Risk management

Agriculture is saddled with a lot of risks, and these risks also present financing opportunities for financial institutions. Some of the risks faced by farmers arise from unpredictable weather leading to floods or droughts, pest and disease outbreaks, price volatility, long gestation periods, impeded access to credit, and inputs and markets. An innovative approach to financing agricultural risk is to incorporate insurance into a credit scheme. For example, NMB Bank Tanzania and Basix in India make life insurance a compulsory component of their loans (IFC, 2012). This way, one of the risk components that could cause the farmer to default on the loan is taken care of. Examples of innovative risk management financing instruments are presented in the following subsections.

INSURANCE INSTRUMENTS Some examples are credit-weather insurance, credit-health insurance, production insurance, and index-based insurance products; because of the seeming reluctance of individual insurance companies to invest in agriculture, there is the need to create a platform that pools a number of insurance companies to design innovative insurance packages for the sector. This reluctance to insure agriculture production may be due to a lack of expertise to understand the peculiarities of the sector, inadequate funds, and a lack of innovation. When several insurance companies come together, these challenges are ameliorated, enabling them to design customized insurance products for various clients in the sector. The Ghana Agricultural Insurance Pool (GAIP) is one initiative that could be replicated in other African countries. It is made of 19 insurance companies that pool their funds and expertise to develop various agricultural insurance products for the Ghanaian market. The following are some of the innovative agricultural products provided by GAIP:

  • • Drought index insurance - this product is designed specifically for small-scale farmers who are many and scattered throughout the country. This insurance package covers the three phases of plant growth - that is, germination, vegetative growth, and flowering/maturity. Payout is based on validated weather reading from a ground weather station or satellite. This type of insurance is suitable for crops such as maize, millet, groundnut, sorghum, and vegetables.
  • • Area yield insurance - claims are paid to the insured farmers when their yield falls below the average yield in a defined geographical area, such as the district where the farm is located. Although the product can be applied to various categories of crops, it is most suitable for cocoa cooperatives and cocoa commercial farmers.
  • • Multi-peril crop insurance - this package is designed for commercial farmers and investors in the agricultural value chain, such as aggregators, banks, off-takers, input dealers, and processors. A key qualifying criterion is that the product be designed for a minimum farm size of 50 acres. This package allows a client to insure against as many hazards as deemed appropriate.
  • • Poultry insurance - this package is designed for a wide range of domestic and foreign poultry, including chicken, turkey, guinea fowl, and duck reared intensively. Some of the perils insured against include diseases (with the exception of avian influenza), pests, flooding, thunder damages, and theft.

MARKET-BASED INSTRUMENTS Market-based price risk management products such as forwards, futures, options contracts, and exchange-traded swaps can be deployed to manage different kinds of risk in agriculture. Emerging economies like Brazil, Argentina, China, India, and South Africa have markets that help manage price risk for players in agriculture. The Bagsa Agricultural Commodity Exchange in Nicaragua facilitates bilateral cash and forwards contracts in the agriculture sector as well as auction services. Bagsa has about 180 shareholders and 36 brokers. The total value traded on the exchange in 2013 alone amounted to USD720 million.6 Some of the commodities traded on the exchange include live cattle, meat, milk products, paddy rice, beans, and coffee.

Financing agriculture through savings

Agricultural firms and households stand to benefit greatly from massive savings mobilization drives. According to Hollinger (2011), savings enable individuals and firms to self-insure and to build capital for investment in business activities, education, health, and asset building. In addition, savings assuage the collateral burden by increasing savers' access to collateral in the form of built assets (assets and properties acquired through savings) and accumulated capital: the amount saved can serve as collateral for a loan (Brune, Gine, Goldberg, & Yang, 2015; Schaner, 2015). Savings can be promoted at the individual level or group level.

Individual savings products entail normal savings products, no-frills savings accounts, and subsidized savings accounts. The normal savings accounts provided by banks and allied financial institutions often require a minimum balance in accounts at all times and impose limits on withdrawals. In some cases, the interest paid on such accounts is minimal. This often makes such savings products unattractive to farmers. This is where no-frills accounts come in. No-frills accounts, also known as zero balance accounts, waive minimum balance requirements on savings accounts. Also, the cost charged per transaction on no-frills accounts is lower than the per unit transaction cost of conventional savings accounts. The promotion of no-frill accounts should enable a large number of the unbanked to be roped into the formal financial system. In cases where no-frills accounts products are not available, savings accounts could be subsidized such that government or an enabling institution bears the cost of minimum balance requirements and other bank charges for farmers. This should reduce the cost of saving for farm households.

The available empirical evidence on the benefits of individual savings in the agricultural sector is encouraging. In a study conducted in Kenya on 779 couples who opened bank accounts in 2009, Schaner (2015) examined the impact of subsidized savings in the form of removing the minimum savings balance and making temporary interest payments to account holders. The findings revealed that the savings subsidy enhanced account penetration while increasing the income of beneficiaries. Men who received higher subsidies reported higher incomes, asset ownership, and entrepreneurial activity two and half years after the intervention. Similar benefits were not reported for women. Using data collected in the Tanzania National Panel Survey (TZNPS), Bandara, Dehejia, and Lavie (2014) reveal that bank account ownership by a household is linked with a reduction of eight to ten child labour hours per month.

Group savings products are suitable for societies where cooperation and social bonds are valued and encouraged. This is usually so in the rural areas of developing countries. The limited availability of formal savings products in agriculture and rural areas has popularised group savings mechanisms such as village savings and loan associations (VSLAs) or rotating credit and savings associations (ROSCAs). A typical VSLA comprises a group of 15 to 25 self-selected individuals who bring their savings together and issue small loans to members on the basis of the savings. The activities of the group run in cycles of one year, after which the savings and profits realized from the small loans are distributed back to members.7 In a typical ROSCA, members pool their savings into a common fund, usually on a monthly basis, such that at the beginning of each cycle, a single member withdraws a lump sum. Each member takes their turn to withdraw a lump sum. This system of continuous contribution and rotation of funds continues for as long as the group survives.8

The empirical evidence shows positive effects of group savings schemes. In a randomized impact evaluation of VSLA establishments in 80 villages in Burundi, Annan, Armstrong, and Bundervoet (2013) found that while the incidence of poverty increased by 10% among households in control villages, it reduced by 14% among treatment households. A similar impact evaluation of ROSCAs in Mali revealed that participating households experienced a reduction in poverty and food insecurity (BARA & IPA, 2013).

Financing agriculture through foreign direct investment (FDI)

The insufficiency of savings and other domestic financing sources to satisfy the funding needs of agriculture in developing countries mean that they will have to look elsewhere to fill this gap. FDI is one source of capital inflow that can help bridge the funding gap in agriculture. To attract more FDI to the agriculture sector, developing countries must understand the factors that drive FDI flows to the sector. The literature shows that factors that draw FDI to the agricultural sector include the size of the economy (the larger the better), trade openness (the more open the better), infrastructure (the more endowed the better), forest land share (the larger the better), size of agricultural market (the larger the better), agriculture value added (the larger the better), and poverty (the lower the better) (Farr, 2017; Abdul Rashid, Abu Bakar, & Abdul Razak, 2016).

Agricultural sectors in developing countries stand to benefit a lot from FDI. Some of the benefits of FDI have been discussed extensively in the literature. FDI increases agricultural production, productivity, employment; lowers prices (Gerlach & Liu, 2010); and has positive technological spillover effects (Tondl & Fornero, 2010). Chaudhuri and Banerjee (2010) found that FDI in agricultural land improves welfare and also reduces unemployment among both skilled labour and unskilled labour.

However, the benefits of FDI must be counterbalanced against the negatives. FDI can hurt the health of households and degrade and pollute the environment (Ben Slimane, Huchet-Bourdon, & Zitouna, 2016). Of recent interest is FDI in agricultural lands, a phenomenon called land grabbing. So far, the literature on the impact of FDI in agricultural land on food security is scanty and controversial. In a qualitative study in Africa, Cotula,

Vermeulen, Leonard, and Keeley (2009) concluded that foreign investors in agricultural land are simply land 'grabbers' that hinder local development and increase food insecurity by exploiting water resources and using certain fertilizers and other chemicals which are harmful to the environment. On the contrary, Sliman et al. (2016) found that agricultural FDI leads to improvements in food security. The authors, however, found that FDI in the secondary and tertiary sectors leads to food insecurity. Santangelo (2018) has advocated an analysis of the impact of land grabbing in developing countries on the basis of the origin of FDI inflows. On the one hand, the author found that FDI in land from developed country investors in addition to positive spillovers enhances food security by increasing land used for crop production due to home institutional pressure for the respect of human rights and responsible farming practices. On the other hand, FDI in land from developing country investors, in addition to negative spillovers, leads to food insecurity by displacing farmlands owing to home-country institutional pressure to align with 'national interests' and 'government objectives'.

Digital financial and agricultural development

Conventional financing mechanisms have not been able to satisfy the financing needs of agriculture, particularly the needs of smallholder farmers. Indeed, access to finance has become a common and intractable problem in developing country agriculture. Meanwhile, 80% of the world's population is fed by smallholder farmers who total about 1.5 billion people (USAID, 2016). Again, smallholder farmers form the largest proportion of the world's poor who live on less than USD2 a day (Grossman & Tarazi, 2014). The financing shortfall among smallholder farmers is estimated to be USD430 billion to USD440 billion (USAID, 2016). Thus, smallholder farmers are by far the group that needs financial inclusion the most, but unfortunately, they are also among the most difficult to reach. The potentials of digital financial services (DFS) can be harnessed to jumpstart financial inclusion among all categories of farmers and those who are hard to reach in general.

DFS refers to gaining access to or using financial services and products through digital channels such as mobile phones, tablets, computers, point-of-sale devices, and electronic cards (debit cards, credit cards, and key fobs). Digital financial instruments can be used to access credit, subscribe to insurance, transfer money, make purchases, access information without the need for face-to-face contact with the parties in the transaction, unlike conventional brick and mortar banking. According to the World Development Report 2016, digital finance can be harnessed to promote financial inclusion, increase the efficiency of financial service delivery, and drive financial innovation. Digital payments (e.g. mobile payments) can break access barriers and bring financial services to the doorsteps of the poor. Digital finance lowers the cost of financial transactions and the delivery cost of financial services. This is because digital finance allows for the unbundling of financial services and products and enables the automation of financial service delivery at any scale: small, medium, and large. Digital finance offers limitless possibilities for financial innovation. These innovations can range from process automation to the development of new and customized products and services at a reduced cost in an efficient manner.

USAID (2016) outlines some roadblocks in smallholder agriculture and indicates how financial digitization can remove them. These roadblocks include difficulty in getting the right financial products for smallholder farmers, the low competitiveness of smallholders in agriculture value chains, women's lack of a voice in decision-making in agriculture, poor post-harvest management and inability to speculate for higher prices for products, low savings capacity, difficulties in managing weather risks, and high cost of inputs. Digital financial services can be used to remove these roadblocks by reducing the cost of delivering financial services, reducing price opacity, encouraging inventory-based credit, reducing risk in the delivery of financial services and increasing access of the poor, including women, to a wide range of financial services, such as credit, savings, crop insurance, weather insurance, and payments.

There are four main innovations in digital finance (Bank of England, 2014):

  • 1 Wrappers provide a digital interface with a bank account or credit card. With the help of wrappers, one can receive SMS alerts when a transaction is done with a bank account by use of either cheque or credit card.
  • 2 Mobile money systems store mostly local currency as a credit on the smart card or in the books of the service provider and enable transactions online or through a mobile phone. Mobile money services, especially those mediated by mobile phones, have become popular among the unbanked and underbanked in Africa. Various telecommunication companies have rolled out mobile money services to help the poor gain access to financial services - speedily, at reduced cost, and at greater convenience. Farmers are able to make and receive payments through their mobile phones. This means they can easily sell farm products and access farm inputs. Farmers can also purchase investment products, save money, and access funds via their mobile phones. Increasingly, mobile money services are being linked to the formal financial system, such that it is now possible to transfer money from a bank account to a mobile money wallet and vice versa. Some common mobile money services include M-Pesa, MTN mobile money, TigoCash, and Airtel money.
  • 3 Credits and local digital currencies are alternative units of account denominated in foreign currency aimed at promoting spending in a local economy or as a way of exchanging game proceeds.
  • 4 Digital currency is a new type of currency that is available only in digital form and not in physical paper currency or coin currency form. Digital currencies can be transferred only electronically. Many countries are still sceptical about the use of digital currency.

Some recent empirical studies have provided support for the importance of mobile technology and digital financial services in promoting agricultural development. Information and communications technology (ICT) has been found to boost extension services delivery (Fu & Akter, 2016), agribusiness (Tadesse & Bahiigwa, 2015), land management (Jordan, Eudoxie, Maha- raj, Belfon, & Bernard, 2016), and productivity (Issahaku, Abu, & Nkegbe, 2017). In particular, Issahaku et al. (2017) showed that mobile phone use increased the productivity of maize farmers by at least 261.20 kg/ha per production season. The authors found that mobile phone use affected productivity through three main channels: extension services, the adoption of modern technology, and market participation.

Already, there are success stories about the application of digital financial services to promote agricultural development along agricultural value chains. For instance, USAID's/Ghana's Agricultural Development and Value Chain Enhancement (ADVANCE) II project is using a digital financial system (mainly mobile phone mediated) to establish and strengthen linkages among smallholder farmers, markets, finance, large-scale farmers, traders, and input and equipment suppliers. Under ADVANCE II, farmers receive payments for their harvest via mobile money; the capacities of mobile money agents have been built to serve farmers well; farmers are encouraged to save. The government of Nigeria implemented a pilot programme, an e-voucher system, for the distribution of fertilizer subsidies in 2011. By 2013, the system was scaled up to the entire country and served over 4.3 million small-scale famers. Under this system, each farmer had a mobile phone e-wallet with a unique personal identification number (PIN) to access fertilizer subsidies. This has drastically reduced corruption in the distribution of subsidized fertilizer in Nigeria (USAID, 2016).

 
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