The intricacies of Agriculture financing (Part 2)

The value chains should aim at creating an environment to allow production of adequate harvest to meet market needs. The value chain should deliver on protecting and growing the margins for the players. Security of the supply, support growth of the value chain and create safety and sustainability of the engagement. 

Cooperation between various players if worked well will bring in added benefits like enhancing reputation of the brand value chain, improve productivity, improve access to capital and access new markets for the produce. 

The Kenyan farmer is fragmented and made of small holder farmers and hence the task of bringing farmers together is one challenge for any value chain. Any value chain should be as an enabler to access to innovation, capital and having a trusted advisor. 

The Kenyan farmer has had a history of value hyped agriculture with no proper structures and control. Farmers have lost resources to con business persons. A recent one was one importing high yielding dairy cows from South Africa and milk being a trading commodity in high demand many farmers paid for dairy cows that were never delivered. 

Historically, farmers in many other areas have unpaid dues for their produce supplied to processors. From Pyrethrum, Sugarcane, Tea, Coffee among others. This has distorted markets and hence structuring agriculture into value chains has not been successful or has been met with skepticism.

Government interventions in bailing out failing processors of agricultural produce by injecting monies into them is welcome. But the common issue among all the processors is that they owe their suppliers, the farmers, substantial sums of funds of unpaid supplies. Production systems are aged and hence inefficient thus ending up with a high priced final product.  

The market for food produce has been flooded since the country has an open door policy to trading with other countries whose markets we also need to access. 

Notably the imported produce is retailing at competitive prices and hence that has opened another insight into our production cost. It’s clear that as a country we are not optimally using our resources in land, capital and agronomy. 

Borrowing form our earlier quoted cases and making an assumption that the entire of the land areas in the three countries is arable our efficiency in land use in agricultural production is below the two countries. India has an area of 3.287 Million Sq Km and a population of 1.4 Billion people translating to almost 0.5 acres per person. Israel has a land area of 20,970 Sq Km and a population of 10 Million translating to 0.5 acres per person. Kenya has an area of 581,309 Sq Km and an estimated population of 45 Million translating to 3.2 Acres per person. India and Israel have made huge strides in Agriculture both in mechanization and production compared to what Kenya achieves. They are food secure and exporting to the world whereas Kenya is not. 

Above 70% of the Kenyan population live in rural areas and as said earlier are engaged in one way or another in agricultural activities. Marketing of food produce is informal for the common food stuff and the high value food produce requiring value addition before going to the market.  

The situation is not bad though. The farmer despite the heavy investment in time, resources and energy the gain is not felt. The middle men in supply chain have been links to the market which have responded to the customer needs. 

An example is the raw milk market, most farmers will prefer to sell their milk to middle men who will supply it to the retailers as opposed to going through an organized farmer association as a marketer. Value addition and packaging will greatly increase the milk price but the infrastructure is lacking. 

How do we revive Agriculture?

The Kenyan farmer is still willing to make agriculture successful however there is need to address several factors affecting the farmer. 

The services adapted to the agriculture production cycle are in need of serious reforms. The supply of quality seeds and related inputs is still a challenge to the farmer. The government subsidizes the cost of fertilizer to the farmers but the supply chain of the same is not functional. Many are the reported media cases of Government fertilizer in the wrong hands. 

There is considerable investment in building dams to collect water that can be used for commercial agriculture in crop and livestock production. The next frontier is to have climate smart agriculture that is not weather reliant so as to create consistency. 

Ensuring that the devolved agriculture functions are felt on the ground. Extension officers to help build the farmers capacity through training and availing related services.

As an incentive to the farmers, the cost of inputs should be subsidize as well to reduce the production cost. 

Legal reforms and legislation needs to be in place to address any legal challenge the farmers or business desirous of engaging in any agriculture value addition business.

Agricultural credit should be looked at. An idea of a farmer’s bank and seeking partnerships will help. The objective being to avail well thought and structured agriculture credit. The current irrigation schemes the Government has engaged in are welcome to produce more food but the small holder farmer should also be facilitated to participate in food production for the country.

Another incentive is in commercialization of agricultural process to boost economic benefits. This will be in aiding the encouraging of value addition to secure more gains to the farmers. The process should be product and people empowerment centered.  

Kenya belongs to a community of nations. We thus have to keep watch of the happenings in the food and agriculture sector. Price volatility on agriculture related products will affect us. There are shifting market power and margins. The world and indeed Kenya population has a growing food need that has to be met. 

Agriculture cuts across boarders in matters trade, environment and development. Food demand and supply is a trade opportunity between countries, through this trade there will be diplomacy and social development and relations between nations. 

Other important agenda’s affected by agriculture is the nation’s population basic need in food and health eating. Agriculture is also a contributor to the energy and environmental sector.

As one of the speakers said, the policies affecting agriculture is an unfinished business, seizing the moment and making the promise of functional agriculture happen is the tough task ahead. We need leave the podiums and boardrooms and get to work.

Kahugu Muiruri

September 17, 2016        

The intricacies of Agriculture financing (Part 1)

I watched with interest as a high profile agriculture forum was happening in Nairobi earlier this month. Most of the speakers were eminent personalities who have worked their way to positions of leadership, business, policy think tanks and political leadership.

When I retreat the narrative that Agriculture is the backbone of our Economy is always present. Many are the developments that are happening in the sector and it is also getting competitive. 

Recent visits by high political leaders from India and Israel to Kenya should be food for thought for us. India is a populous nation 1.4 Billion people and almost 6 times bigger than Kenya my country. 

India’s agriculture is reported to contribute about 14% of the GDP and employs directly or indirectly 50% of the population. India is also an exporter of several agricultural produce. India has mechanized part of its agriculture and largely feeding itself. 

Israel is a fraction in land size compared to my country Kenya, is the largest producer of fresh produce and a leading exporter of agriculture technology.   

Kenya is food reliant, our production is mainly subsistence for food crops. Commercial agriculture and taking shape but is not competitive. One of the cited challenges by farmers is access to markets and capital to fund the farming operations. 

According to 2015 World Bank Data, Agriculture in Kenya is reported our agriculture contributes 31% of the GDP and has two thirds of the population directly or indirectly working in the sector, pointing to a need to innovatively look at the sector to grow it. 

The agriculture forum spoke of opportunities that exist. The production, the entrepreneurial, employment, social political stability, financing business among many others. All the proposals focused to the future. 

Agriculture is evolving. The growth of value addition ventures is on the rise. The growth of towns creating settlements is making new demands for food produce. Agribusiness is being touted as one way to address the high levels of unemployment. 

The Government and any Government has a role to play. The main roles are creating functioning agricultural markets, availing extension services, creating an information source and dissemination system, Legal framework and social protection. 

Israel presents a perfect example that it is possible to change the agriculture sector and profit from it with wise investments irrespective of the odds. India’s case is that despite the numbers proper use of land can provide more than enough. 

To Kenya the Agriculture potential is great. The concern is to seize the moment and make it happen. The undeniable facts are that food security and proper nutrition are issues that will be on our agenda for long. A large number of ailments is coming from unhealthy eating and in some parts of the country there are instances of insufficient food supply and stunted growth in younger population.

The country is spending monies on food imports and hence the need to upscale our production and make savings. There are business establishments focusing on agricultural produce value addition which is proving a viable business. It is thus worth saying that Agriculture is one of the ways to eradicate poverty and can be developed into enterprise. 

Current scenario

Agriculture like any other sector has been changing. Diversification into several crops or sectors is happening, there is an increasing investment being channeled into agribusiness. Farmer associations to market produce still exist despite the challenges though their operations are greatly reduced.

The key to change agriculture is in financing and empowerment through information to the stakeholders in farming. Agriculture as a business also requires right timing, optimal resource employment and management.

Value chains which are associations between farmers and several players involved in production of a particular produce. The essence of forming value chain is to create synergy in the production for the benefit of all the players.

Value chain structuring involves the creation of a support arrangement that facilitates production at the farm level with all players being beneficiaries in the production process. It starts with problem or potential identification, developing solutions for the identified problems and setting up a support arrangement for production. 

Activities will include sourcing for funding, input supply, farm production support, harvesting, value addition, storage and distribution to the market. Of key importance is to realize that just as any business all this comes with risks. 

One of the challenges faced by the sector is volatility of prices, poor agronomy, weather vagaries and yield risks. The mitigation of these risks will largely change production in any value chain.

Understanding the intricacies of agriculture financing, good agronomy practices and market dynamics are the realities that any value chain will have to address.

Most lenders are still developing agricultural based products and have in the past treated agriculture financing like the other products. To effectively handle the financing arrangements the price and cost of production needs to be considered. The cash flow cycle for the financed farmers should be matched with the repayments to reduce the risk of default. Lenders will also take credit life risk insurance and crop insurance to cover for any unforeseen losses. 

Price risk for the produce and yield risks are determinant of the success of a value chain.  Price risk is mostly beyond farmers because of the forces of demand and supply. Yield risk can be addressed by good agronomy practices, obtaining weather, yield or price index based crop insurance. Effective monitoring through the production time is also important in handling yield risk.

Companies involved in trading in agricultural produce are extending their reach to farmers by availing resources to equip farmers with the right capacity. For example companies involved in exporting fresh produce will have their field officers on the ground with contracted farmers to equip them on a continuous basis.

Kahugu Muiruri

September 15, 2016 …. See Part 2

Financial Access and inclusivity, at what cost?

Kenya has been said to have one of the fast progressing financial industry. We pride ourselves as home to a world changing innovation in mobile money an idea that is being studied worldwide and attempts being made to replicate its operations in many economies. 

Recently a world re-known figure the founder of a rapidly growing social and business website facebook Mr. Mark Zuckerberg was in the country to learn about mobile money. 

The mobile money innovation is touted as a way to achieving access to formal financial services to all mainly referred as financial inclusion. Politically inclusion can be said to be democratizing the movement of money. 

Central bank data 2013 indicates that regulated institutions in commercial banks and deposit taking microfinance banks had a total of 17.3 Million deposit accounts and almost 7 million loan accounts. The national population registration bureau indicated that it had issued almost 23 Million Identity cards as at June 2016. The largest mobile phone company reported to have 22 million subscribers as at March 2016.

Assuming that the national identity card is the basic requirement for opening a bank account and registering for a mobile phone number. The banks thus have a huge portion of population to reach out to that is unbanked. 

Financial inclusion comes in form of delivery of mainstream financial services to the target market. Inclusion comes as a package of the financial services targeted at increasing the market size and creating a business case for the market players. The need for financial services as an enabler to economic activities at convenience is vital to economic growth. 

Day to day economic engagements by the citizenry are aimed at creating a benefit for the individuals involved by increasing disposable incomes, accumulate assets and access other services conveniently.

Financial inclusion comes in packages that extend the services offered by financial institutions. 

The innovation is in the mode of delivery. The services packaged are payment services to allow money transfers and payments processing, saving services, credit services extending credit facilities to customers, Risk mitigation and wealth creation tools like insurance and pension packages and digital inclusion where platforms are availed to link services like accessing bank accounts through mobile banking. 

Financial inclusion is a means to an end. The rationale in engaging the service is the convenience and the benefit it offers. The innovation is in adapting the services to the conditions, preferences and context to the lower income market. 

In the Kenyan market, institutions that have engaged in furthering financial inclusion are having a notable social impact and are doing so for profit generation as they serve their customers. Telecoms, Financial institutions and enterprises engaged in solving common basic needs. 

The pricing for set up is high and thus the services extending inclusion comes at a cost. The convenience to which the service extends is the actual cost the consumer has to meet. A payment facilitated through a phone transaction will come at a cost that should otherwise have been incurred to do the conventional payment process. 

Financial institutions vary in their target market. Some have grown from target based institution like farmer cooperatives and building societies to becoming all-inclusive financial services providers.  Modes of deliveries to customers have moved to agencies and mobile phones. Good community banking has delivered inclusivity almost matching what is offered by corporate commercial banking.

Institutions competing for the same services have also partnered to create synergies as they seek to serve and retain their customers. For example a savings cooperative serving employees linked to a single employer say a teacher’s Sacco partnering with a commercial bank to issue Debit cards to the Sacco members to be used on the commercial banks network. Also a Sacco can issue payment instruments like bankers cheques drawn by the partner commercial bank.

The considerations for extending any service is on the innovation in product design and development, the delivery system to be adopted, the institutional business model in customer service all tooled together to reach a wider market.

Financial inclusion aims at trying to provide those with potential for economic growth with the financial tools they need to realize the benefits. It should address the paradox that exist where despite the financial sector deepening and reported economic growth there is a growing inequality. The nation is getting richer and GDP growing but the income gap between the rich and the poor is widening.

At a macro level having observed that the potential of economic growth that will come with financial sector deepening, the need to mainstream it in the law for consumer protection and creating a sustainable development strategy is beckoning.

Our passing of laws to allow agency banking, liberalizing the pension administration, acceptance of innovative products like mobile money have made ours an economy that is said to be financially progressive.

Successful examples are brands like the mobile phone service providers in kenya that have provided platforms for money transfers and credit services through the mobile phone card. The common brands are M-Pesa Orange Money, Equitel, Airtel Money among others.  Banks have adopted agency banking to conveniently reach their customers. KCB Mtaani, Co-op Kwa Jirani are now common in the local estates. Insurance companies are innovating to allow the channels available like Mbao Pension Plan. M-Kopa Solar that is allowing rural household access solar panel and accessories and pay for them over a period of time is also a form of service delivery to a section of the population that is disadvantaged.

From the common adopted definition, Financial inclusion is delivery of financial services at an affordable cost to the disadvantaged section of the economy. Institutions engaged in innovation to reach their customers do make heavy capital investments on top of running costs to have the services running efficiently.

They engage in the outreach for profit. Outreach comes with its own risks to be mitigated. Efficient delivery is what will largely determine the product acceptance in the market.

There is a business case for focusing on the inclusion services. Mobile phone service providers have reported growing profits from their services in financial inclusion. Agent banking also comes at a premium to the consumers. Mobile phone credit services have some of the highest premiums attached to them.

The products in the market have seen access of credit services available at the touch of a button via a mobile phone as long as one is of verifiable good credit history and has maintained regular money transfer service with the mobile service provider. Payments for utilities are easier to make through till numbers registered to the mobile money networks. Savings and bank transactions can are also accessible through mobile networks too.

With access convenience there are many jobs that have been created, transactions made safely and conveniently and savings mobilized. However the next frontier that needs attention is the financial literacy that the consumers have their responsibilities as well.

In the spirit of consumer protection there is need to explore ways of having the charges levied for the services looked at. The undeniable fact is that the convenience has come at a high cost.

Kahugu Muiruri

September 9, 2016

The credit processes and the interest rates debate – my thoughts

A number of banks in commercial business state in their objects that they intend to add value to their shareholders by serving the needs of the communities. The community needs can be transactional or growth intended.  The growth need requirement comes in the form of banks’ lending to commercial interests as one investment of the shareholder funds. 

Banks support all sectors in the economy since their clientele are engaged in the different economic sectors. Banks play an intermediary role in spurring growth in the economy by pooling resources and extending the same to established commercial interests for a profit to spur growth. 

In some markets Kenya being one, banking business is largely regulated by a Central Bank but there are other businesses that deal in lending which are unregulated. Banks soliciting deposits from the public are by law required to obtain business licenses from the Central Bank and regularly report to the Central Bank on their operations.   

Kenya has a financial market that has grown from the commercial banking model to adoption of innovative technology where mobile phones are not only channels of delivery but offer access to financial services. The unregulated market is large and no known data Is available into the size of its business. 

One of the investments available (among many) to the banks is matching the liability book they are holding. Customer deposits are liabilities, is to lend on a sound collectible basis. The investments (Loans among others) should earn some profit for the banks to compensate for the cost of funds. Deposits come at a cost (handling and interest to the depositors) 

The market place is competitive and in every business there are challenges which banks call risks. For example the occurrence of an expected or unexpected that may affect the borrower and thus risking the bank’s capital (borrowed monies) and earnings (interest earning from the loan). 

By the bank extending credit to a customer it’s exposing itself to all the risks faced by the borrower. It is thus imperative for the bank to evaluate all the risks and the interrelationships to its business.

Credit risk is a wide topic in banks and a delicate one that requires careful evaluation to determine the risk acceptance criteria. To best underwrite quality assets in lending, it is imperative for every bank to have in its employ competent staff who understand the loans appraisals, risk identification and mitigation and who are effective in monitoring processes. Sound lending calls for efficient processes in appraisal, structuring, approval and monitoring of every extended facility.

Every credit facility has a number of risks associated with it. The prominent risk is repayment risk, to counter this the banks take collateral as a fall back plan in a worst case. Collaterals vary from charged properties, joint motor vehicle ownership, Cash collaterals, Asset hypothecation among others. 

Another risk associated with lending is the interest rate risk. This is the pricing of the loans asset. This is the return earned from the capital extended, this is determined by the maturities and the cost of funds. Interest income is one of the income streams for the lending bank. High rates are unattractive to the market and even risky for a portfolio. 

Pricing risk considers the cost of funds, risk profile of the borrower and a profit margin for the business bank. Effective processes affects the bank’s profitability and reputation thus avoiding reputation risk and thus better positioning in the market. 

Credit is extended for a long period of time requires a thorough understanding of the credit culture, values, beliefs and behaviour. The credit culture will determine its credit risk management and profile.  

Money being a risky stock to handle, the risk acceptance and reward for extended credit becomes a factor to consider before lending. Fully secured credit facilities will earn less than the unsecured facilities. The banks have clear policy on loan process handling. This covers areas touching on appraisal process, approval limits and process, analysis requirement, documentation, collateral coverage, pricing, monitoring and reporting and a general code of ethics.

Behind the scenes credit administration and monitoring is the core to creating a credit culture that defines the credit business.  Portfolio segmentation, diversification, risk concentration, stress testing, policy administration, asset review and process review remain technical terms for a further date review. 

Another investment channel for banks is lending monies to the Government. The Government budget in most countries goes into a deficit that is met through going to the market to raise funds to meet budget needs. 

Simple economics teach us that we should borrow for investments and not consumption. This is premised on the fact that the investment will spur more income generation and hence create repayment ability and the same (should) apply to Government. 

Government borrowing is done through selling government papers short term or long term. The government papers are treated as risk free on the assumption that the Government cannot default. The papers are sold through the central bank at a determined rate. The administration of which is at very minimal cost for a commercial bank. 

Procedurally, banks in Kenya investing in government papers assist in their reporting compliance. Banks with risk free assets are treated as stable.  The process of selling or buying Government papers is called open market operation and aims at controlling the volume of monies available in the economy.

   

Central banks also influence the interest rate by setting a minimum rate at which the banks can borrow from the central bank for onward trading with their customers. This however does not influence the rate at which the bank will advance credit to its customers in the various sectors in the economy. The central banks however lack the tools to enforce the rates to a desired level. Theirs is just a policy rate. In kenya it’s the central bank rate. 

Government papers should not offer better returns so as to allow the banks concentrate on lending to the economy where growth and employment is generated. Fiscal discipline and integrity needs to be maintained in Government so that the monies spent can have a larger distribution and impact back to the economy. Anything that affects the value of Government spending only worsens the economy and hence the ultimate value of the spent resources.

Kenya Credit market pricing 

The Kenyan market has seen rates vary depending on products and lenders. Informal lenders are reported to charge as high as 100% per annum while commercial banks have had their rates lower than that. Historically the interest rates in the country have remained unpredictable and unregulated.

The last few years have however seen attempts to control the interest rates. 

In year 2000, a banking amendment act was passed by parliament and assented to by the president to become law. The act sought to cap bank lending rates at 4% above the prevailing Treasury Bill rate and as the law required then it had an effective date.  By the time the bill was assented to by the president the effective date had lapsed and that meant the banks had to re-write their loan contracts and review the interest rates for the same. 

The bankers contested that and the high court held that the bill was unconstitutional in the sense that it was operating in retrospect.  That essentially killed the bill.

In 2007 the in-duplum rule was passed and affirmed by courts that a defaulted loan earnings are capped at a 100%. Essentially the interest and fees charged should not exceed the principal amount. The limit of interest to be recovered of a defaulted loan was capped. However this was no panacea to high interest rates since most of the loan accounts are short term loans with most borrowers being business entities with regular need for working capital. 

In 2014 Kenya bankers reference rate KBRR was introduced to further make disclosures on the cost of lending.  KBRR requires the bank to add a premium “K” and disclose the same. The lending rate thus is KBRR+K where K will contain the cost of funds, risk profile margin, administrative cost and the profit margin. 

Of key importance is the understanding of the consumer behavior in regards to income generation and expenditure. Kenya has poverty levels of almost 50% of the population. We define the poor as the persons living below a dollar a day though that has been revised to those living below a dollar a day. Unemployment rate is at 45% thus compounding the already not so good outlook. 

Surveys place the basic needs as a priority to the population. Food, clothing, education, healthcare and security are priority needs to the general population. These are the areas that the population spends monies on and hence have no savings. The absence of a good education system, a frail healthcare system and food production cost on the increase the mobilization of savings by banks from the populace has remained unpromising. 

The country is a net importer, our industrial output is low and hence no tangible employment is happening in the economy. Our Agriculture is facing stiff competition from the trade partners and our production costs are on the rise. This coupled with the lack of value addition for our farm produce is exposing our little resources at the consumption level. The general population has little to save. 

General cost of funds (Deposits) as at June 2016 placed the average cost of funds at 7%. The average earning for Government papers at 10% and average lending rate at 18%. There is however a general increase in default rate and the non-performing loan portfolio is on the increase. Regulated banks provide reserves which are passed as expenses for loans which become delinquent.  Thus the general performance for of loans has a direct impact on the earnings of the lending institutions. 

At a public level, we are running at deficit every year. Our recurrent expenditures have increased exponentially, our discipline in handling our public resources is wanting and thus we are not getting value for the constrained resources we have. The Government is bridging these gaps by domestic borrowing. The cost of Government borrowing in the long term papers has averaged 12%-14% in 2016. 

The recent introduction of a banking amendment law capping the bank’s lending rates at 4% above the Central Bank Rate presents a complex scenario.  It makes the cost of borrowing predictable and it brings relief to the borrower who was paying higher premiums. However there is a flip to this. 

Banking, being the players actively participating in government papers is both a risk taking and profit making business. Bank investments should return earnings commensurate with their risks. The timing is tricky with the country going into an elections year. Already banks have started shoring up their investments in Government papers in the reported results for the first half of 2016. And this year alone the government would be looking for funds to cover an almost 20% deficit. 

A day after capping the commercial rates at 14.5% the Government traded a paper at 15%. Where will you put your monies profitably?

Kahugu Muiruri

 September 2, 2016