About Producer Financing

The Need for Producer Financing
As markets for sustainable agricultural products grow, the availability of finance tools has demonstrated itself as a key factor in determining the overall sustainability of producer participation. In addition to the traditional need for pre-harvest finance faced by many small producers, participation in sustainable supply chains requires additional administrative, training and transition costs which existing producers' capital bases typically cannot cover. Meanwhile, the majority of small-scale rural enterprises are typically too poor and under-capitalized to be regarded as bankable by local financial institutions. The only local credit sources are often local merchants who double as moneylenders, and who may charge unreasonably high monthly interest rates. Known in many parts of Latin America as "coyotes" because of their exploitative practices, these intermediaries use the scarcity of credit and geographical isolation to secure products at extremely low prices. The cycle of poverty worsens and environmental degradation continues in the absence of viable economic alternatives to unsustainable land uses such as slash-and-burn agriculture, unregulated logging, and cattle ranching.

Current State of Producer Financing
Socially oriented lenders is a term that relates to both European and North American lenders and local commercial banks and credit institutions across the developing world that have made explicit commitments to work with SSME producer groups to fill the financing gap. Unfortunately, the availability of producer trade finance has not kept pace with the growth of sustainability initiatives. Commercial lenders often lack commitment to finance and the capacity to perform due diligence activities with cooperative producers in developing countries. Meanwhile, specialized financial intermediaries that have the mandate to support sustainable producers still have limited financial resources. There is a growing sector of "socially oriented" lenders entering the field to fill the credit gap, but their efforts to date have remained fragmented, uncoordinated and inadequate to meet demand.

Existing research on the finance of sustainable trade in North America and Europe suggests that one of the principle barriers to the expansion of access to finance for SSME producers is the perceived risk and the transaction costs associated with dealing with such producers. Another major barrier stems from the high level of exposure to market and climatic volatility which small producers face. While there is anecdotal evidence that the adoption of better management practices associated with sustainability standards can lead to improved and more stable output and more stable trade relationships, the absence of documented evidence keeps farmers from being able to leverage their participation in a sustainability scheme for better financing terms. Notwithstanding any risk-reducing characteristics which standards compliance may bring, small farmers nevertheless tend to remain highly exposed to volatile market conditions of the international commodity markets. Despite the existence of a wide range of specific financial instruments for reducing risk among traders in the agricultural supply chains, farmers typically have neither the infrastructure nor capital necessary to benefit from the advantages of reduced risk which such instruments can provide.

The primary finance needs of sustainable trade producer groups revolve around trade credit lending (pre-harvest/pre-production and export credit) and longer term lending for infrastructure investment. Both of these types of lending are of vital importance to the sustainability and growth of producer groups.

• Pre-harvest finance is used to support individual farmers, often members of cooperative organizations, with loans that act as pre-harvest incomes. This enables farmers to invest in their harvest production as well as manage their day-to-day existence including meeting their family's educational and health requirements. Non-agricultural producers similarly require finance to fund the purchase of raw materials. The use of pre-harvest finance overcomes the problem of farmers being compelled to pre-sell their crops to intermediaries, due to their need for pre-harvest cash. Most local commercial banks will not provide cooperative organizations with pre-harvest finance due to the lack of security in crops which have not yet been harvested.
   
• Trade credit / export credit is required by all types of producer groups, both agricultural and non-agricultural, to fund the period between purchase of the goods from members and the receipt of payment from buyers once the items are received. Both commercial and socially oriented lenders are active in this market; however, many commercial buyers will insist on unrealistically high interest rates and hefty securitization, and will often only advance a limited amount of finance against the total value of the goods.
   
• Term lending is essential for most producer groups but incredibly hard to access at affordable rates. Term lending is most commonly used to fund improvements to infrastructure which can radically improve the quality and quantity of an enterprise's production. However local commercial lenders are often reluctant to lend long-term to producer organizations, especially those that are operated on non-traditional cooperative / membership association models. However, term lending can be transformational allowing an organization to rapidly expand and increase their social impact.

Where there is local commercial provision of finance to sustainable producer groups the costs of lending can vary considerably, depending upon their location, size and financial situation. Cooperative producer groups can often be quoted rates that are economically crippling. This costly lending reduces the profitability of the enterprise and hence the value added to individual farmers, and prevents expansion by pricing since investment becomes more difficult.

An explicit goal of all socially focused lenders is to challenge high interest rates that are predicated on the illusion that sustainable producer groups are inherently riskier than less sustainable concerns. By lending to producer groups and experiencing low levels of lending defaults, many of the socially focused lenders have been able to prove to local commercial lenders that lending to cooperative producer groups is profitable and makes good business sense.