Long-Term Solutions to Food Crises: Building Credit Institutions That Can Finance Agriculture Value Chains

by , | May 6, 2020


Key points:

  • Reorient the discussion from ‘development’ to ‘risk’ 
  • Emphasise the importance of locally owned institutions such as community banks 
  • Adapt credit models and delivery channels

The World Food Programme has predicted that the coronavirus pandemic will double the number of people facing crisis levels of hunger. “We could be facing multiple famines of biblical proportions,” according to its executive director, if we don’t act to avert them. 

Food crises are not extraordinary events, and each has prompted substantive policy analyses and calls for action. Yet despite widespread agreement on the unacceptability of hunger, international institutions have struggled to deal with the problem. Even before the coronavirus, 135 million people worldwide were experiencing acute food insecurity. Words have not translated into deeds.  

Improved agricultural productivity and profitability in the low-income countries that are at greatest risk of food shortages will help allay the threat, at the same time as increasing long-term resilience by reducing poverty.  

Policy discussions on financing agriculture are typically conducted in the language of ‘development finance’. This term is often used synonymously with concessional finance, which involves extending loans to farmers at interest rates below market rates. Concessional finance perpetuates dependence on government and donor assistance, and is unlikely to be sustainable as the demand for capital grows.  

But development finance is essentially a matter of financing risks that need to be financed but are shunned by other lenders. Agriculture is often under-served by lenders. Sometimes this is because the risks are genuinely high relative to other lending opportunities, or because financial institutions have positioned themselves to service businesses in other sectors. Often it is because the risks are not understood.  

To close the funding gap, there is a need to diversify sources of investment beyond governments and donors. What are required are financial institutions that understand agriculture, agricultural value chains and the risks inherent to the sector.  

“To close the funding gap, there is a need to diversify sources of investment beyond governments and donors.”

Changing language from ‘development’ to ‘risk’ reorients discussion to a language of finance and helps structure discussions on sustainable finance. In agriculture as in any other sector, lenders have to be able to assess and manage risk. This means most lending will have to be on commercial rather than concessional terms.  

Commercial finance does not have to be highly priced. It just has to reflect administration costs and a risk premium that will vary according to the risk profile of the borrower and the project. Banks investing in agriculture must be allowed to do the job we have assigned to them in our economic system. The Dutch multinational Rabobank is an example of a successful specialist agriculture lender which has made an organisational investment in understanding the sector. Rabobank, however, operates primarily in middle- and high-income countries.  

Locally owned lenders are more likely than national or multinational banks to understand the risks involved in agricultural investment and the importance of the sector to the local community. In the United States these are known as ‘community banks’, which emerged to finance local farmers because the big national banks were not interested. 

Community banks use a relationship banking model as opposed to a transactional model. They adjust collateral requirements accordingly, sometimes offering unsecured loans when transactional bankers would consider this practice too risky.  

To encourage the establishment and growth of locally owned banks, regulatory relief should be considered, such as reducing the amount of capital that banks are required to hold and lowering the threshold level of financial sector experience required of shareholders and directors. Since community banks are not systemically important, they can be allowed greater room to operate than larger banks.  

“Banks investing in agriculture must be allowed to do the job we have assigned to them in our economic system.”

Community banks do not have to remain small, however, and it is important to lay down clear regulatory pathways that enable good small lenders to grow to become good bigger lenders, while still retaining their commitment to a community. This can be done through graduated licenses, for example, whereby the larger a lender grows, the more demanding licence conditions on capital requirements and financial experience become.  

More flexible credit models are also needed. Credit models that rely on real assets (land and buildings) are often unsuitable for financing agriculture, particularly for small-scale producers and where land is communally owned. Lending models that accept movable assets as collateral (inventory, receivables, contracts, or even transplantable trees and vines) are more suitable.  

Credit delivery channels are changing with technological innovation. Equity crowd-source funding and peer-to-peer lending are internet-based platforms that connect investors with those who need to raise capital. These and other online banking models are less costly and more adaptable than traditional bricks-and-mortar banking. They can be customised to fund investment in small-scale agriculture in particular geographical areas, potentially attracting local investors. 

If we are to live up to our commitments to avert food crises both during and after the COVID-19 pandemic, low-income-country farmers need new sources of funding. Unless a much larger share of finance is provided at commercial rates, it will continue to be insufficient for the improvements in productivity that are required. Commercial banks that are rooted in their communities and allowed the freedom to develop lending models that are tailored to local environments can play a vital role in providing the agriculture sector with sustainable finance.  

Author

  • Peter Dirou works on financial sector policy issues and leads the financial sector programme within the Asian Development Bank’s Pacific Private Sector Development Initiative.

  • Mark Weston

    Mark Weston is a writer, researcher and consultant working on public health, justice, youth employability and other global issues. He lives in Sudan, and is the author of two books on Africa – The Ringtone and the Drum and African Beauty.


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