Why is the time ripe for a revolution in agri-value chain finance?

Lamon Rutten

CTA

Overview

• Value chain finance – why now?• Chain-linking farmers to finance• Forms of value chain finance• What is needed to make it happen?

Value chain finance – why now?

Push ……….. and pull

• The need to secure supply (in terms of

quality and quantity) of the commodities that a fast growing

and increasingly competitive market

requires.• Declining risk capacity

• Consumers demand proper value chains

• ICT makes VC finance easier

• Traditional financial sector barriers are

disappearing

The push…

0

10

20

30

40

50

60

70

80

1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

SSA East Africa Central Africa Southern Africa West Africa

African urbanisation rates as % of total population

Source: AFRACA/CTA/Ecobank, Opportunities for value chain finance in Africa’s intra-regional food trade - forthcoming

The pull...

Exchange

Investor

Farmer

Chicken processing

plant

2. Forward contract

1. Due diligence

3. Cession of the rights to payment under the forward contract

4. Confirmation of assignment of payment

5. Repo: sale of the forward contract, with obligation to buy back after 90

days

6. Purchase of the repo

(through a broker)

Broker

7. Funds

8. Funds

9. Funds

Capital market investors are looking for new ways to invest their funds. And they are growing in size and sophistication, including in many ACP countries.

But push and pull factors only create potential

SME financing requirement in Sub-Saharan Africa, 2012 – appr. US$ 80-100 billion/year

23%

77%

Available financing Financing gap

Source: IFC.

Finance for agriculture has to increase by at least half. Currently, 90% of finance going into agriculture comes from the farmers themselves. So, either farming should become much more profitable, or external financing for agriculture has to increase radically.

But risk perception has to change

A bank tends to make only small margins on loans. One deal that goes bad can wipe out the profits of dozens of deals that went well.

Thus, banks tend to stay away from deals that they perceive as risky.

Is subsidizing agri-loans a solution?

No. Schemes to provide agricultural loans at subsidized interest rates were prevalent in the 1960s and 1970s, but they largely failed (but they still exist, in countries like the USA or Nigeria, and politicians continue asking for them).

The common position now is that subsidies for agri-finance should be indirect: - To help financiers manage risks: weather risk insurance,

credit guarantee schemes- To develop supportive institutional, regulatory and policy

frameworks (eg, for warehouse receipt finance, investment funds)

- To build capacity and improve KM.

Is more micro-finance a solution?

Not in its traditional form: - group-lending and heavy monitoring is too expensive

(paying 1% interest on a 5 day loan permitting a small-scale processing operation with a 10% profit margin looks OK; paying 40% on a 180 day loan doesn’t)

- small loans and regular repayment don’t fit with the agricultural season.

So, MFIs need to adapt their methods to engage in agri-finance. Eg, micro-leasing, VC finance.

Bank

Borrower

Will the borrower earn enough, and

reimburse?

Bank

Borrower

Will the borrower be able to perform

Risk mitigation mechanism

How ?

From credit risk to performance risk

Value chain finance permits financiers to shift their risks

Value chains require a structuring of the link of producers to consumer demand. Producers need to be enabled to meet changing consumer demand. A proper value chain approach therefore cannot focus exclusively on farmers.

Linked to a number of global developments (sustainability, food safety, etc.), many companies have an interest in acting as enablers. In many cases, NGOs, government bodies and development agencies can be facilitators. This should give rise to a new kind of development project, including farmer-business-NGO partnerships, and PPPs.

Seller Buyer Seller Buyer

From supply chain….. to ….. value chain

Value chain supply chain

Value chain financing Financing the value chain

Value chain financing Financing the value chain

Chain-linking farmers to finance

1

2

3

Farmer produces for a specific offtaker

Off-taker

Farmer produces to a set standard and sells in such a way that his market is secure, but competitive

1

2

E.g., warehouse receipts, auctions, commodity exchanges

E.g., contract farming

Chain-linking farmers to finance

1

2

3

Farmer produces for a specific offtaker

Off-taker

Farmer produces to a set standard and sells in such a way that his market is secure, but competitive

1

2

E.g., warehouse receipts, auctions, commodity exchanges

E.g., contract farming

VC finance directly counters the two main risks of agri finance

Inability to reimburse.Agriculture is risky.

Dependency on weather, prices, availability of markets, condition of

roads, rural insecurity…

Unwillingness to reimburse. Past practices often discouraged farmers

from honouring their obligations.

Make sure loan is used to improve farmer’s revenue.

Build risk management tools into the loan.

Ensure that the reimbursement is not by the farmer, but is made through a stronger link in the value

chain.

Forms of VC finance

• Warehouse receipt finance (at different parts of the chain)

• Processor-centered finance• Financing traders through the

monitoring of their value chain operations

• Final buyer-centered finance (eg., factoring)

• Pushing pre-export finance up-country

• Full supply chain financing (from inputs to final buyers)

Warehouse receipt finance

The concept: turn commodities into gold

Vault

Bank

Borrower

Deposit gold in bank vault

… and get an ‘easy’ loan

Showing your wealth isn’t enough – the bank prefers to take it under its own control (to take possession).

Warehouse receipt finance

The concept: turn commodities into gold

Vault

Bank

Borrower

Deposit gold in bank vault

… and get an ‘easy’ loan

“Vault”

Bank

Borrower

Deposit commodities in bank “vault”…

… and get an ‘easy’ loan

Four possible relationships between the bank and its “vault”

The Latin/ Turkish model

1

Banks can set up arms-length collateral management subsidiaries. Still prevalent in Latin America and Turkey; was once quite important in the US.

Four possible relationships between the bank and its “vault”

The Latin/ Turkish model

1

2 Collateral management

Four possible relationships between the bank and its “vault”

The Latin/ Turkish model

1

2 Collateral management

Public warehousing

3

Four possible relationships between the bank and its “vault”

The Latin/ Turkish model

1

2 Collateral management

Public warehousing

3

The Indian model: collateral

manager takes over warehouses for use as public

warehouses

4

Warehouse receipt finance – an example of SME financing

Warehouse

Printer

Financier

Sale at beginning of

school year

Continuous printing of books

during the year

Schools

Paper supplier

Collateral manager

Working capital

finance

Payment of invoices

Reporting

Control

Delivery of paper (imported)

Weekly releases of paper

Port of loading (Black Sea)

Bulky fertilizer (Beira, Dar)

Bagging

Central distribution warehouses

Distribution warehouses,

Zambia

Distribution warehouses,

Malawi

Buyers

trucktruck

truck

train

train

trucktruck

vessel

truck

Financing of an import operation, e.g. fertilizers – the bank starts with control over the goods as they are being loaded, and then retains control as they move down nearer to the buyers. Goods are only released from the warehouses once the bank has received an appropriate payment or guarantee.

The advantages of this are two-fold. International finance (at low cost) can be brought to the buyer’s factory gate; and large, cost-efficient volumes can be combined with low working capital needs for the buyers.

An import financing using collateral management

And an export operation…

Processor-centered value chain finance

Smallholders

Finance the offtaker, who will take full responsibility for the production process…

Off-takerContract

Bank

Young animals; veterinary services

Mature animals; milk

For example, contract farming…

Farmers Off-taker

Contract

BankYoung animals

Mature animals; milk

Veterinary services

Assignment of receivables, and payment

Contract

Insurance ContractDue diligence

Processor-centered value chain finance (a more complex form)

Funding

Off-taker

Bank

Trader

Animals are moved to offtaker

Monitoring agency Check the number and

weight of animals soldCheck the number and weight of animals bought

Assignment of receivables, and payment

Loan

Spot checks

Financing traders by monitoring their value chain operations

Agent

Exporter

InternationalBuyers

(Supermarketchains andAuctions)

2- Issue notes forpayment in 30 days

3 (a)- Issue new notes with payment in 90 days INNOFIN

3 (b)- Pay immediate cash at a discount

5- Pay back after 90 days

Afreximbank

Leveraging on the buyers… starting with factoring

Applying value chain finance to micro-finance

Agent bank

International offtakers 5. Instruction to

release funds to farmers

1.Tripartite

agree-ment

7. Settlement of invoice values

ITFCTransit depots

6. Release of funds to farmers’ cooperatives

4. Verify and submit documents received

8. Final reimbursement

Facility manager

1*

3d#

* Sales contracts, letters of assignment of export proceeds, letter of guarantee by Gambia government.

# Copies of invoices.

3b. Transportation to final depot

3f. Shipping and shipping documents

Export depot GGC

3e. Monitoring (quality, quantity)

3c. Warehouse receipts

3a. Warehouse receipts

2. Delivery

Groundnut farmers’

cooperatives

Pushing pre-export finance up the chain

Fertilizer company 4. Hedge

ProducersBonded

warehouses

Borrower (exporter)

Commodity exchange

Standard Bank

8. Coffee

2. CPRs

3. CPRs

7. Payment

1. Fertilizer

5a. Assignment of CPRs; assignment over hedge proceeds; warrants at bonded warehouse.

6. Loan

5b. Performance guarantee on producers delivering against the CPRs.

Full supply chain financing

VC finance is safe and easy

Value chains generally continue functioning over many years. Thus, financiers can construct standardized financing mechanisms, where the “entry” of the commodity into one particular phase of the chain is sufficient to trigger the financing.

What is needed to make it happen ?

• Learn from best practices

• pro-active governments and Central Banks

• supportive development partners

VC finance is not just a private sector matter

Supportive legal/regulatory environment

Central Bank support/discount facilities

Support institutions

that mitigate risks

Central Banks played a central role in developing agricultural finance in 19th and early 20th century Europe and USA… providing good models for today’s developing country Central Banks and Ministries of Finance.

Learn from history !

Collateral manager

Bank

Commodity owner Central

Bank

Loan of X $

Documentation

Submission of the loan of X $, with documentary proof

that it is a proper warehouse receipt loan, for discounting

Loan of X $, at the official discount rate

In 1848, the Bank of France created 49 "bonded warehouses", which started to provide companies with warehouse warrants for various; sub-discount banks also set up by the Central Bank accepted these warrants as collateral, and their loans constituted discountable paper for the Bank of France.

Farmer InvestorFarmer issues

a FinancialCPR, backed by cattle

Payment

Agent bank escrow account

Buyer

Inspection agency

Reporting

monitoring

Payment

Payment

Assignment

ContractDelivery

Commodity exchange

Price risk management

CPRRegistrar Registration

ICTs facilitate institution-building

ICT-enabled

In conclusion...

• Value chain finance is a need of the day – a key tool to get agriculture to meet current challenges – but also, a great opportunity for banks.

• But mindsets have to change and skillsets need to improve.

• Governments should take their responsibilities… but not fall back in the failed 1960/70s model in state-driven subsidized credit.

• Development partners can provide support in several ways, from capacity- and institution-building to the provision of risk capacity.

Go for it !

www.fin4ag.org