Project Report-study on Credit Appraisal (2)

“STUDY ON CREDIT APPRAISAL”

Submitted by

E.PRAMOD

(PGDMB12/72)

In partial fulfillment for the award of the degree of

POST GRADUATE DIPLOMA IN MANAGEMENT

INSTITUTE FOR FINANCIAL MANAGEMENT AND RESEARCH

24, Kothari Road, Nungambakkam, Chennai - 600 034(2011-13)

CERTIFICATE

1 PRAMOD.E(PGDMB12/72)

This is to certify that this project report “STUDY ON CREDIT APPRAISAL” is

the bona fide work of PRAMOD.E (PGDMB12/72) who carried out the project

work under my supervision.

(Signature)

Name of project Guide: Mr.Raju Designation: Senior Manager

Organization: ALLAHABAD BANKDate


ACKNOWLEDGEMENT

A journey is easier when we travel together. Interdependence is certainly more important than independence. It will always be my pleasures to thank those who have helped me in making this project a good experience for me. I would like to express my heartiest gratitude to Allahabad Bank , for giving me an opportunity to work in SRCM branch, Chennai, my Institute IFMR and important persons associated with this project as without their guidance and hard work I would have never ever have got a chance to have real life experience of working with a Public Sector Bank of such a great repute and learn practically about Credit appraisal process.

I would also like to extend my gratitude to Mr. Raju (Senior Manager, SRCM Branch) for giving me an opportunity to know and learn various aspects.It is my privilege to thank Mr. Ramesh Subramanian (Industry Guide & Chief Mentor) whose guidance has made me learn and understand the finer and complicated aspects of banking, in general and of Credit Appraisal Process, in particular. The help and guidance which he has extended to me has made me feel as being an integral part of the organization.

PRAMOD.E


TABLE OF CONTENTS

Chapter

Number.

TITLE

Page

Number

1 ALLAHABAD BANK- AN INTRODUCTION 5

2 CREDIT APPRAISAL- INTRODUCTION 11

3 CREDIT APPRAISAL PROCESS 24

4 CREDIT RISK ASSESSMENT 34

5 CREDIT RISK GRADING MODULES 36

6 APPRAISAL CASE STUDY 46

7 SUMMARY AND CONCLUSION 57

8 REFERENCES 58

CHAPTER-1


ALLAHABAD BANK – AN INTRODUCTION

BRIEF HISTORY

The Oldest Joint Stock Bank of the Country, Allahabad Bank was founded on April 24, 1865 by a group of Europeans at Allahabad. At that juncture Organized Industry, Trade and Banking started taking shape in India. Thus, the History of the Bank spread over three Centuries - Nineteenth, Twentieth and Twenty-First.

Nineteenth Century

April 24, 1865's The Bank was founded at the confluence city of Allahabad by a group of Europeans.

1890's Opened branches at Calcutta Nainital, Bareilly, Lucknow, Kanpur and Jhansi.

Twentieth Century

1920's The Bank became a part of P & O Banking Corporation's group with a bid price of Rs.436 per share,

1923 The Head Office of the Bank shifted to Calcutta on Business considerations.

July 19, 1969 Nationalized along with 13 other banks, Branches - 151 Deposits - Rs.119 crores, Advances - Rs.82 crores.

October, 1989 United Industrial Bank Ltd. merged with Allahabad Bank.1991 Instituted AllBank Finance Ltd., a wholly owned subsidiary for

Merchant Banking.

Twenty-First Century

October, 2002 The Bank came out with Initial Public Offer (IPO), of 10 crores share of face value Rs.10 each, reducing Government shareholding to 71.16%.

April, 2005 Follow on Public Offer (FPO) of 10 crores equity shares of face value Rs.10 each with a premium of Rs.72, reducing Government shareholding to 55.23%.

June, 2006 The Bank Transcended beyond the National Boundary, opening Representative Office at Shenzen, China.

Oct, 2006 Rolled out first Branch under CBS.February, 2007 The Bank opened its first overseas branch at Hong Kong.March 2007 Bank's business crossed Rs.1,00,000 crores mark.2012 Bank's business crossed Rs.2,71,000 crores mark.


TRENDS IN ALLAHABAD BANK

CONSISTENT GROWTH ALL THE WAY

….


1. The Bank records 55.36 % growth in Net Profit by registering ` 400.22 crore during Q4 of FY-2011-12

2. Operating Profit in Q4 up by 15.52% at ` 901 crore

3. Net Interest Income in Q4 up by 11.91 % (YOY)

4. Net Interest Margin (NIM) stood at 3.23% during Q4

5. Earnings per Share mounts to ` 39.18 at the end of Q4

Net Profit of the Bank increased to `400.22 crore for the quarter ended March, 2012 as against ` 257.60 crore in the corresponding quarter last year registering a YoY rise of 55.36 %.

Operating Profit for quarter ended March, 2012 increased to ` 901.07 crore as against ` 780 crore last year showing a YoY growth of 15.52 %.

Net Interest Income during Q4, FY2011-12 increased to ` 1288 crore as against `1151 crore last year showing a YoY growth of 11.91 %.

Total Other Income during the quarter ended March, 2012 is ` 355 crore. Net Interest Margin (NIM) stood at 3.23 % for Q4, FY2011-12 Yield on Advances increased to 12.02% for Q4, FY2011-12 as against 10.71 %

corresponding quarter last year. Cost of Deposits stood at 7.34% for quarter ended March, 2012. Yield on Investments improved to 7.67% for Q4, FY2011-12 from 7.20% of

corresponding quarter last year. Yield on Funds rose to 10.46% for quarter ended March, 2012 from 9.46% last year. Cost of Funds stood at 7.23% for quarter ended March, 2012.

Highlights of Q4, FY-2011-12 (3 months)

ALLAHABAD BANK’S BUSINESS CROSSES ` 2,71,000 CRORE


Bank opened 101 Branches during the last financial year, of which 40 are Rural, 39 Semi – Urban, 9 Urban and 13 are Metropolitan Branches taking the total number of Branches to 2516( excluding one Overseas Branch at Hong Kong) of which 39 Branches have been opened during the quarter ending March,2012.

During the Financial Year 2011-12, Bank has recruited 1541 Officers and 876 Clerks in the system.

25 branches have been opened under Financial Inclusion Plan during the year 2011- 12; Bank has also opened 4 Satellite Offices during the year.

The Bank has established eight more Rural Self Employment Training Institutes (RSETIs ) during the year 2011-12 for imparting training to farmers, unemployed youths, NGOs, SHGs for improvement of skills and entrepreneurship ability, taking the total number to 21.

New Initiatives

The Bank augmented Operating Profit of `3,770 crore during FY 2011-12 as against ` 3,055 crore last year showing a YOY growth of 23.42%.

Net Profit is ` 1,867crore during the Financial Year ending 31st March, 2012 as against ` 1,423 crore last year showing a YOY Growth of 31.18 %.

Net Interest Income during the Financial Year ending March, 2012 is `5,163 crore as against ` 4,022 crore last year recording a YOY Growth of 28.35 %.

Total Other Income during the Financial Year ending March, 2012 increased to `1,299 crore .

Net Interest Margin (NIM) increased to 3.48 % during the Financial Year ending March, 2012 as against 3.38 % last year.

Total Business of the Bank increased to ` 2,71,843 crore as on 31st March, 2012 as against ` 2,26,458 crore as on 31st March 2011 showing a YOY growth of 20.04 %.

Deposits of the Bank went up to ` 1,59,593 crore as on 31st March, 2012 from ` 1,31,887 crore as on 31st March,2011. Year-on-Year basis, Total Deposits grew by 21.01%.

Gross Credit surged to ` 1,12,250 crore as on 31st March, 2012 from ` 94,571 crore as on 31st March 2011.Year-on-Year basis,the Gross Credit increased by 18.69 %.

Credit Deposit Ratio stood at 71% as on 31st March, 2012. Yield on Advances increased to 12.09% as against 10.50%last year. Yield on Investments increased to 7.56 % as against 7.04% last year. Cost of Deposits stood at 7.07 %. Cost of Funds stood at 6.98 %. Yield on Funds improved to 10.48 % as against 9.19% previous year. Gross NPA to Gross Advances stands at 1.83 % as at March, 2012. Net NPA to Net Advances Ratio stands at 0.98 % as at March, 2012. Provision Coverage Ratio stands at 74 %. Capital Adequacy Ratio was 12.83% as on 31st March, 2012 as against the

stipulated norm of 9%. Business per Employee surged to ` 12.17 crore as on 31st March, 2012 as against

` 10.63 crore last year. Business per Branch improved to ` 108.05 crore as on 31st March, 2012 as against

` 93.38 crore last year.

Highlights of 12 Months period ending 31st March 2012

Earnings per Share surged to `39.18 during the Financial Year ended March, 2012 from ` 31.85 corresponding last year.

Book Value per Share increased to `192.93 during the Financial Year ended March, 2012 from ` 178.64 as on 31.03.11.

Return on Asset for Financial Year ending March, 2012 is 1.02%.

SHAREHOLDER’S VALUE


The Bank, which now has 316 ATMs, issued more than 12.78 lac ATM cum Debit Cards to its customers.

As a part of green initiative, High Definition Video conferencing system has been implemented at 59 identified locations across the country in order to have a seamless communication for review of performance of branches.

Cheque Truncation System (CTS) has been implemented at Chennai on 21.10.2011.

Bank opened 101 Branches during the last financial year, of which 40 are Rural, 39 Semi – Urban, 9 Urban and 13 are Metropolitan Branches taking the total number of Branches to 2516( excluding one Overseas Branch at Hong Kong) of which 39 Branches have been opened during the quarter ending March,2012.

During the Financial Year 2011-12, Bank has recruited 1541 Officers and 876 Clerks in the system.

25 branches have been opened under Financial Inclusion Plan during the year 2011- 12; Bank has also opened 4 Satellite Offices during the year.

The Bank has established eight more Rural Self Employment Training Institutes (RSETIs ) during the year 2011-12 for imparting training to farmers, unemployed youths, NGOs, SHGs for improvement of skills and entrepreneurship ability, taking the total number to 21.

Technology


Bank has planned to achieve ` 3,20,000 crore of Total Business by 31st March, 2013. Bank has envisaged to cross ` 4.00 lac crore in Total Business, to increase the

number of Branches to 3000 and to open 2000 ATMs within the next 2-year horizon. Bank will be recruiting 1600 Probationary Officers and 350 Specialist Officers during

the year 2012-13. Bank has planned to open more Branches Overseas, which include one each at

Dhaka (Bangladesh), Shanghai, Singapore and Kowloon (Hong Kong) for which ground work is in progress.

Priority Sector Credit of the Bank grew to ` 37,390 crore as on 31st March, 2012 from ` 30,764 crore last year registering an absolute YoY growth of ` 6,626 crore (21.54%). Bank has exceeded the National Goal (40%) of Priority Sector Credit to ANBC by achieving 41.19 % as on March, 2012.

Agriculture Credit outstanding rose to `16,590 crore as on 31st March, 2012 from `13,387 crore last year registering an absolute YoY growth of `3,203 crore. Bank has exceeded the National Goal of 18% of Agriculture Credit by achieving 18.05 % as on March, 2012.

Fresh Credit disbursal in Agriculture Loans soared to ` 5,975 crore during FY’11-12 as against the target of ` 5,640 crore.

The Bank issued 1.68 lac Kisan Credit Cards (KCC) involving a credit amount of ` 1,726 crore during 2011-12.

Credit to Micro and Small Enterprises (MSE) surged to `16,182 crore as on 31.03.2012 from ` 11,990 crore last year registering an absolute YoY growth of ` 4,192 crore (34.96%).

Under Financial Inclusion Plan, during FY’11-12, Bank has covered 2618 villages allotted to it with population 2000 and above under various models. 25 “Brick & Mortar” Branches were opened during FY’11-12, exclusively under the Plan.

Social Banking

Awards Received

Total Outstanding under Retail Credit as on 31.03.2012 stood at ` 15,114 crore as against ` 13,029 crore as on 31.03.2011, constituting 13.46% of Gross Credit of the Bank.

Total Disbursement under Retail Credit of the Bank during 2011-12 was `4,078 crore as against `3,869 crore during 2010-11.

Bank has extended Festival Bonanza discount on Select Retail Loan Schemes up to 31.12.2011, under which Rebate up to 1.50 % in Interest Rate and 50 % in applicable Processing Charges have been allowed. Loans amounting to ` 676.89 crore have been disbursed up to 31.12.2011 with Festival Bonanza Discount.

Outstanding under Bank’s Education Loan rose to ` 1,180 crore as against `1,040 crore last year.

Total Outstanding under ALLBANK COMMERCIAL VEHICLE FINANCE as on 31st March,2012 increased to ` 603 crore as against ` 433 crore as on 31st March,2011. (YoY Growth 39%).

Total Outstanding in Auto Loan (Car + Mobike) increased to ` 729 crore as on 31.03.2012 as against ` 621 crore last year.

Total Outstanding under ALLBANK Trade Scheme as on 31.03.2012 increased to ` 2,919 crore as against ` 2,225 crore as on 31.03.11 (YoY Growth 31%).

Retail Credit

CHAPTER-2

CREDIT APPRAISAL-INTRODUCTION

Definition:

Credit appraisal means an investigation/assessment done by the bank prior before providing any

loans & advances/project finance & also checks the commercial, financial & technical viability of


Future Plans

Bank has been awarded The Financial Advisor Award -2012 for Best Performing Bank in PSU category presented by UTI Mutual Fund and CNBC – TV 18, powered by ICRA.

Bank has been awarded the FIBAC Banking Award – 2011 for Best initiatives in Inclusive Banking.

Bank has been awarded 1st prize in Indira Gandhi Rajbhasha prize for its excellent work in Rajbhasha (Hindi) by The President of India.

Bank is positioned 4th fastest growing Bank and 5th efficient Bank among 57 SCBs as per Business World Award, 2011.

the project proposed its funding pattern & further checks the primary & collateral security cover

available for recovery of such funds.

Brief overview of credit:

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. Credit risk is a risk related to non repayment of the credit obtained by the

customer of a bank. Thus it is necessary to appraise the credibility of the customer in order to

mitigate the credit risk. Proper evaluation of the customer is performed, which measures the

financial condition and the ability of the customer to repay back the loan in future. Generally the

credit facilities are extended against the security know as collateral. But even though the loans are

backed by the collateral, banks are normally interested in the actual loan amount to be repaid along

with the interest. Thus, the customer's cash flows are ascertained to ensure the timely payment of

principal and the interest.

It is the process of appraising the credit worthiness of a loan applicant. Factors like age, income,

number of dependents, nature of employment, continuity of employment, repayment capacity,

previous loans, credit cards, etc. are taken into account while appraising the credit worthiness of a

person. Every bank or lending institution has its own panel of officials for this purpose.

However the 6 ‘C’ of credit are crucial & relevant to all borrowers/ lending which must be kept in

mind at all times.

Character

Capacity

Collateral

Capital

Cash flow

Condition

If any one of these is missing in the equation then the lending officer must question the viability of

credit. There is no guarantee to ensure a loan does not run into problems; however if proper credit

evaluation techniques and monitoring are implemented then naturally the loan loss probability /

problems will be minimized, which should be the objective of every lending officer.

Credit is the provision of resources (such as granting a loan) by one party to another party where

that second party does not reimburse the first party immediately, thereby generating a debt, and

instead arranges either to repay or return those resources (or material(s) of equal value) at a later


date. The first party is called a creditor, also known as a lender, while the second party is called a

debtor, also known as a borrower.

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.

A credit is a legal contract where one party receives resource or wealth from another party and

promises to repay him on a future date along with interest. In simple terms, a credit is an agreement

of postponed payments of goods bought or loan. With the issuance of a credit, a debt is formed.

Basic types of credit

There are four basic types of credit. By understanding how each works, you will be able to get the

most for your money and avoid paying unnecessary charges.

Service credit is monthly payments for utilities such as telephone, gas, electricity, and water. You

often have to pay a deposit, and you may pay a late charge if your payment is not on time.

Loans let you borrow cash. Loans can be for small or large amounts and for a few days or several

years. Money can be repaid in one lump sum or in several regular payments until the amount you

borrowed and the finance charges are paid in full. Loans can be secured or unsecured.

Installment credit may be described as buying on time, financing through the store or the easy

payment plan. The borrower takes the goods home in exchange for a promise to pay later. Cars,

major appliances, and furniture are often purchased this way. You usually sign a contract, make a

down payment, and agree to pay the balance with a specified number of equal payments called

installments. The finance charges are included in the payments. The item you purchase may be

used as security for the loan.

Credit cards are issued by individual retail stores, banks, or businesses. Using a credit card can be

the equivalent of an interest-free loan--if you pay for the use of it in full at the end of each month.

Brief overview of loans:

Loans are of following types:

Working Capital


Term Loan

Letter of Credit

Bank Guarantee

Bill Discounting

WORKING CAPITAL: -

General

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

“fixed assets” like land, building, plant, machinery, equipments, vehicles, tools etc., & also to run

the business i.e. its day to day operations.

Funds required for day to-day working will be to finance production & sales. For production, funds

are needed for purchase of raw materials/ stores/ fuel, for employment of labor, for power charges

etc., for storing finishing goods till they are sold out & for financing the sales by way of sundry

debtors/ receivables.

Capital or funds required for an industry can therefore be bifurcated as fixed capital & working

capital. Working capital in this context is the excess of current assets over current liabilities. The

excess of current assets over current liabilities is treated as net working capital or liquid surplus &

represents that portion of the working capital, which has been provided from the long-term source.

DEFINITION

Working capital is defined as the funds required 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 is dependent on

(a) The volume of activity (viz. level of operations i.e. Production & sales)

(b) The activity carried on viz. mfg process, product, production program, the materials &

marketing mix.

DIFFERENT METHODOLOGIES 1. MPBF Method (Maximum permissible bank finance)

A. Total Current AssetsB. Total Current Liabilities ( Other than Bank Borrowings)C. Working Capital Gap ( A- B) D. Less : Margin


a. Minimum Required Margin(25 % of Current Assets less Export Receivables)

b. Estimated Net Current Assetsc. (a) or (b) , whichever is higher

E. MPBF [ C- D(c) ]

2. Turnover Method A. Total Chargeable Current Assets

B. Total Current Liabilities (Other than Bank Borrowings)C. Working Capital Gap (A- B) D. Less: Margin (a) Minimum Required Margin (20 % of C)

(b) Estimated Margin (c) (a) or (b) , whichever is higher.E. Permissible Bank Finance [C- D(c)]

3. Cash Budget MethodCash budget containing cash receipts and cash payments for a particular period is obtained from the borrower.The difference of cash receipt and payments for individual month represents surplus/ deficit.The opening cash surplus/deficit and the surplus /deficit for individual months is carried forward from month to month, with cumulative effect.The limit is fixed based on the peak cumulative deficit and drawings for individual months are allowed within the deficit for the respective month.

TERM LOAN:

1. A term loan is granted for a fixed term of not less than 3 years intended normally for

financing fixed assets acquired with a repayment schedule normally not exceeding 8 years.

2. A term loan is a loan granted for the purpose of capital assets, such as purchase of land,

construction of, buildings, purchase of machinery, modernization, renovation or

rationalization of plant, & repayable from out of the future earning of the enterprise, in

installments, as per a prearranged schedule.

From the above definition, the following differences between a term loan & the working

capital credit afforded by the Bank are apparent:

The purpose of the term loan is for acquisition of capital assets.

The term loan is an advance not repayable on demand but only in installments ranging

over a period of years.


The repayment of term loan is not out of sale proceeds of the goods & commodities

per se, whether given as security or not. The repayment should come out of the future

cash accruals from the activity of the unit.

The security is not the readily saleable goods & commodities but the fixed assets of

the units.

3. It may thus be observed that the scope & operation of the term loans are entirely different

from those of the conventional working capital advances. The Bank’s commitment is for a

long period & the risk involved is greater. An element of risk is inherent in any type of loan

because of the uncertainty of the repayment. Longer the duration of the credit, greater is the

attendant uncertainty of repayment & consequently the risk involved also becomes greater.

4. However, it may be observed that term loans are not so lacking in liquidity as they appear to

be. These loans are subject to a definite repayment program unlike short term loans for

working capital (especially the cash credits) which are being renewed year after year. Term

loans would be repaid in a regular way from the anticipated income of the industry/ trade.

5. These distinctive characteristics of term loans distinguish them from the short term credit granted by

the banks & it becomes necessary therefore, to adopt a different approach in examining the

applications of borrowers for such credit & for appraising such proposals.

6. The repayment of a term loan depends on the future income of the borrowing unit. Hence, the

primary task of the bank before granting term loans is to assure itself that the anticipated income

from the unit would provide the necessary amount for the repayment of the loan. This will involve a

detailed scrutiny of the scheme, its financial aspects, economic aspects, technical aspects, a

projection of future trends of outputs & sales & estimates of cost, returns, flow of funds & profits.

7. Appraisal of Term Loans

Appraisal of term loan for, say, an industrial unit is a process comprising several steps. There are

four broad aspects of appraisal, namely

Technical Feasibility - To determine the suitability of the technology selected & the

adequacy of the technical investigation & design;

Economic Feasibility - To ascertain the extent of profitability of the project & its sufficiency

in relation to the repayment obligations pertaining to term assistance;

Financial Feasibility - To determine the accuracy of cost estimates, suitability of the

envisaged pattern of financing & general soundness of the capital structure; &


Managerial Competency – To ascertain that competent men are behind the project to ensure

its successful implementation & efficient management after commencement of commercial

production.

7.1 Technical Feasibility

The examination of this item consists of an assessment of the various requirement of the actual

production process. It is in short a study of the availability, costs, quality & accessibility of all

the goods & services needed.

a) The location of the project is highly relevant to its technical feasibility & hence special

attention will have to be paid to this feature. Projects whose technical requirements

could have been taken care of in one location sometimes fail because they are

established in another place where conditions are less favorable. One project was

located near a river to facilitate easy transportation by barge but lower water level in

certain seasons made essential transportation almost impossible. Too many projects

have become uneconomical because sufficient care has not been taken in the location of

the project, e.g. a woolen scouring & spinning mill needed large quantities of good

water but was located in a place which lacked ordinary supply of water & the limited

water supply available also required efficient softening treatment. The accessibility to

the various resources has meaning only with reference to location. Inadequate transport

facilities or lack of sufficient power or water for instance, can adversely affect an

otherwise sound industrial project.

b) Size of the plant – One of the most important considerations affecting the feasibility of a

new industrial enterprise is the right size of the plant. The size of the plant will be such

that it will give an economic product, which will be competitive when compared to the

alternative product available in the market. A smaller plant than the optimum size may

result in increased production costs & may not be able to sell its products at competitive

prices.

c) Type of technology – An important feature of the feasibility relates to the type of

technology to be adopted for a project. A new technology will have to be fully examined

& tired before it is adopted. It is equally important to avoid adopting equipment or

processes which are absolute or likely to become outdated soon. The principle

underlying the technological selection is that “a developing country cannot afford to be

the first to adopt the new nor yet the last to cast the old aside”.


d) Labor – The labor requirements of a project, need to be assessed with special care.

Though labor in terms of unemployed persons is abundant in the country, there is

shortage of trained personnel. The quality of labor required & the training facilities

made available to the unit will have to be taken into account

e) Technical Report – A technical report using the Bank’s Consultancy Cell, external

consultants, etc., should be obtained with specific comments on the feasibility of

scheme, its profitability, whether machinery proposed to be acquired by the unit under

the scheme will be sufficient for all stages of production, the extent of competition

prevailing, marketability of the products etc., wherever necessary.

7.2 Economic Feasibility

An economic feasibility appraisal has reference to the earning capacity of the project. Since

earnings depend on the volume of sales, it is necessary to determine how much output or the

additional production from an established unit the market is likely to absorb at given prices.

a) A thorough market analysis is one of the most essential parts of project investigation. This

involves getting answers to three questions.

a) How big is the market?

b) How much it is likely to grow?

c) How much of it can the project capture?

The first step in this direction is to consider the current situation, taking account of the total output

of the product concerned & the existing demand for it with a view to establishing whether there is

unsatisfied demand for the product. Care should be taken to see that there is no idle capacity in the

existing industries.

ii) Future – possible future changes in the volume & patterns of supply & demand will have to be

estimated in order to assess the long term prospects of the industry. Forecasting of demand is a

complicated matter but one of the vital importance. It is complicated because a variety of factors

affect the demand for product e.g. technological advances could bring substitutes into market while

changes in tastes & consumer preference might cause sizable shifts in demand.

iii) Intermediate product – The demand for “Intermediate product” will depend upon the demand

& supply of the ultimate product (e.g. jute bags, paper for printing, parts for machines, and tires for

automobiles). The market analysis in this case should cover the market for the ultimate product.

7.3 Financial Feasibility


The basis data required for the financial feasibility appraisal can be broadly grouped under the

following heads

i) Cost of the project including working capital

ii) Cost of production & estimates of profitability

iii) Cash flow estimates & sources of finance.

The cash flow estimates will help to decide the disbursal of the term loan. The estimate of

profitability & the breakeven point will enable the banker to draw up the repayment programme,

start-up time etc. The profitability estimates will also give the estimate of the Debt Service

Coverage which is the most important single factor in all the term credit analysis.

A study of the projected balance sheet of the concern is essential as it is necessary for the appraisal

of a term loan to ensure that the implementation of the proposed scheme.

Break-even point:

In a manufacturing unit, if at a particular level of production, the total manufacturing cost equals

the sales revenue, this point of no profit/ no loss is known as the break-even point. Break-even

point is expressed as a percentage of full capacity. A good project will have reasonably low break-

even point which not be encountered in the projections of future profitability of the unit.

Debt/ Service Coverage:

The debt service coverage ratio serves as a guide to determining the period of repayment of a loan.

This is calculated by dividing cash accruals in a year by amount of annual obligations towards term

debt. The cash accruals for this purpose should comprise net profit after taxes with interest,

depreciation provision & other non cash expenses added back to it.

Debt Service = Cash accruals

Coverage Ratio Maturing annual obligations

This ratio is valuable, in that it serves as a measure of the repayment capacity of the project/ unit &

is, therefore, appropriately included in the cash flow statements. The ratio may vary from industry

to industry but one has to view it with circumspection when it is lower than the benchmark of 1.75.

The repayment program should be so stipulated that the ratio is comfortable.

7.4 Managerial Competence


In a dynamic environment, the capacity of an enterprise to forge ahead of its competitors depends

to a large extent, on the relative strength of its management. Hence, an appraisal of management is

the touchstone of term credit analysis.

If there is a change in the administration & managerial set up, the success of the project may be put

to test. The integrity & credit worthiness of the personnel in charge of the management of the

industry as well as their experience in management of industrial concerns should be examined. In

high cost schemes, an idea of the unit’s key personnel may also be necessary.

LETTER OF CREDIT

Introduction

The expectation of the seller of any goods or services is that he should get the payment

immediately on delivery of the same. This may not materialize if the seller & the buyer are at

different places (either within the same country or in different countries). The seller desires to have

an assurance for payment by the purchaser. At the same time the purchaser desires that the amount

should be paid only when the goods are actually received. Here arises the need of Letter of Credit

(LCs). The objective of LC is to provide a means of payment to the seller & the delivery of goods

& services to the buyer at the same time.

Definition

A Letter of Credit (LC) is an arrangement whereby a bank (the issuing bank) acting at the request

& on the instructions of the customer (the applicant) or on its own behalf,

i. is to make a payment to or to the order of a third party (the beneficiary), or is to accept &

pay bills of exchange (drafts drawn by the beneficiary); or

ii. Authorizes another bank to effect such payment, or to accept & pay such bills of exchanges

(drafts); or

iii. Authorizes another bank to negotiate against stipulated document(s), provided that the terms

& conditions of the credit are complied with.

Basic Principle:

The basic principle behind an LC is to facilitate orderly movement of trade; it is therefore necessary

that the evidence of movement of goods is present. Hence documentary LCs is those which contain

documents of title to goods as part of the LC documents. Clean bills which do not have document

of title to goods are not normally established by banks. Bankers and all concerned deal only in

documents & not in goods. If documents are in order issuing bank will pay irrespective of whether

the goods are of expected quality or not. Banks are also not responsible for the genuineness of the


documents & quantity/quality of goods. If importer is your borrower, the bank has to advice him to

convert all his requirements in the form of documents to ensure quantity & quality of goods.

Parties to the LC

1) Applicant – The buyer who applies for opening LC

2) Beneficiary – The seller who supplies goods

3) Issuing Bank – The Bank which opens the LC

4) Advising Bank – The Bank which advises the LC after confirming authenticity

5) Negotiating Bank – The Bank which negotiates the documents

6) Confirming Bank – The Bank which adds its confirmation to the LC

7) Reimbursing Bank – The Bank which reimburses the LC amount to negotiating bank

8) Second beneficiary – The additional beneficiary in case of transferable LCs

Confirming bank may not be there in a transaction unless the beneficiary demand confirmation by

own bankers & such a request is made part of LC terms. A bank will confirm an LC for his

beneficiary if opening bank requests this as part of LC terms. Reimbursing bank is used in an LC

transaction by an opening bank when the bank does not have a direct correspondent/branch through

whom the negotiating bank can be reimbursed. Here, the opening bank will direct the reimbursing

bank to reimburse the negotiating bank with the payment made to the beneficiary. In the case of

transferable LC, the LC may be transferred to the second beneficiary & if provided in the LC it can

be transferred even more than once.

BANK GUARANTEES:

A contract of guarantee is defined as ‘a contract to perform the promise or discharge the liability of

the third person in case of the default’. The parties to the contract of guarantees are:

a) Applicant: The principal debtor – person at whose request the guarantee is executed

b) Beneficiary: Person to whom the guarantee is given & who can enforce it in case of default.

c) Guarantee: The person who undertakes to discharge the obligations of the applicant in case

of his default.

Thus, guarantee is a collateral contract, consequential to a main contract between the applicant

& the beneficiary.

Purpose of Bank Guarantees

Bank Guarantees are used to for both preventive & remedial purposes. The guarantees executed by

banks comprise both performance guarantees & financial guarantees. The guarantees are structured

according to the terms of agreement, viz., security, maturity & purpose.


Branches may issue guarantees generally for the following purposes:

a) In lieu of security deposit/earnest money deposit for participating in tenders;

b) Mobilization advance or advance money before commencement of the project by the

contractor & for money to be received in various stages like plant layout, design/drawings

in project finance;

c) In respect of raw materials supplies or for advances by the buyers;

d) In respect of due performance of specific contracts by the borrowers & for obtaining full

payment of the bills;

e) Performance guarantee for warranty period on completion of contract which would enable

the suppliers to realize the proceeds without waiting for warranty period to be over;

f) To allow units to draw funds from time to time from the concerned indenters against part

execution of contracts, etc.

g) Bid bonds on behalf of exporters

h) Export performance guarantees on behalf of exporters favouring the Customs Department

under EPCG scheme.

Guidelines on conduct of Bank Guarantee business

Branches, as a general rule, should limit themselves to the provision of financial guarantees &

exercise due caution with regards to performance guarantee business. The subtle difference

between the two types of guarantees is that under a financial guarantee, a bank guarantee’s a

customer financial worth, creditworthiness & his capacity to take up financial risks. In a

performance guarantee, the bank’s guarantee obligations relate to the performance related

obligations of the applicant (customer).

While issuing financial guarantees, it should be ensured that customers should be in a position to

reimburse the Bank in case the Bank is required to make the payment under the guarantee. In case

of performance guarantee, branches should exercise due caution & have sufficient experience with

the customer to satisfy themselves that the customer has the necessary experience, capacity,

expertise, & means to perform the obligations under the contract & any default is not likely to

occur.

Branches should not issue guarantees for a period more than 18 months without prior reference to

the controlling authority. Extant instructions stipulate an Administrative Clearance for issue of BGs

for a period in excess of 18 months. However, in cases where requests are received for extension of

the period of BGs as long as the fresh period of extension is within 18 months. No bank guarantee


should normally have a maturity of more than 10 years. Bank guarantee beyond maturity of 10

years may be considered against 100% cash margin with prior approval of the controlling authority.

More than ordinary care is required to be executed while issuing guarantees on behalf of customers

who enjoy credit facilities with other banks. Unsecured guarantees, where furnished by exception,

should be for a short period & for relatively small amounts. All deferred payment guarantee should

ordinarily be secured.

Appraisal of Bank Guarantee Limit

Proposals for guarantees shall be appraised with the same diligence as in the case of fund-base

limits. Branches may obtain adequate cover by way of margin & security so as to prevent default

on payments when guarantees are invoked. Whenever an application for the issue of bank

guarantee is received, branches should examine & satisfy themselves about the following aspects:

a) The need of the bank guarantee & whether it is related to the applicant’s normal

trade/business.

b) Whether the requirement is one time or on the regular basis

c) The nature of bank guarantee i.e., financial or performance

d) Applicant’s financial strength/ capacity to meet the liability/ obligation under the bank

guarantee in case of invocation.

e) Past record of the applicant in respect of bank guarantees issued earlier; e.g., instances of

invocation of bank guarantees, the reasons thereof, the customer’s response to the

invocation, etc.

f) Present o/s on account of bank guarantees already issued

g) Margin

h) Collateral security offered

Format of Bank Guarantees

Bank guarantees should normally be issued on the format standardized by Indian Banks

Association (IBA). When it is required to be issued on a format different from the IBA format, as

may be demanded by some of the beneficiary Government departments, it should be ensured that

the bank guarantee is

a) for a definite period,

b) for a definite objective enforceable on the happening of a definite event,

c) for a specific amount

d) in respect of bona fide trade/ commercial transactions,

e) contains the Bank’s standard limitation clause


f) not stipulating any onerous clause, &

g) not containing any clause for automatic renewal of the bank guarantee on its expiry

CHAPTER-3

CREDIT APPRAISAL PROCESS


Receipt of application from applicant

|

Receipt of documents

(Balance sheet, KYC papers, Different govt. registration no., MOA, AOA, and Properties

documents)

|

Pre-sanction visit by bank officers

|

Check for RBI defaulters list, willful defaulters list, CIBIL data, ECGC caution list, etc.

|

Title clearance reports of the properties to be obtained from empanelled advocates

|

Valuation reports of the properties to be obtained from empanelled engineers

|

Preparation of financial data

|

Proposal preparation

|

Assessment of proposal

|

Sanction/approval of proposal by appropriate sanctioning authority

|

Documentations, agreements, mortgages

|

Disbursement of loan

|

Post sanction activities such as receiving stock statements, review of accounts, renew of accounts,

etc

(On regular basis)

Loan Administration - Pre-Sanction process

Appraisal, Assessment and Sanction functions

1. APPRAISAL

A. Preliminary appraisal


1.1 Sound credit appraisal involves analysis of the viability of operations of a business and the

capacity of the promoters to run it profitably and repay the bank the dues as and then they fall

1.2. Towards this end the preliminary appraisal will examine the following aspects of a proposal.

Bank’s lending policy and other relevant guidelines/RBI guidelines,

Prudential Exposure norms,

Industry Exposure restrictions,

Group Exposure restrictions,

Industry related risk factors,

Credit risk rating,

Profile of the promoters/senior management personnel of the project,

List of defaulters,

Caution lists,

Acceptability of the promoters,

Compliance regarding transfer of borrower accounts from one bank to

another, if applicable;

Government regulations/legislation impacting on the industry; e.g., ban on

financing of industries producing/ consuming Ozone depleting substances;

Applicant’s status vis-à-vis other units in the industry,

Financial status in broad terms and whether it is acceptable

The company’s Memorandum and Articles of Association should be scrutinized carefully to ensure

(i) that there are no clauses prejudicial to the Bank’s interests, (ii) no limitations have been placed

on the Company’s borrowing powers and operations and (iii) the scope of activity of the company.

1.3. Further, if the proposal is to finance a project, the following aspects have to be examined:

• Whether project cost is prima facie acceptable

• Debt/equity gearing proposed and whether acceptable

• Promoters’ ability to access capital market for debt/equity support

• Whether critical aspects of project - demand, cost of production, profitability, etc. are prima facie

in order

1.4. After undertaking the above preliminary examination of the proposal, the branch will arrive at

a decision whether to support the request or not. If the branch (a reference to the branch includes a

reference to SECC/CPC etc. as the case may be) finds the proposal acceptable, it will call for from

the applicant(s), a comprehensive application in the prescribed proforma, along with a copy of the


proposal/project report, covering specific credit requirement of the company and other essential

data/ information. The information, among other things, should include:

• Organizational set up with a list of Board of Directors and indicating the qualifications,

experience and competence of the key personnel in charge of the main functional areas e.g.,

purchase, production, marketing and finance; in other words a brief on the managerial resources

and whether these are compatible with the size and scope of the proposed activity.

• Demand and supply projections based on the overall market prospects together with a copy of the

market survey report. The report may comment on the geographic spread of the market where the

unit proposes to operate, demand and supply gap, the competitors’ share, competitive advantage of

the applicant, proposed marketing arrangement, etc.

• Current practices for the particular product/service especially relating to terms of credit sales,

probability of bad debts, etc.

• Estimates of sales, cost of production and profitability.

• Projected profit and loss account and balance sheet for the operating years during the currency

of the Bank assistance.

• If request includes financing of project(s), branch should obtain additionally

(i)Appraisal report from any other bank/financial institution in case appraisal has been done by

them,

(ii) ‘No Objection Certificate’ from term lenders if already financed by them and

(iii) Report from Merchant bankers in case the company plans to access capital market, wherever

necessary.

1.5. In respect of existing concerns, in addition to the above, particulars regarding the history of the concern, its past performance, present financial position, etc. should also be called for. This data/information should be supplemented by the supporting statements such as:

a) Audited profit loss account and balance sheet for the past three years (if the latest audited

balance sheet is more than 6 months old, a pro-forma balance sheet as on a recent date

should be obtained and analyzed). For non-corporate borrowers, irrespective of market

segment, enjoying credit limits of Rs.10 lacs and above from the banking system, audited

balance sheet in the IBA approved formats should be submitted by the borrowers.

b) Details of existing borrowing arrangements, if any,

c) Credit information reports from the existing bankers on the applicant Company, and

d) Financial statements and borrowing relationship of Associate firms/Group Companies.


B. Detailed Appraisal

1.6 The viability of a project is examined to ascertain that the company would have the ability to

service its loan and interest obligations out of cash accruals from the business. While appraising a

project or a loan proposal, all the data/information furnished by the borrower should be counter

checked and, wherever possible, inter-firm and inter-industry comparisons should be made to

establish their veracity.

1.7 The financial analysis carried out on the basis of the company’s audited balance sheets and

profit and loss accounts for the last three years should help to establish the current viability.

1.8 In addition to the financials, the following aspects should also be examined:

• The method of depreciation followed by the company-whether the company is following straight

line method or written down value method and whether the company has changed the method of

depreciation in the past and, if so, the reason therefore;

• Whether the company has revalued any of its fixed assets any time in the past and the present

status of the revaluation reserve, if any created for the purpose;

• Record of major defaults, if any, in repayment in the past and history of past sickness, if any;

• The position regarding the company’s tax assessment - whether the provisions made in the

balance sheets are adequate to take care of the company’s tax liabilities;

• The nature and purpose of the contingent liabilities, together with comments thereon;

• Pending suits by or against the company and their financial implications (e.g. cases relating to

customs and excise, sales tax, etc.);

• Qualifications/adverse remarks, if any, made by the statutory auditors on the Company’s

accounts;

• Dividend policy;

• Apart from financial ratios, other ratios relevant to the project;

• Trends in sales and profitability, past deviations in sales and profit projections, and

Estimates/projections of sales values;

• Production capacity & use: past and projected;

• Estimated requirement of working capital finance with reference to acceptable build up of

inventory/ receivables/ other current assets;

• Projected levels: whether acceptable; and

• Compliance with lending norms and other mandatory guidelines as applicable

1.9. Project financing:

If the proposal involves financing a new project, the commercial, economic and Financial

viability and other aspects are to be examined as indicated below:


• Statutory clearances from various Government Depts./ Agencies

• Licenses/permits/approvals/clearances/NOCs/Collaboration agreements, as applicable

• Details of sourcing of energy requirements, power, fuel etc.

• Pollution control clearance

• Cost of project and source of finance

• Build-up of fixed assets (requirement of funds for investments in fixed assets to be critically

examined with regard to production factors, improvement in quality of products, economies of

scale etc.)

• Arrangements proposed for raising debt and equity

• Capital structure (position of Authorized, Issued/ Paid-up Capital, Redeemable Preference Shares,

etc.)

• Debt component i.e., debentures, term Loans, deferred payment facilities, unsecured loans/

deposits. All unsecured loans/ deposits raised by the company for financing a project should be

subordinate to the term loans of the banks/ financial institutions and should be permitted to be

repaid only with the prior approval of all the banks and the financial institutions concerned. Where

central or state sales tax loan or developmental loan is taken as source of financing the project,

furnish details of the terms and conditions governing the loan like the rate of interest (if applicable),

the manner of repayment, etc.

• Feasibility of arrangements to access capital market

• Feasibility of the projections/ estimates of sales, cost of production and profits covering the period

of repayment

• Break Even Point in terms of sales value and percentage of installed capacity under a normal

production year

• Cash flows and fund flows

• Proposed amortization schedule

• Whether profitability is adequate to meet stipulated repayments with reference to Debt Service

Coverage Ratio, Return on Investment

• Industry profile & prospects

• Critical factors of the industry and whether the assessment of these and management plans in this

regard are acceptable

• Technical feasibility with reference to report of technical consultants, if available

• Management quality, competence, track record

• Company’s structure & systems

• Applicant’s strength on inter-firm comparisons


For the purpose of inter-firm comparison and other information, where necessary, source data from

Stock Exchange Directory, financial journals/ publications, professional entities like CRIS-INFAC,

CMIE, etc. with emphasis on following aspects:

• Market share of the units under comparison

• Unique features

• Profitability factors

• Financing pattern of the business

• Inventory/Receivable levels

• Capacity utilization

• Production efficiency and costs

• Bank borrowings patterns

• Financial ratios & other relevant ratios

• Capital Market Perceptions

• Current price

• 52week high and low of the share price

• P/E ratio or P/E Multiple

• Yield (%)- half yearly and yearly

Also examine and comment on the status of approvals from other term lenders, market view (if anything adverse), and project implementation schedule. A pre-sanction inspection of the project site or the factory should be carried out in the case of existing units. To ensure a higher degree of commitment from the promoters, the portion of the equity / loans which is proposed to be brought in by the promoters, their family members, friends and relatives will have to be brought up front. However, relaxation in this regard may be considered on a case to case basis for genuine and acceptable reasons. Under such circumstances, the promoter should furnish a definite plan indicating clearly the sources for meeting his contribution. The balance amount proposed to be raised from other sources, viz., debentures, public equity etc., should also be fully tied up.

C. Present relationship with Bank:

Compile for existing customers, profile of present exposures:

• Credit facilities now granted

• Conduct of the existing account

• Utilization of limits - FB & NFB

• Occurrence of irregularities, if any

• Frequency of irregularity i.e., number of times and total number of days the account was irregular

during the last twelve months

• Repayment of term commitments


• Compliance with requirements regarding submission of stock statements, financial follow-up reports, renewal data, etc.

• Stock turnover, realization of book debts

• Value of account with break-up of income earned

• Pro-rata share of non-fund and foreign exchange business

• Concessions extended and value thereof

• Compliance with other terms and conditions

• Action taken on Comments/observations contained in RBI Inspection Reports:

CO Inspection & Audit Reports

Verification Audit Reports

Concurrent Audit Reports

Stock Audit Reports

Spot Audit Reports

Long Form Audit Report (statutory audit)

D. Credit risk rating: Draw up rating for (i) Working Capital and (ii) Term Finance.

E. Opinion Reports: Compile opinion reports on the company, partners/ promoters and the

proposed guarantors.

F. Existing charges on assets of the unit: If a company, report on search of charges with ROC.

G. Structure of facilities and Terms of Sanction:

Fix terms and conditions for exposures proposed - facility wise and overall:

Limit for each facility – sub-limits

Security - Primary & Collateral, Guarantee

Margins - For each facility as applicable

Rate of interest

Rate of commission/exchange/other fees

Concessional facilities and value thereof

Repayment terms, where applicable

ECGC cover where applicable

Other standard covenants

H. Review of the proposal: Review of the proposal should be done covering

(i) Strengths and weaknesses of the exposure proposed

(ii) Risk factors and steps proposed to mitigate them

(iii) Deviations, if any, proposed from usual norms of the Bank and the reasons therefore.


I. Proposal for sanction: Prepare a draft proposal in prescribed format with required backup

details and with recommendations for sanction.

J. Assistance to Assessment: Interact with the assessor, provide additional inputs arising from the

assessment, incorporate these and required modifications in the draft proposal and generate an

integrated final proposal for sanction.

2. ASSESSMENT: Indicative List of Activities Involved in Assessment Function is given below:

• Review the draft proposal together with the back-up details/notes, and the borrower’s application,

financial statements and other reports/documents examined by the appraiser.

• Interact with the borrower and the appraiser.

• Carry out pre-sanction visit to the applicant company and their project/factory site.

• Peruse the financial analysis (Balance Sheet/ Operating Statement/ Ratio Analysis/ Fund Flow

Statement/ Working Capital assessment/Project cost & sources/ Break Even analysis/Debt

Service/Security Cover, etc.) to see if this is prima facie in order. If any deficiencies are seen,

arrange with the appraiser for the analysis on the correct lines.

• Examine critically the following aspects of the proposed exposure.

Bank’s lending policy and other guidelines issued by the Bank from time to time

RBI guidelines

Background of promoters/ senior management

Inter-firm comparison

Technology in use in the company

Market conditions

Projected performance of the borrower vis-à-vis past estimates and performance

Viability of the project

Strengths and Weaknesses of the borrower entity.

Proposed structure of facilities.

Adequacy/ correctness of limits/ sub limits, margins, moratorium and repayment schedule

Adequacy of proposed security cover

Credit risk rating

Pricing and other charges and concessions, if any, proposed for the facilities

Risk factors of the proposal and steps proposed to mitigate the risk

Deviations proposed from the norms of the Bank and justifications therefore.


• To the extent the inputs/comments are inadequate or require modification, arrange for additional

inputs/modifications to be incorporated in the proposal, with any required modification to the initial

recommendation by the Appraiser

• Arrange with the Appraiser to draw up the proposal in the final form.

• Recommendation for sanction: Recapitulate briefly the conclusions of the appraisal and state

whether the proposal is economically viable. Recount briefly the value of the company’s (and the

Group’s) connections. State whether, all considered, the proposal is a fair banking risk. Finally,

give recommendations for grant of the requisite fund-based and non-fund based credit facilities.

3. SANCTION: Indicative list of activities involved in the sanction function is given below:

• Peruse the proposal to see if the report prima facie presents the proposal in a comprehensive

manner as required. If any critical information is not provided in the proposal, remit it back to the

Assessor for supply of the required data/clarifications.

• Examine critically the following aspects of the proposed exposure in the light of corresponding

instructions in force:

Bank’s lending policy and other relevant guidelines

RBI guidelines

Borrower’s status in the industry

Industry prospects

Experience of the Bank with other units in similar industry

Overall strength of the borrower

Projected level of operations

Risk factors critical to the exposure and adequacy of safeguards proposed there against

Value of the existing connection with the borrower

Credit risk rating

Security, pricing, charges and concessions proposed for the exposure and covenants

stipulated vis-à-vis the risk perception.

• Accord sanction of the proposal on the terms proposed or by stipulating modified or additional

conditions/ safeguards, or Defer decision on the proposal and return it for additional

data/clarifications, or Reject the proposal, if it is not acceptable, setting out the reasons.

Loan Administration - Post sanction credit process

General


1. Need

Lending decisions are made on sound appraisal and assessment of credit worthiness. Past record of

satisfactory performance and integrity are no guarantee for future though they serve as a useful

guide to project the trend in performance. Credit assessment is made based on promises and

projections. A loan granted on the basis of sound appraisal may go bad because the borrower did

not carry out his promises regarding performance. It is for this reason that proper follow up and

supervision is essential. A banker cannot take solace in sufficiency of security for his loans. He has

to -

a) Make a proper selection of borrower

b) Ensure compliance with terms and conditions

c) Monitor performance to check continued viability of operations

d) Ensure end use of funds.

e) Ultimately ensure safety of funds lent.

2. Stages of post sanction process

The post-sanction credit process can be broadly classified into three stages viz., follow-up,

supervision and monitoring, which together facilitate efficient and effective credit management and

maintaining high level of standard assets. The objectives of the three stages of post sanction process

are detailed below.

CHAPTER-4

CREDIT RISK ASSESSMENT

Definition of RISK


Risk is inability or unwillingness of borrower-customer or counter-party to meet their

repayment obligations/ honor their commitments, as per the stipulated terms.

Lender’ task

Identify the risk factors, and

Mitigate the risk

How does risk arise in credit?

In the business world, Risk arises out of

Deficiencies / lapses on the part of the management (Internal factor)

Uncertainties in the business environment (External factor)

Uncertainties in the industrial environment (External factor)

Weakness in the financial position (Internal factor)

Hence, success factors behind a business are: -

Managerial ability

Favorable business environment

Favorable industrial environment

Adequate financial strength

As such, these are the broad risk categories or risk factors built into our CRA models. CRA takes

into account the above types of risks associated with the borrowal unit. The eventual CRA rating

awarded to a unit (based on a score of 100) is a single-point risk indicator of an individual credit

exposure, & is used to indentify, to measure & to monitor the credit risk of an individual proposal.

At the corporate level, CRA is also used to track the quality of Bank’s credit portfolio.

Credit & Risk

Go hand in hand.

They are like twin brothers.

They can be compared to two sides of the same coin.

All credit proposals have some inherent risks, excepting the almost negligible volume of

lending against liquid collaterals with adequate margin.

Lending despite risks:


So, risk should not deter a Banker from lending.

A banker’s task is to identify/ assess the risk factors/ parameters & manage / mitigate them

on a continuous basis.

But it’s always prudent to have some idea about the degree of risk associated with any

credit proposal.

The banker has to take a calculated risk, based on risk-absorption/ risk-hedging capacity &

risk-mitigation techniques of the Bank.

CREDIT RISK ASSESSMENT (CRA):

Credit is a core activity of banks & an important source of their earnings, which go to pay interest

to depositors, salaries to employees & dividend to shareholders

In credit, it is not enough that we have sizable growth in quantity/ volume, it is also necessary to

ensure that we have only good quality growth.

To ensure asset quality, proper risk assessment right at the beginning, that is, at the time of taking

an exposure, is extremely important.

Moreover, with the implementation of Basle-II accord4, capital has to be allocated for loan assets

depending on the risk perception/ rating of respective assets. It is, therefore, extremely important

for every bank to have a clear assessment of risks of the loan assets it creates, to become Basle-II

compliant.

That is why Credit Risk Assessment (CRA) system is an essential ingredient of the Credit

Appraisal exercise.

Indian Scenario:

In Indian banks, there was no systematic method of Credit Risk Assessment till late 1980’s/

early 1990’s. Health Code System (1985) / IRAC norms (1993) are Asset (loan) classification

systems, not CRA systems.RBI came out with its guidelines on Risk Management Systems in

Banks in 1999 & Guidance Note on Management of Credit in October, 2002.

CHAPTER-5CREDIT RISK GRADING MODULES

Two types of CRG framework have been developed. Software based Risk Assessment Module (RAM) and Manual credit risk grading module.


RAM (Risk Assessment Module) developed with assistance from CRISIL will be used to rate borrowal accounts under various industrial sectors with exposure of Rs.5 crore (to be brought down to Rs.1 crore and above) and above.

Accounts not covered under RAM will be rated using one of the 8 under mentioned manual CRG modules developed by the Bank.

The framework to adopt an internal grading system is done using ten grades to be expressed in alphanumeric characters (AB1 to AB7 and AB8a, b &c).

AB1 will represent accounts with highest degree of safety, while AB8 will represent the accounts, which have defaulted and categorized as NPA. AB8 will be further categorized into three sub-categories depending upon the asset classification (SST-AB8A, Doubtful-AB8B & Loss AB8C).

The risk grades under CRG modules 2 to 6, 7A & 7B will be based on Total Risk Adjusted Score (TRAS) obtained by an account. TRAS is the sum of Risk Adjusted Score computed under various risk categories i.e. Industry/Activity Risk, Business Risk, Financial Risk and Management Risk.

Risk Adjusted Score = Score obtained in the category * Risk weight for each risk category Eligible score for that category for the account

Risk Adjusted Industry Risk Score for accounts with Rs.1.00 crore & above aggregate credit limit falling under those industries /activities for which industry risk score under RAM is available = Score under RAM * Industry Risk Weight /6

The ratings will be used for pricing of credit products, capital allocation as per risk perceived in loans and advances and for risk based monitoring and supervision of individual loan asset apart from formulation / alterations in various policies relating to loans and advances. The ratings help to decide on the frequency/intensity of monitoring the account along with remedial measures to check further deterioration in the asset quality.

CRGMODULES

APPLICATIONS

RISK GRADING OF :


CRG -01 Advances Against Liquid Security & Advances to Staff, irrespective of Credit Limit

Clean Advances & Non Performing Assets, irrespective of Credit Limit Advances Under Retail Credit Scheme of the bank, irrespective of Credit Limit Other Advances with Credit Limit (Funded & Non-Funded) below Rs.10 lac. (but

except accounts with Rs.10 lacs and above limit under ALLBANK TRADE and scheme for concessional rate of interest to customers categorized as gold/silver/others)

CRG -02Risk Grading of Borrowal accounts (with existing units/ project) having Aggregate Credit Limit of Rs.10.00 Lac to Rs.200.00 Lac However, for accounts under ALLBANK TRADE cut-off limit will be Rs.10.00 lac.

CRG -03 Risk Grading of Borrowal accounts (with existing units/ project) having Aggregate Credit Limit above Rs.200.00 Lac.

CRG -04 Risk Grading of Borrowal accounts (with New units/ project) having Aggregate Credit Limit of Rs.10.00 Lac and above but excluding SSI & SME WITH Rs.1.00 crore or more limit/service sector/Fis etc. which are covered in CRG5 to CRG7 modules. However, for accounts under ALLBANK TRADE cut-off limit will be Rs.10.00 lacs.

CRG -05 Risk Grading of Borrowal Accounts with Rs.10.00 Lakh & above aggregate credit limit falling under following categories: Service sectors (Railway, Air way, State Road Transport Corp, Transport

Business, nursing Home/ Amusement Park Hospital etc) Municipality Or Corporation/Development Authority Educational Institute.

CRG -06 Risk Grading of Borrowal Accounts with Rs.10.00 Lakh & above aggregate credit limit falling under following categories: NBFC / Financial Institution Intermediaries engaged in lending activities (like lending for Project,

Infrastructure Development, and Housing.) Financial Corporation like IRFC.

CRG -7A Risk Grading of Borrowal Accounts under SSI/SME category (existing accounts) with credit limit Rs.1.00 crore and above.

CRG -7B Risk Grading of Borrowal Accounts under SSI/SME category (new connection) with credit limit Rs.1.00 crore and above.

Sl. No. OverallRisk

Rating/ Safety

Category of Borrowal Accounts Risk Nature

Grade Description


1. AB-1 Advances against security of Bank’s own Deposit

Advances against security of NSC, KVP, and LIP.

Advances against government securities including RBI Bonds.

Advances to staff members.Very Low

Highly Liquid SecurityLiquid Security

Liquid SecurityRepayment is adequately ensured from monthly salary and terminal benefits.

2. AB-2 Advances against security of Units, Bonds etc. of UTI

Advances against shares and debentures.

Secured Advances to Public Where Salary Tie Up is available (i.e. Housing Loan, Consumer Loan, AllBank Abhushan, Car Loan, AllBank Mobike etc) & Advances under AL-RENT Liquid Scheme

Loans to Pensioners as per Bank’s Scheme and SARAL loans where 50% or more security is available.

Claims/Exposures on a scheduled Bank.

Public Housing Loan where Repayment period is up to ten years and Salary Tie Up is not available.

Low

Liquid Security Available. But volatility can not be ruled out.

Liquid Security Available. But volatility can not be ruled out.

Repayment of Loan is ensured

Bank’s dues recoverable from monthly pension / salary.

Secured loan with comparatively low risk of recovery due to shorter repayment period.

3. AB-3 Personal Loan (i.e. Personal loan to medical practitioner), car Loan where salary Tie Up is not available.

Education Loans fully secured by tangible collateral.

Crop Loans (Standard Assets) including ABKCC/KSY above Rs.50000/-

Advances to Farm Sector Or Farm Mechanisation fully secured by tangible collateral and classified as Standard Assets.

All other Advances (Including Advances Under Govt. Sponsored Schemes) classified as Standard Assets and fully Secured by Tangible Collateral.

SARAL loans on salary tie-up

ModeratelyLow

Risk of recovery of Bank’s dues is moderateAvailability of tangible collateral from the guardian mitigates recovery risk.Sensitive Sector but secured by collateral.

Creation of Genuine Productive Assets has historically reduced the Recovery Risk.

Performance Risk is higher. Though repayment risk is less due to loan repayment tie-up but no full risk


where available security is below 50%.

mitigation by available security.

4. AB-4 Existing regular accounts under old Personal Loan scheme of Bank with salary tie-up, which is not specified elsewhere.

Public Housing Loan where Repayment period is above ten years and Salary Tie Up is not available & Advances under AL-Property Scheme.

Education Loans not fully secured by tangible collateral.

Crop Loans (Standard Assets) including ABKCC/KSY up to Rs.50000/-

All other Advances excluding risk grading of borrowers having aggregate limit of Rs.10 lac and above covered under AllBank Trade Scheme and Scheme for allowing rating based pricing by categorizing borrowers as Gold/Silver/other customers. (Including Advances Under Govt. Sponsored Schemes) classified as Standard Assets and partly Secured/ Not Secured by Tangible Collateral.

Fair

Risk of recovery is fair in view of no risk mitigation by security in case tie-up arrangement for loan repayment is discontinuedSecured loan with fair risk of recovery in view of comparatively longer repayment period.

Future performance risk of the concerned student is fair.Sensitive Sector and Not Collaterally Secured.

Recovery Risk is high due to non-availability of tangible collateral.

5 AB-5 All Advances allowed as clean advances up to 90 days (including Debit Balance arising from Bank’s Credit Card, Bills Remitted under Bank’s Customer Service Guidelines, and Drawals against uncleared effect of cheques etc) and classified as Standard Assets.

Moderate

Clean Outstanding recovery risk is high. However, branches are permitted to allow advances subject to their discretionary authority.

6. AB-6 Of above Clean Advances, Advances not liquidated within due date.

If installments/interest are overdue for 45 days or more but below 60 days.

High Risk

Recovery prospects are minimum. Likely to be NPA.The account may slip to NPA if irregularity persists.

7. AB-7 If installments/interest are overdue for 60 days or more but below 90 days.

VeryHigh Risk

The account may slip to NPA if irregularity persists.

8. AB-8A All sub-standard loans and advances Default Yielding interest from the


asset ceased. It may cause loss to the Bank.

9. AB-8B All Advances Classified as Doubtful Assets under Category D-1, D-2 and D-3.

Default Yielding interest from the asset ceased. It may cause loss to the Bank.

10. AB-8C All Advances classified as Loss Assets.

Default Yielding interest from the asset ceased. It may cause loss to the Bank.

CRG02 to CRG06 and CRG7A & 7B The ratings under modules CRG 02 to CRG 06 and CRG 7A & 7B will be determined on the basis of over all score for an account arrived at by computing weighted average of scores under various risk categories.

Various risk categories and their weightage in computing overall risk grade are given below.

MODULEVARIOUS RISK CATEGORIES & THEIR WEIGHTAGE

INDUSTRY/ ACTIVITY

BUSINESS

FINANCIAL

MANAGEMENT

OPERATIONAL

CRISIL’S RAM*

15% 30% 40% 15% NIL

CRG 2 10% 20% 35% 35% NILCRG 3 20% 25% 35% 20% NILCRG 4 20% 20% 25% 35% NILCRG 5 20% 30% 30% 20% NILCRG 6 15% 25% 40% 20% NILCRG 7A 10% 10% 40% 20% 20%CRG 7B 20% 15% 30% 35% NIL

The norms for assigning risk grade based on in case of manual CRG 2 to CRG 6 module is as under:

Grade Risk Nature Scores under CRG2 to CRG

5

Scores under CRG 6

Score under RAM

AB – 1 Very Low Above 90 Above 90 5.10 - 6.00AB – 2 Low Above 80 &

Up to 90Above 80 & Up to 90

4.40 - <5.10

AB – 3 ModeratelyLow

Above 70 & Up to 80

Above 70 & Up to 80

3.80 - <4.40

AB – 4 Fair Above 60 & Above 60 & 3.40 - <3.80


Up to 70 Up to 70AB – 5 Moderate Above 50 &

Up to 60Above 55 & Up to 60

3.00 - <3.40

AB – 6 High Above 40 & Up to 50

Above 50 & Up to 55

2.50 -<3.00

AB – 7 Very High Above 35 & Up to 40

Above 45 & Up to 50

1.75 - <2.50

AB – 8 Default 35 or Below 45 or Below < 1.75

Over all maximum score will be 100 in manual CRG 2 to CRG 6 modules based on weight attached to different risk categories whereas the same will be 6 in CRISIL’S RAM.All standard assets will be graded between AB1 to AB7 whereas all NPAs will be graded as AB8A, AB8B and AB8C as per the asset class in NPA category.

CRG MODULE USED AS PER CASE STUDY (EXAMPLE)

CRG -02APPLICABLE FOR ↓

Risk Grading Of Borrowers (With Existing Units/Projects) Having Aggregate Limit of Rs. 10.00 Lakh to Rs. 200 Lakh

Name of the Borrower:Line of Activity:Branch: Zone:Scoring Based on Audited Balance Sheet As At:Existing Facility:

Nature of Facility(TL/ WC/Others)

Credit Limit Outstanding Overdue/ Other irregularities, if any

Total

Scoring Under Various Risk Categories:

A. FINANCIAL RISK: (Aggregate Score 36) Parameter ScoreA.1) CURRENT RATIO 1.33 or More 6 1.25 or More but below 1.33 5 1.17 or More but below 1.25 4 1.13 or More but below 1.17 2 Below 1.13 0Comment:A.2) TOL /TNW RATIO


2.00 and below 6 Above 2.00 & up to 3.00 5 Above 3.00 & up to 4.50 4 Above 4.50 &up to 5.00 (Up to7.50 for Infrastructure/construction/PSU

Sector)2

Above 5.00 ( above 7.50 for Infrastructure/construction/PSU Sector) 0Comment:A.3 a) INTEREST COVERAGE RATIO (PBDIT/INTERSET) 3 or More 6 2.50 or More but below 3 5 1.75 or More but below 2.50 4 1.50 or More but below 1.75 2 Below 1.50 00Comment:

FINANCIAL RISK CONTD---A.3 b) Average DSCR :Applicable for Fresh Term Loan of Existing Unit(In Such case Interest Coverage Ratio will be replaced by DSCR) More than 1.75 : 1 6 From 1.50 : 1 to 1.75 : 1 4 From 1.30 : 1or More but below 1.50 : 1 2 Below 1.30 : 1 0Comment:

A.4). RETURN ON CAPITAL EMPLOYED ** PBIT/Av. Capital employed (In % Term), Where Capital Employed= Capital+ Reserve+ Long term borrowing+ other bank borrowing- Reval. Reserve-Capital W.I.P 18% or More 6 BPLR+ 4% or More but below 18% 5 BPLR+ 2% or More but below BPLR+ 4% 3 Above BPLR but below BPLR+ 2% 2 BPLR or Below 0Comment:A.5. Trend Analysis: TREND ANALYSIS – VARIATION IN NET CURRENT ASSET Increasing Trend in Net Current Asset (+) 2 Decreasing Trend in Net Current Asset (-) 2 Stable ( not more than 5% downward variation from previous year or

current ratio not below bench mark)0

TREND ANALYSIS – VARIATION IN TANGIBLE NET WORTH Decreasing Trend in TNW (-) 2 Increasing Trend in TNW (+) 2 Stable (not more than 5% downward variation from previous year) 0TREND ANALYSIS: PROFITABILITY (NET PROFIT/NET SALES OR RECEIPT) Increasing Trend in Profitability (+) 2 Decreasing Trend in Profitability (-) 2 Stable (not more than 2% downward variation from previous year) 0


Comments:A.6 SECURITY COVERAGE (COLLATERAL) SCORE 100% and above 6 75% or More but below 100% 5 60% or More but below 75% 4 50% or More but below 60% 2 Below 50% 0COMMENTS:

B. BUSINESS RISK: (Aggregate Score: 26)B.1 Key Business Features: Score- Yes: 2 Score- No: 01. Product Range/Mix is satisfactory2. After sale service is satisfactory 3. The borrowers are financially able to withstand

competition. 4. Borrowers not dealing in perishable goods. 5. Future growth potential is high.6. Capacity utilisation is 80% or more. (For mfg)Key Business Features (B1) Contd----- Score- Yes: 2 Score- No: 0

7. Business is not cyclical or there is no cyclical earnings.

8. Borrowers not dependent on limited customers.9. The business is not sensitive to changes in Govt

Policies like price control, pollution, custom/excise duty etc.

10. There are only few competitors in local market.Total: Eligible Scores under B.1. ---------------- , Scores Obtained:

B.2. INCOME VALUE OF THE BANK: (Interest, Commission, Exchange etc. from the Account as Percentage of Total Fund Based Limit- Projected figure if new connection but previous year actual if existing account)

PARAMETERS SCORE More than 12 % 6 More than 10% but up to 12% 5 More than 8% but up to 10% 4 More than 6% but up to 8% 2 6% or below 0COMMENTS:

C. MANAGEMENT RISK: (Aggregate Score: 36)C.1.Key Management Features: Score- Yes: 1 Score- No: 0i) Management is established player for more than

5 Years./PSUsii) Having good reputation and track record (no

litigation with customers/suppliers , no penal action from any tax/ govt /statutory authority, fair dealing with customers, timely wage payment to their workmen/employees etc)

iii) Having satisfactory relation with Bank for more than 2 years.

iv) Business is not managed by one or two persons.


v) The associate concern/group/ family is financially sound & their support is available to the borrower , when in need.

vi) The management is proactive rather than reactive and their business policy is sound.

TOTAL : C.2. Payment Records & Operations in the Account: SCOREC.2.APayment of interest/installment, payment of amount involved in devolved LC or Invoked B.G., Payment of Bills :

Due amt paid within 15 working days and less 6 Due amt paid between 16 working days to 30 working days. 5 Due amt paid between 31 working days to 45 working days. 3 Due amt paid between 46 working days to 60 working days. 2 Due amt paid after 60 working days or since un paid . (-) 3

Operations in the account (for working capital limit):In case of consortium/multiple financing, sales would mean proportionate sales based on our share in total limit

High turnover (above 90% of sales) in the account & negligible return of cheques.

6

Good turnover (80-90% of sales)in the account & nominal return of cheques.

4

Average turnover (70-80% of sales) & average level of return of cheques.

2

Unsatisfactory turnover (below 70% of sales or 2 times of working capital limit, whichever is low ) &/or frequent return of cheques.

0

Management Risk Contd---:

C.3. COMPLIANCE OF TERMS & CONDITIONS: SCORE All Terms and Conditions complied with. 6 Compliance of terms & Conditions other than creation of Collateral

Security due to reasons duly accepted by the Sanctioning Authority.4

Non- Compliance of Major Terms & Conditions. 0C.4. Credibility: C.4.A. PAST COMMITMENT WITH RESPECT TO NET SALES: Achievement is 95% or above of Projection 6 Achievement is 90% or More but below 95% of Projection 5 Achievement is 75% or More but below 90% of Projection 3 Achievement is 60% or More but below 75% of Projection 2 Achievement is below 60% of Projection &/or below last year actual. 0C.4.A.1 FOR FRESH CONNECTIONS WHERE PROJECTIONS NOT AVAILABLE (In place of C.4.A) Sales Growth during the year Exceeds 20% of last two year average

Sales6

Sales Growth during the year is 15% -20%of last two year average Sales

5

Sales Growth during the year is 10% -15% of last two year average Sales

4

Sales Growth during the year is 5%- 10% of last two year average 2


Sales Sales Growth during the year is below 5% of last two year average

Sales0

C.4.B. PAST COMMITMENT WITH RESPECT TO NET PROFIT: Achievement is 95% or above of Projection 6 Achievement is 90% or More but below 95% of Projection 5 Achievement is 75% or More but below 90% of Projection 3 Achievement is 60% or More but below 75% of Projection 2 Achievement is below 60% of Projection &/or below last year actual. 0C.4.B.1. FOR FRESH CONNECTIONS WHERE PROJECTIONS FOR NET PROFIT NOT AVAILABLE (IN PLACE OF C.4.B)

SCORE

N. Profit Growth during the year Exceeds 20% of last two year average N. Profit

6

N. Profit Growth during the year is 15% -20%of last two year average N. Profit

5

N. Profit Growth during the year is 10% -15% of last two year average N. Profit

3

N. Profit Growth during the year is 5%- 10% of last two year average N. Profit

2

N. Profit Growth during the year is below 5% of last two year average N. Profit

0

Scores under Credibility (“C.4.A+C.4.B” or C.4.A.1+C.4.B.1)

D) INDUSTRY/ACTIVITY RISK: (Aggregate Score 10)- D.1. For all Industries/Activities other than D.2 belowAssign 1 for Yes & 0 for NO

PARTICULARS Yes (1) No (0)1. Present industry/activity scenario dealt by is favourable.2. Technology/Activity is proven for medium term.3. Demand of the product is increasing.4. Availability of Raw Material/Products (Traders) is adequate.5. Industry/Activity does not depend on the vagaries of nature.6. The products are having established markets.INDUSTRY/ACTIVITY RISK (D.1.) CONTD---7. Quality of the Product is satisfactory.8. Requisite infrastructural facility (power, fuel, road or rail, water supply, telephone etc) are available. 9. Threat of substitute/competitors to the product/s is not there. 10. Firm is not assembler or trader of unbranded items.TOTAL SCORE FOR INDUSTRY/ ACTIVITY RISK:

D.2. For accounts with Rs 1.00 crore & above aggregate limit falling under those Industries/ activities whose Industry Risk Score under Software based RAM Module is available (In this case D.1. will not be applicable): Risk Adjusted Score to be assigned= (Scores under RAM* 10)/6


COMPUTATION OF FINAL SCORE/GRADE:

Sl.No.

RISKCATEGORY

MAXM.SCORE

ELIGIBLE

SCORE

SCOREOBTAINE

D

RISKWEIGHT

S(%)

RISKADJUSTE

DSCORE

X Y Z y/x * zA Financial Risk 36 35B Business Risk 26 20C Management Risk 36 35D Industry/Act. Risk 10 10E Total Marks 108 100

CHAPTER-6APPRAISAL CASE STUDY

Account : M/s J K Medical System (P) Ltd

Branch: SRCM, Manapakkam Zonal Office: Chennai

SUBJECT: To review the account and to consider enhancement in WC facilities as under :(Rs. lacs)

Facilities Existing ProposedCash credit 35.00 70.00Bank Guarantee 10.00

30.00*Bank Guarantee (against 100% margin)

15.15

TOTAL 60.15 100.00

* inclusive of BG Rs.15.15 lacs issued at 100% cash margin which will be retained as collateral security for proposed exposure of Rs.100.00 lacs .

Borrower Profile1. Name of the Account M/s J K Medical System (P) Ltd.

1052, Munusamy Salai, West K K Nagar, Chennai -600078.


2. Constitution Private Limited company3. Business / Activity Trading in medical & surgical equipments4. Incorporated on April’2001

5. Advance since 1995 (when it was a proprietorship firm)6. If the a/c is new , name

of the earlier banker Not applicable

7. Credit rating / Risk Grade.(based on audited financials of 2006-07 enclosed as annexure -A)

Risk Parameter Risk GradeFinancial Risk AB-4Business Risk AB-1Management Risk AB-1Industry/Activity Risk AB-2Overall Grade AB-2

8. Asset Classification Standard9. Group Does not belong to any recognized group.10. Chief Executive/

Promoter Director Mr Ratnakar SahooMrs Priya Sahoo

11. Consortium:Multiple Banking Arrangements

Sole Banking

12. Present Request/ Last Sanction

The company is engaged in trading of medical and surgical equipments. The company imports critical medical and surgical equipments such as spirometers, PFTs , Nebulisers, ECG, Blood Gas Analyzers etc., from Switzerland, UK, USA, Germany , Japan etc., and sells them to reputed hospitals , health care centre, medical research institutes, research laboratories etc., in India. The company specializes in supply of respiratory equipments and is an exclusive distributor in India for many reputed overseas medical and surgical equipments and suppliers.

Last sanction:

The company’s account was reviewed and the then CC limit was enhanced from Rs.20.00 lacs to Rs.35.00 lacs and the then BG limit was enhanced from Rs.5.00 lacs to Rs.10.00 lacs under the authority of the Branch as on 24.12.2006.

Present Proposal:

The present proposal is to review the account and to consider enhancement in WC facilities as under :(Rs. lacs)

Facilities Existing ProposedCash credit 35.00 70.00Bank Guarantee 10.00 30.00TOTAL 45.00 100.00

Present Position of account:


(Rs, lacs)Facilities Limit Outstanding as on 11.12.2007Cash credit 35.00 34.62Bank Guarantee 10.00 9.99*TOTAL 45.00 44.61

Branch has advised that they have issued BG of Rs.15.15 lacs at 100% cash margin over and above the outstanding of Rs.9.99 lacs.

13. Security Existing ProposedPrimary : Cash Credit :

Exclusive hypothecation charge on entire stocks and book debts and other current assets, present & future, of the company.Bank Guarantee :

- Counter indemnity from the company covering the entire BG limit

- Cover under GLH

Cash Credit : Exclusive hypothecation charge on entire stocks and book debts and other current assets, present & future, of the company.Bank Guarantee :

- Counter indemnity from the company covering the entire BG limit

- Cover under GLHCollateral Cash Credit & Bank Guarantee :

- Equitable mortgage of residential land admeasuring 1281 sq.ft at Plot No.22 , Azeez Nagar , Ramapuram, Chennai valued at Rs.19.21 lacs .

- Pledge of LIC policies in the name of Ratnakar Sahoo , SV being RS.1.00 lacs.

- FDR in the name of the company for Rs.30.00 lacs. Dated 25.08.07 due on 25.08.10

Cash Credit & Bank Guarantee : - Equitable mortgage of

residential land admeasuring 1281 sq.ft at Plot No.22 , Azeez Nagar , Ramapuram, Chennai valued at Rs.19.21 lacs .

- Pledge of LIC policies in the name of Ratnakar Sahoo , SV being RS.1.00 lacs.

- Existing pledge of FDR of Rs.15.15 lacs

- Equitable mortgage of all that 2nd floor flat and ground bearing plot no.1068, Survey no. 236/2B Part, Munusamy Salai , K K Nagar, Chennai -600078 measuring approximately 1575 sq.ft (super built up area), including common area and 1031.40 sq.ft of undivided share of land , to be purchased at a price consideration of Rs.68.00 lacs


.

14. Name of Guarantor Guarantor’s Worth (Rs. In Lacs)

As per Credit Report Dated:

Ratnakar Sahoo 65.39 19.11.07Priya Sahoo 42.45 19.11.07

15. Conduct/ Value of Account16. Utilization of Fund Based

Limits(Rs. In Lac)

Last Year: Dec’06*- Mar’07Turnover : 82.00Highest Dr. Bal : 28.00Lowest Dr. Bal : 11.00

Current Year: Apr’07-Nov’07Turnover : 388.00Highest Dr. Bal : 36.00Lowest Dr. Bal : 7.00

* transferred from IB in Dec’06

17. Export Turnover(Rs.----)

Not applicable

18. Earning(Rs. lacs)

Dec’06 – Mar’07

Interest Rs.5.50 lacsCommissionTotal

19. Pricing CC : PLR+1.00% p.a.w.m.rBG : as per circularized instructionsProcessing fees, Mortgage and documentation fees : as per circularized instructions

Comment onConcessionary facilities if allowed/Proposed

20. Share PriceRs. As on:Source of Information:

Not applicable (Pvt. Ltd. Company)

21. Financial Position:

PROFITABILITY STATEMENT (Rs. in Lacs)For the year ended 31st March

2006 2007 2008 2009(Audited) (Audited) Estimate Projection

1 Gross sales 355.94 532.95 987.00 1,215.00 Growth Base year 49.73% 85.20% 23.10%

2 Net sales 355.94 532.95 987.00 1,215.003 Cost of goods sold 286.48 434.28 814.76 996.204 Gross Profit 69.46 98.67 172.24 218.805 Gross Profit/Net sales

(%)19.51% 18.51% 17.45% 18.01%

6 Operating, Administrative, Selling & General Expenses

65.71 83.12 127.81 152.21


7 Interest 1.27 2.42 5.80 8.758 Operating Profit 2.48 13.13 38.63 57.849 Non-operating

surplus/Deficit (+/-)3.78 8.27 5.47 2.97

10 Pre-Tax Profit/Loss 6.26 21.4 44.1 60.8111 Provision for Taxation 4.8 7.69 16 2012 Net Profit/Loss 1.46 13.71 28.1 40.81

NP/Net sales (%) 0.41% 2.57% 2.85% 3.36%13 Profit distributed

through :

a) Equity Dividend 0.00 0.00 0.00 0.00 b) Preference Dividend 0.00 0.00 0.00 0.00

14 Retained Profit 1.46 13.71 28.1 40.8115 Depreciation 1.53 1.66 1.41 1.216 Cash Generation 2.99 15.37 29.51 42.01

STATEMENT OF FINANCIAL POSITION (Rs. lacs)2006 2007 2008 2008 2009 2009

(Aud) (Aud) (Est) (Revised) (Projn) (Revised)Gross Block 12.51 27.26 46.26 114.26 51.26 119.26Depreciation 7.55 9.21 10.62 10.62 11.82 11.82Net Block 4.96 18.05 35.64 103.64 39.44 107.44Total Current Assets 133.39 235.63 239.93 239.93 280.90 280.90Total Current Liabilities 98.76 189

.11 180.

00 180.00 200

.25 200.25

Net Current Assets 34.63 46.52

59.93

59.93 80.65

80.65

CURRENT RATIO 1.35 1.25

1.33

1.33 1.40

1.40

QUICK RATIO 1.11 1.03

0.97

0.97 1.03

1.03

Investment & Non-C.As. 10.72 8.21

2.80

2.80 5.00

5.00

TOTAL 50.31 72.78

98.37

166.37 125.09

193.09

LONG TERM LOANS Secured Loans 0.00 9.

61 6.

75 6.75 3.

90 3.90

Unsecured Loans 29.24 23.56

23.96

91.96 12.75

90.75

SUB-TOTAL 29.24 33.17

30.71 98.71

16.65

94.65

Equity Share Capital 5.00 13.00 18.25 18.25 18.25 18.25Share Application Money 8.65 5.25 0.00 0.00 0.00 0.00 Reserve & Surplus 7.88 21.59 49.69 49.69 90.50 90.50SUB-TOTAL 21.53 39.84 67.94 67.94 108.75 108.75


Intangible Assets 0.45 0.22 0.28 0.28 0.31 0.31Tangible Net Worth 21.08 39.62 67.66 67.66 108.44 108.44TOTAL 50.32 72.

79 98.

37 166.37 125.

09 203.09

D/E Ratio 1.39 0.84

0.45

0.59 0.15

0.47

TOL/TNW 6.07 5.61

3.11

4.12 2.00

2.72

22. Comment in Brief on financial Position: Sales : Gross sales of the company has increased by about 50% in FY 2006-07 over that of FY 2005-06. The company has estimated an increase in sales to 975.00 (exclusive of service charges of Rs.12.00 lacs) for FY 2007-08 which is considered achievable as under :

Sales achieved upto Oct’07 : Rs.507.46 lacs* Estimated for balance 5 months : Rs.467.54 lacsTotal : Rs.975.00 lacs

Profitability: Gross profit margin has remained stable at around 19% in FY 2005-06 & FY 2006-07 and is expected to be around 18% in FY 2007-08 & FY 2008-09. NP margin has increased in FY 2006-07 over that of FY 2005-06 and is expected to increase further in FY 2007-08 & FY 2008-09. The company has estimated a PAT of Rs.28.10 lacs in FY 2007-08 which is considered achievable considering the provisional PAT of Rs.20.13 lacs earned upto Oct’07.Liquidity: Current Ratio has come down from 1.35 as at 31.03.06 to 1.25 as at 31.03.07. This is mainly due to increase in fixed assets without corresponding increase in long term sources as detailed under:

Sources of funds Amount (Rs. lacs)

Applications of funds Amount (Rs. lacs)

PAT 13.71 Fixed assets 14.75Depreciation 1.66 Unsecured loans paid 5.68Secured Loans 9.61 Misc assets 0.23Decrease in Non- CA 2.51 Amount available for WC 11.43Capital 4.60TOTAL 32.09 TOTAL 32.09

The current assets has increased by Rs.102.24 lacs , requiring a margin contribution of Rs.25.56 lacs as against available margin of Rs.11.43 lacs . This lead to decrease in current ratio as at 31.03.07 over that of 31.03.06. However, the same is estimated to increase to 1.33 :1 as at 31.03.08 due to ploughing back of estimated PAT of Rs.28.10 lacs for FY 2007-08.

Solvency: TOL/TNW is high at around 6:1 as at 31.03.06 & 31.03.07 , indicating high dependence on outside borrowings. The same is estimated to come down to 3.11:1 as at 31.03.08 due to ploughing back of estimated PAT of Rs.28.10 lacs for FY 2007-08.

Assessment/ Justification:

27. Working Capital Assessment:

The assessment of WC requirement based on the CMA submitted by the company is as under :

(Rs. lacs)


(Year ending) 31st March 2006 2007 2008 2009 (Actual) (Actual) Estimate Projection

i) Sales (Gross) 355.94 532.95 987.00 1215.00ii) Cost of Production(COP) 286.48 434.28 814.76 996.20iii) Cost of Sales(COS) 286.48 434.28 814.76 996.20iv) Raw Material Consumn 284.95 432.62 813.35 995.00v) % of COP to Sales 80.49% 81.49% 82.55% 81.99%vi) % of COS to Sales 80.49% 81.49% 82.55% 81.99%vii) % of R. M. Cons. to COP 99.47% 99.62% 99.83% 99.88%

Calculation of Company’s Working Capital requirement :DIFFERENT ITEMS OF CURRENT ASSETS

Holding period in Months2006 2007 2008 2009

a) Stock 23.45 40.35 65.00 75.00 (Month's Consumption) 0.99 1.12 0.96 0.90

d) Receivables 94.90 133.30 125.00 150.00 (Month's sales) 3.20 3.00 1.52 1.48

e) Consumable spare (*) f) Other Current Assets (*) 15.04 61.98 49.93 55.90 (*) In amount

TOTAL CURRENT ASSETS 133.39 235.63 239.93 280.90 Less : Creditors 74.30 157.28 85.00 100.00 Others 15.50 16.79 25.00 30.25 Sub-total 89.80 174.07 110.00 130.25 (Working Capital Gap) 43.59 61.56 129.93 150.65

COMPUTATION OF PERMISSIBLE BANK FINANCE: (Rs. in Lacs)(Year ending) 31st March 2008 2009

i) Working Capital Gap 129.93 150.65 ii) 25% margin on Current Assets 59.98 70.23 iii) Projected Working Capital Surplus 59.93 80.65 iv) Item (i) minus Item(ii) 69.95 80.43 v) Item (i) minus Item (iii) 70.00 70.00

vi)Permissible Bank Finance-item(iv) or (v) which is less 69.95 70.00

From the above it is observed that the MPBF for FY 2007-08 & FY comes to Rs.70.00 lacs


Considering the increase in sales we may accept the request of the company.

CREDIT RISK GRADING ( CRG 02)

Name of Borrower: Sri J K Medical Systems (P) Ltd

Line of activity: Trading in medical & surgical equipments.

Branch: SRCM, Manapakkam, Chennai Zone: Chennai.

Scoring based on balance sheet as at 31.03.2007.

Financial Risk:

No Parameter Status Score1 Current ratio 1.25 52 TOL/TNW ratio 5.61 03 Interest coverage ratio (21.40+1.66+2.42)/(2.42)

=10.536

4 Return on capital employed 23.82/261.90=9.10% 05 Trend Analysis

Increase in NCAIncrease in NWIncrease in profitability

Increasing Increasing Increasing

+2+2+2

6 Security Coverage 98.21/100.00 5 Score obtained: 22/36

Business Risk:No Parameter Status Score1 Product mix is satisfactory Yes 2

After sales service is satisfactory Yes 2Borrowers are able to withstand competition Yes 2Not dealing in perishable goods Yes 2Future growth potential is high Yes 2Capacity utilization is more than 80% N.A N.ABusiness is not cyclical Yes 2Borrowers not dependent on limited customers Yes 2Business not sensitive to Govt. policies Yes 2Only few competitors in the local market No 0Total 18 16

2 Income value to the bank (PLR+1% p.a.w.m.r)

More than 12%

6

Total 24 22Score obtained: 22/24

MANAGEMENT RISKNo Parameter Status Score1 Established for more than 5 years Yes 1


Having good reputation and track record Yes 1Having satisfactory relation with the bank for more than 2 years

Yes 1

Business is not managed by 1/2 persons No 0Associate company is sound and support is available

No associates NA

Management is pro active Yes 12 Payment record

Operations in the account15 daysHigh

66

3 Compliance of terms and conditions Complied 64 Sales growth during FY 2006-07

Net Profit growth during FY 2006-07

More than 20% over FY 2005-06More than 20% over FY 2005-06

6

6

Score obtained: 34/35

INDUSTRY/ ACTIVITY RISK.No Parameter Status Score.1 Activity scenario is favorable Yes 12 Technology proven in medium term Yes 13 Demand for product is increasing Yes 14 Availability of mtls adequate Yes 15 Industry does not depend on nature Yes 16 Products having established markets Yes 17 Quality of the product is satisfactory Yes 18 Availability of infrastructure Yes 19 Substitutes/competitors not there No 010 Not an assembler of unbranded iterms Yes 1

Score Obtained 9/10.

Sl no

Risk category Maximum score

Eligible score

Score obtained

Risk weights

Risk adjusted score

Grade

A Financial risk 36 36 29 35 21 AB-4B Business risk 26 24 22 20 18 AB-1C Management risk 36 35 34 35 34 AB-1D Activity risk 10 10 9 10 9 AB-2E Total 82 AB-2

Total risk adjusted score-82/100

Rating: AB-2 (Low).


CHAPTER-7SUMMARY AND CONCLUSION

The Credit Appraisal is a holistic exercise which starts from the time a prospective borrower walks into the branch and culminates in credit delivery and monitoring with the objective of ensuring and maintaining the quality of lending and managing credit risk. The process of Credit Appraisal is multidimensional and includes- Management Appraisal, Technical Appraisal, Commercial Appraisal, Financial Appraisal and Economic Appraisal.

Management Appraisal has received lot of attention these days as it is one of the long term factors affecting the business of the concern.Technical Appraisal emphasizes on the technical feasibility of the venture and also finds out the possible economic life period of the present technology.Commercial Appraisal focuses on the commercial viability of the project .It tries to find matters regarding demand in market, the acceptance of product in market. It also focuses on the presence of other substitutes of the product in the market. It also focuses on the multiple scope of the product.Financial Appraisal is done to find out whether the promoter is having the capacity to raise finance – both own equity and debt? What are the sources of margin? Will the business generate sufficient funds to service the debt and other stakeholders? Is the capital structure optimal?Economic Appraisal examines level of cost/ benefit and IRR (Internal Rate of Return). One of the important monitoring aspects in the credit portfolio is the periodic review of advance accounts. The vital decision to deploy the Bank’s resources should necessarily be based upon the thorough assessment and evaluation of the needs of the borrower. For this, a proper periodical review of any account is inevitable. The CRA models adopted by the bank take into account all factors, which go into risk appraisal involved with a loan. They are broadly categorized into the following. Financial, Business, Industrial and Management risks. Each risk is rated separately.


Usually, it is seen that credit appraisal is evaluated on the lines of financial soundness. But, after the illustrious case study, it can be said that other strong parameters also play an important role in analyzing the credit worthiness of the firm. Moreover, the study at Allahabad bank gave a vast learning experience and has helped to enhance knowledge. During the study I learnt how the theoretical financial analysis aspects are used in practice during the working capital finance assessment. I have realized during my project that a credit analyst must own multi-disciplinary talents like financial, technical as well as legal know-how.

The credit appraisal for working capital finance system has been devised in a systematic way. There are clear guidelines on how the credit analyst or lending officer has to analyze a loan proposal. It includes phase-wise analysis which consists of 5 phases:Financial statement analysis, Working capital and its assessment techniques, Credit risk assessment Documentation, Loan administration.To ensure asset quality, proper risk assessment right at the beginning, is extremely important. That is why Credit Risk Assessment system is an essential ingredient of the Credit Appraisal exercise.We can also conclude that Allahabad bank has a sound credit appraisal system.

REFERENCES

WEBSITES:

www.rbi.org.in www.allahabadbank.in www.wikipedia.com www.google.co.in

BOOKS:

“PRACTICAL BANKING ADVANCES” BY HARDIKAR AND BEDI. “FINANCIAL MANAGEMENT” BY KHAN.

CIRCULARS: “BANK’S DOMESTIC LENDING POLICY” Circular No. 11413/CP & RMD/2011-

12/ 05. “BANK’S CREDIT RISK MANAGEMENT POLICY “

Circular No.: 11448/CPRMD/2011-12/08


http://www.wikipedia.com/

http://www.rbi.org.in/


Documents

Project Report-study on Credit Appraisal (2)