Bank Guarantee Must Be Part Of Credit Limit

The debate over the draft companies bill has focused on the need for greater transparency

Bank guarantees should be part of the credit given to corporates and the regulatory norms for guarantees should be brought into the ambit of the new companies bill, according to Industrial Development Bank of India chairman & managing director S H Khan.

Speaking at a seminar on the draft companies bill organised by the Federation of Indian Chambers of Commerce & Industry in Mumbai yesterday, Khan said the credit scenario would be more disciplined if the guarantees were brought under the purview of the Companies Act since the amount of guarantees raised would come under stringent norms. Besides, the guarantees would form a component of the total credit of the borrower like any other loan or debt instrument. This would restrict the companies from issuing random guarantees.Corporate guarantees or bank guarantees given for corporates should be treated as any other loan or borrowing. Further, a redemption corpus should be created along with formation of the guarantee, Khan said.

 

On the importance of redemption reserve, Khan said: The redemption reserve needs to be created as it is a contingent liability. The moment a guarantee is given for raising resources or even in case of a collateral security, there is always a possibility of it being invoked.

Hence, guarantees should be treated at par with any other loan and advance, Khan said. Further, some regulation needs to be framed for the amount for which guarantees are given. However, modalities of the redemption reserve needs to be worked out, he added.

In case bank guarantees form part of the debt given by institutions, it will tighten the debt equity norms. This is so as the actual debt funds that could be availed of will come down drastically.

According to Khan, the guarantees given by corporates to affiliate companies have created a lot of problems for IDBI since for every guarantee given the risk on IDBIs funds lent to the corporate goes up. In fact, off late a lot of guarantees given by corporates to their affiliates for raising intercorporate deposits has been invoked.

This has resulted in the corporate having to pay up, leading to cash flow problems. Consequently, corporates have not been able to repay the IDBI loans, due to which non-performing assets have been created. But the proposal that a contingent fund be formed for guarantees is likely to be met with objections from the corporate sector.