Feed the Future
This project is part of the U.S. Government's global hunger and food security initiative.

5.2.15. Lessons Learned in Value Chain Finance

Opportunities

There are opportunities for leverage within many value chains to reduce costs, manage risk and build trust. Three examples are:

Increasing Leverage

Examples of how to increase leverage include: (i) expanding on existing credit oriented relationships and (ii) delivering services or products through key ‘points of contact’; and (iii) utilizing enabling environments to create more complex types of value chain finance.

Expand on credit relationships. Banks are often unwilling to serve producers due to their fairly small-sized loan requirements and perceived riskiness (as a result of their more remote locations, limited collateral options, dependency on weather and seasonality of demand for credit). However, formal financial players can be attracted to a new sector by collaborating with entities that can aggregate and/or serve clusters of clients. For example, building on existing credit relationships that exist between smaller (perhaps more informal lenders) and their clients; as such, formal financial institutions rely on a firm’s credit history to offer them larger and longer-term loans. In some cases, lending to an informal or small lender (such as a localized credit union) for further on-lending can assist in reaching more isolated and/or small businesses.

Example: In Central Asia, Frontiers, LLC is a wholesale lender that makes small loans (average $120,000) to credit unions and agriculture associations to on-lend to rural households and small producers. Enabling Environment. In business and banking environments that are more developed, opportunities exist to develop commodity exchanges that link future buyers and sellers to reduce producers’ price and marketing risks. Countries with less transparent enabling environments often provide a limited framework to encourage expanded access to finance due to their inability to lend on commercial terms from international and national banks.
Example: One example is from Kazakhstan which passed a non-banking financial institution (NBFI) regulation in the 1990s that allowed MFIs to register as NBFIs and be supervised by the Kazakhstan central bank. In 2006, the central bankers decided that it was too risky to monitor MFI activities and withdrew this regulation. As such, existing NBFIs had to re-register under a new microfinance organization law which put them outside the formal financial system. International lenders assessing potential investments in the Kazakh MFI market saw this as a step backwards and have become more risk sensitive to investments in the country.

Reducing Risk

Value chain finance can utilize mechanisms that reduce overall risk to the value chain actors.

Example: In Ethiopia, financial institutions were unwilling to work with agricultural cooperatives until a bank tapped a Development Credit Authority mechanism which shared the risk of loans to cooperatives that provided advances against products deposited by their members. After a successful collaboration, the bank obtained a second guarantee, but did not use it, going on to lend to agricultural cooperatives using their own funds. The bank considered the partnership to be successful on its own merits and continued their on-lending to cooperatives for subsequent on-lending to its smallholder members.
Example:In Latin America, Rabobank of the Netherlands has found that they can significantly reduce the risks involved in agricultural lending by getting to know value chain actors and their businesses intimately. Rabobank has also found that building these relationships can help them identify profitable connector firms (input suppliers, distributors, wholesalers) for agricultural lending and future investment opportunities.[1]

Providing a Demonstration Effect

Value chain finance can serve as an important demonstration effect to encourage larger-scale players and formal financial actors to enter a new market. Banks and formal financial institutions are always seeking lucrative markets to diversify their portfolio while at the same time reducing risk. Successful value chain finance activities offer possible new investment opportunities and can open doors for further expansion through more formalized channels.

Example: In Peru, the processor Agromantaro leveraged its financial credibility and offered to sign contracts and manage loan collection and repayment from producers, thereby reducing the risk to financial institutions. After successful repayment, rural banks in Peru were often willing to lend directly to producers affiliated with Agromantaro.[2]

Challenges

Value chain finance holds many positive attributes. These include ease of access, flexibility, the lowering of risk which can lead to the increased competitiveness of a sector. One challenge, however, for value chain finance actors is the provision of longer-term loans for capital investments. Most value chain actors supply short-term working capital to clients that require limited monitoring, collateral or paperwork. As with formal financial institutions, value chain actors often struggle with weighing the risks and rewards of offering investment loans.

Value chain finance actors are also faced with challenges of working in a sector they know little about. Since their main driving factor is securing a product and reducing risk the specifics of the financial transaction can be mismanaged – with risks of non-repayment, lack of equity, and misuse of funds.

Download a learning synthesis related to financial constraints and opportunities among agricultural small and medium enterprises here.

Footnotes

  1. Financing Artichokes and Citrus: A Study of Value Chain Finance in Peru. December 2006
  2. Financing Artichokes and Citrus: A Study of Value Chain Finance in Peru. December 2006