BCom 3rd Year Problems Policies Allocation Institutional Credit Study Material notes

BCom 3rd Year Problems Policies Allocation Institutional Credit Study Material notes: Characteristics Institutional Credit  Allocation Institutional Credit Needs and Importance of Allocation Institutional Credit Factors Affecting the Allocation of Institutional credit Problems of Allocation Institutional Credit Table Advances Given to Priority Sectors  Suggestions to Over Come the Problems of Allocation of Industrial Credit Exercise Questions Long Answer Questions Short Answer Question Objective Correct Option :

BCom 3rd Year Nature Importance Financial Money Study Material notes in Hindi

PROBLEMS AND POLICIES OF ALLOCATION OF INSTITUTIONAL CREDIT

Credit retains a very important place in the economic development of any sector. There are many financial institutions viz. commercial banks, regional rural banks, cooperative committees, industrial finance corporations, EXIM Bank etc. in the country to provide credit. Hence any individual institution or enterprise is provided credit by these financial institutions, it is called institutional credit. In other words, the credit granted by financial institutions is called financial credit.

Institutional finance can broadly be of three categories : – (1) Institutional Finance for Agricultural sector (2) Institutional Finance for Industry and Trade sector (3) Personal Loan.

(1) Institutional Finance for Agricultural Sector: The farmers involved in agricultural work need short term, medium term and long term loans. Farmers need short-term loans for seeds, fertilizers, pesticides etc. while they need medium term loans for simple implements and long term loans for tractor, thresher etc. Farmers can get short term; medium-term and long-terms loans from cooperative societies, Land Development Bank, Regional Rural Banks, Commercial Banks etc. Besides these, there is an apex organization NABARD for agricultural and rural development which provides refinance assistance to all these financial institutions.

(2) Institutional Finance for Industry and Trade Sector : Besides commercial banks, there are many special financial institutions which provide loan for the foundation, development and expansion of industries. Such lending institutions are – Industrial Finance Corporation of India (IFCI), IIBIL, Small Industries Development Bank of India (SIDBI), State Industrial Development Corporation (SIDC), Export Import Bank of India (EXIM Bank) etc.

(3) Personal Loan : People with a certain income are given personal loans by Regional Rural Bank and commercial bank for fulfilling their personal needs like construction of house, loans for purchasing two wheeler or four wheeler Vehicle, T.V., Refrigerator, furniture etc.

Problems Policies Allocation Institutional

CHARACTERISTICS OF INSTITUTIONAL CREDIT

The main characteristics of institutional credit are as follows:

(1) There are three categories of institutional credit – short term, medium term and long term.

(2) The rate of interests varies according to the nature of loans.

(3) The main objective of this loan is increasing productivity and standard of living

(4) A formal procedure has to be followed to get institutional credit.

(5) Institutional credit is a good medium for removing the fault of loans obtained from non-government agencies.

(6) There are many institutional financial organisations to provide institutional credit.

ALLOCATION OF INSTITUTIONAL CREDIT

while distributing credit by any financial institutions the principle that “All the eggs should not be kept in a single basket is considered”. It means that the institutional finance is not given to a particular sector only, but it should be allocated to different sectors in such a way that the loan should be a balanced development of the economy. Thus, the allocation of institutional credit refers to the best allocation of limited institutional credit among unlimited credit requirements. In the allocation of institutional credit, the priorities of economy are considered so that the maximum welfare of the society can be possible.

NEEDS AND IMPORTANCE OF ALLOCATION OF INSTITUTIONAL CREDIT

The main reasons of the need and importance of allocation of institutional credit are as follows:

(1) Determination of Priorities: There is a limited amount of credit with institutional financial organizations. On the basis of limited institutional credit, the entire sector cannot be given equal importance. So selecting a sector of high priority is the need of the allocation of institutional credit. Again, the priorities of other sector have to be known in the same sequence.

(2) Best Use of Credit: There is unlimited need of credit in the country but the amount of credit is limited. So through proper allocations of credit, it has to be assured that of the all available options of using credits the best one has been choosen.

(3) Balanced development: Every sector of the economy is important in its place. so, all the credit cannot be distributed to particular sector. It is taken into consideration in the allocation of institutional credit that the allocation should be in such a way that it may lead to a balanced development of the economy.

(4) Overall Development: Every citizen of the country is important. There is a need of rise in the standard of living of every citizen for the overall development of the country. It is possible when there is a rational allocation of the credit for the overall development of the country.

(5) Economic stability : Stability in the price of money is essential for economic stability in the country. With the little amount of credit, the path of economic development is blocked and at the same time with the, unnecessary expansion of credit, there is rise of inflation. With the proper allocation of institutional credit, there can be development with economic stability.

(6) No Fear of Non-performing Advances : the importance of institutional credit is for this reason also that the allocation of credit should be done at that place only where its best use is possible. With such allocation of credit by financial institutions there is no fear of the granted credit being converted into non-performing advances.

Problems Policies Allocation Institutional

FACTORS AFFECTING THE ALLOCATION OF INSTITUTIONAL CREDIT

There is much differene between the established principles of the allocation of institutional credit and practical life. It is not as easy in practical life as it is in established principles. The established principles are based on the hypothesis that the promise of repayment of all the borrowers is the same and there is a complete competition between the creditor and the borrowers in the market. There is uniformity in the rate of interest due to this complete competition. Thus, in an independent market economy, the price mechanism of the market ensures then proper allocation of credit.

But in the practical life there is neither uniformity in different types of credit market nor is there complete competition. There are many classes in the demand side and supply side of credit. There is dominance of major financial institutions in the supply side of the credit. Similarly the class with strong financial condition dominants the demand side and bring a change in the interest rate. Due to the profit earning intention of the institution the credit allocation is not with the view of public welfare. Thus, the non-financial factors have much influence in the allocation of credit. When there are such differences between the established principle and reality in the context of credit allocation, it gets essential to know which factors influence it.

The factors determining the allocation of credit can be classified into two groups: (i) Financial factors (ii) non-financial factors

Factors of Allocation of Industrial credit

Financial Sector                                                                        Non-Financial Sector

1 Net Rate of Return                                                                  1. Social Factors

2. Risk of Default                                                                       2. Political Factors

3. Securities                                                                                3. Forms of Economy

4. Margin requirements                                                        4. Gravity of Problems

5. Stage of Development

(I) Financial factors : Many financial factors are determined in the allocation of institutional credit. The important ones are as follows:

(1) Net Rate of Return : Granting credit by financial institution is a service and there is a price for this service. The cost of this service is not taken separate by the financial institutions. It is included in the amount of interest itself. Thus, from the total amount of interest if the cost of service is subtracted. we can get the net rate of return. In the practical life, the rate of interest on the institutional loans is actual administrative price which differentiate between the borrower and non-borrower. The rate of interest is predetermined. The borrower who don’t want to take loan on this predetermined rate of interest get away from the credit market automatically. On this basis, there gets the rationing of credit on a particular rate of interest and the allocation of credit is among the remaining people only because those people who are not in favour of this rate of interest have not to be granted credit.

(2) Risk of Default : Loans granted to the borrowers by financial institutions are got repaid with interest. The lenders grant loans on the basis of their past and present economic status and speculation of future but there is also the risk that there will not be payment of the capital or interest on both by the borrowers in future. This situation is referred to as the risk of default Generally, two kinds of loans are given by the financial institutions-government loans and loan to non-government institutions or individuals. There is no risk of default in the government loans but such risk can’t be denied in the nongovernment jobs. There are two kinds of risk of defaults in the loans given to non-government institutions or individuals-personal and commercial. Bad intention of the borrowers or deterioration of the economic condition are examples of personal risk. Such risk can be avoided by finding out the previous credit of the borrowers or granting loan on the basis of collateral. Similarly, when the concerned trade of the borrower deteriorates, it is called commercial risk. So, while allocating credit, the creditor should observe the financial condition of the borrowers. For this, their balance sheet of many years should be studied to find out their clearing ability. In this respect, following financial ratios can be drawn out :

Problems Policies Allocation Institutional

(I) Debt-Equity Ratio: Debt-equity ratio clarifies the relationship between the proprietor’s capital and the loanable capital. Here proprietor’s capital or owners equity includes equity share capital, preference share capital, capital reserve, credit balance of profit and loss account, revenue reserve subtracted by fictitious assets. On the other hand, external loans include both long term and short term loans. For the calculation of this ratio, following formula is used:

Total Debts

Debt-equity Ratio = Owner’s Equity

Generally, a ratio of 1:1 is considered to be the standard ratio.

(II) Capital Gearing Ratio : This ratio tells the relationship between the capital with stable income and that with unstable income. Capital with stable income refers to that capital on which the rate of interest and dividend are fixed. On the other hand capital with unstable income has an unstable rate of dividend. Following formula is used for the calculation of this ratio : Capital Gearing Ratio Equity share capital + Reserve and Surplus +undistributed profits

Preference share capital + Long term loan When the fund with unstable income is less than capital with stable income, it is called high gearing of capital.

(III) Solvency Ratio: This ratio express the total assets and total external liabilities of the company. The formula for its calculation is

Total Assets Solvency Ratio = =

Total External Liabilities (IV) Long-term Debt-Capitalisation Ratio : This ratio explains the relationship between the long term debt and total capitalization (shareholders fund + long-term debt). Following formula is used for this ratio :

Long Term Debt Long-term Debt capitalization Ratio =

10 Total Capitalisation The lower the ratio, safer is the creditor.

(3) Securities : It is good thing to find out the clearing ability of the borrowers at the time of allocation of credit, but it is not proper to grant loan being satisfied with this information only. Sometimes it happens that the clearing! ability is good at the time of the granting the credit but it deteriorates later. Thus, the allocation of loan is dome against securities. Allocation of loan against securities is safe. There are two kinds of securities – Primary security and collateral security. Primary security refers to that security which makes the loan sate and this security is granted by the borrowers. The lender has first charge on this security. On the contrary, the collateral security refers to other securities taken from the borrowers for extra safety of loan. This security is given by the borrowers himself or provided by some other person. The other person guarantees through this security that in the case of default in the repayment of the loan by the original borrowers he/she will repay the loan along with interest. It is worth mentioning here that the asset given as security should come under the legal authority of the creditor. There are many ways of creation of this authority. For ex-Lien, Mortgage, hypothecation, pledge etc.

(4) Margin Requirement: There are two kinds of margin-one for the loan without securities and the other for the loans with securities. In the case of loan without security, it takes the form of getting a certain per cent of the total amount of loan in the form of deposit. It gives the information of the liquidity of the borrowers. On the other hand, in the case of loan with security, if a loan of 80 thousand rupees is granted against the security of 1 lakh rupees, it will be understood that 20 thousand rupees is the margin.

(II) Non-Financial factors: Allocation of institutional credit is also affected by non-financial factors. Some important non-financial factors are as follows:

(1) Social Factors : Social factors also have contributions in the flow of credit. Social factors include the standard of living of financial manager and the borrowers, their lifestyle; social values etc. if the social values are given importance, there will be proper allocation of credit. On the other hand, if the financial manager keeps the personal interest above the interest of the institution and allocates credit by promoting corruption, there will be more flow of credit and it will go to wrong people. Similarly, the view points of the social organisations also influence the flow of credit.

(2) Political Factor: The politicians also influence the allocation of credit. It is seen in India that leaders at all levels pressurise the financial institutions in the allocation of loans and advances. Even incapable people are able to get loan if they have access to leaders. On the contrary, those people who are really in the need of loan are devoid of it due to political inaccessibility.

(3) Form of Economy: The priorities of allocation of credit in different economics are different. There are differences in the allocation of credit in capitalist economy, socialist economy and mixed economy due to the differences of priorities.

(4) Gravity of problems : It is a rule of economics that unlimited needs annot be fulfilled with limited resources. So the most urgent need should be celled the first of all. Similarly the amount of credit in the economy is limited ita demand is high. So, the needs related to public welfare and national interests are met first of all.

(5) Stage of Development: The stage of development in a country can be undeveloped, semi-developed or developed. There is more requirement of credit in underdevelopment and semi-developed economies as compared to developed economies. Thus, the stage of development also influences the allocation of credit.

So, it is clear that there are many factors influencing the allocation of credit. Some of these are financial and some others are non-financial.

Problems Policies Allocation Institutional

PROBLEMS OF ALLOCATION OF INSTITUTIONAL CREDIT

It is not an easy consideration as to how the institutional credit should be the allocated. There are many problems associated to it. The main problems can be divided into three major classes as follows:

(i) Problems of Allocation of Institutional Credit between the Government and the Commercial Sectors.

(ii) Inter-regional and inter sectoral problems of Allocation of Institutional Credit.

(iii) Allocation of Institutional credit between large and small borrowers.

The detailed study of all the above mentioned three types of problems can be explained as follows:

(I) Problems of Allocation of Institutional credit between the Government and Commercial Sectors : There is need of credit in both government and private sectors. So, it is a major problem whether more allocation of credit should be in the government sector or private sector. Different arguments have been given in the favour of the allocation of credit giving priority to the concerned sector :

(A) Allocation of Credit in Government Sector: The reputed economist Prof. Keynes opines that more and more institutional credit should be distributed in the government or public sector. He argues that the government performs the tasks of public welfare such as education, health, transport, defence etc. Moreover, it should also be under responsibility of public sector to establish industries having high capital investment. He says that many faults appear in the private sector in the long run. So, more and more credit should be allocated in the public sector.

(B) Allocation of credit in Commercial Sector: Following arguments have been given in the favour of the allocation of more and more credit to commercial or private sector :

(1) Attraction of Higher Profit : Private Sector has the attraction of higher profit. There is more skill and proficiency in the private sector due to the expectation of earning more and more profit. Maximum production at minimum cost can be done in the presence of a balance and optimum capital. This not only reduces the cost of production but also makes the better quality product.

(2) Best Utilisation of Resources: There is best utilisation of resources due to the attraction of profit in the private sector. There is the use of resources in the public sector but there is not the best use. The reason is that in the public sector service is given priority as compared to profit,

(3) Technical Progress : It is the age of competition at present, there is a constant need of technical progress in trade and industries to establish oneself in the world market. The change in technique according to time can be in the private sector only. The process of obtaining order regarding any changes is so lengthy in the public sector that it kills the trade opportunity.

(4) Direct Relation between Ability and Reward: There is better use of credit in the private sector. Its reason is that the remuneration is on the basis of merit in the private sector. The people with better eligibility are appointed in management.

(5) Quick Decision : Generally, such opportunity arises in the field of trades that there is the need of taking quick decisions to get proper advantage. Such quick decisions can be in the private sector only.

(6) Less Interference of the Government: There is limited interference of the government in the private sector. That is why there is better progress of this sector with the help of skilled managerial force. The government also gets increased revenue due to increased production and sale. The government uses this revenue in the public interest.

(7) Risk Bearing : The path of business is not a bed of roses. It is full of thorns at each and every step. So, for getting success in trade sector there is the need of having the capacity of taking risk. The tendency of bearing risk is more in the private sector as compared to the public sector.

Problems Policies Allocation Institutional

On the basis of above arguments, it is clear that there are different logic in favour of granting credit to public and private sector. Favour of one sector takes the form of the opposition of the other. Thus, as a conclusion, it can be said that in semi-developed countries like India the flow of credit should be towards the mixed sector in higher degree as compared to public and private sector. The mixed sector has a blend of the governmentary discipline and private sector’s qualities. However, in India there is the control of RBI on financial institutions. RBI gives the instructions to distribute credit on the minimum interest to the government sector with high priority.

II. Inter-regional and Inter-sectoral Problems of Allocation of Institutional credit :

The meaning of inter-regional imbalance: When there is not an equal development of different status or regions of a country and some regions have high and others have low development, it is called inter-regional imbalance.

The meaning of inter-Sectoral imbalance: There are many sectors of the economy of any country e.g. agriculture, trade and business, industries, education, transport etc. When there is imbalance in different sectors within a region only, it is called inter-sectoral imbalance.

The economy of any country is large in itself. There is not proper develop of different regions of the whole country. Some regions are more development and some others are less developed. Similarly all sectors in all regions don’t have equal development. One region may have a good development in agriculture while the other may have such development in the industrial sector. The condition of education may be very good at a place and at the other there may be a good development of transport facilities. It means there is a lack of balance in every region and every sector.

So a major problem arises at the time of allocating the limited amount of credit as to which region and which sector should be given priority. There cannot solution of this complex problem. There should be more implementation of rationality as compared to rules. If we see it with the view of social justice in the allocation of credit the most backward region should be given so that the people of that region may come in the main stream. But if Economic consideration, the priority in the allocation of credit should to that region where some development has already taken place.

(iii)  Problems of Allocation of Institutional credit between Large and Small Borrowers: It is also a problem regarding the allocation of credit whether the priority should be given to big borrowers or small borrowers. Big borrowers refer to major industrialist, large traders and large scale farmers. Similarly, small borrowers refer to small and cottage industries and small scale farmers.

There are different arguments in favour of giving priority to big and small borrowers in the allocation of institutional credit.

(A) Allocation of Credit to Big Borrowers: Following Arguments can be given in Farmer of granting priority to Big Borrowers in the Allocation of credit:

(1) Fast Industrialisation : The development of industrial sector is essential for the development of economy. Industries have a major contribution in the development of countries like Japan and China. The major borrowers have to be given priority in the credit for the rapid industrialisation of the country because they play an important role in the foundation and development of large scale industries.

(2) Agricultural Development: India is a predominantly agricultural country. Most of its population depends on agriculture. So, large scale farmers have to be given priority in loans for the development of the country, because for a increase in agricultural productivity there is a need of use of scientific implements and technological development. Only large scale farmers can do new experiments in agriculture. Small farmers avoid taking any kind of risk.

(3) Obtaining Foreign Money : The area of big traders is so wide that they export to foreign market also. Due to an increase in export, more amount of foreign money is obtained.

(4) High Goodwill : Big borrowers have higher good will. So, financial institutions take interest in granting loans to them.

(5) Less Risk: There is a negligible risk of non-repayment by big borrowers due to their good reputation. So big borrowers are given priority in the allocation of credit.

(B) Allocation of Credit to Smaller Borrowers: Following arguments can be given in favour of granting priority to smaller borrowers in the allocation of credit :

(1) Mahatma Gandhi had said that it is essential to promote small scale and cottage industries for the development of the country. So, the small borrowers should be given priority in the allocation of credit for promoting small scale and cottage industries.

(2) Small borrowers are generally the people with lower standards of living. An improvement in their standard of living can be brought by giving loans to small borrowers.

(3) Small borrowers are generally scattered in different sectors and regions. By granting loans to them, regional inequalities can be eliminated.

There is generally lack of collateral with small borrowers. Due to it, they are not able to get loan from any other agency. So. for the allocation of institutional credit, small borrowers should be given priority.

So long as the question of flow of institutional credit between large and small borrowers is concerned, the priority was given to small scale and cottage industries in the industrial policies of 1948 and 1956. Its importance has been accepted in the industrial policy of 1980 also. After the economic liberalisation policy of 1991, the need of more credit for large scale industries was realised. there has been allocation of fund to small and big borrowers from different commercial banks and special institutions.

SUGGESTIONS TO OVERCOME THE PROBLEMS OF  ALLOCATION OF INDUSTRIAL CREDIT

Following suggestions can be given to overcome the problems of allocation of institutional credit.

(1) Expansion of the Branches of Regional Rural Banks : It is a matter of satisfaction that proper steps are being taken in the direction of amalgamation of Regional Rural Banks but there is a need of further expansion of their branches. However most of their branches are in rural areas but the number of branches in remote rural areas is still low.

(2) Expansion of Co-operative Credit Societies : Co-operative credit societies can be instrumental in granting agricultural credit, but their condition in most of the states is bad. These societies are neither expanding properly nor functioning properly. So there is a need of strict regulation for these societies.

(3) Improvement in Working : The working of financial institutions is not satisfactory. The guideline of financial managers to rise above the personal interest and work in the national interest should be strictly implemented. The system of implementing financial discipline in all financial institutions should be implemented strongly.

(4) Effective Control on Loans: There is allocation of credit by financial institutions but there is no attention on the issue whether the granted credit is utilised properly or not. The responsibility should be given to control of the loan. There should be effective control of loan. There should be questioning from the financial managers regarding non-performing advances.

(5) More Finance to Productive Work : However it is a government thing to consider priorities for the allocation of credit but for the national development there should be provision for more finance for productive work so far as possible.

(6) Development of Investigation Institutions : There should be development of investigation agencies or institutions for the detailed inspection of the planning and programmes of the concerned borrowers while granting long term finance. This would be helpful in the recognition of proper borrowers.

(7) Project Evaluation : Long term finances are generally granted for major projects and there is allocation of higher amount in such finances. So the evaluation of project should be on every stage. There should not be allocation of credit under pressure in any condition.

Problems Policies Allocation Institutional

EXERCISE QUESTIONS

Long Answer type questions

1 What do you mean by Institutional Credit ? Explain its characteristics. Describe the importance of allocation of institutional credit.

2. Explain the factors of the allocation of Institutional Credit.

3. Explain the problems of allocation of institutional credit. Also explain the suggestion to remove it.

4 Describe the problems of allocation of institutional credit between government and the commercial sectors.

5. Explain the inter regional and inter sectoral problems of allocation of institutional credit.

Short Answer type questions

1. What do you mean by institutional credit ?

2. What are the characteristics of institutional credit ?

3. What is the allocation of institutional credit ?

4. What is risk of default?

5. What is the net rate of return ?

6. Write a note on debt-equity ratio.

7. What is capital gearing ratio ?

Problems Policies Allocation Institutional

III. Objectives type questions

Choose the correct option

1 Which financial institution will not be included in institutional credit ?

(a) Co-operative Societies

(b) Regional Rural Banks

(c) Commercial Banks

(d) Native Bankers.

2. The main function of NABARD is ……..

(a) Granting loans to Regional Rural Banks

(b) Granting loans to commercial Banks

(c) Granting loans to co-operative societies

(d) Granting refinance to above institutions

3. Net Rate of Return means ……..

(a) Reducing service cost from total interest rate

(b) Total Interest Rate

(c) Service tax

(d) None of these

4. The financial factor (s) of allocation of institutional credit is/are ………….

(a) Securities

(b) Marginal Requirements

(c) Both of these

(d) None of these

5. The non-financial factor (s) of the allocation of institutional credit include

(a) Net Rate of Return

(b) Stage of Development

(c) Risk of default

(d) All of the above

6. A standard debt-equity ratio is ….

(a) 1:1

(b) 2:1

(c) 3:1

(d) None of these

[Ans. 1. (d), 2. (d), 3. (a), 4. (c) 5. (b) 6. (a)]

Problems Policies Allocation Institutional