The regulation of bank finance was developed in order to cope with the problems that came up due to over borrowing of working capital by a particular business sector while the other sector was being deprived. This happened mainly because the working capital for the finance was readily available and it was convenient for the firms to go for the loan.
As a result of which one segment of the industry used to avail the cash more frequently than the other segments. The market was facing the problem of disproportionate allocation of capital. In order to bring a discipline among the borrowers, it was necessary to come up with some regulations from the central bank.
Since the mid 1960s, the Reserve Bank of India (RBI) has been trying to formulate some regulations so that the credit allocation can be done on the basis of priority sectors. On the basis of the recommendations made by various committees, the RBI developed a number of directives and guidelines on the regulation of bank finance.
But now when the country is going through financial liberalization, the RBI has provided much free hand to the commercial banks on the working capital financing.
The grounds on which the RBI has announced a number of guidelines and regulations are:
Maximum Permissible Finance by Bank
The three methods for calculating the maximum permissible bank finance (MPBF) given by the RBI are
MPBF = 0.75 (CA – CL)
MPBF = 0.75 CA – CL
MPBF = 0.75 (CA – CCA) – CL
CA means current asset according to the given norms
CL means non-bank current liabilities
CCA means core current assets .
Receivables and Inventory Norms
The RBI suggested some norms for the fifteen prime industries of the country. These norms give the measure of maximum level of holding receivables or inventory in a certain period.
Reporting and Information System
The reporting and information system was given in order to strengthen the banker and borrower partnership and also giving the bankers a fair knowledge on the borrower’s requirements.
Forms of Assistance
Traditionally the bank credit system is based on cash credit. Hence the banks need to maintain cash management responsibility because the borrowers can withdraw cash within the bank’s cash credit limit. In 1995 a system on the bank credit delivery was introduced. According to this, the banks have to restrict the cash credit limit sanction of the borrowers.
According to this, the RBI carries out the scrutiny of the sanctioned loan when the banks provide the loan beyond the specified cut off level of working capital limit.
Last Updated on : 27th June 2013