Lending at the margins in Africa

By Matt Shakhovskoy

Capital to finance new beehives for a local beekeeping cooperative in Zambia or a line of credit for a tea company in Rwanda to fund tea purchases from smallholder farmers are not your typical projects for the traditional banking sector. But these are examples of the finance needs of Africa’s agricultural sector, where over 60% of the population in most countries obtains livelihoods from 50 million highly-disbursed smallholder farms.

Yet small and medium-sized enterprises (SMEs) like individual farms, co-ops, and producer organizations present challenges to lending; they are frequently disorganized, costly to serve, and more difficult to find than larger commercial agribusinesses. However, they represent a big opportunity for lending – a Dalberg study found the global need for smallholder finance is as large as $450 billion.

Root Capital is one organization that has not been deterred by these difficult conditions. Since 1999, they have disbursed more than $500 million in credit to over 400 businesses in Africa and Latin America, making them the largest global, social lender to agricultural SMEs. Until recently, the majority of their global lending had been related to the coffee industry and they had low market penetration in countries such as Zambia and Malawi. For these reasons, Root Capital asked Dalberg to identify plans to increase their lending in Zambia, Malawi, and Rwanda.

For lending, “attractive” SMEs are those that are have a good track record, are formally registered, have solid cash flows, and operate in well-organized value chains. Examining these countries, we found a high need for SME financing and several attractive lending opportunities. However, understanding each country’s unique government regulation and policy context was a critical part of assessing lending opportunities.

Dalberg’s investigation combined synthesizing existing findings, talking to experts on the ground, and administering new credit surveys to SMEs.

Identifying opportunities for Root Capital to increase lending involved understanding the big picture of supply and demand and the local dynamics of how markets work. One member of a cooperative commented “It is very difficult to get our members to produce tomatoes consistently enough to maintain a contract with a supermarket or large buyer.” Comments like these revealed practical hurdles in the value chains critical to understanding the causes of inefficiency. These insights from the field are essential to developing a lending approach grounded in the reality of these small agribusinesses.

Indeed, a pragmatic, field-based approach will facilitate development of innovative finance products that lenders like Root Capital will need in order to increase lending to more, and different, SMEs. Dalberg estimates that 90% of the global SME financing need exists in crops produced for domestic markets, such as maize and peanuts. SMEs in these value chains are much more difficult to lend to, and the well-understood lending model of providing trade-financing to export-oriented SMEs does not easily apply. In that lending model, lenders secure a loan by setting up contracts with international buyers for the goods sold by the SME. The lenders have first claim to any payments for those goods. Root Capital and other lenders are actively experimenting with new lending models and approaches to more flexibly address the needs of these other SMEs.

By identifying the opportunity clusters and the underlying value chain dynamics, Dalberg positioned Root Capital to explore the potential for lending to individual SMEs. In the two months since receiving our recommendations, Root Capital has restarted lending in Malawi and is actively structuring new deals with tea producers in Rwanda and horticulture aggregators in Zambia.  These are important new steps in lending to African SMEs on the margins and developing agricultural markets in Africa.

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