Rural agricultural financing


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Rural agricultural financing

  1. 1. Strategic Area C: Value Chain Development and access to Financial services ABRAHAM SARFO CONFERENCE OF MINISTERS OF AGRICULTURE OF WEST AND CENTRAL AFRICA CAADP PILLAR II LEAD INSTITUTION CMA/AOC - Conférence des Ministres de lAgriculture de lAfrique de lOuest et du Centre Lead institution for CAADP-Pilar II Tel: (221) 33 869 11 90
  3. 3. Africa Agriculture Can Only Work if Supported by ……• POLICY• Frameworks and • INFRASTRUCTURE incentives that • Roads, railways, ports, protect people, communications links that attract investments facilitate the movement of and facilitate people, goods services and development ideas Policy Infrastructure Sustainable Virtuous Cycle Market Tools Structure • MARKET STRUCTURE• TOOLS • Strong Web of Actors• Interventions to fix that facilitate efficient Specific bottlenecks links between farmer in a region, crop or supply and consumer stage along the value demands chain
  4. 4. 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.
  5. 5. Major Risks Associated With Agric Microfinance Risk Factors Effects Weather Adverse Weather, pests Low yields and loss of and diseases income Price Market Forces (demand Lower prices and income and Supply) Financial Higher than anticipated Uncertain cash flow input costs. Length of production cycle linked to inflation risk. High cost of credit Cash flow problems. Regulatory Regulatory changes affect Changes in inputs costs cost of production6/21/2012 12:57 PM 5
  6. 6. 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
  7. 7. Financing needs along the value chain Typical financial needs of VC operators Primary Processors producers Industry Traders Market1 Short term Bridging the period Bridging the period Bridging the period between up to 12 between between - purchase (in bulk) and months - purchase of inputs and - Purchase of intermediate retail sale of harvest products and sale of (store value) - delivery of produce and product - Export of product and payment of buyers - delivery of products and payment of overseas buyers payment of buyers Long term Investment into Investment into Investment into 1-7 years - tree plantation - buildings - buildings - greenhouses - equipment, machinery - vehicles - storage space - equipment, machinery
  8. 8. Financing value chain development Investment into… Physical & Institutional & Financial Capital Human Capital LT capital Forming Coop´s (equipment) Primary Vocational Producers Industry Traders Market1 ST working capital training Support service Association Support capacity (LT plus ST) building Service Staff training Providers Rural infrastructure Admin. Procedures (from NRM to and organization Government communications) (national or regional)
  9. 9. Financing value chain development The role of public funds to pay for… …physical & …institutional & Financial Capital Human Capital LT capital Vocational (equipment) training ST Privatecapital working Funds Forming Coop´s Public/private Primary Industry Traders Market Producers1 primarily ! Co-Financing Support service Association capacity (LT plus ST) building Support Staff training Public/private Public/private Service Providers Co-Financing Co-Financing Rural infrastructure Admin. Procedures (from NRM to and organization Government communications) (national or regional) Public Funds Public Funds
  10. 10. New Definition of Agriculture Financing OLD DEFINITION FARM BUSINESS NEW DEFINITION AGRIBUSINESS processing, storage, agriculture production packaging marketing activity harvest time activities etc.agriculture crop and livestock consumer inputs products FINANCIAL FINANCIAL REQUIREMENTS REQUIREMENTS AGRICULTURE VALUE CHAIN – FROM FARM TO CONSUMER
  11. 11. EXAMPLE OF AGRICULTURAL VALUE CHAIN AND FINANCIAL INSTITUTIONANALYSIS International Commercial Market Banks Medium/Large- Scale Exporters Commercial Processors Banks Retailers / Local Market Commercial Banks Wholesalers Producer Association MFIs, family & Smallholder Producers friends, personal savings Current Input Suppliers Potential (seeds, pesticides, fertilizers)
  12. 12. Honey, Kenya: Integrated arrangement (+factoring) Honey Cleaning Primary Secondary Retail Bulking Production packaging processing processing N=10 N=50Beekeeper, Producer Collection Processor Honey Traders Retailer marketproducer group centre TARDA Beehive Factoring maker Refinancing FinServices LT Loan Association K-Rep (Credit Bank ooperative) K-Rep Fedha Source: adapted from (business) Services KIT: „Value chain finance“, 2010
  13. 13. Problems financing VCs, especially farmers High risk and cost of lending to small-scale farmers• 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 value chain structure and governance• 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.
  14. 14. 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 14
  15. 15. 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). 15
  16. 16. Innovations In Rural Finance Micro- financial services Newtechnologies Value-chainand transfers financing of money Innovations Using moveable Futures goods as markets collateral Financial Services Provision 16
  17. 17. 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 17
  18. 18. 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 Financial Services Provision 18
  19. 19. 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 Financial Services Provision 19
  20. 20. Forms Of Direct Value Chain Financing• Trader credit involves short-term, seasonal loans (for working capital) between producers and either input suppliers or produce buyers is 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 Financial Services Provision 20
  21. 21. 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 Financial Services Provision 21
  22. 22. 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 Financial Services Provision 22
  23. 23. 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). Financial Services Provision 23
  24. 24. Future Markets: In Practice• Futures contracts are a common practice, and can take many forms They 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 Financial Services Provision 24
  25. 25. 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 exchanges 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. Financial Services Provision 25
  26. 26. Moveable Goods As CollateralBanks used to take as collateral only large fixed properties likeland, buildings or large equipmentIn many African countries, land titling is not well developedand lack of documentation or the unclear status of theproperty prevents its use as collateral for most of farmersAlternative goods and documents are now progressively usedas a guarantee• the harvest can be used as collateral, e.g. with warehouse receipts / warrantage• the purchased equipment, e.g. with equipment leasing Financial Services Provision 26
  27. 27. Warehouse receipts in practice Warehouseorder receipt harvest Client Farmer warehouse receipt credit warehouse receipt Bank repayment payment Financial Services Provision 27
  28. 28. Advantages Of Warehouse ReceiptsThis system will enable farmers to avoid rushing to selltheir produce in accordance with their need for cash, butrather 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 activitiesIn addition, by bulking the products in a central modernstorage facility, this system could contribute to• structuring the market and improving retained price for farmers• improving the quality of the products Financial Services Provision 28
  29. 29. Supporting Warrantage DevelopmentDevelop a network of modern warehouses across thecountrySupport the establishment of clear norms and gradesTrain and supervise managers for the development of areliable warehouse receipt system• Training In Norms And Grades, And Administrative Issues• Supervise And Build A Certification System In Order To Build Trust In All StakeholdersInform and involve financial institutions in the scheme Financial Services Provision 29
  30. 30. 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. Financial Services Provision 30
  31. 31. Equipment Leasing In Practice Financial Services Provision 31
  32. 32. 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 Financial Services Provision 32
  33. 33. 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. Financial Services Provision 33
  34. 34. Functioning of mobile bankingPayment orderprocessed withincentral databaseand account Moneystatus checked transferred from one account to Confirmation another of the transfer received by the local agent Cash orPayment goods areorder sent given Commercial transactionby mobileholder Financial Services Provision 34
  35. 35. 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 Financial Services Provision 35
  36. 36. 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