Because “The earth is what we all have in common” — Wendell Berry
Happy World Environment Day everyone!
Many great informative reports are already written about the importance and urgency of reducing emissions, developing coping mechanisms in the face of the inevitable effects of climate change, and the role of agriculture in achieving our climate change goals. One of such reports is the McKinsey & Company’s April, 2020 Report on “Agriculture and Climate Change” [hereinafter referred to as the Report]. Among the many interesting facts and opinions that the Report includes, two of its observations specifically caught our attention:
First, although agriculture is still considered a major contributor to climate change, we should not forget that “Throughout the course of human history, agriculture has responded to humanity’s greatest challenges,” and it is still a saviour with great “opportunity to make yet another major contribution to humanity’s success during this crucial window for action.” The Report goes on to suggest 15 top measures that, if taken properly and timely, can reduce the emissions of the agricultural sector up to 20% by 2050.
This is great news, of course, if only we can overcome the challenges that are specific to agriculture, which brings us to the second interesting observation in the Report: Agriculture is “significantly less consolidated than other sectors; reducing emissions requires action by the more than two billion people employed in agriculture, or one-quarter of the global population.” It also “has a complicated set of objectives to consider alongside climate goals, including biodiversity, nutritional need, food security, and the livelihood of farmers and farming communities.”
In fact, absent a glue that makes the whole industry to commit to certain boundaries and practices, these challenges make the idea of implementing the aforementioned 15 measures feel like herding cats. Finance, we believe, is that magic glue that has the unparalleled capacity to align the interests and actions of different players. We are not the only genius who has thought of this, however! It’s been a while that both Financial Inclusion and Green/Sustainable Finance have duly been receiving a great deal of attention, and despite the long way that is yet to go, there have also been great achievements.
Finance is critical in achieving climate change goals at least on three levels: 1) Not financing unsustainable practices (e.g. offering sustainability-linked loans). Brazil’s ABC Plan is a great example, which we will explain later. Let’s call this the progressive role of finance. 2) Extending financial resources to marginalized groups of farmers, whose lack of access to affordable finance services sometimes makes them resort to short-termism and unsustainable practices. Finance can play a “controlling” role here to minimize or prevent the worst case scenarios. 3) Moreover, let’s not forget that besides affecting the climate change, “Agriculture is hit hard, taking about a quarter of all damage and losses caused by natural hazards and disasters in developing countries.” Therefore, finance also plays a “protecting” role in order to enhance the financial resilience of farmers, especially in the face of climate change.
Both long term and short term credits are critical in the three roles played by finance. While long-term credits pave the way for changes such as adopting “Scale low- and no-tillage practices” (which is one of the 15 measures suggested by the Report), short-term credits are critical in other ways, such as improving the choice of fertilizers and crop protection.
Ideally, finance should play these roles regardless of the size or commercial orientation of the farms, but had this been the case, we would have not been in this situation in the first place. Green and sustainable finance (which perform the progressive role) are still far from being mainstream, and financial inclusion of the marginalized farmers has a long way to go. It is disturbing to know that according to FAO, globally the total commercial credit that goes to agriculture is lower than the contribution of agriculture to GDP. In 2018, “the agriculture sector in nearly half of the countries received less than 3.5. of total credit”.
If we want to tackle the issue of climate change through agriculture, the crucial question is “How”, not “If”, we should invest more in this sector. There is no easy and single solution to this question, but in any approach that we take, it is critical that we integrate two ingredients into the recipe: 1) Innovative Fintech, which uses the power of technology and Big Data to radically unlock new opportunities 2) Strategic Partnerships within and among the private and public sector that creates unprecedented potential to tackle complex problems at large scales
Traditionally, conducting credit risk assessment of farmers has been associated with operational inefficiencies that increase the cost, and decrease the reliability of the assessment. This has made the agricultural finance to be perceived as a low profitable and high risk business, and has caused many lenders to either stay aside from this sector or to increase interest rates, or impose very heavy collaterals, all of which have caused a large segment of farmers to be financially excluded. Now, with the global climate change, and the pressure towards sustainable agricultural practices, lenders are gradually facing even more difficulties and uncertainties in this market. On one hand, they have to integrate the climate change risks into their credit risk assessment, which is a daunting task. On the other hand, if they want to offer sustainability-linked loans, they have to have effective and efficient systems in place to monitor the borrower’s performance, ideally at all the times throughout the life of the loan, in order to make sure the borrower is complying with the sustainability requirements. This amounts to even higher operational costs, and more uncertainties in the process than it already entails.
This is actually why in many countries that agriculture plays an important role in their economy, the governments have had to interfere and create special credit programs, tied to sustainability requirements. For example, Brazil’s ABC Plan credit line is the world’s largest Climate Smart Agriculture (CSA) program, and it is one of the pillars of Brazil’s strategy for reducing GHG emissions. It encourages the adoption of low carbon agricultural practices by offering low-interest loans to farmers who adopt specific sustainable practices. Embrapa, the state-owned research corporation that is well-known for developing a Brazilian model of tropical agriculture, is supporting the program by providing an integrated system for Monitoring, Reporting and Verification. This system is essential in many respects such as collection of soil samples and remote monitoring of the crops. Since 2010, the Plan has made R$27 billion worth of loans available to farmers who fit specific conditions, out of which a total of R$18 billion (USD$4 billion) have been disbursed among farmers. A combination of factors has hindered the disbursement of the remaining amount, at least some of which could have been avoided through more strategic use of technology to automate and to streamline the processes. Nonetheless, despite all the challenges, the Plan has played a significant role in accelerating the rate of adoption of low carbon practices among farmers.
However, if we want to scale the scope of sustainable agricultural finance, we cannot afford to merely rely on public funds, or on the limited presence of the private financial institutions. It is increasingly becoming more important to move to a market-based agricultural credit and to reduce the dependency of the credit programs such as ABC Plan on public resources. This need is already recognized by the Brazilian government, and is reflected in some of their recent initiatives (about which we will write in another blog post).
This is indeed great news, and a fantastic opportunity to make strategic partnerships with AgFintech companies that are harnessing the power of Big Data, and new technologies such as Machine Learning, NLP Algorithms, drones, image recognition, sensors, satellites, artificial intelligence, etc. to collect an incredible amount of quality data at an unprecedentedly lower cost, and to make even dynamic credit risk assessments that are considerably of higher accuracy rates than before. According to John Deere, the average farm has gone “from generating 190,000 data points per day in 2014 to a projected 4.1 million data points in 2020” (Snyder & Castrounis, 2018 / BRIE working Paper 2020–4). In this era, data collection and credit risk analysis should no longer be a cost barrier for agricultural lenders, when thanks to new technologies, even the remotest rural areas can be feasibly reached.
While both problems of climate change and financial inclusion are a lot more complex than to be solved only by transforming the credit risk assessment, we believe it is an integral part of the solution, and it can untie a key knot. AgFintech companies like Traive are already paving the way for such a credit revolution; however, it is only the power of partnerships that can multiply their impact. Although it is by no means an easy job, we have all that it takes to make this ambitious goal come true. The question is if we can come together to make it happen. In fact, “We are the first generation to be able to end poverty, and the last generation that can take steps to avoid the worst impacts of climate change. Future generations will judge us harshly if we fail to uphold our moral and historical responsibilities.”(Ban Ki-moon)