As a consequence of rapid structural change and new investment support scheme agricultural debts have increased and concentrated heavily in Finland. In addition, New Basel Accord (Basel II) regulating the bank business requires more in-depth credit risk assessment from banks. Therefore, there are both endogenous and exogenous reasoning for researching the agricultural credit risks. The purpose of the study is to find out the factors that affect financial risks in agriculture as well as possible change in credit risks. Credit scores depicting the magnitude of financial risk for 664 Finnish FADN farms are calculated and an econometric model is applied to clarify which farm specific factors influence the credit score. According to the study increasing farm size decreases financial risks. Furthermore, higher yields that also reflect higher professional skills of the farmer decreases financial risks. In contrast, increasing debts also increase credit risks. In addition, cereal farms tend to have higher credit risks than animal farms. The latter is due to negative profitability development as a consequence of deteriorated grain prices. Even though credit risks in general have increased the number of farms facing substantial financial problems has not increased. However, given the perpetual economic development and structural change in Finnish farming industry the agricultural credit risks will increase. Hence, the lenders would be condemned to apply stricter criteria when granting loans and debt will not be granted to some smaller farms.Credit risks, financing, Agricultural Finance,

Latukka, Arto

Pyykkonen, Perttu

Yrjola, Tapani

English

Research Papers in Economics

  1 
12
th Congress of the European Association of Agricultural Economists – EAAE 2008 
Financial risks and factors affecting them on Finnish farms  
Pyykkönen, P.
1, Yrjölä, T.
 1 and Latukka, A. 
2 
1 Pellervo Economic Research Institute PTT, Helsinki, Finland  
2 MTT Agrifood Research Finland, Economic Research, Business Accounting, Helsinki, Finland 
Abstract—  As  a  consequence  of  rapid  structural 
change and new investment support scheme agricultural 
debts  have  increased  and  concentrated  heavily  in 
Finland. In addition, New Basel Accord (Basel II) regu-
lating the bank business requires more in-depth credit 
risk assessment from banks. Therefore, there are both 
endogenous  and  exogenous  reasoning  for  researching 
the agricultural credit risks. The purpose of the study is 
to find out the factors that affect financial risks in agri-
culture as well as possible change in credit risks. Credit 
scores depicting the magnitude of financial risk for 664 
Finnish FADN farms are calculated and an econometric 
model is applied to clarify which farm specific factors 
influence  the  credit  score.  According  to  the  study  in-
creasing  farm  size  decreases  financial  risks.  Further-
more, higher yields that also reflect higher professional 
skills of the farmer decreases financial risks. In contrast, 
increasing debts also increase credit risks. In addition, 
cereal farms tend to have higher credit risks than ani-
mal farms. The latter is due to negative profitability de-
velopment as a consequence of deteriorated grain prices. 
Even though credit risks in general have increased the 
number of farms facing substantial financial problems 
has  not  increased.  However,  given  the  perpetual  eco-
nomic  development  and  structural  change  in  Finnish 
farming  industry  the  agricultural  credit  risks  will  in-
crease. Hence, the lenders would be condemned to apply 
stricter criteria when granting loans and debt will not be 
granted to some smaller farms. 
Keywords—  Credit risks, financing, . 
I. INTRODUCTION  
The  structural  reform  of  Finnish  agriculture  has 
been rapid in the last few decades. The EU (European 
Union) membership in 1995 did not have a major in-
fluence  on  agricultural  structural  change  in  Finland.   
However, agricultural investments have increased sig-
nificantly since 1995. This is mainly due to the fact 
that  major  challenge  of  Finnish  agriculture  with  re-
spect to EU membership was to reduce the competi-
tive  disadvantage  as  a  consequence  of  smaller  farm 
size compared to most important competing countries 
in  the  EU.  To  narrow  this  advantage  down  a  com-
pletely  new  investment  support  policy  scheme  was 
introduced  in  1995.  The  new  investment  policy  has 
encouraged  the  farmers  to  make  substantially  larger 
investments than before. Development of agricultural 
investments is depicted in figure 1. 
As  a  whole,  the  investments  correspond  with  re-
placement investments necessary to maintain produc-
tion capacity. On the other hand, several farms have 
made substantial investments. In addition, number of 
investments  has  decreased.  The  average  size  of  in-
vestments has hence increased, as shown in figure 2. 
Even  though  investments  support  have  been  to  a 
larger extent aids, the total debts of Finnish agriculture 
have  increased  simultaneously  with  agricultural  in-
vestments  as  larger  investments  have  also  required 
larger debts on the investing farms. This has led to 
quite heavy concentration of farm debts. the most in-
debted decile of cereal farms had 61 per cent of the 
debts  of  Finnish cereal  farms.  In  addition, the  most 
indebted decile of beef, dairy and piggery farms had 
51 per cent, 46 per cent and 41 per cent of the total 
debts of the corresponding farms. [1] 
Concentration  of debts  connotes  greater financing 
risks for lenders. Hence, the lenders will apply tighter 
requirements  for  farm  debts.  In  addition,  the  New 
Basel Accord (Basel II) regulating the bank business 
commenced in the beginning of 2007. It aims at ensur-
ing that the lenders have sufficient amount of capital 
with respect to the risks connected to the loans they 
grant.  Furthermore,  Basel  II  requires  the  lenders  to 
classify their clients according to the default risk. The 
more a bank has granted loans to those in credit risk 
classes with higher risks the tighter solvency require-
ments it has to fulfil. Hence, the credit risk class of the 
client will have an influence on interest rate margin 
bank grants [2]   2 
12
th Congress of the European Association of Agricultural Economists – EAAE 2008 
Fig 1. Investment in agriculture in 1990-2005 
Thus  far,  the  creditors  have  mainly  focused  on 
guaranteeing that collateral securities of the agricul-
tural loans are sufficient. Hereafter, it is likely that the 
significance of liquidity, and profitability in addition 
to  solvency,  will  increase  regarding  the  agricultural 
loans. Thus, there are both internal and external rea-
sons for more precise consideration of financial risks 
in agriculture. 
II. OBJECTIVE OF THE STUDY 
The purpose of the study is to find out the factors 
that affect financial risks in agriculture as well as pos-
sible change in credit risks. Recognizing these factors 
will facilitate the development of risk rating as well as 
help the banks to improve risk classification tools re-
lating to farms. Furthermore, the results will assist the 
development and planning of the investment support 
scheme. 
III. RESEARCH METHODS AND DATA 
The analyses carried out in this study require farm 
level data. The panel data we apply in the study con-
sist of 664 Finnish FADN farms (collected by MTT) 
that have kept the records both in 2000 and in 2005. 
The application of this data is reasonable because it 
can be assumed that also bank require more in-depth 
financial data of the clients they grant debts in the fu-
ture. 
In this study, we calculate a credit score for each 
farm. The credit score is composed of financial factors 
(subscores) depicting economic performance of a farm 
(profitability  coefficient  (weight  0,20),  equity  ratio 
(0,35), repayment period (0,35) and family farm in-
come to gross return (0,10)).  
The credit scores for each farm are calculated firstly 
by subtracting the average value of the subscores in 
the base year (2000) from the corresponding subscores 
of each farm. Secondly, each subscore is normalised 
by dividing it by the respective standard deviation in 
the base year. Finally, the total credit score for each 
farm is calculated using the above mentioned weights. 
0
50
100
150
200
250
300
350
400
450
500
550
600
650
700
750
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05
Mill. € (valued at 2005 level)
Machinery
Buildings
Soil improvement
Source: Statistics Finland
Investments in agriculture  3 
12
th Congress of the European Association of Agricultural Economists – EAAE 2008 
Fig. 2. Average size of Finnish agricultural buildings (m
3) 
In order to be able to construct a transition matrix the 
farms were divided into ten credit risk classes accord-
ing to credit scoring in both 2000 and 2005. In analys-
ing  the  factors  affecting  credit  risks  and  credit  risk 
changes we apply an econometric model. 
IV. RESULTS 
Average credit score in 2000 was 6.80, and in 2005 
it  had  decreased  slightly  and  was  6,44.  Hence,  the 
risks had increased at least to some extent. In 2000 
share  of  farms  in  the  three  highest  risk  categories 
(credit  score  1-3)  was  3.2  per  cent  and  in  the  four 
highest risk categories 8.7 per cent. In 2005 the corre-
sponding figures were 4.1 percent and 11.7 percent. In 
contrast, in 2000 share of arms were in three lowest 
risk categories was 38.7 per cent, and in 2005 no more 
than 23.2 per cent of the farms. 
Credit score transformations were, however, not too 
dramatic. The most common credit score was the third 
lowest risk category 8 in 2000 and the fourth lowest 
risk  category  7  in  2005.  The  distribution  of  credit 
scores of farms is represented in figure 3. 
On farm level it can be detected that 43 per cent of 
farms had credit score with higher risk in 2005 than in 
2000, whereas 38 per cent of farms had maintained the 
same credit score and 19 per cent of farms had moved 
to a risk category with lower risk in 2005 than in 2000. 
A regression analysis was applied to clarify which 
farm specific factors influence credit score and, hence, 
credit  risks. The  explanatory  variables  of  the  model 
included factors concerning both economic perform-
ance and production process of the farms. In addition, 
dummies for different production lines and years were 
also applied. The results of the regression model are 
presented in table 1. 
Large amount of agricultural debt, and hence sig-
nificant loan costs, increase credit risk, as expected. 
Additionally, high interest rate increases credit risks. 
This may be partially due to the fact than not all assets 
can be used as collateral for a loan. which may in-
crease the interest rate for a single farm. Also the cred-
itworthiness of farms decreased from 2000 to 2005. 
0
500
1000
1500
2000
2500
3000
1990-1994
1995-2007/I
Source: Statistics Finland, building permits, PTT  4 
12
th Congress of the European Association of Agricultural Economists – EAAE 2008 
Fig. 3. Distribution of farms in risk categories  
Increases in agricultural input prices explain at least 
part of diminishing creditworthiness. 
Table 1 Results of the regression analysis 
Variable    Parameter estimate 
Intercept        -0,04372 
Acreage        0,00221*** 
Capital in buildings and machinery  0,00000113*** 
Interest rate      -0,55055 
Total debts        -0,00000305*** 
Yield        0,00002977** 
D-cereals        -0,08647* 
D-dairy        0,0211 
D-beef        0,03943 
D-pig        0,05497 
D-year        -0,05479 
 
R
2 0,231 
F-test value 33,73*** 
 
The larger a farm, with respect to bots acreage and 
capital  in  agricultural  buildings  and  machinery,  the 
lower credit risks. The larger farms tend to have better 
profitability than smaller farms due to various reasons. 
In addition, solvency in often better on larger farms, 
which implicates better collaterals for loans. The less 
investments  have  been  financed  with  liabilities  the 
higher the collaterals for loans and lower the interest 
rates. 
Credit risks were also lower on those farms, which 
had  a  higher  average  yield.  This  is  partially  due  to 
higher revenues and economic performance in general. 
Furthermore, higher yields also may mean higher pro-
fessional skills of the farmer. 
Credit risks of cereal farms have been higher than 
those of animal farms. This is at least partially due to 
decreasing grain prices of the first half of this decade. 
Therefore, feed costs have not increased significantly, 
which has been an advantage to animal farms. In con-
trast, revenues of cereal farms decreased and the prof-
itability of cereal farms deteriorated. Hence, profitabil-
ity development of cereal farms has been negative and 
inferior to animal farms. 
V. CONCLUSIONS 
The credit risks have increased at least to some ex-
tent. However, this study does not clarify which credit 
0
5
10
15
20
25
30
35
40
1 2 3 4 5 6 7 8 9 10
2000
2005
Risk categories
% of farms
High risk Low risk  5 
12
th Congress of the European Association of Agricultural Economists – EAAE 2008 
score means loss of creditworthiness. Therefore, even 
though  number  of  farms  in  the  risk  categories  with 
highest risks have increased from 2000 to 2005, based 
on this study it cannot be concluded that number of 
farms  in  serious  financial  problems  have  increased 
significantly. 
Structural  change  of  Finnish  agriculture  increases 
the amount of debt of the Finnish farms and, hence, 
financial risks. On the other hand, the largest farms 
tend to have inferior financial risks as a consequence 
of higher profitability and better solvency. In this re-
spect the share of equity capital in investments has a 
crucial effect on credit risks. 
Especially the energy costs have increased substan-
tially in the last few years. In contrast, grain prices 
have  increased  since  2005.  Even  though  the  prices 
would not remain on the current level it seems undis-
puted that they will remain on a relatively high level. 
This  improves  the  economic  performance  of  cereal 
farms.  In  contrast,  as  a  consequence  of  rising  grain 
prices also the prices of feed will go up. Together with 
ascending energy prices the higher feed costs deterio-
rate the financial performance of animal farms. 
Given  the  perpetual  economic  development  and 
structural change in Finnish farming industry the agri-
cultural credit risks will increase. Hence, the lenders 
would  be condemned  to apply  stricter criteria  when 
granting loans. Furthermore, the interest rates of high 
risk loans may rise even substantially. This would also 
mean significantly higher loan costs. In order to re-
main competitive the farms have to make investments 
and liabilities are fundamental in funding the invest-
ments. If the economic performance of the farm is not 
good enough it will not be granted loan with reason-
able terms and, therefore, it is not able to make neces-
sary investments. Hence, there is an inevitable connec-
tion  between  structural  reform  and  increasing  credit 
risks. 
REFERENCES  
1.  Myyrä, S. ja Pietola, K. 2005. Velkojen keskittymiske-
hitys Suomen maatiloilla. MTT:n selvityksiä 92(2005). 
35 s. 
2.  Walraven, N. & Barry, P. 2004. Bank Risk Ratings and 
the  Pricing  of  Agricultural  Loans.  Agric.  Fin.  Rev. 
64:107-118. 

Financial risks and factors affecting them on Finnish farms

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