Risk Management by banks financing agriculture and rural enterprise: African and Asian Experiences Expert Meeting on Managing Risk in Financing Agriculture Johannesburg, 1-3 April, 2009 Ajai Nair, Consultant, The World Bank

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 2 Presentation Outline Study framework Key Research Questions Institutions Studied Findings Conclusions Way Forward

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 3 Study Framework Cover major institutional types - Commercial banks, Development finance institutions, and supply chain organizations Include only institutions with relatively large agricultural portfolios Understand the policy environment and business model Understand credit risk assessment and credit risk management.

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 4 Key Research Questions Agricultural Credit Risk Assessment What information is used to assess credit applications? How important is agricultural domain knowledge? Is credit-risk quantified at the loan-level and at the portfolio level? Does credit risk influence terms of credit?

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 5 Key Research Questions Agricultural Credit Risk Management Are collateral substitutes used? Do lenders facilitate access to risk mitigation services for borrowers? How diversified is the credit portfolio – within the agricultural portfolio / total portfolio? Are risk transfer mechanisms used? Are any special asset classification and provisioning mechanisms used?

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 6 Institutions Studied: 5 countries; 15 institutions Malawi: OIBM, MRFC Zambia: Stanbic, Barclays, Dunavant, Cropserve Kenya: KCB, Equity, Coop Bank, AFC India: ICICI, HDFC, SBI, Basix Thailand: BAAC

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 7 Institutions Studied: 5 countries; 15 institutions 8 Commercial Banks 2 international and 6 national banks 7 traditional commercial banks and 1 microfinance bank 4 provide retail services to small farmers; 4 provide to retail services to large farmers and agribusinesses 1 apex bank lending to cooperatives 4 Development Finance Institutions 1 agricultural development bank 2 agricultural finance corporations 1 microfinance finance company 2 Supply-chain finance providers Produce buyer Input supplier

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 8 Institutions Studied: 5 countries; 15 institutions Agrl Loans (in US$ million/billion) Agrl Loan as % of Total Loan Portfolio Number of Agrl Borrowers 9344 NA , NA 649 NA , , , , , ,680, ,600, NA ,430

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 9 Findings: Commercial Banks (8) Credit Risk Assessment Small Loans  Approach 1: Parametric (2)  Approach 2: Parametric + outsourcing (2) Large loans – traditional financial ratio analysis - (all). 3 banks use credit bureau for large farmers 1 uses bio-metric identification of all borrowers 5 banks use grading; only 1 uses risk modeling

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 10 Findings: Commercial Banks (8) Credit Risk Management All banks lending to small farmers use collateral substitutes (4) Tiered loan approval authority Diversified loan portfolios – agricultural loan portfolios 10 to 40 % 1 bank bundles crop insurance; 1 bundles credit-life insurance. 6 banks use risk-based pricing for large loans; none for small.

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 11 Findings: Development Finance Institutions (4) Credit Risk Assessment All use credit norms and judgment-based process; household and activity financials considered. 3 use joint liability groups as primary lending channel. Only 1 uses credit grading.

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 12 Findings: Development Finance Institutions (4) Credit Risk Management 3 use joint-liability as collateral substitute; 1 uses no collateral for all loans 2 bundle credit life insurance; 3 piloting or selling index insurance but not bundling. 1 provides BDS services 3 use risk-based pricing. All well diversified geographically; 2 have well diversified loan portfolio between sectors.

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 13 Findings: Supply chain Organizations (2) Credit Risk Assessment Very little credit assessment by commodity buyer providing services to small farmers. Traditional financial analysis by input supplier. Credit Risk Management No collateral required by commodity buyer. Fully secured loans by input supplier

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 14 4 Innovations Parametric credit risk assessment Outsourcing of credit risk assessment to agents who share credit risk. Tripartite lending arrangements – produce buyer, lender and borrower, with and without credit risk sharing. Fee-based agricultural and business advisory services.

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 15 Conclusions Lending to small farmers at scale requires non-traditional credit assessment systems Lending to small farmers requires use of collateral substitutes, but not other elements of microfinance. Successful agricultural lenders have domain expertise in agriculture at both loan officer and senior levels Little risk quantification and use of insurance or other financial risk- management tools.

Expert Meeting on Managing Risk in Financing Agriculture, 1-3 April 2009, Johannesburg 16 Some questions Is biometric identification a feasible basis for developing national credit bureaus? Can risk-modeling be used to quantify, optimize, and price credit risk of agricultural loans/portfolio? Can financial institutions finance agricultural and business advisory services to reduce credit risk?