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Credit "aspirin" from the state. Why did 5-7-9 loan program fail?

Author : Oleksiy Kushch

Source : 112 Ukraine

Recently, a group of banks came up with a proposal to stop the 5-7-9 lending program. As the head of Bank Aval said: “If, according to the data of Raiffeisen Bank Aval, we draw up a typical portrait of a program participant, it will be an operating agricultural enterprise that has received an anti-crisis loan or refinancing. In general, such enterprises are quite stable and have not suffered significant losses from curtailing business activity in 2020 and trying to legally reduce the cost of financial activities"
23:12, 20 September 2021

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And for the economy, the effect of the program turned out to be scanty. 1 UAH of compensation led not to 20, but only to 2 UAH of new loans. Which, in general, is not surprising, given that the author of this article argued to Mr. Milovanov: in the case when almost half of the loans go to ordinary refinancing, the program does not work and there is no multiplier effect for the economy. To which Milovanov, who calls himself almost the "founding father" of the 5-7-9 program, declared that "you are lying", and left the studio ahead of schedule.

What mistakes were made during the implementation of the 5-7-9 program?

How the state saved business from bankruptcy

On February 1, 2020, a program of assistance to small and medium-sized businesses called "5-7-9" was activated in Ukraine. It provided for the allocation of loans to business entities at a reduced interest rate: 5, 7 and 9%, respectively, depending on the fulfillment of a number of established criteria.

The purpose of the program was to reduce the cost of credit resources for entrepreneurs - rates on commercial loans are in the range of 15-20%, and this is mainly "short" money. In the best case, these loans were given for the medium-term 1-2 years. And we practically do not issue long-term loans in hryvnia for three or more years. And this despite the fact that it is a long-term credit resource that is one of the key sources of capital investment in long business cycles. By the way, in the structure of capital investments in the Ukrainian economy, bank loans take no more than 4-5%, while the world practice it is 20-30%. Capital investments in Ukraine are carried out mainly either at the expense of the business's own funds (more than 80%), or at the expense of the state (about 10%).

The catastrophic decline in the role of credit leverage in our economy can be illustrated by such an indicator as the penetration coefficient - the ratio of net loans to economic entities to GDP. If in 2013 this indicator was 42.6%, then by 2019 it dropped to 10.4% (a historical low over the past few decades). In 2020, it was only 11%.

The lack of leverage in the Ukrainian economy can be explained quite simply. A loan as an incentive for business development works only if the rate on it is lower than the borrower's rate of return. For example, the profitability of a business project is 10%, and the lending rate is 6%. Therefore, by attracting borrowed funds, an entrepreneur will earn 4% on a loan. In Ukraine, the rate on loans (20%) for many years has exceeded the level of profitability of almost all types of businesses with a high level of added value. Taking out a loan in such conditions is to deliberately activate the risk of bankruptcy for your company.

At the moment, only agricultural companies can take out super-expensive loans for simple raw material cycles: sowing, growing, collecting, selling. Their term is maximum six months, rate is 20% per annum. With a seasonal profitability of 50%, the agrarian company gives the bank only 10% of the profit margin, keeping 40% for itself.

The rest of the business, which produces Ukrainian products with a high level of added value and a profitability of 5-15%, found itself in a state of financial hypoxia, since it was completely cut off from the credit support of banks.

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Thus, in order to “switch on” the economy through the lending channel, it is necessary to ensure a positive effect of the leverage: the interest rate on loans must be below the average level of profitability. In this context, it is very important that the multiplier effect ensures the transformation of UAH 1 of the budget compensation of the interest rate, for example, in UAH 10 of new loans issued by commercial banks to their clients - legal entities. And UAH 10 of new loans led to GDP growth, for example, by UAH 30 (credit multiplier effect 1: 3).

In this case, UAH 1 billion of compensation allocated by the state for the program to reduce the interest rate will first lead to the issuance of new loans by commercial banks for 10 billion, and then the credit multiplier will give an impetus to GDP growth by UAH 30 billion. In the case of interest rate compensation, the multiplier in this case will be 1:30, that is, UAH 1 billion of compensation at the rate = UAH 30 billion of GDP growth.

By the way, I know from my own experience that the application of the program for compensating interest rates on loans to the agro-industrial complex at the beginning of the 2000s formed a multiplier effect in the amount of 1:20: 1 UAH of compensation led to 20 UAH of new loans. And then the agro-industrial complex itself received a powerful credit impulse for development.

But it turned out that this model does not work in Ukraine in 2021.

What is wrong with lending to Ukrainian business?

Recently, a group of banks came up with a proposal to stop the 5-7-9 lending program. As the head of Bank Aval said: “If, according to the data of Raiffeisen Bank Aval, we draw up a typical portrait of a program participant, it will be an operating agricultural enterprise that has received an anti-crisis loan or refinancing. In general, such enterprises are quite stable and have not suffered significant losses from curtailing business activity in 2020 and trying to legally reduce the cost of financial activities."

In addition, the bankers drew attention to the risks associated with the fact that if the state curtails the rate compensation program, then entrepreneurs who have already received soft loans will be forced to pay market interest on them. This situation, by the way, was already in the youth lending system, when young families believed the state, took out mortgage loans, and then the compensation was no longer paid, and many borrowers were on the verge of losing mortgage housing, as they could not pay the market interest.

But the bankers have their own interest here: they do not want the state to actively reduce interest rates through compensation, as this affects the market expectations of borrowers in general and reduces the interest income of financial institutions.

During the implementation of the 5-7-9 program, a number of systemic errors were made. This is the multivariance of lending, the low bar for medium-sized businesses in terms of the maximum loan size, and the absence of a mechanism for obtaining a loan using the "open window" method, and regulatory restrictions on the borrower's assessment, and collateral requirements, and the lack of effective guarantees for loans, and the lack of emphasis on intended use, and non-use of industry markers.

All this once again shows: when the "ultraliberals" & "libertarians" begin to play the policy of state protectionism and support, a mixture of a bulldog and a rhino turns out. Everyone should do what he should, and not what is now in the mainstream. After all, when you have to watch how a good idea is multiplied by zero, it becomes uncomfortable. Moreover, when you know exactly how to correctly and effectively implement it in practice.

In reality, whatever our "reformers" do, we get only slides on a flash drive. In their implementation, only the 7-40 program works well: when 7% interest on loans is offered to a narrow circle of borrowers, and 40% - to the rest of the population. Isn't it "libertarianism"?

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