Microfinance for farmers: too early to write-off?

Mike Warmington

Smallholder finance: banking on impact?

More than 75% of the world’s population living in poverty are farmers. Just US$50 billion of the US$200 billion global demand for smallholder finance is currently being met – half of it through informal channels. But financial service providers (FSPs) largely focus on urban clients.

Investment in agriculture is two to four times more effective at raising incomes among the very poor than investments in any other sector. The scale and impact of meeting that demand makes smallholder finance the greatest opportunity today for financial inclusion.

There are already some great examples of financial services for farmers. The six members of the recently formed Propagate, offer a variety of smallholder finance services. However, there are three reasons why such services are so hard to come by.

1) Cost: it’s expensive to work in rural areas. Operating costs are higher, business loans are usually smaller than in urban areas, and longer loan tenors are needed to accommodate the farming season. This all makes it harder to cover the running costs and capital needs of the FSP. 

2) Risk: working with farmers is perceived as relatively high risk. FSPs worry about weather, pests, diseases and market fluctuations. Even with a bumper harvest, the glut of supply can push prices down and threaten loan repayment. 

3) Complexity: agricultural loans can be complicated. Training and value chain linkages are needed to maintain a healthy and impactful portfolio, but this expertise is often outside the comfort zone of an FSP and its team.

For these challenges to be overcome, FSPs, the financial inclusion sector and the agriculture industry need to collaborate more effectively. There are three ways they can do this.

1) Better structured wholesale finance: there is a mismatch between the terms offered by investors and the borrowing needs of farmers, making it difficult to offer farmers the right loan structure and pricing, and less likely that FSPs will take on the additional credit risk. By addressing this discontinuity, lenders would be able to offer farmers the terms they need, increasing the impact of their investment.

2) Focus on impact: this also helps to mitigate risk. If an FSP offers a loan product with a higher agricultural impact, this will lead to better yields and wealthier customers who are more willing and more able to repay their loans.

3) Create stronger partnerships: by sharing existing knowledge and best practices, FSPs will quickly develop better products. Building stronger partnerships with technical and other service providers will deliver more impactful smallholder-focused products.

There is currently a high level of interest in smallholder finance. Closing the economic gap will have a huge impact on the poor, and by focusing on these recommendations we can achieve that goal much more quickly. What are we waiting for?

The Technical Centre for Agricultural and Rural Cooperation (CTA) is a joint international institution of the African, Caribbean and Pacific (ACP) Group of States and the European Union (EU). CTA operates under the framework of the Cotonou Agreement and is funded by the EU.