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A few weeks ago I reviewed this post by Steve Hodges – an international risk consultant who is doing some good work in South Sudan and Uganda.  He talks about a number of agriculture risks that small holders (farmers) face and of course his view primarily stems from the bank side and if not from the financial institutions’ view, then an academic, textbook, or theoretical one (no fault of the author, that’s just the vantage point from which most of us look when thinking of finance and risk – since most folks who talk about risk this way are not farmers themselves).

His post, in summary, speaks to a conventional textbook risk management and mitigation framework that aims to deliver a farmer ‘success’ by addressing the said risks in a logical, somewhat linear fashion.  That by utilizing the risk management framework, the farmer will then be more attractive to financial institutions who will then push credit or insurance products to these peasant farmers.  The general textbook approach is that of:

  1. identifying agricultural risks (Production, Price / Market, Financial / Credit, Human, Legal, Policy, Catastrophic, Value-Chain / systemic, and Organizational Capacity risks)
  2. evaluating agricultural risks (Severity of Impact, Probability of Occurrence, Ability to Manage the risks), and
  3. implementing risk management methods (via prevention or mitigation, transfer or sharing risk, and dealing with, coping, or diversifying their ability to respond internally).

If the peasant farmer were to follow these steps, would we no longer have challenges in the South related to agriculture and development?

This idea reminded me of a conversation I had in 2007 with one of Uganda’s Presidential Cabinet members who also happened to be attending a local agriculture fair.  I spoke of planning as the bedrock to farm success – not just production choices, but finances and marketing ideas too.  The Cabinet member looked at me with a grin and said, “if we all plan correctly, then our [farm] development problems will go away?”  I’ve since recognized how limited this planning view is and how complex agriculture can be – including the biased viewpoint that the farmer must bear all the risk, when there truly must be a multi-stakeholder approach to agriculture for it to be sustainable (in the long term).

To dispel any myths of risk management and mitigation, the World Food Program (WFP), International Fund for Agriculture Development (IFAD), and the Africa Agricultural Markets Program (AAMP) all point to different conclusions as they research alternative financial products that attempt to address agricultural risk.   They find that textbook risk management methods are limited in dealing with large shocks and these methods are not enough to address the negative impacts to small holder farmers in the South.  In fact, the view from which Steve comes from forgets that households in the South are extremely resilient and have incorporated quite novel and effective ways of managing and mitigating risk for high frequency low covariate risks – we just need to highlight those ways and translate them so that the bank will understand them when drafting policy, terms, or covenants.  For instance, peasant and small holder farmers already diversify their crop, they already fragment their farms sometimes renting out plots in entirely different villages, and they also sometimes share-crop – farming a portion of land owned by elites (all ex-ante or preventative methods to risk mitigation).  Many farmers also access informal forms of credit borrowing from neighbors and family members, they supplement their income with additional employment outside the farm, and they save what little they have either in cash or in physical assets on the farm such as goats and/or chickens (all ex-post or treatment methods to risk mitigation).  The most significant methods, which are counter to the individualistic society that modern financial institutions originate from, include sharing – of food stocks and other resources from family and social networks.  Imagine that.

Is there a loan term or covenant that aligns with the idea of sharing within financial institutions?

Even with these risk mitigating measures, small holders are unable to deal with large (infrequent) catastrophic shocks or highly covariate risks such as flood or drought which impact everyone in the area at the same time and therefore their family and social networks they rely on for protection.   Based on my prior research on famine in Africa, typically one shock (including catastrophic) is manageable, but when multiple shocks hit, that’s when we begin to hear about famines and hunger and that’s when the farmer would have sold off many of his remaining assets for food.

And there is an economic aspect to this as well.  As noted by Rashid and Jayne, without risk management institutions, farmers adopt less risky and less profitable land used that result in overall lower productivity thereby reducing farm income by as much as 30% if farmers had the option of effectively mitigating risks through these institutions.   These authors are referring not just to the private sector, but public institutions that can offset risks through policy, redistribution, risk sharing and risk transfer.   *Note:  the OECD report that Steve derives the Ag risk profile from clearly states that farmers should be ‘empowered to take responsibility for risk management’ – as if the only stakeholder in the room is the small holder!

Traditionally, there are four government led responses that have been employed and that continue to be debated as to their efficacy (these are methods of mitigating, transferring, or sharing risk):

  1. Price Stabilization – unfortunately, this is the avenue taken when governments attempt to mitigate price risks, thereby taking control of markets by increasing food stocks and further depressing prices, discouraging private investment, and stunting agriculture development.  This is all-together independent of preparing for disasters by carrying reserves, as we’ll see next.  However, price stabilization focuses on the symptoms and not the source of the problems which are infrastructure, information, and institutions.  It would be great if African countries could meet the CAADP requirement of 10% expenditure on agriculture, but not if that is going to increasing food stocks, further diverting much needed investment in market fundamentals as noted above.   Plus, a recent study concludes that countries pursuing food price stabilization policies through state interventions have higher price instability and lower productivity.
  2. Strategic Grain Reserves – these are a must with increased drought, civil strife, and other public health related issues as well a country’s inability to respond to crisis in a timely manner vs. relying on external assistance.  However, these reserves have to be autonomous and free of buying and selling in the market, they should be integrated with other social welfare programs, and civil society must have a voice in decision making on those reserves – otherwise, if countries continue to move in the direction they are headed now by increasing reserves above a 3-month carrying period, this starts to distort markets, depressing prices by as much as 40% to 70%.
  3. Crop Forecasting & Market Information – think systems and feedback loops here.  Unless the government has extremely reliable data, their efforts to predict production levels backfires as delays build up within the system, leading to greater price volatility for farmers.  See Rashid and Jayne p.10 for an illustrated example.
  4. Technology and Infrastructure Investment – years of international development history doing this has not provided the intended results – see Sach’s Millennium Villages; policy options are required that are more comprehensive in scope and that include institutional development, information systems, better governance, and education/Ag extension to name but a few.

The recent trends in addressing agriculture risk are considered ‘modern’ methods and these are being piloted now.  Weather indexed insurance, well publicized grades and standards for agriculture products, warehouse receipt systems, commodity exchanges, and public-private partnerships each have programs in various countries, however none to the scale necessary for fundamental change and each has its drawbacks and challenges.   For starters, these ‘modern’ methods assume that the private sector is capable of absorbing this market of risky investments in farmers who are spread throughout rural areas.  It still is a tough sell to a commercial financial institution to sell low-value (in the banks view) products to rural farmers due to the costs associated with its loan portfolio (costs include labor, training, travel, loan losses, etc.) when you contrast this against a higher-value loan size.  Another reality is that these ‘modern’ approaches are still ex-post or treatment in orientation where the source of the risk still remains an issue – in many cases the sources of risk are agro-ecological (food sovereignty), infrastructural (transport, power, information, and communication systems), and institutional (legal, governance).  Lastly, it turns out that income plays a significant role when addressing risk.

Warehouse Receipt SystemsVideo

Summarizing Rashid and Jayne’s Table 2 on p.5, there is no way for farmers below the poverty line to afford the more modern insurance products nor do they have the transaction size necessary for a commodity exchange.  They therefore must rely on social safety nets, distribution from reserves and emergency relief to mitigate risk – all via public institutions, sharing, or social networks.  In essence, income matters when looking at risk mitigating methods and the standard view typically lumps all farmers into one category which is not helpful.

So where does this leave us with financial institutions ability to support small holder farmers? 

Agriculture is still a risky business for financial institutions to engage.   One of the primary issues banks have relates to highly covariate risks – where farmers face a shock at the same time as everyone else in the region causing multiple defaults.  Another issue financial institutions have is managing the independent risks since servicing loans with more small holders is costly and they realize that repayment is not always a certainty.  In order for financial institutions to boast about loan loss rates below 5%, they have to choose higher value loans, typically serving fewer and larger farmers and in a specific region although diversified within the industry by segment (i.e. wet crops vs. livestock vs. fish, for instance).  The fact that many Sub-Saharan African country populations are so widely dispersed adds to the challenge – density is a key contributor to financial service delivery.

Even if the financial institution was to create a rural program within its office, they would still need to train their staff to better relate and develop products that catered to their newfound clients, which it turns out is a bit difficult since many small farmers have many different needs – there is not a standard need that they all face – and it turns out culture is a key factor as well, see my original response to Steve.  Outside of capacity and social considerations, commercial financial institutions require collateral – this is the biggest hiccup since what is accepted as collateral is minimal, primarily tangible assets that can be seized by the bank and we all know that land tenure systems in the third world are unstable.

Can financial institutions accept alternative forms of collateral?

Some alternatives banks could begin considering are:  Social Groups (i.e. Grameen Bank borrowing groups that self-manage independent risks which impact repayment) , Future Revenues via Buyer Agreements, Partnerships with NGO’s, firms, or local governments, Future Revenues via Royalty Financing, even the valuation of exchanges in Products or Labor when defaults do occur.  Although these forms of collateral are not widely accepted, they are finding their way into the conversation with Community Banks, Community Development Finance Institutions, and International Development Finance Institutions.  Here, the issue is the viewpoint from which one looks.  If from the farmer’s view, the question becomes:  ‘can we (farmers) access capital using our already powerful methods of risk mitigation?’  The answer from the bank’s view is clearly no, but innovation is opening up new pathways for institutions to chart and they can begin to incorporate alternative perspectives.

Aren’t all the ‘solutions’ to risk above still geared towards our current unsustainable financial system?

If you haven’t noticed, all these efforts are still geared towards feeding banks with new customers, which we know does not necessarily have a good track record with helping the economically poor.  It can help those who are above water, who can always hedge bets, and hustle for money, but often times (if not all times) it is at the expense of others, typically those who believe in trust, sharing, and an altogether different view on how to find contentment.

We can also consider other forms of capital (e.g. community capital, social capital, etc.) and other more local solutions to these risks and challenges that, not purposely, exclude banks.  Take for instance these more liberal, integrated, and inclusive community capital oriented ideas for risk management and mitigation:

  • Care for the Soil (Environment):  Improve the soil (the land) via permaculture and sustainable agriculture practices using local resources (e.g. organic composted manure, organic teas made from local trees and plants, mulching and digging for water retention, planting nitrogen fixing trees, mixed/companion farming, etc.), at low cost, and with non-toxic inputs.  See Symphony of Soil below.  This has the capacity to improve production – an area of concern for the bankers.
  • Care for Local Economy (Exchange):  “Import substitute” to build sustainable local economy and resilience to external shocks.  Jane Jacobs wrote prolifically on these ideas in ‘Cities and the Wealth of Nations’.  In essence, find ways to build products and services that people around you need and desire – and do so with an urban / dense area in mind in order for creativity to blossom.
  • Care for Each Other (Humanity/Community):  It is not necessary to take the path that our modern form of competition asks of you.  You can share and give to build wealth – banks need to understand that and we need to find a way to allow them to translate that beautiful aspect of life into their policies.  Plus, competition derives from the Latin root competere, which means “to strive together”.  When two runners strive to push each other to become better, they both win.  The same principle of competition needs to be reinstated in how we do business.  So when two banks work to build services and products for all, equitably, they both will win and so will the economically poor.

Imagine putting forward policies and practices within institutions that feed our souls and our communities with the beauty and peace that we all strive for.  There is no reason these forms of collateral could not be used by financial institutions – but if they are not ready for it, then community capital might be our only way to managing risk locally and therefore improving the likelihood that our farms can take care of us.

We have lived our lives by the assumption that what was good for us would be good for the world.

We were wrong.

We must change our lives so that it will be possible to live by the contrary assumption, that what is good for the world will be good for us.  And this requires that we make the effort to know the world 

and learn what is good for it.

~ Wendell Berry

6 thoughts on “Ag Risks – Realigning the Bank’s View

  1. Another significant small farmer risk that is out of the hands of farmers themselves and is not accounted for in bank portfolio reviews is: international aid – this political aspect of the food system interferes with local economies and disrupts and creates disequilibrium. See http://bit.ly/1b6EAoL, this isn’t the solution to addressing the larger issues of trade policy favoring the Northern powers, but it is a step in the right direction.

    The Royce-Engel amendment to the Farm Bill would at least stop our export of excess grain production and instead offer a subsidy to international organizations/NGO’s to purchase food locally to support the poor… this is better than completely dropping prices on those in developing countries who earn a living producing and trading food products, but it continues to exacerbate a local solution – sure folks will be fed, but will that prevent them from raising their voices and asking for change from their own governments? The local social contracts for food are further distorted if money is inserted into the economy (in essence inflating local prices) if not controlled by the central government. These excess cash flows, if handled by International NGO’s, could possibly increase the number of folks who would be priced out of the market due to the increased demand for food, increasing prices – the opposite effect of what direct food aid does, which is to depress prices. So in the end, how many are disempowered with direct food aid vs. those who are priced out of the market with cash infusions to the local marketplace…? Seems like another well intended policy about to go wrong.

    If, however, the aid was delivered to the government who then controlled the cash flow (which has its own issues related to governance, and again questions local responsibility over budgetary priorities) then at least those purchases could be instituted within some type of system or program – creating an incentive for locals to participate in the market if the government were to make purchases for its people. this doesn’t sound appealing either, but at least people could protest how their government is misallocating their own money vs. being voiceless with outsiders interfering in the markets.

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  2. Pingback: Redesigning Our Food Markets | Talk About Food

  3. http://bit.ly/1alkF6s

    This report highlights the view from which I speak above, that the bank, without the right investment into their own operations to support a new client base, can never truly support small holder Ag finance – a risk for all small holders.

    “Access to finance for smallholder farmers can serve as a critical catalyst for economic growth and poverty alleviation. Yet local bank lending – which should be a main avenue for smallholder financial access – meets only 3% of overall demand. Currently, global development donors have tried to incentivize bank lending to smallholders by focusing on guarantees, but those have not been sufficient to stimulate lending.

    Banks need investment funds and technical assistance to build their smallholder banking capabilities. If local banks increased their capacity to serve smallholders, they would support over two billion of the world’s poorest people who depend on agriculture for their livelihood.”

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  4. An interesting model where an NGO (Oxfam) partnered with the HARITA (Horn of Africa Risk Transfer for Adaptation) project in Ethiopia that soon became R4 – Rural Resilience Initiative. R4 builds on the initial success of HARITA, an integrated risk management framework developed by Oxfam America, the Relief Society of Tigray (REST), and their partners to enable poor farmers to strengthen their food and income security through a combination of improved resource management (risk reduction), insurance (risk transfer), microcredit (prudent risk taking), and savings (risk reserves).

    The success of this model is based on building up local assets of the farmer (or farmer group) – but even before that, improving financial literacy so that insurance is something that farmers trust and consider a viable investment. And, apparently, there is no fine print on Swiss-Re’s contract terms – so no “Acts of God” but rather quite practical information based on rainfall which farmers can connect to via their mobile phones to local weather stations.

    See video: http://www.oxfamamerica.org/multimedia/video/r4-the-rural-resilience-initiative

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  5. Here is a great model on public decision making that can also apply to loans. Offered to us by Ursula M. Franklin in the Real World of Technology (http://www.cbc.ca/ideas/massey-archives/1989/11/07/1989-massey-lectures-the-real-world-of-technology/) during the Massey lecture series:

    “Should one not ask of any public project or loan whether it 1) promotes justice, 2) restores reciprocity, 3) confers divisible or indivisible benefits, 4) favors people over machines, 5) whether its strategy maximizes gain or minimizes disaster, 6) whether conservation is favored over waste, and 7) whether the reversible is favored over the irreversible?”

    Behind this statement is the underlying premise that “…scientific constructs have become THE model of describing reality rather than ONE of the ways of describing life around us. A a consequence there has been a very marked decrease in the reliance of people on their own experience and their own ideas.”

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  6. http://www.nextbillion.net/blogpost.aspx?blogid=3890#.U3-tbCz-nMM.twitter

    “Why can’t financial institutions in developing countries meet the demand for credit from SMEs?

    One reason is that these firms represent a particularly difficult market for financiers. The strategies that banks use to loan to large companies – ie: meeting with firm management, gathering and analyzing a packet of financial documents and doing industry research – are too costly to apply to SME applicants. In other words, SME loans are too small to make it profitable for banks to carry out the same level of due diligence that goes into issuing a loan to a large company. At the same time, SMEs require loans that have different risk characteristics and are too large for traditional microfinance lending.”

    “Although revealing a credit score did not change loan outcomes, like the average loan amount or default rates, it improved credit allocation. In other words, credit scores reduced uncertainty about borrowers’ creditworthiness, allowing banks to extend larger loans to less risky borrowers and smaller loans to riskier ones.”

    Credit Scoring!

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