Cash Credit (CC)

Cash Credit (CC) is one of the most important short-term financing instruments used by banks to meet the working capital requirements of businesses. In the context of banking, finance, and the Indian economy, the cash credit system has historically played a vital role in supporting trade, industry, and small enterprises by providing flexible and need-based access to funds. It represents a distinctive feature of Indian banking practice, closely aligned with the country’s commercial and industrial structure.

Concept and Meaning of Cash Credit

Cash credit is a form of working capital finance under which a bank sanctions a credit limit to a borrower, allowing withdrawals up to that limit as and when required. Unlike term loans, interest under a cash credit facility is charged only on the amount actually utilised and not on the entire sanctioned limit.
The facility is usually granted against the security of current assets such as raw materials, work-in-progress, finished goods, and receivables. Cash credit thus provides liquidity to businesses, enabling them to manage day-to-day operational expenses and cyclical fluctuations in cash flow.

Nature and Characteristics of Cash Credit

Cash credit has certain defining characteristics that distinguish it from other forms of bank finance. It is typically sanctioned for a short duration, usually one year, and is subject to periodic renewal based on the borrower’s financial performance.
The limit is determined after assessing the borrower’s working capital requirements, turnover, and creditworthiness. Borrowers can deposit and withdraw funds multiple times within the sanctioned limit, making cash credit a highly flexible financing arrangement.
Interest is calculated on the daily outstanding balance, which makes cash credit cost-effective compared to loans where interest is charged on the full amount disbursed.

Evolution of Cash Credit in India

Cash credit has been a dominant mode of working capital finance in India since the early stages of banking development. During the planned economic era, banks relied heavily on cash credit to finance trade and industry, particularly in the manufacturing and wholesale sectors.
The Reserve Bank of India actively shaped the cash credit system through guidelines on credit assessment, security norms, and inventory financing. Over time, concerns arose regarding inefficiencies in credit utilisation, such as excessive borrowing limits and lack of discipline in fund usage.
To address these issues, several committees recommended reforms, encouraging better monitoring, periodic review of limits, and a gradual shift towards need-based and cash flow-based lending.

Cash Credit and Working Capital Finance

Cash credit is closely linked with working capital management. It enables businesses to bridge the gap between expenditure on production and receipt of sales proceeds. In sectors with seasonal demand or long operating cycles, cash credit acts as a critical liquidity support.
Indian banks often combine cash credit with other working capital facilities such as overdrafts and bills financing. Together, these instruments help firms maintain uninterrupted operations and manage short-term financial obligations effectively.

Role in the Banking System

For banks, cash credit represents a significant portion of short-term advances. It provides a steady source of interest income while supporting productive economic activity. However, it also requires careful monitoring to ensure that funds are used for genuine business purposes.
Banks periodically inspect stock statements, receivables, and financial records of borrowers to assess asset coverage and credit discipline. Effective management of cash credit accounts is essential for maintaining asset quality and preventing the accumulation of stressed assets.

Importance for Small and Medium Enterprises

Cash credit is particularly important for small and medium enterprises (SMEs), which often face constraints in accessing long-term finance. The flexibility of cash credit allows these enterprises to manage fluctuating cash needs without resorting to informal sources of finance.
In the Indian economy, where SMEs contribute significantly to employment and output, cash credit facilities support entrepreneurship, production continuity, and local economic development.

Impact on the Indian Economy

At the macroeconomic level, cash credit plays a stabilising role by ensuring the smooth functioning of trade and industry. By providing timely liquidity, it supports production, distribution, and employment across sectors.
Cash credit also influences monetary transmission, as changes in bank lending rates directly affect the cost of working capital. In periods of economic slowdown, the availability of cash credit can help businesses survive temporary demand shocks and maintain operational viability.

Advantages of Cash Credit

Cash credit offers several advantages within the Indian financial system:

• Flexibility in withdrawal and repayment
• Interest efficiency due to charging only on utilised amounts
• Support for working capital needs of businesses
• Ease of operation through a running account
• Encouragement to formal banking usage

These benefits explain its continued relevance despite financial sector reforms.

Limitations and Criticism

Despite its usefulness, the cash credit system has faced criticism. It may encourage borrowers to maintain high limits without efficient utilisation, leading to idle credit. Monitoring inventory-based lending can be administratively burdensome for banks.
There is also a risk of diversion of funds if controls are weak. Recognising these issues, regulators have encouraged a shift towards cash flow-based lending and greater use of information systems for credit assessment.