The Impact of Institutional and non-Institutional Credit
Source: Flickr, Asian Development Bank

One of the main goals of India’s agricultural policy since independence has been to reduce farmers’ dependence on informal credit, since independence the share of formal credit in India has increased from 9 percent in 1951 to about 64 percent in 2013.

A recent IFPRI discussion paper investigates the impact of institutional/formal credit and non-institutional/informal credit on the incomes and consumption of farm households in India. This is significant as multiple studies in other developing countries have shown a positive correlation between access to formal credit and agricultural productivity and household income. However, the links between formal credit and farm incomes are not very well documented in India.  This paper aims to fill this gap by assessing the impact of formal and informal credit on farm households’ welfare based on a national farmers’ survey.

The study uses farm-level data from a nationally-representative survey conducted by the National Sample Survey Office in 2013. The survey covered 4,529 villages and collected detailed information on 35,200 farming households. The information collected included information on the following indicators: socioeconomic well-being of agricultural households; consumption expenditures; incomes from productive assets; levels of borrowing, lending, and indebtedness; farming practices; receipts and expenses of households’ farm and nonfarm businesses; awareness of technological developments; and access to modern technology. Through a series of regressions, the paper assesses the impact of formal and informal credit on the economic welfare (farm income and household consumption expenditures) of farm households in India.

India has a vast network of financial institutions, with the coexistence of large numbers of formal and informal agencies that lend money to agricultural households for short- and long-term purposes. The survey shows that formal credit makes up around 64 percent and informal credit around 34 percent of the loan volumes for agricultural households. Regarding formal credit, banks provide 71 percent of the total volume, followed by cooperative societies (25.4 percent) and government sources (3.6 percent). Regarding informal credit, professional moneylenders provide 64 percent of total loans, followed by friends and relatives (24 percent), shopkeepers (4.9 percent) and employers/landlords (2.3 percent).

Significantly, the survey shows that almost half of agricultural households (48 percent) do not borrow any money and thus are not participants in the financial markets. The survey argues that not participating in the financial markets may be voluntary or non-voluntary (if they do not meet the necessary requirements to borrow), and a positive relationship is found between the incidence of borrowing and land size, indicating that this may be the case.  Specifically, 58 percent of marginal, 48 percent of small, 41 percent of medium, and 28 percent of large farms did not borrow any money according to the survey. Overall, between 2012 and 2013, 23 percent of agricultural households reported having borrowed money from formal sources, 16 percent borrowed from informal sources, and 13 percent borrowed from both formal and informal sources.

Regarding the impact of access to formal and non-formal credit on farm incomes, the study finds that access to institutional credit is associated with higher net farm income (NFI), overall the NFI of formal borrowers is 43,740 rupees per hectare which is significantly greater than that of informal sector borrowers at 33,734 rupees per hectare. The study also finds that the relationship between farm size and NFI per hectare for households that use both formal and informal credit is negative. For instance, the NFI per hectare of a farmer who owns a marginal plot of land and is a formal borrower is 49,118 rupees while the NFI per hectare of a large-scale farmer who is a formal borrower is 40,840 rupees.  

The study finds similar trends among households’ monthly consumption expenditures finding that access to formal credit increases the monthly consumption expenditures by households by 10 percent.  This is significant as consumption expenditure is a proxy of household income and therefore, poverty. More specifically, the results indicate that access to formal credit is proportionately more beneficial for households who are poorer and own smaller plots of land households, for instance for households who own marginal plots of land a person’s household consumption expenditure averages 1279 rupees if households access informal credit sources which increases significantly to 1695 rupees when households access formal credit sources. This increase is proportionally found to be less as the farm size of households increases, for instance, for households who have large farms, a person’s household consumption expenditure averages 1931 rupees if households have access to informal credit sources which increases to 2158 rupees if households have access to formal credit sources.

In conclusion, the paper notes that access to formal credit could be effective in improving agricultural incomes and per capita monthly household expenditures of agricultural households. However, the results also indicate that formal credit is more easily accessible to agricultural households with larger farms and that marginal and small-scale farmers who are found to benefit most from accessing formal credit find it most difficult to access. The paper argues that policies need to be designed that reverse this trend and improve smallholders’ access to formal credit.

By: Bas Paris


Photo credit:Flickr, Asian Development Bank