Farmer-borrowers' selection of short- and intermediate-term loan contracts: traditional lenders versus nontraditional lenders

Abstract

The emergence and growth of nontraditional lenders in short- and intermediate-term agricultural credit markets during the 1990s prompted a number of studies on the economic incentives and competitive strategies for input supply or manufacturing firms to create captive finance companies. Comparably, little work, however, has been done on the choice of nontraditional lenders from the borrower's perspective. This dissertation examines the farmer-borrower's decision-making process in choosing between traditional and nontraditional lenders when financing short- and intermediate-term loan contracts. The objective of this research is to provide a better understanding of the factors that influence farm-level demand for traditional and nontraditional credit. In addition, the research identifies factors that lenders could use as a marketing strategy to enhance the borrower's acceptance of a particular loan contract;The theoretical model describes a joint decision process through which the lenders determine the optimal terms of loan contracts, and the borrower selects the most appealing loan contract. The model suggests that certain cost and informational advantages may allow nontraditional lenders to offer more attractive loan terms or reach riskier borrowers compared to traditional lenders. Further, the model demonstrates that the borrower's loan contract acceptance decision is significantly affected by the contract attributes, such as loan size, interest rate, and collateral requirement, as well as the borrower's socioeconomic characteristics;An empirical model of the contract participation, or acceptance, decision was estimated from data obtained in the 1993 Iowa Farm Finance Survey. The model was estimated using a two-stage probit procedure. The first stage involved estimating the loan term variables offered in the lender's loan contract. The second stage involves estimating the borrower's participation equation;The empirical results support the hypotheses that loan term differentials, financial measures and borrower characteristics do have significant impacts on the farmer-borrower's choice of traditional and nontraditional lenders. However, interest rate, loan size and collateral incentives appear to be the most important factors influencing the borrower's decision. In other words, the financial loan terms appear to outweigh other socioeconomic factors in explaining the farmer-borrower's selection or use of nontraditional credit.