An Intermediary Mechanism to help FPOs raise Blended Finance
Co-operative based institutions have in general struggled to raise debt finance from banks in their initial years; and this has been the experience of FPOs too. FPOs that were formed in the early years after the introduction of the Producer Company amendment to the Companies act in 2002, struggled to find lenders, since most lending institutions did not know what an FPO was. Today, the situation may have eased a bit, with the emergence of lending institutions such as Samunnati and Nabkisan that specialize in lending to FPOs, however banks still remain reluctant. Multiple anecdotes from stakeholders in the FPO sector indicate that banks in general are reluctant, despite supportive government schemes such as the credit guarantee under CGTMSE, loan subsidies under PMFME and interest subventions under AIF.
Loans from banks are important for being cost competitive. Rates offered by NBFCs tend to be high (ranging between 12–15% p.a.); which eat into trading margins in the short term, and increase the interest load in multi-year project finance. As against this, loans from a commercial bank can come at average rates of 9%. Clubbing this with AIF and PMFME (for project finance requirements) can further reduce this interest load. However, reluctance from banks may lead to either rejection of proposals or significant delays in processing, with need for considerable follow up. There clearly is a key gap in project financing of FPOs; which is inhibiting effectiveness of FPOs to raise crucial finance from the market. An intermediary mechanism may be an answer to this problem.
The genesis of this idea is in a project that this author was part of in Central India. Among multiple components of the project, a key element was helping an FPO set up a medium sized millets processing unit. The unit was set up at a total cost of approx. Rs 35 Lakhs. The processing unit was financed via a grant of Rs 10 Lakhs from a prominent GoI Development institution, and supplemented with a Rs 18.4 Lakh loan under the Agriculture Infrastructure Fund (AIF) of Government of India; the balance funds were invested by the FPO. Project finance for this unit was structured through a blended finance approach; through a blend of a Grant and a commercial loan (from a prominent pvt. sector bank under the AIF facility). The loan was provided against a credit guarantee under the CGTMSE scheme; which was another element in the blend. The Turn Around Time (TAT) for the entire project was approx. 1.5 years; which included about 10 months for sanction. The sanction also required considerable personal follows ups by the various partners involved in this project.
Some of the key reasons why it seems the bank took such a long time to sanction were as follows.
1. Lack of Familiarity. Discussions indicated that bank personnel appraising the loan were unfamiliar with the FPO as an institution and also sceptical of the latter’s ability to repay the loan.
2. Lack of pre-defined assessment metrics and precedents. The banks also struggled with a lack of pre-defined assessment metrics for FPOs and precedents; that would have enabled an assessing officer by laying out the complete context.
3. Small Ticket Size. At Rs 18 Lakhs, the small ticket size evinced little interest from the bank; which was why it was probably put on low priority.
As indicated earlier, the above loan was sanctioned after a considerable amount of personal time spent by the project partners in follow up. Much of this time went into making the bank personnel understand the FPO context, facilitating a realistic assessment of the risk involved and building a solid case for mitigation measures.
We realized then that there is a need for an institutional mechanism to help promising FPOs raise project finance from banks at competitive rates. This institutional mechanism needs to help FPOs develop the right blended capital structure for financing their projects, reduce TAT for loan processing and also help FPOs with making compelling applications so as to increase the success rate.
A Blended Finance intermediary is a concept that could help make financing of FPO projects smoother. The intermediary is visualized as an organization working on a success fee basis. Such organizations would typically undertake the following activities.
1. Develop a pool of potential funders — grant, debt and credit guarantee providers — who are willing to finance promising FPO projects
2. Aggregate multiple promising FPO projects to develop a high potential pool with a collective financing ticket size that is substantial enough to attract financers (Grant + Debt).
3. Support constituent FPOs with designing capital structure for their projects; develop business plans and pitches as well as facilitate legal vetting (where required).
4. Oversee the process end-to-end to ensure final flow of funds.
However, to set the above mechanism rolling, considerable amount of ground work will be required. There is a need to set up successful precedents (at some scale) for banks and donors to use as a reference point. For instance, the first 10 projects successfully financed (although with high time and effort involvement initially) would help set the right context for financers to benchmark against; and make the process smoother for subsequent project applications. Another task would be to develop a solid FPO assessment framework and educate bankers on the same. Such an assessment framework is expected to be on the lines of credit rating frameworks developed for corporates, MSMEs and Micro-Finance institutions. They would develop a basis for bankers to benchmark a loan applicant FPO and evaluate them. Similar context setting would have to be done with donors and agencies providing credit guarantees. The entire exercise would also need a systematic communications and outreach plan to on-board major stakeholders — both Government and non-Government — who can give it scale.
The proposed mechanism aims to make it easier for FPOs to raise project finance in a way that is inherently self-sustaining. Anecdotes indicates that many promising projects suffer due to lack of timely finance; while at the same time, many pools of funds meant for FPOs struggle to find good financing options. This is particularly true where potential projects are highly localized in nature and conceived at the grass roots, and who struggle to communicate their value proposition to funders. This mechanism not only promises to bridge this very important gap but also set up a self-sustaining mechanism for the future.
