LocalBank financial constraints

1. Group 1

2. 
 Financial constraints limit bank’s 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
Introduction

3. 
 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.
Objectives

4. 
 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.
Factors to Test

5. 

6. 
 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).
Scheduled Cooperative
Banks

7. 
 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

8. 
 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.
Frictions to access
External capital

9. 
 The constraint for UCBs in issuing preference shares
is that they can be issued only at face value.
Investment in these shares is unattractive as 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.
Frictions to access
External capital

10. 
 A cooperative‘s typical business model comes with a relatively
high fixed cost base. With employees involved in decision
making, it hard to cut these costs quickly when needed.
 Important of these specific under investment risks are related to
the combination of the governance challenges and the
constraints cooperatives face in managing their capital
 RBI has set statutory liquidity ratio (SLR) limit for UCBs, this
limit is set higher at 25 per cent.
 Many small banks do not have the expertise to trade in
Government Securities. In a rising interest rate regime, these
banks end up booking losses or making market-to-market
provisioning on the balance sheet date
Lack of expertise/Risk averse/unprofitable
investment opportunities

11. 
 The lack of a need to maximize profits and the absence of
many of the factors that lead rational managers in
commercial banks to adopt short-term horizons
 Cooperative banks may be more vulnerable to certain
shocks, including credit quality and interest rate
developments
 cooperatives‘ business model also relies more on one
particular source of revenues (the interest margin),
which is likely to imply higher vulnerability to interest rate.
Lack of expertise/Risk averse/unprofitable
investment opportunities

12. 
 Absence of systematic approach to profit planning,
risk and resources management.
 Miss match in cost, yield and maturity profile of
asset and liability.
 Shoddy accounting practices (income and expenses
recognition,investment valuation, depreciation, NPA
provisioning etc.)
Weaknesses in the working of Urban Co-
operative Banks.

13. 
 Misleading Management control systems, performance
measurement and compensation system.
 Increase in level of NPA‘s due to inadequate asset
portfolio management.
 High deposit and lending rates.
 Unprofessional approach on credit and loan appraisal,
product pricing and management of asset portfolio.
 Shrinking spreads, thinning margins, poor credits off take
due to general industrial recession.
 Confidence crisis.
Weaknesses in the working of Urban Co-
operative Banks.

14. 
 Dual Regulations.
 High burden / cost of operations.
 Conflicting objectives Business V/s Societal
 Miss conceptions about cost of owned funds,
deposits and borrowings.
 Inadequate technological usage and harnessing.
 Miniscule share of Para-banking, fee based banking.
 Limited area of operation and Regional presence.
 Inadequate treasury operations and management.
Weaknesses in the working of Urban Co-
operative Banks.

15. 
 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;
 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.
No lending arbitrated opportunities without
restrictions.

16. 
 Now it is Mahila Urban Cooperative Bank’s 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
Lending opportunities perceived by banks
cannot be arbitrated without restrictions.

17. 
Thank You!