The monetary and credit policy for the slack season announced by the Reserve Bank has, in fact, opened new windows to the corporate financing system. The traditional financing pattern is going to be a thing of the past and its place would be taken by many innovative financial and debt instruments very soon. In this context, it would be interesting to examine the development of working capital financing over a period, its new dimensions, the issues involved and the implications of the new pattern.

It was for the first time in 1965 that the need was felt for imposing some credit discipline on the large borrowers so as to prevent misuse of bank finance by them and to ensure a larger flow of credit to the lowest strata of the society, which were neglected till then. Consequently, the credit authorisation scheme requiring commercial banks to obtain prior permission from the Reserve Bank for extending working capital finance above a stipulated level was introduced.

After a decade, i.e. in 1975, the working capital lending system was reviewed by the Tandon Committee and the Committee prescribed a specific structure for lending for working capital by commercial banks so as to bring some consistency between the method of assessment and the post-sanction follow-up. The Committee formulated a consolidated approach by way of fixation of the maximum permissible bank finance (MPBF) by treating borrowings from different banks for working capital together and fixing limits in totality. Another important aspect was the introduction of a well structured information system enabling smooth flow of information from borrowers to the financing banks through monthly, half-yearly and annual statements.

Subsequent committees headed by K B Chore in 1980 and S S Marathe in 1983, though did not make any structural changes, improved the efficiency of the system by stringent prescriptions as well as modifications conducive to healthy industrial development and uplift of the economic environment overall. However, by 1989, the need for a complete relaxation was felt and consequently the Reserve Bank replaced the credit authorisation scheme with the credit monitoring arrangement, taking away the requirement of pre-sanction approval and making post-sanction reporting compulsory.

The financial and economic liberalisation and the process of integrating the Indian financial system with the global framework necessitated a relook at the contribution of bank lending to money market liquidity so as to avoid distortions and ensure stability. Accordingly, the loan delivery system was introduced to enable banks to plan their cash flow in a more realistic manner and reduce the maturity mismatches. The loan delivery system was also modified thrice by gradually tapering the cash credit component and increasing the term component to provide better liquidity leverage to banks.

Finally, the entire system of following common norms for fixation of MPBF was taken away, giving greater freedom to banks to decide the quantum of finance, pattern, methodology and norms individually. The new system has wider ramifications and involves various issues and implications.

Bank finance to corporates for working capital is going to have a different thrust. Corporates are getting greater manoeuvrability in deciding the pattern of assistance. The windows now available are many and the credit market for banks is going to be a buyers' market. A corporate client can ask his banker to structure a debt instrument and introduce it in the financial market to take advantage of the market liquidity and interest differential.

The reduction in the minimum period of commercial paper would enable corporates to use this instrument widely for their short-term requirements so as to mobilise funds at cheaper rates. Bonds and debentures are other instruments that would invade the market soon. The traditional system of sanctioning working capital finance limits by banks after a lengthy assessment procedure and the borrowers executing voluminous documents would soon be reduced to irrelevant history. Instead, the clients would demand their bankers to structure debt instruments like revolving underwriting facility (RUF), floating rate notes (FRNs), special purpose vehicles (SPVs) etc. Those borrowers having substantial exports would find it cheaper to raise funds abroad through Euro- bonds and Euro-loans, especially when they have considerable imports, so that they can save the exchange difference also. Banks may also have to arrange interest swaps and other hedging tools for their clients to hedge against exposures.

The existing infrastructure in banks is quite insufficient to meet the challenges ahead. While foreign bank branches already possess expertise, the newly constituted private sector banks have acquired the necessary skill either from their sponsors abroad or by sending their personnel abroad. Under the circumstances, Indian banks would find it difficult to structure innovative loan products and compete with foreign banks and the newly constituted private sector banks unless they immediately take steps to acquire this expertise and train their personnel abroad so as to meet the emerging challenges.

Larger banks like the State Bank of India, Canara Bank etc. might have already initiated steps in this direction. But the smaller banks in public sector and those in the private sector risk being dumped on the back benches looking for spill-overs from their big brothers for survival. Banks which are resigned to the traditional gold loan and small business loan would have to surrender these portfolios to the local area banks and co-operative banks.

The scenario of the future is going to be tough for laggards, since mergers and acquisitions are on the anvil. The Finance Minister and the Reserve Bank Governor have, time and again, stressed the need for mergers and acquisitions in the banking sector and have made it clear that the weaker banks would not be allowed to function independently and have to merge with the stronger constituents.

The intention of the Government is to have only a few strong banks so as to smoothen the process of integration of Indian banking system with the global framework. One has to view the recent steps as a beginning of the integration process. The impact of such integration would reduce employment opportunities on account of large scale automation and weeding out operations. Ordinary customers may have to settle for local area and co-operative banks.

The author is Senior Member of Faculty, The Federal Bank Ltd.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.