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Funds available for a period of one year or less are called short term finance. In India short term funds are used to finance working capital. The two most significant ways of working capital financing are TRADE CREDIT & BANK BORROWING.
A typical way of expressing credit terms is for example : 3/15 net 45. This means 3% discount is available if payment is made within 15 days and if this discount is not availed payment is to be made on or before 45 days.
Actually, the banks do not lend 100% of the credit limit. They deduct the Margin money from the loan to keep as security.
The bank gives assurance of payment to suppliers in event of non payment domestic party. Generally, provided by banks sound and creditworthy parties. It is an indirect way of financing. to
A borrower may sometimes require funds in excess of the sanctioned credit limits to meet unforeseen contingencies.
Banks provide such accomodation through a demand loan account . The borrower is expected to pay high rates of interest in such exceptional cases.
The borrower does not transfer the property to the bank physically.
Thus hypothecation is a charge against property where neither ownership nor the possession is passed on to the creditor.
Banks generally grant credit against hypothecation only to first class customers with high integrity.
Banks follow certain norms in granting working capital finance to firms. These norms are greatly influenced by the recommendations of various committees appointed by the RBI.
Banks followed the norms suggested by the Tandon Committee. Further recommendations were made by the Chore Committee to strengthen the procedures and norms.
1.Operating Plan : The borrowers should prepare operating plans and on that basis indicate the amount of working capital finance requirement. 2.Production based financing : The banks should finance only the production based genuine needs of financing.
3.Partial bank financing : The bank should not finance the total requirement of the borrower. Only a reasonable part of it should be financed by the bank.
2.
The borrower will contribute 25% of the total current assets. The remaining of the working capital gap will be financed by the bank.
The borrower will contribute 100% of the core assets and 25% of the balance of current assets. The remaining of the working capital gap will be financed.
3.
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Major recommendations
1. Reduced dependence on Bank Credit : The borrowers should contribute more funds to finance their working capital requirements. The idea was to place all borrowers in the 2nd method suggested by the Tandon Committee. In case of difficulties the resort could be taken to WCTL.
2. Credit limits to be separated in to Peak level and Non Peak Level limits : Credit limits should be assessed and separated in to Peak level and Normal level for borrowers with credit limits more than 10 lacs. Borrowers should, in advance, inform the requirement of peak level limits. Moreover, any deviation in utilisation beyond 10% tolerance, should be treated as an irregularity. Additional interest of 1% should be charged on adhoc borrowings.
Major recommendations
3. Existing lending system to continue : The existing system had three types of lending. (a) Cash credit (b) WCTL, (C) Bill discounting. Cash credit system should be replaced by the other two wherever possible. Cash credit accounts of large borrowers to be scrutinized, at least once a year.
Major recommendations
4. Information System : The discipline regarding submission of quarterly statements should be strictly adhered to, in respect of all borrowers having limits of 50 lacs and above.
COMMERCIAL PAPER
A money market instrument in the advanced countries, to raise short term funds. Introduced in India in 1989 by the RBI on the recommendation of Vaghul Working Group. In USA , only the highest rated and financially sound companies can issue Commercial papers.
COMMERCIAL PAPER
The buyers of C.Ps are Banks, Insurance Companies, Unit trusts and Firms with surplus funds to invest for a short period. In India, the issue of CPs is regulated by the RBI. Only those Companies, which have (a) Net Worth of 10 Crore, (b) MPBF of not less than 25 Crore Listed in Stock Exchange can issue CPs. Size of a single issue should be atleast One Crore and size of each CP should be atleast 25 Lacs. (5 lacs suggested by Vaghul).
COMMERCIAL PAPER
Maturity of the CPs in India runs between 91 to 180 days. In the USA it is 1 to 270 days.
Though the issue of CPs is regulated by the RBI, still the interest rate is determined by the market.
The interest rate depends on (a) PLR, (b) Maturity, Credit worthiness (d) and the rating of the CP provided by agencies. In USA the two main rating agencies are STANDARD & POOR and MOODY. In India this is done by ICRA ( an agency set up by ICICI & UTI).