Overdraft: Definition, Types, and Banking Interest Rates

Comparison of Lendingkart OD with other bank’s OD:

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.

2. 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. 

3. 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