Annual Meeting of the Central European Initiative’s Working Group on Agriculture

22 May 2006, Rome

Tomasz Lonc

Policy Officer

FAO Subregional Office for Central and Eastern Europe

Project Proposal based on Outcome of Seminar on

Rural Credit Guarantee Schemes – A Financial Instrument for Agriculture and Rural

Developmentheld in FAO Subregional Office for Central and

Eastern Europe, 12 and 13 January 2006

The aim of the seminar was to• discuss the practical experience of rural credit

guarantee schemes in the European region;• with focus on problems faced by the agricultural

sector during the transition to a market economy.

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.

• In CEE transition economies, farmers and small businesses face daily the reluctance of commercial banks to lend.

• This is mainly due to stagnant agricultural markets, high risk and low profitability of farming, and, last but not least, 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.

• The overall results of the activities of such funds in CEE countries have been assessed as mixed.

Rural Credit Guarantee Systems: An Instrument for Agriculture and Rural Development -

Survey to assess role and impact on rural credit marketsDraft 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 their 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.

The survey would be composed of two parts:- A succinct description of the active RCGS in selected Western

Europe and CEE 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 undertake 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.

Part one: Rural credit guarantee institution

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. Rural finance products offered4. Cooperation with banks and other rural financial

institutions5. Mission, strategy and policy targets to be achieved:

positive and negative experience6. Organization and structure, branches, staffing scale and

modalities, relations with clients.

Part two: Financial services and products; data and information needed to assess additionality and impact on the

rural credits markets1. Dimensions and modalities of credit guarantees offered; loans and

other financial instruments, if offered2. Number and value of guarantees offered to agriculture and rural

entities a. Types of guarantees and allocation by subsectors and

beneficiaries, including gender allocation where availableb. Repayment and default performance of guaranteesc. Guarantees (number and value) linked to SAPARD or

other programmes3. Assessment of additionality and leverage performance by guarantee

types and groups4. Assessment of impact on rural credit markets, by lender groups,

subsectors/product groups and regions5. Share (estimate and trend) of RCGS in total national and sector

guarantees offer

Part three: Overview and additional information

1.Proposed changes and reform of RCGSa. Legal and financial regulationsb. Approximation with EC regulationsc. Institutional changes

2. Involvement of International Financial Institutions3.Collaboration with EC pre-accession and

association period financial programmes

1. Training for RCGS specialists based on exchange of their own experience and the results of the surveyThe training would follow the Budapest seminar pattern:i. Presentation of national experience, following an agreed outlineii. Selected technical issues, e.g:

1. improving access to credit for clients who do not qualify for standard bank loans;

2. work with small and dispersed clients in rural areas, analysis of transaction costs;

3. assessing additionality impact of RCGS;4. banks’ view of RCGS and cooperation prospects and modalities;5. sustainability of RCGS and 6. avoiding excessive and prolonged reliance on state subsidies.

iii. Policy implications and recommendations for use of RCGS as rural development instrument

iv. Synergy and compliance with EC accession- and association-support agricultural sector restructuring instruments and programmes.

Analysis and conclusions and policy recommendations from the RCGS survey

2. A manual/guide based on the above and

3. A special report for government agencies presenting the outputs and policy experience and recommendations.

4. Participants:i.Western Europe – sharing experience

ii.Central and Eastern Europe – sharing experience and training

iii.CIS countries covered by CEI – training

Analysis and conclusions and policy recommendations from the RCGS survey 2

AECM, AVHGA interest confirmed5. CEI co-funding to:

i.hire an international consultant, specialist in RCGS – probably up to 2 months;

ii. Author’s Contracts with CEE specialists to prepare national presentations, based on the survey but in form to use as training material;

iii. Financing of travel to training by CEE and CIS participants – location could be SEUR.

6. Obviously the EC and EBRD would be invited, perhaps also the UNDP from Bratislava, who have some interest in micro credit recently.

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.

Annex

Policy conclusions and recommendations

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.• 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.

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.

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.

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.

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.

Policy conclusions and recommendations 5

• 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.