Credit Risk Management Practices Used by Banks in Agricultural Finance: A Case Study of Pakistan

Abstract

Purpose: Agricultural sector is an important sector of Pakistan’s economy. Agriculture plays a significant role in the economic development of Pakistan.  Its contribution to GDP is about 23% and approximately 60% of Pakistan’s total population live in the rural areas and most of them earn their livelihood from agriculture.  Due to the green revolution, rapid changes have been occurring  in production technologies, and methods have been changed.  As more capital is required to adopt these methods and technologies, so the small farmers cannot afford these methods. They need finances for production and investment purpose.  The small farmer has very limited ability to agricultural finance for both production and investment needs and they are facing a shortfall of credit. Banks hesitate to grant agriculture credit because of higher credit risk.  The main purpose of this research paper is to find out the credit risk faced by the banks of Pakistan and risk management techniques used by these banks.

Research methodology: This research is basically quantitative in nature, and a Standard questionnaire is used for the collection of data on credit risk and its management techniques from the banks.  A sample of 45 bank branches of 17 banks that grant agriculture credit has been taken and questionnaire were being filled by credit officers of the agricultural sections of these banks. The Frequency distribution technique was applied through SPSS 17 to analyze and finalize the results.

Findings: The major findings of this research are: 82.2% of banks had faced the situation of credit risk in which farmers failed to pay back the credit to the bank.  53.3% respondents considered the production, price and policy risk together affect all the farmers in a particular geographical area. 35% considered ‘’willful rejection risk” as an important risk that arises due to an individual farmer. 60% respondents use the crop insurance for the management of production risk. 48.9% bank used no technique for the management of price risk. 75.6% respondents suggest that the improvement in laws and policies on land ownership will help in credit risk management.  60% respondent does not insure the life of a farmer.  77.8% use collateral management for the management of “willful rejection risk”.  According to 75.6% respondent’s fire/theft insurance of agricultural asset will help to manage this risk.

Originality /Value: The value of this research paper is that it gives us an idea about the credit risk faced and its management techniques used by the banks of Pakistan.  It also gives us an idea about the credit risk management techniques which are being used in the world but not in the Pakistan.

Research Implications: The research implications of this paper are to increase the understanding of factors which are the basis for credit risk in agricultural financing and its management techniques used by the banks of Pakistan.

Paper Type: Research Paper

Keywords: agricultural finance, credit risk, Risk management practices, crop insurance, highly correlated risk, localized risk, price smoothing.