Rigidities in the MPBF method and the relaxations permitted by RBI :

Certain rigidities have crept in the process, which became more prominent during 1990s during the initiation of process of financial liberalization in India. We may summaries these rigidities in the following manner:-

1. Many of the items classified as Current Assets and Current Liabilities did not fit with the principle of Asset backed financing :- As the concept of MPBF is Asset backed Finance (Asset-backed finance is when a loan is taken out by a business using its already existing assets as a way to secure payment. Likewise, the assets to secure payments include buildings, offices, vehicles, IT software, and equipment, but this time it can also include inventory and unpaid invoices, also known as accounts receivable.) which itself is substituted by concept of Asset Finance. There are Current Assets and Current Liabilities which are not fit for Asset Backed Finance. Example of such current assets are security deposits made with government departments and example of Current Liabilities are Short term loans. This left a substantial gap between MPBF assessed and credit amount delivered.

2.  The Standard Current Ratio(CR) of 1.33 was viewed a stiff target: Industry and large section of practicing bankers observed that establishing current ratio as 1.33 a benchmark is a very stiff target for some industries. Example of such industries are BPOs/KPOs and other service units, Departmental stores (They have low receivables and high payables) etc. However on account of the mandatory nature of the compliance, the CR was always required to be projected at the level of 1.33 (minimum) on the basis of which the MPBF was calculated. In most of the cases is resulted in the actual CR falling short of the standard (accompanied with the excess borrowing). At the time of the renewal of the working capital credit limits, it was a difficult proposition for the bankers to explain the basis of such proposition.

As the bankers experienced difficulty in complying with MPBF prescriptions, more so, because they had to compete with other banks for quality lending business (which demands a dilution in the rigidities in case of creditworthy borrowers), RBI made optional the use of MPBF prescriptions by the lending banks, in its credit policy of 1997. Thus banks were now allowed to evolve their own logical and rational system of Working Capital computation method. Most of the banks, however modified the process of classification of Current Assets (CA) and Current Liabilities (CL) for computation of WC Gap and validation of holding norms, while retaining the basic structure of MPBF method. The manner of reclassification and recognition of CA and CL has not been uniform across the various banks, and this leads to an element of heterogeneity in the WC assessment system done by the individual banks. 

Box Diagram Current Assets Financing as per Tandon Committee 

Other Current Liabilities Current Assets

consisting of

Inventory, Receivables

And

Other Current Assest

Bank Borrowing
Net Working Capital

(Part of Net Worth)

 Example :A term loan of Rs. 500 lacs is disbursed for 5 yrs to purchase plant and machinery. Installment of Rs. 100 lacs is due within next 1 year. This 100 lacs [termed as Other Current Liabilities (OCL) has financed Fixed Assets and not Current Assets.

Applying this logic to the box diagram above we come to the conclusion that the Tandon Committee assumes that the OCL (Other Current Liabilities) funds Othet Current Assets (OCA) like Cash, Advance Tax etc. on which lenders do not enjoy a security interest and OCA & OCL level match. As a corollary, the working capital gap becomes equal to the level of Chargeable Current Assets.

If Bills are discounted they find place on both side of balance sheet. As current assets they ought to have margin of 25% but credit is delivered to customer without margin which is reflected on the liability side. 

Suggested Approach:

These inconsistencies result into a substantial gap between WC assessment and WC delivery, if one follows the MPBF computation method in it’s present form. Following modification may be suggested in the MPPBF computation that would ensure a convergence between the assessment and delivery of WC credit, while removing the anomalies observed in the above analysis :

1. The Installment of term loan payable during the ensuing year be treated as part of the long Term Loan. However, irregularities in Term Loan may be treated as Other Current Liabilities (OCL). Bills discounted may be eliminated from both Assets and Liabilities side of the Balance Sheet. This can be added later to find out the full bank borrowing limit by the bank.

2. The current liabilities may be classified into 3 categories : i. Trade Credit, ii. Bank Borrowing and iii. Other Current Liabilities(OCL). Term OCL may be redefined under suggested approach.

3. Similarly the current assets may also be classified into three major categories i.e. i. Inventories i. Receivables and iii. Other Current Assets (comprising Cash, Advance Tax etc.). Charge can be created for I and ii hence they can be called chargeable and financing against them is possible under Asset backed financing mechanism which is the core of MPBF. 

Box Diagram : Suggested Approach for Current Assets Financing 

Trade Credit Inventory (Unpaid)
Fundable WCG funded by Net Working Capital and Bank Borrowing Inventory (Paid Up)
Receivables
Other Current Liabilities Other Current Assets

(Source : Credit Appraisal, Risk Analysis and Decision Making by D.D. Mukherjee)

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Qualification: CA in Job / Business
Company: UCO Bank
Location: Jaipur, Rajasthan, India
Member Since: 01 Mar 2021 | Total Posts: 48
I am a Chartered Accountant working with a nationalized bank in middle management. View Full Profile

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