Rationing Agricultural Credit in Developing Countries: The Role and Determinants of Transaction Costs for Borrowers

Transaction costs in financial intermediation are a measure of the 'friction' existing in the functioning of financial markets. The higher the costs of intermediation, the less efficient the performance of the financial sector in resource allocation and distribution. Transaction costs frequently increase as a result of regulations imposed on financial markets, such as interest-rate restrictions and selective credit policies. Financial intermediaries circumvent interest-rate regulations through non-price mechanisms that generate transaction costs for lenders and borrowers, whereas selective credit policies usually carry built-in cost-increasing procedures and requirements. In this paper we investigate the role of transaction costs of borrowing as a rationing mechanism in the agricultural credit markets of five less-developed countries. We show that borrowing transaction costs become an effective non-price rationing device in these markets. We further argue that the results of these rationing practices are regressive, despite the intended distributional goals of low-interest rate credit policies and small-farmer credit allocations schemes. We also investigate the main determinants of borrowing transaction costs, and show that an inverse relationship exists between the level of the explicit interest rate charged on loans and the magnitude of these transaction costs. Our findings indicate that both development banks and private banks pass on transaction costs to borrowers as an implicit-pricing mechanism to ration out undesired clients. Private banks are generally more effective in doing this than development banks and, at the same time, more responsive to changes in the interest-rate structure. We first present a summary and discussion of recent evidence on the levels and degree of regressiveness of borrowing transaction costs in agricultural credit. The next section deals with the main determinants of these costs borne by farmer borrowers, emphasising the trade-off between transaction costs and interest rates on the one hand, and the differences between private bank and development bank behaviour on the other hand. Major conclusions follow.