USAID BUSINESS ENABLING PROJECT

Transcription

1 USAID BUSINESS ENABLING PROJECT TITLE: AGRICULTURAL FINANCE IN SERBIA STATUS AND RECOMMENDATIONS 15 January 2013 This report is made possible by the support of the American People through the United States Agency for International Development (USAID). The contents of this report are the sole responsibility of Cardno Emerging Markets USA, Ltd. and do not necessarily reflect the views of USAID or the United States Government. This report was prepared by Daniel Gies, an independent consultant, and members of the USAID Business Enabling Project staff.

2 CONTENTS Abbreviations Executive Summary Agricultural Sector in Serbia Background of the Agricultural Sector Government Programs to Support the Agricultural Sector Overview of Government Support to the Agricultural Sector Government Subsidies to Increase Agricultural Lending Agricultural Sector Lending in Serbia Bank Lending to Agriculture in Serbia Non-Bank Lending to Agriculture in Serbia Leasing Companies Serbian State-Owned Funds Microfinance Institutions Input Financing by Integrators / Agricultural Corporates Private Equity Funds Recommendations Recommendations addressed to the Government Recommendations addressed to Agribusinesses Recommendations addressed to the Financial Sector Conclusions Annex 1: Case Study Annex 2: Institutions and Organizations Interviewed Annex 3: NBS Data on Commercial Bank Agricultural Lending Annex 4: Banking Agro Finance Products Annex 5: Agricultural Leasing in Serbia (New Business Volume in 2011) Annex 6: Agricultural Lending and Delinquency by the Development Fund of Serbia, Vojvodina Fund for Development and the AOFI Annex 7: Types of Risks Faced by Serbian Agriculture and Mitigation Strategies

3 ABBREVIATIONS ABS AIS AOFI BEP CGS DCA DEG DFI EUR FDI IFC LTV MDF MFI MoA MoF MoFE NBS NPL OBS PKS RSD SME SGS USAID VAT WHR Association of Serbian Banks AgroInvest Serbia Export Credit and Insurance Agency of Serbia USAID Business Enabling Project Credit Guarantee Scheme Development Credit Authority German Development and Investment Company Development Finance Institution Euro Foreign Direct Investment International Finance Corporation Loan-to-Value Micro Development Fund Microfinance Institution Ministry of Agriculture, Trade, Forestry and Water Management Ministry of Finance Ministry of Finance and Economy National Bank of Serbia Non-Performing Loans Opportunity Bank Serbia Serbian Chamber of Commerce Serbian Dinar Small and Medium-sized Enterprise Société Générale Serbia United States Agency for International Development Value-Added Tax Warehouse Receipts CURRENCY EXCHANGE RATES USED: RSD/EUR = EUR/RSD = RSD/USD = USD/RSD =

4 1. EXECUTIVE SUMMARY a. Purpose and use of this report. Access to finance among farmers and agricultural SMEs is among the poorest of any sector in Serbia. While information on the amount of formal financing used by farmers is not available, information on registered agricultural SMEs show they account of less than 5% of the total debt financing of all SMEs as reported by the national Business Registry, and this share has been dropping over the last few years. There is broad consensus that existing mechanisms for agricultural finance are not adequate and that a change should be made in approach. However, there has to date been no research dedicated to access to finance for agribusinesses 1, or into the sources of constraints and recommendations how to overcome them. The USAID Business Enabling Project (BEP) has already made significant progress in understanding constraints in SME financing, but even taking into consideration these general factors, it does not fully explain why access to finance is so poor in the agriculture sector. The main goal of this report is to provide an overview of the current situation in agribusiness financing in Serbia, identify supply-side constraints to finance and provide recommendation for improvements of detected constraints. To assess the current situation in lending, interviews were conducted with the largest lenders in Serbia that focused on assessing their views of the constraints to increase agricultural finance and hearing lenders recommendations on their alleviation. These interviews were conducted with 13 banks, including 9 of the 10 largest agricultural lenders by volume (using NBS data). In order to better understand constraints for either getting involved in or expanding lending to agribusinesses, during the analysis banks were divided into two groups: active in agricultural lending and non-active in agricultural lending. Additional interviews were held with leasing companies, microfinance organizations and state-owned lenders (including the Serbian Fund for Development, AOFI and two state-owned lending funds in Vojvodina). The interviews included 48 senior lenders, state officials and other stakeholders with a role in the agricultural lending environment of Serbia. Further details are provided on the views and opinions of the lenders interviewed, measured by the consultant against the NBS data and analysis where relevant. In addition, the availability of credit products to the agricultural sector was also examined through a comparative analysis including loan amounts, terms, flexibility, grace periods and interest rates. The last chapter of the report provides recommendations for the government, agribusinesses and financial institutions that should be addressed in order to improve access to finance for agribusinesses. This report is meant to contribute to an understanding of the main causes of the high level financing gap faced by agribusiness in Serbia. Report should support formulation of an agribusiness finance policy framework specific to this country. This research represents a starting point that can be used by the Ministry of Agriculture in developing Rural Development Strategy and related policy documents. Moreover, it can provide information and suggestions to both agribusiness and financial sector to start advocating for reforms in this area. b. Background of the Serbian agro sector. With approximately 10% of GDP, 21% of employment, and 23% of total exports, agriculture is one of the most important economic sectors in Serbia. Agriculture accounts for a significant share of foreign trade, revealing a surplus of USD 150 million in 2005, which increased to USD 640 million in Additionally, if we look at the period, food, beverage and agriculture was the second sector by FDIs, more than telecommunication, retail and automotive industry. In 2010 the Serbian Government declared agriculture to be of strategic economic importance; this role was reinforced during the recent election campaign. 1 The term agribusiness as used in this report denotes SMEs that work in the agro sector, as well as farmers, unless specifically stated otherwise. 3

5 Despite its economic and political importance, the Serbian agricultural sector is still hampered by a variety of constraints limiting its full potential. Aside from outdated production technologies and machinery, the lack of adequate infrastructure (e.g. storage/cooling facilities) and inadequate irrigation and drainage systems, the lack of sufficient agricultural finance in comparison to other sectors is considered by many observers to be one of the major impediments to the growth and development of the sector. Agriculture accounted for only 2.7% of the Serbian 2011 budget, with half of this amount consisting of budget-financed subsidies for price and input support. Officially, only about 3% of bank loans are in the agricultural and food processing industry. This number, however, might actually be higher due to the fact that banks use different classifications, classifying those loans as corporate, industrial, retail, or other. c. Current status of agribusiness financing. The conclusion reached in the assessment is that the Serbian financial sector offers a wide range of loan products to the agricultural sector. The list of active lenders in this market includes banks, state funds, leasing companies, microfinance organizations and integrators 2. Many of the interviewed lenders have a large number of agricultural loan products available that include grace periods, production-contract collateralization, equipment finance and input credit, among others. However, agribusiness finance is significantly constrained both in terms of tenor and of local currency availability. Agribusinesses face significant constraints in their access to finance due to high risk aversion and lack of market understanding by banks. Even those banks that strongly support the agricultural sector indicated that the primary reason for loan-applicant rejections was the perception that the creditworthiness of borrowers in agribusiness was weaker than of those in other sectors. In addition, there are numerous banks are reluctant to target the sector due to this same perceptions. Bank loans to agribusiness are predominately loans with shorter maturity (72% of all loans being for three years or less) and primarily extended to larger agro-processing businesses. Most loans (62%) are made in euros despite the fact that most agricultural production is for domestic consumption and is paid for (approximately 78%) in RSD. Therefore, financing of long-term investment in RSD presents a significant constraint to the sector, and is a particular challenge for farmers and agribusinesses with RSD income. Banks are more active in lending to agriculture in Vojvodina and most of them prefer to offer general products that can afterwards be structured for each borrower, which indicates they are not focused on providing value to their agricultural clients in terms of new, agro tailor-made product development. According to the NBS there is approximately EUR 419 million in outstanding loans to this sector as of end-of-year In addition to banks, a number of other institutions are active in financing the Serbian agricultural sector. The estimated agricultural portfolio held by non-bank organizations is around EUR 252 million. Leasing offers the potential to overcome some of the traditional challenges in agricultural financing, by providing an alternative solution for farmers and SMEs with limited collateral and credit history. In Serbia, agricultural leasing is a small fraction of the overall level of equipment financing provided by the leasing companies. It is limited to tractors and combines and a very few medium-size equipment investments, thus arriving at an average of about 6-7% of the overall portfolio of all leasing companies. Same as with bank loans, the bulk of products were either foreign-currency-denominated or foreigncurrency-clause-indexed. There are a number of state-owned organizations and funds that provide lending or support to lending for the Serbian agricultural sector. The Serbian Development Fund does not break down the size of its 2 Mainly large food-processing companies that finance the agricultural production sector in the form of production inputs such as seeds, fertilizers and pesticides. 4

6 portfolio by sector; however, a breakdown of current outstanding loans made to the agricultural sector since 2007 gives the estimate of EUR 134 million. The terms and conditions of these loans are very favorable, with significantly lower interest rates than those available in the market. AOFI have stated that they provide a significant level of support to the agricultural sector mainly via food-processing exporters. They estimated their exposure to the agricultural sector to be roughly EUR 20 million, which is 33% of the capital of AOFI. In this context, the level of agricultural support by AOFI as a portion of its capital is significantly in excess of the sector s share of total exports of Serbia, which stands at 21%. The Vojvodina Guarantee Fund provides guarantees to agribusiness. To date, they have guaranteed a portfolio of approximately EUR 20 million in the agricultural sector, of which EUR 10 million is current. Due to the lack of adequate regulation, the Vojvodina Guarantee Fund is registered with the Vojvodina Secretariat for Culture. This prevents the institution from sourcing additional funds in the market (through bank loans, bond sales or securitization). The Vojvodina Provincial Fund for Agricultural Development has approximately EUR 15mn in its portfolio and about 1,000 borrowers who have borrowed at lower-than-commercial rates. Fund invests through two commercial banks due to the regulation that prohibits fund to directly lend money. Their main clients are farmers and, to some degree, SMEs. Three years ago Serbia established the Indemnity Fund of Serbia as a government entity responsible for system of public warehouses designed to support agribusinesses and lending to agribusinesses. The success of this fund has resulted in the introduction of warehouse receipts that are recognized by the NBS as adequate collateral for bank loans to agribusinesses. Three non-bank microcredit institutions operate in Serbia at present, and all are forced to issue loans through commercial banks due to the lack of regulation for non-bank, non-deposit taking financial institutions. Their combined total portfolio is approximately EUR 16 million, spread across over 16,500 borrowers. Microcredit is made up mainly of entrepreneurial and agricultural production loans based on internationally accepted methodologies, ranging from EUR 300 to EUR 3,000, with the average loan amounting to between EUR 900 and EUR 1,100. Food-processing companies, integrators, are an important source of lending and liquidity for farmers and SMEs in Serbia, although this is not measured in any formal way. Companies engage in barter operations with their suppliers (paritet) in which they take inputs in exchange for crop sales upon harvest. In those cases the price is set according to parity at the time of contracting, prior to post-harvest delivery. Some estimates put this amount at a significant EUR 100 million at least. It was difficult to find a bank that would be willing to make a loan to my company. Many of the banks I approached lost interest once they learned where my company focused its efforts (Milk-processing company in Vojvodina) d. Major constraints to agribusiness financing 3. No single factor can explain why access to finance for agribusiness and farmers is poor. It is a complex of constraints that are interlinked and influenced by a variety of legal, economic, institutional, and behavioral factors. All those constraints can be broadly summarized as follows: inconsistent agricultural policy; inefficient subsidy programs; regulation disincentives or lack of regulation; few alternative sources of finance; lenders knowledge and perception of risk in agribusiness; weak market leverage of agribusinesses; borrowers psychology, knowledge and access to information; not taking advantage offered by the value chain concept; and high risk of the sector. Banks that are focused on lending to agribusinesses pointed out the uncertainty in planning, inconsistency of Serbian agricultural policy, poorly-designed interest-rate subsidy programs and lack of borrowers leverage as the main obstacles to increasing lending. The relevant ministry has a high turnover of key people and changes priorities very often. This leads to unpredictability in cash flows in agribusiness and decreases the creditworthiness of potential clients. Interest rate subsidy programs do 3 This report focuses on agribusiness-specific constraints, excluding general constrains to access to finance for SMEs. For a detailed discussion of those, see the BEP White Paper 5

7 not involve consultation with the financial sector when the programs are designed, and as a result the way the programs are constructed in does not motivate banks to increase lending to the sector. Furthermore, subsidized loans negatively influence the credit market by sending wrong signals to agribusinesses about financing costs. The lack of an effective Cooperative Law and no efficient agribusiness associations hinder banks ability to offer products that do not rely on creditworthiness of individual borrowers. Outreach costs could be decreased by enabling lenders to better support the activities of tens or hundreds of producers via one cooperative, rather than being forced to contract with hundreds of farmers individually. Banks that are not focused on lending to agribusinesses see the lack of desire on the part of bank owners/shareholders and upper management to increase exposure to this sector as the main constraint. They cite too many unresolved issues related to the policy environment, and too much uncertainty about the ability of agricultural producers and processors to meet their obligations, as the fundamental reasons for those strategic decisions. They also point out that only a small number of agricultural producers are included in modern market chains as they are largely uncompetitive, in addition to not having requested collateral, primarily high value real estate. In many cases the buildings are unregistered and land registers are incomplete. Furthermore, procedures for loan debt collection and contract enforcement are particularly very long in the rural areas of Serbia. Constraints faced by the non-bank lending sector are mainly related to regulations. The lack of regulation for non-deposit taking credit institutions, combined with the official view that only banks can take lend money as their daily business, leaves this sector underdeveloped and unable to serve one segment of the market. In case of leasing, regulation on VAT results in leasing being less attractive to the clients than a bank loan. There is no regulation of operating leasing. This lack of regulation or lack of suitable regulation has negative impact to all SMEs, but due to specifics of agro sector it is even more prominent in case of agribusinesses. e. Recommendations to improve access to finance for agribusinesses. Based on the interviews, discussions and research conducted, we make the following recommendations to facilitate an increase in the agricultural lending of commercial banks, non-bank lenders and state entities currently engaged in lending to farmers, agribusiness SMEs and agricultural cooperatives. The recommendations focus on measures that will help lenders to assess the creditworthiness of borrowers more favorably, and also to improve the lending environment in terms of legal, regulatory and similar constraints identified as pertaining to the agricultural sector. These recommendations, described in greater detail in Section 4 of this document, serve to address many of the constraints identified by the lenders in terms of their outreach to the agricultural sector. On the basis of the key information learned from the lenders and background research, these recommendations are outlined as those that should be addressed by the government, financial institutions, or agribusinesses. The recommendations addressed to the government include: improving the formulation, timeliness and implementation of Serbian agricultural policy measures; improving the legal framework for lending to agribusinesses; and improving government support mechanisms and the institutional framework. 1. Improve the formulation, timeliness and implementation of Serbian agricultural policy measures. The structure and inconsistency of Serbian agricultural policy, followed by the slow or sometimes partial payment of subsidies, leads to poor business planning, increases the illiquidity of agribusinesses and decreases their creditworthiness as borrowers. In order to improve the situation, the government must: o Establish an Agro Sector Financing Data Initiative. With regard to agro financing there are insufficient data available. A joint effort of the MoA, NBS, MoFE, Statistical Office and other relevant stakeholders, is needed to improve the quality and quantity of information and so provide a base for efficient policy-making. The starting point would 6

8 be a review of existing data available and the information gap, and establishing a database that is constantly updated. o o o o Put the agribusiness policy into the right context. The government must develop different, yet coordinated policies related to rural development, poverty reduction and agribusiness development in order to achieve separate goals of each of those policies. Develop Agribusiness Development Strategy and set of policies. The Agribusiness Development Strategy should be a separate document and not just part of the Rural Development Strategy in order to target specific goals. The new policy should provide a vision in the context of supporting agribusiness development, based on an EU approach and public-private dialogue. The strategy should be followed by an action plan with clear deadlines and responsibilities, as well as the establishment of Agribusiness Council and an intergovernmental Working Group on Agribusiness Development in order to ensure implementation and monitoring. Establish Agribusiness Council and intergovernmental Working Group on Agribusiness Development. The government should increase different stakeholders participation in order to provide a two-way flow of information and direction to agricultural sector actors. The Agribusiness Council should be a vehicle for that purpose, providing sustainable framework for public-private dialogue. Bearing in mind that agribusiness improvement implementation cannot be achieved without the coordination of several ministries, agencies, etc. an additional intergovernmental Working Group on Agribusiness Development should be established as an umbrella for the reform coordination. Increase the capacity of the Directorate for Agrarian Payments and the Ministry of Agriculture. The government should have the capacity to develop a clear model for planning and executing subsides according to the available budget. This is even more important bearing in mind that Directorate for Agrarian Payments will be in charge of managing and administering EU funds for agriculture. The government should use coordinated donor support for capacity-building of both the Directorate for Agrarian Payments and the Ministry of Agriculture through trainings, mentoring, coaching, etc. 2. Improve the legal framework for agribusiness. Key pieces of legislation are missing, which hurts the growth of agribusiness even more than that of general business. o o Develop and adopt a new Law on Agricultural Cooperatives. Effective organizational frameworks, such as cooperatives and other farmer-based organizations, enable farmers to focus on commercial activities and participate in value chains. The starting point should be determining the status of the existing Draft Law on Cooperatives. The Law should resolve the issues identified above, including issues related to land ownership of the so-called old cooperatives. It should ensure that a mechanism is in place to establish fair ownership of previous cooperative land and increase the negotiation and market power of cooperative members. Develop and adopt the Commodity Exchange Law. Setting up a modern commodity exchange regulatory and institutional framework is a key element in developing risk management instruments. Commodity exchange financial instruments should be used as a starting point in developing other risk management instruments to manage interest rate and foreign exchange risk. An effort should be made by the Ministry of Internal and External Trade and Telecommunication to finalize and adopt the Commodity Exchange Law. 7

9 o o o Improve leasing regulation. Though the advantages of leasing are evident for all SMEs that struggle with a lack of collateral, they are even more prominent for farmers and agribusinesses. Many farmers and agribusinesses have limited or no collateral and credit history. The collateral they do have is mainly located in rural areas and is not high-value real estate. In many cases the buildings are unregistered and land registers are incomplete. Since most trading is done through farmers markets, farmers usually have no bank credit history, and, in cases of unregistered farms, are not even recognized as potential bank clients. In addition to the fact that leasing is more accessible because of collateral required, there is also a strong relationship with agricultural equipment dealers than can perform any maintenance required. Although not limited to agribusinesses, improvement in leasing regulations would have a strong impact on this sector. Developing the Law on Operating Leasing will create a safer and more transparent business environment. There is currently much uncertainty in the treatment of this product, and as a result operating leasing is currently offered through an inappropriate form of leasing and is underutilized. Leasing companies should be made able to act as agents for insurance products, in the same way that commercial banks are. If leasing companies were able to become agents for insurance products, the time and cost needed to lease equipment to buy would decrease. In addition, the Law on Corporate Income Tax and tax treatment of interest in financial leasing should be changed. The regulation should be amended so that no matter which finance option the firm uses (bank credit, cash or lease contract), the tax treatment stays the same. The current Law on Corporate Income Tax should be amended so that the principal paid in each year of the leasing contract is used as an investment in fixed assets and taken as the base for calculating the tax credit for that year. Develop regulatory framework for the non-banking financial sector. Same as with leasing, the development of non-banking financial institutions will have an even stronger impact on agribusinesses than on other sectors, since unregistered farms with no additional steady income are not recognized as potential bank clients. Excluded from banks financing, their main formal source of borrowing are existing microfinance institutions and state funds. The primary constraint to greater lending by those institutions is the lack of legal rights to lend directly to borrowers in the agricultural sector. New regulation should be well thought-out. The challenge for regulation is striking the right balance between the risks and benefits of NBFIs. If designed properly, a NBFIs system will expand the institutional basis for agricultural finance by introducing new respectable lenders, and encourage a more competitive and more efficient credit market for start-ups and other small businesses. The starting point for MoFE and potentially the NBS in designing the regulatory framework for non-banking financial institutions should be a comparative analysis of financial systems in other countries and a cost/benefit analysis of the introduction of a new tier of financial institutions in Serbia, followed by the formation of an official working group for developing the regulation. Explore possibilities for improving banking regulation. The NBS should review banking regulations in areas where they impact farmers and SMEs working in the agro sector, and eliminate potential sources of constraints to lending. One of the most important changes to be made is broadening the collateral base that can be used to secure a loan. It is essential to introduce enabling regulation to support new models of lending for agricultural enterprises and farms based on pledges, as well as to support further development of collateral on stored products, such as warehouse receipts. The NBS might consider a change in defining assessment of the creditworthiness of a natural person borrower, leaving more latitude to banks. This is very important when it comes to unregistered farmers who do have income that is recognized under NBS regulations. 8

10 3. Improve government support mechanisms and institutional framework. The existing support mechanism must be further developed or used more efficiently, and new mechanisms should be introduced in many cases. The main focus should be on supporting the development of innovative financing programs and reducing risk in cases where risk cannot be managed using market instruments. o o o o Supporting innovations through government mechanisms. Applying financial products and approaches that work in other business sectors has only worked for those agribusinesses that have similar income and risk profiles to nonagricultural activities. The government should provide different incentives to financial institutions that invest in developing innovative programs of financing agribusiness. For example, they can have certain tax/quasi-tax deductions. Introducing partial guarantees and risk sharing facilities. Partial credit guarantees and risk sharing facilities can be an effective mechanism in stimulating agricultural loans, with the vision that they should gradually be phased out. These state support mechanisms could be used for capacity, knowledge and experience building of local financial institutions, bearing in mind that in many cases financial institutions perceive agribusiness as being more risky than it really is, due to a lack of exposure to those clients. Guarantees targeting longer-term loans may also boost finance for equipment. The government should clear the problem of non-existing regulations for guarantee funds 4 and provide a regulatory environment for the further development of guarantees and risk-sharing facilities. Establish the Agricultural Cadaster. In order to establish the agricultural cadaster, which normally exists in many countries, especially EU member states, the government should develop and pass the Law on Agricultural Cadaster. The cadaster entry for each land plot should contain specific data on agricultural production, which are currently unavailable (i.e. whether a greenhouse is installed on the land plot; whether the land plot is under control and certification for organic farming; etc.). The agricultural cadaster would be used for, among other things, expert valuation of mortgages, which would in turn lead to improved access to finance for farms and agro SMEs. Furthermore, the agricultural cadaster would play an important role in determining government incentives and subsidies. The starting point for establishing an agricultural cadaster should be the Census of Agriculture, which is under way. Increase number of public warehouses and use of warehouse receipts. Introduction of warehouse receipts and the Indemnity Fund was a good step in providing instrument for both managing commodity price risk and improving available collateral for agribusiness. It provides benefits such as permitting stored goods to be used as collateral; improving quality, control, and inspection of commodities; improving storage capacity and quality to reduce losses all leading to a decrease in the risk of agribusinesses. Further work should be done to promote the usage of the warehouse receipt by both agribusinesses and the financial sector. The Indemnity Fund and the MoA should work on licensing additional public storage facilities in different regions of Serbia and consider further improvement of the system in order to decrease costs. Moreover, the work should include setting up a system of public cold storages for fruits and vegetables. The increase in the number and variety of public storage facilities will allow more agribusinesses (such as fruit and vegetable producers and 4 See details under the chapter Serbian State owned funds - Vojvodina Guarantee Fund 9

11 processers, unlike now) to have valuable collaterals that can be used to secure financing. Recommendations addressed to agribusinesses. Feedback from lending institutions indicates that borrower risk aversion, misperceptions, poor knowledge, and a weak credit culture are contributing to financing challenges and leading to negative sentiment. Furthermore, agribusinesses, and especially farmers, often lack the capacity to present their business to lenders. The challenges are compounded if they have limited or no formal credit history or cannot unwind business finances from their household finances (which is almost always true in case of farms), participate in the informal economy, etc. Most of these challenges can be overcome through the active efforts of agribusiness, business associations and clusters. Strengthen the capacities of farmers and agribusinesses to access formal finance. It is important to increase knowledge in order to facilitate access to finance and improve the efficiency of value chains. Training in basic farm economics, financial literacy and financial skills, creating and managing business associations, business management, entrepreneurship, etc. should be widely offered directly or through business associations. The government, donors and business associations should join forces in building awareness, knowledge and capacity of small agribusiness and farmers to participate in fast-growing value chains. Best-practice examples should be emphasized and promoted. Capacity building should be undertaken by a combination of public and private providers or, in some cases, through public-private partnerships. One of the possibilities is to use the NBS s Academy for Banking and Finance, which already delivers specialized courses for SMEs. The new courses should be offered in different regions throughout the country, and should be offered in cooperation by the NBS, MoA, Serbian Chamber of Commerce, Employers Union, other business associations and clusters. Strengthen the capacity of business associations and clusters to improve access to finance for their members. Business associations and clusters, existing and/or a new ones, can play a vital role in developing bankable agribusinesses though facilitating information flows and allowing farmers to participate collectively in order to gain economies of scale and bargaining power. Such organizations should build capacity for developing a common network platform for information and knowledge transfer, including sharing information on existing financial products and institutions. Moreover, they should increase the leverage of agribusinesses by helping the business sector communicate with the financial sector. In order to play this role, business associations need to raise their capacity and understanding of financial institutions and agribusiness financing through training that addresses their fundamental gaps in technical, managerial, advocating, business, and financial skills. If good progress is made, training of trainers should be considered in order to achieve spillover effects for businesses and farms. This is an excellent opportunity for private-private partnerships, where the exchange of knowledge between business associations and the financial sector, mainly associations of financial institutions (Banks Association, Leasing Association, Factoring Association, etc.), can lead to a win-win situation. Financial institutions would gain new clients, business associations would position themselves as value-adding institutions for their members, and agribusiness will be able to finance their growth. Strengthen the capacity of business associations and clusters to advocate for reforms to improve access to finance for agribusinesses. Business associations should be able to advocate for improving access to finance for agribusinesses. Including them into the Agribusiness Council will not be beneficial if their understanding, knowledge and advocating capacities are not increased. Close cooperation among donors can help to build those capacities through training, mentoring and coaching. 10

12 Building capacity of value chains. Value chain finance reduces agro sector lending risks and may serve as a collateral substitute. Loan appraisals can become more focused on assessing the cash flow created by the value chain transactions and the profitability of the entire chain, rather than on the creditworthiness of each borrower as applied in traditional lending. In order to achieve this, donors and NGOs, together with business associations and clusters, should promote this concept as a starting point to motivate agribusiness to develop value chains. In addition they need to identify best-case examples of value chains in Serbia and in partnership with them increase knowledge about value chains and their role in financing the agro sector. Donors and NGOs should support existing value chains to work with lenders in order to develop new financing models. Donors can play the roles of facilitator and honest broker in setting up fair and transparent value chain finance arrangement as a pilot project. This should be followed by promoting experience of successful value chains in access to finance. The overall goal should be, after setting a good example, to spread best practices and knowledge throughout both the agro sector and the financial sector. Develop an agribusiness financing portal. MoA and donors should encourage business and financial associations to develop an agribusiness financing portal that should be used both by lenders and businesses. The portal should contain data on agribusinesses, such as crop production, trade, crop prices, etc. This will allow for better evaluation and quantification of agricultural finance risks and long-term planning for both agribusinesses and the financial sector. In addition to information regarding agriculture, the portal should have constantly updated information on financial offers, from market, donors and government sources. Moreover, the portal can be used as the central place for sharing educational material and relevant regulation. Recommendations addressed to the financial sector. Recommendations listed here serve to address many of the constraints identified by lenders that can be partially overcome if properly addressed by the financial sector. The recommendations are focused only on agribusiness-specific issues, excluding those that would generally improve access to finance for SMEs in Serbia. Develop agricultural insurance. Farmers and food processors face a number of agriculturespecific risks that reduce their creditworthiness, often resulting in loan rejection. In Serbia, some insurance against catastrophic risk is available, but generally only to registered farmers and larger firms, and merely for a narrow range of events. Additional work should be conducted by the Association of Serbian Insurers in order to determine what agricultural insurance products are missing in Serbia that can reduce risk and increase creditworthiness of agribusinesses (for example, it is currently not possible to insure greenhouses in Serbia). The work should include examining possibilities and models for encouraging insurance companies to develop agro-specific products. The EU or neighboring countries such as Croatia, that have made recent progress in this area, could be used as examples. Proposed models and possibilities for improvements should be presented to the government. Develop specialized credit skills and policies. Given the unique risks and characteristics of agricultural production and supply chains, financial institutions serving the segment require the development of specialized credit skills and policies, credit scoring and rating tools, and portfolio monitoring practices. It is necessary to develop trainings on financial product development and risk management specific to agriculture. This should include involvement of agro economists, value chain specialists and lenders from abroad that can transfer hands-on knowledge and provide mentoring for Serbian financial institutions willing to improve this segment of their offer. The NBS s Academy for Banking and Finance and the Banks Association should be used to provide continuous education in agro financing for all financial institutions. 11

13 Increase value chain finance. It is important to enhance external value chain finance in Serbia, since it reduces lending risks and provides collateral substitutes, both being critical in agro lending. Donors, the NBS and the Banks Association must work together to increase capacities of banks to create both direct value chain financing models (finance individual farmer or SME) and indirect value chain financing models (financing farmers and SMEs through business associations). The following is closely connected with effort to strengthen the capacity of business associations and clusters. In addition to banks being able to create new models of financing, loan officers should be trained to assess the cash flow created by the value chain and not an individual borrower. As mentioned in the previous recommendation, the NBS s Academy for Banking and Finance and the Banks Association should be used to provide continuous education. To contribute to improving access to finance for agribusinesses, a detailed description of the state of agricultural financing in Serbia, a list of the constraints identified by the various lenders (bank and nonbank, agriculture focused and non- agriculture focused) in targeting the sector, as well as detailed recommendations to alleviate the constraints, are presented in the body of this report. 12

14 2. AGRICULTURAL SECTOR IN SERBIA 2.1. BACKGROUND OF THE AGRICULTURAL SECTOR In terms of its agricultural sector, Serbia has seen dynamic development in the past decade. After 2000, the banking system was restructured and foreign players, backed by a decade of experience in Eastern Europe, started competing for market share. This gave a strong push to the development of agricultural and food exports. As for resources, out of 5,092,000 hectares of agricultural land, 83% is privately owned and 17% belongs to cooperatives or the government. In categorization terms, about 83% of the agricultural land is farmland. Vineyard and orchards account for 1.1% and 4.8% respectively. Harvest yields account for 68.4% of total agricultural production, while cattle breeding accounts for 31.6%. Over 57% of harvest products are made up of cereals and only 8.3% are vegetables. The livestock industry includes pig, cow, poultry and sheep breeding, respectively accounting for 13%, 4%, 77% and 6% of Serbia s total livestock production (Source: Statistical Yearbook of Republic of Serbia 2011, Statistical Office of the Republic of Serbia). The country has specialized in a variety of types of production and processing. For example, with an overall production of 50,000-70,000 tons/year, Serbia has long been one of the major raspberry producers in the world. In the structure of the value of agricultural production in 2010, crop production accounted for 69.5% and livestock production for 30.5%. Agriculture accounts for a significant share in the foreign trade of the country. Since 2001, when a negative balance of USD 136 million was recorded, Serbian exports have been growing at a rate faster than imports, so that by 2005 a surplus of USD 150 million was achieved along with a growing trend. In 2010, the agricultural trade surplus was USD 640 million, with the share of exports of agricultural and food products accounting for 23.2% of the total exports. Today s main export products in terms of value are corn, sugar, raspberry and wheat. The significance of agriculture is reflected in, among other things, its contribution to the creation of gross domestic product. In the period from 2002 to 2010, the share of agriculture in national GDP ranged from 14.3% to 10.6% and the share of food industry ranged from 5.3% to 4.8% (Source: Serbian Chamber of Commerce). The food processing industry is growing and is dominated by a number of large companies. Over the past decade, the Serbian food industry has been one of the most attractive sectors for foreign investors. United States Pepsico, German NordZucker, Austrian Rauch, Denmark s Carlsberg, Belgium s AB InBev, and many others have built their factories in Serbia in order to supply local, but even more so 13

15 markets of EU and the ever growing Russian market. According to the NBS, food, beverage and agriculture accounted for more than 2.7 billion in FDIs from 2001 to 2012, more than telecommunications, retail, or the automotive industry. The main export markets for the Serbian food industry, besides the country s immediate neighbors, are Russia, Germany, Romania and Italy. The comparative results for the period demonstrate an increase in the dollar value of exports to those countries. For example, exports to Russia increased from USD 58,878,000 in 2009 to USD 158,655,000 in 2011 (Source: SIEPA). However, although Serbia has remarkable natural resources and a strong production and processing background, in many areas both industry and farms lack modern technology and strongly need technical assistance and increased financial resources for further development. As a result of weakness in technology and access to finance, Serbia does not have productivity on the level of the EU, or, in many cases even on the level of its neighbors. If Serbian productivity is marked with 100, in case of milk yield, the EU average is seen to be 232, with Hungary and Slovenia recording levels of 257 and 218, respectively The example of meat shows that Serbia is even more uncompetitive measured by production per man-hour, where Serbia is indexed at 100, EU 27 stand at 393, Austria at 400, and France at 427. Productivity based on realized production by one employed person, Serbia = 100 Grain Sugar beet Apple Milk Meat Serbia EU Romania Bulgaria Slovenia Italy Austria France Czech Republic Germany Number of residents fed by one farmer Gross agro production with average production per hectar Romania Serbia Bulgaria Slovenia Italy Austria France Czech Republic Germany Serbia Slovenia France Germany Greece Italy Belgium Holland Source: Economics Institute The productivity comparison and resources that Serbia currently has indicate that the country has great potential for economic growth through growth of agriculture and food industry. 14

16 2.2. GOVERNMENT PROGRAMS TO SUPPORT THE AGRICULTURAL SECTOR As in most countries, the agricultural sector is supported by direct and indirect subsidies funded through the national budget. In agriculture, direct payments to farmers per hectare and financial support to subsidize loans and agricultural insurance premiums, among other examples, are the largest subsidies provided from the government budget. In terms of credit support, the granting of interest-rate subsidies (i.e. transferring money to banks to subsidize the low-interest rate loans that banks provide to registered agricultural producers) is conducted through the MoA. More detail on these programs is provided below OVERVIEW OF GOVERNMENT SUPPORT TO THE AGRICULTURAL SECTOR The Law on Agriculture (Official Gazette of the Republic of Serbia, No. 41/2009) provides the legal framework for the implementation of Serbian agricultural policy and the achievement of goals taken from its strategy for the development of this sector. This Law, in its Chapter II, Incentives, elaborates the types and forms of incentives that are provided by the MoA. The incentives are divided into three groups: direct incentives, market incentives, and structural incentives; all are detailed below: Direct incentives are intended to directly influence the market by reducing the production cost of agricultural products, while ensuring conditions to increase supply by agricultural producers. These measures represent a form of direct payments per unit/hectare/head of cattle, as well as price support for certain products (payment per liter of produced milk, etc.). Market incentives are budgetary funds that are allocated for activities aimed at improving the placement of domestic products in international markets, stabilization of the national market for agricultural products, and creating conditions for balanced and sustained development of agricultural production. Structural incentives support activities that contribute to the sustainable modernization of the agriculture and food sector. They are implemented through targeted investments aimed at strengthening the competitiveness of producers and processors, fostering the development of overall rural economy and rural areas. 5 A peculiarity of the agricultural subsidy system is that in some cases it excludes more than 80% of producers, as it makes only farmers who regularly pay state pension insurance eligible for subsidies. Although it is laudable to include farmers into the pension system, their view is that the amount of the required monthly payment to the state pension insurance agency often exceeds any potential benefit of subsidies and pensions, and thus is often not paid by farmers, who thereby remain outside the system. In 2011 there were approximately 75,000 producers that received subsidies amounting to on average RSD 14,000 per hectare. Statistical data indicate that there are approximately 778,000 farms in Serbia, of which 445,979 are registered in Register of Agricultural Holdings. However, the number and trend of registered farms is misleading due to the structure of subsides. For example, at the moment when the MoA introduced subsides per hectare with a ceiling of 100 hectares per farm to be subsidized, the big farms re-registered as several smaller farms up to 100 hectares, artificially increasing the total number of the registered farms. 5 Credit subsidies provided by the MoA are included in this group, with a sum of RSD 300 million provided in 2010 to incentivize banks to make low-interest loans to agricultural producers. 15

17 GOVERNMENT SUBSIDIES TO INCREASE AGRICULTURAL LENDING To increase producers access to credit markets, in 2004 the Serbian Ministry of Agriculture established a formal model of a short-and long-term lending program for agriculture under conditions more favorable than credits available from banks. According to the Regulation for Establishing the Program of Measures for Stimulating the Development of Agricultural Production, funds were variously distributed: partly through the Serbian Development Fund and banks for short term and long-term loans; and partly through the Fund directly in order to finance agricultural processing facilities. Credit beneficiaries of this system, from , were usually registered agricultural holdings (natural and legal persons). Short-term loans were granted wholly from the budget. The loan amount depended on the amount of land reported in the Register of Agricultural Holdings, and loans were exclusively provided to the natural persons. For the beneficiaries of short-term loans, the interest rate was 5% with a repayment period of 12 months. Long-term loans were disbursed by commercial banks. Loans were given for specific purposes: building and purchasing of irrigation systems and equipment, purchasing of agricultural machinery, establishing plantations, establishing greenhouses, as well as investing in livestock production. Under this system, banks contributed 10-30% of the capital, and the Ministry of Agriculture provided 70-90% of the capital (in 2004, banks contributed 30% of the capital, and in other years provided 10%). This model of lending was very popular with both banks and agricultural entities, and was available each year through 2007, while from 2008 it continued with minor changes until In 2010 a new model of credit support by the Ministry of Agriculture was introduced - interest-rate subsides are provided in order to encourage banks to lend to the sector. The Ministry of Agriculture facilitates very low interest rates to individuals, agricultural households and SMEs via a number of partner commercial banks. This model has been implemented since It transpired that new model was less popular with banks, due to its focus on subsidizing only interest and not principal. In any case, the interest rate subsidy programs of the MoA were quite popular with the producers, primarily because loans are dinar-oriented, have flexible repayment terms and attract low interest rates. Additionally, these programs are actively promoted by the MoA Share of of MoA Interest-Subsidized Lending for Agriculture (in EUR millions) Banca Intesa Credit Agricole 6.0 Komercijalna Banka 10.9 Procredit Bank These subsidy programs were continued in 2012, although now with a smaller number of banks due to the perceived (by the banks) lack of profitability inherent in the design of these subsidized-loan products. The perceived lack of profitability of this subsidy model has resulted in the fact that not all banks disburse subsidized loans, leaving ProCredit Bank and Komercijalna Banka to be the major ones. The interviewed banks are less keen to participate in the program and only ProCredit bank remains committed, disbursing more funds under these programs than all other MoA partner banks combined. Lending from subsidized credit programs to individuals has fallen steadily over the past three years. In 2012 the level fell over 50% relative to 2011 in terms of lending volume. Additionally, subsidized loan programs are offered by the Ministry of Economy and Regional Development (through the Serbian Development Fund), the National Employment Agency, as well as through foreign credit lines provided to banks. These programs facilitate lending, or provide it 16

18 directly, and had a total financing volume of EUR 1.7 billion and EUR 1.6 billion in 2010 and 2011, respectively. No breakdown of this support by sector (agricultural or otherwise) is available, except for the Serbian Development Fund data, which is provided later in this document. However, these subsidized loans reveal some negative effects. In the view of the lenders interviewed, there is a suspicion that loan programs named above have become very political and populist. Since 2010, the government has been trying to find ways to soften the impact of the crisis by launching subsidy programs, mainly by providing or facilitating low-interest loans to companies and individuals in order to maintain levels of economic activity. There is very little analysis of the impact of these loans, but the evidence from the Serbian Development Fund suggests that government subsidies, except for MoA support provided to farmers and processors, are directed at large manufacturing operations and not towards agriculture. At the same time, all subsidized loan programs have had significant negative marketing effects against the commercial banking sector. If annual interest rates of 6-8% for RSD loans are available from government subsidy programs, potential borrowers ask why they should take a loan attracting an interest rate of 18-26% provided by an (unsubsidized) commercial bank. The reality is that many businesses and farmers are not able to access these programs. Indeed, the volume of total subsidized lending in 2011 was less than 2% of the total level of all lending (agriculture and non-agriculture) that year, and the number of loans that were actually subsided (particularly to individuals) is a very small fraction of the overall lending in Serbia. In this context, state funds and Serbian government programs distort the market. They paint an unrealistic picture of the availability of subsidized credit products. The views of bankers and borrowers interviewed indicate that relentless marketing 6 of subsidy programs has given many potential borrowers the impression that they, too, can access a subsidized loan. The reality is very few of them can do so. The focus of this report is on the status of agricultural lending in Serbia and the view of lenders in terms of the constraints that prevent them from lending more to the sector. In this context, detailed information on Serbian agricultural subsidies, except for lending-related structural incentives described above, is not provided here. However, the receipt of subsidy income and market support is obviously a strong factor in creditworthiness decisions made by bankers and other lenders when the credit decision is made. Unfortunately, many of the lenders interviewed indicated that the subsidy income, although certainly beneficial, often comes late or is paid out incompletely by the MoA. This is a significant factor in lenders recommendations for an improved subsidy and policy environment, as detailed below. 6 This marketing takes the form of speeches by politicians, information on the MoA website and other government websites, and in particular a strong marketing effort by each of the participating banks that such products are available to anyone who meets the criteria. 17

19 3. AGRICULTURAL SECTOR LENDING IN SERBIA The following section of the report contains a more detailed description of the discussions held with banks and other financial institutions, as well as a snapshot of the current lending environment in Serbia pertaining to the agricultural sector. In this context, a more accurate picture of the level of agricultural financing in Serbia needs to include the provision of input financing to the agricultural sector by the integrators, as well as that of leasing companies, state organizations and microfinance providers in terms of their lending volumes. Banks and non-bank lenders are in many cases reluctant to finance the agricultural sector, particularly in the undeveloped areas of the country, due to lack of knowledge and experience in agricultural lending and high levels of risk aversion. However, discussions with lenders indicated that most of them believed that were offering products that suited the needs of the agribusiness sector. Generally, with a few exceptions, a lack of products is not an issue for banks; their hesitation rather stems from a perception of high risk in the agricultural sector, a lack of creditworthy borrowers, as well as other issues explained in more detail later in this document. The amounts of lending to the agricultural sector, broken down by type of providers and including all major actors on the market, is presented in the below table: Overall Lending to the Agricultural Sector by Organization Type (in EUR) 7 1 Banca Intesa 58,601, % 2 Nova Agrobanka 47,306, % 3 Komercijalna Bank 45,185, % 4 Societe Générale 35,385, % 5 AIK Bank 24,457, % 6 Hypo Alpe-Adria-Bank 22,971, % 7 Credit Agricole Bank 18,378, % 8 Raiffeisen Bank 17,367, % 9 UniCredit Bank 16,395, % 10 ProCredit Bank 16,358, % 11 State Funds (Dev t Fund, etc.) 153,780, % 12 Leasing Companies 38,022, % 13 Microfinance Organizations 6,650, % 14 All Other Banks 60,650, % 15 Integrators (est.) 100,000, % TOTAL: 661,512, % Source: NBS, author s analysis 7 The data above are based on official sources (for bank lending amounts, NBS data are cross-checked with those provided by the Credit Bureau). Data sources and further information on leasing companies, state funds, microfinance institutions and others is provided in the following sections of the document. 18

20 3.1. BANK LENDING TO AGRICULTURE IN SERBIA In order to learn first-hand about the challenges and mitigating strategies of the banking sector in terms of its outreach to the agribusinesses, the research included interviews with major commercial lenders. A set of interviews with 13 banks in Serbia was conducted. During the assignment, the consultant interviewed the CEOs, Deputy CEOs or sectorial managers (managers focused on agricultural and/or SME lending) of the top lenders 8 in the country. The focus of interviews with commercial bankers was to ascertain the types of products they were offering to the agricultural sector and assess their lending experience and level of commitment to agricultural finance. In particular, given the importance of the sector, it was judged to be important to understand why the lenders were serving the area and what the key features of their business models were that made the agricultural sector worth serving. In this context, the interviews were conducted with the goal of assessing the current state of agricultural finance in Serbia, as well as their views on what they believe needs to be done to improve their ability to finance the sector. The following chapter provides a summary of findings divided into general conclusions on bank lending to agricultural sector in Serbia; specific findings related to banks active in agricultural lending; and findings about banks that are not active in agricultural lending. Specific findings are focused on analyzing the various responses made in interviews with financial institutions and issues related to their ability, capacity and willingness to engage in agricultural lending aimed at farmers, SMEs and large agro-enterprises. Overview of Bank Lending to the Agricultural Sector Serbian commercial banks are by far the largest formal lenders to agriculture, accounting for over 55% of the official sum of lending to the agricultural sector. According to the NBS, 9 there is approximately EUR 419 million in outstanding loans to this sector as of end-of-year This includes corporate and agribusiness SMEs lending, loans to registered farmers, as well as retail-type individual loans for agricultural purposes. Generally, banks offer a wide-range of loan products to the agricultural sector. All banks interviewed have a large number of agricultural loan products available that include, among other features, grace periods, trade contract collateralization, equipment finance and input credit. As in most countries, bank decisions on lending to all sectors, not just agriculture, are based on the banks risk assessments and their estimate of the clients ability and willingness to repay. Bankers make their credit decisions on the basis of the borrower s creditworthiness, taking into account the potential clients business performance, historical data, market prospects and plans for the future. This point is reinforced in the following sections of this document. A short summary of the banking product range and the outstanding amounts of their loans to the agricultural sector, focusing on the largest five agricultural lending banks in Serbia, is provided in the table below: 8 List of interviewed banks can be found in the Appendix. One bank not interviewed is the former Agrobanka, now Nova Agrobanka, which due to its recent change of management and ownership as a result of the NBS receivership was not in a position to discuss their agribusiness financing practices with the consultant. 9 Source: NBS data provided to BEP in June 2012 and cross-referenced with Credit Bureau data. However, there is a clear indication that the data are not comprehensive, as explained below. 19

21 Loan Products Available to the Agricultural Sector from Leading Banks Bank Agricultura l Portfolio in EUR Term of Ag Products Grace? Installmen t Terms Conditions / Collateral Moveable Property Contract Collateral Banca Intesa 58,601,000 Yes M/Q M Yes Yes Yes 70-75% Nova Agrobanka 47,306,835 Yes M/Q 6-84 M Yes Yes Yes 80-90% Komercijalna ,185,983 Yes M/Q Banka M Yes Yes Yes 80-85% Societe ,385,930 Yes M/Q Générale M Yes Yes Yes 70-75% AIK Banka 24, Yes M/Q 6-72 M Yes Yes Yes 70-80% All other banks 208,772,391 TOTAL 419,710,061 Source: NBS data and author s analysis (M=monthly, Q-Quarterly) In addition to the outline of products that apply to the agricultural sector, the table above presents the overall volume of bank lending to the agricultural sector. However, the data are almost certainly incomplete as many of the banks interviewed use different classifications for agricultural loans in terms of their dealing with large corporate borrowers. In many cases, loans that are classified as corporate, industrial or other, are not included in the volume of agricultural lending reported by the banks. Informal estimates from the larger banks are that the actual lending to the sector may be many times higher than the official NBS data. One illustration of this is the case of Societe Générale. According to the Deputy Director of the bank, approximately 30% of its lending is to corporates and SMEs active in the agricultural sector. On the bank s outstanding portfolio of EUR 1.1 billion as of December 2011, this would imply a rough agricultural-lending total of EUR 366 million. However, the NBS data shows only EUR 35.4 million - approximately 10 times lower than the Deputy Director s estimate and less than 2% of its total portfolio. As mentioned earlier, there are two likely explanations to this. One is that banks are careless about reporting the purpose of corporate loans, which are generally reported as corporate and not on a sector basis. Another is that rather than extending credit directly, banks indirectly extend credit to the agricultural sector by lending to large commercial enterprises that buy and trade in agricultural inputs. Some of these companies are large (Viktoria Group, MK Commerce, Delta Agrar, etc.), but this also includes agricultural cooperatives engaging in various types of barter operations with their suppliers (i.e. paritet) in which a farmer takes fertilizer or other inputs from an integrator in exchange for crop sales upon harvest. These arrangements are usually favorable to the supplier, but farmers are in most cases satisfied to have a guaranteed buyer for their production. WH R LTV Agricultural finance is primarily provided by the Serbian banking sector, but it is often constrained in terms of access. Of the total amount of bank loans to the private sector in Serbia (RSD 1,672 billion or about EUR 14.5 billion), officially about 3% is in loans to the agricultural and food processing sectors. Most of this is predominantly with maturity of 2-3 years and primarily extended to SMEs and larger agro-processing businesses. Related collateral costs are relatively high in Serbia and can represent a critical constraint to access to finance, particularly for small producers and processors located in the South, where land records are less detailed and agricultural land generally has less value. As a bank, we are only interested in agricultural lending in Vojvodina, and as a matter of fact we do not have any loans to farmers or food companies outside of Vojvodina or Belgrade. (Bank Manager) Banks are more active in lending to agriculture in Vojvodina. Borrowers in Vojvodina typically approach a bank at a branch office level and, in most banks, branch offices are allowed to extend those credits at amounts needed by agricultural clients without asking for clearance from the headquarters 20

22 credit committee. This is mainly due to the fact that Vojvodina has larger land plots, better infrastructure, closer geographical contact with buyers and a longer tradition of agriculture than the rest of Serbia. In this context, estimates provided by six interviewed banks indicate that less than 5% of all agricultural lending is made in Southern Serbia, with over 70% in Vojvodina and the remainder provided in Central and Western Serbia. Credit is primarily extended for fertilizer/seed inputs or agricultural processing equipment (e.g., tractors, combines) as well as working capital. As highlighted by representatives of the banks, commercial banks have significant challenges related to local currency funding (i.e. insufficient RSD) as compared to the high demand, especially by smaller firms, for loans denominated in RSD. Generally, banks are hampered in their access to currency, credit insurance and securitization technologies/platforms that would mitigate risk and allow them to better meet the credit demand of the small business sector, which includes value-chain actors. The high level of euroization of Serbia s economy is a factor increasing currency risk for borrowers. As of end-2011, the euroization ratio of the total loan stock was, according to the NBS, slightly more than 77%, while euroization on the deposit side was close to 70%. Serbia has embarked upon a strategy for de-euroization. However, a significant risk for banks remains their indirect foreign currency exposure. Due to the high level of foreign exchange credit, banks are indirectly affected by exchange rate appreciations that reduce the ability of borrowers whose revenues are not in foreign exchange to service their debts, which is the majority of agro sector. Credit funded from the bank s own sources is mostly with shorter maturity rarely up to 5 years, and more typically 2-3 years. As already mentioned, this is because banks in Serbia lack longer-term local-currency funding sources, except for the banks own equity. Agricultural clients generally receive credit on the same terms as do small and medium enterprises, but their share of loan approvals is significantly lower and increasingly tied to EUR due to lack of RSD funding. Almost all of the banks interviewed stated that they performed cash flow analysis and considered collateral to be a secondary source of repayment. While this may be the case, three of the interviewed banks stated that the NBS regulations on the collateral-coverage negatively influence the ability of the banks to provide credit, particularly to the economically-active households working in agriculture. Each banks credit policy specifies what can be accepted as collateral. All banks accept equipment and land as collateral, at values determined by professional appraisers. Most banks do accept the warehouse receipts. Recent changes to the NBS classifications to include warehouse receipts as adequate collateral were welcomed by banks in this field. The banks tend to use commercial contracts as an indicator of the creditworthiness of the borrower, i.e. detailed contracts with a respected buyer will generally result in a more positive creditworthiness assessment than a lack of such contracts. About half of the banks interviewed that support the agricultural sector were willing to collateralize purchase contacts of borrowers 10 by including a clause whereby the bank would receive customer payments while others used the contracts as inputs for the credit assessment process but they were not formally collateralized. We have a large number of credit products available to the agricultural sector, particularly large companies, but our lack of RSD funding means that we pass on currency risk to our borrowers, which weakens their creditworthiness in our assessment (Bank Manager) As for natural persons, only employed people or farmers are eligible for bank loans, and this makes it difficult for small-scale producers to achieve financial access. The NBS defines (Official Gazette of the Republic of Serbia, No. 94/2011 and 57/2012) a farmer as a natural person, holder or member of a family agricultural household within the meaning of the Law on Agriculture and Rural Development. This assumes that the agricultural household is registered in the Register of Agricultural 10 Banks included in this list are Societe Generale, ProCredit and OBS. 21

23 Holdings. In the context of individual unregistered producers, many banks are unwilling to provide loans due to the high reserve requirement for estimated loss. Under the NBS regulation (Official Gazette of the Republic of Serbia, No. 94/2011 and 57/2012), to assess the creditworthiness of a natural person borrower, a bank must use the borrower s regular net monthly income, which farmers often lack. Serbian banks generally classify their outreach based on broad classifications into industrial categories and not into value chains. In many cases, albeit not always, they lack knowledge of the functioning of value chains and the inter-relationships of small to large actors in each chain. However, a few of the interviewed banks are active in value chain lending; these include Banka Intesa, ProCredit, OBS and Societe Générale, among others. Many banks stated that they were designing/experimenting with new products (warehouse receipts, factoring, etc.) some because they received international funding sources or technical assistance to do so, and others because their competitors were doing so. Most of the banks interviewed, however, did not demonstrate a commitment to product design, preferring to offer general products that can be structured for each borrower afterwards. The banks indicated that they were not focused on providing value to their agricultural clients in terms of new product development. This does not indicate a lack of product availability, but rather a methodology to adjust each offer to specific clients as needed. In this context, the bankers expressed confidence that they have a sufficient range of products that meets the needs of the agricultural sector. As mentioned earlier, the larger Serbian banks offer a wide range of loan products to agribusinesses. All banks focused on the agricultural sector that were interviewed have a large number of agricultural loan products that include grace periods, contract collateralization, equipment finance and input credit, among others. The author s research was thus unable to find a credit product that was unavailable to Serbian borrowers as compared to similar customer profiles of agricultural producers and processors in the EU. From the interviews with the majority of the banks and other lenders, it appears that some lenders are also constrained in lending to agricultural actors because they do not have the strategic goal of increasing their lending activity to the Serbian agricultural sector. These banks, classified as nonsupportive to the agricultural sector in the structure of this report, are largely satisfied with the current scale of their business outreach and see no strategic imperative that overcomes their assessment of agricultural lending as riskier than other lending, or requiring a specialization they do not have and/or do not want to acquire. In many cases, the banks expressed certainty that they were doing the best they were able to to satisfy the appetite of the agricultural sector for lending products, but that the problems were primarily based on the creditworthiness of the potential borrowers. And, to a degree, this is supported by NPL data. NPL data indicated that over 14% of corporate borrowers and 8% of individual borrowers were delinquent as of Q The level of agricultural NPL as a percentage of NPL was 8% of all corporate NPLs (despite only being 3% of all lending); thus, bankers claims that agricultural lending was riskier than other lending appear to be justified. 22

24 Banks Focused on Agricultural Lending The top five agricultural lenders in Serbia by volume are Banca Intesa, Nova Agrobanka, Societe Générale, Komercijalna Banka, and AIK Banka. All of them offer a wide range of products to the agricultural sector, including input financing/working capital, investment financing and for loans for other purposes such as settling obligations, financial consolidation, etc. These banks provide financing to cover the entire production cycle as well as financing specific aspects of the production cycle and value chains. For example, banks provide credit to agricultural actors for the construction of grain silos. They are offering specialized loans to support fruit production (raspberry producers can access a 5-year loan from ProCredit or OBS) or loans for grain exports (a total volume of EUR 50 million in loans provided by commercial banks was insured by AOFI in 2011). As can be seen from the offer from the banks in the appendix, the majority of loan products that are available have sufficient seasonality adjustments and grace periods so as to be relevant to agricultural lending. The rough breakdown of this lending in terms of input financing (short-term), investment financing (long-term) and other-purpose financing (mixed) varies significantly by each bank, but averages out to a roughly 60/30/10 split within each bank s portfolio. In terms of formal lending by the banking sector designated by the NBS as such, this would indicate a rough portfolio level of these five leading banks as follows: input financing/working capital EUR 126m, investment financing EUR 63m, and EUR 21m in loans for other purposes. The level of commitment of these banks to agricultural finance is exceptionally strong. They are serving the agricultural sector as a key feature of their business model, in particular on the corporate side in terms of an increasingly close relationship with large processing and integrator companies. Of these banks, Banca Intesa, Komercijalna Bank and Societe Générale are heavily focused on the provision of agricultural loans to corporates, while the others allocate higher portions of their portfolios to individual lending. The issue with lending to the agricultural sector is not one of product availability, but rather of the creditworthiness of the agricultural sector. Banks believe that they are supporting the agricultural sector Our bank offers a large number of options to borrowers for the security of the loan. We are working with milk producers to collateralize their milk delivery contracts with Imlek. We are also a large lender to Imlek. (Bank VP) but less so than other sectors, due to the constraints pertaining to the agricultural sector described below that serve to increase the overall risk of lending to agriculture. The banks interviewed did not believe that lenders faced crippling challenges with agriculture-specific collateral registration and valuation e.g. land, equipment, etc. They acknowledged that in some jurisdictions in southern Serbia collection of collateral can be problematic, but judged that their borrower assessment and credit risk policies minimized that constraint to a large degree. The banks also felt that they had enough information on the needs of agricultural firms to make the right lending decisions, particularly when combined with the knowledge and expertise of their loan officers. Generally, banks supporting the agricultural sector feel that they have access to information that allows them to identify opportunities for lending mainly through market information provided by their key loan officers and managerial staff. A general statement, made by four of the interviewed bankers with a focus on agriculture, was that they have chosen to specialize in this sector, as a strategy, and have taken the appropriate steps to train staff, make loan funds available, etc. so that funds are able to be provided to this sector by the banks in accordance with their annual plans. The answer to the question of What needs to be done so that financial institutions can INCREASE their provision of credit services in the agricultural sector? identified the top three constraints to the 23

25 growth of agricultural lending activities by commercial banks 11. Of note is the fact that, of all the constraints listed by the institutions in priority order above, the constraints described in more detail below were identified as being within the top five constraints by each and every financial institution interviewed. These constraints, in priority order as identified by the active agricultural lenders, include: A. Uncertainty in planning and inconsistency of Serbian Agricultural Policy. B. Poorly-designed interest-rate subsidy programs. C. Lack of negotiating power (lack of effective cooperative law, associations, etc.). A. Uncertainty in Planning and Inconsistency of Serbian Agricultural Policy It is a matter of record that the Serbian MoA has gone through a large number of ministers in the past decade, and that each one brought with him/her a different team of advisors and priorities. There have been three phases of agricultural policy in the past ten years. The first one (from 2001 to 2003) was oriented towards price support for certain crops (soybean, sunflower, sugar beet, and wheat) and lacking in other agricultural policy measures. In the second phase ( ) price support was withdrawn and emphasis was placed on investment support and rural development, whereas the third phase ( ) was characterized by establishing payment per surface area and head of cattle, and also by the introduction of a number of ad hoc market facilitation measures. The primary constraints in the area of Serbian policy environment as pertains to agriculture can be summed up as unpredictability of agrarian policy and constant changes to the spending structure of the agrarian budget. The unpredictability of agrarian and financial policy is reflected on the fact that the budget is announced in January and has to be spent in March. Such unpredictability prevents producers from engaging in any kind of long-term planning, which leads to a decrease in their creditworthiness. In addition, every yearly budget from 2001 onwards has had a different spending structure where policies changed from one year to the next (from investment support to payments per hectare, from payments per hectare to input subsidies, from decreasing rural development support one year to be increase it the next year, from paying the subsidies to all Serbian producers to paying only to those that pay pension insurance, etc.). The lack of information and research additionally contributes to uncertainty in business planning in the agro sector. There is no institutional MoA support that would back producer planning through concrete information and market research and planning activities. This includes resolving the lack of market information due to the lack of an effective agricultural extension service. The current situation instigates fear of the unknown in many producers. This unpredictable policy environment, even with the implementation of the Serbian Agriculture Strategy in 2004, reduced the possibility of long term planning and resulted in a significant decrease of investments in the sector. This uncertainly affects the ability of agricultural producers to plan what their expected subsidy income will be the next year, so that they can make borrowing decisions based on their expected total income. Banks agree that this uncertainty decreases creditworthiness of clients and makes their business plans less useful. B. Poorly-designed Interest-Rate Subsidy Programs 11 Note that the typical constraints faced by banks in terms of lending in Serbia, such as weak contract enforcement, cumbersome reporting regulations, among numerous others, are left out of this part of the analysis. In the discussions with the lenders, the consultant expressly solicited input only on those constraints that pertain to lending to the agricultural sector. This was to avoid overlap with a highly detailed study of constraints faced by SMEs as a whole in accessing finance. 24

26 The commercial banks interviewed by the consultant were unanimous in their view the current system of providing subsidies to banks in order to increase their levels of agricultural lending was not a motivating factor for them. As a matter of fact, they were unanimous in seeing the current structure of the subsidy program as a disincentive to lend to the agricultural sector. No one at the Ministry of Agriculture asked us for input on the subsidy calculations it was take it or leave it (Commercial Banker) As mentioned earlier, subsidies are provided by the government to encourage lenders to operate in a sector that is perceived as high-risk. This perception was confirmed by the banks interviewed, which believed agricultural financing was riskier than other types of financing (due to sector-specific risks such as drought, hail, windstorms, etc.) and therefore subsidy support was justified to lower the risk premium which banks would otherwise add to loan costs to the agricultural sector. Subsidies were also provided for the reason that the government faced an issue related to the strategic interest in maintaining domestic food production. Unfortunately, a major issue, according to the banks, is that the subsidy levels provided to them by the MoA, i.e. interest rate subsidy coverage on a 6% interest loan to the agricultural producer, were not sufficient to cover banks outreach costs to the sector and cost of capital. The total average cost of capital for the five banks was approximately 12.5% to 13%, although this varies based on NBS rates and interest rates offered to depositors. A breakdown of the calculation was provided by all the interviewed banks as follows: 1. Bank is allowed to calculate the loan at the NBS repo rate plus 3%. 2. This is approximately 12%, which is what the farmer should normally pay. 3. However, the farmer is only allowed to be charged 6%, with the difference being subsidized by the MoA which refunds the difference (6%) to the bank. According to the calculations of three banks involved in the program, the difference subsidized by the MoA does not provide them with sufficient cost-coverage to motivate and encourage them to participate in the subsidy program. The subsidized loans highly influence demand for commercial loans. Due to high interest-rate sensitivity, many farmers do not ask for an unsubsidized loan even if they desperately need the money to grow or maintain their operations. In addition, banks are publicly criticized for offering high interest rates as compared to the subsidized loan products. In this context, the existence and government boasting of these subsidies distort the market, but the demand for subsidized loans by the agricultural producers forces the government to offer them on a continuing basis. On the other hand, many banks are forced to take part, even though their profitability goals are not being serviced by this participation, just to provide the full range of available products to their clients. 25

27 C. Poor Negotiating Power (lack of effective cooperatives, associations, etc.) An additional constraint identified by the banks interviewed is that there is an absence of effective, member-oriented agricultural cooperatives that could assist their members in negotiating terms not only for sales of produce, but also terms of financing. A cooperative, defined as a membership-based organization in which people working in the same profession join together to individual and mutual benefit, does not have a positive connotation in Serbia. Negative experiences with old-style socialist types of cooperatives tend to make producers suspicious. Currently, there are three types of cooperatives in the country: Old type - concentrating more on production then on If I was able to deal directly with a cooperative or an association of farmers, then my outreach costs would be much lower and I could focus more resources on this sector. (Commercial Banker) marketing (30-40%). Private cooperatives - without any democratic structure and formed by opportunist traders with the objective of using the legal benefits provided to cooperatives (50-60%). Modern cooperatives - with democratic decision making processes and a focus on member benefits. These are currently very rare in Serbia (5%). The lack of negotiating power of producers limits their access to markets, technical assistance, best practices and agricultural finance. 12 The absence of effective cooperatives is particularly felt in the family-holding sector (registered and unregistered farmers) which is highly vulnerable to price volatility. For a large number of farms, their small size, high degree of disorganization, lack of financial and storage capacities, and small and uncertain production, lead to the absence of negotiating power with both buyers and banks. On the other hand, large agricultural producers (large farms and agricultural associations) have, to a certain degree, more reliable buyers and contracted production (especially with regards to the sale of milk, cattle, oil crops, etc.). However, their negotiating power in relation to the food industry or supermarkets is also not significant. In both cases, poor market leverage negatively reflects on their cash flow and overall creditworthiness. All these facts were cited by the banks as a significant constraint to their ability to support individual farmers and small-scale processors. If only cooperatives functioned as active and well-managed integrators and negotiators for production and sale of their outputs, lenders could better support the activities of tens or hundreds of producers via one cooperative, rather than being forced to contract with hundreds of farmers individually. This would serve to significantly lower outreach costs and increase bank profitability per loan. Banks Not Focused on Agricultural Lending Services The largest of these interviewed banks included Raiffeisen, UniCredit, Privredna Banka Beograd, Cacanska Banka and Alpha Bank, which made numerous observations about the policy constraints as well as the various weaknesses of agricultural borrowers. Considering that the level of agriculture to GDP is 11%, but that only 3% of all bank loans are made to the agricultural sector (according to NBS data but not including leasing, integrator and state funds), it is clear that many banks do not support agriculture. If one were to include non-bank funding to the agricultural sector, this would add 12 Many of these same constraints that apply to farmers ability to negotiate through cooperatives could also apply to processors in terms the formation or improvement of business associations, clusters, etc. However, none of the interviewed bankers or PKS personnel mentioned this as a constraint to their corporate lending to the agricultural sector. 26

28 approximately an additional EUR 200 million to the overall amount, for a total of 6%. This is still far below the level of agricultural lending that one would expect considering the contribution of agriculture to Serbian GDP. A major focus of the consultant s assignment was to conduct, as part of the credit supply survey, interviews with financial institutions in an effort to answer the question of Why are financial institutions NOT providing credit services in the agricultural sector? In that context, the lenders interviewed mainly relied on vague assertions that agriculture was too risky and that there was not enough market and business knowledge of potential agricultural borrowers. Generally, the tone of their responses to the question of why don t they lend to agriculture? was a corresponding response of why should we? There are a variety of issues that were mentioned by the interviewed bankers in the context of their lack of focus on the agricultural sector. But generally, these constraints cannot be defined by the author as agriculture-specific. In this survey, the top constraints to lending (specific for agro sector) by nonagricultural banks were identified (in order of priority) as: lack of appropriate fit into the bank s strategy; and low creditworthiness of agribusinesses and high risk of the sector. A. Lack of Appropriate Fit into the Bank s Strategy According to the commercial banks interviewed that did not demonstrate a key commitment to agricultural lending, they are significantly constrained in their ability to target the sector because the owners/shareholders and upper management do not desire to increase their exposure to this sector. It was stated specifically as not being an area where the banks chose to focus, and results in a lack of the organizational strategy of the banks in this sector, i.e. that the banks have made a strategic decision not to target this sector and for this reason are not active in the provision of credit to this segment. During the interviews, the managers stated that there were simply too many problems in the agricultural sector, or too many unresolved issues related to the policy environment, and too much uncertainty about the ability of agricultural producers and processors to meet their obligations. To address this, some banks have chosen to focus on the delivery of products to the agricultural sector. Bankers made clear that this demands a significant effort to train staff, build relationships with farmers and processing companies, and to understand the market for agricultural lending. This is a strategic choice, and investment and those banks that are involved in agricultural lending do not have access to a secret formula that other banks do not. According to bankers, banks focusing in this We are not interested in lending to the agricultural sector. We have very few loans there. Basically, it is just too risky for us, and we don t understand the market well. We will leave it to other banks (Bank VP in Central Serbia) area have simply chosen to have some level of focus on this sector. Most banks, however, have not done so. B. Low Creditworthiness of Agribusinesses and High Risk of the Sector In the overall view of the interviewed banks that do not supporting agriculture significantly, there are a number of structural weaknesses in the sector. According to a very senior banker from a bank that is non-supportive to agricultural lending, there are two basic problems in the functioning of agricultural markets in Serbia. The first is that only a small number of agricultural producers are included in modern market chains because of being largely uncompetitive. They operate through informal channels while the cost of standardization of their production is (relatively) very high. The other problem is the lack of competitiveness when it comes to processing facilities, which is characterized by their inability to increase sales through penetrating new markets. A large amount of competition in 27

29 primary production, combined with a low competitiveness when it comes to food processing, are the fundamental negative traits of Serbian agriculture. At the same time, agribusinesses lack knowledge and understanding of the importance of business planning, drafting of business plans, investment studies and preparation of documents to apply for loans. As a consequence, they present lower-quality plans and documents which result in a long loan approval process or numerous loan rejections. In the bankers view, the reasons for such conditions lie in the failure to attract investments into the food processing sector brought about by the inability to fulfill EU export standards for a great number of products, unreliability of GoS and political support, underdeveloped Our bank doesn t lend to unregistered agricultural producers. Their access to market is too uncertain. The strategy of our bank is to focus only on farmers with 100 or more hectares and on the top 1,000 farmers in the province. (Risk Manager in Vojvodina) institutions, lack of knowledge concerning the real competitiveness due to high tariff protection, etc. This results in a short market chain for many of the small producers, usually ending at the local green market, in the local village, or with a wholesale buyer. The sector demonstrates a lack of collateral, primarily high value real estate, as well as lack of possibility to use mortgages due to unregistered buildings and incomplete land registers. In addition, procedures for loan debt collection and contract enforcement, particularly in the rural areas of Serbia are very long. 28

30 3.2. NON-BANK LENDING TO AGRICULTURE IN SERBIA In addition to banks, a number of other institutions are active in financing the Serbian agricultural sector. There are five categories of non-bank financial institutions, which provide agriculture-related financing to individuals and companies in Serbia. These include leasing, state funds, microfinance institutions (MFIs), integrators and private equity. Overall Lending to the Agricultural Sector by Non-Bank Organization Non-Bank Institution Est. Agricultural Portfolio (EUR) Interest Rate Ceiling, EUR # LTV RSD EUR Secured Unsecured Leasing absent 9-15% absent % State Funds % 8-12% absent % MFIs % absent % Integrators % absent By crop By crop unk. n/a Priv. Equity n/app n/app n/app 3-4 n/a TOTAL Source: Author s research, NBS (n/a means not available, n/app means not applicable) As can be seen in the above table, a range of legal forms and terms of agricultural loan products are offered by these institutions. However, of these lenders (informal or otherwise), only the leasing companies provide their loans under direct NBS supervision. The others operate in accordance with different laws 14 ; publicly-available data on their agricultural-lending activities are difficult to access and are not formally tracked by any state bodies. During the interviews non-bank lenders indicated a variety of challenges and constraints to expanding their operations. Except for the leasing companies, the primary constraint identified by lenders in this category is the lack of legislation supporting non-bank lending. The lack of a legal framework for most forms of non-bank lending is a significant drawback for the Serbian financial system. There is little room for innovation, including the fact that the current regulatory framework does not allow the formation of lending institutions, except banks and leasing companies, which could directly provide loans to the agricultural sector. Considering that much of the current level of agricultural credit is being provided by non-transparent actors in the agricultural supply and purchase markets (integrators), as well as by the Serbian Development Fund (facing high delinquency and non-transparent credit assessment procedures), there is a significant need for improvement. The following section provides a more detailed breakdown on the level of lending to the agricultural sector by type of non-bank organization (categories as per the above table). 13 Data on the estimate for integrator supply finance are provided on page 26 of this document. 14 For example the Law on the Serbian Development Fund, the AOFI Law, and the Company Law (for MFIs). 29

31 LEASING COMPANIES Leasing has grown substantially over the past several years as a number of new companies have entered Serbia and expanded with branches outside of Belgrade. There are 16 registered leasing companies in Serbia, of which 10 lessors are 100% or majority owned by foreign legal entities, five lessors are 100% or majority owned of domestic entities (of which four are owned by domestic banks with foreign capital), while one lessor is jointly owned by a domestic bank with foreign capital share and a foreign legal entity (Source: Financial Leasing Supervision, Second Quarter Report 2012, NBS). With almost 60% of the market, leasing is dominated by five companies (Hypo, Intesa Leasing, NLB Leasing, Raiffeisen Leasing, and EFG Leasing). These companies were initially focused on automobile leasing, but, faced with growing competition, are now financing other movable assets such as trucking fleets, cargo services, as well as agricultural equipment such as combines and tractors. According to the NBS data for second quarter of 2012, balance sheet assets of the leasing sector totaled RSD 83.3bn, up by 3.9% relative to 31 December The bulk of assets and liabilities was either foreign-currency-denominated or foreign-currency-clause-indexed (89.7% of total assets and 88.7% of total liabilities). The largest share in total assets was that of financial lease receivables, 77.1% at end- Q Due to lack of lending and market opportunities, current assets rose by 12.3%, reflecting a 26.4% increase in cash and cash equivalents. The share of this item in total assets expanded from 8.7% at end-2011 to 10.6% at end-q2. As has been stated, although financial leasing companies are well-established in Serbia, they are mainly focused on transport and automobile financing because of strong enterprise and consumer demand, as well as a liquid secondary market for vehicles. Agricultural leasing is a small fraction of the overall level of equipment financing provided by the leasing companies. In Serbia, agricultural leasing is limited to tractors and combines and a very few medium-sized equipment investments, thus arriving at an average of about 6-7% of the overall portfolio of all leasing companies. According to a leasing CEO interviewed, this could be increased with risk-mitigation techniques such as stronger buy-back measures (repurchase agreements for equipment on which there is default) from equipment vendors, or the increased development of a secondary market for agricultural machinery. However, the lack of these vendor and secondary market relationships is not a function of the regulatory environment but rather a result of the relatively low demand for Our experience in leasing to farmers has not given me any evidence that this is an appropriate sector for us to be targeting with our lease products. (Leasing Company CEO) equipment repossessed, and in some cases a reluctance of agricultural actors in Serbia to acquire used equipment. Although the advantages of leasing for agricultural financing are evident (i.e. strong relationships with equipment dealers than can perform required maintenance, and less collateral required than for an equivalent bank loan) the leasing arrangements include substantial down payments (of up to 25-30% of the purchase price). According to a leasing company CEO, many potential lessees do not have the ability to secure sufficient liquidity for the down payment, and as a result cannot meet the requirements of the leasing company. In many cases farmers and enterprises often need to take out bank loans to finance the down payment. Additionally, borrower liquidity constraints combined with the perception of high risk in the agricultural sector by the interviewees has kept the volume of agricultural new business in the leasing sector at a low rate as per the table below: 30

32 Agricultural leasing as percentage of overall number of new leases in 2011 and 2010 Leases with New Clients TOTAL All Leases with New Clients EUR 256,982,328 EUR 202,939,010 TOTAL Agricultural New Business EUR 15,604,756 EUR 14,288,920 Agricultural New Business (% of TOTAL) 6.07% 7.04% Source: Leasing Association of Serbia The Serbian leasing companies identified major challenges to their ability to increase their outreach to the agricultural sector. The most significant constraint to the expansion of leasing is that VAT costs for equipment, as well as VAT on the interest rate charges, are passed onto the lessees by the leasing companies. It is for this reason that the leasing of agricultural equipment is less competitive (on both price and convenience) compared to financing equipment through bank loans. Therefore, the leasing companies have proposed an amendment to the VAT Law. This would lower the cost of financing for leasing, and the leasing companies believe that abolishing VAT on the part of the leasing interest payments will directly increase their ability to make leases of agricultural equipment. The top lessor of agricultural equipment by new business volume stated that it would be easily able to increase lending to the agricultural sector by up to a third each year if VAT conditions were relaxed. If it is indeed the goal of the government and the donor community to increase access to equipment by the agricultural sector, then the alleviation of these constraints would be a good place to start. In addition, it is not possible, under current legislation, for Serbian EU subsidies to be provided for agricultural equipment leases, since a borrower must actually own the equipment (and not just lease it) to be eligible for this type of Contract enforcement is a subsidized financing. major weakness here. In Furthermore, another shortcoming when it comes to leasing activities in Serbia is operational leasing, which is rarely used in the country. Due to the already mentioned lack of liquidity and need for cash advances, this could present an alternative source of medium-to-long-term financing for agriculture. Establishing agriculturally-oriented operational leasing would require a stronger secondary market for specialized agricultural equipment, most likely through buy-back agreement with dealers and the creation of maintenance centers for support and service. In discussions with lessors, the market potential for such operations is perceived as limited in Serbia due to relatively small 2006/2007 we were encouraged by the MoA to make tractor leases in the South. We stopped after dozens of tractors were driven across the Bosnia- Herzegovina border and sold despite our formal ownership. (Leasing CEO) amounts of equipment. In discussions with the Leasing Association, they pointed out a lack of clarity on the taxation implications of operating leasing. This leads to the need for constant clarification from the relevant tax authorities. 16 In this context, there have been no concrete steps to develop operational leasing either on the part of the companies or the regulators in the past years, although the Leasing Association is currently examining this issue. Policy changes to relieve the entire leasing sector of the burden of VAT, and other measures to support the leasing sector, would positively impact their ability to provide additional financing of equipment to the agricultural sector. In the interviews with the leasing companies, there were additional constraints mentioned (weak contract enforcement, high transfer charges, etc.). However, there are relatively few specific constraints to agricultural leasing that are not shared by other sectors targeted by leasing. 15 Leases to new clients is a commonly-used leasing data point that refers to new leases funded in a specific time period (NBV) and does not refer to outstanding portfolio volume. 16 The Leasing Association identified the uncertainty of various tax issues as a constraint to operational leasing, but the interviewed leasing companies did not do so. 31

33 SERBIAN STATE-OWNED FUNDS There are a number of state-owned organizations and funds that provide lending support to the Serbian agricultural sector. These include the following: A. Serbian Development Fund The Law on the Development Fund (Official Gazette of the Republic of Serbia, No. 88/10) governs the Serbian Development Fund. The Fund is 100% state-owned and has the goal of encouraging economic development, facilitating balanced regional development, improving the competitiveness of the economy, and encouraging employment. The Fund generally provides very favorable loans, including start-up loans, to businesses and (in a small number of cases) to individuals on a tender basis. In this context, an assessment of the goals and objectives of the Fund can be summarized as supportive to manufacturing and job-intensive businesses. In recent years the MoERD (now MoFE) has invested significant political capital in guiding the Fund to support activities that create jobs. The Fund s sources of lending capital, approximately RSD 110 billion or EUR 1 billion, consist of government allocations from earlier years (mainly before 2003), the collection of its outstanding loans and credit lines, as well as income from commission business on behalf of the state. The Fund does not break down the size of its portfolio by sector; however, they did provide a breakdown of new loans made to the agricultural sector since 2007 (in Appendix). Since most loans from have either been paid off and/or written off, the total figure used for estimates of agricultural lending by the Fund totals EUR 134 million. The terms and conditions of these loans are very favorable, up to 5 years provided for debt servicing, a grace period of 6-18 months, and significantly lower interest rates than those for commercial bank loans. The Fund currently lends to a range of actors (mainly large and medium-sized manufacturing enterprises) at interest rates below the NBS reference rate (in RSD) and at roughly EURIBOR (for EUR-indexed loans). This is a significantly lower interest rate than that which applies to loans available from commercial banks. However, as mentioned, its levels of lending to agricultural enterprises are quite small as a proportion of the overall portfolio, and total approximately 13% of its outstanding loans. During the interviews, it was implied that politically-directed lending is judged as a major weakness of the development fund model generally, and specifically in the case of the Serbian Development Fund. This view is supported by the extremely high levels of credit delinquency by borrowers of the Fund and similar organizations 17. According to Serbian Credit Bureau statistics (provided in the Appendix), over 65% of all borrowers from these funds, which account for 48% of all loan funds outstanding, are currently in a state of repayment delinquency. 17 The Vojvodina Development Fund was closed down and its activities and assets wound up in

34 B. AOFI The Export Credit and Insurance Agency (AOFI) is the official export credit agency of the Republic of Serbia established by a lex specialis (special piece of legislation) for the purpose of export promotion and development of foreign economic relations (Official Gazette of the Republic of Serbia, No. 61 / 2005). The goal of the AOFI is to provide export credit insurance and financing for Serbian export-oriented companies. The Agency s base capital is EUR 60 million. As an export promotion agency, the AOFI acts jointly with development, financial and other institutions, but also with relevant foreign companies and institutions to finance export-oriented production while the sellers are waiting for payments from foreign buyers. We support the development of the agricultural sector, because this is a significant part of the export volume of the Republic of Serbia. (AOFI senior manager) Breakdown of AOFI support in 2010 by sector Source: AOFI. The AOFI has a special mandate to provide financial and institutional support to Serbian exportoriented companies in their efforts to penetrate foreign markets. Local companies need financial support mainly in the area of working capital financing. Taking this fact into account, the AOFI additionally positioned its two financing products: a) factoring and b) short-term financing. In the structure of the AOFI portfolio, the dominant industries are manufacturing, at 38%, metalworking, at 35% and the woodworking industry at 9%. Officially, agricultural loans are deemed to amount to 5% of all AOFI lending. The AOFI executive interviewed stated that it provides a significant level of support to the agricultural sector mainly via food-processing exporters. However, this level of support, he stated, is not captured in the breakdown above where many agricultural activities are bundled into different categories of manufacturing. Although the AOFI manager interviewed could not provide an exact figure, he estimated that the AOFI provided roughly EUR 20 million in capital to the agricultural sector, which is 33% of the total capital of the AOFI. In this context, the level of agricultural support by the AOFI as a portion of its capital is significantly in excess of the sector s share of total exports of Serbia, which stands at 21%. C. Indemnity Fund of Serbia The Indemnity Fund of Serbia is the government entity responsible for the designation of public warehouses for agricultural products, terms and conditions for issuing public warehouse work licenses, as well as terms and conditions for trade in and pledging of warehouse receipts. The Indemnity Fund does not make loans directly (this is done by banks which can use the receipts as collateral), but rather supports financing through the system of warehouse receipt financing under the MoA. The Indemnity Fund and its ability to support collateralization of crops would significantly benefit by faster implementation at the Ministry of Agriculture for inspection and licensing of new facilities. (Fund CEO) The Indemnity Fund was founded in December The role that the Indemnity Fund plays in the warehouse receipt system is providing guarantees of the quality and quantity of stored goods. In case the stored goods are damaged during the storage period, and provided that a public warehouse cannot 33

35 indemnify the owner of the goods, or where the goods cannot be covered by obligatory insurance and bank guarantee, it is the Indemnity Fund s role to do so. In this way, processors/ farmers are able to withdraw their goods from the warehouse in the quality and quantity noted in the warehouse receipt. Map of locations of secured public warehouses Source: Indemnity Fund (Yellow = Municipalities with Licensed Warehouses, Purple = in Process) Warehouse receipts are a collateralized commodity transaction where the goods themselves can provide collateral for a loan. This type of financing allows lenders to immediately sell off the underlying commodity if a processor or farmer defaults on the loan. Warehouse receipts are a means of accessing post-harvest finance for working capital needs and the financing cycle usually begins after harvesting when the commodity is stored in a licensed warehouse that issues a receipt proving that the commodity is physically in the warehouse. The provision of credit products focused on warehouse receipts is open to all banks in Serbia, but, generally, the banks most active in this area have been Raiffeisen Bank, Credit Agricole, Societe Générale and Banca Intesa. In this context, there are no major issues with the operations of the warehouse receipts program. However, there are a few recommendations made by the Indemnity Fund, which would facilitate the increased effectiveness of its operations and bring more processors and farmers in the system. D. Vojvodina Guarantee Fund One policy response to the perception of high bank collateral requirements and high interest rates are the credit guarantee schemes (CGSs). These schemes can help reduce information asymmetries between borrowers and lenders. Additionally, CGSs can alleviate the high collateral requirements demanded by banks in case of agro lending, since banks perceive agribusiness as a risky sector in Serbia. Thus, a bank wanting to offer an SME a loan would either need to lend at a rate that covers this risk, or demand a significant amount of collateral. However, when an agribusiness is able to access a guarantee from a CGS, the bank can make the loan at a lower interest rate or with a lower collateral requirement. In this context, the Vojvodina provincial government founded the Vojvodina Guarantee Fund (VGF) in order to facilitate better access to financial markets and to provide more favorable credit terms. This task is realized through its core business the issuance of guarantees to banks as collateral for the repayment of bank loans. The fund provides guarantees to banks by entering into cooperation agreements with banks willing to support program activities of the VGF and loan conditions (interest rate, term and repayment method) adapted to eligible borrowers. The VGF regularly announces tenders for guarantees for the provision of loans intended for financing small businesses, start-ups, and agriculture, which are applied for by prospective borrowers. To date, the VGF has guaranteed a portfolio of approximately EUR 20 million in the agricultural sector, of which EUR 10 million is current. The fund works with its partner banks as shown in the following diagram: 34