Corporate Nursing : Health is Wealth

Imagine about a high-tech system : A medical clock like wrist watch on your arm, continuously analyzing your body parameters. Your doctor and his team is getting this data, and the moment there is something abnormal noted, the clock gives blip tone…, before you can think of something, you get call from your doctor on what you need to do in next one minute. In next 15-20 minutes, the medical team is in your cabin, the Helicopter is waiting for you on top of the building to take you to the Hospital ! You are out of danger. Wow ! and Why? Timely analysis and on time medical aid. Cost: Of course the service charges you pay to the doctors.

What encouraged you for this safety major? : Because you know you are important and only on-time service can avoid disasters.

I was thinking that working capital lenders are not less than the doctors team in above example since they have a hand on pulse rate of the borrower company. They have continuous watch on how the funds are being utilized by the borrower, and the moment borrower comes out with the need for temporary overdraft or shows signs in the form of delays in payments, increasing receivables, cheque dishonour, LC devolvement, etc. they get the first signs of something happening wrong with the borrower. But the million dollar question is: Whether the lenders should act like the doctors and immediately take the borrower for restructuring? And why not so? Isn’t it good to get healed? Isn’t it good to take timely action for the long term benefit of stakeholders?

First, I think restructuring would not be the right word. Because, restructuring would be something related to long term treatment, and we are talking of correcting something at the initial warning sign stage itself so that the need for restructuring can be avoided. Also in the current global economic scenario of slowdown, restructuring has not got a good reputation.

I think this area of business is still not explored in India because of the bad reputation attached with restructuring. As mentioned above, there is need to differentiate between Restructuring and Timely Corrective Action. So, it would be better to devise a suitable word for such treatment: may be ‘Corporate Nursing’.

Banks presently keep on analysing the data/accounts of the borrower, however, there is no approved plan of action in place about what to prescribe as soon borrower needs an emergency aid. As a result the borrower has to run from pillar to post for temporary overdrafts / short term loans to meet that unforeseen liquidity mismatches.

The lender and borrower need to create a plan like a reserve fund for meeting the challenges in difficult times of business like presently many of the companies are facing. It is very similar to your medical insurance where you pay a premium today in your good time for your bad time. So, why not devise an emergency plan to help the company when times are not good. No harm in paying premium today for that little but life saving service.

How this can be implemented in the real world? Here are some the possible ways which I can share:

- At the time of assessment only the lead bank, carries out the sensitivity analysis with worst case scenarios and discuss with the borrowers how the business in that situation would be managed.

- A plan of action, which could include availability of short term loans, creation of some reserve funds during good times, borrower keeping some unencumbered assets which can be offered to lenders as an additional security for the emergency support services.

- Promoters agreeing to provide their personal guarantees for emergency support from lenders.

- Borrower/Promoters agreeing to pledge shares for emergency support from lenders.

- A reserve liquid fund kept ready by promoters as their contribution before availing the emergency support.

- Borrower keeping a ready tie-up with another stronger company who will agree to lend corporate guarantee in emergency times (of course such corporate would be charging guarantee premium for this) etc.

- Insurance companies devising products of providing cover to lenders (for securing that additional exposure taken by lenders under the emergency support plan) when the agreed emergency support is facilitated on occurrence of event/parameters.

The moot point here is that the lenders find it difficult to lend an immediate help in difficult time of borrower because it is also difficult for them to pump more money into a company which is in trouble. However, if there is already an approved exigency plan and for which borrower has been paying insurance premium kind of service fee, then the lenders would have no difficulty in providing timely support.

A timely action taken by lenders and borrower would help in avoiding exigencies which could be jeopardizing the interest of all the stakeholders. Therefore, it is of utmost importance to ensure taking all the action to protect the health of the borrower in the interest of long term wealth protection.

I leave this thought here for all of you to nurture it further. Happy innovating.

Mamamiya – Bang – Bang : Outsourcing the loan pricing !!

 

Last Tuesday when I flipped my Economic Times my eyes went spiral when I read the news on SBI’s decision to link its lending rates to the external rating of the Corporates i.e. delinking it from SBI’s internal ratings. Under the existing system, the applicable rates could be advised firmly to the borrower only after approval of the proposal by SBI’s Credit Committee. This was creating hindrance for business at branch/appraisal level as the officers were not able to firmly advise the applicable interest rate to the borrower.

Under the new rule, SBI will advise the Mark-up applicable over its Base Rate for arriving at the applicable interest rate and this applicable Mark up to a borrower will be based on his external rating. So suppose two companies which are externally rated ‘BBB’ and ‘A’, and the applicable  Mark –ups for these ratings are say 3% and 2% respectively, then the applicable rate for these companies will be 12.80% p.a. and 11.80% p.a. based on the current SBI Base Rate of 9.80%.

Well, a great decision and can only be expected from great innovators. But being at the lending side and having experience of dealing with hundreds of Corporates in Indian environment, I got worried due to following nightmares if this new system is universally adopted by all the banks, take a look and enjoy:

(Note: I personally admire this bold and innovative decision in the field of finance. This will set a new paradigm in Indian lending scenario. My Hat’s-off. Writing this note just to share the fun part of our business. Hope you enjoy reading.)

1. Feeling like someone is making a great effort to produce something, and he is told that selling price of his product is outsourced to a third party!!

2. Worse: I am sitting in office, and get a call from client: Hey Kaps, sending my loan application to you. And, now we are not required to discuss the interest rate since for that banker is useless now. I will discuss that with my great external rating analyst who is meeting me on dinner tonight at Taj !!

3. All external rating agencies have suddenly increased their fee rates (and why they should not??).

4. Corporates expecting downward risk on their rating are sending bouquets to the external rating agency team.

5. The rating boys have overnight become the new blue eyed boys in the town and the poor banker who will process the entire application, weighting the entire proposal based on the risk and analysis, taking a lending call (with staff accountability on him for NPAs) and putting hard cash of the bank at a measured level of risks, is lost in dark nights.

6. In the small corner of my heart, I felt a little comfort of relief soothing myself that thank god it is decided to only outsource the loan pricing but still I am the Prince who will have a role in deciding the quantum of loan. Right then only, I got a call from the client telling me: Hey Kaps, I forgot to tell you that in the system it is felt that branches are not in position to tell the client how much loan will be sanctioned by the bank, therefore shortly the loan amount will be also linked to a Project’s/Proposal’s Report weighted by a reputed agencies OR even to the external rating. So, if I get ‘BBB’ rating for my project/proposal, you will take 50% exposure in the total loan requirement and rests by other lenders. But if I get ‘A’, you will take 80% exposure and leave the rests for other bank. At ‘AA’ or above rating, you will take entire 100% of the loan proposed.  

I asked him: What will I do then sitting in this office?

Client: Just chill, forward my project report to credit committee and take care of disbursement and monitoring. Rests I will manage with my Sweet-Heart Rating Agency!

7. Got a call from my internal rating analyst : Hey Kaps, my existence is at risk, any job for me!!

8. A recall of thoughts in my mind about the calls from rating agency guys for sharing information of the clients being rated by them, as they do not get success in extracting the critical information from the borrower, since they have no control over borrower except delaying/suspending the rating. The lender has many controls/levers which helps in extracting the information from the borrower. I was astounded thinking how rating guys will be getting that critical information before giving him the rating which will decide my loan pricing !!

9. The internal rating teams of the bank are not under any influence of the borrower since they are not exposed to the borrower. In most of the cases borrower will not even be able to know the details of the internal people who are engaged with his proposal. All information about the borrower/proposal is represented by the bank’s business/appraisal team. This system proves to be an added layer of safety. However, in case of external rating agency, its team is fully exposed to the borrower.

10. Theories supporting direct linkages between Cost of Funds of a bank and its Lending Rates become irrelevant. 

11. The fee to rating agency is directly paid by borrower. It’s a peculiar situation, in which rating agency is not participating in the loan as a lender, taking fee from my borrower, and deciding my loan pricing!! Specially of long term loans which are not traded on the exchange and which the bank cannot get rid off the moment bank decides like in case of Commercial Papers/other traded papers !

Yes, Abhimanyu can successfully exit from Chakravyuh : in the disguise of Working Capital Lender

 

Everyone knows the difficulty faced by the Vir Abhimanyu in epic Mahabharata. In his biggest war challenge what he was not knowing was how to exit from the Chakravyuh. Well, Abhimanyu was to follow that suit as the destiny had written that great end for him. What about the Working Capital (WC) lender? Lord Almighty has given a better choice to him if he is well planned and can dare to deviate from the tradition. I write this note for those who would like food for thought to innovate.

The exit strategy for a business is as important as entry, if not more.  Working capital funding is sort of short term finance. Generally the WC lines provided under the scheme are for one year period. It is experienced that with the growth of the borrower’s business, his requirement for WC assistance keeps on increasing. Depending on the performance/payment records, generally the lender supports the borrower by increasing the WC assistance. The critical point here is in contrast to that of term lending which comes  with fixed tenor, the WC facilities do not practically have fixed tenor or to say have only virtual tenor (i.e. one year valid line as per sanction terms). Lenders while assessing the Term Lending requirement clearly spell out the repayment period and thereby the drawing the exit route from the transaction i.e at the time of assessment only the lender knows when he will be able to come out/exit. But what about the WC assistance? Do the lenders draw the plan of exit from the relationship? On paper, Yes (since the line is stipulated as valid only for one year) but practically, No. This is because as long as the relationship is good, the lender keeps on being with the company (waiting for the bad time to come to deteriorate the asset quality !!).  So, do I mean to say that even if the account is good, lender should look for exit? I would suggest to consider the following points before developing views on this:

1. All industries see a cycle of performance from good times to bad and vice versa. When it would be bad time and lender would be requiring the borrower to give exit, won’t the borrower see the lender only as friend of good time? Therefore, it is the good time only when the lenders have to have a plan of exit (and it will be very easy for the borrower also to replace the lender). All private equity investment deals have this agreed plan between the parties. So, this is something which is acceptable to the financing world provided it is clearly spelled out as part of relationship terms at the beginning only.

2. By continuing with a relationship, over the years borrower leverages the relationship and succeeds in reducing lenders commissions/margins, and which is generally difficult for the lender to resist. Do you have any client who increases your commission after 4-5 years of fruitful relationship??

3. With the limited resources, lender’s activities would be concentrated only to limited no. of borrowers and lender would be missing the other new clients which may give better income.

4. By focusing his financial resources on existing borrowers lender misses the opportunity of diversifying risks.

5. Practically, if the lender try to exit at time bad time (i.e. borrower not performing well or other unfavourable reasons), it would not be possible due to stressed financial position of the borrower, and lender would most likely end up with a restructured account.

6. Borrower may not mind to know at the start only when the lender would like to exit or his exit plans. Such agreement in advance will make borrower ready to start the replacement exercise in advance.

7. If exit plans are known in advance, both the parties may not like to completely detach. Borrower may have other opportunities by way of relationship in some other group companies.

8.  In a way, the exit plan of WC lender would provide a right direction to the financing plans of the borrower as the borrower would timely take action and right approach for funding. Ascertaining the discontinuation of short term WC funds at a point of time, the borrower would be discouraged to resort to strategy of using the short term funds for long term funds.

9. Ways can be devised to recreate the relationship after a certain time, for example, the lender’s credit policy may allow to re-enter the WC relationship after a cooling period of certain years say 2-3 years.

10. What happens to your existing cross sale business penetration which you garnered over the years of relationship and which will collapse if you exit from the relationship? Suppose you have got all the cross sale business but after a certain point when the borrower requires you to increase the exposure, but your basic instinct/credit policy/assessment does not allow/suggests you to go for such enhancement, do you think that borrower will stick to the loyalty and continue to pass on that cross sale business to you?? He can’t because he will need to offer the same to other lenders in order to get them agree to increase their exposure. So, in the business of lending, advantage of cross sale cannot become the deciding factor to continue the relationship or not and therefore the loss of cross sale business should not be deterrent to exit strategy specially when it is planned at the time of entry only.

But other questions which are posed are, how or on what point one can decide to exit. What should be the parameters to decide exit point? Well, since we are looking from point of view of clarity about the exit at the time of entering into the relationship only, then the way could be a simple plan based on pre-decided period of relationship and overall profitability of account to be provided by the borrower over the planned period of relationship. The beginning of the relationship may enumerate the parameters based on which the exposure would be increased and when it would begin to recede, giving the plan a bell curve shape of lending during the relationship period. I think the best way to think would be to think like private equity investors who first thinks about the exit and overall return from the investment before making the investment !!

ECGC and Whole Turnover Policy Cover

 

 

When an Indian exporter gets orders from abroad for export of goods he faces the risk of non payment from the buyer.  In order to protect its losses due to default in payment by buyer, he can avail insurance from Export Credit Guarantee Corporation of India Ltd. (ECGC) an agency promoted by Government of India. Under this mechanism, as soon as the exporter firms up the export order, he can submit the details of the order along with the details of bank account of the buyer/importer to ECGC for obtaining the insurance. Suppose that the order is of USD 10,000 which is to be shipped in ten months with USD 1000 worth goods to be shipped per month. Say the exporter allows 90 days credit to the importer for payment.  If the first shipment is sent on April 01, second on May 01, third on June 01, by the time of fourth shipment there will be accrued credit of USD 3000 for April, May and June shipments.  When exporter decides to take insurance from ECGC, he can avail either for a shipment specific or a comprehensive buyer specific insurance. Suppose he opts for a buyer specific insurance. Based on the information submitted, ECGC through its information sources and network carries out the due diligence of the buyer and if satisfied with the credentials of the buyer, it will approve a limit for the buyer. Say for example, limit approved in the present example is USD 3000 i.e at any point of time pending payment obligation of the buyer should not be more than USD 3000. Therefore, before shipping the fourth consignment, the exporter has to ensure that the buyer has made the payment of earlier consignments in order to keep the credit within the stipulated limit of USD 3000 by ECGC.

In a Standard Shipments (Comprehensive Risks) Policy ECGC cover risks in respect of goods exported on short-term credit, i.e. credit not exceeding 180 days. This policy covers both commercial and political risks from the date of shipment. It is issued to exporters whose anticipated export turnover for the next 12 months is more than Rs.50 lacs. Under the Standard Policy, ECGC covers, from the date of shipment, the following risks: 

a. Commercial Risks viz.  Insolvency of the buyer, Failure of the buyer to make the payment due within a specified period, normally four months from the due date, Buyer's failure to accept the goods, subject to certain conditions.

 b. Political Risks viz. 1.  Imposition of restriction by the Government of the buyer's country or any Government action, which may block or delay the transfer of payment made by the buyer. 2.  War, civil war, revolution or civil disturbances in the buyer's country. New import restrictions or cancellation of a valid import license in the buyer's country. 3.  Interruption or diversion of voyage outside India resulting in payment of additional freight or insurance charges which cannot be recovered from the buyer.  4.  Any other cause of loss occurring outside India not normally insured by general insurers, and beyond the control of both the exporter and the buyer. 

There are various other insurance policies and Gurantee products by ECGC to meet the needs of the exporters and banks.

Banks in India provide pre-shipment (PC) and post-shipment (PSC) credit facilities to the exporter at the attractive terms. Banks also have the similar concerns as that of exporter regarding the non payment by the buyer. Non payment by the buyer would lead to default by the exporter in repayment of PC/PSC.  ECGC provides a comprehensive policy to the banks under which all the approved PC/PSC limits sanctioned by a bank to various clients are covered for insurance. This policy is called Whole-Turnover Policy. Under this policy all the PC/PSC limits sanctioned to the clients of the bank and status as ‘Standard’ under the RBI’s Prudential norms on Income Recognition, on a particular agreed cut-off date are covered under the policy.

Bank pays premium to ECGC on monthly basis in advance based on the average daily credit outstanding basis. Generally, the premium on PC limit is recovered from the exporter while the premium on PSC is absorbed by the bank. 

Under Whole Turnover PC policy, banks taking the cover for the first time, cover provided by ECGC is 75% up to certain Limit and 65% beyond the said Limit.  (For others it varies from 55% to 75% depending on claim premium ratio of the bank.). For Small Scale Exporters (SSE)/ Small Scale Industrial Units (SSI) with annual Export turnover not exceeding Rs. 50 Lakhs, 90% cover is provided.

Premium under Whole Turnover PC for a fresh cover is 8.5 paise (For others, varies from 6 to 9.5 paise per Rs. 100 p.m. depending on claim premium ratio) per Rs.100 per month on the average daily product basis.

Under Whole-Turnoover-PSC policy, cover provided by ECGC varies from 90% to 95% in respect of exporters who are Policyholders of ECGC and 50% to 75% for non-Policyholders, depending upon the claim premium ratio of the bank. For bills drawn on Associates of Policyholders coverage is 60% and of non-Policyholders it is 50%.

Premium charged by ECGC under Whole-Turnover – PSC Policy is 4.5 paise to 6.00 paise per Rs. 100 per month (p.m.) on the average daily product basis if advances against L/C bills are included for cover otherwise it is 5.5 paise to 7.00 paise depending upon the Claim Premium Ratio for the last 5 years.

Working Capital Lending : In the lanes of Asset Coverage

 

Under the Asset Backed Lending (ABS) environment, generally fund based and non fund working capital facilities are extended to corporates by lenders based on security of first pari passu charge on the currents assets (present & future) and second pari passu charge on the fixed assets  (present & future) of the borrower.  Although as a Working Capital (WC) lender Current Ratio is more relevant to the WC lenders, however, lenders generally monitor the building up of total assets of the borrowing company and its liabilities having charge on the assets by Asset Coverage Ratio. The ratio has more relevance when the lenders need to share charge on the assets for any new loan extended by other existing /new lender.

The existing lender generally shares the charge if the new or additional facilities (WC/capex term loan) are extended to the corporate. The reason being that the new WC facilities (subject to permitted under the MPBF) simultaneously increases current assets, and the new capex term loan facilities (permission for which from the lenders remains subject to satisfactory Debt Service Coverage Ratio and long term Debt Equity Ratio during the tenor of the new term loan) increases the fixed assets, and since the existing lender have the charge on the present and future assets, it will not decrease the asset coverage ratio (as long as the existing promoter contribution share is maintained all the time). However, if the borrower desires to share charge on the existing assets with an existing unsecured lender whose WC limits are already disbursed then generally there is a reluctance among existing charge holders in sharing the security with new lender since there would not be any improvement in assets (since the proposed lenders limits are already disbursed) and sharing of charge would result in reduction of asset coverage. However, if the existing asset coverage is substantially high then the borrower may pursue the existing charge holding lenders for sharing of charge with proposed lender. Generally for term lending, minimum fixed asset coverage of 1.50 times and for WC lending Current Ratio of 1.33 times is desired.

The WC lender generally assesses the WC requirement of a borrower on annual basis based on the audited financials for the previous year and projected financials for the next year. Let’s assume that there is only one lender with sanctioned and outstanding WC loan of USD 750 as per current audited balance sheet. Also assume that present annual WC assessment is over. Based on the assessment, MPBF worked out (based on audited financials) for previous year is USD 750, and based on the projected financials for next year the MPBF works out to USD 1000. Assume that borrower is also enjoying non fund based Letter of Credit limit of USD 100 and Bank Guarantee Limit of USD 100. Now, if the borrower proposes to bring in a new lender with WC fund based limit of USD 250 and non fund based LC limit of USD 30 and BG limit of USD 30 (assume that this proposed LC/BG requirement is within the increased assessed LC/BG limits of USD 130 each based on the projected financials), in this situation, whether the existing WC lender should share the charge on the existing securities available to him? Does he need to calculate asset coverage? What does the WC lender needs to evaluate at this point?

The existing lender should check the following points:

1. Based on current ratio principle of 1.33 times, since the projected WC fund limit requirement has been assessed to increase by USD 250, therefore accordingly there needs to be infusion of NWC/promoter contribution to the extent of 33% of the increased fund based WC which works out to USD 84. The existing WC lenders needs to ensure that these funds are infused (or there is a firm commitment as well as arrangements) by the promoters in order to maintain the current ratio at 1.33 times.

2. Of course the addition of new WC lender with required fresh infusion of NWC would maintain the Current Ratio, the sharing of residual charge on the fixed assets with the new lenders will reduce the residual FACR to the WC lender. Does it mean that no additional WC lender should be allowed unless there is increase in fixed assets? The answer to this query lies on the following two beliefs:

(A). The first school of thought believes that the primary security for WC facilities are Current Assets therefore as long as Current Ratio of 1.33 times is maintained the WC lender need not consider the residual coverage available on the fixed assets, and should share pari passu charge with the new lender.

(B). The second school of thought believes that as long as the promoter’s contribution is maintained for the proposed enhanced WC fund based limits, the WC lender should consider sharing charge with the new lender since there would be proportionate increase in Current Assets funded by new WC fund based limits and infused promoter’s contribution.

However these approaches are not favoured by the lenders who believe that such practice jeopardizes the FACR (on residual fixed assets) available to the WC lender.

 Apart from the above, some other peculiar queries are also posed while calculating the Current Asset Coverage (i.e. Total Current Assets divided by WC Capital Limits):

(i) Whether the lender should take only the sanctioned Fund Based Limit as denominator OR he should take total of sanctioned Fund Based and Non Based Limits as denominator?

(ii) Whether it is the sanctioned limit amount which is to be taken as denominator OR only the outstanding (O/s) of the fund based (OR plus outstanding of non funded limits) prevailing on the date as on which the value of Current Assets is being taken?

The first school of thought in this matter says that since during the period of stress/persistent defaults by the borrower, the borrower faces the liquidity issues and it is experienced that generally during such time, the WC FB and Non FB limits are fully utilized. In such stress time, there are high chances of default by the borrower leading to conversion of Non FB exposure into the FB exposure. Therefore, as a matter of prudent practice, the WC lender should consider the sanctioned limits (FB and NFB) as denominator while calculating the current asset coverage. This ratio should be added to the fixed asset coverage ratio (FACR) (on residual charge available to the WC lender) which is calculated based on the outstanding(O/s) term loans plus any undisbursed part, and the final Asset Coverage (i.e. total of current asset coverage ratio and FACR) should be considered by the WC lender. 

The second school of thought is this matter says that considering dynamic nature of working capital funding, the coverage should be calculated based on current data of current assets and O/s FB and Usance Letter of Credits (LCs) as long as the borrower is on the Positive List.

The current data of current assets reflects the utilized O/s FB and Usance LCs. If one takes the entire sanctioned FB limit, it may not be appropriate since the current assets available with the company are only to be extent of O/s FB and Usance LCs (plus promoter’s contribution and unsecured sundry creditors).

But what happens if the coverage is less than 1.33 times for the existing lenders? Does it mean that the short term funds have been diverted for long term purpose and therefore, the existing O/s level of current assets does not fully reflect the utilization of O/s FB and Usance LCs limits? In such cases, the lenders would need to take a separate view, away from standard logic for deciding on to share charge on the assets and based on the terms negotiated with the borrower in order to ensure suitable security for its WC limits extended to the borrower.

Non fund limits are mainly the LCs and Bank Guarantees (BGs). Outstanding (O/s) Usance LCs should be taken while calculating this coverage since the raw material under Usance LCs would have been delivered to the borrower and reflecting the current data of current assets. Under Sight LCs O/s, the related raw material would not have reached to the company therefore the current asset will be short to that extent. The Bank Guarantees (BGs) are used by the company for submission to various government departments. These BGs do not directly contribute in increasing the current assets therefore including the BG O/s in the denominator would create negative effects on the coverage ratio.

(iii) Whether one should consider the value of Current Assets and WC liabilities outstanding as per the last audited financials OR one should consider the Current Assets as given in the current available Stock Statement and outstanding/sanctioned limits prevailing on the same date?

The advantage of using the audited data is the authenticity and availability of entire current assets data. In case of using the current data of current assets generally the borrower would be able to provide only the details of raw material and receivables (details of which are also reflected in the monthly stock statement) and which is also not audited. But considering this approach being more conservative (since the lender considers only the raw material and receivables under current assets and excludes all the other heads of current assets) the lender may use the current data and also do calculation based on audited data for indicative purpose. While using the current data from the stock statement, it would be prudent to take average data of Raw Materials, Stock in Process, Finished Goods and Receivables, of 3 to 6 months depending on the conversion cycle and credit period received and provided by the borrower in its industry.

 (Disclaimer: The views expressed above are not the opinion of the author. The write up is based on the interaction of author with various related experts in the field.) 

Buyer’s Credit version : 2013

Many Indian companies which require import of materials for their production/manufacturing activities have to provide Letter of Credit to the supplier.  On expiry of LC, the importer avails Buyer’s Credit (BC) which in simplest words is a type of credit/loan made available to the importer by a bank to meet the payment of the importer to his exporter.

 

In case BC is not available, the importer will need to utilize its INR line of fund based working capital limit for the import (non capital goods) payments or a term loan for capital goods import payments. Generally, the cost of such INR funding is much higher than the cost of BC. Therefore, the importers prefer to use BC as long as such sanctioned limit is available from its bankers i.e. we can say that the BC is kind of exercise to exploit existence of interest rate arbitrage. This helps importers in reducing the finance cost. Generally, the banks in India, while assessing the fund based Working Capital (WC) needs of a borrower, also assess his needs for Letter of Credit and Buyer’s Credit based on his projected import requirements. Based on such assessment, LC/BC lines are sanctioned to the borrower. Further, sometimes when the foreign currency (FC) funds are not available with the WC banker or the rate of interest charged by WC banker on FC funds is higher than the rates offered by other banks in the market, in that situation, instead of availing BC from its WC bank (through overseas branch of the bank), the borrower avails Letter of Undertaking(LuT) (a bank guarantee) from its WC bank issued in favour of a overseas funding bank (willing to offer BC at lower rate based on the security of LuT issued by the WC bank of the borrower). Importer’s bank or importer or a BC consultant arranges BC from international branches of a domestic bank or international banks in foreign countries. For this service, importer’s bank or BC consultant charges a fee called an Arrangement Fee.

 

In regulatory terms Buyers’ Credit is defined as loans for payment of imports into India arranged by the importer from a bank or financial institution outside India for maturity of less than three years. Authorized Dealer Banks are permitted to approve trade credits for imports into India up to USD 20 million per import  (non capital goods) transaction for imports permissible under the current Foreign Trade Policy of the DGFT with a maturity period up to one year i.e. 360 days  (from the date of shipment). Recently, in July 2013 RBI has issued modification which prohibits banks to extend Buyers Credit beyond the Operating Cycle and Trade Transaction.

 

For import of capital goods as classified by DGFT, AD banks may approve trade credits up to USD 20 million per import transaction with a maturity period of more than one year and less than three years (from the date of shipment).  For Infrastructure sector, the maturity period is allowed upto 5 years for import of capital goods subject to minimum trade credit period of 15 months from the beginning and not in nature of short term roll-over.

 

No roll-over/extension will be permitted beyond the permissible period.

AD banks are permitted to issue Letters of Credit/guarantees/Letter of Undertaking (LoU) /Letter of Comfort (LoC) in favour of overseas supplier, bank and financial institution, up to USD 20 million per transaction for a period up to one year for import of all non-capital goods permissible under Foreign Trade Policy (except gold, palladium, platinum, Rodium, silver etc.) and up to three years for import of capital goods. For Infrastructure companies as mentioned above, the banks are not permitted to issue Letters of Credit/guarantees/Letter of Undertaking (LoU) /Letter of Comfort (LoC) beyond a period of three years.

 

RBI has prescribed the maximum All-in-Cost ceiling (includes arranger fee, upfront fee, management fee, handling/ processing charges, out of pocket and legal expenses, if any) for the Buyer’s Credit. The present ceiling rate is Six Months Libor plus 350 basis points and is subject to review from time to time.

Importance of Stock Audit for Working Capital Lender

The working capital finance is extended to a company/corporate borrower based on various projections about the operations/business performance. The fund based and non fund based limits are provided to the borrower for procuring raw materials required in the production process. The fund based limits are released to the borrower depending upon the Drawing Power (DP) arrived based on

Stock Statement. The non fund based limits are utilized by the borrower in the form of Letter of Credit(LC)/Buyer’s Credit (BC) for procurement of stocks. The banker understands the financial performance of the corporate borrower based on financial reports and various other statements submitted by borrower. However, since monitoring is the most critical part of working capital lending management, the bank needs to undertake assessment of the position of operations at the factories of the borrower to know about the position of stocks and receivables which are primary security to the working capital lender and appropriate safety measures and valuation of the same is of prime importance for the WC lender.

The Stock Audit report is prepared by a Chartered Account (CA) firm empanelled with the lender, and at the cost of borrower. It is preferred to conduct at least two stock audits in a financial year. The periodicity may depend upon the size of operations of the company/borrower as well their financial health/reputation deciding the criticalness of the stock audit. Sometimes, when the factories of the borrower are spread across several locations, it becomes tedious to conduct multiple stock audits. Similarly, for small companies also multiple stock audits may put burden on their budget as well as time & resources.

Stock Audit report of company is like an X-Ray Report for a Working Capital lender. It provides details of important inside information about the stocks and operations at the factories of the borrower which are generally situated at far-away locations and it is not possible for the banker to undertake regular and exhaustive inspections. The stock audit supports in fulfilling this requirement. The report covers many important details viz installed capacities, major stock items, method of inventory management/control at factory, no. of days for which stock is stored, proper preservation/handling of stocks, identification of movement of stocks, age-wise examination of receivables,  stock valuation methods adopted by borrower, adequacy of insurance coverage, job work received/outsourced, details of slow moving stocks, obsolete stocks, auditors views on marketability of stock, ownership of stock with borrower, demand/supply conditions, stock being commensurate with production or not, no. of workers, any abnormal consequence occurred at factory, data/record management, receivable collection system, quality of stock and receivables, auditors suggestion on any improvement required etc.

The fund based limits are released to the borrower based on drawing power(DP) worked out and DP depends on the stock and receivable statement. Under the stock audit, the auditor physically checks the stock position of raw materials, work in progress and sales registers at the factories. The auditor checks the production and despatch of goods through Excise Register, Purchase Invoices, Sales Bills etc. The stock auditor compares his calculations of drawing power based on his physical verification of stock & receivable position at the factory, with the calculation submitted by the borrower to the lender. Any difference in calculation is reported in the audit report, based on which the borrower is required to submit clarifications to the lender or take corrective measures.

From the above, it can be understood that stock audit is a critical tool which helps the working capital banker to understand the actual positions of the raw materials and production funded by the limits released by the lender. The audit helps to ensure that the bank funds are properly utilized without diversion. Considering, the working capital lending relationships to be long term in nature, and for the growing companies whose working capital need increase year on year, the stock audit helps in understanding the growing requirements. Stock Audit ensures proper valuation of stocks and receivables and measures for safety of stocks. In light of the above, it is of utmost importance for the banker to timely get the stock audits conducted, thoroughly analyze the stock audit report, and also take up any issue mentioned in the report with the borrower.