Farmers' Credit Risks and Liquidity Management

Credit risks are unanticipated variations in costs and availability of credit that arise from forces in financial markets or from lenders ' responses to risks in agricultural markets and farmers ' creditworthiness. An extension of mean-variance portfolio theory shows how credit risks combine with other financial and business risks to determine total risk. Empirical evidence from lender surveys about risks shows that farmers ' credit is positively correlated with changes in farm income, although the correlation is stronger for capital credit than for operating credit, and that variability in fund availability from rural banks has contributed to high credit risks. Key words: agricultural finance, credit, liquidity, portfolio theory, risk management. Liquidity management is a principal means by which farmers cope with variations in cash flows that arise from uncertain commodity prices, yields, and production costs. The farmer's objective is to assure that cash can be generated quickly and efficiently in order-to meet cash demands. Previous studies by Baker (1966, 1968), Baker and Bhargava, Barry and Baker, and Barry and Willmann, have provided much insight on the role of credit in farmers ' liquidity management, how credit appraisals differ among lenders, and how farmers ' perceptions of these appraisals interact with their managerial decisions. How-ever, these credit concepts and measurement procedures are developed in deterministic terms so that once the composition of credit is known, it is modeled as though it can be relied upon with complete certainty. Farmers ' reliance on credit as a source of liquidity introduces risks in terms of lenders' responses to changing conditions in agricul-ture and in financial markets that influence their lending decisions and resulting credit availability. These uncertain responses give credit the characteristics of a random variable whose properties can be expressed through the farmers ' cost of borrowing. Thus, farmers' credit risk is an added element of their port-folio risk that has not been accounted for in Peter J. Barry and C. B. Baker are professors of agricultural economics at the University of Illinois; Luis R. Sanint is a former research assistant at Texas A&M University, now a researc