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3 The (Potential) Contribution of the Financial Sector

As developed above, investments by different types of investors are relevant in order to fuel an efficient and food-loss minimising chain from pasture to plate: The state needs to invest in rural public infrastructure. Different economic sectors are involved in the post-harvest system, and different (private) actors operate in organised value chains. They all need access to finance in order to encourage rural investments in agriculture and beyond.

Why do banks and other financial institutions not finance these activities to the extent needed?

The state. In order to boost agricultural productivity and reduce post-harvest losses, the public sector needs to invest, first of all, in public transport infrastructure, mainly in the rural road network. Rail transport and sea ports are relevant for countries that export agricultural produce. For financing such expenditure, public finance typically uses its instruments such as taxes (as well as royalties, import and other duties) and borrowings.

We do not want to enter into the discussion of public finance here. However, we would like to point to the role of municipalities and other regional administrative levels. Not least driven by policies of decentralization, local authorities become a more important player in providing and maintaining local infrastructure like for instance rural roads. The public finance system does not always provide the necessary funding for the responsibilities transferred to the communities.

But apart from investing into classic public goods like rural roads according to their legal responsibilities, we see municipalities investing in specific commercial support facilities in order to strengthen local economic growth. Examples for such services are serviced market spaces, municipal storage facilities, and municipalityrun ferry-boats or river quays. For such income-generating activities, the outsourcing of services, concession models, or other forms of PPP may be a vehicle to mobilise private investment and engage the financial sector.

Primary agricultural production. Banking to farmers may be more difficult and complex than granting finance to other economic sectors, but there is no proof that agricultural finance is more risky than banking in others sectors.[1] Until the 1980s, the predominant approach in agricultural finance was the provision of farmer credit with subsidized interest rates, particularly via specific state programmes or state-owned agricultural banks. This approach has proven unsustainable and has regularly caused the contrary of what should have been achieved: They excluded rural poor from financial services, instead of making them sustainable and beneficial for all.[2] By now, it has become widely accepted that the approach of strengthening the financial system and promoting strong and efficient financial intermediaries with interest in rural clients will lead to higher-quality financial services for the poor and other previously excluded.[3]

For a couple of years, we have seen several examples of well-managed and strategically positioned financial institutions which service farmers in developing countries, including smallholders.[4] In particular, the financial institution's ability to perform a succinct but useful credit assessment of farming businesses with its peculiarities and an institutional ability to manage risk exposure concentrated in one sector with the agriculture-specific external risks (particularly weather, but also pests and market risks) have been critical for success.

Despite these successes, however, there is still a long way to go before service levels of the financial sector to the farming communities are satisfactory in terms of quality and quantity.

Agricultural service providers and traders. Agricultural service providers, like traders for input and machinery, commodity traders, or providers of ploughing or transport services are traditionally better served by banks, compared to the farmers themselves. Usually they are bigger in size (leading to economically more attractive, larger credit amounts); they are often more professionally run (decent bookkeeping for banks to analyse); they are often located in more urban settings (thus more easily accessible); and they often own – in contrast to farmers – easily sellable collateral (like cars, stock or urban real estate). These factors make it, in principle, easier for banks to serve these actors.

However, in terms of risk-management banks face a similar challenge with clients in agricultural processing and trade as they face with farmers. Both types of customers are exposed to same specific agricultural risks:[5] When draughts or pests lead to a reduction of produce quantity in a region, there is also less produce to be put into tins by processors and to be marketed by traders. Thus, financial institutions need to carefully assess and professionally manage co-variant risks characteristic for agricultural finance, including the different value chain actors, in order to allow for the full potential of finance provision for the sector. Most financial institutions are still far from such professional management of specific agricultural risks.[6]

The efficiency imperative. A core challenge of serving the agricultural sector and its related actors is the fact that the agricultural sector is essentially rural. Clients typically generate lower unit volumes compared to urban markets (both in credits and in savings), clients are more distant to physical branches, and branches are more distant to bank headquarters and to labour markets for qualified bank staff. These factors make service provision to rural areas more costly. Thus, in order to provide services to the countryside cost-effectively, banks need to be highly efficient. Discussions about cost efficiency in reaching the clients often focus on technological solutions, like cell-phone banking as has been mentioned before. But any technological approach needs to be embedded into a clear strategic view how to service rural markets, which may include a distinction between services than can be offered efficiently, and others that shouldn't be offered by the respective financial institution.[7] Product designs and of process organization need to fit to client needs in order to reach out into rural areas. Core strategic questions that

financial institutions need to answer are for instance: Which clients can we serve, and which may remain excluded from our service? Which products can gain enough scale in rural areas in order to be distributed efficiently? What degree of standardization and simplicity of products is adequate in rural areas so that less literate clients can still understand, and potentially less qualified bank staff can still explain to them? What is the best distribution approach for our products? Individual lending or group-based approaches where parts of the distribution costs are passed on to village groups?

In this context, cross-selling opportunities for financial institutions have a critical influence on the cost-income-ratio; the ability to use infrastructure (like branches, cash points, etc.) not only to extend credits, but also for savings services, money transfers and other services which can help banks to make best use of its infrastructure.[8] Thus, traditional, specialised agricultural banks, often providing only credit, are likely to be less cost-effective than full-service banks that provide a wider set of services to a wider range of customers, i.e. not only farmers but also other clients who live in the countryside.

We feel that many of (micro) finance institutions lack the necessary rigour in defining and designing their product offers and the corresponding process organization to provide services to rural communities with the outmost efficiency. Applying such rigour may result in painful choices, since it may well lead to consciously not meeting some demands on parts of the rural population. But the lack of efficiency in process organization is the main impediment to the rural penetration of financial services.

Fig 2. The re-enforcement potential between holistic rural finance, road infrastructure and the agricultural value chain

  • [1] ”No data have been found to confirm the argument that agricultural loans are more risky than others […]” Meyer (2011), p. 46.
  • [2] There are hundreds of studies on this subject. The first publication that contributed to an abolishment of the concept of subsidized and targeted credit for the promotion of ag ricultural production was United States Agency for International Development's 1973 ”Spring Review of Small Farmer Credit”. See USAID (1973). Another ground-breaking publication was Adams et al. (1984) with several important studies on the subject orchestrated by the Rural Finance Group in the Agricultural Economics Department at Ohio State University.
  • [3] As an overview for the transition from the old subsidized credit paradigm to the new financial system approach see Vogel (2006).
  • [4] Several of the originally urban-focused microfinance banks of the ProCredit network, as one example, have invested more than 15% percent of their credit portfolio in the agricultural sector (Ghana, Nicaragua, Ecuador, Ukraine, Serbia, Rumania). See the different banks' annual reports (2011), accessible under Another example of a commercially oriented microfinance bank having entered the rural and agricultural client segment successfully is AccessBank in Azerbaijan. See the contribution of Jainzik and Pospielovsky (2013). Meyer (2013) also refers to a number of examples. Both in this volume.
  • [5] See Maurer (2013) for a discussion of risks involved in crediting farmers and the agricultural value chain.
  • [6] For the different risk-management approaches, see Maurer (2013). To a certain extent, financial institutions can manage specific agricultural risks and limit its potential negative effects internally by applying exposure limits, diversification rules for the institutions portfolio, diversification requirements for the farming business and other measures. If the risk-bearing capacities of financial institutions are exhausted despite of the application of such measures an outplacement of risks can enable them to enlarge agricultural lending without exposing the institution to inadequate risk levels. For the role of agricultural insurance in developing countries see Herbold (2013), for the potential role of structured finance see Hartig et al. (2013), both in this volume.
  • [7] Some services, like for instance payment services, might be better offered by nonbanks, like mobile telecommunications companies.
  • [8] Hartarska et al. (2009) have done an econometric analysis over 750 microfinance institutions worldwide, concluding that the provision of both savings and credit leads to significant economies of scope, i.e. potential cost saving effects. They found that scope economies would not necessarily come from lower costs of capital due to deposit collection. Scope economies seem to be a result of fixed cost distribution and costs interaction among the different products. However, it also turned out that reaching scope economies seems to be harder in rural settings compared to urban areas.
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