Managing Risks in Financing Agriculture

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Roy Higgins
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1 Managing Risks in Financing Agriculture Ajai Nair Program Coordinator Agriculture Finance Support Facility (AgriFin) 3rd World Congress on Rural and Agricultural Finance October 28th, 2010 Marrakech, Morocco

2 Presentation Outline Background Credit Risk Study Conclusions Johannesburg Conference Introduction to AgriFin

3 Background Agriculture Credit - History of failed interventions in the 70s and 80s World Bank s work in Agriculture Risk Management Index insurance, price risk management, supply chain risk assessments World Bank s work in Rural Finance Institutional Development (Financial cooperatives, DFIs), Community-based FIs) Renewed interest in Financing Agriculture

4 Study on Credit Risk Management in Lending for Agriculture Objective: Document key credit-risk assessment and management practices by selected major agriculture finance providers in selected countries. Key Questions What are the factors used to assess credit-risk? What is the process used to assess credit-risk? What are the mandatory requirements to obtain a loan? What type of limits are used to ensure portfolio diversification? Is credit-risk quantified? Do lenders facilitate access to risk mitigation services for borrowers?

5 The Study Sample and Method Sample: 17 institutions in 9 countries Focus on Africa and Asia Cover major institutional types - Commercial banks (12), DFIs, and microfinance organizations. Method: Two-page Survey - overall institutional profile, agriculture portfolio profile, and credit risk management practices In-country follow-up assessment

6 FIs Studied Malawi: OIBM, MRFC Zambia: Stanbic, Barclays Kenya: KCB, Equity, Coop Bank, AFC Mali: BNDA India: ICICI, HDFC, SBI, Basix Thailand: BAAC Armenia: ACBA-Credit Agricole Kyrgyz Republic: Ayl Bank Mexico: Financiera Rural

7 Study Findings- Credit Risk Assessment Small Loans Approach 1: Parametric Approach 2: Parametric + outsourcing Large loans traditional financial ratio analysis. 4 banks use credit bureau - only for large farmers 1 bank uses bio-metric identification 5 banks use credit grading; only 1 uses risk modeling

8 Study Findings Credit Risk Management All banks lending to small farmers use non-traditional collateral Diversified loan portfolios agricultural loan portfolios 10 to 40 % Only 1 bank bundles crop insurance; 1 bundles credit-life insurance. 6 banks report risk-based pricing for large loans; none uses for small loans. 4 DFIs report risk-based pricing for small loans

9 Innovations Use of biometrics to uniquely identify borrowers. Parametric credit risk assessment and partial outsourcing of this process. Risk-based pricing based on statistical risk-modeling. Tripartite lending arrangements produce buyer, lender and borrower; with and without credit-risk sharing. Provision of fee-based agricultural and business advisory services.

10 Example: Financiera Rural - Quantifying Credit Risk Probability of Default - likelihood that a particular borrower of group of borrowers will default. Loss Given Default - Losses to the bank from borrowers default, after taking into account all the money recovered through collateral executions and debt restructurings. Factors that Affect the Value of PDs and LGDs Purpose of loan (working capital vs. investment loan) Age of borrower or firm Main activity of borrower (farmer, warehouse, trader, retailer, etc) Type of commodity Type of land (private or social) Surface of land Region (South vs. North) Irrigated vs. Non-irrigated land Scale of production

11 Example: Financiera Rural - Quantifying Credit Risk Results: Better measurement and pricing of sub-sector risk Highest risk profile in livestock, milk production and fishing (LGD of 18%) and lowest in sugar cane (less than 1%). Highest risk profile in the South and South East regions of the country and lowest in the northwest. Highest risk profile in long term financing and lowest in short-term debt (warehouse s receipts financing) Results: Better ability to diversify risks FR s loan portfolio is diversified: agricultural commodities, fertilizers, forestry plantations, tourist resorts, hotels, radio stations, gas stations, taxis, supermarkets and grocery stores, bio-fuel plants, transportation and machinery, etc.

12 Key Conclusions FIs lending to small farmers at scale use nontraditional credit assessment systems and nontraditional collateral. Multi-level diversification is key to credit risk management at the portfolio level Successful agricultural lenders have domain expertise in agriculture at multiple levels Use of quantitative tools can help FIs better measure and price credit risk.

13 Expert Meeting on Managing Risk in Financing Agriculture, April 2009, Johannesburg 14 Findings Financing for Agriculture is viable if supported by sound risk management at multiple levels Good banking practices combined with understanding of the sector and the client is a core requirement Insurance is one tool in an overall risk management strategy

14 Agriculture Finance Support Facility A World Bank Initiative Supported by the Bill and Melinda Gates Foundation Vision: Significantly increased access to financial services for smallholder farmers in Africa and Asia Objective :Demonstrate that the provision of financial services for smallholder farmers and other rural entrepreneurs is a profitable business for financial institutions Activities: Provide matching grants for capacity building and facilitate knowledge creation and learning

EXPERT MEETING ON MANAGING RISK IN FINANCING AGRICULTURE. Convened and co-sponsored by AFRACA, FAO, the Land Bank of South Africa, and the World Bank

EXPERT MEETING ON MANAGING RISK IN FINANCING AGRICULTURE Convened and co-sponsored by AFRACA, FAO, the Land Bank of South Africa, and the World Bank April 1-3, 2009 Johannesburg, South Africa Proceedings