Shocks and credit choice in Southern Ethiopia

Abstract

Purpose -The purpose of this paper is to examine how shocks suffered by rural households in Ethiopia influence their decision to borrow and the source of credit. Design/methodology/approach -First, suppose a household faces a set of four borrowing alternatives: only formal borrowing, only informal borrowing, both formal and informal borrowing, and non-borrowing. Second, the paper assumes that the random component is independently and identically distributed in accordance with the extreme value distribution. These assumptions lead to the multinomial logit model. The paper estimates the model using data from a survey of 350 rural households in Southern Ethiopia. Findings -The paper finds that shocks are important factors in explaining both the decision to borrow and the source of credit. In particular, negative shocks that affect household's assets, such as the seizing of farmland and theft, or human capital, such as the death of the family head, reduce the probability of borrowing from formal lenders or from both formal and informal lenders at the same time. The study supports only to some extent the assumption that informal credit contributes to smooth consumption. Last, networking effect is very significant and demonstrates how the two markets interact. Research limitations/implications -A model that would consider dynamic consumption patterns would have been more appropriate. In fact, one of the limitations of the study is the reliance on a cross-section analysis and the data is limited to just one village. Further research would extend the data set geographically and across time. Practical implications -The formal lenders are not willing to provide contingent loans, maybe because of a limited ability to assess and diversify risk. Besides, the available formal credit products are not proper to finance long term risk management strategies but pesticides, fertilizers and improved seeds that are entirely used in every agricultural cycle. In this regard, proper risk transfer strategies and instruments, as well as better tailored loan products, are needed in order to increase outreach into the rural areas. Originality/value -To the authors' knowledge, this is the first paper that investigates how shocks influence the decision to borrow and the source of credit in Ethiopia.

Examining institutional credit access among agricultural households in Eastern India: trends, patterns and determinants

“…Kumar et al (2007) study the sectoral choice of the credit market in India through a multinomial logit model by categorizing households into nonborrowers, borrowers in the formal sector and borrowers in the nonformal sector. Several similar approaches have been employed in the literature (Doan et al , 2010; Castellani, 2014; Mpuga, 2010; Pal and Laha, 2015) to divide households into nonborrowers, borrowers from the formal sector, borrowers from the informal sector and borrowers from the semiformal sector, and use the ordered probit model to examine the probability of households being in each group. Kumar et al (2015) use the Heckman selection model to examine a household's probability of borrowing and choosing a given credit source.…”

Sectoral credit choice in rural India

“…She employed a multinomial logit model to compare the probability of being in each borrower group, using a base outcome of the non-loanee group. Similar to Pal (2002), Doan et al (2010) and Castellani (2014) also categorized the surveyed households from peri-urban areas in Vietnam and rural areas of Southern Ethiopia, respectively, in four broad categories: non-borrowing, borrowing from only formal lenders, borrowing from only informal lenders, and borrowing from both formal and informal credit sources. They too employed a multinomial logit model to compare the probability of being in each borrower group with a base outcome of the non-loanee group.…”

The Impact of Microfinance on Household Livelihoods: Evidence from Rural Eritrea

“…Livestock also represents an important instrument of saving in situations where profitable and safe saving opportunities are non-existent. In times of adverse shock such as drought, livestock constitutes a significant copping strategy (Castellani, 2014). Livestock ownership is hypothesised to have positive relationship with the probability of borrowing from microfinance programmes by rural households.…”