An animal called cash credit exists only in India.
Traditionally India had hundi-based financing, where funds were given by money
lenders to traders, against hundis drawn by them, payable on a particular date,
at specified rate of interest. Later to impart purposiveness and to curb
speculation, several committees in late 60's and early 70's focused on
allocating credit directionally towards maintaining price stability .
The cash credit facility allows borrower's
multiple debits and credits on a daily basis and helps them meet their cash
flow gaps within the sanctioned limits. This generally holds true as long as
all debits and credits are routed only through this account and so long as the
assumptions for the working capital cycle remain unchanged. The more mature an
organisation, the more accurate is the assessment of their working capital
requirement. There is, however, no requirement for a clean up at the end of the
tenor from the sales proceeds as the entire assessment is based not on cash
flows but on asset build-up.Due to the high prevalence of cash credit in India,
we have one of the longest cash-to-cash cycles.
As such, the cash credit limit is only renewed
either upwards or downwards depending upon the overall turnover of the company
and assumes a permanency normally associated with equity except that it is made
available at debt returns and with tax shields.
As long as the going is good, this system works
fine. However, in the face of any untoward situation, the current assets that
are the main security for the cash credit are the first to be eroded leaving
lenders unsecured.
While it is understandable that smaller and medium
businesses may not have the wherewithal to efficiently manage their cash
positions on a daily basis, it's not economic for banks to manage the cash or
treasury operations on their behalf.
What is not understandable is the requirement for
such an instrument or credit delivery mechanism for larger corporates (say
which are borrowing more than Rs 500 crore) which are in a position to manage
cash flows efficiently .
In effect, because of multiple deb its and credits
allowed in cash credit accounts in a single day , the risk of the treasury
management of larger businesses devolves on the banks, who are required to
maintain the necessary liquidity , often left under-utilised. It is also
possible for larger corporates to draw cash credit facilities at finer rates to
capitalise on arbitrage opportunities by lending it to smaller sister
corporates.
Thus, why should banks be required to maintain
liquidity support for large, rated corporates?
Essentially , well rated large corporations, draw
on their cash credit limits only in exigent circumstances. This leaves the
banks with large under-utilised limits and opportunity costs.
The moot point is: whether the working capital
assessment of large corporates, which is usually based on prospective data, is
done accurately by banks? Should banks then cancel under-utilised limits or
limit the same to the average utilisation of the previous financial year? Or
better, should large corporates meet their working capital requirements through
cash credit limits at all?
A possible solution lies in evolving the following
proposals:
1. Restricting cash credit facilities only for
small and medium enterprises with borrowings less than Rs 500 crore. Here also
we need to graduate these borrowings from asset based to cash flow based lines
of credits with each drawdown repayable at the end of the term.
2. For all corporates with aggregate working capital
requirements above `500 crore, they should be required to meet their needs from
the money markets only . If they need a core working capital requirement to be
funded, initially , in the process of transition, this should be by way of a
term loan.
3. For even these term fund requirements, this
should be by way of a shared national credit, as more prevalent in advanced
economies, led by a leading bank, with separate security trustees responsible
for the creation, perfection, novation and enforcement of underlying
security.This would help the regulators in a single point examination of the
credit instead of separate asset quality reviews of the same credit exposure
with multiple banks.This would also facilitate smaller banks to participate in
such credit depending upon their appetite, risk and pricing, knowing that they
could exit in adverse circumstances at transparently discovered pricing.
4. As any delinquency or default in the servicing
of such market liabilities would impact their ratings, it would help in
aligning the pricing returns with the attendant risks, without any undue lag as
evidenced in the cash credit system under which such realignment is usually
done only on renewal. The early warning signals would be captured more
discernibly and far quicker than in the present system of cash credit. More
often than not, presently, in the case of a steep derating of the borrower, post
their quarterly or annual results, instead of the pricing being revised upwards,
on grounds of supporting their viability, concessional pricing continues to be
demanded and offered as bankers do not have any option to exit at this point.
5. Multiple banking requires banks to share
information frequently and transparently , which is followed more in the breach
than in compliance. This is a weakness tried to be corrected through the CRILC
by the RBI. However, this is also post the event and any default is evident
only after a lag. Going forward, under the proposed system, the money markets
would factor in the aggregate outstanding debt along with the repayment history
on an ongoing basis, imparting greater discipline, and more efficient use of
capital.
By Sunil Srivastava
The author is DMD of SBI's Corporate Accounts
Group
