credit is the prime source of working capital finance. It
represents the most important source for financing of current
in five ways provide working capital finance:
capital term loans
cash credit, the bank specifies a predetermined borrowing/credit
limit. The borrower can draw up to the fixed Bank
credit. Within the specified limit, any number of drawings
is possible to the extent of his requirements periodically. Likewise,
settlement can be made anytime during the period. The interest
rate depends on the amount utilized by the borrower. However,
a minimum charge may be payable on the unutilized balance irrespective
of the level of borrowing for availing of the facility. This form
of bank financing attracts the borrowers. This is because, firstly,
it is flexible in that although borrowed funds are repayable on
demand, banks usually do not recall cash advances. Secondly, the
borrower has the freedom to draw the amount in advance as and
when required, while the interest liability is only on the amount
this arrangement, the entire amount of borrowing is credited to
the current account of the borrower or released in cash. The loans
can be repaid in periodic installments. They can also be renewed
from time to time. As a form of financing, loans imply a financial
discipline on the part of the borrowers.
this arrangement, Bank credit is
being made available through discounting of bills by banks. In
India, the RBI envisaged the progressive use of bills as an instrument
of credit as against the prevailing practice of using the widely
prevalent cash credit arrangement for financing working capital.
The bill financing is intended to link credit with the sale and
purchase of goods and, thus, eliminate the scope for misuse or
diversion of credit to other purposes.
the bill, the bank satisfies itself about the creditworthiness
of the drawer and the genuineness of the bill. The discounting
banker asks the drawer of the bill to have his bill accepted by
the buyer before discounting it. The latter grants acceptance
against the cash credit limit, earlier fixed by it, on the basis
of the borrowing value of stocks. Therefore, the buyer who buys
goods on credit cannot use the same goods as a source of obtaining
additional bank credit.
Loans for Working Capital
advance loans for at least 3-7 years that is repayable in yearly
or half-yearly installments.
the other forms of Bank credit are
direct forms of financing in which banks provide funds as well
as bear risk, letter of credit is an indirect form of working
capital financing and banks assume only the risk, the credit being
provided by the supplier himself.
purchaser gets a letter of credit from the bank. In case the buyer
fails to meet his obligations, the bank undertakes the responsibility
to make payment to the supplier. The supplier sells goods on credit
to the purchaser, and the bank gives a guarantee. The Bank
credit bears risk in case of default by the purchaser.
provide loans on the basis of the following modes of security:
this mode of security, the banks provide credit to borrowers against
the security of movable property, usually inventory of goods.
The goods hypothecated would continue to be in the possession
of the borrower. The rights of the lending bank depend upon the
terms of the contract between the borrower and the lender. Although
the bank does not have physical possession of the goods, it has
the legal right to sell the goods to realize the outstanding loan.
The facility of hypothecation is not available to new borrowers.
this mode of security, the goods that are offered as security
are transferred to the physical possession of the lender. An essential
prerequisite of pledge, therefore, is that the goods are in the
custody of the bank. The temporary housing of the goods by the
borrower is a kind of bailment to the lender. As a result, pledge
causes a few liabilities for the bank. It must take sound care
of goods. The term 'reasonable care' means care, which a prudent
person would take to protect his property. He would be responsible
for any loss or damage if he uses the pledged goods for his own
purposes. In case of non-payment of the loans, the bank enjoys
the right to sell the goods.
term 'lien' refers to the right of a party to retain goods belonging
to another party until a debt due to him is paid. Lien can be
of two types: (1) particular lien, and (2) general lien. Particular
lien is a right to retain goods until a claim pertaining to these
goods is fully paid. On the other hand, general lien can be applied
till all dues of the claimant are paid.
is used as a method by which individuals can buy residential or
commercial property without paying the full value upfront. The
person who parts with the interest in the property is called 'mortgagor'
and the bank in whose favor the transfer takes place is the 'mortgagee'.
The instrument of transfer is called the 'mortgage deed'. The
property becomes free from mortgage as soon as the debt is paid.
Mortgages are taken as an additional security for working capital
credit by banks.
immovable property of one person is made security for making payment
to another person and the transaction does not result into mortgage,
the latter is charged with all the provisions of simple mortgage.
The provisions are as follows:
.A charge is
not the transfer of interest in the property, though it is security
.A charge may
be formed by the act of parties or by the operation of law. A
mortgage can be formed only by the act of parties.
.A charge should
not necessarily be made in writing but a mortgage deed must be
a charge cannot be imposed on the transferee without notice. In
a mortgage, the transferee of the mortgaged property can obtain
the remaining share in the property, if any.
the mid-sixties, bank credit to industry had been exclusively
in the form of the traditional cash credit system. The prevailing
credit system suffered from the following drawbacks from the viewpoint
of the banks:
.A bank did
not exercise control over the level of drawings in the cash credit
account. No notice was required for drawing under the limits,
which may remain unutilized for long periods.
.A bank was
not able to anticipate a demand for credit. This hampered its
of operations of the credit system to the banker, on account of
the attendant uncertainties, was high because whatever chances
he may take in 'overselling credit', there is always a limit up
to which he could 'oversell'.
a view to injecting discipline in the utilization of bank credit,
modification was introduced initially in the structure. The modus
operandi of the proposed system was that instead of making the entire
credit limit available, it would be bifurcated into (1) loan, and
(2) demand cash credit, subject to annual review. The loan component
of the credit arrangement would comprise the minimum level of borrowings,
which the borrower expects to use throughout the year. The cash
credit component would consider the fluctuating requirements of
Long Term Borrowing
Loans Against 401k