Computation of Drawing Power/Limits in respect of stocks hypothecated
In respect of credit facilities against hypothecation of stocks (inventories) being the primary security, the Bank’s system of appraisal for determining the maximum permissible finance to borrowers and fixing of limits, inter alia, should generally take into consideration the level of sundry creditors (comprising ‘unpaid for’ stocks). The sanction is expected to be in tune with the appraisal so made. While sanctioning such credit facility, the bank is expected to stipulate in the documents, that for computing the Drawing Power, the value of declared stocks is to be considered only net of the stipulated margin; and that the declared stocks shall not cover the borrower’s liability outstanding by way of unpaid for stocks (whether in the form of sundry creditors for purchases or covered by LCs/ guarantees/ co-acceptances or Buyer’s Credit availed for
procurement of material). The Bank should also insist on such information from borrowers. In case of consortium accounts, the drawing power calculation and allocation is made by the Lead Bank and is binding on the Member Banks.
The Reserve Bank of India has been issuing guidelines on the treatment of unpaid stocks while arriving at the drawing power available in the borrowal accounts. The thrust of the guidelines is avoidance of double financing on the unpaid stocks, if such stocks are taken as eligible for computation of drawing power.
The matter having been re-examined by Reserve Bank of India, vide directive No. IECD.No.32/08.10.01/92-93 dated 28th April, 1993 had advised as regards the treatment of unpaid stocks while arriving at the drawing power available in the borrower accounts, wherein the thrust is avoidance of the double finance on the unpaid stock, if such stocks are taken as eligible for computation of drawing power. Thus, it would be unrealistic to assume that the composition of the stock items, the level of stock held and the portion of unpaid stock considered at the time of appraisal would be static and should be presumed to be at the same level for subsequent period. For the said reason, the drawing power needs to be recomputed based on variations, not only in composition and level of stock but also in the unpaid portion of stocks before the stipulated margin is applied as per the sanction terms of a working capital finance.
The auditor should review the policy of the bank in this regard for any inherent weakness in the credit system, where the stringency in appraisal, is relaxed while sanctioning the advances, having consequential effect on monitoring and supervision, and may have effect on the classification status of the Borrower, where the drawing power falls short of the outstanding.
Banks usually consider credit facilities by way of Hypothecation of stocks and a charge on the sundry debtors. The Drawing Power is required to be computed net of the stipulated margin, based on and applied to the total eligible current assets comprising:
Net Value of Stock as stated above, and
Net Value of Debtors (i.e., eligible Trade Debtors Less Bills Discounted with Bank). The bank usually prescribes the conditions as to what comprise eligible trade debtors, and stipulates the period for debts being considered as current and good on which the margin is computed.
For the purposes of classification of advances, the computation of drawing power based on realistic value of hypothecated stocks (net of unpaid for stocks, whether covered by Buyer’s Credit, LCs/ Guarantees/ Co-acceptances or otherwise) and margin as stipulated, is vital, particularly in cases of default, and in border-line cases where the health status of borrowers may be in question, to gauge slippages.
Due care is required to be exercised by the auditor in case of
Documents retained in original at centralised offices where these are not available at the branches that are advised of drawing power limits; and
consortium advances, where the bank, not being the leader, gets the related figures of drawing power from the leader bank, without the related evidence of computation or appropriateness of the drawing power.
The auditor needs to look into this aspect to verify that there is no slippage of the account into NPA classification.