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AECO 241 AGRICULTURAL FINANCE AND CO-OPERATION
Lecture outlines
Theory
1. Agricultural Finance - Meaning, definition, nature and scope - Significance - Micro and
macro finance - Capital and credit problems, need and their importance in Agriculture.
2. Credit - Meaning and definition - Classification of credit based on different criteria with
examples.
3. Credit analysis - Economic feasibility tests - 3 R’s of credit analysis - Returns to
investment - Repayment capacity - Meaning, causes of poor repayment capacity of farmers,
suggestions to improve repayment capacity - Risk bearing ability - Meaning, sources of risk,
means to strengthen RBA.
4. Five Cs of credit – Character – Capacity – Capital - Condition and Commonsense - Seven
Ps of credit - Principle of Productive purpose - Principle of personality - Principle of
productivity - Principle of phased disbursement - Principle of proper utilization - Principle of
payment and Principle of protection.
5. Social control and nationalisation - Meaning, objectives and their importance -
Privatisation of commercial banks - Need and importance for institutional sources and
structure of agricultural lending from different sources.
6. Lead bank scheme - Origin, objectives, functions - District credit plan - Regional Rural
Banks (RRBs) - Origin, objectives, functions — RRBs in Andhra Pradesh.
7. Crop loan system - Objectives, importance, features of crop loan system - Scale of finance
- Meaning and estimation and role of district level consultative committee - Term loans –
Objectives and meaning of unit costs, fixation of unit costs and NABARD guidelines.
8. Financial inclusion - Meaning and importance - Micro finance - Meaning, importance,
agencies providing microcredit banks, NBFCs, NGOs, and Govt. agencies - SHGs and their
role in microfinance and bank linkages - Micro finance lending and control act in Andhra
Pradesh - Objectives and important features.
9. Schemes for financing weaker sections - Differential interest rate (DIR) - Integrated rural
development programme (IRDP) - Swarnajayanti gram swarozgar yojana (SGSY) - Self help
groups (SHGs) etc., Srinidhi, MUDRA.
10. Higher financing agencies - Reserve Bank of India (RBI) - Objectives and functions and
role in agricultural development and finance. National Bank for Agricultural and Rural
Development (NABARD) - Origin, functions, activities and role in agricultural development.
11. World Bank (WB) - Objectives and functions -World Bank group institutions - role and
functions of International Bank for Reconstruction and Development (IBRD) - International
Development Agency (IDA) - International Finance Corporation (IFC), MIGA, ISID.
12. Crop insurance - Meaning and its advantages and limitations in application - Agricultural
insurance company of India - Objectives and functions - Indemnity - Meaning, premiums and
claims - Prime Minister’s Fasal Bhima Yojana (PMFBY) - Salient features - Weather based
crop insurance - Salient features and its importance.
13. Agricultural project - Meaning, characteristics of agril. projects, project cycle and
explanation of different phases of project cycle - Basic guidelines for preparation of project
reports.
14. Co-operation - Meaning, Scope, importance and definition - Principles - Objectives of co-
operation, significance of cooperatives in Indian agriculture.
15. Brief history of cooperative movement development in India - Recent developments in
Indian cooperative movement - Short comings of Indian co-operative movement and
remedies.
16. Agricultural Cooperative institutions in India - co-operative credit structure in India and
Andhra Pradesh – Objectives and functions of state level (APCOB), district level (DCCB)
and Village level (PACS) cooperative societies - Functions of marketing, consumer societies,
multi-purpose cooperatives, farmers’ service cooperative societies, dairy cooperatives -
Andhra Pradesh mutually aided Co-operative Societies Act (1995) - Role of International
Cooperative Alliance (ICA), National cooperative Union of India (NCUI), National
Cooperative Development Council (NCDC).
Practical
1. Estimation of credit requirement of farm business – A case study.
2. Estimation of scale of finance - Unit costs and KCC.
3. Determination of most profitable level of capital use.
4. Analysis of progress and performance of priority sector lending by commercial banks,
Cooperatives, RRBs and non-institutional sources using published data. Working out
different repayment plans with examples.
5. Lump sum repayment /straight-end repayment - Variable or quasi variable repayment.
6. Amortized decreasing repayment plan and amortized even repayment plan.
7. Estimation of indemnity for crop insurance claims.
8. Visit and study of a commercial bank to acquire firsthand knowledge of their management,
schemes and procedures of lending and sanction of loans.
9. Visit and study of a cooperative bank - PACS/ DCCB to acquire firsthand knowledge of
their management, schemes and procedures of lending and sanction of loans.
10. Visit and study of a cooperative society - dairy/ consumers to acquire firsthand
knowledge of their management, schemes and activities.
11. Preparation and analysis of balance sheet – A case study.
12. Preparation and analysis of income statement – A case study.
13. Appraisal of a loan proposal – A case study.
14 -16. Techno-economic parameters for preparation of projects - Preparation of bankable
projects for various agricultural products and value added products.
required for agriculture, the way necessary funds are raised and the pattern of utilization of
funds so raised.
Definitions
Murray (1953) has defined agricultural finance as an economic study of
borrowing funds by the farmers or the organization and operation of farm lending agencies
and of society’s interest in credit for agriculture.
Tandon and Dhondyal (1962) defined agricultural finance as a branch of
agricultural economics which deals with the provision and management of bank service
and financial resources related to individual farm units.
Warren F. Lee et al defined Agricultural Finance as the economic study of the
acquisition and use of capital in agriculture.
The following are implied in the above definitions of agricultural finance:
- All the farmers should be provided requisite finance
- Finance should stimulate and enhance the productivity of farm
scarce resources
- Farm finance has a vital and catalytic role for agro-economic
development of farmers
Nature, Scope and Significance of Agricultural Finance
Agricultural finance is viewed both at macro level and micro level. Macro finance
deals with the different sources of raising funds for agriculture as a whole in the economy and
it is also concerned with the lending procedures, rules, regulations, monitoring and
controlling procedures of different agricultural credit institutions. Thus macro finance
pertains to financing agriculture at the aggregate level. On the other hand micro finance refers
to the financial management of the individual farm business unit and fit is concerned with the
study as to how the individual farmer considers various sources of credit, quantum of credit
to be borrowed from each source and how he allocates the same among the alternative uses
within the farm. It is also concerned with future use of funds.
In sum, macro finance deals with the aspects relating to total credit needs of the
agricultural sector, the terms and conditions under which the credit is available and the
method of using the total credit for the development of agriculture. On the contrary, micro
finance refers to financial management of the individual farm business.
Muniraj (1987) “farm finance is the money extended to the farmers to stimulate the
productivity of the limited farm resources. It is not a mere loan or credit or advance, it is an
instrument to promote the well-being of the society. Farm finance is not just a science to
manage the money, but is an applied science of allocating scarce resources to derive the
optimum output. It is a lever with forward and back ward linkages to the economic
development both at micro and macro levels. Thus the role of farm finance in strengthening
and development of both input and output markets in agriculture is crucial and significant.
Indian agriculture is still traditional, subsistence and stagnant in nature, hence
agricultural finance is needed to create the supporting infrastructure for adoption of new
technology. Massive investment is needed to carryout major and minor irrigation projects,
rural electrification and energisation, installation of fertilizers and chemical plants, execution
of agricultural promotional programmes and poverty alleviation programmes in the country.
Importance of Agricultural Finance
Credit is essential for agricultural development and also for the development of the
economy as a whole. The agricultural finance is required for the following reasons:
i) The scope for extensive agriculture in India is limited. Therefore,
increase in agricultural production is possible only by intensification and
diversification of farming. Intensive agriculture needs huge capital.
ii) Extreme inequalities exist in the distribution of operational holdings and
operational area. The purchasing power of the small and marginal farmers
Lecture No..
AGRICULTURAL CREDIT- MEANING, DEFINITION AND CLASSIFICATION
Definition
Loans are certain amount of money provided for certain purpose on certain conditions
with some interest which should be repaid sooner or later. It is also referred as credit.
Classification of Agricultural Credit
Agricultural credit is broadly classified based on purpose, time (repayment period),
security, generation of surplus funds, number of activities, approach and contact with the
farmers.
I. Based on purpose
1. Development credit or Investment credit: This is provided for acquiring durable
assets or for improving the existing assets. Under this, credit is extended for:
- purchase of land and land reclamation
- purchase of farm machineries and implements
- development of irrigation facilities
- construction of farm structures
- development of plantation and orchards
- development of dairy, poultry, sheep/goat, fisheries,
sericulture, etc
2. Production credit: is given to increase the production of crops. Here, the loan
amount is used for purchasing inputs and for paying wages. These are also called
seasonal agricultural operations (SAO) loans or short term loans or crop loans.
These loans are repayable within a period of 6-18 months in lump sum.
3. Marketing credit: These are meant for helping the farmer to overcome distress
sales and market the produce in a better way. Regulated markets as well as
commercial banks based on the warehouse receipt are extending financial
assistance to the farmers in this regard, by advancing 75 per cent of the value of
the produce. This enables the farmer to clear off their loans and dispose the
produce at remunerative prices.
4. Consumption credit: Any loan advanced for the purpose other than production, is
broadly categorized as consumption loan. It appears to be unproductive loan, but in
fact, it indirectly assists in more productive use of crop loans and investment loans.
II. Based on time
This classification is based on the repayment period of the loan component.
1. Short-term credit: these loans are to be paid back within a period ranging from 6
to 18 months. All crop loans are said to be short term loans, but the length of the
repayment period varies according to the duration of the crop.
Examples
- purchase of seed - sowing - fertilizer application - plant protection - payment of wages to labourers
It serves as the working capital to operate the farm efficiently and is
expected to be repaid at the time of harvesting / marketing of crops.
2. Medium-term credit: these loans are extended for a period of 15 months to 5
years. These loans are required by the farmer for bringing about some
improvements on his farm by way of
- purchasing implements
- electric motors
- milch cattle
- sheep and goat
i. Personal security : borrower himself stands as the guarantor. It is advanced on the
farmers promissory note. Third party guarantee may or may not be insisted upon.
ii. Collateral security : it is the property that is pledged to secure a loan. The movable
properties of the individuals are offered as security.
- LIC bonds
- Fixed deposit bonds
- Warehouse receipts,
- Jewellery
- Machinery
- Livestock
iii. Chattel loans : these are specific type of loans with particular category of lenders.
Loans obtained from pawnbrokers by pledging movable properties such as:
- Jewellery
- Utensils made of various metals
iv. Mortgage : as against collateral security, immovable properties are presented for
security purpose.
There are two types of mortgages, viz. simple and equitable.
a. Simple mortgage : this is done by the banking institution, when the
borrower’s property is inherited from the ancestors. In this process
the farmer- borrower has to register his property in the name of the
banking institution as the security for the loan obtained. This process
entails registration charges to be borne by the borrower.
b. Equitable mortgage : this applies to self acquired property. In this
case there is no such registration because the ownership rights are
clearly specified in the title deeds in the name of farmer-borrower.
Hence documents will be obtained from the borrower as security by
the institutional agency.
v. Hypothecation : this happens in the case of tractor loans and machinery loans etc. under
such loans the borrower will not have any right to sell the equipment until the loan is
cleared off. The borrower is allowed to use purchased machinery or equipment so to
enable him pay the loan instalment regularly.
Hypothecated loans are further categorized in to key loans and open loans.
a. Key loans : the agricultural produce of the farmer borrower will be kept
under the control of the lending institutions and the loan is advanced to
the farmer. As and when the loan is repaid the produce will be handed
over to the farmers. Such facility prevents the farmer from resorting to
distress sales.
b. Open loans: this is another name for hypothecated loans, in which the
physical possession of the purchased machinery rests in the hands of
the borrower, but the legal ownership rights remain with the lending
institution till the loan is cleared.
2. Unsecured loans: based on confidence between the borrower and lender the loan
transactions take place. There is no mention of any type of security here.
IV. Based on liquidity
Under this type the loans are classified in to self liquidating loans,
partially liquidating loans or non liquidating loans.
i. Self liquidating loans: the income generated through these loans helps the farmer
to repay the entire loan amount in the same season or year of obtaining loan. The
productivity increase of the loan is direct in this case.
Example: short term loans or crop loans
ii. Partially liquidating loans or non liquidating loans: the income generated through
these loans helps the farmer to repay the part of the loan component only. In other
i. Direct loans: these are advanced directly to the farmers by the institutional agencies.
Examples: ST loans and Term loans
ii. Indirect loans: the institutional agencies directly do not finance the farmers, but
indirectly benefit the farmer by financing enterprise activities.
Examples
- Financing fertilizer manufacturing companies
- Financing construction of ware house
- Market yard
Lecture No.
CREDIT ANALYSIS
The technological break-through which revolutionized Indian agriculture made it
capital intensive. In our country most of the farmers are capital starved necessitating the
institutional agencies to provide the needed capital base through credit. The farmers need the
credit at right time from the right agency to derive maximum productivity out of it. On the
other hand when the farmer approaches an institutional agency with a proposal for loan, the
banker should be convinced about the economic viability of the proposed investment.
Economic feasibility tests of credit
Credit Appraisal is the process by which a lender appraises the credit worthiness of the
prospective borrower. This normally involves appraising the borrower’s payment history and
establishing the quality and sustainability of his income.
Three basic financial aspects are assessed by the banker
- If the loan is advanced, will it generate returns more than the costs
- Will the returns have surplus, to repay the loan when it falls due
- Will the farmer stand up to risk and uncertainty in farming
These three aspects are popularly known as Three Rs’ of credit, which are as follows:
i. Returns from the investment
ii. Repayment capacity the investment generates
iii. Risk-bearing ability of the farmer – borrower
I. Returns
This is an important measure in the credit analysis. The banker needs to have an idea
about the extent of returns likely to be obtained from the proposed investment. Returns
depend up on the decisions like what to grow, how much to grow, when to sell, where to sell
etc., which the farmers take in their production activities. The main concern in this is the
farmer should be able to generate incremental income when they go for the additional cost to
be made good by the borrowed funds. We can apply partial budgeting technique.
By getting a loan amount of Rs.4500 and Rs.4600 in kharif and rabi seasons respectively,
the farmer can switch over from improved varieties of paddy to high yielding varieties of
NPW =
∑
t = 1
n
B
t
− C
t
1 + r
n
Where,
Bt = Benefits in n
th
year
Ct = Costs in n
th
year
n = Life span of the project
r = Interest or discount rate
If the NPW of a project is positive, then it is considered that the project is
economically feasible, while zero NPW makes the investor indifferent.
2. Benefit-Cost Ratio (BCR)
Here, we compare the present worth of costs with present worth of benefits. Absolute
value of the B-C ratio will change based on the interest rate chosen. While ranking the
projects depending upon the B-C ratio, the most common procedure of selecting projects is,
to choose the projects, having B-C ratio of more than one, when discounted at opportunity
cost of capital. Finally, the given project is opted for implementation, among alternatives
based on the highest B-C ratio.
The BCR can be calculated by using the following formula:
∑
t = 1
n
B
t
( 1 + r )
n
BCR =¿
∑
t = 1
n
C
t
1 + r
n
To compute the NPW and BCR, the opportunity cost of capital (normal/market
lending rate) may be used as a discount rate. If the BCR is greater than 1, then it is
worthwhile to invest on the project.
3. Internal Rate of Return (IRR)
IRR is that rate of discount which makes the present worth of benefits and costs equal or the
net present worth of cash flow equal to zero. The IRR of a project is used as a benchmark in
measuring the profitability of potential investments. IRR for a project gives the measurement
at what rate the project will give return to the capital. If IRR is greater than the opportunity
cost of capital, the project is feasible. The IRR must be foundout by trial and error wuth some
approximation.
In the working procedure, an arbitrary discount rate is assumed and its corresponding NPW is
arrived at. The positive NPW value of the project indicates that IRR is still higher and the
next assumed arbitrary IRR value must be comparatively higher than the initial level. This
process is continued until NPW becomes negative. Then by interpolation method the exact
IRR is found out using the following formula
IRR =
∑
t = 1
n
B
t
− C
t
( 1 + r )
n
II. Repayment Capacity
Repayment capacity means the ability of the farmer to clear off the loan obtained for
production purposes within the time stipulated by the bank. The loan amount may be
productive enough to generate additional income to the borrower, but may not be productive
enough to repay the loan. Hence the necessary condition here is that the loan should not only
be profitable but also have potential for effecting repayment. The estimation of repayment
capacity varies from crop loans (self liquidating loans) to term loans (non-liquidating loans
or partially liquidation loans). In the case of self liquidating loans the repayment capacity is
as follows.
Repayment capacity = Gross income –(working expenses excluding crop loan + family
living expenses +other loans due+ miscellaneous expenditure + crop loan)
In respect of partially liquidating loans or non-liquidating loans, the repayment capacity is
estimated in the following manner
Repayment capacity= Gross income –(working expenses including crop loan + family living
expenses +other loans due+ miscellaneous expenditure + annual instalment due for term
loan)
Causes of poor repayment capacity:
- Small size of land holding
- Low productivity and production
- Low prices and fluctuations of prices for agricultural commodities
- High family expenditure
- Using farm credit for unproductive purposes
- Low farmers equity
Repayment capacity under risk= Deflated gross income –(working expenses excluding crop
loan + family living expenses +other loans due+ miscellaneous expenditure + crop loan)
The coefficient of variation is measured by the formula:
CV =
Standard deviation
Mean
Standard deviation
SD
∑
t − 1
n
( Xi − x̄ )
2
n − 1
Measures to strengthen risk bearing ability:
- Developing owners equity
- Developing moral character
- Reducing farm and family expenditure
- Taking up stable and reliable enterprises
- Providing ability to borrow in both good and bad periods
- Creating ability to earn money and save money
- Taking up crop and other insurance
Lecture No.
Five Cs of credit
Next to the “Three Rs” the other tests that can be applied to study the economic viability of a
scheme or investment activity are Five Cs viz.
- Character
- Capacity
- Capital
- Condition
- Commonsense
Character
The basis for credit transactions is the trust, the trust that the banker has on his borrowers. No
doubt the bank insists up on security for any loan, even then, the element of trust has greater
say in the mind of the banker, before he takes a decision in considering the proposal of a
prospective borrower. It means the mental as well as moral character of the borrower.
Generally people with good mental and moral character will have good credit character.
Capacity:
This is related to the capacity of an individual to clear loans when they fall due. It is
synonymous with the repayment capacity. It largely depends up on the income obtained in
the farm business ie., C=f(Y), where, C = Capacity and Y= Income
Capital
Capital implies availability of money with the farmer –borrower, when character and capacity
proved to be inadequate. It represents the net worth of the individual. It is related to
repayment capacity and risk bearing ability
