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Methods of Lending

The Reserve Bank of India mandated controls on methods and amounts of short-term corporate financing by banks until 1994. This was based on recommendations from the 1974 Tandon Committee, headed by Prakash Tandon, which studied bank financing for working capital. The Committee recommended maximum inventory and receivable levels for corporates and three methods for meeting working capital needs with bank funding: the first method allowed banks to finance 75% of the working capital gap for small borrowers under Rs. 10 lacs; the second method required borrowers to fund 25% of current assets from long-term sources with banks financing the balance; the third method was not implemented and required funding all core current assets and 25% of other current assets from

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64 views

Methods of Lending

The Reserve Bank of India mandated controls on methods and amounts of short-term corporate financing by banks until 1994. This was based on recommendations from the 1974 Tandon Committee, headed by Prakash Tandon, which studied bank financing for working capital. The Committee recommended maximum inventory and receivable levels for corporates and three methods for meeting working capital needs with bank funding: the first method allowed banks to finance 75% of the working capital gap for small borrowers under Rs. 10 lacs; the second method required borrowers to fund 25% of current assets from long-term sources with banks financing the balance; the third method was not implemented and required funding all core current assets and 25% of other current assets from

Uploaded by

Pradeep Shaw
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as DOCX, 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).

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