Financing value chains seems deceptively simple, but don’t be deceived!
By Michael Kortenbusch, Zurich, September 27, 2016
What sounds good in theory does not always work in practice. Value chain finance is a prime example. The theory is simple: If each of the three parties involved—farmer, aggregator, and bank—gains a benefit, the scheme will be a win-win-win. Reality is different: Quite a few programmes that look promising on paper eventually fail to deliver on expectations.
Context is key
National context is a crucial factor that many players who have sought to implement standard approaches in the Eurasian region have overlooked, often at considerable cost.
The key to success is to understand how different levels of maturity in the agricultural and financial sectors of a country interact, and to adjust programming—and expectations—accordingly.
For example, where a well-integrated agricultural sector coexists with a financial sector that poorly serves rural areas, value chain finance can easily blossom, as was the case in Turkey ten years ago.
Conversely, where a maturing rural finance market coexists with poorly developed agriculture, this form of financial development becomes a massive challenge. Such is the case in most of Central Asia, the Caucasus and Eastern Europe, regions where Business & Finance Consulting (BFC), the company I lead, has been working since 2003.
Two core challenges
Value chain programmes in Eurasia typically face two daunting obstacles:
- First, fixing dysfunctional value chains—prior to financing them—is a complex task that most banks are ill equipped to take on.
- Second, borrowers are reluctant to switch to value chain finance in maturing rural finance markets; they will only do so if the new offer is significantly more attractive.
These challenges have caused many programmes to fail, but both can usually be resolved if they are taken into account right from the beginning of the design stage. For example, national context often dictates which aggregators—input suppliers, food processing companies, off-takers, warehouses, or production cooperatives—are promising partners, and which are not.
Where value chains are in a poor state, mutual benefits are easier to realize by starting from input supply driven value chain finance. Interested in growing sales, vendors consider paying a type of “compensation fee” to the bank on all sales made on credit, allowing banks to lower the nominal interest rate down to 0%.
In contrast, processor-driven value chain finance schemes in Eurasia often fail due to lack of trust between farmers and processors, capacity challenges in processing firms, market access issues, and trends toward vertical integration. Often, huge problems need to be resolved before a value chain finance scheme becomes feasible. This can be a lengthy and resource intensive process that requires dedicated, long-term technical assistance.
Similarly, borrower reluctance in the region is a real hurdle, but can be overcome by reducing complexity. Benefits need to be communicated clearly (and loudly) in order to build and maintain commitment, and both product and delivery scheme must offer a significantly improved customer experience.
Making it work
- Not all value chains are equal. Only value chains with a healthy market potential and an acceptable risk profile are promising areas of intervention.
- Choosing an effective aggregator is paramount. The partner must offer a strong commitment, financial health, a significant farmer cluster size, and a readiness to introduce take-off contracts (e.g. Relevant only for off-takers or food processors).
- The aggregator must take the lead on customer relations. After the initial relationship between the client and the bank has been established, most financial transactions should be handled remotely or at the premises of the aggregator.
- When implementing a value chain finance scheme, a detailed partnership agreement between the bank and the aggregator is crucial. It must set out the rights and obligations of all three parties, contain a detailed description of the process, and include reporting forms.
- Outstanding communication and project management skills of the project coordinator (senior bank staff member or external consultant) are a must. Implementation is all about building stable, mutually beneficial relations between all stakeholders.
- Finally, patience and a long-term vision are indispensable. In the long run, as more and more broken value chains become fixed, financing volumes will increase, but this inevitably takes time. This means that the expectations of donors, banks and aggregators need to be openly discussed and aligned at the outset, and carefully managed throughout the design phase and implementation.
The early movers have largely learnt these lessons and are beginning to start to roll out value chain finance across the region. Since the design phase can take up to six months, the time to start preparations for the spring 2017 season is now. As the old saying goes:
“What is the difference between a good farmer and a bad one?”
Let’s start preparing the ground now for taking the agricultural sector in Eurasia to the next level.
The author, Michael Kortenbusch, a former farmer, is the Managing Director of Business & Finance Consulting (BFC), a Zurich-based consulting boutique specialized in the implementation of innovative financing solutions delivered through financial institutions in emerging markets in support of agriculture and micro, small and medium enterprises.