Main Limiter for Crediting Ukrainian Ag Sector. Interview with Mr. Gary Reusche and Mr. Thon Huijser. Part 1
Mr. Gary Reusche, Agricultural Finance and Insurance Expert, advisor to the Management Board of Bank Credit-Dnepr in Agricultural Lending, Professor, worked as IFC (World Bank) Senior Operations Officer in Ukraine (eight years).
Thon Huijser is agri banker who worked most of his career with Rabobank in the Netherlands, has 35 years of banking and international agri-finance consultancy, including 5 years in Ukraine.
UkrAgroConsult: In the article “The Concept of Partnership with the Country: the Focus and Interaction” you point that agri-crediting is the business of commercial banks. Under the ‘bank-falling’ in Ukraine (for the last three years the National Bank of Ukraine has closed around 90 banks), what is, by your opinion, the main limiter for the bank crediting of agro sector in the country – unstable (groggy) position of the farmers, unstable position of the banks themselves or unwillingness of the agrarian managers to deal with banks due to too high interest rate and their requirements for reporting?
→→: First of all, Ukraine should celebrate the closing of 90 banks which means that corruption in the banking sector is less, and Ukraine is moving to an internationally compliant regulation of the banking system according to the Basel norms for the first time.
You mentioned a combination of factors that are likely to be mitigated in the near future. This question needs to be answered from both the perspective of the bank, the perspective of the agricultural producers, the perspective of the Ministry of Agrarian Policy, and the National Bank of Ukraine. This answer is a simplification.
Let start with the bank, as it is indicated, there are banks that can lend to small and medium agricultural producers today. They are ready to grow this business. There is a large market waiting to be developed.
However, only a few banks have developed staff and systems for this market. The bank management must decide to enter this market and invest resources to develop staff and systems. It takes a least a couple of years for an agricultural team and bank systems to develop. I know this because I have been doing this work with banks for years. It is a specialized market. Banks that have developed this capacity can assess clients and approve qualified loans. The proof of the competence of the agricultural team is measured by NPLs and of the banks’ loan workout team by the actual write-off losses. This part of the equation is relatively simple. But these banks need to be distinguished from other banks that do not have the expertise and developed systems. I will call the banks with the expertise: agriculturally competent banks, or “AgBanks”. I will explain why under the perspective of the farmer producer.
AgBanks have the capacity today to assess clients and cash flows and recommend the loan to the credit committee. This market will grow quickly with the success of reforms.
At the credit committee of the AgBank, the bank management will look at the credit from their perspective. Here they will be concerned about the staff and operational costs to process and monitor these loans, and the portfolio risks associated with agricultural lending. And they will be concerned with the Basel rules applied by the bank regulators to maintain an adequate capital for safety and soundness.
Because of the National Bank of Ukraine rules & regulations, the amount and quality of collateral impacts directly on the regulatory requirements for the bank’s capital adequacy. Lack of collateral impacts directly on the bank’s ability to provide credit. Even if the bank does not seek to acquire the land collateral in the case of a non-performing loan, the regulator will play a role in the decision of the bank management.
The next major issue for a bank is the interest rate that will be charged. When this process is understood, the interest rate for the loan becomes transparent, and the prognosis for the future predictable.
UkrAgroConsult: Then, what is about perspective of the agricultural producers?
→→: We move to the perspective of the farmer, producers, agribusiness SME. From recent experience, independent farmers and producers are skeptical of most banks, and have very little trust in the Ukrainian banking system. This is fully understandable. Some reasons are given below.
Since privatization, Ukrainian banks have requested loan applicants to produce a great deal of documentation, causing the producer to spend huge amounts of time to apply for and, possibly, receive credit. This is a real transaction cost for the farmer. It is my observation that banks without proper agricultural staff require excessive documentation— the less they know about agricultural production, the greater the amount of documentation they require. It is a sign of their lack of understanding of the realities of agricultural production and marketing.
A second reason for the lack of trust in banks is due to the moratorium and a general sense that the issue of land is the subject of corrupt and non-transparent political processes. There is a fear that dealings with any bank may put their land and livelihood at risk. Staying away from banks is a risk management strategy until the situation and environment is clear. As indicated in the expression to the World Bank, there is not level playing field and the small and medium sector receive only nice words from the government, but no concrete actions to allay their fears and help them to grow.
Finally, the interest rate and the tenure of the loan are not interesting. The farming community blames the bank for the high interest rate, instead of understanding that banking is simply a margin business. The interest rate a bank client needs to pay is based on:
- the cost of funds: the interest a bank needs to pay to attract external funding, for instance, deposits from savers, loans from other banks or its central bank +
- a margin to cover its operational cost (e.g. costs to arrange the loan, paying staff, renting offices etc.) +
- percentage points related to risk i.e. the actual loan losses (write-offs), related to a banks’ NPL-percentage - The lack of unambiguous jurisprudence with respect to ownership rights, and the very lengthy legal procedures, affect the practical enforceability and the recovery value of security provided to banks. As a result banks do face higher write-offs compared to a situation in which the legal framework and judiciary is adequately functioning. Hence, the lack of judicial reform increases significantly the interest rate on any loan in contemporary Ukraine -; +
- A profit margin for the bank – This tends to be not more then 1-2% i.e. a marginal part of the total amount of interest the client needs to pay.
The following is an example of how a bank arrives at the interest rate. Most of the farmers in Ukraine (and in North America and Western Europe) try to minimize their loans and self-finance their working capital. But they often need available short-term finance to run their business. Today in Ukraine much of the working capital is provided by “trade credits”, or input suppliers who provide inputs at the start of the season and receive payment at the end of the season. Usually the scheme starts with the importer of the inputs, which is then provided to regional input distributors, who in turn provide the input to the producer. Up to now, much of this system was not collateralized. One needs to ask why.
At the same time, these suppliers credit usually carry a significantly higher effective interest rate compared to bank loans, which can be explained by the lack of collateral, but even by the fact that suppliers are not banking specialists, i.e. they are unwillingly engaging in banking.
When banks would focus on banking i.e. providing adequate working capital (crop loans), suppliers can focus on providing supplies, and farmer can focus on farming.
In addition to seasonal working capital, the producers will need credits for 3-5 years for equipment and storage facilities. Today, many Ukrainian banks cannot provide loans for more than one season due to the current market conditions. Some of the international banks have access to funds for more than one season, and don’t have this restriction. So many small and medium producers need loans for more than one season, and the banking sector has difficulties to provide such loans.
UkrAgroConsult: What about loans for land acquisition?
→→ I have stated that farmers will need loans up to 20 years to purchase land. But there are other options. For example, do Ukrainian farmers really need to own the land?
From a pure financial aspect the simple answer is no. Why? Let’s assume the following:
Land lease cost are around USD 100-150/ha/year;
Price of land, assume the Ministry of Finances’ pro forma USD 3,000/ha
NBU “Key policy rate” is 14% (12/31/2016)
Ukraine mortgage rate is 22.3% (Ukraine.depositis.org/loans/ December 2016)
farmer needs to borrow 50% of the purchase amount
Under these assumptions, buying farmland in Ukraine at USD 3,000 when deposit rates are 14% and land lease cost are ‘only’ USD 100-150/ha/year, does not make any economic sense
Own land purchased at USD 3,000/ha, 50/50 own funds/bank loan: USD 3,000*50%*14% (Key policy rate) + USD 3,000*50%*22.3% (Ukraine mortgage rate) = USD 210+USD334.50 = USD 544.50/ha/year. This is excluding cash required for repayment obligations and the fact that the loan for land acquisition ‘eats’ into the total lending capacity of the farmer.
UkrAgroConsult: Land issue is now one of the keys to real farmer development in the country. The main player in this regards is the state authorities. What about Perspective of the government?
→→: Then we move to the perspective of the government. I stated in my paper that there is no option to provide credits to small and medium producers except by commercial banks. Does anybody still believe that the government will provide the finance? Or donors? I hope not.
My proposal is that the government provides services to the producers to increase the lending to small and medium producers. In other words, how can the government partner with AgBanks to increase access to finance. The answer in my opinion is to understand how a bank makes money, and reduce the staff requirements to assess clients and monitor portfolios. And, of course, to remove the moratorium. This includes government funded training for small and medium producers in rural areas to establish and grow a viable business, to employ a modern MIS (Management Information System) for their farm operations such as eFarmer, and prepare high quality credit applications for loans.
In addition, the government needs to complete the establishment of a sound banking environment. Besides rules & regulations it should focus on aspects to bringing down interest rates such as fighting inflation and creating a reliable judiciary.
Additional Notes are:
Cash Flow Based
Crop loans should not be considered on the basis of collateral. The size of crop loans is to be reviewed on the crop plan, direct crop expenses, and the cash cycle. The latter among others depends on the inputs, growth period, post-harvesting activities, terms & conditions in the relevant value chains;
The repayment capacity for crop loans is a function of the crop margins/ha/year;
The provision of crop loans should neither be linked to other debt nor to collateral but rather to the actual crop cash flow. When a farm would not be able to generate sufficient cash to meet its debt obligations, it might still qualify for a crop loan provided its crop margins/ha/year are positive following interest on the crop loan.
NBU Rules and Regulation
Banks are not constrained by the moratorium on the sale of land itself, but by the rules & regulations of the National Bank of Ukraine (NBU) as long as these rules require a minimum collateral coverage also for crop loans;
The access to finance (A2F) for Ukrainian farmers will improve when NBU rules & regulations allow cash flow-based lending as alternative to collateral-based lending;
Cash flow-based lending requires more in-depth knowledge, but this can be transferred via agri-banking courses.
Note: the views of the interviewer and the interviewees may differ