Bank Finance Regulation

Bank Finance Regulation

Banks have been following certain norms in granting work capital finance to companies. These norms have been greatly influenced by the recommendations of various committees appointed by the reserve bank of India from time to time. The norms of working capital finance followed by bank since mid-70 were mainly based on the recommendations of the tendon committee.

Guidelines for bank finance: historical perspective

A study group, popularly known as the tendon committee, was appointed by the reserve bank of India in July 1974 to suggest guidelines for the rational allocation and optimum use of bank credit. This was done on the presumption that the existing system of bank lending had a number of weaknesses.

Background

Bank credit is a scare resource; hence it should be optimally utilized under all circumstances. For industrial units it has become scarcer. These are many other contenders for bank credit: agriculture, small-scale industry, farmers, small man and many others. Public enterprises also approach commercial bank for their working capital requirements.

In fact, the misuse of bank funds was made possible by the existing system of bank lending, based on cash credit system. The practice was to lend generally to the extent of 75 per centof the value of inventory and receivables, the remaining 25 per cent being the margin. The value of inventory included purchases of materials on credit. Thus, this amounted to double financing-from creditors as well as banks. Bank lending, under the cash credit system, was directly related to security in the form of inventory and receivables, irrespective of borrower’s operations. So long as the borrower continued to provide the required margin, the banker considered his advance to be safe and liquid, and sis not bother about the way in which advance was being utilized. The borrower’s limit was generally increased, without mush questioning about his operations, whenever inventory and receivable levels whet up. The banker never took an closer look into the affairs of the customer.

One important drawback of the system was that the banker sanctioned a maximum limit within which the borrower could draw at his will. Under this procedure, the level of advances in a bank is determined not by how much a banker can lend at that time. Under a tight situation, such a system would put banks to considerable strain. The cash credit system makes credit planning by banks very difficult.

The deejay committee

The above-mentioned deficiencies of the existing system of bank lending, Based on cash credit system, were formally highlighted by the deejay committee on 1968. The committee concluded that the diversion of bank finance for the acquisition of fixed and other non-current assets was made possible by the banker’s fixation on security under the cash credit lending system. The committee felt that, while theoretically commercial bank lending was for short-term purposes, in actual practice, it was not so.

The tendon committee recommendations

The recommendations of the tendon committee are based on the following notions:

1. Operating plan:- the borrower should indicate the likely demand for credit. for this purpose, he should draw operating plans for the ensuing year and supply them to the banker. This procedure will facilitate credit planning at the banks’ level. It will also help the bankers in evaluating the borrower’s credit needs in a realistic manner and n the periodic follow-up during the ensuing year.

2. Production-based financing:- the banker should finance only the genuine production needs of the borrower. The borrower should maintain reasonable levels of inventory and receivable; he should hold just enough to carry on his target production. Efficient management of resources should therefore be ensured to eliminate slow moving and flabby inventories.

3. Partial bank financing:- the working capital needs of the borrower cannot be entirely financed by the banker. The banker will finance only a reasonable part of it; for the remaining the borrower should depend upon this own funds, generated internally and externally.

Inventory and receivable norms

The tendon committee made a number of important recommendations regarding the bank lending practices. But it is the recommendation regarding the inventory and receivable norms which have been debated and criticized mostly.

Lending norms

Another important recommendation of the committee related to the approach to be followed by commercial banks in lending credit to borrowers. The committee felt that the main function of a banker as a lender was to supplement the borrower’s resources to carry an acceptable level of current assets. This implied (a) the level of current assets must be reasonable and based on norms, (b) a part of the fund requirements for carrying current assets must be financed from long-term funds comprising owned funds and term borrowings including other non-current liabilities.

Working capital gap

Is defined as current assets minus current liabilities excluding bank borrowings. Current assets will be taken at estimated values or values as per the tendon committee norms, whichever is lower. Current assets will consist of inventory and receivables, referred as chargeable current assets (CCA) and other current assets (OCA).

Maximum permissible bank finance (MPBF) in view of the above approach to bank lending, the committee suggested the following three methods of determining the permissible level of bank borrowings:

1. First method:- in the first method, the borrower will contribute 25 per cent of the working capital gap; the remaining 75 per cent be financed from bank borrowings this method will give a minimum current ratio of

2. Second method:- in the second method, the borrower will contribute 25 per cent of the total current assets. The remaining of the working capital gap (the working capital gap less the borrower’s contribution) can be bridged from the bank borrowings. This method will give a current ratio of .

3. Third method:- in the third method, borrower will contribute 100 percent of core assets, as defined and 25 per cent of the balance of current assets. The remaining of the working capital gap can be met from the borrowings. This method will further strengthen the current ratio.

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Keynes Interest Theory

Keynes Interest Theory

Economics Assignment, Microeconomics Assignment

In his epoch making book, “the general theory of employment, interest and money”. A man with a given income has to be decide first how much he is to consume and how much he is to consume for this property to consume, the individual will save a certain proportion of this resource will he has to make another decision. Should he hold his savings? How much of his resources will he part with or lend depends upon the form of money he spent. Liquidity preferences mean the demand for money to hold or desire of the public to hold cash.

Demand for money or motives for liquidity preference

Liquidity preference of a particular individual depends upon several considerations. The question is: why should the people hold their resources liquid or in the form of ready money, when they can get interest by lending such resources? The desire for liquidity arises because of three motives (i) the transaction motive, (ii) the precautionary motive, (iii) the speculative motive.

The transaction motive: the transaction motive relates to the demand for money need for cash for the current transactions of individuals and businessmen. Individuals want to hold cash in order “bridge the interval between the receipt of income and its expenditure”. This is called the ‘income motive’. Most of the people receive their incomes by the week or the month, while the make current payments for goods and services to be purchased. This amount will depend upon the size of the individual’s income, the interval at which the income at which the income is received and the methods of payment prevailing in the society.

Precautionary motive: precautionary motive for holding money refers to the desire of the people to hold cash balances for unforeseen contingencies. People hold a certain amount of money to provide for a danger of unemployment, sickness, accidents and the other uncertain emergencies. The amount of money held under this motive will depend on the nature of the individual and on the conditions in which he lives.

Speculative motive: the speculative motive relates to the desire to hold one’s resources in liquid form in order to take advantage of market movements regarding the future changes in the rate of interest. The notion of holding money for speculative motive is a new typically Keynesian idea. Money held under the speculative motive serves as a store of money value as money held under this motive does. But it is a store of money meant for a different purpose. The cash held under this motive fluctuation. If bond prices are expected to rise, which, in other words, means that the rate of interest is expected to fall, businessman will buy bonds to sell when their prices actually rise. If, however, bond prices are expected to fall, i.e. the rate of interest is expected to rise, businessmen will sell bonds to avoid capital losses. Nothing being certain in this dynamic world, where guesses about the future course of events are made on precarious basis, businessmen keep cash between balances to speculate on the probable future changes in bond prices with a view to making profits.

Given the explanation about the expectations about the changes in the rate of interest in future, less money will be held under the speculative motive at a higher current rate of interest. The reason for this inverse relation between money held for speculative motive and the prevailing rate of interest is that at a lower rate of interest less is lost by not lending money or not investing it, that is, by holding on to money, while at a higher rate of interest holders of cash balances would lose more by not lending or investing.

Thus, the demand for money under speculative motive is a function of the current rate of interest, increasing as the interest rate falls and decreasing as the interest rate rises. Thus, demand for money under this speculative motive is a decreasing function of the rate of interest.

Integration of product and money market equilibrium

Integration of product and money market equilibrium

In this particular aspect of macroeconomics we will discuss about the theory of product market equilibrium and with the theory of money market equilibrium and interest rate determination. Keynes had analysed the product market and money market equilibrium in isolation of one another. This is considered to be a serious flaw in the Keynesian approach because, in reality, functioning of both the sectors is interrelated and interdependent. Therefore, unless both the markets reach equilibrium simultaneously at the same rate of interest and the same level of income, none of these sectors can attain a stable equilibrium. It was John R. Hicks who integrated the Keynesian analysis of the product and money markets and developed a model, called IS-LM Model, to show how both the markets can attain equilibrium simultaneously at the same interest rate and national income. The post-Keynesian developments in macroeconomics do not end with Hicks’ IS-LM Model. The economists of later generations have also constructed theories that integrate classical and Keynesian economics, and have developed different kinds of aggregate demand and supply models. This was followed by other developments with altogether new approach to deal with macroeconomic issues. This part of the book presents a detailed discussion on the Hicksian IS-LM model and a brief discussion on the other post Keynesian developments in macroeconomics.

Therefore, changes in the variables of one sector affect the activities of other sector. In simple words, changes in the product market affect the money market equilibrium and vice versa. The Keynesian theory ignores the effect of changes in the product market on the money market. Therefore, his theories related to the product and money markets are considered to be partial and incomplete. Fiscal operations of the government affect the first and foremost, the market by changing the aggregate demand. Therefore, changes in money demand and supply are linked to the money market represented by the LM curve. To begin with we will first discuss the effect of government expenditure and taxation on the product market and derive the IS curve. The effect of change in money supply and demand on the monetary sector and the derivation of the LM curve will also be discussed.

Unique solution for economics

Economic Laws Nature

Economic Laws Nature

Theory of Economics >> Microeconomics Help

Economics is a science and like other sciences it also has its laws. Economic laws are also known as general is action principles and uniformities. The economic laws describe how a man behaves as a producer and a consumer. The economic laws are also concerned with how the economic system works and operate. Main the economic life produces wealth consumes wealth exchange it with others. Therefore economic laws have been framed which govern production consumption and exchange of wealth by men. Besides economic laws are also concerned with how the national product profiled is distributed and how the level of income and employment are determined lastly economic laws also describe growth of the economy as well as international trade between the various countries of the world. In fact economic laws have been framed in all fields of the subject matter of economics namely consumption production price determination, determination of income and employment growth of the economy foreign trade etc. among the important laws of economics mentis on may be made of law of diminishing marginal utility law of variable proportions or diminishing return Keynesian psychological law of consumption the principles of multiplier ad accelerator Malthusian law of population law of comparative advantage.

Economic law as mere statements of tendencies

The nature of economic laws has been a subject of controversy. Marshall though that the laws of economics are not exact and definitetheyae mere statements of tendencies according to him this is unlike the laws of physical sciences which are quite exact precise and definite because of the exactness and definiteness the laws of physical sciences can predict the course of events. But laws of economics lack this predictive value. Laws of economics are conditional and are associated with a number of qualifications and assumptions and these assumptions and qualifications are generally contained in the phrase other things remaining the same or ceteris paribus which is attached to every law and theory of economics. But in the real worked these other things generally do not remain the same because the economic world is dynamic and ever- changing. For example according to the law of demand when price of a commodity rises, its quantity demanded by the consumer will fall but fi along with the rise in price of the commodity income of the consumer increases then the consumer may demand more of the commodity even at the higher price. This seems to be contrary to the law of demand but in fact this is not so because the law of demand assumes that other things such a income tastes and prices of the related goods remain the same and in our case this qualify Cation has to been fulfilled because income of the consumer has increased. Law of demand will hold good only if other things such as income tastes and preferences the prices of related goods remain constant and unchanged.

Scientific nature of economic laws

Laws of economics are of scientific nature. All scientific laws establish relationship between cause and effect. Economic laws also establish relationship between cause and effect about economic begaviour of man and economic phenomena. If we observe man in using his scarce resources to satisfy his unlimited wants then we will see that he behaves in a particular manner. By observing the behaviour of several people economists have established certain generalization or general principles which are called economic laws. Therefore these economic laws are general tendencies of man behaviour in his economic life. Therefore economic laws are related to economic life of man. In his economic life man produces wealth and consumes it decides the distribution and exchange of wealth also affect the economic life of man. Economists have made several laws regarding production consumption distribution and exchange of wealth. Like other scientific laws economic laws also establish relationship between cause and effect. For example according to the law of demand when price of a commodity fall sits quantity demanded increase other things remaining the same. Here the fall in the price is the cause and the rise in quantity demanded is the effect law of diminishing marginal utility describes that as a man has more units of a commodity is the cause and the fall in marginal utility is the effect. This holds goods in case of other economic laws also.

It is thus clear that economic laws are hypothetical and conditional. But this does not mean that economic laws are not scientific or that they are useless. As a matter of fact, al scientific laws are conditional. The famous scientific law of gravities a is also conditional. According to the law of gravitiaotn when any commodity is thrown in the air, then it falls down to the ground. This is because the earth has the power to attract and pull the rings to itself. But this famous scientific law also depends upon the fulfillment of certain conditions. The condition for the law of gravitation to apply is that no opposing forces obstruct the commodity form falling to the ground. We often see that aero planes bird’s balloons etc. fly in the air and don t fall to the ground. Due to the working of these opposing forces law of gravitational does not apply in this case. Therefore law of gravitation also applies when the opposing forces do not operate. Take another example of a scientific law form the skied of chemistry. According to a well – known law of chemistry water is formed if two atoms of hydrogen are mixed with two atoms of hydrogen and one atom of oxygen udder certain conditions of temperature and pressure. Thus all scientific laws hold good under certain conditions. Therefore the fact that economic laws are conditional and hypothetical is not a unique thing. Nor does this conditional and hypothetical nature destroy the scientific nature of economic laws. Economic laws are therefore as important and useful s the laws of physical sciences.

Price Discrimination Degrees

Price Discrimination Degrees

The following three types of price discrimination on another ground: (i) price discrimination of the first degree; (ii) price discrimination of the second degree; and (iii) price discrimination of the third degree.

Price discrimination of the first degree involves maximum possible exploitation of each buyer in the interest of a seller’s profits. Price discrimination of the first degree is also called perfect price discrimination. Price discrimination of the first degree or perfect discrimination is said to occur when the monopolist is able to sell each separate unit of the output at a different price. Thus under discrimination of the first degree every buyer is forced to pay the price which is equal to the maximum amount he would be willing to pay rather than do without the good altogether. In other words, under perfect price discrimination, the seller leaves no consumer’s surplus to any buyer.

Price discrimination of the second degree would occur when a monopolist is able to charge separate prices for different blocks or quantities of a commodity from buyers and in this way he takes away a part, but not all of consumer surplus from them. Thus, under the second degree price discrimination a monopolist may charge a high price for first block of say 10 units, the medium price for the additional bloc of 10 units, and a lower price for additional units of a commodity. For example, a monopolist may charge from a buyer a price of INR 2,489.75 per unit for the first 10 units.INR 1,991.8 per unit for the next 10 units and INR 1,493.85 per unit for the next 10 units of the commodity.

Price discrimination of the third degree is said to occur when the seller divides his buyers into two or more than two sub markets or groups depending on the price elasticity of demand and charges a different price in each sub-market. The price charged in each sub market depends upon the output sold in that degree is most common. A common example, of such discrimination is found in the practice of a manufacturer who sells his product at a higher price at home and at a lower price power at a lower price to the households and at a higher price to the manufacturers who use it for degree price discrimination since this is usually more practicable as well as most commonly found in case of the real world.

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Demand Principle

Demand Principle > Economics Assignment Help > Business Economics 

In economic use of the word demand is made to show the relationship between the prices of a commodity which consumers want to purchase at those price. Generally consumers prefer to purchase at those price. Generally consumers prefer to purchase less at higher prices and vice versa.

This relationship between demand and price can be shown with the help of an imaginary schedule as in table 1.

It would be seen from table 1 that as the price of commodity rises consumers demand less of it. Conversely if the prices of commodity falls more of it is demanded.

Thus price and demand show an inverse functional relationship.

Supply

Supply refers to the quantity of a commodity offered for sale at a given price in a given market at a given time. According to the law of supply producers prefer to sale more at higher prices and vice-versa.

Price or market mechanism is a process through which the market economy function. The market economy functions through the market forces, viz. demand and supply. The demand and supply forces interact to determine the price of goods and services. Thus the price mechanism, is the mechanism through which the price of goods and services get determined.

Definitions: it is the mechanism by whjihc prices mechanism are given below:

(1) Cairncross: it is the mechanism by which prices adjust themselves to the pressure of demand and supply and in their turn operate to keep demand and supply in balance.

(2) Ferguson: price mechanism refers to the interaction between the forces of demand and supply determining prices of goods and services and resources in different markets. The price is the amount paid for the specified quantity and quality of any product or factor.

Thus the price mechanism is used with reference to the free market system and the way in which act as automatic signals co-ordinating the action of individual decision making units.

Working of price mechanism: there are three important economic ideas that describe the way in which price mechanism works. In economic use the word demand is made to show the relationship between the prices of a commodity and the amounts of the commodity which consumers want to purchase at those price. Generally consumers prefer to purchase less at higher prices and vice versa.