A Dropdown OD (Overdraft) is a type of overdraft facility provided by financial institutions, where the credit limit gradually decreases or "drops down" over a predetermined period. This feature is often designed for borrowers to align their repayment schedule with a predictable reduction in their borrowing needs. It's a structured form of overdraft that ensures the facility is not extended indefinitely and encourages disciplined repayment.

Key Features of Dropdown OD:

1. Decreasing Credit Limit: The overdraft limit reduces periodically (e.g., monthly, quarterly, or annually) as per the agreement between the borrower and the bank.
2. Interest on Usage Only: Borrowers pay interest only on the amount utilized, not the entire overdraft limit.
3. Flexibility with Repayment: Borrowers can repay the amount as per their convenience, but they must stay within the declining limit.
4. Predetermined Schedule: The reduction schedule is fixed at the time of availing the facility and is typically aligned with the borrower’s expected cash inflows or project milestones.

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Example of Dropdown OD:

Scenario:

Imagine a construction company, ABC Constructions, takes a Dropdown OD facility of ₹50,00,000 from a bank to fund a project that will complete in 5 years. The bank and the company agree on a quarterly reduction schedule for the overdraft limit.

Overdraft Limit Reduction Schedule:

• Initial limit: ₹50,00,000
• Every quarter, the limit drops by ₹2,50,000.

Usage and Interest:

1. In the first quarter, ABC Constructions uses ₹30,00,000 of the available ₹50,00,000. They pay interest only on ₹30,00,000.
2. After the first quarter, the overdraft limit reduces to ₹47,50,000, irrespective of how much ABC Constructions has utilized or repaid.
3. This process continues until the overdraft limit reaches ₹0 by the end of 5 years.

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Benefits of Dropdown OD:

1. Encourages Repayment: The reducing limit pushes the borrower to repay consistently.
2. Customizable: The schedule can be tailored to match the borrower’s cash flow or project timeline.
3. Cost-effective: Since interest is charged only on the utilized amount, it can be cheaper than a term loan if managed well.

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Applications:

• Project Financing: Used in industries like construction or manufacturing where cash flow gradually increases with project completion.
• Seasonal Businesses: Businesses with predictable revenue patterns can align the dropdown OD limit with their seasonal cash inflows.

Dropdown OD is a versatile and disciplined financial tool that caters to businesses requiring both flexibility and structure in managing short-term credit needs