Chapter 5 – Credit Delivery

Documentation

  • The documents should be properly stamped
  • The date of execution of documents should never be earlier than the date of stamping.
  • Date and place of execution should be properly mentioned in the documents.
  • It should be ensured that the parties executing the documents have the necessary authority and the capacity to enter into a contract and executed the documents in that capacity. For example, a partner should sign on behalf of the firm and not in his individual capacity.
  • It should be ensured that the person signing the documents is doing so with his free will.
  • The documents should be filled in before these are signed.
  • In case of companies, the charge should be registered with ROC within 30 days from the date of execution of the documents.
  • If any document is required to be registered with the Sub-registrar, it should be done within the prescribed time limit.

Third Party Guarantees

  • Guarantee is taken as an additional safety against default. These third parties can be individuals or any other legal entity.
  • In case of finance to firms, the personal guarantee of proprietor/ partners is not stipulated as they have unlimited liability and their personal assets can be attached for recovery of bank loans.
  • In case of companies and other legal entities, the promoters/ directors/ trustees do not have unlimited/any liability towards bank’s dues. Therefore, in many cases banks stipulate their personal guarantees.

Charge over securities: 

The type of charge depends upon the nature of security and the operational convenience. Only the owner of an asset can create charge over it. The charge could be any of the following:

  • Mortgage
  • Hypothecation
  • Pledge
  • Lien

Possession of Security

Earlier banks favoured `Lock and Key’ advances in which the goods are kept in a godown and bank holds the keys of the locks of the godown. However, this system is very inconvenient not only for the borrower but for the bank also. Therefore, now a days, ‘Hypothecation’ is preferred, where possession remains with the borrower

Disbursal of Loans : Working Capital Loans

Dealing with one or more banks:

  1. In case of sole banking, the bank providing working capital limits opens a cash credit account of theborrower and all his financial transactions should be routed through this account.
  2. Without bank’s permission, no account can be opened with any other bank. Banks give permission to open current account with other bank only if they are convinced about its necessity. in such cases, periodic statements of that account are obtained to keep a tab on the transaction.

Drawing Power:

  1. The drawings in the cash credit account are regulated through the system of ‘Drawing power’ (DP)which is within the sanctioned cash credit limit.
  2. Ideally, the DP should be calculated by obtaining a statement of all the current assets and liabilities (excluding outstanding in cash credit account with the bank) and deducting from it the NWC stipulated at the time of assessment

of the limit. However, this is not feasible as such a statement is normally available only after accounts are finalized and will be available after much delay and may not serve the purpose.

  1. Banks obtain the statement of stocks, book-debts/receivables and the sundry creditors (account payable).These three items form major portion of current assets and liabilities in majority of the enterprises. Drawing power is allowed on fully paid stocks by deducting sundry creditors from stocks and adding sundry debtors.
  2. Stock and Debtors statement is normally obtained on monthly basis but the periodicity can be reduced in exceptional cases.

5 . By stipulating suitable margins (depending on method of assessment) on stocks and book debts and reducing the amount of sundry creditors, the DP is calculated.

Loan Delivery system

  1. Disbursal of entire WC limit by way of cash credit gives wide flexibility to the borrower in his working capital management but, it creates the problem of fund management for the bank as there could be wide fluctuations in the utilization of limits.
  2. Cash credit system also offers scope for diversion of funds by the borrower. If the liquidity in the market is tight and short-term interest on money market instruments is high, borrower may tend to utilize the limit fully. In situations of abundant liquidity, the situation is reverse and the utilization of limit may tend to be low. The bank loses in such situations as it has to arrange for short term funds when interest rates are high and is left with surplus funds when rates are low.
  3. To meet this situation and to ensure that the utilization of limit is more stable, a portion of sanctioned limit is disbursed by way of ‘Loan’, which is a fixed component, and remaining amount is disbursed as cash credit. With this,if the borrower wants to draw very little amount or no amount, there will be debit in the loan account (fixed amount) while the cash credit account may have credit balance.

RBI guidelines on Loan Delivery System:

  1. In the case of borrowers enjoying working capital credit limits of Rs.10 crore and above from the banking system, the loan component should normally be 80 percent. Banks, however, have the freedom to change the composition of working capital by increasing the cash credit component beyond 20 percent or to increase the ‘Loan Component’ beyond 80 percent, as the case may be.
  2. In the case of borrowers enjoying working capital credit limit of less than Rs.10 crore, banks may persuade themto go in for the ‘Loan System’ by offering an incentive in the form of lower rate of interest on the loan component, as compared to the cash credit component.
  3. In respect of certain business activities, which are cyclical and seasonal is nature or have inherent volatility, the banks may exempt such activities from the loan system of delivery.

Disbursal of Loans – Term loans

  • If the term loan is to be disbursed in one go, e.g. purchase of a machine/ ready house, the borrower is asked to deposit his margin with the bank, his loan account is debited by the amount of the loan and the entire amount to be paid to the buyer, is remitted to him by the bank. If any amount has already been paid to the buyer by the customer, satisfactory proof, like details of bank account etc, of this payment is obtained, and this is considered to be a part of his contribution (margin). In exceptional cases, like personal loans or consumption loans, the amount may be credited to the account of the customer with the bank.
  • In case where the execution of the project is spread over a period of time, the disbursement is normally related to the progress of the project. Therefore promoters may bring contribution in any of these methods:
  1. Promoters bring their entire contribution upfront before the bank starts disbursing its commitment.
  2. Promoters bring certain percentage of their equity (40%-50%) upfront and balance is brought in stages.
  3. Promoters agree, ab initio, that they will bring in equity funds proportionately as the banks finance the debt portion.

The last method has greater equity funding risk. In order to contain this risk, banks should have a clear policy regarding the Debt Equity Ratio (DER) and to ensure that the infusion of equity/fund by promoters should be such the stipulated level of DER is maintained at all times. Further they may adopt funding sequences so that possibility of equity funding by banks is obviated.

Lending under Consortium/ Multiple Banking Arrangements:

  1. The sole banking is suitable for financing working capital needs of an enterprise only if the requirement is within the policy framework of the financing bank. If the requirements grow beyond the comfort level of that bank due to prudential norms or risk perception for a particular segment/borrower, if would like another bank to finance a part of the requirements of that enterprise.
  2. If two or more banks get into a formal arrangement to finance the working capital needs of a borrower, it is called consortium arrangement. The consortium banks decide on one of the members as’Lead bank’ who not only arranges periodic meetings of the member banks but also takes lead in assessment, documentation, charge creation, monitoring of the account, etc.
  3. In case of multiple banking there is no formal arrangement between the banks though they may share the information about the account in their mutual interest.

RBI Guidelines on Consortium:

Various regulatory prescriptions regarding conduct of consortium/multiple banking/syndicate arrangements were withdrawn by Reserve Bank of India in October 1996 with a view to introducing flexibility in the credit delivery system and to facilitate smooth flow of credit. However, as suggested by Central Vigilance Commission, RBI has advised the banks to strengthen their information back-up about the borrowers enjoying credit facilities from multiple banks as follows:

(a) At the time of granting fresh facilities, banks, may obtain declaration from the borrowers about the credit facilities already enjoyed by them from other banks in the format prescribed. In the case of existing lenders, all the banks may seek a declaration from their existing borrowers, availing credit facilities from other banks, and introduce a system of exchange of information with other banks as indicated above.

(b) Subsequently, banks should exchange information about the conduct of the borrowers accounts with other banks at least at quarterly intervals.

(c) Obtain regular certification by a professional, preferably a Company Secretary, Chartered Accountant or Cost Accountant, regarding compliance of various statutory prescriptions that are in vogue.

(d) Make greater use of credit reports available from CIBIL.

(e) The banks should incorporate suitable clauses in the loan agreements in future (at the time of next renewal in the case of existing facilities) regarding exchange of credit information so as to address confidentiality issues.

Syndication of Loans 

The term ‘Syndication’ is normally used for sharing a long-term loan to a borrower by two or more banks. This is a way of sharing the risk, associated with lending to that borrower, by the banks and is generally used for large loans. The borrower, intending to avail the desired amount of loan, gives a mandate to one bank (called Lead bank) to arrange for sanctions for the total amount, on its behalf. The lead bank approaches various banks with the details. These banks appraise the proposal as per their policies and risk appetite and take the decision. The lead bank does the liaison work and common terms and conditions of sanction may be agreed in a meeting of participating banks, arranged by the lead bank. Normally, the lead bank charges ‘Syndication fee’ from the borrower.

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