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2 Microfinance Serving Agriculture and Rural Areas

Microfinance is making inroads into serving agriculture and rural areas. This section explains why MFIs are entering this market segment, how they are adapting to it, and summarizes successful examples.

2.1 Reasons for MFIs Expanding into Rural Areas

Some MFIs began with a mission to serve farmers, while others developed by serving urban and peri-urban clients in areas with high population densities and slowly penetrating into rural areas to serve more agricultural and farm clients.[1]

Over concentration and the need to improve efficiency and sustainability by increasing the scale of operations contributed to expansion into this market segment.

Overconcentration in Some Markets

Overconcentration first emerged where MFIs grew rapidly and became large relative to the total financial market. Bolivia, Uganda, and Bangladesh were important examples (Rhyne, 2001; Wright and Rippey, 2003; Porteous, February 2006). Increased competition can induce positive effects by pressuring MFIs to reduce interest rates, increase loan sizes, introduce new products, and improve client service, but it can also lead to borrowing from two or more lenders simultaneously, excessive indebtedness, and rising loan delinquencies.[2] One solution is for MFIs to seek new markets by expanding into smaller towns, villages, and rural areas.[3]

Improve Efficiency and Sustainability

Since some financial institutions in developing countries realize economies of scale, it is logical to expect similar benefits if MFIs expand.[4] If true, this could produce a win-win situation in which MFIs benefit through lower costs, higher profits, and greater financial sustainability, and customers benefit through reduced interest rates, and greater opportunities for MFIs to serve poorer clients with smaller loans and rural clients located in distant locations. Therefore, increasing scale by horizontal expansion into new rural and agricultural markets could be highly desirable.[5]

Studies testing MFI economies of scale have produced mixed results. For example, Qayyum and Ahmad (no date) found some evidence of MFI economies of scale in Bangladesh, India, and Pakistan. Zacharias (2008) analyzed a sample of MFIs in the 2006 MIX Market data base and concluded that larger MFIs on average appear to be more efficient. Larger portfolios can be achieved by making larger loans but this may conflict with the MFIs' social mission. On the other hand, Gonzalez (2007) studied a larger sample in the 2006 MIX data base and found that scale plays an important role in explaining cost differences for MFIs smaller than 2,000 borrowers, but surprisingly not for larger ones. He also found that as loan sizes grew, there was a significant but decreasing effect on operating costs. Therefore, expansion into new rural markets could have a favorable impact on costs and efficiency, but larger loans in existing markets could produce similar results.

  • [1] Surprisingly, Gonzalez (August, 2010) found that MFI loan officer productivity was actually higher in rural than in urban MFIs perhaps because client dispersion is not as great as expected.
  • [2] Chen, Rasmussen, and Reille (2010) found excessive lending also contributed to rising delinquencies in Nicaragua, Morocco, Bosnia and Herzegovina, and Pakistan.
  • [3] Using MIX data, Gonzalez (June, 2010) concluded there are better possibilities in concentrated markets for high-quality portfolio growth by funding new clients in new branches rather than in attracting new clients in existing locations.
  • [4] Economies of scale refer to advantages that a business realizes through expansion so average production costs per unit fall as the scale of output increases.
  • [5] Economies of scale were also given as a reason for NGOs to transform into formal regulated financial institutions (Ledgerwood and White, 2006).
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