Introduction
In the world of business finance, access to timely funds can make or break growth. Among various tools developed to assess and streamline credit lending, the maximum permissible bank finance (MPBF) remains a foundational concept, especially in the realm of working capital loans.
Understanding what is maximum permissible bank finance is crucial for businesses aiming to secure structured and balanced financing from banks. Whether you’re an entrepreneur, finance student, or a loan consultant, this guide dives deep into MPBF’s background, its methodology, and modern-day relevance.
History & Background
The idea of determining a borrower’s credit limit through maximum permissible bank finance was first proposed by the Tandon Committee back in 1975. Appointed by the Reserve Bank of India (RBI), this committee was tasked with streamlining the lending process for working capital and ensuring financial discipline among borrowers. Before MPBF, banks followed discretionary credit policies, often leading to over-financing and misutilization of funds.
MPBF was recommended as a scientific and formula-driven method to calculate the working capital finance a business truly needs and deserves. Though the RBI later withdrew the mandatory MPBF approach in 1997, the principles laid by the committee still guide the computation of maximum permissible bank finance for working capital in many banks today.
What is Maximum Permissible Bank Finance?
Maximum permissible bank finance refers to the maximum limit of working capital funding that a bank can provide to a borrower, based on their current financial standing. This ensures that businesses maintain a healthy debt-to-equity ratio and contribute a portion of the funds themselves.
The MPBF concept enforces a balance where banks don’t overexpose themselves, and businesses remain financially responsible. Essentially, it determines the maximum permissible banking finance calculated using standardized methods.
3 Methods of Maximum Permissible Bank Finance
The Tandon Committee introduced three separate methods for assessing the maximum amount of bank finance that can be permitted:
Method I
- Borrower must bring 25% of the total current assets from long-term sources (equity or long-term debt).
- Bank can finance the remaining 75%.
Formula:
MPBF is derived by taking 75% of Total Current Assets and then subtracting Other Current Liabilities (not including bank borrowings)
Method II
- The borrower is required to bring in 25% of the total Working Capital Gap (WCG) from their own funds.
- Bank funds the remaining 75%.
Working Capital Gap = Current Assets – Current Liabilities (excluding bank borrowings)
Formula:
MPBF = 75% of (Current Assets – Current Liabilities)
This method became the most widely used and acceptable among banks and NBFCs.
Method III
- Not commonly implemented.
- Core current assets (minimum assets needed for uninterrupted operations) must be funded fully by the borrower.
- Remaining gap funded as per method II.
Formula:
MPBF = 75% × (Current Assets – Core Current Assets) – Other Current Liabilities
The 3 methods of maximum permissible bank finance provide varying degrees of conservative lending. Method II is still considered industry standard in many assessments.
Example of Maximum Permissible Bank Finance
Let’s break it down with an example to understand how Method II is used to calculate maximum permissible bank finance:
- Current Assets = Rs. 100 lakh
- Current Liabilities (excluding bank borrowing) = Rs. 30 lakh
The Working Capital Gap amounts to ₹70 lakh, calculated by subtracting ₹30 lakh (current liabilities) from ₹100 lakh (total current assets).
Borrower’s Contribution = 25% of the Working Capital Gap (Rs. 70 lakh) = Rs. 17.5 lakh
MPBF = 70 – 17.5 = Rs. 52.5 lakh
So, in this case, the maximum permissible bank finance the borrower is eligible for is Rs. 52.5 lakh.
Modern Relevance of MPBF
Even though RBI has withdrawn the mandatory use of MPBF post-1997, banks and consultants still use the maximum permissible bank finance model (especially Method II) as a foundation for assessing creditworthiness.
Many small and medium businesses still request banks to calculate maximum permissible bank finance by Tondon Committee methods, especially when applying for large working capital limits.
The computation of maximum permissible bank finance for working capital still ensures borrowers don’t over-borrow and banks stay protected against NPAs.
Benefits of Using MPBF
- Encourages financial discipline in borrowers
- Standardized approach to avoid over-lending
- Easy integration with CMA data analysis
- Trusted legacy method, even in modern loan evaluations
While MPBF isn’t the only method in use today, it remains a reliable model, especially for consultants helping clients with structured financing.
Limitations of MPBF
- Not suitable for seasonal or fluctuating businesses
- Rigid formula may not match dynamic market needs
- Focuses more on balance sheet than actual cash flow patterns
Today, some banks prefer the Assessed Bank Finance (ABF) method or cash budget method, which considers turnover, cash flow, and operational realities more directly.
How is Maximum Permissible Banking Finance Calculated Today?
While the MPBF framework still influences decisions, many banks now use:
- Projected turnover method
- Cash budget method
- Drawing power calculation using stock and receivables
However, even these approaches often draw indirectly from the maximum permissible bank finance model’s logic.
Practical Tips for Businesses
- Maintain clear distinction between current assets and liabilities.
- Avoid relying solely on bank finance—maintain a margin.
- Understand your working capital cycle to better justify loan amount.
- Keep CMA data updated and clean.
If you’re unsure how to approach it, consult a professional to help you calculate maximum permissible bank finance by Tondon Committee standards.
Frequently Asked Questions (FAQs)
Q1: What is maximum permissible bank finance?
A: It is the highest loan limit a bank may offer to fund your working capital needs, based on your current financials.
Q2: Who introduced the concept of MPBF?
A: The concept of maximum permissible bank finance was introduced by the Tandon Committee in 1975.
Q3: How do banks calculate MPBF today?
A: Though MPBF isn’t mandatory, many banks use modified versions of Method II or rely on modern tools like turnover and cash budget methods.
Q4: Can I request MPBF calculation for loan applications?
A: Yes, many NBFCs and consultants offer services to calculate MPBF and prepare CMA reports.
Q5: What documents are required?
A: Balance Sheet, Profit & Loss statement, GST returns, bank statements, projected financials, etc.
Final Words On Maximum Permissible Bank Finance
The maximum permissible bank finance concept may be decades old, but its structured approach to loan evaluation still holds strong. Whether you’re seeking working capital finance or understanding your business’s borrowing power, learning how to calculate maximum permissible bank finance by Tondon Committee can give you a competitive edge.
If you want help preparing CMA data or computing your MPBF accurately, feel free to reach out to our expert team at WorkingCapitalLoan.co.in.