RESEARCH METHODOLOGY

Introduction to Credit Appraisal:

Credit appraisal means an investigation/assessment done by the bank prior before providing any loans &

advances/project finance & also checks the commercial, financial & technical viability of the project

proposed its funding pattern & further checks the primary & collateral security cover available for

recovery of such funds.

Problem Statement:

To study the Credit Appraisal System in SME sector, at Bank of Maharashtra (BOM), Pune.

Objectives:

To study the Credit Appraisal Methods.

To understand the commercial, financial & technical viability of the project proposed & it’s

funding pattern.

To understand the pattern for primary & collateral security cover available for recovery of such

funds.

Research Design:

Analytical in nature

Data Collection:

Primary Data:

Informal interviews with Branch Manager and other staff members at BOM.

E-circulars of BOM

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Secondary Data:

Books and magazines

Database at BOM

Internal reports of the banks

Library research

Websites

Expected contribution of the study:

This study will help in understanding the credit appraisal system at BOM & to understand how to reduce

various risk parameters, which are broadly categorized into financial risk, business risk, industrial risk &

management risk associated in providing any loans or advances or project finance.

Beneficiaries:

Researcher:

This report will help researcher in improving knowledge about the credit appraisal system and to have

practical exposure of the credit appraisal scenario in BOM.

Management student:

The project will help the management student to know the patterns of credit appraisal in BOM.

Bank of Maharashtra:

The project will help bank in reducing the credit risk parameters and to improve its efficiencies.

It will also help to reduce risk associated in providing any loans & advances or project finance in

future and to overcome the loopholes.

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Short write-up on the researcher and reason for taking up the project:

The researcher are MBA 2nd year students, studying in N.R.INSTITUTE OF BUSINESS

MANAGEMENT(GLS),AHMEDABAD.

The reason for taking up the project is to know and understand the credit appraisal system in

banking sector.

Credit appraisal is the major focus of banking industries these days, so the project will help in

understanding and analyzing the situation prevailing currently.

Limitations of the study:

As the credit rating is one of the crucial areas for any bank, some of the technicalities are not

revealed which may have cause destruction to the information and our exploration of the

problem.

As some of the information is not revealed, whatever suggestions generated, are based on certain

assumptions.

Credit appraisal system includes various types of detail studies for different areas of analysis, but due to time constraint, our analysis was of limited areas only.

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CHAPTER-1

INTRODUCTION TO BANKING SECTOR AND SBI

A snapshot of the banking industry:

The Reserve Bank of India (RBI), as the central bank of the country, closely monitors

developments in the whole financial sector.

The banking sector is dominated by Scheduled Commercial Banks (SBCs). As at end-March 2002, there

were 296 Commercial banks operating in India. This included 27 Public Sector Banks (PSBs), 31 Private,

42 Foreign and 196 Regional Rural Banks. Also, there were 67 scheduled co-operative banks consisting

of 51 scheduled urban co-operative banks and 16 scheduled state co-operative banks.

Scheduled commercial banks touched on the deposit front, a growth of 14% as against 18% registered in

the previous year. And on advances, the growth was 14.5% against 17.3% of the earlier year.

Higher provisioning norms, tighter asset classification norms, dispensing with the concept of ‘past due’

for recognition of NPAs, lowering of ceiling on exposure to a single borrower and group exposure etc.,

are among the measures in order to improve the banking sector.

A minimum stipulated Capital Adequacy Ratio (CAR) was introduced to strengthen the ability of banks

to absorb losses and the ratio has subsequently been raised from 8% to 9%. It is proposed to hike the CAR

to 12% by 2004 based on the Basle Committee recommendations.

Retail Banking is the new mantra in the banking sector. The home loans alone account for nearly two-

third of the total retail portfolio of the bank. According to one estimate, the retail segment is expected to

grow at 30-40% in the coming years.

Net banking, phone banking, mobile banking, ATMs and bill payments are the new buzz words that

banks are using to lure customers.

With a view to provide an institutional mechanism for sharing of information on borrowers / potential

borrowers by banks and Financial Institutions, the Credit Information Bureau (India) Ltd. (CIBIL) was set

up in August 2000. The Bureau provides a framework for collecting, processing and sharing credit

information on borrowers of credit institutions. SBI and HDFC are the promoters of the CIBIL.

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The RBI is now planning to transfer of its stakes in the SBI, NHB and National bank for Agricultural and

Rural Development to the private players. Also, the Government has sought to lower its holding in PSBs

to a minimum of 33% of total capital by allowing them to raise capital from the market.

Banks are free to acquire shares, convertible debentures of corporate and units of equity-oriented mutual

funds, subject to a ceiling of 5% of the total outstanding advances (including commercial paper) as on

March 31 of the previous year.

The finance ministry spelt out structure of the government-sponsored ARC called the Asset

Reconstruction Company (India) Limited (ARCIL), this pilot project of the ministry would pave way for

smoother functioning of the credit market in the country. The government will hold 49% stake and private

players will hold the rest 51%- the majority being held by ICICI Bank (24.5%).

Reforms in the banking sector:

The first phase of financial reforms resulted in the nationalization of 14 major banks in 1969 and resulted

in a shift from Class banking to Mass banking. This in turn resulted in a significant growth in the

geographical coverage of banks. Every bank has to earmark a minimum percentage of their loan portfolio

to sectors identified as “priority sectors”. The manufacturing sector also grew during the 1970s in

protected environs and the banking sector was a critical source. The next wave of reforms saw the

nationalization of 6 more commercial banks in 1980. Since then the number scheduled commercial banks

increased four-fold and the number of banks branches increased eight-fold.

After the second phase of financial sector reforms and liberalization of the sector in the early nineties, the

Public Sector Banks (PSB) s found it extremely difficult to complete with the new private sector banks

and the foreign banks. The new private sector banks first made their appearance after the guidelines

permitting them were issued in January 1993. Eight new private sector banks are presently in operation.

This banks due to their late start have access to state-of-the-art technology, which in turn helps them to

save on manpower costs and provide better services.

During the year 2000, the State Bank of India (SBI) and its 7 associates accounted for a 25% share in

deposits and 28.1% share in credit. The 20 nationalized banks accounted for 53.5% of the deposits and

47.5% of credit during the same period. The share of foreign banks ( numbering 42 ), regional rural banks

and other scheduled commercial banks accounted for 5.7%, 3.9% and 12.2% respectively in deposits and

8.41%, 3.14% and 12.85% respectively in credit during the year 2000.

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Classification of banks:

The Indian banking industry, which is governed by the Banking Regulation Act of India, 1949 can be

broadly classified into two major categories, non-scheduled banks and scheduled banks. Scheduled banks

comprise commercial banks and the co-operative banks. In terms of ownership, commercial banks can be

further grouped into nationalized banks, the State Bank of India and its group banks, regional rural banks

and private sector banks (the old / new domestic and foreign). These banks have over 67,000 branches

spread across the country. The Indian banking industry is a mix of the public sector, private sector and

foreign banks. The private sector banks are again spilt into old banks and new banks.

Banking System in India

Reserve bank of India (Controlling Authority)

Development Financial institutions Banks

IFCI IDBI ICICI NABARD NHB IRBI EXIM Bank SIDBI

Commercial Regional Rural Land Development Co-operative

Banks Banks Banks Banks

Public Sector Banks Private Sector Banks

SBI Groups Nationalized Banks Indian Banks Foreign Bank

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Bank of Maharashtra is the premier bank of Maharashtra, operating in the country. Registered on 16th Sept 1935 with an authorized capital of Rs 10.00 lakh and commenced business on 8th Feb 1936.

Known as a common man's bank since inception, its initial help to small units has given birth to many of today's industrial houses. After nationalization in 1969, the bank expanded rapidly. It now has 1375 branches (as of 31 March 2008) all over India. The Bank has the largest network of branches by any Public sector bank in the state of Maharashtra. The Bank was founded by a group of visionaries led by the Late V. G. Kale and the Late D. K. Sathe and registered as a Banking Company on 16 September, 1935 at Pune. Today, Bank of Maharashtra has over 12 million customers across the length and breadth of the country served through 1577 branches in 23 states and 2 union territories.

As on 30.09.2011 Bank has 1564 Branches in all over India.

Mission

To ensure quick and efficient response to customer expectations. To innovate products and services to cater to diverse sections of society. To adopt latest technology on a continuous basis. To build proactive, professional and involved workforce. To enhance the shareholders’ wealth through best practices and corporate governance. To enter international arena through branch network.

Vision

To be a vibrant, forward looking, techno-savvy, customer centric bank serving diverse sections of the society, enhancing shareholders' and employees' value while moving towards global presence.

Our Logo

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The Deepmal: With its many lights rising to greater heights.

The Pillar: Our institution- Symbolising strength.

The Diyas: Our Branches- Symbolising service.

The 3 M's symbolising:

Mobilisation of Money Modernisation of Methods and Motivation of Staff

Milestones in the journey for nation building:

Registered on 16-09-1935

Commitment stated in the prospectus issued on 21-10-1935:

“Steadily to spread its business operations all over Maharashtra and as opportunity allows, outside that area offering varied services to the general public while trying to be useful to trade , commerce and industry consistently with high standards of safety and efficiency”

1936:Commenced operations on 08-02-1936 in Pune

1938: Second branch of the bank was opened in 1938 at Fort, Bombay.

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1940: Third branch came up at Deccan Gymkhana, Pune

1944: Status as Scheduled Bank obtained

1946: Deposits crossed Rs One crore mark

Formed fully owned subsidiary, The Maharashtra Executor & Trustee Company

First branch outside Maharashtra opened in Hubli (Mysore State, Now Karnataka)

1949: Expansion to AP: Hyderabad branch opened

1963:Expansion to Goa: Panjim Branch opened

1966:Expansion to Madhya Pradesh: Indore branch opened

Entered in Gujarat: Baroda branch opened

1969:Nationalised alongwith 13 other Banks

Entry in Delhi by opening Karolbagh branch on 19-12-69

1974: Deposit base crossed Rs. 100 Crore mark

1976:Marathwada Grameena Bank, first RRB established on 26-08-1976

1978: New Head Office building inaugurated by Hon'ble Prime Minister of India Shri. Morarji Desai

Deposits crossed the figure of Rs.500 Crores

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1979: “Mahabank Agricultural Research and Rural Development Foundation”, registered as a public trust, was established for undertaking research and extension work and to provide more extensive services to farmers.

1985: 500th branch in Maharashtra state was opened at the hands of the then Prime Minister, Mrs Indira Gandhi at Nariman Point, Mumbai.

First Advanced Ledger Posting Machine (ALPM) was installed at the branch.

Golden Jubilee Year Celebrations launched at the hands of Dr. Manmohan Singh, Governor Reserve Bank of India

1986: Thane Grameena Bank sponsored

1987: The 1000th branch of the Bank was inaugurated at Indira vasahat, Bibwewadi, Pune at the auspicious hands of Dr.Shankar Dayal Sharma, the Honourable Vice President of India

1991: "Mahabank Farmer Credit Card " was launched

Entered in to Domestic Credit Card Business

Main Frame Computer installed

Became member of the SWIFT

1995: Diamond Jubilee Celebrations - Dr C Rangarajan the RBI Governor was the Chief Guest

Deposits crossed Rs 5000 crore mark

1996: Moved into “A” category from the earlier “C” category. Autonomy obtained

2000: Deposits crossed Rs 10000 crore mark

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2004: Public Issue of Shares – 24% owned by Public

Listed in BSE and NSE

2005: Bancassurance and Mutual Fund distribution business started

2006: Crossed total business level of Rs.50,000 Crore

Branch CBS Project started

2009: Entered in to 75th year of dedicated service to the Nation

Adopted 75 underdeveloped villages for integrated overall development

2010: 100% CBS of branches achieved

Total Business crossed Rs One lakh crore

Opened 76 branches in the Platinum Year taking the total to 1506 

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CHAPTER 2

INDUSTRY ANALYSIS

Competitive forces model in the banking industry

(PORTER’S FIVE-FORCE MODEL)

Prof. Michael Porter’s competitive forces Model applies to each and every company as well as industry.

This model with regards to the Banking Industry is presented below.

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(2)

Potential Entrants is high as development financial institutions as well as private and foreign banks have entered in a big way.

(5)

Organizing power of the supplier is high. With the new financial instruments they are asking higher return on the investments.

(1)

Rivalry among existing firms has increased with liberalization. New products and improved customer services is the focus.

(4)

Bargaining power of buyers is high as corporate can raise funds easily due to high competition.

(3)

Threat from substitute is high due to competition from NBFCs and insurance companies as they offer a high rate of interest than banks.

1. Rivalry among existing firms

With the process of liberalization, competition among the existing banks has increased. Each bank is

coming up with new products to attract the customers and tailor made loans are provided. The quality of

services provided by banks has improved drastically.

2. Potential Entrants

Previously the Development Financial Institutions mainly provided project finance and development

activities. But they now entered into retail banking which has resulted into stiff competition among the

exiting players.

3. Threats from Substitutes

Banks face threats from Non-Banking Financial Companies. NBFCs offer a higher rate of interest.

4. Bargaining Power of Buyers

Corporate can raise their funds through primary market or by issue of GDRs, FCCBs. As a result they

have a higher bargaining power. Even in the case of personal finance, the buyers have a high bargaining

power. This is mainly because of competition.

5. Bargaining Power of Suppliers

With the advent of new financial instruments providing a higher rate of returns to the investors, the

investments in deposits is not growing in a phased manner. The suppliers demand a higher return for the

investments.

6. Overall Analysis

The key issue is how can banks leverage their strengths to have a better future. Since the availability of

funds is more and deployment of funds is less, banks should evolve new products and services to the

customers. There should be a rational thinking in sanctioning loans, which will bring down the NPAs. As

there is a expected revival in the Indian economy Banks have a major role to play. Funding corporate at a

low cost of capital is a special requisite.

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SWOT ANALYSIS

The banking sector is also taken as a proxy for the economy as a whole. The performance of bank should

therefore, reflect “Trends in the Indian Economy”. Due to the reforms in the financial sector, banking

industry has changed drastically with the opportunities to the work with, new accounting standards new

entrants and information technology. The deregulation of the interest rate, participation of banks in

project financing has changed in the environment of banks.

The performance of banking industry is done through SWOT Analysis. It mainly helps to know the

strengths and Weakness of the industry and to improve will be known through converting the

opportunities into strengths. It also helps for the competitive environment among the banks.

a) STRENGTHS

1. Availability of Funds

There are seven lakh crore wroth of deposits available in the banking system. Because of the recession in

the economy and volatility in capital markets, consumers prefer to deposit their money in banks. This is

mainly because of liquidity for investors.

2. Banking network

After nationalization, banks have expanded their branches in the country, which has helped banks build

large networks in the rural and urban areas. Private banks allowed to operate but they mainly concentrate

in metropolis.

3. Large Customer Base

This is mainly attributed to the large network of the banking sector. Depositers in rural areas prefer banks

because of the failure of the NBFCs.

4. Low Cost of Capital

Corporate prefers borrowing money from banks because of low cost of capital. Middle income people

who want money for personal financing can look to banks as they offer at very low rates of interests.

Consumer credit forms the major source of financing by banks.

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b) WEAKNESS

1. Loan Deployment

Because of the recession in the economy the banks have idle resources to the tune of 3.3 lakh crores.

Corporate lending has reduced drastically

2. Powerful Unions

Nationalization of banks had a positive outcome in helping the Indian Economy as a whole. But this had

also proved detrimental in the form of strong unions, which have a major influence in decision-making.

They are against automation.

3. Priority Sector Lending

To uplift the society, priority sector lending was brought in during nationalization. This is good for the

economy but banks have failed to manage the asset quality and their intensions were more towards

fulfilling government norms. As a result lending was done for non-productive purposes.

4. High Non-Performing Assets

Non-Performing Assets (NPAs) have become a matter of concern in the banking industry. This is because

of change in the total outstanding advances, which has to be reduced to meet the international standards.

c) OPPORTUNITIES

1. Universal Banking

Banks have moved along the valve chain to provide their customers more products and services. For

example: - SBI is into SBI home finance, SBI Capital Markets, SBI Bonds etc.

2. Differential Interest Rates

As RBI control over bank reduces, they will have greater flexibility to fix their own

interest rates which depends on the profitability of the banks.

3. High Household Savings

Household savings has been increasing drastically. Investment in financial assets has also increased.

Banks should use this opportunity for raising funds.

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4. Overseas Markets

Banks should tape the overseas market, as the cost of capital is very low.

5. Interest Banking

The advance in information technology has made banking easier. Business can effectively carried out

through internet banking.

d) THREATS

1. NBFCs, Capital Markets and Mutual funds

There is a huge investment of household savings. The investments in NBFCs deposits, Capital Market

Instruments and Mutual Funds are increasing. Normally these instruments offer better return to investors.

2. Change in the Government Policy

The change in the government policy has proved to be a threat to the banking sector.

3. Inflation

The interest rates go down with a fall in inflation. Thus, the investors will shift his investments to the

other profitable sectors.

4. Recession

Due to the recession in the business cycle the economy functions poorly and this has proved to be a threat

to the banking sector. The market oriented economy and globalization has resulted into competition for

market share. The spread in the banking sector is very narrow. To meet the competition the banks has to

grow at a faster rates and reduce the overheads. They can introduce the new products and develop the

existing services.

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CHAPTER 3

INTRODUCTION TO SME

SME

1 Concept:

The small-scale industries (SSI) produce about 8000 products, contribute 40% of the industrial output and

offer the largest employment after agriculture. The sector, therefore, presents an opportunity to the nation

to harness local competitive advantages for achieving global dominance.

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2 From SSI to SME:

Defining the New Paradigm2.1 Government policy as well as credit policy has so far concentrated on

manufacturing units in the small-scale sector. The lowering of trade barriers across the globe has

increased the minimum viable scale of enterprises. The size of the unit and technology employed for

firms to be globally competitive is now of a higher order. The definition of small-scale sector needs to be

revisited and the policy should consider inclusion of services and trade sectors within its ambit. In

keeping with global practice, there is also a need to broaden the current concept of the sector and include

the medium enterprises in a composite sector of Small and Medium Enterprises (SMEs). A

comprehensive legislation, which would enable the paradigm shift from small-scale industry to small and

medium enterprises under consideration of Parliament. The Reserve Bank of India had meanwhile set up

an Internal Group which has recommended:” Current SSI/tiny industries definition may continue. Units

with investment in plant and machinery in excess of SSI limit and up to Rs.10 crore may be treated as

Medium Enterprises (ME). The definition may be reviewed after enactment of the Small and Medium

Enterprises Development Bill.

3 Definition of SMEs- 

“  At present, a small scale industrial unit is an undertaking in which investment in plant and machinery,

does not exceed Rs.1 crore, except in respect of certain specified items under hosiery, hand tools, drugs

and pharmaceuticals, stationery items and sports goods, where this investment limit has been enhanced to

Rs  5 crore. Units with investment in plant and machinery in excess of SSI limit and up to Rs. 25 crore

may be treated as Medium Enterprises (ME). “

The Government of India has enacted the Micro, Small and Medium Enterprises Development (MSMED)

Act 2006 which was notified on October 2, 2006. The definition of the small and medium enterprises as

provided in the Act (Annex VII) will have immediate effect.

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4 Eligibility criteria

(i)   These guidelines would be applicable to the following entities, which are viable or potentially viable:

a) All non-corporate SMEs irrespective of the level of dues to banks.

b) All corporate SMEs, which are enjoying banking facilities from a single bank, irrespective of the level

of dues to the bank.

c) All corporate SMEs, which have funded and non-funded outstanding up to Rs.10 crore under multiple/

consortium banking arrangement.

(ii) Accounts involving willful default, fraud and malfeasance will not be eligible for restructuring under

these guidelines.

(iii) Accounts classified by banks as “Loss Assets” will not be eligible for restructuring.

(iv) In respect of BIFR cases banks should ensure completion of all formalities in seeking approval from

BIFR before implementing the package.

SME: At present, a small scale industrial unit is an industrial undertaking in which investment in plant

and machinery, does not exceed Rs.1 crore except in respect of certain specified items under hosiery,

hand tools, drugs and pharmaceuticals, stationery items and sports goods where this investment limit has

been enhanced to Rs.5 crore. A comprehensive legislation which would enable the paradigm shift from

small scale industry to small and medium enterprises is under consideration of Parliament. Pending

enactment of the above legislation, current SSI/tiny industries definition may continue. Units with

investment in plant and machinery in excess of SSI limit and up to Rs.10 crore may be treated as Medium

Enterprises (ME). Only SSI financing will be included in Priority Sector.

All banks may fix self-targets for financing to SME sector so as to reflect a higher disbursement over the

immediately preceding year, while the sub-targets for financing tiny units and smaller units to the extent

of 40% and 20% respectively may continue. Banks may arrange to compile data on outstanding credit to

SME sector as on March 31, 2005 as per new definition and also showing the break up separately for tiny,

small and medium enterprises.

Banks may initiate necessary steps to rationalize the cost of loans to SME sector by adopting a

transparent rating system with cost of credit being linked to the credit rating of enterprise.

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SIDBI has developed a Credit Appraisal & Rating Tool (CART) as well as a Risk Assessment Model (RAM)

and a comprehensive rating model for risk assessment of proposals for SMEs. The banks may consider to

take advantage of these models as appropriate and reduce their transaction costs.

In order to increase the outreach of formal credit to the SME sector, all banks, including

Regional Rural Banks may make concerted efforts to provide credit cover on an average to at

least 5 new small/medium enterprises at each of their semi urban/urban branches per year.

A debt restructuring mechanism for nursing of sick units in SME sector and a One Time Settlement

(OTS) Scheme for small scale NPA accounts in the books of the banks as on March 31, 2004 are being

introduced.

5 Challenges faced by SME:

The challenges being faced by the small and medium sector may be briefly set out as follows-

a) Small and Medium Enterprises (SME), particularly the tiny segment of the small enterprises

have inadequate access to finance due to lack of financial information and non-formal business

practices. SMEs also lack access to private equity and venture capital and have a very limited

access to secondary market instruments.

b) SMEs face fragmented markets in respect of their inputs as well as products and are

vulnerable to market fluctuations.

c) SMEs lack easy access to inter-state and international markets.

d) The access of SMEs to technology and product innovations is also limited. There is lack of

awareness of global best practices.

e) SMEs face considerable delays in the settlement of dues/payment of bills by the large scale buyers.

With the deregulation of the financial sector, the ability of the banks to service the credit requirements of

the SME sector depends on the underlying transaction costs, efficient recovery processes and available

security. There is an immediate need for the banking sector to focus on credit and SMEs.

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CHAPTER 4

OVERVIEW OF CREDIT APPRAISAL

Credit appraisal means an investigation/assessment done by the bank prior before providing any loans &

advances/project finance & also checks the commercial, financial & technical viability of the project

proposed its funding pattern & further checks the primary & collateral security cover available for

recovery of such funds.

Brief overview of credit:

Credit Appraisal is a process to ascertain the risks associated with the extension of the credit facility. It is

generally carried by the financial institutions which are involved in providing financial funding to its

customers. Credit risk is a risk related to non repayment of the credit obtained by the customer of a bank.

Thus it is necessary to appraise the credibility of the customer in order to mitigate the credit risk. Proper

evaluation of the customer is performed which measures the financial condition and the ability of the

customer to repay back the loan in future. Generally the credit facilities are extended against the security

know as collateral. But even though the loans are backed by the collateral, banks are normally interested

in the actual loan amount to be repaid along with the interest. Thus, the customer's cash flows are

ascertained to ensure the timely payment of principal and the interest.

It is the process of appraising the credit worthiness of a loan applicant. Factors like age, income, number

of dependents, nature of employment, continuity of employment, repayment capacity, previous loans,

credit cards, etc. are taken into account while appraising the credit worthiness of a person. Every bank or

lending institution has its own panel of officials for this purpose.

However the 3 ‘C’ of credit are crucial & relevant to all borrowers/ lending which must be kept in mind at

all times.

Character

Capacity

Collateral

If any one of these are missing in the equation then the lending officer must question the viability of

credit.

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There is no guarantee to ensure a loan does not run into problems; however if proper credit evaluation

techniques and monitoring are implemented then naturally the loan loss probability / problems will be

minimized, which should be the objective of every lending officer.

Credit is the provision of resources (such as granting a loan) by one party to another party where that

second party does not reimburse the first party immediately, thereby generating a debt, and instead

arranges either to repay or return those resources (or material(s) of equal value) at a later date. The first

party is called a creditor, also known as a lender, while the second party is called a debtor, also known as

a borrower.

Credit allows you to buy goods or commodities now, and pay for them later. We use credit to buy things

with an agreement to repay the loans over a period of time. The most common way to avail credit is by

the use of credit cards. Other credit plans include personal loans, home loans, vehicle loans, student loans,

small business loans, trade.

A credit is a legal contract where one party receives resource or wealth from another party and promises

to repay him on a future date along with interest. In simple terms, a credit is an agreement of postponed

payments of goods bought or loan. With the issuance of a credit, a debt is formed.

Basic types of credit

There are four basic types of credit. By understanding how each works, you will be able to get the most

for your money and avoid paying unnecessary charges.

Service credit is monthly payments for utilities such as telephone, gas, electricity, and water. You often

have to pay a deposit, and you may pay a late charge if your payment is not on time.

Loans let you borrow cash. Loans can be for small or large amounts and for a few days or several years.

Money can be repaid in one lump sum or in several regular payments until the amount you borrowed and

the finance charges are paid in full. Loans can be secured or unsecured.

Installment credit may be described as buying on time, financing through the store or the easy payment

plan. The borrower takes the goods home in exchange for a promise to pay later. Cars, major appliances,

and furniture are often purchased this way. You usually sign a contract, make a down payment, and agree

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to pay the balance with a specified number of equal payments called installments. The finance charges are

included in the payments. The item you purchase may be used as security for the loan.

Credit cards are issued by individual retail stores, banks, or businesses. Using a credit card can be the

equivalent of an interest-free loan--if you pay for the use of it in full at the end of each month.

Brief overview of loans:

Loans can be of two types fund base & non-fund base:

FUND BASE includes:

Working Capital

Term Loan

NON-FUND BASE includes:

Letter of Credit

Bank Guarantee

Bill Discounting

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FUND BASE: -

WORKING CAPITAL: -

1. General

The objective of running any industry is earning profits. An industry will require funds to acquire

“fixed assets” like land, building, plant, machinery, equipments, vehicles, tools etc., & also to run the

business i.e. its day to day operations.

Funds required for day to-day working will be to finance production & sales. For production, funds are

needed for purchase of raw materials/ stores/ fuel, for employment of labour, for power charges etc., for

storing finishing goods till they are sold out & for financing the sales by way of sundry debtors/

receivables.

Capital or funds required for an industry can therefore be bifurcated as fixed capital & working capital.

Working capital in this context is the excess of current assets over current liabilities. The excess of

current assets over current liabilities is treated as net working capital or liquid surplus & represents that

portion of the working capital, which has been provided from the long-term source.

2. DEFINITION

Working capital is defined as the funds required to carry the required levels of current assets to enable the

unit to carry on its operations at the expected levels uninterruptedly.

Thus Working Capital Required is dependent on

(a) The volume of activity (viz. level of operations i.e. Production & sales)

(b) The activity carried on viz. mfg process, product, production programme, the materials &

marketing mix.

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3. Methods & Application

SEGMENT LIMITS METHOD

SSI Upto Rs 5 cr Traditional Method & Nayak Committee method

Above Rs 5 cr Projected Balance Sheet Method

SBF All loans Traditional / Turnover Method

C&I Trade &

Services

Upto Rs 1 cr Traditional Method for Trade &

Projected Turnover Method

Above Rs 1 cr

& upto Rs 5 cr

Projected Balance Sheet Method &

Projected Turnover Method

Above Rs 5 cr Projected Balance Sheet Method

C&I Industrial

Units

Below

Rs 25 lacs

Traditional Method

Rs 25 lacs &

Over but upto

Rs 5 cr

Projected Balance Sheet Method &

Projected Turnover Method

Above Rs 5 cr Projected Balance Sheet Method

4. Operating cycle method

4.1 Any manufacturing activity is characterized by a cycle of operations consisting of purchase of

purchase of raw materials for cash, converting these into finished goods & realizing cash by sale of

these finished goods.

4.2 Diagrammatically, the OPERATING CYCLE is represented as under

4.3 The time that lapses between cash outlay & cash realization by sale of finished goods &

realization of sundry debtors is known as the length of the operating cycle.

25

4.4 That is, the operating cycle consists of:

Time taken to acquire raw materials & average period for which they are in store.

Conversion process time

Average period for which finished goods are in store &

Average collection period of receivables (Sundry Debtors)

4.5 Operating cycle is also called the cash-to-cash cycle & indicates how cash is converted into

raw materials, stocks in process, finished goods, bills (receivables) & finally back to cash.

Working capital is the total cash that is circulating in this cycle. Therefore, working capital

can be turned over or redeployed after completing the cycle.

26

cashRaw

materials

Work-in-progress

Finished goods

debtors

4.6 The length of the operating cycle = a+b+c+d (as in 4.4)

If a = 60 days

b = 10 days

c = 20 days

d = 30 days

The operating cycle is 120 days (nearly 4 months). This means there are 365/120 = 3 cycles of

operations in a year.

Sales = Rs. 1,00,000 per annum

Operating expenses = Rs. 72,000 per annum

But the working capital requirement, as you know, is not Rs. 72,000.

In these cases, there are 3 operating cycles in a year. That means each rupee of working

deployed in the unit is turned over 3 times in a year. (This is also known as working capital

turnover ratio).

Therefore WCR = Operating Expenses = Rs. 72,000/- = Rs. 24,000/-

No. of cycles per annum 3

WCR is therefore not Rs. 72,000/- but only Rs. 24,000/-

4.7 Assessment of Working Capital Requirement & Permissible Bank Finance using Operating Cycle

Concept

Let us consider a case of a unit where:

Sales = Rs. 20,000 p.m. (A)

Raw Materials = Rs. 14,000 p.m.

27

Wages = Rs. 2,000 p.m.

Other manufacturing

Expenses = Rs. 3,000 p.m.

Total expenses = Rs. 19,000 p.m. (B)

Profit = Rs. 1,000 P.m. (C)

The operating cycle is

Raw Materials = 15 days

Stock in Process = 2 days

FG = 3 days

Sundry Debtors = 15 days

The total length of

Operating cycle = 35 days (D)

WCR = B * D = 19,000 * 35 = Rs. 22,167/- (approx.)

30 30

Where B = Operating Expenses; &

D = Length of Operating cycle

The length of the operating cycle is different from industry to industry and from one firm to another

within the same industry. For instance, the operating cycle of a pharmaceutical unit would be quite

different from one engaged in the manufacture of machine tools. The operating cycle concept enables us

to assess the working capital need of each enterprise keeping in view the peculiarities of the industry it is

engaged in and its scale of operations. Operating cycle is an important management tool in decision-

making.

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Traditional Method of Assessment of Working Capital Requirement

The operating cycle concept serves to identify the areas requiring improvement for the purpose of control

and performance review. But, as bankers, we require a more detailed analysis to assess the various

components of working capital requirement viz., finance for

stocks, bills etc. Bankers provide working capital finance for holding an acceptable level of current assets,

viz. raw materials, stocks-in-process, finished goods and sundry debtors for achieving a predetermined

level of production and sales. Quantification of these funds required to be blocked in each of these items

of current assets at any time will, therefore provide a measure of the working capital requirement (WCR)

of an industry.

It can thus be summarized as follows:

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Projected Annual Turnover Method for SSI units (Nayak Committee)

For SSI units which enjoy fund based working capital limits up to Rs.5 cr, the minimum working capital

limit should be fixed on the basis of projected annual turnover. 25% of the output or annual turnover

value should be computed as the quantum of working capital required by such unit .The unit should be

required to bring in 5% of their annual turnover as margin money and the Bank shall provide 20% of the

turnover as working capital finance. Nayak committee Guidelines correspond to working capital limits as

per the Operating Cycle method where the average production / processing cycle is taken to be 3 months

(i.e. working capital would be turned over 4 times in a year).

Projected Annual Turnover Method for C & I industrial units (limits upto Rs 5 cr)

Bank has decided to extend Nayak Committee approach for assessment of limits to C&I industrial units

requiring credit limits upto Rs.5 cr. That is, credit requirement up to Rs.5 crores of C&I borrowers

(industrial units) may be assessed at a minimum of 20% of projected annual turnover. In other words, the

working capital requirement will be assessed at 25% of projected annual turnover, of which 5% should be

borne by entrepreneur as margin and 20% would be allowed as Bank Drawings. While accepting

projected annual sales turnover, a cap of 25% over actual annual sales turnover in the immediately

preceding year should be set, except where production capacity has been substantially increased.

Projected Annual Turnover Method for Business Enterprises in Trade & Services

Sector:

i) For working Capital limits up to Rs. 5 cr to C&I(Trade) sector, the assessment of credit limit is to be

based upon annual turnover. Thus, an across the board credit limit equal to 15% of projected annual

turnover be offered to business enterprises in the T&S sector. It would be available for utilization

generally as a cash credit limit. However, where needed an LC limit (as a sub-limit of total), may also be

allowed.

ii) The credit limit would be secured by hypothecation charge on the current assets of the enterprise.

Periodical stock statements are to be obtained and margin of 25% be retained.

iii) Credit limits under this assessment method may be offered to established (at least 3 years old) profit

making business enterprises, eligible for credit rating of SB-4 and above. Mortgage of property valued at

30

least at 33% of the limit is to be prescribed. Further, an interest rebate of 0.50% p.a. may be given to

borrowers who offer mortgage of property valued at over 75% of the credit limit.

iv) While accepting projected annual sales turnover, a cap of 25% over actual annual sales turnover in the

immediately preceding year should be set. When circumstances warrant its breach, reasons therefor

should be recorded.

v) Where borrowers indicate need for credit limits which are higher than the amount indicated above,

assessment under the traditional PBS method may be resorted to.

Projected Balance Sheet Method (PBS)

The PBS method of assessment will be applicable to all C&I borrowers who are engaged in

manufacturing, services, and trading activities, including merchant exports and who require fund based

working capital finance of Rs. 25 lacs and above. In the case of SSI borrowers, who require working

capital credit limit up to Rs.5 cr, the limit shall be computed on the basis of Nayak Committee formula as

well as that based on production and operating cycle of the unit and the higher of the two may be

sanctioned. Fund based working capital credit limits beyond Rs 5 cr for SSI units shall be computed in the

same way as for C&I units. For business enterprises in Trade and Services Sector, where the projected

turnover method is not applicable, PBS method shall be followed.

8.1 In the Projected Balance Sheet (PBS) method, the borrower’s total business operations, financial

position, management capabilities etc. are analyzed in detail to assess the working capital finance

required and to evaluate the overall risk of the exposure. The following financial analysis is also to be

carried out:

Analysis of the borrower’s Profit and Loss account, Balance Sheet, Funds Flow etc. for the

past periods is done to examine the profitability, financial position, financial management, etc.

in the business.

Detailed scrutiny and validation of the projected income and expense in the business, and

projected changes in the financial position (sources and uses of funds) are carried out to

examine if these are acceptable from the angle of liquidity, overall gearing, efficiency of

operations etc.

31

8.2 There will not be a prescription like mandatory minimum current ratio or maximum level of a current

asset (inventory and receivables holding level norms) under PBS method. Under the PBS method,

assessment of WC requirement will be carried out in respect of each borrower with proper examination of

all parameters relevant to the borrower and their acceptability.

TERM LOAN:

1. A term loan is granted for a fixed term of not less than 3 years intended normally for financing

fixed assets acquired with a repayment schedule normally not exceeding 8 years.

2. A term loan is a loan granted for the purpose of capital assets, such as purchase of land,

construction of, buildings, purchase of machinery, modernization, renovation or rationalization of

plant, & repayable from out of the future earning of the enterprise, in installments, as per a

prearranged schedule.

From the above definition, the following differences between a term loan & the working capital

credit afforded by the Bank are apparent:

The purpose of the term loan is for acquisition of capital assets.

The term loan is an advance not repayable on demand but only in installments ranging over

a period of years.

The repayment of term loan is not out of sale proceeds of the goods & commodities per se,

whether given as security or not. The repayment should come out of the future cash

accruals from the activity of the unit.

The security is not the readily saleable goods & commodities but the fixed assets of the

units.

3. It may thus be observed that the scope & operation of the term loans are entirely different from

those of the conventional working capital advances. The Bank’s commitment is for a long period

& the risk involved is greater. An element of risk is inherent in any type of loan because of the

uncertainty of the repayment. Longer the duration of the credit, greater is the attendant

uncertainty of repayment & consequently the risk involved also becomes greater.

4. However, it may be observed that term loans are not so lacking in liquidity as they appear to be.

These loans are subject to a definite repayment programme unlike short term loans for working

capital (especially the cash credits) which are being renewed year after year. Term loans would be

repaid in a regular way from the anticipated income of the industry/ trade.

32

5. These distinctive characteristics of term loans distinguish them from the short term credit granted

by the banks & it becomes necessary therefore, to adopt a different approach in examining the

applications of borrowers for such credit & for appraising such proposals.

6. The repayment of a term loan depends on the future income of the borrowing unit. Hence, the

primary task of the bank before granting term loans is to assure itself that the anticipated income

from the unit would provide the necessary amount for the repayment of the loan. This will

involve a detailed scrutiny of the scheme, its financial aspects, economic aspects, technical

aspects, a projection of future trends of outputs & sales & estimates of cost, returns, flow of funds

& profits.

7. Appraisal of Term Loans

Appraisal of term loan for, say, an industrial unit is a process comprising several steps. There

are four broad aspects of appraisal, namely

Technical Feasibility - To determine the suitability of the technology selected & the

adequacy of the technical investigation & design;

Economic Feasibility - To ascertain the extent of profitability of the project & its

sufficiency in relation to the repayment obligations pertaining to term assistance;

Financial Feasibility - To determine the accuracy of cost estimates, suitability of the

envisaged pattern of financing & general soundness of the capital structure; &

Managerial Competency – To ascertain that competent men are behind the project to

ensure its successful implementation & efficient management after commencement of

commercial production.

33

7.1 Technical Feasibility

The examination of this item consists of an assessment of the various requirement of the actual

production process. It is in short a study of the availability, costs, quality & accessibility of all the

goods & services needed.

a) The location of the project is highly relevant to its technical feasibility & hence special

attention will have to be paid to this feature. Projects whose technical requirements could

have been taken care of in one location sometimes fail because they are established in another

place where conditions are less favorable. One project was located near a river to facilitate

easy transportation by barge but lower water level in certain seasons made essential

transportation almost impossible. Too many projects have become uneconomical because

sufficient care has not been taken in the location of the project, e.g. a woolen scouring &

spinning mill needed large quantities of good water but was located in a place which lacked

ordinary supply of water & the limited water supply available also required efficient

softening treatment. The accessibility to the various resources has meaning only with

reference to location. Inadequate transport facilities or lack of sufficient power or water for

instance, can adversely affect an otherwise sound industrial project.

b) Size of the plant – One of the most important considerations affecting the feasibility of a new

industrial enterprise is the right size of the plant. The size of the plant will be such that it will

give an economic product, which will be competitive when compared to the alternative

product available in the market. A smaller plant than the optimum size may result in

increased production costs & may not be able to sell its products at competitive prices.

c) Type of technology – An important feature of the feasibility relates to the type of technology

to be adopted for a project. A new technology will have to be fully examined & tired before it

is adopted. It is equally important to avoid adopting equipment or processes which are

absolute or likely to become outdated soon. The principle underlying the technological

selection is that “a developing country cannot afford to be the first to adopt the new nor yet

the last to cast the old aside”.

d) Labour – The labour requirements of a project, need to be assessed with special care. Though

labour in terms of unemployed persons is abundant in the country, there is shortage of trained

personnel. The quality of labour required & the training facilities made available to the unit

will have to be taken into account

e) Technical Report – A technical report using the Bank’s Consultancy Cell, external

consultants, etc., should be obtained with specific comments on the feasibility of scheme, its

profitability, whether machinery proposed to be acquired by the unit under the scheme will be

34

sufficient for all stages of production, the extent of competition prevailing, marketability of

the products etc., wherever necessary.

7.2 Economic Feasibility

An economic feasibility appraisal has reference to the earning capacity of the project. Since earnings

depend on the volume of sales, it is necessary to determine how much output or the additional production

from an established unit the market is likely to absorb at given prices.

a) A thorough market analysis is one of the most essential parts of project investigation. This

involves getting answers to three questions.

a) How big is the market?

b) How much it is likely to grow?

c) How much of it can the project capture?

The first step in this direction is to consider the current situation, taking account of the total output of the

product concerned & the existing demand for it with a view to establishing whether there is unsatisfied

demand for the product. Care should be taken to see that there is no idle capacity in the existing

industries.

ii) Future – possible future changes in the volume & patterns of supply & demand will have to be

estimated in order to assess the long term prospects of the industry. Forecasting of demand is a

complicated matter but one of the vital importance. It is complicated because a variety of factors affect

the demand for product e.g. technological advances could bring substitutes into market while changes in

tastes & consumer preference might cause sizable shifts in demand.

iii) Intermediate product – The demand for “Intermediate product” will depend upon the demand &

supply of the ultimate product (e.g. jute bags, paper for printing, parts for machines, tyres for

automobiles). The market analysis in this case should cover the market for the ultimate product.

7.3 Financial Feasibility

35

The basis data required for the financial feasibility appraisal can be broadly grouped under the following

heads

i) Cost of the project including working capital

ii) Cost of production & estimates of profitability

iii) Cash flow estimates & sources of finance.

The cash flow estimates will help to decide the disbursal of the term loan. The estimate of profitability &

the break even point will enable the banker to draw up the repayment programme, start-up time etc. The

profitability estimates will also give the estimate of the Debt Service Coverage which is the most

important single factor in all the term credit analysis.

A study of the projected balance sheet of the concern is essential as it is necessary for the appraisal of a

term loan to ensure that the implementation of the proposed scheme.

Break-even point:

In a manufacturing unit, if at a particular level of production, the total manufacturing cost equals the sales

revenue, this point of no profit/ no loss is known as the break-even point. Break-even point is expressed

as a percentage of full capacity. A good project will have reasonably low break-even point which not be

encountered in the projections of future profitability of the unit.

Debt/ Service Coverage:

The debt service coverage ratio serves as a guide to determining the period of repayment of a loan. This is

calculated by dividing cash accruals in a year by amount of annual obligations towards term debt. The

cash accruals for this purpose should comprise net profit after taxes with interest, depreciation provision

& other non cash expenses added back to it.

Debt Service = Cash accruals

Coverage Ratio Maturing annual obligations

This ratio is valuable, in that it serves as a measure of the repayment capacity of the project/ unit & is,

therefore, appropriately included in the cash flow statements. The ratio may vary from industry to

36

industry but one has to view it with circumspection when it is lower than the benchmark of 1.75. The

repayment programme should be so stipulated that the ratio is comfortable.

7.4 Managerial Competence

In a dynamic environment, the capacity of an enterprise to forge ahead of its competitors depends to a

large extent, on the relative strength of its management. Hence, an appraisal of management is the

touchstone of term credit analysis.

If there is a change in the administration & managerial set up, the success of the project may be put to

test. The integrity & credit worthiness of the personnel in charge of the management of the industry as

well as their experience in management of industrial concerns should be examined. In high cost schemes,

an idea of the unit’s key personnel may also be necessary.

NON-FUND BASE: -

LETTER OF CREDIT

Introduction

37

The expectation of the seller of any goods or services is that he should get the payment immediately on

delivery of the same. This may not materialize if the seller & the buyer are at different places (either

within the same country or in different countries). The seller desires to have an assurance for payment by

the purchaser. At the same time the purchaser desires that the amount should be paid only when the goods

are actually received. Here arises the need of Letter of Credit (LCs). The objective of LC is to provide a

means of payment to the seller & the delivery of goods & services to the buyer at the same time.

Definition

A Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at the request & on

the instructions of the customer (the applicant) or on its own behalf,

i. is to make a payment to or to the order of a third party (the beneficiary), or is to accept & pay

bills of exchange (drafts drawn by the beneficiary); or

ii. authorizes another bank to effect such payment, or to accept & pay such bills of exchanges

(drafts); or

iii. authorizes another bank to negotiate against stipulated document(s), provided that the terms &

conditions of the credit are complied with.

Basic Principle:

The basic principle behind an LC is to facilitate orderly movement of trade; it is therefore necessary that

the evidence of movement of goods is present. Hence documentary LCs is those which contains

documents of title to goods as part of the LC documents. Clean bills which do not have document of title

to goods are not normally established by banks. Bankers and all concerned deal only in documents & not

in goods. If documents are in order issuing bank will pay irrespective of whether the goods are of

expected quality or not. Banks are also not responsible for the genuineness of the documents &

quantity/quality of goods. If importer is your borrower, the bank has to advice him to convert all his

requirements in the form of documents to ensure quantity & quality of goods.

Parties to the LC

1) Applicant – The buyer who applies for opening LC

2) Beneficiary – The seller who supplies goods

3) Issuing Bank – The Bank which opens the LC

38

4) Advising Bank – The Bank which advises the LC after confirming authenticity

5) Negotiating Bank – The Bank which negotiates the documents

6) Confirming Bank – The Bank which adds its confirmation to the LC

7) Reimbursing Bank – The Bank which reimburses the LC amount to negotiating bank

8) Second beneficiary – The additional beneficiary in case of transferable LCs

Confirming bank may not be there in a transaction unless the beneficiary demand confirmation by his

own bankers & such a request is made part of LC terms. A bank will confirm an LC for his beneficiary if

opening bank requests this as part of LC terms. Reimbursing bank is used in an LC transaction by an

opening bank when the bank does not have a direct correspondent/branch through whom the negotiating

bank can be reimbursed. Here, the opening bank will direct the reimbursing bank to reimburse the

negotiating bank with the payment made to the beneficiary. In the case of transferable LC, the LC may be

transferred to the second beneficiary & if provided in the LC it can be transferred even more than once.

BANK GUARANTEES:

A contract of guarantee is defined as ‘a contract to perform the promise or discharge the liability of the

third person in case of the default’. The parties to the contract of guarantees are:

a) Applicant: The principal debtor – person at whose request the guarantee is executed

b) Beneficiary: Person to whom the guarantee is given & who can enforce it in case of default.

c) Guarantee: The person who undertakes to discharge the obligations of the applicant in case of his

default.

Thus, guarantee is a collateral contract, consequential to a main contract between the applicant & the

beneficiary.

Purpose of Bank Guarantees

Bank Guarantees are used to for both both preventive & remedial purposes. The guarantees executed by

banks comprises both performance guarantees & financial guarantees. The guarantees are structured

according to the terms of agreement, viz., security, maturity & purpose.

Branches may issue guarantees generally for the following purposes:

a) In lieu of security deposit/earnest money deposit for participating in tenders;

b) Mobilization advance or advance money before commencement of the project by the contractor

& for money to be received in various stages like plant layout, design/drawings in project

finance;

39

c) In respect of raw materials supplies or for advances by the buyers;

d) In respect of due performance of specific contracts by the borrowers & for obtaining full payment

of the bills;

e) Performance guarantee for warranty period on completion of contract which would enable the

suppliers to realize the proceeds without waiting for warranty period to be over;

f) To allow units to draw funds from time to time from the concerned indenters against part

execution of contracts, etc.

g) Bid bonds on behalf of exporters

h) Export performance guarantees on behalf of exporters favouring the Customs Department under

EPCG scheme.

Guidelines on conduct of Bank Guarantee business

Branches, as a general rule, should limit themselves to the provision of financial guarantees & exercise

due caution with regards to performance guarantee business. The subtle difference between the two types

of guarantees is that under a financial guarantee, a bank guarantee’s a customer financial worth,

creditworthiness & his capacity to take up financial risks. In a performance guarantee, the bank’s

guarantee obligations relate to the performance related obligations of the applicant (customer).

While issuing financial guarantees, it should be ensured that customers should be in a position to

reimburse the Bank in case the Bank is required to make the payment under the guarantee. In case of

performance guarantee, branches should exercise due caution & have sufficient experience with the

customer to satisfy themselves that the customer has the necessary experience, capacity, expertise, &

means to perform the obligations under the contract & any default is not likely to occur.

Branches should not issue guarantees for a period more than 18 months without prior reference to the

controlling authority. Extant instructions stipulate an Administrative Clearance for issue of BGs for a

period in excess of 18 months. However, in cases where requests are received for extension of the period

of BGs as long as the fresh period of extension is within 18 months. No bank guarantee should normally

have a maturity of more than 10 years. Bank guarantee beyond maturity of 10 years may be considered

against 100% cash margin with prior approval of the controlling authority.

More than ordinary care is required to be executed while issuing guarantees on behalf of customers who

enjoy credit facilities with other banks. Unsecured guarantees, where furnished by exception, should be

for a short period & for relatively small amounts. All deferred payment guarantee should ordinarily be

secured.

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Appraisal of Bank Guarantee Limit

Proposals for guarantees shall be appraised with the same diligence as in the case of fund-base limits.

Branches may obtain adequate cover by way of margin & security so as to prevent default on payments

when guarantees are invoked. Whenever an application for the issue of bank guarantee is received,

branches should examine & satisfy themselves about the following aspects:

a) The need of the bank guarantee & whether it is related to the applicant’s normal trade/business.

b) Whether the requirement is one time or on the regular basis

c) The nature of bank guarantee i.e., financial or performance

d) Applicant’s financial strength/ capacity to meet the liability/ obligation under the bank guarantee

in case of invocation.

e) Past record of the applicant in respect of bank guarantees issued earlier; e.g., instances of

invocation of bank guarantees, the reasons thereof, the customer’s response to the invocation, etc.

f) Present o/s on account of bank guarantees already issued

g) Margin

h) Collateral security offered

Format of Bank Guarantees

Bank guarantees should normally be issued on the format standardized by Indian Banks Association

(IBA). When it is required to be issued on a format different from the IBA format, as may be demanded

by some of the beneficiary Government departments, it should be ensured that the bank guarantee is

a) for a definite period,

b) for a definite objective enforceable on the happening of a definite event,

c) for a specific amount

d) in respect of bona fide trade/ commercial transactions,

e) contains the Bank’s standard limitation clause

f) not stipulating any onerous clause, &

g) not containing any clause for automatic renewal of the bank guarantee on its expiry

CREDIT APPRAISAL PROCESS

Receipt of application from applicant

|

41

Receipt of documents

(Balance sheet, KYC papers, Different govt. registration no., MOA, AOA, and

Properties documents)

|

Pre-sanction visit by bank officers

|

Check for RBI defaulters list, willful defaulters list, CIBIL data, ECGC caution

list, etc.

|

Title clearance reports of the properties to be obtained from empanelled advocates

|

Valuation reports of the properties to be obtained from empanelled

valuer/engineers

|

Preparation of financial data

|

Proposal preparation

|

Assessment of proposal

|

Sanction/approval of proposal by appropriate sanctioning authority

|

Documentations, agreements, mortgages

|

Disbursement of loan

|

42

Post sanction activities such as receiving stock statements, review of accounts,

renew of accounts, etc

(on regular basis)

CHAPTER-5

SBI NORMS FOR CREDIT APPRAISAL

43

Credit appraisal means an investigation/assessment done by the bank prior before providing any loans &

advances/project finance & also checks the commercial, financial & technical viability of the project

proposed its funding pattern & further checks the primary & collateral security cover available for

recovery of such funds.

1. Loan policy – An Introduction

1.1 State Bank of India’s (SBI) Loan Policy is aimed at accomplishing its mission of retaining the

bank’s position as a Premier Financial Services Group, with World class standards & significant

global business, committed to excellence in customer, shareholder & employee satisfaction & to

play a leading role in the expanding & diversifying financial services sector, while continuing

emphasis on its Development Banking role.

1.2 The Loan Policy of the any bank has successfully withstood the test of time and with inbuilt

flexibilities, has been able to meet the challenges in the market place. The policy exits & operates at

both formal & informal levels. The formal policy is well documented in the form of circular

instructions, periodic guidelines & codified instructions, apart from the Book of Instructions, where

procedural aspects are highlighted.

1.3 The policy, at the holistic level, is an embodiment of the Bank’s approach to sanctioning, managing

& monitoring credit risk & aims at making the systems & controls effective.

1.4 The Loan Policy also aims at striking a balance between underwriting assets of high quality, and

customer oriented selling. The objective is to maintain Bank’s undisputed leadership in the Indian

Banking scene.

1.5 The Policy aims at continued growth of assets while endeavoring to ensure that these remain

performing & standard. To this end, as a matter of policy the Bank does not take over any Non-

Performing Asset (NPA) from other banks.

1.6 The Central Board of the Bank is the apex authority in formulating all matters of policy in the bank.

The Board has permitted setting up of the Credit Policy & Procedures Committee (CPPC) at the

Corporate Centre of the Bank of which the Top Management are members, to deal with issues

relating to credit policy & procedures on a Bank-wide basis. The CPPC sets broad policies for

managing credit risk including industrial rehabilitation, sets parameters for credit portfolio in terms

of exposure limits, reviews credit appraisal systems, approves policies for compromises, write offs,

44

etc. & general management of NPAs besides dealing with the issues relating to Delegation of

Powers.

Based on the present indications, following exposure levels are prescribed:

Individuals as borrowers Maximum aggregate credit facilities of

Rs. 20 crores

( Fund based & non-fund based )

Non-corporates

( e.g. Partnerships, JHF, Associations )

Maximum aggregate credit facilities of Rs.

80 crores

( Fund based & non-fund based )

Corporates Maximum aggregate credit facilities as

per prudential norms of RBI on exposures

Term Loans (loans with residual maturity of over 3 years) should not in the aggregate exceed

35% of the total advances of SBI.

The Bank shall endeavour to restrict fund based exposure to a particular industry to 15% of the

Bank’s total fund based exposure.

The Bank shall restrict the term loan exposure to infrastructure projects to 10% of Bank’s total

advances.

The Bank shall endeavour to restrict exposure to sensitive sectors (i.e. to capital market, real

estate, and sensitive commodities listed by RBI) to 10% of Bank’s total advances.

The Bank’s aggregate exposure to the capital markets shall not exceed 5% of the total outstanding

advances (including commercial paper) as on March 31 of the previous year.

45

2. Credit Appraisal Standards

1 (A) Qualitative:

At the outset, the proposition is examined from the angle of viability & also from the Bank’s prudential

levels of exposure to the borrower, Group & Industry. Thereafter, a view is taken about our past

experience with the promoters, if there is a track record to go by. Where it is a new connection for the

bank but the entrepreneurs are already in business, opinion reports from existing bankers & published

data if available are carefully pursued. In case of a maiden venture, in addition to the drill mentioned

heretofore, an element of subjectively has to be perforce introduced as scant historical data weightage to

be placed on impressions gained out of the serious dialogues with the promoter & his business contacts.

1 (B) Quantitative:

(a) Working capital:

The basis quantitative parameters underpinning the Bank’s credit appraisal are as follows:-

Sector/ Parameters Mfg Others

Liquidity

Current Ratio (min.)

1.33 1.20

(For FBWC limits above Rs. 5 cr.)

1.00

(For FBWC limits upto Rs. 5 cr.))

Financial Soundness

TOL/TNW (max.)

3.00 5.00

DSCR

Net (min.)

Gros (min.)

2:1

1.75:1

2:1

1.75:1

Gearing

D/E (max.) 2:1 2:1

46

Promoters’ contribution

(min.)

30% of

equity

20% of equity

(i) Liquidity:

Current Ratio (CR) of 1.33 will generally be considered as a benchmark level of liquidity. However the

approach has to be flexible. CR of 1.33 is only indicative & may not be deemed mandatory. In cases

where the CR is projected at a lower than the benchmark or a slippage in the CR is proposed, it alone will

not be a reason for rejection for the loan proposal or for the sanction of the loan at a lower level. In such

cases, the reason for low CR or slippage should be carefully examined & in deserving cases the CR as

projected may be accepted. In cases where projected CR is found acceptable, working capital finance as

requested may be sanctioned. In specific cases where warranted, such sanction can be with the condition

that the borrower should bring in additional long-term funds to a specific extent by a given future date.

Where it is felt that the projected CR is not acceptable but the borrower deserves assistance subject to

certain conditions, suitable written commitment should be obtained from the borrower to the effect that he

would be bringing in required amounts within a mutually agreed time frame.

(ii) Net Working Capital:

Although this is a corollary of current ratio, the movements in Net Working Capital are watched to

ascertain whether there is a mismatch of long term sources vis-à-vis long term uses for purposes which

may not be readily acceptable to the Bank so that corrective measures can be suggested.

(iii) Financial Soundness:

This will be dependent upon the owner’s stake or the leverage. Here again the benchmark will be

different for manufacturing, trading, hire-purchase & leasing concerns. For industrial ventures a Total

Outside Liability/ Tangible Net worth ratio of 3.0 is reasonable but deviations in selective cases for

understandable reasons may be accepted by the sanctioning authority.

(iv) Turn-Over:

The trend in turnover is carefully gone into both in terms of quantity & valve as also market share

wherever such data are available. What is more important to establish a steady output if not a rising trend

in quantitative terms because sales realization may be varying on account of price fluctuations.

(v) Profits:

47

While net profit is ultimate yardstick, cash accruals, i.e., profit before depreciation & taxation conveys the

more comparable picture in view of changes in rate of depreciation & taxation, which have taken place in

the intervening years. However, for the sake of proper assessment, the non-operating income is excluded,

as these are usually one time or extraordinary income. Companies incurring net losses consistently over 2

or more years will be given special attention, their accounts closely monitored, and if necessary, exit

options explored.

(vi) Credit Rating:

Wherever the company has been rated by a Credit Rating Agency for any instrument such as CP / FD this

will be taken into account while arriving at the final decision. However as the credit rating involves

additional expenditure, we would not normally insist on this and only use this tool if such an agency had

already looked into the company finances.

(b) Term Loan

(i) In case of term loan & deferred payment guarantees, the project report is obtained from the

customer,

(ii) which may be compiled either in-house or by a firm of consultants/ merchant bankers. The

technical feasibility & economic viability is vetted by the bank & wherever it is felt necessary,

the Credit Officer would seek the benefit of a second opinion either from the Bank’s Technical

Consultancy cell or from the consultants of the Bank/ SBI Capital Markets Ltd.

(iii) Promoter’s contribution of at least 20% in the total equity is what we normally expect.

But promoters’ contribution may vary largely in mega projects. Therefore there cannot be a

definite benchmark. The sanctioning authority will have the necessary discretion to permit

deviations.

(iv)The other basic parameter would be the net debt service coverage ratio i.e. exclusive of interest

payable, which should normally not go below 2. On a gross basis DSCR should not be below

1.75. These ratios are indicative & the sanctioning authority may permit deviations selectively.

(v) As regards margin on security, this will depend on Debt: Equity gearing for the project, which

should preferably be near about 1.5: 1 & should not in any case be above 2:1, i.e., Debt should

not be more than 2 times the Equity contribution. The sanctioning authority in exceptional cases

may permit deviations from the norm very selectively.

48

(vi)Other parameters governing working capital facilities would also govern Term Credit facilities to

the extent applicable.

(C) Lending to Non-Banking Financial Companies (NBFCs)

(D) Financing of infrastructure projects

(E) Lease Finance

(F) Letter of Credit, Guarantees & bills discounting

(G) Fair Practices for lenders

Documentation standards

1: The systems and procedures for documentation have been laid down keeping in view

the ultimate objective of documentation which is to serve as primary evidence in any dispute between the

49

Bank and the borrower and for enforcing the Bank's right to recover the loan amount together with

interest thereon (through a court of law as a final resort), in

the event of all other recourses proving to be of no avail. In order that this objective is achieved, our

documentation process attempts to ensure that:

The owing of the debt to the Bank by the borrower is clearly established by the documents.

The charge created on the borrower's assets as security for the debt is maintained and enforceable

The Bank's right to enforce the recovery of the debt through court of law is not allowed to

become time-barred under the Law of Limitation.

2: Documentation is not confined to mere obtention of security documents at the outset. It is a continuous

and ongoing process covering the entire duration of an advance comprising the following stages :

(i) Pre-execution formalities:

These cover mainly searches at the Office of Registrar of Companies and search of the Register of

Charges (applicable to corporate borrowers), also capacity of borrowers to borrow and the formalities to

be completed by the borrowers, searches at the office of the sub-Registrar of Assurances or Land Registry

to check the existence or otherwise of prior charge over the immovable property offered as security,

besides taking other precautions before creating equitable / registered mortgage.

(ii) Execution of Documents

This covers obtention of proper documents, appropriate stamping and correct execution thereof as per

terms of the sanction of the advance and the internal directives of a corporate borrower such as

Memorandum and Articles of Association, etc.

(iii) Post-execution formalities

This phase covers the completion of formalities in respect of mortgages, if any, registration with the

Registrar of Assurances, wherever applicable, and the registration of charges with the Registrar of

Companies within the stipulated period, etc..

(iv) Protection from Limitation / Safeguarding Securities

50

These measures aim at saving the documents from getting time-barred by limitation and protecting the

securities charged to the Bank from being diluted by any charge that might be created by the borrower to

secure his other debts, if any. These objectives are sought to be achieved by:

(a) Obtention of revival letter within the stipulated period

(b) Obtention of Balance Confirmation from the borrower at least at annual intervals

(c) Making periodical searches at the Office of the Registrar of Companies.

(d) Insurance of Assets charged - (unless specifically waived) to insure the Bank against the risk of

fire, other hazards, etc..

3. Keeping the above broad objectives and the documentation process in view, the Bank

has devised standard documents in most cases for various types of loans given to the borrowers.

Wherever standard specimens have not been evolved, these are suitably drafted on a case-by-case basis

with the help of in-house legal department and, on occasions, with the help of reputed outside solicitors.

Furthermore, changes in the documentation procedures and the implications involved are circularised

from time to time to all the branches/offices so that those who are responsible for obtaining and

safeguarding the documents are made fully conversant with them. This is further strengthened through

on-the-job training at the branches as well as at the Bank's training colleges / centres, where the officials

are briefed on the documentation procedures so that the Bank's interest is protected in this crucial area.

4. In respect of consortium advances, the documents are generally executed in consultation with the other

member banks in accordance with the guidelines laid down by RBI /IBA in the matter. Similarly, where

advances are extended jointly with the financial institutions, documents are specially drafted in

consultation with the solicitors / in-house legal experts to ensure pari passu charge and / or second charge,

whichever is applicable, of the movable / immovable assets of the borrower to protect the Bank's

interests.

5. While it is the Bank's endeavor to standardize documents for all types of facilities, in cases

documents have to be specially drafted, the Local Head Offices are empowered to vet and approve

such documents for facilities which are sanctioned at their level. For facilities requiring sanction of

COCC / ECCB, such specially drafted documents are cleared by the Corporate Centre.

3. Requirement of documents for process of loan

51

1. Application for requirement of loan

2. Copy of Memorandum & Article of Association

3. Copy of incorporation of business

4. Copy of commencement of business

5. Copy of resolution regarding the requirement of credit facilities

6. Brief history of company, its customers & supplies, previous track records, orders in

hand. Also provide some information about the directors of the company

7. Financial statements of last 3 years including the provisional financial statement for the

year 2008-09

8. Copy of PAN/TAN number of company

9. Copy of last Electricity bill of company

10. Copy of GST/CST number

11. Copy of Excise number

12. Photo I.D. of all the directors

52

13. Address proof of all the directors

14. Copies related to the property such as 7/12 & 8A utara, lease/ sales deed, 2R permission,

Allotment letter, Possession

15. Bio-data form of all the directors duly filled & notarized

16. Financial statements of associate concern for the last 3 years

4. Delegation of powers

1. A scheme of Delegation exercise by the various functional Powers comprehensively

documented in 1985 and amended from time to time is in operation in the Bank in respect of

financial and administrative matters for rise. This is based on the premise that an executive is

required to exercise only those powers which are related to the responsibilities and duties

entrusted to him/her. In exercising the powers, the authorities concerned are required to ensure

compliance also with the relevant provisions of the State Bank of India Act and the State Bank of

India General Regulations and any rules, regulations, instructions or orders issued from time to

time by appropriate controlling authorities.

2. The Executive Committee of the Central Board (ECCB) has full powers for sanctioning all credit

facilities.

3. The Scheme of Delegation of Financial powers for advances and allied matters in the Bank has a

graded authority structure. The Executive Committee of the Central Board (ECCB) has full powers for

sanctioning credit facilities. The sanctioning powers have been delegated down the line to Committees of

officials at various administrative offices and individual line functionaries.

53

4. An appropriate control system is also in operation in tune with the Delegation structure. The powers,

exercised by various functionaries, are required to be reported to the next higher authority as laid down in

the Scheme of Delegation of Financial Powers.

5. A system of loan review styled 'Credit Audit' which inter alia covers audit of credit sanction decisions

at various levels has been implemented. Presently, all accounts with total fund based indebtedness of Rs.5

cr. and above are subjected to credit audit. The audit system serves as an effective control on the system

of sanction of loans in the bank through widely delegated powers.

SCHEME OF DELEGATION OF FINANCIAL POWER

54

S

L

PARTICULARS LIMITS CCCC WBCC CCC-I CCC-II NLCC AGM

1

CORPORATES

SB-1 &

SB-2

Over

all

500.00 250.00 100.00 50.00 FBL 7.50 2.00

(TL) NA NA (35.00) (15.00) (TL) (5.00) (1.25)

(WC-1.00)

Others Over

all

400.00 200.00 70.00 35.00 NFBL 7.50 1.00

(TL) NA NA (20.00) (10.00) Overall 15.00 3.00

2

NON-

CORPORATES

SB-1 &

SB-2

Over

all

60.00 60.00 40.00 20.00 FBL 5.00 1.00

(TL) NA NA (10.00) (5.00) (TL) (3.00) (1.00)

(WC-0.60)

Others Over

all

50.00 50.00 30.00 15.00 NFBL 5.00 0.60

(TL) NA NA (8.00) (4.00) Overall 10.00 1.20

3

INDIVIDUALS

SB-1 &

SB-2

Over

all

15.00 15.00 15.00 6.00 FBL 2.00 1.00

(TL) NA NA - - (TL) - (1.00)

(WC-0.60)

Others Over

all

10.00 10.00 10.00 5.00 NFBL 2.00 0.60

(TL) NA NA - - Overall 4.00 1.20

55

5. Pricing (Factors deciding interest rates and other charges)

1. Pricing in the Bank can be divided into interest pricing and non-interest pricing. Pricing of loans up to

Rs.2 lacs will be as prescribed by RBI. In line with RBI guidelines, he Bank announces from time to time

its single Benchmark Prime Lending Rate (BPLR), i.e., reference / indicative rates at which the Bank

would lend to its best customers. The BPLR would be referred to as State Bank Advance Rate (SBAR) in

our Bank. Interest rate without reference to SBAR could be charged in respect of certain categories of

loan / credit like discounting of bills, lending to intermediary agencies etc. Interest rates below SBAR

could be offered to exporters or other credit worthy borrowers including public enterprises on the lines of

a transparent and objective policy approved by the Bank's Board. All other loans are to be priced on the

basis of Bank's SBAR with the pricing being linked to grade of the risk in the exposure. The maximum

spread over SBAR which could be charged by the Bank will be decided by the Bank from time to time.

Within such ceiling, the pricing for various credit facilities, schemes, products, credit related services etc.,

including sub-SBAR pricing would be determined by ALCO or COCC, as considered appropriate. Bank

may also price floating rate products by using market benchmarks (e.g. G-Sec rates, MIBOR etc.) in a

transparent manner as per Board approved policies.

2. An internal Credit Risk Rating system covering all advances of Rs.25 lacs and above in C&I, SSI and

AGL segments has been put in place to facilitate structured assessment of credit risks. The system enables

evaluation of the fundamental strength of the borrower so as to charge a graded rate of interest based on

different ratings. However, taking into consideration the trends in movement of interest rates and market

competition, the Bank has also adopted an appropriate authority structure to facilitate competitive pricing

of loan products linked both to risk rating and overall business considerations.

3. Bank has introduced fixed interest rates in respect of certain categories of loans in personal segment,

e.g. housing term loans to individuals. Fixed interest rates are also extended for commercial loans, albeit

highly selectively.

4. Market related charges and a discretionary structure that enables branches to effectively face

competition are in place. These would be reviewed periodically based on feedback from operating units

and the market.

5. Pricing of Bank's funds and services while being basically market driven is also determined by two

important considerations, i.e., minimum desired profitability and risk inherent in the transaction. At the

corporate level, the applicable price for a particular advance or service is fixed taking into account the

marginal cost of Bank's funds and desired rate of return as calculated from indices like profitability levels

56

and return on capital employed. In case of corporate relationship where the value of connections and

overall potential for profitability from a particular account are more important than a particular

transaction, the price is fine tuned even to level of no-loss-no-profit in the transaction. For long term

exposures, the factors that weigh are the rate charged by the financial institutions, the period of exposure,

the pattern of volatility in the interest rates and the expected movement of the rates in the long term

perspective.

Review / Renewal of advances

1. Working capital facilities are granted by the Bank for a period of 1 year and thereafter they are required

to be renewed each year, i.e., fresh sanction is accorded for the limits. Where, however, renewal is not

possible for some reason, sanction for the continuance of the limits is obtained in each case by reviewing

the facilities.

2. Term loans which are irregular will be reviewed once in six months. (However, review of Term Loans

will be included in the periodical review of Special Mention Accounts.)

A separate authority structure, as given below, has been prescribed for above noted half-yearly review of

term loans:

3. In the case of all listed companies with credit rating of SB4/SBTL4 and below, a brief review is to be

put up on the basis of half-yearly working results published by them duly incorporating comments such as

extent of exposure, conduct of the account etc. Such review is to be submitted to the respective GE in

57

respect of ECCB sanctions, to the CGM (Circle) / CGM (CAG-Cen.) in respect of COCC-I&II sanctions

and to the GM (Network) in all other cases.

4. There will be no CRA rating review for term loans. However, in respect of term loans, the following

set of financial covenants is to be stipulated:

(i) Current Ratio

(ii) TOL/TNW

(iii) Interest Coverage Ratio

(iv) Default in payment of interest / installment

(v) Cross Default (default in payment of instalment/ interest to other institutions/ banks)

Default of these covenants would attract penal interest of 1% as under:

(a) Any adverse deviation by more than 20% from the stipulated levels in respect of any two of the

items (i) to (iii) above - penal interest to be levied for the period of non-adherence subject to a

minimum period of 1 year.

(b) Default in payment of interest/installments to the Bank or to other FI/Banks-penal interest to be

levied for the period of such defaults.

Takeover of advances

Bank needs to aggressively market for good quality advances. One of the strategies for increasing good

quality assets in the Bank's loan portfolio, would be to take over advances from other banks/FIs. Keeping

this in view and with the prime objective of adding only good quality assets, a common set of norms /

guidelines for C&I, SSI and AGL segments has been laid down for take over of advances.

A. Advances under SSI / C&I Segments

(i) The advance to be taken over should be rated SB3/SBTL3 or above.

(ii) The unit should score the minimum scores as prescribed, under the various risk

segments, in the Credit Risk Assessment.

58

(iii) The account should have been a standard asset in the books of the other bank/FI during

the preceding 3 years. (If this information is not forthcoming from the bank/FI, a certificate

should be obtained from the borrower’s Auditor that the loan has been a standard asset during the

preceding 3 years in the books of the bank/FI in terms of the asset classification norms of RBI.

The services of statutory auditors of our Bank may also be sought for this purpose). However, if a

unit is not having a track record for 3 years, as it has been in existence for a shorter duration,

takeover can be considered based on the track record for the available period, which should be at

least one year.

(iv) The unit should have earned net profits (post tax) in each of the immediately preceding 3 years.

However, if the unit has been in existence for a lesser period, it should have earned net profit

(post tax) in the preceding year of operation.

(v) The Term Loan proposed to be taken-over should not have been rephased, generally, by the

existing FI/Bank after commencement of commercial production. However, if a rephasement was

necessitated due to external factors and viability of the unit is not in doubt, such proposals may

also be considered for sanction on a case to case basis.

(vi)The remaining period of scheduled repayment of the term loan should be at least 2 years, when

only TLs are taken over.

For takeover of existing TLs, while the original time frame for repayment will be generally adhered to,

flexibility may be allowed in the quantum of periodical repayments. If sanction of fresh term loan is

proposed along with the takeover, the schedule of repayment for the existing term loans, if necessary,

may be permitted to extend up to 8 years. [The norms at (v), (vi) and (vii) above are not applicable for

take-over of working capital advances.

Note 1 : In the case of take-over proposals involving advances up to Rs.25 lacs, the rating

should be carried out, as per the scoring model prescribed under SME Smart Score (Refer page 170,

Chapter 34, Part III, Volume III of Manual on Loans & Advances). Other factors that may be kept in view

are: -

59

Continued viability

Track record

Standing in the market of the unit/ promoter.

Note 2: Take-over of units from our Associate Banks is not permitted.

Note 3 : In the cases of working capital finance through consortium or multiple banking, increasing our

share, and joining a consortium (or when a member bank exits consortium and we join the consortium in

its place), are not reckoned as take-over of advances from other banks.

B. Advances under Trade and Services Sector:

i) The current ratio and TOL/TNW ratio should be at acceptable levels, as per audited balance sheet not

older than 12 months. Current ratio of not below 1 is acceptable up to FBWC limit of Rs.5 cr. For FBWC

limits of above Rs.5 Cr. the current ratio of 1.33 will be indicative. It may be considered acceptable up to

1.20, depending on the activity. TOL/TNW ratio higher than 3 would be permissible depending on the

type of activity.

ii) The unit should have earned post-tax profits in each of the immediately preceding 3 years. However, if

the unit has been in existence for a lesser period, it should have earned net profit (post-tax) in the

preceding year of operation.

C. Other Guidelines:

(i) In all cases of take-over of advances from other banks, the credit information report in the format

prescribed by IBA should be obtained. The experience of the present banker (item 13 of the format)

should show satisfactory dealings with the unit. Where, from the point of competition, it is necessary not

to alert the bank concerned, the report may be obtained after the sanction of facilities but before release of

the facilities.

(ii) In all cases of take-over, branches should ensure proper documentation and other formalities to

protect the interest of our Bank.

60

(iii) In all cases of take-over, branches should assess the requirements of the borrower and obtain sanction

for the proposed limits before actually taking over the outstanding liability of the borrower to their

existing bank/ FI.

(iv) The following aspects should invariably be examined in each case of take-over.

Reasons for take-over

Market perception including the existing bank’s/FI’s perception regarding the unit and its

management. (For this, the appraising officials may record briefly on their enquiries with

market sources/other bank/FI);

Potential ancillary business accruing to the Bank;

Terms and conditions stipulated by the existing bank and those proposed by our Bank,

particularly to ensure against dilution of security cover. No takeover of advances from

any Public Sector Bank will be resorted to by quoting finer rates

(v) The credit rating should be done based on the audited balance sheet which is not older

than 12 months. However if the audited balance sheet is more than 12 months old and the proposal has to

be considered from the business angle, then a provisional balance sheet as on a recent date may be

obtained from the unit and the CRA exercise done based on these figures, additionally. Unit should clear

the stipulated hurdle rate in both the exercises.

D. Administrative Clearance (AC)

In all the cases of take-over proposals, AC is required to be obtained. For this purpose, a brief proposal

containing, inter alia, the comments on compliance with the norms and the other guidelines as above

should be submitted to the appropriate authority as under:

(i) For take-over of units complying with all the norms prescribed:

61

(ii) For take-over of units not complying with any one or more of the norms prescribed:

E. While takeover of 'P' segment advances is not generally encouraged, in consideration of larger

business interests / valuable connections, takeover of housing loans is considered selectively after due

diligence and precautions, in cases where possession of the house / flat has been taken, repayment of

existing loan has already commenced and installments have been paid as per terms of sanction.

Credit facilities to companies whose directors are in the defaulters' list of RBI:

1. The Directors of any company may be classified as promoter / elected / professional/ nominee /

honorary directors. RBI has been collecting and circulating information on defaulting companies amongst

banks / FIs, including names of directors of such companies. Though RBI's defaulters' list is given due

cognizance in the appraisal process, a general policy on the issues relating to sanction / continuation of

credit facilities to such companies whose directors are in the RBI's defaulters' list needs to be put in place.

Accordingly, it has been decided to adopt the following approach:

62

The above policy on defaulters will be a broad framework for sanction / continuation of credit facilities to

companies whose directors are in the RBI's list of defaulting borrowers of banks / FIs with dues of Rs.1

Cr. and above. When the list of such defaulters is circulated by CIBIL instead of RBI), the same Policy

would continue to apply.

2. Willful default & action there against - The penal measures would be made applicable to all borrowers

identified as willful defaulters or the promoters involved in diversion / siphoning of funds with

outstanding balance of Rs.25 lacs or more without any exception. Similarly, the limit of Rs.25 lacs will

also be applied for the purpose of taking cognizance of instances of siphoning and diversion of funds.

3. Where a Letter of Comfort or guarantee furnished by the companies within a Group in favour of a

willfully defaulting unit is not paid when invoked by the Bank, such Group companies also may be

reckoned as willful defaulters.

4. In cases of project financing, Bank would endeavor to ensure end-use of funds by, inter alia, obtaining

certification from Chartered Accountants. In case of short term corporate/clean loans, such an approach

would be supplemented by due diligence on the part of the Bank. It shall be the endeavor of the Bank to

ensure that such loans are limited to borrowers whose integrity and reliability are above board. Bank will

also retain the right to get investigative audit conducted whenever it is prima facie satisfied that there is a

case for such investigative audit to detect siphoning/ diversion of funds or other malfeasance.

5. No additional facilities shall be granted by the Bank to the listed willful defaulters. Further,

entrepreneurs / promoters of companies where the Bank has identified siphoning /diversion of funds, mis-

representation, falsification of accounts and fraudulent transactions shall be debarred from Bank finance

for floating new ventures for a period of 5 years from the date the name of the willful defaulter is

published by RBI / CIBIL.

63

6. The legal process, wherever warranted, against the borrowers / guarantors and foreclosure of recovery

of dues should be initiated expeditiously. The Bank may also initiate criminal action against willful

defaulters, where necessary.

7. Where possible, Bank shall adopt a proactive approach for a change of management of the willfully

defaulting borrowing unit.

6. Credit Monitoring & Supervision

1. Broadly, the objectives of post-sanction follow up, supervision and monitoring are as under:

(a) Follow up function:

To ensure the end-use of funds

To relate the outstandings to the assets level on a continuous basis

To correlate the activity level to the projections made at the time of the

sanction / renewal of the credit facilities

To detect deviation from terms of sanction.

To make periodic assessment of the health of the advances by noting some of the key indicators

of performance like profitability, activity level, and management of the unit and ensure that the

assets created are effectively utilized for productive purposes and are well maintained.

To ensure recovery of the installments of the principal in case of term loans as per the scheduled

repayment programme and all interest.

To identify early warning signals, if any, and initiate remedial measures thereby averting the

incidence of incipient sickness.

To ensure compliance with all internal and external reporting requirements covering the credit

area.

(b) Supervision function:

To ensure that effective follow up of advances is in place and asset quality of good order is

maintained.

To look for early warning signals, identify ‘incipient sickness’ and initiate proactive remedial

measures.

(c) Monitoring function:

64

To ensure that effective supervision is maintained on loans / advances and appropriate responses

are initiated wherever early warning signals are seen.

To monitor on an ongoing basis the asset portfolio by tracking changes from time to time.

Chalking out and arranging for carrying out specific actions to ensure high percentage of

‘Standard Assets’.

2. Detailed operative guidelines on the following aspects of effective credit monitoring are in place:

Post-sanction responsibilities of different functionaries

Reporting for control

Security documents, Statement of stocks and book debts

Computation of drawing power (DP) on eligible current assets and maintaining of DP register

Verification of assets

Inspection by branch functionaries – frequency, reporting, register etc.

Stock Audit

Follow up based on information systems

Follow up during project implementation stage

Follow up post-commercial production

Monitoring and control

Detection and prevention of diversion of working capital finance

Monitoring of large withdrawals

Allocation of limit

Handling of NPA accounts etc.

7. Loan Administration - Pre-Sanction process

Appraisal, Assessment and Sanction functions

65

1. APPRAISAL

A. Preliminary appraisal

1.1 Sound credit appraisal involves analysis of the viability of operations of a business and the capacity of

the promoters to run it profitably and repay the bank the dues as and then they fall

1.2. Towards this end the preliminary appraisal will examine the following aspects of a proposal.

Bank’s lending policy and other relevant guidelines/RBI guidelines,

Prudential Exposure norms,

Industry Exposure restrictions,

Group Exposure restrictions,

Industry related risk factors,

Credit risk rating,

Profile of the promoters/senior management personnel of the project,

List of defaulters,

Caution lists,

Acceptability of the promoters,

Compliance regarding transfer of borrower accounts from one bank to another, if

applicable;

Government regulations/legislation impacting on the industry; e.g., ban on

financing of industries producing/ consuming Ozone depleting substances;

Applicant’s status vis-à-vis other units in the industry,

Financial status in broad terms and whether it is acceptable

The company’s Memorandum and Articles of Association should be scrutinized carefully to ensure (i)

that there are no clauses prejudicial to the Bank’s interests, (ii) no limitations have been placed on the

Company’s borrowing powers and operations and (iii) the scope of activity of the company.

1.3. Further, if the proposal is to finance a project, the following aspects have to be examined:

• Whether project cost is prima facie acceptable

• Debt/equity gearing proposed and whether acceptable

66

• Promoters’ ability to access capital market for debt/equity support

• Whether critical aspects of project - demand, cost of production, profitability, etc. are prima facie in

order

1.4. After undertaking the above preliminary examination of the proposal, the branch will arrive at a

decision whether to support the request or not. If the branch (a reference to the branch includes a

reference to SECC/CPC etc. as the case may be) finds the proposal acceptable, it will call for from the

applicant(s), a comprehensive application in the prescribed proforma, along with a copy of the

proposal/project report, covering specific credit requirement of the company and other essential data/

information. The information, among other things, should include:

• Organisational set up with a list of Board of Directors and indicating the qualifications, experience and

competence of the key personnel in charge of the main functional areas e.g., purchase, production,

marketing and finance; in other words a brief on the managerial resources and whether these are

compatible with the size and scope of the proposed activity.

• Demand and supply projections based on the overall market prospects together with a copy of the

market survey report. The report may comment on the geographic spread of the market where the unit

proposes to operate, demand and supply gap, the competitors’ share, competitive advantage of the

applicant, proposed marketing arrangement, etc.

• Current practices for the particular product/service especially relating to terms of credit sales,

probability of bad debts, etc.

• Estimates of sales, cost of production and profitability.

• Projected profit and loss account and balance sheet for the operating years during the currency of the

Bank assistance.

• If request includes financing of project(s), branch should obtain additionally

(i)Appraisal report from any other bank/financial institution in case appraisal has been done by them,

(ii) ‘No Objection Certificate’ from term lenders if already financed by them and

(iii) Report from Merchant bankers in case the company plans to access capital market, wherever

necessary.

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1.5. In respect of existing concerns, in addition to the above, particulars regarding the history of

the concern, its past performance, present financial position, etc. should also be called for. This

data/information should be supplemented by the supporting statements such as:

a) Audited profit loss account and balance sheet for the past three years (if the latest audited balance

sheet is more than 6 months old, a pro-forma balance sheet as on a recent date should be obtained

and analysed). For non-corporate borrowers, irrespective of market segment, enjoying credit

limits of Rs.10 lacs and above from the banking system, audited balance sheet in the IBA

approved formats should be submitted by the borrowers.

b) Details of existing borrowing arrangements, if any,

c) Credit information reports from the existing bankers on the applicant Company, and

d) Financial statements and borrowing relationship of Associate firms/Group Companies.

B. Detailed Appraisal

1.6 The viability of a project is examined to ascertain that the company would have the ability to service

its loan and interest obligations out of cash accruals from the business. While appraising a project or a

loan proposal, all the data/information furnished by the borrower should be counter checked and,

wherever possible, inter-firm and inter-industry comparisons should be made to establish their veracity.

1.7 The financial analysis carried out on the basis of the company’s audited balance sheets and profit and

loss accounts for the last three years should help to establish the current viability.

1.8 In addition to the financials, the following aspects should also be examined:

• The method of depreciation followed by the company-whether the company is following straight line

method or written down value method and whether the company has changed the method of depreciation

in the past and, if so, the reason therefor;

• Whether the company has revalued any of its fixed assets any time in the past and the

present status of the revaluation reserve, if any created for the purpose;

• Record of major defaults, if any, in repayment in the past and history of past sickness,

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if any;

• The position regarding the company’s tax assessment - whether the provisions made

in the balance sheets are adequate to take care of the company’s tax liabilities;

• The nature and purpose of the contingent liabilities, together with comments thereon;

• Pending suits by or against the company and their financial implications (e.g. cases

relating to customs and excise, sales tax, etc.);

• Qualifications/adverse remarks, if any, made by the statutory auditors on the

Company’s accounts;

• Dividend policy;

• Apart from financial ratios, other ratios relevant to the project;

• Trends in sales and profitability, past deviations in sales and profit projections, and

Estimates/projections of sales values;

• Production capacity & use: past and projected;\

• Estimated requirement of working capital finance with reference to acceptable build up

of inventory/ receivables/ other current assets;

• Projected levels: whether acceptable; and

• Compliance with lending norms and other mandatory guidelines as applicable

1.9. Project financing:

If the proposal involves financing a new project, the commercial, economic and

Financial viability and other aspects are to be examined as indicated below:

• Statutory clearances from various Government Depts./ Agencies

• Licenses/permits/approvals/clearances/NOCs/Collaboration agreements, as applicable

69

• Details of sourcing of energy requirements, power, fuel etc.

• Pollution control clearance

• Cost of project and source of finance

• Build-up of fixed assets (requirement of funds for investments in fixed assets to be critically examined

with regard to production factors, improvement in quality of products, economies of scale etc.)

• Arrangements proposed for raising debt and equity

• Capital structure (position of Authorized, Issued/ Paid-up Capital, Redeemable Preference Shares, etc.)

• Debt component i.e., debentures, term Loans, deferred payment facilities, unsecured loans/ deposits. All

unsecured loans/ deposits raised by the company for financing a project should be subordinate to the term

loans of the banks/ financial institutions and should be permitted to be repaid only with the prior approval

of all the banks and the financial institutions concerned. Where central or state sales tax loan or

developmental loan is taken as source of financing the project, furnish details of the terms and conditions

governing the loan like the rate of interest (if applicable), the manner of repayment, etc.

• Feasibility of arrangements to access capital market

• Feasibility of the projections/ estimates of sales, cost of production and profits covering

the period of repayment

• Break Even Point in terms of sales value and percentage of installed capacity under a normal production

year

• Cash flows and fund flows

• Proposed amortization schedule

• Whether profitability is adequate to meet stipulated repayments with reference to Debt

Service Coverage Ratio, Return on Investment

• Industry profile & prospects

• Critical factors of the industry and whether the assessment of these and management

Plans in this regard are acceptable

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• Technical feasibility with reference to report of technical consultants, if available

• Management quality, competence, track record

• Company’s structure & systems

• Applicant’s strength on inter-firm comparisons

For the purpose of inter-firm comparison and other information, where necessary, source data from Stock

Exchange Directory, financial journals/ publications, professional entities like CRIS-INFAC, CMIE, etc.

with emphasis on following aspects:

• Market share of the units under comparison

• Unique features

• Profitability factors

• Financing pattern of the business

• Inventory/Receivable levels

• Capacity utilization

• Production efficiency and costs

• Bank borrowings patterns

• Financial ratios & other relevant ratios

• Capital Market Perceptions

• Current price

• 52week high and low of the share price

• P/E ratio or P/E Multiple

• Yield (%)- half yearly and yearly

Also examine and comment on the status of approvals from other term lenders, market view (if

anything adverse), and project implementation schedule. A pre-sanction inspection of the project

71

site or the factory should be carried out in the case of existing units. To ensure a higher degree of

commitment from the promoters, the portion of the equity / loans which is proposed to be

brought in by the promoters, their family members, friends and relatives will have to be brought

upfront. However, relaxation in this regard may be considered on a case to case basis for genuine

and acceptable reasons. Under such circumstances, the promoter should furnish a definite plan

indicating clearly the sources for meeting his contribution. The balance amount proposed to be

raised from other sources, viz., debentures, public equity etc., should also be fully tied up.

C. Present relationship with Bank:

Compile for existing customers, profile of present exposures:

• Credit facilities now granted

• Conduct of the existing account

• Utilization of limits - FB & NFB

• Occurrence of irregularities, if any

• Frequency of irregularity i.e., number of times and total number of days the account

was irregular during the last twelve months

• Repayment of term commitments

• Compliance with requirements regarding submission of stock statements, Financial Follow-up

Reports, renewal data, etc.

• Stock turnover, realization of book debts

• Value of account with break-up of income earned

• Pro-rata share of non-fund and foreign exchange business

• Concessions extended and value thereof

• Compliance with other terms and conditions

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• Action taken on Comments/observations contained in RBI Inspection Reports:

CO Inspection & Audit Reports

Verification Audit Reports

Concurrent Audit Reports

Stock Audit Reports

Spot Audit Reports

Long Form Audit Report (statutory audit)

D. Credit risk rating: Draw up rating for (i) Working Capital and (ii) Term Finance.

E. Opinion Reports: Compile opinion reports on the company, partners/ promoters and the proposed

guarantors.

F. Existing charges on assets of the unit: If a company, report on search of charges with

ROC.

G. Structure of facilities and Terms of Sanction:

Fix terms and conditions for exposures proposed - facility wise and overall:

o Limit for each facility – sub-limits

o Security - Primary & Collateral, Guarantee

o Margins - For each facility as applicable

o Rate of interest

o Rate of commission/exchange/other fees

o Concessional facilities and value thereof

o Repayment terms, where applicable

o ECGC cover where applicable

o Other standard covenants

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H. Review of the proposal: Review of the proposal should be done covering

(i) strengths and weaknesses of the exposure proposed

(ii) risk factors and steps proposed to mitigate them

(iii) deviations, if any, proposed from usual norms of the Bank and the reasons therefor.

I. Proposal for sanction: Prepare a draft proposal in prescribed format with required backup details and

with recommendations for sanction.

J. Assistance to Assessment: Interact with the assessor, provide additional inputs arising

from the assessment, incorporate these and required modifications in the draft proposal and generate an

integrated final proposal for sanction.

2. ASSESSMENT: Indicative List of Activities Involved in Assessment Function is given below:

• Review the draft proposal together with the back-up details/notes, and the borrower’s

application, financial statements and other reports/documents examined by the appraiser.

• Interact with the borrower and the appraiser.

• Carry out pre-sanction visit to the applicant company and their project/factory site.

• Peruse the financial analysis (Balance Sheet/ Operating Statement/ Ratio Analysis/ Fund Flow

Statement/ Working Capital assessment/Project cost & sources/ Break Even analysis/Debt

Service/Security Cover, etc.) to see if this is prima facie in order. If any deficiencies are seen, arrange

with the appraiser for the analysis on the correct lines.

• Examine critically the following aspects of the proposed exposure.

o Bank’s lending policy and other guidelines issued by the Bank from time to time

o RBI guidelines

o Background of promoters/ senior management

o Inter-firm comparison

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o Technology in use in the company

o Market conditions

o Projected performance of the borrower vis-à-vis past estimates and performance

o Viability of the project

o Strengths and Weaknesses of the borrower entity.

o Proposed structure of facilities.

o Adequacy/ correctness of limits/ sub limits, margins, moratorium and repayment schedule

o Adequacy of proposed security cover

o Credit risk rating

o Pricing and other charges and concessions, if any, proposed for the facilities

o Risk factors of the proposal and steps proposed to mitigate the risk

o Deviations proposed from the norms of the Bank and justifications therefor

• To the extent the inputs/comments are inadequate or require modification, arrange for additional inputs/

modifications to be incorporated in the proposal, with any required modification to the initial

recommendation by the Appraiser

• Arrange with the Appraiser to draw up the proposal in the final form.

• Recommendation for sanction: Recapitulate briefly the conclusions of the appraisal and state whether

the proposal is economically viable. Recount briefly the value of the company’s (and the Group’s)

connections. State whether, all considered, the proposal is a fair banking risk. Finally, give

recommendations for grant of the requisite fund-based and non-fund based credit facilities.

3. SANCTION: Indicative list of activities involved in the sanction function is given below:

• Peruse the proposal to see if the report prima facie presents the proposal in a comprehensive manner as

required. If any critical information is not provided in the proposal, remit it back to the Assessor for

supply of the required data/clarifications.

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• Examine critically the following aspects of the proposed exposure in the light of corresponding

instructions in force:

o Bank’s lending policy and other relevant guidelines

o RBI guidelines

o Borrower’s status in the industry

o Industry prospects

o Experience of the Bank with other units in similar industry

o Overall strength of the borrower

o Projected level of operations

o Risk factors critical to the exposure and adequacy of safeguards proposed there against

o Value of the existing connection with the borrower

o Credit risk rating

o Security, pricing, charges and concessions proposed for the exposure and covenants stipulated vis-à-vis

the risk perception.

• Accord sanction of the proposal on the terms proposed or by stipulating modified or additional

conditions/ safeguards, or Defer decision on the proposal and return it for additional data/clarifications,

or Reject the proposal, if it is not acceptable, setting out the reasons.

5. MONITORING DELAY IN PROCESSING LOAN PROPOSAL :

Branches have to submit a report on credit proposals pending for more than 30 days in two parts. Part I

will comprise proposals requiring sanctions at the Branch/ SECC/ ZCC and Part II will contain sanctions

by CCC-II and above. Review reports to CCC-I and later to Group Executive for information at

prescribed intervals will be coordinated by DGM (CCFO). The consolidated position in this regard in

respect of all the Circles will be put up to MD & GE (NB) through GM (SME).

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Loan Administration - Post sanction credit process

General

1. Need

Lending decisions are made on sound appraisal and assessment of credit worthiness. Past record of

satisfactory performance and integrity are no guarantee for future though they serve as a useful guide to

project the trend in performance. Credit assessment is made based on promises and projections. A loan

granted on the basis of sound appraisal may go bad because the borrower did not carry out his promises

regarding performance. It is for this reason that proper follow up and supervision is essential. A banker

cannot take solace in sufficiency of security for his loans. He has to -

a) make a proper selection of borrower

b) Ensure compliance with terms and conditions

c) Monitor performance to check continued viability of operations

d) Ensure end use of funds.

e) Ultimately ensure safety of funds lent.

2. Stages of post sanction process

The post-sanction credit process can be broadly classified into three stages viz., follow-up, supervision

and monitoring, which together facilitate efficient and effective credit management and maintaining high

level of standard assets. The objectives of the three stages of post sanction process are detailed below.

8. TYPES OF LENDING ARRANEMENTS

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Introduction

Business entities can have various types of borrowing arrangements. They are

One Borrower – One Bank

One Borrower – Several Banks (with consortium arrangement)

One Borrower – Several Banks (without consortium arrangements – Multiple Banking

One Borrower – Several Banks (Loan Syndication)

A. One Bank

The most familiar amongst the above for smaller loans is the One Borrower-One Bank

arrangement where the borrower confines all his financial dealings with only one bank.

Sometimes, units would prefer to have banking arrangements with more than one bank on

account of the large financial requirement or the resource constraint of his own banker or due to

varying terms & conditions offered by different banks or for sheer administrative convenience.

The advantages to the bank in a multiple banking arrangement/ consortium arrangement are that

the exposure to an individual customer is limited & risk is proportionate. The bank is also able to

spread its portfolio. In the case of borrowing business entity, it is able to meet its funds

requirement without being constrained by the limited resource of its own banker. Besides this,

consortium arrangement enables participating banks to save manpower & resources through

common appraisal & inspection & sharing credit information.

The various arrangements under borrowings from more than one bank will differ on account of

terms & conditions, method of appraisal, coordination, documentation & supervision & control.

B. Consortium lending

When one borrower avails loans from several banks under an arrangement among all the lending

bankers, this leads to a consortium lending arrangements. In consortium lending, several banks

pool banking resourses & expertise in credit management together & finance a single borrower

with a common appraisal, common documentation & joint supervision & follow up. The

borrower enjoys the advantage similar to single window availing of credit facalities from several

banks. The arrangement continues until any one of the bank moves out of the consortium. The

bank taking the highest share of the credit will usually be the leader of consortium. There is no

ceiling on the number of banks in a consortium.

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C. Multiple Banking arrangement

Multiple Banking Arrangement is one where the rules of consortium do not apply & no inter se

agreement among banks exists. The borrower avails credit facility from various banks providing

separate securities on different terms & conditions. There is no such arrangement called

‘Multiple Banking Arrangement’ & the term is used only to donote the existence of banking

arrangement with more than one bank.

Multiple Banking Arrangement has come to stay as it has some advantages for the borrower &

the banks have the freedom to price their credit products & non-fund based facility according to

their commercial judgment. Consortium arrangement occasioned delays in credit decisions & the

borrower has found his way around this difficulty by the multiple banking arrangement.

Additionally, when units were not doing well, consensus was rarely prevalent among the

consortium members. If one bank wanted to call up the advance & protect the security, another

bank was interested in continuing the facility on account of group considerations.

Points to be noted in case of multiple banking arrangements

Though no formal arrangement exists among the financing banks, it is preferable to have

informal exchange of information to ensure financial discipline

Charges on the security given to the bank should be created with utmost care to guard

against dilution in our security offered & to avoid double financing

Certificates on the outstandings with the other banks should be obtained on the periodical

basis & also verified from the Balance sheet of the unit to avoid excess financing.

D. Credit Syndication

A syndicated credit is an agreement between two or more lending institutions to provide a

borrower a credit facility using common loan documentation. It is a convenient mode of raising

long-term funds.

The borrower mandates a lead manager of his choice to arrange a loan for him. The mandate

spells out the terms of the loan & the mandated bank’s rights & responsibilities. The mandated

banker – the lead manger – prepares an information memorandum & circulates among

prospective lender banks soliciting their participation in the loan. On the basis of the

memorandum & on their own independent economic & financial evolution the leading banks

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take a view on the proposal. The mandated bank convenes the meeting to discuss the syndication

strategy relating to coordination, communication & control within the syndication process &

finalises deal timing, management fees, cost of credit etc. The loan agreement is signed by all the

participating banks. The borrower is required to give prior notice to the lead manger about loan

drawal to enable him to tie up disbursements with the other lending banks

Features of syndicated loans

Arranger brings together group of banks

Borrower is not required to have interface with participating banks, thus easy & hassle

fee

Large loans can be raised through syndication by accessing global markets

For the borrower, the competition among the lenders leads to finer terms

Risk is shared

Small banks can also have access to large ticket loans & top class credit appraisal &

management

Advantages

Strict, time-bound delivery schedule & drawals

Streamlined process of documentation with clearly laid down roles & responsibilities

Market driven pricing linked to the risk perception

Competitive pricing but scope for fee-based income is also available

Syndicated portions can be sold to another bank, if required

Fixed repayment schedule & strict monitoring of default by markets which punish

indiscipline

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CHAPTER 6

CREDIT RISK ASSESSMENT

For a bank, what is RISK?

Risk is inability or unwillingness of borrower-customer or counter-party to meet their

repayment obligations/ honor their commitments, as per the stipulated terms.

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Lender’ task

Identify the risk factors, and

Mitigate the risk

How does risk arise in credit?

In the business world, Risk arises out of

Deficiencies / lapses on the part of the management (Internal factor)

Uncertainties in the business environment (External factor)

Uncertainties in the industrial environment (External factor)

Weakness in the financial position (Internal factor)

To put in another way, success factors behind a business are: -

Managerial ability

Favorable business environment

Favorable industrial environment

Adequate financial strength

As such, these are the broad risk categories or risk factors built into our CRA models. CRA takes

into account the above types of risks associated with the borrowal unit. The eventual CRA rating

awarded to a unit (based on a score of 100) is a single-point risk indicator of an individual credit

exposure, & is used to indentify, to measure & to monitor the credit risk of an individual

proposal. At the corporate level, CRA is also used to track the quality of Bank’s credit portfolio.

Credit & Risk

Go hand in hand.

They are like twin brothers.

They can be compared to two sides of the same coin.

82

All credit proposals have some inherent risks, excepting the almost negligible volume of

lending against liquid collaterals with adequate margin.

Lending despite risks:

So, risk should not deter a Banker from lending.

A banker’s task is to identify/ assess the risk factors/ parameters & manage / mitigate

them on a continuous basis.

But it’s always prudent to have some idea about the degree of risk associated with any

credit proposal.

The banker has to take a calculated risk, based on risk-absorption/ risk-hedging capacity

& risk-mitigation techniques of the Bank.

CREDIT RISK ASSESSMENT (CRA):

Credit is a core activity of banks & an important source of their earnings, which go to pay

interest to depositors, salaries to employees & dividend to shareholders

In credit, it is not enough that we have sizable growth in quantity/ volume, it is also necessary to

ensure that we have only good quality growth.

To ensure asset quality, proper risk assessment right at the beginning, that is, at the time of

taking an exposure, is extremely important.

Moreover, with the implementation of Basle-II accord4, capital has to be allocated for loan assets

depending on the risk perception/ rating of respective assets. It is, therefore, extremely important

83

for every bank to have a clear assessment of risks of the loan assets it creates, to become Basle-II

compliant.

That is why Credit Risk Assessment (CRA) system is an essential ingredient of the Credit

Appraisal exercise.

Indian Scenario:

In Indian banks, there was no systematic method of Credit Risk Assessment till late

1980’s/ early 1990’s.

Health Code System (1985) / IRAC norms (1993) are Asset (loan) classification systems,

not CRA systems.

RBI came out with its guidelines on Risk Management Systems in Banks in 1999 &

Guidance Note on Management of Credit in October, 2002.

SBI Scenario:

However, like in many other fields, in the field of Credit Risk Assessment too, our Bank played a

proactive & pioneering role. We had our Credit Rating System (CRA) in 1988. Then, the CRA

system was introduced in the Bank in 1996. The first CRA model was rolled out in 1996 to take

care of exposures to the C & I (Manufacturing) segment. Thereafter, separate models for SSI &

AGL segments were introduced in 1998, when the C&I (Mfg) CRA model was developed for

Non Banking Finance Companies (NBFCs).

As of now, in SBI, CRA is the most important component of the Credit Appraisal exercise for all

exposures > 25 lacs & a very important tool in decision-making (a Decision Support System) as

well as in pricing.

CREDIT RISK ASSESSMENT (CRA) – Minimum scores / Hurdle rates

1. The CRA models adopted by the Bank take into account all possible factors which go

into appraising the risks associated with a loan. These have been categorized broadly into

financial, business, industrial & management risks and are rated separately. To arrive at

the overall risk rating, the factors duly weighted are aggregated & calibrated to arrive at a

single point indicator of risk associated with the credit decision.

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2. Financial parameters: The assessment of financial risk involves appraisal of the

financial strength of the borrower based on performance & financial indicators. The

overall financial risk is assessed in terms of static ratios, future prospects & risk

mitigation (collateral security / financial standing).

3. Industry parameters: The following characteristics of an industry which pose varying

degrees of risk are built into Bank’s CRA model:

Competition

Industry outlook

Regulatory risk

Contemporary issues like WTO etc.

4. Management parameters: The management of an enterprise / group is rated on the

following parameters:

Integrity (corporate governance)

Track record

Managerial competence / commitment

Expertise

Structure & systems

Experience in the industry

Credibility: ability to meet sales projections

Credibility: ability to meet profit (PAT) projections

Payment record

Strategic initiatives

Length of relationship with the Bank

Bank has introduced New Rating Scales for borrower for giving loans. Rating is given on the

basis of scores out of 100. Bank gives loans to the borrower as per their rating like SBI gives

loans to the borrower up to SB8 rating as it has average risk till SB8 rating. From SB9 rating the

risk increases. So banks do not give loans after SB8 rating.

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5. The risk parameters as mentioned above are individually scored to arrive at an aggregate

score of 100 (subject to qualitative factors – negative parameters). The overall score thus

obtained (out of a max. of 100) is rated on a 8 point scale from SB1/SBTL1 to SB 8

/SBTL8.

CRA model also stipulates a minimum score under financial, business, industry and management

risk parameters for a proposal to be considered acceptable in a given form.

The details of such minimum scores are as under:

a. Minimum scores – General

b. Minimum scores under Management Risk : (‘Integrity/Corporate Governance’, ‘Track Record’

and ‘Managerial Competence/ Commitment’)

An applicant unit will be required to score minimum 2 marks each (out of 3) in the above three

parameters of Management Risk to qualify for Bank’s assistance. In case of existing accounts if the

company scores less than this stipulated minimum marks (02), the Bank would explore all possibilities to

exercise exit option.

c. Minimum Score under Business Risk:

Compliance of Environment Regulations To qualify for financial assistance, an applicant unit would have

to secure full marks (02) under the parameter, “ Compliance of Environment Regulations.” In case, the

existing units in the books of the bank do not secure full marks (02), the bank would explore all

possibilities for the exercise of exit option.

Hurdle rates:

No new connections are to be considered in respect of accounts rated below SB4/

SBTL4, subject to exceptions like availability of Central Govt. guarantees and / or

availability of a Corporate guarantee of parent / group company with a CRA rating of SB3 /

SBTL3 and above.

No enhancements in credit limits are to be considered in existing accounts rated below

SB4/SBTL4. (Deviations may be permitted by CCC-I and above, as provided in the Loan Policy.)

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Risk Management Dept., would issue advisories on the general outlook for the industry from time

to time.

Salient features of CRA models:

(a) Type of Models

S.

No.

Exposure Level (FB + NFB Limits ) Non – Trading Sector

(C&I , SSI , AGL)

Trading Sector

( Trade & Services)

(i) Over Rs. 5.00 crore Regular Model Regular Model

(ii) Rs 0.25 crore to Rs. 5.00 crore Simplified Model Simplified Model

(b) Type of Ratings

S. No. Model Type of Rating

(i) Regular Model (i) Borrower Rating

(ii) Facility Rating

(ii) Simplified Model Borrower Rating

(c) Type of Risks Covered:

(i) Borrower Rating

S.

No.

Risk Category Maximum Score

Regular Model Simplified Model

Existing

Company

New

Company

Existing

Company

New

Company

(i) Financial Risk (FR) 65 25

(65 x 0.39)

70 35

(70/2)

(ii) Qualitative Factors (-‘ve) (-10) (-10) (-10) (-10)

87

(iii) Business & Industry Risk (BR &

IR) /Business Risk (for Trading

Sector)

20 30

(20 x 1.5)

20 40

(20 x 2)

(iv) Management Risk (MR) 15 45

( 15 x 3)

10 25

( 10 x 2.5)

(v) Qualitative Parameter

(External Rating)

(+5) (+5) (+5) (+ 5)

Total 100 100 100 100

(vi) Borrower Rating based on the

above Score

(vii) Country Risk (CR)

(viii) Final Borrower Rating after CR

(ix) Financial Statement Quality Excellent/Good/Satisfactory/Poor

(x) Risk Score/Rating Transition Matrix Comments on Trend in Rating

(ii) Facility Rating (Regular Model)

S. No. Parameter Maximum Score

(a) Risk Drivers for Loss Given Default (LGD)

(i) Current Ratio [Working Capital/ Non-Fund Based

Facility (except Capex)] Or Project Debt/Equity[Term

Loan/Non-Fund Based Facility (for Capex)]

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6

(ii) Nature of Charge 4

(iii) Industry /(Trade- for Trading Sector) # 6

(iv) Geography # 2

(v) Unit Characteristics

(a) Leverage/ Enforcement of Collateral-4

(b) Safety, Value & Existence of Assets-4

8

(vi) Macro-Economic Conditions

(a) GDP Growth Rate : Impact of Business Cycle - 2

(b) Insolvency Legislation in the Jurisdiction-1

(c) Impact of Systemic/Legal Factors on Recovery-1

(d) Time Period for Recovery-1

5

(vii) Total Security (Primary + Collateral) 60

(b) Risk Drivers for Exposure at Default (EAD)

(i) Nature of Commitment

89

(Revolving/Non-Revolving) 1

(ii) Credit Quality of Borrower @ 5

(iii) Tenor of Facility 3

Total Score 100

Facility Rating based on the above Score

# No Scoring under these two parameters for AGL & Trade Segments due to non-availability of relevant

LGD Data; Score out of 92 to be normalised to 100 for these segments.

@ Marks linked to Borrower Rating Score of the Unit.

(d) New Rating Scales - Borrower Rating: 16 Rating Grades

S.

No.

Borrower

Rating

Range of

Scores

Risk Level Comfort Level

1 SB1 94-100 Virtually Zero risk Virtually Absolute safety

2 SB2 90-93 Lowest Risk Highest safety

3 SB3 86-89 Lower Risk Higher safety

4 SB4 81-85 Low Risk High safety

5 SB5 76-80 Moderate Risk with Adequate Cushion Adequate safety

90

6 SB6 70-75 Moderate Risk Moderate Safety

7 SB7 64-69

8 SB8 57-63 Average Risk Above Safety Threshold

9 SB9 50-56

10 SB10 45-49 Acceptable Risk

(Risk Tolerance Threshold)

Safety Threshold

11 SB11 40-44 Borderline risk Inadequate safety

12 SB12 35-39 High Risk Low safety

13 SB13 30-34 Higher Risk Lower safety

14 SB14 25-29 Substantial risk Lowest safety

15 SB15 <24 Pre-Default Risk (extremely

vulnerable to default)Nil

16 SB16 - Default Grade

(e) New Rating Scales - Facility Rating (Separate for each Fund Based / Non- Fund Based Facility): 16

Rating Grades

S

NO

FACILITY

GRADES

RANGE

OF

SCORES

LGD LEVEL

(Recovery Level)

RISK LEVEL COMFORT

LEVEL

1 FR1 94-100 Virtually Zero LGD Virtually Zero Risk Virtually Absolute

Safety

2 FR2 87-93 Lowest LGD Lowest Risk Highest Safety

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(Highest Recovery)

3 FR3 80-86 Lower LGD

(Higher Recovery)

Lower Risk Higher Safety

4 FR4 73-79 Very Low LGD

(High Recovery)

Low Risk High Safety

5 FR5 66-72 Low LGD

(Adequate Recovery)

Moderate Risk with

Adequate Cushion

Adequate Safety

6 FR6 59-65 Moderate LGD

(Moderate recovery)

Moderate

Risk

Moderate

Safety7 FR7 52-58

8 FR8 45-51 Average LGD

(Average Recovery)

Average Risk Above Safety

Threshold9 FR9 38-44

10 FR10 31-37

LGD Tolerance Threshold

(Recovery Tolerance

Threshold)

Acceptable Risk

(Risk Tolerance

Threshold)

Safety Threshold

11 FR11 24-30 High LGD (Low recovery) High Risk Low Safety

12 FR12 17-23 Higher LGD

(Lower Recovery)

Higher Risk Lower Safety

13 FR13 11-16 Substantial LGD

(Small recovery)

Substantial Risk Lowest Safety

14 FR14 5-10

15 FR15 1-4 Highest LGD

(Minimal/zero recovery

Highest Risk

NIL16 FR16 0

(f) Mapping to Existing Borrower Rating Bands

92

S. No. New CRA Model Existing CRA Model

Score Grade Grade Score

1 94-100 SB1 SB1 >= 90

2 90-93 SB2

3 86-89 SB3

SB2 >=754 81-85 SB4

5 76-80 SB5

6 70-75 SB6

SB3 >=657 64-69 SB7

8 57-63 SB8 SB4 >=50

9 50-56 SB9

10 45-49 SB10 SB5 >=45

11 40-44 SB11 SB6 >35

12 35-39 SB12

13 30-34 SB13 SB7 >=25

14 25-29 SB14

15 < 24 SB15 SB8 <25

16 - SB16

(g) Qualitative Parameter (External Rating)

Solicited Rating by a recognized External Credit Rating Agency (ECRA) translates to additional Score.

Following ECRAs recognised by RBI are considered for this purpose:

93

. S. Type ECRA

1 Domestic (a) Credit Analysis & Research Limited;

(b) CRISIL Limited;

(c) FITCH India;

(d) (d) ICRA Limited.

2 International (a) FITCH;

(b) Moodys;

(c) Standard & Poor’s

RBI has clarified that “Cash Credit Exposures tend to be generally rolled over and also tend to be drawn

on an average for a major portion of the sanctioned limits. Hence even though a cash credit exposure

may be sanctioned for a period of one year or less, these exposures should be reckoned as Long Term

Exposures and accordingly, the Long Term Ratings accorded by the chosen Credit Rating Agencies will be

relevant.”

CHAPTER 7

CASE STUDY

Case Study-1

Details of case:

Company:- Akshat Polymers

Firm:- Partnership Firm (M/S Umiya Polymers)

* Shri Amrutbhai Laljibhai Desai

* Shri Gunvantbhai Ambaramdas Patel

94

* Shri Natvarlal Mohanlal Patel

* Shri Dharamsinhbhai Lallubhai Desai

* Shri Kanjibhai Maljibhai Desai

Industry:- Manufacturing

Activity:- Maufacturing of HDPP woven sacks

Segment:- SSI

Date of Incorporation:- 19.11.07

Banking arrangement:- Sole Banking

Regd. & Admin. Office:- RS No. 840,

Kadi Thol Road,

Tal-Kadi, Dist-Mehsana

The unit will have installed capacity of 2520 MT. The unit is expected to start commercial production

from first week of September, 2008. The capacity utilization for the year 2008-09 has been projected at

70% of installed capacity in terms of the utilization of the machines. Accordingly the unit is projected to

achieve a sale of Rs.9.26 crores for the year 2008-09 in the first six months of operations.

Further, the unit is projected to achieve capacity utilization of 80% during the year 2009-10 (the first full

year of operations) and accordingly the sale for the year is projected at Rs.19.77 crores. The projections

are considered acceptable in view of the following factors:

i) The unit plans to initially market its product in Gujarat, Maharastra, Rajasthan and sale to

Central Govt. who purchases the HDPP woven sacks for grains through open tenders. The

unit has started negotiating for booking of the orders for the proposed plant and results are

promising as advised.

95

ii) HDPP woven sacks are widely used as packaging material in Cement, Fertiliser, storage of

the AGL commodities. All these segments are reported to have good demand for the

HDPP/PE woven sacks in the Indian market.

iii) As per ICRA report, grading and research services (2006) Flexible packaging sector is

expected to grow at the rate of 12.40%.

iv) The promoters have sufficient experience in the line of activity. The promoters had already

made negotiations of the some of the industries as detailed under for selling the HDPP

woven sacks:

Indian Farmers Fertilizers Company Limited

GUJCOMASOL

Birla cement

Sanghi Cement

Ambuja cement

Various grain & Food Export units of Gujarat, etc.

v) The firm has also started marketing activity for their products by making personnel

contacts & writing introductory letters to potential customers & as the promoters are

in the same line of business activity for the last 15 years they are having very good

market contacts for the sales of the Finished Goods.

vi) The orders worth Rs.2.50 crores is expected to be finalized by end of August, 2008 and

before commissioning of the plant as advised.

Proposal:

Sanction for;

i) FBWC limits of Rs.2.25 crores

ii) Fresh Term Loan of Rs.2.00 crores

Approval for:

i) CRA rating of SB- 6 (71 marks) based on projected financials as on 31.03.2010.

ii) Pricing for WC facilities @1.00% above SBAR as applicable for SB-5 minimum @13.75and for

TL 1.50% above SBAR minimum @14.25%

Performance & Financial Indicators: (Rs. in Crores)

96

 Year 2009 2010 2011 2012 2013 2014

Installed cap Qty.

(MT/pa.)

2520 2520 2520 2520 2520 2520

Net Sales Qty.

(approx) (MT) 1029 2016 2091 2142 2217 2268

Net Sales (Value) 9.26 19.77 20.58 21.09 21.82 22.34

(Export) 0.00 0.00 0.00 0.00 0.00 0.00

Operating profit 0.44 1.18 1.19 1.23 1.31 1.33

Profit before tax 0.43 1.17 1.18 1.22 1.30 1.32

PBT/Net sales (%) 4.64 5.92 5.73 5.78 5.96 5.91

Profit after tax 0.29 0.78 0.79 0.82 0.87 0.88

Cash accruals 0.66 1.10 1.09 1.15 1.24 1.32

PBDIT 1.20 2.04 1.96 1.97 2.02 2.05

Paid up capital 0.95 0.95 0.95 0.95 0.95 0.95

Tangible net worth 1.23 2.01 2.80 3.62 4.49 5.38

Adjusted TNW

1.73 2.51 3.30 4.12 4.99 5.88

TOL/TNW 4.11 2.50 1.67 1.19 0.88 0.66

TOL/Adjusted TNW

2.64 1.80 1.27 0.92 0.81 0.62

Current ratio 1.34 1.52 1.53 1.53 1.57 1.81

NWC 1.01 1.71 2.40 2.57 2.74 3.28

97

Balance Sheet: (Rs. In crores)

Sources of funds 31.03.2009 31.03.2010

Share Capital 0.95 0.95

Reserves and Surplus 0.29 1.07

Secured Loans : short term CC 2.25 2.25

: long term TL 2.00 1.60

Unsecured Loans 0.50 0.50

Deferred Tax Liability

Total 5.99 6.37

Application of Funds

Fixed Assets (Gross Block) 2.67 2.67

Less Depreciation 0.37 0.69

Net Block 2.30 1.98

Capital Work in Progress

Investments

Inventories 1.73 2.13

Sundry debtors 1.85 2.40

Cash & bank balances 0.15 0.15

Loans & advances to suppliers of

Raw material / spares

0.14 0.12

Advance tax 0.10 0.23

( Less : Current liabilities ) 0.31 0.67

(Less : Provisions )

Net Current Assets 3.66 4.36

Misc. Expenditure

(To the extent not written off or adjusted )

Non-Current Assets/ Deposits 0.03 0.03

98

Total 5.99 6.37

Movement in TNW: -

Movement in TNW Projected

31.03.2009 31.03.2010 31.03.2011

Opening TNW 0.00 1.23 2.01

+ PAT 0.29 0.78 0.79

+ Inc. in Equity / Premium 0.95

+/- Change in Int. Assets -0.01

+/- Adj. of prior year exp.

- Dividend payment

Closing in TNW 1.23 2.01 2.80

Bank Income Analysis (Rs. in crores)

From Projection

31.03.2009

Projection

31.03.2010

WC Int. 0.16 0.27

TL Int. 0.14 0.29

LC - -

BG - -

Bill - -

Others loan processing 0.03 0.01

Total 0.33 0.57

99

Deviations in Loan Policy:

Parameters Indicative Min/Max level

as per loan policy

Company's

level as on

31.03.2009 @

Company's level as

on 31.03.2010

Liquidity 1.33 1.34 1.52

TOL/TNW

TOL/Adj. TNW

3.00 4.11

2.64

2.50

1.80

Average gross DSCR (TL) 1.75 2.54 2.54

Debt / equity

Debt/Quasi equity

2:1 2.01:1

1.15:1

1.03:1

0.64:1

Any others - - -

Defaulters List:-

Whether names of promoters, directors, company, group concerns figure in :

RBI defaulters’ list dated 30.09.2007 No

Wilful defaulters’ list dated 31.12.2007 No

ECGC caution list No

Warning signals / Major irregularities in

Credit audit:

inspection report :

Other audit reports :

Not applicable new unit

Adverse observations in Balance sheet Not applicable new unit

Adverse observations in Auditors report Nil.

100

Any NPAs among associate concerns None

About unit and the promoters:

AKSHAT POLYMERS (AP) has been established as a partnership firm on 19th November, 2007

at Kadi. The partnership was constituted for manufacturing and selling of HDPP woven sacks to

be manufactured from HDPP granules.

The firm consists of total six partners. The brief background of the partners is as follows :

Name Age Brief Background

M/s Umiya Polymers 46 Sri Prahaladbhai Hargovandas Patel is the

main partner in M/s Umiya Polymers with 30

share. Sri Prahaladbhai is SSC and have 10

years of experience as Production Manager

in Asia Woven Sacks Ltd., Kadi who are

engaged in similar activity. M/s Umiya

Polymers are engaged in plastic waste

recycling at Kadi.

Sri Amrutbhai Laljibhai Desai 43 Sri Desai is SSC and have 15 years of

experience as Production Manager in reputed

101

Gopala Polyplast Ltd., Santej. He had good

contacts in the market and will look after

production department & raw material

purchases.

Shri Dharamsingbhai Lallubhai Desai 35 Sri Dharamsinhbhai is a partner in the local

unit M/s Ajay Ginning Industries, Kadi

Shri Kanjibhai Malibhai Desai 44 Sri Kanjibhai is a farmer by profession and

sleeping partner.

Shri Gunvantbhai Ambaramdas Patel 42 Sri Gunvantbhai also is a partner in M/s Ajay

ginning Industires, Kadi and has been

inducted in the partnership as a investment

partner.

Shri Natvarlal Mohanlal Patel 48 Shri Natvarlal Patel is a B.Com. and has 10

years of experience in accounting. He is also

partner in M/s Shiv Shakti Steel, Kadi. He

will be looking after general administration

and accounts of the firm.

The overall quality of the management is considered satisfactory.

Commercial viability: (Rs.in crores)

Year ending

31st March

2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 Total

Net Sales 9.26 19.77 20.58 21.09 21.82 22.34

Net Profit 0.29 0.78 0.79 0.82 0.87 0.88

Cash Accruals 0.66 1.10 1.09 1.15 1.24 1.32 6.56

Interest on TLs 0.16 0.27 0.22 0.16 0.11 0.05 0.97

Sub Total (A) 0.82 1.37 1.31 1.31 1.35 1.37 7.53

Total repayment 0.00 0.40 0.40 0.40 0.40 0.40 2.00

Interest on TL 0.16 0.27 0.22 0.16 0.11 0.05 0.97

Sub Total (B) 0.16 0.67 0.62 0.56 0.51 0.45 2.97

DSCR (Gross) 5.13 2.04 2.11 2.34 2.65 3.04

102

Net DSCR - 2.75 2.73 2.88 3.10 3.30

Average Gross

DSCR

2.54

Average Net

DSCR

3.28

Break-even and sensitivity analysis and whether acceptable: (Rs. in crores)

Break even analysis 31/03/09 31-Mar-10 31-Mar-11 30-Mar-12 31-Mar-13 31-Mar-14

Capacity Utilization 70% 80% 83% 85% 88% 90%

Net Sales (A) 9.26 19.77 20.58 21.09 21.82 22.34

Variable costs            

Raw material 8.74 17.13 17.77 18.20 18.84 19.27

Consumable spares 0.00 0.00 0.00 0.00 0.00 0.00

Power and Fuel 0.26 0.47 0.50 0.53 0.56 0.59

Other operating Exp. 0.09 0.13 0.15 0.16 0.17 0.18

Stock Changes 0.73 0.39 0.06 0.03 0.04 0.04

Total Variable Cost(B) 8.36 17.34 18.36 18.86 19.53 20.00

Fixed Costs            

Direct Labour 0.08 0.13 0.14 0.15 0.16 0.17

Selling, Admin. & General

Expenses 0.06 0.10 0.11 0.12 0.13 0.14

Interest Expenses 0.40 0.55 0.48 0.42 0.35 0.29

Depreciation 0.37 0.32 0.30 0.33 0.37 0.44

Total Fixed Cost ( C) 0.91 1.10 1.03 1.02 1.01 1.04

Contribution (D=A-B) 0.90 2.43 2.22 2.23 2.29 2.34

Contribution ratio (E=D/A) 0.10 0.12 0.11 0.11 0.10 0.10

BE sales (F=C/E) 9.10 9.17 9.36 9.27 10.10 10.40

BE sales as % of Net

Sales 98.27 46.38 45.48 43.95 46.29 46.55

Interfirm Comparison: (To be given only where data from comparable units is available.)

103

(Amt in Cr)

Name of Company FBL NFBL Year Sales PBT /

Sales %

TOL /

TNW

CR

Ahmedabad Packaging

Industries Ltd.

3.30 1.20 2007 23.11 2.16 1.47 1.16

Singhal Industries Pvt. Ltd 6.70 -- 2010 15.19 6.52 2.901.90

Asia Woven Sacks Pvt. Ltd. 7.44 1.00 2008 22.98 4.53 3.141.08

Akshat Polymers 4.25 -- 2010 19.77 5.92 2.501.52

Raw material – The major raw material for this plant is HDPP in the form of granules. This raw

material is available locally by sales & distribution network of the major suppliers as under:

Reliance Industries Limited

Nand Agencies

Labdhi International

Hadlia petrochemicals Ltd.

Sharada Polymers

IPCL

The raw materials are purchased from the suppliers against the advance payment only and cash

discounts are offered resulting in the increase n profitability. Any variation in the cost of raw

material is proposed to be passed on to the finished products and will not affect the profitability.

104

Analysis:-

The firm is into manufacturing of HDPP woven sacks which are widely used as

packaging material in cement, fertilizer, etc.

As per ICRA report, grading and research services (2006) Flexible packaging sector is

expected to grow at the rate of 12.40%.

The promoters have sufficient experience in the line of activity. The promoters had

already made negotiations of the some of the industries as detailed under for selling the

HDPP woven sacks:

GUJCOMASOL

Birla cement

Sanghi cement

Ambuja cement

105

Various grain & Food Export Unit of Gujarat

The orders worth Rs.2.50 crores is expected to be finalized by end of Agust, 2008 and before

commissioning of the plant as advised.

The company’s borrower rating is SB-6 based on projected financials as on 31.03.2010 (the first

full year of operations).

Projected financials are in line with the financials of the some of the unit in similar line of activity

and production level.

The promoters are having experience of more than 15 years in the line of the activity.

The affairs of the firm are expected to be managed on professional lines based on their past

experience.

The conduct of accounts of associate with the existing bankers has been satisfactory.

The short and medium term outlook for the industry is stable

Availability of collateral security reflected in collateral coverage of 50.566%.

Gross average DSCR of 2.54.

Average security margin of 48%.

The company has adequate management skills and production/marketing infrastructure in place

to achieve the projected trajectory. There is steady demand for the product.

Case Study 2

(1). Details of case study

Company:- Janak Transport Co.

Firm:- Partnership

* Shri Harisinghbhai Lavjibhai Chaudhari;

* Shri Jesangbhai Lavjibhai Chaudhari;

* Shri Vinodkumar Lavjibhai Chaudhari;

* Shri Pratapbhai Lavjibhai Chaudhari;&

* Shri Janakkumar Jesangbhai Chaudhari

106

Industry:- Transport Activity

Segment:- C& I

Date of Incorporation:- 03.09.82

Banking with SBI since:- 16 years as a current A/C holder

Banking arrangement:- Multiple Banking Arrangement

Regd. & Admin. Office:- Opp. Simandhar Flat,

Nr. Pashabhai Petrol Pump,

Highway, Mehsana.

Janak Transport Co. is a partnership firm established in 1982 for carrying a transport business.

As the company is in this business since incorporation & the unit has good contracts with ONGC

since last 26 years so it has a good repo with ONGC.

As the company has a good repo with ONGC, the ONGC outlook of the business is considered

positive.

The firm has approached for term loan of Rs. 295 lacs to finance the purchase of Mahindra-

Bolero. The total project cost is estimated to be Rs. 363.44 lacs.

Brief of Contract:

107

(1). Fixed hire charges/ taxi/ month: Rs. 29150

(with fixed 3000 Km run/ month & 12 hours duty/ day)

(2). Additional/ km charges beyond 3000 km. Rs. 3.57

(3). Duration of contract = 3 Years

Proposed Credit Requirement:

Fund Based = Rs. 295 lacs

Performance Details

a) PERFORMANCE AND FINANCIAL INDICATORS:

(Rs. in lacs)

  Aud. Aud. Esti. Proj. Proj. Proj. Proj.

31st March 2007 2008 2009 2010 2011 2012 2013

Net Sales 501.78 546.65 713.82 898.65 898.65 898.65 898.65

Operating Profit (after

interest) 149.64 182.92 234.24 326.69 374.32 404.08 425.06

PBT 1.20 2.90 22.48 92.62 125.47 143.51 151.96

PBT/Sales (%) 0.24 0.53 3.15 10.31 13.96 15.97 16.91

108

PAT 1.20 2.90 22.48 92.62 125.47 143.51 151.96

Cash Accruals 39.05 40.51 129.25 233.74 224.25 212.66 200.36

PBDIT 54.44 52.41 150.01 266.99 247.21 226.20 203.72

Paid up Capital 21.04 22.56 91.00 113.48 181.10 256.57 340.08

TNW 21.04 22.56 113.48 181.10 256.57 340.08 427.04

Adjusted TNW 21.04 22.56 113.48 181.10 256.57 340.08 427.04

TOL/TNW 12.22 12.80 5.04 2.15 1.01 0.47 0.27

TOL/Adjusted TNW 12.22 12.80 5.04 2.15 1.01 0.47 0.27

Current Ratio 1.57 1.42 2.22 2.53 2.71 3.80 6.47

Current Ratio (Excl. TL

instalments)

2.34 1.97 3.93 4.49 5.66 5.83 6.47

NWC 100.20 103.87 386.14 349.18 323.80 361.29 438.25

b) Synopsis of Balance Sheet :

Sources of funds 31.03.2007 31.03.2008

Share Capital 21.04 22.56

Reserves and Surplus

Secured Loans : short term 2.57 14.66

: long term 102.87 100.10

Unsecured Loans 39.92 36.21

Deferred Tax Liability

Total 166.40 173.53

Application of Funds

109

Fixed Assets (Gross Block)

Less Depreciation

Net Block

Capital Work in Progress

Investments 52.48 39.3

Inventories (Movable Assets) 110.59 134.66

Sundry debtors 92.61 78.70

Cash & bank balances 11.93 48.15

Loans & advances to

subsidiaries and group companies

Loans & advances to others 10.58 10.49

( Less : Current liabilities ) 109.22 136.74

(Less : Provisions ) 2.57 1.03

Net Current Assets 113.92 134.23

Misc. Expenditure

(To the extent not written off or adjusted )

Total 166.40 173.53

c) Movement in TNW (Rs. in lacs)

2007 2008 2009 2010 2011 2012 2013

Opening TNW 17.63 21.04 22.56 113.48 181.10 256.57 340.08

Add PAT 1.20 2.90 22.48 92.62 125.47 143.51 151.96

Add. Increase in equity /

premium

8.42 10.17 68.44

Add./Subtract change in

intangible assets

Adjust prior year

expenses

Deduct Dividend 6.21 11.55 25.00 50.00 60.00 65.00

110

Payment /Withdrawals

Closing TNW 21.04 22.56 113.48 181.10 256.57 340.08 427.04

Appraisal Memorandum for term loan:

Circle: Ahmedabad

Branch: Mehsana

Company: Janak Transport Company(JTC)

Term Loan :

a) Proposal: Term Loan of Rs.295.00 lacs under the Transport Plus Scheme.

b) Project / Purpose: To purchase 59 new Mahindra Bolero under tie-up arrangement with

ONGC.

c) Appraised by: Inhouse examined by the Branch and found to be economically viable

d) Cost of Project & Means of finance:

111

Cost Means

MAHINDRA Bolero DI-2WD 328.63 Equity :

68.44

Insurance 15.34

RTO Tax 19.47

WC Margin Debt: 295.00

Total 363.44 Total 363.44

e) Remarks on Cost of project & Means of finance (in brief):

Each vehicle shall cost Rs. 6.16 lacs as per details given below:

Basic Price: Rs. 5.57 lacs

RTO : Rs. 0.33 lacs

Insurance : Rs. 0.26 lacs

The cost mentioned above is as per the quotation submitted by Shrijee Motors, Mehsana.

The firm is required to purchase 59 Mahindra Bolero for this purpose. Total cost of

vehicle including the insurance and R.T.O. is Rs.363.44 lacs.

The project is proposed to be financed by way of medium term loan of Rs.295.00 lacs

and firm shall raise capital of Rs. 68.44 lacs as a margin.

Break-even and sensitivity analysis and whether acceptable:

Break even analysis 31/03/09 31/03/10 31/03/11 31/03/12 31/03/13

 

Net Sales (A) 713.82 898.65 898.65 898.65 898.65

Variable costs

Power and Fuel 223.76 253.68 253.68 253.68 253.68

Other operating Exp. 44.89 47.39 48.89 50.89 55.98

Total Variable Cost(B) 268.65 301.07 302.57 304.57 309.66

Fixed Costs

Direct Labour 72.40 85.52 87.52 90.72 94.07

Selling, Admin. & General 8.50 9.50 10.50 11.50 12.50

112

Expenses

Interest Expenses 20.76 33.25 22.96 13.54 3.36

Depreciation 106.77 141.12 98.78 69.15 48.40

Total Fixed Cost ( C) 208.43 269.39 219.76 184.91 158.33

Contribution (D=A-B) 445.17 597.58 596.08 594.08 588.99

Contribution ratio (E=D/A) 0.62 0.66 0.66 0.66 0.66

BE sales (F=C/E) 336.18 408.17 332.97 280.17 239.89

BE sales as % of Net Sales 47.10 45.42 37.05 31.18 26.69

Fixed cost with out

depriciation G 101.66 128.27 120.98 115.76 109.93

Contribution (H=A-B) 445.17 597.58 596.08 594.08 588.99

Contribution ratio (I=D/A) 0.62 0.66 0.66 0.66 0.66

Cash BE sales (J=G/I) 163.97 194.35 183.30 175.39 166.56

CASHBE sales as % of Net

Sales 22.97 21.63 20.40 19.52 18.53

Commercial viability:

Year ending 31st March 2009 2010 2011 2012 2013 Total

Capacity utilization % 100% 100% 100% 100% 100%

Sales 713.82 898.65 898.65 898.65 898.65

Net Profit 22.48 92.62 125.47 143.51 151.96 536.04

Depreciation 106.77 141.12 98.78 69.15 48.40 464.22

Cash Accruals 129.25 233.74 224.25 212.66 200.36 1000.26

Interest 20.76 33.25 22.96 13.54 3.36 93.87

TOTAL 150.01 266.99 247.21 226.20 203.72 1094.13

TL / DPG repayments 83.75 132.92 94.58 93.85 43.02 448.12

Interest 20.76 33.25 22.96 13.54 3.36 93.87

TOTAL 104.51 166.17 117.54 107.39 46.38 541.99

Gross DSCR 1.44 1.61 2.10 2.11 4.39

Net DSCR 1.54 1.76 2.37 2.27 4.66

Average Gross DSCR 2.02

113

Average Net DSCR 2.23

Deviations in Loan Policy/ Scheme:

Parameters Indicative

Min/Max level as per

Scheme

Company's level as on 31/03/2008

Liquidity Min. 1.33 1.42

TOL/TNW Max. 3.00 12.80*

Average gross DSCR (TL) Min. 2.00 2.002

Promoters contribution (under tie-up) Min. 10 % 18.86%

profits in the last two Min. Rs.3.00 lacs with

rising trend

Actual profit Rs. 1.20 lacs for

year 2006-07 and Rs.2.90 lacs for

year 2007-08*

Others Nil Nil

Analysis:-

Janak Transport Company is an existing profit making unit

The main chunk behind giving loan is that Janak Transport Company is doing contract

with ONGC since incorporation

The promoters are having considerable experience as transport contractor with ONGC

The unit has got confirm order/ tie-up with ONGC

A letter of authority from ONGC was received, that if Janak Transport Company will not

make the payment than ONGC will directly make the payment to the bank

114

The promoters contribution to the project is 18.86% which is above the margin

requirement

The current ratio is 1.42 that is satisfactory

Profits in the last two years:-

Min. Rs. 3 lacs with rising trend

Actual profit Rs. 1.20 lacs for year 2006-07 & Rs. 2.90 lacs for the 2007-08

If the partners remuneration & interest is included, the profit for the year ended 31.03.07

& 31.03.08 is Rs. 4.81 lacs & Rs. 6.21 lacs

TOL/TNW should be max. 3 which is 12.80 here, as the co. has done multiple banking

arrangement it has o/s loans with other banks also but the co. is regularly making the

payment of loans of principal amount along with the interest so the loan is given.

Also the contract awarded is backed by guarantee from ONGC regarding direct payment

of monthly bills to SBI. Hence, surety of repayment is assured.

The bank also checks commercial viability of the company & found that the DSCR for

term loan is 2.02 which is considered satisfactory

Despite that the bank has also done B.E. analysis & found that the B.E. sales was 47.10%

of net sales for this current year

The net sales & PAT of the company is increasing year after year so overall profitability

is good

The overall projected performance & financial of the unit are considered satisfactory.

115

CHAPTER 8

FINDINGS

Credit appraisal is done to check the commercial, financial & technical viability of the project

proposed its funding pattern & further checks the primary or collateral security cover available

for the recovery of such funds

Credit is core activity of the banks and important source of their earnings which go to pay interest

to depositors, salaries to employees and dividend to shareholders

Credit and risk go hand in hand

116

In the business world risk arises out of:-

Deficiencies /lapses on the part of the managementUncertainties in the business environmentUncertainties in the industrial environmentWeakness in the financial position

SBI loan policy contains various norms for sanction of different types of loans

These all norms does not apply to each & every case

SBI norms for providing loans are flexible & it may differ from case to case

Different appraisal scheme has been introduced by the bank to cater different industries such as:-

Doctor plus scheme for doctorsTransport plus scheme for transportSchool, colleges and educational institutionsTrader’s easy loanWarehouse receipt financing for commodity traders(agriculture related stock, cotton ginning, etc.)

Bank’s main function is to lend funds/ provide finance but it appears that norms are taken as guidelines not as a decision making

A banker’s task is to identify/ assess the risk factors/ parameters and manage/ mitigate them on continuous basis

The CRA models adopted by the bank take into account all possible factors which go into

appraising the risk associated with a loan

These have been categorized broadly into financial, business, industrial, management risks & are

rated separately

The assessment of financial risk involves appraisal of the financial strength of the borrower based

on performance & financial indicators

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After case study, we found that in some cases, loan is sanctioned due to strong financial

parameters

From the case study analysis it was also found that in some cases, financial performance of the

firm was poor, even though loan was sanctioned due to some other strong parameters such as the

unit has got confirm order, the unit was an existing profit making unit and letter of authority was

received for direct payment to the bank from ONGC which is public sector

CHAPTER 9

RECOMMENDATIONS AND SUGGESTIONS

The problems faced by the bank and the suggestions given are with regards to increase credit flow the

SMEs not only with respect to working capital finance but also project finance and asset finance.

Problems faced by the Bank for SME lending and suggestions to overcome some of these problems:

Banks are now better equipped to handle the varied needs of the SME sector due to better technology and

risk management. Thus, it recommends, may be achieved by extending banking services to recognize

SME clusters by adopting the 4-C approach: Customer focus, cost control, cross-selling and containing

risk.

To enable the banks take more objective decisions, the Government plans to introduce a rating

mechanism for designated industrial clusters; this may be designed jointly by CRISIL, IBA, SIDBI and

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SSI Associations. This would enable institutional funding to be channeled through homogenous

recognized clusters.

There is a critical need to devote substantial resources to improving the skills and capabilities of banks'

lending officers, especially with regard to the analysis of the SMEs' financial statements. Understanding

the nature of the borrower's business and the cash-flow required is paramount to preventing the creation

of NPAs.

Another way of extending loans to the SMEs is the relationship-lending rule, where the lending partly

bases its decision on proprietary information about the firm and its owner through a variety of contacts

over time. The information may be gathered from such stakeholders as suppliers and customers, who may

give specific information about the owner of the firm or general information about the business

environment in which it operates.

Insufficient data on the SMEs, the lack of credible published information about their financial health, the

high vulnerability of small players in a liberalizing market and the inadequacy of risk management

systems in banks are factors leading to higher NPAs and lower profitability than potential in SME

lending. This can be overcome by collection of authentic data on the SME segment, educating the

enterprises on the need for reliable financial data, evolving suitable risk models and close monitoring of

accounts by the bank.

SMEs are increasingly using products such as derivatives to manage their forex flows. Bank needs to

offer sophisticated products to the SMEs in a simplified manner.

They need to innovate their delivery platforms by using Internet banking, mobile banking and card-based

platforms for delivery of transaction-banking as well as credit products, and enhance the service element.

SMEs look for convenience and simplicity in their banking requirements and banks should deliver these

through an effective use of technology.

The Bank should keep on revising its Credit Policy which will help Bank’s effort to correct the course of

the policies

The Chairman and Managing Director/Executive Director should make modifications to the procedural

guidelines required for implementation of the Credit Policy as they may become necessary from time to

time on account of organizational needs.

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Banks has to grant the loans for the establishment of business at a moderate rate of interest. Because of

this, the people can repay the loan amount to bank regularly and promptly.

Bank should not issue entire amount of loan to agriculture sector at a time, it should release the loan in

installments. If the climatic conditions are good then they have to release remaining amount.

SBI has to reduce the Interest Rate.

SBI has to entertain indirect sectors of agriculture so that it can have more number of borrowers for the

Bank.

CHAPTER 9

CONCLUSION

It is boom time for those working in the financial sector. There are opportunities galore in finance and

more will come in the next few years so finance is exciting is exciting both as a subject and a career

option with the greater expansion of the global economy.

Finance management is the backbone of any organizations and hence yields a number of job options

ranging from strategic financial planning to sales.

SBI load policy contains various norms for sanction of different types of loans. There all norms does not

apply to each & every case. SBI norms for providing loans are flexible & it may differ from case to case.

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The CRA models adopted by the bank take into account all possible factors, which go into appraising the

risk associated with a loan, these have been categorized broadly into financial, business, industrial, and

management risks & are rated separately.

Usually, it is seen that credit appraisal is basically done on the basis of fundamental soundness. But, after

different types of case studies, our conclusion was such that, in SBI, credit appraisal system is not only

looking for financial wealth. Other strong parameters also play an important role in analyzing

creditworthiness of the firm.

Morover, The study at SBI gave a vast learning experience to us and has helped to enhance our

knowledge. During the study We learnt how the theoretical financial analysis aspects are used in practice

during the working capital finance assessment. We have realized during my project that a credit analyst

must own multi-disciplinary talents like financial, technical as well as legal know-how.

The credit appraisal for working capital finance system has been devised in a systematic way. There are

clear guidelines on how the credit analyst or lending officer has to analyze a loan proposal. It includes

phase-wise analysis which consists of 5 phases:

1. Financial statement analysis

2. Working capital and its assessment techniques

3. Credit risk assessment

4. Documentation

5. Loan administration

To ensure asset quality, proper risk assessment right at the beginning, is extremely important. That is why

Credit Risk Assessment system is an essential ingredient of the Credit Appraisal exercise. The SBI was

the first to formulate a Credit Risk Assessment model. It considers important parameters like profitability,

repayment capacity, efficiency of the unit, historical / industry comparisons etc… which were not

factored in other models. It is equally efficient as the SIDBI’s CART (Credit Assessment and Rating

Tool) model.

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In all, the viability of the project from every aspect is analyzed, as well as type of business, industry,

promoters, past records, experience, projected data and estimates, goals, long term plans also plays crucial

role in increasing chances of getting project approved for loan.

BIBLIOGRAPHY

WEBSITES:

www.rbi.org.in

www.sbi.co.in

www.indianbankassociation.com

www.bankersindia.com

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www.wikipedia.com

www.iibf.co.in

BOOKS:

Vaidhyanathan, T.S., “Credit Management” Internal circular of SBI

“Credit and Banking” By: K. C. Nanda

JOURNALS:

1) Agarwal, R. G., “Banking Finance” A Leading monthly of Banking and Finance Published by Sashi Publications

2) K.Ramakrishnan, “Indian Bankers” Published by Indian Bank Association

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