Risk Rationing in Agricultural Credit Markets
Observational StudyReview
Smallholder farmers reject productive agricultural credit even when loans are available because credit contracts leave un-hedged risk on the borrower. If a severe drought occurs, smallholders fear losing collateral or productive assets to settle debts.
Picture this
Imagine a delivery driver who is offered a loan to buy a high-capacity truck, but if an unpredictable hailstorm wrecks the truck, the bank will seize their family home. Even though operating the truck could double daily earnings, the driver refuses the loan because the threat of losing their home in a storm is far too dangerous.
What the evidence says
Risk credit constraint significantly decreases the probability of purchasing inorganic fertilizer (coefficient = -0.275, p < 0.01). Quantity credit constraint also significantly reduces fertilizer purchase probability (coefficient = -0.251, p < 0.01).
- Who was studied
- N = 2,399 rural households (average household size 5.3) across 120 Kebeles in 4 zones (North Shewa, West Gojam, South Wello, North Wello) of Amhara, Ethiopia.
- How
- Baseline survey analysis and a linear Heckman two-step consistent estimator modeling fertilizer purchase decisions.
What to do
Design credit contracts bundled with state-contingent debt forgiveness or index insurance to shield smallholders from asset loss following severe weather shocks.
From the source
"In short many farmers seem to be risk rationed in the terminology of Boucher et al. (2008). This risk arises because the incentive constraints against morally hazardous behavior require the lender to leave substantial risk on the borrower, and if a sufficient component of that risk is outside the control of the borrower, then profitable loan contracts may be refused by borrowers."
Productivity, credit, risk, and the demand for weather index insurance in smallholder agriculture in Ethiopia