Freedom Versus Responsibility

The time is now opportune to review the existing credit system and effect changes. It has to be borne in mind that in the current context of shortages, bank credit, if not properly supervised, may be utilised for an undue build up of stocks, which, while proving profitable for some, will result in misallocation of resources among all. Bank credit has thus a crucial role in allocation of resources to prevent such a chase of scarce materials which fuels inflation. (Report of the Study Group to Frame Guidelines for Follow-up of Bank Credit, p.14, 1975. Chairman: Prakash Tandon).

The concept of maximum permissible bank finance emerged out of the recommendations of the Tandon Committee and has been in vogue ever since. Endorsing the committees suggestions, the government introduced in 1975, among other things, norm-based bank lending for working capital and the concept of maximum permissible bank finance (MPBF). Since then MPBF has remained the central focus point of the bank credit system.

But that was more than two decades ago. Now in 1997, the banking regulators have come round to the corporate sectors view that time has come to have a re-look at the system. And the Reserve Bank of India (RBI) has set up a committee to do just that. Headed by K Kannan, chairman and managing director, Bank of Baroda and comprising a few bankers, the panel is expected to examine its working, assess the problems and suggest modifications in credit delivery.

The current system, adopted on the basis of Tandon Committee recommendations and modified in the wake of Chore Committee, has found the borrowers, notably the corporates, bemoaning the rigidity of the system and the water-tight norms it imposes on them. Not only they complain that they find it difficult to borrow adequate amounts of money from banks; but also that the monies are only available after sizable delays, upsetting their production plans. The dual problem relating to adequacy and timeliness have sent the corporates in a perennial search of additional sources of money.

Bankers too agree that there is a need to modify the existing arrangement. In two decades of time, markets have changed but the system has remained static, says Paresh Sukhthankar, vice-president, credit and market risk, HDFC Bank. A number of new industries have come up in this period, and the structures of some of the old industries have undergone profound changes. The system has failed to take a note of these changes, he points out.

More important is the trend of liberalisation initiated in the financial system. In the last few years, access of the corporate sector to other means of resources has been freed to an extent. More freedom in the matter of size and pricing has been given to corporates desiring to raise money from the capital market. Also, new instruments like commercial paper have been evolved. Interest rates have been liberated to a large extent. The prevalent credit system, based on 20-year old norms, is probably the last vestige of the antiquated era, and needs at least a review, say some bankers.

Describing the situation in a more forthright manner, Waseem Saifi, senior manager-corporate banking at Standard Chartered Bank says: It is a system of strict policing based on utter lack of trust. It is like a game between untrusting banks on one side and the corporate sector trying to beat the system on the other. No one benefits at the end of the day.

The rise of the MPBF

How did the MPBF system evolve? In the sixties, when socialistic banking was in its heyday, bank credit came to be considered not a commodity but a resource which could not be given to every one willing to pay the price, explains Sukhthankar. Rationing bank credit was therefore found necessary and asset based norms were evolved by the central bank. Accordingly, parameters such as raw material requirements, production cycle, short and long term means of finance and working capital gaps were taken into account to arrive at industrywise norms of inventories and receivables. What was termed as Method II of working capital calculations came into vogue. The method permits banks to extend working capital credit to corporates to the extent of 75 per cent of current assets.

Current assets as defined under the norms is at variation from the common usage. For the purpose of working capital calculations, current assets only comprise of inventories and trade receivables. The definition leaves out other current assets such as loans, advances and other deposits. Moreover, since the method requires 25 per cent margin, the effective availability of credit to the corporate sector works out at much lower levels than they would like to have, point out many corporate treasurers.

Also, since industry-wise norms were fixed by the RBI based on Tandon and Chore recommendations, the credit regime lacked dynamism. Within an industry, no leeway was given for the fact that one companys needs could be different from that of another. Based on these norms, limits of maximum permissible working capital credit were determined and banks were expected to strictly stick to these norms. Since the norms were considered sacrosanct, any additional request for money was scoffed at. It was suspected that corporates would use the additional money for speculation; or that the corporates were inefficient in their resource-use and needed to be disciplined.

At the more micro level, banks too were suspected of not having the requisite skills to assess the borrowers funds requirements. Hence, the central bank took over this work, says a banker.

MPBF also became the basis of the consortium arrangement which had come into existence in 1972. Unwittingly, the two together paved the way for delays in credit sanctioning process. As Saifi describes it, the process of review for a financial year beginning April would start with the audited accounts of the corporate for the earlier year. These figures would, at the earliest, be available in the month of July. The lead bank would easily take two months to assess the funds requirement. The papers then would go to each member of the consortium, who will put them to their respective boards for approval. By the time this process is over, it is easily the month of December, when nine months of the financial year have already passed. It is a perfect system delivering yesterdays needs tomorrow, says Saifi.

So, in terms of time as also the quantum of credit released, corporates have a lot to complain about. They also find some support in the banking community. There is little doubt that the MPBF system restricted the flow of funds to the corporate sector, says Bandi Ram Prasad, chief economist at the Indian Banks Association. This in turn compelled corporates to look for alternative avenues of funds such as the inter corporate deposits market, with the associated high interest rates and the consequent increased cost of production.

While some bankers find that the thinking behind the concept of MPBF is irrelevant in the currently changing times, others feel that it is the administration of the scheme that created most of the problems. As one banker puts it, the means became the end somewhere down the line. Form filling and target fixing became all important. Since this was a game of numbers, perfect paper work at the corporate end became an end in itself. Bankers too began to urge corporates to improve their homework, so as to ensure that they received more credit.

Two decades are a long enough period for a system to undergo a review. And now that the Kannan committee has been appointed, corporates as well as bankers are hopeful that major modifications are not far off. Some are even visualising a complete scrapping of the system. What gives a boost to such expectations are the changes that the RBI has already introduced in this area. The Tandon committee norms, which were mandatory earlier, were made voluntary two years ago. Banks were granted the freedom to deploy their own norms instead. In addition, the government has also relaxed the consortium discipline last year, giving the banks and the corporates the leeway to have their own mutually agreed framework. This positive attitude of the authorities are deemed to be in tune with the overall liberalisation policy and according to some bankers, the days of the MPBF system are numbered.

A new era in credit?

And what happens if the MPBF and the consortium arrangements are scrapped altogether? Would not the banks require some system to evaluate creditworthiness of borrowers? One answer of course is to leave it to each bank. It is unfair to assume that banks have not learnt anything in the last twenty years. Actually, they have by now acquired enough expertise in the matter of credit evaluation, and should be able to carry on on their own, points out Prasad. Lending is getting risk determined in an increasing manner and banks are well equipped to evaluate risk, he adds. And according to Saifee, the problem with the existing system is that it paints every one with the same brush. This is hardly a practical way to deal with the dynamics of industry. It is therefore necessary that the lending bank should have the major voice in credit decision.

Freedom to banks to determine their own level of comfort with borrowers finds widespread support. The existing system stifled competition and made banks complacent, says Sukhthankar. In case each bank is left to itself in this matter, the overall efficiency will go up, benefiting every one around, he points out. And, as Prasad emphasises, it will give more freedom to banks in selecting their clients.

But there is also a voice of dissent. A few conservative bankers do believe that there is nothing wrong in the existing system of credit delivery. After all, credit is in shortage even now, and corporates have not given up the habit of abusing the system, is their refrain. There is no harm in having a uniform system of credit evaluation and delivery, says B M Bhide, deputy managing director and chief credit officer, State Bank of India.

Notwithstanding the opposite view point, if consortiums are given the go by, is there an alternative system to replace it? Syndication arrangement comes the closest, say bankers. Under such a system, a lead bank would deal with the corporate and sanction the working capital limits. It would then invite some other banks to participate in the deal. This would give more freedom to participating banks to move in and out of the group at will. This could happen either because a bank is not happy with the performance of the corporate or because it is facing liquidity shortage. And with cash credit system going out, this would become even easier because the loan component would be subject to negotiations every six months.

But greater freedom also entails more responsibility. If each bank is left to itself in dealing with a corporate borrower, it will have to evolve its own set of lending norms and criteria. This would perhaps be the most difficult task for banks. Until now, they had only to follow the RBI determined norms. And even when the mandatory nature of the RBI norms was removed two years ago, hardly any bank bothered to evolve its own set. The Tandon committee took one full year to do it. Since no bank had that kind of time nor the inclination, they preferred to adopt the same norms, with a few modifications.

Protecting banks interest was one of the primary objective for setting up the present system. Not many bankers are however, unduly worried about the risks banks will face in this new era. For one, nobody expects the RBI to give full freedom to banks in credit lending. They believe that some strings are bound to be incorporated in the new system. Confirming this belief, S S Tarapore, former deputy governor of the RBI says: Under the new system, exposure limits will be strengthened, says he. And others like Prasad of IBA believe that group lending norms will, in all probability, continue. Not that banks would terribly mind such strings in exchange for freedom. Financial covenants are fine. What bothers us are the arithmetic formulae that tell us to the last paisa, how much we should lend, says Sukthankar.

Now that major changes in the credit delivery system are on the card, banks can certainly look forward to more freedom in dealing with their customers. In a sense, the system may be going back to basics, as banks did have such freedom in the days before the Tandon and Chore norms. But this time around, freedom may come with associated restrictions. Accountability, which is already the latest worry among bankers, can only increase.