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PROBLEMS & PROSPECTS OF PRIORITY SECTOR LENDING BY COMMERCIAL BANKS (A Case Study of Small Scale Industries in Bangalore District)

Clini(}ersi/y of ! /Ky sor e for Ie award o[ 7)oc lor of !PhIiosoph,Y in e conomi c s by UmaS. Wnde r Ie duperuision o[ Prof. Abdul Aziz, Advisor Decentralised Governance and Planning Project Institute for Social & Economic Change Nagarabhavi BANGAI ,ORE - 560 072 October 2001 CERTIFICATE Thi s is to certify that this thesis entitled "Problems and Prospects of Priority Sector LemJing by Commnr ial Banks (A Case Study of Small Scale Industries in Bangalore District) i s a remnI of independent research carried out by Smt. S.Uma at the Institute for Social and economic change for the award of Ph.D. degree in Economics under my supervision. This has not been submitted for the award of any degree. diploma. associate ship or othe r similar title. Place: 8angaIore Date: November Prof Abdul Aziz

Research Supervisor Institute For Social And Economic Change 8anga lor e DECLARATION I declare that the thesis entitled "Problems and Prospects of Priority Sector Lending by Commercial Bank s " (A Case Study of Smal l Scale Industries in Bangalore District) submitted by me for the award of the Degree of Doctor of Philosophy in Economics to the University of Mysore is original and i t has not been submitted previously in part or full to this or any other University for any degree. LA. """" ' S (Uma S.) No.152, "Sri Nrusimha" 208 S.F.S. Yelahanka New Town Bangalore 560064. CERTIFICATE This is to cedify that this thesis entitled "1'robIeas MI l , " ,54 eets of Scale huiJlstries i l l BangaIore District) has be en revised tmder my supervision on die basis of the evaluation report extract provided and the revised thesis i s f i t for re-submissioe.. Place: Bangalore. Date: Oc tobe r 2001 Prof.Abdul Aziz, R.esearch Supervisor, Institute for Social aud Economic Change,

Bangalore. DECLARATION I declare that the thesis entitled "Preblems IIIIIl Prospects of PriDrily ,Ser1er Lending by CDfIJ1Ilen:ial B ' . " (A CI ISe sIIuly of Smal l Scale In" s t r i e s in BtmglllDre Dist r ict ) bas been revised on the basis of the evaNation report exttact provided _ the revised thesis i s fit for resubmission. Pr e f . Abdul Ar i z , Research Supervisor, Institute for Social and Eoooomic Cha agr , Bangalore. \A~,g (UMA.S. ) NO. lS2, "Sr iNms imha " 208SFS, YeJahanka New towa , Baogalore-560064. ACKNOWI ,EDGEMENTS I t is with a deep sense of gratitude that I would like to thank my Research Supervisor Prof. Abdul Aziz, Adviser, Decentralised Governance and Planning Project, Institute for Social and Economic Change (ISEC), Bangalore, for his invaluable guidance, and supervision of my research work.. He is a model teacher and his patience and commitment to work is simply great. Words fail me in expressing my gratitude to him for his encouragement and guidance in undertaking and completing this work. A research theme of the nature that I undertook required information from various sources and involved vast references, discussions with scholars, administrators and policy makers. I t also called for data analysis with the use of

complex methods. In the task of preparing the thesis, I have received tremendous support and help from many quarters. I am immensely grateful to everyone who has assisted me in achieving this. 1be Institute for Social and Economic Change (ISEC), one of the premier Institutes for Social Science Research in India, has been the place where I could T work upon this theme. A number of academicians, administrators and others helped me in achieving my objectives of working on this complex theme. Let me at the outset express my deep sense of gratitude to the Director, ISEC for his encouragement and giving me the opportunity to work in ISEC. Support also came from Sri M Vivekananda, Assistant Professor, ADRT Unit, ISEC, who helped in analysis of data and from Dr.M. Devendra Babu, Assistant Professor, Decentralised Governance and Planning Project, for his valuable suggestions. I would like to acknowledge the timely help received from them as well as Dr M Mahadeva, Associate Professor, ADRT Unit, ISEC. The Registrar and the other administrative staff at ISEC were a constant , source of help in addressing many technical/administrative matters, which arose from time to time during the course of my work. I am highly thankful to Sri H.S. Sadananda, Administrative Officer, ISEC, for his constant guidance and moral support throughout the period of study in matters relating to registration, correspondence with the University etc. Without his support it would not have been possible for me to concentrate upon completion of the thesis. Similar assistance came from the Chairman and I I members of Board of Studies in Economics and Co-operation, Mysore University, for which I am thankful to them The library of ISEC is well known

for its magnificent collection of valuable books, periodicals and other literature necessary for a study set in multi-disciplinary perspective. The Deputy Librarian and all his staff were always ready to help me in meeting the requirements of a thorough scholarly literature survey and documentation. I am highly grateful to them I would like to express my sincere thanks to Mrs. Abdul Aziz, for her concern about my work, her hospitality and encouragement shown throughout the course of my work on this thesis. These went a long way in supporting and motivating me to complete my assignment with success. Many others deserve special mention for their help. Mrs. Shantha Kumari, Receptionist, ISEC, was always obliging whenever I had to use the telephone. The study drew considerable data, insights, and information from a crosssection of officials of Government of Kamataka, Government of India as well as from the banks in the public sector. I would like to thank all the officials of Small Industries Development Organisation (Sloo) , Small Industries Service Institute (SIS I), Department of Industries and Commerce, Government of I I I Kamataka, Kamataka State Small Scale Industries Development Corporation (KSSIDC), District Industries Centre (DIC), for being generous in providing data and clarification on various issues. I am also very grateful to the officers of Reserve Bank of India, State Bank of India, State Bank of Mysore, Lead District Banks, and my special thanks to Mr. Shiva Kumar and Mr. Narasimha Murthy of State Level Bankers' Committee and Mr. K Jagannath, Personnel Department, Syndicate Bank, Gandhinagar, Bangalore. I sincerely thank Sri Mudambadithaya for his scholarly editing of the thesis. I also like to thank Sri Amityush Vyas, Ph.D. Fellow, Development Administration Unit, ISEC.

Guidance in the preparation of bibliography carne from a Senior Social Anthropologist and Ex-Faculty of ISEC, Mr. V.S.Parthasarathy. I am indebted to him for his help. I also thank Dr.K.G.Gayathri Devi, Asst. Professor, Sociology Unit, ISEC, for her help. Neat typing and word processing work was provided by Mr.M.K.Mohan Kumar and excellent laser printing work was done by Mr. T.Srinivasa Murthy. I profusely thank both of them for their help. IV My parents and my father-in-law were always ready with their help, encouragement and blessings, throughout my work. My father Shri P.S. Rao and mother Smt. M.H. Vinoda have been constantly motivating me in all my academic endeavour and have been great source of emotional strength and guidance in my progress. Instead of thanking them I consider it worth dedicating this research work to them I would take this opportunity also to thank my brothers Sri S.Keshava Murthy for providing me with computer facility and Sri SJayathirtha for his comments. My husband, Mr. M.A.Sudhakar, put up with all inconvenience caused due to my pre-occupation and involvement in this research work, and was ever ready to support me emotionally and academically. I am extremely grateful to him Out little son S. Deepak Raj deserves all appreciation for his sweet support, whenever he was deprived of his rightful attention and care by his mother during the course of this study. UmaS. v CONTENTS CHAPTER TITLE OF THE CHAPTER PAGE NOS. ACKNOWLEDGEMENT I-V USTOFTABLES A-E

MAPS i-ii --CHAPTERI INTRODUCTION 1-39 CHAPTER II PRIORITY LENDING PRACTICES - 40-74 INTERNATIONAL AND INDIAN EXPERIENCE CHAPTER III PRIORITY LENDING TRENDS - INDIA, 75-103 KARNATAKA CHAPTERN POUCY PROGRAMMES AND 104-154 PERFORMANCE OF SMALL SCALE INDUSTRIES CHAPTER V PROFILE OF THE SAMPLE UNITS 155-194 CHAPTER VI UTILISATION OF CREDIT AND LOAN 195-229 REPAYMENT CHATPER VII IMPACT OF PRIORITY LENDING ON 230-289 PERFORMANCE AND EMPLOYMENT OF SSIs CHAPTERVm IMPACT Of NEW ECONOMIC POUCY ON 290-314 PRIORITY SECTOR LENDING AND SMALL SCALE INDUSTRIES CHAPTER IX SUMMARY AND POUCY IMPUCATIONS 315-336 Bf f iUOGRAPHY 337-346 ANNEXURES 347-355 LIST OF TABLES TABLE TITLE PAGE NO. NO.

2.1 Schemes 10 Operation (Developed and 57-58 Developing Countries) 3.1 Public Sector Banks Advances to Priority 91 Sectors in India 3.2 Advances Under Integrated Rural Development 93 Programmes - All India 3.3 Priority Sector Advances in Kamataka 96 3.4 Public Sector Banks Advances to Agricultural 97 Sector in Karnataka State 3.5 Public Sector Banks Advances to Small Scale 99 Industries in Karnataka 3.6 Public Sector Banks Advances to Other 100 Priority Sectors in Kamataka 3.7 IRDP Programme during 1980-81 to 1997-98 103 in Kamataka State 4.1 Overall Performance of Small Scale Industries 124-125 Sector from 1973-74 to 1997-98 4.1(a) Investment, Output and Export of SSIs a t 128 Constant Prices (All India) 4.2 The Share of SSI Production in Total Industrial 130 Production and Their Index Growth Rate (All India 4.3 Share of SSIs in total Exports 133 4.4 Principal Characteristics of Major States, 1997- 146 98 (All Industries)

4.5 Number of Registered Small Scale Units in 10 147 States - 31 December 1996 4.6 Trends in Industrial Development in Kamataka 149 TABLE TITLE PAGE NO. NO. 5.1 Districtwise Profile of SSIs in Kamataka State 157 5.2 Industrywise and Regionwise Selection of 163 Sample SSI Units 5.3(a) The Source of Fixed Capital and Working 181 Capital of Surveyed Small Scale Units in Rural Area 5.3(b) The Source of Fixed Capital and Working 182 Capital of Small Scale Units in Urban Area 5.4 Frequency Distribution of Capital-Output Ratio 186 of the 100 Small Scale Units Surveyed 6.1 The Amount of Unutilised Total Bank Credit 200 and SSI's Credit (All India) Sanctioned by Public Sector Banks 6.2 The Amount of Unutilised Total Bank Credit 202 and SSI's Credit Sanctioned by Public Sector Banks - Kamataka 6.3 Gross and Net NPAs of Public Sector Banks as 215 Proportion to Gross Advances and Total Assets (All India) 6.4 Sectorwise NP As of Public Sector Banks 1995- 216 1999 (All India)

6.5 Recovery and Overdues Positions of Total 218 Bank Credit and Credit to SmaIl Scale Industries in Kamataka State (As on June) 6.6 Time Taken to Sanction the Loan (in days) 220 6.7 Beneficiaries' Opinion Regarding Sanctioning 221 of Loans 6.8 Relationship of Beneficiaries with the Banks 222 6.9 Units with Overdues and Causes for Overdues 223 TABLE TITLE PAGE NO. NO. 7.1 Average Gross Profitability of all the Units and 237 Industrywise Average Profitability to Sales (Percentage) (Urban Region) 7.2 Unitwise Gross Profitability (Percentage) 242 7.3 Profitability of Beneficiary Industries and Non- 251 Beneficiaries 7.4 Frequency Distribution of Profitability m 253 Different Industries, Units, Beneficiaries and Non-Beneficiaries 7.5 Annual Sales of Industry, Units and Average 256 Sales as a Percentage of Investment 7.6 Rate of Return on Investment 258 7.6(a) Frequency Distribution of Return on 260 Investment 7.7 Net Profitability, Asset Utilisation and Overall 262 Profitability of Individual Units

7.8 Frequency Distribution of Profitability and 264 Asset Utilisation Ratio 7.9 Average Gross Profitability of all Units and 267 Industrywise Average Profitability (Rural Region) 7.10 Unitwise Gross Profitability to Sales 269 (Percentage) (Rural Region) 7.11 Profitability of Beneficiary. and Non- 270 Beneficiary Units (Industrywise Data) Rural Region (Per cent) 7.12 Frequency Distribution of Profits in Different 271 Industries, Units, Beneficiary and NonBeneficiaries (Rural Region) 7.13 Annual Sales of Industries, Units and Sales as a 272 Percentage of Investment (Rural Region) 7.14 Rate of Return on Investment 274 D TABLE TITLE PAGE NO. NO. 7.15 Frequency Distribution of Return on 275 Investment (Rural Region) 7.16 Overall Profitability of Rural Units 277 7.17 Frequency Distribution of Capital-Labour 282 Ratio - Urban Area 7.18 Frequency Distribution of Gross Productivity 284 of Laobur and Capital in Urban Region 7.19 Frequency Distribution of Captial-Labour 286

Ratio of Sample Units in Rural Areas 7.20 Frequency Distribution of Gross Productivity 288 of Labour and Capital in Rural Areas 8.1 Trends in Priority Sector Lending by Public 298 Sector Banks (All India) 8.2 Index Growth Rate of Total Priority Sector 300 Advances and Advances to SSI, 1969-1995 8.3 Impact of New Economic Policy on Credit 304 Availability to SSIs According to SSI Entrepreneurs under Survey E Key Map Showing KARNATAKA N A Key Map Showing BAN GALORE Bangalore Urban Bangalore Rural N A CHAPTERl PROBLEMS AND PROSPECTS OF PRIORITY SECTOR LENDING BY COMMERCIAL BANKS (A Case Study of SmaIl Scale Industries in Bangalore District) Introduction: Banks pl ay, an important role in the modem economy by providing necessary credit to different sectors of the economy. In recent years they have

been assigned the responsibility of fmancing what are called the priority sectors. The word priority sector i s used for those segments of the Indian economy whose development is considered essential for the e conomi c growth of the country and attainment of ' soc i a l justice', but which had received only indifferent attention from the private sector banks. In the process of development, certain sectors l ag behind, but the development of these sectors is essential for accelerating growth. These sectors lag behind because they lack financial resources. As the banks are urban biased and profit-oriented in their approach they are less likely to finance these sectors because the latter are: (1) less profitable, (2) lack collateral securities, and (3) are high-risk sectors for lending. Without providing necessary assistance to these sectors it will not be possible to accelerate the growth of the economy. In India, 1 agriculture, small scale industries and exports are identified as the priority sectors. Priority sector lending implies priority in the allocation of funds at concessional rate of interest, margins etc., to units of the priority sector identified as such. Small scale industries I form an important sector of the Indian economy. In 1997 -98 they accounted for 40 per cent of the industrial output and 35 per cent of the exports. They provided employment to 160 lakh workers 2 The prime objective of planned economic development is to make more efficient and judicious use of scarce resources in order to achieve economic development. In a country like India, human resources constitute a major resource, which is also relatively abundant and entrepreneurs are capable of making only small

investments. Small industries, which are labour intensive and capital saving play a vital role in the utilisation of these abundant resources and thereby help promote economic development of the country. Case studies undertaken by the study group of the National Credit Council showed that: 1 Inve s tment l imi t s for SSI and Anc i l l a ry indus t r i a l unde r t akings we r e r a i s ed to Rs . 3.00 Cror e s f rom Rs . 60.00 Lakhs and Rs . 75.00 Lakhs , r e spe c t ive ly. The l imi t for t iny uni t s wa s r a i s ed to Rs . 25.00 Lakhs f rom Rs . 5.00 Lakhs . (For mor e de t a i l s s e e Annexur e - I ) . 2 Office of the Development Commissioner. SSI, Ministry of Industry, Govt. of India, Annual 2 ( I ) The credit extended by commercial banks was not widely disbursed and there are credit gaps particularly in the case of small borrowers. (2) There was potential demand for credit by small borrowers, but the nonexistence of institutional facilities resulted in their approaching moneylenders and traders. (3) Co-operatives, which were already in existence, were not in a position to provide adequate finance to these sectors (G.O.1. 1969: 81-6). Also in view of the planned effort for economic development of the country it is necessary to have institutions, which can sub-serve the social and economic objectives of planning. Government's accepted policy envisages that the benefit of development must accrue more and more to the relatively less privileged classes of society and that there should be a progressive reduction in the concentration of income, wealth and economic power. In this context, it is necessary to make credit facilities available to high priority sectors like

Agriculture, Small Scale Industries and Exports. At present other priority sectors include other small business and service sector. In the context of the failure of the large industries to solve the worsening problem of unemployment and poverty which is the result of the concentration of economic power in the hands of few and increased inequalities in the distribution of income and wealth, agriculture (especially small farmers), small scale industry and other priority Report, 1997-98 3 sector play a major role in solving these problems. This has been recognised throughout the world by the policy makers, governments as well as academicians and researchers. As these sectors can be developed with limited available capital and light technology, it permits more population to participate in gainful economic activities with which we can solve the problem of poverty, reduce the inequalities in the distribution of income and wealth at the national level and unemployment problem at the individual level. Since 1950s the Government of India have appointed a number of Connnittees to look into the financial needs of the different sectors of the economy and to assist the government and the Reserve Bank of India in allocating credit among different sectors and to determine the relevant priorities. The All India Rural Credit Review Connnittee (RBI, 1986), the study group of the National Credit Council (RBI, 1968-69), the Banking Connnission (1972) and the Agricultural Credit Review Connnittee (001, 1986), in one or the other way have emphasised the role of commercial banks in providing credit to the priority sectors, as the co-operatives which are providing such assistance were not in a position to meet the needs of these sectors adequately. At the end of July 1967, the Reserve Bank of India urged the commercial

banks to enlarge their assistance to priority sectors. Also a concessional rate of 4 4.5 per cent interest was charged on borrowings of commercial banks from the Reserve Bank of India equivalent to priority sector lending. So emphasis has been laid on the banks moving away from security-oriented lending to purposive, productive and incremental income-oriented lending. M. Narasirnham Committee (1992) suggested that the system of directed credit programme should be gradually phased out and that the credit programme should cover a redefined priority sector, consisting of small and marginal farmers, tiny sector of industry, small business and transport operators, village and cottage industries, rural artisans and other weaker sections. The committee proposed that the credit target for this redefined priority sector henceforth be fixed at 10 per cent of aggregate bank credit, which the Committee observed, would be broadly in line with the credit flows to these sectors at present. With regard to the large and medium farmers and Small Industries now enjoying the benefit of concessional credit and to whom the direction would no longer apply, a preferential refinance from the Reserve Bank of India has been suggested. The Committee believes that the distributive justice should be attained by fiscal instruments rather than the credit system So directed credit programme should not become a regular feature but can be made use of in extra-ordinary situations to correct imperfections in the credit market. I 5 According to the Committee, the growth of agriculture and small scale industries in India has now reached a point where the productive requirements of these sectors could be met by banks on the basis of their commercial judgements. Two decades of such preferred credit is a long enough period to evaluate the

impact of priority credit, the necessity of its continuation, particularly in respect of those who are able to stand on their own feet. In the opinion of the Committee, the directed credit should be limited only to the really needy such as small and marginal fanners and tiny sector industries (1992: 43-4). The Committee set up by the Reserve Bank of India (Chainnan, P.R Nayak, 1991) to look into the various aspects of credit requirements of the small scale industries sector submitted its report in September 1992. The terms of reference of the Committee included examination of: (a) the adequacy of institutional credit and its timely flow to the small scale industries, village and tiny industries, (b) the need for modifications/relaxations m the norms prescribed by the TandonlChore Committees in so far as the SSI is concerned. The Committee has suggested that small unregistered units with credit limits of not more than Rupees One Lakh should have the first claim on the priority sector credit to small scale industries and the new priority sector credit dispensation (R.B.I., 1991: 118). 6 Different Schemes under Priority Sector Lending: The priority sector lending includes lending to agriculture (direct and indirect), small scale industries, transport operators, self-employed persons, rural artisans and the weaker sections. The weaker sections within the priority sector comprise: (1) small and marginal farmers with land holdings up to 5 acres, landless labourers, tenant farmers and share croppers, (2) artisans, village and cottage industries enjoying credit limits up to Rs. 25,000/-, (3) Integrated Rural Development Progrannne (IDRP). Differential Rate of Interest Scheme (DRI) and Self-Employment Progrannne for the Urban Poor (SEPUP) beneficiaries and

(4) beneficiaries belonging to Scheduled Castes and Scheduled Tribes. In accordance with the guidelines recently issued by the Government of India, Ministry of Rural Development. Now the Swamajayanthi Gram Swarozgar Yojana (SGSY) has come into force replacing all the earlier programmes viz., Integrated Rural Development Programme (lRDP), Training of Rural Youth for Self-Employment (TRYSEM). Development of Women and Children in Rural Areas (DWCRA) and so on. Trends in Priority Sector Advances: Priority sector advances of public sector banks increased from Rs. 441 7 Crores (14.6 per cent of the total advances) as at the end of June 1969 to Rs. 91,318 Crores (41.8 per cent of the total advances) as at the end of March 1998. Out of that, agricultural advance which was Rs. 162 Crores (504 per cent) as at the end of June 1969 has increased to Rs. 34,304 Crores (15.7 per cent) at the end of March 1998. The share of small scale industries in priority sector advances as at the end of March 1967 was Rs. 177.9 Crores (6.6 per cent) and has increased to Rs. 38,109 Crores (17.5 per cent) at the end of March 1998. Other priority sector advances (small transport operators, self-employed persons, rural artisans etc.) were Rs. 22 Crores (0.7 per cent) as at the end of June 1969 and has increased to Rs. 18,881 Crores (8.6 per cent) at the end of March 1998. Review of literature: There are many studies regarding the impact of priority sector lending to agriculture. They have concentrated on individual schemes (IRDP, DRI, Service area approach as such). Also there are plenty of studies on the role of credit in alleviation of poverty (NCAER, 1972), Planning Commission Draft VI Plan,

Rao and Aziz (1989), Gunashekaran (1985), Krishnarnaraju (1992), Rao, Malya and Kurian (1980). 8 But not many studies are there which throw light on priority sector lending to small scale industries. A study conducted by Arundati (1991: 168), i s a macro level study, which concludes that there is growth in the credit to small scale industries in absolute values, but in percentage terms this growth is insignificant, and also declining. Some studies have analysed the impact of government policies on small scale industries. The findings of these studies are the following: 1. The average size of investment on fixed assets, annual turnover and employment were found to be larger in Bangalore District than those in other three districts namely, Mysore, Dharwad and Gulbarga (Tiwari, and Others, 1991:198). 2. The units in backward regions have financial constraints and therefore, more liberalisation in the scheme of financial incentives is required. For, financial incentives have brought up labour-intensive units (Bharathan, D. 1990). 3. (a) Units displayed wide variations in output pe r rupee invested in productive capital. (b) Units recording profits over 50 per cent on capital invested accounted for roughly a sixth of the number reporting profits. 9 (c) Commercial banks played a major role providing around 75 per cent of the short-tenn borrowings of the units (NCAER, 1972). 4. (a) The major share of total bank credit to small scale units in the country (52 per cent) has gone to four states namely, Maharashtra,

Tamil Nadu, Gujarat and West Bengal. (b) Financial credibility on the part of the small scale units is a must to induce greater [mance by banks (Pareek, H.S., 1978: 259-62). 5. Bala's study (1981:302) shows that the smaller the size of the units, the lesser was its ability to borrow from institutional sources. A survey made by the Reserve Bank of India found that this was so in India as a whole. 6. Studies carried out by Sandesara (1988:649) revealed that, assisted units had higher labour productivity, higher surplus and higher average wage than non-assisted units in a majority of industries. I t is estimated that this sector accounts for nearly four-fifth of the total workers employed in manufacturing. In the above-mentioned studies pre and post loan framework has been made use of. There are some more studies (Gunashekaran (1985); Rosen, George (1988); Krishnarnaraju (1992); NCAER (1972) and others are based on secondary data alone. They do not give us micro picture of the situation. 10 Available micro studies have covered these aspects partially. The study on the problems and prospects of priority sector lending as a whole with reference to small scale industry i s very much necessary. There are case studies of Rajasthan (Pareek, H.S. 1978), Ludhiana (Singh, 1990), Tirunelveli (Barathan, D., 1990), and Bombay (Doodha, 1965). NCAER (1978) has collected primary data from 250 selected units a l love r the country. However, not many studies are available on Kamataka experience. There is one study (Tiwari, K.V., eL...fJl., 1991), which evaluates the Kamataka State Finance Corporation's assistance to small scale industries. But i t has not dealt with the extent of priority sector lending by commercial banks, its impact, utilisation and recovery. Hence, there is need for a

more comprehensive study on Kamataka. I t is proposed in the present study to carry out a comprehensive study of priority lending with particular reference to small scale industrial sector in Bangalore District. Objectives: The main objective of the proposed study i s to examine the various aspects of priority sector lending to small scale industries by public sector banks. More specifically the objectives are: 1. To assess the extent and purpose of credit channelled to priority sector and especially to small scale industries. 11 2. To assess the extent of utilisation and the extent of recovery of loans provided to small scale industries. 3. To examine the impact of credit on employment and profits of the borrowing units and to compare this with the unassisted units. 4. And to assess the prospects of priority sector lending in the light of the new economic policy and to make some policy recommendations. Hypotheses: The proposed study will verify the following hypotheses: 1. The proportion of credit channelled to small industries has been increasing ove r t ime . 2. Loan utilisation rate has declined ove r time. 3. (a) The rate of loan recovery has declined ove r time. (b) Loan recovery and rate of profit are directly associated. 4. (a) Availability of credit has increased the level of employment. (b) Availability of credit has increased the profit rate.

12 Theoretical and Analytical Framework: The process of development can be accelerated by identifying constraints to development and releasing such constraints. Experience has i t that certain sectors lag behind because of lack of resources especially financial resources. The strategy of development should be to provide finances to such sectors. Theoretically, the third world economies are characterised by dualism, having organised and unorganised sectors. The organised sector is supposed to enjoy monopoly and operate under the oligopolistic market conditions. But since the enterprises operate in the oligopolistic market conditions, they restrict output with a view to maximising profit. Also the equilibrium output level in their case is produced not at the minimum cost but at the level, which is above the minimum cost. Hence in the organised sector not only output is less than optimum but it is also produced under inefficient conditions. On the other hand, in the unorganised industrial sector, since the number of firms is very large, one can say that they are working under competitive conditions. Therefore, output in this case is of optimum level and produced at the lowest possible cost. But since they are starved of financial capital, their average cost curve is likely to be slightly above the cost curve that otherwise obtained when financial capital is provided to them. The rationale of providing financial capital to these units, therefore, is derived from the fact that they produce optimum output at minimum 13 cost. The banking sector which channelises concessional credit to the small scale industries sector, will be expected to function as a discriminating monopoly, that is, it should advance credit a t concessional rate to the small scale industries sector and compensate this loss by charging higher rates to the

organised sector units. By means of such a cross subsidisation process, the banks will not only support the weak enterprises but also maximise their own profits by functioning as discriminating monopolists. Banks have to depend on public deposits to provide finance to different sectors. They try to earn reasonable profit in their transactions. Also they are supposed to provide certain amount of their deposit to priority sectors at concessional rate of interest as directed by the Reserve Bank of India. While doing this, it is very much necessary for the banks to manage the funds in such a manner, that it leads to the development of the bank, beneficiaries and the state. That too while lending to SSIs it is a must on the part of the bank, to take into consideration financial viability and technical feasibility of the beneficiaries. Banks finance only viable projects. There are various techniques involved in the appraisal of the viability of the project, which depend on several factors. 14 One of the important factors is that any project i f implemented on commercial basis should result in generation of adequate profits. When the entrepreneur approaches the bank for credit, the project report will be appraised considering certain parameters stated below: 1. 2. 3. 4. 1. Commercial viability Technical feasibility Financial viability

Economic viability Commercial Viability: A commercial venture is profitable only when it is capable enough to tap sizeable market. The enterprise will be commercially viable i f it precisely assesses the demand for the product. The demand assessed at the planning stage should be realistic. Many projects have failed due to lack of proper market survey, which is an important factor to be considered while assessing the demand. The deciding factor for assessing the demand for the product is demand and supply gap and seasonal fluctuations. 2. Technical Feasibility: Technical feasibility deals with whether the desired output can be achieved with the available facilities. Following factors are to be considered for evaluating the technical feasibility of the project: 15 (a) Manufacturing process (b) Location (c) Land and Building (d) Plant and Machinery (e) Plan Layout (f) Raw Materials (g) Labour (h) Power The entire production flow chart from the state of raw materials to finished product has to be examined in detail. Location has its own influence on the success of the SSI unit. The proximity tomarket, availability of raw materials, skilled labour, power, etc., are the vital points for the success of a project.

Land and Building: The entrepreneur should be advised to start the activity in a rented building. Many projects have failed because of heavy investment on land and building. Plant and Machinery: Plant and machinery should be in accordance with the technology and market demand. 16 Plant Layout: The machinery should be installed in such a way that there should be easy flow of material from one machine to another. Raw Materials: Raw materials pl aya very important role in the production process. Regular and adequate supply of raw materials at reasonable price has to be ascertained before granting the credit. Labour: SSIs require skilled, semi-skilled and unskilled labourers. Arrangements should be made by the entrepreneur to employ all categories of workers. Power: Without power, production cannot be carried on. The power requirement and the cost of power should be correctly ascertained. Before considering the loan, it should be ensured that the concerned authorities sanction the power. 3. Financial Viability: The financial viability deals with the total project fOst and the means of financing the project. 17 4. Economic ViabUity: Operating profit, break-even point, gestation period are to be taken into account to assess the economic viability of the unit. The entrepreneurs have to survey the market regarding input-output linkages. After examining the viability of the project, one should prepare the project proposal giving details regarding all the aspects. The entrepreneur can approach Small Industrial Service Institute (SISI) for

guidance regarding these matters. SISI provides proper guidance for the entrepreneurs regarding all these factors. Asset Liability Ma1Ulgement (ALM): Availability of credit at right time in adequate amount on appropriate terms has a bearing on production. In the process of widening and deepening of credit the health of the credit institutions is increasingly strained. Banks in the process of providing financial services assume various kinds of financial risks viz., credit, interest rate, foreign exchange and liquidity risks. To some extent this could be eliminated through sound business practices and also through a combination of product design and pricing. Till now banks were c~ncentrating solely on asset-management with liquidity and profitability being regarded as two opposing considerations. So, given certain liquidity levels, 18 banks have to distribute the remaining assets in such a way as to get maximum returns. As a result of liberalisation and deregulation of interest rates, there is a sort of interest war between competing banks. Hence, today interest rates are market driven which has resulted in narrowing down of interest spread, (i.e, interest income minus interest expended). Net interest income (spread) of public sector banks as a percentage to assets has shown a decrease of 25 basic points from 3.16 in 1996-97 to 2.91 in 1997-98. This has led to liquidity crunch and forced the banks to go for costly source of funds, which has a direct bearing on profitability of banks. To avoid liquidity crunch, there should not be any mis-match of assets and liabilities. So, this should be dealt scientifically for which commercial banks have to undertake a comprehensive asset-liability management. The monetary and credit policy for the second half of 1997-98 emphasised

the need for banks to have a comprehensive ALM sys t em This encompasses a process of continuous management of assets (in tenns of planning, organising and controlling) and liability volumes, rates and yields and incorporating the maturities of assets and liabilities into consideration as well. This requires gathering of enormous data, market research and quick empirical reports to enhance the Management Information System (MIS). For this purpose, 19 commercial banks have Funds Managers (FMs), who have to assess the mismatches in various time periods, which are called different maturity time buckets. For asset-liability management 90 per cent of the savings bank account is considered as core asset, for current account it depends on area and bank. Time buckets are classified as follows: Buckets: 1 day to 14 days 15 days to 28 days 29 days to 90 days 91 days to 180 days 181 days to 1 year Above 1 year to 3 years Above 3 years up to 5 years and above 5 years For determining volatility in time buckets trend analysis, market analysis and residual maturity pattern (i.e., how many days left for the maturity of an asset) are taken into consideration. To do this, enormous data needs to be collected. There is a problem regarding the collection of data and lack of accuracy in data collection is another drawback. But scientific management of assets and liabilities will not only improve banks credit management processes 20 and increase profits but also enable them to develop mutually beneficial

relationships with customers. So, in order to know the implications of these constraints under which the banks have to work, we consulted banking personnel at different levels (administrative and supervisory). They opined that ALM is a must for the proper management of bank funds, as it belongs to public. Now, they are having separate division consisting of experts to look into the management of ALM and they are doing it in a successful manner and they also assured that ALM would not have any adverse effect on priority sector lending. Small scale units are mostly the units started by persons with meager means. In such cases, once for all capital lending by State Finance Corporation or own resources are available to the entrepreneur. But having started the unit the entrepreneur faces the working capital problem. Considering his means, the working capital requirements of the small entrepreneurs are much larger because his enterprise is both labour and raw material intensive. Since he uses more labour and more value of raw materials pe r unit of fixed capital, he naturally faces the working capital problem. Besides, owing to uncertainty regarding the availability of raw material on time, which is essential for meeting the day-to-day demand schedule 21 promptly, the entrepreneur tends to stock large inventories of raw-material. Besides, because of competition from the l a rge entrepreneurs the small industrialist when approaches the raw-material supplier for the requirement, the supplier has a tendency to charge higher rates. Therefore, to obtain economies of scale the small entrepreneur is forced to buy raw material in bulk and stock it. Because of all the reasons stated above, small scale entrepreneurs require

large amount of Working Capital. Since the Working Capital requirement is large, any increase in its cost is likely to impose a heavy burden on the production cost. This being the situation, the cost of credit constitutes a very important position in determining the production cost and profit margin of SSI's. COST AND BENEFIT OF DIFFERENT SOITRCES OF FINANCE The Indian financial system, which refers to the borrowing and lending of funds or the demand and supply of funds, consists of two parts, viz., the Indian Money Market and the Indian Capital Market. The Indian money market is the market in which short term funds are borrowed and lent. The capital market in India, on the other hand is the market for medium and long term funds. As our study deals more with the working capital problem, let us 22 focus our discussion on Indian money market, which provides working capital funds. The Indian money market is relatively underdeveloped, and cannot be compared with such advanced money markets as the London and New York money markets. The Indian money market is divided mainly into two sectors namely organized sector and the unorganized sector. The organized sector of the money market consists of commercial banks, which includes private sector banks, public sector banks and foreign banks. The unorganized sector consists of indigenous bankers or money lenders including non-banking financial companIes. Channels of funds for small firms also include entrepreneur's own funds (from their personal savings, or from proceeds of sale of their assets as such), loans from their relatives and friends. Dhar, P.N., (1958:41), in his survey in

Delhi found that "the only source of internal finance consisted of relatives, friends and traders." In the survey of handloom industry in Kamataka and Sholapur also, it was found that "on the whole, master weavers and money lenders constituted the major source of funds both in urban and rural centers" (NCAER, 1959). Generally, small entrepreneurs accumulate capital funds from their own 23 savings. As the aggregate savings of the people in the country are very low because of low per capita income. this provides a meager source of funds for investment. But as the majority of the entrepreneurs who come forward to start small scale units are financially poor. and as they have to depend on the unit for their livelihood they will not be in a position to invest more. So they can accumulate only small amount of capital that too with great hardship. When compared to other sources of finance. the cost they incur here is the interest income that they would get i f the same amount had been kept in fixed deposit or lent to some one else. Apart from this they have to take risk and bear the liquidity cost. The point made by the Society for Social and Economic Studies (1959:25). tha t " the dearth of capital resulted from a low income level. a small capacity to save and hence a lack of capacity to invest" is quite apt here. After pooling the money. which they have. small entrepreneurs tum to their relatives and friends for financial assistance. This source can be generally used for fixed capital purpose. because working capital needs will be there throughout the process of production for which they cannot relay on relatives and friends. Also the financial position of their relatives and friends is somewhat the same as those of the entrepreneurs. Even here they have to pay interest at a rate that exists in the unorganised sector of the money market.

which is normally higher than that of the bank interest rate. Again lenders may 24 demand the money back at any time of financial crisis of the business, which make things worse. So the small entrepreneurs cannot consider this source as a reliable source of credit. Indigenous bankers or Money Lenders: Long before the formal establishment of the banking industry in India, indigenous bankers were providing credit to business and industry. In the beginning nearly 95 per cent of credit needs were met by these lenders. Even today they are playing prominent role in the supply of funds. As they do not come under the purview of the Reserve Bank of India, they charge a very high rate of interest, which will be a real burden on the poor entrepreneurs (interest rate is almost double that of the bank interest). They lend money against movable and immovable assets. One big advantage is, they are ready to lend money as soon as they are approached. On the other hand, the borrower has to wait for more than a week or even for months to get bank loans. The indigenous bankers are not worried about the purpose of borrowing as they lend money both for productive and unproductive purposes. Such lending may result in misutilisation of funds by the borrowers, which may lead to failure of the business. Another problem of this source of finance is that, in case of non-repayment of loans, the moneylenders take over the assets against which loan is lent. So there is the fear of losing the property also on the part of the borrower. This works as a deterrent on attempts to misutilise borrowed funds. 25 Review of available literature on financial sources of SSIs reveals some interesting points about costs and benefits of borrowing. I t is said "Informal sector enterprises generally have virtually no access

to credit facilities from formal sector institutions and where credit is available from informal sources, interest rates are exorbitant". (Sethuram, 1977a: 345). ILO studies have also highlighted this fact. According to a study conducted by Thippaiah (1993), " I t is found that 40.12 percent of the informal sector units borrowed by paying interest of Rs.5 per month on Rs.lOO which comes to 60 percent per annum. 13.77 percent of the households paid 120 per cent interest on their loans. These are largely loans borrowed from the informal money markets. 19.78 percent of the households paid interest of Rs.12 to Rs.18 percent per annum, which are the usual lending rates of commercial banks. The rest (15.57 percent) obtained loans from friends and relatives, which are interest free." Small firms face some problems such as the following while borrowing from banks: a) Small firms are not fully aware of the priority loan facilities. b) Lenders have less knowledge about the affairs of small firms than of 26 large fInns. Hence, they do not come forward to lend money to small fInns. Small fInns are also not in a position to prove their credit worthiness to lenders. c) As the transaction cost tends to vary inversely with the size of loan, transaction cost for small loans will be more. d) After applying for loans, they have to wait, some times for months to get the money According to Lakdawala, D.T., and Sandesara, J.e., (1960:70), bureaucratic procedures constituted one of the important impediments to the utilization of institutional resources. Mishra, T.N., (: 72), in his study in Saugar

district found that "industrialists preferred a bania (Private money lender) to a co-operative bank for meeting their needs because of complicated formalities, cumbersome procedure and undue delay." Ramakrishnan, (1975:36), in his study in Delhi found that entrepreneurs were prepared to payor had paid higher rate of interest to non-banking sources to avoid bank formalities. Even with all these defects bank credit is one of the important sources on which SSIs can rely to meet their working capital requirements. Under the above circumstances, bank loans provided to SSIs under priority sector are the only source of fInance available to them at low cost with n convenient repayment schedule. As the priority loans are provided at concessional rate of interest it will not prove to be a heavy burden on the entrepreneurs. Co-operative banks also provide working capital loans for the entrepreneurs in their area at low interest. But due to lack of funds they are not in a position to provide adequate funds for the SSIs. Capital markets play a prominent role in mobilizing the savings of the people and channelising the same into productive investment purposes. I t establishes a link between supply of and demand for credit in the economy. In India, till late 1970's the role of capital market was almost insignificant, as the average amount of capital raised during that period accounted for Rs.80 to Rs . loo crores per annum. But in the later half of 1980' s and the beginning of 90' s India witnessed a drastic change in the field of capital market. Not withstanding this, small companies have less access to both internal as well as international capital markets. As regards share market the minimum capital required to register in the Share Market is Rs.5 crores, small scale industries

whose capital investment limit is within Rs. I crore (at present) have no chance to utilize this opportunity also. Venture capital, which can pl aya key role in the development of SSIs are yet to find a place in this sector. The figures for peak level investments is 1993-94 illustrate both the relative importance of inflows of overseas capital and their disproportionate distribution to large firms. GDR and Eurobond issues up to the end of October 1994 (i.e., 1991 till 1994) amounted to a close to US $ 6.2 billion issued by private sector companies in the domestic stock markets and US $ 8.4 billion disbursed by the Indian financial institutions. Nearly half of the GDR and Eurobond issues were accounted for by the top 20 companies of the Indian corporate sector although fast growing small companies are also beginning to take advantage of the opportunity (Charles Collyns, 1995). Large companies are provided with an opportunity to lower their cost of credit by increasing their equity share prices. SSIs are devoid of that opportunity also because they have less access to equity market. All the available sources of capital market concentrate on providing funds to medium and large scale industries only. Small scale units are too small to attract the attention of these constituents of capital market. As a result, they have no access to these sources of finance. Foreign Direct Investment has also made its way in the Indian capital market after the implementation of the New Economic Policy of 1991. But these investors are also attracted towards large and medium scale units instead of small scale industries, because the information necessary to ascertain the viability of the SSIs is not available in our economy. And also SSIs are not in a position to prove their credit worthiness. In a country like India, where small scale units are more in number and

where majority of the units are proprietorship firms, collecting funds through shares is completely out of question. Such being the situation, banking institutions are the only source of credit available to small scale entrepreneurs. Apart from this, either they have to borrow from their relatives and friends or from the moneylenders. As moneylenders are from the unorganized sector of the money market they charge a very high rate of interest, which is an unbearable burden for the poor entrepreneurs. Even the economic position of the friends or relatives is not any better. Such being the situation, SSIs cannot rely on them also. The following statements from the Report of the Expert Committee on Small Enterprises headed by Abid Hussain support these points: 'The State of development of the venture capital industry in India is a cause for considerable worry. India has the dubious distinction of having one of the smallest venture capital industries in the world and is small even in comparison to its counterparts in Asian countries. The number of venture capital companies per 10 million capita is about I compared to more than 100 in Singapore. Overall, the relative share of credit to the small sector has fallen from 13.0 percent of the gross bank credit in 1994-95 to 11.4 in 1995-96. This clearly constitutes a series of great alarm for the small scale sector, which is heavily dependent on the availability of bank credit for its health. Undoubtedly, large companies are also affected by the stringent supervision of the banking system. However, they have more options to cope with short supply of credit. Credit worthy large companies have the choice to raise capital by commercial paper and certificates of deposits. Many of them have also established in-house finance companies as an additional means to raise resources. Finally, they can take recourse to international capital markets especially since India enjoys the confidence of overseas investors.

In the emerging economic climate in India, small companies will have to inevitably rely more on trade credit which has been their traditional source of finance as bank credit has become more difficult and other sources of finance such as the securities markets are out of reach or sources such as venture capital funds are yet to materialize. Their costs of debt will rise, as interest costs remain high. In periods of economic downturns, small companies will be extremely vulnerable as the costs of servicing debt rise." (Husssain committee (1997. Scope 0/ the Study: Owing to the constraints of time and resources, it is proposed to restrict the scope of the study to some selected small scale industrial units located in Bangalore District. Since 22 per cent of the small scale industrial units of Karnataka are located in Bangalore District, we felt that a study of some of the selected units in this district will be representative of the State of Kamataka. The study examines the priority sector advances by public sector banks, which constitutes major part of the commercial banks. Methodology: In the present study we have collected and used both secondary and primary data. Secondary data regarding the extent of lending to different priority sectors by public sector banks (including small scale industries) was collected from the Reserve Bank of India Bulletins and other related publications. From the same sources data on over dues and repayment was collected. Information regarding priority sector lending was collected from different banks viz., RBI, State level Bankers' Committee, Lead Bank (Hangalore Division) and other public sector banks. Using an interview schedule, the field data was collected about credit requirements, its utilisation, and impact of credit on employment and

profit from the respondent units. 32 SAMPl . lNG PROCEDURE: Karnataka being one of the industrialized states of the country, it had the distinction of having large and medium scale industries started both by private capital and state capital. The public sector units were mostly in the engineering and chemical industries and the private sector units were in cotton textile industry. In response to the demand for spare parts and other equipment, from large and medium scale industries, a large number of small scale industries emerged as ancillary units in the State. An interesting feature of the SSIs is that they have a wide spread not only across the state but also across different industrial categories. I t is because of this reason that the small scale industries are found in all the districts of the State and under all industrial categories. However, since Bangalore has developed as the major industrial center in the State, a large number of SSIs are located in this district. Thus, out of the total number of small scale units of 247103, 56203 (22.75%) units are located in Bangalore district. Of these, 18.41 percent of the units are located in Bangalore urban district and the r em;ning in Bangalore rural district. (Table 5.1). RESPONSE RATE' 33 Having selected one hundred units for study, we contacted the entrepreneurs of these units by personal visits for data collection. But we faced some problems in the field such as the following: 1) Some entrepreneurs being busy did not find time to give interview. 2) Some were not available in the factory premises when we visited the

units. Hence we had to visit the unit again to catch the entrepreneur. 3) Some entrepreneurs who were present were reluctant to share information out of suspicion and fear. As a result 26 units in urban and 4 in rural areas did not respond. This gives us a response rate of 63 percent in urban areas 87 percent in rural areas. Obviously urban entrepreneurs were less responsive compared to rural areas. This was because many of the urban entrepreneurs were both busy and suspicious when compared with rural entrepreneurs. Pooling together the rural and urban units response, the overall rate works out to 70 percent. However since our target was to survey one hundred units, we decided to replace the units, which were not responsive. In this case we took care to sub~titute them by units of similar category, which were closer in geographical terms to the non-responding units. Obviously, this would disturb the randomness of the sample but since we took care to select in the second round 34 units, which were of the same category and located next door to the nonresponding units, we believe that the disturbance in the randomness of the sample would not be too much to invalidate the conclusions. 'Sinc e a large proportion of units were located in Bangalore district it was considered desirable to draw the sample units from this district. The sample procedure followed was a multi stage purposive random sampling. In the fIrst stage, the state of Karnataka was selected for the study on the ground that it represented the industrially developed states of the country. In the second stage, Bangalore district was selected because, in this district the largest proportion of Small Scale units are located and also because this is the only district where the large number of industrial categories were found. In the third stage, we selected the Categories of industrial units to be studied on a

purposive basis. I t was decided to cover eleven industrial category units because these happen to be the major industrial categories, which more or less cover all the units. In the fourth stage, we purposively divided the units into urban and rural because it was felt that the performance of the units and also their requirement would geographically differ from each other. We intended to examine the locational advantages as regards the availability of inputs (mainly raw materials and labour) and marketing facilities. In the fInal stage, the units for study were drawn randomly from rural and urban areas and from different industrial categories. For data collection, an interview schedule was prepared (which is put as Appendix III) and was canvassed among the entrepreneurs. For field study it was considered feasible on the basis of time and resources available to cover one hundred units of which seventy are from urban and 30 from rural, roughly, this was the ratio in which units were distributed between urban and rural areas. To give representation to the various industrial categories we also distributed the sample units accordingly in a rough proportion to the ratio obtains across the industrial categories. We collected the list of SSI units from the District Industries Center (DIC) and from that, sample units were drawn at random in the final stage. At the stage of interview, some of the entrepreneurs had reservation about sharing some items of data such as sales value and profits. After they were told that the information would be treated as confidential, that the data would be used only for research purpose and that the identity of the unit would not be disclosed in the report, did the entrepreneurs agree to share such information. There were also cases of some entrepreneurs who posed a question as to how they would be benefited by the study as in any case they have to spend so much of their valuable time to answer the questions. In such

cases, they were told that there may not be any immediate and direct benefit to 36 them from this study. But from the analysis of the information when policy recommendations are made about the problems faced by the SSI units like theirs, there is a possibility that these recommendations may find a place in the industrial policy of the state. It is this incentive which prompted the doubting entrepreneurs to share information. Having said all this, it is difficult for us to assure that all the entrepreneurs have honestly shared the information and given precise data. There may be cases of under reporting and over reporting, due to some personal bias. We believe that under such circumstances the average of these categories of replies would cancel each other and give us more or less a correct picture of the condition of the units, which is closer to reality. The following statistical tools were used in the analysis of our data. To examine trends in lending, we worked out index numbers and then arrived at trend growth rates. In addition to the use of index numbers, we used simple averages and ratios in the analysis of the data. Limitations of the Study: ~ The main limitation of the study anses on account of difficulties experienced at the data collection stage. It is worth mentioning these difficulties faced by the researcher for a better appreciation of the problem: 37 l . Entrepreneurs were afraid of giving exact data regarding their profit levels. 2. They tried to hide the infonnation regarding the number of labourers, mainly to avoid prosecution under the Labour Acts. 3. During the survey we found child labourers working in the premises in many units, but the entrepreneurs were not willing to admit that fact.

4. The value of fixed capital reported may be very low because many of them have purchased second hand machinery. Chapter Scheme: The research carried out has been reported in the following Chapters: Chapter 1 is an Introductory Chapter dealing with the identification of the research problem, objectives of the study, sources of data and methodology of the study. Chapter 2 presents a brief account of the nationalisation of major banks and the general aspects of priority sector lending practices - International and Indian experience. Chapter 3 presents trends of priority sector lending in India, as well as in the State of Karnataka, wherein we have also identified the various schemes under which financial assistance is provided. 38 Chapter 4 deals with the policy, progranunes and performance of small scale industries at the national as well as state level in terms of number of units, investment, output, employment, export and so on. Chapter 5 presents the profile of sample small scale units in Bangalore Urban and Rural regions. Based on these studies, we have discussed the extent of utilisation of loans and also the extent of repayment and over dues of priority sector lending at national and state level (Kamataka) in Chapter 6. Chapter 7 is devoted to assess the impact of priority lending on small scale industries in terms of performance and employment. The impact of New Economic Policy on priority sector lending and in tum on small scale industries has been discussed in Chapter 8.

Chapter 9 is the concluding Chapter, which summarises the findings and draws policy implications. 39 CHAPTER II PRIORITY LENDING PRACTICES INTERNATIONAL AND INDIAN EXPERIENCE The financial system of most countries experienced dramatic changes over the past decade in both financial regulation and structure. The governments or central banks in most countries used directed credit controls to channel credit to preferred sectors such as agriculture, small scale industries, business enterprises and housing on subsidised terms. That means selective credit control is used as a tool to achieve the development objectives. This strategy of financing development can be studied under two heads: one with reference to developed countries and the other with reference to developing countries. Developed Countries: After {he World War II, governments began to take a greater inter~~st in the financing of high priority sectors. Direct government intervention in the financial system of several industrial countries increased with the nationalisation of large commercial banks after the 1930's depression and Second World War (for example, France and Italy). Most developed countries used direct controls to regulate the overall expansion of credit and to influence the sectoral allocation of financial resources. Several countries put interest rate ceilings on deposits and loans (Clive Crook (Ed.), Policy and Research Series, World Bank, 1990). In the United States of America for example, restrictions have been imposed on bank lending (negative instruments)*l for stock exchange speculation ever since 1934 and there have been restrictions on consumer credit and real estate credit from time to time. In

U.K. during the war, banks were instructed to give priority to loans, which assisted the war effort, and to discriminate against personal loans and those for speculative purposes. After the war priority was given for advances, which helped exports or saved imports (Furness, L. Eric, 1975:56). The supplementary special deposit scheme or Corset scheme was introduced in December 1973 to restrict the level of lending by banks. The Bank of England employed the corset technique several times during the 1970s for controlling the rate of monetary Nega t ive Xns t rument s one way of organi s ing c r edi t ~nstruments i s in t e rms of pos i t ive and nega t ive ~nstruments. The ins t rument s such a s r e s t r i c t ions , c r edi t ce~l~ngs, ma rgin r equi r ement s a r e de s igned to r educ e or el~~nate the f low of c r edi t to c e r t a in s e c tor s or purpos e s , a r e nega t ive ins t rument s . Pos i t ive ins ' t rument s a r e de s igned to channe l the f low of c r edi t into spe c i f i ed a r e a s . expansion and restraining lending to non-priority sectors (Asha, P. (1987). RBI Occasional Papers: 35). The Japanese banks have played a more important role in financing private industrial investment, than banks in any other part of the world (Takeuchi, Ichiro (1976:136-45). The 'ove r loan' policy*2 in Japan enhanced the role of banks in government's macro-economic policy. On the monetary side, the monetary authorities have followed an artificial cheap money policy and placed quantitative controls on bank loans to support the policy with financial priority given to key industries, thereby facilitating business capital investment. In so far as the banks followed the Preferential I nan policy, they were supplied with central bank credit with relative ease, so it is no wonder that they increased loans

without regard to their liquidity positions. This regulatory framework favoured the provision of bank loans for industrial investment. In Australia, the Reserve Bank in the past resorted to qualitative controls by asking banks to disburse credit to particular classes of borrowers like primary producers or exporters or to avoid lending for purposes like speculative stock building (Asha, P. (1987). RBI Occasional Papers: 35). The authorities in * Ove r loan Pol i cy r e f e r r ed to the s i tua t ion in whi ch banks l ent mor e to bor rowe r s than they took in a s depos i t s . Gennany and U.S. conducted selective credit policies through special institutions. France, Italy, Sweden and other European countries used detailed and comprehensive controls. Housing Finance and Contractual Savings assumed great importance in most industrial countries. Central banks in Italy, Japan, Netherlands, Sweden and West Germany have used various techniques such as asset reserve requirements and government borrowing and re-Iending to preferred sectors (with or without subsidies), such as housing, agriculture, export, small business and under-developed regions. In Sweden Risk bank has always played an active role in promoting various economic and social programmes for preferred and priority sectors such as housing principally through asset reserve requirements. Moral suasion is used in U.S.A., U.K. and Japan (where it is known as 'window guidance') for controlling banks lending policy (Asha, P. (1987). RBI Occasional Papers: 35-8). Developing Countries: In many developing countries governments direct the allocation of credit through various mechanisms. The most common means of directing credit are, by imposing lending requirements on banks, refinance schemes, 19ans at preferential interest rates, credit guarantees and so on. These programmes

43 generally targeted small scale industries. agriculture. state owned enterprises and ( to a lesser extent) housing. exports and under-developed regions. Such promotional techniques are sought to be justified on the grounds that these are typically the sectors. which tend to suffer for want of credit. Directed credit plays a very prominent role in almost all developing countries as commercial banks themselves do not provide necessary credit to priority sectors. Governments in developing countries wanted a financial system that would mobilise deposits and make loans to preferred sectors. To accomplish their objectives. governments introduced sweeping changes in financial practices. In Africa, most governments tended to nationalise the largest commercial banks. In South Asia they nationalised practically all the commercial banks. In almost all developing countries. governments took control of substantial segments of the fmancial system With regard to policies in the financial area, government directed the financial institutions (especially commercial banks) to lend to selected sectors on subsidised terms. Interest rates were also kept quite low (Balasa. Bela (1981); World Bank Staff Working Paper. No. 464). In Pakistan in 1986. government targeted 70 pe r cent of new lending by the national banks. which dominate the banking system,. although this proportion 44 was reduced substantially by 1988. In Yugoslavia in 1986,58 pe r cent of shortteon loans were directed credits. In Brazil in 1987, government credit programmes accounted for more than 70 per cent of the total credit outstanding. In Turkey, in the early 1980s roughly three quarters of all financial system advances were made to government directive or at preferential interest rates or both, although the proportion has since fallen. In Malaysia directed credits accounted for an estimated 30 pe r cent of bank portfolios. At one point Korea had 221 formal directed credit programmes. In 1986,

the Phillipines had 49 schemes for agriculture and 12 for industry. In Brazil commercial banks were required to allocate between 20 and 60 pe r cent (depending on bank size) of their ne t deposits to agriculture. In Nigeria banks were required to allocate credit to two sectors viz., agriculture (15 per cent) and manufacturing (40 per cent). Actually the government control of financial resources was almost total via establishment of detailed credit allocation guidelines for each of the 16 sectors into which the economy was divided (Crook, Clive (ed.) (1990). Policy and Research Series, No. IS, World Bank: 37-9). Selective credit controls are perhaps the most effective instrument through which the volume and direction of credit can be influenced. I f there is a strong and widespread demand for credit from credit worthy borrowers of all types, it is easy to provide credit to priority sectors. But the problem in a developing country is often the lack of effective demand for credit from indigenous borrowers in high priority sectors, particularly agriculture and industry. So the only answer to this problem is to provide subsidies to high priority sectors. The Central Bank of Nigeria has considerable powers of credit control. The bank has authority to fix the minimum proportion of lending that each commercial bank must grant to indigenous borrowers, industry and agriculture. The Bank of Ghana also introduced selective credit controls in an attempt to deflect credit towards industry and agriculture. In Kenya in 1972 the banks were required to adopt a moderate stand on all requests for advances except in the case of agriculture, exports and small scale African enterprises (Furness, L. Eric, (1975): 63-4). In Bangladesh different policy instruments have been used for different sectors at different times. Loans to small business, small loan category and exports were the earliest to be regarded as priority sectors. In February 1975 banks were notified that the small loan category be given priority in any credit

allocation following from an increase in deposits. In September 1975, a lending target of TK I Crore per bank was fixed for nationalised commercial banks lending to this category. During the same period restrictions on housing loans 46 were lifted. The differential credit ceilings were introduced in Bangladesh in 1981 to 'subsidise' certain sectors like agriculture and exports. Almost the entire gamut of policy instruments has been applied to agricultural credit. As part of the small enterprises development policy in the Philippines the banking system has a special progrannne. Most of the t e rm loans to small enterprises are provided through two government progrannnes; the Small and Medium Industry lending (SMI) activities of the development banks of the Philippines and the Industrial Guarantee Loan Fund (lGLF). In Korea, nationwide commercial banks, for example, are required to make available 35 per cent of their loanable funds to small business and local banks must allocate 55 per cent of their loans to small and medium scale companies (Vinnani, Arvind (1984). World Bank Staff Working Paper 672:24-5). In most Latin American countries, directed credits plays an important role in the total credit of the banking system. Directed credit accounted for 30 per cent of the total bank credit in Columbia in 1986, while it accounted for 80 per cent of total bank credit in Brazil and over 40 per cent of bank credit in Argentina. This instrument has also been largely used in Peru and Mexico. In all cases directed credit has been the result of strong pressures applied to the 47 government to provide medium and long term credit a t reasonable interest rates to fmance priority activities, including industrial and agricultural development, urban infrastructure and exports. Brazil is probably the major Latin American country which uses directed

credit to the largest extent. Argentina also has made large use of directed credit. As of March 1987, over 40 per cent of total bank credit was rediscounted by the Central Bank. In Peru, the government, through the Central Bank, has passed regulations mandating commercial banks to lend to specific sectors (particularly agriculture). The Bank Agrario, Banco Minero and Banco Industrial, all publicly owned have provided large amounts of credit in recent years many times based on political pressure rather than economic and financial criteria. These credits have by and large been provided at preferential interest rates. Chile has a system of credit allocation, which resembles free market situation, and there are no sectoral guidelines. The government influences housing credit to middle and lower income group through state guarantees of loans and subsidies to qualified borrowers. Uruguay also has a credit system which allocates funds with little government intervention, exoluding the housing. fmance market which is practically monopolised by the government owned Banco Hipotecario, and a large proportion of the commercial bank credit which is provided by publicly 48 owned banks (Morris, Fellip (1990) and Others (ed.). World Bank Discussion Paper, No.81: 48-53). In Indonesia, to strengthen the development of small industries, the government has implemented several programmes, first among them is fosterparent programme that consists of assistance on marketing, management, technical processing (product design and diversification) and financing. Second, financing of small industries development through profits of state enterprise (BUMN). Third, to provide small business credit (KUK). Fourth, selling large company shares to co-operatives. Fifth, training for small businessmen. These policies are intended to promote the development of small industrial sector to achieve more balanced regional development (Bachrum, S. Harahap, (1993).

Small Industry Bulletin for Asia and the Pacific, No. 28: 8). Government of Nepal has given considerable importance to industrial development as the means of economic development. The role of cottage, small and medium industries is more significant in Nepal, because of resources constraint and also market consideration (Pradhan, B. Kalyan, (1993). Small Industries Bulletin for Asia and the Pacific, No. 28: 41). 49 A range of initiatives has therefore been developed in New Zealand to assist small and medium sized business to improve their perfonnance. Direct government assistance to small business is, however, intended only as a supplement and not a substitute for their own resources (The Ministry of Commerce, Govt. of New Zealand, (1993). Small Industries Bulletin for Asia and the Pacific, No. 28:42). Thailand's strategies to develop small and medium industries include identification and stimulation of entrepreneurial talents, human resource development programmes, information exchange networks, linkage between small and medium industries and large industries, strengthening of public-private co-operation at national as well as regional level, emphasis on improvement of product quality and design, marketing organisation and provision of greater financial incentives and access to lending institutions (The Ministry of Industry (1993), Govt. of Thailand, Small Industries Bulletin for Asia and the Pacific, No. 28:53). Bangladesh, Kenya. Nigeria, Peru, Thailand, Turkey and Uruguay, each of the seven countries maintained directed credit programmes such as, (i) regulation :>0 the portfolio composition of intermediaries'ex-requirements to devote a 50 certain portion of lending to specific activities; (ii) Central bank rediscounting oj

credit to priority sectors, usually a t subsidized mtes; and (iii) Control oj intermediaries through direct ownership (Hanson, A. and R.Neal (1986). Industry and Finance Series, No. 14: 790-8). Credit Guarantee Schemes: Small business enterprises in both industrialised and developing countries have difficulties in obtaining loans. Commercial banks are reluctant to provide credit to these sectors because of the perceived high risks of lending to Small enterprises. Hence, credit guamntee schemes have been introduced to enable commercial banks to provide credit. Credit guamntee schemes are set up with the purpose of covering some portion of the losses incurred when borrowers default on loans. The purpose of such schemes i s to encoumge commercial banks to l end to small business with viable projects and good prospects of success, but which are unable to provide adequate collateral or which do not have a suitable record of financial tmnsaction to prove that they are credit worthy. 51 Credit guarantee schemes are set up in almost all developed as well as developing countries. In the United States the credit guarantee scheme guarantees up to 70 per cent of the loan amount. The Small Business Administration (SBA) loan guarantee progranunes has been relatively successful in inducing commercial banks to lend funds to small business. Guarantees for lending to small enterprises were initiated in Canada under the Small Business Loan Act (SBLA) of 1961 under which approved loans are guaranteed to 90 per cent by the government. The Federal Business Development Bank's (FBDB) direct lending is another support for small business.

Loan guarantees in France are of two kinds, one for medium term loans and the other for long term loans. Actually the guarantee is for lOOper cent loan, but in many cases (particularly for smaller loans), the banks provide a counter guarantee of 50 per cent. In the Federal Republic of Germany guarantees are given by 34 locally based private credit guarantee Associations and the guarantee varies from SO to lOOper cent of the loan, the average is 75 per cent. 52 There are approximately 80 mutual consortia funds, one or more for each province in Italy. The percentage guaranteed and the limit of the guarantee sum is decided case by case by the Board of Consortium. In Netherlands, the Ministry of Economic Affairs guarantees loans granted to small and medium sized business. In Portugal after the revolution of 1974, an Institute for Small and Medium Enterprises was created in 1975 to provide guarantees in order to save the small enterprises, which were in danger of collapse. In Indonesia, A.S. Krindo, a publicly financed Credit Insurance Corporation provides guarantee up to 75 pe r cent. In Korea, The Korea Credit Guarantee Fund (KCGF) was established as a special public corporation by the Credit Guarantee Fund Act of June 1976 and provides guarantee up to 80 pe r cent. The Credit Guarantee Corporation (CGC) of Malaysia Berhad was established by Bank Negara Malaysia in 1972, which ha s the responsibility of risk sharing up to 60 per cent. In Nepal, the Credit Guarantee Corporation was established in 1974 and i t provides guarantee up to 75 pe r cent of the credit. In Philippines, the Industrial Guarantee and Loan Fund (IGLF) were established in 53 1952 and it provides: (i) 25 pe r cent collateral short guarantee and (ii) Credit-risk guarantee of 60 per cent to small loans and 40 pe r cent to medium loans.

In U.K., Small Firms Division of the Department of Industry provided 80 per cent guarantee from 1981 to 1984 and reduced it to 70 per cent after 1984. A sin and the Pac(fie: In Japan there were 52 local public-law credit guarantee corporations, which provide 100 per cent guarantee. In New Zealand the Small Business Agency, a division of the Development Finance Corporation of New Zealand provides lOOpe r cent guarantee for credit, to a maximum of NZ $ 2,00,000 pe r borrower. DeVeloping Countries; Sri Lanka introduced a SmaIl Industry Credit Guarantee Scheme in the 1970s administered by the Central Bank. The guarantee is provided to 60 per cent of the loan or SL Rs.4,OO,OOOI- whichever is less. In Thailand Small Industry Credit Guarantee Fund was set up by Industrial Finance Corporation of Thailand in 1985. In general, it provides guarantees of 80 per Cent and 100 per cent in exceptional cases. 54 4f r i&a: In Cameron a credit gua r ant e e fund was established in 1975, whid provides guarantee to 80 pe r c ent of the credit. In Ghana, a credit guarantef scheme was set up by the Bank of Ghana in 1969, which provides guarantee u~ to 66 per cent. In Liberia, a Cr edi t Guarantee Scheme was set up at the National Bank of Liberia (NBL) in 1979, whi ch provides guarantee to 66 per cent of thf amount of default. In Morocco, the Ca i r r e Centrale de Guarantee set up in 19708. which provides government gua r ant e e up to 80 per cent. In Tunisia a guarantef fund, The Fund National de Gua r ant e e (FNG) was set up in 1989, which provide! guarantee for 50 to 75 pe r c ent of out s t anding loan.

In Latin America and Ca r r ibe an, The Central Bank of Barbados introduced a credit guarantee scheme in 1979 and provides guarantee up to 80 per cent. .m Columbia, a credit guarantee fund, Fondo National de Garantia (FNG) was set u~ in 1983, which provides 80 pe r c ent guarantee. In Haiti, Industrial Developmenl Fund was set up by the Central Bank of Republic of Haiti in 1983 and provide! 75 per cent guarantee. In J ama i c a , unt i l 1982, a credit guarantee scheme Wa! operated by Premier Investment Corpor a t ion (Subsidiary of Bank of Jamaica), and in 1982 the National Deve lopment Bank replaced it and provides guarantee up to 50 per cent. 55 Table 2.1 presents details of various credit guarantee schemes that are in operation in different developed as well as developing countries. I t is clear from the Table that in almost all countries the percentage of risk sharing ranges from 80 to 100 per cent, whereas in few countries it is from 40 per cent to 75 per cent. I t is clear from the table that Japan was the first country to establish 52 local public-law credit guarantee corporations 50 years ago and the Philippines followed it by establishing The Industrial Guarantee Loan Fund in 1952. In Canada, Netherlands, India and Ghana, credit guarantee schemes were started during the sixties. France, Portugal, New Zealand, Korea, Malaysia, Nepal, Sri Lanka, a few African countries and Latin America followed them during seventies. It was in the eighties that the U.K., Indonesia, Thailand, Tunisia and other Latin American countries started credit guarantee programmes (Levitsky, Jacob and Ranga N. Prasad, (1987). World Bank Technical Paper, No. 58). 56 n. . . . "'~l." . 10.7.&.1 "'.& ""' '&' - '"1'& .1,. AJ~" . , . ,&.J' - ' .L ~AJ I '1J. " IAJ AJ.LJ . . .LJ ...... .a .... J. " I I I " -J ........ ""'-'.1, .L'&' -L.&. : . I Name of the Country Guarantee Institution Year of Purpose Risk Sharing Establishment

I. Deye loping COl lotde s 1) N. America Small Business Administration 1968 Fixed 90% (a) U.S. Canadian Government 1961 Capital 90% (b) Canada D.Enmpe ,(a) France SDRsorOCM 1978 100% (b) Germany 34 credi t guarantee Associations - 50-90% average 75% (c) Italy 80 Mutual Consortia Funds - differs from case to case 100% (d) Netherlands Ministry of Economic Affairs Since 40 years 50% (e) Portugal The Institute for Small & Medium Enterprises 1975 80% reduced to 70% (f) U.K. Department of Industry 1981 III. Asia IiIDd lbe Eau:ifi (a) Japan 52 Local Public-law Credit Guarantee Corporation Since 50 years 100% (b) New Zealand Dent. Finance Corporation 1978 100% (Small Business Agency) 57 TABLE 2.1 ( ( ,ONTD. l ' . ' " ' ' C! " a , , fnr ~",~II ~n" Name of the Country Guarantee Institution Year of Establishment Purpose Risk Sharing

IY. Aaia India RBI Deposit Insurance and Credit Guarantee Corporation, NABARD, SIDBI 1960-22 districts 60% 0.2 Million Indonesia A.S. Krindo - F Korea The Korea Credit Guarantee Fund 1983-whole country 50% excess of 0.2 million Malaysia The Credit Guarantee Corproation 1976 75% Nepal The Credit Guarantee Corporation 1972 80% Philippines The Industrial Guarantee Loan Fund 1974 60% Sri Lanka Small Industries Credit Guarantee Scheme 1952 75% Thailand Small Industry Credit Guarantee Fund 1970 25% short guarantee 40% medium loans 1985 60% Small loans V.AIi:iI:a Cameroon Credit Guarantee Fund Ghana Bank of Ghana 1975 80% Liberia National Bank of Liberia 1969 66% -213% Morocco The Caise Centrale LC Guarantee

1979 66% -213% Tunissa A Guarantee Fund (FNG) 1970 80% 1981 50 to 75% outstanding loan VI. 1,IIliD awed1I & llu: Ca[dbbau Barbados The Central Bank of Barbados Columbia Fondo Nacional Degarantia (FNG) 1979 80% Haiti Central Bank of Republic of Haite 1983 80% Jamaica Until 1982 a premier Interest Corporation 1983 75% National Denk, BK. 1982 50% Source: World Bank Technical Paper No. 58, Industry and Finance Series Credit Guarantee Schemes for Small and Medium Enterprises. 58 The experience of developed a s well as developing countries shows that, Financial Regulation, Directed Cr edi t Programmes and Credit Guarantee Schemes have be en employed to promote the development of the neglected sectors, particularly small scale sectors in almost all the countries. In the light of this experience we can analyse the Indian situation. Origin of Priority Lending in India: After Independence, India's objective wa s to achieve economic development through the process of planning. During the era of planning, many basic and policy measures were undertaken, efforts we r e made to establish a

socialistic pattern of society, the Industrial Policy was formulated, priority and neglected sectors were declared and nationalisation of private sector business were notable among the important steps in the strategy of development. All these factors had their impact on both the functioning and the development of commercial banking in India. Consequently, the banking system witnessed many structural changes. Notable among them are the following. Under a promotive and directive role steps were taken by the government to improve the structure and functioning of commercial banking. I t included the declaration of priority and neglected sectors for financing by these bank~ on a 59 priority basis and introduction of schemes like the Differential Rates of Interest. Credit Guarantee Scheme. Export Interest Subsidy Scheme and a scheme of social control ove r banks. It was a mixture of private s e c tor initiatives and public sector outlook - a "Golden Mean" between "Rigid Regimentation" and Laissez Faire Policy. The issue of bank nationalisation dates ba ck to 1948. Some of the members of the socialist and conununist parties felt that the nationalisation of banks would be a valuable means of increasing the pace of economic development of the country. The nationalisation of the Reserve Bank of India in 1949 was the first step in this direction. Another was the passing of the Banking Companies Act in 1949. Then the Imperial Bank of India. the management of which had continued to be in the hands of British Officers was nationalised in 1955. I t was even held by some that the nationalisation of banks would be the penacea for all ills afflicting the economic life of peopl e in India. The scheme of social control of banks was devised to put of f the demand for the nationalisation of banks.

The major developments in Indian banking during 1967-68 centred around the implementation of social control ove r banking. The policies and practices of the banking system must serve the basic development needs of all sectors of the 60 economy in confonnity with the national policy and priorities. In this respect, the Congress Government initiated a new banking policy in 1967, de s c r ibed a s the "Social Control" of Banks. The AICC Resolution in fact int roduc ed the conc ept of social control. According to the AlCC Resolution, Soc i a l Cont rol of banks under the effective guidance of the State helps in the mobilisation of deposits and also allocation of credit to the socially desirable sectors of the economy, which would ensure enlarged material benefits to the nation a t large. The t e rm "Social Control of Banks" thus refers to a sor t of s t i f f r egul a t ion of banking activities through appropriate policy measures and legislation. The scheme of social control of banks was int roduc ed by the Gove rnment on December 14, 1967, when the then Finance Minister, MoraIji Desai, made a statement in the Lok Sabha while explaining its objectives, ma in features and the mode of functioning. In his statement, Mr.Desai c a t egor i c a l ly s t a t ed that the r e was no need for nationalising banks a t the time and social cont rol me a sur e s a lone would effectively serve the purpose. The main objective of social cont rol wa s to achieve a wide spread of bank credit to different sectors of the e conomy and diffe~nt areas, to prevent its misuse and to direct its flow to priority sectors and to make it a more effective instrument of economic deve lopment . Gene r a l s t eps had been instituted by the Government for exercising soc i a l cont rol ove r banks with the objective of making banking more purposeful, more dynamic and more helpful to the cOllUIlOn man. The changes sought to be brought about in the implementation of social control were organisational as well as functional. Under organisational changes

the Boards of Directors of banks were to be reconstituted. Under functional change, ftrst of all, a National Credit Council (N.C.C.) at an All India level was established in December 1967. The N.C.C. consisted of representatives from large, medium and small scale industries, agriculture, co-operative sector, trade and bankers and professional accountants. The Finance Minister was its Chairman and the Governor of Reserve Bank, Vice-Chairman. As the basic objective of the social control policy was to ensure in the immediate future, an equitable and purposeful distribution of credit within the resource available, keeping in view the relative priorities of developmental needs N.C.C. was given the responsibility of determining priority sectors and planning of overall credit. Also the Reserve Bank of India has administered a credit guarantee schema, on behalf of the Government of India, since July 1960, to provide guarantee for advances granted to small scale industries by specified banks and financial institutions. The objective of the package of social control measures was to highlight the complaints "that several priority sectors such as agriculture, small scale industries and exports have not been receiving their due share of bank credit". The functional mode of banking had considerable changes by the late sixties as banks adopted the policy of directing credit to the priority sectors. The board was reconstituted. The bank also introduced changes in its branch expansion policy in order to extend banking facilities to wider areas and also to mobilise large deposit resources. But the Government felt that the progress made by conunercial banks under social control was inadequate to reach its social goals. I t was observed that even after the reconstitution of the management boards, the industrialists and business magnets remained on the Boards and could still use their influences. As such, public ownership of banks was felt as an

inevitable means to achieve the goal of socialism. The idea behind bank nationalisation was explained by the late Prime Minister, Indira Gandhi, in the following words: "While the nation is committed to establishing a socialistic pattern of society, the government felt that the public ownership and control of the commanding heights of the national economy and of its strategic sectors were essential and important aspects of the new social 63 order which we are trying to build. As the financial institutions are among the most important levers for the achievements of social objectives, the nationalisation of major banks was felt to be a significant step in the process of mobilisation of people's savings and channelising them towards productive purposes" . The issue of nationalisation remained a subject of great controversy. The debate that ensued, for and against nationalisation in India, was as follows: The Industrial Policy Resolution of 1956, supported banking as an Industry to be in the public sector. It was argued that public deposits kept with the banks must be in the public hands, so that private individuals may not use them in furtherance of their own interests. It was alleged that "private banks had facilitated the concentration of economic power in the hands of a few, permitted the creation of industrial and business monopolies and also mis-utilisation of funds for socially undesirable activities. Another criticism was that the directors of banks had been basically industrialists and they held directorships of companies at the same time. A study of interlocking directorships between banking and other companies made by Dr. 64 R.K. Nigam in 1963 revealed that 188 directors of 20 big banks held 1,452 directorships of other companies. The interlocking of directorships tended to

lead to investment of bank funds in the directors own fields of business, which deprived other genuine applicants to credit facilities. I t further resulted in monopoly and concentration of economic power in the hands of a few. Also nationalisation would promote the confidence of the public in banks, thereby bringing about a rapid and very large increase of deposits. The main argument favouring nationalisation was its harmony with the government policy of social welfare, which requires that the ownership and control of the material resources of the community are to be so distributed as best to sub serve the common good. Whereas banks favoured big borrowers rather than small ones. As per Reserve Bank data, in 1967 as much as 70 per cent of the total bank credit was given to borrowers of over Rs. 5.00 lakhs. There has been a traditional preference of commercial banks for financing mainly the organised sectors like wholesale trade, medium and large scale industries rather than smaller traders, industrialists and agriculturists. The financial operations of these banks added fuel to the fire of inflationary trends in the economy by fmancing speculative operations and investing in securities of stock and bullion exchanges on the one hand, while on the other hand, they deprived the priority and 65 neglected sectors of the economy from getting their legitimate credit needs fulfilled. Credit planning is a sin-qua-non for the effective and successful implementation of economic plans. It envisages a more purposeful direction of credit towards the priority and neglected sectors of the economy, so that the financial resources might be utilised to the maximum social advantage. The increasing importance of credit planning further raised the demand for nationalisation of commercial banks.

It was contended that private commercial banks concentrated their branches in urban and metropolitan areas (they are urban based) and neglected semi-urban and rural areas and hence, left rural deposits untapped and immobilised. Thus it was argued that nationalisation would remove this disparity in the banking spread. Out of 564,000 villages in India, only about 5,000 villages were being served by private commercial banks. Nationalisation was felt necessary to contribute to the growth of agricultural sector, which is the kingpin of Indian economy. The allegation was also made for the practice of setting aside huge sums (about Rs. 100 crores for the entire banking industry as "Secret Reserve") by the private commercial banks. The advocates of bank 66 nationalisation opined that nationalisation would release these funds to the government for productive and plan purposes and their mis-utilisation which is detrimental to the interest of employees and depositors would come to an end. It was also argued that nationalisation of banks would enable the government to obtain all the large profits of the banks as its revenue, thus creating a new resource for financing the plans. Nationalisation as opined by protagonists would replace the profit by service motive in the functioning of the commercial banks. The antagonists on the other hand had put forward arguments against nationalisation in the following manner. For achieving the social objectives, nationalisation was not the only means. They charged the government for the concentration of economic power and further argued that the interlocking of directorships helped the industrial magnates provide fraternal patronage to the banks, which in turn helped them prosper. Thus the association of Tatas with the Central Bank of India, Birlas and Goenkas with the United Commercial Bank

and so, has helped the banks prosper. lIt was argued that "the remedy will be worse th.an the disease as by such step there will be only a shift of power vesting with a few politicians and 67 bureaucrats at whose hands the banking industry will be a mere pawn in the game of political parties. Regarding the allegation on banks providing credit for speculation and hoarding i t was refuted on the ground that ostensibly it was difficult to differentiate between speculators and genuine producers. So far as inflationary trends were concerned these were the result of many factors and bank lending as one of them had a negligible impact on prices. I f the bank lending was so effective a measure to cause inflation, then the mere extending bank credit during depression would have solved the problems. Credit to priority sectors could have been provided with other less stringent measures such as instructions to commercial banks rather than nationalisation. They further argued that the poorer and neglected sections of the priority and neglected sectors would be the sufferers in nationalised banks because of lack of influence/power. I t was also feared that to provide fmance to priority sectors the needs of big industry and trade, specially those getting credit earlier would suffer after nationalisation. I t was argued that the practice of "Secret Reserve" was developed primarily to meet unperceived losses and unexpected contingencies so as to conserve and consolidate the financial position of banks and to stabilise and assure a particular rate of dividend". 68 It was further protested that complete nationalisation would stop healthy .:ompetition and cease to give better service to the community. The Reserve Bank of India under the scheme of Social Control could achieve integration and co-ordination through the regulation of banks. But the supporters of bank

nationalisation insisted that the process of integration and co-ordination of banks to the attainment of social objectives would be attained rapidly i f commercial banks were nationalised. As a result the far-reaching measures affecting the banking system was the nationalisation of 14 major banks in July 1968 and 6 other banks in April 1980. After the recent bank scam there is revival of anti-nationalisation thinking. Many argue that such large misuse of funds would not have happened i f banks were in private sector. They blame that nationalisation of banks itself has given place for such huge mis-use. But in India, the history of private banks shows that they are not necessarily successful. There were several bank failures in the fifties and sixties. The gains of bank nationalisation in the country have been substantial and it is important that these cannot be completely neglected. But, the banking system in India has become over-regulated and over-administered. So, there should be freedom for banks to perform. However, as the Narasimham Committee (1991) has also stated, the question of efficiency, productivity and 69 profitability is ownership neutml and a mere change of ownership cannot pe r fie lead to financial and economic inefficiency. The experience of other countries shows that under any system of finance mistakes will be made. The goal is not perfection but a system. which mobilises resources efficiently, minimises allocative mistakes, and curbs fraud and stops instability from turning into crisis. So, the need of the hour is not complete privatisation but a different orientation to regulation i.e., Social Control. Both developed and developing countries are practicing the priority sector lending in order to develop the neglected sectors in the economy. In developed countries, after the Second World War governments began to take a greater

interest in the financing of high priority sectors. Agriculture, Small Scale Industries, Housing and Export are the sectors, which are given priority in almost all the countries. Directed credit programmes, selective credit control or financial regulation and credit guarantee schemes are some of the measures adopted to help the priority sectors. Commercial banks were directed to provide finance at concessional rate to these sectors. The Central Bank or the other guarantee institutions are providing refinance facilities also for the promotion of priority lending in majority of the countries. The intention of refinance is to 70 enable the commercial banks to extend more and more finance to those sectors that lack collateral securities. In some cases negative credit instruments such a s restrictions, credit ceilings, margin requirements are designed to reduce or eliminate the flow of credit to certain sectors such as share market speculations and so on. And in majority of the cases positive credit instruments are used to channel the flow of credit into specified areas. In developing countries directed credit accounted for 30 pe r cent to 80 pe r cent (Brazil) of bank credit. Many schemes were formulated to implement the directed credit programmes. In Korea there were 221 formal directed credit progrannnes. But in developing countries, there is lack of effective demand f rom indigenous borrowers especially in the agricultural sector. So along with directed credit it is also necessary to provide subsidies in orde r to stimulate borrowing. In Uruguay credit sys t em allocates funds to priority sectors wi th very little state intervention, whi ch is to be really appreciated. One thing that i s common in both developed as well a s developing count r f s is that commercial banks do not come forward to provide loans to small

71 business enterprises, as they consider i t highly risky. So in order to encourage commercial banks to provide more and more credit to these sectors and to cove r the losses incurred when borrowers default on loans credit guarantee schemes were introduced. The Central Bank a s well as other guarantee institutions is doing this job. Summary of the Findings: Different country cases reveal that both developed a s well as developing countries have recognised priority sectors and are giving preferential treatment in order to achieve the economic development and balanced growth of the economy. With this, the importance of the preferential treatment of the priority sectors in India is also very well seen. While many argue that commercial banks should play a prominent role in the development of these sectors by providing them fmancial assistance a t concessional rates of interest those who are against priority sector lending argue that commercial banks are suppose to function commercially. As banks have to deal with public funds, they are suppose to pay them back on demand and they also have to maintain interest, administration and so many other expenditures it is very much necessary to use the funds in a profitable manner. So the commercial banks instead of being allowed to work 72 commercially are burdened with the responsibility of achieving social welfare, then i t will be against the militancy of banking operations. Also in order to provide funds at low rate of interest to priority sectors, there is no other way for banks than to use the method of cross subsidisation in order to sustain themselves. Again the non-priority sector borrowers are victimised and are burdened with high interest rate, which may finally lead to inflation and other related problems.

But still, the priority sectors such as agriculture, small scale industries and other small business operations are not in a position to withstand the market competition and are at infant stage. Without proper protective policy and financial support in the form of concessional interest and preferential credit facilities, it may not be possible for these sectors to stand on their own feet. This would affect the economy as a whole in an adverse manner, which might worsen the economic situation of the country as a whole, by unbalanced development of the sectors, region, and in tum leads to increased inequality in the distribution of income and wealth. There is no need to explain the ill effects of concentration of economic power in the hands of a few. So, in order to avoid such worsening situatipn at the internal as well as international level it is very much necessary to 73 nurture these sectors by providing necessary help. Apart from these priority sectors have gained prominence in our country by the nature of their labour intensive techniques, which helps us to solve the problem of poverty at the macro level and increasing unemployment problem at the micro level. 74 CHAPTER - I I I PRIORITY LENDING TRENDS - INDIA, KARNATAKA Banking operations a l love r the world have undergone a drastic change in the last two decades, which has resulted in the expansion of banking activities. In India also after nationalisation in 1969, the responsibilities of banks have increased, especially in lending to priority sectors. One of the outstanding contributions of the Indian banking system after nationalisation is that, it has become an effective means of canalising credit to priority sectors, backward areas and weaker sections. It was foremost necessary to help the neglected sectors of the society in order to improve the lot of millions

of people living below poverty line. This compelled the need for priority sector lending. Priority sector means to give priority to certain sectors in the allocation of credit by providing concessions in the matter of interest, margin, etc. During 1967, an Expert Committee headed by Prof. Gadgil (RBI, 1969) emphasised that banks should lend to agriculture, small scale industry on priority basis. After nationalisation this gained importance. Government of India and the Reserve Bank of India have formulated schemes, set targets, sub-~gets, 75 benchmarks and other necessary guidelines for priority sector lending. But these targets, sub-targets and benchmarks were modified with the reconunendations of the K.S. Krishna Swamy's Committee (RBI, 1980) and the Ghosh Committee (RBI, 1985). As a result of the reconunendations of these Committees, the percentage of directed credit went up from 33.33 pe r cent to 40 pe r cent. Sub-target for direct agricultural finance was raised in stages to 18 pe r cent where it stands now. It was also stipulated that 25 per cent of the priority sector advances or 10 pe r cent of total bank credit should go to the weaker sections of the conununity as defined by the Committee. As per the RBI guidelines, agricultural advances are classified into three categories namely Direct Finance, Indirect Finance and Non-Priority Agriculture. Direct finance includes all crop loans (other than c rop loans granted to traditional plantations in Coffee, Tea, Rubber and Cardamom, to land holders above 5 acres). It also includes farmers' Green Ca rd Scheme, loans under farmers benefit scheme, gold loans to agriculturists, minor irrigation loans, f ann development loans, f ann mechanisation loans, loans under allied activities, seed produc\ion and processing loans. Indirect finance includes: (i) loans granted to

Corporations! Societies for Rural Electrification Corporation/Special Projects 76 Agriculture (RECISPA) Schemes. (ii) for the construction of godownslcold storage etc., for the purposes of hiring out to government/corporate bodies such as Food Corporation of India (FCI), State/Central Warehousing Corporations etc., (iii) credit for the distribution of fertilizers, seeds, pesticides and insecticides. (iv) loans to farmers through Primary Agricultural Co-operative Societies and other financial institutions. (v) other types of indirect fmance involving agencies. Fmance provided to small scale industries under priority sector can also be classified into direct finance and indirect finance. Direct finance is provided to smaIl scale industries, ancillary units, tiny units, village industries in the form of medium term loan and working capital. Indirect finance to small scale sector includes credit to (a) agencies engaged in assisting the decentralised sector in the supply of inputs and marketing of outputs of artisans, village and cottage industries, (b) government sponsored corporationsl organisations providing funds to the weaker sections in the priority sector and (c) loans for construction of industrial estates. Borrower should satisfy the following general eligibility criteria for availing financial assistance: 77 (i) I t should be a small scale industry as defmed by the Government of India from time to time. The present defmition of small scale industry is "Any industrial unit engaged/to be engaged in ManufacturinglProcessingi Preservation/Servicing activities with original investment in plant and machinery not exceeding Rs.3.00 crores". (ii) Items proposed to be manufactured by the unit are not in the list of

'banned items' by the Government from time to time. (iii) The unit should possess the statutory licences/approvals for setting up the Industry. (iv) Unit's proprietor/partners/directors should have proven integrity and ability to manufacture and sell the product. The unit should not have concurrent borrowings from any other bank. (v) The project should be technically feasible, commercially, financially and economically viable. Technical feasibility deals with whether the desired output can be achieved with the available facilities (manufacturing process, location, land and building, plant and machinery, product mix, plant layout, schedule of implementation, raw-materials, power, labour, are the aspects studied under technical feasibility). 78 A commercial venture is profitable, i f the productsl goods produced are sold at the desired rates. This depends on the pre-assessment of demand, nature of product, seasonality of the product and realistic sales target of the unit. Financial viability considers the total project cost and the sources of finance. The components of project cost are land, building, plant & machinery, furniture/fixtures/deposits (KEB, telephone etc.), preliminary and pre-operative expenses, working capital margin etc. An ancillary industry is an undertaking whose inv.estment does not exceed Rs. 3.00 crores, engaged in manufacturing of parts, components, sub-assemblies, toolings or intermediates or rendering of service of supplying 30 pe r cent of their production or the total services as the case may be to other units for the production of other articles, provided that no such undertaking shall be a subsidiary of or owned and controlled by any other undertaking (including public

sector undertakings). Refinance Facilities: RBI, Industrial Development Bank of India (lOBI), Small Industries Development Bank of India (SlOB I), and National Bank for Agriculture and Rural Development (NABARD) are providing refinance facilities to commercial 79 banks for certain schemes under priority sectors, to enable the connne r c i a l banks to step up credit to these sectors. Besides this, various schemes unde r this sector was also considered for guarantee by the Deposit Insurance and Cr edi t Guarantee Corporation of India (DICGC). Agriculture and small business are covered under the Small Loans Guarantee (Non-Industrial Sector) Scheme in 1977 and small scale industry under the Small Loan Guarantee Scheme in 1981. Lending schemes in priority sector are as under: Expansion in priority sector advances could not have been possible for the commercial banks without the refinance support from NABARD, IDBI and SIOBI. The National Bank for Agriculture and Rural Development (NABARD) has identified non-farm sector as a thrust area to achieve integrated rural development and offers refinance to commercial banks and other institutions for various non-farm lending schemes. The refinance assistance i s now available for production, raw material, marketing, and infrastructure and promotional support functions for both traditional and decentralised as well as modem and organised segments of our industrial economy. 80 NABARD refinance is available to all units in rural areas, which according to NABARD Act, 1981, comprise of all villages irrespective of population and all towns having population of less than 10,000 as pe r 1981 census. The location

criteria are not applicable to agro-industries, leather, sericulture, and marketing projects. NABARD refinance is available for all activities covered under 22 broad group of activities selected by NABARD and such activities a s have been approved by DC, SSI, 001. Besides all service enterprises and trading units providing marketing support, village, tiny and small scale industries are eligible for refinance. Assistance is available for setting up of new units as well as modernisation of existing units, which are at least five years old. All bank finances with outlays up to Rs.15 lakhs are eligible for automatic refinance and outlays above Rs.15 lakhs require prior approval of NABARD. The rate of interest charged by the NABARD on its refinance as well as to ultimate borrowers is stipulated by NABARD according to the RBI directions. The Banks are eligible for lOOper cent refmance for all schemes under non-farm sector except for (i) Project finance scheme for SSI Units, (ii) Project finance scheme for agro-industries, (iii) Project finance scheme for marketing 81 outlets (with loan requirement exceeds Rs. 10 Lakhs), where the refinance support i s restricted to 75 pe r cent of the bank loan. In 1984-85 NABARD started a Soft Loan assistance fund for margin money assistance, which i s utilised to provide 100 pe r c ent refinance to the fmancing banks against their margin money advances to eligible borrowers. Artisans, entrepreneurs and institutions who are not in a position to bring in the required quantum of margin money can avail of equity type assistance. Such loans will be refinanced free of interest by NABARD. The financing banks are, however pennitted to collect one pe r cent per annum as service charges. Amount of assistance will be equal to NABARD's margin stipulation minus borrower's

contribution or NABARD's margin stipulation. However, margin money assistance in respect of project finance scheme for SSI is limited to 15 pe r c ent of the project cost. Repayment period extends up to 10 years. The soft loan ha s to be repaid along with the t e rm loan instalments. Automatic refinance facility is available under composite loan scheme for the block capital or working capital or a composite loan provided to individuals, partnership firms etc. Maximum amount of assistance i s Rs. 50,000/-, no margin required. Loan should be repaid within the t e rm of 3 to 10 years with a 82 moratorium of 12-18 months. Refinance is available for 22 broad groups, service sector and DC, SSI approved activities (Development Commissioner, SSI). Integrated loan scheme also has automatic re-finance facility from NABARD. Under this Scheme, refinance assistance is provided for block capital and block capital integrated with working capital of one operating cycle. Maximum amount of assistance is Rs. 10 lakhs. The projects involving outlays of less than Rs. 15 lakhs can only be covered under the scheme. Stipulated Margin is 5 pe r cent for loans up to Rs. I lakh and 10 pe r c ent for loans above Rs. 1 lakh. Repayment period extends from 3 to 10 years with a moratorium of 12 to 18 months. This scheme also covers 22 broad groups, service sector and DCSSI approved activities. Refmance facility is also available for agro industries projects. Under this, agro industries, agro processing projects and agro-chemical projects (storage, preservation and marketing facilities included) are the eligible activities. Assistance under this scheme is restricted to block capital component only. Amount of assistance will be equal to SSI limit for private sector and no limit on amount of assistance to public sector and co-operative sector. Stipulated margin

anlOunt is 21.5 per cent. Beneficiaries may be Individuals. Firms, Companies, 83 State level Corporations, Agro Industries Corporations, Forest Development Corporations, KUID, KUIC market societies, Federations, Industrial Societies. Refinance facility is also available to (i) Scheme for Assisting Small Road Transport Operators (SRTOS), (ii) Scheme for Mobile Sales Van (automatic refinance facility), (iii) Scheme for setting up of common work shed/common work facilities centre (automatic refinance facility), (iv) Scheme for infrastructure and promotional activities (automatic refinance facility), (v) Scheme for financing Mobile/Static sales Carts and KIOSKS (automatic refinance), (vi) Schemes for financing marketing outlets. Availability of refinance is not linked to recovery performance of the branch as is done in the case of farm sector loans. The Banks in lieu of service charges can collect evaluation fees of 1.0 pe r cent of the project cost. The Branches should submit refinance claims for the loans released by them a t monthly intervals, so as to reach NABARD by 5th of every succeeding month. NABARD provides assistance by way of grant to voluntary organisations, Non-Government Organisations and other promotional agencies (Banks) having a grassroots level presence, with proven track record in conducting Entrepreneur Uevelopment Programmes (EDI's) and other similar types of training 84 programmes for the benefit of youth/women intending and likely to set up small enterprises in rural areas. Small Industries Development Bank of India (SIDBI) was established in 1990 as a wholly owned subsidiary of Industrial Development Bank of India (lOBI) with a view to enlarge the scope of SSIs and providing fmancial assistance to SSI Units. The functions carried out by lOBI before 1990 in respect

of schemes covering SSI units were transferred to SIDBI. Being a principal financial institution for promotion, fmance and development of small scale industries, SIDBI refinances loans and advances provided by primary lending institutions and banks to industrial concerns in small scale sector. SIDBI provides refinance facilities for term loans granted to activities/purposes such as Indigenisation/Import Substitution (cost not to exceed Rs. 25 Lakhs and margin 25%), Hotels and Restaurants (cost not to exceed Rs. 45 lakhs), Small Nursing Homes (cost within Rs. 45 lakhs), Tourism related activities (cost not to exceed Rs. 45 lakhs), qualified professionals (cost not to exceed Rs.I 0 lakhs - margin - 25 per cent). 85 Government Sponsored Schemes: Schemes for providing self-employment to Educated Unemployed Youth (SEEUY) provides credit facilities to educated unemployed youth for selfemployment ventures in industry, services, allied agricultural activities. This scheme was announced on 15th August 1983. Any person who has passed matriculation or an equivalent examination and is within the age limit of 18 to 36 years is eligible for borrowing. Preference will be given to women beneficiaries, physically handicapped, weaker section and technically trained persons. The family income should not exceed Rs. 10,000/- per year. The scheme is applicable to all areas of the country except those cities with population of more than 10 lakhs as per 1981 census. The Government of India grants a subsidy of 25 per cent of the eligible amount, which is treated as the borrowers contribution. So there is no margin under the SEEDY. Rs.35, 000/- for industries Rs. 25,000/- for services and Rs.l5, 000/- for business will be granted as subsidy under this Scheme.

Hypothecation of assets created out of bank loan is accepted as security. Subsidy received should be invested in fixed deposit for a minimum period of three years and should be adjusted to loan after 75 per cent of term loan is repaid. 86 As one of the components of Nehru Rozgar Y ojana, Government of India has launched the Scheme of Urban Micro Enterprise (SUME) to support setting up of urban micro-enterprises, which will provide self-employment opportunities. Scheme was launched on 11.10.1989. The scheme is applicable to Metropolitan areas, cities and towns. Any person engaged in production activitylbusiness, whose annual income does not exceed Rs. 7,200/- in Urban/SemiurbanlMetropolitan areas and Rs. 6,400/- in rural areas, is eligible to borrow under Differentiallnterest Rate (DIR) scheme. Students pursuing higher studies physically handicapped persons, orphanages, women's homes are also eligible. Not less than 40% of total DIR advances should be given to SC/ST beneficiaries. As the loan is given for the entire requirement, there is no need to pay any margin money. Composite loan not exceeding Rs.6, 500/- pe r borrower is granted and 4 per cent interest per annum is charged on DIR loans. Periodical instalments are based on the repayment capacity of the individual. Loans granted under DR! scheme are by themselves to be treated as a separate category under priority sector advances. These loans are to be classified under different categories of priority sector advances depending upon the nature of activity of the borrower. Other than DIR scheme, interest rate for poverty alleviation schemes will be according to instructions from RBI from time to time. 87