Modelling Risk of Financing Agribusiness in Kenya

Abstract

We review agricultural financing strategies in developed and developing economies in light of the risks that agricultural businesses face due to variations in weather conditions among other challenges. We specifically review Kenyan farmers’ agricultural risk management strategies and credit products that are offered by banks, insurance companies and other organizations, that are intended to minimize the negative impacts of agricultural risks. We discuss the application of index-based agricultural insurance and credit products in Kenya. We analyze reasons for low uptake of the product and propose an innovative credit-insurance model that can effectively link the small scale farmers to two potentially important players, commercial banks and the Kenyan government. Our model aims at persuading the commercial banks that there is more business to tap in the agribusiness credit for small scale farmers with reduced exposure to the risk of default. Also, it is aimed at convincing the government of the effectiveness of extending agricultural development funds to groups of farmers through commercial banks that have experience in managing credit. The structured model will increase the uptake of index-based insurance and agricultural credit and therefore enhance agricultural production hence Kenya’s food security. We show that banks who lend to farmers with index linked insurance products are likely to face low credit risks. Furthermore, we design a product to transfer some of the weather-related risks to the financial market.