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(^414) Financial Management
distribution of credit. Though industrial production increased at a slow pace but the call
on bank credit essentially for maintaining inventories even at the same level had gone
up with rising prices. If the growth process is resumed then the volume of inventory
required to maintain a higher level of production will increase and correspondingly the
demand for bank credit.
This state of affairs caused no problem in the year when the credit-deposit ratio in the
banking system was low and a sudden spurt in credit demand could easily be taken
care of and access to refinance from the Reserve Bank was easy. With control on
monetary expansion as part of anti-inflationary policy and a use in demand for fundsó
both from the old and the new claimantsóthe existing system of bank lending came
under considerable strain and the fundamental weakness of the system had been exposed.
Cash Credit System and Financial Indiscipline
The problem of potential imbalance in demand for and supply of funds is accentuated
by the manner in which banks extend credit under the present cash credit system of
lending, where a banker sanctions a maximum limit within which the borrower can
draw at his will. Under this procedure, the level of advances in a bank is determined not
by how much a banker can lend at a particular point of time by the borrowerís decision
to borrow at the time. When the borrowerís need for funds is low, the banker is faced
with the problem of large unutilised funds, and when the borrowerís need for funds, the
banker faces the problem of meeting the demand without notice. In fact, availability of
funds with the bank and the customers need do not always match.
The weakness of the cash credit system can be illustrated by taking the following
example of a borrowerís financial position;
Current Liabilities Current Assets
Bank borrowings Rs. 75,000 Inventory Rs. 1,00.000
Other current Rs. 10,000 Other current assets Rs. 10,000
liabilities Rs. 85,000 Rs.1,10,000
Let us assume that the entrepreneur has raised equity and term loans for covering
the cost of fixed assets as well as a portion of current assets. The bankerís function
is perceived as providing funds required for carrying the balance of the current
asset. Against the total inventory of Rs. 1,00,000, an advance of Rs. 75,000 is
sanctioned by way of cash credit. The advance is secured by a charge over
inventory with an appropriate marginóin this case 25%óthe margin representing
the borrowerís contribution to carry the current assets.
So long as there is security, which is declared in the periodical stock statements, the
borrower is permitted to draw up to the drawing limit, computed on the basis of the
value stocks less stipulated margin, or the sanctioned limit, whichever is lower.