Consumption Credit in Rural Financial Market Development

During the 1980s, there has been a fundamental shift from a supply-leading to a demand-oriented approach to the development of rural financial markets in developing countries. Dale Adams (1984) and his colleagues at Ohio State University provided increasingly persuasive evidence that the supply-leading approach to agricultural credit has failed. This approach was based on the assumption that the savings potential and the supply of finance in rural areas was insufficient for setting development in motion. Therefore, it was suggested to inject cheap funds from government and external sources into rural areas, regularly targeted at specified groups for predetermined productive purposes (investments, fertilizer, seeds, feed, etc.). Specialized, often stateowned agricultural banks, were established with the sole purpose of channelling production credit to a limited clientele. With many of these financial institutions failing, attention has shifted to building financial markets based on rural clients’ demand. The rationale of providing credit for production purposes was simple: credit, used to enhance the productive capacity of the borrower, will increase his future income, which, in turn, will allow him to pay interest and repay the loan. The actual performance of agricultural credit programs in many developing countries, particularly in Sub-Saharan Africa, seems to suggest that borrowers failed to follow this rationale on both accounts: the economic efficiency of credit use has often been low; the repayment performance has been poor. Many agricultural lending institutions operated with losses, and some collapsed when governments became unable to sustain them financially. Cheap credit policies, often implying negative real interest rates, have been seen to be an important contributor to institutional collapse (Adams 1984). Low interest rates make it difficult for commercial banks to mobilize savings. They tend to lower the margin on lending, causing banks to ration credit to a few and generally the larger and wealthier borrowers. Market determined interest rates are likely to reduce the lending bias towards large borrowers and to support the availability of credit for consumption purposes. The central argument of this chapter is that limiting credit to productive purposes is not only futile because of the fungibility of financial resources, but that it is also inappropriate and even counterproductive in the endeavor to build sustainable rural financial institutions. Providing production credit is only one of the three needs financial markets must address at the micro level. Failure to address the other needs will hamper financial market development. The chapter first discusses the functions financial markets have for rural households and then shortly addresses the difficulties in separating consumption and investment expenditure in rural households. Thereafter, a brief review of rural households’ needs for financial services follows. Based on surveys in Cameroon and Benin it will be shown that consumption purposes play an important or even dominant role in credit demand. Besides loan services, rural households show strong preferences for savings opportunities. It is also apparent that rural households look at financial markets as providing important insurance functions. Based on the field surveys in Benin and Cameroon and taking into account experiences of other innovative credit schemes with consumption credit components, we will try to show that credit programs with consumption credit orientation are performing well in terms of target group orientation and outreach and show better or at least not worse repayment results than traditional production oriented credit programs.