Banking Article, Banking Finance 2020, Banking Finance July 2020

Agriculture Value Chain Financing

Banks are not only dealing with money; they are also catalytic agents in Accelerating the growth and development of different sectors of the economy. In a developing economy which is suffering from inadequacy of capital, certain sectors and sections of the society need special and priority attention in the matter of funds availability.

The need of flow of credit to certain sectors of the economy known as priority sectors can be traced to the Reserve bank‘s credit policy for the year 1967-1968. Several changes are made (2015) in Priority sector lending norms by the RBI after the working group (2014) recommendations. The priority sector non-achievement will be assessed on quarterly average basis at the end of the respective year from 2016-17 onwards, instead of annual basis as at present. Among all priority sector, Agriculture is the most important sector. Agriculture is a source of livelihood for about half of Indian population.

The environment for agricultural finance is further influenced by the growing concentration of control in the agricultural sector. Driven by gains from economies of scale and globalization of the food chain along with access to resources, multinational and other interconnected agribusinesses have a greater impact in a sector that is characterized by increasing vertical and horizontal integration.

Concept of value chain

 A Value Chain in agriculture describes the range of activities and set of actors that bring agricultural product from production in the field to final consumption, wherein at each stage value is added to the product. Value chains may include a wide range of activities.

Value Chain (VC) involves the sequential linkages through which raw materials and resources are converted into products for the market. Agricultural Value Chain (AVC) identifies the set of actors (private, public, including service providers) and a set of activities that bring a basic agricultural product from production in the field to final consumption, where at each stage value is added to the product. It may include production, processing, packaging, storage, transport and distribution. Stages of Value Chain given below in fig-1

Agricultural Value Chain Finance (AVCF) is thus, the flows of funds to and among the various links within the AVC in terms of financial services and products and support services that flow to and/or through VC to address and alleviate constraints, and fulfil the needs of those involved in that chain, be it a need for finance, a need to secure sales, procure products, reduce risk and/or improve efficiency within the chain and thereby enhance the growth of the chain.

The various financial instruments which are often used in AVCF can be classified according to Three Categories shown below:

Category Instrument
A.   Product financing Trader credit: Traders advance funds to producers to be repaid, usually in kind, at harvest time.
  Input supplier finance: An input supplier advances agricultural inputs to farmers (or others in the value chain) for repayment at harvest or other agreed time.
  Marketing company credit: A marketing company, processor or other company provides credit in cash or in kind to farmers, local traders or other value chain actors.
B.            Receivables financing Trade receivables finance: A bank or other financier advances working capital to agribusiness (supplier, processor, marketing and export) companies against accounts receivable or confirmed orders to producers.

Factoring: Factoring speeds turnover of working capital and provides credit-risk protection, accounts-receivable bookkeeping and bill collection services.

Forfeiting: A specialized forfeiter agency purchases an exporter‘s receivables of freely negotiable instruments (such as unconditionally guaranteed letters of credit and ―to order‖ bills of exchange) at a discount, improving exporter cash flow, and takes on all the risks involved with the receivables.

C.      Physical asset collateralization Warehouse receipts finance:

Farmers or other value chain enterprises receive a receipt from a certified warehouse that can be used as collateral to access a loan from third-party financial institutions against the security of goods in an independently controlled warehouse.

 

 

 Risk for Banks in Value chain Finance and its Mitigation

Type of

Risk

description Risk Mitigation Measures
Production

risks

These arise from a variety of factors (input                                   supplies, lacking or late                             credit, low quality standards, improper storage and packing, weather risks, diseases, etc.) By employing a comprehensive chain approach that looks beyond the borrower to the health of the chain, the bank is better informed about the capacity of the chain partners and linkages, including producers‘ capacity to ensure adequate supply in terms of quantity and quality
Supply risks This refers to situations where producers (farmers) may not honour their contractual supply Obligations. A commonly

Observed problem in contract Farming is ―side-selling, which derails the built-in repayment mechanisms for farm credits.

Strong producer organizations (farmers ‘cooperatives) and/or Group solidarity systems (mutual guarantees based upon savings) provide some assurance that contracts will be honoured and the risks of ―side-selling Minimized.
Finance risks These relate to the non                       repayment of credit provided to

Farmers, other producers or other value chain actors.

Non-repayment of credit to chain actors can be greatly reduced by incorporating a lead Actor considered trustworthy. Such actors help instil and Ensure accountability.

 

Marketing risks These relate to the inability to sell on time, in the right

Quantities and/or at an Acceptable quality standard.

Fixed contracts throughout the chain help stabilize turnover, especially when dependence on One market can be avoided.

Sales or export agreements are a strong asset in negotiations with financiers, especially when they are also financing other agribusinesses within the value Chain.

Climate risks These relate to shocks produced by weather, such as droughts or Floods. Weather shocks can trap farmers and households in poverty, but the risk of shocks also limits farmers‘ willingness to invest in measures that might boost their productivity and Improve their economic situation. Agricultural insurance, including weather index insurance, has shown potential to help smallholders; input suppliers manage low- to medium frequency covariate risks such as Drought or excess rainfall.

 

Benefits of agriculture value chain finance

There are multiple benefits which flow from successful value chain financing arrangements. Through its ability to reduce risk and enhance incentives, value chain finance can enable the sustainable delivery of services, for example ensuring that farmers, brokers and wholesalers have continuous access to a line of products they need that are delivered in a timely manner and meet certain specifications.   A successful arrangement can often provide a demonstration effect which may prompt larger-scale players and formal financial actors to enter into a new market once the investment opportunities are realized.

Suggestion to improve value chain finance in agriculture

  • The development goals of the government and/or bank must be clear before Decisions can be made about the target group, region or sector, and value chain-specific considerations.
  • Identification proper value chain and activities.
  • Designing effective interventions requires an appreciation of the structure and dynamics of the target value chain. Ensure that value chain analysis is conducted and that the study involves an analysis of the value-added potential in the chain.
  • AVCF is a comprehensive, holistic approach rather than simply a single instrument or ―recipe‖ to be followed.
  • Promoting the development of promising value chain finance strategies and business models.
  • An active player in the chain, such as a farmers‘ marketing organization or a Processing company can take the lead in streamlining the value chain, thus Providing a degree of chain governance.
  • Costs and risks can be lowered by providing financing through the strongest Actor or actors in the chain.

Conclusion

The Agriculture Value chain finance is one of way to encourage agriculture and priority sector lending. The awareness about the Value chain finance among the staff is inadequate which needs to be strengthened. In India lot of agriculture value chains are operating Viz. AMUL, Mahagrapes, Kesla poultry, and contract farming from PepsiCo. Instead of financing individual participant in value chain integrated approach should be followed. If we look for scope in India we find that there are vast opportunities available like Dairy, Poultry Fishery, goat and sheep, sugarcane industry and lot more. Value chain finance has an important place in agricultural finance that augments, but does not replace, conventional finance; most important is its comprehensive, structured and market-competitiveness approach, which complements conventional finance, increasing access to capital and reducing risk for both clients and financiers.

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