Tandon Committee

The Tandon Committee holds a significant place in the evolution of banking regulation and credit management in India. Formally known as the Working Group to Frame Guidelines for Follow-up of Bank Credit, the committee was constituted in 1974 under the chairmanship of P. L. Tandon. Its primary objective was to examine the system of bank credit to industry and recommend measures to ensure disciplined, productive, and efficient use of institutional finance. In the context of banking, finance, and the Indian economy, the Tandon Committee laid the foundation for modern credit appraisal, monitoring, and working capital financing in India.
The committee’s recommendations were particularly influential during a period when India was strengthening its planned economic framework and expanding the role of banks in industrial and developmental finance.

Background and Need for the Tandon Committee

During the late 1960s and early 1970s, India witnessed rapid expansion of bank credit following bank nationalisation. While this expansion supported industrial growth, it also led to concerns about misuse of funds, over-financing, and weak credit discipline among borrowers.
Key issues that necessitated the committee included:

• Inefficient utilisation of working capital by large borrowers
• Diversion of bank funds to non-productive uses
• Lack of uniform standards for credit assessment
• Weak monitoring and follow-up by banks

To address these structural weaknesses, the Reserve Bank of India appointed the Tandon Committee to suggest a systematic framework for bank lending.

Objectives of the Tandon Committee

The Tandon Committee was tasked with developing guidelines to ensure that bank credit was used strictly for productive purposes and aligned with genuine business needs.
Its key objectives were:

• To promote financial discipline among borrowers
• To prevent diversion and misuse of bank funds
• To standardise norms for working capital finance
• To improve follow-up and supervision of bank credit

These objectives reflected the broader goal of strengthening the quality of banking assets and supporting planned economic development.

Concept of Working Capital Discipline

A central focus of the Tandon Committee was the regulation of working capital finance. Working capital represents the funds required for day-to-day business operations such as inventory holding and receivables.
The committee emphasised that:

• Borrowers should finance a reasonable portion of working capital from long-term sources
• Bank credit should supplement, not substitute, owned funds
• Excessive reliance on short-term bank credit should be discouraged

This approach aimed to improve financial health and reduce stress in the banking system.

Maximum Permissible Bank Finance (MPBF)

One of the most important contributions of the Tandon Committee was the introduction of the concept of Maximum Permissible Bank Finance (MPBF). MPBF defined the maximum level of working capital finance that banks could provide to borrowers based on their actual requirements and contribution.
The committee proposed three methods for calculating MPBF:

• First Method: Borrower to finance at least 25% of working capital gap from long-term funds
• Second Method: Borrower to finance at least 25% of total current assets from long-term sources
• Third Method: Borrower to finance the entire core current assets and 25% of the remaining current assets from long-term funds

These methods were designed to progressively strengthen borrower contribution and reduce dependence on bank credit.

Inventory and Receivables Norms

The Tandon Committee introduced the concept of normative levels for inventory and receivables. It recommended that banks should assess reasonable holding periods for raw materials, work-in-progress, finished goods, and receivables.
This ensured that:

• Credit was linked to realistic operational needs
• Excessive stockpiling was discouraged
• Funds were not locked in unproductive assets

These norms improved transparency and objectivity in credit appraisal.

Information and Reporting Requirements

To strengthen monitoring and follow-up, the committee recommended enhanced information systems. Borrowers availing large bank credit were required to submit periodic operational and financial statements.
These included:

• Quarterly information system (QIS) reports
• Funds flow statements
• Stock and receivables statements

Such reporting improved bank oversight and early detection of financial stress.

Impact on Banking Practices in India

The recommendations of the Tandon Committee significantly transformed banking practices in India. Banks adopted more structured and analytical approaches to credit appraisal and monitoring.
Major impacts included:

• Standardisation of working capital assessment
• Improved credit discipline among large borrowers
• Reduction in arbitrary and ad hoc lending
• Better asset quality management

The committee’s framework became a cornerstone of Indian commercial banking.

Role in Credit Risk Management

From a risk management perspective, the Tandon Committee strengthened the linkage between credit exposure and borrower capacity. By insisting on borrower contribution and realistic asset levels, it reduced the probability of default and asset quality deterioration.
This approach:

• Improved predictability of cash flows
• Reduced credit concentration risk
• Strengthened bank balance sheets

These outcomes were particularly important for public sector banks with large industrial exposure.

Macroeconomic Significance in the Indian Economy

At the macroeconomic level, the Tandon Committee contributed to more efficient allocation of financial resources. By curbing misuse of credit, it ensured that scarce banking funds were directed towards productive economic activities.
Its broader economic implications included:

• Improved efficiency of industrial finance
• Reduced inflationary pressure from excess credit
• Strengthened financial discipline in the corporate sector

The committee’s recommendations aligned banking operations with national economic planning objectives.

Limitations and Criticism

Despite its significance, the Tandon Committee framework was not without criticism. Some borrowers and analysts argued that the norms were too rigid and did not adequately account for sectoral differences and business cycles.
Key criticisms included:

• Reduced flexibility in credit availability
• High compliance and reporting burden
• Limited suitability for dynamic and service-oriented industries