Microfinance will not save the world, but it can improve lives in certain parts of the world. Almost 50% of the earth’s population—3.4 billion people1—live in rural areas, mostly in Africa and Asia. Of those, two billion are smallholder farmers. They also represent a large proportion of the world’s poorest people, living on less than $2 a day, the minimum survival threshold2.
Even promising approaches to the expansion of smallholder lending, such as value chain finance, have reached less than 10% of farmers, primarily those in well-established value chains, dedicated to high-value cash crops such as coffee, cocoa, tea, sugarcane and cotton. Despite this critical situation, estimates show that by 2050 there will be 30% more people in the world, with much of the increase in population in Africa. The role of the 450 million African smallholder farmers will be more critical than ever.
Microfinance cannot resolve all these enormous problems. But it can play an important role in helping some of these smallholders to prosper. This article highlights some of the key steps microfinance institutions take to support African farmers.
A tough life for African farmers
In Africa, where agriculture represents 15% of gross domestic product3, soil productivity is still very low, but farming is often the sole opportunity for survival. Smallholders usually cannot afford to have employees and so depend on their families to grow their own crops: their wives, relatives and children help them in the fields. Farmers usually rent the land they cultivate for a certain period under conditions established by village chiefs, private companies or national authorities.
Smallholders use their hands or basic tools to plough the soil and prepare it for planting. A tractor is something the majority cannot afford to buy, since even purchasing seeds can require a loan. This results in subsistence farming and small quantities of goods exported or commercialised.
How to find collateral for African farmers microfinance loans
Mobile phones are common in African rural areas, much more so than banks: there are 650 million cell phones in Africa4. People use them or share them to communicate with relatives who live in distant villages or to stay in touch with their kids who are studying in big cities.
In those regions where agriculture represents the main activity, mobile banking or mobile money could be a great solution for lending to people who live far away from a bank. Conditional tense is mandatory though, since many farmers do not have the competencies to understand how a loan works on a mobile, or what it means to give their savings to an institution via the Internet. Many of them have never seen or entered a bank. Conceiving of a digital bank account could be very difficult for them.
That’s where microfinance and loan officers from local, community-led microfinance institutions are needed: to explain to the clients, who might be illiterate, semi-literate or simply unfamiliar with numbers, what type of contract they are signing, how much debt they will have, if they will be able to repay that debt, when and under which conditions.
This poses, however, another question for financial institutions: what sort of guarantees can be provided by smallholders living off farming?
Since smallholders usually do not know how to keep formal records of their harvests and finances, it’s difficult for loan officers to receive a proper plan, a profit and loss document or a balance sheet. Since there are no inventories or business documents to sign, business is usually carried out verbally. Therefore the loan officer needs to understand the farm and the business behind it really well. He or she especially needs to trust the farmer`s capacity to generate acceptable profits from their activity.
Another potential challenge for microfinance officers, as compared to traditional finance, comes from the lack of hard collateral and is often based on trust. A couch, a television set, kitchen furniture, cattle, or non-perishable goods such as wood can be used as guarantees for a loan, too. But in certain areas where the main assets are livestock, the lack of proper collateral becomes a major obstacle to accessing formal credit. And if a loan cannot be repaid by smallholders because their crops are damaged or destroyed by extreme weather events, parasites or local conflicts, there is not much that can be done.
A couch, a television set, kitchen furniture, cattle, or non-perishable goods such as wood can be used as guarantees for a loan.
A win-win coffee ecosystem
Even though agricultural improvements are still challenging in Africa, there are some stories worth being told.
PRIDE Microfinance Limited (PRIDE stands for Promotion of Rural Initiatives and Development Enterprise) is a financial intermediary based in Kampala. A state-owned enterprise licensed by the Bank of Uganda, it has been active in microfinance since 1995. It started as an NGO (Pride Africa in Uganda Project) and rapidly expanded throughout the country.
As of December 2017, it was lending a total of €36 million to almost 79 000 borrowers through mobile channels and a network of 34 branches all over Uganda.
Today, around 16% of PRIDE’s loan portfolio is allocated to the agricultural sector.
Thanks to microcredit and mobile banking, this enterprise helps entrepreneurs buy seeds, pesticides, fertilisers and other farm consumables through community banking, group loans or individual loans. It also promotes sustainable farming by ensuring that smallholder farmers receive technical support to manage their crops and livestock farming.
When it comes to environment and education, PRIDE encourages the purchase of solar systems, water purifiers and biogas plants and gives smallholder farmers loans to pay for school fees.
PRIDE collaborates with the Uganda Coffee Development Authority, which is known as Ugacof, to support group lending activities in the coffee sector. This includes support for agricultural extension services, which aim to educate farmers in efficient and green farming practices.
A well-designed mechanism with coffee traders such as Ugacof can also prevent these farmers from side selling. Many farmers side-sell as a means of obtaining fast cash to pay school fees at the beginning of the school year, for example. The coffee beans sold to informal wholesalers generally are of low quality and, thus, the prices are lower compared to international market prices. Big formal coffee traders are interested in higher quality coffee and greater quantities. So such eco-systems can create a win-win situation for smallholder coffee farmers and coffee traders.
In 2019, the European Investment Bank financed PRIDE with a €5 million loan in Ugandan shillings under the ACP Smallholder Financing Facility, to be used over a period of five years. European Investment Bank microfinance facilities have brought €300 million to more than 1.5 million beneficiaries.
To right an imbalance between working age people and jobs
Every year in the African country about 700 000 people reach working age, but only 75 000 new jobs are created5. Besides, Uganda hosts more than 1.3 million refugees and asylum seekers who survived local conflicts. It is the third-largest number of refugees in the world6.
To provide financial literacy to farmers living in distant, rural areas and refugee communities, Centenary Bank and the European Investment Bank, in coordination with the Office of the Prime Minister, United Nations High Commission for Refugees and the European Union, have organised intensive training sessions targeting business development, digital services and mobile banking.
This is particularly significant considering that Ugandans without a bank account, legal or financial services amount to 89% of the population. That’s 18.6 million people.
In May 2019, for the first time, local entrepreneurs and more than one thousand refugees attended a nationwide financial inclusion initiative. This included 10 day long training workshops across Uganda, both in the capital Kampala and in areas hosting refugees. An estimated 10 000 bank staff and 20 000 entrepreneurs across East Africa have benefited from the training over the last five years.
The European Investment Bank financed Centenary Bank with a €15 million loan under the ACP Smallholder Financing Facility to support micro, small and medium-sized entrepreneurs.
Small steps with African farmers microfinance
We have to downgrade our expectations a bit, but we should keep relying on microfinance.
It has great potential. It can help people improve their lives and save a bit of money to face emergencies or to develop their business, moving from smallholder farms to profit.
A micro loan may help smallholder farmers seize on good offers on the market to buy extra food for their family, repair tools or pay for medical care or school fees.
Microfinance can be the starting point of a virtuous circle for agriculture in Africa. If those who have a productive activity are able to generate profit, they can use that profit to repay the microfinance institution, which is then able to repay the financing.
Microfinance will not end poverty, but it will make life for poor people easier.
Hannah Siedek and Enrico Pini are investment officers in the NON-EU Equity and Microfinance Division at the European Investment Bank. Their team refinances financial institutions using European Investment Bank funds to support beneficiaries – micro entrepreneurs, one-person shops or microenterprises with up to ten employees - in Africa, the Caribbean and the Pacific.