Alternatives To Mpbf

These are just three of several big banks that are busy identifying options, now that the credit policy guidelines no longer makes it compulsory for them to follow the system of maximum permissible bank finance (MPBF). However, most of them expect to take a couple of months to put alternatives in place.

To begin with, we will follow systems that are essentially

flexible and do not involve

too much paper work for the

borrowers, says Kavita Venugopal, head of corporate banking at the ANZ Grindlays Bank. Simplicity and flexibility are two characters the bank will look for, she adds.

Another feature of the process will be that unlike earlier, companies will have some freedom in selecting the method. Some banks are already talking to their large borrowers about the methods they would like to follow in working capital assessment and disbursement.

 

At Bank of Baroda, for example, companies will have to decide the method they would like to follow. Once they decide on this, we will strictly

implement the method and would not allow for variations in projected figures, says Kannan. He points out, however, that he does not expect more than 20 per cent of the borrowers to choose a method other than the existing MPBF.

Budgeting cash

What are the alternatives that banks are looking at? People in charge of banks credit departments are closely looking at the cash budget method or its derivatives such as net operating cycles (see box).

Many bankers are in favour of adopting the earlier MPBF system without the rigidities. For small units, the turnover method is being mentioned, under which a percentage of turnover would be taken as the working capital requirement of a company. Although the RBI has suggested a figure of 20 per cent subject to a maximum of Rs 2 crore, banks have yet to work out figures acceptable to them. Expectations are that the RBI recommendations will be accepted.

All these methods would be directed towards evaluating the credit eligibility of corporates, says Waseem Saifi, senior manager, Standard Chartered Bank.

The cash budget system will look at the total cash inflows and outflows of a company, identify the gaps and decide on the working capital needs by looking at the peak requirements. This form of lending will essentially be lending against collateral such as securities.

The cash budget approach could be based on quarterly projections submitted by companies, which will be sensitised by banks, points out Venugopal.

A different milieu

Venugopal does not rule out syndication under this method. Banks may decide to opt for syndication after a certain level of lending. Even borrowers may prefer to go in for syndication in a falling interest rate environment since both borrowers and lenders can get the benefit of negotiable rates of interest.

Banks will now have to look at a companys total debt rather than the prevalent practice of looking merely at the current ratio (ratio of current assets to current

liabilities).

Companies now have more freedom to raise resources through a range of instruments such as commercial paper, loans, debentures, preference shares, etc. In some cases, these instruments are becoming interchangeable. From banks point of view, this blurs the difference between various instruments. Today, they are all financing options for banks, points out Venugopal. Hence, banks will now have to offer a full canvas of products including transaction banking.

This, however, does not mean that the current ratio will become irrelevant. Working capital loans must result in creation of current assets, says B M Bhide, deputy managing director and chief credit officer, State Bank of India. Though the new discipline will involve security- based lending, availability of security will not mean automatic availability of credit, he points out.

Adds Venugopal: the new freedom has enhanced the risk factor which would mean stringent methods of evaluation. Under the new arrangement, debt equity and other ratios such as interest cover and overall debt will all be taken into account when the contract is drawn up.

In a way, banks are already following this method for seasonal industries like sugar and tea. Peak and non-peak cash flows are identified, with banks financing the deficit to the maximum extent possible. However, industries like heavy machines, too, can be financed through this method, points out Venkateswaran. Since such industries involve large cash outflows for a short period, banks can finance them, he points out. The same logic can be extended to other industries.

The seamy side

The cash flow approach, however, involves certain problems. Banks will have to insist on detailed projections of cash inflows and outflows from borrowers. Not all borrowers are expected to be meticulous enough to prepare and submit such statements regularly.

Corporate borrowers will also require special skills for

this purpose, Venkateswaran points out.

At the same time, banks will also have to apply skills to evaluate these projections to make sure that they are realistic. They will have to ensure that borrowers are not exaggerating their demand for funds. That would mean examining every component of the projections more minutely than ever before.

A contentious issue in this context will be the monitoring of end use. The RBI has left this matter to the banks discretion. But most banks seem keen to monitor the end use of their funds. Venugopal insists that the end use will be strictly monitored.

At least one foreign bank seems to have taken the lead and finalised the cash flow approach for its top corporate borrowers. At ABN Amro Bank, proposals have been put up for the managements considerations.

The bank would, under these proposals, be willing to finance the total gap between current assets and current liabilities. This would be different from the earlier method under which banks were financing 75 per cent of the gap, the rest being contributed by the borrower.

Some banks are planning to allow companies to have the freedom to continue with the basic structure of MPBF without the rigidities. At Central Bank of India, the management is thinking of changing the definition of working capital and incorporating cash and guarantee margins (provided by the borrower as credit enhancement) within the concept. The Tandon and Chore committees had recommended that these be excluded while working out MPBF, much to the chagrin of industry.

MPBF re-incarnate

Central Bank of India is planning to have a modified MPBF for companies with working capital requirements of more than Rs 50 crore, if they are not able to get into cash budget discipline.

Other bankers do not rule out the modified MPBF system as one of the options. Since the MPBF system is well accepted all over, we may allow its use if a borrower prefers, says Venugopal. However, there will be a degree of flexibility in respect of classification of current assets and liabilities, margin requirements, etc. The evaluation will vary from industry to industry and for each company within the same industry, she adds.

A related issue here would be the monitoring system that banks will come to adopt. The RBI has said that the Quarterly Information System, followed until now, is no more mandatory. But banks are not happy with this idea.

Some form of an information system will be required for banks to follow the progress of companies, points out Saifi. In fact, a few bankers go one step further and say a better interaction between banks and corporate borrowers will be needed to track changing market conditions.

The risk minefield

How do banks perceive the risk in the new climate? Venkateswaran feels that the risk will definitely be higher under the new system. To pre-empt pitfalls, Central Bank has decided to set up a risk management group in the credit cell. The group will identify risk levels attached to different industries and corporate groups. It will be manned by experts in industry, the corporate sector, market research and analysis of economic trends. It will prepare risk profiles of industries and companies, and will be a part of decision-making on credit. What does the future look like for banks in the changed system? For one, the new environment will result in flexible systems and reduced paperwork. Also, competition may intensify for top-rated borrowers. Some banks are already looking at expanding their

business beyond the metros as also in the retail sector. Venkateswaran, for instance, says it will now be necessary for banks to focus on small branches in growing areas. This will expand the scope of operations for banks and enable them to meet competition.These branches will have to be provided with necessary infrastructure and skills to evaluate the clients needs.The doors for competition have been opened up and weaker links in the credit chain will have to go, he says. It will be of vital importance for banks to quickly internalise the new environment, he adds. In a deregulated era, bank boards will come to play a crucial roleconsidering the fact that credit decisions will be largely autonomous. As competition intensifies, small banks will have to fend for themselves without the protection offered by the consortium framework. As the central bank moves away from micro management will it nudge the banking sector towards mature autonomy ? Or, will it result in a free-for-all?

A contentious issue in this context will be the monitoring of end use of funds. The RBI has left this matter to the banks discretion.