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PUTTING IN PLACE THE CONDITIONS TOSET UP A CREDIT GUARANTEE SCHEME FORAGRIBUSINESS SMEs IN UKRAINEFeasibility StudyProject SummaryMarch 20161

ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENTThe OECD is a unique forum where governments work together to address the economic, social andenvironmental challenges of globalisation. The OECD is also at the forefront of efforts to understand andto help governments respond to new developments and concerns, such as corporate governance, theinformation economy and the challenges of an ageing population. The Organisation provides a settingwhere governments can compare policy experiences, seek answers to common problems, identify goodpractice, and work to co-ordinate domestic and international policies. The OECD member countries are:Australia, Austria, Belgium, Canada, Chile, the Czech Republic, Denmark, Estonia, Finland, France,Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, theNetherlands, New Zealand, Norway, Poland, Portugal, the Slovak Republic, Slovenia, Spain, Sweden,Switzerland, Turkey, the United Kingdom, and the United States. The European Union takes part in thework of the OECD.www.oecd.orgOECD EURASIA COMPETITIVENESS PROGRAMMEThe OECD Eurasia Competitiveness Programme, launched in 2008, helps accelerate economic reformsand improve the business climate to achieve sustainable economic growth and employment in two regions:Central Asia (Afghanistan, Kazakhstan, Kyrgyzstan, Mongolia, Tajikistan, Turkmenistan, and Uzbekistan),and Eastern Europe and South Caucasus (Armenia, Azerbaijan, Belarus, Georgia, the Republic ofMoldova, and Ukraine). The Programme contributes to the OECD outreach strategy implemented by theGlobal Relations tmPUTTING IN PLACE THE CONDITIONS TO SET UP A CREDIT GUARANTEE SCHEME FORAGRIBUSINESS SMEs IN UKRAINEThe project Putting in Place the Conditions to Set up a Credit Guarantee Scheme for Agribusiness SMEs inUkraine (CGS project) emerges out of the OECD Sector Competitiveness Strategy for Ukraine, whichidentified high-potential sectors in the Ukrainian economy and competency-based barriers that werehindering their development. Agribusiness is a key sector identified in this work, and access to finance foragribusiness SMEs was identified as a major constraint hampering the sector’s development. Within theframe of the CGS project, the OECD designed an instrument to guarantee a proportion of loans toagribusiness SMEs of 100-2000 hectares. The scheme was designed on the basis of a pilot covering fourOblasts (Cherkassy, Vinnytsia, Poltava, and Kharkiv), before being scaled up as results are revealed. Thisproject was launched in September 2013 and concluded in February 2016. It was fully financed by theGovernment of m2

TABLE OF CONTENTSEXECUTIVE SUMMARY .51. INTRODUCTION .71.1 Summary of pre-feasibility work .71.2 Scope of the feasibility work .7.82. REGULATORY AND SUPERVISORY FRAMEWORK .92.1 Initial assessment of the framework.92.2 Preliminary assessment of supervisory bodies.10.103. FINANCIAL AND ECONOMIC FEASIBILITY .113.1 Macro and microeconomic context .113.2 Modelling assumptions .123.2.1 Guarantee profile .133.2.2 Macroeconomic indicators .143.2.3 Expenses .143.2.4 Income .143.2.5 Risk appetite .153.2.6 Funding modalities .163.3 Projection of key financial accounts .163.3.1 Balance sheet .173.3.2 Income statement.183.3.3 Portfolio report .193.4 Conclusions of financial-modelling exercise .204. SCREENING OF POTENTIAL DONORS .224.1 General aspects/classification .224.2 Type of institutions considered .224.2.1 Institutions considered in category A .234.2.2 Institutions considered in category B .25.265. NEXT STEPS AND ACTION PLAN .275.1 Proposed action plan for scheme implementation .275.2 Training needs identified .285.3 Completion of analytical work.30BIBLIOGRAPHY .31ANNEX .33Annex 1: Financial Model (separate file) .33ACKNOWLEDGEMENTS .343

GLOSSARYAgribusinessAgribusiness represents a comprehensive value chain that covers allaspects of agricultural production (e.g. farming, seed and otheragricultural inputs, crop production, post-harvest handling, and animalhusbandry), processing, and distribution (e.g. wholesaling, retail salesto final consumers) (FAO, 2010; OECD, 2008).Agricultural SMEsIn this report, when referring to the scheme’s target group, this refers toenterprises farming 100-2000 hectares of land.Counter-guaranteeA counter-guarantee is a form of back-to-back guarantee given to aCredit Guarantee Scheme (CGS) by either the state or internationalorganisations, in exchange for a fee, to cover a portion of the potentiallosses when guarantees are paid out. It is as a supplementary risksharing mechanism.FarmersIn this report, “farmers” refers to land-based agricultural SMEs.Leverage ratioLeverage ratio refers to the “multiplier effect” – the size of thescheme’s guarantee portfolio relative to the size of its fund.Moral hazardMoral hazard describes a situation in which agents do not bear the fullcost of their actions and are thus more likely to take such actions. It isparticularly an issue when a party undertakes a risky action knowingthat it is protected against the risk and that others will share/bear thecost.Pari passu basisPari passu refers to loans, bonds or classes of shares that have equalrights of payment, or equal seniority.Primary featuresIn this report, primary features are defined as those aspects whichconstitute the basic concept of the CGS. Broadly, they are the policydecisions – here, they are taken as mission, target and type of CGS.Secondary featuresIn this report, secondary features are defined as all other design featuresof the CGS. These include coverage rate, pricing, legal form andprocedures for guarantee application, and claims pay-out. They aredefined based on the specific institutional and market environment,international best practice, and projections of the financial model.Since 2012, the State Statistics Service of Ukraine has started toclassify SMEs largely in-line with the EU definition – the exceptionSmall and medium-sizedbeing that it excludes a balance-sheet criterion. SMEs are now definedenterprises (SMEs)as enterprises with fewer than 250 employees and generating underEUR 50 million in annual turnover.4

EXECUTIVE SUMMARYBuilding on the conclusions of the project’s pre-feasibility study (PFS), the present feasibility study(FS) provides a more detailed set of design features for a Credit Guarantee Scheme (CGS) in Ukraine tomaximise the scheme’s economic and financial viability, as well as initial recommendations on itsformation and framework requirements for its operation. The PFS presents (i) recommendations onprimary features for a CGS in Ukraine based on international practice, including mission, targeting, type ofCGS, and type of product (ii) the approach to identify potential partner banks, and (iii) project risks, aswell as mitigation measures. The PFS defines the CGS mission as an instrument to increase access tofinance in Ukraine’s agricultural sector, and confirms the target as farms of 100-2000 hectares (ha) inCherkassy, Vinnytsia, Poltava, and Kharkiv. It suggests that a public/private CGS be established forUkraine, with international donor participation. The PFS also presents a method for screening potentialpartner banks.The present FS provides a more detailed assessment of the scheme’s economic and financial viability,as well as its regulatory landscape and the availability of donor funds. The economic and financialassessment was developed principally on the basis of a Financial model (separate file, Annex 1) thatforecast the scheme’s financial statements under various assumptions. This exercise found that such ascheme could be viable in Ukraine, and that it could increase credit access for approximately4,600 members1 of its target group over a five-year period. It found that this would require guarantee feesof at least 1% (on the loan principal) up front and 1% (of the guaranteed amount) annually, capitalisationof EUR 10 million in seed funding and EUR 1.5 million in technical-assistance funds, and a coverage rateof around 50%. These conclusions are presented in Table 1. The assessment also found that the regulatoryand legal landscape should be suitable to establish a CGS in Ukraine, but that additional training(particularly for the regulator, the National Commission for the State Regulation of Financial ServicesMarkets, or “Natskomfinposlug”) may be required to increase capacity.Table 1. Main conclusions of the feasibility study1AspectConclusionGuaranteeCoverage RateThe CGS should in general guarantee 50% of the outstanding loanamount from partner banks.PricingThe CGS should charge for the guarantee as a flat fee, initially set at1% on the overall loan amount, and a subsequent 1% annual fee onthe outstanding guaranteed amount as it declines. This is in line withinternational practice and provides sufficient revenue for the CGS toreach sustainability at capitalisation levels of approximately EUR 10million as forecast in financial projections. This rate may be adjustedin the project’s technical report.Data from 2015 (source: Ministry of Agrarian Policy and Food of Ukraine) found there to be approximately 2,900 land-based agricultural SMEsin the project’s four pilot regions, which would mean that the proposed scheme has the capacity to guarantee 100% of these clients (and couldprovide over 50% with more than one guarantee). However, it has been recommended that the scheme also provide guarantees to non-land-basedagricultural SMEs, the number of which cannot be accurately quantified through available data. It is believed that the number of guarantees thescheme can provide relative to the number of land-based agricultural SMEs indicates that the scheme can have an important impact on its pilotregions.5

AspectConclusionFundingState financing and support is unavailable and inadvisable, andtherefore donor support should be sought for around EUR 1.5 millionof technical-assistance funds for capacity-building and start-up costsduring the first 24 months of operation, as well as EUR 10 million asa capital base for guarantee pay-outs.Potential donorsThe following organisations have been approached to discuss theCGS in Ukraine and potential funding: European Bank forReconstruction and Development (EBRD), International FinanceCooperation (IFC), KfW Bankengruppe (German DevelopmentBank), European Investment Bank/Fund (EIB/EIF), and UnitedStates Agency for International Development (USAID). They haveprovided useful information to better assess donor needs andmaximise the chances of financial support.Source: OECD analysis and IPC - Internationale Projekt Consult GmbHThe content summarised in this project report was discussed at the Fourth Task Force meeting held inJune 2015 in Kyiv. Members of the Task Force, including representatives of the government and theNational Bank of Ukraine, provided feedback on the analysis conducted, and raised issues that will befurther addressed in the following stages of the project.6

1. INTRODUCTION1.1 Summary of pre-feasibility workIn this project’s pre-feasibility study, the rationale for the project was set out and the scheme’sprimary features proposed.The justification for such a scheme in Ukraine was based on the low competitiveness of theagricultural sector in the country despite its strategic advantages – a problem that was principally attributedto the poor environment for SMEs operating in the sector. Access to finance was identified as one of theprincipal constraints for such enterprises: very few bank loans go to the SME segment, whilst public policyhas not been successful in addressing market failures. The analysis suggested that a guarantee mechanismcould help address some of the issues that make banks wary of lending to agricultural SMEs, incentivisingbanks to increase the volume of credit flowing to them.Having provided a rationale for the scheme, the study elaborated its primary features. These arebroadly defined as the key policy decisions of the CGS – namely, its mission, target, and type (broadlymeaning, the stakeholders governing and owning the scheme). The previous study elaborated andconfirmed these features, and its recommendations were presented to, and validated by, Task Forcemembers in February 2015. They are outlined in Table 2 below.Table 2. Recommendations of primary features for the CGS in UkrainePrimary featureRecommendationMissionIncrease loans to target groupTargetingSmall farmers operating on 100-2000 ha of land in fourpilot regionsCGS TypePublic/private internationally funded CGS. The CGS inUkraine will provide guarantees on an individual basis.In addition to the definition of primary features, the pre-feasibility study developed a method forscreening partner banks. The method aims for the final selection of two or three stable, reliable,competitive bank partners.1.2 Scope of the feasibility workAfter the scheme’s primary features have been validated, the next step will be to elaborate itssecondary features, which constitute all other design features of the CGS, as well as its risk managementand monitoring and evaluation procedures. The majority of these will be developed in this project’stechnical report, but before they are elaborated it will be necessary to analyse the conditions for a CGS inUkraine, as well as a projection of its viability.Thus, the present report will assess the scheme’s economic and financial viability through financialstatement forecasting based on various assumptions. In addition, it will assess the availability of potentialsources of funding for the scheme and the fit of the supervisory and regulatory landscape. Finally, it willoutline a proposed action plan for implementation of the scheme, training needs, and aspects for furtheranalysis.7

This analysis will test the viability – particularly the economic and financial viability – of such ascheme in Ukraine, but it will also lead to an initial elaboration of some secondary features. Thesesecondary features noted in this report include the guarantee coverage rate and pricing, as well as the legalform and capitalisation of the scheme. These will be further tested and defined in the upcoming technicalreport.8

2. REGULATORY AND SUPERVISORY FRAMEWORKIt is essential to subject a credit guarantee scheme to a certain degree of regulation, since this signalsthe safety and liquidity of its guarantees to partner banks (Green, 2003). Guarantee schemes operate eitherunder special legislation (as is the case with FOGAPE in Chile) or under general regulation for financialinstitutions. For the purposes of this study, an initial assessment was conducted to assess the suitability ofthe current legal and regulatory framework for the implementation of a CGS for agribusiness SMEs inUkraine. Using existing regulation would be preferable for this scheme, given the high costs implied forspecial legislation relative to the small size of the scheme and the fact that it is not a public scheme butrather a donor-funded initiative. However, an initial assessment was necessary to check its fit andsuitability.2.1 Initial assessment of the frameworkAn initial assessment of the regulatory and legal framework in Ukraine found that the provision ofguarantees is governed by the Law of Ukraine “On Financial Services and State Regulation of FinancialMarkets”, which specifies that loan guarantees are considered a financial service.Under this law, the provision of guarantees is classified as a financial service and the provider isregulated by the National Commission for the State Regulation of Financial Services Markets(Natskomfinposlug in common parlance), which conducts both regulation and market surveillance. The lawand regulation stipulate certain criteria for financial service providers: Minimum size: The Financial Services Law stipulates that in order to be registered toprovide a financial service, a local entity with no regional branches must possess minimumauthorised share capital of UAH 3 million. Slightly more capital is required to provide morethan one service, or in case the entity has regional branches. Registration: Personnel working for Natskomfinposlug indicated in June 2015 that theywould only recognise an entity registered as a limited liability company (LLC) as fit toprovide individual guarantees to agribusiness SMEs in Ukraine that are capitalised throughdonor funds. This was largely on account of currency issues, and is intended to increase thescheme’s operational flexibility. Domicile/Ownership: During these interviews it was confirmed that a CGS may function aseither a resident or a non-resident financial institution. The scheme’s founders have the optionto register the scheme either as a foreign legal entity with its local representative in Ukraine,as a permanent representative office (without the status of a legal entity), or as a local legalentity (i.e. an LLC) with foreign ownership.This initial assessment concluded that a CGS should be able to operate within the existing regulatoryframework for financial services in Ukraine, and therefore it would not be necessary – or cost-effective –to develop special legislation for the scheme. Given the relative weakness of financial sector regulation inUkraine, however, it is advisable that strong internal controls – such as robust risk management procedures– be put into place, along with internal and external oversight (monitoring and evaluation, for instance, viastrict financial accounting). This will be crucial to secure both investor and partner-bank confidence in thescheme.9

However, there is currently (March 2016) a proposal under discussion in the Ukrainian Parliament todismantle Natskomfinposlug and to divide its responsibilities between two entities: the National Bank ofUkraine (NBU) and the State National Securities and Stock Market Commission (NCSSM). If thisproposal is implemented, further analysis will be required to ensure that a potential CGS will still meet therequirements set by its regulator.2.2 Preliminary assessment of supervisory bodiesThe initial assessment of the legal and regulatory environment in Ukraine conducted in June 2015found that currently no entities provide the type of service proposed in this project (that is, an independentlegal entity providing individual guarantees) registered with the regulator. Therefore it concluded that,whilst regulation may provide a sufficient framework for oversight, it would be necessary to provide thesupervisory body responsible for the regulation and oversight of financial services – namely,Natskomfinposlug – with additional training on specific technical elements. Given the novelty of this typeof instrument, increased training on best practices for the regulation of risk-sharing mechanisms andassessment of the impact of CGS activities on the country’s financial sector would be advisable.10

3. FINANCIAL AND ECONOMIC FEASIBILITYIn order to assess the viability of the scheme, a financial model was developed for this report – seeseparate file, Annex 1 CGS Financial Model. The entire model, from the capital investment for the CGS, tothe loan demand by the farmers, to the expenses for the loan guarantees, is expressed in euros (EUR). Themodel forecasts various financial statements in order to assess the potential quantity and volume ofguarantees – as well as the profits – that the scheme could generate. These forecasts are based onassumptions, which themselves rest on an analysis of the Ukrainian context as well as findings from OECDand peer countries. Assumptions are made on features of the scheme such as typical loan amounts,coverage rates, maturities, default rates, collateral recovery rates, and macroeconomic indicators, and arejustified further below. It is anticipated that this exercise can furnish the architects of the scheme with moreinformation on the scheme’s probable financial structure and cash flow, and thereby on both its feasibilityand the fit of specific design features.The model projected that with funding of EUR 10 million and guarantee fees of 1% (of principal)upfront and 1% of guaranteed amount annually, the scheme could generate over five years: 4,620 guarantees An active loan volume of EUR 160 million by year 5 EUR 371,667 in dividend payments between year 3 and year 5Once the scheme’s founders have been identified, this exercise should be repeated to adjust itsassumptions in line with the prevailing macroeconomic context and specific aspects that the founders willdecide (for instance localisation and denomination of funds, eligibility criteria, and risk appetite). Aconsideration of the scheme’s macro- and micro-economic context at the time of foundation will beparticularly important, given the high market risk in Ukraine and particularly the targeted sector, and thesignificant impact that such changes would have on the model’s assumptions. Some of these aspects willbe explored in section 3.1, followed by a description of and rationale for the scheme’s current assumptionsin section 3.2.3.1 Macro and microeconomic contextThe stability of a credit guarantee scheme’s macroeconomic environment and banking-sector liquidityis an important determinant of its impact (Green, 2003). A scheme operating in an unstablemacroeconomic environment will find it difficult (and would be ill-advised) to achieve significant leverage;its profitability (and therefore the capital available to plough back into guarantees) may be adverselyaffected by high default rates or volatile foreign-currency exchange rates if, for instance, the scheme’sfunds are denominated in foreign currency.For the purposes of this exercise, it is important to highlight that Ukraine remains vulnerable tomacroeconomic and structural weaknesses hitherto unaddressed. In 2009 and 2014 the country sufferedfrom dramatic slumps in GDP (Figure 1) and banking crises precipitated by a dramatic depreciation of thehryvnia (UAH). These elements led to a steep increase in non-performing loans (NPLs), the almostcomplete cessation of loan issuance, and substantial deposit outflows. The Ukrainian economy recoveredfrom the 2009 crisis by the first quarter of 2010 thanks to stronger-than-expected growth in the global11

economy, larger social transfers, and a lower price for imported natural gas. The crisis that began in 2014,however, is ongoing.Figure 1. Frequency of shocks in Ukraine (1987-2014)BillionsUkraine GDP at market prices (USD current, 1987-2014)2001801601401201008060402001987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013Source: World Bank dataOn the microeconomic side, a survey and related research conducted in the scheme’s proposed pilotregions produced estimations of credit demand amongst the target group, as well as firm dynamics andcreditworthiness. These are computed in the assumptions of the financial model presented below, and willbe factored into the deliberation of secondary features for the project’s technical report.3.2 Modelling assumptionsIn order to forecast the scheme’s various financial statements, assumptions have been based on thetypical profile of guarantees, macroeconomic indicators, the nature of the scheme’s expenses and revenue,the scheme’s risk appetite, and the scheme’s capital base.The assumptions in the financial model – namely, the scheme’s capital, expenses, the loansthemselves and repayments – are expressed in EUR. The rationale for conducting the financial modellingexercise in EUR is that modelling in UAH can be unreliable given the high macroeconomic volatility inUkraine. It is also expected that the functional currency of the scheme will be EUR, since it would not havea source of UAH funding in the way that a bank would (i.e. through its deposits) and none of the banksconsulted during this stage of the project anticipated a guarantee in UAH. However, this will also dependon where the scheme’s funds are located, which will be discussed in the project’s technical report butwhich will be dependent, in the end, on the wishes of the scheme’s donors and the Ukrainian government.It is also important to bear in mind that the guarantees will be provided in EUR at the value of the day ofthe signing of the contract, but the majority of loans would be extended to farmers in UAH (although loanscould be provided in EUR if the banks wish); therefore, a scheme using EUR as its functional currency willneed to be attentive to exchange-rate fluctuations and the impact of fluctuations on its performance.12

3.2.1 Guarantee profileAverage guarantee size Based on an analysis of the typical loan amounts requested by the target group in Ukraine, it isanticipated that the average size for a medium-term loan will be around EUR 75,000. Given thatthe financial model is expressed in EUR (including the expected inflation and loan growth rates), itis anticipated that the average loan size might increase over time to reach EUR 79,602 by year 5.Experience in other CGS suggests that average loan amounts tend to increase over time simplybecause the creditors’ confidence in the ability to take credit risk typically increases – which isreflected in more flexible decision-making on loan amounts, gradually increasing the average loanamounts.Coverage rate Based on international good practices, desk research2, and the outcomes of the financial model, itis recommended that the scheme guarantee 50% of the outstanding loan amount in EUR frompartner banks, which could be up to 60-70% for priority sectors that the CGS founders identify.This rate may be furt

1.1 Summary of pre-feasibility work In this project’s pre-feasibility study, the rationale for the project was set out and the scheme’s primary features proposed. The justification for such a sche