Unsecured loans are typically provided by the promoters to fill the gap between the promoters’ contribution required by financial institutions and the equity capital subscribed by the promoters. These loans are subsidiary to the institutional loans. The rate of interest chargeable on these loans is less than the rate of interests on the institutional loans. Finally these loans cannot be taken back without the prior approval of financial institutions.
Deposits from public, referred to as public deposits, represent unsecured borrowing of one to three years (five years in the case of non banking finance companies) duration. Many existing companies prefer to raise public deposits instead of term loans from financial institutions because restrictive covenants do not accompany public deposit. However, it may not be possible for a new company to raise public deposits. Further, it may be difficult for it to repay public deposits within three years.
Special Schemes of institutions:
Financial institutions have designed special schemes to serve the varied needs of industry. The important ones are:
Bill Rediscounting Scheme: Operated by the IDBI, the bill rediscounting scheme is meant to promote the sale of indigenous machinery on deferred payment basis. Under this scheme, the seller realizes the sale proceeds by discounting the bills or promissory notes accepted by the buyer with a Commercial Bank which in turn rediscounts them with the IDBI. This scheme is meant primarily for balancing equipments and machinery required for expansion, modernization ad replacement schemes.
Suppliers’ line of Credit: Administered by the ICICI the Suppliers Line of credit is somewhat similar to the IDBI’s Bill Rediscounting Scheme. Under this arrangement, ICICI directly pays to the machinery manufacturer against usance bills duly accepted or guaranteed by the bank of the purchaser.
Subsidies and Sales Tax Deferments and Exemptions:
Governments and development agencies may provide subsidies for certain kinds of projects. Of late, however, these have decreased in importance. Previously the central government as well as the state governments provided subsidies to industrial units located in backward areas. The central subsidy has been discontinued but the state subsidies continue. The State subsidies vary between 5 percent to 25 per- cent of the fixed capital investment in the project, subject to a ceiling varying between Rs 0.5 million and Rs 2.5 million depending on the location.
To attract industries, the states provide incentives, inter alia, in the form of sales tax deferments and sales tax exemptions.
Under the sales tax deferment scheme, the payment of sales tax on the sale of finished gods may be deferred for a period ranging between five to twelve years. Essentially it implies that the project gets an interest free loan, represented by the quantum of sales tax deferred, during the deferment period.
Under the sales tax exemption scheme, some rates exempt the payment of sales tax applicable on purchase of raw materials, consumables, packing and processing materials from within the state which are used for manufacturing purposes. The period of exemption ranges from three to none years depending upon the state and the specific location of the project within the state.
Short term Loans from Financial institutions:
Financial institutions provide short term loans to companies with good track record. To be eligible for such a loan, a company must satisfy certain conditions relating to divided track record, debt equity ratio, current ratio, and interests coverage ratio.
Short term loans provided by financial institutions have the following features:
1. They are totally unsecured and are given to the strength of a demand promissory note.
2. The loan is given for a period of one year and can be renewed for two consecutive years, provided the original eligibility criteria are satisfied.