Managing risks and designing products for agricultural microfinance: features of an emerging model

 

Consultative Group to Assist the Poor

Occasional Paper No.11

Drawing on a few significant, successful experiences in various developing countries, this paper from the Consultative Group to Assist the Poor (CGAP) offers a model, termed "agricultural microfinance", for providing financial services to poor, rural farming households.

CGAP is a consortium of 33 development agencies that support microfinance, and it has backed the research that lies behind this publication because agriculture is widely considered more risky than industry or trade. Thus, says CGAP in an introduction, it is not surprising that agricultural lending projects have had poor repayment performance. Weather, pests, diseases and other calamities affect the yield of crops, and do so substantially in extreme cases.

The authors, Robert Peck Christen and Douglas Pearce of the UK Department for International Development, explain that poverty is predominately a rural phenomenon, and that in developing countries large proportions of the population remain involved in agriculture; it still exceeds 50% in Africa and Asia.

Over the past 40 years, say the authors, billions of dollars have been provided to support agricultural production and the green revolution. However, poor loan repayment rates and unsustainable subsidies have long characterised this financing. Accordingly, agricultural credit from some donors and multilateral development banks has dropped dramatically in recent decades and is now often considered too risky. Microfinance institutions have generally managed default risk very well, while traditional agriculture lenders have developed products that respond well to the cash flow cycles and marketing relationships of farming communities. However, the paper explains, it is important to remember that for many small farmers their main source of credit is not a bank or even a microfinance institution, but agribusiness actors, such as sellers of seed or fertiliser, as well as traders and processors.

The authors provide stories of how circumstances can affect poor farmers. For example, often, a good price one year motivates a lot of farmers to move into the same crop the next year. This shift increases production in the face of constant demand, and drives down the price and makes the crop much less attractive the following year. This happened in Uganda, when a bumper maize harvest in late 2001 and early 2002 caused maize prices (and farmer incomes) to fall. Other stories range from maize growers in Ghana to coffee farmers in Vietnam.

Drawing on a few significant, successful experiences in various developing countries, the paper outlines a model of agricultural microfinance as providing financial services to poor, rural farming households. It combines the most relevant and promising features of traditional microfinance, traditional agricultural finance, and other approaches, into a hybrid model defined by 10 main features.

Each feature is outlined but the paper does not suggest that to be successful in agricultural microfinance all 10 should be present, just that a substantial number of them seem to contribute to a well performing portfolio, in diverse combinations, in a variety of circumstances.

The authors discuss each feature of the proposed agricultural microfinance model, outline the key elements and describe the many challenges that remain to be addressed. Christen and Pearce admit that, measured in terms of long term financial sustainability and high repayment rates, success remains somewhat rare. They conclude, "Clearly, success in agricultural microfinance is harder than in general microfinance." To face this difficulty, the paper aims to provide practitioners, policymakers and donors with a thorough overview of agricultural microfinance. It is hoped that they will use this information to expand the access of farming-dependent households to sustainable financial services on a massive scale.

 

Managing risks and designing products for agricultural microfinance is available from www.cgap.org/publications/occasional_papers.html.