Vinu: Manu, when we sanction credit facilities like Cash Credit or Term Loan, how do we decide what margin percentage to keep?
Manu: Good question, Vinu. The margin is the portion the borrower contributes from their own funds. It ensures they have a financial stake in the business and reduces the bank’s exposure. The percentage of margin isn’t fixed—it depends on multiple factors such as the type of facility, the kind of asset being financed, and how risky the borrower is.
Vinu: So what factors should a banker consider before finalizing the margin?
Manu:
Let me break it down:
First, we look at the nature of the facility. For working capital facilities like Cash Credit, the approach is different from Term Loans which are used to fund fixed assets.
Second, we consider the type of asset. If it’s something that depreciates quickly, like electronic equipment or vehicles, we usually ask for a higher margin. If it’s a stable asset like land or building, the margin might be a bit lower.
Third, the borrower’s risk profile matters a lot. A new or financially weak business will be asked to contribute more. If the borrower has a strong track record and good internal credit rating, we may offer a slightly relaxed margin.
Fourth, we must check if any regulatory guideline applies. For example, RBI sometimes prescribes minimum margins for certain sectors like gold loans or priority sector lending.
Fifth, each bank has its own lending policy approved by its board. That policy often has recommended margins for different types of loans and industries.
Lastly, if the borrower offers additional collateral, the bank might decide to reduce the margin required on the primary asset.
Vinu: Understood. Let’s focus on Cash Credit now. Apart from the recommendations of the Tandon and Nayak Committees, what else should we consider when fixing margin?
Manu:
Besides those guidelines, we should look into a few practical areas. For example, check the quality of the inventory and receivables. If there’s a lot of slow-moving stock or old receivables, we should ask for a higher margin.
Also, understand the business cycle. If it's a seasonal business, the working capital requirement may not be consistent throughout the year, so we need to apply our judgement.
We should also study their cash flows—do they have sufficient cash inflow to justify the working capital need?
GST returns are another useful source of information. If actual sales from GST filings don’t match the turnover projections, it may be a red flag.
And finally, we should look at past stock statements. If they fluctuate abnormally, or seem inflated during loan renewal, we need to be cautious.
Vinu: Makes sense. And what about Term Loans? How is margin fixed there?
Manu:
Term Loans are generally sanctioned for acquiring fixed assets like machinery, equipment, or buildings. The margin depends on what kind of asset is being financed. For example, machinery and vehicles usually require a lower margin, while real estate requires a higher margin.
We also consider how fast the asset depreciates or loses its value. If the resale value is low, we need a higher margin.
The stage of the business matters too. A well-established company might be asked for 25 to 30 percent margin, while a newly set-up business may be asked for 35 to 40 percent.
We also evaluate project risks. For example, infrastructure projects often face cost overruns, so we build in extra margin as a cushion.
Lastly, if there's any government subsidy or incentive coming into the project, we factor that into the margin calculation too.
Vinu: Can you give some idea of what margin percentages are usually expected?
Manu:
Sure, but these are just ballpark figures and can vary from bank to bank. For working capital finance like Cash Credit, a 25 percent margin on inventory and receivables is quite common. For micro or small businesses under the turnover-based method, the margin may be around 20 to 25 percent.
For Term Loans, the margin can range from 15 to 30 percent for machinery and vehicles, and around 30 to 40 percent for buildings or real estate. But again, it all depends on the asset, borrower, and risk involved.
Vinu: So, there’s no fixed margin percentage—it’s all about context?
Manu: Exactly! Margin should be determined thoughtfully, depending on the borrower’s financial strength, nature of the asset, past repayment record, and overall risk. It’s a balancing act between protecting the bank and supporting the borrower’s growth.
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