The role of financial institutions in value chain finance in the global south

2.3. AVCF Challenges

About the challenges of AVCF, the authors have listed several constraints that buyers and suppliers face in lending to farmers as shown in the following Table 2.

12

Table 2: The challenges of the agriculture finance according to the literature review

Challenges	Author(s)
	Pearce (2003)	Langen bucher (2005)	Honohan and Beck (2007)	Meyer (2011)	IFC (2012)	AfDB (2013)	Klonner and Rai (2015)	Herliana (2018)	ISF (2019)
Financial exclusion of farmers		X	X	X	X	X	X	X	X
information asymmetries	X	X		X	X	X	X	X
Transaction cost	X	X			X	X	X	X
High fees					X	X	X	X
insufficient amounts of credit					X	X			X
Low infrastructure, distant location		X			X
Low Education of farmers								X
Fluctuating Production								X
Lack collateral								X
Inefficient Market					X

The challenges cited in most literature studies are the following:

Financial exclusion of farmers: according to Langenbucher (2005) the causes of financial exclusion for the small farmer from the supply side are the lack of robust business models, and limited access to equity capital. Likewise, the key features that influence value chain finance (VCF) are the high incidence of informality (lack of documentation and contract), the intermediation deficiency (high-interest rate and minimum deposit), and the dominance of the banking sector (lack of information about credit worthiness of potential clients, weaknesses of the legal system, and high degree of corruption and inefficient bureaucracies. (Langenbucher, 2005; Honohan & Beck, 2007; Meyer R. , 2011). Meanwhile, formal institutions are less interested in financing the agricultural sector due to several constraints and subsequently obtaining formal credit is a complex procedure (Herliana, Acip, Qorri, Qonita, & Nur, 2018).

Information asymmetries: in accordance with Pearce (2003) and Langenbucher (2005), which makes the agricultural environment very complicated, are a lack of information about

13

14

smallholders' farmers and risk of agricultural activities. In addition, this sector is complicated due to the unique problem of the agricultural sector, the inadequate policy, regulatory environments, and asymmetric information (IFC and World Bank, 2012; Herliana, Acip, Qorri, Qonita, & Nur, 2018). In addition, several studies cited that FIs are not aware about farmer's credit worthiness, and therefore, smallholders' farmers are left when FIs try to mitigate risk (Klonner & Rai, 2005; IFC and World Bank, 2012; Pearce, 2003). Thus, banks were not investing adequately to understand the demands and nuances of value chains (VCs). This lack of information leads to the design of financial products that are not suitable for rural activities (AfDB, 2013).

Transaction cost: can be viewed from a financial point of view as a difference between the price a broker pays for a security and the price the buyer pays (Cheung, 1987). Most authors agree that transaction costs are one of the most important constraints that FIs have to deal with (Langenbucher, 2005; IFC and World Bank, 2012; AfDB, 2013). According to Pearce (2003), buyer and suppliers face difficulties in lending to farmers. Among these difficulties, he mentioned transactions cost as a major problem.

Following the bibliographical study concerning the constraints, the authors show a partial compromise about the following challenges:

High fees: as defined in the report of the AfDB (2013), small farmers who already have access to loans find the terms very rigid and the fees too high, which causes an increase in production costs. As a result, they borrow money from family and friends, or money lenders who charge high interest and limit their potential to expand (IFC and World Bank, 2012; Herliana, Acip, Qorri, Qonita, & Nur, 2018).

Insufficient amounts: according to ISF Advisors (2019), small farmers in South Asia, sub-Saharan Africa and Latin America need about USD 240 billion for agricultural and nonagricultural finance. Service providers are not able to meet this demand and the latest data collection indicated that financial service providers provided only USD 70 billion distributed as follows: USD 30 billion by value chain actors, USD 21 billion by formal financial institutions, and USD 17 billion by informal and community-based financial institutions. This shows that 70% of the global demand of small farmers remains unsatisfied, the equivalent of USD 170 billion and the contribution of FIs remains minimal (ISF Advisors and Mastercard Foundation, 2019). Additionally, most loans are short-term which cannot improve the output and income (AfDB, 2013). Moreover, lenders confront irregular payments and slow rotation of capital (IFC and World Bank, 2012).

Low infrastructure and distant location: While Langenbucher (2005) in this context has listed the lack of appropriate risk mitigation and infrastructure, and no branches or limited

network in rural areas, the authors of IFC (2012) enumerated the low population densities, low infrastructure, distant locations, and the inefficient market, which can only worsen the situation and decrease profitability.

Finally, other challenges were listed separately and show less compromise between the others:

Low education of farmers one of the barriers to agricultural finance is the low education level of small farmers (Herliana, Acip, Qorri, Qonita, & Nur, 2018). This low literacy level of cultivators is the main cause of the limited access to information which translates to low efficiency in resource management and then low productivity crops. This low productivity is due to the lack of knowledge about the right proportion of Inputs (seeds, chemical fertilizers, and pesticides). Besides, in a present changing environment, farmers are unable to compete which traps them in a vicious circle of poverty.

Fluctuating Production Most banks avoid financing agriculture on the ground of fluctuating production and uncontrolled price risk (Herliana, Sutardi, Aina, Himmatul, & Lawiyah, 2018). The main causes of the fluctuating production are climatic factors such as: water, light, rainfall, and temperature which lead to unpredictable food production (Gilbert, 2010). In addition, ecological land change and cultivated land intensity will make the production more complicated (Xie, He, & Xie, 2017; Xie, He, Zou, & Wu, 2016).

Lack of collateral Herliana (2018) showed that FIs avoid financing small farmers following the low profits and lack of collateral. Besides, rural producers do not generally have assets that IFs are willing to accept as collateral. In addition, pledges of agricultural assets have often been insufficient to ensure credit recovery, thus threatening the sustainability of development Financial Institutions (FAO and ALIDE, 1996).

Inefficient Market According to IFC authors (2012), unstable market prices aggravate the financial situation of small farmers. Food demand is constantly rising due to growing population. however, food supply is dropping due to increasing production cost. This imbalance in food demand and supply is the primary cause of the price volatility (Lu, 1999). Besides, continuous changes in input and output prices reduce the income of small farmers (Ijioma & Osondu, 2015).

2.4. Competitiveness of agricultural finance

According to Abid et al. (2020), to achieve the objective of reducing transaction costs (TC) and risk management, several factors should be considered by organizing chain actors in VCF. Among these factors³, we can mention; Agility, Innovativeness, Information sharing, Trust,

3 Source: Abid et al. (2020)

15

Information & Communication, and Contractual Governance (Abid, Jie, Aslam, Batool, & Lili, 2020).

Information Sharing

Agility

Trust

Competitiveness

Information & Communication

Innovativeness

Contractual Governance

Figure 5: Considered factors to reduce TC and risk management in agricultural finance

i. Agility: which is the ability to respond to changing customer needs and satisfy
the unique needs of each customer with flexibility and adapt to unforeseen circumstances (Abid, Jie, Aslam, Batool, & Lili, 2020). Then, agility in the value chain allows the FIs to respond quickly to the needs of customers and then ensure competitiveness in the chain. This accelerates the financial flow in the VC and reduces the intervention of informal money lenders (Ellis, 1992). In the same scope of work, Meyer (2007) emphasized the important role of the intervention of FIs in identifying the unmet demand and to find where the lending cost and risks are lower. He mentioned that this follows up requires more analysis to design appropriate product, improve lending capacity, and make diversified loans portfolio. Therefore, Agility in the VCF improve competitiveness with respect to financial product and innovation (Swafford, Ghosh, & Murthy, 2006).

ii. Innovativeness: is a system in which VC actors provide new products and
services to increase customer satisfaction (Simon & Yaya, 2012). The authors of IFC (2011) and Hult (2004) found that FIs need to develop new credit skills and policies, credit scoring and rating tools, as well as portfolio monitoring practices to provide high value customers. The way of lending credit to farmers is parametric, while it is based only on a few parameters due to the lack of collateral. This should be improved, developed, and replicated. Generally, FIs

16

with a high degree of innovation can adapt to every change in the environment and ensure more competitiveness within the VC. Moreover, according to Kaufmann (2000), FIs can improve their ability by strengthening the process of product innovation by organizing producers and buyer's relationship. Equally, According to Röttger (2015), FIs should understand the risks and opportunities of the sector and link loan with insurance products.

iii. Information sharing: according to Brown (2010) and Pagano (1993),
Information sharing describes how the actors in the chain react to each other over time. Information sharing is very important as it improves market competitiveness, credit allocation efficiency, reduces asymmetric information, and increases lending volume. Furthermore, the sharing of information helps FIs to address asymmetric information using the network, incorporate the collaboration with VC actors to design innovative product (Miller C. , 2012; Röttger, 2015), in this regard, the authors of KIT and IIRR (2010) and Kim (2017) highlighted that information sharing return the relationships in the chain smooth and simplified and build better partnership. Moreover, the cost of credit screening, monitoring and enforcement are reduced due to chain actors, which take part in this procedure and do this work themselves and make agile the VCF (KIT and IIRR, 2010; Kim & Chai, 2017).

iv. Trust: Trust is about how reliable and credible the partners in the value chain
consider themselves to be (Abid, Jie, Aslam, Batool, & Lili, 2020). Trust is therefore considered as an important element to overcome unexpected situations and to act in situations perceived as risky (Song, 2018). According to Jones et al. (2015) trust between stakeholders is an essential requirement for successful management of financial flows in the value chain. In this context, Miller, and Jones (2010) mention that trust between producers and buyers is one of the key factors to mitigate risks. Thus, the adoption of an agile approach VCF is based on a better level of trust (Svensson, 2001).

v. Information & Communication: according to Ali et al. (2011) and Imtiaz et al.
(2015), Information and communication enhance the creditworthiness of smallholder's farmers, reinforce partnerships between value chain actors, minimize the cost of stakeholder interaction and the risk related to the VCF. For more effectiveness and risk reduction through information and communication, the authors of IFC (2012) have mentioned the development of insurance products, such as crop and weather insurance products, credit life product, and emerging health and FIs should rely on cash flow, saving or group guarantee, then within their value chain and take advantage of all information to develop

17

adequate product that combine financial and non-financial services. Besides, FIs should improve their capacities to assess farmer credit, develop insurance and risk-sharing, and identify opportunities to increase their level of comfort and reach more farmers (IFC and World Bank, 2012). Likewise, Röttger (2015) highlighted the importance of relying on the recommendations of group leaders and extension agents in the aim of linking loan with insurance products, increasing loan amounts, and declining interest rate. Zhao et al. (2019) have found that the use of information facilitates innovation in financial services, lower costs, monitor risks, and allow for agile financial flows.

vi. Contractual Governance: is the degree to which a contractual partnership is
legislated by a formal contract specifying formal rules, responsibilities, and duties (Zhou & Poppo, 2010; Cao & Lumineau, 2015). Moreover, it supports innovation-based coordination and strict collaboration between actors. This cooperation between value chain partners, according to Anna Grandori (2019), regulates transactions and the pooling of resources, and thus, procedures for innovation. According to the authors of the AFRACA (2020), AVCF offers several advantages for chain actors. Starting with producers, AVCF makes it easier for them to get credit because of the lack of collateral. Then, for agribusinesses, AVCF strengths the buying-selling relationship and allows market expansion. Finally, for FIs and investors, AVCF reduces transaction costs, improve repayments, and mitigates risk due to more suitable financial products. Due to the absence of FIs in most rural areas because of cost and risk of agriculture lending are too high, the authors found that FIs can take advantage of the collaboration in the VC and work with companies rather than directly with farmers to deal with these risks... Eventually, the public sector has a crucial role for a suitable policy and banking regulations that allow the application of new approaches, and infrastructure.

2.5. Determinants of agricultural credit

Several studies have been done in the past on the identification of the determinants of agricultural credit and the factors that significantly influence the decision (Akpan, et al., 2013; Salami & Arawomo, 2013; Yuan, Hu, & Gao, 2011), many variables (factors) have been identified in the literature leading researchers to analyze their impact on the decision of credit accreditation (Abid, Jie, Aslam, Batool, & Lili, 2020).

To start with Meyer (2007), FIs need to ask farmers before lending, such as others engaged in economic activities for the households, cash inflows and outflows, source of income for

repayment, and structure of the given loan. This can help FIs to determine the amount to be lent to the specific VC, and the method to mitigate risks. Thus, this evaluation allows determining the creditworthiness of farmers, the types, terms, and conditions of financial products needed to meet these demands. Other studies have also identified specific factors for the allocation of credit such as education, marital status of the household, contact with extension agents, years of experience in farming, land size, gender, etc. (Aliero & Ibrahim, 2011; Dzadze, Osei, Aidoo, & Nurah, 2012; Akpan, et al., 2013). Among other socio-economic factors, being a member of a cooperative plays a key role in access to credit (Ijioma & Osondu, 2015). A recent paper in Pakistan has shown also that health status remains one of the determinants for credit accreditation (Saqib, Kuwornu, K.M., Panezia, & Ubaid, 2018).

According to Gammage (2013), access to bank finance is determined by a number of factors such as ownership type, age of the firm, sector, and location of the business, assess tangibility, firm performance, availability of audited financial statements, gender of the owner-manager and perception of the owner-manager of access to bank finance, and characteristics of the borrower at the time of evaluating loan applications. According to Abid (2020), the most common factors are literacy, size of land, marital status, and distance to a lending institution, age of the borrower, caste, religion, and value of assets held by the household. Another study in Nigeria found a significant relationship between gender, marital status, the lack of a guarantor and access to credit (Ololade & Olagunju, 2013). In addition to gender, agricultural experience, education level, farm size, and income, household size and availability of collateral have a meaningful effect on loan accreditation for farmers (Abbas, Yuansheng, Feng, & Liu, 2017).

From the review, these factors were classified into three groups based on common characteristics, characteristic linked to the farmer (Gamage, 2013; Ololade & Olagunju, 2013; Ijioma & Osondu, 2015), others linked to the farm (Aliero & Ibrahim, 2011; Gamage, 2013), and finally those linked to the economic activity (Meyer R. L., 2007; Gamage, 2013), as shown in the Table⁴ 3.

18

4 Source: The Author

Summary of different research on the determinants of access to credit

Table 3: Determinants of credit Access

19

Farmer		Farm		Economic Activity
·	Education	·	Land Size	·	Cash inflows and
·	Marital status	·	Ownership type		outflows
·	Household size	·	Age of the firm	·	Source of income for
·	Years of experience	·	Sector		repayment
·	Being member of a cooperative	·	Location of the business	·	Availability of audited
·	Health status	·	Firm Performance		financial statements
·	Gender	·	Distance to a lending	·	Value of assets
·	Characteristics of the borrower		Institution	·	Availability of collateral
	(caste)
·	Religion
·	Guarantor

2.6. Literature on AVCF

2.6.1. Gap of the Literature on AVCF

Recent studies have focused on the determinants of the sources and amount of agricultural credit (Yadav & Sharma, 2015), and on evaluating the access to finance at the farmers' level (Gamage, 2013). However, few researchers have taken into consideration the contribution of financial institutions (FIs) and the identification of the supply-side determinants of agricultural credit (Meyer R. L., 2002; Yadav & Sharma, 2015). This could be an area of further potential investigation, mainly, in new approaches such as AVCF (Villalba, Venus, & Sauer, 2021).

According to Zander (2016), the research available on AVCF is relatively scarce due to a number of major concern that restricts the knowledge about non-bank based agriculture value chain financing. First, the hesitation of the private sector and agri-businesses to share their information with others due to confidentiality issues. Second, the hesitation of FIs to share operational and performance details of their agricultural portfolio due to confidentiality. Finally, the hesitation of analysts and authors to disclose details on outcomes and impacts, since the initiatives are new and the results are not sufficiently robust.

20

With respect to the adequate information on this topic, there is a significant gap in the available literature overall. The influences of the AVCF are little reported in the literature, even though external facilitation needs strict monitoring of the impact of the AVCF, especially for small-scale producers

2.6.2. Available literature on AVCF

Regarding the Types of the existing literature on AVCF, there are three types of documents available (Zander R. , 2016):

a) Normative information and guidance

b) Descriptive documents with facts and figures

c) Anthropological and sociological studies

Concerning the studies available on the development of AVCF in the literature, Miller and Jones (2010) discuss 5 cases of AVCF involvement; 1. Numeric project in Kenya and Tanzania 2. Inventory credit system Niger 3. Integrated agri-business finance model 4. Technological innovations in Kenya 5. Integrated Agro-food in India. The analysis of actual cases and results in this paper does not show the aspect of the implications of AVCF on agricultural or financial sector development (Zander R. , 2016).

KIT and IIRR (2010) address the financing gaps that exist within agricultural value chains. This book presents detailed case studies. These include sections on results, impact, threats and challenges, and lessons learned. Among the cases discussed we can mention; Credivida in Peru, BASIX group in India, K-Rep Group in Kenya, Organizations supporting the soybean value chain in Ethiopia, UCPCO and Fondo de Desarrollo Local in Nicaragua, and Pro-rural In Bolivia.

A publication of Inter-American Development Bank (2010) has highlighted the relationship between AVCF and local financial and agricultural sectors. This report compared two value chains in Nicaragua (dairy and plantains) and Honduras (plantains and horticulture) and included relative observations on mechanisms used within the value chain financing (Coon, Campion, & Wenner, 2010).

Another FAO publication of Da Silva and Rankin entitled «Contract Farming for Inclusive Market Access» presented case studies of different value chains of cacao, sugar, oil palms, and other plantations crops which work with international markets under contract farming between lead firms and cooperatives. This report emphasized the importance of this instrument which is a very interesting development tool with growing expectations for VC promoters (Da Silva & Rankin, 2013).

21

A recently published discussion paper from the Deutsches Institut für Entwicklungspolitik, discusses the implications of the AVCF arrangements for agricultural sector development and presents strategies that reduce the risks for financial sector growth, with the aim of better reaching priority segments of the rural population such as small-scale farmers and rural micro and small enterprises (Zander R. , 2016). This paper illustrates in detail the following 4 case studies: 1. accelerating production and post-harvest infrastructure in Rwanda 2. Fostering AVCF in Ethiopia 3. COMPACI project in Zambia 4. KELIKO farmer association in South Sudan.

The following table shows the different publications available from which we have selected all the FIs that have experience in the application of the AVCF. These FIs will be contacted for the survey later

Table 4: Number of FIs mentioned in the literature review

Publication	Authors	Year	No. FIs
AVCF: Tools and Lessons	Miller and Jones	2010	45
Value Chain Finance	KIT and IIRR	2010	28+(2^5)
Financing Agriculture Value Chains in Central America	Coon, Campion and Wenner	2010	8+(2^7)
Agricultural finance for smallholder farmer	Daniela Röttger^8	2015	8
Contract Farming for Inclusive Market Access	Da Silva and Rankin	2013	3+(1^7)
Risks and Opportunities of Non-Bank- Based Financing	Zander Rauno	2016	17
Consultative Group to Assist the Poor^9	N/A^8	2015-2016	44
World Council of Credit Unions^9	Elissa McCarter^8	2021	48
Total of FIs mentioned in the literature review:			201

5 Financial institutions mentioned by Miller and Jones (2010)

8 FIs cited in bibliographic studies where the term AVCF is not mentioned

⁹ Source: CGAP, 2016 Assessed: 31 July 2021 See: https://www.cgap.org/small holders data portal/ ⁹ Source: WOCCU, 2021 Assessed : 25 August 2021 See: https://www.woccu.org/

22