How a bank should take entry into a company by extending working capital finance?

Working Capital lending is more of an Art than Science. Unlike Term Loans which have a fixed tenor and repayment schedule, working capital fund based loans are considered to practically perennial. A new bank entering a company first time through working capital finance needs to have a cautious approach despite knowing the external credit rating of the borrower. This is important because external credit rating gives a transparent picture of the borrower but one needs to also remember that it is the lender who is taking a risk on the borrower not the rating company. After the Lehman and mortgage finance collapse in USA, the world has now practically learnt how much one should rely on credit ratings, at what point the reliance on credit rating needs to be stopped and self judgement based on own analysis and experience needs to be factored in because in case of default, it is the lender who is going to be financially affected. Therefore, it is of utmost importance for a banker to really understand the DNA of the borrower. This does not happen overnight by simply analyzing the financials of the borrower or by going through the credit rating report. We should accept that the financial statements are the Fine Art produced by the accounts.

The working capital entry needs to be guided by basic principle of put every step forward slowly and testing the ground. Interact more and more with the borrower’s teams, promoters, senior management and learn more and more about the ethics of the promoters, professionalism of the management, profit margins in the industry to develop your basic instinct about the borrower. These interactions gives a lot of insight about the borrower which can not be found in the financial statements or in credit rating reports. A learned working capital banker would like himself or his team to interact at some level of borrower’s teams at least once in day or two.

To start with, the working capital entry into a company might be only through non fund based limits or through sales bill discounting/purchased of good clients of the borrower.

Based on all these learning over a time period, bank can add or reduce or change the composition of fund based and non fund based limits sanctioned to the borrower. Depending on the collaterals and their real value, slowly and over the years bank can strengthen its security and move forward for enhancement in exposure.