Cash Credit Facility
Under Cash credit facility, a line of credit is provided to the borrower on the basis of his projected level of sales, inventories, receivables and cash requirements. This is also known as “Credit Limit” granted by the bank. This facility is operated in the same manner as overdraft facility.
The cash credit facility is generally given for a period of 12 months and reviewed / revised at the end of the year.
To some extent, the Cash Credit facility is problematic for the banks. This is because customers can draw the credit up to their maximum approved credit limit, but practically they seldom reach the maximum limit. This creates a liquidity problem for the banks. Due to this, RBI encourages the businesses in India avail the working capital finance in the form of two components viz. a short-term loan component and a cash credit component. Out of these two, the borrower would fully withdraw the loan component while use the cash credit component as per requirements. The RBI guidelines say that a business that enjoys working capital credit limit of Rs. 10 crore should avail 80% as loan component while 20% as cash credit component. However, RBI gives banks the freedom to define / alter this composition.