Maximum Permissible Bank Finance (MPBF)

Maximum Permissible Bank Finance (MPBF) is a fundamental concept in Indian banking and finance that defines the upper limit of working capital finance a bank can extend to a borrower. It represents a regulatory and prudential mechanism designed to ensure that bank credit is used efficiently, borrowers maintain adequate stake in their operations, and excessive dependence on bank finance is avoided. In the Indian economy, where bank credit plays a crucial role in supporting industrial and commercial activity, MPBF has significant importance for credit discipline and financial stability.
The concept of MPBF emerged as part of India’s structured approach to working capital management under the guidance of the Reserve Bank of India, particularly during a phase when directed credit and scarcity of financial resources necessitated careful allocation of bank funds.

Concept and Meaning of MPBF

Maximum Permissible Bank Finance refers to the maximum amount of working capital loan that a bank may provide to a borrower based on prescribed norms. It is calculated after assessing the borrower’s working capital gap, current assets, current liabilities, and the minimum contribution required from the borrower’s own long-term sources.
The underlying principle of MPBF is that borrowers should finance a reasonable portion of their working capital needs through their own funds, while banks provide only the permissible balance. This ensures shared responsibility between banks and borrowers and reduces the risk of misuse or over-leverage.

Historical Background and Evolution

The concept of MPBF in India is closely associated with the recommendations of the Tandon Committee, formally known as the Tandon Committee, constituted in 1974. The committee was set up to examine the system of bank credit for working capital and to suggest measures for ensuring disciplined and productive use of bank funds.
Before the introduction of MPBF norms, working capital finance in India was largely demand-driven, with limited emphasis on scientific assessment. The Tandon Committee introduced structured methods for determining permissible bank finance, which later became a cornerstone of Indian banking practice.

Methods of Calculating MPBF

The Tandon Committee recommended three methods for computing MPBF, of which the first two were widely adopted in practice.

• First Method of LendingUnder this method, the borrower is required to finance at least 25 per cent of the working capital gap from long-term funds. The remaining 75 per cent of the gap may be financed by banks.Working Capital Gap = Current Assets – Current Liabilities (excluding bank borrowings).
• Second Method of LendingThis method requires the borrower to finance at least 25 per cent of total current assets from long-term funds. Banks finance the balance after deducting current liabilities other than bank borrowings.
• Third Method of LendingThis method, which was recommended but not widely enforced, required borrowers to finance the entire core current assets and at least 25 per cent of the remaining current assets from long-term sources. Due to its stringent nature, it was not implemented extensively.

MPBF is derived from these methods as the maximum limit up to which banks may extend working capital credit.

Role of MPBF in Banking and Finance

In banking and finance, MPBF serves as a critical credit appraisal and control tool. It helps banks:

• Assess the genuine working capital needs of borrowers
• Prevent over-financing and diversion of funds
• Encourage efficient inventory and receivables management
• Maintain asset quality and reduce credit risk

By linking credit availability to operational requirements, MPBF promotes prudent lending and strengthens the overall health of the banking system.

Regulatory Framework in India

The Reserve Bank of India has historically incorporated MPBF norms into its credit policy and supervisory framework. Although economic liberalisation and financial sector reforms since the 1990s have introduced greater flexibility in lending, MPBF continues to influence working capital assessment, particularly for large borrowers.
In contemporary practice, while banks may use cash flow–based or turnover-based lending methods, MPBF principles remain embedded in credit appraisal systems, internal rating models, and loan covenants. Regulatory emphasis on transparency and risk management has reinforced the relevance of MPBF-derived discipline.

Significance in the Indian Economy

MPBF has played an important role in shaping credit culture in the Indian economy. By ensuring that borrowers maintain a minimum level of own contribution, it has encouraged financial discipline and responsible business practices. This has been especially important in a developing economy where bank resources are limited and must be allocated efficiently across sectors.
The framework has also supported macroeconomic stability by reducing excessive credit expansion and limiting the build-up of non-performing assets. In sectors such as manufacturing, trade, and infrastructure, MPBF-based financing has helped align credit growth with real economic activity.

Advantages of the MPBF System

The MPBF system offers several advantages:

• It ensures rational and need-based allocation of bank credit.
• It promotes borrower participation through minimum net working capital requirements.
• It reduces the risk of speculative use of funds.
• It provides a uniform and transparent basis for working capital assessment.