Processing and Operation of different modes of working capital finance: OD, CC (Pledge & Hypothecation), LTR, LIM, FDR, WDB, ICB Unit certificate, Shares, JBP etc.

Sk. Nazibul IslamFaculty Member, BIBM

OverdraftOverdraft (SOD) is an arrangement between banker and his customer by which the latter is allowed to withdraw over and above his credit balance in the current account up to an agreed limit.This is only a temporary accommodation usually granted against securities. The borrower is permitted to draw and repay any number of times, provided the total amount overdrawn does not exceed the agreed limit.The interest/profit is charged only for the amount drawn and not for the whole amount sanctioned.

FDRCustomers sometimes require advances against their fixed deposit receipts with the bank maturing at a future date.

Procedure:1. Advance should, as a rule, be granted to the person in whose name the deposit stands. If the deposit is in two or more names, a letter of authority should be obtained from all the depositors concerned. They may jointly request the bank to grant an advance to one or more of them according to their own convenience.

2. The deposit receipt should be discharged by the depositor (or all of them if they are more than one) on an appropriate revenue stamp. The signatures must tally with that on the banks record. Whether the receipt is payable jointly or to either or survivor discharge by all the depositors must be obtained.

3. The discharged receipt must be surrendered to the bank along with a letter signed by the depositor/s authorizing the bank to appropriate the proceeds of the receipt on due date towards the repayment of the advance.

4. The banks lien should be prominently noted in the fixed deposit register and ledger, and also on the face of the receipt under the signature of an authorized bank official.5. No advance should ordinarily be granted against a deposit standing in the name of a minor. Some banks make an exception in special cases but obtain a declaration from the guardian that the money belongs to him but has been kept in the minors name as a matter of convenience. The declaration should further mention that the minor is alive and the amount of the advance will be utilized for the benefit of the minor.

6. The procedure followed by a branch of a bank in granting an advance against a deposit receipt of another branch is the same. But as a further precaution, the lending branch should ascertain that no lien is already noted against the deposit receipt at the issuing branch. The branch granting the advance should also get the discharge on the deposit receipt duly verified by he issuing branch before lending against the receipt.

The lending branch should, after granting the advance, intimate the branch which issued the deposit receipt to note and confirm its (lending branchs) lien. A letter should be taken from the borrower addressed to the issuing branch to remit the proceeds to the lending branch on maturity.

Before entertaining an advance against a deposit receipt issued by another branch of the bank, the depositor must be properly identified.

7. Margin and rate of interest as per the PPG of the respective bank.

8. Confirmation of debit balance is obtained on an appropriate revenue stamp every year/half year according to the practice of the bank.

9. Usually advances against deposit receipts are automatically adjusted on maturity from the proceeds of the deposit receipts. If, however, repayment is made before due date, the deposit receipt is returned to the customer after cancellation of the discharge thereon. All notes of lien taken in the deposit register and ledger are also cancelled.

10. Some banks allow advances on the security of third party fixed deposit receipts of their own bank. In such a case, the fixed deposit receipt duly discharged by the person in whose name the deposit stands has to be tendered as security. Lien is registered in the banks books and on the deposit receipt. A letter of request is also taken signed by the party in whose name the deposit stands authorizing the bank to hold the receipt as security for the advance and to apply the proceeds of the deposit when due, towards repayment of the advance.

11. As a rule, no advance should be made against a fixed deposit receipt issued by another bank.

In the case of an advance against deposit receipt in the name of a limited company, the procedure is same except that a duly authenticated copy of the resolution of the directors to borrow against the receipts is to be kept on record.

A cash credit differs from an overdraft in one respect. A cash credit is used for long term by businessmen in doing regular business whereas overdraft is made occasionally and for short duration.Temporary OD: Banks, sometimes, grant unsecured overdraft for small amounts to customers having current account with them. Such customers may be government employees with fixed income or traders. TODs are permitted only where reliable source of funds are available to a borrower for repayment.

Loan against LIP/JBPProcedures:1.The policy stands in the name of the borrower.2. Conditional policies will not be considered for advance.3. Surrender value of the policy should be obtained from the insurance company. Normally, a three years old policy acquires surrender value.4. The stipulated margin, usually 10% to 15% should be maintained on the surrender value.

5. The amount of advance must not exceed the surrender value of the policy.6. The policy must be in force and premiums paid up to date. The last premium receipt must be kept on record by the bank. 7. Letter of authority regarding payment of premium by the borrower regularly.8. The insurance policy against which the advance allowed duly assigned in banks favour by the insured person, the assignment are registered with the company and an acknowledgement from the insurance company to that effect is to be obtained.

9. Particulars of the policy should be entered in the security register. 10. On repayment of the advance by the borrower, the policy should be reassigned to him and the reassignment registered in the company books.

Loan against SharesWhile preparing a list of approved shares, for lending purposes and in fixing margins there against, banks take into account the following points:1. Age of the company2. Reputation of the company and its directors.3. Marketability of the shares. To see whether the shares are quoted on the stock exchanges.4. Market value during recent years with special reference to stability of prices.

5. Companys present financial position and its dividend history during the last few years.6. Financial policy- prudent or otherwise as indicated by distribution of dividends and the provisions for reserves made in the past.7. Prospects of the industry in general and the company in particular.8. Intrinsic value of the share concerned.

9. Ensure shares are transferred in the name of the borrower or any third party and registration has been done in his/their names.10. Ensure a fresh set of transfer deeds signed by the borrower /holder of the shares, witnessed by some body that easily traceable and verified by the companies concerned obtained and retained with the branch along with the share certificates.11. An undertaking obtained from the borrower/share holder that any benefits as and when received by them shall be passed on to the bank for credit or as security against the advance.

Cash credit

Cash credit is a type of working capital facility and is generally sanctioned by banks to industrial, business and trading units.Such facilities are allowed against the security of stock/merchandise like raw materials, goods -in progress, finished goods, consumable stores/spares etc.Such facilities are allowed either in the form of pledge or hypothecation.

Cash credit is a running account where a regular limit is sanctioned by the banker against goods and it is meant for meeting day to day expenses of the business.The account is adjusted by the sale proceeds and the borrower again avails of it for buying the stock.The cash credit account is like a current account with a limit up to which he can withdraw from the bank.The moveable assets are mostly in the shape of produce and commodities and these advances are covered by either pledge or hypothecation.

Processing of cash credit:

The application should be for permissible purposes.Borrowers should apply in the prescribed application form along with requisite loan application fee in the base branch.Cash credit facilities generally should not be given to a borrower not having banking transactions with the bank for at least six months.The purpose should not be stock piling.The period of cash credit can not be more than 12 months if not renewed.Open pledge goods should be avoided as far as possible.

Assessment of cash credit be evaluated on the basis of:CapacityEfficiencyPast operating experience.Production cycleElements of costing for acquiring raw materials, packing materials, factory on-cost, cost of powers, wagesAdministrative costRepair and maintenance of plant and machineryCost of marketing of finished products.

Points to remember while assessing cash credit:

The purpose for consideration of a limit must be permissible one and relates to Banks portfolio.Status of the borrower as to individual, partnership, Company are to be verified in depth.Personal integrity and credit worthiness of the borrower are extremely important, investigation is to be made by the RM/Manager as to whether the borrower is in debt with other banks/DFIs and whether there exists any default.Management and managerial competency are to be examined.Availability of raw materials to feed the production units for finished products.

Marketability of finished goods prompt turnover of stocks need be ensured to avoid risk of stock-piling, deterioration in the quality of produce, price reduction because of out of season sales.In-depth study on the financial position of the borrower applicant and capability for putting up participation/margin.Along with credit need assessment exercise, earning forecast, cash flow of the concern should be made so as to facilitate understanding debt-servicing ability.

Operating cycle:

The cash credit requirement of a concern is basically influenced by the nature of its business. The size of the business also has an important impact on its cash credit needs.While assessing cash credit need of a firm, the cycle of production as to number of days should be worked out.The operating cycle differs product to product.While assessing operating cycle, the number of days taken for acquiring raw materials, processing period , normal marketing period, sum total of these involved would constitute the operating cycle of an unit.

Margin:

Margin is the amount invested in the unit by the borrower himself and is asked for providing protection to bankers against a possible decline in value.The margin indicates the owners stake which very often governs his motivation, i.e., the zeal and interest with which he will work for the success of the unit.The banker should study this amount invested in relation to the borrowers total resources and also in relation to the total investment required in the unit.

Drawing power:

The drawing power of a limit is determined and fixed by the sanctioning authority up to which the borrower can draw.The drawing power should be calculated on the basis of pledged goods/stock, its valuation to be determined as per prescribed rate.Value will be determined on the basis of cost price and market price whichever is lower or any other prices as specified in the sanction letter.All release of limit must be channelized through drawing power register.

Pledge:

Section 172 of contract Act, 1872, defines a pledge as, the bailment of goods as security for payment of a debt or performance of a promise. From the above definition we observe that,i) a pledge occurs when goods are delivered for getting advance,ii) the goods pledged will be returned to the owner on repayment of the debt,iii) The goods serve as security for the debt.

The person who transfers the goods is called pledger and to whom it is transferred is called the pledgee.

Essentials of pledge:i) Delivery of goods: Delivery of goods is essential to complete a pledge. The delivery may be physical or symbolic. Physical delivery refers to physical transfer of goods from a pledger to the pledgee.Symbolic delivery requires no actual delivery of goods. But the possession of goods must be transferred to a pledgee. This may be done in any one of the ways:a) Delivery of the key of the warehouse in which the goods are stored.b) Delivery of the document of title to goods like bill of lading, Railway receipt, Warehouse warrant etc.c) Delivery of transferable warehouse warrant if the goods are kept in a public warehouse.

Precaution and general guidelines for pledgee

The godown must be in good condition and well constructed.

Godown must be effectively under Banks control.

Name board of the bank should be placed outside and inside of the godown.

Letter from the party for free accesses to the godown by bank personnel (Banks prescribed form) to be obtained.

Letter of disclaimer from the owner of godown is to be obtained if the godown is rented one.

6. Godown keeper and godown Chowkider are to be posted for receiving/ delivery and to ensure security of the goods.

7. Insurance of godown is to be done against all risks. Bank clause should be inserted.

8. Periodical Inspection by the authorised person of the bank (monthly/fortnightly) should be conducted.

9. Value of stocks must be determined at landed cost/invoice cost/market price whichever is lower as per Head office guideline (circulars).

10. Restricted item must not be accepted for pledge.

11. Deliveries and rotations of the stocks is to be made as per existing rules/procedures and terms and conditions contained in the sanction advice.

12. Market value of the goods pledged should be ascertained frequently in order to retain proper margin and allow withdrawals within drawing power. No upward revaluation without H.O. approval.

13. Pledged goods must be stocked properly to facilitate counting and checking.

14. Stock report card on each stock mentioning Nos. of bales, bags, cases etc. must be maintained.

15. In case of chemicals, drugs and medicines the date of expiry should be written and technical personnel must be employed to ensure its quality.

Accepting goods for pledge

Before accepting the goods for pledge, banker should be satisfied that proposed pledge goods contain the attributes of a good security.

In the matter of pledge banks may be cheated in one or more of the following manners:Pledge of spurious goods.Inflating the value of goods.Pledging the goods to more than one bank by using various entrances to the godowns.Fraudulent removal of goods with the connivance / due to the negligence of the banks staff.Pledge of goods belonging to a third party.

Attributes of a good Tangible security

MarketabilityEasy ascertainment of valueStability of valueStorabilityCost and labour of supervisionTransportabilityDurabilityAscertainment of titleEasy transfer of titleAbsence of contingent liability.11. Yield

Documents required for Pledge:

Demand promissory note. Agreement for pledge. Letter of continuity. Letter of arrangement Insurance policy covering all risks. Invoice of goods pledged (for imported goods). Latest stock report. Letter of disclaimerOther documents as per sanction letter.

Hypothecation:

The mortgage of movable property for securing loan is called Hypothecation. In other words, in case of hypothecation, a charge over movable properties like goods, raw materials, goods in progress is created.

Hypothecation is a charge against property for an amount of debt where neither ownership nor possession is passed to the creditor.

Though the borrower is in actual physical possession, the constructive possession remains with the Bank as per the deed of hypothecation. The borrower holds the possession not in his own right as the owner of the goods but as the agent of the Bank.

Features of Hypothecation:

Charge against a property for an amount of debt, Goods remains in the possession of the borrower,Borrower binds himself to give possession of the hypothecated goods to the Bank when called upon to do so. It is a floating charge. It is rather precarious.

Being only an equitable charge on movable property without possession, hypothecation facility is risky as clean advances. So it is granted only to parties of undoubted means with the highest integrity.

As goods under hypothecation remains in the possession of the borrower, extra care has to be exercised to see that the banks security is complete, adequate, safe and available at times when required. The banker should take the following precautions:

He must get stock statements periodically which contain a declaration by the borrower regarding his title to goods and correctness of the quality, quantity etc.

On the basis of the statement, he should inspect the stock and books of accounts of the borrower.

An undertaking from the debtor in writing, stating that he has not hypothecated the same goods to any other bank must be obtained.

iv. The banker should get a letter of hypothecation containing several clauses to protect his interest under all circumstances.

v. The banker should insist on the borrower insuring the goods against the risks. He should also get it endorsed and assigned in his favour.

vi. A board reading Stock Hypothecated to X Bank should be displayed in the place where the goods are stored.

In case of hypothecation bank may be cheated in the following ways:The borrower declare wrongly the capacity of the storing place.A false platform between the loose stocks is erected. The borrower creates a hollow square in the middle of stocks. Kind of fraud is generally committed by the borrowers who have, either built-up confidence with the bank or where the branch managers and other officials at the branch office have been got around by such borrowers.

Often the borrower with intention to cheat the bank resorts to dumping deteriorated/obsolete stocks in between the good stocks.The borrower mixes inferior quality liquids or water with good liquids and commits fraud. The device is generally adopted by parties dealing in chemicals or oils.The borrower stores stocks of different qualities in the godown and cheats the bank. In such cases borrowers store goods of qualities different from these declared in lodgment memos.

LTR/LIMLTR/LIM facilities are usually provided to the importers of merchandise. They may be corporate clients or any customer having good reputation in the related business and also based on banker customer relationship.For releasing the imported merchandise by the importer upon whom bank relies upon as to their repayment, documents of L/C are usually handed over to the clients against Trust receipt to the person or the institution concerned by executing this document with them. Normally this facilities are allowed to the importers of Government sectors or very dependable customers of the bank. In many cases the customers who avails of different loan facilities and are very good pay master, LTR facilities is also given to them.

LIM facilities are also provided to the intended importers. Usually in such cases the importers are to sign in a specific format of the bank where they promises to make payment of the imported goods value within a specified period of time and then the documents are released and goods are stored in the godown of the customer but the possetion of the goods remain under the custody of the bank. Importer sells their goods after having the delivery order issued by the bank authority by depositing the goods value in phase by phase.