Warehouse Receipts Finance

In warehouse receipt finance, a financier provides credit to a seller and relies on goods in an independently controlled warehouse to secure the credit. The warehouse operator issues warehouse receipts, in one form or another (depending on a country's legal and regulatory system), which then form the basis of financing since these receipts function as artificially created collateral. Rather than relying on the producers' (or exporters') promise that the goods exist and that the proceeds of their sale will be used to reimburse the credit provider, the goods are put under the control of an independent warehouse operator. However, the credit provider still needs to ensure himself that the goods have not been pledged previously. Proceeds of sales are then used for repayment of credits. Warehouse receipts are negotiable and facilitate the conversion of illiquid farm produce into cash since they allow the farmer to make use of previously non-existing bankable collateral.

The use of warehouse receipts as collateral provides the additional advantage that the commodities are no longer in the possession of the borrower, and hence if the borrower defaults the lender has easy recourse to the commodities. Banks or trading companies normally accept advancing funds against commodities that are being stored in reliable warehouses and have been assigned to the bank or trading company through warehouse receipts. For the financial institution the credit risk is not in the farmer anymore but instead in the successful sale of the stored agricultural produce. Consequently, the financier assumes some specific agricultural risks since the value of the collateral depends on the current market prices.

In principle, warehouse receipts are a strong form of security that can be combined with other structured finance instruments. It can be used for durable goods that can be stored and must be standardized by type, grade, and quality, e.g. cotton or grains. However, its use is restricted to post-harvest financing and cannot solve the working capital problems of small farmers.

While simple in concept, a warehouse-receipt system requires in practice the availability of safe warehouses and widely accepted commodity grades and standards. It needs a well-functioning and transparent warehouse management system and is largely limited to non-perishable goods with relatively predictable price developments (or forward markets). In addition, the system depends on additional legal and regulatory pre-conditions, e.g. the (regulatory) recognition of the receipt as legal document to be used as credit collateral and on fairly developed commodity markets to ensure the tradability and liquidity of the receipts. Due to these requirements and pre-conditions, the warehouse-receipt instrument is feasible in agricultural finance only in more advanced developing and transition countries.[1]

In addition, there is a lack of detailed and careful empirical assessments to conclude whether the receipt system has improved access to finance, in particular for small farmers. The fact that warehousing is common for export crops suggests that economic barriers may constrain expansion into grains and other commodities produced primarily for local markets.[2]

In terms of suitable risk transfer, this form of structure does not allow for a transfer of all specific agricultural risks: Production risk remains with the farmer. The price risk becomes partly transferred to the financier since the value of the collateralised agricultural goods is subject to price risk. Maybe the up-to-now limited success of warehouse receipt finance also relates to unwillingness by the banks to take collateral with usually volatile values.

  • [1] Calvin and Jones (2010) and Miller et al. (2009) quote examples from India, the Philippines and Brazil.
  • [2] Meyer (2011b), p. 44.
 
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