Question

State the various forms of borrowing from commercial banks.

Answer 1

1. Term Loans: Banks now offer loans to business firms for medium term. Loans are generally secured by assets or guarantees. The borrower may be asked to repay in lump sum or in instalments.
2. Cash Credit: It is a formal and revolving credit agreement under which the borrower is allowed to borrow up to the specified limit. The amount may be withdrawn in instalments. Interest is charged on the amount actually withdrawn. The borrower is required to offer security in the form of tangible assets or guarantees.
3. Discounting of Bills of Exchange: This implies procuring cash from a bank for exchange for credit instruments. Commercial banks provide short-term finance to business concerns by discounting their bills of exchange, promissory notes and hundies. Banks charge some commission for this service by paying a price lower than the face value of the credit instrument. The holder of the instrument remains liable to the bank if the instrument is dishonoured on maturity.
   For example, A & Co. sells goods on credit for Rs. 50,000 to B & Co., which signs a bill of exchange due after 60 days. A & Co. can get the payment of the bill from a bank. The bank will deduct some discount to cover interest charges for 60 days. On the due date, the bank will receive payment of the bill from B & Co. Bill discounting is different from overdraft.
4. Overdraft: An overdraft is a kind of temporary financial accommodation extended by a bank to its regular customers. Under this agreement, a customer having a current account with the bank is allowed to overdraw his account. A business enterprise can enter into this agreement to take care of a temporary (a few days) shortage of working capital. Interest is charged on the amount actually overdrawn and not on the amount sanctioned by the bank.