Commodity Based Finance (Monitoring and Follow up)

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Inherent Risks of the product

Perishability of agri Commodity Dependency Primarily on Collateral under lock & Key Volatility of Prices (Margin call) Funding on Forged/ Fake Warehouse receipt (WR) Government Regulations Operational risk Collateral Manager (Third Party agency) Failure Credit risk (Overdue) Liquidity risk in case of Niche commodity

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Selection of commodity

Price volatility

Shelf Life Selection of Commodity

Government Regulations

Niche

Touch and feel

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Warehousing of Commodity
IDEAL CAPACITY AND DIMENSIONS Capacity : Small sized godowns : Capacity of less than 1000 MT Medium sized godowns: Capacity above 1000 MT upto 5000 MT. Large sized godowns: Capacity of 5000 MT and above.
Height - road fed godown is 5.6m , rail fed godown is 6.35m Stacking: size for both 2500 MT and 5000 MT godown is 9.15m X 6.1m X 4.57m Plinth Height - shall be generally kept about 80 cm above the finished ground level. Flooring - damp proof, rigid, durable and free from any cracks and crevices. Slide 4 of 20

Warehousing of Commodity (Contd.)

Walls: 5.60 m high for road-fed and 6.35 m for rail-fed godowns from the floor level, 34 cm thick, plastered with cement mortar. In seismic areas, criteria for earthquake resistant designs of structures shall be followed. Roof - single span structural steel or tubular trusses. Material may be corrugated asbestos sheets or galvanized corrugated sheets, steel sheets or corrugated aluminum sheets

Door - The doors shall normally be steel rolling shutters. Size not less than 2.45 m X 1.83 m.
Ventilators: longitudinal walls two steel ventilators, fixed 15 cm below the top edge of the wall Drainage - cast iron or asbestos cement pipes of diameter not less than 10 cm shall be provided to drain off the rain water from the roofs of main godown and platform.
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Stock Monitoring
Quarterly Inspection to be done by Bank Staff for monitoring the Stock Quality , Quantity, Stacking, Warehouse infrastructure etc as part of ops/credit.
Inspection report to be tracked in case any discrepancy observed : Discrepancy to be categorized into various risk (High / Medium/ low) categories: 1. 2. 3. 4. Physical Stock tally with Bank Date: (Yes/ No) Security Arrangement as per agreed terms: (Yes/ No) Overall conditions of the godown: (Good/ Satisfactory / Needs Improvement) Comments on why godown condition needs improvement:
1. 2. 3. 4. 5. 6. 7. Stacking/Stack Card Related Improvement Spillage In The Godown Fire Extinguisher Other Bank Stocks Cleanliness Godown Related Improvement Excess Utilization Of Godown Capacity Storage

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Risk Categorization and Actions to be taken

* * * * * * * * * HIGH RISK - To be resolved within 7 working days Difference in the stock position. (which is not supported by a valid documentary evidence) Quality of the stock deteriorated and hence needs to be fumigated / released within 7 to 10 days Insurance not available/inadequate. Godown conditions requiring immediate corrective actions MEDIUM RISK To be resolved within 15 working days Security arrangement not as per terms Quality of the stock deteriorated and hence needs to be fumigated / released within 15-30 days Godown conditions requiring corrective actions though not immediately but within 15 -20 days LOW RISK To be resolved within 1 month Quality of the stock deteriorated and hence needs to be fumigated / released within 30-60 days Godown conditions related to proper stacking and stack cards, cleanliness , spillage, improvement in stacking, excess utilization etc
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Volatility of Prices
Recent Fluctuation in prices of Cotton
Average price for Cotton for first fortnight (month wise)
180000 160000 140000 120000 100000 80000 60000 40000 20000 0 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11

153403 164276 169142 115975 117863 124733 121399 104535 94759 109143

Average Price / MT

Source NCDEX site- 28.5 mm Cotton Kadi.

Price Cap can be initiated in case the price hike for the commodity is more than 10% for the month. In above example we need to Cap the Funding rate in the month of Feb as the price hike is more than 10% for the month. No Cap Price fell by 40% in the next 4 months. ( Resulting in margin calls / Loss incase borrower does not repay) Slide 8 of 20

Arriving at Max Commodity Funding Cap

Based on the average prices available at various sources, Cap can be arrived at. E.g. 1. Below mentioned are the cotton prices available at CCI since Jan 2010. The average price for the year 2011(till July 2011) is arrived at Rs. 131099/MT. Keeping the margin of 10% approx for further fluctuation, we can arrive at Max Price Cap of Rs. 120000/ MT.

Monthly Cotton Price (Rs. / MT)

180000 160000 140000

Price (Rs. ) / MT

120000 100000 80000 60000 40000 20000 0

131099 2010 2011 76803 Average 2010 Average 2011

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Arriving at Max Commodity Funding Cap

E.g. 2. Below mentioned are the Guar Seed prices available at NCDEX since Jan 2010 ( Bikaner market). The average price for the year 2011(till August 2011) is arrived at Rs. 32537/MT. Keeping the margin of 10% approx for further fluctuation, we can arrive at Max Price Cap of Rs. 30000/ MT.
Monthly prices for Guar Seed (Rs. / MT)
50000 45000 40000 35000 30000 25000 20000 15000 10000 5000 0
Fe b M ay y A ug us t ov e M ar A pr il Ju n Ju l N D ec Se p O ct Ja n

Price (Rs. / MT)

32537 2010 22716 2011 Average 2010 Average 2011

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Monitoring of Volatility of Prices

Keeping Margin % at Commodity Level as price fluctuation buffer. ( Margin can range from 25 to 40%) Weekly prices and margin monitoring of all commodities. Controlling the Product Cap, Commodity Cap, Commodity Margin, Raising of the margin calls. Emergency Margin call can be raised in case high fluctuation in prices. In case price rising is projected to continue in near future, Price Cap can be put at commodity level. E.g. In case of Cotton, Cap could be initiated in month of February onwards at Rs. 120000 to avoid the risk of over pricing of Commodity

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Monitoring of Volatility of Prices (Contd) Margin Call monitoring: Raising and monitoring of margin call:
Dilution in margin reaches the level of 10% on account of price movement (does not include any accrued/accumulated interest on the loan) and/or the dilution in margin reaches the level of 15% due to combined effect of price movement and inclusive of all accrued interest on the loan.

Servicing of Margin call:

By additional funds or by pledge of commodity of appropriate value, within 15 working days from raising of Margin call.

Monitoring of the Margin call: (T is day when margin call is raised)

Margin Call Letter (T) Margin call reminder Letter (T+7) Liquidation letter (T+15) Auction Process (T+30)

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Monitoring of Volatility of Prices (Contd)

Sectoral research Monthly Outlook published with commodity exposures and price fluctuations.
Content of the Outlook:
Exposure trend of the CBF portfolio Details of Top 5 borrowers, Top 5 mandis. Details analysis of Top 5 Commodities. Commodity Exposure Variety wise Price trends ( in local market as well as Exchanges) Average pricing of the Commodity (Market price viza-viz Banks funding rate) Market outlook (News).
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Funding on Forged/ Fake/ Improper WR

Concept Improper WR Wrong Commodity, Quantity, Quality, Price, etc. Forged WR Tampered WR Fake WR - False WR generated with intention of Fraud. Third party Agency (Collateral Manager) to visit the warehouse and physically verify all the details on the WR. i.e. Quantity of goods, Quality of goods, Physical presence of goods as per the WR.
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Funding on Forged/ Fake/ Improper WR

Concerns: Government Warehouses: Funding Done based on warehouse manager report. Said to Content Clause Large quantity funding ( Capacity can be cross checked at CWC/ SWC site) Unusual single large WR ( > 3 Cr.)- Bank official visit mandatory

WR generated for a commodity of non production / non consumption centers Eg. Basmati in Sangli, Pepper in Bhubaneswar, etc.
Special Care for commodities which are liquid. ( edible oil/ mentha oil) Special care for Commodity with various varieties. (Rice) Additional Due Diligence on borrower in case of Cold Storage.
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Regulatory risk/Government Regulations Funding of Sensitive / Non Sensitive (Essential / Non Essential) Commodity.

Essential Commodities Act, 1955:

Restrictions like licensing requirement stock limits movement restrictions
States impose Temporary restrictions on Price increase.( e.g. Wheat, pulses and edible oils, edible oilseeds and rice)

Compliance to The Warehousing (Development and Regulation) Act, 2007 - Warehousing Development and Regulatory Authority

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Operation Risk
Stock Insurance: Fire Burglary Third party agency (Collateral Manager) to provide the insurance of the total stock to be funded. Monthly monitoring of utilization and expiry of Insurance

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Collateral Manager Monitoring

Empanelment of reputed, experienced CM. Annual review of the company performance in terms of financials and stock under management. Adequate Fidelity resource and Stock Insurance Monitoring of CM portfolio quarterly basis. Diversification of portfolio to different CMs.
Weekly portfolio analysis report to capture the exposure of CMs. ( Individual exposure should not ideally be more than 30% of total exposures)
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Overdue Tracking
Close Monitoring of Overdue accounts Immediate inspection. Communication to borrower in case of Overdue:
(T is the day on which account has turned overdue)

Overdue Letter (T) Overdue reminder Letter (T+7) Liquidation Letter (T+15) Auction process( T+30)

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THANK YOU

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