Wednesday July 30 2014

We don’t need an agricultural bank to finance the sector

By Fred Muhumuza

There is a general feeling that agriculture is a risky business to finance and has limited collateral. Consequently, it attracts about 10 per cent of the total bank credit and yet it is the main source of livelihood for about 75 per cent of the population. Following that diagnosis, the prescription is that government should set up an agricultural bank. I want to submit that some of these facts are not right, and both the diagnosis and prescription are wrong. While I agree that agricultural financing represents a clear case of market failure, the solution is not a government bank but policies to make the market work for the poor. The poor must not work for the market, which is partly the case of consumer protection.
Agricultural finance is not only what banks offer but also households themselves along with their social and business networks. The agricultural sector, just like housing, trade and education, attracts a lot of non-bank funding that is not reflected in official data. Agriculture is a complex practice involving many actors along the value chain, many of whom like processors and traders are not characterised as part of the sector. A lot of credit facilities are inbuilt within this framework whereby traders and processors offer credit or inputs to farmers in advance who may also offer produce to traders on credit. Agro-products are also often provided on credit.
Credit to agriculture should be based on the value-chain and target all actors – farming households and companies, agro-dealers, produce buyers, processors, transporters, and produce sellers who may get paid after weeks or months. Financing must be timely to coincide with the seasonal cycle of events, some of which like planting and weeding, have short windows of less than two weeks. The complexity is increased by the fact that agricultural households also finance other operations like medical treatment, education, and social events. Accordingly, households in agriculture require a range of financial products to manage vulnerabilities and shocks like sickness, famine, death and festivities. One form of specific financing is subject to ‘abuse’ as money will be reallocated to other emerging emergencies. Financing agriculture is not a simple task for one specific financial institution with a name agricultural bank.
The main role of government is to ensure elimination of market imperfections that are largely a result of inadequate information about this complexity, which makes many financiers conclude that the sector is risky. In the financial world, anything unknown translates into risk.
The task of developing financial markets for the poor, many of whom are in the agricultural sector, will hinge on evolving sustainable institutions using approaches and technologies that offer a range of products at low costs.
Development of such institutions and products is a market function that requires more information that is gradually becoming available today and facilitating the design of new financing models and products. Already, the advent of electronic technologies and agency banking has tremendously reduced the cost of reaching the poor in more efficient and effective ways, and also increased the range of financial products beyond the traditional microfinance.
A lot more needs to be done by way of amending and evolving new policies, laws and regulations, which is the core task of government. Financial markets can indeed work for the poor but need to evolve elements that are missing and become more efficient by adopting right models and technologies. Financial stability and profitability are important for growth of the sector and hence more inclusiveness of the poor. The government has to be in every complementary sector where policy, regulation and monitoring are needed but not in everything.

Dr Muhumuza works with KPMG Uganda.