Value Chain Finance
Value Chain Finance (VCF) is an approach that can be used by donors and finance providers to analyze at what point in the chain finance is needed and how finance could help to improve the competitiveness of the entire chain. This approach implies that, when making finance decisions a potential lender would consider not only the client’s business, but factors and players that affect getting the product from producer to end consumer (e.g. information, technology, transport, etc.). When the entire chain is taken into account, relationships within the chain can be leveraged in order to either decrease risk or decrease financing costs. These decisions could result in a variety of products including input financing, out-grower schemes, warehouse receipts financing, or other financial flows.
For donors, the value chain approach can lead to a holistic strategy for pursuing both economic and social objectives. By strategically choosing to support a value chain that will both increase economic growth and improve the incomes of large numbers of households, donors can address market failures that have perpetuated poverty.
Value chain lenders must resolve the same problems that financial institutions face: knowing whether the borrower will be able to repay, and deciding whether the borrower will be willing to repay. USAID’s Microenterprise Development office (MD) seeks to better understand:
- the circumstances that facilitate various types of direct VCF
- the terms and conditions of the production and financial contracts involved
- whether value chain lending plays a role in improving micro, small and medium enterprise (MSME) creditworthiness, leading to greater access to formal finance
- how financial considerations should be incorporated into analyzing and upgrading value chains
- how VCF can increase the competitiveness of value chains
- how VCF can increase the incomes of poor households active within those value chains.
MD is exploring existing examples of value chain financing, and drawing lessons for how USAID missions and other donors could support more effective VCF programming. Using the Value Chain Project Cycle as an organizational framework, MD is developing a suggested methodology for integrating VCF into project design and implementation.
KNOWLEDGE AND PRACTICE
MD has played a key role in advancing the understanding of value chain finance, having supported field research and tool development since 2005. The Rural and Agricultural Finance Initiative (RAFI) Notes series established a framework for understanding how value chain actors and financial institutions contribute to financial flows within value chains.
Using this framework, a set of case studies examined financial services in 13 value chains in Croatia, India, Mali, Malawi, Mexico, Peru, and Uganda. In Mali, the studies were presented at the stakeholder workshop, Developing and Financing Value Chains: Increasing their Productivity to Reduce Poverty. The Peru and Uganda studies were used to develop an interactive training, which helps participants better understand the risks and opportunities affecting value chains and access to finance; how direct VCF differs from indirect VCF in terms of decision making, information and product design; and the role of contracts in facilitating finance and inter-firm cooperation.
Lessons emerging from these studies and workshops include:
- Value chain actors are primarily motivated by production and productivity goals, and offer finance in order to ensure the success and profitability of their business activity rather than to earn income from the financial transaction itself. They may accept higher levels of risk and losses in their lending operation than would traditional financial intermediaries, if the profits from the resulting production provide an acceptable overall rate of return.
- The costs of VCF are often hidden in the price paid for products or in the cost of inputs provided on credit, and can exceed the typical costs of commercial loans.
- Value chain actors are dependent on each other for producing and marketing products, as well as for lending and repayment. Lenders must decide who to lend to, how to monitor the performance of their clients, and how to successfully collect their loans. Borrowers must evaluate whether lenders will fulfill their part of the contract, such as supplying promised inputs on time, buying the product at harvest, and paying on time and at a competitive price.
- Contracts, whether formal or informal, for value chain transactions, can facilitate the provision of VCF.
- VCF can be accompanied by other embedded services, such as training and technical assistance, quality control, or transportation.
- Value chain analysis that incorporates issues of governance (power dynamics) can help to evaluate how product market relationships impact the availability of VCF.
- It is critical to facilitate information flow from agricultural value chains to financial markets to reduce the real and perceived risks of agricultural finance.
- Financial institutions serving value chains must develop products adapted to the cash flow cycles of the value chain, which presents challenges for liquidity management and seasonal operations.
- Partnerships between financial institutions and value chain actors can increase liquidity, lower risk, and lower costs to meet VCF demands.
MD is currently collaborating with two USAID missions to conduct VCF analyses: on the mango value chain in Mexico, and the dairy and horticulture value chains in Burundi. The case studies are aiding in the development of VCF guidelines, which could be used by USAID and other donors as an overlay to the Value Chain Project Cycle.