Re-inventing Agricultural Credit System
Agricultural finance today is at a crossroads: at the same time as more working and investment capital is needed to meet the increasing demand for food, agricultural lending, particularly to small farmers, remains restricted, leading to a demand gap in the provision of rural financial services. The challenge of how best to develop a viable rural financial system and, in particular, finance small farmers in a cost-effective and risk-reducing way remains open.
Agricultural lending to small farmers is particularly challenging and providing them access to formal agricultural credit has been a concern of governments for a long time. Banks generally avoid dealing with small farmers, as they perceive lending to them to be both costly and risky.
Banks, although anxious to extend their operations into rural areas, also worry about how best to provide effective financial services and, in particular, how to lend safely to farm households.
With the growth in the economy, there has been an increasing need for the banks to introduce competitive products, lower prices, segment the market into SF/MF and other farmers and/or generally work on refining the existing products to meet the demand of the farmers in particular region.
Basic Features of Agricultural Lending
For effective delivery of agricultural credit, it is imperative to understand the basic characteristics of existing agricultural loan products.
Loans to farmers can be provided for different purposes and with different lending terms. The most common existing loan types are:
- Seasonal Loans for Agricultural Operations (Working Capital): These loans are used to buy agricultural production inputs such as seeds, fertiliser and tools, as well as financing operating costs such as wages for hired farm labour. It is important that these loans fit in with the seasonal nature of agricultural production. They are usually short term, lasting only a few to eighteen months.
- Harvesting Loans. These are short-term loans used to hire labour or machinery at harvest time. They may also be used to finance other marketing costs.
- Medium term Improvement Loans. This type of loan is used to invest in durable improvements to increase farm productivity, such as the installation of water pumps for irrigation, drought animals, agri-equipment etc,. They are generally repaid over a period of 1-3 years.
- Long term Investment Loans. These are loans which are used to purchase farm land or farm machinery for long-term use, such as tractors. Other uses for long term loans include buying breeding livestock and financing the establishment of perennial crops such as coffee, fruit trees or rubber trees, developing irrigation sources that will require several years before they generate returns. Repayment periods usually extend over many years.
Generally, loan disbursement and repayment schedules should reflect the actual situation of a farm household, with both disbursement and repayment based on the cash-flow situation. Therefore, the design of agricultural loans requires good information about clients’ financial needs and patterns of loan demand, the mix of agricultural activities involved and their associated cash-flows and risks.
Farmers do not only need finance for agriculture, but also for many other non-farm economic activities and household consumption. Thus they may need loans for:
- Working or investment capital for non-farm enterprises;
- Consumption purposes between planting and harvest; housing, travel, religious functions
- Special events such as medical costs, school fees, weddings, funerals, etc.
Diversifying their loan portfolio over these different financing needs allows rural financial institutions to balance the seasonal nature of agricultural lending.
Existing agriculture credit products and system of product development
Banks have besides core credit products like KCC with varying scales of finance across the country and within the country across the states and districts, created area specific products to cater to area specific activities like inland-fisheries, ground water irrigation, water harvesting and soil and moisture conservation projects, rural electrification, pulse production etc,. While developing area based and location specific products, customer’s feedback from the field is given high priorities and accordingly products are reviewed and modified periodically.
Refinements to existing credit products
Kissan Credit Card (KCC)
One of the more recent innovations to improve flow of credit to agriculture sector is the KCC introduced in 1998-99. Though these are not utilised as truly credit cards, credit line in the form of KCCs presents a number of advantages both to the borrowers and banks. It is designed to meet the totality of the credit requirements of the farmer cultivator and allows the farmers the flexibility to draw funds when they need it, up to their allowed credit ‘ceiling’ and it definitely offers a better solution for farm finance.
Despite many positive features of the KCCs, inadequate infrastructure and barrier to using smart card technology on the supply side and lack of willingness and awareness on the demand side limit the effective use of the KCCs.
Improving efficiency of KCC
The success of the KCC, and other similar products/facilities that could be introduced in the future, would depend critically on the following factors:
- Increasing efforts to better publicise the scheme with all its features among the farmers for greater awareness and more effective use of the facility.
- Extending the facility to include financial needs of rural nonfarm activities to meet the totality of credit requirements of the farming household
- Expenditure towards organic certification should be allowed under KCC.
- A scheme of ‘Gold KCC’ with higher flexibility can be introduced for borrowers with prompt repayment records
- In the first step, converting KCC into interoperable smart card and biometric card (Aadhar linked) which will not only hold the holder’s personal data but also his/her savings and loan account history as well as details of land-holding etc,. This would lead to hassle free and cost effective transactions for both the farmer and the banks. Such a smart KCC would also allow the Governments to channel agricultural subsidies directly to the farmer’s account.
- Mobile banking technology should be applied to the KCC which has the promise of revolutionalising the credit delivery mechanism. The pilot project implemented by Pallavan Grama bank in Tamil Nadu has already met with success and shows potential for scalability.
The above recommendations revolve around the issue of operational flexibility envisaged in the KCC through which the KCC farmer could avoid visiting the branch and draw the amounts closer to his door step.
Introduction of new products
The KCC which is in the nature of a cash credit is a comprehensive credit delivery mechanism and has served the interest of small and marginal farmers to a very large extent. The credit requirements of progressive farmers, and new form of farming practices like contract farming, group farming etc, could be addressed by developing customised credit products. Some of the products which could be thought of are;
Contractual loan product – with emergency loan
Given the importance of savings and providing a disciplined way to save (in the same way as many informal sector mechanisms do), instead of a traditional mono- product working capital loan in the form of KCC or GCC, a contractual saving product with an emergency loan facility attached to it could be introduced on a pilot basis, may be by one bank, in one location. As regards to the saving’s part, the customer should have the flexibility of defining the length of contract varying from 2 to 5 years and periodicity of the deposits (weekly, fortnightly, or monthly). A premium interest rate may be offered to those taking longer term deposit contract with penalty provision for premature withdrawal from the account. The savings account holders may be guaranteed, immediate access to an emergency loan of say 90% of the value of the amount in their savings account on demand. This particular product would have the following advantages for the customers;
- Disciplined savings
- Freedom to set term
- Automatic access to loans, and
- No operational charges
This financial product will offer a stable deposit base to the bank, besides offering income from emergency loans and premature withdrawal fees. This is something akin to the ‘no-frills’ account with overdraft facility, but will be of much more commercial nature.
Weather Index-based Insurance
Access to insurance for agriculture by the poor people has received comparatively less attention relative to access to credit. Insurance operates best where it forms part of an integrated approach to risk management where constraints such as lack of access to finance, improved seed, inputs, and markets can be addressed. The conventional agriculture insurance products like NAIS/PAIS and now Pradhan Mantri Fasal Bima Yojona somewhat has limited utility and the newly designed Weather Based Insurance Scheme being piloted in various states need to be scaled up. This will also help bankers to increase lending to agriculture sector and benefit the farmers at large
Warehouse Receipts Financing
Warehouse receipts can play a significant role in agricultural credit by facilitating post harvest financing. With promulgation of Warehousing (Development and Regulation)Act, 2008, warehouse receipts can be treated as negotiable instrument. They should constitute a new and reliable form of collateral in the agriculture sector, where till now there is no other security except land. With about 15-20% of agriculture produce being stored in warehouses at any given time, the potential for warehouse receipts financing is enormous. Hence, as an agri-credit delivery option, more number of warehouses should be accredited as per stipulated criteria, so that banks can be encouraged to develop this as a profitable agri-credit product.
Value Chain Financing
Value Chain Financing in Agriculture offers a response to the issue of access to timely and reasonably priced credit to small farmers. This is a useful financial instrument and approach to provide financial services to all the actors in the value chain like producers, processors, marketers. Funding by banks can be done at many levels in the chain or could enter the chain at one point and then follow up and/or down through the chain to others.
This model has been in practice in some contract farming, mainly by the private commercial banks who have understood the importance of it. Other banks can also develop this as a structured credit product for financing agriculture value chain.
The community based and owned models of delivery of financial services like SHGs and Joint Liability Groups (JLGs) devolve the essential individual decisions and provision of financial services to community groups at the local level. In this, banks can actually outsource the product design role to these institutions and it will also reduce transaction cost of delivery.
An emergency loan (an immensely valuable and popular product for poor people) can be developed with flexible repayment schedules/terms to allow it to meet a wide variety of short-term needs – from education to accident, from ill- health to death, as well as to seize opportunities as they arise.
Credit Guarantee Fund
The objective of credit guarantee fund is to reduce default risks for lenders as an inducement to lend to specific target groups or types of institutions. Risk perceptions by banks in lending to agriculture impede credit expansion, especially to tenant farmers and landless labourers. Coupled with this, absence of documentary evidence to prove cultivation adds to the perception of risk in extending financing. In this context, establishing a Credit Guarantee Fund for agriculture on the lines of the one operating for SME sector will stimulate lending and improve access to credit by the farmers.
The existing system of branches of large retail banking institutions, where, no matter how decentralised, there is ultimately a far greater degree of centralisation in the manner in which individual loans are granted. When evaluating the diverse needs of clients, banks should recognise that it cannot design a product to respond to each and every individual-specific need.
One product can be marketed in many different ways to meet a variety of clients’ needs. As Commercial Banks and Insurance Companies become increasingly interested and involved in the low income segment of the population, so the products and options for delivering them are expanding rapidly.
There are no simple magic solutions available for creating sustainable agriculture credit systems. Success requires careful development of products, policies, institutions, and supportive infrastructure.
Disclaimer: (The author is a Chief General Manager in NABARD and presently the CEO of NABKISAN Finance Ltd. a subsidiary of NABARD. Views expressed are personal and do not necessarily reflect the views of organization.)