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Alfred M. Mthimkhulu
A month ago, we were advised that Treasury would no longer fund agriculture directly. Rather, the private sector, especially banks, would do so backed by a $968 million guarantee from Treasury, a guarantee that Government hopes will unlock funding of up to $2,8 billion. Let us unpack that last sentence. In unpacking it, we must ponder on whether the funding model will increase agricultural output, create jobs, strengthen local industries and boost exports because in only these things is the restoration of national dignity.
Credit Guarantee Schemes (CGS) are common across the world. Seven years ago, I got interested in them. I studied them and visited a few in the process. How were they structured? How did they perform as investment funds? Did they deliver on their promise of increasing the flow of finance to target enterprises? What were other fellow researchers’ finding on them? I was very enthusiastic when I started my study but neither hot nor cold some nine months later as I shared my findings.
CGS seek to promote the flow of capital to enterprises that would typically be shunned by banks. Such enterprises could be without collateral or could be in a sector or in an area considered too risky.
In such circumstances, a third party (usually a Government or philanthropic organisation) may contract banks to lend to the neglected enterprises promising the lenders that in the event of default, the third party would pay on behalf of the defaulting clients.
For that peace of mind, the bank would pay a small periodic premium to the third party, the guarantor. If there is no default, there will be no claims so the fund will grow. If default is high the fund will be depleted as we find to be in CGS across Africa.
A 2016 study by Pietro Calice at the World Bank covering 60 CGS in 54 countries found that besides being the smallest, CGS in Africa had the highest default rates.
For instance, the average default rate in Africa was 17,1 percent against 1,2 percent in Asia. The size of guarantee funds in Africa in relation to GDP are too tiny whereas in Asia countries like Japan and South Korea had ratios of 5,7 percent and 3,7 percent respectively.
Seven years ago, I studied South Africa’s flagship scheme from formation in the late 1990s.
By early 2000s, the fund was substantially depleted thanks to massive defaults and a growing disinterest from banks. Why would guaranteed banks be uninterested? Well, because of the structure of the scheme.
The structure of the CGS is important. It includes the size of the premium to the guarantor. The higher the premium the higher the disincentive. The structure includes the proportion of the loan guaranteed. It is unusual for the entire loan to be guaranteed, which is why CGSs are also called Partial Credit Guarantees.
Guarantees of between 50 percent and 75 percent are normal. If the loan is 100 percent guaranteed, the bank has no incentive for vigilance in wetting loans and monitoring repayments.
There is yet another important component of the CGS structure and it relates to the circumstances triggering a claim by the bank or the reimbursement from the guarantor: should it be on the first month of default or on the sixth, or should a claim only be paid after the courts decide? Should it be after liquidation?
What all this points to is that the premium to the guarantor, the proportion of loan guaranteed, and the speed and consistency with which claims are honoured by the guarantor are key determinants of the success of a credit guarantee scheme.
There are numerous other factors influencing its success. One such is that it must be widely advertised to ensure that targeted enterprises get to know of it and apply for funding through it.
The other factor is that the fund itself must be professionally managed to grow premiums received along with the seed capital thus increasing the ultimate loan book. In some countries such as France, the credit guarantee funds can be jointly owned by government and banks. This is fantastic in that it harmonises all key stakeholders’ interests.
Professional management of guarantee funds is what differentiates Asia and Africa on CGS. Zimbabwe along with the rest of the continent could therefore draw invaluable lessons from, say, South Korea’s Technology Finance Corporation founded in 1989 for the technology sector, a sector now defining the country’s industrial landscape.
Can a credit guarantee model do the same for Zimbabwe’s agricultural sector? It can but there are some red flags even in the little we’ve heard on the new funding model.
First, pegging interest rates at 4 percent if true will be a disincentive for banks.
Second, the fact that we have not heard of competitive bidding by banks to participate in the guarantee scheme is worrying because if the guarantee gives a lender peace of mind, then lenders must be scrambling to be in the scheme.
In fairness, we have patchy details on this proposed funding model to say more than already said. Let marketing brochures and adverts come then more will be said. For now, intense research and reflection must inform the design of the scheme because a well-designed scheme will enhance the flow of capital to farmers, it will deepen the financial sector and boosts the vibrancy of local industry. What more can citizens ask for.
Alfred M. Mthimkhulu — Senior Lecturer, Graduate School of Business, NUST. Email: [email protected]. Twitter: @mthimz
Bongani Ndlovu