NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

The world’s population is expected to reach 7.5 billion by 2020 – and global demand for food is expected to grow right along with it.

Improving smallholder farmers’ access to credit can empower smallholders to help meet the growing global food demand, while also combating extreme poverty, as more than two billion of the world’s poorest live in households whose livelihood depends on agriculture. Currently, however, most smallholders lack the funds to invest in productivity and connect to markets, and many of the businesses that aggregate smallholders lack access to the credit needed to support growth and reach additional farmers.

Social lenders present one possible solution to these challenges. Also known as “impact-first” agricultural lenders, social lenders invest in small and growing agricultural businesses in low- and middle-income countries. These businesses aggregate hundreds or thousands of smallholder farmers to connect them with markets and, in some cases, provide services such as agronomic training and farm input credit. Seven social lenders – Alterfin, Oikocredit, Rabobank’s Rural Fund, responsAbility Investments AG, Root Capital, Shared Interest, and Triodos Sustainable Trade Fund – represent the majority of lending in this sector. Together, these lenders launched the Council on Smallholder Agricultural Finance in April 2014.

The social lending sector is an attractive opportunity for investors and funders to increase access to finance for smallholder farmers and businesses that aggregate producers. Relative to most local lenders – for example, commercial and microfinance banks – social lenders offer larger and more geographically diversified portfolios. Social lenders are further differentiated from local lenders by their triple bottom line focus and by their non-traditional approach to securitizing loans, in which they frequently accept purchase orders from global buyers as security instead of requiring hard collateral.

Investors and funders have a range of options for supporting the social lending sector, depending on their target financial returns and social impact goals. The new Investor and Funder Guide to the Agricultural Social Lending Sector, published by the Initiative for Smallholder Finance, illustrates the variety of roles that a funder or investor may choose to play in the social lending sector. A few scenarios are outlined below. These do not represent an exhaustive set of opportunities and, as with any grant or investment, investors will need to evaluate each opportunity against their own financial and impact objectives.

For investors focused on market building and targeting net returns of 0.5 to 2.5 percent:

Investors targeting net financial returns in the range of 0.5 to 2.5 percent can support social lenders focused on lending to earlier-stage businesses. These social lenders typically disburse smaller loans to younger and smaller businesses with a limited financial track record. They may seek new clients in core markets and new geographies or commodities.

Social lenders report that it is often unprofitable to lend to early-stage businesses, as it takes three to five years for revenue from these clients to cover their loans’ operating costs. Given this lag time, social lenders working with early-stage businesses typically construct blended portfolios, targeting smaller and less-mature businesses as new clients and maintaining relationships with these borrowers as their lending needs and revenue grow. Once they have established a relationship with a client, these lenders typically do not stop lending to them; instead, the revenue from the larger loans of more mature clients subsidizes lending to earlier-stage borrowers and stabilizes social lenders’ portfolio. Grant-funded technical assistance providers also give critical support to the early-stage businesses that these lenders target.

For investors focused on market scaling and targeting net returns of 2.5 to 5 percent:

Investors targeting net financial returns in the range of 2.5 to 5 percent can support social lenders focused on lending to more mature businesses. Social lenders playing a scaling role typically disburse increasingly larger trade finance loans and/or new financial products, including working capital and long-term debt, to larger and more mature businesses. In core markets, many of these clients have borrowed from social lenders in the past; in other markets, these businesses are more often new to the social lending sector. Given their focus on larger clients with track records, these lenders’ portfolios have a higher likelihood of financial stability.

There is likely a long-term need for lending to larger and more mature businesses. Investors can help social lenders further extend their lending to these businesses by tailoring capital to support the deployment of new financial products. For example, to meet borrowers’ need for long-term debt, social lenders will require access to longer-term capital with more flexible terms, such as grace periods, to accommodate the cash flow characteristics associated with crop rehabilitation or new facility construction.

For funders and investors deploying grant capital:

Grant capital is important for supporting the social lending sector’s expansion. The development of new sector infrastructure and complementary technical assistance activities can help address common challenges faced across lenders and facilitate broader sector growth.

One such challenge is the need for a neutral third party to collect, analyze and report social lenders’ lending, finances and impact data on a regular basis. So an ongoing data collection and reporting platform for social lenders would be one possible example of sector infrastructure that could support responsible growth. This potential platform would allow social lenders and their investors to monitor and communicate sector progress along financial, social and environmental dimensions. More rigorous impact measurement would also improve lenders’ ability to monitor borrower business performance and associated risk.

Increased technical assistance for current and potential social lender clients will also contribute to the sector’s growth. Grant-funded technical assistance is required to aggregate smallholder farmers into new producer groups or connect them to other value chain actors, and to help early-stage businesses become eligible for social lender loans. Technical assistance is particularly critical for growing the pipeline of potential social lender clients in non-core social lending markets – for example in countries such as Ethiopia, Indonesia, Uganda and Colombia. Technical assistance can also support the provision of long-term capital, because it increases clients’ capacity to prepare the business plans and financial projections typically required to secure long-term financing.

Growing the social lending sector is one important pathway towards meeting the significant unmet demand for smallholder agricultural finance. To read the complete Investor and Funder Guide to the Agricultural Social Lending Sector, click here.

Laura Goldman is a project manager in the New York City office of Dalberg Global Development Advisors.