How Trust-Based Lending is Transforming Fair-Trade Supply Chains

By Kate Danaher

Many of us rely on a cup of coffee to kickstart our day. Few realize that our ritual is endangered: the plant producing the beans for our morning pick-me-up is under threat. Coffee experts describe the fight against “la roya,” or leaf rust, as a war. Who’s fighting on the front line? Small-scale coffee farmers and their families, who typically don’t have the financial reserves to deal with the hit on production and income caused by this vicious disease.

Coffee leaf rust is a fungus that creates rustlike patches on coffee plant leaves. The patches turn black, the plant’s nutrient supply is cut off, and eventually the plant may die. Farmers facing the highly contagious disease must replant their land. However, it takes three years before a coffee plant is mature enough to produce a large crop of beans, so farmers face the triple impact of a reduced income, the cost of replanting, and a three-year wait for a salable crop. Despite growing demand for coffee, farmers struggle to get access to credit to build their resilience against this disease.

Small-scale suppliers lack access to credit

Coffee farmers aren’t the only fair-trade suppliers dealing with a lack of access to affordable loans. The U.S.-based fair-trade brands that RSF Social Finance works with often tell us that they’d like to buy more from their local suppliers or help those suppliers capture more value for their communities, but a dearth of available credit hampers suppliers’ growth.

Why is finance in such short supply? Trade finance—designed to provide the short-term financing farmers need while growing, harvesting and selling their products—is well established, but capital expenditure (CapEx) financing, enabling smaller enterprises to acquire or upgrade physical assets, is not.

Many fair-trade suppliers lack access to lenders specializing in small and midsize enterprises, and even when they have access, the loans are often too costly. Underwriting a small loan is just as time-consuming and expensive as underwriting a large one, and the risks involved in lending to small-scale suppliers are greater. Few local suppliers have the collateral needed to secure a loan, and many don’t keep the kind of detailed records needed to prove credit-worthiness to a bank. The result is that even when a supplier can get loans, the interest rates start at 12 percent and can be as high as 30 percent. Small fair-trade producers can’t afford that, especially when the loans terms are three to five years.

Trust underwriting enables affordability

The issues around funding fair-trade supply chains got an airing at a panel I hosted at SOCAP in 2015. Since then, a handful of lenders have come forward with different approaches to bridging the funding gap.

At RSF we’ve developed a unique program based on trust underwriting. We partner with fair-trade companies we know well (our borrowers and former borrowers) to provide loans to their suppliers through our Fair Trade Capital Collaborative. We make our decisions based on our relationships with these companies: we trust them, so we’re willing to rely on them to accurately assess the reliability of their suppliers. That means we can forgo some aspects of traditional due diligence and deliver affordable loans to those suppliers. By saving on the costs of sending someone to a remote part of the world to assess the risk and then writing a complex loan agreement, and by drawing on philanthropic rather than investment funds, we’ve been able to keep rates under 10 percent. And in line with our integrated capital approach, we also fund technical assistance, which small-scale suppliers often need to succeed.

Equal Exchange, a provider of organic, fair-trade coffee, chocolate, cocoa and other products, was one of the first to take advantage of trust underwriting. On the basis of our relationship with Equal Exchange, we have provided loans to three coffee cooperatives in Chiapas, Mexico, allowing them to replant with leaf rust–resistant varieties. We also provided them with a technical assistance grant to support field-based training on organic soil management techniques that aid in the fight against la roya. The result is more resilient coffee farms and a continuing supply of fair-trade coffee for Equal Exchange.

Our latest trust underwriting relationship is with Guayakí, an organic yerba mate beverage company that’s committed to restoring the Atlantic rainforest in South America. Guayakí exclusively sources its main ingredient from cooperatives and small-scale farmers who harvest yerba mate from under the rainforest canopy. While it has a reliable supply of this caffeinated plant native to the rainforest, it’s been unable to find a local processor that can keep up with Guayakí’s growing need for drying and milling the crop. RSF has partnered with Beneficial Returns, which specializes in loans to social enterprises in emerging markets, on a loan to Guayakí that solves this challenge. Our financing will enable Guayakí to build and outfit a processing facility in Brazil that will meet its volume and quality needs while creating more jobs for local people.

Lenders take steps in the right direction

In the same way that consumers support fair-trade companies, I’m optimistic that lenders will start to find ways to support fair-trade suppliers at affordable rates. The growing awareness of the challenges of financing fair-trade supply chains is the first step toward more innovation in the sector. The seeds have been planted: alongside RSF Social Finance and Beneficial Returns, Root Capital is also providing local suppliers with affordable CapEx financing.

The fair-trade movement has already transformed the lives of thousands around the world, and with greater investment, fair-trade supply chains could transform entire communities.

Kate Danaher is senior manager for social enterprise lending and integrated capital at RSF Social Finance (@RSFSocFinance), an innovative lending, giving and investing organization based in San Francisco.

Image credit: Carly Kadlec, Equal Exchange