How populism, muted agri growth are laying a farm loan trap for banks

Indian banks’ loan exposure to the high-risk perceived agriculture sector has risen substantially in the last 12 months, with the pace of growth in bank lending nearly doubling during the period, even as potential risk factors that could impact repayment of this money have been on the rise.

Risks have increased on account of a mix of reasons that include politically sponsored farm loan waivers in two of the southern states of India, rampant evergreening of agriculture loans over the years and muted growth in the country’s farm output.

Evergreening refers to the practice of a bank giving fresh loans to a borrower to help him meet interest payments.

According to latest data from the Reserve Bank of India (RBI), bank lending to agriculture and allied activities grew by 19.5 percent in the 12 months ended July 25, compared with a growth rate of 10.5 percent in the comparable period last year.

In the first four months of this fiscal alone, farm loans have grown by 7.6 percent compared with 2.2 percent in the corresponding period in last year, the data showed.

With this, the total loan outstanding to agriculture as on 25 July stands at Rs 7.2 lakh crore, compared with Rs 6 lakh crore in the year-ago period and Rs 5.4 lakh crore in the year before that.

Thus, farm loans currently now contribute about 12 percent of the total bank credit (gross bank credit is about Rs 57 lakh crore at end July).

This means that, for some reasons, banks have steadily increased their exposure to farmers every year, even as lending to fund-starved industries has been muted.

Remember, in the last two years, India’s medium-sized companies have received practically no incremental lending, if one goes by the RBI data.

What is the mystery behind banks’ ever-growing liking towards farmers? The answer lies in the current norms (mandatory priority sector lending under which banks have to lend 40 percent of their loans to agriculture, exports and other weaker sections) and alos in the yearly credit target given by the government.

This virtually forces banks to lend more to the farm sector even though some part of these loans are do not necessarily viable for them. The irony is that with the increase in lending, the farm sector/ production in the country has not gone up.

According to a July report of rating agency, Crisil, India’s agriculture growth is likely to remain muted at 1 percent in 2014-15 largely due to a strong statistical base effect.

The disconnect with such a fast pace growth in bank lending to the agriculture sector and muted growth in actual output clearly increases the chances of banks knowingly embracing a potential danger– the possibility of more bad loans arising out of farm segment in the next few years.

These are the few major reasons that could play out in the ensuing years:

First, a major chunk of the bank loans given to farmers have been extended through the Kisan Credit Cards (KCC), an instrument launched in 1998-99 for farmers and operates like a normal credit card.

Two critical issues associated with this channel are rampant ever greening and diversion of funds, originally intended for agricultural purpose, for consumption needs such as family weddings and medical needs.

The credit limit on this instrument goes up every year. Banks often begin a new loan cycle even before the existing loans are repaid fully.

This means, even though the loan is bad in the absence of proper repayments, the account is performing on technical grounds.

Since the credit limit goes up every year, farmers manage to continue as a performing borrower through part payment of the credit or through temporary adjustments like paying up on the last day. Actually, in many cases, full repayment never happens.

On the other hand, most banks pretend blind on this practice because of their compulsion to meet the farm loan lending targets.

According to norms, every bank should lend 18 percent of the total loans to agriculture.

Second, in many cases, the money lent to farmers are used for not just farming alone but often gets diverted for other consumption-related expenditure. Banks lend farm loans at an interest rate of 7 percent to farmer (2 percent interest is subsidised by the government). On proper repayment, interest rate further falls to 3 percent.

This makes farm loan a cheaper alternative to costly personal loans for borrowers to meet funding for consumption. Even though bankers are aware that many farmers divert farm loans for other needs, they hardly flag caution because of their lending compulsions. The unfortunate result of this is that only a portion of money goes to actual farming.

Third, agriculture as a percentage of gross domestic product (GDP) has been falling over the years, even though the flow of bank money has been only increasing.

The share of agriculture and allied sectors in India’s GDP declined to 13.7 percent in 2012-13 from over 40 percent at the time of independence due to shift from traditional agrarian economy to industry and service sectors. In short, the bank lending to the sector has increased substantially over years, but not the sector.

Four, it has almost become a certainty that banks, especially state-run banks, will have to take huge hit on their books due to the impact of the farm loan waiver announced by the southern states of Andhra Pradesh and Telangana. The total size of the loan waiver in these two states, announced originally as a poll promise, is estimated anywhere between Rs 70,000 crore amd Rs 1 lakh crore.

Given the significant fiscal constraints of the state governments, it is unlikely that the banks will get reimbursed on time for waiving off the loans. Post partition, Andhra Pradesh is running a total deficit of about Rs 15,000 crore.

Even though the RBI and banks have raised caution, chances are that the state governments will go ahead with the plan since the offer of waiver was a key poll promise. Under political compulsion, banks had offered a Rs 71,000 crore loan waiver in 2008.

Loan waivers are the ideal medicines to kill credit culture in any financial system. Besides destroying the credit culture, it kills the chances for getting a new loan for those whose loans are once waived.

In fact, the waiver-impact is already visible with most state-run banks witnessing a surge in their non-performing assets in the farm loan segment in the June quarter, after even good borrowers stopped paying to them in anticipation of the waiver.

Andhra bank, which witnessed its gross non-performing assets (NPA) hitting 5.98 percent of total loans, is the worst hit with the bank classifying agriculture loans worth Rs 1,076 crore as NPAs.

Typically, the lender has around 2.5 percent farm loan NPAs but the chunk rose around three times in the June quarter.

Relying on bank funding alone to fund India’s farmers and forcing annual targets on them may not be a prudent idea. It is time to devise alternative ways to bring in private funds to support farmers.

If not, a farm loan bubble is waiting to burst.