Commodities Backed Finance Project report

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Chapter 1 INTRODUCTION

•

An Introduction

INTRODUCTION

1


Agriculture, the sector engaging about 70 of the Indian population, is proved to have a great impact over India’s overall economic performance. This is in spite of its reduced contribution towards the GDP from 60% to 25%. Recent trends clearly indicate that agriculture is getting highly commercialized and is going through rational changes globally, mainly due to the liberalization of the trade in agricultural commodities. To benefit the Indian farmers, the agriculture system in the country should be totally revitalized. Following changes need to be incorporated

•

Healthy environment

•

Smooth channels for transfer of commodities

•

Physical infrastructure for marketing activities

•

Cash support to commodity producers

Even though the reaping, harvesting and storing of crops is seasonal, the consumption of the commodities is perpetual, as well as variable in nature. The market value of the commodities is the lowest at the time of harvesting, primarily due to an abundant supply. Also, the consumption requirement is periodic, and not in a bulk at a time. This naturally gives a rise to need of storing the commodities, thus giving a way to requirement of strong storage facilities for the producers, in order to hold a portion of the produce. This would facilitate him to meet his requirements such as fertilizers, seed, etc. by selling the stored surplus commodities in the market, whenever the market price is favourable. A need for storage facilities also comes into picture when there is an inadequacy or unavailability of the transport facilities.

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This has contrived the Indian Government to come up aggressively with warehousing facility all over India.

India is currently the largest producer of fruits and vegetables at about 44 Mill Millio ion n tons tons per per annu annum. m. Howe Howeve ver, r, the the expo export rt of thes thesee commo commodi diti ties es is comparatively low. This is mainly due to poor storage and transport facilities, effectively leading to a large-scale wastage. In order to counter this problem, a large number of cold chains of controlled atmosphere are being set up.

In addition to these, the Government needs storage facilities in order to maintain a buffer of reserve stocks to counter the effects of variabilities of weather and other natural calamities on the agriculture in India.

The producers, processors, transporters as well as the people concerned with storage of commodities have to develop the storage facilities for a proper storage of commodities such as food grains, oilseeds, commercial crops like chilies, vegetables, etc., and the seeds needed for sowing in the following seasons.

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Chapter 2 WAREHOUSE

• • • •

•

Functions of the warehouse Warehousing in India Types of warehouses Functions of National Co-operative Development and Warehousing Board Functions of Central Warehousing Corporation (CWC)

WAREHOUSE 4


Warehouses are the scientific storage structures that are specially constructed to facilitate the preservation as well as the protection of the commodities. As far as India is concerned, the Warehousing scheme is an integrated scheme of scientific scientific storage, storage, rural credit price stabilization stabilization and market intelligence. intelligence. Overall, the scheme is intended to supplement the efforts of the co-operative institution.

2.1 Functions of the Warehouse A wareh warehou ouse se is cons constr truc ucte ted d beari bearing ng in mind mind that that it shou should ld perfo perform rm the the following different functions: -

2.1.1

Scientific

Storage:

A

large

quantity

of

the

agricultural

comm commod odit itie iess may may be stor stored ed.. The The comm commod odit itie iess must must also also be protec protected ted agains againstt the quanti quantitat tative ive as well well as qualit qualitati ative ve losse lossess occurring due to unavoidable circumstances such as floods, pests, etc.

2.1.2

Finan Fi nanci cing ng: Another need that a warehouse is expected to meet is

the financial needs of the individual who stores his produce into the warehouse. This is facilitated by the national banks, which extend credit to the individual against the security of the warehouse receipt that is issued to him after he has stored his commodities. A credit of 75 – 80 % of the value of the commodities is generally extended.

2.1.3

Price Stabilization Stabilizati on: Wa Wareh rehou ouse sess also also offer offer the the faci facili lity ty to the the

individuals who hold their commodity stocks with them, in the

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form of providing them with updated market information. They are informed about the prices prevailing in the markets, as well as advice them as to when to release their products into the markets.

2.2 Warehousing in India

According to the report submitted by THE ALL INDIA RURAL CREDIT SURVEY COMMITTEEE of Reserve Bank of India, the Government of India India enacte enacted d the agricu agricultu ltural ral produc produce, e, Develo Developme pment nt and Wareho Warehousi using ng Corporation Act, 1956. In addition to this, the other actions taken in the concerned field are:

•

Establishment of NCDWB (National Co-operative Development and Warehousing board in 1956.)

•

Establishment of Central Warehousing Corporation (CWC) in 1957.

•

Establ Establish ishmen mentt of State State Wareho Warehousi using ng Corpo Corporat ration ion (SWC) (SWC) in all the states, between July 1957 and August 1958

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2.3 Types of Warehouses

The warehouses are classified into various types, based on the following two parameters:

2.3.1 Types of of Warehous Warehouses es based based upon the the basis basis of ownersh ownership ip

2.3. 2.3.2 2 Type Typess of Ware Wareho hous uses es base based d up upon on the the basi basiss of comm commod odit itie iess stored

Types of Warehouses on the basis of the ownership

PRIVATE

Owned individual, business

PUBLIC

by

BONDED

the Owned

by Spec Specia iall lly y

large Government house

storage of own goods

and sea seaport portss

for for meant for the storage of goods.

cons constr truc ucte ted d and

airpo rports rts

near near and

accept accept goods goods for storag storagee till till pa paymen ymentt

of cust custo omers mers by

impo import rter ers. s. The The meth method od of oper operaatio tion

and and

char charg ges for for

stor storag agee is regu regula late ted d by the the Government. Types of Warehouses on the basis of types of commodities stored

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GENERAL

REFRIGERATED

Storage of fertilizers, cotton, tobacco,

Wareho Warehouse usess in which which temper temperatu ature re is

food grains, wool, petroleum, etc.

maintained as per requirement. Meant

Generally no specific requirements.

for perishable commodities such as

Storage items with a longer life span.

Vegetables, fruits, fish, beefs and Meat. The temperature in these Warehouses is maintained below 3 to 5 degrees.

A very good example of the active warehousing and Cold storaging can be found in Maharashtra. The Maharashtra Warehousing Co-

operation Act provides for the setting up of the Warehouse to aid the farmers to store their agriculture produce. Besides, the warehousing Corporation, the agriculture co-operative societies provide for the storage facilities to members under provisions of Nat Natio iona nall Grid Grid of Godo Godown wnss and and Sche Schemes mes.. The The sche scheme me also also includes financial assistance up to 50% of the cost of the storage faci facili liti ties es by the the Cent Centra rall and and the the Stat Statee Gove Govern rnme ment nt.. This This assistance is rendered in the form of the subsidy.

The Mahara Maharasht shtra ra State State Agricu Agricultu ltural ral Market Marketing ing Board Board undert undertook ook the first first initiative in 1990 to promote the use of temperature management technology by setting a pre-cooling unit and a cold storages facility under co-operative

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sector. The main aim was to promote the export of fresh fruits and vegetables from the state. Under the guidance of the Maharashtra State Agricultural Marketing Board today, Maharashtra is the main exporter of the fresh grapes from the country and exports nearly 70% of all the vegetables exported from the country.

Maharashtra State Agricultural Marketing Board also monitors the running of these cold storages units from time to time reviewed. It also controls the working of existing pre-cooling and cold storages, and suggests appropriate stor storag agee capa capaci city ty util utiliz izat atio ion, n, improv improvem emen entt in effic efficie ienc ncy y and and finan financi cial al viability.

The number of cold storages financed by the Bank is less than the actual number of units present in the region. But it is found that there is a significant growth, mainly due to the implementation of the Capital Investment Subsidy Scheme (CIS) and Interest Subsidy Scheme.

2.4 2.4 Func Functi tion onss of Nati Nation onal al Co-o Co-ope pera rati tive ve Deve Develo lopm pmen entt and and Warehousing Board:

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To advance loans and grants to State Government for financing co-operative soci societ etie iess enga engage ged d in Mark Market etin ing g proc proces essi sing ng or stor storag agee of agricultural produce, including contributions to the share capital of these institutions.

To provide funds to warehousing corporations and the State Government for financing co-operative societies for the purchase of agriculture produce on behalf of the Central Government.

2.5 Functions of Central Warehousing Corporation (CWC):

a) To acquire acquire and build build godowns godowns and warehouses warehouses at the suitab suitable le places places in India

b) b) To run run the the ware wareho hous uses es for for the the stor storag agee of the the agric agricul ultu tura rall prod produc uce, e, seed seeds, s, fert fertil iliz izers ers and and noti notifi fied ed commo commodi diti ties es for for indi indivi vidu dual als, s, cocooperative societies and other institutions.

c) To act as an agent agent of the Governme Government nt for the purchas purchase, e, sale, sale, storage storage and distribution of the above mentioned commodities. Food grains, sugar and fertilizers occupy about 78% of the total utilized stor storag agee capa capaci city ty,, whil whilee the the remai remaini ning ng 22% 22% of the the stor storag agee capa capaci city ty is primarily occupied by cement, chemicals an other commodities. comm odities.

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The corpor corporati ation on has introd introduce uced d a scheme scheme called called as “FARME “FARMERS” RS”.. This This scheme circumscribes an extension service at the selected centers to educate the farmers in the benefits of scientific storage and use of public warehouse. The Central Warehousing Corporation (CWC) also provides a package of service servicess such such as handli handling, ng, transp transporta ortatio tion, n, safety safety and securi security ty of goods, goods, insura insurance nce,, standa standardi rdizat zation ion,, docume documenta ntatio tion n and other other connec connected ted service service facilities.

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Chapter 3 RURAL GODOWNS

•

Features of Rural Godowns

•

Rural Godown Scheme

•

Credit Linked Scheme

•

Agriculture Produce Market Committee

RURAL GODOWNS The Government of India had launched a scheme for the establishment of NGRG (National Grid of Rural Godown) in the year 1979. The scheme aims

12


at the creation of a network of rural godowns in state and union territories, primarily to take care of the storage requirements of small and marginal farmers. The objectives of the scheme are as follows:

1. Prev Preven enti tion on of dist distre ress ss sale sale of food food gra grains ins, othe ther agri agriccultu ultura rall commodities, immediately after harvest. 2. Reduct Reduction ion in the quanti quantity ty and qualit quality y losses losses,, arisin arising g primari primarily ly due to the storage in substandard places. 3. Creation Creation of of employmen employmentt in the rural rural areas. 4. Helpin Helping g the farmers farmers in gettin getting g loans loans against against the stored stored product productss and faci facillitat itatee an eas easy pro procure cureme ment nt of the foo food prod roduct ucts by Foo Food Corporation of India.

3.1 Features of Rural Godowns

13


1. The size size of the Godown Godown varies varies from from a capaci capacity ty of 200 tonnes tonnes to 1000 1000 tonnes depending upon the produce expected for storage in the village. 2. The The cost cost of cons constru truct ctio ion n of the rura rurall godo godown wnss is subs subsid idiz ized ed to the the exten xtentt of 50% to be share hared d equ equall ally by the Cen Centra tral and and Sta State Gove Govern rnme ment nts. s. The The remai remaini ning ng 50% 50% of the the capi capita tall is arra arrang nged ed by implementing agencies such as co-operative marketing society in the form of a loan from the commercial banks. 3. The The Stat Statee Wa Ware reho hous usin ing g Corp Corpor orat atio ion n prov provid ides es all all the the tech techni nica call guidance. Its also provides supervision to the implementing agencies in the maintenance and management of the rural godowns. 4. The receip receiptt that is issued issued by the manager manager of the rural rural godown godown on the basis of stocks is a negotiable negotiable instrument. On the basis basis of the receipt, the farmers can get a loan from a commercial bank, up to the extent of the 80% of the value of the produce stored.

3.2 3.2

RURAL URAL

GODO GO DOWN WN

SCHE SCHEME ME

Scheme)

14

(Gra (G rami min n

Bhan Bh anda dara ran n


In spite of being self sufficient in production of the food grains, the farmers obtains low prices for their produce. The main reason for this being a lack of sufficient storage facilities forcing the farmers to sell the produce in the peak of the harvest season. The farmers can expect a pledge loan of around 70 to 75% of the stored produce.

3.3 Credit Linked Assistance:

Subsidy under the scheme is linked to institution available only on such projects, which are financed, by the Commercial Banks, Cooperative Banks, Natio National nalize ized d Banks, Banks, and Region Regional al Rural Rural Banks. Banks. The compos compositi ition on ca be shown as: 25% - Government Subsidy Scheme 25% - Own Investment 50% - Banks Loan

A future future target target of 500 godowns godowns has been fixed with the resulting resulting calculated calculated amount of subsidy coming out to be around 99 lacs.

3.4 Agriculture Produce Market Committee (APMC)

15


The The Agric Agricul ultu ture re Produ Produce ce Mark Market et Commi Committ ttee eess are are the the stat statut utor ory y bodi bodies es establ establish ished ed under under the provis provision ionss of the Mahara Maharasht shtra ra Agricu Agricultu lture re Produc Producee Marketing Regulation Act 1963.

The Agriculture Produce Market Committees create the infrastructure for the agricultural markets in the operational areas at the main markets. Presently, Maharashtra alone has about 256 Agriculture Produce Market Committees ad 572-sub yards.

The APMC market in Navi Mumbai has a total capacity of 6500 MT godown of which 1500 MT is utilized for various commodities. The godown at the auction hall has been leased out by the Agriculture Produce Market (APM) to the Maharashtra State Warehousing Corporation (MSWC).

In spite of all such available facilities, it has been found that there is a low util utiliz izat atio ion n of Cold Cold Sto Storag rages and and a slo slothfu thfull prog rogress ress in the fiel field d of Warehousing. The following reasons can be attributed to this:

1) Low capacity capacity utiliza utilization tion of Cold Cold Storage in certain certain areas areas mainly due due to high concentration of cold storages in a particular area.

2) Erratic Erratic power supply supply disrupting disrupting the the working working of the Cold Storages. Storages.

3) High Electric Electricity ity bills, bills, leading leading to reduction reduction in profits. profits.

4) Lack of transp transportati ortation on facilities facilities..

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5) Comp Compli lica cate ted d and and time time-c -con onsu sumi ming ng proc proced edur uree of depo deposi siti ting ng and and withdrawing the produce from the warehouses and cold storages.

6) Sellin Selling g of the produc producee by the produce producers rs at their their doorste doorstep p in order order to avoid the transportation cost.

7) Lack of regular regular busines businesss for the warehouse warehouses, s, as well as lack lack of grading grading facilities before the storing of the produce.

8) High High intere interest st rates for the loan loan amount amount and a compar comparati ativel vely y shorte shorter r period of repayment of these loans.

9) Pledge Pledge loan loan mostly mostly not provided. provided.

10)

The fac fact tha that the the fin financial ban bank gen generally doe does not not mee meet the the

working capital requirement adequately.

11)

Time lags in in the re releasing of of th the su subsidy am amount.

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Chapter 4 COMMODITY BACKED FINANCING •

Existing scenario

•

The crux of the situation

•

Changing

face

of

Commodity

Backed

Financing

COMMODITY BACKED FINANCINING 18


4.1 Existing Scenario Currently, most of the marketing of the commodities takes place through the private trading in organized markets/mundis. There exist a few restrictions on the marketing of commodities outside the regulated markets. The present India Indian n farme farmers rs commu communi nity ty is prim primari arily ly made made up of smal smalll and and marg margin inal al farmers. About 54% of the marketable surplus and distress sale by these small farmers accounts for about 50% of the marketable surplus.

It is found that the farmers often sell their produce to square off their debts soon after harvesting. Large price spreads and low price realization due to impe imperf rfec ecti tion onss and and weak weak link linkag ages es in comm commod odit ity y mark market etss have have been been dominating the Indian agriculture over a substantial period.

A sub-optimal credit support from formal banking sector had an adverse effect on the development of agricultural marketing systems in India. The informal sector, which includes the commission agents, provides significant credit to agriculture and wholesale trade but the cost of credit is much high as compared compared to the rate at which the the banks may provide provide it. The credit credit that the Banks have been providing to the farmers is certainly not substantial. The lending policies and programmes for financing the agriculture should focus more on the increasing financial needs of the agriculture marketing. The input based financing of the agricultural credit would give way to output bas based ed finan finance ce,, whic which h are are certa certain inly ly more more alig aligne ned d to the the mark market et,, wher wheree produc productio tion, n, proces processin sing g and market marketing ing become become an integr integrate ated d activi activity ty and financed as a package.

19


There have been radical changes in the agricultural sector in the past decade such as the recasting of important laws governing the sector, the rise in commodities trading volumes, the setting up of new warehouses, and the growing share of the organized food retail. Interestingly, unlike the Green revolution, the government would no longer be the main driver of the chain. Instead, Government will be functioning just like an enabler or a catalyst. And a motley group of private companies, cooperatives, NGOs and farmers will learn to work together for their own selfinterest in order to gradually revamp the Indian agriculture. The scene would look something as follows:

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The Indian farmer usually carries a huge load of risk on his shoulders. He plants his crops not knowing what the harvest will be like, or how much it will fetch in the market. Many things can go wrong between sowing and harvesting.

21


There are steps that have been already taken in this respect. Two years ago National Commodity and Derivative Exchange (NCDEX) was set up. It is connected to about 6000 trading terminals in 400 Indian towns. Today, 36 comm commod odit itie iess – 33 of them them agri agricu cult ltur ural al – are are trad traded ed ever everyd yday ay on this this exchange. That translates in to a daily turnover of around Rs. 2300 crores.

Till now, most of this turnover turnover comes from companies companies and speculators. speculators. The companies want to hedge what they buy. Day traders and speculators bet on how much a commodity like wheat might cost three months later. They look at the spot price; the cost of warehousing the produce, followed by the cost of capital, and accordingly trades on the futures of these products.

The first thing that this will do is that it will improve that way in which the farmer decided what to grow. Today he does it on the basis of the past year’s price. If a particular crop yields good prices, everyone sows it the next year. The result is that, at the harvest time, there is a glut in the market, resulting in the price crash of the commodity.

Commodity Futures would serve as a better barometer for consumer demand when sowing time comes. Here is how it will work: Let us say that Mandi offers the farmer Rs. 650 for a quintal of wheat, while the exchange suggests that the prices will climb to Rs 750 in the next three months. The farmer then decides to wait. In order to hedge this risk, he picks up a future, thus committing to sell at this price three months down the line. There would however be skepticism within the farmers as to what would happen of the prices rise.

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The solution of this lies in Options. This is how it will work: In the above case, instead of futures the farmer picks up an option. Three months down the line, if the prices in the Mandi are still at Rs. 650, the farmer will sell. On the other hand, if the spot prices move up to Rs. 850, he can decide no to go ahead with the sale, pay his buyer a small penalty and take his stock to the Mandi.

Thus the exchanges will fix the mandis, not by competing for procurement but by helping the farmer to time his visits to the Mandi better.

Prese Present ntly ly,, Nati Nation onal al Comm Commod odit ity y and and Deri Deriva vati tive ve Exch Exchan ange ge (NCD (NCDEX EX)) is aggress aggressive ively ly holdin holding g semina seminars rs for trader traderss in large large towns, towns, and tellin telling g its brokers in the small towns to do the same. The main barriers here is that the small farmers cannot afford to pay Rs. 30 lakhs to become the member of the exchange. They would have to become the clients of the existing members. Also the minimum trade has to be 10 tonnes. To solve both these problem, National Commodity and Derivative Exchange (NCDEX) is trying to reach out through cooperatives, banks and NGOs.

A major hurdle today is that how to get the real time prices across to the Indian farmer. Today, there are about 10000 – odd information kiosks in the country. Even if each of them would reach out to five villages, it would cover abou aboutt 5000 50000 0 vill villag ages es.. But But Indi Indiaa has has over over 6000 600000 00 vill villag ages es.. The The kios kiosk k infrastructure will have to be increased by 8 to 9 times to give an adequate reach.

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Also, before anything is traded, it has to be graded and valued. But there is no grad gradin ing g infra infrast struc ructu ture re in the the coun country try.. Anot Anothe herr issu issuee is the the cost cost of warehousing warehousing.. Farmers often need money from their their harvests harvests immediately immediately to finance their next crop.

In order to tackle these issues, NCMSL, an offshoot company of the National Commodity and Derivative Exchange (NCDEX), is setting p its warehouses all over India. These warehouses will be open to any farmer who wants to hold his produce after the harvest instead of selling it immediately and sell later when the prices would be favourable. When the produce would arrive at the warehouse, it will be graded into one of the three categories: Premium, Standard or Discounted. If the farmer would be in a need of an urgent money, then NCMSL would be in a position to give as much as 75% of the value of the the crop crop as a loan loan.. The The stoc stock k lyin lying g grad graded ed,, pack packed ed and and valu valued ed in the the warehouse will easily serve as a collateral. Presently, NCMSL can make this payment within a week’s time. But it is expected that over the time when the bank and other parts of the jigsaw would fall into pieces, farmer would be in a position to get their money immediately, imm ediately, without much time delay.

At present, NCMSL has about 100 warehouses across all over the India. By the end of the year 2007, it has a target of setting about 1000 warehouses. NCMSL has aggressively being going ahead in this respect, with their higher authorities themselves touring various states in India, talking personally to the various warehouse owners and persuading them to sign up with NCMSL, thus thus conver convertin ting g their their wareh warehous ouses es into into NCDEX NCDEX – accred accredite ited d wareho warehouse uses. s. NCMSL intends to have a NCDEX – accredited warehouse after every 40 kilometers, all over the country.

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One more important factor is that there has been a radical change in the consumption pattern of the Indian. Indians today are consuming fewer cereals, and more vegetables, fruits, meat, fish, eggs and milk. Indian agriculture is undergoing a change accordingly. accordingly.

Chan Change gess in the the cons consum umpt ptio ion n patt patter ern n of sele select cted ed food foodss over over 1990 1990 – 2000(Kg/person/year)

CEREALS VEGETABLES FRUITS MILK MEAT EGGS FISH 1990

159.9

53.4

28.2

53.9

4 .6

1 .2

3.8

2000

153.1

65.9

37.5

64.9

5 .0

1 .4

4.7

Annual

-0.4

2.1

2.9

1.9

0 .9

1 .9

2.0

Growth (%)

Source: FAO Food Balance Database

4.2 The Crux of the situation Agriculture has been one of the focus areas for the Government of India for quite sometime now, and substantial impetus has been given to it lately,

25


through measures intended to liberalize the sector mainly by providing easy Finance through institutional sources such as Banks. However even after all these measures the primary producer still gets only a small share of the ben benef efit itss whic which h are are mean meantt for for him, him, as most most of it gets gets lost lost in the the long long agricultural value chain mainly comprising of the traders and the middlemen.

Thus Social Justice demands that some rebalancing needs to be done so that all factors of production are adequately compensated for their efforts.

This rebalancing act can be comprised of the following steps: •

Creati Creation on of Superi Superior or Infras Infrastru tructu ctural ral facili facilitie tiess thereb thereby y facili facilitat tating ing efficie efficient nt storag storage, e, transp transport ortati ation on and marketi marketing ng of the agricu agricultu ltural ral produce.

•

Development of a Price Stabilization Mechanism

•

Redu Reduci cing ng the the over overal alll cost cost invo involv lved ed in agri agricu cult ltur ural al produ product ctio ion, n, processing and marketing activities

Even though the reaping, harvesting and storing of crops is seasonal, the consumption of the commodities is perpetual, as well as variable in nature. The market value of the commodities is the lowest at the time of harvesting, primarily due to an abundant supply. Also, the consumption requirement is periodic, and not in a bulk at a time. This naturally gives a rise to need of storing the commodities, thus giving a way to requirement of strong storage facilities for the producers, in order to hold a portion of the produce. This would facilitate the farmer to meet his requirements such as fertilizers, seed, etc. by selling the stored surplus commodities in the market, whenever the market price is favourable. A need for storage facilities also comes into

26


pic pictu ture re when when there there is an inad inadeq equa uacy cy or unav unavai aila labi bili lity ty of the the tran transp spor ortt facilities.

This This has has led led to the the Indi Indian an Gove Governm rnmen entt to come come up aggr aggres essi sive vely ly with with warehousing facility all over India under the aegis of Central Warehousing Corporation (CWC) and State Warehousing Corporations (SWC). However government itself for storage of Grains meant for Public Distribution System (PDS) utilizes most of the warehouse space in these warehouses. Thus the farmer/ farmer/ trader trader still still resort resortss to either either storin storing g the commod commoditi ities es in his own premises or using the private warehousing facility.

Similarly most of the steps taken by the Government had “Food Security” or supp suppor orti ting ng the the farme farmerr throu through gh mini minimu mum m supp suppor ortt pric pricee as the the prim primar ary y objective, which resulted in greater emphasis to schemes such as PDS, and the benefits of the other constituents of the value chain are still largely unaddr unaddress essed. ed.Als Also o in the case case of financ financing ing agricu agricultu ltural ral activi activitie ties, s, local local institutions still dominate the scene while institutional finance is perceived to be someth something ing very very diffic difficult ult to be availe availed d off. off. Thus Thus the only substa substanti ntial al measure of the Government seems to be the setting up of the “Minimum Support Price” mechanism, which ensures the bare minimum returns to the producers, however this alone wont be enough to revitalize the agricultural sector and an easy availability of Institutional finance for improvement in infrastructure and marketing facilities is urgently needed.

4.3 Changing face of Commodity Backed Financing.

SBI has been active in Commodity Backed Financing for a long time now, however most of the products are not in tune with the current market trends

27


and are hence losing market share. Also there has been recent developments such as the setting up of the Commodity Exchanges like Multi Commodity Exchange (MCX) and National Commodity Derivatives Exchange of India (NCDEX), which has given rise to newer business opportunities for SBI in this arena.

Also there has been structural changes in the area of Warehousing with Wareh Wa rehou ouse se rece receip ipts ts been been made made nego negoti tiab able le,, ther thereb eby y resul resulti ting ng in bett better er marketability of warehouse receipts.

Due Due to thes thesee deve develo lopm pmen ents ts the the Trad Tradee and and Serv Servic ices es Wing Wing of the the SME SME department decided to have a revisit their Commodity Backed Financing Business Portfolio.

The Study The SBI thus conducted a study analyzing the commodity backed financing business of the bank. The study included a visit to the Gwalior (Morena) area in Madhya Pradesh along with several visits to the APMC Navi Mumbai to understand the ground realities related to this business.

The study focused on the following businesses: 

Warehouse Receipt Financing  Financing

against Receipts of Central Warehousing Corporation

(CWC) / State Warehousing Corporation (SWC) Warehouses.

28

Downloaded from a2zmba.blogspot.com  Financing 

Fina Finan ncin cing

against Receipts of Private Accredited Warehouses. aga against inst

Rece eceipt ipts

of

Priv Privat atee

(Un (Unaccr accred ediited ted)

Warehouses.



Warehouse Construction Financing



Meeting the banking requirements of MCX Members such as:



Clearing and settlement accounts



Bank Guarantee facility to meet margin requirements. r equirements. Funding

the Margin requirements for Delivery based trades of

MCX Members.

Given below are the recommendations on the various product offerings of the bank in the commodity backed financing arena along with new potential for business in these areas. These recommendations are based on the above study as well as an analysis of the current product offerings of the bank vis-à-vis that offered by other banks and also takes the current trends in the industry into acco accoun unt. t. The The recom recomme mend ndat atio ions ns cons consid ider erss the the rece recent nt dire direct ctiv ives es from from the the regulatory authorities and also the new measures taken by other departments of the bank which also deal in commodity backed financing area namely, Agriculture. This will ensure that the recommendations suggested below will not conflict with the measures taken by the other departments.

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Chapter 5 WAREHOUSE RECEIPT FINANCING

•

Financing against CWC/SWC Receipts

•

Advances against Accredited Warehouse

•

Advances against Warehouse Receipts issued by Private Warehouses

•

Warehouse Construction Financing

WAREHOUSE RECEIPT FINANCING 5.1 Financing against CWC/SWC Receipts Receipts

30


The business of “Financing against Warehouse receipts” is currently in its nascent nascent stages, as far as India is concerned. concerned. However, However, it can certainly certainly prove to be a highly lucrative business with tremendous potential that it possesses, especi especiall ally y in view view of organi organized zed trade trade throug through h multi multi commod commodity ity future futuress exc exchan hanges ges as also lso impe impend ndin ing g laun launch ch of spo spot trad rade in agric gricul ultu tura rall commodities.

Loan against Warehouse Receipts is basically a self-liquidating loan with the tenure of the loan not exceeding 12 months (stipulated so as to guard against depletion in quality/valuation of the underlying goods) and with security margin of up to 30-40%. This margin is taken to guard against the “Market Risk” that the bank is subject to, due to unfavorable movement in the prices of the underlying commodity.

All the major Public as well as Private sector banks have already brought this business into focus, and have started taking aggressive steps in this direction. Other Banks with a substantial presence in Morena area of Madhya Pradesh where a detailed study was conducted are UCO Bank, ICICI Bank, Oriental Bank of Commerce, Central Bank of India, State Bank of Indore etc.,

SBI currently has a portfolio of around Rs.17 crores in this area. However the terms at which other banks are extending finance are very much liberal. We can improve our portfolio if we modify the terms and conditions of our pro produ duct ct and and make make it more more tune tuned d to the the curr curren entt indu indust stry ry tren trends ds.. Such Such modi modifi fica cati tion onss will will requi require re chan change ge in the the margi margin n requ requir irem emen ents ts,, Rate Rate of

31


Interest, Cap on the amount of loan and the period of credit currently offered. (The detailed terms and conditions are detailed in Annexure 1).

Comparative Analysis of SBI’s offering with respect to other banks

Interest Rates

ICICI 8.5-11%

UCO 9%

SBI 11% - 14%

30%

40%

Depending on the amount Security Margin 25-30%

Majo Majorr ch chan ange gess in the the term termss pr prop opos osed ed from from thos thosee at pr pres esen entt are are as under: SR.No. 1

Terms of Finance Rate of Interest

Existing 11% to 14%

Proposed Remarks 9.75% to 1) Self

11%

liquidating

2) Max period of 12 months Processing Charges 2 3 Margin 40% 30% The detailed terms and conditions are detailed in Annexure 1

Risk Assessment and Mitigation:

Risks Identified Ways to Mitigate Risk Risk Associated with fake warehouse • Random checks will be conducted either before

rece receip ipts ts,,

or

misr misrep epre rese sent ntat atio ion n

of

disbursal of the loan or anytime later to cross

quanti quantity/ ty/qua qualit lity y of the commod commodity ity

check the authenticity of the warehouse receipt

stored.

and take stock of the commodities stored in the

32


warehouse. •

In case of Private warehouses, a warehouse will be linked to a particular branch. Only through this this bran branch ch Adva Advanc nces es will will be made made to avoi avoid d

duplication and difficulties in co-ordination. Risk Risk Asso Associ ciat ated ed with with vola volati tili lity ty in The security margin that would be initially charged price price moveme movement nt of the underl underlyin ying g at 30% should be sufficient for mitigating these commodity Risks

risks. related

with

the All

the

commodities

stored

will

be

damage damage/ob /obsol solesc escenc encee of the stored stored comprehensively insured to mitigate this risk. commodities Default Default on interest interest and/or and/or principal principal The Security Margin of 20-30% should be good payment (Credit Risk)

enough to cover for the probabilities of Credit Risk

5.2 Advances against Accredited Warehouses Warehouses

This is a new concept concept gaining prominence prominence with the advent of professional professional collateral management companies in the country like

•

NBHC

- Nati Nation onal al Bulk Bulk Hand Handli ling ng Corp Corpora orati tion on,, a Join Jointt Vent Ventur uree

between MCX and the PRB group Australia

33

Downloaded from a2zmba.blogspot.com •

NCMSL

- Nati Nation onal al Coll Collat atera erall Mana Manage gemen mentt Serv Servic ices es Limi Limite ted, d,

promoted by NCDEX and banks

These institutions provide various services which improves the quality of wareho warehousi using, ng, thereb thereby y reduci reducing ng the risk due to reduct reduction ion in quanti quantity ty and quality of the deposited commodity. Once an agreement is inked with either or both of these institutions, the Bank can look forward to sanction advances against receipts of warehouses accredited/franchised by them and treat them in a very very simi simila larr mann manner er as it trea treats ts for for adva advanc nces es agai agains nstt CW CWC/ C/SW SWC C warehouses.

Services Offered by these Institutions Institutions •

Scientific warehouse maintenance and storage of agri-commodities. Arrangement of Bank finance for construction and renovation of

•

warehouses. Installation of “V Sat” terminal, to get information about online

•

stock of commodity. Arrangement of Bank finance for lending against warehouse receipt.

•

•

Logistic assistance.

•

Quality certification assistance.

•

Training and Awareness programmes.

•

Receiving, storage and outturning of commodities

As we can see from above that NBHC only arranges for Bank Finance for Wareh Wa rehou ouse se Cons Constr truc ucti tion on and and also also for for fina financ ncin ing g agai agains nstt the the wareh warehou ouse se receipts and does not provide any financial assistance for the same, with the

34


resu result lt,, prom promot oter er has has to depe depend nd on Bank Bankss for for fina financ ncin ing g of ware wareho hous usee construction in order to claim the subsidy available on the same, and also for getting finance against the warehouse receipts issued by him.

The Bank can develop a customized product in which it will not only finance the construction of such warehouses but also facilitate easy availability of finance against warehouse receipts issued by them.

Since these warehouses will be accredited by either NBHC or NCMSL who would guarantee superior warehousing facility and also protection against frauds (as one of the terms of the above mentioned agreement), the Bank can offe offerr fina financ ncee agai agains nstt rece receip iptt from from such such wareh warehou ouse sess at par par with with cent central ral warehouse/ state warehouse corporations, detailed as per Annexure 1.

5.3 Advanc Advances es agains againstt Wareho arehouse use Recei Receipts pts issued issued by Priva Private te Warehouses With the advent of Private Warehouses, there is a good potential in lending against warehouse receipts of private warehouses, however the modalities of advanc advances es agains againstt privat privatee wareho warehouse use receip receipts ts will will be differe different nt than than those those against CWC/SWC warehouse receipts.

1) Quality and Quantity – Margin stipulated for financing is higher at 40% compared to 30% for CWC/ SWC

35


2) Genuinity of Receipts – (a) Name and specimen signature of authorised signatory to be held on record. (b) (b) Only nly one one bra branch nch in the the cen centre will will be authorised

to

finance

against

private

Warehouses. (c) Encourage construction of these warehouses with our finance.

(3) Indemnity/ Guarantee to be obtained from the owner against the losses the bank may suffer on A/c of management / genuinity of receipts/ Quantity/ Quality / Insurance etc.

(4) This may also be topped up with personal guarantee from proprietor.

The risks that we apprehend in lending to such WR’s are in lending mainly from the credibility of the owners/ managers, systems and procedures, checks and balances, safety and safeguard in holding of the stocks.

Depending on the above parameters, the branch will appraise and sanction a credi creditt limi limitt for for adva advanc nces es agai agains nstt recei receipt ptss of thes thesee ware wareho hous uses es and and the the warehouses will be assigned to particular branches.

The farmers / traders should not suffer for want of adequate capacity of Public Sector Warehouse capacity. Till such time at least till the accredited W.R. capacity increases we may consider financing against private W.R.

36


receipts to traders also subject to a cap of Rs. 100 Lacs as is in Agri Business. Similar safeguards will be taken against fraudulent use/ mischief.

After the above process, the said branch will accept and approve requests for advances against warehouse receipts of these Private Warehouses.

Comparative Analysis of SBI’s offering with respect to other banks Security

ICICI 10%

UCO NA

SBI 100%

8.5-11%

9%

11% - Traders

Margin Interest Rates

Depending

on

9% - Farmers

the amount Limit

Upto 10 crores

Up-to

1 Upto Rs.20lacs

crore

The new terms and conditions proposed based on the current industry trends are detailed in Annexure 2

5.4 Warehouse Construction Financing Warehouse construction activity is flourishing due to availability of subsidy from NABARD. However, this subsidy is available only if the construction is undert undertake aken n using using bank bank financ finance. e. Genera Generally lly the wareho warehouse use constr construct uction ion is financed as under: Uses

Sources

37


Cost of land

25% - Owners Equity/ Contribution

Cost of Construction

25% - Subsidy

Cost of Necessary Equipments Remaining

by

way

of

Bank

Finance

Working Working Capital Capital for the immediate immediate period after Construction

The subsidy is “Back-ended” and the banks’ finance even this portion until the owner/promoter receives the subsidy. Other banks are funding funding the entire entire subsidy subsidy portion, whereas we are funding just 80% of it making the Warehouse owner to bear the remaining thereby increasing the quantum of his contribution by another 5%. Comp Compar arat ativ ivee

Anal Analy ysis of

SBI wit with

Comp Compet etiitors ors

in

Ware arehous housee

Construction Finance Business

ICICI

UCO

OBC

CBI

State

SBI

Bank Bank of Interest

8.5-10.25%

Rates

Depending on

9%

8.75%

the

amount

38

8.5%

Indore 8.5%

11%


Quantum

75%

75%

75%

75%

NA

70%

of Finance

The The branc branche hess can can cons consid ider er sanc sancti tion on of Term Term Loan Loan and and cons constr truc ucti tion on of warehouses, subject to detailed terms and condition as per the Annexure – 3.

Risk Assessment and Mitigation

Given below in the table are the various risks associated with the product and the proposed mechanism to mitigate them.

Warehouse Construction Financing Risks Identified Ways to Mitigate Risk

39


Risk Risk relate related d with with title title of the land. land.

Detail Detailed ed

verifi verificat cation ion should should be

carried

out

to

ascertain

the

ownership of the land selected for warehouse warehouse constructi construction. on. The Title inv investi estiga gati tion on rep report ort

as part part of

revised SME documentation should Risk

associated

compl mpletion

with

of

the

address these risks adequately. timely We may may stip tipulat ulatee a pena penallty of

wareh rehouse addi additi tion onal al inte intere rest st for for dela delays ys in

construction

project completion, so as to act as a disincentive for delays. comprehensive • A

product

Risk related inadequate business of

facilitating easy financing of the

the

warehouse

wareh rehouse

resulting

in

an

increased credit risk probability

receipts

of

the

warehouse whose construction is financed by the bank. •

A liberal moratorium period of 12 mont months hs may may be allo allowe wed d at the the discre discretio tion n of the the local local author authority ity (ZCC, CCC), which should take care of the slow building up of

Risk

associated

with

volumes. non- A detailed scrutiny of the necessary

fulfillment of necessary regulatory docu docume ment ntss shou should ld be carri carried ed out out requ requir irem emen ents ts like like lice licens nses es from from before sanctioning the loan so as to applicable authorities.

overcome this difficulty.

40


Risk Risk Asso Associ ciat ated ed with with defa defaul ultt on Verification of the business model Interest and/or Principal repayment

and projected volumes of business based

on

scientific

and

sophisticated storing facility offered may be good enough to cover this Risk

associated

occurring

due

Calamities.

with to

risk. losses Comprehensive insurance policy of Natural the Warehouse in joint names of the Wareh Wa rehou ouse se cons constr truc ucto torr and and SBI SBI should be taken.

Chapter 6 MULTI COMMODITY EXCHANGE OF INDIA (MCX) • • •

•

About MCX Banking requirements of MCX members Clearing and settlement account for MCX members Bank guarantee for Margin requirements 41

Downloaded from a2zmba.blogspot.com • •

• •

Credit assessment of the members Financing members for Delivery of Physical commodities at MCX Delivery mechanism at MCX Potential

Multi Commodity Exchange of India (MCX)

6.1 About MCX Multi Commodity Exchange (MCX) has about 920+ trading members across 300+ cities and 4500+ workstations. The average daily turnover is around 900 crores. The total physical delivery from February 04 to December 04 is given in the following table:

COMMODITY Gold Silver Chana Urad Pepper

QUANTITY 397 kgs 14790 kgs. 630 tonnes. 75 tonnes. 10 tonnes.

6.1.1 Delivery Mechanism at MCX

MCX MCX has has thre threee type typess of

delivery contracts:

42


Sellers Option: Only seller has the option to decide about delivery

•

Compulsory Delivery: Gold and Silver

•

Both options (Cash Settled)

MCX contracts are launched on 16 th of every month and expire on 15 th of next month. The delivery period starts from 1 st of every month. During this period the seller or buyer can give his / her intention to give or take delivery. MCX will match the intentions to arrive to design the delivery positions. Once the delivery is assigned to a buyer he cannot square off his position

6.1.2 Matching of Delivery

In MCX the delivery matching happens before the expiry date. 3-5 days before expiry the tendering period starts whereby the sellers’ intentions are matched with the buyers intentions and deliveries are assigned. Once the expiry date is over, whatever is the open position, which is Cash settled. In case of compulsory delivery the delivery is assigned to buyer and if he refuses then a penalty is charged to him. For the both option delivery there is no delivery period and the intention matching takes place after the expiry date.

The delivery is assigned on the first come first basis and also in following order: 1. Same city 2. Near ear by by Cit City y 3. Far Far aw away City ity

6.1.3 Default of Delivery

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There can be two scenarios when a delivery is in default:

1. If seller seller after giving giving intention intention to to deliver deliver fails fails to deliver deliver 2. If the buyer buyer after after assigning assigning deliv delivery ery refuse refuse to take take delivery delivery

In both the cases the settlement will happen on cash basis. There will be a penal penalty ty of 1-3% 1-3% of contra contract ct price price depend depending ing on the commodity commodity for the defaulting party. This penalty will be distributed between defaulted party and the exchange in the ratio of 90:10. Exchange feels that this will be sufficient to compensate for any loss that has occurred to defaulted party.

6.1.4 Warehousing Warehousing

The exchange has accredited warehouses in various states depending on the availability of the commodity. Hence for Rubber Kochin is the center while for soyabean its Indore. The delivery takes place through the warehouse. The seller will deposit the commodity with the warehouse on or before the pay-in date. The warehouse will check it for the quality specification. If it found the specification to the mark it will accept the material and issue a warehousing receipt. The warehousing receipt will be transferred in the name of buyer once buyer pays the money. The buyer will then collect the material on the production of same receipt.

6.1.5 Quality

In case the buyer has doubts about the quality there will be recertification of commodity. There will be three samples taken – for exchange, seller and buy buyer er.. The The buye buyer’ r’ss samp sample le is test tested ed.. If buye buyerr is stil stilll not not happ happy y then then exchange’s sample is tested. That certification will be final and then buyer

44


has to take delivery. In case the buyer is right the seller has to bear the charges of recertification and also take back the commodity. In case the buyer is wrong the certification charges are born by buyer and he has to accept the delivery.

6.1.6 Quantity

If the quantity of material varies from prescribed in the contract then the buyer will pay more or less as per the excess or deficit. The excess or deficit will be priced as:

Price = (Excess or Deficit) * Price / Contract Size

6.1.7 Premium and Discount

Quality of commodity is fixed at the time of launching the contract. But unlike precious metals it is very difficult to get the commodity of same specif specifica icatio tion. n. Hence Hence exchan exchange ge allows allows certai certain n conces concessio sion n in the qualit quality y parameter. Hence there is a tolerance limit allowed in all commodities. So if the commodity is not of exact quality but fits into tolerance limit it will be considered as acceptable delivery. If the quality is better than what is prescribed in the contract then the seller must be compensated for that. This will be assured by asking buyer to pay a premium for it. Similarly when the commodity is inferior the buyer will be compensated by giving him discount over contract price. The premium or disc discou ount nted ed is calc calcul ulat ated ed by the the formu formula la prov provid ided ed by exch exchan ange ge in each each contract.

45


The The prem premiu ium m and and disc discou ount nt is sett settle led d in supp supple leme ment ntar ary y sett settle leme ment nt of exchange.

6.1.8 Tax and Duties

Exchange feels that uniform tax and duty structure will help the situation. Selle Sellerr hand handle less the the taxe taxess up to deli delive very ry in the the wareh warehou ouse se wher wherea eass once once delivery is accepted it becomes buyers’ responsibility. If you take delivery and then keep the material in warehouse and then sell the next month you will not be required to pay CST.

6.1.9 Buyer’s option

If a delivery is allocated to a buyer on the 1st day of the tender period, on the immediate succeeding day he is required to inform the Exchange that he is not willing to lift delivery and wishes to settle the contract as per the Due Date Rate. In such a case, such buyers are required to settle the contract as per the Due Date Rate and also to pay a penalty of 1% of the DDR, of which 90% will go to the seller. In case the buyer intends to take delivery, he is required to make the payment within 2 working days of the allocation of delivery.

6.1.10 Clearing Agents

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For the purpose of effecting delivery of gold and silver, every member will be entitled to appoint a maximum number of two Clearing Agents, who will be entitled to receive and deliver precious metals on behalf of such member

6.1.11 Intimation about clearing agents

By 5.00 pm on the 2nd day of tender period, the member will be required to forward name of the Clearing agent, who will visit Group 4 Securities office for giving or lifting delivery.

6.1.12 Delivery

The seller will be required to deliver gold at Group 4 securities facilities at specified centers. Such specified centers are Mumbai and Ahmedabad. The seller has to submit the delivery along with bill made in favor of individual buyers.

6.1.13 Non-performance by the seller

In case a seller who has submitted tender notice fails to deliver gold on 6th working day as per schedule stated above, the contract will be closed out as per the Due Date Rate and a penalty of 1% will be imposed on him, out of which 90 % will be paid to the buyer, while 10% will be appropriated by the Exchange

6.1.14 Tolerance Limit

In respect of gold, there will be no tolerance in respect of weight. It must be imported gold bar of 1 Kg weight.

6.1.15 Quality adjustment

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The price of gold is on the basis of 995 purity. In case a seller delivers 999 purity, he would get a premium. In such case, the sale proceeds will be calculated by way of delivery order rate r ate * 999/ 995.

6.2 Banking Requirements of MCX members Since its inception MCX has grown steadily both in terms of the number of members as well as the quantum of business transacted through it everyday, curren currently tly the MCX has around around 920+ 920+ Member Memberss and 4500+ 4500+ workst workstati ations ons across the country and the daily volumes on the exchange is averaging more than Rs. 1000 crores. MCX members have a variety of banking requirements ranging from maintaining a clearing and settlement account for MCX trades to Bank guarantee facility to meet the daily margin requirements.

Though the SBI group has around 30% stake in MCX only 3% of the MCX members bank with SBI, the main reasons for this is that SBI has not develo developed ped any produc productt keepin keeping g the requi requireme rements nts of MCX members members into into focus. Thus the 3% of the members that currently bank with us are basically using Bank’s existing products to meet their requirements. Also the terms and conditions offered by SBI is completely out of sync with the current trends and hence do not attract more MCX members towards Banking with us.

48


Give Given n the the siza sizabl blee busi busine ness ss pote potent ntia iall poss possib ible le from from MCX MCX memb members ers we recommend introducing 3 products specially targeting the MCX members. These products are: - Cleari Clearing ng and and sett settlem lement ent accoun accounts ts

-

Bank Guarantee for Margin requirements

-

Finan Financin cing g Member Memberss for for Delive Delivery ry of Phys Physica icall Commo Commodit dities ies at MCX

We expect that introducing the above products will help the SBI attract more MCX members to bank with it.

6.3 Clearing and settlement accounts for MCX members MCX members need to maintain a clearing and settlement account with one of the banks to settle the margin requirements of all its MCX trades.

We have identified many of the existing members and their sub brokers who are are bank bankin ing g with with othe otherr bank bankss wish wish to migr migrat atee to our our Bank Bank for for thei their r transactions with MCX. There is a good scope for attracting current accounts and other related new businesses from these Members / Sub brokers.

MCX has appointed our Mumbai Main Branch, M.S. Marg, as their Clearing Bankers. The clearing arrangement envisages opening of principal account titled MCX Settlement Account at Mumbai Main Branch. The members’ accounts are opened at different up country branches and their settlement acco accoun untt is open opened ed at Mumb Mumbai ai Main Main bran branch ch thro throug ugh h whic which h MCX MCX and and members settle their trade.

49


MCX will have the authority (backed by suitable Undertaking / Power of attorney from the Members) to operate / withdraw funds from the Member’s “Settlement Account” as and when required. The Settlement Account of the Members would not be available for any other use by the Members except for transferring surpluses to the respective Client’s (their own) Accounts at the upcoun upcountry try branch branches. es. Requir Required ed margins margins are funded funded by the Member Memberss through transfer of funds from their Client Accounts to their Settlements Accounts with Mumbai Branch. Similarly surplus margins are remitted back to the clients account from settlement account with Mumbai Main Branch.

In view view of the the fore forego goin ing g and and avai availa labl blee busi busine ness ss oppo opport rtun unit itie iess all all the the Bran Branch ches es have have been been advi advise sed d to open open Curr Curren entt Acco Accoun unts ts as and and when when approached by the Members of MCX, observing ‘KYC’ norms.

Simultaneously branches should forward one more set of KYC compliant account opening forms, with necessary backup documentation for opening of the Member’s ‘Settlement Account” at the Mumbai Main Branch.

6.4 Bank Guarantee for Margin requirements Multi Commodity Exchange of INDIA Ltd requires its members to deposit and maintain in their accounts a certain minimum amount of funds for each open position held. These funds are known as “Margin” and represent a good faith deposit that serves to provide protection against losses in the market. The Clearinghouse collects margins directly from each of MCX clearing members who in turn are responsible for the collection of funds from their clients. The different types of margins are

50


•

Initial Margin – Typically 3-10 % of the contract size depending on the commodity

•

Variation Margin – This margin is collected to avoid any adverse movement in the commodity prices as per the exchange rules.

•

Delivery Margin – This is the Margin required during the delivery period of the contract and is typically 20-25% of the contract size.

Members of the Exchange can deposit initial margin in cash or may furnish Fixed Fixed depo deposi sitt or bank bank guar guaran ante tees es or such such othe otherr inst instrum rumen ents ts as may may be specified by the Exchange from time to time to fulfill the initial margin requirement in respect of open positions. Variation margin shall be paid only in cash or cheque, or by electronically debiting the account of the member of the exchange with the designated Clearing bank of the Exchange.

6.4.1 The Potential

The total volume of trade on the MCX for the month of April’2005 was Rs 26493 Crores. Taking a modest average Initial margin of 4 %, the total Initial Margin requirement of the Members of the MCX for the month April’2005 stands at Rs.1060 crores. Hence the potential of Bank Guarantee requirement of the MCX members has already crossed Rs 1000 crore a month mark, of these even if we take 25% to be provided in the form of Bank Guarantees by our branches, the market potential for Bank guarantees business for MCX Members will stand at Rs 250 Crore a month.

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This level of business opportunity is big enough for us to venture into this business, since the current exposure to this business is a paltry Rs. 2 crore. 6.4.2 The Product

For the proposed product, a one-time credit assessment of the member needs to be carried out by the bank to determine the extent of Bank Guarantees that can be sanctioned to the member. During this assessment the member will be rated on various parameters and depending on his score in the Risk Rating Matrix he may be assigned a suitable Credit Limit.

Also Also at the the time time of this this asse assessm ssmen entt the the follo followi wing ng docu documen ments ts shou should ld be demanded from the members

•

Provisional financials for the current financial year - Balance Sheet / P&L Account/all Schedules

•

Audited Balance Sheet / P&L statements with all schedules / audit report for the previous accounting year.

•

Brief profile of the Member / Company - Back ground /Years in business/ Group Co. details etc

•

Brief Brief profil profilee of direct directors ors - Name, Name, Age, Age, Qualif Qualifica icatio tion, n, Experi Experienc ence, e, Directorships in other companies etc

•

Latest Net worth Certificate (as certified by CA) & copy of IT returns of two major shareholders

•

Latest Shareholding pattern of the company

•

Latest margin statement of MCX - Details of capital with exchange Cash/ Fixed Deposit /Guarantee

52


Business Business Plan, covering covering details of their their existing existing business business model - like bus busin ines esss mix, mix, viz. viz.,, Prop Propri riet etar ary, y, Reta Retail il,, Corpo Corporat rate, e, Appr Approx oxim imat atee Number of registered clients, risk management, exposure management etc

•

Details of existing banking arrangements. •

Bank Bank Guaran Guarantee teess / Other Other Credit Credit facili facilitie tiess enjoye enjoyed d from from bankin banking g system (other banks)

•

Set Settlem tlemen entt

vol volumes umes

(MTM (MTM

pay-i ay-in/ n/pa pay y-out -out

for for

last last

30-5 30-50 0

settlements) •

Month-wise turnover for last six months

•

Status report from MCX

•

Certified true copy of MCX Membership Certificate

6.5 Credit assessment of the members

All the MCX members interested in availing of the bank guarantee facility need need to be asse assess ssed ed for for thei theirr cred credit it wort worthi hine ness ss,, depe depend ndin ing g on whic which h appropriate limits can be sanctioned to each of them.

To facilitate the process of Credit Assessment a Risk Rating Matrix needs to be developed with important parameters given adequate weightages so that the result of the matrix decides the limit that should be allotted to a particular member

Some of the Parameters that can be used are:

53


Type of Membership of the member – There are three types of membership of MCX, thus better the membership better should be the credit standing of the member.

•

Size of Business – This can be determined using the number of SubBrokers and other clients of the member.

•

Bala Balanc ncee shee sheett anal analys yses es of the the memb member er for for the the last last 3 year yearss (if (if available)

•

Assessment of the business model of the member.

•

Previous Credit Standing

These are just few of the points we need to consider for the Risk Rating Matrix. The development of the Risk Rating Matrix was out of the scope of this project.

6.6 Financing Members for Delivery of Physical Commodities at MCX This is yet another new Business opportunity from MCX. Around 3-5% of the trades on MCX result in Physical Delivery of the commodity on the expiry of the contracts.

6.6.1 Warehousing at MCX

The exchange has accredited warehouses in various states depending on the availability of the commodity. For Rubber Cochin is the center while for soyabean is Indore. The delivery takes place through a warehouse. The seller will deposit the commodity with the warehouse on or before the pay-in date. The warehouse will check it for the quality specification. If the quality of the

54


commodity is upto the specification agreed on, it would accept the material and issue a warehousing receipt. The warehousing receipt will be transferred in the name of buyer once buyer pays the money. The buyer will then collect the material on the production of the receipt. There can be dispute on the basis of quality and quantity of commodity. Bank will not be responsible for the

6.7 Delivery Mechanism at MCX MCX has three types of delivery contracts: •

Sellers Option: Only seller has the option to decide about delivery

•

Compulsory Delivery: Gold and Silver

•

Both options (Cash Settled)

MCX contracts are launched on 16 th of every month and expire on 15 th of next month. The delivery period starts from 1 st of every month. During this period the seller or buyer can give his / her intention to give or take delivery. MCX will match the intentions to arrive at the delivery positions. Once the delivery is assigned to a buyer he cannot square off his position, otherwise but through delivery.

6.7.1 Matching of Delivery

In MCX the delivery matching happens before the expiry date. 3-5 days before expiry the tendering period starts whereby the sellers’ intentions are matched with the buyers intentions and deliveries are assigned. If a delivery is allocated to a buyer and he intends to take delivery, he is required to make

55


the payment within 2 working days of the allocation of delivery. SBI can come in here and finance the payment requirements of the buyer.

1 – MCX MCX Memb Member er indi indica cate tess his his will willin ingn gnes esss to take take deli delive very ry of the the commodity 2 – MCX seeks the payment requirement from SBI. 3 – SBI makes the payment to MCX. 4 – MCX endorses the Warehouse receipt in favor of SBI 5 – MCX member makes payment to SBI 6 – SBI delivers the warehouse receipt to the MCX Member

56


Incase the MCX Member defaults SBI can make good of the loss by selling the commodity backed by the warehouse receipt in the open market.

For the above product to be implemented a Tripartite agreement needs to be inked between •

State Bank of India

•

Multi commodity Exchange

•

Member of MCX.

Acc Accord ording ing to this his agre greemen ementt SBI SBI wil will agre agreee to hono honour ur the the marg margiin requirement of the MCX member relating to delivery of commodities upto a fixed fixed limi limitt that that is spec specif ifie ied d sepa separat ratel ely y for for each each of the the MCX MCX memb member er depending on his credit assessment.

MCX in turn will agree to endorse the Warehouse receipts financed by SBI in favour of SBI and deliver it to SBI.

In addition addition to this MCX will also facilitate facilitate the liquidati liquidation on of the warehouse warehouse receipt in case of defaults.

A security margin of around 30-35 % of the value of the contract will be required from the member and an interest rate of around 8-11 % will be charged.

57


6.8 Potential

The total physical delivery from February 04 to December 04 is given in the following table:

COMMODITY Gold Silver Chana Urad Pepper

QUANTITY 397 kgs 14790 kgs. 630 tonnes. 75 tonnes. 10 tonnes.

Given the above size of delivery there is good scope for our Bank to enter this arena. Also Also the the bank bank is wait waitin ing g for for appr approv oval al from from the the RBI RBI for for ente enteri ring ng into into propriety positions in the commodities derivatives market. As and when the product rolls out and the RBI grants approval for entering into propriety positions by the banks, the Commodities desk at the Treasury department should be ready to take up the responsibility of recovering any principal that will be at risk due to defaults by the bank’s customers.

58


Thereby resulting in better price recovery of the goods and resulting smaller losses on account of NPA.

Chapter 7 CONCLUSION

59


CONCLUSION Key Recommendations Recommendations Based Based on my study study of the various various produc products ts I recomm recommend end the follow following ing changes

Warehouse Receipt Finance

•

Downward revision in the interest rates currently charged as these are not competitive.

•

Downward revision in the security margin currently demanded as this is against the market practice

•

Increa Increase se in the warehous warehousee wide wide limit limit for financ financee agains againstt W.R. W.R. of Private warehouses.

•

Advances Advances against Warehouse Warehouse receipts receipts are classified as “Clean” “Clean” and does does not not acce accept pt the the ware wareho hous usee rece receip iptt endo endors rsed ed in its its favo favorr as a primary primary security. This methodology methodology of the bank needs to be modified modified and the warehouse receipt endorsed in its favor should be treated as Primary Security.

•

Mand Mandat atin ing g the the bran branch ches es to enco encour urag agee cust custom omers ers to avai availl of the the Warehouse receipt finance even if they are not current customers of the bank.

60


Warehouse Construction Finance

•

Revision in interest rate that are currently charged

•

Offering Offering Comprehens Comprehensive ive deal to Warehouse Warehouse owners availing availing of

Ware Wa reho hous usee Cons Constr truc ucti tion on fina financ nce, e, wher whereb eby y the the rece receip ipts ts of the the ware wareho hous usee whos whosee cons constr truc ucti tion on is fund funded ed by SBI SBI will will be readi readily ly financed, thereby increasing the business prospect of the venture and reducing the probabilities of credit risk. Curre Current ntly ly only only 80% 80% of the the subs subsid idy y port portio ion n is fund funded ed by SBI SBI

•

there thereby by incr increa easi sing ng the the owne owner’s r’s cont contri ribu buti tion on by anot anothe herr 5%. 5%. We recommend financing 90% of the subsidy portion.

MCX Related Business

•

I recommend introduction of the following new products specially targeting the MCX members -

Clearing and settlement accounts

-

Bank Guarantee for Margin requirements -

Financing Members for Delivery of Physical

Commodities at MCX

61


I recommend using the existing Corporate Internet Banking Platform for the above products and the bank need not wait for implementation of the Core Banking Solution.

Considering the existing market conditions and the tremendous potential in the commodities business as presented in the paper, I can certainly conclude that State Bank of India, with its monumental size, and deepest reach in all over India, can leverage its strength and capitalize the most to bring about an enhancement in the commodities sector, as well as contribute towards the overall agricultural development of the country.

Ind India is a predo redomi mina nan ntly tly an agri agriccultu ulture re dep depend endent ent nat nation ion, and and the the contribution made by State Bank of India I ndia in this sector, would lead to a boost in the country’s Gross Domestic Product, finally leading to the nation’ s economic enhancement.

To summarize it all, I can be certain enough to say that the steps taken by Sta State Bank ank of Indi Indiaa would ould have ave a subs substa tant ntia iall impac mpactt of the the futu future re Agricultural as well as economic progress of India

62


Annexure 1 Financing against CWC/SWC receipts TERMS & CONDITIONS

a) To finance traders against the warehouse receipts of Purpose

Eligibility

commodities stored by them in CWC/SWC warehouses, & warehous warehousee accredit accredited ed by MCX by way of deman demand d loans. Any trader dealing in commodities. Dema Demand nd Loan Loan:: 70 % of the the valu valuee of the the ware wareho hous usee

Eligible amount of finance

receipt, valued at the market value OR 80% of the minimum support pric rice declared by State/Central Government, whichever is lower.

Intere Interest st Rates Rates (in percentage)

Loan category

Upto Rs. 2,00,000

Interest

Rate

to

Charged

0.50% Below SBAR

Effectively 9.75% Over Over Rs. Rs. 2,00 2,00,0 ,000 00 up to 0.25% Below SBAR Rs.25,00,000

Effectively 10.00 %

63

be


Over Rs. 25 25 lacs lacs based based on credit risk assessment

9.75% to 11%

In addition to the above-mentioned Interest rates the ZCC & CCC will have powers to reduce the interest rates on loans in the Rs. 2 lacs and above category by upto 50 bp based on competition and strengths of proposal.

Processing charges

Nil 30% (minimum) of the value of the warehouse receipt, valued at the market value OR

Margin

20% (minimum) of the minimum support price declared by State/Central Government, whichever is higher Comprehensive Insurance

Insurance

Insu Insuran rance ce cost cost to be born bornee by the the ware wareho hous usee rece receip iptt owner.

Security

Char Charge ge over over the the depo deposi site ted d wareh warehou ouse se recei receipt pt,, bein being g a) Primary

endorsed in favour of the bank. None

b) Collateral

64


Repayment

The loan should be liquidated as and when the produce is sold during the interim period not exceeding 12 months. Non None. e. The The loan loan woul would d be repa repaya yabl blee in a maxi maximu mum m

Moratorium

period of twelve months. Interest as and when due would be payable. 1) The Warehouse receipt should be duly endorsed in the favour of the bank. 2) Depending on the type of commodity the Margin may vary.

Othe Ot herr term termss and and

3) The branch should verify the authenticity of the

conditions

ware wareho hous usee recei receipt pt and and get get its its lien lien note noted d with with the the warehouse before disbursal of the loan. 4) The Branch should should inspect the commodity commodity before disbursal takes place and subsequently, every three months at irregular intervals.

65


Annexure 2 Financing against Warehouse receipts of Private Warehouses TERMS & CONDITIONS

a) To finance traders against the warehouse receipts of Purpose

commodities stored by them in Private warehouses, by

Eligibility

way of demand loans. Any Trader dealing in Commodities. Dema Demand nd Loan Loan:: 60 % of the the valu valuee of the the ware wareho hous usee

Eligible amount of finance

receipt, valued at the market value OR 70% of the minim minimum um support support price price declar declared ed by State State Government, whichever is lower.

Intere Interest st Rates Rates (in Loan category Upto Rs. 2,00,000/percentage)

Interest Rate Charged 1.00% Below SBAR

Effectively 9.25 % Over Over Rs. 2,00,0 2,00,000/ 00/-- upto upto Rs. 25 lacs

0.5% Below SBAR Effectively 9.75 %

Over Rs. 25 lacs

10.50% to 12.00%

In additi addition on to the aboveabove-men mentio tioned ned Intere Interest st rates, rates, the ZCC & CCC will have powers to reduce the interest rates on loans in the Rs.25 lacs and above category by upto 1%.

66


Processing charges Nil 40% (minimum) of the value of the warehouse receipt, Margin

valued at the market value OR 30% (minimum) of the minimum support price declared by State Government Comp Compre rehe hens nsiv ivee Insu Insuran rance ce with with Bank Bank’s ’s inte intere rest st duly duly

Insurance

noted. Insu Insuran rance ce cost cost to be born bornee by the the ware wareho hous usee rece receip iptt owner.

Security

Char Charge ge over over the the depo deposi site ted d wareh warehou ouse se recei receipt pt,, bein being g a) Primary

endorsed in favor of the bank. None

b) Collateral

The loan should be liquidated as and when the produce is Repayment

sold during the interim period not exceeding 12 months.

Othe Ot herr term termss and and

a) The Warehouse receipt should be duly endorsed in

conditions

the favor of the bank. b) Depending on the type of commodity the Margin may vary. a) The The bran branch ch shoul should d veri verify fy the authe authent ntic icit ity y of the warehouse receipt before the disbursal of the loan. The Bank’ ank’ss charg hargee shou hould be duly duly note noted d warehouse before disbursal

67

with ith the


b) The commodity should be inspected before disbursal of the loan and once every three months at irregular intervals thereafter.

Annexure 3 Warehouse Construction Financing TERMS & CONDITIONS Purpose Eligibility

To finance construction of warehouses and cold storages. Any Trader dealing in Commodities.

Eligible amount of Term Loan: 75 % of the cost of construction of the

68


finance

warehouse.

Loan category Upto Rs. 5 lacs.

Interest Rate Charged 0.25% Below SBAR

Effectively 10.0 % Over Rs. 5 lacs. upto Rs. 25 lacs Intere Interest st Rates Rates (in percentage)

At SBAR Effectively 10.25 %

Over Rs. 25 lacs upto Rs. 1 crore.

0.25% Above SBAR Effectively 10.50 %

More than 1 crore upto 5 10.50 % - 12.00 % crores.

Depe Depend ndin ing g on the the Cred Credit it assessment.

In additi addition on to the aboveabove-men mentio tioned ned Intere Interest st rates rates the ZCC & CCC will have powers to reduce the interest rates on loans in the 1 crore and above category by upto 1%. Processing charges Nil 25 % of the value of the warehouse construction cost. Margin Comp Compre rehe hens nsiv ivee Insu Insuran rance ce in the the join jointt name namess of the the Insurance

borrower & Bank. Insurance cost to be borne by the warehouse constructor.

Security a) Primary

First Charge over the Warehouse Constructed.

69


None b) Collateral

The loan should be repaid in Equ Equated Monthly Repayment

installments of upto 84 months.

Moratorium

Six months

Annexure 4 Bank Guarantee for MCX Members Term & Conditions Purpose Eligibility Eligible amount finance Commission Margin

To meet meet differe different nt margin margin requir requireme ements nts for trade trade at commodity exchange Members of the Multi Commodity Exchange of India (MCX) Depending on the credit assessment of the borrower of not exceeding Rs 25 crores.

Commission to be charged @1.50% At least 25% margin should be secured in cash, and balance balance amount by other securities securities,, so as to secure the exposure However, in case of existing customers with soun sound d mean meanss and and good good trac track k record record,, and and base based d on

70


value of relationship, collateral security may be waived at the discretion of the sanctioning authority.

Processing Fee

0.25% of the Bank Guarantee amount, subject to a maximum of Rs.1 lac.

Other Terms & a) All the members interested in availing of this service Conditions

need to be assessed for their Credit Standing by the respective Branches. In this process the following documents should be asked for and scrutinised and depending on the scores on these parameters in the Risk Rating Matrix suitable Credit limit should be fixed. The required documents (indicative) are: 1) Provisi Provisiona onall financ financial ialss for the curren currentt financ financial ial year - Balance Sheet / P&L Account/all Schedules

2) Audited Balance Sheet / P&L statements with all schedules / audit report for the previous accounting year.

3) Brief profile of the Member / Company - Back ground /Years in business/ Group Co. details etc

4)

Brief

profile

of

directors

-

Name,

Age,

Qualif Qualifica icatio tion, n, Experi Experienc ence, e, Direct Directors orship hipss in other other companies etc 71


5) Latest Net worth Certificate (as certified by CA) & copy of IT returns of two major shareholders

6) Latest Shareholding pattern of the company

7) Late Latest st marg margin in stat statem emen entt of MCX MCX - Deta Detail ilss of cap capita ital with exch exchan ang ge - Cash ash/ Fix Fixed Depo eposit sit /Guarantee

8) Business Plan, covering details of their existing business model - like business mix, viz., Proprietary, Retail,

Corpo rporate,

reg registe istere red d

clie client nts, s,

Approx roximate risk risk

Numbe mber

mana manage geme ment nt,,

of

expo exposu sure re

management etc

9) Details of existing banking arrangements.

10) 10) Bank Bank Guar Guaran ante tees es / Othe Otherr Cred Credit it faci facili liti ties es enjoyed from banking system (other banks)

11) Settle Settlemen mentt volume volumess (MTM (MTM pay-in pay-in/pa /pay-o y-out ut for last 30-50 settlements)

12) Month-wise turnover for last six months

13) Status report from MCX

72


14) 14) Cert ertifie ified d true true copy opy of MCX Memb Member ersh ship ip Certificate

BIBLIOGRAPHY MAGAZINES REFERRED:

•

Capital Market

•

Business World

•

Dalal Street

•

Business India

WEBSITES REFERRED:

•

www.statebankofindia.com

•

www.mcx.com

•

www.cwc.com

73


www.google.com

•

www.soople.com

74

Commodities Backed Finance Project report

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