Malawi - Rural Financial Markets : Strategic Options for Economic Development

The World Bank FOR OFFICIAL USE ONLY CoAIF~Pf4'r/4 L.- Report No. 11773-MAI MALAWI RURAL FINANCIAL MARKETS: STRATEGIC OPTIONS FOR ECONOMIC DEVELOPMENT June 8, 1994 FILE COPY CONFIDENTIAL Report No: 11773 MAI Type: ECO Southern Africa Department Agricultural & Environmental Division This document has a restricted distribution and may be used by recipients only in the performance of their duties. Its contents may not otherwise be disclosed without World Bank authorization. ABBREVIATIONS AND ACRONYMS ADD Agricultural Development Division CBM Commercial Bank of Malawi Ltd. CF Community Fund CSA Cooperative Savings Associations DEMATT Development of Malawian Traders Trust DFI Development Finance Institution FFI Formal Financial Institution FFS Formal Financial Sector GOM Government of Malawi IDA International Development Association IFI Informal Financial Institution IFS Informal Financial Subsector INDEBANK Investment and Development Bank of Malawi Ltd INDEFUND Indefund Ltd LFC Leasing Finance Company MDC Malawi Development Corporation MMF Malawi Mudzi Fund MRFC Malawi Rural Finance Company MSME Micro, Small and Medium Enterprises MFSP Mudzi Financial Services Project MUSCCO Malawi Union of Savings and Credit Cooperatives Ltd NBFI Non-Bank Financial Institution NBM National Bank of Malawi Ltd. NBS New Building Society NGO Non-Governmental Organization NMC National Mercantile Credit Ltd. NRDP National Rural Development Program POSB Post Office Savings Bank RBM Reserve Bank of Malawi RFI Rural Financial Institution RFSP Rural Financial Services Project SACA Smallholder Agricultural Credit Administration SACCO Savings and Credit Cooperatives - SEDOM Small Enterprise Development Organization of Malawi SCA Savings and Credit Association USAID United States Agency for International Development MALAWI RURAL FINANCIAL MARKETS STRATEGIC OPTIONS FOR ECONOMIC DEVELOPMENT TABLE OF CONTENTS I. INTRODUCTION 1 II. THE RURAL ECONOMY ....................................... 1 A . Background ............................................ 1 B. Structure of the Rural Economy ............................... 2 C. Financial Services to the Rural Sector ............................ 5 m. FINANCIAL SECTOR AND RURAL FINANCE ........................ 6 A. Overview of the Formal Financial Sector .......................... 6 B. Informal FinancialSector..................................... 17 IV. LESSONS OF EXPERIENCE AND EMERGING ISSUES ................... 22 A. Interest Rate Regime ...................................... 22 B. Role of Government andDonors ............................... 24 C. Targeted/DirectedCredit .................................... 25 D . Transaction Costs ........................................ 25 E. Role of Informal Financial Intermediaries ......................... 26 V. STRATEGIES FOR FINANCING RURAL DEVELOPMENT ................. 27 A. Deepening Rural Financial Intermediation ......................... 29 B. Linking Formal and InformalSystems............................ 30 C. Risk M anagement ........................................ 32 D . Capacity Building ........................................ 36 This report is based on the findings of a mission that visited Malawi in June 1992. The mission consisted of Nwanze Okidegbe (Mission Leader), S. Thillairajah (AFTAG) and G. Nwanna (Consultant). Mr. R. Anson participated in the mission's discussions in Malawi. The report also draws on the work of Danish Rural Development Consultants (Consultants to the Government of Malawi) done in the preparation of the Rural Financial Services Project, and of the Mudzi Financial Services Project, October 1993 appraisal mission. LIST OF TABLES Table 1. Size Distribution of Estates by ADD, 1989 ...................... 38 Table 2. Distribution of Commercial Bank Credit by Estate Size, 1989 .......... 38 Table 3. Distribution of Agricultural Holdings by Size, 1987/1988 ............. 39 Table 4. Blantyre ADD, Mean Income (MK) by Landholding ................ 40 Table 5. Lilongwe ADD, Expenditure Patterns ......................... 41 Table 6. Reported Reasons for Non-cultivation of Arable Land ............... 42 Table 7. Total Deposits and Liabilities of POSB, 1980 to 1990 (MK) ........... 43 Table 8. Total Domestic Resources Mobilization by the Financial System (MK) ..... 44 Table 9. Real Interest Rates, 1979-1993............................. 45 Table 10. Malawi Interest Rates Structure ............................. 46 Table 11. Commercial Bank Deposits(MK) ............................ 47 Table 12. Credit Extended - in 1988 by Informal Financial Institutions ........... 48 Table 13. Malawi - Farmers' Club Loans and Repayment Performance ........... 49 Bibliography ......................................... 50 MALAWI RURAL FINANCIAL MARKETS STRATEGIC OPTIONS FOR ECONOMIC DEVELOPMENT EXECUTIVE SUMMARY 1. This report examines the rural financial markets in Malawi and identifies how they could be used to foster rural development. It coincides with intensified efforts on the part of the Government of Malawi (GOM) to alleviate poverty, which is prevalent in rural Malawi. The report explores avenues for deepening the rural financial system and making financial services more accessible to the rural sector. It also attempts to identify the factors of success, present strategies and discuss policy options in support of: * .deepening the rural financial system; * introducing more competition in the financial system; * forging collaboration between the formal and informal financial systems; * managing risk; and * building capacity. Rural Sector 2. Malawi consists of 1.8 million smallholder family farms under customary tenure. The average size of a rural household is five persons. About 55 percent are classified as core poor (with landholdings of less than 1.0 ha and perennially food deficit) or poor (with landholdings of less than 1.5 ha and food deficit in some years). The basic needs income level (poverty line) for Malawi is estimated at US$ 91 (1991); only 45 percent of smallholders reach this level. About 30 percent of all rural households are headed by women, who generally manage home and family subsistence agricultural activities. However, with the declining size of landholdings, an increasing number of these women are seeking wage employment in farm and non-farm enterprises. 3. Agriculture continues to be the backbone of Malawi's economy. It accounts for nearly 35 percent of GDP, contributes 85 percent of exports and employment, provides raw material inputs for about two-thirds of the manufacturing sector and dominates the commercial and distribution sectors. Throughout Malawi, there are approximately 5.7 million hectares available for agriculture, most of which is already under cultivation. Maize, Malawi's staple food, is the dominant crop, occupying nearly 80 percent of the cultivated area. Export earnings are led by three crops: tobacco 68 percent, tea 13 percent and sugar 9 percent (1991). Cultivation is predominantly under rainfed conditions. 4. Malawi's agricultural structure is generally characterized as consisting of smallholder and estate subsectors. These two sectors have been delineated according to legal and institutional rules governing crop production, marketing arrangements, prices and land tenure. Using the traditional classification, the smallholder subsector accounts for about 25 percent of total GDP, 75 percent of agricultural GDP and employs 95 percent of agricultural labor; the estate subsector accounts for 9 percent of total GDP, 25 percent of agricultural GDP, employs 5 percent of agricultural labor and accounts for 90 percent of total national exports. 5. Smallholder farmers operate under customary tenure and cultivate approximately 4.3 million ii hectares. They generate about 80 percent of food production (mostly for subsistence) and 10 percent of export crops. About 55 percent of the households cultivate less than 1.0 ha, 31 percent between 1 to 2.0 ha, and 14 percent more than 2.0 ha. Maize, consists mostly of the local low-yielding white varieties (90 percent), but has storage and milling characteristics preferred by smallholders. Other important crops include groundnuts, tobacco, cassava, cotton, rice and various legumes. The dominance of maize, coupled with an acute land shortage, has resulted in the severe depletion of nutrients from the soil, and has led to a decline in soil fertility, particularly in the densely populated south. Most households produce primarily for subsistence, using simple hand tools and little or no fertilizer, thereby achieving very low yields (averaging 800 kilograms per hectare for maize). Given the small farm size and low yields, about.55 percent of the households deplete their supply of maize at least three months before harvest, in an average rainfall year. 6. Before 1991, dent hybrids and fertilizer were the only higher-yielding technologies available for maize production. Productivity of maize was constrained by the absence of a sustainable high yielding variety that satisfied farmer taste and storage requirements. This changed with the development of flint varieties with potential yield of about 3,000 kilograms per hectare with fertilizer and an estimated daily return to labor of around MK 4.00 - about twice the return on local maize. Smallholders are also now permitted to grow burley tobacco with daily return to labor of MK 5.0 to MK 7.0. Improved soybean varieties are out-producing maize in total nutrient production per hectare. They provide valuable protein and fix nitrogen in the soil. However, in order to take advantage of these developments, smallholders need to be able to purchase necessary inputs. 7. The estate sector consists of at least 26,000 farms, occupies about 1,200,000 ha. (of which only 25 percent is cultivated), and produces mostly tobacco (about 40 percent of the estate-cropped area), maize (34 percent), tea and sugar (26 percent). The low cropping intensity results from rotational management, which minimizes the risk of nematode infestation on highly profitable cash crops. Most estates have easier access to inputs, credit and support services, as well as tobacco licenses, than smallholders, and are able to secure better market prices for their produce. As a result, estates have a much higher level of technology and obtain higher yields than smallholders. Another notable feature in the estate sector is the dramatic increase in numbers during the 1980s from about 8,400 to 14,500 farms. This trend is continuing and the recent estimates are as high as 30,000 estates. Most of this increase resulted from smallholders registering as estates, primarily to gain access to burley tobacco licenses. More than 90 percent of the estates are farmed by sharecropping tenants. 8. Most non-farm economic activities in the rural sector are micro-scale and small-scale, undertaken by individuals or family members, with minimum use of hired labor. Rural families usually engage in non-farm economic activities of one form or another, and they shift labor and working capital among these to take advantage of available opportunities which includes trading, services (for example, repairs), and manufacturing (tailoring, carpentry, bakery, agro-processing, etc.) Rather than continuing to expand one particular activity, families often prefer to shift part of their resources into new fields to reduce the risk of total failure. 9. There are no reliable data to estimate the scope or importance of micro-, small- and medium- scale enterprises (MSMEs) in providing employment both as entrepreneurs and as wage-earning employees. The main available source of information is GOM personnel operating in rural areas that suggest that most rural families attempt to develop some kind of off-farm income generating activities. Given increasing land pressure, the MSME sector can be expected to grow faster in the future, iii primarily to service the internal commodity trading and processing/marketing needs associated with cash and food crop production. Growth of this subsector would, however, require adequate access to financial services. The Financial System 10. The financial system in Malawi is small and not yet well developed, but operates with very few policy distortions. It consists of two distinct sectors - formal and informal sectors. The formal financial sector includes the country's central bank - the Reserve Bank of Malawi (RBM); and two commercial banks - the National Bank of Malawi (NBM) and the Commercial Bank of Malawi (CBM). In addition, there are seven developmental financial institutions -- the Malawi Development Corporation (MDC), INDEFUND, the Investment and Development Bank of Malawi (INDEBANK), the Small Enterprise Development Organization of Malawi (SEDOM), the Smallholder Agriculture Credit Administration (SACA), the Malawi Rural Finance Corporation (MRFC) and the Malawi Mudzi Fund (MMF). There is also a merchant bank -- INDEFINANCE; finance and leasing companies, two savings institutions - the Post Office Savings Bank (POSB) and the Malawi Union of Savings and Credit Cooperatives (MUSCCO); andthe insurance industry consisting of insurance companies, brokers, several pension and provident fund managers, and the New Building Society (NBS). Securities markets are almost nonexistent, and the holding of treasury bills and other Government securities is limited to institutional investors. Active participation by formal financial institutions in the rural sector is limited to the commercial banks, the POSB, the DFIs, MUSCCO and Smallholder Agricultural Credit Administration (SACA). Most of the financial needs of the resource- poor households are being met by the informal financial sector. 11. The health of the formal financial system in Malawi tends to mirror the health of the overall economy. The financial system in Malawi has recovered from the uncertainty and general decline of the mid-1980s and has emerged stronger and more efficient. This positive performance appears to reflect the non-interventionist policies of the government which included full liberalization of interest rates in 1987. This stance has allowed the financial institutions to make autonomous operating and lending decisions based on commercial considerations. 12. The informal financial system, which includes moneylenders, traders, estate owners, friends and relatives, provides a significant share of the rural sector's capital, including that of MSMEs. The informal financial sector reportedly provided more than 66 percent of the total value of loans in any given year, and more than 10,000 MSMEs are estimated to have borrowed from the informal financial markets. Informal financial institutions provide credit services better suited to their borrowers, including ease of access, simple procedures, personal guarantees consistent with the repayment ability of the borrowers, absence of controls and restrictions on the uses of loans, flexibility in repayment, confidentiality and low transaction costs to the borrowers. The very high interest rates, reportedly ranging from 25 percent to 100 percent per annum, do not appear to deter borrowers. These rates could indicate either strong demand for credit or support the position that access to credit is more important than cost of credit to small borrowers in the rural areas. 13. The importance of the rural financial system in the economic development of Malawi is recognized by GOM and donors. Agriculture, which is viewed by GOM as the potential engine of growth of the Malawian economy, employs most of the rural population. Unfortunately most rural inhabitants have no access to financial services, especially in the formal financial market. Participation by the two commercial banks is mostly for deposit mobilization through the rural iv branches and mobile units. The operations of POSB are confined to savings. The limited number of credit activities of the two commercial banks and INDEFUND have generally been directed to estates and large scale farm and non-farm enterprises. SEDOM on the other hand concentrates on providing credit to lower end medium- and small-scale entrepreneurs. 14. SACA, which has been providing input credits to smallholder farmers for some years, however, has had a remarkable record of outreach (about 25 percent of smallholder farmers) as well as loan recovery performance. MMF, which serves the core poor in two pilot districts, has demonstrated that it would be feasible to provide credit to resource-poor rural householders without collateral. MUSCCO, has demonstrated that by combining savings and credit, rural finance could be self-sustaining. The significant factors in all three cases are the use of the group principle, joint and several liability and insistence of 100 percent recovery from cohesive groups to secure acceptable loan recovery performance. Even these relatively successful endeavors have proved to be problematic in terms of increasing outreach, making the operations cost-effective and achieving sustainability. The Government with the support of donors is taking the initiative to build on the positive lessons learned from the experiences of these institutions which have been actively involved in serving the rural sector. 15. The ongoing financial sector reforms in Malawi appear to be a step in the right direction. However, achieving the goal of increased accessibility to finance will require continued efforts to identify and remove remaining constraints that inhibit growth of the rural sector. It will also require identification of those factors that are working positively toward making financial services available, so that these are reinforced and replicated. The removal, for example, of credit ceilings and interest subsidies on agricultural loans, the liberalization of interest rates and the decision to limit the issuance of government securities, are all important macroeconomic policy decisions with potential for positive impact on the rural sector. Success with these policies will create an enabling environment which will lead to growth in the financial system and rural economy. Strategies for Strengthening Rural Financial Services 16. The focus of the strategy for developing the rural financial markets should be on increasing the level of financial intermediation, improving efficiency, and increasing sustainability of the system, maintenance of positive real interest rates to savers and lenders, and freedom to levy interest spreads adequate to cover all costs. The issues of efficiency, cost-effectiveness, competition and sustainability should therefore receive appropriate emphasis in policy formulation. The following are some specific avenues that offer prospects: Expansion of Financial Services to Rural Households and MSMEs The rural financial institutions (RFIs) other than the rural branches of commercial banks are prevented by law from mobilizing resources domestically or lending to particular sectors, groups or purposes. The inability of these institutions to expand their services is a result of their limited financial resources, a factor which also threatens their survival. This has led to the emphasis, by GOM and donors, on self- sustainability. Providing these institutions with a broader mandate to diversify their activities and engage in profitable investments will enable them to mobilize needed resources and enhance their chances of survival. Some of these institutions also have operational and management problems that urgently need to be addressed. With such V strengthening and reforms, they could contribute much more to making financial services accessible to rural households and MSMEs. This will allow RFIs to service a wider clientele and engage in a greater variety of financial services. Use of Informal Financial Institutions as Financial Intermediaries Using informal financial institutions (IFIs) as intermediaries will require that they be legally permitted to mobilize resources and provide credit. They could be engaged as intermediaries in on-lending funds from formal financiaT institutions (FFIs) and serve as deposit collection units for FFIs. Using IFIs as financial intermediaries to provide services to the rural sector has several advantages. It would expand access to financial services, particularly credit, and help to reduce lenders' transaction costs. Some IFIs (such as traders) could be used to provide credit in the form of agricultural inputs. Engaging IFIs to increase access to financial services for rural households and MSMEs through use of structures already in place will permit the deepening of the rural financial system and greater competition. Of even greater importance is that it also has potential for reducing the risks and other causes of poor servicing of the rural sector by FFIs. Risk Management * Financial institutions perceive lending to rural households and MSMEs as a high risk proposition. Risk Management associated with serving such rural borrowers is difficult and costly due to local adverse circumstances including legal and collateral constraints, illiteracy, poor infrastructure and information difficulties, and to the rural economy being virtually dependent on agriculture. Risk management is also adversely affected by external factors such as the pricing of inputs and export crops and the availability of foreign exchange. Some RFIs in Malawi have, however, succeeded in managing credit risks by adopting measures including group lending, collateral substitutes, credit guarantee schemes, and stop-order schemes. Capacity Building * The GOM should provide incentives to rural financial institutions to develop their capacity to manage risk, diversify their activities and develop instruments appropriate to their clientele. Such a strategy would include allowing rural financial institutions to mobilize domestic resources which in turn would result in increased lending to the private sector and better servicing of agricultural and non-agricultural borrowers. Encouragement could be in the form of appropriate incentives, for example, tax relief, cost-sharing or joint ventures, and through the creation of an enabling environment (legal, economic and social). This is critically important for institutions supported by GOM and donors which are also active in servicing disadvantaged groups. It is important for those institutions which have the potential for providing a variety of services to these groups, but which are reluctant to expand or to experiment with alternative instruments and services, because of the risks involved. These strategies should be supported by human resource development through education and training amongst the rural population, particularly women, and the RFIs. vi Sustainability of Rural Financial Institutions Most of the RFIs operating in Malawi are parastatals and depend on GOM and donors for their funding. These institutions do not mobilize domestic resources and their lending is usually targeted to specific sectors or groups of beneficiaries. They generally suffer from weak management, high operating costs, low loan recovery rates and limited outreach in rural areas. The institutions are not operated on commercial principles, and often there are direct government interventions in their activities. Although most of these institutions have been iff business for more than 10 years, none of them is currently profitable or likely to be profitable in the near future. Unless some of these institutions are restructured and removed from the ambit of government they would not likely be sustainable or able to provide financial services to a critical mass of rural households. It is important that a concerted effort be made to reverse this trend. The recent initiative by government in converting entities such as the Smallholder Agricultural Credit Administration (SACA), a development finance institution, from a government department into an autonomous and independent limited liability financial institution to be transformed in time into a full service rural bank is a positive step which could lead to building sustainable RFIs. Collateral Substitutes Lack of collateral is often a constraint to rural households and MSMEs in securing credit from FFIs. Some collateral substitutes such as group lending with joint liability, use of reserve funds, blocked savings accounts and personal guarantees show promise. The potential of these measures should be further explored. -1- MALAWI RURAL FINANCIAL MARKETS STRATEGIC OPTIONS FOR ECONOMIC DEVELOPMENT I. INTRODUCTION 1.1 This report examines the rural financial markets in Malawi and explores how they can be used to foster rural development through improving the accessibility of financial services to the rural sector. It is based on interviews with various institutions in Malawi, government officials, consultants, banks, farmers, women's groups, academics, as well as a review of relevant recent studies. The report also draws on the preparation report of Rural Financial Services Project prepared by Danish Rural Development Consultants, (consultants to the Government of Malawi), and complements the World Bank's Financial Sector Study.' 1.2 A detailed review of the Malawi economy is contained in the Country Economic Memorandum', while a comprehensive review of the country's financial sector was carried out in the course of preparing the report on "Financial Policies for Sustainable Growth". Rural financial systems in Malawi were, however, not analyzed or covered in any depth in either of these studies. This special review of Malawi's rural financial markets and related issues was therefore undertaken to complement the earlier studies and to lay the foundation for undertaking rural finance operations. The aim was to adopt the best possible policy options and strategies to help promote development of financial intermediation in the rural sector. This review thus served as the groundwork for the IDA-financed Rural Financial Services Project (RFSP) and the Mudzi Financial Services Project proposed to be financed by the International Fund for Agricultural Development (IFAD). This review will also serve to provide relevant inputs into the Malawi Agricultural Sector Memorandum now being finalized. The report is presented in six parts. After this introductory section, Section II reviews the rural economy. Section m reviews the financial sector - formal and informal. Section IV identifies the lessons that can be learned from experience in Malawi, and Section V describes some innovative financing schemes which have been adopted. Section VI presents strategies which could enhance the financing of rural development, emphasizing those relating to deepening rural financial intermediation, linking formal and informal markets, managing risk and building capacity. II. THE RURAL ECONOMY A. Background 2.1 With an estimated population of 9.1 million (1992) and a per capita income of US $210, Malawi is one of the poorest countries in the world. The economy has a fragile and narrow resource base and is dependent on a small domestic market, subsistence agricultural World Bank: Malawi, Financial Policies for Sustainable Growth,Report No.9009-MAI February 19, 1992. 2 "Malawi, Growth Through Poverty Reduction", Report No.8140, March 22, 1990. -2- production and a few exports. The economy is vulnerable to external economic shocks, with noticeable year-to-year fluctuations of real growth in GDP. Average annual growth in real GNP per capita between 1964 and 1974 and between 1974 and 1979 was 4.3 percent and 3.0 percent respectively, making Malawi one of the fastest-growing economies in the region during those years. In the early 1980s, however, Malawi's economic problems caused a fall in per capita income growth. These problems included a prolonged drought and a sharp deterioration in terms of trade, following increases in oil prices, and in transportation costs due to the civil war in, neighboring Mozambique. Even for a country historically characterized by effective and pragmatic management, these shocks posed a serious challenge. To counteract the effects of a weakening external position, the Government of Malawi (GOM) embarked on a policy of fiscal expansion. This led to a significant fiscal deficit, largely financed by external borrowing. By 1980/81, the debt amounted to 11 percent of GDP. The weakening economic situation led the government in 1981 to introduce stabilization measures. The result was some recovery between 1982 and 1985 as internal and external imbalances were partially brought under control. . However, the economy continued to deteriorate, through high external debt service payments, rising public sector deficits and worsening terms of trade due to rising transportation costs. Additional strains were put on the economy by an influx of over 800,000 displaced Mozambique citizens. This second round of shocks resulted in further deterioration in the fiscal deficit from 8.5 percent of GDP in 1984/85 to 13 percent in 1986/87. Once again, the GOM's response was a series of adjustment measures contained in a three-year program, supported by the IMF and the World Bank. B. Structure of the Rural Economy 2.2 Malawi is predominantly rural with 1.8 million smallholder family farms. A number of these households are also engaged in off-farm income-generating activities. Agriculture is the largest sector, supporting 85 percent of the population and contributing 35 percent to the GDP. Agricultural exports account for 85 percent of export earnings of which tobacco, tea and sugar account for 68 percent, 13 percent and 9 percent, respectively. Major food crops include maize, pulses, cassava and groundnuts. The agricultural sector in Malawi consists of smallholders who cultivate customary land and estate operators who manage leasehold or freehold land. A recent study' points out the wide variations in holding sizes within these subsectors. To provide a complete picture of the rural sector, one must add to the smallholder and estate subsectors, another category, comprising operators of small-scale non-agricultural enterprises; micro-, small- and medium-scale enterprises (MSMEs). The Estate Subsector 2.3 In 1989 there were 5,624 large estates (i.e., over 30 ha.) which accounted for 38.7 percent of all registered estates (Table 1). Despite the small number of these estates, they held 79 percent of the total estate land of 819,390 ha. This contrasts with small estates which accounted for about 68 percent of all estates and 20 percent of land area. Labor requirements on tobacco estates, which make up a majority of the estates, are met through the employment of tenants and laborers. Although a 1989 study showed 674,400 registered tenants on tobacco estates, the actual number would be much higher because not all tenants are registered. R. Mkandawire, S. Jaffee, and S. Bertoli (1990), Beyond "Dualism", The Changing Face of the Leasehold Estate Sub-sector in Malawi. -3- 2.4 Estate incomes are derived primarily from the production and sale of cash crops. No reliable data on these incomes are available. Similarly, data on estate expenditures, which are comprised largely of the cost of labor and physical inputs (including input credits to tenants and fixed asset investments), are unavailable. The amount of fixed asset investment made by the large estates is believed to be substantial. For example, they have invested heavily in equipment. 2.5 Access to credit is not a major constraint for large estates. Commercial banks have been the major source of credit for large estates and have funded a substantial portion of budgeted costs. Most commercial bank lending to the estate sector has gone to large estates (Table 2). This bias has long been recognized and is often justified by risk-return considerations. The average size of loans to large estates has also been considerably higher than those extended to other farmers. 2.6 Small estates, on the other hand, have had poor access to commercial bank credit. Often they have been subjected to additional collateral requirements and conditions, which, in effect, has excluded them. For example, commercial banks have been known to require small estate owners to contribute their own funds or funds secured from other sources up- front as part of the initial investment and to insist on collateral of much higher value than the loans applied for. In other cases small estate owners have been required to accept only "bridging" loans. The Smallholder Subsector 2.7 Current estimates indicate that 5.5 million ha. or 59 percent of the land in Malawi is held under customary tenure. They produce about 85 percent of Malawi's food supply and account for about 80 percent of total agricultural GDP. Smallholders produce a variety of food crops, led by maize, which is cultivated on 75 percent to 90 percent of the cropped land. Other crops include beans and other pulses, cassava, root crops, other cereals, groundnuts, tobacco, cotton and rice. 2.8 The average farm size is about 1.1 ha, with 55 percent of the holdings being less than 1.0 ha, and 95 percent less than 3.0 ha (Table 3). The family is the primary source of labor in smallholder production. Although labor is not often a constraint for smallholder farmers, some shortages do occur during land preparation and harvesting, especially on larger holdings and in female-headed households. Farm equipment is limited to simple tools, such as hoes, plows, riders and ox carts. 2.9 Most smallholders are subsistence cultivators with very low cash income levels. The average income of a smallholder farm family in 1991 was estimated at MK 502 for households with landholdings of less than 0.5 ha. and MK 2316 for those with over 2.0 ha., respectively. Households with larger landholdings tend to earn more than those with smaller landholdings (Table 4). They also grow more cash crops, have more surplus food crops for sale and their expenditure patterns are different. Based on 1991 research figures for the Lilongwe ADD, food purchases account for 30 percent of household expenditure for farm families with landholding of less than 0.5 ha., while it is only 11 percent for those with more than 2.0 ha. (Table 5). In addition, evidence from the Lilongwe ADD shows that the smaller the landholding, the greater the importance of expenditure on food. Both smaller and larger smallholders supplement their farm earnings with off-farm income generating activities. However, the extent of dependence on, or contribution of off-farm income generating -4- activities to smallholder income, appears to be negatively correlated with size of landholding. The Ministry of Agriculture's annual National Sample Survey of Agriculture (NSSA) estimated that, in 1990/91, smallholders with less than 0.5 ha. of land derived about 70 percent and 20 percent of income from their own agricultural production and off-farm income generating activities, respectively, versus an estimate of 95 percent and 5 percent, respectively, for smallholders with larger landholdings.' 2.10 Access to credit has been recognized by GOM as one of the critical factors influencing the adoption of basic agricultural technologies in Malawi.s Similarly, insufficient capital has been reported as the primary reason for the non-cultivation of arable land (Table 6). The main source of institutional credit for smallholders is the Smaltholder Agricultural Credit Administration (SACA). This credit is administered in a package that includes fertilizer, seed and insecticide and is channelled through farmers' clubs in which the prospective borrower must hold membership. Repayment is often made by selling crops, particularly maize through the Agricultural Development and Marketing Corporation (ADMARC) and tobacco. 2.11 However, about 75 percent of smallholders, especially those with less than 1.0 ha of land, do not have access to institutional credit facilities and formal intermediaries. The NSSA shows that between 1980 and 1987 this category of smallholders accounted for less than 20 percent of all seasonal credit extended by SACA. It can be argued that such credit packages indirectly discriminate against such smallholders, because the cost of the sizes of packages offered puts credit out of this group's reach. Although clubs operating on the principle of joint and several liability have served as viable channels for lending to smallholders, the number of farmers currently reached through this approach is limited. The allocation of credit resourcei to smallholders in Malawi thus appears to be inadequate. 2.12 The livelihood and activities of rural households in Malawi are also affected by other constraints. Mounting population pressure and limited land for expanding the area under cultivation also contribute to the increased fragmentation of holdings and encroachment into marginal lands. The NSSA indicates that the average landholding in the smallholder subsector declined from 1.54 ha in 1968/69 to 1.10 ha in 1986. Future increases in production will therefore have to come from more intensive use of existing land. Productivity in the smallholder subsector is well below its technical potential. Constraints to increasing smallholder productivity and incomes include a policy which until recently prohibited smallholder production of burley tobacco; poor price incentives for crops other than maize; a lack of appropriate technology for smallholders; lack of effective links between research and extension; and lack of access to financial and technical services. The increasing cost of external transport, poor rural infrastructure and insufficient human capital add to these constraints. 4 World Bank (1989) Malawi: Food Security Report. s Government of Malawi (MOA 1990), Household Food Security Situation in the ADDs, Proceedings of a National Meeting, Food Security and Nutrition Monitoring Report-2, Food Security and Monitoring Project, Lilongwe. -5- Micro-, Small-, and Medium-Scale Enterprises (MSMEs) 2.13 Rural households are known to engage in MSMEs as an important survival strategy to supplement their agricultural income. There are no reliable data on the number of MSMEs being operated by rural households or the proportion of their income derived from MSMEs. However, it should be noted that not all MSMEs or off-farm activities are operated to supplement agricultural income or run on a part-time basis. A 1986 survey of 1,383 enterprises, carried out by GOM/USAID, indicated that 80 percent were run by full-time entrepreneurs.6 Forty-two percent were trading activities, 26 percent small-scale service activities and 30 percent manufacturing activities. The survey showed that more than 96 percent of the entrepreneurs were sole proprietors; 91 percent started business with their own savings and 72 percent of the enterprises had initial investments valued at less than MK 1,000 (US$250). Approximately 3,000 persons were employed in the businesses surveyed; 81 percent of the employees were male and 78 percent of the enterprises were rural-based. The preponderance of male employment was evident throughout the sector except in the restaurant and bar enterprises where there was almost equal participation by both genders. A survey carried out in 1989 by the Development of Malawian Traders Trust (DEMATT), covering some 109 trading centers and 8,318 enterprises, found that 2,765 enterprises operated as traders (retail and wholesale), 2,414 as producers and 3,439 provided services. 2.14 The growth in small rural enterprises and off-farm income generating activities remains constrained by many factors including very low purchasing power; lack of transportation; lack of communication and marketing infrastructure; lack of opportunities for relevant training in small business management; and poor credit availability, especially for very small, unsecured, working capital loans. MSME investment in trading, services and manufacturing was projected to rise from MK 1.0 million in 1987 to MK 35.0 million in 1991.7 C. Financial Services to the Rural Sector 2.15 There are no reliable data on the available formal and informal financial services in Malawi's rural sector. It could, however, be imputed from available information that about MK 371.0 million of credit is provided annually to the rural sector (smallholders and MSMEs). The informal finance is estimated to provide MK 281.5 million (Chipeta), SACA MK 86.5 million (1991 seasonal credit) and DFIs MK 3.0 million. Commercial bank lending to estates and large scale farmers are not included in the above figures. The estimated rural sector credit requirements in 1992 were MK 457.3 million (Rural Financial Services Preparation Report). Although the above figures cannot be verified, they do suggest that the credit needs of the rural sector are not fully met by existing financial institutions serving the rural sector. Reliable data on rural savings mobilization by the formal and informal financial institutions are not available either. However, it could be extrapolated from "Malawi Economic Report" of 1992 that the gross savings of the rural sector was about MK 617.4 million of which about MK 357.6 million is mobilized by the formal financial institutions. There is, therefore, potential for increasing domestic savings in the rural sector. 6 Malawi Government/U.S. Agency for International Development (1987), New Directions for Promoting Small and Medium Scale Enterprises in Malawi: Constraints and Prospects for Growth. 7 GOM/USAID (1987), op.cit. -6- 2.16 Existing financial institutions do not provide adequate financial services to the rural households for several reasons. They consider loans to smallholders and MSMEs to be costly to administer, risky and having insufficient collateral. Other factors include a lack of adequate information to determine project viability; the high cost of getting information; a lack of complete documentation from the borrower-to-be for analyzing the project and loan; and inadequate means of supervising loans. It is believed that unless the financial system is deepened and the range of financial instruments broadened, the financial needs of the rural sector are not likely to be met. The GOM is addressing this problem through financial sector reforms, including interest rate liberalization and changing the mandate of DFIs serving the sector to embark on providing a full range of financial services to their clients, including savings and deposit mobilization. The government is also experintienting with pilot operations to test non-traditional approaches to rural households using collateral substitutes and group lending to reduce transaction costs. III. FINANCIAL SECTOR AND RURAL FINANCE A. Overview of the Formal Financial Sector 3.1 The financial system in Malawi is small and not yet well developed, but operates with very few policy distortions. It consists of two distinct sectors - formal and informal sectors. The formal financial sector includes the country's central bank -- the Reserve Bank of Malawi (RBM); and two commercial banks - the National Bank of Malawi (NBM) and the Commercial Bank of Malawi (CBM). In addition, there are seven developmental financial institutions - the Malawi Development Corporation (MDC), INDEFUND, the Investment and Development Bank of Malawi (INDEBANK), the Small Enterprise Development Organization of Malawi (SEDOM), the Smallholder Agriculture Credit Administration (SACA), the Malawi Rural Finance Corporation (MRFC) and the Malawi Mudzi Fund (MMF). There is also a merchant bank - INDEFINANCE; finance and leasing companies, two savings institutions - - the Post Office Savings Bank (POSB) and the Malawi Union of Savings and Credit Cooperatives (MUSCCO); and the insurance industry consisting of insurance companies, brokers, several pension and provident fund managers, and the New Building Society (NBS). Securities markets are almost nonexistent, and the holding of treasury bills and other Government securities is limited to institutional investors. Active participation by formal financial institutions in the rural sector is limited to the commercial banks, the POSB, the DFIs, MUSCCO and Smallholder Agricultural Credit Administration (SACA). Most of the financial needs of the resource-poor households are being met by the informal financial sector. The formal financial system in Malawi is illustrated in Figure 1. -.7- FIGURE 1 FORMAL FINANCIAL SYSTEM Reserve Bank of Malawi Commercial Di0p i lli Merchant Facv Banks Financial Banking o AItutons Institutions NBM(1) MDC(3) INDEFINANCE(10) NMC(11) POSB(15) CBM(2) INDEFUND(4) LFC(1 2) MUSCCO(1 6) INDEBANK(5) CBMFS(13) SEDOM(6) FINCOM(14) SACA(7) MRFC(8) MMF(9) Insurance Building indust S NBS(17) Notes: (1) National Bank of Malawi (2) Commercial Bank of Malawi (3) Malawi Development Corporation (4) Indefund Ltd. (5) Investment & Dev'p. Bank of Malawi Ltd. (6) Small Enterprise and Development Organization of Malawi (7) Smallholder Agriculture Credit Administration (8) Malawi Rural Finance Company Ltd. (9) Malawi Mudzi Fund (10) Indebank Financial Services Ltd. (11) National Mercantile Credit Ltd. (12) Leasing & Finance Co. of Malawi Ltd. (13) CBM Financial Services Ltd. (14) Finance Corporation of Malawi (15) Post Office Savings Bank (16) Malawi Union Savings & Credit Co-operative Ltd. (17) New Building Society -8- The Reserve Bank of Malawi 3.2 The Reserve Bank of Malawi (RBM) was established in 1964 under the Reserve Bank of Malawi Act and was charged with providing all normal central banking services, including the management of foreign exchange reserves and the exchange rate, the issuing of legal tender, the promotion of monetary stability and a sound financial system, and acting as a banker and advisor to the Government of Malawi. RBM administers Malawi's exchange control regulations, issues and underwrites government securities, regulates and supervises the activities of most financial institutions, and acts as banker to commercial banks. Recent restructuring in the bank and revisions to both the RBM Act and the Banking Act (1989) have broadened the scope of RBM's activities, giving it more regulatory and supervisory powers. Although the RBM has been instrumental in the macroeconomic management of the economy and in the allocation of financial resources, it has not had much impact on the rural sector. Its new powers and ongoing financial reforms may mean that the RBM will support rural sector development by providing the appropriate legal, regulatory and policy framework and incentives. The Commercial Banks 3.3 Commercial bank activities in the rural sector are limited and most of their involvement in rural areas is in the area of resource mobilization. These efforts in rural resource mobilization have taken the form of a small number of mobile banking operations serving a limited number of locations. While the agricultural sector remains the largest beneficiary of commercial bank loans, most agricultural lending goes to the estate subsector, and within the subsector, to large estates.! About (40 to 50 percent) of such advances go to finance tobacco production and marketing. Very little credit is provided to smallholders or to MSMEs. Generally, the commercial banks view lending to smallholder agriculture and MSMEs as risky and costly. The high risk of default associated with small-scale operations, the absence of suitable collateral, and the lack of banking experience are often cited as deterrents. Other factors include the lack of access to adequate information on borrowers, the high cost of getting needed information, and the lack of resources and technical capacity to effectively evaluate and monitor loans to this group. Government policies relating to credit ceilings, directed credit and prescribed interest rates have also been said to constrain lending to this group. With the ongoing financial reforms and the efforts towards deepening the financial system, commercial banks should be able to increase their presence and participation in the provision of financial services to the rural sector. Forging links with other formal financial institutions, as well as with informal financial institutions, would minimize the risks inherent in servicing this sector. Other Financial Institutions 3.4 The Post Office Savings Bank (POSB). The POSB established in 1911 commands the most visible presence among formal financial institutions in the rural sector. It has the most extensive network of deposit-taking facilities -- some 158 post offices and 126 postal In recent years, an increasing number of commercial bank loans have gone to the trade and manufacturing sectors. This may reflect a growing desire on the part of commercial banks to reduce their risk exposure in the agricultural sector. In 1990 commercial bank credit to the trade sector surpassed that of agriculture for the first time. -9- agencies. In absolute terms, the POSB has the largest amount of private sector deposits of any institution outside the commercial bank system and may hold the largest amount of rural sector deposit with the FFIs. Because of its wide geographic coverage, competitive interest rates and the tax-exempt status of interest on its savings, the POSB has enjoyed a steady growth in assets. At the end of 1987 the POSB had total assets of MK 104 million compared to MK 22.4 million and MK 61.8 million in 1980 and 1985, respectively. Between 1980 and 1987 the POSB deposit base increased from MK 20.6 million to MK 93 million in 1987, an average annual growth of 23 percent. This compares with only 17 percent annual growth in the deposit base achieved by the commercial banks over the 1980s. By the end of 1990, total deposits were MK 138 million (Table 7). POSB interest rates are set at the same level as savings interest rates paid by commercial banks. 3.5 POSB has been an effective mobilizer of deposits from small and medium scale savers, as well as from corporate savers, who have taken advantage of the tax exemption offered on POSB deposits. However, POSB has no lending mandate and, as a consequence, a majority of its deposits have been invested in Government securities, in part, to finance the public sector budget. With the gradual reduction in the budget deficit, there is increasingly less need for the Government to rely on POSB funds, yet the bank is left with very few alternatives for the investment of its growing savings base. Acknowledging this dilemma, the Government has engaged the services of consultants to review the role of POSB within an evolving financial sector. Given the problem POSB has encountered in computerization of its operations, which has resulted in difficulties in producing timely financial information and updating interest on customer deposits, it is unlikely that it will become a major retail credit institution in the near future. 3.6 Funds have been allocated under the IDA - financed Financial Sector and Enterprise Development Project to assist the Government to streamline the operations of the POSB. This would be part of the Government's initiative to increase competition in the country's financial system, gradually restructure and reorient it into an independent commercially oriented financial institution along the lines of the POSB in the United Kingdom and savings banks in other European countries. In order not to disrupt its current deposit mobilization activities, the initial focus would be on streamlining operations, improving deposit mobilization and strengthening POSB's management capacity to make sound commercial investment decisions. 3.7 Indefund Ltd (INDEFUND). Indefund began operations in 1982 with the objective of financing and developing business enterprises owned and operated by Malawian nationals. It does not mobilize deposits nor promote savings within the context of its program. It relies solely on funds from government and donors to meet its lending activities and cannot be sustainable under its current mandate. Its current loans range from MK 30,000 to MK 350,000 and are extended to enterprises in both urban and rural areas for short-term and long- term investments. As of December 31, 1990 Indefund had a loan portfolio of MK 10.81 million, mostly extended to the urban sector with a recovery rate of about 90 percent. Indefund outreach in the rural areas remains limited and its impact minimal. 3.8 Small Enterprise Development Organization of Malawi (SEDOM). SEDOM was established in 1982 as a government trust and operates as a non-profit institution. Its mandate includes the development of Malawian-owned industries; technology transfer; improvement of rural areas; and income distribution among rural and urban populations. SEDOM concentrates on providing credit services and business/technical assistance to entrepreneurs -10- at the lower end of the formal and informal subsectors. It has three regional offices and four sub-regional outlets. Loan sizes range from MK 5,000 to MK 100,000, and consist of short- term and long-term loans which are lent at below market interest rates. As of December 31, 1991, SEDOM had a loan portfolio of MK 22.6 million. It has a poor loan recovery rate of about 54 percent. SEDOM is facing severe financial and management problems; it depends heavily on government subsidies and its future prospects remain uncertain. It is unlikely that SEDOM would have the capacity or outreach to provide significant financial services to rural areas in the immediate future. 3.9 Malawi Union of Savings and Credit Cooperatives Limited (MUSCCO). MUSCCO was established under the Company's Act in 1980 with the objective of developing financially sound local savings and credit cooperative societies (Credit Unions) throughout Malawi. It is an apex organization with the specific role of promoting and expanding the number of Savings and Credit Cooperative Societies (SACCOs) and developing them into financially viable associations. It also aims to improve the savings capacities, credit- worthiness and financial management skills of its member societies. As of December 31, 1990, MUSCCO and SACCOs had a loan portfolio of MK 3.7 million with 60 percent recovery rate. This poor recovery rate is attributed to weak credit management at the SACCO level; inadequate loan monitoring by MUSCCO; and the image that the societies are welfare organizations. MUSCCO has the potential of effectively providing financial services to the rural sector if it could improve its financial performance. This could be achieved through strengthening of its institutional capacity and systematic training of its members. As of December 31, 1992, MUSCCO represented 129 SACCOs with 22,000 members. It had MK 8.7 million in assets and held MK 6.5 million in SACCO savings. MUSCCO provides loans to SACCOs up to a limit of 50 percent of their shares. SACCOs provide loans to individual members on either short-term or long-term basis. The interest rates charged on these loans are below market rates. 3.10 Malawi Mudzi Fund (MMF). MMF was established in June 1990 as a pilot scheme, modeled on the Bangladesh Grameen Bank as an initiative designed to provide financial services to the core poor in the rural areas of Malawi. The targeted poor are defined as those with assets below one acre for those with land or, if landless, with assets not exceeding five bags of maize (equivalent to MK 400 or US$100). Most of the clients of MMF cannot read or write, and have little or no business management skills. One of the services MMF provides its clients is training in these skills. Following the Grameen Bank concept, MMF clients are organized in groups of five individuals. with similar backgrounds, each with an elected leader. The groups meet weekly at a Group Center, which is controlled by an elected Center Chief. Each center is made up of six groups, making a total of 30 individuals. MMF mobilizes group and personal savings, particularly from the poor in the rural sector, and has been able to demonstrate that the rural poor can save if provided with facilities to do so. 3.11 The pilot project implemented by MMF has revealed important positive elements which form the basis for proposed projects designed to provide financial services to resource- poor rural households. The MMF scheme has confirmed that rural households could have access to credit even if they could not provide collateral acceptable to formal lending institutions, and that cohesive self-help groups would be a very effective mechanism for those without collateral to gain access to credit from formal financial institutions. Another positive feature of the MMF scheme is that all but 223 loans and every one of the 89 new groups that qualified for loans during 1992/93 were comprised of women. Disbursements by gender shows a strong and growing trend in favor of women who appear to be lower credit risks -11- than men, and who also traditionally are involved in trade and processing activities financed by MMF. There is tangible evidence that there are income generating activities in Malawi's rural areas that could be supported with credit facilities. The loans provided by MMF were mostly for small-scale trade and processing activities which showed a high level of profitability. The feasibility of financing on-farm activities along with non-farm enterprises has also been tested. As also evidenced in SACA's group credit scheme, MMF's experience shows that there is potential in Malawi for organized groups of resource-poor rural households to gain access to credit. The experience of MMF's operations in the pilot districts suggests that it would be feasible to provide credit and savings services to resource-poor rural households and support their income-generating activities through group arrangements. 3.12 However, major issues have surfaced in MMF operations. Loan recovery performance has been mixed - as low as 45 percent to 50 percent in the case of first year borrowers, although there has been significant improvement in repayment of second year loans. MMF is perceived by borrowers as that of a public institution managing a credit program on behalf of the government. A study carried out on MMF's first year borrowers concluded that the majority of them considered the loans as government gifts and that the government would write them off if not repaid. This perception of the program being a government effort with the loans being gifts continues to prevail even with second year borrowers despite intensive borrower training to dispel such misperception. The major reason for this appears to be that MMF is governed by a Board of Trustees all but one of whom are government officials or representatives. The Chairman is the Secretary to the President and Cabinet; the Administrator and the Assistant Administrator are civil servants; and the management systems and procedures are highly bureaucratized. The government is aware of such misperceptions and is in the process of instituting a program to address them. 3.13 MMF's operational arrangements have suffered from high operating costs with prohibitive overhead and limited outreach. In its present form, MMF is also disadvantaged by the diseconomies of scale of a small, autonomous institution with disproportionately high development costs and operational overheads due to its restricted geographical coverage and small lending volumes. Small-scale operations in restricted locations, perceived as a government-supported scheme, cannot be sustained for long. 3.14 These problems have now been recognized by government, and efforts are underway to accommodate MMF operations into a lending window within the Malawi Rural Finance Company (MRFC) to target financial services to resource-poor rural households. The MRFC is a newly established, autonomous limited liability financial company. Such a lending window will benefit from the experienced management of MRFC and be better equipped to reach a critical mass of the target groups because of its national coverage. 3.15 Smallholder Agricultural Credit Administration (SACA). SACA was established in 1988 as a smallholder credit scheme within the Ministry of Agriculture. Its objectives are to consolidate and strengthen the rural credit system, increase access of smallholders to institutional credit and introduce efficient and flexible allocation and utilization of funds. SACA uses farmers' clubs as the primary channel of seasonal credit to the smallholders. The farmers clubs served by SACA were for the most part formed at the prompting of the Government. In the 1960s they were formed to facilitate dissemination of agricultural extension messages, and in the 1970s they were formed to gain access to government services such as farm inputs. Such clubs were used to deliver target credit as were those which were subsequently set up solely with the objective of having access to credit provided by -12- Government and donor sponsored credit. These clubs are voluntary and cohesive farmer associations without legal status. As of March 31, 1993, there were about 15,000 clubs with a total membership of about 380,000. SACA's loan portfolio was MK 145.0 million, and the recovery performance had averaged over 90 percent up till 1992 when recovery was low because of severe drought. The loan repayment performance of these clubs before 1992 have in fact been exemplary; with an average of more than 97 percent for the 20 years from 1968/69 to 1987/88 seasons. Such remarkable credit recovery performance, despite traces of government interference, is attributable to group discipline and stringent rules governing the operation of farmers' clubs, including distribution of inputs to ensure proper utilization of the loans. These clubs exhibited some of the positive features in group dynamics, particularly prior to 1988: * self selection of group membership; * strict entry criteria; * coherence of group structure despite the lack of a legal status; * progressive savings regime; * mandatory gestation, in membership period as well as participation in savings scheme before qualifying for credit; * joint liability of members; * committed committee members; * appropriate training; and * active support of local leaders. The most important element, however, is the requirement that groups repay 100 percent of the credit extended to them in the previous season to be eligible for new loans (joint and several liability of groups and group members), and its strict enforcement. When the 100 percent repayment rule was relaxed in 1989, SACA's loan recovery performance dropped significantly and had to be immediately restored at IDA's insistence. Loan recovery in 1993 has been disappointingly low because politicians of all persuasions, particularly in a transitional stage towards multi-party democracy, reportedly have been promising to write-off SACA debts as a means of courting popular support. This is a serious development which could destroy the country's sound rural credit system and unless the Government is prepared to take decisive actions to clear the misconceptions among SACA borrowers and persuade the clubs to comply with the 100 percent repayment requirement. 3.16 Despite SACA's highly impressive performance, measured in terms of annual growth in loans outstanding and in recovery percentage, SACA operates as a government department rather than on commercial principles. Its operations were stifled by overt government involvement and beset by high administrative costs. While it is impossible to accurately estimate SACA's operating costs because all its field staff are MOA personnel, informed estimates based on SACA data indicate that 1990/91 operating costs approached 11 percent of the total loan portfolio. When annual interest rates were fixed by GOM at 18 percent, it -13- was estimated that SACA was subsidized by government at an estimated MK 4.0 million. SACA's mandate precludes further expansion of its loan portfolio outside the agriculture sector. Besides the introduction of measures such as a domestic resource mobilization program, which could assist SACA to eventually achieve financial sustainability, cannot legally be undertaken by a government department. Given the above constraints, government has actively embarked in separating the activities of SACA out of MOA and establishing the Malawi Rural Finance Company (MRFC) to-take over SACA's operations. It is expected that this measure is the first step towards converting SACA into a full service rural bank. 3.17 Non-Governmental Organizations (NGOs). There are about 30 registered NGOs operating in Malawi under the umbrella of the Council for Social Welfare Services. Of these NGOs, only World Vision International of Malawi, Women World Banking and National Association of Business Women have begun to experiment with savings and credit activities. In some cases this has taken the form of revolving funds used to extend credit to groups, and initial indications on credit allocation and loan recovery have been positive. However, most NGOs are still in the initial stages of social mobilization and planning in the specific geographical areas in which they serve but envisage starting programs for income generating activities in the near future. At such a time, it is expected that some of them will engage in savings and credit programs, funded preferably with domestic resources. Constraints on Formal Finance 3.18 Table 8 shows the financial resources mobilized by the FFIs from 1980 to 1989. Domestic resources grew at an average annual rate of 18.5 percent, fluctuating between a high of 37 percent in 1987 to a low of -2.2 percent in 1985. Although a more detailed sectoral breakdown is not available, it is believed that FFI resources mobilized in the rural sector followed a similar trend. Interest rates on deposits, in real-terms, were negative during this period due to the adverse economic conditions (Table 9). 3.19 The 1980s saw a significant shift in resources from the private to the public sector. This resulted from fiscal imbalances and a growing reliance upon the domestic financial system as a source of funding. Resource allocation was pro-public sector, and, of the relatively smaller allocation that flowed to the private sector, the preference for estate agriculture persisted. Lending to the private sector, especially to MSMEs and smallholder farmers, continues to be hindered by several factors. Asset Concentration 3.20 The formal financial sector is characterized by a high degree of asset concentration. Most banks and non-bank financial institutions (NBFIs) are effectively controlled by a small number of agricultural and industrial conglomerates that have dominant market positions in Malawi through interlocking ownerships. The resulting concentration of deposits and loans detracts from sound banking principles which emphasize deposit and loan diversification, and reduces intermediation efficiency. The steps initiated by government to mitigate the more adverse effects of excessive banking concentrations, include encouraging the entry of new financial institutions into the banking sector; switching financing of parastatals from government budget to commercial banks; and syndication of large loans to spread risk. Nonetheless, the problem of asset-concentration is likely to continue in the future unless new banks are encouraged to enter the financial sector. The stronger financial institutions should -14- offer equity shares to the public as a means of broadening the ownership base and increasing Malawian participation in the economy. Lack of Competition 3.21 Linked to the above, there is also concern over the lack of serious competition in the banking sector. Several recent developments, however, may already be addressing this concern. These include emerging competition between the two commercial banks; the aggressive entry by LFC into the market; the movement by the commercial banks into non- traditional areas of activity such as term lending; and the granting of a license to INDEBANK to engage in a wider range of merchant banking and financial services.- The government is hoping to attract more private financial institutions into the market, particularly to the rural sector, and gradually broaden the ownership structure within the banking sector. As a first step, authorities plan to adopt an open and transparent process for considering applications for entry into the country's banking system by both foreign and domestic investors and institutions, including NBFIs. The banking license issued to INDEBANK was the first granted under the new process. The privatization and conversion of SACA from a government department into the Malawi Rural Finance Company, which would evolve into a rural bank, would increase financial services in the rural areas and make them more competitive. Funds for Term Finance 3.22 In the recent past, commercial banks have tended to invest their liquid funds in Government securities. This reflected both the very conservative lending policies of commercial banks and the attractive yield offered by government securities. Investment in government securities has in the past been mandatory for insurance companies and the POSB, which are the main mobilizers of term-savings. The other NBFIs that potentially represent the most innovative part of the financial market are constrained by the lack of adequate term-resou'rces. INDEBANK and Malawi Development Corporation (MDC) have traditionally depended exclusively on external borrowings to finance their lending activities. The need is to create effective intra-market intermediation mechanisms in Malawi that would facilitate the flow of resources between institutions and enable a greater degree of term-transformation to take place. In the longer term, a likely solution would be to encourage the development of new negotiable instruments, loan syndications, direct domestic deposit mobilization by the DFIs, the issue of equity shares as a means of mobilizing longer-term resources, and possibly a national refinance mechanism. 3.23 Financial services to the MSME sector are derived from three primary sources: (a) DFIs, which on-lend donor or government supplied funds; (b) the informal financial sector; and (c) personal and internally generated savings. The main reasons why the formal financial institutions, particularly commercial banks, have been reluctant to finance smallholders and micro-enterprises and why rural lending has often been unprofitable to commercial banks are: Risks: there is high risk associated with lending to smallholders. Intensification of production is inherently high risk, and attractive opportunities are few in Malawian agriculture. Furthermore, under climatic uncertainty, intensified production systems using cash inputs are more vulnerable. A commensurate return on investment is not assured, especially in the poorly developed markets in most parts of the country. In addition, -15- credit programs have tended to concentrate on a few crops and regions, and hence risks tend to be covariant. Finally, readily realizable, asset-backed guarantees scarcely exist as collateral against risk. Transaction Costs: transaction costs of formal credit for clients in distant rural areas are relatively high. Individual loans average MK 300 (US$75), but servicing a small loan may cost almost as much as servicing a larger one. Information for lenders on clients and their activities (and even on production and prices) is hard to come by. Farmers face not only monetary risks but also climatic, technical and marketing risks. Another risk is that loans may not be precisely what they want; arriving too late or being the wrong type. Farmers may also face difficult procedures, endless discussions, trips to town, filling out forms, and fees or commissions that discourage their access to finance from the commercial channels. Institutional Constraints: the rural financial institutions in Malawi have been facing endogenous problems. The commercial banks lack the infrastructure, instruments, outreach expertise, risk management techniques and managerial capacity to mobilize and channel resources to viable rural enterprises. The NGOs and associations working in the rural financial markets have yet to prove their durability, and their ability to link with formal financial markets without preferred treatment and/or subsidy. National Policy Constraints: the overall policy on rural finance has not been conducive to developing a viable market. The administered interest rates structure does not adequately take into account the cost of providing credit to the rural sector including the associated risks, and donor lines of credit which have been used to provide a generalized, nonspecific subsidy. Furthermore, national policies have focused almost exclusively on credit rather than savings, although savings services may rank much higher in smallholder priorities. Financial Sector Reform 3.24 In the late 1980s, the GOM embarked on structural adjustment processes which entailed a series of fiscal and monetary policy interventions. Although some successes were achieved, they were short-term. The more obvious outcome was disruption of the financial system and a structural imbalance which adversely affected the mobilization and allocation of resources and threatened growth. In a country with a shallow financial system which was vulnerable to shocks, there was an urgent need for a major overhaul. Foresight on the part of the GOM, especially after the second round of shocks in the mid-1980s, gave impetus to a broader socioeconomic agenda for the future. 3.25 This is outlined in the government's development policies, 1987 - 1996, and in the Third-Year Policy Framework Paper. These involve the strengthening of monetary control, deepening the financial system and improving resource allocations to stimulate private sector investment. The major flaw in the sector has been the financial sector's inability to respond flexibly to important opportunities. The government, with IDA support, has reviewed the financial system to identify necessary policy reforms to deepen financial markets and improve -16- efficiency in resource mobilization and allocation. Several reforms in monetary policy have already been implemented or are in the process of being implemented. 3.26 In the late 1980s, national monetary policy was liberalized and reliance placed upon indirect measures to control money supply and inflation. Until 1987/88, an administered interest rate structure had been the major instrument of monetary policy operated by the Reserve Bank of Malawi. However, in April 1988 interest rates were fully deregulated, credit ceilings were discontinued and preferential rates for agriculture were abolished. Banks were then free to set lending and deposit rates without consultation with the RBM and to adjust them in accordance with their perception of market conditions. The gains from liberalization are that interest rates on savings are now positive, adequate spreads can be maintained and loans can be priced according to risk. In 1991, the real rates of interest on savings and time deposits were positive at about 1.6 percent to 1.8 percent while maximum rates for lending were a positive 8.8 percent. Increases in savings and time deposits have followed these rates. 3.27 Government now relies upon indirect measures to control the money supply (i.e., reserve requirements of the RBM, and obligations to purchase government paperlbonds as well as instructions to government owned commercial banks and parastatals). The current credit squeeze exerted by the RBM has affected the private rather than the public sector. The initial monetary reforms have not yet benefitted the rural sector. The past emphasis by government on interest rate constraint although now abolished, still appear to persist in the conservative tendencies of the commercial banks. In order to reduce risk, these banks lend only to prime borrowers who are able to offer collateral. Clients such as small estates, smallholders and small-scale enterprises normally do not possess such collateral and therefore do not have access to loans from the commercial banks. The current credit squeeze may have intensified this tendency. Lending to the private rural sector has been further constrained by its low income levels and purchasing power. 3.28 The monetary policy reform program entailed revision of the Reserve Bank of Malawi Act and the Banking Act, as well as a new Capital Market Development Act. The resulting regulatory and legal framework provides for diversification of the financial system's structure and instruments, as well as a broader role for the RBM. The key objectives of the reforms are to: * maximize deposit mobilization, while promoting efficient resource allocation, based on relative risks and returns; * promote market determination of interest rates; * foster efficient financial intermediation based on a competitive financial system; * promote an active domestic money market; * improve the flexibility and efficiency of monetary management to ensure consistency with overall macroeconomic targets; and * develop a securities market. -17- 3.29 Credit ceilings were disbanded in 1987, and by 1988 all interest rates of financial institutions were deregulated. Some effects of these changes have already been observed, in particular a decline in excess liquidity, a fall in lending rates and an increase in deposit rates at commercial banks (Tables 10 and 11). Although the reforms should eventually have a positive effect on savings mobilization and credit allocation in the rural sector, it is not yet clear that this has been the case. The commercial bank presence, number of clients reached, deposits mobilized, and credit extended to the rural sector have not changed noticeably and real rates on savings held with FFIs have yet to show a significant increase. B. Informal Financial Sector 3.30 The informal financial sector (IFS) is an important subsector of the Malawian economy. The size of the IFS is known to be large and its contribution to resource mobilization and resource allocation in the economy as a whole is important. For the most part, it is the only avenue available to rural households and MSMEs in need of credit or savings opportunities. Its contribution toward the economic development and welfare of rural Malawi places the IFS in a pivotal role in the current GOM initiative of lromoting growth through poverty alleviation. A much greater contribution, however, can be envisaged for the IFS as the financial system deepens and it becomes linked with the semi-formal and formal financial sectors. 3.31 Some IFS entities such as traders, moneylenders, credit unions and savings and credit associations (SCAs), are already well positioned to contribute towards monetizing the rural financial system. Through appropriate strategies, some of these entities could be linked with the FFIs or be given a limited legal mandate to engage formally in financial operations, to deal in financial assets and to issue financial instruments suitable to rural households. 3.32 The factors responsible for the existence and development of these entities in Malawi are similar to those documented in the literature regarding other developing countries and can be classified into four categories (a) autonomous factors (which relate to the functioning and organization of the indigenous economy); (b) characteristics of informal financial markets (which relate to the unique nature of its activities); (c) repression of formal and semi-formal financial markets; and (c) the prevailing macroeconomic environment. 3.33 Very little is known about the informal financial subsector or its activities and the government does not appear to recognize its existence or potential role in Malawi's development, despite the sector's potential impact on the economy. Recent studies point to the large and growing size of the informal financial market.' This work also highlights its important intermediary role in the economic development of Malawi, particularly in financing the activities of the rural household and MSMEs. 3.34 Chipeta and Mkandawire (op. cit) estimate that the IFS extended credit of about MK 281.5 million to the private sector in 1988 compared to just MK 104.7 million by the FFS (Table 12). Despite some reservations concerning the accuracy of these estimates, which are 9 C. Chipeta and M.L.C. Mkandawire, The Informal Financial Sector and Macroeconomic Adjustment in Malawi. AERD Research Paper 4, Initiatives Publishers, Nairobi, May 1991. The latest data used in this study are that of 1988. The findings in the study are, however, adequate to gauge the dimensions of Malawi's informal financial system and its significance and impact on the country's rural sector activities. -18- based on a random sample of only 1611 households, they do demonstrate that the IFS is significant in the economy. However, a 1986 GOM/USAID sample survey of 1,383 small and medium-scale enterprises (SMEs) showed that informal financial institutions had little or no impact on their activities. The survey reports that moneylenders financed the start-up of three SMEs, although they had no part in their expansion. Relatives and friends financed the start-up of 6.0 percent of the SMEs and the expansion of 1.0 percent. The survey also showed that 79 percent and 61 percent of the SMSEs financed their own start-ups and expansion, respectively. 3.35 Most Malawians participate in the informal financial market either as borrowers, lenders or savers. Such participation can be attributed to: (a) the relatively low cost of transactions (e.g., loss of time, transportation); (b) low costs of administration; (c) avoidance of inflation costs; (d) the secrecy surrounding financial dealings among participants; (e) flexibility of instruments; (f) personal attention; (g) ease of entry and exit; (h) low or no interest charged, with the exception of moneylenders and some SCAs and community funds; (i) the ease in obtaining loans; (j) the relative simplicity of the procedure; (k) acceptance of alternative collateral and personal guarantees; (1) flexible hours of operation; (in) the absence of the type of penalties used in the formal system; and (n) the "forced savings" element and promotion of friendship as in the case of CSAs and SCAs. Moneylenders (Katapilas) 3.36 Money lending is not legal in Malawi but it is carried out widely in all parts of the country. Many moneylenders in Malawi engage in the trade full-time. Others operate part- time, while engaged in other jobs or businesses. The activities of moneylenders permeate urban and rural areas and service the credit needs of many Malawians who have little or no access to formal finance. The source of start-up capital for moneylenders varies and includes savings from agriculture; income generating activities; salaries and/or wages. Additional funds come from interest charges on previous loans, and in some cases, cheaper funds borrowed from other sources (including other moneylenders). 3.37 There is much less variation in the lending pattern among moneylenders. They generally extend credit to anyone for whom they have personal knowledge and/or who has collateral or a guarantor (Mboni). Several moneylenders interviewed were concerned about the ability and willingness of the borrower to repay. Chipeta and Mkandawire (op. cit.) estimate that moneylenders lent a total sum of MK 9.6 million to over 73,000 borrowers in 1988. Of these loans, 52 percent of the cash was derived from farming, 25 percent from salaries, and 22 percent from business. The study also found that 52 percent of the funds lent by moneylenders is used directly for productive investment, 16 percent for farm labor and 35 percent for trading activities. 3.38 The terms and conditions of credit varied. Fifty-seven percent of the loans were granted for one month, 26 percent for a year, and 17 percent for other time periods. The rate of interest charged ranged from 25 percent to 100 percent per month. The average effective rate of interest on katapila loans is estimated to be 28.8 percent per month (Chipeta and Mkandawire op. cit.). The size and terms of the loan depend on the resources of the katapila, as well as on the degree of personal knowledge and the use of collateral or a guarantor. In the event of default or non-payment, the creditor may have recourse to the Mboni. If that fails, confiscation of the debtor's property is a common alternative. Generally, katapilas wait longer and are more open to renegotiation than the formal sector -19- in the event of default. Moneylenders rarely resort to the court system to seek redress. There are no reliable data on loan recovery and loan default rates. Estate Owners 3.39 Estate owners in Malawi provide credit, in particular, to tenant households. The majority of tobacco estates employ tenant labor to produce their crops, supplying them with agricultural inputs (and sometimes food) on credit. It is estimated that MK 40.2 million was extended to some 61,000 tenants by estate owners in credit during the 1988/89 season. It is not clear, however, to what extent this can be compared with credit from other IFIs, because of the link between credit, labor, land and produce markets usually- involved in estate owner/tenant relationships. Most of the loans (51.5 percent) made by estate owners to tenants were made at an interest rate of 5.0 percent per annum, although estate owners charged rates ranging from 2.0 percent to 25 percent per annum. Prices set by estate owners for inputs/outputs may distort the rate structure by masking much higher effective interest rates. It is estimated that estate owners earned about MK 2.3 million in interest from loans made to tenants in 1988. 3.40 Many estate owners demand some form of security from tenants, while an equally large number provide credit to the tenants as signature loans. Defaults are not common, since for the most part, tenants sell their tobacco to the estate owners and the latter rarely take action in the case of default for fear of losing their tenants. Although it is estimated that about 61.1 percent of estate owners derived some of their interest income indirectly through lending to tenants (some 9.4 percent devoted all of their time to lending), there is no indication that estate owners provided regular credit to non-tenants or to borrowers outside the estates. Non-Financial Intermediary Lenders 3.41 As in the case of IFIs, not much is known about the extent or the terms and conditions of credit offered by traders and other non-financial intermediaries. Chipeta and Mkandawire (op. cit.) estimate that the total amount of credit advanced by traders in 1988 was MK 7.2 million (Table 12). The credits were in the form of cash advances or credit sales of commodities. Very low interest was charged on these loans in some cases, none at all. This is usually the case where the intention is to attract clients and promote sales, although low nominal rates charged by traders may go with high product prices. The default rate is relatively low, with repayment period averaging two months. Inadequate resources limit the ability of traders to service more clients. The demand for credit from traders surpasses their own resources and their inability to obtain additional funds from the formal financial sector means they must deny credit to many creditworthy clients. 3.42 It is estimated that in 1988 grain millers extended MK 2.5 million in credit, almost entirely to rural households. Most of the loans commanded no interest charges. Non-interest bearing loans were often used as a way of promoting friendship and good public relations. The average loan repayment time was 10 months. Very little or no default is reported for this group. The size and number of loans extended by grain millers are limited by a shortage of loanable funds. 3.43 Besides traders and grain millers, smallholder farmers also extend credit among themselves (mostly short-term). In 1988 MK 2.0 million is estimated to have been extended -20- on credit to this group. As a way of promoting solidarity and reciprocal obligations, most of the loans are interest-free. Smallholder loans are generally small, with an average repayment time of six months. The default rate on smallholder loans is reported to be low. Smallholders, like grain millers and traders, are unable to make substantial loans or term loans because of insufficient financial resources. Access to credit for this group is very limited. 3.44 The other category of non-financial intermediary includes employers and similar individuals. Total credit by this group in 1988 was estimated at MK 12.4 million. An additional MK 27.5 million is also estimated to have been lent between firms. Loans extended by this group were similar in terms and conditions to those given for traders, grain millers and smallholder farmers. Savings and Credit Associations 3.45 Mutual aid institutions include Savings and Credit Associations (SCAs) or Savings and Credit Cooperatives (SACCOs) Cooperative Savings Associations (CSAs), and Community Funds (CFs). SCAs are found in both urban and rural areas. Participants include persons from all walks of life. Each member contributes a fixed sum of money to the fund. Money accumulated in the fund may then be lent to members or non-members. At the agreed termination date for the fund, the total sum accumulated, including interest, is distributed between members. SCAs ranging from 2 to 250 people have been reported. Most SCAs in Malawi are formed by work colleagues and neighbors, with a few between friends, relatives and business colleagues. It is estimated that 8.8 percent of all households take part in SCAs. The primary reasons cited for joining a SCA include using access to future loans, earning money and saving. 3.46 It is estimated that in 1988 a total of MK 8.4 million was mobilized by SCAs in Malawi. During the same period, it is estimated that MK 7.8 million was extended by SCAs in the form of loans. Of the total amount of credit provided, 72.7 percent was invested, mostly in the purchase of fertilizer (64.9 percent); 7.8 percent was used on farm labor and school fees; and the remaining 27.3 percent went to consumption, of which food accounted for only 2.8 percent. Interest rates charged on loans varied between SCAs. Rates also varied for members and non-members with non-members charged more. The nominal rates of interest charged on loans ranged from 10 percent to 60 percent per month. Interest income for SCAs in 1988 is estimated at MK 2.3 million. 3.47 Moral suasion and peer pressure are often used to encourage regular contributions (savings and deposits) and repayment of loans. In the event of non-payment over a prolonged period, some SCAs resort to other measures including automatic, direct deductions from the member's salary. This practice is confined mainly to urban-based SCAs whose members, as well as primary loan beneficiaries, are salaried workers. SCAs in Malawi are limited in their ability to generate more resources. This is due in part to the inability of members and potential members to earn more. Cooperative Savings Associations 3.48 Cooperative Savings Associations (CSAs) or (chiperegani) are also commonly known as Rotating Savings and Credit Associations (ROSCAs). Unlike SCAs, CSA members contribute equal sums of money periodically. This capital is given to one member at a time -21- in its entirety. Once every member has taken a turn, the CSA technically dissolves and a new arrangement may be started. Membership in CSAs is larger than in SCAs. It is estimated that 13.7 percent of all households have participated in CSAs at one point or another, almost twice the participation level in SCAs. However, available data do not indicate the number of households who simultaneously belong to CSAs and SCAs. The size of CSAs ranges from 2 to 50 persons. Most groups tend to have less than 10 members. The composition of the groups varies along income, religious, gender, occupational, geographical and blood lines. CSAs are very popular among low income groups. Most CSAs in Malawi are formed between work colleagues (54 percent) with a few between friends, relatives and neighbors. In forming CSAs, members are motivated primarily by the desire to raise money and by the desire to force themselves to save. But for many members, the fostering of friendship and solidarity is also important. 3.49 It is estimated that 56.1 percent of CSA allocations in 1988 was spent on consumer goods and 43.9 percent on savings and investments. Of the amount spent on consumption, 24.5 percent was spent on food while of the 43.9 percent allocated to savings and investments, 5.1 percent went to savings and 38.8 percent to investments. CSAs mobilized an estimated total of MK 51.6 million in 1988, most of it coming from salaries (62 percent), business (14 percent) and farming (14 percent). The volume of resources mobilized by the CSAs is a function of their size and the level of disposable incomes of members. For CSAs with a comparable number of members, the latter is important, since the size of contributions invariably reflects members earnings. Community Funds (CFs) 3.50 Community groups are also active in the mobilization and allocation of financial resources. Community funds are found in urban as well as in rural areas. The nature of these groups varies; some are religious, some social and some civic. Membership can comprise the entire village, a part of it or a group of villages. The size of CFs in Malawi ranges from an average of 55 members in the rural areas to 168 in the urban areas. In 1988 CFs mobilized an estimated MK 2.0 million, primarily through group work (27 percent) and member financial contributions (70 percent). Of resources mobilized through group work, 89 percent was through members performing agricultural work for wages. In some CFs, additional resources are derived from interest earnings on loans extended to its members. Resources mobilized by CFs are largely spent on community projects, with a relatively small proportion going to finance private enterprises. Many CFs in Malawi lend to their members without interest. In other cases, interest rates range from 5.0 percent to 50 percent per month. Welfare Funds 3.51 The activities of these groups have often filled a void in services of formal financial institutions. The contribution of employers stems from their ability to deduct repayments from wages/salaries and to lend out funds set aside for this purpose. In other cases, it may involve special funds contributed by employees themselves, especially senior and better-paid employees. It is estimated that MK 79.8 million in credit was extended to employees by their employers in 1988. During this time over 83,000 persons are estimated to have borrowed from their employers. In some cases the loans were interest-free; in other cases they commanded interest, usually about 10 percent per annum. The average repayment time was 5.1 months. -22- Other Sources for Credit 3.52 Loans between friends, relatives and neighbors are common in Malawi. The loan amounts are usually small and for short periods, averaging two months. Most of the loans are interest-free. Such loans are often regarded as a way of promoting and maintaining friendship, solidarity and social relationships. In 1988, some MK 49.1 million, MK 23.7 million and MK 10.8 million in credit was estimated to have been extended between friends, relatives and neighbors, respectively. Uses of Funds 3.53 No estimates are available on resource allocation by source for the IFS as a whole. Of the total amount of loans extended by the IFS (except SCAs and CSAs or 74.6 percent of the total) 59.5 percent was invested in business, 3.1 percent in farm labor and 12 percent in fertilizer. The proportion of SCA and CSA loans going to production is estimated to be 72.7 percent and 38.8 percent, respectively. Thus, most IFS credit is used for productive purposes. Constraints on Informal Finance 3.54 The IFS has some features and advantages that the FFS does not have and these would be useful in forging a productive link between the two sector markets. Such a link would benefit both sectors and the economy as a whole, and may reduce some of the risks in providing financial services to MSMEs and the rural sector. What appears to be lacking are an understanding and interest in each others' markets and activities, cooperation, competition, and effective linkage. Equally lacking is sustained government policy that would create an enabling environment to promote IFS institutions and their activities. Government policies in the past adversely affected their activities because they did not recognize their potential impact and role in promoting rural development and the development of the MSME and rural sectors. To the extent that the GOM adopts policies that facilitate development of the IFS and does not disrupt its basic structure, one may envision an increased contribution by the IFS to the overall development effort. 3.55 The IFS faces several constraints. Some of the major ones are a result of government fiscal, monetary and commercial policies and strategies. This is reflected in the lack of legal recognition given to IFS institutions. The IFS is unable to meet demand for its services, particularly term credit, because of limited funds which have traditionally gone toward meeting short-term financing. Few of the institutions have the resources and legal authority to introduce pertinent instruments or to take advantage of central bank facilities. The ability of the IFS to mobilize additional resources is also limited by other government policies and strategies, in particular those relating to agricultural land ownership, enterprise development and income generating activities. IV. LESSONS OF EXPERIENCE AND EMERGING ISSUES A. Interest Rate Regime 4.1 Government control of interest rates has been the main instrument of monetary policy in Malawi. Until 1987 the. entire interest rate structure was directly administered by the Reserve Bank of Malawi, which set deposit rates and allowed financial institutions to set -23- lending rates within prescribed limits. Changes in administered interest rates occurred only three times between 1980 and 1985. Despite rising inflation during this period, real lending rates were generally positive. This contrasts with real inierest on deposits which was generally negative (Table 9). 4.2 Persistent negative real rates on deposits and a constaht yield curve for longer term loans (over 12 months) discouraged resource mobilization, distorted credit allocation and contributed to market segmentation. Until 1984, there was virtually no incentive for commercial banks to issue long-term loans, as they could only charge one-half point premiums for loans over 12 months. Also, a fixed spread left no room for pricing loans according to risk. Mobilization and allocation of short-term funds- thus became their specialty, with 90 percent of their lending being channelled by way of overdraft facilities. Long-term lending was for the most part left in the hands of DFIs, such as INDEBANK and INDEFUND, which are constrained by law from mobilizing long-term domestic resources for term lending."o 4.3 The limited room for interest rate adjustment reinforced the conservative tendencies of the commercial banks. To minimize risk, commercial banks lent only to prime borrowers, placing higher emphasis on collateral than on other measures of creditworthiness. This bias intensified during periods of tight liquidity. Commercial banks had little incentive to pursue new business aggressively. As a result, clients such as MSMEs, small estates and smallholders were not served by commercial banks. 4.4 In 1987, as part of the reform efforts, credit ceilings were removed and interest rates on deposits were adjusted upwards by 3.0 percentage points. In April 1988 interest rates were fully deregulated. The practice of setting preferential rates for banks lending to agriculture was discontinued in August 1989. Following the 3 percentage point increase in deposit rates in 1987, the banks (with the agreement of RBM) lowered the lending and deposit rates in 1988 by 3 and 2 percentage points, respectively. This differential reduction was intended to offset a decline in commercial bank income resulting from the reduction after February 1988 of the level of excess reserve requirements deposited at the RBM. 4.5 With deregulation of interest rates, banks were free to set interest rates without consultations with the RBM, and several financial institutions have adjusted their deposit and lending rates since 1988/9 (Table 10). At the end of June 1993, savings and deposit rates at commercial banks were 24 percent, up from 10.75 percent in 1989 and 12 percent in 1990. Similarly, minimum and maximum lending rates have gone from 16 percent and 23 percent in 1989 to 26 and 31 percent in 1993. Deposit rates at the New Building Society (NBS) increased from 10.75 percent and 12.25 percent in 1989, for savings and investment deposits respectively, to 22.0 and 22.5 percent in 1993. In the same period mortgage rates at NBS have increased from 12.75 to 19.75 percent. Since 1989 deposit rates on savings at the POSB have remained at the 1988 and 1989 level of 10.75 percent, except in 1987.and 1990 when the rates rose to 13.75 percent and 12 percent, respectively. 4.6 Although there is no evidence of interest rate competition between the two commercial banks, rate differentials between the various financial institutions are now quite apparent. On 'o Recently, INDEBANK has been permitted to float a local currency bond and to accept deposits, as well as to introduce new banking products and services. -24- savings deposits, the POSB continues to pay the lowest rate, 16 percent versus 22 percent for NBS (for 6 to 12 months deposits), 24.50 percent (for 6 months deposits) for commercial banks; and 19 percent (for 6 months deposits) for the Leasing Finance Company (LFC) and National Mercantile Credit Ltd. (NMC). A differential also exists in lending rates, although not to the same degree as observed for deposit rates. The base (prime) lending rate at the commercial banks was 25 percent in 1993. Other loan arrangements include mini and term loans made by SEDOM, the interest rate on both of which as of March 1993 was 18 percent. At the same time, the rate for Building Contractors Standing Facilities loans stood at 20 percent. The interest rate structure in the semi-formal financial institutions, such as MUSCCO and MMF has now been adjusted to reflect market rates. However, transaction costs continue to be subsidized. The MMF now charges 18.5 percent on its loans, while rates for MUSCCO (for loans to SACCOs) range from 6 percent on development loans to 12 percent for long-term business loans (Table 10). 4.7 Various rates are charged in the informal sector, although there are no reliable data on the actual rates being applied on transactions. Recent survey studies (Chipeta and Mkandawire 1991) report the prevalence of small to no nominal interest charged on loans made by informal financial institutions such as neighbors, friends, employers, traders, grain millers, CSAs and smallholder farmers. Some employers have been reported to charge interest of up to 25 percent while the rate for moneylenders has been reported to be as high as 100 percent per month. Rates charged by SCAs range from 2 percent to 60 percent per month, while those of Community Funds range from 1 percent to 5 percent per month. Although it is not clear how different IFIs determine the rates they charge, it is likely that some take their cue from the prevailing rates in the FFS. It is more difficult to be precise on the effective lending rates on credits granted by IFIs. 4.8 By and large, the formal interest rate structure in the early 1980s was negative in real terms and had an adverse impact on both resource mobilization and on-credit allocation in the rural sector. Following the deregulation of interest rates, and the financial sector reform currently in progress, some positive changes have been observed. Lending and deposit interest rates at FFIs have been adjusted, and deposits at the commercial banks have risen (Table 11). Increased lending activities to the private sector have also been observed. B. Role of Government and Donors 4.9 The GOM's role in the economy is set out in the Statement of Development Policy 1987-1996. One of the instruments GOM has used, with the assistance of donors, is interventions in rural financial markets. This has been in the form of credit schemes or lines of credit through apex arrangements for on-lending by DFIs, mainly for agriculture related investments and non-farm micro- and small-scale enterprises. These interventions have generally been targeted and accompanied by subsidized interest rates that distort the financial system. Interest rate ceilings and credit controls meant to help small farmers often end up limiting their access to credit and making lending to them unprofitable. The net result is that most of these interventions have not achieved their objectives. Several donor-supported credit programs in Malawi have performed no better than GOM-sponsored interventions. Some of these programs are also targeted and subsidized, and often they are not coordinated. Most donors have been so concerned with achieving results that they have relied on technical assistance to implement their programs, rather than building the capacity of RFIs. The outcome is that a number of donor-assisted interventions have not been sustainable and have not attained their objectives. -25- 4.10 Direct intervention in rural financial markets by GOM and donors often led to supporting financial institutions which were unlikely to be sustainable on their own and further taxed government budgets. One of the lessons that should be learned from this experience is that the government's role in the financial sector should be limited to providing an enabling environment for the financial markets to operate efficiently by supporting sound macroeconomic and financial policies. The government should, through its policies, promote domestic resource mobilization, provide incentives for capacity building amongst the RFIs and their clients and promote private ownership and management of RFIs on commercial basis rather than direct intervention in their operations. It appears that the GOM has recognized this important lesson and has embarked on full liberalization of the financial system, including the interest rate regimes on deposits and lending. The current efforts by GOM and donors in converting SACA from a government department to a limited liability finance company (MRFC), with the goal of transforming it into a full service rural bank, is also a positive development. C. Targeted/Directed Credit 4.11 Evidence suggests that targeted credit programs are an inefficient means of dealing with market imperfections or in redistributing income and other resources." Experiences from many other countries point to negative outcomes, characterized by increased distortion in prices and resource allocation. The results of targeted credit have been mixed in Malawi. Some have benefited, but the majority of the target groups have yet to be reached. Available credit continues to reach only a few, mostly estates, large smallholder farmers and a small minority of MSMEs. The GOM's strategy of reliance on interest rate subsidy to influence the flow of credit has had only a limited impact. Most financial institutions currently providing credit and other financial services to rural Malawi have performed their tasks well, though there is great room for improvement, particularly in expanding outreach. Ultimately, how well they perform will depend on their ability to improve outreach, while at the same time becoming self-sustaining. In the meantime, emphasis should be placed on encouraging and supporting their efforts and expanding their mandates. D. Transaction Costs 4.12 Reliable data on the transaction costs of formal rural financial institutions are not available, but they are believed to range from 7 to 20 percent of outstanding loan portfolio. An analysis of SACA's transaction costs which does not adequately account for the cost of the services of the extension staff, is about 11 percent. SACA's transaction costs would be much higher if all its costs, including those borne by government on its behalf were added. It is, therefore, not surprising that high transaction costs are a major constraint on the provision of financial services by RFIs to rural Malawians. In addition to risks in agricultural lending, financial intermediaries face high costs in servicing accounts and supervising and collecting small loans. Such costs are increasingly becoming a constraint on government/donor supported institutions, such as SACA, SEDOM, Indefund, MMF, and " Avocet Braverman and J. Luis Guasch (1986). "Rural Credit Markets and Institutions in Developing Countries: Lessons for Policy Analysis from Practice and Modem Theory. World Development, Vol. 14, No. 10/11; World Bank, World Development Report 1989.. -26- MUSCCO.11 Data available for 1988 indicate that every MK1.00 lent by SEDOM and INDEFUND to the MSMEs sector, cost (transaction cost and risk premium) MK 0.67 and MK 0.44, respectively. It is clear that these institutions cannot be self-sustainable without a massive cost-cutting strategy that could hamper their ability to expand coverage of rural households. 4.13 Rural households bear significant transaction costs which are not reflected in the interest rates charged by the lending institutions. Some of the non-interest costs borne by borrowers include service fees, closing costs and charges for the loan paperwork; travel and subsistence, and the value of the work foregone in meeting bureaucratic requirements. To this must be added, especially for tenant farmers, the costs of "tie-in" -ontracts, including contracts to sell to the lender. There are no reliable data but the transaction costs to the rural borrower, particularly for a small short-term commercial loan, could be as high as 20 percent of the value of the loan. These costs could be significantly reduced if such loans were provided through groups rather than on an individual basis. Reduction of transaction costs is therefore one of the important advantages of group lending to rural households (see para 5.18). 4.14 The need for cash and inputs by rural farmers in Malawi is seasonal. Farmers have little time for bureaucratic delays. Given the cash costs, the delays between application approval and disbursement, and the uncertainty of loan approval, it is not surprising that most small estate and smallholder farmers prefer informal sources of credit. While the interest charges on some informal credits are very high, approval and disbursement are immediate, the terms are flexible and transaction costs are lower. E. Role of Informal Financial Intermediaries 4.15 Some of the reasons cited for the absence of interaction between the formal and informal finance markets include the perceived high risk of lending to the informal sector, the small size of transactions, high transaction costs, the absence of suitable collateral and the perception that they are not bankable. A recent study" reported that 23 percent of SCA funds are deposited with FFIs for safe-keeping, but that the amount of borrowing from FFIs is considerably less. Forty-seven percent of moneylenders were reported to save with commercial banks, 26 percent with NBFIs and 27 percent kept the money at home. No moneylender sampled in the study reported borrowing from a commercial bank. They relied on their own income and resources or borrowed from the informal financial market. Many traders, grain millers and community funds save with FFIs, and some large estate owners who lend money, save with, and get credit from, FFIs. 12 Most of these institutions are expected to be financially viable. 13 F. O'Regan, C. Wescott, and G. Butler, Malawi: Informal Sector Assessment. Submitted to USAID, July 1989. -27- V. STRATEGIES FOR FINANCING RURAL DEVELOPMENT 5.1 The focus of the strategy for developing the rural financial markets should be on increasing the level of financial intermediation, improving efficiency, and increasing sustainability of the system, maintenance of positive real interest rates to savers and lenders, and freedom to levy interest spreads adequate to cover all costs. The issues of efficiency, cost-effectiveness, competition and sustainability should therefore receive appropriate emphasis in policy formulation. The following section explores some strategies and policy options for making Malawi's financial markets to be more effective channels for rural development and for improving access to financial services, particularly for women, smallholders and micro-enterprises. The strategies for developing the rual financial markets are summarized in Figure 2. FIGURE 2 STRATEGIES FOR FINANCING RURAL DEVELOPMENT Strategy Current Status Required Actions Deepening Rural Financial * Limited scope of the formal financial * Capacity building and infrastructure Intermediation system support for existing and new institutions * Fragmented with specialized institutions * Re-examination of the mandate and legal operating in distinct market niches status of some FFIs * Excessive concentration of resources * Possible expansion of services by financial * Lack of a dependable and sustainable institutions cooperation between the formal and * Creation of conducive policy and legal informal financial markets environment to improve cooperation between formal and informal markets Linking Formal and Informal * Limited collaboration among and between * Promotion of linkages between formal and Systems FFIs, IFIs and NGOs informal financial sectors * Limited joint venture undertakings between * Improved liquidity of informal sources, various institutions and limited credit- flexibility and convenience in lending relevant information sharing between * Legal recognition of IFIs the commercial banks * Each financial market must get associated *Lack of on-lending from NGOs and IFIs to with the activities of the other the rural sector or MSMEs * Increased IFI access to FFI credit and * Untapped potential in both the formal and possible use as intermediaries informal financial market * Expanded role for NBFIs Risk Management * Limited risk management capacity due to * Alternative strategies to reduce risk should adverse conditions including legal include group lending,insurance, collateral constraints, poverty, and poor substitutes, stop-orders, credit guarantee communications and information, plus schemes and interlinking loans external factors such as import and export * Improving farmer and MSME access to prices, and price and availability of forex technical support and to financial services, could reduced lending risk Capacity Building * Insufficient human resource development * Assistance to institutions including training * Absence of large entrepreneurial group and in legal and regulatory area lack of competant managers * Improved education and training * Improved education and training throughout throughout Malawi, including institutional Malawi, including institutional level level -29- A. Deepening Rural Financial Intermediation 5.2 A major characteristic of the Malawian financial sector is the limited scope of the formal financial system and its resultant lack of depth. The system is fragmented with specialized institutions operating in distinct market niches. An equally conspicuous feature is the excessive concentration of resources, lack of competition (reflecting in part the fragmentation of the formal financial system), and the oligopolistic structure of the formal sector economy. The need for cash and inputs by rural farmers in Malawi is seasonal. The IFS has some features and advantages that the FFS does not have and these would be useful in forging a productive link between the two sector markets. 5.3 The activities of the IFS have often filled a void in the services of the FFS. However, the IFS faces several constraints. GOM's efforts to change this situation are evident in recent revisions of the Reserve Bank of Malawi Act (1989) and the Banking Act (1989), and the enactment of the Capital Market Development Act (1990). The Revised RBM Act has expanded the operations in which the Central Bank can engage, including open market operations, implementation of reserve requirements and serving as lender of last resort to the banking system. The Act has provided a policy framework for new direction in monetary policy, which relies increasingly on indirect (rather than direct) monetary instruments and mechanisms. Success with the strategy of indirect monetary management, however, will require a sufficient level of development in financial markets. The Banking Act paves the way for new intermediaries and the use of new instruments by banks and non-bank financial institutions (NBFIs) to generate resources. 5.4 The Capital Market Act of 1990 provides the framework for developing a capital market, another important avenue for widening the mobilization and allocation of resources. Together, these acts are intended to strengthen the legal and operational framework needed to deepen the level of intermediation in the system. Other reforms, including the liberalization of interest rates, will also aid deepening of the financial system and broadening the range of financial services. 5.5 The need now is for capacity building and infrastructural support for existing and new institutions to take advantage of the new opportunities. With the entry of more formal financial institutions into the rural market, competition will emerge and the rural financial markets will deepen. However, deepening rural financial intermediation will also require a re-examination of the mandate and legal status of some of the FFIs. GOM should consider allowing some financial institutions to expand their present activities - to provide a full range of financial services, in particular savings mobilization, and to experiment with appropriate instruments which will enable them to become viable and sustainable. 5.6 An important source of financing for rural households and MSMEs is the IFS. Despite the activities of IFIs, the credit needs of the rural sector are still not being adequately met. For most IFIs, the absence of any dependable and sustainable linkage with the formal financial market makes it difficult to expand and improve their services. The focus should be on creating a policy and legal environment conducive to cooperation between the formal and informal systems. This will foster competition, expand the existing pool of institutions and instruments and deepen the financial system. The resultant wider coverage will provide additional impetus for economic growth and the alleviation of poverty. -30- 5.7 Although in the short term expansion of the legal mandate of some of the formal and informal financial institutions would add depth to the financial system, it remains doubtful whether such expansion alone would be adequate to substantially increase formal financial services to the rural sector. This raises the need to consider establishing and encouraging new financial institutions capable of providing a variety of services to the rural sector. To ensure viability and to minimize some of the problems now constraining the DFIs, the new institutions should be made independent of government and managed along commercial lines, with mandates to use diverse financial instruments and assets appropriate to rural savers and borrowers. B. Linking Formal and Informal Systems 5.8 There is little or no collaboration among and between FFIs, IFIs and NGOs. This negates the possibilities of risk reduction through information-sharing and joint activities. Information sharing between RFIs is virtually non-existent, especially on credit clients, and joint venture undertakings between the various institutions in the rural financial market are lacking. Even between the two commercial banks, where some form of cooperation exists, little credit-relevant information is exchanged. None of the FFIs in Malawi use NGOs or IFIs to on-lend funds to the rural sector or to MSMEs. Using NGOs and IFIs as intermediaries has several advantages, the most relevant being the potential for risk sharing and reducing transaction costs. IFIs, such as moneylenders, traders and community funds, are likely to have better information on the creditworthiness of potential loan applicants and be better able to monitor the use of loans than FFIs. 5.9 Promoting linkages between the formal and informal financial sectors is a proven way of promoting the flow of formal funds to informal lenders to supplement their own funds and deposits". The formal sector has proved more successful in mobilizing small savings than in making small loans. The basic advantage in promoting the linkages approach is that it combines the strengths of both sectors to supplement the resources of the informal sector. 5.10 Some countries already have models linking formal and informal finance. For example in 1986, the Asian and Pacific Regional Agricultural Credit Association (APRACA) adopted a program of access to formal financial institutions for the poorer sections by focusing on "a financial intermediation system built around self-help groups as grassroots intermediaries between banks and rural microentrepreneurs."15 Subsequently, several APRACA member institutions held discussions and carried out research on self-help groups and their importance for the development of rural finance. The first country to test this linkage model was Indonesia, thus minimizing transaction costs for both bankers and final borrowers and overcoming the shortcomings of informal lending. The program has two principal linkage dimensions: institutional linkages between self-help groups and banks (direct or indirect), and financial linkages between savings and credit. Interest rates on savings and credit are at market rates and an adequate interest margin provides the basis for the institutional viability of each intermediary: the bank, the private voluntary organization/NGO 14 Prabu Ghate et al "Informal Finance: Some Findings from Asia". ADB 1989. 's H.D. Seibel and U. Parhusip, "Linking Formal Financial Institutions: An Action Program in Asia and Pacific", 1989. -31- and the grassroots organizations. The program also seeks to preserve the autonomy of the existing groups and institutions. 5.11 Another example of this linkage is the Praja Naya Niyamaks (PNN) scheme inaugurated in 1988 in Sri Lanka.'" The basic features of the scheme are that the two state banks lend funds to persons of proven creditworthiness, often on the basis of collateral, at 18 percent per annum and expect PNNs to lend at an interest rate not exceeding 30 percent per annum. The banks give the PNNs guidelines on how to lend but do not require them to provide documentation and other proof of their lending. This will solve the problem of the liquidity of informal sources and at the same time provide the flexibility and convenience in lending, which the banks as formal institutions could never provide. However, one weakness of the scheme is that PNNs do not mobilize savings and are entirely dependent on the two state banks for their resources. 5.12 Forging collaboration and cooperation between the markets will also promote rural development through increasing access to a variety of financial instruments and services. For the same reasons that IFIs have survived and become popular among rural households and MSMEs as a source of credit, they may attract potential savers even at deposit rates of interest lower than those available at urban-based FFIs. The operations of IFIs require legal recognition. Success may depend on the extent to which the government limits interference with IFIs traditional mode of operation. Some of the IFIs may grow and graduate into larger formal institutions, as in the case of many building societies in England and elsewhere, and some banks in Cameroon and India. 17 5.13 Collaboration and linkage will allow the different financial markets to draw on the strengths and experiences of each. This could lead to a better intra- and inter-sectoral/market allocation of resources and more effective management of the economy. Some links do exist between the formal and the informal financial markets via group lending schemes and credit unions. Strengthening and broadening these links will require getting each market associated with the activities of the other, adopting techniques of the other that are appropriate and beneficial, enabling informal financial institutions to deposit surplus funds with FFIs, and meeting their requirements for extra resources through borrowing from the FFIs. 5.14 Experimenting with IFI Entities as Intermediaries. A number of IFIs are important in providing finance to MSMEs and rural households. Yet many are unable to meet all the loan needs of their clients. Although a significant number of IFIs operate savings accounts with FFIs, access to FFS credit is narrow. Considering the size of the informal financial market in Malawi, and its prominence in the rural sector and in servicing the credit needs of MSMEs, policymakers may consider using some of the IFIs as financial intermediaries on an experimental basis to provide savings and credit services, in association with donors, the GOM, FFIs, and rural households. Increased IFI access to FFI credit may lower the cost of funds to both parties, and may lower interest charges on their loans. It may lower the cost of lending/borrowing to both the lender and the ultimate borrower. This could lead to more competition in the delivery of services to the rural sector, thus adding more depth to the financial system. 1 Nimal Sandaratne, "Informal Lenders in Sri Lanka: Linking Formal and Informal Markets", 1989. "7 Dale W. Adams and P.B. Ghate, "Where to From Here in Informal Finance. -32- 5.15 Expanding the Role of NBFIs. Financial institutions other than banks could be allowed to broaden their range of financial services. A restrictive legal mandate is one of the constraints facing several of the NBFIs serving the rural sectors and small enterprises. Many of these institutions are prohibited under their charter from engaging in domestic resource mobilization, or resource allocation, or from extending their services to certain sectors or activities. These institutions, for the most part, are obliged to rely on funds from the GOM and external donors, and operate on a narrow financial base, a situation that continues to threaten their survival.. The GOM should re-examine the mandate and financial status of these institutions with a view to expanding their operations, in order to allow them to provide other financial services and to service more of the rural households. This would also provide the institutions with the means of becoming self-sustainable and facilitate linkage between the markets. C. Risk Management 5.16 Risk management for rural financial institutions is made difficult and costly because of adverse circumstances, including legal constraints, poverty, illiteracy, poor communication and infrastructure, poor information and a rural economy which is almost totally dependent on agriculture. In addition, national policies have not always been supportive of rural financial institutions. Risk management is also affected by factors external to Malawi, such as the price of export products and imported inputs and the price and availability of foreign exchange. Recent reform efforts, including stimulating growth across all sectors of the economy, have the potential for lessening risks for most of the RFIs. 5.17 The types of risks requiring management include credit risk, portfolio risk, interest rate risk, foreign exchange risk and those related to off-balance sheet items. " Risk of default and non-payment are of particular concern to RFIs. The perceived high risks associated with lending to rural households and MSMEs is a key factor limiting credit availability. Other factors that adversely affect the provision of financial services to the rural sector include the high cost of transactions in servicing the sector, the lack of suitable collateral and the uncertainty inherent in agriculture. Devising alternative strategies to minimize credit risk and reduce transaction costs (as well as exploring and experimenting with collateral substitutes) becomes a challenge for Malawian RFIs. 5.18 Strategies being used by RFIs in Malawi to manage credit and other risk-related factors include group lending, insurance, collateral substitutes, stop-orders, credit guarantee schemes and interlinking loans with present or future transactions in other activities or markets. Although experiences with these approaches have varied, they have generally had some positive results. Not every RFI has employed these approaches and some strategies have not been properly implemented so as to minimize risk. 5.19 Portfolio Diversification. Lending patterns among RFIs appear highly skewed towards farming activities and towards males. Considering the volatile nature of farm production, diversifying credit activities to include more non-farm and non-agriculture 1 Credit risk - the basic risks inherent in lending; portfolio risk - the risks inherent in the composition and management of a portfolio, including those relating to capital inadequacy; interest rate risk - the risks resulting from mismatching of assets and liabilities by maturity or rate structure; foreign exchange risk - the risks related to increased foreign exchange transactions; off-balance sheet risk - the risks resulting from commitments entered by the RFI, such as contingent guarantees, foreign exchange coverage, collateral, including the quality of coverage of related collateral. -33- activities may minimize uncertainties in income flow. Similarly, shifting resource allocations in favor of women may reduce the comparatively high delinquency and low recovery rate reported with lending to men." These options have the added advantage of making more resources accessible to women. 5.20 Group Lending. Group arrangements in the form of ROSCAs and Tontines have been in existence in African as well as in other developing countries for a long time and can be a major instrument of savings and credit in developing Malawi's rural financial markets. Since these grassroot organizations are the product of local initiatives, self-selected members of groups can more easily relate to each other. The members are entirely responsible for the management of funds mobilized and for borrower selection. The credit-worthiness of members and their individual debt-servicing capacity are well known. This in turn helps to minimize loan processing and recovery costs. Group membership enhances the groups' as well as the individual members' standing in the eyes of formal lenders, improves information about potential borrowers, and facilitates the offering of joint guarantees, mutual guarantees and group guarantees. It also facilitates mobilization of small savings in small installments, at greater frequency and at minimal transaction cost, and monetization of real form savings because of ready accessibility of saved funds in case of emergencies. Social impact of group schemes is also significant as has been acclaimed under the Grameen Bank Scheme in Bangladesh. 5.21 The Grameen Bank has attracted a lot of attention from policy makers in other developing countries as one of the more successful schemes for the poor.' Under its credit schemes the Grameen Bank provides loans and organizational help to landless poor who otherwise would be excluded from formal credit system due to lack of collateral, high transaction cost and high risk of loan default. Savings mobilization, in the form of "Group Fund" and "Emergency Fund", is an integral part of Grameen Bank lending. Group lending offers access to credit tied to group responsibility and repayment behavior by screening out good borrowers from bad ones, creates peer pressure and helps to enforce financial contracts. Savings mobilization aims to promote financial discipline. The Grameen Bank does not itself bear the entire burden of monitoring which is primarily the responsibility of self-selected groups where members monitor each others activities. The Bank has also been involved in social intermediation which helps to improve individual and social accountability. 5.22 In this context, the Madagascar case too is noteworthy. A significant aspect in the National Rural Bank's (BTM) credit operations is the relatively better loan repayment performance by groups. The cohesiveness of these village groups is regarded as the cornerstone for developing the "saving-first" cooperative scheme now being financed by the World Bank as a technical assistance project. 5.23 Group lending is particularly attractive because of its potential to improve loan recovery rates.2' It also has potential for reducing credit transaction costs associated with 19 ADB/UNESCO (January 1992). Malawi: The Promotion of Income-Generating Activities for Women. 2 S.R. Khandker, B. Khalely and Z. Khan, "Grameen Bank: What De We Know?", October 1993. 21 Higher recovery rate has been reported for group lending in the seasonal credit programs. World Bank, World Development Report 1989. -34- lending to smallholders and MSMEs in the rural areas from 20 percent to 5 percent. Some institutions that provide credit to the rural sector do not use the group lending approach. Although there are weaknesses associated with group lending, such as the tendency to foster "moral hazard" and "free rider" problems,' it can be effective, especially where self-help groups are formed bottom-up and are small in size and homogeneous in composition. In addition, recovery of group loans significantly increases if the group and the group members are jointly and severally responsible for repaying the loan, adhering to a 100 percent repayment principle, whereby a group in arrears is not eligible to borrow until the previous loan is fully repaid. The group would be required to maintain a reserve fund which could be used to meet the obligations of members who are in arrears and are unable to repay their debt on time to maintain the 100 percent repayment. Such a group would use its internal procedures to recover the outstanding amounts and replenish the reserve fund. 5.24 It is important to recognize the groups brought together by outside parties governments donors, NGOs etc. - those set up merely for purpose of delivering credit, or stipulations of group membership as the sole or most vital criteria to qualify for loans are bound to destroy financial systems. Spontaneous emergence of groups for non-credit purposes, self-selection, commonality of members, voluntary participation, autonomy in operation, self-reliance, appropriate training, establishment of savings record prior to seeking credit facilities etc. are important in group dynamics to ensure sustainability in the savings and investment process. 5.25 Effective Loan Recoveries. Effective loan recovery strategies include using indirect controls and raising the cost of defaulting to borrowers by: (a) imposing a penalty on arrears; (b) disqualifying the borrower or group from future loans even if the loan is eventually paid off; or (c) disqualifying the borrower or group from future credit until existing arrears are settled. Recoveries could also be improved by providing greater incentives to borrowers to repay early and to staff to improve collection. To encourage borrowers to pay on time, most of the rural financial institutions have relied on such borrowers becoming eligible for future available credit or receiving an increased amount of loans in the future. RFIs could explore the use of interest rebates for prompt or early repayment. Appropriate incentives would also lead to increased staff accountability and motivation. These incentives could be monetary or non-monetary, taking the form of periodical bonuses based on branch or departmental profit, number of loans executed, loans collected or savings mobilized. Non-monetary compensation could include promotions, trips, plaques and certificates of recognition and appreciation. 5.26 Collateral Substitutes. Although most RFIs require collateral, usually land, equipment, or real estate, alternatives might include group lending with joint and several liability, blocked accounts, or requiring the borrower to open a joint savings account with the institution, or guarantee fund or reserve fund. Collateral could also take the form of interlinking or loan hypothecation, an arrangement familiar to many estate farmers. Hypothecation requires the temporary transfer of legal ownership to the bank of an investment item or future production. The commercial banks are using interlinking of loans in cooperation with auction houses, while loan hypothecation is currently being used by SACA. With some modifications such practices could be adopted by other RFIs. A. Braverman and J.L. Guasch (April 1990), "The Theory of Rural Credit Markets." -35- 5.27 A modified form of trade-credit linkage in which the borrower sells the farm output/s to the lender has also been a very effective enforcement mechanism prevalent in the rural sector. Such an arrangement closes the borrower's option to seek additional credit from other lenders. This in a sense also reduces the lender's risk in securing repayment by preventing the borrower from entering into more financial commitments, thereby increasing total indebtedness. The ability of a trader-moneylender to enforce claims is thus enhanced. Hypothecation of a title, or the deposit of title deeds to land and saleable and fixed assets, though of no practical significance, is an effective method of preventing the borrower from accessing another lender and from selling the subject property to a third party. 5.28 Usufruct loans could be extended to borrowers who are unable to offer conventional forms of collateral - physical assets, including land, capable of being realized quickly and without too much loss - in the event of loan default. This might be in the form of the lenders' right to use or have control over the borrower's property. The lender may be given the right to occupy or use the borrower's land or other assets until the loan is repaid following the principle "possession is nine-tenths of the law". Loans are sometimes guaranteed by the lender being allowed to harvest the borrower's crop for the whole or part of a season in satisfaction of the principal and interest owed. Such arrangements are common with tree crops. 5.29 Interlinkage and hypothecation of loans would be a much more effective strategy where a significant amount of collaboration, cooperation and information sharing already exists between institutions. 5.30 RFIs could also minimize the risks of lending by employing some form of borrower classification. This would entail setting maximum and minimum loan sizes to different borrowers, depending on the level of risk as perceived by the lender. The process would allow larger loans, for instance, to estates than to smallholders. Classifications of borrowers now used by some RFIs could be adopted by others. 5.31 Crop Insurance Schemes. Crop insurance could be required as collateral for estate farmers and large smallholders, most of whom grow export crops. Experiences of the last two decades could provide a starting point from which to rationalize, as well as market, crop insurance programs. Premiums for such insurance would depend on the size of the loan and could be factored into the loan agreement. Crop insurance schemes are not new and many countries have successfully experimented with them, although there is a very high organization and administration requirement for self-sustaining programs.. 5.32 Technical Support/Services. Improving farmer and MSME access to technical support and to financial services could raise productivity and reduce the risk of lending. Most financial institutions provide their clients with some technical assistance, mainly in the form of training in management and business skills. However, only a limited number of rural borrowers have benefited from such programs, partly as a result of inadequate number of qualified and experienced staff of lending institutions and their lack of financial resources to intensify and expand these activities. D. Capacity Building 5.33 Strong and viable institutions are crucial in increasing the level of rural financial intermediation. They should be within easy reach of both rural savers and borrowers and also -36- be responsive to client needs. The challenge therefore would be to develop such institutions so that they could provide the needed financial services in a cost effective way and to mobilize as much as possible of the resources required locally to meet the ever increasing credit demand in the rural sector. 5.34 Success in the GOM's effort to provide more financial services to the rural sector and to improve access to these services will also depend on an enabling environment. The ability of the financial institutions to compete and to contribute more towards rural and MSME development will depend on how successfully rural infrastructure and human resource development are tackled. The GOM has to establish the proper environment through appropriate policies and directives and by fostering a stable and healthy economic climate. 5.35 Institution building in the form of capacity development would inevitably increase the efficiency of financial intermediaries and enhance the effectiveness of the linkage process, as well as the quality of services. Capacity enhancement would entail solving problems commonly faced by financial institutions, such as: (a) setting objectives and priorities; (b) becoming efficient and cost-effective; (c) managing change; (d) creating independence; (e) reviewing project design; (f) developing accounting practices; (g) managing personnel and the organization; and (h) managing information.' Assistance to financial institutions servicing the rural sector and microenterprises would enable them to improve their activities and strengthen and expand their operations. Future support could be both financial and non- financial. Resources for institution building are especially critical. Devoting resources to building up incentive systems, adequate training, efficient and meaningful managerial information and accounting systems would greatly enhance the efficiency of these institutions. Such support should also include a legal and regulatory framework that would allow existing financial institutions to provide a broader range of'services to the rural sector and MSMEs. 5.36 Training and Education. Economic development in Malawi will depend on an increased effort on the part of the Government in training and education for rural inhabitants, particularly women. A high illiteracy rate and insufficient human resource development have been constantly cited as development constraints for Malawi. The absence of a large entrepreneurial class and the lack of a large pool of competent managers continues to limit the provision of services to the sector. Well trained person-power will enhance the capacity of rural institutions. In addition to the need to make formal education accessible and affordable to a significant portion of the rural population, and to improve the quality of education, there is a need to increase training opportunities for farmers, MSMEs, women, field officers and bank employees. At the institutional level, continuous training in project analysis and credit processing, supervision, monitoring and loan recovery will also be needed. 5.37 Infrastructural Development. Building of physical infrastructure associated with rural credit has been successfully adopted in some countries. The National Cooperative Development Corporation (NCDC) in India has been operating a successful credit scheme under which primary cooperative societies were extended loans for the construction of storage-cum-office buildings. Such infrastructure served partly as storage for farm inputs and * Maryke Dessing (July 1990), Support for Microenterprises: Lessons for Sub-Saharan Africa, World Bank Technical Paper Number 122. 2 Grindle, "Capacity Building" (1987) in Maryke Dessing (July 1990). -37- partly as crop storage for society members. The physical facility enables the society to stock fertilizer, made available in a timely manner, and to be sold to farmers for cash. Storage of harvested crop not only helps farmers to sell their produce when the time and price are right but also to secure loans from their society, pledging the crop as collateral. 5.38 The National Rural Bank (BTM) in Madagascar has been operating a "Paddy Bank Scheme", utilizing its grain storage facilities. Under the Paddy Bank Scheme, farmers who offer to deposit their paddy crop in the grain stores controlled by BTM could secure a loan up to a prescribed proportion their crop until it is sold. The paddy harvest, in effect, thus serves as an acceptable collateral for the loan. 5.39 The limited presence of FFIs (commercial banks) in rural Malawi and the lack of timely access to financial services by rural inhabitants is in part the result of poor transportation and communication systems. Rural households have to face the high costs of transportation in marketing their products and services. Deficient rural infrastructure also hampers the adoption of new technologies, which is vital for increased productivity and higher real incomes and savings. 5.40 Adoption of Recommended Strategies. The research and analysis undertaken in the course of this study and the strategies recommended in this report have formed the basis for the two most recent rural finance sector operations in Malawi, i.e. the IDA financed Rural Financial Services Project (RFSP), and the Mudzi Financial Services Project (MFSP) proposed to be financed by IFAD. In both projects, reliance is placed on grassroot groups in rural areas as a method of collateral substitution and thereby to increase outreach, and the emphasis is on sustainability of the financial intermediary permitted to function as a private autonomous entity. - 38 - TABLE 1: SIZE DISTRIBUTION OF ESTATES BY ADD, 1989 Percent of Total Estate Area ADD < 30 Ha > 30 Ha Kasungu 75.30 24.70 Lilongwe 80.90 19.10 Mzuzu 60.80 39.20 Salima 42.00 58.00 Liwonde 48.70 51.30 Blantyre 45.20 54.80 TOTAL 68.30 38.70 Source: Mkandawire, Jaffee and Bertoli (1990). TABLE 2: DISTRIBUTION OF COMMERCIAL BANK CREDIT BY ESTATE SIZE, 1989 Estate Size Category (Ha) 0-15 15-30 30-100 100+ Number of Estates 8.00 14.00 20.00 13.00 Total Credit (MK'000) 35.90 53.10 398.90 1392.90 Average Loan Size (MK'000) 4.49 3.79 19.95 107.14 Minimum Loan Size (MK'000) 1.20 1.20 2.00 2.00 Maximum Loan Size (MK'000) 8.00 10.00 200.00 470.00 Share of Total Credit (%) 1.9 2.8 21.2 74.1 Source: Mkandawire, Jaffee and Bertoli (1990). - 39 - TABLE 3: DISTRIBUTION OF AGRICULTURAL HOLDINGS BY SIZE, 1987/1988 Size Category (Ha) Percent of Holdings Cumulative Percent of Holdings 0.00 - < 0.50 26.00 26.00 0.50 - < 1.00 29.60 55.90 1.00 - < 1.50 20.40 76.30 1.50 - < 2.00 11.00 8730 2.00 - < 2.50 5.10 92.50 2.50 - < 3.00 2.70 95.20 >= 3.00 4.80 100.00 Source: The World Bank . - 40 - TABLE 4: BLANTYRE ADD, MEAN INCOME (MK) BY LANDHOLDING . Landholding Category (Ha) SOURCE < 0.5 0.5 > 1.0 1.0 - < 2.0 > 2.0 Food Crop Sale 72.57 100.80 131.20 173.50 Business 45.26 26.62 50.11 201.28 Trading 52.84 75.42 124.12 857.92 Wage/Salary 118.89 83.31 62.48 150.10 Ganyu 46.09 54.42 46.34 48.83 Remittances 35.71 34.48 59.58 46.59 Interest 1.10 1.20, 1.51 1.20 Loan Repayment 13.13 15.90 15.58 112.23 Other Cash Income 85.08 114.86 153.43 245.49 Cash Crop Sales 30.95 77.23 174.76 478.79 TOTAL 501.62 584.24 819.11 2315.93 Source: Center for Social Research, Zomba, Malawi (1991). * Note : This Table is based on a sample size of 205 farmers. 39 with land <0.5 Ha, 84 with land 0.5>1.0 Ha, 57 with land 1.0<2.0 Ha and 25 with land >2.0 Ha. - 41 - TABLE 5: LILONGWE ADD, EXPENDITURE PATTERNS (MK) * Landholding Category (Ha) EXPENDITURES < 0.5 0.5 > 1.0 1.0 - < 2.0 > 2.0 School Fees 8.49 10.44 11.94 35.08 Clothes 53.18 64.21 86.94 209.47 Fertilizers 16.41 30.88 25.69 88.57 Agri. Inputs 7.60 9.78 6.71 19.57 Farm Equipment 3.47 3.68 6.12 37.92 Employee Pay 1.58 4.07 13.65 119.25 Ganyu Pay 10.52 14.31 38.75 76.09 Fuel 14.32 12.29 19.16 45.13 Taxes 3.12 5.07 5.55 31.82 Market Fees 2.68 2.36 2.86 2.48 Business Inputs 1.73 2.85 3.87 6.72 Trading 0.74 2.56 24.76 9.59 Loan Repayments 14.19 16.28 35.82 55.90 Interest 0.77 1.00 0.79 4.03 Transfers 3.31 4.69 11.56 41.97 Household Goods/Serv. 29.11 38.48 42.74 91.45 Livestock 4.14 3.73 5.87 12.37 Food 75.14 77.74 114.34 120.38 TOTAL 250.50 304.42 457.12 1007.79 Source: Center for Social Research, Zomba, Malawi (1991). * Note : This table is based on a sample size of 205 farmers. 39 with land <0.5 Ha, 84 with land 0.5>1.0 Ha, 57 with land 1.0<2.0 Ha and 25 with land >2.0 Ha. - 42 - TABLE 6: REPORTED REASONS FOR NON-CULTIVATION OF ARABLE LAND * Estate Size Category (Ha) WEIGHTED REASON 0-15 15-30 30-100 100 + AVERAGE Insufficient Capital (%) 42 29 47 40 40 Small / No Quota (%) 25 35 26 36 31 Insufficient Labour (%) 21 21 18 12 18 Lack of Farm Inputs (%) 12 15 9 12 12 No. of Farmers by Estate Size 24 34 34 33 Source: Mkandawire, Jaffee and Bertoli (1990). * Note: The Table is based on a sample size of 125 farmers. - 43 - TABLE 7: TOTAL DEPOSITS AND LIABILITIES OF POSB, 1980 TO 1990 (Million Kwacha) 1980 1981 1982 1982 1983 1984 1985 1986 1987 1988 1989 1990 Deposits 20.6 24.3 30.2 30.2 41.4 65.2 55.8 62.2 -89.4 135.0 139.4 138.1 Liabilities 22.4 25.8 32.1 32.1 48.9 26.1 61.8 76.2 104.1 N/A N/A 157.0 Source Reserve Bank of Malawi Note The Liabilities figures for 1988 and 1989 were not available from the data set. Data for years subsequent to 1990 not available. TOTAL DEPOSITS AND LIABILITIES OF POSB Million Kwacha 160- 140-, 120- 100 - 80- 40-1 20- 1880 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 0 Deposits E Liabilities -44- TABLE 8: TOTAL DOMESTIC RESOURCE MOBILIZATION BY THE FINANCIAL SYSTEM (Million Kwacha) 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 Com. Banks 166.0 209.9 237.5 246.3 330.9 326.5 405.8 545.3 628.8 665.4 807.7 941.7 1103.4 Leasing 1.4 1.6 1.7 1.9 2.1 1.5 0.0 7.6 20.8- 36.4 48.9 75.8 105.6 POSB 20.6 24.3 30.2 41.4 65.2 55.8 62.2 89.4 135.0 139.4 140.0 140.0 140.0 NBS 8.0 11.1 13.8 15.5 20.1 25.3 28.8 39.5 58.1 69.5 79.0 131.6 187.4 TOTAL 196.0 246.9 283.2 305.1 418.3 409.1 496.8 681.8 842.7 910.7 1075.6 1289.1 1536.4 Growth 26.0% 14.7% 7.7% 37.1% -2.2% 21.4% 37.2% 23.6% 8.1% 18.1% 19.8% 19.2% Source: Reserve Bank of Malawi, Annual Reports. Note: Data for LFC is for August each year, which understates the deposits in this category. Information for POSB for 1985, 1988 and 1989 is based on Mission Estimates. TOTAL DOMESTIC RESOURCE MOBILIZED BY THE FINANCIAL SYSTEM Million Kwacha 1600- 1400- 1200 - 10001- 600--* 400-- 200- 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 -45 - TABLE 9: REAL INTEREST RATES, 1979 - 1993 (Percentages, end of period) INSTITUTION / TYPE OF ACCT. 1979 1982 1983 1984 1985 1986 1989 1990 1991 1992 1993 COMMERCIAL BANKS Lending (Maximum) 7.20 4.30 2.30 0.30 4.60 5.60 7.30 8.50 8.80 3.81 5.99 Savings 0.21 -0.50 -0.70 -2.50 -2.70 -1.70 -5.00 -0.50 1.80 -2.68 0.32 Time Deposits 4.10 1.30 1.10 -0.80 0.40 1.40 -2.50 2.00 1.60 -3.08 0.93 (12-23 Months) POST OFFICE SAVINGS BANK 2.10 -0.50 -0.70 -2.50 -2.70 -1.70 -4.95 0.50 -0.50 -5.92 -6.15 BUILDING SOCIETY Minimum Mortgage 8.80 -5.90 5.60 3.60 3.50 4.50 1.95 1.25 1.05 -8.56 -3.11 Fixed Deposits 3.60 0.90 0.70 -1.20 -0.50 0.50 2.45 2.05 2.30 -3.08 0.73 (6-11 Months) Investment Deposits 4.10 1.30 1.10 -0.80 -0.90 0.10 -2.95 1.50 1.80 -4.70 -0.89 Local Registered Stock - 3.40 3.20 1.20 1.10 3.60 4.05 8.25 8.60 -6.33 -2.10 Memorandum Item: Change in implicit GDP deflator 4.50 9.30 11.50 13.60 13.80 12.70 23.36 12.79 26.20 Somme: Reserve Bank of Malawi, Financial and Economic Review, Vol. XVIII; No. 4, 1988 and INF International Financial Statistics, Various Issues, Mission estimates. ** Data for 1989, 1990 and 1991 assume domestic inflation rates of 15.7, 11.5 and 11.2 % (2nd quarter) respectively. - 46 - TABLE 10: MALAWI INTEREST RATES STRUCTURE INSTITUTION / TYPE OF ACCOUNT 1985 1986 1987 1988 1989 1990 1991 1992* 1993** Bank Rate (Prime Rate) 11.00 11.00 14.00 11.00 11.00 14.00 14.00 20.00 25.00 Maximum Treasury Bills (91 Days) 12.75 12.75 15.75 15.75 15.75 11.50 11.50 12.50 16.50 COMMERCIAL BANKS Savings Deposits 10.75 10.75 13.75 10.75 10.75 12.00 13.00 20.00 24.00 7 Days call 3.00 10.00 15.00 30 Days call 11.50 11.50 14.50 8.75 8.75 6.00 6.00 13.00 18.00 Fixed Deposits 3 Months 12.75 12.75 15.75 12.75 12.75 13.00 12.25 19.25 24.25 6 Months 13.25 13.25 16.25 13.00 13.00 13.25 12.50 19.50 24.50 12 Months 14.25 14.25 17.25 13.25 13.25 13.50 12.75 19.75 24.75 Up to K250,000 12.75 19.75 24.75 Over K250,000 13.00 20.00 25.00 24 Months Up to KS00,000 13.25 18.00 22.00 Over K500,000 13.50 18.00 22.00 Lending Rates Minimum Lending Rate 16.00 16.00 17.00 16.00 18.00 15.00 14.00 21.00 26.00 Maximum Lending Rate 19.00 '19.00 23.00 23.00 23.00 20.00 20.00 28.00 31.00 NEW BUILDING SOCIETY Fixed Deposits (Deposits accepted between KIOO-K3Mil.) 6 Months - 12 Months 12.25 13.25 16.25 13.25 13.25 13.25 13.50 19.50 24.50 13 Months - 24 Months 12.75 14.25 17.25 13.75 13.75 13.75 14.00 18.00 22.00 25 Months - 36 Months 14.50 18.00 22.00 60 Months 14.75 Saving Deposits up to K1000 (Demand in any one day, 10.00 17.00 22.00 minimum K10 maximum KIMil.) Investment Deposits 12.25 17.50 22.50 K10 - K2Million 13.00 17.50 22.50 K5000 - 1 Month's notice 13.00 17.50 22.50 K5001 - K10,000 1 Month's notice 13.00 17.50 22.50 Over K10,000 - 6 Months notice 13.00 17.50 22.50 Leading (Buildings only) POST OFFICE SAVINGS BANK 10.75 10.75 13.75 10.75 10.75 12.00 10.75 10.75 15.00 MALAWI MUDZI FUND 15.00 15.00 15.00 INDEFUND 16.5 -21.0 SEDOM 18.00 18.00 18.00 MUSCCO 10.00 10.00 10.00 Loans to SACCOs 10.00 10.00 10.00 Short Term Loans 12.00 12.00 12.00 Development Loans 6.00 6.00 6.00 Long Term Business Loans 11.00 11.00 11.00 SACA Seasonal 12.00 15.00 18.00 Medium Term 15.00 15.00 15.00 * As of June 25, 1992 ** As of July 13, 1993 - 47 - TABLE 11 : COMMERCIAL BANK DEPOSITS (Million Kwacha) 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 Non-Residents Deposits 10.3 9.3 11.5 9.7 9.2 11.5 13.7 18.4 22.1 25.5 31.4 23.6 23.6 39.7 Demand Deposits 61.4 73.9 80.4 71.6 87.7 97.5 124.1 156.5 230.1 230.9 244.0 295.6 385.9 505.9 Time and Savings 94.3 126.7 145.6 165.0 234.0 217.5 268.0 370.4 376.6 409.0 419.1 482.2 542.9 808.3 TOTAL 166.0 209.9 237.5 246.3 330.9 326.5 405.8 545.3 628.8 665.4 694.5 801.4 952.4 1353.9 Source: Reserve Bank of Malawi, Annual Reports. TOTAL COMMERCIAL BANK DEPOSITS Million Kwacha 1400- 1200- 1000-11 800 - 600 - 400 - 0- 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 - 48 - TABLE 12: CREDIT EXTENDED IN 1988 BY INFORMAL FINANCIAL INSTITUTIONS Credit Percentage Average Credit Extended Distribution of Period Rank Lender (K Million) Credit Extended (Months) 1 Employers 79.8 28.3 5.4 2 Friends 49.2 17.5 2.0 3 Estate Owners 40.2 14.3 5.6 4 Firms 24.5 8.7 12.0 5 Relatives 23.7 8.4 2.0 6 SACAs 17.8 6.3 1.0 7 Neighbors 10.9 3.9 2.0 8 Moneylenders 9.6 3.4 2.0 9 Traders 7.2 2.6 2.0 10 Grain Millers 2.5 0.9 10.0 11 Smallholder Farmers 2.0 0.7 6.0 12 Community Funds 1.7 0.6 1.0 13 Other 12.4 4.4 3.7 TOTAL 281.5 100.0 4.6 * Source: C. Chipeta and K.L.C. Mkandawire "The Informal Financial Sector and Macroeconomic Adjustment in Malawi" 1991. Weighted average. - 49 - TABLE 13: MALAWI - FARMERS' CLUB LOANS AND REPAYMENT PERFORMANCE Million SEASON VALUE (Kwacha) % REPAYMENT 1968 /69 0.043 100.00 1969 / 70 0.125 99.78 1970 / 71 0.276 99.83 1971 / 72 0.634 99.58 1972 / 73 0.666 99.00 1973 / 74 0.796 99.83 1974 /75 1.210 98.70 1975 /76 1.483 99.26 1976 / 77 1.666 98.26 1977 / 78 2.397 97.60 1978 / 79 2.867 98.49 1979 / 80 3.572 97.46 1980 / 81 5.679 97.58 1981 /82 5.235 97.92 1982 / 83 8.337 97.19 1983 /84 11.460 97.95 1984/85 15.555 96.67 1985/86 19.065 88.59 1986/87 18.283 92.18 1987 / 88 26.871 91.00 1988/89 41.478 79.90 1989 / 90 55.996 85.90 1990 / 91 76.313 86.50 1991 / 92 86.45 22.00 1992 / 93 14339 14.00 - 50 - Bibliography Adams, Dale W. and Vogel, Robert. Rural Financial Markets in Low-Income Countries: Recent Controversies and Lessons, World Development. Vol. 14. No.4, 1986. pp. 477-487. Adams, Dale W. and Ghate, P. B. Where to From Here in Informal Finance. ADB/UNESCO. 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