In the wake of questionable credit discipline shown by Indian corporate borrowers, the Reserve Bank of India (RBI) is leaving no stone unturned to instil some discipline through the banks it regulates.
The latest proposal by the central bank through a draft guideline is to make all borrowers enjoying working capital limit in excess of Rs150 crore to compulsorily borrow through the demand loan route for at least 40% of the limit before touching other modes like cash credit, overdraft, bill discounting etc.
Cash credit is the most popular method of accessing working capital funds from a bank. When a company is assigned a cash credit limit for a year, it can withdraw as much as it wants for as long as it wants within that limit during that year. Cash credit is like a credit card the company swipes when it needs quick money. It is required to pay only the interest and only on the amount withdrawn.
Cash credit is a key to a company’s daily functioning and is used to meet a variety of needs from salary payments to supplier transactions. The fact that utilization of cash credit limits is over 68% shows its popularity. The share of cash credit in overall working capital loans has been over 40% historically. Given that it is a revolving credit, big companies accessing working capital limits from multiple banks tend to borrow from one to pay another. At times, it is just rolled over since only interest is paid. The central bank believes this method is getting abused and indeed, in cases of fraud the funds involved are typically short-term working capital loans.
RBI wants companies to meet their working capital needs first through demand loans so that banks can predict their outflow. Demand loans are like any other secured term loans requiring regular repayment of both principal and interest. The share of demand loans in total working capital loans is about 25%.
Kotak Securities in a note pointed out that borrowers will have to be careful about end-use of funds borrowed. “Any diversion of funds by borrowers for non-business related purposes or outside the scope of business to which the working capital limit was extended can probably be captured with greater efficiency under the current system,” the note said.
Since cash credit results in sudden outflows for banks, the burden to replenish this liquidity shortfall comes at the door of RBI through its repo operations. The ripple effect of this is an upward pressure on short-term rates. The draft norms, if formalised, will have a salutary effect on liquidity of banks. But companies will be staring at larger short-term repayments as they avail demand loans.