Risk has been part of life since time immemorial. Even before the dawn of modern banking, risk could not be separated from human survival opportunities such as hunting and gathering food. African forests teemed with dangerous animals, rendering hunting a risky adventure. One would spend a whole day or an entire week without catching game meat and that meant loss of time which could have been used in alternative ways such as fishing. Risks and opportunities are always competing just as success and failure compete in business. Today, risks are associated with unforeseen factors and uncertainties such as climate change that are outside human control. However, human beings continue to build their capacity to reduce or mitigate some of the risks through reliable experiences and information.
Balancing risks and opportunities in the agriculture sector
Like any other business, farming is a risky business characterised by the good and the bad. The main reason farmers and other value chain actors continue with agriculture is because the bad is often outweighed by the good. To the extent that the weather, climate and markets are not always predictable, farmers and traders get into agribusiness fully aware that possibilities of success and failure are unknown. Should they stop investing in agribusiness because of unknown risks? In most African countries, when farmers and traders decide to get into agriculture as a business, they will have cushioned themselves against bigger portions of the risk. Investing years into learning the tricks of agriculture is a key part of absorbing risk.
Some farmers and traders invest all their pension and remittances in pursuit of agriculture in order to identify wealth creation opportunities. At an individual level, a farmer makes a conscious decision to put all his life savings into the agricultural experience. On the basis of such investment and experience, the farmer will become confident of approaching a bank for a loan. Farmers and traders who approach banks for loans will have gained valuable experience and can clearly see opportunities with high probability of success.
Who is competent to assess agricultural risk?
Somebody who has spent more than 10 years in a particular agricultural enterprise or someone with two years office experience in assessing risks through reading proposals that come to his / her desk? How much business experience, intuitions and nuances can be fully expressed through business proposals which are currently used by risk assessors to either accept or reject a business case? To what extent is the person who assesses risks in a bank an all-rounder in terms of expertise? There may be more than 30 business proposals from diverse fields like engineering, trading, exporting and agriculture. How reliable is one template in assessing risk?
The combined experience of those applying for bank loans could be more than 100 years. By rejecting most of these applications on the basis of the same risk assessment blue prints, most African financial institutions are killing a lot of business ideas and potential solutions that could contribute to national economic development. Foreign Direct Investment (FDI) may not bring better solutions in the form of reliable and sustainable business ideas that are abundant in local people.
Need for dynamic risk assessment toolkits
New hybrid African economies characterised by a growing informal sector alongside a stagnant formal sector, compel financial institutions to continuously revisit their risk assessment toolkits. For instance, while a formal company may produce export receipts, most SMEs may not be able to bring documentary proof of their more than 12 year business enterprise. A trader in the informal sector can save more than 100 customers a day and generate more sales than a formal company but lack documentary proof of all those transactions. Is that enough basis to consider that trader high risk?
Rather than assess the risk profile of an individual trader, financial institutions should assess and determine the risk profile of an entire industry such as Agriculture, Clothing, Mining, etc. Such a holistic assessment will enable crafting of specific business models that minimize risk for the entire industry or sector. Such assessments presuppose financial institutions have robust data and evidence on the industry or sector. In most African countries such data and evidence is missing. In the agriculture sector, financial institutions should know the performance of agricultural commodities in informal markets which currently absorb more than 70% of diverse commodities, for instance in Zimbabwe.
Through informal markets, financial institutions can be able to reach more smallholder farmers who constitute more than 70% of a potential clientele base. Robust evidence should be part of every risk assessment toolbox from individual value chain actor, sector and policy levels. It is the market that gives you the rate of investment. Without identifying and analyzing market evidence, it is difficult to see an investment opportunity. The rate of investment comes from looking at price trends, actors, demand & supply trends, standards & specifications, consumption patterns, seasonality and whole market dynamics.
Minimizing fragmented socio-economic perspectives
Due to the current mismatch between formal risk assessment tools and economic realities in the hybrid economy, most African countries have an informal economy that is fully aware of its opportunities and potential on one side and outsiders such as financial institutions who think this sector is too risky on the other side. As an institution, the informal market has several opportunities waiting to be explored. Risk assessments should be informed by many forms of evidence as opposed to relying on a written proposal. The new risk assessment toolkit should consider the loan applicant’s passion, previous investments and other attributes. Smallholder farmers and traders have tied their livelihoods to their small businesses. They have no capacity or inclination to externalize funds compared to big corporates.
A new farmer with all resources such as land, water and labour may have challenges trying to access a $50 000 loan from a bank on the basis that he is new to the business. The risk tends to be connected to the person as opposed to looking at the business with its own advantages such as a ready market, land, water and other resources. Although available resources constitute 80% of the business, financial institutions would let such an opportunity go begging because the individual lacks what is considered collateral. Risk assessments should consider gaps that need funding rather than the person. More than 70% of the collateral should be about the business and 30% be about capacity building issues. As part of assessing risk, a critical question that financial institutions should direct at potential clients is: In starting and sustaining your business, what opportunities have you forgone in terms of finance, time, career, etc..?
Limitations of excessive risk-aversion
Excessive risk-aversion by financial institutions is stifling innovation in many African countries. For instance, it prevents youths from participating in the mainstream economy. Being inexperienced and lacking collateral, ideas from youths are classified as green field and therefore high risk. The green field label is stuck on the idea and the person. Yet the fact that youths are young is beyond their control. How are they expected to have gained experience when they were at school from where they have generated innovative ideas? Due to an unresponsive economic and financial environment, the majority of youths end up leaving their countries in desperation. Some are encouraged to compete for funding under energy-sapping challenge fund competitions that are only accessible to the privileged. The rest are condemned to poverty although they may have brilliant ideas.
There is a tendency to forget that by pursuing entrepreneurship, many young people including university graduates will have forgone other things they could have done over the past 17 years or so. Some engineers have become traders while some have left employment to become traders. Isn’t that risk taking of the highest order? It is important to consider the fact that someone is so convinced about the business to the point of fore-going other opportunities. Ignoring this fact is the main reason why we end up with copycat businesses which are fueled by what risk assessors have become used to approving as good business ideas merely because many people are doing them. What is the point of approving the same business models which end up competing and failing to service loans when new models could become opportunities for creating new value if supported?
The risk of mono-cultural business models
When risk assessments from financial institutions ignore new innovation, the economy remains stagnant. Limiting financial support prevents growth and exploitation of creative businesses. Risk assessment committees should comprise experienced advisors who have actually been in business trenches. Too much risk-aversion puts the whole economy in a comfort zone, thus stalling progress. Achieving national targets is a question of balancing risks and opportunities. Taking a cue from formal financial institutions, some value chain actors tend to shy away from risk and congest in established value chains such as tobacco, tea, coffee, cocoa, sugar cane and others with deep roots colonial routes. If everyone goes for these few established commodities, who will develop new models around hundreds of African commodities that have enormous potential to present unique selling propositions for African economies?
In economies that are trying to promote entrepreneurship, risk assessment approaches should be positive and energizing for new entrance. If somebody applies for a loan and is denied, it lowers his/her spirits and self-esteem. If that happens to many people, the collective mood of the economy is weakened. Risk assessors should not behave like prophets of doom who undermine innovation and creativity. People will start thinking that their ideas are not worth pursuing and therefore wait for government donations.
Current financial principles focus on adhering to formal standards and controls which are not fully embedded into agricultural value chains but delegated to risk and compliance departments which have a limited understanding of the agribusiness context. Assessments are based on analyzing proposals yet, a proposal is only 10% of what an agribusiness is all about. Failure to understand the whole agriculture system is the main reason why financiers are often caught off-guard when failure occurs. Formal risk management approaches are insufficient for a dynamic ICT-fueled agricultural sector where sources of value and knowledge sharing are expanding every day.
Old ideas are making it difficult for financial institutions to see abundant opportunities in African agriculture. As a result, most opportunities are passing unnoticed due to technical financial obstacles. Value chain opportunities are either dismissed as too hard or pursued partially depending on the balance between the comfortable familiarity of old financial habits. Without the right ambition levels, financial institutions in developing countries will take decades to become key catalysts in translating abundant resources into economic growth and stability. Such ambition levels can be measured through appetite for risk.
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