Executive Summary

Small and medium enterprises (SMEs) have difficulties accessing credit to grow their operations. Regularly, SMEs operating in agricultural value chains (AVC) face even bigger difficulties, because (micro)financial institutions (FIs) preconceive agriculture as excessively risky and do not make efforts to understand business models of agri-SMEs. So far, the experiences of agricultural SMEs in Ethiopia have hardly been studied. Yet, within the reform agenda of economic and financial sector policies of the Government of Ethiopia (GoE), SMEs in general and agricultural SMEs in particular, will be increasingly important. They contribute to innovation and modernisation along AVC and the creation of jobs. Therefore a study on ‘barriers to access to finance for agricultural SMEs in Ethiopia’ was conducted. The field study stands out by its carefully stratified sample of agri-SMEs, not micro enterprises as in most other studies. The 61 SMEs interviewed are active across all stages of several AVC, most of them in cereals, dairy, and vegetables/ fruits. Furthermore, the field study surveyed 15 financial institutions: banks, microfinance institutions, insurers, leasing companies, and an investment fund. The SMEs affirmed that access to finance is an important challenge for them. Interestingly, it is one among four main challenges, which are: 1) market linkages; 2) technology; 3) access to finance; and 4) inflation. The GoE has recently established a legal framework for leasing operations, which is the first segment of the financial sector opening for foreign direct investment. Still, the respondents from (public) leasing companies related that the shortage of foreign currencies is the main constraint for their services. This is a macro-economic constraint that negatively affects the credit markets as well. Most tangibly, it takes away incentives for financial institutions to build capacity in agri-finance, because of the existence of sufficient easier and less costly-to-assess credit applications from other economic sectors to choose from. This allows them to apply exorbitant collateral-to-loan ratios, reflected in substantially below market valuation of built property pledged as collateral. This in turn fuels fears of SMEs to lose their property unfairly when loan schedules ill-align with their business models which lead to repayment irregularities. The conducted field study is the first to reflect in detail the demand-side barriers of Ethiopia’s agri SMEs. It confirms the literature focussing on SMEs that financial management practices and systems are often weak and thus do not generate the reports required by lenders or investors. Different from much of the literature, AFC’s study argues that overconfidence of entrepreneurs about their financial management (skills) are key to these weaknesses. This results in the recommendation that capacity building should be designed differently than common training concepts; in particular by focussing on specific management practices and not broadly on entrepreneurship; and by integrating a mentoring approach. In line with the desk study, the field study affirms that collateral and non-transparent procedures are major supply-side barriers. SMEs therefore often prefer semi- and informal finance, often from suppliers. This points out the potential for AVC finance; a concept for which Ethiopia’s FIs still lack capacity. The study findings and recommendations are being shared with interested stakeholders to inform Ethiopia’s reform processes and eventually strengthen agri-SMEs to contribute effectively to Ethiopia’s development.