The Hindu Business Line : Banks concerned about price volatility in farm lending

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Mumbai Feb. 15 Commercial banks concerned about commodity price volatility arising out of their agricultural lending portfolio have begun to use prices disseminated by commodity futures exchanges.

Daily price changes on the bourses are being keenly watched for early indications or price trends to calculate margins while lending against agricultural commodities.

Lending to the farm sector involves inherent risks like credit, price, calamity and yield risks, said Ms Usha Thorat, Deputy Governor, RBI.

Banks use `margin system' to deal with the price risk involved in agricultural lending and such margin differs from commodity to commodity, said Mr Somak Ghosh, President, YES Bank, adding that margin management is the key to managing price risk.

Banks appoint agricultural specialists with knowledge of the trade and pulse of the market. These specialists have a dialogue with large players in the market to gauge the market pulse.

Because of price discovery and liquidity, in case of commodities traded on future exchanges, banks levy margins that are usually lower at around 25-35 per cent of the value, Mr Ghosh added.

On the other hand, unlisted commodities or those not traded on bourses would attract higher margin of about 50 per cent. "This is where the derivative markets are of use to indicate the prices three months later — to manage margins", said Mr H.N. Sinor, Chief Executive, Indian Banks Association.

While the lending banks continually monitor price trends, there is usually a weekly review of marked to market, especially in case of quality deterioration based on analytical report.

Price risk

While commodity futures trade has been advocated to manage this price risk — if it does not cover all the stakeholders involved in agricultural activity but comprises only traders and speculators — there is a problem in using the commodity futures prices by the banks, said Ms Thorat in her keynote address at a seminar on Banking in the Hinterland here recently.

There are issues to be considered such as access of commercial banks to the futures platform and also functioning of the commodity exchanges, remarked Ms Thorat.

While lending to the venerable segment of society, banks should have employees who understand the agricultural activities and must provide credit counselling to the farmers to educate them, said Ms Thorat.