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This paper analyses the relationship between financial intermediation and economic development in the state of Bihar in India. We find that the standard index of depth of financial intermediation measured by credit deposit (CD) ratio is very low in the state (30%) and has little impact on economic development at the aggregate level.
However, the analysis of sectoral CD ratios show that credit allocation to agricultural sector influences per capita income across districts but similar allocation to the industry has almost no impact on that sector. This finding is robust to different model specifications including other financial indicators. Interestingly, when we examine the impact of bank branches, they tend to be significant in explaining variation in per capita income across districts, as reflected through its indirect effect via higher realised credit relative to planned credit limit.
On the other hand, directed lending towards the priority sectors in the form of Kishan credit card (KCC) has significant impact on economic development in Bihar. Since the loan disbursement under KCC is voluntary, its over utilization suggests rationing of credit in the rural sector while the limited impact on industrial growth points to poorer screening of projects and lack of proper financial intermediation in the state. A firm-level analysis for the state suggests limited impact of different sources of financing, although companies are heavily dependent on bank borrowing as opposed to equity financing.