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2.3 Value Chain Financing, Borrowing from Private Sector Financial Services to Small and Medium Farmers

Brief Definition of Agricultural Value Chains and Value Chain Financing

A value chain encompasses the full range of activities and services required to bring a product or a service from its conception to its end use. It involves the sequence of productive (i.e. value added) activities leading to and supporting final use. Hence, the term from “farm to fork” for agro-food value chains.[1]

However, all the value chains are not well organized or structured. The landscape goes from a very loosely structured value chain where there is a multitude of small buyers serving a large number of markets, which is often the case for food crops serving domestic markets, to contract farming where a large, often multinational, firm is dominating and vertically integrating the whole process downstream, usually for an export market. There is also a variety of intermediary situations in between.

There are short value chains where little value has been added from producers to consumers and longer value chains involving different levels of processing, conditioning, and distribution. Generally, the latter are those that are the most profitable and therefore the most promising to finance.

However, experience show that there are loopholes in all categories as behaviors condition the stability of relations between buyers and sellers. Ultimately, what really matters in a value chain is the width of the demand/market and the relative weigh of suppliers that will lead to a balanced negotiation and an overall win-win situation for both parties. The strength of a value chain resides in the sustainability of the relation between actors involved and a fair distribution of profit along the value chain. This is why a good analysis of value chains in a given market is essential to success in value chain financing. No financial intermediaries should enter this business unless they have done this exercise thoroughly and with the appropriate expertise.

The new approach that could be observed recently on the ground in developing countries is “value chain financing” (VCF) or using value chains as an approach to financing agriculture in an innovative and more secure way. A “value chain approach” means a form of financing that emphasizes the funding of actors that are connected among them and that are connected to the market. The links and securing the market outlet are the most important factors for success and loan repayment. Ultimately, the strategy in VCF is to ensure finance along the value chain in a continuum, and secure the outcome. This financial continuum could be provided by one player, i.e. a bank or an agribusiness company, especially in the case of an integrated value chain, but could also be developed in a partnership between different financial intermediaries which may complement one another in skills and in products.

Box 2: Case in Fair Trade: The Experience of Starbucks[2] in Chiapas (Mexico)

Starbucks is aiming to have a sustainable supply of high-quality coffee by investing in the future of the coffee farmers and their communities in Chiapas through alternative loan programs and biodiversity conservation.

Farmers have access to loans that the commercial or traditional lending sector is unable to serve. During growing and harvest cycles, many coffee farmers dip into their modest reserves to cover expenses until they can sell their crops. Some farmers may even experience a cash shortage, prompting them to sell their crops early—and for less—to local buyers. Alternatively, farmers will sometimes borrow money at exorbitant interest rates until they can sell their crops. This cuts into their profits and sets up a similar scenario for the next year.

Starbucks provides funding to organizations that make loans to coffee growers, which will help them sell their crops at the best time to get the right price. The loans also help farmers to invest in their farms and make capital improvements. Starbucks provided with a US $4.5 million loan to Verde Ventures to increase access to financial services to around 380 small-scale coffee producers in Chiapas. Most of these resources were made available in a three-year rotating fund to pre-finance or provide working capital for C.A.F.E. Practices and Conservation Coffee farms in Chiapas, with a loan-loss guarantee for 70 percent from the Starbucks Coffee Company. Loans are made against coffee contracts with Starbucks and require a 6 to 7 percent savings by the cooperatives.

In addition, to improved on-farm productivity, more than 5,000 hectares of on-farm forested land was set aside for permanent protection. These set-asides lands contribute to the restoration of El Triunfo biosphere reserve's 121,000 hectares of buffer zone, and the price benefits and debt reduction of the program will impact more than thousand people.

Role and Positioning of Financial Institutions

The main lessons to draw from field experiences are the following:

Value chain financing works best when a tripartite arrangement, involving the farmers or farmers groups, the buyer/processor/distribution company and the bank in performing as contractually planned to assure the outcome of the operation, can be put in place. The contractual relations between the three players are the major substitute to formal guarantee. They are stronger when all parties have a long term market stake for which they are willing to sacrifice potential short term gains.

Fig. 1. Tripatite arrangements

In value chain financing, a financial continuum is often needed, both for operational considerations such as service delivery and repayment collection to farmers' door step where decentralized MFIs have their comparative advantage and for funding since different products and terms are needed when various actors/activities of a chain should be considered for financing.

The New Agricultural and Rural Finance Paradigm

This new paradigm is the result of a positive combination of lessons learned from the causes of failures from old agricultural finance, application of microfinance best practises for rural households who have diversified their income sources, and the new opportunities provided by market-driven agricultural value chains.

It is about provision of a large range of financial products and services to different segments of the rural markets designed with specific clientele to fit their needs and constraints, including savings, credit, insurance, transfer, and payments. These products and services are provided in such a way that they can fit into a personal financial management strategy and enhance autonomy and empowerment of the excluded. Access to non-financial services could either be delivered by a department of the financial intermediary or through linkages with private agricultural BDS provider.

Whenever an organized value chain could be identified, financing could be facilitated through a tripartite arrangement where contractual relations between the farmers, the buyer, and the financial institution serve as a substitute for formal collateral. Even in this case, cash flow analysis of the borrower should constitute the basis of setting installments so as to have borrowers be responsible for their debt and align repayment calendar with all possible incomes.

IT can be used to systematize to lower costs, secure operations, and innovate. Technology is certainly a very strong pillar of this new financing since it can lead to significant breakthroughs. Hence, it could be considered as inclusive, holistic, responsible, and sustainable.

  • [1] See also the contribution of Swinnen (2013) on value chains and value chain finance in this volume.
  • [2] Renée Chao-Beroff, “Starbucks, Fair Trade and Conservation Coffee in Chiapas”, case study in Incentives that work for enhancing public private partnership in Local Economic Development (UNCD, 2010).
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