A New Approach to Institutional Lending and Loan Administration in Rural Areas of Ldcs
International review of economics and Business (RISEC), Vol. XLV, No. 4, 1998
Posted: 9 May 2005
In most low-income economies, agriculture represents the main sector since it contributes substantially to GDP, sustains a great share of total population and is an important earner of foreign exchange. The lack of adequate financial services seems to be one of the major constraints in expanding agricultural output. With particular reference to the institutional sector of rural financial markets, given that collateral is not often available and/or not easily enforceable, credit risk evaluation represents the core problem faced by banking industry doing business in a peasant milieu. Conventional methods for assessing credit worthiness, mainly based on the analysis of financial quantitative data are seldom applicable to a large segment of potential customers, as these borrowers are mostly smallholders, belong to the informal sector of the economy and are totally unable to provide adequate accounting evidence. Furthermore, in many instances these potential small borrowers are not in a position even to make available the very basic financial information to lending institutions. It is, therefore, clear that banks which intend to extent their business to rural credit markets in LDCs have to design and adopt new methods in loan administration, and particularly in loan appraisal. The increase in depth of creditworthiness analysis does not represent, however, a workable solution in such a context because it is too costly to predict and determine the extent of default risk for each borrower in relation to the average size of rural loans in the segment of the market represented by smallholder farmers. Financial institutions involved in this business should rather develop and implement new, more suitable, methods and take full advantage of the available information, which is easy to be collected and quite unexpensive to be handled because of its very simple nature. The paper introduces an evaluation model of repayment capacity based on symptomatic information, which could replace, when necessary, conventional information on profitability and customer's financial equilibrium. The symptomatic information is mainly of qualitative nature and it is based on gathering of data such as the kind of activity carried out by the customer, the location and the size of the farm, the level of technology used, output dependence on climatic conditions, the flexibility of productive structure towards technological innovation and market change. To some extent the symptomatic model recalls the lender's decision making process which most likely occurs in the informal market.
Keywords: Credit risk evaluation, loan administration, rural financial markets of LDCs
JEL Classification: O16, O17
Suggested Citation: Suggested Citation