Drawing Power, Stale Stock and an Overdue Cash Credit
Sunrise Footwear is a proprietorship firm with a cash credit limit of ₹30 lakh from a bank, secured by hypothecation of stock and a second charge on the proprietor's house. The outstanding is ₹27 lakh and interest is being serviced monthly. The last stock statement, dated 3 April, shows stock of ₹48 lakh and sundry creditors of ₹12 lakh. The bank's margin is 25% on paid stock. On 10 July the branch manager physically verifies stock worth ₹36 lakh and finds creditors of ₹15 lakh. The proprietor seeks an additional ₹5 lakh to execute a large order, arguing that the existing limit is fully utilised. The account has been irregular for 95 days because two interest debits remained unpaid, though they were cleared on 5 July. The branch also holds collateral worth ₹18 lakh.
1. Calculate the drawing power on 3 April and on 10 July and comment on the account's position.
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Formula. Drawing power = (stock − creditors) × (1 − margin). The margin is 25%, so the bank finances 75% of paid stock.
On 3 April. (₹48 lakh − ₹12 lakh) = ₹36 lakh; DP = ₹36 lakh × 75% = ₹27 lakh. The outstanding of ₹27 lakh was exactly equal to the DP - fully drawn, with no headroom.
On 10 July. (₹36 lakh − ₹15 lakh) = ₹21 lakh; DP = ₹21 lakh × 75% = ₹15.75 lakh. The outstanding of ₹27 lakh exceeds DP by ₹11.25 lakh.
Comment. The account is over-drawn against the current drawing power, even though it is within the sanctioned limit of ₹30 lakh. The stock statement used on 3 April was already more than three months old by July; the bank should not rely on stale stock statements. The physical verification shows both a fall in stock and a rise in creditors, which reduces the bank's effective security. The branch should call for an explanation, stop further drawings, and consider reducing the limit or bringing in additional collateral.
2. Should the bank sanction the additional ₹5 lakh? What conditions would you impose?
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Decision. The additional ₹5 lakh should not be sanctioned as a funded limit in the present state. The borrower is already over-drawn relative to the current DP by ₹11.25 lakh, the stock statement is stale, and the physical stock is lower than the book stock. A fresh funded limit would be largely unsecured.
Conditions if the bank still wants to support the order. (i) Regularise the overdue interest and bring the account within DP; (ii) obtain a fresh stock statement and get the stock insured; (iii) reduce the excess by depositing cash or by substituting collateral; (iv) increase the margin or collateral cover; (v) for the specific order, issue a letter of credit or bill discounting rather than a cash credit, so that the bank controls the end-use; (vi) obtain a personal guarantee and a charge on the order proceeds. The bank should also verify the buyer's creditworthiness. The decision should be documented as a credit exception approved by the appropriate authority.
3. How should the account be classified for prudential purposes? Does the 95-day irregularity matter if the overdue interest was cleared on 5 July?
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NPA rule. An account is classified as a non-performing asset if interest or principal remains overdue for more than 90 days. Here two interest debits remained unpaid for 95 days. The account therefore became an NPA on the 90th day of continuous overdue.
Effect of clearing on 5 July. Subsequent payment does not erase the fact that the account was overdue beyond 90 days. It may become eligible for upgradation only after the account remains regular for the prescribed period, usually 90 days of no overdue, and the bank records the recovery. The branch cannot treat it as standard merely because the interest was later cleared.
Provisioning. For a sub-standard asset, the bank generally provides 15% of the secured portion and 25% of the unsecured portion. The collateral of ₹18 lakh and the hypothecated stock will determine the secured portion. The bank should also check whether the account was already in SMA-2 before becoming NPA, because that affects earlier reporting.