The Dahejia Committee:
In September 1969, Dahejia Committee of the RBI pointed out in its reports that in the financing practice of banks, there was no relationship between the optimum requirements for production and the bank loan.
The general tendency with business was to take short-term credit from banks and use it for purposes other than production. The committee also pointed out that banks do not give proper attention to the financing pattern of their clients. Further, the clients resort to double financing or multiple financing of stocks.
The Dahejia Committee suggested that the banks should make an appraisal of credit applications with reference to the total financial situations of the client.
It also suggested that all cash credit accounts should be bifurcated in the following two:
(i) The hard core which would represent the minimum level of raw material, finished goods and stores which any industrial concern is required to hold for maintaining certain level of production.
(ii) The strictly short-term components which should be the fluctuating part of the account. This part would represent the short-term increases in inventories, tax, dividends and bonus payments.
The committee also recommended that to determine the hard core elements of cash credit accounts, norms for inventory levels should be worked out by the chamber of industry or by the Indian Bank Association.
It can thus be seen that the orientation towards project oriented and need based lending was first given by the Dahejia Committee. However, in practice the recommendations of the committee did not have more than a marginal effect on the pattern of bank financing.
In April 1979, the RBI constituted a committee under the Chairmanship of Shri K.B. Chore to review the cash credit system of lending in its entirety. The committee submitted its report in Aug. 1979.
The main recommendations of the Chore Committee as accepted by RBI as follows:
(i) Enhancement of Borrower’s Contribution:
The committee had recommended that the Over dependence on bank credit by medium and large borrowers should be reduced by requiring them to enhance their contribution towards working capital.
For this purpose in assessing the permissible bank credit, the borrower should adopt the second method of lending recommended by the Tandon committee, according to which the borrowers contribution from own funds and term finance to meet the working capital requirements should be equal to at least 25% of the total current assets.
This would give a minimum current ratio of 1.33:1. Whenever borrowers are not in a position to comply with the above requirements, immediately the excess borrowing should be segregated and treated as working capital loan (WCTL) which could be made repayable in half yearly installments with the definite period and this period should not exceed 5 years in any case.
(ii) Compulsory Periodic Review of Cash Credit Limits and Submission of Quarterly Statements:
The committee recommended that in future cash credit limits of all the borrowers with working capital limit of Rs. 10 lakhs and over should be reviewed at least once a year compulsorily to verify the continued viability of the borrowers and to assess the need based character of credit limits. All the borrowers with working capital limits of Rs. 50 lakhs and over should submit quarterly statements compulsorily prescribed under the information system designed by the Tandon Committee.
(iii) No Bifurcation of Cash Credit into Demand Loan of Core Portions and Fluctuating Cash Credit Components:
The committee recommended that banks should no more bifurcate the cash credit accounts recommended by Tandon Committee into demand loan components and cash credit proportions and to maintain a differential interest rate between these two components. In case where the cash credit accounts have already been bifurcated steps should be taken to abolish the differential interest rate with immediate effect.
(iv) Separate Limits for Peak and Normal Non-Peak Level Periods:
According to this recommendation, the banks should fix separate limits wherever feasible for the normal non-peak level as also for the peak level credit requirements indicating the duration of these periods when the separate limits would be utilized by the borrowers,
(v) Drawal of Funds to be Regulated through Quarterly Statements:
With limits sanctioned for the peak level and non-peak level periods, the borrower should indicate before the commencement of each quarter the requirements of the funds i.e., operating limit during the quarter. Drawings less than or in excess of the operative limit so fixed (with a tolerance of 10% either way i.e., ± 10%) but not exceeding the sanctioned limit should be deemed to be an irregularity and appropriate corrective steps should be taken.
There recommendations of panel interest for deviation beyond the tolerance were not accepted by RBI.
(vi) Penalty for Default in the Submissions of Quarterly Statements:
For timely submission of quarterly statements, the committee recommended that if a borrower fails to submit these returns within the prescribed time limit banks may charge panel interest of 1% per annum on the total outstanding in the period of default in the submission of quarterly return.
At the same time, the borrower should be given notice that if default persist the account may be frozen without further notice at the bank’s discretion.
In spite of the levy of penal interest, if default persists, banks should review the positions and if it is satisfied that a stun action is necessary the operation of the account of such borrower may be frozen.
If the borrower has accounts with more than one bank, the decision taken by the bank to freeze the account be intimated to other banks concerned. As soon as advice is received by the other financing banks, they should ensure that no operations are allowed in such accounts with them.
(vii) Ad-Hoc or Temporary Limits:
The Committee recommended that a request for ad- hoc or temporary limits to meet unforeseen contingencies should be considered very carefully and allowed for a predetermined period through a separate demand loan or non-operatable cash credit account. Banks are allowed to charge additional interest of 1% per annum on these recommendations.
(viii) Encouragement for Bill Finance:
(a) Advance against Book Debts:
Generally, sales are financed by banks through purchase, discount of bills. The RBI has advised banks to replace cash credit against book debts by bill finances. Steps should be taken for review of such accounts and convert such cash credit limits into bills limit’s whenever possible.
(B) Drawee Bills:
The Committee has recommended that banks should earmark at least 50% of cash credit limits against raw material to manufacturing units for drawee bills only.
(c) Payment to Small Units:
With a view to ensure timely payment of the amount due to small suits the committee has recommended that publics sector undertakings and other large borrowers maintain control accounts and give precise information in their quarterly statements about dues to small units. On the basis of such information banks may take such steps as may ensure timely payments to small units. One such step may be stipulation that a portion of the credit limits for bills acceptance (drawee bills) will be utilized only for drawee bills of small-scale units.
Besides the above recommendations other recommendation of the course committee relate to:
(a) Relaxation in inventory norms.
(b) Devising check list of security of data at the operational level.
(c) Reducing delay in sanctioning credit limits.
(d) Taking up of communications system and procedure to ensure minimum time for the collection to instruments.
(e) Revision of plan of action by Banks in the light of new credit policy announced by the RBI from time to time and setting up a cell attached to the chairman’s office at the central office to attend such matters.
(f) Effective continuous monitoring of the credit portfolio of the key branches.
As regards the relative superiority of cash credit loans and bill system of lending, the committee found that not one system was superior to the other. The group, therefore, advocated the retention of the existing system of extending credit by a combination of the three systems of lending.
In brief, the Core committee recommended an amended system of lending, the adoption of which, would have the following beneficial effects:
(i) The pre dominant share of cash credit is total lending will be reduced.
(ii) Over dependence on bank borrowings will be reduced.
(iii) The ‘gap’ will be reduced.
(iv) Better planning consciousness and discipline among the borrowers will be fostered.
In July 1974, the RBI constituted a study group under the chairmanship of Mr. P. L. Tandon.
This study group was asked to give its recommendations on the following:
(i) What constitutes the working capital requirements of the industry and what is the end use of credit?
(ii) How is the quantum of bank advance to be determined?
(iii) Can norms be evolved of current assets and for debt equity ratio to ensure minimal dependence on bank finance?
(iv) Can the current manner and state of lending be improved?
(v) Can an adequate planning, assessment and information system be evolved to ensure a disciplined flow of credit to meet genuine production needs and its proper supervision?
The final recommendations of this committee regarding the approach of the banks towards the assessment of the working capital requirements of industrial units are very significant.
The major recommendations have been as below:
(i) Banks Finance Essentially for Meeting Working Capital Needs:
Bank credits is essentially intended to finance working capital requirements only, for other requirements, other sources have to be found.
Even for working capital requirements, same portion of the contribution must come from source other than bank finance, such as from owner’s own funds, plough back of surpluses and long-term borrowed funds.
With increased scale of operation and production the owner’s own state in the business should keep on rising. While it is not practicable to lay down absolute standards of debt equity ratio, each borrower should take appropriate steps to strengthen his equity base.
(ii) Working Capital Gap:
The study group has emphasised the concept of the working capital gap which represents the excess of current assets over current liabilities other than bank borrowing.
The maximum permissible bank finance shall be limited to 75% of this working capital gap. In other words, the balance of 25% will have to be provided by the borrower from equity and long-term borrowings.
For the purpose of arriving at the working capital gap, the current assets and the current liabilities will have to be estimated on the basis of the production plan submitted by the borrower. The level of inventories under raw materials, work-in-progress, finished goods, consumable stocks and also the level of receivables shall be projected on the norms prescribed by the study group.
The borrowing requirement of any industrial unit basically depends on the length of the working capital cycle, from building inventories of raw material to getting the sale proceeds.
If norms of inventory and other current assets are laid down for different industries, the bank can easily work out the standard working capital required by a unit and sanction the advance accordingly.
The study group has, therefore prescribed norms for inventory and receivables for 15 industries. The industries covered by the report are cotton and synthetic textile, man-made fibres, jute, textiles, rubber products, fertilizers, pharmaceuticals, dyes and dyestuffs, basic industrial chemicals, vegetable and hydrogenated oils, paper, cement, consumer durables, automobiles and ancillaries, engineering ancillaries and components supplies and machinery manufacturers. The study group has not suggested any norms for the heavy engineering industry because each unit in this industry has certain special characteristics.
The norms for the various items are below:
(a) Raw materials – Consumption in terms of months.
(b) Stock-in-progress – Cost of production in terms of months.
(c) Finished goods – Cost of rules in terms of months.
(d) Receivables – Sales in terms of months.
(iv) Three Different Methods of Calculating the Borrowing Limit to Finance the Working Capital Requirements:
The group views the role of banker only to “supplement the borrower’s resources in carrying a reasonable level of current assets in relation to his production requirements”.
It proposes three progressive alternatives by which the banks may finance the working capital requirements of their industrial borrowers.
At the 1st stage the current assets may be worked out as per norms and the current liabilities (excepting bank borrowings) may be deducted therefrom. This amount would represent the working capital gap, 25% of which must be financed by the borrowers out of long-term funds. The maximum permissible bank borrowings would, therefore, be only 75% of the working capital requirements. Calculated as per the norms laid down regarding, inventories and receivables.
The committee suggests that as a 1st step, the banks may adopt this method of sanctioning advances. In case where the banks have already sanctioned advances higher than the requirements as calculated above, the excess should be converted into a term loan to be phased out gradually. Thus the committee does not support that the bank should finance excessive inventory buildup by industrial enterprises.
The 2nd alternative, the borrower will have to provide a minimum of 25% of total current assets from term funds (as against his providing 25% of working capital gap from long-term funds in the 1st alterative).
In the 3rd and the ideal method of calculating the borrowing limits, the group makes a distinction between core current assets and other current assets. Accordingly the total current assets need to be divided into these two categories.
The borrower should finance the entire core current assets plus minimum of 25% of the other current assets. The group feels that this classification of current assets and current liabilities be as per the accepted approach of the bankers.
The recommendations of the committee aim at reducing the reliance of the borrowers on the bank finance. Implementation of these recommendations would result in a better current ratio of the industrial borrowers. This would avoid unfortunate stringencies on account of lack of working capital as those faced by the industrial units in the recent years.
When the government had to enforce a strict credit squeeze in order to fight galloping inflation. There can be no two opinions on the fact that the industrial units must maintain a sound current ratio — something which can be achieved only if a good part of working capital in financed through long-term funds.
(v) Style of Credit:
The group also recommends a change in the style of credit i.e. the manner in which bank finances is extended to the borrower. It is mentioned that the present credit system of lending does not provide any controls to the bankers over the levels of advances in cash credit accounts. This results in a lack of credit planning. Therefore, the total credit limit of borrower should be bifurcated into two components; the minimum level of borrowing which the borrower expects to use throughout the year i.e., loan and a demand cash credit which would take care of his fluctuating requirements.
Both these limits should be reviewed annually. It is recommended that the demand cash credit should be charged slightly higher interest rate than the loan component, so that the borrower is motivated to take higher level of fixed component and a smaller limit of cash credit. This would enable the bankers to forecast the demand for credit more accurately.
(vi) Information System for Banks:
The following points may be noted in this regard:
(a) In order to ensure that the customers do not use the new credit facility in an unplanned manner the financing should be placed on a quarterly budgeting reporting system for operational purposes in the prescribed forms.
(b) Actual drawing within the sanctioned limit will be determined by the customer’s inflow and outflow of funds as reflected in the quarterly funds flow statements and the permissible level of drawing will be the level as at the end of the previous quarter plus or minus, the deficit or surplus shown in the funds flow statements.
(c) Variances are bound to arise in any budget of plan. The variances to the extent of say 10% should be permissible and beyond this, the banker and the customer should discuss the reason.
(d) Since projected funds flow statement would form the basis of determining the line of credit, the banker would be justified in laying down a condition that any material change, say beyond 10% of the figure projected earlier, would require his prior approval.
(e) From the quarterly forms the bankers will verify whether the operational results conform to earlier expectations and whether there is any divergence showing red signals.
(f) In addition to quarterly data, the large borrower should submit a half yearly proforma balance sheet and profit and loss account within two months from the end of the half year.
(g) Stock statement will be continued to be submitted but these will be improved. The basis of valuation in the stock statements and the balance sheet should be uniform. The stock should be reconciled in the stock statement sharing the opening and closing stocks, quantity-wise and value-wise.
(h) Stock inspection passes problems especially in large industries. In such cases there is no alternative to depending on financial follow up. Where a banker feels that detailed stocks verification is called for a regular stock audit may have to be arranged with the assistance of outside consultants.