The evaluation of credit risk in structured finance lending transactions in agriculture

Abstract

English: The study focuses on the evaluation of credit risk in Structured Finance lending transactions in agriculture. The secondary motivation of the study is that Structured Finance lending techniques have the potential of increasing access to credit for farmers, especially smallholder farmers, in the agricultural sectors of developing and emerging countries. Recent studies, in agriculture finance, done by the World Bank, Food and Agriculture Organization (FAO) and the United Nations Conference on Trade and Development (UNCTAD), highlights that application of Structured Finance lending techniques such as warehouse receipts, agricultural value chain financing and securitization, inter alia, has the potential of deepening credit services in agricultural sectors, especially in developing countries. Access to credit services, among other things, has the ability to unlock the potential for agriculture in developing and emerging countries. The primary motivation of the study is the observation that most of the studies that have been done so far, with regard to the application of Structured Finance in agriculture, have primarily focused on the principles underlying Structured Finance lending techniques in agriculture and not on the fundamental question that is of importance to a lending institution, in any lending transaction, namely: how to evaluate or measure the credit risk associated with Structured Finance lending transactions in agriculture. Therefore, the study contributes to the body of literature on Structured Finance in agriculture finance by developing a model or tool that can be used to measure credit risk in agricultural based Structured Finance lending transactions. Therefore, the primary objective of the study is to develop a credit risk model for agricultural-based Structured Finance lending transactions. To develop the credit risk model, the study conceptualizes theoretical framework of modelling credit risk as proposed by Merton (1974) as well as the principles underlying Structured Finance lending techniques in agriculture. Time series econometric forecasting techniques and risk simulation techniques are used to achieve the primary objective of the study. The developed model measures credit risk as the Probability of Default (PD). To demonstrate the application of the developed credit risk model, the study uses a conceptualized example, where the production of white and yellow maize in the Free State province of South Africa, during the 2009/2010 production season, is financed by Structured Finance loans. Using the developed model, the study shows that the probability of a farmer in the Free State province, defaulting on a Structured Finance white maize production loan with a face value of R3783/ha (for instance) is 0.0347 or 3.47%. The output of the developed model, which is the probability of default (PD), can be used by agricultural financial institutions (or agricultural lenders in general) to appraise Structured Finance loans; appropriately price Structured Finance loans and determine the amount of capital to hold against credit risk, inter alia. In other words, the developed credit risk model is a tool that can help financial institutions to manage credit risk in agricultural based Structured Finance lending transactions.

Afrikaans: Die hoofoogmerk van hierdie studie is die evaluering van kredietrisiko by Gestruktureerde Finansiering wanneer leningstransaksies in die landbousektor ter sprake kom. ‘n Sekondêre motivering is dat Gestruktureerde Finansiering se leningsmetodes die potensiaal bevat om meer geredelik en makliker toegang tot kredietfinansiering aan boere te verseker, veral die kleinboere in die landbousektore van ontwikkelende lande. Onlangse navorsing oor landboufinansiering wat deur die Wêreldbank se Voedsel- en Landbou-organisasie (FAO), asook die Verenigde Nasies se Konferensie oor Handel en Ontwikkeling (UNCTAD) gedoen is, beklemtoon dat die aanwending van Gestruktureerde Finansiering se leningsmetodes, soos byvoorbeeld pakhuiskwitansies, landbou waardeketting-finansiering en versekerde dekking, onder andere, die moontlikheid van uitgebreide kredietlewering in die landbousektor, veral in ontwikkelende lande, inhou. Toegang tot geredelik-beskikbare krediet, kan onder andere, help om die moontlikhede vir landbou in ontwikkelende en ontluikende lande te ontsluit. Die hoofdoel en motivering vir hierdie studie is die feit dat meeste van die studies wat tot dusver op die gebied van Gestruktureerde Finansiering in die landbou gedoen is, hoofsaaklik gefokus het op die onderliggende beginsels van Gestruktureerde Finansiering se leningstegnieke in die landbou en nie op die basiese kwessie van belang vir enige leningsinstelling, te wete, hoe om die kredietrisiko wat met leningstransaksies deur Gestruktureerde Finansiering in die landbou gepaard gaan, te meet of te bepaal nie. Hierdie studie kan dus bydra tot die bestaande literatuur oor Gestruktureerde Finansiering in landboufinansiering deur middel van die ontwikkeling van ‘n model of instrument wat gebruik kan word wanneer kredietrisiko in landbou-verwante transaksies bepaal moet word. Aangesien die hoofdoel van die studie is om ‘n kredietrisikomodel vir landbou-verwante Gestruktureerde Finansiering leningstransaksies te ontwikkel, het die studie vir hierdie doel ‘n teoretiese raamwerk of model vir kredietrisiko, soos voorgestel deur Merton (1974), sowel as die beginsels onderliggend tot die leningstegnieke van Gestruktureerde Finansiering in die landbou, voorgestel. ‘n dinamiese model vir ekonometriese voorspellingstegnieke en risiko-nabootsingstegnieke word gebruik om die primêre oogmerke van hierdie studie te bereik. Die model wat sodoende ontwikkel is, meet kredietrisiko as ‘n Moontlikheid van Wanbetaling [PD – Probability of Default]. Ten einde die aanwending van die ontwikkelde kredietrisikomodel te demonstreer, word ‘n gekonsepsualiseerde voorbeeld gebruik; waar byvoorbeeld, by die produksie van wit- en geelmielies geproduseer gedurende die 2009/2010 seisoen in die Vrystaatprovinsie, Suid-Afrika, van Gestruktureerde Finansieringslenings gebruik gemaak is. Indien van genoemde ontwikkelde model gebruik gemaak word, dui die studie daarop dat die moontlikheid dat ‘n Vrystaatse boer, aan wie ‘n Gestruktureerde Finansiering witmielie-produksielening ter waarde van R3,783/ha toegestaan is, se wanbetalingspersentasie byvoorbeeld 0.0347 (3,57%) sal beloop. Die ontwikkelde model beskik oor die vermoë om die moontlikheid van wanbetaling [PD] te voorspel en kan met groot vrug deur landbou-finansieringsinstellings of enige landboukrediteure aangewend word om ‘n bepaling van Gestruktureerde Finansieringslenings, veral prys-gestruktureerde finansieringslenings, se risiko te skat en sodoende die kapitaalbedrag ten opsigte van, onder andere krediet, te bepaal. Met ander woorde, bogenoemde kredietrisikomodel is ‘n instrument wat finansieringsinstellings kan help om kredietrisiko by landbou-gebaseerde Gestruktureerde Finansiering leningstransaksies te bestuur.