SPIS Toolbox - Bank Loan

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1. Bank Loan

Outcome/Product

A commercial bank is defined as a financial institution whose main occupation consists of giving loans and taking deposits. A commercial bank earns its income through the interest resulting from the loans provided. Therefore, a commercial bank uses a business financial model.

Depending on the size, the length and the purpose of the credit, banks offer different types of agricultural loans. Unfortunately, the majority of commercial banks have not developed a financial product specific for the purchase of Solar Powered Irrigation Systems yet. Consequently, a standard agricultural loan needs to be requested.

In order to secure a loan from a commercial bank, several documents are required to be signed by both parties. A note in which the borrower agrees to pay the loan back at the decided interested rate, a loan agreement which contains the terms and conditions of the loan, a security agreement which explains what will happen with the collateral in case the borrower fails to pay back the loan and finally a financial statement.

Depending on their term, loans can be subdivided into three categories: short, intermediate and long term loans. Normally for the purchase of a farm equipment an intermediate term loan, which has a life span between 1 to 5 years, is used. Since the usual payback time for a SPIS stretches between 2 to 5 years, depending upon the farm income and other associated economics, an intermediate loan, is the best solution.

Once the loan is availed, interest needs to be paid. It can be fixed, adjustable or variable. Fixed interest remains constant during the entire loan period, adjustable interest is allowed to change but only in determinate intervals of time while variable interest changes as per the market conditions.

Bank loans can be paid through fixed constant payments or fixed principal payments. In the first case, interest and the principal are equally divided among the length of the loan. In the second case the principal is equally divided and interest is calculated each time based on the amount of the loan remaining to be repaid. In case of fixed principal payments, the initial payments are the highest.

Due to the high risk of the agricultural sector, interest on agrarian loans are typically high.

One example: in Kenya, which is the East African country with the highest financial inclusion, interest rates range between 20 and 30% (as at 2017). The Equity Bank of Kenya requires 18% of interest plus an additional 3% for the application fee. The KCB Bank, partly owned by the Kenyan government, charges 22% interest and an additional 2.5% for the application fee. In addition, two compulsory insurances are required: a credit insurance with a 2.5% interest rate and a crop insurance with a 7% interest rate. Overall, the interest reaches about 30%.

Data Requirements

The data required in order to finalize a credit are the following for most commercial banks:

Farmer personal data:

• Sex: According to studies women are more likely to pay back debts than men.
  
• Age: Some banks offer credit only to specific age groups: i.e. between 25 and 55 years old. In addition, in many countries, interest rate subventions are provided to senior citizens.
  
• Marital status: Married people with kids are more likely to pay back debts.
  
• Documents of identification.

Farm information:

• Property certification: If the land is leased, the chance to obtain credits is much lower.
  
• Credit history: Did the farmer pay back all his past loans? Is the farmer creditworthy?
  
• Insurance of the loan (if applicable) • Bank account statement: In order to check the farmer’s cash flow and transactions.
  
• Income from agriculture
  
• Income from other activities besides farming
  
• Collaterals: Banks need a security in case the farmer is not able to pay back his debt.

People/Stakeholders

• Commercial Bank
  
• Financial experts / Risk analysts
  
• Farmer

Important Issues

Generally, big farmers are more likely to obtain credits from big banks; conversely, small farmers will be better off dealing with smaller financial institutions. Small farmers with narrow financial means and limited access to the market and customers, are challenged to obtain credits from a commercial bank.

Collaterals, alternative sources of income and a bank account represent the main barriers for credit eligibility. Collaterals and alternative source of income act as an insurance for the bank, safeguarding them in case the agricultural activity is not profitable.

Unfortunately, the solar pump itself is not considered as collateral, since banks lack information about this product. Therefore, financial institutions which mostly rely on internal data, do not have experts that can assess the risk of the loan. In order to use a solar pump as collateral, a financial analyst is required to know the initial price, the lifespan and the depreciation rate of the product in order to be able to trace its value back. Furthermore, it is necessary to know the optimal utilization conditions, the presence of a second-hand market and risk of theft.

Banks require this kind of information in order to safeguard themselves from inconvenient situations, which will end up in a loss of money. If for example, the system is stolen or the pump is positioned in an area with high salinity and it breaks down, the farmer is not likely to continue to pay the loan back and the bank will end up with unpaid credit and a worthless collateral.

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