A New Rural Finance Model

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

2. CONTENTS • Introduction • Theoretical Framework • Background • A New Rural Development Model • Banrural: What Went Wrong? • Strategic Alternatives • The New Model • Financiera Rural • What is Financiera Rural? • Results After Two Years of Operations • Lessons Learned and Challenges Ahead

3. INTRODUCTION T h e o r e t i c a l F r a m e w o r k Evolution of Rural Credit as Public Policy… • Government Intervention • Directed Credit • Subsidized i-rates • Debt Forgiveness • Restructurings Disappointing Results Useful, but Insufficient Macroeconomic Reforms Structural distortions & regional disparities remain in rural sector Financial Systems Approach Government as facilitator of market forces Non Interest-Rate, Targeted Subsidies Improvement in Producer & RFI Capabilities Basic premise: an efficient, well structured, regulated rural financial market facilitates economic growth and reduces poverty.

4. INTRODUCTION The History of Mexico’s Rural Credit Banks First public bank focused on agricultural development, Banco Nacional de Crédito Agrícola, S.A. On December 26, 2002, Congress passed a law authorizing the creation of a new development agency: FINANCIERA RURAL (FR). 1926 1975 2002 2003 Rural Credit Bank (Banrural) to unify existing agricultural and rural state banks. Ceased operations in 2002. July 1st  FINANCIERA RURAL started operations.

5. A New Rural Finance Model

6. BANRURAL What Went Wrong? Inefficient Operating Structure: system of 13 regional banks operating as “independent” entities Operating costs above operating income Distorting, subsidy-based first-tier operation “Unlimited” access to public funds allocated by Congress No risk-management strategies Unsustainable non-performing loan ratio No strategic planning Political pressure and moral hazard; no payment culture among customers Inadequate supervision from authorities; negative incentive structure BANKRUPTCY

7. THE CONTEXT Mexico’s Rural Sector • “Rural” refers to localities of 50,000 or less inhabitants. • 61% of extremely poor families live in rural areas.* Spacial Dispersion Poverty Covariance Risk Ethnicity Issues RURAL SECTOR CHARACTERISTICS Seasonality No Access to Financial Svcs. Migration No Integrated Prod. Chains *Data as of 2004. World Bank estimates, using the ENIGH 2002.

8. 2002 Strategic Alternatives POLITICAL CONTEXT • Corporate Governance • Restructuring / Recapitalization GOVT. BUDGET CONSTRAINTS MARKET DEVELOPMENT • New Development Agency PRESENCE OF SUSTAINABLE FINANCIAL INSTITUTIONS MARKET FORCES ALONE WERE NOT ENOUGH TO ACHIEVE THE PUBLIC POLICY OBJECTIVE OF RURAL DEVELOPMENT

9. REDIRECTING STRATEGY A New Rural Development Model Poverty Reduction Through Self-Sustainable Institutions Rural Development Agency with “private bank” practices Sustainable Rural Financial System Credit: Emphasis on service & “down-up” approach to product design Government as a Facilitator NEW RURAL DEVELOPMENT MODEL Efficiency+Profitability+Social Development = Success Subsidies: Temporary. Only directed to improving producer & RFI capabilities No differentiated regulatory framework vs. private banks

10. What is Financiera Rural?

11. COMPARATIVE ANALYSIS Financiera Rural vs. Banrural Banrural Financiera Rural • Development bank focused on agricultural activities • Funding through “unlimited” access to loans from the Federal Government • Operated as a subsity manager, with a high ratio of non-performing loans • Inefficient cost structure; operating costs over 100% of operating income • Defficient risk management • New Development Agency focused on rural productive projects • Legally banned from taking deposits, loans or market funding. Must maintain endowment value over time to sustain operations • Operates with credit processes that apply international best practices. Has spread payment culture among clients • Efficient cost structure • Best risk management practices * The Mexican Government received a USD 505 million IBRD loan for the creation of Financiera Rural.

12. FINANCIERA RURAL Mission and Vision Agriculture Forestry Structural Transformation of Rural Credit Supports any productive activity in the rural area Fishing Productivity Tourism Commerce FR MEXICAN GOVERNMENT Financial Resources Supports the creation and consolidation of Rural Financial Institutions Creation of a Rural Financial System Training and Advisory Services Quality of Life Technical Assistance * “Rural” refers to locations with up to 50,000 inhab.

13. FINANCIERA RURAL Objectives • Grant credit to rural producers, directly[1] or organized in informal credit organizations, as well as rural financial intermediaries, through: • Products, programs and services designed to suit the specific needs of the rural sector • The use of commercial bank branches for the dispersion of funds and the reception of payments • Promote the creation, development, strenthening and organization of Rural Financial Intermediaries (RFIs), providing training, advisory and technical assistance services • Provide training, advisory services and technical assistance to producers for the better use of credit [1] Even thouth currently Financiera Rural operates in the first tier, as well as the second, in the long term it expects to serve only as a second-tier lending institution.

14. FINANCIERA RURAL Geographical Distribution • Six Regional Coordinating Areas • 96 Local Agencies (Branches) • Corporate Offices in Mexico City

15. FINANCIERA RURAL Decision-Making Processes • 12 Members of the Board, Incluiding the Ministries of Finance and Agriculture, the Central Bank and several Agricultural Organizations. • Organizational Structure with 6 Operational Units, 6 Regional Heads and an independent Risk Management Unit; all report to the CEO. CREDIT COMMITTEE • Top Management • Independent Members • Central Bank • Ministry of Finance RISK MGMT. COMMITTEE OPERATIONS COMMITTEE

16. FINANCIERA RURAL An Integral Model RURAL DEVELOPMENT AGENCY Initial Endowment of USD 1.72 billion** Technical assistance for credit enhancement and the creation of RFIs USD1,534 Mill. Credit* USD 79 Mill. pre-operating expenses USD 49 Mill. Technical Assistance Credit Supervised Rural Financial Intermediaries Informal Rural Credit Institutions Individual Rural Producers *Of the initial USD 1.6 billion, USD 46 million could be used for the acquisition of Banrural assets (other than loans). ** Provided by Congress.

17. FINANCIERA RURAL Second-Tier Customer Base • Rural Financial Intermediaries • Credit Unions (Uniones de Crédito) • Financial Cooperative Associations (Sociedades Financieras Populares*). • Thrift Cooperatives (Sociedades Cooperativas de Ahorro y Préstamo*). • Depository Warehouses (Almacenes Generales de Depósito). • Other Organizations • Agribusinesses • Non-regulated financial intermediaries • Microfinance organizations • Local producer organizations *Governed by the new law for popular savings and loans (Ley de Ahorro y Crédito Popular)

18. FINANCIERA RURAL Loan Pricing RISK MARGIN OPERATING COST Interest Rate Components Average: Cetes + 5 pp INFLATION

19. FINANCIERA RURAL Credit Enhancement Commercialization Of the Product Conception of the Project FR C R E D I T • Before Granting • Credit • Business and • Market Plans Specialized Technical Assistance and Training CREDIT ACCOMPANIMENT *Payment of 70% of the service cost, with an upper limit of USD 3,300 per item. Total support up to USD 19,600.

20. FINANCIERA RURAL The Road to Intermediation FR’s Credit and Technical Assistance to Develop Institutional Capabilities Individual Producers Supervised Rural Financial Intermediaries Z A Unsupervised Credit Organizations Establishment Sustainable Development

21. FINANCIERA RURAL Main Achievements After Two Years of Operations

22. TOTAL CREDIT USD Million --------Financiera Rural--------- ---Banrural------- Avg. 2001-2002 2003 2004 2005p/ Source: Financiera Rural. p/Programmed

23. OPERATING COSTS / NET LOAN PORT. 45 7.5 Banrural 2002 FR Oct 2005 % MAIN INDICATORS Financiera Rural vs. Banrural NON-PERFORMING LOAN RATIO NET INTEREST MARGIN 48.0 9.42 % % 2.6 -1.67 Banrural 2002 FR Oct 2005 Banrural 2002 FR Oct 2005 EFFICIENCY RATIO* 623 % 96 45 Banrural 2002 FR Oct 2005 *Operating Costs / Operating Income (Margin + Commissions + Trading Net Income before training and technical assistance to RFIs and Repomo on non-loanable assets.

24. PROFITABILITY Financiera Rural vs. Banrural RETURN ON EQUITY % Banrural 2002 Banrural June 2003 0% 3.5 FR 2004 FR 2005e -32.8 -97.6 206 96 e/ Expected

25. CREDIT EVOLUTION 2 0 0 4 - 2 0 0 5 Nr. OF CREDITS CREDIT AMOUNT 7.8% 8.9% 163,878 902 USD Million Number of Credits 150,485 837 2004 2005 OCT 2004 2005 OCT CREDIT THROUGH RFIs 62% 118 USD Million 73 96 2004 2005 OCT

26. CREDIT 2 0 0 4 - 2 0 0 5 LOAN RECOVERIES LOAN PORTFOLIO 37.6% 60.9% 947 740 USD Million 688 460 2004 2005 OCT 2004 2005 OCT • Financiera Rural’s credit has reached 15% of total financing to Mexico’s rural sector, using its own resources and applying its own interest rate policies. • Most credits have benefited producers with anual income below 140,000 pesos (USD 13,084). • Over 387,000 producers have benefited directly from loans that average 62,000 pesos (USD 5,794). 2.9% 96 2.6%

27. STRUCTURE Comparative Efficiency PERSONNEL OPERATING COSTS 69% 73% Number of Employees 3,459 293 USD Million 1,061 79 BANRURAL FINANCIERA RURAL BANRURAL 2002 FINANCIERA RURAL 2005 OFFICES 206 6 96 12 Regional Centers Banks Branches Agencies BANRURAL FINANCIERA RURAL

28. CONFERENCES AND SEMINARS 339 183 34 2003 2004 2005 OCT TRAINING Specialized Technical Assistance TRAINING COURSES TRAINED PRODUCERS Nr. Of Courses 46,111 46,481 Nr. Of Producers 1,242 1,371 13,650 368 2003 2004 2005 OCT 2003 2004 2005 OCT PARTICIPATING PRODUCERS Nr. Of Producers Nr. Of Conferences 95,881 39,395 10,283 2003 2004 2005

29. TRAINING Creating a Rural Financial System SUPPORTED ENTITIES IN TRANSITION TO BECOMING FORMAL RFIs Nr.of Institutions 138 00 47 NUMBER OF “SUPPORTS” GRANTED 2004 2005 OCT 151 Nr. Of Supports 53 2004 2005 OCT

30. Lessons Learned and Challenges Ahead

31. LESSONS LEARNED A New Rural Development Model • Macroeconomic reforms, although necessary, have not been enough to correct existing disparities and market imperfections in rural areas. • A new approach to rural development is based on an “integral” vision that goes to the micro-level using a “down-up” approach to ensure the success of entire production chains. • Unsuccessful past Government experiences which targeted rural credit development through directed, subsidized credit are being replaced with a new model, where: • The Government acts only as a facilitator for market forces to operate efficiently. • Subsidies are used only to build producer capabilities and to support the creation of financial intermediaries. • Government development institutions have to be profitable in order to ultimately reduce poverty.

32. CHALLENGES AHEAD Sustainable Growth of Financiera Rural • Continue to strengthen the rural financial system in order to gradually pull out of the first-tier. • Maintain the value of FR’s endowment over time, through self-sufficient operations. • Tailor FR’s programs and products to a dynamic rural sector. • Differentiate interest rates based on tier and risk level of clients. • Diversify client base into non-agricultural activities. • Improve human resource management. • Foster the relationship and coordination with other government entities and international institutions. • Find alternative liquidity sources (loan securitization).

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