By all possible means, a farm financial manager has to raise the capital for running the farm business. The sources through which capital can be raised include savings generated in previous years and borrowings. For many farming households, credit (non-equity capital) is a sine-qua-non in running the farm business.
As far as possible, credit transactions are maintained with institutional agencies. However, the utilisation of non-equity capital carries attendant risks, which can be clearly explained through the principle of equity and increasing risk.
Understanding the Principle of Owner’s Equity and Increasing Risk
This principle hinges upon the fact that the risk in farming tends to increase at an increasing rate as the owner’s equity decreases. When owned capital (equity capital) is limited, borrowings become necessary to raise the needed capital for production.
This introduces the concept of leverage, which is the ratio of debt to equity. The leverage will be higher on farms using more non-equity capital. While higher leverage can contribute to the prosperity of the farm business when expected returns are achieved, it is equally destructive when the farmer’s expectations go awry. Borrowed capital, which initially brings prosperity, can spell doom if the farmer’s plans fail.
Statement of the Principle
As the debt-equity ratio or leverage increases, the borrower runs a greater risk of losing owned capital. To illustrate this, consider five farms with identical owned capital of N5,000 each. Apart from Farm A, the other four farms have borrowed N2,500, N5,000, N7,500, and N10,000, respectively. Consequently, the total capital available to Farms A, B, C, D, and E exhibits an increasing trend.
Assuming a uniform 15% gain on all farms, the resultant profits would be N750, N1,125, N1,500, N1,875, and N2,250, respectively. After paying interest to the lending agency, the owned capital increases in ascending order for each farm, and the percentage gain on owned capital follows a similar trend.
Now, assume a 15% loss uniformly across the five farms. The calculated loss also reveals an increasing trend for Farms A, B, C, D, and E. The position of owned capital after the loss shows a progressive decline, leading to increased percentage losses on owned capital.
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Procedural Formalities in Sanction of Farm Loans
The financial bank is vested with the authority to accept or reject a farmer’s loan application based on an objective appraisal of the farm credit proposal and adherence to procedural formalities. Below is an explanation of the steps involved in processing a farm loan application.
Step 1: Interview with the Farmer
During the interview, the banker studies the farmer-borrower’s credit characteristics, such as honesty, integrity, repayment capacity, and progressive thinking. The banker also explains the terms and conditions under which the loan will be sanctioned. This interview is more than a mere formality; it helps the banker understand the farmer’s genuine credit needs and assess their creditworthiness.
Step 2: Submission of Loan Application by the Farmer
Once satisfied with the farmer’s credentials, the banker provides a loan application form. The farmer fills in details such as the farm’s location, purpose of the loan, cost of the scheme, credit requirements, farm budgets, and financial statements. Supporting documents, including land ownership certificates, cropping patterns, farm maps, and a passport-sized photograph, are affixed to the loan application form.
Step 3: Scrutiny of Records
The ownership and extent of land mentioned in the certificates are verified by bank officials with village or clan heads and other appropriate authorities.
Step 4: Pre-Sanction Visit to the Farmer’s Field
After verifying the records, the Field Officer of the bank visits the farm to confirm the particulars provided by the farmer. This visit helps identify the farmer and guarantor, locate the boundaries of the land as per the map, assess the farmer’s managerial capacity, and evaluate their attitude toward modern technology.
The officer also examines the economics of crop and livestock enterprises, feasibility of proposed plans, and the farmer’s loan position with non-institutional sources. This step is crucial for verifying the farmer’s creditworthiness and trustworthiness.
For example, for a loan to dig a borehole, the officer verifies the proposed location, groundwater availability, distance from nearby boreholes, rainfall, and command area. Similar verifications are conducted for other types of loans. The findings are included in a report submitted to the Branch Manager for a final decision.
Step 5: Criteria for Loan Eligibility
The following aspects are considered when judging a farmer’s eligibility for a loan:
- The farmer should have sound character and financial integrity.
- Their dealings with friends, neighbors, and financial institutions must be proper (no history of default).
- They must have a progressive outlook and be receptive to modern technology.
- They should sincerely implement the proposed scheme and ensure proper use of credit.
- The security provided by the farmer must be free from encumbrances and litigation.
Step 6: Sanction of Loan
After reviewing the pre-sanction farm inspection report, the Branch Manager decides whether to sanction the loan. Factors considered include technical feasibility, economic viability, repayment capacity, risk-bearing ability, and sureties offered by the farmer.
If the loan amount exceeds the Branch Manager’s authority, the application is forwarded to the Regional Manager or Head Office with recommendations. The final decision is communicated to the Branch Manager for further action.
Step 7: Submission of Requisite Documents
Once the loan is sanctioned, additional documents, such as guarantors’ letters and mortgage deeds, are obtained. The bank’s legal officer examines the title deeds to ensure a clear, marketable, and unencumbered title. Mortgage procedures vary depending on whether the property is acquired or ancestral.
Step 8: Disbursement of Loan
After completing the documentation, the loan amount is credited to the borrower’s account. Disbursement is done in phases, ensuring the loan is used properly. A realistic repayment plan is framed based on the income flow of the proposed project.
Step 9: Post-Credit Follow-Up Measures
The Branch Manager or Agricultural Officer visits the farmer to ensure proper use of the credit. These visits also provide technical advice and foster a close rapport between the farmer and the banker. They help assess any need for supplementary credit to complete the scheme.
Step 10: Recovery of Loan
The bank reminds the farmer in advance about loan repayment. Special drives or village meetings may be organized to encourage timely repayment. If repayment fails, the reasons are investigated. Genuine cases may receive additional financial support, while willful defaulters face stringent measures, including legal action. In some cases, loan recovery is linked to marketing, and repayment plans are rephased for justifiable cases.
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Repayment Plans for Farm Loans
Repayment plans vary depending on the nature of the loan. Below are the common types:
1. Straight-End Payment Plan (Single Repayment Plan): The entire loan amount is repaid in a lump sum at the end of the loan period, with interest paid annually.
2. Partial Repayment Plan (Balloon Repayment Plan): The loan is repaid in quarterly, half-yearly, or annual installments (principal + interest). The installment amount decreases over the years, with a large final payment at the end of the loan period.
Example:
i. Loan amount: N10,000
ii. Time period: 6 years
iii. Interest rate: 12%
3. Amortised Repayment Plan:
The loan is repaid in a series of installments. There are two types:
i. Amortised Decreasing Repayment Plan: Installments decrease over time.
ii. Amortised Even Repayment Plan: Installments remain constant.
4. Variable Repayment Plan: Installment amounts vary based on the farmer’s income flow.
5. Optional Repayment Plan: The farmer can choose between different repayment options.
6. Reserve Repayment Plan: A portion of the loan is reserved for future repayment, based on the farmer’s financial capacity.
This article highlights the importance of capital acquisition, attendant risks, and the procedural formalities involved in farm loan sanctioning. It underscores the dual nature of credit as both a tool for prosperity and a potential risk, emphasizing the need for prudent borrowing and effective loan management in farm business.
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