Innovative Approaches in Rural Finance for Early Transition Countries

1. 2006 Annual MeetingRound Table 1: Rural Finance - Innovative and Promising Approaches in Early Transition Countries Tomasz Lonc Policy Officer FAO Subregional Office for Central and Eastern Europe

2. Credit policy assumptions and establishment of a specialist agricultural bank An agricultural policy point of view, based on project experience1 1/ TCP/BIH/2901 “Assistance in the preparation of the national Poverty Reduction Strategy Paper” (PRSP) Report of the final project workshop, Sarajevo, 27 January 2005, Summary of papers and discussions; policy options and recommendations; Prepared on the basis of project technical papers and project workshops by the Policy Assistance Unit - SEUP, FAO Subregional Office for Central and Eastern Europe, Budapest.

3. Macroeconomic fiscal policy and agriculture • Bosnia and Herzegovina (BiH) has a well functioning currency board system that has prevented inflation and secured macroeconomic stability. The exchange rate was recently recalculated and fixed to the €. • While this system is seen as successful, it has not solved the issue of crediting the economy and especially the food production sector which is the most vulnerable part of the economy. • The currency board is often criticized by national economists who promote the idea of modest inflation that would boost investments. In conditions of a restrictive monetary policy, financial instruments that could be used for development of the agricultural sector are few.

4. Government credit policy • Declared Government credit policy aims are to improve the competitiveness and the income generation potential of farms. • However comprehensive evaluations of the on-going and completed donor-funded credit programmes that would show that this has been achieved are not readily available. • Further, subsidies to interest charged on credits, do not resolve the problem of collateral. • Soft credit terms may in fact give wrong signals to producers. • A basic problem of past soft credit lines was that they were being given on the basis of social rather than economic criteria.

5. Objectives and instruments of rural credit policy • The government may wish to reconsider the objectives and instruments of rural credit policy, in particular subsidizing interest rates on loans. • Subsidizing interest rates on loans will not resolve the problem of lacking collateral. • Potential borrowers’ poor reputation needs to be addressed as well increased availability of working capital loans (small scale loans for small farms). • The appropriateness of banking technology, screening and monitoring by banks is a serious technical constraint.

6. A special bank for agriculture • Strong support was expressed for the proposal to • establish of a special bank serving exclusively the credit needs of the agricultural production sector or, as an alternative, • a special, independent credit line that would finance agricultural activities1/ • It was recorded that a most realistic although a long term and difficult to implement option, is the establishment of a broad network of savings and credit associations with a nationwide presence. 1/ A decision of the FBiH Government is pending to transform an existing bank into a development (credit) agency with the task to manage donors’ funds that are intended for crediting of local economy.

7. Rural Credit Guarantee Schemes A Financial Instrument for Agriculture and Rural Development

8. Seminar on “Rural Credit Guarantee Schemes - A Financial Instrument for Agriculture and Rural Development” took place in the FAO Subregional Office for Central and Eastern Europe on 12 and 13th January 2006.

9. The underlying rationale was to exchange best practice and lessons learnt by Western Europe institutions and economic agents with their Central and Eastern Europe (CEE) counterparts.

10. Difficult access to rural credit is mainly due to (i) stagnant agricultural markets, (ii) high risk and (iii) low profitability of farming, and, last but not least, (iv) lack of collateral. As a result, economic entities that in many cases do not qualify for standard bank loans are referred to guarantee schemes. There is increasing interest in transition economies in these schemes and guarantee funds have been used in a number of countries to offset risks from lending to the agricultural sector. They have also been used as an instrument to reduce risk of start up operations through guarantees schemes, which are subsidized.

11. The seminar agenda included: (i) a review of the experience of national rural finance institutions providing credit guarantees, and (ii) technical sessions on relevance and financial additionality of guarantee schemes for rural development and assessment and monitoring of specific risks in agri-business and (iii) public policies for moderation of structural risks in rural development. The seminar participants also analysed the issue of support to credit guarantee schemes from the state budget.

12. Main points • As presented and analyzed by both Western and CEE participants, the vulnerability of the agricultural sector frequently results in gaps: communication, institutional, technical between agricultural entities, rural SMEs and the potential creditors. Thus, there is a clear need for an intermediary, such as guarantee schemes, between these sides. • Beneficiaries of rural credit guarantee schemes are usually farmers, miscellaneous agricultural entities, processing companies, businesses in rural areas e.g. rural tourism, but also local councils developing rural infrastructure etc. In most cases, the issued guarantee concerns long-term and short-term credits of up to 70% of the unpaid loan amount; (in the case of young farmers this may increase up to 80%).

13. Main points 2 • Rural development requires attracting and sustaining rural investment which promotes employment, income generation and asset growth. Specific conditions must be fulfilled – a supportive operating environment, suitable financial products and services and attractive returns to investment. • Guarantee schemes play a key role in boosting entrepreneurship as demonstrated by the region wide experience of AECM. Guarantee schemes encourage entrepreneurship by compensating lack of or insufficient collateral, providing access to longer term loans, and providing advice and coaching to the clients. • Guarantee schemes are usually a mix of private and public initiatives and tend to involve entrepreneurs directly or indirectly in the shareholding, decision and management process.

14. Main points 3 • Public support is necessary since it provides equity and protection in order to reach higher leverage and efficiency. Some schemes are completely public as the case with Instituto di servizi per il Mercato Agricolo Alimentare (ISMEA), a government agency in Italy, whose institutional role is collection of and processing economic data on rural markets, preparing and publication of financial and economic reports on developments in the rural economy in Italy, against a background of sector and macro-economic trends. Its rural credit guarantee scheme activities are supervised by the Ministry of Agriculture and Forestry Policies. • Other credit guarantee funds have a mix of shareholders, including from commercial banks, public entities and entrepreneurs.

15. Policy constraints • State aid plays an important role. The state guarantee is an indirect subsidy from the central budget and an efficient financial instrument to fulfil goals of government economic policy. • Its principal function is assistance to entrepreneurs, to obtain credit necessary for investments or to restructure the enterprise. • The Lithuanian Rural Credit Guarantee Fund was chosen as an instrument for business development in rural areas and to foster lending processes since starting a new business in rural areas without owning property would not be possible. • The experience of Lithuania shows that without state aid in the form of credit guarantees, a major part of economic entities would not be able to obtain a bank loan. • EC Phare and SAPARD have provided funding and technical assistance to a number of rural credit guarantee schemes, such as the Hungarian Rural Credit Guarantee Foundation and Rural Credit Guarantee Fund in Romania.

16. Policy conclusions and recommendations • Rural credit guarantee systems were found to be a functional financial policy instrument to resolve some of the problems faced by farmers and rural entrepreneurs that apply for loans without a credit history and face poor rating by banks. • This is in particular true in the transition to market economy period, when emerging private farms lack collateral, among other since land markets do not function. It is to be noted, from a policy point of view, that this niche for support policy will gradually disappear as reforms are implemented, farms accumulate assets and incomes increase.

17. Policy conclusions and recommendations 2 • While credit guarantees are no substitute for financial reform and building rural financial institutions, they do contribute to reducing the asymmetry of information between the borrower – emerging farms and lender – banks only starting to serve the private sector, additionally reducing high transaction costs. • It was noted that credit guarantees are one of the few elements of rural finance well documented, compared to informal credit and limited assessment of the impact of micro lending.

18. Policy conclusions and recommendations 3 • Rural credit guarantee systems have performed an important role in the period of agricultural markets liberalization, land reform and distribution to create private farms; no less important was their role in financial bridging of support to farm and rural investment under the EC SAPARD and other instruments in support of accession-oriented restructuring. • The guarantees have demonstrated important additionality, bringing significantly larger volume of lending to a credit-constrained sector. Measuring additionality remains a problem and challenge for policy evaluation.

19. Policy conclusions and recommendations 4 • Experience of a number of countries has shown that while state budget support is necessary to start rural credit guarantee systems, a major policy recommendation is that the systems should strive to become sustainable without state support. It was noted that so far there is limited experience of such sustainability. A clear criterion should be the definite time horizon of support offered. • Frequent criticism is that guarantee programmes in reality function like income subsidies and distort the agricultural credit market. Credit guarantees should not be used as instrument to rescue bankrupt farms or enterprises.

20. Policy conclusions and recommendations 5 • Policy makers need to strike a balance between the tasks for the rural credit guarantee systems and operational feasibility and high transaction costs when small, fragmented farms and small entrepreneurs are the main clients. • Improvement of the agrarian structure, development of farmer, trader and producer organizations and approximation to common market organization models may be expected to change the profile of the applicants for guarantees.

21. Policy conclusions and recommendations 6 • When establishing or expanding rural credit guarantee systems, a recommended orientation is approximation and harmonization with relevant European Commission legislation; this is reflected in the AECM rule of assisting countries that are orienting their economy to European integration. • As rural financial institutions are structured for the medium- and long-term, thus European orientation and compliance with EC regulations is necessary.

22. Rural Credit Guarantee Systems: An Instrument for Agriculture and Rural Development - Survey to assess role and impact on rural credit markets Draft project proposal • The purpose of this survey would be to assess the impact of rural credit guarantee systems (RCGS) on rural credit markets, in particular the additionality, thus, bringing significantly larger volume of lending to a credit-constrained sector. • The idea of the survey was conceived during the seminar on Rural Credit Guarantee Schemes - A Financial Instrument for Agriculture and Rural Development organized by the EastAgri Network in Budapest, 12 and 13 January 2006.

23. The survey is composed of two parts: - A summary description of the operating RCGS in selected countries and - An analytical part of the major financial and institutional modalities as needed to assess additionality and impact on the rural credits markets. • The purpose of the survey would be to collate original data and information on RCGS activities and operation modalities in the selected countries to under an overview and analysis of these, combined with an assessment of additionality and impact on the rural credits markets. • The original material contributed by participating organizations will be available for information by practitioners and new entrants in the field, while the analytical part and recommendations will be used to draft a manual presenting the experience of RCGS in the European region.

24. 1.Name, coordinates, including country and contact for organization 2. Date established, sources of capital and funding, including state budget financing; legal status, supervision mechanism, owners and shareholders 3. Mission, strategy and policy targets to be achieved 4. Rural finance products offered 5. Organization and structure, branches, staffing scale and modalities, relations with clients 6. Cooperation with banks and other rural financial institutions Part one: Rural credit guarantee institution

25. Part two: Financial services and products and information to assess additionality and impact on the rural credits markets 1.Credit guarantees offered; loans and other financial instruments, if offered 2. Number and value of guarantees offered to agriculture and rural entities a. Types of guarantees and allocation by subsectors and beneficiaries, including gender allocation b. Repayment and default performance of guarantees c. Guarantees (number and value) linked to SAPARD and other EC programmes 3. Assessment of additionality and leverage performance by guarantee types and groups 4. Assessment of impact on rural credit markets, by lender groups, subsectors/product groups and regions 5. Share (estimate and trend) of RCGS in total national and sector guarantees offer

26. Part three: Prospects, comments and additional information 1.Proposed changes, adjustment and reform of RCGS a. Legal and financial regulations b. Approximation with EC regulations c. Institutional changes 2. Involvement of International Financial Institutions 3. Collaboration with EC pre-accession and association period financial programmes