A traditional approach to risk management

There is more news indicating that the world economy is recovering. Governments and experts are worried, though, that a loan shortage might choke the fledgling growth that we are seeing. It seems that it’s not so much the fact that many people are poorer than they thought they were two years ago that is holding us back. It’s lost confidence that keeps aggravating and prolonging this recession. Especially small and medium-sized firms find it hard to get the funds they need to finance their operations.

News reaches us from Italy that there is a solution to this problem. Rather than subjecting each and every customer to the risk rating process, Credito Emiliano, a regional bank in Northern Italy, simply accepts a fairly durable commodity as collateral: parmesan cheese. According to Bloomberg, Credito Emiliano keeps cheese worth about 132 million Euros in its climate-controlled “vaults” – a considerable sum. For the producers, that’s very convenient. They can borrow money to make their cheese and pay back the loan up to two years later – which is about the time it needs to mature. For the bank, there is very little risk: in case of a default, it can simply sell the precious …

There is more news indicating that the world economy is recovering. Governments and experts are worried, though, that a loan shortage might choke the fledgling growth that we are seeing. It seems that it’s not so much the fact that many people are poorer than they thought they were two years ago that is holding us back. It’s lost confidence that keeps aggravating and prolonging this recession. Especially small and medium-sized firms find it hard to get the funds they need to finance their operations.

News reaches us from Italy that there is a solution to this problem. Rather than subjecting each and every customer to the risk rating process, Credito Emiliano, a regional bank in Northern Italy, simply accepts a fairly durable commodity as collateral: parmesan cheese. According to Bloomberg, Credito Emiliano keeps cheese worth about 132 million Euros in its climate-controlled “vaults” – a considerable sum. For the producers, that’s very convenient. They can borrow money to make their cheese and pay back the loan up to two years later – which is about the time it needs to mature. For the bank, there is very little risk: in case of a default, it can simply sell the precious parmesan. The arrangement, by the way, isn’t new. Credito Emiliano has been following this practice for decades and deals involving credit and cheese have been struck since the Middle Ages.

So here is one line of business that has no credit problems amid the recession. It’s obvious, though, that this solution wouldn’t work for others. In fact, Credito Emiliano has given up on similar arrangements for ham and olive oil, because these goods are stolen too easily. Parmesan wheels, on the other hand, have serial numbers and can be identified with no trouble. But the most important factor that makes this arrangement so exceptional is probably that the bank actually controls the collateral and knows pretty well in advance how much it will be worth if it should have to sell it. In most cases, banks cannot be so sure about this, and rating the borrower’s assets is usually a very complex exercise. This is not only true for derivative-buying, short-term debtors in the financial markets but also for small businesses and home-owning consumers. The value of parmesan has been quite stable in comparison to house prices in many countries.

Confidence is based on past experiences and sound assumptions about the future. The more accurate these assumptions are and the more reliably credit risks are rated, the more often banks will grant loans again. This is why many actors in the financial sector are making huge efforts and investments to refine their risk management. Because, unfortunately, things cannot always be as easily resolved as in the parmesan business.

Simon Doherty