Loan Covenants: Evidence from India

We, for the first time ever, provide evidence on loan covenants usage by the Indian banks based on primary loan data over a period from 2002 to 2011, using a two stage least squares method with five instrumental variables, and actual number of accounting based covenants in a loan contract. Our analyses of the primary data shows banks in India put more emphasis on severe non-accounting based covenants contrary to the proposition of costly contracting hypothesis. We find contradictory results in the relationship between accounting based covenants and loan category, profitability, leverage, firm size and issue of securities. We find that firm size and issue of securities have a positive relation, leverage has a negative relation, and loan category and profitability have an insignificant relation with accounting based covenants. Our study looks at non-accounting based covenants in much more greater details and find that materiality, firm size, profitability, collateral, reserve account, and bank relationship have significant relations with the setting of non-accounting based covenants. However, the relations of bank relationship, profitability, collateral, and reserve accounts with non-accounting based covenants are contradictory when compared to relations with accounting based covenants.