This part introduction presents an overview of the key concepts discussed in the subsequent chapters. The part gives more detail on new policy directions that might help to substantially improve financial market performance. It argues for dramatic changes in the way rural financial markets are used to support development. The part presents insights into how rural financial markets might be better used. It points out that recent research in a number of low-income countries has shown that these nonfarm firms make up a very large part of the rural economy and are often an important source of income, goods, and services for the rural poor. Many policymakers in formal financial markets are geared to do battle with informal lenders. Most of the agricultural credit systems in low-income countries have received assistance from external donors, who have put considerable time, effort, and money into these systems over the past couple of decades.

Agricultural credit projects and credit components in rural development projects are an intervention in rural financial markets by development-assistance agencies in many countries. Credit projects have provided substantial amounts of liquidity in rural areas and are frequently thought to produce high economic returns. This chapter attempts to explain how rural credit projects are presently designed and why these design techniques often cause serious problems. It suggests an alternative approach that stresses debt capacity and views credit as part of a financial process. The chapter examines the extent to which financial and nonfinancial stimulants to rural development may be substitutes or complements. Farm budgets are an important agricultural-credit design tool. Credit is generally accorded an important role in financing technical packages or innovations provided under projects.

An astronaut who was also an economist landed on one of the moons of Jupiter where there was a grain shortage. It appeared to the astronaut that producers had no incentive to grow grain, despite the fact that consumers were being forced to queue in long lines for their allotment of grain. Like its earthling counterpart on the Jovian moon, the Martian might conclude that interest-rate restrictions caused rural people not to save in financial form, resulted in long queues of people who want cheap credit, allowed rich people to get a disproportionate share of the cheap credit, and induced foreign-aid agencies to provide money to sustain rural credit programs. It appears that low-interest-rate policies are very closely associated with much of the poor performance of rural financial markets in many developing countries and that reform is necessary to substantially improve performance.

In most countries political considerations play a large role in financial markets, especially those in rural areas. Manipulation of financial markets, however, typically goes well beyond the bounds of simply supervising the creation of money. In many countries, financial markets are more thoroughly regulated than other markets. Politicians are generally confident of their ability to control financial markets. Even in those cases where the economic results of cheap-credit programs fall short of expectations, policymakers are generally tenacious in continuing to push these programs. Even with that information in hand, policymakers insist on going ahead with credit policies and programs that are very similar to those that have failed in the past. It is increasingly apparent that one must delve into the political economy of financial markets to understand why these policies persist. In addition to direct interventions in financial markets, politics can also have major impacts on these markets through general economic policies.

Governments and donor agencies are funding an increasing number of programs in low-income countries directed at owners of small businesses, particularly the smallest firms called micro enterprises. Although many micro-enterprise programs are too new for definitive evaluation, a review of earlier small farmer credit schemes may foretell what to expect from this new wave of credit efforts to help poor people. Small farmer credit programs in low-income countries have a long history; some programs date back to the early 1900s. Key assumptions about the status, potential, and behavior of small farmers were virtually identical to the assumptions involved in many recent credit programs for micro-entrepreneurs. Common assumptions spawned virtually identical policies and practices in small farmer and micro-enterprise credit. Various lessons can be drawn from small farmer credit schemes that may predict future results of many credit programs for micro enterprises.

The study of the American Dream Demonstration (ADD) has shown that the poor can save and accumulate assets in Individual Development Accounts (IDAs). ADD suggests that the possibility of saving and asset accumulation by the poor—even the very poor—cannot be dismissed. In ADD, deposits increased markedly in tax season, probably because IDA participants saved some of their tax refunds. Policy could facilitate this saving from tax refunds by allowing people to specify that refunds be split across a check and automatic transfers to multiple accounts. ADD also showed that the poor—whatever their characteristics—can save and accumulate assets in IDAs. ADD offers lessons for the design of an inclusive asset-based policy by showing how aspects of the institutional structure of IDAs were associated with savings outcomes. ADD demonstrated both a concept of asset-building by the poor and a mechanism …

Microfinance investment funds are a recent development that will grow in importance. These funds expand the range of opportunities for financing microfinance institutions, enabling them to offer greater outreach and diversity of products for microentrepreneurs and small businesses. Microfinance now spans the range of finance, from the most simple enterprise to the complexity of capital markets. KfW actively promotes microfinance investment funds and other activities that facilitate the growth of microfinance. This book is an expression of KfW's role as information broker and trend setter. The authors who contributed to this collection offer a comprehensive range of perspectives and themes related to microfinance investment and its promotion.

AbstractProgression from product‐centred to client‐centered lending is made possible by innovation, which is by definition cost‐reducing. Innovation in finance occurs in three ways: lengthening term structure, reducing transaction costs, and refining valuation processes. Each of these involves risk. The Thesis Statement is consistent with observed market behaviour but may be criticized for insufficient attention to risk as part of the mechanics of the progression it portrays. As is rapidly occurring in the US, personal credit in other countries will move toward being based almost entirely on empirical probability and hence client‐centered as foreseen in the Statement.In the meantime, the market for money progresses at various speeds from being product‐centered to being client‐centered. When this progression is complete, marketing will be as strategically important as risk management. To the extent that marketing is thought, prematurely, to trump risk management as the key to success, and to the extent meeting client ‘needs’ is viewed as the primary objective, attempts at innovation are likely to fail. When this failure occurs, the social and economic benefits of denying loans will be foregone, hindering development. Questionable projects with problematic sponsors and improper financing will be taken on, limiting growth. Copyright © 2002 John Wiley & Sons, Ltd.

The progression of microfinance NGOs from small, money-losing operations to large providers of banking services to the poor involves many risks. Unless these risks are managed successfully, the conflict between the objectives of outreach and sustainability becomes destructive to both. Several analytical tools based on accounting data and financial analysis can monitor progress toward sustainability with expanding outreach. These should be routinely applied by microfinance providers and the donors that sponsor them.