MANAGEMENT OF BANKING

OPERATIONS

CHAPTER 6-BANKS IN INDIA-

CREDIT DELIVERYAND LEGAL
ASPECTS OF LENDING
 FORMS OF CREDIT IN INDIA

WORKING CAPITAL FINANCE PROVIDED IN

FOLLOWING WAYS
Cash Credits/Overdrafts

Loans

Bills Purchased/discounted

Working capital term loans

Non fund based credit limits

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 Cash Credit
3

Credit limit is backed by prime securities like inventories or book debts

or receivables and collaterals and guarantees

The nature of account balance is debit, as per the cash cycle, account is
credited which ideally reflect the ‘sales’

Periodical sales revenue data is called by the bank

Bank levies a ‘commitment charge’ for unutilized portion of the cash

credit limit

CC leads to higher transaction, monitoring and opportunity costs

Working capital limits over Rs 10 cr are to be funded by way of 2

components: 80% of the credit limit by WC Demand Loan and
20% by CC
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 Working Capital Demand Loan: RBI
Guidelines
4

Banks may change the composition of working capital

finance by adjusting the 80:20 ratio as per the credit
limits

Even for borrowers of below Rs. 10 cr., Banks may

persuade the loan component alongwith the CC
Component

WCDL is a more disciplined version of CC, with more

advantages to lending bank

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 Overdrafts
5

Permitted withdrawls over and above

the borrower’s credit balance

Collateral security is taken

Interest is charged on the overdrawn

amount for the time period utilized
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 Bills Finance
6

Purchase of bills (fund based)

Discounting of bills (fund based)

Drawee Bill acceptance (non-fund)

Bills co-acceptance (non-fund)

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 Bills Finance
6

Clean Bills

Documentary Bills

Supply Bills

Drawee Bills
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SECURED VS UNSECURED LOANS

If a loan is not backed by any tangible security, except the personal

guarantee of the borrower himself or a third party, the loan is
classified as ‘unsecured’.

Secured loans are backed by tangible assets in the form of ‘floating

(current)’ or ‘fixed’ assets.

Observing some basic safeguards such as [a] ensuring adequate

margin, [b] ensuring easy marketability, and [c] proper
documentation while accepting assets as securities would help the
bank recover most of its dues in the event of default

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 Why do Banks keep margin while funding?
8

Fluctuation Interest
in Market may
Value accumulate

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 MODES OF SECURITY

Pledge
• Cumbersome for the bank and hence unpopular
Hypothecation
• Unrestricted right of inspection of stocks and
books of the borrower
• Borrower has to mention a clear title of goods
and slow moving or obsolete stock has to be
excluded
Assignment
• Book Debts, Money due from government or
semi-govt. organizations and life insurance
policies

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 MODES OF SECURITY
10

Lien
• Right to retain securities until the debt due is fully repaid

Mortgage

• Transfer of interest
• Every co-owner or joint owner of property is entitled to
mortgage his share of property

Charge

• Fixed Charge
• Floating Charge
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SOME COMMON SECURITIES FOR
BANK LOANS IN INDIA
Land / real estate

Goods / Inventory

Documents of title to goods

Shares and debentures

Fixed deposit receipts

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 Lending norms for working capital

Within prudential guidelines and exposure norms, banks have

operational freedom to assess working capital needs of borrowers

Some of the methods prevalently used:

Turnover method (Less than 2 crores)

MPBF method (Over 2 - 10 crores)

Cash budget method (Over 10 crores)

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 Example: Turnover method
Case 1 (NWC information is not provided
Borrower: ABC Ltd [Rslacs]
1. Projected turnover for the coming year 60.00
2.Gross working capital [assessed at 25% of [1]] 15.00
Less
3. Borrower’s margin [ a minimum of 5% of [1]
or projected NWC, whichever is higher] [Here 3.00
Assume 5%] 12.00
4. Permissible bank finance [2-3]

Case 2
• If the borrower has projected an NWC [current assets less
current liabilities] of say, 7 lacs, the permissible bank
finance will reduce to Rs 8 lacs.
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 Maximum Permissible Bank Finance
14

● Commonly used methods for Maximum Permissible Bank

Finance (MPBF)

First Method: 75% (CA-CL)

Second Method: 75% (CA) - CL

Third Method: 75% (CA-CCA) – CL

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 Example: MPBF Method
15

● Current Assets : Rs.10 Cr

● Core Current Assets: Rs. 2 Cr
● Current Liabilities: Rs. 5.5 Cr

● Funding as per:
● Method 1: 75% (10-5.5)
● Method 2: 75%(10) – 5.5
● Method 3: 75% (10-2) – 5.5

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CASH BUDGET METHOD FOR
WORKING CAPITAL
ASSESSMENT

Suitable for seasonal industries

Fund-based limits of over Rs.10 crores

Assesses working capital needs at various points of

time and decides peak / non peak levels of finance

Applies appropriate margin

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 CASH FLOW FORECAST

n Description Quarterly cash flow projections

o Q1 Q2 Q3 Q3

1 Total cash outflows from operations

2 Total cash inflows to operations
3 Cash gap in operations
4 LESS: cash to be brought in from
other sources – for example,
cash surplus under non business
operations
/ capital accounts/ sundry items
5 NET CASH GAP from operations
[3 – 4]

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 Fixing the Working Capital Credit limit –
example 1
The borrower seeks working capital finance against raw material inventory, which
needs to be stocked for 2 months.

The value of this inventory is assumed at Rs 1 crore.

The borrower gets market credit for the inventory, creditors for which at any point in
time, show a balance of Rs 25 lacs.

The limit is structured as a percentage of the fully paid inventory that the borrower
holds in one working capital cycle at any point of time

The eligible bank finance against raw material inventory can therefore be only Rs 75
lacs [ to avoid double financing].

Of this amount, the borrower is expected to bring in a margin of 20%, or Rs 15 lacs.

Hence, assuming that the projected NWC of the borrower is not higher than Rs 15
lacs, the bank will finance upto a limit of Rs 60 lacs.
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 Fixing the credit limit – example 2

The borrower seeks working capital finance against inventory and receivables in the
form of book debts.

Let us assume that the borrower in situation 1 has WIP and finished goods inventories
of Rs 2 crores and book debts amounting to Rs 50 lacs outstanding at any point of
time.

After ascertaining that these inventories and book debts are current, marketable and
realizable, the bank fixes appropriate margins of, say, 25% for inventories and 50% for
book debts.

Accordingly, against inventories of Rs 3 crores [inclusive of Raw material], the bank

would fix a credit limit of 75% amounting to Rs 2.25 crores, and against book debts of
Rs 50 lacs the borrower would be eligible for Rs 25 lacs as credit limit.

Thus the bank would finance upto Rs 2.75 crore of working capital.

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 20

Now you are able to analyze various forms of credit,

set the working capital limits and
evaluate various security types

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