How risk-sharing approach can uplift farmers

Sorghum farmer Evans Ruto at his farm in Kilos Village ,Elgeyo Marakwet County on July 15, 2023. [Christopher Kippsang, Standard]

Participants in the agricultural value chain are always happy to share the outputs of farming activities. The crops, the produce, the profit. Unfortunately, few seem willing to share financial risks. 

Traditionally, farmers and financial institutions have shouldered the burden, creating high-stakes, high-pressure financing arrangements which simply don’t work.

To finance agriculture effectively, we must spread the risks among a wider network of stakeholders. ‘Value chain finance’ a new risk-sharing solution currently being piloted in West Africa, appears to hold the answer. The risks associated with agricultural finance are many and complex. Farmers often deliver poor returns or default on loans due to forces beyond their control, such as climate shocks, pests and prices. 

For smallholder farmers in particular, this situation has led to widespread exclusion from financial services and products, constraining their efforts to improve food security and disincentivising production.

In Africa, more than 50 per cent of the population is involved in agricultural activities while less than 1 per cent of banking credit goes to the sector.

According to the International Finance Corporation, African SMEs generate about 33 per cent of GDP but receive on average less than 5 per cent of bank financing. 

Of course, there are established models for improving financial inclusion and reducing the costs and complexities of agricultural finance. ‘Blended finance’, for instance, uses public funds to de-risk private money, with innovative programs, supported by AGRA in several countries.

Examples include PROFIT and RK-FINFA in Kenya, GIRSAL in Ghana, ABC Fund in ACP countries. ‘Digital finance’, meanwhile, uses digital channels to deliver financial services and reduce transaction costs, But to accelerate financial inclusion among smallholder farmers, we have to address the issue of risk more broadly, which is where ‘value chain finance’ offers a compelling and viable solution.

Typically, there are four key parties who have a vested interest in crop production: input (seed and fertiliser) dealers; buyers; farmers; and banks. Each party stands to benefit from a certain quality and quantity of output; therefore, within the ‘value chain finance’ model, each party shares a portion of the financial risk involved.

First, the farmer and the buyer establish a market contract, then make a deposit to the bank. The bank and farmer draw up a loan contract for the full value of the required inputs before the bank disburses part of that value to the input dealer. The input dealer delivers the inputs. The farmer produces his/her crop and delivers it to the buyer.

The buyer then repays the loan and interest to the bank and remits the remainder to the farmer, while the bank pays the input dealer’s remaining percentage. In this way, by leveraging cash collateral from other value chain participants, farmers can purchase the inputs they need without relying solely on banks. In turn, those participants become more proactive in field monitoring and knowledge sharing to ensure a successful outcome. With their own money in the game, input dealers and buyers want to ensure crops are well produced and correct processes are followed. 

It’s essentially an input financing mechanism with risk-sharing principles, which draws on the interdependencies and relationships within the agricultural value chain. And it’s a win-win for all involved. Input companies increase their sales and reduce pre-financing risks.

Buyers can dictate crop variety and planting methods. Farmers receive loans at lower prices and gain access to guaranteed markets. And banks reduce the rate of default, while expanding their portfolios. It also helps to manage expectations in the value chain, giving participants a clear idea of crop yield and profit. The ‘value chain finance’ model is gaining traction.

The writer is head of inclusive finance at AGRA