Financial Sector Development in Africa: Opportunities ... - World Bank

Financing Agriculture: Selected Approaches for the Engagement of Commercial Finance 93
• The intermediary firms are much better placed to make sure that the
finance is spent by the borrower on productive inputs rather than
diverted into activities that may not realize repayment.
• The finance is a real trading advantage to the intermediary firm and can
be used to solidify current banking relationships or to attract new customers
from competitors.
Supplier versus buyer finance. There are subtle differences between the
transactional structures, which present different risk profiles for each of
the transactions. In supplier finance, the producer undertakes to sell produce
to the buyer in return for the provision of credit to prefinance
production. Assuming the producer fulfills this promise, the buyer is then
in a very good condition to control repayment, which is a positive feature.
Usually the buyer will deduct the costs of the loan directly from the payment
due to the producer, who will receive the balance. However, this
positive feature can be undermined by poor business relationships and
behavior between the parties. Side-selling occurs where producers breach
their promise to the buyer to sell an agreed amount and quality of produce
at a predetermined rate in favor of other buyers who may be offering
a better market rate at the time the produce is ready to sell. This
behavior can be exacerbated by buyers who renege on price promises (or
manipulate the overall amount due to the producer) and contribute to a
breakdown in trust. In this circumstance, the buyers lose control of the
source of repayment to the risk of both themselves and the financier.
Alternatively, input suppliers are in an excellent position to ensure
that the funds advanced are spent on agricultural inputs rather than
diverted to other, potentially nonproductive, activities. However, they
have less control over the ultimate source of repayment. Both buyer and
supplier finance arrangements rely on stable and professional relationships
between producers and intermediary firms. To some extent it is
beneficial if the intermediary firms are in a position of relative market
power to the producer, and the practical sanctions for breach of loan
covenants (for example, difficulty in sourcing alternative suppliers or
buyers) for the producer are clear. This sort of sanction is usually more
obvious to producers than the more ambiguous threats of legal action in
costly and ineffective legal systems.
In some circumstances, intermediaries have the best of both worlds and
are able to practically control repayment, as well as ensure that the credit
is spent on the required input supplies. Contract farming operations and
outgrower schemes—business relationships in which the buyer provides