Warehouse Receipts Financing of Commodity Markets

Right from nationalization of banks and the emphasis on priority sector lending to financing self help groups through micro finance many innovations had taken place in agriculture and rural finance in India. However, the efforts mainly concentrated on production financing and neglected to a large extent the equally important marketing finance. A good marketing system facilitates easier financing and a good financing system improves efficiency in marketing. Warehouse receipt financing can help a great deal in bringing liquidity to marketing of agricultural goods.

Warehouse receipts are documents issued against the deposit of the commodities in the warehouses. When these receipts are backed by legal provisions to ensure quality and safety of the stocks stored they can be used as collateral. These receipts can be pledged to raise money, sold or transferred. Generally, farmers face two problems bulky cash flows at the time of harvest and non availability of intermediate finance. Lack of adequate post production financing impedes the ability of farmers to realize optimal prices for their crops. Warehouse receipt finance can play an important role in smoothening income for farmers by providing liquidity at times when cash flows dry out.

Agricultural Marketing and Finance

Farmers in India generally dispose of the crops immediately after harvest. Prices are normally low when the supply is high. Farmers have to resort to immediate post harvest sales as they have no holding capacity. They cannot hold on to the harvested crop as they need immediate cash to pay back the loans raised to cultivate the crop and as well as to meet their household expenses. Further, most of the farmers lack storage space with them. This twin handicaps prevent them from taking advantage of a better price that may prevail few months down the line. Warehouse receipts provide farmers with an instrument that allows them to manage their liquidity requirement by extending the selling well beyond the harvesting period. This helps in preventing the farmers from resorting to distress sales.

How does the warehouse receipt financing system operate? The warehouse receipt financing operate with some variations in different countries. However, it essentially has the following mechanics. After harvest the farmer deposits his crop in an accredited warehouse and receives a receipt of the stock stored. The warehouse promises secure and safe storage.  The warehouse will release the stock only on production of the receipt. The farmer then can approach a bank to raise a loan by pledging the warehouse receipt. The bank gives the loan based on the current market valuation of the crop. Usually it will lend upto a certain percentage of the value of the crop deposited, for example, may be upto 70 percent. The period of the loan is related to the annual price pattern the borrower is required to repay before the time when prices normally pass their seasonal peak. The bank places a lien on the commodity so that it cannot be sold without the proceeds first going to repay the loan outstanding.

Farmer can in consultation with the bank sell the stocks when the prices are favourable and payback the loan with interest. The farmer instead of taking out the physical stock to sell simply hands over the receipt to the trader or processor who made the purchase. The buyer can take delivery of the commodity by paying storage fees loan principal and interest are deducted before delivery is made. The lender/ bank can dispose of the commodity/pledged goods only if the borrower defaults on the loan. Otherwise, the title and any changes in the value of the deposited commodity belong to the depositor/borrower.

 As it is clear from the above description there are three parties involved in the process. a) the borrower i.e. the farmer who uses the produce as a security for a loan. b) the bank which treats the produce as collateral. The bank has several advantages in lending this way. Warehouse receipts’ liquidity is much higher than conventional collateral such as land and machinery which are difficult to enforce hence, provides banks and financiers with the comfort to lend to the farmer without lengthy documentation and long processing delays.  c) the warehouse operator who maintains the produce in good condition and assures the bank that the collateral is secure. Apart from collecting the rent for storage the warehouse owner collects insurance fee to guard against fire or unusual weather conditions to offset any loses in terms of quality and quantity of stored commodities. So, empowering farmers to hold on to the produce would need three enablers i) accredited warehouses in the vicinity ii) commercially acceptable grading and assaying standards and iii) ease of raising liquidity against commodities stored in the warehouses.

The farmers can also use future trading for the purpose. Here, the farmers can book a short (sell) contract in the commodity exchange for a future price. The collateral management companies such as National Collateral Management Limited have accredited warehouses which are electronically connected to the central hub which enables the stock position to be updated on real time. The collateral management company issues a dematerialized (demat) warehouse receipt to the farmer through the warehouse where he has deposited his crop. The farmer then approaches a bank for loan against the electronic warehouse receipt. The collateral management company will electronically update all information of the warehouses to the bank, this will also decrease the  risk attached to the loan issued against the pledged warehouse receipt

As it is clear from above description the warehouse receipt is the instrument which is pledged /traded in lieu of the fundamental assets. Warehouse receipts are functionally equivalent to stored commodities. As the whole transaction takes place without the physical verification of the stocks by the bank or the processor the assurance about the quality and quantity of the goods mentioned in the warehouse receipt is of at most importance to the entire process of making the warehouse receipt negotiable. The integrity of the warehouses needs to be ensured by licensing or accreditation to carry out the activity. The rights, liabilities and duties for each party to a warehouse receipt (producer, bank warehouse etc) must be clearly defined. Ideally, the receipt should be freely transferable by delivery and endorsement. Holders of receipts must have the right to receive stored goods or their fungible equivalent if the warehouse defaults or its business is liquidated and the lender should be able to determine before granting the loan if there is a competing claim.

Warehouse Receipts in India

In India, Agricultural Produce (Development & Warehousing) Act, 1956 was enacted, later   repealed and replaced by Warehousing Corporations Act, 1962. Central & State Warehousing Corporations were established under this act. Private sector initiative on warehousing was limited.  Warehouse receipts were issued by a warehouseman to any person depositing goods in the warehouse. The licensed warehouseman was authorized to issue a negotiable or a non negotiable warehouse receipt. Banks did have a facility for lending against commodities. However, this potential has never been realized in the Indian context as lending against commodities was considered to be risky. Further, the banks were not internally equipped to evaluate the goods stored in the warehouse and was uncertain of the quantity and quality of the goods lodged therein.

The Warehousing receipts in vogue did not enjoy the fiduciary trust of depositors and banks. There was fear of not being able to recover the loans in events, such as fraud, or mis-management on behalf of the warehouse or insolvency. The available legal remedies were also time consuming and inadequate. Further, the format of warehouse receipts used in the country was not uniform. Hence, there were impediments in the negotiability of warehouse receipts creating difficulties to the farmers and other depositors of goods.

In order to ensure an efficient warehouse financing system the government of India had enacted the Warehouse Regulation and Development Act 2007. Under this act the warehousing development and regulatory authority would be established. (It has been established in 2010).  The authority is in charge of certifying or registration of warehouses, renews, modify, withdraw, suspend or cancel such registrations. The authority will regulate the registration and functioning of accreditation agencies who grant accreditation to warehouses. It will regulate the process of pledge, creation of charges and enforcement in respect of goods deposited with the warehouse. Specify the duties and responsibilities of the warehouse. WDRA can regulate the rates, terms and conditions that are offered by the warehousemen. It ensures a fair dispute settlement between warehouses and warehouse receipt holders. Ensure minimum percentage of space for storage of agricultural commodities in a registered warehouse. Further, the grades and standards to be followed for different crops that are to be stored are specified in the act. In short, the act has put in place proper measures to ensure the negotiability of the warehouse receipts.