Structural Change in the South African Agricultural Sector Assignment

Assignment Task

Background of the Study

Agricultural lending refers to the loans sought out by farmers and agricultural investors to fund the production of crops, vegetables, fruits, and livestock. These loans also aid the purchase of farm equipment accrual of new farm technologies and upgrades. With the growing population and poor climate conditions, there is no doubt that more food is needed to serve the country. About 6.5 million South Africans experience hunger, and this is projected to increase soon with the accelerating poor living conditions and population growth (Mazenda & Ngarava, 2022). An astonishing 70% of the rural population gets their livelihood and employment from agriculture (USAID, 2022). Due to its poor performance, the national and regional economic states have been primarily affected. Currently, 27.4 million people are expected to experience food shortage within a half year (U.N., 2022). Thus, finance institutions and various players in agri-lending are taking an interest in financing agriculture (Botha, 2018).

South African rural areas depend entirely on agriculture for food and employment. Without adequate farm products, the local citizens experience food shortages, a demoralized workforce, increased crime, and a surge in nutritional diseases. The rural inhabitant primarily contributes to the urban labor pool. However, with living conditions dropping in the rural areas, rural-to-urban migration will cause overcrowding in the urban areas. With this great need to increase farm production, the niche for financial provision has not been filled due to the factors described in the coming chapters.

South Africa boasts one of the most advanced agricultural sectors. It has a tremendous agricultural processing system and diverse agricultural practices- from grains, fruit, wine, and vegetables (ITA, 2021). However, the glaring reality is that small-scale farming has not received as much support as large–scale farming. While large-scale farming is good for exports and contributes to the revenue earned from agri-trade, poor subsidiary farming quickly leads to inadequate amounts and food availability. Since 2005, the agricultural sector has only contributed 3% to the economy. Some reasons why subsidiary farming underperforms include adverse weather conditions, pests and diseases, and

lack of financial, technical, and even policy support. Investing in agriculture is the best chance there is to increase agricultural activities. In South Africa, lending institutions offer agricultural credit and monetary funds required to gain produce. Financial lending promotes production by enabling farmers to purchase farm produce by ensuring availability and improving purchasing ability (Bougard, 2017). Furthermore, this arrangement is likely to prove financially rewarding for both parties.

Problem Statement

Through lending, finance institutions get the most significant portion of their revenue (Nwankwo, 2007). Farmers can get resources needed for farming practices, and fiancé institutions profit from interest rates attached to loans. Finance institutions can pool funds, thus keeping them responsible for dispensing the same funds to a diverse economic sector . This role is a position of influence in the economy. Collaborations, therefore, between these two crucial economies should be able to save the cou n try from poverty and also increase the GDP of the country.

Several finance institutions in South Africa engage in agri-lending. These institutions are both from the formal and informal sectors and are also both from the private and public sectors. Despite an impressive number of institutions offering loans, several challenges make it difficult for farmers to access these loans. This disconnect does not help with the low production capacity and poor agricultural innovations. More should be allocated towards ensuring that agriculture is boosted to develop production rates and thus reduce the risk in agri-lending. Agriculture is viewed as a risky venture with its high-risk capacity, and thus, finance institutions are reluctant to give these loans (Inderst & Mueller, 2006). Does this accuse the institutions of remaining rigid when there is a great need for better agricultural infrastructure?

Small hold farmers face challenges while applying for credit facilities to finance agricultural development. Financial institutions, especially commercial institutions, require collateral in the form of agricultural land. This requirement has proven to be a problematic criterion for small farmers to attain. Subsistence farmers do not have land to use as collateral value to cover production credit. Therefore most of their applications get quickly disqualified. In South Africa, the commercial agricultural industry has been tasked with ensuring food security in South Africa. Financial institutions favor these farmers due to the reduced risks and managerial histories. However, with inflation rates rising and the cost of livelihood rising, the need for a developed subsistence agricultural infrastructure has increased. More than ever, the role of financing institutions needs to shift from a financer to other areas like developmental and supervisory attributes.

However, the work toward empowering farmers needs to begin. Policies and combined efforts among stakeholders will contribute to sufficient and sustainable development in the agricultural industries. The blocks put on the path of the small-hold farmer should be reasonably lifted to attract more farmers to engage formal credit lenders. Many small-scale farmers prefer informal financial institutions due to their low-interest rates compared to official institutions. Collateral options should be reconsidered, and action should be taken to lower credit rates. Furthermore, financial institutions should educate the farmers on emerging market opportunities and niches. The problem this paper seeks to address is:

What are the factors that influence agro-lending and that influence financial lenders to loan out?

Research Objective

This study aims to research and report the factors that encourage South African institutions to lend to farmers.

The research hypothesis for this study is:

• There is no functional relationship between the lenders and the creditors.
• There is a functional relationship between the services (loans) the lenders and the lending institutions offer.

Justification for the Study

The information in this paper will be resourceful to the ministry of agriculture as various stakeholders will better recognize their role in the department. This report will prove fruitful to local farmers seeking to understand how the system works and thus stand a better chance of acquiring credit for their agricultural practices. They will find tips on increasing their creditworthiness, applying for these financial opportunities and enhancing their ability to manage their roles as farmers and debtors. Furthermore, this can guide financial institutions and government personnel to improve their lending relationships with farmers. Researchers and interested parties can use this as supporting evidence and guidelines in establishing future work. As the national food market shifts towards subsistence farming, the relevance of this work will only serve as fuel to ensure that small farmers are empowered and supported. All stakeholders involved will, thus, be able to jointly develop policies that will allow agriculture more room to contribute to the country's GDP.

Extent of the Study

The scope of this study only extends to the financial institutions listed and licensed by the South African Reserve Bank (SARB).

LITERATURE REVIEW

Overview of the South African Banking System

The banking system consists of members from the formal and informal sectors. The market is also divided based on the kinds of financial institutions. The land bank and Industrial Development Corporation are some institutions that play a part in South Africa's agri-lending. The Micro-Agricultural Financial Institutions of South Africa (MAFIA) is an example of a government initiative set up to promote agricultural activities and increase the capabilities of small-scale farmers. These organizations have gone into the grass-root to mobilize subsistence farmers and find more ways to encourage sustainable agricultural practices. Commercial banks have also played a crucial role in financing working capital for upcoming farmers and developmental funds for those wishing to upgrade livestock and crop breeds. Medium-term loans are also used to purchase farm equipment and build technologically advanced systems.

However, Landbouw (2020) reminds us that commercial banks contribute only a limited amount of funds to overall agriculture funding. This condition can be attributed to their high-interest rates and the need for agricultural land to be used as collateral. It is important to note that the average rural farmer does not have farming land valuable enough to cover the cost of production; thus, many farmers miss out. Their lending criterion also focuses on the managerial skills of the farmer. Studies have shown that emerging farmers who are younger and have not built up a credit score are disadvantaged in the process. Collateral is not a significant factor to consider. Commercial banks focus on the reality and practicality of the farmer's financial position. These can give helpful information on the farmer's ability to cover personal risks while still meeting the loan requirements. This literature review will discuss previous works on the disproportionate nature of lending behavior.

Public Sector Institutions

Public sector institutions contribute to the credit-funding pool. For example, the land bank was established to offer lending services to registered members. The institution is vital in supplying monetary services to the rural poor. This bank is tasked with providing small to medium-term loans to boost agricultural production and encourage developmental technology. These loans are offered to cooperatives, who then distribute them to members. The small-scale farmer can thus acquire these loans as they do not mainly require land as collateral.

In 2004, the ministry of agriculture came up with MAFIA. The cabinet tasked the institution with sourcing funds and giving small-medium loans to small-scale farmers. The objective was to improve the state of agriculture in rural areas and to boost the country's food stability. This investment by the government casts a minimum of R50000 without collateral. This amount was due t any credit-worthy farmer who could prove the ability to fulfill the loan obligations within five years maximum. The maximum amount an individual or group could be offered was R50 000 with collateral. Service offered to the farmer included:

• Credit. These funds were mainly production credit for the upcoming farmers.
• Savings. The funds were to boost savings amongst farmers, which would increase the said farmer's credit credibility. However, this branch has not been adequately developed.
• Insurance. These funds were to shield the farmer's risks while doing agricultural activities.

If properly utilized, these features will build the rural finance infrastructure, boost the job market and contribute more to the economy. However, this has not been efficiently communicated to the local farmers, and thus most of them are unaware of these opportunities. As these financial aids are diversified into the rural market, awareness will be significantly dispersed, and members will be able to apply for credit.

Private sector institutions

Non-governmental institutions in South Africa have been set up to provide credit to farmers at affordable interest rates. They work with rural farmers and provide funds to upcoming, established, and micro-established farmers. For example, commercial banks are crucial in delivering finances to large and small-scale farmers. With technology, they can project the farmer's financial position from their past financial history and expected market changes. Their loan-repayment ability is, thus, drawn, and their credit score is determined. The four most popular commercial banks in South Africa are Standard Bank, Nedbank, ABSA Bank, and First National Bank. Despite their wide reach and spread, these banks have only provided a limited number of finances in the agricultural sector (van Landbouw, 2020). This condition is despite their monopoly of 80% of the financial lending pie.

Life insurance companies

This sector controls only a small part of the total shares. Despite that, they have reduced risks and provided funding to large-scale agricultural businesses. Landbouw (2020) said that these institutions offer large credit amounts greater than one million dollars.

Captive lenders

Captive lenders are other stakeholders in the agricultural industry offering services to increase the penetration of factors of production into the market. They include retailers, fertilizer companies, and other role players. This unity has seen the rise of Value Chain Financing (VCF), where the movement of agricultural factors of production is smoothly enabled by the relationship developed between the various role-players in this chain, including fertilizer retailers, importers of technology, and even seed companies. Every party wins as it is economically viable for the members involved.

Risks Associated with Agri-lending

 In the business between finance institutions and small-hold farmers, there exist risks that may interfere with the running and funding of finance institutions. These risks have caused institutions to shy away from Agri-lending and to set up criterions not viable for small-scale farmers. These include operational risks, reputational risks, low liquidity, and strategic organizational compliance (Bougard, 2017). Disproportionate lending refers to a loaning system where credit is unevenly distributed, and variables cause astonishing levels and criteria for funding. Here are the risks that bring about this situation.

Credit risk

Credit risk is the risk that financial institutions shoulder rising from the framer’s failure to fulfill the obligations of a loan (Bougard, 2017). To control this risk, financial institutions should always evaluate the risks stemming from external factors that affect agricultural production. This strategy should go hand in hand with ensuring that farmers retain the ability of loan repayment despite the other factors that may affect production. Financing institutions function by accepting the risks related to production, and through projection, they can work with customers to reduce this risk.

Production risks

Production risks occur due to the probability of uncertain events affecting yield and production. Banks can project the farmer's produce yields, and thus, the fact that there can be variations of it poses a risk to the financial institution. The farmer may be unable to meet targeted obligations, which will risk potential loss on the part of the finance institution (Bougard 2017). This kind of risk occurs in any setting where agricultural yields are expected. Production risk refers to any production-related event or uncertain activity in farm production. External factors beyond the farmer's control can result in low production, thus upsetting the farmer's ability to repay the loan. Such factors include droughts, floods, cyclones, heatwaves that upset livestock farming, and excessive rain. These factors cannot be easily controlled unless the technology is used to make predictions based on the patterns of a certain geographical agricultural area.

To lend credit, finance institutions assume the ability of the farmer to attain target product sales. However, with agriculture, more risks make the system hard to penetrate by small-hold farmers. Farmers are therefore required to get educated on best practices to guard against possible adverse effects that reduce the scale of production. These practices include practicing proper farming techniques to maintain the value of the soil, using trenching to reduce flooding, and regular pesticide control to ensure the crops and livestock remain healthy. The farmers themselves risk issues like a sudden change in market prices and costs incurred during a production cycle. Farmers likely to prove themselves in this regard will receive credit from financial institutions.

Market volatility

The market is always changing. This fact poses a risk to the investment and the output incurred. Prices differ and widely range depending on the economic state of the country. With inflation rising, the factors of production are likely to get expensive, greatly influencing product pricing. South Africa is more commercial attuned rather than subsistence in terms of agriculture. These make it difficult for the local farmer to obtain credit funds for production and development purposes. Furthermore, the government of South Africa does not provide subsidies for farmers, thus putting South African farmers at a disadvantage.

As South Africa engages in international trade, factors like changes in currency value affect the whole of agriculture's effects on pricing. Both internal and global politics shape the volatility in the market, and financial institutions consider this while lending credit. Farmers who show diversification and have great credit records can acquire these loans.

Government policies

Government policies greatly determine the purpose of businesses in South Africa. Beyond some point, some agricultural practices may go against government laws, thus posing legal challenges. Farming practices that promote themes like deforestation and soil damage are prohibited. There are serious consequences if these policies are disregarded. Some policies restrict the placement of certain agricultural practices in population centers (Sowman and Malan, 2018)

Limited collateral

Specific agriculture-related collateral's limited use increases credit risk because when loan repayment issues emerge, these deposits may only be used for a small number of other purposes, if at all. For instance, if a farmer loses a processing agreement, a broiler barn can still have some value (Maloba, 2018). In addition, land and product prices are closely related, particularly in agricultural areas with no alternative uses for the land. Accordingly, regions with various farm services may only have a tenuous link between land and product pricing.

Trends of bank credit to the agricultural sector in South Africa

Both conventional and informal rural financial markets provide services to the rural and agricultural sectors. Self-help organizations, stokvels, burial societies, and women's organizations are examples of informal rural markets. They provide their members with financing, which they might utilize for consumption, emergencies, businesses, or farming (Machete et al. 2011). Commercial banks, non-profit organizations, microfinance organizations, the Land and Agricultural Bank of South Africa (often referred to as the Land Bank), and agricultural cooperatives make up the traditional rural financial markets.

Literature review on the subject

Much research has been conducted and contributed to this area. Several research studies have examined the relationship between the players in the credit-lending field. Patterns have been discerned to come up with projections that predict the farmers' future production and financial positions, thus creating a system of regulations and practices that affect credit lending. For these results, many multiple-case experiments have been conducted to incorporate both fixed variables and the factors that shift.

Most banks conduct business with customers with whom they have a relationship (Chodechai 2004). It is thus important to stress the benefits of relevant credit scores. This step will increase the farmer's chance of acquiring a loan as the financial institution can access their financial information. This relationship builds credibility by projecting the farmer's financial position, and the bank can predict their loan repayment abilities.

This problem is majorly experienced in rural areas. Due to the village's undeveloped business infrastructure, many farmers cannot present their positions in the means statement by financial institutions. Due to ignorance and a lack of financial and technical support, rural home farmers cannot structure their businesses and have formal evidence of their financial positions. The structural organization of the financial institution determines its lending abilities ( Betubiza and Leatham, 1995).

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