Common Myths of Tractor Finance

Written Originally on June 12, 2017

“ What is Risk ? Can you define it for me ? “ was the question asked by a highly experienced panelist, to a boy with probably 1/4th his experience. As the boy went about beating around the bush, in an attempt to impress the panelists with his armoury of jargons and crafted lines… I began to wonder how I would have preferred to answer.

Here as panelists we were looking for clarity of thought, simplicity of expression and precision. It didn’t take us long to decipher we would not find we looked forward to find in our interviewee.

Yet the subject of Risk is a very interesting one.

 Risk is a combination of

1. The probability of a negative outcome

2. My ability to withstand the impact of that negative outcome (As a measure)

Let me just explain this using an example :

Company A, has a structure, wherein Sales and Collections are manned by different people for a particular product – let’s say – Tractor Finance.

Company B, has a structure, wherein Sales and Collections are vested in the same officer and he would be responsible for both.

Whom do you think would take higher risk and why ?

Yes, Of Course. Company A will be taking higher Risk.

History has shown that the model used by Company A would have :

1. Aggression in Sales

2. Quicker / Shorter Processes

3. Higher Arrears / Delays / NPAs / Write-offs

If you analyze a little more carefully, some portion of the effort in Aggression in Company A gets compensated for additional efforts that a person would take to ensure he/she doesn’t have problems in collections / repayment. Are we really talking Risk here ? No, we are talking about 2 models that companies adopted consciously keeping in mind their ability to withstand the outcome.

It is like Equity Vs Debt Investment. Can you call investments in Debt Plans bad ? Neither can you call Equity plans bad ! The answer is in striking the right balance that is comfortable to us. The right balance is different for different people.

Knowing and Assessing risk becomes important, because this forms the basis of the strategy that the company can adopt.

Here are some common myths about RISK in Tractor Finance :

Higher the land the better          : 

If you walk into a tractor dealership, the biggest discussion will be on landholding norms. It is popular belief that higher the land holding, the better is the quality of deal.

Just imagine 2 scenarios :

1.  Customer holds 12 Acres out of which he has irrigated 6 Acres.

2. Customer holds 12 Acres out of which he has irrigated 6 acres. Previous year he irrigated 8 Acres and the year prior to that 10 Acres.

Going only by face value – 12 Acres land – SUPERB PROPOSAL

Going by Scenario A       -  Outcome 1.    He has 6 Acres land which is sufficient for a tractor

Outcome 2.  He has irrigated only 50%

Going by Scenario B       - In addition to the observations made in scenario A, Irrigation showing a diminishing irrigation pattern.           

Many a time, it is the face value scenario. Risk Assessors are never provided the full picture. Numbers merely should not rule a decision. Quality should.

FOIR ( Fixed Obligation Income Ratio) – Higher the better :

The best statement I’ve heard from a Salesman during a heated discussion – “ Tell me what FOIR you are comfortable with. We will provide the same “. While it was shocking, sadly true.

Ask and thy shall get – the best FOIR calculations ! Never rely a decision only on numbers. There are a lot of qualititative aspects to a decision.

It is AGRI Customer – So Half Yearly

In major part of India today, this statement is not true. Agri can be 2 / 3 / 4 seasons, 5 is rare.

Each Agri cycle with a land coverage less than 15 – 20 Acres will only take 15 days per cycle. We may grant 1 month per cycle. So max would be 4 months ? Typically income cycles are maximum quarterly. Else sustainance for the person would be difficult.

It is popular belief that Agri Customers should be given Half Yearly. People who have been given half yearly cycles have more often than not ended up using the repayment amount elsewhere.

Standard 12 months in a year operation @ 10 Hours @ Rs. ____ / Hr – Myth of Paper Arithmetics

Tractor Dealers and executive openly communicate that usage is typically 6-8 hours a day in their marketing calculations. Yet we take great pride in quoting a higher figure on paper @ 10 hours working per day.

Actually, the law of average incomes works better in this business. Try finding out from your customer how much he makes instead of bracket fitting his incomes into a tabulation on paper. True measure of performance is in repayment – which is guided by capability. If such a critical component is assessed by using pre-defined templates, one will never get a clear picture.

No Pucca House - Negative Profile

I have found this comment being made by many financiers at dealerships, mentioning this as a reason for not funding. Yet I remember one statement made by one of the NABARD trainers, whom I was fortunate to be trained under – “ Show of wealth / money is never a rural consumer’s forte. Urban and Rural customers differ largely on this count. A house need not be a painted RCC structure. You and I think 100 times on purchasing a car worth 5 lakhs. Yet, this consumer will have a tractor worth 10 Lakhs outside his semi – pucca house “

Presence of house / Education / Documents should never be basis of judging eligibility.

Multiple Business – A sign of positive repayment capability

In my personal view, after land, this is the largest misnomer. In fact, the contrary is true. If

you find a tractor customer divesting into multiple businesses, his interest is flagging and risk quotient is high.

The argument that incomes from multiple business with aid the customer in repayment is a farce. The business rule is “ Each business has to sustain by itself “. When dependency of one exceeds 40% on another business, the primary business viability and sustenance is questionable.

Margin Money Receipt Ensures Customer Equity

This is one of the largest menaces in the Tractor Finance industry. Receipts are issued without actual receipt of money. Financiers do not take it up since they want continued business, and dealers take financiers silence as "Go Ahead" sign and indulge in all kinds of practices. These would range from giving parrallel credit to customer for margin money, bond execution between dealer and customer, RC issual being withheld till margin payment is complete.

Just because a proposal has a Margin Money Receipt on file does not mean that the customer has paid money. It warrants due diligence on the part of the financier !

I’m sure there are many more such observations out there, which get masked in the name of RISK. Risk – it is. What is your appetite ? I would be glad to hear from various counterparts in the industry.

As prudent Risk Assessors and ambassadors of our companies, getting to know, which actually is risk and which is not is the critical start point.

There are some inherent risks in the business. If Risks were defined right, the tolerances would also have been defined. (Tolerance - Upto what point is acceptable and beyond point Risk taking is unacceptable.).

Once tolerance points are defined - Control Mechanisms need to be defined.

There can be broadly be 3 Risk Levels :

1. Risks that are not identified

2. Risk Identified – Control Mechanism not Defined

3. Risk Identified – Control Defined – Measure and Assessment Weak

This is what your management is interested in. The direct connect to the bottomlines of the business.

Top line is the growth in numbers, Bottom line actually defines the earnings of the organization. Where do you want to measure Risk ? Topline or Bottomline ?