Int Prj Cr Appr

8/7/2019 Int Prj Cr Appr

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OBJECTIVE

1. To study & understand the different appraisal methods of working

capital financing.

2. To understand the components and format ofCAM of the bank.

3. Development of new model of appraisal in Working Capital Financing

which may applicable in Financial Sector.

4. To make a critical analysis of Different committees recommendations

constituted by The RBI on Working Capital Finance

5.How to determine the maximum permissible amount of bank finance

provided towards the borrowing unit according to their credit worthiness.


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Chapter 1 Project Appraisal-a Basic Idea.

Methodology Of Project Appraisal

How to carry effective appraisal

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Overview

Project appraisal

SummaryProject appraisal is an essential tool in regeneration and neighbourhood renewal, but audits of

appraisal practice have found significant weaknesses. Effective project appraisal offers

significant benefits to partnerships and, most importantly, to local communities. A good

appraisal justifies spending money on a project. It is an important tool in decision making and

lays the foundation for delivery and evaluation. Getting the design and operation of appraisal

systems right is important. The proper consideration of each of the key components of project

appraisal is essential. These are

need, targeting and objectives

context and connections

consultation

options

inputs

outputs and outcomes

PROJECT APPRAISAL - A METHODOLOGY

Appraisal involves a careful checking of the basic data, assumptions and

methodology used in project preparation, an in-depth review of the work plan, cost

estimates and proposed financing, an assessment of the project's organizational

and management aspects, and finally the viability of project .

It is mandatory for the Project Authorities to undertake project appraisal or atleast

give details of financial, economic and social benefits and suitably incorporate it in

the PC-I. These projects are examined in the Planning and Development Division

from the technical, institutional/organizational/managerial, financial and economic

point of view depending on nature of the project. On the basis of such an

assessment, a judgement is reached as to whether the project is technically sound,

financially justified and viable from the point of view of the economy as a whole.

In the Planning and Development Division, there is a division of labour in the

appraisal of projects prepared by the concerned Executing Agencies. The

concerned Technical Section in consultation with other technical sections i.e;

Physical Planning & Housing, Manpower, Governance and Environment

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sections undertake the technical appraisal, wherever necessary. This covers

engineering, commercial, organizational and managerial aspects, while the

Economic Appraisal Section carries out the pre-sanction appraisal of the

development projects from the financial and economic points of view.

Economic appraisal of a project is concerned with the desirability of carrying

out the project from the standpoint of its contribution to the development of the

national economy. Whereas financial analysis deals with only costs and returns

to project participants, economic analysis deals with costs and returns to society

as a whole. The rationale behind the project appraisal is to provide the decision-

makers with financial and economic yardsticks for the selection/rejection of

projects from among competing alternative proposals for investment.

The techniques of project appraisal can be divided under two heads viz (i)

undiscounted and (ii) discounted. Undiscounted techniques include (a) Pay back

period, and (b) Profit & Loss account. Discounted techniques take into account

the time value of money and include (a) Net Present Value (NPV), (b) Benefit

Cost Ratio (BCR), (c) Internal Rate of Return (IRR) (d) Sensitivity Analysis

(treatment of uncertainty) (e) and Domestic Resource Cost (Modified Bruno

Ratio). Different investment appraisal criteria are given at Appendix-I.

Economic viability of the project is invariably judged at 12 percent discount

rate/opportunity cost of capital. However, in case of financial analysis, the

actual rate of interest i.e. the rate at which capital is obtained is used. For the

government-funded projects, the discount rate is fixed by the Budget Wing of

the Finance Division for development loans and advances on yearly basis. The

provisional rate of mark-up fixed by the Finance Division for the current year

(2005-06) is 8.22%. In case the project is funded by more than one source, the

financial analysis is carried out on the weighted average cost of capital (WACC)

for each project. If the project is financed through foreign grants, the financial

analysis is undertaken at zero discount rate. However, the economic analysis is

undertaken at 12% discount rate.

Many investment projects are addition to existing facilities/activities and thus

benefits and costs relevant to the new project are those that are incremental to

what would have occurred if the new project had not been added. During the

operating life of a project, it is very important to measure all costs and benefits

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as the difference between what these variables would be if no project (without

project) were undertaken and what they will be should the project be

implemented (with project). It is very common error to assume that all costs and

benefits are incremental to the new project when, in fact, they are not. Hence,

considerable care must be taken in defining a base case which realistically

sets out the profile of costs and benefits expected if no additional investment is

undertaken.

Although projectappraisal has been a

requirement beforeregeneration fundingis given, it has been a

source of confusionand difficulty for

partnerships.

Whats the Problem?

Project appraisal - the process of assessing and questioning proposals before

resources are committed - is an essential tool for effective action in

regeneration and neighbourhood renewal. Its a means by which

partnerships can choose the best projects to help them achieve what theywant for their neighbourhood.

But appraisal has been a source of confusion and difficulty for partnerships

in the past. Audits of the operation of Single Regeneration Budget schemes

have highlighted concerns about the design and operation of project

appraisal systems, including:

mechanistic, inflexible systems

a lack of independence and objectivity

a lack of clear definition of the stages of appraisal and of responsibility

for these stages

a lack of documentary evidence

Its no surprise that these audits werent impressed with the quality of

appraisals, and specifically found:

individual appraisals which did not cover the necessary information or

provided only a superficial analysis of the project

particular problems in dealing with risk, options and value for money

appraisals which were considered too onerous for smaller projects

rushed appraisals

Project appraisal is a requirement of regeneration funding programmes. But

tackling problems like those outlined above is about more than getting the

systems right on paper. Experience in partnerships emphasises the

importance of developing an appraisal culture which involves developing

the right system for local circumstances and ensuring that everyone involved

recognises the value of project appraisal and has the knowledge and skills

necessary to play their part in it.

What can Project Appraisal Deliver?

Project appraisal helps a partnership to

be consistent and objective in choosing projects

make sure its programme benefits all sections of the community,

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including those from ethnic groups who have been left out in the past

provide documentation to meet financial and audit requirements and to

explain decisions to local people.

Appraisal justifies spending money on a project.

Appraisal asks fundamental questions about whether funding is required andwhether a project offers good value for money. It can give confidence that

public money is being put to good use, and help identify other funding to

support a project. Getting it right may help a partnership make its resources

go further in meeting local need.

Appraisal is an important decision making tool.

Appraisal involves the comprehensive analysis of a wide range of data,

judgements and assumptions, all of which need adequate evidence. This

helps ensure that projects selected for funding:

will help a partnership achieve its objectives for its area

are deliverable

involve local people and take proper account of the needs of people from

ethnic minorities and other minority groups

are sustainable

have sensible ways of managing risk.

Appraisal lays the foundations for delivery.

Appraisal helps ensure that projects will be properly managed, by ensuring

appropriate financial and monitoring systems are in place, that there are

contingency plans to deal with risks and setting milestones against which

progress can be judged.

How to carry out effective appraisal

Government guidance.

Guidance on project appraisal continues to develop and exactly what is

required of a partnership depends on which government funding programme

is providing the funding. Current guidance includes:

New Deal for Communities and Single Regeneration Budget Guidance

on Project Appraisal and Approval, issued in October 2000 and oftenreferred to as the unified guidance. This now applies only to SRB

schemes

New Deal for Communities Project Appraisal and Approval Guidance,

revised version, April 2002. This now applies to NDC programmes

Single Programme Appraisal Guidance, issued by the Department of

Trade and Industry in September 2001. Within this general guidance

each Regional Development Agency can develop its own appraisal

system for the RDAs single programme

There are some significant variations between these guidance documents,

particularly in relation to option appraisal and value for money assessments.Overall, although the stated aim of changes in guidance has generally been to

improve and simplify matters, it can add up to a confused and rather

daunting picture - and partnerships will certainly need to check with RDA

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and/or Government Office on current, local, requirements.

However, in spite of these changes, certain core components continue to be

essential in project appraisal.

Getting the system right

The process of project development, appraisal and delivery is complex and

partnerships need systems which suit local circumstances and organisation.

Good appraisal systems should ensure that:

project application, appraisal and approval functions are separate

all the necessary information is gathered for appraisal, often as part of

project development in which projects will need support

race equality and other equality issues are given proper consideration

those involved in appraisal have appropriate information and training

and make appropriate use of technical and other expertise

there are realistic allowances for time involved in project development

and appraisal

decisions are within a partnerships powers, with non-delegated

projects referred to others for approval where necessary

there are appropriate arrangements for very small projects

there are appropriate arrangements for dealing with novel, contentious or

particularly risky projects.

Appraising a project

Key issues in appraising projects include the following.

Need, targeting and objectivesThe starting point for appraisal: applicants should provide a detailed

description of the project, identifying the local need it aims to meet.

Appraisal helps show if the project is the right response, and highlight what

the project is supposed to do and for whom.

Context and connections

Appraisal should help show that a project is consistent with the objectives of

the relevant funding programme and with the aims of the local partnership.

Are there links between the project and other local programmes and projects

does it add something, or compete?

Consultation

Local consultation may help determine priorities and secure community

consent and ownership. More targeted consultation, with potential project

users, may help ensure that project plans are viable. A key question in

appraisal will be whether there has been appropriate consultation and how it

has shaped the project

Options

Options analysis is concerned with establishing whether there are different

ways of achieving objectives. This is a particularly complex part of project

appraisal, and one where guidance varies. It is vital though to review

different ways of meeting local need and key objectives.Inputs

Its important to ensure that all the necessary people and resources are in

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place to deliver the project. This may mean thinking about funding from

various sources and other inputs, such as volunteer help or premises.

Appraisal should include the examination of appropriately detailed budgets.

Outputs and outcomes

Detailed consideration must be given in appraisal to what a project does and

achieves: its outputs and more importantly its longer-term outcomes.Benefits to neighbourhoods and their residents are reflected in the improved

quality of life outcomes (jobs, better housing, safety, health and so on), and

appraisals consider if these are realistic. But projects also produce outputs,

and we need a more realistic view of output forecasts than in the past.

Value for money

This is one of the key criteria against which projects are appraised. A major

concern for government, it is also important for local partnerships and it may

be necessary to take local factors, which may affect costs, into account.

Implementation

Appraisal will need to scrutinise the practical plans for delivering the project,asking whether staffing will be adequate, the timetable for the work is a

realistic one and if the organisation delivering the project seems capable of

doing so.

Risk and uncertainty

You cant avoid risk but you need to make sure you identify risk (is there a

risk and if so what is it?), estimate the scale of risk (if there is a risk, is it a

big one?) and evaluate the risk (how much does the risk matter to the

project.) There should also be contingency plans in place to minimise the

risk of project failure or of a major gap between whats promised and whats

delivered.

Forward strategies

The appraisal of forward strategies can be particularly difficult, given

inevitable uncertainties about how projects will develop. But is never too

soon to start thinking about whether a project should have a fixed life span

or, if it is to continue beyond a period of regeneration funding, what support

it will need to do so. This is often thought about in terms of other funding

but, with an increasing emphasis on mainstream services in neighbourhood

renewal, appraisal should also consider mainstream links and implications

from the first.

Sustainability

In regeneration, sustainability has often been talked about simply in terms of

whether a project can be sustained once regeneration funding stops but

sustainability has a wider meaning and, under this heading, appraisal should

include an assessment of a projects environmental, social and economic

impact, its positive and negative effects.

While appraisal will focus detailed attention on each of these areas, none of

them can be considered in isolation. Some of them must be clearly be linked

for example, a realistic assessment of outputs may be essential to a

calculation of value for money. No project will score highly against all these

tests and considerations. The final judgement must depend on a balanced

consideration of all these important factors.

Checklist

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Whether you are involved in a partnership with an appraisal system in place,

or starting to design one from scratch, these questions are worth asking.

Are appraisals systematic and disciplined with a clear sequence of

activities and operating rules?

Is there an independent assessment of the project by someone who has

not been involved with the development of the project?

Does the appraisal process culminate in clear recommendations that

inform approval (or rejection) of the project?

Is the approval stage clearly separate?

Is the appraisal process well documented, with key documents signed,

showing ownership and agreement, and allowing the appraisal

documentation to act as a basis for future management, monitoring and

evaluation?

Does the appraisal system comply with any relevant government

guidance (See the information section for further details)? Are the right people involved at various stages of the process and, if

necessary, how can you widen involvement? (Here, you may also want

to look at other topics, such as building a partnership, or community

involvement.)

Does your system enable the key components of successful project

appraisal (summarised above) to be considered within a balanced

appraisal of a project as a whole?

If you are involved in the appraisal of projects receiving government

funding, you will need to be aware of the relevant guidance. Currently, this

is includes separate guidance for

New Deal for Communities

Single Regeneration Budget

Single Programme.

These are summarised above and full details can be found elsewhere on

renewal.net

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CHAPTER 2 -What is Credit?

-Cost Of Credit.

-Importance of Credit.

-Principles Of Good Lending.

-Working Capital Loan.

-Factors to be taken while determining Working Capital

Requirement.

- Introduction Of Credit Risk.

-Credit Appraisal and Credit Appraisal with the help of

financial Ratio/Statement.

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* What Is Credit?

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

We use credit to buy things with an agreement to repay the loans over a period

of time. The most common way to avail credit is by the use of Credit cards.

Other credit plans include personal loans, home loans, vehicle loans, student

loans, small business loans, trade financing, etc.

* What Is The Cost Of Credit?

Interest Rate is charged on the credit amount that you take. Banks and other

lenders will give credit and charge interest on the amount that is borrowed.

There are two types of loans:-

Secured loans are loans such as home loan and vehicle loans. They are backed

by your assets in order to minimise the risk assumed by the lender. The assets

may be forfeited in case there is a failure to make the necessary payments.

Unsecured loans are loans such as personal loans and credit cards, where the

lender has no entitlement to any of the borrower's assets in case borrowers fail

to repay the loan. Such a loan normally carries a higher interest rate than a

secured loan.

Repayment plans of loans vary based on each type of loans. Home loan

repayment plans can be as high as 20 years or more, whereas vehicle loans can

be repaid in 3, 5 or 10 years, and the credit period for credit cards is around 50

days.

* Importance of credit

Suppose you are planning to start your business, It is well known that capital is

the blood of business, no matter what the nature of your business is and how it

is organized; you will have to address the following questions-

- How will you raise the money to pay for proposed capital investment?

- How will you handle day to day financial activities?

When you are planning for a big venture, then it may happen that you dont

have sufficient amount of fund with you. For solving out this problem you will

approach to banks, Apex institutions, Primary Lending Institutions etc for

getting capital from them. This capital is provided by them in form of credit.

Same is in case of credit to an individual. After some times, you will have to

pay that debt with some interest.

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* Modes of Bank FinanceA firm can draw funds from its bank within the maximum credit limit

sanctioned. It can draw fund in the following forms:

OverdraftUnder the overdraft facility, the borrower is allowed to withdraw funds in

excess of the balance in his current account up to a certain specified limit during

a stipulated period.

Cash Credit

It is the most popular method of bank finance for working capital in India.

Under this method a borrower is allowed to withdraw funds from the bank up to

the sanctioned credit limit.

Purchase of Discounting Bills

Under the purchase or discounting of bills, a borrower can obtain credit from

bank against its bills. The bank purchases or discounts the borrowers bills. The

provided under this agreement is covered within the overall cash credit or

overdraft limit.

Letter of Credit

Suppliers, particularly the foreign suppliers, insist that the buyer should ensure

that his bank will make the payment if he fails to honor its obligation. This is

ensured through a letter of credit arrangement. A Bank opens a Letter of Credit

in favor of a customer to facilitate his purchase goods.

Bank Guarantee

A Bank Guarantee is a guarantee made by a bank on behalf of a customer

(usually an established corporate customer) should it fail to deliver the payment,

essentially making the bank a co-signer for one of its customer's purchases.

Principles of good lending

A prudent lender shall lend only after evaluating the following factors

1. Safety

2. Liquidity

3. Profitability

4. Spread

5. Purpose

6. End use

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7. Need based finance

8. Viability oriented rather than security oriented lending

9. Own stake

10. National priorities

The decision of whether or not to give credit facility to an applicant will be

arrived using financial & accounting tools especially, the analysis of financial

ratios. Financial ratios are defined as the numerical expression of the

relationship between two variables drawn from basic financial statements .i.e.

the profit & loss account & the balance sheet

Working Capital Loan/Term Loan or Mortgage loan for

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Banks are the main institutional sources of working capital finance in India.

After trade credit, bank credit is the most important source of financing working

capital requirements. A bank considers a firms sales and production plans and

the desirable levels of current assets in determining its working capital

requirements. The amount approved by the bank for the firms working capital

requirements is called credit limit. Credit limit is the maximum funds which a

firm can obtain from the banking system.

In case of firms with seasonal businesses, banks may fix separate limits for the

peak level credit requirements indicating the periods during which the separate

limits will be utilized by the borrower. In practice, banks do not lend 100% of

the credit limit; they deduct margin money. A margin requirement is based on

the principle of conservatism and is meant to ensure security. If the margin

requirement is 30%, bank will lend only up to 70% of the value of the asset.

This implies that security of banks lending should be maintained even if the

assets value falls by 30%.

A borrower may sometimes require ad hoc or temporary accommodation in

excess of sanctioned credit limit to meet unforeseen contingencies. Banks

provide such accommodation through a demand loan account or a separate non

operable cash credit account. The borrower is required to pay a higher rate of

interest above the normal rate of interest on such additional credit.

The purpose of such loan is to provide hassle free working capital finance to the

borrower. The nature of this loan can be cash credit, overdraft or a term

loan. The borrower should have a good track record of 3 years.

The security in this case goes as follows: Primary Hypothecation of stocks and

book-debts Collateral Mortgage of Unencumbered residential house/flat,commercial or industrial property with a clear marketable title in the name and

possession of the borrower/Proprietor/ Partner/s/Director/s either self occupied

or vacant.

The Rate of interest is PLR+1% with monthly rests. The term loan (against

mortgage of immovable property) from a minimum Rs. 0.50 lacs to maximum

Rs. 50 lacs or 30 times net monthly income whichever is lower. The security is

the Mortgage of the unencumbered residential house/flat, commercial or

Industrial property with a clear marketable title in the name and possession of

borrower/proprietor or partner/s/Director/s either self occupied or vacant with a

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security cover of 1.5 times the amount of loan. The Rate of Interest is

PLR+2.5% with a repayment period of 60 months.

Factors to be taken into consideration while determiningrequirements for working capital:

Production Policies

A sugar factory which belongs to a seasonal industry would obviously have its

working capital need affected by the length of the crushing season. The

production schedule i.e. the plan for production, has great influence on the level

of inventories. In some cases raw material can be procured only in a particular

season and have to be stocked for the production of the whole year. In many

others, the production cycle is limited to a part of the year and raw materials

have to be accumulated throughout the year. In all such cases the need for

working capital will vary according to the production plans. Similarly, the

decision of the management regarding automation, etc, also affects working

capital requirements. In a labor- intensive process, the requirements of working

capital will be higher. In the case of highly automatic plant, the requirements of

long-term funds would be greater.

Nature of the business

The shorter the manufacturing process, the lower is the requirements of working

capital. This is because, in such a case, inventories have to be maintained at a

low level. Longer the manufacturing process, higher will be the requirements of

working capital. This is the reason why highly capital-intensive industriesrequire large amount of working capital to run their sophisticated and long

production process. Similarly, a trading concern requires lower working capital

than a manufacturing concern.

Credit policy

The credit policy of the company also determines the requirements of working

capital. A company, which allows liberal credit to its customers, may have

higher sales but consequently will have large amount of funds tied up in sundry

debtors. Similarly a company, which has very efficient debt collection

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machinery and offers strict credit terms, may require lesser amount of working

capital than the one where debt collection system is not so efficient or where the

credit terms are liberal. The credibility of a company in the market also has an

effect on the working capital requirements. Reputed and established concerns

can purchase raw material on credit and enjoy many other services also like

door delivery, after sales service etc. This would mean that they could easily

have large current liabilities; therefore the required working capital may not be

very high.

Inventory policy

The inventory policy of a company also has an impact on the working capital

requirements since a large amount of funds is normally locked up in inventories.

An efficient firm may stock material for a smaller period and may, therefore,

require lesser amount of working capital.

Abnormal factors

Abnormal factors like strikes and lockouts also require additional working

capital. Recessionary conditions necessitate a higher amount of stock of finished

goods remaining in stock. Similarly, inflationary conditions necessitate more

funds for working capital to maintain same amount of current assets.

Market conditions

Working capital requirements are also affected by market conditions like degree

of competition. Large inventory is essential as delivery has to be off the shelf or

credit has to be extended on liberal terms when market competition is fierce or

market is not very strong is a buyers market.Conditions of supply

If prompt and adequate supply of raw materials, spares, stores etc. is available it

is possible to manage with small investments in inventory or work on the just in

time (JIT) principle. However if the supply is erratic, scant seasonal, channel

zed through government agencies etc., it is essential to keep large stocks

increasing working capital requirements.

Business Cycle

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Business fluctuations lead to cyclical and seasonal changes in production and

sales and affect the working capital requirements.

Growth and expansion

The growth in volume and growth in working capital go hand in hand.

However, the change may not be proportionate and the increased need for

working capital is felt right from the initial stages of growth.

Level of taxes

The amount of taxes paid depends on taxation laws. These amount usually have

to be paid in advance. Thus need for working capital varies with tax rates and

advance tax provisions.

Dividend policy

Payment of dividend utilizes cash while retaining profits acts as a source of

working capital. Thus working capital gets affected by dividend policies.

Price level changes

Inflationary trends in the economy necessitate more working capital to maintain

the same level of activity.

Operating efficiency

Efficient and coordinated utilization of capital reduces the amount required to

be invested in working capital

* What is credit risk?

A credit risk is the amount of potential for default that is inherent in a given debt

investment or extension of credit. A lender or an investor in various types of

bonds carries a degree of credit risk on any transaction conducted. Assessing the

degree of risk involved is essential before completing any type of lending or

investment transaction.

In the case of lending money, the entity that provides the loan carries the credit

risk. For this reason, a lender will want to know pertinent information regarding

the ability of the borrower to repay the amount of the loan, including all finance

charges and related fees. If the lender is unable to determine that the borrower

will be able to repay the loan, the borrower may be considered a poor credit risk

and be denied.

With the purchase of bond issues, it is the buyer who assumes a degree of credit

risk. Bonds generally carry a commitment on the part of the bond issuer to

provide the buyer with full repayment of the purchase price of the bond at some

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future point. As part of the transaction, the buyer also anticipates some type of

dividend or interest payment in exchange for the purchase of the bond. If the

bond issuer is not likely to be able to repay the principal or provide interest

payments as outlined in the terms of the bond, the issuer is understood to be a

poor credit risk.

Just about any type of transaction that involves the extension of credit in some

form carries a degree of credit risk. In many cases, the level of risk is very low

and thus considered acceptable. At the same time, it is important to explore all

relevant factors before assuming any degree of credit risk. Failure to do so can

result in a loss to a lender or bond investor that may be significant.

Lenders will trade off the cost/benefits of a loan according to its risks and the

interest charged. But interest rates are not the only method to compensate for

risk. Protective covenants are written into loan agreements that allow the lender

some controls. These covenants may:

Limit the borrower's ability to weaken their balance sheet voluntarily

e.g., by buying back shares, or paying dividends, or borrowing further.

Allow for monitoring the debt requiring audits, and monthly reports

Allow the lender to decide when he can recall the loan based on specific

events or when financial ratios like debt/equity or interest coverage

deteriorate.

A recent innovation to protect lenders and bond holders from the danger of

default are credit derivatives, most commonly in the form of a credit default

swap. These financial contracts allow companies to buy protection against

defaults, from a third party, the protection seller. The protection seller receives

a periodic fee (the credit spread) as compensation for the risk it takes, and in

return it agrees to buy the debt should a credit event ("default") occur.

Credit scoring models also form part of the framework used by banks or

lending institutions grant credit to clients. For corporate and commercial

borrowers, these models generally have qualitative and quantitative sections

outlining various aspects of the risk including, but not limited to, operating

experience, management expertise, asset quality, and leverage and liquidity

ratios, respectively. Once this information has been fully reviewed by credit

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officers and credit committees, the lender provides the funds subject to the

terms and conditions presented within the contact (as outlined above).

Credit analysis is the method by which one calculates the creditworthiness of

a business or organization. The audited financial statements of a large company

might be analyzed when it issues or has issued bonds. Or, a bank may analyze

the financial statements of a small business before making or renewing a

commercial loan. The term refers to either case, whether the business is large

or small.

Credit analysis involves a wide variety of financial analysis techniques,

including ratio and trend analysis as well as the creation of projections and a

detailed analysis of cash flows. Credit analysis also includes an examination of

collateral and other sources of repayment as well as credit history and

management ability.

Before approving a commercial loan, a bank will look at all of these factors

with the primary emphasis being the cash flow of the borrower. A typical

measurement of repayment ability is the debt service coverage ratio. A credit

analyst at a bank will measure the cash generated by a business (before interest

expense and excluding depreciation and any other non-cash or extraordinary

expenses). The debt service coverage ratio divides this cash flow amount by the

debt service (both principal and interest payments on all loans) that will be

required to be met. Bankers like to see debt service coverage of at least 120

percent. In other words, the debt service coverage ratio should be 1.2 or higher

to show that an extra cushion exists and that the business can afford its debt

requirements.

* CREDIT EVALUATION/ IMPORTANCE OF CREDIT APPRAISAL

Credit evaluation means determination of the type of customers who are going

to qualify for credit. Several costs are associated with extending credit to less

credit worthy customers. As the probability of default increases, it becomes

more crucial to identify which clients are risky. When more time is spent on

investigating the credit worthiness of clients, the cost of credit investigation

rises. Default costs vary directly with the client quality. Collection costsincrease as the client quality falls.

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Client evaluation is based on 3 Cs

1. Character: willingness of the client to repay, honesty, integrity, sincerity

& reputation in the market

2. Capacity: ability to make payments depending on clients financial

position determined from the final accounts, financial ratios & other

books of accounts

3. Condition: refers to the economic factors which can affect the clients

ability to make repayments. For example: recession, poor demand, poor

liquidity etc.

* Credit Appraisal

Credit Appraisal is a process to ascertain the risks associated with the

extension of the credit facility. It is generally carried by the financial

institutions which are involved in providing financial funding to its

customers. It is the process by which the lender appraises the credit

worthiness of a prospective borrower. This involves analyzing the

borrowers financial strength, fund requirement, repayment capability,

borrowing power, payment history etc. It helps the banker in identifying,measuring and hedging the credit risk involved in lending to particular

borrower and also understanding the way-out involved in case of default

The debt service coverage ratio (DSCR), is the ratio of cash available for debt

servicing to interest, principal and lease payments. It is a popular benchmark

used in the measurement of an entity's (person or corporation) ability to

produce enough cash to cover its debt (including lease) payments. The higherthis ratio is, the easier it is to obtain a loan. The phrase is also used in

commercial banking and may be expressed as a minimum ratio that is

acceptable to a lender; it may be a loan condition or covenant. Breaching a

DSCR covenant can, in some circumstances, be an act of default.

* Uses

In corporate finance, DSCR refers to the amount of cash flow available to meet

annual interest and principal payments on debt, including sinking fund

payments.

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In personal finance, DSCR refers to a ratio used by bank loan officers in

determining debt servicing ability.

In commercial real estate finance, DSCR is the primary measure to determine if

a property will be able to sustain its debt based on cash flow. In the late 1990s

and early 2000s banks typically required a DSCR of at least 1.2, but more

aggressive banks would accept lower ratios, a risky practice that contributed to

the financial crisis of 20072009. A DSCR over 1 means that (in theory, as

calculated to bank standards and assumptions) the entity generates sufficient

cash flow to pay its debt obligations. A DSCR below 1.0 indicates that there is

not enough cash flow to cover loan payments.

CalculationIn general, it is calculated by: DSCR =

Annual Net Income + Amortization/Depreciation + other non-cash and

discretionary items (such as non-contractual management bonuses)

Principal Repayment + Interest payments + Lease payments

Major financial ratios relevant for the lender

LIQUIDITY

RATIO CALCULATION DEFINITION

Working

Capital

Current Assets / Current Liabilities It helps determine the amount of

cushion that the company has. As in to

what extent the current assets are

sufficient to cover current liabilities.

Quick Ratio (Current Assets-Inventory) /Current Liabilities

Measures the coverage of currentassets minus inventory over current

liabilities.

Current Ratio Current Assets / Current Liabilities Measures the coverage of current

assets over current liabilities.

PROFITABILITY

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Return on Assets

(ROA)

Profit After Tax / Total Assets Measures the effectiveness of

management at making a profit and

using the assets efficiently.

Return on Equity

(ROE)

Profit After Tax / Net Worth Measures profitability as a percentage

of net worth.

Net Operating

Profit Margin

Net Operating Profit / Net

Sales

Measures profitability after Cost of

Goods Sold and Operating expenses.

Gross Profit

Margin

Gross Profit / Net Sales Measures profitability accounting only

for Cost of Goods Sold.

LEVERAGE AND COVERAGE


Net Worth Total Assets Total Liabilities This is the Owners equity in the

company.

Tangible Net

Worth

Net Worth Intangible Assets This is the Owners equity in the

company adjusted by taking out

intangible assets.

Debt to Worth Total Liabilities / Net Worth Very important ratio determines

the relationship between leverage

and equity. The lower the number

the better.

Interest Coverage Operating Profit / Interest Expense Reflects the capability of the

borrower to meet financing

obligations. The higher the better.

EBIDA Net Income + Interest Expense +

Depreciation + Amortization.

Earnings before Interest,

Depreciation and Amortization.

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ACTIVITY


Accounts

Receivable

Turnover Days

(Accounts Receivable / Sales) x 365 Number of days that it takes

the company on average to

collect its receivables

Inventory

Turnover Days

(Inventory / Cost of Goods Sold) x 365 Number of days it takes the

company on average to sell

its inventory.

Accounts

Payable

Turnover Days

(Accounts Payable / Cost of Goods Sold)

x 365

Number of days it takes the

company on average to pay

its payables.

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Chapter 3Research Methodology

(a) Problem and Research Objective.

(b) Data collection.

Research Methodology

Methodology is one of the most important parts in survey to collect information

and knowledge. The word methodology means a particular way of doing

something.A research should have a defined systematic design, data collection

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technique, analysis and reporting of data and finding relevant to a specific

situation facing the company.

Problem and research objective-

The main objective of study was to analyse the topic Analysis of an appraisal

system of a bankable project. The most difficult part of this study was to

identify the factors which create risk due to which need of appraisal occurs and

nitty-gritty of the activities related to the topic. This research report has been

prepared

The main things to be known was

(1) Process of credit

(2) Credit appraisal in Working Capital Finance.

(3) Risks before bank

(4) Techniques to overcome risks

(a) Research approach-

Descriptive research approach has been adopted to carry out this project.

(b) Data collection:-Here all the data are secondary and collected from different sources like book,

internet, Journal and library.

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Chapter 4(a) A Critical Analysis of Different Committee constituted by

RBI namely Tandon Committee,Nayak Committee,Dahejia

Committee,Marathe Committee,K.S Chore Committee and

K.Kannan Committee.

(b)Case Study Analysis.

(c) Finding/Development of a new Model in Working CapitalFinancing.

(d)Limitation of Study.

(e) Conclusion

(f) Bibliography.

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Case Studies

Assessment of Working Capital /Cash Credit

Facility/Term Loan

M/S Quality Crafts Store

M/S Quality Crafts Store Proprietor Mr. Shah Alam Mateen 256-D 1 st floor,

Green Towers, established in the year 2002, is engaged in retail business of

Kashmiri shawls particularly trading ofPashmina and woolen shawls and allied

items. The party has been in connection with and dealing with the J&K Bank

Lajpat Nagar branch since year 2006 with satisfactory dealings and good

conduct. The turnover of account is encouraging. The party has established

good trade connections and is involved in related trade. No negative complaints

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Third Party Guarantee of two persons:

1. Mr. Azam Ahmad S/o Mr. Naseeruddin Ahamad

2. Mr Shoeb Tak S/o Mr. Younis Tak

Both the guarantors are dealing with the J&K Bank Branches. As reported Both

are availing cash credit facility with their respective branches and with a

satisfactory performance.

Financials of the Firm (Amt. in Rs. Lacs)

Particulars 31/03/2007 31/03/2008

Projected

Sales 6.12 19.00

Purchases 4.12 17.53

% of Sales Growth 325.00

Net Profit 1.42 2.23

Liabilities

Share Capital 2.64 3.30

Total Term Liabilities 2.64 3.30

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Current Liabilities

Working Capital 0.00 8.00

Sundry Creditors 0.38 1.20

Expenses Payable 0.23 0.65Borrowings 0.00 0.00

Other liabilities 0.00 0.00

Total Current Liabilities 0.61 9.85

Tolal Liabilities 3.25 13.15

Assets

Investments 0.00 0.00

Fixed Assets 0.24 0.72

Total Fixed Assets 0.24 0.72

Current Assets

Stocks 1.24 8.50

Sundry Debtors 0.52 3.16

Cash in hand/Bank Balance 1.25 0.77

Loans/Advances 0.00 0.00

Total Current Assets 3.01 12.43

Total Assets 3.25 13.15

Financial Indicators

Particulars 31/03/2007 31/03/2008

Net Working Capital (In Rs. Lacs) 2.40 2.58

Current Ratio 4.93 1.26

Stocking Velocity ( Days) 108 175

Debtors Velocity (Days) 31 60

Creditors Velocity (Days) 33 25

Apart from the above financials of the party, the account statement reveals the

following transactions of the party with the Bank Branch (Amt. in Rs. Lacs) :

Debit Summation CreditSummation

From 01/04/2006 to 31/03/2007 (1 6.52 6.50

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year)

From 01/04/2007 to 31/10/2007 (7

months)

11.62 11.10

Comments and Observations:

Financial Indicators has been calculated as follows:a) Net Working Capital: Total Current Assets less Total Current

Liabilities.

b) Current Ratio: Total Current Assets divided by Total Current

Liablities.

c) Stocking Velocity: Stock for the year divided by Cost of Goods Sold or

Credit Purchase during the year multiplied by 360 days.

d) Debtors Velocity: Average Receivables or Debtors for the year divided

by Credit Sales during the year multiplied by 360 days.

e) Creditors Velocity: Average Payables or Creditors for the year divided

by Credit Purchase during the year multiplied by 360 days.

Other Comments and observations:

f) The party has projected to achieve a sales target of Rs. 19.00 Lacs over

previous year achievement of Rs. 6.12 Lacs. The projected sales target

seems to be achievable owing to the fact that up to 31/10/2007 (7

months) the party has a sales turnover of Rs. 11.62 lacs through the

account.

g) Stock Velocity reveals the part of sales always invested in stock during

the year or in other words it refers to the period of sales sans obstacles

out of the current stock in case the production halts due to strike or other

reason.

The stocking period of 175 days is on higher side hence its been

accepted at 90 days level.

h) Debtors Velocity reveals the duration within the debtors are expected to

be realized. The projected debtors period seems reasonable hence

accepted for assessment as projected.

i) Creditors Velocity reveals the duration within the creditors are expected

to be paid. Lesser the days better is the position of the firm. The

projected creditors velocity is at a lower level, keeping the kind of stocks

in trade into consideration, the velocity has been accepted at 50 days

level.

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Assessment of MPBF (Amt. in Rs. Lacs)

Particulars Amount

Accepted Sales 19.00

Accepted Purchase 17.53

Current Assets

Stock (17.53*19360) 90 days 4.38

Debtors (19*60360 60 days 3.16

Cash in hand 0.54

Loans & advances 0.00Total Current Assets (a) 8.08

Current Liabilities

Creditors (17.53*50360) 50 days 2.50

Other liabilities 0.00

Total Current liabilities (b) 2.50

Working Capital Gap (a-b) 5.58

Margin (as projected by the party) 2.58

MPBF 3.00

Recommendations of Bank Branch

In view of above, it is proposed, if agreed, to allow Cash Credit Facility of Rs. 3

Lacs (Rupees three lacs only) in favor of M/S Quality Crafts Store Prop. Mr.

Shah Alam Mateen for a period of one year subject to renewal after review

against securities as discussed.

Rate of Interest : PLR presently 13 % with monthly rests or any

other rate

This may be prescribed by the Bank from time to

time.

Margin : 40% on Stocks

50% on Book-Debts (excluding book debts older

than

6 months).

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.

M/S Healthy Heart Hospital

M/S Healthy Heart Hospital (Popularly known as 3H) South Extension New

Delhi is headed by eminent cardiologist of the country Dr. Nasir. Dr. Nasir is

the recipient of various prestigious awards and has a rich expertise in treating

heart ailments. The hospital run with the specialization of treating heart ailments

with all kinds of modern equipment and infrastructure. There are four stake

holders of the hospital one being Dr. Nasir himself, apart from him, out of three

stacke holders, two are doctors by profession and both are the daughters of Dr.

Nasir. The fourth partner Mrs. Zainab Kareem is teacher by profession and is

part of the family. All the three partner have 2% stake each in the Hospital rest

is lying with Dr. Nasir.

Dr. Nasir presently enjoying the facilities of Car Loan, and Housing Loan and

he has requested for sanction of mortgage loan of Rs. 100.00 lacs. The conduct

of all the loan accounts of Dr. Nasir is satisfactory.

Borrowers Information

Name of Applicant Borrower : Healthy Heart Hospital (3H)

Address of the Head/Regd. Office : South Extension, New Delhi.

Constitution : Partnership

Date of Incorporation : Year 1995

Period since dealing with branch : Year 2002

Net worth : Rs.600.00 lacs. Approx.

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General Information of the Proposal

Existing Banking Arrangements : 1. Working Capital Limit of Rs.

25.00 Lacs. Presently Adhoc

Facility of Rs. 25.00 lacs over

and above the Regular limit of Rs.

25.00 Lac.

2. Term Loan Facility of Rs. 396.00

Lac with

Outstanding Balance of Rs. 50.41

Lac as on

Date.

3 Term Loan facility of Rs. 15.00 lac

for

Purchase of Machinery with O/S

Balance

Of Rs. 3.99 lacs as on date of

proposal.

4 Term Loan facility of Rs. 9.00 Lac

with O/S

Balance of Rs. 7.13 lacs

Proposed Banking Arrangements : Enhancement in working capital

limit of Rs.

25.00 lacs to Rs. 100.00 Lacs as

Cash Credit

Limit under Mortgage Loan under

Trade

And Service sector.

Sanction Comes Under Powers of : Zonal Office

Activity : Running Hospital with

specialization in

Treating heart ailments.

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Sector : Professionals

Present Facilities by the Applicant : Detailed above at the head Existing

Banking

Arrangements

Facility Requested by the Applicant : Cash Credit limit underMortgage

Loan

Under Trade and Service Sector.

Purpose of Borrowing : For Expansion and growth of

Business

Amount Requested : Rs. 100.00 Lacs.

Securities Existing/Proposed for the Facility

Primary

Hypothecation of stocks of medicine, machinery and receivables/Book debts.

Collateral

The property is commercial in nature and is one of the reputed hospitals of

metropolis. The property secured is none other than Healthy Heart Hospital

itself. The full description of property is :

Plot No-1 South Extension New Delhi with four storied building and basement.

The property has been valued to the tune of Rs. 889.58 Lacs as per recent

valuation report prepared by Mr. P Kumar, registered valuer on approved panel

of the Bank. In view of the fact that real estate has witnessed enormous price

escalation particularly in preceding years and the present property is enjoying

placement at prime location the assessed value seems reasonable.

Apart from above mentioned securities there is also personal guarantee of

partners.

Details of Credit Facilities Enjoyed By Dr. Nasir Partner M/S HealthyHeart Hospitals (3H):

Serial

No.

Nature of

Credit Facility

Limit Balance

O/S

Security

1. Car Loan 2.26 1.70 Hypothecation of Car

2. Housing Loan 15.00 9.90 Mortgage of Flat Purchased

for Rs. 56.33 Lacs

3. Housing Loan 102.00 60.00 Mortgage of House valued

Rs. 154.00 Lacs

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Financials of the Firm (Amt. in Rs. Lacs)

Particulars 31/03/2006 31/03/2007 31/03/2008

Audited Provisional Projected

Income 335.38 339.16 424.55

Net Profit 12.36 10.31 25.68

% of growth in sales

Liabilities

Share Capital 50.96 66.21 91.64

Term Loan-J&K Bank 84.57 54.21 38.21Term Loan-Other Banks 39.15 41.19 32.24

Unsecured Loans 76.41 70.43 73.18

Total Term Liabilities 251.09 232.04 235.27

Current Liabilities

Working Capital 20.82 15.89 18.39

Sundry Creditors 73.88 70.30 84.37

Expenses Payable

Other liabilities 17.06 16.51 16.21

Total Current Liabilities 111.76 102.70 118.97

Total Liabilities 362.85 334.74 354.24

Assets

Fixed Assets 346.53 321.88 297.26

Total Fixed Assets 346.53 321.88 297.26

Current Assets

Receivables 5.40 3.48 3.20

Cash in hand/Bank Balance 4.39 3.29 3.35

Loans/Advances 6.53 9.39 6.10

Others 44.33

Total Current Assets 16.32 16.16 56.98

Total Assets 362.85 338.04 354.24

Financial Indicators

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Particulars 31/03/2006 31/03/2007 31/03/2008

Tangible Net worth (In Rs. Lacs) 251.09 232.04 235.27

Current Ratio 0.14 0.15 0.48

Comments and Observations:

a) The Hospital income has shown marginal increase over previous years

income (from 335.38 lacs to 339.16). However projected income (Rs.

424.55 Lacs) seems achievable owing to proposed expansion program.

b) The current ratio has remained below bench mark, however keeping into

account the nature of engagement present level seems justified..

CRITICAL ANALYSIS OF DIFFERENT

COMMITTEE

Methods of lending: P.L Tandon Committee:

Like many other activities of the banks, method and quantum of

short-term finance that can be granted to a corporate wasmandated by the Reserve Bank of India till 1994. This control was

exercised on the lines suggested by the recommendations of a

study group headed by Shri Prakash Tandon.

The study group headed by Shri Prakash Tandon, the then

Chairman of Punjab National Bank, was constituted by the RBI in

July 1974 with eminent personalities drawn from leading banks,

financial institutions and a wide cross-section of the Industry with

a view to study the entire gamut of Bank's finance for working

capital and suggest ways for optimum utilisation of Bank credit.

This was the first elaborate attempt by the central bank to organise

the Bank credit. The report of this group is widely known as

Tandon Committee report. Most banks in India even today

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continue to look at the needs of the corporates in the light of

methodology recommended by the Group.

As per the recommendations of Tandon Committee, the corporates

should be discouraged from accumulating too much of stocks of

current assets and should move towards very lean inventories and

receivable levels. The committee even suggested the maximumlevels of Raw Material, Stock-in-process and Finished Goods

which a corporate operating in an industry should be allowed to

accumulate These levels were termed as inventory and receivable

norms. Depending on the size of credit required, the funding of

these current assets (working capital needs) of the corporates could

be met by one of the following methods:

First Method of Lending:

Banks can work out the working capital gap, i.e. total

current assets less current liabilities other than bankborrowings (called Maximum Permissible Bank Finance or

MPBF) and finance a maximum of 75 per cent of the gap;

the balance to come out of long-term funds, i.e., owned

funds and term borrowings. This approach was considered

suitable only for very small borrowers i.e. where the

requirements of credit were less than Rs.10 lacs

Second Method of Lending:

Under this method, it was thought that the borrower should

provide for a minimum of 25% of total current assets out of

long-term funds i.e., owned funds plus term borrowings. A

certain level of credit for purchases and other currentliabilities will be available to fund the build up of current

assets and the bank will provide the balance (MPBF).

Consequently, total current liabilities inclusive of bank

borrowings could not exceed 75% of current assets. RBI

stipulated that the working capital needs of all borrowers

enjoying fund based credit facilities of more than Rs. 10

lacs should be appraised (calculated) under this method.

Third Method of Lending: Under this method, the borrower's contribution

from long term funds will be to the extent of the entire CORE CURRENT

ASSETS, which has been defined by the Study Group as representing the

absolute minimum level of raw materials, process stock, finished goods and

stores which are in the pipeline to ensure continuity of production and a

minimum of 25% of the balance current assets should be financed out of th

Maximum Permissible Bank Finance (MPBF)

Current Assets ( All Current Assets)

Less: Current Liabilities ( Crs. + Other Current

Liabilities)

Working Capital GapLess: 25% of the Total Current Assets or NWC

whichever is higher of the two amounts

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MPBF

Assessment Of Working Capital Fund Based : under Mortgage

Loan Scheme

Sales for last financial year

Projected Sales for next financial year

Accepted Sales

(Maximum 125% of the achieved turnover)

Permissible Limit

(20% of the accepted sales)

A

Forced Sale value of Property

Permissible Limit

(75% of the forced Sale Value)

B

Maximum Permissible Limit

(Lower of A or B)

C

Available Limit

Limit Recommended by the branch

Nayak Committee ( Turnover Method)

Considering the contribution of the SSI sector to the overall industrial

production, exports and employment and also recognising the need to

give fillip to this sector, a special package of measures was devised by

RBI (during April 1993) to ensure adequate and timely credit to this

sector. While doing so the recommendations of the PR Nayak committee

were taken into account. Examination of bank finance profile of working

capital to the small scale sector by the committee has revealed that this

sector as a whole received a level of working capital which was only

8.1% of the its output. The village industries and the smaller tinyindustries among them could get working capital finance to the extent of

only about 2.7% of their output.

The salient features of the package are set out below:

Banks have been advised to give preference to village industries, tiny

industries and other small scale units in that order, while meeting the

credit requirements of small scale sector.

The banks should step up the credit flow to meet the legitimate

requirements of the SSI sector in full during the 8th 5-year plan. For thispurpose the banks should draw up annual credit budget for the SSI

sector on a bottom-up basis. Each branch of the banks should prepare an

annual budget in respect of working capital requirements of all SSIs

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before the commencement of the year. Such budgeting should cover (a)

functioning units which already have borrowing limits with the branch

(b) new units and units whose proposals are under appraisal and (c) sick

units under nursing and also sick units found viable after discussion/

feedback received from the borrowing units. The budget should take into

account, among other relevant aspects, normal sale growth, price rise

during the past year, anticipated spurt in business etc.

It is desirable that a single financing agency meets both the requirement

of the working capital and term credit for small scale units. The Single

Window Scheme of SIDBI enables the same agency SFC or commercial

bank, as the case may be, to provide term loans and working capital to

SSI units having a project outlay upto Rs. 20 lac and working capital

requirement upto Rs. 10 lac. The banks have been advised to adopt this

approach.

At present norms for inventory and receivable are applicable to all units

enjoying aggregate fund based working capital credit limits of Rs. 10 lac

and above from the banking system. Units enjoying limit of Rs. 10 lacand above but upto Rs. 50 lac are subject to the 1st method of lending.

Henceforth for the credit requirements of village industries, tiny

industries and other SSI units having aggregate fund-based working

capital credit limits upto Rs. 50 lac (subsequently raised to Rs. 1 crore

and Rs. 200 lac during April 1997, to Rs.400 lac during August 1998

and further to Rs.500 lac during May 1999) from the banking system,

the norms for inventory and receivables and also the 1st method of

lending will not apply. Instead such units may be provided working

capital limits computed on the basis of a minimum of 20% of their

projected annual turnover for new as well as existing units.

The banks may satisfy themselves about the reasonableness of the projected annual turnover of the applicant on the basis of annual

statements of account or any other documents such as returns filed with

sales-tax/revenue authorities and also ensure that the estimated growth

during the year is realistic. These SSI units would be required to bring in

5% of their annual turnover as margin money. In cases where output

exceeds the projections or where the initial assessment of working

capital is found inadequate, suitable enhancement in the working capital

limits should be considered by the competent authority as and when this

is deemed necessary. Drawals against the limits should be allowed

against the usual safeguards so as to ensure that the same are used for the

purpose intended. Banks will have to ensure regular and timelysubmission of monthly statements of stocks, receivables etc. and also

periodical verification of such statements vis-a-vis physical stocks.

The banks can lend on the basis of 1st method of lending to those units

(companies/ organisations) which are engaged in marketing/trading of

products of SSI, village and cottage and tiny sector units. This would be

subject to the condition that 100% dealing is with the above mentioned

products. If there are dealings with other products also, then the

relaxation of application of 1st method of lending will be only to that

portion of the marketing business relating to products manufactured by

above category of units. It is also a condition that dues of such units are

settled by such borrowers within a maximum period of 30 days from

date of supply and it is to be certified by the statutory auditors of the

borrowing units on a quarterly basis.

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Action on Nayak Committee recommendations by RBI:

Banks should take immediate steps to ensure full adherence in letter and

spirit by all their branches and controlling offices to the RBI guidelines.

With a view to ascertaining the position regarding implementation of

these guidelines by the branches, banks themselves should carry out

special studies on an annual basis on as large a sample or branches, aspossible. The findings of the these studies should be reported to RBI

periodically indicating among others, the steps taken for rectifying the

deficiencies, if any, observed in the process.

The procedure and time frame laid down for disposal of loan application

received from SSI borrowers should be strictly enforced. Whenever

application for fresh limits/enhancement of existing limits was not

considered favourably by the sanctioning official or where the limits

applied for are proposed to be curtailed, the same should be referred to

the next higher authority with all relevant particulars, to ensure scrutiny

by any independent authority and the latter should confirm the decision

of the sanctioning official or otherwise dispose of the same, within a

time bound manner. Another alternative which would also help eliminate

delays inherent in the consideration of the proposal by the successive

tiers in the hierarchy and facilitate timely decisions on credit proposals it

would be for banks to adopt a system of Committee approach, in which

decisions are taken by the competent authority after a structured

discussions with the branch managers and also the authorities at the

intervening levels.

Problems faced by the SSI sector in regard to bank finance, to a large

extent could be solved if the branch level officials have the right

aptitude, skills and orientation. In understanding their role, the branchmanagers/officials at the branches should be made aware of the

importance of small scale sector from the point of view of creation of

additional employment opportunities, exports etc. A healthy growth of

the sector will facilitate smooth loan recovery in the SSI borrowal

accounts. Further, timely assistance will prevent these accounts from

becoming sticky. The aforesaid aspects should therefore, form part of the

inputs in the training imparted to the banks staff. There should an

interaction between the banks staff and the SSI borrowers as part of the

training programmes. Banks may also consider awarding trophies to

branches for the outstanding performance in financing SSI units as a

mark of public recognition. One of the complaints frequently voiced by the SSI units pertains to

insistence by some banks on compulsory deposit mobilisation as a quid

pro quo for the sanction of credit facilities to the units. While enlisting

the cooperation of banks customers for deposit mobilisation cannot be

faulted, insisting on deposit mobilisation of stipulated amounts as a

precondition to the sanction of credit or otherwise, has no justification.

The 2nd All India Census of SSI (1988) carried out by the Development

Commissioner(SSI), Govt. of India, has revealed that there were 85

district in the county each with more than 2000 registered SSI units with

Industries Deptt. of the State Govt. and another 110 districts each having

between 1000 to 2000 registered SSI units. RBI decided during July1993 that while SFCs would act as the principal financing agency for

SSIs in 40 out of the 85 districts referred to above to take care of both

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the term loan and working capital requirements of all new SSI units

which can be financed under Single Window Scheme (SWS) of SIDBI,

the commercial banks should act as the principal financing agency under

the SWS in the remaining 45 districts, as well as in rest of the country.

Banks should also consider converting such of the branches as having a

fairly large number of SSI borrowal accounts, into specialised branches.

Important banking operational clarification on Nayak Committee

Recommendations

The implementation of recommendations of Nayak Committee, relating

particularly to the assessment of working capital, gave rise to certain

operational problems. Reserve Bank has clarified these issues on the

following lines:

The assessment of credit limits for all borrowers enjoying aggregate

fund based working capital limits of less than Rs. 1 crore from the

banking system, is to be done both as per the traditional method and onthe turnover basis and the higher of the two limits is to be fixed as the

permissible bank finance. However, the neither the inventory norms

stipulated under Tandon Committee apply nor the PBF is subject to

ceiling as per the first method of lending. In cases where the limits

determined by the traditional method are less than 20% of the turnover,

the assessment will have to be re-examined. Nayak Committee has

stated that the working capital below the minimum level of 20% may be

justified under special circumstances in which the requirement is

demonstratively lower than the minimum level as in the case of ancillary

units.

Where the working capital cycle is shorter than 3 months, the workingcapital required would be less than 25% of the projected turnover. In

such case it is not required to still give PBF at 20% of the turnover.

If the liquid surplus available with the borrower is higher than 5% of the

turnover, as stipulated under the recommendations, the limits can be

fixed at a lower level than 20% of the turnover keeping in view that the

genuine requirements of the unit are met adequately. If a unit has been

managing its working capital efficiently, the limits can be set at a lower

level.

The units having longer operating cycle for working capital than three

months, should be provided proper limits to operate at a viable level

taking into account the recommendation that 20% of the turnover is theminimum stipulation and not the maximum.

In case of seasonal industries the distinction between the peak and non-

peak level of turnover has to be considered instead of annual turnover.

The creditors and other current liabilities are among the sources of funds

required for building up the current assets and will be treated in the same

manner as in the traditional method.

The borrowers contribution (margin) will be 5% of the turnover in all

cases except where the working capital cycle is not taken at three

months. The margin will proportionately increase with the increase in

the period of operating cycle. Care is to be taken that the proportion of

margin to bank finance should be maintained in the ratio of 1:4 or even

higher in case of availability of higher liquid surplus. If the borrower is

not able to bring in minimum contribution of 5%, as a general rule, no

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Turnover Method or the Cash Budget Method or the MPBF System with

necessary modifications or any other system.

Financing of working capital had always been an exclusive domain of

commercial banks. Too much emphasis on security by the banks

directed the flow of credit to affluent section of society with the result

that economic resources of the country were concentrated in a few

hands. Projects promoted by technically qualified entrepreneurs with no

tangible security to offer found it difficult to raise finance for the

working capital required by them from banks. With the nationalisation

of the banks an entirely new breed of entrepreneurs made a demand on

bank credit. Small sector and other segments of priority sector were to

be the major beneficiary of nationalisation and were preferred claimants

of credit. This resulted in an unexpected demand on lendable funds of

banks and naturally called for a reform in the policies of banks to orient

them to the new developmental role assigned to the banking industry.

Another important factor which called for reforms was the inbuilt

weakness in the cash credit system linked with emphasis on security.

The limits were directly fixed on the basis of security available in the

account which in many cases resulted in double finance. Banks also had

no control over the level of advances at any particular time. It was not

related to how much a bank can lend at a particular time but was linked

to the decision of the borrower to borrow at that time. A major part of

credit limits sanctioned by the bank remained unutilised and there was a

strong tendency within the banks to oversell the credit. It was noted as at

the end of June, 1974 that total limits sanctioned by the banking industry

was far in excess of its total deposits. Bank could afford this oversellingas 43% of the limits sanctioned by them remained unutilised. Any

unexpected demand within the sanctioned limits could prove disastrous

and had the capacity to put the entire banking industry out of gear. The

fear was proved true in late 1973 when a sudden demand on bank credit

was made due to unprecedented rate of inflation and the banks had to

arbitrarily freeze the credit limits of their borrowers.

Dehajia CommitteeFor over a decade the RBI has been making sustained efforts to come to grips

with the financial indiscipline in the corporate sector. The Dehejia Committee,

in particular, pointed out three aspects of it: (1) There has been a generalincrease in borrowing from the banks both in relation to production and

inventory. Even financing by other sources, such as trade credit, has shown a

marked increase, (2) the period of credit was unduly lengthened and the

quantum of bank credit tended to stabilize at higher levels, and (3) in some

cases, the misuse in acquiring long term assets even spilled over into financing

fixed capital assets.

Both the Dehejia Committee and the Tandon Committee (which gave

operational expression to the norms) suggested that the demand for bank credit

be reduced partly by trimming the inventory levels and secondly by insistingthat the enterprises raise adequate funds to finance net working capital from

retained earnings or other long term sources.

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The response from the corporate sector was essentially that the Tandon

Committee norms lack the flexibility to account for the practical exigencies that

individual firms are confronted with.

The present study has four primary purposes: (1) To establish theoretically the

possibility of developing micro level norms for the components of physical

inventory based on the operating cycle concept,

(2) to empirically demonstrate the plausibility of the approach by offering

specific calculations for twelve firms, based on the stock exchange directory, (3)

to develop a norm for bank credit starting from the inventory norms, and (4)

examine the differences of the approach with that of the Tandon Committee and

their implications.

The major findings of the study can be summed up as follows: (1) some firms

do have excess inventory of raw materials. But more importantly, for many

firms, including those where the inventory problem is not prominent, there have

been chronic difficulties in the collection of receivables. In some cases the

Tandon Committee norms appear inadequate relative to our micro level norms.(2) The general trend in the case of bank borrowings is that, from the Tandon

Committee vantage point, many of them have inflated drawings of bank credit.

But the micro level norms of the present study suggest that in most of these

cases the reasonable level of bank credit requirements was in excess of the

actual being made available after 1968 though the reverse was the case earlier.

Of course, some firms are excess users even on our norms and some firms have

always shown restraint. (3) On the whole, it appears that the Dehejia Committee

created an excessive reverse momentum so much so that the corporate sector is

now-a-days justified in its complaint regarding credit granting policies. The

Tandon Committee sought to carry credit policy in the same restrictive direction

rather than consider the objective reality of the situation at hand.

The anti-inflationary measures may have been the source of recessionary trends

in certain sectors. The firms were compelled to liberalize credit terms and in

many cases simultaneously increase the stocks of finished goods and

receivables. But the finances necessary to sustain this activity were not

forthcoming. Given these observations we cannot say that the financial

indiscipline is exclusively a result of the corporate decision making process.

Instead the low ebb of demand and tight credit conditions left them high and

dry.

When the question of macro credit policy is resolved in the appropriate spirit we

can return to the much neglected domain of cost effectiveness and

systematically improve the situation by using the micro level norms based on

concepts such as the operating cycle. The chief merit of the disaggregated

approach consists in the efforts to assess working capital needs keeping the

technical features and trading conventions in perspective. The micro level

norms developed in this study can be invaluable guides both to the firm and the

banker in their long term efforts to brings about efficient resources utilization.

That is the major contribution of the present study.

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Marathe Committee

3.2 The Committee observes that there are no quantifiable, objective criteria for determining the

need for an UCB in a given area. The Committee has also noted the recommendations of the

Marathe Committee, which felt that "the Reserve Bank may address itself to the task of prescribing

quantitative definitions for the key indicators like `need', `potential' and `adequacy' or otherwise of

the `banking cover'. The Marathe Committee was of the view that while "need" for the organisation

of a new UCB refers to concepts such as population coverage, spatial and geographical spread of

existing banks etc., the "potential" criterion relates to an assessment whether, in the area of

operation proposed, the new entity would be able to achieve the norms of viability within a

reasonable period of time. Marathe Committee also felt that the determining basis for such an

assessment should be the `credit gap' in the functional area and suggested the following guidelines

for assessing the same.

i) Industrial activity present and proposed; setting up of new industrial estates etc;

ii) Level of trading activity; emerging markets and market yards;

iii) Sub-urban areas - existing and proposed;

iv) Existing banking network, deposits, advances, credit-deposit ratio;

v) Average population served by existing bank offices.

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3.3 The Committee has examined these factors in the context of a substantially deregulated regime

and policy posture of RBI with reference to organisation of new Private Sector Banks and Local

Area Banks (LABs). The Committee is of the view that in a market driven regime, focus of the

regulator should be on strong start-up capital, compliance to prudential norms, adherence to CRAR

ab initio and professional character and integrity of management. If these factors are given dueweightage before granting licence for a banking entity, there may not be any need to prescribe other

parameters.

3.4 While responding to the questionnaire on this issue, a section of urban cooperative banks, their

federations, and state cooperative banks have suggested that credit gap' criterion should be a

determining factor to establish the need for a bank, in a given locale specific. The Committee has

examined this aspect and in its view, credit gap' in a given area cannot be determined on

unidentifiable parameters. The concept has to be well defined, structured and universally acceptable.

Hence, in the absence of precise, measurable and scientific tools to determine exact quantum of

credit gap, prescription of credit gap' criterion for assessing the need, will only result in a laborious

exercise without any tangible results. The suggestion that the credit gap may be determined on the

basis of Potential Linked Credit Plan (PLP) of NABARD has also been examined by the

Committee. The objective behind the preparation of Potential Linked Credit Plan is to bring to the

notice of the planners, government, developmental agencies, bankers, farmers, private sector

agencies etc, the need for infusion of specific infrastructure and non credit inputs to facilitate

planned development of the district. The focus of PLP is essentially on rural development with the

thrust on district as a whole. Since UCBs initially start at an urban centre, it is difficult to arrive at

credit gap of an exclusive urban locale from PLP. Given the weak conceptual relevance of credit

gap', the Committee is not inclined to agree with this criterion for determining the need for a newurban cooperative bank at a given centre.

3.5 Yet another suggestion put forth by respondents to the questionnaire circulated by the

Committee is, that the adequacy or otherwise of banking network at a given centre can be

determined by the conventional arithmetical formula viz., Average Population Per Bank Office

(APPBO). The APPBO is arrived at by application of following formula :

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FINDINGS/DEVELOPING A NEW MODEL

Bank Finance for working Capital has been based on the Tandon Committee

norms introducing 25 years ago by RBI.These norms ration scarce Bank credit

to needy borrowers,on the basis of end use principle and purpose

orientation.Evaluation is on the basis of Working Capital operating cycle and

follow up is on the basis of component of gross current Asset and Current

liabilities.Current Ratio is the key of these norms.During the period 1997 RBI

has accorded operational freedom to banks in assessing the working capital

requirement of borrowers.It is hoped that Banks will come out with innovative

models of Working Capital Financing as a consequence.

Cash Flow method of financing and finance based on security,beside balance

sheet method of financing though not entirely novel are the new model that

emerged recently.Still many banks follow Tandon Committee norms for high

value limits I n view of their soundness.

Nayak Committee norms introduced in 1993 to provide hassle free finance to

SSI borrowers,Stipulate that banks should fix as credit limit,a minimum of 20%

of the projected gross sales,with a margin of five percent on sales.

As banks appear to be reluctant to reduce the margin while computing drawingpower to 20% as envisaged in this model,SSI borrower often complain that this

new model is not of much help to them.Any credit appraisal system will be

successful only when there is real time follow up based on ledger and financial

data.

We Can Make a new Working Capital lending model with the help of two

financial tool namely (1)Working Capital Cycle and (2)Value Addition

Concept.The basic concept and framework of the model works in followingway:

(1)Determination of Operating cycle and find out the time period of each

working capital component namely Sundry Debtors, Bills Receivables,

WIP,Finished Goods,Cash and Cheque Collection etc in WC Cycle.

(2)Determination of amount of value addition from companies income

statements.

Documents

Int Prj Cr Appr