When a farmer approaches an institutional agency with a loan proposal, the banker must be convinced of the economic viability of the proposed investment.

Each investment activity differs in terms of productivity, making it essential for the banker to evaluate the proposal carefully. This article provides detailed guidelines for assessing farm credit proposals, including repayment plans, to ensure informed decision-making.

The Three R’s of Credit in Farm Business

When a credit proposal reaches the banker, three fundamental financial aspects are evaluated:

Will the loan generate returns exceeding its cost?
Will the returns provide a surplus to repay the loan when due?
Can the farmer withstand risks and uncertainties in farming?

These aspects are collectively known as the Three R’s of Credit: Returns from the investment, Repayment capacity generated by the investment, Risk-bearing ability of the farmer-borrower

1. Returns from the Investment: This is a critical measure in credit analysis. The banker must estimate the likely returns from the proposed investment. The farmer’s credit request can only be accepted if the returns are sufficient to cover the costs.

Returns depend on decisions such as what to grow, how to grow, how much to grow, when to sell, and where to sell. The primary concern is whether the farmer can generate incremental income to cover the additional costs funded by the loan.

For example, with a loan of N4,500 in the wet season and N4,600 in the dry season, a farmer can switch from local paddy varieties to high-yielding improved varieties. This results in an incremental return of N5,700 per hectare, making the loan productive and strengthening the farmer’s case for approval.

2. Repayment Capacity: Repayment capacity refers to the farmer’s ability to clear the loan within the stipulated time. While a loan may generate additional income, it may not always be sufficient for repayment. Therefore, the loan must not only be profitable but also have the potential for timely repayment. Repayment capacity depends on returns as well as other factors.

Causes for Poor Repayment Capacity

Three R’s and Five C’s of Credit in Farm Business

i. Small land holdings

ii. Low productivity and production

iii. Low and fluctuating agricultural commodity prices

iv. High family expenditure

v. Use of farm credit for unproductive purposes

vi. Low farmer’s equity

vii. Lack of adoption of improved technology

viii. Poor management of farm resources

Measures to Strengthen Repayment Capacity

i. Increasing net income through proper farm business organization

ii. Adopting promising technologies to boost production and reduce expenses

iii. Addressing resource imbalances

iv. Aligning loan repayment plans with income flow

v. Strengthening the net worth of farm households

vi. Diversifying farm enterprises

vii. Implementing risk management strategies like crop insurance, hedging, etc.

Risk-Bearing Ability

Risk-bearing ability refers to the farmer’s capacity to withstand financial losses due to unforeseen events. Risks in farming can arise from production, technology, illiteracy, personal health, institutional factors, weather, and price fluctuations.

Even if a farmer demonstrates strong returns and repayment capacity, the ability to bear risks is crucial. Statistical techniques like the Coefficient of Variation can help quantify risk.

For instance, if the Coefficient of Variation for paddy yields is 15%, the expected gross returns are deflated by 15% to estimate the corrected income. Repayment capacity under risk is then calculated as:

Repayment capacity under risk = Deflated gross returns – (working expenses excluding proposed loan + family living expenses + other loans due + miscellaneous expenditure + crop loan).

A hypothetical example in Table 3.4 illustrates this. If the expected gross income is N48,000 with a 15% variability, the deflated gross income is N40,800. After accounting for this reduction, the repayment capacity increases with the loan amount, indicating the farmer’s risk-bearing ability.

Measures to Strengthen Risk-Bearing Ability

Developing owner’s equity
Building moral character (honesty, integrity, dependability)
Reducing farm and family expenditure
Engaging in stable and reliable enterprises
Ensuring access to funds during both good and bad periods
Saving a portion of earnings to meet uncertainties
Adopting crop and other insurance schemes

The Five C’s of Credit in Farm Business

Beyond the Three R’s, the Five C’s of Credit provide additional criteria for evaluating the economic viability of a loan proposal:

1. Character: The trustworthiness and integrity of the borrower are critical. The banker assesses whether the borrower is honest, responsible, and capable of executing the investment project. Past records and moral qualities like commitment and promptness influence the banker’s confidence.

2. Capacity: This refers to the borrower’s ability to repay the loan with interest. It depends on the income generated from the farm business and the borrower’s managerial skills and experience.

3. Collateral: The borrower must provide security (collateral) to guarantee loan recovery in case of default. The collateral’s value should ideally exceed the loan amount to account for depreciation and inflation.

4. Capital: The borrower’s equity or net worth is evaluated. Insufficient capital for running the proposed farm enterprise may lead to loan rejection.

5. Condition: The purpose of the loan (productive, consumption, political, or welfare) and its potential to generate income for repayment are assessed. The borrower’s overall well-being and the alignment of conditions with the lender’s expectations are also considered.

A clear understanding between the lender and borrower is essential for successful credit transactions. By evaluating the Three R’s and Five C’s, bankers can make informed decisions, ensuring that loans are granted to farmers with viable repayment plans and risk-bearing abilities. This approach strengthens the farm business ecosystem and promotes sustainable agricultural practices.

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