Platform to Create Shared Value in Agribusiness Key Issues and Solutions in Agri -finance

1. Platform to Create Shared Value in Agribusiness Key Issues and Solutions in Agri-finance Analysis of questionnaire responses and interviews of bank and agribusiness leaders on agri-finance January 29, 2013 Agri-finance Collaboration Meet

2. Table of contents • Bank and company priorities by type of collaboration • Key issues and solutions in agri-finance • Key issues and solutions in value chain and warehouse receipt financing • Key issues and solutions in building BC networks with agro-dealers • Meeting agenda • Background

3. Banks and companies responding to the questionnaire • Banks • Axis Bank • HDFC Bank • ICICI Bank • SBI • Yes Bank • Companies • Coromandel • ITC • Mother Dairy • StarAgri

4. A. Bank and company priorities • by type of agri-finance collaboration

5. Banks view warehouse receipt financing, value chain financing and agro-dealer networks as means to reduce costs and risk and increase outreach in agri-finance Mechanism, business model Promise in reducing risks Promise in reducing costs, increasing profitability Promise in achieving major outreach Five participating banks responded to the questionnaire H: High M: Medium L: Low 5

6. Crop and weather insurance for farmers are considered important to banks and agribusinesses Importance of crop and/or weather insurance to banks and to agribusinesses Banks * Average score for all five banks Main changes needed to make crop and/or weather insurance accessible to farmers: 6

7. Banks are interested in pursuing a range of agri-finance collaborations with value chain agribusinesses, agro- input suppliers and dealers, and storage companies. 7

8. Companies are interested in pursuing collaborations with banks in a range of areas 8

9. B. Key issues and solutions in agri-finance

10. Key issues in agri-finance

11. Key solutions in agri-finance

12. C. Key issues and solutions in value chain and warehouse receipt financing

13. Issues and solutions in value chain financing

14. On value chain financing, banks want companies to provide procurement history. Both consider distinct value proposition and shared MIS important. Banks would like the agribusiness to share risk and subtract loan repayments from payments to farmers. Four banks and four companies responded to the questionnaire H: High M: Medium L: Low 14

15. Both banks and agribusinesses think financial services beyond loans, specialized bank staff, weather insurance and payment systems are important in value chain financing collaborations. 15 Four banks and four companies responded to the questionnaire H: High M: Medium L: Low

16. Key lessons in providing value chain financing to farmers in collaboration with agribusinesses

17. Solutions in warehouse financing

18. In loose value chain financing relationships, the FI performs most functions, relying on procurement track records and non-financial services of the agribusiness. Buyer / Trader Conditions for loose value chain financing to work • Farmers have track record of steady sales to agribusinesses or buyers. • Prices adequate and stable, for bank to assess cash flow, capacity to pay. • Useful if agribusiness or buyer provides technical services, access to quality inputs, quality control. Traders almost never provide such services. Crop Payment Loan Bank Farmer Loan repayment Roles of each key actor: Risk and risk mitigating measures: • Bank assumes all risk, appraises loans, disburses and collects. • Useful if focus on promising, high value commodities and if agribusiness/buyer provides data on procurement history from individual farmers in value chain. • Risk of non-repayment, with agribusiness, buyer not directly involved in loan and repayment process. • Risk of bank losing interest—relatively high cost, high risk model unless with established, progressive medium sized farmers. • Useful to get agribusiness or buyer to provide procurement history to bank. Useful to engage agribusiness in productivity building measures, and in process of moving from loose to tight value chains. 18

19. In tight value chain relationships, risks of side-selling are lower and the agribusiness assumes more functions, reducing costs to the financial institution. Agribusiness / Buyer Conditions for tight value chain arrangements to work: Loan repayment • Agribusiness has tight, stable relationships with a substantial number of farmers e.g. over 1,000 ideally over 10,000 to justify value chain financing with bank • Agribusiness has developed strong, differentiated value proposition based on services, price and procurement arrangements—if not contracts—to protect against side selling. Crop Payment Pre-harvest loan Bank Farmer Loan repayment Roles of each key actor: Risk and risk mitigating measures: • Risk of participating farmers: side-selling to avoid repayment, linked to agribusiness procurement. • Risk mitigating instruments: focus on high value commodities and agribusinesses/buyers providing strong value to farmers e.g. price for quality, inputs, TA, quick payment. • Lend to farmers with at least two years of steady supply to the agribusiness/buyer, representing at least 70% of farmer’s cash crop sales • Agribusiness performs many functions in the loan cycle, normally including: data bases on procurement, screening farmer borrowers, and collecting repayments from the procurement amounts. • Agribusiness provides complementary services to build productivity, quality of farmer output. • Bank assumes all risks, does loan appraisal and normally direct disbursements. 19

20. Warehouse receipt financing Conditions for the model to work: • Farmers (or traders) derive strong price benefits from waiting to sell crops and from storage. • Secure warehouses, including cold storage and CA storage units exist in the geography in which small farmers are concentrated. Buyer / trader Bank Repayment Produce Receipt Finance Harvest produce Farmers Warehouse Warehouse receipt Roles of each key actor: Risk and risk mitigating measures: • Bank provides the farmer or trader with warehouse receipts against crops stored in warehouse. • Warehouse operator provides secure storage, insurance. • Farmer provides harvest produce for storage, until decides to sell at higher price. • Risks of theft, spoilage • Risk of mismanagement by warehouse operators • Risk that price at sale lower than loan+interest. • Risk mitigating instruments: insurance and solid credit and risk management, experience in commodity lending, ability to assess instruments, collateral managers, warehouses. Source: IFC and Agri-Finance. Creating Opportunity Where It’s Needed Most

21. Agri-finance with aggregators can involve direct finance for aggregator operations and value chain type arrangements for financing small farmers. Conditions for the model to work: Cooperative / Agro-entrepreneur • If producer organizations solid, legal financial structures with strong track record in marketing products, providing technical services to farmer members, and borrowing for cooperative activity and on behalf of farmer members. • If agro-entrepreneur, solid organizations with strong sales channels to buyers, agribusinesses, retailers—with established procurement and TA links with smaller producers. Repayment out of amounts procured Loan for aggregators and farmers Loan, cash and in-kind Loan repayment Farmers Bank Roles of each key actor: Risk and risk mitigating measures: • Strong aggregators borrow for own operations and serve as wholesaler or agent on loans to farmer members, cutting costs to bank. • Aggregator often provides productivity enhancing, quality control, processing, storage and transport roles • Bank appraises aggregator, and if aggregator an agent, bank appraises farmer member borrowers. • Risks that the cooperative or agro-entrepreneur will not repay loan for own operations or loans on behalf of farmers—due to poor management, mismanagement. • For all but the strongest aggregators, with impeccable financials and track records, bank can use aggregator for origination and complementary services, but bank should lend directly to farmers in the network. 21

22. D. Key issues and solutions in building • BC networks with agro-dealers

23. Issues in BC networks

24. Solutions in BC networks

25. Several banks and companies are interested in building agri-finance collaborations using agro-dealer networks 25

26. Banks and companies judge that shared objectives, clear margin sharing arrangements, and strong agro-dealer selection criteria to be key to successful BC and BF collaborations Four banks and four companies responded to the questionnaire H: High M: Medium L: Low 26

27. Banks and input companies see incentives linked to origination and repayments, finding agro-dealers with the time and willingness, strong IT, and integrity of the parties to be key to solid agri-finance through dealers Four banks and four companies responded to the questionnaire H: High M: Medium L: Low 27

28. Input companies consider strong training, measures to streamline operations, top management commitment and shared MIS to be important for successful agro-dealer BC networks Four banks and four companies responded to the questionnaire H: High M: Medium L: Low 28

29. Banks do not see buy-back, patience with piloting, geographical focus, dealer agro-knowledge or value add to farmers as important. Companies see these elements as quite important. 29 Four banks and four companies responded to the questionnaire H: High M: Medium L: Low

30. Key lessons in providing financing to farmers through agro-dealers, traders, small processors

31. Banks are looking for collaborations with input supply and value chain companies to reduce costs and risks in agri-finance, and to help farmers get what they need to succeed 31

32. In designing banking correspondent agent relationships with agro-dealers, the FI needs to be actively engaged in training, ICT, and initial loan appraisals. Conditions for the model to work: • Input suppliers need to have strong rural distribution networks of agro-dealers. • Works best if input suppliers can collaborate to ensure supply and financing of improved seed, fertilizer, plant protection. • Agro-dealers need to be solid, respected, with strong understanding of who are solid, progressive farmers. • Need strong, shared MIS and ideally internet based payments. Input supplier / agro-dealer Inputs Funds Bank Farmers Loan repayment Roles of each key actor: Risk and risk mitigating measures: • Bank does appraisal of farmers, provides farmers loans, provided in kind from agro-dealers. Bank takes full credit risk. • Input supplier/agro-dealer provides inputs, advice and ideally loan origination, screening support. • Agro-dealers can become BC agents acting for the bank in WC loans-doing origination, screening, loan doc, disbursing, collecting. • Risk of non-repayment, no procurement tie-up. • Risk that inputs only will not be adequate financing for farmers, limiting yields • Mitigate risks by building strong training of agro-dealers to provide value adding advice and identify strong borrowers, with incentives based on farmer loan repayments to the bank. 32

33. E. Meeting agenda

34. Meeting agenda 10:00 to 10:45 Presentation by ESP of questionnaire responses and IIMA interviews on agri-finance 11:05 to 12:20 Meetings of individual companies and banks 12:20 to 1:00 Discussion of main lessons on building effective agri-finance collaborations, and key Platform actions to support bank and company initiatives.

35. F. Background

36. Background • Strategies, issues and solutions being built by: • HDFC Bank • SBI • Axis Bank • Yes Bank • ICICI Bank • Key competitors • Statistics on agricultural lending • Implications of new priority sector lending regulations for agri-finance

37. Strategies, issues and key success factors in agri-finance. HDFC Bank Key success factors Key issues in agri-lending • Long term strategies for collaborative connection and operation with farmers • Progressive management • Ensuring attractive, prompt dealer payouts. • Ensuring effective cash logistics mechanisms. • Ensuring improved turnaround time. • Ensuring corporate involvement at the procurement level. • Cash-based cash flow • Fraud, loan default • Customer assessment • Inaccurate mortgage documents • Issues in customer selection • High transaction costs of cash collection • Profitability—particularly in lending to smaller farmers • Low claim settlement efficiency • Issues of “vested interests and inertia between various layers of corporate”.

38. Lessons learned

39. Key issues and success factors in agri-lending State Bank of India Key success factors Key issues in agri-lending • Working with all three models: value chain financing, agro-dealers as BCs, warehouse receipt financing. • Strong relationship with farmers by very deep reach through different value-chains. • Related to costs: • Small loan size • Inadequate number of stable value chains • Lack of investment credit • Related to risks: • Absence of tangible collateral • Spread of defaulters in an area • Related to collaborations: • Unstable value chains • Restricted direct agriculture lending areas

40. Key issues and success factors in agri-lending State Bank of India

41. Strategy, issues and success factors in agri-finance –Axis Bank Key success factors Key issues in agri-lending • Loan repayment risks high • Limited branch outreach • Competitive disadvantage due to interest subsidies by scheduled banks • Manpower- productivity and ROE issues • Farmer perception of private vs. public sector banks • Add-on costs to farmers e.g. bribes, fees • Related to collaborations: • Identifying collaborators with reach, qualifications, intent and goal congruence • BCs must accept terms of sharing NPA risks • Identifying collaborators and setting up a system that takes care of the three parties. • Technology to reduce manpower costs. • Reducing turnaround time

42. Lessons from current agri-business collaborations

43. Challenges and success factors in the agro-business collaborations and agri-lending – Yes Bank Key success factors Key issues in agri-lending • Developing a wide network through collaboration to improve the quality of loans and hence reduce repayment risks. • Targeting and mastering each link in the value chain one by one is more efficient • Branch outreach • Loan recovery • Due diligence of farmers • Estimation of credit limits for a farmer • Lack of proper documents • Building own field force • Related to collaborations: • Dealer collaboration is challenging because dealers of a company are dispersed • Increased costs due to margin paid to them • Insistence on banks to handle cash because dealers/traders do mainly cash business • Proper training of intermediaries is costly

44. Lessons from current agri-business collaborations

45. Key issues and success factors in agri-finance – ICICI Bank Key success factors Key issues in agri-lending • Related to cost: • Small loan sizes, high fixed cost • Issues of reach, low density of farmers • High transaction costs, including need to handle cash directly • Related to risk: • Difficult to predict weather • Lack of credit history of farmers • Difficult to find out end use of loans • Related to collaborations: • Turning small loan portfolio into a profitable one • Credibility of dealers. Ensuring effective cash logistics mechanisms to handle cash • Ensuring timely payments by farmers. Designing an effective incentive system for dealers • Strong and result oriented relationship with rural value chains. • Progressive management team

46. Current strategy and key lessons

47. Major competitors 47 High competition Medium competition Low competition

48. Historical performance under lending to total agriculture Lending to total agriculture sector • This is presented as a percentage of Adjusted Net Bank Credit • Without 4.5% cap on indirect agriculture lending Source: RBI

49. Trends in NPAs in agriculture sector Source: RBI

50. Implications of the new priority sector lending regulations for commercial banks