Overdraft

Definition of Overdraft (OD)

Overdraft is a type of financial instrument in which money transactions can be done through a savings or current account. This account’s unique feature is that money can be withdrawn even when the true balance falls to zero. Here are few characteristics of an Overdraft account:

  1. The account’s monetary limits are extended, and many financial institutions offer this unique financial tool of convenience. 
  2. The nature of the relationship of the customer with the financial institution determines the total credit limit, rate of interest applied for the OD account. 
  3. After analyzing the borrower’s financial history, different banks assign different rates of interest in the bank account. 
  4. The OD applications process goes through a significant vetting process that credit rating agencies carry out.

Lendingkart Finance Limited (LK) offers an unsecured Overdraft (OD). To meet the short-term working capital needs of existing MSME and new customers alike, Lendingkart offers Overdraft. In partnership with banks, Lendingkart will offer unsecured overdrafts. However, the Bank will only provide back-end support for the product, and Lendingkart will handle the entire process including customer origination, due diligence, credit underwriting, KYC.

What are the salient features of an OD option on a bank account?

  1. The overdraft facilities are a privilege extended by bank management to their most trusted and valued customers as they give a credit limit without the requisite collateral. The OD account should be opened by analyzing the transactions that are carried out on a savings account.
  2. The extension of the credit limit in the OD conduct is carried out after assessing the previous repayment capacity, regularity of payments, and the individual’s present earning capacity.
  3. The OD account attracts an interest rate on the outstanding amount, and there may be a grace period provided by the financial institution that ranges from a couple of days to a few weeks.
  4. The conditions governing the repayment tenure of the OD account are under the full control of the banking institution’s respective departments.
  5. The RBI regulations stipulate that the cash credit accounts (CC accounts) and the current accounts are eligible for a maximum limit of Rs. 50000 on an annual basis.

Overdraft by Lendingkart: Features and comparisons

The account will have the following features: An overdraft facility (with the ability to operate a current account).

  1. Deposit of funds
  2. Maintenance of credit balance in customer accounts (due to deposits from the customer) Money withdrawals/drawdowns
  3. Using the customer’s account (negative balance) beyond the limit allotted by the bank  

An interest charge will be imposed only for Overdrawn amounts and will be assessed on the last day of the month. Interest will be charged to accounts on the 5th of the month following the month of the overdraft (actual overdraft/principal can be revolved).

Comparison of Lendingkart OD with other bank’s OD:

Parameters

Bank/ Small Finance Banks  OD

Lendingkart OD

Product type 

Secured Overdraft (as collateral FD/property)

Unsecured Overdraft (No collateral  needed)

Type of customer 

Customers with Current Accounts only

Both New & Existing customers 

Documentation required post-issuance

Statement of quarterly stock holdings

None 

Penalty for non-usage 

Yes

No 

Overdraft fees 

Yes

No 

How do OD accounts help businesses and revamp the total economic scenario?

Overdraft is a unique tool of the financial system that brings lots of benefits to the banking institution and the end-user. The business organizations are the ones that are highly advantaged by the introduction of the OD facilities as they can meet their capital expenditure and cash flows comfortably. 

Businesses now need not wait for long periods for payments from the clients, and OD facilities help them to target more customers. The additional funds made through OD accounts can be used to make payments for new contractors, which increases the flexibility of supply chain systems and improves the logistics of the company.

Cheque flexibility offered by OD accounts:

Businesses can now sign cheques to respective vendors without the hassle of checking the real balance on the accounts, as any claim on an OD is immediately honored by the bank. 

  1. OD accounts help reinforce small businesses’ brand identity in front of the customer and the supply chain contractors. This enables valuable momentum in their procurement of raw materials, payments to employees, and any other related expenses are carried out without delay. 
  2. Cheques drawn on an OD account can never be dishonored, and this helps the organizations to be on the good side of law and maintain financial solvency without any extreme need to file for bankruptcy.
  3. There are a lot of banking systems that offer vanilla types of overdraft facilities on savings and salary accounts. The credit score is an important pre-determiner when individuals or business organizations make OD facility applications. 

The onset of digital transactions over the last decade has brought in a centralized repository of all people’s financial history in society. All financial parameters such as loans taken, amount of individual loans, and credit repayment indexed are comprehensively evaluated and checked for consistencies or anomalies. Also, not every customer can afford an OD facility as the bank charges a certain amount of fees for availing of the credit facility.

What are the unique advantages of availing of an OD facility?

Overdraft facility provides the much-needed capital injection into the account books of business organizations and eliminates the structural mismatches in the fund flows. A skipped cycle of financial inflows can easily be managed by invoking the OD facility, which helps manage the cash flow inconsistencies that are arising due to the present disruptions in global payment systems.

  1. Maintaining Ideal reputations with Lenders

The present business environment rewards those entrepreneurs who are in the good books of the lending institutions and those who display adherence to the credit rating systems. OD accounts help in clearing pending payments thanks to the bank’s trust in the profitability of your business.

The higher the bank which places trust in your business increases your credit standing among international credit agencies. For example, an OD limit approved by major banks goes directly into the systems of financial governance maintained by Basel, thus making you eligible for international banking loans.

  1. Timely Payments

Lack of sufficient balance to cover the existing financial commitments is a thing of the past, thanks to OD facilities’ extension to the business and individuals with huge monthly turnovers. 

  1. Goodbye Paperwork

Generally, the conventional type loans require vigorous backchecking, and only after considering the collateral, the loans are granted. This instability is removed thanks to the presence of OD amounts which are easy to avail without the hassles of looking for altering the collateral portfolio of existing loan accounts.

What are the cons of availing Overdraft accounts?

Every good tool comes with certain conditionality, and wrong use of the OD account can result in some unsavory circumstances such as the following:

1. Decree in Overall Limits

The bank’s management constantly revisits the OD approval processes and their subsequent functioning for finding the risk factors that may result in a loss for the bank. The bank’s credit teams continuously evaluate the company’s financial quarter’s loss and profit statements, and any discrepancies in their overall sustainability will result in a reduction of credit limits. This may be a double whammy for the businesses as they are now facing the twin problems of reduction in profits, and their credit limits are confined as well.

2. Risk of Seizure

Inventory of raw materials and shared collaterals are the central indicators on which the overdraft is granted. Any reduction in their market values leads to automatic stoppage of the overdraft facilities according to the RBI guidelines and SARFAESI Act. The company stands to lose the critical inventory to the bank’s management due to fluctuations in the supply chain systems and alterations in the global financial systems. 

3. Collections from Debtors take backstage.

Provision of Overdraft facility has a delinquent effect on the ability to collect payments from debtors at the right times. The debtors negotiate with the companies as they will play the trust card, which is indeed important in businesses, and this leads to a delay in the final payments.

How is the interest charged on the Overdraft facility?

Since there is an absence of monthly repayments, the banks make a profit by charging interests at periodic intervals. The interest amounts can be either charged on the full amount or predetermined amounts of money. In certain cases, a daily interest rate is charged on the minimum due amount when the applicant fails to repay the contracted amount in the stipulated time.

Eligibility for Approval for an Overdraft account

The financial institutions reserve the right to apply selective procedures for determining the individual or collective eligibility when there is an application for overdraft.

1. The Financial Viability

of the individual and business is evaluated with the assessment of various bank records and previous tax statements. The business owners’ creditworthiness is checked, and a model is forecasted and checked for adverse scenarios where the appropriate risk factor is calculated. The business’s various criteria are calculated taking the parameters of debt-equity ratios, solvency factors, and market capitalizations of assets.

2. Band reputation of the business

When the company is incorporated, the health of the business is calculated, and cash injections are checked whether there was any artificial inflation of bank assets. This makes sure that the business has grown organically and there are no structural issues that can lead to a flight of capital away from the business. The SEBI rating is cross-checked, and the reports of credit rating agencies are evaluated for the final approval of the Overdraft facility.

3. Credit Score

The modern financial disruptor is the credit score which is taking every business and individual financial history by storm. The credit score is the greatest equalizer where everything is determined by merit, and there is no need to lobby the bank management by other means for successful approval of the overdraft. The credit rating is determined by the number of loans the entity or individual has and their credit repayment history.

Documents necessary for an Overdraft application

  1. PAN Card
  2. Voter ID card
  3. Passport
  4. Aadhar
  5. Electricity Bill
  6. Registered rental deed
  7. Lease accord

Income Proof

  1. The basis of IT solely does the computation of income returns
  2. Profit and Loss accounts
  3. Balance Sheet assessments

Business documents

  1. VAT and GST certificates
  2. Office address proof
  3. Company Letterhead as proof of ownership
  4. Articles of association and Memorandum of understanding
  5. Bank account statements of the latest financial years

What are the points of difference between overdraft and loans?

One major difference between overdraft and other bank loans is the interest charged. The interest amount that is charged on overdraft is negligible. There are no monthly repayments that need to be done for an overdraft since it does not come under a conventional loan.

 

Comparison Parameter

Overdraft

Loan facility

The intent of the instrument

Utilized for daily business operations. Such as payment to debtors and employees.

Purchase of long-term capital assets, For example, buying of heavy equipment and system upgrades.

Requirements of security

In many cases, there is no need for collateral security

Collateral is a necessary factor

Repayment conditions

Applied interest rates are on the higher side compared to loans

Lower interest rates compared to ODs

Time durations

Lies in the range of 3 days to 6 months

It is provisioned for an extended period, with the upper cap reaching up to 20 years.

What is the main divergence point of overdraft and cash credit?

A dissimilar point between cash credit and overdraft is that both can be categorized as working capital facilities. There are certain technical points of difference that can set them apart. A CC facility takes into account the total value of stock and various other inventory items during the calculation of the loan to value ratio. In an overdraft, the main priority of banks is to calculate the LTV based on collateral which is a residential property.

Overdraft (OD) FAQs:

1. What are the loan processing fees associated with an overdraft account?

2% processing fees of the overdraft account will be applicable which is excluding taxes and non-refundable. Some banks do not levy this charge.

2. Is there a specific amount that would be sanctioned?

The amount of loan which will be sanctioned will depend on the banking transactions along with the account conduct which will be assessed by the bank in question over 1 year.

3. What is the tenure offered by overdraft loan facilities?

Despite differing from bank to bank, the typical tenure ranges from 12 months to 60 months.

4. What are the types of overdrafts?

The different types of overdrafts are; 1. Overdrafts against properties, 2. Overdrafts against salaried accounts, 3. Overdrafts against savings accounts, 4. Overdrafts against term deposits

5. How is the rate of interest calculated on overdraft accounts as opposed to loans?

In overdraft accounts, the rate of interest is calculated daily and charged monthly, whereas, in the case of loans, the rate of interest will be calculated every month.

6. Is an overdraft the same thing as a loan?

Basically, yes, this is the same thing. However, the difference lies in the fact that overdraft is a short-term loan in which you can withdraw money beyond your account balance whereas most loans are long-term borrowing and won't work on credit.

7. What are the types of people that can apply for a bank overdraft?

Self-employed professionals, entrepreneurs, and enterprises can avail bank overdraft facilities on both, saving as well as current accounts.

8. Is engaging in an overdraft a good idea?

For those looking for funds on short-term requirements in cases of urgency, this is a great idea for creating liquidity.

9. How often will I receive statements regarding the use of my overdraft account?

Statements, as in most cases, are issued monthly. Duplicate statements can be requested at any time from whichever bank you are using the facilities of. These can be received in both, soft copy forms as well as hard copies.

10. Is there any type of security associated with taking out an overdraft?

No. The greatest benefit of this facility is that no security is needed. It only works based on the account conduct and credibility of the account holder.