The middle-man we need: How intermediation in the philanthropic and capital market can unlock finance for smallholders

Agriculture or Food
22. Jun 2016

When we think about expanding access to finance for smallholder farmers, we often think about the direct transaction between a financial service provider (FSP) and farmer or agro-enterprise. But of course, this interaction is not the only one that matters; the philanthropic and capital markets from which FSPs receive funds are just as critical in achieving the ultimate goal of expanding smallholder access to finance.

Over three years of research into different aspects of farmer financing, including our recent report titled Inflection Point, our team at the Initiative for Smallholder Finance (ISF) has grown to understand the critical need for an intermediary role between capital providers and FSPs – and we have transformed our own organization to support that role.

ISF’s initial mandate was to act as a design-catalyst, focusing on targeted industry research, product/service development, and partnership formation to expand models of financial service provision for smallholders. Now, our research and experience in the field has shown us the need – and opportunity – for us to shift toward intermediating and advising blended finance structures at the level of philanthropic and capital markets.

So what does this all really mean? We are interested in the level of philanthropic and capital providers, which can include industry players such as development finance institutions (DFIs), governments, foundations, private investors, and impact investors. Blended finance is the use of grant and concessional funding to mobilize private capital and make investments more financially viable. We help structure partnerships and blended finance facilities to increase the flow of capital to FSPs such as local banks, microfinance institutions, social lenders, and certain NGOs, which then serve smallholder farmers (see chart below).

Why is this new role important?

The Inflection Point report calls for a substantive shift in the level of coordination in the farmer finance industry and challenges stakeholders to rally around the goal of doubling annual growth from roughly 7 per cent to 14 per cent in order to meet more than half the need for smallholder financing by 2025. The research – which drew on interviews from nearly 80 different organizations – highlighted the need for this intermediary role that enables FSPs to access the capital they need to increase lending to smallholders.

Building on this research, we’ve shifted our approach at ISF to prioritise filling gaps where we are best positioned to do so:

  1. Intermediating at the level of philanthropic and capital markets. We are helping create partnerships and financial structures that allow money to flow more easily from philanthropic and capital markets to FSPs, so they can ultimately better serve smallholders. In frontier markets, actors frequently lack the capacity, dedicated resources, or relative incentive to focus on the development of new financial structures until there is a refined business concept, an engaged set of investors, and local partners interested in moving forward. The ISF helps shape these early stage opportunities, bringing them to the point at which the principals involved, and the supporting cast frequently engaged, have the incentive to execute the investment.
  2. Continuing to support the evolution of a global conversation around smallholder finance. The ISF provides a structured forum for the donor and investor community to share programmatic activity, interests and intent while respecting the varied mandates of the individual organizations. Beyond the funder community, we facilitate market actors working in related markets on a pre-competitive basis in order to improve transparency and establish standards. For example, the ISF has been a partner for several years with the Council on Smallholder Agricultural Finance, a pre-competitive alliance of social lenders.
  3. Selectively using research to support partnerships and financial structures. We continue to publish industry research, with a focus on documenting specific past transactions or forward-looking opportunities – for example, we recently released research on the application of big data in smallholder finance and how to unlock local currency lending through foreign exchange risk management.

We’re not the only ones who have recognized the importance of an intermediation role to unlock blended financing. The development community has recognized that structuring blended finance requires a patient and flexible approach, given the associated complexity and risk. A few comparable and complementary examples include:

  • Convergence is a blended finance platform to connect private, public, and philanthropic investors; it also offers grant funding to design blended instruments or products
  • NatureVest, sponsored by JP Morgan Chase, uses a similar approach and team structure to the ISF, but focuses primarily on conservation
  • IDB InfraFund supports the identification and design of bankable infrastructure projects that involve blended sources of finance

What’s working so far? Lessons for others aiming to play this role

In our transition to an intermediation role, we’ve found a few key components to be critical, and hope these lessons will inform others trying to play a similar role in other sectors:

  1. Connect with all the major players. We have a diverse steering and advisory committee consisting of influential funders and practitioners in the space, from donors such as USAID, the Small Foundation, and the Bill and Melinda Gates Foundation to FSPs and practitioners like Root Capital, One Acre Fund, and IDH. We maintain active communication with over 100 collaborators, and we share our industry learnings with a contact list of over 1000 practitioners. To make meaningful impact, we have found it critical to retain a large active network that can provide input on our efforts and benefit from our support around building partnerships and financial structures.
  2. Develop deep sector knowledge and define specific needs. We spent three years building a strong evidence base for the sector, and we continue to regularly publish executive briefings about critical issues the industry is facing. We use this research to not only inform our own endeavours, but also to help guide practitioners and funders in their strategies. As we transitioned from a research-focused role to an intermediation role, we built a partnership with the Rural and Agricultural Finance Learning Lab, where we publish our research and share our data.
  3. Build commitment. Our steering committee recognises the importance of our intermediation role to push the market forward, and they work flexibly with us, allowing us to collaboratively determine the most effective agenda and align resources accordingly. This flexibility frees us to play the intermediary role based on where we see market gaps and opportunities, thus avoiding typical barriers of more structured project-based grants.
  4. Staff the right team. We've crafted a team consisting of a mix of i.) well-connected and knowledgeable sector experts with strong strategy and facilitation skills, and ii.) experienced finance professionals who know how to design and structure complex blended finance facilities. The combination of these two skillsets on our team has been essential to our success in flexibly responding to complex intermediation needs.

Looking ahead

Moving forward, we are committed to helping the industry accelerate from a 7 per cent growth rate to 14 per cent in order to close the financing gap in partnership with others. We need the concerted efforts of financial service providers and other actors to engage closely with customers to design and offer appropriate, desirable products through integrated partnerships, supported by more and smarter subsidy. The ISF looks forward to playing our role in closing the gap in smallholder finance and we hope that you’ll join us.

This blog is part of the July 2016 series from the Practitioner Hub and Seas of Change on Inclusive Agribusiness. Download the PDF for more insight, updates and opinion.