If an American farmer needs money to tide him over till the next harvest, the first person he'll probably turn to is a community banker.

In the Philippines, however, a farmer would most likely resort to the neighborhood loan shark or a rich relative before even thinking of the local bank.

Rural banks in the Philippines, where over 60% of the population is engaged in farming, now make only 6% of the agricultural loans.

Natural Disasters

The reason is straightforward: Banks have become wary of lending to farmers because of the disproportionate risks involved. Floods, like as the one that ravaged the U.S. Midwest this summer, are commonplace in the Philippines So are typhoons, volcanic eruptions, earthquakes, and droughts.

When any of these calamities strike, farmers are further burdened by government limits on crop prices. Thus, farmland is not viewed as desirable collateral - and banks tend to set up shop in cities.

The situation for smaller banks is far less stable than it is in the United States, and it will worsen as the big banks take what is left of the farm market.

Moreover, with Philippine rural banks also losing turf to cooperatives and nongovernment and self-help groups, the trend of the past five years indicates that the rural banking sector could be reduced to an insignificant player as its growth rate lags behind industry benchmarks.

Philippine rural banks are thus at a crossroads: They can sell out to stronger banks or they can change their focus.

Luzon Development Bank chose the latter.

Nestled in the town of Calamba, Laguna - 40 miles south of Manila - the bank was started in 1960 when some private investors put up $100,000, and the government, through a standard incentive package, matched it with $100,000 in preferred stock. Being located in a huge sugarcane region, the bank dealt almost solely in agricultural loans in the '60s and '70s.

Drought Crisis

"We gave a lot of loans to sugarcane farmers, but when there was a drought, we had problems and had to restructure the terms of payment," said Leopoldo P. de Guzman, who was president of the bank during the crucial turnaround stage and stepped down in 1988.

"When agrarian reform came about [in the late '80s], it inadvertently and unwittingly made it more difficult to get a loan, because it was hard to resell a farm if a mortgage had been foreclosed, since the land was subject to subdivision. The value of the land also dropped to 10% of its market value after land reform."

Luzon Development Bank diversified by reducing agricultural loans to 8% of its portfolio, lending more heavily to feed mills and other small businesses, and concentrating on housing loans. The 19-branch bank is now the province's biggest originator of housing loans, providing funding during the development stage at an interest rate of 16% and then selling the mortgage to the home financing corporation after the house is built.

Stricter Capital Rules

But despite having earned 57% on total equity last year, the bank's problems are far from over. Like their U.S. counterparts, Philippine rural banks are straining under increased capital requirements.

With the Philippine Deposit Insurance Corp. insuring depositors at rural banks only up to 100,000 pesos ($3,333). the requirements for paid-up capitalization have been progressively raised to favor bigger banks with nationwide networks, said Mr. de Guzman, a former chairman of the Chamber of Thrift Banks and former president of the Development Bankers Association of the Philippines.

LDB now has to increase its capital to 100 million pesos ($3.3 million) from its current size of 39 million pesos ($1.3 million) so it can make more and bigger loans and have sufficient capital to offer checking accounts and letters of credit.

In order to avoid the pitfalls of U.S. banks, Philippine regulators have two new rules designed to keep small banks from being used as piggy banks by those who control them. Philippine banks are not allowed to lend more than 25% of their net capital to one borrower.

In addition, loans made to shareholders, bank officers, and people who have related interests, which cannot exceed their holdings in the bank, are subject to approval from the Central Bank of the Philippines.

"If they had control mechanisms like this in the U.S., they might have avoided the problems" with the S&L crisis, said Mr. de Guzman.

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