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Methods of Lending

The document discusses methods of lending that were historically mandated by the Reserve Bank of India. It summarizes the recommendations of the 1974 Tandon Committee, which studied bank finance for working capital. The Committee suggested inventory and receivable norms for corporates and three methods for banks to finance working capital needs based on the proportion funded from long-term versus short-term sources. The first method financed up to 75% of the working capital gap for small borrowers, while the second method required minimum 25% funding from long-term sources for larger borrowers. Banks analyzed balance sheets using the CMA data format per RBI guidelines.

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233 views

Methods of Lending

The document discusses methods of lending that were historically mandated by the Reserve Bank of India. It summarizes the recommendations of the 1974 Tandon Committee, which studied bank finance for working capital. The Committee suggested inventory and receivable norms for corporates and three methods for banks to finance working capital needs based on the proportion funded from long-term versus short-term sources. The first method financed up to 75% of the working capital gap for small borrowers, while the second method required minimum 25% funding from long-term sources for larger borrowers. Banks analyzed balance sheets using the CMA data format per RBI guidelines.

Uploaded by

muditagarwal72
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
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Methods of lending

Like many other activities of the banks, method and quantum of short-term finance
that can be granted to a corporate was mandated by the Reserve Bank of India till
1994. This control was exercised on the lines suggested by the recommendations
of a study group headed by Shri Prakash Tandon.

The study group headed by Shri Prakash Tandon, the then Chairman of Punjab
National Bank, was constituted by the RBI in July 1974 with eminent personalities
drawn from leading banks, financial institutions and a wide cross-section of the
Industry with a view to study the entire gamut of Bank's finance for working capital
and suggest ways for optimum utilisation of Bank credit. This was the first
elaborate attempt by the central bank to organise the Bank credit. The report of
this group is widely known as Tandon Committee report. Most banks in India
even today continue to look at the needs of the corporates in the light of
methodology recommended by the Group.

As per the recommendations of Tandon Committee, the corporates should be


discouraged from accumulating too much of stocks of current assets and should
move towards very lean inventories and receivable levels. The committee even
suggested the maximum levels of Raw Material, Stock-in-process and Finished
Goods which a corporate operating in an industry should be allowed to accumulate
These levels were termed as inventory and receivable norms. Depending on the
size of credit required, the funding of these current assets (working capital needs)
of the corporates could be met by one of the following methods:

• First Method of Lending:


Banks can work out the working capital gap, i.e. total current assets less
current liabilities other than bank borrowings (called Maximum Permissible
Bank Finance or MPBF) and finance a maximum of 75 per cent of the gap;
the balance to come out of long-term funds, i.e., owned funds and term
borrowings. This approach was considered suitable only for very small
borrowers i.e. where the requirements of credit were less than Rs.10 lacs
• Second Method of Lending:
Under this method, it was thought that the borrower should provide for a
minimum of 25% of total current assets out of long-term funds i.e., owned
funds plus term borrowings. A certain level of credit for purchases and
other current liabilities will be available to fund the build up of current
assets and the bank will provide the balance (MPBF). Consequently, total
current liabilities inclusive of bank borrowings could not exceed 75% of
current assets. RBI stipulated that the working capital needs of all
borrowers enjoying fund based credit facilities of more than Rs. 10 lacs
should be appraised (calculated) under this method.
• Third Method of Lending: Under this method, the borrower's
contribution from long term funds will be to the extent of the entire CORE
CURRENT ASSETS, which has been defined by the Study Group as
representing the absolute minimum level of raw materials, process stock,
finished goods and stores which are in the pipeline to ensure continuity of
production and a minimum of 25% of the balance current assets should be
financed out of the long term funds plus term borrowings.
(This method was not accepted for implementation and hence is of only
academic interest).
As can be seen above, the basic foundation of all banks' appraisal of the needs of
creditors is the level of current assets. The classification of assets and balance
sheet analysis, therefore, assumes a lot of importance. RBI has mandated a
certain way of analysing the balance sheets. The requirements of this break-up of
assets and liabilities differs slightly from that mandated by the Company Law
Board (CLB). The analysis of balance sheet in CMA data is said to give a more
detailed and accurate picture of the affairs of a corporate. The corporates are
required by all banks to analyse their balance sheet in this specific format called
CMA data format and submit to banks. While most qualified accountants working
with the firms are aware of the method of classification in this format, professional
help is also available in the form of Chartered Accountants, Financial Analysts for
this analysis.

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