Technology is playing a critical role in moving the world’s citizens from cash-based markets towards a vision of cashless economies. Digital financial services have been at the forefront of that transition, with the advent of mobile wallets and agent networks in rural areas and have shaped how providers approach financial inclusion and how they interact with customers with greater efficiency and outreach. Financial institutions have also invested in improving back-end processes through a range of solutions to create a seamless experience for customers. This blog discusses some of these trailblazing digital solutions and how they are improving the financial inclusion of smallholder farmers in developing economies.

Why do smallholder farmers, as a customer segment, still shy away from formal financial institutions?

To understand how technology will shape the future and shake up the approach to financial inclusion, it is important to first understand the conditions under which a smallholder farmer has typically lived:
1) Low and cyclic income.
2) Heavy reliance on informal financial services.
3) Financial aspirations for the household and family.

Until recently, the smallholder farmer has generally avoided transacting with formal financial institutions for several reasons:
1) Lacks documents, including an identity document (ID).
2) Lacks collateral.
3) Finds documentation processes complex and lengthy.
4) Has limited financial and technological literacy.
5) Has poor access to branch networks.
6) Finds the bank branch environment overwhelming.
7) Finds the products unsuitable for their financial lifecycle.
8) Has minimal or no credit history with financial institutions.
9) Lacks trust in financial institutions.

Ten years ago, the financial service landscape for a smallholder farmer looked like figure I.
 
Figure I
Financial service landscape for the smallholder farmer 10 years ago

Moreover, a smallholder farmer typically had just two choices when it came to credit, as listed below:

Option 1: Savings and credit cooperatives
a) Farmer can receive small-ticket credit against savings.
b) For a small loan, the documentation process is simple and minimal.
c) For a large loan, there is a complicated and time-consuming process.

Option 2: Local moneylenders
a) Farmer can receive credit against collateral in the form of gold, cattle or farms.
b) For a large loan, no formal documentation is required.
c) It is simple and quick to process a loan.

However, within the last decade, the emergence of mobile money helped create an enabling environment for outreach to the large un-banked smallholder customer segment. Usage thus expanded beyond airtime top-ups and bill payments to other use cases—predominantly bulk payments, savings and credit—for the smallholder farmer. A smallholder farmer currently has the option to receive his/her income in a mobile money account and to save a sum in the account or withdraw it from the nearest agent point. The financial service landscape for a smallholder farmer now looks like figure II.The smallholder farmer tended to prefer local moneylenders to savings and credit cooperatives for the following reasons:
1) No formal documents or formalities were required.
2) Loan catered to the financial lifecycle of agricultural outputs.
3) Societal norms and behaviours favoured the practice of borrowing from moneylenders.
4) There was a high level of trust between the two parties.

Figure II
Financial service landscape for the smallholder farmer in 2019

In the earlier landscape, a cooperative offered short-term credit by assessing the farmer’s credit risk based on his/her social capital as well as the farmer’s financial behaviour and transaction history with the cooperative. In contrast, in the current landscape, mobile money companies have entered the picture, taken over the role of cooperatives by leveraging digital technology, and offered short-term credit by digitally tracking the farmer’s payment history, savings pattern and mobile-money usage to generate a credit score reflecting the farmer’s credit risk. However, for a large loan, the smallholder farmer still relies on moneylenders. Although banks have established some presence in rural areas, they were, and still are, far from achieving near-universal coverage. Thus, banks remain a slow runner in this fast-emerging market, where technology is leveraged to reach underserved market segments.

The scenario is changing quickly, and the future of financial inclusion of those people who have been historically underserved is being shaped by a combination of technological solutions and human interventions, as envisioned in figure III. In the emerging tech space, banks are slowly picking up the pace with other tech-based financial service providers to serve the low-income segment, especially smallholder farmers.

Figure III
Financial service landscape for the smallholder farmer in the future

Banks traditionally faced challenges in serving low-income customers due, on the customers’ side, to their lack of ID and collateral and, on the banks’ side, to their limited presence in rural areas (inhibiting access) and low level of trust in offering credit to low-income customers. One critical challenge banks still face is conducting credit due diligence for customers whose financial footprints are limited or scattered among different service providers.

A range of technological solutions is being used to help financial service providers, especially banks, improvise with their services. Some examples are distributed ledger technology, artificial intelligence, cloud-based solutions, and credit algorithms or predictive analysis.

What digitization projects are being tested that could benefit smallholder farmers?

This section describes some of the above-mentioned technological solutions that have been, or are being, tested in low-income countries with the aim of serving smallholder farmers.

Cloud-based solution, value-chain digitization and credit scoring: Most people based in rural areas of developing economies are engaged in agriculture. Farmers require a wide range of financial services to support agricultural activities; however, their access to formal financial services remains limited, due to the reasons described in earlier sections. One successful approach is to leverage the linkages and influencers in the agricultural value chain in which farmers are engaged, as the UN Capital Development Fund (UNCDF) did in Nepal. By digitizing the operations and payments in a value chain, financial service providers can tap into an existing well-oiled, functioning system to reach out to a large segment and influence their behaviours.

Specifically, UNCDF supported a dairy value chain digitization project in Nepal with its partner Prabhu Management. Dairy is one of the biggest agricultural value chains in the country and contributes 31 percent of agricultural GDP. UNCDF and Prabhu Management piloted the digitization of milk collection and record-keeping operations through a cloud-based milk ledger. The automated milk ledger connected to a wallet-based payment platform to transfer milk payments to the farmers’ wallets. Prabhu Management created an interoperable cloud-based core banking solution for financial cooperatives as well. Over the long run, the data generated through the milk ledger, wallet payment platform and other sources, such as remittances, can be used for a credit algorithm to grant short-term small loans to farmers on the fly.

Remote loan origination, distributed ledger and credit algorithm: A smallholder farmer who receives remittance income and farm income in his/her wallet and uses the wallet for payments has a scattered financial footprint. However, a bank can leverage technology such as a shared ledger or blockchain, along with other innovations like remote loan origination with digital ID, to reach out to and serve this last-mile customer. The bank can offer a loan application process through its agents, using a remote loan origination platform that also captures the farmer’s digital ID (e.g., biometric or retina scan). Once the application is received at the back-end and the farmer’s profile is authenticated, the bank can use a blockchain platform to share the loan request among different stakeholders such as remittance companies and mobile money providers to request the farmer’s financial data. Once the bank receives the data, it can use the data in a credit algorithm to generate a score that the bank can use to approve and deliver credit.

In Nepal, UNCDF launched a project in this vein for rural remittance recipients in partnership with Laxmi Bank, one of the biggest commercial banks in the country. In fact, 30 percent of the nation’s GDP comes from international remittances. The project’s objective is to leverage this inflow as collateral for financial institutions to offer credit to remitters’ family members in Nepal. The project rides on distributed ledger technology to generate a loan application from a migrant, conduct due diligence and deliver credit through a bank account to the family member receiving the remittance in Nepal.

In Sierra Leone, the Government signed a memorandum of understanding with UNCDF, the United Nations Development Programme and the lending organization Kiva to strengthen the credit reference bureau in that country. UNCDF supported the Government to incorporate the principle of an effective identification system and to add the dimension of neutrality/level-playing field in the solutions to be adopted with Kiva. The credit bureau will provide low-income customers with access to formal financial services as well as greater control over their credit information. In addition, the bureau will capture a range of financial transactions, ranging from a loan from a bank to credit with a local shopkeeper, in order to generate the financial footprints of customers.

Conclusion

Distributed ledger technology, cloud-based solutions and predictive analysis are just some of the transformative emerging technologies that can and will shape the future of financial services. For banks, these technologies offer simplified operations; for customers, they mean faster processes and fewer documentation needs. There is still a long way to go to prove the effectiveness, feasibility and scalability of such technological solutions in their current form, as the majority of the interventions are still in the design or pilot phase. Along with the need for further technological development, there is a need for investment in financial literacy, behaviour change and human-centred product development. Such investments are critical to ensuring long-term sustainability for financial service providers.