Catalyzing Smallholder Agricultural Finance
Published in Partnership with Forbes.com.
This article was co-authored by Andrew Stern, Tom Carroll, and Dan Zook of Dalberg Global Development Advisors.
- The world’s 450 million smallholder farmers occupy a critical segment of the agricultural value chain, yet are often plagued by low yields, low quality products, poor linkages, and little access to finance.
- The demand for smallholder agricultural financing cannot be addressed with a single strategy because agricultural markets exhibit variations in features, such as crop characteristics (e.g., export crops versus domestic staples), aggregation points (e.g., fragmented versus tight value chains), and value chain power dynamics (e.g., buyer power versus supplier power).
- Actors should deploy investments through five primary growth pathways, including i) scaling existing models, ii) innovating new products, iii) financing out-grower schemes of multinational buyers, iv) financing through alternate points of aggregation in the value chain, and v) building out new direct-to-farmer distribution channels.
The world’s 450 million smallholder farmers represent a large — and largely unmet — opportunity for agricultural financing. As population growth and rising incomes create unprecedented demand for food, multinational companies increasingly rely on smallholders to secure their supply of agricultural commodities.
In response to consumer preferences for ethical and sustainable sourcing, traceability, and quality, companies have also made bold sustainability commitments that implicate smallholder value chains. As a result, smallholders present a compelling opportunity for buyers, lenders, and other actors in the agricultural value chain. However, smallholder production is often characterized by low yields, low quality, poor linkages, and little access to finance.
A recent Dalberg report — supported by the Citi Foundation and Skoll Foundation — called “Catalyzing Smallholder Agricultural Finance” suggests that with increased financing, farmers can improve their yields and products and in some cases double their income. Strengthening these farms is also important for the environment, as smallholders represent stewards of natural resources that are in need of sustainable management to prevent deforestation and the degradation of ecosystems.
At an estimated $450 billion, the global demand for smallholder agricultural finance is a large opportunity. Impact-driven smallholder agricultural lenders such as Root Capital, Oikocredit, Triodos, and Rabobank have played a catalytic role in driving financing into this market. With a total of $350 million in disbursements, global impact-driven agricultural lenders have been meeting smallholder financing needs, building local markets, and drawing in commercial lenders. However, they have still have headroom for additional expansion.
Additional actors, including donors, impact investors, technical assistance providers, governments, and commercial banks, also play a critical role in driving the market, but require tailored approaches to maximize their impact and ensure that they are deploying their resources to the most relevant opportunities.
The demand for smallholder agricultural financing cannot be addressed with a single strategy. Agriculture markets exhibit variations in features, such as crop characteristics (e.g., export crops versus domestic staples), aggregation points (e.g., fragmented versus tight value chains), and value chain power dynamics (e.g., buyer power versus supplier power). According to the Dalberg report, actors should deploy investments through five primary growth pathways, each of which maps to a particular market typology.
First, existing models of short-term trade finance for producer groups can be replicated and scaled, while encouraging commercial banks to follow. Second, new products can be innovated, such as providing long-term financing to cooperatives, addressing working capital needs, and developing on-lending schemes to finance group members. Third, financing schemes can be deployed through multinational buyers who have tightly integrated out-grower schemes (i.e., strong contractual relationships) with smallholder farmers.
These first three growth pathways have a reasonably clear path forward and can build from successful models and existing experience. However, these models will only address 10 percent of the world’s smallholder farmers who are aggregated into producer organizations. To get to the remaining 90 percent and truly unlock smallholder potential, investors can explore two additional pathways. A fourth pathway suggests a way to reach the remainder of farmers by providing finance through alternate points of aggregation in the value chain (such as warehouses or input suppliers). Finally, for farmers that are in very loose and dispersed value chains, direct to farmer financing models can be piloted, such as augmenting microfinance with new technology platforms.
Each of the five growth pathways above is discrete and can be pursued independently of the others. However, within each pathway different actors are interdependent, so collaboration is required. Donors and impact investors, including bi-lateral and multi-lateral agencies, provide the foundational capital for all five pathways, but their role depends on whether they are focused on scaling proven models or innovating new models.
Multinational buyers can work with lenders to facilitate financing, using purchase contracts as collateral or using their relationships with farmers to originate loans, assess risk, and collect payments.
Commercial and impact-driven lenders must decide where to apply resources in order to match their capabilities with the most appropriate need and opportunity. More specifically, impact-driven smallholder agricultural lenders can replicate existing proven financing models and innovate new financing products. Within commercial banks, small business teams can follow agriculture lenders into commercially viable markets; corporate agriculture teams can support out-grower schemes of multinational buyers; and, transaction teams can develop tailored hedging and insurance products to manage and share risk. Finally, microfinance institutions can tackle the cost of distribution for direct to farmer lending.
More broadly, information collection and transparency are required in order to accurately size and segment specific market opportunities and inform the appropriate pathways. Furthermore, industry alliances and working groups can be strengthened or established in order to develop and promote best practices among investors, multinational buyers, and other actors in the smallholder finance ecosystem.
The report draws on the experience and insights of an advisory committee that included the Citi Foundation, the Skoll Foundation, Root Capital, Technoserve, and ANDE, as well as interviews with over 65 commodity buyers, investors and value chain experts. The full version is available on Dalberg’s web site, here.
With collective action across these five pathways, actors from the private sector and the development community can contribute to feeding the world, increasing incomes in farming communities, and preserving our natural resources.
Andrew is a Partner in Dalberg’s Washington DC office. He leads many of the firm’s efforts to engage the private sector on global issues and development initiatives. Andrew helped to design and launch the Aspen Network of Development Entrepreneurs, a program at the Aspen Institute that helps to build small businesses in developing countries, and serves on its Executive Committee.
Tom is a Partner in Dalberg’s Washington DC office and is a leader in Dalberg’s agriculture practice. For the last several years, he has led engagements focused on identifying challenges and opportunities across the agricultural market and supply chain in sub-Saharan Africa, including cash crops (for export), staples, and horticulture.
Dan is a Project Leader in Dalberg’s New York office. He specializes in engagement of investors and corporations on international development and emerging markets strategy.