Learning to manage risk: CSAF lenders' past year in the context of Inflection Point

Published on

August 31, 2016

The Learning Lab recently supported research by the MIX on detailed 2015 lending data from leading social lenders, who make up the Council on Smallholder Agricultural Finance (CSAF). The findings were summarized in the 2015 CSAF annual report, which takes a deeper look into the current state of the sector through the lens of donors, investors, and lenders. Dan Zook, Director of Investments at the Initiative for Smallholder Finance (ISF), unpacks some of the key highlights from the report, many of which corroborate and illustrate major insights from our study, Inflection Point.

By Dan Zook

Agriculture is an inherently risky industry, and 2015 was no different as a year of substantial and unpredictable risks posing challenges for farmers and agricultural businesses. While finance and markets are powerful tools, lenders in the agricultural sector also faced significant obstacles in their work to finance farmers and agricultural businesses.

A new report from the Council on Smallholder Agricultural Finance (CSAF) – a pre-competitive alliance founded in 2012 by representatives from various agriculture lenders – sheds light on the current state of the sector. From our perspective at the Initiative for Smallholder Finance (ISF), where we focus on intermediating and advising blended finance structures at the philanthropic and capital market level to expand access to finance for smallholders, several key highlights emerge from the CSAF report.  These include new data on risk factors, sector and regional growth trends, and opportunities for smart subsidy and progressive partnerships among CSAF members and industry stakeholders.


Key findings from CSAF’s 2015 Annual Report:

CSAF members play an integral role in financing the world’s 450 million smallholder farmers. The 2015 CSAF annual report draws on the insights from CSAF members Alterfin, Global Partnerships, Inco Fin, Oikocredit, Rabobank, responsAbility, Root Capital, Shared Interest, and Triodos. Key findings include:

RISK MANAGEMENT: A challenging coffee market caused portfolio lending to slow

Compared to CSAF members’ portfolio growth in 2013-2014, the 2014-2015 year saw a significant slow down due to unexpected risks.  Most notably, the portfolio’s slow growth can be attributed to El Niño and the crop disease La Roya. CSAF lenders invest a significant amount of their portfolio in the coffee sector (46% down from 55% in 2014), with a heavy concentration in Latin America (85%), where many farmers and cooperatives were dramatically affected. As a result, CSAF members took a substantial hit to their top line lending. However, when coffee is removed from the dataset, lending for 2014 grew by 25%, which suggests that CSAF members are expanding and diversifying their overall portfolio, despite specific challenges in the coffee sector.

Figure 1: CSAF Lending
Source: 
CSAF Annual Report
Figure 2: Coffee Sector Disbursements and Share of Total

Source: 
CSAF Annual Report

SECTOR AND REGIONAL TRENDS: CSAF members expanded their portfolio to new geographies

Figure 3: Disbursements by Region
Source: 
CSAF Annual Report

Although CSAF members disbursed a vast majority of their credit to Central and South America, they are rapidly expanding their regional presence in new markets as well. For instance, disbursements in South and South East Asia increased by 46% (especially due to growth in rice and cashews) and portfolio disbursements in sub-Saharan Africa increased by 9% (most notably because of Ivory Coast cocoa and Kenya’s tree nuts). CSAF members’ expansion and diversification of their portfolios helped mitigate some of their declines in the coffee market. 

 

BLENDED FINANCE AND PARTNERSHIPS: How CSAF lenders can leverage these approaches to grow the supply of capital, build capacity of agricultural SMEs, and foster enabling environments

The report highlighted that to grow the supply of capital for SMEs and lenders, funders need to leverage blended capital and targeted subsidy to offset risks, market failures, and foreign currency losses involved in the agricultural sector. Non-financial subsidies, such as technical assistance offerings, can also help foster significant market growth and build capacity of agricultural SMEs. Finally, improved public sector legal and regulatory infrastructure and transparency in data and information will help promote a better enabling environment and allow greater access to investment.


How do these findings align with insights from Inflection Point?  

ISF and the RAF Learning Lab recently released a state of the sector report titled Inflection Point, in which we highlighted the large gap between the $200 billion in financing need and $50 to $60 billion in current supply in Latin America, sub-Saharan Africa, and South and Southeast Asia. The report calls for financial service providers to engage closely with customers to design and offer appropriate, desirable products through integrated and innovative partnerships supported by more and smarter subsidy.

Given the global financing need, we at the ISF believe there needs to be considerably more blended financing and smarter subsidy across the industry. The CSAF Annual Report echoed this perspective outlining three main calls to action:

  1. Increase capital supply by leveraging a blend of capital and targeted subsidy to reduce risk and attract investment
  2. Build agricultural SMEs’ capacity by investing in technical assistance for clients (also known as extension services)
  3. Expand risk-management solutions with the help of donors and investors


In regards to the first point, the industry can increase blended capital by attracting investments from public investors – such as development finance institutions and foundations – who can help leverage more private-sector capital by investing in partial loan guarantees, emergency disaster funds, and dedicated funding pools to offset foreign currency losses. The diagram below shows some considerations and examples of other associated subsidy options

Figure 4: Considerations in choosing an appropriate subsidy tool

Source: 
Inflection Point

Furthermore, as cited in the upper-right hand quadrant above, smarter subsidies can be made through sidecar facilities such as technical assistance facilities. CSAF lenders unanimously agree that financial investments are constrained due to the lack of investable businesses. By providing agricultural SMEs technical assistance in financial literacy, business modeling, and agronomic training, SMEs become less risky and more attractive to lenders. To encourage more funding for this type of sidecar support, we believe that technical assistance providers should contribute to the evidence base around the effectiveness of subsidy related to technical assistance by being more transparent about costs and results.

Finally, Inflection Point supports the third recommendation from CSAF’s annual report to expand risk management solutions through donors and investors. In order to do this, Inflection Point, calls for strategic efforts from funders to participate in the design of blended instruments and support coordinated funding activities across investors and donors. Additionally, funders can leverage emerging blending platforms (e.g., Convergence) to identify partners, organize, and deploy funds.

While blended finance and smart use of subsidy is a promising approach to introducing new capital to sectors with low risk-adjusted returns, the process of blending is challenging in its own right. In order to overcome those challenges, there will need to be a higher level of transparency across the industry to create an enabling environment for investors. CSAF’s annual report, which consists of an active collaboration to consolidate and share results, is a great example of just that.

Faster growth is needed

Although CSAF lenders experienced some significant challenges throughout 2015, particularly in the coffee market, they were able to appropriately manage their risk and maintain a fairly even level of disbursements between last year and this year. However, average growth across the smallholder finance market is currently too slow (7% per anum). As cited in Inflection Point, we will need to accelerate growth (14% per anum) to meet the smallholder financing need in a reasonable time frame. To do so, there needs to be a concerted effort around smart and targeted subsidies deployed through new cross-industry partnerships. With these efforts, the industry will draw closer to addressing the financing gap and ultimately make progress in positively impacting the lives of smallholder farmers.

 

About the Author(s)

Initiative for Smallholder Finance
Learning Lab Strategic Partner

ISF is an advisory group committed to transforming rural economies by delivering partnerships and investment structures that promote financial inclusion for rural enterprises and smallholder farmers. Combining industry-leading research with hands-on technical expertise, ISF develops practical, profitable, and sustainable financial solutions.