Processing and Operation of different

modes of working capital finance:

OD, CC (Pledge & Hypothecation),
LTR, LIM, FDR, WDB, ICB Unit
certificate, Shares, JBP etc.
Sk. Nazibul Islam
Faculty Member, BIBM

Overdraft
Overdraft (SOD) is an arrangement between
banker and his customer by which the latter is
allowed to withdraw over and above his credit
balance in the current account up to an agreed
limit.
This is only a temporary accommodation usually
granted against securities. The borrower is
permitted to draw and repay any number of times,
provided the total amount overdrawn does not
exceed the agreed limit.
The interest/profit is charged only for the amount
drawn and not for the whole amount sanctioned.

FDR
Customers sometimes require advances against
their fixed deposit receipts with the bank maturing
at a future date.
Procedure:
1. Advance should, as a rule, be granted to the person in
whose name the deposit stands. If the deposit is in two or
more names, a letter of authority should be obtained from
all the depositors concerned. They may jointly request the
bank to grant an advance to one or more of them according
to their own convenience.

2. The deposit receipt should be discharged by the

depositor (or all of them if they are more than one)
on an appropriate revenue stamp. The signatures
must tally with that on the banks record. Whether
the receipt is payable jointly or to either or
survivor discharge by all the depositors must be
obtained.
3. The discharged receipt must be surrendered to
the bank along with a letter signed by the
depositor/s authorizing the bank to appropriate the
proceeds of the receipt on due date towards the
repayment of the advance.

4. The banks lien should be prominently noted in

the fixed deposit register and ledger, and also on
the face of the receipt under the signature of an
authorized bank official.
5. No advance should ordinarily be granted against
a deposit standing in the name of a minor. Some
banks make an exception in special cases but
obtain a declaration from the guardian that the
money belongs to him but has been kept in the
minors name as a matter of convenience. The
declaration should further mention that the minor is
alive and the amount of the advance will be utilized
for the benefit of the minor.

6. The procedure followed by a branch of a bank in

granting an advance against a deposit receipt of
another branch is the same. But as a further
precaution, the lending branch should ascertain
that no lien is already noted against the deposit
receipt at the issuing branch. The branch granting
the advance should also get the discharge on the
deposit receipt duly verified by he issuing branch
before lending against the receipt.

The lending branch should, after granting the

advance, intimate the branch which issued the
deposit receipt to note and confirm its (lending
branchs) lien. A letter should be taken from the
borrower addressed to the issuing branch to remit
the proceeds to the lending branch on maturity.
Before entertaining an advance against a deposit
receipt issued by another branch of the bank, the
depositor must be properly identified.

7. Margin and rate of interest as per the PPG of the

respective bank.
8. Confirmation of debit balance is obtained on an
appropriate revenue stamp every year/half year according
to the practice of the bank.
9. Usually advances against deposit receipts are
automatically adjusted on maturity from the proceeds of the
deposit receipts. If, however, repayment is made before due
date, the deposit receipt is returned to the customer after
cancellation of the discharge thereon. All notes of lien taken
in the deposit register and ledger are also cancelled.

10. Some banks allow advances on the security of

third party fixed deposit receipts of their own bank.
In such a case, the fixed deposit receipt duly
discharged by the person in whose name the
deposit stands has to be tendered as security. Lien
is registered in the banks books and on the deposit
receipt.
A letter of request is also taken signed by the party
in whose name the deposit stands authorizing the
bank to hold the receipt as security for the advance
and to apply the proceeds of the deposit when due,
towards repayment of the advance.

11. As a rule, no advance should be made against

a fixed deposit receipt issued by another bank.
In the case of an advance against deposit receipt in
the name of a limited company, the procedure is
same except that a duly authenticated copy of the
resolution of the directors to borrow against the
receipts is to be kept on record.

 A cash credit differs from an overdraft in one

respect. A cash credit is used for long term by
businessmen in doing regular business whereas
overdraft is made occasionally and for short
duration.
Temporary OD: Banks, sometimes, grant
unsecured overdraft for small amounts to
customers having current account with them. Such
customers may be government employees with
fixed income or traders. TODs are permitted only
where reliable source of funds are available to a
borrower for repayment.

Loan against LIP/JBP

Procedures:
1.The policy stands in the name of the borrower.
2. Conditional policies will not be considered for
advance.
3. Surrender value of the policy should be obtained
from the insurance company. Normally, a three
years old policy acquires surrender value.
4. The stipulated margin, usually 10% to 15%
should be maintained on the surrender value.

5. The amount of advance must not exceed the

surrender value of the policy.
6. The policy must be in force and premiums paid
up to date. The last premium receipt must be kept
on record by the bank.
7. Letter of authority regarding payment of
premium by the borrower regularly.
8. The insurance policy against which the advance
allowed duly assigned in banks favour by the
insured person, the assignment are registered with
the company and an acknowledgement from the
insurance company to that effect is to be obtained.

9. Particulars of the policy should be entered in the

security register.
10. On repayment of the advance by the borrower,
the policy should be reassigned to him and the
reassignment registered in the company books.

Loan against Shares

While preparing a list of approved shares, for
lending purposes and in fixing margins there
against, banks take into account the following
points:
1. Age of the company
2. Reputation of the company and its directors.
3. Marketability of the shares. To see whether the
shares are quoted on the stock exchanges.
4. Market value during recent years with special
reference to stability of prices.

5. Companys present financial position and its

dividend history during the last few years.
6. Financial policy- prudent or otherwise as
indicated by distribution of dividends and the
provisions for reserves made in the past.
7. Prospects of the industry in general and the
company in particular.
8. Intrinsic value of the share concerned.

9. Ensure shares are transferred in the name of the

borrower or any third party and registration has
been done in his/their names.
10. Ensure a fresh set of transfer deeds signed by
the borrower /holder of the shares, witnessed by
some body that easily traceable and verified by the
companies concerned obtained and retained with
the branch along with the share certificates.
11. An undertaking obtained from the
borrower/share holder that any benefits as and
when received by them shall be passed on to the
bank for credit or as security against the advance.

Cash credit
Cash credit is a type of working capital facility
and is generally sanctioned by banks to
industrial, business and trading units.
Such facilities are allowed against the
security of stock/merchandise like raw
materials, goods -in progress, finished
goods, consumable stores/spares etc.
Such facilities are allowed either in the form
of pledge or hypothecation.

 Cash credit is a running account where a regular

limit is sanctioned by the banker against goods
and it is meant for meeting day to day expenses of
the business.
The account is adjusted by the sale proceeds and
the borrower again avails of it for buying the stock.
The cash credit account is like a current account
with a limit up to which he can withdraw from the
bank.
The moveable assets are mostly in the shape of
produce and commodities and these advances are
covered by either pledge or hypothecation.

Processing of cash credit:

The application should be for permissible purposes.
Borrowers should apply in the prescribed application form
along with requisite loan application fee in the base branch.
Cash credit facilities generally should not be given to a
borrower not having banking transactions with the bank for at
least six months.
The purpose should not be stock piling.
The period of cash credit can not be more than 12 months if
not renewed.
Open pledge goods should be avoided as far as possible.

Assessment of cash credit be evaluated on the basis of:

Capacity
Efficiency
Past operating experience.
Production cycle
Elements of costing for acquiring raw materials, packing
materials, factory on-cost, cost of powers, wages
Administrative cost
Repair and maintenance of plant and machinery
Cost of marketing of finished products.

Points to remember while assessing cash credit:

The purpose for consideration of a limit must be permissible
one and relates to Banks portfolio.
Status of the borrower as to individual, partnership, Company
are to be verified in depth.
Personal integrity and credit worthiness of the borrower are
extremely important, investigation is to be made by the
RM/Manager as to whether the borrower is in debt with other
banks/DFIs and whether there exists any default.
Management and managerial competency are to be
examined.
Availability of raw materials to feed the production units for
finished products.

 Marketability of finished goods prompt turnover

of stocks need be ensured to avoid risk of stockpiling, deterioration in the quality of produce, price
reduction because of out of season sales.
In-depth study on the financial position of the
borrower applicant and capability for putting up
participation/margin.
Along with credit need assessment exercise,
earning forecast, cash flow of the concern should
be made so as to facilitate understanding debtservicing ability.

Operating cycle:
The cash credit requirement of a concern is basically
influenced by the nature of its business.
The size of the business also has an important impact
on its cash credit needs.
While assessing cash credit need of a firm, the cycle of
production as to number of days should be worked out.
The operating cycle differs product to product.
While assessing operating cycle, the number of days
taken for acquiring raw materials, processing period ,
normal marketing period, sum total of these involved
would constitute the operating cycle of an unit.

Margin:
Margin is the amount invested in the unit by the
borrower himself and is asked for providing
protection to bankers against a possible decline in
value.
The margin indicates the owners stake which very
often governs his motivation, i.e., the zeal and
interest with which he will work for the success of
the unit.
The banker should study this amount invested in
relation to the borrowers total resources and also
in relation to the total investment required in the
unit.

Drawing power:
The drawing power of a limit is determined and
fixed by the sanctioning authority up to which the
borrower can draw.
The drawing power should be calculated on the
basis of pledged goods/stock, its valuation to be
determined as per prescribed rate.
Value will be determined on the basis of cost price
and market price whichever is lower or any other
prices as specified in the sanction letter.
All release of limit must be channelized through
drawing power register.

Pledge:

Section 172 of contract Act, 1872, defines a pledge as, the

bailment of goods as security for payment of a debt or
performance of a promise.
From the above definition we observe that,
i) a pledge occurs when goods are delivered for
getting advance,
ii) the goods pledged will be returned to the owner on
repayment of the debt,
iii) The goods serve as security for the debt.
The person who transfers the goods is called pledger and to
whom it is transferred is called the pledgee.

Essentials of pledge:
i) Delivery of goods:
Delivery of goods is essential to complete a pledge.
The delivery may be physical or symbolic. Physical
delivery refers to physical transfer of goods from a
pledger to the pledgee.
Symbolic delivery requires no actual delivery of goods.
But the possession of goods must be transferred to a
pledgee. This may be done in any one of the ways:
a) Delivery of the key of the warehouse in which the
goods are stored.
b) Delivery of the document of title to goods like bill of
lading, Railway receipt, Warehouse warrant etc.
c) Delivery of transferable warehouse warrant if the
goods are kept in a public warehouse.

Precaution and general guidelines for pledgee

1. The godown must be in good condition and well
constructed.
2. Godown must be effectively under Banks control.
3. Name board of the bank should be placed outside and
inside of the godown.
4. Letter from the party for free accesses to the godown by
bank personnel (Banks prescribed form) to be obtained.
5. Letter of disclaimer from the owner of godown is to be
obtained if the godown is rented one.

6. Godown keeper and godown Chowkider are to be posted for receiving/

delivery and to ensure security of the goods.
7. Insurance of godown is to be done against all risks. Bank clause
should be inserted.
8. Periodical Inspection by the authorised person of the bank
(monthly/fortnightly) should be conducted.
9. Value of stocks must be determined at landed cost/invoice
cost/market price whichever is lower as per Head office
guideline (circulars).
10. Restricted item must not be accepted for pledge.
11. Deliveries and rotations of the stocks is to be made as per
existing rules/procedures and terms and conditions contained
in the sanction advice.

12. Market value of the goods pledged should be ascertained

frequently in order to retain proper margin and allow withdrawals
within drawing power. No upward revaluation without H.O.
approval.
13. Pledged goods must be stocked properly to facilitate counting
and checking.
14. Stock report card on each stock mentioning Nos. of bales, bags,
cases etc. must be maintained.
15. In case of chemicals, drugs and medicines the date of expiry
should be written and technical personnel must be employed to
ensure its quality.
Accepting goods for pledge
Before accepting the goods for pledge, banker should be
satisfied that proposed pledge goods contain the attributes of a
good security.

In the matter of pledge banks may be

cheated in one or more of the following
manners:
Pledge of spurious goods.
Inflating the value of goods.
Pledging the goods to more than one bank
by using various entrances to the
godowns.
Fraudulent removal of goods with the
connivance / due to the negligence of the
banks staff.
Pledge of goods belonging to a third party.

Attributes of a good Tangible security

1. Marketability
2. Easy ascertainment of value
3. Stability of value
4. Storability
5. Cost and labour of supervision
6. Transportability
7. Durability
8. Ascertainment of title
9. Easy transfer of title
10. Absence of contingent liability.
11. Yield

Documents required for Pledge:

1. Demand promissory note.

2.
3.
4.
5.
6.
7.
8.
9.

Agreement for pledge.

Letter of continuity.
Letter of arrangement
Insurance policy covering all risks.
Invoice of goods pledged (for imported goods).
Latest stock report.
Letter of disclaimer
Other documents as per sanction letter.

Hypothecation:
The mortgage of movable property for securing loan is called
Hypothecation. In other words, in case of hypothecation, a charge
over movable properties like goods, raw materials, goods in
progress is created.
Hypothecation is a charge against property for an amount of debt
where neither ownership nor possession is passed to the creditor.
Though the borrower is in actual physical possession, the
constructive possession remains with the Bank as per the deed of
hypothecation. The borrower holds the possession not in his own
right as the owner of the goods but as the agent of the Bank.

Features of Hypothecation:
Charge

against a property for an amount of debt,

Goods remains in the possession of the borrower,
Borrower binds himself to give possession of the
hypothecated goods to the Bank when called upon to
do so.
It is a floating charge.
It is rather precarious.
Being only an equitable charge on movable property
without possession, hypothecation facility is risky as
clean advances. So it is granted only to parties of
undoubted means with the highest integrity.

As goods under hypothecation remains in the possession of the

borrower, extra care has to be exercised to see that the banks
security is complete, adequate, safe and available at times when
required. The banker should take the following precautions:
i. He must get stock statements periodically which contain a
declaration by the borrower regarding his title to goods and
correctness of the quality, quantity etc.
ii. On the basis of the statement, he should inspect the stock
and books of accounts of the borrower.
iii. An undertaking from the debtor in writing, stating that he has
not hypothecated the same goods to any other bank must be
obtained.

iv. The banker should get a letter of hypothecation

containing several clauses to protect his interest
under all circumstances.
v. The banker should insist on the borrower insuring
the goods against the risks. He should also get it
endorsed and assigned in his favour.
vi. A board reading Stock Hypothecated to X Bank
should be displayed in the place where the
goods are stored.

In case of hypothecation bank may be

cheated in the following ways:
The borrower declare wrongly the capacity
of the storing place.
A false platform between the loose stocks
is erected.
The borrower creates a hollow square in
the middle of stocks. Kind of fraud is
generally committed by the borrowers who
have, either built-up confidence with the
bank or where the branch managers and
other officials at the branch office have
been got around by such borrowers.

 Often the borrower with intention to cheat the

bank resorts to dumping deteriorated/obsolete
stocks in between the good stocks.
The borrower mixes inferior quality liquids or
water with good liquids and commits fraud. The
device is generally adopted by parties dealing in
chemicals or oils.
The borrower stores stocks of different qualities in
the godown and cheats the bank. In such cases
borrowers store goods of qualities different from
these declared in lodgment memos.

LTR/LIM
LTR/LIM facilities are usually provided to the importers
of merchandise. They may be corporate clients or any
customer having good reputation in the related
business and also based on banker customer
relationship.
For releasing the imported merchandise by the
importer upon whom bank relies upon as to their
repayment, documents of L/C are usually handed over
to the clients against Trust receipt to the person or
the institution concerned by executing this document
with them. Normally this facilities are allowed to the
importers of Government sectors or very dependable
customers of the bank. In many cases the customers
who avails of different loan facilities and are very
good pay master, LTR facilities is also given to them.

 LIM facilities are also provided to the

intended importers. Usually in such cases
the importers are to sign in a specific format
of the bank where they promises to make
payment of the imported goods value within
a specified period of time and then the
documents are released and goods are
stored in the godown of the customer but
the possetion of the goods remain under the
custody of the bank. Importer sells their
goods after having the delivery order issued
by the bank authority by depositing the
goods value in phase by phase.