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Financial Management



                      Notes         3.4.3  Loans from Commercial Banks

                                    The primary role of the commercial bank is to short-term requirements of industry. Of late,
                                    however, banks have started taking an interest in term financing of industries in several ways,
                                    though the formal term lending is so far small and is confined to major banks only.
                                    Term lending by banks has become a controversial issue these days. It has been argued that term
                                    loans do not satisfy the canon of liquidity, which is a major consideration in all bank operations.
                                    According to the traditional values, banks should provide loans only for short periods and for
                                    operations, which result in the automatic liquidation of such credits over short periods. On the
                                    other hand, it is contended that the traditional concept of liquidity requires to be modified. The
                                    proceeds of the term loan are generally used for what are broadly known as fixed assets or for
                                    expansion in plant capacity. Their repayment is usually scheduled over a long period of time.
                                    The liquidity of such loans is said to depend on the anticipated income of the borrowers.
                                    As a matter of fact, a working capital loan is more permanent and long-term than a term loan.
                                    The reason for making this statement is that a term loan is always repayable on a fixed date and
                                    ultimately, a day will come when the account will be totally adjusted. However, in the case of
                                    working capital finance, though it is payable on demand, yet in actual practice it is noticed that
                                    the account is never adjusted as such, and, if at all the payment is asked back, it is with a clear
                                    purpose and intention of refinance being provided at the beginning of the next year or half year.
                                    To illustrate this point let us presume that two loans are granted on January 1, 1996 (a) to A; term
                                    loan of  60, 000 for 3 years to be paid back in equal half yearly installments, and (b) to B; cash-
                                    credit limit against hypothecation, etc. of  60, 000. If we make two separate graphs for the two
                                    loans, they may be something like the figure shown below.

                                                           Figure 3.1: Graphs for the Two Loans





















                                    Notes: It has been presumed that  both the concerns are good. Payment of interest has been
                                    ignored. It has been presumed that cash credit limit is being enhanced gradually.
                                    The above graphs clearly indicate that at the end of 1999 the term loan would be fully settled
                                    whereas the cash credit  limit might have been  enhanced to over a lakh of rupees. It really
                                    amounts to providing finances for the long-term.
                                    This technique of providing long-term finance can be technically called “rolled over for periods
                                    exceeding more than one year”. Therefore, instead of indulging in term financing by the rolled
                                    over method, banks can and should extend credit term after proper appraisal of applications for
                                    terms  loans. In  fact, as  stated  above,  the degree  of liquidity  in  the  provision  for  regular
                                    amortization of term loans is more than some of these so-called demand loans that are renewed
                                    from year-to-year. Actually, term financing disciplines both the banker and borrower as long-




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