RBI's new norms to force small businesses to get cash management act right

From the start of this fiscal, firms with a working capital limit of Rs 150 crore and above will first have to avail of 40% of it in the form of a working capital demand loan

A new credit regime is upon us, and borrowers will have to grin and bear for a while. Effective from the start of this fiscal, firms with a working capital limit of Rs 150 crore and above will first have to avail of 40 per cent of it in the form of a “working capital demand loan”; and from July 1, it will move up to 60 per cent. It’s a departure from the current practice wherein banks have to maintain adequate cash or liquidity to meet a borrower’s requirement time to time even as borrowers with surplus cash typically reduce the utilisation of their limits. In both cases, the burden of cash management rests with a bank — RBI has moved the same to borrowers.

The change, according to Ananda Bhaumik, managing director and chief analytical officer at India Ratings can be tough on medium-sized and smaller entities which will have promptly invest in cash management systems. That said in view of relatively non-conducive market conditions and a rise in corporate leverage, borrowers could face challenges in repaying their working capital loan (WCL) component, as and when due. In particular, nearly Rs 7.6 trillion worth of debt, as on end-March 2019, of the top 500 debt-heavy corporates would be due for repayment through FY20; and nearly Rs 4.1 trillion of the due debt is required to be rolled over. “Failure of the rollover could lead to a significant shortfall between debt servicing requirements and operating cash flows”, he says.

Many of the smaller firms have raised the issue with their bankers; some even expect the latter to lobby Mint Road on it. It’s unlikely the banking regulator will budge on this as it will eventually lead to better transparency and credit discipline. You get a sense of deja vu -- back in April 1996, Mint Road had with a view to strengthening credit discipline, reduced the cash credit component (for borrowers with a maximum permissible bank or MPBF of Rs 20 crore and above) to 40 per cent of the MPBF and the loan component raised to 60 per cent. For MPBF of Rs 10 crore and above but less than Rs 20 crore, the cash credit and loan components were at 60:40. It had made an allowance for the smaller players, but the current regime is a one size fits all approach.

An analyst with ICRA says a borrower who is currently able to fully utilise the sanctioned revolving bank facilities such as cash credit and overdraft, without having to bear the burden of principal repayment (given the absence of a pre-defined repayment schedule for such facilities) will now have to adjust to the new paradigm whereby at least 40-60 per cent of the working capital borrowings would have a defined repayment schedule. “Banks will have the discretion to stipulate repayment of the ‘loan component’ in instalments or by way of a bullet repayment, subject to the tenor not being less than seven days and likely within one year,” he notes.

While borrowers with a strong position in credit markets may not find it difficult to roll over their maturing WCL, there could be borrower-specific or market-related credit events, which could lead to a tight situation. Borrowers with a relatively high proportion of working capital borrowings, such as those from the gems and jewellery and metals and mining sectors, are likely to require the largest part of the loan component -- and these sectors are some of the most stressed too. In the case of the power sector, a large portion of the rollover requirement to originate from thermal power producers, which typically are required to procure coal on a cash payment and, or advance basis. “The receivable collection period of thermal power producers is 30-120 days. Nonetheless, despite the high rollover requirement, there are no borrowers from the power sector that are likely to be in the very high-risk bucket,” adds Bhaumik.

The other variable is that banks will need to set aside capital for the unused portion of a working capital facility. And that may be seen in higher pricing of these loans. The most interesting bit is the one-day default norm in the now withdrawn Reserve Bank of India’s (RBI) February 12 circular on credit facilities that have a pre-defined repayment schedule. “But rating agencies recognise default on cash credit and overdraft facilities only when such facilities are continuously overdrawn for more than 30 days. This distinction in the regulatory definition might also push up default rates upon an increase in the proportion of the loan component in working capital facilities,” says the ICRA analyst.

Working capital will have to work a bit harder.