The Reserve Bank is warning banks to be “far more prudent” about lending to dairy farmers, but says it doesn’t see mycoplasma bovis as a threat to financial stability.
In its latest Financial Stability report, the regulator warns that the dairy farming sector continues to have a level of debt leaving it vulnerable to downturns in milk prices. It also warns that the sector will be challenged by the need to respond to increasing environmental concerns.
Reserve Bank governor Adrian Orr told the finance and expenditure select committee that the discovery of the spread of cattle disease Mycoplasma bovis would probably not have a serious impact on the banking sector – but was still a “wake-up call” for those looking to borrow or lend.
“Looking at the banking sector as a whole it is not that big a concern in the sense that the Government is saying they are stepping up with a big part of the cheque, [and] the industry bodies themselves are picking up a third of that,” he said.
“So a serious impact to farming, but not necessarily a serious impact to the banking system.”
“Be careful and prudent when you are borrowing to operate in this industry.”
Orr said a “simple rule of thumb” calculation was that the cost of the Government’s plan to attempt to eradicate the disease “comes to a maximum of about 15 cents per kg of milk solids”.
“To put that in perspective they rose by 25 cents per kg of milk solids just recently,” he said.
“That gives you an idea on the scale of this incident, but longer term it is a true vulnerability.
“It is another wake-up call on lending into this sector; that biological impacts, long-term productivity and consumer branding are all key parts of the value, or the income that we can generate in this industry.
“Be careful and prudent when you are borrowing to operate in this industry.”
Describing the Mycoplasma bovis eradication plan as a terrible thing for farmers to go through, Orr said: “I can’t speak for the farmers but as the central banker we have a strong belief that the banking sector will see their way through this.”
Dairy debt creeping up
Nevertheless, the banking regulator is calling on banks to reduce their financial risks by being prudent in how much they lend to dairy farmers, especially the 20 percent of farmers that are carrying the bulk of the sector’s debt.
“The good news is most dairy farms are now cashflow positive, but they remain vulnerable to any price shocks as we have seen in the recent past, and we think reducing these financial risks would be a prudent thing to be doing,” Orr said.
“So we have called on banks to continue their more prudent lending practices that we have observed over the last six months or so.
The select committee heard that about 80 percent of outstanding dairy debt is held by around 20 percent of farmers, who run about 2500 farms.
However, across the entire dairy sector debt has now grown to an average of around $22 to $23 per kilogram of milk solids produced. An Reserve Bank analyst told the committee that there has been “a slow upward trend over time, but the highly-indebted farms are becoming more indebted”.
Many of them are large consolidated farms.
The high debt concentrated amongst a few borrowers “is not a risk in itself, we don’t see it as a systemic risk to the banking sector,” Orr said.
“But it is certainly a vulnerability to rural lending and something that we have asked the banking sector to be a bit more cognisant of,” he said.
