Credit Management In Indian Overseas Bank

A detailed report on...

Credit management in

INDIAN OVERSEAS BANK

By

Akash Dixit

NIILM CMS

Greater Noida

1 | P a g eAkash DixitNIILM CMS, GREATER NOIDA, BATCH 12-14

Faculty Guide

Dr. Puneet Dublish

Industry Guide

Mr. N.K. Singh

DECLARATION

I, AKASH DIXIT, student NIILM CMS, GREATER NOIDA, declare that this project titled “Credit management in Indian Overseas Bank” is my original creation. Some parts have been taken from Internet and reference books mentioned at the end of the report.

AKASH DIXIT

PLACE: GREATER NOIDA


INFORMATION SHEET

Name of Company Indian Overseas BankAddress of Company Goldarwaza Chowk LucknowPhone +91-522-2287164/61Date of Internship Commencement 1st May,2013Date of Internship Completion 30th July 2013Name of the Industry Guide Mr. N.K. SinghDesignation of the Industry guide Chief ManagerStudent’s Name Akash DixitRoll Number 2012007E-Mail ID [email protected] Number +91-8377091869


Certificate of Completion from Faculty Guide

This is to certify that project report on “Credit Management in Indian Overseas

Bank” prepared by Akash Dixit, Roll No. 2012007 of PGDBM 2012-14 is his

genuine effort under my guidance and supervision.

Signatures of the Faculty Guide Signatures of the Student

Name of the Faculty Guide Name of the Student


Acknowledgement

I would like to thank INDIAN OVERSEAS BANK for providing me an opportunity to work with them and giving me necessary guidance in completing the project to the best of my abilities.

I extend a gratitude to Dr. Puneet Dublish, faculty guide, who helped me throughout the project.

I am obliged to Mr. N. K. Singh, Chief Manager, Indian Overseas Bank, Chowk, and Lucknow who provided me the essential information and extended his best support.

I would like to extend special gratitude to Mr. Amit Kumar, Assistant Manager, Loans and Advances Department, IOB, Chowk, Lucknow for providing me an insight into various issues pertaining to the cases mentioned in the report. This is his sincere support and consistent guidance that led to the completion of the project.

I am highly indebted to Mr.Vimal Mishra for his mentorship and valuable suggestion that gave me confidence and encouragement that helped me to put in my best.


INDEX

TOPIC PAGEChapter 1 Literature Review

Introduction Scope and purpose of the study Objectives Methodology Limitations & Outline of the work

91014151516

Chapter 2 General Concepts of Loan And Advances

18

Chapter 3 Basel Accords 20

Chapter 4 Lending and Advances Loan Procedure

23

23

Chapter 5 Financial Analysis of lending

Financial ratios

2829

Chapter 6 NPA & Securitization NPA Categories SARFAESI Act

323334

Chapter 7 Security Creation Pledge Hypothecation Mortgage

41414245

Chapter 8 Case Analysis Mohan Infotech Pratibha Constructions

484855

Chapter 9 :Findings 56 Problems observed during pre

and post sanction of advance Conclusion and recommendation Learnings

56

5758

Attachments: Balance Sheet 59References 60


ABSTRACT

Financial sector reform in India has progressed rapidly on aspects like interest rate deregulation, reduction in reverse requirements, prudential norms and supervision of risk. Though the progress on the structural institutional aspects has been comparatively been slower, major changes required to take the loans and advances problem have gained importance.

Chennai based Indian Overseas Bank is one of the nationalised bank in India that has substantive history since 1937. The bank not only deals in retail banking providing utility services to its customers but has also expanded its area of operation and multidimensional services like merchant banking, agri-business consultancy and e-banking. It recently registered a profit of Rs.1050.13 crore (March 2012).

The report deals with clear understanding of the lending procedures followed by the Indian Overseas Bank. It not only explains the basic concepts and the terminologies used in the banking sector but also gives an insight into the legal aspects and the paper work required for the final sanction of a loan proposal.

Different types of advances, method of assigning credit limit and drawing power to individuals and business units has been a part of the study during the internship period. The credit rating methods applied by the banks to rate the credibility of the prospective clients, securities accepted against lending and calculation of Equated Monthly Instalments have also been discussed to give an overview of the lending concept of the bank.

The most important part of the study includes case analysis of Mohan Infotech. This explains the significance of the financial ratios and credit rating of the client in a precise manner. The forecasting pecuniary status of the prospective borrower is shown by the study of the balance sheets and other financial details furnished by the borrower to the bank.

Later, the report includes the final sanction of the loans, their regular monitoring and conversion of accounts into standard or bad debts. The treatment of those Non Performing Assets and the recovery of the same along with the legal procedure followed by the bank are discussed in detail. A compendious note on NPAs brings about clear understanding of the issues associated with the recovery procedure of such assets and the final treatment. The same has been explained lucidly with the help of two cases that were witnessed during Summer Internship Program.Problems observed while rendering financial assistance to prospective borrowers are also mentioned in brief. Finally conclusion and recommendation as per the analysis during the training period winds up the report.


Literature Review

The c red i t managemen t i s popu la r among t he banks and o the r f i nanc ia l resources. The main purpose of the credit management is to lessen or diminish the effects of the non-performing loans came from the consumers. The procedures and p rocesses o f t he banks and t he i r a f f i l i a t es c rea te a g rea t impac t i n t he f l ow o f t he financial resources. However, various economic uncertainties, international markets, or f i nanc ia l cons t ra i n t s can cause t he f i nanc ia l s t a tus t o be uns tab le . As ide f r om the f i nanc ia l de f i c i enc ies , t he o the r causes o f t he f i nanc ia l cons t ra i n t s a re t he l ack o f c o n f i d e n c e a m o n g t h e f i n a n c i a l m a r k e t t o p r o v i d e e x t e r n a l h e l p f o r t h e n e e d e d consumers, lack of capability to gather the information of the consumers, and the lack of push to have an aggressive debt collecting. The non-performing loans can definitely c a u s e t o o m u c h s t a g n a t i o n o f t h e f i n a n c i a l s o u r c e s . T o p r o v i d e t h e c r e d i t r i s k management effectively, the banks and other financial institutions should asses the c red ib i l i t y o f t he l oane rs . I n t e rms o f an en te rp r i se , t he assessmen t o f t he i r c red i t portfolio is enough to provide a system that continuously promotes the reviewing the risks and the capability of the business enterprise to pay. F rom the different financial indicators, the position of the institution on the market failure are still depends on the internal process and the actions of the people. The economic theory in banking encompasses the interest and income theory in which is the basis of the cash flow approach in bank lending (Akperan, 2005). Credit risk management needs to be a r obus t p rocess t ha t enab les t he banks t o p roac t i ve l y manage t he l oan po r t f o l i os t o m in im i ze t he l osses and ea rn an accep tab le l eve l o f r e tu rn t o i t s sha reho lde rs . The importance of the credit risk management is recognized by banks for it can establish the standards of process, segregation of duties and responsibilities such in policies and procedures endorsed by the banks (Focus Group, 2007). Credit risks appear in banking institution because of the uncertainties plagued the financial system. The uncertainties remain a major challenge in country. Still, the major approaches applied by the banks are the continuing efforts on research and close mon i t o r i ng . Banks be l i eve t ha t t he resea rch and mon i t o r i ng a re t he key sou rces o f uncertainties like data generating institutions and the treasury (Uchendu, 2009). The marke t s t r uc tu re i s impo r tan t i n bank ing f o r i t i n f l uences t he compe t i t i veness o f t he b a n k i n g s y s t e m a n d c o m p a n i e s t o a c c e s s t o f u n d i n g o r c r e d i t i n v e s t m e n t . T h e econom ic g row th a f f ec t s t he s t r uc tu re and deve lopmen t o f t he bank ing sys tem. I n addition, the vast knowledge in risk assessment and managerial approach is recognized as part of the development. Moreover, because the banks and the processes are highly regulated, it became very useful in assess the effects or impact of the credit risk management in the banks and even in other financial sources (Gonzalez, 2009).


INTRODUCTION

Indian Banking Industry

Banks are the financial backbone of any country’s economy. A bank is a financial institution which deals with money and credit. It accepts deposits from individuals, firms and companies at a lower rate of interest and gives it at a higher rate of interest to those who need them. The difference between the terms at which it borrows and which it lends forms the source of profit, thus bank being a profit earning institute. For the past three decades India’s banking system has several outstanding achievements to its credit. The most striking is its extensive reach to customers. It is no longer confined to only metropolitans or cosmopolitans in India. In fact the Indian banking system has reached even to the remote corners of the country. This is one of the main reasons for the India’s growth process.

The first bank in India though conservative, was established in 1786. From 1786 till today, the journey of Indian banking system can be segregated into distinct phases. They are:

Phase 1: Early phase from 1786 to 1969 of Indian banks.

Phase 2: Nationalization of Indian banks and up to 1991 prior to Indian banking sector reforms.

Phase 3: New phase of Indian banking system with the advent of Indian banking and financial reforms 1991.

The Indian banking can be broadly categorized into nationalized (government owned), private banks and specialized banking institutions. The RBI acts as a centralized boy monitoring any discrepancies and shortcomings of the system. It is the foremost monitoring body in the Indian financial sector. Since the nationalization of the banks in 1969, the public sector banks have realized the need to become highly customer centric that faced the slow moving public sector banks to adopt a fast track approach.

The banking market is growing at an astonishing rate, with assets expected to reach US$ 1 trillion by 2010. An expanding economy, middle class and technological innovations are all contributing to this growth. The country’s middle class accounts for over 330 million people. In correlation with the growth of the economy, rising income levels, increased standard of living and affordability of banking products are promising factors of continued expansion.


The unleashing of products and services through the net has galvanisized players at all levels of the banking and financial institutions markets grid to look new at their existing portfolio offering. The Indian banking system has finally worked up to the dynamics of the ‘new’ Indian market and is addressing relevant issues to take on the multifarious challenges nationalized banks have acquired a place of of prominence.

Banking in India is highly fragmented with 30 banking units to almost 50% of the deposits and 60% of the advances. The nationalized banks (i.e. government owned banks) continue to dominate the Indian banking arena. They continue to be the major lenders in the economy due to their share size and penetrative networks which assures them high deposits mobilization. Industry estimates indicates that out of 274 commercial banks operating in India, 223 banks are in public sector and 51 are in the private sector. The private sector banks operating in India, 223 banks are public sector and 51 in the private sector. The private sector bank grid also includes 24 foreign banks that have started their operations in India.

INDIAN OVERSEAS BANK

Indian Overseas Bank (IOB) is a major bank based in Chennai with more than 2650 domestic branches, 3 extension counters and six branches overseas as of 31.03.2012. Indian Overseas Bank has an ISO certified in-house Information Technology department, which has developed the software that 2650 branches use to provide online banking to customers; the bank has achieved 100% networking status as well as 100% CBS status for its branches. IOB also has a network of about 1433 ATMs all over India and IOB's International VISA Debit Card is accepted at all ATMs belonging to the Cash Tree and NFS networks. IOB offers internet Banking (E-See Banking) & Mobile Banking and is one of the banks that the Govt. of India has approved for online payment of taxes.The bank's business more than doubled in the last four years.


2009 2010 2011 2012 20130

50000

100000

150000

200000

250000

AdvancesDeposits

Advances and Deposits

Figure 1 : Advances and Deposits of Indian overseas Bank

The net profit for the year ended March 31, 2012 stood at Rs 1,050.13 crore. Total income stood at Rs 19,578.13 crore as against Rs 13,326.56 crore registered during the same period last financial year. For the full year, the total business grew by 24 per cent to Rs 3,21,707 crore from Rs 2,59,020 crore.IOB has planned to achieve total business of Rs 3,85,000 crore to Rs 4,00,000 lakh crore this fiscal.

History

Pre-World War II

In 1937, Thiru. M. Ct. M. Chidambaram Chettyar established the Indian Overseas Bank (IOB) to encourage overseas banking and foreign exchange operations. IOB started up simultaneously at three branches, one each in Karaikudi, Madras (Chennai) and Rangoon (Yangon). It then quickly opened a branch in Penang and another in Singapore. The bank served the Nattukottai Chettiars, who were a mercantile class that at the time had spread from Chettinad in Tamil Nadu state to Ceylon (SriLanka),Burma (Myanmar), Malaya,Singapore, Java, Sumatra, and Saigon. As a result, from the beginning IOB specialized in foreign exchange and overseas banking (see below). Due to the war, IOB lost its branches in Rangoon, Penang, and Singapore.

After World War II

In the 1960s, the banking sector in India was consolidating through the merger of weak private sector banks with stronger ones; IOB absorbed five banks, including


Kulitali Bank (est. 1933). Then in 1969 the Government of India nationalized IOB. At one point, probably before nationalization, IOB had twenty of its eighty branches located overseas. After nationalization it, like all the nationalized banks, turned inward, emphasizing the opening of branches in rural India.

In 1988-89, IOB acquired Bank of Tamil Nadu in a rescue.

The new millennium, in 2000, IOB engaged in an initial public offering (IPO) that brought the government's share in the bank's equity down to 75%. In 2001 IOB acquired the Mumbai-based Adarsha Janata Sahakari Bank, which gave it a branch in Mumbai. Then in 2009 IOB took over Shree Suvarna Sahakari Bank, which was founded in 1969 and had its head office in Pune. Shree Suvarna Sahakari Bank had been in administration since 2006. It had nine branches in Pune, two in Mumbai and one in Shirpur. The total employee strength was estimated to be little over 100.

International expansion

As mentioned above, IOB was international from its inception with branches in Rangoon, Penang, and Singapore. In 1941, IOB opened a branch in Malaya that presumably closed almost immediately because of the war.

In 1946, after the War, IOB opened a branch in Ceylon. More overseas branches followed quickly. In 1947, IOB opened a branch in Bangkok and re-opened others. In 1948 United Commercial Bank (see below) opened a branch in Malaya. In 1949, IOB opened a branch in Bangkok.

Then in 1963, The Burmese government nationalized IOB’s branch in Rangoon. In 1973, IOB, Indian Bank and United Commercial Bank established United Asian Bank Berhad in Malaysia (Indian Bank had been operating in Malaysia since 1941 and United Commercial Bank Limited had been operating there since 1948.) The banks set up United Asian to comply with the Banking Law in Malaysia, which prohibited foreign government banks from operating in the country. Also, IOB and six Indian private banks established Bharat Overseas Bank as a Chennai-based private bank to take over IOB's Bangkok branch.

In 1977: IOB opened a branch in Seoul. Two years later, IOB opened a Foreign Currency Banking Unit in Colombo, Sri Lanka.

International expansion slowed thereafter, for a while. In 1992 Bank of Commerce (BOC), a Malaysian bank, acquired United Asian Bank (UAB).

In the new millennium, international expansion picked up once again. In 2007, IOB took over Bharat Overseas Bank. Three years later, Malaysia awarded a commercial banking license to a locally incorporated bank to be jointly owned byBank of Baroda, Indian Overseas Bank and Andhra Bank. The new bank, India International Bank (Malaysia), will reside in Kuala Lumpur, which has a large population of Indians. Andhra Bank will hold a 25% stake in the joint-venture; Bank of Baroda will own 40% and IOB the remaining 35%.


Scope and purpose of study

The purpose of preparation of this report is to focus on the lending function of banks with specific reference to Indian overseas bank. The report states the following points:

The study gives an insight into the procedure followed by the bank as per norms of RBI and the authority that governs the functioning of the Indian Overseas Bank. It also explains certain terminologies commonly used in the banking industry.

The report states the different types of advances that are financed by the bank and their classification as fund and non fund advances.

The financial analysis of lending i.ee the study of balance sheets and other financial accounts, to judge the credibility and the repaying capacity of the prospective borrower is done in great detail. The same is illustrated with the help of a practical case analysis (MOHAN INFOTECH) to build a better understanding of the importance and the procedure of such a financial analysis.

It also helps us infer the risk involved in sanctioning of advances by imputing the bankruptcy chances of the proposed borrower in the quantitative terms applying Multiple Discriminant Analysis. It also helps us understand the whole process of the financial analysis involved in appraising a loan.

This brings forth the method to assess the credit worthiness of the borrowers and estimate the net worth of the assets owned by him, which assists the bank to ascertain the amount that can be sanctioned to them. The extent to which the credit limits can be sanctioned and drawing power be enhanced are also mentioned.

Further the documentation of the proposed advances and their final sanction forms another major area that is taken into consideration.

Credit monitoring, identification of Non-Performing Assets (NPA) and the legal procedure adopted by bank in the recovery of those advances forms the most significant part of the study. The same is exhibited in various case studies that are included in the project to give a better view, comprising of an integral part of the report.

The last topic discussed as per the schedule of the project involves an in depth study of the problems related to pre and post sanction of advances and their possible solutions. Certain conclusions and the recommendations are made as per the analysis of the cases.


Objectives

The objective of the proposed project is to understand the entire process involved in successful lending by the bank beginning from the financial analysis of the lending of, identification of reliable procedure through scheduled EMI structure. This aims at analysing the ways n which the bank manages its non-performing assets. T includes identification of the problems associated with pre and post advances simultaneously finding out viable solutions and alternatives to address those issues.

The project is likely to help organisation understand the various issues related to the advances, giving it criteria solutions to reduce the losses due to non recovery of loans and maintain a healthy trend line of decreasing NPA thereby it to maintain a balance between its deposits and advances and an increase percentage yield.

Methodology

The proposed methodology for fulfilling the objectives of the project is as follows:

The study of guidelines laid by the RBI and the governing authorities of the IOB to be adhered to (pertaining to advances) as published in the journals issued from authorities from time to time.

The secondary data is deducted from the books of accounts maintained by the bank (without disclosure of any personal details of the borrower).

The data from the official books as maintained by the bank, reference books, news letters published by the financial institutions and websites have been utilised or the analytical study of the advances made by the bank.

The methodology includes a detailed study of the data collected from the bank, pre and post requites of lending, calculation of interest and equated monthly instalments and documentation of the same.

The observation of the advances sanctioned by the bank in the past few years that resulted successful lending constitutes the most substantial part of the project work.

It also involves active participation in bang transaction and internal functioning of the Advances Department of the branch. An elaborate study of loans and advances granted by the branch and analysis of the same has been the most significant component of the project.


Information mentioned in the cases are deducted from the books of accounts and the solution of the same with certain recommendations is to be provided after analysing certain loans to help the advances department f the bank.

Limitations of the study

The study of advances management pertaining to the IOB is subject to ceartain limitations that are identified as follows:

As far as the illustrations and the case analysis included in report are concerned the scope of the study is limited to Indian Overseas Bank, Chowk, Lucknow.

The personal details related to borrowers have intentionally not been revealed as per the norms of the bank specific crucial financial data of the clients has also not been disclosed.

The secondary data collected and taken into consideration in order to ufill the objectives of the project includes published data from the journals, magazines and data available from the website of the bank and other companies for the general public.

It also includes the data collected and observed during the daily functioning of the advances department of the bank(exclude confidential data )

The scope is limited to the types of advances funded by the branch and not all types of advances. So agriculture advances against shares and unit trust of India do not fall in the ambit of the study, therefore they have been excluded.

Further, the study serves the Advances Department of the bank branch to identify the issues related with to advances, maintain a decreasing trend in the net value of the Non performing assets in future and minimize the formation of the same. All summer internship program regulations laid down by the bank have been duly complied with.

Outline of the work

The project proposed deals in the advances, management of Indian overseas bank, Chowk, Lucknow. The project is completed and discussed in detail as per the schedule stated in the project proposal.

In the first phase, the project highlights the general concepts of loans and advances, which familiarizes us with the terms used in this context. It then covers principles and practices of lending as per the instructions laid down by the RBI and as received by the bank from its regulating authority.


The types of advances are classified as funds and non fund based are described, giving an overview of the various categories of advances. This section describes the term deposits, demand loans, secured and unsecured loans including letter of credit and bank guarantee.

Later, it explains the financial analysis of different types of advances considering both the business concerns and the advances to the individuals. The overdraft facility provided by the bank, cash credit and estimation of the drawing power along with the way it is to be calculated is mention.

The financial analysis of lending forms an integral section of the report where an attempt is made to explain the evaluation procedure of any proposal in hand. This analysis is distinctly illustrated with the help of a case study where the financials of a company are assessed to forecast its financial health and its capacity to repay to in near future.

The credit rating method followed by the bank to ascertain worthiness in case of both individuals and business enterprises is discussed. The different parameters of judging the same are mentioned along with the format used by the bank to rate any business concern and assess its financial position.

As far as the short term credits are concerned the project incorporates the methods and concepts applied by the bank to find the credit ratings of the customer, assigning of the credits limits and calculation of drawing power. The credit worthiness of the potential customer and his repayment capacity is estimated.

Calculation of equated monthly instalment based on the amount of loan to be sanctioned and the time duration required for repayment, including the prevailing interest rates as per norms of RBI are expounded.

The securities accepted against lending, the collateral that the customer offers the bank, modes of charging securities (lien, hypothecation, pledge, assignment, and mortgage) and bank guarantee required for particular credits is also studied under the project.

Credit documentation and sanction forms another major area of the study where all the documents pertaining to the advances are enlisted along with their significance and the final proposal is approved by the sanctioning authority.

Categorization of advance accounts as NPA, factors lending to such a consequence. Its provision and treatment of such accounts are studied. The legal procedure of their recovery through SARFESI Act 2002 and ultimately their management has been included to give a more comprehensive idea of the subject matter.


General Concepts of Loan & Advances

Borrower: A borrower being a party in the loan agreement that receives money and promises to repay it. He may bring a very attractive lending proposition. The banker needs s to know about the character, capacity and capital of the prospect. The borrower may compromise of an individual, a firm, a company, an HUF or any other business concern.

Purpose: The purpose for which a borrower seeks finance should not be anti social and anti national. The finance required should be proposed to be used for a good cause, the objective being legal in the eyes of the law.

Borrower’s stake or margin: The term margin refers to that prtion of the loan that needs to be contributed by the borrower. This is most likely to sustain commitment of the borrower throughout the life of the venture. The percentage of the margin is fixed by considering certain factors like borrower’s capacity to bring in capital, nature of business, level of risk, guidelines of RBI, etc.

Interest: Interest income refers to the profit that any lending would generate. It is the return on advances granted by the bank. The interest amount should be sufficient enough to cover the cost of lending i.e it should cover the estimated risk involved and simultaneously generate enough revenue to fulfil banks prime objective of being profitable.

Security: the banker advances loan keeping certain security which may either be collateral or in the form of personal guarantee. Each landing is backed by adequate security that creates a binding on the part of the borrower to repay. Security acts as an assurance, an alternative to recover the amount by liquidation but the bank’s basic motto remains recovery of advances from the income of the borrower. The security must qualify of being marketable, ascertainable, transferable and stable. This means that the security should be easy enough to sell without incurring much cost in selling. The assets must be easy to identify and must not result in much loss of value. It should be stable over a significant period of time and easy transferrable.

Principles of lending

According to general principles of lending, all mortgage originators should act in “good faith and with fair dealing“in any transaction. A realisable customer forms the basis of a successful lending:


Safety of funds ensures that the bank although being a profit generating unit continues to buid and retains the trust of the public at large.

Security accepted from the borrower as an alternative for recovery of advances in case of default must be of significant value.

Purpose of advances should remain inthe favour of the nation’s security. Profitability and yield on advances should be in line with the banks

objectives, so the advances made must be successful. Liquidity of advances made by the bank indicates its ability to meet its

deposit liabilities, so the advances made should be adequately liquid. Integrity of borrower is very vital to consider the loan proposal envisaged by

him for further sanction. Adequacy of bank finance is of prime importance for a borrower to

accomplish his project so both under and over financing should be avoided by the bank.

Timely availability of funds of the borrowers helps the bank grow in the current scenario.

These principles strengthen the bank finance eventually lending to safe advances.


Basel Accords

The Basel Accord of 1988 (Basel I) focused almost entirely on credit risk. It defined capital, and a structure of risk weights for banks. Minimum requirement of capital was fixed at 8% of risk-weighted assets. The G-10 countries agreed to apply the common minimum capital standards to their banking industries by end of 1992. The standards have evolved over time.

In 1996, market risk was incorporated in the framework. In June 2004, a revised international capital framework was introduced through Basel II. The following year, an important extension was made through a paper on the application of Basel II to trading activities and the treatment of double default effects. In July 2006, a comprehensive document was brought out, which integrated all applicable provisions from the 1988 Accord, Basel II and the various applicable amendments.

The Basel II framework is based on three pillars:

• The first Pillar – Minimum Capital Requirements

Three tiers of capital have been defined:

Tier 1 Capital includes only permanent shareholders’ equity (issued and fully paid ordinary shares and perpetual non-cumulative preference shares) and disclosed reserves (share premium, retained earnings, general reserves, legal reserves)

Tier 2 Capital includes undisclosed reserves, revaluation reserves, general provisions and loan-loss reserves, hybrid (debt / equity) capital instruments and subordinated term debt. A limit of 50% of Tier 1 is applicable for subordinated term debt.

Tier 3 Capital is represented by short-term subordinated debt covering market risk. This is limited to 250% of Tier 1 capital that is required to support market risk.

The second Pillar – Supervisory Review Process

Four key principles have been enunciated:

Principle 1: Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels.

Principle 2: Supervisors should review and evaluate the bank’s internal capital adequacy assessments and strategies, as well as their ability to


monitor and ensure their compliance with regulatory capital ratios. Appropriate corrective action is to be taken, if required.

Principle 3: Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to hold capital in excess of the minimum.

Principle 4: Supervisors should seek to intervene at an early stage to prevent capital from falling below the minimum levels required to support the risk characteristics of a particular bank and should require rapid remedial action if capital is not maintained or restored.

• The third Pillar – Market Discipline

This is meant to complement the other two pillars. Market discipline is to be encouraged by developing a set of disclosure requirements that will allow market participants to assess key pieces of information on the scope of application, capital, risk exposures, risk assessment processes and overall capital adequacy of the institution. The bank’s disclosures need to be consistent with how senior management and the Board of Directors access and manage the risks of the bank. The capital adequacy requirement was maintained at 8%. However, the whole approach is considered to be more nuanced than Basel I.

The stresses caused to institutions and the markets during the economic upheaval in the last couple of years, created a need for further strengthening of the framework. At its 12 September 2010 meeting, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, announced a substantial strengthening of existing capital requirements. These capital reforms, together with the introduction of a global liquidity standard, deliver on the core of the global financial reform agenda (Basel III).

Basel III is a comprehensive set of reform measures to strengthen the regulation,supervision and risk management of the banking sector. These measures aim to:

• improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source• improve risk management and governance• strengthen banks' transparency and disclosures.

The reforms target:• Bank-level, or micro-prudential regulation, which will help raise the resilience of individual banking institutions to periods of stress.• Macro-prudential, system wide risks that can build up across the banking sector as well as the pro-cyclical amplification of these risks over time.

These two approaches to supervision are complementary as greater resilience at the individual bank level reduces the risk of system wide shocks.The Committee's package of reforms will increase the minimum common equity requirement from 2% to 4.5%. In addition, banks will be required to hold a capital


conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%. This reinforces the stronger definition of capital agreed by Governors and Heads of Supervision in July and the higher capital requirements for trading, derivative and securitisation activities to be introduced at the end of 2011.


Lending and Advances

Banking system in India has gone through enormous changes. In addition banks are constrained from optimally diversifying their activities, thereby increasing the opportunity to reduce operating risk faced by industry, but the primary activity remains lending. Lending is the provision of monetary resources by the banker where other party reimburses in instalments or any other form of deferred payment, thereby by generating a debt.

Loans and advances portfolio being the most significant asset of the bank has impact on its profitability. Increase in competition and emergence of new types of risks in the banking sector has lead to efficient loans and advances management.

In order to cope up with the changing scenario, banks in India are strengthening their organisational setup through specialized departments to meet the credit requirements of the borrowers and continuous analysis of the potential credit growth.

The ideal advanvce is one that is granted to a reliable customer for a legal purpose where he has enough experience for efficient utilization of the amount and repays the amount within a given time frame as per agreement.

What is loan procedure?

Banks extend loan facilities in form of fund based and non fund based facilities. The banks provide fund based facility by way of term loans, demand loans, bill discounted, cash credit, overdraft etc. Whereas the non fund based facilities include letter of credit and bank guarantee.

Indian overseas bank offers a wide range of services in the loans and advances segment some of which are listed below

Personal loan Education loan Loans on bank term deposit Loans against NSC Loans against insurance policies


Loans against shares Loans against insurance policies Loans against gold jewels Loans against collateral security , stocks and debtors

Tthe term loan refers to the length of time you have to repay the debt. Debt financing can be either long term or short term.

Long term loan financing is commonly used to purchase, improve or extend fixed assets such as your plant facilities, major equipment and real estate. If you are acquiring an asset with the loan proceeds, you will ordinarily want to match the length of the loan with the useful life of the asset. Short term loan is often used to raise cash for cyclical inventory needs, accounts payable and working capital.

In the current lending climate, interest rates on long term financing tend to be higher than on short term borrowing, and long term financing usually requires more substantial collateral as security against the extended duration of the lender’s risk

Types of advances

For Business

• Bank Overdraft – a facility where the account holder is permitted to draw more funds that the amount in his current account.

• Cash Credit – an arrangement where the working capital requirements of a business are assessed based on financial projections of the company, and various norms regarding debtors, inventory and creditors.

Accordingly, a total limit is sanctioned. At regular intervals, the actual drawing power of the business is assessed based on its holding of debtors and inventory. Accordingly, funds are made available, subject to adherence to specified limits of Current Ratio, Liquid Ratio etc.Funding could come from a consortium of bankers, where one bank performs the role of lead banker. Alternatively, the company may make multiple banking arrangements.

• Bill Purchase / Discount – When Party A supplies goods to Party B, the payment terms may provide for a Bill of Exchange (traditionally called hundi). A bill of exchange is an unconditional written order from one person giving it (supplier), requiring the person to whom it is addressed (buyer) to pay on demand or at some fixed future date, a certain sum of money, to either the person identified as payee in the bill of exchange, or to any person presenting the bill of exchange.

When payable on demand, it is a Demand Bill


When payable at some fixed future date, it is a Usance Bill.

The supplier of the goods can receive his money even before the buyer makes the payment, through a Bill Purchase / Discount facility with his banker. It would operate as follows:

The supplier will submit the bill of exchange, along with Transportation receipt to his bank.

The supplier’s bank will purchase the bill (if it is a demand bill) or discount the bill (if it is a usance bill) and pay the supplier.

The supplier’s bank will send the Bill of Exchange along with transportation Receipt to the buyer’s bank, who is expected to present it to the buyer: _ For payment, if it is a demand bill _ For acceptance, if it is a usance bill.

The buyer will receive the Transportation Receipt only on payment or acceptance, as the case may be.

• Term Loan / Project Finance – Banks largely perform the role of working capital financing. With the onset of universal banking, some banks are also active in funding projects. This would entail assessing the viability of the project, arriving at a viable capital structure, and working out suitable debt financing facilities. At times, the main banker for the business syndicates part of the financing requirement with other banks.

For Individuals

Bank credit for individuals could take several forms, such as:

• Credit Card – The customer swipes the credit card to make his purchase. His seller will then submit the details to the card issuing bank to collect the payment. The bank will deduct its margin and pay the seller. The bank will recover the full amount from the customer (buyer). The margin deducted from the seller’s payment thus becomes a profit for the card issuer.

So long as the customer pays the entire amount on the due date, he does not bear any financing cost. He may choose to pay only the minimum amount specified by the bank. In that case, the balance is like a credit availed of by him. The bank will charge him interest on the credit. Such a mechanism of availing of credit from the credit card is called revolving credit.

It is one of the costliest sources of finance – upwards of 3% p.m. Besides, even for a few days of delay in payment, the bank charges penalties. Similarly, penalties are charged if the credit card outstanding crosses the limit specified by the bank.

Owners of many unorganized businesses (who find it difficult to avail of normal bank credit) end up using the credit card to fund their business in this manner – undesirable, but at times, inevitable.


• Personal Loan – This is a form of unsecured finance given by a bank to its customer based on past relationship. The finance is given for 1 to 3 years. Cheaper than credit card, but costly. It is not uncommon to come across interest rates of 1.5% p.m. plus 2-3% upfront for making the facility available plus 3-5% foreclosure charges for amounts pre-paid on the loan. At times, banks convert the revolving credit in a credit card account to personal loan.

Such a conversion helps the customer reduce his interest cost and repay the money faster. This is however a double edged sword. Once the credit card limit is released, customers tend to spend more on the card and get on to a new revolving credit cycle.

• Vehicle Finance – This is finance which is made available for the specific purpose of buying a car or a two-wheeler or other automobile. The finance is secured through hypothecation (discussed in next Chapter) of the vehicle financed. The interest rate for used cards can go close to the personal loan rates. However, often automobile manufacturers work out special arrangements with the financiers to promote the sale of the automobile. This makes it possible for vehicle-buyers to get attractive financing terms for buying new vehicles.

• Home Finance – This is finance which is made available against the security of real estate. The purpose may be to buy a new house or to repair an existing house or some other purpose. The finance is secured through a mortgage (discussed in next Chapter) of the property. The finance is cheaper than vehicle finance. As with vehicle finance, real estate developers do work out special arrangements with financiers, based on which purchasers of new property can get attractive financing terms.

Non-Fund-based Services

These are services, where there is no outlay of funds by the bank when the commitment is made. At a later stage however, the bank may have to make funds available. Since there is no fund outflow initially, it is not reflected in the balance sheet. However, the bank may have to pay. Therefore, it is reflected as a contingent liability in the Notes to the Balance Sheet. Therefore, such exposures are called Off Balance Sheet Exposures. When the commitment is made, the bank charges a fee to the customer. Therefore, it is also called fee-based business.

For Business

• Letter of Credit - When Party A supplies goods to Party B, the payment terms may provide for a Letter of Credit. In such a case, Party B (buyer, or opener of L/C) will approach his bank (L/C Issuing Bank) to pay the beneficiary (seller) the value of the goods, by a specified date, against presentment of specified documents. The bank will charge the buyer a commission, for opening the L/C.

The L/C thus allows the Part A to supply goods to Party B, without having to worry about Party B’s credit-worthiness. It only needs to trust the bank that has issued the L/C. It is for the L/C issuing bank to assess the credit-worthiness of Party B.


Normally, the L/C opener has a finance facility with the L/C issuing bank. The L/C may be inland (for domestic trade) or cross border (for international trade).

• Guarantee – In business, parties make commitments. How can the beneficiary of the commitment be sure that the party making the commitment (obliger) will live up to the commitment? This comfort is given by a guarantor, whom the beneficiary trusts. Banks issue various guarantees in this manner, and recover a guarantee commissionfrom the obliger. The guarantees can be of different kinds, such as Financial Guarantee, Deferred Payment Guarantee and Performance Guarantee, depending on how they are structured.

• Loan Syndication – This investment banking role is performed by a number of universal banks.


Financial Analysis of Lending

Financial analysis is the systematic examination and interpretation of financial data to evaluate the past performance of a business, its present conditions and its future prospects. It refers to an assessment of the viability, stability and profitability of a business, sub–business or a project.

Essentially, financial analysis moves from a preliminary investigation of the client to an in depth examination of operating performance, an interpreted form historical and projected financial statements.

With financial analysis, the advances manager assesses the company’s financial performance to arrive at a conclusion about the future prospects of the loan repayment.

Financial analysis access the firm’s profitability

1. Profitability: Its ability to earn income and sustain growth in both short term and long term. A company’s degree of profitability is usually based on the income statement, which reports on the company’s result of operations;

2. Solvency: Its ability to pay its obligation to creditors and other third parties in the long term;

3. Liquidity : Its ability to maintain positive cash flow, while satisfying immediate obligations;

4. Stability: The firm’s obligation to remain in business in long run, without having to sustain significant losses in the conduct of its business. Assessing a company’s stability requires the use if income statement and the balance sheet, as well as oter financial and non financial indicators.

Steps involved in financial analysis of lending

Step 1: Company’s financial statement for at leat 3 to 5 years is acquired which includes Balance Sheets, Income statements and shareholders equity statement and cash flow statements.

Step 2: A quick scanning of all statements is done to look for large movements in specific terms form one year to the next. If there is something suspicious, relevant research about the company is done from the information available to find out the reason. Notes accompanying the financial statements are also reviewed for additional information that may be significant to analysis.


Step 3: The stage calls for an exhaustive scrutiny of the balance sheet. While examining the advances manager looks for the large changes in overall components of company’s assets and liabilities of equity.

Step 4: This level to an assessment of income statement as furnished by the client. The advances manager looks for the trends overtime. Raphs and growth of the following entries over the past several years are calculated.RevenueNet incomeFor each component on the income statement, percentage of sales of each year is calculated/ for example percentage of cost of goods over sales, general and administrative expenses over the sales and development over sales are computed. Favourable and unfavourable trends are highlighted.

Step 5: The very phase pertains to an evaluation of the cash flow statement. It gives information about the cash flow from operating, financing and investing activities.

Calculation of financial ratios

By using ratio analysis managers can understand the financial health of comapnaies. Most frequently used ratios are:

Liquidity Ratios Degree of leverage Profitability ratios Efficiency ratios Value ratios

Analysing Liquidity: This can be done by either using following of the two ratios:

Current Ratios= Total current Assets /Total Current Liabilities

Quick Ratios=Total current assets-Inventories/Total current Liabilities

Leverages Ratio: This ratio indicates what proportion of debt a company has relative to its assets. The measure gives an idea to the leverage of the company along with the potential risks the company faces in terms of its debt-load.


Profitability Ratios:

The long-term profitability of a company is vital for both the survivability of the company as well as the benefit received by shareholders. It is these ratios that can give insight into the all important "profit".

In the income statement, there are four levels of profit or profit margins - gross profit, operating profit, pre-tax profit and net profit. The term "margin" can apply to the absolute number for a given profit level and/or the number as a percentage of net sales/revenues. Profit margin analysis uses the percentage calculation to provide a comprehensive measure of a company's profitability on a historical basis (3-5 years) and in comparison to peer companies and industry benchmarks.

Basically, it is the amount of profit (at the gross, operating, pretax or net income level) generated by the company as a percent of the sales generated. The objective of margin analysis is to detect consistency or positive/negative trends in a company's earnings. Positive profit margin analysis translates into positive investment quality. To a large degree, it is the quality, and growth, of a company's earnings that drive its stock price.

Formulas:


http://www.investopedia.com/terms/o/operatingmargin.asp

http://www.investopedia.com/terms/g/gross_profit_margin.asp

http://www.investopedia.com/terms/g/gross_profit_margin.asp

http://www.investopedia.com/terms/i/incomestatement.asp

http://www.investopedia.com/terms/p/profit.asp

Efficiency Ratios: Ratios that are typically used to analyze how well a company uses its assets and liabilities internally. Efficiency Ratios can calculate the turnover of receivables, the repayment of liabilities, the quantity and usage of equity and the general use of inventory and machinery.

Inventory Turnover ratios= Cost of goods sold/ Average Inventory Total Assets Turnover= Sales/Average Total Assets Accounts Receivable Turnover=Annual credit Sales/ Average Receivables Average Collection Period=Average Accounts Receivables/(total sales/365) Days in inventory=days in a year/inventory turnover

Value Ratios:

Value Ratios show the “embedded value”on stocks, and are used by investors as a screening device before making investmensts.

Price to Earnings Ratios(P/E)= Current Market price/After-tax Earnings per share

Dividend Yield= Annual Dividends per share/ Current Market price per share

Debt service coverage ratio:

It is a ratio of cash servicing to interest, principle and lease payments. It is a popular benchmark used in the measurement of an entity’s ability to produce enough cash to cover its debt payments.

Calculation of EMI

EMI are used to pay off both interest and principle each month so that over a specified number of years, the loan is paid off in full.

EMI= (p*r) (1+r)^n

(1+r)^n-1

P= principle(amount of loan)

R=rate of interest per instalment period

N= no. of instalments in the tenure

^ denotes whole to the power


NPA and Securitisation

Non-Performing Assets

In the normal course, borrowers repay their dues to the bank by their respective due dates. Some debts, however, turn sticky. The borrower is unable or unwilling to pay. If such debt is shown as a regular debt, and interest is accrued on such debt as a regular income, thenthe financial statements would give an incorrect picture of the financial status of the bank. Therefore, RBI has laid down strict requirements regarding recognition of Non-Performing Assets (NPA).

An NPA is a loan or advance where:

1. Term Loan – interest and / or instalment of principal remains overdue for more than 90 days.

2. Overdraft / Cash credit - account is out of order i.e.

Outstanding balance remains continuously in excess of the sanctioned limit / drawing power; or Outstanding balance is within the sanctioned limit / drawing power, but there are no credits continuously for 90 days as on the date of balance sheet, or the credits are not enough to cover the interest debited during the same period.

Bills purchased and discounted – bill remains overdue for more than 90 days.

• Short duration crops (crop season is upto a year) – instalment of principal or the interest thereon remains overdue for two crop seasons.

• Long duration crops - instalment of principal or the interest thereon remains overdue for one crop season.

A few more relevant points –

• Banks are supposed to classify an account as NPA only if the interest charged during any quarter is not serviced fully within 90 days from the end of the quarter.

• If an advance is covered by term deposits, National Savings Certificates eligible for surrender, Indira Vikas Patras, Kisan Vikas Patras and Life policies, then it need not be treated as NPA. This exemption however does not extend to government securities and gold ornaments.


• Drawing power should be determined based on stocks statements that are not older than 3 months. Else, it would be treated as irregular.

• If irregular drawings are permitted in the working capital account for a continuous period of ninety days, it will become an NPA (even if the financial status of the borrower is stable).

• Regular and ad hoc credit limits are to be reviewed / regularized within 3 months from the due date / date of ad hoc sanction. If this is not done within 180 days of the due date / date of ad hoc sanction, the asset would be treated as NPA.

• Once arrears of interest and principal are paid by the borrower, the NPA becomes a standard asset.

• If even one facility to a borrower or investment in securities issued by a borrower becomes NPA, all the facilities granted by the bank to the borrower and investment in all the securities issued by the borrower will have to be treated as NPA.

NPA Categories:

I. Sub-Standard Assets

An asset that has remained NPA for upto 12 months.

II. Doubtful Assets

An asset that has remained sub-standard for upto 12 months.

III. Loss Assets

An asset that the bank or its auditors or the RBI has identified as a loss, but the amount has not been written off entirely. In exceptional cases, such as fraud by the borrower, the above mentioned stages of NPA can be skipped. The asset can directly be treated as a doubtful asset or loss asset. If the realizable value of the security is less than 50% of the value assessed by the bank or accepted by RBI at the time of last inspection, then the asset will be treated as doubtful.

If the realizable value of the security, as assessed by the bank or valuers or RBI is less than 10% of the amount outstanding, then the existence of the security is to be ignored. The NPA asset will be immediately treated as a loss asset. Where a sub-standard asset is re-structured, then it would be treated as standard asset only 1 year after the first payment (interest or principal) is due. This too is subject to satisfactory performance during the one-year period.

NPA Provisioning Norms

Loss Assets


Loss assets should be entirely written off. If this is not done, provisioning should be made for 100% of the amount shown as outstanding.

Doubtful AssetsRealisable value of the security, if any should be estimated. The excess of the outstanding over the security value should be entirely provided for provisioning requirement for the secured portion is as follows:

• 20%, if the advance has been doubtful for up to 1 year

• 30%, if the advance has been doubtful for 1 to 3 years

• 100%, if the advance has been doubtful for more than 3 years.

Sub-standard Assets

Provision of 10% of the total outstanding should be made, without any allowance for security available or ECGC guarantee available. Unsecured exposures i.e. where the security value is less than 10% of the outstanding exposure need to be provided for to the extent of a further 10% (i.e. total 20%).

Standard Assets

Provision is required, even for such assets, as follows:

• Direct advances to agricultural and SME sectors – 0.25%

• Personal loans, loans in the nature of capital market exposures, residential housing loans beyond Rs20lakhs and commercial real estate loans – 1%

• Other advances – 0.40%

SARFAESI ACT

Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest, 2002 (SARFAESI Act, 2002) was enacted to provide banks and financial institutions with a more effective framework to enforce the security structure underlying loans and advances given by them, and recover their dues expeditiously. As is evident from the name, it addresses the regulation of three distinct areas:

• Securitisation

• Reconstruction of Financial Assets

• Enforcement of Security Interest


Banks and Financial Institutions can benefit from SARFAESI. The term ‘bank’ includes all banking companies, including co-operative banks. However, regional rural banks have been kept out.

‘Financial institution’ means:

• A public financial institution within the meaning of the Companies Act, 1956• Any institution specified by the Central Government under the Recovery of Debts due to Bank and Financial Institutions Act, 1993

• The International Finance Corporation, established under the International Finance Corporation (Status, Immunitis and Privileges) Act, 1958

• Any other institution or non-banking financial company as defined in the Reserve Bank of India Act, 1934, which the Central Government may specify as a financial institution for the purposes of the Act. The bank or financial institution which has lent money to a borrower is also called originator in the context of securitization. The person who has an obligation to the bank or financial institution is an obligor. Under the Act, obligor includes a borrower and means a person liable:

• To pay to the originator, whether under a contract or otherwise; or

• To discharge any obligation in respect of a financial asset, whether existing, future, conditional or contingent. What does ‘financial asset’ mean? Under the Act, financial asset means debt or receivables, and includes:

• A claim to any debt or receivables, or part thereof, whether secured or not; or

• Any debt or receivable secured by mortgage of or charge in immoveable property; or

• A mortgage charge, hypothecation or pledge of moveable property; or

• Any right or interest in the security, whether full or part, securing debt; or

• Any beneficial interest in any moveable or immoveable property or indebt, receivables, whether such an interest is existing, future, accruing, conditional or contingent; or

• Any financial assistance.

‘Property’ means:

• Immoveable property

• Moveable property

• Any debt or any right to receive payment of money, whether secured or unsecured


• Receivables, whether existing or future

• Intangible assets such as know-how, copyrights, trademarks, license, franchise or any other business or commercial right of a similar nature. The Act uses the term ‘asset re-construction’ for the acquisition of any right or interest, of any bank or financial institution, in any financial assistance, by any securitization company or re-construction company, for the purpose of realization of such financial assistance. An entity holding more than 10% of the equity capital of a securitization company or reconstruction company is its sponsor. RBI is the regulator for securitization companies and re-construction companies, which are companies created for the purpose, under the Companies Act, 1956. Such companies need to be registered with RBI. At the time of registration, they need to have net owned funds of at least Rs2crore. RBI can set a higher requirement, up to 15% of the total financial assets acquired or to be acquired. The capital adequacy requirement is Rs100crore or 15% of the total assets acquired whichever is less.

A point to note is that a company that is not registered with RBI too can handle the securitization and re-construction business. However, such an unregistered company cannot benefit from the provisions of SARFAESI.

Securitisation

This is a process where financial assets (say, dues from a borrower) are converted into marketable securities (security receipts) that can be sold to investors. In the first stage of a securitization transaction, an originator sells the financial asset to the securitization company. This can be done as follows:

• The securitization company / asset re-construction company issues a debenture or bond or any other security in the nature of a debenture, for the agreed consideration, and as per the agreed terms and conditions, to the originator; or• Entering into an agreement for transfer of the financial asset as per the agreed terms and conditions.

On acquisition of the financial asset, the securitization or reconstruction company becomes the owner of the financial asset. In rights, it steps into the shoes of the lending bank or financial institution. It is to be noted that only the assets get transferred – any related liability remains with the bank or financial institution (originator). However, any pending suit, appeal or proceeding against the originator can be continued against the Securitization Company or asset Reconstruction Company.

In the second stage, against the security of the financial asset, the securitization company can mobilise money by issuing security receipts to QIB investors. Thus, securitization makes it possible to transfer loans secured by mortgage or other charges.

The term ‘security receipt’ is defined as a receipt or any other security issued by a securitization company or reconstruction company to any qualified institutional buyer (QIB) pursuant to a scheme, evidencing the purchase or acquisition by the


holder thereof of an undivided right, title or interest in the financial asset underlying the securitization.

Qualified institutional buyer (QIB) means a financial institution or an insurance company or a bank or a state financial corporation or a state industrial development corporation or trustee or any asset management company making an investment on behalf of a mutual fund or provident fund or gratuity fund or pension fund or SEBI-registered foreign institutional investor (FII) or any other body corporate specified by SEBI.

Any other company will have to register itself with SEBI, if it wants to be treated as QIB. The securitization company can create separate trusts for each scheme, and act as trustee for the schemes. It is not compulsory to give notice of the transfer to the obligor; or to register the charge with the Registrar of Companies, if the obliger is a company.

• In the absence of notice, payments by the obligor to the bank or financial institution shall be treated as a valid discharge of obligation. The bank or financial institution shall receive the proceeds, in trust, for the benefit of the Securitization Company / asset Reconstruction Company.

• If notice is given to the obligor, then the obliger will have to make payments to the securitization company / asset Re-construction Company. Further, if the obliger is a company, then the charge is to be registered with the Registrar of Companies.

Asset Re-construction

Here, the right or interest of any bank or financial institution in any financial asset is acquired by the asset re-construction company for the purpose of realization of dues.

Asset re-construction might entail taking several measures such as:

• Takeover the management of the business of the borrower or bring about any such change. On realization of the secured debt in full, the management of the business is to be restored back to the borrower.

• To sell or lease a part or whole of the business of the borrower.

• Reschedule debts of the borrower.

• Take possession of secured asset

• Enforce security interest

• Settle dues payable by the borrower


The grounds on which these actions may be taken would be as per the loan agreement between the borrower and the lender. Default is not a necessary pre-condition.

Although the Act does not provide for notice to the borrower before these measures are taken, court rulings in similar cases indicate that it is better that the notice be given.

Within 12 months of acquiring a NPA, the securitization company or the re-construction company has to formulate a plan for its realization. During this period, it can classify the asset as a standard asset.

SARFAESI does not cover pledge and enforcement of pledge. Therefore, if the loan is backed by pledge of owner’s stake in the company, then the enforcement of power to sell the owner’s stake in case of default, would be as per the loan agreement, SEBI requirements (if it is a listed entity) and the Indian Contract Act – not as provided for in SARFAESI.

Enforcement of Security Interest

In the normal course, court intervention is required for sale of property and realization of money due from a defaulter. This is equally applicable to mortgage of immoveable property, as well as charge created on moveable property. Only realization of money from pledged security is outside the requirement of court intervention. SARFAESI gives another window for banks and financial institutions to enforce their security interest without the intervention of Civil Court or the Debt Recovery Tribunal (DRT). If the lender also holds security through a pledge of any moveable assets, or the guarantee of any person, then it can sell the pledged goods or proceed against the guarantor without initiating any action against the secured assets.

Under SARFAESI, the bank or financial institution needs to give 60-day notice to the defaulter, giving details of the amount payable and the secured asset intended to be enforced by the secured creditor, in the event of non-payment of the secured debt. The effect of this notice is that the borrower is barred from transferring the property mentioned in the notice. If the borrower responds to the notice, then the secured creditor needs to consider the representation or objections fairly. If these are not acceptable, then the reasons for non acceptance need to be conveyed to the borrower within 7 days. Such non-acceptance howeverdoes not confer a right on the borrower to approach the DRT or any Civil Court. If the dues are not paid during the notice period, then the secured creditor gets the following rights:

• Take possession of the secured assets, and transfer it by lease, assignment or sale for realization of money.

• Appoint a manager to manage the secured assets that have been re-possessed.

• Takeover management of the secured assets, and transfer it by lease, assignment or sale for realization of money.


• Give notice to any person who has acquired the secured asset from the borrower, and from whom any money is due or may become due to the borrower, to pay the moneys to the secured creditor. Such payment to the secured creditor will be a valid discharge of the person’s dues to the borrower. When the secured creditor transfers the secured asset under SARFAESI, the transferee gets all the rights in, or in relation to the asset, as if the owner of the asset executed the transfer.

In order to take possession or control of the secured asset, or sell or otherwise transfer it, the secured creditor can make a request in writing to the Chief Metropolitan Magistrate or the District Magistrate. On receiving such a request, the judicial authority is bound to take the requisite steps. Amounts realized from the secured asset are to be applied in the following sequence:

• Costs, charges and expenses incidental towards preservation and protection of securities, insurance premium etc. that are recoverable from the borrower.

• Dues of the secured creditor

• Any surplus will be paid to the person entitled to it in accordance with the rights and interests.

Thus, dues to the secured creditor have precedence over the preferential payments to the government or labour or other creditors.

At any time before the date fixed for sale or transfer, the borrower can pay the entire dues, costs, charges and expenses incurred by the creditor. In that case, the secured creditor will not sell or transfer the asset. Only in the event the borrower company is being wound up, dues to workmen will rank pari passu with secured creditors, as provided in the Companies Act, 1956.

If the financing facility is offered by a consortium of lenders, then no secured creditor can take possession of the secured asset unless agreed upon by the creditors representing not less than three-fourths in value of the outstanding dues (principal, interest and other dues).

If at least three-fourths by value agree to the action, then it is binding on the rest of the creditors. If the sale of secured assets does not fully cover the dues, then for the balance, the bank or financial institution can approach the DRT or Civil Court.

The rights under SARFAESI need to be executed a person of appropriate seniority. The authorized person should be of the level equivalent to a Chief Manager of a public sector bank or equivalent or any other person exercising the powers of superintendence, direction and control of the business or affairs of the creditors.

Central Registry


SARFAESI also provides for a Central Registry to register transactions that are in the nature of securitization and reconstruction of financial assets or creation of security interest under the Act.

The securitization company or reconstruction company or secured creditor is required to file the details with the central registrar within 30 days of the transaction or the creation of security. A further time period of 30 days is available for the registration, provided penalty is paid.Registration under this Act is in addition to registration requirements under other acts, like the Companies Act, 1956, Registration Act, 1908 and Motor Vehicles Act, 1988.When payment is made in full, details of the satisfaction of charge are to be filed by the securitization company or the reconstruction company or the secured creditor within 30 days. If, otherwise, the central registrar receives notice of satisfaction of charge, then it has to issuea notice to the securitization company or the reconstruction company or the secured creditor, to respond within 15 days on why the satisfaction of charge should not be recorded in the central registry. If no response is received, then the satisfaction of charge will be recorded in the registry. If a response is received, the borrower will be informed about it.

Resolution of Disputes

Disputes between the securitization or re-construction company and the bank or financial institution or QIB relating to securitization or re-construction or non-payment of any dues or interest, have to be settled by conciliation or arbitration under the Arbitration and Conciliation Act, 1996. The obliger / borrower is however not covered by this requirement.


Security Creation

Financing provided by a bank may be backed by some asset as security (also called collateral).Loans that are backed by such security are called secured loans. The benefit of security is that if the borrower does not re-pay, the bank can sell the asset to recover the dues. If the asset sale does not cover the entire dues, then the bank can still recover the balance from the borrower; any excess recovered on the sale of asset belongs to the borrower. Loans that are not backed by the security of an asset are called unsecured loans. Different kinds of assets are offered as security – land and buildings, plant and machinery, inventory, receivables, shares, debentures, fixed deposit receipts, insurance policies, licenses, brands etc. The banker working on a security structure needs to keep the following in mind:

• The borrower should have clear title to the asset being offered as security. If the asset belongs to someone who is not the borrower (for example, entrepreneur’s house being mortgaged for loan to the entrepreneur’s business), there has to be clear documentation regarding the same. Even otherwise, documentation is key.

• The security has to be readily encashable. This, for instance, becomes the problem when a telecom license is offered as security. Realising the license to recover moneys gets quite complicated because of the government permissions required.

• Encashment of the asset should not impose significant additional costs on the bank.

• The security has to adequately cover the financing provided. Bankers typically ask fora higher security value than the financing provided. The difference is the margin totake care of potential decline in value of the asset or expenses involved in realizing the security. Where the value of the asset is subject to fluctuations (for example, in the case of shares) a higher margin is insisted on. In market parlance, the margin is also called hair-cut. Greater the uncertainty, higher the hair-cut.

• With most intangible assets (like brands), the valuation of the asset is highly subjective. Extra precaution has to be taken in such cases. The rights of the banker also depend on how the security is created. The following are thetypical forms of security creation:

Pledge

As per the Contract Act, 1872, pledge means bailment of goods for the purpose of


providing security for payment of a debt or performance of a promise. Bailment is nothing but delivery of goods to the financier. The person offering the goods assecurity is the bailer, pawner or pledger. The person to whom the goods are given is the bailee, pawnee or pledgee.At times, the delivery of goods may not be actual, but constructive. For instance, goods in a warehouse may be pledged by handing over the warehouse receipt. This constructively implies delivery of goods of the pledgee. There is no legal necessity for a pledge agreement; pledge can be implied. However, it is always preferable for the banker to insist on a pledge agreement. The pledger is bound to inform the pledgee about any defects in the goods pledged, or any risks that go with possession of the goods. He is also bound to bear any incidental expenses that arise on account of such possession. Pledge becomes onerous for the pledger, because he has to part with possession. For the same reason, the pledgee is generally comfortable with a pledge arrangement. He does not need to take any extra effort or incur any cost for realizing the security. He is however bound to take reasonable care of the goods. The pledgee has a general lien on the goods i.e. he is not bound to release the goods unless his dues are fully repaid.

A point to note is that the banker’s lien is limited to the recovery of the debt for which the pledge is created – not to other amounts that maybe due from the borrower. This is the reason that banks often provide a protective clause in their pledge agreement that the pledge extends to all dues from the borrower. In the event of default by the borrower, the pledgee can sell the assets to recover his dues. The dues may be towards the original principal lent, or interest thereon or expenses incurred in maintaining the goods during the pledge.

Hypothecation

Hypothecation is defined under the SARFAESI Act, 2002, as follows:

Hypothecation means a charge in or upon any movable property, existing or future, created by a borrower in favour of a secured creditor, without delivery of possession of the moveable property to such creditor, as a security for financial assistance, and includes floating charge and crystallization of such charge into fixed charge on moveable property. As with pledge, hypothecation is again adopted for movable goods. But, unlike pledge, the possession of the asset is not given to the bank. Thus, the borrower continues to use the asset, in the normal course.

A good example is vehicle financing, where the borrower uses the vehicle, but it is hypothecated to the bank. The bank protects itself by registering the hypothecation in the records of the Regional Transport Officer (RTO). Therefore, ownership cannot be changed without a NOC from the bank. Further, to prevent any unauthorized transfers, the bank takes possession of the vehicle (re-possession) in the event of default by the borrower. In the business context, it is normal to obtain working capital facilities against hypothecation of stocks and debtors. Since these are inherent to the business, the stocks and debtors keep changing form (some debtors clear their dues; new debtors are created based on credit sales by the borrower) and value.


The bank only insists on a minimum asset cover. If the hypothecated assets are worth Rs. 40lakhss and the outstanding to the bank is Rs. 25 lakhs, the asset cover is Rs. 40 lakhs ÷ Rs. 25 lakhs i.e. 1.6 times. Since the form and value of the assets charged keep changing (the outstanding amount also keeps changing), this kind of a charge is therefore referred to as floating charge. In the event of default by the borrower, the bank will seek possession of the assets charged. That is when it becomes a fixed charge viz. the assets charged as well as the borrower’s dues against those assets get crystallised. Since possession is with the borrower, there is a risk that non-recoverable debts are included in debtors, or non-moving or obsolete goods are included in inventory. Further, an unethical borrower, despite all provisions in the hypothecation deed, may hypothecate the same stock to multiple lenders. Therefore, banks go for hypothecation in the case of reputed borrowers, with whom they have comfort. Companies have a requirement of registering the charge with the Registrar of Companies (ROC).

Under the Companies Act, if the charge is not registered with ROC within 30 days, (or a further period of 30 days on payment of fine), then such charge cannot be invoked in the event of liquidation of the company. This is a protection against multiple charges created on the same property, in case a company is a borrower. This is also a reason, why banks pursue borrowers until they register the charge with the ROC.

At times, when the asset cover is high, banks may permit other bankers to have a charge on the same property. Such a charge in favour of multiple lenders, all having the same priority of repayment in the event of default, is called pari passu charge. Not all banks are comfortable with pari passu charge. There are situations, where the first lender insists on priority in repayment. Subject to such priority, it may not object to thecreation of an additional charge in favour of a second lender. The first lender is said to have a first charge on the property; the second lender has second charge. Similarly, third charge, fourth charge etc are possible, but not common. Let us consider a situation where in the event of default by a borrower, the following charges get fixed:

Value of assets charged Rs. 50 lakhsDues to first charge-holder Rs. 40 lakhsDues to second charge-holder Rs. 35 lakhs

In such a situation, the first charge-holder will be fully paid. After that only Rs. 50 lakhs less Rs. 40 lakhs i.e. Rs. 10 lakhs worth of charged asset is left. This will be paid to the second charge-holder.

The second charge holder now has due of Rs. 35 lakhs less Rs. 10 lakhs i.e. Rs. 25 lakhs. He can still recover the money from the borrower, but he will rank with other unsecured creditors for the payment. If other unsecured creditors are Rs. 5 lakhs, and other assets of the borrower are Rs. 15 lakhs, then the following is the borrower’s position:

Assets Rs. 15 lakhsDues to second charge-holder Rs. 25 lakhs


Other unsecured creditors Rs. 5 lakhsTotal dues Rs. 30 lakhs

The second charge-holder will receive 50% of Rs. 25 lakhs i.e. Rs. 12.5 lakhs. Other unsecured creditors will receive 50% of Rs. 5 lakhs i.e. Rs. 2.5 lakhs. Since the company has no further assets left, the lenders will have to write-off their remaining dues as bad debts. The following will be the bad debts position of the two lenders:

Second charge-holder

Total dues of Rs. 35.0 lakhsLess Recovered from charged asset Rs. 10.0 lakhsLess Recovered from other assets Rs. 12.5 lakhsBad Debts Rs. 12.5 lakhs

Other unsecured creditorsTotal dues of Rs. 5.0 lakhsLess Recovered from other assets Rs. 2.5 lakhsBad Debts Rs. 2.5 lakhs

If however, the first two lenders had pari passu charge, the position would be as follows:

Value of assets charged Rs. 50 lakhsDues to pari passu charge-holders Rs. 75 lakhs(Rs. 40 lakhs plus Rs. 35 lakhs)

Therefore, the first two lenders will receive (Rs. 50 lakhs ÷ Rs. 75 lakhs i.e.) 2/3rd of their dues viz.

Lender 1 2/3 of Rs. 40 lakhs i.e.Rs. 26,66,667

Lender 2 2/3 of Rs. 35 lakhs i.e. Rs. 23,33,333

With this, the asset charged is fully used up. For the balance amount, the 2 lenders will be like unsecured creditors:

Lender 1 1/3 of Rs. 40 lakhs i.e. Rs.13,33,333Lender 2 1/3 of Rs.35 lakhs i.e. Rs.11,66,667

Unsecured creditors Rs. 5,00,000Total Rs. 30,00,000

Since assets available is only Rs. 15 lakhs, every lender will receive only 50% of their dues.

Lender 1 will receive Rs. 6,66,667Lender 2 will receive Rs. 5,83,333


Unsecured creditors will receive Rs. 2,50,000

Thus, all of them will have bad debts as follows:

Lender 1 Rs. 6,66,667Lender 2 Rs. 5,83,333Unsecured creditors Rs. 2,50,000

Lender 1 ends up with bad debts in the pari passu charge situation, which he could have avoided with a first charge. That is the reason banks tend to insist on first charge. The unsecured creditors’ bad debts are the same, irrespective of whether any of the secured creditors have first charge or pari passu charge.

Mortgage

The term mortgage is defined in the Transfer of Property Act, 1882 as follows:A mortgage is the transfer of interest in specific immoveable property for the purpose of securing the payment of money advanced or to be advanced by way of loan, on existing or future debt or the performance of an engagement which may give rise to a pecuniary liability. The person transferring the property is the mortgager; the transferee is the mortgagee. The mortgage is generally created through a mortgage deed. However, there are exceptions as will clear from the following discussion on different kinds of mortgages. These kinds of mortgages are again defined in the Transfer of Property Act, 1882.

Simple Mortgage

The mortgage is simple because possession of the mortgaged property is not handed over to the mortgagee. However, the mortgager accepts personal liability to pay the mortgage money (principal plus interest). If the mortgager does not pay the dues, the mortgagee has the right to approach court for a decree to sell the mortgage property. This right of the mortgagee may be expressed in themortgage deed or implied. As is logical, the mortgagee does not have the right to receive rent or any other proceeds from the property. These would belong to the mortgager. Registration is mandatory if the principal amount secured is Rs100 or above.

Mortgage through Conditional Sale

Here, the mortgager “sells” the mortgage property, but subject to conditions:

• The sale becomes absolute only if the mortgager defaults on paying the dues by aspecified date; or

• The sale becomes void if the mortgager pays the dues by the specified dates. In that case, the mortgagee will transfer the property back to the mortgager.

A legal technicality is that the mortgagee cannot sue to sell the property, but he can sue to forclose the mortgage deed. Once court grants the foreclosure, the


mortgager loses the right to claim the property. Thereafter, the mortgagee can sell the property to recover his dues. In a standard form of such a mortgage, there is no personal liability on the mortgager to pay the dues [he only (presumably) has an interest in paying it, so that he will get the property back]. If he does not pay, and the asset sale does not fully cover the mortgagee’s dues, he cannot claim the balance from the mortgager. Therefore, bankers typically are not comfortablewith such a mortgage.

Usufructuary Mortgage

This is a mortgage where the mortgagee has the right to recover rent and other incomes from the mortgaged property, until the dues are cleared. Thus, repayments come from the property rather than from the mortgager.The transfer of possession from the mortgager to the mortgagee may be express or implied. Thus, legal possession is more important than physical possession. For example, physical possession may be with a tenant who pays the rent. As with Conditional Sale, there is no personal obligation on the mortgager to pay. The banker has to keep holding the property for an indeterminate period of time, until the dues are cleared. Therefore, bankers are not comfortable with such mortgages.

English Mortgage

In this form of mortgage, the mortgager transfers the property to the mortgagee absolutely. However, the mortgagee will have to re-transfer the mortgaged property to the mortgager, if the dues are paid off. Since the mortgager assumes personal liability to repay, the mortgagee can sue the mortgager for recovery of dues or seek a court decree to sell the property. This gives comfort to the banker.

Equitable Mortgage / Mortgage by Deposit of Title Deeds

As is clear from the name, the mortgager merely deposits the title deeds to immoveable property with the mortgagee, with the intention of creating a security.Such mortgages can only be created in Mumbai, Chennai or Kolkatta. The mortgaged property may be located anywhere, but the mortgage creation has to be in any of these three cities. Benefit of this kind of mortgage is that stamp duty is saved. Further, it is less time consuming to create. The risk is that a fraudulent mortgager may obtain multiple title deeds, and create multiple mortgages, thus adding to the complexity of the banker when it comes to recovering money.

Anomalous Mortgage

A mortgage which does not fall strictly into any of the above mortgages is an anomalous mortgage. For instance, in a usufructuary mortgage, the mortgager may take personal obligation to pay the dues.

The mortgage creation format is one of the key conditions in the sanction letter of the lender / term sheet that the lender and borrower sign to freeze the terms of their arrangement.


Assignment

The Banker may provide finance against the security of an actionable claim. Under the Transfer of Property Act, an actionable claim is a claim to any debt other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property. Since security depends on the quality of the debt, bankers are comfortable if the dues to the borrower are from the Government. With such a structure, the bank can earn a return that is higher than what is normal for taking a sovereign risk. In housing loans, where repayment depends on the earning cycle of the borrower, financiers tend to ask for assignment of life insurance policy that covers the life of the borrower. This can be done by mentioning the same in the reverse of the insurance policy document, along with signature of the assigner. Alternatively, a separate deed of assignment can be signed. Either way, the insurance company needs to be informed about the assignme


CASE ANALYSIS

Mohan InfoTech: a case on credit appraisal

Borrower/ comapny profile

The borrower is banking exclusively with IOB since September 2006. He is successfully running an NIIT computer training centre at Kanpur for which he is having a cash credit in account IOB with a limit of Rs. 1 lakh. Credit rating of the borrower is ‘A’ as in December 2008 and the worth of proprietor is Rs. 33.77 lakh. He has also taken a term loan of Rs. 12 lakh from the bank out of which Rs. 9.89 is still outstanding. There are no irregularities in cash credit and the loan account till date.

Comments on operation (Full last year and current year up-to-date)

A) F209 period to Max (lakh) Min Turnover Income earned

1) Fund Based

01.4.12-31.3.13 1.97 00.36 14.57 .15

03.46 1.18 22.21 .14

2) Non fund based -------------------- ----------- ------------- ----------------

3) Obtention of stocks RegularAnd book debts Statements and quarterlyAuditors certificate on latest dates

B) Details of Ad-Hoc/ The excess granted under Br discretion and were Excess granted with period regularized within the commitment period and its adjustments within the expiry time etc

Present Request/Proposal

The borrower is into business since 1992, and his existing branch of NIIT is working successfully. NIIT has offered him opening n new unit at Kanpur and he


has paid more that Rs. 10 lakh as advance for starting the same. The present proposal of the borrower is as follows:

Present request/proposalLIMIT RS. IN LACS

NATURE OF FECILITY

EXISTING PROPOSED INCREASE

TERM LOAN LIMIT 12.00DP 09.89

19.69 7.80

CASH CREDIT AGAINST STOCKS/BOOK DEBTS

1 5 4

BILLS/OTHERS ------------------- ----------------- -------------------NON FUND BASED ------------------- ------------------- -------------------

Collaterals/Gurantors

Collateral Rs. In LacsNature Face Value Preasent Value Owned ByDeposits 1.5 1.73 ---NSCs/KVPs ---- ---- ---LIC Policy 5 ---- ---Others 09.85 9.85 ---Totals 16.35 11.58 ---Details of Land and Building/Flat

Land Area/ Extended in Acre/Sq.ft

Constructed Area

Covered Area

Forced sale Value

Owned by (Relationship between partner/director)

Deatails of Collateral Security (Land & Building)

(Should contain details of ownership , nature of property, location, extent of land and building, preliminary valuation report/Desk-top valuation/ whether Agricultural/Housing)

Forced Sale Value Rs. 9.85

Financial Analysis

PARTICULARS 1 2 3 431.03.10

31.03.11

31.03.12

31.0313

Tangible Net Worth 7.01 7.57 11.87 16.77Debt Equity Ratio 2.83 2.70 01.39 01.78


Current Ratio 1.55 1.59 01.42 01.56Net Working Capital .56 1.63 02.69 04.83TOL/TNW 2.83 2.70 01.39 1.78Sales(net Sales) .26 21.00 30.00 40.00Gross fixedAssets 10.79 09.06 7.33 06.23NAPAT 0.03 02.34 04.50 07.40Net Cash Generation (net of dividend/drawings)

----- 04.07 06.23 08.50

NPAT/Sales 11.54 11.14 15.00 18.50PBIT/Sales 11.54 11.14 22.40 27.63Stocks 0.00 2.40 2.40 03.00Sundry Debtors --- ---- 3.70 05.00Sundry Creditors --- ---- ---- ---Unsecured Loan(To be pegged) (From Directors/Partners/friends/Relatives/Associate

--- ---- ---- ----

Comments on estimates:Net worth of the borrower is Rs. 33.77 lakhs.Guarantor in this case is the proprietor’s wife. Details of the collateral security are as follows:

Comments in brief:

a) Estimated/ projected sales turnover

b) 25% of projected/estimated sales turnover:

c) Minimum margin at 5% of projected/estimated sales:

d) Available margin(as per last balance Sheet):

e) PBF((B)-(C) OR (B)-(D) whichever is less:

40

10

2

37

PBF(as per Nayak/Vaz Commitee/Turnover Method)

7.00 Lacs, Proposed and sanctioned Rs. 5.00 Lacs

Comments on Margin/adequacy NWC for 2011-12 is 1.63 and for 12-13 is 2.69, we consider 3.00 for arriving MPBF

Structure of limits proposed Fecility LIMIT MARGIN1) Cash Credit 5.00 25%2) Term Loan 7.80 25%Comment on the adequacy of Drawing power Availibility Based on the balance

Present stocks and Book debts


NET WORKING CAPITAL ASSESSMENTSales current year(2012-2013)

Estimated sales Current year

Projected sales

Accepted Sales Turnover

sheet value are sufficient to cover DP

TERM LOAN ASSESSMENTCapital Asset to be Purchased/ created New NIIT centre to be opened at

Kanpur with rental flat, along with all furniture, fixture, machinery and stationeries.

Margin proposed :(as per norms- minimum of 50% for land 40% for Building 25% for Machinery / equipment )

05.80

Availble from internal generation/fresh/infusion of addl. Capiatl/USL(TO BE PEGGED)

15.40

Need for capital assets/machinery/building construction(Justification to be commented)

07.80

Availibility of adequate space/power/manpower(All other requisite infrastructure fecilities)

Yes

Caculation of DSCR (values in Rs. Lacs)Particulars 1 2 3 4 5 6

31.3.08

31.3.09

31.3.10

31.3.11

31.3.12

31.3.13

PAT 2.34 4.50 7.40 9.01 7.78 10.24Depreciation 3.04 1.73 1.01 0.80 0.64 0.54Interest on term loan Existing

1.63 1.60 1.56 1.51 0 0

Proposed 1.05 1.00 0.95 0.91 0.86 0.80A) Funds Available 8.09 8083 11.01 12.23 11.28 11.58

RepaymentTerm loan Installment 3.62 3.62 3.62 3.62 ----- ----Proposed 2.14 2.14 2.14 2.14 2.14 2.14Interest on term loan existing

NA NA NA NA NA NA

Proposed NA NA NA NA NA NAB) TotalObligation 5.76 5.76 5.76 5.76 2.14 2.14

DCR (A/B) (RANGE 1.50 TO 2.00 IS ACCEPTABLE AS BANK NORMS

1.40 1.53 1.91 2.12 5.27 5.41

Comments:


(Whether the machinery/equipments to be purchased is new or second hand (Higher margin to be stipulated), Obtention of authenticated invoices/quotations/comparative price list on similar brands and satisfactory credit reports on the suppliers to be ensured)

The debt service coverage ratio, is the ratio of cash available for debt servicing to interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity’s (person or corporation)ability to produce enough cash t cover its debt (including lease) payments. The higher this ratio is, the easier is to obtain a loan. The phrase is alos used in commercial banking and may be expressed as a minimum ratio that is acceptable to a lender; it may be a loan condition or covenant. Breaching a DSCR covenant can, in some circumstances, be an act of default.

The DSCR up to 2011 s considerable as it rounds about the level 2.00. From 2012, since the existing term loan will be closed their total obligations will be reduced suddenly and accordingly the DSCR level will also be enhanced. However the bank will be revising the DSCR with every year estimates and projections to compare with the actual achievements.


Pratibha Constructions

CASE ON CASH CREDIT

Borrower’s information

Mr. Ghanshyam Pandey initially owned a utility store. He was banking with IOB since inception. The customer ventured into construction business in 2003. He became a proprietor of a new business enterprise named pratibha constructionsbusiness in 2003. He became a proprietor of new business named Pratibha Constructions.

Mr. Ghanshyam, being the qwner of one third of a property valued at Rs. 203.73 lacs. came up with the proposal of a constructing company.

Details of proposal

The proprietor required financial assistance of Rs. 32 lacs to develop property owned by him. After due the bank sanctioned a cash credit of Rs. 15,00,000 at an interest of 15% FOR THE BUILDING AND CONSTRUCTION PURPOSE IN September 2004.

The land that was proposed to be developed was mortgaged as security with the bank. Details of the property were furnished by the owner. The loan request was sanctioned, keeping 80% as margin and the proprietor with his construction work.

Later in april,2005 client requested for a further sanction of two loans, one of Rs. 2,50,000 and the other of Rs. 5,00,000. The two term loans were required for lift construction and for flooring, sanitary and sewage pipes respectively. He also requested for enhancement of cash credit from Rs. 15,00,000 to Rs. 30,00,000 for carrying on the remaining construction work. The client promised to pay back the term loan by September,2004 and the cash credit limit availed by December 2004. The payment was supposed to be made out of sale proceeds of the flats that were being constructed.

PROPOSED PROJECT/PROJECT PROFILENumber of residential flats 10Number of Business Shops 8Number of Garage 4Total investment Rs.6150000Already Invested Rs. 2940000Loan required Rs. 3210000


Bank Finance And Repayment Schedule

After an in depth analysis bank decided to grant him a cash credit limit of Rs. 15 . Lacs. in October 2004. Land nd building of the borrower was charged as security. The property was valued at Rs. 203.73 lacs where 80% was kept as margin.

In april 2004, as per the request of the client bank sanctioned the following:

Enhancement of credit limit from Rs. 15,00,000 to Rs. 25,00,000 Approval of a term loan of Rs. 2,50,000for construction of lift(costing Rs.

3,90,000) Another term loan of Rs. 5,00,000 for flooring, sewage, sanitary etc

(costing Rs. 15 lacs).

All loans and limits were sanctioned at an interest rate of BPLR +3.5%. THE REPAYMENT SCHEDULE OF THE LOAN AS FOLLOWS:

Twelve EMIs of Rs. 41667 against the term loan of Rs. 5 lacs. Miscellaneous cash credit limits to be adjusted in full latest within 12

months.

The entire term loans hould have been repaid in full, the bank in may 2006 observed that the account had turned irregular. The total outstanding amount as on May 2006 was as follows:

Rs. 2313533 against cash credit account including the interest Rs. 132665 against term loan of Rs. 2.5 lacs Rs. 219137 against loan of Rs. 5 lacs.

Follow up by the bank

As soon as the account was classified as irregular, bank sent a notice to the borrower stating that the period of repayment has lapsed and the condition stipulated by theregional office had not been met. No response was received from either for further extension of credit limit or request for renewal of the same.

Request from borrower for extension of repayment period was received in July 2006 along with the reason of non compliance with the terms. He agreed to repay the entire amount with interest by December 2006. The same was forwarded by the branch to the regional office with the recommendation to the time frame to frame 2007 by which he shall be able to clear the entire amount and new the limit. The request was considered and sanctioned by the regional office.

Despite of extension of repayment period, the borrower was still to regularize his account till March 2006, the account was always on the of slipping into NPA but each time borrower either credited a part the amount due or renewed the account


by submission of relevamt financial documents. The following steps were taken by the client save his account from bein NPA:

A payment of Rs. 6 lacs was made in September 2007 Renewal of account in March 2008 A sum Rs. 4 lacs paid in November 2008 A part payment of Rs. 3 lacs in March 2008 The last amount credited to the loan account October 2008 was rs. 7 lacs.

After October 2008, the borrower neither made payment to adjust his account nor renewed it. The bank tried to contact the borrower through notices and in person but failed to solicit any response. So in march 2010 the account was finally categorized as substandard asset.

Course of Action

The bank issued the securitization and econstruction of financial assets enforcement of security interest (SARFAESI) notice. As per the guidelines of SARFAESI, the borrower is given 60 days to clear the amount due else the bank would have all the legal right to liquidate the security to realize the unpaid amount. The borrower contacted the bank after receiving the notice and promised to repay the amount in full before the lapse of the period, through the sale proceeds of the flats that wedre unsold.


SOME PROBLEMS OBSERVED DURING PRE & POST SANCTION ADVANCES

Certain issues relating ro prior and post advances are identified. Thse issues may be addressed to ease the sanction procedure of loans and facilitate the consumers to comply with the legal formalities. The problems are discussed as under:

Problems associated with pre sanction of loans :

The overall procedure is a lengthy one thereby taking long duration in final sanction. This not only a time consuming process but also lacks single window service.

This involves too much of paper work, making the process tedious. A number of verifications are required that discourages the borrower to

avail the credit facility offered by the bank The terms agreement might sound ambiguous to the borrower leading to

further misconception regarding the condition stated in loan agreement. There is a fixed limit on the amount of loans that can be sanctioned by the

branch. For limits exceeding such an amount, the approval of regional office needs to be taken. This again consumes a lot of time.

There are a number of instances where there remain certain discrepancies, regarding the terms and conditions of loans between bank and regional office.

Problems associated with post sanction of loans:

Depsite of regular monitoring of accounts, certain accounts result in NPA. Recovery of NPA id major cause of cercern.

CONCLUSION AND RECOMMENDATION


The conclusion based on the cases that were witnessed in due course of time brings forth certain recommendations. The suggested recommendations may include the following:

A through analysis of any proposal is required stage so that chances of such a loan account being NPA in future is forecasted well in advance and minimized.

Similarly, as soon as the accounts slip into Special Mentioned Accounts (SMAs), strict and regular follow ups are essential to save them from turning into loss accounts.

Moreover, incorporation of a Z-score Modal to access the bankruptcy changes of the prospective borrower in near future would prove to be great help.

Learnings57 | P a g e

Akash DixitNIILM CMS, GREATER NOIDA, BATCH 12-14

Professional

After working in the credit department in Indian overseas bank I learnt various skills and knowledge pertaining to,

risk ascertainment and non-performing assets

In the credit department I learnt how the documentation of credit is done. The Chief Manager gave me the various insights in case of loan accounts becoming bad.

Apart from the credit management, I also learnt how the daily business in the banks is done. The staff of the bank was very corporative and explained me the internal processes of the bank.

Personal

Earlier, before the summer training, I used to wonder how hectic would it be to get a loan from a bank. But now after understanding the credit management I feel confident in getting loans. As of now, till date, I have taken an Education loan from Allahabad Bank of which I never knew the internal working and EMI calculation. But from now onwards I can better understand those issues.

Academic

The credit department helped me to practically understand the various topics which were taught to me in the classroom. Various aspects like,

Pledge, Hypothecation, Contract Act 1872, are now better understood to me. Also the balance sheets and

the cash flow statements which always used to haunt me are now on my figure tips.

ATTACHMENT

BALANCE SHEET: INDIAN OVERSEAS BANK 58 | P a g e

Akash DixitNIILM CMS, GREATER NOIDA, BATCH 12-14

Balance Sheet of Indian Overseas Bank ------------------- in Rs. Cr. -------------------

Mar '13 Mar '12 Mar '11 Mar '10 Mar '09

12 mths 12 mths 12 mths 12 mths 12 mths

Capital and Liabilities:

Total Share Capital 924.10 797.00 618.75 544.80 544.80

Equity Share Capital 924.10 797.00 618.75 544.80 544.80

Share Application Money 0.00 0.00 0.00 0.00 0.00

Preference Share Capital 0.00 0.00 0.00 0.00 0.00

Reserves 12,533.26 9,989.40 7,546.19 5,804.18 5,396.59

Revaluation Reserves 0.00 1,141.26 1,159.99 1,175.60 1,209.57

Net Worth 13,457.36 11,927.66 9,324.93 7,524.58 7,150.96

Deposits 202,135.35 178,434.18 145,228.75 110,794.71 100,115.89

Borrowings 23,322.86 23,613.85 19,355.40 8,982.20 6,548.28

Total Debt 225,458.21 202,048.03 164,584.15 119,776.91 106,664.17

Other Liabilities & Provisions 5,740.47 5,672.50 4,875.19 3,794.90 7,258.26

Total Liabilities 244,656.04 219,648.19 178,784.27 131,096.39 121,073.39

Mar '13 Mar '12 Mar '11 Mar '10 Mar '09

12 mths 12 mths 12 mths 12 mths 12 mths

Assets

Cash & Balances with RBI 9,837.83 10,198.91 10,010.89 7,666.45 5,940.44

Balance with Banks, Money at Call 5,420.59 6,062.19 2,007.76 2,158.19 4,981.46

Advances 160,364.12 140,724.44 111,832.98 79,003.93 74,885.27

Investments 61,417.35 55,565.88 48,610.45 37,650.56 31,215.44

Gross Block 1,847.04 2,699.76 2,535.57 2,460.53 2,352.74

Accumulated Depreciation 0.00 970.66 859.36 768.63 655.95

Net Block 1,847.04 1,729.10 1,676.21 1,691.90 1,696.79

Capital Work In Progress 0.00 14.95 4.90 7.67 13.07

Other Assets 5,769.11 5,352.70 4,641.08 2,917.70 2,340.93

Total Assets 244,656.04 219,648.17 178,784.27 131,096.40 121,073.40

Contingent Liabilities 52,745.62 42,601.94 33,490.63 31,288.74 31,016.27

Bills for collection 30,900.63 24,927.12 15,838.45 11,252.80 10,839.82

Book Value (Rs) 145.63 135.34 131.96 116.54 109.06


REFERENCES

Indian overseas Bank, 2008 Introduction program for Probationary officers

Indian Institute of Banking and Finance, 2008 Second Edition Principles and Practices

Iyenger Vijyaragvan 2007, First Edition , Introduction to Banking


Credit Management In Indian Overseas Bank

Documents

Transcript of Credit Management In Indian Overseas Bank