Rural finance. The rural poor – over 800 million people – require and use a variety of financial services. However, in most cases these services are inappropriate and provided on usury terms and not on conditions that are conducive to rural poverty reduction. Microfinance has evolved as an efficient and effective means to provide financial services to the poor. Some of the good practice standards of microfinance have been applied to rural areas. However, low population densities, remoteness of areas, and risks associated to lending to agricultural production increase the risks and impede the extent to which financial service providers extend outreach to rural areas.
IFAD's lending, grants and policy for rural finance. Over the last ten years (1996-2005) IFAD approved 194 projects with rural finance components for a total amount of US$3 billion. Of these total loan amounts US$822 million were earmarked for rural finance with an additional US$912 million raised from co-financiers. In addition, the International Fund for Agricultural Development (IFAD) approved US$21.5 million in grants for global, regional, and project level rural finance activities. In 2000, IFAD adopted its Rural Finance Policy (RFP) to underpin its commitment to the sector and provide policy guidance to its operations. The RFP was complemented by Decision Tools, a donor peer review organized by the Consultative Group to Assist the Poor (CGAP), and an action plan for rural finance.
Corporate level evaluation of rural finance. The rationale for this evaluation was the size of the rural finance portfolio, its performance observed by previous evaluations, and the fact that the RFP had been in place for five years. The objective of the evaluation was to assess the quality and effectiveness of the RFP, and in particular to determine whether it meets best practice standards, has been implemented and to which effect, and whether IFAD has the right resources, instruments and processes to meet the RFP objectives. The evaluation analyzed corporate policy and strategy documents, country strategies and projects of twenty countries, plus selected evaluative information for an additional eight countries. The coverage was global and included visits to ten countries in all regions assisted by IFAD.
Meeting best practice standards. The RFP sets out four challenges: sustainability and outreach, stakeholder participation, differentiated (or diversified) financial systems, and conducive policy and regulatory frameworks. On the positive side, the RFP sets standards for sustainability that exceed best practices for microfinance, and includes sector diversification and conducive regulatory frameworks, which are a sine qua non for sector development. However, the RFP does not meet best practice standards in a number of areas: for outreach it does not set clear targets (rapid expansion), for sector diversification it falls short of the meso-level intermediary institutions necessary to make the sector function, and for the regulatory framework it could have included a condition, namely to work at this level only when necessary, rather than making it an equal part of the whole. The challenge that stands out the most is that of stakeholder participation, which fits more with IFAD's modus operandi rather than being specific to rural finance. On the contrary, making it one of the four challenges diverted attention away from the more important concept of demand-driven services, which is fundamental to providing the rural poor with appropriate financial services that meet their needs.
Consistency with other IFAD policies. The RFP is consistent with other corporate policies of IFAD, which generally are supportive of the rural finance objectives set in the RFP. However, in a couple of areas improved consistency between policies would enhance IFAD's work in rural finance, in particular: (i) the rural enterprise development policy speaks of guarantee mechanisms, the soundness of which would have to be assessed in context of the financial sector; (ii) the gender dimension of rural finance is insufficiently represented in the RFP; and (iii) environmental sustainability and the link to rural finance is not recognized as an area relevant to IFAD.
Providing strategic guidance. The RFP combined information on rural finance and rural development together with IFAD's policy in such a way that description and prescription were mixed together. While informative, this limited the extent to which policy requirements stood out clearly, priorities were set, or norms were established. Some of these shortcomings were addressed through subsequent initiatives, such as the Decision Tools, the action plan for rural finance with followed the donor peer review, or the learning notes on rural finance. The regional strategies, generally, did not translate the corporate RFP into region-specific strategies, with the exception of one division where such strategy was articulated and resulted in better policy compliance and higher project design quality. Systematic portfolio reviews in this and another division contributed to strategic orientation and knowledge generation in those regions.
Project performance in meeting RFP standards. Projects are increasingly meeting the RFP challenges, although overall performance falls short of being satisfactory. The average performance rating for the five years before adopting the RFP was 2.7, which improved to 3.2 for the five years after the RFP was approved. This rating indicates that positive performance characteristics only marginally outweighed the negative. Some projects embodied RFP principles even five years before it was written, although the number of better performing projects increased after its adoption. In terms of each of the RFP challenges, the evaluation observed (i) on sustainability: 60 per cent of partner finance institutions achieved operational self-sufficiency, but only 24 per cent met the RFP's requirement of meeting financial self-sufficiency. This is comparable to the performance of financial institutions working with the United Nations Development Programme; (ii) greater diversification has been introduced in terms of types of financial intermediaries – gradually moving away from state-owned service providers – and of types of financial products – gradually introducing more off-farm credit services, but still falling short of a gamut of new services like insurance and remittance transfers; (iii) there was limited change in the frequency of working on policy or regulatory frameworks, but a slight improvement in the quality of interactions was noted; and (iv) there was no change in stakeholder participation. In terms of outreach, IFAD-supported partner finance institutions continued to reach the rural poor, although the percentage of women among clients of rural finance services was lower than of comparators working with the poor.
Explaining performance: process and experience. The continuous, but limited improvement in project performance can be explained by a number of factors. Some of them are systemic – related to the project cycle – others were generated from the project examples that the evaluation reviewed. The project cycle shows weaknesses that are not conducive to designing rural finance projects. The design process is longer than that of comparators and a technical appraisal of the project concept (for rural finance) often comes too late in the process. Project implementation is managed by units and cooperating institutions that do not have the technical expertise to manage the rural finance component with the level of competence required for this sector. Reporting lines mean that rural finance components can be subjected to political interests rather than professional considerations, introducing interest rate caps or preferential treatment for select clients, none of which ensures the rural poor receive professional and reliable rural financial services. In the earlier projects in the sample, rural finance projects lacked sector analysis and, instead provided supply-led directed credit: clients and products, including terms and conditions, were so over-defined that they were impossible to implement and of limited interest to the rural poor. More recent projects work, more and more, through financial service providers that are professional and provide an increasing range of financial products to their clientele. However, whatever gradual improvements in design have been achieved also mean projects get technically more sophisticated, which goes hand-in-hand with increasing challenges during implementation.
Corporate arrangements – matching RFP requirements? Best practice experience shows that governments are best at providing a conducive policy and regulatory environment and ensuring supervision of the sector and its actors. It is less efficient and effective in providing financial services. IFAD's lending to governments thus is inherently not in line with best practice and will always affect the way in its assistance to rural finance development is delivered. For instance, financial service providers that do not perform according to IFAD required standards (in terms of sustainability and/or outreach to the rural poor) cannot be called to correct their action, unless this is specified in the loan agreement (and subsidiary loan agreement) and government accepts to act together with IFAD. Related to this issue are limitations that arise from IFAD's instruments, typically a loan to government, which makes it difficult to meet more diverse financing needs of partner finance institutions, such as venture capital, private equity, or subordinate debt. Finally, the limits of working through cooperating institutions and without field presence apply to rural finance components as well, although technically specialized expertise would be needed in the field to have a significant impact on the performance and impact of IFAD-assisted partner finance institutions.
Human and financial resources. The RFP did not estimate whether human or financial resources would be sufficient to attain its objectives. Instead, it assumed the status quo of resource allocations. This meant that a considerable amount of IFAD lending (27 per cent of the total over the last 10 years) was handled by one full-time staff and country programme managers, who however, in general, would not be able to dedicate a commensurate amount of time to rural finance. This is reflected in IFAD's administrative budget (dedicated fully to rural finance), which is small compared to that of other institutions, such as the International Finance Corporation, the United States Agency for International Development, or the United Nations Development Programme (UNDP). In terms of qualifications, country programme managers need to cover a range of sectors, of which rural finance is but one, even if an increasingly demanding area from the technical point of view. IFAD has tried to address this issue through staff training, establishing a network among technical regional centers that will provide expertise during design and implementation, and through an internal thematic working group that serves to exchange views and distribute latest knowledge products. IFAD also supports an international database for performance data from financial service providers by aiming to have its partner finance institutions report to the database, which will not replace the need for technical in-house expertise to assess the information, but make it more accessible and comparable with international, regional and country standards. On this basis, country programme managers will know whether their partner finance institutions are performing according to expectations.
Conclusions. IFAD has led the work in rural finance in terms of approved loan allocations. It has made steps in the right direction with the RFP, which meets in some areas international best practice, while it can be improved (easily) in others to catch up with evolving best practice. The prescriptions of the RFP are increasingly met in project designs, although unevenly so, and challenges remain in project implementation. Many of the shortfalls can be explained by systemic weaknesses, in particular in the project cycle and in the founding agreement of IFAD that limits through whom and how IFAD provides loans and how it manages its assistance programme. Nonetheless, given the amount of resources and some of the key ingredients that IFAD has, it has the potential to become a much needed leader in assisting the development of rural finance, provided a commitment exists to making fundamental changes.
Recommendations. The evaluation provided two options to IFAD's Senior Management and Executive Board. The first option would entail gradual and less resource intensive change, but also mean only a gradual improvement in the programme. It would require clarifying the norms set out in the RFP, ensuring compliance with policy requirements through an integrate quality check, provision of technical appraisals of project proposals earlier in the process, and building greater in-house capacities. The second option would require more fundamental changes, but would promise IFAD could assume rightfully a leadership role in the sector. This option would entail deciding to become a leader and developing strategy for doing so, with region-specific strategies, allocating commensurate resources to the rural finance portfolio; developing and testing new instruments; and shortening the project cycle to become more efficient and relevant to the development of rural finance services.