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Access to Finance for Smallholder Farmers

Learning from the Experiences of Microfinance Institutions in Latin America

Of the three-quarters of the world’s poor that live in rural areas, 80 percent directly or indirectly depend on agriculture as their main source of income and employment (IFC 2011). These smallholders also play a key role in increasing food supplies, more so than large farms in poor countries. Despite their socio-economic importance, smallholders tend to have little or no access to formal credit, which limits their capacity to invest in the technologies and inputs they need to increase their yields and incomes and reduce hunger and poverty, both their own and that of others.

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Financial institutions interested in serving this market face myriad risks and challenges associated with agricultural production and lending, including seasonality and the associated irregular cash flows; higher transaction costs; and systemic risks, such as floods, droughts, and plant diseases. While these challenges apply generally to smallholder lending (in fact to all agricultural lending), it is more challenging to serve some smallholders than others. With smallholders in “tight” value chains—where a strong relationship between the farmer and buyer exists—such relationships can be leveraged to reduce the costs and risks of agricultural lending through shared credit screening, monitoring and collection, and/or use of alternative collateral, such as sales contracts. The challenges become greater when trying to provide financing to smallholders in “loose” value chains, particularly for low-value staple crops, where farmers do not have strong relationships with other value chain actors. The challenges are compounded when trying to provide financing to subsistence farmers.

The spectrum of financial institutions involved in financing agriculture is broad, and seemingly reflects the farmers’ segmentation, as the importance of banks diminishes as the farmer clientele becomes smaller in scale and as value chains become less defined. The relative importance of different channels for different segments, however, is for the most part unknown. In particular, the evidence of microfinance institution (MFI) involvement in financing commercial and semicommercial smallholders remains anecdotal and lacks specifics on what makes MFI lending to these segments feasible, and what restricts their reach and effectiveness.