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Farm Finance: How this Budget can give a push to rural credit, post-demonetisation

Originally appeared in The Indian Express on January 19, 2017

Just across the road from the sprawling, leafy campus of IIT-Madras lies the main office of Samunnati Financial Intermediation and Services on the first floor of a non-descript glass-fronted building. Led by Anil Kumar, an ex-banker with nearly 25 years of hands-on retail lending experience, it’s one of a handful of new-generation non-banking finance companies (NBFCs) breaking fresh ground in agricultural financing. Samunnati is the kind of institution that, with the right policy support, could be the key to reducing the role of cash in farm financing, while bringing vast numbers of borrowers currently ignored by mainstream banks into the ambit of formal credit.

The Reserve Bank of India (RBI) does not allow NBFCs to take public deposits or open savings accounts. They, therefore, largely rely on borrowings from banks and development institutions to on-lend to their clients. It makes their loans more costly than conventional bank finance. Yet, banks are happy to make available bulk funds to NBFCs, as they aren’t keen to lend directly to farmers, given the risks in agriculture and the distortion of interest rates by governments through untargeted credit subsidies. Rural borrowers, too, line up before NBFCs because they, unlike banks that offer a set menu of non-customised financial products, are responsive to the needs of different clients. NBFCs are also quicker to adopt innovative technology to reach out to borrowers, as against the continued brick-and-mortar branches and boots-on-the-ground approach of banks. NBFCs’ operating expenses are lower than banks’, despite the latter’s lower cost of funds from access to public deposits.

Samunnati typifies the sort of lean go-for-growth NBFC that views agriculture as a business opportunity (the government’s own data shows that barely 60 per cent of Indian farmers overall access bank finance; it is even lower at 15 per cent for small and marginal farmers). Started in November 2014, Samunnati now has 15 branches in Tamil Nadu and Andhra Pradesh. But through tie-ups with over 70 farmer producer organisations (FPO), it has managed to connect to about 40,000 small and marginal farmers, including in states like Bihar and Madhya Pradesh. Besides, it has used India Stack — an open application programme interface system that leverages the Aadhaar platform — to do away with paper forms, physical verification and cash handling. All loan proposals originate through e-mailed documents, with client verification being done through access to digital lockers. Farmers today can seek and receive a loan from Samunnati even on a Smartphone.

Samunnati, moreover, has targeted every player in the agri value chain, seeking to address their financing needs in a way that reduces and distributes risks. For example, it will offer input finance to farmers and simultaneously meet the input trader’s credit requirement to build his inventory before the season’s start. This ensures that even while the trader is able to place timely indents with the supplier, the inventory gets lifted by the farmers. Samunnati would, at the same time, also offer trade finance to a buyer, who is willing to purchase produce from the farmers in advance.

The above approach of risk mitigation allows an NBFC like Samunnati to extend loans without any hard collateral that banks usually insist upon. Recently, its team met a group of FPOs from MP in Bhopal for the first time. Two hours later, they had signed an MOU with Samunnati; the FPO representatives still can’t get over the fact that a financial institution could design a product specifically for them during a discussion. With such innovative reaching-out solutions customised to individual client needs, it isn’t surprising that in just over two years, this small NBFC has disbursed loans of almost Rs. 100 crore, with a 98 per cent standard portfolio and negligible defaults on its loan installment repayments. And all this while focusing on agricultural financing — supposedly a losing proposition!

But with cost of funds raised from financial institutions now at 15-17 per cent, NBFCs like Samunnati are forced to offer higher priced loans compared to banks. Besides, their borrowings from banks do not qualify as priority sector credit under RBI norms, even if this money is used exclusively for agricultural lending. Also, they cannot seek protection of the Credit Guarantee Fund (GCF) set up under the Small Farmers’ Agribusiness Consortium (SFAC) to provide comfort to lenders reaching out to FPOs. CGF protection is available only on banks’ lending to FPOs. It makes access to low-cost capital for expanding operations a key challenge for the likes of Samunnati.

Current indications are that the farm sector has emerged from the initial shocks of demonetisation. Full recovery will be, however, largely predicated on how vigorously credit flows through the system in the next two crop seasons. The cash crunch has delivered a body blow — for good or bad — to rural commercial capital. Cooperatives are also under a cloud. With enforcement agencies swooping down to nail out suspected malpractices in their receiving deposits of the outlawed notes, they are likely to be distracted from lending operations in the next few months. Banks, too, will take time to get back to normal lending; it is unlikely they would make a big push for expanding rural credit this year. This is the time to incentivise new channels of rural financing, including the new-generation NBFCs.

Three small steps in the forthcoming Union Budget can be decisive. First, lending by banks to NBFCs having at least two-thirds of their portfolio in agriculture must be covered under the priority sector category. Secondly, all loans to FPOs and rural SMEs by NBFCs should be entitled to the SFAC’s CGF facility up to a limit of, say, Rs 100 lakh. Finally, allow NBFCs to sell the Pradhan Mantri Fasal Bima Yojana — this government’s flagship crop insurance scheme — to so-called non-loanee farmers who don’t receive credit from banks or cooperatives.

These three steps can help unleash a wave of innovation in agricultural financing and incentivise institutions to look at this under-served segment of the economy.