Bank Finance in India
Most of the joint stock banks in India are modeled on the lines of the British banks, which are purely commercial bank. In other words, they provide only short-term finance to business firms.
They play an important role in financing the short-term requirements and they account for over four fifths of the total credit by all the financial institutions. However, in recent years commercial banks in India have ventured into new lines of activity of extending medium and long-term credits to industries. Thus, there is a visible change in the attitude of the commercial banks.
They provide loans and advances to village artisans and other weaker sections of the community. They are very liberal in advancing to educated unemployed to create self-employment opportunities. However, it should be noted that still 90% of the banks finance available to corporate sector today comprises of the working capital finance.
Here, we should also consider the practical difficulties of a banker. The lending capacity of the banker is limited by law as well as by financial considerations. In spite of these limitations, the banks share is by far the largest — at about 50% of the loaned fund of the industry.
Classification of Bank Advances
The Indian Banking Companies Act classifies the bank advances into two categories. They are-
- Secured Loans, and
- Unsecured Loans.
Secured loan means loans granted on the backing of some tangible security. Unsecured loan is one for which the banker has to rely upon the personal security of the borrower. They are also called as clean loans or clean advances since no formalities of pledge etc. are needed in this case. Unsecured advances are not popular in India.
Most of the bank advances are secured ones. Only a small portion of about 11% to 15% of the total bank advance is unsecured.
The bankers in India generally accept the following securities.
- Government and other trustee securities.
- Gold and Silver.
- Gold and Silver ornaments.
- Shares of Joint Stock Companies.
- Inventories and Merchandise.
- Real Estate.
- Miscellaneous Securities.
The manufacturers generally offer inventories like raw materials and finished goods as securities for bank advance. Similarly, dealers opt for providing merchandise and finished goods as securities to get bank finance, Industrial raw materials, minerals and ore, oil seeds, food articles like paddy etc., and tea, coffee, cashew nut and other similar durable agricultural commodities are also accepted as securities.
Advances are also granted against Warehouse Keeper’s Receipt or Certificate, Documents of Title to Goods etc.
Since a detailed study about the various forms of loans and advances is beyond the scope of our book we shall confine our discussion with a few elementary aspects of bank finance.
Forms of Bank Loans and Advances
Bank finance is usually provided in the following forms:
- Cash Credit.
- Discounting of Bills and other Commercial Papers etc.
1. Cash Credit
Cash credit is an arrangement by which a banker allows his customer to borrow money up to a certain limit against either a bond, promissory note of one or more sureties and or on the hypothecation of stock.
This is the most popular method of financing by commercial banks. The borrower should bring the account to credit at least once in a year. The interest will be charged for the amount actually utilized by the borrower and not for the amount sanctioned.
Under this arrangement, the banker allows his customer to overdraw his current account temporarily. The period of credit shall be generally one week to one month. This overdraft facility is provided only to overcome the occasional shortage of funds.
When a banker makes an advance in a lump sum, the whole of which is withdrawn in cash and is supposed to be repaid generally in one single installment, it is called a loan.
The borrower should pay interest on the whole amount. However, it is also allowed to repay the amount in installments. If so, the borrower should pay interest only on the reduced balance. Here the advance is kept as a separate loan account.
These are the traditional ways of providing advance to the customers by commercial banks. Besides, discounting of bills is also becoming popular in India.
4. Discounting of Bills
The most important form in which bankers give accommodation, without any collateral security is the discounting of clean bills. This form of financing is very popular in Western countries. Genuine trade bills are of much use to the traders, acceptors and also to the commercial banks. But the Bill Market has not developed sufficiently in India.
Other Methods of Bank Finance
The other methods of providing assistance are as follows:
1. Purchasing of shares and debentures issued by companies.
2. Providing medium and long-term loans.
3. Granting loans and advances on the collateral security of shares and debentures of the corporation.
4. Underwriting the issue of shares and debentures.
5. Provision of financial consultancy services.
Though commercial banks mainly provide short-term finance, the short-term facility provided by the banks is gradually being converted into medium finance by the renewal of the loan from time to time. Banks are also now providing long-term finance to deserving cases.
However, they have done very little in this direction. Certain efforts were made in the recent past to introduce industrial banking on the lines of German example in order to provide long-term finance to Indian Industries. However, the results are not satisfactory.
Merits of Bank Finance
It is advisable to get short-term accommodation from commercial banks because of the following advantages to the borrowing companies.
1. Timely Assistance
Banks assist the borrowing companies by providing timely assistance to meet the working capital requirements. A company can usually rely upon the bank for amounts of loan up to an agreed limit sanctioned by the bank as advance.
Bank assistant is highly flexible in nature. The accommodation can be easily getting extended and may be used when it is urgently needed.
Bank finance does not involve the kind of costs, which are to be incurred in the issue of new securities such as commission on underwriting, brokerage etc. The borrower has to pay the interest only. Thus, the cost of this type of borrowing is comparatively very cheap.
4. No Permanent Burden
The bank finance does not constitute a permanent burden on the financial resources of the company. The company should pay interest only on the amount actually utilized by it. Further, it can be repaid if it is no longer required.
5. No interference with Company Management
The commercial banks do not generally interfere with the management of the borrowing companies till the bank is assured of the repayment of the loan.
This is by far the greatest advantage of bank finance. The banker maintains utmost secrecy of the information furnished by the borrower.
Demerits of Bank Finance
Bank finance, though forms a viable source, is also subject to certain inherent defects. The main defects of this finance are the following:
1. Burden of Mortgage
The inventories like raw materials, finished goods are to be kept in the bank’s sealed godowns and can be used only with the permission of the bank or after paying the amount of loan.
2. Duration of Assistance
Bank generally provides only short-term assistance for periods of less than a year and its renewal or extension is quite uncertain. Hence, it is not a totally reliable assistance.
3. Terms of Advances
Bankers generally require a margin of 30% to 50%. In addition, they press the borrowing companies to have the goods in their godowns. The terms are generally too harsh. It indirectly increases the cost of borrowing and of the production.
In spite of these limitations, business concerns find it a more convenient and reliable source to get short-term accommodation. After nationalization of all major banks, small entrepreneurs are also benefited increasingly by bank finance.