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Unit 4: The Financing Mix

6. Classification of Customers: For purposes of better control, there should a system of Notes
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.
7. 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 India context. In discussing norms for capital
structure, the Group kept in mind both the relationships-long-term debt to equity and
total outside liabilities to equity. Where a company’s long-term debt-net worth and total
outside liabilities-net worth ratios are worse than the medians, the banker would endeavor
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 debt – net worth and total outside liabilities – net 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 maximize
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 funds so further. However, on
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
maximizing 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 attractive to the
investor, no company can afford, even if it were possible, to trade entirely on owned
funds, nor rely too heavily on borrowed funds. There has thus to be a balance between the
two – what the company provides and what it borrows.

Problems in Implementing Tandon Committee Report

The Reserve Bank of India in its notification dated August 21, 1975 considered some of the main
recommendations of the Group and advised the banks accordingly. The scheme was required to
be implemented at the micro-level where advances were made to the borrowers. But a thorough
understanding of the scheme required knowledge about the analysis of financial statements and
credit appraisal by the officers at branch level. This knowledge was slowly spreading and till the
officers at the grass root level were equipped with the basic knowledge of credit appraisal, the
implementation was bound to be quite slow.
Another problem was that of gearing the attitudes of the bank men to this new scheme being
something new as being not in the routine nature of credit appraisal, it was difficult task to
kindle the interest of the staff to study the Tandon Scheme for enforcing it in the case of big
industrial customers. In addition, the new scheme also called for in-depth knowledge about
each industry and various units in each industry so that the norms could be realistically applied
in each case to determine the level of current assets, working capital gap and the style of credit.

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