Addressing Rigidities in the Modified Primary Borrowing Facility (MPBF)

Introduction

This blog examines the rigidities within the Modified Primary Borrowing Facility (MPBF) method and the relaxations permitted by the Reserve Bank of India (RBI). The MPBF, designed as an asset-backed financing mechanism, has faced challenges since the financial liberalization process began in India in the 1990s.

Rigidities in the MPBF Method

The following key rigidities have been identified in the MPBF approach:

1. Categorization Issues with Current Assets and Liabilities:

   • The MPBF framework relies on asset-backed finance, where loans are secured by existing assets. However, certain current assets and liabilities do not align with this principle.
   • Examples include:
     • Current Assets: Security deposits made with government authorities.
     • Current Liabilities: Short-term loans.
   • This discrepancy often leads to a significant gap between the assessed MPBF and the actual credit extended.

2. Challenging Standard Current Ratio (CR):

   • The standard current ratio of 1.33 has been viewed as an unrealistic benchmark by many industry players and bankers.
   • Certain sectors, such as BPOs/KPOs and departmental stores, struggle to meet this ratio due to their inherent low receivables and high payables.
   • As a result, when working capital limits were renewed, bankers faced difficulties justifying these requirements, especially when the actual current ratio fell below the mandated level.

Due to these challenges, and increased competition among banks for quality lending, the RBI made compliance with the MPBF method optional in its 1997 credit policy. This change allowed banks to adopt their logical and rational financing methods for working capital calculations. However, modifications in the classification of current assets and liabilities varied widely among banks, leading to a lack of uniformity in working capital assessments.

Current Assets Financing According to the Tandon Committee

The Tandon Committee suggests that:

• Current Assets include inventory, receivables, and other assets.
• Bank borrowings form part of net working capital.

Suggested Modifications to the MPBF Computation

To bridge the gap between working capital assessment and delivery, the following modifications to the MPBF computation are recommended:

1. Treatment of Term Loan Installments:

   • Installments due within the year should be classified as part of long-term loans. Irregularities in term loans can be categorized as Other Current Liabilities (OCL). Additionally, any discounted bills may be removed from both the assets and liabilities sides of the balance sheet, allowing them to be added later for determining the full borrowing limit.

2. Classification of Current Liabilities:

   • Current liabilities can be divided into three categories:
     1. Trade Credit
     2. Bank Borrowing
     3. Other Current Liabilities (OCL), with potential reevaluation of the definition of term OCL.

3. Categorization of Current Assets:

   • Similarly, current assets can be organized into three major classifications:
     1. Inventories
     2. Receivables
     3. Other Current Assets (including cash and advance tax).
   • Chargeable assets could be created for inventories and receivables, facilitating financing through asset-backed mechanisms essential to the MPBF.

Conclusion

The rigidities in the MPBF method necessitate a reassessment to align financial assessments with credit delivery more effectively. By implementing the suggested changes to the classification of current assets and liabilities, banks can enhance the efficiency and accuracy of working capital financing, ultimately leading to improved financial management.