Agricultural Value Chain Finance: A Guide For Bankers

AGRICULTURAL
VALUE CHAIN FINANCE

A GUIDE FOR BANKERS
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AGRICULTURAL
VALUE CHAIN FINANCE
A GUIDE FOR BANKERS
Carlos Cuevas and Maria Pagura
Table of Contents
Acknowledgements .............................................................................................................................................................. ii
Introduction ..........................................................................................................................................................................1
Chapter 1: The Business Case for Value Chain Finance ....................................................................................................6

Chapter 2: Identifying a Target Value Chain .......................................................................................................................9
Chapter 3: Mapping the Value Chain – Market Intelligence............................................................................................15
Chapter 4: Entry Points for Financial Institutions ...........................................................................................................23
Chapter 5: Value Chain Financial Products ......................................................................................................................29
Chapter 6: Risk Management, Costs and Returns ...........................................................................................................32
Chapter 7: Adapting the Bank Structure and Operations to the VCF Model ..................................................................37
Chapter 8: From Pilot to VCF Launch ................................................................................................................................43
Conclusions.........................................................................................................................................................................45
Annex A: Basic Concepts and Principles...........................................................................................................................49

Annex B: Assessing Commercial Criteria in Value Chain Selection ................................................................................56
Annex C: Agriculture Value Chain Financial Products .....................................................................................................59
Annex D: Internal Bank Proposal to Management ...........................................................................................................65
Annex E: VCF profit and loss account template ...............................................................................................................69
References .........................................................................................................................................................................70
List of Tables
Table 1: Value chain participants. Main features and typical demand for financial services ........................................3
Table 4.1: Value chain organizational structures..............................................................................................................24
List of Boxes
Box 2.1: Building upon existing relationships with HDFC in India ..................................................................................10
Box 2.2: Partnering with large processors to pilot VC interventions in Pakistan ..........................................................10
Box 2.3: The selection of the horticulture value chain in Mexico ....................................................................................12
Box 3.1: Research and development and biotechnology in input supply .......................................................................17
Box 3.2: What defines an anchor company?.....................................................................................................................19
Box 7.1: Roles for monitoring ..............................................................................................................................................41
Box 7.2: Bank’s early warning system ...............................................................................................................................42
Box 8.1: A value chain project at Yapi Kredi, Turkey ..........................................................................................................44
Box 8.2: Yapi Kredi value chain action plan ......................................................................................................................44
List of Figures
Figure 2.1: Key success factors in the Brazilian poultry industry ...................................................................................14
Figure 3.1: Turkish poultry value chain ..............................................................................................................................17
Figure 3.2: Mexico tomato production ..............................................................................................................................18
Figure 4.1: Financial flows within the value chain ...........................................................................................................24
Figure 4.2: Cross-selling and tailoring products to the value chain ...............................................................................28
Figure 5.1: Value chain finance products ......................................................................................................................... 29
Figure 6.1: Costs and rates to borrower (gross return for bank) .................................................................................... 35
Figure 7.1: Industry analysis for a value chain in Yapi Kredi ............................................................................................38
Figure 7.2: Credit evaluation of a Turkish poultry operator ............................................................................................ 39
Agricultural Value Chain Finance - A Guide for Bankers i

Acknowledgements
The Agricultural Value Chain Finance - A Guide for led the drafting of the Guide. Senior consultants, Ken
Bankers has been developed under the Agriculture Shwedel in Mexico, Nico van Wageningen in Pakistan,
Finance Support Facility (AgriFin) of the World Bank. and Raman Ahuja in India, provided quality inputs and
Funding for this activity was provided by the Bill and insightful analysis of the respective value chain case
Melinda Gates Foundation without which this activity studies. Patrick Flajole provided research assistance
would not have been possible. and editorial support throughout the drafting of the
case studies and the Guide.
This Guide would also not have been possible without
the contributions and frank collaboration of three The team would like to acknowledge and thank the
leading banks in agricultural finance: Bankaool, following individuals for their input to the development
Mexico; HBL, Pakistan; and HDFC, India. Their senior of the Guide. Roy Parizat, AgriFin Project Coordinator,
representatives, Francisco Meré, Kashif Thanvi, and provided valuable feedback throughout the entire
Michael Andrade and their respective teams in Mexico, project. The peer reviewers, Jamie Anderson, John
Pakistan and India, have been a permanent source Blanchfield, Juan Buchenau, Hans Dellien and Panos
of wisdom and insight throughout the development Varangis, contributed with comments and suggestions
of this Guide. Michael Andrade has been particularly that greatly improved the original draft. The current
generous with his time during the writing of the Guide. version is better focused on the intended audience –
The document has also benefitted from inputs coming bankers – than the initial draft thanks to the reviewers’
from presentations at the AgriFin “Boot Camp” value inputs. Damian Milverton of globaleditor.org completed
chain financing training in Johannesburg, South Africa, the review and refined the final document.
October 2014, notably those by Ömer Demirhan, at the
time with Yapi Kredi, Turkey. Lastly, the team is particularly grateful for the
assistance provided by Marc Sadler, Advisor, Agriculture
At AgriFin, the team has worked under the leadership Global Practice, for his leadership and guidance on this
of Maria Pagura, Task Team Leader for this activity. project.
Carlos Cuevas, Senior Technical Advisor, coordinated
the case study work with the banking partners and
ii Agricultural Value Chain Finance - A Guide for Bankers

INTRODUCTION
The perceptions of serious lending risks and high costs only expands credit use along the value chain, but also
of service delivery, among other limitations, are well- makes available a number of other services such as
known barriers to the financing of smallholders. These payments, deposits, and insurance that were previously
barriers make it difficult and sometimes impossible beyond the reach of producers and other value chain
for farmers to get a loan, therefore denying them a participants. By taking a value chain approach,
chance to grow their businesses and incomes. Clearly, banks can benefit from such portfolio expansion and
traditional banking does not meet the needs of the diversification by bundling and cross-selling products
smallholder. Experience suggests that value chain and services.
finance is arguably one of the most sustainable and
effective ways of reaching smallholder farmers with the The Guide has been created by bankers for bankers.
potential to benefit a significantly greater proportion of The Guide has been developed by practitioners carrying
the 450 million smallholders worldwide.1 out field experiments (in partnerships with AgriFin) that
involve new agricultural value chains in their relevant
This Guide to agriculture value chain finance (AVCF) is markets. These field case studies have been supported
based on existing good-practice knowledge, and the by a comprehensive review of existing literature and
experience and insights of well-recognized bankers experiences worldwide, and the drafting of this Guide
partnering with AgriFin. It represents a “how-to” has been assisted by expert advice.
approach to enable other banks to engage in value
chain finance with a much better understanding of what The intended audience. The Guide will be useful
works, and what to avoid. to financial institutions and practitioners already
engaged in agricultural lending and rural finance who
The main objectives of the Guide are: are interested in improving outreach and profitability.
Information contained within the guide will also be
a. To provide practical, evidence-based guidance to useful to those not currently active in agricultural
financial institutions engaging in AVCF. lending, but who might be considering a strategy to
b. To offer a comprehensive picture of agricultural enter this market.
value chains so as to enable financial institutions
to work with different segments of the value By combining a review of good practice models in
chain and adapt financial products to the specific several countries with three individual case studies
demands of value chain participants. (field experiments in India, Mexico and Pakistan), the
c. To provide examples of field-tested AVCF products methodology aims to answer the following questions
and procedures that have shown value or promise. most relevant to bankers:
While value chains can finance internally with loans 1. What works in value-chain finance?
from one participant to another, this Guide emphasizes 2. Why it works?
the role and challenges of “external” value chain finance, 3. Where does it work? Under what conditions?
i.e., the financing arrangements that include banks 4. What are the finance instruments that make it work
and other financial institutions. External finance not (risk-sharing, structured finance, others)?
5. What factors deter success in VCF?
1. See Christen and Anderson, 2013, for detailed estimates.
Agricultural Value Chain Finance - A Guide for Bankers 1

Organization of the Guide requires an assessment of the broader risks of the
value chain. Agricultural value chain finance often
This Introduction deals mainly with the question of “why” prioritizes bringing together individual farmers and
value chain finance is important, and summarizes a few their productive capacity via producer associations,
basic concepts on value chain finance. The subsequent cooperatives, and other forms of collective enterprise,
chapters, the core of the Guide, focuses on practical thereby greatly improving their access to methods
questions in implementing value chain finance models. of diversifying and transferring risk. It also leads to
Its contents derive primarily from the three value chain economies of scale in market transactions and greater
case studies, and other field-based evidence from banks bargaining power to form more reliable and profitable
actively employing a value chain financing approach. The relationships with other market participants.
Conclusion addresses the guiding questions above, and
highlights lessons from the field. By focusing on agriculture value chain finance, banks
can develop a long-term strategy for growth in lending
Why should the value chain matter to bankers? to other market segments and increased adoption of
banking services leading to large increases in deposit
Understanding the structure, relationships, and drivers balances, and payment services. Costs and risks can
of an agriculture value chain can shed light on the be reduced through AVCF, offering a means to reach
opportunities for a bank to profitably penetrate or smallholder farmers who may have otherwise been
expand its presence in specific market segments. It is excluded from formal financial services.
important to recognize some key ways in which value
chain analysis differs from examinations of traditional Key value chain participants and
commodity systems or industries: financial interactions
• It focuses on net value added; There are five main categories of participants in a value
• It recognizes that linkages between activities and chain. Their main features, as well as the relationships
participants vary according to the product, even if among them, are summarized below. A comprehensive
the participants are the same; discussion of these participants is included in Annex A.
• It recognizes that there are different kinds of
value chains depending on their “drivers” and the Participants
associated governance relationships; and
• It looks beyond physical flows to include Input suppliers and providers of agricultural equipment
informational flows represent the beginning or upstream section of a value
chain, while retail distributors to end consumers are
In contrast to conventional direct lending to individual at the tail or downstream part. Table 1 summarizes
participants in a value chain, AVCF is characterized the features and typical demands of the five main
by a comprehensive assessment and understanding categories. It is common, in practice, to find the same
of the entire chain and the use of (and in some cases individual/firm in more than one role, e.g., a trader/
development of) specially tailored financial products aggregator can be an input supplier; a processor might
that meet the needs of the chain. Rather than a also be a wholesaler or exporter.
simple credit risk assessment of the borrower, AVCF
2 Agricultural Value Chain Finance - A Guide for Bankers

Table 1. Value chain participants. Main features and typical demand for financial services
Participant Main features services

Input suppliers Provide farmers with the inputs necessary for • Short-term working capital
production. These include seeds, chemicals, fertilizers • Mid-term financing (equipment
and equipment, as well as technical assistance. Input dealers)
suppliers often vary in size, and have different and • Payments, transfers
individualized financial needs.
Producers/farmers All of those engaged in primary production including • Short-term working capital
farmers, their families and seasonal/part-time workers. • Mid-term financing (equipment,
Many producers face significant risks associated with livestock)
agricultural production, such as predictable and stable • Deposit accounts (value storage,
income, and household and medical expenses. commitment savings)
• Payments, transfers
Aggregators, service Buy produce from the farmers or co-ops and bulk it • Short-term working capital
providers, traders2 before selling it on. Their success hinges on making their • Mid-term financing (storage
working capital flow as quickly as possible in buying and facilities, vehicles)
reselling produce. Every transaction offers an opportunity • Deposit accounts (checking)
to make a profit (or incur a loss). Small rural traders have • Payments, transfers
to stop buying when they run out of cash, leaving farmers
stranded with their products.
Processors Add value to a raw product during the processing stage. • Short-term working capital
Small-scale processors may lack the working capital they • Mid-term financing (equipment)
need to buy products in bulk from a farmer group or • Deposit accounts (checking)
trader. They often lack the money to invest in equipment, • Payments, transfers
leading to losses, lower quality, and higher processing
costs.
Retailers, Sell the processed product to local and global retailers, • Short-term working capital
wholesalers, supermarkets, and smaller storefront retailers, which • Mid-term financing (equipment)
exporters in turn, sell to consumers. Wholesalers often manage • Deposit accounts (checking)
credit relations in two directions: they provide funding to • Payments, transfers
trusted traders so they can buy on their behalf, and they
may provide products to retailers on credit, expecting to
be paid after the retailer has sold the goods. In this way,
wholesalers often act as a de facto bank for other actors
in the chain. They often need more capital than other
traders in the value chain.
In traditional finance, several banks might lend to Participants’ relationships

various actors along the chain, with no coordination of
services and knowledge. AVCF can create efficiencies Value chain types have been characterized by several
by promoting coordination of a variety of financing sources according to which participants “drive” or
services along the chain. While much of the interest in initiate systematic cooperation within the value chain.
AVCF focuses on its potential to expand credit access Its connection with the identification of entry points
to smallholder producers, there may also be downward for financial institutions is developed in Chapter 4. The
flows in the chain; that is, producers finance buyers and focus here is on what determines the “tightness” of
processors by accepting delayed payments or delivering value chain relationships, since this is a rather critical
products on consignment. principle to consider. We also summarize the notion of
internal versus external VCF.
2. “Aggregators” are often also referred to “off-takers” by agribusiness partners in

the value chain. “Aggregators” has been favored throughout this Guide given it is
more familiar to those in the financial sector.

Tight versus loose value chains. Commercial While internal value chain finance offers the advantage
relationships between producers and buyers take place of utilizing relationships and transaction mechanisms
along a continuum from spot market transactions already in place, there are also drawbacks: working
(usually local) to full vertical integration (e.g., the capital is tied up in finance; farmers may not
broiler value chain; see Annex A). Tight value chains understand the costs of finance (as it is deducted from
are those with clearly established relationships and a payment for products, or hidden in price discounts); and
single channel, usually involving contracts or formal agribusinesses must allocate resources to financing
agreements. Often these involve what are called “closed suppliers, rather than to their core business.
marketed crops”, which pose transportation challenges
due to bulk or perishability, thus making side selling External value chain finance. When actors outside
costly and unlikely. In these value chains, producers the value chain, such as financial institutions, provide
have few or only one option to sell their products. Tight finance to the value chain based on relationships within
value chains may include export commodities, highly the chain, this finance may be referred to as “external”
perishable crops, and those that require commercial financing. A typical example is when a bank provides a
processing. Sources of internal conflict in tight value loan to a producer based on a contract with a buyer. The
chains can arise from a lack of transparency in entry of financial institutions and external financing can
contracts and uneven negotiating power among the benefit all value chain participants: buyers do not need
parties. The stability of the chain is contingent upon to use working capital to provide finance to producers;
these factors, and bankers need to understand the producers can access finance without meeting typical
likelihood of breakdowns in value chain relationships collateral requirements; and banks can enter profitable
before engaging. new markets without the risk and transaction costs
associated with lending to smallholders directly.
By contrast, in loose value chains (often involving “open
marketed crops”) farmers have a variety of marketing Guide Overview
options and may sell to various buyers. In addition to
a range of marketing options, open marketed crops This introductory chapter focused on why value chain
may also be stored for home consumption. Loose value finance is important for bankers. It also provided a
chains present more opportunities for competition and brief overview of value chain financing concepts and
may present producers with a variety of options for principles. The remainder of the guide focuses on the
marketing their crops. However, loose value chains are information and inputs that a bank requires to design
not necessarily better for smallholders. Such chains and implement value chain financing models. A brief
present fewer opportunities to forge long-lasting overview of each chapter is provided as follows:
relationships where credit, inputs, extension, and sector
knowledge flow between participants in the chain. • Making the Business Case for Value Chain
Finance: Why diversify into agricultural value
While the tightness of a value chain is often based chain finance? How can a financial institution use
on crop characteristics, specific context analysis information about the value chain to inform their
is necessary to determine how a particular chain lending practices? This chapter outlines the main
functions. components of the business case for financial
institutions.
Internal vs. external value chain finance
• Identifying a Target Value Chain: What is the
Internal value chain finance. Finance will flow in value basis for identifying a value chain? This chapter
chains regardless of the presence of formal financial explores the qualitative and quantitative criteria for
institutions. Participants further down the value chain evaluating the viability of financing a value chain.
provide loans to smallholders with or without the
involvement of financial institutions. Forms of internal • Mapping the Value Chain - Market Intelligence:
value chain financing include aggregator credit, input What exchanges take place within a value chain?
supplier credit, marketing company credit, and “lead Mapping of the value chain implies identifying and
firm” financing. This lead firm may borrow from a quantifying the flows and relationships that make
financial institution but there is no connection between the provision of inputs, production, processing and
the financial institutions and upstream value chain distribution possible. This chapter discusses the
participants (i.e. farmers, aggregators). relationships, and charts the various participants of
the value chain.

• Entry Points for a Financial Institution: Where • Adapting Bank Structure and Operations: What
should the bank come in? With a value chain changes are necessary in the structure and
identified and a successful mapping of the internal practices of the financial institution? Banks
and external flows completed, the next step is need to be prepared to manage their value chain
to determine the appropriate points to target for clients slightly differently. Not only will products
financial services. The success of a value chain does be different, but monitoring services and review
not imply successful financing unless appropriate processes also should reflect the different risks and
partnerships are in place. costs associated with the VCF approach.
• Value Chain Financial Products: How are traditional • From Pilot Project to Value Chain Finance Launch:
financing products different than value chain What information does senior management require
products? Many of the products used in value chain for approving the scale-up of a VCF pilot? What
finance are very similar to traditional financial information goes into a VCF proposal and business
products except that they leverage the information plan? How long does it take a VCF project to become
and relationships already in place within the value ‘business as usual’?
chain. There are a host of products that can be
tailored to the specific needs of the value chain and
the participant being targeted for financial services.
• Risk Management, Costs and Returns: How does

the value chain approach make agricultural lending
feasible? When banks partner with participants
within the value chain, it is possible to share
the risks and costs associated with lending to
smallholder producers and other value chain
participants.

1. THE BUSINESS CASE
FOR VALUE CHAIN
FINANCE
Why diversifying into value chain finance makes business sense.
Reduced credit risk through leveraging existing information inside the value chain.
Information on where value is added along the chain – as well as the identification of key
participants, intermediate and ultimate markets, and the nature of customer demand –
helps financial institutions make better informed lending decisions.
Substantially lowers transaction costs in lending and other services.
Greater profitability is possible through economies of scale in market transactions and the
provision of multiple financial services using value chain connections.
The value chain finance model presents a compelling implemented wisely, VCF can be a profitable line of
business case given that it reduces information business for commercial banks.
asymmetries it is and lowers transaction costs. If
Reduced information asymmetries

Information asymmetries are substantially reduced traders and collectors, mid-level and wholesale
because the bank – through partnerships or contracts aggregators, processors and exporters.
with value chain participants such as aggregators • Region-specific and cultural factors, e.g., dominant
and processors – is able to utilize information that local language, and customary trade relationships.
otherwise would have been unavailable or expensive to • Market intelligence, including price behavior, market
obtain. This information encompasses: shares of different buyers, and input suppliers.
• Agronomic technical/engineering knowledge of Channeling loans for crop or livestock production

the crop(s) or livestock involved in the value chain through the buyers eliminates or reduces the need for
encompassing yields, desirable practices, input the bank to have full information about all value chain
demands, and timing of input delivery. The bank does participants. In fact, extensive due-diligence may be
not need to have in-house expertise to collect this needed mainly at the outset of the relationship and will
information. It is merely enough to interact with the likely focus on the main buyer or buyers.
value chain participant who has that expertise and
well-established business relationships with other There are a number of elements that need to be in place
participants (usually upstream). to drive a successful VCF experience, beginning with the
• Profiles of participants/customers engaged in the existence of a structured process for the commodity and
value chain, such as primary producers, small-scale a clear understanding of participants and relationships.

There should be a large number (typically thousands) of an availability of technological solutions to reduce
producers, as well as traders (buyers) willing to set up transaction costs associated with service delivery.
long-term relationships with the producers.
When all or most of these elements are present, then
The bank should set out to engage key suppliers of farm the specific commodity within the value chain is less
inputs and verify the track record of aggregators and relevant; it could range from grains, to tropical fruits or
producers in honoring contracts. It also needs to ensure industrial crops.
Reduced transaction costs

Banks can see substantially lower transaction costs It is also important to be able to deliver services up
in delivering and servicing multiple financial products and down the chain in a cost-effective manner. While
by relying upon the existing networks or transaction production financing can be achieved through the buyer,
platforms of VCF partners. In some cases, financial other services require a different delivery method. The
institutions have created payment platforms around choice of delivery mechanism becomes a decision
those existing relationships, allowing them to operate between direct provision through bank branches, or the
as if they had an extensive branch network but without use of agent networks (e.g., business correspondents)4.
the fixed costs of having established one.3 The latter seems to be the preferred means for creating
such a VCF platform. It not only allows better servicing of
Connecting the bank with the lead buyer or trader in the VCF participants, it also makes the services available
an already-established commercial relationship is to other farmers or rural clients outside the value chain
a preferable starting point. Once this relationship is who reside or work within reach of the agents.
created and well understood, the bank can design and
introduce financing vehicles priced to reflect the cost-
sharing and risk-sharing arrangements between the
bank and the value chain business partners.
3. The experiences of HDFC, India, and Yapi Kredi, Turkey, offer examples of these
platforms in the dairy and the broiler industries, respectively. Bankaool, Mexico, 4. Business correspondents conduct business transactions, accept deposits and
and Habib Bank Ltd. (HBL) in Pakistan are also employing this model. gather documents on behalf of the financial institution.

Multiple services expand bank business
The benefits of an agent-based delivery network become have additional options, such as savings accounts,
more apparent when considering that farmers who have particularly if they can choose from among a few types
been able to receive financing from within the value of accounts that meet their needs and preferences (e.g.,
chain tend to lose financial access once their produce term deposits). That way, the farmers develop the ability
is delivered, the loan is repaid and the surplus revenue to pay providers as needed or transfer funds to relatives
to the producer is paid out. Smallholder farmers are through the financial institution. At the same time, those
more likely to benefit from financial inclusion (and additional non-lending services bring additional revenue
remain active financial product consumers) if they to the bank.
Making the case

Broadly speaking, there are two principal business case While the India study’s conclusion that such an
scenarios in support of a bank adopting a VCF approach approach requires a higher degree of supervision and
to broadening its agriculture lending base: therefore additional costs may be correct, it should be
understood that those costs are shared across the value
• Expanding the coverage of a value chain in which the chain participants and do not necessarily accrue in full
bank already maintains some established business to the bank. This ability to defray loan transaction costs,
relationships (e.g., with an aggregator or processor) including client screening and selection, monitoring and
yet only limited outreach upstream to producers and supervision, and loan recovery, is a key aspect of the
input suppliers. business case for VCF.
• Establishing a presence in a value chain new to
the bank’s portfolio, using market intelligence and Of course, success of the VCF approach obviously
research (such as that carried out by AgriFin and its requires an appreciation of its merits by members of the
selected partner banks). This could be initiated on a value chain in addition to the financial institution. In the
pilot basis within the bank’s existing standards (e.g., three field case studies associated with this Guide, this
loan caps; see Chapter 6 below). would mean creating plausible business cases for seed
production organizers in India5, dairy collectors (and
In both scenarios, the bank will need to establish possibly larger collectors and small-scale processors)
relationships using conventional banking techniques, in Pakistan6, and vegetable processors in Mexico7.
i.e., dealing with each client individually. Illustrative There is the principal argument that wider access to
internal proposals are outlined in Chapter 8. financing and financial services for the producers will
generate more business for the upstream aggregators
Regardless of the selected business case imperative, and processors, an expansion that they can support
successful adoption of VCF hinges upon a clear and accelerate through investment of the funds that
understanding the target segment (based upon they otherwise would have provided as loans to the
market intelligence and value chain mapping) and the producers.
identification of appropriate entry points and products.
Of the field case studies considered here, the example
from India has perhaps succeeded more than others in
incorporating the various VCF components by analyzing
incentives for the main key participants (farmers, seed
producer organizers, and hybrid seed companies) and
drawing conclusions about unsecured lending based on
the information available inside the value chain.
5. HDFC Bank, AgriFin. 2015. Creating Value Chain Finance for Farmers – A
Summary of HDFC’s Market Study on the Hybrid Seed Production Chains. World
Bank.
6. HBL. 2015. Structure and Performance of the Dairy Value Chain in Pakistan – A
Summary of HBL’s Case Study on the Dairy Value Chain in Pakistan. World Bank.
7. Bankaool, AgriFin. 2015. Selecting a Target Value Chain – A Summary of
Bankaool’s Market Study on the Vegetable Value Chains in Mexico.

2. IDENTIFYING
A TARGET
VALUE CHAIN
Where does the process begin?
What is the basis for targeting a value chain for financial services?
What criteria and indicators can help determine the health and viability of an
existing value chain?
This section outlines a procedure for identifying a target value chain through a selection
process based on both quantitative and qualitative criteria.
Commercial viability should be evaluated through a holistic perspective, taking into

consideration industry growth, investment, fluctuations in price and production volume,
variations in size of operations, and trends in international trade.
Each value chain should also be assessed at the farm-level, considering annual growth in
size of operation, yields (technology is often an important factor), value of production per
growing unit, and the proportion of area planted that is ultimately harvested.
Scores in each category can be tallied to compare and contrast value chains. The specific
preferences and market orientation of the financial institution should be used in weighting
these criteria as well other qualitative criteria, including the policy environment and
structural changes in the market.
Key success factors and risks associated with the selection process are highlighted.
The choice of a target value chain can be approached By contrast, India’s HDFC sought to deepen its
in one of two ways: by building upon existing business understanding and presence in one sector in which it
relationships within a value chain, or selecting a new already operated – the seed industry – to identify new
value chain to expand the bank’s portfolio. In the case opportunities for value chain financing (see Box 2.1).
study from Mexico, Bankaool took the second approach
as it sought to identify and rank new opportunities that
fit their existing VCF business model and agribusiness
banking practices. This involved developing a
methodology to identify food industry sectors with
characteristics similar to other segments in the bank’s
existing portfolio, thereby requiring minimal adaptation
of its business model.

Box 2.1: Building upon existing relationships with HDFC in India
Banks will often start a value chain targeting process based on information available from
preexisting business relationships. HDFC in India was already working with seed companies and
aggregators by the time it initiated research to identify specific seed value chains in an effort
to extend the bank outreach upstream to producers. The following is an excerpt from HDFC’s
presentation at the Istanbul AgriFin Forum 2015.
Why the Seed Industry?
In 2012 HDFC Bank came upon seed companies looking for payment solutions. Off-balance sheet
transactions for advances made to seed organizers (aggregators) followed. The next logical step
for the bank was to take credit to farmers but to do so it needed to select the best VCF partners
within the seed industry. There was, therefore, a need for a deep understanding of the dynamics
and processes of the industry. What followed was a joint HDFC-AgriFin market study that mapped
the main hybrid seed production chains and that profiled the key participants. The bank has
defined next steps to work with selected seed chains.
Source: HDFC. AgriFin Forum 2015.
In the Pakistan case study, the objective was to better chain analysis.
understand the commercial relationships and structure
of the dairy value chain in order to identify options There is a recognized set of criteria that provides
for entry. In this case, the bank (HBL) had an initial the basic building blocks for analysis in identifying
understanding with a potential agribusiness partner, a a prospective value chain opportunity. The choice of
large dairy processor (see Box 2.2). criteria (which often is limited by both the availability
and quality of the data) used in evaluating the viability
In the India and Pakistan cases, although the value and relative ranking of the agri-food industry sectors
chains had been previously selected, an important part is also important for understanding the potential risks
of each analysis focused on the commercial nature and associated with financing the specific value chain. What
viability of the respective value chains. Each of the case follows is a summary of the main criteria and key factors
studies reveals a slightly different motivation for value in selecting a value chain.
Box 2.2: Partnering with large processors to pilot value chain interventions in
Pakistan
The significance of the dairy sector in Pakistan made it a logical choice for Habib Bank. (HBL)
to design a pilot value chain intervention that leveraged the dominance of established major
processors. The dairy sector accounts for (11 percent) of Pakistan’s GDP and is critically important
to smallholders, who own close to 90 percent of the dairy cattle (with herd sizes of 3-5 animals
per household).
Therefore, while there was no process to identify a value chain as such, HBL still needed to gain
a large volume of specific knowledge about dairy sector participants, paths to market, and the
nature and terms of transactions. This extensive mapping exercise is outlined in the Chapter 3.
Source: HBL. 2015.

Commercial (quantitative) criteria
The first step focuses on the commercial viability of the Ranking the value chains can be done by using
industry in which the value chain operates. Although this quantitative scores. When choosing between different
may seem obvious, it is often overlooked and is essential value chains, the financial institution can use a scoring
in determining a successful business proposition for method that ranks the results each of the criteria listed
value chain finance.8 The selection process takes on above. In the Mexico case study, a scale of values was
added significance in agricultural value chain finance assigned to the results for each criterion (Box 2.3).
where establishing long-term relationships and As such, each value chain was measured against its
developing future clientele are important supplementary peers. The results for each agri-food industry were then
objectives for financial institutions. compared to determine the most attractive value chain
for further analysis. The weighting process is largely
Commercial viability is assessed using the following subjective, both within each criterion and between the
criteria (see Annex B for greater detail): different criteria. Weighting can be adjusted to reflect
the individual financial institution’s appetite for risk
a. Growth in industry, measured by both the value and and/or specific market conditions.
volume of production over a specific period of time.
b. Investment in the industry, which is also an
important indicator of how the market perceives the
specific risks and potential of an industry.
c. Price volatility and changes in production volume
(adjusted for seasonality), which provide an
indication of potential operational risks.
d. Size (measured as the value of production), which
can be used to determine the attractiveness of a
specific industry.
e. Trends in international trade. These provide an
indication of both the potential and the vulnerability of
an agri–food industry sector and can offer particularly
relevant insight regarding value chain financing.
f. Financial flows into the industry, as these provide
insight into how the financial market views the
specific industry.
8. The term “industry” is used here in a broad sense given that, depending on the
particular market, it may refer to the farm activities, companies, and products
within an entire country, or limited to a geographical region or sub-sector.

Box 2.3: The selection of the horticulture value chain in Mexico
In order to identify the target value chain, both the commercial and production criteria were used.
At the commercial level, the case study utilized four different criteria:
1. Growth in food industry value-added production between 2000-2013, measured in 2008 pesos.
2. Investment as a percentage of value of production for the period from 2009 to 2012. In this
case the selection of the timeframe was limited by data availability. Percentages rather than
absolute values were used so as to adjust for the various sizes of the different businesses,
allowing for the subsequent relative ranking.
3. Volatility was calculated based on the value of monthly production for the period (again,
limited by data availability) from 2007 to 2013. While volatility per se does not determine the
viability of the value chain, it does provide an indication of the potential credit risk.
4. Size measured in the value of production was used to determine the attractiveness of the
specific chain. Although size, in and of itself, does not indicate viability, it is felt that the larger
the size of the chain, the greater the probability of applying Bankaool’s “commercial agents”
VCF model. Since all of the criteria were measured in relative terms (instead of absolute), there
was not an inherent bias toward large industries.
At the producer level, two criteria were used:
1. Growth in area planted between 2000 and 2012 provided a measure of expanding value chains.
The choice of 2012 as the end year reflected data limitations at the time of analysis. It must
be noted that, while positive growth is important, contraction in planted area may actually
indicate that there is consolidation occurring at the primary production level of the value chain.
2. Value of production per hectare between 2000 and 2012 offered a deeper insight into the
potential viability of the primary production process.
As Mexico’s food and agricultural sector typically runs a balance-of-trade deficit, the results of
the previous exercise were compared with the trade balance for the food and agribusiness sector.
A negative balance was viewed as suggesting a larger business risk, while a positive trade balance
was believed to be associated with a smaller risk arising from imports (although it could also have
signaled potential risks arising from the international market). The fruit and vegetable industries
showed a long-term trade surplus, while trade in cereals had led to deficits.
The results of each of the criteria were ordered and subsequently given a value running from zero
for the bottom half, one for the third quartile, and two for the top quarter of the results for each
criterion. Each criterion was given equal weight and the results summed for each of the four-digit
food industry business categories. The results pointed to the horticulture industry as the most
viable.
To test the sensibility of the results, the weighting of the results was adjusted to place greater
significance to the volatility and investment criteria. In this case the results were very similar,
with the horticulture industry continuing to be ranked at the top.
Source: Bankaool, 2015.

Qualitative considerations
Even though the value chains can be quantitatively The India study identifies a number of structural issues
ranked, the final selection process must take into affecting agriculture that deserve attention in the value
consideration other factors that might have an impact on chain identification process:
the attractiveness of the business proposition in relation
to the value chain. Since value chain finance is often 1. Rising labor costs
structured around developing long-term relationships 2. Increasing pressure on land use (from agriculture,
as a strategy to mitigate risks and offer a wider range housing, industrial, and mining sectors)
of financial products, the more important qualitative 3. Growing energy costs and deficient energy
criteria are: 1) the policy environment; and 2) structural infrastructure
changes taking place within the agri-food sector. 4. Widely scattered pockets of demand, leading to high
distribution costs.11
Policy environment. Food and agriculture value
chains often operate in highly politically-charged Another factor to consider is consolidation at the
environments, both in developing countries as well as aggregator level. This increases opportunities for value
in the more developed nations. As a result, government chain financing and value chain products, even though
policies and actions can impact both the attractiveness in the short-term this may increase the risk profile of a
and the risk profile of the value chain. Accordingly, it is value chain.
important to understand types of policy measures, any
changes in government support, and their implications
for the value chain. Relevant examples include input
subsidies, price subsidies and price controls, credit
subsidies, and consumer protection interventions (food
availability and safety), among others.
Structural change. The food and agricultural system is

constantly evolving and structural changes having far-
reaching implications for a financial institution’s value
chain business propositions. One of the major recent
changes, for example, has been an increase in the power
of retailers, especially large national and multinational
retail firms9. Their concerns about quality, food safety,
and traceability have driven the development of tighter
value chains10. To the extent, therefore, that large
retailers take a greater share of the food market from
the smaller retailers, the need for value chain financing
may actually increase.
9. Reardon, T. and B. Minten. 2011. “Surprised by Supermarkets: Diffusion of

Modern Food Retail in India,” Journal of Agribusiness in Developing and Emerging
Economies 1(2). October: 134-161.
10. Tight value chains are those that are characterized by formal relationships,
often through contracts, between chain participants. Contracts will not only
refer to delivery and – possibly – pricing but also may include requirements for
production practices. Technical assistance, marketing advice as well as financing 11. HDFC Bank. 2015. Creating Value Chain Finance for Farmers – A Summary of
may be provided. HDFC’s Case Study on the Hybrid Seed Value Chain. World Bank.

Key success factors
There are key factors along the value chain that can whole, such as contract enforcement. To identify key
influence successful engagement. While there is no success factors, it is necessary to look at successful
single set of key success factors that apply across the businesses in the industry as well as business and
board to all participants in the value chain, part of the market trends, not only in the country market, but also
process of selecting the target value chain involves globally. Figure 2.1 offers an example in detailing the
identifying those factors that are relevant for the key success factors in the Brazilian poultry industry
specific value chain in question. That is, what defines used by Rabobank Brazil. The extent to which the
success in one industry, in one country is likely not key success factors characterize the value chain and
the same for a different industry in another country. the participants will also define the attractiveness
Some success factors are more conceptual in nature, of selecting a particular value chain. It will also be a
such as economies of scale, while others may be highly significant factor for determining risks across the value
quantifiable; e.g. market share. Likewise, some success chain.
factors can apply to the value chain environment as a
Figure 2.1: Key success factors in the Brazilian poultry industry
Input Input
farmers Meat cos Retailers Consumers
manufacturer distributor
• Consolidation • Search for • Consolidation • Sophistication

• Differentiation of products scale • Private label • Convenience
• Global presence • Local business • Differentiate & Specialize • Smaller portions
• Social and environmental • Mecanization • Global presence • Universal
responsibility • Social and • Safety and traceability • Maturation
environmental • Food safety
responsibility • Social conscience
Source: Rabobank. AgriFin VCF Bootcamp, 2014.

3.
MAPPING THE VALUE
CHAIN – MARKET
INTELLIGENCE
What are the primary participant types involved in the value chain approach?
What is exchanged between participants?
Are certain relationships stronger than others?
Though the exact structure and organization varies considerably from value chain to value
chain, we can identify four key participant types in each: input suppliers, producers,
aggregators, and retailers/consumers.
Mapping the interactions and relationships of these participants can provide a wealth of
knowledge and confidence for a financial institution.
Mapping of a value chain implies an understanding of the flows of products, finance,

information, and services.
This chapter explores the process of mapping and provides key insights from current case
studies of how mapping knowledge can inform decision-making.
Once the target value chain has been identified, an in- Informal agreements are built on an understanding
depth analysis that goes beyond the concepts included between the participants of their obligations and
in a traditional credit application becomes imperative responsibilities, which may or may not be in writing, and
for evaluating credit worthiness and risk profile. The that typically has no formal recourse in case of non-
financial institution should “map” the value chain, compliance. These informal pacts are usually the result
identifying the participants, the links among them (both of an ongoing interaction and confidence between the
strong and weak), as well as the key players operating in participants in the value chain. This tends to be the way
the value chain. At the same time, the evaluation should local moneylenders and first stage intermediaries or
identify those relationships that impact both product rural collectors operate. Established value chains rely
and credit flows. This takes on particular significance on both formal contractual agreements and informal
given that value chain finance facilitates the extension agreements among participants in the value chain.
of formal banking operations to large numbers of small When engaging with small farmers, buyers may depend
producers building upon existing internal linkages in the on informal relationships or, as is the case with the
value chain. Indian hybrid seed value chain, companies will work
through an intermediary (in that case, a seed production
It is important to recognize that the relationships can organizer) whose interaction with producers is largely
be both formal and informal. Formal relationships are based on informal relationships.
those that are grounded in a contract, spelling out
obligations of the parties to the agreement. Formal Determining relations of resource controls (negotiating
agreements imply legal recourse for non-compliance. power) is another key objective in mapping the value

chain. Agricultural financing is often provided in-kind; management that the relationships between
buyers will supply inputs into the production process participants represent; particularly in environments
with the expectation that reimbursement will occur only where formal contracts are not the norm or where
upon delivery of production from farmers. Additionally, contract enforcement is weak.
buyers will set production requirements and standards,
which determine the type and levels of technology used These concepts within the mapping stage should be
in production. Understanding how information moves understood as a supplement, rather than substitute,
through the value chain is a key determinant of both the to the traditional analysis involved in credit decisions.
chain’s competitive position and inherent risk profile, These would include, among others, the competitive
as well as an indicator of power within the chain. This position (e.g. cost of production, competitors, etc.),
understanding must include the consumer market potential risks and mitigation, and the chain’s product
to reduce the credit risk from downstream market position in reference to the end consumer market. The
adjustments.12 mapping of the value chain not only strengthens the
traditional analysis, but also supports the financial
The value chain is about market-focused collaboration institution’s evaluation of the entry points in the value
among participants, hence mapping focuses primarily chain, as well as the potential financial products that
on the participants and their inter-relationships. This can be offered to the participants along the value chain.
recognizes the importance for effective risk
Participants in the value chain – real flows (inputs

and product)
From the general categories of participants enunciated to aggregators entering into agreements with input
in the introductory chapter, four key participant types suppliers to supply these to producers. Production
can be identified for mapping purposes along the value parameters are also commonly specified in these
chains: 1) input suppliers; 2) producers; 3) aggregators; aggregator-producer agreements. Depending on
and 4) retailers and consumers. the role of the input in the production process, the
aggregator may actually produce the input and/or enter
Input suppliers. Traditionally, inputs into the production into an alliance with a specialized firm to produce
process have been sourced from separate, identifiable and supply it. This is the case in the Turkish poultry
suppliers. For crop agriculture these often include, value chain, which is typical of many poultry value
seed, fertilizer, and agrochemicals. As for animal chains (Figure 3.1). The processor enters into formal
agriculture, key inputs in the production process are agreements with breeders and growers. The breeder
feed ingredients, feeder stock, and medicine. The types produces hatching eggs for the processor. In this portion
of technology and their availability depend on the of the value chain, the breeder is the input supplier. The
relations, including financing, between the supplier and transaction is commercial, i.e. the processor pays the
producer. Often this does not ensure the most up-to- breeder for the hatching eggs. In the next stage in the
date technology or the lowest cost of credit. The result value chain, the processor will supply the inputs – day-
is higher input costs with the ensuing negative impact old chicks – to the grower, as well as other inputs, such
on margins and competitiveness. Furthermore, these as vaccine and feed. The grower will deliver the grown
relations are not focusing on or promoting aggregation chick – a broiler – to the processor in 45 to 50 days.
of the financial process.
The supply of inputs may itself be a context specific
Within the more structured value chains, the input value chain, especially when it involves research and
supply function is changing from direct in-kind development (R&D), and biotechnology. The India case
provision of inputs by aggregators (to reduce diversion), study is a good example of this evolution (Box 3.1).
12. For example, in the cut flower market for roses the dominant color for the
end market changes practically from year to year. This means that the producer’s
financial success is dependent on Information about the changing market
dynamics. And the buyer power is partially based on the knowledge of what the
market is demanding in terms of the colors of the flowers.

Figure 3.1: Turkish poultry value chain
A CONTRACT CONTAINS:
1. Price for the Breeder/Grower

2. Quantity of production
3. Quality of production
4. Place of production
Some of the Broiler 5. Services/Advances that will be
processors also produce & given by the Manufacturer
sell animal fodder 6. Description for the Bonus/Penalty
System
7. Time of delivery
1
8. Payment Method
5
Processor:
Delivers final
Processor:
products to retail
Signs contracts with
(dealers)
Breeders & Growers
Broiler
Processor: Parent stock,
Delivers the
Breeder: fodder, vaccine,
Rears parent technical
broilers to factory assistance, fuel for
stock and produces
for slaughtering & heating (sometimes)
hatching eggs
processing are supplied by
during 65 weeks Processor
Payment to Grower
(6 times in a year) 4 2 Payment to
Breeder
Broiler Processor:
Grower: Delivers the eggs
Chick, fodder, vaccine, to his Hatchery
Raises the chicks
technical assistance, fuel
to a Broilers in for incubation.
3
for heating (sometimes) are
supplied by Processor 45-50 days Produces chicks
Source: Yapi Kredi. AgriFin VCF Bootcamp.
Box 3.1 Research and development and biotechnology in input supply

The India case study focused on the seed industry value chain. The case study found that, “the
private sector seed industry underwent a transition following the Indian government’s focus
on biotechnology research as a means of increasing agricultural production and was driven by
trends in the domestic and world seed market. Intensifying international competition, increasing
R&D costs, and the complexity of biotechnology have led to increased consolidation of the Indian
seed industry with several of the large and medium companies merging or being taken over by
multinational seed companies. India’s varied agro climatic conditions, abundant skilled and
unskilled labor, are attracting several multination hybrid seed companies to India. Several large
seed producers with deep pockets, both domestic and multinational, are hoping to buy financially
strained or ‘technologically rich’ smaller firms with sizeable geographical reach and distinct
product portfolio.”
Source: HDFC. 2015.

Figure 3.2 Mexico tomato production: percent of producers and production by farm size
(hectares)
100%
Production
Number farmers
80%
60%
40%
20%
0%
Micro < 5 Small < 10 Medium < 25 Large > 25
Source: Bankaool, 2015.
Producers. At the producers’ level, mapping involves 88 percent of the dairy producers are not part of a
developing an understanding of their operations, and structured value chain, participating largely in the
the first-level marketing structure, i.e., the producers’ informal economy.
relationship with the immediate purchaser(s) of their
products. Optimally, this would include collecting An important advantage of value chain financing
information on farm size, average production, yields, is that it represents a strategy for aggregating or
yearly production variations, production costs, and scaling-up the activities of smallholder farmers,
prices received. Existing relations with input suppliers bringing them more deeply into the formal financial
and aggregators should be identified, including both system and offering them the chance to improve farm
formal and informal arrangements, particularly if productivity and income levels and to help increase
they impact the prices farmers receive. Given that food production.13 Scaling-up operations through value
the agricultural industry operates in an information chain finance turns a money-losing proposition into a
economy, it is also important to identify market and feasible business proposition. For example, HDFC in
technology information flows. The results of the India estimated that it would take two years to reach
mapping exercise should allow the financial institution break even financing medium-sized dairy operations
to estimate the changes in costs and returns that may through the value chain. For stand-alone, direct credit
be possible with improved access to formal credit. to the same producer, at the same interest rate, it would
Additionally, due to the extent of governmental support take four years to reach the break-even cost return ratio.
to agriculture in many countries, it is important to
identify the types of support to producers in the value Aggregators. Understanding the aggregator and
chain, including impacts and limitations. identifying “anchor companies” are important aspects
of analyzing the value chain (Box 3.2). The aggregator
Markets throughout the developing world tend to be is defined as an agent that acquires the farmer’s
characterized by large numbers of small producers. production and is the primary vehicle for promoting
In the Mexico horticultural case study, for example, small producer financing. Using this definition, the
practically 90 percent of the tomato producers operated aggregator may be a farmer cooperative or farmer
on less than five hectares (Figure 3.2). Similarly, in producer organization that receives and aggregates
the Mexican sugar industry practically 70 percent of production from members for subsequent sale. In
cane growers cultivate less than five hectares. At the
same time most of the farmers operate in an informal
13. HDFC, AgriFin. 2015. Creating Value Chain Finance for Smallholder Farmers -
environment. In the Indian dairy industry, for example, Summary of the Market Study Report of Indian Hybrid Seed Production Chains.

Box 3.2. What defines an anchor company?
What makes a firm an “anchor company” in a value chain? Anchor companies are the prominent
companies in the value chain that drive the volume of production and value-added products.
The value chain mapping should seek to highlight prominent companies in the value chain by a
number of criteria:
1. Market share in final product

2. Market share in critical intermediate outputs
3. Number of suppliers as a proportion of total producers
4. Stability of supplier relationships (e.g., percent of repeat suppliers each season)
5. Financial performance and credit rating
Where there are several companies active in the area in which the bank operates, the mapping
exercise should build a score for each company using all five criteria, to facilitate comparisons
and to define negotiating approaches as needed. In the extreme case in which there is only one
anchor firm present in the bank’s field of operations, the criteria addressing stability of supply
and financial performance/credit rating should be the key determinants of whether to engage in a
formal partnership with the anchor firm.
this case, the aggregator takes possession but not the Mexican vegetable industry, trust based on long-
ownership. The aggregator may be a distributor/ term relationships is the operating norm since cross-
trader or processor that will turn around and sell the border financing is used for harvesting and packing.14
production to another buyer or aggregator. The number
of aggregators in the market may be significant. The In the India seed case study, the relationship is
Pakistan case study identified the number of milk somewhat more complicated as seed companies
collectors at an estimated 300,000 agents, sometimes depend on seed production organizers (SPO). The SPOs
collecting as little as a bucket full of milk. provide several services, including farmer selection,
seed production management on behalf of the seed
Alternatively, farmers may be the final seller, as is the company, and technical and financial support to the
case in Mexico’s vegetable industry where retailers farmers. The seed production process and the success
have established direct relationships with producers of crops are heavily dependent on the technical inputs
for delivery of their production. On the other hand, it is provided by the company and the organizer, as well as
frequently the case that producers are “represented” the financial assistance provided at the appropriate
by aggregators with regard to other downstream time. The SPO was found to be a nerve center in the
participants or a financial institution. The aggregator value chain. The majority of payments made by the
may be a company operating in the domestic market, or company to farmers are routed through the SPO, which
perhaps even in a foreign market. often also fulfilled the role of a moneylender. The SPO is
generally a local villager who is financially stable. From
The relationship between the aggregator and the a banker’s perspective, this is a relatively safe avenue
producer plays an integral part in defining the risk for extending collateral-based agriculture credit, as
profile for value chain financing. Ultimately, the the SPO is usually a landowner with diversified sources
producer’s ability to repay a loan will, of course, depend of income. The nature of the transactions between the
on payment from the aggregator. The aggregator SPOs and the seed farmers depend largely on informal
conversely depends on producers honoring their relationships. With multinational seed companies,
commitments to deliver their production. In many transactions are based on formal contracts whereas
developing country markets, transactions are based on these are scarcer when considering regional and
informal agreements. This was identified in the Pakistan national Indian companies.
case study on the dairy industry, which is characterized
by unwritten, year-long agreements. The quality of the
milk is based on trust, rather than laboratory analysis,
14. HBL/AgriFin. Structure and Performance of the Dairy Value Chain in Pakistan.
with payments made on a monthly basis. Similarly, in Implications for Value Chain Finance. Draft June 2015.

Where the aggregator is an intermediary or trader, the The agri-food system has evolved from being production-
credit risk exists not only between the producer and oriented to one that is demand-focused. In the Mexican
the aggregator but also between the aggregator and vegetable industry, for example, it is estimated that
the client. In fact, the weak point in the value chain may supermarkets account for 27 percent of the vegetables
actually lay in the transactions between the aggregator purchased by consumers. With the supermarket segment
and its client. This is often overlooked in credit analysis, dominated by a relatively small number of retailers,
and when mapping the relationships in the value chain. this suggests that only a few retailers control almost a
quarter of the Mexican domestic vegetable market.
It is the aggregator that often performs the role as the
anchor company. That is, they represent the point of The consumer market for food is rapidly changing,
contact, or entry point, between the financial institution reflecting a greater focus on health and concerns about
and the value chain in general and, in particular, the the impact of food production on the environment.
farmers. Typically, the aggregator/anchor company or Accordingly, profitability and credit risk hinge to far
farmer organization has a preexisting relationship with greater extent on the ability to meet changing market
the financial institution, which can be leveraged through tastes and demands. For example, another factor
a value chain financing strategy. This is of particular stimulating the growth of greenhouse production in
importance since the ongoing financial relationship Mexico is its ability to ensure the quality (i.e., food safety)
helps to validate, at least partially, the financial viability of produce. In the Turkish poultry industry, market
of the value chain. At the same time, the aggregator can demands directly influence the decision by the processor
undertake the role of a financial agent for the financial as to which breed of chickens to provide to the grower.
institution and/or even provide a first loss guarantee
(i.e., a secondary source of repayment), thereby partially Changes in the agri-food system has shifted power to
sharing the risk involved in the financial operation. those participants in the value chain that are closest
to the final consumer. At the same time, many markets
End-market participants. A common mistake by financial have seen consolidation at the retail, trader, and food
institutions is to make a credit decision solely on the service levels, further enhancing their power in the
basis of production and productivity. An important part of value chain. As highlighted above, retailers (particularly
reducing risk is that the mapping of the value chain should large retailers) will buy directly from producers to
identify the participants and the role they play as well as ensure that they have products that meet consumer
what is happening at the consumer level. This is especially demand. However, even when retailers buy directly from
important when the market is situated partially or entirely producers they will not typically provide financing or
outside the country. In the Mexico case study, for example, technical support. Instead, they often set standards
it is estimated that 45 percent of 2013 production was that must be met for the products that they purchase.
exported, up from 34 percent in 2000. Greenhouse In the Mexican vegetable industry, where technical
production was a significant contributor to this growth, support and financing from retailers is uncommon,
as the area in greenhouse production went from large retailers have begun to provide contracts to large
approximately 9,000 hectares to 30,000 hectares over the suppliers. Notably, this type of arrangement has been
same period. A key driver for the growth in greenhouse limited to cross-border transactions between U.S.
area was an increase in consumer demand and premium retailers and Mexican export producers.
prices for greenhouse produce in the U.S. market (which
receives 90 percent of Mexico’s vegetable exports).
Financial flows – intra- and extra-value chain

transactions
Mapping of the value chain not only focuses on the these producers, while local moneylenders are often
participants and the product flow but also on the the main source of financing. Mapping the financial
sources of financing inside and outside the value chain. flows, while pairing them with the product flows and
As indicated, formal bank financing for smallholder participants in the value chain, represents an important
farmers is frequently absent. In some cases, it is the tool for recognizing risks and identifying potential entry
input supplier or the aggregator that supplies credit to points for financial institutions.

During the field research associated with the value Besides the nature of the transactions between
chain mapping, creating a profile (however approximate) the aggregator and its clients, the other areas of
of financial flows for each main participant in the value vulnerability are extra-value chain transactions in which
chain is crucial to understanding the potential demand the supplier fails to sell or deliver the product to the
for financial products a bank may be able to offer. These aggregator (known as side selling). This is a risk to the
profiles could be based on field surveys of a sample of aggregators with clear implications for the recuperation
participants, as was done in India for the seed value of credit. In some cases, this risk can be addressed
chain, or on key-informant interviews, which were used by having no other aggregators in the operating area
in Pakistan and Mexico. and/or the setting of extremely high transportation
costs, resulting in a cash loss to the producer. Supply
The weak links. As indicated throughout this chapter, contracts are not a particularly attractive option given
mapping the value chain provides important insights the costs involved in establishing a large quantity of
into the risk points or weak links within an industry. The contracts with many small farmers who are outside the
mapping not only looks at the relationship between the formal market system. Informal agreements among
participants but the numbers of participants and their aggregators to respect the each other’s suppliers in
impact on the business proposition of the value chain. the Mexican vegetable industry have been reported.
For example, an important criterion in successful value However, since these agreements are informal, and
chain financing is the ability to dilute risk. As such, when might be considered to be collusive, they are hardly
working with an aggregator the number of farmers must enforceable. Once again, the quality and understanding
be large enough so that non-repayment by a single of the relationship between the aggregator and the
or even a small number of farmers will not seriously supplier becomes crucial for compliance and risk
damage the quality of the transaction. mitigation.
Risks across the value chain

The final piece in the mapping process involves identifying Side-selling risks. Side selling, in which suppliers fail
the risks inherent in the value chain and understanding to honor delivery commitments to the aggregator or the
their implications for the financial institution’s value chain processor and therefore imperil loan repayment, is a
business opportunities. Among the more important risk significant risk. To the extent that there is a high level of
categories that financial institutions should consider competition (a large number of buyers), the risk of side
for selection of the target value chain, in addition to the selling increases. Given that formal contracts might
political and structural risks discussed above, are: 1) not exist or might be unenforceable, past experience
production-level risks; 2) side-selling risk 3) aggregator or track record with regard to honoring delivery
risks; 4) downstream market-level risks; 5) client-level commitments provides an indication of the extent of
risks; and (6) reputation risks. 15 financial risk. Hence, gathering existing information on
past transactions in a manageable, useable way is of
Primary production level risks. Production-related high value for the stability of the value chain finance
risks include changes in both expected output and relationship.
product prices. They typically stem from weather
effects, disease or insects, food safety scares or Aggregator risk. While primary production risks and
changes in the international market environment. Many producer creditworthiness are important, the weakest
of these can be mitigated through risk management link in value chain finance may in fact be the aggregator.
products, such as crop insurance. Understanding The financial institution’s business model and the
what steps a producer can take to mitigate price risk aggregator’s primary interest and standard operating
is important in selecting a value chain. Sophisticated procedures should be aligned with the market. Similarly,
instruments, such as derivatives, are usually beyond the when the aggregator has a commitment to provide
reach of smallholder farmers (or most farmers, for that inputs to producers, risks include not only failure to
matter) but may be an option for large aggregators or deliver but also delayed delivery. This is particularly
processors downstream. important given that delayed delivery of inputs may
result, for example, in extemporaneous planting by
farmers, impacting negatively on productivity. Similarly,
15. Standard credit risk assessment may also be modified when dealing with VCF
lending. See Chapter 6. there is the risk that the aggregator may not comply

with the agreement to acquire farm production in its and dairy production (HBL, Pakistan) as a risk-reducing
entirety or in the agreed-upon proportion. At the same criterion. Portfolio diversification and specific-crops
time, delay in payment to producers increases the lending caps are commonly used for the coffee-rust
financial risk, particularly when unsecured credit is type risk, where disease damage occurs across different
provided to producers. When the aggregator assumes a geographies. Price-related systemic default is usually
commitment in the credit delivery or recovery process, more predictable, and its mitigation can take advantage
credit risk relies to a large extent upon aggregator of hedging and insurance instruments (if available), in
performance. addition to diversification to other value chains.
Downstream market-level risk. There are three types of Client-level risks. At the client level (e.g., large
downstream market risks: compliance risk; competitive aggregator or processor), typically the financial
risk; and management risk. Many of the risks that exist institution looks at the client’s financial situation,
between aggregators and producers also arise as the concentrating on cash flow criteria. These include:
aggregator sells or moves product downstream, be it
processed or not. These include payment and contract • Liquidity, which shows how the amount of assets
compliance, among others. In fact, the true risk in the that can be converted into cash compares to
value chain may reside with the aggregator’s buyer. payables within the year, with a minimum ratio of 1;
The second source of risk has to do with competition • Leverage of cash flow, which considers how debt
in the market. The more sellers there are, the greater (bank, supplier, or land) compares to sales and to
the competition and, subsequently, the greater the operating cash flow (using a conservative scenario of
market risk related to the specific aggregator. Similarly, a maximum of 60 percent of net sales and debt less
the existence of imports and/or similar-type products than three-times earnings before interest, taxes,
impacts the competitive environment. Finally, there is depreciation, and amortization);
the ability of the participants to deal with market-related • Payment capacity, which evaluates the relationship
developments. For example, market risk is heightened between expected operating cash compared to debt
where there is a marked seasonality of production and/or service (interest plus installments), with a minimum
demand. Here, effective inventory management becomes of 1:2;
important in controlling market risk. • Solvency, which reveals how total debt compares
to total assets, looking for a maximum ratio of 40
Systemic risk/systemic default. Most value chains percent. At the client level, the financial institution
are by nature subject to covariance risks, usually often fails to look at the adequacy of the financial
associated with weather phenomena, or pests/diseases operations.
(e.g., coffee rust in Latin America) that affect the chain’s
base commodity. Market developments, such as price Reputation risks. Reputation risk in value chain finance
fluctuations may also create conditions for widespread/ may emerge in different ways. If, for example, a bank
systemic failures that will result in systemic default. is financing an aggregator who in turn exercises bad
A common related aggravating factor is government practices with the upstream customers (farmers), the
intervention through debt relief or forgiveness, bank will get negative publicity and, possibly, regulatory
which, while alleviating the effects for farmers, attention. As such, due diligence by the bank on the
makes the effects on financial service providers even different partners it may have in the value chain is
more significant. An obvious mitigation for weather important. If, for example, the bank is extending non-
related systemic risk (drought, floods) is geographic lending services to value chain customers, compliance
diversification. Indeed, the two partner banks that had with “know your client” requirements – even for small
already selected a value chain had used geographic farmers – will be important to protect the bank’s
diversification of hybrid seed production (HDFC, India) reputation.

4. ENTRY POINTS
FOR FINANCIAL
INSTITUTIONS
How are value chains organized?
How can financial products be designed according to the value chain structures?
What can flows of finance and product in the value chain tell us about potential
financing opportunities and risk mitigation?
Financial institutions evaluating entry points into a value chain should consider: 1) the
organizational structure of the value chain; 2) financial flows with the associated risks; and
3) key players, lead firms.
When looking at an entry point, there are important considerations beyond financial
performance when determining the key participants. Financial institutions should look for
leaders in the field and participants with positive relations with other actors in the chain,
especially producers.
Organizational structure
The organization of the value chain provides an
indication of where the financial institution should
place its emphasis in developing products for
value chain products. There are essentially four
organizational structures for value chains, each with
its own rationale, opportunities and risks. These
organizational structures are summarized in Table 4.1
in order of significance as entry points for financial
institutions. A comprehensive description is included
in Annex C.

Table 4.1 Value chain organizational structures
Key factors for banks to
Value chain consider in assessment of
type Main features potential partners
Leading firm- Value chains where there is one firm or only few companies • Strength, organizational and
coordinated downstream that constitute the “ultimate buyer” or “super financial
value chains aggregator.” Typical examples of lead firms are found in industrial • Strength, reliability of
crops such as sugar cane, cotton, palm oil, and breweries. Lead upstream contracts (with
companies tend to be retailers, large processors, and export- aggregators, with producers,
oriented food businesses. Perhaps the best examples of anchor or if applicable)
lead firms are found in the broiler industry (see Annex C). • Solvency and reliability of
aggregators involved
Value chains This value chain structure is centered on buyers of agricultural • Information aggregators
centered on products. They may be: a) local traders who will bundle products hold about producers
aggregators for onward sale into the domestic market; b) commodity traders, • Ability of aggregators
which can either be local or multinational firms, that intend to to share in lending
sell primarily into the export markets; c) processors who require administration costs
farmer production as a key input; d) wholesalers who specialize • Solvency and reliability of
in the product or rely upon the product for a significant portion of aggregators
their product mix; or e) retailers who have special needs for the
product.
Value chains Value chains developed around farmer-based organizations (FBOs) • Information FBOs manage
centered around established with the purpose of marketing members’ production, about producers
producer among other objectives. The marketing objective is generally to • Ability of FBOs to share in
organizations obtain higher prices for their members through joint selling and/ lending administration costs
or coordinating market access. In terms of legal status, these • Solvency and reliability of
organizations may be farmer cooperatives or (registered) producer FBOs
associations. • Governance and
management of FBOs
Value chains Where there is a concern for rural development, financial • Ability of facilitator to
driven by inclusion, or other social and policy objectives, governments provide credit guarantees
outside as well as non-governmental organizations will facilitate the • Exit strategy of facilitator
“facilitator” organization of value chains as part of a strategy used in achieving
organizations these objectives.
Examples and lessons from the case studies supplemented by financing from wholesalers for use
in harvesting and packing. In some cases, the producer
As mentioned earlier, within an industry there may has become integrated downstream, assuming the
be more than one value chain, defined as a path from role of wholesaler to serve the U.S. market. In contrast,
producer to consumer. Frequently, small farmers Mexican small farms producing for the domestic market
operate in a value chain in ways that differ from operate in a value chain centered on aggregators, and
large producers. Similarly, there may be different financing largely comes from local moneylenders.
organizational structures of the same value chain Farmers will generally sell to local collectors, who
across different regions in the same country; or the will take the produce to a wholesale market. The local
organizational structure may be influenced by the collectors tend to be small business operators; they
nature of the end market. In the Mexico horticulture often do not provide financing, and will pay producers
study, for example, large producers in the country’s only after they sell the produce.
northwest that are focused on the export market are
organized in a “leading firm-coordinated value chain”. The Pakistan dairy study identifies a large number
In fact, in a number of cases the largest producers of paths to market within the overall value chain,
frequently are the leading firm. Produce is typically beginning with the relationship between milk collectors
sold through a contract or on consignment. Production and small producers. Approximately 90 percent of the
financing is sourced through commercial banks, marketed milk in the country is channeled through milk

collectors. The smaller collectors will buy from a small national and multinational seed companies. Their
number of producers, pool the milk, transport it and sell central role in the value chain is the result of the
it either to consumers directly or to larger collectors. regulatory environment and their development and
Typically, the collector will enter into an arrangement control of seed variety-specific technology. They do not
with the producer on a yearly basis, buying the milk on deal directly with the producers of their hybrid seeds;
an agreed price per liter with payments made at the rather they depend on seed producer organizers (SPO)
end of a month’s delivery. Side selling is not considered that may be considered the nerve centers in the value
a serious risk, since this arrangement is based on a chain. The SPO – essentially a major aggregator – is
strong relationship between producer and collector. generally a local villager who is financially stable. The
When producers sell to a different collector it is when SPO selects the producers and provides both technical
the collector’s operations are temporarily disrupted or and financial assistance to farmers and most often
inadequate. At times, large dairy stores (open milk- fulfills the role of a moneylender. Most companies do
selling shops) will operate as a collector for their own not give direct financial support to farmers. Payments
use. An alternate value chain exists that is organized by made by the company to farmers in most cases are
leading firms through collection centers. Typically, large routed through the SPO, including advance payments
producers will deliver their own milk to the collection by seed companies. A small number of the companies
centers, which will also purchase milk from local will provide financial support to farmers at the time of
collectors. sowing and cross-pollination, but many do not offer
any such assistance. A formal contract exists between
Of the three case studies, the Indian hybrid seed value the SPO and the multinational seed companies, which
chain, which is organized around leading companies is not always the case with the SPO and regional seed
is the tightest. In this case, the anchor companies are companies.
Financial flows and associated risks

In contrast to product flows, which move from upstream and payment, although it can be as long as 90 days
(primary producers) to downstream (processors and or more.16 This creates additional opportunities for
consumers), financing flows within the value chain financial institutions to enter the value chain by offering
move in both directions (Figure 4.1). The magnitude factoring products.
and direction of these flows are important factors
in determining a suitable entry point for a financial In the value chains where the focus is on financing
institution. producers, the basic model has the financial institution
working with the aggregator to supply credit to
Financial flows from downstream participants within producers. When the producer sells the product, the
the value chain typically finance primary production. aggregator retains a portion for loan repayment, which
It is much less common for downstream participants is sent to the financial institution.
to provide financing to intermediaries, unless there is
a formal agreement for them to operate as purchasing A common entry point for a bank is its relationship with
agents. Likewise, downstream participants rarely one or more (usually only a few) aggregators. The major
finance non-corporate affiliate processing companies. variation of the basic financial flow relates to the role
This, of course, opens opportunities for financial of the aggregator. The aggregator sometimes acts as
institutions to enter into the value chain through a commercial or bank agent. This involves identifying
products such as bonded warehouse financing. those producers that are acceptable credit risks. The
selection is made in accordance with the financial
In many cases, payment to farmers is not made at the institution’s policy. While the aggregator acting as the
time they deliver their production. Rather they are paid bank agent identifies the creditworthy farmers, the final
after the aggregator sells the product. In the more decision is made by the financial institution. The two
formally structured value chains, such as with Mexico’s
horticulture exporters, the packer (leading firm) will 16. A variation of this form of seller financing takes place within the Mexican
vegetable industry. The producer will deliver the produce on consignment to the
sell to national and international retailers on credit. wholesaler/broker. The wholesaler, in turn, will pay the producer upon sale of the
The duration of this type of financial flow is usually product. While technically the producer is not financing the wholesaler/broker
(who, in fact, has taken delivery of the produce), for all practical purposes this is a
the number of days between delivery of the product form of producer providing financing.

Figure 4.1: Financial flows within the value chain
Financial flows: production, working capital, leasing, etc.
Financial flows: credit sales, factoring
Financial Working capital Production & Working capital Working capital Factoring
Products Consumption loans Warehouse finance Equipment finance Warehouse
& leasing Factoring financing
Equipment leasing
Agricultural Trading & Distribution &

Input supply Processing
production logistics Retailing
Risk Medium High Medium Low Low

Need Medium High High Medium Medium
Type Formal Informal Informal Formal/contract Formal/contract
Food & Ag Product flows
Source: AgriFin VCF Bootcamp, 2014.
banks financing sugar producers in Mexico (Bankaool The aggregator sometimes will provide a guarantee (a
and Finterra) rely on a pre-established list of criteria first-loss guarantee) to the financial institution. The
to make the final decision. Among the criteria is size of size of the first-loss guarantee is negotiated and set
operation, credit history, and average yields. according to the financial institution’s assessment of
the aggregator and an appreciation of the risk. This
A similar scheme for financing dairy producers existed negotiation is usually part of a broader agreement
in Pakistan. The country’s largest public bank providing between the bank and the aggregator that includes the
agricultural credit entered into a strategic partnership loan terms and the commission for administering the
with a major aggregator, Nestlé, to provide credit to lending to producers (see Chapter 6). In the cases from
dairy farmers. The farmers in Pakistan were identified Mexico and Pakistan, government programs provided
by Nestlé, while the lending instructions and guidelines additional guarantees. In Mexico, financial institutions
were provided by the State Bank of Pakistan, an are able to rediscount loans through a government trust
approach that stands in contrast with the Mexico case. fund.
When functioning as a commission agent, Occasionally, the aggregator acting as a commercial

the aggregator will also collect the necessary agent will deliver the financing to the producers. In the
documentation, which is usually forwarded to the Indian seed value chain, the collectors provide technical
financial institution. This reflects bank policy as well assistance in addition to dispersing financing sourced
as regulatory requirements. The financial institution from the seed companies.
will typically pay the aggregator for performing these
services. The payment typically is not a fixed amount,
but rather is set according to the financial institution’s
perception of the aggregator and the quality and
amount of work required.

Key players
A common strategy for financial institutions is to enter In the Pakistan case, the collectors as a whole are
a value chain business through a key player or lead/ responsible for 90 percent of the marketed milk in the
anchor company in the value chain. Three criteria are country. Collectors, however, vary in scale and market
commonly used by financial institutions to select the coverage, from small-scale collectors (known locally as
leading player: “khatcha doddis”) carrying milk cans on motorcycles and
collecting from small producers, to large trucks serving
Strong financial performance. Staying power sizeable dairy farmers. They are also close to producers,
and financial responsibility provide an element with commercial dealings based on strong relationships
of confidence, indicating that the leading player with the farmers. In Mexico, the sugar cane value chain
understands and successfully manages its role in the is structured around the sugar mills. The banks only
market and meets its financial commitments. Sound work with those mills that are financially sound. The
financial performance also suggests that the leading banks are able to leverage the mills’ relationships with
player is adept at managing risks within the agri-food the growers, who number in the hundreds for every mill.
system. This takes on added importance when the
leading player assumes the role of credit distributer, or In the case studies, the primary entry point was a
provides a guarantee, such as a first-loss guarantee. leading firm, or a small number of large aggregators.
The initial financial product in the case studies was
Leading role in the value chain. The food and credit to farmers, based on a strategy using aggregators
agricultural markets are dynamic. New technologies, or key players to reduce risks as well as lower delivery
policy adjustments, consolidation and changing costs. Value chain finance, however, is a holistic and
consumer preferences, among others, drive their encompassing framework touching on all the links in
evolution. Leading players are able to recognize the chain of activities, from the primary producer to the
changes, adjust their business model, and transmit consumer. What this implies is that credit to farmers is
these changes to other participants in the value chain, not the only product that can be offered to value chain
bolstering the value chain’s sustainability. participants (Figure 4.2). Similarly, a number of financial
institutions that have been studied have indicated that
Close to producers. As pointed out above, demand they plan to leverage interest in their loan products to
for credit is generally strongest at the producer level. eventually offer additional tailored finance products,
Working with a leading player that is close to producers further incorporating farmers into the formal credit
is positive for financial institutions and makes the market. For example, some banks, like HDFC Bank in
greatest use of information available. Being close to India, started by offering dairy processors a payment
producers suggests more than merely performing as platform to facilitate payments to their suppliers.
an aggregator; it implies deep understanding of the This involved setting up deposit accounts with several
production process and strong relationships based on thousand dairy producers and linking the accounts
trust with producers. to the processor’s payment platform. Over time, with
a better understanding of how the dairy value chain
All three criteria where evident among the functioned and the behaviors of the milk collectors and
characteristics of key players in the case studies of producers, HDFC was able to offer cow loans, first loss
various value chains. In the Indian hybrid seed value guarantees, and insurance products. The following
chain, the SPOs are generally local villagers who are chapter covers value chain financial products in detail.
financially stable and many have a degree in agriculture.

Figure 4.2: Cross-selling and tailoring products to the value chain
• Loan for inputs of growers/breeders

• Guarantee to pay broilers from the Bank
Bank products for dealers (DDS, Agri Card for his fodder • Guarantee to confirm the assignment of
L/G, POS, Chequebook) business claims of the Farmer
• Payroll from the Bank
• L/C if any import exists
5 1
Dealer:
Sell the final Processor:
product in retail Signs contracts with • Loan for the
Breeder & Grower rest of inputs
• Submits
«assignment of
Broiler receivables» to
Processor: Breeder: the Bank (as a
Deliver the Rears parent collateral)
broiler to factory stock and produces • Can present
henhouses
for slaughtering & hatching eggs as mortgage,
processing during 65 weeks if he wants
Payments done by Bank
4 2
investment loan
Payment to Grower
Payment to
(6 times in a year)
Breeder
Broiler
Processor:
Grower: Deliver the egg Payments done by Bank
Raise the chick to
to his Hatchery
a Broiler in 45-50
for incubation.
3
• Bank loan for the rest of
days
inputs of breeders Produces chick
• Submits «assignment of
receivables» to the Bank
(as a collateral)
• Can give his henhouses
as a mortgage, if he wants
investment loan

5. VALUE CHAIN
FINANCIAL
PRODUCTS
What differentiates value chain financial products?
When should value chain products be used?
The value chain financing model reflects the increasingly complex agribusiness market,
encompassing financial products that respond to client needs, the operational environment,
and the evolution of the value chain.
Value chain products can be grouped into five different categories, each responding to
the particular needs of the client and the value chain: 1) product-linked financing; 2)
receivables financing; 3) physical asset collateralization; 4) risk mitigation products; and 5)
structured financing.
The applicability and attractiveness of these products will depend on the operating
environment and legal systems, particularly contract enforcement, in which both the
financial institutions and value chain clients operate.
Figure 5.1: Value chain finance products

Equipment
Off-Taker Purchase
Wholesaler/Retailer
Contract Warehouse
Receipt
Financing
Factoring
Financial Institution
Production Credit
Transfer of Lease
Lease Payments Contract
Processor Farmer
Long-term (raw materials) supply contract
Source: Miller and Jones, 2010.

Once established, the value chain relationship gives to bankers, and so require only a brief description.
the bank opportunities to extend conventional loan The emphasis is on their relevance to a value chain
products and services to all parties in the chain. Most financing approach (Figure 5.1). A more extensive
of the financial products outlined here are familiar description of each product is included in Annex C.
Product-linked financing
These are products that directly relate to financing upstream in the value chain to offer financial services
production as well as the aggregator and processing to smallholder farmers. The commercial relationship
or marketing company for the purpose of acquiring between the off-taker/aggregator varies according to
farmer’s production. In this case, the aggregator uses the financial institution’s objectives and the structure
financing or advance payments to producers as a way to of the value chain. In the Indian dairy and Mexican
secure product. Essentially, this works to deleverage the sugar cases, the aggregator also assumed the role
aggregator’s supply risk. This can allow the aggregator to of the bank’s agent. In the Mexican case, the credit is
guarantee or even formally contract downstream sales. documented with the individual farmer. The sugar mill
(the aggregator in this case), undertakes a number
Banks should structure the financial product to attract of operational functions (i.e. identifying the farmer,
a significant number of farmers, ensuring it can defray preparing the documentation, and
repayment risk by limiting the potential impact from
a default of individual or small groups of producers. supervision). For this, the financial institution pays the
Further, the smaller the value chain (in terms of number mill a commission for their involvement. Through this
of farmer participants), the more bank oversight is arrangement, the financial institution has turned what
required. By working with an aggregator (also referred would have been a fixed cost structure into a variable
within the industry to as an aggregator/off-taker), cost structure.
financial institutions are able to penetrate further
Receivables financing
These products are largely used as a means for risk and collection payments. Receivables can also
providing working capital to aggregators, marketing be structured as collateral. In a well-established VCF
companies, and processors. They include bill operation, farmers should be able to benefit from this
discounting, factoring, and forfaiting (the purchase of form of financing to the extent that their contracts with
receivables from an exporter, for a margin). Although aggregators are recognized as equally enforceable as
all three products revolve around the conversion of with receivables further downstream.
receivables, they differ in their method of managing
Physical asset collateralization

These financial products rely on a physical asset as a As with the other value chain products, the legal system
guarantee or collateral. The two most common products, has to recognize the rights and obligations inherent
warehouse receipts and repurchase agreements, are in the control of the assets as a precondition for the
used largely for working capital. Financial leasing, by development and use of these products. Additionally,
contrast, involves the use of an asset over a fixed period there should be a known market for pricing the assets
of time, after which the client may or may not eventually (mark-to-market), as well as a fairly liquid resale market
take ownership. for the assets. For agricultural commodities and foods,
the markets should also reflect the types and grades
used commercially for the assets under control.

Risk mitigation products
These are financial products used to reduce risk by institution’s structure and the regulations in the country
transferring it to a third party. This is achieved through in which it operates. As a result, financial institutions
the use of insurance, futures, and forward contracts. may acquire the risk directly or through a subsidiary,
For the financial institution, risk mitigation products or alternatively sell part of the risk to a specialized
are particularly attractive as they can be offered to company or broker. In some instances or products, the
participants across the entire value chain. The role that financial institution’s role will be limited to providing
financial institutions play varies depending on both an financing for the operation.
Structured financing
These are specialized products that facilitate and party will charge the producer a fee for the guarantee.
deepen financial availability, frequently involving third The producer is willing to pay the fee when it is required
parties outside the value chain. Of these products, in order for banks to grant them a loan. The option of
the most common for primary producers are loan paying a fee is also attractive when this results in a
guarantees. In this case, a third party will provide a lower cost of credit. The third party can be a private firm
guarantee to the lender, shifting the risk (partially or or even a government institution. In fact, governments
wholly) from the primary producer to the third party. The (e.g., Mexico) have used this as a policy instrument to
assumption is that the third party guarantor represents entice financial institutions to lend to agriculture.
less of a risk than that of the primary producer. The third
Cross-selling
Cross-selling is the selling of more than one financial is to focus on the entire value chain, identifying or
product to an individual client, or, in the case of value creating opportunities for selling multiple products that
chain finance, to multiple value chain participants. satisfy the value chain’s financial needs, while further
This should be an important part of a financial enhancing the financial institution’s bottom line. Typical
institution’s business strategy, turning a potentially products and services that banks cross sell include:
attractive business into a highly valuable one. The payroll and supplier payments, credit cards, short to
business strategy of value chain financing, as such, medium term loans, insurance, letters of credit.

6. RISK MANAGEMENT,
COSTS AND RETURNS
How does value chain financing impact risk?
What procedures should be in place for effective monitoring?
Partnering with aggregators or commission agents in value chain financing creates

opportunities for risk- and cost-sharing mechanisms in which banks and their partners can
negotiate mutually beneficial terms that would not be available in conventional lending.
Nonetheless, it is still important for financial institutions to perform due diligence and have
proper monitoring mechanisms.
When assessing the reliability of aggregators or commission agents, necessary attributes

include: (a) evidence of a process and capacity to manage the collection and distribution
functions within the chain; (b) access to accurate data and farmer profiles; and (c) stable
finances.
Financial institutions typically pay a commission to the aggregator that performs a number
of the credit process functions, including (but not limited to) identification of farmers for
credit, document processing, supervision, and payment retention.
The observed reluctance among banks to lend to Value chain financing, however, represents a viable
agriculture and especially to small farmers is based on alternative business model for financing agriculture.
the perception that agriculture is a high-risk business, By focusing on the entire value chain, it addresses
and that smallholder farmers represent a high cost financial institutions’ basic concerns and redefines
per client, with small returns. Essentially, banks have the risk-return assumption. Chapter 3 addressed risk
tended to avoid the majority of this market segment factors across the value chain and these are revisited in
because it is not seen as a viable business proposition. further detail here in order to explain how the financial
When banks have financed small farmers, they often institution can manage those risks. The emphasis here
rely on government programs to limit repayment risks is upon those aspects that are particular to the value
and reduce costs. Even these programs have had chain approach, since most other factors in pricing
limited success because they fail to address the banks’ and risk management are well within the domain of
fundamental structural concerns when building a conventional commercial banking.
sustainable business model for financing agriculture. As
the HDFC Bank in India has commented: “Smallholder
farms require markets, credit, inputs, and advice to
improve productivity and income levels. Standalone
credit is not enough. Standalone credit to smallholder
farmers is not viable or sustainable.” 17
17. HDFC Bank. 2015. White Paper: Supply Chain Tool Kit, unpublished.

Risk management
The first step in risk management is the determination and providing seed production management on behalf
that the financing is going to a creditworthy party within of the seed companies. In Mexico, financial institutions
the value chain. Three criteria are crucial in determining collaborate with millers as commission agents who
creditworthiness: deal with more than a thousand producers, and reach
large numbers of small growers. This mitigates the
• The first (referenced earlier) is that the lending risks and costs associated with financing individual
decision is based on how the borrower relates to the producers. The financial institution is able to build on
sector or industry’s key success factors; the aggregator’s knowledge of the farmers that are good
• The second is that the loan reflects value chain producers and those who are likely to be repayment
participants’ business needs. Among the more risks. When the aggregator provides a first loss
common purposes are: a) capacity expansion; b) crop guarantee, risks are further mitigated.
finance; c) support for growth of working capital;
d) equipment finance; e) inventory finance; and f) Aggregator risk. Due to the importance of the
to move transactions off the balance sheet. For aggregator (particularly when it assumes the role of
example, in the Pakistan study, the loan product commission agent or business correspondent), financial
would be targeted to market-oriented farmers who institutions conduct thorough due diligence. There are a
are eager to improve productivity through better number of criteria commonly used for selection:
quality animals;
• The third factor that must be considered is cash Process Management. Evaluation of the systems
flow; in short, verification that the client will have the and the process that the aggregator/commission
ability to repay the financing. agent has in place for interaction with farmers and
other downstream value chain participants. These
If the loan product is improperly structured, the include both formal and informal interactions.
probability of loan forfeiture increases. For agricultural
lending, the structure has to be designed in accordance Credit management experience. Related to the
with seasonality and the crop or animal cycle. The above, and given that the aggregator/commission
Pakistan credit project provides an example whereby agent performs a number of the credit process
the calving cycle of livestock was deemed a crucial functions, it is important that the company has
factor for the success of the project and repayment had experience, and success, in such work. Positive
cycles were aligned with this cycle by starting the factors would include, among others, a high
project in the winter, rather than in summer. percentage of completed supply commitments
and the retention of, and successful payback to,
A significant characteristic of value chain finance is suppliers.
that banks work through an aggregator or commission
agent to finance large numbers of small farmers. In the Data quality. The financial institution must be
India hybrid seed case, the SPO (often working with up assured that the aggregator/commission agent has
to 500 small seed producers) played a key role in the accurate farm-related information that is available,
value chain, assisting in the farmer selection process verifiable, and reliable.

Dependence within the chain. The caggregator/ Insurance products can be used to compensate for
commission agent should have an acceptable degree production losses. By offering these products and
of maneuverability (they are not overly dependent on strategies within the context of an AVCF business
other participants within the value chain), as well as model, financial institutions can not only increase
internal mitigation strategies. profits, they can also effectively reduce risks in
financing agriculture.
Financial strength. The financial institution should
undertake a review of the commission agent’s In some of the case studies the aggregator provided
financial situation and reputation. This becomes technical support to small producers. For example,
particularly important when the company provides a in the India hybrid seed value chain, the technical
first-loss guarantee. assistance that the seed producer organizer provides
is crucial to the success of the value chain proposition.
Farm-level losses. Although this is not necessarily In the credit project for the Pakistan milk value chain,
a aggregator/commission agent characteristic, the technical assistance role is included as an integral
it is important for: a) measuring the risk related part of the structure. Personnel of the milk collecting/
to the primary production process; b) identifying processing company provide advice on feeding
risk-mitigating strategies; and c) determining the practices, vaccination and deworming, and general
products and costs for mitigating risks. management of the more demanding animal(s). At the
same time, the processor is involved in selection and
Contracts. The financial institution should purchase of the animals.
determine whether formal contracts exist between
the aggregator/commission agent and the farmers. Smallholder farmers can be characterized as risk
If formal arrangements are in existence, it should be adverse because of the implications for their wellbeing
verified as to whether the contracts are enforceable. and that of their family from a market or production
If contracts are not used or are unenforceable, the failure. Insurance and hedging products can protect
financial institution should explore the compliance farmers from significant losses, reducing resistance to
mechanisms that the commission agent has at its change.
disposal.
Reputation. The aggregator/commission agentt

must have a good reputation within the community. A
track record of fair dealing with farmers is important,
given the bank assumes the reputation risk of its
associated agents.
Market risks can also be moderated when working with

a leading firm that is able to transmit market signals
along the value chain; this serves to ensure that the
financial services reflect and meet market demand. In
the Mexican horticulture industry, support to broccoli
producers was structured through leading companies,
many of which required strict standards for the export
market.
Price and foreign exchange risks can be managed

through hedging and swap products.18 Likewise,
production risks can be mitigated through facilitating
access to modern inputs and technical support.
Financing input suppliers will facilitate small farmer
access to inputs, while off-takers/aggregators are in a
good position to provide technical support.
18. Several of the many products reviewed in the previous chapter can be used to
manage and mitigate risks within the value chain. See Annex C for more detail.

Pricing and returns
Pricing of financial products (simplifying somewhat) is the Financial institutions have found that using the
result of the sum of cost of funds, operating costs, delivery aggregator as a commission agent works best when
costs, a risk premium, and a margin or (net) return; the they are already performing some of the functions. In
latter set by the financial institution’s objective earnings this case the aggregator is performing a task that was
ratio and market conditions (Figure 6.1). already underway. It also means that the aggregator
has some experience in the credit process. For the
financial institution, the commission should be less
Figure 6.1: Costs and rates to borrower than the costs involved in promoting, processing,
(gross return for bank) supervising, and collecting the loan through the bank’s
own operations. The commission system also has the
Margin advantage of turning a fixed cost into a variable cost,
strengthening the institution’s balance sheet.
Risk premium
First -loss guarantee. The first-loss guarantee has
Delivery costs the potential to be a win-win situation. Many times,
financing to small producers is absent because neither
Operating costs the financial institution nor the aggregator wants to
assume the credit risk. The first-loss guarantee is
Funding costs an option that allows for risk sharing between the
Traditional Value Chain financial institution and the aggregator and, in some
Finance Model Finance Model cases, the input supplier. This works effectively when:
a) the aggregator is able to perceive the potentially
increased business benefits from agreeing to assume
part of the risks; and/or b) the aggregator is already
financing growers. In the second case, having the
The value chain finance model, as described, has the financial institution provide credit to producers frees
potential for reducing delivery costs, and for mitigating the aggregator to use its resources for other purposes.
many of the risks associated with financing agriculture, Additionally, the risk is smaller than that the aggregator
and therefore the size of the risk premium that financial would have assumed being the sole credit provider.
institutions build into their cost models.
Using the case studies as a benchmark, financial
Working with an aggregator is the central strategy that institutions ask for between 10-30 percent coverage
financial institution can employ to diminish the costs for the first-loss guarantee. The size varies according
associated with financing large numbers of small farms. to both the appreciation of the risks involved and
In some cases, the aggregator will provide credit to the perception of aggregator/commission agent
farmers; in others the aggregator assumes the costly creditworthiness.
task of dispersing and supervising credit that banks may
have documented separately to each farmer. Although Most financial institutions have pricing models that
banks will depend on the aggregator to identify farmers, adjust for the type and quality of the risk involved. When
they will often use the bank’s own scorecards or similar the aggregator provides a first-loss guarantee, the
methodology before documenting the individual loans. quality of the loan structure should improve, thereby
reducing the risk premium. Given that the aggregator
When the aggregator performs a number of the should identify the most creditworthy producers, this
credit process functions (including but not limited to, mitigates part of the primary-level production risk
identification of farmers for credit, document processing, (although this may not be captured by the financial
supervision, and payment retention), financial institution’s pricing model). This then tends to have more
institutions will pay a commission to the aggregator. of a qualitative impact on the financial institution’s
The commission is typically a percentage of the credit decisions to participate in value chain financing than a
extended. Often the entire commission is not paid in quantitative impact on pricing.
full at the time of disbursement, with the final payment
subject to adjustment based on loan repayment rates.

In the value chain financing model, back office costs Financial institutions have found that aggregators
(i.e., cost of funding and operating) remain the same.19 perform best as commission agents when they are already
However, the total cost is lower, including the charge for performing some of the associated functions and have
the risk premium. This presents the financial institution some experience in the credit process. For the financial
with two strategic options: it can either reduce the institution, the commission it pays should be less than
pricing to the value chain, thereby gaining market share; the costs it would incur if it undertook loan promotion,
or conversely, it could maintain pricing to clients at processing, supervision, and collection itself. At the same
existing levels, thereby increasing margins. The financial time, the commission system has the advantage of turning
institution might also opt for a strategy that lowers a fixed cost into a variable cost, which strengthens the
pricing while retaining a higher margin than that under financial institution’s balance sheet.
the traditional business model.
In short, partnering with aggregators or leading firms
The value chain finance business model, it should be in value chain financing creates opportunities to
remembered, increases the awareness and, as such, establish risk-sharing and cost-sharing mechanisms
the opportunity for cross-selling. This has the potential through which banks and their partners can negotiate
of increasing the return on equity. Additionally, some mutually beneficial terms that would not be available in
products and services generate fees that do not involve conventional lending. Negotiable items include:
using solvency, which further improves the financial
institution’s balance sheet. • Extent (in percentage terms) and coverage of the
first-loss guarantee
In short, partnering with aggregators or leading firms • Terms of the bank’s financing of the aggregator’s
in value chain financing creates opportunities for individual operations
risk-sharing and cost-sharing mechanisms through • Size of commission to the aggregator for identifying
which banks and their partners can negotiate mutually- borrowers, disbursing credit, and loan recovery
beneficial terms that would not be available in • Terms of funding to producers and other upstream
conventional lending. Negotiable items include: participants (e.g., input suppliers)
• Use of the payments platform for cross-selling bank
• Extent (percentage) and coverage of the first-loss products
guarantee
• Terms of the bank’s financing to the aggregator’s
own operations
• Size of commission to the aggregator for identifying
borrowers, disbursing credit, and loan recovery
Terms of funding to producers and other upstream

participants (e.g., input suppliers)
• Use of the payments platform for cross-selling bank

products
19. If the financial institution documents each farmer as it expands its business,
operating costs may increase but not to the extent that they will significantly
diminish the attractiveness of the financial operation.

7.
ADAPTING BANK
STRUCTURE AND
OPERATIONS TO
THE VCF MODEL
How does a bank adapt to the services associated with VCF?
What procedures need does a bank need to put in place?
What are critical contract clauses in VCF?
With a value chain approach, financial institutions can obtain a holistic view of the
connections their clients have with other value chain actors and use this knowledge to offer
services and tailored financial products to address and mitigate risks traditionally associated
with the agricultural sector.
Monitoring and maintaining clear means of collecting payments are crucial. Sales forecasts,
profitability, and capital flows help anticipate loan repayment issues that may arise.
Internal bank proposals are prepared based on an evaluation of the value chain as well as
client’s analyses and are submitted for approval. Sometimes these proposals represent pilot
projects within existing bank standards (e.g., loan amount caps) or they might be expanded
and revised iterations of previous pilots.
This chapter examines the adjustments the banks make

when adopting the VCF approach. While the mainstream
functions of the bank remain, the scope of their work
changes due to the need to incorporate the intra-value
chain relationships among the bank’s partners in the
chain and among other participants.20
20. This chapter draws primarily upon presentations at the AgriFin Bootcamp
2014 by Ömer Demirhan, with Yapi Kredi Bank of Turkey. Personal exchanges
with and contributions from Michael Andrade, HDFC Bank, India are gratefully
acknowledged.

Relationship management – managing a VCF deal
inside the bank
Rather than creating a dedicated “value-chain India), responsibility may be shared among several
department,” banks tend to manage their value chain regional managers. When entering a brand new value
engagements by allocating specific analysis and chain using a pilot project within the bank’s existing
processing functions across their existing units; e.g., standards (e.g., loan caps), a small team drawn from
marketing, sales, commercial credit, agricultural credit, several units may be assigned responsibility for design
risk management, etc. Primary responsibility for a VCF and implementation. As the relative importance of
relationship typically depends on the nature of the VCF operations in the bank’s portfolio increases, the
relationship of bank individuals or teams with the trade bank may create a specialized team with primary
or agribusiness side of the value chain. responsibility.
For example, if the VCF operation will expand upon Figure 7.1 provides an example of a bank process to
an existing relationship with a major processor undertake a relatively major value chain operation for
or aggregator, the office in charge of that client Yapi Kredi Bank and the broiler industry in Turkey. In
relationship may then hold primary responsibility this example, functions and roles are allocated across
for the entire operation. If, however, a VCF operation existing headquarters and branch/regional units.
will reach out to multiple aggregators (e.g., SPOs in
Figure 7.1: Industry analysis for a value chain in Yapi Kredi
1. Demand and Information flow for

Risk a specific Value Chain Finance
Treasury Operations
Management from Branches & Regions
2. Agri Marketing Dept.:

Agri Credit & • Defines
Process Design Others
Monitoring • Measures, Analyse
• Produce Project Report
2 • Develop Product & Sales
3 Strategy for VC, with the help

of other parties within Bank
Marketing Sales
3. Agri Sales Dept.:
• Prepares an Action Plan
1 4 • Implement strategies
• Design Campaigns
• Monitor the results for the VC
Regions / Branches 4. Branches and Regions:

• Implements Project
• Manages Client Relations
Source: AgriFin VCF Bootcamp, 2014

Credit policy and processes
As suggested earlier, value chain finance does not aggregator relationship with suppliers is evaluated and
necessarily require major changes in credit policies production risks are usually taken into account, going
and processes, albeit loan contracts with different beyond the traditional assessment of the viability of
value chain participants can include special clauses the client’s business. A bank may collect and analyze
grounded on value chain relationships. What differs information for a value chain as a “project” and create
from conventional loans are analysis of credit proposals forms and pro-forma reports for internal processing. An
and client assessments. The stability of the processor/ example is provided by the case of Yapi Kredi (Figure 7.2).
Figure 7.2: Credit evaluation of a Turkish poultry operator

Profit of a Broiler Farmer of 20K chicken capacity
REVENUES
Data for VC Broiler production is
Weight per mature Broiler 2.5 kg
embedded in the Bank’s Agri Loans
Payment for 1 kg (avg.) 0.4 Evaluation System also, with a «Broiler
Duration for 1 period of production 60 days Questionnaire» for efficiency and quality
# of production periods within a year 6 times

Sales Revenue (TL, yearly) 120.000
COSTS Unit Cost TL/Unit) The Bank plans to serve below
Labor 0,07 products to this farmer:
Electricity, Fuel and Water 0,2 Bank Products/Services TL
Repair and Maintenence 0,02 Operating Loan (revolving/ 41.400
installment)
Underlay (wood shavings) 0,15
Agri Card limit 4.140
Others(General - Unexpected 0,016
Expenses) Investment Loan (5years maturity) 290.000
Total Cost Per Unit 0.46 Create cash flow from broiler 720.000
payments*
Total Cost for 20K Broiler (x6 period) 55.200 TL
+ Products/Services to other parties (value)
NET PROFIT 64.800 TL of VC
* 120K TL for 6 times in a year
Critical clauses in contractual arrangements

The nature of contractual arrangements between the Risk management provisions (discussed in Chapter 6
bank and its value chain clients vary widely depending above) make reference to formal contracts between
upon the legal environment for business transactions. aggregators and producers and their enforceability as
In the VCF model, the quality (i.e. enforceability) of part of the criteria in evaluating aggregators. If formal
contracts between value chain participants impacts contracts between producers and an aggregator
how the bank will set collateral requirements exist and are enforceable, then an “assignment of
for aggregators and farmers (including first-loss claim” is introduced in favor of the bank at the time
guarantees from processors). the bank assumes the funding role. This means that

the aggregator (or processor) will play the role of loan It is important to remember that the strengths of
collector for the bank as part of their agreement. the contractual relationships and legal agreements
will typically influence the structure of any pact
Legal contracts between bank and aggregator will typically with the main anchor firms or aggregators; i.e., the
make reference to the assignment of claim as an obligation terms (interest rates, maturity) under which they
of the aggregator and include subsidiary clauses that receive financing, the revenue sharing in the form
ensure repayment, even in the case the producers have of commissions or fees, the coverage of first-loss
defaulted on their contracts with the aggregators. The guarantees, etc. If all goes well and a stable relationship
contract may also establish claims on aggregator property is created after a couple of business cycles, terms can
(e.g., mortgage on buildings or other tangible assets) even be softened and revenue sharing adjusted.
when the aggregator provides a first-loss guarantee, or
when there are other guarantees in place.
VCF loan management

VCF loan implementation and monitoring typically into the risk monitoring system (Box 7.1), and in the
follows the bank’s established practices, albeit with customer’s file.
the recognition of the value chain context. Turkey’s
Yapi Kredi, for example, has defined criteria for Loan monitoring and early warning systems under the
placing customers on a watch list in cases of delayed VCF approach will include consideration of the overall
repayment. It also has created a list of basic principles value chain risks, and not just those directly associated
to follow in such a situation that consider whether with the individual client. Box 7.2 offers an example from
the problem temporary or permanent, and if the the India case study.
problem affects only one party in the value chain or
all participants. Information is subsequently entered

Box 7.1: Roles for monitoring
Yapi Kredi has developed RiskMon, a centralized, automated monitoring system for all customers,
connected to three different inter-bank bureaus (Central Bank, Retail and Corporate Credit
Bureau, Ministry of Finance). The system retains historical data, facilitates analysis, derives
strategies and takes action.
What does RiskMon do?
1. Monitors 34 types of customer anomalies, including:

• Delinquency in all types of loans and credit, including value chain loans and agriculture cards
• Unpaid checks, fees
• Payments not received to “transfer account”
• Stagnation/increase/decrease in credit balances
• Loan default/restructuring
• Delinquency in tax, social security payments, notes
• Deficit in collaterals
• Negative balance in revolving loans/overdraft account for consecutive 180/90 days,
respectively
2. Produces behavioral scores looking at:
• All anomalies
• Discrepancies in financial figures
• All delinquencies
• Demographic figures
3. Determines the customer classification (rating)
4. Determines strategy and action (with due dates) for customers: close monitoring, assistance,
freezing/contraction of limits, amortization, liquidation
5. Processes data from credit bureaus, the risk management unit and other units in the bank, and
checks data from the central bank, the the Ministry of Finance (for arrestments and encumbrance
of tax, social security, and note payments), and retail and corporate credit bureaus that collect
all information for consumer and commercial loans and agriculture loans evaluation systems
(connected to farmer registry databases).
Roles for Monitoring – Intelligence and sector reports
• Intelligence Dept. the Credit Group of the bank has to produce a special report for limits
above US$350,000. Regardless of the amount, the unit with loan authority (branch, regional
manager, head office) may want an intelligence report for any customer
− Intelligence Dept. consists of credit specialists, each of whom are experienced in
specific regions and sectors (no special personnel for value chains)
− Intelligence reports contains nearly the same headlines of Customer Intelligence Report,
with two extra sections (mystery shopping from the market, and the financial institutions)
Agri News Bulletin prepared by Underwriting Team through news, national statistics, agriculture
chambers’ reports
Sector outlook is reported by Agri-Banking Marketing Dept. to explain the effects of below cases
(bank’s consultant also produce, upon request):
• Drought, floods, hail, heavy rains & snow
• Dramatic price changes in a region or at a specific agri-product
• Government regulation / intervention for a specific sub-sector or product.

Box 7.2: A bank's early warning system
A good credit product will necessarily be accompanied by measures that explain, monitor, and
manage risk. Any early warning system will need to incorporate both the formal and informal
sources of information that will be processed within the bank at various levels. This information
will emerge from the relationship with the anchor company, the seed producer organization (SPO),
and also from the local bank staff and the banking correspondent. HDFC Bank monitors the
following factors to identify and address problems as soon as they arise:
1. Staging release of crop loan timed to key crop stages and concomitant money needs. Labor
component is a big cash drain (for the farmer who contracts labor). A high labor requirement
exists at the time of ‘crossing’ and also at the harvesting stage.
2. Company’s continuity of farmer relationships; the number of repeat farmers and ability to
attract new farmers. This is a very important indicator of the trust that the seed company is
able to build.
3. Yield estimates; companies normally monitor crop progress and frequently estimate the likely
harvest yields for the hybrid seeds. This information is crucial to estimating the how well
its parent seeds have been used (or sold in the open market) and also serves as a means of
understanding likely farmer income and seed availability for commercial sales
4. Changes in the company’s planted acreage over time for the same crop. This is an indicator of
the company’s performance in the market. A decline in acreage would indicate a potential risk
5. Changes in famer’s family situation; illness, death, wedding, birth, acquisition of farm
and non-farm asset, etc. Informal tracking of these developments allows for a better
understanding of the likely usage of available cash and assets. It also indicates if the farmer
is able to repay loan on time.
6. Changes in the tenancy structure of the land holding.
7. Changes in weather conditions; adverse weather-related events could have a major impact on
the farmer’s ability to produce quality hybrid seeds. Delayed rains, inadequate water supplies
from upstream canals, temperature changes are all contributors to the performance risk of
the crop. While the company would normally monitor these situations, it is important for the
bank to have a macro-level track of weather conditions in the regions where it is providing
loans.
8. Changes in availability of factors of production; labor, water, energy, etc. Diversion of resources
to other agriculture crops, to development of newer industries (e.g. the creation of two states
from the erstwhile Andhra Pradesh is likely to create pressure on agriculture land), growing
urbanism are all factors that will have a negative influence on the development of strong
agriculture value chains in hybrid seed
9. Seed Producer Organization structure, e.g. changing field staff to farmer ratio, expansion of
other (non-seed production) business interests, addition/deletion of companies forming part
of the seed production clients, are elements that bank would need to track. The social capital
that the SPO enjoys - its reputation in the community - is by far the most critical asset.
Source: HDFC, AgriFin. 2015.

8. FROM PILOT TO
LAUNCHING THE VCF
PROJECT
The launch of a new VCF project or the expansion of a The product program is created for each aggregator
piloted operation typically begins with an internal bank or set of aggregators and their respective groups of
proposal to management. Such proposals differ among farmers. HDFC formulates a companion document
individual banks differ but there are several common outlining the profit and loss account associated with the
characteristics. The examples of HDFC and Yapi Kredi program, including estimates of revenue from cross-
are illustrative cases that have successfully established selling products such as credit, insurance and other
value chain finance operations in their existing markets retail products (Annex E).
and are actively seeking new opportunities.
Yapi Kredi follows a very similar process that involves
At HDFC, a “Product Program” is put together for internal doing the market research and assessment of the
approval that includes eight components (see Annex D value chain. Then the marketing department prepares a
for full details): “Value Chain Project Report” for presentation to senior
management (Box 8.1).
1. Objective; e.g., to provide payment services to
smallholder farmers working with an aggregator and Once approved by senior management, Yapi Kredi
dairy processor. formulates an action plan for the value chain
2. Purpose of the loan; e.g., working capital, or micro- operation (Box 8.2). This plan includes the assignment
irrigation investment. of responsibilities within the bank for the different
3. Arrangements in place between aggregator components of the plan.
and farmers, the implications for agreement
between aggregator and the bank, the existence of From VCF scale up to ‘business as usual’: Once the
guarantees, and aggregator assessment. senior management has given the green light to scale up
4. Facility details: terms, maturity, pricing, collateral, the VCF pilot, it will take some time for VCF to become
geography, documentation, and service-level business as usual for the bank. Based on the experience
agreements, if any. of the contributors to this Guide, it can take 3-5 years
5. Product caps and triggers, including total lending for the bank to get its policies and systems in place,
under the program, delinquency triggers, and structure reoriented and staff trained before the VCF
remedial actions. Caps, within existing bank model becomes business as usual. Once the VCF model
standards, will depend on risk appetite at the time of is set and the system is working well in one sector, e.g.,
program formulation. dairy, the approach can be applied easily to other value
6. Reporting and management information systems. chains and sectors.
7. Risk analysis; includes side-selling risk, payment
risk, and first, second, and third ways out.
8. Business plans, and three-year projection.

Box 8.1: A value chain project at Yapi Kredi, Turkey
1. The agri-marketing department collects all raw information, together with a “Value Chain Project
Form”, from the regions and branches, combining this with sector and official data using:
1. Sector reports from government bodies, chambers, associations, and NGOs
2. Visits to related chambers, associations, and, occasionally, potential customers
3. Internal intelligence reports produced by its intelligence unit
2. After data gathering, the marketing department prepares a “Value Chain Project Report” for
presentation to a group director, including:
1. Executive summary
2. Definitions, statistics, profitability and flows of the value chain
3. Expectations and market perceptions
4. Entry points for the bank
5. Products/services to be presented for the value chain
6. Requirements to enter the sector, if necessary (e.g., product developments, information
technology and infrastructure requirements, changes to legislation, policies, regulations,
changes within bank’s organization, etc.)
7. Forecasts for sales and revenue
8. Action and acquisition proposal
Box 8.2 Yapi Kredi value chain action plan

1. After validation by a director, the marketing department arranges meetings with related
parties to discuss requirements for an action plan. A steering committee is established if the
value chain project requires major development. The secretariat of the committee is held in
the “Process Design and Execution Department”.
2. If the project does not require changes to existing procedures, the marketing department will
meet with the “Agri-sales Department to consider an acquisition strategy and action plan
3. Execution of the action plan falls to the sales department. An action plan consists of:
a. Estimated sales volume and revenues from the value chain project
b. Products/services to be presented for the value chain
c. Terms and conditions for the products (pricing, maturity, collateral)
d. A specific campaign structure for the value chain, if necessary
e. Required visits to processors and other parties of the value chain
f. Agreements and protocols if required
4. The sales department prepares a timetable and to-do list for the action plan and begins
to implement the plan with regional supervisors and branches. Occasionally, the to-do list
entails the cooperation of other sales departments within the bank (and possibly corporate/
commercial/small- and medium-enterprise/mass segment sales teams). In that case, an
“Agri-Segment Director” takes the responsibility to cooperate with other teams.

CONCLUSION
The field case studies and other sources discussed in Value chains must be a viable business proposition. As
this report support the notion that when a bank has with all business lending, finance will not (nor should it)
the systems in place and experience with farmers and rescue a losing business proposition. Value chains must
supply chains, agricultural value chain lending can be be market-driven, sustained by demand, and supported
an effective path for banks to increase business and by suitable preexisting infrastructure. During the
diversify portfolios. They also clearly indicate that there identification stage, it should be determined whether
is no single formula to create a successful agricultural or not the value chain is likely to become dependent
value chain operation; solutions are context-specific, upon financing for its viability or whether it is capable
not only in terms of the particular agricultural activity of growing through financial support. As banks become
involved and the value chain structure but also in involved in value chain finance, they should recognize
regards to the legal and business environments in the risks associated and be prepared to make sacrifices
which the dealings between the bank and value chain and view their involvement in the value chain as a
participants take place. Rather than seeking to create business opportunity, and one not without risks.
such a single recipe, this chapter outlines what both
theory and practice suggest financial institutions The case studies suggest that there is no alternative
should consider when adopting the value-chain to the research and close examination of all of the
approach to agricultural finance. participants involved in a value chain. The heterogeneity
of farmers across countries and across crops and
Successful value chains create value for all livestock activities yields a multiplicity of models and
participants involved. As a general principle, the approaches, providing many examples of potential
VCF relationship must make economic sense for all solutions. There is no single financial product or group
participants, and not just for the bank. In practice, this of products that is guaranteed to unlock the potential
principle translates into properly aligning incentives for inherent in lending to farmers. Banks and financial
all participants: producers, aggregators, processors, and institutions must invest in understanding the activities
financial institutions. that take place throughout the value chain. They also
should recognize the variations in demand for products
Financial institutions should expand their and the potential for managing risks through existing
understanding of the linkages that farmers might value chain relationships. With better research comes
have with other value chain participants, recognize better products. With better products, clients are more
the benefits of identifying producer organizations and likely to succeed and repay loans.
cooperatives as aggregators for services to farmers,
and seek out innovations in distribution channels and
delivery mechanisms that can reduce the overall cost
barriers to serving farmers.

1. What works in value chain finance
What follows is a brief account of the factors found to accept the risks associated with agricultural finance.
to be conducive to success in agricultural value chain In addition, value chain actors have more information
operations. Examples from the field case studies as to business activity, cash flows, and firms within
illustrate some of these points. the value chain than financial institutions, which
lowers their transaction costs and reduces risk. The
Partnering with aggregators or lead-firms. Value interdependence of value chain actors further reduces
chain participants have different drivers for supplying credit risks. In the case of value chain finance for a
credit, most often the desire to increase production key input, such as seedlings or fertilizer, non-payment
and efficiency, and/or to expand their markets. As a would likely result in losing access to the input as well
result, they are more willing than financial institutions as the related financing.
LESSON 1: HDFC. Partnering with value chain participants - the importance of

seed producer organizers (SPOs)
The SPO was found to be a nerve center in the value chain. All payments made by the company
to farmers in most cases were routed through the SPO, who also provided both technical and
financial assistance to farmers and often acted as a moneylender. Given that the SPOs had a
very tight relationship with the farmer, their horizons for farmer financial exposure were longer
than might be expected from banks. An SPO’s risk assessment capability, its knowledge about
the viability of the farming operations for a particular farmer, and its supervision during the crop
stages resulted in better management of farmer credit. For all these activities and the potential
risk that an SPO carried (farmer default on production, quality issues with hybrid seed, etc.), the
SPO would charge farmers higher rates of interest on advances.
Formal contracts facilitate access to finance. Despite processors and farmers by clarifying prices per quality
the fact that contract enforcement is challenging in level. Some formal financial institutions are more
some countries, farmers with contracts that defined willing to lend to producers when they have defined
the terms for which they would be able to sell goods sales terms and fixed market prices for their products
had significantly greater access to finance than those than when they do not. It is important to note than in
who did not. In vegetable value chains, the use of the value chain context, contracts offer an opportunity
written contracts solidified the backward and forward to formally assign claims and reduce repayment risks,
linkages between the processors and wholesalers and and/or introduce factoring solutions.
LESSON 2: HDFC. A bank's early warning system

A good credit product will necessarily be accompanied by measures to understand the risk and
monitor and interpret signals that will facilitate risk management. Any early warning system will
need to incorporate both the formal and informal sources of information that will be processed
within the bank at various levels. This information will emerge from the relationship with the
anchor company, the SPO, and from local bank staff and the banking correspondent.

Information flows from agricultural value chains to VCF works where market opportunities exist but
financial markets reduce real and perceived risks of supply is lagging. The Pakistan dairy value chain case
agricultural finance. As consumer preferences become highlighted producers that were already delivering
more refined and differentiated, agricultural markets quality products but without strong connections to the
become more segmented and specialized. For example, consumer market, collectors/processors were unable to
as with the Bankaool case study, most of the vegetables keep up. VCF is likely to be the best solution to improve
exported to the U.S. from Mexico are closely regulated. collection and processing, while also increasing small
Financial institutions can forge strategic relationships farm productivity.
with dynamic agricultural value chain actors, such as
large processing firms, to expand their loan portfolio
by either lending directly to its related producers or
by making larger loans for the processor to on-lend to
producers.
LESSON 3: HBL. Use preexisting participants as conduits for technical

assistance
Channeling credit and repayments through milk processors had an advantage that it was not an
isolated activity but one embedded in the routine of milk processors. Their technical field services
were essential to guide farmers on management issues for their new animals (if animals are
purchased under the loan), for example.
VCF succeeds where value chains lack working capital. the suppliers, and performs payment retention.
For many small-scale farmers, traders and processors, Examples of this mechanism are provided by
a lack of working capital is the principal constraint to Bankaool in sugar, Yapi Kredi in broiler chickens and
growth and to increasing supply to the market. The HDFC Bank in dairy.
VCF approach addresses this constraint through two • Capacity-building/banking infrastructure strategy.
mutually reinforcing channels: Another approach is to build the capacities of
the suppliers to make them bankable. When
• Lead-firm strategy. When there is a strong lead firm the suppliers are trained and supported in their
in the chain, this company can be used as a vector businesses for a couple of years, they can build a
to reach non-bankable suppliers. The lead firm is proven credit history and then become eligible for
the collateral for providing finance to the suppliers; financial services from mainstream banks.
it provides the lender the information needed on
LESSON 4: HDFC. Extending the bank’s agricultural outreach

Presence and reach remain important considerations. India’s HDFC has been engaged in pioneering
work developing a suite of structured products to support value chain finance in agriculture. HDFC
Bank has an extensive network on the ground – branches and ATMs – and is aggressively expanding
its footprint in agricultural areas by relying upon the business correspondents (authorized under
India’s regulations) and digital technology (mobile- and card-based).

VCF facilitates investments in the chain. Besides the products, develop new markets, and pursue other mid-
lack of working capital, another key reason value chains to long-term ventures. Value chain finance is found to be
may not realize their full potential is through a lack of a viable means of funding medium-term investments,
investment capital. Entrepreneurs in the chain need such as improved breeds of cattle (Pakistan), or storage
to invest to upgrade their technologies, introduce new facilities (India).
2. What factors deter success in VCF?

What can go wrong?
While the cases reviewed for this Guide were primarily of Weak relationships within the value chain. A history
successful value chain finance operation, experiences of short-term or sporadic transactions between
suggest that specific features of the value chain may aggregators and producers represent a risk the bank
conspire against a strong VCF operation. Aside from needs to assess and mitigate. Poor quality of aggregator
the obvious importance of the legal environment for information on suppliers would constitute a warning
commercial contracts and contract enforcement, a few sign; the financial institution would need to audit
features of the value chain can be listed as potential information quality before engaging.
weaknesses and these need to be considered before
testing a new value chain operation. Generalized crop failure. This is obviously a nearly
universal risk but one that banks might mitigate by
Too many small aggregators. The Pakistan study entering a value chain that boasts sufficient geographic
identified small milk collectors as a key component of diversification, as well as reliable access to guarantees
the path to market. However, each collector covered a and insurance.
relatively small number of producers, and they posed
the risk of possible reverse-financing given the collector
paid the producer at the end of each monthly collection.
A VCF intervention would likely need to establish its
primary connection with larger collectors or processors
further downstream.
LESSON 5: Bankaool. Aggregator roles are important.

One major difference between Mexico’s vegetable value chain and the cane sugar value chain in
which Bankaool had already been operating was that small farmers sold to small aggregators
(collectors or acopiadores), the majority of whom were on the margin of the formal economy.
The ability of these aggregators to be the main entry point was limited given they frequently did
not have a credit record, making taking a first loss guarantee from them a high risk proposition.
Similarly, their ability to provide the legal documentation was unlikely. Even adjusting the model
to work with wholesalers offered very limited opportunities, since the relationship between the
collector and wholesaler was in cash. Even where there is credit, it is often the collector who will
provide “financing” by waiting until the wholesaler makes the sale in order to be paid.

ANNEX A.
BASIC CONCEPTS
AND PRINCIPLES
The Introduction provided readers with an overview of the basic concepts and issues
that arise in value chain financing. The basic concepts discussed in this annex aim
to provide readers greater detail that will be useful in becoming familiar with the
terms and processes of value chain financing.
Agriculture value chains overview. What is a value chain? What are the basic concepts that
make up a value chain financing model? This introductory section outlines the fundamental
concepts of agricultural value chain finance. In addition to categorizing the various actors
along a value chain, this section offers some tools for determining sources of finance and
the level of integration within a given chain.
Financing agriculture value chains – Summary of main issues. What drives bankers to
consider value chains in their agriculture finance portfolio? Value chain finance is intended
to address some crucial issues that arise when financing agricultural operations. The topics
of information asymmetry, entry points and products (which are all discussed in-depth
throughout the guide) are mentioned briefly.
Nearly every commodity exchanged in the global to capture, holistically, the chain itself rather than
marketplace is subject to a series of value-creating emphasize the significance of any one individual actor,
activities that transform raw commodities into a focusing upon the connections between actors within
multitude of products available for consumption the value chain and the ways in which value is added to
worldwide. The segmentation of the various activities a product. Value chain analysis considers the system as
or processes, which add value to a product or service a single structural unit, albeit often times with various
at each step along the way, is commonly referred to as pathways through which inputs to production are
‘value chain analysis’. Value chain analysis attempts processed for final markets.
1. Defining the Value Chain

A large body of theoretical and applied literature has interventions aimed at repositioning entire industries,
focused on value chains – agriculture or otherwise building competitiveness, and support economic
– since Michael Porter’s 1985 seminal work on firm growth. Value chain analysis can shed light on the size
competitive advantage. Value chain analysis is of firms participating in each link, and on potential
deemed useful at many levels. Businesses use it to improvements in their participation, which makes it
devise competitive strategies and to guide product and an appealing tool for governments and aid agencies
process innovations. Governments and donors have concerned with the inclusion of smallholder farmers in
recently shown interest in value chain analysis to inform modern value chains.

Why it matters to bankers? For the purposes of this • focuses on net value added;
Guide, understanding the structure, relationships, and • recognizes that linkages between activities and
drivers of an agricultural value chain can shed light on participants vary according to the product, even if
the opportunities for a bank to profitably penetrate or the participants are the same;
expand its presence in specific market segments. It is • recognizes that there are different kinds of value
important to recognize at the outset some important chains depending on the “driver” and the associated
ways in which value chain analysis differs from governance relationships; and
traditional commodity system or industry analyses. • looks beyond physical flows to include information
Namely it: flows
2. Defining Value Chain Finance

Value chain finance relies upon the relationships It is important to note that agricultural value chain
throughout the system in order to determine finance is primarily a demand-based approach that
appropriate flows of capital. The value chain approach leverages relationships to address the inherent risks
to finance actively engages the connections between in agricultural finance. While AVCF may provide loans
actors within a value chain and the ways in which value to farmers, traders, and processors, its value is in
is added to products at each step along the way. understanding the relationships between actors in the
value chain and how they share risks and benefits (or do
By systematically approaching the value chain as not). A value chain is not an entire sector or subsector.
a single unit, financial institutions are able to more It involves a specific group of interrelated producers
effectively mitigate risk (Box A.1) by encouraging new and other actors who supply a particular end-market.
and leveraging preexisting value chain relationships. The relationships between buyers and sellers can be
With information pertaining to where value is added described through various types of linkages along a
along the chain as well as identification of vital actors, continuum. This definition of value chain finance does
intermediate and ultimate markets, and understanding not include conventional agricultural financing from
customer demand, financial institutions are better financial institutions such as banks and credit unions
informed to make decisions regarding the credit risk to actors in a chain unless there is a direct link with the
of those to whom they lend. Agriculture value chain value chain.
finance (AVCF) has increasingly been adopted by
development practitioners as a means of substantively AVCF is characterized by a comprehensive assessment
contributing to smallholder food security, effectively and understanding of the entire chain and the use of
growing incomes by increasing agricultural and in some cases development of specially tailored
productivity, and improving efficiency of smallholders financial products that meet the needs of the chain.
and small and medium enterprise producers Rather than a simple credit risk assessment of the
throughout the value chain. borrower, AVCF requires an assessment of the broader
Box A.1 Pathways to improving quality and efficiency

Banks can provide financial services to spread risk and reward in a manner than incentivizes
quality production so that all actors in the chain, including the bank, benefit.
1. Identifying needs for finance that will strengthen the value chain as a whole
2. Modifying existing financial products and designing new ones tailored to the specific needs of
those in the value chain
3. Reducing transaction costs of providing financial services
4. Mitigating risk through information sharing and relationships
Source: Miller, 2010.

risks of the value chain. Agricultural value chain finance emphasis must therefore be placed on models that
often prioritizes bringing together individual farmers allow the full participation of smallholders in value
and their productive capacity via producer associations, chains.
cooperatives, and other forms of collective enterprise,
thereby greatly improving their access to methods Recent findings from lending practices by HBL in
of diversifying and transferring risk. It also leads to Pakistan suggest that banks can develop a long-term
economies of scale in market transactions and greater strategic environment for growth in lending to other
bargaining power to form more reliable and profitable market segments and increase adoption of banking
relationships with other distinct market actors. services leading to greater deposits by focusing on
agriculture value chain finance. AVCF can reduce costs
Organized associations of farmers facilitate access and risks and it offers a way to reach smallholder
and bargaining capacity in input and output markets farmers who may have otherwise been excluded from
as well as to channels of technical knowledge. When formal financial services. Many of the components of
aggregated, farmers are much more willing to invest AVCF may be familiar but the systematic approach to
in productivity-enhancing practices and to undertake its application has been pursued only more recently
activities with higher profit margins. Often times, it (Miller & Jones, 2010). Agricultural value chain finance
entails moving from diversified subsistence farming to can contribute substantively to increasing agricultural
specialized surplus production activities; i.e., from net productivity, distributing gains from trade to actors
buyers to net suppliers of food. Smallholders account throughout the value chain, and to improving bank
for a large proportion of rural poor people in developing profitability. The agricultural sector is becoming
countries and produce much of the countries’ food. increasingly integrated, both horizontally (with large
As such, they are an important target group, offering multinational firms participating in a range of value
opportunities to increase the socioeconomic welfare chains) and vertically (with firms involved in all aspects
of a large number of people, improve food security, and of production, transport, and processing).
drive the economic development of the country. Special
3. Key Value Chain Participants and Financial

Interactions
When analyzing a value chain, typically there are Input Suppliers
five main categories of participants to consider,
as depicted in Figure A.1. Although they frequently Suppliers provide farmers with the inputs necessary
will engage with actors throughout the value chain, for production. Agricultural inputs often include
dealers in agri-commodities or input suppliers are the seeds, chemicals, fertilizers, and equipment as well
beginning of the agricultural value chain, followed by as technical assistance. Input suppliers often vary
producers, aggregators or assemblers, processors, considerably in size (ranging from foreign-owned firms
and finally retailers. Though not present in the basic to small-scale local retailers) and often have very
diagram, service institutions as well as commercial different and individualized financial needs. Whereas
banks and financial institutions are often included local retailers may require short-term seasonal working
as they play critical roles in the success of the value capital loans that can often be anticipated, other input
chain. Agriculture value chains might not include all suppliers who provide more expensive products (such
participants. In a vertically-integrated system, one as specific pesticides or fungicides) may have quite
participant may engage in activities along several different financial needs. Additionally, since they often
stages in the value chain, while in a horizontally- serve various different actors within the value chain
integrated system one actor may engage in a range of (as well as various different value chains, i.e. grain and
value chains. In other cases, agricultural products may dairy production), they must account for the financial
not require processing or farmers may sell direct to end availability and timescales of producers, processors and
consumers. retailers.

Figure A.1: Stages of the Value Chain
Farm
Input Supply Assembly Processing Distribution
Production
1. Arrows from input supply to all other stages show that input supply is a cross-cutting function.
2. Arrows from production directly to processing and distribution indicate that some farmers may deliver crops directly to
factors or directly to final markets (for unprocessed goods).
Source: Tchale and Keyser, 2010.
Producers/Farmers qualify for credit, banking costs associated with

financing rural operations can be insurmountable. High
Refers to all of those engaged in primary production interest rates and transaction costs are frequently
including farmers, their families and seasonal/part- tied to financing smallholder farmers. Some farmers
time workers. Most smallholder farmers lack sufficient have benefitted from informal or in-kind loans from
working capital to buy seeds and other inputs or to hire value chain partners, but they are generally small in
appropriate help to plough and harvest their crops or size and rarely provide more than short-term capital.
care for animals. Due to the insecurities involved with Informal loans from other parties such as moneylenders
investing for the production cycle, many producers often impose excessive interest rates, which can place
face significant risks associated with paying for food farmers in a vicious debt-cycle.
as well as household and medical expenses. Many
smallholder farmers lack the economies of scale Cooperatives and farmers’ associations have been one
and investment capital to purchase equipment or way of delivering credit to farmers, with loans often
infrastructure to improve yields. Farmers require tied to farm inputs and machinery. However, like other
financial intermediation not only to help procure inputs semi-formal institutions, co-ops suffer from weak
for production, but also in the form of cash payouts for governance, flawed administrative controls, lack of
their crops after harvest. Farmers also use credit to independent decision-making, inflexibility, and high
invest in livestock, equipment, and treatment facilities administrative costs. Apart from having the funds to
and to cover costs of labor (if they require assistance for finance such loans, co-ops face various other financial
maintaining crops or during harvest.). A lack of financial needs, such as covering their administrative costs.
support not only compromises the quality and quantity Those that market their members’ produce need cash
of production, but farmers are unable to remain to pay their members promptly, which requires working
competitive or maintain their share in the final value of capital; if farmers do not get paid quickly, they may
production. sell to a private trader who pays less but who can
provide fast cash. Farmer organizations that function
Historically, farmers have had few reliable sources of as collection points need to invest in warehousing and
finance. Lacking the conventional means of collateral, transport.
they are viewed as ‘unbankable’ and, when they do

Aggregators/Service Providers/Traders Retailers/Wholesalers/Exporters
The traders buy produce from the farmers or co-ops These participants sell the processed product to
and bulk it before selling it on. Their business depends local and global retailers, supermarkets, and smaller
crucially on making their working capital flow as quickly retailers, who in turn sell to consumers. Wholesalers
as possible in buying and re-selling produce. Every often manage credit relations in two directions: they
transaction offers an opportunity to make a profit provide money to trusted traders so they can buy on
(and, of course, carries a risk of losing money). Small their behalf, and they may provide products to retailers
rural traders have to stop buying when they run out of on credit, expecting to be paid after the retailer has
cash, leaving farmers stranded with their products. sold the goods. In this way, wholesalers often act as a
The traders need working capital to optimize their bank for other actors in the chain. They often need more
turnover and keep transaction costs down. They also capital than other traders in the value chain. To avoid
need longer-term investment capital so that they can bad debts, they need good information on the reputation
buy a vehicle, build a warehouse, or pay for equipment and financial status of their suppliers and buyers.
to weigh or grade a product. Because so much of their Wholesalers and exporters have access to the financial
capital is tied up in products at any time, traders have services of commercial banks. These loans can be long-
little collateral, so find it difficult to get loans. Few term, or at least medium-term. Exporters may have the
financial services are designed specifically for traders. option to provide guarantees to their suppliers (e.g., if
they apply for a bank loan), based on an export contract.
Processors Exporters (or importers) can also participate in a joint
venture, together with other value chain actors.
Processors are those that are adding value to a raw
product during the processing stage. Small-scale In traditional finance, several banks might lend to
processors may lack the working capital they need to various actors along the chain, with no coordination
buy products in bulk from a farmer group or trader. They of services and knowledge. Agriculture value chain
often lack the money to invest in equipment, leading finance (AVCF) can create efficiencies from the financial
to losses, lowering quality, and pushing up the cost of institution perspective by promoting coordination
processing. They typically need access to medium-term of a variety of financing services along the chain.
loans and the ability to lease equipment. Commercial While much of the interest in AVCF from NGOs and
banks are becoming involved in lending to such development organizations focuses on AVCF as a way
processors. to expand credit access to smallholder producers, there
may also be flows down the chain; that is, producers
finance buyers and processors by accepting delayed
payments or delivering products on consignment.
Figure A.2: Continuum of Relationships between producers and buyers
Likely Success of Agricultural Value Chain Finance
Spot market Contract farming Long-term

Capital investment Vertical integration
producers sell products producers and buyers relationship buyer invests buyer owns production
markets with fluctuating make predetermined producers and buyers
in producer capacity
markets agreement have trust and
Continuum of Producer-buyer Relationship

4. Variations in Value Chains – The Importance of
Participants’ Relationships
Value chains types have been characterized by several chains present fewer opportunities to forge long-
sources according to which participants “drive” or lasting relationships where credit, inputs, extension,
initiate systematic cooperation within the value and sector knowledge flows between participants in
chain. While useful as a categorizing framework, this the chain. While the tightness of a value chain is often
classification does not lead to practical implications. based on crop characteristics, specific context analysis
Its connection with the identification of entry points for is necessary to determine how a particular chain
financial institutions was developed in Chapter 4. The functions. In contract or out-grower arrangements, side-
focus here is what determines the ‘tightness’ of value selling is a risk for loose, but not tight, value chains.
chain relationships, as this is a critical principle within Value chains may be tight due to incentives and trade
the AVCF model. arrangements that favor farmers, or farmers may be
penalized or unable to sell outside the chain.
Tight Versus Loose Value Chains
Internal vs. External Value Chain Finance
Value chains exist along a continuum depending on
the market. Tight value chains are those with clearly Internal value chain finance
established relationships and a single channel. Often
these involve what are called “closed marketed crops”; Depending on the nature of the value chain, financial
those that pose transportation challenges due to bulk institutions may provide services directly to a “lead
or perishability, thus making side-selling costly and firm”, which in turn serves farmers and others along the
unlikely. In these value chains, producers have few or value chain. In other cases, a lead firm may facilitate
only one option to sell their products. Tight value chains the direct provision of financial services to other actors.
may include export commodities, highly perishable Finance flows in value chains regardless of the presence
crops, and those that require commercial processing. of formal financial institutions. Participants further
down the value chain provide loans to smallholders
In contrast, in loose value chains (often involving “open with or without the involvement of financial institutions.
marketed crops”) farmers have a variety of marketing Internal or “within chain” value chain finance refers
options and may sell to various buyers. In addition to to various participants providing loans and other
a range of marketing options, open marketed crops financial services up and down the value chain. Forms
may also be stored for home consumption. Loose value of internal value chain financing include aggregator
chains present more opportunities for competition credit, input supplier credit, marketing company credit,
and may present producers with a variety of options lead firm (contract or out-grower farms) financing, and
for marketing their crops. However, loose value chains warehouse receipts financing , as depicted in Figure A.3.
are not necessarily better for smallholders. Such
Figure A.3: Internal Value Chain Finance
Bank Bank
Finance Finance
Farm
Input Supply Assembly Processing Distribution
Production

While internal value chain finance offers the advantage on relationships within the chain, this finance may be
of utilizing relationships and transaction mechanisms referred to as “external” financing. A typical example
already in place, there are also drawbacks. When is a bank that provides a loan to a producer based
financial institutions are not involved, working capital is on a contract with a buyer. External value chain
tied up in finance, farmers may not understand the costs finance can provide benefits for all stakeholders by
of finance (as it is deducted from payment for products), including financial institutions in value chain finance.
and agribusinesses must devote resources for financial Milder (2008) notes the following primary benefits:
service provision, rather than their core business. firms do not need to use working capital to provide
finance to producers, producers can access finance
Value chain finance without bank involvement may without meeting typical collateral requirements,
provide what an ACDI/VOCA report calls a “demonstration banks can enter new profitable markets without the
effect” whereby banks may be encouraged to expand risk and transaction costs associated with lending to
services to agricultural enterprises based on the track smallholders directly (Figure A.4).
record of internal financing within to the value chain.
Because financial services are typically bundled with From a financial institution’s perspective, connecting
other services in AVCF, buyers may regard the benefits the bank with the lead buyer or trader in an already-
of strengthened ties with producers and other actors as established commercial relationship is a preferable
being more important than the profitability of a particular starting point (Bankers, 2014). In some cases,
loan. An interview with Starbucks revealed the company smallholder producer organizations may be in a position
is providing substantial credit to farmers, motivated by to play this role. Once the bank and the lead value chain
a need to secure long-term supply of coffee and other actor establish a relationship and share information,
products, rather than by the returns they receive for financing vehicles can be designed and introduced, their
loans.21 pricing reflecting the cost-sharing and risk-sharing
arrangements between the bank and the business
External value chain finance partners. Other formal financing options include
secured transactions, equity finance and joint ventures,
When actors outside the value chain, such as financial commodity exchanges, and government liquidity
institutions, provide finance to the value chain based support (African Development Bank, 2013).
Figure A.4: External Value Chain Finance

Information about farmers
Finance Finance Bank

Bank
Farm Processing Distribution

Input Supply Assembly
Production
21. Personal communication with authors, May 2014.

ANNEX B. ASSESSING
COMMERCIAL CRITERIA IN
VALUE CHAIN SELECTION
Commercial viability is assessed using the following financial success, i.e. payback risk. The operating
downstream criteria: hypothesis is that a high level of volatility increases
both the operational and credit risks22.
1. Growth in industry should be measured by
both the value and volume of production over 4. Size – measured as the value of production – can
a specific period of time. Using the real rather be used to determine the attractiveness of a
than nominal currency value of production specific industry. Although when considered by
eliminates inflationary distortions. Measuring itself, size may not indicate a healthy agri-food
growth using volumetric data offers additional industry sector, the hypothesis is that the larger
insights into product availability and procurement the size of the chain, the greater the attractiveness
potential, which can help in developing value chain and opportunity may be for developing and
relationships. Additionally, when the product is promoting value chain financial products.
exported, using long-term volume data provides a
measure of performance independent of foreign 5. Trends in international trade provide an indication
exchange movements. The operating hypothesis of both the potential and the vulnerability of
is that the higher the growth rate, the higher the an agri–food industry sector and can offer
probability of the viability of a specific value chain particularly relevant insight regarding value chain
within the given industry. Specific agricultural financing. Sustained export growth suggests that
production criteria used in ascertaining industry the industry maintains a competitive advantage
growth are outlined below. in the international market. However, exposure
to international markets changes the risk profile
2. Investment is an important indicator of the way the since the industry is subject to an additional set
market perceives the specific risks and potential of variables, including movements in exchange
of an industry. The use of this criterion is based rates and shifting foreign trade policies. Even if the
on the assumption that entrepreneurs would be primary orientation of an industry is to the domestic
reluctant to invest in businesses in which they saw market, if imports comprise an increasingly larger
limited growth potential. Rather than absolute share of the domestic market the value chain is
values of investment over a specific period, the ratio considered particularly vulnerable at the primary
of investment to the value of production should production level.
be used in order to adjust for variations in size of
the different businesses. This makes it easier to 6. Financial flows provide insight into how the
establish a relative ranking across industries. financial market views the specific industry. Since
credit availability is finite, changes over time in
3. Price volatility and changes in production volume the share of total formal credit directed toward a
(adjusted for seasonality) provide an indication specific industry indicate a growing or decreasing
of the potential operational risks. Success in a business potential/risk. Additionally, changes in
highly volatile market depends on a special set past due loans as a percentage of total lending offer
of business skills, frequently supported through an indication of the credit worthiness of the value
policies and financial instruments designed to chain.
mitigate and facilitate volatility management and
its associated risks. At the same time, volatility
22. While this does suggest a high level of risk, it can also be considered as an
provides an indication of the potential business and indicator of demand for risk management products.

Assessing industry growth – upstream criteria23 values should be used to eliminate inflationary
distortions. Due to short-term variations in
While the basic conceptual criteria for evaluation production and market conditions, at least a decade-
are similar for field and fruit crops and for animal long trend should be considered.
husbandry, due to the differences in production
systems, the specific measures and indicators tend to 4. The difference between planted and harvested
be different. area provides an indication of the on-going
production risk. Large differences and/or
Field and fruit crops significant variations from year-to-year indicate an
unstable or sub-optimal production system. While
1. Growth is measured as the change in area this might suggest that crop insurance products
planted over a certain period of time. The working could be offered (due to ongoing and large losses),
hypothesis is that an increase in planted area the costs associated with purchasing crop insurance
is indicative of a more dynamic industry. Since would most likely be too high to be an affordable
agriculture is frequently the beneficiary of targeted component of producers’ risk management
government support, the period of analysis should strategies. Again, the period evaluated should be
be long enough to cover more than one change in sufficiently long (at least a decade) in order to
administration to account for changes in policy that account for one-off climatic effects, and disease
may have an impact on the economic perspective of and/or insect infestation.
the industry.
Animal husbandry
2. Changes in yield offer a vision of the availability
and application of technology to the production 1. Growth is measured by the change in the animal
process. The use of this criteria is based on the population over a certain time period. Much like
assumption that sustained growth in yields is the criteria for crop and fruit production, the
consistent with investment in a healthy industry. working hypothesis is that an increase in the
Since investment data is usually difficult to obtain, animal numbers is consistent with the profile of
yield growth can serve as a proxy for investment. a dynamic industry. By way of contrast, a decline
Given that long-term crop budgets are often in animal numbers may be an indication of loss of
unavailable in many developing economies, competitive advantage to foreign competitors or of
sustained growth in productivity and planted area a structural change in the market with consumers
would suggest that returns have been positive. eating less meat or favoring a different source of
animal protein.
3. Value of production per hectare offers a deeper
understanding of the potential viability of the 2. In the case of animal husbandry, yield is considered
primary production process. Changes in value to be the conversion of feed to weight gain, or,
of production combine yield fluctuations with in the case of the dairy industry, to milk volume.
(sometimes counterbalancing) price changes. Changes in yields reflect the willingness to
As mentioned previously, real rather than nominal invest in and apply technology to the production
process. The basic assumption is that increasing
23. “Upstream” is used here to refer to the origin of the product flow, i.e., the yields or conversion ratios suggest an industry with
producer. The product flows “downstream” towards the consumer through the
different components of the value chain. sustained potential. It should be noted that changes

in slaughter weight do not necessarily reflect an large number of smaller units, the opportunities for
improvement in conversion ratios. They may instead value chain financing may actually be greater, since
be indicative of a response to economic conditions, the aggregator will necessarily need to aggregate
with producers adjusting slaughter weight to supply. This indicator offers important insights
improve profitability or cut losses. into the viability of a given value chain, but should
not be considered in isolation of the rest of the
3. The size of the operating unit provides an insight measurements provided.
into the changing structure of the industry. In
many markets, heard size (i.e. the number of For both agriculture and animal protein operations, the
animals managed/produced), has increased technical coefficients should be benchmarked against
while the number of farms/feed operations has the larger national market as well as international
decreased. While a trend to larger-sized units may farm operations, particularly if the product is to be
be considered as a positive indication of growth exported or has to compete with foreign imports. This
within an industry, there are cautionary factors to is important when the macroeconomic environment
consider. If growth and consolidation is occurring is characterized by instability and/or the currency
rapidly, it may result in more difficult conditions is subject to frequent volatility. When the results of
for value chain financing in the short run due to the comparison are favorable, they suggest that the
structural changes occurring in the value chain. industry is sustainable and capable of growing under
Interestingly, when the industry is characterized by a suboptimal economic conditions.

ANNEX C. AGRICULTURE
VALUE CHAIN FINANCIAL
PRODUCTS
This Annex covers in further detail the value chain

finance products summarized in Chapter 5. A synthesis
diagram is included below in Figure C.1.
1. Product-linked Financing
These are products that directly relate to financing Product-linked financing may also be an option in
production, as well as financing the aggregator and working with trader-suppliers. Additionally, product-
processing or marketing company for the purpose of linked finance can be tailored to input suppliers, who in
acquiring farm production. In this case, the aggregator turn will finance producers. The underlying advantage
uses financing or advance payment to producers as a of input-supplier credit is that it works to assure the
form of securing production. Essentially, this works to de- timely availability of inputs. This is especially important
leverage the supply risk to the aggregator (see Figure C.1). in agriculture where plantings, fertilizing, and other
Figure C.1: Producer financing
Guarantee (whole or partial)
Large Processor Financial

“Off-Taker” Repayment of loans Institution
Purchase Advance on
Payment contract contract
for goods
less Primary goods
amount (e.g., meats,
owed to produce, grains)
the bank
Farmer

practices have to be carried out at fixed times. If not in the previous chapter, this can provide an additional
appropriately timed, production can be negatively degree of confidence for the financial institution in
impacted. By the careful selection of the input supplier, offering these financial products.
the financial institution can assure that the producer
is getting proper, quality inputs, which should result in When the aggregator acts as the conduit for credit to
improved productivity. producers, including as a commission agent, typically
the financial institution will put a risk-sharing structure
For the financial institution, the pre-conditions for in place. This is usually requires the aggregator to
mitigating the risks related to product financing revolve provide a first-loss guarantee.
around assuring that the aggregator-client (whether or
not acting as a commission agent) is able to work with As mentioned, it is important that a large number
reliable supplier producers. Even when contracts are of farmers are participating in the value chain when
signed, the key element is the relationship and trust structuring the financial product. This has the effect
between the producer and the off-taker/aggregator. of limiting the risks from a default of an individual or
Additionally, it is important to know the aggregators’ small groups of producers. At the farm level, supervision
clients and their financial reputation. Furthermore, plays a key role in risk mitigation, by ensuring that
the financial institution should verify that the use of good farming practices are employed. These include
financing adequately reflects the market demand for sustainability practices, which are being included in
the farmer’s production. When the off-taker/aggregator credit evaluation criteria.
is the leading player in the value chain, as indicated
2. Receivables Financing
These products are largely used as a means of providing Forfaiting can be considered as a form of factoring used
working capital to aggregators, marketing companies largely in international trade, and/or when repayment
and processors. They include bill discounting, factoring, is expected over an extended period of time (often six
and forfaiting. Although all three products revolve months or longer). Typically the forfaiting company will
around the conversion of receivables, they differ in undertake the collection and assume the repayment risk.
their means of managing risk and collection payments.
Receivables can also be structured as collateral. For the client, the advantage is not necessarily that the
process is more agile than the normal credit process.
In the case of bill discounting, the financial institution The advantage lies in that the “all-in” cost may be lower
will advance (i.e. essentially lend) to the client a than an actual credit line for working capital. Given that
percentage of the value of the receivables. In this case, receivables financing is not a debt, it does not impact the
the client has the collection risk, which means that the client’s borrowing capacity, as opposed to working capital
financial institution’s repayment risk remains with the credit. It has the advantage of partially eliminating
client. As such, the financial institution will use similar business risk for the client, depending on the particular
criteria as with a “typical” credit loan. receivables financing product. When that is the case, the
financial institution will have to evaluate the repayment
For factoring, the financial institution will purchase risk and will often adjust the discount accordingly. Many
the receivable and be responsible for collection. financial institutions require that the legal system
The financial institution will typically purchase the provide for strict payment enforcement mechanisms as a
receivable at a discount, and may also charge an up- precondition for offering receivables financing products.
front fee. Types of factoring vary with the either client
assuming the risk of losses from non-payment or the One variation of receivables financing uses receivables
financial institution taking the repayment risk without as loan collateral. The financial institution will create
holding the client responsible. The discount is larger in a fiduciary-type account. The account is pledged to
the latter case than in the former. If there is any follow- the financial institution, with the buyer paying directly
up legal action for collection, it becomes solely the into the account. This type of structure can be used to
responsibility of the financial institution. manage aggregator risk by ensuring that the financial
institution will be paid first.

This is also an attractive structure to balance risk the fiduciary account pledged to the financial institution.
mitigation with the client’s need for working capital. The financial institution would retain loan repayment and
As products are sold with payment going into the pay the input suppliers; the remaining proceeds would
fiduciary-type account, the financial institution will go to the aggregator. The advantage for the financial
withhold funds according to the amortization schedule, institution is that both the input supplier and aggregator
with the remaining difference going to the client for potentially share in the risk.
working capital.
Interestingly, the financial institution may actually find
This type of structure can be adapted to input-supply it more appealing to take the repayment risk than the
financing. In this case, the input supplier, the producer, and original client risk. This could be the case when the
the aggregator would agree to the fiduciary-type account receivable is from a highly reputable company with
pledged to the financial institution. The input supplier strong financial credibility. Where there is a secondary
would provide inputs to the producers. In this arrangement market, the financial institution has the option of selling
the aggregator would not typically retain payment, rather the receivable, thereby offloading risk and making the
the proceeds from the sales of the product would go into receivable financing potentially more attractive.
3. Physical Asset Collateralization

These financial products center on the use of a five percent over one week then the value of the product
physical asset as a guarantee, or collateral. The two used as a guarantee has to be adjusted accordingly.
most common products – warehouse receipts and
repurchase agreements – are largely used for working The warehouses are generally bonded or certified;
capital. Financial leasing, by contrast, involves the use nevertheless, the financial institution making the
of an asset over a fixed period of time, after which the loan on the certificate will often indicate in which
client may or may not eventually take ownership. warehouse the asset should be placed. Working with
a known warehouse company provides an additional
As with the other value chain products, the legal system layer of confidence for the financial institution. Where
has to recognize the rights and obligations inherent the legal system allows, a particular advantage of
in the control of the assets as a precondition for the warehouse receipts is the flexibility in defining what is
development and use of these products. Additionally, a “warehouse”. It may be a fenced-in field where grain
there should be a known market for pricing the assets is stored under a tarpaulin, or even a corral in a feedlot.
(mark-to-market), as well as a fairly liquid resale market Whether it is a formal warehouse building, or one of
for the assets. For agricultural commodities and foods, these ad hoc type structures, the risk is associated with
the markets should also reflect the types and grades the performance of the warehouse company.
commercially used for the assets under control.
Where the warehouse is an ad hoc structure, periodic
Warehouse receipt products are fairly common around inspections should be built into the loan document.
the world. The farmer or other participant in the value Typically, the client absorbs the costs of inspections.
chain will receive a receipt for the products upon It should be recognized that even the use of a trusted
placing them in a warehouse. The receipts are then used warehouse company does not mean that the financial
as collateral for a loan. The loan, in turn, is often used institution need not perform inspections of the
to pay off an existing debt (e.g., a production loan) or existence and quality of the product.
for working capital (Figure C.2). The size of the loan is
related to the value of the products, with the financial Repurchase agreements tend to be more frequently
institutions requiring that value of the product under used by traders and processors in the value chain. The
guarantee be a specific percentage above the amount product is sold to a third party, with the agreement that
of the credit. Part of the loan supervision is the ongoing the seller will buy back the product after a given period
valuation of the product stored. Typically, the loan of time. The third party may be a company created by
agreement will contain a provision for changes in the the financial institution to take possession. The product
amount warehoused in relation to changes in the price will typically be stored in a bonded warehouse during
of the product. For example, the loan agreement may the course of time that the third party owns the product.
stipulate that if the price of the product increases by Here again the financial institution has to take into

Figure C.2: Warehouse receipts
Bank
Pledged Note
Payment
Payment
Trade co./ co./
warehouse
Product Product
Farmers Buyers
Finance Contracts
Source: Miller and Jones, 2010.
consideration the performance of the storage company. client, in many countries, the payment for the leased
For the seller (client), the advantage of a repurchase is asset is considered as a deductible business expense.
that it often results in a lower cost of money than a bank It also has a favorable balance sheet effect, since the
loan. The sale of the product, however, may result in the client does not incur debt, as would have been the case
seller incurring a tax obligation in the short run. For the if the asset had been purchased. Since the financial
financial institution, the fact that the client does not institution maintains ownership of the asset, there is no
own the collateralized asset facilitates the disposal of collateral issue.
the asset in case of non-payment.
Generally, leased assets are likely to be machinery
Financial leasing is a product that the financial or vehicles, yet practically anything can be leased
institution can tailor to the needs of all the participants to participants in the value chain (e.g., factories
along the value chain. As indicated above, leasing and feedlots). This creates interesting business
involves the use of an asset without ownership, akin to opportunities for financial institutions. However, as
renting. Where there is a purchase agreement at the end these become more esoteric, the financial institution’s
of the agreed-upon period, the net result is equivalent risk increases in case of default.
to the asset having been purchased on credit. For the
4. Risk Mitigation Products

These are financial products used to reduce risk by operates. As a result, financial institutions may acquire
transferring it to a third party. This is achieved through the risk directly, through a subsidiary, or alternatively
the use of insurance, futures, and forward contracts. For sell part of the risk to a specialized company or broker.
the financial institution, risk mitigation products are a In some cases or products, the financial institution’s role
particularly attractive business proposition since they will be limited to providing financing for the operation.
can be offered to participants throughout the entire
value chain. The role that financial institutions play Insurance tends to be more widely used and accepted
varies depending on both institutional structure and by downstream participants. This reflects the fact that
the regulations in the country in which the institution most insurance products are designed to insure fixed

assets as well as other goods, which can be priced are offered to larger clients in the form of two types
in the market and damage or loss can be accurately of swaps, focused on interest rates or currency. The
quantified. Likewise, downstream participants are interest rate swap allows for switching (or swapping) the
better able to quantify the relationship of the cost of variable interest rate on a loan for a fixed rate, or a fixed
insurance to the impact that loss or damage would have rate for a variable rate. The decision to enter into an
on their businesses. At the farm level, besides insurance interest rate swap is based on the perception of future
for fixed assets (e.g., barns, tractors), producers can costs and the client’s risk profile. The other type of swap
be insured for crop or animal loss. These specific is a cross-currency swap. This involves a contract to
agricultural insurance products tend to be somewhat exchange one currency for another at a specific point
costly since the pool of insured farmers may be quite in time. This is frequently used as a part of export trade
limited and losses due to weather or disease impact a finance. This approach is particularly attractive when a
large number of farms in a given area, which may make loan is in a currency different from that of the country
up a large percentage of the insured pool. Increasingly, where the client operates. In effect, the use of cross
though, banks will require that crops or animals be currency swaps eliminates the foreign exchange risk.
insured as a precondition for production loans, with the For swaps to be an effective risk management tool there
bank as the beneficiary up to the amount of the credit. has to be a strong legal and regulatory environment in
Likewise, as a precondition for insurance products to the markets in which the swaps take place to ensure
be successful, the legal structure has to be in place to commitment by the involved parties.
support the claims adjustment process.
Forward contracts involve the actual transaction of a
Futures and options. Whereas insurance products food or agricultural product at a set price for delivery
provide the ability to reduce risks related to the loss in the future. In some cases, the contract will allow for
of a physical product, hedging through futures and a degree of flexibility according to market conditions
options allow for price risk mitigation. These products at the time of delivery. Likewise, there may be some
do not involve delivery, although in some markets with flexibility in the delivery date in order to account for
forward contracts, delivery may be an alternative but growing conditions. The use of forward contracts
not an obligation. The major difference between the essentially eliminates the market risk for the seller,
two is that futures involve the buying and selling of transferring it to the buyer. However, when the contract
forward contracts at a price for the agricultural product includes product specifications, some risk does remain
set by the market. Options, by contrast, are the right with the seller. Because the forward contract involves
but not the obligation to buy or sell a futures contract. delivery, contract delivery mechanisms have to be in
Options price the specific forward contract through a place as a precondition for this to be an effective risk
range of prices related to the perception of risk. Options mitigation strategy. Although financial institutions are
have recently become popular as they allow for greater not typically involved in forward contracts, significant
flexibility and do not tie up working capital for margin business opportunities exist. For example, the buyer
calls. Since hedging products are priced using specific may wish to offload some of the future price risk
– and frequently foreign – markets, a strong correlation through futures or options products. Likewise, the seller
between prices in the local market and the market may wish to use the contract as collateral for working
where the futures contracts are priced is a precondition capital.
for their effective use.
Market-based research, produced internally by financial
Swaps are financial products that can be offered institutions and sold to clients, also representative a
as a standalone, risk-mitigating product or as part third risk mitigation product that does not shift risk to a
of a cross-sell strategy. Generally, these products third party.

5. Structured Financing
These are specialized products that facilitate and deepen numbers of small farmers. The financial institution
financial availability, which frequently involve third may actually do the lending and packaging, selling all
parties outside the value chain. Of these products, the or part of the new security to investors. Likewise, the
most common for primary producers are loan guarantees. financial institution may be a buyer of the loan package
In this case, a third party will provide a guarantee to the from either another financial institution or an agent
lender, shifting the risk (either partially or wholly) from specializing in lending and packaging. The underlying
the primary producer to the third party. The assumption risk, as was seen in the housing crisis in the last decade,
is that the third party guarantor represents less of a risk resides in adequately identifying the true quality of the
than that of the primary producer. The third party will packaged asset.
charge the producer a fee for the guarantee. The producer
is willing to pay the fee when it is required in order More often than not, opportunities for joint ventures
for banks to grant them a loan. Paying the fee is also occur in the value chain. The joint ventures may be
attractive when this results in a lower cost of credit. The between existing participants or a participant and a
third party can be a private firm or even a government third party that will use this as a means for joining the
institution. In fact, governments, such as Mexico, have value chain. For the companies involved, there are many
used this as a policy instrument to entice financial objectives that may make a joint venture attractive.
institutions to lend to agriculture. These include enhancing economies of scale, bringing
in expertise, injections of capital, improving competitive
Another structured financing product involves pooling position by expanding up or down stream in the value
and packaging financial assets that are in turn sold to chain, among others. For the financial institution, this
investors. What makes these attractive to investors is is an especially attractive option since it can generate
that the financial assets typically produce a cash flow. income by charging an advisory fee. The financial
Theoretically, the risk associated with the repackaged institution may cross sell by also providing financing to
product is reduced through the pooling of assets, one of the parties in the joint venture.
conceptually. This type of structure is particularly
advantageous for facilitating financing to large

ANNEX D. INTERNAL BANK
PROPOSAL TO MANAGEMENT
(ILLUSTRATIVE)
1. Objective: 2. Purpose of the loan:

State the objectives here (e.g. to provide credit and State the nature of the service being provided to the
payment services to smallholder farmers working farmers. For example, working capital for fertilizer or
with off taker ‘ABC company’ through its aggregators investment credit for micro-irrigation in coordination
recommended by the company). Objective may include with the company. This section should include
general information about the industry of the off taker estimations of the benefits of the credit expected to
company and the rural areas in which they source the accrue to the farmer, off-taker company or aggregator
raw materials through the supply chain, as well as the over a given period of time
motivation for value chain financing as opposed to a
direct lending program to smallholder farmers.
3. Arrangement in place between off-taker,

aggregator and farmer(s):
Summary of the nature of the agreement between the
aggregator and the bank, including details of guarantees
and service level agreements, if applicable:
Credit, market, history and solvency of aggregators
(standard credit assessment of ratios for long term
facilities):
The degree of specialization in production that is required
by the company:
Details of the agreement, which should include; selection
procedure for aggregators and history of aggregators
being connected to the aggregator company (2 years
minimum, average net-worth of aggregators). This step
is unnecessary if farmers are directly associated with
the company under consideration through their own
collection outlets:
Any arrangements (formal and informal) between
aggregators and farmers:
Insurance, technical support and infrastructure already
in place:

4. Facility details:
Facility:
Working capital/term loan:
Term/Maturity:
Average ticket size:
Proposed pricing:
Collateral if any:
Term/ moratorium/servicing cycle:
Non-performing asset classification norm (if left to the
discretion of the bank):
Selection criteria for farmers:
Define the geography being covered, distance from the
branch:
List of aggregators whose arrangements will be
considered:
List of commodities produced:
Borrower (Farmer) eligibility:
Earning capacity; estimated annual income (including
income from other sources), net of loan installments,
savings available for sustaining daily activities:
Land under cultivation; define minimum criteria
proposed:
Payments received through the supply chain and/or
company records of supplies delivered over the last 2-3
years or certification from the aggregator if data is not
available from the company aggregator:
Age of the farmer (specify maximum age):
House ownership, time in the village, referral from other
farmers in the village:
Recommendation by the aggregator (or aggregator
company in the case of a direct arrangement between
farmers and off takers):
Other standard requirements, if any, as per regulators or
bank policy:
Loan documentation (simplify):
Guarantor assessment (assessment of aggregators):
Agreement/arrangement with the company:
Time in this line of business, history with the company
and recommendation by the company:

Income, net-worth, tax returns, bank statement
assessment (if any) or estimates of income, details of
other business interests (income from the aggregator
should be the main business interest to keep the
aggregator totally engaged):
First-loss deficiency guarantee; % negotiated and nature
of collateral:
Commercial agreements between the bank and the
aggregator:
Documentation between bank and aggregator (similar to
SME or guarantee document):
Company/Aggregator:
MOU/Agreement to route payments delivered through the
bank accounts of the individual farmers/aggregators:
Service level agreement or document defining the
technical support provided by the off-taker directly or
through the aggregator or any third party to provide
technical support to farmers to increase productivity or
quality (traceability or certification, etc.):
5. Product Caps and Triggers

Caps; Total lending to be provided under the produce
program (can be assessed for increasing caps based on
portfolio performance):
Triggers; define % of delinquency levels in various
buckets (90 days, 180 days), where the product program
will be reviewed before booking further new business.
Define the level of the officers who will review and take
decisions, along with an escalation matrix:
Remedial action; define who is responsible for collections
and remedial action when triggers are breached:
6. Reporting & Management Information System (MIS)

Customer visits by field staff before or after disbursement;
every customer or sample basis:
Periodic customer visits by field staff during the term
of the loan to check on the process between farmer-
aggregator-off-taker as defined above and evaluate the
productivity estimates of the farmers to provide an early
warning system:
Early warning reporting:
Back office MIS on volumes, assets, liabilities, cross
sales, delinquencies, income, costs of the project:

7. Risk Analysis
Performance risk: determine the technical support from
the off-taker or aggregator by way of inputs or package
of practice that helps farmer deliver produce +/- 20%
quality yield:
Side selling risk: this is to be managed by the aggregator
and covered by guarantee/first-loss guarantee:
Payment risk: the solvency risk of the off-taker and its
ethics and transparency in keeping the chain together:
Primary source of repayment:
Secondary source of repayment:
Any additional sources of repayment (including market
value of any collateral):
8. Business Plans
Year 1: Assets, liabilities, possibility of cross-selling,
income, cost-to-income ratio and delinquency estimates:


ANNEX E. VCF PROFIT AND
LOSS ACCOUNT TEMPLATE
(ILLUSTRATIVE)
Month 1 Plan Plan
Number of farmer accounts opened
Number of farmer accounts activated receiving
VCF payments
Payment throughput turnover

Cumulative float in all the accounts
Number of activated accounts converted to loans
during the month
Cumulative value of loans disbursed during the
month
Cumulative loans outstanding (asset book)
Float income ( float x transfer pricing )
Asset income (average asset X net interest
margin for assets )
Commission Income on loans disbursed
Cross sell Income
- Insurance
- Other retail products
Total income
Costs
Cost of field staff at actuals + overheads
Cost of business correspondents, if any
Commissions paid to Aggregator -
Service division costs for accounts opened/loans
booked
Total Cost
Gross Revenue
Provisions for Bad loans
Net Revenue
Ratios
% of accounts activated to accounts opened
% of activated accounts converted to loans
Cost-to-income ratio
Units of cross sell/number of activated accounts

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AGRICULTURAL

VALUE CHAIN FINANCE

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Cover photo: World Bank Flickr

Chapter 1: The Business Case for Value Chain Finance ....................................................................................................6

Annex A: Basic Concepts and Principles...........................................................................................................................49

Agricultural Value Chain Finance - A Guide for Bankers i

ii Agricultural Value Chain Finance - A Guide for Bankers

Agricultural Value Chain Finance - A Guide for Bankers 1

2 Agricultural Value Chain Finance - A Guide for Bankers

Participant Main features services

In traditional finance, several banks might lend to Participants’ relationships

2. “Aggregators” are often also referred to “off-takers” by agribusiness partners in

Agricultural Value Chain Finance - A Guide for Bankers 3

4 Agricultural Value Chain Finance - A Guide for Bankers

• Risk Management, Costs and Returns: How does

Agricultural Value Chain Finance - A Guide for Bankers 5

Substantially lowers transaction costs in lending and other services.

Reduced information asymmetries

• Agronomic technical/engineering knowledge of Channeling loans for crop or livestock production

6 Agricultural Value Chain Finance - A Guide for Bankers

Reduced transaction costs

Agricultural Value Chain Finance - A Guide for Bankers 7

Making the case

8 Agricultural Value Chain Finance - A Guide for Bankers

Commercial viability should be evaluated through a holistic perspective, taking into

Agricultural Value Chain Finance - A Guide for Bankers 9

Why the Seed Industry?

10 Agricultural Value Chain Finance - A Guide for Bankers

Agricultural Value Chain Finance - A Guide for Bankers 11

At the producer level, two criteria were used:

12 Agricultural Value Chain Finance - A Guide for Bankers

Structural change. The food and agricultural system is

9. Reardon, T. and B. Minten. 2011. “Surprised by Supermarkets: Diffusion of

Agricultural Value Chain Finance - A Guide for Bankers 13

Figure 2.1: Key success factors in the Brazilian poultry industry

• Consolidation • Search for • Consolidation • Sophistication

Source: Rabobank. AgriFin VCF Bootcamp, 2014.

14 Agricultural Value Chain Finance - A Guide for Bankers

What is exchanged between participants?

Are certain relationships stronger than others?

Mapping of a value chain implies an understanding of the flows of products, finance,

Agricultural Value Chain Finance - A Guide for Bankers 15

Participants in the value chain – real flows (inputs

16 Agricultural Value Chain Finance - A Guide for Bankers

1. Price for the Breeder/Grower

Source: Yapi Kredi. AgriFin VCF Bootcamp.

Box 3.1 Research and development and biotechnology in input supply

Agricultural Value Chain Finance - A Guide for Bankers 17

18 Agricultural Value Chain Finance - A Guide for Bankers

1. Market share in final product

Agricultural Value Chain Finance - A Guide for Bankers 19

Financial flows – intra- and extra-value chain

20 Agricultural Value Chain Finance - A Guide for Bankers

Risks across the value chain

Agricultural Value Chain Finance - A Guide for Bankers 21

22 Agricultural Value Chain Finance - A Guide for Bankers

Agricultural Value Chain Finance - A Guide for Bankers 23