Factors Determining Access to Credit Facilities for Farmers in Cherangany Constituency in Trans-Nzoia County

Master's Thesis, 2013

55 Pages







Table of content

List of Tables

List of Figure

1.1 Background of the Study
1.1.1 Credit Facilities for Farmers
1.1.2 Factors Determining Access to Credit
1.1.3 Relationship Between Credit and Determinants of Access to Credit
1.2 Research Problem
1.3 Objective of the Study
1.4 Value of the Study

2.1 Introduction
2.2 Theoretical Review
2.2.1 Demand and Supply Theory
2.2.2 The Pecking Order Theory
2.2.3 Signaling Theory
2.4 Summary of Literature Review

3.0 Introduction
3.1 Research Design
3.2 Target Population
3.3 Data Collection Methods
3.4 Data Analysis and Interpretation

4.1 Introduction
4.2 Demographic Information
4.3 Study Information
4.4 Model Analysis

5.1 Introduction
5.2 Summary of Findings
5.3 Conclusion
5.4 Recommendations
5.5 Limitations of the Study

Suggestions for Further Research




I dedicate this work to God who has bestowed me with knowledge and wisdom throughout the entire course, to my brothers and sisters for their immense support and to my friends for their motivation.


It has been postulated that access to credit for farmers has been influenced by a number of factors. It is presumed that there exists a relationship between agriculture productivity and poverty alleviation (Nyoro, 2002), and hence the critical need to address inadequate credit facilities in rural areas that are a key constraint to farmers investments. Given that the major economic function of financial institutions include addressing the restraints imposed by inadequate access to financial services; it is argued that these institutions are well positioned to dealing with these financial constrains among which include access to credit. Literature review in chapter two revealed that access to credit was a challenge facing farmers in various parts of the globe. Studies indicated that a significant proportion of challenges in the farming industry could be alleviated through the provision of sustainable and easily accessible credit. For this study, data was gathered using questionnaires and was analyzed using Ms-Excel and presented using elementary statistical techniques such frequency tables and charts. After analyzing the findings, the researcher drew conclusions and made recommendations. Areas for further studies were identified as well. Research established that collateral, basic loan requirements and interest rates on loans are key determinants to farmer’s access to credit, deficiency in any of the above factors hindered farmers from getting credit. After assessing the findings of the study, the researcher made recommendations aimed at improving and making it easy for farmers to access credit, e.g. coming up with loan products specifically tailored for farmers and opening of rural branches by financial institutions to bring services closer to farmers.


Table 4.1 Respondents Age in Years

Table 4.2 Respondents Gender

Table 4.3 Years of Farming

Table 4.4 T Test Coefficients

Table 4.5 Model Summary

Table 4.5 F Test for Full Model


Figure 4.1 Size of the Firm 24

Figure 4.2 Income from Farming

Figure 4.3 If the Respondents Owe Credit to Financial Institutions

Figure 4.4 Measure of Security for a Loan

Figure 4.5 Measures for Loan Requirements

Figure 4.6 Measure of Factors Determining Interest Charged on Loans

Figure 4.7 Sources of Money for Firm Inputs, School Fee and Other Investments...

Figure 4.8 What Lenders should do to Encourage Farmers Apply for Credit



1.1 Background of the study

Until recently, the African agricultural landscape was characterized by sluggish growth, low factor productivity, declining terms of trade, and often also by practices that aggravated environmental problems. Since the late 1970s to mid 1980s, many African countries have implemented macroeconomic and sectoral reforms aimed at ensuring high and sustainable food productivity, economic growth and poverty reduction.

Some recent agricultural growth accelerations notwithstanding, the sector’s growth remained insufficient to adequately address poverty, attain food security, and lead to sustained GDP growth on the continent (Nyoro, 2002).

The principal function of credit is to transfer property from those who own it to those who wish to use it, as in the granting of loans by banks to individuals who plan to initiate or expand a business venture. The transfer is temporary and is made for a price, known as interest, which varies with the risk involved and with the demand for, and supply of, credit. Credit puts to use property that would otherwise lay idle, thus enabling individuals or a country to more fully employ its resources.

A study by Atieno (2001), indicates that income level, distance to credit sources, security, past credit participation and assets owned were significant variables that explain the participation in formal credit markets. Hussein (2007), also indicated that Farm households are more likely to prefer the informal sector to the formal sector with respect to flexibility in rescheduling loan repayments in times of unexpected income shocks. This was also supported by Padmanabhan (1996), comparing the informal credit sector from the formal stated that proximity, comfortable atmosphere, quick credit, all times access, freedom of deployment, repayment flexibility and lower transaction costs are the advantages of the informal sector have made them almost indispensable, particularly to small farmers.

1.1.1 Access to Credit by farmers

Rural credit markets in developing countries are full of imperfections. The imperfections manifest in the generally accepted fact that, despite numerous government policies to increase household’s access to credit, many rural households remain credit-constrained. The formal banking sector does not satisfy the growing demand for credit, and many borrowers turn to informal loan sources (relatives, private moneylenders, etc.) to meet their production and consumption needs. It has been estimated that only five percent of the farmers in Africa and about fifteen percent in Asia and Latin America have had access to formal credit; and on an average across developing countries five percent of the borrowers have received eighty percent of the credit (Bah, 2001). Access to affordable agricultural credit enables farmers, who constitute the majority of population in most developing countries, to adopt new technology and take advantage of new economic opportunities to increase production and income.

The principal function of credit is to transfer resources from those who have and don’t use them to those who don’t have and wish to use them, this is done using different avenues e.g. granting of loans by banks and MFI’s to individuals who plan to initiate or expand a business venture or agricultural production. The transfer is temporary and is made for a price, known as interest, which varies with the risk involved and with the demand for, and supply of, credit (Kimuyu and Omiti 2000).

According to Mutua and Oyugi (2005), interest in access to finance has increased significantly in recent years, as growing evidence suggests that lack of access to credit prevents lower-income households and small firms from financing high return investment projects, having an adverse effect on growth and poverty alleviation. They examined literature on the causal relationship between access to financial services and its impact on agricultural production. The literature, mostly observational from a few case studies, reveals that access to financial services by the rural people (or low income population segments) can improve their incomes and therefore their welfare.

1.1.2 Factors determining access to Credit

The business of Kenya is agriculture - the principal source of income for 75% of the nation’s population. Yet agriculture accounts for only 25% of the Gross Domestic Product. As a result, 75% of Kenyans depend on a technically inefficient industry whose average labor input is three times greater than its output. Due to its dominance, any change in the agricultural sector translates to changes in the entire economy. Efforts to grow the economy and reduce poverty must begin with agriculture. For the majority of Kenyans, farming exists mainly for subsistence. The level and scale of crop production is geared towards satisfying household requirements. Kenya’s agriculture is mainly rain-fed and is entirely dependent on the bimodal rainfall in most parts of the country. A large proportion of the country, accounting for more than 80 per cent, is semi-arid and arid with an annual rainfall average of 400 mm. Droughts are frequent and crops fail in one out of every three seasons.

Kenya’s agriculture is predominantly small-scale farming mainly in the high-potential areas. Production is carried out on farms averaging 0.2-3 ha, mostly on a commercial basis. This small-scale production accounts for 75 per cent of the total agricultural output and 70 per cent of marketed agricultural produce.

In 2005, agriculture, including forestry and fishing, accounted for about 24 percent of the GDP, as well as for 18 percent of wage employment and 50 percent of revenue from exports. (Macharía etai, 2008).

Farming is the most important economic sector in Kenya, although less than 8 percent of the land is used for crop and feed production, and less than 20 percent is suitable for cultivation. Kenya is a leading producer of tea and coffee, as well as the third-leading exporter of fresh produce, such as cabbages, onions and mangoes. Small farms grow most of the corn and also produce potatoes, bananas, beans and peas. Growth of the national economy is therefore highly correlated to growth and development in agriculture.

1.1.3 Credit and determinants for access to credit for farmers

Credit provision is one of the principal components of rural development, which helps to attain rapid and sustainable growth of agriculture. Rural credit is a temporary substitute for personal savings, which catalyses the process of agricultural production and productivity. To boost agricultural production and productivity farmers have to use improved agricultural technologies. However the adoption of modern technologies is relatively expensive and small farmers cannot afford to self finance. It is widely acknowledged that inadequate financial resources are a key constraint to farmers’ investments, the key to enhancing agricultural productivity (Townsend, 2008). In Kenya, MFI’s have set strategies aimed at addressing financial deficiency in the farming industry. Such institutions are well positioned to explore innovations and design products that are tailored toward addressing constraints of access to credit, with a view of stimulating agricultural growth and productivity.

In the first Medium Term Plan of Kenya’s vision 2030, the government aims at transforming the agriculture sector into a vibrant modern sector, supporting value- addition through scientific and technological innovation, and most importantly access to credit.

1.2 Research Problem

Despite the fact that a bigger percentage of Kenya’s population live in rural areas and that 80 percent are involved in farming activities, there is little effort by commercial banks and other financial institutions to facilitate credit to this industry which is crucial in rapid development of this dominant section of the population. There is no bank which caters for the specific credit and saving needs. The available piecemeal credit services are operated by small credit schemes, which are limited in scope and have specific target groups. The inadequacy in financing and credit arrangements in rural Kenya and in specific the spread of this study impede development of agriculture and rural sectors. Given that this sector is the mainstay of a large segment of the populace; their poor performance makes the fight against poverty even more challenging (Kimuyu and Omiti, 2000).

According to Nyoro (2002), lack of access to credit facilities has been highlighted a key constraint to farmers investment. The demand for credit by farmers has been high and increasing. It includes access to credit to cover lump sum and smooth farmers’ consumption among others. The expenditure requiring lump sum includes purchase of farm inputs, ploughing, top dressing, and labor and irrigation activities. Many farmers have hardly been able to meet these farm expenditures due to lack of financial command and potential. The thrust of this study draws from the premise that access to credit by farmers is key to increasing productivity. In this respect, one of the major reasons is that purchased seasonal inputs and requisite labor are rarely affordable by farmers on a “cash” basis. Majority of these farmers face liquidity constraints that compromise the crucial investments in agriculture and other sectors necessary in increasing productivity (Doward etai, 1998).

The study therefore seeks to establish how lack of collateral, basic loan requirements by financial institutions and interest on loans has hindered farmer’s access to credit.

1.3 Objective of the study

The objective of the study is to establish factors determining access to credit facilities for farmers in Cherangany constituency.

1.4 Value of the study

The study will provide useful information on the status of farmers in accessing credit from commercial banks and other financial institutions. This information will be vital for policy makers in taking appropriate actions toward facilitating the establishment of comprehensive and sustainable credit products for the development of agriculture in Cherangany. The study results will also benefit development partners and civil society organizations involved in the provision of credit facilities to farmers in modifying the lending measures and conditions to better serve the specific credit needs of their clients. In general, it is hoped that the end result of this study will provide a thrust to explore the possibility of providing credit facilities that directly support farmers to increase productivity.



2.1 Introduction

This chapter will look into studies done by other researchers on the same topic. It will therefore contain theoretical review, give an overview on rural finance and discuss on empirical studies on determinants of borrowers access to credit.

2.2 Theoretical Review

2.2.1 Demand and Supply Theory

Demand theory was first raised as a fundamental principle of microeconomics by a French economist Walras (1834-1910). The theory is an analysis of the relationship between the demand for goods or services and prices which examines purchasing decisions of consumers and subsequent impact of prices on commodity demanded. According to Walras (1834-1910), price of a commodity influences its demand. This theory was criticized by later up-coming economists as shallow; however, they used it as a base to develop the law of demand, stated by many economists as: an inverse relationship exists between the price of a commodity and the quantity demanded of the product, that is, when the price of some commodities goes up, the quantity we consume of these commodities goes down and vice versa, other things held equal (Saleemi, 2000; Mudida, 2003).

Economists have attempted to explain consumer behavior on demand for a commodity using different theoretical and empirical economic concepts. A large number of social- economic factors play an important role in determining demand for a commodity by an individual entrepreneur. Credit is an important commodity for improving the welfare of the poor in their micro-economic activities especially in developing countries. In the Kenyan economy, most of small-scale enterprises are operated within the informal sector. The sector covers all semi-organized and unregulated economic activities that are small scale in terms of employment. Its economic contribution is more than double that of medium and large enterprise sectors that stands at 7% of the country’s GDP (GoK, 2003). The sector therefore is a major source of employment and income to many households in Kenya.

When cost of credit goes up, the marginal utility per Shilling raised from that credit goes down. The household therefore chooses to consume, or use less of the credit (David, 2001). The concept of utility and marginal utility used by economists explains consumer demand on a commodity. Utility is the capacity or power of a commodity to satisfy the desire of a user (Lisper et al, 1987). Any commodity that satisfies human wants has utility. For example, if credit borrowed will satisfy financial needs of a household, then credit has utility (Saleemi, 2000). The main objective of any individual business operator is to maximize satisfaction out of any financial support borrowed, given or self made.

Mudi da (2003), points out that if income increases, the demand for most goods will increase. Small-scale investors tend to cluster and limit their business activities to similar products mostly of low quality that target low income earners. This leads to low business retums that cannot empower the business owners to borrow credit from formal institutions where the trader will be required to undergo implicit and explicit costs.

Livingston and Ord (1994) argued that the amount an individual wishes to buy of a commodity depends on several factors. Firstly is his/her taste or preference, which may be influenced by factors such as age, sex, education or religion. Secondly, the amount an individual buys may depend on the price of the commodity. Therefore, if the goods are very expensive, the buying power is reduced and vice versa. In the credit market, this consideration is on implicit and explicit costs of credit, which are added costs to business operators and have to be considered when making a decision to borrow or not to borrow and from which source. Thirdly, Livingston and Ord (1994) explained that amount bought is affected by availability of other goods. This applies more to close substitutes like in this case, consideration of borrowing credit from commercial formal institutions, formal government subsidized institutions, or from informal credit markets. If formal markets prove expensive, borrowers are likely to turn to informal markets. The opposite will apply if the informal markets are expensive. Lastly, Livingston and Ord (1994) pointed out that the size of a household’s income affects the amount it buys of a commodity. If the income increases, they will be able to buy more. This argument holds only for necessity goods such as credit borrowing to finance business operations, otherwise it will not apply to inferior goods.

2.2.2 The Pecking Order Theory

The pecking order theory of capital structure is among the most influential theories of leverage. Originally developed by Myers (1984), it considers the role of information asymmetries. According to Myers, firms use internal funds that are less costly than external funds. When internal funds are insufficient, firms then consider outside funds. Here, firms prefer debt to equity because of lower information costs associated with debt issues, while equity is rarely issued. Later, these ideas were refined into testable predictions and confirmed by Vogt (1994) who finds that internal funds have an important influence in firm’s investment decisions. In agriculture, pecking order behavior is clearly pronounced where farmers who invest in this industry prefer to use internal funds (in many cases savings) and when the latter is not sufficient they resort to debt in form of loans from financial institutions to finance their farming investments.

2.2.3 The Signaling Theory

The concept of signaling was first studied in the context of job and product markets by Akerlof and Arrow and was developed into signal equilibrium theory by Spence (1973), which says a good firm can distinguish itself from a bad firm by sending a credible signal about its quality to markets. The signal will be credible only if the bad firm is unable to mimic the good firm by sending the same signal. If the cost of the signal is higher for the bad type than that of the good type firm, the bad type may not find it worthwhile to imitate, and so the signal could be credible. Ross (1977) shows how debt could be used as a costly signal to separate the good from the bad firms. Under the asymmetric information between management and investors, signals from firms are crucial to obtain financial resources. Signaling of higher debt by managers then suggests an optimistic future and high quality firms would use more debt while low quality firms have lower debt levels. In this way, good firm can separate itself by attracting scrutiny while the bad firm will not ape because the bad firm will not want to be discovered. Two types of signaling inside information have been suggested: one is the costly signaling equilibrium discussed by Spence (1973), Leland and Pyle (1977), Ross (1977) and Talmor (1981) etc., the other is the costless signaling equilibrium as proposed by Bhattacharya and Heinkel (1982), Rennan and Kraus (1984). A signal is costly if the production of the signal consumes resource or if the signal is associated with a loss in welfare generated by deviations from distribution of claims in perfect markets. The signaling paradigm is multivariate for financial instruments.

Poitevin (1989) demonstrates that debt could be used as a signal to differentiate the potential competition of new entrant firms. Low cost entrants signal this fact by issuing debt while the incumbent or high cost entrants issue only equity; (Harris and Raviv, 1985) argue that calling firm’s convertibles can be a kind of signal and Bhattacharya and Dittmar (1991) show stock repurchase is another kind of signal to represent firm value.

In farming industry, the signaling theory talks about financing tactics, where good firms try to distinguish themselves from bad quality firms by using different financing device. Farm owners also have incentives to get external financing by adopting such financing strategies. Unlike corporate firms who offer signals to stock market, farm owners send signals to all potential lenders in agricultural capital market.


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Factors Determining Access to Credit Facilities for Farmers in Cherangany Constituency in Trans-Nzoia County
Master of Business Adminstration-Finance
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credit, facilities, farmers, factors, determining, access, cherangany, constituency, trans-nzoia, county
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Isaac Mbugua (Author), 2013, Factors Determining Access to Credit Facilities for Farmers in Cherangany Constituency in Trans-Nzoia County, Munich, GRIN Verlag, https://www.grin.com/document/266044


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