Adoption, Access To Agricultural Financial Services In Rural Ethiopia

The Ethiopian government, for the past decades, has committed at least 10% of the federal budget to the agricultural sector development for the past decade. Although improvements in productivity is observed, there is still a long way to go. One of the reasons for this is the slow adoption of new technology. It is believed slow adoption can be caused by low access to financial services prohibiting farmers from investing in yield-improving technologies.

The Ethiopian government, for the past decades, has committed at least 10% of the federal budget to the agricultural sector development for the past decade. Although improvements in productivity is observed, there is still a long way to go. One of the reasons for this is the slow adoption of new technology. It is believed slow adoption can be caused by low access to financial services prohibiting farmers from investing in yield-improving technologies.

Despite these sustained efforts by the government, there remains a clear financing gap in the sector. One of the major factors contributing to this gap is the concentration of financial institutions in urban areas, while the majority of the population (> 80%) resides in rural areas.

These challenges are further exacerbated by the fact that rural households are less likely to use modern financial institutions; instead, they rely on informal alternatives like informal institutions, safety net programs, and cost-cutting measures (primarily non-food costs).

The Ethiopian Economics Association conducted a literature and empirical review (three-round panel survey) to analyze demand and supply dynamics between 3,005 rural households from across the country and their access to modern financial services. The study also analyzes the existing literature on agricultural financing in Ethiopia through the past decade, identifying key areas of focus.

Saving

MFI savings show positive trends averaging a growth rate of 32.53% annually for a decade (2010 – 2019) and total savings growth exceeding total borrower growth. Despite this, MFIs’ capacity to meet loan demands has decreased due to the increasing amount of loan per borrower.

While many respondents did not have knowledge of savings instruments, those that reported utilizing savings primarily relied on in-kind or cash savings (72.6%). Expectations of higher returns and inflation protection were identified as primary motivations for adopting in-kind savings, while safety issues and high liquidity value drove cash savings.

Higher-income, land, and livestock holdings, and closer proximity to financial institutions had positive correlations with utilizing savings instruments, especially on in-kind saving.

Credit

Of the total amount of credit supplied to the agricultural sector, 80% was sourced from formal and semi-formal institutions. Total outstanding agricultural credit grew from 10.9 billion birr in 2010/2011 to 21.1 billion birr ln in 2019/2020. Despite this growth in credit, the share of loans that goes into the sector declined from 13.61% to 2%.

Given the low uptake of bank loans by smallholder farmers, the research preferred to use the microfinance sector to illustrate the state of agricultural credit.

Total outstanding credit owed by the agricultural sector to MFIs increased by more than 156% between 2014 and 2019. However, its share against other sectors declined by 8.1% during the same period.

However, nearly a quarter of all respondents reported seeking financing from either formal or informal sources, indicating a significant gap on the customer side. Fear of indebtedness, high-interest rates, low liquidity constraints, fear of default and related consequences, lack of collateral, preconceptions, lack of knowledge, and prior debt were all significant factors deterring respondents from taking on loans. The rate of success for those that did seek credit, on the other hand, was 91%, suggesting the need for efforts to address customer-side barriers to financing.

Friends and family loans continue to dominate, accounting for 42.5% of requests; requests to MFIs accounted for 30% of all requests. Flexible payback arrangement is the primary factor for people to opt for informal loans.

Distance from financial institutions, on the other hand, is linked to a lower likelihood of seeking financing. Additionally, the concentration of financial institutions in urban areas was identified as a primary factor affecting accessibility. While residents of urban areas only travel an average of one kilometer to access financial services, rural residents travel an average of 15 km. This gap is one of the primary factors that increase the use of traditional systems like Iqub and Idir.

Risk and Insurance

The research identified the primary risks that smallholder farmers face are adverse market prices, livestock disease, drought, illness of a household member, crop disease, livestock death, theft, death within the family, unemployment, and unrest.

Depending on the prevailing risk, respondent said they use some coping mechanisms, which includes, selling produce and assets and reducing consumption.

Development agents play a significant role in driving the availability of insurance services in rural areas. A significant portion of respondents reported they obtained information on insurance services from development agents, followed by radio.

Yet, the adoption of insurance services remains suboptimal. Only 4.3% of all respondents purchased crop insurance in the previous five years. The average annual premium payment was 213 ETB per policy.  21.5% of the respondents affirmed their willingness to purchase index-based crop insurance.

Trust was found to be a significant contributing factor for seeking index-based insurance services both for crops and livestock. These findings are consistent with studies that have shown higher uptake for insurance products when presented by communal leaders.

Higher income, land size, membership in local organizations, and time are positively correlated with increased interest in insurance.  

Challenges

Agricultural financing faces both demand and supply-side challenges. Inadequate all-weather roads, lack of internet services, and product mismatch dominate challenges to supply while inadequate financial knowledge, high cost of access, lack of trust, and availability of traditional alternatives are the main demand-related issues.

The novelty of index-based insurance products was also cited as a factor for the low rate of adoption of related services. Officials from various insurance companies affirmed that one of the key areas that need to be addressed for the optimized expansion of insurance services is the lack of a separate agriculture insurance regulatory framework. Inaccessibility of the necessary technological infrastructure such as rainfall gauges, satellite information, and other related tools and resources that are necessary for handling insurance claims, is one of the major challenges.

All of these problems stem from the fact that most modern financial services are located in major cities, with comparatively low penetration rates in rural areas. A well-defined and comprehensive agricultural financing policy and regulatory framework is necessary to advance the agricultural sector, guarantee the adoption of technology, disperse risks among agricultural players, boost confidence in the formal financial sector, create financial products tailored to farmers’ needs, and combat poverty and ensure food security.

Read the full research here

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