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Agricultural Credit, the least evolved.



The Agriculture ecosystem has four major components: input, credit, markets and insurance. Among these, the input sector is the most evolved when it comes to seeds, chemicals, nutrients and farm equipment this sector has kept investing in new technology and products and spent vast amounts on R&D. Crop insurance is the second most evolved product category, it has evolved during colonial times when it was thought important to keep farmers in business by protecting them against natural calamities. In the 1930s the US Government provided massive subsidies on insurance premiums paid by farmers. Riding the back of subsidies crop insurance has been evolving well in the developed and developing world alike However, when it comes to credit and marketing not much has changed. Probably low margins in agricultural marketing have led to the consolidation of large trading houses such as the Archer Daniels, Bunge, Cargill etc… but there have been no major investments in improving and developing marketing mechanisms.


It is the same with agricultural credit, there is very little development to meet farmer needs despite the availability of plenty of technology. In India, for example, the Kissan Credit card is more than 25 years old and still remains the go-to product for lenders. When it comes to commercial lending there are three major lending categories corporate finance, SME Lending and Consumer Credit. SME lending is largely loan against some security, the most popular being mortgage of property. SME business is too diverse for lenders to understand economics and cash flow dynamics so the easy way out is lending against property, jewellery, or stocks. Agricultural credit typically falls under the SME category, which means farmers can mortgage the family farm to avail institutional credit. ( Kissan credit card is also a loan against property ). But there is a problem, this method only works for large farmers. The cost of acquiring small farmers are not worth lenders while. The cost of creating a mortgage and collecting cash at the end of each harvest does not get recovered by the interest income collected on small value loans.


In developed countries, this has driven small farmers out of business but in those countries, the displaced farmers could be employed in the rapidly expanding Industry that required a lot of manpower. In developing countries Industry is incapable of absorbing displaced farmers resulting in urban migration and the creation of megacities filled with slums of urban poor. Credit is essential to keep the small farmer on the farm. It is proven that credit enables farmers to produce better quality and earn more. However, lenders do not have the incentive to develop products for small farmers.


In order to solve the small farmer problem we have to first bust a few myths


Cost of serve: Solving the small farmer credit problem is more about cost than of risk. Small farmers are more disciplined than thought to be. Further, it is observed that landless farmers tend to be more innovative and end up with better earnings and non-farm assets than landowning farmers. Technology as a cost saver is the second stage not first. The most significant cost is the cost collection. Agricultural revenues are uncertain both in terms of value and timing, further agricultural settlements happen in cash, hence at every harvest, one has to deploy an army of resources to collect cash from farmers to keep the loans regular. When you consider Banks and NBFC’s incurring an operating cost of around 10% on small value consumer credit such as motorcycle loans and consumer durables (similar loan size as a small farmer) in dense urban and semi-urban areas, one could well hazard a guess on how much it would cost to disburse and collect in deep less dense geographies. It is next to impossible for a four-man rural branch to collect from a thousand customers in 25 villages within a 45-day harvest window. This inability to collect shows up as NPA’s and does not truly reflect the intention of farmers to pay.


Farmers receiving money in their bank accounts will solve the collection problem. However, there are two issues here, one they have to access to their account through a bank branch, ATM or a business correspondent. The current set of the business correspondent is geared up to handle small value transactions they are unable to handle large amounts averaging 1 lac plus payout per farmer, ATM and branch penetration remains limited by cost dynamics The second major problem is a settlement at the Markets. More often than not traders insist on a cash settlement for well-known reasons.


Risk Assessment: Credit and insurance face the same issues of cost of distribution, cost of servicing ( claim settlement for insurance and loan collection for lenders) and frauds or moral hazards. Lenders assess farmers individually crop insurers generally ensures a complete area without individual assessment. However, a combined process that goes beyond bundling at the time of distribution would be more beneficial to both industries in cutting down each other's risk of moral hazard significantly. Once a moral hazard is reduced, the risks that remain are production (yield) risk and price risk, In fact climate risk on production is highest in the first 30 days of sowing (germination stage) and the last 30days when the crop is ready for harvest. During the vegetative stage (middle 3-4 months) the climate risk is low. Overall statistics indicate that price and yield risks are in the range of plus, minus 25%. both of which have their good years and bad years and can be averaged out through innovative financial products.


Ecosystem development: Everybody wants it, nobody knows how to get there. Can we get Inputs, credit, insurance and markets to play together at scale? The input sector is organised up to the whole-seller, the input retailer that connects with farmer falls under the unorganised sector, A major missing piece is an efficient Warehousing System that involves the farmer at scale. Today it costs 15% of value to move goods from the farmer to a processor. The farmer ends up receiving mandi price minus 10%-12% being charged for brokerage, labour, gunny bags, transportation and other unaccounted charges, while the processor incurs a cost of 2%-3% in the form of inferior material, stones and cost of re-grading and sorting. An efficient warehousing system can cut this cost by 50% by doing away with bags and having only one movement between the farmer and the processors. The East African grain council has demonstrated this well where the warehouses are online with the market and the banking system, farmers dump goods lose into a hopper it is graded sorted weighed and stored in front of them producing an electronic receipt which can be traded on spot or forward and pledged to a bank for an advance. This has been in operation since 2006-7. Back home the eNAM is a step in this direction along with other recent initiatives we hope they achieve farmer inclusive scale fast.

The mechanisation of material management through a silo system can reduce this cost by 70%. Mechanical handling cleaning and de-stoning happening at the far end. A small silo occupying around 200sq feet can service the turnover of up to 10 villages. Silos may seem expensive if you only look at post-harvest margins of 2-3%, however when you look at what the farmers pay to sell their grain even after cutting that by 70% it still makes good commercial sense. However, entrepreneurs on the ground need the advice, finance and network of buyers to make this happen, The most important outcome of a good warehousing system is that settlement can happen digitally between farmer and processor facilitating self-liquidating crop production loans. Some State Governments have already incentivised processors buying directly from farmers, the next step would be setting upgrading standards and incentivising co-mingling of stocks.


New Kids on the block: If the big boys do not develop and evolve the new kids on the block (Start up’s) will sooner or later disrupt them in almost all aspects of this business. There are a large number of start-ups in the space doing good work but there is one major issue in their ability to scale. They have to go a significant distance on capital, requiring them to raise a lot of capital from the market and dilute themselves. The need of the hour is lenders who can understand and partner with them either directly or through structured innovative debt products distributing the risk, improving margins and enabling scale When one looks at the start-up ecosystem across Latin America, Africa and India, I believe we are a few steps away from a small farmer revolution.


However, we must not underestimate the impact climate change is having. This is likely to disrupt established processes and systems as farmers adapt to new crop categories to adapt to warmer and dryer weather it will call for a reorientation of the marketing, input, credit and insurance systems. The times they are a changing as Bob Dylan wrote, the role of technology in this situation is to help the entire ecosystem to stay ahead of the curve.



Thank you, Michael Andrade

MD& CEO of Samaaru India Pvt Ltd


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