new strategies for financing agricultural mechanization

New Strategies for Financing Agricultural

Mechanization

Paper Presented By:

Mr. Philip Ikeazor - MD/CEO, Keystone Bank Limited

At the Africa International Conference on Revolutionizing

Finance for Agri-Value Chains

14th – 18th July 2014, Nairobi Kenya.

1. Introduction 3

2. Purpose of Agricultural Mechanization 4

3. Levels of Agricultural Mechanization 5

4. Problems of Agricultural Mechanization 6

5. New Agricultural Mechanization Financing Models/Strategies 7

6. Agricultural Mechanization Financing Models – Farmers 8

7. Agricultural Mechanization Financing Models –

Manufacturers and users of movable assets 11

8. Agricultural Mechanization of Financing Models - Buyers 16

9. Challenges in Financing Agricultural Mechanization 23

10. Solutions to the Challenges in Financing Agricultural Mechanization 24

11. Keystone Experience 25

12. Conclusion and Recommendation 26

13. Picture Gallery 27

Table of Contents

2

Definition

• Agricultural Mechanization embraces the use of tools, implements and

machines for agricultural land development, crop production,

harvesting, processing, storage, and on-farm processing. It includes

three main power sources: human, animal and mechanical.

• Agricultural mechanization should be viewed as a tool needed by the

farmer to maximize production and profit.

Introduction

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Purpose

The purpose of an agricultural mechanization strategy is to create a policy and institutional framework for farmers and other end-users in the selection and usage of farm power and

equipment within a sustainable delivery and support system.

Major Effects of Agric Mechanization

• Mechanization is one of the factors responsible for increased urbanization and the development of industrial economies.

• Besides improving production efficiency, mechanization encourages large scale production and improves the quality of farm produce.

• On the other hand, it has displaced unskilled farm labor, causes environmental pollution, deforestation and erosion.

Purpose of Agricultural

Mechanization

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• Hand tool technology - This is the simplest and most basic level of agricultural mechanization: the use of tools and simple implements using human muscle as the main power source.

• Draught animal technology - This refers to implements and machines utilizing animal muscle as the main power source.

• Mechanical power technology - This is the highest technology level in agricultural mechanization. It embraces all agricultural machinery which obtains its main power from other sources other than muscular power.

Levels of Agricultural Mechanization

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• Literacy levels of African farmers

Huge capital outlay

Land tenure systems prevent large farm holdings

Soil types and composition

Debris from clearing, stumping and logs pose an obstacle to mechanization

Poor maintenance - Spare parts are not available locally, limited technical expertise

Inadequate manpower to service the implements and machines

Some topographies and landscapes are not good for mechanization.

Problems of Agricultural

Mechanization

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New Agricultural Mechanization

Financing Models/Strategies

This presentation will address agricultural mechanization financing strategies for various parties. The financing models are:

• Direct smallholder lending • Indirect lending through FBOs/Cooperatives • Emerging farmers finance • Equipment finance • Leasing • Warehouse receipt financing

• Collateral management • Tight market Value Chain Finance (VCF) with output buyers • Loose market (VCF) with output buyers • Nucleus farm / Outgrowers • VCF with input suppliers • Factoring

• Trade Finance

The parties involved are: 1. Farmers 2. Manufacturers and users of movable assets

3. Buyers (output and input)

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Financing Model (Farmers)

1. Direct Smallholder lending:

• Direct smallholder finance models seem to be more effective than indirect or wholesale models in providing access to financial services for agricultural SMEs.

• The main advantage of the direct model is that it enables distribution of a full range of financial services, whereas the wholesale model mainly focuses on credit.

Key risk mitigants for this model are:

(i) Deep knowledge of the farmer and his or her business;

(ii) A cap on the exposure to a single farmer;

(iii) Group lending (collective responsibility);

(iv) Integration into a supply chain;

(v) providing cash to the farmer during the lean season to lower the side selling risk;

(VI) The direct model allows the bank to attract deposits this helps to lowers funding costs and facilitates more effective asset/liability management.

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2. Indirect lending through FBOs/Cooperatives:

This model, also known as a wholesale model, is based on a bank lending indirectly to smallholders through an aggregator organization, such as a Farmer-Based Organization (FBO) or Cooperative. In the wholesale model, the entire group is the borrower, and therefore group members guarantee each other.

In the agent model, the group’s organization only administers the loans, and

individual group members are the borrowers.

The benefits of this approach are:

1. Savings on costs of creditworthiness.

2. Assessment and loan administration.

3. The security of the model is enhanced by cash collateral requirements at the organization level, instead of traditional collateral or claims on harvest proceeds at the individual farmer level.

4. Direct integration with input suppliers to reduce the amounts of cash disbursed directly to farmers.

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3. Emerging farmers finance:

• “Emerging farm businesses” are those farmers who build up balances in their account with a view to fund their businesses in the future based on their turnover history.

• The deposits represent long-term savings that can be used effectively for collateral.

• They can become the principal collateral to secure a loan while linking the loan to the savings account.

Success factors of this model are:

1. Strong checks and balances that prevent farmers from “gaming” the system.

2. “Checks” such as (a). “know your customer” (KYC), (b). Requirement for references (c). Membership with a farmer associations (d). Guarantees (e). Minimum contribution and closing

“balances” to reduce loan defaults.

3. Encouraging strong savings culture with interest for high savings balances over the period.

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New Agricultural Mechanization Financing Model (Manufacturers and users of movable assets)

1. Equipment finance:

Equipment finance denotes financing of usually movable and sometimes specialized assets. This is carried out in order to manage the farmer’s cashflow. An important factor in this type of asset

finance is close collaboration between the equipment providers (vendors) and the bank.

The following are key success factors for equipment finance:

(i) Understanding the farmers’ payment capacity.

(ii) Avoiding intermediates.

(iii) Local network and local decision processes with efficient Turn Around Time (TAT).

(iv) Products that suit farmers and account for seasonal payment patterns.

(v) Creating a platform for effective repossession and remarketing of equipment for defaulting farms

(vi) Direct vendor payment.

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2. Leasing:

A lease is a contractual arrangement between two parties whereby a party that owns an asset (the “lessor”) lets another party (the “lessee”) use the asset for a predetermined time in exchange for periodic payments.

• Leasing focuses on the lessee’s ability to generate cash flow from business operations to service the lease payment, rather than on the balance sheet or on past credit history.

• Leasing is particularly advantageous for young companies, as well as for small and medium businesses that do not have lengthy credit history or a significant asset base for collateral.

• Because the lessor owns the equipment, it can be repossessed if the lessee fails to meet lease rental obligations; this is particularly advantageous in instances where secured lenders do not have priority in the case of default.

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Agricultural Mechanization Financing Model (Manufacturers and users of movable assets)

3. Warehouse receipt financing:

Warehouse receipt finance is a form of secured lending to owners of non-perishable

commodities, which are stored in a warehouse and have been assigned to a bank through warehouse receipts.

Warehouse receipts give the bank the security of the goods until they have been sold and the proceeds collected.

Given the limited collateral available to support farmers’ financing needs, such post-harvest commodities and warehouse receipts represent a liquid form of collateral against which banks can lend.

When a well functioning warehouse receipt system is in place, farmers have a choice in

deciding whether to sell immediately after harvest (when prices are often lowest) or to store in a licensed warehouse and to apply for a short-term credit thus enabling farmers to sell at a later date, when prices may be higher).

Warehouse financing also enables aggregators and processors to secure their sourcing throughout the year and to purchase their raw materials.

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There is the need to put in place a framework for a proper warehouse receipt system.

The conditions are:

(i) Legal environment that ensures easy enforceability of the security, and makes warehouse

receipts a title document.

(ii) Reliable and high-quality warehouses that are accessible.

(iii) A system of licensing, inspection, and monitoring of warehouses.

(iv) A performance bond and/or indemnity fund.

(v) Financial Institutions’ support

(vi) Agricultural market prices that reflect carrying costs.

(vii) Supportive public authorities.

(viii) Well-trained market participants.

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4. Collateral management:

A Collateral Management Agreement (CMA) is a tripartite agreement between a collateral manager/warehouse operator, a named depositor or owner of the commodities and a bank.

The collateral manager acts as the custodian of the commodities held in storage at the warehouse on behalf of the bank.

The collateral manager will not release the goods to the depositor or a buyer until the bank provides a written form of release to the collateral manager, usually only upon receipt of loan repayment or other payment assurance against its loan secured by the goods in storage.

CMAs are generally costly and thus are often not accessible to smallholder farmers and

agricultural SMEs.

Banks in developing countries often provide financing to aggregators, processors, and exporters backed by agricultural commodities held in warehouses.

The bank maintains physical control over the commodity in storage via its custodian (the collateral manager) until its loan repayment is secure, there is limited risk that the bank’s security interest will not be perfected.

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Financing Model (Buyers)

1. Tight market Value Chain Finance (VCF) with output buyers:

In VCF, there is always a coordinating point i.e. multiple “constriction” points for farmers that

ultimately prevent side-selling.

These constriction points can be incentives (technical assistance for farmers, loans, club

` membership, prizes, cash advances during the lean season, sustainable price premiums, etc.) as well as penalties and constraints (such as perishable crop or enforced legal

sanctions).

These models are predicated upon strong commercial intermediaries with a focus on the physical trade and optimization of production, quality, logistics, storage, processing, and risk management functions in between.

Finance mechanisms may be either through the buyer or from the bank to the farmer directly with the security of a tri-partite agreement between bank, buyer and farmer.

These models often bundle finance with other services, such as improved inputs, extension services, and training, which can lead to increased cash flow for farmers.

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2. Loose market (VCF) with output buyers:

VCF for tight value chains is generally easier and more prevalent than VCF for loose value chains, which typically feature easily marketable and staple crops.

There are few success stories of value chain finance in staple crops such as maize, cassava,

wheat, and ground nuts. For these crops, the side selling risk is naturally higher, because there are many buyers and crops can be sold in local markets.

Additionally, government interventions are more frequent and sometimes unpredictable, causing market distortions and price volatility.

Value chain structure would only work if there is a strong relationship between the farmers and the factory owners/output buyers.

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3. Nucleus farm / Outgrowers:

Outgrower models, often based on a central processing unit or estate, can allow farmers to access input finance because of the additional security the buyer provides to the lender.

The schemes bring together four elements:

1. A central farm and facilities surrounded by growers who produce on their own land under contract.

2. The provision of inputs and technical assistance to growers by the nucleus farmer;

3. It guarantees the purchase of the farmers’ crops/livestock subject to meeting predefined standards;

4. Growers typically receive an agreed-upon percentage of the final sales price of their

products.

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4. VCF with input suppliers:

Most commercial banks have limited branch networks outside of major urban centers, and no branches in rural areas.

Banks interested in financing smallholders may choose to pursue lending directly to local agricultural input dealers, but leave the provision of credit to individual farmers completely in

the hands of the agro-dealers themselves.

Lending through the agro-dealer have the following advantages:

• Leverages the benefits of farmer facing trusted parties.

• Lending decisions are made through local knowledge of the farmer’s capacity and commitment. Furthermore, the overall transaction costs are reduced.

Value chain finance with input dealers is a special type of model, because the lender generally assumes the agro-dealer risk, which requires a very different type of creditworthiness assessment and collateral structure including cash collateral.

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5. Factoring:

Factoring is a powerful tool in providing financing to high-risk agricultural SMEs.

Factoring is based on a company selling its accounts receivable (A/R) to a bank or factoring company at a discount.

Factoring differs from the VCF models because the account receivable are only generated once goods have been delivered but cash payment is still forthcoming.

The company (farmer) selling its A/R benefits by receiving cash earlier than it would under the terms of the receivable and is thus able to immediately utilize the cash received to

invest in working capital needs and meet cash flow problems.

From the bank’s perspective, the key virtue of factoring is that underwriting is based on the risk of the receivables (i.e.t he buyer).

Therefore, factoring may be particularly well suited for financing receivables from multinational firms because of their reputation and track record.

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6. Trade finance:

Trade finance is the provision of banking services to facilitate the movement of goods and the performance of trade related services.

In such a financing arrangement, the bank or other institution of the importing SME provides for payment for goods traded on behalf of the importer. Similarly, exporting agricultural SMEs must offer their customers attractive sales terms supported by the appropriate

payment method with the use of instruments/structures like letters of credit, bills for collections, performance bonds, APGs etc. that give comfort to the lender and also protect the SME.

The primary goal in Trade finance is getting paid and adhering to international payment terms and conditions; therefore, an appropriate payment method must be chosen carefully to minimize the payment risk while also accommodating the needs of the buyer.

There are four primary methods of payment for international transactions:

1. Cash in advance

2. Letters of credit

3. Documentary collections

4. Open account

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Cash in advance is the most secured payment mode for the seller (not allowed in Nigeria), while open account is the least secured.

Banks may assist by providing various forms of support. For example, the importer’s bank may provide a letter of credit to the exporter or the exporter’s bank, providing for payment upon presentation of certain documents, such as a bill of lading.

Alternatively the exporter’s bank may make a loan by advancing funds to the exporter on

the basis of the export contract.

Open Account on the other hand is the opposite of Cash in Advance wherein payment is

made to seller after goods have been shipped or received, on trust.

All the above agricultural mechanization financing models have led to substantial improvement in farm output in the advanced Countries but more need to be done in the developing Counties.

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Challenges in Financing

Agricultural Mechanization

1. Lack of suitable and appropriate collateral as farm assets are of limited purpose.

2. Inappropriate/obsolete technology.

3. Equipment and machinery that are suitable in other climes are not necessarily suitable for other countries.

4. Capacity Building and Skills Gap.

5. Technical and after sales Service Agreements.

6. Some of the machines lack all year round utilization due to seasonality.

7. Land holding is fragmented making it unsuitable for machine power.

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Solutions to the Challenges in

Financing Agricultural Mechanization

1. Grouping the small scale farmers into clusters.

2. Following from point 1 above, the Value Chain financing approach should be adopted.

3. Government intervention wherein the security risk is borne by Government.

4. Consistency in Government policies on Agriculture.

5. Finance Lease.

6. Capacity building for agricultural finance officers in the Financial Institutions .

7. Training for technical operators of agricultural machines and equipment.

8. Customization of machines and equipment for the local terrain, etc.

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Keystone Bank Experience

S/N FINANCING MODEL BENEFICIARY EQUIPMENT/MACHINE

1 Direct smallholder lending MERCYLAND FISH FARM

OVEN

2 Indirect lending through

FBOs/Cooperatives

ASTRON FARMS LTD PIGGERY EQUIPMENT/FEED MILL

3 Collateral management JIMSINA INT’L LTD SILOS/GRAIN CLEANING MACHINES

4 Tight market Value Chain Finance (VCF) with output buyers

TRANS AFRICA FOODS & FARMS LTD

BROILER PROCESSING PLANT

5 Trade Finance EMBIK INV’T LTD CASHEW PROCESSING MACHINES

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Conclusion and Recommendation

1. Identifying and discussing the policy issues which impact on farm mechanization – Governments, Agencies, Cooperatives, etc.

2. Value chain/supply chain integration - setting up a process/work-plan that would be used to put the farmers into clusters.

3. Financing structure – matching funding needs with capacity.

4. Geographic location and choice of machinery.

5. Vendor Support and Capacity building.

6. Giving consideration to the impact of agricultural practices on sustainability.

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PICTURE GALLERY

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PICTURE GALLERY

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PICTURE GALLERY

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PICTURE GALLERY

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new strategies for financing agricultural mechanization

Presentations & Public Speaking

agricultural smes

agricultural machinery

agricultural land development

direct model

agent model

wholesale models

usage of farm power

main power sources