The current debate about different rural-urban lending rates has its roots in the 1970s when commercial banks were, for the first time, involved in agricultural financing.

Earlier, a bank’s lending activities were almost entirely concentrated in financing trade and commerce along with lending to the government for procurement of certain essential commodities like wheat, rice and cotton.

The main purpose behind the policy shift was to make small farmers the chief beneficiaries of the monetary policy.

About 45 years ago, providing retail credit in small chunks to farmers in far-flung rural areas carried a more than ordinary risk. Therefore, the policy emphasis was on enhancing the quantum of credit to this neglected, but important, player of the economy. Cost considerations were left to be solved at a proper time.

Mandatory credit targets for agricultural production and the SBP branch licensing policy played a very positive role in this regard.

Mandatory credit targets helped divert the flow of available bank credit towards farmers. In case of failure, banks were forced to keep the undisbursed amount with the SBP (without any remuneration) till provision of the remaining loan amount.

Through the branch licensing policy, the SBP linked the opening of new urban branches with the opening of branches in far-off rural areas.

In the eighties, loans for small farmers were made interest-free where the federal government used to provide a subsidy of 10pc to commercial banks as against the conventional market lending rates of 14pc.

All banks being state-run, the question of cost of rural credit became a zero sum game, paying a subsidy on one hand and getting a profit from banks on the other.

Banks consider agricultural financing as cumbersome and small farmers as sub-prime borrowers

With the dawn of the 21st century almost all mainstream banks (except the NBP) were denationalised and the SBP’s credit ceiling discipline was replaced by indirect monetary control. Under a market-based banking system, rationalisation of deposit and lending rates was supposed to take place in line with importance banking services for different users.

Due to the 9/11 incident, there was a flux of excess liquidity in the banking system which adversely affected the country’s interest rate structure. Conventional lending rates tumbled to 4-5pc whereas the export finance rate fell to 3pc.

In subsequent years, the SBP invented a yield curve, known as the Karachi Inter-Bank Offered Rate (KIBOR), to be used by banks for pricing their products. However, the cost of rural credit remained unchanged because banks kept financing the rural sector at more than 10pc.

After 5-6 years, when interest rates rose once again, banks immediately increased the agricultural credit rate to 18pc.

In 2017 we see a repetition of this pattern, the SBP policy rate is below 6pc and KIBOR, for the three months to around a year has been around 7pc, but poor farmers are still getting accommodation from banks at 14 to 16pc.

It seems that despite doing so for a period of around 45 years, banks still consider agricultural financing as cumbersome and small farmers as sub-prime borrowers.

Even a small farmer, who has never delayed or defaulted in any loan instalment during a decade long banker-customer relationship, has to pay the same high cost for getting a loan of a few hundred thousand.

The above attitude of banks is not understandable when they are mobilising a larger part of their very low cost deposits from rural areas.

Cost of funds for consumers and micro borrowers are even higher. Consumer loans generally carry an interest rate in the range of 18 to 20pc whereas micro finance — largely meant for weaker sections of the society — are provided loans at 22-24pc.

For on-line transfer of money, through banks or by third party service providers like Easypaisa, Mobicash etc, much higher rates are being charged as against a very negligible actual cost.

The quantum of agricultural credit increased from around Rs300bn in 2003-2004 to Rs600bn in 2017, yet the central bank did not consider it worthwhile to take up the issue of cost of rural credit.

The SBP’s Quarterly reports and periodic banking sector reviews are almost silent about this important national issue.

It is very important to mention here that Rs600bn of rural finance caters to around one-third of total annual credit requirements of the rural sector. Farmers are forced to get around one trillion rupees from the informal sector consisting of shop-keepers, commission agents and local money lenders at rates much higher than those of commercial banks.

This perpetual neglect has adversely affected the country’s rural life which manifests itself in a number of ways: much lower cotton production, delayed payment to sugarcane growers and the frustration of farmers trying to avail the current Kissan Package.

At a time when the issue has been echoing in the parliament, a great deal of pro-activity is required from the autonomous State Bank. A two-pronged policy is needed to resolve the long- cherished agenda of rural development.

Since banks are working in a market-based environment, they may first be asked to rationalise the pricing of agricultural credit. In case of non-response, the SBP should again resort to mandatory credit targets regime. And such targets should not only mention the quantum of credit but also the rate at which these funds are to be provided to the farmers.

munir9511@outlook.com

Published in Dawn, Business & Finance weekly, February 13th, 2017