Lecture Notes on

AGECON - 531
AGRICULTURAL FINANCE AND PROJECT
MANAGEMENT (2+1)

Dr. P. S. Shekhawat
Assistant Professor & Inchage
Department of Agricultural Economics
SKN College of Agriculture, Jobner
Jaipur (Raj.)
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 Syllabus: Course Contents
The Course Objective of the course is to impart knowledge on issues related to lending to
priority sector credit management and financial risk management. The course would bring in the
various appraisal techniques in project - investment of agricultural projects.

Theory
UNIT I
Role and Importance of Agricultural Finance. Financial Institutions and credit flow to
rural/priority sector. Agricultural lending – Direct and Indirect Financing - Financing through
Co-operatives, NABARD and Commercial Banks and RRBs.
District Credit Plan and lending to agriculture/priority sector. Micro-Financing and Role of
MFI’s - NGO’s, and SHG’s.
UNIT II
Lending to farmers – The concept of 5 C’s, 7 P’s and 3 R's of credit. Estimation of Technical
feasibility, Economic viability and repaying capacity of borrowers and appraisal of credit
proposals. Understanding lenders and developing better working relationship and supervisory
credit system. Credit inclusions – credit widening and credit deepening.
UNIT III
Financial Decisions – Investment, Financing, Liquidity and Solvency. Preparation of financial
statements - Balance Sheet, Cash Flow Statement and Profit and Loss Account. Ratio Analysis
and Assessing the performance of farm/firm.
UNIT IV
Project Approach in financing agriculture. Financial, economic and environmental appraisal of
investment projects. Identification, preparation, appraisal, financing and implementation of
projects. Project Appraisal techniques – Undiscounted measures. Time value of money – Use of
discounted measures - B-C ratio, NPV and IRR. Agreements, supervision, monitoring and
evaluation phases in appraising agricultural investment projects. Net work Techniques – PERT
and CPM.
UNIT V
Risks in financing agriculture. Risk management strategies and coping mechanism. Crop
Insurance programmes – review of different crop insurance schemes – yield loss and weather
based insurance and their applications.

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 Practical

Development of Rural Institutional Lending - Branch expansion, demand and supply of

institutional agricultural credit and Over dues and Loan waiving- : An overview, Rural Lending
Programmes of Commercial Banks, Lead Bank Scheme- Preparation of District Credit Plan,
Rural Lending Programmes of Co-operative Lending Institutions, Preparation of financial
statements using farm/firm level data, Farm credit appraisal techniques and farm financial
analysis through financial statements, Performance of Micro Financing Institutions - NGO’s and
Self-Help Groups, Identification and formulation of investment projects, Project appraisal
techniques – Undiscounted Measures and their limitations. Project appraisal techniques –
Discounted Measures, Network techniques – PERT and CPM for project management, Case
Study Analysis of an Agricultural project, Financial Risk and risk management strategies – crop
insurance schemes, Financial instruments and methods – E banking, Kisan Cards and core
banking.
Suggested Readings
Dhubashi PR. 1986. Policy and Performance - Agricultural and Rural Development in Post
Independent India. Sage Publ. Gittinger JP 1982. Economic Analysis of Agricultural Projects.
The Johns Hopkins Univ. Press. Gupta SC. 1987. Development Banking for Rural Development.
Deep & Deep Publ.
Little IMD & Mirlees JA. 1974. Project Appraisal and Planning for Developing Countries.
Oxford & IBH Publ. Muniraj R. 1987. Farm Finance for Development. Oxford & IBH Publ.

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 UNIT-I
Meaning:
Agricultural finance generally means studying, examining and analyzing the financial aspects
pertaining to farm business, which is the core sector of India. The financial aspects include
money matters relating to production of agricultural products and their disposal.
Definition of Agricultural finance:
Murray (in 1953) defined agricultural. finance as “an economic study of borrowing funds
by farmers, the organization and operation of farm lending agencies and of society’s interest in
credit for agriculture .”
Tandon and Dhondyal (1962) defined agricultural. finance “as a branch of agricultural
economics, which deals with and financial resources related to individual farm units.”

Nature and Scope:

Agricultural finance can be dealt at both micro level and macro level.
Macro finance deals with different sources of raising funds for agriculture as a whole in the
economy. It is also concerned with the lending procedure, rules, regulations, monitoring and
controlling of different agricultural credit institutions. Hence macro-finance is related to
financing of agriculture at aggregate level.
Micro-finance refers to financial management of the individual farm business units. And it is
concerned with the study as to how the individual farmer considers various sources of credit,
quantum of credit to be borrowed from each source and how he allocates the same among the
alternative uses within the farm. It is also concerned with the future use of funds.
Therefore, macro-finance deals with the aspects relating to total credit needs of the agricultural
sector, the terms and conditions under which the credit is available and the method of use of total
credit for the development of agriculture, while micro-finance refers to the financial management
of individual farm business.

Importance of agriculture finance

Finance in agriculture is as important as development of technologies. Technical inputs
can be p u r c h a s e d a n d u s e d b y f a r m e r o n l y i f h e h a s m o n e y ( f u n d s ) . B u t h i s
o w n m o n e y i s a l w a y s inadequate and he needs outside finance or credit. Professional
money lenders were the only source of credit to agriculture till 1935. They use to charge unduly
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high rates of interest and follow serious practices while giving loans and recovering them. As a
result, farmers were heavily burdened with debts and many of them perpetuated debts. There
were widespread discontents among farmers against these practices and there were instances of
riots also. With the passing of Reserve Bank of India Act 1934, District Central Co-op. Banks
Act and Land Development Banks Act, agricultural credit received impetus and there were
improvements in agricultural credit. A powerful alternative agency came into being. Large-scale
credit became available with reasonable rates of interest at easy terms, both in terms of granting
loans and recovery of them. Although the co-operative banks started financing agriculture with
their establishments in 1930’s real impetus was received only after Independence when suitable
legislation were passed and policies were formulated. Thereafter, bank credit to agriculture made
phenomenal progress by opening branches in rural areas and attracting deposits. Till 14 major
commercial banks were nationalized in 1969, co-operative banks were the main institutional
agencies providing finance to agriculture. After nationalization, it was made mandatory for these
banks to provide finance to agriculture as a priority sector. These banks undertook special
programs of branch expansion and created a network of banking services throughout the country
and started financing agriculture on large scale. Thus agriculture credit acquired multi-agency
dimension. Development and adoption of new technologies and availability of finance go hand in
hand. In bringing "Green Revolution", "White Revolution" and now "Yellow Revolution"
finance has played a crucial role. Now the agriculture credit, through multi agency approach has
come to stay. The procedures and amount of loans for various purposes have been standardized.
Among the various purposes "Crop loans" (Short-term loan) has the major share. In addition,
farmers get loans for purchase of electric motor with pump, tractor and other machinery, digging
wells or boring wells, installation of pipe lines, drip irrigation, planting fruit orchards, purchase
of dairy animals and feeds/fodder for them, poultry, sheep/goat keeping and for many other
allied enterprises.

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Institutional finance
Agricultural credit is disbursed through a multiagency network consisting of Commercial
Banks (CBs), Regional Rural Banks (RRBs) and Cooperatives. There are approximately 100,000
village-level Primary Agricultural Credit Societies (PACS), 368 District Central Cooperative
Banks (DCCBs) with 12,858 branches and 30 State Cooperative Banks (SCBs) with 953
branches providing primarily short- and medium term agricultural credit in India. The long-term
cooperative structure consists of 19 State Cooperative Agricultural and Rural Development
Banks (SCARDBs), with 2609 operational units as on 31 March 2005 comprising 788 branches
and 772 Primary Agricultural and Rural Development Banks (PA&RDBs) with 1049 branches.

Flow of Credit
A comprehensive credit policy was announced by the Government of India on 18 June
2004, containing measures for doubling agriculture credit flow in the next three years and
providing debt relief to farmers affected by natural calamities. The following are the highlights
of this announcement:
1 Credit flow to agriculture sector to increase at the rate of 30 per cent per year.
2 Debt restructuring in respect of farmers in distress and farmers in arrears providing for
rescheduling of outstanding loans over a period of five years including moratorium of two years,
thereby making all farmers eligible for fresh credit.
3 Special One-Time Settlement scheme for old and chronic loan accounts of small and marginal
farmers.
4 Banks allowed to extend financial assistance for redeeming the loans taken by farmers from
private moneylenders.
5 Commercial Banks (CBs) to finance at the rate of 100 farmers/ branch; 50 lakh new farmers to
be financed by the banks in a year.
6 New investments in agriculture and allied activities at the rate of two to three projects per
branch.
7 Refinements in Kisan Credit Cards (KCCs) and fixation of scale of finance

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PRIORITY SECTOR LENDING
Introduction
Banks are not merely purveyors of money; they are also catalytic agents in accelerating
the tempo of development of different sectors of the economy. In a developing economy which is
starved of capital, certain sectors and sections of the society, need special and priority attention
in the matter of funds availability. Banks in India have been called upon to perform this function
and they have evolved specla1 schemes and regulations for the deployment of credit to sectors
that deserve primary care and attention. This explains the need for PSL by Commercial banks.
This chapter provides a N l account of the schemes of PSL in general and Pondicheny in
particular.

Historical Background of Priority Sector Lending

As far back as in 1967-68, the RBI in its credit policy has introduced the concept of PSL
to tide over the severe imbalances, existed then both in agricultural and industrial fronts. In order
to channelize the flow of credit to the priority sectors RBI had enunciated a credit policy. The
major impediment before the introduction of the concept of PSL was that for various historical
reasons, the bulk of bank advances was directed towards medium and large scale industries and
big business houses, whereas, sectors like agriculture, small scale industries and export were
languishing for want of funds. The concept of PSL was evolved to ensure the flow of adequate
credit from banks to certain prioritized segments of the economy, as enunciated in the national
planning priorities To give incentive to banks for lending to small borrowers under priority
sector. the RBI in January 1971, has set up the Credit Guarantee Corporation of India Limited .
now known as the Deposit Insurance and Credit Guarantee Corporation . The idea was to
administer a comprehensive credit guarantee scheme for loans by banks to the individual small
borrowers under the priority sector. During the period of social control of banks, major banks did
make an attempt to assist the agricultural sector by providing credit for marketing of agricultural
products. Despite commercial banks' lending to agriculture under a) direct financing and b)
indirect financing, Agriculture - direct and indirect finance.
Small scale industries.
Industrial estates.
Road and water transport operation.
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 Retail traders.
Small business,
Professionals and self-employed persons.
Education
CATEGORIES OF PRIORITY SECTOR
The broad categories of priority sector for all scheduled commercial banks are as under:
DIRECT FINANCE
Finance to individual Farmers [including Self Help Groups (SHGs) or Joint Liability
Groups (JLGs), i.e. groups of individual farmers] for Agriculture and Allied Activities.
1 Short-term loans for raising crops, i.e. for crop loans. This will include traditional-
nontraditional plantations and horticulture.
2 Advances up to Rs. 10 lakh against pledge/hypothecation of agricultural produce (including
warehouse receipts) for a period not exceeding 12 months, irrespective of whether the farmers
were given crop loans for raising the produce or not.
3 Working capital and term loans for financing production and investment requirements for
agriculture and allied activities.
4 Loans to small and marginal farmers for purchase of land for agricultural purposes.
5 Loans to distressed farmers indebted to non-institutional lenders, against appropriate collateral
or group security.
6 Loans granted for pre-harvest and post-harvest activities such as spraying, weeding, harvesting,
grading, sorting, processing and transporting undertaken by rural and semi urban households or
groups/cooperatives of rural and semi-urban households.

INDIRECT FINANCE

1 Loans to entities covered under 1.2 above in excess of Rs. 20 lakh in aggregate per borrower
for agriculture and allied activities. In such cases, the entire amount outstanding shall be treated
as indirect finance for agriculture.
2 Loans to food and agro-based processing units with investments in plant and machinery upto
Rs.10 crore, undertaken by other than rural and semi-urban households.
3 Loans to Non-Banking Financial Companies (NBFCs) for on lending to individual farmers.
4 (i) Credit for purchase and distribution of fertilizers, pesticides, seeds, etc.
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 (ii) Loans up to Rs. 40 lakh granted for purchase and distribution of inputs for the allied
activities such as cattle feed, poultry feed, etc.
5 Finance for setting up of Agric-clinics and Agribusiness Centers.
6 Finance for hire-purchase schemes for distribution of agricultural machinery and implements.
7 Loans to farmers through Primary Agricultural Credit Societies (PACS), Farmers’ Service
Societies (FSS) and Large-sized Adivasi Multi Purpose Societies (LAMPS).
8 Loans to cooperative societies of farmers for disposing of the produce of members.

A SMALL SCALE INDUSTRIES

DIRECT FINANCE
A Direct Finance in the small scale industry sector will include credit to:
1 Small Scale Industries
Units engaged in the manufacture, processing or preservation of goods and whose
investment in plant and machinery (original cost) excluding land and building does not exceed
Rs. 5 crore.
2 Micro Enterprises
Small scale units whose investment in plant and machinery (original cost) excluding land
and building is up to Rs. 25 lakh, irrespective of the location of the unit, are treated as Micro
Enterprises.
3 KVI Sector
All advances granted to units in the KVI sector, irrespective of their size of operations,
location and amount of original investment in plant and machinery. Such advances will be
eligible for consideration under the sub-target (60 per cent) of the SSI segment within the
priority sector.

INDIRECT FINANCE
Indirect finance in the small-scale industrial sector will include credit to:
1 Persons involved in assisting the decentralized sector in the supply of inputs to and marketing
of outputs of artisans, village and cottage industries.

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2 Advances to cooperatives of producers in the decentralized sector viz. artisans village and
cottage industries.
3 Loans granted by banks to NBFCs for on lending to SSI sector.

B SMALL BUSINESS / SERVICE ENTERPRISES

1 (i) Advances granted to retail traders dealing in essential commodities (fair price shops),
consumer co-operative stores, and;
(ii) Advances granted to private retail traders with credit limits not exceeding Rs. 20 lakh.
2 Loans to NBFCs for the purpose of on-lending to various categories of small business and
service enterprises.

C MICRO CREDIT
1 Loans of very small amount not exceeding Rs. 50,000 per borrower, provided by banks
to the poor in rural, semi-urban and urban areas, either directly or through a group mechanism,
for enabling them to improve their living standards.

D STATE SPONSORED ORGANIZATIONS FOR SCHEDULED CASTE SCHEDULED

TRIBES
Advances sanctioned to State Sponsored Organizations for Scheduled Castes/ Scheduled
Tribes for the specific purpose of purchase and supply of inputs to and/or the marketing of the
outputs of the beneficiaries of these organizations.

F EDUCATION
Educational loans should include only loans and advances granted to individuals for
educational purposes up to Rs. 10 lakh for studies in India and Rs. 20 lakh for studies abroad,
and not those granted to institutions.

G HOUSING
1 Loans up to Rs. 15 lakh, irrespective of location, for construction of houses by individuals,
excluding loans granted by banks to their own employees.
2 Loans given for repairs to the damaged houses of individuals up to Rs. 1 lakh in rural and
semi-urban areas and up to Rs. 2 lakh in urban areas.
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3 Assistance up to Rs. 1.25 lakh per housing unit given to any governmental agency/
nongovernmental agency (approved by the NHB for the purpose of refinance) for construction/
reconstruction of houses or for slum clearance and rehabilitation of slum dwellers.

H Weaker Sections
(a) Small and marginal farmers with land holding of 5 acres and less, and landless laborers,
tenant farmers and share croppers.
(b) Artisans, village and cottage industries where individual credit limits do not exceed Rs.
50,000.
(c) Beneficiaries of Swarnjayanti Gram Swarozgar Yojana (SGSY).
(d) Scheduled Castes and Scheduled Tribes.
(e) Beneficiaries of Differential Rate of Interest (DRI) scheme.
(f) Beneficiaries under Swarna Jayanti Shahari Rozgar Yojana (SJSRY).
(g) Beneficiaries under the Scheme for Liberation and Rehabilitation of Scavengers (SLRS).
(h) Advances to Self Help Groups.
(i) Loans to distressed urban/rural poor to prepay their debt to non-institutional lenders, against
Appropriate collateral or group security.

I Export Credit
This category will form part of priority sector for foreign banks only.

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Commercial bank

A commercial bank (or business bank) is a type of financial institution and intermediary.
It is a bank that provides transactional, savings, and money market accounts and that accepts
time deposits.

Origin of the word

The name bank derives from the Italian word banco "desk/bench",

The role of commercial banks

 processing of payments by way of telegraphic transfer, EFTPOS, internet banking, or

other means
 issuing bank drafts and bank cheques
 accepting money on term deposit
 lending money by overdraft, installment loan, or other means
 providing documentary and standby letter of credit, guarantees, performance bonds,
securities underwriting commitments and other forms of off balance sheet exposures
 safekeeping of documents and other items in safe deposit boxes
 sales distribution or brokerage, with or without advice, of insurance, unit trusts and
similar financial products as a “financial supermarket”
 cash management and treasury
 merchant banking and private equity financing

Types of loans granted by commercial banks

Secured loan

A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property)
as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the
loan.

Mortgage loan

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 A mortgage loan is a very common type of debt instrument, used to purchase real
estate. Under this arrangement, the money is used to purchase the property.

Unsecured loan

Unsecured Loans are monetary loans that are not secured against the borrower's assets
(i.e., no collateral is involved). These may be available from financial institutions under many
different guises or marketing packages:

Functions of Commercial Banks

National Bank for Agriculture and Rural Development

National Bank for Agriculture and Rural Development (NABARD) is an apex development bank
in India having headquarters based in Mumbai (Maharashtra) and other branches are all over the country.
It was established on 12 July 1982 by a special act by the parliament and its main focus was to uplift rural
India by increasing the credit flow for elevation of agriculture & rural non farm sector and completed its
25 years on 12 July 2007. It has been accredited with "matters concerning policy, planning and operations
in the field of credit for agriculture and other economic activities in rural areas in India". RBI sold its
stake in NABARD to the Government of India, which now holds 99% stake.

History

NABARD was established on the recommendations of Shivaraman Committee, by an act of

Parliament on 12 July 1982 to implement the National Bank for Agriculture and Rural Development Act
1981. It replaced the Agricultural Credit Department (ACD) and Rural Planning and Credit Cell (RPCC)
of Reserve Bank of India, and Agricultural Refinance and Development Corporation (ARDC). It is one of
the premiere agencies to provide credit in rural areas.

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Role of NABARD

NABARD is the apex institution in the country which looks after the development of the cottage
industry, small industry and village industry, and other rural industries. NABARD also reaches out to
allied economies and supports and promotes integrated development. And to help NABARD discharge its
duty, it has been given certain roles as follows:

1. Serves as an apex financing agency for the institutions providing investment and production
credit for promoting the various developmental activities in rural areas
2. Takes measures towards institution building for improving absorptive capacity of the credit
delivery system, including monitoring, formulation of rehabilitation schemes, restructuring of
credit institutions, training of personnel, etc.
3. Co-ordinates the rural financing activities of all institutions engaged in developmental work at the
field level and maintains liaison with Government of India, State Governments, Reserve Bank of
India (RBI) and other national level institutions concerned with policy formulation.
4. Undertakes monitoring and evaluation of projects refinanced by it.
5. NABARD refinances the financial institutions which finances the rural sector.
6. The institutions which help the rural economy, NABARD helps develop.
7. NABARD also keeps a check on its client institutes.
8. It regulates the institution which provides financial help to the rural economy.
9. It provides training facilities to the institutions working the field of rural upliftment.
10. It regulates the cooperative banks and the RRB’s.

REGIONAL RURAL BANKS

The Narasimham committee on rural credit recommended the establishment of Regional Rural
Banks (RRBs) on the ground that they would be much better suited than the commercial banks or co-
operative banks in meeting the needs of rural areas. Accepting the recommendations of the Narasimham
committee, the government passed the Regional Rural Banks Act, 1976. A significant development in the
field of banking during 1976 was the establishment of 19 Regional Rural Banks (RRBs) under the
Regional Rural Banks Act‚1976.

RRBs established with the explicit objective of

1 Bridging the credit gap in rural areas

2 Check the outflow of rural deposits to urban areas

3 Reduce regional imbalances and increase rural employment generation

The main objectives of setting up the RRB is to provide credit and other facilities‚ especially to
the small and marginal farmers‚ agricultural labourers artisans and small entrepreneurs in rural areas.

Functions

Every RRB is authorized to carry on to transact the business of banking as defined in the
Banking Regulation Act and may also engage in other business specified in Section 6 (1) of the said Act.
In particular‚ a RRB is required to undertake the business of

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 (a) granting loans and advances to small and marginal farmers and agricultural laborers‚ whether
individually or in groups, and to cooperative societies‚ including agricultural marketing
societies‚ agricultural processing societies‚ cooperative farming societies‚ primary agricultural credit
societies or farmers’ service societies‚ primary agricultural purposes or agricultural operations or other
related purposes, and

(b) granting loans and advances to artisans‚ small entrepreneurs and persons of small means
engaged in trade‚ commerce‚ industry or other productive activities‚ within its area of operation.

The Reserve Bank of India has brought RRB’s under the ambit of priority sector lending on par with the
commercial banks. They have to ensure that forty percent of their advances are accounted for the priority
sector. Within the 40% priority target, 25% should go to weaker section or 10% of their total advances to
go to weaker section.

Microfinance

History

The history of micro financing can be traced back as long to the middle of the 1800s when the
theorist Lysander Spooner was writing over the benefits from small credits to entrepreneurs and farmers
as a way getting the people out of poverty. Independently to Spooner, Friedrich Wilhelm Raiffeisen
founded the first cooperative lending banks to support farmers in rural Germany.

The modern use of the expression "micro financing" has roots in the 1970s when organizations, such as
Grameen Bank of Bangladesh with the microfinance pioneer Muhammad Yunus, were starting and
shaping the modern industry of micro financing. Another pioneer in this sector is Akhtar Hameed Khan.

Microfinance is usually understood to entail the provision of financial services to micro-

entrepreneurs and small businesses, which lack access to banking and related services due to the high
transaction costs associated with serving these client categories. The two main mechanisms for the
delivery of financial services to such clients are (1) relationship-based banking for individual
entrepreneurs and small businesses; and (2) group-based models, where several entrepreneurs come
together to apply for loans and other services as a group.

In some regions, for example Southern Africa, microfinance is used to describe the supply of
financial services to low-income employees, which however is closer to the retail finance model prevalent
in mainstream banking.

For some, microfinance is a movement whose object is "a world in which as many poor and near-
poor households as possible have permanent access to an appropriate range of high quality financial
services, including not just credit but also savings, insurance, and fund transfers." Many of those who
promote microfinance generally believe that such access will help poor people out of poverty. For others,
microfinance is a way to promote economic development, employment and growth through the support of
micro-entrepreneurs and small businesses.

Microfinance is a broad category of services, which includes microcredit. Microcredit is

provision of credit services to poor clients. Although microcredit is one of the aspects of microfinance,
conflation of the two terms is endemic in public discourse. Critics often attack microcredit while referring
to it indiscriminately as either 'microcredit' or 'microfinance'. Due to the broad range of microfinance
services, it is difficult to assess impact, and very few studies have tried to assess its full impact.

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What is a Microfinance Institution (MFI)?

A microfinance institution (MFI) is an organization that provides financial services to the poor. This
very broad definition includes a wide range of providers that vary in their legal structure, mission, and
methodology. However, all share the common characteristic of providing financial services to clients who
are poorer and more vulnerable than traditional bank clients.

During the 1970s and 1980s, the microenterprise movement led to the emergence of nongovernmental
organizations (NGOs) that provided small loans for the poor. In the 1990s, a number of these institutions
transformed themselves into formal financial institutions in order to access and on-lend client savings,
thus enhancing their outreach.

Specialized microfinance institutions have proven that the poor are “bankable”. Today, formal institutions
are rapidly absorbing the lessons learned about how to do small-transaction banking. Many of the newer
players in microfinance, such as commercial banks, have large existing branch networks, vast distribution
outlets like automatic teller machines, and the ability to make significant investments in technology that
could bring financial services closer to poor clients. Increasingly, links among different types of service
providers are emerging to offer considerable scope for extending access.

The Role of Microfinance Institutions

The basic role of microfinance institutions (MFI) is to provide basic financial services to poor people
who do not usually have access to financial products, such as loans and savings accounts.

Characteristics of MFIs

Formal providers are sometimes defined as those that are subject not only to general laws but also to
specific banking regulation and supervision (development banks, savings and postal banks, commercial
banks, and non-bank financial intermediaries). Formal providers may also be any registered legal
organizations offering any kind of financial services. Semiformal providers are registered entities subject
to general and commercial laws but are not usually under bank regulation and supervision (financial
NGOs, credit unions and cooperatives). Informal providers are non-registered groups such as rotating
savings and credit associations (ROSCAs) and self-help groups.

Ownership structures: MFIs can be government-owned, like the rural credit cooperatives in China;
member-owned, like the credit unions in West Africa; socially minded shareholders, like many
transformed NGOs in Latin America; and profit-maximizing shareholders, like the microfinance banks in
Eastern Europe. The types of services offered are limited by what is allowed by the legal structure of the
provider: non-regulated institutions are not generally allowed to provide savings or insurance.

WHAT IS A SHG?

Self Help Groups are small groups of people facing similar problems. The members of the group
help each other to solve their problems. A reasonably educated but helpful local person takes the lead in
mobilizing these people to form a group.

The person, called animator or facilitator, helps the group members develop the habit of thrift and
promote small savings among them. The group savings are kept in a common bank account from which
small loans are given to members.

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 After six months, the SHG can approach any bank for availing loan facility to undertake a
suitable entrepreneurial activity. The group loan is distributed among the members to run a small
business. The loan is repaid out of the profits earned.

FORMATION OF SHG

The ideal size of SHG is 10-20 members. A smaller size is preferred because in a big group
members cannot participate actively. The group may or may not be registered. Only one person from one
family can become member of a SHG. A group of either men or women is formed. A mixed group is
generally not preferred. It is important that the members have a common social and financial background.
For example, the group should be of farmers, artisans, craftsmen, housemaids, mill workers etc. The
advantage of a homogeneous group is that members can interact freely. Following could be some of
common factors for membership of SHG:

1. Women / men from poor households.

2. Those with dry land holding not mre than 2 acres.
3. Having no access to safe drinking water
4. Having illiterate adults in family
5. Presence of alcoholic or drug addict or a person with prolonged illness in the family.
6. SC or ST families

MAJOR FUNCTIONS OF A SHG:

1. Savings and thrift

2. Internal lending
3. Keeping proper accounts of transactions
4. Discussing problems

General Objectives
1 To describe and discuss the common characteristics of health system functioning in the given socio-
economic, socio-cultural, political and ecological settings
2 To highlight and delineate crucial factors responsible for the health sector reforms and to undertake, as
the most challenging Endeavour, effective and efficient health management and quality health care
service provisions in the community
3 The fundamental objective is to act as a catalyst in bringing about local initiative and community
participation in overall improvement in quality of life.

Non-governmental organizations (NGOs): Non-governmental organizations (NGOs) have played a

major role in pushing for sustainable development at the international level. Campaigning groups have
been key drivers of inter-governmental negotiations, ranging from the regulation of hazardous wastes to a
global ban on land mines and the elimination of slavery.

But NGOs are not only focusing their energies on governments and inter-governmental processes.
With the retreat of the state from a number of public functions and regulatory activities, NGOs have
begun to fix their sights on powerful corporations - many of which can rival entire nations in terms of
their resources and influence.

Aided by advances in information and communications technology, NGOs have helped to focus
attention on the social and environmental externalities of business activity. Multinational brands have
been acutely susceptible to pressure from activists and from NGOs eager to challenge a company's labour,

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environmental or human rights record. Even those businesses that do not specialize in highly visible
branded goods are feeling the pressure, as campaigners develop techniques to target downstream
customers and shareholders.

In response to such pressures, many businesses are abandoning their narrow Milton Friedmanite
shareholder theory of value in favour of a broader, stakeholder approach which not only seeks increased
share value, but cares about how this increased value is to be attained.

Such a stakeholder approach takes into account the effects of business activity - not just on
shareholders, but on customers, employees, communities and other interested groups.

There are many visible manifestations of this shift. One has been the devotion of energy and
resources by companies to environmental and social affairs. Companies are taking responsibility for their
externalities and reporting on the impact of their activities on a range of stakeholders.

Nor are companies merely reporting; many are striving to design new management structures
which integrate sustainable development concerns into the decision-making process.

Much of the credit for creating these trends can be taken by NGOs. But how should the business
world react to NGOs in the future? Should companies batten down the hatches and gird themselves
against attacks from hostile critics? Or should they hold out hope that NGOs can sometimes be helpful
partners?

For those businesses willing to engage with the NGO community, how can they do so? The term
NGO may be a ubiquitous term, but it is used to describe a bewildering array of groups and organizations
- from activist groups 'reclaiming the streets' to development organizations delivering aid and providing
essential public services. Other NGOs are research-driven policy organizations, looking to engage with
decision-makers. Still others see themselves as watchdogs, casting a critical eye over current events.

They hail from north and south and from all points in between - with the contrasting levels of
resources which such differences often imply. Some are highly sophisticated, media-savvy organizations
like Friends of the Earth and WWF; others are tiny, grassroots collectives, never destined to be household
names.

Although it is often assumed that NGOs are charities or enjoy non-profit status, some NGOs are
profit-making organizations such as cooperatives or groups which lobby on behalf of profit-driven
interests. For example, the World Trade Organization's definition of NGOs is broad enough to include
industry lobby groups such as the Association of Swiss Bankers and the International Chamber of
Commerce.

Such a broad definition has its critics. It is more common to define NGOs as those organizations
which pursue some sort of public interest or public good, rather than individual or commercial interests.

Even then, the NGO community remains a diverse constellation. Some groups may pursue a
single policy objective - for example access to AIDS drugs in developing countries or press freedom.
Others will pursue more sweeping policy goals such as poverty eradication or human rights protection.

18
 UNIT II
Lending to farmers – The concept of 3 R’s, 5 C's and 7 P’s of credit. Estimation of
Technical feasibility, Economic viability and repaying capacity of borrowers and
appraisal of credit proposals. Understanding lenders and developing better working
relationship and supervisory credit system. Credit inclusions – credit widening and credit
deepening.

Investment appraisal/loan appraisal

To estimate the rationality of a loan, it is essential to do credit analysis. The considerations of
credit analysis fall into three groups; returns, repayment capacity and risk bearing ability;
these are popularly known as the three R’s of credit. To estimate the rationality of borrowing,
three questions should be carefully examined.
1 Whether investment will provide sufficient returns to cover the principal and additional costs?
2 Whether the borrower has sufficient repayment capacity to return the loan and the interest on it
when these amounts are due?
3 Whether the borrower has capacity to meet the risk and uncertainties involved in using the
borrowed funds. If the answer to the above questions are “yes”, then there is a sound case for
advancing/taking the loan. If the answer to any of the question is “no”, then the loan should not
be advanced/taken. A negative answer to question (i) indicates that the use of funds, if borrowed,
will not be profitable; negative answers to the questions (ii) and (iii) mean that the borrower may
fail to fulfill his obligations. Hence, in any of these cases, the loan should not be advanced/taken.

3 R’s. Of credit:

o Returns from the investment;

o Repayment capacity the investment generates and
o Risk-bearing ability of the farmer-borrower.
1. Returns from the investment:
This is an important measure in credit analysis. The banker needs to have an idea about the extent
of returns likely to be obtained from the proposed investment. The farmer’s demand for credit can be
accepted only when he will be able to generate returns that will enable him to tide over the costs. Returns
depend upon the decisions like what to grow, how to grow, how much to grow, when to sell, where to
sell, etc., which the farmers take in their production activities. The main concern here is that the farmers
should be able to generate incremental income when they go for the additional returns from the borrowed
funds by getting a loan amount of Rs. 4,500 and 4,600 in kharif and rabi respectively, the farmer can
switch over from improved varieties of paddy to high yielding varieties in both the seasons. The borrowed
fund is quite productive in generating an incremental amount of Rs. 5700 per hectare of land. It is an

19
 important positive factor in favour of the farmer to present his claims for the loan amount from the
institutional agency.
2. Repayment Capacity
This simply means the ability of the farmer to clear off the loan obtained for production purpose
within the time stipulated by the bank. The loan amount may be productive enough to generate additional
income to the borrower, but it may not be productive enough to repay the loan. Hence, the necessary
condition here is that the loan should not only be profitable but also have potential for effecting
repayment. Then only the farmer has a favorable point on his side. Though the returns are encouraging,
other factors may offset the returns reducing the farmer to a helpless condition with regard to repayment
capacity. The estimation of repayment capacity varies from crop loans (self-liquidating loans) to term-
loans (partially-liquidating loans).in the case of self-liquidating loans the repayment capacity is as
follows:
Repayment capacity =Gross income – (working expenses excluding crop loan +family living expenses +
other loans due + miscellaneous expenditure + crop loan).

In respect of partially liquidating loans, the repayment capacity is estimated in the following manner.

Repayment capacity = Gross income – (working expenses including short term loans+ family living
expenses+ other loans due+ miscellaneous expenditure+ annual installment due for term loan).

3. Risk Bearing Ability

It is the ability of the farmer to withstand the risks that arise due to financial loss.
Some of the types or sources of risk in farming are:
i. Production risks;
ii. Technological risk;
iii. Risk caused by illiteracy and ignorance;
iv. Inefficiency by sickness of the farmer (personal risk);
v. Institutional risk;
vi. Weather uncertainty;
vii. Price uncertainty; etc.,
Here what we wish to know is whether the farmer has got shock-absorbing capacity to
withstand the onslaught of the unforeseen events or not. The gross returns are deflated to
the extent of variability of income CV. For eg., if the CV of paddy yields in a given area
is 15% to arrive at the corrected yield or income. From this income so arrived at, the
repayment capacity is estimated.
Repayment Capacity under risk = deflated gross returns – (working expenses excluding
proposed loan + family living expenses + other due + miscellaneous expenditure + crop
loan).
5 C’s of credit:
To study the economic viability of a scheme or investment activity are the
‘Five Cs’ of credit, viz.,
1. Character
2. Capacity
3. Capital
4. Condition and
5. Commonsense
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1. Character
The basis for credit transactions is the trust, the trust that the banker has on his borrowers. No doubt
the bank insists upon security for any loan, even then, the element of trust has greater say in the mind of
the banker, before he takes a decision in considering the proposal of a prospective borrower. The
confidence which the institutional agency keeps is influenced by the moral qualities like honesty,
integrity, commitment, hard work, promptness, etc., which the borrower exhibits. In essence it means the
mental as well as moral characters of the borrower. Generally, people with good mental and moral
character will have a good credit character.
2. Capacity

This is related to the capacity of an individual borrower to repay loans when they fall due. It is
synonymous with repayment capacity. It largely depends upon the income obtained in the farm business,
i.e., C=f(Y),where, C= Capacity and Y= Income.

3. Capital
Capital implies the availability of money with the farmer-borrower, when character and capacity proved
to be inadequate. It represents the networth of the individual. It is related to repayment capacity and risk-
bearing ability.
4. Condition
This refers to the conditions needed for obtaining a loan from the financial institutions (presented in detail
under the topic, procedural formalities followed in obtaining a loan).
5. Commonsense
This relates to perfect understanding between the lender and the borrower in credit transactions. This is in
fact a prima facie requirement for obtaining credit for the borrower.

7 P’s of Credit:
The role of financial institutions in light of the technological changes that have been brought in, on the
agricultural front, lies in evolving principles of farm finance which are expected to bring not only
commercial gains to the bankers but also social benefits. The principles thus evolved by the institutional
agencies are supposed to have universal validity. These are popularly known as ‘seven P’s of credit which
are listed and explained hereunder:
1. Principle of productive purpose;
2. Principle of personality;
3. Principle of productivity;
4. Principle of phased disbursement;
5. Principles of proper utilization;
6. Principle of payment; and
7. Principle of protection.
1. Principle of Productive purpose
When owned capital is a limiting factor on the farms, the credit needs of the farmers are many and varied.
The requirements of credit commence right from short-term loans to term loans. This capital limitation is
visible on all the farms but more pronounced on small and marginal farms. The farmers of these tiny
holdings require another type of credit, which the large farmers do not need, i.e., the consumption loans
for the small and marginal farmers, the crop loans advanced may not be as productive as they are
expected to be, because of their diversion for other purposes. But inspite of this known fact, the
consumption credit is relegated to the backseat by the institutional agencies. When the loan is diverted for
21
 other purposes, the productivity of the loan receives a setback and the desired results will be a far cry. But
the principle of productive purpose says that the loan distributed to any borrower should be capable of
generating incremental income. If one wants the principles of productive purpose to hold well, the short-
term loans of small marginal farmers can be made productive, if they are provided with other income
augmenting assets through term loans. The income generated from these productive assets will add to the
income obtained from farming. In this process, the term loans not only turn out to be productive but also
help in enhancing the productivity of crop loans taken by these categories of farmers. To cite some of the
assets for which term loans required are dairy animals, sheep and goat (grazing or stall-feeding), poultry,
installation of pumpsets on group action, etc.
2. Principles of Personality
The ‘Three Rs.’ which was explained earlier is the sound indicators of credit-worthiness of the farmers.
Credit-worthiness of the farmer makes him eligible for the loan he desires from the institutional agencies.
Over the years of experience in lending, the bankers have identified an important factor in credit
transactions, i.e., the trust-worthiness of the borrower. It has relevance to personality of the individual.
When the farmer-borrower fails to repay the loan in the event of natural calamities, his is a case of non-
willful default. He has to be bracketed in the category of defaulters, not by his own fault, but by the
natural forces that influence farming, which are beyond the control of human beings. But a large farmer
who profitably uses the loan, and still falls in the category of defaulters means, his is a case of sheer
willful default. The personality of the individual and growth of the financial institutions, thus are inter-
linked.
3. Principle of Productivity
This principle emphasizes that the credit, which is advanced, is not just meant for increasing production
from that enterprises alone, but should be able to increase the productivity of other factors employed in
the enterprises. To cite a few more examples in crop choosing the one, which is superior among
alternatives, etc better competing crops and superior breeds, not only increase the returns by themselves,
but also augment the productivity of other complementary factors employed in the respective production
activities. Thus, this principle is based on the point of making the resources as productive as possible by
choosing the most appropriate enterprises.
4. Principles of Phased Disbursement
No enterprise or investment activity needs all the required funds at a time and the requirements of funds is
spread over a period of time. In paddy crop enterprise, the need for capital is felt over 4 or 5 months for
different operations, for sugarcane over an year and investment activities like digging a well or
installation of pumpsets require an altogether different time schedule. Relevant to this situation, the
principle of phased disbursement underlines that the loan amount needs to be distributed in phases or
spells to make it productive and the banker can also make himself sure about the end use of the borrowed
funds. The phased disbursal of the loan helps to overcome the misuse or diversion of funds, but the
demerit of this system is that it will make the cost of credit higher.
5. Principle of Proper Utilization
Whether the farmers are getting the type of resources they need at the right time and in right quantities.
6. Principle of Payment
This principle deals with the fixing of repayment schedules of the loans advanced by the institutional
agencies. As far as the investment credit is concerned, say for irrigation structures, tractors, etc., the
annual repayments are fixed over a given number of years depending upon the incremental returns that
are supposed to be obtained after duly accounting for consumption needs of the farmers.

22
7. Principle of protection
To tide over the situation of this nature, the institutional agencies resort to safety measures, viz.,
i. Insurance coverage ,
ii. Linking credit with marketing or tie-up arrangement,
iii. Provision of finance on production of warehouse receipt,
iv. Covering credit under small loan guarantee scheme of Deposit Insurance and Credit Guarantee
Corporation of India, and
v. Taking Securities.
1. Insurance Coverage: The loans for certain crops and investment activities like poultry, dairy, piggery,
irrigation structures, etc., are insured.
2. Linking Credit with Marketing or Tie-up Arrangement: by linking credit with marketing, the banker is
quite safe in recovering the loan.
3. Provision of Finance against the Warehouse Receipt: When the prevailing product prices are not
acceptable to the farmers, they need not submit to the situation. They can store the produce in the
warehouse and based on the warehouse receipt, the financial institution advances loans to the extent of 75
per cent of the value of the produce. It is a symbiotic process wherein the bank can recover the loans and
the farmers can derive the price benefits when they sell after the glut period was over.
4. Credit Guarantee: When the banks fail to recover the loans advanced to the weaker sections, Deposit
Insurance and Credit Guarantee Corporation of India (DICGC) reimburses the loans to them.
5. Taking Sureties: The banks advance loans either by hypothecation or mortgage of assets.

Appraisal of farm credit proposals.

The processing procedure is detailed under the following sub-heads.
1. Interview with the farmer;
2. Submission of loan application by the farmer;
3. Scrutiny of records;
4. Visit to the farmer’s field before sanction of loan;
5. Criteria for loan eligibility;
6. Sanction of loan;
7. Submission of requisite documents;
8. Disbursement of loan;
9. Post-credit follow-up measures; and
10. Recovery of loan.

1. Interview with the Farmers

The banker studies the farmer-borrower in the interview regarding his credit characteristics such as
honesty, integrity, frankness, progressive thinking, indebtedness, repayment capacity, etc. The banker
explains to the farmer the terms and conditions under which the loan is going to be sanctioned. Interview
helps the banker to understand the genuine credit needs of the farmer. So interview is more than a mere
formality, as it facilitates the banker to study the farmer in detail and assess his credit requirements.
2. Submission of loan application by the farmer

23
 After getting satisfied with the credentials of the farmer, the banker gives a loan application form to him.
Details required the location of the farm, purpose of the loan, cost of the scheme, credit requirements,
farm budgets, financial statements, etc., as required in the form are filled in by the farmer. Certificates
such as ownership of the land or title deeds and crop grown statement showing cropping pattern adopted
by the farmer-borrower, farm map, no objection certificate from the co-operatives, non-encumbrance
certificate from sub-registrar of land assurances, affidavit from the borrower regarding his non-mortgage
of land elsewhere are appended to the loan application. A passport size photograph is affixed to the loan
application form.
3. Scrutiny of records
The ownership and extent of land as indicated in the relevant certificates are verified by the bank officials
with village revenue officials.
4. Visit to the farmer’s fields before sanction of loan
After verifying the records, the field officer of the bank pays a visit to the farm to verify the particulars
given by the farmer. The pre-sanction visit is expected to help the banker to identify the farmer and
guarantor, locate the boundaries of land as per the map and assess the managerial capacity of the farmer
in farming and allied enterprises and the farmer’s attitude towards latest technology. Details on
economics of crop and livestock enterprises, feasibilities for implementing proposed plans, and farmer’s
loan position with the non-institutional sources are ascertained in the pre-sanction visit. Thus, pre-
sanction visit of the bank officials is very important to verify credit-worthiness and trust-worthiness of the
farmer-borrower.
5. Criteria for Loan Eligibility
The following are considered in judging the eligibility of a farmer-borrower to receive the loan.
i. He should have sound character and financial integrity,
ii. His dealings with friends, neighbours, financial institutions, etc., must be proper (He should
not be a defaulter in the past),
iii. He must have progressive outlook and be receptive to modern technology,
iv. He should sincerely implement the proposed scheme and ensure proper use of credit,
v. The security provided by the farmer must be free any sort of encumbrance and litigation.
6. Sanction of Loan
After examining all the aspect presented in the pre-sanction farm inspection report, the branch manager
takes a decision as to whether to sanction the loan or not.
7. Submission of requisite documents
Before sanctioning the stipulated amount to the farmer-borrower, the following documents are obtained
by the banking institution.
i. Demand promissory note;
ii. Deed of hypothecation;
iii. Guarantee letter;
iv. Installment letter;
v. Authorization letter regarding the payment of loan from the marketing agencies or
intermediaries on behalf of the farmer; and
vi. Mortgage deeds.
vii. Title deeds are examined by the legal officer of the bank and his opinion with regard to
clear, marketable and unlitigated title is sought.

8. Disbursement of Loan
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 As soon as the execution of documents is completed, the loan amount is credited to the borrower’s
account. The loan amount is disbursed in a phased manner, that too after ensuring that the loan is used by
the farmer-borrower properly. A realistic repayment plan is framed and given to the farmer keeping in
view the income flow of the proposed project.

9. Post credit Follow-up measures

The branch manager or the agricultural officer pays a visit to the farmer to ascertain the proper use of the
credit. This also benefits the farmer, for they can get the technical advice if any needed from the
agricultural officer in the implementation of the scheme.
10. Recovery of Loan
The bank reminds the farmer-borrower in advance about the repayment of loan in time. If needed,
recovery camps, special drives, village meetings, etc., are organized at an appropriate time. All
appropriate measures are taken to persuade the farmer-borrower to repay the loan in time. In the case of
default, the reasons for the same are ascertained to find out whether the borrower is a deliberate defaulter
or not.
In all possible cases the bank officers make tie-up arrangements, i.e., the recovery of the loan is linked
with marketing. Rephrasing of repayment plan is allowed in the case of justifiable cases.

Technical Feasibility
The examination of technical feasibility requires a detailed assessment of good and services
needed for the project. Technical feasibility involves the study of the following considerations.
Once of the most important technical considerations affecting the feasibility of a new unit
is the type of technology. The lending agency should know whether the technology is latest or outdated,
capital intensive or labour intensive and what will be the effect on the firm of the continuous change of
technology. In case of changes in product or shift in consumer preference, whether the unit will be able to
meet the situation by diversifying its production activities. Another significant factor which affects the
technical feasibility is that of determining the right size of the plant basing on capital requirements, cost
benefit analysis and present and future demand for the product. The location of the project is one of the
most important factors on which technical feasibility is largely dependent. It is governed by the adequate
supply of raw materials, power, water, labour and the availability of other infrastructure facilities.

In sum, identification of the location of the project would depend on the considerations
like-
a) The need for the project in the area,
b) Availability of required inputs in the project implementation,
c) Backwardness of the area,
d) The extent to which it could rectify regional imbalances and
e) The lending agency should see that the entrepreneur follows all the rules and regulations of the
government as far as the technical and social considerations are concerned.

25
Credit Widening:

The expanding credit spreads between corporate bonds and treasuries, and in particular between
junk bonds and treasuries, has also led arbitrage spreads to widen. Deals that will be financed and closed
have spreads that warrant investors' attention. There may be some easy money to be made as a result.

Credit Deepening:

Deep financial sectors that intermediate efficiently between savers and investment projects
improve choices and productivity in the “real” economy.
Credit gets available to the “broken” financial sectors in many poorer developing countries.

Credit deepening or vertical expansion of the programme is dependent on expansion and growth
of the economy as a whole and the agriculture sector in particular.

 Credit deepening which is important for income augmentation is also threatening several other
aspects of these operations (faltering repayment, weekly repayment through borrowing from
money lenders, large size loans encouraging many non-target group borrowers)
 From the point of view of organizing the borrowers, there are several models of micro-finance,
none universal and no particular model has proven to be better or worse than the other.

What The Lender Expects of The Borrower

The repayment of a loan depends on the earning power of the farm and the qualifications of the
farmer as a manager, a careful lender will require certain information about both before making a
loan. He will want to know something about the productivity of the farm, its efficiency as a farm
unit, and the dependability of the market for the products of the farm. Most lenders require that a
borrower submit a financial statement in order to determine how much capital the farm family has
accumulated and whether they have any debts. The lenders will want to investigate the reputation
and ambitions of the farm family to find out whether they can be depended upon to carry through
their plans and pay their debts. Usually, lenders will also expect a farmer to pledge collateral in
some form as security for the loan.

Personal qualifications:
The lender must determine whether both the operator and his family are good credit risks. He
must submit accurate information when applying for a loan.
26
 Productivity of the farm:
One of the basic considerations in analyzing the earning power of the farm business is to know
something about the fertility and productivity of the soil. A lender who is making a farm
mortgage loan that is going to be repaid over a period of years will want to know whether the soil
is stable and is likely to remain productive or whether it is subject to erosion and wastage.
Size of farm:
The size of the farm business is also important. It is necessary that the farm be large enough to
pay operating expenses and taxes, provide a satisfactory living for the farm family, and have
sufficient income left over for the payment of interest and principal on the farm debt.
Efficiency and costs of operation:
Farm should be productive and of adequate size, but it should be an efficient farm unit with low
operating costs if it is to command the highest credit rating from lenders. In order to use
borrowed money wisely, a farmer needs to organize and manage his farm to make the best use of
the advantages his farm possesses. A low-cost, efficiently operated farm is well balanced if it
most effectively utilizes the family labor and resources available.
Dependability of the market:
While farm products are used primarily for food and clothing and are always needed by
consumers, there are circumstances under which farm products may be difficult to sell expect at
low prices.
However, a farmer should be assured in advanced of markets for such products as market milk
and fresh fruits and vegetables, which depend either on local markets or upon refrigerated
transportation facilities to larger cities.

As most farmers are not marketing specialists and do not have the time nor facilities to study market
trends from day to day or week to week, they and those who lend money to them can best be assured of
the most favorable market for their products if they sell through organized channels. These channels may
be either commercial organizations operated for the profit of the owners, or the farmer’s own cooperative
marketing associations.

Nationalisation of Banks in India - Introduction

After independence the Government of India (GOI) adopted planned economic

development for the country (India). Accordingly, five year plans came into existence since
27
1951. This economic planning basically aimed at social ownership of the means of production.
However, commercial banks were in the private sector those days. In 1950-51 there were 430
commercial banks. The Government of India had some social objectives of planning. These
commercial banks failed helping the government in attaining these objectives. Thus, the
government decided to nationalize 14 major commercial banks on 19th July, 1969. All
commercial banks with a deposit base over Rs.50 crores were nationalized. It was considered
that banks were controlled by business houses and thus failed in catering to the credit needs of
poor sections such as cottage industry, village industry, farmers, craft men, etc. The second dose
of nationalisation came in April 1980 when banks were nationalized.

Objectives Behind Nationalisation of Banks in India

The nationalisation of commercial banks took place with an aim to achieve following major
objectives.

1. Social Welfare : It was the need of the hour to direct the funds for the needy and required
sectors of the indian economy. Sector such as agriculture, small and village industries
were in need of funds for their expansion and further economic development.
2. Controlling Private Monopolies : Prior to nationalisation many banks were controlled
by private business houses and corporate families. It was necessary to check these
monopolies in order to ensure a smooth supply of credit to socially desirable sections.
3. Expansion of Banking : In a large country like India the numbers of banks existing those
days were certainly inadequate. It was necessary to spread banking across the country. It
could be done through expanding banking network (by opening new bank branches) in
the un-banked areas.
4. Reducing Regional Imbalance : In a country like India where we have a urban-rural
divide; it was necessary for banks to go in the rural areas where the banking facilities
were not available. In order to reduce this regional imbalance nationalisation was
justified:
5. Priority Sector Lending : In India, the agriculture sector and its allied activities were the
largest contributor to the national income. Thus these were labeled as the priority sectors.
But unfortunately they were deprived of their due share in the credit. Nationalisation was
urgently needed for catering funds to them.
6. Developing Banking Habits : In India more than 70% population used to stay in rural
areas. It was necessary to develop the banking habit among such a large population.

Demerits, Limitations - Bank Nationalisation in India

Though the nationalisation of commercial banks was undertaken with tall objectives, in many
senses it failed in attaining them. In fact it converted many of the banking institutions in the loss
making entities. The reasons were obvious lethargic working, lack of accountability, lack of
profit motive, political interference, etc. Under this backdrop it is necessary to have a critical
look to the whole process of nationalisation in the period after bank nationalisation.

The major limitations of the bank nationalisation in India are:-

28
 1. Inadequate banking facilities : Even though banks have spread across the country; still
many parts of the country are unbanked. Especially in the backward states such as the
Uttar Pradesh, Madhya Pradesh, Chhattisgarh and north-eastern states of India.
2. Limited resources mobilized and allocated : The resources mobilized after the
nationalisation is not sufficient if we consider the needs of the Indian economy. Some
times the deposits mobilized are enough but the resource allocation is not as per the
expansions.
3. Lowered efficiency and profits : After nationalisation banks went in the government
sector. Many times political forces pressurized them. Banking was not done on a
professional and ethical grounds. It resulted into lower efficiency and poor profitability of
banks.
4. Increased expenditure : Due to huge expansion in a branch network, large staff
administrative expenditure, trade union struggle, etc. banks expenditure increased to a
dangerous levels.
5. Political and Administrative Inference : Many public sector banks badly suffered due
to the political interference. It was seen in arranging loan meals. It ultimately resulted in
huge non-performing assets (NPA) of these banks and inefficiency.

These are several limitations faced by the banks nationalisation in India.

Apart from this there are certain other limitations as well, such as weak infrastructure, poor
competitiveness, etc.

But after Economic Reform of 1991, the Indian banking industry has entered into the new
horizons of competitiveness, efficiency and productivity. It has made Indian banks more vibrant
and professional organizations, removing the bad days of bank nationalisation.

Economic Reforms of the Banking Sector In India

Indian banking sector has undergone major changes and reforms during economic reforms.
Though it was a part of overall economic reforms, it has changed the very functioning of Indian
banks. This reform have not only influenced the productivity and efficiency of many of the
Indian Banks, but has left everlasting footprints on the working of the banking sector in India.

Let us get acquainted with some of the important reforms in the banking sector in India.

1. Reduced CRR and SLR : The Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio
(SLR) are gradually reduced during the economic reforms period in India. By Law in
India the CRR remains between 3-15% of the Net Demand and Time Liabilities. It is
reduced from the earlier high level of 15% plus incremental CRR of 10% to current 4%
level. Similarly, the SLR Is also reduced from early 38.5% to current minimum of 25%
level. This has left more loanable funds with commercial banks, solving the liquidity
problem.
2. Deregulation of Interest Rate : During the economics reforms period, interest rates of
commercial banks were deregulated. Banks now enjoy freedom of fixing the lower and
upper limit of interest on deposits. Interest rate slabs are reduced from Rs.20 Lakhs to
just Rs. 2 Lakhs. Interest rates on the bank loans above Rs.2 lakhs are full decontrolled.
29
 These measures have resulted in more freedom to commercial banks in interest rate
regime.
3. Fixing prudential Norms : In order to induce professionalism in its operations, the RBI
fixed prudential norms for commercial banks. It includes recognition of income sources.
Classification of assets, provisions for bad debts, maintaining international standards in
accounting practices, etc. It helped banks in reducing and restructuring Non-performing
assets (NPAs).
4. Introduction of CRAR : Capital to Risk Weighted Asset Ratio (CRAR) was introduced
in 1992. It resulted in an improvement in the capital position of commercial banks, all
most all the banks in India has reached the Capital Adequacy Ratio (CAR) above the
statutory level of 9%.
5. Operational Autonomy : During the reforms period commercial banks enjoyed the
operational freedom. If a bank satisfies the CAR then it gets freedom in opening new
branches, upgrading the extension counters, closing down existing branches and they get
liberal lending norms.
6. Banking Diversification : The Indian banking sector was well diversified, during the
economic reforms period. Many of the banks have stared new services and new products.
Some of them have established subsidiaries in merchant banking, mutual funds,
insurance, venture capital, etc which has led to diversified sources of income of them.
7. New Generation Banks : During the reforms period many new generation banks have
successfully emerged on the financial horizon. Banks such as ICICI Bank, HDFC Bank,
UTI Bank have given a big challenge to the public sector banks leading to a greater
degree of competition.
8. Improved Profitability and Efficiency : During the reform period, the productivity and
efficiency of many commercial banks has improved. It has happened due to the reduced
Non-performing loans, increased use of technology, more computerization and some
other relevant measures adopted by the government.

These are some of the import reforms regarding the banking sector in India.

With these reforms, Indian banks especially the public sector banks have proved that they are no
longer inefficient compared with their foreign counterparts as far as productivity is concerned.

Functions of RBI ( The India's Central Bank )

As a central bank, the Reserve Bank has significant powers and duties to perform. For smooth
and speedy progress of the Indian Financial System, it has to perform some important tasks.
Among others it includes maintaining monetary and financial stability, to develop and maintain
stable payment system, to promote and develop financial infrastructure and to regulate or control
the financial institutions.

30
For simplification, the functions of the Reserve Bank are classified into the traditional functions,
the development functions and supervisory functions.

Traditional Functions of RBI

Traditional functions are those functions which every central bank of each nation performs all
over the world. Basically these functions are in line with the objectives with which the bank is
set up. It includes fundamental functions of the Central Bank. They comprise the following tasks.

1. Issue of Currency Notes : The RBI has the sole right or authority or monopoly of
issuing currency notes except one rupee note and coins of smaller denomination. These
currency notes are legal tender issued by the RBI. Currently it is in denominations of Rs.
2, 5, 10, 20, 50, 100, 500, and 1,000. The RBI has powers not only to issue and withdraw
but even to exchange these currency notes for other denominations. It issues these notes
against the security of gold bullion, foreign securities, rupee coins, exchange bills and
promissory notes and government of India bonds.
2. Banker to other Banks : The RBI being an apex monitory institution has obligatory
powers to guide, help and direct other commercial banks in the country. The RBI can
control the volumes of banks reserves and allow other banks to create credit in that
proportion. Every commercial bank has to maintain a part of their reserves with its
parent's viz. the RBI. Similarly in need or in urgency these banks approach the RBI for
fund. Thus it is called as the lender of the last resort.
3. Banker to the Government : The RBI being the apex monitory body has to work as an
agent of the central and state governments. It performs various banking function such as
to accept deposits, taxes and make payments on behalf of the government. It works as a
representative of the government even at the international level. It maintains government
accounts, provides financial advice to the government. It manages government public
debts and maintains foreign exchange reserves on behalf of the government. It provides
overdraft facility to the government when it faces financial crunch.
4. Exchange Rate Management : It is an essential function of the RBI. In order to maintain
stability in the external value of rupee, it has to prepare domestic policies in that
direction. Also it needs to prepare and implement the foreign exchange rate policy which
will help in attaining the exchange rate stability. In order to maintain the exchange rate
stability it has to bring demand and supply of the foreign currency (U.S Dollar) close to
each other.
5. Credit Control Function : Commercial bank in the country creates credit according to
the demand in the economy. But if this credit creation is unchecked or unregulated then it
leads the economy into inflationary cycles. On the other credit creation is below the
31
 required limit then it harms the growth of the economy. As a central bank of the nation
the RBI has to look for growth with price stability. Thus it regulates the credit creation
capacity of commercial banks by using various credit control tools.
6. Supervisory Function : The RBI has been endowed with vast powers for supervising the
banking system in the country. It has powers to issue license for setting up new banks, to
open new braches, to decide minimum reserves, to inspect functioning of commercial
banks in India and abroad, and to guide and direct the commercial banks in India. It can
have periodical inspections an audit of the commercial banks in India.

Developmental / Promotional Functions of RBI

Along with the routine traditional functions, central banks especially in the developing country
like India have to perform numerous functions. These functions are country specific functions
and can change according to the requirements of that country. The RBI has been performing as a
promoter of the financial system since its inception. Some of the major development functions of
the RBI are maintained below.

1. Development of the Financial System : The financial system comprises the financial
institutions, financial markets and financial instruments. The sound and efficient financial
system is a precondition of the rapid economic development of the nation. The RBI has
encouraged establishment of main banking and non-banking institutions to cater to the
credit requirements of diverse sectors of the economy.
2. Development of Agriculture : In an agrarian economy like ours, the RBI has to provide
special attention for the credit need of agriculture and allied activities. It has successfully
rendered service in this direction by increasing the flow of credit to this sector. It has
earlier the Agriculture Refinance and Development Corporation (ARDC) to look after the
credit, National Bank for Agriculture and Rural Development (NABARD) and Regional
Rural Banks (RRBs).
3. Provision of Industrial Finance : Rapid industrial growth is the key to faster economic
development. In this regard, the adequate and timely availability of credit to small,
medium and large industry is very significant. In this regard the RBI has always been
instrumental in setting up special financial institutions such as ICICI Ltd. IDBI, SIDBI
and EXIM BANK etc.
4. Provisions of Training : The RBI has always tried to provide essential training to the
staff of the banking industry. The RBI has set up the bankers' training colleges at several
places. National Institute of Bank Management i.e NIBM, Bankers Staff College i.e BSC
and College of Agriculture Banking i.e CAB are few to mention.
5. Collection of Data : Being the apex monetary authority of the country, the RBI collects
process and disseminates statistical data on several topics. It includes interest rate,
inflation, savings and investments etc. This data proves to be quite useful for researchers
and policy makers.
6. Publication of the Reports : The Reserve Bank has its separate publication division.
This division collects and publishes data on several sectors of the economy. The reports
and bulletins are regularly published by the RBI. It includes RBI weekly reports, RBI
Annual Report, Report on Trend and Progress of Commercial Banks India., etc. This
information is made available to the public also at cheaper rates.
32
 7. Promotion of Banking Habits : As an apex organization, the RBI always tries to
promote the banking habits in the country. It institutionalizes savings and takes measures
for an expansion of the banking network. It has set up many institutions such as the
Deposit Insurance Corporation-1962, UTI-1964, IDBI-1964, NABARD-1982, NHB-
1988, etc. These organizations develop and promote banking habits among the people.
During economic reforms it has taken many initiatives for encouraging and promoting
banking in India.
8. Promotion of Export through Refinance : The RBI always tries to encourage the
facilities for providing finance for foreign trade especially exports from India. The
Export-Import Bank of India (EXIM Bank India) and the Export Credit Guarantee
Corporation of India (ECGC) are supported by refinancing their lending for export
purpose.

Supervisory Functions of RBI

The reserve bank also performs many supervisory functions. It has authority to regulate and
administer the entire banking and financial system. Some of its supervisory functions are given
below.

1. Granting license to banks : The RBI grants license to banks for carrying its business.
License is also given for opening extension counters, new branches, even to close down
existing branches.
2. Bank Inspection : The RBI grants license to banks working as per the directives and in a
prudent manner without undue risk. In addition to this it can ask for periodical
information from banks on various components of assets and liabilities.
3. Control over NBFIs : The Non-Bank Financial Institutions are not influenced by the
working of a monitory policy. However RBI has a right to issue directives to the NBFIs
from time to time regarding their functioning. Through periodic inspection, it can control
the NBFIs.
4. Implementation of the Deposit Insurance Scheme : The RBI has set up the Deposit
Insurance Guarantee Corporation in order to protect the deposits of small depositors. All
bank deposits below Rs. One lakh are insured with this corporation. The RBI work to
implement the Deposit Insurance Scheme in case of a bank failure.

 Reserve Bank of India's Credit Policy

 The Reserve Bank of India has a credit policy which aims at pursuing higher growth with
price stability. Higher economic growth means to produce more quantity of goods and
services in different sectors of an economy; Price stability however does not mean no
change in the general price level but to control the inflation. The credit policy aims at
increasing finance for the agriculture and industrial activities. When credit policy is
implemented, the role of other commercial banks is very important. Commercial banks
flow of credit to different sectors of the economy depends on the actual cost of credit and
arability of funds in the economy.

33
 What is E-Banking ? Online Banking

E-banking refers to electronic banking. It is like e-business in banking industry. E-banking is

also called as "Virtual Banking" or "Online Banking".

E-banking is a result of the growing expectations of bank's customers.

E-banking involves information technology based banking. Under this I.T system, the banking
services are delivered by way of a Computer-Controlled System. This system does involve direct
interface with the customers. The customers do not have to visit the bank's premises.

Popular services covered under E-Banking

The popular services covered under E-banking include :-

1. Automated Teller Machines,

2. Credit Cards,
3. Debit Cards,
4. Smart Cards,
5. Electronic Funds Transfer (EFT) System,
6. Cheques Truncation Payment System,
7. Mobile Banking,
8. Internet Banking,
9. Telephone Banking, etc.

Advantages of E-Banking

The main advantages of E-banking are :-

1. The operating cost per unit services is lower for the banks.
2. It offers convenience to customers as they are not required to go to the bank's premises.
3. There is very low incidence of errors.
4. The customer can obtain funds at any time from ATM machines.
5. The credit cards and debit cards enables the Customers to obtain discounts from retail
outlets.
6. The customer can easily transfer the funds from one place to another place electronically.

What is core banking?

Core banking has historically meant the critical systems that provide the basic account
management features and information about customers and account holdings.

34
Modern packaged core banking platforms are typically more holistic and often include these
features as well as:

 Customer relationship management features including a 360 degree customer view

 The ability to originate new products and customers
 Banking analytics including risk analysis, profitability analysis and provisions for capital
reserve allocation and collateral management
 Banking finance including general ledger and reporting
 Banking channels such as teller systems, side counter (sales) applications, mobile
banking and online banking solutions
 Best practice workflow processes
 Content management facilities
 Governance and compliance capabilities such as internal controls management and
auditing
 Security control and audit capabilities

UNIT III
BALANCE SHEET OR NETWORTH STATEMENT

Balance sheet is the most widely used statement for measuring farm
business performance. It is also called as net worth statement. It is a summary of
statement showing the assets, liabilities and net worth or net deficit of a farm
business over a point of time. It indicates a snapshot of a farm business on a given
date.
The balance sheet indicates an account of total assets and total liabilities of
the farm business revealing the financial solvency of the business. More specifically
it is a statement of the financial position of a farm business at a particu lar time,
showing its assets, liabilities and equity. If the assets are more than the liabilities it
is called net worth or equity and its converse is known as net deficit. The typical
balance sheet shows assets on the left hand side and liabilities and equity on the
right hand side. Both sides are always in balance hence the name balance sheet.
Net worth is placed on the right hand side, along with liabilities, in order to indicate
that like any other creditor the farmer has a claim against the farm business equal
to the equity amount. The balance sheet can be easily prepared by the farmer in
the presence of farm records. It can be prepared at any point of time to know the
financial position of the farm business. It can also be prepared to study the perform-
ance of a business over years by preparing the same number of balance sheets. If
the net worth increases over the different periods, it indicates efficient performance
of the business.
To prepare a balance sheet the prime requisites are total assets, total liabilities
and net worth or net deficit of the farm.
I. Assets:
Assets are those, which are owned by the farmer. Assets are the three types,
viz., current, intermediate or working and long-term or fixed. This classification
35
 of assets facilitates the analysis of liquidity of the farm business.
a) Current Assets: They are very liquid or short-term assets. They can be
converted into cash, within a short time, usually one year. For example, cash
on hand, agricultural produce ready for disposal, i.e., stocks of paddy,
blackgram, jowar, wheat, etc.
b) Intermediate or Working Assets: Intermediate assets are less liquid than
the current assets. Examples: Machinery, equipment, livestock, tractors,
trucks, etc.
c) Long-term Assets or Fixed Assets: An asset that is permanent or will be
used continuously for several years is called a long-term asset. It takes longer
time to convert into cash due to verification of records, legal transactions, etc.
Examples: Land, farm buildings, etc.
II. Liabilities:
Refers to all the things, which are owed to others by the farmer
a) Current Liabilities: Debts that must be paid in the short term or in very near
future. Examples: Crop loans, accounts payable, hand loans, etc.
b) Intermediate Liabilities: These loans are due for the repayment within a
period of two to five years. Examples: Livestock loans, machinery loans, etc.
c) Long-term Liabilities: The duration of loan repayment is five or more years.
Ex:: Tractor loan, orchard loan, land development loan, etc.

III. Net worth or net deficit:

Shows the difference between the assets and liabilities, and if the
difference is positive, it is called net worth (solvency position/ credit worthy/
owner’s equity). In case the difference is negative, it is called net deficit
(insolvency position).
Test Ratios:
The balance sheet is analyzed with the help of a number of financial ratio
measures so as to know the exact financial (solvency) position and stability of the
farm business.
The test ratios, viz., current ratio, intermediate ratio, net capital ratio, quick
ratio, current liability ratio, debt-equity ratio and equity-value ratio are used to
analyze the balance sheet.
Total current 126500
assets
1. Current Ratio = = = 1.86
Total current 68000
liabilities
This ratio indicates the capacity of the farmer to meet immediate financial obli-
gations or solvency of the business.
2. Intermediate = Total current = 126500 + = 35050 = 3.4
Ratio assets + Total 224000 0 7
or working Ratio intermediate

36
 assets
Total current 68000 + 10100
liabilities + Total 33000 0
intermediate
liabilities
This indicates the liquidity position of the farm business over an intermediate
period of time, ranging from 2 to 5 years. This ratio should also be more than one to
indicate sound running of the farm business.
Total assets 975500
3. Net Capital Ratio = = = 3.81
Total liabilities 256000

If the net capital ratio is more than one, the funds of the institutional agencies
are safe. This ratio is also the most important measure of overall solvency position
of the farmer-borrowers in the long-run.
Gross income
4. Rate of capital turn over =
Total farm assets
It is the most common measure of capital efficiency. A faster turn over rate is a
good sign of farm business.
Fixed or long-term assets
5. Fixed ratio =
Fixed or long-term liabilities

This ratio measures the financial safety of the business over a longer period of
time.

Cash receipts + accounts receivable +

marketable securities
6. Acid Test Ratio or Quick
=
Ratio (Bonds, shares etc.) available more than one
year
Total current liabilities
This reflects adequacy of cash and income surpluses to cover all current liabilities
during the period of one to two years. If there is no difference in income position of
a farmer within that period, current ratio and acid test ratio reflect the same
position.
7. Current Current liabilities 68000 0.0
= = =
liability ratio Owner’s equity 719500 9
This ratio indicates the farmer's immediate financial obligations against the net
worth. A ratio of less than one indicates a healthy performance of the farm business
and over the years the ratio should become smaller and smaller to reflect a consist -
ently good performance.
8. Debt-equity Ratio Total debts 256000 0.3
= = =
(Leverage ratio) Owner’s equity 719500 6
This ratio indicates the capacity of the farmer to meet the long-term
commitments. A consistently falling ratio indicates a very heartening performance
of farming and the ability of the farmer to reduce dependence on borrowings.

37
 Owner’s equity
(net worth) 719500 0.7
9. Equity to asset value ratio = = =
Value of assets 975500 4
(net assets)
This ratio measures the overall financial position of the farm business.
Net worth
10. Equity Ratio =
Total liabilities

Example:

Balance Sheet of a Farm in Dharwad District as on 31st January, 2008

Amount (in Amount (in

Assets Liabilities
Rs.) Rs.)
Current assets Current liabilities

Cash on hand 10,000 Crops loans 8,000

Savings in bank 8,000 Accounts payable 11,000
Value of grains ready for 38,500 Hand loans 5,000
sale
Livestock products(eggs, 60,000 Money owed to input 25,000
birds) supplies
Fruits, vegetables, fodder & 8,000 Annual installments of 19,000
feed MT & LT Loans
Value of bonds & shares 2,000
Sub-total 1,26,500 Sub-total 68,000
Intermediate Assets Intermediate
Liabilities
Dairy and cattle 10,000 Livestock loans(o/u ) 8,000
Bullocks 9,000 Machinery loans(o/u) 15,000
Poultry birds 15,000 Unsecured loans(o/u) 10,000
Machinery & equipment 15,000
Tractor 1,75,000
Sub-total 2,24,000 Sub-total 33,000
Long term assets Long term liabilities
Land 6,00,000 Tractor loan(o/u) 1,20,000
25,000 Orchard loan(o/u) 25,000
Farm buildings Unsecured loans(land 10,000
Development]
Sub-total 6,25,000 Sub-total 1,55,000
Total of liabilities 2,56,000
Net worth or equity 7,19,500
TOTAL OF
TOTAL OF ASSETS 9,75,500 LIABILITIES + NET 9,75,500
WORTH

INCOME STATEMENT OR PROFIT AND LOSS STATEMENT

An income statement is also called as Profit and Loss Statement. It is defined

as a summary of receipts and gains minus expenses and losses during a specified
38
accounting period (usually a year). It is nothing but input and output expressed in
value terms. Income statement is supplemented by showing where the fund comes
from and where the funds are used. It reveals the success or failure of a farm
business over a period of time. Income statement basically constitutes three items,
viz., receipts, expenses and net income.
This is entirely different from a balance sheet in the sense that in a balance
sheet, we considered assets and liabilities and did not consider operational
efficiency in terms of receipts and expenses. In income statement, the items
included are receipts, expenses, gains and losses. It is prepared for the entire farm
for one agricultural year. In income statement monetary values are assigned to
inputs and output. It is also prepared over time.
Primary function of Income statement is to know the returns and expenses
involved in business during given period with resultant of net profit or net loss.
Income statement is opening point of cash flow statement.
Receipts: They mean the returns obtained from the sale of crop produce and other
supplementary products like milk and eggs, wages, gifts, etc. Gain in the form of
appreciation in the value of assets is also included in the receipts. However, returns
from the sale of capital assets, such as livestock, machinery, farm buildings, etc. are
not included because such returns/income are not really obtained during the period.
Expenses: Operating and fixed costs are recorded here. Losses in the form of
depreciation on the asset value fall under the expenditure item. However, the
amounts incurred on the purchase of capital assets are not considered.
FINANCIAL MEASURES:

Net income = cash receipt – cash expenses

Net income:
It constitutes net cash income, net operating income and net farm income
Net cash income:
It gives the position of cash receipts minus cash expenses only during the
period for which income statement is prepared.
Net operating income = Gross income – operating expenses
Net operating income: It is arrived at by deducting operating expenses from the
gross income. Fixed costs are not given any consideration. Operating expenses
include crop loans.
Net farm income = net operating income - fixed cost.
Net farm income: Net farm income equals net operating income less fixed costs.
Compared to net cash income and income operating income, it is relatively a better
measure of assessing the performance of a farm. It is the return accrued to owned
capital and family labour employed.
Example: Income Statement of ‘X’ farm for the period 2007-08

Particulars Amount (in Rs.)

I. RECEIPTS
A. Returns from the sale of crop output(paddy+pulse) 52,000

39
B. i. Revenue from milk and milk products 5,000
ii. Revenue from poultry enterprise 12,000
Revenue from supplementary enterprise( i+ ii) 17,000
C. Gifts 2,000
D. Gross cash income(A+B+C) 71,000
E. Appreciation on the value of assets 3,000
F. Gross income(D+E) 74,000
II. EXPENSES:
Operating expenses or costs
A. Hired human labour 10,500
B. Bullock labour 900
C. Machine labour 1,500
D. Seeds 1,100
E. Feeds 5,000
F. Manures & fertilizers 3,000
G. Plant protection measures 1,550
H. Veterinary aid 500
I. Irrigation 250
J. Miscellaneous 2,000
K. Interest on working capital 2,100
Total operating expenses
28,400
(A+B+C+D+E+F+G+H+I+J+K)
III. FIXED EXPENSES OR COSTS
L. Depreciation 3,00
M. Land revenue 200
N. Interest on fixed capital 3,200
O. Rental value of owned land 10,000
P. Total Fixed costs (L+M+N+O) 16,400
IV. Net cash income : 71,000-28,400 = 42,600
V. Net operating income : 74,000-28,400 = 45,600
VI. Net farm income : 45,600 – 16,400 = 29,200

40
 Financial Test Ratios:

Total operating expenses

Operating
=
1. ratio
Gross income

Fixed expenses
2. Fixed ratio =
Gross income

Total expenses
Gross ratio =
3. Gross income

Gross income
4. Capital turn over ratio =
Average capital investment

Net return to capital

Rate of return on
5. =
investment
Average capital investment

UNIT-IV
PROJECT EVALUATION TECHNIQUE

Capital Budgeting (Investment Analysis): Capital budgeting is the method of

evaluating investment expectations. An investment is defined as the commitment
of resources (capital) to production activities which yield returns over a reasonably
long period of time. Simple cost - return analysis is sufficient to ascertain the
profitability of enterprises where the capital spent yields returns within a short
period of time (say a year). But in the case of investments requiring commitment of
capital for longer periods of time, the cost - return analysis will not be a sufficient
measure of profitability. Such investments need to be evaluated for their economic
viability using appropriate criteria. This is essential as the substantial capital
committed will have long term consequences and is difficult to reverse the
investment decisions once made.

Steps in capital budgeting: Capital budgeting consists of an orderly sequence of

steps or actions that provide information relevant to an investment choice. These
steps are (a) Identification (b) Formulation (c) Appraisal (d) Implementation (e)
Monitoring and (f) Evaluation.

1. Identification refers to recognition of farmer's needs. It is searching for

profitable investments and is an important and continuous function of management.

41
2. Formulation is the detailed preparation of a plan for the identified project, which
includes (a) location of the project (b) Size and number of units (c) Value of
investment (d) Technical aspects (e) Economic aspects. The detailed project
planning is generally preceded by a feasibility study (in the case of macro projects).

3. Appraisal is the critical review of the project proposed to assess the

appropriateness and soundness of the project. Broadly four types of appraisal may
be conducted, viz., Technical appraisal, financial appraisal, Economic appraisal and
organizational appraisal. The project is appraised using different criteria.

4. Implementation refers to translating the investment proposal into a concrete

project. It refers to putting the plan into action. Though a administrative aspect,
implementation is a more crucial aspect as the anticipated costs, returns and time
depend on effective implementation.

5. Monitoring is the process which is concerned with supervising and watching the
project to see whether its implementation is as per plan. This helps to identify and
diagnose the problems and to modify the project design, if necessary, for improving
the performance of the project.

6. Evaluation: This is an analytical process for systematically and objectively

pursuing the relevance, efficacy and effectiveness of the project activities in the
light of the objectives set earlier. By evaluating the project, one can find its
achievements and weaknesses so as to suggest ways of overcoming such
weaknesses in future projects. The different types of evaluation are ex-ante
evaluation, concurrent evaluation and ex-post/end evaluation. In deciding the costs
and benefits of an investment, the following principles need to be borne in mind.

1. Cash flow Principle: The costs and benefits associated with an investment are
to be measured in terms of cash flows - the cash outflows that occur due to, out
flows of cash from the project expenses and the cash inflows which are the inflows
of cash into the project due to the benefits derived. The cash flows take place
during the entire life of the project. The difference between cash inflows and cash
outflows is termed as net cash flows.

2. Incremental Principle: The cash flows (both cash inflows and cash outflows)
need to be measured and accounted at the incremental level. According to this
principle, the changes in the cash flows of the farm that arise from the
implementation of the project alone are relevant. Only the incremental cash flows
need to be considered in the evaluation of the project.

3. Interest exclusion Principle: This principle envisages that the interest paid on
the debt arising out of the project should be excluded from the economic analysis of
the project. This is because of the fact that the discount rate used will represent the
interest rate.
42
The following steps are needed in the Preparation of project proposal:

1. Identify a potential project

2. Workout the details- collect the data on economical and technical aspects of
the project.
a. Technical data: information on investment, resources requirement and yields

b. Economic data: where to buy, how much to buy, the price at which to buy,
where to sell, when to sell, at what price to sell, etc.,

3. Compilation and analysis

4. Cash flow analysis for the project
5. Project evaluation: Test the projects for technical & financial feasibilities(SRR,
PBP, NPV,BCR & IRR )
6. Project report writing

DISCOUNTED MEASURES: Discounted cash flow technique is employed as a tool

in evaluating long-term projects in agriculture. Many studies conducted earlier
successfully employed this technique to evaluate the long-term investment in
agriculture projects. Hence, for evaluating the investments and to find out the
technical feasibility and economic viability of investment on agricultural, irrigation
and plantation crops, a few measures of project evaluation (discounted cash flow
techniques except Pay back period) were used. These measures are advocated as
tools or aid to evaluate and find out the worthiness of an investment, especially
those of long term projects.

The measure used in the analysis were, Net Present Value (NPV), Benefit Cost
Ratio (B: C ratio), Internal Rate of Returns (IRR) and Pay back period (PBP) Cash
flows are the yearly net benefits accrued from the project. If they are weighed by
discount rate, they become discounted cash flows. These discounted cash flows are
the best estimates to decide on the worth of the project. This approach will give the
net present worth of the project. The present worth of the costs is subtracted from
the present worth of the benefits in order to arrive at the net present worth of the
project every year.

Measurement of the Cash Flow of the Project: From the annual stream of
gross benefits of the project, the capital invested and the other input costs like
labour, machinery, fertilizers, pesticides, management, etc., are deducted. From the
residual, the return of capital, and return on capital or return to capital, i.e.,
investment made in the project (depreciation) and compensation for the use of
money (interest) are computed. This residual is called cash flow of the project. In
financial analysis the cash flow is the net incremental benefits of the project. But, in
accounting, the term implies the sum of cash flows of projects plus depreciation
allowance. The concept of cash flow in the financial analysis includes, both return of

43
capital and return to capital. We generally do not resort to deduction of
depreciation, i.e., allowance of return of capital or interest in the economic analysis,
because our analytical technique automatically takes care of return of capital in
determining the worth of the project. In economic analysis, income taxes, sales
taxes, custom duties, etc., are only the transfer payments, but not payments used
in the production process. Hence, from the gross returns these are not deducted.
But in the financial analysis taxes are the costs which individuals must pay for the
use of capital.

By far, financial analysis aims at the estimation of return to all resources em-
ployed in the project. Hence, borrowed capital is considered as benefits received,
while, its interest is considered as cost and it is deducted from the gross returns. In
economic analysis, this consideration is ruled out because of the assumption, that
all the resources employed in the project belong to someone or the other within the
society. In the economic analysis, it is important that the price of some of the inputs
must be the shadow prices. In financial analysis all prices are market prices and
they must include taxes and subsidies. For clear distinction between cash inflows
the economic analysis vis-a-vis financial analysis (Gittinger, 1976) may be referred.
NET PRESENT VALUE

The net present value is simply the present worth of net benefit of a project
discounted at the opportunity cost of capital. This criterion ranks the investments
for selecting the best alternatives. Generally, higher the net present worth better
would be the preference. In computing net present worth, the difference between
the present values of the cost were considered at a discount rate of 9.5 per cent as
this is the present prevailing bank rate of interest on fixed capital. The general
verbal and mathematical form of net present worth criterion is presented below.

This is simply the present worth of the cash flow stream. Sometimes, it is referred to as Net
Present Value (NPV). The selection criterion of the project depends on positive value of NPW
when discounted at the opportunity cost of the capital. This could be satisfactorily done,
provided there is a correct estimate of opportunity cost of capital. NPW is an absolute measure,
but not relative.
NPV = [Present worth of benefits] – [Present worth of costs]

(Bn - Cn )


NPV = (1 + d)n
r=
1

Where,
Bn = Benefits in nth year
Cn = Costs in nth year
n = Number of years

44
 d = Discount rate
OR

(1 + r)-n] – I0]
NPV = [ Y
n

r=1 n

Where,
Yn = Net cash inflows in the nth year
r = Discount factor (%)
I0 = Initial investment
i = Number of years

In order to select worthiness of the project, the net present value should be
positive.

NPW of the project is estimated using the following equation:

Y1 Y2 Y3
NPW = (1 + i)t1 +(1 + i)t2 (1 + i)tn
+ ……….+ - C

Where,

Y1= Net cash flow in first year, i = Discount rate (%),

t = Time period, and
C = Initial cost of the investment.
The decision criteria are:
If NPV > O: Investment is profitable and project is said to be financially feasible/
worthwhile.
If NPV < O: Investment is not profitable and the project is not worthwhile/ infeasible.
If NPV = O: Indifferent case. The project may or may not be taken.
It possesses the additive property / aggregate of different projects. It concern
with the financial objective of maximization of wealth of stockholders. It considers
all the cash flows in its entirety. It takes into account of time value of time. Ranking
of the projects are not correctly done.

Benefit: Cost ratio (B-C RATIO) : It is the ratio of discounted cash inflows and
outflows which must be unity or more for an enterprise to be considered worthwhile.
The minimum ratio required is 1:1. This 1:1 indicates the coverage of costs without
any surplus benefits. But, usually, the ratio should be more than unity in order to
provide some additional returns over the costs for clear decision. Following formula
45
depicts the estimation of B-C ratio can be stated both verbally and mathematically
as:

Discounted cash inflow Discounted net cash inflow

B:C =
Discounted cash outflow Initial investment
n
Bn

(1+r)
n
OR n
t=1 Yi
B:C =  ÷I
n (1+i)n
Cn i=l

(1+r)n
t=1
Where,
Bn Benefits in each
= year
Cn = Costs in each year
n = Number of years
r or i = Discount rate ,
I = initial investment
Yi = Net Cash Inflow

Here, we compare the present worth of costs with present worth of benefits.
Absolute value of the benefit-cost ratio will change based on the interest rate
choosen. While ranking the projects depending upon the B-C ratio, the most
common procedure of selecting a project is, to choose the project, having B-C ratio
of more than one, when discounted at opportunity cost of capital. Finally, the given
project is opted for implementation, among alternatives based on the highest B-C
ratio. It ranks the projects correctly, but it could not aggregates of all projects.

Ex: Estimation Procedure of benefit-cost ratio (BCR) for 2 Projects

(Hypothetical)

Sericulture (one ha) Mango orchard (one ha)

Discou
Costs Retur Net NPW Cost Retur Net NPW
nt
Yr ns income Year s ns income
(Rs.) factor (Rs.) (Rs.)
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
at 12%
1. 38900 - 0.8929 34733.81 - End of 6th yr 2500 - 0.507 12675.00 -
0
2. 9239 28475 0.7972 7365.33 22700.27 End of 7th yr 4250 10260 0.452 1921.00 4637.52
3. 10575 32550 0.7118 7527.29 23169.09 End of 8 yr th
4792 12550 0.404 1935.97 5070.20
4. 11952 35610 0.6355 7595.50 22630.16 End of 9th yr 5368 14530 0.361 1937.85 5245.33
5. 12858 39802 0.5674 7295.63 22583.65 End of 10 th
5975 16275 0.322 1923.95 5240.55
yr

46
 64517.5 91083.1 End of 11th 6456 19396 0.287 1852.87 5566.55
6 7 yr
End of 12th 7187 21470 0.257 1847.06 5517.79
yr
24093.7 31278.
0 04

Present worth of gross 91083. 31278.0

BC returns 18 1.4 BC 4 1.3
= = = = =
R Present worth of costs 64517. 1 R 24.093. 0
56 70

UNDISCOUNTED MEASURES: The undiscounted measures are the naive methods

of choosing among the alternative projects. The methods listed under these
measures often mislead in ranking of the projects and hence, choices go wrong.
Ranking by Inspection: It is based on the size of costs and length of cash-flow
stream. Suppose if the two projects are with the same investment and the same net
value of production, but with difference in the length of the period, then the project
with longer duration is preferred to the one with shorter time period. This leads to
bias in the choice obviously due to the absence of more elaborate and appropriate
analysis.

1. Simple Rate of Return: It is the average rate of return on the investment

made in the project.

Y E–D
10
SRR = X Or =
0
I I

Where,

Y = Average annual cash flows.

E = annual net benefits or cash flow per annum

I = initial Investment of the project

D = Annual average depreciation

The decision rule here is that all projects whose SRR is more than the investor's
required rate of return are acceptable. Though simple and easy to use, the biggest
drawback of this criterion is that it ignores the time value of money.
47
2. Payback period: Payback period represents the length of time required for the
stream of cash proceeds produced by the time required for the project to pay for
itself. The payback period is calculated by successively deducting the initial
investment from the net returns until the initial investment is fully recovered.
Another simple method of ranking a project is the length of time required to get
back the investment on the project. or It is length of time required to cover its initial
investment. It is length of time required for project to pay for itself. It ignores the
cash flow after payback period has been crossed and it also ignores the time value
of money.

The pay back period of the project is estimated by using the straight forward
formula:
I Initial investment
P = X 100 =
E Net cash flow or net return
Where,
P = Payback period of the project in years
I = Investment of the project in Rs. and
E = Annual net cash revenue in Rs.
The preference of a particular project is based on the shorter payback period. This
is shown in Table
Ex: Estimation Procedure of payback period
Cash flow (in Rs.)
Year
Project ‘A’ Project ‘B’
0 -20000 -20000 Rs.2000
=4
Project ‘A’ = 0
years
1 5000 4000 Rs.5000
2 5000 4000
3 5000 4000 Rs.2000
=5
Project ‘B’ = 0
years
4 5000 4000 Rs.4000
5 5000 4000
6 5000 4000

Decision rule:
If PBP < life period of project (n), than we accept the project,

If PBP > life period of project (n), than we reject the project.

It is inadequate to exercise the option among the alternatives, because it fails to

consider very important points like, consistency of running, timing of the proceeds,
48
returns after the payback period and whether the cash-flows would be positive or
negative in future.
Proceeds per Rupee of Outlay: This is worked out by dividing the total proceeds
with the total amount of investment, and a given project is ranked based on the
highest magnitude of the parameter.

Average Annual Proceeds of Rupee Outlay: This is another simple choice

criterion and in this procedure, total receipts are first divided by the project life
span and the average proceeds obtained per year are divided by the initial
investment on the project. Here too, ranking is given to the projects, based on the
highest magnitude of the estimate.

The major drawback with undiscounted measures is that for the same data of
the project, we get different rankings; hence, choice process becomes useless.
Rankings by these methods are inconsistent and incompatible.

Internal rate of return: It is the discount rate at which the present values of the
net cash flows are just equal to zero, i.e., NPW = zero. This represents the average
earning capacity of an investment in the projects over its life period. This is
generally determined by Trial and Error method. By this method, one discount rate
is found which is too low and NPV with negative, and another discount rate is found
which is too high with NPV of project is positive. The mathematical form of IRR is;

n
n Bn -Cn n
IRR =  Or NPV = ∑ Yi (1+r)-n - I i.e., ∑ Yi (1+r)n -1 =0
n
t=1 (1 + d) t=1

The internal rate of return is arrived at by interpolation technique by using different

discount rates so as to see that the net present worth is equated to zero. The
interpolation method the exact IRR is found out using the following equation.

Difference Present worth of the cash flow at

Lower between lower discount rate
IRR = discount + higher and X
Absolute difference between the
rate lower
present worth of cash flow at two
discount rate
discount rates

In the computation of Internal Rate of Return (IRR), the time value of money is
accounted. The method of working IRR provides the knowledge of actual rate of
return from the'-different projects. Thus IRR is known as 'marginal efficiency' of
capital or yield on the investment. The IRR must be found out by trial and error with
some approximation. The procedure is elucidated for the projects on sericulture and
mango in Tables.

49
 The positive NPW value of the project indicates that lRR is still higher and the
next assumed arbitrary IRR value must be comparatively higher than the initial
level. This process is continued until NPW becomes negative. In the working
procedure, an arbitrary discount rate is assumed and it’s corresponding
Decision rule: If IRR value > ruling rate of interest, than project is said to be
feasible. If IRR value < ruling rate of interest, than project is said to be infeasible.
Ex: Estimation Procedure of IRR for sericulture (one hectare)
(Hypothetical)
Net Net
Gross Net Discount Discoun
Costs present present
Year income income factor t factor
(Rs.) worth worth
(Rs.) (Rs.) (40%) (43%)
(Rs.) (Rs.)
1 38900 - -38900 0.7143 -27786.27 0.6993 -27202.77
2 9239 28475 19236 0.5102 9814.21 0.48902 9406.4
3 10575 32550 21975 0.3644 8007.69 0.3419 7513.25
4 11952 35610 23658 0.2603 6158.17 0.2391 5656.62
5 12858 39802 26944 0.1859 5008.89 0.1672 4505.04
52913 1202.69 -121.46

Note: The entire lifespan of mango orchard should be considered for working out
IRR. For want of data we considered here only for seven years for illustration
purpose.
1202.69
1202.69 + 121.46
IRR = 40 + 3

= 40 + 3 (0.9083)
= 40 + 2.7249
= 42.7249%
= 42.7%
Ex: Estimation Procedure of IRR for Mango Orchard (one ha)
(Hypothetical)
Net Net
Gross Net Discount Discount
Costs present present
Year (Rs.) incom income factor factor
(Rs.) worth worth
e (Rs.) (Rs.) (25%) (30%)
(Rs.) (Rs.)
End of 6th yr 2500 - -25000 0.262 -6.550 0.207 -5175.00
0
End of 7th yr 4250 10260 6010 0.21 1262.01 0.159 955.59
End of 8th yr 4792 12550 7758 0.168 1303.30 0.123 954.23
th
End of 9 yr 5368 14530 9162 0.134 1227.71 0.094 861.23
End of 10 yr th
5975 16275 10300 0.107 1102.10 0.073 751.90
End of 11 yr th
6456 19396 12940 0.086 1112.84 0.056 724.64
End of 12 yr th
7187 21470 14283 0.069 985.53 0.043 614.17
35453 443.49 -313.24
50
 443.49
IRR = 25 + 5 443.49 + 313.24

= 25 + 5 (0.586)
= 25 + 2.93
= 27.93%

Project management
Introduction
Project management is concerned with the overall planning and co-ordination of a project from
conception to completion aimed at meeting the stated requirements and ensuring completion on time,
within cost and to required quality standards.

Project management is normally reserved for focused, non-repetitive, time-limited activities with
some degree of risk and that are beyond the usual scope of operational activities for which the
organization is responsible.
Steps in Project Management
The various steps in a project management are:
1. Project Definition and Scope
2. Technical Design
3. Financing
4. Contracting
5. Implementation
6. Performance Monitoring

1. Project Definition and Scope

What is a Project?
“A project is a one-shot, time-limited, goal-directed, major undertaking, requiring the commitment
of varied skills and resources”.
A project is a temporary endeavor undertaken to create a unique product or service. A project is
temporary in that there is a defined start (the decision to proceed) and a defined end (the achievement
of the goals and objectives). Ongoing business or maintenance operations are not projects. Energy
conservation projects and process improvement efforts that result in better business processes or
more efficient operations can be defined as projects. Projects usually include constraints and risks
regarding cost, schedule or performance outcome.

Four Basic Elements of Project Management

A successful Project Manager must simultaneously manage the four basic elements of a project:
resources, time, cost, and scope. Each element must be managed effectively. All these elements are
interrelated and must be managed together if the project, and the project manager, is to be a success.

51
Managing Resources

A successful Project Manager must effectively manage the resources assigned to the project. This
includes the labor hours of the project team. It also includes managing labor subcontracts and
vendors. Managing the people resources means having the right people, with the right skills and the
proper tools, in the right quantity at the right time.

However, managing project resources frequently involves more than people management. The
project manager must also manage the equipment (cranes, trucks and other heavy equipment) used
for the project and the material (pipe, insulation, computers, manuals) assigned to the project.
Managing Time and Schedule
Time management is a critical skill for any successful project manager. The most common cause of
bloated project budgets is lack of schedule management. Fortunately there is a lot of software on the
market today to help you manage your project schedule or timeline.

Any project can be broken down into a number of tasks that have to be performed. To prepare the
project schedule, the project manager has to figure out what the tasks are, how long they will take,
what resources they require, and in what order they should be done.

Managing Costs

Often a Project Manager is evaluated on his or her ability to complete a project within budget. The
costs include estimated cost, actual cost and variability. Contingency cost takes into account
influence of weather, suppliers and design allowances.

How the 80/20 Rule can help a project manager?

The 80/20 Rule means that in anything a few (20 percent) are vital and many (80 percent) are trivial.
Successful Project Managers know that 20 percent of the work (the first 10 percent and the last 10
percent) consumes 80 percent of your time and resources.

Project Management Life Cycle

The process flow of Project management processes is shown in Figure 1. The various elements of
project management life cycle are
a) Need identification
b) Initiation
c) Planning
d) Executing
e) Controlling
f) Closing out

52
Figure 1 Process Flow of a Project Management Process
a) Need Identification

The first step in the project development cycle is to identify components of the project. Projects may

be identified both internally and externally:

 Internal identification takes place when the energy manager identifies a package of energy
saving opportunities during the day-to-day energy management activities, or from facility
audits.
 External identification of energy savings can occur through systematic energy audits
undertaken by a reputable energy auditor or energy service company.

In screening projects, the following criteria should be used to rank-order project opportunities.
Cost-effectiveness of energy savings of complete package of measures (Internal rate of
return, net present value, cash flow, average payback)
Sustainability of the savings over the life of the equipment.
Ease of quantifying, monitoring, and verifying electricity and fuel savings.
Availability of technology, and ease of adaptability of the technology to Indian conditions.
Other environmental and social cost benefits (such as reduction in local pollutants, e.g. SO )
x

b) Initiation

Initiating is the basic processes that should be performed to get the project started. This starting point
is critical because those who will deliver the project, those who will use the project, and those who
will have a stake in the project need to reach an agreement on its initiation. Involving all stakeholders
in the project phases generally improves the probability of satisfying customer requirements by
shared ownership of the project by the stakeholders. The success of the project team depends upon
53
starting with complete and accurate information, management support, and the authorization
necessary to manage the project.
c) Planning

The planning phase is considered the most important phase in project management. Project planning
defines project activities that will be performed; the products that will be produced, and describes
how these activities will be accomplished and managed. Project planning defines each major task,
estimates the time, resources and cost required, and provides a framework for management review
and control. Planning involves identifying and documenting scope, tasks, schedules, cost, risk,
quality, and staffing needs.
The result of the project planning, the project plan, will be an approved, comprehensive document
that allows a project team to begin and complete the work necessary to achieve the project goals and
objectives. The project plan will address how the project team will manage the project elements. It
will provide a high level of confidence in the organization’s ability to meet the scope, timing, cost,
and quality requirements by addressing all aspects of the project.
d) Executing

Once a project moves into the execution phase, the project team and all necessary resources to carry
out the project should be in place and ready to perform project activities. The project plan is
completed and base lined by this time as well. The project team and the project manager’s focus now
shifts from planning the project efforts to participating, observing, and analyzing the work being
done.

The execution phase is when the work activities of the project plan are executed, resulting in the
completion of the project deliverables and achievement of the project objective(s). This phase brings
together all of the project management disciplines, resulting in a product or service that will meet the
project deliverable requirements and the customers need. During this phase, elements completed in
the planning phase are implemented, time is expended, and money is spent.

In short, it means coordinating and managing the project resources while executing the project plan,
performing the planned project activities, and ensuring they are completed efficiently.
e) Controlling
Project Control function that involves comparing actual performance with planned performance and
taking corrective action to get the desired outcome when there are significant differences. By
monitoring and measuring progress regularly, identifying variances from plan, and taking corrective
action if required, project control ensures that project objectives are met.

f) Closing out

Project closeout is performed after all defined project objectives have been met and the customer has
formally accepted the project’s deliverables and end product or, in some instances, when a project
has been cancelled or terminated early. Although, project closeout is a routine process, it is an
important one. By properly completing the project closeout, organizations can benefit from lessons
learned and information compiled. The project closeout phase is comprised of contract closeout and
administrative closure.

2. Technical Design

54
For a project to be taken up for investment, its proponent must present a sound technical feasibility

study that identifies the following components:

The proposed new technologies, process modifications, equipment replacements and other
measures included in the project.
Product/technology/material supply chain (e.g., locally available, imported, reliability of
supply)
Commercial viability of the complete package of measures (internal rate of return, net
present value, cash flow, average payback).

Any special technical complexities (installation, maintenance, repair), associated skills

required.
Preliminary designs, including schematics, for all major equipment needed, along with
design requirements, manufacturer’s name and contact details, and capital cost estimate.
Organizational and management plan for implementation, including timetable, personnel
requirements, staff training, project engineering, and other logistical issues.

3. Financing

When considering a new project, it should be remembered that other departments in the organization

would be competing for capital for their projects. However, it is also important to realize that energy

efficiency is a major consideration in all types of projects, whether they are:

• Projects designed to improve energy efficiency

• Projects where energy efficiency is not the main objective, but still plays a vital role.

The funding for project is often outside the control of the project manager. However, it is important

that you understand the principles behind the provision of scarce funds.
Project funds can be obtained from either internal or external sources.

Internal sources include:

• Direct cash provision from company reserves
• From revenue budget (if payback is less than one year)
• New share capital

Funding can become an issue when energy efficiency projects have previously been given a lower
priority than other projects. It is worth remembering that while the prioritization of projects may not
be under our control, the quality of the project submission is.
External sources of funds include:
• Bank loans
55
 • Leasing arrangement
• Payment by savings i.e. A deal arranged with equipment supplier
• Energy services contract
• Private finance initiative

The availability of external funds depends on the nature of your organization. The finance charges on
the money you borrow will have a bearing on the validity of your project.
Before applying for money, discuss all the options for funding the project with your finance
managers.
It is reiterated that energy savings often add substantially to the viability of other non-energy
projects.
4. Contracting
Since a substantial portion of a project is typically executed through contracts, the proper
management of contracts is critical to the successful implementation of the project. In this context,
the following should be done.
• The competence and capability of all the contractors must be ensured. One weak link can affect
the timely performance of the contract.
• Proper discipline must be enforced among contractors and suppliers by insisting that they
should develop realistic and detailed resource and time plans that are matching with the
project plan.
• Penalties may be imposed for failure to meet contractual obligations. Likewise, incentives may
be offered for good performance.
• Help should be extended to contractors and suppliers when they have genuine problems.
• Project authorities must retain independence to off-load contracts (partially or wholly) to other
parties where delays are anticipated.

If the project is to implemented by an outside contractor, several types of contract may be used to
undertake the installation and commissioning:

􀂃Traditional Contract: All project specifications are provided to a contractor who purchases
and installs equipment at cost plus a mark-up or fixed price.
􀂃Extended Technical Guarantee/Service: The contractor offers extended guarantees on the
performance of selected equipment and / or service/maintenance agreements.
􀂃Extended Financing Terms: The contractor provides the option of an extended lease or other
financing vehicle in which the payment schedule can be based on the expected savings.
􀂃Guaranteed Saving Performance Contract: All or part of savings is guaranteed by the
contractor, and all or part of the costs of equipment and/or services is paid down out of
savings as they are achieved.
􀂃Shared Savings Performance Contract: The contractor provides the financing and is paid an
agreed fraction of actual savings as they are achieved. This payment is used to pay down the
debt costs of equipment and/or services.
5. Implementation
The main problems faced by project manager during implementation are poor monitoring of
progress, not handling risks and poor cost management.
a) Poor monitoring of progress: Project managers sometimes tend to spend most of their time in
planning activity and surprisingly very less time in following up whether the implementation is
following the plan. A proactive report generated by project planner software can really help the
project manager to know whether the tasks are progressing as per the plan.
56
b) Not handling risks: Risks have an uncanny habit of appearing at the least expected time. In spite
of the best efforts of a project manager they are bound to happen. Risks need immediate and
focused attention. Delay in dealing with risks cause the problem to aggravate and has negative
consequences for the project.
c) Poor cost management: A project manager's success is measured by the amount of cost
optimization done for a project. Managers frequently do all the cost optimization during the
planning stages but fail to follow through during the rest of the stages of the project. The cost
graphs in the Project planner software can help a manager to get a update on project cost
overflow. The cost variance (The difference between approved cost and the projected cost should
be always in the minds of the project managers).
6 Performance Monitoring
Once the project is completed, performance review should be done periodically to compare actual

performance with projected performance. Feedback on project is useful in several ways:

a) It helps us to know how realistic were the assumptions underlying the project

b) It provides a documented log of experience that is highly valuable in decision making in future

projects

c) It suggests corrective action to be taken in the light of actual performance

d) It helps in uncovering judgmental biases

e) It includes a desired caution among project sponsors.

Performance Indicators (PIs) are an effective way of communicating a project’s benefits, usually as

part of a performance measuring and reporting process. Performance Indicators are available for a

wide range of industries and allow a measure of energy performance to be assigned to a process

against which others can be judged.

Depending on the nature of the project, savings are determined using engineering calculations, or
through metering and monitoring, utility meter billing analysis, or computer simulations.

57
 Project Planning Techniques

The three basic project planning techniques are Gantt chart, CPM and PERT. All monitor progress
and costs against resource budgets.
Gantt Chart
Gantt charts are also called Bar charts. The use of Gantt charts started during the industrial revolution
of the late 1800's. An early industrial engineer named Henry Gantt developed these charts to improve
factory efficiency.
Gantt chart is now commonly used for scheduling the tasks and tracking the progress of energy
management projects. Gantt charts are developed using bars to represent each task. The length of the
bar shows how long the task is expected to take to complete. Duration is easily shown on Gantt
charts. Sequence is not well shown on Gantt Charts (Refer Figure 2).
If, for example, the start of Task C depends on both Activity B and Activity E, then any delay to
Task E will also delay Task C. We just don't have enough information on the Gantt chart to know
this information.

Figure 2 Gantt Chart

CPM - Critical Path Method

DuPont developed a Critical Path Method (CPM) designed to address the challenge of shutting
down chemical plants for maintenance and then restarting the plants once the maintenance had been
completed.
Complex project, like the above example, require a series of activities, some of which must be
performed sequentially and others that can be performed in parallel with other activities. This
collection of series and parallel tasks can be modeled as a network.
CPM models the activities and events of a project as a network. Activities are shown as nodes on the
network and events that signify the beginning or ending of activities are shown as arcs or lines
between the nodes. The Figure 3 shows an example of a CPM network diagram:

58
Figure 3 CPM Diagram

Steps in CPM Project Planning

1. Specify the individual activities.

2. Determine the sequence of those activities.
3. Draw a network diagram.
4. Estimate the completion time for each activity.
5. Identify the critical path (longest path through the network)
6. Update the CPM diagram as the project progresses.

1. Specify the individual activities

All the activities in the project are listed. This list can be used as the basis for adding sequence and
duration information in later steps.

2. Determine the sequence of the activities

Some activities are dependent on the completion of other activities. A list of the immediate
predecessors of each activity is useful for constructing the CPM network diagram.

3. Draw the Network Diagram

Once the activities and their sequences have been defined, the CPM diagram can be drawn. CPM
originally was developed as an activity on node network.

4. Estimate activity completion time

The time required to complete each activity can be estimated using past experience. CPM does not
take into account variation in the completion time.

5. Identify the Critical Path

The critical path is the longest-duration path through the network. The significance of the critical
path is that the activities that lie on it cannot be delayed without delaying the project. Because of its
impact on the entire project, critical path analysis is an important aspect of project planning.

59
The critical path can be identified by determining the following four parameters for each activity:

• ES - earliest start time: the earliest time at which the activity can start given that its precedent
activities must be completed first.

• EF - earliest finish time, equal to the earliest start time for the activity plus the time required to
complete the activity.

• LF - latest finish time: the latest time at which the activity can be completed without delaying
the project.

• LS - latest start time, equal to the latest finish time minus the time required to complete the
activity.

The slack time for an activity is the time between its earliest and latest start time, or between its
earliest and latest finish time. Slack is the amount of time that an activity can be delayed past its
earliest start or earliest finish without delaying the project.

The critical path is the path through the project network in which none of the activities have slack,
that is, the path for which ES=LS and EF=LF for all activities in the path. A delay in the critical path
delays the project. Similarly, to accelerate the project it is necessary to reduce the total time required
for the activities in the critical path.

6. Update CPM diagram

As the project progresses, the actual task completion times will be known and the network diagram
can be updated to include this information. A new critical path may emerge, and structural changes
may be made in the network if project requirements change.

CPM Benefits

• Provides a graphical view of the project.

• Predicts the time required to complete the project.

• Shows which activities are critical to maintaining the schedule and which are not.

CPM Limitations

While CPM is easy to understand and use, it does not consider the time variations that can have a
great impact on the completion time of a complex project. CPM was developed for complex but
fairly routine projects with minimum uncertainty in the project completion times. For less routine
projects there is more uncertainty in the completion times, and this uncertainty limits its usefulness.

PERT
The Project Evaluation and Review Technique (PERT) is a network model that allows for
randomness in activity completion times. PERT was developed in the late 1950's for the U.S. Navy's

60
Polaris project having thousands of contractors. It has the potential to reduce both the time and cost
required to complete a project.

The Network Diagram

In a project, an activity is a task that must be performed and an event is a milestone marking the
completion of one or more activities. Before an activity can begin, all of its predecessor activities
must be completed. Project network models represent activities and milestones by arcs and nodes.

PERT is typically represented as an activity on arc network, in which the activities are represented
on the lines and milestones on the nodes. The Figure 4 shows a simple example of a PERT diagram.

Figure 4. PERT Chart

The milestones generally are numbered so that the ending node of an activity has a higher number
than the beginning node. Incrementing the numbers by 10 allows for new ones to be inserted without
modifying the numbering of the entire diagram. The activities in the above diagram are labeled with
letters along with the expected time required to complete the activity.

Steps in the PERT Planning Process

PERT planning involves the following steps:

1. Identify the specific activities and milestones.

2. Determine the proper sequence of the activities.
3. Construct a network diagram.
4. Estimate the time required for each activity.
5. Determine the critical path.
6. Update the PERT chart as the project progresses.

1. Identify activities and milestones

The activities are the tasks required to complete the project. The milestones are the events marking
the beginning and end of one or more activities.

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2. Determine activity sequence

This step may be combined with the activity identification step since the activity sequence is known
for some tasks. Other tasks may require more analysis to determine the exact order in which they
must be performed.

3. Construct the Network Diagram

Using the activity sequence information, a network diagram can be drawn showing the sequence of
the serial and parallel activities.

4. Estimate activity times

Weeks are a commonly used unit of time for activity completion, but any consistent unit of time can
be used.

A distinguishing feature of PERT is its ability to deal with uncertainty in activity completion times.
For each activity, the model usually includes three time estimates:

• Optimistic time (OT) - generally the shortest time in which the activity can be completed. (This
is what an inexperienced manager believes!)

• Most likely time (MT) - the completion time having the highest probability. This is different
from expected time. Seasoned managers have an amazing way of estimating very close to
actual data from prior estimation errors.

• Pessimistic time (PT) - the longest time that an activity might require.

The expected time for each activity can be approximated using the following weighted average:

Expected time = (OT + 4 x MT+ PT) / 6

This expected time might be displayed on the network diagram.

Variance for each activity is given by:

[(PT - OT) / 6]2

5. Determine the Critical Path

The critical path is determined by adding the times for the activities in each sequence and
determining the longest path in the project. The critical path determines the total time required for the
project.

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If activities outside the critical path speed up or slow down (within limits), the total project time does
not change. The amount of time that a non-critical path activity can be delayed without delaying the
project is referred to as slack time.

If the critical path is not immediately obvious, it may be helpful to determine the following four
quantities for each activity:

• ES - Earliest Start time

• EF - Earliest Finish time

• LS - Latest Start time

• LF - Latest Finish time

These times are calculated using the expected time for the relevant activities. The ES and EF of each
activity are determined by working forward through the network and determining the earliest time at
which an activity can start and finish considering its predecessor activities.

The latest start and finish times are the latest times that an activity can start and finish without
delaying the project. LS and LF are found by working backward through the network. The difference
in the latest and earliest finish of each activity is that activity's slack. The critical path then is the path
through the network in which none of the activities have slack.

The variance in the project completion time can be calculated by summing the variances in the
completion times of the activities in the critical path. Given this variance, one can calculate the
probability that the project will be completed by a certain date.

Since the critical path determines the completion date of the project, the project can be accelerated by
adding the resources required to decrease the time for the activities in the critical path. Such a
shortening of the project sometimes is referred to as project crashing.

6. Update as project progresses

Make adjustments in the PERT chart as the project progresses. As the project unfolds, the estimated
times can be replaced with actual times. In cases where there are delays, additional resources may be
needed to stay on schedule and the PERT chart may be modified to reflect the new situation.

Benefits of PERT

PERT is useful because it provides the following information:

• Expected project completion time.

• Probability of completion before a specified date.

• The critical path activities that directly impact the completion time.

• The activities that have slack time and that can lend resources to critical path activities.

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 • Activities start and end dates.

Limitations of PERT

The following are some of PERT's limitations:

• The activity time estimates are somewhat subjective and depend on judgment. In cases where
there is little experience in performing an activity, the numbers may be only a guess. In other
cases, if the person or group performing the activity estimates the time there may be bias in
the estimate.

The underestimation of the project completion time due to alternate paths becoming critical is
perhaps the most serious.

Case Example
Replacing an existing boiler with an energy efficient boiler.

Replacing an Activity Duration in days Depends on

existing boiler with
an energy efficient
boiler. Activity
Code
A Prepare technical 10 -
specifications
B Tender Processing 25 A
C Release of work 3 B
orders
D Supply of Boiler 60 C
equipment
E Supply of 20 C
Auxiliaries
F Supply of Pipes & 10 C
Pipe fittings
G Civil Work 15 C
H Installation of 5 E, F&G
Auxiliary
equipment & piping
I Installation of 10 D&H
Boiler
J Testing and 2 I
Commissioning

A. Gantt Chart

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The Figure 5 shows a Gantt chart for a simple energy management project, i.e. Replacing an existing

boiler with an energy efficient boiler.

As already mentioned, Gantt chart is the simplest and quickest method for formal planning. Gantt

charts can be very useful in planning projects with a limited number of tasks and with few inter-

relationships. This chart typically depicts activities as horizontal lines whose length depends on the

time needed to complete the activities. These lines can be progressively overprinted to show how

much of activity has been completed.

Drawing a Gantt chart requires information on:

􀂃The logic of the tasks;

􀂃The duration of the tasks;

􀂃The resources available to complete the tasks.

Task Duration
(days)
A 10 Prepare technical specifications
B 25 Tender Processing
C 3 Release of work orders
D 60 Supply of Boiler equipment
E 20 Supply of Auxiliaries
F 10 Supply of Pipes & Pipe fittings
G 15 Civil Work
H 5 Installation of Auxiliary equipment & piping
I 10 Installation of Boiler
J 2 Testing and Commissioning
Figure 5 A Simple Gantt Chart for Boiler Replacement

B. PERT / CPM Technique:

A PERT/CPM network for Boiler Replacement (Refer Figure 6)
Activity on Arrow: Activity and duration of the activity are shown in arrow.

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 Figure6

 10/10: In this Numerator denotes the Earliest Event Occurrence Time and Denominator is the

Latest Event Occurrence Time.

 The Critical Path for this network is: A-B-C-D-I-J.

 Dummy activity has no duration ------------------------------

 The total duration for the completion of the project is 110 days based on the critical path.

Difference between PERT & CPM

CPM PERT

1. Developed to solve schedule problems 1 Calculate the expected value of an

in industrial setting . activity duration

2. It is concerned with obtaining the 2 It is crated to a means of planning &

tradeoff b/n cost and completion data . accelerating development of a
for large projects. technological innovation.

3. It is activity oriented (segments of work 3 It is event oriented (a point of time).

done over a period of time). .

4. It is used more in projects such as 4 It is used more in research and

construction. . developmental projects.

5. It is not concerned with uncertain job 5 It is concerned with uncertain job times.

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 times. .

6. Orientation is 'deterministic'. 6 Orientation is 'probabilistic'.

.

UNIT V
Risks in financing agriculture. Risk management strategies and coping mechanism. Crop
Insurance programmes – review of different crop insurance schemes – yield loss and weather
based insurance and their applications.

Crop Insurance-meaning and its- advantages-progress of crop insurance scheme in India-

limitations in application-Agricultural Insurance Company of India-National Agricultural
Insurance scheme (NAIS) - salient features-Weather insurance

Origin and Importance of crop Insurance scheme: Insurance-

meaning
Insurance is a legal contract that transfers risk from a policy holder to an insurance company in
exchange for a premium.
? Risk: The possibility of financial loss
? Policyholder: The person who has purchased and owned an insurance policy.
? Insurance Company: A company that provides the insurance coverage for
its policyholders ? Premium: The cost of
insurance

The desire to introduce two pilot schemes viz., crop insurance and cattle insurance with the
objective of protecting the farmers from the heavy losses of crop and livestock by Government of India
was dates back to 1948 soon after the independence. But due to paucity of funds, none of the state
governments agreed to implement the programme.
The Government of India during the year 1970 appointed an expert committee on crop
Insurance under the chairmanship of Dharam Narain to examine and analyse the administrative and
financial implications of the scheme. Sri. Dharam Narain ruled out the possibility of implementing the
scheme in India. In contrast to the above committee, Prof. Dhandekar strongly supported the
implementation of the scheme. By accepting Prof. Dhandekar's views in 1973, the GOI had set up
General Insurance Corporation (GIC) to carry out all types of insurance business throughout the country
with four subsidiary insurance companies. They are

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1. National Insurance Company Limited
2. The New India Assurance Company Limited
3. The oriental Insurance Company Limited
4. United India Insurance Company Limited

On pilot basis in 1973, the GIC introduced the crop Insurance scheme in selected centres of
Gujarat covering only H4 variety of cotton. Later on the same was extended to West Bengal, Tamilnadu
and Andhra Pradesh for the cotton crop and this scheme was in operation till 1979.
In 1979, area based crop Insurance scheme was introduced on pilot basis in selected areas. If the
actual average yield of the crop in the area was less than the guaranteed yield of the crop, then the
indemnity would be payable to all the insured farmer-borrowers. Sum insured under crop insurance was
100 per cent but with a ceiling limit of Rs.5000 per farmer in the case of dry land and Rs.10, 000 per
farmer - borrower in the case of irrigated areas. The scheme was implemented in 12 states up to 1984.
Comprehensive Crop Insurance Scheme (CCIS): In the year 1985, the Comprehensive Crop Insurance
Scheme (CCIS) was introduced by GIC in all the states. This scheme covers all farmers who availed the
crop loan and it is limited to cereals such as paddy, wheat, millets, oil seeds and pulses. The loans given
from 1st April to 30th September were considered for kharif insurance business. The loans granted from 1 st
October to March 31st of next year qualify for rabi insurance. Therefore the insurance cover will be
considered as built-in-aspect of crop loan.
Crop insurance risk is taken by GIC and the respective state governments in 2:1 ratio. The sum
insured is 100 per cent of crop loan taken by the farmers during that season. Here the sum insured was
limited to Rs. 10000 /- per farmer for all insurable crops irrespective of the quantum of loan taken by the
farmer. Only that part of crop loan is insurable which is utilized for the purpose of covering insured crops.
The insurance premium is fixed at 2 per cent of sum insured for paddy, wheat and millets and for
oilseeds and pulses it is one per cent. The premium is sanctioned as an additional loan to the farmers and
should not be deducted from original loan amount. For small and marginal farmers, 50 per cent of
insurance premium is subsidized by the central and state governments in equal proportion.
Indemnity payable under the scheme is calculated on the basis of "threshold yield" and it is
equal to 80 per cent of the average yield for a given crop for the previous 5 years . Normally 80 per cent
of the average annual yield of the given crop in a given area over the last preceding five years is
considered as "threshold yield" of that area. Short fall in yield of crop is difference between threshold
yield and actual yield of the crop in particular area for the year under consideration.

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 Shortfall in the yield of the crop
Indemnity = __________________________________ x Sum insured.
(Guaranteed
Compensation) Threshold yield of the crop

The yield data for this purpose is obtained from the crop-cutting experiments conducted by the
state Government in accordance with the prescribed procedure as approved by National Sample Servey
organization (NSSO), Ministry of Planning, Government of India. Advantages of CCIS:

Comprehensive crop insurance scheme has some specific advantages, which is in operation in all the
states from 1985 onwards. They are
• It stabilizes the farm business during the periods of crop failure.
• The farmer can act much more confidently in farm business as there is protection against hazards
of farming.
• It prevents the farmers to approach non-institutional agencies at times of crop failure.
• It enhances the use of modern inputs to boost the productivity in agriculture
• In high-risk areas crop insurance serves as a catalyst in bringing areas under cultivation, which
otherwise would have remained uncultivated.
Demerits of CCIS are

• It provided coverage only to a limited number of crops like wheat, paddy, oilseeds, millets and
pulses excluding important cash crops like sugarcane, potato, cotton etc.
• As the coverage was restricted to rainfed crops only, the scheme was not effective in
agriculturally intensive states such as Punjab, Haryana and Western U.P.

• The scheme covered only those farmers who had availed crop loans from financial institutions.
Sum insured per farmer was also limited to a maximum of Rs.10, 000 /- only.

Eminent economists made some suggestions for the satisfactory functioning and improvement of CCIS
and they are:

• All crops and all the farmers should be brought under the purview of the scheme.
• The premium rates should vary with the nature and indices of crop production in
different areas.

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 • The unit area considered for paying indemnity should be a village or group of
villages as against block/mandal.
• Threshold yield should be worked out on the basis of crop production indices
over a ten year period as against five year period.

National Agricultural Insurance Scheme (NAIS)/Bharatiya Krishi Bhima Yojana (BKBY):

With a view to take insurance closer to the farmers, a newly improved insurance package
over the existing CCIS was launched by the former Prime minister Sri. Atal Bihari Vajpayee on 23-
06-1999. It is National Agricultural Insurance Scheme.
Irrespective of the size of their holdings, the NAIS would provide insurance facilities to all
farmers from 1999 -2000 season onwards. The NAIS would cover all crops, including coarse cereals,
all pulses and oil seeds. Apart from these, three more cash crops viz., sugarcane, potato and cotton
were also brought under the purview of the scheme in the first year i.e.1999-2000 itself.
All the other crops i.e. horticulture and commercial crops were also proposed to be
included under the scheme from the year 2002. There was no maximum limit for the sum insured.
The premium rates were 3.5 per cent of sum insured for bajra and oilseeds and 2.5 per cent for other
kharif crops. It was 1.5 per cent of sum insured for wheat and 2 per cent for other rabi crops. Similar
to that CCIS, in this NAIS also 50 per cent subsidy in premium is there for small and marginal
farmers. However, this subsidy will be proposed to be phased out from five years after its inception.
i.e 2005 onwards.
The scheme would be operated on the basis of area approach. All the farmers in a defined
area would be entitled for payment of insurance claim according to the indemnity rates prescribed for
that area. Individual claims of the affected farmers would also be entertained in the case of localized
calamities like hailstorm, land slip, cyclone, floods etc.

Agriculture Insurance Company of India (AIC) Limited:

Agriculture Insurance Company of India Limited (AIC) had been formed by the Government of India in
2003 to subserve the needs of farmers better and to move towards a sustainable actuarial regime. It was
proposed to set up a new corporation for agriculture Insurance. AIC has taken over the implementation of
National Agricultural Insurance Scheme (NAIS) which until 2003 was implemented by General Insurance

70
Corporation of India. In future, AIC would also be transacting other insurance businesses directly or
indirectly concerning agriculture and its allied activities.

Agriculture Insurance Company of India Limited is a public sector undertaking with

headquarters at New Delhi. It currently offers area based and weather based crop insurance programs in
almost 500 districts of India. It covers almost 20 million farmers, making it one of the biggest crop
insurers in the world.

Agriculture Insurance Company of India Ltd (AIC) is promoted by General Insurance

Corporation of India (GIC), NABARD and the 4 public sector general Insurance companies. AIC has
taken over the implementation of National Agricultural Insurance Scheme (NAIS) in 2003 which until the
financial year 2002 - 03 was implemented by GIC.

AIC is under the administrative control of Ministry of Finance, Government of India, and under
the operational supervision of Ministry of Agriculture. Insurance
Regulatory and Development Authority, Hyderabad, is the regulatory body governing
AIC.
Main objective of AIC:

To provide financial security to persons engaged in agriculture and allied activities through
insurance products and other support services.

Share Capital

• Authorized share capital - Rs. 1500 crores

• Paid-up share capital - Rs. 200 crores

Promoted by:

• General Insurance Corporation of India - share holding: 35 %

• National Bank for Agriculture And Rural Development (NABARD) - share holding: 30
%
• National Insurance Company Ltd - share holding: 8.75 %
• New India Assurance Company Ltd- share holding: 8.75 %

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 • Oriental Insurance Company Ltd - share holding: 8.75 %
• United India Insurance Company Ltd.- share holding: 8.75%

Weather Insurance:
Agriculture is still the dominant sector in India, contributing around 20 per cent of GDP and
providing employment to two-thirds of its population. Therefore, even the slightest change in this sector
can affect the economy. However, most of it is rain-fed and prone to unfavourable weather conditions like
deficit or excess rainfall and variations in temperature. Though phenomenon of unpredictable rainfall in
India remains an unresolved issue, weather insurance has emerged as a ray of hope to farmers to tackle
the uncertain pattern of their crops.
Weather Insurance- an insurance cover against crop losses incurred due to unfavorable
weather conditions such as deficit, excess or untimely rainfall or variations in temperature. Weather
insurance product is designed on the basis of location's agricultural and climatic properties and
productivity levels over the last several years. This serves as a good alternative to farmers for mitigating
their production related losses.
Weather insurance is now a common term in countries likes US, Canada, UK and other western
countries. In India, ICICI Lombard is the most popular company in the field of weather insurance.
In India Weather Insurance was developed by government of India in association with the
World Bank and launched in kharif 2007 in Karnataka. In 2008-09 it was extended to states like Andhra
Pradesh, Rajasthan, Bihar, Haryana, West Bengal Chhttisgarh, Gujarat, Madhya Pradesh, Maharastra,
Orissa, Tamilnadu, Jharkhand, Himachal Pradesh, Kerala, Uttaranchal and Uttar Pradesh. It was launched
as a pilot scheme to insure groundnut in Andhra Pradesh during Kharif 2008. There are several benefits of
weather insurance. They include:

• High level of client comfort

• Low management expenses
• Scientifically developed objective

Weather insurance provides protection to the farmers, banks, micro-finance lenders and agro-
based industries. This in turn results in boosting the entire rural economy. Some vital factors of Weather
Insurance are:

• Peril/ hazard Identification

• Index Setting
• Back testing for payouts
• Pricing

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 • Monitoring
• Claims Settlement

There are some examples of deals initiated by Weather Insurance for oranges in Jhalawar, Rajasthan, 782
farmers were aided by the Weather Insurance which provided a cover for 613 acres for a sum insured of
Rs.18.3 million to them. Another example states various crops in Andhra Pradesh were provided cover
when they faced losses due to deficit rainfall.

Weather Insurance - Broad Challenges/limitations

1. Needs large no. of Automatic Weather Stations (AWS) to minimize Basis Risk (Basis risk:
Without sufficient correlation between the index and actual

losses, index insurance is not an effective risk management tool. This is mitigated by self-
insurance of smaller basis risk by the farmer; supplemental products underwritten by private
insurers; blending index insurance and rural finance; and offering coverage only for extreme
events.)

2. Precise actuarial modeling: Insurers must understand the statistical properties of the
underlying index.

3. Education: Required by users to assess whether index insurance will provide effective risk
management.

4. Market size: The market is still in its infancy in developing countries like India and has some
start-up costs.

5. Weather cycles: Actuarial soundness of the premium could be undermined by weather cycles
that change the probability of the insured events

6. Microclimates: Make rainfall or area-yield index based contracts difficult for more freque nt
and localized events.
7. Reliable and verifiable data
8. Tamper proof weather stations (Automatic Weather Stations - AWS)

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 REFERENCES

• Ghosal, SN., Agricultural Financing in India, Asia Publishing House, Bombay, 1966
• Johi, S.S. and C.V.Moore., Essentials of Farm Financial Management, Today and Tommorow's
Printers and Publishers, New Delhi, 1970
• John, J.Hamptron., Financial Decision Making: Concepts, Problems and Cases, Prentice-Hall of India
, New Delhi, 1983
• Kenneth, Duft D., Principles of Management in Agribusiness, Reston Publishing Company, Reston,
1979
• Mamoria, C.B. and R.D. Saksena., Co-operation in India, Kitab Mahal, Allahabad,
1973
• Mamoria, C.B. and Saxena., Agricultural Problems in India, Kitab Mahal, Allahabad
• Mukhi, H R. 1983. Cooperation in India and Abroad. New Heights Publishers, New Delhi.
• Muniraj, R., Farm Finance for Development, Oxford & IBH Publishing Company Private Ltd., New
Delhi, 1987
• Subba Reddy, S. and P.Raghuram., Agricultural Finance and Management, Oxford & IBH Publishing
Company Private Ltd., New Delhi, 2005
• Subba Reddy, S., P.Raghu ram., P. Sastry, T.V.N. and Bhavani Devi I. 2010. Agricultural
Economics., Oxford & IBH Publishing Company Private Ltd., New Delhi,
2010
• William, G. Murray and Nelson Aarson, G., Agricultural Finance, The Iowa State University Press,
Ames, Iowa, 1960

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