Dalberg, in partnership with IDH Farmfit Intelligence, hosted a panel discussion to mark the release of a long-term study led by the Rural Agricultural Finance Learning Lab (RAFLL) of the MasterCard Foundation and Dalberg looking into the viability of financing smallholder farmers in sub-Saharan Africa.

Smallholder farmers represent a huge and underserved market for global and socioeconomic growth—it’s an industry that already produces 30 percent of the world’s food supply and is responsible for the livelihoods of 2.5 billion people. And even though agriculture development is three times more effective at reducing poverty in low-income countries than investments in other sectors, its progress is limited due to wariness among financial service providers of the high-risk, high-cost nature of these ventures.

As such, there’s a massive gap in financing available to smallholder farmers; 70 percent of the credit demand, or $170 billion, goes unmet every year, trapping farmers in a cycle of poverty.

This is why Dalberg, RAFLL and IDH Farmfit Intelligence partnered on a study to look at the economics of smallholder farmers and gauge the viability of profitability in the sector. The report culminates three years’ worth of work researching the service delivery models of seven different Financial Service Providers (FSPs), and interviewing some 2,000 smallholder farmers in sub-Saharan Africa.

To mark the report’s release and discuss some of its key findings, Dalberg and IDH hosted a discussion with three panelists from different corners of the conversation: Esther Kariuki, Head of Agribusiness at the Co-operative Bank of Kenya, Hillary Miller-Wise, Deputy Director of the Bill & Melinda Gates Foundation, speaking from a donor/fintech perspective, and Roel Messie, CEO of the Farmfit Fund, a potential investor.

The panel was moderated by Dalberg’s Kusi Hornberger, the lead advisor and co-author of the project, and the study’s key findings were presented by Clara Colina, also a co-author and the Program Director for the Farmfit Intelligence Center, IDH.

“There’s a new wave of financial service providers that have entered the market driven by technology and a shift towards a more market-based approach, but the reality is capital is not entering the market at the pace that we need,” Colina said, as she opened her presentation. “Bluntly put: For any lending opportunity or any investment opportunity to make sense, the revenues need to outweigh the costs, and for most financial service providers, when it comes to smallholder finance, this equation is unclear. They just simply want to put their money where they have certainty (or greater certainty) that they will be able to get a higher return on their investment.”

The reality of the challenges stacked against farmers is stark: Only one of the seven financial service providers examined in the study broke even without the use of subsidies or grants. Inadequate scale, small loan sizes, loan losses, high costs of funds and the inherently vulnerable business of agriculture can paint a bleak picture to FSPs, however, the study also found that all of the FSPs studied could turn a profit if they scaled up.

“The question or the challenge is: How do we scale?” Colina posed. That’s something the Co-operative Bank of Kenya has made headway in figuring out, as Kariuki noted while fielding the first panel question about how farmers have benefited from the bank’s partnerships with various value chain actors.

Kariuki spoke of the success the bank has seen in offering bundles to farmers that provide financing, as well as non-financial services such as training on agricultural practices, new technology and financial literacy through value chain actors. She cited the bank’s partnership with Brookside Dairy, one of the largest dairies in Kenya. The two entities share the costs of running a capacity building program, the dairy sets up demo farms and trains farmers on the technical aspects of the operation, while the bank supports farmers with financial literacy and corporate governance. Brookside also buys milk from the farmers, allowing the bank to deduct their loan payments from the credit before passing along the balance to farmers.

“That has seen us service over 80,000 farmers, organizing corps and giving them CapEx credit to set up the cooling centers, the milk transport, to the collection centers, to some even transitioning to set up very robust daily processing operations and becoming, actually, competitors of Brookside. So that model works well for us,” Kariuki said.

In another example, when American fast-food restaurant Kentucky Fried Chicken entered the Kenyan market and needed potato supply, the bank partnered with a Dutch agribusiness to train farmers on the trade and build capacity, putting the bank on track to work with 30,000 new farmers. In total, the bank now counts about 3 million farmers as direct beneficiaries of its financial services.

“For us, each value chain, with the right partners, you unlock and bring the appetites of everybody on the table and it’s a sustainable business,” she said.

Kariuki acknowledged that her bank’s only option is to find solutions that make lending to farmers sustainable, since the bank is owned by farmers and organized as a cooperative.

But other financial service providers do have an option, and there isn’t always enough proof of concept to warrant an investment in smallholder farmers.

Miller-Wise referenced a review done five years ago by J-PAL that showed farmers increased productivity with more access to financing but didn’t actually increase income because of factors like weak links to markets. Donors and investors must navigate complex waters to find the right combination of farmer profile, capital structure and product design, she said, but there’s no question that it’s worth the effort to facilitate access to financing for smallholder farmers.

“Even with the messiness of the data, we’re still very committed to it because the preponderance of data shows that if you can get the targeting right, then you can realize that outcome. It does require a more nuanced view of the market that you’re working on, and to not think about smallholder farmers writ large but to understand the difference between farmers in a high-value export crop versus farmers in a stable crop for example; to think very differently about the product design: Is the product actually tailored to the cash flow of the crop or is it a traditional you pay every week or every month or whatever structure there might be?”

“It just requires you to get much more in the weeds and understand all the different levers that could be pulled to both mitigate the downside risk of getting it wrong but ultimately to try and drive that positive impact in terms of net income,” Miller-Wise said.

Messie, from the Farmfit Fund, said he sees the most potential for future investments in FSPs lending to smallholder farmers by utilizing the entire value chain to lower risk, especially when working with traditional banks that aren’t generally innovative on their own. For instance, starting not at the microfinance level, but with a large offtaker, then going down the chain and identifying the different types of suppliers to find the necessary liquidity to back the investment.

“Then you’re going to the FSP and saying, ‘Hey, we have here a value chain that makes sense, it’s profitable. You can partner with that in providing the finance in a way that is much better structure and much more secure,’” because they know it’s backed by a reputable local or international company,” he said. “These are the approaches that in the end are profitable.”

But, as the study pointed out, it’s extremely difficult to end up in a place of profitability without addressing the proverbial elephant in the room: subsidies.

Investors often don’t like to see grants or subsidies on the balance sheet because to them, it indicates a lack of viability. Using grants, for example, to pay for expensive but critical work, like testing or R & D, can be the best way to incorporate subsidies into an overall capital structure without turning off investors, Miller-Wise said.

“I think the message is: Try to be as targeted as you can with the use of that subsidy in particular areas of the business and for particular purposes,” she said.

Co-operative Bank of Kenya, for instance, uses a grant from USAID that allows the bank to lend to farmers without asking for as much collateral, alleviating a huge roadblock. When that grant money is incorporated into the entire capital structure, it lowers the cost of the loans to farmers, enabling them a better chance at success, Kariuki said. The partnership with USAID has also allowed the bank to branch into sectors it previously perceived as risky, and likely wouldn’t have ventured into otherwise.

“As a commercial bank, especially a coop bank, because we don’t have a choice, we just have to work with the farmers, the guarantees and the partnerships, particularly with NGOs and development partners, has been incredible in letting us get into spaces we could not ordinarily get in with a commercial eye. Then we got in and we can’t get out because it’s actually a profitable business or a profitable value chain,” Kariuki said.

Long-term, that is what Colina at IDH is hoping will happen across the board—FSPs will place a bet on financing smallholder farmers, despite how bumpy and nuanced the road may seem, and eventually forge a pathway to profitability through valuable partnerships and the right combination of services.

“We hope to keep building that data to be able to do much more rigorous analysis, and building that evidence on whether there is a business case and how to get there,” Colina said as she wrapped up the conversation.

To view the full report and watch the launch event replay, click HERE.