Investors' Channels to Finance Agriculture

From the investor perspective, there are three ways of financing agricultural activities.[1] Firstly, direct financing of agricultural producers, for example via agricultural investment funds that target farms directly.[2] Secondly and most obvious, indirect financing through rural financial institutions, and, thirdly, using nonfinancial intermediaries such as traders or processors as financiers. The involvement of processors or wholesalers in the process of providing finance is particularly common in approaches described as “value chain finance”.[3]

Agricultural Value Chain Finance

Value chain and value chain finance have a range of meanings and connotations, and seem to be an evolving terms. Value chain in agriculture can be defined as a set of actors who conduct a linked sequence of value-adding activities starting from the agricultural producer or produce to processing and to the final consumer or product.

Agricultural value chain finance comprises the financial flows to these different actors from within the chain (internal finance) and from outside institutions (outside finance) as a result of their being a member of the value chain.[4] The importance of value chains in agriculture and its financing mechanisms has grown in many developing and transition countries as a result of globalization and the integration of local and regional markets into global agri-business value chains.

For the small farmer, value chain finance offers a mechanism to obtain financing that may otherwise not be available due to a lack of traditional collateral and high transaction cost of securing a loan.[5] This can be achieved either through members of the value chain, such as suppliers and traders, who are less confronted with information asymmetries and transaction cost compared to financial institutions (internal finance). Or it can be achieved by outsiders like banks that substitute traditional collateral and screening techniques for the strength and reputation of the strongest partners in the value chain and for predictable cash-flows due to secure markets in organised value chains. Therefore, agricultural value chain finance offers the principal opportunity to reduce cost and risk in agricultural finance, thus increasing access of small farmers to credit.[6]

There are different classifications of value chain finance mechanisms in agriculture ranging from very old and traditional instruments like trader and supplier credit to more complex products such as factoring or warehouse receipt finance. Some authors see a close relation between agricultural value chain finance and SF,[7] and indeed some mechanisms used in agricultural value chain finance apply elements of SF according to our definition above: “The main purpose [of agricultural value chain finance] is sharing risks among various actors, transferring defined risks to those parties that are best equipped to manage them, and as far as possible, reducing costs through direct linkages and payments.”[8] Additionally, warehouse receipts – collateral substitutes used in warehouse receipt finance schemes – can be pooled and securitized in future-flow securitizations.[9]

We will describe and assess some of these instruments with elements of SF in the next section.

  • [1] Please note that we focus on formal financial services. Provision of capital by family or money lenders is widely used in rural economies in developing countries, but is not discussed here. Also, internal and self-financing – the financing by the cash-generating capacity of the enterprise or by the entrepreneur him-/herself – are not discussed.
  • [2] Typically this requires financing volumes of significant size, i.e. investments of smallholders will not be financed directly by outside investors. An example for this approach is the African Agriculture Fund. The minimum investment by the AAF is USD five million. See phatisa.com/The_Fund_Manager/AAF/.
  • [3] For value chain finance see the chapter by Swinnen and Maertens (2013) in this volume and in the following chapter of this article.
  • [4] Compare Miller and Jones (2010), p. 9. Although rarely made explicit in the analysis and discussions of value chain development and value chain finance, authors typically refer to organized value chains, i.e. such value chains that are characterized by a specific and defined governance structure, typically arranged and structured via a set of longer-term contracts in order to facilitate the exchange process in the market. Such structure for the exchange of goods along a value chain is somehow the middle alternative in the span between a goods exchange in pure spot markets on the one end, and a vertically integrated firm on the other.
  • [5] Though empirical evidence on how much small farmers have benefited from agricultural value chains is mixed. See Swinnen and Maertens (2012), in this volume.
  • [6] However, successful agricultural value chain finance needs some minimum enabling environment, e.g. quality standards, effective contract enforcement to avoid the common problem of side selling and other forms of contract breaking as well as regulatory and legal provisions in the banking sector to allow traditional collateral substitutes. These framework conditions are not always in place.
  • [7] For example, Winn, et al. (2009) and Miller and Jones (2010).
  • [8] Miller and Jones (2010), p. 15.
  • [9] See Ananth and Sahasranaman (2011), p. 114.
 
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