Credit Rating of Bank Financial

8/7/2019 Credit Rating of Bank Financial

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Credit Rating Procedure of

Banks/Financial InstitutionsProject Guide :Prof. Naveen Bhatia

Submitted by:Bhavin D. Mehta

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Prof. P.L.AryaProf Naveen BhatiaDirector

Project Guide

ACKNOWLEDGEMENT

I wish to thank and express my gratitudeto those who extended their valuable co-operation and contribution towards theproject who took out of their busy

schedule and provided easy access to theinformation required.

I would also like to thank my project guideProf Naveen Bhatia for timely andunobtrusive guidance given to me.

Also thanks to my friends and colleaguesfor their enduring patience and valuablecriticism which shaped the project well.

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Bhavin D. Mehta

EXECUTIVE SUMMARYEXECUTIVE SUMMARY

The Reserve Bank of India (RBI), Indias central bank, is responsible for licensing and

supervising financial institutions and banks as well as non-banking financial companies.

Established in 1934, the RBI is vested with extensive powers under The RBI Act, 1934

and The Banking Regulation Act, 1949 to monitor and regulate all commercial banks and

banking activities in India. The RBI has laid down guidelines on the prudential norms

with which it expects all commercial banks to comply. The areas covered include capital

adequacy, income recognition and asset classification, provisioning for non-performing

assets (NPAs), valuation of investments and other related matters. These guidelines are

based on the November 1991 recommendations of the Committee on the Financial

System (The Narasimham Committee)set up by the RBI and the subsequent 1998

suggestions of the Committee on Banking Sector Reforms (the second Narasimham

Committee). In recent years, the RBI has been tightening its prudential norms to bring

them into line with best international practice . A basic precept of rating is that one should

get to understand the business of the bank in question, the objectives of its management,

the environment it operates in and the most likely future development of its business.

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This assists in arriving at a rating judgement rooted in an international perspective,

which, nevertheless, accommodates the particular circumstances of the bank (whether

national, regional or sectoral), preventing hasty pre-judgements based on criteria which

are in one way or another inappropriate. There are, however, certain universally

applicable attributes of banks asset quality is a good example - for which the rating

agency considers it is possible, and desirable, to set standards which have a degree of

uniformity.

Table of contentTable of content

Topic PageNumber

Introduction 1

Rating Definition 3

Rating Process & Framework 11

Credit Rating Process Of Bank &

Financial Institution

15

Case Report I 32

Case Report II 54

Conclusion 56

Annexure-I 57

Annexure-II 65

Annexure-III 66Annexure-IV 68

Bibliography 69

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IntroductionIntroduction

The primary objective of rating is to provide guidance to investors\creditors in

determining a credit risk associated with a debt instrument\credit obligation. It does not

amount to a recommendation to buy, hold or sell an instrument as it does not take into

consideration factors such as market prices, personal risks preferences and other

considerations which may influence an investment decision. The rating process is itself

based on certain givens. The agency, for instance, does not perform an audit. Instead, it

is required to rely on information provided by the issuer and collected by analysts from

different sources, including interactions in -person with various entities. Consequently,

the agency does not guarantee the completeness or accuracy of the information on which

the rating is based. To quote "In determining a rating, both quantitative and qualitative

analyses are employed. The judgment is qualitative in nature and the role of the

quantitative analysis is to help make the best possible overall qualitative judgment

because, ultimately, a rating is an opinion." Standard & Poors

Ratings, usually expressed in alphabetical or alphanumeric symbols, are a simple and

easily understood tool enabling the investor to differentiate between debt instruments on

the basis of their underlying credit quality. The credit rating is thus a symbolic indicator

of the current opinion of the relative capability of the issuer to service its debt obligation

in a timely fashion, with specific reference to the instrument being rated. It is focused on

communicating to the investors, the relative ranking of the default loss probability for a

given fixed income investment, in comparison with other rated instruments.

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Credit Rating; as elucidated by the leading rating agencies of the world

"A rating is an opinion on the future ability and legal obligation of the issuer to make

timely payments of principal and interest on a specific fixed income security. The rating

measures the probability that the issuer will default on the security over its life, which

depending on the instrument, may be a matter of days to 30 years or more. In addition,

long term ratings incorporate an assessment of the expected monetary loss should a

default occur." Moodys " Credit ratings help investors by providing an easily

recognizable, simple tool that couples a possibly unknown issuer with an informative and

meaningful symbol of credit quality." Standard & Poors

A rating is specific to a debt instrument and is intended as a grade, an analysis of the

credit risk associated with the particular instrument. It is based upon the relative

capability and willingness of the issuer of the instrument to service the debt obligations

(both principal and interest) as per the terms of the contract. Thus a rating is neither a

general purpose evaluation of the issuer, nor an overall assessment of the credit risk

likely to be involved in all the debts contracted or to be contracted by such entity.

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RATING DEFINITIONSRATING DEFINITIONS

Long Term Rating ScalesHigh Investment Grades

AAA

(Triple A)

Highest

Safety

Debentures rated ÀAA' are judged to offer highest safety of timely

payment of interest and principal. Though the circumstances providing this

degree of safety is likely to change, such changes as can be envisaged are

most unlikely to affect adversely the fundamentally strong position of such

issues.AA

(Double A)

High Safety

Debentures rated 'AA' are judged to offer high safety of timely payment of

interest and principal. They differ in safety from ÀAA' issues only

marginally.Investment GradesA

Adequate

Safety

Debentures rated À' are judged to offer adequate safety of timely payment

of interest and principal; however, changes in circumstances can adversely

affect such issues more than those in the higher rated categories.BBB

(Triple B)

Moderate

Safety

Debentures rated `BBB' are judged to offer sufficient safety of timely

payment of interest and principal for the present; however, changing

circumstances are more likely to lead to a weakened capacity to pay

interest and repay principal than for debentures in higher rated categories.

Speculative GradesBB

(Double B)

Inadequate

Safety

Debentures rated `BB' are judged to carry inadequate safety of timely

payment of interest and principal; while they are less susceptible to default

than other speculative grade debentures in the immediate future, the

uncertainties that the issuer faces could lead to inadequate capacity to

make timely interest and principal paymentsB

High Risk

Debentures rated `B' are judged to have greater susceptibility to default;

while currently interest and principal payments are met, adverse business

or economic conditions would lead to lack of ability or willingness to pay

interest or principal.C

Substantial

Risk

Debentures rated `C' are judged to have factors present that make them

vulnerable to default; timely payment of interest and principal is possible

only if favorable circumstances continue.D Debentures rated `D' are in default and in arrears of interest or principal

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In Default payments or are expected to default on maturity. Such debentures are

extremely speculative and returns from these debentures may be realized

only on reorganization or liquidation.

Note:

1) CRISIL may apply "+" (plus) or"-" (minus) signs for ratings from AA to

D to reflect comparative standing within the category.

2) The contents within parenthesis are a guide to the pronunciation of the

rating symbols.

3) Preference share rating symbols are identical to debenture rating

symbols except that the letters "pf" are prefixed to the debenture rating

symbols, e.g. pfAAA ("pf Triple A").

Fixed Deposit Rating ScalesFAAA

("F Triple

A") Highest

Safety

This rating indicates that degree of safety regarding timely payment of

interest and principal is very strong.

FAA

("F Double

A") High

Safety

This rating indicates that the degree of safety regarding timely payment of

interest and principal is strong. However, the relative degree of safety is

not as high as for fixed deposits with "FAAA" rating.

FA

Adequate

Safety

This rating indicates inadequate safety of timely payment of interest and

principal. Such issues are less susceptible to default than fixed depositsrated below this category, but the uncertainties that the issuer faces could

lead to inadequate capacity to make timely interest and principal

payments.FB

Inadequate

Safety

This rating indicates inadequate safety of timely payment of interest and

principal. Such issues are less susceptible to default than fixed deposits

rated below this category, but the uncertainties that the issuer faces could

lead to inadequate capacity to make timely interest and principal

payments.FC

High Risk

This rating indicates that the degree of safety regarding timely payment of

interest and principal is doubtful. Such issues have factors at present that

make them vulnerable to default; adverse business or economic conditions

would lead to lack of ability or willingness to pay interest or principal.FD This rating indicates that the issue is either in default or is expected to be

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Default in default upon maturity.

Note: 1) The rating agency may apply "+" (plus) or"-" (minus) signs for ratings

from FAA to FC to indicate the relative position within the rating category

of the company raising fixed deposits.


rating symbols.

Rating For Short-Term Instruments (Commercial Paper)P-1 This rating indicates that the degree of safety regarding timely payment on

the instrument is very strong.P-2 This rating indicates that the degree of safety regarding timely payment on

the instrument is strong; however, the relative degree of safety is lower

than that for instruments rated "P-1".P-3 This rating indicates that the degree of safety regarding timely payment on

the instrument is adequate; however, the instrument is more vulnerable to

the adverse effects of changing circumstances than an instrument rated in

the two higher categories.P-4 This rating indicates that the degree of safety regarding timely payment on

the instrument is minimal and it is likely to be adversely affected by short-

term adversity or less favorable conditions.P-5 This rating indicates that the instrument is expected to be in default on

maturity or is in default.Note : CRISIL may apply "+" (plus) sign for ratings from P-1 to P-3 to reflect a

comparatively higher standing within the category

Rating Scales For Structured Obligations (so)AAA(so)

(Triple A

SO)

This rating indicates highest degree of certainty regarding timely payment

of financial obligations on the instrument. Any adverse changes in

circumstances are most unlikely to affect the payments on the instrument.

AA(so)

(Double A

SO)

This rating indicates high degree of certainty regarding timely payment of

financial obligations on the instrument. This instrument differs in safety

from `AAA' instruments only marginally.A(so) This rating indicates adequate degree of certainty regarding timely

payment of financial obligations on the instrument. Changes in

circumstances can adversely affect such instruments more than those in the

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higher rated categories.BBB(so)

(Triple B

SO)

This rating indicates a moderate degree of certainty regarding timely

payment of financial obligations on the instrument. However, changing

circumstances are more likely to lead to a weakened capacity to meet

financial obligations than for instruments in higher rated categories.BB(so)

(Double B

SO)

This rating indicates inadequate degree of certainty regarding timely

payment of financial obligations on the instruments. Such instruments are

less susceptible to default than instruments rated below this category.B(so) This rating indicates high risk and greater susceptibility to default. Any

adverse business or economic conditions would lead to lack of capability

or willingness to meet financial obligations on time.C(so) This rating indicates that the degree of certainty regarding timely payment

of financial obligations is doubtful unless circumstances are favorable.D(so) This rating indicates that the obligor is in default or expected to default.Note : 1) CRISIL may apply "+" (plus) or"-" (minus) signs for ratings from AA to

C to reflect comparative standing within the category.


rating symbols.

Foreign Structured Obligations (Fso) Rating Scales

The credit rating agency has developed a framework for rating the debt obligations of

Indian corporates supported by credit enhancements extended by entities based outside

the country. The issues considered inter alia include the credit worthiness of the offshore

entity, the nature and structure of the credit enhancement mechanism to ensure timely

payments on rated debt obligations an regulatory issues as regards the transfer risk. The

credit rating would notch up the standalone credit ratings of these Indian issuers

depending on all these factors.

CRISIL ratings of Foreign Structured Obligations (fso) factor the credit enhancement

extended by an entity based outside the country. The ratings indicate the degree of

certainty regarding timely payment of financial obligations on the instrument. These

ratings have been assigned in the current regulatory framework as regards the transfer

risk and any change therein could impact the ratings.

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The credit enhancements could be in the form of guarantees, letters of credit, asset

backing or other suitable structures. Due to the current regulatory controls on inward

remittances, CRISIL would require suitable liquidity mechanisms to be in place for

ensuring timely payment on due dates.

Foreign Structured Obligations ratings are based on the same scale (AAA through D) as

CRISIL ratings for long-term instruments. Foreign Structured Obligations ratings

symbols are defined below:

High Investment GradesAAA(fso)

(Triple A)*

Highest Safety - This rating indicates highest degree of certainty regarding

timely payment of financial obligations on the instrument. Any adverse

changes in circumstances are most unlikely to affect the payments on the

instrument.AA(fso)

(Double A)*

Highest Safety - This rating indicates high degree of certainty regarding

timely payment of financial obligations on the instrument. This

instrument differs in safety, from "AAA(fso)" instruments only

marginally.

Investment GradesA(fso) * Adequate Safety -This rating indicates adequate degree of certainty

regarding timely payment of financial obligations on the instrument.

Changes in circumstances can adversely affect such instruments. Changes

in circumstances can adversely affect such instruments more than those

in the higher rated categories.BBB(fso)

(Triple B) *

Moderate Safety - This rating indicates a moderate degree of certainty

regarding timely payment of financial obligations on the instrument.

However, changing circumstances are more likely to lead to a weakened

capacity to meet financial obligations than for instruments in higher rated

categories.Speculative GradesBB(fso)

(Double B) *

Inadequate Safety - This rating indicates inadequate degree of certainty

regarding timely payment of financial obligation on the instrument. Such

instruments are less susceptible to default than instruments rated below

this category.B(fso) High Risk - This rating indicates high risk and greater susceptiblity to

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default. Any adverse business or economic conditions would lead to lack

of capability or willingness to meet financial obligations on time.C(fso) Substantial Risk - This rating indicates that the degree of certainty

regarding timely payment of financial obligations is doubtful unless

circumstances are favorable.D(fso) Default - This rating indicates that the obligation is in default or expected

to default.

Note: The contents within Parenthesis are a guide to the pronunciation of

the rating symbols.

Credit Rating Scale for Financial Strength Ratings (FSR)Ratings are broadly divided into two categories - Secure and Vulnerable. Rating

categories from "AAA" to "BBB" are classified as 'secure' ratings and are used to indicate

insurance companies whose financial capacity to meet policyholder obligations is sound.Rating categories from "BB" to "D" are classified as vulnerable ratings and are used to

indicate insurance companies whose financial capacity to meet policyholder obligations is

vulnerable to adverse economic and underwriting conditions.

The opinion does not take into account timeliness of payment or the likelihood of the use

of a defense such as fraud to deny claims. For insurance companies with cross-border or

multi-national operations, including those conducted by branch offices or subsidiaries,

ratings do not take into account any potential that may exist for foreign exchange

restrictions to prevent policy obligations from being met. Financial strength ratings do not

refer to an insurance company's ability to meet non-policy obligations (i.e. debt

contracts).The ratings are not recommendations to purchase or discontinue a policy,

contract or security issued by an insurance company nor are they guarantees of financial

strength.

Secure Ratings

AAA Reflects Highest Financial Strength to meet policyholder obligations. Though the

circumstances providing this strength are likely to change, such changes as can

be envisaged are most unlikely to affect adversely the fundamentally strong

position.AA Reflects High Financial Strength to meet policyholder obligations. Though the

circumstances providing this degree of strength are likely to change, such

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changes as can be envisaged are most unlikely to affect adversely the

fundamentally strong position. Companies in this category differ only marginally

from the 'AAA' rated insurance companies.A Reflects Adequate Financial Strength to meet policyholder obligations. However, change

in circumstances can adversely affect such companies more than those in the

higher rated categories.BBB Reflects Moderate Financial Strength to meet policyholder obligations. However,

changing circumstances are more likely to lead to a weakened capacity to meet

policyholder obligations than the higher rated categories.Vulnerable Ratings

BB Reflects Inadequate Financial Strength to meet policyholder obligations. While

companies rated in this category are less susceptible to default than other

speculative grade companies in the immediate future, the uncertainties that theyface could lead to inadequate capacity to meet their policyholder obligations.

B Reflects Greater Susceptibility to default on policyholder obligations. While current

obligations are met, adverse business or economic conditions would lead to lack

of ability or willingness to meet policyholder obligations.C Vulnerable to default. Ability to meet policyholder obligations is possible only if

favourable circumstances prevail.D In default. Current policyholder obligations are in default. Insurance companies

rated "D" are extremely speculative and policyholder obligations may be realized

only on reorganization or liquidation.

Financial strength ratings from "AA" to "BB" may be modified by use of a plus (+) or (minus

(-) sign to show the relative standing of the insurance / reinsurance company within the

rating categories.

Bond Fund Rating Scales

AAAf The funds portfolio holdings provide very strong protection against losses from

credit defaults.AAf The funds portfolio holdings provide strong protection against losses from credit

defaults.Af The funds portfolio holdings provide adequate protection against losses from

credit defaults.BBBf The funds portfolio holdings provide moderate protection against losses from

credit defaults.BBf The funds portfolio holdings provide inadequate protection against losses from

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credit defaults.Cf The funds portfolio holdings have factors present which make them vulnerable to

credit defaults.

Rating Process & FrameworkRating Process & Framework

Rating is an interactive process with a prospective approach. It involves series of steps.

The main points are described as below :

( a ) Rating request : Ratings in India are initiated by a formal request (or mandate )

from the prospective issuer . This mandate spells out the terms of the rating assignment .

Important issues that are covered include : binding the credit rating agency to maintain

confidentiality , the right to the issuer to accept or not to accept the rating and binds the

issuer to provide information required by the credit rating agency for rating and

subsequent surveillance.

( b ) Rating team :The team usually comprises two members. The composition of the

team is based on the expertise and skills required for evaluating the business of the issuer.

( c ) Information requirements : Issuers are provided a list of information requirements

and the broad framework for discussions. These requirements are derived from the

experience of the issuers business and broadly conforms to all the aspects which have a

bearing on the rating. These factors have been discussed in detail under Rating

framework.

(d) Secondary information : The credit rating agency also draws on the secondary

sources of information including its own research division. The credit rating agency also

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has a panel of industry experts who provide guidance on specific issues to the rating

team. The secondary sources generally provide data and trends including policies about

the industry.

(e) Management meetings and plant visits : Rating involves assessment of number of

qualitative factors with a view to estimate the future earnings of the issuer. This requires

intensive interactions with the issuers management specifically relating to plans , future

outlook , competitive position and funding policies.

Plan visits facilitate understanding of the production process , assess the state of

equipment and main facilities , evaluate the quality of technical personnel and form an

opinion on the key variables that influence level , quality and cost of production. These

visits also help in assessing the progress of projects under implementation.

(f) Preview meeting:After completing the analysis, the findings are discussed at length

in the internal committee, comprising senior analysts of the credit rating agency. All the

issues having a bearing on the rating are identified. At this stage , an opinion on the rating

is also formed.

(g) Rating Committee meeting:This is the final authority for assigning ratings. A brief

presentation about the issuers business and the management is made by the rating team.

All the issues identified during discussions in the internal committee are discussed. The

rating committee also considers the recommendation of the internal committee for the

rating. Finally, a rating is assigned and all the issues which influence the rating are

clearly spelt out.

(h ) Rating communication : The assigned rating along with the key issues is

communicated to the issuers top management for acceptance. The ratings which are not

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accepted are either rejected or reviewed. The rejected ratings are not disclosed and

complete confidentiality is maintained.

( I ) Rating Reviews : If the rating is not acceptable to the issuer , he has a right to appeal

for a review of the rating . These reviews are usually taken up only if the issuer provides

fresh inputs on the issues that were considered for assigning the rating. Issuers response

is presented to the Rating Committee. If the inputs are convincing, the Committee can

revise the initial rating decision.

( j ) Surveillance :It is obligatory on the part of the credit rating agency to monitor the

accepted ratings over the tenure of the rated instrument. As has been mentioned earlier,

the issuer is bound by the mandate letter to provide information to the credit rating

agency. The ratings are generally reviewed every year, unless the circumstances of the

case warrant an early review . In a surveillance review the initial rating could be retained

or revised (upgrade or downgrade ).

How Does the Ratings Process Work?

The process of Rating starts with the issue of the Rating Request by the issuer/ signing of

the Rating agreement. A detailed flow chart is as under:

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Limitations of Credit Ratings

A Credit Rating is an assessment carried out from the limited standpoint of credit risk

evaluation. A Credit Rating from rating agency therefore constitutes a current Opinion

on the credit quality of a specific issue of debt, in terms of the issuers ability and

willingness to meet principal and interest payments on rated debt instruments in a timely

manner. Credit Ratings are arrived at based on information obtained in the rating process.

In addition to management meetings and information provided by rated entities, the rated

entitys audited accounts, regulatory filings, and information provided by trustees form

an important source of information. CRISIL does not verify and validate all the

information that it uses for its ratings. However, reasonable due diligence is carried out

on all information used to the extent feasible to ensure that a meaningful and accurate

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rating exercise is done (for instance, financial accounts are extensively adjusted to

ensure that they present a relevant picture of the financial position of an entity from a

debt servicing perspective, to the extent feasible).

Rating process for Bank/Financial institutionRating process for Bank/Financial institution

Once we have received a request for a new rating of a bank (this should subsequently be

backed by a formal rating agreement), we follow the procedures outlined below:

1. Analyzing the Banks/FIs environment

It is first necessary to collect and analyze data relating to the it system in which the

Banks/FIs in question operates and to the place of the Banks/FIs within that system.

This process includes analysis of the relevant national Banks/FIs market and of existing

and potential competition in that market and also of the degree of concentration within it.

It requires examination of the role and functions of the Banks/FIs supervisory authorities

in the country in question, of the degree of state control (or decontrol) of that countrys

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Banks/FIs system, of the requirements of public reporting Banks/FIs and of the

accounting practices that lie behind the figures publicly reported by Banks/FIs. On a still

wider scale it is necessary to take into account the requirements of the Basle G 10

Agreement on "International convergence of capital measurement and capital standards"

and subsequent interpretative statements from the Basle Committee (of international bank

supervisors).

2) Bank questionnaire:

Based on our initial analysis of publicly available data, we prepare a questionnaire for

presentation to the management of the bank to be rated. A copy of our "prototype"

questionnaire is attached as Appendix 1. This is intended to serve as a basis which may

be adapted for the particular circumstances of the bank being rated.

3) Meeting with bank:

As already indicated, the next step is a meeting with senior management of the bank in

question to discuss and assess the data provided. Such meetings are usually arranged with

the bank's chief financial officer, but many of the more sophisticated banking groups and

banks now employ rating agency liaison officers. The length and number of meetings

with management depend on the complexity of the entity being rated, but, normally the

first time we rate a bank there will be one such meeting, and it will last for half a day to a

day.

4) Analysis of the bank:

The Cramel Model comprises the following:

I. Capitals adequacy ratio

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II. Resource raising ability

III. Asset quality

IV. Management & system evaluation

V. Earning potential

VI. Liquidity / Asset Liability Management

NO one factor has an overriding importance or is considered in isolation.

These entire six factors are viewed in conjunction before assigning rating.

In addition to the factors which constitute the CRAMEL, the size of the financial entity is

also an important parameter. The size of an entity in the financial sector, imparts it the

ability to with stand systematic shock, support that can be expected for the entity.

I CAPITAL ADEQUACY:

Capital adequacy of an entity provides the necessary capital cushion to with stand credit

risks. While assigning a rating, it analyses the capital adequacy level and its sustainability

in the medium to long term. The analysis of capital adequacy encompasses the following

factors:

I.1 Size of capital:

The absolute size of a capital imparts flexibility to a bank / FI to withstand shock

and thus an entity with higher absolute capital is viewed favorably.

I.2 Quality of Capital (Tier-I Capital):

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The proportion of Tier I capital or core capital of a bank /FI is the primary

indicator of the quality of capital .The level of Tier-I capital is given primary

importance when assigning rating for capital adequacy .Although the presence of

Tier-II capital does provide some cushion in the short to the medium term , the

Tier-II capital needs to be periodically replenished .It also analyses other issues

like the presence of hidden reserve and the percentage of the investment portfolio

marked to the market. These issues help in streamlining accounting policy

differential across various entities and have a bearing on the quality of capital.

I.3 Flexibility to raise Tier I capital:

An entity has the flexibility to raise Tier I capital either through internal accruals

or through the capital markets. The ability of the entity to access the capital

market to meet its Tier I capital needs and its ability to service the increased

capital base is considered while evaluating the flexibility of a bank /FI to support

the increased asset base through earning is an important parameters in assessing

sustainability of capital adequacy .An entity which is able to sustain asset growth

through internal generation without impairing capital adequacy is viewed

favorably.

I.4 Growth Plans:

Its factors the future growth plans of a bank/ Fi while analyzing capital adequacy

.The capital adequacy of the entity (although at currently high levels) would be

regarded as unsustainable , if it pursuing a strategy of high growth .

II Resource raising ability:

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It analyses the resource position of the bank /FI in terms of its ability to maintain a low

cost , stable resource base .In the domestic context , the resource (funding) composition

of bank and FIs is very different .Bank are significantly deposit funded where as the FIs

have to depend on wholesale funds .

Although some FIs do raise retail funds, they are at a natural disadvantage (in raising

retail deposits) as compared to the banking sector in terms of the restrictions on the

minimum tenure and interest rates, the absence of a cheque issuing facility and a

relatively smaller branch network. Some of the FIs do have access to significant

concessional funding from the government if they are playing a role which is of policy

importance t the country. However, in general the dependence on wholesale funding

attaches a degree of risk t the funding profile of FIs.These risks (especially stability of

resource) are partly mitigated by the access that the all India Financial Institutions

(AIFIs) have to funds from provident funds and insurance sectors; these funds are of a

retail origin .Given this basic distinction in funding profiles between bank/FIs, the

funding risk profile of bank / FIs is discussed separately.

The following issues are considered while analyzing the resources position of a bank.

II.1 Size of a deposit base:

A large deposit base provides stability to the resource position of a bank. The size

of a deposit base provides the bank, a critical mass for effectively managing its

cash flows and adds considerably to the diversity (in term of the number of

deposits) of the deposit base.

Diversity in the deposit base & in term of large numbers of small ticket size

deposit, the geographically spread and the optimal rural /urban mix, lend stability

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III ASSET Quality:

Asset quality of bank/FIs is a measure of the ability of the bank to mange credit risks.

Its analyses the asset quality on the basis of the following parameters:

Geographical diversity and diversity across industries:

Geographical diversity of an asset base and diversity across industries, along with single

risk concentration limits are important inputs in determining the asset quality of bank/FIs.

Industrial development of the states in the western region, like Maharashtra and Gujarat

is relatively higher. Thus, the amount of credit extended in this region is higher

concentration of advances in the western region .However , the bank /FIs with all India

presence have the additional flexibility due to their widespread branch network , to

enhance their exposure to other region , in case of adverse economic development in

these states .However , the regional banks with limited operation and branch network

have lesser flexibility to diversify their advances portfolio and are thus susceptible t

adverse economic condition in a particular region.

Diversity across industries is largely a function of the geographical presence of the

Bank/FIs and Management policy. The industry exposure and single risk concentration is

monitored by the central bank through exposure guidelines. However, some bank/FIs

show a high degree of exposure t certain industries thus making themselves vulnerable to

downturns in those industries.

III.1 Client Profile of the corporate asset portfolio:

Credit quality of the corporate portfolio of the bank is an important input in the

analysis of the asset quality .It analyses the profile of the client in the asset

portfolio to make a judgement on portfolio quality. The ability of bank/FIs to

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attracts better credit quality, especially after the dismantling of consortium

lending. The size (of capital) of a financial sector entity lends considerable

flexibility to the entity to attract larger and better quality clients given its sheer

ability to take on larger exposure in its balance sheet. Also, the ability of the

entities to attract and retain good quality clients by providing value added service

would enhance asset quality in the future.

III.2 Quality of Non-industrial lending:

Bank in India have an obligation to lend a proportion of their funds to the priority

Sector which primarily encompasses agriculture and small scale industries. To

this extent, FIs are better placed than banks because they do not have any such

obligation. It analyses the credit quality of this non-industrial portfolio in arriving

at a judgement on an overall asset quality of a bank. The credit quality of the asset

portfolio is also indicated by the segment wise NPA levels of the portfolio,

indicates the performance of the bank in each segment. This help in gauging the

relative strength of the bank in each of the loan segment. Some of the banks have

a higher level of exposure to the trading. These advances provide a comparatively

higher yield and also provide diversity due to their small ticket size. The Indian

banks have to compulsorily lend 40% of their total advances to the priority sector.

The break up of the loan within these sectors in an important indicator of the

quality of the portfolio .E.g. An agricultural loan in an agriculturally prosperous

state of Punjab would have a better probability of being repaid as compared to

other agriculturally weak states.

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scenario of increasing deregulation of the financial market assumes critical

importance.

IV.2 System & monitoring:

It studies the credit appraisal system for managing and controlling credit and

market risk at a portfolio levels. Significant emphasis is laid on the risk

monitoring system and the periodically and quality of such monitoring. Most

Indian banks face the challenges of enhancing their information system and

quality of information reporting. The degree of acceptance of new system and

procedure in the bank, data monitoring systems and the extent of computerization

within the bank is given significant importance .The level of computerization is

gauged on the basis of the extent of the business covered by computerization, the

computerization in branches and computerization of money market and forex

market desks.

It attaches significance to the operating system for data capture and MIS reporting

in a bank .A bank balance sheet with a large volume of operating system in the

bank, and is viewed negatively.

IV.3Appetite for risk:

A high risk propensity of a management , typically reflect in the higher volatility

in earning in both fund based as well as non- fund based business .A management

with a higher propensity to take risk is viewed cautiously.

IV.4 Motivation level of staff:

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The motivational level of employees would direct affect the service level of the

bank which is a key success factor in a market driven environment.

V Earning Potential:

It analyses on the following basis of the level

V.1 Level of earning:

It is measured by return on total asset provides the cushion for its debt service,

and also increases the ability of the bank to cover its asset risk. The ROTA is a

function of interest spread, expenses levels provisioning levels and the non-

interestincome earned by the bank.

The size of net profit is also factored while rating of the entity. Earning of the

bank /FIs has been affected due to the volatility in interest rates. Thus, the trend

in profitability at gross profit levels is examined over the past levels is examined

over the past years to take a view on the sustainability of earning. The various

elements leading to the profitability like net interest income, non-interest income ,

expense levels and the provisioning levels are also analyzed to take and the

sustainability of profits in future.

V.2 Diversity of income sources:

It is an important input in analyzing the stability of earning. Diversity of income

sources between various categories of funds based income like industrial portfolio

, retail portfolio, etc. lends stability to the income streams through non-interest

income like guarantees, service charges from its retail customer, trading income,

etc. The non-interest income provides cushion to the profitability, especially

which have the capability to provide better value added service would be in a

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better placed to improve their fee based income. A closer analysis the

composition of the revenue streams, help in taking a view regarding the

sustainability of the earning.

VI Liquidity/Asset Liability Management:

It assesses the liability maturity profile of the entity to form an opinion on the liquidity

risk as well the interest rate risk.

VI.1 Liquidity risk:

It factors the resources strength of the bank in form of access to call borrowing

and the extent of refinance available from RBI. The bank are the primary channel

through which retail saving are channeled back into the public sector bank having

a wide spread branch network act as conduits for mobilization of retail saving . It

views most of the public sector bank favorably on the liquidity support available

to the liquidity support available to the bank in the form of call money and RBI

refinance.

VI.2 Interest rate Risk:

The rating factor the volatility of the bank /FIs earning to interest rate changes .It

analyses the asset liability maturity profile of an entity to judge the level of

interest rate risk carried by the entity. In the Indian banking system, the interest

rate and maturity profile of the asset and liabilities have an inherent mismatch. the

floating rate advances portfolio (linked to prime lending rates ) and the relatively

long duration investment portfolio are funded through short to medium tenure

liabilities which exposes the bank to an element of interest rate risk.

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FIs do score over bank in this regard due to the whole sale nature of their

operation and policies which link the nature of their operation and policies which

link the nature of borrowing (fixed/ floating ) with corresponding matched

lending .On an overall basis , FIs carry relatively lesser interest rate risk as

compared to the bank.

Parent support:

It factors the parentage of the entity in the final rating decision .The extent of support

factored is a function of the relative size of the two entities, the credit quality of the

parent and the strategic importance of the subsidiary to the parent .It positively factors the

system support for specialized entities in the financial sector, which have a policy role in

the national economy.

5. Draft report:

Following the meeting with its management and subsequent analysis of the data obtained,

the analysts draft a rating report on the bank. Depending on the rating agreement and the

particular circumstances, this may be a short-form report (one page of text forming the

rating report, plus spread sheets) or a long-form report (one front page of text forming the

rating report, plus ca. five pages of text providing our rating analysis, plus spread sheets,

plus spread sheet annex, providing explanatory notes to the spread sheets). The analysis

in the text of the long-form report is arranged under main and sub- headings which tie in

with the topics covered in the bank questionnaire.

6. Presentation of draft report to bank

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We send our draft report (without ratings) to the bank being rated, for two reasons:

- so that its factual accuracy may be checked;

- to allow management to determine whether we have included any information in our

draft which was given in confidence and which should be excluded on these grounds.

7. Amendment and subsequent circulation of report to rating

committee; composition of the committee

We amend our report in accordance with any comments from the bank which meet the

criteria in 6., above, and circulate it together with other, relevant documentation among

the members of a rating committee, which normally has a complement of five.There is no

single, standing rating committee; rather there is a committee for ach country we cover,

or, in some cases, for each peer group of banks in each country. The two analysts who

visited the bank, did the analysis and wrote the report are always members of its rating

committee.

8. Rating committee meeting; assignment of ratings

At the rating committee meeting the two analysts responsible for the work done so far

present the rest of the committee with the report they drafted, which has since been seen

by the bank and possibly amended, as explained above, to accord with its comments.

They also present relevant confidential data, which they have not been able to include in

the report, and peer group analyses comparing the bank with its domestic and foreign

peers. The ratings implied by the formula are not treated as definitive: they are

considered only as further input to the rating decision so that there remains a strong

subjective element in our final judgements - a subjectivity tempered, we trust, by several

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years experience (allowing a reasoned extrapolation of the future), by common sense

and by specialized knowledge and research.

9. Dissemination (or non-dissemination) of the ratings

When a bank being rated for the first time has been informed of the decision of the rating

committee, it has no recourse to an appeal, but it does have the right to decide whether it

wishes our ratings to be made public and the rating report to be sent to our subscribers.

However, normally before launching ourselves into the work involved in a new rating,

which possibly also involves coverage of a country which is new to us, we would have

tried to provide the entity being rated with an "indicative" rating. That is to say, on the

basis of a brief analysis of the data available to us we would provide a range of likely

ratings within our rating scales so that the bank being rated has from the start an

approximate idea of what its ratings will be. In the event that the bank does accept that

publication should take place, then the rating report and the ratings will be dispatched to

our subscribers who include over 1,200 major institutions worldwide. In addition, our

ratings will be made available to the public by means of the "wire" services, press

releases, etc. If the bank does not want the ratings published and the report disseminated,

then the project will be terminated, and regular subscribers will not be informed that we

have done rating work on the bank concerned.

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CASE REPORTCASE REPORT

Case IThe Federal Bank Limited

National

Subordinate Debt A+(ind)Rating Outlook Stable

Foreign Currency

Short-term Senior -Long-term Senior -Long-term Rating Outlook -

International

IndividualSupport 5T

Sovereign Risk

National AAAForeign Currency Long-term BBSenior

Local Currency Long-term BB+Senior

Financial Data

The Federal Bank Limited

31/03/2002 31/03/2001

Total Assets [US$ mn] 2,104.7 1,891.1

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Total Assets [INR mn] 101,446.1 88,200.4Equity [INR mn] 4,487.9 4,154.7 Net Income [INR mn] 820.1 610.4ROA [%] 0.86 0.74ROE [%] 18.98 15.70

Equity/Assets [%] 4.42 4.71

Rating Rationale

Assessment

The ratings of The Federal Bank Limited (FBL) reflect its relatively small size, average

financial profile and long operating history. With a large proportion of its branches and

business concentrated in its home state of Kerala, the Bank enjoys a strong franchise

among depositors in the state and the expatriate Keralite community. FBLs pursuit of

rapid loan and asset growth since the mid-1990s (its loan book has grown by over three

times since FY95) without commensurate credit appraisal and risk management systems,

coupled with a slowdown in the economy has resulted in a deterioration of its asset

quality. Gross and net NPLs as a proportion of gross and net advances have risen over the

years and were at 11.82% and 7.36% for end-September 2002. FBLs loan loss reserve

coverage improved to 40% at end-September 2002 from 29.2% at end-FY02. Its net

NPLs to equity ratio, although improved, was still high (at over 77%) in comparison to

some of its peer banks. Although FBLs total capital ratio of 10.63% (Tier 1 ratio was

6.96%) at end- March 2002 was above the regulatory minimum of 9%, its low capital

base is reflected in its low equity to asset ratio of 4.42%, emphasising the need to bolster

the Banks equity base, especially Tier 1, to enable it to better absorb the present and

future asset quality shocks and support its planned asset growth. Of FBLs total deposits,

NRI deposits form a substantial proportion and these, along with the term deposits,

render its funding base stable, but expensive. The Bank is focussing on reducing its

funding costs by increasing the share of lowcost savings and current deposits by

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enhancing its reach through an increased branch and ATM network. As against the

general industry trend, FBLs net interest margins have improved in the last couple of

years on the back of declining average funding costs and higher average yields from its

retail loan portfolio. Net Interest Margin (NIM) at 3.1% was better than its peer group

banks. Backed by higher operating income, FBLs cost-to-income ratio improved to

38.5% for end-FY02 from 56.7% in FY00. With its loan-to-deposit ratio consistently

above 55%, FBLs reported liquidity ratios were low. FBL reported some mismatches in

its asset-liability maturity in the short term, although these are mitigated by high deposit

renewal rates.

Support

FBL has no identifiable controlling shareholder, and while its existing shareholders are

likely to be willing or able to provide support to the Bank as a going concern, it is less

clear whether they will be willing or able to provide resources in an extreme situation.

Although RBI has a good track record of supporting banks in times of need, FBL is a

small player in the banking system. In our opinion, therefore, support is possible, should

that be necessary, but it cannot be relied upon. The 'T' suffix to our Support rating

indicates certain subinvestment grade features of the Indian economy that could limit

support for foreign currency creditors.

Background

The Federal Bank Limited was established in 1931 as the Travancore Federal Bank

Ltd.. The Bank was listed on local bourses after its initial public offering in 1994. The

ICICI group is the single largest shareholder, with 21.35% of the Banks equity, while

public holding was 61.72% as at end-June 2002. FBL primarily lends to mid-size

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Apart from providing its customers with traditional retail and commercial services, FBL

has an active treasury. In FY2000, the Bank decided to cease the operations of its wholly

owned subsidiary Fedbank Financial Services Limited that was engaged in the

business of hire purchase, leasing and merchant banking due to an unfavourable

environment affecting non-banking finance companies in general, and the company now

exists only as a shell company with a core capital of INR5 million. FBL has links with 13

exchange houses and seven banks in the Middle East for providing foreign currency

remittance facilities to its customers, especially in the Middle East. The Bank has an

agreement with ICICI Prudential Life Insurance to undertake distribution of life

insurance products. FBL also offers Depository Services to its customers. FBL has the

largest branch networks amongst the old private sector banks. As of March 31, 2002, the

Bank serviced it customers through 416 branches and 62 ATMs. 73% of the Banks

branches are located in its home state of Kerala, and given the high concentration of its

business in the state, FBL can be viewed as a regional player in the banking sector. The

Bank plans to increase both its branch and ATM network to 500 each by FY06. FBL had

appointed Accenture, an international management consulting group, to conduct an

organisational restructuring study for the Bank. The consultants have submitted their

report and recommendations and the Bank is now working on implementation of these.

Technology: FBL has automated all of its branches using its in-house banking software

FedSoft. At present, 74 of its branches are interconnected through leased lines with

plans to switch to a Wide Area Network (WAN). The Bank already offers Internet

banking under the brand name FedNet in addition to mobile and telephone banking.

FBL has invested INR650m in its IT initiatives and plans to invest an additional INR 1

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billion over the next three years for interconnecting its branches, expanding its ATM

network, extending its current mobile and telephone banking capabilities and to migrate

to a centralised banking solution from the current hub and spoke set-up.

PERFORMANCE

Weak, but improving, asset quality requiring higher loan loss provisions have

constrained FBLs profitability.

Improving net interest margins despite high funding costs and declining yields on

loans and investments.

Post liberalisation in the early 1990s, FBL pursued aggressive loan and asset book

expansion, but faced asset quality problems on account of prolonged economic slowdown

and its own weak credit appraisal and monitoring systems, requiring increased loan loss

provisions. This, coupled with declining interest rates amidst intensifying competition,

has adversely impacted the Banks performance. ROA and ROE, which were at 1.3% and

30.73%, respectively, in FY95, have since declined to 0.86% and 18.98%, respectively,

in FY02.

Net Interest Revenue:Net interest income (NII) continues to the predominant source of

revenue for FBL, although its share in total operating income has declined to 55.6% in

FY02 compared to 68.75% in FY95. After recording a sharp decline in its NII in FY99 on

account of a steep rise in its interest expenses, the Banks NII has grown nearly three

times since then. NII growth at 16.6% in FY02 continued to be healthy, though it was

below the 34.5% growth recorded in FY01. Interest expenses, which had declined during

FY01 and FY00, grew by over 12% during FY02 on the back of substantial deposit

growth in last two years, which explains the lower NII growth rate.

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As against the general industry trend,

substantial decline in its NII), and its

NIM at 3.1% FBLs net interest

margins (NIM) have improved after

recording a sharp decline in FY99

(which was due to for FY02 was better

compared to its peers old private

sector banks as well as some of the

better- performing government banks. Although declining, FBLs average funding costs

at 8.9% for FY02 continued to be high, and the bank is focussing on reducing this

further by cutting the interest rates on its high cost foreign currency NRI deposits and

increasing the share of low cost retail deposits by enhancing its delivery capabilities.

Non-interest Income: FBLs non-interest incomes are primarily derived from its

treasury money market and foreign exchange and trade finance related activities. The

share of non-interest income a fivefold increase in its profits from sale of in total

operating income, which had been declining since FY99, grew to 44.4% in FY02

primarily due to investments, mainly Government securities (G- Secs). In the last couple

of years, most Indian banks have built up government securities investments in excess of

reserve requirements as there has been a dearth of quality lending opportunities and the

declining interest rates provided increased arbitrage opportunities on these investments.

Profits from trading in G-Secs have continued in H1 FY03, and annual profits in 2003

from this business are projected at the same level as FY02.

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FBLs total non-interest income grew

by over 76% in 0 FY02 compared to

a contraction of 5.4% in the previous

year. While the growth was fuelled

by a 560% rise in its income from G-

Sec trading, its other non-interest

incomes declined during FY02. A

high proportion of treasury income

adds an element of volatility to the Banks revenue profile, and it has entered into a

number of areas, including cash management services and distribution of third-party

insurance, to augment its non-interest income, in an attempt to ensure a more stable

revenue profile and maintain its profitability levels.

Operating Expenses: The large infrastructure maintained by Indian banks in terms of

branches and employees renders

their operating expenses high.

FBLs non-interest expenses have

grown by over two and a half times

since FY95 on account of higher

employee costs on the back of two

wage revisions during the period.

However, its cost-to-income ratio

has improved to 38.52% for FY02 compared to a high of 75.45% in FY99. Employee

costs continue to be the major contributor, accounting for over 63% of total operating

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expenses and 1.36% of average earning assets. Going forward, FBLs operating expenses

are expected to rise further in view of the on-going expansion of its branch and ATM

network as well as technology related and other operating and marketing expenses.

However, given the improving operating income levels, the cost-to-income ratio is not

expected to rise significantly.

Loan Loss Provisions: The rapid expansion to the banks loan book since the mid-1990s

(loans and advances grew by over

three times since FY95), coupled with

the pronounced slowdown in the

Indian economy and progressively

tightening prudential norms, have

adversely impacted FBLs asset

quality necessitating higher loan loss

provisions in recent years. While

FBLs total loan loss provisions grew by 54% in FY02, these have grown by over four

times since FY98. Loan loss provisions formed 51% of total pre-provision operating

profits for FY02. As a proportion of average loans these have grown to 3.1% for FY02

from 0.96% in FY99. FBLs loan loss provisions are expected to remain high in the

medium term, in view of its high level of NPLs amidst a weak macro-economic

environment, implementation of the 90-day default norm that takes effect from 31 March

2004 and the building up of loan loss coverage by the Bank.

Half-Year Performance: As per the audited (limited review) results for the half-year

ended September 30, 2002 (H1 FY03), FBLs net income (profit after tax) grew by 1.9%

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and was supported by 11.9% growth in NII. Operating profits growth at 5% was

constrained by a 9.4% increase in total non-interest expenses during H1 FY03. Provisions

including loan loss provisions were higher by 3%. For FY03, FBL has projected higher

operating profits on account of improved net interest income (NII), while lower

provisions are projected to result in substantially higher net incomes (profit after tax).

Prospects: FBLs performance, to a large extent, is dependant on the economy of its

home state Kerala and its NRI deposits base. Saddled with a high level of NPLs, the

Bank is currently focusing on cleansing its balance sheet by reducing its NPLs, further

strengthening its credit risk measurement and management systems, reducing reliance on

costly NRI deposits and increasing the low cost retail deposits to reduce its funding costs.

In the short to medium-term, FBL is expected to benefit from higher treasury income and

its sustained recovery efforts resulting in improved asset quality. Given the intensifying

competition, amidst a generally declining interest rate environment, the Bank will be

required to develop its fee-based incomes for a more balanced revenue profile. Over the

long-term, we expect FBL to emerge a stronger player with a solid deposit franchise in

Kerala and a geographically diversified asset book.

RISK MANAGEMENT

Aggressive loan book growth and relatively weak credit appraisal and

monitoring in mid-1990s have resulted in weak asset quality.

FBL has been strengthening its risk management systems.

FBLs Board of Directors is responsible for setting up the Banks risk management

policies and has put in place the Risk Management Committee to implement policies and

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procedures to identify, monitor and manage risks including credit, market, liquidity and

operational risks. The Credit Risk Management Committee (CRMC), reporting to the

Chairman, measures and monitors the credit risk of the Banks loan portfolio, while the

Asset Liability Committee (ALCO) measures and monitors market and liquidity risks and

uses Earnings at Risk (EaR) for measuring the risk of its trading and banking

book. Recently, the Bank has also set up the Operational Risk Committee (ORCO) to

measure and monitor operational risks arising from the failure of people, processes,

products, technology, etc. Going ahead, the Bank is strengthening its risk management

systems through increased use of technology, training its staff in risk measurement and

management and prescribing stringent appraisal and monitoring norms for the risks faced

by FBL.

Credit Risk: FBL lends to corporates and small and medium-sized enterprises (SMEs)

for their working capital requirements

and trade financing. Large credits

(greater than INR50m) and lending to

the SME sector collectively

accounted for over 80% of the Banks

total loan book, while retail and other

loans made up the balance. In FY02,

growth in FBLs loan book at 6.9%

was lower compared to FY01s 20.3%. Over 80% of the Banks loans are secured by

collateral, including inventory, receivables, land or plant and machinery. Additional

security by way of shares, as well as corporate or personal guarantees is obtained,

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wherever necessary. FBLs top four exposures to the industrial sector were to textiles

(11.59%), food processing (10.4%), iron & steel (9.8%) and real estate 8.4%.

FBL follows a credit rating model for all its credit exposures above INR50m, where they

are classified into 10 categories of risk grades from FB-1 to FB-10 (FB-1 being the

best and FB-10 being the worst). Borrowers are evaluated on various business an does

not qualify for assistance. The loan booked financial parameters and assigned a credit

rating, and any proposal failing to attain at least a FB-6 rating composition as per the

Banks credit ratings for end-FY02 is given in Table 2.

.Table 2: Loan Book Composition by Credit Ratings

(%) FB-1 FB-2 FB-3 FB-4 FB-5 FB-6 D

2.03 17.88 29.38 19.94 5.94 0.0 24.81

By end-FY03, FBL intends to assign credit ratings to all loans above INR200, 000, with

plans to review the ratings every six months, instead of the annual basis currently

followed. The Bank has been linking the pricing of its loans to its self-defined credit

rating; however, it maintains some flexibility in pricing, especially for top-rated credit

accounts, given the intense competition in this segment.

Loan Loss Reserves: FBL follows the RBI norms for classifying NPLs and providing

for loan losses, and these are somewhat liberal by international standards. A loan is

classified as an NPL when interest and/or principal are outstanding for 180 days. FBLs

lending to the real estate sector accounted for nearly 9.3% of the total gross NPLs as of

end-FY02. This was followed by loans to the iron & steel sector (5.5%) and non-banking

finance companies (3%).

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(INRm/%) FY 02 FY 01 FY 00 FY 99

Gross NPLs 6,380 6,420 4,900 4,790As % of Gross Loans 11.88 12.84 11.75 10.93

Loan Loss Reserves (LLR) 1,864.4 1486.0 1,389.9

1,562.9

LLR to NPLs (%) 29.21 23.14 28.34 32.61

Net NPLs to Equity (%) 99.34 117.78 95.31 98.61

Net NPLs to Net Loans (%) 8.60 10.08 8.56 7.53

Grading of Net NPLs (%)

Sub-standard 52.41 63.16 - -

Small-Doubtful 47.53 47.53 36.84 - -

Bad debts 0.0 0.0

Table 3: Trends in FBLs Asset Quality

FBL pursued aggressive loan book expansion in the mid-1990s, which was followed by a

prolonged economic slowdown, tightening asset classification and provisioning norms.

Due to FBLs relatively weak credit appraisal and monitoring mechanisms, this led

to a substantial deterioration in its asset quality. Both gross and net NPLs have grown in

absolute terms as well as a proportion of gross and net advances.Reported gross and net

NPLs as a ratio of gross and net advances, at 11.88% and 8.6% respectively, for end-

FY02, continued to be high. Application of the 90-day default norm, to be effective from

March 31, 2004, would result in gross NPLs rising to over 17% of gross advances as at

end-FY02. However, under the RBIs monitor able action plan on FBL, the Bank has

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given an undertaking to bring its net NPL ratio below 7% by end-March, 2003. Net NPLs

were already down to 7.36% as of September 30, 2002. FBLs NPL composition

deteriorated in FY02 as doubtful assets as a proportion of total net NPLs increased to

over 47% compared to 37% in FY01 the previous fiscal primarily due to ageing of sub-

standard assets, and while this somewhat adds to our asset quality concerns, FBL has

been able to contain fresh accretion of NPLs in recent times. FBLs loan loss provisions

had failed to keep pace with the deterioration in its asset quality and this is reflected in its

low loan loss reserve coverage ratio, which stood at only 29.2% for end-FY02 from a

high of 32.6% in FY99. However, the coverage improved to 40% for end-September

2002 on the back of increased provisioning, and if the technical write-offs are added

back, the coverage improves further to 57.4% as at end-September 2002. FBL plans to

further reduce its NPL levels through aggressive recovery efforts and increased loan loss

provisioning. FBLs net NPLs to equity ratio improved to 77.6% for end-September 2002

from 99.34% for end-FY02 and is expected to improve further to about 56% by end-

FY03.

Market Risk: As for most Indian banks, FBL is exposed to interest rate and liquidity

risks on account of a structural maturity mismatch arising from funding the loan and

fixed-income investment portfolio through short-term customer deposits. To a large

extent these risks are mitigated by high renewal rates and relatively stable nature of the

Banks deposits and because the bulk of the Banks loans are contracted on a floating rate

basis. Even on fixed-rate loans, the Bank reserves the right to re-price them periodically.

In addition, the Banks holds government securities in excess of reserve requirements and

the portfolio has witnessed appreciation in value on account of falling interest rates.

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FUNDING AND CAPITAL

Customer deposits, especially NRI deposits, have funded FBLs growth.

Low capitalisation levels; capital ratios under pressure due to expanding asset base

and high level of NPLs.

Funding and Liquidity: FBL, like most Indian banks, is predominantly funded through

customer deposits and these accounted for 91.7% of total deposits and money market

funding as of end-March 2002. However, the deposit mix has historically been skewed

towards relatively stable but costlier term-deposits, especially the foreign currency term

deposits on account of expatriation by non-resident Indians (NRI). These NRI deposits

form approximately 45% of the total deposit base, and nearly 61% of total deposits from

branches in the state of Kerala are NRI deposits. FBL plans to reduce its funding costs

through a two-pronged strategy. Firstly, the Bank intends to phase out the premium it

pays on its NRI Deposits, and secondly, it plans to increase the share of low-cost retail

savings and demand deposits through enhanced delivery capabilities in form of

expanding branch, ATM and Internet banking network and improvised retail liability

products. Presently, the bank reports high renewal rates of its term-deposits and the

accretion to deposits has consistently exceeded the repayments. Historically, FBLs credit

to deposit ratio has been relatively high at above 55%, and consequently its liquidity

ratios have been somewhat lower. While loans as a proportion to deposits and money

market funding declined to 56.2% for end-FY02 compared to 60.6% in the previous year,

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these were still high compared with most other banks, while its quasi-liquid assets

(deposits with banks and G-Secs) comprised 33.1% of the Banks total assets. As FBLs

is expected to continue expanding its loan book in the medium-term, its liquidity ratios

are expected to remain low in the near future. The maturity profile of FBLs assets and

liabilities as on March 31, 2002 over the next five years is shown in Table 4. FBL reports

negative gaps in some of the time buckets up to one year and in the one-to-three year

time bucket. As most of these negative gaps are on account of maturing customer

deposits and given the fact that the Bank reports a high renewal rate in case of term

deposits (58% in case of domestic term deposits and 62% for NRI deposits) and high

retention in savings and demand deposits, Fitch is of the opinion that liquidity risk is

substantially mitigated.

Capital: Continued growth in FBLs asset base coupled with tightening prudential norms

in recent years has led to decline in its capital adequacy ratio. FBLs reported total capital

adequacy ratio at 10.63% for end-FY02 was slightly above the regulatory minimum of

9%, although its Tier 1 ratio at 6.96% was low, and in the absence of any fresh equity

raising, the Tier 1 ratio has hovered between 7% and 8% for the last four years. Further,

like most Indian banks, FBLs capital adequacy ratios are partly boosted by its holding of

low-risk G-Secs that accounted for nearly 26% of its total assets as of end-FY02.

Table 5: Trends in FBLs Capital Ratio

(%) FY 02 FY 01 FY 00 FY 99

Tier 1 6.96 7.72 7.72 6.48Tier 2 3.67 2.57 3.61 3.84Total 10.63 10.29 11.33 10.32

Equity/Asset 4.42 4.71 4.76 4.00

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In the past decade, FBL enhanced its equity base on two occasions first in 1994 through

its initial public offering, and then in 1996 through a rights issue; since then its capital

ratios have been supported by internal accretions and subordinated debt issuances. FBLs

capital ratios are expected to come under pressure as the Bank continues to expand and

addresses its asset quality problems through higher provisioning and write-offs over the

next few years. The low equity levels are also reflected by the Banks low equity to asset

ratio that has ranged between 4% and 5% and stood at 4.42% at end-FY02. This

emphasizes the need for the Bank to bolster its Tier 1equity levels going forward.

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BALANCE SHEET ANALYSISThe Federal

Bank Limited

31

Mar

ch

2002

(US

Dm)

31

March

2002

(INRm

)

As

%

OfAs

set

s

IN

R

m)

of

Aver

age

(INR

m)

31

Mar

ch

2001

INR

m)

As

%

OfAs

set

s

31

March

2000

INRm)

As

%

OfAs

set

s

31

Mar

ch

1999

INR

m)

As

%

OfAss

ets

A Loans

1.GuaranteedbyBanks/Gov

147.1 7,092.3 7.0 7,017.5

6,942.6

7.9 6,215.3 8.2 9,148.9

11.3

2. Secured 864.8 41,683.8

41.1

39,797.5

37,911.3

43.0

32,857.6

43.2

28,569.4

35.4

3. Unsecured 64.6 3,115.1 3.1 3,401.2

3,687.3

4.2 1,284.2 1.7 4,559.4

5.6

4. (Loan LossReserves)

n.a - 0.0 - - -

TOTAL A 1,076.6

51,891.1

51.2

50,216.2

48,541.3

55.0

40,357.1

53.1

42,277.7

52.4

B. OtherEarning Assets

1. Depositswith Banks

125.1 6,027.8 5.9 5,076.5

4,125.1

4.7 4,484.9 5.9 6,631.8

8.2

2. GovernmentSecurities

544.7 26,253.2

25.9

22,539.3

18,825.3

21.3

17,760.0

23.4

17,315.7

21.4

3. OtherSecurities

234.1 11,284.7

11.1

11,395.5

11,506.3

13.0

8,538.4 11.2

8,405.7

10.4

4. Investmentsin Subs &Joint Ventures

0.1 5.0 0.0 5.0 5.0 0.0 150.0 0.2 150.0 0.2

5. OtherInvestments

0.3 15.4 0.0 16.9 18.3 0.0 211.7 0.3 145.8 0.2

TOTAL B 904.3 43,586.1

43.0

39,033.1

34,480.1

39.1

31,145.0

41.0

32,649.0

40.4

C. TOTAL

EARNINGASSETSa+b

1,980

.9

95,477.

2

94.

1

89,24

9.3

83,02

1.4

94.

1

71,502.

1

94.

1

74,92

6.7

92.

8

D. FIXEDASSETS

27.6 1,328.7 1.3 1,330.0

1,331.4

1.5 1,449.5 1.9 1,548.2

1.9

E.NON_EARNING ASSETS

1. Cash 15.8 760.1 0.7 704.6 649.1 0.7 605.6 0.8 571.7 0.7

2. Other 80.5 3,880.2 3.8 3,539.4 3,198.6 3.6 2,468.2 3.2 3,697.8 4.6

F. Total 2,104 101,44 10 94,82 88,20 10 76,025. 10 80,74 100

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Assets .7 6.1 0.0 3.2 0.4 0.0 5 0.0 4.3 .0

The Federal

Bank Limited

31

Mar

ch

2002

(US

Dm)

31

March

2002

(INRm

)

As

%

OfAs

set

sIN

R

m)

of

Aver

age

(INR

m)

31

Mar

ch

2001

INR

m)

As

%

OfAs

set

s

31

March

2000

INRm)

As

%

OfAs

set

s

31

Mar

ch

1999

INR

m)

As

%

OfAss

ets

G. Deposits &Money MarketFunding

1. Demand 106.8 5,147.2 5.1 4,745.2

4,343.2

4.9 3,891.7 5.1

3,392. 1

4.2

2. Savings 278.4 13,419.5

13.2

12,439.9

11,460.2

13.0

9,999.1 13.2

8,468. 4

10.5

3. Time 1,372

. 4

66,149.

7

65.

2

61,

029.3

55,90

8.9

63.

4

45,265.

0

59.

5

41,86

6. 3

51.

94. Inter- bankDeposits

81. 7 3,936.7 3.9 4,439.4

4,942.1

5.6 5,478.2 7.2

14,094. 0

17.5

5. Otherborrowing

77. 6 3,741.1 3.7 3,588.6

3,436.2

3.9 3,796.2 5.0

4,883. 3

6.0

Total G 1,916. 9

92,394.1

91.1

86,242.3

80,090.5

90.8

68,430.0

90.0

72,704. 0

90.0

H. OtherFunding

1. Long- termBorrowing

n. a - 0.0 - - -

2.

SubordinatedDebt

31. 1 1,500.0 1.5 1,

500.0

1,500

.0

1.7 1,500.0 2.

0

1,500

. 0

1.9

3. HybridCapital

n. a - 0.0 - - -

I. Other (Non-Int. Bearing)

63. 6 3,064.1 3.0 2,759.6

2,455.1

2.8 2,475.6 3.3

3,314. 2

4.1

J. Loan LossReserves (SeeA Above)

n. a - 0.0 - - -

K. OtherReserves

n. a - 0.0 - - -

L. Equity 93. 1 4,487.9 4.4 4,

321.3

4,154

.7

4.7 3,619.8 4.

8

3,226

. 1

4.0

M. Total

Liabilities &

Equity

2,104

. 7

101,44

6.1

10

0.

0

94,823.2

88,20

0.

41

00.

0

76,025.

5

10

0.

0

80,74

4. 3

100

.0

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INCOME STATEMENT ANALYSIS31 March 02 31March01 31March00 31March99

Incom

e.Expenses

(INRm

)

As

% ofTotal

Av

Earn

ing

Asset

s

Incom

eExpenses

(INRm

)

As

% ofTotal

Av.

Earn

ing

Asset

s

Inco

meExpe

nses

(INR

m)

As

% ofTotal

Av.

Earn

ing

Asset

s

Incom

eExpen

ses(IN

Rm)

As

% ofTotal

Av

Earn

ing

Asset

s

1. InterestReceived

10,424. 0

11.68

9,191.7 11.90

8,817.9

12.04

8,594.4

11.96

2. Interest Paid 7, 661.5

8.58 6,821.9 8. 83 7,014.5

9. 58 7,715.7

10.74

3. Net Interest

Revenue

2, 762.

5

3.10 2,369.8 3. 07 1,803

.4

2. 46 878. 7 1. 22

4. Other OperatingIncome

2, 203.1

2.47 1,252.0 1. 62 1,323.8

1. 81 1,128.9

1. 57

5. PersonnelExpenses

1,209.6 1. 36 1, 109.0

1. 44 1,181.2

1. 61 926. 4 1. 29

6. Other Non-interest Expenses

703.1 0. 79 641.4 0. 83 590.3 0. 81 588. 3 0. 82

7. Pre- ProvisionOperating Profit

3, 052.9

3.42 1,871.4 2. 42 1,355.8

1. 85 493. 0 0. 69

8. Provision forLoan Losses

1, 555.0

1.74 1,009.6 1. 31 811.1 1. 11 392. 9 0. 55

9. Provision for

diminution inInvestments

201.5 0. 23 16. 9 0.02 - - (232.

2)

(0.

32)

10. OtherProvisions

34. 1 0.04 7.0 0. 01 (0. 0) (0.00)

307. 8 0. 43

11. OperatingProfit AfterProvisions

1,262.3 1. 41 838.0 1. 08 544.7 0. 74 24. 5 0. 03

12. Other Non-operating Income

1. 1 0.00 (1. 0) (0.00)

(0. 8) (0.00)

0.9 0. 00

13. ExceptionalIncome

- - - - - - - -

14. Pre- Tax Profit 1, 263.

4

1.42 837.0 1. 08 543.9 0. 74 25. 4 0. 04

15. Taxes 443.3 0. 50 226. 6 0.29 80. 0 0.11 0. 1 0.00

16. Net Income 820. 1 0.92 610.4 0. 79 463.9 0. 63 25. 3 0. 04

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Ratio Analysis31 Ma rch

02

31Ma rc

h0

1

31Ma

r ch0031Ma rch9

9

I. Profitability Level1. Net Income/Equity (av.) %

18.98 15.70 13. 55 0.73

2. Net Income/Total Assets (av.)

%

0.86 0.74 0.59 0.03

3. Non- int Exp/Net Interest Rev.+Other Operating

Income %

38. 52 48. 33 56. 65 75. 45

4. Net InterestRev./ Total Assets

(av.) %

2.91 2.89 2.30 1.14

5. Pre- ProvisionOperating Profit/

Total Assets (av.)%

3.22 2.28 1.73 0.64

6. Op. Profit AfterProvisions/ Total

Assets (av.) %

1.33 1.02 0.69 0.03

II. Capital Adequacy(year end)

1. Internal CapitalGeneration %

17. 22 13. 75 11. 62 0. 03

2. Equity/ TotalAssets % 4.42 4.71 4.76 4.00

3. Equity/ Loans%

8.65 8.56 8.97 7.63

4. Capital/ Risks- Tier 1 %

6.96 7.72 7.72 6.48

5. Capital/ Risks- Total %

10. 63 10. 29 11. 33 10. 32

6. Fitch GradeCapital Ratio/Total Assets %

III. Liquidity(year end)

1. Liquid Assets/Deposits &Money MktFunding %

2. Liquid Assets+ Marketable

36. 36 30. 23 34. 36 34. 75

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Debt Securities/Deposits &Money MktFunding %

3. Loans/

Deposits &Money MktFunding %

56. 16 60. 61 58. 98 58. 15

IV. Asset Quality

1. Provision forLoan Losses/Loans (av.) %

3.10 2.27 1.96 0.96

2. Provisions forLoan Losses/Pre- prov. Op.Profit %

50. 93 53. 95 59. 83 79. 70

3. Loan LossReserves/ Loans%

3.59 3.06 3.44 3.70

4. Loan LossReserves/Impaired Loans%

29. 21 23. 14 28. 34 32. 61

5. Gross NPL's/Loans %

11. 88 12. 84 11. 75 10. 93

6. Net NPL's/Equity %

99. 34 117.78

95. 31 98. 61

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CASE II

AAA RATING FOR ICICI BANK LTD

The rating agency has reaffirmed the AAA [Triple A] rating assigned to the various

outstanding debt instruments of ICICI Bank Ltd (IBL). Instruments carrying this rating

are considered to be of the best quality, carrying negligible investment risk. Debt service

payments are protected by stable cash flows with good margins. While the underlying

assumptions may change, such changes as can be visualized are most unlikely to impair

the strong position of such instrument. CARE has also reaffirmed the PR1+ [PR One

Plus] rating assigned to the Rs.30 bn Certificate of Deposit programme of IBL and Short

term Deposit programme aggregating Rs.76.58 bn. This rating indicates superior capacity

for repayment of short-term promissory obligations. The rating factors in IBLs strong

market position, its proactive management, the measures taken by it to diversify and

reduce its loan portfolio risk as also to adapt to the changing external environment, its

resource raising strengths, strong technology infrastructure, its significant retail reach and

satisfactory capital adequacy. IBLs importance in the Indian banking sector as also the

significant ownership by institutional investors are also factors that have a favourable

impact on rating. However, legacy of weak assets inherited from erstwhile ICICI remains

a concern and improving asset quality amidst a difficult economic scenario will remain a

challenge for the banks management. IBL was promoted in 1994, jointly by ICICI (75%

equity stake) and SCICI Ltd. (25%). In March 2000, In March 2001, IBL acquired Bank

of Madura (BoM), a south based old private sector bank, in an all-stock deal to improve

its retail reach. As on March

Credit Rating of Bank Financial

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