How and when to use lines of credit?

What is it and how can it help? 

Donors and other aid organizations often use lines of credit (LOCs) to assist small rural financial service providers (FSPs) in their development. However, LOCs can be more destructive than helpful and organizations should use them sparingly and with caution. This toolkit discusses the problems with LOCs and how and when they might best be used. It highlights the philosophy and rationale for using LOCs, examining the strengths, weaknesses and opportunities of different types of credit arrangements. It presents practical aspects of specific approaches, methodologies and models that have been tested and can be recommended for implementation and scaling up, including best practices and case studies.


 

When does it work best? 

Due to the volatility of LOCs, the toolkit recommends using them under the following conditions: The market demonstrates a clear lack of liquidity, as demonstrated by a rigorous market assessment; the LOC will not undermine the initiatives of other donors or private-sector partners; and loans to retail financial institutions are priced at commercial or near-commercial rates to avoid undermining their incentive to mobilize deposits or access other sources of capital.

In addition, performance-based agreements are written so that the FSPs will: use private, professional fund managers or institutions to manage the LOC (rather than the recipient governments); allocate resources for the capacity-building of partner institutions to successfully manage rural finance operations and effectively use the additional capital; and have a clear exit strategy that develops linkages with other sources of refinancing and ensures that the target group will continue to access these services after the project ends.

How do I use it? 

The need for LOC is usually identified in the design or concept phase and the toolkit cautions that proper discussions should be held on structure of the LOC. A five-step process in the design stage is recommended that includes conducting a market assessment, analysing the financial sector problem, assessing technical assistance (TA) requirements, establishing M&E and KPI system and designing exit strategies. The toolkit presents guidance framed around a step-by-step progression from design to implementation. 

Where has it been used? 

IFAD rural finance projects in Bangladesh, China, Colombia, Ethiopia, Jordan.

What are its limitations? 

This toolkit is guide for country programme management teams, project design teams, implementing partners and other practitioners. However, it does not provide all the answers, nor does it provide models that can simply be replicated from one context to another. Instead, it provides guidance, ideas, tools and suggestions to assist practitioners in making strategic choices about LOC interventions so that they will be appropriately designed and have greater impact. IFAD generally discourages the use of LOCs to support retail financial institutions. Experience has shown that, in most cases, this financial instrument has failed to trigger the development of sustainable financial services. LOCs often do not meet the longer-term needs of FSPs and can even negatively impact the wider financial sector. Further, liquidity (i.e. access to loan capital) is usually not the main constraint that keeps FSPs from offering loans to poor people in rural areas. Instead, most FSPs need support for capacity- building rather than credit.