The provision of investment funds by the Banks to the villagers,
however, still remains very limited despite attempts to change this
situation. The only area in which such facilities extended by the Bank
have been utilised on a significant scale is on paddy cultivation, which
29
is a short term crop. For longer term agricultural investments such
as rubber replanting, cultivation of cotton (which is encouraged officially
in some of the drier regions), the banks, though they are committed to a
policy of provision of better credit facilities, in fact provide little or
no funds at the level of smallholder farmers. Thus for rubber replanting
a small sum (Rs.500) is approved under relatively convenient terms and
conditions to those farmers who have been selected as being eligible for
the replanting subsidy. The rate of interest on this is5"to7per cent and
is attractive compared with the interest rates prevailing elsewhere. Yet
it is noticeable that the 'red tape' involved deters many of the
prospective creditors and little use is actually made of this facility.
Thus it could be said that as a source of investment capital, particularly
for long term investments, the institutional sector plays only a very
limited role. Only the better off farmers and those enjoying substantial
regular incomes from other activities are sufficiently creditworthy in
terms of the rules and regulations governing the conduct of the banks and
other, related, institutional sources of credit. Only they can offer
acceptable collateral. Since the large majority of villagers do not fall
into these categories, they are effectively excluded from access to bank
credit for investment purposes (and even more so for consumption purposes).
4.2.5 Tlie Non-institutional (Unorganised) Sector
In general, however, the unorganised sector remains a major source
of borrowings. Since production and consumption are so closely interwoven
I l l
at the l e v e l of the farm-family, with ceremonial expenses, dowries and g i f t s , e t c . , being s o c i a l o b l i g a t i o n s that are considered necessary expenses, the s t r i c t d i s t i n c t i o n that i s drawn by the banks between p r o d u c t i v e and n o n - p r o d u c t i v e a c t i v i t i e s has the e f f e c t of pushing the v i l l a g e r s i n t o the unorganised s e c t o r to meet t h e i r c r e d i t needs. Since the consequence of such borrowings from t h i s s e c t o r at the high rates of i n t e r e s t prevalent i s to reduce the capacity of the farmers to pay back loans obtained from the banks, d e f a u l t i n g on bank loans i s common. Such d e f a u l t i n g then makes such farmers i n e l i g i b l e f o r further bank c r e d i t , even f o r a c t i v i t i e s such as paddy farming and helps to perpetuate a v i c i o u s c i r c l e . This may w e l l be an important f a c t o r in the high
30 percentage of d e f a u l t s on loans f o r paddy c u l t i v a t i o n .
Under these circumstances, the discussion by U Tun Wai (1957) of the f a c t o r s that make the unorganised s e c t o r of the c a p i t a l market so
important in the v i l l a g e s of the l e s s developed countries i s broadly a p p l i c a b l e to the s i t u a t i o n e x i s t i n g in rural areas of Sri Lanka:
The i n s t i t u t i o n s are usually at a considerable distance from the borrowers, while moneylenders are a v a i l a b l e in every v i l l a g e . Borrowers obtain t h e i r loans more promptly from n o n - i n s t i t u t i o n a l s o u r c e s . N o n - i n s t i t u t i o n a l sources do not i n s i s t on punctual
repayment as banks and c o - o p e r a t i v e s o c i e t i e s do. Usually i t i s p o s s i b l e to obtain loans f o r such purposes as marriages and
l i t i g a t i o n only from n o n - i n s t i t u t i o n a l sources. There i s no p u b l i c i t y on the amount of money borrowed from n o n - i n s t i t u t i o n a l
l e n d e r s . There are generally no i n t r i c a t e and complicated rules governing the granting of loans by the v i l l a g e moneylenders. And n o n - i n s t i t u t i o n a l sources are w i l l i n g t o lend money more
f r e e l y without c o l l a t e r a l and on the borrower's mere promise to repay. The absence of a c o l l a t e r a l requirement i s e s p e c i a l l y important, s i n c e the majority of the p o t e n t i a l borrowers in the unorganised money market have very l i t t l e in the way of f i n a n c i a l or p h y s i c a l a s s e t s .
Within the unorganised sector there exists two substantially distinct
sub-markets: (a) a market from which comparatively large sums of
money (about Rs.500 and over) are available on credit on a long term basis
and (b) a market which mainly deals with smaller sums of money on a short
term basis.
A.2.6 Mortgages and Long Term Credit in the Unorganised Sector^^
In the first type of market it is usual to demand collateral, usually
land for the credit supplied, and mortgage of land is the commonest form
of credit transaction wlien large sums of money are involved. llie two main
types of mortgage that exist are: (a) mortgage of land with interest
regularly paid in cash; and (b) ' usufructory' mortgage where the returns
from the land go to the creditor in lieu of interest payments in cash. In
the latter case it is not uncommon for the creditor to allow the debtor to
continue working on the land as a tenant-farmer until the mortgage is
redeemed or the land is alienated.
It is the author's observation that generally the creditor is aware
of the claim of the debtor to the land that is to be mortgaged and knows
that this claim is accepted by the other villagers through the debtor's
use and cultivation of that land for a long period. As a result, an
absolutely clear title to the land is not demanded, and the creditor is
usually ready to accept the title that is available. (Owing to the
inheritance laws, joint ownership of lands is very common in the villages
and clear titles are a rarity. Since banks demand clear titles to accept
land as collateral for a loan, most find it impossible to borrow from the
^^ The following discussion, where not explicitly mentioned, is based primari ly on data from Tilakaratna, W.M., Agricultural Credit in a Developing Economy - Ceylon, Central Bank of Ceylon, Colombo, 1963, and
113
banks.) Wliat is important to the creditor is whether he would be able to
establish ownership to that land if the mortgage were not redeemed and
also, in usufructory mortgages, whether he will be able to claim the
returns from the land without major problems.
This form of credit transaction is the main form of long term
32
borrowing open to the villagers. The rate of interest charged varies
in different localities, and even in the same locality depending on the
creditor-debtor relationship (20 to 40 per cent per annum). These rates are 33
high, as observed during the field survey, even in comparison with the
rates charged for consumption loans by the banks; however, they are lower
than the rates charged by money lenders on short term loans.
The disincentives to entering into such credit arrangements to
finance long term agricultural investments are obvious. Not only are the
rates of interest extremely high, they also carry the risk of loss of the
land thus mortgaged. The returns have to be unusually high or there must
be other compelling reasons for resort to such borrowings to finance any
sort of investment. As it is, almost the only example of such borrowings is
provided by those who do so in order to finance the education of a gifted
child. Education is seen as a major vehicle for gaining upward mobility
in society, not only for the person being educated, but through him for
the entire family. This is supplemented by the traditional view of
parental responsibilities which emphasises the duty of parents to provide
their children with all opportunities that they possibly can to further themselves in life.
\
^^ Final Report on the Eoonomio Survey of Rural Ceylon 1950-51 and Survey of Rural Indebtedness, 1957.
^^ It is the author's observation that it is difficult to determine the actual interest rate charged from a perusal of mortgage documents since it is usual to understate the interest being charged to meet legal
requirements by recording a larger sura than that actually received by the debtor as the amount of the loan.
Otherwise only when dire necessity compels such borrowings would one enter into such a transaction. The villagers are well aware of the
3 A sorry plight of many who have lost their lands through this process.
4.2.7 Short Term Credit
Tlie nature of the short term credit facilities available directly influence preferences for particular patterns of income flows. In the villages the sources of supply of such short term credit are diverse and
the costs of credit reflect this diversity. They include professional and semi-professional money lenders and pawn brokers, village shopkeepers, middlemen, friends and relatives.
In comparison with many other countries it appears that relatives and friends are a more important source of credit in rural Sri Lanka. Thus the source of some 44 per cent of all loans has been relatives and
friends according to the Survey of Rural Indebtedness (1957) which 35
compares with a figure of 14.2 for India.
In general, though not always, such loans would be free of interest. However,this does not imply that they are costless. Such loans carry with them obligations to help the creditors in future need, both
^^ The paying of the high interest payments is difficult and by reducing the normal net income makes the redemption of the mortgage doubly
difficult. (The usufructory mortgage does this by reducing the normal net income directly since the farmer loses the income from the land.) A
life crisis or similar event will make it impossible to redeem the mortgage within the stipulated time. Available evidence suggests that
the concentration of land ownership in the hands of those who have been able to accumulate some cash reserves (traders, white collar workers, teachers and professional money lenders) has occurred to a great extent through credit operations of this sort. As Tambiah (1963) comments: 'Thus mortgage continues to be the predominant form in which loans are taken, and it is mortgage precisely which contains the possibility of the final'takeover of land by the creditor.' (Tambiah, op. ait., p.92). 35
115
financially and in other ways. These may include unpaid labour during periods of peak farm activities, liousebuilding, ccremonial functions, etc. Also such sources cannot be tapped at all times, nor can they be
tapped too often.
The village shopkeeper is a source of credit, often through the provision of goods on credit. The interest chargcd is hidden, being extracted through higher prices. The rate of interest is difficult to ascertain and estimates vary from quite low to very high. The same is true of the various middlemen, one of whom may be the shopkeeper himself. Tills is quite often the case in many rubber growing areas wliere the
shopkeeper is a rubber dealer who extends credit on goods, to be paid back by the proceeds of rubber sales. The risk of default is lowered since rubber is a crop whose supply, while depending on the number of
rainy days, is nevertheless stable (to the extent that it is almost certain of escaping complete destruction through weather factors). The shopkeeper in general not only ensures that the debtor would sell his rubber to him, but also extracts a higher profit through both
undergrading and underpricing. Substantially the same occurs in the case of loans extended by other middlemen, in this case usually cash loans - the farmer is compelled to sell his crop at below market prices. There is disagreement on the extent of such practices; however their
prevalence is universally admitted. No reliable data is available on this for any useful estimates to be made of the hidden interest charged, though it seems reasonable to assume that it cannot be very low.
The more professional moneylenders are found in almost every village. They often extend credit on no security other than the verbal promise of
36
repayment or on a promissory note. Their operations are characterised
by rapidity, smoothness and confidentiality; the rates of interest are
extremely high (in a number of villages during the period of the survey
of rubber smallholders carried out by the author in 1975 the rate was
37
15 per cent a month ). It is quite common for the first month's interest
(interest being paid monthly) to be deducted from the amount of the loan.
Many such small scale money lenders are women, often ones who have husbands
in regular salaried employment. Some of these women may also operate a
'Seettu', a system of co-operative saving where each participant regularly
(usually montlily) contributes a specified sum of money to a common pool
38 which is then made available to one person each month.
The collection of loans and, in the Seettu system, of contributions is
a task that the moneylenders face with little or no possibility of recourse
to legal action against defaulters. (The costs of such legal action in any
case would be likely to far exceed the amount of the loan itself.) He can,
however, choose his clients with care and reduce the risks, utilising his
knowledge of the villagers. His resourcefulness, in using persuasion
^^ Mortgaging of the Rice Ration Book (which allows the owner to obtain the weekly ration of free rice and to purchase specified quantities of a range of other goods including clothes, sugar, etc.) appears to be
widespread, though illegal, according to observations made during the field survey (1975).
^^ For certain (smaller) transactions, the rates were higher; thus petty traders borrow sums of money up to Rs.25-50 per day to purchase village produce and sell in the nearly urban centres at daily rates of interest of 5-10 per cent.
^^ If the order of payment is decided by the drawing of lots the operator may receive a commission, but where the operator is a money lender it is more common to 'auction' the places in the sequence of receipts so that the highest bidder gets the first month's collection and so on. The price that is paid for the places in the order of payment is collected by the operator. People participating in the 'Seetu' may in times of need
approach the operator to obtain a higher place even after the places had been sold as previously and the operator would then negotiate with the person entitled to that place for deferment of receipt in return for a sum of money. This system, with local variations, is found almost universally in rural Sri Lanka and is both a source of credit and a method of saving that is both functional and efficient (Field Survey, 1975).
117
with a combination of types of coercion in the form of public abuse,
intimidation as well as threats of physical assault, determines to a
large degree the extent of default. According to money lenders interviewed
by the autlior, the fact that his services may be needed again in the future
and the fear of loss of social status are all factors that keep down the
rates of default. Thus the risk of such lending varies not only with the
individual debtor, but also with the creditor. Writers have argued both
for and against the view that the high rates of interest charged (both
explicit and implicit) reflect the cost of lending in such a risky
environment and that such rates are, to that extent, not only understandable
but are also justifiable. That, however, still remains a moot point.
The above description of the type and nature of the capital 'markets'