Innovative Financial Models

When structuring smallholder-inclusive value chains, the pressing need for farmers (especially smallholder farmers) to sell at harvest time for cash income contrasts with buyers’ need for steady and reliable supply. While large-scale end-users can structure long-term supply arrangements because they have easier access to working capital, smaller-scale buyers face acute liquidity constraints. Farmers also face considerable difficulty in obtaining production finance, for instance to procure productivity-enhancing inputs, hence hampering output growth and increase in farm productivity. In this research we explored how use market-institutions, such as the warehouse receipt systems (WRS), can boost trade between farmers and multiple nonspecific buyers, including traders of all size, processors and exporters. By facilitating inventory-backed financing, the WRS can make initial bulking of commodities possible, without compelling depositors (farmers or traders) to achieve household or firm-level liquidity only through cash sales. In the research, we also explored how producer organisations, which use the WRS, are able to establish track records and funded guarantees with financial institutions, thereby making it relatively easier for farmers to obtain production finance. 

This study aimed at fostering shared learning among farmers’ organisations on innovative and replicable institutional arrangements and policies which can improve access to finance for smallholder farmers and traders. It specifically included reviewing successful financial models and identifying best principles or practices in the development and operation of these models. The study pays particular attention to understanding the context in which the innovative financial models have worked in developing countries and the role of producers’ organisations in promoting them.

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A methodology for the study has been developed. A key element of the methodology is the adoption of the value chain analysis framework in identifying points in agricultural value chains where different types and modalities of finance are required to take advantage of market opportunities (both pre- and post-harvest). The following comparative framework will, therefore, guide the value chains studied: major players and types of financing they require; nature of financing constraints the players face and the underlying factors that hinder supply of finance; description of innovative financial models; and review of the performance of the innovative financial models in terms of volume of finance provided, outreach to smallholder farmers and other players with whom they transact in the value chain, and sustainability of the model.

Brief questionnaires reflecting the issues to be reviewed were circulated to members of IFAP in September 2010. The aim of this process, which was co-ordinated by IFAP, was to engage farmers’ organisations in the process of identifying the innovative financial models; and to agree the definition of the performance criteria adopted in the study. It was expected that their initial involvement would encourage participation in validating preliminary outcomes of the study and embedding relevant recommendations on policy and institutional reforms in their advocacy programmes. This process was complemented by a desk review of relevant innovative models. However, collation of feedback from the farmers’ organisations has been constrained by the internal organisational difficulties faced by IFAP.

Lack of finance limits smallholders’ productivity and income growth

Access to finance remains a major challenge for smallholder farmers in most developing countries. The problem often is seen in terms of limited access to production credit to buy and use farm inputs as well as pay for non-family farm labour and other farm maintenance costs. Because smallholder farmers cannot afford yield-enhancing inputs, farm productivity often remains low on smallholder farms despite available technology for achieving higher yields. However, smallholder farmers also face major difficulty in accessing post-harvest credit, leading to severe household liquidity constraints which often compel them to sell the bulk of their produce at harvest when prices are extremely low. Financial constraints also prevent them to condition produce to meet quality requirements in premium markets. This way they miss out on opportunities for higher household income. Furthermore, smallholders have limited access to formal savings facilities because there are few financial institutions that provide such services in rural communities. Consequently, smallholders tend to hold their wealth in non-liquid assets (e.g. livestock and household goods), risking loss through theft, fire or other perils. Insurance and price hedging instruments are almost non-existent because markets for these are missing or severely under-developed.

This brief ESFIM Financial Innovations Policy Brief – reviews some of the advances being made in developing countries to address financing constraints in the rural/agricultural sector by identifying financial models that improve access to financial services to smallholders. It focuses particularly on sustainable models that are embedded in enduring transaction-based relations in agricultural value chains.