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Value chain finance. Building upon chain relationships. Day 2. Today. Finance in the value chain What is value chain finance? How does it work? When is it relevant? Two cases: honey chain in Kenya and rice chain in Rwanda Assignment for work session 2
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Value chain finance. Building upon chain relationships Day 2
Today • Finance in the value chain • What is value chain finance? • How does it work? • When is it relevant? • Two cases: honey chain in Kenya and rice chain in Rwanda • Assignment for work session 2 • Exchange of your business case embedded in the value chain • Prepare business pitch for expert panel
The issue at stake Rural SMEs in developing countries: entrepreneurial, resilient, but not bankable…?
Problems in financing ruralSMEs • Lenders with few assets and informal management • High transaction costs on the countryside • Lack of information in the market • High risks in agriculture • Distortion from government & donor programs • Poor repayment culture • “Too large for microfinance, too small for banks”
Financing the value chain Bank MFI Bank Agricultural finance Value chain finance Chain liquidity
Triangle of value chain finance • Reducing costs: • Due diligence • Monitoring • Enforcement • Administration • Cash mngt • Reducing risks: • Production • Price • Market • Default • Currency
Lessons • As a donor, do not start without an exit strategy • A value chain is a business not a project • Take your time • Building and destroying triangles
Lessons • It is only feasible in value chains that show a healthy balance between supply and demand: • there needs to be a strong market demand revenues to pay back • market demand needs not be too strong side-selling • The strength of the value chain determines its bankability • Cooperation between chain actors is the soft collateral finance • All chain actors should be visible and have entrepreneurial skills
Lessons • Four ways of risk mitigation: • Group formation and building the organizational capacity of suppliers • Combined investments with other financial and non-financial services • Ownership in hands of financial institutions • Risk-sharing
Value chain mapping (2) • What happened in the honey and rice chain?
Reviving the honey chain • Feasibility study showed business opportunities: • Beekeepers in Kitui were only producing 3,000 tons a year, while the potential of the district was 10,000 tons. • In the medium term the honey subsector might produce up to 50,000 tons a year. The market value would be KSh 3 billion ($37.5 million) if the chain were efficiently organized. • Three interventions by K-Rep Development Agency (KDA) to revive the chain: • Form strong producer organizations • Strengthen market linkages • Provide appropriate financial services
Financial products micro-leasing of equipment factoring to enable purchase of semi-processed honey short term loans for working capital Non-financial products (information and services) guarantee hives (inputs) monitoring training, supervision memoranda of understanding Financial products and non-financial products
Financial products micro-leasing of equipment factoring to enable purchase of semi-processed honey short term loans for working capital Non-financial products (information and services) guarantee hives (inputs) monitoring training, supervision memoranda of understanding Financial products and non-financial products
Micro-leasing • Why micro-leasing? • Honey production and processing require relatively large one-time investments in things like hives, bee colonies and processing equipment. Such purchases lend themselves to a leasing arrangement. • How does it work? • K-Rep (or the village financial services association) buys an item (such as a hive or processing equipment), then allows the lessee to use it for a certain period, during which the lessee must pay for it in installments. The item becomes the property of the lessee at the end of the period.
Advantages of micro-leasing • The financial institution remains the owner of the item until the lessee has paid it off fully. • The financial institution has more control over how the money is used: it buys the item, so it can choose the supplier and make sure the item is good quality. • The financial institution can negotiate with suppliers to provide items in bulk at a low price. • The borrowers also benefit, since they are assured that the items are good quality and reasonably priced.
Micro-leasing services • Beekeepers • A typical investment for a hive plus equipment is worth KSh 3,500 ($44). This is for many beekeepers almost unaffordable. • Hive makers • The hive makers also need wood and other materials, and tools to build the hives. The financial services associations provide leases (or loans) for these items, along similar lines as for the beekeepers. • Traders • The traders also need equipment to process the honey. The financial services associations lease this to them using a similar procedure to the microleases for beekeepers, though with much higher amounts because the equipment is more expensive
Requirements: • To qualify for the micro-leasing arrangement, beekeepers must have received training in hive management. • The beekeeper must also belong to a group, which guarantees the request for the lease. • For the duration of the lease, the trader and the group monitor the equipment to make sure it is being used properly. • The lessees are required to report to the groups periodically on the status of their repayments, so enabling the group to take collective responsibility for the equipment. • The financial services associations also train the groups on how to manage loans and cash flow, and on how to use the credit properly.
Short term loans for working capital • Collection centres • Collection centres lack cash to pay farmers immediately. • The financial services associations loan them money for this. • The producer gets 80% of the price immediately, and the remaining 20% once the centre has sold the honey to a trader, minus ($0.01) administration fee per kilogram. • Any excess is paid out as dividends at the end of the year. • These loans are for a maximum of 6 months and are repaid once a month in equal installments. The interest rate is 18% a year. • Traders • The traders need money so they can buy the honey from the collection centres. K-Rep Bank and the financial services associations provide them with short-term loans of up to KSh 150,000 ($1,875) during the honey harvesting season
Memoranda of Understanding • The loans and leasing arrangements are subject to memoranda of understanding between the trader, collection centre, the financial services association and K-Rep Bank, in which the trader agrees to buy all the honey that the collection centre has available, trains the producers and maintains their hives. • The collection centre agrees to sell its honey to the trader, giving it an assured market and the trader an assured supply.
Factoring or invoice discounting • The honey traders and TARDA need constant cash so TARDA can buy the semi-processed honey from the traders, and the latter can continue to buy crude honey from the collection centres. • Factoring, how does it work? • When TARDA’s refinery receives a delivery of honey, K-Rep Bank pays the traders 80% of the price on TARDA’s behalf. • Three months later it pays the bank the full amount, and the bank pays the traders the remaining 20%, minus a fee equivalent to 20% a year flat rate. • What are the advantages? • Enough chain liquidity • The traders get their money on time • This prevents honey going to waste
Training • Beekeepers, on group dynamics, business skills, production techniques • Hive makers, to improve their traditional hives and to make modern hives • Local traders, on financial management and business development • Financial service associations, building their capacities of staff and board members
Mitigating risks and benefits • Production risk • Market and price risk • Default risk • Governance risk • Benefits: • beekeepers • farmer groups and collection centres • traders • TARD • financial institutions • value chain
Benefits • Beekeepers They have increased both the quantity and quality of the honey they produce: in 2006, they harvested 2,500 tons of honey, while in 2007,they produced 4,000 tons. The improved quality is reflected in higher prices: in December 2008 a kilogram of honey fetched KSh 89 ($1.10), compared to KSh 60 ($0.75) a year earlier. • Farmer groups and collection centres They have been able to get loans that let them pay producers immediately for the honey they deliver. • Traders can buy and process more honey. Improved quality and an assured market give them higher prices: their prices rose by 25%. • TARDA Factoring gives TARDA and the traders enough liquidity to continue buying honey throughout the year. From a low of just one ton, in 2008, TARDA processed 3,000 tons, and in 2009 it expects to handle 10,000 tons. • Financial institutions The financial services associations have increased their membership and loan portfolio by over 20%. Some 2,000 farmers have joined the associations, borrowing a total of KSh 3 million ($37,500) in the first year. K-Rep Bank lent KSh 5 million ($62,500) in the first year to traders, a figure that is expected to rise to KSh 30 million ($375,000) as factoring becomes more common.
More benefits • Chain as a whole • The quality and output of honey have risen. • There is a lot more liquidity in the value chain, with each actor now able to handle more honey because the financial constraints have been removed. • Prices throughout the chain have risen, and the chain is now more organized and streamlined. • The level of trust among actors has risen, cemented by a network of memoranda of understanding.
Business opportunities • MFI CAF Isonga was looking for new opportunities in rice and saw a business opportunity in COPRORIZ. • It received technical assistance from SNV and from Terrafina Microfinance training and equity capital
Financial products and non-financial products • Financial products • production loans • commercialization loan • equity fund • lease for transport • Non-financial products (information and services) • voucher system • training • information on production forecasts • reports on disbursement • credit history • inputs and advice • processing rice
Production loans • Credit to farmers for fertilizer and labour • How does it work? • Only farmers that are members of COPRORIZ can apply for these loans; the co-op screens each applicant for integrity and capacity to repay – as evidenced by the size of the applicant’s rice plots. • It guarantees the loan by co-signing the contract between CAF Isonga and the farmer, agreeing to repay the loan if the farmer defaults. • If the application is approved, CAF Isonga transfers the money to the borrower’s bank account (CAF maintains accounts for all the co-op members, which farmers can use for savings as well as to manage their loans). • The farmer repays the loan by delivering paddy to the co-op. If the farmer defaults on the loan (for example, by not delivering to the co-op), the co-op has to repay the debt. The average loan is $100.
Paddy commercialization loan • This is a credit line that allows the co-op to pay farmers on the same day that they deliver rice to the co-op warehouse. • How does it work? • The co-op bulks and stores the rice until it is a good time to sell. • Once it has found a buyer prepared to pay a good price,the co-op takes the rice to a miller and delivers it to the buyer. • It then repays the loan, plus interest, to CAF Isonga. • The ceiling of the credit line depends on the estimated rice output for that season. In 2008, it was set at $464,000.
Voucher system • A voucher system is used to speed payments to the farmers. • How does it work? • When a farmer delivers rice to the co-op warehouse, he or she is given a voucher showing the amount, co-signed by the warehouse manager and the CAF Isonga credit officer (who doubles as warehouse keeper) • The co-op can give out vouchers up to the maximum amount of its credit line. • The farmer presents the voucher to the CAF Isonga office just down the road from the warehouse, and CAF Isonga pays the farmer the full value of the paddy delivered, after deducting the production loan and interest. • The value depends on the price the co-op has negotiated with the trader (it sells to the trader who offers to pay most). • The trader pays the co-op through CAF Isonga, enabling the co-op to repay its credit line. • The repayment rate is 100%, and the portfolio at risk is close to zero
Lease for transport • CAF Isonga’s credit officers helped COPRORIZ carry out an internal assessment to find out why the co-op was continuing to lose money. • They discovered this was mainly due to transport expenses. The co-op used to hire lorries to carry paddy to millers in Kigali; the costs were so high that it was impossible to make a profit. • The cooperative was too new to be able to buy its own lorry, and it had nothing to use as hard collateral to get a loan • So CAF Isonga leased a 5-ton truck to the co-op, and it started to generate a net income. • Why a lease rather than an investment loan? • Because CAF Isonga still owns the truck until the co-op has paid off the lease. That reduces CAF Isonga’s risk.
Mitigating risks and benefits • Production risk • Market and price risk • Default risk • Governance risk • Benefits: • farmers • cooperative • micro-finance institute • value chain
Benefits • Farmers • Productivity rose by around 30% between 2007, when production loans were introduced, and the end of 2008. • The farmers get paid immediately on delivering the rice to the co-op warehouse. • The farm-gate price of paddy has risen by 67%, from $0.33 to $0.55 per kilogram over the same period. • Higher and more reliable incomes enable the farmers to invest in new equipment. • Some have bought more land. • The farmers are more organized financially: all now have a bank account, compared to only 3% in 2003. • COPRORIZ • The co-op has a credit line that enables it to buy grain from farmers and hold it until market prices are attractive. • Members have stopped selling to other traders, and the co-op retains 10% of the profits as savings. • It has cut costs through leasing a lorry, and has professionalized its management and operations. • Until 2007 it recorded losses, but in 2008 managed to post a profit of $29,500.
Benefits continued • CAF Isonga • The microfinance institution has expanded its operations and developed a reliable, profitable set of clients in a new area. • The repayment rate is 100%. • In only 4 years, its agricultural loan portfolio has increased 18-fold. • Value chain • The system has worked so well that the government is pushing for it to be replicated in other areas and on other commodities. • The Ministry of Agriculture has asked CAF Isonga to support other microfinance institutes to develop similar services in various parts of the country.
Working group session 2 • Develop your business case • Step 1 • Look at your business case again, and focus on the perspective of the financer • Does your business case attribute to your competitiveness in the market? • Does your business case (re)organize the chain? • Does this change contribute to a reduction in transaction costs and risks for financial institutions? • Step 2 • Make a new value chain map, in which your business case is inserted • Indicate the flows: product, money, services and information. • In case of VCF, indicate the triangle of value chain finance • Indicate other types of finance: chain liquidity and agricultural finance • Explain the type of relations and arrangements • Define how your business plans reduce risks and costs for financial institutions and how they can benefit from the case • Define how chain actors individually and jointly benefit from the business case • Step 3 • Prepare a pitch for the expert panel
