This blog post, which originally appeared on the Microlinks blog, was written by SEEP staff Sonali Chowdhary and Bethany Bengfort after attending the recent Microlinks After Hours Seminar, ”Viewing Value Chain and Household Finance From a Demand Perspective.”
Financial access for various entities in the rural and agricultural sector is crucial to the mission of sustainable poverty reduction, livelihood promotion and overall economic growth. The nature of the rural and agricultural value chains, as well as the elements surrounding it, imparts both unique challenges and opportunities for innovation in this field. During USAID’s Microlinks After Hours Seminar on February 16, 2012, Geoffrey Chalmers from ACDI/VOCA and Jason Agar from Kadale Consultants Limited discussed these various challenges and innovations, referencing Agar’s report, Rural and Agricultural Finance: Taking Stock of Five Years of Innovations.
What does “innovation” mean in rural finance?
Chalmers and Agar raised some bigger questions like what do innovations truly mean in this field? What do we do when standard business models fall short and how do we bring in new perspectives?
According to Chalmers, recent innovations in the field of rural finance include solutions which address challenges from a demand side while also addressing challenges from a supply side. While traditional approaches often focuses on service providers and products, new solutions in the field are going beyond the product and service provider approach and are looking at household level challenges as well as the overall institutional and enabling frameworks . Chalmers and Agar talked about rural financing needs and challenges across four categories:household finance, non-farm enterprise finance, the enabling environment, and agricultural value chain finance.
Chalmers and Agar emphasized the concomitant nature of each category and the need for an integrated model of finance that addresses the shared constraints within each area. As Chalmers put it, “Often we forget that cash flow involves the entire household, the entire environment- not just the steps on the value chain.”
Multiple-level challenges in rural finance
Household Finance Challenges
Chalmers and Agar noted that some of the biggest financial restraints on households are vulnerability to shocks and the need to meet urgent and non-urgent household requirements like education and health. Poor access to promotional services and lack of financial literacy are additional household level constraints. A lack of basic needs combined with poor cash flows force households to focus on short-term gains rather than maximizing long-term business opportunities.
Non-farm enterprise finance challenges
A major challenge for non-farm enterprise financing includes poor understanding of household borrowing capacity in a non-farm context. “Rural” is often associated with agriculture, and non-agriculture related businesses in rural areas are given far less attention than their urban counterparts. This leads to poorly designed products for the rural non-farm sector and to conservative lending which relies more on collateral and less on an understanding of household cash-flows.
Chalmers and Agar noted that progress in this field include improvements in collateral requirements and an increase in the physical presence of financial institutions in rural areas through cellular access, banks on wheels, etc. Both noted that there is still a long way to go in this area.
Enabling environment challenges
Challenges in this area include the high cost of access to rural markets which deters institutions from providing needed services combined with inappropriate legislation and an inadequate regulatory framework. Microfinance institutions (MFIs) that are better positioned to service the rural poor have limited access to capital, inhibiting their ability to take risks in the area of rural lending.
Innovations include smart partnerships and use of technology combined with improvements in MFI strengthening and increased access to capital.
Agricultural value chain finance challenges
Chalmers and Agar observed that many of the problems facing the agricultural value chain were present in the other categories, including poor infrastructure for remote households, seasonality of products, price distortions, skewed perceptions of risk, unequal access, lack of storage capabilities, and the difficulty of analyzing and assessing proper cash flow needs. Many of these factors contribute to market disruptions such as side selling, increased risk, and general failure to access finance in any area.
Solutions require addressing the problems in every category by developing relationships based on mutual incentives. For example, offering integrated support packages that allow both farmer oversight and “hungry season” support reduces side-selling by addressing the household need for year-round cash flow, the business need for reduction of risk and market disruptions, and general improvement of liquidity and trust.
Integrated support packages in recent years have included innovations in disaster response, various kinds of insurance, marketing and outreach efforts, and promotion and encouragement of saving. For example, index based insurance, which is based on measurable factors like rainfall, drought, and snow, is an important risk mitigating tool because itbrings down the cost of monitoring by eliminating issues of moral hazard and information asymmetry.
Chalmers and Agar talked about two key risks in value chain financing: side selling and risks associated with price and markets. Innovations mentioned that address side selling are products like hungry season payments, agriculture commitment savings, measures to increase liquidity and the provision of integrated support packages that reduce the need for urgent selling at a household level. Innovations that address risks in price and markets include offering fixed price bands, formal or informal contracts, index insurance and integrated packages.