Effectiveness of agriculture loans

Effectiveness of agriculture loans
6 Sep, 2008, 0006 hrs IST, ET Bureau

By Saji Gopinath and Abhilash Nair

Financial inclusion forms the corner stone of inclusive growth in any economy. However, despite having strong government regulations to direct the channel of credit to rural agricultural sectors, the financial inclusion of the same, by formal means of credit, remains abysmally low as brought out by several studies including the recent one by the Radhakrishna committee.

Lack of awareness, high risk perception, strong presence of informal means of finance coupled with complex socio-political issues and knee-jerk reactions by governments from time to time in the event of crises have come in the way of efficient allocation of agriculture credit. With serious questions being posed regarding the food security of the country, there is a strong need to understand the issues that plague rural agriculture credit and to address them constructively.

Presently, in the case of domestic scheduled commercial banks, except regional rural banks (RRBs), 18% of the total loans and advances as well as non-SLR investments have to be directed towards the agriculture sector. Advances to the agriculture sector can be in the form of direct finance or indirect finance.

Indirect finance is limited to a maximum of 25% of the specified 18% (that is, a total of 4.5% of loans and advances). Any shortfall from this 18% requirement needs to be deposited in the Rural Infrastructure Development Fund (RIDF) of National Bank for Agriculture and Rural Development (NABARD).

Hence, on the face of it, there seems to be no way that a bank could avoid fulfilling the 18% target assigned to it. However, data reveals otherwise. While public sector banks advance a little above 15% of their funds, private sector banks allocate only about 11% towards this sector. At the outset, this seems to defy logic, since any shortfall has to be deposited in RIDF.

However, as the adage goes “Evil is not to be traced back to the individual but to the collective behaviour of humanity,” if all the banks (both private and public sector) do not meet the target of 18% then NABARD has to accept a really big amount on which it needs to pay interest.

Hence, NABARD, on its part, asks the banks to keep such money ready to be invested on demand. However, the interest rates it would pay will depend on how much of the banks’ advances have been channelised to the agriculture sector. In other words, for banks that have advanced about 15% of their loans to agriculture sector, NABARD would pay the bank rate on the amount they have invested; for banks that have advanced about 10% to 15%, NABARD would pay bank rate minus 2%; and for banks that have advanced less than 10%, NABARD would pay bank rate minus 4%.
As a rational entity, NABARD would first like to borrow from banks that have lent less than 10% and then from banks that have lent between 10% and 15% and finally from banks that have lent 15% and above. In other words, if a bank directs just more than 15% of its advances to the agriculture sector, then it could be roughly sure that NABARD may never demand money from it.

This is a kind of win-win situation for NABARD as well as the bank. If we need to efficiently and effectively channelise credit to the farmers, policy makers should ensure ways and means of overcoming this loophole.

Another issue that seemingly plagues advances to the agriculture sector is the preference for indirect lending. Though, as per rules, banks are not supposed to include any indirect agriculture loan beyond 25% of their total agriculture advances as priority sector advance, the data speaks otherwise.

Between 2001 and 2007, while public sector banks did more or less adhered to the norm, the private sector banks, on an average, advanced about 50% of their total agriculture advances as indirect loans. Resultantly, in the case of private sector banks, agriculture advances generated the least amount of NPAs!

In a nutshell, there seems to be an increased risk perception, emanating from discounted and targeted lending, while making advances to the agriculture sector. Somewhere, the feeling that the farmer’s income is cyclical and he does not have enough tangible assets leads the banker to assign a higher risk weightage. However, on account of political pressure, banks are forced to keep lending rates at artificially low levels.

This leads to the ‘crowding out effect’, thus resulting in credit reaching ‘safe’ non-farm hands, because banks advance direct agriculture loans to people whose secondary source of income is agriculture or give gold loans at a discounted rate to agriculturists. Even when the credit rightly reaches the marginal farmer, there is a ‘moral hazard’ involved.

Because of lack of access to other formal sources of credit, he may use a part of the agriculture credit for other purposes. While there is nothing wrong in this, current banking policies does not allow this flexibility to the farmer. Hence, it is suggested that banks should offer a basket of loans to meet the varied requirement of the marginal farmer, rather than only agriculture loan.

Moreover, to avoid ‘moral hazard’ the agriculture loan should not be offered at a discounted rate but at a risk adjusted rate. Lending to agriculturists at a risk adjusted rate will also help overcome the constraint imposed by the higher operating cost while advancing small loans. The huge success of micro-finance institutions, in different parts of India and other developing countries is a testimony to the fact that the genuine farmer needs genuine access to credit and not just cheap credit.

(The authors are faculty members of the Indian Institute of Management, Kozhikode)