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Since India’s warehousing lacks quality, penetration and spread, farmers hardly knows anything about it. The only place where the farmers have seen stocks piled up are FCI godowns where rodents perform Tom and Jerr..
29 Jan 2009
Commodity Online
NEW DELHI: Since India’s warehousing lacks quality, penetration and spread, farmers hardly knows anything about it. The only place where the farmers have seen stocks piled up are FCI godowns where rodents perform Tom and Jerry shows.

Unless warehouses come up, lending on its receipt will be lackluster. But see how it can benefit various sectors.

At the time of harvesting, farmers usually sell a substantial quantity of produce at lower prices. However, price tends to rise as the season progresses. If farmers keep their goods in warehouses and use them as collateral to avail credit facility, they would be better placed to take advantage of the benefits of higher price and meet their immediate credit requirements (banks generally have such a scheme).

Warehouse Receipts can be used to lower access barriers. By attracting deposits from small farmers and traders, the system will help formalize their trade transactions, enabling a database on their activities to be generated. This will help overcome the problem of lack of track record, and enable banks to screen borrowers more effectively and with minimum delay.

Lenders can mitigate credit risk by using the stored commodity as collateral. This form of collateral is more readily available to rural producers and may be less difficult to liquidate than most assets traditionally accepted as collateral. For instance, availability risk associated with movable collateral can be reduced by the warehouse operator’s guarantee of delivery from a stated location.

Foreclosure can be made simple and low cost, without any resort to the courts, depending on how the financing is structured.

The Warehouse Receipts systems will also make it less necessary for lenders to monitor a large number of small borrowers as a few warehouse operators assure loan performance. This will reduce monitoring costs and encourage commercial lending to the rural sector, helping to capitalise the rural trade.

A lender holding a Warehouse Receipt has a claim against the issuer (the warehouse company) as well as the borrower in the event of the non-existence or unauthorised release of the collateral.

The risk of loss of value of the collateral can be reduced by monitoring movements in its market value as well as by margining and the use of price risk management instruments.

There are many corporates who are in the business of procurement of agri-commodity on large scale. These corporates are blocking their capital at the time of procurement. Commodities kept by them in warehouse could be taken as collateral and loan given to them.

Bank guarantee against Warehouse Receipts:
Brokers in commodities are required to deploy funds with the exchange to obtain trading limit and the composition of funds is in the form of bank guarantee and fixed deposit. In order to obtain bank guarantee most of the brokers are required to deploy liquid funds which reduced their leveraging capacity as a significant component of their assets are in the form of commodities.

This is particularly true for traders in commodities which have long shelf life like castor, pulses, cereals, cotton, rubber etc. Banks may provide guarantee to members of commodity exchanges against commodities owned by members through the mechanism of Warehouse Receipt.

Margin funding against Warehouse Receipts
Like securities market brokers, the commodity brokers are required to fund margin to the extent defined by the Exchange for obtaining trading limits. In case of long term requirement, the brokers would normally take a bank guarantee and deploy cash or fixed deposit to maintain the margins in the desired ratio of cash and bank guarantee or fixed deposit.

However, there may be times when due to short term requirement. In such situations, the banks can grant short term loans against the commodities more or less on the lines of issuance of bank guarantees against Warehouse Receipts so that the trader or his client is not required to make distress sale of commodity to make good the short term requirement of funds. The banks would be protected through the use of warehouse based storage system.

Lending to farmers through Corporate Purchase arrangement
Companies for own consumption or meeting export commitments, purchase raw materials from a large number of farmers and pay them upfront. Purchase is mainly made at the time of harvesting and the raw material is the stored in the warehouse. A tripartite agreement between bank, farmer and company could be worked out whereby based on commodity market prices company agrees to buy certain produce at a future price.

If necessary, the company covers its risk by using commodity futures. These goods are kept in warehouses by farmers. As per the understanding with the company, the bank extends higher finance (lower margin on future prices) to the farmer against the warehouse receipt endorsed by the farmer in favour of the company and pledged to the bank.

On an agreed date, the company pays to the bank and applies for vacation of the bank's lien / charge on warehoused goods. The payment made by the company is adjusted by the bank against the farmer's loan and surplus credited to his savings account.

Indian scenario
Available data in respect of a large Private Sector Bank, and three large public sector banks in respect of finance extended against Warehouse Receipts do not show an encouraging picture. It may be seen from the data that financing against Warehouse Receipt is still not a very popular method of financing though it is showing an upward trend.

In India, three new electronic commodity exchanges -- National Commodities and Derivatives Exchange Ltd. (NCDEX), Mumbai, Multi-Commodity Exchange Ltd. (MCX), Mumbai and National Multi-Commodity Exchange Ltd. (NMCE), Ahmedabad -- have been set up.

These exchanges deal in commodity futures. Limited opportunity for disposing of physical commodities exist by using futures contracts in the near month and choosing to make physical delivery. However, there is no specific platform for spot-trading in commodities.

Commendable efforts have been made in developing a physical infrastructure by NCDEX and other exchanges in collaboration with the Central Warehousing Corporation and quality assurance and grading agencies.

NCDEX has set up a National Collateral Management Services Company which would extend help in setting up warehouses, their accreditation and management of collaterals for the banks. The other exchanges too, are identifying warehouses and encouraging creation of infrastructure which would be accredited to them.

For healthy development of commodities market, such facilities should not only be exchange specific but be usable across exchanges. These efforts need to be augmented as ­

--the infrastructure is too spread out;

--the Warehouse Receipts are still in the physical form.

The proposals
In effect, the national level commodity exchanges are trying to create a Closed User Group where some warehouses and quality assurance and grading companies are members and provide a degree of comfort to the persons dealing with the exchanges.

After deliberating on the above issues the Group reached a conclusion that there is a need to create an umbrella structure which could act as a Closed User Group (CUG) for everyone engaged in the commodities business.

The membership of the CUG could extend to commodity exchanges; APMCs; commission agents registered with APMCs; warehouses; exporters, importers and domestic users of commodities; banks; insurance companies; and producers. In short, everyone who may be connected with production, grading, trading or financing of commodities may become a member of the Group.

The umbrella structure or the CUG is envisaged as an electronic platform that would offer straight through processing for everyone connected with the commodities.
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