How Financial institutions can mitigate the risks associated with agricultural financing

Understanding how to expand your reach in agricultural communities, provide better service to smallholder farmers and mitigate your risks as a lender.

According to a study by the Initiative for Smallholder Finance “The global demand for smallholder farmer finance is $300 billion, and the current global supply is between $20 and $30 billion”. An increasing number of financial institutions in Africa, Asia and Latin America are filling this gap by providing access to capital and financial services for smallholder farmers. This market is an opportunity for your financial institution to grow and reach more clients while making a social and economic impact in your community.

In this article we describe the mechanisms of how financial institutions like rural banks, microfinance banks, microfinance institutions and savings and loans companies, can overcome some of the challenges of serving agricultural clients.

Challenges of lending smallholder farmers

Financial institutions including microfinance Institutions (MFIs), rural banks, microfinance banks (MFBs), lending cooperatives and financing companies play a pivotal role in providing the financial services smallholder farmers need to grow their agricultural businesses, make a living and contribute to the local economy.

The nature of agricultural lending: Unlike other businesses, agricultural finance cashflows are lumpy and loans repayments are aligned with clients’ seasonality of income.

The remoteness of rural borrowers: Loan officers must make long journeys to reach their clients, leading to high operating costs that hinder financial institutions’ outreach growth and efficiency.

Lack of specialised expertise: Financial institutions might lack the knowledge and expertise required to manage agricultural lending decisions.

Unpredictable conditions: Smallholder farmers and the financial institutions serving them are challenged by extreme weather events and crops pests, which affect the harvest and performance of agricultural loans.

Solutions and best practices

There are several measures in place for financial institutions to make better lending decisions to smallholder farmers among which:

Partner with other stakeholders

Financial institutions need to be informed about best practice for agriculture in the regions. For institutions that are moving into this industry, you can gain knowledge and expertise in managing an agricultural loan portfolio by partnering with peasant organizations, governmental agriculture-based entities and NGOs such as Food and Agriculture Organisation (FAO) and technoserve. These organisations provide technical assistance, training in management and financial advisory services, and even co-funding. Alliances with stakeholders help financial institutions better serve smallholder farmers populations and alleviate the risk involved with agricultural funding.

Diversify your portfolio

To mitigate the risks of lumpy cashflows, diversification is key. Your financial institution should ensure diversity within your portfolio, making agriculture just a portion of the portfolio. If other parts of the portfolio are generating sufficient liquidity each month for the institution’s needs, 20% of the portfolio could be lent out for agricultural lending with bullet payments after five months.

Participate in an agricultural value chain financing arrangement

Lending large amounts to low-income individuals with a four-month repayment deadline might unfold risks. Some borrowers might not be able to pay the principal and interest by the due date. To mitigate this risk, financial institutions can participate in an agricultural value chain financing arrangement. Doing so, lenders will disburse the loan in inputs like seeds and fertilizer, instead of a cash loan. They can negotiate bulk rates from the input providers and get better prices and ensure a higher quality input. Then, they will arrange contracts with the smallholder farmer who buys the inputs to lock in a fair price for the harvest. The off-taker pays back the loan to the MFI and returns the remaining cash payment to the borrower. This way, the borrower does not have to deal with cash and the financial institution mitigate the risk of delayed payments and provide more secure transactions.

Agricultural insurances

Extreme weather events – flooding rains, high winds, hail could prevent lenders from providing financial services to farmers. However, many financial institutions overcome this cumbersome by having a weather insurance that pays out in the event of crops damages.

Agricultural value chain finance offers an opportunity to reduce cost and risk in financing and reach out to smallholder farmers. For financial institutions, value chain finance creates the impetus to look beyond the direct recipient of finance to better understand the competitiveness and risks in the sector and to craft products that best fit the needs of the businesses in the chain. www.fao.org

Weather insurance is a type of protection against a financial loss that may be incurred because of rain, snow, storms, wind, fog, undesirable temperatures or other adverse, measurable weather conditions. Weather insurance is used to insure an expensive event that could be ruined by bad weather, like an outdoor wedding or an outdoor film production. Investopedia

Expand your reach to agricultural financing through technology

SMS messaging and mobile applications as a tool for microfinance

As part of its Instafin core banking system, Oradian designed a messaging service which enables you to send messages to you clients directly from an easy-to-use dashboard. An MFI lending to farmers in Zimbabwe has successfully used SMS messaging to warn farmers about the spread of a pest that could damage the potato crops, explained Laura Dreese, a former fund manager at Envest Microfinance with an experience working with agricultural loans in Zimbabwe. Through SMS messaging this MFI also advised farmers on how to vanquish the pest.

Another mobile function that Oradian offers is Instafin On The Go, the mobile application connected to Instafin, Oradian’s cloud-based core banking system. It can be downloaded and installed on mobile devices, enabling field officers to use Instafin and be fully connected to the branch or head office when they are out in the field. With Instafin On The Go, field officers can collect repayments and deposits, record transactions, manage and create individual client accounts and create loan accounts.

Bridge the remoteness gap, reduce costs and simplify administration

To overcome the cumbersome and cost of traveling for hours to reach your clients, Oradian offers an all-in-one solution that enables your institution to manage all operations from one easy-to-use dashboard. Using Instafin, Oradian’s cloud-based core banking system, your team can generate real time reports, collect payments and dedicate more time to serve more clients. Instafin is designed to work with low internet connection speeds, enabling you to serve clients in rural areas.

Ready to expand your business and reach more clients?

Innovative and visionary financial institutions use Oradian’s core banking system to operate more efficiently, grow and reach more clients. Contact us to learn more on how Oradian’s digital toolset can help you take your business a step further.