Opinion

Zero balance

Srinivas Dindi | Updated on January 20, 2018 Published on May 30, 2016

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Has the cash credit system outlived its utility?



There is an imperative need to re-visit the way banks appraise and assess funding requirements of companies. The prevalent method of meeting working capital requirements in public sector banks is through the age-old cash credit system.

Though private and foreign banks bundle all facilities into one and provide various lines of credits within the overall assessed limit, the contracted debt continues to remain.

Working capital needs

The assessment of working capital needs has evolved over time with the proven traditional method of assessing based on holding periods to various other methods suggested by Chore, Tandon and Nayak committees and the current projected balance sheet method and cash budget method depending upon the quantum of loan and industry specifics.

All along, the focus has been on the margin available from long-term source — net working capital (NWC), the ‘skin in the game’ as far as working capital is concerned.

Historically, in India, working capital needs are expected to be met out of short-term sources, the main component being cash credit facility. Whereas, international practice indicates that short-term uses can also be funded by long-term source, like a term loan, rather than a cash credit system.

Such term loans are referred to as revolving credits (RCs), which restore to their full value during the agreed tenure.

Further, the NWC is expected to be monitored by banks on a regular basis, which is an uphill task. Though the post sanction tools to track movement of NWC such as financial follow up reports and cash flow statements help to an extent, they lose their significance when there is divergence in the way the corporate and bank classifies components of balance sheet, taking the process nowhere.

Indian corporates, mainly unlisted entities, have to scale up to the compliance standards of international best practices so that their balance sheets can be accepted by lenders on the face of it so that the follow up exercise by banks remains meaningful and actual balance sheet funding takes place.

Phasing out cash credit

Though the cash credit facility (CC) is short-term in nature and is payable on demand, it is everyone’s knowledge that it is perpetual in real terms. All along, banks and the regulator have turned a blind eye to the perpetual nature of CC and corporates have taken for granted its ever increasing size.

It is high time that the cash credit system is phased out and replaced with suitable revolving credits with repayment stipulated to bring down corporates’ debt levels over a period time.

A thought in that direction was given sometime back by converting a portion of CC as working capital demand loans with repayment, but it had never taken off. The RBI may look at providing one-time special dispensation for such conversion by easing out any regulatory impediments and the debt/Ebitda would be a guiding factor to arrive at the optimum instalments and tenure. To start with, corporates with good credit metrics should come forward for such conversion.

Adopting the method of funding working capital needs with revolving credit with suitable repayment period, we can look forward for improvement in corporate balance sheets with parity in scale of operations and debt levels.

The writer is Vice-President (Syndications) at SBI, New York. The views are personal

Published on May 30, 2016
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