Scaling Up Access to Finance for Agricultural SMEs

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Saing Up Aess o Finane or Agriuura SMEs

Poi Reiew and Reommendaions

OctObER 2011


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InternatIonal FInance corporatIon 2011. a ihs svd.

2121 Pennsania Aenue, N.W.

Washingon, D.c. 20433

Inerne: www.i.org

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onerning he ega saus o an errior or he endorsemen or aepane o suh oundaries. the

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Inernaiona Finane corporaion is an inernaiona organizaion esaished Aries o Agreemen

among is memer ounries, and a memer o he Word bank Group. A names, ogos and

rademarks are he proper o IFc and ou ma no use an o suh maerias or an purpose wihou

he express wrien onsen o IFc. Addiiona, Inernaiona Finane corporaion and IFc are

regisered rademarks o IFc and are proeed under inernaiona aw.


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1ScAlING UP AccESS tO FINANcE FOR AGRIcUltURAl SMEs | POlIcy REvIEW AND REcOMMENDAtIONS

lis o Areiaions 2

Aknowedgemens 3

Inroduion 5

Exeuie Summar 6

cHAPtER 1 Agriuura SME Finane in conex 12

1.1 Denitions and Segmentation 12

1.2 Basic Challenges in Agricultural Finance 18

1.3 Changing Paradigms in Agricultural Finance 19

cHAPtER 2 Poiies, Reguaor Framework, and Goernmen Suppor 21

2.1 Developing Countr Specic Diagnostics and Strategies 21

2.2 Developing a Supportive Legal and Regulator Framework 22

2.3 Designing Efective Government Support Mechanisms 32

cHAPtER 3 Finania Inrasruure and Daa 44

3.1 Strengthening the Financial Inrastructure 44

3.2 Building Consistent and Reliable Data Sources 49

cHAPtER 4 capai buiding o Agriuura Finane Insiuions and their ciens 53

4.1 Building Capacit o Financial Institutions 54

4.2 Building Capacit o Value Chains 56

4.3 Building Capacit o Farmers and Farmer Organizations 58

4.4 Innovative Instruments and Deliver Mechanisms 61

cHAPtER 5 conusion 73

ANNEX I Grans o he Poor 75

ANNEX II Smar Susidies and he Quesion o Feriizer Susidies 77

biiograph 78

tae o conens


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2 GlObAl PARtNERSHIP FOR FINANcIAl INclUSION

AFD Agence Franaise de Dveloppement

AFI Alliance or Financial Inclusion

AFRACA Arican Rural and Agricultural Credit

Association

AGRA Alliance or a Green Revolution inAgriculture

ATM Automated Teller Machine

BMZ German Federal Ministr or

Economic Cooperation and

Development

CABFIN Capacit Building or Rural Financial

Institutions

CBRO Communit-Based and

Resource-Oriented Organization

CECAM Caisses dEpargne et de Crdit

Agricole Mutuels

CGAP Consultative Group to Assist the Poor

DFI Development Finance Institution

DLL De Lage Landen

FAO Food and Agriculture Organization

o the United Nations

FBO Farmer-Based Organization

GIZ Gesellschat r Internationale

Zusammenarbeit (ormerl GTZ)

GPFI Global Partnership or Financial

Inclusion

GTZ Gesellschat r Technische

Zusammenarbeit

IFAD International Fund or Agricultural

Development

IFC International Finance Corporation

IFRS International Financial Reporting

Standards

KfW Kreditanstalt r Wiederaubau

LSMS-ISA Living Standards Measurement

Stud-Integrated Surves on

Agriculture

MDG Millennium Development Goal

MFI Micro Finance Institution

MFW4A Making Finance Work or Arica

NBFI Non-Bank Financial Institutions

NGO Non-Governmental Organization

PCG Partial Credit Guarantee

POS Point O Sale

PPP Public-Private Partnership

RIAS Rabo International Advisor Services

RSF Risk Sharing Facilit

SME Small and Medium Enterprise

UNCDF United Nations Capital Development

Fund

VCF Value Chain Finance

WFP World Food Programme

WRMS Weather Risk Management Services

lis o Areiaions


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Inernaiona Finane corporaion (IFc) is he ead ehnia adisor o he G-20 Goa Parnership

or Finania Inusions (GPFI) SME Finane Su-Group. this repor was produed IFc on eha

o he GPFI. the GPFI is he main paorm or impemenaion o he G-20 Finania Inusion Aion

Pan. the group engages parners rom G-20 and non-G-20 ounries, priae seor, ii soie,

and ohers. I is haired he G-20 roika ounries, urren Korea, Frane, and Mexio. the GPFI is

suppored hree impemening parners: he Aiane or Finania Inusion (AFI), he consuaie

Group o Assis he Poor (cGAP), and Inernaiona Finane corporaion (IFc). www.gp.org

the repor Saing Up Aess o Agriuura SME Finane: Poi Reiew and Reommendaions

was deeoped under he oera guidane o Peer Sein (IFc) and Susanne Dorasi (bMZ). the

working group eam or he repor, ed Ghada teima (IFc) and Roand Gross (GIZ), omprised

Heaher Mier (IFc), Ahim Deuher (GIZ), and Susanne Shehard (GIZ). Panaois varangis (IFc)

proided ehnia exper adie o he working group.

this repor has een a oaoraie efor wih onriuions rom indiiduas a he oowing

organizaions: Agene Franaise de Deoppemen (AFD), Aiane or a Green Reouion in

Agriuure (AGRA), German Federa Minisr or Eonomi cooperaion and Deeopmen (bMZ),

he Food and Agriuure Organizaion o he Unied Naions (FAO), Gesesha r Inernaionae

Zusammenarei (GIZ), he Inernaiona Fund or Agriuura Deeopmen (IFAD), Krediansa r

Wiederauau (KW), Making Finane Work or Aria (MFW4A), Rao Inernaiona Adisor

Series (RIAS), Sani bank, tehnosere, Unied Naions capia Deeopmen Fund (UNcDF),

and Word bank.

the eam woud ike o hank he Word bank-IFc inerna peer reiewers: Ro behrnd, Gar Reushe,

bradord Roers, Ernes behe, Damien Shies, Urih Hess, Mar Sader, Ajai Nair, and Diego Arias,

as we as GIZ inerna peer reiewer, Ariane Riemann.

las, u no eas, his work was ompeed under he eadership o he o-hairs o he G-20 SME

Finane Su-Group: Susanne Dorasi (German), Anuradha bajaj (Unied Kingdom), Aen Kuakogu

(turke), and chrisopher Grewe (Unied Saes).

Aknowedgemens


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this akground repor reies heai on he oowing iniiaies and papers, or whih we

exend speia graiude o he auhors:

Rural and Agricultural Finance: Trends, Issues and Challenges. Hoeinger, Frank. GIZ (2011

- orhoming);

Policy Support to Agricultural Finance in Africa. Roers, Rihard A.J.Paper prepared or he

Making Finane Work or Aria conerene Zipping Finane and Farming (June 29-30

2011);

Managing Risk in Financing Agriculture. Proeedings o he Exper Meeing conened and

co-Sponsored Arian Rura and Agriuura credi Assoiaion (AFRAcA), FAO, the

land bank o Souh Aria, and he Word bank (Apri 1-3, 2009);

Subsidies as an Instrument in Agriculture Finance. Meer, Rihard l. Join Disussion Paper

o he Capacity Building for Rural Financial Institutions (cAbFIN) inernaiona nework,

inuding Word bank, bMZ, FAO, GIZ, IFAD, and UNcDF (2011); and

Stocktaking Background Study on Agricultural SME Finance, RIAS on eha o IFc.


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the ojeie o he G-20 Work Sream on Agriuura Finane is o ideni appropriae

approahes o assess or redue he main risks and oss ha inhii aess o nania series in

he agriuure seor in deeoping ounries. Srenghening he produii and apaiies o

agriuura sma and medium enerprises (SMEs) and armers hrough enhaned aess o nane

is a he ore o his su-groups ous. this work sream wi onriue o and generae snergies

wih oher piars o he G-20 deeopmen agenda, pariuar he piars on food security and

private investment and job creation. based on a goa sokaking exerise, his repor deries

guideines or poi and reguaor rameworks onduie o agriuura nane and onsisen

wih he G-20 Prinipes or Innoaie Finania Inusion. these reommendaions sha e used o

reae a roadmap or impemenaion. this paper is addressed primari o hose poimakers

responsie or ormuaing, managing, and ending he agriuura nania ssem, u aso arges

donors and managers o rura nania insiuions operaing in he agriuura nane spae.

this poi reiew and reommendaions doumen is designed o eaorae on he reommendaions

o he G-20 SME Finane Su-Group speia as he reae o aess o nane or agriuura

SMEs. I is mean o onriue o he ormuaion o an agriuura SME nane poi ramework,

whih sha e impemened aiiaing he deeopmen o onree naiona aion pans. In

addiion o he poi reommendaions and akground inormaion supporing suh poiies, his

paper wi aso rie reiew promising approahes, inuding innoaie nania insrumens suh

as aue hain nane, warehouse reeips, ranhess anking, and index-ased insurane

shemes. I shoud e noed ha his repor exusie oers issues spei o agriuura nane

and on reers o oher, more genera needs or he agriuure seors deeopmen where here

are dire impiaions or naning.

Pariuar exampes o innoaie insrumens are ound in seion 4. these are ased on a ak-

ground sokaking repor, whih inudes approximae 60 ase sudies, hosen aording o sa-

aii (poenia or expansion), repiaii (possiii o ranser o oher regions and onexs),and susainaii (opion o oninue wihou exerna suppor). Eah o he seeed modes demon-

sraes a eas one o hese rieria. the sokaking is a non-exhausie is o experienes and

modes u neerheess is er omprehensie. the sokaking repor, wih spei insighs ino

he naning rameworks o he modes, wi e prepared in ime or he G-20 Mexio Summi 2012.

Inroduion


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Exeuie Summar

Around the world, agriculture is and will continue to

be a major building block in the achievement o the

Millennium Development Goals (MDGs). Recent sta-

tistics show that agricultural production needs to

increase by 70 percent by 2050 in order to eed the

world, while demographic growth, climate change,

and urbanization put pressure on available cultivable

land. Three-quarters o the worlds poor live in rural

areas and more than 80 percent o them either

directly or indirectly depend on agriculture or their

livelihoods. Hence, in low income countries, the agri-

culture sector is vital or economic growth, as it pro-

vides about 60 percent o total employment and 20

percent o GDP. However, agriculture in developing

countries is still characterized by low productivity;

without a renewed eort to accelerate growth in the

agriculture sector, ew countries will be able to reachthe MDGs, especially the goal o halving poverty and

hunger by 2015.1

Increased agricultural productivity

can enhance ood security, poverty reduction, job cre-

ation, and economic growth.

Thereore, this brings new attention to the issue o agri-

cultural nance. Ater more than a decade o low recog-

nition, international donors, politicians, and specically

the G-20 are putting a renewed ocus on this topic.

Within the nancial systems development expert com-

munity, the debate on eective solutions to sustainablysupport agricultural development has been renewed. The

issue o agricultural nance is requently on top o the

international development agenda. Now, with the triple

shocks o the recent years ood, uel, and nance

the urgency o ood security has increased greatly and

created political pressure to act immediately. There is

now broad support or more and better investments to

increase agricultural production, to improve marketing

o commodities, and to combat poverty.

However, there are no quick political xes and the pro-

vision o sustainable nancial services or agriculture has

proven to be dicult. The past years have demonstrated

that neither commercial banks nor the emerging micro-

nance industry are willing or able to suciently meet

the nancial needs along agricultural value chains, leav-

ing armers and agricultural SMEs unserved in the

so-called missing middle. There is a broad consensus

that existing mechanisms or agricultural nance are not

adequate and that we need to move to innovative and

market-based approaches that are scalable and can reach

a large number o beneciaries.

By endorsing and promoting a set o key policy rec-

ommendations, the G-20 strives to help policymakers

in the developing world ocus their resources on

creating the right environment or agricultural SME

nance by designing country specic government

support mechanisms. On the basis o the key lessons

learned rom the stocktaking and background

exercises, these recommendations and a summary o

key ocus areas are outlined as ollows:

1. Developing Countr Speciic

Diagnostics and Strategies

Policymakers need to undertake a detailed baseline

diagnosis o the supply and demand or agricultural

1 Fan (2008)


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nance at the country level, and engage in a dynamic

process to continuously assess needs in the sector in

order to develop strategies based on relevant inorma-

tion. It is useul to examine solutions or various cate-

gories o armers and commodity sub-sectors, such as

smallholders, commercial armers, and agribusinesses,

along with larger commercial armers and corporate

agribusinesses. Assessments to identiy client needs

(including savings, insurance, and other nancial

needs) and strategies to address this demand should be

participatory processes, including stakeholders rom

agricultural organizations and private sector representa-

tives. Such on-going evaluations must assess how agri-

cultural nance policies are established, as well as

whether they are properly implemented and eective

in achieving stated goals and objectives.

2. Developing a Supportive Legal and

Regulator Framework

Coordination o policies intersecting both the nancial

and agriculture sectors is critical to acilitating access to

nance or armers and agricultural SMEs. The appoint-

ment o a single coordinating body as the advocate or

agricultural nance can optimize policies that target

arming as an economic enterprise to promote agricul-tural development through nance and investment. This

high-level body can also reconcile and harmonize poli-

cies ocused on objectives related to rural development,

social support, and ood security that are aligned with,

but not necessarily the same as, policies supporting agri-

cultural nance. Coordination is oten necessary

between the ministry o nance, the ministry o agricul-

ture, the central bank, and the ministry o trade and

commerce. Developing countries also require solutions

to increase access to long-term, local currency unding

or nancial institutions as well as to promote equitynance in addition to credit. This issue is not specic to

agriculture but infuences overall nancial fows to sup-

port sustainable growth in the agriculture sector.

Ecient and responsive credit services depend on a

well-unctioning judiciary system that provides objec-

tive decisions in a timely manner and with minimal

political intererence. Legal enorcement o contract

rights or creditors, armers, and SMEs is important to

strengthen value chain structures and acilitate nance

to all market participants. Commercial contracts

between actors in the supply chain represent an alter-

native collateral source to lenders, help mitigate risks

or armers and SMEs, and serve to promote value

chain linkages, growth-oriented contract arming,

and nucleus arm or out-grower schemes. Lease

nancing can benet rom improved rights or repos-

session upon deault as well as tax laws that encourage

utilization o leasing arrangements.

Under certain conditions, promoting secure orms o

land tenure can be benecial to stimulate productive

arm-level investment and to allow producers to

pledge land as collateral or obtaining nance. In the

absence o long-term land-use rights, armers lack

incentives to grow through land expansion, produc-

tivity enhancements, and long-term investments, as

well as sustainable and environmentally-riendly land

use. Lenders may be more willing to nance opera-

tions in which they are able to take and enorce a

charge over land, both in terms o larger loan

amounts and longer terms. The move rom usuruct

to more permanent orms o tenure could be done

with better systems o recording rights to land. Social

and local legal considerations should be taken into

account, including (among others) communal rights,

sensitivity to local customs, and limiting speculative

and external investment except when broadly bene-

cial to local communities.

Warehouse receipt nancing, including the appropriate

legislation, regulatory and supervisory oversight, and

licensing o warehouses, represents an opportunity to

lower vulnerability o armers to unavorable pricesand conditions, reduce post-harvest losses, and increase

the fow o credit into supply chains. A well-unction-

ing warehouse receipt system can provide broad bene-

ts such as permitting stored goods to be used as

collateral; improving quality, control, and inspection o

commodities; acilitating investments to increase and

improve storage capacity and quality to reduce losses;


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enhancing marketing within value chains; and sup-

porting the establishment o commodity exchanges.

Alternative systems based on collateral management

agreements can provide viable solutions to inventory

nancing but also require relevant legislation, such as

registration or movable collateral.

Eective organizational rameworks, such as coopera-

tives and other armer-based organizations (FBOs),

enable armers to ocus on commercial activities and

participate in value chains. Governments need to pro-

vide an enabling environment and legislation sup-

porting the development o cooperatives and other

FBOs as economic enterprises. Cooperatives, as cur-

rently dened, operate under some inherent limita-

tions, and other organizational options, such as

inormal associations o armers and limited liability

companies, in many cases may oer more appropriate

organizational rameworks. A less hands-on approach

when promoting cooperatives and armer-based orga-

nizations would likely lead to better results in terms

o ownership, protability, and sustainability. In some

countries, a revised legal ramework permitting easy

registration and legal status or armer groups may be

needed. Governments and donors can support capac-

ity building or cooperatives and FBOs that encouragebest practices, such as clearly dened market-oriented

objectives, mandatory supply agreements, proper cap-

italization structures, and sound business and gover-

nance principles.

3. Designing Eective Government

Support Mechanisms

Government support should be directed towards

public goods and investments in nancial and physi-

cal inrastructure with industry-wide, systemic ben-ets. Utilization o smart subsidies that minimize

market distortions and elimination o regressive

measures help encourage private sector investment,

leading to sustainable agricultural development and

nance. Subsidies should be used to support the

institution and not the borrowers. Moreover, subsi-

dies should not undermine competition by avoring

specic institutions but should support natural spill-

over eects to non-subsidized institutions. Subsidies

unction best when time-bound, limited, decreasing

over time, and ocused on inrastructure and prod-

uct development. Incentives to encourage increased

lending to the agriculture sector are welcome, but

policymakers should avoid historically ineective

and sometimes damaging measures such as interest

rate caps, debt orgiveness, and directed or manda-

tory lending targets, which impede the unctioning

o nancial markets.

State agricultural development banks oten need eval-

uation and a decision to privatize, reorm, or close

those institutions ound to be ineective. Good exam-

ples o reormed state-owned agriculture development

banks are characterized by a governance and manage-

ment structure ree o political pressures and gener-

ally employ commercially-oriented policies, ull risk

management practices, loan products priced accord-

ing to risk, and a portolio mix to limit concentration

risk. Reorm o the entire institution is the most chal-

lenging option, requiring strong political commit-

ment and extensive technical assistance. Alternative

options to complete reorm include creating special-

ized units using bank branches and systems or adopt-ing a second-tier or apex unction, providing nancial

linkages with other nancial service providers.

Partial credit guarantees and risk sharing acilities

can be an eective mechanism in stimulating agri-

cultural loans, particularly when accompanied by

complementary technical assistance to banks. These

schemes may include capacity building o local

nancial institution sta, support to develop tar-

geted agriculture loan products, and technology

transer to support implementation. Guarantees tar-geting longer-term loans may also boost nance or

equipment and other productivity-enhancing

investments. It is recommended that guarantees in

general require an appropriate portion o deault

risk to remain with the retail nancial institution

(i.e., coverage maximums, shared losses) to avoid

moral hazard and adverse selection, and that the


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guarantees be gradually phased out in order to pro-

mote nancial sustainability.

Inrastructure investments via public-private partner-

ships (PPPs) are best targeted towards public goods

supporting broad agricultural development. Certain

types o inrastructure underpin the broader market

or agricultural nance, such as weather stations or

insurance, irrigation systems to mitigate weather

risks, quality storage acilities to support warehouse

receipt nancing, and market inormation systems

(e.g., prices, production, etc.), but these are best

implemented via the private sector and/or PPPs or

long-term sustainability. It is worth noting that other

inrastructure investments, such as roads, railways,

cold chain, transport, energy, and telecommunica-

tions are critical to agricultural development but not

directly linked to agricultural nance.

Development o agricultural insurance markets repre-

sents an opportunity or public-private partnerships to

oster access to nance and improve agricultural pro-

ductivity. Governments can actively support growth

o agricultural insurance through investments in

weather stations and data collection, such as weather

and area yield data, necessary or commercial prod-ucts to be developed, which may also require suitably

designed premium support. The government can also

promote more traditional yield-based crop insurance

through appropriate incentives and support systems.

Fiscal support is necessary or reinsurance markets

and unding or catastrophic risks.

4. Strengthening the Financial

Inrastructure

Support to extend credit reerence bureaus, as well asother orms o client identication and credit report-

ing, into rural areas is benecial to acilitate increased

lending to agricultural producers. Eorts to establish

credit bureaus are oten concentrated in urban areas,

but access to better client inormation is especially

important in decision-making or agricultural loans

given moral hazard concerns combined with the

broad geographic dispersion o rural clients. There are

promising innovations, such as biometric and nger-

print data, which support client identication and

reporting, but pricing and ee systems must be appro-

priate or rural clientele and smaller loan sizes.

Improved collateral registries or movable collateral

and development o alternative orms o collateral are

particularly important to increase lending in the agricul-

ture sector. There are severe constraints to medium- and

long-term nance or agricultural producers, yet invest-

ments in assets such as machinery, equipment, and irri-

gation are necessary to enhance productivity and

agricultural development. Movable collateral registries,

which support borrowers ability to pledge such assets as

collateral and lenders ability to register their charge over

these assets, are integral to support long-term invest-

ments in agricultural production and value chains, espe-

cially when land tenure rights are not secure.

Additionally, improving creditor rights to register secu-

rity interests on sales contracts can support increased

lending via value chain and contract arming structures.

Growth o a vibrant rural nancial system, including

a variety o nancial institutions, platorms, and dis-

tribution networks, is critical to supporting growthand development in the agriculture sector. The nan-

cial system should oster a mix o diverse nancial

institutions serving agricultural clients, with stan-

dards, oversight, and support appropriate to each type

o institution, as well as acilitation o wholesale and

partnering relationships between players to support

innovation and expanded rural reach. A diverse

system can best address demand or nancial services

beyond credit to include savings, insurance, and other

products tailored or specic groups, such as youth

and women. Although competition is important,cooperation and partnerships can leverage various

institutions strengths to play complementary roles

and establish distribution channels. Commercial

banks have strong managerial capacity and balance

sheets, and nancial cooperatives and rural credit

unions oer rural reach and local knowledge, while

alternative delivery platorms such as correspondents,


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agents, mobile branches, and mobile banking plat-

orms support access to hard-to-reach clients.

5. Building Consistent and Reliable

Data Sources

Governments should invest in the regular collection

and dissemination o reliable data related to agricul-

tural nance, agricultural production, supply chains,

and market pricing inormation. There is an extensive

need or collection, organization, analysis, and dis-

semination o a broad range o agricultural nance

data. Such data is necessary to inorm eective agri-

cultural nance policies and to bridge the gap in

understanding that divides market participants rom

the supply and demand sides. Financial institutions

need more inormation about prospective agricultural

clients and supply chains, while armers and agricul-

tural SMEs also need better understanding o banks

and other nancial service providers.

Measurement o the agricultural nance gap, along

with quantication o the opportunities or growth, is

paramount to setting, evaluating, and improving agri-

cultural nance policies. Policymakers can require

banks and nancial institutions to report data on agri-cultural lending, such as the amount, term, loan pur-

pose, and repayment perormance. Such data rom

nancial institutions, together with census and other

survey research, contributes to the on-going diagnos-

tics and strategic reviews o agricultural nance

within each country and leads to sound policy.

The public sector can play a vital role in generating

and disseminating data and inormation about a

countrys agriculture sector, which can reduce prob-

lems o imperect and asymmetric inormation thatcurrently hinder the ecient allocation o resources

toward and within the agricultural economy.

Although individual banks may collect some inorma-

tion rom agricultural clients, certain data (particu-

larly in aggregate orm) has public good characteristics

that benet all players in the market. Central banks

oten collect aggregate data on loan portolios to the

agriculture sector. Such inormation can then be

utilized by banks and other nancial institutions

to assess borrowers through parametric lending

models and to support portolio monitoring and risk

management eorts.

6. Building Capacit o Financial

Institutions and Their Clients

Banks and nancial institutions require support in

training, product development, and risk management

specic to agriculture. Given the unique risks and

characteristics o agricultural production and supply

chains, bankers serving the segment require the

development o specialized credit skills and policies,

credit scoring and rating tools, and portolio monitor-

ing practices. It may also be necessary to utilize agron-

omists and value chain specialists to provide research

and analysis o key agricultural sectors. Lastly, rural

nancial institutions and savings and credit coopera-

tives need special attention to improve proessional-

ism, governance, and management in order to remain

a key link to the rural client base.

Banks need assistance in strengthening value chain

nance arrangements, such as multi-partite arrange-ments between nancial institutions, agribusiness

companies, and armers. Banks can enhance value

chains by oering a ull range o nancial services,

improved product design, transparent pricing, direct

disbursement to armers, and cross-selling. These

value chain nance linkages reduce agricultural lend-

ing risks and may come to serve as collateral substi-

tutes. Extension services and access to quality inputs

reduce production risks, while market and price risks

are oten addressed by orward contracts. Hence, loan

appraisals can become more ocused on assessing thecash fow created by the value chain transactions and

the strengths and protability o the entire chain,

rather than solely on the creditworthiness o the indi-

vidual borrower as applied in mainstream lending.

It is important to strengthen armers and armer-

based organizations in order to acilitate access to


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nance and improve the eciency o value chains.

Training in basic arm economics, nancial literacy,

organization, governance, business management,

and nancial skills promotes the development o

economically-oriented armer associations or coop-

eratives. Eective organization o armers ocused on

commercial activities brings structure to value

chains, allows armers to pool resources or pur-

chasing and marketing power, supports collective

risk management eorts, and provides a counter-

party through which nancial institutions

may nance production o smaller armers.

Well-organized armer groups also ease the delivery

o valuable extension services, training in improved

agronomic and husbandry practices, certication,

and other orms o technical assistance to

elevate productivity.

Another crucial need is capacity building or innovative

instruments and approaches in the agricultural SME

nance space, with ocus on identiying the needs o

armers. Innovative instruments support hedging

commodity price and weather risks, inventory nanc-

ing, and payment and delivery systems, among others.

This will enable nancial institutions to develop appro-

priate products through capacity building aimed at

armers. Among such products are savings and pay-

ment services, loans, leases, hedging, and a range o

insurance services, including health, lie, crop, weather,

and property insurance.

This policy review and recommendations paper is laid out according

to the ollowing organization. Section 1 provides denitions o impor-

tant terms, including segmentation o agricultural SMEs and armers.

It also provides the historical context and changing paradigms o agri-

cultural nance. Section 2 covers the recommendations related to gov-

ernment support, regulatory rameworks, and policy-setting. Section 3

outlines the recommendations and ocus areas related to nancial inra-

structure and the importance o reliable data. Section 4 provides an

overview o the areas o capacity building, both or nancial institutions

and their clients, that are necessary to advance agricultural nance in a

sustainable manner. This section also includes a summary o certain

innovations in the agricultural nance space, and serves as a preview to

a ollow-up stocktaking report on agricultural nancing models.


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2 OEcD (1988)

3 the ie o his paper rees he a ha his work as under he G-20 SME Finane Work Sream. thereore, when using he ermagriuura inane herein, we aua reer o Agriuura Finane or Sma- and Medium-sized Enerprises, whih inudes oharmers and agriuura SME usinesses. See deiniion o SMEs ha inudes oh armers and agriusinesses aer in his seion.

4 the deiniions draw arge on Hoeinger (2011) and Haze, Anderson, bazer, cemmensen, Hess, and Rispoi (2010).

CHAPTER 1

Agriuura SME Finane in conex

1.1 Deinitions and Segmentation

This paper ocuses on policy recommendations and

ocus areas or governments in emerging and develop-

ing countries interested in increasing access to nance

or agricultural SMEs. Agricultural SME nance policies

reer to all actions that enhance nancial services or

agricultural SMEs, encompassing objectives and plans,

laws and regulations, actions and behaviors, and all ac-

tors impacting on institutions, rms, and individuals

within the country in question. This publication sets

out to clariy the process o policy making or agricul-

tural and rural nance, and looks especially at the

mechanisms involved. It is addressed primarily to those

policymakers responsible or ormulating, managing,

and tending the agricultural nance system, but also

targets donors and managers o rural nancial institu-tions operating in the agricultural nance space. It lists

some o the key issues and provides instruments to

overcome the risks and challenges that are specic to

agricultural nance.2

This report is about Agricultural Finance or SMEs.

However, it is important to note that agricultural SME

nance is dierent rom rural nance, micronance,

and SME nance. While micronance reers to nan-

cial services or low-income households, rural nan-

cial services are used in rural areas by all incomegroups and or all activities, both agriculture and non-

agriculture related. However, agricultural nance is

dened as nancial services or all agriculture-related

activities, rom production to marketing, or enter-

prises o all sizes. Hence, agricultural SME nance (the

subject o this paper) is dened as nancial services

or SMEs with respect to agricultural production (i.e.,

arming) and production-related activities (i.e., input

supply, wholesaling, processing, marketing, and

trade).3

The ollowing section provides denitions

or some common terms that are used in this broad

space, both in terms o nancial actors on the supply

side and a segmentation o armers and agribusinesses

(SMEs) on the demand side.4

FINANCIAL INSTITUTIONS AND SUPPLy SIDE

ACTORS

Rural fnance is a spatial concept that encompassesthe provision o dierent nancial services to house-

holds and enterprises in rural areas or both produc-

tive and consumptive purposes. It reers to nancial

transactions related to both agricultural and non-agri-

cultural activities in rural areas. Credit is believed to

be the binding constraint in many cases related to

agriculture project objectives, leading to the incorrect

assumption that rural nance and agricultural credit

are the same. Instead, rural nance encompasses the

ull range o nancial services demanded by rural

households, including loans, savings, payment andmoney transer services, and risk management (e.g.,

insurance, hedging, and guarantees).


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5 this appies o imporers o agriuura inpus and mahiner and arger ompanies engaged in proessing and expor o agriuuraommodiies.

6 the upper oundar o miroinane is eiher reaed o he poer saus o usomers in reaion o naiona poer ines or he sizeo inania ransaions o he aerage Gross Naiona Inome (GNI).

7 chrisen and Peare (2005)

8 See IFc (2010) or more inormaion on deining SMEs.

Rural nancial services are provided by a continuum

o institutions with dierent levels o ormality, rang-

ing rom inormal grassroots nancial institutions

such as Rotating and Accumulating Savings and Credit

Associations (ROSCAS and ASCAS) to ormal nancial

institutions such as banks, leasing and insurance com-

panies, investment unds, and non-bank nancial

institutions. Financial NGOs, mutualist nancial insti-

tutions such as credit unions, savings and loan coop-

eratives, and nancial services associations, sometimes

called semi-ormal institutions, are somewhere

between. Although more structured and with higher

levels o unctional dierentiation and proessional-

ization, their regulatory ramework and supervision

are oten weak or non-existent.

Agricultural fnance is a sectoral concept that com-

prises nancial services or agricultural production,

processing, and marketing; this includes short-,

medium-, and long-term loans, leasing, savings, pay-

ment services, and crop and livestock insurance.

Recently, the concept o agricultural value chain

fnance has been introduced to emphasize the vertical

dimension o agricultural nance to and between di-

erent segments o agricultural value chains. Although

agricultural nance can largely be regarded as a subseto rural nance, some larger companies operating on

both ends o agricultural value chains are also located

in bigger towns and cities.5

Non-fnancial institutions such as traders, input suppli-

ers, processors, and exporters have always played an

important role in providing short-term nance or agri-

cultural production and marketing. The role o agribusi-

ness as provider o agricultural credit might even have

increased in recent years, in response to the decline o

bank lending and as part o an overall trend towardsincreased vertical coordination and integration.

Microinance can be broadly dened as nancial

service provision to poor people in urban and rural

areas.6Micronance only partly overlaps with rural

nance, given that most micronance customers

are in urban areas. Agricultural microinance

reers to the provision o nancial services to small

armers and poor rural households or agricultural

production, marketing and processing.7

SME inance is the unding o small and medium

enterprises. As outlined in the IFC SME Finance

stocktaking report, the term SME typically

encompasses a broad spectrum o denitions across

countries and regions. SMEs are usually dened

based on the number o employees, sales, or assets.

One o the most widely used denitions covers all

rms with ewer than 250 employees, thereore

including micro-rms.8

Under this denition, the

vast majority o all businesses are SMEs, typically

95 to 99 percent. SMEs account or a signicant

share o employment and GDP around the world,

especially when taking into account the inormal

sector. A substantial portion o the SME sector may

not have the security required or conventional

collateral-based bank lending, nor high enough

returns to attract risk investors, while their nan-cial requirements are too large or micronance.

This has led to claims o an SME inance gap

particularly in emerging and developing countries.

Frequently, agricultural inance heavily overlaps

with SME inance in the agriculture sector. Hence,

agricultural SME inance is deined as inancial

services or small and medium enterprises engaged

in agricultural production (i.e., arming) and

production-related activities, such as input supply,

processing, trade, wholesaling, and marketingat all levels.


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The discussion in this paper ocuses primarily on

agricultural SME nance. The diagram in Figure 1

seeks to represent agricultural SME nance as a subseto agricultural nance within the broader space o

rural nance, micronance, and SME nance.

DEMAND SIDE AND AGRICULTURAL

FINANCE CLIENTS AGRICULTURAL SMEs

AND FARMERS

On the real sector or demand side o the agricultural

nance equation, this paper ocuses on both armers

and agricultural SMEs in developing countries. In

other words, it generally includes agricultural produc-tion, processing, trade, and marketing at all levels,

with a perspective o economic growth and proes-

sionalization. We use the term Agricultural SMEs

broadly, to include both those engaged in primary

production, as well as agricultural businesses engaged

in activities all along the agricultural value chain.

Those engaged in primary production can include

individual armers, armer-based organizations and

cooperatives, or larger enterprise arm operators. The

discussion in this report includes all o these eco-nomic entities, as illustrated by the Agricultural Value

Chain diagram in Figure 2 on the ollowing page.

Value is added throughout the chain by the

armer, processors, marketers, and service provid-

ers all the way to the consumer. As such, agricul-

tural inancial services are required to support this

value addition all the way along the chain.

However, agricultural value chains and value addi-

tion have associated risks, transaction costs, and

inormation asymmetries, all o which impedeaccess to inance or agricultural players along the

value chain. In general, access to inance is oten

less available at the beginning o the chain

(or inputs and arm production needs) and more

available to agricultural businesses engaged in the

value-additive activities urther along this chain

(processors, wholesalers, etc.).

Urban Rural

Micro

SME

Microfinance

GeographicLocation

Enterprise

Size

AgriculturalSME

Finance

Agricultural Finance

Rural/Agri

Micro-finance

FIgure 1 AGRIcUltURAl SME FINANcE


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9 See IFc (2010) pg. 9 and Annex A pg. 89 or exampes o SME deiniions.

In order to develop tailor-made policies and nanc-

ing instruments or agricultural SMEs, segmentation

o armers and agribusinesses is essential.

Agribusiness SMEs tend to have characteristics simi-

lar to traditional SMEs. For example, these agribusi-nesses are enterprises engaged in input supplies,

processing, trading, wholesaling, retailing, and

services, much like non-agricultural SMEs.

Thereore, traditional denitions used or SME seg-

mentation can be applied to distinguish agribusiness

SMEs rom microenterprises and large enterprises

engaged in the same business activities. These deni-

tions are generally measures according to either

number o employees or annual sales turnover.9

Thereore, agribusiness SMEs can be thought o as

those agricultural businesses that t the general de-nition o an SME or a given country or region.

SEGMENTATION OF PRIMARy PRODUCERS

However, armers and enterprises engaged in pri-

mary agricultural production do not conorm easily

to conventionally agreed upon SME denitions. As a

result, there is no clear international consensus on

how to segment those who all into the arm pro-

duction stage o the agricultural value chain.

Thereore, it is particularly important that policy-makers begin to try to distinguish and dene the

segment o armers engaged in primary production

that would be considered SMEs.

In this vein, the ollowing section provides an il lus-

trative ramework to attempt to segment primary

agricultural producers into dierent categories. We

recognize that there is no clear cut segmentation

that can be universally applied because o varia-

tions across countries and regions, as well as dier-

ences due to the types o crops or agriculturalcommodities produced at the arm level. However,

we eel that these characteristics oer a starting

point rom which policymakers can begin to seg-

ment their own countrys agricultural producers in

order to better design policies that meet the needs

o the various categories.

Logistics,Trade andDistributionMiddle-men,

Warehouses

Farm

ProductionCrops, Livestock

Farm InputsLand, Labor, Seeds,

Fertilizer, Pesticide,

Livestock

Processor Wholesale

Trader

Fresh Market

Food

Retail &

Services

FIgure 2 AGRIcUltURAl vAlUE cHAIN


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Annual farm net income(as function of skilled laborer (SK) income)

> 2 * SK

< 0.8-2 * SK

< 0.8 * SK

< 0.3 *SK

Largefarmer

Medium-sizedfarmer (emerging)

Commercial smallholder

Semi-commercial smallholder

Key characteristics

Land Size of cultivated land is large (>500ha)

Labor Mainly depending on skilled labor

Technology Fully mechanized

Resources Formal bank loans and/or external capital, skilled(risk) management

Production Fully commercial and often dollarized

Capacity Good market access, own storage/logistics andaccess to market information

Value chain Well positioned within the value chain

LARGE FARMER

Land Cultivated land is medium sized (20-500ha)

Labor Combination of family members and external labor

Technology Partly mechanized

Resources Limited access to formal bank loans

Production Largely commercial

Capacity Reasonable market access but limited access tomarket information

Value chain Weak position, stronger in cash crops

MEDIUM-SIZED FARMER

Land Size of cultivated land is small (2-20ha)

Labor Primarily family labor

Technology Minimal mechanization

Resources Mainly informal finance

Production Partly commercial (at least one cash crop)Capacity Marketing through group structures

Value chain Position depending on group strength

COMMERCIAL SMALLHOLDER

Land Size of cultivated land is relatively small (e.g. < 2ha)

Labor Dependence on family members for mostof the labor

Technology Low technology, little access to know-how

Resources Limited resources (capital, skills, labor, risk mgt, etc.)

Production May produce subsistence or commercial

commodities, with on-farm and o-farm sourcesof income

Capacity Limited capacity of marketing, storage andprocessing

Value chain Are often vulnerable in supply chains

SEMI-COMMERCIAL SMALLHOLDER

Finance gap =

FIgure 3 SEGMENtAtION OF FARMERS


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Segmentation by arm income is particularly chal-

lenging due to income dierences across countries

and the earnings potential o various crops. For exam-

ple, cash crops can oten earn a high income on a

small landholding, while staple crops may earn mini-

mal income on a much larger plot o land. Thereore,

the segmentation illustrated in Figure 3 provides an

income proxy by comparing the annual net income

generated by arming (ater all costs are deducted) to

the annual earnings o a skilled laborer in that coun-

try or region. Again, this is not an exact science and

perhaps other comparable measures could be

employed; nevertheless, there is benet in trying to

segment arm size according to characteristics that

include both income and other non-income qualities.

The challenges here are not dissimilar to the various

denitions o SMEs, in which there is ocus not only

on annual revenue but also on the number o employ-

ees as a proxy or business size.

Semi-commercial smallholders (also reerred to as

subsistence armers) generally exhibit no or very

small marketable surpluses. They are generally not

active in agriculture or economic reasons but arm to

survive and due to lack o alternative opportunities. In

some literature, semi-commercial smallholders areconsidered to have a land size smaller than 2 hectares.

Other literature holds that it is typical or agriculture

to account or less than 60 percent o the income o

these households. The annual arm net income ater

costs is generally less than 0.3x the annual earnings o

a skilled laborer in that country or region.

Commercial smallholders are armers with some

marketable surpluses in a particular crop. Land hold-

ings may range rom 2-20 hectares, and crop produc-

tion oten includes at least one cash crop. The annualarm net income ater costs may range between 0.3x

and 0.8x the annual earnings o a skilled laborer in

that country or region.

Medium-sized armers generate meaningul income

rom arming, oten with land under production

totaling more than 20 hectares and up to 500 hectares

(also reerred to as emerging armers). The smaller

armers o this segment are likely producing cash

crops, while the larger land holdings are more likely

to be used or commercial arming o staple crops.

Annual arm net income ater costs is generally more

than 0.8x but less than 2.0x the annual earnings o a

skilled laborer in that country or region.

Large armers produce and market their output in a

proessional manner, employ sta, and oten have

access to a ull range o nancial services. These arm-

ers are oten producing on land holdings in excess o

500 hectares, though this may be smaller i arming

only cash crops. In general, the annual arm net

income ater costs o large armers is in excess o 2.0x

the annual earnings o a skilled laborer in that coun-

try to region.

AGRICULTURAL SME FINANCE GAP

When we reer to the agricultural SME nance gap or

armers, we especially reer to the lowest three seg-

ments. Commercial smallholders that are active in

integrated, mostly cash crop, sectors may get access to

nance through value chain nancing instruments;medium-sized armers may have just the minimum

size to appeal to some banks. However, by and large

both segments have diculties accessing ormal

nancing, especially when producing staple crops

(such as cassava, maize, wheat, rice, etc.) and when

seeking medium-term and long-term nancing.

Oxam reers to the armer nance gap as the missing

middle, and particularly points to the gap that exists

or armers in need o loan amounts between USD

5,000 and USD 500,000 that have diculty with

access to nance because they are too large or micro-nance institutions (MFIs) and too small, risky, and

remote or commercial banks.10

In agriculture, the vast majority o SMEs consist o

semi-commercial and commercial smallholders.

Hence, this report reers to this broad category o SMEs

10 Doran, MFaden, and voge (2009)


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and includes semi-commercial smallholder armers. In

practice, semi-commercial armers (or subsistence

armers) do not have access to nance through most

commercial banks and even through micronance

institutions. Although we acknowledge that there is a

serious need or nancial inclusion measures at this

level, this paper keeps within the ocus o the G-20

SME Finance Subgroup and primarily reerences

policies geared towards the nancial needs o commer-

cial smallholder and medium-sized armer segments as

the core o the agricultural SME space. However, we do

not ignore the needs o the semi-commercial

smallholders, and the policy recommendations attempt

to be sensitive to any policies that would urther

marginalize this segment.

1.2 Basic Challenges in Agricultural

Finance11

Given the characteristics o rural areas and rural eco-

nomic activities, rural nancial services provision has

to tackle a number o specic challenges, in addition

to those inherent in any nancial intermediation.

These specic challenges are related to seasonality,

covariant risks, and low population densities.

Many rural economic activities are subject to season-

ality and gestation periods, which oten lead to a slow

rotation o the invested capital and are refected in the

cash fows o rural entrepreneurs. Longer loan matur-

ities and irregular repayment schedules are more risky

and present additional challenges to liquidity manage-

ment. More than in other sectors, the protability o

agricultural enterprises depends to a signicant extent

on external actors such as weather, major outbreaks

o pests and diseases, or prices o inputs and outputs,

which are largely beyond the control o armers. Inaddition to idiosyncratic risks aecting individual cli-

ents (e.g., illness or death o amily members, thet o

productive assets, etc.), agricultural enterprises are

exposed to covariant risks arising rom the above

external actors, which may simultaneously aect

large numbers o armers in a given area.

Finally, agriculture is a politically sensitive sector

prone to government interventions. Although perma-

nent interventions through lending quotas, interest-

rate ceilings, or direct government provision o

nancial services have been reduced substantially in

the last decades, governments continue to intervene

on an ad hoc basis. Such interventions include loan

rescheduling or orgiveness and preerential lending

programs or specic target groups, which are oten

granted ater major economic downturns or natural

calamities, and especially in the advent o elections.

They create additional uncertainties or nancial

institutions and tend to weaken the repayment culture.

Despite these challenges, rural nancial services providers

have ewer instruments at their disposal to manage the

various risks and reduce operational costs than their

urban counterparts have. Many rural nancial institu-

tions try to protect themselves against the various risks

through excessive credit rationing and over-reliance on

collateral. However, rural assets are less suitable as loan

collateral than, or example, urban real estate. Due to

legal and administrative impediments as well as cultural

actors, land and other rural assets are oten not regis-

tered and may be more dicult to oreclose and sell.

Even where these constraints do not apply, collateral is a

poor protection against massive deault due to covariant

risks. However, other more appropriate instruments or

managing covariant risks, such as crop insurance or

hedging, are rarely available.

Classical micronance techniques to cope with delin-

quency risks include highly standardized loan products

based on small credit amounts, requent (oten

weekly or bi-weekly) repayments without grace periods,

short maturities, and collateral substitutes such as

joint liability mechanisms. While these techniquesstill work rather well in peri-urban areas and or a ew

rural economic activities, they are dicult to apply in

rural economies characterized by strong seasonality

and low population densities, and they are unsuitable

or the larger loan amounts and longer maturities that

are typical or agricultural nance.

11 this seion is aken dire rom Hoeinger (iid)


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1.3 Changing Paradigms in

Agricultural Finance12

In view o the above-mentioned challenges, commer-

cially-oriented nancial institutions tend to avoid

rural and agricultural nance as long as other, less

risky business opportunities are available. Due to the

importance o the rural economy or overall eco-

nomic growth, employment, and poverty reduction

in most developing and transition countries, expand-

ing rural and agricultural nance used to be a major

concern or governments and donors. However, poli-

cies and instruments or enhancing rural nance have

evolved considerably over the past decades, refecting

undamental changes o the underlying paradigms.

During the 1960s and 1970s, the emphasis was on

addressing market ailures through massive public

intervention in the orm o directed and subsidized

credit. The overall objective was to accelerate the

modernization o agriculturethrough the adoption o

Green Revolution technology packages combined with

arm mechanization and irrigation. Credit was con-

sidered as an input or agriculture production, and

specic institutions such as agricultural development

banks and cooperatives were established to make

cheap credit widely available to armers. Rather thannancial intermediation, the main purpose o these

institutions was to channel loans at subsidized interest

rates to armers. Outreach, not loan repayment, was

the main concern, and little attention was paid to the

nancial health o the lending institution.

Although subsidized and directed credit helped some

developing countries, especially in Asia, to improve

agricultural yields, it proved to be a high-cost approach

that scored poorly on eciency and sustainability. All

too oten, state-owned agricultural banks and creditunds were raught with poor management, political

intererence, and rent-seeking elites. Interest rates were

set too low to cover operational costs, and high loan

losses urther undermined the nancial health o the

lending institutions. Politically motivated loan orgive-

ness ollowing major natural calamities or price slumps

weakened the repayment culture in rural areas. Hence,

periodic capital injections were required to keep the

lending institutions alive. Notwithstanding sizable

amounts o public unds invested, outreach to small

arms and landless households oten remained limited.

Like other nancial institutions, agricultural banks pre-

erred lending to medium and large armers who had

sucient collateral and could be served at lower trans-

action costs. Thereore, in many countries the majority

o rural households did still not have access to credit,

let alone other nancial services.13

During the 1980s, major donor organizations and

many governments started reviewing their agricul-

tural credit policies. In the wake o structural adjust-

ment programs and scal austerity, unding or

agricultural banks and credit projects declined

sharply. Many countries, especially in Latin America

and Arica, liberalized their nancial markets, closed

down agricultural development banks, and phased

out credit lines to agriculture and other priority sec-

tors. At the same time, micronance gained popular-

ity amongst donors and governments. Pioneers like

the Grameen Bank, Banco Sol, Bank Rakyat Indonesia,and others demonstrated that large numbers o poor

households deemed unbankable could be serviced in a

cost-covering way and that lending institutions were

able to become nancially sustainable (at least in the

medium term) i appropriate institutional arrange-

ments and nancing technologies were put in place.

In addition, a new strand o research based on the

concepts o new institutional economics provided resh

insights into the unctioning o rural nancial markets

and the nancial management practices o poor

households, including a better understanding o theirdemand or nancial services.

During the 1990s, these trends converged into a new

paradigm in development nance, ocusing on the

12 this seion is aken dire rom Hoeinger (iid)

13 Meer and Nagarajan (2005) and FAO and GtZ (1998)


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development o ecient and inclusive nancial sys-

tems and markets. The Financial Systems Approach

acknowledges the importance o ecient nancial

intermediation or economic development and pov-

erty reduction. The development o stable, ecient,

and inclusive nancial systems is regarded as a devel-

opment objective on its own, rather than a means to

achieve other development objectives.

According to the Financial Systems Approach, govern-

ments should rerain rom directly providing nancial

services or intervening in nancial markets. Lending

quotas, interest rate ceilings, or subsidized unding to

priority sectors should be avoided as they distort

resource allocation and crowd out private nancial

institutions. The main role o governments is to provide

a conducive ramework and an enabling environment

or the development o competitive and transparent

nancial markets and eective nancial intermedia-

tion. This includes sound macro-economic policies

that keep infation and domestic borrowing rates

low and exchange rates stable. Governments should

urther create a strong legal and regulatory ramework

or dierent types o nancial institutions coupled

with eective supervision in order to stimulate

competition while saeguarding the stability o thenancial system.

Further important areas or public-sector investments

are transport and communication inrastructure,

which reduce transaction costs and enhance the pro-

itability o both economic activities and nancial

services provision in rural areas. Subsidies to nancial

institutions should be limited to institutional

strengthening and capacity building, with a view

to enhancing outreach, nancial sustainability, andpoverty reduction impact. Subsidized unds or

on-lending might only be justied or a limited time

period in order to compensate nancial institutions

or the higher initial costs and risks o launching

nancial innovations. Interest rates or clients should

not be subsidized. According to the Financial Systems

Approach, victims o wars or natural disasters should

be given direct grants rather than subsidized loans.14

14 Word bank (2006), Kein, b., e a. (1999), and Meer and Nagarajan (iid)

Box 1 bASIc PRINcIPlES AND ASSUMPtIONS

OF tHE FINANcIAl SyStEMS APPROAcH

Finania insiuions mus e aowed o harge os

oering ineres raes in order o grow and proide

oans in a durae wa.

Poor iens aue reiae and quik aess o oans

more han heir oss.

Finania ieraizaion reaes ompeiion amongs

nania insiuions, whih simuaes produ

innoaions and a gradua expansion o nania

serie proision (he so-aed ronier o orma

nane) owards rura areas, ow-inome iens, and

riskier eonomi aiiies suh as agriuure.

Saings, insurane, and pamen series are a eas

as imporan as redi or poorer rura househods.Moreoer, deposi moiizaion an e an imporan

soure o unds or nania insiuions.

Due o proems regarding goernane, eien, and

poiia inererene, goernmens shoud rerain rom

dire engaging in nania series proision.


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assessment o the quality o nancial inrastructure and

relevant laws and regulations that impact the supply o

nance. Much o the heart o this diagnosis can be

guided by the recommendations in Section 3.1. When

thinking about agricultural nance, it is important to

understand the ull range o suppliers o credit to agri-

cultural SMEs and armers beyond simply commercial

banks and micronance institutions. There is a wide

variety o nancial service providers that can and

should be supported with appropriate policies.

Recommendations around this topic are also discussed

in Section 3.1. The many orms o nance supplied via

value chains are covered in Sections 4.2 and 4.4.

From the policy perspective, it is critical that diagno-

sis and strategy-setting be undertaken regularly and

consistently as part o an on-going and dynamic pro-

cess. Policy assessments should be measured against

specic policy objectives. Policy-setting is only one

part o the process, whereas much o the evaluation o

eectiveness may be ound in implementation. An

assessment o the success and ailure o past policies

can help to identiy existing weaknesses, acilitate the

ormulation o coherent and integrated policies, and

provide the basis or monitoring progress in expand-

ing the agricultural SME nance space. It is crucial toconsider the entire policy context or policies that

impact the agricultural nance space. This is covered

in signicantly greater detail in Section 2.2. It is also

worth noting that regional rameworks and regional

integration sometimes infuence a countrys agricul-

tural policies and strategies.

2.2 Developing a Supportive Legal

and Regulator Framework

CHALLENGE:

Agricultural nance is a policy orphan - too oten

responsibility or policies impacting agricultural

nance alls into a void among several government

ministries, such as nance, agriculture, planning, trade,

and commerce. Dierent government bodies oten

have divergent interests and perspectives concerning

agricultural nance. Accordingly, the subject area is re-

quently pushed to the side and neglected, inhibiting a

coordinated legal environment that promotes the cohe-

sive development o strong, sustainable, and socially-

responsible agricultural nance policies and supportive

underlying legal and regulatory systems.

POLICy FOCUS AREA

Coordination o policies intersecting both the

nancial and agriculture sectors is critical to acili-

tating access to nance or armers and agricultural

SMEs. The appointment o a single coordinating

body as the advocate or agricultural nance can

optimize policies that target arming as an eco-

nomic enterprise to promote agricultural develop-

ment through nance and investment. This

high-level body can also reconcile and harmonize

policies ocused on objectives related to rural

development, social support, and ood security that

are aligned with, but not necessarily the same as,

policies supporting agricultural nance.

Coordination is oten necessary between the min-

istry o nance, the ministry o agriculture, the

central bank, and the ministry o trade and com-merce. Developing countries also require solutions

to increase access to long-term, local currency

unding or nancial institutions as well as to pro-

mote equity nance in addition to credit. These

issues are not specic to agriculture but infuence

overall nancial fows to support sustainable

growth in the agriculture sector.

NEED FOR A POLITICAL FRAMEWORK WITH

A ROBUST POLITICAL MANDATE

A strong regulatory ramework is crucial or the suc-

cess o agricultural nance, as bank lending and e-

cient investments are adversely aected i the

necessary legislation is absent or, even worse, i exist-

ing legislation is a roadblock or progress in agricul-

tural nance. The correct regulatory ramework is


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critical or many areas important to agricultural

nance: land rights, ecient leasing, contracts or

value chain nance, contract enorcement via an inde-

pendent and reliable judiciary, warehouse receipt sys-

tems, or a supportive environment or armers to

organize into economic groups, including coopera-

tives. The regulatory ramework encompasses the

agricultural and nancial sectors and is crucial to

ensure business planning and bank collaterals. The

general role o nancial sector policy is to provide a

air and competitive marketplace ramework or nan-

cial institutions. Hence, regulators should ensure a

level playing eld in rural areas.

A common challenge acing agricultural SME nance

is that policies aecting agricultural and rural nance

belong to several dierent policy-making areas. In

other areas o the economy, it is oten easier to iden-

tiy the ways in which an economic sector corre-

sponds with a certain division or ministry within the

governmental structure. At a minimum, agricultural

nance straddles agriculture sector policies, nancial

sector policies, and policies or the macroeconomic

environment. Given the overlap o policy areas, there

is a danger that the needs unique to agricultural

nance may be overlooked or that policies may par-tially confict with one another instead o being

mutually supportive.

Figure 4, next page, illustrates an example o a com-

prehensive diagnostic outline or agricultural nance

policymakers, demonstrating that many inputs and

many actors at various levels need to participate in

order to ensure robust and ruitul results. The gen-

eral and background inormation takes into account

the bigger picture in which agricultural nance

resides, including overall political, rural inrastruc-ture, social and cultural, and demographic contexts.

Agricultural nance policy also has to t within the

macroeconomic context or the nancial sector and

the agriculture sector. Finally, there are the policy

elds that relate specically to the agriculture sector

and the nancial sector, as well as institutions and

real sector market participants, all o which are areas

in which the primary stakeholders must be brought

together and key coordination activities should occur.

The basic problem is that dierent government bodies

have diering interests and perspectives concerning agri-

cultural nance. This is particularly true with respect to

macroeconomic policies, agriculture sector policies, and

nancial sector policies. As explained by Coey:

All three policy areas have their own impact on the eective

provision o nancial services. Generation o an eective agri-

cultural and rural nance policy depends on the denition o a

clear overall rural nance policy ramework and strategy.

Tensions and contradictions do occur between each o these

policy areas, which need to be debated and addressed through

eective and continuous policy dialogue. Oten, however, an

eective policy dialogue platorm does not exist, with a lack o

condence between the public and private sectors.16

In order to unction eciently, agricultural nance

policies have to integrate the perspectives o the agri-

cultural and the nancial sectors, despite the act that

both sectors pursue dierent rationales. Agriculture

sector policies strive to make agricultural agents moreprotable, while nancial sector policies endeavor to

build protable nancial institutions in order to serve

the economy, including the agriculture sector.

However, these rationales have been requently con-

used. Financial institutions were assigned many tasks

o direct agricultural development, with little atten-

tion paid to the logic o nancial markets and to the

required nancial inrastructure.

Furthermore, there may be other policy areas that

come to bear on agricultural nance, such as tradeand commerce in the case o export o agricultural

commodities, tax policies with respect to imports,

exports, and leasing, and social aairs in terms

o support ollowing catastrophic events or ood

security concerns.

16 coe (iid)


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RELATION TO MACRO LEVEL

Identification of Policy Decision Makers Actors in the field of

Agricultural Finance Policy

Identify Policy Objective

Identify Policy Measures and Instruments

AGRICULTURAL/FINANCIAL SECTOR ANALYSIS

Overview of the Agricultural/Financial Sector

Identification of the Role and Participation of the

Main Interest Groups/Pressure Groups/Stakeholders in the forumlation

and Execution of Agricultural/Financial Policy

related to Agricultural Finance Regulatory Framework

INSTITUTIONAL LEVEL

Role and participation in the Policy Decision Making

Eect and Performance of Policy at Institutional level

RELATIONSHIP WITH FARM LEVEL

Role and Participation in Policy Decision Making

Eect and performance of Policy Instruments and Measures on Farmers

Agricultural Sector Policy

related to Agricultural FinanceFinancial Sector Policy

related to Agricultural Finance

43

General Background InformationDemographics, Social and Cultural Issues; Political Climate

Rural Infrastructure, Agricultural ProductionSocio-Economic Situation at Farmer Level

1

Macroeconomic Policy with relevance to

the Financial SectorGeneral Macroeconomic Policy

Macroeconomic Policy relating to the Financial SectorMacroeconomic Policy relating to the Agricultural Sector

2

FIgure 4 DIAGNOStIc MEtHOD FOR AGRIcUltURAl FINANcE POlIcIES

S: coe (1998)


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In addition to the lack o an eective policy dialogue,

very ew countries have a strong advocate or agricul-

tural nance. The dominant government player in the

agricultural and rural nance policy-making process

varies rom country to country. The challenge is not

only to ormulate an appropriate policy ramework

that suits the dierent interests o public and private

groups but also to nd a governance structure that

can implement such policy. Whichever governance

structure is chosen, it is dicult to achieve a Pareto

optimum objectively speaking and subjectively per-

ceived by the various interest groups o the sector.17

Generally, two primary orms o leadership have

emerged in ormulating successul agricultural nance

policies: that o a dynamic leader, which may be at

the highest levels o either the ministry o nance or

ministry o agriculture; or leadership through some

orm o inter-ministerial policy committee to ocus

on agricultural development, which can then bring

coherence on agricultural nance policies.18

There are strong arguments that countries need a rec-

ognized lead agency or coordination body, preerably

made up o representatives rom the key government

ministries or departments, who would be vested with

institutional responsibility or coordinating agricul-tural nance policy. This coordination body would

also be responsible or acilitating interactions and

reconciling policies between intergovernmental,

public, and private interests. According to the specic

country context, this lead body may be the ministry

o nance, the ministry o agriculture, the central

bank, or an intergovernmental coordinating agency.

There may be good reasons or designating each o

these institutions. However, conficting issues may

evolve around the act that agricultural nance is a

sensitive political topic with dierent perspectivescoming rom the agricultural and nancial sectors.

The ministry o nance is the lead political agency o

the nancial sector and, rom the viewpoint o the

nancial sector, could be a powerul promoter o

agricultural nance policies. The ministry o nance

has signicant political and decision-making power

and covers the ull nancial sector, including insur-

ance companies. However, more oten than not, the

nance ministry does not see itsel as a promoter o

agricultural nance and hands over this responsibility

to the ministry o agriculture.

At rst glance, the ministry o agriculture appears to

be the predestined body to take the lead in promot-

ing agricultural nance as it traditionally has been

responsible or agricultural nance, with the goal o

achieving development objectives, such as social

equity. However, the track record or this leadership

approach has not always been successul. Achieving

agricultural development goals with the instruments

o another sector (namely nance), which unctions

completely dierently, has proven rather dicult.

Hence, nancial sector experts may think that the

ministry o agriculture might not have the expertise

and mandate to promote agricultural nance accord-

ing to the standards o the nancial sector. In addi-

tion, the ministry o agriculture may wish to push

agricultural nance with interventions that contra-

dict best practices in nance.

Last but not least, a third key acilitating agency would

be the central bank. Even though the central bank is

not a ministry, requently the central bank is among

the most powerul institutions in the nancial sector,

concentrating technical and supervisory capacities.

The central bank is a regulator and supervisor o

nancial institutions. It is thus already close to agri-

cultural nance practice, as banks are the dominant

provider or agricultural nance. Moreover, the cen-

tral bank possesses the greatest expertise in the nan-

cial sector and oten enjoys a reasonable degree oindependence rom political interest groups. This

makes it a potentially neutral acilitator and watchdog

o agricultural nance. The central bank could help

strengthen the supervision o rural nancial institu-

tions and set ratios that address the unique

17 Roers (2011)

18 Meer and Nagarajan (2005) and FAO and GtZ (1998)


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risk management aspects o agricultural nance. The

central bank can also play a strong role in collecting

data on agriculture lending. However, the central

banks primary responsibilities are to regulate nan-

cial institutions and ensure stable macroeconomic

conditions. Thereore, it may not have the capacity or

willingness to take on the lead role in setting and pro-

moting agricultural nance policies.

Hence, what becomes clear is that one lead agency could

choose to take on the lead role to oversee and promote

agricultural nance, but which entity would depend on

the country-specic context. Coey notes that potential

tensions and contradictions between overall nancial

sector and agriculture sector policies should be taken

into consideration. A national level body, such as an agri-

cultural or rural nance policy committee, can act as a

single coordination body to advocate or agricultural

nance. This is especially important given that certain

objectives related to agriculture, such as rural develop-

ment, social development, and ood security, are impor-

tant but do not necessarily align directly with the

objectives o agricultural nance policies. In addition to

government ministries engaged directly in nancial

sector policies and agricultural and rural development

policies, such a national body can also bring together thevarious stakeholders o the private sector such as nan-

cial institutions, agribusiness, and representatives o

armer organizations.19

LACK OF MEDIUM- TO LONG-TERM FINANCE

A dierent, but still noteworthy, challenge exists in

developing countries with respect to a general lack o

long-term local currency unding or nancial institu-

tions. This is commonly cited as a constraint or

nancial institutions unwilling to extend longer termcredit. However, this issue is not unique to agricul-

tural nance; it applies to the nancial sector in gen-

eral. I long-term unding is available, it is rarely used

or medium- and long-term agricultural investments,

such as equipment or irrigation, which are crucial or

modernization o the agriculture sector and agricul-

tural inrastructure. Government policies can even

have a negative eect on the local currency long-term

unding market by encouraging unds rom pensions

and insurance companies to nance government

bonds. Although long-term unding through oreign

currency is much more readily available, many insti-

tutions involved in rural nance have no capacity to

deal with currency mismatches. It is recommended

that governments review their policies to ensure that

a level playing eld is established in the long-term

local currency unding market.

The central bank can have a role by supporting the

legal and regulatory environment and a ramework

or green bonds and other renancing mechanisms

to support agriculture nance. It is also advisable to

engage with donors, international nancial institu-

tions, and others to nd workable and low cost solu-

tions or currency mismatches or long term

agricultural investments. Increasing equity invest-

ments are also necessary or growth, as agricultural

SMEs oten do not have sucient capital on their bal-

ance sheets to support additional credit. However, an

outstanding question is the extent to which agricul-

tural SMEs are actually open to equity investments intheir businesses. Nonetheless, there is limited equity

nance in many developing countries to support busi-

ness growth and expansion, which applies to agricul-

tural enterprises and many other sectors alike.

NEED FOR A WELL-FUNCTIONING

jUDICIARy SySTEM

POLICy FOCUS AREA

Ecient and responsive credit services depend on a

well-unctioning judiciary system that provides

objective decisions in a timely manner and with

Documents

Scaling Up Access to Finance for Agricultural SMEs