The research underlying this report was carried out at the request of the AgroInvest Project in June of 2013. The report describes the current situation regarding lending to agricultural SMPs by the Ukrainian banking sector, describes key characteristics of such lending, and provides relevant conclusions and recommendations.
This report is produced in response to recommendation number 9 of the USAID Office of Inspector General Audit of USAID/Ukraine’s AgroInvest Project (audit report no. 9-121-13-002-P, dated March 31, 2013). Recommendation number 9 states: “We recommend that USAID/Ukraine work with Chemonics International Inc. to reassess AgroInvest’s future relationship with commercial banks, dedicate more resources to activities with credit unions, and document the results.” The report is therefore intended to assist AgroInvest in revising its strategy with regard to expanding agrilending to SMPs and the future development of relationships with Ukrainian banks. The study assesses the current market situation in the Ukrainian banking sector and identifies existing opportunities for increasing the volume of lending to SMPs.
To address the goals of the study, the following tasks were completed:
- Review the current situation with Ukrainian bank services with regard to SMP finance and development trends with allowance for general trends in the financial services market;
- Assess commercial banks’ interest and ability in increasing the volume of SMP financing in the short term (within two or three years);
- Provide AgroInvest with recommendations on (i) the feasibility of allocating AgroInvest resources for the purpose of fostering lending to SMPs by banks and (ii) the Project’s further strategic and tactical actions in this area of activities.
Professional publications and Ukrainian regulations affecting SMP agrilending directly or indirectly constituted the informational basis for the study. Data from informational bulletins, statistical compendia, and reports of the State Statistical Service and National Bank of Ukraine (NBU) and other publically available sources provided the factual basis for the study.
Limitations on the study: the study was limited to assessing prospects for direct agrilending to SMPs.
Based on the study the following overarching findings (detailed in the body of the report) can be stated:
- The situation in the Ukrainian agriculture sector affects not only national food security but also the situation in other sectors of the national economy and development of rural areas where one third of the Ukrainian population resides.
- Agriculture is an important export-oriented sector of the national economy which demonstrates good performance, even under crisis conditions.
- SMPs are an important category of agricultural producers, whose operations significantly affect the entire agricultural sector and social development across Ukraine.
- In the process of business operations, agriculture producers experience cash gaps for reasons beyond their control.
- SMPs may satisfy their need for finance by replenishing floating capital or reinstating fixed assets by means of direct loans from banks and/or credit unions.
- During the post-crisis period banks “expanded” their loan portfolios predominantly by converting loans in foreign currencies into loans in UAH. Despite the fact that retail deposits are the primary source of funding for banks’ loans, real retail loan portfolios do not tend to grow.
- There was no trend toward material expansion of banks’ portfolio of loans to SMPs during the last four and a half years.
- An analysis of available statistics evidences that neither banks nor SMPs are interested in lending/receiving loans at this time because of high interest rates.
- High risks and, consequently, large losses sustained by agricultural producers cause substantial uncertainty in agriculture business operations, especially those of SMPs. This leads to a higher percentage of defaults, discourages banks from lending to SMPs, and makes loans more expensive for borrowers.
- At times when production output falls, agriculture producers have to raise prices for produce, thus negatively affecting general inflation expectations of the Ukrainian population.
- Risks associated with agricultural production finance makes loans more expensive for SMPs which, in turn, increases agriculture production costs. There are no reasons to expect bank lending of SMPs to grow in the short and medium-term.
In a situation where demand for financing is high in areas outside of agriculture, banks are not sufficiently motivated to lend to agricultural SMPs, especially if their creditworthiness is doubtful. As there are other options for investing their liquidity, banks will opt for less risky alternatives rather than lending to agricultural SMPs. In addition to expensive money (deposits) banks also have the option of using cheap money (current account balances), transactions with domestic government bonds and other – less risky – transactions have become a good alternative to a search for other lending opportunities (like lending to SMPs, for instance).
Recommendations to AgroInvest:
- It is not feasible for AgroInvest to allocate resources and make efforts to engage new partner banks for SMP lending purposes because of the low level of Ukrainian banks’ activity in this segment of the lending market;
- It is recommended that AgroInvest not expand its collaboration with new banks and at present focus on training activities with only its four defined partner banks which already have certain developments and are willing and ready to invest their own resources in SMP lending;
- Continue developing cooperation with credit unions so that they develop their agrilending capacities and continue activities related to drafting and implementing new laws which would improve the institutional capacities of credit unions and their SMP lending capacities;
- Intensify activities in the identification of existing legal and economic hindrances to SMP’s access to finance. It is important to draft and lobby for changes to the current legislation which would facilitate both direct lending to SMP business operations by banks and/or credit unions and indirect finance through agriculture input suppliers;
- Train workers and managers of agriculture enterprises, farmers, and rural residents on direct loan origination processes and agriculture cooperative organizations;
- Further analyze the economic feasibility of implementing a DCA guarantee programs to support expanded SMP lending in collaboration with the State Committee of Ukraine on Regulatory Policies and Entrepreneurship, Ukrainian Entrepreneurship Support Fund, or other institutions whose activities would facilitate access to finance for SMPs.