on profits may not be the way to favor the most promising firms: while the projected turnover calculation does favor faster growing firms, the loan officer is not allowed to project a growth rate greater than 15 percent. This may be enough to meet the needs of a mature firm, but a small firm that is growing fast clearly needs much more than 15 percent. It is important that the rules encourage the loan officers to lend more to companies on the basis of promise.
Actual Lending Policy
The lending policy statements give us the outside limits on what the banks can lend. There is nothing in the policies that stops them from lending less, though bankers are always enjoined to lend as much as possible in official documents.24 It is also possible, given that it is not clear how these rules are enforced, that the banks sometimes exceed the limits–it is, for example, often alleged that loan officers in public sector banks give out irresponsibly large loans to their friends and business associates. It is not even clear how one would necessarily know that banker had lent too much given that he is given the task of estimating expected turnover. In this sub-section, based on work by Banerjee and Duflo, we therefore look at the actual practice of lending in our sample of loans.25
Data: We use the same data source that was used in previous work by Banerjee and Duflo (and described in the previous section) to look at what bankers actually do.26 Since we have data on current assets and other current liabilities, it is trivial to calculate the limit according to the traditional, working capital gap-based method of lending (henceforth LWC). We can also calculate the limit on turnover basis (henceforth LTB). The maximum of LTB and LWC is, according to the rules, the real limit on how much the banker can lend to the firm.
[TABLE 6 ABOUT HERE] Results: In Table 6, we show the comparison of the actual limit granted with max(LT B, LW C).
24 For example, a document prepared for the board meeting of the bank we studied reads “The busy season credit policy announced by the Reserve Bank of India stresses on increase in credit off-take by imparting further liquidity into the system and by rationalizing some of the existing guidelines. Banks have, therefore, to pay special attention to this aspect in the coming months and locate all potential/viable avenues so as to accelerate the path
of credit expansion.” 25 Banerjee and Duflo (2001) 26 Banerjee and Duflo (2002).