Credit Market Inefficiencies  


Beneficial technologies may be unaffordable to farmers who face limited access to credit.

Increasing farmers' access to credit.

Many farmers cite a lack of financial capital as a major reason for not adopting beneficial technologies. Research has also suggested that farmers with less access to credit plant fewer high yielding crop varieties. In many developing countries, and particularly in rural areas, access to financial services, including credit and formal saving mechanisms, is limited. Even where financial services are available, they are often highly disadvantageous to smallholder farmers. For example, within a single market, interest rates often vary according to the characteristics of the borrower and the activity being financed.

High Interest Rates and Unfavorable Borrowing Conditions

Farmers and other small-scale borrowers often face high interest rates and unfavorable borrowing conditions. Lacking formal credit rating mechanisms, lenders often charge high interest rates to help offset the risk that loans will not be repaid. These higher interest rates for risky borrowers can, perversely, have the effect of attracting only borrowers with no intention of repaying, thus driving interest rates even higher, as lenders seek to offset increased risk, and further reducing access to credit for the small-scale farmer.

In addition to problems with monitoring and contract enforcement, many smallholder farmers have few substantial capital assets that they can use as collateral (perhaps due to poor property rights). As a result, these farmers have limited liability—meaning that they will be bankrupt before then can fully repay outstanding loans should an investment not work out.

Access to Finance Varies for Different Technologies and Farmers

Certain types of technologies are particularly difficult for smallholder farmers to finance. For example, technologies that require large initial investments will require larger one-time loans, which may be more difficult for smallholder farmers to access. Similarly, technologies that require many years to yield a benefit—such as certain tree crops—are difficult for small farmers to finance.

A lack of finance may have different effects for different farmers. Women, in some settings, may have more difficulty accessing credit than men. On the other hand, women have been identified by some financial service providers as more responsible borrowers, with higher repayment rates, and other microfinance institutions cater specifically to women.

In recent years, the range of financial products available to the poor has expanded to include savings, money transfers, insurance and leasing. Microfinance institutions have diversified beyond credit to include savings options that allow for very small deposits, and other financial products catered to smallholder clients.

Improvements in information technology can help reduce the administrative costs that make financial services difficult to access by smallholder farmers. Such examples include agricultural credit cards for input purchases and mobile banking. The first rigorous evaluation of the impacts of microfinance—without a particular emphasis on agriculture—points to both greater investment and higher profits for current business owners.1 Ongoing research on rural microcredit will generate findings on agricultural productivity impacts. Further research on the impact of microfinance and other financial products targeted toward farmers is needed.

Substituting for Traditional Collateral

Poor farmers, who typically lack valuable assets to use as collateral for loans, may be particularly ill-suited to access financing, however substitutes for traditional forms of collateral are emerging. For example, “supply contracts” for farm outputs (where lenders are repaid with future production) have been used to provide loans to smallholder farmers. A frequently used collateral substitute is group liability, which relies on social capital for collateral and is typically viewed as an innovation that reduces monitoring costs and lowers default rates. However, a recent rigorous evaluation suggests that joint liability may not actually improve repayment rates.2 Other collateral substitutes, specifically tailored to an agricultural context, deserve further research.

Targeting Credit Access

The benefits of making credit more available to smallholder farmers may be enhanced by targeting those who most stand to gain. In a randomized evaluation in Kenya, Ashraf, Gine, and Karlan found that credit for the production of an export crop had a greater impact on farmer income, if it was targeted to those who had previously not adopted the crop.3

Low Financial Literacy as a Constraint to Technology Adoption

In addition to the challenges created through the lack of financial services available to small farmers, low financial literacy can pose as another constraint. Further research suggests that a lack of financial sophistication does not appear to be as important as the high costs that poor people incur in accessing financial products. In a field experiment, Cole et al. (2009) find that adoption of financial products increases when cash incentives are offered but not when participants are given financial literacy training without the incentive.4

Psychological Biases in Financial Decision-Making

Financial decisions are often subject to psychological biases such as lack of self-discipline. For example, in multiple settings, financial products that allow individuals to commit themselves to future saving or investment at the moment when they have cash available, such as immediately following the harvest, improve technology adoption. In a rigorous evaluation in Kenya, Duflo et al. (2009) show that offering farmers the opportunity to purchase fertilizer at harvest time led to purchases by all who indicated a demand for the input. A few days’ delay in collecting the funds cut purchases by almost half, and waiting to collect payment until the fertilizer was delivered reduced purchases to zero.5

New projects funded during the first round of ATAI proposals investigate approaches to encouraging technology adoption through better access to finance. Duflo, Kremer and Robinson will explore strategies for scaling up the savings commitment approach. Fertilizer coupons that are only valid for a certain period of time will be offered in group settings, such as schools and churches, immediately after the harvest period—the time when farmers typically have cash available.

Casaburi, Kremer and Mullainathan will evaluate an approach to overcoming the high discount rates that can deter adoption of crops with a relatively long payback period. Contracted farmers will receive cash advances conditional on farmers' performance at intermediate stages of the harvest cycle. If myopia and credit constraints play a large role, anticipated payments tied to intermediate outcomes should increase adoption.

1 Banerjee, A., E. Duflo, et al. (2009). "The miracle of microfinance? Evidence from a randomized evaluation." J-PAL Working Paper.
2 Giné, X. and D. Karlan (2009). Group versus Individual Liability: Long Term Evidence from Philippine Microcredit Lending Groups. Working paper Working paper.
3 Ashraf, N., X. Giné, et al. (2008). Finding Missing Markets (and a disturbing epilogue): Evidence from an Export Crop Adoption and Marketing Intervention in Kenya, World Bank.
4 Cole, S., X. Gine, et al. (2009). Barriers to Household Risk Management: Evidence from India, Harvard Business School Working Paper.
5 Duflo, E., M. Kremer, et al. (2009). Nudging Farmers to Use Fertilizer: Theory and Experimental Evidence from Kenya, Harvard University Department of Economics working paper.