Scant institutional credit to farm sector

Bank credit forms just 13% of farmers’ loans

A recent farm survey shows that only 5% of agricultural loans were from banks in two districts of West Bengal, 24% from cooperative banks, 65% from informal lenders and the remaining 5% from family and friends. Bank and cooperative loans required collateral and charged with interest rates of 12% and 16% respectively.

However, private money lenders charged interest rate of 26% and mostly the loans did not involve any collateral. The farmers who took loans from Micro-Finance Institutions (MFI) or Self-help groups (SHG) also paid interest similar to private money lenders loan rates only. At all-India level, MFI interest rates, according to Malegam Committee, range from 30-50% with an average of 30%.

Most of the small and marginal farmers even today are not able to access loans from banks and they are compelled to pay high interest rates to MFIs and informal sector. Most of the priority lending initiatives are centred on interest rate subvention schemes that aim to make a credit available to farmers at low interest rates.

One of the schemes that was popular during 2006-07 gave banks a 2% subvention on short-term loans to farmers up to a loan amount of Rs 3,00,000. Besides there is further 3% subvention to farmers who repay their loans on or before due date of the loan in subsequent years. This brings effective interest rate to 4% only. The scheme initially was available only to public sector banks and later was extended to private sector banks since 2013-14.

To prevent distress crop sales by farmers after production, another scheme “Loans to store post-harvest produce in warehouses” for small and medium farmers with Kissan cards is eligible for interest rate subvention so that such loans are made available at interest rate of 7% per year. There are no additional subventions for timely repayment and applicable to farmers who took crop loans.

However, these schemes are not working. Moreover, agriculture lending is only about 13% of overall institutional lending in India in 2015. The reason for failure of the subvention schemes is that the mandated interest rates are set too low relative to the costs that banks incur in offering such loans.

How then 13% of institutional lending to the agricultural sector takes place is that a large share of private sector lending from the banks goes indirectly through various financial intermediaries; non-bank financial companies (NBFCs) which comprise of MFIs, besides rural banks and cooperatives.

Moreover, MFI loans do not come cheap; they charge interest rates ranging between 30-50%. Due to such high interest rates and allegations of coercion in loan collection by MFI officers gave rise to the microfinance crisis in Andhra Pradesh a few years ago.

In the light of the AP micro finance crisis, the Malegam Committee recommended a cap on MFI interest rates of 24% and 10% cap on margins above the cost of capital. Clearly, most MFIs will not able to break even, if these were to be enforced.

Then what are the solutions? Regulators could set higher ceilings on margins above costs of capital, which would help banks recover their lending costs. The bankers have suggested that these costs would be at least of the order of 7-8%. If banks could access priority sector funds at 5%, they ought to be able to charge interest rates up to 15%.

The other suggestion is to channel rural credit through non-bank intermediaries such as MFIs, as the most cost-efficient of these institutions incur transactions costs of the order 7-8%. So they should also access priority sector funds from banks at about 5-6%, the rate at which banks access these funds.

Therefore, either way policy makers have to acquire a realistic sense of the costs of delivering institutional credit without collateral to poor borrowers and permit interest rates of the order of 15%. This has the potential to raise the volume of credit substantially to the rural sector, at rates still considerably lower than they are currently paying to informal lenders.

By G Rajendera Kumar