Local Bank Financial Constraints and Firm Access to External Finance

Local Bank Financial Constraints and Firm Access to External FinanceGroup 1Ashwin ShankarAkshith ReddyArun kumarRajeev RanjanDebraj Chatterjee1ContentsIntroductionObjectivesFactors to focusFrictions to access External capitalLack of expertise/Risk averse/unprofitable investment opportunitiesWeaknessNo lending arbitrated opportunities without restrictions.

IntroductionFinancial constraints limit banks credit supply and lead to low investmentFinancial constraints are more likely to be prevalent among local banks, as opposed to large foreign banks; local banks do not have large domestic capital markets from which to draw funding.Local banks can get external capital infused by Government; sometimes there will be restrictions to lend loans only for certain sectors like agriculture, SMEs etcObjectivesThe financing frictions in the banking sector affect lending behavior and economic activity has long been a concern.Based on our understanding, lending channel and credit crunches have focused on two issues:If there are financial frictions and, if so, if shocks to the financial position of a bank have a real effect on investment.The question of whether limited financial intermediaries lead to underinvestment, however, has received little attention.

Factors to test

Bank face frictions in their access to external financing.Financing frictions prevent banks from conducting profitable investment opportunities.WeaknessLending opportunities perceived by banks cannot be arbitrated without restrictions.

Scheduled Cooperative Banks

Urban credit cooperative institutions Rural cooperative credit institutions. Rural cooperative banks undertake long term as well as short term lending.Credit cooperatives in most states have a three tier structure (primary, district and state level).

Frictions to Access External capital

Growth prospects for the 1,600-odd UCBs are hamstrung due to limited options for raising capital

Banks primarily depend on plough back of profits and borrowers' subscription to share capital at the time of loan disbursement, to shore up their capital.

Frictions to Access External capital

Though UCBs, which as of March-end 2011 collectively had deposits and advances aggregating Rs 2,12,031 crore and Rs 1,36,341 croreUCBs allowed to issue preference shares and long-term deposits to augment their capital, both these options are not preferred.

Frictions to Access External capital

The constraint for UCBs in issuing preference shares is that they can be issued only at face value. No exit mechanism is available for investors wanting to liquidate them.In the case of long-term deposits, the RBI's approval is required to pay back depositors even if a bank is financially sound.This is proving to be a deterrent for prospective investors.Reasons for Underinvestment

Reasons for Underinvestment

Reasons for Underinvestment

Lending opportunities perceived by banks cannot be arbitrated without restrictions.

Section 20 - Restriction on loans and advancesNo cooperative bank shall:Make loans and advances on the security of its own shares;Grant unsecured loans or advances to any of its directors; any firm or private company in which the director has interest.This above clause shall not apply to grant of unsecured loans or advances made by a cooperative bank Against bills for supplies or services made or rendered or bill of exchange arising out of bona fide commercial or trade transactions;

Lending opportunities perceived by banks cannot be arbitrated without restrictions.

Section 20 - Restriction on loans and advancesTrust receipts furnished to the cooperative bank;If on examination of any return submitted by the bank, it appears that any loans or advances are being granted to the detriment of the interest of the depositors of the cooperative bank, RBI by order in writing, prohibit the cooperative bank from granting such further loans, or impose such other restrictions as it thinks fit.

Also,UCBs cannot lend more than Rs 10 lakh against the pledge of shares.

Lending opportunities perceived by banks cannot be arbitrated without restrictions.

Misuse of funds Now it is Mahila Urban Cooperative Banks turn. So would it seem. The Reserve Bank of India has imposed a monetary penalty on the Bhilwara Mahila Urban Co-operative Bank Limited, Bhilwara.The bank was found guilty of violating the RBI guidelines/directives pertaining to breach of ceiling on unsecured advances and loans to relatives of directors of the bankThe deposits and advances of urban cooperative banks constitute for about 9 and 8 percents of the aggregate deposits and advances of the banking system respectively.The deposits and advances of urban cooperative banks constitute for about 9 and 8 percents of the aggregate deposits and advances of the banking system respectively.

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