Commodity query

Our bank is into warehouse receipt funding. We are getting a lot of enquiries from traders who stock natural rubber in warehouses. We fund them at 70 per cent of value of commodity stored on the day of deposit. The valuation of the commodity is arrived by multiplying stock in tonnes with the price/tonne of the commodity. Most of the stocks pledged are also hedged for price risk with NMCE.

So the borrower is compelled to release the stocks on or before due date of the warehouse receipt. Thereby there is very less price risk to the bank. Hence, borrowers are seeking a reduced margin of 10 per cent, i.e., are asking for a 90 per cent loan. We seek your advice as to will it be proper to allow this reduced margin? We also want to understand from you how the hedging is done at NMCE. What are the steps involved?

Shyam, Chief Manager, Agri Business Department, Federal Bank, Ernakulam

In commodities such as rubber which are internationally traded, the price risk is high because of market volatility. So, banks generally do not extend loan for over 70-75 per cent of value. So, it’s best to think twice. But, since you say that the commodity is fully hedged, there is no price risk for you. However, note that if there is any quality issue and the stock does not earn the full market value, it can pinch you. So, unless you are sure about the assaying procedure at the warehouse, lending up to 90 per cent is a risk. Since commodity exchanges in India are at a nascent stage, the risk of gaps in quality and quantity checks are high. We suggest you call a meeting of the exchange officials and your customer before you decide to finance him against his collateral. Ask the exchange not to close the client’s position without your knowledge. In NMCE, as far as we know, all the stocks delivered through it are with the Central Warehousing Corporation. The warehouse issues a receipt after checking the quality and quantity of the stock. It is this receipt that the trader then pledges as collateral with the bank when he wants to borrow money. When the futures position is closed, the exchange gives credit to the bank and takes the warehouse receipt from the bank and hands it over to the buyer of the stock.

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