A trader uses a calculator (Photographer: Sanjit Das/Bloomberg)

New RBI Rules May Change The Way Banks Look At Working Capital

The Reserve Bank of India’s decision to tighten rules for working capital facilities offered by banks could mean tougher days for Indian corporates.

Banks will be more judicious in sanctioning working capital limits to firms and would most likely provide these facilities at a higher cost. That's according to bankers and analysts who spoke to BloombergQuint.

The change in the landscape for working capital facilities stems from guidelines released by the Reserve Bank of India on Wednesday.

According to these guidelines:

  • Borrowers with a working capital limit of Rs 150 crore and above will need avail of the first 40 percent of their limit in the form of a "working capital demand loan". This provision comes into effect from April 1, 2019. From July 1, the loan component will go up to 60 percent.
  • Additionally, banks will need to set aside capital for the unused portion of a working capital facility.
The rules are intended to enhance credit discipline among the larger borrowers enjoying working capital facility from the banking system, said the RBI in its circular.

How Will The Loan Component Work?

Until now, a firm which held a certain cash credit limit with a bank would withdraw money from that account whenever they wanted and repay it whenever they wanted. A rate of interest agreed upon between the lender and the borrower would be charged accordingly.

Cash credit is the most popular form of working capital and essentially functions like an overdraft account.

While having the ability to avail of this cash credit whenever the need arose was useful for firms, it created some volatility in liquidity management for banks, explained a senior banker.

Borrowers often enjoy substantial (working capital) limits but hardly use them, said PK Gupta, managing director of the State Bank of India. However, banks intermittently see a surge in working capital demand, making it hard to manage liquidity, Gupta said in an interview with BloombergQuint. The new rules will limit these issues, he added.

Under the new rules, if ‘Company A’ wanted to avail of its working capital limit, it will need to take the first 40 percent of this limit as a working capital demand loan. The tenure of this loan can be between 7 days to 1 year. What this does it give the bank some certainty on when a firm would avail of the funds and when they would be repaid.

While the new rules help banks, they put the onus on firms to manage their cash needs better.

Cash credit is usually extended for one year but is currently used a perpetual instrument by rolling it over. Having to treat the borrowing as a loan will require borrowers to plan cash flow better. 
Aditya Acharekar, Care Ratings. 

In particular, the move may be onerous for borrowers with weaker cash flows, added Soumyajit Niyogi, associate director at India Ratings. "Cash management will have to become more sophisticated, especially if they belong to industries such as engineering, procurement, and construction, which have more volatile cash flow cycles.”

Lower, Costlier Cash Credit Limits?

The new rules could also mean lower cash credit limits which come with a cost attached.

Until now, corporations, particularly large firms which have banking relationships with a certain lender, would get access to generous cash credit limits.

Since banks had to set aside no capital against these sanctioned, but often unused limits, there was no reluctance on the part of lenders to give these limits out. This changes now with the RBI attaching a "risk weight" to the unused limits.

Banks will now work with customers to get a clearer fix on the extent of working capital limits required by the firm, explained Brijesh Mehra, who heads corporate banking at RBL Bank. Earlier banks were willing to give firms a large buffer via cash credit but lenders may now be willing to sanction just a little more than what they think is the genuine need, Mehra said. He added that this will also ensure better end-use of funds.

The cash credit limits may also come with a cost attached.

Considering that banks will now  need to set aside capital for the unutilised credit facility extended, they could very well charge borrowers on the same.
Brijesh Mehra, Head - Corporate, Institutional & Transactional Banking, RBL Bank

The Silver Lining

If the new environment is managed well by corporates, it could eventually lead to a lower cost of borrowing.

With part of the working capital coming in the form of a demand loan, borrowers may benefit from lower rates on that part of the facility, said Anu Aggarwal, who co-heads the conglomerates and corporates group at Kotak Mahindra Bank. Broadly, the interest rate levied on cash credit tends to be higher for tenors of up to one year in comparison with the interest rate on a demand loan, she explained.

To be sure, interest rates levied are bank-specific and will differ depending on the bank and the borrower. Mehra of RBL agreed with this and said rates are likely to be marginally lower or stable on the demand loan portion of the working capital facility.