Agri Commodity Warehousing and Finance – Risks & its Mitigants

Agriculture commodities business is a high volume and low margin business and is often accompanied by moderate to high level of risk. The economic returns of warehousing activity are highly vulnerable to the Production Risk, Market Risk and Regulatory Risk. The utilisation of the warehousing space largely hinges on the Production of Crop, Expected Price Outlook of Agri Commodity, Export Prospects, Domestic Demand, Government Procurement and Regulatory Guidelines. Here’s a closer look at the current scenario and some measures that could help mitigate the risks involved.

Agri warehousing business is fraught with high degree of Operational Risk, Quality Risk, Quantity Risk, Market Risk and Regulatory Risk therefore it requires constant monitoring and surveillance. One of the biggest challenges in Agri warehousing business emanates from the fact that numerous warehouses are spread across the remote parts of the country, which are not economically viable due to underutilisation and increased cost of construction driven by high land price, surge in cement and steel price. At the same time, warehouses situated at remote locations are exposed to the fraud risk because of the movable nature of the Agri commodities. Additionally, the commodities kept in the remote warehouse locations are further vulnerable to the risk of theft, burglary and also prone to the delayed remedial action in the event of fire, flood or natural calamity related incidents.

Agriculture warehousing being predominantly an unorganised and low-cost sector, professional practices, systems and procedures are still at nascent stage making it challenging for organised, professional players to survive because low entry barriers which has brought down margins with increased risks and created an adverse Risk to Reward ratio in the business. Agriculture being a seasonal activity, the harvested Agri commodity stored in the warehouse, which is utilised over the period that blocks significant working capital of the producer. Traders or Processors, who in turn necessitates these entities to avail finance against the value of these underlying Agri commodity from the financial institutions. Agri commodity finance has transformed in the last few years and with the advent of Collateral Management Business because of which banks and other financial institutes have ventured into this business aggressively. Commodity Finance products got impetus in 2004-05 and was mainly driven by 2-3 large private sector banks and now this business has spread across more than 50 financial institutions and banks. Commencement of Future Trading has further paved the way for demit funding for banks/financial institutions and now with the introduction of option in Exchange and with the setting up of National E-Repository Limited (NERL), which is a national level market infrastructure institution that records and stores Warehouse Receipts in an electronic form (e-NWRs), under the aegis of Warehouse Development and Regulatory Authority (WDRA), will further play important role in deepening the Agri commodity business. However, this is yet to get fillip.

The loans against Agri commodities are typically short term and self-liquidating in nature. The collateral manager guarantees the banks about the quality and quantity of the Agri commodities, provides price information required for margin call and also aids in disposal of the commodities, if necessary. The last few years of subdued agricultural growth and economics has increased counterparty risks with rising incidents of fraud, especially for all players in the collateral management business. This industry is manpower intensive and the industry due to its low-cost profile and less organised nature, has a significant challenge in attracting talent with the right skills, integrity and value systems especially at field level. The banks and financial institutes transfer the risk of quality and quantity of underlying commodity through the Collateral Management (CM) agreement by paying services charges to the Collateral Manager. Therefore in the event of any short fall incident arising on account of infidelity of employees, liability to make good losses to the bank /financial institution sometimes crystallises on the CM agencies.

CM business is fraught with high degree of operational risk

Additionally this industry is manpower intensive and CM companies remain dependent on the effective supervision of storage and monitoring of inflow and outflow of commodities and the risk reward ratio is very slender therefore this business requires constant monitoring and surveillance.

Another challenge in providing CM services emanates from the logistics complexities of securing numerous warehouses spread across the remote parts of the country and safe custody of commodity as usually commodity is stored in the warehouse/cold storages owned by the third party therefore possibility of undue influence of the warehouse owner/cold storage owner cannot be totally ruled out.
In Agri commodity finance business downward volatility of prices erodes the margin of the client and in such a situation delayed disposal of the commodity may snowball into financial loss to the financial institution/ company.

Further, transfer of risk to the insurance company is limited due to the reduction in the quantum of sum assured coupled with surge in the insurance premium cost.

• Extensive risk profiling of client based on the past antecedent of the client, analysis of financial standing.
• Exposure capping based on the client rating, commodity concentration and geography concentration.
• Continuous streamlining of the operating process and issuing detailed standardised operating process and ensuring its adherence to ensure the security of the underlying commodity.
• Several levels of audit checks based on the risk profile of warehouses/godowns.

The current collateral management processes in India are evolving and now shifting more towards technology-driven monitoring which plays an important role in the management of the thinly spread structures. The system not only ensures that the issuance and release of the warehouse receipt are centralised, but also keeps all relevant personnel updated in real time on the status of the collateral. The use of CCTV cameras is also an important element to initiate corrective action and downsize the likely quantum of risk.

Agriculture commodities business is a high volume