives will be accumulating sufficient capital to finance improvements and expansion of services. ¹⁰⁵

Financial cooperatives, by definition, depend heavily on their members' savings. Members who deposit shares in the financial cooperative do not receive yield on their shares. Consequently the incentive for extra savings does not exist.¹⁰⁶ As a result the financial cooperative endures a chronic shortage of loanable funds.¹⁰⁷ The total effective credit demand of its members can not be met. Consequently loans are granted for smaller amounts than were applied for. Furthermore there can be high incidence of over-dues within the lending process and limited impact on members’ income.¹⁰⁸

[...]

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¹ Morduch J. 1999: 1573.

² The Economist Intelligence Unit Limited 2004: 33.

³ Bundesministerium für wirtschaftliche Zusammenarbeit und Entwicklung (BMZ) 2004: 5-21.

⁴ Von Pischke, J.D. 1991: 13.

⁵ Zeller, M. and Sharma, M. 1998: 23.

⁶ Von Pischke, J.D. 1991: 13.

⁷ Food and Agriculture Organisation of the United Nations (FAO), Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ) 1998: 34–35.

⁸ Food and Agriculture Organisation of the United Nations (FAO), Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ) 1998: 34–35.

⁹ The World Bank 2005: 1.

¹⁰ Hoff, K. (Ed.), Braverman, A. and Stiglitz J. E. 1993: 53.

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