Transformation and Rural Finance

Abstract:     
In the process of transformation from a centrally-planned to a market-orientated economy, the domestic financial sector plays two important roles. First, the financial sector itself has to be fundamentally restructured, and second, its efficient functioning is a crucial precondition for the necessary economic transformation. During the central-planning era, the financial sector typically carried out fiscal functions, namely it distributed subsidies and supported production plans. In a market-orientated economy, this fiscal function of the financial sector has to be altered to one of financial intermediation, in which the financial intermediaries mobilize, and efficiently allocate, capital. This includes the selection and monitoring of investment projects. In addition to the more general set of problems associated with macro-economic instability, which slows down the development of the financial market overall, rural financial institution-building faces specific obstacles. These obstacles include difficulties relating to the provision of credit collateral due to an unclear land property situation; the relatively high transaction costs related to supplying financial services to small enterprises, the still prevalent misuse of the financial sector to supply subsidies to bankrupt state enterprises and the related poor financial discipline and credit repayment behaviour. The consequence is the development of weak financial intermediaries with large portfolios of non-performing loans. Also, these intermediaries fail to address the medium- and long-term credit demand of private enterprises for capital investments. At the macro-economic level, reforms and innovations are necessary to foster economic stability and public confidence in the reliability and efficiency of the domestic financial sector. This includes the establishment of an independent central bank and effective internal and external mechanisms for the control of banking operations. At the level of the financial intermediaries, the restructuring of the organization and its management and the adoption of innovative financial instruments are necessary in order to increase the efficiency of financial intermediation. More efficient financial intermediation will allow the needs of cost-intensive market segments formerly ignored by commercial banks, such as the rural clientele, to be addressed.

Number of Pages in PDF File: 21

JEL Classification: E20, E44, P34

working papers series