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:
- Investment readiness: The fact that many agri-SMEs describe an investment need but do not meet the minimum requirements of investors;
- 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
- 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.
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:
- A new characterization of agri-SME demand for funding to achieve their business growth and adaptation goals;
- A sizing and characterization of current finance by different types of service providers; and
- A more sophisticated landscape of approaches to catalyze sub-commercial finance.