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Financing for smallholder farmers has high impact and low margins

Honduras, long-plagued by gang violence and narco-trafficking, has become a leading supplier of speciality coffee.

The change follows a dramatic expansion of credit to small farmers in the country. International social financiers, including Oikocredit, Alterfin, Incofin, Root Capital, paved the way for local commercial banks to lend to Honduran smallholder cooperatives, enterprises and farmers. 

For such social lenders, who plough hundreds of millions of dollars every year into nascent, frontier agriculture markets, the very existence of a competitive lending market is itself a success story. “It’s possible that they are going to compete many of us out of the market,” says Root Capital’s Brian Milder of the local banks. “Which is certainly what we hoped for.”

Smallholder farmers are investable

Farmer finance economics

The Council on Smallholder Agricultural Finance’s annual state of the sector report shows a mixed picture. The council’s dozen members, which also include AgDevCo, Global Partnerships, Triodos Bank and others have more than doubled their annual lending to small and medium-sized farming enterprises to $716 million over the last five years. But the year-over-year growth rate fell to just 2%, after robust 12% growth over the previous two years. And similar to small business venture capital, reflecting the challenging economics of small-business investing, the share of lending to smaller agriculture enterprises is decreasing.

A separate report, released in parallel with CSAF’s state of the sector, makes clear how difficult lending into small, often informal and vulnerable agriculture markets can be. A Dalberg study found that members’ average loans are just not profitable. The economics of low revenues (the average loan is $665,000), high discovery costs, and higher risks mean limits the ability to scale up lending.

Boosting financial flows

Some loans perform better than others. Loans in Latin America perform better than those in Africa. Larger loans outperform shorter loans – costs are similar, while revenues grow with size. Shorter term loans do better than longer loans. Loans to existing borrowers outperform loans to new borrowers. Lending into formal coffee and cocoa markets is a better bet than lending in less develop value chains.

Market Access: Helping smallholder farmers in Africa move up the food value chain

But small farmers across the board still need access to credit. Dalberg’s prescription: blended finance instruments that mix grants, guarantees, low-cost lending and technical assistance could help shore up risky, unprofitable small farmer lending. Concessional funding, for example, would lower lenders’ cost of capital, costs that are generally passed on to borrowers. First loss buffers, grants or equity, that absorb a lenders early losses, could encourage lending into new, high-risk markets.

Lending to small farmers in emerging markets is risky business. Such flexible finance can help social lenders lower costs, build markets — and pass the baton, as is beginning to happen in Honduras, to local banks.

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