INTRODUCTION

In many developing countries, risk management techniques are underdeveloped or insufficient for institutions to efficiently lend to activities in the agricultural sector. Information on borrowers’ credit histories is rarely available, resulting in information asymmetries that make accurate credit risk assessment difficult. In addition, while agricultural client’s major assets are production and land, it is often difficult for banks to use these as collateral, and particularly difficult to foreclose on land in case of default. Compounding this lack of traditional collateral is the presence of a high degree of covariate risk, in particular market price risk and weather risk. Banks lending to agricultural clients know that agricultural and rural revenues easily drop below break-even levels due to extreme weather events and price falls, which result in defaults and higher loan loss provisions, thereby making lending to agribusiness unprofitable.
The second major constraint in agricultural lending, high transaction and supervisory costs, is due to the particular risk, nature, and characteristics of the rural sector. In all financial markets, there is a trade-of between minimizing loan default and supervisory costs, but the nature of agricultural lending, especially through microfinance institutions, makes transaction costs and supervision costs disproportionately high relative to its urban counterpart. The small size of seasonal agricultural credit results in high due diligence costs per loan. The large geographical spread of customers, coupled with poor transportation and communication infrastructure, increase supervisory costs for financial institutions and compliance costs for customers. In addition, banks in rural areas find it difficult to attract qualified and trained loan officers.
High levels of risk and transaction and supervisory costs