As climate change poses fresh challenges to farmers across ACP countries, donors, development banks and private lenders are developing innovative blended finance and risk-sharing solutions.
Climate change is having a profound impact on agricultural value chains across ACP countries, with smallholder farmers feeling the worst of the pain. Changing weather patterns pose a new threat to already precarious livelihoods and are rendering many traditional agricultural practices ineffective. But while climate-smart finance has become a fashionable topic, only a tiny proportion of funding is directed towards agriculture. Without more investment, feeding the world will become ever harder, warns Margarita Astralaga, director of Environment, Climate Division at the International Fund for Agricultural Development (IFAD).
While no corner of the world is immune to climate change, regions in most need of smart solutions include Africa’s Sahel, where more frequent and longer droughts are disrupting the planting calendar. “Farmers don’t know when to plant corn, when to plant cassava, because they cannot predict what is going to happen next,” notes Astralaga. Farmers on small Pacific islands – many of which are already isolated in terms of external markets or supply chains – face shrinking fresh water resources while rising sea levels threaten to consume arable land.
In a recent CTA discussion paper, A Business Case for Engaging the Private Sector in Climate-smart Solutions for Smallholder Farmers, the authors emphasise the need to harness financial, technological and intellectual capital in the private sector to complement public sector-driven climate actions, as a new dimension in the delivery of sustainable climate-smart solutions at scale. “Climate finance through a blend of grant, commercial and quasi-commercial financing instruments has the potential to unlock resources from the private sector towards promoting climate-smart agriculture (CSA) at scale,” says Oluyede Ajayi, CTA’s Senior Agriculture and Climate Change Programme Coordinator.
Blended finance – where public and private funds are combined in a common investment scheme or deal – has proven one of the most successful ways of funding CSA, states Astralaga. Many blended finance schemes include a grant component from a government body, development or philanthropic organisation which, when mixed with funds from a commercial lender, reduces the interest that borrowers have to pay. Some blended schemes include a guarantee that lenders will receive back a proportion of the loan funds should the borrower fail to repay. This reduces the risk that financial institutions take, encouraging them to offer more or bigger loans to borrowers or sectors that they perceive as high risk, or to offer them more favourable terms such as interest-free periods or favourable repayment schedules.
The grant component of many blended finance schemes can persuade governments, organisations or firms in countries that are not directly responsible for climate change – and are therefore loath to pay for its consequences – that borrowing to alleviate its effects might still be in their best interest. Once they experience the benefits of climate-smart investments in agriculture or other sectors, they tend to be more open to borrowing in the future, via blended finance schemes or even pure commercial loans, says Astralaga. Others are resigned to having to make climate-smart investments but simply cannot afford a loan unless interest rates are reduced. “In many countries, the only way they would take a loan is if we have a grant component. That’s a fact,” she affirms.
In 2012, IFAD launched its flagship Adaptation for Smallholder Agriculture Programme (ASAP). The programme, which channels climate and environmental finance to smallholder farmers, helped persuade reluctant ministries of agriculture – many of whom initially argued that environmental issues were outside their remit – that the potential losses if they failed to invest in climate-change adaptation were greater than the costs of borrowing, Astralaga explains. Investments funded so far through ASAP include everything from improved meteorological data and early warning systems to solar energy, biogas and making rural roads that are essential for getting crops to market less vulnerable to flooding.
Six years later, “the change is just incredible,” with many governments now seeking second loans. IFAD’s first ASAP project in Nicaragua, for example, included a large grant, but it is now taking a second full loan to fund climate-adaptation activities, she says. In Bolivia, a number of indigenous communities are applying for loans after they saw the benefits enjoyed by other indigenous communities that have implemented IFAD-facilitated climate resilience projects.
Development banks reduce the risk
Using blended structures to provide a first-loss or subordinated tranche to “take away the first pain” in any climate-smart financing can be “very effective,” says Hans Bogaard, manager at the Dutch Development Bank (FMO). Once this is in place, commercial banks or lenders like FMO are often willing to provide regular funding on top. For example, MASSIF and the Infrastructure Development Fund – blended funds that FMO manages on behalf of the Dutch government and which are partly used to support projects supporting smallholders and climate resilience – allow FMO “to take a bit more risk,” says Bogaard.
FMO is also supporting a partnership, led by commercial lender Rabobank and the UN Environment Programme, which is looking to scale up forest-friendly sustainable agriculture using blended finance. FMO has agreed to share its knowledge in sustainable agriculture and forestry with the partnership – which in October 2017 launched an €867 million facility – and to mobilise its own blended finance resources where possible, states Bogaard. The facility aims to provide grants, de-risking instruments and credits to clients involved in sustainable agricultural production, processing or soft commodities trading who commit to forest protection, restoration and the involvement of smallholders, but has not yet disbursed any funds.
The Development Bank of Jamaica (DBJ) supports climate projects under the framework of Jamaica’s Pilot Programme for Climate Resilience, which was developed by the government in collaboration with the Inter-American Development Bank and the World Bank to invest in climate adaptation across priority sectors, such as agriculture. The programme supports CSA with grants and partial loan guarantees for lenders, from its own funds and via a Caribbean Development Bank line, says general manager Edison Galbraith. For example, for small loans of up to €38,750, DBJ can provide a guarantee of up to 80% of the loan amount on a pari passu – or shared loss – basis.
One initiative that DBJ plans to support with guarantees is a programme run by international humanitarian organisation INMED Partnerships for Children, which aims to help smallholder farmers launch climate-smart aquaponics businesses in Jamaica. INMED is currently working with Jamaican commercial banks and credit unions to create financial packages under which lenders would offer lower interest rates and better terms, such as reduced collateral requirements and a longer initial repayment holiday, to help entrepreneurs buy modular aquaponics systems. Loan sizes will vary depending on the system required, which can cost up to €17,340 for a good-sized commercial system, but could be as simple as one module, two grow beds and a single fish tank. INMED expects first loans to be disbursed before the end of 2018 and aims to reach 150 farmers over the next few years.
DBJ is also funnelling money through local lender Jamaica National, which is offering subsidised loans to support activities such as rainwater harvesting, says Galbraith. Jamaica National’s climate change loan programme provides entrepreneurs with loans of between €1,295 and €32,360 to finance climate-change adaptation activities and energy-efficiency projects in the agriculture and tourism sectors. Loans feature an annual interest rate of 4% and up to 48-month repayment schedules, including a moratorium period of up to six months.
A balancing act
Satisfying the needs of smallholders and lenders in any climate-smart investment is a delicate balancing act, notes Bogaard. It can be challenging for development banks to invest in CSA projects that focus on adaptation, such as improving the climate-robustness of an individual farm. If, however, interventions are scalable – for example involving the introduction of drip irrigation at a plantation in a project that then integrates an outgrower scheme – they become more bankable, Bogaard says. Being able to leverage climate-smart investments for bigger projects to benefit smallholders surrounding it is the “silver bullet” that every development bank strives for, he adds.
One recent project in which FMO has participated saw Africa Improved Foods (AIF) – a Rwandan producer of nutritious complementary foods to combat nutrition (see Spore article, Rwandan Farmers Reduce losses with Nutritious Grains) – set up rural maize collection centres in 2017. It did this in an effort to combat the growing problem of farmers’ crops being rejected by buyers because they contained aflatoxin-producing fungi – a problem that is expected to become a growing challenge globally as temperatures rise. AIF states that rejection rates for maize due to the presence of aflatoxin fell by 52% in the second harvest of 2017 – after the collection points had been established – compared with the first harvest, and were down to zero by the third harvest.
Another way development banks can contribute to climate-smart adaptation is by issuing green bonds or green loans that can be used for climate-smart applications, via financial institution clients, Bogaard adds. Typically, however, development banks focus on climate mitigation investments, for example forestry projects that will sequester carbon. For projects with long ramp-up periods – such as agroforestry, where it can take 5 years for production and revenue to start – banks must be prepared to forgo interest payments initially, perhaps in return for profit-sharing later on, states Bogaard. Development bank provision of long-term or mezzanine finance – a mix of debt and equity financing that gives the lender the right to take an equity stake in a borrower if it defaults – can be vital here.
There remains a need for more innovative financing solutions for CSA. To this end, IFAD has started exploring opportunities for crowd-sourcing as an alternative to traditional finance, as well as ways in which it could facilitate access to climate and commodity hedging, and help microfinance institutions measure and price climate risks.
Risk remains a key concern for both governments and financial institutions, with microfinance organisations in particular often uncertain about what interest rates they should charge when lending to smallholders to reflect climate-related risks and the extent to which they are reduced by any adaptation or mitigation initiatives. Lenders “need feedback so that they can design their own products based on the information we can provide them on climate risks,” Astralaga says. IFAD hopes to be able to launch a product or service related to this in early 2019.
Risk is also front of mind for DBJ, which is keen to support the scaling up of weather-related crop insurance in Jamaica. So far, Jamaica International Insurance Co (JIIC) has experimented with weather-related insurance, but has struggled to offer premiums that are considered affordable, Galbraith notes. In 2013, JIIC teamed up with the Caribbean Catastrophe Risk Insurance Facility, which sells storm and earthquake coverage to governments, to pilot a livelihood protection policy to protect individuals’ income following severe wind or rain events (see Spore article Innovative Insurance for Minimising Climate Risk).
Innovations like this in risk management will encourage financial institutions to offer more agri-finance, adds Galbraith. And as the financing tools available for climate-smart agriculture projects in general become more sophisticated, investments in sustainable agriculture should finally gain pace.