Banking on commodities: Banks can enable development of markets

Published: April 19, 2019 12:36:20 AM

Between Independence and now, though, markets have got transformed, and ICT initiatives and various other infrastructural and legal initiatives have further emerged to safeguard the interests of stakeholders.

India’s commodity sector has, likewise, benefitted from bank financeIndia’s commodity sector has, likewise, benefitted from bank finance

By V Shunmugam & Debojyoti Dey

When the Ohio-based Huntington Bank, established in 1866, decided to diversify its product offerings in 2012, it had only to look at the opportunities available in its backyard—the vibrant commodity markets of the US Midwest. In the event, the bank started not only speciality initiatives in energy, food and agribusiness, but also launched commodity hedging services to help its customers succeed in the global markets. Today, Huntington is counted as one of the most successful banks, with matching metrics of operational performance and equivalent valuation comparable to that of the largest American banks. In India, banks have traditionally been one of the most significant players in financial markets, enabling and controlling the flow of finance to the real sectors while connecting money to the financial markets. India’s commodity sector has, likewise, benefitted from bank finance—whether through crop loans at mandated below-market rates; business finances to those in the mining and metals segment; finance for creating infrastructure for storing, quality testing or transporting commodities; funding the production, procurement, refining, value addition, or financing commodities though pledge including the gold pledge.

Thanks to the section 8 of the Banking Regulation Act, 1949, our banks have been, since Independence, saved from the vagaries of financing commodities and having to end up dealing with the dilapidated ways of functioning of the opaque markets for commodities. Between Independence and now, though, markets have got transformed, and ICT initiatives and various other infrastructural and legal initiatives have further emerged to safeguard the interests of stakeholders. This is one of the key reasons the Essential Commodities Act, which safeguarded consumers against hoarders, has been sparingly used in the recent years, ably aided by the open trade policy adopted at the start of the 21st century. Further, legal codes such as Warehousing Development and Regulation Act, and institution of WDR Authority (WDRA), have been brought into being—not only to safeguard the interests of commodity stakeholders but also to make the electronic-Negotiable Warehouse Receipts (e-NWRs) issued by the Electronic Repositories under the regulatory supervision of WDRA safe, pledgeable electronic instruments. Coming into being of e-NWRs not only makes commodities underlying them loan-worthy but also protects the bankers from the misdeeds of the paper era. It is a different story that WDRA approved warehousing is just about 4.5% of total available warehousing capacity for agri/horticultural products. In fact, the total value of issued e-NWRs during FY19 accounts for a negligible portion of the total amount of the banks’ exposure to commodity lending. Ignorance is not only no bliss for growth of regulated warehousing capacities, but also retards the development of the commerce behind storage capacity. A well-developed storage infrastructure, backed with funding of stored commodities, would have gone a long-way to contribute to a well-developed forward curve for commodities, leading to efficient decision making by borrowers.

Compared with a decade ago, greater efforts have been made by exchanges, regulators and government institutions to make prices transparent. Though, the quality of products sold is a missing dimension of the prices disseminated, it would help lenders protect their credit risk effectively—thus making commodities a clearly bankable product. Growth of collateral management agencies and related activities provided by the warehousemen is a clear boon to the lenders, improving the bankability of commodities. Further, with the adoption of the Model APMC by almost all the states, the monopoly of the APMC mandis and their registered traders is a thing of the past. It makes disposal of commodities behind defaults or the e-NWRs seamless through a standard process acceptable to the regulators and wins the trust of the participants. Healthy financing of commodities sector will go a long way in aiding businesses efficiently fund their working expenditure needs, and improve their competitiveness.

Besides, like their developed economy counterparts, banks can also help the commodity market stakeholders effectively hedge their commodity risks and thus reduce the risk of these businesses ending up as NPAs. A Working Group (2017) of RBI had, for instance, recommended that banks offer customised hedging products to their borrowers exposed to commodity risks, while taking back-to-back positions on commodity exchanges. If the same can be taken forward, it will ease the hedging process for the commodity businesses and could lead to effective adoption of risk management culture amongst commodity businesses. With banks participation, there could be higher coverage of commodities as banks can enable development of the markets by bringing in assistance on various other aspects of market development such as bringing in hedgers and hand-holding them, providing participants with independent market research, customising hedge instruments as per the risk profile of the participants with back-to-back hedge on the exchange platform. An offshoot of the activity of making available research reports could be setting up of an advisory desk with the knowledge of commodity markets and trade for banks. In fact, RBI has already asked banks to advise their clients to hedge their agricultural commodity price risks. Taking a cue from this, banks can also start a full-fledged commodity advisory desk, consulting clients on hedging or investment strategies. The Indian commodity derivatives market is currently undergoing path-breaking transformation, focussed on institutionalisation of the markets, widening of participation, enriching the product profile, strengthening intermediation, etc. Such a transformation opens up opportunities for the banking sector in terms of diversifying product/service portfolio. Policy initiatives such as ‘Make in India’ and increasing per capita income levels are likely to make the country commodity-intensive as the manufacturing sector shifts its production base, to cater for increasing domestic consumption besides serving the export demand. Sustenance of such a transformative policy measure is dependent on the opportunities available for adoption of global best practices by the investors. Banking sector handholding them and serving them with products that best suits their hedging needs with a back-up on the existing exchange traded commodity derivatives will go a long way in inculcating risk management as culture.

Shunmugam is Head, and Dey is AVP, Research, MCX. Views are personal

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