Commercial Banking, Project Finance & Working Capital

Commercial banks represent the bedrock of the Indian financial ecosystem. They handle the public’s daily savings, facilitate smooth national payments, and provide the credit fuel that powers both day-to-day business operations and massive industrial infrastructure.

1. What is a Commercial Bank?

A Commercial Bank is a financial institution licensed to accept public demand and time deposits, make business and personal loans, and offer agency and general utility services with the primary objective of earning profit.

According to the Banking Regulation Act, 1949 (Section 5b):
“Banking means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise.”

The Credit Creation Process

Commercial banks do not simply sit on deposits; they create credit through the fractional reserve banking system:

• When a customer deposits Rs. 1,00,000 in cash, and the Cash Reserve Ratio (CRR) is 4 percent, the bank holds Rs. 4,000 as reserves and lends out Rs. 96,000.
• When that Rs. 96,000 is spent and redeposited into another bank account, that second bank lends out 96 percent of it.
• Through this continuous multiplier cycle, an initial primary deposit expands into multiple derivative deposits, increasing overall economic liquidity.

2. Core Functions of Commercial Banks

┌────────────────────────────────────────────────────────────────────────┐
│                      FUNCTIONS OF COMMERCIAL BANKS                     │
├──────────────────────────┬─────────────────────────────────────────────┤
│ 1. Primary Functions     │ • Accepting Deposits: Current, Savings,     │
│                          │   Fixed Deposits (FD), Recurring (RD).      │
│                          │ • Advancing Loans: Cash Credit, Overdraft,  │
│                          │   Term Loans, Bill Discounting.             │
├──────────────────────────┼─────────────────────────────────────────────┤
│ 2. Secondary Agency      │ • Collection of cheques, drafts, dividends. │
│    Functions             │ • Payment of insurance premiums, utility.   │
│                          │ • Execution of standing instructions.       │
├──────────────────────────┼─────────────────────────────────────────────┤
│ 3. General Utility       │ • Safe deposit lockers.                     │
│    Functions             │ • Issuing Letters of Credit (LC) and        │
│                          │   Bank Guarantees (BG).                     │
│                          │ • Foreign exchange transactions.            │
└──────────────────────────┴─────────────────────────────────────────────┘

3. Role of Banks in Working Capital Finance

Working Capital is the capital required to fund day-to-day operational activities—buying raw materials, paying factory wages, holding finished inventory, and carrying accounts receivable.

Commercial banks are the foremost source of working capital finance in India through several standard facilities:

┌────────────────────────────────────────────────────────────────────────┐
│                  WORKING CAPITAL FINANCING FACILITIES                  │
├─────────────────┬──────────────────┬─────────────────┬─────────────────┤
│ 1. Cash Credit  │ 2. Overdraft     │ 3. Bill         │ 4. Non-Fund     │
│    (CC) Limit   │    Facility (OD) │    Discounting  │    Facilities   │
│ (Against stock) │ (Against FDs/    │ (Instant cash   │ (LCs & Bank     │
│                 │  property)       │  on invoices)   │  Guarantees)    │
└─────────────────┴──────────────────┴─────────────────┴─────────────────┘

1. Cash Credit (CC) Facility:
   • The most popular working capital facility for manufacturing and trading firms.
   • The bank approves a sanctioned limit backed by the hypothecation of current assets (raw materials, work-in-progress, finished inventory, book debts).
   • Interest is charged only on the exact amount utilized on a daily balance basis, not on the total sanctioned limit.
2. Overdraft (OD) Facility:
   • Allows a current account customer to withdraw funds beyond their available account balance up to an agreed limit.
   • Often granted against financial collateral like Fixed Deposit receipts, shares, or life insurance policies.
3. Bill Discounting:
   • Commercial banks purchase verified trade bills of exchange from suppliers at a discount, providing immediate liquidity against goods delivered on credit.
4. Letter of Credit (LC) & Bank Guarantees:
   • Non-fund-based assistance where the bank guarantees payment to raw material suppliers, enabling companies to obtain supplier credit.

4. Role of Banks in Project Finance

Project Finance is the long-term financing of industrial, infrastructure, or commercial projects (like solar power plants, toll highways, airports, cement factories) based upon the projected cash flows of the project rather than the general balance sheet assets of the project sponsors.

Key Aspects of Project Finance

1. Long Gestation Period: Projects take 3 to 7 years to build (construction phase) and 15 to 25 years to operate and repay loans.
2. Non-Recourse / Limited-Recourse Debt: Lenders look primarily to the revenues generated by the completed project for debt servicing and repayment. Project assets are mortgaged to the lenders.
3. Special Purpose Vehicle (SPV): The project is typically set up as a legally distinct subsidiary (an SPV) to insulate parent companies from project risks.

Project Appraisal by Commercial Banks

Before committing hundreds of crores, commercial banks conduct an exhaustive four-pillar appraisal:

• Technical Feasibility: Validating technology choice, civil engineering designs, raw material availability, water/power supply, and environmental clearances.
• Financial Viability: Calculating Debt Service Coverage Ratio (DSCR), Internal Rate of Return (IRR), Payback Period, and Sensitivity Analysis under adverse price scenarios.
• Economic & Market Feasibility: Assessing national demand for the product, competitor capacity, and pricing trends.
• Managerial Competence: Evaluating the track record, integrity, and promoter equity commitment of project sponsors.

Consortium Lending & Loan Syndication

Because a single megaproject (such as an airport costing Rs. 8,000 crores) carries too much risk for one single bank, banks use Consortium Lending or Loan Syndication:

• A Lead Bank conducts appraisal and drafts documentation.
• Multiple participating public, private, and foreign banks pool funds together, sharing risk and interest income in agreed proportions.

5. Working Capital Finance vs Project Finance

6. Summary for BBA Exams

• Commercial banks mobilize deposits and create credit via fractional reserve banking.
• Working Capital: Funded via Cash Credit (against stock), Overdraft, and Trade Bill Discounting.
• Project Finance: Long-term funding for infrastructure/industrial plants evaluated through thorough technical and financial appraisal.
• Loan Syndication / Consortium: Multiple banks pooling resources under a Lead Bank to finance mega-projects.