₹ Agriculture Finance

Credit

• The word “Credit” comes from the Latin word “Credo” which means “I believe”. Hence credit is based up on belief, confidence, trust and faith. Credit is otherwise called as loan.
• Definition: Credit / loan is certain amount of money provided for certain purpose on certain conditions with some interest, which can be repaid sooner (or) later.
• According to Professor Galbraith credit is the

“Temporary transfer of asset from one who has to other who has not”.

Credit Needs

• Agricultural credit is one of the most crucial inputs in all agricultural development programmes. For a long time, the major source of agricultural credit was private moneylenders. But this source of credit was inadequate, highly expensive and exploitative.
• To curtail this, a multi-agency approach consisting of cooperatives, commercial banks and regional rural banks credit has been adopted to provide cheaper, timely and adequate credit to farmers.

Credit Needs of Indian Farmer

1. Buying agricultural inputs like seeds, fertilizers, plant protection chemicals, feed and fodder for cattle etc.
2. Supporting their families in those years when the crops have not been good.
3. Buying additional land, to make improvements on the existing land, to clear old debt and purchase costly agricultural machinery.
4. Increasing the farm efficiency as against limiting resources i.e. hiring of irrigation water lifting devices, labor and machinery.

Role of Credit in Indian Agriculture

1. Agri-finance assumes vital and significant importance in the agro – socio – economic development of the country both at macro and micro level.
2. It is playing a catalytic role in strengthening the farm business and augmenting the productivity of scarce resources. When newly developed potential seeds are combined with purchased inputs like fertilizers & plant protection chemicals in appropriate / requisite proportions will result in higher productivity.
3. Use of new technological inputs purchased through farm finance helps to increase the agricultural productivity.
4. Accretion to in farm assets and farm supporting infrastructure provided by large scale financial investment activities results in increased farm income levels leading to increased standard of living of rural masses.
5. Farm finance can also reduce the regional economic imbalances and is equally good at reducing the inter–farm asset and wealth variations.
6. Farm finance is like a lever with both forward and backward linkages to the economic development at micro and macro level.
7. As Indian agriculture is still traditional and subsistence in nature, agricultural finance is needed to create the supporting infrastructure for adoption of new technology.
8. Massive investment is needed to carry out major and minor irrigation projects, rural electrification, installation of fertilizer and pesticide plants, execution of agricultural promotional programmes and poverty alleviation programmes in the country.

Classification of Agricultural Credit

1. Based on Purpose

• a) Production loans: intended to increases production of crops. Also called Seasonal Agricultural Operations (SAO) loans or short term loans or crop loans.
• b) Marketing loans: These are meant for helping the farmers to overcome distress sales and market the produce in a better way.
• c) Consumption credit: It is the credit required by the farmer to meet his family expenses.
• d) Investment loans: These are loans given for purchase of equipment the productivity of which is distributed over more than one year. Loans given for tractors, pumpsets, tube wells, etc.

2. Repayment Period

Based on the period for which the borrower require credit, it is divided into:

• a) Short-Term Credit: It is given to farmers for periods ranging from 6 to 18 months and is primarily meant to meet cultivation expenses viz., purchase of seed, fertilizer, pesticides and payment of wages to labourers. It serves as the working capital to operate the farm efficiently and is expected to be repaid at the time of harvesting/ marketing of crops. It. should be repaid in one instalment.
• b) Medium-Term Credit: Repayment is for the period of 2 to 5 years. It is for the purchase of pump-sets, farm machineries and implements, bullocks, dairy animals and to carry out minor improvement in the farm. It can be repaid either in half- yearly or annual installments.
• c) Long-Term Credit: These loans fall due for repayment over a long time ranging from 5 years to more than 20 years or even more. These loans together with medium terms loans are called investment loans or term loans. These loans are meant for permanent improvements like levelling and reclamation of land, construction of farm buildings, purchase of tractors, raising of orchards, etc. Since these activities require large capital, a longer period is required to repay these loans due to their non-liquidating nature.

👉🏻 Both medium and long term loans combined known as term loan.

3. Security

Secured loans

Loans advanced against some security by the borrower are termed as secured loans. Various forms of securities are offered in obtaining the loans and they are of following types:

a). Personal security Under this, borrower himself stands as the guarantor. Loan is advanced on the farmer’s promissory note. Third party guarantee may or may not be insisted upon (i.e. based on the understanding between the lender and the borrower).

b). Collateral Security Here the property is pledged to secure a loan. The movable properties of the individuals like LIC bonds, fixed deposit bonds, warehouse receipts, machinery, livestock etc. are offered as security.

c). Chattel loans Here credit is obtained from pawn-brokers by pledging movable properties such as jewellery, utensils made of various metals, etc.

d). Mortgage

• As against to collateral security, immovable properties are presented for security purpose.
• For example, land, farm buildings, etc.
• The person who is creating the charge of mortgage is called mortgagor (borrower) and the person in whose favour it is created is known as the mortgagee (banker).
• Mortgages are of two types:
  • a) Simple mortgage: When the mortgaged property is ancestrally inherited property of borrower then simple mortgage holds good. Here, the farmer borrower has to register his property in the name of the banking institution as a security for the loan he obtains. The registration charges are to be borne by the borrower.
  • b) Equitable mortgage: When the mortgaged property is self-acquired property of the borrower, then equitable mortgage is applicable. In this no such registration is required, because the ownership rights are clearly specified in the title deeds in the name of farmer-borrower.

e). Hypothecated loans

• Borrower has ownership right on his movable and the banker has legal right to take a possession of property to sale on default (or) a right to sue the owner to bring the property to sale and for realization of the amount due.
• The person who creates the charge of hypothecation is called as hypothecator (borrower) and the person in whose favor it is created is known as hypothecate (bank) and the property, which is denoted as hypothecated property.
• This happens in the case of tractor loans, machinery loans etc. Under such loans the borrower will not have any right to sell the equipment until the loan is cleared off. The borrower is allowed to use the purchased machinery or equipment so as to enable him pay the loan installment regularly.
• Hypothecated loans again are of two types viz., key loans and open loans.
  • a) Key loans: The agricultural produce of the farmer - borrower will be kept under the control of lending institutions and the loan is advanced to the farmer. This helps the farmer from not resorting to distress sales.

• b) Open loans: Here only the physical possession of the purchased machinery rests with the borrower, but the legal ownership remains with the lending institution till the loan is repaid.

Unsecured loans

Just based on the confidence between the borrower and lender, the loan transactions take place. No security is kept against the loan amount.

4. Lender’s classification

Credit is also classified on the basis of lender such as

• a) Institutional credit: Here are loans are advanced by the institutional agencies like co-operatives, commercial banks. Ex: Co-operative loans and commercial bank loans.
• b) Non-institutional credit: Here the individual persons will lend the loans Ex: Loans given by professional and agricultural money lenders, traders, commission agents, relatives, friends, etc.

5. Borrower’s classification

• The credit is also classified on the basis of type of borrower. This classification has equity considerations. Based on the business activity like farmers, dairy farmers, poultry farmers, pisciculture farmers, rural artisans etc.
• Based on size of the farm: agricultural labourers, marginal farmers, small farmers, medium farmers, large farmers,
• Based on location: hill farmers (or) tribal farmers.

6. Based on liquidity

The credit can be classified into two types based on liquidity and they are

• a) Self-liquidating loans: They generate income immediately and are to be paid within one year or after the completion of one crop season in lumpsum. Ex: crop loans.
• b) Partially-liquidating: They will take some time to generate income and can be repaid in 2-5 years or more, based on the economic activity for which the loan was taken. Ex: Dairy loans, tractor loans, orchard loans etc.

7. Based on approach

• a) Individual approach: Loans advanced to individuals for different purposes will fall under this category.
• b) Area based approach: Loans given to the persons falling under given area for specific purpose will be categorized under this. Ex: Drought Prone Area Programme (DPAP) loans, etc.
• c) Differential Rate of Interest (DRI) approach: Under this approach loans will be given to the weaker sections @ 4 per cent per annum.

8. Based on contact

• a) Direct Loans: Loans extended to the farmers directly are called direct loans. Ex: Crop loans.
• b) Indirect loans: Loans given to the agro-based firms like fertilizer and pesticide industries, which are indirectly beneficial to the farmers are called indirect loans.

Economic Feasibility Tests of Credit

When the economic feasibility of the credit is being observed, three basic financial aspects are to be assessed by the banker. If the loan is advanced,

1. Will it generate returns more than costs?
2. Will the returns have surplus, to repay the loan when it falls due?
3. Will the farmer stand up to the risk and uncertainty in farming?

3R of Credit

These three financial aspects are known as 3 Rs of credit, which are as follows

1. Returns from the proposed investment
2. Repayment capacity the investment generates
3. Risk-bearing ability of the farmer-borrower

👉🏻 The 3R of credit are sound indicators of credit worthiness of the farmers.

Returns from the Investment

This is an important measure in credit analysis. The banker needs to have an idea about the extent of returns likely to be obtained from the proposed investment. The farmer’s request for credit can be accepted only if he can be able to generate returns that enable him to meet the costs. Returns obtained by the farmer depend upon the decisions like,

1. What to grow?
2. How to grow?
3. How much to grow?
4. When to sell?
5. Where to sell?

👉🏻 Therefore the main concern here is that the farmers should be able to generate incremental returns that should cover the additional costs incurred with borrowed funds.

Repayment Capacity

• Repayment capacity is nothing but the ability of the farmer to repay the loan obtained for the productive purpose with in a stipulated time period as fixed by the lending agency. At times the loan may be productive enough to generate additional income but may not be productive enough to repay the loan amount. Hence the necessary condition here is that the loan amount should not only profitable but also have potential for repayment of the loan amount. Under such conditions only the farmer will get the loan amount.
• The repayment capacity not only depends on returns, but also on several other quantitative and qualitative factors as given below.

Y = f(X1, X2, X3, X4, X5, X6, X7…)

• Where, Y is the dependent variable ie., the repayment capacity
• The independent variables viz., X1 to X4 are considered as quantitative factors while X5 to X7 are considered as qualitative factors.
  • X1 (+) = Gross returns from the enterprise for which the loan was taken during a season /year (in Rs.)
  • X2 (-) = Working expenses in Rs.
  • X3 (-) = Family consumption expenditure in Rs.
  • X4 (-) = Other loans due in Rs.
  • X5 (+) = Literacy
  • X6 (+) = Managerial skill
  • X7 (+) = Moral characters like honesty, integrity etc.

👉🏻 Signs in the brackets are apriori signs.

Hence, even though the returns are high, the repayment capacity is less because of other factors. The estimation of repayment capacity varies from crop loans (i.e. self-liquidating loans) to term loans (partially liquidating loans).

i) Repayment capacity for crop loans

Gross Income - (working expenses excluding the proposed crop loan + family living expenses + other loans due + miscellaneous expenditure)

ii) Repayment capacity for term loans

Gross Income - (working expenses + family living expenses + other loans due + miscellaneous expenditure + annual installment due for term loan)

Causes for the poor repayment capacity of Indian farmer

1. Small size of the farm holdings due to fragmentation of the land.
2. Low production and productivity of the crops.
3. High family consumption expenditure.
4. Low prices and rapid fluctuations in prices of agricultural commodities.
5. Using credit for unproductive purposes.
6. Low farmer’s equity/ net worth.
7. Lack of adoption of improved technology.
8. Poor management of limited farm resources, etc.

Measures for strengthening the repayment capacity

1. Increasing the net income by proper organization and operation of the farm business.
2. Adopting the potential technology for increasing the production and reducing the expenses on the farm.
3. Removing the imbalances in the resource availability.
4. Making the schedule of loan repayment plan as per the flow of income.
5. Improving the net worth of the farm households.
6. Diversification of the farm enterprises.
7. Adoption of risk management strategies like insurance of crops, animals and machinery and hedging to control price variations, etc.

Risk Bearing Ability

• It is the ability of the farmer to withstand the risk that arises due to financial loss. Risk can be quantified by statistical techniques like coefficient of variation (CV), standard deviation (SD) and programming models.
• The words risk and uncertainty are synonymously used.
• Some sources / types of risk
  1. Production/ physical risk
  2. Technological risk
  3. Personal risk
  4. Institutional risk
  5. Weather uncertainty
  6. Price risk

Repayment capacity under risk

• Deflated gross Income - (working expenses excluding the proposed crop loan + family living expenses + other loans due + miscellaneous expenditure)
• Measures to strengthen risk bearing ability
  1. Increasing the owner’s equity/net worth
  2. Reducing the farm and family expenditure
  3. Developing the moral character i.e. honesty, integrity, dependability and feeling the responsibility etc. All these qualities put together are also called as credit rating.
  4. Undertaking the reliable and stable enterprises (enterprises giving the guaranteed and steady income)
  5. Improving the ability to borrow funds during good and bad times of crop production
  6. Improving the ability to earn and save money. A part of the farm earnings should be saved by the farmer so as to meet the uncertainty in future
  7. Taking up of crop, livestock and machinery insurance

5 Cs of Credit

Character

• The basis for any credit transaction is trust. Even though the bank insists up on security while lending a loan, an element of trust by the banker will also play a major role. The confidence of an institutional financial agency on its borrowers is influenced by the moral characters of the borrower like honesty, integrity, commitment, hard work, promptness etc.
• Therefore both mental and moral character of the borrowers will be examined while advancing a loan.
• Generally people with good mental and moral character will have good credit character as well.

Capacity

• It means capacity of an individual borrower to repay the loans when they fall due.
• It largely depends upon the income obtained from the farm.

C = f(Y) where C = capacity and Y = income

Capital

• Capital indicates the availability of money with the farmer - borrower.
• When his capacity and character are proved to be inadequate the capital will be considered.
• It represents the networth of the farmer. It is related to the repayment capacity and risk bearing ability of the farmer - borrower.

Condition

• It refers to the conditions needed for obtaining loan from financial institutions i.e. procedure to be followed while advancing a loan.

Commonsense

• This relates to the perfect understanding between the lender and the borrower in credit transactions.
• This is in fact prima-facie requirement in obtaining credit by the borrower.

7 Ps of farm credit/ Principles of farm finance

1. Principle of Productive Purpose
2. Principle of Personality
3. Principle of Productivity
4. Principle of Phased disbursement
5. Principle of Proper utilization
6. Principle of Payment and
7. Principle of Protection

🙋🏼 Productive Purpose ke leye Personality me Dam hona chaheye.

🙋🏼 Bar Bar utilization ke leye Payment, Protection ke sath karna chaheye.

Principle of Productive Purpose

• This principle refers that the loan amount given to a farmer - borrower should be capable of generating additional income. Based on the level of the owned capital available with the farmer, the credit needs vary. The requirement of capital is visible on all farms but more pronounced on marginal and small farms.
• The farmers of these small and tiny holdings do need another type of credit i.e. consumption credit, so as to use the crop loans productively (without diverting them for unproductive purposes). Inspite of knowing this, the consumption credit is not given due importance by the institutional financial agencies.
• This principle conveys that crop loans of the small and marginal farmers are to be supported with income generating assets acquired through term loans.
• The additional incomes generated from these productive assets added to the income obtained from the farming and there by increases the productivity of crop loans taken by small and marginal farmers. The examples relevant here are loans for dairy animals, sheep and goat, poultry birds, installation of pumpsets on group action, etc.

Principle of personality

• The 3Rs of credit are sound indicators of credit worthiness of the farmers. Over the years of experiences in lending, the bankers have identified an important factor in credit transactions i.e. trustworthiness of the borrower. It has relevance with the personality of the individual.
• When a farmer borrower fails to repay the loan due to the crop failure caused by natural calamities, he will not be considered as willful – defaulter, whereas a large farmer who is using the loan amount profitably but fails to repay the loan, is considered as willful - defaulter. This character of the big farmer is considered as dishonesty.
• Therefore the safety element of the loan is not totally depends up on the security offered but also on the personality (credit character) of the borrower. Moreover the growth and progress of the lending institutions have dependence on this major influencing factor i.e. personality. Hence the personality of the borrower and the growth of the financial institutions are positively correlated.

Principle of productivity

• This principle underlines that the credit which is not just meant for increasing production from that enterprise alone but also it should be able to increase the productivity of other factors employed in that enterprise.
• For example the use of high yielding varieties (HYVs) in crops and superior breeds of animals not only increases the productivity of the enterprises, but also should increase the productivity of other complementary factors employed in the respective production activities. Hence this principle emphasizes on making the resources as productive as possible by the selection of most appropriate enterprises.

Principle of phased disbursement

• This principle underlines that the loan amount needs to be distributed in phases, so as to make it productive and at the same time banker can also be sure about the proper end use of the borrowed funds. Ex: loan for digging wells.
• The phased disbursement of loan amount fits for taking up of cultivation of perennial crops and investment activities to overcome the diversion of funds for unproductive purposes. But one disadvantage here is that it will make the cost of credit higher. That’s why the interest rates are higher for term loans when compared to the crop loans.

Principle of proper utilization

• Proper utilization implies that the borrowed funds are to be utilized for the purpose for which the amount has been lent.
• It depends upon the situation prevailing in the rural areas viz., the resources like seeds, fertilizers, pesticides etc., are free from adulteration, whether infrastructural facilities like storage, transportation, marketing etc., are available. Therefore proper utilization of funds is possible, if there exists suitable conditions for investment.

Principle of Payment

• This principle deals with the fixing of repayment schedules of the loans advanced by the institutional financial agencies.
• For investment credit advanced to irrigation structures, tractors, etc. the annual repayments are fixed over a number of years based on the incremental returns that are supposed to be obtained after deducting the consumption needs of the farmers.
• With reference to crop loans, the loan is to be repaid in lumpsum because the farmer will realize the output only once. A grace period of 2-3 months will be allowed after the harvest of crop to enable the farmer to realize reasonable price for his produce. Otherwise the farmer will resort to distress sales. When the crops fail due to unfavourable weather conditions, the repayment is not insisted upon immediately. Under such conditions the repayment period is extended besides assisting the farmer with another fresh loan to enable him to carry on the farm business.

Principle of Protection

• Because of unforeseen natural calamities striking farming more often, institutional financial agencies cannot keep away themselves from extending loans to the farmers. Therefore they resort to safety measures while advancing loans like
  • Insurance coverage
  • Linking credit with marketing
  • Providing finance on production of warehouse receipt
  • Taking sureties: Banks advance loans either by hypothecation or mortgage of assets
  • Credit guarantee: When banks fail to recover loans advanced to the weaker sections, Deposit Insurance Credit Guarantee Corporation of India (DICGC) reimburses the loans to the lending agencies on behalf of the borrowers.