Working capital advances by commercial banks represent the most important source for financing current assets.
Forms of Bank Finance: Working capital advance is provided by commercial banks in three primary ways: (1) cash credits/overdrafts, (2) purchase / discount of bills. In addition to these direct forms, commercial banks help their customers in obtaining credit from other sources through the letter of credit arrangement.
Cash Credits/Overdrafts: Under a cash credit or overdraft arrangement, a pre-determined limit for borrowing is specified by the bank. The borrower can draw as often as required provided the out standings do not exceed the cash credit/overdraft limit. The borrower also enjoys the facility for repaying the amount, partially or fully, as and when he desires. Interest is charged only on the running balance, not on the limit sanctioned. A minimum charge may be payable irrespective of the level of borrowing for availing of this facility. This form of advance is highly attractive from the borrower’s point of view because while the borrower has the freedom of drawing the amount in installments as and when required, the interest is payable only on the amount actually outstanding.
Loans: These are advances of fixed amounts to the borrower. The borrower is charged with interest on the entire loan amount, irrespective of how much he draws. In this respect, this system differs markedly from the overdraft or cash credit arrangement wherein interests is payable only on the amount actually utilized. Loans are payable either on demand or in periodical installments. When payable on demand, loans are supported by a demand promissory note executed by the borrower. There is often a possibility of renewing the loan.
Purchase /Discount of bills: A bill arises out of a trade transaction. The seller of goods draws the bill on the purchaser. The bill may be either clean or documentary (a documentary bill is supported by a document of title to goods like a railway receipt or a bill of lading) and may be payable on demand or after usance period which does not exceed 90 days. On acceptance of the bill by the purchaser, the seller presents it to the bank for discount/ purchase. When the bank discounts/purchases the bill, it releases the funds to the seller. The bank presents the bill to the purchaser (acceptor of the bill) on the due date and gets its payment.
Letter of Credit: A letter of credit is an arrangement whereby a bank helps its customer to obtain credit from its (customer’s) suppliers. When a bank opens a letter of credit on favor of its customer for some specific purchases, the bank undertakes the responsibility to honor the obligation of its customer, should the customer fail to do so.
Sanction and Terms mad conditions:
Once the application is duly processed, it is put up for sanction to the appropriate authority. The sanctioning powers of various officials like Branch Manager, Regional Manger, General Manager, etc., are defined by virtue of the position they occupy.
If the sanction is given by the appropriate authority, along with the sanction of advance the bank specified the terms and conditions applicable to the advance. These usually cover the following: (1) the amount of loan or the maximum limit of the advance, (2) the nature of the advance, (3) the period for which the advance will be valid, (4) the rate of interest applicable to the advance, (5) the primary security to be charged, (6) the insurance of the security, (7) the details of the collateral security, if any, to be provided, (8) the margin to be maintained, and (9) other restrictions or obligations on the part of the borrower. It is a common banking practice to incorporate important terms and conditions on a stamped security document to be executed by the borrower. This helps the bank to career the required charge on the security offered and also obligates the borrower to observe the stipulated terms and conditions.