SME Finance Policy Guide

G-20 SME FINANCE POLICY GUIDE
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costs, given that the financing structure and related
contractual arrangements and procedures for monitoring
and enforcement need to be tailored to a specific
situation. Moreover, many financial institutions lack
sufficient knowledge about value chain financing techniques
and the skills to apply them.
Leasing offers the potential to reduce some of the risks
of traditional loan provision for investment financing
in agriculture. Leasing can provide an alternative
financing solution for smallholder farmers and rural
enterprises with limited collateral and credit history
for the acquisition of equipment and other production
assets. It helps to circumvent some of the problems
related to the registration and foreclosure of collateral
and can be used for financing machinery and movable
assets such as vehicles and farm equipment. Since the
lessor owns the equipment, repossession in case of
default is more straightforward as it does not require
court procedures. Leaseback enables rural entrepreneurs
to access funds by selling a productive asset to
the lessor, who then leases it back to the lessee. At the
end of the stipulated period, the lessor sells the asset
back to the lessee at a pre-determined price. The use of
leasing and leaseback is greatly facilitated by a suitable
legal framework stipulating the rights and obligations
of both parties. However, tax regulations can make
leasing less lucrative than lending. Despite the advantages
of leasing in principle, few institutions offer
equipment leasing and leaseback to rural customers.
A further policy instrument to stimulate medium- and
long-term agrifinance lending can be agricultural
guarantee funds. Guarantees may provide additional
comfort for financial institutions interested in testing
the feasibility of lending to a new clientele, but a guarantee
alone is unlikely to induce additional lending if
the lenders lack such interest. International agencies
can perform a valuable service by conducting evaluations
to determine if and under what conditions guarantees
produce the expected results and how the details
of guarantee designs affect performance. It is also critical
to evaluate whether they distort markets and discourage
private credit market development.
Index-based crop insurance shows promise in overcoming
some of the risk related constraints. Indemnity
payments are triggered by deviations from an independently
verifiable indicator such as rainfall data
measured at local weather stations, and not by on-site
loss assessments. Weather-index insurance thus offers
the promise of reducing the administrative, adverse
selection, and moral hazard problems of traditional
insurance. Different indices can be used, such as
rainfall, temperature, or livestock mortality, as long
as they are highly correlated with regional farm yields
and are accurately and objectively measurable.
However, weather index based insurance has its own
operational challenges. Not all pilot programs have
been successful and the scalability of the successful
pilots has not yet been proven.
Challenges and priorities for LDCs
The challenges of providing financial services to agricultural
enterprises are wide ranging, and can be more
severe in LDC rural sectors. The dispersed location of
rural clients, the difficulties and high costs of transportation
and communication, the heterogeneity in
farming activities, and the level of management skills
make small farm lending a costly endeavour. The high
agricultural production risks, further complicated by
the sensitive political nature of agriculture and domestic
food production, explain why lending to agriculture
is risky. All of these challenges are present at
different levels of the financial system, the policy level,
the financial infrastructure level, and the level of financial
institutions.
Financing agricultural SMEs requires both SME finance
and knowledge about the agricultural sector. However,
in many LDCs, financial institutions know very little
about agriculture and lack the specific agricultural risk
management skills, suitable products, and term liabilities
to finance agricultural SMEs. On the demand side,
agricultural SMEs frequently lack the required financial
data, business plans, marketing tools, and sufficiently
powerful projects to convince financial
institutions to provide adequate funding.