CHAPTER 1: CONCEPT AND DEFINITIONS

 Terminologies related to Agricultural finance should be defined to

avoid ambiguities in understanding the whole concept of finance in
agriculture.
 There is a great deal of ambiguity among finance, rural finance,
agricultural finance, and microfinance.
 By considering this the following definitions for the financial sector to
differentiate agricultural finance from rural finance.
 Finance is narrowly interpreted as capital in monetary form that is
in terms of funds lent or borrowed, normally for capital purposes,
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 Rural finance , as defined by the World Bank, 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.

 RF refers to the financial transactions related to both agricultural and non-

agricultural activities that take place among households and institutions in
rural areas.

 RF provide a range of financial service to rural community at all level of

income.

 Rural finance is an important subject matter for small scale farmers and
modern farming businesses.
 Conti
 Rural finance encompasses the full range of financial services that farmers and

rural households required.

 RF encompass all the saving, lending financing and risk minimizing opportunity.
 RF is a part of domestic financial system and affected by government and central

bank.
 The objective of RF is to improve rural livelihood through providing financial

service and insurance for rural peoples.

 The service provide by RF are: Saving, risk minimize, remittance service,

Lending, guarantee fund, credit, Investment, loan and insurance.

 The role of rural finance
 Improve rural livelihood
 Provide financial service for people
 Providing insurance
Rural community demanded the following financial service

1, Intermediaries; involve resource mobilizing and transferring

surplus to deficit and provide safe, liquid and convenient saving.

2, saving; wealth kept in the form that preserve its value and is
liquid and readily accessible.

3, Credit; for consumption smoothing and to invest in agricultural

sector. The main objective of investing in agricultural sector is to
modernize agriculture.

4, Insurance; insurance is important to safe guard rural

community and provide service to rural people to cope shock like
weather variability.
 conti
 The main role of RF reduces risk and poverty associated to rural society
and brings economic growth through capital formation.

Wealth of nation

Productivity of labor The ratio of productive and

unproductive labor

Division of labor Capital

accumulation

Extent of Capital
market accumulation

Capital accumulation
 Micro finance

 Microfinance is the provision of financial services for poor and low

income people and covers the lower ends of both rural and agriculture
finance.
 Microfinance is defined as the attempt to improve access to small deposits and
small loans for poor households neglected by banks or is defined as the
provision of financial services to the poor involving small deposits and loans
 Most microfinance institutions provide collateral-free small loans to low income
households.
 Microfinance can be also defined as financial instruments, such as loans,
savings, insurance and other financial products that are tailored only to the poor.
 Microfinance is created in the economy for the economic benefit of the poor
and to alleviate poverty
 Microcredit is the lending side of microfinance .
 Microcredit loans help the poor to be involved in income generating
activities that allow them to accumulate capital and improve their
standard of living.
 Agricultural finance

 Agricultural finance is defined as a apart of rural finance dedicated to financing

agricultural related activities such as input supply, production, distribution,
wholesale, processing and marketing.

 Agricultural finance is the economic study of the acquisition and use of capital in
agriculture.
 It deals with the supply of and demand for funds in the agricultural sector of the
economy.
 Agricultural Financing is needed for investments in sustainable production systems

and climate adaptation technologies.

 Agricultural finance provides many opportunities for financing various players from

production to processing and distribution of agricultural product through value

chain.
 A.F examine and analyze the financial aspect pertaining to farm business which is

the core sector in Ethiopia.

 cont.
• The role of agricultural credit and finance
 Effective resource allocation and credit expansion
 to intensification agricultural output and productivity,
 adoption of and use of new technologies, improving farm’s inputs
such as fertilizer, purchased from farm finance.
 Accretion to in farm assets and farm supporting infrastructure
 needed to create the supporting infrastructure for adoption of new
technology.
 stabilizing household’s income
 increasing rural employment and reducing poverty.
 catalytic role in strengthening the farm business

 Agricultural finance is mainly designed to provide financial service to

the actors who involve in agricultural production such as input supply,
production and whale sale in agricultural sector
cont
 The agricultural finance is required for the following
reasons:
 The scope for extensive agriculture in Ethiopia is limited. Therefore,
increase in Agricultural production is through intensification and
diversification of farming.
 Farmers’ economic condition is subject to frequent risk ,uncertainty
onslaught of flood, drought, famine etc.
 In order to sustain the development of agro-based industries, there
should be a substantial increase in the supply of raw materials needed
for such industries.
 The weaker sections of the farming community should be motivated
to participate in development programmes by giving financial
assistance to acquire productive assets
 Most of the farmers are trapped in the vicious cycle of poverty i.e.,
low returns → low saving → low investment → low return. To break
this cycle, credit has to be injected in agricultural sector.
 1.2. Role of Agricultural Finance to Growth
• Technological revolution including mechanization, improved
varieties, modern chemical pesticides and fertilizers, and new
production methods have contributed to the increase in production
per acre, per animal, per labor-hour.
• These technological and structural changes in agriculture have
increased the risks of owning and operating a farm business.
•The increased use of credit in farm business along with narrower
profit margins has increased the financial risk of farming.
•The importance of finance in agriculture has significantly increased
over time in accordance with the change in technology and the
increase in production.
 1.3. Functions and Component of Financial Systems
 Acquisition of finance for some business objectives will be effective if the
acquired finance is managed by appropriate financial systems.
 The financial system plays a key role in a market economy because of its
importance in mobilizing and allocating resources to finance agricultural
investment projects that are necessary for economic development.
 A poorly functioning financial system can be a major constraint to
private investment and entrepreneurship without 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.
 Component of financial system
1, Money, to pay for purchase and store wealth
2, financial instrument, Facilitate the trading, diversification, and
management of risk and to transfer resource from saver to investor
and to transfer risk to those best equipped to bear it.
3, Financial market ,to buy and sell financial instrument.
4, financial institution, to provide access to financial market and
collect information and Produce information about possible
investments and allocate capital;
5, Regulatory agency, Monitor investments and exert corporate
governance and to provide oversight for financial system
6, Central bank, to monitor financial institution and stabilize the
economy
 1.3. Financial system in agriculture

 People living in poverty, like in Ethiopia, need a wide range of financial

services for consumption smoothing, running their business and building
assets.

 But due to collateral problems, poor people in most cases have no credit
access from Banks
 Credit is defined as a legal contract between the lender and the borrower,
where the borrower receives resources or wealth with a promise to repay in
the future.

 Credit refers to terms and conditions associated with deferred payment

arrangements.
•Credit is a means to enable investment by solving a liquidity problem.
 conti
•Lenders participate in the financial system by providing credit and liquidity to
the borrowers.
• In return the lenders expect to be repaid in timely manner with interest and/or
fees that are agreed on the terms of the loan.
• Interest rate on the credit varies based on the amount, riskiness of the borrower
and the supply and demand of credit in the loan market.
 By consuming the credit made available by the lender, borrowers play an
important role in the financial system. Borrowers enter the financial market
intending to get a loan to cover a need.
 In order to ensure a smooth interaction between the lenders and the
borrowers, the financial system needs to be fair, transparent and non-
 conti
Sources of Agricultural Finance:
•This can be divided into two categories:
•(i) Non-institutional sources.
•(ii) Institutional sources
•(i) Non-Institutional sources are the following:
•(a) Moneylenders
•(b) Relatives
•(c) Traders
•(d) Commission agents
•(e) Landlords
•(ii) Institutional sources:
•(a) Cooperatives
•(b) Scheduled Commercial Banks
•(c) Regional Rural Banks (RRBs)
 There are different source of financial system and source of finance in our
countries.
 conti
 Formal source of finance include bank, cooperative, government
association.
 Informal source of finance are the financing service those getting
from informal lender such as; idir, equb, friend and relative, money
lender and Neighbors
 In Agriculture, access to credit and financing service is primarily
seen as a tool to increase agricultural output and productivity,
adoption of modern technologies, and improving farm’s inputs such
as fertilizer, increasing rural employment and reducing poverty.
 A well-functioning financial system that makes an efficient
transaction of credit possible is essential to the functioning of the
overall economy.
 Challenge in Agricultural finance

 Production risks linked to natural hazards (such as droughts,

floods and pests)
 Limited collateral – farmers generally lack the collateral
traditionally required by banks to secure loans.
 Land use management/ land ownerships -Women who are
majority players in the sector lack traditional collateral to
access credit.
 Regulatory Environment Contracts those are not enforceable
 Poor infrastructure in rural areas — for example, poor
roads, erratic electricity provision
 High transaction cost; a cost incurred to get adequate
information for transaction,
 Increasing climate variability and rampant land degradation
 CON
Challenge of agricultural finance

 Transportation cost  Rain fall

 Lack of collateral  Institutional capacity  Population density  Natural disaster
 Land fragmentation  political intervention  Accessibility  seasnality
 Poor Infrastructure  policy  Culture
 Source of income  legal system
 information
 summary
 Rural Finance is the provision of financial services in rural areas that
support a wide range of economic activities and households of various
income levels.
 It includes financial services that support agricultural as well as non-
agricultural activities. In contrast,
 Agricultural Finance is the provision of financial services that support all
agriculture-related activities, including those of processors, distributors
and exporters who may be located in rural, urban or peri-urban areas.
 Microfinance means the provision of small-scale financial services that
include savings, insurance, loans (productive, emergency, consumption),
leasing products, money transfer services, or guarantees.
 UNIT TWO: RESOURCE ACQUISITION AND USE OF
CREDIT IN AGRICULTURE
 Why the capital requirements of a farm business are large and
increasing?
Technological change
Inflation
Increase in size of farm land
How does farmers capital requirements met?
farmers met their capital requirement through credit
 Agricultural credit is one of the most crucial inputs in all
agricultural development programmers. For a long time, the major
source of agricultural credit was private money lenders.
 But this source of credit was inadequate, highly expensive and
exploitative.
 conti
 For what purpose farmers required capital through financial service?
 Buying agricultural inputs like seeds, fertilizers, plant protection chemicals,
feed and fodder for cattle etc.
 Supporting their families in those years when the crops have not been good.
 Buying additional land, to make improvements on the existing land, to clear
old debt and purchase costly agricultural machinery.
 Increasing the farm efficiency as against limiting resources i.e. hiring of
irrigation water lifting devices, labor and machinery.
 The questions related to the amount, type, timing, and benefits of credit are
very important for a farmer's decision in acquiring additional funds using
credits.
how much credit to use in the farm operation and where to use it?
When farmers need credit? And how long farmers need credit?
What are the contributions that credit can make?
What types of credit are available? How a farmer can work with a lender for
successful credit?
2.1. Resource Acquisition in Agriculture

 What are the contribution that credit can make?

• Resources of a farm business are limited in which case an owner of a farm
business should try to acquire the optimum size of financial and other
resources in order to involve in an optimum size of operation.
• Sources of funds used to control capital assets can be classified as equity
and non-equity or debt financing.
• Equity capital is the capital owned by the operator while
• no equity capital is the capital gained from debt financing.
• They include savings and retained earnings, gifts and inheritance, pooling
equity capital through a partnership or corporation, leasing, contract
farming, and borrowing.
 Debt financing means you’re borrowing money from an outside source and
promising to pay it back with interest by a set date in the future.
 Debt financing requires entrepreneurs to pay back the amount borrowed as
well as interest rate
 Equity financing means someone is putting money or assets into the
business in exchange for some percentage of ownership.
 cont
 from two financial source, which financial source more advisable to invest within agriculture sector?
Alternative sources of resource acquisition for agriculture
 Savings and Retained Earnings
 Gifts and Inheritances
 Pooling Equity Capital
 Leasing
 Contract Farming
 borrowing
 Savings and Retained Earnings
 Farmers can use their personal savings or profits from previous harvests to invest in their agricultural
operations. This provides them with a self-financing option that doesn't involve external debt.
 Except for gifts and inheritance, savings provide the backbone for farm capital.
 Savings provide not only capital, as such, but risk-bearing ability (reserves) and demonstrate capacity to
earn and save the two very essential components of a strong credit rating.
Gifts and Inheritances
 In some cases, farmers may receive land, equipment, or capital as gifts or inheritances from family
members. This can help them expand their operations without incurring additional costs.
 much of the owner equity in agriculture can be acquired through gifts and inheritances from the previous
generation of farm operators.
 The disadvantage of this type of source of capital is that such funds are often not received when needed
 conti

 Pooling Equity Capital There are several methods of combining

equity capital in a farm business.
•Farmers can pool their resources with other individuals or
organizations to create an equity fund for agricultural projects. This
shared ownership model can provide access to larger amounts of capital.
 The primary advantages of pooling equity capital are to take
advantage of economies of size and to distribute risk among two or
more persons.
 Generally, the participants in a farm business venture should share
profits in direct proportion to their respective contributions of labor,
management, and capital.
 The pooling of equity capital follows various organizations including
partnerships, and incorporation to pool capital from family members,
and non-farm equity capital from nonfarm investors.
 Leasing
 A lease is a binding legal agreement whereby one party holding ownership of
an asset (lessor) agrees to rent the underlying asset to another party (lessee)
willing to comply with the terms and conditions entailing the lease.
 lease is a finance agreement in which lessor (owner of the asset) purchases
the asset and let the lessee (user of the asset) use the asset for a limited period
against periodic payments, i.e. lease rentals.
 A lease is basically a capital transfer agreement that gives the lessee (the user
farmer) control over assets owned by the lessor for a specific period of time
for an agreed-upon payment or rent.
 Leasing is an alternative to purchase an asset in order to acquire the services
of that asset. By leasing an asset the lessee essentially acquires its use value
from the lessor, who actually purchased and owns the asset.

 Lessor refers to the person who leases his property to the other person on the
lease as per the lease agreement made between the parties containing all the
required terms and conditions of the lease.
 conti
 There are various types of leasing facilities. The major types of
leasing common in agriculture include financial lease, operating lease,
and leverage lease.
 A financial lease is a lease where rewards and risk associated with the
leased asset gets transferred to the lessee with a transfer of the asset
while
 in operating risk A lease in which all risks and rewards related to asset
ownership remain with the lessor for the leased asset is called an
operating lease.
 leverage lease defined as a lease arrangement in which the lessor
provides an equity portion (say 25%) of the leased asset’s cost and the
third-party lenders provide the balance of the financing.
 Three parties are involved in case of leveraged lease arrangement –
Lessee, Lessor and the lender.
 conti
Basis for Comparison Financial Lease Operating Lease

A commercial contract in which the A commercial contract where the

lessor lets the lessee use an asset lessor allows the lessee to use an
1. Meaning
instead of periodical payments for asset in place of periodical payments
the usually long period. for a small period;

A financial lease is a long-term Operating lease is a short-term

2. What it’s all about?
concept. concept.

The ownership is transferred to the The ownership remains with the

3. Transferability
lessee. lessor.

4. The term of the lease It is a contract for the long term. It is a contract for a short term.

The contract is called a loan The contract is called the rental

5. Nature of contract
agreement/contract. agreement/contract.

In the case of a financial lease, the In the case of an operating lease, the
6. Maintenance lessee would need to take care and lessor would need to take care and
maintain the asset. maintain the asset.

7. Risk of obsolescence It lies on the part of the lessee. It lies on the part of the lessor.

Usually, during the primary terms, it In the case of an operating lease, the
8. Cancellation can’t be done; but there can be cancellation can be made during the
exceptions. primary period.

In a financial lease, the lessee gets

In an operating lease, the lessee is
9. Purchasing option an option to purchase the asset he
not given any such option.
has taken on a lease.
 conti
 Difference between leverage lease and operating lease is
explained as
 In leverage lease, the risk and obligations are with lessee. Whereas
in operating lease, the risk and obligations are with lessor.
 In leverage lease, three parties are involved a lessor, a lessee and
the lender. Whereas in operating lease, only two parties are
involved a lessor and a lessee.
 In leverage lease, funds are arranged by lessor and the lender
(third party or by some financial institutions). In operating lease,
total funds are arranged by lessor only.
 In leverage lease, payments can be shown as leased assets in
balance sheet. Whereas in operating lease, payments can’t be
shown in balance sheet.
 conti
 Leverage Leasing including real estate, machinery, and livestock leasing.

Real-estate leasing: Leasing is a common way for farmers to obtain control of

additional land. Real estate leases can be the share lease or the cash lease.
With a share lease part of a crop or livestock production is paid to the lessor as
rent.
With cash leasing arrangements, the lessor is paid a specified cash payment and
usually furnishes the land, building, and other improvements.
• Machinery leasing: Purchase of machinery often with borrowed funds is the
traditional method of acquiring control over farm machinery.
• Livestock leasing: The typical livestock-share lease contract usually covers land,
buildings, and livestock.
• Advantages of leasing to the lessee:
Higher incomes
Certainty:
Additional source of finance:
 Contract Farming
 Contract farming is an active vertical coordination between growers or
producer of an agricultural product and buyers or processors of that product.
 Contract farming involves agreements between farmers and buyers or
agribusinesses.
 In this model, the buyer provides inputs and technical support to the
farmer in exchange for the produce. This can be a source of financing
for farmers as they receive support upfront
 contract farming involves businesses signing contracts with farmers to grow
for them a specific crop in order to get a specific product, at an agreed
quantity, quality and time, where in return the business promises to buy back
the produce at an agreed price or range of prices in addition to other benefits
as outlined in the contract”.
 Forward contract refers to a futures contract to buy or sell a specific
physical commodity at some time in the future.
 There are three basic types of forward contracts used in farming
namely market specification contracts, production-management
contracts, and resource-providing contracts.
 conti
 Market specification contracts: such type of contract is a pre-harvest
written or verbal mutual agreement between a farmers and a contractor
about specifying quantity, quality, and price and delivery time.
 Resource providing contracts: under this type of contract the contractor
not only provides a market for the product, but also provides key farm
inputs at several stages of production to farmers on a credit base.
 The timely delivery of inputs is a key to success under this contract
and this type of contract is applied when the product quality depends
on the inputs used .
 Production management contracts: This type of contract are a
combination Production and management contracts.
 in this type of contract the producers coincide to follow correct and
consistent production methods, input use, specific cultivation and
harvesting systems.
conti
Contract farming offers compelling benefits to both buyers and producers

CF is an agreement between
between buyers
buyers and
and CF benefits buyers, producers,
producers, and
and even
even
at aa later
producers to trade at later date
date to the
people not party to the agreement
agreement

“Contract farming is an agreement between Benefit to producers

farmers and processing and/or marketing • Provision of inputs and production
firms for the production and supply of services
agricultural products under forward • Access to credit
agreements, frequently at predetermined • Introduction of appropriate technology
prices.” • Skill transfer
-FAO, Eaton and Shepherd (2001) • Guaranteed and fixed pricing structures
• Access to reliable markets
• Higher incomes
“Contract farming may be defined as Benefit to buyers
agricultural production carried out according • Reduced transaction costs
to a prior agreement in which the farmer • Elimination of unnecessary middle-men
commits to producing a given product in a • Economies of scale with aggregation,
given manner and the buyer commits to transportation, and marketing
purchasing it. Often, the buyer provides the • Guaranteed quality and quantity supply
farmer with technical assistance, seeds,
Benefit to others
fertilizer, and/or other inputs on credit and
offers a guaranteed price for the output.” • Non participating farmers in contract
might also benefit from spillover of
-IFPRI, Nicholas Minot (2011)
technology from participating farmers
Source: : FAO, Contract farming – partnership for growth; Minot (2011), CF in Sub-Saharan Africa: opportunities and challenges; Minot (2007), CF in developing countries: patterns,
impact and policy implications;
34
 2.1.6. Borrowing

• Borrowing constitutes the remaining method of farmers use to acquire

funds. The word 'borrow' means to receive some thing with the
understanding that it or its equivalent will be returned as agreed upon.
• Farmers can also acquire resources by borrowing money from banks,
financial institutions, or microfinance organizations.
• Loans can be used to invest in seeds, equipment, land, or other
agricultural inputs. However, borrowing involves repayment with
interest.
2.2. Role and Classification of Credit

 has The potential to improve net farm income in several way

 Create and maintain adequate size
 Increase efficiency, utilization of idle resources, and intensity of
production to secure efficient use of resources;
 Adjust to changing economic conditions of technology and
market;
 Meet to seasonal and annual fluctuations in income and
expenditures;
 Protect against adverse conditions of weather, disease, and price;
and
 Provide continuity of business during transfer.
NB,
 In absence of credit farmer cope liquidity problem and distress by selling
their livestock and their food product.
2.2.1. Classification of Credit

Four primary classifications are presented here based on time, purpose, and
lender.
Classification by time: Based on the length of the terms of loans, credit can be classified
into three:
• a. Short-term credit (production credit):
 Monthly credit (0-3 months);
 Seasonal credit (3-9 months); and
 Annual credit (9-1 year).
b. Intermediate-term credit: 1-10 years.
c. Long-term credit: Real-estate credit (more than 10 years).
 Classification by purpose: This classification can facilitate analysis of the profitability of
a specific loan if records as to income and expenses are kept.
 Production loans (short-term and intermediate-term loans): Used to buy inputs, pay
operating expenses, buy feeder livestock, range livestock, dairy cattle, machinery, and
finance storage.
 Real-estate loans (long-term loans): Used to purchase a farm, additional land, finance
buildings, drainage, irrigation, and other permanent or long-life improvements.
 Classification by lender: Lender classification of credit is frequently used
because the policies of lenders vary greatly:
1. Short-term and intermediate-term (non-real-estate) loans may be provided
by commercial banks, credit associations, commodity credit corporations,
merchants and dealers, or individuals.
2. Long-term (real-estate) loans may be provided by commercial banks,
insurance companies, or individuals.
2.3. Bases of Credit
• Numerous factors influence the creditworthiness of a farmer. Credit
managers usually talk of the seven C's of credit: character, capacity,
collateral, capital, condition, courage, and competition.
1.Character: Character or integrity is the most important factor of
confidence.
2. Capacity: the financial ability to repay a loan with present income.
3. collateral: property promised to assure repayment of a loan.
4. capital: refers to financial assets (bank accounts, investments, and
property) you possess after deducting your debts.
5.conditions: refer to the overall economic climate and external
environment
6. Courage: This is the courage of the credit executive when faced with a
difficult decision making situation.
Competition: The extent of competition to extend credit also matters to
get credit.
 2.2.1. Features of Successful Agricultural Credit Provider

1. Household as a financial unit:

2. Managing systemic risk
3. Long term relationships:
4. Various types of collateral:
5. Decentralized decision making:
6. Regular monitoring:
7. Management and information system:
8. Adapting more flexible rural services
 2.2. Capital Structure, Leverage and Financial Risk

 Capital structure refers to the amount of debt and/or equity employed by a firm to fund its
operations and finance its assets.
 A firm’s capital structure is typically expressed as a debt –to –equity or debt-to-capital ratio.
 Capital structure is how a company funds its overall operations and growth.
 Capital structure is the particular combination of debt and equity used by a company to
finance its overall operations and growth.
Debt consists of borrowed money that is due back to the lender, commonly with interest
expense.
 Debt comes in the form of bond issues or loans,
 Debt is one of the two main ways a company can raise money in the capital markets.
 Companies benefit from debt because of its tax advantages; interest payments made as a result
of borrowing funds may be tax-deductible.
Equity consists of ownership rights in the company, without the need to pay back any
investment.
 Equity capital arises from ownership shares in a company and claims to its future cash flows and profits.
 Equity may come in the form of common stock, preferred stock, or retained earnings.
 Equity represents a claim by the owner on the future earnings of the company.
• Equity is more expensive than debt, especially when interest rates are low.
o The debt-to-equity (D/E) ratio is useful in determining the riskiness of a company's borrowing practices.
•
 Some of the key factors affecting capital structure, including the following:
 Company life cycle:
 Cost of capital:
 Financing considerations:
 Competing stakeholder interests:
 Flexibility of financial plan
 Choice of investors
 Sizes of a company
 Financial risk Is the risk arising due to the use of debt financing in the capital structure.
 Financial leverage is the extent to which fixed income securities and preferred
stock are used in a company’s capital structure.
 The use of financial leverage also has value when the assets that are purchased
with the debt capital earn more than the cost of the debt that was used to
finance them.
• Financial leverage is the use of borrowed money (debt) to finance the purchase
of assets with the expectation that the income or capital gain from the new
asset will exceed the cost of borrowing.
 2.3. Credit risk assessment and lender-borrower relationship
 People living in poverty, like in Ethiopia, need a wide range of financial services for consumption
smoothing, running their business and building assets.
 But due to collateral problems, poor people in most cases have no credit access from Banks.
Microfinance offers financial services such as loans, savings and micro insurance to the poor people
either in individual or in a group basis.
 Credit is defined as a legal contract between the lender and the borrower, where the borrower
receives resources or wealth with a promise to repay in the future.
 The relationship between the borrower and lender has always been known to be an integral factor in
the loan approval process.
 Lenders participate in the financial system by providing credit and liquidity to the borrowers.
Credit Risk Assessment
 Credit risk assessment involves estimating the probability of loss resulting from a borrower’s failure
to repay a loan or debt.
 Traditionally, it refers to the risk that the lender may not be able to receive the principal and interest.
 Credit risk assessments are carried out on the borrower’s overall ability to repay a loan according to
its original terms. To assess credit risk, lenders often look at the 5 Cs:
 Credit history,
 Capacity to repay,
 Capital,
 The loan’s conditions and
 Associated collateral
 Key Principles of Agricultural Credit

I. Equity or increasing risk principle: - It helps to decide the farmer

Optimum limit of Borrowing because the borrowing money always
increasing risk. Hence, he is forced to pay the interest for borrowed
money.
II.Added cost- added return principle: - it guides the farmer in
deciding how profitably he can use the credit.
III.No profit- no loss principle: - this shows the limit of borrowing for
the expansion of the farm business without losing “the net worth of
the farm”
IV.The opportunity cost principle: - it helps the farmer to determine
the most use of credit or loan/ borrowed fund
• NB: - cost of credit: is total amount of interest on loan.
• - cost of borrowing: is total amount of interest on loan plus
service charges like, stamps, paper charges, legal charges,
documentation charges, inspection costs.
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