Access to Finance for Smallholder Farmers

Smallholder farmers make up a significant percentage of the individuals employed in agriculture across developing regions. According to one study, there are an estimated 450 to 500 million smallholder farmers in the world; most of these individuals reside in Asia and Sub-Saharan Africa, where they make up 90 percent of farmers and produce 80 percent of the continent’s food. Given the numbers involved, development institutions focused on agriculture and rural development have prioritized providing support to smallholders to improve their economic and social conditions. But many (if not most) smallholder farmers lack critical inputs that will unlock the gains in productivity and income that will lead to these economic and social development gains. Financing is central to smallholders gaining access to these inputs. Yet, most smallholder farmers are also unable to access the financing they need to secure these inputs. To increase access to finance, donors and development finance institutions (DFIs) should increase the use of official finance to incentivize commercial banks and rural-focused financial institutions.

Smallholder farmers lack basic inputs such as fertilizer, seeds, tools, and the knowledge provided by agricultural extension services to increase their yields. Further, they are also frequently isolated from markets because of a lack of basic infrastructure that would enable them to bring their goods to markets. Smallholder farmers also suffer from significant post-harvest loss because of a lack of proper storage. These challenges make it difficult for farmers to obtain the best price for their crops by creating pressure to sell as soon as they harvest. Smallholder farmers lack the resilience to manage the disruptions caused by climate change and Covid-19. Finding ways to improve the condition of smallholder farmers and improve their production is even more critical in the wake of Russia’s invasion of Ukraine that has further exacerbated disruptions in food supply.

Financing is a critical barrier for smallholder farmers to access the other inputs that they need to increase crop yields and income. By one estimate, smallholders in Africa, Latin America, and Asia face a $170 billion funding gap. This gap is caused by several reasons. First, local financial institutions in these geographies generally do not want to provide financing to smallholders. This is because they either see farmers as too risky or they do not offer the specialized financial products needed in the sector. Financial institutions also frequently do not have a physical presence near where smallholder farmers work. Second, the farmers themselves are largely outside the formal economic sector and frequently do not have the means—e.g., collateral—to secure loans or other financial support. This causes many farmers to turn instead to informal finance. Finally, there are also cultural barriers among farmers—many of whom are reluctant to take on loans or other financial exposure.

According to research by the Mastercard Foundation, the total financial market for smallholder farmers is estimated to provide $50 billion in credit per year, with $14 billion from formal financial institutions, $17 billion from value chain actors, and $25 billion by informal or community-based organizations. The vast majority of the formal financial sector ($9 billion) is provided by state banks largely active in Asia, where governments have provided them with a mandate to support the agricultural sector. Microfinance institutions (MFIs) provide the next-highest amount ($3 billion) followed by social lenders ($350 million) such as impact driven organizations like Root Capital, Oikocredit, and Triodos. These operations are largely concentrated in Latin America with expanding operations in Sub-Saharan Africa. Commercial banks remain limited in their engagement but provide an estimated $1 billion in credit per year.

To tackle the challenges faced by smallholder farmers, donors and other development actors have sought to innovate through different models that seek to provide a package of inputs, support, and financing. One Acre Fund, for example, seeks to offer farmers in East Africa greater access to training, services, and products that they need to increase their crop yields and incomes. The products include seeds, fertilizer, and tools that are provided to farmers on credit that they can payback over the course of the farming season. In 16 years, One Acre Fund has reached 3 million farmers and helped increase farmer’s income by $3.60 per $1 invested by the organization. Another model is Babban Gona that works in Northern Nigeria. Similar to One Acre Fund, Babban Gona provides training, financial credit, and improved inputs. It also acts as an aggregator by buying crops from the farmers who participate in the program and then storing them to allow the sale of crops at the best moment.

DFIs should play a critical role in deepening financial services for smallholder farmers. With their mandate to de-risk investments, DFIs can provide an important source of financing to encourage local financial institutions to be more willing provide credit and other financing to smallholder farmers. DFIs can provide on-lending facilities geared toward the unique needs of the agricultural sector. This would entail working with rural-based financial institutions, something DFIs have not necessarily done in the past. The U.S. International Development Finance Corporation (DFC), for example, provided a $17.5 million loan guaranty facility to Mibanco (Banco de la Microempresa de Colombia S.A.) to help increase the amount of financing available to rural borrowers. DFC has also supported the work of One Acre Fund through the provisions of direct loans (most recently $20 million) to help facilitate agricultural inputs, such as fertilizer and other services. Finally, DFIs can also provide financing to investment funds that target the agriculture sector. In 2022, DFC provided $50 million in equity to Aqua Capital Fund II that “targets business development for enterprises in Latin America focused on agriculture and food value chains, especially in improved agricultural yield, water management, distribution, and job creation and particularly in rural areas.”

DFIs, however, face barriers of their own of supporting smallholder farmers and the agricultural sector more broadly. To address these and increase access to finance for smallholder farmers, there are several steps that DFIs, donor agencies, multilateral development banks, and other development actors, including increased specialization, localization, product innovation, and partnerships.

First, if DFIs and other providers of official finance are to increase their support for smallholder farmers, they will need to develop a cadre of personnel who can specialize in investing in the agricultural and rural sectors. Such an approach would enable them to develop a pipeline of investment projects and identify ways to create financial products that can address the unique constraints smallholder farmers face in accessing finance. Some DFIs—such as the Dutch Entrepreneurial Development Bank, known by its Dutch acronym as FMO—already have a strong portfolio of investments in agriculture and smallholder farmers. The DFC, however, is still growing its portfolio in agriculture. It has increased its portfolio in recent years, but it should continue to prioritize this and hire accordingly to be successful.

Second, DFIs need to embrace localization, as agriculture is a hyperlocal sector. While there are broad trends, the sector is very country-by-country when it comes to the actors and financial needs. In larger markets, DFIs should develop a local presence by basing investment officers with the requisite expertise in agriculture. In addition, DFIs should engage bilateral and multilateral donors that could provide targeted technical assistance programs at the country-level to help farmers develop the skills needed to understand the value that credit, and other forms of financing can provide them.

Third, DFIs should seek to create more innovative financial products that can better address the unique needs of smallholder farmers. For the DFC this would mean a greater use of concessional finance to de-risk investments in this space. One area that could be helpful is through the greater use of local currency loans; under the of 2018, the DFC can now make non-U.S. dollar denominated loans. To date, this has been underutilized, but for smallholder farmers and others in the sector who need access to working capital, local currency loans could be incredibly helpful. This is especially true as interest rates are forecast to continue rising in the United States for next year. Technology and other forms of innovation also provide important pathways for increasing access to finance for smallholder farmers.

Finally, DFIs and other donors should prioritize forming partnerships with organizations that work closely with smallholder farmers. Ideally, they could create these by relying on companies and other organizations that already receive funding. For example, the DFC could look to One Acre Fund or Babban Gona, two organizations that have received financing and are models of engaging smallholder farmers. The DFC could work to identify other potential investments—such as those in the “missing middle”—that engage with farmers through One Acre Fund or Babban Gona. DFC could also partner with rural-based financial institutions that work closely with smallholder farmers and understand the unique needs of the sector. It could take an approach similar to its on-lending for small and medium sized enterprises (SMEs) with local financial institutions. Marrying this with grant-based technical assistance will be important to help smallholder farmers provide the necessary skills and knowledge to qualify for loans and other financing.

Smallholder farmers face numerous challenges and their ability to resist disruptions caused by climate change, the growing food price crisis, and now Russia’s unprovoked invasion of Ukraine. The sector is characterized by low yields and subsistence-level incomes. Successful projects have shown that if smallholder farmers have access to improved inputs—seeds, fertilizer, knowledge, and training—it can increase yields and raise their incomes. This enables improved social and economic development outcomes. But to do so, smallholder farmers need to have access to finance that will enable them to buy or lease new equipment, improved seeds, and other inputs. DFIs could help increase the finance available in this space by making greater use of concessional finance.

Conor M. Savoy is a senior fellow with the Project on Prosperity and Development at the Center for Strategic and International Studies in Washington, D.C.