Demand and call loans: Economics and regulatory considerations
Vinod Kothari | finserv@vinodkothari.com
From lenders’ perspective, demand and call loans seem to be as liquid as money in a bank fixed deposit, and yet an option to earn substantially higher interest rates. The practice of demand loans exists in the financial marketplace; at the same time, it is often commonplace in the case of intra-group loans. However, there are various risks, considerations and regulatory implications in case of such lending.
This article goes beyond Reg. 28 of the Scale Based Regulations of the RBI and discusses economics, policy issues, liquidity and credit risk considerations, both for the lender and the borrower, as well as issues like NPA treatment, expected credit losses, etc.
What is a demand/call loan?
The word “call money” is typically used in the banking sector for very short-term loans, which are callable at any time by the lender. Demand loan is a term usually associated with longer-term loans, though with no fixed repayment date, that is to say, the loan may be demanded back by the lender at any time. The following features of demand/call loans are discernible:
- There is no fixed repayment date, but that does not mean there is no outer date for seeking repayment of the loan at all. For example, the terms of the loan may say – the lender may seek repayment of the loan at any time; however, if any earlier repayment is not demanded by the lender, the loan will be repaid on its 1st anniversary. Hence, there is an outer date, subject to the possibility of the lender demanding repayment at any time.
- Given its nature, the loan is also puttable by the borrower, that is, repayable by the borrower at the borrower’s instance. It does not seem logical to impose a prepayment penalty for earlier voluntary repayment by the borrower.
- Does the demand loan have to be repaid immediately upon demand? Except in the case of call loans which are very short-term loans by nature, a demand loan may provide a certain number of days after demand, for example, 14 days after demand is made by the lender.
- Can the repayment of the loan be demanded by the lender partially? The answer seems to be affirmative; of course, the borrower may repay the whole of the loan.
- The principal amount of the loan is payable on demand; how about the interest? The interest should still be serviced regularly. Reg 28.2 (iv) and (v) expect interest to be serviced monthly or quarterly, unless the sanctioning authority records a reason for not insisting on regular interest service.
- In demand loans, liquidity evaluation is as equally as important as the credit evaluation of the borrower. This is quite obvious, because however strong the financial position of the borrower, if the borrower does not have access to ready sources of liquidity, he will not be able to pay on demand.