Analysis of Small Scale Dairy Farmers’ Access to Agricultural Credit in Kabete Sub County

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Table of Contents

  • Sustainable dairy farming and credit access
    Economic pillar
    Social pillar
    Environmental pillar
  • Sources of credit for small holder dairy farmers
  • Non institutional sources
    Institutional sources
  • Commercial Banks
  • Microfinance institutions
  • Producer Cooperatives and Savings and Credit Cooperative Organizations
  • Government Agencies and Programs
  • Constraints to access to credit
  • Rationing of credit
    Individual institution’s constraint
    General Institutional Environment
    Market Failure
  • Theoretical framework
  • Trade off theory
    Consumer Theory
    Agency Theory


This chapter shows a review of literature related to the study which involves access to credit by small holder dairy farmers. It also shows the relationship between credit and sustainable dairy farming, the sources of credit for the smallholder dairy farmers and finally the constraints to access to credit by small holder dairy farmers.

Sustainable dairy farming and credit access

Access to agricultural credit can be defined in several ways. (Ihimodo, 2005) defined it as the process of gaining control over how money, goods or services are used for agricultural activities in the present with the promise of payment at a future date. It can also be defined as a situation whereby there are no constraints to credit access (Perderson & Khitarishvili,1997). In this study, the definition of access to agricultural credit that is adopted combines two perspectives; the ability to access and the willingness to pay. Access to credit is therefore defined as a situation whereby finances are made available whenever needed and in a consistent, flexible and convenient manner as well as the ability and willingness of the borrower to pay up the loan(Manganhele, 2018).

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Sustainable dairy farming refers to practices that ensure that milk produced on a farm is safe, of good quality and produced from healthy cattle in a manner that ensures social, economic and environmental sustainability (International Dairy Federation (IDF) and the Food and Agriculture Organization of the United Nations (FAO), 2009). The aim of sustainable dairy farming is to ensure optimization of the production systems while simultaneously ensuring sustainability of the enterprise. In order to achieve this, sustainable dairy farming embodies three pillars; the social pillar, the economic pillar and the environmental pillar

Economic pillar

The economic pillar revolves around the economic sustainability of the farm. It focuses on the ability of farm to sustain operations in both the short and long run. The main objectives in the economic pillar are increasing production, ensuring quality of the products, diversification of the farm operations, providing access to markets as well as collective action by the smallholder dairy farmers for better integration into the value chains

Social pillar

The social pillar is concerned with the ability of the farm to survive through the changing political, economic and social environment. It relates to the emerging trends in the sector as people become more and more concerned with how agricultural activities affect the wellbeing of human beings. The main objectives in this pillar are providing training for farmers and farmworkers as well as ensuring fair wages for the employees and the farmers as well.

Environmental pillar

The environmental pillar focuses on how the operations on the farm influence the use of environmental resources. It includes aspects such as water conservation and management as well as energy, soil fertility, recycling and proper waste management on the farm.

Providing access to credit to smallholder dairy farmers will enable them to invest in inputs and technologies that increase milk production and ensure the safety and quality of the milk. It will also enable them to gain better information and access to the markets through diversification and increased collective action. Credit will also promote farm operations leading to fair incomes for farmers and their employees. It will also enable farmers to invest in water management systems and waste management systems such as biogas units. Studies, have also depicted that increased access to credit promotes environmental conservation therefore providing access to credit for small holder farmers promotes the environmental pillar of sustainable agriculture(Olatunbosun, 2013).

Sources of credit for small holder dairy farmers

There are two main sources of credit for agricultural producer; Institutional and non-institutional sources.

Non institutional sources

These refer to informal sources of credit for small holder farmers such as friends, middlemen, family and shylocks. They are the most common source of credit for small holder farmers. They are quick to extend credit to the farmers and the term of payment are usually convenient.

However, these loans are usually small in amount and cannot support any viable farm investments. They are also charged with high interest rates and in some instances, the repayment system may be exploitative on the side of the farmer for example in cases where middlemen offer cash advances and loans at low interest rates in exchange for extremely low milk prices (Sawe, 2016). They then proceed to sell the milk at a much higher price to either consumers, cooperatives or processors. The low access to credit and incomes forces smallholder dairy farmers to accept unfair repayment conditions out of lack of alternatives.

Institutional sources

These refer to formal financial institutions such as commercial banks and microfinance institutions, government agencies, producer cooperatives as well as savings and credit cooperatives (SACCOS).

Commercial Banks

Commercial banks have generally been hesitant in extending credit to the agricultural sector. Although they do offer some level of credit to farmers, the mostly focus on large scale farmers or commercial smallholder farmers in stable producer organizations or those operating in value chains with a strong producer-buyer relationship. This represents approximately 7% of the total number of small holder farmers leaving out a major portion of the potential market (International Finance Corporation, 2014).

In Kenya, there are some commercial banks that offer credit services to dairy farmers. Equity Bank Kenya partnered with New Kenya Cooperative Creameries to offer loans of between Ksh. 1000-50000 to dairy farmers for farm investments, veterinary requirements, feed requirements as well as increasing their herds. The bank has also set aside a kitty fund for extending loans to dairy farmers at a 15% interest rate. Family Bank Kenya has also developed credit packages for dairy farmers. The farmers are required to have an account with family bank and deliver their milk to known and established processors. The amount of money the farmers can take up in terms of a loan relies on the number of litres delivered and the value of the milk. In return, farmers can borrow an unsecured loan of up to Ksh. 100,000 payable within a year (Wachekeh, 2013) .

Majority of the banks, however, do not have any loan packages for dairy farmers. This is because the banks incur some level of fixed costs such as checking the creditworthiness of potential borrower before extending credit(Manganhele, 2018).. In the case of smallholder dairy farmers, such costs are driven up by the characteristics that define such farmers. Small holder farmers tend to borrow small amounts of money which ultimately makes it uneconomical for the banks to extend credit to them. The fixed costs, borrowing costs such as the interest rate charged and the transaction costs such as transport to and fro the bank, negotiation and agreement costs drive the cost of the loan higher making it unattractive for both the lenders and borrowers.

Small holder farmers are also dispersed in remote areas characterized by poor levels of infrastructure. This makes monitoring and enforcing the loans difficult for the banks. In order for the banks to remedy the situation, the commercial banks would be forced to adjust their organizational structure to include loan officers, branches in rural areas or mobile banking units. All these will increase the costs for the bank further in terms of salaries, maintenance and security (Asogwa, 2014).

The seasonality of production related to agricultural activities also poses a challenge in extending credit. Agricultural loans are usually large in amount, and given the long gestation periods associated with it, the repayment system, is usually characterized by two large deposits as opposed to the usual monthly or weekly deposits associated with nonagricultural activities. In light of this, the banks are unable to sometimes match their assets and liabilities. This is because during the gestation period, before repayment, the bank is not receiving any payments. However, it is incurring costs such as monitoring costs which are a liability. The mismatch between assets and liabilities in this period causes financial stress on the bank (Manganhele, 2018).

The heterogeneity of small holder dairy farmers in terms of farm and non-farm activities as well household characteristics also makes it difficult to collect information on the financial situation of the farmer. This places a burden on the loan officers as it will take longer to appraise the loans and consequently on the bank as it will entail additional cost. In addition to this, the information gap caused by the heterogeneity of farmers increases the risks of moral hazard by the farmers and adverse selection by the banks all of which increase the risk levels for the bank (Asogwa, 2014).This provides incentive for commercial banks to limit their lending to smallholder dairy farmers.

Microfinance institutions

A microfinance institution is a financial institution that specializes in providing credit to low income groups. These financial institutions would therefore be most suitable for providing credit to smallholder dairy farmers who fit in their target market. Despite this, only a few microfinance institutions such as KWFT, offer credit to dairy farmers(International Trade Centre, 2011). Even though microfinance institutions are designed to offer credit to low income groups such as small holder farmers, the costs and risks associated with agricultural credit are too high for them. In addition to that, the loan packages offered by the microfinance institutions are limited to a few farmers and bear high interests rates. They are also short term which renders them insufficient in meeting all the required agricultural needs.

Producer Cooperatives and Savings and Credit Cooperative Organizations

Producer cooperatives and Sacco’s in Kenya form and important source of credit for dairy farmers. Despite the collapse of several producer cooperatives and their poor performance, they still form an important source of credit for small holder dairy farmers. In Kabete, the Kiambu Unity Finance Cooperative Union funds the Kabete Dairy Farmers Cooperative Society which provides credit to its members (Wachekeh, 2013).

Studies indicate that these cooperatives offer dairy farmers a convenient and reliable source of credit. This is because cooperatives are tailored to be for the farmers. Their main goal is not profit making but rather the welfare of the farmer. Cooperatives are therefore able to offer small scale dairy farmers loans that are customized to meet their needs.

Cooperatives offer a reliable and steady source of credit to farmers at interest rates that are much lower than that of banks. This makes the loan affordable to the smallholder farmers with small incomes. They also flexible in terms of the amount of money they can offer most instances the smallholder farmers ask for loans that are too small for banks to award. Offering such loans would be uneconomical for the bank thus they decline. Cooperatives on the other hand are able to award small loans making them a more suitable source of credit for farmers. Servicing of loans is also easier through cooperatives. The loans are deducted using a check off system based payments to farmers for milk delivered. This ensures that the cooperative gets its money and the farmer comfortably services their loan.

Government Agencies and Programs

Providing credit to the agricultural sector has been one of the strategies embodied by the Kenyan government to bring about increased agricultural productivity since independence. The government has since then put in place strategies in order to achieve this including the formation of the Agricultural Finance Cooperation (AFC). The AFC is the main government agricultural credit institution and was formed under the agricultural credit Act in 1963 (Wachekeh, 2013).The main function of AFC was to offer loans to farmers, cooperative societies or any other entities involved in agriculture. The loans offered by the corporation range from livestock development crop and planation loans as well as loans for investing in mechanization (Echoka, 2010). Unfortunately AFC was mismanaged and suffered losses from several non-performing loans. This led to a lot of bad debt by the body forcing the government to intervene and restructure the body as a means of damage control. Despite the efforts by the government to restore the organization its performance has been on the decline. However, AFC still remains the formal agricultural credit body for the G.o.K.

Constraints to access to credit

According to Manganhele (2010),in her study on improving access to credit for smallholder farmers in Mozambique the constraints to small holder farmers access to credit include, rationing of credit by financial institutions, market failure and institutional constraints.

Rationing of credit

Dairy production and agricultural production in general, is faced with a lot of challenges including high risk and uncertainty levels, price volatility and heterogeneity of farmers. All these challenges, make it difficult for formal financial institutions to collect information on the farmers and their activities thus providing an incentive for rationing of credit. Credit rationing in this case refers to deliberate action by the financial institutions to reduce extension of credit to small holder dairy farmers.

Individual institution’s constraint

This occurs when the credit packages being offered by the institution do not match the needs of the farmers. Most financial institutions offer loans in value addition and marketing possibly because of the higher rewards and reduced risks. However, most farmers demand credit for production purposes leading to a mismatch between the products offered and those being demanded. The higher fixed and transaction costs borne out of the fact that smallholder farmers borrow small amounts of money, leads to the increased probability of rejection by the financial institutions.

The lack of information coupled with high risk levels associated with agricultural activities lead to delays in processing information

General Institutional Environment

Drafting of functional rural financial institutions policies requires the presence of financial technologies as well as proper organizational design. Financial technologies allow information to flow into the banking arena while appropriate organizational designs ensures that the operations and products are suitable for the rural markets. Unfortunately, information is scarce in rural areas and appropriate organizational designs are lacking. This leads to poor assessment of assets that can be used as collateral by farmers, the repayment abilities of the farmers and poor product design all of which limit credit access to the farmers. Lack of strong policy frameworks that ensure proper enforcement of contracts as well as government interference in the credit market for example through interest rate caps also act as constraints to lending for small holder farmers.

Market Failure

Market failure arises when the interaction of the forces of demand and supply result in disequilibrium in allocation of credit. In most agricultural markets, this arises due to rationing of credit to smallholder farmers by formal institutions leading to mismatch between demand and supply .The rationing reduces the amount of credit in supply for small holder farmers from the real possible supply . Lack of information as well as weak enforcement of contracts lead to market failure and consequently limited access to credit by smallholder farmers.

Theoretical framework

Trade off theory

The tradeoff theory was developed from the Modigliani and Miller capital structure (1950). The theory states that a business opts for equity or debt financing based on the costs versus benefits derived from borrowing. In this study, farmers require credit in order to finance their operations. It is assumed that farmers will take opt for credit finance up to the point where the farm’s operations are maximized. This means that the farmers will take up credit up to the point where the benefits obtained from the investments made with the credit, equal the costs associated with the credit.

In this this study, the effects of access to credit on the sustainability of dairy farming in terms of gains and losses from the investment are the costs and benefits that would be traded off in determining whether to opt for credit or not. This will help shed light on the dynamics behind the farmers’ choice to take on credit.

Consumer Theory

The consumer theory was developed by Lancaster (1966). It argues that consumers value the attributes associated with a good rather than the actual value of the good itself. This means that the utility derived from the consumption of a good can be analyzed by looking at the characteristics associated with the good.

In this study, the choice of source of credit by the farmers can therefore be analyzed by looking at the characteristics of the sources of credit available. This allows for analysis of preference based on the level of utility or disutility that the farmers associate with the traits of a given source of credit.

Agency Theory

In this theory, there are two parties; the principle and the agent. In most instances, the agent is privy to some information that the principle is unaware and stands to potentially benefit from it. This gives rise to two problems; moral hazard on the part of the agent and adverse selection on the part of the principle. In the credit markets the principle is the bank whereas the agent is the smallholder dairy farmer. Obtaining access to information on the small holder dairy farmers is essential to the bank (here on the principle) in order to protect itself from the effects of moral hazard from the smallholder farmers (here on the agent).Moral hazard in this case refers to actions that smallholder dairy farmers can undertake in order to benefit unfairly at the expense of the bank .In order for the bank to protect itself from such, it requires the small holder farmers to draft a report on how the loan is to be used and present it before the loan is approved. The process is long and tedious and involves several trips to the bank as well as paperwork which delays processing of the loans. It also requires some level of literacy on the part of the farmer. The bank will also require collateral form the farmers and may charge high interests against the loans which would discourage farmers. In addition to this the bank would also have to collect information on the credit worthiness of the farmers in order to protect itself from adverse selection. Such processes increase transaction costs for both the principle and agent thus constraining access to credit for small holder dairy farmers (Manganhele, 2010).

In this study, this theory is relevant in analyzing the factors that constrain access to credit for the smallholder dairy farmers. The factors that raise the transaction costs for both the principle and agent could shed light on some of the constraints to access to credit by smallholder farmers.

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