Working capital funding is an important support framework of business viability and expansion, enabling organizations to efficiently manage their daily operations and attain financial stability. In the years that have passed since, the scene of working capital financing in India has been dramatically changed by developments in the business environment, shifting business requirements and progress in financial technology.
What had been so heavily reliant on hard-and-fast rules and fixed proportions is now a more flexible, more businesslike approach to financing.
The age-old Maximum Permissible Bank Finance (MPBF) model of working capital financing has been a dominant method of determining the maximum permissible credit limits for businesses in India for decades. This model, introduced by the Tandon Committee, which was established by the Reserve Bank of India in 1974, was primarily focused on assessing a business’s financial health based on its assets, liabilities, and current operational requirements The Reserve Bank of India (RBI) withdrew the concept of Maximum Permissible Bank Finance (MPBF) on April 15, 1997. However, at the same time, Banks were given freedom to decide on the minimum current ratio and determine the working capital requirements according to their perception of the borrowers and their credit needs. Banks were also allowed to retain the concept of the Maximum Permissible Bank Finance (MPBF) with necessary modifications in the case of borrowers whose requirement may be above Rs.1 crore. Before delving into the enduring role in Working Capital Finance of Maximum Permissible Bank Finance (MPBF), let its aspects be understood.
Understanding of Maximum Permissible Bank Finance (MPBF)
To understand the MPBF better and in detail we will try to define its meaning, components and calculations. We will delve deeper to understand its benefits and drawbacks. Later we will critically evaluate the importance of Maximum Permissible Bank Finance (MPBF) in forming a framework for future lending practices and RBI guidelines thereof.
What is Maximum Permissible Bank Finance (MPBF)?
Maximum Permissible Bank Finance (MPBF) is a method utilized by banks of India for finding the highest possible working capital finance that could be extended to the borrower. It is largely based on the borrower’s short-term financial need, its value of current assets, and the amount of working capital required to perform its business activities. Maximum Permissible Bank Finance (MPBF) can be calculated by looking at a company’s current liabilities, current assets, and the way they balance with one another in an effort to keep the business in liquidity that will suffice to meet its short-term financial obligations.
Maximum Permissible Bank Finance (MPBF) is generally used by banks to provide working capital loans to businesses so that businesses can satisfy their running expenses on a daily basis. It simply puts a ceiling on the amount of working capital which a bank wants to grant as per the finance of the borrower.
Components of Maximum Permissible Bank Finance (MPBF)
The bank would determine the available credit limit using a calculation based on several parameters:
Current Assets (CA):
These are the proportional assets convertible to cash, within the time of one year. These include cash, accounts receivable, and inventories.
Current Liabilities (CL):
These are short-term obligations due within one year. Examples include accounts payable, short-term loans, and outstanding expenses.
Working Capital:
Working capital is equal to current assets, less, current liabilities, thus a measure of liquidity with which to carry on day-to-day activities.
The method of evaluating the maximum credit amount, which may be permissible to be extended, rests on this calculation by the application of certain percentages to the total current assets and liabilities.
Maximum permissible bank finance
An Example of How to Calculate Maximum Permissible Bank Finance (MPBF)
Here’s an example of how MPBF is calculated:
Example Company: Company XYZ (Manufacturing Business)
Step 1: Identify Key Components
Current Assets:
- Inventory: ₹100,00,000
- Receivables (Accounts Receivable): ₹60,00,000
- Cash & Bank: ₹20,00,000
- Total Current Assets: ₹180,00,000
- Current Liabilities:
- Creditors (Accounts Payable): ₹70,00,000
- Short-term Loans: ₹40,00,000
- Total Current Liabilities: ₹110,00,000
Step 2: Calculate Working Capital
Current asset less current liability:
Rs.1,80,00,000 less Rs.1,10,00,000 which comes to Rs.70,00,000
It is going to help in determining how much cash is available in hand with this company over which it can utilize while carrying on its business. Banks.
Banks typically allow a maximum of 75% of the working capital gap as the permissible bank finance (MPBF).
MPBF = 75% of Working Capital
= 75% × Rs.70,00,000
= Rs.52,50,000
Therefore, the Company XYZ is able to borrow up to Rs.52,50,000 from the bank to pay bills and purchase inventory for sale. This is basically to guarantee that the business is capable of providing sufficient cash flow to cover the immediate costs and to maintain the continuity of the operations. The financial assistance plays a critical role in enabling the company to control costs and meeting its needs on an immediate basis without facing interruptions. We will now dive into the benefits of availing Maximum Permissible Bank Finance (MPBF).
Advantages of Maximum Permissible Bank Finance (MPBF)
Maximum Permissible Bank Finance (MPBF) has several benefits, both to banks and companies:
Guaranteed Financing:
MPBF is a guaranteed formula for the size of working capital loan available, hence companies can know their funding levels.
Lender Protection:
By linking the loan size to the firm’s current assets and liabilities, MPBF ensures that there are sufficient assets to cover borrowings by the firm, hence lowering the risk for banks.
Efficient Process:
As a formula-based system, MPBF makes the working capital finance evaluation process easy, with simple loan applications by companies and simple approval by banks.
Supports Business Expansion:
With MPBF-backed working capital loans, companies can focus on their primary business, expand operations, and meet short-term obligations without concern for liquidity issues
Limitations Of Maximum Permissible Bank Finance (MPBF)
Though Maximum Permissible Bank Finance (MPBF) bears positive metrics, MPs do not lay themselves open to criticism:
Rigid and Inflexible:
Maximum Permissible Bank Finance (MPBF) is based upon formulas that, while reasonably successful, can hardly capture fully the dynamic nature of financial requirements of a business. This rigidity hinders growth prospects for those businesses that demand flexible financing.
Short-term Focus:
Maximum Permissible Bank Finance (MPBF) considers much in the light of the very short-term financial position of the borrower, dismissing matters such as long-run growth, long-run profitability, or any other important features of a business.
Asset-Dependent Financing:
There is an overreliance on the current asset and liability position of the borrower to assess the Maximum Permissible Bank Finance (MPBF), which, in itself, does not guarantee the complete picture of the business’s financial health in a time of seasonal fluctuations or unique business challenges.
Standardized Assessment Approach:
The Maximum Permissible Bank Finance (MPBF) uses an approach that does not allow for much customization regarding the unique needs of businesses. It tends to disburse financing based on standardized calculations rather than specifically catering to businesses that may require complex or evolving solutions.5. Calculations of Maximum Permissible Bank Finance (MPBF) for Working
Withdrawal Of The Maximum Permissible Bank Finance (MPBF) Concept
The Reserve Bank of India (RBI) resolved to withdraw the Maximum Permissible Bank Finance (MPBF) concept, with effect from April 15, 1997. Although the particular circular to this effect is not readily available on the RBI’s website, indications of such change have been noted in the Master Circulars released by the RBI under the title “Working Capital Requirements Above Rs. 1 Crore.” The concerned details are encapsulated as below:
Withdrawal of Maximum Permissible Bank Finance (MPBF) and
The previous directive in respect of Maximum Permissible Bank Finance (MPBF) pegged on a minimum current ratio of 1.33:1 as envisaged by the Tandon Working Group has been withdrawn.
Banks’ Flexibility
Banks are now free to choose their own minimum current ratio and fix the working capital requirements subject to their judgment of the needs of the borrowers and credit worthiness of the borrowers.
Options for Assessing Working Capital Needs
Banks are encouraged to develop suitable systems to evaluate the working capital requirements of borrowers with needs exceeding Rs. 1 crore. They may choose from the following methods:
Turnover Method:
Similar to the method used for smaller borrowers, this can be employed for this segment as well.
Cash Budgeting Method:
Since major corporations use cash budgeting for managing their funds, banks can adopt this approach for large borrowers.
Retention of MPBF:
The MPBF system can also be retained by banks with appropriate modifications.
Revisions of Classification of Current Assets and Current Liabilities
With the elimination of MPBF, inventory norms, and the minimum current ratio, the categorization of current assets and current liabilities is no longer required. Banks now have the freedom to determine which items are to be considered as current assets or current liabilities.
Maximum Permissible Bank Finance (MPBF) As A Foundation For Modern Lending Practices
Despite the RBI’s withdrawal of Maximum Permissible Bank Finance (MPBF) in 1997, its core principles of assessing short-term liquidity needs and ensuring sufficient working capital continue to influence how banks assess working capital requirements today. Maximum Permissible Bank Finance (MPBF) laid the foundation for evaluating a business’s financial health based on current assets and liabilities. Even though lending practices have evolved to incorporate new tools and technologies, the primary objective of Maximum Permissible Bank Finance (MPBF)—ensuring that businesses have enough liquidity to meet short-term obligations—still remains central in modern lending assessments.
Impact Of Maximum Permissible Bank Finance (MPBF) On Modern Technology-Based Appraisals
While Maximum Permissible Bank Finance (MPBF) relied on asset-based calculations for determining loan adequacy, advanced technologies like AI and real-time money dashboards have supplemented and extended these estimations. Through these technologies, banks can offer loans faster and more conveniently through existing data that is more liquid than Maximum Permissible Bank Finance (MPBF) equations. The theoretical grounding of liquidity analysis, though a core of Maximum Permissible Bank Finance (MPBF), nonetheless remains the anchor of modern-day AI-based models.
Maximum Permissible Bank Finance (MPBF)’s Legacy In Ai And Fintech Integration
FinTech and AI are among the technologies that have enhanced how firms are assessed for credit. While Maximum Permissible Bank Finance (MPBF) used straightforward asset proportions like the current proportion to determine how well a company can fulfill short-term financial needs, advanced tools aid in such a determination with additional parameters like payment performance and cash flow trend. In spite of such developments, Maximum Permissible Bank Finance (MPBF)’s core goal of generating liquidity is the substance of such technologies, a more all-around though fundamentally similar vehicle of finance for working capital.
Real-Time Financial Monitoring and Maximum Permissible Bank Finance (MPBF)s Central Postulate
Maximum Permissible Bank Finance (MPBF) was based on intermittent reporting of financial health, whereas modern-day financial systems provide observation of a firm’s liquidity in real-time.
Even though the contemporary systems are better, the emphasis being on perpetual data updates, they continue to have Maximum Permissible Bank Finance (MPBF)’s original principle—ensuring that companies are capable of fulfilling their short-term financial commitments. New technology only hastened the process, but how one goes about assessing short-term financial health remains the same since Maximum Permissible Bank Finance (MPBF).
Alternative Lending Models And Maximum Permissible Bank Finance (MPBF)
New lending models, such as peer-to-peer lending and crowdfunding, provide more flexibility than Maximum Permissible Bank Finance (MPBF), but they still follow the core principle of ensuring liquidity. Though these models are outside the confines of traditional bank loans, they still evaluate a business’s capability to cover short-term financial requirements, similar to Maximum Permissible Bank Finance (MPBF) but with a more individualized and dynamic method.
RBI’S GUidelines post MPBF and Its Ongoing Relevance
Even after Maximum Permissible Bank Finance (MPBF) was withdrawn, RBI guidelines allowed liberal methods to reach working capital requirement estimation, such as the turnover method, cash budgeting, or even having amended forms of Maximum Permissible Bank Finance (MPBF).
This points towards the continuing relevance of liquidity-based estimates to finance working capital. Though RBI introduced more liberal guidelines, the intent behind keeping companies well-funded in the case of working capital to support their short-term needs is the same
Tailor-Made Financing Solutions And Maximum Permissible Bank Finance (MPBF)’s Function
Banks currently create more tailor-made financing solutions according to some business requirements, yet they continue to uphold Maximum Permissible Bank Finance (MPBF)’s requirement of evaluating short-term liquidity. Although such solutions become more dynamic and flexible, the fundamental need to enable businesses to meet their current financial commitments remains in line with Maximum Permissible Bank Finance (MPBF)’s objectives.
Dynamic Credit Policies And Maximum Permissible Bank Finance (MPBF)
The transition to dynamic credit policy enables banks to take into account larger sets of financial variables, but the policies remain founded on the same fundamental purpose of liquidity measurement—just as with Maximum Permissible Bank Finance (MPBF). There are simply more variables taken into account these days, but the basic question of whether or not a firm can pay its some-term obligations remains no different than in the Maximum Permissible Bank Finance (MPBF) model.
Shifting from Fixed Maximum Permissible Bank Finance (MPBF)
The shift from fixed Maximum Permissible Bank Finance (MPBF) valuations to long-term relationships is a sign of the trend towards more flexible and personalized financing. But Maximum Permissible Bank Finance (MPBF)’s underlying concept of providing firms with sufficient liquidity to cover their short-term obligations remains as a force of practice today while banks are increasingly focusing on long-term relationships.
Conclusion – Permanent Role of Maximum Permissible Bank Finance (MPBF):
Although the RBI put an end to Maximum Permissible Bank Finance (MPBF)’s formulaic strategy in 1997, its underlying principles—measuring short-term liquidity and providing appropriate working capital—remained the substance of contemporary working capital lending.
Technology and liberal lending mechanisms have certainly simplified the process, but the inherent intention of Maximum Permissible Bank Finance (MPBF)—to ensure that businesses are capable of settling immediate financial liabilities—continues to be the essence of modern lending principles. The development of financial products does not take away from the legacy of Maximum Permissible Bank Finance (MPBF) but enhances it, making it a reality that businesses possess the liquidity they require to prosper. Need help understanding working capital finance for your business you may follow the link or contact us at BankKeeping.