Misuse of Agricultural Loans

Misuse of Agricultural Loans

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Misuse of Agricultural Loans

Introduction

During the FY 2013-14, the agriculture sector contributed 13.9% of the gross domestic output and employed 54.9% of the country’s workforce. But, modernisation of the sector continues to remain a challenge and future productivity increases will depend upon conversion of even small land holdings into profitable ventures through introduction of innovative technology.

A New Sunrise

Ajay Parida, Executive Director of M.S.Swaminathan Foundation has been quoted as saying “Unless agriculture is made remunerative and attractive, it would be difficult to retain youth in the field.” Indian agriculture could be revolutionised by devising productive implements - tailor-made for use on small holdings -, producing high-quality seeds, tapping existing water resources to reduce dependence on the monsoon, etc. Agriculture has the potential to be the newest sunrise industry.

Priority for Agriculture

Agriculture has long been a priority sector for extension of loans by banks. To comply with directions of the Reserve Bank of India (RBI), domestic commercial banks must extend 40% of annual credit to the priority sectors. The sub-target for lending to agriculture is 18%. The shortfall in fulfilling prescribed targets is taken into account by RBI while considering grant of regulatory clearances and approvals that may be sought by banks which fail to achieve the targets. While stipulating the targets, RBI has made it clear to banks that end use of funds is to be diligently monitored to guard against diversions for unauthorized use. For this purpose, banks are expected to implement appropriate internal controls and systems.

Crop Loans: Commercial banks lead the way

Crop loans are a major exposure of commercial banks to the agriculture sector and contribute to meeting the priority sector lending target. Crop loan disbursements were estimated at Rs.70,000 crore during the year 2012-13. Of this, nearly 80% to 90% was extended by commercial banks.

Why Crop Loans are Risky?

Why Crop Loans are Risky?
Why Crop Loans are Risky?

Agriculture output is unpredictable because of deficit rains, unseasonal rains and pest attacks, prices volatility and post-harvest losses. The risk of default by farmers in paying installments of interest and principal of crop loans is high.

The Impact for Banks

The lending bank has mandatorily to refrain from accounting the interest income on the outstanding loan once that account is classified as sub-standard. A provision, out of the profits, is also to be made for the sub-standard loan. Needless to say, this is not a situation that brings any cheer to the lending bank.

Agricultural Gold Loans: The Plan

Agricultural Gold Loans are disbursed by banks to persons engaged in agriculture or allied activities. The applicant is required to produce evidence of farming activity; a revenue record such as 7/12 extract establishing the ownership of farmland is one such evidence that banks readily accept. The owner is not required to mortgage the land. The loan is extended against pledge or hypothecation of gold ornaments. The Loan to Value ratio is at the discretion of individual banks and may be 75% to 80% of the assessed value of the jewelry. The scheme envisages that the loan will be deployed to meet crop production expenses or investment expenses related to agricultural or allied agricultural activity. The payback period is 1 year where the loan is extended as production credit and 3 years where the loan is released for investment purposes.

An Analysis

Banks mounting NPAs
Banks mounting NPAs

Banks mounting NPAs

Driven by a target oriented approach, commercial banks have been rapidly increasing their farm sector exposure. Given the vulnerability of the sector and the known inability of these Borrowers to face adverse financial situations, there has, perhaps inevitably, been a sudden escalation in the contaminated portfolio of banks. Non-Performing Assets (NPA) of private and public sector banks in the agriculture sector moved north from Rs.71.49 billion in 2009 to Rs.302 billion in 2013. As a percentage of outstanding of the agriculture sector, NPA climbed disturbingly from 25.57% to 41.88%. Significantly, the level of NPA in the agriculture sector and the acceleration in growth was much higher than for other priority sector segments such as loans to micro and small enterprises, housing, education. exports, etc.

Agricultural gold loans: What’s happening

What, if any, could be the connection between crop loans and agricultural loans? Banks are usually reluctant to make the necessary provisions because of the adverse impact that they have on its profits, capital adequacy ratio, net NPA / net advances and its credit rating. They are, therefore, encouraging farmers to avail themselves of agricultural gold loans. The funds released against these loans are used for payment of dues of crop loans. This tantamounts to evergreening of the crop loan in default. But, the arrangement is a win-win one for both the borrower and the lender. The borrower avoids a default situation and spoiling of his credit record. The bank shows a higher level of loan business and recovery.

City residents turn farmers
City residents turn farmers

But, beside farmers, banks engaging in unethical business practices have not been shy of extending such loans even to urban residents (pretending to be farmers) who own a plot of agricultural land and have jewelry to pledge. Such business contributes to achievement of the priority sector target, and is safer and less likely to slip into default.

The Money finds its way to Deposit Accounts

Agricultural Loans to Deposit accounts
Agricultural Loans to Deposit accounts

Agricultural gold loans are sanctioned at an interest rate of 9% per annum. A default free track record entitles the Borrower to interest subsidy of 2% per annum and interest rate subvention of 3% per annum (provided by the Government exchequer) making the effective interest rate 4% per annum. The result is that the Borrower laughs all the way to the bank as he deposits the loan amount in a deposit account that fetches him around 8% per annum; an arbitrage opportunity that is simply too good to be refused.

Bankers Speak

The bank view point is summed up by a Patna-based branch manager who is reported to have stated, “It is being promoted as quick loan. Also, we will not be bothered if they will repay or not as the gold collateral is already there.” An official working with the National Bank for Agriculture and Rural Development (NABARD) is quoted as having said, “It is win-win situation for borrower and branch. Borrower gets cheap money which is parked for interest income and branch gets to book loan and also raise liabilities. This is a business done without serving the purpose and that too at cost to exchequer - public money from budget of governments”.

Private Sector Banks want it too

Banks in the private sector have also shown considerable interest in operating the scheme. Eligibility for interest subsidy is expected to create “a level playing field…” But, operation of the scheme is not a feasible proposition for private sector banks because they are unable to assure credit to the farmers at an end rate of 4% per annum which is the direction of the Government of India. A banker from the private sector has said that, “For that to happen, some refinancing facilities must be made available from institutions like Nabard”. Private sector banks are unable to sanction these loans at low rates given their present resource mix. PSU banks have an advantage and can offer low sanction rates because of the refinance facility available to them from NABARD

The Road Ahead

Reserve Bank of India knows

RBI to crack down on malpractices
RBI to crack down on malpractices

The whispers of misuse of agricultural loans are cause for concern. RBI is not unaware of the hanky-panky in the banking world and has started an investigation to identify and close loopholes and crack down on malpractices. A representative of RBI has been quoted as having said that, “The central bank has already done preliminary work on flow of loans to agriculture and intends to carry out detailed examination”.

What’s wrong is wrong

There is virtually zero monitoring of the end use of these loans. This is a violation of RBI instructions and an invitation to diversion of funds. Whether Banks are physically unable to monitor the end use or are deliberately turning a blind eye to the misuse of funds is irrelevant. The critical factor is that these funds come from the public exchequer, the taxpayers, really speaking you and me. RBI must, therefore, enforce accountability for the misuse.

But Crop Loans must continue

Crop loans are a praiseworthy initiative and notwithstanding the clamour for an end to directed lending, its role in supporting a key sector of the economy cannot be over-emphasised. Such loans are estimated to constitute 30% of the credit extended to agriculture and for agriculture allied activities and 50% in the Southern states. The misappropriation of disbursements must be viewed as a national loss since no productive use is made of the funds.

In Conclusion

Modernising agricultural technology is a priority and the youth of today have the capacity to be the torch-bearers of change. But, the present atmosphere is more likely to discourage rather than to attract talented and capable youth to the agriculture sector. The time has come for concerted and decisive action by the Government of India and the Reserve Bank of India to compel banks to clean up their acts and ensure adherence to good governance standards, and sovereign and regulatory instructions, in both letter and spirit, while implementing strategies designed to upgrade the agriculture sector.

Bibliography

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Randolph Rowe is a professional banker and former General Manager of Small Industries Development Bank of India (SIDBI). He brings with him the wealth of 34 years of all-round experience in the banking sector - comprising 12 years with IDBI and 22 years with SIDBI - which he combines with his flair for writing.

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