Managing Risks in Financing Agriculture

Renate Kloeppinger Rural Finance Adviser The World Bank

AFRACA Agribanks Forum 4-7 May 2010, Abuja, Nigeria

Presentation Outline
Background Findings from a Conference Findings from a Study Conclusions

Background
Agriculture Credit - The history of failed interventions Agriculture Credit Overview of recent approaches World Banks work in Agriculture Risk Management Food Crisis and the renewed interest in Financing Agriculture Studies, Conferences, and New Interventions

Agriculture Credit and a History of Failed Interventions in the 80s and 90s and little activity in most of the 2000s

Emphasis on Agriculture Development Banks and large credit lines = low repayments, elite capture, political influence on credit decisions Subsidized interest rates or interest rate caps = banks are unable to recover their costs; if there is reimbursement from the government most often limited funding leads to credit rationing and again to elite capture Loan forgiveness programs = bad credit culture Savings completely neglected = farmers are unable to build up reserves for own risk management purposes One off actions - sustainable access to credit for farmers not a topic Guarantee programs for banks are expensive and often lead to moral hazard and cherry-picking

Recent approaches to agriculture finance

Focus on private commercial financial institutions Emphasis on institutional development and capacity building of financial institutions Sustainable access to financial services, not only credit Managing risk in financing agriculture is in the forefront Focus on smallholder farmers (or their organizations) rather than large farmers only Financing (along) the value chain receives attention Insurance is a hot topic Partial risk guarantee schemes are increasingly set up Use of smart subsidies

Expert Meeting on Managing Risk in Financing Agriculture, April 2009, Johannesburg 14 Findings
Financing for Agriculture is viable if supported by sound risk management at multiple levels Good banking practices combined with understanding of the sector and the client is a core requirement Insurance is one tool in an overall risk management strategy

 Mutually beneficial partnerships through which risk and benefits are shared lower risk Aggregation of clients reduce risk and transaction costs Innovative forms of collateral and collateral substitutes provide added security to lenders Financial literacy education is equally important for staff and clients of financial institutions

Expert Meeting on Managing Risk in Financing Agriculture, April 2009, Johannesburg 14 Findings

 Agricultural Credit Risk Assessment

The Study on Credit Risk Assessment and Management The Questions

How is a credit request assessed? How important is agricultural domain knowledge? Is credit-risk quantified at the loan-level and at the portfolio level?

Agricultural Credit Risk Management

How common is the use of collateral substitutes? Do lenders facilitate access to risk mitigation services for borrowers? What mechanisms are used?

The Study Sample and Method

Sample: 17 institutions in 7 countries
Focus on Africa and Asia Cover major institutional types - Commercial banks (12), DFIs, and microfinance organizations.

Method:
Rapid assessment of 15 institutions Detailed assessment of 2 institutions

The Institutions Studied

Malawi: OIBM, MRFC Zambia: Stanbic, Barclays, Dunavant, Cropserve Kenya: KCB, Equity, Coop Bank, AFC India: ICICI, HDFC, SBI, Basix Thailand: BAAC Armenia: ACBA-Credit Agricole Kyrgyz Republic: Ayl Bank

Study Findings - Credit Risk Assessment

Small Loans
Approach 1: Parametric (rules of thumb, experiencebased) Approach 2: Parametric + outsourcing

Large loans traditional financial ratio analysis. 3 banks use credit bureau only for large farmers 1 bank uses bio-metric identification 5 banks use credit grading; only 1 uses risk modeling

Study Findings Credit Risk Management

All banks lending to small farmers use collateral substitutes Diversified loan portfolios agricultural loan portfolios 10 to 40 % Only 1 bank bundles crop insurance; 1 bundles credit-life insurance. 6 banks report risk-based pricing for large loans; none for small. 3 DFIs report risk-based pricing for small loans

Innovations
Use of biometric tools to uniquely identify borrowers. Parametric credit risk assessment and partial outsourcing of this process Tripartite lending arrangements produce buyer, lender and borrower. Provision of fee-based agricultural and business advisory services.

Some Conclusions
Lending to small farmers at scale requires nontraditional credit assessment systems Lending to small farmers requires use of collateral substitutes, but not other elements of microfinance. Multi-level diversification is key to credit risk management at the portfolio level Successful agricultural lenders have domain expertise in agriculture at multiple levels