RBI/2008/50
UBD.BPD (PCB) MC. No.5 /13.05.000/2008-09

             July 1, 2008

The Chief Executive Officers of
All Primary (Urban) Co-operative Banks
Dear Sir/Madam,

Master Circular on Management of Advances- UCBs

Please refer to our Master Circular UBD.BPD (PCB) MC. No.9 /13.05.000/2007-08 dated  July 4, 2007 on the captioned subject. The enclosed Master Circular consolidates and updates all the instructions/guidelines on the subject issued upto June 30, 2008.

Yours faithfully,

(A.K Khound)
Chief General Manager-in-Charge

MANAGEMENT OF LOANS AND ADVANCES

1. Background

In the context of rapid growth of primary (urban) co-op. banks (PCBs), qualitative aspects of lending, such as adequacy of lending to meet credit requirements of their borrowers and effective supervision and monitoring of advances have assumed considerable importance. Previously working capital finance provided by the banks to trade and industry was regulated by the Reserve Bank of India through a series of guidelines/instructions issued. There were various quantitative and qualitative restrictions on bank’s lending. The banks were also expected to ensure conformity with the basic financial disciplines prescribed by the RBI from time to time under Credit Authorisation Scheme (CAS).

1.2 However, consistent with the policy of liberalisation and financial sector reforms, several indirect measures to regulate bank credit such as exposure norms for lending to inpidual/group borrowers, prudential norms for income recognition, asset classification and provisioning for advances, capital adequacy ratios, etc. were introduced by RBI and greater operational freedom has been provided to banks in dispensation of credit.

1.3 Banks are now expected to lay down, through their boards, transparent policies and guidelines for credit dispensation, in respect of each broad category of economic activity, keeping in view the credit exposure norms and various other guidelines issued by the Reserve Bank of India from time to time. Some of the currently applicable guidelines are detailed in the following paragraphs.

2. Working Capital requirements UPTO Rs. 1 crore

2.1 The assessment of working capital requirement of borrowers, other than SSI units, requiring fund based working capital limits upto Rs.1.00 crore and SSI units requiring fund based working capital limits upto to Rs.5.00 crore from the banking system may be made on the basis of their projected annual.

2.2 In accordance with these guidelines, the working capital requirement is to be assessed at 25% of the projected turnover to be shared between the borrower and the bank, viz. borrower contributing 5% of the turnover as net working capital (NWC) and bank providing finance at a minimum of 20% of the turnover.

2.3 The banks may, at their discretion, carry out the assessment based on projected turnover basis or the traditional method. If the credit requirement based on traditional production/processing cycle is higher than the one assessed on projected turnover basis, the same may be sanctioned, as borrower must be financed upto the extent of minimum 20 per cent of their projected annual turnover.

2.4 The banks may satisfy themselves about the reasonableness of the projected annual turnover of the applicants, both for new as well as existing units, on the basis of annual statements of accounts or any other documents such as returns filed with sales-tax/revenue authorities and also ensure that the estimated growth during the year is realistic.

2.5 The borrowers would be required to bring in 5 per cent of their annual turnover as margin money. In other words, 25 per cent of the output value should be computed as working capital requirement, of which atleast four-fifth should be provided by the banking sector, the balance one-fifth representing the borrower's contribution towards margin for the working capital. In cases, where output exceeds the projections or where the initial assessment of working capital is found inadequate, suitable enhancement in the working capital limits should be considered by the competent authority as and when deemed necessary. For example, in case, annual turnover of a borrower is projected at Rs. 60.00 lakh, the working capital requirement will be computed at Rs. 15.00 lakh (i.e. 25%) of which Rs. 12 lakh (i.e. 20%) may be provided by the banking system, while Rs. 3.00 lakh (i.e. 5 %) should be borrower's contribution towards margin money.

2.6 Drawals against the limits should, however, be allowed against the usual safeguards so as to ensure that the same are used for the purpose intended. Banks will have to ensure regular and timely submission of monthly statements of stocks, receivables, etc., by the borrowers and also periodical verification of such statements vis-à-vis physical stocks by their officials.

2.7 In regard to the above, few clarifications to some of the issues raised by banks are given in Annex I.

3. Working Capital Requirements ABOVE Rs. 1 crore

3.1 Method of Assessment

The revised guidelines in respect of borrowers other than SSI units, requiring working capital limits above Rs.1 crore and for SSI units requiring fund based working capital limits above Rs.5 crore, from the banking system bestow greater level of flexibility to the primary (urban) co-operative banks in their day-to-day operations without diluting the prudential norms for lending as prescribed by Reserve Bank of India.

3.1.2 The earlier prescription regarding Maximum Permissible Bank Finance (MPBF), based on a minimum current ratio of 1.33:1, recommended by Tandon Working Group has been withdrawn. Banks are now free to decide on the minimum current ratio and determine the working capital requirements according to their perception of the borrowers and their credit needs.

3.1.3 Banks may evolve an appropriate system for assessing the working capital credit needs of borrowers whose requirement are above Rs.1 crore. Banks may adopt any of the under-noted methods for arriving at the working capital requirement of such borrowers.

a) The turnover method, as prevalent for small borrowers may be used as a tool of assessment for this segment as well,

b) Since major corporates have adopted cash budgeting as a tool of funds management, banks may follow cash budget system for assessing the working capital finance in respect of large borrowers.

c) The banks may even retain the concept of the MPBF with necessary modifications.

3.2 Norms for Inventory/Receivables

3.2.1 In order to provide flexibility in the assessment of credit requirements of borrowers based on a total study of borrowers' business operations, i.e., taking into account the production/processing cycle of the industry as well as the financial and other relevant parameters of the borrower, the banks have also been permitted to decide the levels of holding of each item of inventory as also of receivables, which in their view would represent a reasonable build-up of current assets for being supported by bank finance.

3.2.2 Reserve Bank of India no longer prescribes detailed norms for each item of inventory as also of receivables.

3.3 Classification of Current Assets and Current Liabilities

3.3.1 With the withdrawal of MPBF, inventory norms and minimum current ratio, the classification of current assets and current liabilities ceases to be mandatory. The banks may decide on their own as to which items should be included for consideration as current assets or current liabilities.

3.3.2 Banks may also consider evolving suitable internal guidelines for accepting the projections made by their borrowers relating to the item "Sundry Creditors (Goods)" appearing as an item under "Other Current Liabilities" in the balance sheet.

3.4 Bills Discipline

In respect of borrowers enjoying fund-based working capital credit limits of Rs. 5 crore and more from the banking system, the banks are required to ensure that the book-debt finance does not exceed 75 per cent of the limits sanctioned to borrowers for financing inland credit sales. The remaining 25 per cent of the credit sales may be financed through bills to ensure greater use of bills for financing sales.

3.5 Grant of Adhoc Limits

To meet the contingencies, banks may decide on the quantum and period for granting ad hoc limits to the borrowers based on their commercial judgement and merits of inpidual cases. While granting the adhoc limits the banks must ensure that the aggregate credit limits (inclusive of adhoc limits) do not exceed the prescribed exposure ceiling.

3.6 Commitment Charge

The levy of commitment charge is not mandatory and it is left to the discretion of the financing banks/ consortium/syndicate. Accordingly, banks are free to evolve their own guidelines in regard to commitment charge for ensuring credit discipline.

3.7 Consortium Arrangement

The mandatory requirement of formation of consortium for extending working capital finance under multiple banking arrangements has been withdrawn.

3.8 Syndication of Credit

The syndication of loans is an internationally practised model for financing credit requirements. The banks are free to adopt syndication route, irrespective of the quantum of credit involved, if the arrangement suits the borrower and the financing banks.

3.9 Loan System for Delivery of Bank Credit

3.9.1 Background

3.9.2 Loan Component and Cash Credit Component

(i) Banks may change the composition of working capital by increasing the cash credit component beyond 20 per cent or to increase the loan component beyond 80 per cent, as the case may be, if they so desire.

(ii) Banks are expected to appropriately price each of the two components of working capital finance, taking into account the impact of such decisions on their cash and liquidity management.

(iii) If a borrower so desires, higher loan component can be granted by the bank; this would entail corresponding pro-rata reduction in the cash credit component of the limit.

(iv) In the case of borrowers with working capital (fund based) credit limit of less than Rs. 10 crore, banks may persuade them to go in for the Loan System by offering an incentive in the form of lower rate of interest on the 'loan component' as compared to the 'cash credit component' The actual percentage of 'loan component' in these cases may be settled by the bank with its borrower clients.}

(v) In respect of certain business activities which are cyclical and seasonal in nature or have inherent volatility, the strict application of loan system may create difficulties for the borrowers. Banks, may with the approval of their respective Boards, identify such business activities which may be exempt from the loan system of credit delivery.

3.9.3 Adhoc Credit Limit

3.9.4 Sharing of Working Capital Finance

3.9.5 Rate of Interest

3.9.6 Period of Loan

3.9.7 Security

3.9.8 Export Credit

3.9.9 Bills Limit

3.9.10 Renewal/Roll-over of Loan Component

3.9.11 Provision for Investing Short Term Surplus Funds of Borrowers

3.9.12 Applicability

4. Credit Administration

4.1 Rate of interest

4.1.1 UCBs are permitted to determine their lending rates taking into account their cost of funds, transaction costs etc with the approval of their Board. However, banks are advised to ensure that the interest rates charged by them are transparent and known to all customers. Banks are also required to publish the minimum and maximum interest rates charged on advances and display the information in every branch.

4.1.2. It may however be appreciated that though interest rates have been deregulated, rates of interest beyond a certain level may be seen to be usurious and can neither be sustainable nor be conforming to normal banking practice.

4.1.3. Boards of banks are, therefore, advised to lay out appropriate internal principles and procedures so that usurious interest, including processing and other charges, are not levied by them on loans and advances. In laying down such principles and procedures in respect of small value loans, particularly, personal loans and such other loans of similar nature, banks may take into account, inter-alia, the following broad guidelines:

1. An appropriate prior-approval process should be prescribed for sanctioning such loans, which should take into account, among others, the cash flows of the prospective borrower.
2. Interest rates charged by banks, inter-alia, should incorporate risk premium as considered reasonable and justified having regard to the internal rating of the borrower. Further, in considering the question of risk, the presence or absence of security and the value thereof should be taken into account.
3. The total cost to the borrower, including interest and all other charges levied on a loan, should be justifiable having regard to the total cost incurred by the bank in extending the loan, which is sought to be defrayed and the extent of return that could be reasonably expected from the transaction.
4. In the case of loans to borrowers under priority sector, no penal interest should be charged for loans up to Rs.25,000. Penal interest may be levied for reasons such as default in repayment, non-submission of financial statements, etc. However, the policy on penal interest should be governed by well-accepted principles of transparency, fairness, incentive to service the debt and due regard to genuine difficulties of customers.
5. Banks should ensure that the total interest debited to an account should not exceed the principal amount in respect of short term advances granted to small and marginal farmers. The small and marginal farmers for the purpose shall include those with land holding of 5 acres and less.
6. An appropriate ceiling may be fixed on the interest, including processing and other charges that could be levied on such loans, which may be suitably publicised.

4.2 No Objection Certificate

The primary (urban) co-operative banks should not finance a borrower already availing credit facility from another bank without obtaining a 'No Objection Certificate' from the existing financing bank.

4.3 Opening of Current Accounts

4.3.1 Keeping in view the importance of credit discipline for reduction in NPA levels at the time of opening of current accounts banks should:

(i) insist on a declaration from the account holder to the effect that he is not enjoying any credit facility with any other commercial bank or obtain a declaration giving particulars of credit facilities enjoyed by him with any other commercial bank/s.

(ii) ascertain whether he/she is a member of any other co-operative society/bank; if so, the full details thereof such as name of the society/bank, number of shares held, details of credit facilities, such as nature, quantum, outstanding, due dates etc should be obtained.

4.3.2 Further, in case he/she is already enjoying any credit facility from any other commercial/co-operative bank, the bank opening a current account should duly inform the concerned lending bank(s) and also specifically insist on obtaining a "No Objection Certificate" from them. In case of a prospective customer who is a corporate or large borrower enjoying credit facilities from more than one bank, the banks may inform the consortium leader, if under consortium, and the concerned banks, if under multiple banking arrangement. In case a facility has been availed from a co-operative bank/society, it is essential for the bank to comply with the requirements of the Co-operative Societies Act/Rules of the state concerned in regard to membership and borrowings.

4.3.3 Banks may open current accounts of prospective customers in case no response is received from the existing bankers after a minimum waiting period of a fortnight. If a responses is received within a fortnight, banks should assess the situation with reference to information provided on the prospective customer by the bank concerned and are not required to solicit a formal no objection, consistent with true freedom to the customer of banks as well as needed due diligence on the customer by the bank.

4.4 Certification of Accounts of Non-Corporate Borrowers by Chartered Accountants

As per the Income Tax Act, 1961, filing of audited balance sheet and profit & loss account is mandatory for certain types of non-corporate entities. Therefore, the banks must insist on the audited financial statements from the borrowers enjoying large limits; since such borrowers would, in any case, be submitting audit certificate to the income-tax authorities, based on audit of their books of accounts by a Chartered Accountant.

4.5 Defaults in Payment of Statutory Dues by Borrowers

4.5.1 It has been observed that many of the borrowers enjoying credit facilities from primary (urban) co-operative banks default in payment of Provident Fund, Employees State Insurance and other statutory dues. Despite this, such borrowers continue to carry on operations with the assistance of bank finance without meeting their statutory obligations.

4.5.2 In the case of insolvency/winding up of a borrowing employer, under the law, there are certain priorities in regard to the recovery of statutory dues e.g., employees contribution towards provident fund deducted from wages of the employee members for a period of more than six months and not paid to the Commissioner, are a first charge on the assets of borrowers.

4.5.3 In the circumstances, the banks should safeguard their interest vis-à-vis such statutory dues and, therefore, it would be desirable for the banks to ensure that provident funds and similar other dues are paid by the borrowers promptly. For the purpose, the banks should incorporate an appropriate declaration in their application forms for grant/renewal/ enhancement of credit facilities so as to ensure that the position regarding the statutory dues is disclosed therein.

4.5.4 Where warranted, banks should satisfy themselves about genuineness of the party's declaration in this regard. Thus, the sanction/renewal/ enhancement of credit facilities can be utilised by banks as a leverage for enforcing necessary discipline on the part of their borrowers.

4.5.5 In respect of the corporate borrowers and non-corporate borrowers, the amount of statutory dues should normally be reflected in their annual accounts which should be duly certified by the auditors, and hence, the banks should have no difficulty in ascertaining the position of their statutory dues. Nonetheless, in addition to duly audited annual accounts, banks should also obtain a specific certificate from the Chartered Accountant as regards the position of statutory dues, if the audited accounts do not clearly indicate the position.

4.5.6 After ascertaining the quantum of statutory dues, the banks should ensure that these are cleared by the borrowers within a reasonable period and that too through internal generation of funds. The non-payment of statutory dues is one of the symptoms of incipient sickness of an industrial unit. Therefore, it is in the interest of both the lender and borrower to give high priority to the clearance of these dues. Apart from insisting on the borrowers to indicate a definite programme for clearance of arrears, banks may consider suitable restrictions on the outflow of funds by way of pidends, repayment of loans from promoters or their friends, relatives or inter-corporate borrowings etc., till the overdue statutory liabilities are cleared.

4.6 Sanction of Advances

4.6.1 Irregularities/ Deficiencies in Credit Sanction

4.6.2 Delegation of Powers

4.6.3 Oral Sanction

4.6.4 Proper Record of Deviations

(a) Record of such instructions/sanctions should be maintained by the sanctioning/disbursing authorities explaining the circumstances under which sanctions were made.

(b) Written confirmation of the competent sanctioning authority should be obtained by the disbursing authority / official within a week/fortnight.

(c) Sanctions within discretionary powers should also be reported to Head Office within a stipulated time and Head Office should meticulously follow up receipt of such returns.

(d) Head Office should diligently scrutinise the statements/ returns and should initiate stringent action against erring functionary(ies) if he/they is/are found to have indulged in unauthorised sanctioning.

4.7 Monitoring Operations in Loan Accounts

4.7.1 persion of Funds

4.7.1.5 Whenever stocks under hypothecation to cash credit and other loan accounts are found to have been sold but the proceeds thereof not credited to the loan account, such action should normally be treated as a fraud. In such cases, banks may take immediate steps to secure the remaining stock so as to prevent further erosion in the value of the available security as also other action as warranted.

4.7.2 Post-Sanction Monitoring

1. It is the primary responsibility of banks to be vigilant and ensure proper end use of bank funds /monitor the funds flow. It is, therefore, necessary for banks to evolve such arrangements as may be considered necessary to ensure that drawals from cash credit/overdraft accounts are strictly for the purpose for which the credit limits are sanctioned by them. There should be no persion of working capital finance for acquisition of fixed assets, investments in associate companies/subsidiaries, and acquisition of shares, debentures, units of Unit Trust of India and other mutual funds, and other investments in the capital market. This has to be so, even if there is sufficient drawing power/undrawn limit for the purpose of effecting drawals from the cash credit account.
2. Post sanction follow-up of loans and advances should be effective so as to ensure that the security obtained from borrowers by way of hypothecation, pledge, etc. are not tampered with in any manner and are adequate.
3. Accounts showing sign of turning into NPAs: Banks may put in place more stringent safeguards, especially where accounts shows sign of turning into NPAs. In such cases banks may strengthen their monitoring system by resorting to more frequent inspections of borrowers' godowns, ensuring that sale proceeds are routed through the borrower's accounts maintained with the bank and insisting on pledge of the stock in place of hypothecation.
4. Drawals against clearing cheques should be sanctioned only in respect of first class customers and even in such cases the extent of limits and the need therefor should be subjected to thorough scrutiny and periodical review. Banks should not issue banker’s cheques/pay orders/demand drafts against instruments presented for clearing, unless the proceeds thereof are collected and credited to the account of the party. Further, banker’s cheques /pay orders/ demand drafts, should not be issued by debit to cash credit /over draft accounts which are already overdrawn or likely to be overdrawn with the issue of such instruments.
5. Drawals against clearing instruments should be normally confined to bank drafts and government cheques and only to a limited extent against third party cheques.
6. (v) Cheques against which drawals are allowed should represent genuine trade transactions and strict vigilance should be observed against assisting kite-flying operations.
7. Drawals against cheques of allied /sister concerns should not be permitted and the facility of drawal against clearing cheques should normally be of temporary nature and should not be allowed on a regular basis without proper scrutiny and appraisal.
   
8. Bills of accommodation nature should never be purchased and the officials responsible for purchase of such bills should be punished suitably.

4.7.3 Responsibility

(ii) Banks should take serious view of instances of misuse of power, corruption and other malpractices indulged by the members of staff and erring staff members should be given punishments befitting the seriousness of the irregularity. Light punishments such as issue of warning, stoppage of increments, transfer, etc. may not prove a deterrent in all cases. Quick disposal of enquiries by the banks and award of deterrent punishment would be necessary in all such cases, The Board should take more active interest in these matters.

4.8 Annual Review of Advances

For an effective monitoring of the advances, it is imperative for the banks to undertake an exercise for review of the advances on a regular basis. Apart from the usual objective of such a review of assessing the quality of operation, safety of funds, etc. the review should specifically attempt to make an assessment of the working capital requirements of the borrower based on the latest data available, whether limits continue to be within the need-based requirements and according to the bank's prescribed lending norms.

4.9 Valuation of properties-empanelment of valuers:

It has been observed that different banks follow different policies for valuation of properties and appointment of valuers for the purpose. The issue of correct and realistic valuation of fixed assets owned by banks and that accepted by them as collateral for a sizable portion of their advances portfolio assumes significance in view of its implications for correct measurement of capital adequacy position of banks. Banks are therefore advised to put in place a system/procedure for realistic valuation of fixed assets and also for empanelment of valuers for the purpose as per the guidelines given at Annex II.

5. Other Guidelines

5.1 Guidelines on Relief Measures to be Extended by Banks in Areas Affected by Natural Calamities--

5.1.1 The primary (urban) co-operative banks are expected to provide relief and rehabilitation assistance, in their area of operation to people affected by natural calamities such as droughts, floods, cyclones, etc. Reserve Bank of India has from time to time issued guidelines/instructions to banks in regard to relief measures to be provided in areas affected by natural calamities. These guidelines have been consolidated and are given in Annex III

5.1.2 In order to avoid delay in taking relief measures on the occurrence of natural calamity, banks should evolve a suitable policy framework with the approval of the Board of Directors. An element of flexibility may be provided in the measures so as to synchronise the same with the measures which could be appropriate in a given situation in a particular State or District and parameters, in this regard, may be decided in consultation with SLBC/DCC, as the case may be.

5.1.3 Banks should get the documentation settled as per revised guidelines in consultation with their legal departments, taking into account the relevant provisions of the Contract Act and the Limitations Act and may issue appropriate instructions to their offices in respect of documentation in relation to cases covered by these guidelines.

5.1.4 Whenever required, RBI advises the banks to follow these guidelines in respect of persons affected by riots and disturbances.

5.2 Disclosure of Information on Defaulting Borrowers of Banks and Financial Institutions

5.2.1 The Reserve Bank of India has been collecting information regarding defaulting borrowers and suit filed accounts of scheduled commercial banks and financial institutions for circulation among banks and financial institutions to put them on guard against such defaulters.

5.2.2 Similar information has also to be collected from scheduled primary (urban) co-operative banks. These banks are, therefore, required to submit to the Reserve Bank of India as at the end of September and March every year, the details of the borrowal accounts which have been classified as doubtful, loss or suit filed with outstanding (both under funded and non-funded limits) aggregating Rs. 1 crore and above as per the format given in Annex IV.

5.2.3 The Reserve Bank of India is circulating to the banks and financial institutions the information on the defaulters (i.e., advances classified as doubtful and loss). The banks and financial institutions may make use of the information while considering the merits of the requests for new or additional credit limits by existing and new constituents.

5.2.4 The data on borrowal accounts against which suits have been filed for recovery of advances (outstanding aggregating Rs.1.00 crore and above) and suit filed accounts of wilful defaulters with outstanding balance of Rs 25 lakh and above , based on information furnished by scheduled commercial banks and financial institutions is available at www.cibil.com

5.2.5 It is likely that some of the borrowers named in the list of suit filed accounts may approach the scheduled primary (urban) co-operative banks for their credit requirements. The information available will be of immense use to scheduled primary (urban) co-operative banks, while considering requests for fresh/additional credit limits. The banks can verify the list to ensure that the defaulting borrowing units as also their proprietors/partners/ directors etc. named in the list of suit-filed accounts, either in their own names or in the names of other units with which they are associated, are not extended further credit facilities.

5.2.6 The banks may make enquiry, if any, about the defaulters from the reporting bank/ financial institution.

6 MONITORING OF WILFUL DEFAULTERS

6.1 Collection and dissemination of information on cases of wilful default of Rs. 25.00 lakh and above

6.1.1 Pursuant to the instructions of the Central Vigilance Commission for collection of information on wilful defaulters by RBI and dissemination to the reporting banks and financial institutions, a scheme has been framed under which the banks and financial institutions will be required to submit the details of the wilful defaulters. The scheduled primary (urban) co-operative banks have also been brought within the ambit of the scheme.

6.1.2 The details of the scheme are given below:

(i) The scheme has come into force with effect from 1st April 1999. Accordingly, scheduled primary (urban) co-operative banks are required to report on a quarterly basis, all cases of wilful defaults which occurred, or are detected after 31st March 1999 in the proforma given in Annex V.

(ii) The scheme covers all non-performing borrowal accounts with outstanding (funded facilities and such non-funded facilities which are converted into funded facilities) aggregating to Rs. 25.00 lakh and above.

6.2 Wilful Default

A wilful default would be deemed to have occurred if any of the following events noted:

1. The unit has defaulted in meeting its payment / repayment obligations to the lender even when it has the capacity to honour the said obligation.
2. The unit has defaulted in meeting its payment / repayment obligation to the lender and has not utilized the finance from the lender for the specific purposes for which finance was availed of but has perted the funds for other purposes.
3. The unit has defaulted in meeting its payment / repayment obligations to the lender and has siphoned off the fund so that the funds have not been utilized for the specific purpose for which finance was availed of, nor are the funds available with the unit in the form of other assets.
4. The unit has defaulted in meeting its payment / repayment obligation to the lender and has also disposed of or removed the movable fixed assets or immovable property given by it for the purpose of securing a term loan, without the knowledge of the bank / lender.

6.3 persion and siphoning of funds

6.3.1 persion of funds would be construed to include any one of the under-noted occurrences:

(a) utilisation of short-term working capital funds for long-term purposes not in conformity with the terms of sanctions;
(b) deploying borrowed funds for purposes / activities or creation of assets other than those for which the loan was sanctioned;
(c) transferring funds to the subsidiaries / group companies or other corporates by whatever modalities;
(d) routing of funds through any bank other than the lender bank or members of consortium without prior permission of the lender;
(e) investment in other companies by way of acquiring equities / debt instruments without approval of lenders;
(f) short fall in deployment of funds vis-à-vis the amounts disbursed / drawn and the difference not being accounted for.

6.3.2 Siphoning of funds should be construed to have occured if any funds borrowed are utilised for purposes unrelated to the operations of the borrower, to the detriment of the financial health of the entity or of the lender. The decision as to whether a particular instance amounts to siphoning of funds would have to be a judgement of the lenders based on objective facts and circumstances of the case.

6.4 Cut-off limits

6.5 End-use of Funds

In cases of project financing, banks should seek to ensure end use of funds by, inter alia, obtaining certification from the Chartered Accountants for the purpose. In case of short-term corporate / clean loans, such an approach ought to be supplemented by `due diligence' on the part of lenders themselves, and to the extent possible, such loans should be limited to only those borrowers whose integrity and reliability were above board. UCBs therefore, should not depend entirely on the certificates issued by the Chartered Accountants but strengthen their internal controls and the credit risk management system to enhance the quality of their loan portfolio. Needless to say, ensuring end-use of funds by banks should form a part of their loan policy document for which appropriate measures should be put in place.

6.5.1 The following are the illustrative measures that could be taken by the lenders for monitoring and ensuring end-use of funds :

1. Meaningful scrutiny of quarterly progress reports / operating statements / balance sheets of the borrowers ;
2. Regular inspection of borrowers' assets charged to the lenders as security;
3. Periodical scrutiny of borrowers' books of accounts and the no-lien accounts maintained with other banks;
4. Periodical visits to the assisted units;
5. System of periodical stock audit, in case of working capital finance;
6. Periodical comprehensive management audit of the `Credit' function of the lenders, so as to identify the systemic weaknesses in the credit-administration.

6.6.Penal measures

In order to prevent access to the capital markets by the wilful defaulters, a copy of the list of wilful defaulters is forwarded by RBI to SEBI as well. It has also been decided that the following measures should be initiated by scheduled PCBs against the wilful defaulters

1. No additional facilities be granted to the listed wilful defaulters. In addition, the entrepreneurs / promoters of companies where banks have identified siphoning / persion of funds, misrepresentation, falsification of accounts and fraudulent transactions should be debarred from institutional finance for floating new ventures for a period of 5 years from the date the name of the wilful defaulter is published in the list of wilful defaulters by the RBI.
2. The legal process, where warranted, against the borrowers/guarantors and foreclosure of loans should be initiated expeditiously. The lenders may also initiate criminal proceedings against wilful defaulters, wherever necessary.
3. Wherever possible, the banks should adopt a proactive approach for a change of management of the wilfully defaulting borrower unit. It would be imperative on the part of the banks to put in place a transparent mechanism for the entire process so that the penal provisions are not misused and the scope of such discretionary powers is kept to the barest minimum. It should be ensured that a solitary or isolated instance is not made the basis for imposing penal measures.

6.7 Treatment of Group

While dealing with wilful default of a single borrowing company in a group, the banks should consider the track record of the inpidual company, with reference to its repayment performance to its lenders. However, in cases where a letter of comfort and/or the guarantees furnished by the companies within the group on behalf of the wilfully defaulting units are not honoured when invoked by scheduled banks, such group companies should also be reckoned as wilful defaulters.

6.8 Role of Auditors

6.8.1 In case any falsification of accounts on the part of the borrowers is observed by banks, they should lodge a formal complaint against the auditors of the borrowers, with Institute of Chartered Accountant of India (ICAI) if it is observed that the auditors were negligent or deficient in conducting the audit to enable the ICAI to examine and fix accountability of the auditors.

6.8.2 With a view to monitoring the end-use of funds, if the lenders desire a specific certification from borrowers' auditors regarding diversion / siphoning of funds by the borrower, the lender should award a separate mandate to the auditors for the purpose. To facilitate such certification by the auditors scheduled pcbs will also need to ensure that appropriate covenants in the loan agreements are incorporated to enable award of such a mandate by the lenders to the borrowers / auditors.

6.9 Filing of Suits to Recover Dues from Wilful Defaulters

6.9.1 There are few cases where the amount outstanding is substantial but the banks have not initiated any legal action against the defaulting borrowers. It may be noted that the cases of wilful defaults have an element of fraud and cheating and therefore, should be viewed differently.

6.9.2 Scheduled pcbs should examine all cases of wilful defaults of Rs. 1.00 crore and above and file suits in such cases, if not already done. Banks should also examine whether in such cases of wilful defaults, there are instances of cheating/fraud by the defaulting borrowers and if so, they should also file criminal cases against those borrowers. In other cases involving amounts below Rs. 1.00 crore, banks should take appropriate action, including legal action, against the defaulting borrowers.

7. Small and Medium Enterprises (SMEs) and its restructuring-

As part of announcement made by the Government of India for improving flow of credit to small and medium enterprises, certain guidelines have been issued to UCBs for restructuring of debt of all eligible small and medium enterprises (SMEs). Details are furnished in Annex VI. Consequent to the enactment and notification of the Micro, Small and Medium Enterprises Development (MSMED) Act 2006 on June 16, 2006 and October 2, 2006, respectively, the definition of micro, small and medium enterprises engaged in manufacturing or production and in providing or rendering of services has been modified and is required to be implemented by the banks with immediate effect. (Details in Annex VII)

8. SPECIFIC LENDING ACTIVITIES

8.1 Bridge Loans/Interim Finance

8.1.1 The grant of bridge loan/interim finance by pcbs to any company (including finance companies) is totally prohibited.

8.1.2 The ban on sanction of bridge loans/interim finance is also applicable in respect of Euro issues.

8.1.3 The banks should not circumvent these instructions by purport and/or intent by sanction of credit under a different nomenclature like unsecured negotiable notes, floating rate interest bonds, etc. as also short-term loans, the repayment of which is proposed/expected to be made out of funds to be or likely to be mobilised from external/other sources and not out of the surplus generated by the use of the asset(s).

8.1.4 If any bank has sanctioned and disbursed any bridge loan/interim finance, it should report the same to the concerned Regional Office of the Urban Banks Department with full particulars and certifying that the loans are utilised strictly for the purpose for which the public issue and/or market borrowing was intended. Thereafter, the concerned banks should immediately take steps to ensure timely repayment of such bridge loans/interim finance already sanctioned and disbursed and under no circumstances, should the banks allow extension of time for repayment of existing bridge loans/interim finance.

8.1.5 These instructions are issued by the Reserve Bank of India in exercise of powers conferred by the Sections 21 and 35A read with section 56 of the Banking Regulation Act, 1949.

8.2 Advances to Builders/Contractors

8.2.1 The builders/contractors, who generally require, huge funds, take advance payments from the prospective buyers or from those on whose behalf construction is undertaken and, therefore, may not normally require bank finance for the purpose. Any financial assistance extended to them by banks may result in dual financing. The banks should, therefore, normally refrain from sanctioning loans and advances to this category of borrowers.

8.2.2 However, where contractors undertake comparatively small construction work on their own, (i.e. when no advance payments are received by them for the purpose), the banks may consider extending financial assistance to them against the hypothecation of construction materials, provided such loans and advances are in accordance with the by-laws of the bank.

8.2.3 The banks should frame comprehensive prudential norms relating to the ceiling on the total amount of real estate loans, single/aggregate exposure limit for such loans, margins, security, repayment schedule and availability of supplementary finance taking into account guidelines issued by RBI and the policy should be approved by the bank's Board.

8.2.4 Exposure to builders and contractors for commercial real estate will include fund based and non-fund based exposures secured by mortgages on commercial real estates (office buildings, retail space, multi-purpose commercial premises, multi-family residential buildings, multi-tenanted commercial premises, industrial or warehouse space, hotels etc). Further while framing the policy the banks may also consider for inclusion the National Building Code framed by Bureau of Indian Standards (BIS). For detailed information the website of Bureau of Indian Standards (www.bis.org.in ) can be accessed.

8.2.5 Banks should undertake a proper scrutiny of the relevant loan applications, and satisfy themselves, among other things, about the genuineness of the purpose, the quantum of financial assistance required, creditworthiness of the borrower, his repayment capacity, etc. and also observe the usual safeguards, such as, obtaining periodical stock statements, carrying out periodical inspections, determining drawing power strictly on the basis of the stock held, maintaining a margin of not less than 40 to 50 percent, etc. They should also ensure that materials used up in the construction work are not included in the stock statements for the purpose of determining the drawing power.

8.2.6 The banks may also take collateral security, wherever available. As the construction work progresses the contractors will get paid and such payments should be applied to reduce the balance in the borrowal accounts. If possible, the banks could perhaps enter into a tripartite agreement with the borrower and his clients, particularly when no collateral securities are available for such advances. Thus, the banks should ensure that bank credit is used for productive construction activity and not for activity connected with speculation in real estate

8.2.7 UCBs should not extend fund based / nonfund based facilities to builders / contractors for acquisition of land even as a part of a housing project. Further, wherever land is accepted as collateral, valuation of such land should be at the current market price only.

8.3 Financing of Leasing/Hire Purchase Companies

8.3.1 Enrolment of Financial Companies as Members

1. Primary (urban) co-operative banks are normally not expected to enroll non-banking financial institutions like investment and financial companies as their members since it would be in contravention of the State Co-operative Societies Act concerned and will also not be in conformity with the provisions of model by-law No.9 recommended for adoption, by all banks.
   
   
2. Therefore, the primary (urban) co-operative banks are not permitted to finance such type of non-banking financial companies (NBFCs).

8.3.2 Norms for financing Leasing/Hire Purchases Companies

1. As in the case of finance and investment companies, admission of non-banking financial companies which are not engaged exclusively in leasing/hire purchase business as members may be contrary to the provisions contained in the state co-operative societies act concerned and model bye-law No.9 referred to above. It will, therefore, be necessary for banks to obtain prior approval of the concerned Registrar of Co-operative Societies before admitting them as members.
   
2. Even financing the leasing/hire purchase companies by primary (urban) co-operative banks on a large scale is not favoured by the Reserve Bank of India, since the banks are basically required to cater to the credit needs of the people of small means.
3. Presently banks with working capital funds aggregating to Rs. 25 crore and above only are permitted to take up the financing of leasing/hire purchase companies, that too, only in consortium with other scheduled commercial banks. The banks should observe the following norms, while financing such companies :
   
   
(a) The level of finance to leasing/hire purchase companies depends on the net owned funds of the companies, subject to the overall ceiling on their borrowings upto ten times of their owned funds.

(b) Bank credit to companies exclusively engaged in equipment leasing and hire purchases and such leasing/hire purchase companies which are predominantly engaged in equipment leasing/hire purchase business (i.e., at least 75 per cent of assets are in equipment leasing/hire purchase and 75 per cent of their gross income is derived from these two types of activities as per their last audited balance sheet) may be extended within the ceiling of three times of the net owned funds within the overall ceiling of their borrowings upto ten times of net owned funds.

( c) In the case of other equipment leasing/hire purchases companies (i.e. companies whose assets in equipment leasing/hire purchase business are less than 75 per cent and whose gross income derived from these two types of activities as per the last audited balance sheet is less than 75 per cent of its gross income), the credit limit has to be within two times of their net owned funds from the present level of four times.

8.4 Working Capital Finance to Information Technology (IT) and Software Industry

8.4.1 Banks are permitted to decide on their own the loan policy and the manner of estimating the working capital finance based on MPBF method or any other method to be approved by their Board of Directors. The stance of Reserve Bank policy towards operational freedom to banks remains unchanged. At the same time, Reserve Bank recognises the fact that the banks are not comfortable with extending aggressive credit support to a relatively new area of software industry unlike other traditional industries, due to several factors which make the assessment of credit needs and follow up thereof difficult, if not insurmountable.

8.4.2 In order to bring about uniformity in approach, the Reserve Bank has formulated guidelines for information of banks, on various aspects of lending to information technology and software industry to facilitate free flow of credit. The same were enclosed to our circular DS.SUB.No.4/13.05.00/98-99 dated 5 October 1998, addressed to scheduled PCBs. Banks are, however, free to modify the guidelines based on their own experience without reference to Reserve Bank to achieve the purpose of the guidelines in letter and spirit.

8.4.3 These guidelines have been framed based on the recommendations made by the study group appointed by Reserve Bank to study the modalities of credit extension to software industry as also taking into account the suggestions made by the industry associations.

8.4.4 This being a relatively new area of credit deployment, primary (urban) co-operative banks may take adequate steps to develop expertise in this area. Besides other measures which banks might take, the need for training staff for developing them in acquiring skills of project appraisal in this new area of activity need not be over-emphasised. It has to be ensured that the concerned staff is well aware of the requirements of the industry and remain in tune with the latest developments so that the higher standards of project appraisal can be maintained before extending the working capital finance to Information Technology and software industries.

8.5 Advances against Gold:

8.5.1 Bullet Repayment: UCBs with the approval of their Board may permit bullet repayment of gold loans up to Rs 1.00 lakh as an additional option subject to the following guidelines :

(i) The amount of gold loan sanctioned should not exceed Rs 1.00 lakh at any point of time.
(ii) The period of the loan shall not exceed 12 months from the date of sanction.
(iii) Interest will be charged to the account at monthly rests but will become due for payment along with principal only at the end of 12 months from the date of sanction.
(iv) The bank should prescribe a minimum margin to be maintained in case of such loans and accordingly, fix the loan limit taking into account the market value of the security (gold / gold ornaments), expected price fluctuations, interest that will accrue during the tenure of the loan etc.
(v) Such loans shall be governed by the extant income recognition, asset classification and provisioning norms which shall be applicable once the principal and interest become overdue.
(vi) The account would also be classified as NPA (sub standard category) even before the due date of repayment, if the prescribed margin is not maintained.

Crop loans sanctioned against the collateral security of gold / gold ornaments shall continue to be governed by the extant income recognition, asset classification and provisioning norms for such loans

8.5.2 Hallmarking of gold jewellery ensures the quality of gold used in the jewellery as to caratage, fineness and purity. Banks would find granting of advances against the security of such hallmarked jewellery safer and easier. Preferential treatment of hallmarked jewellery is likely to encourage practice of hallmarking which will be in the long-term interest of consumers, lenders and the industry. Therefore, banks while considering granting advances against jewellery may keep in view the advantages of hallmarked jewellery and decide on the margin and rates of interest thereon.

8.6 Grant of loans for acquisition of of/investing in small savings instruments including Kisan Vikas Patras:

Grant of loans for acquiring/investing in KVPs does not promote fresh savings and, rather , channelise the existing savings in the form of bank deposits to small savings instruments and thereby defeat the very purpose of such schemes. Banks may therefore ensure that no loans are sanctioned for acquisition of/investing in small savings instruments including Kisan Vikas Patras.

9. DISCOUNTING / REDISCOUNTING OF BILLS BY BANKS

Banks may adhere to the following guidelines while purchasing / discounting / negotiating / rediscounting of genuine commercial / trade bills:

1. Since banks have already been given freedom to decide their own guidelines for assessing / sanctioning working capital limits of borrowers, they may sanction working capital limit as also bills limit to borrowers after proper appraisal of their credit needs and in accordance with the loan policy as approved by their Board of Directors.
2. Banks should clearly lay down a bills discounting policy approved by their Board of Directors, which should be consistent with their policy of sanctioning of working capital limits. In this case, the procedure for Board approval should include banks’ core operating process from the time the bills are tendered till these are realised. Banks may review their core operating processes and simplify the procedure in respect of bills financing. In order to address the oft-cited problem of delay in realisation of bills, banks may take advantage of improved computer / communication network like Structured Financial Messaging System (SFMS), wherever available, and adopt the system of ‘value dating’ of their clients’ accounts.
3. Banks should open letters of credit (LCs) and purchase / discount / negotiate bills under LCs only in respect of genuine commercial and trade transactions of their borrower constituents who have been sanctioned regular credit facilities by the banks. Banks should not, therefore, extend fund based (including bills financing) or non-fund based facilities like opening of LCs, providing guarantees and acceptances to non-constituent borrower or / and non-constituent member of a consortium / multiple banking arrangement.
4. For the purpose of credit exposure, bills purchased / discounted / negotiated under LC (where the payment to the beneficiary is not made ‘under reserve’) will be treated as an exposure on the LC issuing bank and not on the borrower. All clean negotiations as indicated above , will be assigned the risk weight as is normally applicable to inter-bank exposures, for capital adequacy purposes. In the case of negotiations ‘under reserve’ the exposure should be treated as on the borrower and risk weight assigned accordingly.
5. While purchasing / discounting / negotiating bills under LCs or otherwise, banks should establish genuineness of underlying transactions / documents.
6. Banks should ensure that blank LC forms are kept in safe custody as in case of security items like blank cheques, demand drafts etc. and verified / balanced on daily basis. LC forms should be issued to customers under joint signatures of the bank’s authorised officials.
7. The practice of drawing bills of exchange claused ‘without recourse’ and issuing letters of credit bearing the legend ‘without recourse’ should be discouraged because such notations deprive the negotiating bank of the right of recourse it has against the drawer under the Negotiable Instruments Act. Banks should not, therefore, open LCs and purchase / discount / negotiate bills bearing the ‘without recourse’ clause.
8. Accommodation bills should not be purchased / discounted / negotiated by banks. The underlying trade transactions should be clearly identified and a proper record thereof maintained at the branches conducting the bills business.
9. Banks should be circumspect while discounting bills drawn by front finance companies set up by large industrial groups on other group companies.
10. Bills rediscounts should be restricted to usance bills held by other banks. Banks should not rediscount bills earlier discounted by non-bank financial companies (NBFCs) except in respect of bills arising from sale of light commercial vehicles and two / three wheelers.
11. Banks may exercise their commercial judgment in discounting of bills of services sector. However, while discounting such bills, banks should ensure that actual services are rendered and accommodation bills are not discounted. Services sector bills should not be eligible for rediscounting. Further, providing finance against discounting of services sector bills may be treated as unsecured advance and therefore, should be within the limits prescribed by UBD for sanction of unsecured advances.
12. In order to promote payment discipline which would to a certain extent encourage acceptance of bills, all corporate and other constituent borrowers having turnover above threshold level as fixed by the bank’s Board of Directors should be mandated to disclose ‘aging schedule’ of their overdue payables in their periodical returns submitted to banks.
13. Banks should not enter into Repo transactions using bills discounted / rediscounted as collateral.

Any violation of these instructions will be viewed seriously and invite penal action from RBI.

Appendix

Master Circular
Management of Advances
A. List of Circulars consolidated in the Master Circular

B. List of Other Circulars from which instructions relating to Management of Advances have also been consolidated in the Master Circular