Report on Credit Appraisal in PNB (1)

7/29/2019 Report on Credit Appraisal in PNB (1)

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Credit Appraisal in Punjab National Bank

Pre-Sanction And Post-Sanction Follow-up

Submitted in partial fulfillment of PGDM program

2011-2013

Submitted by

Name Kanika Rai

Roll No- FB11078

Faculty Mentor

Ms Dilpreet Kaur

JAGAN INSTITUTE OF MANAGEMENT STUDIES

ROHINI

DELHI


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Credit appraisal in PNB

Chapter 1 EXECUTIVE SUMMARY

This project was undertaken at the Punjab National Bank Circle Office Delhi, at the Credit

Department. Financial requirements for Project Finance and Working Capital purposes are taken

care of at the Credit Department. Companies that intend to seek credit facilities approach the

bank. Primarily, credit is required for following purposes:

a. Working capital finance

b. Term loan for mega projects

c. Non Fund Based Limits like Letter of Guarantee, Letter of Credit etc.

Project Financing discipline includes understanding the rationale for project financing, how to

prepare the financial plan, assess the risks, design the financing mix, and raise the funds. In

addition, one must understand some project financing plans have succeeded while others have

failed. A knowledge-base is required regarding the design of contractual arrangements to support

project financing; issues for the host government legislative provisions, public/private

infrastructure partnerships, public/private financing structures; credit requirements of lenders, and

how to determine the project's borrowing capacity; how to analyze cash flow projections and use

them to measure expected rates of return; tax and accounting considerations; and analytical

techniques to validate the project's feasibility

Project finance is different from traditional forms of finance because the credit risk associated

with the borrower is not as important as in an ordinary loan transaction; what is most important is

the identification, analysis, allocation and management of every risk associated with the project.

The purpose of this project is to explain, in a brief and general way, the manner in which risks are

approached by financiers in a project finance transaction. Such risk minimization lies at the heart

of project finance. Efficient management of credit portfolio is of utmost importance as it has a

tremendous impact on the Banks assets quality & profitability. The ongoing financial reforms

Jagan Institute of Management Studies,Delhi

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have no doubt provided unparallel opportunities to banks for growth, but have simultaneously

exposed them to various risks, which need to be effectively managed.

The concept of Credit Management is undergoing radical changes. Credit Risk in all exposures

calls for precise measuring and monitoring for taking considered credit decisions with suitable

risk mitigants, risk premium, etc. Credit portfolio should be well diversified in various promising

sectors with a cautious approach to be adopted in risky segments.

Also, lending continues to be a primary function in banking. In the liberalized Indian economy,

clientele have a wide choice. External Commercial Borrowings and the domestic capital markets

compete with banks. In another dimension, retail lending- both personal advances and SME

advances- competes with corporate lending for funds and for human resources. But lending by

nature cannot be an aggressive selling activity, disregarding the risks involved. Bank has to be

competitive without compromising on the basic integrity of lending. The quality of the Banks

credit portfolio has a direct and deep impact on the Banks profitafitability.

The study has been conducted with the purpose of getting in-depth knowledge about the credit

appraisal and credit risk management procedure in the organization for the above said first two

purposes.

Chapter2 CREDIT APPRAISAL AN INTRODUCTION


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OBJECTIVES -

To study broad contours of management of credit, the loan policy, credit appraisal for

business units i.e. for working capital loan or Term Loan.

To understand the basis of credit risk rating and its significance .

To utilize the above learning and appraise the creditworthiness organizations those

approach PUNJAB NATIONAL BANK for credit. This would entail undertaking of the

following procedures:

i. Management Evaluation

ii. Business / Industry Evaluation

iii. Technical Evaluation

iv. Legal Evaluation

v. Financial Evaluation

vi. Credit Risk Rating

Project / Credit appraisal is a skill which has to be acquired by study and supplemented by

practice. Intuitive guess work has little place in appraising the credit rating or credit needs of a

corporate unit. The credit managers of banks and Non Banking Finance Companies (NBFCs) are

duty bound to accept or reject a proposal on the basis of its viability or non - viability.


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Project / Credit appraisal is done by banks or financial institutions by obtaining credit information

of the borrowing company.

Credit information of the borrowing company can be obtained by the following sources:

1. Banks and Financial Institution

2. Bank References

3. Trade References Credit Rating Agencies

4. Published Books: Basic information about a company may be taken from printed

sources like the Stock Exchange Year book, Corporate Path finders data base, etc.

5. Company Financial Reports

6. Press Reports

7. Stock Market Opinion

8. Charges Registered: Charges created on the assets of a company have to be registered

with the Registrar of Companies.

9. Personal discussion

10. Factory Visit

11. Credit Rating Agencies

12.Published Books: Basic information about a company may be taken from printed



14. Press Reports


16.Charges Registered: Charges created on the assets of a company have to be registered



18. Factory Visit


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19.Study of Financial Statements: Financial analysis determines the significant operating

and financial characteristics of a firm form accounting data and financial statements.

Analysis can be done through:

a. Ratio Analysis

b. Trend analysis: Trend analysis can be through:

i. Intra firm comparison that is review of the trend of the ratios over the years

within the firm and

ii. Inter firm comparison.

c. Reading of notes to accounts and other information: Careful reading and

analysis of the notes on accounts, one can gauge the policies of the management,

performance of the company, and its future planning.

20. Credit Rating Agencies

21.Published Books: Basic information about a company may be taken from printed



23. Press Reports


25.Charges Registered: Charges created on the assets of a company have to be registered



27. Factory Visit

Information required to be submitted by the Company (Borrower) to the Bank

The company should make sure that the following information required for processing credit

requests are collected by the company for submitting it to the bank or financial institution in order

to obtain the required credit facility:

1. Basic background information on the company:

2. Required facility


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3. Key industry dynamics:

4. Management:

5. Management information system: Details of the planning, controlling and monitoring

systems which have been put in place have to given.

6. Financials

7. Details of the Security to be pledged:

8. Present banking relationship: The bank requires full details of the present credit

facilities being enjoyed at the moment.

Chapter6 COMPANY PROFILE


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Punjab National Bank (PNB) was set up in 1895 in Lahore - and has the distinction of being the

first Indian bank to have been started solely with Indian capital. The bank was nationalized in July

1969 along with 13 other banks. Today, PNB is a professionally managed bank with a successful

track record of over 110 years. The bank has the 2nd largest branch network in India, with 4525

branches including 432 extension counters spread throughout the country. PNB was ranked as

248th biggest bank in the world by Bankers Almanac, London. Punjab National Bank is not only

the first bank to specialize in credit rating models in India but also the first one to launch image

based cheque transaction system for collection of intra bank intercity cheques thereby providing

credits merely in 48 hrs in 13 cities.

CORPORATE VISION

To be a Leading Global Bank with Pan India footprints and become

a household brand in the Indo-Gangetic Plains providing entire

range of financial products and services under one roof

MISSION Banking for the unbanked

With over 56 million satisfied customers and 5002 offices, PNB has continued to retain its

leadership position amongst the nationalized banks. From its modest beginning; the bank has

grown in size and stature to become a front-line banking institution in India at present. Based on

its sound and prudent banking experience and consistent profit performance, PNB looks

confidently to the futurethe name you can bank upon

PNB has achieved significant growth in business which at the end of March 2010 amounted to Rs

4,35,931 crore. Today, with assets of more than Rs 2,96,633 crore, PNB is ranked as the 3rd

largest bank in the country (after SBI and ICICI Bank) and has the 2nd largest network of

branches (5002 offices including 5 overseas branches ). During the FY 2009-10, with 40.85%

share of CASA deposits, the bank achieved a net profit of Rs 3905 crore. Bank has a strong

capital base with capital adequacy ratio of 14.16% as on Mar10 as per Basel II with Tier I and

Tier II capital ratio at 9.15% and 5.01% respectively. As on March10, the Bank has the Gross and

Net NPA ratio of 1.71% and 0.53% respectively. During the FY 2009-10, its ratio of Priority


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Sector Credit to Adjusted Net Bank Credit at 40.5% & Agriculture Credit to Adjusted Net Bank

Credit at 19.7% was also higher than the stipulated requirement of 40% & 18%.

Products and Services of PNB :

(1) PNB UPHAAR PREPAID CARD This card is used mainly in festival season basically

to gift as well it targets students and for segment who is not having Bank Accounts.

(2) WORLD TRAVEL CARD Frequent Travellers who are going Abroad can use this card

and make their travelling easy and comfortable. Students, Businessman can easily take the

facility of this card and enjoy their trip.

(3) PNB BAL VIKAS DEPOSIT SCHEME PNB BAL VIKAS DEPOSIT SCHEME

provides a deposit product with feature of monthly recurring deposit for first five years

and thereafter the maturity value of RD would be placed in FIXED DEPOSIT scheme

under income option for the next 5 Years. The objective of the scheme is to provide

regular income for the future studies for the child.

ORGANIZATIONAL STRUCTURE


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Hierarchy


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Chapter7 REVIEW OF LITERATURE


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7.1WORKING CAPITAL AND ITS ASSESSMENT

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

fixed assets like land and building, plant and machinery, equipments, vehicles etc and also torun the business i.e. its day to day operations.

Working capital is defined, as the funds required for carrying the required levels of current assets

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

capital required (WCR) is dependent on

i. The volume of activity (viz. level of operations i.e. Production and Sales)

ii. The activity carried on viz. manufacturing process, product, production programme, and

the materials and marketing mix.

The purpose of assessing the WC requirement of the industry is to determine how the total

requirements of funds will be met. The two sources for meeting these requirements are the units

long-term sources (like capital and long term borrowings) and the short-term borrowings from

banks. The long-term resources available to the unit are called the liquid surplus or Net Working

Capital (NWC).

It can be explained by visualizing the process of setting up of industry. The units starts with a

certain amount of capital, which will not normally be sufficient, even to meet the cost of fixed

assets. The unit, therefore, arranges for a long-term loan from a financial institution or a bank

towards a part of the cost of fixed assets. From these two sources after meeting the cost of fixed

assets some funds remain to be used for working capital. This amount is the Net Working Capital

or Liquid Surplus and will be one of the sources of meeting the working capital requirements.

The remaining funds for working capital have to be raised from banks; banks normally provide

working capital finance by way of advantage against stocks and sundry debtors. Banks, however,

do not finance the full amount of funds required for carrying inventories and receivables: and

normally insist on the stake of the enterprise at every stage, by way of margins. Bank finance is

normally restricted to the amount of funds locked up less a certain percentage of margins. Margins

are imposed with a view to have adequate stake of the promoter in the business both to ensure his

adequate interest in the business and to act as a protection against any shocks that the business


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may sustain. The margins stipulated will depend on various factors like salability, quality,

durability, price fluctuations in the market for the commodity etc. taking into account the total

working capital requirements as assessed earlier, the permissible limit, up to which the bank

finance cab be granted is arrived.

While granting working capital advances to a unit, it will be necessary to ensure that a reasonable

proportion of the working capital is met from the long-term sources viz. liquid surplus. Normally,

liquid surplus or net working capital be at least 25% of the working capital requirement

(corresponding to the benchmark current ratio of 1.33), though this may vary depending on the

nature of industry/ trade and business conditions.

Various methods for assessment of Working Capital are discussed in detail:

Operating cycle method:

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

raw materials for cash, converting them into finished goods and realizing cash by sale of these

finished goods. The time that lapses between cash outlay and cash realization by sale of finished

goods and realization of sundry debtors is known as length of operating cycle. That is, the

operating cycle consists of:

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

Conversion process time

Average period for which finished goods are in store and

Average collection period of receivables (sundry debtors).

Operating Cycle is also called cash-to-cash and indicates how cash is converted into raw

materials, stocks in process, finished goods, bills (receivables) and finally backs to cash. Working

capital is the total cash that is circulating in this cycle. Therefore, working capital can be turned

over or deployed after completing the cycle. Factors, which influence working capital

requirement, are Level of operating expenses and Length of operating cycle.


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Any reduction in either of the both will mean reduction in working capital requirement or indicate

an efficient working capital management.

It can thus be concluded that by improving that by improving the working capital turnover ratio

(i.e. by reducing the length of operating cycle) a better management (utilization) of working

capital results. It is obvious that any reduction in the length of the operating cycle can be achieved

only by better management only by better management of one or more of the individual phases of

the operating cycle period for which raw materials are in store, conversion process time, period

for which finished goods are in store and collection period of receivables. Looking at whole

problem from another angle, we find that we can set up extremely clear guidelines for working

capital management viz. examining the length of each of the phases of the operating cycle to

assess the scope for reduction in one or more of these phases.

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

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

be quite different from one engaged in the manufacture of machine tools. The operating cycle

concept enables to assess working capital need of each enterprise keeping in view the peculiarities

of the industry it is engaged in and its scale of operations. Operating cycle is an important

management tool in decision making.

1. Traditional method of assessment of working capital requirement

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

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

various components of working capital requirement viz., finance for stocks, bills etc.


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FUND RM SIP RECEIVABLES FUND


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Bankers provide working capital finance for holding an acceptable level of current assets viz. raw

materials, stock-in-process, finished goods and sundry debtors for achieving a predetermined level

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

items of current assets at any time will, therefore provide a measure of the working capital

requirement of an industry.

Raw material: Any industrial unit has to necessarily stock a minimum quantum of materials used

in its production to ensure uninterrupted production. Factors, which affect or influence the funds

requirement for holding raw material, are:

i. Average consumption of raw materials.

ii. Their availability locally or form places outside, easy availability / scarcity,

number of sources of supply

iii. Time taken to procure raw materials (procurement time or lead time)

iv. Imported or indigenous.

v. Minimum quantity supplied by the market (Minimum Order Quantity (MOQ)).

vi. Cost of holding stocks (e.g. insurance, storage, interest)

vii. Criticality of the item.

viii. Transport and other charges (Economic Order Quantity (EOQ)).

ix. Availability on credit or against advance payment in cash.x. Seasonality of the materials.

This raw material requirement is generally expressed as so many months requirement

(consumption).

Stock in process: Barring a few exceptional types of industries, when the raw material get

converted into finished products within few hours, there is normally a time lag or delay or period

of processing only after which the raw materials get converted into finished product. During this

period of processing, the raw materials get converted into finished goods and expenses are being

incurred. The period of processing may vary from a few hours to a number of months and unit

will be blocked working funds in the stock-in-process during this period. Such funds blocked in

SIP depend on:


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i.The processing time

ii.Number of products handled at a time in the process

iii.Average quantities of each product, processed at each time (batch quantity)

iv.The process technology

v.Number of shifts.

Finished goods: All products manufactured by an industry are not sold immediately. It will be

necessary to stock certain amount of goods pending sale. This stock depends on:

i. Whether the manufacture is against firm order or against anticipated order

ii. Supply terms

iii. Minimum quantity that can be dispatched

iv. Transport availability and transport cost

v. Pre-dispatch inspection

vi. Seasonality of goods

vii. Variation in demand

viii. Peak level/ low level of operations

ix. Marketing arrangement- e.g. direct sale to consumers or through dealers/

wholesalers.

The requirement of funds against finished goods is expressed so many months cost of production.

Sundry debtors (receivables): Sales may be affected under three different methods:

i. Against advance payment

ii. Against cash

iii. On credit

A unit grants trade credit because it expects this investment to be profitable. It would be in theform of sales expansion and fresh customers or it could be in the form of retention of existing

customers. The extent of credit given by the industry normally depends upon:

i. Trade practices

ii. Market conditions


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iii. Whether it is bulky by the buyer

iv. Seasonality

v. Price advantage

Even in cases where no credit is extended to buyers, the transit time for the goods to reach the

buyer may take some time and till the cash is received back, the unit will have to be cut out of

funds. The period from the time of sale to receipt of funds will have to be reckoned for the

purpose of quantifying the funds blocked in sundry debtors. Even though the amount of sundry

debtors according to the units books will be on the basis of Sale Price, the actual amount blocked

will be only the cost of production of the materials against which credit has been extended- the

difference being the units profit margin- (which the unit does not obviously have to spend). The

working capital requirement against Sundry Debtors will therefore be computed on the basis of

cost of production (whereas the permissible bank finance will be computed on basis of sale value

since profit margin varies from product to product and buyer to buyer and cannot be uniformly

segregated from the sale value).

The working capital requirement is expressed as so many months cost of production.

Expenses: It is customary in assessing the working capital requirement of industries, to provide

for 1 months expenses also. A question might be raised as to why expenses should be takenseparately, whereas at every stage the funds required to be blocked had been taken into account.

This amount is provided merely as a cushion, to take care of temporary bottlenecks and to enable

the unit to meet expenses when they fall due. Normally 1-month total expenses, direct and

indirect, salaries etc. are taken into account.

While computing the working capital requirements of a unit, it will be necessary to take into

account 2 other factors,

i. Is the credit received on purchases- trade credit is a normal practice in trading

circles. The period of such credit received varies from place to place, material to

material and person to person. The amount of credit received on purchases reduces

the working capital funds required by the unit.


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ii. Industries often receive advance against orders placed for their products. The

buyers, in certain cases, have to necessarily give advance to producers e.g. custom

made machinery. Such funds are used for the working capital of an industry. It can

be thus summarized as follows:

Raw materials Months requirement Rs. A

Stock-in-process Months (cost of Production) Rs. B

Finished Goods Months cost of Production required to be stocked Rs. C

Sundry Debtors Months cost of Production (o/s credits) Rs. D

Expenses One month(normally) Rs. E

Total Current Assets A+B+C+D+E

Credit received on Purchases(months Purchase value)

Rs. F

Advance payment on orderreceived

Rs. G

WORKING CAPITAL REQUIRED (H) = (A+B+C+D+E)- (F+G)


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2. Projected Annual Turnover Method for SME units (Nayak Committee)

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

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

or annual turnover value should be computed as the quantum of working capital required by such

unit. The unit should be required to bring in 5% of their annual turnover as margin money and the

Bank shall provide 20% of the turnover as working capital finance. Nayak committee guidelines

correspond to working capital limits as per the operating cycle method where the average

production/ processing cycle is taken to be 3 months.

Example:

Anticipated Annual Output (A) 120

Working Capital Requirement: 25% of A (B) 30

Margin : 5% of A (C) 6

Maximum Permissible Bank Finance (B-C) 24

In Rs lacs

Important clarifications:

i. The assessment of WC limits should be done both as per Projected Turnover Method and

Traditional Method; the higher of the two is to be sanctioned as credit limit. If the

operating cycle is more than 3 months, there is no restriction on extending finance at more

than 20% of the turnover provided that the borrower should bring n proportionally higher

stake in relation to his requirements of bank finance.

ii. While the approach of extending need based credit will be kept in mind, the financial

strengths of the unit is also important, the later aspect assumes greater significance so as to

take care of quality of banks assets. The margin requirement, as a general rule, should not

be diluted.


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MPBF Method (Tandon and Chore Committee Recommendations)

The Tandon Committee was appointed to suggest a method for assessing the working capital

requirements and the quantum of bank finance. Since at that time, there was scarcity of banks

resources, the Committee was also asked to suggest norms for carrying current assets in different

industries so that bank finance was not drawn more than the minimum required level. The

Committee was also asked to devise an information system that would provide, periodically,

operational data, business forecasts, production plan and resultant credit needs of units. Chore

Committee, which was appointed later, further refined the approach to working capital

assessment. The MPBF method is the fall out of the recommendations made by Tandon and Chore

Committee.Regarding approach to lending: the committee suggested three methods for assessment

of working capital requirements.

First Method of lending: According to this method, Banks would finance up to a max. of

75% of the working capital gap (WCG= the total current assets - current liabilities other than bank

borrowing) and the balance 25 % of the WCG considered as margin is to come out of long term

source i.e. owned funds and term borrowings. This will give rise to a minimum current ratio of

1.17:1. The difference of (1.17-1) represents the borrowers margin which is popularly known as

Net Working Capital (NWC) of the unit

Second Method of lending: As per the 2

nd

method Bank will finance maximum up to 75%of total current assets (TCA) & Borrowers has to provide a minimum of 25% of total current

assets as the margin out of long term sources. This will give a minimum current ratio of 1.33:1

Third Method of lending: Same as 2nd method, but excluding core current assets from

total assets and the core current assets is financed out of long term funds. The term core current

assets refers to the absolute minimum level of investment in current assets, which is required at

all times to carry out minimum level of business activity. The current ratio is further improved i.e.

1.79: 1


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Example:

Current Liabilities Current assets

Creditors for purchase 100 Raw material 200

Other current liability 50 Stock in process 20

Bank borrowings 200 Finished goods 90

Receivables 50

Other current assets 10

Total Current Liabilities 350 Total Current Assets 370

(In Rs lacs)

Calculating NWC

First method of lending Second method of lending Third method of lending

Total CA 370 Total CA 370 Total CA 370

Less: CL Bank

Borrowing150 Less: 25% of CA 92

Less: core CA from

LT95

275

Working Capital Gap 220Less: CL - Bank

Borrowing150

Less: 25% from

LTS69

25% of WCG from

long term sources55

Less: CL Bank

Borrowing150

MPBF 165 MPBF 128 MPBF 56

Current ratio 1.17: 1 Current ratio 1.33: 1 Current ratio 1.79: 1

The above example shows that the contribution of margin by the borrower increases when

financing is shifted from First method to Second method which is known to be stringent from

borrower point of view (Third method was not accepted by RBI).


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3. Projected Balance Sheet Method (PBS)

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

manufacturing, services and trading activities who require fund based working capital finance of

Rs. 25 lacs and above. In case of SSI borrowers, who require working capital credit limit up to Rs.

5 cr, the limit shall be computed on the basis of Nayak Committee formula as well as that based

on production and operating cycle of the unit and the higher of the two may be sanctioned.. The

assessment will be based on the borrowers projected balance sheet, the funds flow planned for

current/ next year and examination of the profitability, financial parameters etc. unlike the MPBF

method, it will not be necessary in this method to fix or compute the working capital finance on

the basis of a stipulated minimum level of liquidity (Current Ratio). The working capital

requirement worked out is based on the following:

i. CMA assessment method is continued with certain modifications.

ii. Analysis of the Profit and Loss account, Balance Sheet, Funds flow etc. for the past

periods is done to examine the profitability, financial position, and financial

management etc of the business.

iii. Scrutiny and validation of the projected income and expenses in the business and

projected changes in the financial position (sources and uses of funds). This is carried

out to examine whether these parameters are acceptable from the angle of liquidity,

overall gearing, efficiency of operations etc.

In the PBS method, the borrowers total business operations, financial position, management

capabilities etc. are analysed in detail to assess the working capital finance required and to

evaluate the overall risk. The assessment procedure is as follows:

i. Collection of financial information from the borrower

ii. Classification of current assets / current liabilities

iii. Verification of projected levels of inventory/ receivables/ sundry creditors

iv. Evaluation of liquidity in the business operation

v. Validation of bank finance sought


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7.2ASSESSMENT OF TERM LOANS

vi. Term Loans are generally granted to finance capital expenditure, i.e. for acquisition of

land, building and plant and machinery, required for setting up a new industrial

undertaking or expansion/diversification of an existing one and also for acquisition of

movable fixed assets. Term Loans are also given for modernization, renovation, etc. to

improve the product quality or increase the productivity and profitability.

vii. The basic difference between short-term facilities and term loans is that short-term

facilities are granted to meet the gap in the working capital and are intended to be

liquidated by realization of assets, whereas term loans are given for acquisition of

fixed assets and have to be liquidated from the surplus cash generated out of earnings.

They are not intended to be paid out of the sale of the fixed assets given as security for

the loan. This makes it necessary to adopt a different approach in examining the

application of the borrowers for term credits.

viii. For the assessment to Term Loan Techno Economic Feasibility Study is done. The

success of a feasibility study is based on the careful identification and assessment of all

of the important issues for business success. A detailed Project Report is submitted by

an entrepreneur, prepared by a approved agency or a consultancy organization. Such

report provides in-depth details of the project requesting finance. It includes the

technical aspects, Managerial Aspect, the Market Condition and Projected performance

of the company. It is necessary for the appraising officer to cross check the information

provided in the report for determining the worthiness of the project.

ix. The feasibility study is a part of Credit Appraisal process and the same is discussed in

the following chapter.


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7.3BASEL ACCORD & RISK MANAGEMENT

The Basel accord/accords refer to the banking supervision accords namely Basel I and Basel II

issued by the Basel Committee on Banking Supervision (BCBS).

BASEL I ACCORD

The 1988 Basel Accord primarily addressed banking in the sense of deposit taking and lending.

The main focus was Credit Risk. It described the strength of the Bank as measured by the Capital

employed. Accordingly it put a minimum level of capital adequacy (Capital to Credit Risk

Weighted Assets ratio) at 8%. Basel I allocated 4 risk weights i.e. 0%, 20, 50% and 100% to

different exposure types, based on the risk perceived on the exposure types under the credit

portfolio. Basel I provided a set norm for capital allocation which helped many banks to allocate

capital to counter the risks faced by them.

CRAR = Capital

Risk Weighted Assets (Credit Risk+ Market Risk +Operational Risk)

CAPITAL

Tier I

Capital

Paid Up Equity Capital + Statutory Reserves + Other disclosed free

reserves + Capital Reserves representing surplus arising out of sale

proceeds of Assets + Innovative Perpetual Debt instruments

Tier II

Capital

Revaluation Reserves (at a discount of 55%) + General Provisions and

Loss Reserves + Subordinated Debt + Hybrid Debt Capital

Instruments

Risk Weighted Assets

Basel I introduced the concept of Risk Weighted Assets (RWA). All the assets of a bank

(advances, investments, fixed assets etc.) carry certain amount of risk. In proportion to the

quantum of this risk, bank must maintain capital. Quantification of risk is done in percentage (0%,

20%, 50% etc.). Exposure when multiplied with these percentages gives risk based value of

assets. These assets are also called Risk Weighted Assets (RWA).


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BASEL II ACCORD

Banking has changed dramatically since the Basel I document of 1988. Advances in risk

management and the increasing complexity of financial activities / instruments prompted

international supervisors to review the appropriateness of regulatory capital standards under Basel

I. To meet this requirement, the Basel I accord was amended and refined which came out as the

Basel II document. The Basel II document is structured into three parts. Each part is called as a

pillar. Thus these three parts constitute three pillars of Basel II.

PILLAR IThis pillar is compatible with the credit risk, market risk and operational

risk. The regulatory capital will be focused on these three risks

PILLAR IIThis pillar gives the bank responsibility to exercise the best ways to managethe risk specific to that bank. It also casts responsibility on the supervisors to

review and validate banks risk measurement models.

PILLAR IIIThis pillar is on market discipline is used to leverage the influence that other

market players can bring

DIFFERENCE BETWEEN

BASEL I BASEL II

1 Limited role of collateral as risk mitigant 1Recognizes wide range of Collateral &

Guarantees as risk mitigant

2 Not recognizing Operational Risk 2Recognizes Operational Risk and prescribes

explicit capital charge for

3Risk weights assignment on transaction

basis3 Risk weight assignment on risk rating basis

4

Not recognizing tenure or remaining time

to maturity of exposures in risk

assessment

4Recognizes the tenure or remaining time to

maturity of exposures in risk assessment

5Provisions are through AssetClassification. 5

Provisions are through Expected Loss

Estimation

Chapter8 CREDIT APPRAISAL


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8.1INTRODUCTION

Effectiveness of Credit Management in the bank is highlighted by the quality of its loan portfolio.

Every Bank is striving hard to ensure that its credit portfolio is healthy and that Non Performing

Assets are kept at lowest possible level, as both of these factors have direct impact on its

profitability. In the present scenario efficient project appraisal has assumed a great importance as

it can check and prevent induction of weak accounts to our loan portfolio. All possible steps need

to be taken to strengthen pre sanction appraisal as always Prevention is better than Cure. With

the opening up of the economy rapid changes are taking place in the technology and financial

sector exposing banks to greater risks, which can be broadly classified as under:

Industry Risks

Government regulations and policies, availability of infrastructure facilities,

Industry Rating, Industry Scenario & Outlook, Technology Up gradation,

availability of inputs, product obsolescence, etc.

Business Risks

Operating efficiency, competition faced from the units engaged in similar

products, demand and supply position, cost of labor, cost of raw material

and other inputs, pricing of product, surplus available, marketing, etc.

Management Risks

Background, integrity and market standing/ reputation of promoters,

organizational set up and management hierarchy, expertise/competence of

persons holding key position in the organization, delegation and

decentralization of authority, achievement of targets, track record in

execution of project, debt repayment, industry relations etc.

Financial Risks

Financial strength/standing of the promoters, reliability and reasonableness

of projections, past financial performance, reliability of operational data and

financial ratios, adequacy of provisioning for bad debts, qualifying remarks

of auditors/inspectors etc.

In light of the foregoing risks, the banks appraisal methodology should keep pace with ever

changing economic environment. The appraisal system aims to determine the credit

needs/requirements of the borrower taking into account the financial resources of the client. The


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end objective of the appraisal system is to ensure that there is no under - financing or over -

financing. Following are the aspects, which need to be scrutinized and analyzed while appraising:

8.2MARKET ANALYSIS

(Demand & Potential)

The market demand and potential is to be examined for each product item and its

variants/substitutes by taking into account the selling price of the products to be marketed vis-a-

vis prices of the competing products/substitutes, discount structure, arrangement made for after

sale service, competitors' status and their level of operation with regard to production and products

and distribution channels being used etc. Critical analysis is required regarding size of the marketfor the product(s) both local and export, based on the present and expected future demand in

relation to supply position of similar products and availability of the other substitutes as also

consumer preferences, practices, attitudes, requirements etc. Further, the buy-back arrangements

under the foreign collaboration, if any, and influence of Government policies also needs to be

considered for projecting the demand. Competition from imported goods, Government Import

Policy and Import duty structure also need to be evaluated.

8.3TECHNICAL ANALYSIS

In a dynamic market, the product, its variants and the product-mix proposed to be manufactured in

terms of its quality, quantity, value, application and current taste/trend requires thorough

investigation.

Location and Site

Based on the assessment of factors of production, markets, Govt. policies and other factors,

Location (which means the broad area) and Site (which signifies specific plot of land) selected for

the Unit with its advantages and disadvantages, if any, should be such that overall cost is

minimized. It is to be seen that site selected has adequate availability of infrastructure facilities

viz. Power, Water, Transport, Communication, state of information technology etc. and is in


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agreement with the Govt. policies. The adequacy of size of land and building for carrying out its

present/proposed activity with enough scope for accommodating future expansion needs to be

judged.

Raw Material

The cost of essential/major raw materials and consumables required their past and future price

trends, quality/properties, their availability on a regular basis, transportation charges, Govt.

policies regarding regulation of supplies and prices require to be examined in detail. Further, cost

of indigenous and imported raw material, firm arrangements for procurement of the same etc.

need to be assessed.

Plant & Machinery, Plant Capacity and Manufacturing Process

The selection of Plant and Machinery proposed to be acquired whether indigenous or imported

has to be in agreement with required plant capacity, principal inputs, investment outlay and

production cost as also with the machinery and equipment already installed in an existing unit,

while for the new unit it is to be examined whether these are of proven technology as to its

performance. The technology used should be latest and cost effective enabling the unit to compete

in the market. Purchase of reconditioned/old machinery is to be dealt in terms of laid down

guidelines. Compatibility of plant and machinery, particularly, in respect of imported technology

with quality of raw material is to be kept in view. Also plant and machinery and other equipments

needed for various utility services, their supply position, specification, price and performance as

also suppliers' credentials, and in case of collaboration, collaborators' present and future support

requires critical analysis. Plant capacity and the concept of economic size has a major bearing on

the present and future plans of the entrepreneur(s) and should be related to the availability of raw

material, product demand, product price and technology.

The selected process of manufacturing indicating the adequacy, availability and suitability of

technology to be used along with plant capacity, manufacturing process needs to studied in detail

with capacities at various stages of production being such that it facilitates optimum utilization

and ensures future expansion/ debottlenecking, as and when required. It is also to be ensured that


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arrangements are made for inspection at intermediate/final stages of production for ensuring

quality of goods on successful commencement of production and completion, wherever required.

8.4FINANCIAL ANALYSIS

The aspects which need to be analyzed under this head should include cost of project, means of

financing, cost of production, break-even analysis, financial statements as also profitability/funds

flow projections, financial ratios, sensitivity analysis which are discussed as under:

Cost of Project & Means of Financing

a. The major cost components of any project are land and building including transfer,

registration and development charges as also plant and machinery, equipment for auxiliary

services, including transportation, insurance, duty, clearing, loading and unloading charges

etc. It also involves consultancy and know-how expenses which are payable to foreign

collaborators or consultants who are imparting the technical know-how. Recurring annual

royalty payment is not reflected under this head but is accounted for under the profitability

statements. Further, preliminary expenses, such as, cost of incorporation of the Company, its

registration, preparation of feasibility report, market surveys, pre-operative expenses like

salary, travelling, start up expenses, mortgage expenses incurred before commencement of

commercial production also form part of cost of project. Also included in it are capital issue

expenses which can be in the form of brokerage, commission, advertisement, printing,

stationery etc. Finally, provisions for contingencies to meet any unforeseen expenses, such

as, price escalation or any other expense which have been inadvertently omitted like margin

for working capital requirements required to complete the production cycle, interest during

construction period, etc. are also part of capital cost of project. It is to be ensured while

appraising the project that cost and various estimates given are realistic and there is no

under/over estimation. Further, these cost components should be supported by proper

quotations, specifications and justifications of land, machinery and know-how expenses etc.

ii. Besides Banks loan, the project cost is normally financed by bringing capital by the

promoters and shareholders in the form of equity, debentures, unsecured long term loans and


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deposits raised from friends and relatives which are not repayable till repayment of Bank's

loan. Resources are raised for financing project by raising term loans from Institutions/Banks

which are repayable over a period of time, deferred term credits secured from suppliers of

machinery which are repayable in installments over a period of time. The above is an

illustrative list, as the promoters have now started raising funds through Euro-issues, Foreign

Currency loans, premium on capital issues, etc. which are sometimes comparatively cheap

means of finance. Subsidies and development loans provided by the Central/State

Government in notified backward districts to attract entrepreneurs are also means of financing

a project. It is to be ascertained that requirement of finance has been properly tied-up for

unhindered implementation of a project. The financing structure accepted must be in

consonance with generally accepted levels along with adequate Promoters' stake. The

resourcefulness, willingness and capacity of promoter to contribute the same have also to be

investigated.

In case of project finance, the promoter/borrower may bring in upfront his contribution (other

than funds to be provided through internal generation) and the branches should commence its

disbursement after the stipulated funds are brought in by the promoter/borrower. A condition

to this effect should be stipulated by the sanctioning authority in case of project finance, on

case to case basis depending upon the resourcefulness and capacity of the promoter to

contribute the same. It should be ensured that at any point of time, the promoters

contribution should not be less than the proportionate share.

Profitability Statement

The profitability statement which is also known as `Income and Expenditure Statement' is

prepared after considering the net sales figure and details of direct costs/expenses relating to raw

material, wages, power, fuel, consumable stores/spares and other manufacturing expenses to


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arrive at a figure of gross profit. Thereafter, all other expenses like salaries, office expenses,

packing, selling/distribution, interest, depreciation and any other overhead expenses and taxes are

taken into account to arrive at the figure of net profit. The projections of profit/loss are prepared

for a period covering the repayment of term loans. The economic appraisal includes scrutinizing

all the items of cost, and examining the assumptions, if any, to ensure that these are realistic and

achievable. There should not be any optimism or pessimism in working out profitability

projections since even a little change in the product-mix from non-remunerative to remunerative

or vice-versa can distort the picture. While preparing profitability projections, the past trends of

performance in an industry and other environmental factors influencing the cost and revenue items

should also be considered objectively.

Generally speaking, a unit may be considered as financially viable, progressive and efficient if itis able to earn enough profits not only to service its debts timely but also for future

development/growth.

Break-Even Analysis

Analysis of break-even point of a business enterprise would help in knowing the level of output

and sales at which the business enterprise just breaks even i.e. there is neither profit nor loss. A

business earns profit if it operates at a level higher than the break-even level or break-even point.

If, on the other hand, production is below this level, the business would incur loss. The break-

even point in an algebraic equation can be put as under:


31

Break-even point

(Volume or Units)

Total Fixed Cost / (Sales price per unit - Variable Cost per unit)

Break-even point

(Sales in rupees)

(Total Fixed Cost x Sales) / (Sales - Variable Costs)


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The fixed costs include all those costs which tend to remain the same up to a certain level of

production while variable costs are those costs which tend to change in proportion with the

volume of production. As regards unit sales price, it is generally the same for all levels of output.

The break-even analysis can help in making vital decisions relating to fixation of selling price

make or buy decision, maximizing production of the item giving higher contribution etc. Further,

the break-even analysis can help in understanding the impact of important cost factors, such as,

power, raw material, labor, etc. and optimizing product-mix to improve project profitability.

Fund-Flow Statement

A fund-flow statement is often described as a Statement of Movement of Funds or where got:

where gone statement. It is derived by comparing the successive balance sheets on two specified

dates and finding out the net changes in the various items appearing in the balance sheets.

A critical analysis of the statement shows the various changes in sources and applications (uses)

of funds to ultimately give the position of net funds available with the business for repayment of

the loans. A projected Fund Flow Statement helps in answering the under mentioned points.

How much funds will be generated by internal operations/external sources?

How the funds during the period are proposed to be deployed?

Is the business likely to face liquidity problems?

Balance Sheet Projections

The financial appraisal also includes study of projected balance sheet which gives the position of

assets and liabilities of a unit at a particular future date. In other words, the statement helps to

analyze as to what an enterprise owns and what it owes at a particular point of time.


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An appraisal of the projected balance sheet data of the unit would be concerned with whether the

projections are realistic looking to various aspects relating to the same industry.

Financial Ratios

While analyzing the financial aspects of project, it would be advisable to analyze the important

financial ratios over a period of time as it may tell us a lot about a unit's liquidity position,

managements' stake in the business, capacity to service the debts etc. The financial ratios which

are considered important are discussed as under:

Ratio Formula Remarks

1Debt-Equity

RatioDebt (Term Liabilities)

Equity

(Where, Equity = Share capital,

free reserves, premium on shares,

, etc. after adjusting loss balance)

There cannot be a rigid rule to a satisfactory debt-

equity ratio, lower the ratio higher is the degree of

protection enjoyed by the creditors. These days the

debt equity ratio of 1.5:1 is considered reasonable.

It, however, is higher in respect of capital intensive

projects. But it is always desirable that owners

have a substantial stake in the project. Other

features like quality of management should be kept

in view while agreeing to a less favorable ratio.

In financing highly capital intensive projects like

infrastructure, cement, etc. the ratio could be

considered at a higher level.

2 Debt-

ServiceCoverage

Ratio

Debt + Depreciation +

Net Profit (After Taxes)+ Annual interest on long

term debt

Annual interest on long

term debt + Repayment

This ratio of 1.5 to 2 is considered reasonable. A

very high ratio may indicate the need for lowermoratorium period/repayment of loan in a shorter

schedule. This ratio provides a measure of the

ability of an enterprise to service its debts i.e.

`interest' and `principal repayment' besides

indicating the margin of safety. The ratio may vary


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of debt

from industry to industry but has to be viewed with

circumspection when it is less than 1.5.

3TOL / TNW

Ratio

Tangible Net Worth

(Paid up Capital +

Reserves and Surplus -

Intangible Assets)

Total outside Liabilities

(Total Liability - Net

Worth)

This ratio gives a view of borrower's capital

structure. If the ratio shows a decreasing trend, it

indicates that the borrower is relying more on his

own funds and less on outside funds and vice versa

4Profit-Sales

Ratio

Operating Profit (Before

Taxes excluding Income

from other Sources)

Sales

This ratio gives the margin available after meeting

cost of manufacturing. It provides a yardstick to

measure the efficiency of production and margin

on sales price i.e. the pricing structure

5

Sales-

Tangible

Assets Ratio

Sales

Total Assets - Intangible

Assets

This ratio is of a primary importance to see how

best the assets are used. A rising trend of the ratio

reveals that borrower has been making efficient

utilization of his assets. However, caution needs to

be exercised when fixed assets are old and

depreciated, as in such cases the ratio tends to be

high because the value of the denominator of the

ratio is very low.

6Current

Ratio Current Assets

Current Liabilities

Higher the ratio greater the short term liquidity.

This ratio is indicative of short term financial

position of a business enterprise. It provides margin

as well as it is measure of the business enterprise to

pay-off the current liabilities as they mature and its

capacity to withstand sudden reverses by the

strength of its liquid position. Ratio analysis gives

indications; to be made with reference to overall

tendencies and parameters in relation to the project.

7 Output Sales This ratio is indicative of the efficiency with which


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Investment

Ratio

Total capital employed

(in fixed & current

assets)

the total capital is turned over as compared to other

units in similar lines.

Internal Rate of Return

The discount rate often used in capital budgeting that makes the net present value of all cash flows

from a particular project equal to zero. Higher a project's IRR the more desirable it is to undertake

the project. IRR should be higher than the Cost of the project (interest rate in case of project

financing)

Sensitivity Analysis

While preparing and appraising projects certain assumptions are made in respect of certain

critical/sensitive variables like selling price/cost price per unit of production, product-mix, plant

capacity utilization, sales etc. which are assigned a `VALUE' after estimating the range of

variation of such variables. The `VALUE' so assumed and taken into consideration for arriving at

the profitability projections is the `MOST LIKELY VALUE'. Sensitivity Analysis is a systematic

approach to reduce the uncertainties caused by such assumptions made. The Sensitivity Analysis

helps in arriving at profitability of the project wherein critical or sensitive elements are identified

which are assigned different values and the values assigned are both optimistic and pessimistic

such as increasing or reducing the sale price/sale volume, increasing or reducing the cost of inputs

etc. and then the project viability is ascertained. The critical variables can then be thoroughly

examined by generally selecting the pessimistic options so as to make possible improvements inthe project and make it operational on viable lines even in the adverse circumstances.

8.5MANAGEMENT & ORGANIZATION ANALYSIS


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Appraisal of project would not be complete till it throws enough light on the person(s) behind the

project i.e. management and organization of the unit. It is seen that some projects may fail not

because these are not viable but because of the ineffectiveness of the management and the

organization in controlling various functions like production, marketing, finance, personnel, etc.

The appraisal report should highlight the strengths and weaknesses of the management by

commenting on the background, qualifications, experience, and capability of the promoter, key

management personnel, and effectiveness of the internal control systems, relation with labor

working conditions, wage structure, and the other assigned essential functions. In case the

promoter(s) have interest, in other concerns as Proprietor or Partner or Director, the appraisal

report should also comment on their performance in such concerns.

A business is more vulnerable if decision making in all the functional areas rests with a particularperson, in other words, `one man show'. Further, the management and the organization should be

conducive to the size and type of business. In case it is not so, it should be ensured that

professional managers are inducted to strengthen the organization.

8.6APPRAISAL OF PROJECT - A CHECK LIST

An indicative list of issues which need to be looked into while appraising a project is given below:


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MARKETING

1. Reasonable demand projections keeping in view the size of the

market, consumption level, supply position, export potential, import

substitute, etc.

2. Competitors' status and their level of operation with regard to

production and sales.

3. Technology advancement/Foreign Collaborator's Status/Buy-back

arrangements etc.

4. Marketing policies in practice, for promotion of product(s) and

distribution channels being used. Expenses on marketing are done

so as to popularize the product.5. Local/foreign consumer preferences, practices adopted, attitudes,

requirements etc.

6. Influence of Govt. policies, imports and exports in terms of quantity

and value.

7. Marketing professionals employed their competence, knowledge

and experience.

TECHNICAL

1. Product and its life cycle, product-mix and their application.2.Location, its advantages/disadvantages, availability of

infrastructural facilities, Govt. concessions, if any, available there.

3. Plant and machinery with suppliers' credentials and capacity

attainable under normal working condition.

4. Process of manufacturing indicating the choice of technology,


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position with regard to its commercialization and availability.

5.Plant and machinery - its availability, specification, price,

performance.

6. Govt. clearance/ license, if any, required.

7. Labor/ Manpower, type of skills required and its availability

position in the area.

FINANCIAL

1. Total project cost and how it is being funded/financed.

2. Contingencies and inflation duly factored in project cost.

3. Profitability projections based on realistic capacity utilization

and sales forecast with proper justification. Unrealistic/ambitious

sales projections without reference to past performance and

justification to be avoided.

4. Break-even analysis, fund flow and cash flow projections.

5. Balance sheet projections should be realistic and based on latest

available data. The components of financial ratios should be

subjected to close scrutiny.

6. Aspect of support of parent company, wherever applicable, may

be taken into account.

MANAGERIAL

1. Financial standing and resourcefulness of the

management.

2. Qualifications and experience of the promoters

and key management personnel.

3. Understanding of the project in all of its aspects -

financing pattern, technical knowledge and marketing programme

etc.

4. Internal control systems, delegation of adequate

powers and entrusting responsibility at various levels.


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5. Other enterprises, if any, wherein the promoters

have the interest and how these are functioning.

ECONOMIC

1.Impact on increase in level of savings and income distribution in

society and standard of living.

2.Project contribution towards creation and rate of increase of

employment opportunity, achieving self sufficiency etc.

3.Project contribution to the development of the region, its impact

on environment and pollution control

To judge whether the project is viable, i.e. it can generate adequate surplus for servicing its debts

within a reasonable period of time and still left with some funds for future development. This

involves taking an over-all view to analyse the strengths and weaknesses of the project. It should

also be analysed to see whether the management and organisation can prove effective for

successful implementation of the project.


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Chapter4 RESEARCH METHODOLOGY

Primary sources of Information

Meetings and discussion with the Chief Manager and the Senior Manager of both

Credit and Credit Risk Management Department

Meetings with the clients

Secondary sources of Information

Loan Policy and Internal Circulars of the bank

Research papers, power point presentations and PDF files prepared by the bank and

its related officials

Referring to information provided by CIBIL, Income Tax files, Registrar of

Companies (Ministry of Corporate Affairs), and Auditor reports.


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Chapter4 CREDIT RISK MANAGEMENT

9.1CREDIT RISK

Credit risk means the possibility of loss associated with diminution in the credit quality of

borrowers. In a banks portfolio, losses stem from outright default due to inability or

unwillingness of a customer or counter party to meet, commitments in relation to lending, trading,

settlement and other financial transactions.

9.2CREDIT RISK MANAGEMENT SYSTEM IN PNB

A comprehensive credit risk management system, which is in place in the bank, encompasses the

following processes:

Identification of Credit Risk

Measurement of Credit Risk

Grading of Credit Risk

Reporting and analysis of rating related data

Control of Credit Risk

CREDIT RISK IDENTIFICATION

In order to take informed credit decisions, it is necessary to identify the areas of credit risk in each

borrower as well as each industry. Risk Management Division HO, in coordination with other HO

divisions involved in disbursal of credit and also the risk management departments of various


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zonal offices identifies these risks areas and develops necessary tools and processes to measure

and monitor the risk.

CREDIT RISK MEASUREMENT

In order to measure the credit risk in banks portfolio, the bank has developed the following

models:

Credit Risk Rating Model Total limits Applicable from the Bank

Small 2 Loans Above Rs. 20 lacs and up to Rs. 50lacs

Small Loans Above Rs. 50 lacs and up to Rs. 5crores

Mid Corporate Above Rs.5 crores and up to Rs. 15crores

Large Corporate Above Rs. 15 crores

Non Banking Financial Corporation Model (irrespective of any limit)

New Business Model Below Rs. 5 crores

New Project Model Above Rs. 5 crores

The credit risk rating models have been developed with a view to provide a standard system for

assigning a credit risk rating to all the borrowers on the basis of the overall credit risk involved in

them. Inputs to the models are the financial, management, business and conduct of account,

industry information. The evaluation of a borrower is done by assessment on various

objective/subjective parameters. The model evaluates the credit risk rating of a borrower on a

scale ofAAA to D with AAA indicating minimum risk and D indicating maximum risk.

The credit risk-rating models incorporate therein all possible risk factors, which are important for

determining the credit quality/ rating of a borrower. These risks could be:

Internal and specific to the company,

Associated with the industry in which the company is operating or

Associated with the entire economy and can influence the repayment capacity and/

or willingness of the company.


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Evaluation methodology under rating models

The scores are assigned to each of the parameters on a scale of 0 to 4 with 0 being very

poor and 4 being excellent. The scoring of some of these parameters is subjective while for some

others it is done on the basis of pre-defined objective criteria.

The scores given to the individual parameters multiplied by allocated weights are then

aggregated and a composite score for the company is arrived at, in percentage terms. Higher the

score obtained by a company, the better is its credit rating. Weights have been assigned to

different parameters based on their importance. Weights assigned to different parameters have

been loaded in the software. After allocating/evaluating scores to all the parameters, the

aggregate score is calculated and displayed by the software.

The overall percentage score obtained is then translated into a rating on a scale from AAA

to D according to a pre-defined range of scores.

Wherever a particular parameter is not applicable, no score should be given and the

parameter should be made Not Applicable.

For multi-divisional companies, which are involved in more than one industrial activity,

evaluation should be done separately for each business. However, the management evaluation,

conduct of account and financial evaluation will be done on a common basis. In such cases, for

the business section, each business should be evaluated and scored separately, taking into account

the different industrial activity involved.


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GRADING OF BORROWERS UNDER THE RATING SYSTEM

In order to provide a standard definition and benchmarks under the credit risk rating system,

following matrix has been adopted in all the risk rating models.

Rating

categoryDescription Score (%) obtained

Grade within the

rating Category

PNB AAA Minimum Risk Above 80.00 PNB- AAA

PNB-AA

Marginal Risk Above 77.50 up to 80.00 PNB- AA +

Above 72.50 up to 77.50 PNB- AA

Above 70.00 up to 72.50 PNB- AA -

PNB-A

Modest Risk Above 67.50 up to 70.00 PNB- A +

Above 62.50 up to 67.50 PNB- A

Above 60.00 up to 62.50 PNB- A -

PNB-BB

Average Risk Above 57.50 up to 60.00 PNB- BB +

Above 52.50 up to 57.50 PNB- BB

Above 50.00 up to 52.50 PNB- BB -

PNB-B

Marginally

Acceptable RiskAbove 47.50 up to 50.00 PNB- B +

Above 42.50 up to 47.50 PNB- B

Above 40.00 up to 42.50 PNB- B -

PNB-C High Risk Above 30.00 up to 40.00 PNB- C

PNB-D Caution Risk 30.00 and below PNB D


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SYSTEM FOR ASSIGNMENT & APPRAISAL OF RATING

The process of rating and vetting is as under:

Loan Sanctioning

AuthorityCredit Risk Rating Authority

Vetting/Confirming

Authority

Head Office

i. Zonal CRMD in consultation

with branches

ii. Large Corporate Branches

GM (RMD), HO

Zonal / Circle

Office

i. In case of Large Corporate

Model, ELB/VLB

ii. In case of other Models, branches

to rate the accounts

Zonal CRMD

Branch Office Officer/Manager, Credit Section

An official designated by the

Incumbent not connected

with Processing/

recommending/rating of the

concerned loan proposal

In order to adopt internal rating based approaches (IRB) for credit risk, Basel II has placed certain

minimum requirements which inter-alia require, validation of rating system, process and

estimation of all relevant risk components. Banks must regularly compare realized default rates

with estimated probability of default (PD) of each grade and able to demonstrate to its supervisor

(RBI), that the internal validation process enable it to assess the performance of internal rating

and risk estimation system consistently and meaningfully. In view of above fact, not only rating

but consistent practices in evaluation of credit risk rating as well as evolving and updating robust

data on various risk components is must for adopting IRB approaches.

CONTROLS


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The Credit Risk Management process in the bank encompasses the following management

Control techniques which help in mitigating the adverse impacts of credit risk in its credit

portfolio.

i. Credit Approving Authority

a. Credit Committee

b. Linkage of loaning powers with risk rating categories

ii.Prudential Exposure limits

iii.Risk Based Pricing

iv.Portfolio Management

v.Loan Review Mechanism

vi.Legal documentation

vii.Preventive Monitoring System

viii.Others

a. Use of CIBIL data and RBI defaulters list

b. Diversification of Risks

Chapter10 POST SANCTION FOLLOW UP OF LOANS


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Supervision and Follow-up of bank credit has assumed considerable significance particularly after

introduction of new norms of assets classification, provisioning and derecognition of interest

income on NPAs, affecting profitability. System of supervision and follow up can be defined as

the systematic evaluation of the performance of a borrowal account to ensure that it operates at

viable level and, if problems arise, to suggest practical solutions. It helps in keeping a watch on

the conduct and operational/financial performance of the borrowal accounts. Further, it also helps

in detecting signals/symptoms of sickness and deteriorations, if any, taking place in the conduct of

the account for initiating timely corrective actions to check slippage of accounts to NPA category.

The goals and objectives of monitoring may be classified into fundamental and supplementary

goals. Fundamental goals help a bank to ensure safety of funds lent to an enterprise while,

supplementary goals are directed towards keeping abreast of problems arising out of changes in

both the internal and the external environment for initiating timely corrective actions. Some of

the important goals of monitoring are listed as under:

i. To keep a watch on the project during implementation stage so that there are no time &

cost overruns.

ii. To ensure that the funds released are utilized for the purpose for which these have beenprovided and there is no diversion of such funds.

To evaluate operational and financial results, such as production, sales, profit/loss, flow of funds,

etc. and comparing these with the projections/estimate changes in both the internal and the

external environment for initiating timely corrective actions. Some of the important goals of

monitoring are listed as under:

iii. To keep a watch on the project during implementation stage so that there are no time &

cost overruns.

iv. To ensure that the funds released are utilized for the purpose for which these have been

provided and there is no diversion of such funds.


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v. To evaluate operational and financial results, such as production, sales, profit/loss, flow

of funds, etc. and comparing these with the projections/estimates given by the borrower

at the time of sanction of credit facilities.

vi. To ensure that the terms and conditions as stipulated in the sanction have been complied

with.

vii. To monitor operations in the account particularly cash credit facilities which indicate

health of the account.

viii. To obtain market report on the borrower, to gather information like reputation/financial

standing etc.

ix. To detect signals and symptoms of sickness or deterioration taking place in

conduct/performance of the account.

x. To ensure that the unit's management and organizational set-up is effective.

xi. To keep a check on aspects like accumulation of statutory liabilities, creditors, debtors,

raw-material, stocks-in-process, finished goods, etc.

xii. To ensure charging of applicable rate of interest/penal interest/ commitment charges as

per bank's guidelines.

System of supervision & monitoring of credit as laid down by the Bank needs to be meticulously

followed by the branches/controlling offices which, inter alia, covers the following:

i. Conveying the sanction

ii. Maintenance of Loan Document File

iii. Quarterly Review Sheet

iv. Preventive Monitoring System

v. Quarterly Monitoring System


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vi. Inspection and Physical Verification of stocks Stock Audit

Chapter11 ANALYSIS & INTERPRETATION

11.1PNBs LOAN POLICY

11.1.1 OBJECTIVE

The Credit Management & Risk Policy of the bank at the macro level is an embodiment of the

Banks approach to understand, measure and manage the credit risk and aims at ensuring

sustained growth of healthy loan portfolio while dispensing the credit and managing the risk. This

would entail reducing exposures in high risk areas, emphasizing more on the promising

industries / productive sectors/ segments of the economy, optimizing the return by striking

balance between the risk and the return on assets and striving towards maintaining/improving

market share.

11.1.2 BASIC TENETS OF THE POLICY

All loan facilities considered only after obtaining loan application from the borrower and

compilation of Confidential Report on them and the guarantor. The borrowers should

have the desired background, experience/expertise to run their business successfully


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Project for which the finance is granted should be technically feasible and

economically/commercially viable i.e. it should be able to generate enough surplus so as to

service the debts within a reasonable period of time.

Cost of the project and means of financing the same should be properly assessed and tied

up. Both, under-financing and over- financing can have an adverse impact on the

successful implementation of the project.

Borrowers should be financially sound, enjoy good market reputation and must have their

stake in the business i.e. they should possess adequate liquid resources to contribute to the

margin requirements.

Loans should be sanctioned by the competent sanctioning authority as per the delegatedloaning powers and should be disbursed only after execution of all the required

documents.

Projects financed must be closely monitored during implementation stage to avoid time

and cost overruns and thereafter till the adjustment of the bank's loan.

The policy sets out minimum or benchmark lending rate, BPLR = 11 %

The policy lays down norms for takeover of advances from other banks/ financial

institutions

As a matter of policy the bank does not take over any Non-performing Asset (NPA) from

other banks

11.1.3 METHODS OF LENDING

1. For Working Capital

i. Simplified method linked with turnover

Simplified method based on turnover for assessing working capital finance up to

Rs.2 crore (upto Rs. 5 crore in case of SSI units)


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ii. MPBF System

Existing MPBF system with flexible approach shall be followed for units

requiring working capital finance exceeding the above-mentioned amount

iii.Cash Budget System

Cash Budget System shall be followed in Sugar, Tea, Service Sector and Film

Production accounts. It will be our endeavor to introduce the same selectively in

other areas also

2. Term Loan

In case of infrastructure/mega projects, proper appraisal will be made by utilizing the

services of specialized / Technical officers.

The term loans with remaining maturity period of above 5 years shall not exceed 50% of

the term deposits with remaining maturity period of above 5 years after taking into account

the renewal of term deposits as per the past trend

11.2CREDIT APPRAISAL PROCESS AT PNB

11.2.1 FLOWCHART:


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Not feasible

No Queries

Queries

Feasible

Submission of Project Report along

with the Request Letter

Carrying out Due Diligence on the

Client

Submission of Proposal to designated

Authority (Circle office)

Re-verification and analysis of the

Proposal

Submission of Proposal to designated

Authority

Preparing Credit Report / Feasibility

Report and Risk Rating

Determining of Interest Rate and

Preparation of Proposal

Meeting with the client to clarify the

queries

Vetting of Credit Risk Rating ReportApproval of request made by the client

like Reduction of Interest Rates etc

Sanction of Proposal on various Terms

& Conditions

Acknowledgement of Sanction Terms

& Condition by the client

Application to comply with SanctionT&C. Execution of Loan Documents

Disbursement of Sanctioned Amountfrom the branch office


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11.2.2 BRIEF ON THE PROCESS

At Punjab National Bank, proposal for financing working capital limits and term loans can relate

Report on Credit Appraisal in PNB (1)

Documents

Transcript of Report on Credit Appraisal in PNB (1)