Philippines - Rural Finance Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 9563-PH STAFF APPRAISAL REPORT PHILIPPINES RURAL FINANCE PROJECT MAY 30, 1991 Agriculture Operations Division Country Department II Asia Regional Office This document has a restricted distribution and may be used by recipients only in the perfonnance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit - Peso (P) The following exchange rates for US$1.00 are used: 1988 (average) - P 21.095 of 1989 (average) P21.737 of June 30, 1990 P23.27 As of November 1. 1990 P 28.00 ACRONYMS ACPC Agricultural Credit Policy Council ALF Agricultural Loan Fund CALF Comprehensive Agricultural Loan Fund CBP Central Bank of the Philippines CLF Countryside Loan Fund DA Department of Agriculture DBP Development Bank of the Philippines DENR Department of Environment and Natural Resources DOF Department of Finance FIs Financial Intermediaries FSAL Financial Sector Adjustment Loan GOP Government of the Philippines GRT Gross Receipts Tax IRFP Integrated Rural Financing Program IGs Insurance/Guarantee Institutions LBP Land Bank of the Philippines M-99 Masagana 99 Agricultural Credit Program NGO Non-Government Organization NEDA National Economic and Development Authority P Peso PCIC Philippine Crop Insurance Corporation PDIC Philippine Deposit Insurance Corporation PFI Participating Financial Institution QGFB Quedan Guarantee Fund Board RBs Rural Banks RBRP Rural Banks Rehabilitation Program SRTF Special Revolving Trust Fund WAIR Weighted Average Interest Rate (of time deposit up to 180 days) FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY PHILIPPINES RURAL FINANCE PROJECT Loan and Proiect Summarv Borrower: Land Bank of the Philippines Guarantor: Republic of the Phi'ippines Beneficiaries: Accredited financial institutions. Amount: US$150 million equivalent Terms: The Bank Loan would be for 20 years, including 5 years of grace at the standard variable interest rate. Re-lending Terms: The Land Bank of the Philippines (LBP) would relend the proceeds of the Bank loan to accredited Participating Financial Institutions (PFIs) in domestic currency at the prevailing market rate. Maturity would conform to the maturities of sub-loans made by the PFIs to sub-borrowers, but would not exceed 15 years. The foreign exchange risk would be borne by the Government in exchange for a market related fee payable by LBP. PFIs would be given a choice of a fixed rate for several years or a variable interest rate periodically adjusted. PFIs would onlend the proceeds to their sub-borrowers at prevailing market interest rates. Project DescriDtion: The objective of the proposed Rural Finance Project would be to enhance the policy framework governing the rural financial sector, in order to provide more efficient and active credit support to the rural areas of the Philippines. The project would complement, and is consistent with the objectives sought under the ongoing Financial Sector Adjustment Loan (FSAL, Loan No. 3049-PH). More specifically, the proposed operation would: (a) provide investment and seasonal production credit to support private agricultural/rural investments to increase production, incomes, and employment, thereby helping to alleviate rural poverty; (b) induce financial Institutions to attend the credit needs of the rural areas more efficiently, and to facilitate better access to commercial, saving, and rural banks in rural areas; and (c) enhance the access of rural borrowers to formal credit sources. The project would provide a second stage of support to the Agricultural Loan Fund (ALF) rediscounting facility. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - Enhancing the operations of financial institutions in rural areas would be achieved through further liberalization of banking policies concerning opening new branches in rural areas, merging of banks in rural areas, adjusting -urrent limit on maximum shareholding by single investors in a distressed rural bank to enable the mobilization of the additional required capital, and inducing banks in good standing to invest in rural banks with an equity deficiency. Enhancing farmer access to formal credit sources would be carried out through the strengthening of two existing insurance/guarantee institutions (PCIC and QGFB), to provide banks and farmers with adequate services at market irices; training of cooperative staff to upgrade their capability to perform financial intermediary functions for their members; and designing and implementing pilot/experimental projects to develop new and efficient credit delivery systems and technical assistance to rural areas. The project would be implemented over a five-year period. -zad Risks: The proposed project would facilitate private agricultural/ rural sector investments, foster policy measures to induce financial institutions to provide credit facilities to the rural areas and to facilitate better access of rural bor- rowers to formal credit sources. The Bank loan would help to finance about 2,200 investment sub-projects, at an estimated total cost including sub-borrowers' equity of about US$200 million. These sub-projects are expected to generate incremental direct employment for 25,000 people, and an increase in gross value added of about US$40 million annually. Since the precise mix of the project lending program would depend on market forces, the quantification of an aggregate economic impact is not possible. The main risks associated with this type of program concern possible delays and/or inadequate implementation. The principal risk is that implementation of agreed policy measures, wt-.d be thwarted or delayed because of budgetary constraints or political considerations, which are likely to become increasingly important over the coming election period. However, a gradual and realistic implementation process has been agreed upon and would be formalized through dated covenants to be included in the project legal documents. With respect to the credit component, the volume of demand for CLF resources will certainly depend on the overall performance of the economy, but this is not considered a major risk as such demand during the project period has been projected conservatively and is well within the historical performance record of ALF.  - Iiii- Estimatgd Cost: Loca ForeLg Togtal (USS million) Short-Term Credit 40.0 26.7 66.7 Medium- and Long-Term Credit 80.0 53.3 133.3 Training and Studies 2.6 D.Q..2 3.5 Total 122.6 80.9 203.5 FinancEng PlAn: Sub-loan beneficiaries 30.0 30.0 PFIs 20.0 - 20.0 LBP 2.5 0.9 3.4 ACPC 0.1 0.1 IBRD 70.0 800150.0 Total 122.6 80.9 203.5 Estimated Disbursements: IBRD FY 92 93 94 95 96 97 - -(US$ million) - Annual 36 27 27 27 18 15 Cumulative 36 63 90 117 135 150 Rate of Return: N.A.  I-a 44  - v - PlHILIPPINE RURAL FINANCE PROJECT Table of Contents P No. LOAN AND PROJECT SUMMARY i I. THE ECONOMY . . . . . ...................... Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Agriculture and the Economy .... . . . . . . . . . . . . . . . . 3 II. THE RURAL FINANCIAL SECTOR . . . . . . . . . . . . . . . . . . . . . 5 Overview .... . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Policy and Institutional Reform ... . . . . . . . . . . . . . . . 7 The Rural Banking System .... . . . . . . . . . . . . . . . . . . 8 Rural Financial Guarantee and Insurance Programs . . . . . . . . . . 11 The Borrower: Land Bank of the Philippines . . . . . . . . . . . . 3 Bank Sector Assistance Strategy .... . . . . . . . . . . . . . . 15 III. THE PROJECT .... . . . . . . . . . . . . . . . . . . . . . . . . 18 Project Objectives and Description ... . . . . . . . . . . . . . . 18 Detailed Features .... . . . . . . . . . . . . . . . . . . . . . 19 Project Cost and Financing .... . . . . . . . . . . . . . . . . . 23 Procurement.. . ... ... 24 Disbursement .25 Monitoring, Reporting and Audits .26 IV. PROJECT IMPLEMENTATION .26 General .26 Credit Operation .27 Other Project Components . . . . . . . . . . . . . . . . . . . . . . 33 This report is based on the findings of a pre-appraisal mission, comprising Messrs. A. Chupak (mission leader) and Y. Goldschmidt, P. Harrison and J. Nogales (Consultants) who visited the Philippines in October/November 1990; and an appraisal mission comprising Messrs. A. Chupak and J. Nogales who visited the Philippines in February-March 1991. Task Manager, A. Chupak; Peer Reviewers, Messrs. Z. Hasan (AS2IE) and J. Yaron (AGRAP). Document clearance was provided by Ms. D.M. Dowsett-Coirolo, Chief, AS2AG and Mr. G.S. Kaji, Director, AS2.  - vi - Rage No. V. PROJECT IMPACT. A912115 AM hISK . . . . . . . . . . . . . . . . . 34 LBP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Risks .............................. . 37 VI. AGREEMENTS AND RECOMMENDATION .37 4NNEXES Annex 1.1 Estimated Capital Requirements for Development of the Agricultural Sector. . . . . . . . . . . . . 40 Annex 2.1 Land Bank of the Philippines Operation and Performance. . . . . 45 Annex 2.2 LBP Lending to Rural Cooperatives . . . . . . . . . . . . . . . 67 Annex 2.3 Nature of Sub-loans Supported Under ALF, 1985-89. . . . . . . . 78 Annex 3.1 ALF/CLF Cash-flow Projections .83 Annex 3.2 Eligibility Criteria for Cooperatives Under ALF/CLF . . . . . . 88 Annex 3.3 Project Training Program. . . . . . . . . . . . . . . . . . . . 89 Annex 3.4 Disbursement Schedule . . . . . . . . . . . . . . . . . . . . . 93 Annex 3.5 Supervision Plan. . . . . . . . . . . . . . . . . . . . . . . . 94 Annex 4.1 CBP's Loan Classification System. . . . . . . . . . . . . . . . 97 Annex 5.1 LBP Financial Projection. . . . . . . . . . . . . . . . . . . . 99 Annex 7.1 Documents in the Project File . . . . . . . . . . . . . . . . . 107 Map: IBRD No. 22431  ZTHLIPIENES STAFF APPRAISAL REPORT RURAL FINARICE PROJECT I. THE ECONOMY Overview 1.1 Located in Southeast Asia, the Philippines is an archipelago of about 7,107 islands, the largest of wbich (Luzon and MHndanao) account for two-thirds of the country's area of about 300,000 km2. With a total population of about 60 million at the end of the 1980s, the Philippines has a higher demographic density than Indonesia, Malaysia and Thailand. In the 1950s, the Philippines had one of the greater per capita incomes in Asia. After growing at an average rate of 8% per annum during 1950-56, the Philippine economy slowed to 5% p.a. during 1957- 72. Real GNP then grew at a slightly higher rate of 6.8% p.a. during 1973-79, but decelerated again during 1980-83, and turned negative during 1984-85. 1.2 The economic history of the country has been marked by intermittent balance of payments crises. Deteriorating external terms of trade certainly played a role.11 However, the extent of government intervention in the economy was an even greater factor, resulting at times in serious misallocation and underutilization of scarce capital and foreign exchange resources. The growth in manufacturing productivity, for example, which had been marginally positive in the 1960s, turned negative during the 1970s, as resources were allocated towards relatively poor performers. The growth of agricultural productivity accelerated during the 1970s compared to the previous decade, but this was largely confined to rice and, to a much lesser extent, corn; productivity of sugar and coconuts, on the other hand, largely stagnated over the two decades. Irregular and poor productivity improvements and the chronic foreign exchange constraint, gave rise to the "stop-and-go" nature of Philippines' exports and economic growth through the mid-1980s. 1.3 In a majoi break with past policies, since 1986 the current Government has made greater efforts to enhance economic performance by allowing market mechanisms to improve the quality of resource allocation. Viewed against the backdrop of the deep recession of 1983-85, the achievements of the Philippine economy in 1987-89 have been particularly impressive. In 1984, the worst year of the recession, GDP declined by 6%, investment plunged by 43%, the external debt rose by 8% of GNP, and inflation soared to 50%. The recession was espe- cially hard on the poc:: a survey of household incomes showed that 59% of Philippine families (about 32 million people) subsisted on i.Lcomes below the poverty line in 1985. During 1987-89, however, the economy recovered across a broad front. GDP grew steadily; both consumption and investment rose 1/ World commodity prices were more volatile in the 1970s than during the previous two decades. The oil price hikes raised the share of the oil import bill from less than 11% before 1974 to around 25% during 1980-82. Finally, world real interest rates rose sharply during the early 1980s, raising the debt service burden of the country.  - 2 - significantly; and inflation was kept at single-digit levels. The current account deficit, the fiscal deficit and the external debt were reduced relative to earlier levels. Macroeconomic management by the Government was distinguished by a prudent fiscal stance, conservative monetary growth, and actions to reduce the external debt. Fiscal discipline helped to generate surpluses in the primary balance of the Government, which improved from a 1.5% deficit in 1986 to a 2.1% surplus in 1988. This, together with tight monetary policy, kept inflation at an average of 4.5% p.a.. Responsible external debt management initiatives in the form of commercial and Paris Club reschedulings and debt-equity swaps, postponed the bulk of repayments to after 1992 and retired about $1.6 billion of foreign debt, contributing to an aggregate debt reduction equivalent to about 17% of GDP (i.e., a decrease from 92% to 75% by the end of 1988). From a comparative standpoint, among highly-indebted countries, the adjustment performance of the Philippines ranks near the top. Its growth has been relatively stable; the fiscal adjustment has been deeper and more consistent; inflation lower and less volatile; and external debt reduction faster. 1.4 Macroeconomic performance since the end of 1988 has, however, been more disappointing. The consolidated fiscal deficit rose from 3.1% of GDP in 1988 to 4% in 1989, and 5.2% of GDP in 1990. The interesi: rate on the benchmark financial asset--the Treasury Bill--has averaged arcund 10% in real terms, or 23% in nominal terms. The current account deficit rose from 1% of GDP in 1988 to 3.3% in 1989, and has since risen to almost 5% of GDP. These trends have been accompanied by a slowdown in growth from 6.2% in 1988 to only 2.5% in 1990, and an increase in inflation from just under 9% in 1988 to around 13% currently. Table 7.1: Econaic Growth Rates in the Philippines (1987-89) (Annual Percentage Changes) SectorL Ite 1967 1968 1989 1990 Agriculture -1.0 3.5 4.0 2.2 Industrv 7.8 8.5 7.1 1.9 Mining -1.7 4.4 -2.7 2.5 Manufacturing 6.8 8.9 6.9 1.4 Construction 17.3 9.5 12.0 4.2 Utilities 10.7 4.6 7.1 3.2 Services 6.6 6.3 6.4 3.3 GOP 4.7 6.2 6.0 2.5 GNP 5.9 6.6 5.6 3.1 Personal Consumption 5.7 6.0 5.6 6.2 Government Consumption 7.2 7.2 7.7 3.7 Investment 34.1 17.5 15.6 -0.4 Govermient Construction 6.0 0.4 6.7 -1.1 Private Constrirtion 21.4 11.8 14.0 8.5 Durable Equipment 24.5 24.1 15.6 14.2 SOJRCE: NEDA, report on the Performance of the 'hilippine Economy for 1990. 1.5 A major source of macroeconomic distress in recent years has been the sharp increase in domestic debt, from 19% of GDP in 1985 to around 25.6% in 1989. Despite significant fiscal adjustment, domestic debt increased as access to  - 3 - external finance waz limited, the public revenue system yielded low returns, and pressing infrastructure and poverty problems required constant if not rising expenditures. Domestic interest rates have risen sharply, intensifying fiscal pressures and making macroecono,nic management considerably more difficult. An escalating sequence has been established linking rising interest rates to rising fiscal deficits and borrowing requirements. 1.6 Exchange rate developments have also affected macroeconomic perfor- mance. During 1989, the real effective exchange rate apprecia'ad relative to competitor countries such as Indonesia, Thailana, and Malaysia, a:.d major trading partners like Japan and the US. The current account deficit has risen, as export growth slowed while import growth remained relatively high. The Philippines has lost market shares in the developed countries. The deteriorating current account deficit raised expectations of devaluation, which in turn were built into the interest rate structure, thereby further aggravating fiscal imbalances. These developments prompted a more rapid depreciation of the nominal exchange rate in recent months which, if supported with fiscal and wage restraint, should improve external competitiveness. 1.7 Macroeconomic performance has also been adversely affected by a series of unexpected exogenous shocks. A prolonged drought lasting over the winter and spring months of 1989-90 substantially reduced crop output: the value added of agricultural crops declined by 1.1% during 1990, although combined sectoral output increased by 2.2% due to the contribution of the livestock, poultry and fisheries sub-sectors. The drought was also partly responsible for power shortages, that in turn cut growth in industrial output to 1.9%, from 7.1% registered in 1989. The major earthquake in July 1990 caused considerable economic damage in Luzon, and turmoil in the Middle East Gulf War caused the price of oil to jump by almost 50% during the last months of 1990, increasing the current account deficit: for the year to over 5% of GDP. As a result of all these factors, GDP growth registered a meager 2.5% in 1990 compared to 6% in 1989 and 6.2% in 1988. Agriculture and the Economy 1.8 General. The agricultural seb.tor is critical to the Philippine economy. In 1989, it accounted for about one-fourth of both GDP and exports, and about half of the employed labor force. Growth averaged 4% p.a. between 1970 and 1982, when a major economic recession commenced. Droughts in 1983 and 1987 resulted in negative growth of 2% and 1%, respectively, in those years. Nonetheless, because of improved sectoral policies and more favorable weather conditions in 1988 and 1989, recovery was significant (3.4% growth in 1988 and 4.3% in 1989). The good performance of the 1970s was facilitated by high international prices for agricultural commodities, large investments in irrigation, the introduction of high-yielding rice varieties and increased use of fertilizers, all of which helped to outweigh policy biases at the time against agriculture (including an overvalued exchange rate, export taxes, price controls, trading bans and heavy protection for industrial goods). The 1980's have witnessed an important diversification of agricultural production: while non-  - 4 - traditional crops occupy only 14% of cultivated land, they now account for 45% of total gross value added in the crop sub-sector. However, recent growth in crop production has again been based on traditional products, mainly rice and corn, rather than upon non-traditional products, which are more capital-inte.asive and require substantial investment credit. Improved institutional financial arrangements and an increased volume of credit will be essential to further the diversification process. 1.9 Historically, high growth rates in agricultural crop output occurred mainly during or immediately after a Peso devaluation (1961/62 and 1970/73) and/or world commodity price increases (1974/76-1980). Periods of low growth of crop output appear to have been associated with low world commodity prices, bad weather and intercrop substitution under tight land constraints. Average real growth of gross value added of the four main crops during 1973-84 were around 3.7% p. a. for rice, 3.4% for corn, 3.0% for sugar, and 0.1% for coconut. There has been a secular decline in the share of these four crops, from more than two- thirds of total agricultural crop value added during the late 1960s to about one-half during the early 1980s. 3.10 Philippine farms are preponderantly small: about 85% of the 3.42 million crop and livestock farms in 1980 were under 5 ha, accounting for about 50% of Lotal farm area. Only about 60% of all farms (and total farm area) are owned by the farmers themselves. Thm' inequity in the land size distribution and ownership of farms has been at the heart of the agrarian unrest in the Philippines during the post World War II period. Rice and corn farmers, the most numerous in the country, have historically been the focus of government's land tenure and ref5rm programs. 1.li In 1989, agriculture grew by 4.7% in real terms, exceeding all expectations and having its best performance since 1982. Sectoral growth was a result of sustained production increases in the livestock and poultry sub-sectors and improved performance of the crops subsector, attributable to favorable weather conditions, increased areas under cultivation, Government policies (tax and duty reductions on farm inputs, higher support prices for palay); and real increases in rural infrastructure investments, especially 'n irrigation and feeder roads. Table 1.2 shown agricultural value and volume in 1988-89: Table 1.2: Volsum and Value of Agrfcultural Production in 1988-J9. Volune Value (poo-s Tons) (million Pesos) Growth Rates (X? Real Croos: 1988 1989 1988 1989 Volume Value Price Palay 8,971 9,459 30,950 38,120 5.4 23.2 9.2 Corn 4,428 4,522 12,664 18,359 2.1 45.0 31.2 Coconut 12,482 11,810 17,350 23,620 -5.4 36.1 22.0 Sugarcane 15,567 17,591 8,406 10,203 13.0 21.4 7.4 Others 16,510 16,955 51,926 54,746 3.5 4.5 -9.5 Total 121,296 144,048 2.9 18.8 4.8 LivestEck 1,186 1,308 23,358 30,328 10.4 30.4 16.4 oUtr 654 717 20,541 22,005 9.6 7.1 -7.1 Fishery 2,270 2,367 42,118 46,592 4.4 10.6 -3.4 total 207.214 L249n 4Z ILI Li SOURCE: Bureau of Agricultural Statistics, Report dated December 28,1989.  1.12 The Crop Subsector. The crop subsector, which accounts for 59X of total sectoral output, grew by 2.9% in real terms in 1989, compared to only 0.9X in 1988. The best performance was recorded in sugarcane, coffee, palay and tobacco, which together account for 22X of sectoral output and increased in real terms at 13%, 10%, 5.4%,and 5.3%, respectively. Palay output achie-ed a record high of 9.5 million tons and prices remained nigh. Meanwhile, corn production grew slowly at 2.1%, due to poor weather in several main corn regions, while sugar production increased by 13% as a result of three continuous years of higher prices. Also, banana production recovered from its two-year drop. Coconut production, on the other hand, continued to decline for a third year, showing a 5.4% contraction in 1989. DOA development plans for the crop subsector, including perennial crops, envisage an annual growth rate of about 41 between 1990 and 1995. This implies substantial increases in input usage and investments, raising the need for incremental seasonal and term credit (Annex 1.1). The annual incremental working capital and fixed assets financing requirements for the next five years are estimated at P4.1 billion (US$168 million) and P9.2 billion (US$378 million), respectively. 1.13 Livestock and Fisheries. Livestock production has grown rapidly since 1986, reaching a growth rate of 10.4% in 1989, mainly as a result of increased internal demand, especially for pork, which accounts for three-fourths of total livestock production. Poultry has also performed quite well, showing a 9.61 growth rate in 1989. Strong pork and poultry demand has offset the impact of major corn price increases. There are also signs that producers have been able to partially substitute corn feed for rice and wheat by-products. Finally, the fisheries subsector contitnued its hearty growth trend, achieving a real rate of 4.4% in 1989. Aquaculture (prawns, seaweeds and tilapia) increased at 6.21 in 1989, commercial fisheries at 4.2% and municipal fisheries at 3.31. Five-year DOA development plans suggest continued high growth of about 9.71 for livestock and 4.5% for fisheries. The incremental working capital and fixed assets requirements to support this level of growth are estimated at P13 billion (US$464 million) and P35 billion (US$1.25 billion), respectively. II. The Rural Financial Sector Overvie 2.1 Financial services in the Philippines are provided by a network of banks and non-bank financial institutions. The banking system comprises the Central Bank of the Philippines (CBP), commercial banks (KBs), thrift banks (TBs)21, rural banks (RBs) and specialized government banks (SGBs). Non-bank financial institutions include investment houses, insurance companies, financing companies, securities, dealers, brokers, lending investors, and pawnshops. In addition, there are a few public specialized non-bank financial institutions that 2/ Thrift Banks include private developmient banks, saving and mortgage banks, and stock savings and loan associations.  - 6 - provide guarantee and insurance services to the agricultural sector, of which the most important are the Quedan Guarantee Ftund Board (QGFB) and the Philippine Crop Insurance Corporation (PCIC). 2.2 The total assets of the financial system peaked in 1984, both in nominal and real terms, but there has since been a substantial real contraction of both financial assets and operat-ions. During 1984-89, total assets declined in real terms by about 10%, and the total loan portfolio of the banking system by 40%. As a result, three commercial banks, 147 rural banks and 32 thrift banks went out of business. In addition, the largest banks, the Philippines National Bank (PNB) and the Development Bank of the Philippines (DBP) --both government owned-- became insolvent and had to be bailed out in 1986 by transferring their non-performing assets and liabilities (about 60% and 90X, respectively, of their total assets) to an Asset Privatization Trust. The productive and financial sectors are still suffering the effects of this major contraction. 2.3 The banking system as a whole, however, has emerged stronger from the crisis, and in the last three years its profitability has improved and its solvency strengthened. The rural productive sectors are still suffering the effects, in that they have unsatisfied credit needs, particularly for long-term maturities, and this has had a depressing effect on output and productivity growth. Total outstanding credit to agriculture, fisheries and forestry through the formal financial sector, declined substantially (measured in constant 1988 Pesos) from P54.9 billion in 1983 to P25.6 billion in 1986, and to P22.7 billion in 1987. While formal credit to agriculture increased slightly to P24.1 billion in 1988 and to P28.3 billion in 1989, the last figure represents only 52% of the 1983 level. 2.4 Today most formal credit to the rural sector comes from commercial banks, which accounted for 53% of banking system credit to the sector in 1981, 47% in 1984, and 62% in 1989. Thrift banks have remained quite marginal actors in the agricultural sector, while rural banks have declined in importance to only 18% of total agricultural lending in 1989. Specialized government banks decreased their lending to the sector substantially during 1982-85, but they have since increased their rural lending slightly, from only 9% of total outstanding credit in 1985 to 12% in 1989. 2.5 Land Bank of the Philippines (LBP), the specialized government bank mandated to play a significant role in the rural sector, had by 1990 year-end an agricultural loan portfolio of about P4.4 billion or 51% of its total loan portfolio. This included P2.0 billion of mortgage loans to agrarian reform beneficiaries and 02.4 billion of production loans to small farmers and commercial agricultural loans. LBP is actively attempting to expand its small farmer lending and its disbursement to small farmers have increased dramatically from P105 million in 1987 to P343 million in 1988, P1,110 million in 1989 and 02.8 billion in 1990. 2.6 The major shortcomings of the banking system, as far as support for rural development is concerned, have been: (a) the perception that agriculture  - / 7 has much higher risks than other sectors; (b) the insistence on supporting rural loans with urban collateral or with relatively liquid commodity assets, rather than relying on project appraisal techniques; (c) limited availability of resources for medium- and long-terin investments; and (d) the weak financial condition of many rural banks. As a consequence, the participation of the banking system in rural financing has remained marginal, with the e --_