CHAPTER SIX

AGRICULTURAL FINANCE & RURAL CREDIT

MARKETS
1 Introduction

•Finance is the art and science of managing money. It is concerned with the
process, institutions, markets involved in the transfer of money among and between
individuals, businesses and governments.

Financial service providers offer:

rural finance (financial services used in rural areas by people of all income levels),
microfinance (financial services for poor and low-income people), and
agricultural finance (financing of agriculture-related activities, from production to
market)
Why do People Demand Credit in Rural Areas?
• Short-term credit to cover operating expenses;
• Intermediate credit for investment in farm equipment and real estate
improvements;
• Long-term credit for acquisition of farm real estate and construction financing;
• Debt repayment and refinancing.

Types of Rural Credits

There are three types of rural credits:
1. Short-term loan/credit:
2. Medium-term loan/credit
3. Long-term loan/credit
 Advantages and Disadvantages of Credit
Advantages of Credit
Economical
Increases productivity of capital
Convenient
Expand internal and external trade
Encourages investment
Increases demand
Utilizes resources
Price stability
Helpful to government
Disadvantages of Credit
Too much and too little credit harmful
Growth of monopolies
Wastage of resources
Cyclical fluctuations
Extravagance
Speculation and uncertainty
Black money
Political instability
2. Bases of Credit

Character
Capacity (risk-bearing ability) Condition (return)
Collateral
Courage
Capital (repayment capacity)
Competition
3. Sources of rural finance/ credit
Suppliers of rural and agricultural finance:
1. Value Chain Actors:
Exporters/wholesalers
 Processors; local traders
Producer groups; farmers
Input suppliers
2. Financial Institutions:
Banks (commercial, agricultural banks, state development banks)
Non-bank financial institutions
Not-for-profit MFIs
Classification of source of finance
• Sources of finance can be classified based on a number of factors. It can be:-
Internal or External
Short-term or Long-term
Equity or Debt
1. Internal or External
Internal sources of finance are the funds readily available within the organization.
 Personal savings
 Working capital
 Retained profits
 Sale of fixed assets
•External sources of finance are from sources that are outside the business.
Ownership capital
Non-ownership capital
4. Characteristics of Rural Credit Markets

o Informational Constraints
o Segmentation
o Interlinkage
o Interest Rate Variations
o Rationing
o Exclusivity
 5. Agricultural Credit Policies In Ethiopia:
After Financial Liberalization

• Financial liberalization: is the act of deregulation of domestic financial markets

and liberalize capital account. It is advocated that financially repressed systems
should abolish or relax:-
• Interest rate controls
• Eliminate or greatly reduce controls on allocation of credit
• Switch to market based indirect methods of money supply control
• Develop money and capital markets
In Ethiopia Financial liberalization began at the end of 1992.

The financial reform undertaken in Ethiopia include:

 Elimination of priority access to credit,
 Interest rate liberalization,
 Restructuring and introduction of profitability criteria,
 Reduced direct government control on financial intermediaries
 Limits bank loans to the government,
 Enhancement of the supervisory, regulatory and legal infrastructure of the
NBE,
 Allowing private financial intermediaries through new entry of domestic private
intermediaries (rather than privatization of the existing ones) and
 Introduction of treasury bills auction markets.
 As a result of the liberalization,
• Nominal interest rates on deposits and loans were raised by 60 – 90% and 58-
144% in 1992, respectively.
• Interest rate liberalization was accompanied by other reforms including the
floating of the exchange rate and trade liberalization.
• Discrimination of credit access and interest rates by type of ownership (i.e.
between state owned enterprises, cooperatives and private firms) were eliminated.
• Sectoral interest rates discrimination was reduced, and domestic establishment of
private financial institutions was allowed and encouraged through proclamation
number 29/1992 (NBE, 1992).
• Banks are no longer required to specialize their credit services to certain sectors of
the economy.
• Banks no longer face restrictions on the types and sources of deposits they accept.
• Banks Entry restrictions into banking were lifted for domestic banks.