Types of Borrowing

Borrowing can be broadly split into two dimensions – security (secured vs unsecured) and tenure (short‑term vs long‑term). The security dimension reflects whether the lender has a claim on specific assets if the borrower defaults. The tenure dimension reflects the period over which repayment is expected.

In the Indian context, the Reserve Bank of India (RBI) defines short‑term borrowing as credit that matures within 12 months, whereas long‑term borrowing extends beyond one year. Both dimensions often overlap; for example, a secured term loan is long‑term, while an unsecured overdraft is short‑term.

Exam questions frequently test your ability to map a given instrument (e.g., cash credit, debenture) to its correct classification. Mis‑classifying an instrument leads to loss of marks, especially when the question asks for “primary purpose” or “collateral requirement”.

• Security dimension – Secured (collateral‑backed) vs Unsecured (no collateral).
• Tenure dimension – Short‑term (≤12 months) vs Long‑term (>12 months).

A secured loan is one where the borrower pledges an asset as collateral. If the borrower defaults, the lender can enforce the security and recover dues by selling the asset.

Common secured instruments in India include mortgage loans (real‑estate as security), lease financing (equipment lease), hypothecation of inventory or receivables, and debentures issued against specific assets. Secured borrowing generally attracts lower interest rates because the lender’s risk is mitigated.

For the NISM exam, remember that the presence of collateral is the defining feature, not the loan’s purpose or tenure. Questions may ask you to identify the security type based on a scenario, such as “a bank lends against a borrower’s warehouse”.

• Mortgage loan – real‑estate pledged; typical tenure 5‑20 years.
• Lease financing – equipment as security; often structured as a hire‑purchase.

An unsecured loan does not involve any specific asset as collateral. The lender relies on the borrower’s creditworthiness, cash‑flow profile, and reputation.

Typical unsecured instruments include personal loans, credit‑card facilities, overdraft limits without hypothecation, and unsecured corporate bonds. Because the lender bears higher risk, interest rates are usually higher than comparable secured loans.

Exam‑wise, the key is to spot the absence of collateral language. A question describing “no asset pledged” or “based purely on credit rating” signals an unsecured borrowing type.

• Personal loan – individual credit, no asset pledged.
• Credit‑card facility – revolving unsecured credit up to a limit.

Short‑term borrowing addresses immediate working‑capital needs and is usually repaid within a year. The RBI classifies these as “cash credit”, “overdraft”, “working‑capital term loan”, and “commercial paper”.

Cash credit (CC) and overdraft (OD) are revolving facilities where the borrower can draw up to an approved limit against inventory or receivables. Commercial paper (CP) is an unsecured, discount‑based instrument issued by corporates for up to 364 days.

In exam scenarios, focus on the maturity horizon and the purpose (e.g., financing inventory). Short‑term instruments often have variable interest rates linked to the repo rate.

• Cash Credit (CC) – short‑term working‑capital loan, usually secured by inventory.
• Commercial Paper (CP) – unsecured, short‑term debt instrument for corporates.

Long‑term borrowing supports capital‑expenditure projects, infrastructure financing, or strategic acquisitions. Typical instruments include term loans, term loans with amortisation, debentures, bonds, and mortgage loans.

Term loans are usually disbursed in a lump sum and repaid in equal instalments (EMI) over several years. Debentures may be secured or unsecured and can be listed on stock exchanges, subject to SEBI regulations.

For the NISM exam, remember the tenure (greater than 12 months) and the repayment structure (fixed EMI vs bullet repayment). Questions may ask you to calculate the interest component using simple interest for a short‑term loan or to identify the correct instrument for a 10‑year infrastructure project.

• Term Loan – fixed tenure, EMI repayment, often secured.
• Debenture – debt instrument, may be secured or unsecured, listed under SEBI.

Many short‑term loans in India are quoted on a simple‑interest basis. Simple interest (SI) is calculated only on the principal amount, not on accumulated interest.

The formula is widely used in NISM questions that provide principal (P), annual rate of interest (R) in percent, and time (T) in years. Remember to keep the time unit consistent with the rate.

Exam tip: If the loan tenure is expressed in months, convert it to years before applying the formula, or adjust the rate to a monthly basis.

The Debt Service Coverage Ratio (DSCR) measures a borrower’s ability to meet debt obligations from operating earnings. It is a key underwriting metric for both secured and unsecured loans.

DSCR is calculated as Net Operating Income (NOI) divided by total Debt Service (principal + interest) due in the same period. A DSCR greater than 1 indicates sufficient cash flow, while a DSCR below 1 signals potential default risk.

In the NISM exam, you may be asked to interpret a DSCR value or to compute it given NOI and debt service figures. Remember that the ratio is unit‑less; both numerator and denominator must be for the same time horizon (usually annual).

The Reserve Bank of India (RBI) governs most borrowing activities through its Master Direction on Loans and Advances. Key provisions include caps on cash‑credit limits relative to inventory, mandatory security valuation, and periodic reporting of loan‑to‑value ratios.

For listed companies issuing debentures or bonds, the Securities and Exchange Board of India (SEBI) prescribes disclosure norms, credit rating requirements, and investor protection measures under the SEBI (Issue of Capital and Disclosure Requirements) Regulations.

Exam candidates should remember that RBI rules apply to banks and NBFCs, while SEBI regulations become relevant when the borrowing instrument is a marketable security. Questions may ask which regulator oversees a corporate bond issue versus a bank overdraft.