Financing Family Farms, and Creating a Level Playing Field with Large Financial Holdings

Small and medium farms need bank finance to develop, and banks are interested in a potentially huge market.


Small and medium farms need bank finance to develop, and banks are interested in a potentially huge market. The strategic vision needs to include opportunities for employment for rural residents, and mechanisms for rural households to acquire and consolidate land plots and develop family businesses that generate sufficient income for the current generation, and generations to come. None of this will happen if the commercial banking sector is not a full and active participant.

What will rural Ukraine look like in the future? Over the past decade, incomplete reforms and a weak banking sector resulted in strong corporate producers with “land-banks” up to half a million hectares, and weak small and medium farms producing on 500 or less hectares, as well as in migration of rural youth to the cities. Recently started banking reforms can lead to a more balanced development if they continue. Small and medium farms need bank finance to develop, and banks are interested in a potentially huge market. Hence, reforms need encourage the consolidation of land parcels, solve collateral issues, and reduce interest rates. If reforms are not forthcoming, or reforms are endlessly delayed, huge, corporate farms will dominate the ex-soviet rural landscape to the detriment of Ukraine.

Are family farms viable?

Large agricultural holdings, leasing and controlling huge land banks, up to 500,000 hectares, have dominated recent agricultural development. Similar soils and crop rotations in the United States do not see such huge groupings because the advantages of scale are balanced by the limitations of management. The majority of US farms with crop production are family farms (96%) and the average production area is 445 hectares (link).

Family farms are viable in Ukraine and are of interest to the banking sector. To demonstrate feasibility, a cash flow for a 500 ha farm was developed utilising a bank instrument designed and tested by IFC, plus the financial model was verified and confirmed by an experienced agricultural economist that operates his own family farm [1]. Working capital requirements were estimated at 1.6 M UAH/year; equipment renewal requirements are estimated at 4 M UAH over a 5 year period. Based on assumptions for credit (25% per year), the farm produces sufficient income to cover equipment renewal costs and generate profits of 2.5 M UAH per year [2]. Assuming a family structure (2 full time and 4 part-time), this translates into a monthly income of 35 k UAH for each family member. This is enough income to encourage families in Ukraine to choose farming as their occupation, and for children to stay on the farm and not move to the cities.

Another advantage of family-owned farms is that agricultural work is highly seasonal and variable. Owner/operator/family labor adapts to this work environment. Hired labor is less flexible. Agricultural work requires many specialised skills that are only developed by substantial farming experience. Family management identifies and exploits the comparative advantage of their own farm; corporate management often does not.

Family farms cannot develop without finance

Currently small and medium sized Ukrainian farmers are at a competitive disadvantage compared to large producers in Ukraine and other major agricultural exporting countries. The competitive disadvantage arises from several sources including access to competitively priced inputs, technological progress, international markets, and, most importantly, capital. Capital is either unavailable or available at rates four times or more higher than rates charged in some other major agricultural commodity exporters. Large Ukrainian producers, on the other hand, are financed by investors in countries with much lower interest rates. This difference in interest rates puts small and medium sized Ukrainian producers in a nearly unbearable position.

Large producers use financial strength to have lower production costs, whereas the choices of small and medium farmers are often dictated by lack of finance. Large producers employ highly qualified technical experts to help make choices, whereas small and medium producers must rely on their own resources for technical decisions. Large producers have improved storage, allowing them to use financial instruments such as warehouse receipts, and to maintain product quality for markets, both internal and export. Small and medium producers typically only have on-farm storage without drying and aeration facilities, reducing opportunities for better commodity prices and access to international markets.

Various publications indicate that commercial banks are reluctant to lend to smaller producers and thus hedge themselves against perceived risk by raising the interest rate and imposing excessive collateral requirements. Such arguments are wrong. Banks are interested to lend to this sector. The banking sector is ready and capable to expand into the small and medium producer sector, but it is constrained by the lack of reform. Government and donor efforts for rural development will be ineffective and non-sustainable if the environment for bank loans to small and medium agriculture is not sufficiently addressed.

The decision of a bank to lend to agriculture is directly influenced primarily by the operational costs to lend to producers, and the cost of risk [3]. Anything that increases productivity (reducing personnel costs [4]) or reduces the risk (resulting in low non-performing loans, or NPLs) makes agricultural lending attractive to the bank’s management board. Any bank lending to agriculture must take a strategic decision and include the development of specialised expertise.

The list of impediments to provide reasonable credit for independent, small producers starts with the lack of land rights, constrained by the moratorium. The agro-land is not useful for collateral, not merchandisable, and there are no legal possibilities to use leased land as collateral. Further, bank costs to assess and monitor loans are excessive which reduces the potential for profitable operations. It is not, as some suggest, that banks are not interested to lend to family farms. Rather it is the bank responding to its business environment.

Farmer lending constrained by high Interest Rates

Another major issue is high interest rates. High interest rates have to be addressed by reforms that impact all businesses, not just agriculture. The way to solve this is not to re-introduce corrupt schemes to subsidise interest of small farmers. The table below describes a realistic example showing the building up of interest rates for a loan. Note that the difference is not the bank margin.

Research demonstrates that real interest rates, prior to borrower default, may double to triple for countries with weak policy and legal systems [5]. Reducing interest rates in Ukraine requires reforms that include judicial independence, assurance of property rights, legal system integrity, legal enforcement of contracts, and reducing the business costs of crime. Without them, the future of small farmers will be reduced by credit constraints.

US Ukraine (hypothetical)
Risk free interest rate (t-Bill or extended LIBOR) 2.5 2.5
Bank Margin 1.5 2.0
Inflation beyond US 0 10
Default risk 0.5 6.0
Political & Judicial Risk 0 5.0
Total 4.5 25.5

Incomplete reforms will favour holdings

There will be no significant government-subsidised finance of the rural sector. Even more relevant, there should not be. Ukraine is a world class producer and the financial sector, both in and out of Ukraine, is interested to meet the demand. The restructured role of the government is to create an environment where finance by private sector banks will achieve the social and economic goals of the government. To believe otherwise is to return to a soviet mindset. All participants in the Ukrainian agro-industry need to forget the illusion of direct government finance and instead look at the market for agricultural finance and its untapped potential. Any state subsidy is the way back to corruption.

If reforms advantageous to family farms are not forthcoming, or too slow, then a better balance between family farms and huge farming corporations will not be attained. The holdings will increase in size and strength. This is not the best solution for Ukraine.

For the availability of reasonably priced capital to improve bank reforms must continue. There is no place in the world with a vibrant agricultural economy that does not have a strong financial system. For a financial system to perform well, the government must implement appropriate regulation and public policy. Conversely, without appropriate public policy the financial system will not develop to provide the needed capital to support the productive potential of Ukraine and leave small and medium Ukrainian farmers uncompetitive with large Ukrainian farmers as well as other producers around the world.

Reforms that will enable small farm finance (Quick Wins)

During much of 2015 a new development strategy was developed by the Ministry of Agrarian Policy and Food (MAPF) [6] with extensive support from international experts. The policy includes support for a more balanced rural development in Ukraine, but to implement the policies developed by the MAPF, many of the reforms proposed must be legislated by the Verkhovna Rada, a process that has barely started [7].

Reforms related to land rights and interest rates are paramount. In addition, from the perspective of a banker, the fragmented and unconsolidated production fields are a serious impediment to lending [8]. A recent EU project indicated the necessity to consolidate agricultural land, to improve “the structure, composition of tracts, configuration and size of agricultural land plots and land use masses that would ensure formation of sustainable land use[9].

Standing crops as collateral via crop receipts (impacts loan loss cost). Although this is not a collateral per se, it represents significant pressure on a producer receiving a loan to make payment. If a repayment is not made, the land plot(s) linked to the crop receipt will indicate a problem and cannot be used for a new loan. In addition, the lender receives rights to monitor the crop during growth until the repayment is made. If the crop receipts gains acceptance, it can also serve as a mechanism for a secondary finance market. Much effort has been made by the Ministry, donor community and private sector to implement crop receipts, but endless delays slow development [10].

Most non-durable collateral (buildings, automobiles, farm machinery) need to be insured. Lending is more viable when the collateral value is strengthened with insurance. Legal reforms for agricultural insurance are drafted; however they remain unfulfilled [11]. Without legally mandated data and transparent data systems, there is no effective regulation of agricultural insurance and the market cannot grow normally.

The establishment of a level playing field that will result in a more balanced development and a viable small and medium farm sector must be based on a transparent and long term state policy / strategy. The state needs to effectively support AgroSMEs and monitor progress towards their development. This is not a social service program. AgroSMEs are both technically and financially viable, and from a management point of view perhaps even more desirable. To encourage development, for example, state lands can be provided to AgriSMEs under a lease/purchase agreement whereby, for example, lease payments are made for 20 years and then title is transferred to the producer.

University-based outreach education for the rural public can teach existing and potential farmers innovative and cost-effective technical methods, crop and financial management, help to adopt newly available and free on-line information systems that can form the basis for realistic and verifiable cash flows, provide monitoring information to bank risk managers, and promote understand between banks and farmers leading to improved access to finance.


When implementing strategy and projects for the development of agricultural value chains in rural Ukraine, a comprehensive vision that includes a balance between large financial holdings and small and medium sized farms is required. For more than a decade the lack of access to finance has been a constraint for small and medium family farms. The strategic vision needs to include opportunities for employment for rural residents, and mechanisms for rural households to acquire and consolidate land plots and develop family businesses that generate sufficient income for the current generation, and generations to come [12]. None of this will happen if the commercial banking sector is not a full and active participant.


[1] The senior author together with his team developed over 5 years a cash-flow based agricultural risk assessment instrument for banks (CLARA). The research agricultural economist was part of the CLARA development team.

[2] More details about the analysis can be obtained from [email protected]

[3] Reusche, Huijser, Watts, and Kostromytskyi. 2014. The Profit Motive: Encouraging Bank and MFI Lending to Farmers and Agri-Businesses. Summary published in Manual 4, Credit and Insurance, published by the World Bank group.

[4] From a practical perspective, operational costs can be simplified as: personnel costs, and other operating costs. The personnel cost is the amount of staff time for the various bank officers throughout the internal credit process chain to assess and monitor agricultural loans. Productivity is measured by the average time required to complete a full credit process and monitoring cycle for a 3-year loan product.

[5] Jorge Castiblanco and Myles Watts. 2014. Interest Rates and Institutions. Department of Agricultural Economics & Economics, Montana State University.

[6] Strategy Working Group 3.2 (Access to Finance) provided recommendations many of which are discussed in this paper.

[7] Response to questions at AmCham meeting, 4 December 2015.

[8] One example is the cost of the bank with relation to the verification of land plots and historical yields. Confirming all these facts can be very time consuming; not confirming the lease agreements and history can increase unacceptably the bank’s risk. Another example is the bank cost to assess and verify the cash flow. AgriSMEs may have little or no experience with banks, and cannot adequately describe their overall cash flow for an operation producing 4-6 different crops on 1000 to 3000 ha.

[9] Stefan Verbunt. EU Twinning Project: “Assistance in development of an open and transparent agricultural land market in Ukraine.” The project concluded that land consolidation is a pre-requisite for the development of the agricultural land market and Ukrainian agricultural sector.

[10] The Law on Agricultural Receipts was signed by the President of Ukraine on November 6, 2012. This law was developed by a working group that included representatives of IFC, EBRD, FAO, the Ministry of Agrarian Policy and Food of Ukraine, and the private sector.

[11] Reusche, Gary and IFC Team. 2015 (June) PPP Agri-Insurance Development in Ukraine: main challenges, results, lessons learned, and future directions.

[12] The EU Rural Development Policy is an example of what is needed to balance development. The EU policy catalyses the economic, social and environmental development in the countryside.

[13] The calculations of possible farm income was prepared by agro-economist Alexander Vashchuk.


The authors do not work for, consult to, own shares in or receive funding from any company or organization that would benefit from this article, and have no relevant affiliations