Managing Risk and Designing Products for Agricultural Microfinance: Features of an Emerging Model – Paper

The paper begins by highlighting that agricultural finance has been characterised by poor loan repayment rates and unsustainable subsidies. Accordingly, agricultural credit from some donors and multilateral development banks has dropped dramatically in recent decades and is now often considered too risky. Agriculture is widely considered more risky than industry or trade.

The purpose of this paper is to provide practitioners, policymakers, and donors with a thorough overview of agricultural microfinance. It aims to provide them with information to expand the access of farming-dependent households to sustainable financial services on a large scale.

This paper sets out a model, termed agricultural microfinance, for providing financial services to poor, rural farming households. The model aims to combine key features of traditional microfinance, traditional agricultural finance, and other approaches – including leasing, area-based insurance, and contracts with processors, traders and agribusinesses – into a hybrid defined by 10 main features.

The analysis in this paper suggests that successful agricultural microfinance lenders rely on various combinations of these features to mitigate the risks associated with lending to farming households, although in no experience were all 10 features present. It contends that the presence of a substantial number of these features appears to contribute to a well-performing portfolio, in diverse combinations, in a variety of circumstances – in general, the first few features are found in most successful experiences, while those that come later on the list have proven important in addressing particular risks or situations found in lending to specific types of agricultural activities.

  1. Repayments are not linked to loan use
  2. Character-based lending techniques are combined with technical criteria in selecting borrowers, setting loan terms, and enforcing repayment
  3. Savings mechanisms are provided
  4. Portfolio risk is highly diversified
  5. Loan terms and conditions are adjusted to accommodate cyclical cash flows and bulky investments
  6. Contractual arrangements reduce price risk, enhance production quality, and help guarantee repayment
  7. Financial service delivery piggy-backs on existing institutional infrastructure or is extended using technology
  8. Membership-based organisations can facilitate rural access to financial services and be viable in remote areas
  9. Area-based index insurance can protect against risks of agricultural lending
  10. To succeed, agricultural microfinance must be insulated from political interference

The paper is based around a discussion of each of these features – outlining the key elements, giving examples and highlighting the challenges that still need to be addressed. Case studies from leading organisations are also provided.

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