Chapter 5

5.Agricultural Finance
Dear learners! What do we mean by the phrase agricultural finance? Or simply finance within
the context of agriculture?
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Definition: Agricultural finance is the provision of multiple types of services dedicated to

supporting both on- and off-farm agricultural activities and businesses including input
provision, production, and distribution, wholesale, processing and marketing.

The concise MC Graw- Hill Dictionary of modern Economics defines Credit as an

exchange of goods and services on the basis of promise for future payment.

Farm finance includes the principles of farm credits, the ways in which farmers make use of
credit and the activities of lending agencies. The word credit is derived from the Latin word
‘credo’ meaning I believe. It is viewed as the power to borrow which an individual possess.

5.1. Sources of agricultural finance

Dear learners, as a general case, sources for agricultural finance could be divided in two basic
categories. These are:

(i) Non-institutional sources.

(ii) Institutional sources

(i) Non-Institutional sources are the following:

(a) Moneylenders (d) Commission agents

(b) Relatives (e) Landlords

(c) Traders

(ii) Institutional sources:

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(a) Cooperatives (b) Scheduled Commercial Banks
(c) Regional Rural Banks (RRBs)

(a) Cooperatives:

(i) Primary Agricultural Cooperative Societies (PACSs) provide short- and medium-term
loans.

(ii) PCARDBs provide long term loan for agriculture.

(b) Commercial banks, including RRBs, provide both short- and medium-term loans for
agriculture and allied activities.

Hence the moneylenders exploited the poor farmers. Thus, they used to charge exorbitant
interest for their loans. The moneylenders used to manipulate their accounts and force the
farmers to sell their produce to them at low price. The government has therefore undertaken
various steps to regulate the activities of the moneylenders. The most important move was
to free the agriculturists from the clutches of the money lenders and the expansion of
institutional credit to agriculture.

5.2. Credit Worthiness Analysis

Well, creditworthiness implies creditor's judgment of a borrower’s current and future ability,
and inclination to honor debt obligations as agreed upon. It is usually based on the credit
history, credit rating, and character of the entity. It is the creditor’s measure of an individual's
(borrower’s) or company’s ability to meet debt.

Financial institutions attempt to mitigate the risk of lending to borrowers by performing a

credit analysis on individuals and businesses applying for a new credit account or loan. This
process is based on a review of five key factors that predict the probability of a borrower
defaulting on his debt. Called the five Cs of credit, they include capacity, capital conditions,
character and collateral. There is no regulatory standard that requires the use of the five Cs
of credit, but the majority of lenders review most of this information prior to allowing a
borrower to take on debt.

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Capacity: Lenders must be sure that the borrower has the ability to repay the loan based on
the proposed amount and terms. For business-loan applications, the financial institution
reviews the company's past statements to determine how much income is expected from
operations. Individual borrowers provide detailed information about the income they earn as
well as the stability of their employment. Capacity is also determined by analyzing the
number and amount of debt obligations the borrower currently has outstanding, compared to
the amount of income or revenue expected each month.

Capital: Lenders also analyze a borrower's capital level when determining creditworthiness.
Capital for a business-loan application consists of personal investment into the firm, retained
earnings and other assets controlled by the business owner. For personal-loan applications,
capital consists of savings or investment account balances. Lenders view capital as an
additional means to repay the debt obligation should income or revenue be interrupted while
the loan is still in repayment.

Banks prefer a borrower with a lot of capital, because that means he has some skin in the
game. If his own money is involved, it gives a borrower a sense of ownership and provides
an added incentive not to default on his loan. Banks measure capital quantitatively as a
percentage of the total investment cost.

Conditions: Conditions refer to the terms of the loan itself, as well as any economic
conditions that might affect the borrower. Business lenders review conditions such as the
strength or weakness of the overall economy and the purpose of the loan. Financing for
working capital, equipment or expansion are common reasons listed on business loan
applications. While this criterion tends to apply more to corporate applicants, individual
borrowers are also analyzed for their need for taking on the debt. Common reasons include
home renovations, consolidation or financing major purchases.

This factor is the most subjective of the five Cs of credit and is evaluated mostly
quantitatively. However, lenders also use certain quantitative measurements such as the
loan's rate, principal amount and repayment length to assess conditions.

Character: Character refers to a borrower's reputation or record vis-à-vis financial matters.

The old adage that past behavior is the best predictor of future behavior is one that lenders
devoutly subscribe to. Each has its own formula or approach for determining a borrower's
character, honesty and reliability, but this assessment typically includes both qualitative and
quantitative methods.

The more subjective ones include analyzing the debtor's educational background and
employment history; calling personal or business references; and conducting a personal

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interview with the borrower. More objective methods include reviewing the applicant's credit
history or score, which agencies standardize to a common scale. (See also "What
Is the Difference between the Five Cs of Credit and Credit Rating?")
Although each of these factors plays a role in determining the borrower's character, lenders
place more weight on the last two. If a borrower has not managed past debt repayment well
or has a previous bankruptcy, his character is deemed less acceptable than a borrower with a
clean credit history.

Collateral: Personal assets pledged by a borrower as security for a loan are known as
collateral. Business borrowers may use equipment or receivable to secure a loan, while
individual debtors often pledge savings, a vehicle or a home as collateral. Applications for a
secured loan are looked upon more favorably than those for an unsecured loan, because the
lender can collect the asset should the borrower stop making loan payments.

The roles of credit;

Credit is the key means to have access to inputs in any development program.
Credit can be used as an instrument for market stability.
Credit plays a key role in covering consumption deficit.
Financial institutions:

A) Formal financial institutions: are regulated by central bank supervisory authority

for licensing and credit policy implementations.
E.g. - Banks (private and government)

- Cooperatives

- Microfinance institutions (MFIs)

B) Informal financial institutions: operate outside the banking system and does not
follow government regulation.
E.g. Commercial money lenders.

- Non- Commercial money lenders.

Classification of Farm Credit:

Agricultural credit may be classified on the basis of:

(A) The purpose for which it is needed;

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(B) The length of the period for which loans are required; and
(C) The security against which loans are advanced.

(A) According to Purpose:

Following the Reserve Bank’s classification of agricultural credit by purpose, we may say
that such credit is required to purchase land to effect permanent improvements on it.

1. For Agricultural Purposes: such credit is needed for the purchase of seed, manure and
fodder, payment of rent, wages, revenue and other charges, irrigation of crops, hire
charges of pumps and purchase of water, purchase of live-stock. In addition, effecting
other land improvements; repairs of agricultural implements, machinery, transport
equipment’s, farm houses, cattle sheds, repairs of wells and other irrigation services;
laying of orchards; for reclamation of lands and construction of irrigation wells, tanks
and embankments; and other capital expenditure on agriculture.

2. For Non-Farm Business Purpose:

Such credit is needed for repair of production and transport equipment and furniture; current
expenditure in non-farm business; purchase, construction, and repair of building or non-farm
business; purchase of farm equipment and other capital expenditure on non-farm business.

3. For Meeting Family Expenditure:

Such credit is needed for purchase of domestic utensils and clothing’s; paying for medical,
educational and other family expenses; purchase, construction and repair of residential
houses; and expenses relating to death and marriage and other ceremonies and litigation
expenses.

4. Other Purposes:

These include purchase of building and ornaments; shares and debentures of cooperative
societies; deposits with cooperative societies, private money lenders and traders; unspecified
purposes; and payment of old debts.

(B) According to the Length of the Loan Period:

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From the point of view of the length of the loan period, agricultural credit may fall
into three categories, viz.:
1. Short-Term Credit:

It is needed normally for short period of less than 15 months to meet current expenses of
cultivation, to facilitate production and for meeting domestic expenses. For example, a
farmer may need credit to buy seeds, fertilizers and fodder for cattle. He may also require
funds to support his family in those years when the crops have not been good or adequate
for the purpose. Such short-term loans are normally repaid fully after the harvest. They are
recoverable out of the sale proceeds of the crops concerned.

2. Medium-Term Loans:

These loans are required for medium period ranging between 15 months and 5 years for the
purpose of making some improvements on land, buying cattle, agricultural implements,
gardening, fencing, plantation etc., purchase of shares in cooperative sugar factories, pig
breeding, sheep and goat rearing, purchase of storage bins and purchase of rubber rollers
under agricultural machinery.

These loans are larger than short term loans and can be repaid over a longer period of time.
The period of loan is generally linked up with the period of serviceability of the assets to be
procured with the loan but normally it does not exceed 5 years.

3. Long-Term Loans:

It is which the farmer needs for the purpose of buying additional land and to make permanent
improvements on land like reclamation and bending, construction of farm house, cattle and
machine-sheds, horticulture, tractors, oil engines, machinery for crushing sugarcane,
manufacturing of gaur, consolidation of holdings, purchase or acquisition of title to
agricultural lands by tenants, etc. In addition, to pay off old debts and to purchase costly
machinery. Such loans can be repaid only out of the extra income secured by the investment
on land. Therefore, these loans are for long periods of more than 5 years, ranging from 15 to
20 years.

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It may be observed that almost all types of credit are needed by the farmer at different stages
of fanning. But the pressing need is the provision of long- and medium-term credit as the
same is not readily available to him.

(C) According to Security:

On the basis of the security offered, agricultural credit can be classified into following
categories:

(1) Farm Mortgage Credit:

It is secured against land by means of a mortgage of land.

(2) Chattel and Collateral Credit:

In this, the farmer is given on the security of the farmer’s livestock, crops or warehouse
receipts, and the latter on the security of other kinds of property such as shares bonds and
insurance policies.

(3) Personal Credit:

It is that credit which is advanced on the promissory’ or personal notes of the farmer with or
without another’s security or guarantee.

Summary

Dear students! In this chapter you have learned about the nature of agricultural finance and
the basic sources of financing agricultural economic activities. Agricultural finance is the
provision of multiple types of services dedicated to supporting both on- and off-farm
agricultural activities and businesses including input provision, production, and distribution,
wholesale, processing and marketing.

Funds for agricultural could be gained from different sources such as individual borrowers,
financial institution (like, banks and insurance companies, deposit institutions,) and
traditional credit associations (Iqud and Iddir) and the like… are amongst the major sources
of agricultural finance. Loans from agricultural finance could be classified in to short term,
medium term and long-term loans depending on time through which the loan stays. All these

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types of loans are of paramount in mitigating the shortages of funds to precede in the
elaboration of remedies to future occurring agricultural conditions disastrous events of funds
in availability.