Introduction

Globalization brings about enormous challenges and opportunities for small- and medium-scale farmers. On the one hand, structural adjustment policies have reduced urban bias and farmers may obtain higher prices and better access to export markets. On the other, trade liberalization has exposed farmers to increased competition in both domestic and export markets. Some farmers will respond to these challenges by diversifying into non-farm activities or gradually leaving the farming sector. However, another group of small- and medium-scale farmers - entrepreneurial and commercially oriented - has the intention and capacity to remain in the agricultural sector. This group frequently needs to invest in their productive assets to intensify production and enhance the productivity of their existing farming operations or to diversify into new enterprises.

Many investments in agriculture (and in farm machinery, irrigation, land purchase, and post-harvest and processing facilities) require larger amounts of capital that only amortize over several years. Other investments, such as the establishment of tree-crop plantations, are characterized by long gestation periods. These term investments are often beyond the self-financing capacity of farmers and require access to term finance, which allows spreading the investment costs over several years. Term finance comprises various financial instruments such as term loans, leasing, and equity finance.

Obviously, providing larger amounts of funds over longer time horizons is more risky for a financial institution and requires specific skills to manage these risks at a reasonable cost. Thus financial institutions are often reluctant to provide such finance. In the past, governments and donors have frequently stepped in to enhance the supply of term loans through agricultural development banks and credit projects. However, after the recognition of the poor performance of directed credit, both in terms of outreach and sustainability, most credit programmes have been phased out and many agricultural development banks have been liquidated. Moreover, the liberalization of marketing boards in many countries has dismantled interlinked credit arrangements, which constituted another important source of working capital for small farmers that lacked tangible collateral. Even non-agricultural and urban small and medium enterprises (SMEs) frequently do not have access to medium- or long-term investment finance.

This decline in funds for agricultural term lending has not yet been compensated by other financiers. Even in countries that have implemented financial-sector reforms for development of the financial market and often have a booming ‘microfinance industry’, the availability of term finance for small and medium-scale farmers has remained extremely limited or non-existent.

Despite this apparent gap between the supply and demand of longerterm investment finance in many rural areas, the topic has been given little attention by donors and the microfinance industry over the past decade. However, the shortcomings of conventional microfinance for financing term investments for urban and rural SMEs (including farmers) are increasingly being recognized. There is a growing interest in exploring ways to adapt medium-term loans, leasing and equity finance instruments to meet the financing requirements of medium, small and microenterprises. At the same time, there is a renewed interest among donors, researchers and practitioners in revisiting agricultural finance as an important part of rural finance.

Apart from an enabling economic, legal and policy environment, suitable financing technologies and products are critical to the ability of financial institutions to offer term finance. This publication focuses on innovative, sustainable approaches to providing term finance to market- oriented small- and medium-scale farmers. It also discusses complementary measures and policy options for enhancing the environment for both the supply and the effective demand for term finance.

Research was carried out over a two-year period by FAO^[1] in collaboration with the World Bank^[2]. Case studies were conducted in Bolivia, India, Indonesia, Madagascar, the Philippines, South Africa, and Thailand^[3]. They included diverse types of rural financial institutions such as agricultural development banks, rural banks, commercially oriented microfinance institutions, mutualist financial institutions and financial NGOs. Moreover, the experiences from other domestic term finance providers in Benin, Ghana, Kenya and Mali, as well as from donor agencies and international finance institutions, have been assessed through remote surveys, interviews and a review of the literature.

The text is structured in four parts comprising a total of 10 chapters. Part A (chapter 1) reviews the different types of risk involved in financing agricultural term investments. It distinguishes between general risks of financing agricultural term investments and the specific risks faced by financiers, and discusses which of these risks can be managed by financial institutions and farmers and which are beyond their control and may require policy reform or access to specific risk-management tools. It then analyses the cost of providing term finance in comparison with seasonal- and microfinance.

Part B (chapters 2-6) illustrates the design of term finance instruments in practice and discusses the technology of financing. Chapter 2 presents the features of the case-study institutions and their motives for engaging in agricultural term finance. Chapter 3 discusses general issues and guiding principles in building up a term finance portfolio and controlling the associated risks and costs. Chapter 4 takes a closer look at term lending and discusses the main elements of a successful lending technology as analysed in the case studies. Chapter 5 highlights the basic principles of leasing and its possibilities as an alternative for the medium-term financing of farm equipment. It further discusses the issues in using financial lease in informal businesses in rural areas. Chapter 6 briefly touches on other financial mechanisms and institutional arrangements for financing larger-scale investments in the context of vertical integration, including equity finance, nucleus estate smallholder schemes, and joint venture companies.

Part C (chapters 7-9) deals with generic constraints that limit the expansion of term finance in rural areas and may require action or support by governments and donors. Chapter 7 focuses on legal and institutional constraints affecting the use of collateral, highlighting some options for legal reform. It also discusses complementary measures such as guarantee funds and credit bureaus. Chapter 8 outlines policy options and instruments for managing systemic risk. Some innovative approaches to providing crop insurance are presented that may warrant further attention and support. Chapter 9 discusses the role of donors and governments in enhancing the availability of suitable funding sources to term finance providers.

Part D (chapter 10) summarizes the main findings, the recommendations for financial institutions, and some options for governments and donors.