Reserve Bank of India setup a committee under the chairmanship of Shri P.L. Tandon in July 1974.
The terms of reference of the Committee were:
1. To suggest guidelines for commercial banks to follow up and supervise credit from the point of view of ensuring proper end use of funds and keeping a watch on the safety of advances;
2. To suggest the type of operational data and other information that may be obtained by banks periodically from the borrowers and by the Reserve Bank of India from the leading banks;
3. To make suggestions for prescribing inventory norms for the different industries, both in the private and public sectors and indicate the broad criteria for deviating from these norms ;
4. To make recommendations regarding resources for financing the minimum working capital requirements ;
5. To suggest criteria regarding satisfactory’ capital structure and sound financial basis in relation to borrowings ;
6. To make recommendations as to whether the existing pattern of financing working capital requirements by cash credit/overdraft system etc., requires to be modified, if so, to suggest suitable modifications.
The committee was of the opinion that:
i. Bank credit is extended on the amount of security available and not according to the level of operations of the customer
ii. Bank credit instead of being taken as a supplementary to other sources of finance is treated as the first source of finance. Although the Committee recommended the continuation of the existing cash credit system, it suggested certain modifications so as to control the bank finance.
The banks should get the information regarding the operational plans of customer in advance so as to carry a realistic appraisal of such plans and the banks should also know the end use of bank credit so that the finances are used only for purposes for which they are lent.
The recommendations of the committee regarding lending norms have been suggested under alternatives. According to the first method, the borrower will have to contribute a minimum
of 25% the working capital gap from long-term funds, i.e., owned funds and term borrowing; this will give minimum current ratio of 1.17 : 1
Under the second method of the borrower will have to provide a minimum. of 25% of the total current assets from long-term funds; this will give a minimum current ratio of 1.33:1. In the
third method, the borrower’s contribution from long-term funds will be to the extent of the entire core current assets and a minimum of 25% of the balance current assets, thus strengthening the current further.
Computation of Maximum Permissible Bank Finance
The Tandon Committee had suggested three methods for determining the maximum permissible bank finance(MPBF).
Method 1: MPBF=0.75(CA-CL)
Method 2: MPBF=0.75(CA)-CL
Method 3: MPBF=0.75(CA-CCA)-CL
Where CCA=Core Current Assets- this represents the permanent component of working capital.Under special consideration, within the MPBF so arrived at in terms of the present guidelines, banks/consortia/syndicates are required to restrict sanction of cash credit limits to borrowers up to a certain portion (25% of the MPBF).Where borrowers desire to avail of bank credit for the balance portion (75% of the MPBF), or any part thereof, this will be considered on merit by banks/consortia/syndicates in the form of a short term loan repayable on demand for working capital purpose for a stipulated period.