Working Capital - Definition
Funds deployed for managing business operations.
It is that part of the firm’s capital, which is required for financing
current assets such as cash, marketable securities, debtors &
inventories.
Funds thus invested in current assets keep revolving fast and are
constantly converted into cash.
It is also called revolving or circulating capital or short-term capital
Credit Appraisal – key aspects
Working capital cycle
Cash
Sundry
debtors
Finished
goods
Raw
Materials
Semi
finished
goods
Working Capital Cycle
1. Sales order is
received by an
entity
5. Funds are
released for next
production cycle.
Sales
Order
Cash
4. Goods may be sold on
cash or credit. Credit
receivables are realized
Collect
Account based on the credit period
Receivable
offered. There is a time lag
between sale & receipt of
funds.
2. Entity purchases
raw material, goods , Produce
incurs expenses for Goods or
Service
services, overheads.
Deliver
Goods or
service
3. Once the production cycle is
complete, finished goods/services are
delivered to the customer
Sources of Working Capital Finance ?
Working Capital
Sources
• Owned Funds
• Long Term Funds
• Equity Share
Capital
• Reserves &
Surplus
• Bank Borrowings
• Working Capital
Products
• Cash Credit
• Overdraft
• Bill
discounting
Creditors
• Credit period
availed from
creditors
Types of Working Capital Facilities from Banks
Working Capital
Fund Based
Cash Credit/
Overdraft/
Dropline OD/
WCDL
Bill Discounting/
Pre Shipment/
Post Shipment
Finance/Buyers
Credit
Non Fund based
Bank Guarantee
Inland
5
Letter of Credit
Foreign
Working Capital Assessment Methods
Computation of Maximum Permissible Bank Finance
 Maximum permissible bank finance – based on recommendation of
Tandon Committee
 3 Methods of calculation
MPBF = 75% ( Current Asset – Current Liabilities other than Bank
6
1st method
borrowings)
2nd method
MPBF = (75% of Current Asset – Current Liabilities other than Bank
borrowings)
3rd method
MPBF = 75% of (Current Asset – Core Current Asset ) - Current
Liabilities other than Bank borrowings
MPBF Calculation - Example
Current Liabilities:
Current Assets:
• Bank borrowings : 200
• Creditors
: 100
• Other CL
: 50
Inventories:
• Raw materials
: 200
• Stock – in – process : 20
• Finished Goods
: 90
Total Current
Liabilities
7
: 350
Receivables
Other CA
: 50
: 10
Total Current Asset
: 370
MPBF Calculation - Example
1st method
1.
2.
3.
4.
5.
6.
7.
8
Total Current Assets
Current Liabilities other than Bank borrowings
Working Capital Gap
25% of Working capital gap to be brought in from long term sources
Maximum Permissible Bank Finance (MPBF)
Excess borrowing
Current Ratio=CA/CL=370/(150+165) =1.17:1
MPBF = 75% ( Current Asset – Current Liabilities other than Bank
borrowings)
= 75% ( 370 - 150)
= 75% of 220
= 165
370
150
220
55
165
35
1.17 : 1
MPBF Calculation - Example
1st method
1.
Total Current Assets
370
2. Current Liabilities other than Bank borrowings
150
3. Working Capital Gap
220
4. 25% of Working capital gap to be brought in from long term sources
55
5. Actual / Projected net working capital
20
6. Item 3 – Item 4
165
7. Item 3 – Item 5
200
8. Maximum Permissible Bank Finance ( Item 6 or 7, whichever is
lower)
165
9. Excess borrowing
35
10 Current Ratio
.
9
1.17 : 1
MPBF Calculation - Example
2nd method
1.
10
Total Current Assets
370
2. 25% of Current Asset to be brought in from long term sources
92.5
3. 75% of Current Asset
277.5
4. Current Liabilities other than Bank borrowings
150
5. Maximum Permissible Bank Finance (MPBF)
127.5
6. Excess borrowing
72.5
7. Current Ratio
1.33 : 1
MPBF = (75% of Current Asset – Current Liabilities other than Bank
borrowings)
= (75% of 370 - 150)
= 277.5 - 150
= 127.5
MPBF Calculation - Example
2nd method
1.
Total Current Assets
370
2.
25% of Current Asset to be brought in from long term sources
92.5
3.
75% of Current Asset
277.5
4.
Current Liabilities other than Bank borrowings
150
5.
Actual / Projected net working capital
20
6.
Item 3 – Item 4
127.5
7.
Item 3 – Item 5
257.5
8.
Maximum Permissible Bank Finance (MPBF : Item 6 or 7, whichever is lower)
127.5
9.
Excess borrowing
72.5
10. Current Ratio
11
1.33 : 1
MPBF Calculation - Example
3rd method
1.
Total Current Assets
370
2.
Less, Core Current Asset (say)
90
3.
Current Asset – Core Current Asset
280
4.
25% to be brought in from long term sources
70
5.
75% of Current Asset
210
6.
Current Liabilities other than Bank borrowings
150
7.
Maximum Permissible Bank Finance (MPBF)
60
8.
Excess borrowing
140
9.
Current Ratio
> 1.7: 1
MPBF = 75% of (Current Asset – Core Current Asset ) - Current Liabilities
other than Bank
borrowings
= (75% of 280) - 150
= 210 - 150
= 60
WC Finance
1. Payables – supplier of RM on Credit- Payables
2. LT source – promotor/ LT source DFI –25% of CA
3. Bank- 75% of CA
• Core CA-promotor
• Core CA is that part of the CA without which you cannot run your
show
Borrowing units engaged in exports
• Need not bring 25% contribution from long term
sources i.e. bank will finance 100% of Export
Receivables.
Which method is followed in reality?
• 3rd method was not accepted for implementation and
hence is of only academic interest
• Banks generally calculate MPBF using 2nd method of
lending
• Exceptions :
• Fund based limit are up to and inclusive of Rs. 5.00 Crore
(Turnover methodology is used)
• Rehabilitation of Sick/Weak units etc.
Projected turnover
• PT 100
• WC 25
• MPBF 20
• PMM 5 Promotor’s Margin Money
Working Capital Assessment Methods
 Maximum permissible bank finance – based on
recommendation of Nayak Committee
Turnover Method
17
• Working capital requirement = 25% of the projected
Turnover
• Promoter Contribution (Margin) = 5% of the Turnover
• Bank Finance = 20% of the Turnover
• This method is usually used to assess requirement of small
scale industries.
• Today this is used for Non - SSI segment to all borrowers
enjoying fund based working capital limits up to and
inclusive of Rs. 5.00 Crore with the banking system
• Op cash balance 100
• Receipts
1000
• Payments
2100
• Deficit
1000
• 75% MPBF
750
• PMM 25%
250
Working Capital Assessment Methods
 Maximum permissible bank finance – based on
recommendation of Kannan Committee
Cash Budget
Method
19
• Working capital limit in excess of Rs. 5.00 Crore.
• The Peak Level Cash Deficit will be the level of
the total working capital finance.
• Borrower need to submit projected Cash Budget
Statement.
• Promoter Contribution should be 25% of Peak
Deficit.
Credit Monitoring Arrangement
• Introduced by RBI in 1975
• Prescribed the format to obtain the necessary data from the
borrower to access working capital requirements under the Credit
Authorisation Scheme.
• This scheme was changed to Credit Monitoring Arrangement in 1988
• Banks continue to obtain CMA forms for fund based working capital
limit on Rs. 1 crore and above as this facilitate computation of MPBF
Credit Monitoring Arrangement : 6 Forms
Form I
Form II
Contains particulars of existing credits from the entire
banking system
Operating Statement
Form III
Balance Sheet
Form IV
Details of Current Assets and Current Liabilities
Form V
Computation of MPBF
Form VI
Funds Flow Statements
Credit Monitoring Arrangement : Purpose
• To clean-up and purify Current Asset and Current
Liability before calculating MPBF
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form II (OPERATING STATEMENT)
1. Gross Sales
i. Domestic Sales
ii. Deemed Export Sales/Exports
Total
2. Less Excise Duty
3. Net Sales
4. % rise (+) / fall (-) in Net Sales as
compared to previous year
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form II (OPERATING STATEMENT)
5. Cost of Sales
i. Raw Materials
(a) Imported
(b) Indigenous
Total
ii. Other Spares
(a) Imported
(b) Indigenous
iii. Power & Fuel
iv. Direct Labour
(Factory wages & salaries)
v. Other Manufacturing Expenses
vi. Depreciation
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form II (OPERATING STATEMENT)
vii. SUB-TOTAL (i to vi)
viii. Add : Opening Stocks-in-process
Sub-total
ix. Deduct : Closing Stocks-in-process
x. Cost of Production
xi. Add : Opening Stock of Finished Goods
Sub-total
xii. Deduct : Closing Stock of Finished Goods
xiii. SUB-TOTAL (Total Cost of Sales)
6. Selling, General and Administrative Expenses
7. SUB-TOTAL (5+6)
8. Operating Profit Before Interest (3-7)
9. Interest
10. Operating Profit After Interest (8-9)
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form II (OPERATING STATEMENT)
11. i) Add Other Non-operating Income
(a) Exchange Rate diff.
(b) Int./Dividend/Sales Tax refund etc.
Sub-total (Income)
ii) Deduct other Non-operating Expenses
(a) Loss on sale of fixed assets
(b)
Sub-total (Expenses)
iii) Net of other Non-operating
Income/Expenses {net of 11(i) & 11(ii)}
12. Profit Before Tax / Loss {10+11(iii)}
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form II (OPERATING STATEMENT)
13. Provision for Taxes
14. Net Profit / Loss (12-13)
Deduct : Previous Year Adjustment
15. Deduct :
(a) Equity Dividend Paid
(b) Dividend Rate
16. Retained Profit (14-15)
17. Retained Profit / Net Profit (% age)
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form III (BALANCE SHEET)
CURRENT LIABILITIES
1. Short term borrowings from banks (including
bills purchased, discounted & excess
borrowings placed on repayment basis)
i) From application bank
ii) From other banks
iii) ( of which BP & BD )
Sub-total (A)
2. Short term borowings from others
3. Sundry Creditors (Trade)
4. Advance Payments from Customers /
Deposits from dealers
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form III (BALANCE SHEET)
5. Provision for Taxation
6. Dividend Payable
7. Other Statutory Liabilities
8. Deposits/Instalments of term loans/DPGs/
debentures, etc.(due within one year)
9. Other Current Liabilities & Provisions (due
within one year)
Sub-total (B)
10. TOTAL CURRENT LIABILITIES
(Total of 1 to 9)
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form III (BALANCE SHEET)
TERM LIABILITIES
11. Debentures (not maturing within one year)
12. Preference Shares (Redeemable within
one year)
13. Term Loans (excluding instalments payable
within one year)
14. Deferred Payment Credits excluding
instalments due within one year (Sales tax)
14 a) Creditors for Capital Expenditure
15. Term Deposits (Repayable after one year)
16. Other Term Liabilities (Unsecured Loans
from Directors/Relatives/Associates)
17. TOTAL TERM LIABILITIES
(Total of 11 to 16)
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form III (BALANCE SHEET)
18. TOTAL OUTSIDE LIABILITIES
(10+17)
NET WORTH
19. Ordinary Share Capital
20. General Reserve/Share Premium
21. Revaluation Reserve
22. Other reserves (excluding provisions)
23. Surplus (+) or Deficits (-) in
Profit & loss Account
24. NET WORTH
25. TOTAL LIABILITIES (18 + 24)
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form III (BALANCE SHEET)
CURRENT ASSETS
26. Cash and Bank balances
27. Investments (other than long term invetsments)
i) Government & other trustee securities
ii) Fixed deposits with banks / Margin Money
28. i) Receivables other than deferred & exports
(including bills purchased & discounted
by banks)
ii) Export receivables (including bills purchased
/discounted by banks)
29. Instalments of deferred receivables (due
within one year)
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form III (BALANCE SHEET)
30. Inventory
i) Raw Materials (including stores & other
items used in the process of manufacture)
a) Imported
b) Indigenous
Total
ii) Stocks-in-process
iii) Finished Goods
iv) Other consumable spares
a) Imported
b) Indigenous
Total Inventory
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form III (BALANCE SHEET)
31. Advances to suppliers of raw materials &
stores/spares
32. Advance Payment of Taxes
33. Other Current Assets
34. TOTAL CURRENT ASSETS
(Total of 26 to 33)
FIXED ASSETS
35. Gross Block(land & building, machinery,
work-in-progress)
36.Depreciation to date
37. NET BLOCK
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form III (BALANCE SHEET)
OTHER NON-CURRENT ASSETS
38. Investments/book debts/advances/deposits
which are not curent assets
i) a) Investments in subsdiary companies/
affiliates
b) Others
ii) Advances to suppliers of Capital Goods
& Contractors
iii) Deferred Receivables(maturity exceeding
one year)
iv) Others
39. Non-consumable stores & spares
40. Other non-current assets including dues
from directors
41. TOTAL OTHER NON-CURRENT ASSETS
(Total of 38 to 40)
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form III (BALANCE SHEET)
42. Intangible assets
i) Patents, Goodwill etc. (not provided for)
ii) Doubtful Debts
iii) Prelim. Expenses
iv) Debit Balance in Partners A/c. of
erstwhile firm
TOTAL INTANGIBLE ASSETS
43. TOTAL ASSETS
(Total of 34, 37, 41, & 42)
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form III (BALANCE SHEET)
44. TANGIBLE NET WORTH (24-42)
45.NET WORKING CAPITAL
[(17+24) - (37+41+42)] To tally with (34 - 10)
46. Current Ratio (Item 34/10)
47. Total Outside Liabilities/Tangible Net Worth
(Item 18 / 44)
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form III (BALANCE SHEET)
ADDITIONAL INFORMATION
(A) Arrears of depreciation
(B) Contingent Liabilities
I) Arrears of Cumulative Dividends
ii) Gratuity Liability not provided for
iii) Disputed Excise/Customs/Tax liabilities
iv) Other Liabilities not provided for
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form IV
A. CURRENT ASSETS
1) Raw Materials (including stores
& other items used in the process
of manufacture)
a) Imported
Months' Consumption
b) Indigenous
Months' Consumption
2) Other consumable spares excluding
those included in 1) above
a) Imported
Months' Consumption
b) Indigenous
Months' Consumption
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form IV
3) Stocks-in-process
Months' Cost of Production
4) Finished Goods
Months' Cost of Sales
5) Receivables other than deferred &
exports (including bills purchased
& discounted by banks)
Months' domestic sales, excluding
deferred payment sales
6) Export receivables (including bills
purchased /discounted by banks)
Months' Export Sales
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form IV
7) Advances to suppliers of raw
materials & stores/spares
8) Other Current Assets including
cash/bank balances & deferred
receivables due within one year
9) TOTAL CURRENT ASSETS
(To agree with item 34 in Form III)
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form IV
B. CURRENT LIABILITIES
(other than bank borrowings for
working capital)
10. Creditors for purchase of
raw materials, stores &
consumable spares
Months' Purchases
11. Advance from Customers
12. Statutory liabilities
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form IV
13. Other Current Liabilities
(short term borrowings, unsecured
loans, dividend payable,
instalments of TL, DPG, public
deposits, debenures)
14. TOTAL
(To agree with sub-total B-Form III)
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form V (Computation of MPBF)
1. Total Current Assets
(9 in Form IV)
2. Current Liabilities
(Other than bank borrowing)
(14 of Form IV)
3. Working Capital Gap (WCG)
(1 - 2)
4. Min. stipulated Net Working
Capital, i.e. 25% of WCG / 25%
of total current assets as the case
may be depending upon the
method of lending being applied.
(Export receivables to be
excluded under both methods)
ASSESSMENT OF WORKING CAPITAL REQUIREMENTS : Form V (Computation of MPBF)
5. Actual/Projected net working
capital (45 in Form III)
6. Item 3 minus item 4
7. Item 3 minus item 5
8. Maximum Permissible Bank
Finance (Item 6 or 7 whichever
is lower)
9. Excess borrowings representing
short fall in NWC.(4 - 5)
Fund Based Facilities
Cash
Credit
• Running Account facility
• Drawing power determined each month based on
stock and/or debtors statement declared by the
borrower
• Borrower can make payments to creditors or for
expenses
• Sale proceeds to be credited in this account
Overdraft
• Borrower can withdraw up to sanctioned limit
• It may be temporary or regular, secured or
unsecured
Fund Based Facilities
Working
Capital
Demand
Loan
Drop
Line
Overdraft
• To be repaid on demand.
• Unlike a term loan it is not payable in a fixed schedule at a
fixed time.
• To meet short term working capital requirement of the
borrower.
• An overdraft facility where sanction limit gets reduced
over a period of time by a fixed amount, for a fixed time
period.
Fund Based Facilities
• Under Bill discounting , bank takes the bill drawn by
borrower on his (borrower's) customer and pay him
immediately
deducting
some
amount
as
discount/commission.
Bills
Discounting
• The Bank then presents the Bill to the borrower's customer
on the due date of the Bill and collect the total amount.
• If the bill is delayed, the borrower or his customer pays the
Bank a pre-determined interest depending upon the terms
of transaction.
48
Fund Based Facilities
Pre
Shipment
Finance
• To enable exporters to procure raw materials, processing,
manufacturing, packing, transportation and warehousing of
goods meant for export.
• There must be an export order.
Post
Shipment
Finance
• Finance to enhance the exporters capability to offer credit
and gain competitive edge in global markets.
• Shipping / other documents evidencing exports must be
present.
Non Fund Based : Letter of Credit
• Banker’s Undertaking on behalf of a constituent to pay to a third
party against compliance of stipulated conditions.
• On submission of documents as per terms, the LC opening Bank is
duly bound to make the payment.
• It is the responsibility of the borrower to make the payment of the LC
on the due date to the issuing bank, failing which it leads to
devolvement of LC.
• Letters of Credit facilitate settlement of trade payments and are used
for both local and international trade.
Non Fund Based : Letter of Credit
Inland LC
51
Foreign LC
Sight LC
Inland LC is
Foreign LC is
LC payable
issued to meet
issued to meet
immediately on
out the credit
out the credit
presentation of
requirement for
requirement for
requisite
domestic trade.
foreign trade.
documents
Usance LC
LC payable at
determined
future date after
presentation of
necessary
documents
SBLC
Issued to serve as
guarantee to
beneficiary of LC
that borrower shall
perform the
contract with
beneficiary.
Assessment of Letter of Credit
Assessment of BG Requirements
Total Purchases
Purchases under LC ( X % say 60% )
Period under LC - ( Y days )
Lead Time under LC (days) only in case of
Offsite LC
LC Requirement C = ( B * (Y + Z )/365 )
Example - Rs.
Rs. In Millions In Millions
A
100
B= A * X %
Y
60
90
Z
30
C
19.73
Non Fund Based : Bank Guarantee
Bank guarantee is issued by the bank, undertaking the liability of applicant.
In case of non fulfillment of the underlying conditions by the borrower, the
Bank is liable to compensate the principal
Financial Bank Guarantee
Performance Bank Guarantee
• Performance Guarantee is a guarantee
• Financial Guarantee is a guarantee by
Bank to discharge the financial
obligation of the applicant.
• These are normally issued in lieu of
for due performance of a contract by the
applicant.
• These are generally required by
contractor profiles, BG to be issued in
payment of tender deposits, earnest
favor of various Government, Semi-
money deposits, customs duty/excise
Government organizations, or
duty/income tax and guaranteeing
manufacturing entities who supply to
payment of goods purchased under
larger Corporate Houses.
credit.
• E.g., BG for Advance mobilization
advance
53
Assessment of Bank Guarantee
A ssessm en t o f BG Req u i r em en t s
Order to be bid in next 12 m onths
Successful contract value ( assum ing a strike
rate of X% )
EM D (A)
Period ( m ax 6 m onths )
Required @ 2% * (1) / 2
Perform ance Guarantee ( B)
Required @ 5% * (2)
M obilization Advance ( C )
Required @ 10% * ( 2 )
Retention m oney ( D ) @ 5% of the projected
topline of next financial year
Total guarantee requirem ent for new orders
( E = A+ B+ C+ D )
Existing outstanding Bank guarantees ( F )
Bg expiring in next 12 m onths ( G )
Total guarantee requirem ent ( H = E+ F-G )
Our proposed lim its
BG lim its w ith existing bankers
Untied Gap
54
Rs. i n M i l l i o n s
1
2
A
Ex am p l e – Rs.
In M i l l i o n s
100
60
6 m onths
1
B
3
C
6
D
6.25
E
F
G
16.25
5
4
H
I
J
K = H - ( I+ J)
17.25
10
5
2.25
Key Financial Parameters
55
Total Current Assets
All assets with maturity less than one year
Total Current Liabilities
Total liabilities with maturity less than one year, including installments
of term
liabilities /
DPGs due within one year
Net Working Capital Gap
Current Ratio
Total Current Assets – Total Current Liabilities
Total Current Assets / Total Current Liabilities
Working Capital Bank
Finance
Secured and unsecured working capital availed from the Banks
(include, Bills
discounted /
purchased, Cash Credit / WCDL, Demand loans, Export finance etc.)
Tangible Networth (TNW)
Paid up share Capital + Reserves - Revaluation Reserves - Intangible
assets
(patents, goodwill, prelim. Expenses, bad / doubtful expenses not
provided
for etc.)
Adjusted TNW (ATNW)
TNW – Exposure in subsidiaries/group by way of investments / loans &
advances
Key Financial Parameters
56
Long term debt (LTD)
Debt greater than one year (term loans, debentures, preference
shares, DPGs,
other term liabilities) excluding installments due within one year
Short term debt (STD)
Debt due within one year (includes demand loans, unsecured
loans etc.) but
excluding
Working Capital Finance.
Total Debt
Short Term Debt + Long Term Debt + Working Capital Finance
TOL/TNW
(Total Current Liabilities + Total Term liabilities +Deferred Tax
Liability) /TNW
Debtors Inventory Days
(Debtors + Inventory )*No. of working days(365) / TOI
Key Financial Parameters
EBIDTA
Total Operating Income - ( Operating Expenses excl. Interest,
Depreciation )
EBIDTA/TOI %
EBIDTA / TOI ( Total Operating Income )
Operating Profit
EBIDTA – Interest – Depreciation
Non-operating income
Income not from normal course of business net of non-operating
expenses
PBT
Operating Profit – Non Operating Income
PAT
PBT - Taxes ( incl. Deferred Tax )
5 Cs of Credit
Character
of
Borrower
Willingness to
Pay
Borrower’s
Capital
Risk-bearing
•
•
•
•
Conduct of existing facility
Repayment track of loans
Promoters background/ vintage
Dedupe checks
• Capital/Investment in Business
• Personal Net worth
Commitment
Business of
Condition
borrower &
Industry Trend
Ability to pay,
Capacity
Cash Flow
Adequacy
Priority of
Collateral
Charge and
Value
58
• Key ratios
• Business model
• Products dealt with
• Cash Accruals from business
• Growth trend in business
• Operating margins
• Marketability of collateral offered
• Attachment to borrower
• Legal title
What is the Ideal DSCR
• PAT+DEPN+INT on TL/INT on TL+PRINCI of TL
• MYTH/REALITY
•A bird in hand is worth two in the bush
•2/1
• 2:1
• It is desirable to have a dscr of 2:1 under normal circumstances
Buyers’ Credit
Here’s how the business works.
• A company, with which a bank has an existing credit
relationship (gives loans to), is in the import-export business.
• It needs capital to manage some part of its operations in a
foreign jurisdiction.
• However, banks in that jurisdiction may either be unwilling to
lend to this company (because they are not familiar with it) or
charge it high rates of interest for loans.
• Also, borrowing in India is more expensive because interest
rates are high.
Buyers’ Credit
• But if the company is willing to take on some currency risk, it
can reduce its interest rate risk.
• So, the company goes back to its relationship bank in India
and gets a guarantee (in the form of a ‘Letter of
Understanding’ or ‘Letter of Credit’).
• It then goes to the offshore branch of another Indian bank
and borrows against this guarantee at a lower rate.
Buyers’ Credit
• For the company, this means cheap and quick credit.
• For the overseas branch of the Indian bank, it means low-risk
lending income since it is giving out money against the
guarantee of another bank.
• For the home bank, it means cross-selling and another stream
of income from the same client.
Buyers’ Credit
• Even prevailing regulations lull everyone into a false sense of
comfort. The risk weight assigned to buyer’s credit is 20
percent compared to the 100 percent risk weight attached to
corporate loans.
• It worked well for all concerned. Till now.
Buyers’ Credit
• The PNB case has exposed a whole series of issues, which
need to be examined at a system level and plugged, said a
retired Reserve Bank of India official who spoke on the
condition of anonymity.
• This person added that this is not the first time that
fraudulent transactions have been reported linked to ‘Letter
of Understanding’ / ‘Letter of Credit’ facilities and it won’t be
the only instance found, if the regulator combs through the
system.
Buyers’ Credit
• In the hierarchy of high profile banking functions, the trade
finance department which deals with buyer’s credit falls
closer to the bottom rather than the top.
• It has been seen as a low-risk, short-term, sometimes
mechanical business, built atop an existing client relationship.
• As such, it flies under the radar. But those same perceived
characteristics - short-term, low-risk and mechanical - may be
among the key reasons that the fraud at Punjab National
Bank went unnoticed until it blew up into a Rs 11,400 crore
scam - the biggest in the history of Indian banking.
Security
Type of Securities
Residential Property
Commercial Property
Industrial in non Industrial Area
Industrial in industrial area
Vacant residential land
Liquid Collateral
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Comparison…
Name of Process
Ownership of the
Asset During the
tenure of the loan
Possession
of the Asset
During the
tenure
Type of Asset
on which
charge
is created
Governing
Statute
Lien
Borrower
Lender
Financial Asset
Indian Contract Act
Pledge
Borrower
Lender
Hypothecation
Borrower
Borrower
Mortgage
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Borrower
Borrower
Both Financial
Asset and
Movable
Physical Asset
Movable
Physical
Asset
Immovable
Physical Asset
Indian Contract Act
Indian Contract Act
Transfer of
Immovable
Properties Act
Charge creation Types
 Lien : Under this process, security is created on financial asset. The
name of the liability holder is marked on the face of the financial
instrument as lien. Under this system, the ownership is with the
borrower where as the possession is with the lender. The security is
created on financial assets
 Pledge : Under this process , security is created on both financial and
physical assets. In the case of Pledge, the ownership is with the
borrower where as the possession is with the lender. The lender can
keep the assets in its own premises or in other premises.
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Charge creation Types
 Hypothecation : Under this process, security is created on physical
assets. In the case of hypothecation, both the possession and
ownership is with the borrower. For creation of hypothecation,
charge needs to be created for limited company
 Mortgage : For immovable property, mortgage is created. In the case
of mortgage, the possession and ownership is with the borrower.
But mortgage is created on the immovable property where as the
hypothecation is created on movable physical assets.
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In Case of term loan following additional information is
required.
• Complete details of project, diversification/expansion if any including technical details/feasibility
study, technology adopted.
• Estimated cost of project with detailed break up of each item, import duty if any, indigenous
items and names of suppliers of machinery etc with supporting documents evidence.
• Means of finance alongwith repayment schedule, Debt equity ration & promoter contribution.
• Implementation schedule
• Project Appraisal Agency, if any and its recommendations (In house, IDBI/competent consultant)
• Detailed assumptions underlying profitability projections
• Breakeven analysis
• Detailed calculation of DSCR for the repayment period
• Cash flow statement
• Internal Rate of Return (IRR) in case of term loan of Rs 1.00 crore and above.
• Sensitivity Analysis in case of term loan of Rs.1.00 crore and above.
Finance my Business
•Our Finance Management
Solutions
1. Long Term Loan
2. Working Capital Finance
3. Structured Finance