Informal credit and the ease with which it is available are the biggest menace prevalent in the agricultural sector since it has kept farmers hostage to money lenders from pre-partition era. Referred to as aarti in domestic lingo, the phenomenon of borrowing for the middleman is common not just in the subcontinent but in many third world countries.
Subsequent to partition and migration of Hindu money lenders, informal credit in the agriculture sector is now almost fully dominated by aartis, the basis of which is usually personal relations. Normally, no interest is charged, no documents are signed (except for aarti unilaterally noting it down in a register maintained by him) and no collateral is required. Most importantly, no questions are asked regarding the purpose of the borrowed amount or the schedule for release of funds to match with crop production stages.
The only condition imposed on the borrower is that he has to bring his produce for auctioning at the lender’s shop and pay commission on the value fetched. Failure to fulfill this condition makes the borrower liable to pay interest in proportion to the shortfall in the quantity the farmer was supposed to auction. In an event of complete crop failure, farmer is usually extended credit again to enable him to grow the next crop and repay the combined outstanding loan amount. However, in this case farmer pays interest on the unpaid loan.
The borrowing cost of informal credit significantly surpasses the interest charged by commercial banks
On the face of it this interest free, uncollateralised and undocumented informal running finance facility should have been a blessing for poor farmers. However, unlimited greed has turned these financial messiahs into blood sucking moneylenders. Being perpetual borrowers, poor farmers are never in a position to question their financiers about the fairness or transparency with which their produce is auctioned. It is very common for aartis to manipulate the auction process to disadvantage the farmer who is almost never present when the auction is taking place.
Similarly, aartis have a free hand with respect to weighing the shipment normally sent by farmers on shared cargo vehicle. Any quantity can be declared substandard and categorised as wastage. The cost of borrowing paid by farmers in the form of losses incurred due to these unfair practices, plus the commission paid, significantly surpasses the interest charged by commercial banks.
The main reason that farmers are unable to borrow from commercial banks is the cultural practice of keeping family assets in joint names. In many areas it is considered improper to transfer inherited property, particularly the agricultural land, into the names of individual heirs’ even years after the original owner has passed away. Sometimes the property is not only in the name of siblings but also first cousins. Therefore, it is not the unavailability of collateral but the manner in which its title and possession is held that limits farmers’ ability to offer agricultural land as collateral against commercial borrowing.
Secondly, farmers are highly uncomfortable dealing with banks. Bankers appear to be people different in terms of dressing, language, and environment, offering products that farmers do not fully understand. The invariably lengthy documentation process necessary to avail bank borrowing further scares away farmers as they often lack the ability to read papers that they are required to sign.
Religion also plays a huge role. One of the major reasons why farmers do not opt for formal financing is the interest factor. Many farmers do not want to pay interest and willingly prefer to be fleeced by aartis.
Lastly, the unstable and unpredictable wholesale market hugely limits farmers ability to predict revenues and hence their capacity to repay the loans. The crop insurance products that are currently available, and are made mandatory for farmers to avail if they opt for bank credit, are quite ineffective. Their protection is limited as a claim is only entertained when a farmer’s entire land has been declared calamity hit by the relevant government authorities.
Banks are also reluctant to increase exposure into this highly lucrative but semi documented market. Farmers are prone to high default rates due to volatile wholesale markets that limit farmers’ ability to have consistent revenue streams.
Another problem faced by banks is their limited ability to understand the farming sector. Officers dealing with agri credit are mostly business graduates who lack in-depth understanding of agriculture. It’s a pity that agriculture economics or agriculture marketing is not part of any major MBA program offered by numerous business schools in the country.
In order for banks to effectively penetrate the agri credit market they must completely overhaul their strategy. Agriculture extension services have failed to provide the required support to farmers. Banks must assist farmer’s earning capability by playing a role in educating them and introduce better paying crops. This in turn will help them attain a more stable revenue stream.
State Bank must step in to remove the mismatch between value of collateral and loan amount in agriculture lending. Farmers are required to place their pass books (ownership document for agricultural holding) as collateral with the bank when they borrow, which pledges their entire holding. This is especially painful when per acre value of land is more than ten times the State Bank’s approved per acre credit ceiling for different crops.
Working with select group of farmers and forming them into cooperatives will slowly develop entities in the agriculture sector that could borrow from banks based on the strength of their balance sheets.
Financing viable projects in downstream agro processing will create alternate marketing channels for farmers. This will eventually stabilize wholesale prices and enable farmers to better predict their revenue cash flows. Also, a vibrant Islamic Banking arm will aid banks into exploiting lending potential in the agri sector.
However, these shifts in approach will take place only when banks genuinely want to explore new avenues for increasing their profitability. This will remain a far cry as long as government borrowing continues to crowd out the private borrower.
The writer is a banker-turned-agribusiness specialist
Published in Dawn, The Business and Finance Weekly, March 18th, 2019