Risk, insurance and small farm credit in developing countries: A policy proposal

Published date01 July 1986
Date01 July 1986
DOIhttp://doi.org/10.1002/pad.4230060308
PUBLIC ADMINISTRATION AND DEVELOPMENT,
k‘ol.
6,
309-3 19 1986
Risk, insurance and small farm credit in developing
countries: a policy proposal
PAUL
MOSLEY
University
of
ManchesteP
SUMMARY
Lending to small farmers is often too risky
for
commercial banks; consequently extremely
high interest rates have to be paid. Agricultural development banks go some way towards
solving the problem. However, default rates tend to be high,
so
that credit has to be
subsidized by government grants
or
overseas aid. One cause of the problem is that loans lack
proper security. Risks are increased by uncertainties of weather, disease and produce prices.
The paper proposes
a
system
of
compulsory insurance
of
crops and livestock. The risks and
associated costs are quantified
for
one particular case: the Small Farmer Development
Programme administered by the Agricultural Development Bank of Nepal. The scheme is
assumed to
run
on
a no-profit,
no-loss
basis. The data suggest that the cost of insurance
premiums, when added to Bank interest rates, would still leave the Bank competitive as a
source of rural credit. The practical problems of implementation are considered and deemed
surmountable by reinsurance and graduated premiums.
THE
PROBLEM
It is a truth universally acknowledged that credit markets in underdeveloped rural
areas are by their very nature imperfect,
so
that market forces left to themselves
produce an outcome highly obstructive to the process of rural development. The
reasons, briefly summarized, are that borrowers are often too poor to offer
adequate security for a loan, lenders do not have adequate information to
distinguish good from bad lending propositions, and the judicial system is often
unable to enforce the repayment of arrears
on
private debts.
In
these conditions of
extreme risk, commercial banking institutions keep right out of the small farm areas
and the ‘urban informal sector’, which
if
able to obtain credit at all can only obtain
it from private moneylenders, who deal only with the individuals who are known to
them, and charge an interest rate which reflects not only a massive risk premium but
also substantial monopoly profits. This rate is often five or ten times the rate
charged by commercial banks in towns (see Table
1);
it clearly constitutes a very
substantial barrier to increases in Third World food production.
This problem
is
now well understood, and most developing countries now possess
government-financed agricultural development banks designed precisely to remove
this imperfection in rural credit markets. However, in removing one imperfection
these institutions have frequently created another. For political reasons they usually
*
Paul Mosley
is
Professor
of
Development Economics and Policy, Department
of
Administrative
Studies, University
of
Manchester, Precinct Centre, Oxford Road, Manchester, M13
9QS
0271-2075/86/030309-ll$OS.SO
0
1986
by John Wiley
&
Sons,
Ltd.

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