Banks provide a number of credit facilities to customers engaged in activities related to agriculture. Many a time banks take the brunt when unforeseen disaster strikes the farmers in the form of ‘on-farm loss’ and or ‘off-farm losses. These types of losses caused mainly due to production risk and price risk. The risk management in agriculture involves choosing among alternatives that mitigate financial effects that can result from such uncertainties.
Production risk: on-farm risks like famine; flood, extreme weather, disease, pests, and other factors affect both the quantity and quality of commodities produced.
Price risk: off-farm risk refers to uncertainty about the prices producers will receive for commodities or the prices they must pay for inputs. The nature of price risk varies significantly from commodity to commodity.
Production risk mitigation: Using ring gun sprayer for combating unexpected drought, (the ring gun sprayer saves water, as well as washes away pests and insects),air blowers to fight against frost, timely spraying of pesticides, are the some of the methods used by farmers to mitigate the on-farm risks. As a strategy to reduce the on-field risk, many farmers try on diversification of their crop and livestock productions, which basically helps a farm to compensate loss of one activity by another activity.
Price risk mitigation: One of the prominent, albeit indirect, risks in agricultural sector is that of volatility in agricultural commodity prices. This risk is more noticeable in cases where large agricultural borrowers do not hedge the underlying agri-commodity price risk which could negatively impact such borrowers and the banks. The hedging can be through agri-commodity derivative products available on recognised exchanges in India. There is the need of creating awareness among the agriculture borrowers about the suitability and appropriateness of using various hedging tools so that they can take an informed decision. Currently, hedging tools including derivatives are available in the Indian market, but these are not being used extensively due to lack of awareness of the products or their inherent complexity. The informed decision on the availability and use of these instruments will reduce the scope of mis-selling of derivatives. Banks have to keep the sophistication, understanding, scale of operation and requirements of their agri-borrowers in mind while advising them on the availability and use of these instruments.
The most important strategy however is agriculture insurance. The insurance company will be able to calculate the probability of a loss in order to come up with a premium rate. This way, the individual farm owner doesn’t have to take the full brunt of the loss should an unforeseen disaster strike.
- How agriculture insurance helps farmers on crop losses?
- What is hedging of Agri-Commodity Price Risk?