Agricultural finance: The short-term loan trap

“Although having wider geographical spread and greater capacities to adopt technological innovations and mobilise financing for on-lending, commercial banks mainly target large-scale farms and agricultural firms involved in commodity processing,” reveals the 2022 Agricultural Finance Year Book, applauded by Finance Minister Matia Kasaija as offering in-depth analysis of the agricultural financing landscape in Uganda.  
Additionally, EPRC researchers also found out that RFI have stringent loan requirements and limited outreach outside urban areas. These attributes limit access of small-holder farmers to Agricultural Credit Financing (ACF) and other resources for agriculture held by commercial banks.

As if that is not bad enough RFIs also fear that ACF lending yields far lower interest returns and income earnings compared to other agricultural/business products, constraining the uptake of the loans disbursed to farmers and agro-processors at more favourable terms than are usually available under conventional banks. 

Ignored outlets
According to 2020 UBOS statistics, slightly more than seven percent of households in the country get capital for business expansion from Savings and Credit Cooperatives (SACCOs). This is already more than the number of people with formal accounts with commercial banks in the country.  In other words, smallholder farmers - most of whom are primary producers of crops and livestock --access credit from local SACCOs, Village Saving and Loan Associations (VSLAs).

They also depend on Rotating Savings and Credit Associations, Community-Based Organisations and family members instead of ACF – which comes at the tail end, if at all. Sadly, these farmers would rather access exorbitant services of money lenders than endure labourious paper work required of ACF channeled through commercial banks.
Sector experts and researchers recommend that government devises more functional financial delivery mechanisms to deepen uptake of ACF – the country’s largest public-private programme for agricultural credit delivery whose interest rate exceeds 12 per cent for small holder farmers – a bargain compared to 20-30 percent lending rates charged outside the ACF arrangement.

These delivery mechanisms, according to sector researchers, could entail tier 1 Participating Financial Institution (PFIs) liaising with lower Tiers, such as SACCOs and VSLAs, to directly deliver ACF funds.

Bleeding value-chain
The assessment of agriculture sector value chain also disclosed that the volumes of credit flow towards production and agro-processing have been highest while credit flow towards agricultural leasing has remained persistently meagre, confirming the fears that primary producers – small holder farmers in the value chain remain a foot note in the grand scheme of things. This large decline in disbursement of new loans for agriculture during the period emanated from the emergence of the Covid-19 pandemic in 2020 and the resultant measures undertaken by financial institutions to reduce health risks and maintain capital and liquidity buffers. 

Consequently, banks increased their investment in government. 

Data shows that, overall, since reopening of the economy in 2021 following the Covid-19 economic slowdown of 2020, agricultural credit flow towards production, processing and leasing registered significant recoveries.

Private sector credit flow to the agro-processing segment registered the highest recovery in agricultural loan disbursements, increasing by twofold from Shs186 billion in 2020 to Shs357 billion by December 2022, according to the 2022 year book assessment.

According to BoU analysis, rapid expansion of credit for agro-processing was partly enabled by opportunities that emerged for agro-processing which the onset of the Covid-19 pandemic curtailed food access and distribution and increased demand for maize flour. 

This, coupled with the then increasing influx of refugees from neighbouring countries, catalysed need for investments in grain processing for value addition. As such, banks increased financing for acquisition of milling machines for maize, wheat, rice and other grain commodities.

After agro-processing, agricultural credit flow to the production segment also registered significant improvement, rising by 22 percent from Shs290 billion in 2020 to Shs355 billion by December 2022, going by the 2022 Year Book analysis.

This recovery is largely buoyed by amendments to the ACF Memorandum of Agreement (2018) that allowed for financing of agricultural inputs, farm expansion, and by the revitalisation of efforts to operationalise the Block Allocation Product, a loan product under the ACF that targets smallholder farmers and micro-borrowers engaged in primary production.

Whereas the flow of credit towards agricultural leasing also improved, its volume has remained persistently meagre compared to lending for other activities; with annual new loan disbursements for leases averaging only Shs10 billion in the study.

Further constraining growth in agricultural leasing are unfavourable tax laws for leases associated with the inability of lessors to claim capital allowances on leased assets. In addition, because of capacity gaps, particularly limited local leasing expertise within Uganda’s financial sector, banks prefer offering asset loans rather than leases.

Stagnant long term credit 
Did you know that new loans disbursed to the agriculture sector are not only largely short-term in nature, but also mature in less than one year? The EPRC researchers also note that whereas the volume of new short-term loan disbursements repayable in less than one year declined by 28 percent, from Shs296 billion in 2021 to Shs212 billion in 2022, short term credit of this nature still contributed 48 percent in total new agricultural credit disbursement by 2022.

The researchers also found out that growth of the medium-term credit to the agriculture sector repayable within three years grew by 20 percent, increasing from Shs147 billion in 2021 to Shs177 billion in 2022. On the other hand, long-term credit repayable beyond three years stagnated at Shs53 billion in the last three years.
“The above trends in agricultural lending reflect the riskiness of the sector despite past Government interventions to de-risk it and attract private credit,” reads the sector assessment report.

Meanwhile, the report observes that Insurance scheme, commercial banks remain reluctant to bring in patient capital while the banks and other RFIs are little attracted to agricultural de-risking programmes, such as the ACF, due to lengthy loan write-off processes, and to lack of legal framework for the operation of Credit Guarantee schemes.

Policy options
Adopting digital channels in disbursing credit to the agricultural sector to increase outreach while limiting service costs is something that government will have to consider. 
Already use of financial technological (FinTech) innovations for disbursement of new loans to the agriculture sector rapidly increased following the emergence of Covid-19 in 2020, with especially growth in agency banking. Nevertheless, disbursement of new loans remains lower than their pre-Covid-19 levels.

The report also points out that government should expand internet connectivity and infrastructure, reduce cost of internet and power, ensure power reliability, and reduce taxes on smartphone gadgets to increase uptake of agricultural credit through new digital channels.

To address barriers that limit advances for agricultural leases, EPRC researchers and sector analysts concur that government should streamline and ease taxation related to leases; and put in place robust legal and regulatory frameworks for agricultural leases that will enable RFIs to easily issue leases.

Government should streamline the Agricultural Credit Guarantee schemes. Terms and conditions should be clearly spelt out for the operation of the schemes that will attract private capital to the agriculture sector. 
The executive director of Federation for Small and Medium sized Enterprise (FSME), Mr John Walugembe, says the bureaucracies around accessing credit should be dropped as the system is a put off for majority would-be beneficiaries of ACF.  

The report further recommends that, considering that majority of agricultural borrowers who are small-holder farmers obtain their credit largely from Tier IV financial institutions, government should institute quick measures to incorporate lower Tier (Tier IV) financial institutions into the delivery of the Agricultural Credit Facility loans. This will entail working with the Uganda Microfinance Regulatory Authority to link registered microfinance institutions with Bank of Uganda regulated financial institutions.