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Additional Topics (Chapter 7)

1 RBI directive vide its circular on December 5, 2018 for large borrowers
 In respect of borrowers having aggregate fund based working capital limit of Rs. 1500 million and above from
the banking system, a minimum level of ‘loan component’ of 40 percent shall be effective from April 1, 2019.
 Accordingly, for such borrowers, the outstanding ‘loan component’ (Working Capital Loan) must be equal to at
least 40 percent of the sanctioned fund based working capital limit.
 Hence, for such borrowers, drawings up to 40 percent of the total fund based working capital limits shall only be
allowed from the ‘loan component’. Drawings in excess of the minimum ‘loan component’ threshold may be
allowed in the form of cash credit facility.
 Further, Loan against shares Banks are permitted to provide loan against shares, convertible bonds & deben-
tures, units of equity oriented Mutual funds to individuals subject to a maximum limit of Rs. 10 lakhs per individ-
ual if these securities are held in physical form and Rs. 20 lakhs if the securities are held in Demat form, from the
banking system. Banks stipulate high margins including specified minimum cash margins, on these loans as per
their credit policy – 50 to 60% in case of physical form & 25 to 40% in case of Demat form.

2
Forfaiting
 Forfaiting is a mechanism through which exporters can avail finance by discounting their medium term/long
term export receivables with a forfaiter.
 Long term receivable can be as long as 10 years where as medium term can be anywhere between three to five
years. Thus receivables on deferred basis evidenced by export bills and commercial documents can be forfeited.
 Forfaiting is done on a without recourse basis i.e. if the importer fails to pay, the forfaiter cannot recover the
dues from the exporter for whom he has discounted the export receivable. Of course, a forfaiter covers this risk
by getting the export documents co-accepted by a importer’s bank/ reputable bank from the importer’s country.

 A brief overview of general working mechanism of Forfaiting is as follows:

1. A foreign importer and an Indian exporter meet and finalize the transaction between them by entering in to a
contract.
2. Thereafter the exporter readies goods and ships the same to the importer as per contract terms.
3. Exporter simultaneously prepares set of export documents. (which are in a standardized formats of the forfait-
er.)
4. Before hand, the foreign importer agrees to get the co-acceptance the export documents sent by the Indian im-
porter, from his bank/reputed bank in his country as agreed between him and the exporter – this is known as
“avalised “document.
5. Once the co-accepted documents reach the exporter he hands over the same to the forfaiter ‘forfait’ the same -
.i.e. discount the same,” without recourse” basis to him.
6. The ‘forfaiter’ discounts the same and credits the amount of the bill after deducting his charges such as Commit-
ment Fee, Discount and Documentation fee.
7. The forfaiter thereafter sends the export documents to the importer’s bank/ co-accepted bank for reimburse-
ment on maturity date of the bill.

Forfaiting is an approved method of export financing by RBI. EXIM Bank in India has been authorised to facilitate the
forfaiting transactions. The advantage for the exporter is that he can convert the credit sale in to cash sale without
recourse to him or his banker.

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3 Project Finance
The key participants in a project finance are:
Government – They participate indirectly in the project. Their work includes approval of the project, control of the
state company that sponsors the project, etc.
Project Sponsors or Owners.-They are the owners with the equity stake in the project The sponsors of a project fi-
nance deal include:- • Industrial sponsors – these are the industrialist who see some kind of connection of the pro-
ject with their core business • Public sponsors – These include central or local government, municipalities, or munici-
palized companies • Contractors / Sponsors –These include individuals who develop, build or run plants. • Financial
investor shall contain disclosures with regard to credit rating and rationale for roll-over.
Project Company –This entity is created solely for the purpose of execution of the project. They are controlled by the
project sponsors. They form the center of the project because of its contractual arrangements with operators, con-
tractors, suppliers and customers.
Contractor – The contractor is responsible for constructing the project to the technical specifications outlined in the
contract with the project company.
Supplier – They are the input provider for the project
Customer – They are the party who are willing to purchase the projects output
Commercial banks – They source the fund required for project financing. For arranging these large loans banks often
form syndicates to sell down their assets.

Project Report
For getting financial assistance from any Bank or Financial Institution for implementation of any business idea, a com-
pany is required to prepare a Project Report. A Project Report is a detailed report containing all the details of compa-
ny. A good project report must present diverse range analytical challenges to its clients and shareholders.

Report covering certain important aspects of the project as detailed below:

 Introductory Page
 Summary of the project
 Details about the Promoters, their educational qualifications, work experience, etc.
 Current Status of the Bank, its products and services, target market, and activities.
 Infrastructure facilities, tools deployed, operational premises, machinery, etc.
 Customers, details about them as well as prospective customers
 Fiscal acquisitions and tie-ups
 Means of Financing
 Profitability projections and Cash flows for the entire repayment period of financial assistance
 Balance Sheet
 Profit and Loss Statements
 Fund Flow Statement
 Chief Ratios
 Break Even Point Evaluations
 Product with capacity to be built up and processes involved
 Project location
 Cost of the Project and Means of financing thereof
 Availability of utilities
 Technical arrangements
 Market Prospects and Selling arrangements
 Environmental aspects

Specimen of Project Report (Refer module for the specimen format)

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4 Types of Factoring
Non-Recourse or Full Factoring Under this type of factoring the bank takes all the risk and bear all the loss in case
of debts becoming bad debts.
Recourse Factoring Under this type of factoring the bank purchases the receivables on the condition that any loss
arising out or bad debts will be borne by the company which has taken factoring.
Maturity Factoring Under this type of factoring bank does not give any advance to the company rather bank col-
lects it from customers and pays to the company either on the date of collection from the customers or on a guaran-
teed payment date.
Advance Factoring Under advance factoring arrangement the factor provides an advance against the uncollected
and non-due receivables to the firm.
Undisclosed Factoring Under this type of factoring, the customer is not informed of the factoring arrangement. The
firm may collect dues from the customer on its own or instruct to make remit once at some other address.
Invoice Discounting Under this type of factoring the bank provide an advance to the company against the account
receivables and in turn charges interest rate from the company for the payment which bank has given to the compa-
ny.

Advantages for the Seller

The Seller gets funds immediately after the sale is effected and on presentation of accepted sales invoices and Prom-
issory notes.
Major part of paper work and correspondence is taken care of by the factor.
The follow-up, for recovery of funds, is done mainly by the factor.
The Interest rates are not as high as normal discounting.
There is an Immediate funding arrangement, No additional debt is incurred on balance sheet.
Other assets are not encumbered and approval is not based on seller’s credit rating

ISLAMIC BANKING


Islamic Banking works on the principle of interest free banking. (interest is considered haram)
They do not invest money in business involved in alcohol, drugs, war weapon, etc. which are considered as ha-
5
ram.
 They collect money from investors and invest in allowed business and take a share of the profits and divide it
among the investors.
 In India, Banking Regulation Act has to be amended to incorporate Islamic Banking.

6 
CMA DATA FOR DIFFERENT TYPES OF LOANS AND CREDIT FACILITIES
CMA refers to Credit Monitoring Arrangement data, which is a report to be presented to a bank to show the
company’s past financial history, current financial position and future financial planning.
 It is necessary for a bank loan or a working capital loan or for seeking Cash Credit Limit.
 In CMA data there are different parts.
 In case of existing units, the data should be for current year estimated) and past 3 years (Audited) and projec-
tions for next 5 to 7 years covering the proposed repayment period of Term loan.

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7 APPRAISAL METHODOLOGY FOR DIFFERENT TYPE OF LOANS AND CREDIT PRODUCTS

Appraisal of Working Capital
1. Operating Cycle Method:
 The time gap between cash outlay & cash realization by sale of finished goods & realization of sundry debtors is
known as the length of the operating cycle.
 Operating cycle is also called the cash-to-cash cycle & indicates how cash is converted into raw material, stocks in
process, finished goods, bills (receivables) & finally back to cash. Working capital is the total cash that is circulating
in this cycle. Therefore, working capital can be turned over or redeployed after completing the cycle.

2. Turnover Method (Nayak Committee) :

Working capital limit is computed as per Turnover method as under:
For example, the projected annual turnover of ABC Company is Rs 100 lakh for the FY 2018-19.
According to turnover method, working capital requirement of the unit is 25% of Rs.100 lakh = Rs.25 lakh
The margin of the borrower will be 5% of the projected sales turnover (5% of 100) = Rs.5 lakh
Hence, the working capital to be financed by bank is (25-5) – Rs.20 lakh.

3. Maximum Permissible Banking Finance Method (Tandon Committee)

There are three methods:
 1st Method of Lending: 75% of the working capital gap (Working Capital Gap= Total current assets– Total current
liabilities other than bank borrowings) is financed by the bank and the balance 25% of the Working Capital Gap con-
sidered as margin is to come out of long term source i.e. owned funds and term borrowings.
 2nd Method of Lending: Bank will finance maximum up to 75% of total current assets (TCA) and borrower has to
provide a minimum of 25% of total current assets as the margin out of long term sources.
 3rd Method of Lending: This is same as 2nd method of lending, but excluding core current assets from total assets
and the core current assets are financed out of long term funds of the company. The term ‘core current assets‘ re-
fers to the absolute minimum level of investment in current assets, which is required at all times to carry out mini-
mum level of business activity.

4. Chore Committee: The committee recommended assessment of working capital requirements have to be mandato-
rily assessed based on 2nd method of lending suggested by Tandon Committee except for sick/Units under rehabilita-
tion.

5. Cash Budget System: In case of tea, sugar, construction companies, film industries and service sector requirement
of finance may be at the peak during certain months while the sale proceeds may be realised throughout the year to
repay the outstanding in the account. Therefore, credit limits are fixed on the basis of projected monthly cash budgets
to be received before beginning of the season.

Appraisal of Term Loans

Appraisal of term loan for an industrial unit is a process comprising several steps. There are four broad aspects of ap-
praisal, namely
Technical Feasibility - To determine the suitability of the technology selected & the adequacy of the technical investi-
gation & design;
Economic Feasibility - To ascertain the extent of profitability of the project & its sufficiency in relation to the repay-
ment obligations pertaining to term assistance;
Financial Feasibility - To determine the accuracy of cost estimates, suitability of the envisaged pattern of financing &
general soundness of the capital structure; &
Managerial Competency – To ascertain that competent men are behind the project to ensure its successful implementa-
tion & efficient management after commencement of commercial production .

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