RISK MANAGEMENT STRATEGIES IN FINANCING AGRICULTURE IN NIGERIA BY MIKE. O AGBAYEKHAI.

1. RISK MANAGEMENT STRATEGIES IN FINANCING AGRICULTURE IN NIGERIA BY MIKE. O AGBAYEKHAI. GENERAL MANAGER, RISK MANAGEMENT NIGNERIAN AGRICULTURAL COOPERATIVE & RURAL DEV. BANK LIMITED, NIGERIA. West Africa Regional workshop. 18th -20th August,2010. Accra,Ghana Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

2. Outline of presentation. • Introduction • Overview of risk management • Risk management framework. • Some challenges of Agricultural financing. • Risk management strategies in agriculture financing. • Impact of risk on profitability of agric. Finance institutions. • Nigerian Agric. Coop. & Rural Development Bank and its risk management strategies Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

3. INTRODUCTION • The business of agriculture is often characterized by high variability of production outcomes or production risks. • Unlike most other entrepreneurs, agriculture producers are not able to predict with certainty the amount of outputs that the production process will yield due to external factors such as weather, pest and diseases. • Risks in agriculture affects both the farmer the Institution lending to the farmer for agricultural purposes. • Agriculture is an inherently risky economic activity with a large array of uncontrollable elements which can affect output production and prices. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

4. Introduction cont’d • Risks in agriculture are correlated the reason why the bad fortune of a farmer is likely to affect many others. • When commodity prices decline, everyone faces a lower price. • The same goes when there is a natural disaster that destroys either crops or livestock, in such circumstance many suffer. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

5. WHAT IS RISK? • Risk can be viewed as the possibility that the occurrence of an event would have adverse impacts or repercussion on set goals and objectives of a company. They are uncertainties which might crystallize in the course of a transaction whose consequence may exploit the vulnerability of a process. Thus risk managers are concerned with “what if”, everyday and every time in all their decisions. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

6. WHAT IS RISK? • It can also be defined by the adverse impact on profitability of several distinct sources of uncertainties. The type and degree of risk of an organization or system may be exposed depends upon a number of factors such as size, complexity, business activities, volume, etc. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

7. WHAT IS RISK? Cont’d • Outcomes which are the consequence of risks could either result in a direst loss of earning/capital or may result in imposition of constraints on Bank’s ability to meet its business objectives. In order to deal with these uncertainties, it is imperative that Banks and Organizations put in place effective Risk Management Framework. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

8. Risk management • May be viewed as the adoption of a risk based approach in the business process to ensure that key risk areas which may result in significant losses are identified, reviewed, mitigated, monitored and reported on a continues basis. • Risk management embraces all aspects, processes, people, markets, environment and risks in an organization. It is an integral part of enterprise management strategies. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

9. RISK MANAGEMENT FRAMEWORK The risk management framework deals with the following: • Risk governance structure, • Risk identification • Risk assessment • Risk treatment • Risk reporting • Risk monitoring and review Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

10. RISK GOVERNANCE. • This deals with the risk management structure and risk defense levels. The board of directors set the tone and determines the risk appetite and policies for its organization. The risk oversight committees of management ensure that the risks policies approved by the board are complied with and guide the implementation of strategies. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

11. RISK IDENTIFICATION. • Risks identification is the hallmark in a risk management process. This stage is so important that any misalignment at this stage adversely affects the organisation and its risk appetite. Risk identification is the duty of all members of the organisation; • The board set the tone. • CEO in the lead and must secure a buy in from management and staff. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

12. Risk identification cont’d Why risk identification? • Risk identification is very cardinal if a company is to survive in these turbulent times. • Risk identification should be entrenched in the organisation culture. • All business units must be taught how to identify the risks in their areas of operation. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

13. Risk identification cont’d How to identify risks. Risk identification is usually better done in a brainstorming sessions. Some outcomes from brainstorming sessions include; • A list of all the possible risks that need to be managed is developed. • Decision on what action to be taken or their coverage in order to handle each possibility that is outlined. • Risk categories are to be reviewed constantly and new categories may be added in response to changes in operating environments. • Consider alternatives. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

14. RISK ASSESSMENT • Risk assessment includes measurement, trends analysis, etc. It helps a company to decide which risks are worth pursuing, and which should be shunned. • Risk assessment helps to set priorities based on the threats. • Determine which risks should have the highest priority. • Identify controls and security • Selection of countermeasures • Cost of the control vis-à-vis the benefit • Management appetite for risk • Preferred risk reduction methods (I.e. termination, minimization, transfer/insurance) Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

15. RISK TREATMENT. • Regardless of the sophistication of measures, banks often distinguish between expected and unexpected losses. • Expected losses are those which the banks know with certainty will occur eg the expected default rate of a corporate loan portfolio or credit card portfolio. • Unexpected losses are those associated with unforeseen events e.g losses experienced by banks. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

16. Risk treatment cont’d • Risk management evaluates which risk identified in the risk assessment process require management and selects and implement the plan of action that are required to ensure that those risks are controlled. • Risks with greatest threats are handled first and then those with lower probability of occurrence. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

17. Risk treatment cont’d • In risks treatment, the following strategies may be pursued depending on the severity of the risk evaluated; • Retention • Mitigation • Elimination • Transfer Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

18. Risk treatment cont’d. • Elimination includes not performing an activity that could carry risk. • Mitigation is measures to reduce the severity of loss. • Retention involves accepting the loss when it occurs. It is a good strategy for small risks where the cost of insurance is higher than the expected loss to be suffered. • Risk transfer. All risks that are not avoided are transferred. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

19. RISK MONITORING /REPORTING. • Risks are reported openly and fully to the appropriate levels once they are identified. • Risks are measured regularly to ensure they remain within tolerance levels • Auditing to ensure that the procedures are followed. • A programme of continuous improvement to keep the company abreast of best practices, reduce risk and reduce costs. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

20. RISK MONITORING /REPORTING. • Risks would be kept under regular review: • Management Team and the Audit Committee will regularly review the strategic risks facing the bank. • Heads of Divisions will formally review Divisional Risk Registers as part of the business planning, and • Quarterly reviews or as may be neccessary. • The internal Auditors too review these risks and also requests management response. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

21. SOME CHALLENGES OF AGRICULTURAL FINANCING. • Formal lenders avoid financing agriculture for a host of reasons which include: • high cost of service delivery, • information asymmetries, • lack of branch networks, • perceptions of low profitability in agriculture, • lack of collateral and difficulties in foreclosures, • high levels of rural poverty, or low levels of farmer education and financial literacy. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

22. Some challenges …. Cont’d • But, predominantly, most Commercial Banks would not finance agriculture because of the high degree of uncontrolled production and price risk that confronts he sector. For example, a farmer can be an able and diligent manager with an excellent reputation for repayment, guaranteed access to a market, and high-quality technical assistance, but an unexpected drought or flood can force him or her to involuntarily default. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

23. RISK MANAGEMENT STRATEGIES IN AGRICULTURE FINANCING. • Agricultural finance needs even more and better risk management strategies because agriculture is comparatively a more risky business. • Agricultural finance institutions should care about risk management because the risks faced by the farmer in agriculture have direct impacts on the institution. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

24. Some Agricultural risks. Risks that affect agricultural financing can be broadly grouped as; • 1. Systemic/correlated risks, and • 2. Idiosyncratic/independent risks. • Major systemic risks include production risks (farming practice, weather, pests, etc), price risks, and political risks (export bans, price caps, debt write offs, etc). Both producers and lenders face the impact of these systemic risks.. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

25. Some Agricultural risks. Cont’d • Idiosyncratic risks on the other hand include risks that the borrower faces (life, health, asset, etc) as well as that the lender faces (willful default, wrong estimation of credit-worthiness, wrong pricing, etc) Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

26. Weather risk. • Are those of unfavorable weather on production (eg drought, climate change, flood) pest or diseases. These variables include natural adversities and factors not within the control of agricultural producers. Climate change has become a very important issue in agriculture production and financing. Many countries are now putting in place agricultural practices to mitigate its effects. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

27. Economic/market risk • Market risks are threats due to uncertainty in market conditions. Market risk is more felt in a mono crop economy. Changes in world prices, etc are systematic risks to both lenders and farmers. Data and availability of information on market prices are imperative in managing the risks. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

28. Credit risk. • Credit risk is simply defined as the potential that a bank’s borrower will fail to meet its obligations in accordance with agreed terms. It is the possibility of a loss arising from a credit event, caused by deterioration in the financial condition of a borrower that causes an asset to loss value. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

29. Credit risk cont’d The purpose of credit risk management is to; • maintain the soundness of assets, and • ensure returns commensurate with risk. The consequence is a loan portfolio mix that achieves high returns on capital and assets. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

30. Credit risk cont’d • The major cause of serious banking problems continues to be directly related to lax credit standards for borrowers or, • poor portfolio risk management, • or a lack of attention to changes in economic or other circumstances that can lead to a deterioration in the credit standing of a bank's borrowers. • This experience is common in developed and developing countries. The global financial meltdown is a clear testimony of this. • Loans are the largest and most obvious source of credit risk; Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

31. Strategies for mitigating agricultural risks. • Better management of risks in agricultural financing involves managing risks at; • the level of the borrower, • the level of the lender, and • the level of the economy. • At the borrower’s level, this means reducing and managing risks directly related to agriculture as well as those related to life, health, and productive assets. • Use of improved seeds, • farming practices and technology, • and agricultural development services, and access to agricultural insurance help reduce direct agricultural risks. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

32. Mitigating credit risks • At lenders’ level, Lenders can manage their risk better by • facilitating access to risk management tools for borrowers, • using processes and tools that allow them to assess and manage their own credit-risks better. • The latter involves using improved credit-risk assessment techniques (such as use of credit scoring), using joint-liabilities and sale contracts, better monitoring of loans, and pricing loans according to credit-risk. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

33. Mitigating credit risks. • Credit risk could be minimized by appropriate collateral and information database of borrowers, credit worthiness. The repayment schedule should be designed as such that is convenient for borrowers to repay the loan on time with interest. • Market risk can be mitigated by diversifying income generation sources for rural household. • Group guarantees as away of mitigating risk in micro loans where collateral is not required. Lien deposits, etc • Agricultural insurance. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

34. Mitigating credit risks • Weather risk can be mitigated through accumulation of buffer stock as precautionary savings. • Mitigation of price risks. • This can be overcome by entering into pre-harvest agreements that set a specific price for future delivery. These arrangements are known as forward contracts and allow producers to look in a certain price. Thus reduces risk but also foregoing the possibility of benefiting from positive price deviations. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

35. Mitigating credit risks. At economy level. Better management of risks at the level of the economy includes both indirect and direct measures by governments. Indirect measures include; • Increased investment in infrastructure and research, • Creation of better legal and Policy frameworks for agriculture . Direct measures such as ; • facilitating pooling of risks among national intermediaries and their transfer to global reinsurance markets, and • using futures market contracts to ensure availability and affordability of food to ensure food-security. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

36. Challenge of risk management in agriculture. Absence of or inadequate risk mitigation strategies leads to; • Low private investments in farming and agribusiness, • low availability of finance for farming and agribusiness, • slow adoption of agricultural technology, and • low bargaining power for producers in commodity markets. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

37. The impact of risk on profitability of agric finance institutions. • Weather risk-Unlimited rains and drought, lack of crop insurance. • Liquidity risk- seasonality of agric crops, unlimited amount of savings. • Operational risk- dispersed rural clientele, high servicing costs. • Market risks- lower offer prices, entry of big external players. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

38. Impact of agric risks on profitability…… cont’d • Weather, liquidity, operational, market risks collectively have effects on banks profitability. This is why often commercial banks hesitate in funding loan to this sector and eventually credit demand is not covered by the supply of credits. • Agriculture is inherently dependent on the vagaries of weather such as the variation of in rainfall. This affects production yield of the farmer and ability to pay back and meet basic needs. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

39. The Nigerian Agric. Coop & Rural Dev. Bank perspective • Established in 2000 from the merger of Nigerian Agricultural Bank (NACB) Ltd and People’s Bank of Nigeria (PBN) and the risks assets of the Family Economic Advancement programme (FEAP). • Has authorized share capital of N50billion. • Shares subscribed to by; • The Federal Ministry of Finance Incorporated (MOFI) -60%, and • The Central Bank of Nigeria CBN - 40% Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

40. NACRDB PERSPECTIVE…cont’d • NACRDB is dedicated primarily to agricultural financing at both the micro and macro levels, as well as micro financing of small and medium scale enterprises . • Mandate encompasses savings mobilization and the timely delivery of affordable credit to meet the funding requirements of the teeming Nigerian population in the agricultural and non-agricultural sectors of the national economy. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

41. Services. • Direct Credits • Micro, Small and Medium credit facilities for financing the following agricultural projects: • Arable crops • Fisheries • Horticulture • Agro-Processing • Livestock • Agric Produce Marketing • Tree Crop Production Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

42. Services…. Cont’d On-Lending Schemes – For the purpose of expanding outreach of services, the Bank also lends through: • States Government • Local Governments, • Government agencies, and • Cooperatives groups Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

43. Services … cont’d • Collaborations • The Bank engages in collaborative ventures with • International Agencies • Local Agencies • Governments ,and • NGOs Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

44. Allocation of credit schemes • Micro 70% • Macro( small and medium) 30% Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

45. Services… cont’d • SAVINGS MOBILISATION • General Savings (Individuals and Groups) • Fixed Deposit • Call Accounts CAPACITY BUILDING • Capacity Building services for • Cooperative Development. • Market Information for Agric Inputs and output. • Extension and Advisory Services. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

46. RISK ACCEPTANCE CRITERIA IN NACRDB • The Banks lending policy and guideline is to provide a corporate focus and orientation to credit operators and administrators through systematic and standardized procedures and practices in lending activities. The policies define boundaries of acceptable risk with focus on reduction of credit losses and provide benchmarks of acceptable credit behavior. Viz: • Return on investment must be greater than cost of loan. • The Cash flow Projection at the expiration of the gestation period must be such that the net balance in one period must at least cover all the direct costs in the next period. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

47. RISK ACCEPTANCE CRITERIA IN NACRDB • For most livestock projects, the relevant basic infrastructure e.g. buildings, water supply, etc. must be in place. • Adequacy and realizeability of security offered e.g. secondary source of repayment. • For production and processing loans, the force sale value of collateral must be at 100% of the loan amount. • Valuation of assets must be carried out and adequately established. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

48. RISK ACCEPTANCE CRITERIA IN NACRDB • COLLATERAL • Personal Guarantee • Mortgages • Endowment insurance policies • Cash deposit/ lien deposits • Government Guarantees Stocks and Bonds Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

49. Credit Risk management. • Credit risk management practices may differ among banks depending upon the nature and complexity of their credit activities. In NACRDB, the comprehensive credit risk management program addresses these four areas. • Credit Risk Management (CRM) begins through preventive steps before issuing a loan. • CRM reduces credit risk through loan product design, rigorous client screening, and client orientation to expectations and procedures. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana

50. Credit risk mgt ..cont’d • Once a loan is issued, risk management expands from prevention of the potential losses to control that reduces actual losses through delinquency management procedures.   • Mitigate a significant portion of default risks by designing loan products that meet client needs. Risk mgt strategies in Agriculture financing. AFRACA Workshop. Accra, Ghana