No Overdraft Facility

An overdraft facility is a core banking service that allows an account holder to withdraw funds in excess of the available balance, subject to a pre-approved limit. In the Indian financial system, overdraft facilities are primarily associated with banks and are not universally available across all financial institutions. The absence of overdraft facilities, particularly in non-banking financial institutions, reflects structural, regulatory, and economic considerations that shape banking, finance, and the broader Indian economy.

Concept of Overdraft Facility

An overdraft is a short-term credit arrangement provided by banks, usually linked to a current or savings account. It enables customers to meet temporary liquidity shortages and is widely used by businesses for working capital management.
Key features of an overdraft facility include:

• A sanctioned credit limit
• Interest charged only on the utilised amount
• Flexible repayment based on cash flows

This facility is closely tied to deposit accounts and day-to-day banking operations, making it a specialised product within the formal banking system.

Institutional Context and Regulatory Framework

Overdraft facilities are governed by banking regulations and prudential norms laid down by the Reserve Bank of India. Banks are authorised to offer such facilities because they accept demand deposits, maintain current accounts, and participate directly in the payment and settlement system.
In contrast, institutions such as Non-Banking Financial Companies (NBFCs) do not accept demand deposits and are not permitted to operate current accounts in the same manner as banks. As a result, they do not offer overdraft facilities, which are inherently linked to transactional deposit accounts.

Reasons for Absence of Overdraft Facility in Non-Banking Institutions

The non-availability of overdraft facilities outside the banking system is based on clear regulatory and economic rationale.
Major reasons include:

• No demand deposit acceptance: Overdrafts are extensions of deposit-based banking relationships, which NBFCs and similar institutions do not maintain.
• Risk management considerations: Overdrafts involve unsecured or semi-secured exposure that requires continuous monitoring of account operations.
• Payments system linkage: Overdrafts rely on cheque clearing and electronic payment mechanisms, access to which is restricted to banks.

These restrictions help preserve financial discipline and prevent excessive credit creation outside the regulated banking framework.

Distinction Between Overdrafts and Other Credit Facilities

While overdraft facilities are unavailable in non-banking institutions, alternative credit products are offered to meet borrower needs.
Key distinctions include:

• Overdrafts are flexible, revolving credit linked to accounts.
• Term loans have fixed tenures and repayment schedules.
• Cash credit facilities, though similar to overdrafts, are also predominantly bank-provided and linked to working capital cycles.

NBFCs focus on structured loans rather than open-ended credit lines, reflecting their different role in financial intermediation.

Implications for the Banking System

The exclusive provision of overdraft facilities strengthens the central role of banks in India’s credit and payments ecosystem.
From a systemic perspective:

• Banks remain the primary providers of short-term liquidity support.
• Monetary policy transmission is more effective through bank credit channels.
• Credit risks associated with revolving facilities are contained within closely supervised institutions.

This arrangement supports stability and efficiency in the financial system.

Impact on Businesses and Borrowers

For businesses, especially small and medium enterprises, overdraft facilities are valuable tools for managing cash flow mismatches. The absence of such facilities outside banking channels encourages firms to maintain strong banking relationships.
However:

• Borrowers who lack access to bank credit rely on NBFC loans, which are less flexible but more accessible.
• Interest costs may be higher, but credit availability improves for underserved segments.

Thus, while flexibility is reduced, credit outreach is expanded through alternative institutions.

Role in Financial Inclusion and Credit Discipline

From a financial inclusion perspective, the absence of overdraft facilities does not significantly hinder access to finance. Instead, it promotes credit discipline by encouraging borrowers to opt for clearly defined loan products.
In the Indian economy:

• Banks cater to transaction-heavy and liquidity-sensitive needs.
• NBFCs serve niche segments with customised lending products.
• The separation of functions reduces the risk of over-leveraging and misuse of open-ended credit.

This balance supports sustainable credit growth.

Macroeconomic and Policy Implications

At the macroeconomic level, restricting overdraft facilities to banks helps regulate money supply and credit expansion. Since overdrafts can contribute to short-term money creation, limiting their provision ensures better control over liquidity conditions.
Policy implications include:

• Enhanced regulatory oversight of credit creation
• Reduced systemic risk from unmonitored revolving credit
• Clear functional boundaries within the financial sector