Journal of Agribusiness in Developing and Emerging Economies

Agricultural credit market participation in Finoteselam town, Ethiopia

Maru Shete Roberto J. Garcia
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Maru Shete Roberto J. Garcia, (2011),"Agricultural credit market participation in Finoteselam town,
Ethiopia", Journal of Agribusiness in Developing and Emerging Economies, Vol. 1 Iss 1 pp. 55 - 74
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Credit market
Agricultural credit market participation
participation in Finoteselam
town, Ethiopia
Maru Shete 55
School of Graduate Studies, St. Mary’s University College,
Addis Ababa, Ethiopia, and
Roberto J. Garcia
Department of Economics and Resource Management,
Norwegian University of Life Sciences, Ås, Norway
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Abstract
Purpose – The purpose of this paper is to identify the proportion of farmers with constrained and
unconstrained participation in the agricultural credit market and estimate the parameters that
determine agricultural credit market participation in Finoteselam town, Ethiopia.
Design/methodology/approach – The study followed cross-sectional study design where primary
data were collected from 210 households through a questionnaire survey in Finoteselam town, north
western Ethiopia. A combination of purposive and random sampling techniques was employed.
Descriptive statistics were used to identify the proportion of farmers with different levels of
participation in the agricultural credit market. The bivariate probit model was estimated to identify
the parameters that determine smallholder credit market participation.
Findings – The study revealed that 48 percent of smallholder farmers are constrained non-
participating (i.e. rationed out) from the agricultural credit market due to lack of access to the service,
44.8 percent of them are constrained participating, 2.4 percent unconstrained participating and 4.8
percent of them are unconstrained non-participating. Estimation results of the bivariate probit model
indicated that variables such as high dependency burden, large landholding size, household’s labor
endowment, participation in off-farm employment activities and incurring unforeseen expenses
increased the probability of households to participate in agricultural credit markets. On the other hand,
village dummy variable, old age of household head and borrowing from other sources decreased the
probability of households participating in the agricultural credit market.
Practical implications – The findings raise policy concerns to devise a mechanism for creating a
functioning rural insurance market, improve the labor market for encouraging off-farm employment
activities, devise wealth-creating schemes and address the credit need of those smallholder farmers
who are still rationed out from the agricultural credit market.
Originality/value – Little has been done on the subject of agricultural credit market participation in
Ethiopia. Hence, this research will add to the thin literature on the subject.
Keywords Agriculture, Credit, Ethiopia
Paper type Research paper

Introduction
Rural financial markets are characterized by asymmetric information (Hoff and
Stiglitz, 1993). Lenders do not have full information about the characteristics of
borrowers. Financial markets in developing countries face problems of adverse
selection, moral hazard and weak enforcement of contracts (Eboh, 2000; Dowd, 1992;
Ghosh et al., 2000; Conning and Udry, 2007). Thus, formal financial institutions (banks)
Journal of Agribusiness in
are characterized by high costs and lower interest rates (Hoff and Stiglitz, 1990), and Developing and Emerging Economies
Vol. 1 No. 1, 2011
The authors are indebted to the Norwegian Government State Educational Loan Fund pp. 55-74
r Emerald Group Publishing Limited
(Lånkasen) for covering the expenses of the study. They thank the two anonymous reviewers of 2044-0839
the article for their constructive comments. However, all errors or omissions remain the authors’. DOI 10.1108/20440831111131514
 JADEE are often inadequate in supply (Chaudhuri and Gupta, 1996). They discriminate
1,1 against the poor and women (Ray, 1998), and exhibit delayed disbursement of loans
(Sarap, 1990; Hoff and Stiglitz, 1990). This has led to the search for alternative financial
service delivery systems for the poor so as to help them get out of poverty (Krahnen
and Schmidt, 1994; Nguyen, 2007).
The concept of providing cheap credit services to the poor was started in the 1950s
56 by governments and donor agencies (Bose, 1998). However, studies (Krahnen and
Schmidt, 1994; Jodhka, 1995; Basu, 1994; Bell, 1990; Hoff and Stiglitz, 1990; Siamwalla
et al., 1990) confirmed that such efforts were not successful for reasons such as adverse
composition effect, low repayment performances and the inability of the institutions to
be financially viable after donors quit. Coupled with this, the concept of providing
subsidized credit to the poor was challenged as most developing nations adopted
structural adjustment programs that emphasize a paradigm shift from state
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intervention to a market-oriented economy ( Johnson and Rogal, 1997). Therefore, the

popular alternative of launching microfinance institutions (MFIs) emerged in the 1990s
(Krahnen and Schmidt, 1994; Ghatak and Guinnance, 1999).
The performance of MFIs is evaluated based on their level of outreach,
sustainability and impact (Amha, 2004). Outreach is conceptualized as the extent to
which a microfinance institution succeeded in reaching its target clientele (the poor,
women, the under-served segment of the population, etc.), and the degree to which it
has met the clientele’s demand for financial services (Yaron, 1992; Conning, 1999;
Amha, 2004). Hence, outreach addresses the supply side of the credit market. However,
the fact that MFIs make substantial efforts to reach the poor does not mean that the
poor participate in the credit market. Therefore, households are said to participate in
the credit market if they borrow from a credit scheme when they want to do so. On the
contrary, non-participants in the credit market include those who have applied for
credit but have not been selected (for various reasons), and those who did not apply at
all. This makes participation in credit markets more of a demand-side issue where
borrowers are free to choose between the alternatives.
The participation of the poor in credit markets in developing countries, a concept
that is different from access to credit markets, is affected by both demand- and supply-
side factors. These factors are not under the full control of the lender and/or the
borrower. However, access to the credit market is more of a supply-side issue that is
linked to the availability of the micro-credit program to the poor, and about the
eligibility criteria of the borrowers. Zeller and Manohar (2002) indicated that the poor
face many constraints in getting access to credit services provided by MFIs as the poor
are required to fulfill eligibility requirements.
Poor farmers in developing countries often lack the financial resources to make the
necessary investments in agriculture (Komicha and Ohlmer, 2006; Ageba, 1998). The
formal financial services provided by banks are less accessible to poor farmers in rural
areas because the poor in rural areas lack collateral (supply-side constraint), their loan
size demands are small (demand-side constraint), there is high degree of covariant risk
and weak enforcement capacity of formal lenders (Ageba, 1998; Bose, 1998). Agricultural
credit constraint is believed to influence agricultural production and improving financial
services to the poor enhances agricultural productivity through facilitating adoption of
yield improving agricultural technologies (Ellis, 2000; Blancard et al., 2006; Petrick, 2005;
Barry and Robinson, 2001; Bose, 1998; Alene and Hassan, 2006).
Demand for agricultural credit in Ethiopia is very high, and only 20 percent of the
demand of the poor for financial services is so far met by MFIs (Amha, 2004). The poor
 in Ethiopia (Amha, 2004; Bezabih et al., 2005) and farmers in Finoteselam town (BoRD, Credit market
2002) face agricultural credit constraints due to limited access to institutional credit. participation
Previous studies on rural credit in Ethiopia focused on the impact on poverty (see
Alehegn, 2007; Komicha and Ohlmer, 2006; Haile, 2005; Birhanu, 1999; Fiona, 1999),
loan repayment rates (see Abafita, 2010; Haile, 2005; Mengestu, 1997) and
sustainability of institutions (see Amha, 2000, 2004). A single study by Abebe (2002)
in the Ethiopian highlands only looked at the determinants of access to rural credit 57
services employing a probit model. Studies on agricultural credit market participation
have not been done so far in this specific part of the country. This research was done
with the objective of identifying the proportion of farmers with constrained and
unconstrained participation in the agricultural credit market and estimating the
parameters that determine agricultural credit market participation in Finoteselam
town, Ethiopia. The contribution of the article is significant in terms of bridging the
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gap in information in agricultural credit market study, and it also contributes toward
improving financial service delivery through suggesting some policy implications.
The remainder of the article is structured into four sections. The literature section
presents the nature of credit markets in developing countries, rural credit in Ethiopia
and a conceptual framework for credit market participation. The methodology section
provides a description of the study area, sampling procedures and data sources and
data analysis techniques used in the study. The third section discusses major findings
of the study. Finally, the article gives conclusions and policy implications.

Literature on credit markets

Credit markets in developing countries
The neo-classical farm household model explains that there is a perfectly competitive
market for all commodities, and fails to explain the full picture of markets in
developing countries where there are imperfections in the product, service and input
markets (Abafita, 2010; Bell et al., 1997; Tviland 1996). According to Holden
and Binswanger (1998), “market imperfections are deviations from a perfectly
competitive market”. These include a situation of missing markets, markets with
price bands, seasonality of markets, interlinked markets, markets with imperfect
competition, rationing of commodities, etc. (Ellis, 2000). Imperfections in the credit
market, agricultural input markets and agricultural output markets are common in
many developing countries (Gine and Yang, 2009).
In the world of perfect information and zero transactions costs, resource allocation is
efficiently achieved through market prices. If credit markets are competitive, then interest
rates reflect the best uses of financial resources among alternative uses. Nevertheless,
such a market situation is far from a reality since the economies of developing countries
are characterized by information asymmetry (Blancard et al., 2006; Hoff and Stiglitz,
1990; Hoff and Stiglitz, 1993), poor infrastructure development (Aryeetey et al., 1997;
Komicha and Ohlmer, 2006) and high transaction costs (Zeller et al., 1997; Carter and
Weibe, 1990). Hoff and Stiglitz (1990) and Ellis (2000) described credit markets in
developing countries as imperfect, missing and repressive where different groups of
borrowers have different levels of access to financial resources. Hence, credit constraints
to the poor (Pal, 2002; Kochar, 1997; Bali, 2000) are common in developing countries.
When markets fail, credit rationing (Zeller et al., 1997), market segmentations,
interlinkages of markets and interest rate variations are the features that prevail in the
markets (Stiglitz and Weiss, 1981). With market failures, high interest rates attract
risky projects and low interest rates attract many borrowers compared to available
 JADEE financial resources. Credit rationing is the mechanism for clearing available resources
1,1 leading to limit the access of some households to the credit market although the
applicants appear to be identical (Stiglitz and Weiss, 1981; Jaffe and Stiglitz, 1990),
limit the amount of loan they should take compared to their actual demand for loans
(Jaffe and Stiglitz, 1990; Stiglitz and Weiss, 1992) or a situation where a borrower may
be denied credit ( Jaffe and Stiglitz, 1990).
58
Rural credit markets in Ethiopia
As in the case of other developing countries, although the potential demand for small
loans is tremendous in Ethiopia, the formal banking sector in the country is less
interested in providing financial services to smallholder farmers (Amha, 2004). The
formal banks consider farmers as credit risky. The majority of the poor (69 percent of the
borrowers) gets credit from informal channels. In an effort to provide financial services to
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the poor, the government of Ethiopia has been supporting cooperatives and MFIs.
Nevertheless, 86 percent of the cooperative credit and saving cooperative members are
employees with a monthly salary and hardly serve the credit needs of poor farmers
(Bezabih et al., 2005). Since the 1970s, NGOs have been delivering micro-credit services to
poor farmers in Ethiopia as a strategy to alleviate poverty. The financial scheme of
NGOs had the problem of mixing social and financial objectives (ACDI/CEE, 1995), and
with the coming of Proclamation No. 40/96 on the licensing of microfinance institutions
(Federal Negarit Gazeta, 1996), they stopped providing subsidized credit to farmers.
The desire to meet the demand of the poor for financial services in the country
necessitated the promotion of sustainable microfinance institutions. There are about 26
MFIs legally registered in Ethiopia which mainly address the financial needs of
the rural poor but which meet only 20 percent of the demand for credit (Amha, 2004).
The microfinance industry is generally constrained by lack of skilled human resources,
lack of adequate infrastructure to reach the rural poor and lack of adequate finance to
meet borrowing needs (Abinet, 2006). Hence, supply-side constraints are prevalent in
the agricultural credit markets in Ethiopia.
The Amhara Credit and Saving Institution (ACSI) is one of the legally registered MFIs
by the National Bank of Ethiopia in April 1997 and provides financial services to
smallholder farmers residing in Amhara regional state. As of 2005, it had 394,374 active
borrowers, which is the largest outreach figure compared to other MFIs operating in
other parts of the country (Amha, 2004). The operational area of ACSI is the Amhara
Regional State, which is the northwest and northeast part of the country (ACSI, 2004).
It is the only MFI that operates in the study area of this research paper.
Conceptual model for credit market participation
A conceptual model that identifies four categories of smallholder farmers as affected
by demand- and supply-side constraints is presented in Table I.

Credit market participation Constrained Unconstrained

Participating Constrained participation Unconstrained participation

(rationed borrowers) (non-rationed borrowers)
Non-participating Rationed-out Voluntary non-participation
(involuntary non-borrowers) (voluntary non-borrowers)
Table I.
Conceptual model Source: Adapted from Chen Ke and Chivakul (2008); Zeller et al. (1997)
 A farm household is credit constrained (rationed borrower) when it has access Credit market
to the credit market but the level of participation is limited due to supply-side participation
constraints (Chen Ke and Chivakul, 2008; Diagne and Zeller, 2001; Duca and
Rosenthal, 1993), i.e. if latent demand for credit is greater than latent supply for credit
(LDXLS). The MFI rations out funds because demand for loans exceeds supply of
funds. The second group includes those smallholder farmers who want to participate
in the credit market but are denied borrowing, i.e. involuntary non-borrower or 59
rationed out from the agricultural credit market due to supply-side constraints
(LSo0, S ¼ 0). In other words, this category includes those farmers who do not fulfill
the eligibility criteria set by the microfinance institution, i.e. lack access to credit
(Zeller et al., 1997). Unconstrained participation includes those smallholder farmers
who do not face demand- or supply-side constraints and fully participate in the credit
market, i.e. non-rationed borrower (LSo0, S ¼ 1). Voluntary non-participation
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represents a case whereby a smallholder farmer does not face supply-side constraint
but they choose not to participate in the market because they do not have demand for it
(LSo0, D ¼ 0). According to Komicha and Ohlmer (2006), voluntary non-borrowers
decline to borrow for reasons of high-risk aversion behavior or because they are prudent.

Methodology
Description of the study area and sampling procedures
Ethiopia is administratively classified into nine ethnicity-based regions. The Amhara
National Regional State (ANRS) is one of the regions with its capital town (Bahir Dar)
located 565 km northwest of the capital city of Ethiopia (Addis Ababa). It has an
estimated area of 0.17 million square kilometers inhabited by a total population of 19.1
million. ANRS is further classified into 105 districts. The study area, Finoteselam town,
is administered under the Jabi Tehnan district, which is one of the districts of the region
(Amhara, 2007). Finoteselam town is administratively further classified into five
kebeles[1], namely Kebele 01, Kebele 02, Kebele 03, Bakel-Abater and Shembekuma-
Yedefas. The town hosts a total of 7,239 households. The first three kebeles host
households that derive their livelihood from sources other than agriculture. They have
a total of 4,666 households. The last two kebeles have their major livelihood source
from agricultural activities, and host a total of 2,573 households (see Table II).
The two kebeles that derive their major livelihood source from agricultural
activities are purposefully selected for this study. This was done because micro-credit
services provided by ACSI are targeted to financing such activities like oxen fattening
and lending for input loans. The tax payer’s list, further updated by key informants in
each kebele, was used as a sampling frame. A total of 210 households were randomly

Sl. no. Name of kebele Total population Household population

1 Kebele 01 9,522 1,587

2 Kebele 02 12,057 2,009
3 Kebele 03 6,396 1,070
4 Bakel-Abater 8,759 1,250
5 Shembekuma-Yedefas 9,263 1,323
6 Total 45,997 7,239 Table II.
Estimated population in
Source: Finoteselam Town Administration (FTA) (2006) Finoteselam town, 2006
 JADEE selected from the two kebeles. A proportional sampling technique was employed to
1,1 decide the number of households to be surveyed from each kebele. Then, a structured
questionnaire, pre-tested in the field, was conducted to collect primary data. Data on
variables such as household characteristics, participation of households in a credit
scheme, participation in off-farm employment activities, oxen ownership, landholding
size, borrowing from other sources, etc. were collected in the summer period of 2006.
60 In addition, data such as client eligibility criteria, and background information about
the study area were also collected from secondary sources.

Data analysis technique

In developing countries, services offered by MFIs are often targeted. They follow
some eligibility criteria to select those productive but resource-poor borrowers who
have the potential to engage in income-generating activities, and those borrowers
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who have the potential to repay debts on the due date. This means that some poor
households that have a demand for financial resources might not have the access to
credit services though the program is physically available to them. On the other hand,
participation in a credit market is affected by a host of factors given that households
have access to the program. This makes participation a two-stage process. Therefore,
estimating the parameters of credit market participation could yield a biased estimate
if we assume that access to credit service is independent to participation in agricultural
credit market.
Heckman (1979) argued that there is selection bias when self-selection by
individuals is the situation. For this reason, the bivariate probit model, instead of
the probit model, is adopted for this study to estimate the parameters that affect
participation in the agricultural credit market. The model uses the maximum
likelihood estimation technique to estimate the probability of participating in the
agricultural credit scheme.

The bivariate probit model

In the bivariate probit model two decisions are inter-related. Green (2003) specified the
bivariate probit model as:

Y1i ¼ bi x1i þ u1i

Y1i ¼ 1 if Y1i 40 ð1Þ
Y1i ¼ 0 otherwise

where Y1i is a binary variable for the probability of households participating in the
agricultural credit market with 1 if the household participates, and 0 if otherwise; X1i is
a vector of exogenous variables affecting participation; bi is a vector of parameters to
be estimated; u1i is the error term; and i ¼ 1, 2, 3yn, where n is the number of
observations.
Likewise, the access to a credit program can be modeled as:

Y2i ¼ b2 x2i þ u2i

Y2i ¼ 1 if Y2i 40 ð2Þ
Y2i ¼ 0 otherwise
 where Y2i is a binary variable representing the probability of households that have Credit market
access to credit services; X2i is a vector of exogenous variables affecting access; b2i is a participation
vector of parameter to be estimated; u2i is the error term; and i ¼ 1, 2, 3yn, where n is
the number of observations.
In both equations (1) and (2), the error terms are assumed to be normally
distributed with mean 0 and variance 1, and the correlation between them is unity (1),
i.e. Cov (u1i, u2i) ¼ r where ra0 implies that the two equations are dependent, and 61
the observations on the participation equation (Y1i) are observed only if
Y*2i ¼ b2x2i þ u2iX0. The joint probability for the two equations is thus: Pr(A and B) ¼
Pr(A7B)  Pr(B), which is Pr(Y1 ¼ 1, Y2 ¼ 1) ¼ Pr(Y1 ¼ 17Y2 ¼ 1)  Pr(Y2 ¼ 1). The
parameters of the two models are then estimated through maximum likelihood
approach. But, if r ¼ 0, the equations are independent and the parameters for credit
market participation can be estimated through probit model independently of the
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access to the credit market.

In this study, since the objective is to estimate the parameters that determine
participation of a smallholder farmer in the credit market, those groups of farmers
under “constrained participation” and “unconstrained access” are considered as
“participating” in the agricultural credit market, though their level of participation is
different. On the other hand, those smallholder farmers who fall under the category of
“voluntary non-participation” and “constrained non-participation” are considered as
“non-participating” in the credit market. Further, in order to see the factors that
determine involuntary non-participation (rationed out), a second biprobit model was
employed dropping those small groups of voluntary non-participants with no credit
demand from the analysis.

Results and discussion

Result of descriptive statistic
Table III presents data on the profile of the household and income characteristics for
both the study area and the average for Ethiopia. Average family size for the study
area is 5.84, which is well above the national average of 4.9 persons. The dependency
burden for the area is 1.57, which is the ratio of the total number of household members
who are dependents (who are under 15 years of age and older than 65) to household
members in the working age (the group aged between 15 and 64 years of age). It is
relatively higher than the regional average of 0.89 and the national average 1.15.
Gender is an important factor influencing participation in microfinance programs.
Female-headed households account for about 26 percent of the entire population,
29 percent of the Amhara region and 24 percent of the study area. Outreach is
disproportionately in favor of male-headed households. Out of the total male-headed
households, 47 percent of them participated in the credit market in the study area.
Comparatively, out of the total female-headed households, 35 percent of them
participated in the credit market. If we further consider credit market participation,
then out of those household populations that have access to the service, 65 and
51 percent of the male- and female-headed households, respectively, participated in
the credit market. The former have the advantage of getting better information
compared to the latter that has led to a disparity in outreach.
Given the important role of agriculture in households’ livelihoods, land and cattle
ownership is a major indicator of well-being in society. About 64 percent of rural
households own o1 ha of land. The average landholding size for Ethiopia is 1.026 ha
(FDRE, 2002) and average land ownership for the study area is estimated at 0.8 ha.
 JADEE Indictors Ethiopia Amhara region Sample statistics
1,1
1. Household characteristic
1.1 Average household size 4.9 4.5 5.84
1.1 Average adult equivalent household size 3.9 3.6 5.04
1.3 Dependency ratio 1.15 0.89 1.57
62 1.4 Mean age of household head 44 46 53
1.5 Female-headed households (%) 26 29 24
1.6 Average consumption expenditure (Birr) 1056.71 1087.74 986.26
1.6 Literate household heads (%) 29 23.3 22.5
2. Income by proportion
2.1 Agricultural activities 72.53 75.8 88.45
2.2 Wage from off-farm employment 2.86 2.15 6.37
2.3 Household enterprise other than agriculture 5.36 3.8 1.02
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2.4 Remittance 3.88 4.46 2.81

2.5 Saving account source 0.22 0.08 0.0
2.6 Housing rent 3.53 3.16 0.0
2.7 Profit share source (dividends) 0.014 0.021 0.0
2.8 Other sources 11.6 10.5 1.35
Total 100 100 100
Table III. 2.9 Average income (Birr)/adult equivalent 784.99 798.16 814.14
Comparative statistics Source MoFED (2002b) MoFED (2002b) Own calculation

On average, rural households in the country own 4.1 cattle compared to 3.6 cattle
in Amhara region (MoFED, 2002a) and 3.0 in Finoteselam town. To qualify for
micro-credit services provided by ACSI, it is required that a farmer owns no more
than the value of one ox or its equivalent. This implies that, at least in principle,
those households that are relatively better off are excluded from the service. In addition
to the credit worthiness of a borrower, households in the area also consider the
wealth status of the borrower before they join a certain borrowers group. This justifies
the importance of wealth indicators for agricultural credit market participation in
Finoteselam town. As previously presented in Table III, off-farm employment is the
next most important source of income after agriculture for Finoteselam town
accounting for about 6 percent of total household income. This compares with almost
3 percent for the country and 2 percent for the Amhara region.
As presented on Table IV, 52 percent of households in the study area fulfill the
eligibility criteria to have access to the agricultural credit service offered by the ACSI.
The remaining 48 percent of households are rationed out from the agricultural credit
market because the service is inaccessible to them. From the total households surveyed,
45 percent of them are constrained participating, 2.4 percent are unconstrained
participating and 5 percent of them are unconstrained non-participating. Out of those
households, who have access to the agricultural credit service, the majority of them
(91 percent) participated in the agricultural credit market, which is a qualitative
indication of the dependence of the credit market participation on the access to the
credit service.

Determinants of agricultural credit market participation

Variables and hypothesis. A household’s decision to participate in the credit market
does not only depend on profitability as in the case for a “pure” producer. Instead, it
 Variables Frequency % or mean Standard deviation
Credit market
participation
Participating (out of N ¼ 210) 99 47.2%
Unconstrained participation (out of N ¼ 99) 5 5.1%
Unconstrained participation (out of N ¼ 210) 2.4%
Constrained participation (out of N ¼ 99) 94 94.9%
Constrained participation (out of N ¼ 210) 44.8% 63
Non-participating (out of N ¼ 210) 111 52.8%
Unconstrained non-participation (out of N ¼ 111) 10 9%
Unconstrained non-participation (out of N ¼ 210) 4.8%
Constrained non-participation (out of N ¼ 111) 101 91%
Constrained non-participation (out of N ¼ 210) 48.1%
Access to agricultural credit (out of N ¼ 210)
Have access 109 51.9%
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Lack access (Rationed out) 101 48.1%

Participation in credit market (out of those who have access to credit; N ¼ 109)
Participating 99 90.8%
Not participating 101 9.2%
Village dummy (N ¼ 210)
Shembekuma-Yedefas Kebele 103 49%
Bakel-Abater Kebele 109 51%
Sex of household head (N ¼ 210)
Male-headed 160 76.2%
Female-headed 50 23.8%
Dependency burden 210 5.84 2.20
Labor endowment 210 5.05 1.96
Age of household head 210 52.75 14.29
Education level of household head 210 2.19 3.34
Landholding size 210 0.82 0.36
Borrowing from sources other than ACSI (N ¼ 210)
Borrow 135 64.3%
Does not borrow 75 35.7%
Participation in off farm employment (N ¼ 210)
Participate 74 35.2%
Do not participate 136 164.8% Table IV.
Descriptive statistics of
Note: Standard deviation is calculated only for continuous variables variables

depends on household characteristics (such as age and sex of household head,

dependency burden, education level of household head, etc.), production characteristics
(such as farm size, resource endowment, off-farm employment, etc.) and location
factors. Based on economic theory and previous empirical studies, a set of explanatory
variables are hypothesized to affect credit market participation (see Table V).
The explanatory variables are estimated through biprobit model by considering two
different scenarios. A first biprobit model is estimated by including all the respondents
in the analysis in which the response variable included those smallholder farmers
who are participating (unconstrained participants and constrained participants) and
who are not participating (unconstrained non-participants and constrained
non-participants) (see Table VI). A second biprobit model is estimated by dropping
those smallholder farmers who have unconstrained access to microfinance services
but are not participating in the credit market. Hence, the response variable included only
those who are participating (unconstrained participants and constrained participants)
 JADEE Variables Description Measurement Expected sign
1,1
Credpart Credit market participation Dummy (1 if participates, Response variable for the
0 otherwise) participation equation
Eligib Access of households to Dummy (1 if have access, Response variable for the
microfinance 0 otherwise) access equation
64 Village Geographical location of Dummy (1 if located in No prior expectation
households Shembekuma-Yedefas
kebele, 0 if located in
Bakel-Abater kebele )
Sexhh Sex of household head Dummy (1 if male, Positive
0 otherwise)
Agehh Age of household head Years Positive
Agehh2 Age of household head Years Negative
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squared
Dependency Dependency burden Proportion of dependent Positive
families to active ones
Labor Labor endowment of Family size adjusted for Positive
households adult equivalence scale
Educhhh Education level of Years of schooling Positive
households
Farmsiz Landholding size of Hectare No prior expectation
households
Oborrow Borrowing from sources Dummy (1 if borrowed Negative
other than MFIs from other sources,
0 otherwise)
Offarm Participation in off-farm Dummy (1 if participates, Positive
Table V. activities 0 otherwise)
Description, measurement Uexpens Incurring unforeseen Dummy (1 if incurred Positive
and expected sign for expenses unforeseen expenses,
variables 0 otherwise)

and those who are not participating (constrained non-participants/rationed out only)
(see Table IX). The purpose of estimating a second biprobit model considering only
constrained non-participants is to see the determinants of being rationed out, if at all
there are changes from the previous scenario.

Result of the biprobit model

As presented in Table V, the estimated biprobit model is significant at po0.001. In
addition, most of the variables included in the model maintained the expected sign
further justifying appropriate model specification. The results of the bivariate probit
model indicated the null hypothesis that r is equal to 0 (H0: r ¼ 0) is rejected at po0.05.
This justifies the use of the bivariate probit model instead of using the independent
probit model. In other words, the participation of households in the agricultural credit
market in Finoteselam town is dependent on a household’s access to the microfinance
services.
The result indicated that variables such as village dummies, age squared, family
size, labor endowment of households, landholding size, borrowing from other
sources, participation of households in off-farm employment activities and incurring
unexpected expenses significantly affected a household’s decision whether to
 Coefficient Standard error Z P47Z7
Credit market
participation
Credpart
Village1 0.5235463 19168901 1.84 0.045*
Sexhh 0.2919097 0.3703822 1.36 0.169
Agehh 0.0798921 0.068761 1.42 0.18
Agehh2 0.000971 0.0005655 1.39 0.025* 65
Dependency 0.4362121 0.272631 1.78 0.086**
Labor 0.8644324 0.2919687 2.45 0.026*
Educhhh 0.0294451 0.0358754 0.85 0.391
Farmsiz 1.827631 0.2740552 4.52 0.000***
Oborrow 0.4965882 0.2555736 1.94 0.052**
Offarm 1.251429 0.2344177 5.34 0.000***
Uexpens 0.8396552 0.2325591 3.61 0.000***
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_cons 0.7631219 3616712 1.74 0.076**

Eligib
Village1 0.1211513 0.2126028 0.53 0.598
Sexhh 0.0617220 0.2671223 0.27 0.838
Agehh 0.0788815 0.057862 1.30 0.18
Agehh2 0.0009671 0.000586 1.39 0.236
Dependency 0.1843696 2749465 0.67 0.552
Labor 0.1291148 0.2961767 0.47 0.688
Educhhh 0.017318 0.0293581 0.57 0.577
Farmsiz 0.5974203 0.2479053 2.65 0.028*
Oborrow 0.5426582 0.3236722 1.96 0.044*
Offarm 1.240969 0.2678542 4.60 0.000***
Uexpens 0.1032691 0.2403046 0.43 0.667
_cons 0.3614583 0.3484197 1.04 0.300
/athrho 11.02231 4.585759 2.40 0.016*
r 1 4.89e-09
Likelihood ratio test of r ¼ 0 Number of observations ¼ 210
w2(1) ¼ 60.093 Log likelihood ¼ 164.45814 Table VI.
ProbXw2 ¼ 0.0162* Wald w2(18) ¼ 104.58 Estimation result of the
***po0.001 ProbXw2 ¼ 0.0000*** bivariate probit model:
*po0.05 **po0.1 voluntary non-
participants included
Source: own estimation (N ¼ 210)

participate in the agricultural credit market or not, given that the household has access
to the microfinance service.
The geographical difference was expected to have an impact on agricultural credit
market participation. Its sign is found to be negative and is statistically significant
at po0.05. As the value for village dummy runs from 0 to 1 (being located at
Bakel-Abater kebele compared to being located at Shembekuma-Yedefas kebele), the
probability of participation decreases by about 49 percent (see Table VII for marginal
analysis results). This indicates that households who are located in Bakel-Abater
kebele are more likely to participate in the agricultural credit market. Bakel-Abater
kebele is relatively better suited for agricultural activities owing to the availability
of small-scale irrigation schemes compared to Shembekuma-Yedefas kebele. The fact
that the credit service in Finoteselam town is targeted for agricultural activities
justifies the difference in credit market participation between the two villages.
 JADEE y ¼ Pr(Credpart ¼ 1, Eligib ¼ 1) (predict) ¼ 0.43315428
1,1 Variable dy/dx Standard error Z p4z X

Village1a 0.1652733 0.0833 1.98 0.047 0.49

Sexhha 0.1424856 0.09983 1.43 0.153 0.76
Agehh 0.0788815 0.05988 0.89 0.37 0.022
66 Agehh2 0.000971 0.0006 1.39 0.37 0.020
Dependency 0.182942 0.10407 1.76 0.390 0.84
Labor 0.2849523 0.11871 2.40 0.016 5.05
Educhhh 0.0119755 0.01393 0.86 0.015 2.19
Farmsiz 0.4867882 0.10772 4.52 0.690 0.82
Oborrowa 0.1952036 0.09932 1.97 0.050 0.65
Offarma 0.4684208 0.07654 6.12 0.000 0.35
Table VII. Uexpensa 0.325113 0.08557 3.80 0.000 0.35
Marginal effects after
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biprobit Note: ady/dx is for discrete change of dummy variable from 0 to 1

The variable used to capture the effect of dependency burden on agricultural credit
market participation is found to be positive and statistically significant at po0.1. As
dependency burden increases, the probability of participating in the agricultural credit
market also increases. The likely explanation is with a large number of dependent
families, liquidity constraint will be stringent and that further increases the demand
for financial resources. However, studies (Shete and Garcia, 2010) indicate that the
likely outcome of default is higher with higher dependency burdens that jeopardize
financial sustainability of MFIs.
The variable that captures labor endowment of households is positive and
significant at po0.05. From the lender’s point of view, those households that are
endowed with better labor availability are less risky clients, which increases their
probability of being selected by creditors. Abebe (2002) carried out a probit estimate to
identify the determinants of access to formal credit services in the Ethiopian highlands
using household level data from 117 households. His result for labor endowment was
consistent with the findings of this study. The wealth variable (farm size) is also found
to be positive and statistically significant at po0.001. Theoretically, relatively wealthy
households are less risky clients that are preferred by lenders. Nevertheless, MFI loans
generally target resource poor clients that could be termed as a “small household bias”.
The results from this study indicated that when farm size increases by 1 ha, the
probability of households participating in the agricultural credit market increases by
82 percent. Chowdhury (2005) in Bangladesh and Milanzi (2003) in Nigeria studied
determinants of access to the credit market employing probit with sample selection
model and probit model, respectively. Their findings for the landholding variable were
consistent with the findings of this study.
The sign for the variable that captures borrowing from other sources is negative,
and it is statistically significant at po0.1. As the value for the variable changes from
0 to 1, the probability of participating in the agricultural credit market decreases by
65 percent. It is likely that those households that borrowed from other sources face
little liquidity constraint, which decreases their demand for additional credit from
MFIs. On the other hand, the variable that indicates whether households face incidental
liquidity constraint (i.e. unforeseen expenditure) was found to be positive and
statistically significant at po0.001. As the dummy value for unforeseen expenses
 shifts from 0 to 1, the probability that households participate in the agricultural credit Credit market
market increases with a marginal effect of 35 percent. Given the fact that rural participation
insurance markets are not available in the country, demand for loan increases with the
incidence of misfortune. Milanzi (2003) in Nigeria also found that liquidity constraint
due to misfortune increases credit market participation. Shete and Garcia (2010)
indicated that due to misfortune, loan diversion from productive purpose to
consumption ends in increased default rate in Finoteselam town, which could affect the 67
sustainability of MFIs.
The sign for participation in off-farm employment activities was also found to be
positive and statistically different from 0 at po0.001. As the value of the variable shifts
from 0 to 1, the probability of participating in the agricultural credit market increases
by a value of 35 percent. Participation in off-farm employment activities increases the
disposable income of households. Households with better disposable income are less
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risky clients from the lenders’ point of view, hence, this increases the chance of being
served in the credit market. Chowdhury (2005), in Bangladesh, also found that with
increased income status of borrowers, the probability of participating in credit markets
also increased.
Age of household head was another variable that was found to affect agricultural
credit market participation. The variable for old age (age squared) significantly
reduced the probability of a household’s participation in the credit market at po0.05. In
old age, farmers fear risk of crop failure and loss of assets due to indebtedness. The
sex of household head was found to be insignificant but maintained the expected
sign. However, the variable for education level of household head is insignificant
with unexpected sign. Relatively, educated household heads might have little liquidity
constraint since they engage in off-farm employment activities, and hence might
have less demand for credit services. A chi-square test to see the association between
educational level of household head and participation in off-farm employment
activity indicated that with an increase in level of education, participation in
off-farm activity increases significantly (Pearson’s w2 value of 47.54 at po0.001)
(see Table VIII).
The second bivariate model (Table IX), which considered only those groups of
smallholder farmers who are rationed out from participation, gave similar results in
terms of model performance (overall model is significant at po0.001 and the null
hypothesis for r is rejected at po0.05) and significance of the explanatory variables.
The performance of the two models and the determinants of the factors for credit
market participation in the two different scenarios showed similar results. This is
because of the fact that the number of smallholder farmers who have unconstrained
access but are not participating is very small in the second model (only 4.8 percent).

Conclusion and policy implication

Conclusion
The data for this study came from a household survey of 210 households. The small
sample size could be one source of limitation, and its findings should be accepted with
this limitation. The bivariate probit model confirmed that participation of households
in the agricultural credit market in Finoteselam town is dependent on access of
households to credit schemes. Besides, 48 percent of the smallholder farmers are
rationed out (constrained non-participation) because of lack of access. This necessitates
improving the conditions that increase access of households to the agricultural credit
schemes, given that supply-side constraints are not stringent. MFIs operating in the
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1,1

68
JADEE

Table VIII.

household heads
Cross-tabulation of

educational level of
participation in off-farm
employment activities and
Educational level of the household head
Does not read Read and Primary education Primary education Secondary education Secondary education
Type of household and write write only complete drop out complete drop out Total

Participating
Frequency 29 95 9 12 8 12 165
% 17.6 57.6 5.5 7.3 4.8 7.3 100
None participating
Frequency 26 8 0 1 0 0 35
% 74.3 22.9 0 2.9 0 0 100
Total
Frequency 55 103 9 13 8 12 200
% 27.5 51.5 4.5 6.5 4 6.0 100
Test of significance Pearson’s w2 test Likelihood ratio
Value Significance level Value Significance level
47.54 0.000 46.11 0.000
Source: own calculation
 Coefficient Standard error Z p47Z7
Credit market
participation
Credpart
Village1 0.4235463 2162008 1.96 0.050*
Sexhh 0.2718196 0.2912011 1.34 0.165
Agehh2 0.012972 0.0004921 1.37 0.023*
Dependency 0.4362121 0.272631 1.78 0.086** 69
Dependency 0.4651121 0.264639 1.76 0.079**
Labor 0.7244634 0.3019688 2.40 0.016*
Educhhh 0.0304465 0.0354644 0.86 0.391
Farmsiz 1.237611 0.2740552 4.52 0.000***
Oborrow 0.4965882 0.2555736 1.94 0.052**
Offarm 1.251429 0.2344177 5.34 0.000***
Uexpens 0.8396552 0.2325591 3.61 0.000***
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_cons 0.6620619 3808719 1.74 0.082**

Access
Village1 0.1120813 0.2126028 0.53 0.598
Sexhh 0.0518218 0.2530227 0.20 0.838
Agehh 0.0766825 0.057662 1.36 0.19
Agehh2 0.0108672 0.001090 1.48 0.632
Dependency 0.1742693 2849395 0.61 0.541
Labor 0.1310048 0.3161869 0.41 0.679
Educhhh 0.017009 0.0313571 0.54 0.588
Farmsiz 0.6104203 0.2599053 2.35 0.019*
Oborrow 0.4416582 0.2236739 1.97 0.048*
Offarm 1.240969 0.2695542 4.60 0.000***
Uexpens 0.1032691 0.2403046 0.43 0.667
_cons 0.3614583 0.3484197 1.04 0.300
/athrho 11.02231 4.585759 2.40 0.016*
r 1 4.89e-09 Table IX.
Likelihood ratio test of r ¼ 0 Number of observations ¼ 200 Estimation result of the
w2(1) ¼ 5.77727 Log likelihood ¼ 165.9712 bivariate probit model:
ProbXw2 ¼ 0.0154* Wald w2(18) ¼ 136.26 voluntary non-
***po0.001 ProbXw2 ¼ 0.0000*** participants dropped
*po0.05 **po0.1 (N ¼ 200)

area that have the prime goal of addressing the demands of the poor need to revise
their selection criteria so as to embrace more of the under-served or the poor who are in
need of financial resources but rationed out due to eligibility requirements.
The signs for the variables included in the model such as high dependency burden,
larger landholding size, higher household labor endowment, incurring unexpected
expenses and participation in off-farm employment activities are found to be positive
and their respective coefficients are significantly different from 0 either at 1, 5 or 10
percent level of significance.
In a wider policy framework, it is often discussed that getting institutions right has
a poverty-reducing effect. Correcting market imperfections in developing countries
such as imperfections in rural credit and insurance markets, labor markets,
agricultural input and output markets, etc. has a re-enforcing and positive-sum-game
effect. In this study, participation in off-farm employment activities and the existence of
high dependency burdens are linked to the functioning of the labor market; incurring
unforeseen expenses, which is linked to the availability and functioning of insurance
 JADEE markets, is found to affect participation of households in the agricultural credit market.
1,1 Hence, the following policy implications are forwarded:
Policy implications
(1) Participation in the off-farm labor market is found to be associated with
education level of households, which further increased participation of
70 households in agricultural credit markets. Nevertheless, only a small
proportion of smallholder farmers participate in off-farm employment
activities. Social policies that enhance the work capacity of individuals
through improved education level of households and policies that facilitate the
labor market in the area enables non-participating households to join the
agricultural credit market.
(2) Wealth indicators such as farm size and labor endowment increased the
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probability of a smallholder farmer’s participation in the agricultural credit

market and suggest focusing on wealth creation schemes and/or poverty-
reducing schemes for the area.
(3) Incurring unforeseen expenses due to misfortune is another significant
variable that increased a smallholder’s participation in the agricultural credit
market. Nevertheless, studies also indicated that the variable is found to
decrease loan repayment performances of borrowers, which affects the
sustainability of MFIs. It is, therefore, a policy concern to create rural
insurance markets in the country, which are currently non-existent, so that a
balance between participation and repayment can be achieved.
(4) Dependency burden due to large families is a factor that increased participation
of smallholder farmers in the agricultural credit market. Although high family
size is a source of labor and a source of demand for financial services, studies
also indicated that it has a negative effect on the repayment performance of
borrowers. Therefore, family planning is an area of policy concern.

Note
1. Kebele is the smallest administrative unit in Ethiopia.

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Further reading
Greene, W.G. (2003), Econometric Analysis, 5th ed., Prentice Hall, Upper Saddle River, NJ.
Wolday, A. (2002), “The role of microfinance in poverty reduction in Ethiopia” in “Challenges in
rural development and poverty alleviation in eastern and Southern Africa: the role of civil
society and development institutions”, a paper presented at a Workshop Organized by
IFAD/NGO, May 6-9, 2002, Nairobi.

About the authors

Maru Shete obtained a MA degree from the Addis Ababa University (Ethiopia) in Development
Studies in 2004. He earned a second MSc degree from the Norwegian University of Life Sciences
(UMB in Norway) in Development and Resource Economics in 2007. He also attained his third
MSc degree from UMB in Ecology in 2010. He has over eight years of working experience in
teaching and research in a university. Currently he is a Research Director at St. Mary’s University
College and a Research Fellow for the Future Agricultures Consortium of the Institute of
Development Studies at the University of Sussex. Maru Shete is the corresponding author and
can be contacted at: marushet@yahoo.com or maru.bekele@gmail.com
Roberto J. Garcia is an associate professor in the School of Economics and Business at the
Norwegian University of Life Sciences. He teaches courses in international economics and his
research focus is on international trade and development, particularly on agricultural policy
and WTO commitments and compliance. He served as a trade advisor to ministries in
the Government of Albania during its WTO accession, and continued as a consultant for the
country’s post-WTO accession compliance efforts and preparation for regional free trade
negotiations as part of the EU integration process. In addition, he has undertaken external
evaluation assignments to assess various Norwegian funded agricultural development
assistance projects in Latin America.

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