Szilvia Bencze works at the Hungarian Ministry of Agriculture and she presented her managing authority’s experience with financial instruments for rural development at the fi-compass seminars in Riga and Dublin. These seminars formed part of a series of regional fi-compass events which were focused on the European Agriculture and Rural Development Fund (EAFRD). Ms Bencze and her colleagues have undergone the process of an ex-ante assessment of financial instruments for addressing the gap in agricultural financing, an experience which was shared with the events’ participants. In a follow-up interview after her presentation in Riga, fi-compass asked Ms Bencze for her perspective on the value-added of EAFRD loans.
SB: In Hungary we had been using financial instruments under the European Regional Development Fund (ERDF) before, and we started to consider EAFRD financial instruments after the first awareness raising actions of the European Commission in 2013. Having daily contact with the various stakeholders on the ground, the Ministry of Agriculture was already aware that a group of farming enterprises faced difficulties in accessing finance. In addition, the financial and economic crisis had had a severe impact on lending, especially on the banks’ willingness to take risk. In the summer of 2014, we launched the market research and gap analysis parts of the ex-ante assessment for financial instruments. This included a survey with which we received detailed feedback from 585 [agri-food] businesses on their situation, needs and challenges. Analysing and identifying the financing gap in the sector took approximately one year, and it enabled us to see the value added of loan funds for a specific target group and to develop a strategy.
We found that 60% of the respondents needed investment loans but could not get one, either because of insufficient financial accounting, i.e. lack of track record, providing poor basis for measuring risk, because of their size, i.e. ‘low’ annual turnover, below EUR 100 000, or because of their lack of administrative knowledge, i.e. to compile proper business plans and loan applications. Aside from the fact that it is difficult for banks to measure the level of risk of these enterprises, the relatively high transaction cost of such contracts is also a challenge for the lenders. At the same time, we noticed the surprisingly high relative profitability ratios and low debt levels of these small sized enterprises showing significant potential for absorption of external finance.
It must be emphasised that agricultural producers in Hungary show exceptional payment discipline, due mainly to their strong attachment to their land and farms. In addition, a new measure in the EAFRD, specifically the income stabilisation tool, can further alleviate the risks of the target group. The ex-ante assessment clearly confirmed the justification of a new approach in the finance of agricultural enterprises. The findings of the analysis enabled us to define a significant group of viable and profitable enterprises, which do not have access to finance at the moment. This group includes micro or small agricultural enterprises, mainly individual businesses, with holding size above the viability threshold (around EUR 6000 of standard output), active mainly in the horticulture and animal husbandry subsectors (crop production was excluded).
We found that the most suitable vehicle would be a loan type financial instrument, as this type could best address our target group’s needs and specificities. In our opinion, the other types of financial instruments, such as guarantees and equity investments, were not appropriate for this purpose. The target group does not receive market finance even in the case of high level of guarantees, which do exist in Hungary. Equity investments are not suitable due in part to the legal form of the enterprises in the target group, yet also because these farmers are not interested in having co-investors in their enterprises.
Instead, the managing authority can take advantage of the unique opportunity offered by financial instruments to create a targeted financing tool, in this case a loan fund. The main advantage of this scheme is that these businesses, which would otherwise not receive finance from the market, will have the chance to become ‘bankable’, all due to financial instruments using the European Structural and Investment Funds [ESIF]. After receiving investment finance from such a loan fund, building their credit history with a bank and growing in size and competitiveness, they can anticipate having greater chances of accessing market based finance from financial institutions in the future, all made possible by ESIF.
It is important to note that it is not riskier for managing authorities to introduce financial instruments and repayable assistances in their Rural Development Programmes [RDPs]. Using financial instruments allows them to generate repayments leading to re-use of programme resources (revolving effect, around 50-80% in the worst case), whereas using grants does not bring returns at all. Beyond that, the added support in the form of the expertise of financial institutions in the selection of loan recipients provides extra assurance when it comes to choosing credible beneficiaries and feasible projects as well as helping to decrease the rate of default.
What is the current state of play with regard to the programming?
SB: Currently the managing authority is focused on launching the grant type measures of the RDP until the end of 2017 at the latest, after which the discussions will continue on whether to introduce financial instruments in the RDP. Since the demand for regular grant type aid is quite high among our farmers, there will also be a resource allocation dilemma which must be taken into account during the decision-making process.
What would be your key advice for other managing authorities interested in EAFRD financial instruments?
SB: Identify your target group and its problems first! This is very important. The rest has to follow. Analysing the statistics and consulting with sector stakeholders during the market analysis process helped us to design the main features of a financial instrument that would fit the needs of the sector.