The organization of rural economic activity in general, and agricultural production in particular, is strongly conditioned by the fact that inputs are transformed into outputs with considerable time lags, and that production and sale outcomes can be highly uncertain because of the vagaries of nature or the swings of volatile commodity markets. In such environments, the ability of agricultural enterprises and rural households to make longterm investments, take calculated risks, and create stable consumption streams will be shaped by the set of available financial instruments and strategies to transform one pattern of variable and uncertain resource inflows and outflows into another. If the available set of financial services is very limited, households may have to forego valuable investment and income-generating activities and suffer the consequences of volatile consumption.
Financial transactions are implicit within, and often the reason behind, many contractual and organizational forms in the rural economy. Financial innovation therefore can have dramatic consequences on the ownership and governance structures of agricultural firms and community institutions. Financing options can affect decisions such as the physical placement and scale of agricultural operations, crop choices, and the decision to invest in risky but profitable new technologies or infrastructure. They may also affect choices about the size and composition of the rural household, and decisions such as whether to migrate, how much to invest in education, or the use of child labor. The availability of financing can also be a force that shapes political dynamics within a community, for example by affecting agent’s outside opportunities and bargaining power.
Making new financial services and contract forms available can be viewed as a form of opening to trade. Agents in a financially isolated rural economy have little choice but to transform one set of variable and uncertain cash flows into another using available production and storage technologies and local financial instruments. Since risks in a local rural economy are typically subject to common external shocks and the pool of savings may be limited, local markets often cannot offer very good diversification opportunities and the cost of funds may be high.
The introduction of new financial instruments allows agents to face new relative price tradeoffs across time periods and state-contingent events. The new trading opportunities this creates may then allow agents to specialize in higher value income activities while at the same time allowing households to purchase smoother consumption streams. Unfortunately, agents in the rural sectors of most developing countries remain cut-off from many of the opportunities for investing, risk-taking and risk spreading that would be available through better financial integration into larger national and global financial markets (de Soto 2000).
An important research agenda is to understand the dynamics of financial innovation. There are both winners and losers from the introduction of new financial services and opportunities for trade. Losers may include incumbent local financial service providers who may stand to lose monopoly rents or market share in the face of increased outside competition (Rajan and Zingales 2003; Platteau 1997), or those who might fear for the collapse of local informal insurance mechanisms (Scott 1976). Just as common have been the calls by organized groups of borrowers or activists for political and economic authorities to intervene to regulate allegedly exploitative or harmful activities of informal moneylenders or landlords.
Contents
1 Introduction
2 Salient Characteristics of Rural Financial Markets
- 2.1 Fragmented or absent markets
2.2 Government Interventions
3 Models of Rural Financial Markets
- 3.1 The complete markets benchmark
3.2 Empirical tests of efficient risk sharing
3.3 Consequences of imperfect financial markets
3.4 Contracting under asymmetric information and imperfect enforcement
3.5 Moral Hazard
3.6 Multi-period and Repeated Contracts, Limited Commitment, and Reputation
3.7 Limited Liability, Collateral and its Substitutes
3.8 Property rights and credit supply
4 Rural financial intermediaries
- 4.1 Crowding-in vs. Crowding-out of Financial Services
4.2 Group Loans, Cooperatives, ROSCAs, and Mutuals
4.3 Policies to promote rural financial intermediation
5 Conclusion
Bibliography
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