IT’S true that credit alone can’t solve all of the farmers’ woes. But a lack of credit would only aggravate the problems that farmers, particularly smallholders, face at the moment.

It’s a sad reality that production loans provided to farmers sometimes don’t work due to underutilisation and misallocation, social and cultural reasons and a lack of support from local shopkeepers. However, to say that timely and need-based loans don’t play any role in helping farmers improve their productivity and living standards would be a sweeping generalisation.

There is little doubt that average yields of crops in Pakistan are below potential, and the country fares poorly even when compared to regional peers.

In the absence of loans from a financial institution, farmers’ requirement for credit doesn’t diminish and, more often than not, they fall prey to loan sharks

Evidence suggests that extending credit to farmers at rational rates leads to their well-being. The logic is simple: timely and affordable credit allows farmers to invest in the inputs necessary for sowing crops.

Every input that a farmer requires, including high-yield varieties and farm technologies, comes for a price, and a bank loan bundled with farmer education regarding resource utilisation and latest farming practices provides farmers with the independence to invest in such inputs and technologies that can improve yields and quality.

In the absence of such a loan from a financial institution, farmers’ requirement for credit doesn’t diminish; in fact, it is fulfilled through other informal sources such as arthis (middlemen or private lenders) or loan sharks who offer usurious loans on extremely exploitative terms. As a result, farmers find themselves trapped in a perpetual cycle of debt and poverty.

These loan sharks or informal money lenders have many faces, including local shopkeepers, who sell inferior quality input to farmers as some companies offer higher margins and other incentives to dealers and shopkeepers for selling their products. But such low-quality products hamper farm productivity.

On the other hand, the middleman also fills the financing void by offering quick credit to farmers on exorbitant rates and in return of a deal to purchase output at below-market prices.

It is true that farmers have credit needs that go beyond working capital, such as the need to pay for life events like child birth, and marriage, or for unforeseen events such as a death in the family or to meet other consumption needs such as paying for a child’s school fee. However, to assume that working capital needs do not exist or such loan products provided by banks do not perform their desired function is a faulty premise.

Banks can and do offer consumption loan products, such as personal loans, to customers (including farmers) who can meet banks’ lending criteria.

Most commercial and microfinance banks have recovery rates on agricultural loans that are just as good as those provided to retail customers and their performance and return exceed that of loans provided to the small and medium enterprises.

Some public sector banks do have above-average bad loans because of structural and operational inefficiencies and because loans from such state-run organisations are often taken as unilateral grants by farmers because of historical precedence of loan write-offs under the nationalised regime.

Rapid improvement in information and communication technology is also increasingly making it easier for banks to monitor if loans are properly utilised.

Moreover, by disbursing loans through mobile wallets banks can limit farmers’ loan utilisation by permitting drawdown at certain registered vendors who offer quality input and farm advisory.

This will serve the double benefit by limiting misuse of loans and improving farm output due to the use of quality seeds, fertilisers, technologies and other inputs.

Another effective and promising approach is bundling financial services with real-side interventions, such as farm advisory and extension services.

The provincial extension departments have their own challenges, but this doesn’t preclude the important role that financial services have to play. Many banks have started practising innovative lending approaches, such as value chain financing, that offer multiple benefits for all stakeholders.

In particular, farmers benefit from improved yields and better prices for their output which is helping them break away from the vicious poverty trap.

—This is in response to the article titled ‘Why loans to farmers will not work’ that appeared in Dawn’s Business and Finance section on July 24, 2017.

— The writer is assistant director of State Bank of Pakistan’s Agricultural Credit and Microfinance Department

Published in Dawn, The Business and Finance Weekly, July 31st, 2017