By Gareth Vaughan
The Reserve Bank's plans to introduce new farm lending capital requirements from June could act as a brake on growth in the rural economy and increase borrowing costs to the productive sector, possibly hampering an export-led recovery, warns accounting firm KPMG.
In its Financial Institutions Performance Survey review of 2010, KPMG notes the Reserve Bank's proposed capital overlay for rural lending, which is expected to force the banks to hold more capital against their rural books, comes at a time of heightened concern about rural debt levels and when many banks have sought to "aggressively" reduce their rural exposures.
This has seen specialist rural lender Rabobank accounting for nearly 65% of new lending to the sector during 2010, albeit during a year of modest growth compared to historical averages. The latest Reserve Bank figures show agriculture lending at NZ$47.48 billion in March, up slightly from NZ$47.45 billion in March 2010, but down from NZ$47.75 billion in February this year.
The Reserve Bank plans to introduce new farm lending capital requirements in June in a move that's expected to see banks assign more equity to the funding of rural loans and probably lead to higher borrowing costs for farmers. Further details are expected in the central bank's next Financial Stability Report due on May 11.
"If imposed, one would expect this will ultimately increase lending costs for farmers and potentially act as a brake on growth in the rural economy, one of the central planks to economic growth in an otherwise uncertain economic landscape," KPMG says.
"(This) will ultimately increase borrowing costs to the productive sector possibly hampering an export-led recovery."
'Expansion should be based on cashflows not land prices'
John Kensington, KPMG's acting head of financial services, told interest.co.nz in a Double Shot interview that historically when farm returns rise farmers take it as an opportunity to expand their business.
"And I think when that expansion happened last time, it was very much based on land prices," says Kensington.
"The amount to be paid was based on land prices, perhaps opposed to what the economic unit (farm) was producing as cashflows. So a lot of farmers went out, bought more land, became bigger farmers, but did so with debt. And when there was a bit of a dip in commodity prices, that caused some of those farmers to be quite stressed."
The latest monthly ANZ Commodity Price Index, for April, recorded a 1.6% gain to 342.5 representing the eighth consecutive monthly rise taking the index to a new record high. The index has now doubled in value since the low point that was reached in February 2009.
Kensington says the rural sector is currently a two speed one. Some farmers have managed to repay debt and are now perhaps thinking about buying another farm because they’re in a good financial position.
"But everyone has had a bit of a fright over this crisis and they’re being very hesitant about doing it," says Kensington. "There are still some large farms, corporate and otherwise, that have extensive amounts of debt. And I think what the Reserve Bank’s saying is that’s not healthy for farmers in such a key sector to carry debt based on ballooning prices."
"The amount of debt they have should be based on the cashflows they can service from their farm. I think it (new farm lending capital requirements) could be a bit of a brake on the rural sector and it could increase farmers' interest costs to do business a little bit."
KPMG says if banks are forced to hold more capital against their rural loan book, this in turn, will increase the internal cost allocation and, ultimately, the banks will look to pass this cost on to farmer borrowers to ensure their return on equity is consistent across loan books.
However, KPMG notes the banks need also to be mindful of farmers’ long memories, saying it took some banks many years to rebuild market share following previous downturns in 1987 and the early 1990s. It points out that a number of the major Australian owned banks were backing off new rural lending during 2010 because of large numbers of non-performing rural exposures.
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