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GAYATHRI V S3 MBA CET

Term Loans
A term loan is a monetary loan that is repaid in

regular payments over a set period of time. Term loans usually last between one and ten years, but may last as long as 30 years in some cases. A term loan usually involves an unfixed interest rate that will add additional balance to be repaid.

Term loans can be given on an individual basis but are often used for small business loans. The ability to repay over a long period of time is attractive for new or expanding enterprises, as the assumption is that they will increase their profit over time. Term loans are generally provided as working capital for acquiring income producing assets (machinery, equipment, inventory) that generate the cash flows for repayment of the loan.

Characteristics of term loan


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MATURITY The maturity period of term loans is typically longer in case of sanctions by financial institutions in the range of 6-10 years in comparison to 3-5 years of bank advances. NEGOTIATED The term loans are negotiated loans between the borrowers and the lenders. SECURITY Term loans typically represent secured borrowing. INTEREST PAYMENT AND PRINCIPAL REPAYMENT The interest on term loans is a definite obligation that is payable irrespective of the financial situation of the firm. To the general category of borrowers, financial institutions charge an interest rate that is related to the credit risk of the proposal.

Features of term loan


Type of debt financing.

Mainly for investment in fixed assets.


Also for getting technical know-how, preliminary expenses and

margin money for working capital. FI provide rupee term loan and foreign currency term loan. Foreign currency term loan for import of plant and machinery.

Contd
Assets which are financial with term loan is the prime security. Other assets of the firm can be collateral. Repayable in monthly or quarterly or half yearly installment. Interest rate charged is as per credit risk of the project. Incase of default of payment penal interest is charged.

Sources of term loans


Development financial institutions

or development banks sponsored by national govts and international organisations provide long-term credit for projects. FIs make term loans of 5 to 7 years and even extending to 10 years. They also make foreign exchange loans.

Development Financial Institutions


Industrial Development Bank of India (IDBI) - established in 1964. - the principal financial institution for providing credit and other facilities for the development of industry. Industrial Credit and Investment Corporation of India - established in 1955. - provides term loans in Indian and foreign currencies, underwrites issues of shares and debentures.

Contd
Industrial Finance Corporation of India (IFCI) - set up in 1948. - provides to industrial units project finance, financial services and promotional services. State Finance Corporations (SFCs) - set up under State Financial Corporations Act 1951. - there are 18 SFCs in the country. - they provide financial assistance to small and medium enterprises by term loan, direct subscription to equity/debentures, discounting of bills of exchange and guarantees.

Contd
Small Industries Development Bank of India (SIDBI) - established in 1981. -functions as the principal financial institution for promotion, financial and development of industrial concerns in small scale sector. Shipping Credit and Investment bank of India (SCICI) -set up in 1987 by ICICI for the development of shipping, fishing and related industries.

Contd
Industrial Investment Bank of India (IIBI) -formed on 1997 under the Companies Act. Tourism Finance Corporation of India Ltd. (TFCI) -sponsored by IFCI which commenced operations in 1989 to sanction project loans, lease assistance and direct subscription to shares. Commercial Banks -Apart from these FIs, commercial banks also can sanction term loans.

Procedure
Priority

in financing is given to projects contributing to infrastructural facilities and agriculture and rural development, projects located in backward areas, generation of employment, export oriented etc. The project should not fall under negative list which includes cigarettes, beer and alcohol, toilet & cosmetic preparation, powerlooms etc.

After verification that the project would be eligible for a term loan, a preliminary meeting should be fixed with the FI. If the DFI agrees to consider the proposal the application for term loan along with the check list of information to be supplied has to be obtained.

Requirements of a loan application


The loan application requires details of promoters background, technical skills, relevant experience and financial soundness. The market study research for the project. Aspects on technical, financial and economic appraisal. Cash flow statement for a seven to ten year period.

Contd
The land for the project, plans for building and

quotations for machinery. The actual production process. Working capital requirements.

Final Structure
Promoters Contribution ie,the stake of promoters in the project. It is fixed at 22.5 % of the project cost. Debt- equity ratio 3:1 for small industrial units and 2:1 for medium and large units.

Debt Service Coverage Ratio (DSCR) The payment of interest and repayment of principal within the stipulated time is measured by DSCR. Security margin It represents the excess value of fixed assets over the term loan. The security margin is 25%.

Types of term loan


Long-term loans Intermediate term loans Short term loans

Long-term loans
A long term loan is of several years duration,

generally 3-5 years, but can be considerably longer . The loan can be renewed at the end of the loan period if both parties agree. These loans are used for major business expenses such as vehicles, purchasing facilities, construction and furnishings.

Intermediate term loans


Term loans finance the purchase of furniture,

fixtures, vehicles, and plant and office equipments. Maturity generally runs more than one year but less than five. Consumer loans for autos, boats, and home repairs and remodeling are also of intermediate term.

Short term loans


Short term loans, typically lines of credit, working

capital loans, or accounts receivable loans. They usually reach maturity within one year or less. A short term business loan is an option for an established business that has a strong support and patronage.

Advantages of short-term loans


do not usually require collateral. allow quick application that makes the funds available in several days or even hours. require little paperwork. provide you with money when you feel a sudden unexpected need. With short term loans you do not burden yourself with long term obligations.

Disadvantages of short term loans


are usually more expansive. As short term loans are not secured by collateral the lender raises interest rates to cover the risk. Before giving you short term loans the lender is likely to investigate into your credit history and if it is excellent you will be offered short term loans with lower interest rates.

Financing of SME
Small and Medium Enterprises (SMEs) play a very significant role in the economy in terms of balanced and sustainable growth, employment generation, development of entrepreneurial skills and contribution to export earnings. However, despite their importance to the economy, most SMEs are not able to stand up to the challenges of globalisation, mainly because of difficulties in the area of financing.

Issues in financing SME


Information Asymmetry: Accurate information about the borrower is a critical input for decision-making by banks in the lending process. Granularity: This refers to a situation where the risk grading system at banks does not have the requisite capability to discriminate between good and bad risks. Pecking Order Theory: SMEs try to seek out alternative sources of funding. SMEs prefer to utilise retained earnings instead of raising loans from banks.

Moral Hazard: Even when loans are made to

SMEs, it may so happen that the owners of these SMEs take higher risks than they otherwise would without lending support from the banks. Switching Costs: SMEs may find it harder to switch banks, when countered with any issue.

Instruments of SME Financing


SIDBI is the principal financial institution for the promotion, financing and development of industry in the SME sector in the country. Credit Guarantee Fund Trust for Small Industries: Government of India, in association with SIDBI, has set up a Credit Guarantee Fund Trust for Small Industries (CGTSI) to implement the guarantee scheme. Risk Sharing Facility: For loans above 2.5 million, a Risk Sharing Facility for the SME sector is being examined, wherein the risk is shared between the originating banks and the suggested entity.

Contd

Venture Capital Funding: SIDBI, along with some other institutions, has taken a lead in promoting venture capital funding in the country. Micro Credit: SIDBI Foundation for Micro Credit has been established. Small and Medium Enterprises Fund: The most important amongst the sectoral initiatives taken by the GoI and SIDBI is an SME Fund, with a view to giving impetus to the fund flow to the SME sector. Under the Fund, assistance is being provided to SMEs at an interest rate of 200 basis points below the Banks PLR.

References
Introduction to Project Finance by H.R.

Machiraju. www.wisegeek.com http://www.managementparadise.com/ http://www.slideshare.net http://www.uberloanz.com/ http://cab.org.in http://www.sreeneevaas.com

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