As practitioners and policymakers increasingly recognize the role of agricultural small- and medium-sized enterprises (agri-SMEs) in developing economies—and seek to finance their growth—they require a sophisticated view of the agri-SME financing landscape. Previous research has identified a persistent smallholder financing gap, while giving a partial accounting of supply and demand of financing for agri-SMEs. But the analysis was incomplete.
In our latest State of the Sector report, we analyze the current state of the agri-SME finance sector, focusing on sub-Saharan Africa and Southeast Asia. In our most recent blog post, we presented a new characterization of agri-SMEs and their finance needs. Part Three of this series looks at how different types of capital and financial service providers are currently striving to meet demand in this market.
An overview of the agri-SME finance market
The agri-SME finance market involves funding flows between three types of actors: capital providers, financial service providers, and agri-SMEs. When a real, articulated demand from an investment-ready SME aligns with an available financial product or capital offering, the market clears.
As illustrated in the figure below, there are several different kinds of players in this financial market structure. Capital providers, who typically raise capital from the market or public/private donors, fall into five main categories in the agri-SME finance market:
- Overseas development assistance (ODA) and other public/taxpayer-funded institutions
- International/development finance institutions, often financed by government or multilateral institutions
- Multilateral development banks chartered by two or more countries
- Other capital providers, including pension and sovereign wealth funds
Financial service providers source funds from capital providers and distribute them to agri-SMEs in the form of different financial products. While capital providers hold power in the form of funding, they rely on financial service providers to achieve their objectives and to understand the local market.
In parallel to these actors are others who play a role in fostering an enabling environment for agri-SME finance, including policymakers, market platforms, and technical assistance providers.
Finance market structure
To understand the financing flows in the current market, we look at how capital providers and financial service providers collaborate, deploying subsidies and blended financing to address the challenges of the agri-SME market.
Mapping agri-SME finance flows by channel
Our analysis shows that the current annual supply of finance to the 220,000 agri-SMEs in sub-Saharan Africa and Southeast Asia is estimated at USD 54 billion. With the understanding that estimated amounts probably overlap to a certain extent, we mapped the size of this funding per different channels, as seen in the figure below and described in Part One of this blog series.
FSP alignment with agri-SME segments and needs
Surprisingly, despite the emergence of numerous social lenders and impact-oriented funds, the bulk of current funding—about USD 40 billion—is supplied by local commercial banks. This is particularly true in Southeast Asia, where banks are supported by a strong enabling environment and policies to lend to creditworthy agri-SME borrowers.
Key insights about the agri-SME finance gap
The demand and supply mapping in our report reveals a complex market with many different segments of SMEs and types of capital and financial service providers. Here are five key insights from this analysis that should shape strategies to bridge the financing gap:
- The small “top of the market” is disproportionately served. About 85% of currently available funding is supplied by local commercial banks and impact-oriented funds, which both tend to serve more mature and creditworthy agri-SMEs OR those active in export-oriented value chains. While no global data exists, anecdotally these larger, more mature agri-SMEs represent a very small fraction (<5%) of the market, leaving a huge funding gap.
- The large “bottom of the market” continues to struggle to become investment ready. Many enterprises won’t develop rapidly enough to raise commercial debt or equity. Often, they do not even have an ambition to do so. The high costs of financing such enterprises requires both capital subsidy and technical assistance—raising questions of sustainability.
- Where is the equity for the promising “middle of the market”? Many practitioners noted the need for higher equity capitalization of agri-SMEs to help them invest in growth and withstand market shocks. There is, however, a fundamental mismatch between the demand and supply of such funding.
- Growth financing is increasing for more disruptive agri-SMEs, but still tough going. In particular, agtech promises disruptive innovation and the potential to address some of the sector’s pain points at scale. Several international funders are now deploying growth financing solutions, hoping to follow the example of successful agtech models such as Rural Taobao in China, and DeHatt and AgroStar in India; but many startups in sub-Saharan Africa are struggling to raise funds.
- Despite the urgency of climate change, climate finance for agri-SMEs has yet to strongly emerge. Of the USD 580 billion in climate financing in 2020, only 3% went to the agriculture, forestry, and land use sectors (and 4% of that to value chain actors in non-OECD countries). This funding is almost exclusively provided by the public sector, focused on big-ticket initiatives, and disbursed as grants and concessional debt—leaving many missed opportunities that may have dire consequences.
In the face of a persistent financing gap in the agri-SME market, we must double down on our approaches to subsidy and blended finance. In the next blog post, we’ll look at how the sector can deploy these approaches to catalyze more private capital investment in the agri-SME market.