Posted on July 26, 2016

A Collaboration of Hivos, Enclude, and Triodos Investment Management

Posted by: Celine van Soest, Consultant, Inclusive Finance

Smallholder farmers, who run 85 percent of the world’s farms, have a crucial role to play in feeding their communities. Given the widespread poverty in rural areas and the labour intensive nature of agricultural production, growth in agriculture will do more to reduce poverty and hunger than growth in any other sector of the economy. In particular, improving the productivity of small-scale farmers, and connecting them to the markets is thought to have the highest potential for increasing food production and supply. The flow of investment into agriculture – both from private and from public sources – is more generous today than in the past. Still, access to capital and financial services is among the most prominent bottlenecks for small-scale farmers and processors.

There is no doubt that food production, in general, must grow significantly in the next decades. The Food and Agriculture Organization of the United Nations (FAO) estimates that a 70 percent rise in agricultural output is needed by 2050. Others state that the global food system is largely sufficient to feed the world’s seven billion people and that agricultural production has always been able to grow along with exponential demographic growth thus far.

However, the success story called “the green revolution” has had its price. Turning more and more land to agricultural uses will have severe environmental consequences, including water shortages, concentration of toxic elements, deforestation, loss of biodiversity, erosion, and more. These negative trends will be aggravated by climate change.

In view of these developments, the importance of the agricultural sector to achieving sustainable development is clear. Agriculture is crucial to reducing poverty, achieving food security and improving economic growth. At the same time, the agricultural sector must consider responsible consumption and production, climate action, and life below water and on land as defined in the UN Sustainable Development Goals.In this context, the movement to “green” agriculture has arisen, including the introduction of better agricultural practices, energy-efficient technology, institutional innovations to improve sustainable food systems, and access to energy in emerging countries. Sustainable agriculture attends to the triple bottom line of sustainability: people, profit, and

In this context, the movement to “green” agriculture has arisen, including the introduction of better agricultural practices, energy-efficient technology, institutional innovations to improve sustainable food systems, and access to energy in emerging countries. Sustainable agriculture attends to the triple bottom line of sustainability: people, profit, and planet. Sustainable agriculture also ensures higher supply of sustainable and organic food along the value chain, reaching the end client.

Despite the many positive benefits of sustainable agriculture, it remains extremely difficult to engage socially-oriented financial institutions in the move towards sustainable agricultural finance. The reason is simple: agricultural finance, sustainable or otherwise, is already extremely challenging and laden with risks that financial institutions’ directors are not yet ready to accept, or do not know how to mitigate due to lack of agricultural experience, lack of tailored products, and inadequate collateral and instruments to mitigate agriculture-related risks.

Preparing institutions for agricultural finance

For organisations to be successful in agricultural finance, they must have the right policies and processes in place, as well as a certain level of flexibility among financial products and services, so they can be easily adapted to the value chains (in terms of loan size, tenor, and collateral required). Financial institutions also need in-depth agricultural knowledge to understand the value chain and the related environmental and social risks, and to be able to address them adequately. Often, we are talking about starting with small steps, one at a time. However, if a proper framework is in place, the potential is enormous, as demonstrated by financial institutions that are part of the Global Alliance for Banking on Values. Sustainable and green finance is part of their DNA and has proven to be profitable.

The Sustainable Agricultural Finance Expansion Programme

In the period 2013-2015 Hivos, Enclude and Triodos Investment Management implemented the Sustainable Agricultural Finance Expansion Programme whose goal was to enhance access to finance for small producers involved in agriculture, producer organisations and agricultural SMEs by building the capacity of Hivos’ and Triodos Investment Management’s partner microfinance institutions.

The program made visible three pillars of greening agriculture: institutional, financial and environmental sustainability.

Institutional sustainability: Scaling up of green agricultural finance requires a strong institutional basis of product and agriculture knowledge at management and staff levels. Under this programme, technical assistance interventions focused on strengthening the institutional basis were primarily used to ensure financial and environmental sustainability in the long term. Institution building efforts included strategy development, process design, product development and staff training. Training included on-the-job training, development of training manuals, train-the-trainer courses, and exchange visits to gain staff and management buy-in.

Environmental sustainability: Products that are appropriately tailored to the agricultural target group enhance environmental sustainability. In addition to matching agricultural cash flows, a loan product with seasonal loan repayment instead of monthly payment offers farmers more financial opportunities to utilise their land flexibly, rotate crops to protect soil ecosystems and minimise pest infestation, and implement sustainable land use practices. To encourage sustainable agriculture among clients, the participating MFIs developed and communicated good agricultural practices to their clients. In some cases, agronomists supported branch staff while, in other cases, a web-based good agricultural practices (GAP) tool or client communication via SMS was used.

Financial sustainability: The development of new products laid a strong basis for growth and diversification for participating financial institutions while improving their financial sustainability. The improvement of processes and procedures reduced costs and enhanced the organisations’ financial performance. Credit risk was decreased by mitigating harmful business practices.

Lessons learned when implementing greening agricultural finance projects

Our experience in this program has provided numerous lessons for successfully implementing green agricultural finance projects. The most notable of these relate to the need for regulatory clarity, a comprehensive diagnostic of institutional capabilities, alignment of products and technical assistance with overall business strategy, and careful, context-specific product design which includes a testing phase.

The regulatory framework, particularly one which leaves many areas unclear, can be a limiting factor for access to agricultural finance. Reviewing, interpreting, and assessing implications of regulatory framework changes are time-consuming processes for organisations originating new products. Fear of regulatory risks, especially those that might not be fully appreciated at the time of product launch, can stifle product innovation or even stop new initiatives before they get off the ground.

Before financial inclusion players consider rural expansion, it is important to complete a thorough internal diagnostic and ensure that strong, transparent operating processes and management information systems (MIS) are in place. Operating policies, MIS, and business processes should be reviewed for gaps in proper controls, monitoring ability and oversight, costs and efficiencies. If these issues are not addressed prior to expansion, the MFI risks being swamped in uncontrolled transactions.

A technical assistance intervention should not be an isolated operation and should be embedded in a wider institutional perspective or strategic plan. Because it is more difficult to build a rural portfolio than an urban one, MFIs with a rural focus need management that firmly believes in that market and is willing to invest in learning. A new agricultural loan product needs not only solid support from top management, but also from loan officers, who are closer to the clients and realities of daily operations. Hence, any new product development should incorporate feedback from both head office staff and field staff. Lastly, failure is likely if a small team is appointed to develop an agriculture loan without having much influence across the organisation.

To embed an understanding of the local reality in product design, it is critical to spend time at the branch and client/farmer level. This allows for a better understanding of client needs and daily challenges faced by loan officers, which are all critical to product design, particularly when targeting rural communities. Agronomists can provide significant insight when introducing agricultural lending and can help avoid costly mistakes related to technical and practical risks inherent to specific crops or value chains.

Product design is a slow but crucial process, which is why timing for development and implementation cannot be taken lightly. A customer-centric design approach with a deep understanding of the value chains can ensure products are appropriate to local context and farming realities. Thus, starting a pilot and disbursing sufficient loans to make decisions for further implementation is a multi-month effort from market study and client assessment to prototype development and pilot testing. Planning and implementation should begin at least four months before the start of a pilot test, and will need to be aligned with seasonal cycles for agricultural production in a given area.

Interesting lessons can also be drawn from the existing client base. There is potential to green agriculture through financing of equipment in partnerships between financial institutions and equipment suppliers. Such financial products provide, for example, access to packaging and storage equipment with the potential to reduce post-harvest losses.

The use of digital financial services and data can be an integral part of the product design phase. Electronic loan appraisal enables financial institutions to make the appraisal processes uniform, incorporate the assessment of good agricultural practices, and provide them with a wealth of data that can be used to improve their appraisal process in future. Going a step further, loan disbursements and repayments can be done through the use of mobile phones.

The Sustainable Agricultural Finance Expansion Programme shows what it takes to deal with both smallholder inclusion and environmental sustainability. But it also shows that there is still a long way to go for the MFI sector to truly become a key player in shaping our future food system. Hivos, Enclude and Triodos Investment Management are committed to continuing to work towards the further greening of the sector by building on the experiences of the Sustainable Agricultural Finance Expansion Programme.

This excerpt comes from Enclude’s report on The Sustainable Agricultural Finance Expansion Programme.  Read the rest of the report and the six case studies included here.

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