Privatization of Stateowned development banks

In carrying out privatization, governments can encourage the creation of agricultural commercial banks by selling some of the shares to farmers and farmers' associations. In the case of Banco Ganadero, a government holding of over 80% of the shares was reduced to less than 20% over a period of about a decade through the mechanism of an agreed levy per head of livestock that was invested in shares of the bank, in the name of the ranchers. In cases in which the financial wealth in the sector is not sufficient to make such a conversion of ownership feasible, an alternative is to use government seed capital funding to capitalize a privatized bank, in the name of producers' associations (of small, medium and large farmers), assuming that other sources of private capital can be tapped as well and producers can repay the seed funding over time.

However, in order to promote a more complete development of agricultural banking, two needs are critical: (a) the development of a separate regulatory framework for agricultural finance, and (b) a policy decision on how the higher cost of agricultural banking, which results from the higher risk, is to be apportioned. Once it is acknowledged that agricultural loan portfolios require different prudential and non-prudential norms, and liquidity management for both rural saving and lending also requires a different treatment, it follows that a separate regulatory framework for agricultural banks is needed. Liquidity requirements and many other regulations apply to an entire financial institution, not to part of its portfolio, and so a special financial regime is required under which private agricultural banks would be licensed. An operational decision would have to be taken as to what percentage of its portfolio must be in agriculture before it falls under the new regime, but the principle is clear.

In the absence of such a regime, most commercial banks in developing countries have found it too risky to become significantly involved in agriculture. In the past, the response was the creation of State agricultural banks, instead of reforming the regulatory regime. Today, a more appropriate response would be the creation of a regulatory regime that would encourage the development of private agricultural finance.

As Fiebig (2001) has noted, recognition of the higher capital and liquidity requirements for agricultural lending implies that it necessarily is more expensive. Pretending that agricultural finance can function adequately under the same regulatory requirements as urban-oriented finance does has the effect of discouraging private banks from lending to agriculture. There are three options for covering this higher financial cost in agriculture: (a) through higher interest rates, i.e. the clients pay the cost, (b) through subsidies to cover the risk premium, i.e. taxpayers pay the additional cost, or (c) a combination of the two approaches. If a decision is made to authorize a subsidy element for agricultural banking, care must be exercised not to create moral hazard. In other words, the subsidy element would have to be small in relation to the total cost of lending, so that it does not prejudice efforts at loan recovery.

The arguments mentioned in Chapters 1-3 of this book, that agriculture is not simply another sector and its growth generates exceptional benefits for the rest of the economy, can be read as arguments for a partial subsidy of an agricultural banking system, through a special risk fund. Equally, it can be argued that producers should pay part or all of the risk premium. It is a decision that would have to be made according to the circumstances of each country.

A crucial need of the sector which is not well serviced by financial markets in developing countries is for long-term finance. Many investments in the sector require this kind of finance, from irrigation pumps and channels and small silos to barns and livestock to tree crops and soil conservation works. It was mentioned earlier in this chapter that returns to fixed investments in isolation appear to be much lower than those associated with working capital in the sector. A possible approach that merits exploration, by private agricultural banks, is the packaging of long-term and short-term finance, so that disbursements are made for both purposes over a defined period of years, and the interest rate is calculated for the package as a whole. In addition, arguments have been mentioned for donor support and govern ment support for long-term lending in the sector. International bond issues may be considered as well, if the financial institution is sufficiently solid.

As an example of how this issue has been dealt with in Africa,

In general, savings are loanable funds of a short-term nature. The main sources of medium and long-term agricultural lending funds used to come in the past from equity and international and government loans, that were often made available at concessionary terms. The Cooperative Bank of Kenya has set up a subsidiary merchant bank as a specific institutional set-up for its agricultural term lending. This bank mobilizes funds in the form of fixed-term deposits as well as by issuing bonds. Similar arrangements are found in India. The Land Bank of South Africa, as a strong financial institution, on the other hand, obtains its medium and long-term loanable funds mainly from issuing promissory notes and long-term debentures, government loans and a reallocation of general reserves from retained earnings. The African Development Bank Fund provides international loans for development purposes. . . .176

Rediscount lines through commercial channels are already implicit in the approach of land funds or land banks that are being implemented in several countries (see Chapter 5). To the extent that rediscount lines are used, to ensure their viability it is essential to target them on sub-sectors that represent a country's comparative advantage, and not necessarily those that are applying the greatest amount of political pressure for access to new financing.

It should also be noted that there are opportunities to attract more domestic investors into agriculture through securitization of assets such as livestock herds, crops in the field, private irrigation systems, forward contracts, and so forth. The national agricultural commodity exchange in

Colombia (Bolsa Nacional Agropecuaria), initially conceived as a commodity exchange, has become a major source of finance for the sector though measures like this.

For adapting and implementing all of the new approaches, the most essential need is for technical assistance and training, of various forms and at all levels, from clients to directors of institutions. This is the area in which finance supplied by donors and governments can have the greatest impact on the development of the rural financial sector in the long run. The experience of BRAC in Bangladesh, cited above, is one of many that show the value of accompanying credit programs with training of clients. Along with the establishment of an appropriate regulatory framework for agricultural finance, this emphasis accords with the new vision of the government's role in the sector: that of facilitating the development of rural financial systems, rather than supplying credit for production.

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