ECONOMIC ANALYSIS

OF FINANCIAL
STRUCTURE
 TOPICS

01 Sources for External Funds

02 Basic Facts

03 Transaction Costs

04 Asymmetric Information

05 Regulations
 BASIC FACTS ABOUT FINANCIAL
STRUCTURE
THROUGHOUT THE WORLD
This chapter provides an economic analysis of how our
financial structure is designed to promote economic
efficiency.

The bar chart in Figure 1 shows how American businesses

financed their activities using external funds (those
obtained from outside the business itself) in the period
1970–2000 and compares U.S. data to those of Germany,
Japan, and Canada

01
 FIGURE 1 SOURCES OF EXTERNAL FUNDS FOR 40,000

30,000

NONFINANCIAL BUSINESSES: A COMPARISON OF THE 20,000

UNITED STATES WITH GERMANY, JAPAN, AND CANADA 10,000

0
2018 2019 2020 2021 2022
 Stocks are not the
Indirect finance is
most important
many times more
sources of external
important than direct
financing for
finance
businesses.

Basic Facts
Issuing marketable Financial intermediaries,
debt and equity particularly banks, are
securities is not the the most important
primary way in which source of external funds
businesses finance used to finance
their operations businesses.

01
 The financial Collateral is a
system is among prevalent feature of
the most heavily debt contracts for
regulated sectors of both households and
the economy businesses.

Basic Facts
Only large, well- Debt contracts are
established extremely complicated
corporations have legal documents that
easy access to place substantial
securities markets to restrictive covenants on
finance their activities borrowers

01
Financial intermediaries have evolved to
reduce transaction costs
Economies of scale
Expertise
ASYMMETRIC INFORMATION:
ADVERSE SELECTION AND MORAL
HAZARD

• Adverse selection occurs before the

transaction
• Moral hazard arises after the transaction
• Agency theory analyses how asymmetric
information problems affect economic
behavior
REGULATIONS FOR
AGRICULTURAL
FINANCING
 Agricultural loans have To facilitate the recovery Banks are strictly prohibited
Credit Report
been extended for efforts, banks are allowed to to undertake any sort of
Borrower Basic
specified purposes undertake cash adjustment lending
Fact Sheet (BBFS) collection/recovery at outstanding mark-up has
The banks/DFIs may
Repayment places other than their been received by the banks it
consider it prudent to
Capacity of the authorized places of may roll over
make payments directly to
the suppliers wherever
Borrower business. In case of Revolving Credit
appropriate Manage security risks and Scheme, based on their
avoid fraud. cropping cycle, banks may
segregate the repayments in
two stages i.e. at least 50% of
the utilized credit during the
year after harvest of each
Rabi and Kharif crop
PROPER UTILIZATION
CREDIT ANALYSIS AND CASH RECOVERY OUTSIDE
OF LOAN BAR ON ADJUSTMENT
OTHER CONDITIONS THE BANK’S AUTHORIZED
PLACE OF BUSINESS LENDING TO AVOID
CLASSIFICATION OR MEET
INDICATIVE TARGETS
All guarantees issued by the loans are self-liquidating at
banks/DFIs shall be fully secured the end of the growing cycle
finance provided by banks/DFIs to purchase inputs
In case of back to back letter of from the proceeds of the
like seeds, fertilizers, pesticides, etc
credit issued by the banks/DFIs
capital finance provided to meet various sort of product sale, therefore, the
for export oriented goods and
expenses attributable to farming like wages, etc maturities of these loans shall
services, banks/DFIs are free to
decide the security arrangements
coincide with the production
at their own discretion subject to cycle for the product being
the condition that the original L/C financed
has been established by branches it is less than one year
of guarantee by bank,

GUARANTEES
FARM CREDIT FOR INPUTS TENURE AND
CLASSIFICATION
 loan is for godown,
orchards
loan is for tractors,
threshers and harvestors
they are for long term for 1-
5 years
I. LOANS FOR FARM
TENURE, CLASSIFICATION AND
DEVELOPMENT AND
MACHINERY/ EQUIPMENT
Tenure is maximum is for 5 years of
loan
this is given for farm development
PROVISIONING
The banks/DFIs would
ensure that the tractors
financed by them remain
insured at all times during
the tenure of the loan.
Banks/DFIs are also
encouraged to arrange
insurance of all other
machinery and equipment
financed by them to protect
their interest.
INSURANCE
The loans extended for
goat/sheep farming,
breeding of animals,
dairy farming, fishing
farms, poultry farms
Livestock financing can
be made for working
capital as well as for
development purposes.
As such, these loans are
usually short to long
term in nature.
FINANCING FOR
LIVESTOCK

Besides all familiar and
The maximum tenure
for livestock financing generally acceptable
securities, the banks/DFIs at
would be five years
their own discretion can
(including grace
accept livestock as an
period). exclusive or partial security
for livestock financing.
it may depend upon animal
age,sex,breed and health
TENURE
SECURITY
PERIODIC INSPECTION AND
Due to the relative ease
with which livestock can
be moved, lack of formal
mechanism for transfer of
title and ownership and
volatility of livestock values
banks/DFIs shall, in all
cases where livestock has
been accepted as
primary/sole security,
conduct periodic
inspections, atleast twice a
year.
VERIFICATION
Since the financing
requirement of
livestock sector is of
both short-term
(working capital) as well
as of long term loans,
therefore, the loans to
this sector are
categorized under both
the working capital and
the development or
long term loans.
CLASSIFICATION AND
PROVISIONING

In case of Corporate Farming,
in addition to the regulations
prescribed above and all
other applicable rules/
regulation of Commercial
Banking and SME Financing
etc, following regulations
shall also apply.
CORPORATE FARMING
The Board of Directors of the bank/DFI shall
approve a credit policy prescribing a minimum
current ratio and linkage between borrower‟s
equity and its total financing facilities from all relating to the business of every
financial institutions
Credit policy should be on higher standards
LINKAGE BETWEEN FINANCIAL INDICATORS
OF THE BORROWER AND TOTAL EXPOSURE
FROM FINANCIAL INSTITUTIONS
Banks / DFIs shall, as a matter of
rule, obtain a copy of financial
statements duly audited by a
practicing Chartered Accountant,
borrower who is a limited
company or where the exposure of
a bank / DFI exceeds Rs.10 million,
for analysis and record.
it should not be exceed than 10
million
COPY OF AUDITED ACCOUNTS
WHERE EXPOSURE EXCEEDS
RS. 10 MILLION