Warehouse Receipt

Finance for Farmers

A Glimpse
By Mr. Nachiket Mor and Dr. Kshama Fernandes

While warehouse receipt (WR) finance has been in existence in India for a long time, and
traders and large farmers do benefit by availing of the mechanism, small and marginal
farmers have been virtually left out of it. This paper discusses the advantages and
disadvantages of WR financing in India from small farmers point of view, while citing
examples of how this mechanism has been used globally. It also lays stress on some key
requirements for implementing a successful WR finance programme, concluding with a
brief on IFMR Trusts agricultural commodity pilot in Gujarat.

Agricultural production, processing and trade are often

considered low-margin, high-uncertainty operations,
and are perceived as risky investments by financiers.
Physical collateral, such as land and real estate or
machinery and agriculture implements, is often of little
use in mitigating financiers risks as such collateral
tends to either be very difficult to enforce or of very
little resale value. No wonder, to obtain finance for
agriculture can be really difficult and often expensive,
given the risk premium charged by financiers. In light of
this, warehouse receipt finance has emerged as an
attractive alternative for farmers and processors in the
developed world.
Under a warehouse receipts financing scheme, goods
stored in a warehouse are used as collateral against a
loan. These goods could be agricultural or nonagricultural in nature. This has become a fairly
mainstream method of financing in most industrialised
countries, and there is evidence that the overall
efficiency of markets, particularly in the agribusiness
sector, is greatly enhanced when producers and
commercial entities can convert inventories of
agricultural raw materials or finished products into a
readily tradable device. Producers deposit goods of a
certain quality, quantity, and grade in accredited
warehouses and receive a receipt for it. Being
negotiable instruments, these receipts can be traded,
sold, swapped, used as collateral to support borrowing,
or accepted for delivery against a derivative instrument
such as a futures contract.

42 | A PUBLICATION BY MCX AND PRICEWATERHOUSECOOPERS

According to a report by the Reserve Bank of India

Working Group on Warehouse Receipts & Commodity
Futures (2005), the overall efficiency of markets,
particularly in the agribusiness sector, immensely
improves when producers and commercial outfits are
able to convert inventories of agricultural raw materials
or finished products into a readily tradable instrument.
Producers receive a receipt against goods of a given
quality, quantity and grade deposited in accredited
warehouses. It also says that being negotiable
instruments, these receipts can be traded, sold,
swapped, used as collateral to enable borrowing, or
accepted for delivery against a derivative instrument
such as a futures contract.
Warehouse Receipt Finance for Farmers
Despite growth projections, what remains the reality of
the agriculture-related business is its high dependence
upon seasonality. Broadly speaking, farmers face two
major problems lumpy cash flows and nonavailability of intermediate finance. Warehouse
receipts finance can play an important role in
smoothening income for farmers by providing liquidity
at times when cash flows dry out.
WR financing as a means of extending the sales
period beyond the harvest season: As the harvest
season approaches, small and marginal farmers find
themselves in dire need of liquidity. The simple
demand and supply equation results in prices falling to
their lowest during harvest and gradually rising during

the lean season1 . Although farmers are aware of this

seasonal trend, they cannot take advantage of this and
benefit from it as they are hard put to organise
immediate cash. A typical small farmer sells his crop
when its prices are at their lowest. This crop is often
bought by traders or village-level aggregators who
hold the stock through the harvest season till prices
pick up and then sell it at a profit. To cite some numbers,
the seasonal variation in castor seed prices during 2008
was almost Rs.200 per 20kg which translates into a
profit of Rs.750 a bag of castor seed (which translates
into an annualised return of 88.9 %). If farmers are
enabled to hold on to their crop beyond harvest, a part
of the price benefit could accrue to them. So, by
providing farmers with a mechanism to store and hold
on to their produce, warehouse receipts finance
enables the extension of the sales period beyond the
harvest season.
WRs as secure collateral for obtaining finance: Most
banks are uncomfortable in extending pre-harvest
loans to farmers. Warehouse receipts form sound
collateral whose market value can be easily estimated
and whose liquidity is much higher than conventional
collateral such as land and machinery. In the event of
default, the holder of the warehouse receipt has the
first call on the underlying goods or its value. This
provides banks and financiers with the comfort to lend
to the farmer without lengthy documentation and long
processing delays. Farmers, on their part, can avail of
loans either to overcome immediate liquidity
requirements or to finance future crop/investments on
farm equipment or alternative businesses. According
to the RBI Working Group report, on notion of reduced
risk premia, collateralisation of agricultural inventories
using warehouse receipts will lead to increased credit
availability and reduced cost of credit. Besides, it will
lead to mobilisation of mainstream financial resources
into the agricultural sector.
In their study on the use and impact of warehouse
receipts in developing and transition economics,
Lacroix and Varangis (1996) concluded that warehouse
receipts are an important addition to the store of
negotiable instruments in a countrys financial sector.
According to them, they not only provide important
long-term economic benefits but also have immediate
positive impact on the farmers life.

Is There a Downside for the Farmer?

While availing of finance against warehouse receipts
appears to be an attractive option for the farmer, there
are concerns about its inherent speculative nature. One
must seriously look into a likely adverse outcome: this
financing avenue may encourage farmers to take
speculative positions having the potential of resulting
in losses beyond their risk-taking ability. Warehouse
receipt financing is profitable only when the expected
rise in the value of the stored product is actually more
than the cost of storage plus that of the borrowed
funds (i.e., loan principal plus interest payments, bank
fees, etc).
Many would argue that farmers ought to confine their
activity to the area of their core competence farming
and not indulge in speculation. However, in the
absence of a readily accessible hedging mechanism,
the Indian farmer is a speculator in any case. From the
point of time he sows the seed till the point of time he
sells the crop in the market the farmer is long on the
commodity, unless he hedges his long spot exposure
by selling his produce in a forwards, futures or options
market, which he has no access to in India. Most
farmers who sell their standing crop to traders and
other local financiers before harvest do so at suboptimal rates under tremendous liquidity pressure and
not from the point of view of hedging their exposure.
So, the contention that farmers should not engage in
speculative activity because it is not their core
competence is something that must be looked into in
the light of alternatives available. Warehouse receipt
financing is in essence a speculative activity. Availing of
the facility simply extends farmers already existing
price exposure beyond the harvest, providing him with
a readily available cash flow and a potential upside.
And, in general, even if the farmer wishes to sell in the
spot market, it allows him to do price averaging (thus
reducing his exposure to impact cost) by selling his
harvest gradually instead of being forced to sell the
entire quantity on a single day.

1 The persistence of this arbitrage is a conundrum. If indeed this pattern was risk-less and the large traders or buyers were not credit constrained then, at least for
non-perishables, the return from this arbitrage should have been lower than the cost of financing and storage costs. In perishables, wherever possible, it should
have led to more aggressive calendaring (more distributed production throughout the year). However, in almost all commodities this arbitrage persists. It is
possible that the existence of the peso problem (the risk of a sudden, completely unexpected precipitous fall in value that is rationally anticipated by the market
first pointed out by Rogoff (1980)) makes this arbitrage both persistent and highly risky. If indeed that is the case, then one wonders if availability of warehouse
receipt finance for the small farmer is a boon or a curse (discussed later in the note). Two alternate directions however look promising: commodity forward
contracts to be offered to farmers at the time of sowing (so that they may square off the long position that they create as soon as they commit themselves to
planting a particular crop and thereby lock in their profit margins) and an options contract or least a delta hedge (since options contracts on commodities are not
legal in India) which allows the farmer to buy protection against a further drop in commodity prices but retain the right to benefit from a rise in prices.
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Warehouse Receipt Financing International

Experience
Experiences around the world suggest that warehouse
receipt financing can be a profitable avenue for both
the farmer and the financier. TechnoServe in Ghana has
achieved considerable success in its inventory credit
programme over the past two decades. According to
TechnoServes Inventory Credit Programme in Ghana
by Frank Hicks, the firm believes that only the
confidence of being able to sell the produce at a
reasonable profit to buyers can be the incentive for
small and marginal producers, constituting 60% of
Ghanas farming population, to augment both
production and productivity, and supply to local
industries and exporters. As in most agricultural
markets including India, small farmers remain the
classic price takers, cut off from information flowing
into and out of the market and profitable market
opportunities. To improve their conditions, Hicks says,
TechnoServe ushered in the concept of inventory
credit in Ghana in 1989. The idea was to create an
opportunity for these farmers to take advantage of
seasonal price swings (used smartly by local traders) to
mitigate risks for banks that were hesitant about
lending in the rural belt and to increase food security
for farmers who can buy back (or redeem) their
produce rather than sell it.
Participating farmers usually form groups of 20-50
members to store their produce and carry it into the
lean season when prices are at their peak much
higher than harvest time price levels. At the same time,
they have the flexibility to exercise one of the following
options:

can decide to sell the produce through the group,

using the proceeds to repay the bank for its credit
and the group for the use of storage facilities,
earning a net profit of 40 to 100%;

They can take back the produce from the group to

consume as food, repaying the bank loan and the
groups storage costs, and still saving a substantial
amount by avoiding high lean season food prices.

TechnoServe has refined the model of inventory credit

and expanded its application to other areas in Ghana.
At preset, it is offering facilitating over 100 farmers
groups access inventory credit. For nearly two decades
now the participating farmers have maintained a cent
per cent on-time loan repayment record, significantly
improved their incomes and agricultural production,
cut down post-harvest losses and accumulated capital
to invest in other agricultural activities.

44 | A PUBLICATION BY MCX AND PRICEWATERHOUSECOOPERS

In a similar effort, the RBI Working Group report says,

PTA Bank in Kenya finances coffee exporting farmers by
accepting warehouse receipts as collateral. It also offers
them a put option, purchased at the London
Commodity Exchange, which guarantees sellers a
minimum price for the coffee in storage. By assuring a
floor price for the stored coffee, PTA Bank can provide
finance for a higher percentage of the value of coffee
than it could justify in the absence of the floor price.
According to Lamon Rutten (then Coordinator
commodity marketing, risk management and finance
at United Nations Conference on Trade and
Development), in Venezuela, under a system
developed by private firm Induservices, provided
capital enhancement to warehouse receipts on
seasonal maize stocks. And this enabled the firm to
attract huge investment to finance maize stocks.
Again in Colombia, Rutten said, a more complex
structure, introduced in mid-2000, made it possible for
cattlemen to receive strong financing support to feed
their cattle at rates determined through the
competition among institutional investors on the
countrys stock and commodity markets.
Keys to Successful Implementation of a Warehouse
Receipts Programme
According to the RBI Working Group report, to work
effectively, warehouse receipts require a recognised
foundation in law ensuring that the ownership
established by the receipts is not challenged.
Warehouse receipts must be functionally equivalent to
stored commodities with well-defined rights, liabilities,
and duties of each party to a warehouse receipt (for
example a farmer, a bank, or a warehouseman). They
must be freely transferable by delivery and
endorsement and the holder of a warehouse receipt
must be first in line to receive the stored goods or their
fungible equivalent on liquidation or default of the
warehouse. A robust legal framework is a prerequisite
to warehouse receipts being treated as secure
collateral.
Also essential is a warehouse infrastructure, grading
and collateral management system that provides
guarantees on quality, quantity and storage of
commodities, thus assuring that the quantities of
goods stored match those specified by the warehouse
receipt and also their quality is the same as stated on
the receipt. This will give farmers the confidence to
store their produce and banks the comfort to accept
warehouse receipts as secure collateral for financing
agricultural inventories.

And finally what is required is a combination of fair and

transparent spot and futures markets that provide
liquidity and price discovery, enabling both farmers
and banks to value and sell warehouse receipts at short
notice if need be.
In the Indian context, the proposed Warehousing
(Development and Regulation) Act, 2007 incorporates
almost all the aforesaid legal and warehouse
infrastructure related requirements. Once approved
and implemented, it should provide a sound basis for
developing and promoting warehouse receipt-backed
trade and finance activity in the country.
IFMR Trusts Pilot in Kadi Taluka (Gujarat)
In pursuit of its mission for financial inclusion, IFMR
Holdings has ventured into the agricultural space.
Dealing exclusively with small and marginal farmers in
the Kadi Taluka of Mehasana in Gujarat, three of its
entities, Agricultural Terminal Markets Network
Enterprise (ATMNE), IFMR Holdings, and IFMR Capital
are working together on a pilot with the following
objectives:

To provide price discovery to farmers for their crops

in a fair and transparent manner (ATMNE);

To explore other services required but not available

to small farmers currently such as transportation
from the village to the market/buyer, village level
warehousing capability, and agricultural extension
services (ATMNE and IFMR Holdings);

To provide commodity-backed finance to farmers

who would like to avail of finance against the
commodity as collateral (IFMR Holdings);

To explore other financial products and services

required but not available to small farmers currently
such as commodity forward contracts and deltahedging (IFMR Holdings and ATMNE);

To develop tradable Asset-Backed Warehouse

Finance Receipts (ABWFRs) so that they may be sold
to mutual funds and other financial institutions
(IFMR Capital).

As part of this pilot, the three IFMR Trust entities are

working with the National Spot Exchange Ltd. (NSEL) to
help farmers realise the best possible price for their
agricultural commodities. ATMNE is an institutional
trading and clearing member and provides trading
access to small and marginal farmers. IFMR Holdings
provides warehouse receipt finance, helping farmers
wait out the low price realisation period during harvest.

This is in line with IFMR Trust's mission of ensuring

complete access of financial services to every
individual and every enterprise. Towards this, after
extensive survey, Dharampur, a village 20 km from Kadi
town, with 1,000 acres under castor production and a
population of 3,000, has been identified as an ideal
village to operate the pilot from.
Trading operations: The trading facility is located at
Kadi in the exchange-managed warehouse premises.
As part of the servicer agreement, the exchange
provides guarantee on quality, quantity, and storage of
commodities in the warehouses managed by it. The
electronic exchange market provides nationwide
access to buyers and sellers. The first crop to be traded
was castor seed. While the market is still at its nascent
stage, its volumes have been encouragingly large. The
market caters to farmers from around 125 villages
around Kadi. Farmers come to the warehouse with their
commodities which are then put through a standard
weighing and quality testing process. Depending upon
the quality, weight adjustments are made and the
commodity is packed in 75 kg bags and stacked away.
The collateral manager issues a receipt of weight and
quality, following which the farmer places a sell trade
through the ATMNE agri-broker sitting at the trading
terminal at the warehouse. Once the trade goes
through, the farmer is handed over the cash and receipt
for the same.
So far castor seed worth Rs. 2.5 crore has been traded
by over 500 farmers based in 25 different villages
surrounding Kadi, the smallest trade being one bag
and the largest 70 bags. Over the last four months, price
differentials between the mandi and the electronic
exchange have dropped from Rs. 75 to Rs. 18 a bag
possibly in response to a credible price discovery
mechanism being provided to small farmers through
the exchange.
Financing operations: Warehouse receipt finance in
India is typically used by traders and affluent farmers. It is
largely perceived to be non-applicable to or non-viable
for the small and marginal farmer. Barriers to
participation from the financiers side include reluctance
on their part to deal with small-size transactions due to
operational reasons. From the farmers end, there are
issues concerning non-availability of reliable price
information, lack of storage space, inefficient quality
testing procedures, existence of multiple layers of
intermediaries, hidden charges, documentation
challenges, and high transportation costs.

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In our experience, the biggest challenge in terms of

giving farmers access to warehouse receipt finance has
been awareness creation. IFMR Trust has been putting
in a lot of efforts at farmer education. By interacting
with farmers in their local settings, it is explaining to
them the concept of an electronic exchange that
provides a transparent price discovery process, as well
as the documentation, process, risks and returns from
availing commodity-backed finance through IFMR
Holdings.
IFMR Holdings provides loan against commodities as
collateral. The purpose of the loan product is to provide
short-term finance to farmers collateralised by
commodities for which warehouse receipts are issued
by a collateral management company. The exchanges
arrange for collateral management services and act as a
service provider.
The branch through which the IFMR Holdings finances
farmers against commodities is located at Dharampur
village such that it would serve a cluster of villages that
cultivate in large quantities crop such as castor seed,
mustard seed, and wheat, among others. Currently,
loans are being given to farmers coming from five
villages. Farmers can avail of finance against a single
bag of castor seed placed in a warehouse. The
maximum loan amount they can avail of against a
particular commodity is Rs. 10 lakh (Rs.1 million). It
goes like this: a farmer visits the branch and registers
himself, which involves fulfilling the KYC (Know Your
Client) process that includes biometric identification
and physical verification of address proof. On
completion of the process, the farmer is given a smart
card which henceforth is used as a single source of
identification and data capture for all transactions
done by the farmer. After charging appropriate
margins to cover price fluctuations, loan is given
against the warehouse receipt for the commodity
stored by the farmer in the NSEL-managed warehouse.
While farmers response to the warehouse receipt
finance mechanism has so far been a cautious one, they
are definitely gradually becoming aware of this facility
and coming forward to avail of loans through this
route. Reasons for their initial inhibitions could be:

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Lack of awareness - For farmers used to centuries of

trading through adhathiyas on the mandi and availing
of loans from them, trading on an electronic exchange
and availing of finance against the stored commodities
has been a new experience.
Rigour of the quality testing process - The exchange
follows a rigorous quality-testing procedure unlike
regular mandis where quality is gauged simply by
picking up a handful of commodity. A value reduction
is applied if the commodity does not meet the set
parameters. Farmers who initially took a while to
understand the quality testing process now feel the
process is more fair and transparent than the one they
were used to.
Reluctance to store commodity in warehouse Perishability of castor seed is almost negligible. Instead
of storing it in a warehouse and incurring storage costs,
farmers prefer to store it in their backyards.
Prior advances taken from traders - Almost 30-40%
of farmers around Kadi have already taken loans from
traders against commitments to sell their existing
commodities to these traders.
Conclusions
The contribution of warehouse receipt systems in
developing agricultural markets has been well
recognised across the world. The Ghana experience
shows that these schemes can dramatically reduce
inter-seasonal price fluctuations, benefiting small and
marginal farmers who otherwise have no choice but to
resort to distress sales (sell immediately after harvest).
Warehouse receipt finance can offer farmers a
marketing and credit option that spurs productivity
and thus increases their incomes. Farmers can also sell
some of their stored products to finance future crop,
thereby obviating or reducing the need for borrowing
from moneylenders and traders. Financial institutions
benefit from reduced risks and from liquidity due to
ready collateral to guarantee or reimburse defaulted
loans. Farmers, on their part, benefit from higher
profitability being able to delay sales; from improved
price transparency, and from increased bargaining
capacity through working in farmers groups.

However, warehouse receipt finance is essentially a

speculative activity and requires serious monitoring of
grain quality as well as market price trends and
fluctuations. When properly designed and managed, a
warehouse receipt finance programme can allow small
farmers to graduate from the status of price takers to
that of price negotiators in the local market economy.
The mechanism can also provide rural entrepreneurs
with a route to capital accumulation that can be
invested in more diversified and sustainable ventures
capable of stimulating long-term rural economic
growth and development, which in turn can contribute
significantly to the overall economic growth in line
with national aspirations.

References:
1. Bamako (Technical Note No. 5). 2000. Warehouse
receipts: financing agricultural producers
2. Evans, Martin D.D., and Karen K. Lewis. 1992. NBER
Working Paper Series, No.4003
3. Hicks, Frank. 1998. TechnoServe inventory credit
programme in Ghana. United Nations Conference
on Trade and Development
4. Lacroix, Richard, and Varangis, Panos. 1996. Using
warehouse receipts in developing and transition
economies, Finance & Development
5. Report of the Working Group on Warehouse
Receipts & Commodity Futures. 2005. The Reserve
Bank of India
6. Rutten, Lamon. 2001. Local market opportunities
with respect to warehouse receipt finance tapping into the local capital market, ESCAP-ADB
Joint Workshop
7. Rutten, Lamon. 2001. Financial engineering
techniques for directly linking domestic capital
markets and the agricultural sector a short note,
ESCAP-ADB Joint Workshop
8. The World Bank (Agricultural Investment
sourcebook series). 2004. Ghana: Inventory Credit
for Small-Scale Farmers

Mr. Nachiket Mor is President, ICICI Foundation, and Dr. Kshama Fernandes is Vice-President, IFMR Trust. Views are personal.

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