How should a bank loan to farmers work?

<b>Banks like to make asset backed loans.</b>What this means is that an applicant for a farm loan is evaluated on the basis of the assets that can be provided as collateral.


For example let's say our farmer wishes to grow rice on 2 hectares of farmland:


Planting time: 1st week of June 2018

Harvest time: 2nd week of November 2019

Working capital per hectare: USD 400

Total working capital for 2 hectares for 6 months: USD 800

Sale price of Rice: USD 200/ MT

Output at 6 MT per hectare: 12 MT

Sale Value: USD 2400


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Loans should be adjusted to the farmer's ability to repay and not to the value of the assets owned.


However the typical question asked by the bank's credit officer is about the collateral that the farmer can put up.


Let's say the farmer cannot put up any. So he doesn't get any working capital loan for an intrinsically profitable business. So he has to turn to local moneylenders for loans as usurious rates.


On the other hand let's say the farmer puts up his house as collateral and the value of the house is USD 5000. The bank takes a mortgage on the house and lends him USD 4000 which is 80% of the market price of the house. However note that the farmer can effectively deploy only USD 800 of capital and his repayment ability is capped at USD 2400 only. In such situation it is possible that the farmer will be unable to repay the loan.


This requires an understanding of farming as a business. Estimation of the income generation potential of the farm business in a particular crop cycle should determine the quantum of the working capital loan.


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