Why lenders are shunning agri-based small enterprises

Bananas going to waste at a stall in Muthurwa market, Nairobi. [Denish Ochieng, Standard]

Lenders have termed Small and Medium Enterprises (SMEs) in the agricultural sector risky, which explains the low credit advanced to the market segment.

The report, which interviewed 24 lenders, also found that most loans to SMEs in the country are borrowed by the informal value chain part of the agricultural sector.

The report by Aceli Africa, a financing intermediary that provides incentives for lending to SMEs, describes informal value chains as those involving crops like maize, rice and livestock.

The formal value chain, on the other hand, includes cash crops like tea, coffee and sunflower.

One of the major reasons why lenders are jittery to lend to SMEs in the agricultural space as detailed in the report is the fact that their businesses deal largely with perishable agricultural products.

This is unlike high-value products like tea and coffee, which the report notes, are dominated by multinational lenders that are guided by their social impact and hence can have the financial muscle to absorb any losses due to market diversification. 

The January 2024 report titled, Financial Benchmarking Report analyses agri-SME lending trends for 2023 across East Africa - Kenya, Uganda, Tanzania and Rwanda.

The report analyses 20,300 agriculture loans valued at $1.17 billion (Sh163 billion) disbursed between 2019 and 2022.

The data was sourced from 35 lenders, including commercial banks, non-banking financial institutions (NBFI) and multi-country social lenders across the four markets.

According to the report, lenders cited higher risks and origination costs (or processing fees) as barriers to lending to SMEs in the agricultural sector.

“Returns from lending to agri-SMEs are generally perceived as less attractive,” the report says.

Of the polled lenders, 84 per cent agreed that agri-SMEs are riskier than lending to other borrowers. At the same time, 77 per cent agreed that due diligence is costlier for agricultural-based SMEs than in other sectors.

Additionally, 69 per cent were of the view that returns from agri-SMEs are less attractive after considering risks and costs while 50 per cent stated that their interest rates, coupled with collateral requirements hinder agri-SMEs from borrowing or securing financing.

“High collateral requirements and interest rates also remain a hindrance to access to finance for Agri-SME borrowers,” the report says.

“While many lenders report that these challenges are more pronounced in the agriculture sector, several noted that they are also present in other SME sectors outside of agriculture.”

To make agricultural-based SMEs attractive to lenders, Aceli Africa, also known as Aceli, came up with two products - portfolio loss and origination incentive.

In portfolio loss, the firm incentivises lenders by depositing two to eight per cent of qualifying loans from $25,000 (Sh3.5 million) to $1.5 million (Sh210 million) to a reserve account, which will cover the first losses across the lender’s portfolio.

Loans that are categorised as gender inclusive have an aspect of climate resilience, food security and nutrition. These are awarded with more incentives to motivate lenders.

On origination incentives, smaller loans to new borrowers are compensated by Aceli, offering origination incentives to compensate lenders for the lower revenues and higher operating costs on loans ranging between $25,000 (Sh3.5 million) and $500,000 (Sh70 million).

Similarly, these incentives are higher when the loans meet the criteria of gender inclusion, food security, nutrition and climate resilience.

The report documents that informal value chains predominate in Kenya, Uganda and Tanzania whereas in Rwanda, formal value chains take the lion’s share.

“In Kenya, Uganda, and Tanzania, the majority of loans are directed towards informal value chains, primarily comprising maize, rice, and livestock,” the report says.

“In Rwanda, formal value chains take a larger share, propelled by growth in coffee, tea, and horticulture in recent years.”

The report adds that commercial banks mostly finance loans in informal value chains, while social lenders focus on formal value chains, such as coffee and tree nuts (primarily macadamia).

Meanwhile, NBFIs strike a balance between formal and informal value chains with a notable emphasis on equipment financing.

“It is noteworthy that social lenders are mission-driven, consciously choosing to operate in the sector despite incurring losses,” the report notes.

“To sustain their Agri-SME lending in East Africa, these lenders typically employ a cross-subsidization strategy, using profits from larger and more lucrative loans in other regions or sectors like microfinance).”