Few products suitable to agricultural livelihoods are available, and despite the wide proliferation of microfinance institutions , most are limited to non-agricultural activities given there are substantial challenges inherent in long-cycle agricultural lending . Lenders in these contexts charge high interest rates to help offset their assessment of the risk that loans will not be repaid. These higher interest rates 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 , further reducing access to credit for the small-scale farmer . Group-liability microfinance models, though popular in urban markets to reach low-income borrowers through social guarantees, may be ill-suited to serve smallholders in contexts where dominant risks driving default like weather and price shocks are common among members in the localized group. Group members will be unable to insure other members who cannot pay off a loan if, for example, everyone’s harvest is devastated by the same local flood or pest. On the demand side, demand from farmers for formal credit products is low. Even where formal financial products are available, farmers may opt to borrow money from within their social networks, or informal lenders. Preliminary findings from the rollout of Kshetriya Grameen Financial Services , a microfinance portfolio in rural Tamil Nadu,aeroponic tower garden system show that 72% of farmers’ loans at the beginning of the season are from formal sources, but only 35% are from formal sources by the end of the season.
Farmers seem to shift to informal borrowing given quick loan approvals and more flexible loan terms are available. This use of informal borrowing is particularly prevalent among marginalized farmers: 82% of the agricultural loans taken out by marginal farmers were from informal sources compared to 46% among medium-landholding farmers . Even where formal financial services are available, they are often highly disadvantageous to smallholder farmers. Farmers’ credit needs are different from urban micro-credit customers for which the common micro-credit products are designed, with weekly repayments and group liability. Most loan offers and repayment schedules are poorly timed to fit seasonal production cycles and price fluctuations. Uncertainty or risk aversion can also make farmers hesitant to take on debt. Profits in farming are uncertain, and are often low without complementary investments. Options for collateral to back a loan are limited in these environments, and assets like land may be too fundamental to basic livelihood to risk in order to access a line of credit , or unacceptable to back a loan in insecure contracting environments. Accessing and using financial products can also be even more difficult for farmers without high levels of financial literacy.technology adoption, pulling from a range of rigorous non-experimental work and some theoretical work to characterize the constraint facing farmers. We then summarize findings from recent randomized evaluations in an effort to distill policy-relevant insights.Agricultural income streams are characterized by large cash inflows once or twice a year that do not align well with specific times when farmers need access to capital to either make agricultural investments or, for example, pay school fees.
If there is limited access to credit in an area, farmers may not have cash on hand to make agricultural productivity investments unless they are able to save, or can afford the potentially high interest rates of informal lending. However, saving can be difficult for farmers given their limited resources, a variety of demands on their money, and the seasonal cycle of production and prices of their agricultural production. Credit and saving products could help farmers make investments in inputs and other technologies by making cash available when needed. Yet many developing countries, and particularly rural areas, have limited access to formal financial services that could provide this liquidity. Credit constraints have been reflected in farmers self-reports , and are associated with less use of productive inputs like high-yielding varieties . On the supply side, formal financial service providers are often unwilling or unable to serve smallholders. Few products suitable to agricultural livelihoods are available, and despite the wide proliferation of microfinance institutions , most are limited to non-agricultural activities given there are substantial challenges inherent in long-cycle agricultural lending . Lenders in these contexts charge high interest rates to help offset their assessment of the risk that loans will not be repaid. These higher interest rates 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 , further reducing access to credit for the small-scale farmer . Group-liability microfinance models, though popular in urban markets to reach low-income borrowers through social guarantees, may be ill-suited to serve smallholders in contexts where dominant risks driving default like weather and price shocks are common among members in the localized group. Group members will be unable to insure other members who cannot pay off a loan if, for example, everyone’s harvest is devastated by the same local flood or pest. On the demand side, demand from farmers for formal credit products is low.
Even where formal financial products are available, farmers may opt to borrow money from within their social networks, or informal lenders. Preliminary findings from the rollout of Kshetriya Grameen Financial Services , a microfinance portfolio in rural Tamil Nadu, show that 72% of farmers’ loans at the beginning of the season are from formal sources, but only 35% are from formal sources by the end of the season. Farmers seem to shift to informal borrowing given quick loan approvals and more flexible loan terms are available. This use of informal borrowing is particularly prevalent among marginalized farmers: 82% of the agricultural loans taken out by marginal farmers were from informal sources compared to 46% among medium-landholding farmers . Even where formal financial services are available, they are often highly disadvantageous to smallholder farmers. Farmers’ credit needs are different from urban micro-credit customers for which the common micro-credit products are designed, with weekly repayments and group liability. Most loan offers and repayment schedules are poorly timed to fit seasonal production cycles and price fluctuations. Uncertainty or risk aversion can also make farmers hesitant to take on debt. Profits in farming are uncertain, and are often low without complementary investments. Options for collateral to back a loan are limited in these environments,dutch bucket for sale and assets like land may be too fundamental to basic livelihood to risk in order to access a line of credit , or unacceptable to back a loan in insecure contracting environments. Accessing and using financial products can also be even more difficult for farmers without high levels of financial literacy.These credit market inefficiencies result in limited access to liquid capital from formal financial services. There is policy appetite to leverage new technologies and approaches to expand formal credit and savings mechanisms to rural households, particularly given the proliferation of micro-credit in urban markets. But even where micro-credit has expanded widely among low-income urban clientele, evidence from randomized impact evaluations show limited ability for micro-credit to transform the average entrepreneur’s business productivity and revenues, instead providing value through increased flexibility in how households “make money, consume, and invest” . In the smallholder context, we focus specifically on whether expanding access to formal credit on the margin of what is already available shows potential to unlock productive, profitable investments that improve rural livelihoods. Where expanding access to credit shows potential, studies investigate product designs aiming to increase credit access and their benefits specifically for smallholder farmers.Although the experimental evidence suggests that an injection of credit alone is unlikely sufficient to transform smallholders’ livelihoods, there is some encouraging evidence from approaches with careful product design. Financial service design innovation, particularly to encourage storage or savings, can generate more supportive services for farmers that can help them make investments or manage their volatile livelihoods. There is policy appetite to identify whether digital financial services will be able to connect rural borrowers to lending institutions and encourage financial behavior conducive to agricultural investment. More research is needed on these digital financial service channels and product designs, to understand their potential to support farmers’ financial portfolios in a manner that protects farmers while encouraging profitable investments. More research is needed to develop and test credit product designs and delivery channels that fit smallholders’ needs with respect to the timing of offers, repayment structures, and collateral agreements.Smallholder farmers have limited buffer stocks to cope with volatile food prices and climate uncertainty, and typically have few formal financial services to protect them from risk. The systemic risks of agricultural production jeopardize smallholder farmers’ ability to recoup their investments at harvest. Risk exposure therefore plays an important role in farmers’ agricultural investment decisions, including the use of productive inputs like fertilizer .
Rural communities have developed many informal mechanisms to cope with risk. For example, households may buy or sell assets in response to fluctuations in income , and communities may temporarily assist households experiencing a negative shock like an unexpected medical expense with the expectation that the household will do the same for others in the future . While these strategies are useful, in many cases they are insufficient. Farmers face many sources of uncertainty beyond weather and environmental factors including natural disasters, pests, and disease. Price risk and relationships with output markets can jeopardize farmers’ ability to recoup their investments at harvest, and such risks can depress productive input use. In addition to the risks inherent in the agricultural production status quo, new technologies often bear specific risks, such as uncertainty about how to use the technology correctly and how to market the output16. The classic economic view of poor farmers is that their lack of savings and other resources to fall back on causes them to prefer agricultural approaches with more reliable, but lower, average returns. Households often diversify their sources of income to spread around risk . Farmers may see the adoption of new technologies as risky, especially early in the adoption process when proper use and average yields are not well understood. Technologies that carry even a small risk of a loss may not be worth large expected gains if risks cannot be offset .So, while investments exist that could increase profitability, these may also increase the risks of farming. Behavioral biases also come into play around risky decisions . Risk averse farmers may prefer a more certain, but possibly lower, expected payoff over an uncertain payoff from unfamiliar technologies. Ambiguity aversion can lead farmers to stick to their status quo, preferring known risks with a more familiar probability of gains and losses, rather than unknown risks, even in cases where these choices may actually be less risky. Both risk and ambiguity aversion are important considerations when looking to encourage take-up of novel risk mitigating financial products or technologies . Evidence exists that rural households are able to mitigate idiosyncratic risk , but that rural residents are relatively unprotected against aggregate risks – weather and crop price shocks – common to smallholder rain-fed agriculture in poorly integrated markets . Given extreme weather events can destroy a large portion of harvest across a region, and that such weather events are only increasingly likely given global trends including climate change, there is a need for effective risk-mitigation strategies to protect farmers from these aggregate risks.“Linking credit with insurance has mixed results, suffering from the same demand problems that have beset standalone index insurance. The offering of indemnified loans that interlink an insurance product with credit appears promising, but demand for such loans has been shown to be surprisingly low in the few trials that have tested this mechanism ” . Linking credit with insurance has even been shown to drive down credit demand . Recent research has found that companies that engage in contract farming can be well-positioned to adjust the timing of insurance and payment arrangements to increase take-up. Casaburi and Willis find that when a large private company engaged in contract farming in Kenya offered to provide insurance to sugar cane producers by deducting premiums from farmer revenues at harvest time, take up rates at actuarially fair prices were 71.6%, 67 percentage points higher than the equivalent standardly timed contract.