Smallholder farms require capital to operate and grow. The most common capital requirement for Asian farms is to cover the cost of inputs such as fertilizers and crop protection products. Although traditional, localized lending models currently dominate the market, digital platforms may enhance loan repayment rates and opportunities for formal lenders.
Today, farmers are presented with two main sources of finance to cover these costs: the retailer who sells them the product, or the trader who will buy their crop at the end of the season. These “village level” funding options are usually expensive, often charging 10% interest per month.
These high interest rates reflect both a high level of inherent risk, but also the reality that village-level lenders have a number of advantages over formal lenders:
It is cheaper for them to acquire lenders. Banks struggle to sell smallholder loan products because the customers are expensive to reach.
They have insights the banks don’t on each farmer’s credit worthiness.
They don’t need to comply with the same Know Your Customer (KYC) requirements as a bank; and
They ask the farmer for less paperwork.
Due to the advantages to both farmers and village-level lenders, the smallholder farmer segment has remained hard to reach for formal lenders. This leaves farmers with few options and drives high interest rates. Formalizing loans to farmers could offer compelling, desirable returns to lenders and lower interest rates for farmers.
A range of digital solutions are emerging which solve one or more of these challenges. Digital lending solutions can help address all four limitations, which are: lowering the cost of acquisition, helping to gather data on the farms, reducing the cost of the KYC process, and reducing paperwork required.
At the forefront of this digital transformation are the Peer to Peer (P2P) lending platforms. P2P platforms emerged as a means of allowing urban professionals (often in capital cities) to tap into the high interest rate market for loans to farmers in rural areas. The motivations of urban lenders vary from seeking a higher return than other assets, to a philanthropic motivation to help farmers succeed. Investments are typically small - a few hundred dollars per farmer - but lenders often provide loans to dozens of farmers.
Loans are typically made at the start of the cropping season and repaid a few months later. Short cycle crops that generate strong returns are ideal; including chili, vegetables and corn.
P2P lending is growing quite quickly, with leading solutions in both the Philippines and Indonesia seeing double digit growth annually.
 Know your customer is the process of a business verifying the identity of its clients and assessing their suitability, along with the potential risks of illegal intentions towards the business relationship.
However, the pool of potential lenders in a P2P model is limited compared to the size of the market for loans. As a result, P2P lending platforms are changing over time, packaging up larger portfolios of loans from their platform to be securitized at scale by financial institutions. It is at this point that digital lending to smallholders is likely to expand much more rapidly. However, for now, the P2P model allows the platforms to continue to improve their acquisition processes and credit scoring algorithms. Once developed, these two capabilities (low cost acquisition and sound scoring model) will unlock portfolio investments, and much faster growth.
The P2P lending model is quite simple. The platform matches a farmer with a lender and charges the farmer a higher rate than it pays to the lender. On a loan size of $1,000 (over three months) a platform can earn $60 based on a 5% interest rate markup. The platform normally carries the cost of non-performing loans, so accurate scoring is critical to ensuring this margin is not lost to bad loan decisions. Most platforms provide the loans as vouchers for inputs, rather than cash, which improves repayment rates.
While P2P lending is growing quickly, in order to reach scale and move from a peer lender to a portfolio securitization model, two key challenges need to be addressed:
The regulatory environment for P2P is uncertain, and the unscrupulous practices of one or two lenders could put the whole industry in jeopardy.
Pricing the loans, and correctly setting rates remains a challenge for platforms; it can take years to gather enough data to price accurately.
Of the six models covered in this series, P2P stands out for its strong underlying profitability because smallholder farmers are valuable lending customers. While the other models in the series rely on data sales or subscriptions, which typically net only a few dollars per season per farmer, this model generates the highest lifetime value from each farmer client.
Digital lending is likely to grow quickly, opening a new market for financial institutions and reducing loan costs for farmers. The diagram below highlights the key competitive pressures on P2P lenders.
Comment from Yohanes, CEO at Crowde.co
"From my perspective as someone who works in this field on adaily basis, the article is very much well-explained and easy to understand especially to those who know little to none about the problems that P2P lending platforms are tackling. Smallholder farmers are exposed to a million problems and we see that access to alternative financing matters is a big problem in the beginning. When they gain access to the right financing, they are going to face more advanced challenges such as how to market their product/produce, how to get access to the market, and how to use technological innovation for growing their business.
What I hope is covered more in the article is what it takes for farmers to get a loan to start their business. Sometimes it costs their life because the village-level system has been inherited from generation to generation and it instills a belief in their minds that it's difficult to start and has always been that difficult. It is either giving up or giving it all out that cost lives.
The output of the P2P is not only can we channel an alternative investment portfolio for urban people in the agriculture sector, but also to fuel a traditional agri-ecosystem to change so data can be gathered for a better agri-decision, save lives, and feed the world better."
Comment from John, Director of Makana Ventures
"The evolution of digital lending platforms is particularly exciting for the agriculture industry due to the constant need for working capital among smallholder farmers, and the ability for technology to expand across a broader geographical reach.
As the article suggests, developing a robust credit scoring metric is arguably the most important
feature if a lending platform is to ensure the success of its business model, digital or otherwise. In the case of agri-lending, this could be assisted through engagement with local farming
communities, partnerships with coops, corporate suppliers etc. At the same time these
community partnerships are beneficial for the expansion of the platform’s user-base, which is
ultimately critical for growth.
Another important aspect to consider is how to manage the collection-end of the loan, which has
to do with monetizing the crop production. Several existing companies offer a digital take on the traditional “village” model of lending to farmers who then guarantee their crop sale through the
same platform. While this digitally integrated lending and off take solution has its benefits, in my
mind it still prevents the farmer from gaining full access to the broader market and potentially
better prices for their produce.
As with any P2P lending there is the question of who bears the burden of non-payment, the platform or lender? Crop loss due to disease or natural disaster make NPL risk in agri-lending that much more unpredictable. These considerations should be clearly articulated and need not be borne entirely by the lending platform, especially when institutional financing is involved.
Ultimately, I see the advent of digital lending platforms as an important evolution to traditional
agri-financing solutions. The combination of industry sector and business model makes P2P
lending in agriculture an exciting prospect for both traditional finance-focused investors as well as those with a more impact-driven mandate, assuming the factors discussed above are well thought out."