Tandon Committe Report

http://www.banknetindia.com/banking/metlend.htm
Methods of lending

Like many other activities of the banks, method and quantum of short-term finance that can
be granted to a corporate was mandated by the Reserve Bank of India till 1994. This control
was exercised on the lines suggested by the recommendations of a study group headed by Shri
Prakash Tandon.

The study group headed by Shri Prakash Tandon, the then Chairman of Punjab National Bank,
was constituted by the RBI in July 1974 with eminent personalities drawn from leading banks,
financial institutions and a wide cross-section of the Industry with a view to study the entire
gamut of Bank's finance for working capital and suggest ways for optimum utilisation of Bank
credit. This was the first elaborate attempt by the central bank to organise the Bank credit.
The report of this group is widely known as Tandon Committee report. Most banks in India
even today continue to look at the needs of the corporates in the light of methodology
recommended by the Group.

As per the recommendations of Tandon Committee, the corporates should be discouraged from
accumulating too much of stocks of current assets and should move towards very lean
inventories and receivable levels. The committee even suggested the maximum levels of Raw
Material, Stock-in-process and Finished Goods which a corporate operating in an industry
should be allowed to accumulate These levels were termed as inventory and receivable norms.
Depending on the size of credit required, the funding of these current assets (working capital
needs) of the corporates could be met by one of the following methods:

First Method of Lending:

Banks can work out the working capital gap, i.e. total current assets less current liabilities
other than bank borrowings (called Maximum Permissible Bank Finance or MPBF) and finance a
maximum of 75 per cent of the gap; the balance to come out of long-term funds, i.e., owned
funds and term borrowings. This approach was considered suitable only for very small
borrowers i.e. where the requirements of credit were less than Rs.10 lacs

Second Method of Lending:

Under this method, it was thought that the borrower should provide for a minimum of 25% of
total current assets out of long-term funds i.e., owned funds plus term borrowings. A certain
level of credit for purchases and other current liabilities will be available to fund the build up of
current assets and the bank will provide the balance (MPBF). Consequently, total current
liabilities inclusive of bank borrowings could not exceed 75% of current assets. RBI stipulated
that the working capital needs of all borrowers enjoying fund based credit facilities of more
than Rs. 10 lacs should be appraised (calculated) under this method.

Third Method of Lending: Under this method, the borrower's contribution from long term funds
will be to the extent of the entire CORE CURRENT ASSETS, which has been defined by the
Study Group as representing the absolute minimum level of raw materials, process stock,
finished goods and stores which are in the pipeline to ensure continuity of production and a
minimum of 25% of the balance current assets should be financed out of the long term funds
plus term borrowings.
(This method was not accepted for implementation and hence is of only academic interest).

As can be seen above, the basic foundation of all banks' appraisal of the needs of creditors is
the level of current assets. The classification of assets and balance sheet analysis, therefore,
assumes a lot of importance. RBI has mandated a certain way of analysing the balance sheets.
The requirements of this break-up of assets and liabilities differs slightly from that mandated
by the Company Law Board (CLB). The analysis of balance sheet in CMA data is said to give a
more detailed and accurate picture of the affairs of a corporate. The corporates are required by
all banks to analyse their balance sheet in this specific format called CMA data format and
submit to banks. While most qualified accountants working with the firms are aware of the
method of classification in this format, professional help is also available in the form of
Chartered Accountants, Financial Analysts for this analysis.

http://www.banknetindia.com/banking/domlend.htm
Domestic Lendings

Traditionally, bank finance to trade/industry has been considered as an important source of

finance. The bank as a purveyor of credit, plays an important role in the economy. The role of
the banker as a financier has undergone a sea change over the years.

What is the necessity for a borrower to approach the Bank? To understand this, one has to
understand the requirements of short-term finance for conducting the day to day business.
This type of finance is required to fund the current assets in the business. The current assets in
any business have two basic characteristics. These are:
(i) short life span and
(ii) swift transformation into other forms of current assets.

The short life span refers to the time required in the activities of purchase and storage of raw
material, conversion into finished products, sale and collection of receivables, which is further
converted into the form of cash.

The operating cycle of a firm, begins from the obtention of raw material (or payment of
advance for the same) and ends with conversion of receivables (or sometimes finished goods)
into cash. This can be represented as under:
O=R+W+F+D-C
O is the operating cycle
R is raw material storage period
W is the duration of work in process
F is finished goods storage period
D is debtors' collection period
C is creditors' payment period

Each stage is influenced by various factors. For example, storage of raw materials depends on
regular availability of raw materials, the lead time for procurement, the level of safety stock
required, possibility or perception of price fluctuations, economics of bulk purchase etc. The
length of work in process depends on the type of business, consistency in capacities at various
stages of production etc. The duration of finished goods depends on level of competition,
pattern of production and seasonality of demands. The duration of debtors, again depends on
competition, discounts offered and efficiency in collection.

The total investment in current assets represents generally the gross current assets. The
sources for meeting this normally are accruals, trade credit, working capital advance from
bank, long term sources and commercial papers, factoring and forfeiting.

All other sources notwithstanding bank finance is one important component for funding
working capital requirements.

Let us now see how the banks look at these requirements of the corporates and the type of
facilities offered by the Banks to finance the working capital needs.

This can be done under the following three heads:

METHODS OF LENDING

COMMITTEES

RECENT POSITION
Tandon Committee on Follow-up of Bank Credit

http://bankingindiaupdate.com/tandon.html

The group (headed by Sh. Prakash Tandon) was appointed in July 1974 which was to frame
guidelines for follow-up of bank credit and submitted its final report during 1975 and gave
following recommendations, applicable to borrowers availing fund based working capital limits
of Rs. 10 lac or more:

Norms for inventory and receivables

Norms for 15 major industries proposed by the committee now have more than 50
disintegrated industry groups. Normally the borrower would not be allowed deviations from
norms except in case of bunched receipt of raw material, power cuts, strikes, transport delays,
accumulation of finished goods due to non-availability of shipping space for exports, build up of
finished goods stocks due to failure on the part of purchasers. For those units which are not
covered by the norms, past trends to be made the basis of assessment of working capital.
(Discretion given to individual banks for deviations in norms)

Approach to lending

The committee suggested three methods of lending out of which RBI accepted two methods for
implementation. According to First Method, the borrower can be allowed maximum bank
finance upto 75% of the working capital gap (working capital gap denotes difference between
total current assets required and amount of finance available in the shape of current liabilities
other than short term bank borrowings). The balance 25% to be brought by the borrower as
surplus of long term funds over the long term outlay.

As per Second Method of lending, the contribution of the borrower has to be 25% of the total
current assets build-up instead of working capital gap. (Method of lending as per Vaz
Committee will now apply to borrowers availing working capital fund based limits of Rs. 100 lac
or more only)

Other major recommendations of the committee were:

No slip back in current ratio, normally.

Classification guidelines for Current assets and current liabilities.
Identification of excess borrowing.
Information system, which was modified by Chore Committee Recommendations.
Bifurcation of limits into loan and demand component.
Tarapore Committee on Capital Account Convertibility

http://bankingindiaupdate.com/convert.html

The Committee on Capital Account Convertibility headed by SS Tarapore, the former Deputy
Governor RBI submitted wide ranging recommendations. It has prescribed a time bound
programme phased between 1997-2000 at the end of which the rupee will be fully convertible.
The capital account convertibility and pre-conditions has to be an on going process. As per the
committee, the capital account convertibility means the freedom to convert local financial
assets into foreign financial assets and vice versa at market determined exchange rates. It
implies freedom to citizens to buy and sell foreign exchange and utilise it for defined purposes.

Committee has suggested certain pre-conditions in terms of:

(a) fiscal consolidation i.e. reduction in Central Govt.s gross fiscal deficit to GDP ratio from
budgeted 4.5% in 1997-98 to 4% in 1998-99 and 3.5% in 1999-2000 accompanied by
reduction in States deficit as also a reduction in the quasi-fiscal deficit),
(b) a mandated inflationary target i.e. the mandated rate of inflation for the three year period
should be an average of 3-5 % and there should be empowering of the RBI on the inflation
mandate approved by Parliament and
(c) strengthening of financial system i.e. complete deregulation of interest rates in 1997-98
without any formal control on interest rates, average effective CRR to be reduced from 9.3%
as on 31.03.97 to 8%, 6% and 3% during the aforesaid three years period. Similarly NPAs of
the banks should be reduced to 5% by 1999-2000.
In addition, the conduct of exchange rate policy, balance of payments, adequacy of foreign
exchange reserves are the macro level economic indicators that should be continuously
monitored.
The committee envisages many advantages of more open capital account which include the
availability of a larger capital stock to supplement domestic resources and thereby higher
growth, reduction in the cost of capital and improved access to international financial markets.
CAC allows the resident to hold an internationally diversified portfolio which reduces the
vulnerability of income streams and wealth to domestic real and financial stocks, lowers
funding costs for borrowers and creates prospects of higher yield for savers. Associated gains
would be dynamic gains from financial integration. Allocative efficiency improves as a result
and this can stimulate innovation and improve productivity. CAC provides the impetus for
domestic tax regimes to rationalise and converge into international tax structures. This
removes inducement for domestic agents towards evasion and capital flight.

Apprehension and concerns

(a) Pre-conditions too tough to achieve

(b) Difficult fiscal deficit target which will result in cut-down in infrastructure investment
(c) Autonomy for RBI requires political consensus.
(d) Three year time frame too short
(e) Drastic reduction in NPAs will result in write-off and will cause losses for banks.
(f) Concept of narrow banks is impractical and will lead to closure of weak banks.
(g) Checks and balances needed to prevent freedom from being misused.
(h) Interest rates too high and will attract hot money and lead to instability.

Pre-conditions:

(a) Gross fiscal deficit to GDP ratio has to come down from a budgeted 4.5% in 1997-98 to
3.5% in 1999-2000.
(b) A consolidated sinking fund has to be set up to meet govt.s debt repayment needs, to be
financed by increases in RBIs profit transfer to the Govt. and disinvestment proceeds.
(c) Transparent and globally comparable procedures for fiscal accounting.
(d) Inflation rate should remain between an average 3-5 for the 3 year period 1997-2000.
(e) Gross NPAs of the PSBs needs to be brought down from the present 13.7% to 5% by 2000.
At the same time, average effective CRR needs to be brought down from current 9.3% to 3%.
(f) RBI should have a monitoring exchange rate of plus minus 5% around a neutral real
effective exchange rate, RBI should be transparent about the changes in real effective
exchange rate (REER).
(g) External sector policies should be designed to increase current receipt to GDP ratio and
bring down the debt servicing ratio from 25% to 20%.
(h) Four indicators should be used for evaluating adequacy of foreign exchange reserves to
safeguard against any contingency. Plus, a minimum net foreign assets to currency ratio of
40% should be prescribed by law.
Narrow banks mean the banks that do not perform the full range of banking functions but
focus instead on a limited range of activities. The objective of such limitation is to limit their
activities so that the scope for losses is reduced.
Implications of CAC for the Indian Banking system: The Indian Banking system consists of an
array of banks with divergent resource base, functional coverage and clientele. The public
sector bans have been the mainstay of the banking system in India with a market share of
about 85% of total business. Foreign banks are basically concentrated in metro/urban areas
and their exposure to non-fund based / off-balance sheet items are relatively of higher
magnitude than the PSBs. In terms of operational efficiency and viability, the performance of
PSBs has been far from impressive. An important factor responsible for the low profitability of
banks in India is the relatively high intermediation cost which varies from around 2.88% of
total assets in PSBs compared with 2.5% of private sector banks.

Given the structure of liabilities and assets of banks in India, CAC throws a number of
challenges which banks have to cope with, as under:

(a) Convertibility exposes banks liabilities and assets to more price and exchange risks and
banks may have to build necessary expertise to manage these risks.
(b) With the removal of capital controls, banks can supplement their domestic deposit base
with borrowings from off-shore markets. The volatility in foreign money and capital markets
could be easily transmitted to Indian banks balance sheets, especially so in the case of weak
and fragile banks, and could prove contagious. To avoid the risks associated with the
transmission of volatility of interest rates or exchange rates, adequate asset-liability
management systems by banks should be put in place. Besides, technology upgradation in
banks should be undertaken to help build strong risk management systems and management
information systems and to pave the way for an efficient payment and settlement mechanism.
(c) Fluctuations in interest rates are likely to affect the cost of borrowings for emerging
markets and alter the relative attractiveness of investing in these markets. Real exchange rate
volatility may cause currency and maturity mismatches, creating large losses for bank
borrowers.To curb the incipient insolvency leading ultimately to banking crises, a system of
vigilant and alert internal control system as well as a comprehensive supervisory system
should be evolved.
(d) A direct fall-out of CAC will be increasing pressure on the margins of banks arising partly
out of greater competition and partly due to the disintermediation process with strong
domestic corporate borrowers accessing world markets directly. The resultant pressure on the
return on assets of the PSBs is likely to make the banking system vulnerable.

CONVERTIBILITY

A currency is considered to be fully convertible if its holder can convert at any time, into gold
or any other generally acceptable foreign currency at a predetermined fixed rate, without any
restriction from the monetary authority. In such a situation, the currency is convertible both
for affecting payment against the current transactions and capital transactions and the
monetary authority fixes buying and selling prices for gold and other generally acceptable
foreign currencies.
Full convertibility on current accounts was introduced by RBI on 19.08.94, it had taken steps
like making LERMS effective from 1.3.92 and accepting during Aug 1994, the IMF Article VIII
which makes it mandatory on a member to have no inward or outward restrictions on current
account and trade related transactions.
As regards the capital account, it is a complex issue, the details of which are given as under: