Challenges

The challenges of agricultural development are multiple and complex. High systemic risks: from the environment (drought, flood and disease) and from markets (price volatility, trade policy and trade practices affecting exports and market access) are critical challenges.

Financing is a major barrier to growth in Africa’s agricultural sector, particularly for smallholder farms. Interest rate are particularly high, up to 47%. The lack of collaterals from farmers and businesses, combined with difficulties for banks to price the risk of loans to smallholder farmers is an important impediment to the development of the sector. Other key challenges are the lack of adequate rural infrastructure, lack of access to the range of inputs required by farmers, knowledge gaps, including financial literacy, and the lack of reliable data.

The share of commercial bank lending to agriculture in Africa only ranges from 3% in Sierra Leone, 4% in Ghana and Kenya, 6% in Uganda, 8% in Mozambique, to 12% in Tanzania, compared with the sector’s 20-40% contribution to GDP across the continent. On average, only about 5% of domestic resources are being allocated to the agricultural sector. In part, a combination of perceived high risk and modest returns – as well as the costs of extending traditional banking infrastructures in rural areas – has deterred many financial service providers. The G-20 Global Partnership for Financial Inclusion’s (GPFI) SME Finance Sub-Group reported that neither commercial banks nor the emerging microfinance industry are willing or able to sufficiently meet the financial needs along agricultural value chains, leaving farmers and agricultural SMEs unserved in the “missing middle”.

                                                                                  Figure 1: Share of commercial banks' lending to agriculture relative to share of agriculture to GDP

Opportunities

Despite these challenges, agricultural finance can be commercially viable. Value chain financing is widely used as a risk-mitigation mechanism for short-term finance. It works best where there is strong end-market demand, as well as transparency, trust and strong and repeated inter-firm transactions. In practice, it is important to understand how value chain governance, relations, and linkages are structured to respond to market opportunities, because these factors determine the viability of a financing arrangement.

Many innovative financing mechanisms can catalyse growth in the African agriculture sector, and several are already being deployed. For example, efforts such as AGRA’s credit guarantee and risk-sharing facilities with Equity Bank and Standard Bank in South Africa have leveraged ten times their commitments of risk-sharing public capital into private lending to farmers. Other innovative financing approaches gaining attention in agriculture include risk management tools like weather index-based insurance that helps farmers mitigate climatic risk; guarantee or guarantee-like products such as warehouse receipts programs that eliminate the need for external collateral; and private partnerships like equitable outgrower schemes that link agribusinesses and farmers, enabling bank financing of productivity-enhancing farm inputs.

Some countries have also established agriculture credit guarantee schemes (e.g. Ghana, Nigeria, and Uganda) housed in their Central Banks however the performance of these schemes has been mixed. The Nigerian Incentive-based Risk Sharing System for Agricultural lending , for example has deployed its seed capital of USD 500 Million through five pillars (i.e., risk sharing facility, insurance facility, technical assistance facility, bank rating, and bank incentive). The idea is to 'de-risk' the agricultural financing value chain, build long-term capacity, and institutionalize agricultural lending. It aims to increase agricultural lending from 1.4% to 7% of total banking lending in Nigeria. This initiative has triggered interest from other countries such as Ghana, Liberia, Rwanda, and Uganda to introduce risk sharing facilities (RSFs).

Agricultural insurance is widely used in developed and emerging markets to de-risk agriculture value chains and stimulate agricultural lending, while protecting farmers. However, only a marginal proportion of smallholder farmers (roughly 2 million) have insurance cover across Africa. A growing practice is to bundle agricultural insurance with other products and services provided to smallholder farmers, through aggregators. Agricultural lease finance is another option to expand access to finance, without requiring collaterals, allowing for greater mechanization of agriculture in Africa.

While access to financial services is a frequent constraint at all segments of agricultural value chains, pre-harvest financing at the farm level is perhaps the biggest gap, as evidenced by the low usage of agricultural inputs and equipment in Africa. Improved access to pre-harvest financing is critical for farmers to use high quality inputs and equipment more quickly and on a larger scale. Crop Receipts (CRs), an innovative financing instrument developed in Brazil during the 1990s, and being now implemented in Zambia and Uganda, enables smallholder farmers to mobilize necessary funding from the market to finance their crop production. It also facilitates the entry of new financiers, including the capital market.

Policy recommendations

An enabling environment—with smart regulation, targeted and effective agricultural finance policies, and well-established financial infrastructure—is essential to the development of agricultural finance. This can be achieved through the provision of guarantees, capacity-building schemes to increase understanding of value chain financing, and the promotion of partnerships between institutions which offer other products, including insurance. In 2011, The MFW4A Secretariat established a joint task force of African stakeholders to identify agricultural finance policies and practices to support investments in African agriculture. These policy recommendations led to the adoption of the the Kampala Principles in June 2011 which include, together with promising practices and lessons learned from various experiments the following:

• Avoid direct interventions such as interest rate caps, directed lending and subsidized lending to borrowers, and lending quotas on banks;

• Provide “smart” or “market friendly” subsidies to financial services providers as well as to institutions that are critical to facilitate the flow of finance to the agricultural sector (e.g.: credit information agencies, insurance schemes, training and technical service providers, producers organizations, market and data information systems, etc.);

• Support the development of rural financial service providers such as Credit Unions (Savings and Credit cooperatives – SACCOs), which are often better equipped to capture and intermediate the savings of local communities;

• Provide banks and other private lenders with partial credit guarantees and risk-sharing facilities, particularly in combination with technical assistance;

• Reform existing state-owned agricultural development banks to free management and lending decisions from political interferences;

• Digital finance has the potential to scale up financial services in the agriculture sector. However, regulatory frameworks need to support the continuous innovation of digital initiatives, while at the same time managing potential risks to ensure customer protection;

• Invest in physical infrastructures underpinning the broader market for agricultural finance, either directly—such as weather stations for insurance, irrigation systems, and warehouses—or indirectly—such as with roads, railways, transport, telecommunications, and power supply, especially in rural areas. Critical information includes climate data for agricultural insurance and information on business transactions between producers and buyers for value chain financing; and

• Enhancing policy coordination among the different Government agencies (i.e., Ministry of Finance, Ministry of economy, Ministry of Agriculture, Central Bank, etc.) involved in agricultural finance policies is imperative to drive the change process.

• Finally, establishing a specific high-level coordination body and recognize a single entity as the lead advocate for agricultural finance can have a positive impact as well.

Highlights of our Activities

MFW4A’s work to expand agricultural finance is aligned with the Comprehensive Africa Agriculture Development Programme (CAADP), a programme of the African Union (AU) and the New Partnership for Africa’s Development (NEPAD), which aims to support African countries to reach greater economic growth through agriculture-led development. We support efforts to develop and implement risk management solutions for the agricultural sector both as means of improving access to finance and managing emerging risks, particularly with respect to climate change.