MPBF System / Method II Working Capital

The Maximum Permissible Bank Finance (MPBF) system is a structured method used by banks in India to assess and regulate working capital finance extended to business enterprises. Within this framework, Method II of MPBF represents a prudential approach aimed at ensuring that borrowers contribute a reasonable portion of working capital requirements from long-term sources. The MPBF system, including Method II, has played a significant role in shaping credit discipline, liquidity management and financial stability in the Indian banking system.

Concept and Background of the MPBF System

The MPBF system was introduced to bring uniformity, discipline and prudence in the assessment of working capital requirements of borrowers. Prior to its introduction, working capital finance was often based on ad hoc assessments, leading to excessive bank dependence and inefficient use of credit.
The system was developed following recommendations of expert committees and implemented under the guidance of the Reserve Bank of India. Its core objective was to ensure optimal utilisation of bank credit while encouraging borrowers to finance a part of their working capital needs through owned funds.

Meaning of Working Capital

Working capital refers to the funds required by a business to finance its day-to-day operations, such as procurement of raw materials, holding of inventory, and extension of credit to customers. It is generally measured as the difference between current assets and current liabilities.
Efficient working capital management is critical for business continuity, liquidity and profitability, making its financing a key concern for banks and financial institutions.

Overview of MPBF Methods

Under the MPBF framework, different methods were prescribed for assessing bank finance for working capital. These methods determine the minimum contribution that borrowers must make from long-term funds and the maximum extent to which banks can finance working capital needs.
Method II represents an intermediate but more disciplined approach compared to earlier practices, placing greater responsibility on borrowers to fund a portion of current assets through long-term sources.

Concept of Method II of MPBF

Under Method II, banks finance a portion of the borrower’s working capital gap, while the borrower is required to contribute a minimum level of net working capital from long-term funds.
The working capital gap is defined as the excess of total current assets over current liabilities other than bank borrowings. Method II stipulates that the borrower must finance at least 25 per cent of total current assets from long-term sources, such as equity or long-term debt.
The remaining portion of the working capital gap is eligible for bank finance, subject to prudential norms.

Calculation under Method II

The assessment under Method II involves the following steps:

• Estimation of total current assets based on operating cycle requirements
• Determination of current liabilities excluding bank borrowings
• Calculation of the working capital gap
• Borrower’s minimum contribution of 25 per cent of total current assets
• Maximum permissible bank finance as the residual requirement

This structured approach ensures that borrowers maintain a stable funding base for working capital operations.

Objectives of Method II

The key objectives of Method II include:

• Reducing excessive dependence on bank credit
• Encouraging financial discipline among borrowers
• Improving liquidity management and asset quality for banks
• Ensuring alignment between short-term assets and long-term funding sources

By enforcing a minimum borrower contribution, Method II strengthens the financial resilience of businesses.

Role in Banking and Credit Discipline

Method II has been particularly relevant for medium and large industrial borrowers, where working capital requirements are substantial. By standardising credit assessment, it helps banks manage risk, prevent over-financing and monitor end-use of funds more effectively.
It also promotes transparency in borrower financial statements, as accurate reporting of current assets and liabilities becomes essential for credit assessment.

Significance for the Indian Economy

At a macroeconomic level, disciplined working capital financing contributes to efficient allocation of credit and financial stability. By preventing excessive short-term borrowing, the MPBF system supports healthier balance sheets for both banks and borrowers.
Method II, by balancing bank finance with borrower contribution, helps sustain industrial production, trade and employment without encouraging imprudent leverage.

Limitations and Evolution

Despite its strengths, the MPBF system, including Method II, faced criticism for rigidity and administrative complexity. Over time, with financial liberalisation and improved risk management practices, banks have moved towards more flexible cash-flow-based lending approaches.
However, the principles underlying Method II—prudence, borrower contribution and alignment of asset–liability maturities—continue to influence modern working capital assessment practices.