Managing Risks in Financing Agriculture

1. Managing Risks in Financing Agriculture Renate Kloeppinger Rural Finance Adviser The World Bank AFRACA Agribanks Forum 4-7 May 2010, Abuja, Nigeria

2. Presentation Outline • Background • Findings from a Conference • Findings from a Study • Conclusions

3. Background • Agriculture Credit - The history of failed interventions • Agriculture Credit – Overview of recent approaches • World Bank’s work in Agriculture Risk Management • Food Crisis and the renewed interest in Financing Agriculture • Studies, Conferences, and New Interventions

4. 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

5. 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

6. 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

7. Expert Meeting on Managing Risk in Financing Agriculture, April 2009, Johannesburg14 Findings • 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

8. The Study on Credit Risk Assessment and Management – The Questions • Agricultural Credit Risk Assessment • 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?

9. 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

10. 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

11. Study Findings - Credit Risk Assessment • Small Loans • Approach 1: Parametric (rules of thumb, experience-based) • 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

12. 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

13. 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.

14. Some Conclusions • Lending to small farmers at scale requires non-traditional 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