What’s Holding Agricultural Finance Back?: The MIX describes what’s needed to help this crucial sector grow
Three-quarters of the world’s poor live in rural areas, and most of them depend either directly or indirectly on agricultural activities. Consequently, one of the most effective ways to reduce poverty is to increase agricultural productivity, which improves farmers’ incomes through higher yields and better returns for their crops. However, for many farmers, access to yield-increasing technologies and inputs only becomes a realistic possibility with access to financial products specially tailored to their needs. A farmer’s investment decisions (like everyone’s investment decisions) are dependent on the financial instruments available. Expanded access to agricultural finance products broadens the range of options available to those who earn their livelihoods through agriculture, offering them appropriate tools to manage their risks and improve the efficiency of their production. Unfortunately, as we know, financial services of any kind are scarce in rural areas.
Rural v. agricultural finance
It’s true that most agricultural activities take place in rural areas, and it’s also true that economic activity in rural areas is quite often related to agriculture. So it’s not hard to see why “rural finance” and “agricultural finance” are sometimes used interchangeably. That said, it’s important to distinguish between these concepts.
On the one hand, agricultural finance is a sectorial concept that refers to providing financial services to households and business that are engaged in agricultural activities. These services can include crop, livestock and index-based insurance products, warehouse receipt financing, leasing, savings, and payment services, among others. The need for financial products extends from the first planting to the warehousing of harvested crops.
On the other hand, rural finance is a geographic concept that refers to financial services offered to individual clients and businesses physically located in rural areas. While agriculture is a very important activity in rural areas, it is not the only activity. In rural zones, just as in cities, we find shopkeepers, cooks, carpenters, teachers and government officials, among others.
Keeping in mind that there are agricultural activities that go on in urban settings as well, we could generally consider agricultural finance as a subcategory of rural finance. It’s also important to be aware that, although many households that are dependent upon agricultural activities are poor, agricultural finance is a concept that takes in everything from offering remittance services to farm day laborers, to providing lines of credit to large-scale agricultural businesses. In this sense, when we want to talk about the provision of financial services to low-income farmers, it is probably more precise to use the term “smallholder finance.”
Why might agricultural finance fail to take root?
So, if agricultural finance is such a clearly winning idea, why don’t we see more of it? Despite a currently renewed interest in this area of financial inclusion, a combination of factors continues to limit its growth:
- Most agricultural activity takes place in rural zones. The dearth of financial service providers (FSPs) in rural areas simply and directly limits access to savings, insurance and credit products for the farmers and agribusiness that make their home in these areas.
- Lack of agricultural know-how on the part of FSPs creates hesitancy. In order to accurately assess the financial performance of an agricultural business, FSPs need to develop specific knowledge – from crop cycles to the characteristics of a valuable and healthy cow. In the absence of this knowledge, FSPs may be hesitant to take on the risks associated with financing agricultural activity.
- Agricultural activities tend to be seasonal. This leads to a concentration of risk that is unpalatable for some FSPs.
- Many farmers lack necessary collateral to back financial services.
- Data on agricultural finance is scarce.
What we need to know about agricultural finance
Probably one of the most important constraints for FSPs and policymakers in the promotion and advancement of agricultural finance is the lack of reliable data. In fact, there is a clear need for the collection, organization, analysis and dissemination of agricultural finance data (both supply and demand side), which is crucial to better understanding the position of those who depend on agricultural activities from the standpoint of financial inclusion. Better data could aid FSPs to provide adequate products and services by providing information on the profiles of agricultural clients, and it could help policymakers assess the state of demand and supply for these products and services.
One unusual characteristic of agricultural finance is that not all regulators require banks and financial institutions to report data on their agricultural lending, including the amount, term, loan purpose and repayment performance, which creates a challenge to obtaining this important data. The fact that a large proportion of agricultural credit is provided in the form of inputs or trade finance by companies in the same agricultural supply chain, contributes to the murkiness of data. It is also true that agricultural finance providers go beyond banks and microfinance institutions, and include many nontraditional suppliers of credit.
The Microfinance Information Exchange (MIX) is committed to collecting and disseminating reliable data on agricultural finance and the agricultural sector, with the long-term goal of supporting greater financial inclusion for those who depend on these economic activities. With this objective in mind, and with the generous support of the Citi Foundation, we have developed an “agricultural finance data framework” to collect and share data on national agricultural sectors and agricultural finance, adding to its existing financial inclusion datasets. In an upcoming blog, we’ll discuss the details of the framework. In the meantime, the MIX continues to gather country-specific data related to agricultural finance. Check in with http://www.finclusionlab.org, our new financial inclusion data visualization platform, to find the latest geo-spatial tools for India, and in-depth data on agricultural finance for five Indian states.
Xavier Martin Palomas works as a financial inclusion data analyst consultant at the Microfinance Information Exchange (MIX).