rural agricultural financing

LINKING RURAL FARMERS TO FINANCIAL SERVICE IN

AGRICULTURAL VALUE CHAINS

CMA/AOC - Conférence des Ministres de l'Agriculture de l'Afrique de l'Ouest et du CentreLead institution for CAADP-Pilar IITel: (221) 33 869 11 90www.cmaoc.org

ABRAHAM SARFOCONFERENCE OF MINISTERS OF AGRICULTURE OF WEST

AND CENTRAL AFRICACAADP PILLAR II LEAD INSTITUTION

Strategic Area C: Value Chain Development and access to Financial services

http://www.cmaoc.org/

OUTLINE

INTRODUCTION AND CONCEPT NOTES

CHALLENGES IN AGRICULTURAL FINANCING

TRENDS AND INNOVATIONS IN RURAL AGRICULTURAL FINANCING

TOOLS IN MANAGING RURAL FINANCING

TOOLS IN MANAGING RISK IN AGRICULTURAL FINANCING

LESSONS LEARNT AND THE WAY FORWARD

Africa Agriculture Can Only Work if Supported by ……

• MARKET STRUCTURE• Strong Web of Actors

that facilitate efficient links between farmer supply and consumer demands

• TOOLS• Interventions to fix

Specific bottlenecks in a region, crop or stage along the value chain

• INFRASTRUCTURE• Roads, railways, ports,

communications links that facilitate the movement of people, goods services and ideas

• POLICY• Frameworks and

incentives that protect people, attract investments and facilitate development

Policy Infrastructure

Market StructureTools

Sustainable Virtuous

Cycle

The Problem of Agricultural Financing

• Over 60% percent of Africa’s population lives in rural areas where they are engaged in agriculture, both as a source of food and income.

• In Africa, as in other developing markets, there have been significant and sound developments in functional financial markets, as well as in the uptake of latest lending and other bank-related technologies.

• These improvements are, however, not vested in the agricultural sector to any large extent, even though investment in this sector is seen as the main engine of economic and social growth, especially in the Sub-Saharan African countries, for the years to come.

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Major Risks Associated With Agric Microfinance

Risk Factors EffectsWeather Adverse Weather, pests

and diseasesLow yields and loss of income

Price Market Forces (demand and Supply)

Lower prices and income

Financial Higher than anticipated input costs.Length of production cycle linked to inflation risk.High cost of creditCash flow problems.

Uncertain cash flow

Regulatory Regulatory changes affect cost of production

Changes in inputs costs

Is Risk the Only Problem?

• Because of long-term neglect, the agricultural sector needs large investments by both the farmers and, through the provision of financing for such investments, by financial institutions in order to boost production.

• However, increased investment also means increased exposure to risks and, in many cases, this translates into exposure to new and little known-about risks.

• Improved and new risk management techniques and instruments must, therefore, accompany investments, both at the financial institutions and farmer levels, as well as along the whole value chain. HOWEVER RISK CAN BE REDUCED IF OTHER FACTORS ARE IMPROVED

Primaryproducers Traders

ProcessorsIndustry

Bridging the period between - purchase of inputs and sale of harvest - delivery of produce and payment of buyers

Bridging the period between

- purchase (in bulk) and retail(store value)- Export of product and payment of overseas buyers

Market

Short termup to 12 months

Bridging the period between - Purchase of intermediate products and sale of product- delivery of products and payment of buyers Long term

1-7 yearsInvestment into - tree plantation - greenhouses- storage space- equipment, machinery

Investment into - buildings- equipment, machinery

Investment into - buildings- vehicles

Financing needs along the value chain

Typical financial needs of VC operators

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PrimaryProducers MarketIndustry Traders

Financing value chain development

SupportServiceProviders

Physical & Financial Capital

Institutional &Human Capital

Investment into…

LT capital (equipment)ST working capital

Support service capacity (LT plus ST)

Rural infrastructure(from NRM to communications)

Forming Coop´sVocational training

Association buildingStaff training

Admin. Proceduresand organization Government

(national or regional)

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PrimaryProducers MarketIndustry Traders

Financing value chain development

SupportServiceProviders

…physical & Financial Capital

…institutional &Human Capital

LT capital (equipment)ST working capital

Vocational trainingForming Coop´s

Support service capacity (LT plus ST)

Association buildingStaff training

Government(national or regional)

Rural infrastructure(from NRM to communications)

Admin. Proceduresand organization

Public Funds Public Funds

Private Fundsprimarily !

Public/private Co-Financing

The role of public funds to pay for…



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New Definition of Agriculture Financing

agriculture inputs

crop and livestockproducts

agriculture production activity harvest time

consumer

processing, storage, packaging marketing

activities etc.

AGRICULTURE VALUE CHAIN – FROM FARM TO CONSUMER

FINANCIALREQUIREMENTS

FINANCIALREQUIREMENTS

OLD DEFINITION NEW DEFINITIONFARM BUSINESS AGRIBUSINESS

Current

Potential

Medium/Large- Scale Exporters

Producer Association

Wholesalers

International Market

EXAMPLE OF AGRICULTURAL VALUE CHAIN AND FINANCIAL INSTITUTION ANALYSIS

Smallholder Producers

Input Suppliers(seeds, pesticides, fertilizers)

Retailers /Local Market

Processors

Commercial Banks

Commercial Banks

Commercial Banks

MFIs, family & friends, personal

savings

Beehivemaker

Honey, Kenya: Integrated arrangement (+factoring)

HoneyProduction

Cleaningpackaging

Primaryprocessing

Retail Bulking Secondaryprocessing

Honeymarket

Beekeeper,producer

Producergroup

Collectioncentre

Traders ProcessorTARDA Retailer

K-RepBank

K-Rep Fedha(business) Services

N=10 N=50

FinServicesAssociation(Credit ooperative)

Factoring

RefinancingLT Loan

Source: adapted fromKIT: „Value chain finance“, 2010

Problems financing VCs, especially farmers

High risk and cost of lending to small-scale farmers

Weak value chain structure and governance

• High transaction costs due to small scale of farms • Little to no hard collateral of smallholders• Many farmers don´t have a credit history and no bank accounts. • The inherent risk of agriculture is high (crop failure, post-harvest loss)• Agricultural markets suffer from price volatility and high price risk.• Smallholders may see borrowing as a risk to their livelihoods.• Informal moneylenders compete with the formal system. • Rural and agricultural credit has a bad reputation due to past experience

with low payback rates and political interference

• Weak organization of business linkages entails high contract risk• Fragmentation of operations, lacking business leadership • Demand / market risk of final products

Financial institutions lack VC knowledge• Financial institutions lack knowledge of agriculture and food markets• Financial institutions have little to no experience in VC finance.• The offer of agriculture-specific financial products is limited.

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Challenges faced by Financial Institutions agricultural finance service provision

Low volumes of transaction, due to limited pieces of land/agricultural projects. Income too meager from such low value transactions.

Spatial dispersion of farming enterprises rendering them very costly to administer through follow-ups and projects monitoring.

Long gestation periods of most agricultural projects Sugarcane, Tea, Coffee etc. This causes a challenge especially when resources are scarce as huge capital outlays are tied up. Subsequent shortages push up the cost of credit due to a high unmet demand

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Challenges faced by Financial Institutions agricultural finance service

provision Seasonality of agricultural credit demand dictated by

seasonal nature of enterprises. The flip side is a strain on farmers to undertake their financial obligations during off seasons

Due to the high seasonal nature of rain fed agriculture, huge investments are incurred during planting seasons and relatively low during other times of the year generating a pattern of high credit demand during planting seasons. This demand cannot be adequately fulfilled at this time

High covariant risks (vagaries of weather, pests, fluctuating and often unpredictable produce prices and markets etc).

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Innovations In Rural Finance

Financial Services Provision

Innovations

Micro- financial services

Value-chain financing

Futures markets

Using moveable goods as collateral

New technologies and transfers

of money

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Definition Of Microfinance Institutions (Mfis)• An MFI is an organization that provides financial services to

low-income individuals who have no access or limited access to the formal financial sector (mainly commercial banks)

• MFIs refer to a wide variety of organizations, differing in– size (number of members or groups) – level of structuration – legal status

• Depending on the country, these institutions may be regulated or unregulated, and supervised or unsupervised by the financial authorities or other entities– some operators who may in practice be significant players in

microfinance are sometimes only allowed to offer credit Financial Services Provision

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How To Support MFI Development In Rural Areas

• Financial support– Over time, the funding needs of MFIs change. – While subsidies or participation of donors in guarantee funds

might be needed to establish the institutions, the mature structure can prove to be profitable, attracting new financing sources: equity capital from private investors, commercial loans from formal financial institutions, investment funds and dedicated investments fund, and even flotation.

• Staff training and information• Potential client training and information• Support partnerships

– financial services delivery can piggyback on existing local networks – support greater use of technology and support relevant

partnerships in this area


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Definition Of Value Chain Financing• Relationships between actors in the value chain

may facilitate financial flows– directly (credit from one value-chain actor to another)

or – indirectly (by making the potential client more

attractive to ‘traditional’ financial institutions)

• In general, the majority of agricultural finance in developing countries is provided either from savings or from within the value chain (i.e. direct value-chain finance), with no direct involvement of financial institutions


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Forms Of Direct Value Chain Financing

• Trader credit involves short-term, seasonal loans (for working capital)between producers and either input suppliers or

produce buyersis usually provided in cash or in kind for suppliers

(inputs retailers, shopkeepers, etc.)

• Contract farming or out-grower schemes are relationships in which buyers lend funds (either in

kind or in cash) to producers as part of a purchasing agreement


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What Is Indirect Value Chain Finance?• It is a link that is established between a financial institution

and value-chain operators thanks to the intermediation of a value-chain partner– this may be the case in contract farming

• bank lends to a producer based on that producer’s relationship with a well-established buyer

– warehouse receipts• bank lends to a producer based on the fact that a given quantity of

produce (detailed on the receipt) is stored in a certified warehouse – when a buyer (or supplier) with a sufficiently strong reputation is

willing to stand surety for its producers, even small producers become more attractive clients to financial institutions

– futures contracts, or long-term relationships with a strong partner can be recognized and act as a guarantee


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Advantages Of Value-Chain Financing• It builds on existing relationships and networks

– it overcomes information gaps – it needs no additional infrastructure

• It would offer reduced non-repayment rates – due to the familiarity and trust between actors– it has easy ‘embedded’ repayment mechanisms (good

for cash-strapped farmers) • It could provide technical assistance to producers,

thus increasing production revenue and improving the profitability of the credit for the producer


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Commodity Exchange Market• Futures contract, in finance, refers to a standardized contract

to buy or sell a specified commodity of standardized quality at a certain date in the future, at a market-determined price (the futures price).

• The price stipulated by the agreement that should be paid in the future upon delivery of the goods, reflects the present expectation of future market conditions.

• Both parties of a futures contract must fulfill the contract on the settlement date. To exit the commitment prior to the settlement date, the holder of a futures contract has to offset their position by either selling or buying it back (assuming any financial gain or loss this may represent).


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Future Markets: In Practice• Futures contracts are a common practice, and can

take many formsThey can take the simple form of an oral or written

agreement between the buyer and the seller, with short- or longer-term engagements (such as in contract farming in the latter case)

However, in some countries, the futures market has developed towards a real futures commodity exchange – this is a virtual marketplace

In Brazil, most commodities, from cattle to grain are traded on open online futures markets


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How To Support Futures Market Development• To develop, the futures market needs the existence of a well-functionning

bourse for commodities, including in particular– Norms and grades– Certification bodies– Warehouse network

• The exchange's clearinghouse acts as counterparty on all contracts, sets margin requirements, and crucially also provides a mechanism for settlement

• The staff of the exchange and main operators within the targeted sectors should be trained in futures exchanges and the specificities and market fluctuations of the products to be traded

• A reliable market information system needs to be created

But not all operators (in particular small-scale farmers) can trade in such a virtual marketplace. This would rather benefit larger-scale farmers or intermediaries. However, its advantage can trickle down the value chains.


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Moveable Goods As Collateral

Banks used to take as collateral only large fixed properties like land, buildings or large equipment

In many African countries, land titling is not well developed and lack of documentation or the unclear status of the property prevents its use as collateral for most of farmers

Alternative goods and documents are now progressively used as a guarantee

• the harvest can be used as collateral, e.g. with warehouse receipts / warrantage

• the purchased equipment, e.g. with equipment leasing


Warehouse receipts in practice

Financial Services Provision 27

Farmer

Warehouse

Client

Bank

orderreceipt

harvest

warehouse receipt

warehouse receipt

credit

payment

repayment

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Advantages Of Warehouse Receipts

This system will enable farmers to avoid rushing to sell their produce in accordance with their need for cash, but rather with prevailing favorable market conditions• this may be very useful, particularly in the cross-financing of

successive crops or with animal production• farmers will be able to keep a higher share of the added value of

downstream activities

In addition, by bulking the products in a central modern storage facility, this system could contribute to

• structuring the market and improving retained price for farmers• improving the quality of the products


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Supporting Warrantage Development

Develop a network of modern warehouses across the country

Support the establishment of clear norms and grades

Train and supervise managers for the development of a reliable warehouse receipt system• Training In Norms And Grades, And Administrative Issues• Supervise And Build A Certification System In Order To Build Trust In All

Stakeholders

Inform and involve financial institutions in the scheme


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Equipment Leasing: Definition• A lease is a contractual arrangement between two parties,

where the provider (the lessor) owns the asset and lets the client (the lessee) use the equipment asset in exchange for regular payments.

• In a finance lease, the lease period typically extends for most or all of the equipment’s useful life, and the lessor recovers the equipment costs plus interest through a regular stream of lease payments. The lessee bears all the costs of maintenance, damage and insurance and the lease usually cannot be canceled. Furthermore, at the end of the lease, the lessee usually has the option to purchase the asset for a nominal price.


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Equipment Leasing In Practice


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How To Support The Development Of Equipment Leasing

• The legal and institutional frameworks should be supportive of such arrangements by– adopting clear definitions of leasing concepts; and the rights and

responsibilities of lessor and lessee, in particular regarding the priority of lessor’s claims over leased assets; and clear ground rules for repossession of leased assets.

• Support the creation of links between leasing companies (often urban based) and the local network of rural shops that could provide maintenance, monitoring and other support services

• Support links between equipment providers and financial institutions to develop such offers in rural areas


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Definition Of Mobile (And Internet) Banking • Mobile banking refers to the ability to perform balance

checks, account transactions, payments, etc. via a mobile device such as a mobile phone. Mobile banking today is most often performed via SMS.

• The advent of the Internet has already revolutionized the financial services industry with the emergence of new players, thanks to the considerably reduced fixed costs.

• The mobile banking development is in turn entering a new era with a new generation of operators and in particular mobile operators.

• Mobile phones are used to do a wide range of operations such as payments and money transfers, savings, and withdrawals.


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Functioning of mobile banking


Payment order sent by mobile holder

Payment order processed within central database and account status checked

Confirmation of the transfer received by the local agent

Money transferred from one account to another

Cash or goods are given

Commercial transaction

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Advantages Of Mobile Banking• Mobile banking has proved useful in many parts of the world with little or

no infrastructure development, especially in remote and rural areas – this aspect of mobile commerce is also very popular in countries where most of the population is unbanked

– thus in turn it should support microfinance development both for savings and credit

• With mobile technology, banks can offer a wide range of services to their customers, such as doing funds transfer while traveling, at low costs

– the ease and automation of some transactions would reduce operating and transaction costs, making handling small amounts viable

• This technology should ease the collection of savings in financial institutions and could help build on remittances or other source of non-farming income for agricultural financing

• Much more people are equipped with a mobile phone than have a bank account, creating tremendous potential for market development


And Finally!!!• Many of these initiatives are based on the premise that there is a

supportive policy environment that allows innovation to flourish. • The gravest risks to sustainable financing for agriculture often come

not from inherent business risks or the inability of financial institutions to design profitable financial products for the rural population, but rather from misguided government interventions such as– subsidized interest rates and lack of or non-enforcement of appropriate

rules and regulations. • Conversely,

– an enabling environment and legal framework– enforcement of regulations– and a supportive rural infrastructure

• would eventually lead to lower but sustainable interest rates by reducing transaction costs and risks and increasing competition.

• All this would contribute immensely to making sustainable access to finance a reality

rural agricultural financing

Business