The Impact of Extension and Ecosystem Services on Smallholders’ Credit Constraint.

On formal credit markets, access to formal credit and reasonable credit terms of smallholder farmers<br/>in rural sub-Saharan Africa is limited due to adverse selection. Financial institutions operating in<br/>rural areas often cannot distinguish between borrowers (farmers) that are creditworthy and those that<br/>are not, thus, allocate limited resource to agriculture to reduce credit risk. In the presence of limited business quality signaling by smallholder farmers, financial institutions shall demand for collateral and/or offer unfavorable contract terms. Moreover, agricultural productivity of rural sub-Saharan<br/>Africa, dominated by subsistence or small-scale farmers, is also negatively impacted by the adverse<br/>effect of climate change. A strategy that may make the farming practices of smallholder farmer’s<br/>climate resilient and profitable may also improve smallholder farmer's access to formal credit. This<br/>study investigates to what extent participating in ecosystem and extension services (EES) programs<br/>signals business quality of smallholders, thus granting them credit accessibility. We collected data<br/>on 210 smallholder farmers in 2013, comprising farmers that receive payments for ecosystem<br/>services (PES) and farm management training from the International Small Group Tree Planting<br/>Program (TIST) Kenya to test the aforementioned theory empirically. We use game theory,<br/>particularly a screening and sorting model, to illustrate the prospects for farmers with EES to access<br/>formal credit and to improve their credit terms given that they receive PES and banking services<br/>training. Furthermore, the PES’ long term duration (10 – 30 years) generates stable cash-flow which<br/>may be perceived as collateral substitute. Results suggest that smallholder farmers in the TIST<br/>program were less likely to be credit constraint compared to non-TIST farmers. Distance to market,<br/>education, livestock and farm income are factors that determine access to credit from microfinance<br/>institutions in rural Kenya. Amongst farmers that have obtained loans, those keeping business records<br/>enjoy more favorable formal credit conditions. These farmers were observed to pay ca. 5 percent less<br/>interest rate in microfinance charges. For TIST farmers, this type of farm management practices may<br/>be attributed to the banking services and other training they receive within the program. While the<br/>availability of classical collateral (farmlands) and PES may reduce interest rate, the latter was found<br/>to be statistically insignificant. This research underlines the importance of an effective extension<br/>services in rural areas of developing countries and the need to improve gains from conservation<br/>agriculture and ensuing PES. The benefits associated with EES and PES may encompass agricultural<br/>financing.