4. Value Chain Loan
Value chain finance is a financial method to enable investments and loans within the value chain. This type of loan is a partnership between different actors in the same value chain, who want to increase the productivity and the competitiveness of the value chain itself. Suppliers and traders act as financial providers and enable farmers to access financial products, which they would otherwise not be able to obtain from classic financial institutions. Value chain actors either lend their own capital to farmers, or, if they do not possess the financial means necessary for the loan, they act as financial mediators between farmers and FIs. Actors involved in value chain loans work with a business financial model.
This type of financing creates a win-win situation for all parties: farmers obtain a customized loan, which they will need to start to pay months after the disbursement, suppliers and traders guarantee themselves a profit through the interest earned and the improved value chain.
The main advantage of a value chain loan is that it reduces the typical risks of agricultural financing. Suppliers and traders, working at the local level, take care of money transfers, facilitating the transactions. Furthermore, thanks to their personal relationship with farmers, suppliers and traders can guarantee for them. The main disadvantage is the interest rate which can be as high as 30% since banks` interest are summed up with financial mediators’ interest.
This financial model can also apply to loans for the purchase of SPISs:
- SPISs’ producers supply farmers with the technology, farmers need to pay them just at a later time, normally after the sale of the harvest. Using this type of loan, more farmers will be willing to purchase a SPIS, and suppliers will increase their customer base.
- Food traders instead, pay farmers in advance for the food they will buy at a later point, providing farmers with the cash necessary to purchase a SPIS. Farmers in return will guarantee traders the delivery of the food after the harvest. Food traders agree to this kind of financial agreement because they have obligations to deliver a high quantity of quality food to downstream actors. SPISs increase both these variables. Furthermore, traders use this type of loan to earn the loyalty of farmers, preventing them from selling their harvest to other interested buyers.
Examples of value chain loans both from upstream and downstream actors include:
Hortifruti is a company which provides fruit to wholesale supermarkets in Costa Rica. In the 70s, when Hortifruti started to operate in the sector, the fruit market was fragmented, farmers lacked infrastructures and technologies, making it impossible for retailers to sell good quality fruits on a large scale. Hortifruti, therefore, decided to support farmers with technical support and financing. Hortifruti developed two types of financial models: a bank financing and a non-bank financing model. The bank financing was supported by the BAC San Jose´- Hortifruti guaranteed to the bank that they will buy fruits from the farmer with the bank financing comprising 60% of the production costs. In this model, no collateral was requested, but an insurance on the yield was required. The farmer, needed to pledge that he will deliver the crops to Hortifruti at a later point. With just a selling contract, the farmer was considered creditworthy at BAC San Jose`. The second type of loan is a non-bank financing model in which Hortifruti paid for 30% of the fruit production costs. No interest was charged. The farmer only needed to sign a contract to deliver the food in the future and in return obtained the required inputs.
An example of an upstream value chain loan is the one offered by the equipment dealer SolarNow in Kenya. SolarNow proposes loans with 6, 12 and 24 months terms. In order to get a 6 months loan, the farmer needs to deposit half of the price of the pump upfront, to secure the loan. Since the total price of the pump is KSh. 68,500, the payment will be of KSh.34, 250. After the first payment, six equal installments of KSh. 6,550 each will need to be paid. At the end of the loan, the farmer will have paid KSh. 73,550, which is 7% more expensive than the original price of the pump. For the 12 months loan, the upfront deposit will be of 15%, followed by 12 monthly payments of KSh. 10,275 each. Finally, the 2 year loan requires a 15% deposit also, followed by 24 installments of KSh. 3,850 each.
Futurepump in Kenya provides farmers with the option to purchase a SPIS through loans with major banks. Equity Bank offers loans up to 2 years with an upfront deposit of 30%, a 5% set-up fee and an interest rate of 14%. With KCB, a lower deposit of 10% needs to be given in advance and the interest rate is 14% plus an additional set-up fee.
Finally, SunCulture ran a pilot initiative in 2017 with 150 Rainmakers. Every Rainmaker cost KSh. 50,000. Farmers needed to deposit 20% of the total cost followed by 12 monthly installments of KSh. 4,500 each. Therefore, every farmer invested KSh. 64,000 in the system. This price did not include the delivery, the installation and the training cost. After this pilot project, SunCulture decided to increase the price of the Rainmaker since they decided to improve the product and they realized that higher margins are needed.
Farmers will obtain a loan under the following conditions:
- Documents of Identification.
- Bank account: In order to check the farmer’s cash flow and transactions.
- In some cases farmers need to pay a deposit: In order to secure the loan.
- Show the existence of a market for the food produced.
- Prove one or two successful past harvests: In order to verify the experience on the field.
- This type of loan, implies a closer relationship between farmers and financial providers. The latter need to trust farmers and be convinced in their ability to succeed and repay the loan.
- Sometimes financial institutions ask for quotations from suppliers and traders (similar to a guarantee).
- Purchasing or sales contracts are necessary to finalize the loan: FIs need to be sure that the farmer will earn money.
- Collateral as assets and alternative source of income are normally not required.
- Farmers do not need to be landowners: land could be rented or leased.
- Size of the farm and type of food cultivated play an important role: Traders have obligations to supply downstream actors with large quantities of a specific product, therefore they will choose among farmers, who meet their expectations.
- Upstream / Downstream Actors (SPIS’s manufacturers and suppliers, food processors, food traders)
- Financial institutions
Value chain loans can reduce farmers` independence. Buying and purchasing contracts are mostly necessary for the loans, binds farmers to specific suppliers and/or distributors. Furthermore, farmers need to meet some requirements in order to be eligible for a loan.