The Agricultural Lending Industry: Commercial Banks and the Farm Credit

System

Chapter 8

Commercial Banks

In US today there are 8,000 independently chartered banks.

Chartering of first bank came in 1791

Regulatory History

National Banking act of 1863 - congresses third attempt to regulate banking at the federal level.

Federally Chartered – office of the Comptroller of the Currency.

State Chartered – all states already had their own state chartering agencies, thus the beginning of our dual banking system.

Regulatory History

Federal Reserve Act established our current national bank in 1913.

Fed’s original task was to provide liquidity to banks as a lender of last resort.

Federal Reserve was established as a system of twelve district banks.

Great Depression Price Deflation

Mergers

The banking industry is consolidating Ultimately the nation may have just 2000 or

so chartered banks Will this improve the lot of the consumer?

REAL PRIME INTEREST RATES

REAL PRIME INTEREST RATE

-2

0

2

4

6

8

10

1956

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004%

Pri

me

less

% C

han

ge

in C

PI

Bank Balance Sheets

Assets Liabilities and Equity

Cash and Reserves $ 2,000 Demand Deposits $20,000

Securities 26,000 Savings Deposits 65,000

Consumer Loans 20,000 Bank Debentures 17,000

Real Estate Loans 25,000 Other Borrowings 0

Commercial Loans 31,000 Common Stock @par 2,000

Less Loan Reserves 2,000 Excess paid in Capital 1,000

Premises & Equipment 4,000 Retained Surplus 5,000

Total Assets $110,000 Total Liabilities &Equity

$110,000

Liabilities

Banks earn maintenance fees on traditional demand deposit accounts.

Demand deposits have been shrinking as a percentage of total since 70s due to money market accounts.

Savings include passbook savings, CDs, educational savings funds and IRAs

Interest Rate Differences.

Equity

Remaining accounts on RHS are Ownership Accounts or Equity

Common Stock @ Par Excess Paid in Capital Retain Surplus or Retained Earnings

– How banks use this is a matter or asset financial management

Assets

Cash and Reserves– Fed Requires approx. 10% of bank demand

deposits to be placed in reserve.– Not a significant source of liquidity for the bank

Securities Portfolio Loan Portfolio Premises and Equipment

Introduction

Many farmers have long argued that credit for agriculture has not been met by conventional financial institutions.

Private lending procedures, sources of funds, and loan terms are not beneficial to the needs of agriculture.

History

Government began to make direct loans to farmers for short term credit requirements in the 1920’s.

In the 1930’s FCS, FmHA, REA, and CCC were created.

All of these agencies continue to operate although the names and scope of work have changed over time.

Farm Credit System

Long Term FCS loans are made to farmers, corporations producing farm products, agribusinesses, and rural homeowners.

Loans can be used to acquire land, equipment, and livestock or to refinance existing debt.

The largest holders of farm real estate debt are the FCS and commercial banks.

Farm Credit System

Short and intermediate term FCS loans can be used for the production of farm products, aquatic products, and purchase or repair of rural homes.

FCS holds 20% of non real estate farm debt.

Government-Sponsored Enterprise

Farm Credit began as a government sponsored cooperative effort to provide a system through which farmers could provide their own credit.

FCS is now self-supporting. As a GSE , FCS can borrow money from the US

Treasury cheaper than commercial banks. In turn, FCS can usually loan out money cheaper

than commercial banks.

FCS Independence

FCS became wholly user owned when the last government loan was repaid in 1968.

In 1985 FCS lost $2.7 billion through mortgage and loan defaults.

Several of the FCS banks had become insolvent and Congress responded with a Federal bailout.

Now FCS is run by the Farm Credit Administration which is an agency of the U.S. Executive Branch.

USDA

USDA has a number of credit programs for ag and rural areas.

FSA is the direct lending arm in agriculture.

Rural Development is the direct lending agency for rural programs.

FmHA

Farmers Home Administration was created to implement all direct lending, loan insurance, and grant programs for low income farmers.

FmHA was abolished in 1994 and its farm credit programs were transferred to the newly created FSA.

Farm Service Agency

Lender of last resort to farmers. Loans are for farmers who can not get credit

with commercial banks or FCS. FSA makes farm ownership loans, operating

loans, and emergency loans.

Farm Service Agency

Emergency loans are made only to counties designated as a disaster area.

Interest rates on FSA loans are significantly lower than those of commercial banks.

FSA held 4.1% of total US farm business debt in 2000.

Because of their risky loans, many FSA loans result in default.

Rural Development

Rural Development includes the Rural Housing Service, Rural Business Cooperative Service, and Rural Utilities Service.

Direct loans, loan guarantees, and rental assistance are available to low income people in rural areas which include cities with populations up to 50,000.

Rural Development

The Rural Business-Cooperative Service administers the business assistance programs.

Grants are made to non profits and public bodies for business development.

Large loan guarantees are also available to businesses.

Rural Development

Rural Utilities Service provides large loans and grants for electricity, water, and sewer.

Assistance is available to public bodies and utility districts for expanded utility programs.

Commodity Credit Corporation

Farmers would pledge a quantity of a commodity as collateral and obtain a recourse loan from the CCC.

Farmers can either repay the loan with interest within a period of time or they must forfeit their commodity to the CCC.

Effects of Subsidized Credit

Immediate effects are to reduce interest rates and to increase the amount of credit used in agriculture.

This contributes to increased production and larger, more highly mechanized farms.

It is harmful to nonusers because it increases output and decreases product prices.

Problems with Subsidized Credit

Moral Hazards Government restrictions reduced

diversification in bank loan portfolios, thereby increasing risk and likelihood of bank failure.

These instances have made it difficult to make a case for subsidized credit to agriculture.