The challenge of smallholder farmer financial exclusion
Low productivity in agriculture globally is largely related to smallholder farmers’ lack of capital and access to affordable credit. The unmet demand for smallholder finance is tremendous: the short- and long-term credit gap for farmers in developing countries is estimated at about $170 billion per year (ISF, 2019). Smallholder farmers are often at the bottom of the economic pyramid, yet they are most likely to need access to financial services. Access to finance can drive food security, improve the lives of farmers, who depend on the agricultural sector for their livelihoods; and spur the growth of the rural, and in turn, the national economy.
They are unable to attain a loan and other financial services for many reasons; they lack credit history, have little to no contact with formal financial institutions, low rates of digital and financial literacy and, in general, because of the perceived high risk of lending to the agricultural sector. Their inability to gain a financial track record creates a cycle of exclusion. Without a financial track record, smallholder farmers are often excluded from formal financial services. Meaning they do not have access to lower interest rates on loans, or trading on a larger scale with formal buyers, such as agribusinesses and cooperatives.
Whereas moving from an informal value chain to a more formally organized one, smallholders’ benefits extend beyond access to finance and markets. Operating in formalized and digitalized value chains is more efficient, reducing for example the risks of fraud for crop buyers and sellers, and improving traceability for certification requirements.
Partnerships benefit to the whole value chain
This cycle of financial exclusion can be broken by new partnerships between agribusinesses and financial institutions. Partnerships can enable sharing of information, distribution channels and risks. By sharing select data, different value chain actors gain a more holistic understanding of different financial need and potential services to offer smallholder farmers.
Each value chain player brings unique strengths to the partnership:
- Agribusinesses bring greater smallholder knowledge and better service distribution channels to new partnerships.
- Banks can bring a wider set of financial services for smallholder families through new partnerships.
- Mobile Network Operators (MNOs), fintechs, card payment companies, FMCG companies, and e-commerce firms can bring customer acquisition, product development, and agent network management expertise to viably serve rural areas and smallholder families.
A pilot partnership model in Kenya
In 2021, IDH Farmfit, in collaboration with the Office of the UNSGSA’s Agricultural Finance Working Group, will launch a pilot in agricultural finance making it possible to offer new financing options to smallholder farmers in Kenya. This builds off the recent action paper we developed together with the UNGSA: Sowing the seeds of innovation for smallholder finance.
About 70 percent of the marketed agricultural production in Kenya is produced by smallholder farmers, of which only 10 to 20 percent are part of formal value chains. This leaves a huge potential in the country to formalize and digitalize the value chain and increase agricultural production.
The pilot partnership will bring together agribusinesses, banks and fintechs on a digital platform to share anonymized data, which allows them to design better services and more accurately estimate risks. The platform offers unique benefits to each value chain player:
- Transactions and interactions between agribusinesses and farmers are digitized on the platform, making operations more efficient. The platform allows traders to organize, communicate, advice, buy, and pay farmers. In addition to being more efficient, the data collected gives valuable insights. For example, traders can more easily identify what services farmers need to reduce their production risk.
- Banks receive basic farmer profiles (KYC), loan amount, interest rate indication, prescription of services. This includes information on what services and how frequently they are needed to lower the farmer repayment risk, making it easier for banks to lend to farmers. Moreover, the platform enables banks to collaborate with input providers in order to offer inputs on credit rather than through cash loans. The amount can be deducted directly from traders’ purchases of farmers’ produce.
- MNOs can take advantage of their agent network and rural penetration to make payments to farmers for trader’s purchase on the platform. Also, other FSPs (Financial Service Providers) can cross sell insurance products or savings products.
Watch the video below to learn more about the Kenya Pilot. And for more exciting examples of partnerships also download our Action Report on innovations for smallholder finance here.