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Rural Financial Institutions - Issues

Rural Financial Institutions - Issues. How to ensure the recovery with those borrowers who cannot offer tangible collateral? How to ensure that large number of borrowers can access financial services? How to provide a mechanism for screening out bad borrowers/projects?.

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Rural Financial Institutions - Issues

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  1. Rural Financial Institutions - Issues • How to ensure the recovery with those borrowers who cannot offer tangible collateral? • How to ensure that large number of borrowers can access financial services? • How to provide a mechanism for screening out bad borrowers/projects?

  2. Features of Credit Transaction • Credit is a pure service transaction between two time points • It is not a spot transaction • There is time gap to complete the transaction • Because of the time lag, the lender has to confront several risks

  3. Lenders’ Risks associated with Credit Transaction • Risks involved in the economic activity being supported by credit • The borrower himself may engage into opportunistic behavior vis-à-vis lender • Risks due to imperfect information about the borrower and the range of his activities • Practical difficulty in monitoring and enforcement of credit contracts.

  4. Features of the Credit Market • Since credit involves interpersonal trust between borrower and lender, it must involve some collateral • Credit cannot stand alone – it must be accompanied by credit complementary activities • Since tangible collaterals are not always available, credit often involves interlinking with markets for inputs and outputs.

  5. Interlinked Credit Transactions • When more than one transactions take place • Between the same two parties of exchange process • Within a given period of time • Terms of such trades are jointly determined rather than independent determination

  6. Forms of Interlinked Rural Transactions • Credit and tenancy • Credit and labor • Credit and sale of output • Credit and purchase of inputs “Credit market tends to interlink with other markets including land, labor, output and input”

  7. Reasons for Interlinked Credit Transactions • Mode of exploitation of the borrower • Imperfect land, labor, credit, output and input market in rural areas • To reduce the risk of default • Mechanism to control the borrower • Voluntary participation of both parties in interlinked credit transactions

  8. Interlinked Credit Transactions and Implicit Interest Rate • Forward purchase of Inputs • Thus, implicit interest rate in this case can be calculated as: • Implicit Interest 1 = 100 (PAB – PMP) * QPB --------------------------------- VL • PAB = Actual input price charged to the borrower; • PMP = Prevailing market price of input at the time of purchase; • QPB = Quantity of input bought by the borrower; and • VL = Value of loan made

  9. Forward sale of output • Implicit interest depends on - the difference between actual price paid and the prevailing market price - the quantity of paddy sold - the variation in the price of paddy between when the loan is made and when the paddy is sold.

  10. Month Price (Rs. Per Quintal) • April-May 205 • May-June 210 • June-July 215 • July-August 220 • August-September 210 • September-October 200 • October-November 170 • November-December 160 • December-January 170 • January-February 180 • February-March 190 • March-April 200

  11. Implicit interest rate in this case can be calculated as: • Implicit interest 2 = (PMS – PRB) * QPS/PMS ----------------------------------- * 100 VL/PML • PMS = prevailing market price of paddy at the time of sale; • PRB = actual price received by borrower at the time of sale; • QPS = quantity of paddy sold; • PMS = prevailing market price when the paddy is being sold; • VL = value of the loan; and • PML = prevailing market price of paddy when the loan is being made

  12. Forward sale of labor services • implicit interest in this case can be calculated as: • Implicit interest 3 = (WMS – WAB) * QLS/PMLB ---------------------------------------- * 100 VL/PML • WMS = prevailing market wage rate at the time of sale of labor; • WAB = actual wage rate received by borrower; • QLS = quantity of labor services sold by the borrower; • PMLB = prevailing market price of paddy at the time of sale of labor services; • VL = value of loan • PML = prevailing market price of paddy when the loan is being made

  13. Credit and tenancy • Implicit interest 4 = 50 per cent (AYRP – AVGP) * AL -------------------------------------------- * 100 VL/PML • AYRP = actual yield rate of paddy on borrower’s (tenant) land; • AVGP = average yield rate of paddy • AL = amount of leased-in land • VL = value of loan; • PML = prevailing market price of paddy at the time of loan.

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