How banks size working capital limits: MPBF and the Tandon methods
How does a bank decide how much working capital finance a business should get? For decades, Indian banks have used the idea of maximum permissible bank finance (MPBF), built on the recommendations of the Tandon Committee. Even today, the logic behind it shapes how working capital is assessed.
Start with the working capital gap
A business needs money to hold stock and to wait for customers to pay. Part of that is funded by suppliers and other current liabilities. What's left is the working capital gap:
Working capital gap = Total current assets (TCA) − Other current liabilities (OCL)
Here OCL means current liabilities other than bank borrowings: creditors, advances from customers, provisions and so on.
The bank does not fund the whole gap. The borrower is expected to bring part of it from long-term sources, so they have a stake in the business. The three Tandon methods differ in how big that stake should be.
The three Tandon methods
| Method | MPBF | Borrower's contribution |
|---|---|---|
| Method I | 75% of (TCA − OCL) | 25% of the working capital gap |
| Method II | 75% of TCA − OCL | 25% of total current assets |
| Method III | 75% of (TCA − core current assets) − OCL | All core current assets, plus 25% of the rest |
Method II asks for a bigger contribution than Method I, and Method III asks for the most, because core current assets (the minimum stock and receivables a business always needs) are treated as permanent and funded entirely from long-term money.
One example, three answers
Take a business with TCA of ₹400 lakh, OCL of ₹100 lakh and core current assets of ₹60 lakh.
- Method I: 75% × (400 − 100) = ₹225 lakh
- Method II: (75% × 400) − 100 = ₹200 lakh
- Method III: 75% × (400 − 60) − 100 = ₹155 lakh
The same balance sheet supports very different limits depending on the method.
What it means for the current ratio
The methods also set a minimum liquidity level. Under Method II, the current ratio always works out to at least 1.33, because the borrower funds a quarter of all current assets from long-term sources. That's why 1.33 is the number credit teams still quote when they look at a borrower's current ratio. Method I allows a lower current ratio (1.17 in the Tandon Committee's own illustration; 1.23 in the example above).
The turnover method for smaller limits
For smaller borrowers, especially MSMEs, banks use the turnover method (from the Nayak Committee): working capital requirement is estimated at 25% of projected annual turnover, of which the bank finances 20% and the borrower brings in 5% as margin.
With projected turnover of ₹1,200 lakh, the limit works out to 20% × 1,200 = ₹240 lakh.
Where things stand today
RBI gave banks the freedom to choose their own method of assessing working capital back in 1997, so there's no single mandatory formula now. In practice, banks use a mix of these approaches, the turnover method for smaller MSME limits, and cash budget methods for seasonal or specialised businesses, all set out in their own credit policies.
The Tandon logic is still worth learning properly. Once you understand why the borrower is asked to fund part of the gap, every working capital assessment, CMA data sheet and appraisal note becomes much easier to read.
All content is for educational purposes only and isn't financial or investment advice.
