The Warehousing (Development and Regulation) Bill 2005 passed in Parliament recently will help create a legal body for regulation of warehouses, develop warehousing and popularize negotiable warehouse receipts (WRs). An efficient WR financing system offers several benefits to both farmers and the government. Farmers will be able to use WRs from accredited warehouses after delivering their produce as collateral for short-term borrowing for working capital. Farmers can hope to maximize profits by selling when prices are favourable. WR financing is also likely to lead to reduction of government involvement in procurement of farm commodities. Since WRs guarantee the existence of stocks, the government can hope to achieve food-security objectives by simply holding these receipts.
Small landholdings and heavy monsoon dependence make farming in the country a very risky activity and inhibit farmers’ access to credit. The National Sample Survey Organisation’s 2003 Survey shows that 51% of farmer households have no access to debt at all and only 27% of all cultivator households receive institutional credit. Informal credit comes at very high interest rates, while banks are reluctant to lend because farmers can’t provide good collateral and hence do not qualify for their loans. Most banks, however, have, so far, looked at a very small range of collateral guarantees such as land, gold, fixed deposits and cash. WR-based collateralized lending offers immense possibilities against this backdrop.
Collateralized or inventory credit is not at all a new concept. Archaeological evidence shows it was practised even in the ancient Roman Empire. Under this system, the farmer delivers his goods to the warehouse. After checking for quality, grade and weight, the operator gives the farmer warehouse receipts. These receipts are the warrant of the loan. After their presentation to the bank, the loan is credited to the farmer.
The size of loan depends on the value of the goods stored—it could be up to 70-80% of the estimated value and is at normal interest rates. If the farmer fails to repay, the bank becomes the owner of the commodity and can sell it to liquidate the loan. The bank’s risk thus gets reduced.
The other aspect is the sale of the goods in question. To take the goods from the warehouse, the farmer needs the bank’s consent, but he can sell the receipt directly to a local trader. If the trader wants the goods, he pays the bank, which reimburses the loan and gives the rest to the farmer.
WR financing is very popular in many countries and there are several successful examples of increasing farm-credit flow by using this route. In the Philippines, the ‘quedan’ (indicating the volume stored, the name of the producer and mill, and the quality of the product) issued by sugar and rice mills provide sugar and paddy growers with easy access to credit. In Kenya, the WR finance system offers secured credit to coffee farmers. In Malaysia, the designated warehouses of the Pepper Marketing Board issues ownership certificates to farmers who store pepper, which are used as collateral for loans. In Eastern Africa, the Eastern and Southern African Trade and Development Bank uses the concept of the “price guarantee contract facility” with the involvement of local banks. The financing is done on the basis of warehouse receipts and with price protection built into commodity options.
In India, too, in the last few years, leading national commodity exchanges have tied up with banks to lend to farmers on the basis of produce stored in their accredited warehouses. National Bulk Handling Corporation, an associate of the Multi Commodity Exchange, and National Collateral Management Services Ltd, an associate of National Commodity & Derivatives Exchange, have entered into a deal with about 20 banks, from both the private and the public sector, to provide warehouse credit to farmers. The aim is to help farmers get a better price for their produce and banks meet their government targets for lending to farmers. The commodity exchanges also benefit as the quantum of futures trading grows. Backed by warehousing receipts, about Rs2,000 crore was disbursed through different banks in 2006-07 and more than 100,000 farmers benefited. What is most significant is that in almost two years, there has been no instance of default on repayment of bank loans by farmers so far.
There is immense potential for increasing farm credit through this approach to financing.
The farmer can get a competitive price when he decides to sell a particular amount of a commodity at a future date for a future price, which will likely be higher than what he gets while selling during the harvest season. He also benefits from grading, packaging, fumigation and auditing of the produce by accredited warehouses. Banks are also happy to extend loans against warehouse receipts because this covers their lending obligations to the sector. Banks, incidentally, have a mandate to devote 40% of their lending to the priority sector of which 18% has to go towards direct lending to agriculture. WR financing can be a sure way to achieve these targets with ease.
(Sunil Kumar is an alumnus of Irma and IIM, Lucknow. He has about 20 years of experience in the development finance sector. Comment at email@example.com)