ALLIANCE FOR A GREEN REVOULUTION IN AFRICA (AGRA)

ALLIANCE FOR A GREEN REVOULUTION IN AFRICA (AGRA) IMPLEMENTATION STUDY OF THE EQUITY BANK KILIMO BIASHARA AGRICULTURAL LOAN SCHEME FINAL REPORT Submitted by: Block B, 1st Floor, Kush Offices Rhapta Road, Westlands P.O Box 43483-00100 Tel: 020-3004751/3002676 admin@sbaconsulting.co.ke www.sbaconsulting.co.ke

CONTENTS 1.0 Introduction... 8 1.1 Methodology and Approach... 8 1.2 Structure of the Report... 8 2.0 Background... 9 3.0 General Operational Issues... 13 3.1 Review of Loan Scheme Agreement... 13 3.2 Use of Loans... 18 3.3 Supporting Documents... 19 3.4 Impact and Effectiveness of Loan scheme... 19 4.0 Performance Assessment... 21 4.1 Background to Agricultural Lending in Kenya... 21 4.2 Innovations in Agricultural Lending... 21 4.2.1 Overall Financial Systems Innovations... 21 4.2.2 Institutional Innovations... 22 4.3 Additionality and Mode of Lending... 23 4.3.1 Loan Scheme Disbursements Assessment... 23 4.3.2 Additionality in Disbursements... 25 4.3.3 Institutions Modes of Lending... 26 4.3.4 Transaction Costs Reduction... 26 4.3.5 Size distribution of Loans by Farm Type... 27 4.3.6 Diversification of risk... 29 4.3.7 Assessment of Reasons for Taking Credit... 30 4.3.8 Interest Rates Comparison with Other Banks... 30 4.3.9 Loan Distribution by Type of Enterprises... 31 4.4 Risks, Repayments and Business Model... 32 4.4.1 Returns or losses on AGRA guarantee... 32 4.4.2 Distribution of Loan Repayments, Outstanding Loans or Loan at Risk... 33 4.4.3 Determination and Inspection of Claims... 34 STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 2

4.4.4 Effectiveness in Loan Monitoring and Recovery... 35 4.4.5 Risks facing the Facility and Farmers... 37 4.4.6 Facility Roll-out Plan... 37 4.4.7 Sustainability of Business Model... 37 4.4.8 Development of Internal Capacity... 37 4.4.9 Diversification to Other Products... 38 5.0 Other Issues... 39 5.1 First Loss Arrangement Assessment... 39 5.2 Effectiveness of Committee System... 39 5.3 Support of Bank s Senior Leadership to the Facility... 39 6.0 Key Challenges... 40 7.0 Conclusion and Recommendations... 41 7.1 Key Findings and Insights... 41 7.2 Recommendations... 42 Annexes... 43 Annex 1: Kilimo Biashara Loan Process... 43 STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 3

Executive Summary I. Introduction and Methodology Introduction AGRA in partnership with IFAD entered into an agreement in 2008 with Equity Bank to set up a loan scheme to primarily benefit small scale farmers in Kenya. This agribusiness loan scheme named Kilimo Biashara was made possible by the provision of risk sharing facilities by AGRA and IFAD in the amount of US$ 5 million to enable the Bank to lend US$ 50 million to agro-dealers over a three-year period. AGRA is commissioning this study to review the implementation of the Loan Scheme, impacts, lessons learnt, challenges and how to improve the operation of the scheme. This interim report outlines preliminary findings based on review of documentation based on sampled files and limited field work. Methodology and Approach The methodology and approach for this draft final report included a review a sample of about 100 files at branch level, visits to several branches in Nakuru, Nyahururu, Bungoma, and Kitale, interviews with credit managers, loan officers and field visits with over 50 farmers that were loan scheme beneficiaries 1. II. Performance The Scheme was able to achieve the following; Cumulatively since the start of the program a total of 45, 408 beneficiaries with total cumulative approved loan amount of Ksh 2,033,114,850 currently as at May. The bank has disbursed US$ 26,308,264, (Ksh 2,033,144,850) which is US$ 1,308,264 (Ksh 101,104,776) above the stipulated lending target of US$ 25 million (Ksh 1,932,040,074) as spelled out in the loan agreement. The bank has been able to reach previously unbanked customers e.g. the Bura irrigation scheme (rice) has been revived after 20 years of dormancy due to credit facilities afforded to eligible beneficiaries by the bank; Lending in crop value chains has increased where previously lending was limited e.g. maize, rice and sorghum farmers; Establishment of successful partnerships with key players in the value chain. For example working with the World Food Programme (WFP) in developing market linkages to buy maize. 1 The field interviews with loan beneficiaries were aimed at understanding in more detail the impact and challenges of the scheme. A detailed quantitative impact assessment however was not possible with the time and resources available. It should also be noted that no baseline data was available to make comparisons on pre and post project impact. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 4

The success of the scheme thus far has prompted the Government of Kenya (GoK) to develop a larger scheme to incentivize and attract more banks to lending in the agricultural sector. III. Key Challenges In the course of implementing this project, there have been some challenges which Equity Bank tried to overcome given the experience that is continuously being gathered in the process. These are presented below: Political interference with respect to the dissemination of information about the scheme sent mixed messages to beneficiaries that Kilimo Biashara was a government program. Equity Bank had to spend additional time and increase its marketing efforts to articulate that they bore 90% of the risk, and that Kilimo Biashara was not a grant scheme. After farmers are empowered through the scheme and increase their production they are faced with the challenge of limited market. Market access for farmers to sell their produce remains a challenge. The integrity of some stockists has been questionable. Some have been found to be selling bad inputs to farmers after benefiting from the scheme. The maize value chain is not as organized as value chains in other sectors such as tea, coffee or even dairy. Fragmented and disorganized maize value chain increased costs for the bank as they had to educate farmers, develop systems such as group lending for efficient service delivery and develop partnerships such as with KACE to strengthen critical parts of the value chain. Despite these challenges the bank is committed to lending in the maize sector as this will address some food security challenges the country is currently facing. Many small scale farmers never had bank accounts and the first entry in the transaction account was a loan. It was very difficult for staff to implement the scheme at the same time hand hold the farmers at each step of the lending process. Introduction of financial education to farmers has greatly helped in administration and delivery of the lending facility. The long time taken for the government to make its contribution to the fund and the resultant lack of a clear Memorandum of Understanding (MOU) or underlying framework that clearly stipulates partner s roles and responsibilities has hampered operations, reporting and claims process; Equity Bank has learnt from these challenges and has been able to adapt its approach to mitigate against them. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 5

IV. Conclusions and Recommendations The overall reception of the loan scheme among farmers and agri-businesses has been very positive. The Kilimo Biashara loan scheme has been able to reach 45,408 beneficiaries and disburse US$ 23,780,472. The scheme has succeeded in increasing access to financial services to previously unbanked small holder farmers and helped transform livelihoods. Key Findings and Insights Based on a review of the scheme, our key findings are as follows: i.) ii.) iii.) iv.) v.) The risk sharing mechanism has effectively facilitated increased lending to the agricultural sector. Equity has been able to meet the leveraging requirement above the ratio of 10 to 1 outlined in the scheme agreement. Business model: Equity has shown tremendous ability to adapt and tailor the facility to the customer. Particularly how the bank has been able to mitigate challenges faced with small scale farmers. Overall this scheme has proved that lending to the higher risk value chains in agriculture, like maize, can actually be a profitable experience. Despite an expected loss of 10.43% over the three year period, the scheme has generally been well managed. The financial literacy training has had a positive effect on customers. These are new customers that have never had experience with a lending institution. Thus financial literacy education is a critical component to successful implementation of the scheme. The importance of having clear expectations among all stakeholders to avoid political interference and mixed messages about the scheme. Recommendations In line with the findings above, we propose the following recommendations: i.) ii.) iii.) iv.) Equity bank should continue to be supported under this scheme to reach more farmers. There is a need to come to a clear understanding in the MOU on how to go about the claims process. It appears that this has not taken place during the period of the agreement. Undertake formalized documentation of policies and procedures developed under this scheme. The government and AGRA should look into providing more technical support to the bank in the roll out facility to a wider audience. The bank has been shouldering the responsibility of training and value chain development. To increase the rollout of the program greater technical support and partnerships are required. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 6

The Kilimo Biashara project has overall been very well received, has been moving along well and has had various successes. There is a need to consolidate the business model to deal with some of the challenges and risks identified but growth prospects look positive. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 7

1.0 Introduction AGRA in partnership with IFAD entered into an agreement in 2008 with Equity Bank to set up a loan scheme to primarily benefit small scale farmers in Kenya. This agribusiness loan scheme named Kilimo Biashara was made possible by the provision of risk sharing facilities by AGRA and IFAD in the amount of US$ 5 million to enable the Bank to lend US$ 50 million to agro-dealers over a three-year period. AGRA is commissioning this study to review the implementation of the Loan Scheme, impacts, lessons learnt, challenges and how to improve the operation of the scheme. This interim report outlines preliminary findings based on review of documentation based on sampled files and limited field work. 1.1 Methodology and Approach The methodology and approach for this interim report included a preliminary review of the loan portfolio based on a review of the loan portfolio based on a sample of about 100 files at branch level, visits to several branches in Nakuru, Nyahururu, Bungoma, and Kitale, interviews with credit managers, loan officers and field visits with over 50 farmers that were loan scheme beneficiaries 2. 1.2 Structure of the Report This interim report provides the consulting team s preliminary findings. The report is divided into three distinct segments that cover the following:- Section 2 Section 3 Section 4 Section 5 Section 6 Background: this section provides background to The Kilimo Biashara Loan Scheme, rationale for the scheme and a description of the scheme; General Operating Issues: this section examines the loan scheme agreement and an overall assessment of the loan portfolio; Performance Assessment: this section examines the performance of the scheme, innovations in agricultural lending, additionality and mode of lending, risks, repayments and business model; Other Issues: this section assess other issues concerning the scheme, first loss arrangement, and effectiveness of committee systems Conclusion: this section provides a summary of the preliminary findings of this interim report and charts the way forward on the next phase of the assignment. 2 The field interviews with loan beneficiaries were aimed at understanding in more detail the impact and challenges of the scheme. A detailed quantitative impact assessment however was not possible with the time and resources available. It should also be noted that no baseline data was available to make comparisons on pre and post project impact. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 8

2.0 Background The agribusiness loan scheme Kilimo Biashara was setup to ultimately address national food security and agricultural income challenges. By increasing access to financial services and capacity building agricultural value chain actors 3 the scheme would be critical link to increasing productivity and small holder farmer incomes. Challenges the scheme is to address include: The low usage of farm inputs such fertilizer, pesticides and herbicides, poor quality seed used by farmers and limited investment in farming equipment and storage facilities because they lack access to affordable finance, Lack of essential financial management and record keeping skills among agricultural value chain actors, Input suppliers and other agri-businesses have weak credit collection tools and skills for goods sold on credit, Lack of adequate working capital and operational capital for produce traders, input manufacturers, input importers, agro-dealer and agro-processors, To provide an efficient administration and delivery system for government input subsidy schemes 4 National Accelerated Agriculture Input Access Program (NAAIAP), The Kilimo Biashara scheme commenced in 2008 and is to disburse a total of USD 50 million over the three year life of the scheme. The programs goals and objectives included:- To facilitate acceleration of access to affordable financial services to agricultural value chain actors, To enhance the distribution of government input subsidies through NAAIAP, To develop products aimed at mitigating financial risks affecting the agricultural sector such as insurance products, To increase the efficiency of agricultural value chain players, To develop business capacity along the agricultural value chain and enhance service delivery, To develop a working consortium with different players in the agricultural value chain to deliver the required synergy to achieve the scheme s goals and objectives, 3 Agricultural value chain actors include farmers, agro-dealers, traders, processors, input manufacturers and input importers. 4 National Accelerated Agriculture Input Access Program (NAAIAP) was formed with the objective to improve access and affordability of key inputs for the millions of smallholder farmers, especially those living below the absolute poverty line. NAAIP has been addressing problems of food security among poor farmers. NAAIP improves access and affordability of the key inputs to smallholder farmers and have also trained agro-dealers and stockists on how to handle farm inputs and seeds professionally. There is also ongoing training to raise business management skills to the agrodealers as well as product knowledge so that they can advise the farmers well. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 9

The main products and services developed to deliver and achieve the scheme s goals and objectives are bank accounts (both saving and current accounts) for deposits, savings, collection and remittance, and Kilimo Biashara loans and advances products. Each product is discussed in brief; 1. Kilimo Biashara Loans and Advances Kilimo Biashara loans were developed to assist agricultural value chain player to access loans and repay at affordable rates. Three loan products were developed for small scale, large scale and agribusiness. Each product is discussed in turn. 1.1 Kilimo Biashara Small Scale Features:- Loan Amount: Ksh 1000 to 100,000 Collateral required: Chattels mortgage over household and farm assets, salary/ pensions, Logbooks, quoted shares, cash cover, individual guarantee supported by tangible assets, group guarantee system-borrowers can guarantee through group lending methodology Loan term: Maximum 1 year (flexible to meet crop cycle) Credit life insurance: 0.275% per annum LACE: 3% Interest rate: 10% Flat rate Eligibility:- a.) Active equity bank account b.) Must be in commercial farming for at least one year c.) Loan purpose for purchase of inputs like seeds, fertilizer or chemicals Issues to note:- a.) Client to provide invoice for cost of input from a reputable dealer b.) Direct payments to the dealers for the purchase of inputs c.) Ministry of agriculture recommendation d.) Officers to conduct a farm visit to confirm size of land for inputs applied for and to cross check information given by the ministry of agriculture extension officers STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 10

1.2 Kilimo Biashara Large Scale Features:- Loan Amount: Collateral required: Loan term: Credit life insurance: LACE: 3% Interest rate: 15% reducing rate Ksh 100,000 and above (limit depends on the individual requirements and the ability to pay) Logbooks, Quoted shares, Cash cover, individual guarantee supported by tangible assets, title deeds Maximum 3 years (but matched to meet crop cycle) 0.275% per annum Eligibility:- a.) Active equity bank account b.) Loan for purchase of inputs and other farm equipment and assets c.) Demonstrate ability to repay d.) Already be in commercial agriculture with experience of one successful season 1.3 Kilimo Biashara Agribusiness Target market:- Agribusiness enterprises involved in stocking manufacturing, exporting, importing of agricultural products, such as, a.) Agrodealers b.) Agro input manufactures c.) Agro processors d.) Agro importers and exporters Features:- Loan Amount: Collateral required: Loan term: Credit life insurance: Interest rate: Depends on individual requirements and the ability to repay Logbooks, Quoted shares, Cash cover, Individual guarantee supported by tangible assets, Title deeds, Business stocks combined with chattels mortgage (those in micro level) maximum 3 years 0.275% per annum 15% reducing rate STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 11

Eligibility:- a.) Be account holders with equity bank b.) Loan purpose for working capital and operational needs c.) Demonstrate ability to pay d.) Already in agribusiness experience of 1 year e.) Licensed by KEPHIS (Kenya Plant Health Inspectorate Services), PCPB (Pest Control Products Board) f.) Training and certification from AGMARK (Agricultural Marketing Development Trust) STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 12

3.0 General Operational Issues Presented in this section are findings on general operational issues based on specific requirements of the terms of reference. 3.1 Review of Loan Scheme Agreement The current loan scheme agreement between Alliance for a Green Revolution in Africa (AGRA), the Government of Kenya (GoK) and Equity Bank is a general partnership framework and not the final tripartite agreement outlining the framework for partnership and guarantee agreement for Kilimo Biashara scheme. This current agreement was signed in May 2008 but guarantee funds from AGRA were availed in September 2008. Equity Bank commenced the lending process immediately the agreement was signed. The guarantee contribution from government was availed in June. At the time of writing this report the final tripartite agreement was still awaiting signing from government. The loan scheme agreement reviewed in this report is the initial agreement signed at the commencement of the scheme. Table 1 below provides a review of the agreement and assesses adherence. Table 1: Kilimo Biashara Loan Scheme Agreement Review Scheme Agreement Section Adherence Whereas 4. The Bank has agreed to commit by way of loans and advances the sum equivalent to USD $50,000,000 5. The bank has also agreed to offer the Eligible Borrowers a concessionary interest rate of 10% for small scale farmers and 15% of other Eligible Borrowers across the value chain. 6. The partners have agreed to share with the Bank the loss (if any) suffered by the Bank following default by an Eligible Borrower subject to a maximum contribution of 10% of the outstanding principal amount of the advance made to and Eligible Borrower in each case. 7. AGRA shall give cash deposit of US$2.5 million and GoK shall give cash deposit of In-progress: currently disbursed USD $ 23,780,472 (Ksh 2,021,340,199) i.) Small scale farmers; initial interest rate was 10% but has increased to 15% over time ii.) Other Eligible Borrowers across the value chain: initial interest rate was 15% but has increased to 18% over time The credit committee has not as yet met to determine total losses of the scheme This has been adhered to US$ 2.5 million Section 2: Project Framework 2.1 Operating Principles 2a The project shall be carried out in the This has been adhered to STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 13

2b 2d 2e 2f 2g 2h 2i 2j 2k Scheme Agreement Section whole of Kenya Inclusion of the loans disbursed under this agreement from the date of launch, May 2008 The term of any Loss Sharing Fund shall be 3 years from the commencement date. The term of each Credit Facility shall not exceed 3 years inclusive of any grace period Credit facilities shall be provided to eligible borrowers within the tenure period or the tenure term as may be adjusted by mutual consent by the parties or either of the partners with the bank Upon giving 15 days notice to the partner, the bank shall set off in each case an amount not exceeding 10% of the declared credit loss on the principal amount default by an eligible borrower Upon expiry of the term of the loss sharing fund, the bank shall discharge the balance of the loss sharing fund less any declared credit loss amount to be offset from the fund and shall retain an amount equivalent to 10% of the outstanding loans covered under this agreement as at the date of expiry of tenure term the ban shall be required to discharge the net o the retained amount once all loans covered have been fully repaid or credit loss if any declared Notwithstanding sections 2.1 (c) and (d) the loss sharing arrangement contained in this agreement shall expire upon the occurrence of any event provided for in Section 6 The bank shall open interest bearing accounts with respect to the loss sharing fund i.) AGRA and ii.) GoK In the event of credit loss declared on eligible borrowers the partners shall be responsible for 10%, each bearing 5 % and the bank shall be responsible for 90% of the declared credit loss on the principal amount of the credit facility advanced unless this amount of contribution is higher than 20% of the principal sum Adherence This has been adhered to This is satisfactory This has been adhered to This is satisfactory This situation has not come to pass This situation has not come to pass An error has been identified in the agreement, Section 6: Collaboration with other stakeholders not the intended Section 7: Force Majeure clause. This has been adhered to This situation has not occurred as yet STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 14

2l 2m 2n 2o 2p Scheme Agreement Section outstanding in which case the partners shall be responsible for 10% of the principal sum outstanding as t the moment of writ off in its system provided always that the maximum contribution by the partners in respect to all losses under this loss sharing arrangement is the aggregate sum of US$ 5 million As between the partners loss and any profits (interest or refunds from any sums recovered from the eligible borrowers) shall be share pro rata. Any later recovery after write off shall be credited equally to the bank and the partners The loss sharing fund shall unless earlier terminated as provided in this agreement be subordinated to the bank for a period of 3 year from the commencement date after which period the partners or any of the patterns shall be free to adjust the term, withdraw the available balance or use it as part of a new guaranteed fund on terms agreed by the parties or either of the partners and the bank A monitoring and implementation committee shall be formed to monitor on monthly basis progress on loan advances and provide a report to the board. Each party shall be represented in the monitoring and implementation committee. The criteria for appointment shall be set by the parties. Each party shall bear its own costs at the meeting venue Board shall hold quarterly meetings to deliberate on reports of the monitoring and evaluation committee and review status of project implementation and shall submit reports to parties to this agreement Joint reviews of the performance of the project shall be carried out half yearly by representatives of the parties Adherence This situation has not yet come to pass This situation has not yet come to pass The bank has a monitoring and evaluation committee that regularly submits reports to partners. 2q The bank reserves the right to finance non This is satisfactory There is no sanctioned overarching monitoring and evaluation committee with representatives of each partner. There was no underlying framework because the final tripartite agreement had not been finalized at the time of writing this report. There have been periodic meetings carried out by the partners however they have been operating without a sanction underlying framework. See 2n above. Reviews on the performance of the project have been carried out. These have been independent reviews and not joint efforts STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 15

Scheme Agreement Section certified eligible borrowers directly without bringing them under the project 2r The bank shall charge the loan beneficiaries under this agreement the concessionary interest rate of 10% per annum for farmers and 15% per annum for other eligible borrowers for as long as AGRA and the GoK provide the monies to the loss sharing fund 2.2 Lending Policies and Procedures a In extending credit facilities the bank shall abided by prudential banking practises b The bank may only grant credit facilities under this loss sharing arrangement to an eligible borrower who is certified by the partners and has met other conditions set exclusively by the bank in their normal lending policies and procedures c The bank shall use its existing lending policies and procedures in assessing and approving the credit facilities including the taking of collateral or security if deemed necessary d The agreement shall cover all credit facilities expect, for those provided for under clause 2.2. c lending policies and procedures 3 Section 3: Duties and Responsibilities of the bank a To act as custodian of the loss sharing fund and ensure that the funds are used in a manner set out in this agreement b To conduct its normal lending basis towards the eligible borrowers by sin prudent banking judgement. Business discretion, due diligence and adhering to the applicable prudential regulations c To monitor performance of the credit facility d To ensure that the credit facility allow provision of information on eligible borrowers to the Credit Reference Bureau e Not to alter any terms and conditions of the credit facility agreement without obtaining written consent of the partners Adherence The interest rate charge to farmers has been adhered to One instance of an agri-business borrower charged 18% interest was identified. This has been adhered to This has been adhered to This has been adhered to This has been adhered to This has been adhered to This has been adhered to The has been adhered to This has been adhered to This is satisfactory STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 16

Scheme Agreement Section to this agreement f To maintain transparent, accurate and complete record in respect of all transactions under the scheme and such report to be submitted to the partners on semi-annual basis according to benchmarks to be agreed among the parties g To provide the board and or monitoring and implementing committee the schedule of loans recovered from the loss sharing fund on a half yearly basis; and h To diligently pursue the recovery of any debt immediately following default Section4: Duties and responsibilities of AGRA and GoK 4.1 AGRA and GoK shall have the following duties and responsibilities; a AGRA and GoK shall provide cash for the loss sharing fund as well as receive and review reports submitted by the bank in relation to the credit facility b AGRA and GoK shall ensure that the eligible borrowers are trained and certified by appointed intermediaries; and c AGRA and Gok shall facilitate regular training of eligible borrowers for effective use of credit facilities 4.2 Without prejudice to any obligations of the parameters set out herein, the partners undertake a To provide credit loss cover to the bank covering 10% of the principle amount of the credit facility advanced as may be outstanding at any one time by the eligible borrowers under this scheme, and; b To provide feedback on reports submitted by the bank in relation to the credit facility Adherence This is satisfactory This is satisfactory This is satisfactory - Provision of cash for the loss sharing facility has been adhered to - reports have been submitted by the bank to the partners in relation to the credit facility This is satisfactory This is satisfactory Situation has not come to pass Feedback has been ongoing the bank and AGRA have been communicating regularly. a Section 5: Duties and Responsibilities of GoK To utilize the US$2.5 million committed towards the project by the GoK through SHoMaP for the loss sharing fund and to This situation has not come to pass. At the time of writing this report government portion of project funding STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 17

b Scheme Agreement Section ensure that all eligible beneficiaries in Kenya and particular SHoMaP areas participate in the project and are able to access the credit facility To mobilize sector players to participate in training and education to existing formal and informal farmer groups and other value chain players involved in input supply and produce marketing Section 6: Collaboration with other stakeholders The parties recognize the important role of other stakeholders implementing the objectives of the scheme or project and therefore undertake to work with such stakeholders when applicable Section 7: Force Majeure Section 8: Dispute Settlement Section 9: Termination of the Agreement Section 10: Amendment of the Agreement Section 11: Notices Adherence had just been submitted to the bank two weeks previously This is satisfactory This has been adhered to enforcement of these clauses has not be necessary to date The agreement has not been amended This has been adhered to In general the agreement has been adhered to however it appears that the claims process has not been properly executed to date. Based on discussion with Equity Bank they felt they were not in a position to make a claim until the tripartite agreement had been finalized. 3.2 Use of Loans The consulting team was able to establish that the loans have been used in accordance with the conditions of the loan scheme and for intended purposes. Kilimo Biashara Small Scale Loans and Kilimo Biashara Large Scale Loans were used for the purchase of inputs, mainly seeds and fertilizer. Kiliom Biashara Agri-business Loans are used by Agrovets to increase stock. The farmer education on financial literacy done through the Equity Group Foundation (EGF) has played a large part in ensuring proper use of the loan facility. Farmers receive four weeks training on financial education and further two weeks training from the Agricultural Loan Officers that has sensitized farmers on the importance of complying with the conditions of the loan scheme. The sample size visited in the field, have all used the loans solely for the intended purposes. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 18

3.3 Supporting Documents The Kilimo Biashara scheme is a unique product and first of its kind in Kenya. Therefore there is no reference point and policies and procedures are being developed as the scheme continues and as the bank learns from implementation challenges and success. Documentation, policies and procedures have been drawn from existing agricultural lending products and applied to Kilimo Biashara where applicable. For example policies and procedures governing the group model currently being employed were drawn from another existing group lending product under the agricultural lending department and tailored to Kilimo Biashara. 3.4 Impact and Effectiveness of Loan scheme Insights from loan scheme beneficiaries and loan officers revealed the most direct impact the Kilimo Biashara loan scheme has had on beneficiaries is increased income through increased productivity. Prior to the Kilimo Biashara scheme small holder farmers had to sell off their maize before they could buy inputs for the next planting season. But due to other financial responsibilities at the time of harvest farmers had to prioritize their needs. Oftentimes it came down to a choice of paying for school fees or buying enough seed to meet subsistence demands for the next year. The use of fertilizer was not widespread because of the cost. With the Kilimo Biashara loan scheme small scale farmers are able to grow enough produce for consumption and have additional produce for sale. An ancillary impact of the Kilimo Biashara scheme is that small holder farmers have been able to educate their children. Their revenue is not reduced at harvest because they can access a financial facility to purchase inputs in time for the next growing season. Small holder farmers no longer have to make the choice between food and children s education. Increased access to financial products is another benefit of this program. Every new customer must first have a bank account with Equity Bank to be able to access the lending facilities. This has increased the number of banked small holder farmers. For instance Nyahururu and Bungoma make up 26% of all scheme beneficiaries and 80-90% of these were previously unbanked. During the implementation of the program Equity Bank realized that a fundamental missing component to the delivery of the scheme, financial literacy education was missing. Small holder farmers account for 96% of total current beneficiary count, majority of who were previously unbanked and the first time they access financial services is with a loan product. Lack of financial literacy was having an adverse impact on the portfolio. Through the Equity Group Foundation the bank has been able to appoint 2-4 financial literacy education trainers to teach small holder farmers the basics of financial management (e.g. budgeting, record keeping) and the financial discipline required to service a loan product. The financial literacy education programs are open to all. As a result small holder farmers are slowly changing their mindset from being mainly subsistence farmers to approaching farming as a business. With good record keeping and budgeting skill many small holder farmers have now realized STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 19

that they were growing their crop at a loss and are now more watchful of the cost of production and minimum selling prices. Farmers are also learning the benefit of diversification; not being over reliant on one crop. As a result of the financial literacy education the bank has seen a number of farmers that had bad records that were in the substandard, doubtful and even loss categorizes, approaching the bank with repayment schedules. Another evidence of impact of the scheme is in repeat borrowing with escalation in amounts borrowed and an increase in the sizes of farm land under cultivation. Several farmers indicated that they used to lease farming land and through the scheme now own their farms and have also diversified into dairy farming. Some farmers indicated they now own more land and others that owned their land are now leasing more farming land. There were a number who have reinvested into the farm to purchase farm inputs and machinery. The small scale farmer group s first loans in 2009 increased the livelihoods of the farmers greatly and they gained interest to take up second loans which has helped increase their produce and access to more financial products. The loan application process second time round was easier as the farmers already had bank accounts and a credit history with the bank. Farmers, especially those with children in university level are standing proud on the gains that the Kilimo Biashara Loans are bringing for them and are anticipating taking more loans in the future. An intangible but crucial benefit of the program is increased dignity among beneficiaries through increased incomes and better livelihoods. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 20

Percentage ALLIANCE FOR GREEN REVOLUTION IN AFRICA: IMPLEMENTATION STUDY OF THE EQUITY 4.0 Performance Assessment 4.1 Background to Agricultural Lending in Kenya Lending by banks has been on the increase in general over the years. The chart below highlights the distribution of credit across key segments of the private sector of the economy. As highlighted, overall lending to agriculture went from Ksh. 32.9bn in 2005 to Ksh.41.7 bn in 2010. Although lending has increased in agriculture, its proportion in terms of lending has (decreased from 5% in 2006 to 3.1% in 2010). Chart 1: Total Bank Lending Sectoral Distribution 14% 12% 10% 8% 6% 4% 2% 0% Sectoral Distribution 2006,2008,2010. Agriculture Manufacturing Trade Building and Construction Transport and Comm. Finance and Insurance 2006 5% 12% 9% 6% 7% 4% 2008 4% 11% 12% 4% 7% 2% 2010 3% 9% 12% 3% 5% 2% Source: Central Bank of Kenya, It is of significant concern that lending in agriculture has declined vis a vis other sectors of the economy. This highlights the potential scope and opportunity for increased lending in this sector. The Kiliomo Biashara Loan Scheme has contributed 5%, Ksh 2.02bn, of total lending in agriculture, Ksh 41.7bn. 4.2 Innovations in Agricultural Lending 4.2.1 Overall Financial Systems Innovations Equity experience is beginning to trigger a change in terms of lending to agriculture but it still at the early stages. The scheme however has had a big impact on convincing government that appropriate interventions of this nature can stimulate significant growth in lending to the agricultural sector. Based on evidence presented by AGRA and Equity Bank to the government on the success of this scheme, the GOK in its budget speech has announced the formation of the Kenya Incentive Based Risk Sharing for Agricultural Lending (KIRSAL) scheme. Under this scheme the government has allocated, Ksh 5 billion over four years; as a risk sharing facility to stimulate up to Kshs 50 billion lending by banks to the agricultural sector. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 21

4.2.2 Institutional Innovations There are several innovations that Equity Bank has developed to increase accessibility and efficient and cost effective delivery of services to its customers. Some of the innovations that the bank has developed include the following:- Group lending model for small scale farmers is now being applied to the Kilimo Biashara Small Scale segment. Prior to the group lending model farmers applied individually and were required to make one lump sum repayment at the end of the one year term of the loan. This model provided some challenges to the bank with respect to administration, and early detection of farmer challenges that may result in default. Some of the observed benefits of the group lending model include:- o promoting strong social bonds with group members, increases efficiency administrative concerns such as reduction of cost due to more coordinate visits to farmers in groups based on location, o the group model has an inbuilt savings facility where group members of the group agree on a sum which they are comfortable with and are then obligated to deposit in the savings account either fortnightly or monthly. This assists in the promotion of a savings culture among the group and increase contact between the bank and the group. This helps the bank monitor performance of the group; strengthens interrelations with farmers and detect challenges earlier, o the group lending model now has a monthly paying component. This helps with repayment because small installments normally covers interest by end of loan. Also the monthly installments serve as an early detection system for any challenges facing the group. The bank has also streamlined harmonization of delivery methodology with the seasonal agricultural patterns particular to each region. Some of the ways the bank is accomplishing this is by approaching farmers earlier in the season to ensure they have the money to buy the inputs in time for planting. For example in the Kitale region the main plating season is during the months of March, April and May. The bank begins approaching small scale farmers from as early November through to February the following year. Equity bank has changed is model of lending to small scale farmers. It now disburses enough funds to cover planting season input requirements, that is seed and DAP fertilizer. When the time approaches for the second disbursement the loan officer conducts a visit to the farm to ensure the performance of the crop before recommending the approval or declining of the second disbursement. The use of crop insurance product now available in the market from various insurance companies such as UAP is not very widespread among small holder framers. The crop insurance product s premiums are reasonable at about Ksh 165 STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 22

and are available in areas prone to crop failure. The bank is in the process of including an inbuilt feature especially for the Kilimo Biashara Small Scale product to mitigate this risk. Education programs have been introduced to increase financial literacy particularly for small scale farmers. The introduction of the agency bank 5 model by the Central Bank has helped increase accessibility to financial services in the rural areas. Equity Bank has adopted the use of the agent bank model to reduce distances that rural customers have to travel to access financial services. Agent banks offer all financial services provided by the Bank except for lending services. For instance, a loan scheme beneficiary interviewed explained that it is now easier to access financial services from the agent bank that is 2kms from the farm as opposed to the main Bank branch that is 43kms away. 4.3 Additionality and Mode of Lending 4.3.1 Loan Scheme Disbursements Assessment The loan scheme agreement mandated Equity Bank to extend credit facilities to players in the agricultural value chain, ( persons dealing in farming and or the business of stocking and selling agricultural inputs and or equipment and include but not limited to players in the agricultural value chain such as agro-dealers, agro-processors, agro-inputs, manufacturers and agro-importers and exporters ) based on the existing lending policies and procedures for agricultural loans. In view of that, borrowers were/are required to pledge collateral as per the standing lending procedures. The project so far has been implemented in provinces or areas where Equity Bank is in existence. Cumulatively since the start of the program a total of 45, 408 beneficiaries with total cumulative approved loan amount of Ksh 2,033,114,850 currently as at May. 5 The Finance Act, 2009 amended the Banking Act to enable use of third party agents by banks. Banks will therefore be able to leverage on additional cost effective distribution channels to offer financial services. This initiative is informed by the need to leapfrog access to financial services in Kenya and push forward financial inclusion frontiers. Currently over 5,800 agents have been approved thus far. Source: Central Bank of Kenya STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 23

Chart 2: Kilimo Biashara Disbursement Trend 900,000,000 800,000,000 700,000,000 600,000,000 500,000,000 400,000,000 300,000,000 200,000,000 100,000,000 - Source: SBA Research, Disbursement by Year (2008 - ) Total Disbursements = Ksh 2,033,144,850 108,088,126 787,545,241 737,382,055 400,099,428 2008 2009 2010 * Chart 2, shows the disbursement trend of the Kilimo Biashara loan scheme. Of the current total disbursements 5% were disbursed in 2008, majority were disbursed in 2009 and 20010, 39% and 36% respectively, and 20% in 6. The scheme agreement stipulated the bank would lend US$ 50 million against the loss sharing fund of US$ 5 million. Thus far the bank received US$ 2.5 million of the loss sharing fund and are obligated to disburse US$25 million. Using the mean US dollar rate for the period May 2008 to May 2009, US$1 is equal to Ksh 77.28 we compare the disbursement against the target specified in the scheme of US$ 25 million. The bank has disbursed US$ 26,308,264, (Ksh 2,033,144,850) which is US$ 1,308,264 (Ksh 101,104,776) above the stipulated lending target of US$ 25 million (Ksh 1,932,040,074) as spelled out in the loan agreement. 6 * figures are based on half year performance of the loan portfolio this year, STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 24

Chart 3: Kilimo Biashara Beneficiary Trend Beneficary Count by Year Total Beneficary Count = 45,532 51% 27% 10% 12% 2008 2009 2010 * Source: SBA research, With regard to beneficiaries reached under the Kilimo Biashara loan scheme, chart 3, shows that majority of beneficiaries, 51% were reached during 2009. Thereafter, a declining trend is observed in 2010, 27% beneficiaries and 12% in. This declining trend in disbursements and beneficiaries reached can be partially attributed to the drought in 2009 that resulted in crop failure in many parts of the country. The banks rescheduled some loans mainly to small scale farmers that were adversely affect by crop failure in some regions in the 2008/2009 season, for instance in Nyahururu and Bungoma The Bank over the period 2010 and is in the process of consolidation and recovery. Through the development of more efficient delivery platform for small scale farmers such as the introduction of the group lending model and introduction of financial literacy education the rate of loan recovery in regions with extensive crop failure in 2008/2009 are increasing their rate of loan recovery. The process in both on beneficiaries, especially small scale, and disbursements based on half year results has been increasing. Indications are that lending period will surpass 2010 period. 4.3.2 Additionality in Disbursements Assessment of additionality in disbursements shows that beneficiaries of the program were both established customers already with Equity Bank accounts and first time borrowers. Majority of small scale farmers that make up 96% of loan scheme beneficiary count were previously unbanked. Kilimo Biashara scheme increased access to financial product to many new customers. For instance, at the Nyahururu branch average disbursement was Ksh 29,633 to 2,984 beneficiaries of whom 80-90% were first time customers that did not have a bank account and had never borrowed a loan before the Kilimo Biashara scheme. The same is true for the Bungoma branch that has an average disbursement of Ksh 27,630.53 and 8,923 customers of whom 80-90% were first time customers. This is an indicator that the scheme has reached new previously unbanked customers. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 25

4.3.3 Institutions Modes of Lending An assessment of loan application files at branch level showed individual borrowers, individual guaranteed by a group, individuals guaranteed by another individual who provided tangible security, group borrowers, and agri-business. Currently for 100% small scale farmers the mode of lending used is group lending with individuals guaranteed by group members. For 100% of large scale farmers the mode of lending used is individual with personal guarantee from at least two people that are active account holders with the bank. For agribusinesses the mode of lending is mainly commercial. Annex 1 outlines the loan process for small scale, large scale and agri-business. With regard to mode of loan disbursements, different methods are used for the three product segments, small scale, large scale and agribusiness. i.) Mode of disbursement small scale:- Disbursement to the borrower s account but no direct cash withdrawal is allowed. Banker s cheque payable to the dealer/stockiest or other convenient methods like transfers from the borrowers accounts are used as alternative to cash withdrawal. All disbursements for financing of inputs are done in phases upon verification of crop production stage and signing of post disbursement visit forms. ii.) Mode of disbursement large scale:- Direct payment to the suppliers of farm inputs and/or machinery and equipment vendor. All disbursements for financing of inputs are done in phases upon verification of crop production stage and signing of post disbursement visit forms. iii.) Mode of disbursement agri-business:- Directly to the borrowers account. 4.3.4 Transaction Costs Reduction Transaction cost for loans small scale loans especially those under Ksh 50,000 are high. For instance, each loan requires at least two visits, a pre-disbursement visit and post disbursement visit from the loan officer over the term of the loan. The cost of communication and transportation to make the each visit is about Ksh 3,000. On average total spend for the required two farm visits is estimated at Ksh 6,000. For a loan facility earning 10% interest, Ksh 5,000 it becomes imperative to reduce transaction costs and application processing times. A Loan Application Credit Evaluation (LACE) fee helps offset some to the transaction costs incurred by the bank. From the sample of files examined total average disbursement for small scale was Ksh 47,526.67 and average LACE was Ksh 1,403.83. The bank is using the group lending model to reduce transaction costs and processing times. With the group model the loan officer is able to visit more farmers in the STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 26

same area of coverage as groups are formed on the basis of location, thereby reducing overall costs of transportation. The loan officer also does not have to call each individual group member but instead calls selected group officials thereby reducing communication costs. With regard to application and processing the practice currently being adopted is to hold a group meeting where the loan facility features, the application and required documentation are explained to the group. The group officials are then tasked to collect all necessary documentation which they deliver for processing at the bank. The loan officer will then verify that all documents are in order, if not the group official addresses the shortfall in documentation and returns proper documents to the loan officer. The applications are processed as a group. This model greatly helps reduce transaction costs and processing times for the bank. Average processing times for Kilimo Biashara small scale are the shortest of the customer segments at 15 days, 26 days for large scale and 18 days for agri-businesses. 4.3.5 Size distribution of Loans by Farm Type The scheme beneficiaries have been divided into three distinct beneficiary categories, small scale farmers who borrowed between Ksh 1,000 and Ksh 100,000; large scale farmers and agribusiness. Borrowing limit begins from Ksh 100,000 and upwards, for large scale and agribusiness is determined by security, individual requirement and ability to pay. Charts 4: Total Disbursement and Beneficiary Distribution Total Kilimo Biashara Disbursements Distribution (%) Total Disbursement = Ksh 2,033,114,850 SMALL SCALE LARGE SCALE AGRIBUSINESS. Kilimo Biashara Beneficiary Count Distribution Total Beneficary Count = 45,532 SMALL SCALE LARGE SCALE AGRIBUSINESS. 3% 1% 7% 34% 59% 96% Source: SBA research & analysis, Charts 4 illustrate the disbursement and beneficiary distribution. The total value of disbursements to small scale was 59%, large scale 34% and agri-businesses 7%. Contrast of total value disbursed and beneficiary count distributions show that 96% of beneficiaries were STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 27

small scale. This also points out that 3% of large scale loan scheme beneficiaries account for 34% of the total disbursements value. Chart 5: Disbursements Distribution Trend (2008-) 600,000,000 500,000,000 400,000,000 300,000,000 200,000,000 100,000,000 Kilimo Biashara Disbursements Distribution Trend Total Disbursement = Ksh 2,033,114,850 0 2008 2009 2010 * SMALL SCALE LARGE SCALE AGRIBUSINESS. Source: SBA research and analysis, 100% 80% 60% 40% 20% 0% Kilimo Biashara Disbursements Trend (%) Total Disbursements = Ksh 2,033,144,850 2008 2009 2010 * SMALL SCALE LARGE SCALE AGRIBUSINESS. According to the graphs above in 2008 Equity bank was lending to more small scale farmers and the numbers did increase in 2009 and then a sharp decline as the year ended. It is observed that Equity bank reduced the lending to small scale farmers during 2009 but continued to lend in 2010 to the large scale and agri-business. In it appears that the trend after this period has reversed and lending to small scale farmers has resumed and is on the increase. Chart 6: Disbursements Distribution by Province Disbursement/ Province (%) Total Disbursement = Ksh 2,021,340,199 Central 2% Western 15% Rift Valley 66% Coast Eastern 2% 7% Nairobi 0% North Eastern 1% Nyanza 7% From the analysis of Chart 6, total disbursement is Ksh 2.02 billion cumulatively. The biggest share of 66% has been disbursed in the Rift valley region which has a high potential for agricultural production and also happens to be the most populous region in the whole of Kenya, (According to the 2009 Census, Rift Valley Province accounts for 26% of the country s total population 38,610,097 persons). It is then followed by the Western province STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 28

that received 15% of the disbursements. The north Eastern region and Nairobi received 1% combined mainly because there is hardly any agriculture in those areas. Nyanza and Eastern provinces each have 7%; the central and coast also have 2% each. Central province is a region with high agricultural production potential however only 2% of disbursements have been made in this province. This is partly because Equity Bank has a its traditional lending base in Central province and is already providing credit in this area. Rift Valley and Western are new growth areas for the bank. Chart 7: Beneficiary Count by Province Beneficary Count/Province (%) Total Beneficary Count = 45,408 Central 1% Western 23% Rift Valley 42% Coast 4% Eastern 19% Nairobi 0% North Eastern 3% Nyanza 8% From the analysis presented in the Chart 7 above the total cumulative beneficiaries have been 45,408 that have received Kilimo Biashara from equity bank since 2008. Rift valley still has the biggest number of beneficiaries constituting 42% with western region having 23%. The Eastern region has 19% Cost and Nyanza have 4% and 8% respectively north eastern 3% central only 1%. Source: SBA research and analysis, 4.3.6 Diversification of risk The main risks facing agricultural lending are adverse weather, fluctuations in pricing and lack of market. These three main risks affect farmers ability to repay their loan obligations. Adverse weather conditions that result in crop failure affect both the farmer and facility alike. The bank has partnered with several insurance companies which ones? that provide crop insurance to mitigate the risk of adverse weather conditions. The banks area of coverage for the scheme is countrywide. The bank thereby has diversified risk such that crop failure in one region does not affect the overall portfolio as probability of countrywide crop failure is limited. Fluctuation in pricing whereby the prevailing market prices are below the breakeven price at the time of sale adversely affects farmers and increases the risk of none repayment. The bank has been working in partnership with Kenya Agricultural Commodities Exchange (KACE) to, i) supply inputs to farmers, ii.) supply pricing information in various markets and iii.) to STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 29

assist in market linkages. KACE sponsors a radio program known as Soko Hewani that airs requests for orders of produce and receives supply information from farmers. Through the use of Short Messaging Services (SMS) on mobile phones the farmer is linked with buyers that offer the best price. Small scale farmers are the highest risk group compared to Agri-business and large scale farmers. Equity bank has put several measures such as adopting a group model and introducing monthly repayments to reduce transaction cost and risk of lending to small scale farmers. Farmers are diversifying risk in various ways. The Kilimo Biashara Loan has been mostly taken by farmers to invest in production of maize but most farmers have used a portion of their farms to cultivate other products such as sugar cane, beans, horticultural products and even keeping livestock like cows for milk production and chickens to supplement their produce. These other sources of income are not being used to help repay loans that the farmers have but to help the farmer meet the financial obligations before the harvest season of the maize. 4.3.7 Assessment of Reasons for Taking Credit The main reason farmers gave for accessing credit was to reduce the financial burden at harvest time. Using the loan facility leaves the farmer with more disposable revenue that can be used for other pressing needs at the time, e.g. paying school fees. Another reason given as to why farmers are taking credit is due to observable positive results they have witnessed with their peers that have benefited from the loan scheme. The main purpose for accessing credit for small scale and large scale farmers, over 97% of our sample, was the purchase of seed and fertilizer. Few large scale farmers also used the loan facility for the purpose of purchasing chemicals, 4% of the sample, and 8% of the sample used the facility for purchase of other farm machinery. Agri-business main reason for taking credit was to restock their stores with greater varieties and quantities of stock. 4.3.8 Interest Rates Comparison with Other Banks Currently Equity Bank is charging 1o% interest on small scale loans, 15% interest on large scale loans and agri-business loans under the scheme. The table below shows interest rates being charged by other banks with similar agricultural lending products. Table 2: Bank AFC: Agricultural Finance Corporation Interest Rates Comparison Name of Product Seasonal Crop Credit, Machinery Loans, Agricultural Value Chain Interest Rate Security Fisheries, 15% normal Title deed, Livestock, Cash business loans 15% cash Crops, deposit Horticultural & 10% for group Floriculture, Oil lending Crops Loan Term Max. 3 years STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 30

Bank Name of Product Agricultural Value Chain Interest Rate Security KCB Mavuno loan Tea farmers 13% any valuable Agri-loan All farmers assets like log book, title deed Ngombe Loan Dairy farmers Co-operative Bank Maziwa Loan, Agri-Business Loans, Vuna Kilimon Dairy farmers 12% Farm inputs, machinery, related investments Family Bank Dairy Products Dairy farmers 15% Cash deposit: After deliver milk for 3 months consecutive, get receipts. Get an a loan of equivalent to those amounts Faulu Kenya Ufugaji Bora Dairy farmers 18% Household Nafaka All farmers goods with group saving 20% of the loan amount All farmers 19.50% Collateral savings of 20% Loan Term Max. 3 years Max. 2 Years 12 Months Max. 12 months KADET Mkopo 6-9months Shambani BIMAS Mifugo Loan Dairy farmers 17% 12 months Juhudi Kilimo Asset financing dairy cow loan Dairy farmers 16-18% 12-24months Source: SBA Fieldwork Research, From the data highlighted in the table, Equity Bank s rate is competitive and in fact cheaper than most banks and microfinance institutions in the market that lend to the agricultural sector. Agricultural Finance Corporation (AFC) has similar interest rates to Equity Bank products. Farmer responses about the borrowing experience from AFC told of tedious and lengthy application procedure, high processing charges, land as the only form of security and 15% cash deposit felt as though they were being charged interest in advance. Kilimo Biashara products are competitive and application processes and procedures and securitization requirements are friendlier towards farmer needs than most products in the market. 4.3.9 Loan Distribution by Type of Enterprises All farmers visited have taken loans to produce maize. Some farmers plant the crop purely for commercial purposes while other farmers retain some produce for home consumption. The food crop farmers were mainly planting maize for commercial use but would keep a few bags for home consumption. Loan beneficiaries are engaged in farming over a variety of enterprises from cash crops, food crops, high value crops, horticulture, livestock, dairy, fisheries and many more. Chart 8 shows the distribution of other farming activities that Kiliomo Biashara loan scheme beneficiaries are engaged in. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 31

Chart 8: Distribution of Loan Beneficiary Farming Enterprises 40% 35% Distribution of other Farming Entreprises 37% 30% 25% 26% 20% 15% 14% 17% 10% 5% 3% 3% 0% Cash Crops Livestock Dairy Poultry Fisheries Horticulture Source: SBA Fieldwork, The farming enterprises shown in chart 8 are activities the farmers engage in addition to planting maize. Most of these additional farming activities have been financed through the utilization of other agricultural lending facilities not included within the Kilimo Biashara scheme, whilst others have been financed using gains from the Kilimo Biashara scheme. This is especially true of small scale farmers. The main additional farming enterprises that farmers engage in are dairy farming, 37%, horticulture, 26% and poultry farming 17%. 4.4 Risks, Repayments and Business Model 4.4.1 Returns or losses on AGRA guarantee As at 11 th May total disbursement was Ksh 2,021,340,199. The total risk exposure is 10.43%, and total loss exposure is 4.53%. Chart 9 bellow provides an assessment of the loan portfolio performance. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 32

Chart 9: Kilimo Biashara Portfolio Performance (as of May ) 1,600,000,000 1,400,000,000 Kilimo Biashara Porfolio Performance (as of May ) Total Disbursement = Ksh 2,021,340,199 67.44% 1,200,000,000 1,000,000,000 800,000,000 600,000,000 400,000,000 200,000,000-20.96% 1.17% 2.08% 3.82% 4.53% Current Normal Watch Substandard Doubtful Loss Source: SBA research and analysis, From the above analysis reveals the following observations; Total current farmer and agri-business facilities as of May is 67% of the total outstanding portfolios of Ksh 2.02 Billion. Borrowers in that current portfolio have been in arrears for less than 30 days. Total borrowers categorized as substandard as at end of May is 2.08% of the total outstanding portfolio. These have been delinquent for more than 60 days but less than 90 days. Total loans categorized as doubtful are 3.82% of the total outstanding portfolio. These have been delinquent for more than 90 days but less than 180 days. Total loans categorized as loss is 4.53% of the total outstanding portfolio which is Ksh 91.6 million. These have been delinquent for more than 360 days and are being collected on by third party. Total expected loss as at May is Ksh 210.9 million which is 10.43% of the total outstanding from the classifications substandard, doubtful and loss. 4.4.2 Distribution of Loan Repayments, Outstanding Loans or Loan at Risk Small scale accounts for 59% of disbursements, large scale 34% and agri-business 7%. An examination of the distribution of loan repayments and loans at risk shows that the small STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 33

scale category contributes to the greatest amount of loans at risk, as illustrated in table 10 bellow. Chart 10: Kilimo Biashara Portfolio Performance Distribution 900,000,000 800,000,000 700,000,000 600,000,000 500,000,000 400,000,000 300,000,000 200,000,000 100,000,000 Kilimo Biashara Porfolio Performance Distribution (as of May ) Total Disbursement = Ksh 2,021,340,199 Small Scale Large Scale Agri Business - Current Normal Watch Sub-Standard Doubtful Loss Source: SBA research and analysis, The total portfolio risk exposure is 10.43%, Ksh 210,895,946 of which 9.17%, Ksh 185,281,526 is attributable to small scale, 1.18% or Ksh 23,829,504 to large scale and 0.09% or Ksh 1,784,916 to agri-business. Total loss portfolio loss exposure is Ksh 91,615,281or 4.53% of which 3.8% or Ksh 76,746,485 is attributed to small scale, 0.73% or Ksh 14,694,845 and 0.01% or Ksh 173,951 to agri-business. 4.4.3 Determination and Inspection of Claims Bases on this review the expected loss by Equity Bank is 10.43% and the amount of claims will likely to be Ksh 210,895,946. In order to determine whether the claims were accurate we reviewed a sample of non-performing files. Based on this it appears that the bank has followed the proper procedures for loan recovery and the claims are accurate. The following section 4.4.4: loan monitoring and recovery, describes the steps taken by loan officers during recovery. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 34

4.4.4 Effectiveness in Loan Monitoring and Recovery The consulting team s observations show that the loan officers at branch level know and understand their customer s needs challenges and limitations well. The loan officers know where the farmer and farm is located and continually follow up with their customers. The consulting team did not observe any specific documented predetermined policies and procedures in file that govern loan monitoring and recovery. The steps for loan recovery observed to be used by loan officers were:- Table 3: Loan Monitoring and Recovery Process Loan Days Past Due Classification (DPD) Loan Monitoring and Recovery Process Normal 0 30 days At this stage the loan officer monitors the performance of the loan by keeping in contact with the farmer via telephone and through group events e.g. field days, financial education training etc This constant contact with the farmer allows the loan officer to detect issues with loan performance early and therefore take action earlier. From the first day that the client is late, the agricultural loan officer will call the farmer and alert them of their loan status. Watch Sub-standard 31-90 days 91-180 days If the client does not pay immediately then a Client Contact Form is filled where the client signs a commitment with a deadline when they will clear the balance. At this stage the loans are considered Non-Performing Loans and it is during this stage that Demand Letters are issued. The customer has 14 days to comply with before further action is taken. If the loan is secured, copies of the farmers files are sent to the DRU (Dept Recovery Unit) at the Head Office in Nairobi and Legal Proceedings begin. If the client still does not pay in those 14 days, then a third party is engaged e.g. External Debt Collector/Auctioneer when all the banks recovery efforts are exhausted. Doubtful 181-365 days Loss over 366 days Source: SBA Fieldwork Research, At this stage the third parties will have collected as much of the loan as possible and it is doubtful that the bank would collect any outstanding balance. At this stage all recovery efforts have been exhausted and the loan is considered a loss. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 35

Loan officers use all means at their disposal to recover a debt before engaging third parties for collection. Other processes that assist in loan monitoring and recovery include: Loan officers conducting evaluations to determine validity of application prior to disbursement. Loan officers also perform reference checks with area chiefs and district commissioners on the character and ability to service the credit prior to disbursement. The disbursement of small scale loans is now have a monthly repayment feature that enables loan officers to keep in touch with their customers, The bank also relies on its management information system to monitor loans and prompt loan officers early when loan seems likely to become non-performing. Third party debt collection agents can be quite ruthless in their approach. Therefore the bank tries as much as to use methods that will not damage the social good and brand equity the bank has built with farmers over the years. Village elders and chiefs in the rural areas are still quite respected and carry a lot of influence. The bank works closely with village elders and chiefs to assist with collection with the least social damage to the community. In some cases of massive crop failure in a region the bank will ascertain the farmers that were seriously affected and restructure their loans. The bank has had challenges in collections especially with small holder farmers. The loan officers have had to come up with innovative ways of collections. For instance in most regions farmers know which vehicle the bank uses when visiting farmers. Thus when they see the vehicle they hide from the loan officer or they hide the household goods and or livestock that secured the facility. There were some incidences in Bungoma where farmer groups have taken the bank to court to seek an extension and rescheduling of their loan facility. Some lessons learnt in loan monitoring and recoveries were shared by loan officers. These included:- i.) ii.) Don t lose touch with the customer: the previous model of lending to small scale farmers was in the form of a bullet payment at the end of the harvest season. During the period of the loan, one year, the bank only met the farmer during the application process and disbursement and then at collection after harvest. Changing model of lending to include a small monthly payment and having a post disbursement visit increases points of contact between the bank and customer and ultimately works as an early warning system in case of default. Increase the amount of information collected about the farmer: the bank has changed the documentation process and now collects more information about the farmer and their farming activities (e.g. recording past harvest performance, information on other farming activities, information on other sources of income, STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 36

iii.) iv.) v.) information on performance of current crop and so on) than at the start of the scheme. Advising farmers not to put the entire farm under one crop: The bank encourages the farmer to have an alternate form of daily income. For instance investing in a dairy cow that can give the farmer some daily proceeds by selling the milk to market daily. This will also give the farmer an alternate source of income and an alternate source of repayment. Educating the farmer on farming as a business: most small scale farmers that benefited from the scheme were mainly subsistence farmers. Through financial education training and other technical training e.g. on good farming practices, farmers are now viewing farming from a business perspective and developing the financial discipline to service a loan facility. Educating the farmer on the importance of savings. 4.4.5 Risks facing the Facility and Farmers The major risk facing the bank and farmers alike is weather. Majority of agriculture in Kenya is rain fed thus crop failure due a lack of rain or too much rain is the greatest risk facing farmers and providers of credit. If there is crop failure then the farmer s ability to repay their borrowing for that season is hampered. Disease and pricing fluctuations are also other risks that have been identified. Diversification and mitigation of risks has been covered previously in section 4.3.6 Diversification of Risk. 4.4.6 Facility Roll-out Plan The bank has slowed down its lending rate and is now undergoing consolidation as lessons learnt are beginning to emerge. Disbursements in however are scheduled to be more than in 2010 but less than those in 2009. The bank senior management have??? 4.4.7 Sustainability of Business Model Overall Equity Bank has a strong business model that is capable of significant outreach to smallholders in rural areas. This has been strengthened by the introduction of Agency banking. The model does however require further reinforcement to ensure caveat risks, such as drought in 2009 that resulted in massive crop failure increased risk of default by beneficiaries as a result, are mitigated. 4.4.8 Development of Internal Capacity Equity bank has a widespread branch network, extensive experience in lending to the agricultural sector and the human capacity to implement the program. The bank increased the number of loan officers in agriculture section by at least four staff per branch to effectively deliver the Kilimo Biashara product. All staff at the Kilimo Bank? receives standard bank training and training on Kilimo Biashara products and services. The bank has taken to hiring persons with a strong agricultural background as the Kilimo program requires the bank officer to be well versed in agricultural practice. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 37

4.4.9 Diversification to Other Products New products that have been introduced at the bank include crop insurance products to mitigate the risk of weather. The bank has entered into partnerships with various insurance companies that have a desk at the bank to deliver this product. The bank has also stimulated the use of other products and services by building in systems within the existing products such as the savings component in the group lending product and the use of money transfer services when paying for inputs. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 38

5.0 Other Issues 5.1 First Loss Arrangement Assessment The Bank would have lent to small holder farmers without the risk sharing arrangement however not at this scale and would have been much more conservative when lending to small holder farmers. The first loss arrangement allowed the bank to learn from the lessons of implementing the scheme and determine whether there is a business case for such as product. The bank has demonstrated a strong business case for a product such as Kilimo Biashara scheme. The bank has gained experience and developed appropriate delivery mechanisms to implement the scheme at scale. 5.2 Effectiveness of Committee System The scheme has operated for three years without a comprehensive undying framework that stipulated clearly roles and responsibilities of each party. The scheme has been operating without a joint committee that represents each party. 5.3 Support of Bank s Senior Leadership to the Facility Support of the Bank s senior leadership to the facility, future scaling up and diversifications strategies are very strong. This is evident by the fact the bank has continued supporting and lending through the scheme despite not? having an underlying tripartite framework to work with. The bank has committed to continue lending under the scheme and is looking to introduce such innovative products as it expands regionally. The bank has given full support to the roll out of the facility and is very positive about its impact thus far. Senior management is fully committed to the growth of the product. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 39

6.0 Key Challenges In the course of implementing this project, there have been some challenges which Equity Bank tried to overcome given the experience that is continuously being gathered in the process. These are presented below: Lack of a clear Memorandum of Understanding (MOU) or underlying framework that clearly stipulates partner s roles and responsibilities has hampered operations, reporting and claims process; Political interference with respect to the dissemination of information about the scheme sent mixed messages to beneficiaries that Kilimo Biashara was a government program. Equity Bank had to spend additional time and increase its marketing efforts to articulate that they bore 90% of the risk, and that Kilimo Biashara was not a grant scheme. After farmers are empowered through the scheme and increase their production they are faced with the challenge of limited market. Market access for farmers to sell their produce remains a challenge. The integrity of some stockists has been questionable. Some have been found to be selling bad inputs to farmers after benefiting from the scheme. The maize value chain is not as organized as value chains in other sectors such as tea, coffee or even dairy. Fragmented and disorganized maize value chain increased costs for the bank as they had to educate farmers, develop systems such as group lending for efficient service delivery and develop partnerships such as with KACE to strengthen critical parts of the value chain. Despite these challenges the bank is committed to lending in the maize sector as this will address some food security challenges the country is currently facing. Many small scale farmers never had bank accounts and the first entry in the transaction account was a loan. It was very difficult for staff to implement the scheme at the same time hand hold the farmers at each step of the lending process. Introduction of financial education to farmers has greatly helped in administration and delivery of the lending facility. Equity Bank has learnt from these challenges and has been able to adopt its approach to mitigate against them. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 40

7.0 Conclusion and Recommendations The overall reception of the loan scheme among farmers and agri-businesses has been very positive. The Kilimo Biashara loan scheme has been able to reach 45,408 beneficiaries and disburse US$ 23,780,472. The scheme has succeeded in increasing access to financial services to previously unbanked small holder farmers and helped transform livelihoods. 7.1 Key Findings and Insights Based on a review of the scheme, our key findings are as follows: The risk sharing mechanism has effectively facilitated increased lending to the agricultural sector. Equity has been able to meet the leveraging requirement above the ratio of 10 to 1 outlined in the scheme agreement. Business model: equity has shown tremendous ability to adapt and tailor the facility to the customer. Particularly how the bank has been able to mitigate challenges faced with small scale farmers and have moved to the group lending. Overall this scheme has proved that lending to the higher risk value chains in agriculture, like maize, can actually be a profitable experience. Despite an expected loss of 10.43% the scheme has generally been well managed. The financial literacy training has had a positive effect on customers. These are new customers that have never had experience with a lending institution. Thus financial literacy education is a critical component to successful implementation of the scheme. The importance of having clear expectations among all stakeholders to avoid political interference and mixed messages about the scheme. Some key achievements of the scheme include:- o The Bura irrigation scheme (rice) has been revived after 20 years of dormancy due to credit facilities afforded to eligible beneficiaries by the bank; o Lending in crop value chains has increased where previously lending was limited e.g. rice and sorghum farmers; o Establishment of successful partnerships with key players in the value chain. For example working with the World Food Programme (WFP) in developing market linkages to buy maize. The Bank has also been working with very poor smallholder farmers in under the Millenium Project in Siaya County in Nyanza province. A number of farmers have been able to move from subsistence farming to more sustainable farming as a business. o The success of the scheme thus far has prompted the Government of Kenya (GoK) to develop a larger scheme to incentivize and attract more banks to lending in the agricultural sector. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 41

7.2 Recommendations In line with the findings above, we propose the following recommendations: Equity bank should continue to be supported under this scheme to reach more farmers. There is a need to come to a clear understanding in the MOU on how to go about the claims process. It appears that this has not taken place during the period of the agreement. Undertake formalized documentation of policies and procedures developed under this scheme. The government and AGRA should look into providing more technical support to the bank in the roll out facility to a wider audience. The bank has been shouldering the responsibility of training and value chain development. To increase the rollout of the program greater technical support and partnerships are required. The Kilimo Biashara project has overall been very well received, has been moving along well and has had various successes. There is a need to consolidate the business model to deal with some of the challenges and risks identified but growth prospects look positive. STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 42

Annexes Annex 1: Kilimo Biashara Loan Process 1. Kilimo Biashara Small Scale: Loan Process Farmer obtains MoA recommendation and pro-forma invoice for inputs required. Customer approaches the bank for the loan at least one month before planting time Initial meeting conducted; Fills an application form (assisted by Relationship Officer- Agriculture credit) Appraisal done by Relationship Officer-Agriculture Credit (Farm and residential visits must be conducted) Loan Request Presented to Branch Credit Committee for approval (branch approval limits apply) and/or recommendation to HOCC Documentation (full particulars of items taken as chattels to be listed) Security Perfection Disbursement by phases (All disbursements subsequent to the first disbursement must be accompanied by visit report) Note: No subsequent disbursement should be processed in case the crop has failed at the preceding stage. Monitoring & follow Up as per Agriculture Credit Procedures Farmer obtains MoA recommendation and pro-forma invoice for inputs required. Customer approaches the bank for the loan at least one month before planting time Initial meeting conducted; Fills an application form (assisted by Relationship Officer-Agriculture credit) Appraisal done by Relationship Officer-Agriculture Credit (Farm and residential visits must be conducted) Loan Request Presented to Branch Credit Committee for approval (branch approval limits apply) and/or recommendation to HOCC Documentation (full particulars of items taken as chattels to be listed) Security Perfection Disbursement by phases (All disbursements subsequent to the first disbursement must be accompanied by visit report) Note: No subsequent disbursement should be processed in case the crop has failed at the preceding stage. Monitoring & follow Up as per Agriculture Credit Procedures STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 43

2. Kilimo Biashara Large Scale: Loan Process Farmer obtains pro-forma invoice for inputs and/or machinery/equipment required. Customer approaches the bank for the loan at least one and half months before the due date of utilization of the funds Initial meeting conducted; Fills an application form (assisted by Relationship Officer- Agriculture credit) Appraisal done by Relationship Officer-Agriculture Credit (Farm and residential visits must be conducted) Loan Request Presented to Branch Credit Committee for approval (branch approval limits apply) and/or recommendation to HOCC Documentation (full particulars of items taken as chattels to be listed) Security Perfection Disbursement by phases (All disbursements subsequent to the first disbursement must be accompanied by visit report) or as per the sanction conditions for HOCC approved loans. Monitoring & follow Up as per Agriculture Credit Procedures 3. Kilimo Biashara Agri-Business: Loan Process Customer approaches the bank for the loan Initial meeting conducted Fills an application form (assisted by Relationship Officer- Agriculture credit) Appraisal done by Relationship Officer-Agriculture Credit (Residential and agri-business visits Must be conducted) Loan Request Presented to Branch Credit Committee (branch approval limits apply) for approval or recommendation to HOCC Documentation and security perfection Disbursement Monitoring & follow Up as per Agriculture Credit Procedures STRATEGIC BUSINESS ADVISORS (AFRICA) LTD Page 44