Working Capital Finance from Banks

Banks in India today constitute the major suppliers of working capital credit to any business activity. Recently some term lending financial institutions have also announced schemes for working capital financing. The two committees viz., Tandon Committee and Chore Committee have evolved definite guidelines and parameters in working capital financing, which have laid the foundations for development and innovation in the area.

Now the RBI has withdrawn all the instructions relating to MPBF and the banks are now free to evolve, with the approval of their Boards, methods for assessing the working capital requirements.

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Forms of Bank Credit:

The bank credit will generally in the following forms:

i. Cash Credit:

This facility will be given by the banker to the customers by giving certain amount of credit facility on continuous basis. The borrower will not be allowed to exceed the limits sanctioned by the bank.

ii. Bank Overdraft:

It is a short-term borrowing facility made available to the companies in case of urgent need of funds. The banks will impose limits on the amount they can lend. When the borrowed funds are no longer required they can quickly and easily be repaid. The banks issue overdrafts with a right to call them in at short notice.

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iii. Bill Discounting:

The company which sells goods on credit, will normally draw a bill on the buyer who will accept it and sends it to the seller of goods. The seller, in turn discounts the bill with his banker. The banker will generally earmarks the discounting bill limit.

iv. Bills Acceptance:

To obtain finance under this type of arrangement, a company draws a bill of exchange on bank. The bank accepts the bill thereby promising to pay out the amount of the bill at some specified future date. The bill itself is then worth something as the holder is to receive a sum of money at a future date.

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This bill can be sold either at once or when the funds are needed. It is sold in the money market to, say, discount houses. It is similar to an arrangement to an ordinary bills of exchange between two companies but now one of the parties is a bank.

A bill bearing a reputable bank’s name can be sold in the money markets at a lower discount rate than a bill bearing the name of a medium or small sized company because of the reduced risk.

v. Line of Credit:

Line of credit is a commitment by a bank to lend a certain amount of funds on demand specifying the maximum amount of unsecured credit the bank will permit the customer to lend at any point of time. The bank will charge extra cost over the normal rate of interest since it will keep the funds available to make use of the funds by the customer at all times.

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vi. Letter of Credit:

It is an arrangement by which the issuing bank, on the instructions of a customer or on its own behalf, undertakes to pay or accept or negotiate or authorizes another bank to do so against stipulated documents subject to compliance with specified terms and conditions.

The documentary credit is considered as the best payment arrangement since a reputed bank who pays against the presentation of stipulated documents as mentioned in the letter of credit.

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