Case Study 1 - Quedan programme for paddy marketing credit in the Philippines

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During the 1970s food production in the Philippines underwent a rapid expansion enabling the country to move from a situation of deficit to self-sufficiency. However, the rapid increase in production proved difficult for the marketing system to handle. In particular, traders were unable to raise operating finance to purchase the crop from farmers. Banks required traders to mortgage property to obtain loans, but working capital could often not be raised in that way as traders' property was already mortgaged to pay for the necessary expansion of milling and storage capacity.

To address this constraint, the Quedan Financing Programme was instituted in 1978, under the auspices of the Quedan Guarantee Fund Board and, in 1992, this organization became the Quedan and Rural Credit Guarantee Corporation (Quedancor). Quedancor was established with an authorized capital stock of P2 billion (about US$80 million) and a broader mandate than its predecessor, to enable it to cover not only inventory financing, but also other types of credit financing in the agriculture sector.




Quedancor carries out a full evaluation of the credit and financial capacity of the paddy millers and traders applying for Quedan-backed inventory credit. The applicants' warehouse facilities are also examined by the National Food Authority (NFA). The NFA absorbs costs associated with inspection, while Quedancor's costs are met partly out of interest on its capital base and partly by the millers who pay a Guarantee Fee calculated at the rate of 2 percent of borrowed funds per year.

After the evaluation, which usually takes three to four weeks, a decision is made on whether to franchise the miller and, if so, for how many bags the Certificate of Franchise will be granted. This can be as low as 500 bags or as high as 20 000 but will never represent the entire storage capacity of the miller. The Certificate, which is issued by NFA on the advice of Quedancor, entitles the holder to issue warehouse receipts (Quedans) against stocks of his own grain or against stocks of a third party.

The fact that millers can pledge stocks stored on their own premises is a major advantage, as they are spared the cost of transporting paddy to and from independent warehouses. Moreover, the cost of storage in their warehouses is generally lower than commercial storage rates


Procedures for obtaining loans

Millers seeking franchise certificates for the first time can apply for loans from banks at the same time as they request a Certificate of Franchise. However, many millers have established Certificates and thus apply to one of the accredited banks close to the time the loan is required. For new Certificates the banks will make parallel enquiries regarding the miller's creditworthiness, although they do tend to lean heavily on the recommendation of Quedancor.

Although it takes the banks just a few days to process documents for a Quedan loan, the procedure is more complex, both for the bank and the customer, than for standard loans secured by conventional collateral. The applicant must present to the bank a copy of the Certificate of Franchise, a warehouse receipt, a Stock Inspection Report, an affidavit of stock ownership and evidence that the stock is insured. He or she is also required to post a security bond for one-third of the value of the stored stocks. Loans are for up to 180 days for paddy, but for up to only 90 days for other grains. In practice, millers take out loans for a period which is likely to maximize their return from stockholding. Stock is inspected at least twice during a 180-day period by Quedancor officials while it is held in the millers' warehouses.


Guarantee cover and rediscounting

After the loan is released the lending bank applies to Quedancor for guarantee cover. Quedancor guarantees the existence of the stocks used as collateral and undertakes to pay 80 percent of the loan principal plus accrued interest. It does not guarantee the value of the stocks which, theoretically, could fall if excessive supplies were introduced onto the market by the NFA. This possibility is covered by an agreement that all stocks held under Quedan loans will, if necessary, be purchased by NFA on maturity of the loan. In practice this has not happened, the market price always being above the official NFA price during the pre-harvest season.

Banks can immediately rediscount Quedan loans through the Central Bank of the Philippines. A "second window" rediscount rate is offered. In July 1992 this was 18 percent, compared with commercial rates of 24 percent. The full benefit of this spread is not passed on to the trader/miller as the Quedancor Guarantee Fee of up to 2 percent per year of the value of the loan is deducted, together with bank costs, giving an interest rate of 2021 percent per year.


Loan repayment

On maturity the borrower repays the bank and receives a certificate of loan settlement permitting him to remove the paddy from his warehouse for sale or milling. Early repayment incurs no penalty. Procedures exist to permit stock rotation while maintaining the same franchised quantity in store. Using a device known as a Commodity Trust Receipt, it is even possible for the miller to mill Quedan stocks provided that those stocks are covered by funds in the bank or are guaranteed by the bank.

In the unlikely event of default the bank must file a notice of default within 15 days of the maturity date. An inspection of the miller's warehouse is then carried out by Quedancor, the bank and NFA. Where stocks are found to be missing, procedures are then instituted for Quedancor to reimburse the bank and undertake recovery actions against the miller.



Banks in the Philippines almost invariably require some sort of collateral as security when lending to grain millers. Agricultural stocks are unacceptable, even if held in bonded warehouses, regardless of the creditworthiness of the applicant.

Given that Quedan loans attract a repayment rate of around 99 percent, the reluctance of the banks to deal directly with traders without the benefit of a Quedancor guarantee or property mortgage is not easy to understand. This reluctance is partly historical; banks have made significant losses on loans to the agricultural sector and millers tend to be regarded as part of the agricultural sector rather than part of the commercial sector. Banks also state that they lack information on paddy prices and market trends to enable them to assess the potential viability of a loan against stock.

It was only with some difficulty that the banks were originally persuaded to take part in the Quedan programme, but 184 are now accredited, ranging from large organizations with national coverage to small local banks. When the scheme was set up the banks wanted stocks to be held in NFA warehouses and only after considerable persuasion did they agree to millers holding their own stocks.

For the banks, the provision of Quedan loans is now largely risk-free. The existence of the stocks is guaranteed by Quedancor. The stocks must be insured by the millers before they can obtain a loan and their value is guaranteed by NFA.



Millers themselves often extend credit. Farmers are supplied with inputs at planting time and beyond, while a 30-day payment credit is often provided to rice retailers. The additional liquidity in the marketing system as a result of the Quedan scheme increases both the amount of grain which they can buy from farmers and the funds available for credit.

A small survey of millers operating north of Manila revealed an average (mean) Quedan franchise of around 10 000 bags and an average milling capacity of 900 bags a day. Thus a Quedan loan (worth about US$7 per bag in 1992) in the area surveyed provides millers with operating capital equivalent to 11 days' milling. In other areas of the country, however, such loans appear to be responsible for a higher proportion of total milling capacity. It should be stressed that, immediately after harvest, there is often a surplus of milled rice and millers encounter difficulties in disposing of it. Thus, a Quedan loan, although representing a small part of their total throughput, is made available at an opportune time, assisting them to build up stocks of paddy.



The operation of a guarantee system is underpinned by legislation relating to warehouse deposits. Quedan transactions are governed by a General Bonded Warehouse Act and by a Warehouse Receipts Law.

Under the General Bonded Warehouse Act, an operator of a bonded warehouse (which all Quedan franchise holders are) is required to obtain a licence, to put up a bond, to insure the warehouse contents against theft and fire, to keep complete records of commodities received, receipts issued and withdrawals made, and to forward such documentation to the appropriate Ministry. Failure to comply with his legal obligations, so causing a loss to another party (e.g. Quedancor), renders the warehouse owner liable to civil suits, and criminal prosecution.

Under the Warehouse Receipts Law, the contents of a written warehouse receipt and all other necessary documentation related to receipt and delivery are defined.



The benefits of the Quedan programme are widely believed to be higher prices for farmers immediately after harvest and a strengthening of trader/ millers so that they are able to take over the functions of an increasingly financially strapped NFA, together with less tangible benefits such as better post-harvest handling and an increased exposure of banks to rural areas. Without detailed research it is impossible to confirm that farmer prices are higher, though one consultancy study found that in one area farmgate prices were 7.7 percent higher than they would have been without inventory credit.

When the Quedan programme was set up, it was in response to a lack of capital for traders, but it is not clear whether this remains a constraint. Many millers do not avail themselves of Quedan loans and mortgage their plant for all of their credit requirements.

Millers benefitting from Quedan loans receive two forms of subsidy. Firstly, as indicated above, there is an interest rate subsidy, which although reduced in recent years, is still substantial. Secondly, the loan premium charged by Quedancor does not fully meet the costs of the programme, which are covered by the income from Quedancor's capital. Millers say that they use Quedan loans because of the favourable interest rate and because they are not required to mortgage plant and equipment. As they seem to have less problems in finding such collateral than they did when the Quedan scheme was set up, it is not clear whether the latter advantage would motivate millers to use Quedan loans in the absence of the interest rate subsidy.

The NFA buys less than 10 percent of marketed paddy annually. However, its influence on the rice market is somewhat greater than this figure would imply as NFA rice is usually marketed only during the "lean" season, a period of about three months. Thus if the Authority buys 5 percent of the crop in one year, it may market 20 percent of the rice sold in the lean season. NFA involvement in the market tends to squeeze the margins of millers and diminishes the profitability of inter-seasonal storage, but this has usually remained sufficiently profitable to justify the risk of stockholding.

While NFA operates within clearly defined boundaries, millers are able to assess - with a reasonable degree of confidence - the likely returns from longterm storage of paddy. However, the Philippines has sometimes imported rice unexpectedly, or planned exports have not materialized. The consequent additional rice on the market has, on a few occasions, resulted in losses on interseasonal storage, although no traders have had to adopt the fall-back position of selling their stock to the NFA at its official buying price. Even when some losses do occur on stocks, those traders who roll over Quedan loans several times in a season are able to compensate for their losses by the increased turnover.

In summary, the Quedan system provides selected, creditworthy millers and traders with a useful channel of credit which facilitates both the procurement of paddy from farmers and inter-seasonal storage. However, given the availability of other sources of finance, the extent to which millers would make use of Quedan loans if there were no interest rate subsidies remains to be seen.



Case Study 2 - Agricultural marketing credit in India



The arrangements made for agricultural marketing credit in India provide, on the face of it, the basis for a system which could be replicated in many other countries of the world. The country has a mixed marketing system, with state procurement and distribution accounting for about one quarter of marketed grain and the private sector the remainder. It has an efficient warehousing network run at national and state level, which can provide secure storage with minimal losses. There are appropriate Warehouse Acts and provision for negotiable Warehouse Receipts to be issued which can be used by the trader, miller or farmer to raise loans against deposited stocks.

While the mechanism for providing credit for marketing is in place, it is not widely used by traders and millers. Since the 1940s, Government policy towards both the financial sector and food grain marketing has been more concerned with containing and regulating private initiative than with stimulating it. Most of the commercial banks have been nationalized, they are highly subsidized, and there are multiple restrictions on lending for agricultural trade. There are also restrictions upon the level of food stocks which can be held by the private sector, the purpose of which is to prevent "hoarding". The lessons to be learned from official marketing credit arrangements in India are thus lessons of potential rather than of actual achievement.



Until 1943 Government rarely intervened in food marketing, but starting in that year a succession of programmes was implemented until 1965, when the Food Corporation of India (FCI) was formed to take over most procurement activities from the Department of Food. Since then, the Corporation has been handling the purchase, storage, movement and distribution of food at national level. Its annual procurement now runs at around 18 million tonnes, equal to about 25 percent of the marketed surplus.

Food procured by FCI, and to a lesser extent by the states themselves, is distributed by the states under the Public Distribution System (PDS). Grain is issued by FCI at a uniform price, to which states add sales taxes and other charges and may subtract an additional subsidy before distribution to consumers through Fair Price Shops and Ration Shops. There is a high element of subsidy involved, estimated at over US$1 billion per year nationally, including losses incurred by FCI.

Grain can enter the market in a number of ways. Farmers can sell directly to traders or millers: an arrangement which often involves an advance payment prior to harvest. Alternatively, direct sale can take place through a commission agent, who is responsible for cleaning and bagging the grain and having it officially weighed, in one of the numerous markets around the country. Sale is either by regulated open auction or by tender. Indirect sale can be made through middlemen in the villages. Most communities have brokers who will buy from farmers for sale to traders. Often they advance funds to farmers for input supply and other purposes. Grain millers and traders tend to form closely knit groups; they are almost all organized into associations and some groups operate co-operative banks.

In addition to procurement by FCI and public distribution by the states, the operation of a free grain market is constrained in many other ways. Traders allege that they have to be aware of around 18 different Acts and Regulations. The exact meaning of these can be difficult to find out and they tend to change frequently. There is often contradiction between national and state regulations. There does, however, appear to be a move to liberalize grain marketing, in concert with the general liberalization of the Indian economy now taking place.




Inventory credit using warehouse deposits

Traders in wheat, paddy and rice, together with wheat and rice millers have, in theory, the opportunity to obtain credit from banks against stocks deposited in warehouses, which will normally be those operated by the Central Warehousing Corporation (CWC) or by state warehousing corporations. The storage of food crops is carried out at favourable rates and is being subsidized by revenue from the storage of industrial products.


Credit against stocks held in the traders' own stores

Traders with long-standing relationships with a bank and a reputation for reliability can hypothecate stock held on their own premises (this is similar to the Philippine case described in Case Study 1). It is instructive to examine some of the features of this arrangement, though it should be noted that due to the above-mentioned credit restrictions, it is rarely used in practice.

The bank either places the stock under lock and key or, alternatively, inspects it on a regular basis. A major advantage to the borrower is that the pledged stock does not have to be moved to and from the warehouse and it can be rotated, i.e. it can be milled or sold on a first-in-first-out basis. Moreover, the value of the loan is not necessarily fixed but may be subject to a "cash credit limit" based on the maximum stock (subject to stockholding regulations) that the trader wishes to maintain. A disadvantage of this arrangement is that loans may take slightly longer to arrange.


Private and informal sources

Many traders can fund their operations from their own equity, particularly since the extent of these operations is constrained by stockholding limits. Others can raise money on India's highly developed informal credit markets at rates of interest between 3 and 8 percent greater than the prevailing bank rate. Sometimes such loans are made against negotiable warehouse receipts. Traders will often lend short-term funds or "call" money to each other.



All farmers have the option of seeking credit against warehouse receipts, subject to the same constraints as apply to traders. However, in practice, they make only limited use of these facilities, and when they store in warehouses it is often for their own consumption, and not for trading purposes. Discharging inventory loans can be difficult because traders are reluctant to go through all the procedures required (i.e. inspecting the grain at the warehouse, paying the bank, receiving the warehouse receipt and then collecting the grain), when they can more easily procure similar produce from farmers at the local market.

As a result of these difficulties, some co-operatives have introduced schemes whereby farmers can receive advances on crops deposited in warehouses situated in or adjacent to government-regulated markets. When the farmer wishes to sell, his produce is auctioned, the loan repayment and costs are deducted and he is paid the excess. This appears to be an attractive system, but its widespread use is constrained by a shortage of appropriate storage space close to markets.

For small (up to 2 acres: 0.8 hectares) and marginal (2-5 acres: 0.8-2 hectares) farmers, special Produce Marketing Loan Schemes apply which provide marketing credit at lower interest rates than paid by traders and permit on-farm storage. In most areas of the country farmers can obtain marketing loans of a maximum of R5000 for a period of up to six months. This maximum sum has remained unchanged for 12 years and now represents just 25 100-kg bags of wheat or 11 bags of paddy, as loans are based on 75 percent of the official procurement price. These loans are available only to farmers who have taken out production loans. Eighty-two of the 360 districts in the country have been chosen as Special Foodgrain Production Areas where the maximum loan has been increased to R10000 or twice the production loan, whichever is the lesser. In 1990, when supplies were short, the scheme was suspended for a season in order to encourage more production to come onto the market.



Warehouse receipts can be either negotiable or non-negotiable. Space on warehouse receipts is provided for recording quantities deposited and quantities released. The warehouse operator must insure all stocks deposited (based on the value at the time of deposit) and, upon presentation of the receipt, release the same quality and quantity of goods as deposited, subject to natural storage loss. The CWC and other warehousing organizations keep the deposits of each farmer/trader separate, there being no question of combining them in one big stack. Preservation of the identity of the grain, inevitably, leads to inefficient use of warehouse space as some farmers may deposit just a few bags and, combined with the favourable storage rates charged for agricultural produce, means that agricultural depositors are effectively subsidized by those using the warehouses for industrial purposes.

A trader or farmer seeking a bank advance endorses the receipt to the bank which then informs the warehouse operator that it has a lien on the receipt through the issuance of a "Notice of the Bank's Lien of Specified Goods". When the loan is cleared, in full or in part, the bank sends a letter requesting delivery from the warehouse and this is submitted by the depositor, together with the endorsed warehouse receipt. If the depositor fails to clear the loan within the stipulated time the bank has the right to sell the stock; often it will request the warehouse operator to do this on its behalf.

The use of warehouse receipts for bank advances requires the existence of appropriate legislation governing the use of the receipts and setting out the responsibilities of the warehouse operator. The following are some of the salient points from Indian legislation.



The Reserve Bank of India (RBI) issues periodic instructions to the banks regarding the overall level of credit to be made available and regarding priority sectors. Trading in agricultural crops has relatively low priority.

All loans against stock are subject to the Selective Credit Control Act. Under this Act the RBI is able to vary the use of credit for marketing purposes by controlling the overall level of credit, the margin that the borrower must fund from his own resources, and the rate of interest. In addition there are marketing restrictions relating to the levels of stocks which may be held by the private sector.


Credit margins

The main method employed by RBI to control private sector access to trade credit is the adjustment of the loan margin. The margin refers to the percentage of the value of the crop being pledged or mortgaged by the farmer, miller or trader which cannot be loaned by the bank. Thus where a margin of 40 percent applies, banks can lend 60 percent of the value (i.e. the official procurement price) of the pledged stock.

While the margins applied to farmers are relatively low, at 25 percent, those which apply to traders are high and do not appear to offer any significant incentive for a trader to seek a loan. The margin for traders permits them to obtain loans equivalent to 25 percent of the value of their hypothecated stock and 40 percent of the value of stock supported by warehouse receipts.

Margins are adjusted periodically by RBI according to prevailing market conditions. The assumption underlying the adjustments is that an increase in the margin will force traders to sell part of their stock in order to comply with the new conditions. For example, a miller borrowing R100000 when the margin is 50 percent will be entitled to borrow only R80000 on the same level of stock when the margin is increased to 60 percent. The miller is therefore forced either to increase his stocks to a level which can support a loan of R100000 (when he may fall foul of stockholding restrictions) or immediately pay back R20000 of the advance. It is assumed the miller will do this by selling part of his stock.

RBI conducts studies of food availability throughout the year and adjusts margins accordingly. If supplies are tight margins are increased while if food is abundant the margins are relaxed. Where changes are made to the margins these are required to be implemented "with immediate effect", the intention being to have sudden impact on the state of the market. Inevitably, however, the concept of immediacy is diluted by the time it takes to inform banks of margin changes and the time the banks take to inform their clients. Failure on the part of the borrower to adjust the loan when requested results in the imposition of "penal" interest rates.

It is uncertain whether the RBI's intervention has any effect on the market there have been no studies to determine impact. The basis for intervention may be that banks do not wish to be seen to be doing anything that might encourage "hoarding", rather than any practical effect that margin changes may have. Moreover, it is likely that traders seeing potential profits by stockholding will be undeterred by margin changes and will, instead, seek funds from the private/informal market.


Interest rates

Interest rates are set by the RBI according to the sector receiving the loan and the size of the loan. At the beginning of January 1993 the rates of interest charged for foodgrains, pulses and oilseeds ranged from 12 percent for loans up to R5000 to 17.25 percent for loans above R25000. While the RBI has some flexibility to set rates charged to the agriculture sector, margin adjustment is its main tool in controlling the grain market.


Stockholding levels

Stockholding levels are set by State Governments, which are responsible for their enforcement, in consultation with the Ministry of Food at national level. Authorized levels at the beginning of 1993 varied but in most states were around 250 bags of 100 kg of paddy and 1 000 bags of wheat or rice. Fortnightly inspections are conducted at mills and at the premises of traders to verify stocks.

Inevitably, the private sector has developed ways of avoiding these controls, e.g. by holding stock in the names of others or by purchasing from the farmer but allowing him to retain title until such time as the trader requires the crop. Clearly, however, it is not possible for the trader or miller to borrow money against stocks held in such unofficial ways. Thus the official stock levels effectively establish a maximum amount that a trader can borrow from banks.



The Indian system has certain features of interest to those seeking to introduce inventory credit into other countries. However in India itself, the scope for inventory credit is restricted by Federal and State Governments' preference for a high level of official control, both with regard to food marketing and the financial sector. Detailed analysis of the pros and cons of such interventionist policies is beyond the scope of this study. Suffice it to say that they are likely to have negative effects in terms of: market efficiency, for example, by decreasing competition in rice marketing; and unnecessarily high costs to Government of supporting both the public distribution system and a heavily subsidized banking sector.

If and when the grain market in India is liberalized, increasing attention will probably be paid to capital requirements of the grain marketing sector, and the country will be fortunate in already having in place appropriate mechanisms for providing advances against stock.

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