COLLEGE OF AGRICULTURE

DEPARTMENT OF AGRICULTURAL ECONOMICS

Course Name: Agricultural Credit and Finance

Course Code: AgEc 342

3rd Year semester II
Instructor: Beifa F.(MSc)

Oda Bultum University, Chiro

August 2024
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 OUTLINES
 CONCEPTS AND DIMENSIONS OF
AGRICULTURAL CREDIT AND
FINANCE

 Definition and concepts

 Roles of Agricultural Finance and Financial
System
 Financial System (FS) in Agriculture
 Challenges in Agricultural Finance

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 UNIT ONE
1. CONCEPTS AND DIMENSIONS OF AGRICULTURAL CREDIT AND
FINANCE

Meaning and scope

 There is a great deal of ambiguity among finance, rural
finance, agricultural finance, and microfinance.
 Finance: is the management of money and includes
financial activities such as investing, borrowing, lending,
budgeting, saving, & forecasting.
 Rural finance, is the provision of a range of financial
services such as savings, credit, payments and insurance to
rural individuals, households, and enterprises, both farm
and non-farm, on a sustainable basis.
 It includes financing for agriculture and agro-processing.
 helps the people living in rural areas to overcome their
financial issues.
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 Meaning and scope Cont’d…

─ Agricultural finance is a subset of rural finance

dedicated to financing agricultural related activities such
as input supply, production, distribution, wholesale,
processing and marketing.
─ is the economic study of the acquisition and use of
capital in agriculture.

─ Agricultural credit refers to one of several credit vehicles

used to finance agricultural transactions.

─ This type of financing is specially adapted to the specific

financial needs of farmers and allows them to secure
equipment, plant, harvest, marketing, and do other things
that are necessary to keep their farms running.
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─ Microfinance is the provision of financial services for poor
 1.2. Roles of Agricultural Finance and Financial System
─ Finance and financial systems are highly related concepts.
─ Obtaining finance for some business objectives will be
effective if the acquired finance is managed by
appropriate financial systems.
Role of Agricultural Finance to Growth
─ Agri-finance assumes vital and significant important in Agro-
socio- economic development and growth of the country.

─ It is playing a catalytic role in strengthening the farm-business

& augmenting the productivity of scarce resources,
─ when newly developed potential seeds are combined with
purchased inputs like fertilizers & plant protection chemicals in
appropriate / requisite proportions will result in higher
productivity.
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─
 Cont’d…

• Policy should focus on fostering a market-based

financial system for rural areas.
• However, due to market failures that hinder support for
disadvantaged groups, a targeted priority program may
be needed to provide credit access to women,
smallholder farmers, and the rural informal sector.

• To improve rural financing, the system of property

rights, title and default enforcement must also be
strengthened, among other reforms.

• Overall, to improve performance in the rural

economy and efficiency in financial institutions, rural
credit markets must be liberalized(legalized).
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 Cont.…
The following reforms are important in an economy( to
improve rural finance)
Avoiding produce and price controls;
• w/c allows market forces to determine prices and product
availability, promoting efficiency.
 Operation of commercial banks in a competitive
environment;
 encourages innovation, cost-effectiveness, and better
service for customers.

Availability of credit to support productivity growth for

agricultural smallholders and small producers of the
rural non-formal sector, where growth potential of
developing countries lies; and

 Credit availability to women and to the rural poor

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 1.3. Financial System (FS) in Agriculture

FS is importance in mobilizing and allocating resources

to finance agricultural investment projects that are
necessary for economic development.
A poorly functioning FS can be a major constraint to private
investment and entrepreneurship which growth would be
difficult to sustain over the long run.
Investment can be constrained by low returns on investment
or high cost of finance.

As a result, high cost of finance can be linked to bad

external finance or bad local finance, while bad local
finance can be caused by low savings or poor financial
intermediation.
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 Cont’d…
─ FSs play a crucial role in easing market frictions and
influencing the allocation of resources across space and
time.
─ It have many functions contributing to growth and
development of a country.
 The five key functions of FSs that are essential to
growth can be identified as follows:

1. Produce information about possible investments and

allocate capital;
2. Monitor investments and exercising corporate
governance;
3. Facilitating the trading, diversification, and
management of risk.
4. Mobilize and pool savings; and
5. Easing the exchange of goods and services. 7
 1.4. Challenges in Agricultural Finance

 There are variety challenges that inhibit sufficient capital

allocation and growth in the agricultural sector.

 These challenges result in persisting financing gaps and

hinder the deepening of agricultural finance markets.

 The challenges are often caused by similar underlying

market or policy failures.
 However, the occurrence and extent of these challenges
can vary significantly depending on the country & specific
characteristics of the agricultural sector.

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 Cont’d…

 D/nt factors specific to rural and agricultural markets

limit both the supply and demand for financial resources,
These factors includes :
economic,
political,
 legal,
institutional, and
 climatic influences.

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 Economic challenges
 Transaction costs – high transaction costs affect both
borrowers and lenders;

 Economic activities – Often limited economic

opportunities available to local populations;
 Risk –Potential borrowers and depositors faced high risks
due to income variability, external economic shocks, and
insufficient risk management tools.

 Concentration of activities – heavy concentration on

agriculture and agriculture related activities exposes
clients and institutions to multiple risks;

 Portfolio concentration – Increased risks associated with

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the concentration of a portfolio on agricultural activities;
Economic challenges Cont’d…

 Collateral – Lack of adequate or usable collateral

(lack of assets, unclear property rights);

 Infrastructure – Undeveloped or inadequate

infrastructure;

 Land fragmentation – Land held may be too small

to be sustainable in an optimal use; and

 Sources of income – Individuals may be dependent

upon only one crop with no other external sources of
income.
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 Political, legal and institutional challenges
 Institutional capacity – Weak institutional capacity
including poor governance and operating systems, low
staff and management skills;

 Political intervention – Risk of political intervention,

which can undermine payment morale through debt
forgiveness and interest rate caps;

 Policy – unfavorable policy, legal and regulatory

frameworks;

 Legal systems – Undeveloped legal systems,

inadequate contract enforcement mechanisms;
 Information – Lack of reliable information about
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borrowers; and lack of market information and/or market
 Cultural and geographical challenge

 Population density and demand – The lower population

density in rural areas often leads to dispersed/fragmented
demand, complicating financial service delivery.

 Repayment culture –Due to the history of a bad

repayment culture, many rural communities have
historically wrongly linked attempts to reduce poverty with
charitable donations from NGOs.
 making it a challenge to develop good repayment behavior
for microfinance institutions.

 Accessibility –Getting into the communities and getting

them to agree to credit terms might be challenging at
times.
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 Weather-Related Challenges in Rural Finance

 Rainfall Patterns: Rainfall patterns vary by region,

resulting in some areas having one growing season and
others having three, which can create challenges in
matching financial services to the agricultural cycle.

 Natural Disasters: Susceptibility to natural disasters,

which can cause sudden and severe devastation/challenge
to rural livelihoods. Eg. Flooding , drought

 Seasonality: The seasonality of agricultural activities can

affect both the client and the financial institution,
creating challenges in managing cash flows and loan
repayment.
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 However, financial services providers in rural markets
are not able to choose which challenges they will face.
 The many obstacles/challenges usually amplify and
reinforce one another

 Calvin Miller (2004) has identified 12 key challenges in

rural finance.

 These challenges can be grouped into four categories:

 vulnerability constraints,
 operational constraints,
 capacity constraints, and
 political and regulatory constraints in a country.

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 1. Vulnerability constraints:
 include systematic risk, market risk, and credit /
financial risk arising from the following issues in a
country including:

(1)weather condition, (2) pests and diseases, (3)

prices, (4) production, (5) useable collateral, (6)
demand preferences, and (7) health and family
needs.
2. Operational constraints
 These constraints are caused by low investment returns,
low investment and asset levels, and low geographical
dispersions of the rural financial institutions in a
country.
 include: (1) low growth potential, (2) low velocity of capital,
(3) non-competitive technologies, (4) lack of market
integration, (5) lack or quality of roads and communication,
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Capacity constraints:
 Capacity constraints significantly hinder rural finance
services, particularly in rural areas.
 They encompass various aspects, including infrastructural
capacity, technical training, social inclusion, and
institutional competency.

 These are caused by the following constraints:

(1) lack of business investment, (2) lack of

competitive technologies, (3) lack of roads, (4) lack of
communication, (5) lack of education, (6) lack of technical
and management skills, (7) lack of institutional capacity,
and (8) lack of social representation (civil society).

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 Political and regulatory constraints

 encompass challenges that hinder effective governance

and sustainable development through weakening rural
finance, particularly in rural areas.
 These challenges include political and social
interference, and regulatory framework.

They are related to the following challenges:

(1) political interference, (2) NGO donation
interference, (3) cultural and gender constraints, (4)
land tenure laws, and (5) financial regulations and tax
policy.

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 Questions from unit 1
1. What is the difference between rural finance and
agricultural finance, and how does each define its scope
of services?
2. How can a market-based financial system be structured
to effectively support disadvantaged groups, such as
women and smallholders, while addressing the
challenges posed by market failures in rural finance?
3. In what ways can improved financial intermediation
enhance the mobilization of savings in rural areas, and
what role does this play in boosting agricultural
investment and economic development?
4. Discuss the four challenges facing rural finance?

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THE END Of UNIT ONE

THANK YOU

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