3. METODOLOGÍA
3.2 Materiales e instrumentos de investigación
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UNIT 5 ACQUISITION OF CAPITAL AND
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equity. The leverage will be higher on the farms using more and more of non-equity capital. As the leverage stands higher and the farmers get expected returns, it contributes to the prosperity of the farm business.
The non-equity capital is productive, when everything goes right on farms, but it is equally destructive when the farmer‟s expectations go topsy-turvy. The borrowed capital which earlier brought prosperity to the farmers now spells doom.
Statement of the principle
As the debt-equity ratio or leverage increases, the borrower runs a greater risk of losing owned capital. This principle is clearly explained with the example presented in Table 16. Before that, we should state the formula of percentage of equity.
Percentage of equity = x100
capital borrowed
capital Owned
capital Owned
We can consider five farms with an identical owned capital of N5,000 each. Apart from farm A, the other four farms have borrowed an amount of N2,500, N5,000, N7,500and N10,000 respectively. Consequently, the total capital available with A, B, C, D and E farms will exhibit an increasing trend. Assuming a 15 per cent uniform gain on all the farms, the resultant profit would be N750, N1,125, N1,500,N1,875, N2,250 on the corresponding farms.
After paying the interest to the lending agency, owned capital increased in ascending order for the respective farms in question. The percentage gain on owned capital too, exhibited a similar trend. Now let us assume that there is a 15 per cent loss uniformly on the five farms. Analogous to the profit trend, the loss calculated too reveals an increasing trend on farms A,B, C, D, and E respectively. The position of owned capital after the loss resulted in progressive decline leading to increased percentage loss on owned capital on the above farms. An overview of the particulars in Table 16 infers that, as the borrowed funds increase the percentage of equity gets reduced under the condition of losses. No doubt borrowed capital is productive as long as there is no setback, but in the context of any eventuality, it is equally destructive to the farmer.
This amply demonstrates that credit is a double edged knife and hence the requisite amounts only, need to be borrowed by the farmers.
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3.2 Procedural Formalities In Sanction of Farm Loans
The financial bank is vested with the powers either to accept or reject the farmer‟s loan application. This is sequel to an objective appraisal of farm credit proposals and procedures and formalities followed in the processing of loans. Here an attempt is made to explain the set of procedures and formalities required in processing a farm loan application. The processing procedure is detailed under the following sub-heads:
1. Interview with the farmer;
2. Submission of loan application by the farmer;
3. Scrutiny of records;
4. Visit to the farmer‟s field before sanction of loan;
5. Criteria for loan eligibility;
6. Interview with the farmer;
7. Submission of loan application by the farmer;
8. Scrutiny of records;
9. Visit to the farmer‟s field before sanction of loan;
10. Criteria for loan eligibility;
11. Sanction of loan;
12. Submission of requisite documents;
13. Disbursement of loan;
14. Post-credit follow-up measures; and 15. Recovery of loan
Table 16: Principle of Equity and Increasing Risk
S/No Items
FARMS
A B C D E
1 Owned capital (equity capital) (N)
5,000 5,000 5,000 5,000 5,000
2 Borrowed capital (non-equity capital) (N)
- 2,500 5,000 7,500 10,000
3 Owned +
borrowed capital (Total capital) (N)
5,000 7,500 10,000 12,500 15,000
4 Leverage ratio 0 0.5 1.0 1.5 2.0
5 Gain @ 15% on total capital
750 1,125 1,500 1,875 2,250
6 Interest to be paid to the
Institutional agency @ 12%
- 300 600 900 1,200
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7 Owned capital @ at the end of the year (N)
5,750 5,825 5,900 5,975 6,050
8 Gain on owned capital in %
15.0 16.5 18.0 19.5 21.0
9 Loss @15% on total capital
750 1,125 1,500 1,875 2,250
10 Interest to be paid to the
Institutional agency @ 12%
- 300 600 900 1,200
11 Owned capital at the end of
the year( N)
4,250 3,575 2,900 2,225 1,550
12 Loss on owned capital %
15.0 28.5 42.0 55.5 69.0
3.2.1 Interview with the Farmer
A banker studies the farmer-borrower in the interview regarding his credit characteristics such as honesty, integrity, frankness, progressive thinking, indebtedness, repayment capacity, etc. The banker explains to the farmer the terms and conditions under which the loan is going to be sanctioned. Interview helps the banker to understand the genuine credit needs of the farmer. So interview is more than a mere formality, as it facilitates the banker to study the farmer in detail and assess his credit requirements.
3.2.2 Submission of Loan Application by the Farmer
After getting satisfied with the credentials of the farmer, the banker gives a loan application form to him. Details regarding the location of the farm, purpose of the loan, cost of the scheme, credit requirements, farm budgets, financial statements, etc, as required in the form are filled in by the farmer. Certificates indicating ownership of the land or title deeds and statement showing cropping pattern adopted by the farmer-borrower, farm map and passport size photograph is affixed to the loan application form.
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3.2.3 Scrutiny of records
The ownership and extent of land as indicated in the relevant certificates are verified by the bank officials with village or clan heads and other appropriate authorities.
3.2.4 Visit to the Farmer’s Field before Sanction of Loan
After verifying the records the Field Officer of the bank pays a visit to the farm to verify the particulars given by the farmer. The pre-sanction visit is expected to help the banker to identify the farmer and guarantor, locate the boundaries of land as per the map and assess the managerial capacity of the farmer in farming and allied enterprises and the farmer's attitude towards latest technology. Details on economics of crop and livestock enterprises, feasibilities for implementing proposed plans, farmer's loan position with the non-institutional sources are ascertained in the pre-sanction visit. Thus, pre-sanction visit of the bank officials is very important to verify credit-worthiness and trust-worthiness of the farmer-borrower. While appraising different types of loans, different aspects should be verified. For example, to advance 1oan for bore hole and wash bowl digging, the location of the proposed bore hole, ground water availability, distance from the nearby borehole, rainfall, command area of the well, etc., are verified in the pre-sanction visit.
Similarly, for other loans, the pertinent aspects are verified. All these aspects are included in the report submitted to the Branch Manager for taking up final decision in the sanction of the loan.
3.2.5 Criteria for Loan Eligibility
The following aspects are considered in judging the eligibility of a farmer-borrower to receive loan.
(a) He should have sound character and financial integrity,
(b) His dealings with friends, neighbors, financial institutions, etc., must be proper (He should not be a defaulter in the past),
(c) He must have progressive outlook and be receptive to modern technology,
(d) He should sincerely implement the proposed scheme and ensure proper use of credit,
(e) The security provided by the farmer must be free from any sort of encumbrance and litigation.
3.2.6 Sanction of Loan
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After examining all the aspects presented in the pre-sanction farm inspection report, the Branch Manager takes a decision whether to sanction the loan or not. Before sanctioning, the Branch Manager considers the technical feasibility, economic viability and bankability of proposed projects including the repayment capacity, risk-bearing ability and sureties offered by the farmer-borrower. If the loan amount is beyond the sanctioning power of the Branch Manager, it is forwarded to the Regional Manager or Head office of the bank, incorporating his recommendations. The authorities at the respective offices take the final decision on the proposed projects, and communicate their decision to the Branch Manager for further action.
3.2.7 Submission of Requisite Documents
After sanctioning the stipulated amount to the farmer-borrower, some further documents are obtained like guarantors letter and mortgage deeds. Title deeds are examined by the legal officer of the bank and his opinion with regard to clear, marketable and unmitigated title is sought.
Simple mortgage is followed in the case of acquired property and equitable mortgage or registered mortgage in respect of ancestral property. However, the opinion of the bank‟s legal officer is obtained in this regard. Mortgage of land is done prior to obtaining non-encumbrance certificate and sanction of loan.
3.2.8 Disbursement of Loan
As soon as the execution of documents is completed, the loan amount is credited to the borrower‟s account. The loan amount is disbursed in a phased manner, that too after ensuring that the loan is used by the farmer-borrower properly. A realistic repayment plan is framed and given to the farmer keeping in view the income flow of the proposed project.
3.2.9 Post-credit Follow-up Measures
The Branch Manager or Agricultural Officer pays a visit to the farmer to ascertain the proper use of the credit. This also benefits the farmer, for, they can get the technical advice if any needed from the Agricultural Officer in the implementation of the scheme. These visits are also meant for developing a close rapport between the farmer and the banker. These visits are more informal than formal, which are supposed to inculcate the feeling of friendliness and underlying the obligation of the farmer to repay the loan when it falls due. Such visits also facilitate in assessing any further requirement of supplementary credit to complete the scheme.
3.2.10 Recovery of Loan
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The bank reminds the farmer-borrower in advance about the repayment of loan in time. If needed, special drives, village meetings, etc. are organised at an appropriate time. All appropriate measures are taken to persuade the farmer-borrower to repay the loan in time. In the case of failure, the reasons for the same are ascertained to find out whether the borrower is a deliberate defaulter or not. If the reason is genuine, the borrower is further helped by extending finance to accelerate farm production. In such situations, a closer supervision is necessary. If the bank officials find that the borrowers are willful defaulters stringent measures are initiated to recover the loans through court of law. In all possible cases the bank officers make tie-up arrangements, i.e. the recovery of the loan is linked with marketing. Re-phasing of repayment plan is allowed in the case of justifiable cases.
3.3 Repayment Plans
For term loans which are characterized by partially liquidating nature, the loan repayment plan is not as similar as that of short term loans.
These loans are recovered through a given number of installments depending upon the nature of asset and the amount advanced for the asset in question. Various repayment plans in vogue are listed and briefly explained here.
(i) Straight-end payment plan or single repayment plan or lump sum repayment plan;
(ii) Partial repayment plan;
(iii) Amortized repayment plan;
(a) Amortized decreasing repayment plan;
(b) Amortized even repayment plan;
(iv) Variable repayment plan;
(v) Optional repayment plan; and (vi) Reserve repayment plan.
3.3.1 Straight-end Payment Plan or Single Repayment Plan or Lump sum Repayment Plan
The entire loan amount is to be cleared off after the expiry of loan period stipulated. More clearly in this method, the principal component is repaid by the farmer at a time in lump sum when the loan matures, while the interest component is paid each year.
3.3.2 Partial Repayment Plan or Balloon Repayment Plan
The farmer is expected to settle the entire loan amount in quarterly, half-yearly or annual installments (principal + interest). It implies that repayment of loan will be done partially over the years. Usually, the399
installment amount will be decreasing as the years pass by except in the maturity year (final year) during which the investment would have generated sufficient revenue for liquidation. Table 17 i1lustrates this.
Example: Loan amount N10,000 Time period 6 years Rate of interest 12%
This is also known as balloon repayment plan, as the large final payment is made at the end of the loan period following a series of smaller partial payments.
3.3.3 Amortised Repayment Plan
It is an extended version of partial repayment plan. Amortisation means the repayment of the entire loan amount in a series of installments. Here we have two types of amortisation plans, viz., amortised decreasing repayment plan and amortised even repayment plan.
Table 17: Partial Repayment Plan
Year Principal (N) Interest (N) Installment (N) Balance amount (N)
1 2 3 4 5 6
1,000 1,000 1,000 1,000 1,000 5,000
1,200 1,080 960 840 720 600
2,200 2,080 1,960 1,840 1,720 5,600
9,000 8,000 7,000 6,000 5,000
-Total 10,000 5,400 15,400
A. Amortised Decreasing Repayment Plan
In this repayment plan, the principal component remains constant over the entire repayment period, while the interest part decreases continuously.
With the principal amount remaining fixed and interest amount decreasing, the annual installment amount decreases over the years. The advance made for the purchase of machinery is one of the suitable examples under this category, for the machinery does not demand much repairs in the initial years of loan payments enabling the farmer to repay a large amount of installments in the initial years. The diagrammatic representation of the repayment schedule is shown in Figure 25.
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Principal + Interest Principal
Figure 25: Amortized Decreasing Repayment Plan
1 6
Year
The arithmetic calculation of the plan is embodied in Table 18.
Example: Loan amount N10, 000
Time period 6 Years Rate of interest 12%
Table 18: Amortised Decreasing Repayment Plan
Year Principal (N) Interest (N) Installment (N) Balance amount (N) 1
2 3 4 5 6
1,666.67 1, 666.67 1, 666.67 1, 666.67 1, 666.67 1, 666.67
1,200 999.99 799.99 600.00 399.99 199.99
2,866.67 2,666.66 2,466.66 2,266.67 2,066.66 1,866.67
8,333.33 6,666.67 5,000.00 3,333.33 1,666.67
-Total 10,000.00 4,199.96 14,199.96
B. Amortised Even Repayment Plan
This is called equated annual installment method. The annual installment over the entire loan period remains the same in this method. The principal portion of the installment increases continuously, while the interest part declines gradually. This
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method is mostly adopted for term loans. Loans granted for farm development, digging of wash bowls or bore holes, dairy, poultry, etc., are the examples. This is depicted diagrammatically
in Figure 26.
P ri nc ip al + I nt er es t
Principal Interest
Figure 26: Amortized Even Repayment Plan
1 6
Year
The annual installment is arrived at through the formula given below:
i n
B i
I
) 1 ( 1 Where,
I = Annual installment in N
B = Principal amount borrowed in N n = Loan period in years
i = Annual interest rate in fraction The plan is shown in Table 6.8
Example: Loan amount N10, 000 Time period 6 years Rate of interest 12%
i n
B i
I
) 1 ( 1
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) 6
12 . 0 1 ( 1
12 . 000 0
,
10
)6
12 . 1 ( 1 1
12 . 000 0 , 10
= 10,000 x 0.243225 = N2, 432.25
Table 19: Amortised Even Repayment Plan Year Installment
(N)
Principal (N) Interest (N) Balance amount (N) 1
2 3 4 5 6
2,432.25 2,432.25 2,432.25 2,432.25 2,432.25 2,432.25
1,232.25 1,380.12 1,545.73 1,731.22 1,938.97 2,171.64
1,200.00 1,052.13 886.52 701.03 43.28 260.61
8,767.75 7,387.63 5,841.90 4,110.68 2,171.71
-Total 10,000.00 9,999.93 4,593.57
3.3.4 Variable Repayment Plan
As the very name indicates, various levels of installments are paid by the borrower over the loan period. In times of good harvest a higher installment is paid, while in periods of low yield lesser amount is credited towards installment to the lender. According to the convenience, the borrower effects the repayment. This method is not found with institutional borrowings.
3.3.5 Optimal Repayment Plan
In this method provision is made for the borrower to make payment towards the principal amount in addition to the regular interest annually.
3.3.6 Reserve Repayment Plan or Future Payments
This type of repayment is made by the borrowers in areas which are subject to high income variability of farms. The impending problem here is that the farmers are haunted by the fear that they may not be able to keep up their promise of repaying crop loans or installments towards
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term loans at scheduled time. To overcome such situations, the farmers make advance payments of the loan realised from the savings of the previous year. The farmer is not a looser in this transaction by any means since he is paid interest at the rate charged on the loans for the advance amount credited. This type of repayment is advantageous to the banker as the institutional agency need not worry regarding loan collection during the periods of crop failure. The farmer too gains here as he can keep up his integrity in credit transactions.
SELF-ASSESSMENT EXERCISE
i. Explain the set of procedures and formalities required in processing a farm loan application
ii. For a loan of 20,000 naira with 6 years repayment period at 10%
rate of interest complete the amortised decreasing repayment plan
4.0 CONCLUSION
You have learnt about the principle of owner‟s equity and increasing risk, procedural formalities in sanction of farm loans and repayment plans.
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5.0 SUMMARY
You have learnt that the principle of owner‟s equity hinges upon the fact that the risk in farming tends to increase at an increasing rate, as the owner‟s equity decreases.
Leverage is the ratio of debt to equity which becomes higher on the farms using more and more of non-equity capital. As the leverage gets higher with more borrowed capital, the farmer gets expected returns and the prosperity of the farm business increases. But if the farmer incurs losses, the effect is destructive.
Therefore credit is a double edged knife and hence the requisite amounts only, need to be borrowed by the farmers.
In this unit you have also learnt the set of procedures and formalities required in processing a farm loan application.
You have also learnt the various repayment plans in vogue particularly:
Straight-end payment plan or single repayment plan or lump sum repayment plan;
Partial repayment plan;
Amortised decreasing repayment plan;
Amortised even repayment plan;
Variable repayment plan;
Optional repayment plan; and
Reserve repayment plan.
6.0 TUTOR-MARKED ASSIGNMENT
1. Credit is a double edged knife. Discuss.2. What is amortisation?
3. For a loan of 20,000 naira with 6 years repayment period at 10%
rate of interest complete the amortised even repayment plan
7.0 REFERENCES/FURTHER READING
Nelson, A. G. & Murray, W. G. (1968). Agricultural Finance. USA:
Iowa State University Press.
Olukosi, J. O. & Alamu, J. F. (2013). Introduction to Agricultural Finance: Principles and Applications. Nigeria: Great Glory Publishers.
Reddy, S. S. & Ram, P. R. (2004). Agricultural Finance and Management. New Delhi: Oxford & IBH Publishing Co. PVT.