In a new draft paper published on his personal website, Mor argues that consumption loans to marginal farmers and landless labourers should qualify as Direct Agricultural Finance (DAF) for purposes of calculating banks' fulfillment of priority sector lending. Currently, a loan to a poor farmer which goes toward the purchase of food or medical treatment is not treated as DAF (one of the most difficult of the priority sector requirements to fulfill) by the RBI while a loan to a well off farmer for the purchase of a tractor is. Mor’s point is that the landless labourer or small farmer himself is, through his labour, an important input into the farming process and thus a “consumption loan” to a landless labourer or marginal farmer has as much potential increase agricultural productivity just as much as an investment in a tractor or new seed type does.
I wholeheartedly agree with Mor’s calls for greater access to reasonably priced credit for landless labourers and marginal farmers, but I’m not convinced that changing the priority sector norms as he suggests would accomplish this or that, even if the change were to take place, it would necessarily result in an increase in agricultural productivity. First, there is already an incentive built in to the priority sector requirements for banks to lend to landless labourers and marginal farmers in the form of the “weaker sections” lending requirement. This requirement stipulates that banks lend 10% of net bank credit to the “weaker sections” of society which include, among other groups, marginal farmers and landless labourers. Currently, the shortfall against the “weaker sections” target is even greater than that against the DAF target. (see here and here for more.) Banks are unwilling to lend to these segments, despite this inducement, because interest rates on loans under 2 lacs in size, which make up the majority of loan demand from these segments, are capped at prime lending rate. (Update: Please see comment from Leena Pillai below for why the "weaker sections" target doesn't provide a real incentive for banks to lend to landless labourers and marginal farmers.)
Second, Mor argues in the latter half of the paper that increased access to credit by the rural poor would allow them to improve their health and thus increase their productivity. Yet, there is another channel through which increased access to credit could affect agricultural productivity: it could increase the cost of production by improving the bargaining power of labourers vis-à-vis farm owners. This, of course, would be a good thing but it would also mean decreased ag productivity.
At the end of the day, marginal farmers and landless labourers are ill served by the formal banking sector in India and the government would do well to increase the incentive for banks to serve this segment of society.
4 comments:
The paper makes an important point, namely that for marginal farmers and landless labourers, human labour is a key production input, and “consumption” loans that finance the upkeep this productive input are conceptually no different than “production” loans that finance farm machinery or fertilizers. For this reason, they ought to, as Dr. Nachiket Mor suggests, qualify as Direct Finance to Agriculture (DFA) under Reserve Bank of India’s (RBI) priority sector lending directive.
Notwithstanding the above, I have one central comment on the paper: it is not quite clear to me how merely re-classifying consumption loans as DFA, by itself, provides greater incentives for commercial banks to increase net lending to the agricultural sector in general or to marginal farmers/landless labourers in particular.
I raise this point for two reasons: First, I note that under current RBI regulation, interest rate on loans under Rs 200,000 are capped at the bank’s prime lending rate. Individual loans to marginal farmers/landless labourers are thus most likely to be amounts small enough to be subject to this regulatory interest rate cap. Also, per unit transactions cost for lenders is likely to be relatively high for such loan sizes. Hence it is not all that clear whether banks will sufficiently recoup costs incurred in lending small amounts to marginal farmers and landless labourers. The case that Dr. Mor makes would be considerably strengthened if the paper further fleshed out reasons why commercial banks -- currently unwilling to fulfil their DFA obligations even by lending to large farmers in amounts not subject interest rate caps -- will suddenly turn around to service much smaller consumption loans to marginal farmers simply because they are now counted as DFA. Second, commercial banks (like ICICI) are already using a variety of innovative financial instruments to partner with MFIs that provide general-purpose loans to poor rural households either directly or through Self Help Groups (SHGs). I am sure that Dr. Mor himself played a critical role in some of these innovations. From the point of view of commercial banks, these arrangements are rather nice: the loans qualify as priority sector lending and reach relatively poor households, but at the same time avoid interest rate caps and also shift a significant chunk of administrative costs to the MFIs. So, this leads me to my second question: how will merely redefining this financial portfolio as DFA lead to its net enlargement? Would it not, by simple arithmetic, result in equivalent reduction loans classified as non-DFA credit?
Thus, in both cases, I would suggest that the paper address the additionally factor a little more clearly.
Manohar Sharma, International Food Policy Research Institute, Washington DC
The point sought to be made in the paper is that there is a great deal of lending already going on in this sector – using various models – SHG lending, MFI partnership model, etc. that is already taking care of the interest rate question. There is also an RBI scheme for Generalised Credit Cards (GCC) of which 50% qualifies as indirect agri. The opportunity is that if it was classified as direct agri it would be more interesting for banks – the indirect agri requirement is often already met through many other sources and banks have a limited interest in pursuing that. Even if there is a cap it may better to lend here at even 10% below cost of funds because otherwise the penalty is over 12% for non-fulfillment.
Willingness of Banks: My experience is that there simply isn’t sufficient opportuity to lend. Default rates amongst mid-sized farmers are over 20 to 30% -- it is better to pay the penalty to NABARD (which is of the order of 10 to 12%) than to get into this. Indirect Agri has rarely been a challenge for Banks – just housing alone meets most of the requirements so there is no real danger of any reduction of indirect agri. Lending to agri-coompanies fully qualifies as indirect agriculture and other prioirity – fertlizer dealers, seed companies, cattle feed dealers, etc.
Two issues that we want to highlight:
1) If lending to landless labourers is included in direct agi, this could significantly increase credit flows to this under-served segment as well as open up a large market for banks (according to a recent NCAER survey, labourers account for 40% of farming households).
2) Though lending to this segment is happening via the weaker section category, there is no penalty on banks for under-performing and hence no incentive to use innovative lending models.
Removal of interest rate caps can improve credit flows to the poor, however, this would require tremendous political will and is a long term goal.
I read Dr Mor's piece with great interest. The idea of substitutability between consumption loan for marginal farmer vis-à-vis loans for animals and machine; and its impact on agricultural productivity is great. From an outsider perspective I have some questions/thought. Some of these might sounds trivial, which is okay, given my limited knowledge on this area.
First, Dr Mor has mentioned that the banks upon failing their target lending to the priority sector have to perk the shortfall amount to NABARD at a much lesser rate of interest. Is there any way the banks can trade among themselves where the banks which have achieved priority sector lending (may be with better rural network) can buy some of the loan amount from the banks which are finding it hard to fulfill their target. The trading rate will obviously hover between 6 and 10 percent; and both the parties gain – something in the line of Ronald Coase law.
Second, States with highest labor days per hectare are Bihar, Andhra Pradesh, West Bengal, Uttar Pradesh, Tamil Nadu and Orissa. West Bengal makes sense as they have done land reform program. Orissa, Uttar Pradesh and Madhya Pradesh also make sense as these are the States with lower State GDP; with prevalence of larger number of farm labors. What about Tamil Nadu and Andhra Pradesh. Does it tell us anything about skewed income distribution in these two States?
Third, if I understand correctly there is a hump in the mode of loan repayment - most part of loan repayment happens immediately post harvest. Since market price tend to be less just immediately after the harvest season with most farmers trying to sell at the same time, the pay off to the farmers and hence probability of loan default might increase. Why can’t the bank step in here? I mean it makes sense for banks to invest in warehouse to hoard grain stocks and release the same when the market price stabilizes. In that way both the bank and the farmers gain. Banks can actually benefit from this arbitrage.
These are few observations which come to my mind at this moment.
Nilanjan Banik (IFMR)
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