Implications and Perspectives for Agricultural Finance

Towards a Hybrid Model of Agricultural Microfinance

A hybrid model – or rather models – of agricultural microfinance has been emerging that combines and incorporates lessons learned from traditional agricultural finance, especially from successful agricultural lending institutions, from microfinance, from the financial systems approach in general, and from recent experience with innovative insurance instruments. Christen and Pearce (2005) have presented ten key features of such a hybrid model (see Appendix 1), much in line with the new paradigm of rural finance.

Some of these features are directly related to credit risk and risk management, for example, the principle that repayments are not linked to loan use (feature 1) and the character-based lending technology combined with technical analysis (feature 2). The model suggests to provide savings services (feature 3) that enables precautionary savings as an important coping mechanism for farmers. Portfolio diversification is a key element (feature 4) and when loan terms and conditions are adjusted to accommodate cyclical cash flows (feature 5) the risk of non-repayment is lowered considerably.

Such hybrid models will expand the frontier of outreach specifically to small farmers in distant rural areas, and will help to manage and mitigate much of the principal and some of the specific credit risks. As such, the models cater to the vast majority of farmers in most countries but they are less applicable to large farms and agricultural enterprises. Moreover, as the models seek to incorporate innovative market instruments such as index-based microinsurance (feature 9) – though still being under development – or contractual arrangements to reduce price risk (feature 6) they offer the potential of controlling and managing also the specific risks of agricultural finance, at least to the extent that such risks are insurable. Certainly, managing catastrophic risk (market failure layer) will remain outside of the scope of such model.

Furthermore, these models serve to reduce the cost of rural and agricultural lending. For example, recently developed models of mobile and branchless banking may provide cost-efficient solutions to reach out to farmers in remote rural areas (feature 7).

Innovative Insurance Instruments Need Further Study and Development

While initial experience with index-based insurance pilot projects seems to be very promising, further research and monitoring of these initiatives needs to be done to enable conclusions to be drawn about their sustainability, financial viability, and implementation on a larger scale. At the same time, advances in technology, e.g. the use of satellite images, will lead to a better availability of data needed to properly calculate and offer index-based insurance policies (Levin and Reinhard, 2007). While the first pilot projects focus purely on the protection of small farmers affected by negative weather events, index-based insurance products are also attractive to agribusiness intermediaries along the value chain, such as input suppliers, processors and traders whose business operations are correlated with agricultural products. A collaboration with (re-)insurance companies can foster the development of yield-insurance products that are inexpensive, sustainable, and appropriately designed.

 
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