QUESTIONING THE ASSUMPTIONS OF COLLATERALS AGAINST LOANS BY SAYING CHEESE!
Banks have truly been the pillars of economic development in a nation. A nation’s stability and sustainability is considered strong only if it has a robust banking ecosystem. Since time immemorial, banks have rightly been the ‘friend in need’ in turning our aspirations into reality.
Banking has come a long way since the earlier days. It is one domain which is appropriate to the proverb of ‘change is the only constant’. The advent of technology, the ever-changing regulatory compliances, dynamic monetary and fiscal policies, modifying their products according to the needs and desires of the Gen Z customer and of course living up to the comparisons with their competitors – all these have ensured that banks constantly keep re-innovating themselves w.r.t their products and solutions, to stay ahead of the curve.
The role of the bank is even more crucial when it comes to facilitating trade between exporters and importers in different places. Right from verifying, auditing and performing due diligence on the documentation to enabling supply chain finance, they are the catalysts of modern day trade & commerce. In many ways, they are the backbone of the nation’s agricultural economy by providing loans to farmers for purchasing seeds, equipment and fertilizers, for farming.
When a bank offers a customer a loan, it typically takes collateral in lien against the sum of money given. They often undertake this as a security measure, lest the customer should default on his loan in unforeseen circumstances. They accept anything ranging from property to gold to farming equipment & vehicles etc.
What if we told you, a bank in Italy offers loan to farmers by…….accepting Cheese as collateral?! Yes you heard that right!
Let us rewind a few years behind to understand how this happened and its significance in today’s scenario.
Cheese is an important ingredient in Italian cuisine. Be it pizzas, sandwiches, pastas or any other dish, the presence of cheese makes it an enjoyable affair. Italian cheese has so much demand, that recently Italian cheese exports hit a whopping 3 billion Euros! It’s worth its weight in gold, more so, if the cheese in question is Parmegiano Reggiano.
Popularly known as ‘The King of Cheeses’, it is produced in the Emilia Romagna region of Northern Italy. Very high in demand, primarily due to its superior taste, rich quality and texture, the process of making this particular type of cheese is a long & arduous one requiring enormous dedication, patience and significant financial resources. You’ll be surprised to know that it takes 140 gallons of milk to make a single wheel of Parmegiano, which ends up weighing 100 pounds! It must legally be aged for a minimum of 12 months to a maximum of 36 months (the more it ages, the more delicious it becomes), during which the wheels containing the cheese has to be rotated and cleaned on a weekly basis. Not only does this make the storage of enormous wheels of cheese a challenge, but it is also not a sustainable venture for a family-owned cheese business when they don’t have access to funds, as their capital is tied to the inventory which takes a long time to age.
The long time period required for these resources to liquefy stepped up the need for ensuring timely and uninterrupted finance and credit lines. And this was where Credito Emiliano, a bank came forward to facilitate an expensive portion of the operations process for dairy farmers in the Emilia Romagna region.
The bank, while typically choosing to accept cheese as a collateral & insurance, also takes care of the storage and ensuring the proper ageing of the wheels in specially designed climate-controlled vaults for the entire duration of the loan. The farmers thus save on operating costs and gains access to crucial supply chain finance which enables them to pay their creditors for the raw materials. The bank, in turn charges between 3% to 5% interest, depending on the quality of the cheese, and a fee for making sure the cheese matures properly in their air-conditioned, humidified vault.
Let us understand this with a small example.
Milano is a small dairy farmer producing Parmegiano Regiano for a long time — in fact; it’s a business of generations. Needless to say, his cash flow is tight owing to the long time taken for maturing the cheese. Which is why he urgently needs a loan from a bank to keep his operations up and running.
He has a meeting at Credem bank and asks for a loan. He gets approved for the amount he requested; under the condition that he surrenders a certain number of cheese wheels with the bank. In most cases, typically the bank approves the loan up to 70-80 percent of the value of cheese, which acts as a safety layer for the bank to protect it against market fluctuations and product degradation.
Milano now has the financial means to run his operations. He has enough funds to feed the cows, pay workers to milk those cows, and then make the cheese. Once Parmegiano is ready, a representative from the bank collects it and a dedicated team takes care of it, for upto 36 months.
One might ask as to what’s so special about this cheese that convinces a bank to accept this as a loan. Well, the prices of Parmegiano tends to fluctuate wildly with market demand. More demand, automatically leads to more prices for this variety of cheese which is often viewed as a luxury item! They treat each wheel of cheese as gold by cleaning, turning, hammering, pricking and from time to time even tasting certain batches.
In an ideal scenario, once Milano repays the loan and the cheese is aged, the bank releases the collateral. His distributors get the cheese to sell, and he continues his operations. Everyone is happy; especially those of us who get to taste the lip-smacking Parmegiano on pasta!
While this is the lifecycle of typical Parmegian cheese backed collateral for a dairy farmer in most cases, sometimes not everything goes according to the plan. It’s not as if the bank accepts any cheese posing as Parmegian in order to qualify for the loan. Each batch has to meet certain criteria to qualify. If it doesn’t, the cheese is downgraded; the Parmigiano Reggiano imprint is scraped off and sold simply as Italian cheese.
The job of the bank doesn’t just end with accepting the cheese and storing it in a conducive environment. It has to ensure that the cheese quality doesn’t deteriorate as it matures! Chances are that it may swell so much that cracks develop on the wheels. Every tiny flaw lowers the value of the cheese. If under any circumstances, the producers default on their loans, the bank sells their collateral after it matures, ideally at the time of inflation.
A popular question in everyone’s mind would be as to why don’t the dairy farmers use other methods & techniques to store and cultivate the cheese than approaching the bank. Studies have shown that outside of the Credem warehouse, about 10 percent of Parmigiano-Reggiano wheels degrade due to environmental damage, which is a fairly significant chunk considering their value and long maturation period. At Credem’s warehouse, only about 1 percent of the cheese actually degrades owing to the state-of-the-art climate controlled warehouse and expert supervision of trained officials.
This unique, first-of-its-kind approach taken up by a bank to support its local ecosystem is a classic case of applying design thinking, keeping the user at the center. Credem identified the anti-patterns of several dairy farmers who had no means of keeping their operations afloat while waiting for their inventory to mature. They observed the unstated requirements of farmers like Milano, who even though wanted to store the cheese in ideal environments for ageing, could not do so due to the rapid degradation of the cheese, thus rendering it useless.
They actually connected the dots outside the box, as to how would a banking company view this seemingly difficult problem by actually developing, running and maintaining state- of-the-art warehouses to store the cheese, thus ensuring a proper environment for the cheese to grow. On being an integral part of this entire cycle, Credem bank was actually questioning the assumptions as to why a bank can’t think beyond the usually accepted norms as collaterals!
On a more serious note, lending is something that is not generally perceived as a sign of growth in Italy. It automatically brings to their mind the evils of usury, going back to Shylock in The Merchant of Venice! Even today, many people still perceive lenders and banks that way in Italy. By questioning these assumptions and setting up this infrastructure and showcasing their value to the community, Credem has not only truly earned the goodwill of the public, but has also become the subject of a Harvard Business School case study.
Many other banks have actually started accepting several unique artifacts as collateral in lien for a loan. Recently a bank in Hong Kong, actually accepted designer hand-bags as collaterals! One bank actually went to the extent of putting up Cristiano Ronaldo as collateral for financing the players’ transfer to Real Madrid! Not sure if they are inspired by Credem, but it does sound crazy though!
It is important to have an end-state visualization in mind, as to how you would like to visualize yourself a few years from now. The power of imagination of all the stakeholders in this case – the farmers, Credem bank, the suppliers and the officials maintaining the warehouses has ensured that the farmers produce around 3.6 million cheese wheels each year, which values the industry at 2.5 billion US dollars (or 2.2 billion Euros). Evidently, people around the world love and appreciate Italian cheese!
In many ways, business and life are like a bank account! You can’t take out more than you put in! And that is trust! The trust which the dairy farmers have reposed on the bank to take care of their cheese for 3 years and the trust which the bank has reposed on the farmers for repaying their loan! At the end of the day, as the popular quote goes, “It is not us versus them or us on behalf of them. For a design thinker, it always has to be us with them!”
Credem bank’s passion and care for empowering the community, region and produce is as strong & tasty as the Parmegian cheese it nurtures along with the farmers!