APRA tells the cold hard truth about banking

Risk. It’s something that bankers are acutely aware of. Particularly when it comes to lending money and specifically for agribusinesses and commercial assets. The risks within a bank’s agribusiness book look very different to those in its residential mortgage book.

In its submission to the Hayne Royal Commission into Misconduct in Banking, Superannuation and Financial Services Industry, APRA sets out the interests of the bank and the agribusiness customer.

When a loan is taken out, both parties have similar interests, which is essentially the success of the venture being financed.

“An agribusiness borrower wants the farm business to be prosperous to generate income and wealth, while the ADI wants the money owed to it to be paid in full, and to earn interest on the funds in the meantime,” the regulator stated.

“Proper consideration must be given, at inception and over the life of the loan, by both the lender and the borrower, and having regard to the external risks attendant on the business of agriculture, as to how these aspirations will realistically be achieved. Prudent banking generally requires assessing a borrower’s ability to repay as the primary means of recouping a loan, with collateral used as a backstop.”

Both parties are effectively happy at the beginning. High hopes for the future and an agreement in place. Like a marriage.

But what happens when things don’t turn out the way they were supposed to? APRA acknowledges that underwriting an agribusiness loan requires a different approach.

The regulator stated that in agribusiness lending, the ability of the ADI to recoup the money it is owed is likely to be influenced by factors (climate, pests, disease and market volatility) that are beyond the control of the borrower or itself.

“The ADI’s assessment of these factors will be relevant both at origination and when a borrower may be in financial difficulty. That assessment may well — indeed is likely to — differ between ADI and borrower,” the regulator said.

The cracks begin to appear. Brought on by something as simple yet catastrophic as a change in the weather. Something the bank and the borrower are powerless over. Then things get worse.

“In circumstances when conditions deteriorate and the borrower’s ability to service the loan is threatened, the parties’ interests — and assessment of how to protect those interests — may diverge,” APRA stated.

“The borrower is not simply interested in repaying its debt but may also want to minimise the loss of, for example, the family home or business.”

This makes sense from a borrower’s perspective.

APRA stated: “For a farmer, there is also likely to be an interest that is not strictly financial: retaining what may be a long-standing connection to a particular farm or community.”

But the bank has no interest in any long-standing connections with the community. They are in the business of making money from the loan and recouping their investment. It’s not personal. It’s just business.

“The ADI will remain primarily concerned to ensure repayment of the loan within a reasonable time and to minimise the risk that this may not occur,” the regulator continued.

“Even if interests are examined purely on a financial basis, minimising the aggregate financial loss from the venture may not always equate to minimising the loss for each party.

“In particular, the strategy that minimises the overall financial loss to both parties may not be the strategy that minimises the loss to the ADI (and vice versa).

“Typically, in a lending relationship, the borrower receives the upside but shares the risk of downside with the ADI, and thus an ADI will naturally tend to be more risk-averse. Subject to not acting unethically, unfairly or unlawfully, the ADI will quite reasonably put its interest in achieving repayment first and focus on downside scenarios.”

And there’s the rub: “focus on downside scenarios”. The bank is keenly aware of the negative situations that can play out. It’s part of a bank’s job to be aware of that four-letter word: risk.

But to what extent is the farmer responsible for acknowledging the risks? When is a borrower simply blaming the big bad bank? On the flipside, when does a bank overstep its boundaries?

APRA has some view on this. In its submission, the regulator stated that an ADI acting fairly and reasonably in balancing its interests with those of its agribusiness borrower would be expected to:

• make a proper credit risk assessment of the borrower before making the loan
• adhere to the terms of the loan contract, taking account of regulatory hardship and other consumer protection obligations
• not impose unreasonable requirements on the borrower that are unsuitable to the circumstances (for example, acknowledging that cash flows for agribusinesses may be seasonal, considering providing longer time frames for realising collateral than may be applied for a residential mortgage loan)
• subject to securing the ADI’s interests, pursue repayment of debts in a manner that avoids unnecessary diminution in the value attributable to the borrower

However, APRA believes an ADI should not be expected to provide forbearance to a borrower in financial difficulties where it is clearly apparent that doing so will generate a larger economic loss for the ADI relative to the likely outcome of enforcement action.