Rural and Agricultural Financial Products and Services. Module 7

Rural and Agricultural Financial Products and Services Module 7

Rural Finance Module 7 Agenda Block 1 Introduction Different products and different target groups Term finance Block 2 Trader finance: Trader Credit and Out-grower Schemes Coffee Break Block 3 Trader finance: Benefits and limitations Block 4 Warehouse receipts schemes: Definition and actors involved Precondition and expertises needed Block 5 Review of the day by a participant volunteer Daily evaluation Readings for next day

Potential Rural and Agriculture Financial Flows Commercial Banks Medium and Large Exporters and Processors Non-Bank Financial Institutions Local Traders and Processors Grass- Roots MFIs NGOs, Coops Farmers Producer Producer groups groups High volume Medium volume Low volume Input Suppliers Household 2 (includes input supplier, and salaried work)

Rural Products for Differentiated Groups Products for farmers Investment loans Warehouse receipt loans Trader loans to the trader to the clients linked with trader informal arrangements Future options Index based insurance Products for non-agr. or transition rural households Multi purpose loans: microenterprise loans (flexible ME and, esp. working capital) Products for emergencies Flexible savings products Remittances Health insurance

Loan Product Diversity: farmers Term loans Trader loans Warehouse receipts schemes Leasing schemes

Loan Product Diversity: non agriculture or transition households Multipurpose loans Working capital loans Lines of credit Emergency loans

Definition Term finance - Time horizon: a distinction can be made between medium-term finance (from one to five years) and long-term finance (above five years). - Source of funds: internal or self-finance (through deposit, or other income sources of the farm household) can be distinguished from external finance using funds owned by third parties (through term loans, leasing or equity finance)

Products Term Finance Term loans: are the most widely used instrument because they can finance a wide range of investments and allow a considerable degree of flexibility in designing disbursement and repayment modalities. Financial lease: offers the advantage of reducing or even eliminating the need for additional collateral and the problems related to the creation, perfection and enforcement of security interests. Equity finance: by existing or new shareholders avoids fixed repayment schedules and costs.

Constraints in Term Finance Institutions Users - Cash flows - Risk vs. Increasing term - Match Short/long terms - Systemic risks - Higher amount - Risk vs. Investment purposes - Guarantees and collateral (no solidarity groups) vs. costs

Dimensions of Term Finance Dimensions of Term Finance Time horizon Source of Funds Financing Instruments Medium - term Finance Long-term Finance External Finance Self Finance - Term loans - Leasing - Equity

Innovations in Term Finance Potential for innovations - Collateralization - Product design - Role of non financial institutions - Role of donors

Trade Credit and Out-grower Schemes Trade Credit Short term or seasonal loans between buyers and sellers of inputs and products Out-grower Schemes Cash advances or inputs provided, tied to formal purchase agreements

Trade Credit and Out-grower Schemes Both may be in-cash advances; commonly are in-kind advances of inputs Trade Credit is more temporary and price-driven, common for commodities In Out-grower Schemes, salespurchase relationship is more formal buyer also provides marketing and technical assistance, common for high value specialty products

Trade Credit Bank Inputs Importer/ Wholesaler Exporter/ Wholesaler or Processor Large Scale Trader Input shopkeeper/ Small Scale Trader/ Farmer Organization Farmers Key Input sales Trade credit Trade / seasonal credit Product sales

Out-grower Scheme

Marketing and Financing Flows for Horticultural Produce in Asia FARMERS LOCAL ASSEMBLERS ASSEMBLY BUYER WHOLESALERS Commission agents SUB WHOLESALERS RETAILERS CONSUMERS

Marketing and Financing Flows for Rice in Asia FARMERS VILLAGE BUYER ASSEMBLY BUYER or MILLER S AGENT MILLERS LARGE WHOLESALERS RETAILERS SMALL WHOLESALERS CONSUMERS N.B. The chart represents a generalised view of flows of produce and finance in the region as a whole and does not apply to any particular country.

Sources of funds millers % of finance Own funds Family, relatives and friends Moneylenders Deferred payment to farmers/ traders Financial institutions Other Cambodia 73 13 12 2 India 41 59 - Myanmar 60 10 20 10 Nepal 30 60 10 Pakistan 15 13 63 9 Vietnam 20 10-67 3

Sources of Funds Fresh Produce Wholesalers (% of finance) Own funds Family, relatives & friends Moneylenders Deferred payment to farmer/traders Financial institutions Other Cambodia 65 25 10 India 45 10 40 5 Myanmar 60 20 20 Nepal 40 40 20 Pakistan 48 37 15 Philippines 57 43

Effective Cost of Marketing System Loans Practices vary widely and costs are difficult to assess. Estimates vary from nil to 300% p.a. (trader loans to farmers in remote Bangladesh) India payment by 15-30 day post-dated cheque; 2% discount if cash required by farmer Loan recipients may have to pay more for their inputs, accept lower output prices, have to accept delays in selling their products and accept less favorable payment terms Retailers may have to accept lower quality produce

Financial Linkages with Farmers Practice tends to grow as commercialization increases; Money flows both ways: from traders to farmers, in the form of inputs and consumption credit; from farmers to traders by accepting deferred payment; Deferred payment sums are greater but the duration is usually much less. In most cases traders are net lenders.

Benefits of Trade Finance Reduces marketing transaction costs and thus makes marketing more efficient Reduces risks by facilitating availability of supply and guaranteeing sales Reduces credit transaction costs because funds are circulated within the production-marketing system and borrowers do not incur costs of dealing with financial institutions

Trader Credit and Out-grower Schemes Benefits by product Benefits Cost-Effective Screening of Willingness to Pay Expanded Collateral Trader Credit Through personal relationships Future product Out-grower Scheme Through contractual relationships Future product/contract Appropriate terms, conditions Timing tied to product transactions; in-cash and in-kind Increased Yields Via increased inputs Via increased inputs and technical and marketing assist Lower Costs Higher Product Prices Through Bulk Purchases of Inputs Increased quality, bulk sales of high-value products Standards and Efficient Sales Market Access Technical Services Informal Some Through agreements Formal Common

Trader Credit and Out-grower Schemes Product Limitations Limitations Trader Credit Out-grower Scheme Bias to Larger Producers Expanded Outreach Monopoly/Unfair Pricing Preference more efficient Time needed for personal contacts Traders have bargaining power Economies of scale required for many high value crops High value producers only Captive relationship, checked by Side-Selling Enabling Environment over producers, checked by market info and trader competition Frequent, high default risk need for reliable product Closer monitoring Enforceable contracts

Warehouse Receipts Definition Warehouse Receipt: document listing goods or commodities kept in safekeeping in a warehouse; the warehouse receipt can be used to transfer ownership of the commodity, instead of physical delivery

Participants Warehouse Receipts Producers and traders who deposit commodities in warehouses Warehouse operators who provide secure storage and issue warehouse receipts Lenders who accept receipts as collateral Inspectors who certify that warehouse standards are met Insurers who insure contents against loss

Warehouse Receipts Benefits of Warehouse Receipts Result from Use Cost-Effective Screening Secured product, inspected warehouses of Willingness to Pay Expanded Collateral Appropriate terms, conditions Increased Yields Lower Costs Higher Product Prices Standards and Efficient Sales Secured product, legal receipts Receipts enable longer storage, delayed sales Reduced spoilage Sight unseen transactions, fungible product Bulk sales, extend sale season Sight unseen transactions through standards and security Market Access Technical Services Systematic through upgraded marketing process None

Map of Products, Receipts and Credit Transactions Exporter/ Wholesaler or Processor Inspection & Licensing Co. Insurance Co. Traders and Farmer Organizations Bank Warehouse Farmers Key Receipt Trade credit Trade / seasonal credit Product

Warehouse Receipts Preconditions Legal and regulatory requirements, rights and responsibilities of participants, title and transferability of goods, use of receipts for collateral Common accepted grades and standards Trustworthy certification and inspection service Market information systems Legal and regulatory expertise, contracts, commercial code, financial regulations Financial institution acceptance of instrument

Warehouse Receipts Expertise Needed Warehouse management, certification and inspection Commodity grades and standards Grain merchandising Legal and regulatory: title, collateral, negotiable receipts, warehouse inspection and certification Insurance Appropriate lending experience

Module 7 Rural and Agricultural financial products and services Thanks for the attention!!