A New Rural Finance Model The World Bank December 5, 2002

A New Rural A New Rural Finance Finance ModelModel

The World BankDecember 5, 2002

CCONTENTSONTENTS

IntroductionIntroduction

Theoretical FrameworkTheoretical Framework

BackgroundBackground

A New Rural Development ModelA New Rural Development Model

Banrural: What Went Wrong?Banrural: What Went Wrong?

Strategic AlternativesStrategic Alternatives

The New ModelThe New Model

Financiera RuralFinanciera Rural

What is Financiera Rural?What is Financiera Rural?

Results After Two Years of OperationsResults After Two Years of Operations

Lessons Learned and Challenges AheadLessons Learned and Challenges Ahead

IINTRODUCTIONNTRODUCTION

Basic premise: an efficient, well structured, regulated rural Basic premise: an efficient, well structured, regulated rural financial market facilitates economic growth and reduces financial market facilitates economic growth and reduces poverty.poverty.

T h e o r e t i c a l T h e o r e t i c a l F r a m e w o r kF r a m e w o r k

Government Intervention• Directed Credit• Subsidized i-rates• Debt Forgiveness• Restructurings

Evolution of Rural Credit as Public Policy…

Disappointing Results

Financial Systems Approach

Useful, but InsufficientMacroeconomic Reforms

Non Interest-Rate, Targeted Subsidies

Structural distortions & regional disparities remain in rural sector

Government as facilitator of market forces

Improvement in Producer & RFI Capabilities

IINTRODUCTIONNTRODUCTION

The History of The History of Mexico’s Rural Mexico’s Rural Credit BanksCredit Banks

1926 1975 2002 2003

First public bank focused First public bank focused on agricultural on agricultural development, development, Banco Banco Nacional de Crédito Nacional de Crédito Agrícola, S.A.Agrícola, S.A.

Rural Credit Bank Rural Credit Bank ((BanruralBanrural) to unify ) to unify existing agricultural and existing agricultural and rural state banks. Ceased rural state banks. Ceased operations in 2002.operations in 2002.

On December 26, 2002, On December 26, 2002, Congress passed a law Congress passed a law authorizing the creation of a authorizing the creation of a new development agency: new development agency: FINANCIERA RURAL (FR). FINANCIERA RURAL (FR).

July 1st July 1st FINANCIERA FINANCIERA RURALRURAL started started operations.operations.

A New Rural Finance ModelA New Rural Finance Model

BBANRURALANRURAL

Inefficient Operating Structure: system of Inefficient Operating Structure: system of 13 regional banks operating as 13 regional banks operating as

“independent” entities “independent” entities

Operating costs above operating incomeOperating costs above operating income

Distorting, subsidy-based first-tier Distorting, subsidy-based first-tier operationoperation

““Unlimited” access to public funds Unlimited” access to public funds allocated by Congressallocated by Congress

No risk-management strategies No risk-management strategies

Unsustainable non-performing loan ratioUnsustainable non-performing loan ratio

No strategic planningNo strategic planning

Political pressure and moral hazard; no Political pressure and moral hazard; no payment culture among customerspayment culture among customers

Inadequate supervision from authorities; Inadequate supervision from authorities; negative incentive negative incentive structure structure

What Went What Went Wrong?Wrong?

BANKRUPTCY

TTHE HE CCONTEXTONTEXT

““Rural” refers to localities of 50,000 or less inhabitants.Rural” refers to localities of 50,000 or less inhabitants.

61% of extremely poor families live in rural areas.*61% of extremely poor families live in rural areas.*

*Data as of 2004. World Bank estimates, using the ENIGH 2002.

Spacial Dispersion Covariance

Risk

SeasonalityEthnicity Issues

No Integrated Prod. Chains

No Access to Financial Svcs.

Poverty

Migration

RURAL SECTORCHARACTERISTICS

Mexico’s Rural Mexico’s Rural SectorSector

20022002

GO

VT.

BU

DG

ET C

ON

STR

AIN

TS

PRESENCE OF SUSTAINABLE FINANCIAL INSTITUTIONS

MA

RK

ET D

EV

ELO

PM

EN

T

POLITICAL CONTEXT

New Development Agency

Corporate Governance

MARKET FORCES ALONE WERE NOT ENOUGH TO ACHIEVE THE PUBLIC POLICY OBJECTIVE OF RURAL DEVELOPMENT

Strategic Strategic AlternativesAlternatives

Restructuring / Recapitalization

RREDIRECTING EDIRECTING SSTRATEGYTRATEGY

A New Rural A New Rural Development Development

ModelModel

NEW

RU

RA

L D

EV

ELO

PM

EN

T M

OD

EL

Government as a Facilitator

SustainableRural

FinancialSystem

Eff

icie

ncy+

Pro

fita

bilit

y+

Socia

l D

evelo

pm

en

t =

Su

ccess

Poverty Reduction Through Self-Sustainable Institutions

Rural Development Agency with “private bank” practices

Credit: Emphasis on service & “down-up” approach to product design

Subsidies: Temporary. Only directed to improving producer & RFI capabilities

No differentiated regulatory framework vs. private banks

What is Financiera Rural?What is Financiera Rural?

Development bank focused Development bank focused on agricultural activitieson agricultural activities

Funding through “unlimited” Funding through “unlimited” access to loans from the access to loans from the Federal GovernmentFederal Government

Operated as a subsity Operated as a subsity manager, with a high ratio manager, with a high ratio of non-performing loansof non-performing loans

Inefficient cost structure; Inefficient cost structure; operating costs over 100% operating costs over 100% of operating incomeof operating income

Defficient risk management Defficient risk management

New Development Agency New Development Agency focused on rural productive focused on rural productive projectsprojects

Legally banned from taking Legally banned from taking deposits, loans or market deposits, loans or market funding. Must maintain funding. Must maintain endowment value over time to endowment value over time to sustain operations sustain operations

Operates with credit processes Operates with credit processes that apply international best that apply international best practices. Has spread payment practices. Has spread payment culture among clients culture among clients

Efficient cost structure Efficient cost structure

Best risk management Best risk management practicespractices

BanruralBanrural Financiera RuralFinanciera Rural

CCOMPARATIVE OMPARATIVE AANALYSISNALYSIS

Financiera Rural Financiera Rural vs. Banruralvs. Banrural

* The Mexican Government received a USD 505 million IBRD loan for the creation of Financiera Rural.

* “Rural” refers to locations with up to 50,000 inhab.

MEX

ICA

N G

OV

ER

NM

EN

T

Structural Transformation of

Rural Credit

Creation of a Rural Financial System

FR

Supports any productive activity in the rural area

Supports the creation and consolidation of Rural Financial Institutions

Financial Resources

Training and Advisory Services

Technical Assistance

Agriculture

Forestry

Fishing

Tourism

Commerce Pro

du

cti

vit

yQ

uality

of

Lif

e

Mission and Mission and VisionVision

FFINANCIERA INANCIERA RRURALURAL

Grant credit to rural producers, directlyGrant credit to rural producers, directly[1] or organized in or organized in informal credit organizations, as well as rural financial informal credit organizations, as well as rural financial intermediaries, through:intermediaries, through:

Products, programs and services designed to suit the Products, programs and services designed to suit the specific specific needs of needs of the rural sector the rural sector

The use of commercial bank branches for the The use of commercial bank branches for the dispersion of dispersion of funds and the reception of paymentsfunds and the reception of payments

Promote the creation, development, strenthening and Promote the creation, development, strenthening and organization of Rural Financial Intermediaries (RFIs), organization of Rural Financial Intermediaries (RFIs), providing training, advisory and technical providing training, advisory and technical assistance servicesassistance services

Provide training, advisory services and technical assistance Provide training, advisory services and technical assistance to producers for the better use of creditto producers for the better use of credit

[1] Even thouth currently Financiera Rural operates in the first tier, as well as the second, in the long term it expects to serve only as a second-tier lending institution.


ObjectivesObjectives

• Six Regional Coordinating Areas• 96 Local Agencies (Branches)• Corporate Offices in Mexico City


Geographical Geographical DistributionDistribution


Decision-Making Decision-Making ProcessesProcesses

CREDIT COMMITTEE

RISK MGMT. COMMITTEE

OPERATIONS COMMITTEE

•Top Management•Independent Members•Central Bank•Ministry of Finance

12 Members of the Board, Incluiding the Ministries of Finance and 12 Members of the Board, Incluiding the Ministries of Finance and Agriculture, the Central Bank and several Agricultural Agriculture, the Central Bank and several Agricultural Organizations.Organizations.

Organizational Structure with 6 Operational Units, 6 Regional Organizational Structure with 6 Operational Units, 6 Regional Heads and an independent Risk Management Unit; all report to Heads and an independent Risk Management Unit; all report to the CEO.the CEO.

RURAL DEVELOPMENT AGENCY

Initial Endowment of USD 1.72 billion**

USD 1,534 Mill. Credit*

USD 79 Mill. pre-operating

expenses

USD 49 Mill.TechnicalAssistance

Supervised Rural Financial Intermediaries

Informal Rural Credit Institutions

Individual Rural Producers

Technical assistance for credit enhancement and

the creation of RFIs

Credit

*Of the initial USD 1.6 billion, USD 46 million could be used for the acquisition of Banrural assets (other than loans). ** Provided by Congress.


An Integral An Integral ModelModel

Rural Financial IntermediariesRural Financial Intermediaries

• Credit Unions (Uniones de Crédito)Credit Unions (Uniones de Crédito)

• Financial Cooperative Associations (Sociedades Financieras Financial Cooperative Associations (Sociedades Financieras Populares*).Populares*).

• Thrift Cooperatives (Sociedades Cooperativas de Ahorro y Préstamo*).Thrift Cooperatives (Sociedades Cooperativas de Ahorro y Préstamo*).

• Depository Warehouses Depository Warehouses (Almacenes Generales de Depósito).(Almacenes Generales de Depósito).

*Governed by the new law for popular savings and loans (Ley de Ahorro y Crédito Popular)

Other OrganizationsOther Organizations

• AgribusinessesAgribusinesses

• Non-regulated financial intermediariesNon-regulated financial intermediaries

• Microfinance organizationsMicrofinance organizations

• Local producer organizationsLocal producer organizations


Second-Tier Second-Tier Customer BaseCustomer Base

RISK MARGIN

OPERATING COST

INFLATION

Average: Cetes + 5 pp

Interest Rate

Components


Loan PricingLoan Pricing

Conception of the Project

CommercializationOf the Product

Before GrantingCredit

1. Business and Market Plans

FR C R E D I T

Specialized Technical Assistance and Training

CREDIT ACCOMPANIMENT

*Payment of 70% of the service cost, with an upper limit of USD 3,300 per item. Total support up to USD 19,600.


Credit Credit EnhancementEnhancement

Establishment

Sustainable Development

Individual Producers

Unsupervised Credit Organizations

Supervised Rural Financial

IntermediariesA Z

FR’s Credit and Technical Assistance to Develop Institutional Capabilities


The Road to The Road to IntermediationIntermediation

Main Achievements After Two Years of Main Achievements After Two Years of OperationsOperations


---Banrural-------

--------Financiera Rural---------

Source: Financiera Rural. p/Programmed

800

459

837

1,020

Avg. 2001-2002

2003 2004 2005p/

TTOTAL OTAL CCREDITREDIT

USD MillionUSD Million

Financiera Rural vs. Financiera Rural vs. BanruralBanrural

96

%

48.0

2.6

Banrural2002

FROct

2005

NON-PERFORMING NON-PERFORMING LOAN RATIOLOAN RATIO

-1.67

9.42

NET INTEREST NET INTEREST MARGINMARGIN

MMAIN AIN IINDICATORSNDICATORS

Banrural2002

FROct

2005

%

EFFICIENCY RATIO*EFFICIENCY RATIO*

623

45

%

Banrural2002

FROct

2005*Operating Costs / Operating Income (Margin + Commissions + TradingNet Income before training and technical assistance to RFIs and Repomo on non-loanable assets.

45

7.5

Banrural2002

FROct 2005

OPERATING COSTS / OPERATING COSTS / NET LOAN PORT.NET LOAN PORT.

%

206

96

0% 3.5

RETURN ON EQUITYRETURN ON EQUITY

FR 2004 FR 2005e

Financiera Rural vs. Financiera Rural vs. BanruralBanrural

PPROFITABILITYROFITABILITY

Banrural2002

Banrural June 2003

-32.8

-97.6

%

e/ Expected

2 0 0 4 - 2 0 0 52 0 0 4 - 2 0 0 5

96

Nu

mb

er

of

Cre

dit

s

150,485

163,878

2004 2005 OCT

Nr. OF CREDITSNr. OF CREDITS

8.9%

US

D M

illion

837

902

2004 2005 OCT

7.8%CREDIT AMOUNTCREDIT AMOUNT

CREDIT THROUGH CREDIT THROUGH RFIsRFIs

73

118

2004 2005 OCT

62%

US

D M

illion

CCREDIT REDIT EEVOLUTIONVOLUTION

CCREDITREDIT

2 0 0 4 - 2 0 0 52 0 0 4 - 2 0 0 5

96

LOAN LOAN PORTFOLIOPORTFOLIO

688947

2004 2005 OCT

US

D M

illion 37.6%

LOAN RECOVERIESLOAN RECOVERIES

460

740

2004 2005 OCT

60.9%

2.9%

2.6%

Financiera Rural’s credit has reached 15% of total financing to Financiera Rural’s credit has reached 15% of total financing to Mexico’s rural sector, using its own resources and applying its Mexico’s rural sector, using its own resources and applying its own interest rate policies.own interest rate policies.

Most credits have benefited producers with anual income below Most credits have benefited producers with anual income below 140,000 pesos (USD 13,084).140,000 pesos (USD 13,084).

Over 387,000 producers have benefited directly from loans that Over 387,000 producers have benefited directly from loans that average 62,000 pesos (USD 5,794).average 62,000 pesos (USD 5,794).

SSTRUCTURETRUCTURE

12

206

6 96

Banks Branches Regional Centers

Agencies

BANRURAL FINANCIERA RURAL

OFFICESOFFICES

Nu

mb

er

of

Em

plo

yees

3,459

1,061

BANRURAL

FINANCIERA RURAL

69%

PERSONNELPERSONNEL

US

D M

illion

293

79

BANRURAL

2002

FINANCIERA RURAL2005

OPERATING COSTSOPERATING COSTS

73%

Comparative Comparative EfficiencyEfficiency

Nr.

Of

Cou

rses

TRAINING COURSESTRAINING COURSES

368

1,242 1,371

2003 2004 2005 OCT

13,650

46,111 46,481

N

r. O

f P

rod

ucers

2003 2004 2005 OCT

TRAINED PRODUCERSTRAINED PRODUCERS

TTRAININGRAINING

Specialized Specialized Technical Technical

AssistanceAssistance

34183

339

2003 2004 2005 OCT

CONFERENCES AND SEMINARSCONFERENCES AND SEMINARS

Nr.

Of

Pro

du

cers

PARTICIPATING PARTICIPATING PRODUCERSPRODUCERS

95,881

2003 2004 2005

10,28339,395

Nr.

Of

Con

fere

nces

Nr.

of

Insti

tuti

on

s

SUPPORTED ENTITIES IN SUPPORTED ENTITIES IN TRANSITION TO BECOMING TRANSITION TO BECOMING

FORMAL RFIsFORMAL RFIs

47

138

2004 2005 OCT

53

00

N

r. O

f S

up

port

s

2004 2005 OCT

NUMBER OF “SUPPORTS” NUMBER OF “SUPPORTS” GRANTEDGRANTED

151

TTRAININGRAINING

Creating a Rural Creating a Rural Financial SystemFinancial System

Lessons Learned Lessons Learned

and Challenges Aheadand Challenges Ahead

Macroeconomic reforms, although necessary, have not been Macroeconomic reforms, although necessary, have not been enough to correct existing disparities and market enough to correct existing disparities and market imperfections in rural areas.imperfections in rural areas.

A new approach to rural development is based on an A new approach to rural development is based on an “integral” vision that goes to the micro-level using a “down-“integral” vision that goes to the micro-level using a “down-up” approach to ensure the success of entire production up” approach to ensure the success of entire production chains.chains.

Unsuccessful past Government experiences which targeted Unsuccessful past Government experiences which targeted rural credit development through directed, subsidized credit rural credit development through directed, subsidized credit are being replaced with a new model, where:are being replaced with a new model, where:

The Government acts only as a facilitator for market The Government acts only as a facilitator for market forces to operate efficiently.forces to operate efficiently.

Subsidies are used only to build producer capabilities Subsidies are used only to build producer capabilities and to support the creation of financial intermediaries.and to support the creation of financial intermediaries.

Government development institutions have to be Government development institutions have to be profitable in order to ultimately reduce poverty.profitable in order to ultimately reduce poverty.

A New Rural A New Rural Development Development

ModelModel

LLESSONS ESSONS LLEARNEDEARNED

Continue to strengthen the rural financial system in order to Continue to strengthen the rural financial system in order to gradually pull out of the first-tier.gradually pull out of the first-tier.

Maintain the value of FR’s endowment over time, through self-Maintain the value of FR’s endowment over time, through self-sufficient operations. sufficient operations.

Tailor FR’s programs and products to a dynamic rural sector. Tailor FR’s programs and products to a dynamic rural sector.

Differentiate interest rates based on tier and risk level of Differentiate interest rates based on tier and risk level of clients.clients.Diversify client base into non-agricultural activities. Diversify client base into non-agricultural activities.

Improve human resource management.Improve human resource management.

Foster the relationship and coordination with other Foster the relationship and coordination with other government entities and international institutions. government entities and international institutions.

Find alternative liquidity sources (loan securitization).Find alternative liquidity sources (loan securitization).

CCHALLENGES HALLENGES AAHEADHEAD

Sustainable Sustainable Growth of Growth of

Financiera RuralFinanciera Rural

A New Rural Finance Model

The World BankDecember 5, 2002

Documents

A New Rural Finance Model The World Bank December 5, 2002