Need of the Hour: Innovating the Cash Credit System

 

 

It has been disappointing to experience many borrowers defaulting in servicing their working capital (WC) dues in the current economic slowdown World over. But when it is economic slowdown then automatically the need for WC should get reduced since the need for Cash Credit (CC)/WC facility ultimately depends on the business volumes. In a downturn, volumes cannot be predicted to be high! So why is there need for more credit or non availability of the same resulting in default on the name of cash crunch? Many people give the argument that the slowdown is resulting into increased receivable period due to competition, inventory is not available, many of the receivables are turning out to be junk etc. Ok, agreed. But then it should be a one-time exercise when corporate/borrower analyzes its receivable pool and segregates the junk in a separate pool. The lender can come forward and analyze the pool to decide on the liquidity required as a one-time measure. But generally  corporates do not come forward for this, they keep on hiding the bad under the good, keep on extending the goods on credit to customers and ultimately putting the lenders funds on risk. Such practices lend the Corporate into undesirable Corporate Debt Restructuring (CDR).

 

Well, this is a fact and we have to live with this until we decide to think differently. If we think for a second holistically, it can be noted that over the years the war strategies have changed. The game strategies have changed. The communication technology has revolutionalized. Everything has been innovating, and not only innovating but also flourishing using the technology. In this scene, why are we sticking to same years old Cash Credit system of lending? Don’t we want to innovate and improve the lending system? Are we not open to reward the borrowers who practice good corporate governance and are open to justifiable use of the borrowed funds, leaving no room for misutilization?

In case of heritage Cash Credit (CC) style of lending, the total CC limit is decided based on the MPBF analysis. The actual CC limit is released when borrower submits the monthly Stock Statement, carrying brief details of inventory and receivables based on which drawing power is calculated by the bank and CC is disbursed to the borrower to finance its funds trapped in creating those inventory and receivables.

We need to give a thought that in an innovative World what is the need of Stock Statement when with the help of technology, banks can directly fund the suppliers and debtors of borrower?

The issue with the traditional CC operations is that the lender has to depend on the monthly Stock and Receivable statement prepared by the borrower. The only check on the authenticity of this statement by a third party is the annual stock audit which is also not very effective if the borrower has multiple factories at various locations. This system encourages many borrowers to miss use the CC facility. The lender does not have strong mechanism to check whether actually there is sufficient stock or the receivables as mentioned in the monthly Stock Statement. This lacuna needs to be corrected. But how?

There are some existing lending solutions available one of which is banks stop funding the receivables. The receivable may be made to be funded only by factoring agencies (which are mostly floated and funded by banks) as these agencies are fully focused on receivables funding so have hands on due diligence excellence of the debtors of corporate.

For inventory funding, banks may also rigorously pursue vendor financing/bills discounting under which the vendors are directly funded by banks.

Apart for meeting these major heads of funding the current asses, the other small requirement can be funded by long term working capital term loans which come with a fixed tenor and repayment schedule.

The out of box and revolutionary things to make it possible would be innovation to connect the inventory and stock management software of the borrower with the controls of the banks. This will provide a system under which the borrower and its suppliers both are connected with the lender and as soon as the sale of material by supplier/vendor to the corporate happens, the cost can automatically be debited to the borrower’s Cash Credit Account and credited to supplier’s Account subject to online approval of the transaction by the borrower. Such systems would bring more transparency in CC utilization and lenders would be also able to analyze the stocks and receivable position on real time basis.

I would like readers to contribute on this to bring more thoughts on improving the working capital lending system.