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The last decade has seen increasing recognition by policymakers, capital providers, and finance practitioners of the vital role played by agricultural small- and medium-sized enterprises (agri-SMEs) in agriculture and food systems in developing countries, as well as their key challenge of limited access to finance.

In sub-Saharan Africa and Southeast Asia, there is an estimated USD 160 billion demand for financing by ~220,000 agri-SMEs. However, we estimate that only USD 54 billion (~34%) is currently being met through formal finance channels—leaving an annual financing gap of USD 106 billion.

These headline estimates are large, but reflect in numbers what most practitioners have experienced through working with agri-SMEs. Digging beyond numbers, our new State of the Sector report with CASA introduces a more specific view of where the market for agri-SME finance is (and isn’t) clearing.

To add new perspective, this report breaks down the market in a more comprehensive and holistic way to show where finance is specifically flowing, via specific types of products from specific types of funders to specific types of agri-SMEs. The report also presents four long-term change priorities that we see as crucial to systematically closing the USD 106 billion agri-SME financing gap over time.

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1

In 2018, ISF Advisors, in partnership with the Syngenta Foundation, published Protecting Growing Prosperity: Agricultural Insurance in the Developing World. Alongside the release of that report, more than 100 industry stakeholders convened to consider solutions for maximizing the uptake and impact of insurance for smallholder farming households. However, since that time, the climate crisis has rapidly escalated and the disruptive effects of the COVID-19 pandemic have shifted market dynamics for smallholder farmers. These trends called for a new convening and reflection process for the sector. 

To that end, this 2022 State of the Sector update was commissioned by a new partnership of donors—including the Bill and Melinda Gates Foundation, Syngenta Foundation, FSD Africa, and Swiss Re Foundation—and written by ISF Advisors with support from the Microinsurance Network. The findings of this report were shared and debated in a virtual industry convening of over 130 stakeholders in January 2022. Key ideas and reactions from these discussions have been captured in this report, which sets out to: 

  • Take stock of the current state of agri-insurance for smallholder households, distilling what has changed in the sector since 2018; 
  • Introduce new ways of thinking about the sector in the form of four deep dives; and 
  • Propose a set of priority areas to guide work over the next 5 years. 

We hope that this research will continue to support the insights, partnerships and investments needed to respond to the climate crisis, with smallholder farmers at the center of the action agenda. 

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1

Donors deploy subsidies to catalyze private sector investment in many nascent and imperfect markets, including agri-SME finance. This type of blended finance can mitigate the rural and perceived risk of agri-SME lending, reduce the high costs of serving rural areas, and address other bottlenecks to clearing market transactions.

However, fully unpacking the different approaches to subsidy in agri-SME finance is difficult, as is understanding and linking it to the impact case. In order for the sector to more efficiently and effectively deploy subsidies, we need a more sophisticated way of comparing the subsidy-to-impact tradeoffs of different models. In our latest State of the Sector report (and summarized in this blog post), we present some examples that can currently be observed in the market as a first step in more fully interrogating blended finance approaches.

The current landscape of blended finance

In recent years, the landscape of blended finance approaches in the agri-SME sector has become more sophisticated. Capital providers have become better at matching the diverse investment profiles of agri-SMEs, in terms of growth ambition, profitability, value chain, risk exposure, and investment readiness. 

In the figure below, we lay out seven key ways in which blended finance is structured in the agri-SME market, and the particular pain points addressed by each approach.

Addressing finance market pain points through blended finance

Local commercial banks, for example, often make use of risk share, incentive payments, and technical assistance; social lenders, on the other hand, leverage a broader set of approaches. In general, capital providers tend to use more than one of the blended finance channels to achieve their objectives.

The bottom line: More approaches are being tried today than ever before, and combinations of different approaches are starting to address constraints in more sophisticated ways. But comparison between approaches is still very difficult—more research and learning is required.

Specialized funds as a blended finance channel

Since 2017, when ISF developed a typology of specialized funds, a number of new examples have emerged, often focused on impact themes such as climate resilience or gender inclusion. 

In particular, recent years have seen the emergence of more high-risk “impact venture” funds and other accelerators dedicated to supporting niche and high-growth ventures. These more commercially oriented funds are heavily investing in agtech in a small subset of countries, including Kenya, Nigeria, South Africa, India, and Singapore. Earlier grant-based investment by donors such as Mastercard Foundation, Gates Foundation, and USAID laid the groundwork; however, early-stage venture funds represent an opportunity to transition agtech and digital agriculture start-ups from grant funding to a more commercial model.

It’s also worth noting that, in the current landscape, very few funds are set up and managed by local or regional teams. Local fund managers can provide deep local insight, operate with lower cost structures, and offer stronger links for local investor participation. Yet they often lack the track record and network required to access international funding. Growing local fund management capacity will be an important step in refining this specialized fund channel.

Landscape of specialized funds

Interestingly, despite the strong push for climate finance, very few funds focus specifically on agri-SME climate resilience. Those that do often retrofit their existing investments into a climate-focused category; but this doesn’t mean that the financing is truly helping farmers adapt to climate change.

The role of public capital providers

Blended finance structures have traditionally been seeded by public or private donor capital providers. According to Convergence, in 2019 international and development finance institutions deployed USD 1.9 billion in concessional capital and mobilized another USD 5.1 billion of their own financing at commercial terms, across sectors. But this financing has failed to catalyze significant private capital—with ratios of USD 1.1 in private capital mobilized for every dollar of concessional capital.

Our analysis confirms that DFIs are the primary source of blended capital, but they operate within stringent mandates. DFI ticket sizes are usually in excess of USD 10 million and the targeted rate of return is often at commercial levels. Thus, the expectation that DFIs might bend their risk-taking rules in order to mobilize more private capital is misplaced. On the other hand, overseas development assistance and philanthropic investors, are often first to fund innovative blended finance structures. Their development and impact agendas often give larger latitude for innovation and concessionality.

Interviews with various capital providers revealed a few clear dynamics that influence the use of subsidy in agri-SME finance, namely:

  • A lack of transparency. There is no common language or taxonomy of the different blended finance structures and approaches in the market. Capital providers don’t disclose their financial terms. And the evidence base for the efficiency of blended finance structures is limited. This overall lack of transparency makes collaboration and evaluation of impact difficult.
  • Limited coordination of investments. Even among DFIs and ODA donors, there is limited coordination of investment strategies at a national level. In addition, each DFI is recognized for its different sector specialization, products, risk appetite, or level of concessionality. Collaboration and—where possible—co-investment would be beneficial to the sector, but this requires more intentional strategy and intergovernmental dialogue. 
  • Large, repeated, and unchallenged allocation of grants to technical assistance programs with limited tracking of efficiency. The impact and sustainability of technical assistance efforts are difficult to measure. Some interviewees are advocating for a reallocation of funds with the aim of accelerating the mobilization of private capital for climate resilience and food systems transformation.

What's next?

We’ve painted a picture of the blended finance landscape where, while innovation has increased over the last decade, traditional approaches seem stuck in a repeat cycle. A lack of transparency, coordination, comparative learning, and genuine private sector participation leave significant room for improvement. In order to realize the promise of blended capital approaches to agri-SME finance, the sector must develop more sophisticated ways of comparing the subsidy-to-impact tradeoffs inherent in these models.

For more recommendations, read the full report.

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1

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
  • Philanthropies
  • 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:

  1. 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.
  2. 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.
  3. 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. 
  4. 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.
  5. 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.

What's next?

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.

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1

Agricultural small- and medium-sized enterprises (agri-SMEs) play a vital role in rural communities, providing employment, livelihoods, markets, and food for local households. Like smallholder farmers, agri-SMEs have historically been thought of as a static, relatively homogenous group. At the most basic level, they are profit-oriented enterprises and cooperatives that are central to global food systems. 

However, this static definition fails to capture the different types and sizes, as well as the dynamic nature of agri-SMEs. As a result of operating within food systems and the unique dynamics of developing economies, agri-SMEs are exposed to multiple challenges, including climate change. Their role changes as markets move through different stages of development, and this has implications for what services they require at any given moment.

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. Part Two of the report presents a new characterization of agri-SMEs based on their growth pathways and their role in food systems. With this characterization, policymakers and practitioners can better define agri-SMEs and characterize their finance needs.

Six different growth pathways for agri-SMEs

As shown in the figure below, we can sort agri-SMEs into six different categories according to their growth ambitions and potential:

  1. High-growth ventures are highly innovative business models serving large, addressable markets with high margins and experiencing a rapid growth trajectory. 
  2. Niche ventures are business models that are creating innovative products and services that target niche markets or customer segments.
  3. Diversifying enterprises are small, family-run enterprises that have seen minimal growth, but are run by an entrepreneur with a desire to grow, likely through diversification.
  4. Dynamic ventures are enterprises in stable “bread and butter” industries that experience moderate, sustained growth by deploying established business models for producing goods and services.
  5. Livelihood-sustaining enterprises are small, family-run enterprises that are opportunity-driven and on the path to formalization, though growing incrementally. 
  6. Static enterprises are small, family enterprises with no ambition to grow beyond their current status.

To achieve their potential and move along these growth pathways, agri-SMEs need support across five areas: 1) access to finance; 2) access to talent; 3) an ecosystem of support; 4) access to knowledge; and 5) access to markets. Given the persistent financing gap for agri-SMEs—which we estimate to be USD 106 billion in sub-Saharan Africa and Southeast Asia—our analysis focuses on the first area: access to finance.

Understanding different agri-SME investment profiles

The six growth pathways above can help financial service providers better understand the potential investment profiles of different agri-SMEs, including both need for and ability to access finance. 

For example, high-growth ventures and niche ventures develop innovative business models, products, and services. This means that, while they may be riskier and less profitable in their early stages, they can offer more upside as they mature. On the other end of the spectrum, livelihood-sustaining and static enterprises have a narrow path to profitability and high-risk profiles; their financing needs are also smaller in scale. Somewhere in the middle, diversifying enterprises and dynamic ventures have moderate growth potential and risk exposure, with semi-formal structures and governance that may be more attractive to financiers (though some subsidy is likely still required). 

How does this help define the financing needs of different agri-SMEs? While variations in the types of agri-SMEs and opportunities for growth in different markets and value chains exist, we can still use the growth pathways to systematically analyze demand across geographies—and in so doing, establish a new way of linking agri-SME goals with their articulated demand for finance.

What agri-SME goals & pathways tell us about their financing needs

In making the link between individual agri-SME goals and financing needs, it is important to distinguish the specific uses for finance under each goal. Agri-SMEs looking to:

  1. Sustain current growth require finance to support day-to-day operations and cash flow cycles in the form of short-term working capital and trade finance.
  2. Accelerate the growth to market potential require medium- to long-term investment capital to finance either productivity and cost efficiency investments OR expansion investments.
  3. Adapt to changing environment require medium- to long-term investment capital to finance new product/service development AND/OR efforts to build resilience.

With these goals and types of finance defined, we can clearly see in the figures below how agri-SMEs on different growth pathways typically have different needs and ability to afford types of finance. 

The first figure illustrates the foundational link between the types of businesses, their growth goals, and the uses and types of finance needed to realize those goals. However, the types of financing typically change as companies move through early stages of growth through to maturity. Looking at the growth pathways in terms of their orientation to the types of capital in the market and their stage of development (early-stage, growth, maturing) clearly shows where different forms of capital are typically used. 

 

The second figure shows a more granular, conceptual understanding of agri-SME investment profiles and needs, as well as the types of financial service providers most equipped to meet those needs. With this in mind, we can map current funding flows to see where the market clears and where gaps still remain.

What’s next?

Having established both a sizing and a new way of thinking about the demand for agri-SME finance, our report delves deeper into current efforts to meet this demand. In the next blog post, we’ll look at an overview of the agri-SME finance market, map current agri-SME funding via different channels, and present new insights for how to bridge the persistent agri-SME finance gap.

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1

Over the last several years, the agricultural financing landscape has become increasingly sophisticated, involving a wider variety of actors delivering a more complex menu of services. ISF Advisors has analyzed this evolution through a range of lenses—from the landmark Pathways to Prosperity report on smallholder farmer finance to deep dives into the state of smallholder agri-insurance and the rise of digital platforms.

These reports provide a snapshot of the rural and agricultural finance market, with a focus on smallholder farmers. In Pathways to Prosperity, we estimated the funding gap for smallholder farmers in Latin America, sub-Saharan Africa, and South & Southeast Asia at USD 170 billion. That report also referenced the lending market to agricultural small- and medium-sized enterprises (agri-SMEs), while acknowledging that—at the time—a comprehensive sizing of the demand and supply for agri-SME finance did not exist.

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 these emerging markets, new funding structures and specialized financial intermediaries have emerged in recent decades, complementing a financing landscape previously dominated by local banks and government-backed lending programs. This evolution has been guided, in part, by increasingly sophisticated thinking about the use of subsidy, segmentation of agri-SMEs, and holistic investment approaches. But in order to continue evolving, we must develop a clear view of where this finance is and is not flowing.

A USD 106 billion financing gap

More policymakers and practitioners are recognizing the crucial role that agri-SMEs can play in transforming global food systems, reducing poverty, and contributing to smallholder farmers’ climate resilience. However, our analysis shows that agri-SMEs’ access to finance remains severely limited—with huge implications for these development goals. 

We have determined that an estimated 220,000 agri-SMEs in sub-Saharan Africa and Southeast Asia (excluding India) have a total financing need of USD 160 billion. With limited data available, these estimates have been created from the latest self-reported agri-SME surveys and thus represent “articulated demand”—of which only a subset is addressable and met by a source of financing.

Of the total USD 160 billion in demand for agri-SME financing, we estimate that only USD 54 billion (34%) is currently being met through formal finance channels leaving an annual formal financing gap of USD 106 billion. 

 

Diving deeper into existing agri-SME financing

In our research, we undertook a comparative analysis of the channels through which the existing USD 54 billion in agri-SME finance is flowing. This revealed a complex picture of the market, in which the vast majority of funding—about USD 40 billion—is supplied by local commercial banks. In line with their risk appetite, these banks typically invest in more mature agri-SMEs, primarily in the form of short- to medium-term debt with strong collateral and covenant requirements and relatively high interest rates. While commercial banks use deposits and raise institutional debt to onlend, they also often use risk guarantees from public donors, particularly to lend to agri-SMEs. 

Another USD 6 billion comes from non-bank financial institutions (NBFIs), such as leasing or factoring service providers. This financing typically takes the form of specific products collateralized against tangible assets. NBFIs serve a wider range of agri-SMEs than commercial banks, which has led more donors to recognize their importance in serving underpenetrated markets and to provide them with guarantees and concessional capital.

The next largest tranche of financing is USD 4 billion disbursed by public development banks, which are state-owned financial intermediaries specializing in long-term credit to promote the economic development of different countries or regions. These financial products range from subsidies to concessional and commercial debt, often linked to a state-sponsored development agenda. 

Despite being at the forefront of agri-SME finance innovation, social impact lenders and impact-oriented funds only disburse USD 3 billion per year. These lenders are funded by concessional capital providers and typically pursue a combination of profit and impact returns. Most finance agri-SMEs in export-oriented cash crops (e.g., coffee and cocoa) in the form of working capital or trade finance.

Finally, despite the need for equity to fund the higher-risk growth ambitions of agri-SMEs, private equity and venture capital funds provide only USD 1 billion in (quasi) equity funding per year. Fund partners’ expectations around risk-adjusted returns, ticket size, and investment horizon often do not match up with the investment readiness, scale, and capital strategies of agri-SMEs.

A complex market that struggles to clear

For most practitioners involved in agricultural finance, the USD 106 billion formal financing gap will likely not be surprising. Relative to other sectors, agricultural markets are volatile—with high transaction costs, high risks, and low margins for many of the smaller value chain players. To fully understand the agri-SME financing gap, we looked at the role of subsidy and informal finance in how the market clears. 

As depicted in the figure below, within the estimated USD 54 billion of current agri-SME finance, a small proportion is offered on fully commercial terms (free of any subsidy). Unsurprisingly, it goes to the most profitable agri-SMEs. 

Most agri-SMEs, however, have less revenue and higher risk profiles. Financing these enterprises requires some subsidy to offset costs, hedge against risks, and support capacity building to make them more investment-ready. In this sub-commercial segment, a range of financiers—including commercial banks, NBFIs, social lenders, impact funds, and public development banks—utilize blended finance solutions.

As the graphic shows, this leaves a much bigger segment of the least commercially attractive agri-SMEs. Some of these have access to capital through informal finance channels, including informal lenders and family members. However, the vast majority of this segment remain unserved.

This model demonstrates a complex financing market that struggles to clear. Thus, the large financing gap can be simply understood as a function of three factors:

  1. Investment readiness: The fact that many agri-SMEs describe an investment need but do not meet the minimum requirements of investors; 
  2. Product availability: Even when agri-SMEs are investment ready, there are not financing products in that market that meet their needs and investment profile; and
  3. The volume of capital: Even when agri-SMEs are investment ready and there are matching financial products, there is not enough capital of the right profile to meet demand.

What’s next?

Having established the scale of the financing challenge, we believe there is an urgent need to build on past research and develop more sophisticated and consistent ways of understanding this financing gap. In the full State of the Sector report and in subsequent blog posts, we will present:

  1. A new characterization of agri-SME demand for funding to achieve their business growth and adaptation goals;
  2. A sizing and characterization of current finance by different types of service providers; and
  3. A more sophisticated landscape of approaches to catalyze sub-commercial finance.

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The last decade has seen increasing recognition by policymakers, capital providers, and finance practitioners of the vital role played by agricultural small- and medium-sized enterprises (agri-SMEs), as well as their limited access to finance. As a result, new funding structures and specialised financial intermediaries have emerged, complementing a financing landscape previously dominated by local banks and government-backed lending programs. 

However, of the USD 160 billion in demand for agri-SME financing in sub-Saharan Africa and Southeast Asia, only USD 54 billion (34%) is currently being met—leaving an annual financing gap of USD 106 billion unaddressed. To address the economics of agri-SME lending and bridge the supply-demand gap, subsidies are widely used by all financial service providers (FSP) channels. But little transparency exists on the different tiers within this sub-commercial market of agri-SME lending, the efficiency of subsidies, and how well they address the different market bottlenecks.

In a forthcoming report with Commercial Agriculture for Smallholders and Agribusinesses (CASA), we seek to improve the investor’s understanding of the state of agri-SME finance globally. In this blog, we explore further the sub-commercial part of the market and evaluate the current state of blended finance, including gaps and opportunities to facilitate more financing transactions and agri-SME adaptation to climate change.

A complex market that struggles to clear

Agri-SMEs have three primary goals that require finance:

  1. Sustaining current growth
  2. Accelerating growth-to-market potential
  3. Adapting to changing circumstances, particularly climate change

In sub-Saharan Africa and Southeast Asia, there is an estimated USD 160 billion in demand for agri-SME financing to achieve these goals. However, only USD 54 billion (34%) is currently being met through formal finance channels—leaving an annual financing gap of USD 106 billion.

Challenges on both the demand and supply sides prevent the agri-SME finance market from clearing in full, thereby contributing to this gap. To start, agri-SMEs are a much more difficult investment asset class, operating in an industry with higher exposure to exogenous risks—such as yield, climate, and price variability. Secondly, their articulated demand often doesn’t correspond to an investment-ready demand aligned with the expectations of financial service providers and investment profiles of agri-SMEs. Similarly, on the supply side, financing is influenced by access to different sources of capital and the products and investment strategy deployed by financial service providers—which may not always be appropriate for agri-SMEs. 

Blended finance as the linchpin of the agri-SME finance market

As with many nascent markets, Capital Providers and Financial Service Providers (FSPs) deploy subsidies to mitigate these real and perceived risks and reduce the high—transaction and opportunity—costs to serve agri-SMEs. These subsidies are used to mobilise private capital in so-called blended finance structures which are applied across all channels of agri-SME financing (e.g., commercial banks, non-banking financial institutions, or impact-oriented funds) with different tiers of sub-commercial capital.

At one end of the spectrum, commercial banks may leverage Development Finance Institutions’ (DFI) capital with commercial pricing but a higher risk appetite and more flexible terms to lend to more mature agri-SMEs with the collateral requirements and product requirements (e.g., receivables finance) to make lending possible. At the other end of the spectrum, specialised funds or state banks will use high levels of subsidy to support their pipeline development, directly support their agri-SMEs with complementary technical assistance (TA), and reduce their costs of capital with guarantees or grants.

However, fully unpacking the approaches and tiers between these two extremes is more difficult. Moreover, for an appropriate comparison, the amount of subsidy deployed by different sub-commercial, blended finance approaches needs also to consider the anticipated impact associated with the agri-SMEs being supported, or, said differently, “the impact case for going downmarket with more subsidized finance.” Structures such as Aceli Africa seek to link the amount of subsidy to this impact case in an adaptive way, where subsidies are applied on a loan-by-loan basis. Other funds and financial institutions make this case for subsidy in the initial design and targeting of the product with reporting over time. 

We believe that for the sector to truly start to make substantive progress in the more efficient and effective use of subsidy to facilitate sub-commercial lending, a more sophisticated way of comparing the subsidy to impact tradeoffs—inherent in different approaches and models—is imperative. While our forthcoming report will not fully establish this comparison model, it will offer a first step in laying out the different blended finance approaches and examples that can be observed in the market, as well as the current ways in which capital is allocated by some of the leading public sources. 

A more sophisticated landscape of approaches

In recent years, the landscape of these blended finance approaches has become more sophisticated. Capital providers are more nimble in trying to match the different investment profiles of agri-SMEs, in terms of growth ambition, profitability, value chain, risk exposure, and investment readiness.

In our research, we have observed seven key ways in which blended finance is structured to address pain points in the market (see Figure 1). For instance, local commercial banks will primarily make use of risk share, incentive payments, and, at times, investment facilitation or technical assistance. Social lenders and impact-oriented funds will typically leverage a broader set of those approaches—in particular, raising catalytic capital, attaching a technical assistance facility (externally-funded and operated) to their investments, and using investment facilitation and business development services (BDS) support in their value chain(s) of activity.

Figure 1 - Addressing the finance market pain points through blended finance

Example 1

Aceli Africa is an innovative approach to bridging supply and demand for agri-SME finance. First, it incentivises lenders to serve market segments that are higher risk but generate substantial impact by 1) depositing 2%-8% of the loan value into a reserve account that can cover first losses across the lender’s portfolio of qualifying loans; 2) providing additional financial incentives for loans that meet criteria related to gender inclusion, food security and nutrition, and/or climate resilience; and 3) offering origination incentives that compensate lenders for the lower revenues and higher operating costs on loans ranging from USD 25K-500K. Second, Aceli works on expanding the investment-ready demand by facilitating technical assistance for agri-SMEs at both pre- and post-investment stages. From September 2020 to October 2021, Aceli has facilitated more than USD 28 million in loans, with an average ticket size of USD 124K.

Example 2

IDH Farmfit brings together three sets of solutions aimed at comprehensively addressing both supply- and demand-side bottlenecks. IDH Farmfit Business Support helps companies and banks develop cost-efficient, smallholder-inclusive business models by providing them with 1) data and insights on the cost efficiency and sustainability of their service delivery models; 2) technical assistance to trial new service delivery models; and 3) blended finance to scale these models. IDH Farmfit Intelligence shares key insights on how to make smallholder value chains more efficient, effective, and impactful. And finally, the IDH Farmfit Fund is a EUR 100 million facility that takes the highest-risk positions in an investment, including first-loss coverage, and is supported by a second-loss guarantee facility from USAID (up to USD 250 million).

In our forthcoming report with CASA, we build on and refine this initial typology to link the supply of financing support to the needs of agri-SMEs based on their growth pathways. Through linking supply and demand, we can start uncovering potential gaps, mismatches and opportunities.

Developing specialised funds as a channels

While 80% of current funding is supplied by local commercial banks, many capital providers are increasing the range and volume of agri-SME finance by supporting the development of specialised funds (e.g., impact-oriented or VC) as a channel. In doing so, they are pursuing specific impact themes such as gender inclusion or climate adaption.  

Since 2017, when ISF developed its typology of five categories of specialised funds, a number of new examples have emerged (see Figure 2). Some are specifically focused on increasing the climate resilience of agri-SMEs by investing in climate change mitigation, adaptation, and nature-based solutions. The last four years have also seen increased attention to, and investment in, AgTech across sub-Saharan Africa and Southeast Asia—driven by early-stage venture funds.

Figure 2 - Landscape of specialised funds

Three key trends are particularly worth drawing the attention of the readers to:

EARLY STAGE VENTURE FUNDS: Recent years have seen the emergence of more high-risk “impact venture” funds and other accelerators (e.g., Small Foundation partnership with Founders Factory, The Nature Conservancy Venture Fund, Mercy Corps Ventures, Ankur Capital or Omnivore in Asia) dedicated to supporting what we would categorise as “Niche” or “High-Growth” ventures.  The emergence of these more commercially-oriented venture funds to invest in the promise of agri-Tech is heavily concentrated in a small subset of countries including Kenya, Nigeria, South Africa, India and Singapore and comes against the backdrop of 8-10 years of heavy grant-based investment by donors such as the Mastercard Foundation, Gates Foundation and USAID.  While many of these early donors established a groundswell of new digital-agriculture startups with over 700 catalogued by GSMA in 2020, many of these initial start-ups have struggled to transition from primarily grant funding and establish a more commercial mindset and model.

Past ISF research into digital agricultural Platforms, insurance, and data has identified a growing funding valley of death at the seed and series A investment stages for many of these agri-tech companies while at the same time a number of new impact investors and commercial funds are beginning to invest in those agri-tech companies that are successfully moving to series B and beyond. As this landscape of providers continues to evolve, and more climate-smart solutions come to market, we believe this is a critical part of the finance market that can continue to be served through specialised funds.  

LOCAL OR REGIONAL FUNDS: In the current landscape, very few funds are set up and managed by local or regional teams. While many of these local fund managers lack the required track record and network to access international funding, they are often set up to operate with lower cost structures, can provide deeper local insights and knowledge, as well as offering stronger links for local investor participation. For instance, Investisseurs & Partenaires pioneered a fund-of-fund approach in West Africa for first-time managers—with two funds raised to date—providing seed capital, technical assistance, and fundraising support. Part of those local funds’ capital has been provided by local or regional investors. Over time, growing this local fund management capacity, or establishing more locally embedded fund-management teams will be an important step in refining the efficiency and effectiveness of this channel.  

LACK OF CLIMATE RESILIENCE-FOCUSED FUNDS: Despite the strong push for climate finance, very few funds focus specifically on agri-SME climate resilience. Those that do often retrofit their investments into one of the climate-focused categories. For example, Acumen ARAF’s investment in Tomato Jos claims that the increase in smallholder farmers’ productivity translates into higher and more diversified incomes, which in turn improves their livelihoods and increases resilience to climate change. However, this does not mean that the financing actually goes toward investing in tools, technologies, or practices that will help these farmers adapt to climate change.

Reflecting on the role and positioning of public capital providers

Traditionally, blended finance structures are seeded by public or private concessional sources of capital with the stated objective of mobilising private, commercially-priced capital. According to Convergence, in 2019 International Finance Institutions (IFIs) and Development Finance Institutions (DFIs) deployed about USD 1.9 billion in concessional capital and mobilised another USD 5.1 billion of their own financing at commercial terms, across sectors. However, these sources of funding have failed to mobilise private capital en masse—with ratios of USD 1.1 in private capital and USD 2.9 of IFI/DFI/Multilateral Development Bank (MDB) commercially priced capital mobilised for every one dollar of concessional capital. While there is always the goal to leverage capital from private capital markets, this global picture of blended finance puts into context the disproportionate importance of development-oriented funding sources in supplying the capital that currently flows to agri-SMEs in the sub-commercial market. 

We interviewed multiple IFI/DFIs and Official Development Assistance (ODA) providers to understand their approach to blended finance, level of concessional vs. commercial capital, use of blended finance structures, and key priorities. These interviews highlighted three interesting takeaways for the reader:

  • DFIs are the primary source of commercial capital and operate within stringent mandates, not unlike private investors (return, sector exposure, risk management). Interviewed fund managers, investors and other stakeholders reported DFIs as being slightly less flexible and require longer to assess investments owing to their strict mandates. In addition, their ticket sizes are high, often in excess of US 10 million and the targeted rate of returns are at commercial levels (high single digits when reported by DFIs). This is driven by their shareholders, most often their national government and at times private investors (e.g. FMO private placement on public markets). Expectations for DFIs to bend their risk-taking and rate of return rules to mobilise private capital are therefore misplaced, unless and until their prime backers adjust their mandates.
  • ODA donors or philanthropic investors often provide the first tranche of catalytic capital to mobilise DFI funding or are the first to fund innovative blended finance structures. Funding from the same governments is channelled through their foreign affairs departments in support of a similar development agenda but with larger latitude for innovation and concessionality. For example, the Dutch Ministry of Foreign Affairs (MinBuZa) invests in blended finance structures directly – e.g. such as Aceli Africa – with mostly impact objectives and capital preservation as conditionality. In other instances, philanthropic investors provide at times the first loss tranche necessary to de-risk DFIs.
  • When IFI and DFIs innovate or take a more lenient approach to blended finance, they usually do so off their balance sheet. For instance, IFC’s Global Agriculture and Food Security Program (GAFSP) is a facility managed on behalf of six donor countries. For every investment its Private Sector Window executes, there is an expectation of IFC co-investment (operated through its standard credit process) that GAFSP de-risks; and the objective is to achieve at minimum capital preservation. Another example is the Kinetic facility currently piloted by CDC and funded by the FCDO. The facility is off CDC balance sheet and aims to invest in innovative business models in nascent markets to promote inclusive and sustainable livelihoods. 

Interviews with capital managers across ODA providers, major philanthropies and DFIs/IFIs revealed some clear dynamics that influence how “smart” these capital allocations are towards agri-SME investments. Three key themes were consistently repeated by a number of stakeholders:

  1. Lack of transparency on multiple levels. There is no common language or taxonomy of the different structures and approaches used to deploy subsidies in the agri-SME market. Capital providers don’t disclose their financial terms. And the evidence base for the efficiency of blended finance structures and channels is limited. As a result, capital providers cannot easily collaborate and private investors find it difficult to appropriately assess risks and potential returns.
  2. Limited coordination of investments. DFIs and ODA donors source capital from their national governments. Yet there is limited coordination of investment strategies and funding allocations at a national level. In addition, each DFI is recognised for its sector specialization and/or different products, risk appetite, or level of concessionality. The sector could benefit from increased collaboration and, where complementarity exists, coordinated co-investments. At a country level this coordination likely requires more intentional strategy and inter-governmental dialogue about how different funding institutions can collaborate. However, there is also the opportunity for coordination across national Governments that are interested in the same agenda which typically require specialised and impartial forums (e.g. G20 initiatives, WEF, AFRF etc.) to facilitate.
  3. Large, repeated, and unchallenged allocation of grants to traditional development/technical assistance programs with limited tracking of efficiency in the use of funds. The impact and sustainability of grant-funded Technical Assistance Facilities (TAF) and value chain development channels are difficult to measure. Yet some ODA donors interviewed are advocating for a large reallocation of funds by ODA providers to direct investments into funds, with the aim of accelerating the mobilisation of private capital for climate resilience and food systems transformation. First-loss funding (e.g., provided by KfW) is often critical to crowd in more investors, particularly DFIs. 

This landscape paints the picture of a blended finance landscape where more innovative approaches have been tried over the past decade – from innovative incentive structures, to more sequenced application of blended tools, to an evolving high-growth venture-finance landscape.  At the same time, there is the impression that many of the traditional approaches (such as TA facilities and commercial bank guarantees) are stuck on a repeating cycle without the accompanying learning and sophistication in understanding the comparative efficacy of approaches to drive smarter capital allocation decisions over time.  Finally, a lack of transparency, coordination and genuine private sector participation are significant issues in the capital markets funding the sub-commercial part of the agri-SME market. As described at the beginning of this section, the authors of this report believe that the imperative for the sector to develop more sophisticated ways of comparing the subsidy to impact tradeoffs inherent in different blended finance approaches and models.

What’s next

In our forthcoming Agri-SME Finance State of the Sector report with CASA, we investigate deeper the needs and investment profiles of agri-SMEs and map the existing funding flows by channel. Our proposed segmentation of the agri-SMEs by growth potential and ambition provides for a more nuanced understanding of their needs and potential; whereas our mapping reveals the current areas of strengths and key gaps of the finance market. Of particular interest is the identification of concrete interventions for capital providers, financial service providers, and other intermediaries to collaborate in holistically addressing the demand and supply pain points and bridge the USD 110 billion financing gap. 

To this effect, we propose four “leverage points” in the report that are critical to moving the agri-SME finance market forward, which concrete opportunities for each of them:

  1. Use agri-SME growth pathways to get clear on needs and impact tradeoffs.
  2. Focus on specific financing channel/product gaps and innovate to push the frontier.
  3. Mobilise more capital, more efficiently.
  4. Create the fundamentals for agri-SME climate finance. 

While much more work is needed to fully understand and address the pain points and bottlenecks in the agri-SME finance market, we hope this will generate a conversation that further unearths existing gaps, spurs new ideas and models, and fosters more effective collaboration.

At the core of this lies the question of how to get ‘smarter’ on subsidies; as in how can capital providers and donors apply both an impact and a financial-sustainability lens to their investment–for example by incorporating a pathway to profitability in subsidy disbursement considerations; how can they ensure the additionality of their grant investments in mobilising private capital to fund financially sustainable agri-SMEs and support the transformation of food systems?

 

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