Research by Professors Bruce Chapman and David Lindenmayer, Research Directors of Sustainable Farms at The Australian National University, has identified a new way of financing farm improvement investments that minimises the financial risk and accompanying stress that often comes with the use of traditional bank loans.
In an era where drought seems like the new norm, farm improvement projects that restore degraded land and improve drought resilience are becoming ever more important.
Yet it’s exactly these kind of forward-thinking investments that are hard to fund, one reason being that it can take years for the farm to benefit financially, making it difficult for farmers to feel confident that taking out a loan that won’t realise extra profits for many years is a good idea. Plus, if market or climatic conditions take a big downturn, the farm business can find itself in financial difficulty repaying conventional loans, which can put enormous stress on farmers and rural communities more broadly.
A new system is needed: revenue-contingent loans
What if there was a way to fence your farm dam or plant some shelter trees for your stock without major concerns of repayment hardships?
The Chapman and Lindenmayer research shows that revenue-contingent loans could be the answer. These loans would be provided to farms by government but would be repaid as a proportion of a farm’s future annual revenue, thus mitigating debt repayment concerns.
This is in contrast to conventional bank loans, which require repayments to continue even in times of drought or market downturn. This can leave farmers who find themselves in challenging circumstances, such as come with prolonged drought, struggling to pay a debt.
Is there a precedent for this type of finance?
The idea for revenue-contingent loans is based on another loan system that’s already widely used in Australia and has been very successful.
If you or someone you know studied at university since 1989, chances are you’re aware of the student loan system. Originally called the Higher Education Contribution Scheme (HECS), but now known as HELP (Higher Education Loan Program), it provides students with a loan from the government to cover their university fees.
These loans are income-contingent. Unlike a traditional bank loan, there’s no need to start repaying until their future annual incomes exceed a given level, which is around $47,000.
It’s a much more sensible and practical approach than burdening students with “normal” loans in which repayments are required regardless of the financial circumstance of the student. It also places less of a burden on government budgets than subsidies or grants, which are expensive for governments to fund in the long run.
And just as income-contingent loans enable students to invest in their future through education, a similar approach could be the solution for farmers seeking to invest in their farm’s future.
How would these loans work for farmers?
Just like a student invests in education to increase their future earning capacity, farmers should be able to invest in improvement projects that will restore natural assets on the farm and in turn increase future productivity and profits. As noted, this can all be achieved without repayment traumas.
With this system, and similar to what happens with HELP, repayments towards the loan could be administered through the Australian Tax Office, which has access to legally required quarterly Business Activity Statements recording a farm property’s revenue. Low, or no, revenue for the period means low or no repayments; high revenue means higher repayments.
A recent paper co-authored by Professors Chapman and Lindenmayer demonstrated that a loan of $50,000, paid back at a rate of 6 per cent of the farm’s revenue for the year, would take a farm of median income just 4 years to repay. The modelling shows that 93.4 per cent of all loans of this amount would be completely repaid within 10 years, meaning that the loans would have minimal impact on government budgets.
How could these loans be used?
Improving dams, planting shelter belts and revegetating degraded land all help restore the natural capital of a farm while increasing productivity, but all require some capital to get started.
For instance, establishing shelterbelts of planted trees between paddocks can block prevailing winds and wind-chill, so that animals put less energy into keeping warm. This increases stock live-weight and wool production, and reduces lamb mortality. Shelterbelts can also boost pasture production by as much as 8%.
However, fencing an area for the shelterbelt, preparing the ground and purchasing and planting young trees requires significant initial investment. This investment could come from a revenue-contingent loan – a way of enabling investment in the farm’s future without the risks of a traditional debt.
Could the banks be involved as well?
It is possible, even desirable, that commercial banks could be part of new financing arrangements; after all, government do not generally have the resources to take over major aspects of agricultural lending. Chapman and Lindenmayer envisage an arrangement in which commercial loans are made available from banks for investment projects at the same time as RCLs are provided. In this situation the money from the RCL can be used to help repay the commercial debt while investments are underway. Modelling this type of the arrangement is now being undertaken.
This new research demonstrates the exciting potential for new ways of financing farm improvements that would ease normal debt burdens, at the same time minimising the impacts on government budgets.