Intent Versus Reality Incentivize banks, ease rate ceiling to boost farm credit

Amartya Lahiri & Dilip Mookherjee 

Promoting financial inclusion for po or farmers is a high priority for Indi an policy makers. Most rural poor are excluded from the ambit of the formal financial system, which raises their dependence on informal sources as well as exposure to financial distress. Despite various policy attempts at priority lending to poor farmers, progress on the ground has been very limited. Recent surveys suggest that over two-thirds of agricultural loans continue to originate in informal sources such as moneylenders and familyfriends with associated loan rates around 25%, compared to 12% charged on bank loans.Loans from micro-finance institutions (MFIs) and self-help groups (SHGs) are even more expensive with the 2011 Malegam Committee reporting an average rate of around 37% Stock Market Trading Tips

Given all the government programmes on priority lending, why is formal sector lending to farmers so limited? Also, why are the lending rates of MFIs double the rates of formal sector rates on agricultural loans? The inability to translate intent into reality suggests problems in the design and implementation of priority sector lending policies. Understanding this is a complex task. In this article, we try to figure out where the problem really lies, and what could be done to get around these problems. 

Most priority lending initiatives have centred on interest rate subvention schemes that aim to make credit available to farmers at low interest rates. The best known scheme gives banks a `subvention' on short-term crop loans up to Rs 3 lakh and caps the interest rate on these loans at 7%. There is a further 3% subvention to farmers who repay their loans on or before the due date of the loan, which lowers the interest rate to 4%. A related scheme aims to prevent distress crop sales by making loans to store post-harvest produce available to small and medium farmers at an interest rate of 7%. However, these policies are clearly not working as evidenced by the low quantities being lent and the high rates being charged Himanshu Tiwari Astrologer Blog

We speculate that the reason the subvention schemes are not working is that the mandated rates are set too low. Banks typically incur transaction costs of the order of at least 5-6% in processing and managing loans. Hence, if banks obtain capital at a subvented base rate of 4%, they need to charge around 10% just to break even. Clearly , loans at the 4% rate mandated by the subvention law imply losses for banks. Bottom-line pressures imply bank officials end up making very few loans directly to poor farmers. As noted earlier, a large share of priority sector lending from the banks goes indirectly through non-bank financial companies such as MFIs, apart from regional rural banks and cooperatives. The main attraction of the MFIs is that they typically make non-collateralized loans. Moreover, given the group liability structure of their loans, MFIs are often able to get around information and other problems that tend to make repayments of non-collateralized loans difficult for standard commercial banks. However, MFI loans have been expensive with interest rates of 30-50% being quite common. The Malegam Committee found that banks typically charge MFIs around 12% for funds lent through them, despite paying far lower rates to depositors and RBI priority lending lines.MFIs' staff costs and overheads amount to 14%, and provisioning for bad loans costs 2%. This amounts to a total cost of 28%. No wonder, then, that MFI interest rates are upwards of 30% Indian stock market astrology prediction

In light of the AP micro-finance crisis, the Malegam Committee recommended a cap on MFI interest rates of 24%, and a 10% cap on margins above the cost of capital. Clearly, most MFIs will not be able to break even if these caps were to be enforced. Whatever credit has been flowing to the priority sector will then dry up. 

Herein lies the Catch-22 characterizing rural sector lending policies. Direct lending by banks is hamstrung by the subvention laws, which mandate interest rates that are so low that the banks incur losses. And lending through NBFCs such as MFIs is constrained by the high costs MFIs incur in administering the loans, which in turn owes partly to the high rates that MFIs have to pay banks for these funds Share Market Astrology

What are the likely solutions? One route is to do away with the subvention restrictions on interest rates that banks must charge poor farmers. Then banks would be free to set rates that cover their costs. If banks could access priority sector funds at 5%, they ought to be able to lend profitably if allowed to charge interest rates up to 15%. The other alternative is to channel rural credit through NBFCs such as MFIs.However, the most cost-efficient of these institutions incur transaction costs of the order of 7-8%. So if they could also access priority sector funds from banks at roughly 5-6%, MFIs would also be able to break even if they charged borrowers 15%. 

More generally , interest rate ceilings often lead to credit being rationed by lending agencies. 

They create an appearance of helping poor farmers, but end up with opposite results. A more fruitful approach might be to give subsidies to banks to lower their cost of funds and then cap the margins that they can charge over this subsidized cost. Incentivizing lenders to provide farmers with credit is key. The subventions have just tended to squeeze farmers' access to formal credit. 

Amartya Lahiri is professor at University of British Columbia; Dilip Mookherjee is professor at Boston University Commodity Market Astrology Tips