How financial institutions can create a climate-smart future for the agricultural sector

Rising temperatures, erratic rainfall, and extreme weather events are threatening food security and the livelihoods of those who depend on agriculture, particularly smallholder farmers. As climate change intensifies, transitioning the agri-food sector towards low-carbon and more resilient systems is no longer an option, but a necessity to guarantee farmers’ participation and competitiveness in the future. However, this transition requires immediate and significant investment in climate smart agriculture (CSA) technologies and practices.

As climate change intensifies, transitioning the agri-food sector towards low-carbon and more resilient systems is no longer an option, but a necessity to guarantee farmers’ participation and competitiveness in the future.

Climate-smart agriculture: A win-win for all

Climate-smart agriculture (CSA) integrates practices that enhance yields, resilience, and mitigate climate impacts across the agricultural value chain. Despite the estimated need for significant investment in CSA, current climate finance falls short, with only a small fraction allocated to the agricultural sector compared with other sectors such as energy and transport.

It is estimated that agri-food systems need US$260 billion per year in annual climate-smart investments (World Bank Group 2024), but only 4.3% of the total climate finance tracked in 2019/2020 went to the agriculture, forestry, and land use sectors (AFOLU), of which 85% came from public sources (CPI, 2023).

Private financial institutions can fill this gap by providing financing for CSA solutions, leveraging market opportunities while managing risk. By investing in CSA, financial institutions not only contribute to a greener future but also benefit from more resilient and better-performing agricultural portfolios.

By investing in CSA, financial institutions not only contribute to a greener future but also benefit from more resilient and better-performing agricultural portfolios.

Financial institutions can turn CSA from a niche concept into a mainstream reality, by:

• Anticipating farmers' needs and developing tailored financial products such as CSA loans and weather-index insurance products specifically designed for climate-smart practices. Some CSA solutions, such as agroforestry systems and coffee renovation with climate-adapted varieties, require long-term investments (6 to 10 years). To support the adoption of such solutions, financial institutions should design CSA loans that consider payment terms and grace periods specific to the crop cycles and expected returns.     
• Incentivizing the adoption of CSA solutions and rewarding climate smart farmers through variable interest rates linked to climate performance, rebates, discounted insurance premiums and non-financial services. For example, farmers in areas of elevated risk of drought that adopt water harvesting practices and drip irrigation systems could pay a lower interest rate than conventional farmers.
• Understanding physical and transitional risks affecting agriculture portfolios and by conducting climate scenario analyses and stress tests for smarter climate-related decisions to capitalize on emerging opportunities. These analyses will help FIs evaluate the portfolio's resilience, detect financial risks beforehand, and adjust lending strategies.
• Adopting risk management tools that factor in climate risks throughout the loan cycle. There is a rising number of digital solutions that can assess climate risks in agricultural portfolios. By integrating historical and real-time data (including satellite and drone imagery) with simulation models and machine learning algorithms, these solutions can estimate borrowers’ repayment capacity and assess portfolio's exposure to climate risks (IFC, 2024).
• Investing in digital platforms that connect farmers to markets, weather data, and agronomic advice, empowering them to make informed decisions and adopt climate smart practices.
• Building capacity and knowledge by partnering with local organizations (NGOs, research institutions, governmental agencies) to provide training and technical assistance to farmers on CSA practices and financial management.
• Establishing value chain partnerships that link input and CSA technology providers, processors, wholesalers, traders, and FIs. By pre-arranging produce purchases, farmers can gain better access to financing, enabling them to adopt CSA solutions. In return, farmers and other upstream actors - will ensure a reliable supply of climate smart produce in the face of a changing climate. In the Philippines, IFC partnered with CARD SME Bank, one of the largest microfinance organizations in the country, to boost their capacity to finance CSA solutions for farmers. This initiative includes advisory support, capacity building, and fostering partnerships with CSA technology providers. CARD SME Bank will facilitate farmers' access to these technologies and introduce a tailored underwriting process to better assess agricultural risks.

Mobilizing private capital for climate-smart agriculture through financial institutions offers numerous advantages, including simplified fund delivery, reduced transaction costs, and broader outreach to diverse farmers.

Mainstreaming climate finance through FIs

Mobilizing private capital for climate-smart agriculture through financial institutions offers numerous advantages, including simplified fund delivery, reduced transaction costs, and broader outreach to diverse farmers.

Blending concessional finance with commercial funds, facilitated by risk-sharing instruments, further stimulates investment in CSA. Concessional finance has a multiplier effect, as each dollar of concessional finance can mobilize four dollars of commercial finance (GDPRD, 2024).

The International Finance Corporation (IFC) exemplifies this through its investments in global CSA projects, like in Kenya, where a $100 million loan to Equity Bank supported more than forty-seven thousand smallholder tea farmers to adopt CSA solutions, such as solar energy equipment, climate-resilient seeds and appropriate fertilizer use. In Brazil, IFC provided a $100 million loan to Banco ABC Brasil S.A. to enable the bank to strengthen its operational capacity and expand its climate portfolio in climate-smart agriculture lending, as well as by contributing to certified biofuel production.

Investing in CSA finance transforms FIs into partners, not just providers, in fostering a resilient agricultural sector crucial for ensuring food security.