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Banking Reform in India∗ - page 25 / 57





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more weight on past loans for recent clients than for old clients.27 the inertia it has to be something much more complicated.

If there is a good reason for

It is also conceivable that it is rational to ignore profit information in lending, if the projected turnover calculated by the bank and included in the calculation of LTB, already takes into account any useful information contained in the profits. To examine this we looked at whether current profitability has any role in predicting future profitability, delay in repayment and actual default, once we control for the variables that seem to determine the level of lending–past loans, LTB, LWC. As reported in Banerjee and Duflo, current profit is a good predictor of future profit, and the variables that the bank uses (past loans, etc...) are not: the only good predictor of future

negative profit is current negative profit.28 past loans, LTB and LWC do not.

Negative profits, in turn predict default,



Conclusion: This sub-section suggests an extremely simple prima facie explanation of why many firms in India seem to be starved of credit. The nationalized banks, or at least the one we study (but again, this is one of the best public banks) seem to be remarkably reluctant to make fresh lending decisions: in two-thirds of the cases, there is no change in the nominal loan amount from year to year. While the rules for lending are indeed fairly rigid, this inertia seems to go substantially beyond what the rules dictate. Moreover the deviations from the rules do not seem to reflect informed judgments, but rather a desire to do as little as possible.

Moreover, when they do take a decision to make a fresh loan the beneficiaries tend to be firms whose turnover is growing, irrespective of profitability. This indifference to profitability is entirely consistent with the rules that bankers work with: none of the many calculations that bankers are supposed to do before they decide on the loan amount pay even lip service to the need to identify the most profitable borrowers. Yet current profits do a much better job of predicting future losses and therefore future defaults, than the variables that do seem to influence the lending decision. In other words, it seems plausible that a banker who made better use of profit information would do a better job at avoiding defaults. Moreover, he might do a better job of identifying the firms where the marginal product of capital is the highest. Lending based on turnover, by contrast, may skew the lending process towards firms that have been able

27 See Banerjee and Duflo (2001) Table 5. 28 Banerjee and Duflo (2001). 29 There is some question about whether we have the right measure of default.


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