INSTITUTE OF MANAGMENT STUDIES, DAVV, INDORE

FINANCE AND ADMINISTRATION – SEMESTER IV

CREDIT MANAGEMENT AND RETAIL BANKING

TYPES OF ADVANCES
In our country, advances are generally being sanctioned in the following forms-
(i) Cash credit loan
(ii) Overdrafts
(iii) Loans/ Term Loans
(iv) Purchasing and Discounting of bills/cheques etc.
(v) Bills Negotiated under Letter of Credit (BNLC)
(vi) Working Capital Demand Loan (WCDL)

(i) CASH CREDIT LOAN

 A popular form of advances in our country is cash credit loan (CC loan).
 Under the CC loan system, a limit is sanctioned to the borrower against assets,
generally merchandise goods i.e. raw materials, stock in process, stores & spare,
finished goods and receivables, etc., created out of the working capital advance.
 These assets become the primary security, and charged to banks as
hypothecation on these assets.
 At the same time, collateral security i.e. third party guarantees and/or mortgage
of land and building is also proposed.
 There are immense benefits of this mode of borrowing to the large commercial
and industrial concerns. Under the CC loan system, entire cash management of
the corporate entity is being done by the banker because whenever the need
arises, the client has to issue a cheque for withdrawal of money and whenever
the borrower has surplus funds, these may be deposited in the CC loan account
and interest may be saved.
 CC loan account is a running account.
 Drawing Power (DP) is drawn based on the stock statement.
 Limit sanctioned may be on higher side but DP should not go beyond the amount
of sanctioned limit.
 DP depends on the value of stock offered by the borrowers as security.
Cash Credit loans are of various types i.e.
- Cash Credit (Pledge - Lock & Key)
- Cash Credit (Pledge - Factory type) and
- Cash Credit (Hypothecation).

(ii) OVERDRAFT
 Under the overdraft system also withdrawal of funds by the borrower is done only
when the funds are required by the borrower.
  Interest on the portion of the amount withdrawn is applied and not on the entire
amount of the sanctioned limit.
 When a customer requires temporary accommodation, he may request to the
banker for sanction of an overdraft limit against Govt. securities, Shares & bonds,
TDR, Gold Ornaments, etc.
 However, the difference between cash credit loan and overdraft is that, cash
credit loan limit is generally sanctioned against merchandise goods to the entity
which is doing some business while overdraft limit is ordinarily sanctioned for the
purpose of meeting out the temporary requirement of funds.
 Now-a-days overdraft limits are also being sanctioned on regular basis which are
being renewed over a period of time.

(iii) DEMAND LOANS/ TERM LOANS

 Loans are sanctioned for a fixed term, for a fixed sum and are withdrawn
generally in one stroke.
 An installment is fixed up for repaying the loan. Installment could be payable at
monthly, quarterly, half-yearly or yearly interval.
 It all depends on cash generation capacity of the unit. When the loan is
sanctioned repayable in more than one year it is called term loan.
 When the period exceeds one year but up to 5 to 7 years, it is called medium
term loan, and
 A loan with longer repayment schedule is known as long term loan.
 If it is repayable on demand or within one year of its sanction, it is called demand
loan or short term loan.
 Installments of loan are repaid out of future earnings from the fixed assets.
 Rate of interest in case of term loans is generally low because of low service cost
involved as the withdrawal is done only once and installments at stipulated
periods are being deposited. Hence, operational cost in case of loans is very low
as compared to the cash credit loan where frequent withdrawals and credits in
the account increase the service cost.

(iv) PURCHASE AND DISCOUNTING OF BILLS

 Purchase and Discounting of Bills is generally safe and lucrative business for a
bank.
 Bills drawn by the borrower are tendered to the bank for purchase or discount.
 When bills are payable on demand, the transaction is called the purchase of bills
– Demand Bill Purchased (DBP).
 When bills are payable after sight i.e. after specified period or usance, the
transaction is called Discounting of Bills – Usance Bill Discounted (UBD).
 This type of advance is of self liquidating nature. While sanctioning Working
Capital Limit (WCL) some portion of WCL is sanctioned in the form of DBP/UBD
limit at the request of the borrower.
 The bills tendered by the borrower (drawer/seller of the goods) after purchasing/
discounting are sent to the branch of the same bank or other bank, if there is no
branch of the same bank, with a request to present the document (Bill of
 exchange, Railway Receipt/ Motor Transport Receipt, invoice etc.) for payment/
acceptance, as the case may be, to the drawee of the bill (i.e. purchaser of the
goods).
 The drawer (seller) is secured because goods will be delivered after payment of
money and drawee (purchaser) is secured because on payment he gets the title
of goods ordered by him.
 The Banker is also secured as it has the possession over the title of goods till
payment is made by the drawee of the bill. However, the banker must ensure that
genuine trade bills are routed through it.
 The Banker must avoid playing with accommodation bills.

(v) BILLS NEGOTIATED UNDER LETTER OF CREDIT (BNLC)

 BNLC also forms the part of working capital finance. This is another way of
financing debtors.
 The supplier of good (not necessarily a borrower) holding letter of credit in its
favour may draw bills on the purchaser of goods, and may approach a bank to
purchase/ discount a bill drawn under Letter of Credit.
 When a banker negotiates such bill, the transaction is called as the Bills
Negotiated under Letter of Credit (BNLC). The Banker before negotiating bills
drawn under LC must ensure that the LC is a genuine one and is opened by a
first class bank.
 Documents are drawn strictly as per the terms of LC.
Limits sanctioned under BNLC will not form the part of Maximum Permissible Bank
finance (MPBF) hence this facility may be sanctioned out side the purview of MPBF.

(vi) WORKING CAPITAL DEMAND LOAN (WCDL)

 As per the existing system of working capital loan, a borrower is sanctioned a
limit. In certain cases very small portion of limit is being utilised while the banks
have to keep funds arranged to the extent of limit sanctioned.
 Hence, with a view to bringing about an element of discipline in the utilisation of
bank credit, a ‘Loan System for Delivery of Bank Credit’ was introduced by the
Reserve Bank of India in April, 1995.
 Under this system a prescribed percentage of WCL has to be availed of through
WCDL for a fixed period. The prescribed percentage has been undergoing a
change from time to time. Remaining amount of WCL is being permitted to be
utilized through Cash Credit Loan Account. Hence WCDL also forms the part of
working capital finance.
 The system is now mandatorily applicable on the accounts where WCL is for
Rs.10 crore and above.

Prepared by :
Arvind Paranjape, M.Sc., CAIIB
paranjape.arvind@yahoo.com
9425067026