Friday, March 29, 2024

Farmers’ debt must come down

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Banks say the costs of the Reserve Bank’s minimum capital proposal outweigh the benefits and will hit rural borrowers the hardest. Deputy governor Geoff Bascand says it is needed so the banks can withstand not just a rerun of the global financial crisis but remain solvent in a once-in-200 years financial meltdown.
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The costs of the last banking crisis are only becoming clear more than a decade later so the bank is rolling out significant changes now.

“The costs are higher than thought and I am not just including the immediate output costs but also social costs and health problems that come from deep recessions and suicides that come from unemployment and the distress that comes with it.”

The proposals are not the result of some warning light in the bank’s bowels suddenly flashing red but more debt and record low interest rates have increased the banking system’s vulnerabilities to a downturn. 

The Reserve Bank is just one of many regulators around the world asking trading banks to strengthen their balance sheets.

“As a general rule most of the banks have said more capital makes some sense … what we are doing now is asking do we have the right level,” he said.

But the banks say doubling the amount of capital they must hold from 8.5% of all loans to 16% is too much. 

They are warning of hikes in lending rates of 80-120 basis points – well above the 20-40 basis points predicted by the Reserve Bank.

Rural borrowers are being primed by their bankers for the largest increases.

The banks say the Reserve Bank already demands proportionately more capital for loans secured against farms. 

Farms are seen as a more risky form of security than houses, which historically have not fluctuated in price as much.

If the banks have to set aside yet more capital then it will depress the returns on rural loans further and force them to increase interest rates to compensate or cut back in favour of lending with less onerous capital requirements.

Two decades of easy credit providing a tail wind to rampant farm price inflation and a just-as-spectacular run-up in rural debt could be about to be brought to a screeching halt.

But if that happens it won’t be because of the new capital requirements, Bascand said.

“There are some historical issues here where rates of return have been below those in other sectors and they appear to be considering now whether what they have tolerated for some years is something they have less tolerance for.”

Instead, any tightening of the screws will be caused by banks reassessing their exposure to high farm debt because costs are rising and dairy commodity prices have passed their peak.

“There is a lot of reassessment going on about what is the future of the agricultural sector.

“Are returns temporarily lower or are they structurally lower … are they going to be lower over time because the cost side has gone up for irrigation or environmental reasons?”

The banks and regulator agree the proportion of the farming sector funded by debt must come down.

The Reserve Bank’s May Financial Stability Report noted 35% of dairy debt is held by farmers with borrowings of more than $35 a kilogram of milksolids.

“On average these highly indebted farms require a price of $6.20/kg of milk olids just to break even,” the report said.

Bascand said those farmers are the most vulnerable to falling prices and higher interest rates.

Those same farmers will struggle to afford environmental improvements to their properties increasingly demanded of them by local authorities and will need new equity to fund them.

“Some of them have got more corporate structures and it is easier to put in outside equity.

“I do not think there is a general answer except the generality is not always debt.”

That isn’t to say there will not be debt available to farms with strong business cases for new investment and good levels of equity.

That debt is also increasingly likely to come from outside the large lenders farmers have been used to dealing with.

The Reserve Bank is looking at ways of evening up the advantage the big four banks have been able to get from using their own models to calculate the capital they hold.

That let the Australian-owned banks lend with less capital than their local rivals.

Under the proposal the big four banks will be required to hold at least 90% of the capital per dollar of lending held by the smaller lenders.

Increased competition will help farmers get sharper rates and partly offset any increases in interest rates caused by the new capital proposals, Bascand said. 

“There are definitely some banks that have an appetite for growing lending in this area while some are making strategic decisions, saying they have got quite a large ag book which they now think is making a return that is less than the cost of capital and do not want to grow it any more.” 

While borrowing might cost marginally more under the proposals the benefits will be stronger banks able to keep the money taps flowing through good times and bad, Bascand said.

“Would farmers pay something for credit to be available on a more sustainable basis? We think they would.” 

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