284 Corporate Finance
Bank Guarantee
There is no standard formula for the assessment of bank guarantee limits. The details pertaining to the na-
ture of the guarantee, purpose, particulars of the contract, period for which the bank guarantee is sought and
the amount of guarantee, are to be obtained. This information, along with the view on creditworthiness
of the borrower and the relationship with the bank, would comprise the major inputs towards deciding the
sanction of limits required by the borrower.
Margins
The bank, in its assessment of working capital requirement of the borrower, stipulates limits up to which
it would extend finance against each component of working capital. This is done after the assessment of
levels of raw material, stock-in-process, finished goods and bills receivable to be held at any one point
by the borrower to reach the desired production. Banks thus stipulate margins, which the borrower should
bear as its contribution to finance working capital. The bank’s objective for demanding margin from
the borrower:
- Ensure a degree of stake of the borrower in his own enterprise.
- A security measure to ensure commitment of borrower in times of adversity.
- Hedge against price level changes in the event of distress sale to recover advance.
Margins applied by banks vary but the range of margins on different kinds of working capital assets is
usually 10 percent to 40 percent. They basically convey the extent of marketability of the particular asset in
the event of distress sale.
Banking Arrangement
The assessed working capital is made available to the borrower under the following arrangements:
Consortium Banking Arrangement
RBI, till 1997, made it obligatory for availing working capital facilities beyond a threshold limit (Rs 50 crore
in 1997), through the consortium arrangement. The objective of the arrangement was to jointly meet the
financial requirements of big projects by banks and also share the risks involved.
While the consortium arrangement is no longer obligatory, some borrowers (especially large ones) continue
to avail working capital finance under this arrangement. The major features of this arrangement are as follows:
- Bank with maximum share of the working capital limits usually takes the role of ‘lead bank’.
- Lead bank, independently or in consultation with other banks, appraises the working capital requirements
of the company. - Banks at the ‘consortium meeting’ agree on ratio of sharing the assessed limits.
- Lead bank undertakes the joint documentation on behalf of all member banks.
- Lead bank organizes collection and dissemination of information regarding conduct of account
by borrower.