Monday, February 18, 2013

CMA -Part 1

Like much else, Bank Credit was also rationed in our economy for a long time. The RBI had introduced the CAS or Credit Authorisation Scheme in 1965 under which Banks were required to seek RBI approval for release of working capital limits of Rs. 1.00 crore and above . In fact we were required to get the limit sanctioned by the Competent Authority, viz the Board, and then forward a set of papers to RBI for the said permission.

Much of the credit dispensation set up in India and even branches of Indian banks abroad owes to the Tandon Committee and the Chore Committee appointed by RBI to go into the Working Capital Lending system of the banking sector.(We are not talking about rotation methods like Nayak Committee approach for small units.)In the past, Banks were supposed to assist units for working capital requirements, to the exclusion of term loans, as their liability portfolio was basically short term and demanding of liquidity. If you recall, the word ‘bank’ is the equivalent of ‘bench’ where merchants in middle age Europe used to wait before the ‘deposit shops’ where they would deposit their collections for safe-keeping, and the next step in evolution of banking was the practice of lending by these safe keepers, consequent upon the observation that some money would always be available with them for lending, for under normal circumstances, all the merchants were not expected to run for their money to the bank. Thus the banks could earn and pay interest to the depositors instead of charging for safe-keeping. However, the banks needed to ensure safety and liquidity for their clientele’s primary need was this. The safety of a term loan depends on the success of the project, that is whether or not it generates cash surpluses and when. However, a working capital loan simply intervenes in or bridges the working cycle of the business, money comes and goes regardless of profit or loss question, and as long as the unit is working to maybe 50-60% capacity, and a reasonable degree of long term funds are involved in the working cycle, any day the flow could be arrested by the banker, and their limits got vacated, at least theoretically the possibilities are there. Thus the safety of funds of a commercial bank is of a higher order. However today the funds requirements are basically for investment purposes, esp infrastructure and moreover the working capital requirements show a declining trend with companies becoming ‘lean and mean’(less of inventory and receivables). To that extent, the banks’ term loans are today in excess of working capital loans and correspondingly the NPAs and risks are going up and repeated re-capitalisation is called for.

RBI introduced Credit Monitoring Arrangement (CMA) after discontinuing Credit Authorisation Scheme (CAS) in 1988. Under CMA system, RBI prescribed two sets of formats viz. (i) Assessment of working capital requirements and (ii) Monitoring through Quarterly Information System (QIS)-later renamed FFR, to cover borrowers i.e. ‘General Category’ and ‘Traders & Merchant Exporters’. The first set of formats refers to those required for assessing need, and the second is required for validating the assumptions of the first set, and for checking end use of funds.

It is to be noted that all these systems and forms addressed the need of the hour of the Indian economy at that point of time and are not immutable like the laws of Physics. The Indian economy had been severely hit by the oil shock of 1973 and as oil prices reached $ 100 per barrel, the deficit finance model the Govt was following for industrial development- increase spending, print notes- growth comes at the cost of inflation. The only way was to restrict the country’s ambitions, ration credit, and settle for lower growth rate. In such a scenario question of quantum of loan to be given to a unit was important, but so was end-use of funds- for instance if a family has only Rs. 100 today, it would rather spend on food than movies. Today the system is flush with funds, but since the lending system laid down by Tandon (he was a very capable man-the first Indian head of Hindustan Levers from 1961 to 1968, later PNB Chairman) worked in a certain era, it became a holy cow for all times to come. Today the ability to pay should receive more attention than putting it to the stipulated use. For example, if the unit borrows some funds from the bank for manufacturing ornaments, and increases raw material inventory from 2 months mentioned in the CMA, to 6 months in anticipation of price rise, the credit expert in an Indian bank will cry ‘murder’. What we are saying is that this act could have objectionable in the rationing environment, but today the situation is different and all we should concentrate is the repayment capacity. Unfortunately we have not infused fresh blood in our credit manpower and the expert who learnt 100/75= 1.33 fears losing his importance. He will ask silly questions at the consortium meetings, and the rookie analyst will be put on a false trail. As everybody knows, in the developed world, you get term funds for short and medium tenures at quoted rates with simple covenants, and time-to-time, the facilities are renewed. But RBI looks at itself as Lady Justice with eyes blind-folded, and assumes that the Banks will never address the borrower’s periodically rising needs if it doesn’t prescribe annual renewal of working capital limits. In the process the borrower is the party which suffers, because in absence of paper renewal the account becomes an NPA and the bargaining power of the bank vis-a-vis the borrower further increases.

The Credit Monitoring Arrangement (CMA) under which banks were required to report to RBI the details of credit facilities sanctioned to large borrowers from the banking system for post sanction scrutiny was also discontinued in December 1997 and in lieu thereof a new reporting system for statistical use was put in its place. In all spheres of banking where the Central Bank had earlier much to prescribe and control, be it Forex or Credit, the trend has been towards deregulation and leaving the thing the wisdom of commercial banks. We hope the trend continues and we move away from the cash credit system. Anyway…

Some clarifications on assessment system:

·      Is it like covenants ?: First of all, as the CMA is supposed to be signed by the party or its authorized representative, the financials therein are in the nature of covenants between the bank and borrower, and should be taken in spirit, but not one can hold the other party to the figures if the variations are not inspired, or are explainable on grounds of business.

·         Next year projections: what is ‘next year’ will be determined by how many months of current year have passed:  in February 2013, next year will be 2013-14, but if assessment is being done in November 2013, the projections required will be those of 2013-14 and 2014-15 and maybe two limits as per date sanctioned.

·         Level of current assets: No norms prescribed now, but better check up actual levels of unit in recent past, other units in same situation, reason for change in assumptions which would lead to request for change in level, if any to be ascertained.

·         Remark that ‘the projected sales are increasing only by (say) 20%, then why 100% rise in facilities demanded: there could be some merit in the query, but the comparison has to be of corresponding figures that is, the next year projections of sales and levels of current assets ABF is to be compared to current asset levels and ABF assumed at the time of last assessment, and not those of last audited results.

·         There is no increase shown in projected sales. An enhancement is requested for substitution of current liability, mainly sundry creditors. Is it permissible?
Ans: it is ok if the reasons are convincing and substitution    will do good to the business.
        What is NWC? : Please remember you should not say :it’s the excess of current assets over current liability, or (CA-CL),though that’s the way we compute it. Net Working Capital is the long term fund deployed in current assets. This is how to understand it. In the figure 1, NWC= (purple)- (pink)is arithmetically correct, but you’ll understand the concept  better if you say NWC= (yellow+brown) – (green+blue).

LIABILITIES                                                                                                                                  ASSETS


  Slip-back of current ratio, whether permissible: again, if due to higher than projected profit or any other reason, there is an unexpected rise in current ratio, it is likely that NWC will have risen beyond projected level. In case higher capacity utilization or expansion or modernization is envisaged, the dilution to level earlier settled may be permitted. Slip-back can be considered otherwise also, looking into overall circumstances, for example it may be acceded to in case the promoter needs to pay for a personal house and will charge the property to us.

·     Classification of Current Assets and Liabilities: We saw that in the system of assessment first one estimates next year sales, then level of current assets required for the achieving the same, then who will arrange for the funding. The basis for the above estimated figures of all kinds will be largely objective, but the classification of balance sheet items into current and non-current was considered a subjective matter by the RBI and the CAS/CMA system would provide very strict guidelines for the classification of current assets and current liabilities. The system is now dispensed with, though the accountancy principles are to be followed. For example, on how to classify relatively a very small item, you may classify it ‘anywhere’ on principle of ‘materiality’. The test of any item being classified as current or non-current is whether it is a part of the working cycle or not, not the period of retention, as explained earlier (case of shipyard). If the analyst feels, even debts over 180 days can be considered current if they are considered recoverable in the BS period remaining. Sufficient flexibility is provided to the analyst.
    In the next post we discuss the figures part of the CMA formats


  1. What is the whole context of all this? Why post this here?

  2. I was teaching a bit of Finance and some pupils wanted me to share first-hand experiences reg bank finance in India. This is how it began: Some friends would then suggest topics and sometimes I remembered something of sort of meanders...