## Working Capital Finance from Banks
### Overview
- Banks are the major suppliers of short-term credit for working capital.
- The Tandon Committee and Chore Committee gave foundational guidelines.
- RBI withdrew the Maximum Permissible Bank Finance (MPBF) concept in April 1997.
- Banks now develop their own assessment methods (board-approved), subject to prudential guidelines.
### RBI Directions
| Category | Details |
|---|---|
| Directed Credit | Priority sector lending, export credit (mandatory) |
| Prohibited Credit | Bridge finance, NBFC re-discounted bills (not permitted) |
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## Forms of Bank Credit
### 1. Cash Credit (CC)
- A continuous credit facility — borrower withdraws and repays within a sanctioned limit as needed.
- Interest is charged only on the amount actually drawn, not the full limit.
- Typically secured by stock and book debts.
- Best for: Ongoing working capital needs.
### 2. Bank Overdraft (OD)
- Allows withdrawal beyond the current account balance, up to a sanctioned limit.
- Repayable on demand — bank can call it back at any time.
- Typically short-term and occasional (not continuous like CC).
- Best for: Temporary cash shortfalls.
### 3. Bills Discounting
- A seller (who holds an accepted bill from the buyer) discounts it with the bank for immediate cash.
- Bank holds the bill and collects from the buyer on maturity.
- Risk: If buyer defaults, bank has recourse to seller.
### 4. Bills Acceptance
- Company draws a bill on the bank itself, and the bank accepts it — promising to pay a third party on a future date.
- The bank's acceptance enhances the bill's creditworthiness.
- Bank charges an acceptance commission.
### 5. Line of Credit
- Bank's commitment to lend up to a specified maximum on demand.
- Not an actual loan until drawn — but provides certainty of access to funds.
- Interest charged only on amounts actually drawn.
### 6. Letter of Credit (LC)
- Bank commits to pay or negotiate funds against documents presented as per agreed terms.
- Used in trade (domestic and international) to assure the seller of payment.
- Bank pays seller when documents are presented; then recovers from the buyer.
### 7. Bank Guarantees
- Bank promises a third party to pay on behalf of its client if the client defaults.
- A contingent liability for the bank — actual payment only if the client fails.
- Used in construction contracts, government tenders, etc.
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## Comparison: Key Distinctions
| Pair | Key Difference |
|---|---|
| Cash Credit vs Overdraft | CC is continuous and secured; OD is occasional and on-demand |
| LC vs Bank Guarantee | LC: bank pays on document presentation (primary obligation); Guarantee: bank pays only if client defaults (contingent) |
| Bills Discounting vs Bills Acceptance | Discounting: bank buys the bill; Acceptance: bank commits to honor the bill itself |