- The agricultural financing institution claims that this transformation will see it serve the agricultural value chain better and stimulate investment by providing cheap loans.
- But a word of advice: the AFC management needs to be careful what it wishes for.
Since last year, the Agricultural Finance Corporation (AFC) has made its desire to transform into a commercial bank known.
The agricultural financing institution claims that this transformation will see it serve the agricultural value chain better and stimulate investment by providing cheap loans. But a word of advice: the AFC management needs to be careful what it wishes for.
There is a misleading idea that the end point for any financial institution is to be a commercial bank. It’s this strategy that saw Mwalimu National Sacco, in a rush to be the first sacco in East Africa to own a commercial bank, ended up acquiring an illiquid Equatorial Commercial Bank where 96 percent of borrowers had defaulted on their loans.
Let us look at how banking works. Banks are required to keep assets, the value of the loans it has made to customers and other investments, and also keep liabilities — the value of deposits and other borrowing that the bank has taken in to finance its operations.
The difference between the assets and liabilities is the bank’s net worth or value of the bank. In short, banks transform short-term liabilities (savings from depositors) into long-term assets (loans to borrowers) by engaging in relatively low-risk activities.
This activity of borrowing short to lend long always makes banks vulnerable to “bad banking situation” where they attempt to build assets quickly by lending more of their depositors’ savings and fail to convert them into long-term assets.
Coming to AFC, which would be another government-owned bank if it transforms, the bad practice has been that it always lends to individuals and corporations without taking adequate security for the loans. Later when the loans are defaulted, banks have little recourse to get their money bank.
The management of AFC will claim that they will put tight controls to deter this eventuality but evidence available shows that many of the government-owned banks are already in this mess.
Another issue is how AFC intends to transform into a bank. The first route is through acquiring an existing bank, but AFC doesn’t have the financial muscle to make such an acquisition.
Even if it were to acquire one of the government-owned banks, many of them face a liquidity crisis and AFC has no capital to pump in.
The second option, which is to get a new licence, will be a long one. Since AFC currently is not a deposit-taking institution, it lacks the capital under the banking regulation to run lending operations. So, it will have to get a deposit-taking licence and build its depositors portfolio to transform into a commercial bank, and that takes time.
Third, which is the crux of it all, is the concentration risk that arises in the vision of AFC. If AFC manages to transform into a bank, it will have to drop its vision of primarily targeting lending the agricultural sector.
The risk of lending one sector is that any shock to that sector means the commercial bank is at risk of landing into a “bad banking situation” and posing a risk to the entire banking system.
No commercial bank can afford to specialise its lending approach to one sector. So, the central bank will require AFC to diversify its lending approach and that means AFC abandoning its main stakeholders, who are farmers.
Now, there is space for AFC to play a leading financial role in the transformation of agriculture without being a commercial bank.
For example, Kenya loses up to a third of its food production to post-harvest losses and financial institutions can solve this problem by financing cold storage facilities, building agro-processing factories and even silos.
So the best place for AFC to position as a financial institution for farmers is to be an issuer of credit guarantees to farmers to make it easier for them to access credit.