A study group under the chairmanship of Shri P.L. Tandon was constituted in 1974 by the RBI in order to frame guidelines for bank credit.
study group under the chairmanship of Shri P.L. Tandon was constituted in 1974
by the RBI in order to frame guidelines for bank credit. The terms of reference
of the committee were as follows.
Terms of reference
1. To suggest guidelines for commercial banks to follow up and supervise credit from the point of view of ensuring proper end-use of funds and keeping a watch on the safety of advances.
2. To make recommendations for obtaining periodical information that may be obtained by banks from the borrower.
3. To make suggestions for prescribing inventory norms for different industries.
4. To suggest criteria regarding satisfactory capital structure and sound financial basis in relation to borrowings.
5. To suggest whether the existing patterns of financing working capital requirements by cash credit / overdraft system, etc. are required to be modified, if so, to suggest modifications.
On the basis of the reference given above, the committee studied the existing system of working capital finance provided to industry and identified the following as its major weaknesses.
1. The banks do not have any credit appraisal or planning. It is the borrower who decides how much he would borrow.
2. The security-based approach to lending has led to division of funds to purchase of fixed assets.
3. Bank credit is treated as the first source of finance rather than being taken as a supplementary to other sources of finance.
4. The working capital finance should be made available only for a short period, as it has otherwise, led to accumulation of inventories with the industry.
Recommendations The report was submitted on 9th August 1975 and it is a landmark
in the history of financing working capital by commercial banks in India. The
Tandon Committee made comprehensive recommendation regarding the bank lending
practices, which can be broadly classified into four groups’. Important
features of the Tandon Committee recommendations based on the fixation of norms
for bank lending to industry are as follows.
Norms for Bank Lending
1. Inventory and receivable norms The borrowers are allowed to keep
reasonable current assets particularly inventory and debtors. The normal
current assets based on economic ordering levels and certain level of safety
should be financed by banker. Finance to borrower in the form of working
capital should not be made available for profit making or to keep excess
inventory. Similarly the bank should finance the bills receivable, which are in
line with the practices of the borrower’s industry. The norms have been worked
out according to the time element. The limit of the raw materials is expressed
as so many months of total consumption in the year. The work-in-progress limit
determined as so many months of cost of production, the finished goods and
bills receivable limits are determined by cost of sales and credit sales
respectively. The Tandon Committee has suggested norms for fifteen industries.
2. Lending norms or Maximum Permissible Bank Finance (MPBF) Tandon Committee introduced the
concept of MPBF in the working capital finance by banker. The Committee
suggested that bank should attempt to supplement the borrowers’ resources in
financing the current assets. It has recommended that the current assets first
should be financed by trade creditors and other current
liabilities. The remaining current assets, which is called working capital gap, should be financed particularly by bankers in
the form of bank credit and through long-term borrowings or owner’s funds. In
the context of this approach, the committee has suggested three alternative
methods for working out the MPBF. Each successive method reduces the
involvement of short-term bank credit to finance the current assets.
First method In the first method, 25% of the
Working Capital Gap (CA-(CL excluding bank borrowing)) should be contributed by
borrower through long-term funds and remaining 75% can be financed from bank
borrowings. This method will give a minimum current ratio of 1.17:1. The term
working capital gap refers to the total of CA less CL other than bank
borrowings. This can be understood with the help of the following examples. Example 1 Amount
of maximum permissible bank borrowings as per the first method can be
ascertained as follows:
Second method Under this method the borrower
should provide 25% of the total current assets through long-term funds and this
will give a current ratio of 1.33:1
Example 2 The
maximum permissible bank borrowings as per second method can be ascertained as
In this method the borrower
should contribute from long-term sources to the extent of core current assets
(Fixed Current assets) and 25% of the balance of the current assets. The
remaining of the working capital gap can be met from bank borrowings. This
method will further strengthen the current ratio.
Example 3 The
maximum permissible bank borrowings as per the third method can be ascertained
The committee recommended the
first method mainly as a stop-gap method till borrowers get used to the new
approach of lending. The borrowers who are already in the second method would
not be allowed to revert to the first stage.
Core Working Capital It is also known as Core current
assets or fixed current assets. Any organization has to maintain minimum level
of current assets throughout its existence as long as production cycle
continues. They are permanent in nature. Thus a minimum amount of raw material,
WIP, finished goods etc, that are required to be kept for running a company are
called hard core working capital. The hard core working capital are like fixed
assets such as machinery and building are for long-terms, but the difference
between them is that the same machinery and building continues to exist but in
case of elements of hard core working capital the level of working capital
remains same but not the exact raw material, WIP on finished goods.
These are replaced continuously by other items
consisting of utmost same value.
Reserve Bank’s Direction The RBI accepted the
recommendations of the committee as a whole. It instructed the commercial banks
in 1976 to put all the borrowers having aggregate credit limits from banking
system in excess of `10 lakhs, under the first method
Suitability of lending method to bankers
At present, all sanctions of working capital by banks are based on Method 2. Because, the second method of lending is more acceptable to bankers since, it provides more cushion to them as far as quantum of margin is concerned compared to first method of lending. Obviously the amount of maximum permissible bank finance under the second method is lesser when compared to the first method.
3. Style of Credit
The Tandon committee also suggested that total MPBF should be bifurcated into two components 1. Loan component represents the minimum level of borrowing throughout the year and 2. Demand cash credit component, which would take care of the fluctuating needs and is required to be reviewed periodically. The demand cash credit component should be charged slightly higher interest rate than the loan components. This would provide the borrower an incentive for better planning. Apart from the loan component and cash credit component, a part of the total financing requirements should also be provided by way of bills limit to finance the seller’s receivables. The proposed system of lending and the style of credit might be extended to all borrowers having credit limits in excess of ` 10 lakhs from the banking system.
4. Information and Reporting System
In order to ensure that the borrowers do not use the cash credit facility in an unplanned manner and they keep only required level inventories and receivables, the committee suggested a new information system. Under this system the borrowers are required to submit the following documents to the bankers periodically.
1. A copy of the audited financial statements at the end of each year.
2. A copy of a projected financial statement and funds flow statement for the next year.
3. Quarterly budgeting cum reporting statements.
4. Monthly stock statement.
The Tandon committee further suggested that the information system might be introduced to start with in respect of borrowers with limit of Rs1 crore and above from the entire banking system and then extended progressively to others.
Tags : Financial Management - WORKING CAPITAL MANAGEMENT
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