Use of collateralized commodities to mitigate credit risks: the case of cotton financing in Tanzania

This study has been prompted by the growing concerns for credit risks in lending business. By and large credit risk is still regarded as the most pervasive of banking risks and efforts to control its impacts are not conclusive. This entails that banks must continue to be conscious and wherever necessary impose strict and conscious lending requirements including demanding adequate security to ensure banks are secured against credit risks. Collateral in a form of collateralized agricultural commodities is being used by banks in Tanzania to mitigate credit risks, however considering that the commodities involved are subject to price volatility, there are doubts that the adverse effects of price volatility may erode the value of the security held. This study has used deductive research methodology to analyze data gathered from commercial banks a sample of which comprised of big and small banks of local and international status to establish the extent which banks are covered. The empirical findings show that banks are covered against price volatility by applying a discount ratio less than 76% which the buffer allows the banks to hedge against price volatility in the global market. Banks are however, facing enormous credit risks associated with the practices of the traders to engage into forward contracts prior start of the season and also holding onto stock waiting for prices to raise. Collateral management services have been found to be inadequate due to lack of qualities as required by law and international practices. It is recommended to banks to review the applicable ratio in order to maximize their lending business not only to cotton and coffee but also to other commodities. It is further recommended that banks should put strict policies in the appointment of collateral management companies who play the major roles of safeguarding the collateralized assets being the only security for banks' exposure.