Warehouse receipts: Role of MFIs in agric finance

THE Reserve Bank of Zimbabwe in its mid-term monetary policy review underscored that it is working with relevant ministries to operationalise the warehouse receipting system (WRS) which will, inter alia, unlock agricultural finance, provide markets and reduce post-harvest losses.

This is sweet music to the Zimbabwean economy. This week’s instalment brings in an interesting dimension on how Micro Finance Institutions (MFIs) can play a significant role on WRS. This is also important and timely considering the support the RBZ is giving to MFIs in Zimbabwe.

Small-scale farmers have always struggled to pay their debts. They often sell off their goods when harvest season begins so they can hold onto their crops until the lean season, when the price and potential for profits are at their highest.

However, improper preservation or drying techniques, coupled with inadequate storage facilities, can force small farmers to let commercial or foreign traders reap the rewards of seasonal price swings. With the use of warehouse receipt financing, also known as inventory credit, small farmers gain an advantage on the playing field.

Experience from around the world illustrates that warehouse receipts can make a difference to farmers. By storing their goods in a reliable warehouse until the price increases while using the goods as loan collateral, farmers may access funds before they sell their goods.

Warehouse receipts are often administered to producer groups, instead of individuals, which helps the flow of market information. Warehouse receipts can also create price transparency. This empowers farmers to make informed sales decisions rather than waiting for “farmgate” buyers who often offer below-market prices.

Evidence has shown that MFIs have a strong incentive to offer warehouse receipt financing. With this system, their risk is reduced because the system has a built-in use of collateral that can retain a high commercial value and be liquidated quickly.

But warehouse receipt financing is a speculative activity. Producers often attempt to wait until the market has reached its perceived peak to gain the highest profits.

This activity often leaves the farmer with the bulk of the harvest as prices begin to decrease, leaving the farmer with the smallest possible profits.

Preventing this type of speculation is critical to making warehouse receipts a success. The key, however, is to ensure that a few critical factors, such as a good warehouse system and careful monitoring, are in place to make it a success.

Nuts and bolts of warehouse receipts

Warehouse receipt financing is the use of securely stored goods as loan collateral. These programmes allow producers to deposit a finished good or agricultural product in a secure warehouse where the producer receives a receipt certifying the deposit of goods of a particular quantity, quality, and grade. The farmer can use the receipt as a form of portable collateral to request a loan from a financial institution such as a bank or an MFI.

There are typically three parties involved in warehouse receipt financing: the bank, the farmer, and the warehouse. The farmer identifies a warehouse and takes his or her goods to the warehouse for deposit. The warehouse operator grades and classifies the goods and gives a receipt for storage of said goods to the farmer. The farmer then takes the receipt to the MFI and, based on projections of the goods’ market value, the MFI gives the farmer a loan. The loan is extremely flexible as it allows the farmer to spend it to finance expansion activities, pay off debts, or use it for any other reason.

Warehouses can be either open to the farmer, allowing the farmer to withdraw produce at any time, or sealed, so the farmer cannot access produce until a predetermined date. If the produce is withdrawn, the farmer must repay the bank for the loan - principal and interest - and the warehouse operator for any storage fees. Alternatively, the farmer may use the warehouse as a channel for selling the goods, in which case the goods are released to the buyer, the loan and fees are deducted from the selling price, and any remaining profits are released to the farmer.

Types of Warehouses

Warehouses operate in a number of ways. Each type of warehouse provides the customer with a different range of security and services. The five basic types of warehouses are:

◆ Public warehouses are open to anyone on a non-qualifying basis. Any person who brings in agricultural goods may store them in a public warehouse.

◆ At field warehouses, an operator manages a warehouse on the premises of another business. This occurs in industries such as milling or cotton spinning where the industry finances the acquisition of raw materials, while someone else controls the stock for the bank.

◆ Dual-key warehouses provide secure storage as both the bank and the depositor have control over the warehouse. Both parties hold keys to the storage facility, and both keys must be presented to access the facility.

◆ Self-managed or single-key warehouses provide depositors with complete control over their goods at the storage facility. Typically, a bank or an MFI provides some supervision.

◆ At trading warehouses, the warehouse operator trades the stored commodity on the depositor’s behalf. This may seem to be a conflict of interest for the warehouse operator, but these facilities have operated successfully in North America for many years.

Warehouse receipts: advantages and disadvantages

As in all types of microloans, there are advantages and disadvantages for the MFI and the client with warehouse receipts. The advantages and disadvantages include: For the MFI Advantages

◆ Decreased risk: Warehouse receipts provide entrepreneurs with instant collateral to guarantee a loan. Having this type of collateral with a high market value is attractive to MFIs, which usually rely on group pressure to ensure loan repayment, especially when lending to first-time loan clients who do not have a proven track record. ◆ Reduce seasonal price variability: The warehouse receipt system has the effect of smoothing out seasonal price variations throughout the year for a specific agricultural product. As this occurs, more people will become involved in the warehouse system, which can result in shorter and more competitive supply chains.

◆ Liquidity: Unlike real estate or other forms of collateral, the warehouse receipt is liquid. It can be converted into cash either at a bank or at the marketplace. This is especially attractive to MFIs, which may have difficulty collecting repayments from the farmer.

Disadvantages

◆ Decreasing profitability: Experience has shown that some warehouse receipt programs help market prices level out and the overall price remain steady. In methodologies where the loan amount is tied to the estimated worth of the product, a decreased price decreases the loan amount available to the farmer and the interest that the MFI collects.

◆ Warehouse operation: This system works only if there are reliable warehouses in place. An MFI can establish or manage a warehouse, but experience has shown that this is usually not sustainable for the MFI. If an MFI must step in to build or manage a warehouse, it should proceed cautiously and add this cost to the price of its inventory credit program.

Advantages for the Entrepreneur

◆ Profitability: Warehouse receipts allow small-scale farmers to delay the sale of goods, allowing them to take advantage of large seasonal price swings for produce while obtaining cash when the harvest begins.

◆ Price transparency: A side effect of the warehouse system is that farmer groups work together with the warehouse operator to establish prices based on the product’s market value. This empowers farmers by providing them with up-to-date information on prices throughout the season. The farmers gain additional knowledge about current prices and can become “price setters” rather than “price takers.”

◆ Food security: Farmers can realise savings by “buying back” their produce from the warehouse for home consumption during the lean season when food prices are high.

Disadvantages

◆ Speculation: Warehouse receipts promote speculative activity on the seller’s part because the farmer tries to maximise profits by holding the produce until the price reaches its peak. Once the price peaks, the rush of additional inventories into the market causes the price to fall almost immediately. This practice may catch farmers with more than half of their inventory selling at the lowest, instead of the highest, price. The net effect is to substantially decrease overall profits.

◆ Shortage of small-scale drying or preservation technologies for agricultural products: This is especially true in rural areas, where the technology can be scarce or expensive; as a result, the stored product is at risk for spoilage, loss from pests, and quality depreciation.

◆ An unreliable supply or shortage of storage chemicals that are needed to preserve agricultural goods can decrease the farmer’s total volume of usable produce and compromise the product’s total value, thus decreasing the farmer’s ability to receive the best price for the produce.

◆ Dr Mugano is an Economic Advisor, Author and Expert in Trade and Competitiveness and Research Associate at Nelson Mandela Metropolitan University (SA) and Senior Lecturer in the Faculty of Commerce at Zimbabwe Ezekiel Guti University. Feedback: email:gmugano@gmail.com, Cell: +263 772 541 209.