Analysis of Causes and Management of Agricultural Loan Default by Rural Banks in the Northern Region of Ghana

Abstract

Agriculture is important in developing countries because of the role it plays in attaining food security and rural economic stability. Financing the agriculture sector however, has been a challenge because of the sector‟s exposure to exogenous risk factors, limited collateral of clients and the seasonal nature of agricultural production. As a result of these risks that result in loan default, financial institutions in Ghana allocate a rather small share of their loan portfolios to the sector, compared to other sectors. Given the perception of financial institutions that lending to farmers is risky, the study sought to find out how rural banks manage their lending to reduce loan default. The study was conducted in the Northern region of Ghana and included 5 functioning rural banks and their clients. The logit model and Likert scale procedures were used to identify the causes of loan default from the perspective of borrowers and lenders respectively; rank the causes of default from the perspectives of rural banks with Kendall‟s W; identify and assess the effectiveness of strategies adopted by banks to mitigate loan default using a Likert scale. Using performance of group loans, the study finds that the size of the group and group executives being educated, have a positive relationship with loan default, whiles farmers engaging in off-farm businesses, years of business relationship between the lender and borrower and monitoring had a negative relationship with loan default. From the perspective of the banks, borrowers diverting the loan for other purposes was the predominant cause of default. A significant degree of agreement was found among the rural banks in the region regarding the causes of loan default. The most adopted and effective credit risk management measure was evaluating the repayment capacity of the borrower. The study recommends that since the rural banks were in agreement on the causes of loan default in the region, a general management strategy will be relevant to the whole region. It is recommended that capacity building workshops should be organised for rural banks and farmer groups on ways to control endogenous causes of agricultural loan default. Also, rural banks should upgrade their management information systems (MIS) to be more analytical to identify characteristics of clients associated with high risk of default.