Agricultural Finance PDF

Agricultural finance generally means studying, examining and analyzing the financial aspects pertaining to farm businessAgricultural finance plays great role to finance agricultural activities in both developing and developed nations. This finance is obtained from different countries or other lendin...

Agricultural finance generally means studying, examining and analyzing the financial aspects pertaining to farm businessAgricultural finance plays great role to finance agricultural activities in both developing and developed nations. This finance is obtained from different countries or other lending national and international formal and informal institutions. Farmers access to agricultural finance (credit access) will be determined by different factors including the repayment ability and plan of the individual farmer and some other determinants. Significance of Agricultural Finance Agriculture finance assumes vital and significant importance in the agro–socio-economic development of the country both at macro and micro levels.It is playing a catalytic role in strengthening the farm business and augmenting the productivity of scarce resources. When newly developed potential seeds are combined with purchased inputs like fertilizers & plant protection chemicals in appropriate / requisite proportions will result in higher productivity.Use of new technological inputs purchased through farm finance helps to increase the agricultural productivity.Farm finance can also reduce the regional economic imbalances and is equally good at reducing the inter–farm asset and wealth variations. Sources of Agricultural Finance There is no lending without financial resources. Loans to agriculture can be financed by different sources of funds such as farmer household savings, capital markets, equity, budget allocations of the government, central bank refinance facilities and international borrowing. All these various funds, some of which are highly political, have different implications on the fund management, performance, and autonomy of financial institutions.Funds to agriculture can be classified in to two broad categories, viz, formal financial institutions and semiformal and informal financial intermediaries. Funds to agriculture can be classified in to two broad categories, viz, formal financial institutions and semiformal and informal financial intermediaries. (1) Formal Financial Institutions Formal financial institutions can also classified (i) Funds at Concessionary TermsInternational Donor Funds: Bilateral and multilateral development agencies provide agricultural financial intermediaries with various types of support: loans and capital ranging from concessionary to almost commercial terms and technical aid grants. Government Budget Funds: not only international donor agencies, but also most governments of developing countries and formerly centrally planned economies provide various types of funds and support for agricultural lending. Both the international donor community and national governments use taxes and other budgetary funds to establish, maintain or enlarge agricultural lending activities of financial institutions. Central Bank Funds: In numerous cases world-wide, central banks or central bank affiliated institutions are significant creditors of agricultural financial institutions. In many developing countries central banks offer various instruments to stimulate and finance agricultural lending. Compulsory Deposits: In many countries, governments have tried to increase the amount of money available for investment in agriculture by introducing regulations affecting urban-based commercial banks. s resources. ii) Funds at Commercial Terms Savings and Deposits: Most of the agricultural development banks were established in order to channel public funds to target groups financing predefined purposes (2) Semiformal and Informal Financial IntermediariesNGOs and Informal Financial Institutions: some types of funds are only accessible to formally regulated and supervised financial institutions ruled by banking or co-operative laws. Without a banking license, deposits usually cannot be mobilized, debt instruments cannot be used and capital markets remain inaccessible. Hence, it is obvious that the range of funding sources for semiformal and informal financial intermediaries is narrower than that of formal financial institutions. Rural Unit Banks: Unit banks (savings, rural, village, community banks) are faced with a lot of limitations regarding their fund raising strategies. Their main funding sources are savings mobilized locally and to a lesser extent share capital. The scope for long-term lending is usually determined by their amount of equity. Savings and Credit Co-operatives Although often used or misused in the past to channel donor funds in Latin America and other regions, credit co-operatives are basically financed by savings and member shares. Their liability structure is similar to that of rural unit banks. However, co-operative banks and rural banks might have different objectives. Rural unit banks and other small commercial banks are profit-oriented institutions. The management tries to achieve a loan portfolio size where the surplus is at its maximum. In the case of mutually owned institutions, where the owners are both suppliers and users of the available funds, the maximum surplus position is not a stable one. Non-Institutional Sources the major non-institutional sources of farm credit are money lenders, friends, relatives, shopkeepers and commission agents. Moneylenders usually do not lend for direct productive purposes but for unforeseen emergencies or consumption needs, due to the absence of appropriate savings facilities. The short term credit needs of the farmers are met from commission agents, friends and relatives which supply roughly 50% of total rural borrowing. The lenders of the informal sources (friends, relatives etc) have certain advantages over the formal credit sources. The informal lenders usually know the borrowers personally. They require little security for advancing loans. The loans are given for consumption as well as production purposes. The lenders are approachable at all times. They are also lenient in rescheduling loans. However, informal lenders are also accused of charging higher rates of interest. Credit Worthiness Analysis A creditor's measure of an individual's or company's ability to meet debt obligations. An assessment of the likelihood that a borrower will default on their debt obligations. It is based upon factors, such as their history of repayment and their credit score. Lending institutions also consider the availability of assets and extent of liabilities to determine the probability of default. Several firms have developed rating systems to determine an individual or company's credit worthiness. It is important for each person to keep track of their credit score because this is the main metric used by institutions when determining if the individual is worthy of a favorable rate.Creditworthiness has to do with the ability of a borrower to pay current debt in a timely manner. Within the context of the ability, several basic factors come into play. An evaluation of the creditworthiness of a borrower involves identifying the presence of resources that may be used to repay debts, the willingness of the debtor to use those resources for repaying debt, and a history of choosing to repay debt obligations in a timel Stages of the Credit Analysis The credit analysis can be defined as a process of determining the current creditworthiness of the loan applicant and forecasting the tendencies in its future development. This process is connected with the financial and accounting analysis of the current and future activity and the financial situation of the loan applicant in the specific economic environment and the expected changes in the forthcoming periods. The priority of the credit analysis is to determine the following: The managerial qualities of the loan applicant;His ability to regularly repay the loan, the interest accrued and charges by using his current revenue from his business activity at present and in the future;The amount of his capital and the possibility to use it to secure the borrowing of the commercial bank-creditor in the event of risky situations;The influence of micro and macro environment over the business activity of the company during the current period and in the future and respectively over his ability to service the bank loan;Specific risk situations which can affect the borrower's money inflow and consequently result in problems with the repayment of the loan;The correspondence between the extended credit and the real need for it;The correspondence between the term of credit and the circulation speed of the funds for the raising of which it was extended. The stages of the credit analysis are as follows: Collecting and analyzing information about the company applying for a loan and formulating indicators about its financial situation;Collecting and analyzing information about the credit event;Assessing the credit risk;Checking the reliability of the information, provided by the company applying for a loan;Preparing an analysis of the credit risk;Taking a decision;Setting the credit terms Loan Repayment Plans and Methods Money borrowed for long-term capital investments usually is repaid in a series of annual, semi- annual or monthly payments. There are several ways to calculate the amount of these payments: equal total payments per time period (amortization); equal principal payments per time period; or equal payments over a specified time period with a balloon payment due at the end to repay the balance.. Repayment Principles To calculate the payment amount, all terms of the loan must be known: interest rate, timing of payments (e.g., monthly, quarterly, annually), length of loan and amount of loan. Borrowers should understand how loans are amortized, how to calculate payments and remaining balances as of a particular date, and how to calculate the principal and interest portions of the next payment. This information is valuable for planning purposes before an investment is made, for tax management and planning purposes before the loan statement is received, and for preparation of financial statements The Old and New Agricultural Credit Policies Typical device for selecting borrowers is to demand that the borrower provide some collateral for the whole or a proportion of the loan. Collateral might be a plot of land, a piece of equipment, a draft animal, or a proportion of the crop. Historically there are two arrangements observed in the world, mainly in developing countries, in the credit transaction: the old and the new credit policies. The inability of tenants and poor farmers to provide collateral in the private or informal financial systems is one of the main reasons for creating institutional credit schemes. Objectives of Old Credit Policy aid. The objectives of the old credit policy, and the reasons for their popularity with governments and aid donors alike, are summarized as follows:To accelerate the adoption of new technology by peasant farmers, by providing working capital for the seasonal purchase of variable inputs, and then optimizing the complementarity’s between inputs. To assist small farmers to overcome their inability to borrow from commercial or informal credit sources, due to lack of collateral and lack of information; To provide short-term credit in order to bridge seasonal and temporal cash shortfalls of small farmers, compared to the medium and long- term lending preferences of commercial financial institutions; To achieve equity goals, whether these are related to intra-rural, interregional, or rural-urban income distribution;To offset the disincentive effects for small farmers of policies unfavorable to them including low output prices, over-valued exchange rates, and inefficient market interventions by state; Objectives of New Credit Policy Now it is time to look into the objectives and instruments of the new credit policy. The most important attribute of a successful credit system is that it should be self-sustaining in the long run, not reliant on ever increasing subsidies to cover losses, and not dependent forever on injections of external funds from foreign aid donors. The critical new objective of credit policy is therefore the creation of a self-sustaining rural financial system. The following three important points are relevant in changing the direction of policy instruments:i. Savings mobilization: the generation of funds from savers is considered a key feature of self-sustaining credit institutions. First, a strong savings base reduces the reliance on external funding. Second, savers and borrowers are often the same people at different points in time in the community, reducing the information costs of transactions. Third, people to an institution for both saving and borrowing are less likely to default on loans. Lastly, farmers with savings can often self- finance small outlays so that loans become oriented to bigger outlays with lower transaction costs per unit of money.ii. Interest rate level: a self-sustaining financial system requires an interest rate on loans sufficient to cover:The interest rate paid to saversThe average cost of making transactionA risk margin to cover the probability of defaultiii. Loan recovery: poor loan recovery amounts to giving borrowers a gift, it encourages the use of credit for non-productive purposes, and it promotes the idea that rural development is more about cash handouts than about improved productivity and outputs.