LOCAL BANK FINANCIAL CONSTRAINTS AND FIRM

ACCESS TO EXTERNAL FINANCE

Group 1
Ashwin Shankar
Akshith Reddy
Arun kumar
Rajeev Ranjan
Debraj Chatterjee

Contents
Introduction
Objectives
Factors to focus
Frictions to access External capital
Lack of expertise/Risk averse/unprofitable investment opportunities
Weakness
No lending arbitrated opportunities without restrictions.

Introduction
Financial constraints limit banks credit supply and lead to low

investment
Financial 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 etc

Objectives
The 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.
Weakness
Lending 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).

FrictionstoAccessExternalcapital

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.

FrictionstoAccessExternalcapital

Though UCBs, which as of March-end 2011 collectively had deposits

and advances aggregating Rs 2,12,031 crore and Rs 1,36,341 crore

UCBs allowed to issue preference shares and long-term deposits to
augment their capital, both these options are not preferred.

FrictionstoAccessExternalcapital

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

A cooperative bank typical business model

comes with a relatively high fixed cost base.

Employees involved in decision making, it

hard to cut these costs quickly when needed

RBI has set statutory liquidity ratio (SLR)

limit for UCBs, this limit is set higher at 25
per cent Banks its 23%.

Reasons for Underinvestment

The lack of a need to maximize profits and the

absence of many of the factors.

Cooperative banks may be more vulnerable to certain

shocks, including credit quality and interest rate
developments

Business model also relies more on one particular

source of revenues (the interest margin),
which is
likely to imply higher vulnerability to interest rate.

Reasons for Underinvestment

Absence of systematic approach to profit
planning, risk and resources management.
Poor accounting practices
Increase in level of NPAs due to inadequate
asset portfolio management.

Misleading Management control

systems.
High deposit and lending rates.
Unprofessional approach on credit
and loan appraisal, product pricing
and management of asset portfolio.

Weaknesses in the
working of Urban
Co-operative
Banks.
Misleading Management control
Unprofessional approach on credit
systems, performance measuremen
and loan appraisal, product pricing
and compensation system.
and management of asset portfolio.
Increase in level of NPAs due to
Shrinking spreads, thinning
inadequate asset portfolio
margins, poor credits off take due to
management.
general industrial recession.
High deposit and lending rates.
Confidence crisis.

Lending opportunities perceived by banks cannot be arbitrated

without restrictions.

Section 20 - Restriction on loans and advances

No 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 advances

Trust 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 bank

 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.

 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.

Thank You!