USAID – Workshop on agricultural sector financing

USAID – Workshop on agricultural sector financing USE OF THE VALUE CHAIN IN FINANCING AGRICULTURE Workshop on July 22 and 23, 2011

CONTENTS • Context of financing Congolese agriculture • What is an agricultural value chain? • Financing in the value chain • Innovations in the financing of the agricultural value chain • Lessons and perspectives • Recommendations

CONTEXT OF FINANCING AGRICULTURE IN THE DRC • Weakness of bank aid to agriculture • Financing of Congolese agriculture is insufficient due to the risks it involves and the disintegration of the financing system (non-financing of the value chain) • The value chain actors face two risk categories: systemic risks (risks connected with production, prices, the market and policies, etc.) and financial risks (risks connected with the borrower and risks connected with the capacity of financial institutions) • High costs of financial transactions in the rural area both for financial institutions and for their client • Volatility of cash flow for agricultural operators and weak capacity for risk absorption • Problems of structuring the request for financing coming from agricultural producers, and from medium and small businesses [MPE] at the transformation and commercialization level

CONTEXT OF FINANCING AGRICULTURE IN THE DRC (continued) • Absence of traceability of accounting and financial information for the majority of agricultural operators with the corollary problem of loan structuring and the application of a weighted high-risk coefficient • Destructuring of certain agricultural networks, even an absence of a vertical organization • No access to factual information on agricultural value chains for financial institutions • Lack of agricultural financing competencies within financial institutions, specifically at the commercial bank level • Absence or weak development of risk management instruments (agricultural insurance, commodities exchanges, etc.) • Offering of bank and non-bank financial services (leasing, factoring, risk capital, etc.) for agriculture insufficient and not adapted

DEFINITION OF A STANDARDVALUE CHAIN A value chain is all of the stages determining the capacity of an organization to obtain a competitive advantage • Example: a company creating wood furniture that takes possession of a lumber or timber company realizes an upward vertical integration. If this same company purchases a furniture distribution company, it realizes a downward vertical integration • A value chain may be understood as a set of companies, activities and relationships involved in the creation of a product or final service. The approach is based on the idea that a final product is rarely consumed in its original form, but enters into a transformation process, combines with other products, is transported, packaged, marketed, etc. until it arrives at the final consumer. In this sense, a value chain describes the way in which producers, transformers, buyers, sellers and consumers - separated in time and space - progressively add value to the products as they pass from one link to another in the value chain

WHAT IS AN AGRICULTURALVALUE CHAIN? • The general value chain is “the complete range of activities and services required to put a product or a service from its design up to its sale on the final markets - local, national, regional or international” • This is a set involving suppliers, producers, transformers and buyers, serviced over by a range of technical, commercial (exporter) and financial service providers. • Value chains in agriculture may be considered as a series of procedures and flows ranging “from the field to the fork” - from production inputs, to transformation, commercialization and to the consumer • Each link of a chain has one or several upward and downward connections • The solidity of a value chain will depend on its weakest link…in general, the production link • The basic goal sought in the value chain is competitiveness, while ensuring a better return on investments at all levels. The market ensures the quality and quantity control of products and services

WHAT IS AN AGRICULTURALVALUE CHAIN? (continued) • In general and in a simplified manner, the value chain encompasses three parts: • A vertical structure consisting of producers, transformers, distributors and merchants; • A range of connected services including financial and support services; • A horizontal structure between the members of a chain from the same network. • The chain is pulled by the market, which may be local, national, regional and international. The market ensures the quality and quantity control of products and services that provide “feedback” to the process. • A value chain is a collaboration established with companies focused on the market whose goal is to achieve a more rewarding place in the market. By linking production, processing and distribution activities in order to meet market demand, a value chain offers a unique way to manage risk.

DIAGRAM OF THE AGRICULTURAL VALUE CHAIN

ESSENTIAL ELEMENTS OF A VALUE CHAIN • Production flow • Financial flow • Information flow • Incentive and • governance measures Inputs Production Transformation commercialization

FINANCING IN THE VALUE CHAIN • Finance in the value chain is simply defined by the financing granted to an actor in the chain in order to support the growth and the competitiveness of the value chain in its entirety through different financial products and risk management mechanisms. • In the process of financing the value chain, the actors, in pairs or groups, irrigate (commercial flows and financial flows) the value chain through partnerships or business relationships, formal or informal, tacit or written, in all directions of the layers or the links • This approach seeks acceptance by the banks and the IMF, of the sound basis of commercial and financial transactions by the actors, brought about by tacit or written contracts, in the guise of guarantees of additional financing in the value chain

FINANCING IN THE VALUE CHAIN (continued) • Value chain financing is based on the products and financial flows that result therefrom, rather than on (or in addition to) traditional guarantee mechanisms • To summarize, the value chain financing structures may make it possible to reduce costs, to manage risks and to build trust, aspects that are fundamental not only for the value chain, but also for the bankers and financial institutions when they evaluate types of future profitable investments • Financing constitutes one of the essential elements of the value chain in its supplying (offering), its quantity (demand) and its quality • The financial need throughout the chain is diverse and varied. From production to packaging and commercialization, time is the key element. Timeliness in the financing of activities in a chain is obligatory; otherwise, strangulation occurs and prevents the proper functioning of the chain processes.

FINANCING IN THE VALUE CHAIN (continued) • finance in the value chain may be proposed by different entities at the level or outside the chain as illustrated by the graph below:

FINANCING IN THE VALUE CHAIN (continued) • The basic premise in the approach is: “The chain’s links of interdependence and the confirmation of market demand for the final product reduce the economic risks and thus increase the chances of obtaining financing” • The State must play an important role in the approach, specifically through the creation of a favorable environment through legal and regulatory frameworks favorable to the financial sector • In this approach, financial institutions are encouraged to base loan criteria on:i) the information the other actors hold about the actor, candidate for the loan,ii) the borrowing capacity of an actor (the conditions are adapted to the cash situation of the actors) and iii) the guarantee (the contract replaces the material guarantee) • The financing of value chains is also investing in a)the knowledge of market trends, b)the understanding of major risks, and c)the knowledge of the system of alliances and partnerships. For the banks and the agro-businesses, this means the use of improved methodologies in order to reduce their exposure to risks connected with market prices, to the client’s production risk and to the risk connected with guarantees

FINANCING IN THE VALUE CHAIN (continued) • Finally, it is a matter of substituting a classical approach to financing agriculture with an approach that is more pragmatic and more appropriate for managing risk. The table below identifies several differentiation points: In summary:value chain financing ranges from small input loans to more complex loans, all serving as driving forces towards competitiveness and the growth of the value chain. The fundamental themes are: reduce costs, manage risks and build trust.

LESSONS AND PERSPECTIVES • The value chain financing (FCV) models that have succeeded have as a common point the effective participation of small producers who are progressively inserted in the value chains that gain in competitiveness • The development of the FCV cannot occur without taking into account the challenge posed by the weak structuring of markets for agricultural products • The use of syndicate members and/or the strengthening of producers’ organizations is effective for inserting the maximum number of small farmers into the value chains, from the perspective of enabling the financial service providers to better manage financial risks and to lower transaction costs • The development of risk management mechanisms and tools is critical in the financing of value chains • The development of management systems and of certification of product quality is indivisible from the financing of the agricultural value chain

LESSONS AND PERSPECTIVES (continued) • In the FCV, attenuation of risks must be based on the combination between: assured market access, a production system capable of meeting technical terms and specifications, a proper analysis of loans…A good understanding of the market is an element of success • Business Development Services (BDS) are often needed to increase the use of banking services by producers, specifically to involve them in contractual agriculture. Farmers must be trained to understand commercial agriculture, to take the necessary measures to comply with buyers’ specifications • The financial institutions must understand that developing a portfolio on the agricultural value chain is not limited only to granting a loan; they are not isolated actors and should, from this perspective, invest in the knowledge of agriculture value chains

LESSONS AND PERSPECTIVES (continued) • The success in the FCV approach may depend in large part on the legal environment. If there is a weakness in the application of contracts, or if no agreed-upon standards exist for the quality of products and the control of products, then the program may not work well • The use of the value chain framework, the evaluation of its level of competitiveness, of the risks it presents in its different links as well as the borrower’s potential performance capacities within this chain, must guide decision-making, in part, both on the client level as well as on the level of the financial institution • An adapted political, regulatory and legal framework is essential for the sustainable development of the agricultural value chain

RECOMMENDATIONS The sustainable improvement of the financing of value chains depends, in part, on the political, regulatory and legal environment. It is therefore expected that the State: • Create an environment for facilitation of governance of value chains • Define a guiding framework for financing agriculture that correlates macroeconomic objectives and financial market requirements • Put in place a regulatory and legal framework favorable to the development of non-banking financial services (leasing, etc.) • Make effective and timely use of subsidies in order not to create market distortions • Put in place an appropriate legal framework for commercial transactions (clear contracts and property rights, regulatory and control framework appropriate for rural financial institutions, contract application mechanism).

RECOMMENDATIONS (continued) • Develop a national financial Education program to change producers’ behaviors • Prepare a national strategy for financing of inputs with an effective and efficient use of subsidies • The implementation of a support program for strengthening the capacities of banks and development finance companies (SFD) in financing the agricultural value chain • Improve capacities for financial management and planning to increase solvency

RECOMMENDATIONS (continued) • Develop structuring infrastructures: storage warehouses, etc. • Promote market information systems • Support the creation and the development of strong interprofessions • Put in place standardization and quality certification systems

USAID – Workshop on agricultural sector financing