## Working Capital Finance from Banks
### Role of Banks
Banks are the major short-term credit providers for working capital. The Tandon Committee and Chore Committee provided the foundational guidelines for bank lending to industry.
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## RBI Instructions on Bank Finance
- RBI withdrew the Maximum Permissible Bank Finance (MPBF) concept in April 1997.
- Banks may now develop their own assessment methods (must be board-approved).
- Banks must follow prudential guidelines and exposure norms.
RBI Directions on Type of Credit:
| Direction | Examples |
|---|---|
| Directed Credit (mandatory) | Priority sector lending, export finance |
| Prohibited Credit | Bridge finance, NBFC re-discounted bills |
Effect of Liberalisation:
- All previous MPBF instructions withdrawn.
- Banks can voluntarily adopt earlier Tandon/Chore guidelines in their lending policies at their discretion.
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## Forms of Bank Credit
| Form | Description | Key Feature |
|---|---|---|
| Cash Credit | Continuous revolving facility; borrower withdraws up to a sanctioned limit as needed | Flexible; interest on amount actually utilised |
| Bank Overdraft | Withdraw beyond account balance up to a limit; repayable on demand | Short-term; usually for temporary mismatches |
| Bills Discounting | Seller discounts an accepted trade bill with the bank for immediate funds | Bank pays now; collects from buyer on due date |
| Bills Acceptance | Firm draws a bill on the bank; bank accepts it and promises payment on a future date | Bank's acceptance enhances bill's creditworthiness |
| Line of Credit | Bank's commitment to lend up to a specified maximum amount on demand | Arrangement fee; not actual drawdown until needed |
| Letter of Credit (LC) | Bank commits to pay/negotiate funds against documents per agreed terms | Common in import/export trade |
| Bank Guarantee | Bank promises to pay a third party on behalf of its client if client defaults | Used for tender, performance, or advance payment guarantees |
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## Key Distinctions
Cash Credit vs Bank Overdraft:
- Cash Credit is a revolving facility specifically for business working capital with a formally sanctioned limit.
- Overdraft is against an existing current account and is typically used for very short-term cash flow gaps.
Bills Discounting vs Bills Acceptance:
- In discounting, the bank pays the seller upfront against an already-accepted trade bill.
- In acceptance, the bank itself becomes the acceptor (drawee) on a bill — its own promise to pay.
Letter of Credit vs Bank Guarantee:
- LC is primarily used in trade transactions (import/export) — bank pays on presentation of specified documents.
- Bank Guarantee is used for contract/performance obligations — bank pays only if the client defaults on an obligation.