Lending to Agribusinesses in Zambia

Figure 5. Critical Interest Rate that Maximizes Return to the Bank

Source: Stiglitz and Weiss (1981)

When lenders require collateral, some problems in the credit market may be
alleviated because the lender’s expected return is increased by the collateral asset. The
borrower’s payoff structure changes as well, to

π (R^, r_b) = ^max R -⁽¹ + r_b ) B ; ^-C ] .                (7)

The entrepreneur has two possible outcomes from this venture. First, if successful, the
project will pay off returns R, hence the borrower receives R less principal and interest
repaid at rate r_b, on the borrowed amount B. Alternatively, the project is a failure and the
borrower defaults, losing the collateral pledged (C).

Innovations in loan contracts, in monitoring approaches, and in programs that
manage the riskiness of projects are potential solutions to the credit rationing problem. As
will be shown, there are features of microfinance institutions in Zambia and abroad that
illustrate these loan contract innovations. Before presentation of the lending program,
background on the Zambian economy is presented.

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