Progressive Lending in Microfinance—What about the Farmers?

• Author: Oliver Musshoff,Imke Hering
• DOI: http://doi.org/10.1111/rode.12273
• Date: 01 August 2017
• Published date: 01 August 2017

Progressive Lending in Microfinance—What about

the Farmers?

Imke Hering and Oliver Musshoff*

Abstract

Dynamic incentives have become a common measure in microfinance institutions (MFI) to counteract

the risk of default and to strengthen the borrower’s identification with his micro-lender. This article

focuses on progressive lending over the course of the bank–borrower relationship. As the agricultural

sector is increasingly important for Azerbaijan’s economy, this study differentiates between the lending

policies faced by farmers and non-farmers, and matches the findings with the repayment performances of

both client groups. By means of a rich data set spanning from 2007 through 2012 provided by an MFI in

Azerbaijan, it can be demonstrated that farmers face a higher degree of loan volume rationing that

cannot be justified by our findings on repayment performances. Moreover, we find that repeated

borrowing increases the default probabilities of both client groups. In conclusion, we deduce that the

MFI and borrowers could benefit from reconsidering the current lending policies.

1. Introduction

In developing and transition countries, promoting the agricultural sector is an

important driver for the development of rural areas. Enhanced access to finance is

a key factor for increasing private investments in order to foster productivity in

agriculture. Since small-scale farms are particularly prevalent in these countries,

microfinance plays an important role in terms of financial access and the willingness

to invest (World Bank, 2015).

However, a number of studies reveal that it is farmers who face relatively greater

initial obstacles in terms of loan access since agriculture is associated with higher

risk exposition (Petrick, 2004; Weber and Musshoff, 2012; Zeller et al., 1998).

Simultaneously, empirical findings indicate that farmers do not necessarily default

more often (Raghunathan et al., 2011; Vogel, 1981; Weber and Musshoff, 2012);

this inevitably contradicts the perception of higher risk.

Regardless of the client groups, microfinance institutions (MFI) are generally

challenged by a high degree of information asymmetries and lack of legal

enforcement instruments (Egli, 2004; Menkhoff et al., 2012), both of which increase

repayment risk (Armend

ariz de Aghion and Morduch, 2010). As a feasible

enforcement measure, MFIs often apply so-called progressive lending, which

overcomes information asymmetries between MFI and client by rationing the loan

volume for first-time borrowers and rewarding reliable repayment behavior by a

stepwise increase in the available loan amount for the following loan(s) (among

*Hering (Corresponding author) and Musshoff: Department of Agricultural Economics and Rural

Development, Georg-August-Universitaet Goettingen, Platz der Goettinger Sieben 5, 37073, Goettingen,

Germany. Tel: +49-551-3914214; Fax: +49-551-3922030; E-mail: imke.hering@agr.uni-goettingen.de. The

authors gratefully acknowledge financial support from the German Research Foundation (DFG).

Furthermore, the authors would like to thank Access Microfinance Holding AG for the provision of data

and two anonymous referees for providing greatly appreciated comments.

Review of Development Economics, 21(3), 803–828, 2017

DOI:10.1111/rode.12273

©2016 John Wiley & Sons Ltd

others Armend

ariz de Aghion and Morduch, 2010; Egli, 2004). However, studies

that previously focused on financial access and repayment performances of farmers

and non-farmers do not take into account this lending relationship aspect.

To the best of our knowledge, this is the first study that compares lending

policies for farmers and non-farmers with explicit focus on the dynamics of bank–

client relationships by considering the application of progressive lending. Moreover,

it matches the progressive lending policies with the repayment behavior of the

client groups over the course of repeated borrowing. The analysis is drawn on a

rich dataset provided by the AccessBank Azerbaijan and contributes to the quite

limited research on credit histories and dynamics of lending relationships in Eastern

European countries in general, and former Soviet Union countries in particular

(Brown et al., 2009; Van Gool et al., 2012). Azerbaijan is an area of special interest

since the country’s government currently aims to achieve a sustainable economic

development of the non-oil sector (Food and Agriculture Organization of the

United Nations (FAO), 2014). Among others, the empowerment of rural areas by

promoting the agricultural sector is a major objective. Presently, agriculture plays a

minor role in terms of gross domestic product (GDP), although more than a third

of workforce is engaged in the sector. Catching up to other sectors could be

achieved through increased agricultural productivity, which is in turn subject to

private investments. In consideration of Azerbaijan’s farm-support strategy, we

detect if there is potential for adjusting the present lending policies in favor of

farmers since the alignment of lending policies for farmers is currently even more

of mutual interest.

Indeed, our results on repayment analysis are in line with the literature and

confirm that farmers do not default more often than non-farmers and, moreover,

demonstrate a significantly lower probability for delays. This finding is contrasted

by the significantly higher loan volume restrictions for farmers, which relax over the

course of borrowing. According to Agier and Szafarz (2013), loan size is equally as

important for investments as general access to loans. Hence, in the interest of a

successful farm-support strategy, the Azerbaijani government should encourage

MFIs to discard reservations against farmers and instead strengthen agricultural

lending engagements.

The remainder of the paper is structured as follows. Section 2 provides a

literature overview and the derivation of hypotheses. Subsequently, the case study

area and the applied dataset are presented in Section 3. While Section 4 focuses on

progressive lending policies, the repayment behavior of farmers and non-farmers

are analyzed in Section 5. Section 6 concl udes.

2. Previous Empirical Findings and Hypotheses

Relationships between borrower and MFI are considered highly valuable for banks

since the lender can learn more about its clients over the course of time (e.g.

Armend

ariz de Aghion and Morduch, 2010). In turn, the borrower often profits

from repeated borrowing with respect to loan availability and loan contract terms

(Berger and Udell, 1995; Petersen and Rajan, 1994) even in the presence of

economic or environmental shocks (Berg and Kirschenmann, 2015; Berg and

Schrader, 2012).

Regarding lending relationships in microfinance, progressive lending—namely the

increase in loan volume over the course of the bank–borrower relationship—is

believed to enhance the loyalty and intrinsic motivation of borrowers (Armend

ariz

804 Imke Hering and Oliver Musshoff

©2016 John Wiley & Sons Ltd