Agricultural Market Systems Failure May Lead to Low Demand for Financial Services by Smallholder Farmers

Mar 14, 2016 | All, Digital Financial Services, Market Access

fAn agricultural market system includes the full range of products, services, and relationships such as access to finance, inputs, information, formal and informal rules, policies and logistics, buyers, and so on. These products and services work together more or less based on demand and determine the interaction between smallholder farmers and the end market. Where the interactions do not function well resulting in lack of information, poor infrastructure, limited access to financial and other services, and high cost of access indicates that the market system has failed and will not benefit the smallholder farmer.

Financial services are a very important aspect of any agricultural market system, but unmet demand is significant. Dalberg Consulting, a leading global development consulting company reports that globally there is an unmet demand of credit amounting to $450b required by smallholder farmers with lenders only servicing 2% of this demand.

In Kenya, there is a low supply of financial services, especially credit in Kenya’s agricultural sector. Tegemeo Institute, a Kenyan policy research organization, states that only 10% of smallholder farmers have access to formal credit with women farmers receiving less than 5%. And AFA’s 2015 Farmer Benchmark Study found that only 28% of farmers said they were currently servicing a loan from any source, formal or informal, and for multiple purposes.

Farmers said they were averse to credit and preferred savings, such as MPESA or on Mshwari, and sought remittances from social networks to manage their cash flow.

One farmer in a focus group discussion also said,

‘We have the money lenders and micro-finance that are illegitimate whose main aim is to steal from the common man. It is through such experience that have made many people to shy away from taking loans.’

During AFA’s human-centered design fieldwork farmers spoke of their aversion to bank credit too. One such farmer is Noami Njoki a poultry and dairy farmer from Maragwa area, Muranga County in Kenya.

‘I can never ever take a bank loan,’ she says emphatically. ‘Bank loans will sink you,’ she adds.

Anne Bett, a dairy farmer in Nandi County Kenya narrated how a microfinance bank repossessed dairy cows from a villager who was unable to repay a loan.

‘That family is now doing very badly. They took the best cows and without mercy, sold them to fellow villagers’, she explains. ‘I can never take a loan. A big bank recently offered me $2000 a while ago which I declined,’ she adds.

Research has established that farmers were borrowing from informal and certain formal sources but not necessarily to invest in farming. Just what did they borrow for? Tegemeo Institute reported that farmers borrowed for pay school fees, for medical care, for consumption, to buy assets, and invest in business outside farming. Mercy Corps AgriFin Accelerate program’s Farmer Benchmark Study for Kenya confirmed that smallholder farmers borrowed to pay school fees, but also to purchase assets such as improved cattle and small equipment, pay for certain categories of inputs e.g. fertilizer and improved seed for valued crops such as maize.

Mary Njoki, a dairy farmer from Ndumberi in Kiambu County borrowed from a microfinance bank to pay university fees for her son.

‘I want my son to succeed and get a job elsewhere. That is why I struggle with loans to ensure he gets a good education’.

She repays the loan through the sale of milk and trading in vegetables.

It is noteworthy that commercial farmers (small and medium-size) especially those in poultry and horticulture do borrow from formal institutions. However, Financial Access, an agricultural financial advisory company reports that banks view agriculture to be risky and compensate through high-interest rates which make loans beyond the reach of many farmers.

Those farmers in more formalized value chains preferred delayed payments where they would pick inputs from their cooperatives and pay from the proceeds of commodity delivered. This was especially prevalent among dairy farmers. Kenyan Dairy Farmers explained to Mercy Corps that they preferred borrowing from their SACCOs and Cooperatives because the SACCO accepts to delay payments when a cow is sick, production reduces, or dies. Other financial institutions would not be so understanding. However, the problem with informal or semi-formal sources of finance is that they are inadequate to meet farmer requirements, but could help meet other household needs that still could hurt the farm. Mercy Corps established that the SACCOs owned by dairy Cooperatives extended credit depending on the level of milk delivered by a farmer. There is little room to finance potential or to boost production. In addition, the SACCOs could only meet about 30% of credit demand by farmers.

The need for farmers to be in more structured markets that pay a fair price is emphasized by Tegemeo Institute. In a review of the status of Rural Finance in Kenya, Tegemeo states that the supply of agricultural credit is dominated by commodity-based off-takers (processors, agents, and cooperatives) who promote Tea, Sugarcane, and Coffee, dairy and horticultural crops. These value chains have one thing in common. They are relatively structured and farmers have a predetermined market and price which makes digital or non-digital value chain financing possible.

The current situation somewhat portrays a scenario where there is limited financing for agriculture on one hand and on the other hand farmers do not want to borrow to invest in their farming.

Is this reality?

Interestingly, Ineke Bussemaker, the CEO of National Microfinance Bank (NMB, the largest in Tanzania) disagrees.

‘I (NMB) have more money than SHFs to lend to. Even if the money I have is not enough, there are partners willing to provide financing to enable us lend’, she said during a panel discussion at the annual SACGOT stakeholder forum in Dar es Salaam Tanzania.

Although smallholder farmers face many challenges such as high-interest rates, lack of collateral to secure loans, lack of information, and so on, no challenge, however, has a more profound impact on smallholder farmer’s ability to invest in their farming than market failure.

Market failure takes various forms. The most important is market access. Market access is one of the biggest challenges facing smallholder farmers in Kenya. Most value chains are largely unstructured and the produce is sold at the farm gate and delivered to market through a chain of middlemen. As such, farmers often get a fraction of the end market price which is normally below the production cost or at very small margins, with the middlemen benefitting most from the agricultural trade. When farming does not pay sufficiently there is no motivation to invest. Bussemaker said that she believed that if farmers had consistent and predictable markets it would make it easier to unlock lending from banks and other financial institutions.

Many market interventions provide market information such as market prices and market opportunities. It is usually expected that awareness of end-market prices will help farmers bargain with middlemen. However, the reality is often that knowing terminal market prices is not enough to transform farmers’ livelihoods. They need to sell their produce as close to the end market as possible and reduce the length of value chains to increase their incomes. In order to do this, farmers will essentially need to deliver commodities to markets and require transport. Transportation is usually one of the biggest expenses to get produce to market and is difficult for SHF to own or access affordably.

Typically agricultural produce comes to the market at the same time resulting in oversupply and a drastic drop in prices. Agricultural produce is highly perishable and farmers are forced to sell immediately. The poor state of roads and lack of technologies for storage or value addition means that farmers cannot delay sales to wait for prices to improve. When prices crash or become unstable and unpredictable, farmers cannot afford to repay credit.

Another major market failure is that many financial institutions do not understand farmers and farming cycles. Most of these institutions use traditional lending models and expect farmers to start repaying loans immediately. How does one expect a farmer to start repaying a loan immediately when his pigs will be ready for the market after 6 months? It simply implies that only farmers with other more formal and regular incomes such as those earning a salary can borrow.

Policy issues also contribute to market failure. One of the biggest sources of market distortion and uncertainty is the importation of produce particularly from countries that are highly subsidized or where the cost of production is much lower. This is so, especially for sugar, maize, wheat, and rice. This reduces the ability of local farmers to profitably and consistently sell their produce and therefore discourages borrowing.

Development agents such as Kenya Markets Trust and commodity organizations such as The Eastern African Grain Council are advocating with the government for more conducive policies.

The above market dynamics make it risky for the farmers to borrow and for financial institutions to lend. The relationship between markets that work for smallholders and their impact on access to agricultural financing is mutually inclusive. This means that the uptake of financial services of every kind will depend on how consistently farmers sell and get paid for their produce. An efficient market system is an engine that drives value chains and all the associated products and services and in particular the demand for financial services.

The AgriFin Accelerate program recognizes that markets that work for the poor are important to stimulate and accelerate the uptake of financial services. The program is working with relevant partners to ensure that farmers are as much as possible, linked to the community, domestic and international markets.


Lucy Kioko. Agriculture Manager AgriFin Accelerate Program, Mercy Corps.

AgriFin Accelerate is a program implemented by Mercy Corps and supported by the MasterCard Foundation and aims to increase access to digital financial and informational services for one million farmers in Kenya, Tanzania, and Zambia over the next six years. The program will also work towards increasing the volume and velocity of electronic payments, bundled with information services.