5.2.16. Value Chain Finance Implications for Program Designers

Design sustainable value chain finance interventions.

Effective interventions require an appreciation of the dynamics that exist within the value chain, including the following:

Conducting a value chain analysis that identifies the driving opportunities for growth and increased competitiveness.
Specifying those opportunities that are constrained by a lack of appropriate financial services.
Identifying players who will benefit from these services, those with an incentive to introduce or expand these services, and the relationships these players currently have.
Bringing together players who possess incentives, knowledge, skills and resources to develop and deliver appropriate financial products and services.

Facilitate information flow from the value chain to financial markets.

Facilitating the flow of information from value chain actors to financial markets can reduce real and perceived risks of agricultural finance. Donors can play a role in strengthening agricultural markets by supporting the creation of market information systems (e.g., radio, news bulletins, information databases) and the exchange of value chain contacts between value chain actors and financial institutions. Financial institutions can forge strategic relationships with dynamic agricultural value chain actors, such as large processing firms, to expand their loan portfolio by either lending directly to its related producers or making larger loans for the processor to on-lend to producers. ^[1]

Design interventions with ‘integrated components’ that focus on increasing access to finance.

Donors can design interventions with connector firms to create ‘integrated components’ that focus not only on increasing access to finance, but also providing technical knowledge in growing high value-added products that meet the demands of growing and dynamic markets. Looking at forward and backward linkages, connector firms can identify opportunities to strengthen the value chain as a whole, including addressing financing gaps. By providing additional support at the smallholder level, such as in the negotiation of agreements and the design of win-win contracts, donors can facilitate the flow of benefits to poor rural farmers, who often have less power to influence pricing and terms.^[1]

Identify sources of risk reduction and new incentives.

Institutions and individuals involved in designing new value chain finance interventions must identify the specific sources of risk that exist while drawing on incentive structures that will facilitate greater access to finance. There are various sources of risk inherent in value chain finance—first and foremost is non-repayment due to limited collateral conditions. Designers must have a comprehensive understanding of all risks before designing sustainable interventions. Coupled with a strategy of risk reduction, a successful value chain project should also create or identify incentives that will encourage expanded lending to the sector under consideration.

Provide training and technical assistance to value chain connector firms.

Donors can have a significant and sustainable impact by providing training and technical assistance on agricultural finance management to value chain firms that are providing financial services to their clients. Agribusiness connector firms could use assistance in evaluating their approach to providing finance to make sure all unit costs are adequately factored into their pricing and all risks are being cost-effectively managed. In addition, they could benefit from banks’ experiences in managing loan portfolios and handling collections.^[1]

Introduce and link value chain firms with financial institutions.

Donors that are probing for ideas to facilitate value chain finance can consider the introduction of value chain connector firms (i.e., input suppliers, wholesalers and distributors), to financial institutions and provide them with training and technical assistance on agricultural lending. Formal financial institutions need assistance in understanding value chains and how to manage risks associated with lending to the agricultural sector. While most financial institutions are averse to lending directly to farmers, by introducing mechanisms to draw on value chain connector firms they can lower their risk exposure while facilitating access to finance for the entire value chain.^[1]

Identify ways to improve access to longer-term agricultural finance.

Given that the lack of access to medium- and long-term finance is a common hindrance to agricultural and manufacturing value chain development, donors should seek ways to overcome the obstacles and increase incentives for agricultural lending. This is particularly true for drip irrigation, tractors and other agricultural equipment, as well as packing sheds, transportation and refrigeration to develop agribusinesses. Donors could look to bond markets, insurance companies and pension funds—rather than banks alone—for sources of funds to match agricultural finance’s longer investment time frame.

Additional incentives are also needed to develop agricultural markets and offer guarantees or other types of risk-sharing to improve the attractiveness of agricultural investments as compared to other alternative long-term investments. For example, the Development Credit Authority (DCA) guarantees could be combined with Export-Import (EXIM) Bank terms to facilitate the purchase of agricultural equipment, such as drip irrigation and tractors, which are sorely needed to improve production quality and yields around the world. ^[1]

Short-Term Loans. Most financing is provided in the form of short-term loans. This hinders value chain actors such as manufacturers who often need larger, longer-term loans for capital improvements. This requires larger, longer-term fixed asset loans, which value chain actors cannot provide given their emphasis on their business operations (which are not lending in nature).

Scale. Because credit from traders and buyers draws mostly on business relationships, it also lacks the potential for achieving the same volume and numbers as a specialized financial institution.

Transparency. Given that many value chain financing transactions focus on the final delivery of a good—and not on the financial service—there can be a tendency for less transparency in the pricing structure of the loans and in accounting transactions. This can limit the value chain actors’ understanding of whether they are making or losing money (on the delivery of credit) and can create unrealistic borrower expectations. When the financial sector enters a market dominated by trader credit, farmers are unaware of the effective price that they are paying for their financing and can view rates offered by financial institutions as high. However, the effective rate offered by a financial institution may most likely be equal to or lower than a trader credit. Many microfinance institutions now have customer service policies that require full disclosure of interest rate structuring.

Attention should be given to how and where these issues may arise and how to correct them. Examples include having a project facilitator review formal contracts or including a third party mediator during the value chain finance process.

Recognize the limits as well as the benefits of financing by value chain actors.

While the advantages of a value chain financing approach are significant, financing by value chain participants is not a panacea. Financing provided is mostly in the form of short-term loans. Input providers are generally constrained by the fact that they are financed by their providers with short repayment periods and they have no means by which to extend credit for a longer period without gaining new forms or sources of financing themselves.

Value chain participants tend to have less transparent mechanisms than formal financial institutions for pricing financial services. This can limit their own understanding of whether they are making or losing money, and it can create unrealistic price expectations for borrowers—expectations that are impossible for financial institutions to meet. For example, when a financial institution enters a market dominated by trader credit, producers may be unaware of the real (or effective) price they are paying for their financing, and view rates offered by the institution as high. However, a cost comparison would probably show that the bank’s offered rates are reasonable.

Availability of the credit by value chain actors is also limited. Because credit from traders and buyers draws mostly on business relationships, it is rarely possible to achieve the same volume of business as a specialized financial institution.

Another possible pitfall is the potential for exploitative relationships, such as buyers who control the market and price their services unfairly; or producers who sell to competing buyers, breaking the contracts they have signed with the value chain firms that had provided them with initial financing.

Look for solutions for gender-based constraints to finance.

Constraints on access to finance for women may require practitioners to seek creative solutions that enable women to invest in their businesses. Examples of gender-based constraints to accessing finance include bank requirements of a male guarantor, as well as time and mobility limitations that prevent women from regularly visiting a bank. In Ghana, women save regularly through susu savings accounts where agents visit women at their doorstep or market stalls on a daily basis to collect small deposits. This allows women to put aside very small amounts on a regular basis without having to take the time to travel to a bank. Practitioners should make sure they are aware of how gender affects financing in a value chain and look for effective mechanisms such as susu savings accounts to alleviate these constraints.^[2]