October 05, 2007
RISK PLATFORMS IN INDIAN AGRICULTURAL BANKING
Risk Management in Agriculture
Farmers are exposed to risks arising from rainfall variability, market price fluctuations, credit uncertainty, and adoption of new technology. In other words, the farmers basically face weather risk, product risk, price risk and market risk. The diversities in the sources of risks require a variety of instruments for protecting the farmers. In India, these include crop insurance, rainfall insurance, farm income insurance and a calamity relief fund. Most of these measures other than crop insurance are in the experimental stage. The farmer is pretty unsure of the product because of uncertainty in the quality of the seed he purchased at the time of sowing. There are States where the State Seed Act is in position with varying degrees of regulatory imperfections and implementation failures. Still the farmer gambles with his sweat. The quantity targeted for production is at best a guestimate. The marketable surplus for most small and marginal farmers is again uncertain. Neither the farmer nor the extension machinery has farm planning as an integral part of farm future. Even where it existed, the farmer does not swear by it. After the produce comes to hand and after arriving at the marketable surplus, the farmer is also unsure of the price – whether it fetches him cost of inputs plus a reasonable margin for maintenance excepting for a few cereal crops where State subvention exists. These uncertainties cast their shadow on the policy approaches and implementation agenda of the credit institutions.
Vyas Committee (2005) and the internal working group on agricultural credit of the Reserve Bank of India have identified majority of the problems and modified the directions to the banks for ensuring enhanced credit flow to agriculture. But would it mitigate the inherent risks and provide adequate insurance to the lender? This remains an unanswered question. If credit for agriculture is a commercial proposition Banks would flock to it. Unfortunately, it is not. The efforts to make it viable and bankable through the supposedly cost-effective interventions like the correspondents, Agents, and contract farming route are in the nascent stage. In the meantime, distress of farmers is reflected sadly in suicides in a few stressed regions like Andhra Pradesh, Maharashtra, Karnataka, Punjab etc. The package announced by the Prime Minister in 2006 is reportedly yet to reach in full measure. Banks are in the throes of implementing Basel II that adds a new dimension to examining risks attached to financing agriculture from the point of view of capital adequacy. Excepting corporate lending for agriculture, rest of the farm lending remains away from the cover of either tangible security or sovereign guarantee and thus also away from external rating institutions. Unrated and unsecured credit carries higher capital allocation. (of course, the regulator is considerate in providing 75% CRAR for the present). However, in the context of global presence of a few Banks that also carry a reasonably large portfolio of farm credit – at 18 percent of the total credit to go for agriculture – how long this concessionary platform would become available is a question mark. This paper intends to examine the risk mitigation efforts in the farm sector and see whether enough enthusiasm can be generated among the credit agencies to take to farm lending as fish takes to water in the context of Basel II. Please click here to view a diagram of the cycle of risk management of the Indian Rice Economy.
The financial insecurity thus arises from the weak links in the value chain of most farm products not withstanding the sporadic interventions of ITC, MSSRF, Commodity Futures, SHG women groups resorting to market operations in a few districts successfully in Andhra Pradesh etc. Financial efficiency at the farm front may be improved predominantly in two ways: cost cutting and better realization. One is internal and the other is external and is subject to market fluctuations. However much the farmer would like to cut costs through appropriate technology interventions, labour costs continue to rise providing serious limitations on the internal efficiencies. External factors influencing efficiency are market related and therefore, the need for State subvention both through insurance and guarantee mechanisms hardly requires emphasis. Let me attempt a review of their performance.
Risk Mitigation Efforts:
Crop Insurance:
The National Agricultural Insurance Scheme (NAIS), introduced in Rabi 1999-2000, and implemented by the Agricultural Insurance Corporation (AIC) is a major public sector initiative to mitigate yield risk. The yield loss assessment is based on ‘threshold yield’ and ‘level of indemnity’. The threshold yield is the three year moving average yield for rice and wheat and five years moving average for other crops. The unit area for assessing the actual yield has been district and the indemnity levels fixed at 90 percent, 80 percent and 60 percent for compensation under the scheme based on crop cutting experiments. The schemes cover a wide range of crops including food crops (cereals, millets and pulses), oilseeds and annual commercial/horticulture crops in respect of which past data on yield are available for sufficient number of years. Sugarcane, potato, cotton, ginger, onion, turmeric, chillies, pineapple, banana, jute, coriander, cumin and garlic have also been covered under this scheme. The entire loan amount is insured at a premium rate of 3.5 per cent for kharif bajra and oilseeds and 2.5 per cent for other crops or actuarial rates if the above rates are higher than actuarial rates. Small and marginal farmers are entitled to 10 per cent premium subsidy, which is shared equally by central and state governments. The rates are uniform across states. The claims over and above 100 per cent of the premium amount and administrative costs are borne by central and state governments. The scheme is implemented through crop loan granting banks for the regions and crops notified by the state governments and are compulsory for farmers taking crop loan from banks and voluntary for non bank loaners. During 1999-2003, the premium collected was Rs.299 crore per annum; the subsidy was Rs.55 crore per annum and the total claim was Rs. 1277 crore per annum implying an expenditure of about Rs.1000 crore per annum by central and state governments over and above the administrative costs incurred by AIC (Sidharth Sinha, “Agricultural Insurance In India: Scope for Participation of Private Insurance,” Economic and Political Weekly, June 19, 2004). The claim-premium ratio was high at 4.27 for all the crops; and 6.77 for crops such as groundnut.
The NAIS covered only about 10 per cent of the cropped area. Moreover, there are significant disparities in insurance coverage across crops and states. Groundnut accounted for 36 per cent of claims whereas crops such as maize and jowar accounted for less than two per cent of claims each, and among the states, Gujarat alone accounted for more than 40 per cent of total claims, whereas Bihar and Uttar Pradesh accounted for less than one per cent each. Even with 10 per cent of coverage of cropped area, excluding the administrative costs, the scheme would have cost central and state governments together Rs.1000 crore if all claims were met. Some of the weaknesses can be attributed to adverse selection and moral hazard problems. (The crop shown as cultivated in record is different from the crop that is actually lost on account of calamity. There is connivance of the farmer and the banker in quite a few instances) High premium rates (for example, as high as 8 per cent for cotton and 10 per cent for banana crop in Andhra Pradesh), collusion between implementing agencies and farmers in wrongful claims and ignorance of warrantee conditions of the policies led to inefficiencies. The policy of charging uniform rates across states without taking into consideration risks peculiar to the area where the crop is sown and the risk sharing mechanism between the insurer and lender deserve a relook.
The central government launched the Farm Income Insurance Scheme (FIIS) on a pilot basis in 20 districts during Rabi 2003-04 for rice and wheat. The farmer will be paid the difference between actual income and guaranteed crop income per hectare. The guaranteed income is obtained by valuing threshold yield at the minimum support price fixed by the central government and the actual income by valuing actual yield at the prevailing market price. District is the unit of area for yield considerations is the district. The central government meets the expenditure in excess of the premium amounts as well as the administration costs incurred in operating the scheme.
Field visits and empirical studies reveal the poor performance of existing schemes. The insurance coverage of NAIS is very little and its spread is mostly limited to a few states; insurance cover is not available to crops like fruits and vegetables; and there is inordinate delay in the settlement of claims. The indemnity level of 60 per cent is very low and needs to be increased (G. S. Bhalla, Indian Agriculture since Independence, National Book Trust, 2007).
There is demand for making gram panchayat as the threshold area, basing premium rates on actuarial rates and subsidy at half the premium rate. Marginal and small farmers may be requiring higher rates of subsidy. This requires a substantial increase in the number of crop cutting experiments, substantial financial resources and trained manpower. ‘In the case of rainfall insurance, although the moral hazard problem may not exist, its efficacy is conditional on yield predicting power of the rainfall index, which is likely to depend on soil conditions, irrigation level and crops among others.’ Research on comparative evaluation of crop insurance, rainfall insurance and insurance based vegetation stress indices is needed. The system of SHG based insurance to manage a part of the risk at the village level also requires scrutiny.
Disaster Mitigation:
The National Calamity Contingency Fund (NCCF) created by the central government deals with severe calamities and meets the excess over and above the balance available in the state’s calamity relief fund. The Twelfth Finance Commission has recommended that implementation of NAIS should be a precondition for assistance from NCCF. It is desirable that this Fund is managed by NABARD with contribution to the Fund by the State and Central Governments, participating Banks and RRBs, albeit nominally.
Weather Risk and Drought Mitigation:
The AIC introduced Varsha Bima as a pilot project in about 25 rain gauge stations across four states in 2004. The products include insurance based on (a) seasonal rainfall, (b) sowing failure, (c) rainfall distribution, (d) agro-economic optimum index and (e) catastrophe cover. A private insurer has launched rainfall insurance in Mehabubnagar district of Andhra Pradesh. The insurance policy makes payments if the cumulative rainfall during the seasons is less than the historical average by more than predetermined threshold value. This is implemented on the basis of a rainfall index computed from rainfall during different periods, with weights based on the relative importance of rainfall during different periods.
It is important to recognise that in the long term, risk preventive measures are likely to be more cost effective. These include better water supplies in water stress periods, reducing ground water stress by grounding well designed ground water recharge programmes through dug-well recharge, tank recharge and strengthening of water harvesting structures, instituting drought management system based on remote sensing methods and household income diversification. Such preventive measures would reduce risk and thereby the premium rates of crop and weather insurance. But these would require project approach to farm lending as most of the investments relating to ground water are in the private domain. No State has passed legislation preventing indiscriminate digging of wells. Spacing norms between dug-wells is a contentious issue and no State Government would like to take any risk with the farmers’ vote bank on this issue.
It is also necessary to strengthen crop surveillance mechanism for forecasting drought well in advance. This would facilitate the design and preparation of action plan for mitigating the adverse effect of drought on the farming community. The efforts of National Remote Sensing Agency (NRSA) based on satellite data at the district level for 10 drought-prone districts and at mandal/taluka level for three states viz., Andhra Pradesh, Karnataka and Maharashtra needs scaling up and wider dissemination for the preparation of action plans in farm sector at the beginning of both kharif and rabi seasons. The crop assessment made at the end of the season could be utilised in crop insurance schemes.
Technology Risk Mitigation:
Technology risk arises with the adoption of new crop cultural practices, new strains, and farm mechanization of a different order (related to a particular crop and not just tractorization). ICRISAT has contributed to introducing innovative instruments – mechanical threshers, low-cost weeders, etc. Government of India has introduced technology missions in crop specific areas like the Oil Technology Mission, Cotton Technology Mission (divided into four mini missions targeting production technology, extension, industry applications and marketing) and strategically moved in respect of certain crops like paddy in the Eastern States, maize,etc. Certain area specific technology interventions through waste land development and dry land tracts are in place.
Credit Risk Mitigation:
Credit Risk starts from the origination itself. This origination level is targeted for mitigation through Business correspondent/Agent model and through Banks’ internal training systems. While the moral hazard is doubtful for avoidance, adverse selection could be easily avoided. In any case, a farmer is bound to be a more dependable borrower than other categories because of the fact that farmer and farm are inseparable from his livelihood perspective. All individual farm loans of >Rs.2lacs are targeted for credit scoring by quite a few commercial banks. They take into consideration risks attendant on origination and transaction. At the origination level, they look to the age of the borrower, family size, present net agricultural income, type and extent of land holding and the crops traditionally in cultivation vis-à-vis the new ones, if any, being introduced etc., and at the transaction level, crops grown, tangible/intangible security, collateral deposits, mortgage cover, conduct of the account etc. In most parts of the country, Banks have introduced Kisan Credit Cards to assure credit for crop cultivation and other investments related to land but their performance left much to be desired. The allegation is that this instrument contributed to Banks showing the required number of accounts to the Government.
Market Risk mitigation:
PRICES AND MARKETS:
According to the Report of the Expert Committee on Agricultural Indebtedness (2007) set up by the PMO , “since price volatility is more pronounced in the world market, the integration of domestic agriculture with global trade without putting in place necessary institutional arrangements such as monitoring of price and production trends in the world market, enhancing internal capacity to anticipate price changes in the world market, and developing required skills to manage variable tariff rate instrument to protect the domestic market is likely to increase price volatility in the domestic market. Trade liberalisation affected the domestic market prices of several agricultural commodities in the recent period, particularly those of plantation crops such as coffee, tea, rubber, pepper and dry land crops such as oilseeds. The small peasants growing plantation crops and oilseeds were hurt the most. The variable tariff rate instrument must be utilised for moderating the adverse impact of price fluctuations in the world market on domestic prices of agricultural commodities. Capability to operate the instrument should be developed. Efforts should be made to enhance the total factor productivity of agriculture to improve its competitiveness.
Market risk arises from (1) lack of access to market; (2) inadequate volumes acceptable to the market; (3) absence of post-harvest technologies, which in turn, contribute to disruptions in the value-chain (4) producing what the farmer knows and not what the market wants again because of information asymmetry and lack of confidence in the outcomes. GoI’s efforts in formulating model legislation – Agricultural Produce Marketing Act (Model Bill) - to bring about reforms in the agricultural marketing did not meet with success, as this subject is in the concurrent legislation domain. The greedy kutcha arthiyars still rule the agricultural market yards. The farmer delivers the produce; waits for the payment, sometimes even at the uneconomic price. He has to make a few rounds to the Arthiyar for realizing the value for the produce. The transaction cost is pushed up, as a consequence and also makes him a bad borrower to the financing bank. In respect of certain cereal crops, minimum support is available from the Government. Here also, the delivery mechanisms leave a lot to be desired. The MSP is more on political than economic considerations in respect of paddy and wheat crops as barely five to six States contribute to the food security system managed by the Government through the Food Corporation of India and State Civil Supplies Corporations. In respect of paddy, since the procurement is mostly rice, a value added product, it is mostly millers that get into the price advantage and not the farmer. Then there is Contract farming. In this case, the contractor sensitizes the farmer to modern cultural practices, post-harvest methods leading to assured quality, packing and customer preferences.
Basel II guidelines of the RBI on credit risk indicate certain general disclosures for all Banks. These are broadly divided into qualitative and quantitative disclosures. The qualitative aspects demand clear-cut definitions of past dues and impaired (for accounting purposes) accounts and the Bank’s credit risk management policy. Banks go by the definition of past dues given by the RBI itself. In the case of farm loans, past dues are defined as those remaining due beyond two crop seasons. Among the quantitative disclosures, they have to specify the total exposure; activity-based exposure; residual contractual maturity breakdown of assets and the amount of gross NPAs; net NPAs; movement of NPAs, and movement of provisions.
We have seen in the credit risk management of this sector, most crop loans and all loans backed by the collateral security of farm lands virtually amount to clean loans not withstanding the unencumbered title to the land to the holder and eventually the transfer either as charge or mortgage. (Section 6 of SAFRAESI Act prohibits sale of land by the mortgagee in the event of mortgagor’s default on the loan). The Basel II guidelines under comprehensive approach clearly specify: “Banks must have clear and robust procedures for the timely liquidation of collateral to ensure that any legal conditions required for declaring the default of the counterparty and liquidating the collateral are observed, and that collateral can be liquidated promptly.” Thus even under the most favourable circumstances, credit risk for agriculture is going to weigh high on the capital provisioning. It is learnt that the RBI is mulling over providing a guarantee cover for all the farm advances on the basis of the recommendations of an Internal Expert Committee that examined the issues of disaster management and farmers’ suicides. There will be host of issues associated with such a fund: the size of the Fund; contributors to the Fund; replenishment; claim procedures; management of the fund etc. If this is treated on par with the sovereign guarantee, there will be truly reprieve for the Banks in terms of capital to risk weighted assets under this segment.
MULTIPLE LINES OF CREDIT:
There is no better way for a bank to ward off NPAs than to extend multiple lines of credit to the small and marginal farmers, who constitute nearly 70 percent of the total farmers occupying 23 percent of the land holdings and whose demand for credit from institutional sources is aggressive, because most of them pursue crop farming, storage of the produce, dairy, backyard poultry/fish pond cultivation, sheep/goat rearing and quite a few women of those households pursue non-farm activities either as members of SHGs or individually. It is not one loan repaying another but that the asset-yield of one loan would mitigate the risk of loss arising from another asset in the event of an adverse situation arising in the farmer’s household. Each of these activities mentioned above is potentially viable and interdependent. Products from off-farm activities supplement the income of the household. The animal and bird waste is used as organic manure. In times of natural calamity, unless all assets extinguish at the same time, the loss of crop asset has potential in-built compensations in off-farm and non-farm activities. Ceteris paribus, one economic activity reinforces the other activity and therefore, providing multiple lines of activities would itself act as an insurance against the losses incurred in one or a few of them. However, this would require a careful loan origination process, which would be worth its while for a lending institution since it would reduce transaction cost for the farmer on one side and enhances interest income for the lending institution. The instrument could be a SMART CARD for the farmer with a comprehensive credit limit with biometric application.
In fine, the burden of this article rests on the criticality of the Basel II interpretations and facilitation provided by the regulator. While some Banks are seeing structuring loans on corporate lines, and some others linking up with the micro finance entities like the Self-Help Groups, the broad question remains whether the farmer could be given different loan products and multiple loans with ability to cross-holding of risks. Presently what he gets, if at all, is a term loan and mostly, a loan for working capital in the shape of crop finance that is mostly a mathematical exercise based on the scale of finance for each crop decided by the National Bank for Agriculture and Rural Development ( the apex Bank to look after the sector) multiplied by the number of hectares cultivated under each crop. The two basic risks – one, related to the farmer, and the other related to the farming activity need to be addressed in terms of adverse selection, moral hazard and information asymmetry.
________________________________________________________________________*Dr. B. Yerram Raju is Regional Director, PRMIA, Hyderabad Chapter and formerly a senior Executive of the State Bank of India. Can be reached at yerramr@gmail.com The views are personal.
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