WORKING CAPITAL GUIDELINES, 2079

(Unofficial and Mutated Translation by Nirmal Shrestha)

Second Amendment 2080/05/13

1. Introduction to Working Capital Guidelines, 2079

Nepal Rastra Bank has issued Guidelines relating Working Capital Loans known as Working Capital Guidelines, 2079. The guideline has been issued with an intention to assure justification, effectiveness and usefulness of working capital loans. The mere intention is to have effective management of credit risk of the Banks and Financial Institutions (BFIs).

2. Objectives

• To bring uniformity in determining limits of working capital loans and its review.
• To make loan approval process and its utilization more transparent.
• To develop basic procedures to ascertain utilization of loans.

3. Limits of Working Capital Loans

3.1 Working Capital Loans up to Rs. 10 million (Rs. 30 million in case of Production based Industry)

• This working capital guidelines shall not be applicable.
• The limit provided to such customer in working capital loans shall be as prescribed by Working Capital Policy of the Bank itself.
• However, types of loans provided in respect of working capital loans shall be as prescribed by this Guideline.

3.2 Limits of Working Capital Loans up to Rs. 20 million (Rs. 40 million in case of Production based Industry)

• Maximum Limits of Working Capital Loans provided to firm/entity/company = 20% of Annual Estimated Transactions/Sales.
  • Loans up to Rs. 20 million (Or Rs. 40 million in case of production based industry) means sum of all the loans taken from more than one BFIs.
  • The loan tenure must be equal to or less than one year.
  • The loans must be renewable in nature.
• However, upon analysis based on Operating Cycle, Cash Conversion Cycle, Days Sales Outstanding, Inventory Conversion Period, Lead Time, Accounts Payable Period, etc.; if special condition is found to be prevailed then the maximum limit of Working Capital Loans can be 50% of Annual estimated Transaction/Sales. Such reasoning for prevalence of special condition must be mentioned in the file.
• Before approving limit of working capital loans, BFIs must conduct physical verification and valuation   of current assets of the firm/entity/company and must analyze the authentic loan limit and drawing power. The loan disbursal limit shall be determined on the basis of Drawing Power derived from such analysis.
• While assessing limits of working capital loans to firm/entity/company, the loan can be identified as Permanent Working Capital and Fluctuating Working Capital Need. The Bank can provide
  • loans for fluctuating working capital – for less than one year and
  • for permanent working capital – 3 to 10 years

3.3 Limits of Working Capital Loans above Rs. 20 million (Above Rs. 40 million in case of Production based Industry)

• While assessing limits of working capital loans of more than Rs. 20 million (Above Rs. 40 million in case of Production based Industry)to firm/entity/company and upon analyzing justification of such loan requirement, the loan must be identified as Permanent Working Capital and Fluctuating Working Capital Need.
• When approving loans for Fluctuating Working Capital Need, it shall not be more than 25% of annual transactions/sales. The tenure of this type of loans shall be less than or equal to one year and such loan limit shall be renewable.
• However, upon analysis based on Operating Cycle, Cash Conversion Cycle, Days Sales Outstanding, Inventory Conversion Period, Lead Time, Accounts Payable Period, etc.; if special condition is found to be prevailed then the maximum limit of Working Capital Loans can be 40% of Annual estimated Transaction/Sales. Such reasoning for prevalence of special condition must be mentioned in the file.
• The BFIs must provide term loan with 3 to 10 years’ tenure for Permanent Working Capital Need.
• When determining term loan limits for the purpose of working capital, minimum of 3 years’ projected financial statements and minimum of 3 years’ audited financial statements must be analyzed and internal Working Capital policy must also be followed.
• In case of firm/entity/company which is new or its commencement of commercial operation is less than 3 years, the BFIs can determine limit on the basis of operating costs, estimated cash flows and according to its own Working Capital Loan Policy.
• Before approving limit of working capital loans, BFIs must conduct physical verification and valuation   of current assets of the firm/entity/company and must analyze the authentic loan limit and drawing power. The loan disbursal limit shall be determined on the basis of Drawing Power derived from such analysis.

4. Provisions relating to Renewals of Working Capital Loans

• Working capital loans shall be renewed based on:
  • Audited financial statements
  • Actual details of current assets and current liabilities
  • Loan utilization
  • Need Analysis of working capital loans
• Loan customer must be fully informed in offer letter about the
  • Renewal fee charges
  • Interest rate determination
  • Security details
  • Conditions when loans are renewed.
• Provisions relating to variance under this guideline must be fully complied with.

5. Provisions Relating to Security

• As working capital loans are provided for working capital needs of the customers, they must be secured by current assets.
• The working capital loan policy of the BFI must clearly disclose the extent of current assets required as security or its margin.
• The working capital loan must be provided obtaining security instrument such as:
  • Pledge or hypothecation deed
  • Loan deed
  • Promissory notes
  • Insurance policy, etc.
• The working capital loans shall not require security of any fixed and/or non-current assets like land and building.
• The BFI providing loans must have the first claim over insured current assets. The BFI can hand over claims from insurance company to loan customer only when their loans are regular.

6. Review and Management of Working Capital Loans

• The BFI must conduct inspection of current assets and current liabilities at least once in every three months and one compulsory sudden inspection in a year. Such inspection report must be included in loan file.
• In addition to physical examination of goods during inspection, the BFI must also inspect VAT register, excise register, receivables register and payables register, etc.
• The quality of goods and probable sale of goods in the market must also be assessed during physical inspection of goods.
• During inspections, the current assets and current liabilities must be analyzed to ascertain compliance with the working loans outstanding. Such analysis must be recorded in loan files.
• During physical inspection of the goods, if loan is found to be misutilized then the loans must be categorized into loss loans and 100% provision must be set aside and recovery process must also be initiated.
• Following details must be included in loan files relating to current assets and current liabilities of the loan clients:
  • Quarterly details certified by the customer in case of working capital loans up to Rs. 50 million,
  • Semi-annually details certified by internal auditor of the firm in case of working loans exceeding Rs. 50 million.
• The notice board containing following information of firm/entity/company must be placed (not easily removable) in a place where goods are kept by the loan customer or in a shop, godown or factory:
  • Name of firm/entity/company,
  • Address where security is located,
  • Registration number,
  • Name of BFI where assets are pledged.
• When current assets relating to inventory or receivables are accepted as security by any BFI, the other BFI cannot accept those assets as their security. But BFIs can accept as joint security in case of consortium financing.
• The BFI must register the details of current assets accepted as security while providing loans or in its renewals at Secured Transaction Registration Office. The BFI, before accepting current assets as its security, must also obtain details from Secured Transaction Office and confirm that they are not secured in other BFIs.
• When approving working capital loans, the BFI must manage to have insurance of goods in security based on its probable risk analysis. The BFI must inform to customers for renewals of the policy before 15 days of the expiry of the policy. If the policy is not renewed until before one day of the expiry of the policy, the BFI must carry out the renewal of the policy by expending from the customer’s loan account with their prior approval. The reason for not having insurance of the goods or not covering any types of risk in the policy must be documented when approving the loans.
• The BFI must include the details of current assets and current liabilities of the loan customers in Core Banking System or in any appropriate Management Information System (MIS) and must develop system for its continuous review.

7. Provisions relating to Variance in Projections

• The projected financial statement submitted by the customer must be thoroughly analyzed for its reality and the statement closer to the real scenario must be based to ascertain the loan limit.
• Projected financial statement must be obtained annually and be analyzed. Once the loan is approved after its analysis, the loan limit cannot be reviewed on the basis of another projected financial statement until the audited financial statement is obtained.
• The audited financial statement must be verified to ascertain whether it comply with the tax clearance details and projected financial statement must be analyzed to ascertain its reality. This must be verified by loan approving officer and documented in loan files.
• After receiving audited financial statement, this should be compared with projected information of the same period for variance analysis.
• When renewing working capital loans or in review of term loans relating to working capital, the renewal or review must be performed by adjusting the loan limit based on Variance Analysis. However,if time is demanded by customer to present audited financial statement along with reasonable justification, the loan can be renewed or reviewed. But such loans shall be immediately adjusted as per necessity when audited financial statement is obtained.
• In variance analysis, if real transaction amount of the customer is found less than projected transactions by more than 20% , the limit of working capital loans of the customer must be adjusted as below:
• Limit of Working Capital Loan

= (Projected transactions x Prescribed Loan Limit %) x (1 – 0.50 x variance**)

* Prescribed Loan limit means percentage prescribed when approving loan based on projected transaction.

** Variance means negative difference between audited information and projected information and such variance shall be calculated in decimal.

Example:

Variance observed is 40% [(30-50)/50 = -0.40].

As actual transaction of the customer is less than 40% of estimated transactions, the limit of working capital loan shall be adjusted as per variance observed.

Therefore,

Working Capital Loan Limit = (Rs. 70 million x 0.2) x (1-0.50×0.4)

                                           = Rs. 11.2 million

If the audited transaction amount was Rs. 40 million, the variance will have 20% and in such case the loan limit shall be determined without adjusting variance i.e. Rs. 14 million (Rs. 70 million x 20%).

• In respect of loans disbursed for long-term projects, for performance under construction contracts concluded in relation with Government, Semi-Government or International Organizations; loan limit is not required to be reduced on the basis of variance observed under this guideline during renewal or review time.

But BFI must ensure that working capital loans outstanding shall not more than certain percentage of Net Trading Assets (NTA) as prescribed in Working Capital Policy of BFI.

• Loan limit of Term Loans provided for Permanent Working Capital Need shall also be reviewed on the basis of variance analysis. If the audited annual transactions of last 3 years is less than projected amount by more than 25% on an average, then the limit of term loan shall also be revised. If the limit of the term loan is reduced, then the customers must be allowed one year time to repay the excess loan amount.

8. Provisions relating to Utilization of Working Capital Loans

• The fund of working capital loan shall be assured that they are utilized only for commercial purpose. They cannot be paid or transferred for other than commercial purpose to unrelated person or partner/proprietor/director/employee. If they are found to be paid for other than commercial purpose, all the working capital loan shall be categorized as loss loans and 100% provision must be set aside.
• The current account and loan account must be separately operated for customers availing working capital loans.
• All the revenue or sales proceed of the business of the loan customer must be routed through current account maintained at BFI. Customer can give standing instructions to transfer revenue or sale proceeds of the business to loan account. BFI must manage to transfer funds from current account to loan account automatically as per standing instruction of customer.
• The loan amount must be transacted by directly transferring from loan account for the purpose of business. The amount more than two percent of loan limit cannot be withdrawn in cash in a monthly basis by transferring it to other account.
• Any type of loan unrelated with the purpose/use (installment/principal/interest/other charges) cannot be paid from the amount of working capital loan. If any type loan is found to be paid from working capital loan amount, such loans are presumed to be unpaid and categorized accordingly as per prevailing rule and paid amount must be managed to be refunded in working capital loan account. However, loan relating to import can be paid by disbursal of working capital loan approved while opening LC.
• Cash Credit Account must maintain loan balance less than 10% of the loan limit for continuous 7 days at any point of time in a financial year.

However, from the date of implementation of this Guidelines, following application can be done:

• For the first year, the loan customer can maintain less than 30% of the loan limit as loan balance for continuous 7 days.
• For the second year, the loan customer can maintain less than 20% of the loan limit as loan balance for continuous 7 days.
• After third year, the loan customer can maintain less than 10% of the loan limit as loan balance for continuous 7 days.

9. Policy Formulation relating to Working Capital Loans

• The BFI must implement Working Capital Loan Policy and Procedure after approval from its Board of Directors. Such policy or procedure must cover following subject matters compulsorily:
  • Types of Working Capital Loan, Limit, Interest Rate, Tenure, Renewals and Review,
  • Computation process of permanent and fluctuating working capital, repayment schedule and its recovery process,
  • Computation of Drawing Power of customer, process and time schedule of loan disbursal and review,
  • Loan to equity ratio,
  • Commitment fee,
  • Current ratio acceptable to loan customers,
  • Procedure and time schedule of Evaluating Loan Utilization of customer,
  • Matters relating to loan categorization to loss loans, provision setting aside and its recovery if loan is misutilized and found utilized for purpose other than predetermined purpose,
  • Time allowed to customers for regularization of loans if during onsite inspection, goods or current asset does not found to be covered by outstanding loan amount or loan is found to be provided in excess of actual requirement and also, step to be taken for management of credit risk,
  • Matters relating to loan categorization to loss loans, provision to be set aside and recovery process if excess financing (current assets not covering loan outstanding) is repeated as stated above for more than 3 times.

10. Other Provisions

• The types of working capital loan shall be according to annexure 1. The type of loan to be provided shall be decided according to the nature of business of the customers and as per the Working Capital Loan Policy of the BFI.
• When determining working capital loan limit, debt equity ratio must be complied with prevailing directives.
• No any loan shall be provided or limit shall be extended for the purpose of payment of any loan of the customer in same BFI or other BFI. However, for any reason, if any liquidity requirement arises related with business of the customer, working capital loans adhoc in nature can be provided in a condition that the funds shall be transferred directly to the purpose of the loan. Such loans can be provided to seasonal business (like chemical fertilizer, business related with any festivals, etc.). If such adhoc loans are found renewed or misutilized, the loan must be categorized into loss loans and 100% provision be set aside. If this type of adhoc loans are required by customers for more than 2 times in a financial year then this can be provided only after due approval from Board of Director of the BFI.
• The working capital loan cannot be revised/reviewed before 6 months of its approval for whatsoever reason. This provision shall be applicable when loans are transferred from another BFI or in case of Credit Purchase/Takeover.
• The BFI must assure that the customer has not made capital expenditure or has created any fixed assets by the use of fund from working capital loan. If it is found that any capital expenditure has been made or any fixed asset has been created by the use of fund from working capital loan, loan shall be categorized in to loss loan and 100% provision be set aside.
• If it is found that customer has not paid for raw materials as per the predetermined terms, such unpaid raw materials shall not be allowed to be computed into current assets.
• The loan must be renewed or reviewed only after obtaining self-declaration from the customer that they have complied or not with their legal responsibilities like timely payment of salary, the social security amount, tax, other fees payable to government, etc. and must obtain other details as per the requirement to confirm the matters.
• Before approving working capital loan, the BFI must obtain credit information and also must obtain no objection letter from BFI where customer has been found utilizing loan above Rs. 10 million from other BFI. The BFI providing no objection letter must issue no objection letter or information letter for not issuing such letter within 5 working days of receiving such request letter.
• The BFI must update record on a monthly basis by obtaining credit information of the customer and confirming the details of all the loans utilized by the customers from overall banking system.
• If it is found that customer has been utilizing working capital loans of Rs. 100 million or more from more than one BFI, pari pasu agreement must be concluded between BFIs providing loans before renewal of those loans. Such agreement must include provisions relating to recovery process of loans in case of default, auction of collateral and resolution of conflict.
• The BFIs must communicate following information immediately amongst themselves in respect of customers utilizing working capital loans from more than one BFI:
  • If any problems observed in transaction of the customers,
  • If loans are found to be misutilized, or
  • If no regular payment is made.
• The limit of working capital loan of existing customers cannot be increased or new working capital loan cannot be approved for old customers on the last month of every quarter (i.e. Ashwin, Poush, Chaitra and Ashad). Also, interest/principal of the loans cannot be recovered by making payment from working capital loan accounts. However, renewals and disbursal of approved loans are not affected by this provision.
• BFI must identify following customer as willful defaulter and categorize their loan in loss loan category and must set aside 100% loan loss provision and blacklist such customer:
  • If timely payment of loan is not found even when they are not facing problem in financial condition or cash flow,
  • Loan is utilized in other areas and defaults payment on due date.
• The BFI must file compliant without any delay to Institute of Chartered Accountants of Nepal if:
  • Significant error is observed in audited financial statement, or
  • False statement are found to be submitted.
• The “B” and “C” class BFIs cannot provide loans by way of hypothecation of current assets.
• When determining limit of working capital loan of customer if customer files application with valid reason stating that they are unable to submit audited financial statement because their audit work is not completed then BFI can allow reasonable time period to submit such financial statement. After receiving such audited financial statement Variance shall be calculated and limit shall be adjusted as required.
• The BFI cannot charge prepayment charges if loan customer wishes to repay term loan under working capital loans in advance.  However, this provision is not applicable if loans are transferred to other BFI or there are credit purchase/takeover.

Implementation of the Guideline

• At the time of first-time renewal or review of working capital loans provided before implementation of this Working Capital Guideline 2079 i.e. before 2079/07/01 and when such loans are reviewed to set limit as per permanent and fluctuating working capital loans, these loans are not considered as rescheduled or restructures loans for the purpose of loan classification or loan loss provision.
• At the time of first-time renewal or review of working capital loans provided before implementation of this Working Capital Guideline 2079 i.e. before 2079/07/01, if such loans are found beyond the limit of the Guideline then such excess loan amount shall be adjusted into term loans payable semi-annually by the end of Ashad 2082 as below:

The tenure, repayment schedule and installment amount of such loans cannot be altered. In addition, if customer wishes repay such loans before maturity, the BFI cannot charge prepayment charges.

Annexure 1: Types of Working Capital Loans

A. Cash Credit Loans

The loans provided by BFIs to industrial or commercial company/firm/entity for management of current assets by mortgaging (hypothecation) or pledging such current assets and are renewable in nature are cash credit loans.

B. Short Term Loans

The lump sum loans provided prescribing time limit by BFIs to industrial or commercial company/firm/entity for fulfillment of working capital needs by mortgaging (hypothecation) or pledging such current assets are short term loans. These loans are not eligible for renew.

C. Loan related to Import Export

Loans provided to the extent of invoice amount for its payment by opening letter of credit for industrial or trade purpose or import or export of goods via other means are loans related to import export. Trust Receipt loans are included under this category. These loans are not eligible for renew.

D. Term Loan for the purpose of Working Capital

When assessing working capital needs of business, term loans for period of 3 to 10 years are provided for fulfillment of permanent working capital needs. Such loans are considered as term loans for the purpose of working capital.