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Access To Credit By Rural Enterprises By Julius Opuni Asamoah (BSc MBA CA)

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The provision of credit has increasingly been regarded as an important tool for raising the incomes of rural population, mainly by mobilising resources to more productive uses. As development takes place, one question that arises is the extent to which credit can be offered to the rural poor to facilitate their advantage of the developing entrepreneurial activities.

The generation of self-employment in non-farm activities requires investment in working capital. However, at low levels of income, the accumulation of such capital may be difficult in these rural areas. Under such circumstances, granting loans to rural entrepreneurs, most often increase family income and can help the poor and most vulnerable to accumulate their own capital and invest in employment generating activities.

Commercial banks and other financial institutions fail to cater for the credit needs of rural smallholders, however, mainly due to their lending terms and conditions. It is generally the rules and regulations of the formal financial institutions that have created the myth that the poor are not bankable, and since they cannot afford the required collateral, they are often considered not creditworthy. Hence, despite efforts to overcome the widespread lack of financial services, especially among these rural smallholders in developing countries, Ghana has taken the lead but countless financial scandals and impropriety are negatively affecting its rural financing.

The expansion of credit in the rural areas of developing countries, where the majority still have only limited access to banking services to support their private initiatives, continue to be the best strategy of governments in checking rural-urban drift. In the recent past, there has been an increased tendency to fund credit programmes in the developing countries aimed at small-scale enterprises.

In Ghana, despite emphasis on increasing the availability of credit to small and micro enterprises, access to credit by such enterprises remains as one of the major constraints they face. Majority of enterprises keep on mentioning lack of capital as their principal problem. Although causality cannot be inferred a priority from the relationship between credit and enterprise growth, it is an indicator of the importance of credit in enterprise development. The failure of specialised financial institutions to meet the credit needs of such enterprises has underlined the importance of a needs-oriented financial system for rural development.

Experience from informal finance shows that the rural poor, especially women, often have greater access to informal credit facilities than to formal sources. A relevant question then becomes; Why do informal financial institutions often succeed even where formal institutions have failed? Lack of an empirical analysis of the relationship between lending policies and the problem of access to credit make it difficult to answer such a question. Small-scale enterprises have become an important contributor to the Ghanaian economy.

The sector contributes to the national objective of creating employment opportunities, training entrepreneurs, generating income and a source of livelihood for the majority of low-income households in the country. If more small-scale enterprises are located in the rural areas, the sector will have a high potential for contributing to rural development. Yet the majority of these entrepreneurs are considered not creditworthy by most formal credit institutions. Whereas a small number of NGOs finance an increasing number of micro enterprise activities, most formal institutions still deny these enterprises access to their services.

Ghana realised the need for such financial intermediaries in the rural areas and introduced the rural banking concept, decades of years ago. This has really contributed immensely to the growth of rural small scale enterprises in certain parts of the country. However, Ghana’s recent financial scandal equally hit a number of these rural banks.

Some rural banks in Ghana made huge investments with a number of fund managers registered under Ghana’s Securities and Exchange Commission (SEC) and most of these investments are now impaired and these fund managers are unable to pay back. The question is, how can SEC help these rural banks to retrieve their locked up funds with these fund managers? In furtherance to that, in some of the instances, the capital structure of these fund managers are insignificant to make good these locked up funds of the rural banks.

These fund managers used their exorbitant and uneconomical interest rates to entice investments from these vulnerable rural banks. It is an established fact that Bank of Ghana monitors the lending and interest rates of banks, similarly, do the fund managers have their autonomy in fixing high arbitrary interest on their various investment portfolios?

Perhaps these fund managers acted ultra vires and if so, SEC should use its effective arsenals to retrieve these locked up funds of these rural banks because these invested funds are definitely their depositors’ money. It should be noted that, it is only vibrant rural financing that could sustain the government’s one-district-one-factory flagship programme because majority of the districts in Ghana are predominantly rural, with all due respect.

The more the rural banks become liquid the more the credits they grant rural enterprises. Improving the availability of credit facilities to rural entrepreneurs is one of the incentives that have been proposed for stimulating growth in the rural areas and the realisation of its potential contribution to the economy. Despite this emphasis, the effects of existing institutional problems, especially the lending terms and conditions on access to credit facilities, have not been addressed.

In addition, there is no empirically accepted finding indicating the potential role of improved lending policies by both formal and informal credit institutions in alleviating problems of access to credit. Knowledge in this area, especially a quantitative analysis of the effects of lending policies on the choice of credit sources by entrepreneurs, is inadequate rural financial markets in Ghana.

Although informal credit institutions have proved relatively successful in meeting the credit needs of small enterprises in some parts of the country, their limited resources restrict the extent to which they can effectively and sustainably satisfy the credit needs of these entrepreneurs.

This is because as micro enterprises expand in size, the characteristics of loans they require become increasingly difficult for informal credit sources and they still remain too small for the formal lenders. Studies on financial markets in Ghana have shown that credit markets are segmented and unable to satisfy the existing demand for credit in rural areas. A relevant issue for empirical investigation is therefore that of the factors behind the coexistence of formal and informal credit sources in Ghana’s financial market.

An increasing body of analytical work has attempted to explain the functioning of credit markets using new theoretical developments. Challenging the paradigm of competitive equilibrium, they have explored the implications of incomplete markets and imperfect information for the functioning of credit markets in developing countries. These provide a new theoretical foundation for policy intervention.

Most of this body of literature has followed from the pioneering work of early financial analysts. The work of these financial analysts marks the beginning of attempts at explanations of credit rationing in credit markets. In this explanation, interest rates charged by a credit institution are seen as having a dual role of sorting potential borrowers (leading to adverse selection), and affecting the actions of borrowers (leading to the incentive effect).

Interest rates thus affect the nature of the transaction and do not necessarily clear the market. Both effects are seen as a result of the imperfect information inherent in credit markets. Adverse selection occurs because lenders would like to identify the borrowers most likely to repay their loans since the banks’ expected returns depend on the probability of repayment. In an attempt to identify borrowers with high probability of repayment, banks are likely to use the interest rates that an individual is willing to pay as a screening device.

However, borrowers willing to pay high interest rates may on average be worse risks; thus as the interest rate increases, the riskiness of those who borrow also increases, reducing the bank’s profitability. The incentive effect occurs because as the interest rate and other terms of the contract change, the behaviour of borrowers is likely to change since it affects the returns on their projects.

The study further showed that higher interest rates induce firms to undertake projects with lower probability of success but higher payoffs when they succeed (leading to the problem of moral hazard). Since the bank is not able to control all actions of borrowers due to imperfect and costly information, it will formulate the terms of the loan contract to induce borrowers to take actions in the interest of the bank and to attract low risk borrowers.

The result is an equilibrium rate of interests at which the demand for credit exceeds the supply. Other terms of the contract, like the amount of the loan and the amount of collateral, will also affect the behaviour of borrowers and their distribution, as well as the return to the banks. Raising interest rates or collateral in the face of excess demand is not always profitable, and the banks will deny loans to even prospective borrowers.