Top 5 Committees to Control the Regulation of Bank Finance

This article throws light upon the top five committees to control the regulation to bank finance. The committees are: 1. Dehejia Committee 2. Tandon Committee 3. Chore Committee 4. Martha Committee 5. Chakraborty Committee.

1. Dehejia Committee:

The National Credit Council (NCC) was constituted in October, 1968, under the Chairmanship of V.T Dehejia to examine how far the credit requirements of trade and industry were inflated and at the same time to suggest some measures on the basis of its findings.

In other words, “The extent to which credit needs of industry and trade are likely to be inflated and how much trends could be checked”. The study group submitted its report in September, 1969. It may be noted here that the term ‘infla­tions’ means the borrowers have taken short-term credit in excess of their real requirements for working capital.

Criteria:

For the purpose of such ‘inflation’ the study group took the following criteria:

(i) Whether the rise in short-term credit was substantially higher than the growth in the value of output.

(ii) Whether the rise in such credit is higher than the increase in inventories;

(iii) Whether short-term bank borrowings have been diverted for building up fixed asset or other non-current asset;

(iv) Whether there is double or multiple financing of the same stocks; and

(v) Whether the period of credit is unduly lengthened.

Findings:

The major findings of the Dehejia Committee were noted below:

(a) Inflation of bank credit:

Granting bank credit to industry increased significantly in comparison with the increase in industrial output or inventories in value terms, e.g. granting bank credit (short-term) to industry was increased by 130% in between 1961-62 and 1966-67, whereas industrial output was increased by only 60% for the same periods.

(b) Improper utilization of short-term credit:

Although the bank credit was allowed for short-term current assets, the same was actually utilized for the acquisition of non-current/fixed asset i.e. short-term credit was diverted.

(c) Granting credit without proper securities and projected financial statements:

Banks granted credit to industry without proper securities and without assessing their real needs which are based on their projected financial requirement.

(d) Prevailing Lending System:

The prevailing lending system helps the industry to depend on short-term bank financing in order to acquire fixed assets.

Suggestions:

The following significant suggestions are prescribed by the Dehejia Committee in order to control the regulation of bank finance between the industry and other private sectors:

(a) The appraisal of credit applications must be made in relation to the total financial situations i.e., current and projected which can be reflected by Cash Flow analysis along with forecast submitted by the borrowers.

(b) Cash credit account must be distinguished into two parts, viz, (i) ‘the hard core’ which represents the minimum level of current assets required for maintaining a given level of production; (ii) ‘the strictly short-term ‘ components which represent the fluctuating part of the account. The second component of the accounts, however, reveals the requirement of funds for short-term purpose. Thus, the said borrowings should be against out of turnover in a short-period.

(c) In the case of ‘Double’ or Multiple financing the group, however, suggested that a customer must be required to deal with only one bank. But if the requirements of the borrowers are high or more, and which cannot be provided by one bank only, in that case, a Consortiums’ arrangement may be adopted which has been recom­mended by the group.

(d) The period of trade credit must not exceed 60 days and 90 days in case of special cases so that the bank’s resources must not be blocked in unproductive purposes.

(e) The committee also suggested that a levy of commitment charges on unutilized limit along with a provision to impose a minimum interest charge should be con­sidered to control the tendency of having credit more than their requirements

(f) Another suggestion of the committee was that industry, trade and commercial banks may introduce the system of issuing bills which would help both the purchasers and the suppliers for their financial activities.

2. Tandon Committee:

The Reserve Bank of India appointed in July 1974 a Study Group, under the Chairmanship of Sri P L Tandon to frame guidelines for the follow-up of bank credit.

Terms of Reference:

The important terms of reference for the Study Group were as under:

(i) to suggest guidelines for commercial banks for the follow-up and supervision of credit from the point of view of ensuring proper end-use of funds and keeping a watch on the safety of advances and to suggest the type of operational data and other information that may be obtained by banks periodically from such borrowers and by the Reserve Bank of India from the lending banks;

(ii) To make recommendations for obtaining from borrowers periodical forecast of

(a) Business/production plans, and

(b) Credit needs;

(iii) To make suggestions for prescribing inventory norms for different industries both in private and public sectors and indicate the broad criteria for deviating from these norms;

(iv) To suggest criteria regarding satisfactory capital structure and sound financial basis in relation to borrowings;

(v) To make recommendations regarding the sources of financing the minimum working capital requirements; and

(vi) to make recommendations as to whether the existing pattern of financing working capital requirements by way of cash credit/overdraft system etc., requires to be modified, if so, to suggest suitable modifications.

The Study Group submitted its final report in August 1975. After accepting the major recommendations made by the Study Group, the RBI advised the banks as under.

Norms for Inventory and Receivables:

The Study Group suggested norms for 15 major industries which represent the maximum level for holding inventory and receivables in each industry.

The suggested norms are presented below:

From the ‘norms’ presented above, it becomes clear that there is no uniformity among banks while assessing working capital requirements, particularly, in case of inventories. The prescribed ‘norms’ have been suggested by the Study Group in respect of inventories and receivables.

In the opinion of the group, bank credit is to be viewed as a tool for resource allocation in the economy and bank must uniformly assess working capital requirements. Norms have been suggested for 15 major indus­tries stated above.

The group suggested the norms in relation to:

(i) Raw Materials;

(ii) Stock-in-process;

(iii) Finished goods; and

(iv) Receivables and Bills purchased on the basis of time element, i.e., in terms of month. These norms represent the maximum level for holding inventory and receivables.

The RBI advised the scheduled banks in regard to the implementation of these norms which are as under:

(i) These norms are applicable in case of both the existing and new borrowers with immediate effect. All fresh proposals including those from the existing borrowers seeking enhanced credit facilities may be regulated by these norms.

(ii) In case of all existing borrowers whether or not they seek enhancement in credit limits, if their inventories and receivables level are excessive on the basis of the suggested norms, the matter should be discussed with them and a programme for a phased reduction may be worked out.

(iii) In case the excess levels of inventories and receivables continue without justi­fication, the bank must not abruptly stop operations in the accounts of the borrower since it may upset his normal functioning. In that case, the bank must consider, after a reasonable period of time, say about 2 months, whether it should charge a higher rate of interest on the proportion of the borrowings which is considered to be excessive.

The bank should exercise control with due flexibility and understanding of the circumstances which may warrant deviation from the norms for temporary periods. The bank may call for additional information for this purpose.

(iv) At the initial stage, all industrial borrowers including small-scale industries with aggregate limits from the banking system in excess of Rs. 10 lakhs should be covered. Borrowers with aggregate limits of Rs. 10 lakhs or less should be covered progressively as early as possible.

Approach to Lending:

Financing Working Capital Cap and Bank Credit:

It was the opinion of the Study Group that the borrower should be expected to hold only a reasonable level of current assists in relation to the requirements of his production. The Group defined the working capital gap as, ‘total current assets minus total current liabilities other than bank borrowings’.

The working capital gap could be bridged partly from the own funds of the borrower and long-term borrowings and partly through bank borrowings. The Study Group has also suggested that the bank must supplement the resource of the borrower in order to enable the latter to carry an acceptable level of current assets. For this purpose, the Study Group suggested the following three methods in order to work out the maximum permissible bank bor­rowing to meet the working capital gap.

The methods are presented below:

(A) Work out first, the working capital gap. The borrower will have to contribute a minimum of 25% of the working capital gap from long-term fund, i.e., equity and/or debt. In other words, the bank will finance a maximum of 75% of the gap and the balance to be met by the borrower. Minimum current ratio, in this case will be 1:1.

(B) The borrower will have to provide a minimum of 25% of total current assets out of long-term funds (i.e., owned funds plus term borrowings), balance will be financed by other current liabilities (excluding bank borrowings) first and then by bank credit. Total current liabilities {including bank borrowings) must not exceed 75% of current assets.

Minimum current ratio, in this case, at least, will be 1.3: 1.

(C) The contribution made by the borrower from long-term funds must be to the extent of the entire ‘core’ current assets and a minimum of 25% of the balance current assets. The balance left, after being reduced by other current liabilities (excluding bank borrowings) if any, will be financed by bank credit. That is, the level of bank borrowings would be reduced in these stages and it will strengthen the current ratio.

The entire process can be illustrated better with the help of the following illustration:

Illustration:

The financial position of a firm, projected as at the end of next year, are as under:

Solution:

(Figures are in Rs. 00,000)

Working capital gap = Rs. 370 – Rs. 350 = Rs. 20 lakhs, which has to be financed from long- term sources. According to the recommendations made by Tandon Committee norms of lending bank credit, under the three methods.

From the table presented at the next page, it is most interesting to note that each successive method reduces the amount of bank credit and increases simultaneously the amount which is to be financed from long-terms sources It is followed on the principal that amount of risk reduces gradually.

This point will be clear from the following table:

Thus, long term-sources are gradually increasing which reduce the risks.

The other information of the Study Group Were:

(a) Style of Credit;

(b) Differential lending Rates;

(c)Information System,

(d)Follow-up and Supervision;

(e)Norms for Capital Structure;

(f)Norms for Trade;

(g)Need for gearing the Organizational Set-up;

(h)Need for Inter-Bank Co-operation.

3. Chore Committee:

In 1979, the Reserve Bank of India set lip a Working Group in order to review the cash credit system under the chairmanship of Shri k. B Chore (Chief Officer of RBI, Dept. of Banking Operations and Development). The working group made a number of recommendations which were accepted by RBI after certain modifications. The features of the guidelines which were issued by RBI in Dec.

1980 were as under:

(a) Annual Revenue of Accounts:

Bearing in mind the information that the system of cash credit cannot be totally replaced by any other lending system, the RBI felt the necessity of streamlining the system with regular periodical reviews of limits in order to verify the continued viability of borrowers and for assessing the need-based character of their limits.

All scheduled banks are required to review accounts of the borrowers having working capital limits of Rs 10 lakhs and over at least once in a year. If the borrowers’ limit exceeds by Rs. 50 lakhs and over, they are required to submit quarterly statement for the purpose.

(b) Bifurcation of Accounts Discontinued:

The RBI withdrew its past directives which were issued to the scheduled banks requiring them to bifurcate the cash credit accounts into demand loan, cash credit components and charging differential interest rates. If the accounts are already bifurcated, the differential rates are to be abolished as an immediate effect.

The RBI indicated the following four measures that are applicable on all the borrowers having total working capital limits of Rs. 50 lakhs and over.

(i) Peak Level and Non-Peak Level Limits:

Banks are to fix separate credit limits for the borrowers according to the normal peak level and non-peak level as far as possible which are to be selected on the basis of past performances of the borrowers and the utilization of such limits. At the same time, the period for which the borrowings are to be utilized is to be specified.

For agriculture based industries and consumer goods industries, separate limits are to be fixed since they have seasonal demand of their products and for others, only one limit is to be fixed by the banks

(ii) Withdrawals of Funds:

After sanctioning the credit limit, the borrower must indicate, before the com­mencement of each quarter, his expected requirements of funds in the said quarter. Such limits are known as operating limit. It is expected that borrower must withdraw funds from bank within the operating limit in that particular quarter subject to a tolerance limit of 10% either way.

That is, if a borrower withdraws any amount which is more than or less than that tolerance limit, the same is considered as irregularity in the account and as a consequence, bank should take corrective steps in order to avoid such repetition of irregularity of funds in future which is actually the product of defective planning of the borrower.

(iii) Temporary Limits:

Banks must be very careful about the request made by the borrower for ad hoc/ temporary limits in excess of the sanctioned limits in order to meet unforeseen contingencies. Such limits should be allowed for pre-determined short-durations and in the form of a demand loan or ‘non-operable’ cash credit account for which an additional interest of 1% over and above the normal rate is to be charged.

But if the borrower is unable to provide corresponding additional contributions for this purpose, bank will simply refuse.

(iv) Contribution of the Borrowers:

The RBI stressed the need in order to reduce the over-dependence on bank credit by medium and large borrowers. Borrowers must increase their contribution towards working capital. Bank must assess the maximum permissible bank finance by applying the second method of lending which was recommended by Tandon Committee.

That is, under this method, borrowers must have to contribute from (i) his owned funds and (ii) term loans an amount which must be at least 25% of total current assets. In short, the contribution of the borrowers towards working capital should be in­creased from 25% of the working capital gap (under 1st Method) to 25% of the total current assets which result in a current ratio of 1.3: 1 instead of a 1: 1 current ratio.

Arrangement during Transition Period:

If it is found that the borrower fails to comply with the above requirements, immediately bank may segregate the excess borrowing and may treat the same as Working Capital Term Loan (WCTL). This loan must be repaid by the borrowers in half-yearly installments within a period not exceeding 5 years.

Of course, banks may charge a higher rate of interest for this purpose which must not exceed the ceiling for encouraging early payments. Bank also may charge a penal rate if there is any default in repayment of the said loans.

Additional Credit Limits:

Banks are permitted to grant additional credit limits to the borrowers, if such limits are necessary for increased production. But Bank must insist on (i) the incremental current ratio of 1.33: 1 and (ii) WCTL component must not be increased.

Exemption:

However, the RBI exempted the following categories of borrowers from the compliance of this requirement:

(a) New companies floated prior to December 8, 1980.

(b) Companies showing signs of incipient sickness.

(c) Companies having finalized modernization or expansion programme before the Chore Committee recommendation.

(d) Borrowers who have failed to pay the installment/interest due to term lending institutions, if the efforts to re-schedule the installments do not succeed.

In the above categories of borrowers, the RBI has advised the scheduled banks to examine carefully the financial position on the basis of cash flow/fund flow statements and other relevant information.

If they are satisfied, they may assess the credit requirement of the borrowers without applying the second method of lending recommended by Tandon Committee which is permitted only for a period of 3 years and bank, in these cases, should impress upon the borrowers the usefulness of changing-over to second method.

The RBI has also clarified that the above measures are not applicable in those cases that enjoy aggregate working capital limits below Rs. 50 lakhs but exceed this level due to sanctioning additional credit limits for the temporary periods.

RBI also has advised to adopt a flexible approach in case of exporters who are unable to bring in additional contribution for additional credit limits sanctioned for specific export transactions.

If any borrower exports a substantial part of his produc­tion and the WCTL has to be carved out of the existing paking credit limit, bank may identify the WCTL on a national basis. That is, the amount of excess borrowings may be identified but not transferred to a separate account for concessionary rate of interest.

The borrower must contribute the required amount within a period of 5 years.

Consider the following illustrations for the purpose of Lending Method.

Illustration:

Solution:

From the problem presented above, it is quite clear that the difference between current assets and current liabilities is Rs. 20 lakhs (370 — 350) which reveals actual contribution from long-term sources.

The position under Method II, recommended by Tandon Committee is shown as under:

Since, the long-term funds available is only Rs 20 lakhs, as against the prescribed limit of Rs 92.5 lakhs, the excess borrowing is found to be, i.e., Rs 72.5 (92.5 – 20) lakhs. Accordingly, as per Chore Committee recommendation, Rs. 72.5 lakhs should be converted into Working Capital Term Loan (WCTL) which will carry a higher rate of interest.

Problem:

You are supplied with the following information in respect of XYZ Ltd for the ensuring year:

There is a regular production and sales cycle and wages and overheads accrue evenly Wages are paid in the next month of accrual Material is introduced in the beginning of production cycle.

You are required to find out:

(i) Its working capital requirements,

(ii) Its permissible bank borrowing as per 1st and 2nd Method of lending.

Solution:

Problem:

Rainbow Ltd who has started a new unit is scheduled to go in for commercial production shortly and you have been asked to assess the need of working capital and also how much of it the banks are likely to provide.

The following information is available:

(b) Company is required to give 3 months credit to its customers On the other hand, the company would enjoy 1 ½ months credit from its caditors for purchase of materials.

Stock of material has to be kept for 3 months consumption. The work-in-progress at any time would be represented by material (1 month) and expenses (1 ½ A months). There is a delay of 1 month before the finished goods are sold

(c) The following are the holding norms accepted by the bank for the particular industry:

Prepare a report giving your assessment with your comments. You may make assumptions as considered necessary and relevant in this connection

4. Marathe Committee:

The Reserve Bank of India appointed a committee under the chairmanship of Marathe in 1982. The objectives of the committee were to analyse the working of the Credit Authorisation Scheme (CAS).

Recommendations:

The Marathe Committee had given some importance to examine and to analyses the CAS in the following forms:

(i) The CAS must be considered as a regulatory measures which would be applicable in the case of all borrowers, irrespective of size i.e., large or small.

(ii) The objectives of the CAS was to see that proper credit management and improved quality of bank lending had taken place according to the principles and policies which were laid down by Central Banking Authority (CBA) for the purpose.

(iii) The CAS must not be applied only in case of certain kinds of borrowers the lending criteria above the minimum level must be the same.

(iv) Simply by concentrating only one point it is impossible to improve the quality of lending

(v) The time taken by the commercial banks for their necessary formalities must be reduced together with the time taken by RBI for the same purpose.

However, the recommandations of the Marathe Committee was to give incentive to the borrowers of all categories after complying with the necessary formalities of the CAS and at the same time to improve the quality of lending It also stated that the commercial banks should be given discretion to grant credit without the prior authorization of RBI if the following conditions are satisfied.

(a) The estimates relating to production, sales, current assets, current liabilities (excluding bank borrowings), working capital are quite reasonable in comparison with the past trend and norms justified assumptions for the future.

(b) Whether or not, the so-called classification of assets and liabilities as per RBI norms are made

(c) The estimated or projected current ratio must not be less than 1.33: 1 (although the norm is 2: 1 in all other normal cases) excluding certain specified categories.

(d) Whether the borrower submitted the quarterly income-statement for the past six months within the schedule date/period and promises to do the same in future also.

(e) Whether the borrower submitted his annual accounts in time and the bank makes an annual review of the various facilities provided by it and also to examine whether the borrower requires any further credit.

However the Marathe Committee recommended that the CAS should be re-named as Credit Monitoring Scheme as a result of the proposed change in its approach.

Now we are going to explain the Credit Monitoring Arrangement in brief.

The Reserve Bank of India introduced the term Credit Monitoring Arrangement (CMA) in place of Credit Authorization Scheme (CAS) on the basis of the recommen­dation of the Marathe Committee in October 1988.

The fundamental characteristic of CMA is noted below:

(a) A post-sanction scrutiny of term loans and working capital limits which were provided by commercial banks, will be made by the RBI. It is the duty of the commercial bank to submit the necessary paper to the RBI within 15 days from such transactions.

(b) The commercial banks must mention whether the minimum prescribed level made by RBI relating to finance for credit transactions by drawing and accepting trade bills in each and every case and steps must be taken if RBI norms is not followed.

5. Chakraborty Committee:

The RBI appomited a committee under the chairmanship of Sukhamoy Chakraborty in order to review and to analyse the workings of the Indian monetary system. The report was submitted by him in April, 1985. In the report, the committee presented some suggestions for the improvement of lending activities by the commercial banks.

Its two major recommendations are given below:

(i) Introducing Penal Interest Payment Clause:

After careful scrutiny the committee observed that delayed payments were made at random. Thus, in order to control such activities, the committee suggested that the government should introduce a penal interest payment clause for delayed payments beyond a certain specific date e.g. 3 months.

It should be remembered that such rate of interest should be fixed at 2% more than the basic increasing rate for borrowings

(ii) Credit limits should he separated under three different heads:

For this purpose, the committee prescribed the following rates of interest under different heads, viz:

viz., (a) Cash Credit 1 — to cover supplies to Governments

(b) Cash Credit II — to cover special circumstances or contingencies

(c) Limit of normal working capital

These are discussed below:

(a) Cash Credit I = Minimum basic lending rate

(b) Cash Credit II = Minimum prevailing lending rate

Normal Working Capital Limit:

(i) Loan portion = The rate in between the minimum and the max­imum lending rate.

(ii) BUI finance limit = 2% below the basis minimum.

(iii) Cash Credit Portion = Maximum prevailing lending rate.