W O L A I T A S O D O UNIVERSITY
DEPARTMENT OF AGRICULTURAL
ECONOMICS
AGRICULTURAL CREDITS A N D F I N A N C E (AGEC
592)
Course Instructor:AlulaTafesse (PhD)
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Chapter One:
Concept and Dimensions ofAgricultural
Finance
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Meaning and Scope
Rural Finance is a spatial concept, which
encompasses the provision of different financial
services to households and enterprises in rural
areas for both productive and consumptive
purposes.
◦ The services include loans, savings, payment and
money transfer services, and risk management
(e.g. insurance, hedging and guarantees).
◦ It includes financial services that support
agricultural as well as non-agricultural activities.
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Agricultural Finance particularly involve
in studying, examining and analyzing the
financial aspects pertaining to the farm
business.
It is the provision of financial services that
support all agriculture-related activities
(processors, distributors and exporters) who may
be located in rural, urban or peri-urban areas.
It is a sectorial concept which comprises financial
services for agricultural production, processing
and marketing, such as short, medium and long-
term loans, leasing, and crop and livestock
insurance.
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Microfinance can be broadly defined as
financial service provision to poor people in
urban and rural areas.
◦ Financial management of the individual farm
business units.
◦ The provision of small-scale financial services.
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Agricultural Macro-finance is related to
financing of agriculture at aggregate level.
◦ It deals with the aspects relating to total
credit needs of the agricultural sector, the
terms and conditions under which the credit
is available and the method of use of total
credit for the development of agriculture
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Agricultural Microfinance: the provision of
financial services to small and poor
households for agricultural production,
marketing and processing.
Concerned with how the individual farmer considers
various sources of credit, quantum of credit to be
borrowed from each source and how he allocates
the same among the alternative uses with in the
farm.
Also concerned with the lending procedure, rules,
regulations, monitoring and controlling of different
agricultural credit institutions.
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Credits in Agriculture: Meaning,
Definition and Classification
The word “credit” comes from the Latin word
“Credo” which means “I believe”.
Hence credit is based up on belief, confidence, trust
and faith. Credit is otherwise called as loan.
Thus it can be defined as certain amount of money
provided for certain purpose on certain conditions
with some interest, which can be repaid sooner (or)
later.
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Generally financial requirements of most farmers
are for;
◦ Buying agricultural inputs (seeds, fertilizers, plant
protection chemicals, feed and fodder for cattle etc.)
◦ Supporting their families in those years when the
crops have not been good.
◦ Leasing/purchasing additional land, to make
improvements on the existing land, to clear old debt
and purchase costly agricultural machinery.
◦ Increasing the farm efficiency as against limiting
resources i.e. hiring of irrigation water lifting devices,
labor and machinery.
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Credit is broadly
classified based on Borrower’s classification
various criteria’s:
Based on liquidity
Based on time
Based on approach
Based on purpose
Based on contact
Based on security
Lender’s classification
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Based on time: repayment period of the loan
Short–term loans: repaid within a period of 6 to
18 months.
Medium – term loans: here the repayment
period varies from 18 months to 5 years.
Long – term /investment loans: these loans fall
due for repayment over a long time ranging from 5
years to more than 20 years or even more.
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Based on Purpose: credit is sub-divided into
4 types.
Production loans: the credit given to the
farmers for crop production and are intended to
increase the production of crops.
Investment loans: loans given for purchase of
equipment.
Marketing loans: meant to help the farmers in
overcoming the distress sales and to market the
produce in a better way.
Consumption loans: any loan advanced for
some purpose other than production.
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Based on security: loan transactions are
governed by confidence
The institutional financial agencies do have their own
procedural formalities on credit transactions.
Loans under this categorized into secured and
unsecured loans.
Secured loans: Loans advanced against some
security by the borrower
The various forms of securities are Personal Security,
Collateral Security, Chattel loans andMortgage
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Mortgages are of two types
a)Simple mortgage: When the mortgaged
property is ancestrally inherited property of
borrower then simple mortgage holds good.
b)Equitable mortgage: When the
mortgaged property is self-acquired property
of the borrower, then equitable mortgage is
applicable.
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◦ Hypothecated loans: Borrower has
ownership right on his movable and the
banker has legal right to take a possession of
property to sale on default (or) a right to sue
the owner to bring the property to sale and
for realization of the amount due.
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Hypothecated loans again are
Key loans: The agricultural produce of the farmer -
borrower will be kept under the control of lending
institutions and the loan is advanced to the farmer.
Open loans: Here only the physical possession of
the purchased machinery rests with the borrower,
but the legal ownership remains with the lending
institution till the loan is repaid.
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Unsecured loans: Just based on the
confidence between the borrower and
lender, the loan transactions take place.
No security is kept against the loan
amount
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Lender’s Classification: based on the
lender
◦ Institutional credit: loans are advanced by
the institutional agencies (co-operatives and
commercial banks)
◦ Non-institutional credit: the individual
persons will lend the loans (by professional
and agricultural money lenders, traders,
commission agents, relatives, friends,etc.)
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Borrower’s classification: based on type
of borrower.
◦ Based on the business activities (dairy
farmers, poultry farmers, pisiculture farmers,
rural artisans etc).
◦ Based on size of the farm agricultural
labourers (marginal farmers, small farmers,
medium farmers and large farmers).
◦ Based on location hill farmers (or) tribal
farmers.
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Based on liquidity:
◦ Self-liquidating loans: they generate
income immediately and are to be paid within
one year or after the completion of one crop
season.
E.g crop loans.
◦ Partially -liquidating: they will take some
time to generate income and can be repaid in
2-5 years or more, based on the economic
activity for which the loan was taken.
E.g Dairy loans, tractor loans, orchard loans etc.
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Based on approach:
◦ Individual approach: Loans advanced to
individuals for different purposes
◦ Area based approach: Loans given to the
persons falling under given area for specific
purpose
E.g Drought Prone Area Programme (DPAP) loans,
etc.
◦ Differential Interest Rate (DIR) approach:
loans will be given to the weaker sections at
specified per cent per annum.
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Based on contact:
◦ Direct Loans: Loans extended to the
farmers directly are called direct loans.
E.g Crop loans.
◦ Indirect loans: Loans given to the agro-
based firms like fertilizer and pesticide
industries, which are indirectly beneficial to
the farmers.
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Potential Roles and Prospects of
Agricultural Financial Institutions
It has a big role in structural economic
transformation.
The costs of acquiring information and making
transactions create incentives for the emergence
of financial markets and institutions.
The financial system has the primary role of
facilitating the allocation of resources across
space and time in an uncertain environment.
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The primary role consists of five basic
functions:
Reducing risk
Allocating resources
Monitoring managers and exerting corporate
control
Mobilizing savings and
Facilitating the exchange of goods and
services
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When these functions are performed
well, they contribute to economic growth
through two channels:
◦ Capital accumulation and technological
innovation.
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The potential role of agricultural finance can
also be understood as follows:
Productivity Enhancement
Enhanced Farmers’ Income
Balanced Regional Development
An enabler of Inclusive Growth and Poverty
Reduction
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Productivity Enhancement:
It plays a catalytic role in strengthening farm
businesses and augmenting the productivity of
scarce resources.
The combined new technological inputs purchased
through farm finance helps to increase agricultural
productivity.
E.g in India, green-revolution technologies
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New technologies expand agricultural production and
induce demand for fertilizers, chemicals, and other
purchased inputs.
The rise in marketable surpluses led to increased
marketing of agricultural inputs and outputs.
More importantly, decisions about product choice and
input use evolved from subsistence to a profit
maximization orientation.
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Enhanced Farmers’ Income:
Creation of farm assets and farm supporting
infrastructure by large scale financial investment
activities results in increased farm income levels
leading to increased standard of living of rural
masses.
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Balanced Regional Development:
It reduces the regional economic imbalances and is
equally good at reducing the inter–farm asset and
wealth variations.
It is like a lever with both forward and backward
linkages to the economic development at micro and
macro level.
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An enabler of Inclusive Growth and Poverty
Reduction:
◦ Agri-finance assumes vital and significant importance
in the agro-socioeconomic development of the
country both at macro and micro level.
◦ It is needed to
Create the supporting infrastructure for adoption of new
technology,
Build major and minor irrigation projects,
Rural electrification,
Installation of fertilizers and pesticide plants,
Execution of agricultural promotional programs and poverty
alleviation programs.
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Challenges in Rural andAgricultural
Finance
Given the peculiarities of rural areas and
rural economic activities, rural financial
services provision has to tackle several
specific challenges, in addition to those
inherent in any financial intermediation.
These specific challenges are related to
seasonality, covariant risks and low
population densities.
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Many rural economic activities (farming, agro-
processing, input supply and service provision) are
subject to seasonality and gestation periods
◦ This lead to a slow rotation of the invested capital and
are reflected in the cash flows of rural entrepreneurs.
Gestation periods can last from a few months
(seasonal crops, small livestock) up to several years
(tree crops).
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Investments in lumpy assets such as farm
equipment require larger capital outlays,
which need to be repaid over several
years.
Longer loan maturities and irregular
repayment schedules are more risky and
present additional challenges to liquidity
management.
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The slower rotation of capital results in a
lower profitability of agriculture and
related activities if compared to other
sectors such as trade and services with a
quick turnover of funds.
Hence, lenders need to offer longer loan
maturities and less frequent repayment
installments to match the cash flow of
borrowers.
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This requires
◦ Strong appraisal skills and efficient loan
monitoring and borrower supervision to
manage credit risk;
◦ Lenders also need to mobilize sufficient long-
term funding sources to minimize asset
liability mismatches and the associated risks.
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The seasonal variations in the demand for funds
from rural clients, reflected in the demand for
loans and supply of deposits, pose additional
challenges to the liquidity management of rural
financial institutions.
The profitability of agricultural enterprises
depends significantly on external factors
(weather, major pest and disease outbreaks or
prices of inputs and outputs)
Which are largely beyond the farmers’ control.
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In addition to idiosyncratic risks affecting
individual clients agricultural enterprises are
exposed to covariant risks that may
simultaneously affect numerous farmers in a
given area.
For rural financial institutions, this translates
into considerable portfolio and solvency
risks,
◦ Which require a strong capital base and sound
risk management practices, including sufficiently
high sectorial and regional diversification of their
loan portfolios.
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Despite these additional challenges, rural
financial services providers have fewer
instruments at their disposal to manage
the various risks and reduce operational
costs than their urban counterparts.
Many rural financial institutions (RFIs) try
to protect themselves against the various
risks through excessive credit rationing
and over-reliance on collateral.
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However, rural assets are less suitable as
loan collateral than for example urban real
estate.
Due to legal and administrative impediments
as well as cultural factors, land and other
rural assets are often not registered and may
be more difficult to foreclose and sell.
Even where these constraints do not apply,
collateral is a poor protection against
massive default due to covariant risks.
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However, other more appropriate
instruments for managing covariant risks,
such as crop insurance or hedging, are rarely
available.
Classical microfinance techniques to cope
with delinquency risks include
◦ Highly standardized loan products based on small
credit amounts,
◦ Frequent (often weekly or bi-weekly) repayments
without grace periods,
◦ Short maturities,and
◦ Collateral substitutes such as joint liability
mechanisms.
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These techniques still work rather well in
peri-urban areas and for a few rural
economic activities, they are difficult to
apply in rural economies
◦ Due to they are characterized by strong
seasonality and low population densities, and
◦ They are also unsuitable for larger loan
amounts and longer maturities which is typical
for agricultural finance.
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Low population densities and poor
infrastructure result in high transaction costs
for rural financial service providers and for
their clients.
This reduces enterprise profitability and
increases the costs of financial services.
The returns of rural enterprises often do
not permit them to fully pay cost-covering
interest rates, thereby reducing the effective
demand for loans.
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Finally, agriculture is a politically sensitive
sector prone to government interventions.
◦ Permanent interventions (lending quotas, interest
rate ceilings or direct government provision of
financial services)
◦ Other interventions are loan rescheduling/
forgiveness and preferential lending programmes
for specific target groups,
Which are often granted after major economic
downturns or natural calamities, and especially in the
advent of elections.
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However, they create additional
uncertainties for financial institutions and
tend to weaken the repayment culture.
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Lack of financial literacy/capability of farmer
support organizations such as advisory
services and farmers’ lobbying groups is
another issue.
Farmers usually need this support because
they tend to be neither frequent nor
sophisticated borrowers.
Developing a bankable business plan is a
challenge for those without such experience.
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Targeting is also other specific challenge
of Agricultural finance.
The financial institutions have only limited
interest in supporting small and poor
farmers and rural households.
Most of the agri-finance banks prefer big
players.
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