Rural Finance and Smallholder Farming in Ethiopia

A well-functioning financial market is important for smallholder agriculture development and for the transformation of rural economies. Yet a substantial proportion of the rural population in Ethiopia remains underserved. The literature points to market failures, attributed to information asymmetry between lenders and borrowers, which affects households’ access to financial services. In the case of credit, this problem is exacerbated by households’ lack of collateral to pledge to access loans. Information asymmetry arises because lenders lack the information needed to screen the creditworthiness of potential borrowers and monitor them after granting loans. Also, serving poor rural communities geographically dispersed involves high transaction costs. Insurance and savings financial services are subject to the same challenges. In response, lenders require collateral that incentivizes borrowers to reduce non-repayment. This chapter documents the progress made in unlocking these challenges and discusses avenues for maximizing the transformational roles of these markets in Ethiopia.