Blog by Alex Morrice, Communications Officer, Global Canopy
Why does financing smallholders matter?
The vast majority of deforestation in the Peruvian Amazon is driven by agricultural expansion. This threatens biodiversity, the livelihoods of already vulnerable populations, and Peru’s climate targets, which include zero net deforestation by 2021. A large proportion of this deforestation is driven by smallholders on farms of less than 5 hectares, which make up 70% of Peru’s agricultural sector.
Global Canopy interviewed 14 national financial institutions and 49 smallholder farmers in three regions of San Martin, Peru, to better understand their respective needs, where support is needed, and opportunities for alignment. We found that while there are barriers for both smallholders and for financial institutions in the transition to sustainability, there are also significant opportunities to provide the necessary finance to smallholders with environmental criteria to ensure deforestation is curbed. This would create truly green credit to transform the sector.
What are the barriers?
Smallholder farmers’ view
From the farmers’ perspective, high interest rates are a major problem. In the Peruvian Amazon, interest rates are regularly over 20%, with short repayment periods. This makes naturally risk-adverse farmers tentative about taking loans for sustainable agriculture. Indeed, as our studies show it is likely that under current terms they would struggle to repay their loans due to short-term decline in profits in the transition to sustainability.
There is a lack of specific green credit products, designed to support the shift to more sustainable production, as opposed to general lending. There is also a lack of technical assistance – it is not enough for a farmer to receive a cash injection to ensure sustainable production; they must also be given the support they need to implement new farming techniques.
Graph 1: Showcasing current dept
This leaves farmers trapped in a cycle of deforestation. They are cutting further into the forest to support their livelihoods and families, while being keenly aware this damages the important services provided by the forest – including consistent rainfall, soil stabilisation, and shade from the sun – that they rely on.
To understand how a green credit line could be developed to break this cycle, we also spoke to financial institutions.
Financial institutions’ views
Despite enthusiasm on the part of financial institutions to provide more green finance products – 11 of the 14 we interviewed see it as a key strategic area of growth for them – they also identified several barriers:
- agriculture is a relatively ‘risky’ sector, with production often unpredictable — an issue which will be intensified by climate change;
- lending to smallholders, a diverse group with different management practices, is seen as riskier than lending to large agricultural companies;
- there is a lack of insurance and guarantees – without this safety net for financial institutions, the chance of investment being successful is diminished.
Without these in place lenders are not willing to provide green credit products for smallholders. The financial institutions we interviewed identified NGOs and governments as potential sources of information to assess risk and funding to de-risk investment respectively.
How can these barriers be overcome?
Technical assistance must be provided for financial institutions, as well as for farmers. For financial institutions, this could involve NGOs and government providing clearer data on the size, status and climate-related risks for individual farms, so that lenders can assess the risks. This is something the Peruvian government is starting to work on.
Financial institutions will also require access to cheaper finance themselves, which could be provided from development finance institutions.
Graph: Main sources of income and secondary sources with criteria defining maximum loan amount and defined limits on maximum loan
Risks could be further reduced with a form of communal credit, where credit is supplied to a group of farmers or a community rather than individual farms. In the two regions where women were involved in decision making process, they indicated a preference for this approach. It reduces risk by collating lending and repayments across several farms and reduces transaction costs, and so is also favoured by financial institutions.
Reducing risks for lenders would make it possible to offer green credit to meet farmers’ needs. Farmers would be particularly keen to have access to a ‘balloon payment’ made at the end of harvest, and longer credit terms and lower-interests. This would form the basis of a truly viable green credit line for smallholder farmers in the Peruvian Amazon.
Sustainable agriculture can be achieved: this is how
Smallholder agriculture in Peru must urgently be transformed to meet development and climate targets. At present, the needs of farmers are clear – longer-term payments with lower interest rates which incorporate technical as well as financial assistance. But until now, the barriers preventing local financial institutions from offering this have been less clear.
Graph 3: Area of land for main crops
By aligning the needs of farmers and financial institutions, and acknowledging the capacity building role of NGOs and the risk mitigation ability of governments, the transition to sustainable agriculture can be achieved.
The views expressed in this article are those of the author alone and not the Tropical Forest Alliance.