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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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