How to include small-scale fisheries into financing schemes: Exploring the use of inventory credit mechanism Frida Youssef commodity risk management and finance United Nations Conference on Trade and Development LINKS BETWEEN ARTISANAL FISHERIES AND WORLD MARKETS The Gambia, 11-12 April 2002
The source of finance are generally either, semi-formal (credit unions, cooperatives, etc.) informal or formal
Relatively easy to obtain
Devoid of administrative delays,
Non-insistence on security/collateral
Flexibility built into repayment programmes.
However, they have limitations
Size of the loan
high interest rates.
1. SOURCE OF FINANCE
Difficult to obtain
Insistence on security/collateral
Stringent terms and repayment programmes.
However, they have advantages
Size of the loan
May lend at regulated interest rates.
Exploring the relevance of inventory credit / Warehouse receipt finance: shifting the risk
Inventory credit is lending secured against inventories of storable commodities of any kind, which may be agricultural or fisheries products, frozen foods, building materials, minerals, metals etc.
When there is not enough capital or security to guarantee access to credit (or when a borrower cannot access credit based on the strenght of his balance sheet and track record) , another alternative will be the use of commodity as a n accpetable collateral for a loan , provided that all technical barriers are mitigated to secure the quality and quantity of the commodities.
The objectives are to:
Lower transactions costs
Improve loan recovery
When there is not enough capital to guarantee access to credit Lending may be based against the use of the commodity as a collateral
What is Inventory Credit ?
From the point of view of the borrower it has the following uses:
I t can be used to finance storage and transactions as commodities move through a marketing chain from producer to consumer. This is particularly significant in import and export trade where it may be used for pre-export or post-import financing, or ‘structured finance’ deals involving various forms of collateral.
It can be used by farmers, fishermen, and others to finance storage of commodities subject seasonal price variations. Fishermen can use it to increase their bargaining power in the marketing chain. Processors, can use it to finance stocks required during the year.
What is Warehouse receipt ?
A bank may simply advance funds to a customer against a borrower’s assignment of some commodities, but generally speaking it will prefer to lend against documents called ‘warehouse receipts’ or ‘warehouse warrants’, issued by the warehouse operator against goods deposited in the warehouse. Warehouse receipts may be:
non-transferable (beyond the person to whom they were originally issued),
transferable or negotiable . Negotiability is a special case of transferability, where the local legal system treats the ‘a good faith transferee’ as having ‘good title’.
WAREHOUSE FINANCIAL INSTITUTION Producer/ trader Loan W. Receipt W. Receipt Deposit Attornment agreement
Mechanism of inventory credit
There are 3 parties to a commercial inventory credit scheme:
The borrower, who use to produce a security for a loan.
The lender, usually a bank, which is looking for a relatively secure way to lend its funds and expands its clientele.
The warehouse operator, third party, which maintains the produce in goods conditions and assures the lender that the collateral is secure. The warehouse operator will hold the commodity in a warehouse or possibly that is either owns or leases from another property. The borrower is charged a fee to cover the cost of warehouse rent, managing the commodity and insuring it against fire and other risks.
Borrower Warehouse Operator Lender
The relevance of warehouse receipts (2): The asset conversion cycle Commo- dities “ Paper” (e.g., warehouse receipts) Money Using warehouse receipt finance, the financier can then enter into a longer-term relationship with a client based on his asset-conversion cycle. The “commodities” that the client handles are, in a way, “turned into money” . And for this, they need to pass through a financial transformation - they need to be replaced by “paper” which represents the commodities, in other words, warehouse receipts.
The relevance of warehouse receipts (2): The asset conversion cycle Commo- dities “ Paper” (e.g., warehouse receipts) Money
Compared to traditional finance, this system has a number of major advantages.
Among other things, the financing can become revolving; and
the size of the financing becomes an automatic function of the value of the commodities and the client’s accounts receivable - important in the commodity sector, where prices are highly volatile.
Technoserve Ghana : Helping Producer Groups succeed - 1989
In advance of harvest, Technoserve staff/farmers assess how much group members intend to store and for which they require credit. Using these storage projections, a credit facility is arranged with a lending institution. After harvest, the farmers treats the grains to meet previously determined quality standards in terms of moisture content, foreign bodies, and weight per bag before it is deposited in a designated community storage facility .
A receipt is issued by the collateral manager to the farmer/borrower who then presents the receipt to the lender for the release of the loan. The borrower is free to use the loan funds at his/her discretion.
The loans are given to the groups on behalf of members and the group disburses to individual members on pro-rata basis. As such, all members of a group are liable for any default.
Interest rates on the loans are the prevailing market rates with some flexibility.
WAREHOUSE FINANCIAL INSTITUTION Farmers/ borrowers Loan W. Receipt W. Receipt Deposit
The ministry of rural development: Pilot testing warehouse receipts in Rural Niger - 1998
In the first phase of the two-year pilot program, the ministry established warehouses located in the villages for product storage. It used a dual-key system, whereby one key was kept by the producer organization while the other was kept by MUTEC, the financial institution that provided the loans to the producer groups.
At the time of deposit, MUTEC assessed the goods and provided the producer groups with a receipt that established the quantity and quality of the goods deposited. Producer groups were then able to take out a MUTEC loan that was equivalent to the harvest price of the deposited goods, up to 1.7 million FCFA (US$2,833). When the loan were disbursed, the group was required to save 500,000 FCFA (US$833) in a savings facility at the bank.
The loan term was typically five months, the length of time between the initial harvest and the estimated peak selling price. The producer groups paid an interest rate of approximately 15 percent on the full loan balance, including the amount they were required to save.
WAREHOUSE MUTEC Farmers/ borrowers Loan W. Receipt W. Receipt Deposit
An example of making a loan revolving - fish in West Africa The fisheries sector is one of the fastest expanding commodity sectors. In this case, a processor knew that if it could expand its supply, it had a ready market. The processor did not have its own fishing fleet, but relied on small fishermen. It found that in order to enable these to catch more fish, it should make it possible for the fishermen to go further offshore, for longer periods. This required fishermen to buy more diesel, for which they did not have the money... Lending cash to small, poor fishermen is risky. So instead, an international bank did not provide cash to the processor (for onlending), but diesel oil. This was put in a terminal controlled by a local bank. Individual fishermen had passbooks that allowed them to take diesel oil on credit. Reimbursement was through their sale of fish to the processor. This created a continuously revolving, easily administered credit scheme for the fishermen. The processor reimbursed through assigning a part of its proceeds from overseas fish sales.
Scope for using with fishery commodities Inventory credit can be used for any commodity that is storable for a significant period of time without quality deterioration of a kind which would have a major impact on product value. This excludes fresh fruits and vegetables, but allows for its use with frozen fish properly handled in cold stores, and some cured fish products. Where commodities of the same kind belonging to more than one depositor are stored in the same warehouse, they can either be stored as: (a) Separate lots belonging to individual depositors. This is known as ‘identity-preserved’ or IP storage), or (b) A commingled mass containing commodities belonging to various depositors. The parties to a storage and collateral management agreement will need appropriate and agreed means of assessing quality of the commodities at the time of intake and discharge from the store, and a means of rapidly settling quality disputes arising. One needs to avoid recourse to the Courts, which is normally costly and time-consuming (in a situation where commodity price fluctuations and/or contractual commitments to buyers call for quick decisions). Hence the normal system of dispute settlement is to refer the dispute to a third party or an arbitrator, capable of determining quality according to agreed procedures, and whose decision is final and will be upheld by the courts.
Requirements for successful implementation of inventory schemes
Warehouse operators should be reliable
A supportive legal framework
A conducive policy environment
The availability of reliable market intelligence
Sufficient scale to ensure financial viability
Along the West African coast, there are various sites where warehouses and cold stores might be established for the purpose of facilitating the provision of inventory credit and the issue of warehouse receipts against fishery products. It might be possible to establish a tailor-made regulatory régime for these sites. A feasibility study covering demand, technical, operational, financial and legal aspects, would be needed to establish feasibility or otherwise, and draw up an action plan for implementation. The suggested study would investigate different options, including less costly ones that would go along the lines of Ghana’s Agricultural Development Bank’s financing of stocks held in cold stores in Tema. According to information provided, the bank was financing stocks held in the borrower’s own cold stores. There was no official regulatory régime and international inspection companies were not involved. The bank oversaw the cold store operators directly, and on that basis were sufficiently confident to continue lending. The way forward?
For further information please contact: Frida Youssef Commodity finance, United Nations Conference on Trade and Development (UNCTAD) 1211 Geneva 10, Switzerland Tel. (41 22) 9075022/ 5755 / 5014 Fax (41 22) 917 0509 email [email_address] UNCTAD’s work in the area of commodity risk management and finance: - organizing international policy meetings on commodity risk management and finance. - reports, advice, training materials, training seminars and conferences on structured commodity finance, including warehouse receipt finance - reports, advice, training materials, and training seminars on commodity price risk management - advice to emerging commodity exchanges - advice to Governments on price risk management practices; use of modern financial instruments to support policy liberalization; and legal and regulatory structures affecting the use of risk management and structured finance markets.