This paper examines the high degree of success of several systems of rural financial intermediaries in Indonesia, in terms both of self-sustainability and outreach. These systems have provided credit and deposit services, profitably and at low transaction costs, to large numbers of very small individual clients. This generalized success reflects both a hospitable environment for financial intermediation and, particularly, the elements of an effective organizational design, in reflection of an underlying concern with institutional viability. This design has provided both the incentives and opportunities for successful behavior. The provision of financial services to marginal clientele depends on the solution of the paradox resulting from those agents with inexpensive access to information and monitoring mechanisms not having enough resources or being too risk averse to locally provide sufficient credit, while those with the resources have no access to the required information and contract enforcement tools. Regulatory constraints may make this situation worse. The design of Indonesian locally-operated financial institutions offers a solution to this paradox. Character-based lending that relies on local agents is comparatively inexpensive. With the recruitment of local agents for lending, however, the information/ enforcement problem becomes an agency problem. In Indonesia, the solution has been a system of compatible incentives (performance-based remunerations and efficiency wages), coupled with the verification of profits. In practice, managers have been made co-owners. This requires that managers possess discretionary powers over performance-relevant variables. Thus, no loan targeting exists and financial policies, while not uniform, have been adequate to protect institutional viability. The one-time subsidies implicit in seed capital and start-up loans to these intermediaries have not created dependency on outside funds, while the extent of the interventions has been proportional to the magnitude of the problems to be solved, rather than being massive undertakings with large fixed-cost structures. Gradual growth, by trial and error, has been a good approach to institution building. These organizations have been credibly committed to collect loans, while borrowers have pledged their (valuable) reputation as collateral. Traditional hierarchical structures (village chief) have been used for contract enforcement. The chief may also be operating as an indigenous credit rating agency. The lessons learned in Indonesia shed light on successful institution building elsewhere.

Romanian policy makers are justifiably concerned with the performance of financial markets in rural areas because these markets have an important impact on rural growth and poverty. In the absence of sufficient investment capital, the rural economy has experienced difficulty in adjusting to the major policy reforms of recent years, the aftermath of the exchange rate crisis of early 1997, and the strong depreciation of the Leu that has occurred since early 1999. These events require rural enterprises and households to adjust factor proportions, modify output mixes, change their scale of operations, and invest in new technologies. Their success in this endeavor, which depends on the performance of all factor markets, has been hindered by the observed poor performance of financial markets. This report is intended to assist Romanian policy makers as they seek to formulate and implement a market-based rural sector strategy that aims to render rural areas internationally competitive with significantly less incidence of poverty through the establishment of effective private financial markets and intermediaries which will provide access to investment capital and safe deposit services to all segments of the rural population, especially individual farmers, rural microentrepreneurs, and small and medium businesses.The report is the latest addition to a long and growing series of World Bank publications on the former socialist countries of Europe and Central Asia. The unique features of all these publications is their reliance on first-hand empirical information collected through extensive surveys of rural constituencies. Analysis of survey findings enables the World Bank to base its policy dialogue with governments in the region on empirical fact, rendering the Bank's recommendations more credible and relevant. The new findings for Romanian rural financial markets contained in this report will provide a solid platform for policy discussions with the Government of Romania and supply the many international donors active in the country with essential information for the design of their strategic programs.

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