New model for bank finance for rice production
There are many compelling reasons for banks in Sri Lanka which are the biggest providers of finance to the private sector to assume a major role in providing finance for paddy cultivation.
According to the Central Bank 2016 annual report, total loans and advances given by all commercial banks in Sri Lanka as at December 2016 was Rs.4.715 trillion. Of this amount a sum amounting to Rs. 425 billion or 9 per cent of total advances was given for agriculture and fishing. This includes all loans and advances to the tea, rubber, coconut and fisheries industries and all agriculture related activities. The amount given for cultivation of paddy is not separately shown and one can assume that the amount involved is less than one per cent of total loans. Most paddy related loans given by the two state banks are mainly for post-production paddy marketing rather than for paddy cultivation.
File pic of pepper being laid on a field in between rice harvest periods.
Considering the fact that Sri Lanka needs to strengthen its rice production capability so that the country can achieve and maintain self-sufficiency in food production, and considering the fact that paddy cultivation employs about 60 per cent of rural labour, the paddy production sector is of significant strategic importance to the economy of the country.
It is most unfortunate however that banks have chosen to remain uninspired in lending support for paddy cultivation and have further chosen to treat this very vital sector of the economy, the way wealthy urban folk view their poor country cousins; with disdain and whose existence they do not want even to see.
Let us examine dispassionately some of the issues involved in paddy cultivation:
1. Sri Lanka is a naturally gifted country for agricultural development. Its reliable rainfall patterns and the immense potential its topography provides for water storage in irrigation tanks and reservoirs and the ability of stored water to be distributed over long distances via gravity based irrigation channels, makes the country an ideal model for extensive development in agriculture. Much of the land mass is arable and cultivation of food crops has been a forte of the local farming community from very ancient times.
2. The population density of the island is very high and the need to feed its people is therefore a major responsibility of the state. A stated goal of the country is to achieve food security and this has come very close to being achieved as a result of all stakeholders working in unison to realise this goal. The weak link in the chain however are banks who have so far chosen, sadly, to watch all the unfolding events from the pavilion.
Risks in financing paddy cultivation
Banks tend to treat agriculture finance as high risk lending stemming from the assumption they make that the entire cultivation process is very weather dependent.
Actual events on the ground however have clearly shown that this fear psychosis is impulsive and factually incorrect. An analysis of real events in food production, both locally and globally and empirical evidence worldwide proves a food production pattern of steady growth. The probability of crop failure in agriculture, in managed irrigation areas, is perhaps not any higher than the average incidence of business failure in non-agricultural sectors.
The assertion that paddy cultivation is heavily rain dependent in this country is a fallacy. The country has made huge strides in water management techniques for paddy cultivation with irrigation engineering commissioning several mega reservoirs throughout the country for large scale water storage.
In the 1950s Sri Lanka had a population of around eight million people and the country did not produce sufficient food to feed the people. The country was heavily dependent on imported rice especially from China under the Rubber Rice pact and we were also heavily dependent on imported wheat flour given to us as US Aid under the PL 480 programme. The population today has increased to around 20 million plus and fortunately and very surprisingly the country is now on the threshold of self-sufficiency in food.
This proves one thing for sure and beyond any doubt; our island nation given the necessary support, has the potential not only to achieve food security but can also become a major rice producer in the region with strong export potential.
An alternate approach: Forward purchase agreements
From the banks’ perspective, the risk perception of loans for paddy cultivation can be significantly modified if the modality of giving money to cultivators is redefined. In the popularly understood and practiced model, loans are given for cultivation to the farmer which results in the bank also buying into all the glorious uncertainties of paddy cultivation.
What is perhaps required is a fresh approach and a new business model: A model defining a different role for banks.
In the model proposed here, banks would enter into a trading relationship with the cultivator and purchase in advance, an agreed quantity of paddy and pay the full purchase price in advance. This forward purchase agreement (FPA) introduces two noteworthy changes to the process of providing finance to the farmer.
Firstly, the banks’ credit assessment will focus on the ability of the farmer cum seller to fulfil his delivery obligation under a contract of sale.
Secondly, the farmer as a seller of paddy is obliged to deliver the contracted amount of paddy either from his field or from any other source on the contracted delivery date regardless of any uncertainties in the cultivation process. This business model for agriculture finance is not new. It is as old as the hills. The people in the Arabian peninsula practised this system for thousands of years and continue to use it even today.
They called this mode of finance “SALAM” and developed in parallel a whole body of law specifying the rights and obligations of the two parties to the forward sale contract.
The objective of the forward purchase model is to provide working capital to cultivators in advance, to help pay for all cultivation and pre-harvest expenses.
What is important to remember is that the financier is not dependent on the seller for the production of the contracted goods, but is dependent on his ability to deliver goods as specified in the sale agreement. If the seller is unable to produce the quantity required for delivery, he is contractually obliged either to procure the goods in the open market and effect delivery or repay the money taken on the contract of forward sale if he is unable to fulfill his delivery obligations.
Comfort zone
A financing arrangement on a forward purchase platform has many attractive features to paddy farmers. Traditional paddy production is usually full of uncertainties. Unpredictable weather conditions, price uncertainty at the time of harvest or disposal of the harvested paddy at the end of the cultivation cycle at a reasonable price, etc can cause a lot of anxiety to heavily indebted and impoverished farming communities.
In the proposed model, price and delivery uncertainties are totally non-existent. The cultivator is now in a very privileged position of knowing the selling price of his harvest, prior to the commencement of the cultivation process and also receiving the entire sale proceeds in advance.
Delivery arrangements are also pre-agreed. The quality, quantity of goods sold forward, the mode and place of delivery are also contractually agreed in the forward sale contract. From a cultivator’s perspective, this arrangement is indeed a source of great comfort.
Banks and paddy trading
Banks are in the business of dealing in money. Commodity trading, especially paddy, is a speciality in which banks are unlikely to have all the required expertise.
It would be prudent for banks who wish to use this business model to enter into a strategic partnership with reliable and experienced paddy merchants/millers. The miller/merchant would be the active third player in the proposed business model. They will be the party who will purchase forward from the bank on deferred payment terms, the consignment of paddy that the farmer will deliver to the bank under the first forward sale contract. The two contracts need to be stitched up end to end so that the bank can confine itself to its primary role of financier. The miller/merchant must also play an advisory role for the bank when the forward purchase contract is being negotiated and concluded with the farmer, especially on determining the forward purchase price.
The cost of funds in this model is factored into the price. The two contracts, the first between the bank and the farmer, and the second between the bank and the miller would be signed simultaneously.
Banks have a social contract with people and country. Under this contract banks have been accorded a very privileged position of being the custodians of the wealth of the citizens of this land. They also enjoy oligopoly privileges of garnering deposit funds from the public which is a favour they alone enjoy.
The flip side of this contract obliges banks to extend financial support to development initiatives which profoundly affect the quality of life of the people. The nation’s food security ranks as the single most important initiative affecting the people’s quality of life. Security from food shortages, malnutrition and famine is a fundamental right of every human being. Banks must discharge this contractual obligation as a matter of utmost national importance. Under the social contract, people have entrusted their wealth to banks not to be used only for the narrow purpose of maximising profits by lending only to trade and industry. Banks are also obliged to help to maximise cereal production from the limited arable land that our country has at its disposal.
Banks must not perceive food production as just another hunting ground for amassing profits. They must instead treat agriculture finance as a major expression of social responsibility arising from the social contract they have with the people and country.
( The writer is a Commerce Graduate of the University of Ceylon, an Associate of the Chartered Institute of Bankers, London with over 40 years’ experience in senior banking positions in Sri Lanka and abroad)