Unlocking rural wealth – Part 1

How land-backed overdraft will help farmers?

Many farmers in India own land of significant value but still face liquidity crises at very many crucial moments, almost every year. In contrast, urban middle classes often have no substantial assets but enjoy better lives due to a significant flow of money.

Farmers’ land is frequently hypothecated for crop loans, but these loans are typically purpose-specific and tied to cultivation needs. This leaves little room for non-farming expenses, like delayed sale of their crops at better prices, investment in livestock, children’s education, medical emergencies, home improvements, and when they run out of cash.

What if farmers could tap into their land’s unused equity, drawing funds through a flexible overdraft (OD) facility while retaining cultivation rights and ownership?

While this idea won’t replace crop loans, it offers farmers a second line of credit linked to their land’s residual value. This provides much-needed liquidity without driving them to frequent distress.

The current situation – Land as collateral

In India, there are many farmer-friendly schemes like Kisan Credit Cards (KCC). Small and marginal farmers get loans (like crop loans) without hypothecating their land.

But farmers end up hypothecating their land for varied requirements of loans (like term loans for the purchase of land, tractors, and livestock, installing farm infrastructure, irrigation systems, allied non-crop activities like dairy, poultry, horticulture, fisheries, etc, warehouse receipt, etc).

Loan amounts are also mostly not fully linked to the value of land hypothecated. Land hypothecation is just a surety.

Almost all the loans are mostly conceived keeping the bank’s convenience and safety of collection in mind, with pre-determined payment schedules (like EMIs, and repayment after the sale of crops in case of Crop loans and Warehouse Receipts).

Small and marginal farmers particularly don’t have fixed incomes at fixed intervals. Their quantum and frequency of income are extremely unpredictable.

If only they can have additional access to a moderate OD facility, based on their land holding value, it will help them immensely. If they can structure any of the above loans (esp EMI-based ones) as OD, at their convenience, it will help too. Of course, they will pay a slightly higher rate of interest as applicable to OD.

This could be just a small additional facility, but it could mean a world of difference to the farmers, esp the small and marginal ones. I think the scope exists to offer such an option for the following reasons:

• Residual Land Value: In many cases, the full market value of land isn’t utilized for existing loans, leaving untapped potential for OD.
• Larger Landholders: Farmers with larger landholdings often have surplus value not fully leveraged for existing loans.
• Secondary Land Use: Portions of land not directly used for farming (like barren land or extra parcels) can serve as collateral without affecting crop loans.
• Even where there is no residual land value, banks can offer a low OD facility and keep increasing it to a moderate level in stages subject to their proven creditworthiness over time. This will motivate the farmers to pay back their loans quickly, though there may be no pre-set payment schedule.
• In the absence of OD, typically there are 3 ways the farmers handle such situations:
  • They take the loan in some other name but as a term loan on an EMI basis, which becomes a huge burden for the farmers, as the flexibility of repayment is lost.
  • They borrow from private moneylenders at usurious rates of interest, which works against the interest of the farmers.
  • They end up foregoing the opportunity or necessity for the use of funds, which frustrates them.

This is the most important reason why OD should be seriously considered.

Land-backed OD: A secondary credit line

A land-backed overdraft (OD) is not meant to replace existing loans but to supplement them by:

• Leveraging unused land equity that isn’t tied to cultivation loans.
• Partially collateralizing land for non-farming needs, without disturbing primary agricultural finance.
• Providing farmers with flexible access to funds for personal, household, or secondary farm investments.

Key differentiation:

• Crop loans with repayment upon crop value realization focus on farm inputs (like seeds and fertilizers).
• Term loans with EMI payments are meant to help create a capital asset or infrastructure.
• The OD facility additionally supports broader financial needs including personal needs: education, healthcare, weddings, and even farm infrastructure improvements.

Addressing limited land value

For small and marginal farmers, available land equity may be minimal. This is acknowledged in the model. Therefore:

• The initial focus can target larger farmers with underutilized land value for a larger OD limit.
• Small and marginal farmers may be offered OD limits starting with moderately small amounts, increasing in stages based on their repayment history.
• As land prices appreciate, even smaller farmers can be offered higher OD limits against rising land values.
• Risk guarantees by the government can encourage banks to extend these overdrafts without undue hesitation.

Implementation – Who does what?

1. Central government:

• Develop overarching policies with RBI to guide overdraft structures.
• Allocate funds for risk guarantees (covering partial defaults).

2. State governments:

• Digitize land records, ensuring clear ownership and up-to-date valuations.
• Run awareness campaigns to educate farmers on OD benefits.

3. RBI (Regulator):

• Issue guidelines for land-backed OD facilities.
• Monitor interest rates, tenure, and risk exposure.

4. Banks and financial institutions:

• Provide overdraft services by hypothecating unused land value.
• Regularly reassess land worth and credit worthiness to adjust credit limits.

5. Financial advisors (District Level):

• Offer free consultations and financial education to farmers.
• Assess debt levels to prevent over-borrowing.

Why this will work for farmers

• Liquidity Without Land Sale: Farmers retain ownership while accessing funds for pressing needs.
• Debt Consolidation: Converts high-interest debts into lower-cost overdrafts.
• Resilience During Bad Seasons: Prevents distress sales of crops or land.
• Generational Wealth Preservation: Keeps land intact for future generations.
• They can avoid taking it as a term loan or from money lenders, suffering the consequences.

Safeguards to prevent misuse

1. No Waivers or Write-offs: The OD facility should come with a rider, and it will not be subject to loan waivers. In case of default, after a reasonable time and due notice, a proportionate part of the land may be auctioned.
2. Cap on Overdraft Limit: Borrowing is capped at a certain % of land value, preventing over-borrowing.
3. Risk Mitigation: Farmers receive mandatory financial counseling to ensure they borrow responsibly.

Addressing key concerns

• Land Disputes: Unclear land titles delay loans.
  • Solution: Digitize and verify land records.
• Over-Borrowing – Farmers may overdraw beyond repayment capacity.
  • Solution: Annual credit reviews and advisory services.
• Falling Land Values – Market volatility may shrink overdraft limits.
  • Solution: Conservative valuations, reassessed annually.

Economic impact and feasibility:

Unlocking even 10-20% of incremental land value could inject billions into rural economies. The government’s role will focus on:

• Risk guarantees (covering 10-20% of loans).
• Land digitization to simplify processes.
• Hiring financial consultants at the district level.

The long-term returns: self-sustaining rural economies, demand growth leading to higher GDP, and improved farmer welfare will far outweigh these costs.

Unlocking rural wealth – Part 2 will follow

Note:
1. Text in Blue points to additional data on the topic.
2. The views expressed here are those of the author and do not necessarily represent or reflect the views of PGurus.

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