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Agricultural Credit, Value Chain Finance and Contract Farming

Agricultural Credit

The term agricultural credit, in its broader sense, is used to describe the system of banking finance that covers the field of primary production, the processing and trade of agricultural products, and the distribution of agricultural inputs (seeds, plants, agrochemical products). In a stricter sense, agricultural credit is limited to primary production, which is usually not the focus of the banking system’s attention due to its organizational model and the particular attributes that characterize the agricultural sector. Constraints to agricultural credit access have been identified in the theoretical and empirical literature, referring mainly to developing countries and vary depending on each country’s particular context. Jessop et al. (2012), among others, designate as significant constraints high delivery cost, weak farming practices, lack of collateral, exogenous risks, government intervention and weak collaboration among farmers. Moreover, Temu (2009), examining rural finance challenges in Africa, mentions that there are constraints on agricultural credit related to high transaction costs, asymmetric information, low-income cash flows and capital bases, and highly risky commodity and financial markets.

Furthermore, Miller (2008) identifies some key challenges for rural financial service provisions that are currently recognized as obstacles that should be overcome for an effective agricultural credit system. These challenges are related to several constraints, such as vulnerability, operational, capacity, political and regulatory constraints. These constraints affect the progress of expanding agricultural financing and limit its success. According to Gashayie and Singh (2015), donors and governments that had invested heavily in agricultural development banks and agricultural credit in the 1980s and early 1990s found that their efforts did not produce the expected results and withdrew their support. It was hoped that private commercial banks would step in. However, many researchers (Chalmers 2005; Zeller 2003) reported that financial institutions have demonstrated a lack of interest in agriculture finance.

Carroll et al. (2012) identify five alternative “pathways” to address smallholder finance demand:

  • • Replicate and scale existing financing models, such as the one of the social lenders
  • • Innovate new financial products beyond short-term export trade finance
  • • Finance out-grower schemes of multinational buyers in captive value chains
  • • Finance through alternate points of aggregation in the value chain
  • • Provide finance directly to farmers

Each of these pathways has advantages and disadvantages. According to Carroll et al. (2012), they differ in cost structures, value chain typologies, geographies and crops. Thus, some types of institutions are better suited to be the lead financial operator than others for any given pathway, in different markets and credit conditions. However, in all cases, better industry coordination is required to address the smallholder financing gap. Thus, the holistic view of the value chain is critical.

The evolution of agricultural finance, especially for smallholder farmers, has passed from the farm credit era to the microfinance donor era, to the Commercialization of Microfinance Financial Institutions and finally to value chain financing (Gashayie and Singh 2015).

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