Interest rate arbitrage on farm loans

Take an agri loan at four per cent and keep the money as a fixed deposit in the same branch at nine per cent interest rate — that's the mantra for some of the branches of scheduled commercial banks in the south.

The interest rate arbitrage works like this. A farmer avails an agri loan at the subsidised interest rate at four per cent and deposits the same amount in the same branch at a higher interest rate of 8.5-9 per cent. It's a perfect win-win situation: while the farmer earns the difference in interest, the bank also manages higher liquidity, apart from meeting the priority sector lending target as mandated by the Reserve Bank of India (RBI) for funding agriculture activities.

RBI has not yet drafted any guidelines for the end-use of the fund borrowed by farmers due to an assumption that the agri loan would be used for buying seeds and fertilisers. Both bankers and farmers take advantage of this loophole and make book entries under which money is lent to farmers just on paper, thereby avoiding the risk of default.

“This practice was driven by compulsions of meeting the target for agriculture credit. It works for the benefit of both bank and borrower. Money is safe (coming back as deposit), but there is very limited benefit for actual farming operations,” said a senior official at a public sector bank.

Under the interest subvention scheme, the government gives short-term farm loans, which carry an interest rate of seven per cent. But, the advantage here is a three per cent interest subvention scheme for farmers who repay their loans on time. Thus, with this scheme, the effective interest rate comes to around four per cent. Banks, meanwhile, adopt many strategies to meet the priority sector lending target every year.

Looking at the amount involved, the ongoing practice has raised many eyebrows. The finance ministry in the last annual Budget increased the target for subsidised agriculture credit to Rs 575,000 crore. “Even if we assume a very conservative estimate of 10 per cent of these being misused and diverted for a purpose beyond agriculture, the figure comes to a mammoth Rs 57,500 crore,” said a banking sector analyst. RBI has also said there was a possibility of subsidised agriculture credit being diverted for non-agricultural purposes.

The interest rate arbitrage, according to banking sources, is prevalent in Kerala, Andhra Pradesh, Tamil Nadu and Karnataka.

A senior official said no bank branch was insisting on deposits from the proceeds of loans granted to them. Farmers are free to keep deposits from their own sources/surplus and withdraw the same according to their requirements, he added. In case of agri loans, the borrower has to prove himself a farmer by showing his passbook or any other proof.

With the way the scheme is being misused, stern measures cannot be ruled out to put a curb on this practice, analysts said.