Maximum Permissible Bank Finance: MPBF Methods for CAIIB ABM

Maximum permissible bank finance is the most examined calculation in the credit module of CAIIB ABM, and it is also the number your credit committee argues over at every renewal. It fixes how much of a borrower's working capital gap the banking system will fund, and how much the promoter has to bring from long-term sources. Get the method wrong and you either starve a healthy unit or over-finance a weak one, which is exactly why the paper keeps returning to it.

This guide walks through the working capital gap, the three Tandon methods, the turnover and cash budget alternatives, and the delivery mechanics RBI now expects, followed by five exam-level MCQs.

🧮 What Maximum Permissible Bank Finance Actually Measures

Every unit locks money into inventory and receivables before it collects a rupee. Part of that block is funded free of cost by suppliers and accruals; the rest is the working capital gap, and maximum permissible bank finance is the ceiling a bank places on how much of that gap it will carry.

The arithmetic starts with two figures from the projected balance sheet:

• Current assets (CA) — inventory, receivables, advances to suppliers, cash and short-term investments, taken at levels the bank considers reasonable, not at whatever the borrower projects.
• Other current liabilities (OCL) — sundry creditors, accrued expenses, advances from customers and statutory dues, but excluding existing bank borrowing for working capital.

Working capital gap = CA − OCL. The reason bank borrowing is stripped out of OCL is structural: you cannot use the facility you are sizing as an input into sizing it. That single exclusion is where most calculation errors in the exam begin.

The Tandon Committee (1974) then added the discipline that gives the concept its name: a borrower must fund a defined slice of its current assets from long-term sources — capital, reserves and term borrowing — so that short-term bank credit never finances a permanent block of funds. That slice is the net working capital or margin; the residue is the MPBF ceiling. If you want the classroom treatment of the underlying balance sheet logic, the working capital finance chapter builds it up line by line before any formula appears.

💡 Exam Tip: Read the question for the phrase "current liabilities other than bank borrowing". When a paper gives you total current liabilities including the cash credit outstanding, you must back out the bank borrowing first, or every method below returns a wrong answer.

📊 The Three Tandon Methods Compared

Tandon prescribed three progressively tighter methods, each raising the borrower's own stake and, with it, the projected current ratio.

Method I: the borrower brings 25% of the working capital gap. MPBF = 0.75 × (CA − OCL).

Method II: the borrower brings 25% of total current assets. MPBF = (0.75 × CA) − OCL.

Method III: the borrower funds the entire core current assets — the permanent, irreducible level of inventory — plus 25% of the balance current assets. MPBF = 0.75 × (CA − CCA) − OCL.

Run one set of numbers through all three — CA ₹600 lakh, OCL ₹200 lakh, core current assets ₹100 lakh:

• Method I: 0.75 × (600 − 200) = ₹300 lakh; margin ₹100 lakh.
• Method II: (0.75 × 600) − 200 = ₹250 lakh; margin ₹150 lakh; current ratio 600 ÷ 450 = 1.33:1.
• Method III: 0.75 × (600 − 100) − 200 = ₹175 lakh; margin ₹225 lakh; current ratio 1.60:1.

The 1.33:1 benchmark examiners love is not a separate rule — it falls straight out of Method II. The Chore Committee (1979) recommended moving borrowers to that method, which is why it remains the default for large exposures.

🏛️ After 1997: Bank Boards, Not RBI, Fix the Method

A point candidates routinely miss: RBI withdrew the mandatory MPBF prescription in April 1997. Banks were left free to evolve their own methods of assessment, subject to a board-approved loan policy. The Tandon arithmetic survives not because it is compulsory but because most loan policies still adopt Method II as the reference point and require a written justification whenever a sanction departs from it.

That shift moved the accountability upward. The board's credit approval framework, its risk management committee and the delegation matrix now decide how liberally the gap may be funded, which is why questions on assessment and questions on corporate governance in banks often sit in the same module.

Three assessment routes are now common in practice:

1. Turnover method — for MSE borrowers seeking fund-based working capital limits up to ₹5 crore, the working capital requirement is taken at 25% of projected annual turnover, of which the bank funds a minimum of 20% of turnover and the borrower brings a margin of 5%. It is quick, and deliberately crude.
2. Cash budget method — for seasonal industries such as sugar, tea and construction, where the peak requirement bears no relation to an annual average. Limits are drawn from month-wise projected cash inflows and outflows rather than from a balance sheet snapshot.
3. MPBF / Method II — the default for regular manufacturing and trading exposures above the MSE threshold.

Government-backed relief lines sit on top of this framework rather than inside it; the eligibility rules for ECLGS 5.0 are assessed separately from the sanctioned MPBF and do not substitute for the promoter's margin. The second part of the working capital finance chapter covers the seasonal and cash-budget cases in detail.

🏦 Delivery: How the Sanctioned Limit Actually Reaches the Borrower

Assessing maximum permissible bank finance is only half the job. RBI's Loan System for Delivery of Bank Credit governs the form in which the limit is released.

For borrowers with an aggregate fund-based working capital limit of ₹150 crore and above from the banking system, a minimum 60% of the sanctioned limit must be a working capital demand loan (WCDL), with only the balance available as fluctuating cash credit. The intent is to stop cash credit being treated as a costless, permanently rolled-over facility. A credit conversion factor of 20% applies to the undrawn portion of both components for capital adequacy.

Day-to-day control then shifts to drawing power, computed monthly from stock and book-debt statements after deducting the stipulated margin and creditors for goods. A borrower with a ₹250 lakh limit but ₹180 lakh of drawing power can operate only up to ₹180 lakh, and a persistent gap is an early warning signal long before the account slips. The overview of credit management chapter ties this monitoring to the wider credit cycle.

⚠️ Common Mistake: Treating drawing power and maximum permissible bank finance as the same number. MPBF is fixed at sanction for the year; drawing power is recomputed every month from actual stock and receivables. Drawings are always restricted to whichever is lower.

Where current assets include imported inventory or export receivables, the assessment must be read alongside the hedging cover in place — the mechanics are set out in this explainer on call and put options. More revision sits in the Advanced Bank Management topic hub, and since every figure above comes from the borrower's returns, classification and tabulation of banking data is the input layer for this chapter, not an unrelated statistics topic.

📎 Always cross-check the current text of the governing circular on the Reserve Bank of India website before you rely on it in the exam hall or at your desk.

🧠 Practice MCQs: Maximum Permissible Bank Finance

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❓ Frequently Asked Questions

Maximum permissible bank finance rewards candidates who practise it rather than read it. Fix the exclusion of bank borrowing from current liabilities, memorise the three formulae in the order Tandon wrote them, and keep the 60% loan component and the ₹5 crore turnover-method threshold on the same revision card. Then run the numbers under time pressure — the full CAIIB course on iibf.store pairs each credit chapter with a timed set so you meet these variants before the examiner does.