Plain Economic Sense News Release

National Policy Options for Enhancing Rural Credit for Business Development

September 22, 1997

By Mark A. Edelman
Extension Public Policy Economist
Iowa State University Extension to Communities

I recently provided testimony in Washington on rural capital markets before the U.S. Senate Agriculture Committee. During the past few years, rural financial interest groups have trial- ballooned several proposals before Congress and, during the past year, the U.S. Department of Agriculture, the General Accounting Office, the Kansas City Federal Reserve Bank and the Rural Policy Research Institute (RUPRI) conducted studies on rural capital markets. Congressional members wanted to take stock of the status of the current debate. I participated as a member of the RUPRI study team. Here's my analysis of the interest group proposals and what they mean for rural America.

Option 1. Create a Farmer Mac Secondary Market for Rural Development Loans.

Creation of an effective secondary market for rural development loans accomplishes three things in regard to the gaps identified by the RUPRI panel. First, a successful secondary market allows community lenders to serve large projects and projects requiring longer term financing that might not otherwise be served. Second, it provides smaller community lenders with an opportunity to transfer interest rate and local project risks to an external pool that appropriately spreads the risks over a larger portfolio of projects and a market willing to accept such risks. Thus large projects are served without jeopardizing the safety and soundness of smaller rural community lenders. Finally, the Farmer Mac secondary market concept fosters wider competition by giving access to a wide range of lenders including community banks, the Farm Credit System affiliates and other institutions to the degree that their respective charters permit.

Option 2. Broaden Federal Home Loan Bank (FHLB) Authority.

Including "small" business and industry loans, agricultural loans, and possibly infrastructure under "rural development" loan authority for the FHLB system would allow the FHLB system to diversity its portfolio and allow community lenders to pool and access loan participation by a national government sponsored enterprise (GSE) network to transfer credit risks. This also allows community lenders to better match the term of loans more appropriately with project life.

Presently, many community lenders have limited ability in providing longer term loans for agriculture and rural development, particularly for small business start-ups, non traditional business enterprises and large projects. The FHLB proposal before Congress would address each of these gaps except large projects.

Option 3. Broaden the Farm Credit System (FCS) Charter.

The FCS serves a national network of farmer owned agricultural credit affiliates. If current regulatory limits on the FCS were removed and authority broadened for nonagricultural business and industry loans, housing, infrastructure and equity capital participation, the FCS would gain flexibility to better facilitate rural community development. FCS housing loan eligibility is constrained to housing for farmers, cooperatives and smaller rural communities. Business loan eligibility is constrained to businesses owned by farmers and cooperatives. Infrastructure is limited to small communities.

Presently, FCS affiliates are barred from equity participation beyond FCS affiliates. While FCS has authority for an internal equity capital foundation, external equity capital participations with local and regional community development corporations and SBICs are not allowed. Allowing FCS portfolio diversification and equity participation could reduce the risks faced by FCS during major agricultural downturns.

Option 4. A Combination of Options.

In contrast to conventional wisdom, the first three options are not mutually exclusive from a rural community perspective. In fact they are complementary and more capital market gaps would likely be reduced if all three were considered as a part of the same package.

Rural communities are diverse in their resources, leadership capacity and circumstances. The financial market gaps and policy interventions that work in one rural community often do not work for a neighboring community due to lack of community leadership, community capacity or lack of interest on the part of a key local financial institution. In addition, testimony by Mark Drabenstott of the Kansas City Federal Reserve Bank pointed out that a much wider array of capital sources is available for farmers than for nonfarm rural entrepreneurs and start up businesses. So, policy approaches that empower a broad range of farm and nonfarm rural community institutions to address capital market gaps are more likely to serve rural America compared to approaches which favor expanding charters of a single class or type of institution.

If Congress decides to use a narrow approach, some communities and rural institutions will receive opportunities for competitive advancement, but the gaps faced by other rural communities potentially served by other financial institutions will remain unaddressed.

Edelman is a professor of economics and an extension public policy specialist at Iowa State University. Contact Mark A. Edelman, ISU Department of Economics, (515) 294-6144.

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