Credit Risk

Credit Risk

• Possibility of loss from the failure of loan or debt instrument repayments.

• Change in the repayment capacity of borrowers or debt instruments that indicates possible failure by bank borrowers.

• Banks represent credit risk through rating systems.

Rating Methods

• Rating agencies.

Agencies gather financial and qualitative information to access the possibility of the instrument not repaying the obligations in the future.

Rating agencies assign codes to indicate the repayment status of firms / instruments that have applied for an evaluation with them.

• Internal rating system.

Banks establish their own procedures and methods to rate their customers.

Risk Rating

• Rating grades

- (AAA, AA, A, BBB, BB, B, B, C, D)

• Qualitative grades

- Good loans, Substandard loans, Default loans, Bad loans

• Rating Scale

- 1, 2, 3, 4, 5, 6 (Good -------- Bad)

Credit Life Cycle

Bank Credit Risk Origination

• Business Loans and advances

Short term

Long term commitments

• Consumer Loans

Vehicle

Jewellery

Consumer durables / White goods

• Micro Credit

• Off-Balance Sheet Transactions

Loans and Advances

• Loans are given through bank accounts from which the customer will not be able to withdraw.

• Loan sanctions are mostly through the purpose for which they have been sanctioned.

• Example, if the loan sanction is for purchase of machinery, the amount involved will be directly paid to the machinery supplier than the borrower of the bank.

Loans and Advances

• Loan payments can also be made on a time basis where payments will be made in stages to the borrower for the purpose for which the loan has been sanctioned.

• Loans sanctioned by the bank can be utilized by the customer on a withdrawal basis only if the customer opens an operational account for this purpose.

• Advances that are sanctioned are at the disposal of the bank customer and can be withdrawn whenever the customer has a need. Withdrawal is permitted based on the terms of advance sanction.

Working Capital Finance

• Working capital finance can be through the sanction of loans or advances.

Demand loans

Cash credit facility (advance)

• Overdraft facility from banks

Current accounts (advance)

Loans against collateral security of fixed deposits, house documents, jewellery or shares.

Credit Worthiness

• Influences the loan / bank commitment decision.

• Determination of terms and prerequisites for loan decisions.

• Type of credit / service to be granted to the customers.

• Quantum of loan / service to be offered to the customers.

Credit Worthiness

• ‘Bankable’ projects / proposals from the customer.

Projected cash flows from the proposal.

Projected investment from the proposal.

Past data on the performance of the company.

• On going performance of the project after the credit sanction by the banks.

Rating Guidelines by Reserve Bank India

• Individual banks can use their own internal rating methods to determine credit worthiness of their borrowers.

• Banks can define default on credit exposures when a scheduled payment obligation by a borrower is not met within 90 days from the due date.

Exposure Risk for Banks

• Loss of value outstanding at the time of default by a borrower.

• Loss on default is computed based on

- Default percentage (D)

- Exposure value for the bank (E)

- Recovery rate (R)

• Loss on default = D x E x (1-R)

Credit Risk Evaluation Information Requirement by Banks

• Account Number of Applicant

• Date of Account Opening

• Branch of Applicant Account

• Whether Existing Borrowing Customer

Credit Risk Evaluation Information Requirement by Banks

Details of Applicants• Name of the entity

• Registered office address

• Name of the contact person

• Address of factory / establishment

• Address for correspondence

• Office contact details

• Date of incorporation

• Date business commenced

• Date of formation

Details of Applicants• Line of business

• Nature of product / service offered

• Type of constitution of the business

• Existing activity of the business entity

• Proposed activity of the business entity

• Name of parent company if any

Credit Risk Evaluation Information Requirement by Banks

Purpose of Loan

• Expected source of funds

• Business owner

• Expected account turnover

• Return on investment

• Sale proceeds

• Details of Director

• Details of the Board

• Principal shareholders of the company and their address

Purpose of Loan

• Exposure of the borrowing entity with other bank groups

• Credit facility availed

• Credit facility applied

– Type of facility

– Amount

– Purpose

– Tenor

– Primary security

– Collateral security

– Currency of security

Credit Risk Evaluation Information Requirement by Banks

Details of Assets

• Land

• Tools

• Electrical

• Machinery

• Other assets

Information on each type of Assets

• Purpose of asset

• Imported / Indigenous

• Supplier

• Total cost

• Promoter’s contribution

• Loan required

Credit Risk Evaluation Information Requirement by Banks

Business Information

• Details of collateral

• Details of customers of business

• Currencies in which business is conducted

• Number of employees

Existing Credit Facility Details

• Types of facility

• Limits (value)

• Outstanding as on the previous accounting date

• Names of banks presently working with

• Security lodged

• Rate of interest

• Repayment terms

Credit Risk Evaluation Information Requirement by Banks

Past Performance (Two years)

• Net Sales

• Net profit

• Capital (net worth)

• Total debt

• Imports

• Exports

Future Estimate (Current year and next year)

• Net Sales

• Net profit

• Capital (net worth)

• Total debt

• Imports

• Exports

Additional Details Required• Purpose of request detailing various heads under which financial

assistance is sought

• Organization chart, affiliate information, subsidiaries, and ownership pattern

• Copies of IT returns for the last three years

• All bank account statement for the last 12 months

• All loan account statement for the last 12 months with amortization schedule / sanction letter

• Copy of latest sanction letter with existing banker/s

• Value of stock / debtors and creditors for the last 6 months

• Month wise sales / purchases for the past 12 months (break up showing exports / imports and domestic).

• Sales / purchases to/from top 5 buyers / suppliers with contact details

• Details of bad debts during the past three years

Additional Details Required

• Latest net worth statement of the proprietor / partners / directors / guarantors certified by a Chartered Accountant

• Projected financials for the business for the next 3 years.

• Photocopy of the documents of property offered as collateral security (agreement for sale and related documents, share certificate, sanction plan, no-objection certificate (NOC) from concerned society)

• Detailed project report (expenses, machinery to be purchased, project cost, method of finance, financial projections for the tenor of the term loan sought with necessary assumptions, break even analysis)