Bridging the Financing Gap: Unlocking the Impact Potential of Agricultural SMEs in Africa

Published 14 December 2021

There are many well-documented barriers to agri-SME finance: risk aversion on the part of lenders, lack of collateral on the part of SMEs, and weak infrastructure, among many others.

The Aceli team, led by Head of Financial Sector Andrew Ahiaku, has recently delved into a set of barriers that is not commonly discussed: Central Bank regulations.

These highly technical policies and the ways in which regulated financial institutions interpret them are key drivers of the agricultural credit gap. Our new Learning Brief on this topic draws upon our review of the literature, conversations with more than 70 practitioners in East Africa, and the experiences of our team from the perspective of both lending and borrowing.

Read it here

By Andrew Ahiaku

 

It was a good year. The rains came early to my farming community of Atidzive in the Akatsi-South District of Ghana, and we ploughed the fields for planting. Then came a truck with certified seeds (not the lower yielding ones we had saved from the last harvest) and bags of fertilizer (which we usually couldn’t afford). The farmers had formed groups and received loans for the farming season. The interest rate was high but the farmers were happy for the support from the district Community and Rural Bank.

My auntie, who was the Matriarch of the family, used her loan to hire additional farm hands for weeding. The harvest was so big that she had to hire extra help to carry it to the storage building. I remember being exhausted and sore from carrying so many 15 kg sized-bags of maize, but also jubilant – for the first time, my entire boarding school fees were paid at the beginning of the term! I was known for late payment of fees when I lost my Dad in at age 12. All the farmers in the village paid their loans on schedule. My auntie bought a new metal roof for her house, we got new clothes, and Christmas was festive with presents for all the kids. Around our village of a few hundred families, several families were able to send their children to secondary school that year, which was a big deal – that was the generation that became teachers and police officers.

The next season, my auntie leased additional land in anticipation of a higher loan amount. We cleared the farm early and waited for the bank to approve her loan. She stopped by the bank every week she was in the district town on a market day; they kept assuring her that approval would eventually come. A month later, after she had missed the best time to plant, she was told the bank won’t be giving loans – they had exceeded their limit or something of the sort. My young mind didn’t understand what that meant. Why would a bank refuse a client a loan when she has met her obligations on an earlier one? If they knew she won’t get the loan, why did they encourage her to lease more land?

That season was like most before and since. My auntie and the other farmers planted on small plots with the seed they had saved up from the previous harvest. They couldn’t afford the good seed or fertilizer, couldn’t pay for labor to weed – and at the end of the season, they didn’t need to hire extra labor because the harvest was paltry. We paid my school fees in bits throughout the semester and I was sent home more than once when we couldn’t keep up with the payments. But I was lucky. I made it through secondary school, worked for a few years as a basic school teacher, saved up money, and went to university.

Fast forward eight years, I was working at Barclays Bank and an opportunity came up to lead a new lending unit focused on agriculture. I took the job hoping I could help more farmers like my auntie and agricultural SMEs get loans. We were able to accomplish a lot. Our unit grew from just me to six people in three years. We broke down silos between origination and credit risk through a joint team training on underwriting and managing agri-loans. As the portfolio grew, senior management got excited and we also received accolades in the media. USAID even gave us an award for Agri-Lender of the Year in Ghana!

But we also came up against the barriers that have persistently stifled lending to my auntie and so many others. My colleagues on the credit risk team didn’t fully understand seasonality in farming and how timing makes all the difference in agriculture. Many times, we couldn’t get loans approved before planting season and farmers lost interest. We also had conservative policies. We required collateral valued at 120% of the loan amount but then we discounted the value of the collateral presented to us by 30-50% – so a business looking for a $100k loan needed to have collateral of $200k or more!

These internal policies at the bank were so frustrating, but over time I began to understand where they came from. To begin with, banks are naturally risk averse. Lending in agriculture is risky, takes a lot of work, and bankers have to get their nice shoes and suits dirty visiting clients. In Ghana (and most African countries) banks can earn a nice profit by collecting deposits, lending to the government, and getting fat on the interest spread.

Some economists call this the “lazy bank” model. But that’s only part of the story. Around the time my auntie was waiting for her loan that was never approved, international banking standards were changing under the first of the Basel Accords. By the time I was trying to make agri-loans for Barclays, Basel III had taken effect. Basel III was designed to prevent the kind of daredevil lending that led to the collapse of Lehman Brothers and the 2007-08 financial crisis.

The result of Basel III and the International Financial Reporting Standard 9 designed during the same period was more stringent requirements on banks. When I joined Aceli a couple of years ago, I wanted to understand better how these international standards affected Central Bank policies in Africa, and how those policies influenced commercial bank practices. Did banks really need to have such conservative collateral requirements, or were we just being lazy? Read Aceli’s new Learning Brief to find out what I learned.

Auntie Minawo Ate Ahiaku, I promised you that I’ll get to the bottom of this.

Andrew Ahiaku is the Head of Financial Sector for Aceli Africa, leading engagement with commercial banks to increase their lending to agricultural SMEs and supervising capacity building for both SMEs and lenders.

 

 

 

 

 

 

With support from the Swiss Agency for Development and Cooperation (SDC) and other partners, Aceli is working to mobilize $600M in private capital for agri-SMEs and positively impact the livelihoods of over a million people in East Africa.

“Small and medium enterprises (SMEs) are vital. They strengthen climate resilience, generate income and jobs, help smallholder women farmers and less qualified workers – especially women and young people – to emerge from poverty.”

Learn more in this article by SDC.

USAID is working in partnership with Aceli to increase private sector lending to agricultural SMEs in East Africa that use regenerative agriculture methods and other environmentally sustainable practices.

In 2018, USAID and Aceli set out to learn what it takes to increase investment in sustainability-minded SMEs across the African continent. In 2019, USAID went on to become the first anchor funder in Aceli with a $10 million award to design agricultural finance programs in Rwanda, Uganda, and Tanzania. USAID’s support also helped Aceli secure an additional $60 million from the Swiss, Dutch, and UK governments, and the IKEA Foundation.

Learn more about the partnership.

ISF Advisors and CASA Programme published a new State of the Sector report that sizes the demand for agri-SME financing in sub-Saharan Africa and Southeast Asia at USD 160 billion. They estimate that only USD 54 billion (~34%) is currently being met through formal finance channels—leaving an annual financing gap of USD 106 billion.

Going beyond these headline numbers, the report introduces a more specific view of where the market for agri-SME finance is and isn’t functioning. The research breaks down the market in a more comprehensive and holistic way to show where finance is specifically flowing, via specific types of products from specific types of funders to specific types of agri-SMEs. The report also presents four long-term change priorities to help systematically close the USD 106 billion agri-SME financing gap.

Read the report.

African agriculture has long been neglected by the capital markets – and understandably so:  agriculture is much riskier and costlier to serve than other sectors. While agriculture employs the majority of the population in East Africa and is a leading contributor to GDP, lenders have historically gravitated to easier alternatives, including the stable returns of government bonds without the hard work of navigating dusty roads in remote regions. However, increasing competition is pushing East African lenders into underserved markets. Many have opened branches in rural areas and are now graduating from collecting deposits to lending to customers. Agricultural small and medium enterprises (SMEs) are a large if not well-understood market. 

Aceli is a market incentive facility that aims to unlock financing for high-impact agri-SMEs (see more background on Aceli’s approach). Aceli’s financial incentives aim to bring two things into alignment:

  1. Improve the risk-return profile of agricultural SME lending in East Africa; and
  2. Incentivize lenders to seek out and serve the highest-impact agri-SMEs.

Aceli’s multi-year data collection on loan-level and portfolio-level economics across the region formed the basis for addressing the first objective. Our task around impact was more challenging given the inherent challenges of objectively quantifying impact and the multiple layers of impact we seek to generate: increased incomes for smallholder farmers and enterprise employees, particularly women and youth; higher production of nutritious food at the regional level; and a more sustainable and climate-friendly food system.

Aceli’s recent learning report noted that capital mobilization (i.e., the total loan volume supported by Aceli’s incentives) is a relevant but limited measure of whether our incentives have been successful. At least as important are: 

  • capital additionality (i.e., whether Aceli’s incentives have shifted lender behavior and agri-SMEs are gaining improved access to finance);
  • the impact profile of the SMEs being served (i.e., whether the businesses gaining improved access are aligned with Aceli’s livelihoods and environmental objectives); and 
  • whether capital that is both additional and directed to high-impact agri-SMEs  contributes to increased impact (e.g., by enabling improved market access for farmers, creating more jobs, or allowing the business to manage through market downturns).

This post summarizes Aceli’s approach to incentivizing lending that is (1) additional and (2) targeted to high-impact SMEs. Follow-on posts will go into more depth on Aceli’s incentive design and initial learning related to improved farmer and worker livelihoods and our four thematic impact areas: gender inclusion, food security & nutrition, climate & environment, and  youth inclusion. To learn more, please see Aceli’s Environmental, Social & Governance (ESG) and Impact Policy.

In Q4 2022, our annual learning report will share results from Aceli’s upcoming round of data collection from lenders and two years of implementing the incentives program. We will also delve into how Aceli is working with our data and learning partners – Dalberg Advisors, International Growth Centre, and 60 Decibels – to evaluate (3) the effectiveness of Aceli’s incentives and complementary technical assistance in advancing our impact objectives.

Capital additionality

Aceli defines capital additionality as:

  • Loans to “new” borrowers (defined as a business receiving its first loan of $25k or more from any source in the past three years)
    • To date, 49% of the loans supported by Aceli’s incentives programs go to new borrowers (compared to a target of 35%).
  • Improved access to finance for returning borrowers based on loan amount, financial product, and terms such as collateral requirements and pricing
    • One promising indicator, albeit with a small sample size, is that for the 17 SMEs that are entering the second round of loans supported by Aceli, there has been an average increase in loan size of 37% from Y1 to Y2 (and a corresponding increase in enterprise revenue of 62%). Aceli’s targets for average increase in loan size and revenue are 10%.
    • Several lenders have indicated anecdotally that they are reducing their collateral requirements, lowering their interest rates, and/or more proactively searching for new agri-SME customers that are woman-owned. We will be tracking these changes systematically through structured interviews with lenders during Q2-Q3 and through annual reviews of lenders’ portfolio composition and credit terms.
Approach to impact

Aceli aims to meet market participants – both lenders and SMEs – where they are and shift them towards increased impact over time. We pursue three interrelated strategies to do so:

1. Require “Good” Practices. Aceli has set minimum criteria for every lender, loan, and SME that we support. 

Lender-level: Aceli requires that each of our lending partners has a formal Impact / ESG policy, that staff are trained in the policy, and the policy is integrated into loan-level and portfolio-level management. Several lenders seeking to work with Aceli have not met this requirement when applying to participate in our financial incentives. Rather than rejecting these lenders, our approach has been to allow a six-month grace period and support the lender in designing or improving its ESG policy and integrating the policy into its loan due diligence and monitoring processes. 

Loan-level: To be eligible for Aceli’s incentives, a loan must meet Aceli’s ESG standard, which includes both negative screens (aligned with the IFC exclusion list – see Appendix in Impact Policy) and additional positive social impact criteria (i.e., the SME must either source from at least 25 smallholder farmers or employ at least five full-time workers).

The agribusiness manager for one East African bank reflected on the internal process it has undergone over the past year following Aceli’s support in developing its ESG policy:

“The bank has embedded the ESG policy into our lending process… All AgriSME loans are subject to ESG covenants like gender inclusiveness, environmental protection and social transformation among others. The bank has also scaled up its appetite for green enterprises financing. Exclusions were integrated in our credit analysis due diligence tools and general credit procedure standards. The bank now has an ESG checklist in place and [we have] conducted an online Training of Trainers to all Branch Relationship Officers, Assistant Managers, Branch Managers and the Head Office Credit and Agfin team to skill them up on ESG aspects.
Areas of improvement include continuous awareness raising to staff and SMEs on the importance of ESG compliance for sustainable business and climate proof banking. There is also a need to build an ESG credit score to supplement the usual bank eligibility criteria and underwriting.”

 

2. Incentivize “Better” Practices. Aceli’s incentives for lenders are tiered: on top of the baseline incentives for loans to businesses that clear the “Good” bar outlined above and increased incentives for loans to new borrowers, we offer impact bonuses to reward lenders for seeking out and serving higher impact agri-SMEs. 

Aceli’s baseline incentives comprised 40% of the total eligible incentive for each loan. An additional 30% is added for loans to new borrowers and 30% on top of that if the loan qualifies for all three of Aceli’s impact bonuses. 

Initially, Aceli offered these bonuses for impact in three different categories: i) gender inclusion, ii) food security & nutrition, and iii) climate & environment. As of March 31, 2022, 68% of the 369 loans supported by Aceli’s incentives qualify for the gender inclusion impact bonus, 57% for food security & nutrition, and 23% for climate & environment. Overall, 150 loans qualified for an impact bonus in one category, 180 in two, and 8 in all three.

As of May 2022, Aceli is adjusting our impact policy and bonus areas based on learning to date and in line with our vision to shift the lending market towards increased impact. 

  • First, we are adding a fourth impact bonus area for youth inclusion to promote lending to SMEs that create economic opportunities for youth as entrepreneurs, business managers, farmers, or employees. The impact rationale is clear: youth account for 45% of the population in East Africa; the majority live in rural areas but have limited employment opportunities. Translating this high-level objective into incentives that can tangibly increase economic opportunities for youth is more challenging. Unlike the gender inclusion criteria, where Aceli was able to adopt the international standard established by the 2X Collaborative, there was no pre-existing standard for youth inclusion – so Aceli has created our own. We will present this approach in more detail in an upcoming post and pilot this policy over the next year.
  • The second notable change in our impact policy is that we have sub-divided the criteria for gender inclusion, food security & nutrition, and climate & environment. In practical terms, this means offering higher incentives or a “double bonus” for loans to SMEs that meet multiple criteria for a given impact area. For example, the standard established by 2X considers an SME gender inclusive if it meets any single criterion across ownership, management, board, employees, or customers (note: Aceli added a category for farmer suppliers since this is a significant impact dimension in the agriculture sector). Aceli’s previous policy – aligned with the 2X definition – treated gender inclusion as binary: either an SME met the standard by fulfilling at least one criterion or it did not. Our revised policy divides the criteria into two sub-categories: 1) leadership (assessed based on ownership, management, and board composition); and 2) inclusion (based on farmer suppliers, employees, and customers). An SME can qualify for a single impact bonus under either gender leadership or gender inclusion OR it can qualify for a double bonus if it meets criteria in both sub-categories. Under the revised impact policy, we are applying a similar approach for food security & nutrition and climate & environment. These adjustments re-weight Aceli’s incentives to place additional emphasis on impact.

Aceli supplements self-reported data from lenders with field visits conducted by our verification partner, Africert, which specializes in ESG audits and certifications for agriculture and forestry in East Africa. Verification visits focus on practices related to Aceli’s climate & environment impact bonus and include assessments at both SME and farmer levels. We will share more detail about this process and learning in the upcoming post focused on climate & environment.

3. Continuous improvement. Practices related to impact at lender and SME levels are not static; nor should we accept the status quo in food systems that remain deeply inequitable and environmentally unsustainable. Aceli is committed to learning and continuous improvement across all of our work. In concrete terms, this includes:

      • Improving the Impact / ESG policy that defines minimum criteria for Aceli’s support and the higher standards to qualify for impact bonuses. We embrace the changes incorporated into our revised policy even as we look ahead to further learning and enhancements in the coming years.
      • Promoting continuous improvement at lender-level. In 2021, the USAID INVEST program supported Aceli and advisory firm Value for Women (VfW) to offer a series of workshops on Gender Lens Investing to Aceli’s lending partners. Fifteen lenders participated in sessions on applying a gender lens to lending processes and strategies for identifying and serving women-led and gender-inclusive SMEs. Two lenders are now working with VfW to develop gender action plans to guide their portfolio management practices. In response to lender demand, Aceli may offer similar advisory to other lenders as well as capacity building related to climate finance.
      • SME-level. In 2021, Aceli collaborated with partners to run a pilot promoting reforestation practices with eight Agri-SMEs and more than 2,000 affiliated smallholder farmers in Rwanda and Uganda. Aceli and Value for Women are exploring an approach to support SMEs in improving their gender practices, particularly related to sourcing and employment. Later in this series, we will share learning from the reforestation pilot and how Aceli is approaching partnerships to promote continuous improvement in Impact / ESG at SME level specifically linked to financing needs (e.g., for off-grid renewable energy).

Forthcoming posts will delve into more detail on Aceli’s incentive design and initial learning related to gender inclusion, farmer and worker livelihoods, food security & nutrition, climate & environment, and youth inclusion.

By Eddah Nang’ole

 

In my role defining criteria for Aceli’s climate & environment impact bonus and supporting lenders to develop and implement ESG policies, I hold two competing realities in my head. There are the agro-ecological practices that I learned early in my career as a researcher studying how beneficial insects can control pests and in later roles in program management and evaluation for regenerative agriculture. And then there are the practices that I grew up with on our family farm in the North Rift region of Kenya – practices that produced high yields in the past but may no longer, at least in their current form, be viable.

My parents grew maize on a 30-acre plot. We were lucky in many ways because they also had full-time jobs so the farm supplemented our family’s income and paid for education and other basic needs. British settlers had brought mechanized practices to our region decades earlier, and our farm and those around us combined mechanized with manual farming.  We applied synthetic manure and used hybrid seeds. Tilling and planting was mechanized while spraying herbicides, top dressing, weeding, and harvesting was done by casual workers, mostly women and youth.

While my siblings preferred non-farm activities like household chores, I was always interested in the farm and wanted to contribute. From the age of 12 years, I manually kept the farm records in a notebook, tracking our expenses, making sure the workers were paid on time, and helping my parents to balance the books at the end of the harvest. The production cycle followed a steady calendar rhythm: land preparation and planting in March-April, harvesting in October-November. Yields were consistently high – 40-50 bags per acre.

But the yields started to decline in the late 1990s to 30 bags; today, it’s rare for farmers in the region to harvest more than 15 bags per acre. The soils are depleted from intensive monocropping. The weather is changing too: heavy rains around the harvest increase post-harvest losses; fall army worms multiply with the warming temperatures and drive up costs of pest management. Farmers like my brother, who took over the family farm, must choose between doubling down on chemical fertilizers, pesticides, and mechanization or adopting regenerative practices that are more labor-intensive, like planting cover crops, mulching with organic compost, using beneficial insects, and preparing their fields with no-till or low-till techniques.

I’m convinced that regenerative agriculture will benefit farmers, the environment, and our food system in the long run, but the choice for any given farmer today isn’t as clear. Farmers are living on the front lines of climate change. They have limited information, technology, and access to finance. And most don’t have the luxury to experiment with new approaches that might not work.

In developing and administering Aceli’s impact policies, my task is to distinguish between practices that are detrimental to human health and the environment and should be excluded entirely, those that are acceptable or even “good,” and those that are better for both humans and the environment and should be positively rewarded. It has been gratifying to see some positive changes in the year and a half since we launched – four lenders now have ESG policies that didn’t before; many lenders are responding to Aceli’s incentives by proactively looking for businesses that are gender inclusive, youth inclusive, contribute to food security and nutrition, or promote regenerative and circular agricultural practices that qualify for our impact bonuses. Aceli is only one actor in an ecosystem of organizations trying to make African agriculture more prosperous and sustainable. I am happy to be playing a small part.

Eddah Nang’ole is the Impact & Learning Manager for Aceli Africa and responsible for designing and implementing the Impact / ESG policy and impact bonus criteria for Aceli’s financial incentives program.

Aceli Africa believes that environmental, social, and governance (ESG) standards can have a positive impact on the performance of both lenders and their agricultural SME borrowers and should therefore be integrated into the policies and practices of these actors. We require our partner lending institutions to commit to and practice ESG standards that meet or exceed Aceli Africa’s ESG standard outlined in our policy, which has been newly revised and takes effect on May 1, 2022.

This ESG policy applies to all lenders seeking to participate in Aceli Africa’s financial incentive program. The policy is complementary with the governing laws and regulations for environmental and social practices in each country. Lenders participating in the Aceli financial incentive program are expected first and foremost to comply with laws in each country where the lender is operating and, secondarily, to comply with Aceli’s ESG policy by meeting or exceeding the ESG due diligence criteria related to underwriting and managing any loans that are submitted to Aceli for financial incentives.

Read Aceli’s ESG & Impact Policy Summary.

 

 

Amid the ongoing challenges posed by COVID-19 and climate change—compounding the finance gap that pre-dated both—the need for investment in the African agriculture sector is more urgent than ever.

Aceli’s experience in Year 1 indicates that there is growing interest from private sector lenders to expand their agriculture portfolios. See here for a deeper data dive into Aceli-supported loans to date.

With new commitments from the Dutch and UK governments, Aceli has now secured $62M in funding through 2025 to scale up our activities.

Our latest report distills learning from our first year of implementation and highlights three key areas for learning in the years ahead:

  • How can public & philanthropic resources be targeted most effectively to attract private sector investment?
  • How can private investment be steered to optimize social & environmental impact, and what meaningful measures can we use to assess progress toward this goal?
  • How can the learning from Aceli’s model build an evidence base for blended finance that can spur adoption at the country level and replication in other sectors & geographies?

Click here to download the Learning Report.

At a sector convening in December 2017, lending practitioners discussed barriers to growing the finance market for agricultural SMEs: namely, the mismatch between the risk-return hurdle of capital providers and the addressable demand among businesses. Stakeholders in attendance pushed lenders to put hard evidence behind their anecdotal experiences.

This report synthesizes our journey over the past two and half years: first to distill the economics of agri-SME lending across a diverse set of lenders and then to design solutions to bridge the gap – estimated at $65 billion a year across Sub-Saharan Africa – between capital supply and demand for agri-SMEs.

In partnership with Dalberg Advisors and with funding from 12 donors, we reviewed data from 31 lenders on 9,104 transactions totaling $3.7 billion and also conducted in-depth interviews with lenders, technical assistance providers, and many other ecosystem actors.

This report shares our findings and presents Aceli Africa’s new data-driven, marketplace approach to align capital supply and demand and unlock increased financing for agri-SMEs.

Download the summary and full report below:

>> Summary Report

 

>> Full Report