What is hedging of Agri-Commodity Price Risk?

The Reserve Bank of India in its press release today (May 28,2015) advised banks to encourage large agricultural borrowers such as agricultural commodity processors, traders, millers, aggregators, etc., to hedge their risks related to agricultural commodity prices. Banks provide a number of credit facilities to customers engaged in activities related to agriculture.  One of the prominent, albeit indirect, risks in this sector is that of volatility in agricultural commodity prices. This risk is more noticeable in cases where agricultural borrowers do not hedge the underlying agri-commodity price risk which could negatively impact such borrowers and the banks. The hedging can be through agri-commodity derivative products available on recognised exchanges in India. Therefore RBI feels that it is desirable to educate the bank borrowers about the suitability and appropriateness of using these products for hedging specific exposures so that these customers can take an informed decision, lessening the scope for mis-selling of these derivatives.

The Reserve Bank has, therefore, advised banks, the need of creating awareness among the borrowers about the suitability and appropriateness of using various hedging tools so that they can take an informed decision. Currently, hedging tools including derivatives are available in the Indian market, but these are not being used extensively due to lack of awareness of the products or their inherent complexity. The informed decision on the availability and use of these instruments will reduce the scope of mis-selling of derivatives. Banks have to keep the sophistication, understanding, scale of operation and requirements of their agri-borrowers in mind while advising them on the availability and use of these instruments.

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2. What is risk management in agriculture?