Regulation of Bank Finance^421
financial ratios compiled by the Reserve Bank of India, for furnishing to banks.
Besides examining financial and operating ratios, certain productivity ratios may
also be examined to determine efficiency in use of resourcesóman, money,
machines and materials. A banker can choose his own criteria, but some useful
ones are: labour efficiency; capital efficiency and fixed assets efficiency.
Classification of Customers
For purposes of better control, there should be a system of borrower classification in
each bank, within a credit-rating scale. Such a system of classification according to
credit-risk will facilitate easy identification of the borrower whose affairs require to be
watched with more than ordinary care. An incidental advantage of such classification
will be the formulation of a rational base for purpose of fixing the rates of interest for
the respective borrowers.
Norms for Capital Structure
The debt-equity relationship is a relative concept that depends on several factors and
circumstances such as the state of the capital market at any one time, government
policy on created money, the need to maintain current assets at a specified level (which
again is contingent on other factors), marginal efficiency of capital or the opportunity
cost, etc. The experience of other countries in this matter may not be of much assistance
in formulating guidelines in the Indian context. In discussing norms for capital structure,
the Group kept in mind both the relationshipsólong-term debt to equity and totaíl outside
liabilities to equity. Where a companyís long-term debt-net worth and total outside
liabilities-net worth ratios are worse than the medians, the banker would endeavour to
persuade the borrower to strengthen his equity base as early as possible. This would be
a more practical approach for the banker than attempting to legislate absolute standards
of long-term debtónet worth and total outside liabilitiesónet worth ratios for all
industries or even industry by industry.
The impact of taxation in considering this subject is also important for, under the tax
structure, it is advantageous to trade as much as possible on borrowed capital to maximise
earnings per share. The higher the level of borrowings, or the financial leverage, the
greater is the advantage in view of this and coupled with the cheap money policy, there
may be limited incentive to the borrower for efficient management of funds. Introduction
of higher interest rates in the banking system has changed this position. In fact, the
lending banker likes to see as high an equity stake as possible because it makes advances
safer and, in times of credit shortage, makes available bank funds so further. However,
one cannot lose sight of the need to promote the capital market while resolving this
dichotomy of interest between the banker and borrower as the ultimate goal being to
assist in maximising investment and production. If the end-product of industry has to be
sold at a cheaper price and adequate dividends are also to be given to make equity