value chain finance and risk management
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Financement de la chaîne de valeur et gestion des risques
Forum Regional sur le Manioc en Afrique CentraleYaoundé, 6-9 décembre 2016
Lamon Rutten
Situation % of firms
identifying access to
finance as a major
constraint
% of firms with a bank loan/line of
credit
Proportion of loans
requiring collateral
Value of collateral
needed (% of loan amount)
% of firms using bank
loans to finance investments
Sub-Saharan Africa
42 24 79 171 18
Cameroon 55 30 83 213 31CAR 46 26 84 233 25Chad 47 21 75 136 4Congo DR 39 9 72 152 7Rep. Congo 45 13 68 47 8Gabon 30 9 53 N.A. 6Source: IFC, Access to Finance, 2014
SME access to bank finance
On the other hand, agricultural finance in 2015 accounted for 14.9% of total bank credits, as compared to 7.6% in 2011.
Capital market
Banks
Farmers Processors Traders Service providers
Need to place money at a reasonable rateGovern-
ment borrowingBench-
mark
Need investment and working capital at a rate that permits them to improve revenues/profits
Risks; tenor mismatches
Why doesn’t money flow to
agriculture?
Forms of agricultural finance
Traditional finance:
Loans based on client risk assessment
Micro-finance:
Loans based on social links
Value chain finance:
Loans based on economic links
Secured finance
Unsecured finance
Structured finance
Long-term
finance
Medium-term
finance
Shortterm
finance
Bank
Client
Unsecured finance
1. Due diligence,
2. Loan Hope you get your money back
If the client does not reimburse, then the bank can start recovery procedures. In case of bankruptcy of the client, the bank is just one of the creditors, without any preferential access to the client’s assets.
Loan can have conditions, eg., maintenance of profit ratios, no secured loans from others
Who can get unsecured finance?
• People/companies with a good track record
• Those with good and stable revenues
• Those with good connections (high-risk for bank…)
• Those able to borrow if an organization is forced to lend under a political mandate
• Those with good business plans and good stories• Venture capital finance (eg., MITFUND)• Crowdfunding on the internet (if you can combine
economic and social/environmental impact)
Small farmers are therefore not good candidates for unsecured finance…
Efforts to give them such finance have in the past only led to large losses for the government and a lot of corruption.
But at the same time, small farmers generally do not have the security that banks need. Banks also know that farmers who operate on a subsistence basis have a lot of financial pressures… and in practice, seizing collateral in case of late payment often does not make any sense.
The best possibilities is to engage in finance schemes that raise farmers’ profitability and revenues, and reduce their risks (with insurance and contracts with buyers). That’s value chain finance, linking smallholders to large buyers.
Bank
Client
Secured finance
Loan GroupEquip-ment
Guaran-tor
Real estate Pay-
ment
If all goes well…
Bank retains ownership
Member-ship
Client meets criteria
Partial repay-ment
Full repay-ment
Registra-tion of collateral
User rightsOwner
Equipment finance (leasing)
Possible for both new and second-hand items. For new items, the financier is directly invoiced by the vendor, and resells with deferred payment terms to the client.
Operating versus financial lease
Normally, upfront deposit required (say 10-20%; can be more for equipment with very limited secondhand market; period normally from 1 to 5 years). Payments can be structured to reflect buyer’s expected cashflow (eg. growth, seasonality).
The only security is on the equipment that is financed. In case of loan default, the financier takes the equipment back, without any need to have recourse to a court first.
It is essential that the financier can have a clear title, which means that he has to be able to register the security.
The collateral that banks habitually accept as collateral leaves much potential collateral unutilized. The general situation in developing countries with respect to SME lending:
Source: IFC, Access to finance, 2014
One consequence: long-term assets used for working capital finance
Long-term assets (land, real estate)
Long-term investment finance
Equipment, machinery
Medium-term (5-7 years) finance, leasing
Crops, stocks, receivables
Revolving working capital finance
How it should be:
Equip-ment
Recei-vables
Bank
Client
To properly use movable collateral one needs a proper legal framework, and it is very useful to have a web-based centralized electronic collateral registry. This permits financiers to ensure they have first claim on collateral. A World Bank project to create such a registry started in Cameroon in April 2016.
Collateral registry
Goods in warehouse
A few words on microfinance
Microfinance can be unsecured, secured (by group guarantees) or structured (value chain finance). Using joint liability groups a the main lending instrument has been the most common among MFIs.
While this is suitable for the typical microfinance one finds in cities and small towns, it is not suited for agriculture:
- With its stress on regular group meetings and regular repayments of small amounts, it has high operating cost. This leads to interest rates that are too high for agriculture.
- Agriculture needs a fairly big loan at the start, then many months of nothing, then, after harvest, reimbursement…
- Group lending may reduce credit risk, but it does nothing to reduce performance risk (ie., to improve the profitability/revenues of farmers)
In India, one of the largest rural MFIs is BASIX. It’s active in 25,000 villages, and has lent to more than a million people. It had started in 1996, and in 2001, it was widely seen as a very successful MFI. But then, its management did an evaluation of its operations…
Findings: It wasn’t that successful at all. About 52% of its clients showed increased incomes, but 23% showed income declines. Reasons:
1. unmanaged risk;2. low productivity; and3. unfavorable terms in input and output market transactions.
BASIX decided to turn from joint liability groups (secured finance) to structured finance, in which it directly addressed all three problems.
Risk management: among others:- Insurance (life, sickness, even weather insurance)- Active risk mitigation: if you borrow from BASIX to buy a
milk cow, BASIX will help you chose the cow, and veterinarian services are included in the package.
Productivity improvement: BASIX set up its own extension agency, training some 1,000 people to provide extension services: soil-testing, integrated pest management, field surveillance, linking farmers with the proper input markets, health checkups of animals, livestock vaccination, training on use of feed and fodder and better dairying practices. Farmers pay an annual fee of around US$ 10.
Improving bargaining power in input and output markets:
BASIX started promoting contract farming schemes. Not all worked – mostly because of problems with the buyers (who were not sufficiently organized). But many did, eg., in potatoes, cotton, dairy. Eg in dairy, BASIX worked on the whole value chain, enabling farmers to invest in the first part of the chain (reception points with cooling centers).
In cotton:
Bank
Client
Value chain finance
Input provider Offtaker
Payment Repayment
Inputs Produce
Pre-harvest Post-harvestSeedlings, fencing
Producer Processor
End-buyer
Warehouse
Supplier of improved varieties
Goods can be owned by producer,
processor or end-buyer…
Warehouse receipt finance
Payment of supplier,
reimbursed once
processor pays
Factoring
Factoring
Working capital finance, based on total of inventories (under collateral management) and
receivables
Value chain finance can cover all or parts of the value chain.
Value chain finance is revolving finance that scales itself automatically to the (seasonal) needs of the business (as long as certain covenants are met)
(because the credit line is linked to the movable assets in the client’s business operations).
If goods become more expensive, automatically, the credit line increases.
(But the bank will consider price risk, so in the absence of a commodity exchange, the value of crops will remain much discounted).
(CTA recently finished a report on the potential for a regional commodity exchange in Central Africa, concluding it is feasible as long as government are willing to set up a proper licensing regime and then get out of the way)
Value chain finance tackles directly the main constraints that hinder finance from flowing to agriculture:
Risks; tenor mismatches
Need investment and working capital at a rate that permits them to improve revenues/profits
Bank
Agricultural sector
Collaboration with value chain partners makes it possible to improve productivity and revenues
Reduced risks, permitting
lower interest rates and
higher loans
Why reduced risk?
Because the bank replaces
Credit risk
by
Performance risk.
Unwillingness to pay
Inability to pay
If the financing is structured properly, as long as the client performs normally in the value chain (i.e., the goods arrive with the intended buyer), the bank will get its money back.
Value chain finance starts on the demand side. The starting point cannot be: farmers produce X, they have to find a buyer.
Difference between a subsistence farmer and a commercial farmer: the first tries to sell what he produces, the second tries to produce what he can sell.
Ideally, buyers tap into an already known market. Eg., to supply cassava flour to bakeries.
Successful schemes have relied on the private sector, with governments in a supportive role and occasionally as a catalyst; and often, donor agencies’ involvement, to provide technical assistance to farmers so that they can raise their productivity and revenues.
Technical assistance can also cover the capacity-building needs of offtakers and banks.
Bank
Client
Using the value chain for financing
Input provider Offtaker
Payment Repayment
Inputs Produce
Ware house
Confirmed invoice
FactoringWarehouse
receipt finance
Deposit
Invoice discounting/factoring
A small seller delivers to a larger buyer, who is well-known to the banks.
The buyer only will pay in 60 days, but confirms that the goods have been delivered. I.e., the seller has a receivable.
The seller can now discount his receivable(s) with a bank or a specialized financing company. He gets finance at an interest rate that corresponds to the risk of his buyer.
In practice, factoring schemes nowadays normally work on electronic software, in which invoices are created and confirmed.
Financiers have to understand well how exactly to manage this product, otherwise there are large fraud risks.
Accounts ReceivableFinancing
Legal Capacity to
SecureAccounts
Receivable
Credit Framework to
ManageAccounts receivable
loans
Good documentation with capacity to
collectAccounts receivable
Cameroon adopted the legal framework in 2014
Have banks already set up the necessary internal procedures? Do they have competition from non-bank financing houses?
Is there already a good electronic invoicing platform used widely by Cameroonian SMEs?
For factoring to take off, certain conditions need to be met.
How do you open a factoring account with a financier?
First, you provide information: • Financial Statements (multiple periods)• Accounts Receivable summary ledger, with listing of
creditors (buyers)• Inventory summary schedule
Then, the bank will go through the following process:• Analyse accounts• Calculate average accounts due• Calculate average inventory on hand• Evaluate pool of buyers, and load their details• Determine acceptable lending level• Set loan covenants• Set up reporting criteria to monitor (easiest in case of an
electronic invoicing system).• Give clients an internet account.
A common form of factoring is Invoice Discounting. Characteristics:
Assignment of all receivablesNon-disclosed or disclosedClient does own collectionBuyers proceeds banked direct to bank/lender’s account Reconcile account balances at each drawdown and periodicallyOngoing reviews/field auditsRecourse to client in case of borrower default.
Financing is for 60-90% of the invoice value. The client needs to have good accounting systems, and a well-diversified client base.
What’s the operational process?• Invoice batch sent weekly by client to bank• Reports listing what the client processed that week• All debtor payments must come to the client’s account at the
factoring bank• Client can view the bank account through the internet• Concentration issues are checked (i.e., overly important clients)• Debtor ageing is reviewed (are clients paying late?)• Calculate the “Available Funds” based on approved balance of
accounts due (at chosen funding ratio).• Client can execute drawdowns any day• Buyers (creditors) reviewed monthly to check ageing and for
signs of problem)• Bi-monthly reviews performed at the client’s premises. The
reviews will focus on the client’s internal processes.
If the client’s processes are weak, then the bank is likely to insist on non-recourse (or full-service) factoring. This is somewhat more expensive, but the bank will take care of the full process of debt recovery from buyers, and will take all the risks related to late payment or non-payment by buyers.
In practice, this is the most suitable form of factoring for most SMEs.
Invoices are still issued by the client, and have to be issued properly (this will be checked from time to time by the bank). All receivables are assigned to the bank, and the bank directly interacts with the buyers.
Financing is 50-90% of the invoice value. Cash received is often retained for a number of days.
Banks can also do single-invoice discounting.
Warehouse receipt finance is a game-changer for agriculture
France: overcoming mid-19th century social tensions (revolution!) coming from the gap between fast urban growth and lagging agriculture
US agriculture: enabling the development of late 19th/early 20th century agri-processing industry
Globally: leveling the playing field by creating a farmer- and SME-friendly financing instrument
… and a robust instrument, that can be used in very difficult environments (in Africa, warehouse receipt finance has even worked while civil wars were going on).
The concept: turn agri-commodities into gold
Vault
Bank
Borrower
Deposit gold in bank vault … and get
an ‘easy’ loan
Implies that the banks knows it’s gold
So why not extend this mechanism to (processed) cassava and other commodities…
“Vault”
Bank
Borrower
Deposit cassava in bank “vault”…
… and get an ‘easy’ loan
The bank needs to know the commodity’s value
What’s a good bank “vault” for agri-commodities?
“Vault”
Bank
Borrower
Critical issue: the relationship between the bank and its “commodity vault”
How can a bank effectively extend its “vault” to include warehouses suitable for storing agri-commodities?
Affordable Safe
Post-harvest finance (crops in warehouse)
In bank’s own
warehouse
In independent warehouse (“public
warehouse”)
In borrower’s warehouse,
managed by:
Independent collateral manager (“field warehouse”
or “collateral management”)
Borrowing corporate(“private
warehouse”)
Farmers (warrantage)
Different possible relationships between the bank and its “vault”…
One possibility is for the bank to create a warehousing subsidiary, which sets up its own warehousing network. This has been done in Latin America and Turkey. But is this really part of a bank’s core business? Moreover, does it make sense for a warehousing network just to serve the needs of one single bank?
Ware-house(s)
Bank
Borrower
Warehousing subsidiary
1. Deposit commodities in the warehouse…
2… and get an ‘easy’ loan
Another option is to use the borrower’s own warehouse. But for this warehouse to give (almost) as much security as a bank’s own vault, the bank needs to take over its control. It does so using the services of an independent, financially sound collateral manager (CM) which will act as its agent in controlling the warehouse.
Ware-house
Bank
Borrower
Collateral manager
2. Control
1b. Agency agreement
1a. Trilateral agreement permitting the CM to take control over the borrower’s warehouse
Ware-house
A collateral manager
“wraps” the warehouse with
professional management,
improved logistics and
grading, and full insurance
coverage.
Physical infrastructure
A collateral manager accepts liability for the continued presence of (90%) of the stocks. As banks normally only finance up to 80% of the stock value, this makes bank lending safe… as long as the collateral manager has the means to meet his obligations.
To make a borrower’s warehouse as safe as its own vault, the bank uses a collateral manager…
Staff of the collateral manager (CM) takes control over the warehouse at the borrower’s premises. No commodities are allowed to enter or leave without their permission. The CM reports to the bank on the quantity and quality of the paddy/rice in the warehouse, and on this basis, the bank provides credit to the borrower.
Ware-house
Bank
Borrower
3. Deposit commodities in the warehouse…
5… and get an ‘easy’ loan
Collateral manager
4. Reports
2. Control
1. Agency agreement
Alternatively, there may be warehousing companies in the country which store commodities for third parties (“public warehouses”). If the bank trusts this public warehouse, it can give loans against the security of any goods deposited by anyone … all depositors become potential borrowers.
Ware-house(s) Bank
Borrower 1
1. Master agreement
Borrower 2 Borrower 3
For each borrower, the warehouse weighs and tests the paddy/rice deposited, and issues corresponding “warehouse receipts”. Against this collateral, the bank provides loans. The goods remained blocked in the warehouse until the bank authorizes their release.
Ware-house(s) Bank
Borrower
2. Deposit commodities in the warehouse… 5.… and get
an ‘easy’ loan
1. Master agreement
3. Warehouse receipts
4. “Blocks” the goods in the bank’s name
It is possible to finance the inventory in a borrower’s own warehouse without using a collateral manager. But this is risky. It should only be done:
- For reputable clients- As part of a value chain financing that covers a larger part of
the value chain- With a proper monitoring system in place, with the bank
having access to all the paperwork that accompanies the purchase, processing and sale of the stock
- With periodical checking by an independent monitoring company.
Warehouse
Processor, trader
Collateral manager
Collateral Management Agreement: Full control
Collateral management – borrower’s warehouse controlled by a 3rd party. What’s the scope?
Can be done if a processor’s/trader’s warehouse is physically separate from the processing equipment, or a trader’s distribution space
But the problem: This only works is you use a suitable collateral manager:- domain expertise- electronic backing for his activities- access to suitable insurance.Otherwise, whatever you call it, you have just a monitoring arrangement, without any effective risk transfer to a third party.
Works for the bank !
The big success story in India, a collateral manager operating public warehousesCollateral managers (NBHC, NCMSL) have taken over control of private warehouses, and operates them as public warehouses, open to a large variety of depositors.
NBHC arranges credits for several dozen banks, under master agreements in which it acts as a bank’s agent. In many cases, NBHC originates the deal: a farmer or a trader deposits goods in a NBHC warehouse, and if the quality is OK, NBHC staff then arrange a loan from one of the banks from which it has a mandate. The funds arrive in the client’s account the next day…
The Indian model streamlines the warehouse receipt finance process
Prospective clients can apply online, and the process after that is easy, and transaction costs low.
One result is that warehouse receipt finance becomes feasible even for small loans. Eg, from 2007 to 2011, NBHC arranged more than 100,000 warehouse receipt financing loans for farmers, starting as small as US$ 500. Loan distribution is often through smart card.
Risk management in case of collateral management
Warehouse
Borrower
Financier
Collateral manager
Reporting, incl. on prices
Control
Loan up to 75% of the initial value of the collateral (higher with hedging)
Borrower pays top-up margin (in cash or extra stocks) to ensure bank margin stays above 5%
Deposit
Pledge, guarantees
Insurance
Theft, natural hazards
Warehouse receipt finance for the export supply chain
Trader
Processor
Port warehouse
International buyer
Farmers
BankCredit
support company
Full control
The situation in Cameroon6 collateral managers with HQ in Douala. All handle imported and exported commodities (cocoa, coffee, cotton, rubber, rice), but not locally produced commodities.
Only 2 of them are active outside of cities/ports.
All banks work with these collateral managers.
Several donor-supported initiatives in the past:• Northern Cameroon, seeds and inputs for cotton farmers
(IsDB, SODECOTON, Credit du Sahel, Cotton Producers Assoc.• IFAD & Government, Projet d’appui au développement de la
microfinance rural (PADMIR)• CAMCCUL (microfinance network) funding cocoa and coffee.• ONCC: negotiated with a private equity fund a 30 mln $
revolving line of credit, to be channelled through MFIs and banks to finance coffee and cocoa, using warehouse receipts.
Legal framework: OHADA. Requires registration of pledges in order to establish bank’s security.
But OHADA does not include regulation on warehouses or collateral managers… As already recommended years ago, Cameroon should draft a proper warehouse receipt law.
It would also help if there is a commodity exchange: exchange users are bound by the exchange’s rules and, in case of contractual disputes, its arbitration panels, which helps give security to financiers.
As to cassava: PIDMA, according to value chain stakeholders, should have a component to develop “warrantage” for processed cassava products. But not everyone agrees it’s feasible.
Anchor finance
Starting point: an organized buyer (eg., Guiness) who wants to procure specific kinds of cassava.
Elaborate these plans: what quantities, from where?
Identify who is able to supply the cassava.
Verify that they can do so profitably, and (probably) put in place a technical assistance scheme to improve farmers’ profitability.
Get contracts signed. Start to make finance flow to where it is needed. This can include both working capital finance and equipment finance (e.g., for the rapid processing into intermediate products close to the field).
cassava flour, fermented flour,
Garri
attiéké,
starch
tapioca
Cassava
So, whether you can get access to value chain finance depends on how organized is the market into which you sell:
Bakeries
Industry
CommodityVolume Value
Status Haircut Credit available
Upcountry, cassavaUpcountry, starchCity WHReceivables
50%
30%
10% 3%
TOTAL
60
600
8001000
An example of a value chain financing for an integrated processor (controlling some fields of its own)
* 5 tons of cassava is processed into 1 ton of starch
Do farmers need to remain “just” farmers in a value chain structure? No. In Europe, Japan and the USA farmers have moved both upstream (inputs, equipment) and downstream (processing, distribution, banking).
So in principle, farmers could set up a cassava processing plant. Problem: banks may not trust the farmers’ ability to manage such a plant.
Possible solution: a corporative structure. For example:
Total finance needed for the processing plant: 100.Farmers’ own contribution: 5. Loan to farmers to buy equity: 35. Farmers will reimburse this through deductions from their deliveries.Bank-controlled vehicle: 60. With an agreement to sell the full 60 to farmers, through deductions, once farmers have repaid their loan. Meanwhile, the bank controls the plant, and can appoint and supervise its own managers. By the time the farmers have majority control, they are used to the professional management…
Supermarket chain (UK)
Contract farming scheme
Farmers
Long-term contract
Forward contracts
Dam
Irrigation, electricity
Local pension fundsLong-term
finance
EscrowaccountPayments
Debt service (hard currency)
Payment after water & electricity charges
Surplus
Export of flowers, fruits & vegetables
In principle, as long as one has the right buyer and a good control over the production process, farmers can even attract long-term finance from institutional investors.
But farmers have to keep in mind that value chain structures are long-term win-win structures. They cannot walk away from a supply market just because the price on the open market is a few percent higher, or because they think they have something better to do with their time than to harvest the cassava as promised.
This has gone wrong very often, and corporates as well as financiers want to have a high level of confidence that farmers are serious and in the business for the long term.
This can be facilitated by a proper deal structuring, e.g., not have forward prices that are entirely fixed, and an equity stake of farmers in the processing plant.