Adjusting To The New Paradigm In Finance

Working Capital (WC) finance is provided by banks in India mainly in the form of long term/short term loans, cash credit (CC) facility and non fund based (LC/BG) facilities.

The bifurcation of fund based credit facilities in the form of loan/cash credit has been kept at the discretion of banks by the regulator. Recently, Reserve Bank of India (RBI), the banking regulator, has vide its guideline of December 05, 2018 introduced Loan Component in WC finance. The guidelines are applicable for borrowers enjoying aggregate fund based (FB) WC finance of Rs150 crore and above from banking system.

As per these guidelines, now the borrowers falling in this category will be compulsorily required to avail 40 per cent of sanctioned FB WC finance in the form of a loan component with effect from April 01, 2019. This minimum limit will be further increased to 60 per cent w.e.f. July 01, 2019. The balance FB limit can be in the form of cash credit limit. RBI has stated that bifurcation into loan component and cash credit shall be effected after excluding the export credit limits and inland sales bills discounting limit.

Based on the guidelines, it appears that for testing the total aggregate FB WC finance (Rs.150 crore and above) and applicability of these new norms, components of export credit and inland bills limit will be included to arrive at the total aggregate FB WC limit. In case, this is not the understanding, clarification would be required to be issued by RBI in the matter. It also appears that 40 per cent or 60 per cent loan component norms are the minimum threshold limits and lenders would be free to decide any higher limit also.

Generally, the WC loan component is provided in the form of WC Demand Loans (WCDL), WC Term Loans (WCTLs) and Commercial Papers (CP). For the tenor of the loan component, RBI has prescribed minimum tenor of seven days. As per the guidelines, the loan component can be split into multiple loans having different maturities.  Banks have been also given freedom for allowing rollover of these loans subject to compliance with IRAC norms. The IRAC norms stipulate that rollover can be allowed based on the actual requirement of the borrower and no concession has been provided due to credit weakness hence the new guidelines restrict scope for allowing any ever greening of accounts by banks.

It would be interesting to mention that loan component in WC finance is not a new invention. This was proposed by Prakash Tondon Committee way back in 1975. RBI also from time to time stipulated that loan component should be 80 per cent. However at the same time RBI allowed freedom to banks for changing the composition by increasing the cash credit component beyond 20 per cent and reducing the loan component below 80 per cent. Now this time, in order to bring more credit discipline from the large borrowers, RBI has made the loan component (40 per cent / 60 per cent) as a compulsory arrangement.

RBI has not provided any guidance on applicable rate of interest (ROI) on loan component. However, going by the past guidelines wherein loan component was favoured with low rate of interest as compared to cash credit in order to encourage borrowers precisely planning their credit needs, it is felt that lenders may consider the past practices and may favour with lower ROI (generally by 1 per cent as compared to CC) on loan component depending on the loan tenor and credit ratings.

The new RBI guidelines mention that ground rules for sharing of cash credit and loan component may be laid down by consortium. Under Multiple Banking Arrangement (MBA), it will be responsibility of each bank under MBA to ensure adherence to these guidelines.

It would be interesting to mention here that in order to bring more co-operation and effective implementation of lending among the public sector banks (PSBs) under consortium/MBA, Ministry of Finance (MoF) had advised guidelines on Joint Lending Arrangement (JLA) in the FY 2012-13. These guidelines are applicable for all borrowers with aggregate credit limits (both fund based and non fund based) of Rs.150 and above, and also to the non investment grade borrowers irrespective of the amount of exposure. The PSBs Manthan and Ease of Access Service Excellence (EASE) by MoF, have also put impetus on effective co-ordination among PSBs for large borrowers. However, these measures are yet to bring the required co-ordination among all the banks, specially the banks under MBA. With the introduction of new RBI guidelines on loan component, banks will have to compulsorily co-ordinate and         co-operate specially under MBA since guidelines stipulate accountability of adherence at individual bank level. RBI has presently not stipulated penalty for non adherence, however going forward with the implementation experience, penalties for renegades cannot be ruled out.

From the above, it is observed that loan component stipulation (80 per cent) has been in prevalence in Indian WC finance however on a voluntary basis and most of the banks have preferred to avoid it in order to remain flexible with the borrowers in disbursing credit to the industry. With the increasing NPAs in the Indian banking sector reaching to alarming level, the regulator has decided to change the loan component doctrine from voluntary to compulsory basis. With the much ado on MSME credit issues, regulator has preferred to make the loan component guideline compulsory only for the large borrowers.

Apart from bringing better discipline and improved cash flow planning by borrowers, the loan component is expected to bring required co-ordination among banks in MBA. The banks under MBA are now expected to meet periodically, ensure adherence to loan component guidelines, and share experience about the account. The large borrowers will be now required to precisely plan their cash flows, show their repayment capacity of loan component on due dates, and come out from the comfort of cash credit which was practically not having any repayment schedule. This may also benefit CP market, as large borrower may consider availing loan component in the form of CPs under the new regime where compulsion is on lenders also.

The regulator has softly allowed rollover of loan component, however going forward with stabilization of new system some restriction may be expected on this front. Considering loan components may also be in the form of long tenor loans and practice of banks stipulating higher security cover for such loans, the new loan component regime may take Indian WC finance to a new dimension. It would be also interesting to see how credit rating agencies will treat the loan component when uncertainty of rollover will be involved.

Instead going into the macro details and defining everything, the regulator has preferred to keep the guidelines very short, which will result in banks and borrowers evolve the loan component implementation in their own forms. Overall, compulsory implementation of loan component will make banks and borrowers experimenting and adjusting to the new paradigm in finance in FY 2019.

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