CREDIT CONTROL-1

The specific authority vested in the Reserve Bank of India includes the powers to issue directions either generally to all banks or to a bank in particular as to: 

a)      The purpose for which advances may or may not be made;

b)      The margins to be margins to be maintained in respect of secured advances;

c)      The maximum amount of advances or other financial accommodation which, having regard to the paid-up capital, reserves and deposits of a banking company to any other relevant considerations, may be given by a banking company to any one company, firm, association of persons or individual;

d)      The maximum amount upto which, having regard to the considerations reterred at c) above, guarantees may be given by a banking company on behalf of any one company, firm, association or persons or individual; and

e)      The rate of interest and other terms and conditions on which advances or other financial accommodation may be made or guarantees may be given.

 

The credit control measures are framed by the Reserve Bank of India (RBI) in line with the monetary policy of the country. The objectives of the monetary policy are two-fold: 

1.      To facilitate flow of adequate volume of bank credit to the various sectors with specific reference to the weaker sectors, and

2.      To keep a control on inflationary pressures by ensuring restraint on credit expansion and proper end-use of bank credit.

CREDIT CONTROL

All the functions of scheduled commercial banks are governed by the Banking Regulation Act, 1949 as amended from time to time. The Banking Regulation Act defines “banking”, “banking company” and “banking policy”. In terms of the Act “Banking” means accepting, for the purpose of lending or investment, of deposits of money form the public, repayable on demand or otherwise, and withdrawals by cheque, draft, order or otherwise.

 

“Banking Company” means any company which transacts the business of banking in India. “Banking policy” means any policy which is specified from time to time by the Reserve Bank in the interest of the banking system or in the interest of monetary stability or sound economic growth, having due regards to the interests of the depositors, the volume of deposits and other resources of the bank and the need for equitable allocation and the efficient use of these deposits and resources.

 

The Banking Regulation Act, 1979 has provide vast powers to the Reserve Bank of India to control the patters, direction and extent of bank credit. We will discuss on the specific authority vested in the Reserve Bank of India includes the powers to issue directions either generally to all banks or to a bank in particular in our next post.

 

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BANK CREDIT-1

INTRODUCTION OF BANK CREDIT: THE FRAMEWORK 

In view of the state of Indian money and capital markets as described in unit 5, it is no wonder that bank credit constitutes one of the major sources of working capital finance for trade and industry. Equally, it should be a matter of no wonder that bank credit has been highly regulated in India. We shall, therefore, in this unit first of all like to acquaint ourselves with the framework of credit control operating in India. We shall then discuss the principles of bank lending, the forms of credit extended and the types of security required by banks. This unit also covers credit investigation and post-lending control aspects of bank credit. Let us now discuss credit control. 

CREDIT CONTROL 

All the functions of scheduled commercial banks are governed by the Banking Regulation Act, 1949 as amended from time to time. The Banking Regulation Act defines “banking”, “banking company” and “banking policy”. In terms of the Act “Banking” means accepting, for the purpose of lending or investment, of deposits of money form the public, repayable on demand or otherwise, and withdrawals by cheque, draft, order or otherwise.

FACTORING

Factoring is a financial service designed to help firms in managing their receivables better. It involves an outright sale of the receivables of a manufacturing or trading firm to a financial institution called the ‘factor’ who specialized in the management of trade credit. A factor collects the accounts on the due dates, effects payments to the firm on these dates, irrespective of whether the customers have paid or not; and also assumes the credit risks associated with the collection of accounts. For rendering these services, the fee or commission charged is usually a percentage of the value of receivable factored. 

Apart from the regular invoice discounting being provided by the banks factoring is a new concept in Indian financial system. The market potential is considerable. In the present context where industrial sickness is spreading like an epidemic, the reason for which particularly is SSI sector being delayed payment from suppliers, there is a clear-cut rationale for introduction of this system. There has been some progress on this front. The recommendations of the Study Group to examine the feasibility of setting up of factoring organizations in the country, under the Chairmanship of Shri C.S. Kalyanasudaram have been accepted by Government of India. A summary of these recommendations is set out in Appendix-5.1. The modalities in this regard are being finalized and in near future some of the Indian banks or their subsidiaries will launch their factoring operations.

 

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REFINANCE

In the previous section it was indicated that there is a pre-emption of the resources (Demand and Time Liabilities or DTL) of the banks by the Reserve Bank of India in the form of the Statutory Liquidity Ratio and the Cash Reserve Ratio. In fact, currently, 53% if the bank resources are pre-empted under SLR (38%) and CRR (15%). Of the balance, in terms of the policies of the Government, 40% of the resources have to be extended to what is known as the Priority Sector which includes agriculture and allied activities, small scale industry, government sponsored schemes and the Differential Rate of Interest (DRI) advances.

 

As banks are required to subscribe under the SLR and CRR statutorily and also extend credit at concessional rates to various sectors, they often face a shortfall of resources in financing the residual sectors. In order to ensure that they are in a position to meet the requirements of the residual sectors and also to maintain their working funds and profitability, various schemes of refinance have been evolved from time to time. Refinance implies that against certain outstanding credit (especially usance bills financed by banks), certain agencies refinance the banks. These agencies include the Reserve Bank of India, Industrial Development Bank of India, National Bank for Agriculture and Rural Development and The Export-Import Bank of India (EXIM Bank). The refinance or rediscounting is mainly available on eligible bills finance by banks, export credit, term loans to selected industries, credit to selected priority sector activities and a discretionary refinance quota with the Reserve Bank of India. Depending upon the conditions on which the rediscounting ore refinance is allowed, the banks are able to reinvest the funds, so made available, to generate additional income.

CERTIFICATES OF DEPOSIT

With a view to further widening the range of money market instruments And to give investors great flexibility in the deployment of their short-term surplus funds, Certificates of Deposit (CDs) were introduced recently.  

 

As per the detailed guidelines issued by the Reserve Bank in June 1989, CDs can be issued only by Scheduled Commercial banks excluding Regional Rural Banks. CDs issued by a bank and outstanding at any point of time should not exceed two per cent of the fortnightly average outstanding aggregate deposits of the bank during the financial year 1989-90. 

 

The minimum amount of CDs issued to a single subscriber should not be less than Rs.50 lakhs and CDs above Rs.50 lakhs should be in multiples of Rs.10 lakhs. CDs can be issued individuals, Corporations, Companies, Trusts, Funds, and Associations etc. Non-Resident Indians (NRIs) may subscribe to CDs only on a non-repairable basis and such CDs cannot be endorsed to another NRI in the secondary market. The maturity period of CDs should not be less than 3 months and not more than one year. CDs should be issued at a discount on face value and the issuing bank is free to fix the discount rate. Banks will have to maintain, Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) on the total issue price of CDs. CDs are freely transferable by endorsement and delivery only after 45 days of the date of issue. Furthermore, banks cannot grant loans against CDs nor buy back their own CDs before maturity.

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INTER-BANK PARTICIPATIONS-2

With a view to providing an additional instrument for evening out short-term liquidity within the banking system, two types of Inter-Bank Participations (IBPs) were introduced, one on risk sharing basis and the other without risk sharing. These are strictly inter-bank instruments confined to scheduled commercial banks excluding regional rural banks. The IBP with risk sharing can be issued for 91-180 days and only in respect of advances classified under Health Code No. 1 Status. Under the uniform grading system introduced by Reserve Bank for application by banks to measure the health of bank advances portfolio, a borrower account considered satisfactory or assigned Health Code No. 1 is the one in which the conduct of account is satisfactory, the safety of advance is not in doubt, all the terms and conditions are complied with, and all the accounts of the borrower are in order. The IBP risk sharing provides flexibility in the credit portfolio of banks. The rate of interest is left free to be determined between the issuing bank and the participating bank subject to a minimum 14.0 per cent per annum. The aggregate amount of such IBPs under any loan account at the time of issue is not to exceed 40 per cent of the outstanding in the account.

 

The IBP without risk sharing is a money market instrument with a tenure not exceeding 90 days and the interest rate on such IBPs is left to be determined by the two concerned banks without any ceiling on interest rate.

INTER-BANK PARTICIPATIONS-1

Participation Certificates (PCs) as a money market instrument emerged on the scene first in 1970 but came into greater focus from 1977. PCs were initially intended to serve as a short-term money market instrument. However, for the most part, PCs were utilized by the financial institutions for ‘Parking’ their funds for increasingly long maturities and hence, this instrument was not developed for evening out liquidity between banks and/or financial institutions. The basic tenet of PC, which the credit risk of the relative advances to the borrowers designated in the certificates would be shared, was not realized and the instrument mainly became a mechanism for obtaining additional resources rather than to share the advances as part of evening out liquidity.

 

In the late 1970’s it was felt that the manner in which PCs had developed, they were merely deposits from institutions without risk sharing; hence PCs were subject to reserve requirements and as a result they were merely deposits from institutions without risk sharing; hence PCs were subject to reserve requirements and as a result they were eventually phased out. While the earlier version of PCs is extinct specie, a thoroughly rejuvenated version has been recently introduced.

 

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COMMERCIAL BILLS MARKET

Bills rediscounting is an important segment of the Money Market and this instrument provides short-term liquidity to banks in need of funds. The effective cost of funds raised by scheduled commercial banks through the bills rediscounting scheme is lower than the effective cost of inter-bank term deposit/loans of over 60 days as the latter are subject to reserve requirements; as such banks seeking funds through the money market find bill rediscounting very lucrative. The presence of a healthy bills market can enable the banks and also the other financial institutions to invest their surplus funds profitably by selecting appropriate maturities and it would impart flexibility to the money market by evening out liquidity in the banking system and there would be more effective monetary control. Progressive use of bills imposes financial discipline on borrowers as also on lenders.

 

The development of a healthy bill market in our country has languished for want of a widespread practice of issue of usance bills and their acceptance for the purpose of trade credit and for securing discounting facilities against them. The need for such healthy growth has been markedly highlighted for a long time by various Committees appointed by the Government and the Reserve Bank of India.