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ABSTRACT: Banks are in the business of managing risk, not avoiding it..

Risk is the fundamental element that drives financial behaviour. Without risk, the financialsystem would be vastly simplified. However, risk is omnipresent in the real world.Financial Institutions, therefore, should manage the risk efficiently to survive in this highlyuncertain world. The future of banking will undoubtedly rest on risk management dynamics.Only those banks that have efficient risk management system will survive in the market in the long run. The effective management of credit risk is a critical component of comprehensive risk management essential for long-term success of a banking institution. Credit risk is the oldest and biggest risk that bank, by virtue of its very nature of business,inherits. This has however, acquired a greater significance in the recent past for various reasons. Foremost among them is the wind of economic liberalization that is blowing across the globe. India is no exception to this swing towards market driven economy.Better credit portfolio diversification enhances the prospects of the reduced concentration credit risk as empirically evidenced by direct relationship between concentration credit risk profile and NPAs of public sector banks. A banks success lies in its ability to assume and aggregate risk within tolerable and manageable limits. In India, agricultural risks are exacerbated by a variety of factors, ranging from climate variability and change, frequent natural disasters, uncertainties in yields and prices, weak rural infrastructure, imperfect markets and lack of financial services including limited span and design of risk mitigation instruments such as credit and insurance. These factors not only endanger the farmers livelihood and incomes but also undermine the viability of the agriculture sector and its potential to become a part of the solution to the problem of endemic poverty of the farmers and the agricultural labour. The criticality of agriculture in the rural transformation and the national economy seen along with its structural characteristics require substantial governmental and financial sector interventions not only to ensure household food and nutritional security of the farming community but also to generate savings and investments in this grossly underfunded sector. The poor penetration and development of various risk management tools in the country also represent the huge opportunities for the emerging agricultural insurance and commodity markets to pull the producer from out of the poverty trap by insulating him from income shocks and by ensuring that a fair share of the price goes to the producer. Making a strong case for moving risk management solutions towards a sustainable actuarial regime as also harnessing the technological advances in climate science, remote sensing technologies and ICT in developing early warning systems, increasing the effectiveness of instruments for pooling, sharing and transfer of risks, enhancing the coping capabilities of the farmers and other mitigation measures has therefore guided the careful formulation of this Report.

Credit Risk, that is, default by the borrower to repay lent money, remains the most important risk to manage till date. The predominance of credit risk is even reflected in the composition of economic capital, which banks are required to keep a side for protection against various risks. According to one estimate, Credit Risk takes about 70% and 30% remaining is shared between the other two primary risks, namely Market risk (change in the market price and operational risk i.e., failure of internal controls, etc.).Quality borrowers (Tier-I borrowers) were able to access the capital market directly without going through the debt route. Hence, the credit route is now more open to lesser mortals (Tier-II borrowers). With margin levels going down, banks are unable to absorb the level of loan losses. There has been very little effort to develop a method where risks could be identified and measured. Most of the banks have developed internal rating systems for their borrowers, but there has been very little study to compare such ratings with the final asset classification and also to fine-tune the rating system. Also risks peculiar to each industry are not identified and evaluated openly. Data collection is regular driven. Data on industry-wise, region-wise lending, industry-wise rehabilitated loan, can provide an insight into the future course to be adopted. I Introduction Risks associated with agricultural credit are a universal problem, and not specific to any single country. Compared to industry and service sector activities, agriculture is usually a weaker sector, forcing most governments worldwide to be following a system of support for promotion of agriculture and protecting the interest of the farmers. The degree and the extent of credit risks in agriculture, however, vary according as the level of economic development of nations and the state and structure of agrarian economy within the overall economy. Nature of commodities produced is yet another differentiating factor. In this paper, we shall discuss the problem of agricultural credit risks with reference to the situation in the Indian agriculture, and suggest the mitigation strategy keeping the Indian farmers in mind. But before that a few general observations about the sources of risk in agriculture credit may be relevant. The enterprise of agriculture is subject to a great many uncertainties. Yet, more people in India earn their livelihood from this sector, than from all other economic sectors put together. In rural India, households that depend on income from agriculture (either self-employed or as agricultural labour), accounted for nearly 70% of the population(estimates from Survey of Consumption Expenditures, National Sample Survey,1999/00).Seventy five percent of all rural poor, are in households that are dependent on agriculture,in some way or other. Households that were self-employed in agriculture, account for 28% of all rural poor, while households that were primarily dependent on agriculture as labour, account for 47% of all rural poor. Agricultural risk is associated with negative outcomes that stem from imperfectly predictable biological, climatic, and price variables. These variables include natural adversities (for example, pests and diseases) and climatic factors not within the control of the farmers. They also include adverse changes in both input and output prices. To set the stage for the discussion on how to deal with risk in agriculture,its essential that the different sources of risk that affect agriculture are classified.

Objective of the Study: The main objective of the study is to have a bigger picture of how banks manage their credit risk. Thus attention is geared towards: To understand why and how banking credit risk exposure is evolving recently. To examine how proper credit risk management can result in better performance in Indian banks. To study the different methods adopted by Indian banks to efficiently manage their credit risk. To suggest some measures through which banks can manage their credit risk in a better way and improve their performance.

Literature Review S.Rajagopal, "Bank Risk Management - A risk pricing model", State Bank of India, Monthly Review, VoI. XXXV, No.11, November 1996, p.555. He commented on risk management in relation to banks. He opined that good risk management is good banking. A professional approach to Risk Management will safeguard the interests of the banking institution in the long run. He described risk identification as an art of combining intuition with formal information. And risk measurement is the estimation of the size, probability and timing of a potential loss under various scenarios. V.T.Godse, "Conceptual Framework for Risk Management", I.B.A, Bulletin July 1996, p.22. He revealed the two separate but simultaneous processes involved in risk management. The first process is determining risk profile and the second relates to the risk management process itself. Deciding risk profile is synonymous with drawing a risk picture and involves the following steps. 1. Identifying and prioritising the inherent risks 2. Measuring and scoring inherent risks. 3. Establishing standards for each risk component 4. Evaluating and controlling the quality of managerial controls. 5. Developing risk tolerance levels. He opined that such an elaborate risk management process is relevant in the Indian context. The process would facilitate better understanding of risks and their management. Mal1.C.P. and Singh J.P, "Managing Lenders risk in the agricultural credit to the form business sector", The management accountant monthly, Vol. 39, No. 10, October 1988, p.725.They emphasised the importance of diversification and introducing flexibility to reduce risk. They stated that diversification reduces risks on the one hand and increases the possibility of large gains on the other. They also reviewed insurance as a way-out for reducing the risk. The immense schemes help transfer of risks to the insurance companies, especially applicable in agricultural business. Seema Shukla, "Don't Risk it, Manage it",The Economic Times, Dossier, Vol. 39, No. 99. May 14th 1999. She is of the view that the risk can be managed whether it be political, commercial or technological. But 'mathematical risk management' has not yet been fully

applied across all sectors of companies,the concept is still evolving world-wide. She commented that risk management comes into focus due to the uncertainty that prevails in the business environment. It has developed more in countries whose economies are deregulated and privatised, as opposed to economies like India, which are in the process of opening up. However, once risks are identified, they are measured and managed. She concluded that the risk function has to form the basis for decision- making. Indu Salian, "Risk Management of Financial sector", The Express Investment Week, weekly, February 8-14, 1999, p.10.He reviewed risk management of the financial sector. She opined that managing financial risk systematically and professionally becomes an important task, however difficult it may be. A11 risks are to be monitored within reasonable limits. He revealed that tested risk control systems are today available virtually off the shelf and can be made universally applicable with a little bit of judgement and modification. While discussing on financial sector reforms introduced in 1992-93 and its effect on risk management, he revealed that reforms would necessarily have transition risks and volatility. And margins will get squeezed and the cushion to absorb risk will get reduced. Then management of risk requires strong risk control. He concluded that if we are able to manage the transition phase of the reforms and upgrade our infrastructure for improved risk management capabilities, we are certain to come out ahead. Raghavan.R.S, "Risk Management in Banks", The Hindu, Daily, Vol. 123, No. 272, November 16,2000, Business p.4.He reviewed the need for a risk management system, which should be a daily practice in banks. He opined that bank management should take upon in serious terms, risk management systems, which should be a daily practice in their operations. He is very much sure that the task is of very high magnitude, the commitment to the exercise should be visible, and failure may be suicidal as we are exposed to market risks at international level, which is not under our control as it was in the insulated economy till sometime back. S L Shetty (1978), "Performance of Commercial Banks since Nationalisation of Major Banks: Promises and Realty." Economic and Political Weekly, Vol. XI1 No. 31, 32 & 34, August, pp. 1407-1451. He observed that the share of medium and large industry in total bank credit had declined due to priority sector lending. Another observation in line with his earlier finding was that growth in bank credit had always been disproportionate to growth of their physical output, especially in industries like cotton textiles. In line with these observations, he suggested policies to scrutinise credit claims vigorously and relate credit to the genuine production requirements so that funds are not tied up with these large borrowers.

Methodology: To fulfil the objectives of my study I have taken into consideration secondary data. The data is collected from the Magazines, Annual Reports, Internet, Text books, etc. The various sources that were used for the collection of secondary data are o Internal files & materials o Websites-various sites like www.sharekhan.com www.indiainfoline.com www.investopedia.com www.wikipedia.com & other sites

Chapterisation: I. Introduction 1.1 Abstract 1.2 Briefing about the topic 1.3 Objectives 1.4 Literature Review 1.5 Methodology II General Remarks on Agricultural Credit Risks III Agricultural Credit system in India IV Rural Household Indebtedness in India V Some Broad Observations Strategy VI Inclusive Banking: Technology as an Enabler VII Innovative & Structured Rural Financing VIII Observations & Recommendations IX Conclusion X References

Types of Risk (i) Production risk:Agriculture is often characterized by high variability of production outcomes or,production risk .Unlike most other entrepreneurs, farmers are not able to predict with certainty the amount of output that the production process will yield due to external factors such as weather, pests, and diseases. Farmers can also be hindered by adverse events during harvesting or threshing that may result in production losses. (ii) Price or Market risk:Input and output price volatility is important source of market risk in agriculture. Prices of agricultural commodities are extremely volatile.Output price variability originates from both endogenous and exogenous market shocks.Segmented agricultural marketswill be influenced mainly by local supply and demand conditions, while more globally integrated markets will be significantly affected by international production dynamics. In local markets, price risk is sometimes mitigated by the natural hedge effect in which an increase (decrease) in annual production tends to decrease (increase) output price (though not necessarily farmers revenues). In integrated markets, a reduction in prices is generally not correlated with local supply conditions and therefore price shocks may affect producers in a more significant way. Another kind of market risk arises in the process of delivering production to the marketplace. The inability to deliver perishable products to the right market at the right time can impair the efforts of producers. The lack of infrastructure and well-developed markets make this a significant source of risk. (iii) Financial & Credit risk:The ways businesses finance their activities is a major concern for many economic enterprises. In this respect, agriculture also has its own peculiarities. Many agricultural production cycles stretch over long periods of time, and farmers must anticipate expenses that they will only be able to recuperate once the product is marketed. This leads to potential cash flow problems exacerbated by lack of access to insurance services, credit and the high cost of borrowing. These problems can be classified as financial risk. (iv) Institutional risk:Another important source of uncertainty for farmers is institutional risk, generated by unexpected changes in regulations that influence farmers activities. Changes in regulations, financial services, level of price or income support payments and subsidies can significantly alter the profitability of farming activities. This is particularly true for import/export regimes and for dedicated support schemes, but it is also important in the case of sanitary and phyto-sanitary regulations that can restrict the activity of producers and impose costs on producers. (v) Technology risk:Like most other entrepreneurs, farmers are responsible for all the consequences of their activities. Adoption of new technologies in modernizing agriculture such as in introduction of genetically modified crops causes an increase in producer liability risk. (vi) Personal risk:Finally, agricultural households, as any other economic entrepreneur, are exposed to personal risks affecting the life and the wellbeing of people who work on the farm, as also asset risks from floods, cyclones and droughts and possible damage or theft of production equipment and any other farming assets. II General Remarks on Agricultural Credit Risks Agricultural credit risks emerge from a number of factors. We define risks in terms of farmer s ability to repay loans advanced to them. Also, though in developing economies farmers tend to depend a lot on non-institutional sources of credit such as local moneylenders, we would consider only the institutional sources of credit. The non-institutional credit providers usually thrive on the risks and change unusually high rate of interests. The menace associated with credit from such sources is well known. But that

is not an issue that we are addressing here. Our concern is about risks of non-recovery of institutional loans. In India, one of the objectives of bank nationalization in 1969 was to ensure increased availability of credit to agriculture, and free the farmers from the strangulating hold of the private (usually local) money lenders.Accordingly,the commercial banks were advised to allocate a certain percentage of lendable resources for the purpose of providing adequate loans to this sector. Further, thrust was also laid on Expansion of bank branches in rural areas. Going back to the issue of risks, the central issue is that of the ability to repay, and the purpose of the loan. So far as the purpose is concerned, again a general observation can be made. One can broadly talk of three types of requirements of loan in the farming community. First, there is pure consumption loan, whereby the farmers borrow money for non-asset creating purposes such as marriages, social obligations and even pure selfconsumption. This is typical of most developing economies,including in India. Second,the farmers need loans to meet the requirements of the current production,such as purchase of seeds, chemical inputs, and other running expenses. This, we may call production loans. Third, there is need for capital formation, and the farmers may need loan for purposes such as purchase of capital assets (tractors, harvesters, thrashing machines,etc).

Consumption Credit

Types of Agricultural Credit


Production Credit

Credit for Assetbuilding

Needless to say, consumption credit has high risk proneness. Particularly, if consumption is not related to production in any way and loan for this purpose is generally unproductive. Risks of default are exceptionally high. The risk is all the more high, when the farmers do not have enough capacity to save. Usually, demand for consumption credit is high in families with low or nil savings. It may be mentioned that since institutional credit providers usually shy away from consumption loans, the farmers usually take recourse to unorganized sources, and this explains the phenomenon of high dependence of the farmers on the money lenders, and high incidence of indebtedness in the developing economies in general. Production loan is essentially working capital loan, and the farmers ability to repay such loans depends on a number of factors such as cost of loan, yields,cost of production,net revenue/ hectare etc. Cost of production in agricultural operations may be broadly put as: Cost of Production = (rent on land) + (input cost) + (Manpower Cost) + (Interest Cost)

Similarly, revenue is a function of price received by the farmers at the time of disposal of the produce (ex-farm or farm-gate price) and the quantity sold. If there is excessive demand for self-consumption, the quantity sold reduces. This point assumes importance in overall understanding of the issue of agricultural credit risks. Farmers ability to repay loan depends on the size of the cash income that accrues to him. A farmer with large self -consumption needs will have less cash income which we may define as: Net Cash income= [price*quantity sold in the market] Cost of Production If the farmers do not have enough quantity to sale in the market, i.e. if they suffer from poor level of commercialization, they will have limited ability to repay loans. Two other factors are also important in this context. One, there is the yield factor. Higher the yield, higher should be the size of saleable (marketable) surplus and higher the cash income. Second important factor is cost of production and farm-gate price of the product. Farmers ability to repay loan commitments depends on movements in these factors. In the absence of effective governmental interventions, any of the factors can seriously affect the farmers ability to repay loans. Risk of default in loan repayment is relatively less in the case of loans for asset creation, since such loans are usually syndicated loans and are supposed to improve productivity and enhance efficiency. However, even then farmer s ability to repay does not depend entirely on productivity. It depends on his ability to generate adequate income. Typically, a farmer encounters innumerable problems, over which he has little control. Mention may be made of monsoon conditions, market conditions etc.Also pattern of asset class distribution of farmers, etc, for instance, have much to do with agricultural credit risks. III Agricultural Credit system in India The system of agricultural credit in India has come a long way since independence and especially since the drive for self-sufficiency in production of food grains was launched in mid 1960s. In what follows, we shall briefly capture the developments and initiatives launched by the government to augment credit supply to the farmers, before we go into the issues and dimensions of risks in Indian agriculture. Before independence, and during the British Raj, the need for agricultural credit was met by co-operative credit societies, which were the only sources of institutional credit. These societies were brought within the legal ambit, when in 1904 Cooperative Societies Act was passed by the government of British India.This ensured legal recognition to cooperative societies. The Reserve Bank of India Act of 1934, under its Section 54, required RBI to set up an agricultural credit department which would look into the entire issue of credit needs of the farmers. Since its establishment in 1935, the RBI was strongly focused on reinvigorating the Cooperative Credit Societies and building a viable co-operative credit structure. However, the progress in spread of credit had remained poor, as credit through cooperative societies was meager, with only 3.3% of the farmers having access to credit from cooperatives and negligible 0.9% having access to credit from commercial banks. The problem of the farmers access to institutional credit continues to persist throughout the 1950s and 1960s. This meant that the farmers were highly dependent on non-institutional, informal sources of credit, i.e. moneylenders who charged exorbitantly high interest rates, besides collaterals in the form of fixed assets, giving rise to the problem of indebtedness and the menace of bonded labourers in the process. It is one of the factors that had motivated the government to go into social control of banks in 1966, and subsequent nationalization of commercial banks in 1969. Agriculture was declared a priority sector for disbursement of loans by commercial banks. Earlier in 1963, the RBI had established Agricultural Refinance Corporation to provide funds by way of refinance.

Under the concept of priority sector lending, the banks were required to deploy a certain percentage (40% including 18% for agriculture) of their net bank credit to designated priority sectors such as agriculture, small scale enterprises, economically weaker section etc. Since then, there has evolved a multi-agency structure of institutional credit for agricultural operations namely cooperative credit societies, Regional Rural Banks (1977), commercial banks, etc. The National Bank for Agriculture and Rural Development (NABARD) was set up in 1982 as an apex institution to provide re-financing facilities to rural financial institutions. Since then, NABARD has been playing a key role in providing financial assistance and encouraging promotional efforts in the area of rural credit, besides guidance in policy formulation. It also administers the Rural Infrastructure Development Fund (RIDF), and has been playing a catalytic role in micro credit through self-help groups (SHGs). What is significant to note here is that with establishment of NABARD, the network of agricultural credit got a defined and organized structure, as shown below.

TIER I

Reserve Bank of India

NABARD

Commercial Banks

Regional Rural Banks

TIER II
Rural Cooperative Credit Institutions

Long Term Credit

Short term Credit

Since nationalization of banks in 1969 and continued effort of the government to facilitate spread of agriculture credit, there has been a significant growth in agricultural credit in the country, in absolute as well as in relative terms. Share of agricultural credit as a proportion of agricultural GDP was as low as 3.3% in 1960-61, but rose to 8.7% in 2001-02. In absolute terms, total direct institutional credit rose from Rs 711 crore in 197071 to Rs 41,385 crore in 2001-02.Share of borrowing from institutional sources had increased from 7.3% in 1950-51 to 31.7% in 1971 and over 66% in 1991. After 1991, however, there has been noticeable decline in the share of institutional debt in total outstanding cash debts of the cultivators from 66% to 61% in 2002, lower even than 63% in 1981. This had happened particularly in the case of cultivator households. Aggregate picture of total household debt shows an increase in share of institutional sources of debt from 60% in 1981 to 72% in 1991 and 75% in 2002. This is an issue that needs detailed understanding i.e. the issue of declining share of institutional debt in total outstanding debt of the cultivator households. IV Rural Household Indebtedness in India

The latest available information on the state of indebtedness of rural households is available from All India Debt and Investment Survey January-December 2003 (NSS 59th round, (NSSO,2005). We give below some of the broad and relevant highlights of the Survey as below: Rural households (Rhhs) accounted for 63% of total outstanding household debt of Rs 1,76, 795 crore Cultivator household (Chhs), accounting for nearly 60% of Rhhs, shared about 73% of the total debt of Rhhs, meaning Chhs have relatively higher dependence on debt. The Survey observed both the shares in terms of value of debt and households for cultivator households peaked at 93% in 1981, declined to 80% in 1991 and dropped to 7.3% in 2002. In absolute terms, amount of outstanding debt (Rs. crore) of Chhs, increased from 3374 in 1971 to 5737 in 1981, 17,668 in 1991 and 81, 709 in 2002, indicating growing incidence of indebtedness (IOI) among the cultivator households. Share of Chhs/self-employed hhs in total debt of all hhs, though on the decline, was still high at 73.3% in 2002. Also, this decline is due to the fact that share of chhs in total hhs itself has been on the decline from 76.3% in 1981 to 54.7% in 2002. In rural areas, the overall IOI is very high at nearly 27%, compared to about 18% in urban areas. In distribution of IOI to institutional and non-institutional credit in 2002 is shown below: Distribution of IOI(%) Institutional Rural Urban Overall 13.4 9.4 26.5

Non-Institutional 15.5 21.4 17.8

It is also observed that rural households in the higher asset size class have higher IOI against loan from institutional agencies compared to credit from non-institutional agencies, but this again is due to the fact that in higher asset class access to institutional loan is much better compared to those in lower asset class where debt/ asset ratio in 2002 was 20.12%. See the following figure, while overall debt/ asset ratio in 2002 was 2.84%, the ratio is found to decline with increase in asset size. According to the Survey, both the average value of assets and average amount of institutional debt systematically increased with asset holding class. Finally, it is to be noted that the IOI among rural households is not uniform throughout the country and has wide variations among the states. Very high rural IOI (un-institutional) is observed in the states of Kerala, Maharashtra, Karnataka, Orissa, Haryana and Andhra Pradesh. Andhra Pradesh tops the list of IOI- affected states with 42.3%, mainly because of high IOI in the state with non-institutional agencies (32.9% against all India average of 15.5%). Other states where institutional agencies havent made much headway are: Rajasthan, Bihar and Tamil Nadu. The cultivator households, it may be mentioned, still have high dependence on noninstitutional agencies (especially money lenders) for their debt needs. In 2002, such agencies accounted for 39% of outstanding cash debt for the chhs. However, the non-cultivator household s dependence on non-institutional agencies was even higher at 54%. Overall, in rural areas, non-institutional agencies continue to be large players in the indebtedness scene, with a share of 43% in 2002. Among the institutional agencies engaged in the business of credit supply, co-operative societies, followed by commercial banks, play the major part, while the money lenders play major role among the non-institutional players, followed by relatives and friends. Without going into further accounts of rural indebtedness, we start with the basic premise that is well-established by the Household Debt Survey 2002. i. There is high incidence of indebtedness among rural households, especially among the cultivators ii. The indebtedness exists, even as the sources of credit are institutional iii. The spread of institutional agencies only resulted in shift of indebtedness from noninstitutional agencies, but does not have much impact on the level and incidence of indebtedness. On the contrary, there has been a steady growth in IOI with institutional agencies. For the cultivators, however, dependence on moneylenders remain very high V Some Broad Observations Strategy The strategy for reduction of incidence of indebtedness among the rural households has been attracting the attention of government of India for quite sometime now, and various schemes are also afloat for this purpose. In this paper, where focus is on a strategy for mitigating the credit risks in agriculture, we need not go into the initiatives launched for reduction in IOI. The point before us is this- the fact of high (and perhaps growing) IOI shows that agricultural credits are highly risk-prone and recovery of loans is doubtful. Our concern is about mitigation of risks with a view to ensure better recoverability of credits. In what follows, we shall discuss some aspects of strategies for risk mitigation. The fundamental point that we need to keep in mind is that we are discussing the issue when the incidence is already very high, and, if one may say so, the problem is of gigantic proportion, if not unmanageable. It is therefore, imperative that we need to write down the existing indebtedness to the extent possible, and start with a cleaner slate.

The UPA government s policy for waiver of loans acquires a lot of credibility in this context. However, loan-waiver strategy is meaningful only when we are not going to repeat the mistakes of the past. Two points may be mentioned here: First, it is important to remember that good functioning of the agricultural credit system is a function of overall agricultural policy. Further agricultural credit system is not just about extending credit, but also about total efficiency and productivity of the system. Second, agricultural credit system, cannot, and must not, be looked at in isolation of the economy. Risks of agricultural credit, in our view, are minimum when the overall economy is efficient and healthy. It is easy to understand if we try to understand a simple question: Can the urban people, or the people in general, pay higher prices for food grains or other agricultural products? In broad terms, among other factors, farmers capacity to repay loans depends on the price he receives and the price he pays. That the farmers suffer income insecurity is a generalized truth in the developing economies, but in India the severity of the problem is a particular bane of Indian agriculture. Much of the causes of indebtedness lie in the phenomenon of income insecurity. If we have to evolve a strategy for mitigating the incidence of farm credit risk, particularly in the case of foodgrain farmers, we have to make this issue of income insecurity as the starting point. This insecurity arises from a number of factors of which instability in farm income is the most important. Stability in farm income depends on two factors, namely, stability of output and stability of prices that the farmers receive. Farmer s income is a function of the price he receives for the product he produces. But for the purpose of his ability to repay loans, there is yet another aspect, which is about the net income. With a Ceteris Paribus assumption, farmers real income, and increase in that, depends on, among other things, the input price, i.e. the price he pays for inputs he requires for production. Then there is also the issue of purchasing power of his net income. This is about the price he pays for purchase of his daily needs or maintaining his living standard. Importance of cost of inputs and inflation of goods and commodities that a farm household buys is not too difficult to understand. We need to look at the whole issue from the point of input price inflation on one hand and product price inflation on the other hand, and the movement in both the indices, which brings us to the issue of terms of trade. Without stretching the point too far, it can be said that price situation is a significant element that needs to be kept in mind in any strategy for mitigating credit risk for farms. A farmer must be able to repay his debt, and therefore, anything that has the potential to disturb the ability to repay has to be controlled. Thus, input prices have to be controlled and managed. Similarly, cost of living for farmers, which is usually expressed as Consumer Price Index (CPI) for agricultural labourers, has to be kept under control. Management of agricultural prices and management of inflation in rural areas thus assume a typical importance in the strategy for mitigation of farm credit risk. Unfortunately, this is not how we approach the problem. The general tendency is to look at the problem of credit risk in agriculture purely from the point of view of banking and interest rates. There is need for a change in strategy for a more holistic approach. If we acknowledge this, then it is easy to understand the imperative of agricultural reforms which would aim at first providing stability to farm income and then the imperative of growth in farm income.Without any measures to support the income and its growth, farm credit is bound to remain as risky as ever.

The Government of India has a plethora of schemes to support the farmers income and ensure prosperity of agriculture, but much of the strategy is centered around physical support and subsidies. The latter, in turn, is meant to provide inputs subsidies.Such subsidies do serve some useful purpose, in so far as it helps to control the cost of production. Similarly, the scheme of minimum support price (MSP) is intended to provide some guaranteed income. Even as these approaches are good and have helped in bringing Indian agriculture to its present level of development, it is observed that physical achievements in agriculture, such as increase in production, have been achieved with high and growing incidence of indebtedness among the farmers. It is felt that, and this needs to be considered seriously, subsidies may have to be reoriented to support income. In other words, shift from input subsidies and price subsidy to income subsidy may be looked at as an alternative. Similarly, for the purpose of mitigating the credit risk, it is felt that we have a re-look at the entire gamut of agricultural insurance scheme. A combined strategy of income subsidy and effective agricultural risk insurance strategy, in our view, may go a long way in mitigating credit risk in agriculture. In view of resource limitations, one can probably think of a multi-faceted approach, whereby in the first step one can try and identify those areas of agricultural production where credit risks are very high. While there is high and growing incidence of farm indebtedness, it is our view that not all households have the same level and incidence of indebtedness. So, we need a selective approach where special packages are evolved with households having very high exposure to incidence of indebtedness. A generalized approach must be avoided if we are thinking of result-oriented strategy.Broadly speaking, one can classify agricultural loss into two categories: farmers and non-farmers, and then with respect to farmers, one can go for further bifurcation between foodgrain farmers and non-foodgrain farmers or foodgrain farmers vis--vis commercial crop farmers, and then we should try and get a clearer picture of incidence of indebtedness in each of the categories. Probably, it is only then we would get to know where the problem is most acute. However having said this, a general point must be mentioned. This is about the question of degree of commercialization in Indian agriculture. A very clear picture of the level and extent of commercialization in Indian agriculture is not available.Even though a vague picture may exist, it is mostly based on an aggregate picture of some backdate period.There is hardly any sector / activities based picture with respect to commercialization.The real issue is this: in the current situation of well-being of farm households what is the maximum possible level of commercialization that is possible to achieve, and how far are we from that situation. What is needed right now is a strategy for greater commercialization of Indian agriculture.There is a very pertinent issue in this connection. Is India ready for commercialization of agriculture to the extent the market would permit, and much more important issue in this contention is whether India is open to the idea of necessary market orientation of its agricultural sector. Many would probably say that this is an issue which needs a political will, but probably that is not where the issue should be left. This question needs to be taken to other sectors of the Indian economy, as well namely, industry and services. The question is whether non-agricultural sectors are ready to pay the farmers the market price for the foodgrains and other food products. Are they ready to address this fundamental question of equitable terms of trade between agricultural sector and non-agricultural sector; the terms of trade that would meet the requirements of both non-agricultural economy and the agricultural economy in a mutually accommodative manner. This is the issue that has been

avoided, but has to be addressed in evolving a strategy to mitigate the credit risk in agriculture. It may be re-iterated here that credit risk in agriculture is not merely a banking issue but a much larger issue that probably can no longer be escaped, especially since the government has been talking of a strategy for inclusive-growth. This is not to suggest that that the banking has little or no role in mitigation of credit risk. On the contrary, commercial banks need to seriously address an important question of how is it that the reach of institutional credit to the farmers in particular, and rural areas in general, continues to remain rather limited. One needs to go beyond the issue of availability of lendable funds and into such issues as quality of lending from the point of view of the farmers. VI Inclusive Banking: Technology as an Enabler As in the case of life insurance or General Insurance, where Banks have played an important role in the distribution of insurance products, and remain integral to facilitating premium payments primarily through their branch and online network; banks will play an important role in enabling the delivery of Agriculture Credit & Insurance. One of the challenges in the business model for agriculture insurance is to evolve this delivery and financial transaction solution to farmers outside the service area of a bank branch. Technology has emerged an important enabler in facilitating this. On one hand, while banks can support the delivery of agriculture insurance and credit delivery; this is an opportunity significant need to complement these efforts with effort for an enhanced & comprehensive integration and participation in the formal banking and financial system. The efforts for Financial Inclusion need to be designed with a vision beyond just the percentage of the country population with access to a bank account or a no frills account; to focus more on how this can enhance the capability and convenience for the un-banked and under-banked, particularly the small and marginal farmers in this case, to enable greater transparency, accountability, efficiency and convenient access to necessary facilities. It is from this perspective that it is important for financial institutions to integrate across the entire Agri value chain. The challenge in this is the last mile delivery. Technology is redefining how this is emerging and cannot be ignored. While the brick-and-mortar model of branch expansion continues; technology has enabled quicker and wider access, at a relatively lower cost ; with the ultimate beneficiary being the end-user who can now participate in the formal system from the most distant and rural pockets, in some cases eliminating lengthy travel to a bank branch. The mobile telecom revolution in particular India has changed the way we need to look at this. Mobile phones for example, today have one the highest penetration levels with the rural population, higher than that of bank accounts and can serve as a medium of access for a much larger section of India s population. This is particularly relevant in efforts for delivery of agriculture insurance where a mobile based transaction facility for premium payments, could offer the convenience that defines whether or not a farmer would finally subscribes to this. Not only can mobiles be a medium for transacting in a cashless environment; the potential of mobiles to comprehensively deliver farmers a one-stop solution to several other needs of information and knowledge such as commodity prices, weather updates among others is behind its enhanced potential and acceptability. Some banks have already been making strides in this direction. YES BANK for example launched a commercial pilot of its innovative mobile payments platform in Pune (Maharashtra) and Chandigarh to facilitate customer convenience and encourage financial inclusion in India. Mobile Money Services by YES BANK in partnership with Nokia' would allow its mobile phone users to transfer money to another person by using the person s mobile phone number and also Top-up the prepaid card of any mobile services or pay postpaid mobile/land line and utility bills as well as cashless

shopping. A similar pilot effort is being attempted, using a mobile based platform for delivery of crop insurance to farmers by creating a enabling transaction environment for a farmer access such facilities through the most simplistic handset; leveraging technology to extend the convenience that will revolutionize the transaction environment for them. VII Innovative & Structured Rural Financing Since the early 2000s a number of organizations have developed innovative approaches to financing agriculture. They have sometimes adapted microfinance concepts to the provision of agricultural finance, used good banking practices, and above all drawn on knowledge of agriculture to enter and succeed in this market. Many of these new approaches show great promise, but no single approach works for all situations. Rather, organizations have the most success when they are non-dogmatic, apply comprehensive risk-management strategies and tools, retain the ability to pick and choose their clients rather than having the government do so, and are innovative and pragmatic.

CASE STUDY: YES BANK s financing to Nomadic Honey Bee Farmers As part of its efforts on financial inclusion in the state of Jammu and Kashmir,YES BANK structured an innovative rural financing solution of providing finance to over 2000 nomadic honey bee farmers. This structured and pioneering deal entailed extending financing of $3.5 million for a tenor of six months to small bee keeping nomadic farmers in north India by using a Ware House Receipt Based Structured Trade Finance Solution. YES BANK has created a structure whereby credit risk was transferred from the farmers to the stocks of honey kept in warehouses, to overcome the risk associated with doing business with small farmers. YES BANK enrolled Kashmir Apiaries Exports (KAE), a large honey processor and one of the largest exporters of honey from India. As a buyer, KAE extended a purchase commitment at a pre-determined price for the honey as supplied by various small farmers, providing YES BANK with greater credit enhancement for the commodity. This deal has helped over 2,000 farmers, providing individual loans of an average of just $500. The facility has provided farmers with immediate access to credit facilities at a reasonable interest rate of 11% per annum. The farmers were able to obtain higher selling prices for their honey stocks , and in turn KAE was able to increase its sales turnover becoming the number one Indian exporter of honey. The process included honey farmers brining their produce to the carefully selected warehouse premises, and depositing their honey to National Collateral Management Services , YES BANK's appointed collateral management agency. The collateral manager then assessed the quality and quantity of the commodity, monitored the stocks and issued storage receipts to the farmers. The ownership of the honey remained with the farmers . The stock receipts were submitted by the farmers to KAE, acting as the managing and collecting agent, and the loan documentation was completed and sent to YES BANK, with a minimum purchase commitment for a base price.YES BANK then released the loan funds equivalent to 70% of the collateral value on the same day directly to the farmers.The farmers could either repay the loan to the Bank after six months, by selling the stock to KAE or to another bidder.

CASE STUDY: HLL-ICICI-Rallis Tie-up to Provide Inputs, Credit and Assured Market to Farmers Contract farming in wheat is being practised in Hoshangabad, Madhya Pradesh by Hindustan Lever Ltd (HLL), Rallis and ICICI. Under the system, Rallis supplies agriinputs and know-how, and ICICI finances (farm credit) the farmers. HLL, the processing company, which requires the farm produce as raw material for its food processing industry, provides the buyback arrangement for the farm output. In this arrangement, farmers benefit through the assured market for their produce in addition to timely, adequate and quality input supply including free technical know-how; HLL benefits through supplychain efficiency; while Rallis and ICICI benefit through assured clientele for their products and services. What started out as a 1,000-acre project has now expanded to a whopping 5,000 acres. Encouraged by its success in Hoshangabad, the company set up new projects, including those for fruits at Bangalore, vegetables at Nashik and Basmati rice at Panipat. While there are different market-end partners for all three projects, including Food World for fruits and HLL for basmati rice, the credit agency for all three remains ICICI. Standard Chartered Bank has started something similar in Africa, where the contract farmers are financed depending on the value chain of the crop and not the farmer s assets.Balance sheet constraints have been replaced by growing opportunities for smaller farmers to gain financing, especially given the continuing boom in most commodity prices. The Structured Agricultural Finance schemes are slated to be brought to India in near future.

VIII Observations & Recommendations To conclude, the problem of credit risk in agriculture is a larger systemic issue, and solution of the problem requires a holistic approach. First , on broader basis, there is need for total re-examination of the entire gamut of agricultural policies in the country, with a view to identify the sources that cause, or may cause, indebtedness. Introduce necessary reforms/ policy changes. Second , it is imperative to encourage greater commercialization in agriculture, but commercialization would receive a big boost if focus is directed towards full scale development of infrastructure for markets. One specific point in this context that needs serious consideration is the need for more organized retailing of agricultural products. Third , it is equally important that the issue of effective risk insurance is adequately addressed. It is important to further cover the farm households that have high exposure to risk of defaulting in their loan repayments, especially those with smaller asset holdings. Risk insurance coverage has to be maximized. Fourth , so far as commercial banks are concerned, it is felt that mere expansion of bank branches in rural areas is not enough. What is equally important is that the farmers should be encouraged to access bank credits. The commercial banks may consider greater use of the concept of banking correspondents in rural and remote areas, not only for the purpose of loan marketing but also for better appreciation of the state of the farmers and their needs, besides better coordination of repayment of loans. Fifth , existing policies meant to support the farmers may be geared to ensure income stability and increase in real income of the farmers. They need to be protected against the risk of market failure and hazards. It has been observed that there is a greater challenge of promoting market economy principles while protecting the farmers against market risks. Development of efficient market infrastructure would go a long way if the same is developed as common properties. Sixth , for the purpose of ensuring growth in real income of the farmers it is imperative that special attention is paid to control inflation in rural areas. This is no doubt a difficult task, especially since the rural markets are highly unorganized. But such difficulty is encountered largely in the case of consumer goods that the farmers buy for daily needs. To start with, attention may be given to controlling the input price inflation. The Kishan Credit Card, introduced by the government in recent years, may be made more popular with affordable terms and conditions. Last but not the least; in the context of minimizing credit risks, it is a serious blunder to think of agricultural credit as one-off affair, especially in a situation of large incidence of poverty and poor bankability. Loans authorized and sanctioned should be monitored right from the beginning, with a view to ensure its appropriate utilization. It is important, therefore, that all loans above a certain threshold are properly monitored and mentored, for which an appropriate mechanism needs to be worked out. Without being authoritative on it, an approach has been conceived and bulleted below: i. Each bank having branches in rural areas can identify a cluster of villages ii. Assess the cluster from the point of its loan-ability and credit risks iii. Identify the requirements of each cluster in terms of activities, as also the nature of requirements iv. Appoint suitable mentor and guide for each cluster.While this is just an idea, the point that is highlighted and advocated is that provision of agricultural credit should be considered as a complete service to the primary sector and not in bits and pieces as credit for irrigation or rural household.

IX CONCLUSION: Credit risk management in today s deregulated market is a challenge. The very complexion of credit risk is likely to undergo a structural change in view of migration of Tier-I borrowers and, more particularly, the entry of new segments like retail lending in the credit portfolio. These developments are likely to contribute to the increased potential of credit risk and would range in their effects from inconvenience to disaster. To avoid being blindsided, banks must develop a competitive Early Warning System (EWS) which combines strategic planning, competitive intelligence and management action. EWS reveals how to change strategy to meet new realiti es, avoid common practices like benchmarking and tell executives what they need to know not what they want to hear. The reputation of a bank is very important for corporate clients. A corporation seeks to develop relationshi p with a reputable banking entity with a proven track record of high quality service and demonstrated history of safety and sound practi ces. Therefore, it is imperative to adopt the advanced Basel-II methodology for credit risk. The Basel Committee has acknowledged that the current uniform capital standards are not sensitive and suggested a Risk Based Capital approach. Reserve Bank of India s Risk Based Supervision reforms are a fore-runner to the Basel Capital Accord-II. For banks in India with the emerging markets tag attached to them going down the Basel-II path could be an effective strategy to compete in very complex global banking environment. Indian banks need to prepare themselves to be competed among the world s largest banks. As our large banks consolidate their balance sheets size and peruse aspirations of large international presence, it is onl y expected that they adopt the international best practices in credit risk management. .A banks success lies in its ability to assume and aggregate risk within tolerable and manageable limits.

X References 1) http://www.manage.gov.in/pgpabm/spice/March2k3.pdf 2) http://www.tata.com/innovation/articles/inside.aspx?artid=9yEcS/cM4Wc 3) http://wholesalebanking.standardchartered.com/en/mediacentre/pressreleases/Pages/05062007. aspx 4) Household Consumer Expenditure and Employment-Unemployment Situation in India NSS 59th Round (JanuaryDecember 2003) 5) Agricultural Credit in India: Status, Issues and Future Agenda*, RAKESH MOHAN, Reserve Bank of India Bulletin, November 2004 6) INDEBTEDNESS OF RURAL HOUSEHOLDS AS ON 30.6.1991, DEBT AND INVESTMENT SURVEY NSS FORTY-EIGHTH ROUND, January - December 1992 7) Recovery Management in Rural Credit by K.C. Sharma, R JOSHI, JC MISHRA, SANJAY KUMAR, R. AMALORPAVANATHAN, R. BHASKARAN, National Bank for Agriculture and Rural Development, Mumbai 2001 8) Report of THE WORKING GROUP ON RISK MANAGEMENT IN AGRICULTURE FOR THE ELEVENTH FIVE YEAR PLAN (2007-2012), Government of India, Planning Commission