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Banking Reform in India∗ - page 26 / 57





26 / 57

to finance growth out of internal resources and therefore do not need the capital nearly as much.


Why is there under-lending?

Given that the rules for lending are quite rigid and largely indifferent to profitability, it is perhaps not surprising that there are opportunities for profitable investment that have not yet been exploited. What is surprising is that to the extent that there are deviations from the rules, they tend to be in the direction of lending less.

One plausible reason for why this happens is that the loan officers in these banks have no particular incentive to lend. They are government employees on a more or less fixed salary and promotion schedule and the rewards are at best weakly tied to their success in making imaginative lending decisions. On the other hand, failed loans, as discussed below, can lead to investigations by the Central Vigilance Commission, which is the body entrusted to investigate potential cases of fraud in the public sector. They therefore have a lot to lose and little to gain from being brave in lending. Not taking any new decisions may dominate any other course of action and moreover, this is especially likely to be true if there are attractive alternatives to lending (such as putting your money in government bonds).

The next sub-section examines the role that the fear of prosecution plays in discouraging lending. The following sub-section asks whether the reluctance to lend is exacerbated when the rewards from putting money in government bonds become relatively more attractive.


Inertia and the fear of prosecution

Since public sector banks are owned by the government, employees of the bank are treated by law as public servants, and thus subject to government anti-corruption legislation. There is an impression among bankers that it is very easy to be charged with corruption, and that the law states that if any government functionary takes a decision which results in direct financial gain to a third party, the individual is prima facie guilty of corruption, and must prove her or his innocence.

The executive director of a large public sector bank was quoted saying “Fear of prosecution for corruption hangs over every loan officer’s head like the sword of Damocles.” The Economic


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