Description
The Credit Risk Management 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.
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Grand Grand Grand Grand Project Report on Project Report on Project Report on Project Report on
Credit Risk Management at Credit Risk Management at Credit Risk Management at Credit Risk Management at
State Bank of Mysore State Bank of Mysore State Bank of Mysore State Bank of Mysore
2010
N. R. Institute of Business Management
23/3/2010
A
Grand Project Report on
Credit Risk Management at
State Bank of Mysore
N. R. Institu
Grand
Credit Risk Manag
(IN PARTIAL FULFILLMENT O
MASTER OF BUSINESS ADMIN
Submitted To:
Prof. Dharmesh Shah
(Asst. Professor, NRIBM)
Prof. Viral Pandya
(Asst. Professor, NRIBM)
itute of Business Manag
A
rand Project Report on
anagement at State Bank of M
LMENT OF PROJECT STUDY COURSE, IN TWO YEAR
SS ADMINISTRATION PROGRAMME OF GUJARAT U
hah
Subm
Sandip A. Makwa
Luv D. Palk
(Batch: 2008-10)
agement
k of Mysore
WO YEARS FULL TIME
UJARAT UNIVERSITY)
Submitted By:
akwana (08056)
. Palkar (08064)
N. R. Institu
This is to certify that
Mr. Sandip A. Makwa Mr. Sandip A. Makwa Mr. Sandip A. Makwa Mr. Sandip A. Makwa
students of N.R.Institute
their grand project on “
in partial fulfillment o
Programme of Gujarat U
been submitted elsewhere
_________________________
Dr. Hitesh Ruparel
Director In-charge,
NRIBM
Date: / / 2010
Place: Ahmedabad
nstitute of Business Management
CERTIFICATE CERTIFICATE CERTIFICATE CERTIFICATE
wana (08056) wana (08056) wana (08056) wana (08056) and and and and Mr. Luv D. Palk Mr. Luv D. Palk Mr. Luv D. Palk Mr. Luv D. Palk
te of Business Management has successf
“Credit Risk Management Credit Risk Management Credit Risk Management Credit Risk Management at at at at State Ba State Ba State Ba State Ba
of two years Master of Business A
t University. This is their original wor
ere.
_____________________________
Prof. Dharmesh Shah
Asst. Professor, NRIBM &
Internal Project Guide
______________
Prof. Vir
Asst. Profess
Internal Pr
ent
alkar (08064 alkar (08064 alkar (08064 alkar (08064) )) )
essfully completed
Bank of Mysore Bank of Mysore Bank of Mysore Bank of Mysore” ”” ”
s Administration
work and has not
_______________________
of. Viral Pandya
st. Professor, NRIBM &
nternal Project Guide
ii
Preface
Banks are regarded as the blood of the nation’s economy without them one cannot imagine
economy moving. Therefore banks should be operated very efficiently.
Advance is heart and recovery is oxygen for the bank and to survive it is necessary to give
advances and recover the amount at the appropriate time. Through credit risk management
we have tried to learn the various aspects related to credit appraisal and credit policy of
SBM. Credit RiskManagement covers all the areas right from the beginning like inquiry till
the loan is paid up.
We are preparing comprehensive report on “Credit Risk Management at State Bank of
Mysore”. The basic idea of project is to augment our knowledge about the industry in its
totality and appreciate the use of an integrated loom. This makes us more conscious about
Industry and its pose and makes us capable of analyzing Industry’s position in the
competitive market. This may also enhance our logical abilities.
There are various aspects, which have been studied in detail in the project and have been
added to this project report.
Though credit management, a very vast topic, we have tried to incorporate to the best of our
capacity from all possible aspects in this project.
Sandip A. Makwana
Luv D. Palkar
iii
Acknowledgement
A journey is easier when we travel together. Interdependence is certainly more important
than
independence. It will always be our pleasures to thank those who have helped us in making
this project a lifetime experience for us.
We would like to express our heartiest gratitude to State Bank of Mysore, for giving us an
opportunity to work with its Ahmedabad Branch, in the Department of Loans and Advances,
our Institute and important persons associated with this project as without their guidance
and hard work we 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 the
Credit Risk Management.
We would also like to extend our gratitude to Mr. Nagesh B. (Assistant General Manager)for
giving us an opportunity to join them to know and learn various aspects of the Loans and
Advances in the organization.
It is our privilege to thank Mr. Navneet Dwivedi (Assistant Manager)whose guidance has
made us learn and understand the finer and complicated aspects of banking, in general and
of Credit Risk Management 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.
Our heartiest gratitude extends to our faculty Prof. Dharmesh Shah (Assistant Professor,
NRIBM)and Prof. Viral Pandya (Assistant Professor, NRIBM) who have helped us in every
aspect of our work.
Finally, we thank all those who directly and indirectly contributed to this project.
23
rd
March, 2010 Sandip A. Makwana
Ahmedabad
Luv D. Palkar
iv
Executive Summary
Our prima facie objective for taking up this project is to acquire knowledge of banking
sector and to take a practical exposure and expertise of credit risk management.
The Credit Risk Management 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, and Financial 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
mattersregarding 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?
The scope of credit structure is incomplete without examination of credit proposal. Credit
proposal has to be examined from the point of 6 C’s viz. Character, Capacity, Capital,
Condition, Collateral and Cash flow.
Initially we have introduced banking as a whole sector in India. Earlier banking industry
was highly protected by sovereign government but in 1991 it has opened the door in the
form of liberalization for the growth and progressive future of this sector. Banking as a
sector provides life and blood in the form of finance for the industrial growth.
As our objective is to gain practical exposure it was necessary to be precise and focused to a
particular bank so as to understand their techniques of Credit Risk Management;we have
v
taken up State Bank of Mysore as a part of banking network in India. For better
understanding of Credit Risk Management, we have also studied the loan proposals
provided by SBM.
The Credit Policy of State Bank of Mysore has undergone changes to cope with
theenvironmental changes, tap the available opportunities, achieve their commercial
objective, fulfill social obligations and adhere to mandatory directed lending norms over the
years. The credit policy consists of both fund based credit exposure and non fund based
credit exposure.
One of the important monitoring aspects in the credit risk management 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.
After analyzing the proposal and Credit Risk Management process, we have rationalized our
observation and tried to provide practical and feasible suggestions that may help them to
improve upon their present practices.
Table of Contents
Chapter 1
Research Methodology ............................................................................................................................. 1
1.1) Introduction to Credit Risk Management ....................................................................................................... 1
1.2) Objectives of the Study ......................................................................................................................................... 1
1.3) Research Design....................................................................................................................................................... 1
1.4) Sources of Data ......................................................................................................................................................... 1
1.5) Expected contribution of the study ................................................................................................................. 2
1.6) Beneficiaries of the Study .................................................................................................................................... 2
1.7) Limitations ................................................................................................................................................................. 2
Chapter 2
Introduction to Banking Sector ........................................................................................................... 3
2.1) History of Banking in India ................................................................................................................................. 3
2.2) Reserve Bank of India (RBI) ............................................................................................................................... 7
Banking structure .................................................................................................................................................... 8
2.3) Types of banks ....................................................................................................................................................... 9
2.3.1) Scheduled Banks.................................................................................................................................................... 9
2.3.2) Non-scheduled banks ....................................................................................................................................... 12
2.4) Opportunities and Challenges for Players ................................................................................................. 14
2.5) Current trend in banking .................................................................................................................................. 15
Chapter 3
Industry Analysis ....................................................................................................................................... 16
3.1) Competitive Forces Model (Porter’s Five-Force model) ..................................................................... 16
3.2) SWOT Analysis ...................................................................................................................................................... 18
Chapter 4
Introduction to SBM ................................................................................................................................. 21
4.1) SBM - Introduction ................................................................................................................................................ 21
4.2) Key areas of operation ....................................................................................................................................... 22
4.3) Technical Initiatives ............................................................................................................................................ 24
Chapter 5
Credit Risk Management ....................................................................................................................... 25
5.1) Introduction ........................................................................................................................................................... 25
5.2) Definition ................................................................................................................................................................. 26
5.3) Scope of Credit Risk............................................................................................................................................. 26
5.4) what is the role of Credit Analysis? .............................................................................................................. 27
5.5) Credit Risk Management Process ............................................................................................................. 28
5.5.1) Collect Obligor and Loan data...................................................................................................................... 28
5.5.2) Compute Credit Risk ........................................................................................................................................ 29
5.5.3) Monitor and Manage Risk Rating ............................................................................................................... 31
5.5.4) Manage portfolio and allocate capital ...................................................................................................... 31
5.5.5) Summary of the key priority areas ............................................................................................................ 32
5.6) Significance of Credit Risk Measurement and Management ............................................................. 34
Chapter6
Overview Of Credit Appraisal ............................................................................................................. 36
6.1) Brief overview of credit ..................................................................................................................................... 36
6.2) Basic Types of Credit ....................................................................................................................................... 37
6.2.1) Brief Overview of Loans: .............................................................................................................................. 38
(A) Fund Base .................................................................................................................................................. 38
(B) Non-Fund Base ........................................................................................................................................ 45
6.3) Credit Risk Assessment (CRA) ................................................................................................................... 49
6.3.1) Indian Scenario: ............................................................................................................................................... 49
6.3.2) SBM Scenario: ................................................................................................................................................... 49
6.3.3) Credit Risk Assessment (CRA) – Minimum Scores / Hurdle Rates ............................................ 50
6.3.4) Salient Features of CRA Models: ............................................................................................................... 52
(a) Type of Models .......................................................................................................................................... 52
(b) Type of Ratings ......................................................................................................................................... 52
(c) Type of Risks Covered ........................................................................................................................... 53
(i) Borrower Rating ............................................................................................................................... 53
(ii) Facility Rating (Regular Model) ................................................................................................ 53
(d) New Rating Scales ................................................................................................................................... 54
6. 4) Comparative Analysis of Credit Risk Appraisal ........................................................................................ 57
Chapter 7
Risk Management in Banks .................................................................................................................. 59
7.1) Introduction ........................................................................................................................................................... 59
7.2) Classification of Risks ......................................................................................................................................... 59
Chapter 8
SBM Norms for Credit Appraisal & Credit Risk management ............................................ 62
8.1) Loan Policy – An Introduction .................................................................................................................... 62
Credit Appraisal Standards ......................................................................................................................... 64
(A) Qualitative ................................................................................................................................................ 64
(B) Quantitative ............................................................................................................................................. 64
Required Documents for Process of Loan ............................................................................................ 67
Delegation of Powers ..................................................................................................................................... 67
Pricing .................................................................................................................................................................. 69
Credit Monitoring & Supervision ............................................................................................................. 70
8.2) Loan Administration - Pre-Sanction Process..................................................................................... 72
8.2.1) Appraisal ............................................................................................................................................................. 72
8.2.2) Assessment ........................................................................................................................................................ 79
8.2.3) Sanction ............................................................................................................................................................... 80
8.2.4) Monitoring Delay in Processing Loan Proposal ................................................................................. 81
8.3) Loan Administration - Post Sanction Credit Process .................................................................... 82
8.3.1) Need ...................................................................................................................................................................... 82
8.3.2) Stages of post sanction process................................................................................................................. 82
8.4) Types of Lending Arrangements ............................................................................................................... 83
A. Sole Banking ................................................................................................................................................ 83
B. Consortium Lending ................................................................................................................................ 83
C. Multiple Banking Arrangement ........................................................................................................... 84
D. Credit Syndication .................................................................................................................................... 84
Chapter 9
Proposals and Analysis .......................................................................................................................... 86
Proposal: I – GDP Ltd. ..................................................................................................................................................... 86
Analysis – GDP Ltd. ............................................................................................................................................................. 93
Proposal: II – CAB Ltd. .................................................................................................................................................... 95
Analysis – CAB Ltd. ...........................................................................................................................................................102
Proposal: III – IMP Ltd. ................................................................................................................................................104
Analysis – IMP Ltd. ...........................................................................................................................................................110
Proposal: IV - ABC Enterprises Ltd. ......................................................................................................................111
Analysis - ABC Enterprises Ltd. ..................................................................................................................................114
Proposal: V - VANRAJ Tractors ...............................................................................................................................116
Analysis - VANRAJ Tractors ..........................................................................................................................................117
Comparative Analysis of the proposals .............................................................................................................119
Proposal I & II ..............................................................................................................................................................119
Proposal III & IV .........................................................................................................................................................120
Chapter 10 Findings ..................................................................................................................................... 121
Chapter 11 Suggestions .............................................................................................................................. 122
Chapter 12 Conclusion ................................................................................................................................ 123
Bibliography ...................................................................................................................................................... 124
Appendix ....................................................................................................................................................... A1-A10
Credit Risk Management at SBM
N R Institute of Business Management Page 1
Chapter 1
Research Methodology
1.1) Introduction to Credit Risk Management
Credit risk "is the risk to a bank's earnings or capital base arising from a borrower's failure to
meet the terms of any contractual or other agreement it has with the bank. Credit risk arises
from all activities where success depends on counterparty, issuer or borrower
performance".
Credit appraisal means an investigation/assessment done by the bank before providing any
loans & advances/project finance & also checks the commercial, financial & industrial viability of
the project proposed its funding pattern & further checks the primary & collateral security cover
available for recovery of such funds.
1.2) Objectives of the Study
x The main objective of the study is, to evaluate the Credit Appraisal system & Risk
Assessment Model for effective credit risk management.
# Sub-Objectives:
x To understand the commercial, financial & technical viability of the proposal
proposed & it's funding pattern.
x To understand the pattern for primary & collateral security cover available for
recovery of such funds and management of credit risk.
1.3) Research Design
Ö It is a descriptive research.
1.4) Sources of Data
Primary Data:
x Information collected from the Credit Appraisal Officer of Bank as well as
informal interviews with Assistant General Manager and Assistance Manager.
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Secondary Data:
x Details regarding the Live Cases of applicant companies which are provided by the
Bank
x E-circulars of Bank
x Books
x Library research
x Websites
1.5) Expected contribution of the study
This study will help in understanding the credit Risk Management system at SBM& to
understand how to reduce various risk parameters, which are broadly categorized into
financial risk, business risk, industrial risk & management risk, associated in providing any
loans or advances or project finance.
1.6) Beneficiaries of the Study
Researcher
This report will help researcher in improving knowledge about the credit appraisal system
and to have practical exposure of the credit appraisal scenario in bank.
Management Student
The project will help the management student to know the patterns of credit appraisal in
bank.
Bank
The project will help bank in reducing the credit risk parameters. It will also help to reduce
risk associated in providing any loans & advances or project finance in future and to
overcome the loopholes.
1.7) Limitations
x As the credit risk management is one of the crucial areas for any bank, some of the
technicalities are not revealed which might cause destruction to the information and
our exploration of the problem.
x Credit appraisal system includes various types of detail studies for different areas of
analysis, but due to time constraint, our analysis will be of limited areas only.
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Chapter 2
Introduction to Banking Sector
2.1) History of Banking in India
Without a sound and effective banking system in India it cannot have a healthy economy.
The banking system of India should not only be hassle free but it should be able to meet
new challenges posed by the technology and any other external and internal factors.
The word bank is derived from the Italian banca, which is derived from German and means
bench. The terms bankrupt and “broke” are similarly derived from bancarotta, which refers
to an out of business bank, having its bench physically broken. Moneylenders in Northern
Italy originally did business in open areas, or big open rooms, with each lender working
from his own bench or table.
Banking in India originated in the first decade of 18th century with The General Bank of
India coming into existence in 1786. This was followed by Bank of Hindustan. Both these
banks are now defunct. The oldest bank in existence in India is the State Bank of India being
established as "The Bank of Bengal" in Calcutta in June 1806. A couple of decades later,
foreign banks like Credit Lyonnais started their Calcutta operations in the 1850s. At that
point of time, Calcutta was the most active trading port, mainly due to the trade of the
British Empire, and due to which banking activity took roots there and prospered. The first
fully Indian owned bank was the Allahabad Bank, which was established in 1865.
By the 1900s, the market expanded with the establishment of banks such as Punjab
National Bank, in 1895 in Lahore and Bank of India, in 1906, in Mumbai - both of which
were founded under private ownership. The Reserve Bank of India formally took on the
responsibility of regulating the Indian banking sector from 1935. After India's
independence in 1947, the Reserve Bank was nationalized and given broader powers.
For the past three decades India's banking system has several outstanding achievements to
its credit. The most striking is its extensive reach. It is no longer confined to only
metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to
the remote corners of the country. This is one of the main reasons of India's growth process.
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The government's regular policy for Indian bank since 1969 has paid rich dividends with
the nationalization of 14 major private banks of India.
Not long ago, an account holder had to wait for hours at the bank counters for getting a
draft or for withdrawing his own money. Today, he has a choice. Gone are days when the
most efficient bank transferred money from one branch to other in two days. Now it is
simple as instant messaging or dials a pizza. Money has become the order of the day.
The first bank in India, though conservative, was established in 1786. From 1786 till today,
the journey of Indian Banking System can be segregated into three distinct phases. They are
as mentioned below:
x Early phase from 1786 to 1969 of Indian Banks
x Nationalization of Indian Banks and up to 1991 prior to Indian banking sector
Reforms
x New phase of Indian Banking System with the advent of Indian Financial & Banking
Sector Reforms after 1991
x Scenario of Bank as per Phase I, Phase II and Phase III
Phase I
The General Bank of India was set up in the year 1786 followed by Bank of Hindustan and
Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay
(1840) and Bank of Madras (1843) as independent units and called it Presidency Banks.
These three banks were amalgamated in 1920 and Imperial Bank of India was established
which started as private shareholders banks, mostly Europeans shareholders.
In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab
National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and
1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and
Bank of Mysore were set up. The Reserve Bank of India which is the Central Bank was
created in 1935 by passing Reserve Bank of India Act, 1934 which was followed up with the
Banking Regulations in 1949. These acts bestowed Reserve Bank of India (RBI) with wide
ranging powers for licensing, supervision and control of banks. Considering the
proliferation of weak banks, RBI compulsorily merged many of them with stronger banks in
1969.
During the first phase the growth was very slow and banks also experienced periodic
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failures between 1913 and 1948. There were approximately 1100 banks, mostly small.
To streamline the functioning and activities of commercial banks, the Government of India
came up with The Banking Companies Act, 1949 which was later changed to Banking
Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of
India was vested with extensive powers for the supervision of banking in India as the
Central Banking Authority.
During those day public has lesser confidence in the banks. As an aftermath deposit
mobilization was slow. Abreast of it the savings bank facility provided by the Postal
department was comparatively safer. Moreover, funds were largely given to traders.
Phase II
Government took major steps in this Indian Banking Sector Reform after independence. In
1955, it nationalized Imperial Bank of India with extensive banking facilities on a large scale
especially in rural and semi-urban areas. It formed State Bank of India to act as the principal
agent of RBI and to handle banking transactions of the Union and State Governments all
over the country.
Seven banks forming subsidiary of State Bank of India was nationalized in 1960 on 19th
July, 1969, major process of nationalization was carried out. It was the effort of the then
Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country were
nationalized.
Second phase of nationalization Indian Banking Sector Reform was carried out in 1980 with
seven more banks. This step brought 80% of the banking segment in India under
Government ownership.
The following are the steps taken by the Government of India to Regulate Banking
Institutions in the Country:
1949: Enactment of Banking Regulation Act.
1955: Nationalization of State Bank of India.
1959: Nationalization of SBI subsidiaries.
1961: Insurance cover extended to deposits.
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1969: Nationalization of 14 major banks.
1971: Creation of credit guarantee corporation.
1975: Creation of regional rural banks.
1980: Nationalization of seven banks with deposits over 200 crore.
After the nationalization of banks, the branches of the public sector bank India rose to
approximately 800% in deposits and advances took a huge jump by 11,000%. Banking in
the sunshine of Government ownership gave the public implicit faith and immense
confidence about the sustainability of these institutions.
Phase III
This phase has introduced many more products and facilities in the banking sector in its
reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set
up by his name which worked for the liberalization of banking practices.
The country is flooded with foreign banks and their ATM stations. Efforts are being put to
give a satisfactory service to customers. Phone banking and net banking is introduced. The
entire system became more convenient and swift. Time is given more importance than
money.
The financial system of India has shown a great deal of resilience. It is sheltered from any
crisis triggered by any external macroeconomics shock as other East Asian Countries
suffered.
This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital
account is not yet fully convertible, and banks and their customers have limited foreign
exchange exposure.
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2.2) Reserve Bank of India (RBI)
The central bank of the country is the Reserve Bank of India (RBI). It was established in
April 1935 with a share capital of Rs. 5 crore on the basis of the recommendations of the
Hilton Young Commission. The share capital was divided into shares of Rs. 100 each fully
paid which was entirely owned by private shareholders in the beginning. The Government
held shares of nominal value of Rs. 2,20,000.
Reserve Bank of India was nationalized in the year 1949. The general superintendence and
direction of the Bank is entrusted to Central Board of Directors of 20 members, the
Governor and four Deputy Governors, one Government official from the Ministry of Finance,
ten nominated Directors by the Government to give representation to important elements
in the economic life of the country, and four nominated Directors by the Central
Government to represent the four local Boards with the headquarters at Mumbai, Kolkata,
Chennai and New Delhi. Local Boards consist of five members each Central Government
appointed for a term of four years to represent territorial and economic interests and the
interests of co-operative and indigenous banks.
The Reserve Bank of India Act, 1934 was commenced on April 1, 1935. The Act, 1934 (II of
1934) provides the statutory basis of the functioning of the Bank.
The Bank was constituted for the need of following:
¾ To regulate the issue of banknotes
¾ To maintain reserves with a view to securing monetary stability and
¾ To operate the credit and currency system of the country to its advantage
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Banking structure
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2.3) Types of banks
2.3.1) Scheduled Banks
Scheduled banks are those banks that come under the purview of the second schedule of
Reserve Bank of India act 1934. The banks that are included under this schedule are those
that satisfy the criteria laid down vide section 42(6) of the act.
1) The bank is dealing in banking business in India only.
2) The paid up capital and total funds of the bank should not be less than five lacs.
3) It should convince RBI that its activities would not be against the interest of the
investors.
4) The bank must be:
¾ State co-operative bank, or
¾ A company according to the definition of the companies act 1956, or
¾ An institution notified by the central government, or
¾ A corporation or a company incorporated by or under any law in force in any place
outside India.
Thus, Indian Commercial Banks, Foreign commercial banks, and state cooperative banks
fulfilling the above conditions are considered as scheduled banks. Moreover under the RBI
Act section 42, the central Government has declared the following banks as scheduled
banks.
i. State bank of India and its 7 subsidiary banks,
ii. 20 Nationalized banks, and
iii. Urban banks
In June 1980 there were 149 scheduled banks which included
i. Public Sector banks
ii. Private sector banks
iii. Foreign exchange banks and
iv. State cooperative banks.
A bank which wants to register its name as scheduled bank has apply to the central
government. On receiving such applications, the central government orders RBI to
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investigate Banks’ accounts. If RBI gives favorable reports, the central government
sanctions its proposal, and the bank is listed under schedule annexure II and is considered
as a scheduled bank.
Some co-operative banks come under the category of scheduled commercial banks though
not all cooperative banks.
# PUBLIC SECTOR BANKS
Public sector banks are those in which the government of India or the RBI is a majority
shareholder. These banks include the State Bank of India (SBI) and its subsidiaries, other
nationalized banks, and regional rural banks (RRBs). Over 70% of the aggregate branches in
India are those of the public sector banks. Some of the leading banks in this segment include
Allahabad Bank, Canara Bank, Bank Of Maharashtra, Central Bank Of India, Indian overseas
bank, state bank of India, State bank of Patiala, state bank of Bikaner and Jaipur, state bank
of Travancore, bank of Baroda, Bank of India, oriental bank of commerce, UCO Bank, Union
Bank of India, Dena Bank and corporation Bank.
# PRIVATE SECTOR BANKS
Private Banks are essentially comprised of 2 types:
Old banks
The old private sector banks comprise those, which were operating before banking
nationalization act was passed in 1969. On account of their small size, and regional
operations, these banks were not nationalized these banks face intense rivalry from the
new private banks and the foreign banks. The banks that are included in this segment
include: Bank Of Madura ltd.(now a part of ICICI bank), Bharat overseas bank ltd., Bank of
Rajasthan, Karnataka bank ltd., Lord Krishna bank ltd., the Catholic Syrian bank ltd., the
Dhanlakshmi bank ltd., the federal bank ltd., the Jammu & Kashmir bank ltd., The
KarurVyasya bank ltd., The Lakshmi Vilas bank ltd., The Nedungadi Bank ltd. and Vysya
Bank.
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New banks
The new private sector banks were established when the banking regulation act was
amended in 1993. Financial institutions promoted several of these banks. After the initial
licenses, The RBI has granted no more licenses. These banks are gearing up to face the
foreign banks by focusing on service and technology. Currently, these banks are on an
expansion spree, spreading into semi-urban areas and satellite towns. The leading banks
that are included in this segment includes bank of Punjab ltd., Centurion Bank ltd., HDFC
Bank ltd., ICICI Bank corporation ltd., CITI Bank ltd., IndusInd Bank ltd. And UTI bank ltd.
# Co-operative banks
Co-operative banks act as substitutes for money lenders, and offer timely and adequate
short-term and long-term institutional credit at reasonable rates of interest. Co-operative
banks are relatively similar in terms of functions to the other banks except for the following:
a) They are organized and managed on the principle of co-operation, self-health, and
mutual health.
b) They operate under the rule of “One member, one vote”.
c) Operate on “No profit, no loss” basis.
d) Co-operative bank conducts all the main banking functions of the deposit mobilization,
supply of credit and provision of remittance facility. Co-operative Banks offer limited
banking products and are functionally specialists in agriculture- related products, and
even in providing housing loans of late. Urban co-operative banks offer working capital
loans and term loan as well.
e) Co-operative banks primarily operate in the agriculture and rural sector. However,
UCBs, SCBs, and CCBs function in the semi urban, urban, and metropolitan areas too.
f) Co-operative banks are probably the first government sponsored, government-
supported, and government- subsidized financial agency in India. They get financial and
other aid from the reserve bank of India NABARD, central governments and state
governments. They are the “Most favored” banking sector with risk of nationalization.
g) Co-operative banks normally concentrate on “High revenue” niche retail segments.
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# Development Banks
Development banks are primarily intended to encourage industrial development by
providing adequate flow of funds to industrial projects. In other words, these institutions
undertake the responsibility of aiding all- round development in the country’s economy by
promoting new industrial projects, and providing financial assistance for the expansion,
diversification, and up gradation of the existing units. Development banks may be classified
as all India developments banks and regional development banks. While all India
development banks include industrial development banks of India and industrial finance
corporation of India, examples of regional development banks include state finance
corporation and state industrial development corporation.
2.3.2) Non-scheduled banks:
The banks, which are not included in the second schedule of RBI act, 1934, are known as
non-scheduled banks. Such banks total share capital is less than 5 lacs. These banks are not
governed according to the RBI act and they receive no benefits from the RBI. These banks
have no place in the list of recognized banks of the RBI. These banks are not much trusted
by the people and they do not get handsome deposits. Since 1951 the numbers of such
banks have been gradually decreasing. In 1979 there were only 5 non-scheduled banks.
Generally now days we found many co-operative banks which are belongs to the non-
scheduled co-operative banks. Following are the types of non-scheduled banks they are
work like the schedule banks but here the difference in it status and it not having the status
of the scheduled banks.
a. Deposits bank
b. Co-operative banks
c. Central banks
d. Exchange banks
e. Investment or industrial banks
f. Land development banks
g. Savings banks
a) Deposits banks:
Generally, banks which provide short-term loans to business and industrial units and which
mobilize savings of people as deposits are called deposit banks. Deposit banks accept
deposits from people, and provide short-term advances. They provide over draft and cash
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credit facilities to merchants. To meet long-term requirement of industrial units is not
possible for these banks. They accept 3 types of deposits saving bank deposits, fix deposits
and current account deposits. They accept these deposits which are payable on demand or
on short notice, and provide funds to trading and commercial units for short durations.
b) Cooperative Banks
Cooperative banks meet the short-term financial needs of farmers. Agriculturists, Petty
farmers and artisans organized themselves on cooperative principles and form cooperative
societies and banks. Cooperative banks raise funds through various means, besides
receiving all kinds of deposits to make them available as lendable funds to its members. In
India developed cooperative banks supply finance for agriculture and non-agriculture
activities.
c) Central Banks
A central bank is a special institution which controls and regulatesthe entire banking
structure of country. It also strives to maintain monetary stability of the country. Central
bank is also known as the Apex bank of the country. Since it functions in the best interest of
the country and making profits is unknown to it, it is entrusted the right it issue currency
notes. No other bank is allowed this right. It operates in close cooperation with the
government of implementing economic policies, thereby promoting economic development.
d) Exchange Banks:
There is a difference in financing of foreign trade and financing of internal trade. Generally a
person carrying on international trade requires foreign currencies to meet this obligation. It
is here that exchange banks play the role of financing the dealer for setting transactions
involved in foreign trade, there are specialized banks for exchange business. In India, there
is an export-import bank (EXIM).
e) Investment or industrial banks:
Investment banks provide long-term credit to industries. They raise their funds by way of
share capital, debentures, and long-term deposits from the public. They also raise fund by
the issue of bonds for business operations and government agencies. Usually they
underwrite fresh issue of shares and debentures of companies. Such banks also buy the
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entire issue of new securities of public limited companies and try to get them subscribed at
a higher price by the public.
f) Land Development Banks:
Land development banks were earlier known as land mortgage banks. In India, there is
limited number of such banks. There are special institutions providing long-term loans to
agricultures and farmers. They provide loans on security of land and other immovable
properties. They supply long-term funds for periods exceeding 6 years. Agriculturists and
farmers need such funds for making permanent improvements to land and for buying
farming machinery and equipment.
g) Savings Banks:
Saving banks are specialized institutions, which encourage general public to save something
from their earnings. In other words such banks pool the small savings of middle and lower
income sections of society. They are the banks in the true sense of the term and their main
aim is to promote and collect of the public. Not only the depositors are given interest, but
also they are allowed to withdraw in times of need. The numbers of withdrawal are,
however, restricted. Separate saving banks are organized in various nations. The
government can also run a savings bank. In India the postal department runs the postal
saving bank allover the country. It is very popular in rural areas where no branches of
established commercial bank operate. In urban areas, commercial bank handles savings
business.
2.4) Opportunities and Challenges for Players
The bar for what it means to be a successful player in the sector has been raised. Four
challenges must be addressed before success can be achieved. First, the market is seeing
discontinuous growth driven by new products and services that include opportunities in
credit cards, consumer finance and wealth management on the retail side, and in fee-based
income and investment banking on the wholesale banking side.
These require new skills in sales & marketing, credit and operations. Second, banks will no
longer enjoy windfall treasury gains that the decade-long secular decline in interest rates
provided. This will expose the weaker banks. Third, with increased interest in India,
competition from foreign banks will only intensify. Fourth, given the demographic shifts
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resulting from changes in age profile and household income, consumers will increasingly
demand enhanced institutional capabilities and service levels from banks.
2.5) Current trend in banking
Currently (2009), banking in India is generally fairly mature in terms of supply, product
range and reach-even though reach in rural India still remains a challenge for the private
sector and foreign banks. In terms of quality of assets and capital adequacy, Indian banks
are considered to have clean, strong and transparent balance sheets relative to other banks
in comparable economies in its region. The Reserve Bank of India is an autonomous body,
with minimal pressure from the government. The stated policy of the Bank on the Indian
Rupee is to manage volatility but without any fixed exchange rate-and this has mostly been
true.
With the growth in the Indian economy expected to be strong for quite some time-
especially in its services sector-the demand for banking services, especially retail banking,
mortgages and investment services are expected to be strong. One may also expect M&As,
takeovers, and asset sales.
Currently, India has 88 scheduled commercial banks (SCBs) - 28 public sector banks (that is
with the Government of India holding a stake), 29 private banks (these do not have
government stake; they may be publicly listed and traded on stock exchanges) and 31
foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs.
According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75
percent of total assets of the banking industry, with the private and foreign banks holding
18.2% and 6.5% respectively.
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Chapter3
Industry Analysis
3.1) Competitive Forces Model (Porter’s Five-Force model)
Prof. Michael Porter’s competitive forces Model applies to each and every company as well
as industry. This model with regards to the Banking Industry is presented below:
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1. Rivalry among existing firms
With the process of liberalization, competition among the existing banks has increased.
Each bank is coming up with new products to attract the customers and tailor made loans
are provided. The quality of services provided by banks has improved drastically.
2. Potential Entrants
Previously the Development Financial Institutions mainly provided project finance and
development activities. But they now entered into retail banking which has resulted into
stiff competition among the exiting players.
3. Threats from Substitutes
Banks face threats from Non-Banking Financial Companies. NBFCs offer a higher rate of
interest.
4. Bargaining Power of Buyers
Corporate can raise their funds through primary market or by issue of GDRs, FCCBs. As a
result they have a higher bargaining power. Even in the case of personal finance, the buyers
have a high bargaining power. This is mainly because of competition.
5. Bargaining Power of Suppliers
With the advent of new financial instruments providing a higher rate of returns to the
investors, the investments in deposits is not growing in a phased manner. The suppliers
demand a higher return for the investments.
Overall Analysis
The key issue is how banks can leverage their strengths to have a better future. Since the
availability of funds is more and deployment of funds is less, banks should evolve new
products and services to the customers. There should be a rational thinking in sanctioning
loans, which will bring down the NPAs. As there is an expected revival in the Indian
economy Banks have a major role to play. Funding corporate at a low cost of capital is a
special requisite.
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3.2) SWOT Analysis
The banking sector is also taken as a proxy for the economy as a whole. The performance of
bank should therefore, reflect “Trends in the Indian Economy”. Due to the reforms in the
financial sector, banking industry has changed drastically with the opportunities to the
work with, new accounting standards new entrants and information technology. The
deregulation of the interest rate, participation of banks in project financing has changed in
the environment of banks.
The performance of banking industry is done through SWOT Analysis. It mainly helps to
know the strengths and Weakness of the industry and to improve will be known through
converting the opportunities into strengths. It also helps for the competitive environment
among the banks.
STRENGTHS
1. Availability of Funds
There are seven lakh crore wroth of deposits available in the banking system. Because of
the recession in the economy and volatility in capital markets, consumers prefer to deposit
their money in banks. This is mainly because of liquidity for investors.
2. Banking network
After nationalization, banks have expanded their branches in the country, which has helped
banks build large networks in the rural and urban areas. Private Banks allowed operating
but they mainly concentrate in metropolis.
3. Large Customer Base
This is mainly attributed to the large network of the banking sector. Depositors in rural
areas prefer banks because of the failure of the NBFCs.
4. Low Cost of Capital
Corporate prefers borrowing money from banks because of low cost of capital. Middle
income people who want money for personal financing can look to banks as they offer at
very low rates of interests. Consumer credit forms the major source of financing by banks.
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WEAKNESSES
1. Loan Deployment
Because of the recession in the economy the banks have idle resources to the tune of 3.3
lakh crore. Corporate lending has reduced drastically
2. Powerful Unions
Nationalization of banks had a positive outcome in helping the Indian Economy as a whole.
But this had also proved detrimental in the form of strong unions, which have a major
influence in decision-making. They are against automation.
3. Priority Sector Lending
To uplift the society, priority sector lending was brought in during nationalization. This is
good for the economy but banks have failed to manage the asset quality and their intensions
were more towards fulfilling government norms. As a result lending was done for non-
productive purposes.
4. High Non-Performing Assets
Non-Performing Assets (NPAs) have become a matter of concern in the banking industry.
This is because of change in the total outstanding advances, which has to be reduced to
meet the international standards.
OPPORTUNITIES
1. Universal Banking
Banks have moved along the valve chain to provide their customers more products and
services. For example: - SBI is into SBI home finance, SBI Capital Markets, SBI Bonds etc.
2. Differential Interest Rates
As RBI control over bank reduces, they will have greater flexibility to fix their own interest
rates which depends on the profitability of the banks.
3. High Household Savings
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Household savings has been increasing drastically. Investment in financial assets has also
increased. Banks should use this opportunity for raising funds.
4. Overseas Markets
Banks should tape the overseas market, as the cost of capital is very low.
5. Interest Banking
The advance in information technology has made banking easier. Business can effectively
carried out through internet banking.
THREATS
1. NBFCs, Capital Markets and Mutual funds
There is a huge investment of household savings. The investments in NBFCs deposits,
Capital Market Instruments and Mutual Funds are increasing. Normally these instruments
offer better return to investors.
2. Change in the Government Policy
The change in the government policy has proved to be a threat to the banking sector.
3. Inflation
The interest rates go down with a fall in inflation. Thus, the investors will shift his
investments to the other profitable sectors.
4. Recession
Due to the recession in the business cycle the economy functions poorly and this has proved
to be a threat to the banking sector. The market oriented economy and globalization has
resulted into competition for market share. The spread in the banking sector is very
narrow. To meet the competition the banks has to grow at a faster rates and reduce the
overheads. They can introduce the new products and develop the existing services.
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Chapter4
Introduction to SBM
STATE BANK OF MYSORE
Working for a better tomorrow
Mission
“A premier commercial Bank in Karnataka, with all India presence, committed to provide
consistently superior and personalized customer service backed by employee pride and will
to excel, earn progressively high returns for its shareholders and be a responsible corporate
citizen contributing to the well being of the society.”
4.1) SBM - Introduction
State Bank of Mysore was established in the year 1913 as Bank of Mysore Ltd. under the
patronage of the erstwhile Govt. of Mysore, at the instance of the banking committee headed
by the great Engineer-Statesman, Late Dr. Sir M.Visvesvaraya. Subsequently, in March 1960,
the Bank became an Associate of State Bank of India. State Bank of India holds 92.33% of
shares. The Bank's shares are listed in Bangalore, Chennai, and Mumbai stock exchanges.
The Bank has a widespread network of 682 branches (as on 30.09.2009)and20 extension
counters spread all over India which includes5 specialized SSI branches, 4 Industrial Finance
branches, 3 Corporate Accounts Branches, 4 specialized Personal Banking Branches, 10
Agricultural Development Branches, 3 Treasury branches, 1 Asset Recovery Branch and 8
Service Branches, offering wide range of services to the customers.
The Bank has a dedicated workforce of 9720 employees consisting of 3169 supervisory staff,
6551 non-supervisory staff (as on 31.03.2008). The skill and competence of the employees
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have been kept updated to meet the requirement of our customers keeping in view the
changes in the environment. The Chairman of State Bank of India is also the Chairman of
this Bank; The Managing Director is assisted by a Chief General Manager and 6 General
Managers.
The paid up capital of the Bank is Rs.360 Millions as on 31.03.2009 out of which State Bank
of India holds 92.33%. The net worth of the Bank as on 31.03.2009 is Rs.1619.44 Crores and
the Bank has achieved a capital adequacy ratioof12.99% as at the end of March 2009. The
Bank has an enviable track record of earning profits continuously and uninterrupted
payment of dividend since its inception in 1913. The Bank earned a net profit of Rs.336.91
Crores for the year ended March 2009 and earnings per share are at Rs.94.
Total deposits of the Bank as at the end of March 2009 isRs.32915.76 Crores and the total
advances stood at Rs. 25616.05 Crores which include export credit of Rs. 1158.13 Crores. The
Forex Merchant turnover of the Bank is Rs.19607.42 Crores and the Forex Trading turnover is
Rs.82197.27 Crores at the end of March 2009.
4.2) Key areas of operation:
1) Personal Banking Schemes:
The personal banking scheme consists of the following types of services:
¾ Personal loan
¾ Mortgage loan
¾ Housing loans
¾ Educational loan
¾ Cash Key: To meet unforeseen expenses, without premature withdrawal of term
deposit. Immediate overdraft facility is available
¾ ATM Facility: Round the clock ATM facility for customers of Bangalore city and
different parts of the country.
2) Commercial And Institutional Banking Schemes:
¾ Scheme for Traders-Liberalized Trade Finance: State Bank of Mysore has designed
schemes for traders to meet their working capital needs – under C&I and SME Segment.
The following categories of borrowers will be covered:
» Small business enterprises.
» Retail traders/ wholesale traders.
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» Professional and Self employed.
¾ Handy Loans Scheme - For Trade and Services sector: Handy Loan can be availed for :
» Holding stocks / Receivables
» Acquisition of land and buildings for establishing trading house
» Building construction & renovation of offices, showrooms, godowns, etc.
» Purchase of equipment, furniture & vehicles
» Augmenting networking capital
» Payment of long term deposits / advances to supplier
» General trade purposes
¾ Corporate Loan (Earlier Name: Short Term Corporate Loan):The Short Term
Corporate Loan is essentially in the form of Term Loan for corporate for certain
specific purposes with maturity not exceeding three years
¾ Current Account Plus: The services offered under this services are as follows:
» Issue of 30 DDs cumulative value not exceeding Rs.25 lacs per month free of charges
» Collection of 30 outstation cheques per month with a cumulative value of Rs.10 lacs,
free of collection charges (This facility is only for the account holder’s instruments
and not for third party cheques). Handling charges of Rs.20/- per instrument to be
collected
» SBI Life policy of Rs. 1 lakh coverage. In the unfortunate event of death, SBI Life
would pay the assured to the nominee. In the event of the death due to an accident,
SBI Life would pay the Nominee double the sum assured. Free of cost, for
individuals/proprietor of concern. In case of Partnership firms / Company Accounts
any one partner/ Director.
¾ Rent Plus: This scheme is to meet liquidity mismatch / any other purpose of the
applicants.
3) Agricultural Schemes:
The schemes under agricultural are as under:
¾ Kisan Gold Card Scheme
¾ Kisan Credit Card Scheme
¾ GraminBhandaranYojana (GBY)
¾ Scheme for Combined Harvesters
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¾ Kisan Chakra Scheme
4) Micro & Small Enterprises Scheme: The various schemes under MSE schemes are as
follows:
¾ Credit Guarantee Fund Trust Scheme For Micro & Small Enterprises (CGTMSE)
¾ Loans to Micro & Small Enterprises (MSEs)
¾ Small Business Finance
¾ Small Business Enterprises
¾ Professionals & Self-Employed persons
¾ Transport Operators
¾ LaghuUdyami Credit Card Scheme
4.3) Technical Initiatives:
State Bank of Mysore is the first Karnataka-based Bank with fully networked branches. The
Bank made significant investment in order to upgrade technology and the major
developments are as under:
(1) Core Banking Solution: Which contains,
¾ Facilitates 24 X 7 Banking
¾ Anywhere Banking
¾ Integration with strategic sectors
¾ Business Process Re-engineering (BPR) enabler
(2) Internet Banking
(3) Real Time Gross Settlement (RTGS)
(4) National Electronic Funds Transfer (NEFT) System
(5) Mobile Banking
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Chapter5
Credit Risk Management
“Banks are in the business of managing risk,
not avoiding it……………”
5.1) Introduction
Lending has always been the primary function of banking, and accurately assessing a
borrower's creditworthiness has
always been the only method of
lending successfully. The method of
analysis varies from borrower to
borrower. It also varies in function of
the type of lending being considered.
For example, the banking risks in
financing the building of a hotel or rail
project, or providing lending secured
by assets or a large overdraft for a
retail customer would vary considerably. For the financing of the project, you would look to
the funds generated by future cash flows to repay the loan, for asset secured lending, you
would look at the assets and for an overdraft facility, you would look at the way the account
has been run over the past few years.
Credit risk is the oldest risk among the various types of risks in the financial system,
especially in banks and financial institutions due to the process of intermediation. Managing
credit risk has formed the core of the expertise of these institutions. While the risk is well
known, growth in the markets, disintermediation, and the introduction of a number of
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innovative products and practices have changed the way credit risk is measured and
managed in today's environment.
5.2) Definition
Credit risk "is the risk to a bank's earnings or capital base arising from a borrower's failure
to meet the terms of any contractual or other agreement it has with the bank. Credit risk
arises from all activities where success depends on counterparty, issuer or borrower
performance". Credit risk enters the books of a bank the moment the funds are lend,
deployed, invested or committed in any form to counterparty whether the transaction is on
or off the balance sheet.
5.3) Scope of Credit Risk
It can be understood from the above that credit risk arises from a whole lot of banking
activities apart from traditional lending activity such as trading in different markets,
investment of funds, provision of portfolio management services, providing different type of
guarantees and opening of letters of credit in favour of customers etc.
For example, even though guarantee is viewed as a non-fund based product, the moment a
guarantee is given, the bank is exposed to the possibility of the non- funded commitment
turning into a funded position when the guarantee is invoked by the entity in whose favour
the guarantee was issued by the bank. This means that credit risk runs across different
functions performed by a bank and has to be viewed as such.
The nature, nomenclature and the quantum of credit risk may vary depending on a number
of factors. The internal organization of credit risk management should recognize this for
effective credit risk management. Credit risk can be segmented into two major segments viz.
intrinsic and portfolio (or concentration) credit risks. The focus of the intrinsic risk is
measurement of risk at individual loan level.
This is carried out at lending unit level. Portfolio credit risk arises as a result of
concentration of the portfolio to a particular sector, geographic area, industry, type of
facility, type of borrowers, similar rating, etc. Concentration risk is managed at the bank
level as it is more relevant at that level.
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5.4) what is the role of Credit Analysis?
The role of credit analysis generally encounters the following questions:
x In which stage of the life cycle the
companyis?
x Is the company's business cyclical or
counter cyclical?
x How will this affect the long-term cash
flow of the firm?
x What are the considerations of
generaleconomic conditions and, if appropriate, political conditions in the country
where the company is operating?
Credit analysis supports the work of marketing officers by evaluating companies before
lending money to them. This is essential so that new loan requests can be processed, a
company's repayment ability assessed, and existing relationships monitored. The extent of
the credit analysis is determined by
¾ The size and nature of the enquiry,
¾ The potential future business with the company,
¾ The availability of security to support loans,
¾ The existing relationship with the customer.
The analysis must also determine whether the information submitted is adequate for
decision-making purposes, or if additional information is required. An analysis can
therefore cover a wide range of issues.
For example, in evaluating a loan proposal for a company, it may be necessary to:
¾ Obtain credit and trade references,
¾ Examine the borrower's financial condition,
¾ Consult with legal counsel regarding a particular aspect of the draft loan agreement.
By making these checks you are ensuring that your report does not look at a company's
creditworthiness in a narrowly defined sense. You will be taking the further step of deciding
whether the provisions in the loan agreement are appropriate for the borrower's financial
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condition. Often it will be necessary for the analyst to place the assessment of the
borrower's financial condition within the wider context of the conditions existing in the
industry in which it is operating.
5.5) Credit Risk Management Process
Credit risk is the largest and most elementary risk faced by banks. It essentially focuses on
determining likelihood of default or credit deterioration and how costly it will turn out to be
if it does occur. And this is true for consumer lending (retail) or corporate lending
(commercial) in banking.
A comprehensive Credit Risk Management Process encompasses the following steps:
Fig.1: Processes of a typical Credit risk management lifecycle
5.5.1) Collect Obligor and Loan data
The very foundation of a sound credit risk management system lies in the data that it gets.
The inputs needed in this stage are the obligor (borrower), Facility (Loan) and external
(ratings) data. This is first critical step in any loan process and all necessary data about the
obligor needs to be collected. Fig 2. highlights the key tasks and challenges involved in this
step.
Fig.2: Key tasks and chal enges involved in col ecting obligor & Loan Data
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The key steps here include,
Get the Obligor Data: The crucial task here is to get the financial, demographic and
qualitative data related to the obligor. A majority of the data comes from the financial
statements but other sources also exist for example past repayment performances.
Get the Loan Data: Next on, the system must beadequately designed to capture Loan data
related to the type of loan, amount, maturity etc accurately. Of particular concern here is
data related to collaterals, guarantees and contract terms on netting and liquidation. These
must be accurately captured in the system as they are crucial in the rating process.
Get External Ratings Data: The system must be capable enough to pull relevant data from
external systems such as data from rating agencies and also information such as loan data
from internal systems.
5.5.2) Compute Credit Risk
The next and one of the most crucial phases is calculating the credit risk in the form of risk
ratings to meaningfully differentiate risk among different firms or exposures. Fig 3 shows a
typical credit risk calculation scenario.
Fig.3: Key tasks and challenges involved in Computing Credit Risk
Key Tasks
The basic approach involves combining internal rating models (point of time) with external
risk information (through the cycle). The basic tasks involved in the rating process of a
Commercial obligor are highlighted as follows:
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Develop Rating Model: The obligor has to be rated using an appropriate model for example
there are different models for a Commercial & Industrial category obligor and a Commercial
Real Estate category obligor.
Calculate Probability of Default (PD): The Probability of Default is the likelihood that a loan
will not be repayed and fall into default. The credit history of the counterparty and nature of
the investment will all be taken into account to calculate the PD figures. The following steps
will commonly be used
x Analyze the credit risk aspects of the
counterparty; This will involve not only
the quantitative aspects of the obligor
based on his/her financial statements
but also qualitative factors related to
contingencies, management quality and
other factors which are yet to be
reflected.
Fig. 4 shows a sample of quantitative
and qualitative factors in a typical risk
grading model for a commercial obligor.
x Map the counterparty to an internal risk grade which has an associated PD.
Calculate Loss Given Default (LGD), Exposure At Default (EAD) & Expected Loss (EL):The
Credit Risk Solution also needs to calculate
¾ Loss Given Default – It is the magnitude of likely loss on the exposure in the event of
default. Both quantitative and qualitative factors are used to calculate Facility LGD
which may include Government guarantees, Collateral Support, Guarantor Support
etc.
¾ Exposure At Default - It is defined as the exposure to the borrower at any point of
time.
¾ Expected Loss – It is calculated using the PD, LGD and EAD together. It is the
probability weighted loss which is also used for pricing.
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5.5.3) Monitor and Manage Risk Rating
The job is not over with the credit risk rating process. In fact, it is quintessential to monitor
and manage the risk ratings as highlighted below in Fig 5
Fig .5: Key tasks and chal enges involved in Monitoring and managing Risk Rating
Key Tasks
Develop Workflow to manage approval of Ratings: The Credit Risk Solution should ensure
that the risk ratings and exceptions go through proper approvals by appropriate authorities
as laid down by guidelines such as the Bank’s credit policy. The workflow should also
accord traceability to ratings, changes and approvals.
Ensure notification on external rating changes: The system should ensure that external
ratings changes or other material changes are reflected as early and accurately as possible
in the credit risk ratings of an obligor. The system should ensure ratings are reviewed
periodically and also based on criteria such as likelihood of credit changes.
Interface with Internal Collections: Adequate interface with internal collections is needed so
that the system is updated consistently with any default information.
Perform Back Testing of Ratings: The system should provide for back testing and
calibrating credit risk models within Basel-II guidelines.
5.5.4) Manage portfolio and allocate capital
Portfolio Management has become one of the most difficult challenges in the financial
world especially from the point of view of credit risk management. Efficient portfolio
management and capital allocation is a process which an organization must put on the top
of its agenda. Illustrated below in Fig 6 are the steps in this process
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Fig 6: Key tasks and chal enges involved in Portfolio Management and Capital Al ocation
Key Tasks
Compute and monitor Portfolio risk: The System must be capable of computing and
monitoring the credit risk at a portfolio level and also enable drill down based upon criteria
such as different lines of businesses etc. The system should provide interface with a risk
engine to calculate regulatory and economic capital, allocate capital and calculate RAROC
Allow creation of SPVs for transfer of risk: The system must facilitate the creation of SPVs for
the appropriate transfer of credit risk.
Reporting on risk: The system must be capable enough to satisfy the reporting requirements
of the organization. There are different levels of reporting that are required especially in the
case of portfolio management.
Stress Testing/ Scenario Analysis: The system should also allow for stress testing of the
portfolio under differing conditions specially taking into consideration varying economic
circumstances.
5.5.5) Summary of the key priority areas
It will be quite safe to assume that any competitive and proactive financial institution must
have already started laying down the foundation blocks of a robust credit risk management
system. However it would be pertinent to summarize the key priority areas for this
process. These areas are highlighted in Fig 7.
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Fig 7: Key Priority Areas in Credit Risk management
Notification of External Rating changes: It is crucial that an organization effectively uses a
combination of internal models with external ratings. Therefore changes in the external
inputs should be reflected as soon as possible in the internal ratings. This can be achieved
through the use of notifications in the form of real time alerts.
Data Architecture: A robust data backbone is crucial to enable credit assessment process.
The data backbone should have adequate and accurate data history. Care should be taken
to make sure the data design incorporates relevant data fields which are required in current
and future models.
Back Testing: The models should be properly back tested to improvise them and also for
regulatory approvals.
Compute & Monitor Portfolio Risk: Measuring and managing individual credit ratings
contribute to the management of portfolio risk. This is a crucial phase for the risk
department within the organization as credit risk levels have to be maintained within
statutory and organizational requirements.
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5.6) Significance of Credit Risk Measurement and Management
Increase in Bankruptcies:
Compared to the past, bankruptcies have increased. As a result of this, the permanent,
accurate credit risk analysis practices h a v e become more important than in the past.
Deregulation:
Innovation stimulated by deregulation has led to new entrants into the markets to provide
services. The credit risk assessment of the new entrants is very much essential for the well
functioning of the market.
Disintermediation:
As large institutions with strong credit quality are less dependent on bank funds, banks are
left to serve institutions with weaker credit quality. A recent study by Subramanian and
Umakrishnan (2004) of 876 corporate in India, the bank debt to total debt ratio for very
small firms (sales turnover not more than Rs. 10 crores per annum) was 73% while the
ratio for very large firms (sales turnover Rs. 1000 crores and above per annum) was only
41%. A similar fall in the ratio was witnessed as the size measured by sale turnover
increased. This disintermediation has led to fall in the overall credit quality of the lending
book, increasing the importance of credit risk measurement and management.
Shrinking Margins on Loans:
Trends in international markets reveal that the interest margins or spreads, i.e. the
difference between interest income and interest expenses has been falling. Apart from other
factors, the increasing competition in the market is cited as the major reason for this.
Growth of off-Balance Sheet Risks:
The phenomenal expansion of the Over-the- Counter (OTC) derivative products which carry
counterparty risk unlike the exchange traded derivatives has increased the exposure of a
number of banks to such products.
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Volatility in the Value of Collateral:
It has been observed that predicting the market value of collateral held against loan is very
difficult. This may lead to a situation where the value of collateral may fall below the value
of loan granted against it. Falling value of the collateral had been the cause for banking
crises in well developed countries such as Switzerland and Japan.
Advances in Finance Theory and Computer Technology:
These advances have paved the way for banks to test very sophisticated credit risk models
that would not have been possible in the absence of finance theory and computer
technology.
Risk-based Capital Regulations:
Apart from the above, the development of risk- based capital requirements pronounced by
the Basle Committee has been one of the important drivers of credit risk initiatives. This is
more so with the Basle Accord -II which recognizes the differences in credit quality in the
form of ratings and availability of collateral unlike the previous accord which is in force till
date.
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Chapter6
Overview Of Credit Appraisal
Credit appraisal means an investigation/assessment done by the banks before providing
any loans & advances/project finance & also checks the commercial, financial & technical
viability of the project proposed, its funding pattern & further checks the primary &
collateral security cover available for recovery of such funds.
6.1) 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 pay 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.
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.
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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.
6.2) 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,
andwater. 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 daysor
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 orthe
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
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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 creditcard
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.
6.2.1) Brief Overview of Loans:
Loans can be of two types fund base & non-fund base:
FUND BASE includes NON-FUND BASE includes
Working Capital Letter of Credit
Term Loan Bank Guarantee
Bill Discounting
(A) FUND BASE
¾ WORKING CAPITAL: -
1. 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.
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2. Definition
Working capital is defined as the funds required to carry 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 programme, the
materials & marketing mix.
3. Methods & application
SEGMENTS LIMITS METHODS
SSI
UPTO 5 CRORES Traditional method &Nayak Committee method
ABOVE 5 CRORES Projected Balance Sheet Method
SBF All loans Traditional/ Turnover Method
C&I TRADE &
SERVICES
UPTO Rs. 1 CRORE
Traditional method for trade & projected
turnover method
ABOVE Rs. 1 CRORE
& UPTO Rs. 5
CRORE
Projected Balance Sheet Method & Projected
Turnover Method.
ABOVE Rs. 5 CRORE Projected Balance Sheet Method
C&I INDUSTRIAL
UNITS
BELOW Rs. 25 Lacs TRADITIONAL METHOS
Above Rs. 25 Lacs
but up to Rs. 5
crores
Projected Balance Sheet Method & Projected
Turnover Method
ABOVE Rs. 5 Crores Projected Balance Sheet Method
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¾ 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:
x The purpose of the term loan is for acquisition of capital assets.
x The term loan is an advance not repayable on demand but only in installments
ranging over a period of years.
x 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.
x 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 programme 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.
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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
x Technical Feasibility - To determine the suitability of the technology selected & the
adequacy of the technical investigation & design
x Economic Feasibility - To ascertain the extent of profitability of the project & its
sufficiency in relation to the repayment obligations pertaining to term assistance
x Financial Feasibility - To determine the accuracy of cost estimates, suitability of the
envisaged pattern of financing & general soundness of the capital structure and
x Managerial Competency – To ascertain that competent men are behind the project to
ensure its successful implementation & efficient management after commencement
of commercial production.
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
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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) Labour – The labour requirements of a project, need to be assessed with special care.
Though labour in terms of unemployed persons is abundant in the country, there is
shortage of trained personnel. The quality of labour 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.
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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.
1) How big is the market?
2) How much it is likely to grow?
3) 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.
b) 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.
c) 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, tyres for automobiles). The market analysis in this case should cover
the market for the ultimate product.
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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 break even 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.
¾ Break-even point:
In a manufacturing unit, if at a particular level of production, the totalmanufacturing 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.
¾ 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
Coverage Ratio
=
Cash accruals
Maturing annual obligations
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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 programme should be so stipulated that
the ratio is comfortable.
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.
(B) NON-FUND BASE
(1) LETTER OF CREDIT
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.
¾ 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
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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.
¾ 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.
¾ 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 its 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
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transferred even more than once.
(2) 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 theapplicant
in case of his default.
Thus, guarantee is a collateral contract, consequential to a main contract between the
applicant & the beneficiary.
¾ 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.
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g) Bid bonds on behalf of exporters
h) Export performance guarantees on behalf of exporters favoring the Customs
Department under EPCG scheme.
¾ 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
¾ 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
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f) not stipulating any onerous clause, &
g) not containing any clause for automatic renewal of the bank guarantee on its expiry
6.3) 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, 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.
6.3.1) Indian Scenario:
¾ In Indian banks, there was no systematic method of Credit Risk Assessment till late
1980’s/ early 1990’s.
¾ Health Code System (1985) / IRAC norms (1993) are Asset (loan) classification systems,
not CRA systems.
¾ RBI came out with its guidelines on Risk Management Systems in Banks in 1999 &
Guidance Note on Management of Credit in October, 2002.
6.3.2) SBM Scenario:
However, like in many other fields, in the field of Credit Risk Assessment too, SBM played a
proactive & pioneering role. Bank had its Credit Rating System in 1988. Then, the CRA
system was introduced in the Bank in 1996. The first CRA model was rolled out in 1996 to
take care of exposures to the C & I (Manufacturing) segment. Thereafter, separate models
for SSI segments were introduced in 1998, when the C&I (Mfg.) CRA model was developed
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for Non Banking Finance Companies (NBFCs) too.
As of now, in SBM, CRA is the most important component of the Credit Appraisal exercise
for all exposures > 25 lacs & a very important tool in decision-making (a Decision Support
System) as well as in pricing.
6.3.3) Credit Risk Assessment (CRA) – Minimum Scores / Hurdle Rates
1. The CRA models adopted by the Bank take into account all possible factors, which go
into appraising the risks, associated with a loan. These have been categorized broadly
into financial, business, industrial & management risks and are rated separately. To
arrive at the overall risk rating, the factors duly weighted are aggregated & calibrated to
arrive at a single point indicator of risk associated with the credit decision.
2. Financial parameters: The assessment of financial risk involves appraisal of the
financial strength of the borrower based on performance & financial indicators. The
overall financial risk is assessed in terms of static ratios, future prospects & risk
mitigation (collateral security / financial standing).
3. Industry parameters: The following characteristics of an industry which pose varying
degrees of risk are built into Bank’s CRA model:
¾ Competition
¾ Industry outlook
¾ Regulatory risk
¾ Contemporary issues like WTO etc.
4. Management parameters: The management of an enterprise / group is rated onthe
following parameters:
¾ Integrity (corporate governance)
¾ Track record
¾ Managerial competence / commitment
¾ Expertise
¾ Structure & systems
¾ Experience in the industry
¾ Credibility: ability to meet sales projections
¾ Credibility: ability to meet profit (PAT) projections
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¾ Length of relationship with the Bank
¾ Strategic initiatives
¾ Payment record
Bank has introduced New Rating Scales for borrower for giving loans. Rating is given on the
basis of scores out of 100. Bank gives loans to the borrower as per their rating like SBM
gives loans to the borrower up to SB8 rating as it has average risk till SB8 rating. From SB9
rating the risk increases. Thus, SBM do not give loans after SB8 rating.
5. The risk parameters as mentioned above are individually scored to arrive at an
aggregate score of 100 (subject to qualitative factors – negative parameters). The
overall score thus obtained (out of a max. of 100) is rated on a 16 point scale from
SB1/SBTL1 to SB 16 /SBTL16.
¾ CRA model also stipulates a minimum score under financial, business, industry and
management risk parameters for a proposal to be considered acceptable in a given
form.
The details of such minimum scores are as under:
a. Minimum scores – General
b. Minimum scores under Management Risk : (‘Integrity/Corporate Governance’, ‘Track
Record’ and ‘Managerial Competence/ Commitment’)
An applicant unit will be required to score minimum 2 marks each (out of 3) in the
above three parameters of Management Risk to qualify for Bank’s assistance. In case of
existing accounts if the company scores less than this stipulated minimum marks (02),
the Bank would explore all possibilities to exercise exit option.
c. Minimum Score under Business Risk:
Compliance of Environment Regulations to qualify for financial assistance, an applicant
unit would have to secure full marks (02) under the parameter, “Compliance of
Environment Regulations.” In case, the existing units in the books of the bank do not
secure full marks (02), the bank would explore all possibilities for the exercise of exit
option.
Overview of Credit Appraisal
N R Institute of Business Management Page 52
d. Hurdle Scores:
RISK TYPES
REGULAR MODEL SIMPLIFIED MODEL
EXISTING
COMPANY
NEW
COMPANY
EXISTING
COMPANY
NEW
COMPANY
FINANCIAL RISK 25/65 10/25 30/70 15/35
BUSINESS & INDUSTRY
RISK
12/20 16/30 10/20 20/40
MANAGEMANT RISK 8/15 22/45 5/10 13/25
AGGREGATE HURDLE
SCORE
45/100 48/100 45/100 48/100
OVERALL HURDLE GRADE SB10 SB10 SB10 SB10
6.3.4) Salient Features of CRA Models:
(a) Type of Models
No.
Exposure Level (FB + NFB
Limits )
Non – Trading
Sector
(C&I , SSI , AGL)
Trading Sector
( Trade & Services)
(i) Over Rs. 5.00 crore Regular Model Regular Model
(ii) Rs 0.25 crore to Rs. 5.00 crore Simplified Model Simplified Model
(b) Type of Ratings
No. Model Type of Rating
(i) Regular Model
Borrower Rating
Facility Rating
(ii) Simplified Model Borrower Rating
Credit Risk Management at SBM
N R Institute of Business Management Page 53
(c) Type of Risks Covered:
(i) Borrower Rating
No.
Risk Category
Maximum Score
Regular Model Simplified Model
Existing
Company
New
Company
Existing
Company
New
Company
(i) Financial Risk (FR) 65 25(65 x 0.39) 70 35 (70/2)
(ii) Qualitative Factors (-‘ve) (-10) (-10) (-10) (-10)
(iii)
Business & Industry Risk
(BR& IR) /Business
Risk(for Trading Sector)
20 30 (20 x 1.5) 20 40 (20 x 2)
(iv) Management Risk (MR) 15 45 ( 15 x 3) 10 25 ( 10 x 2.5)
(v)
Qualitative Parameter
(External Rating)
(+5) (+5) (+5) (+ 5)
Total 100 100 100 100
(ii) Facility Rating (Regular Model)
NO.
Parameter Maximum Score
(a) Risk Drivers for Loss Given Default (LGD)
(i)
Current Ratio
[Working Capital/ Non-Fund Based Facility (except Capex)]
OR Project Debt/Equity
[Term Loan/Non-Fund Based Facility (for Capex)]
6
(ii) Nature of Charge 4
(iii) Nature of Charge 6
(iv) Geography 2
(v)
Unit Characteristics
(a) Leverage/ Enforcement of Collateral-4
(b) Safety, Value & Existence of Assets-4
8
(vi)
Macro-Economic Conditions
(a)GDP Growth Rate : Impact of Business Cycle- 2
(b) Insolvency Legislation in the Jurisdiction-1
(c) Impact of Systemic/Legal Factors on Recovery-1
(d) Time Period for Recovery-1
5
Overview of Credit Appraisal
N R Institute of Business Management Page 54
(vii) Total Security (Primary + Collateral) 60
(b) Risk Drivers for Exposure at Default (EAD)
(i)
Nature of Commitment
(Revolving/Non-Revolving)
1
(ii) Credit Quality of Borrower 5
(iii) Tenor of Facility 3
Total Score 100
(d) New Rating Scales - Borrower Rating: 16 Rating Grades
No.
Borrower
Rating
Range of
Scores
Risk Level Comfort Level
1 SB1 94-100 Virtually Zero Risk Virtually Absolute Safety
2 SB2 90-93 Lowest Risk Highest Safety
3 SB3 86-89 Lower Risk Higher Safety
4 SB4 81-85 Low Risk High Safety
5 SB5 76-80
Moderate Risk with Adequate
Cushion
Adequate Safety
6 SB6 70-75
Moderate Risk Moderate Safety
7 SB7 64-69
8 SB8 57-63
Average Risk Above safety threshold
9 SB9 50-56
10 SB10 45-49
Acceptable Risk (Risk
Tolerance Threshold)
Safety Threshold
11 SB11 40-44 Borderline risk Inadequate safety
12 SB12 35-39 High Risk Low safety
13 SB13 30-34 Higher Risk Lower safety
14 SB14 25-29 Substantial risk Lowest safety
15 SB15
The Credit Risk Management 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.
A AA A
Grand Grand Grand Grand Project Report on Project Report on Project Report on Project Report on
Credit Risk Management at Credit Risk Management at Credit Risk Management at Credit Risk Management at
State Bank of Mysore State Bank of Mysore State Bank of Mysore State Bank of Mysore
2010
N. R. Institute of Business Management
23/3/2010
A
Grand Project Report on
Credit Risk Management at
State Bank of Mysore
N. R. Institu
Grand
Credit Risk Manag
(IN PARTIAL FULFILLMENT O
MASTER OF BUSINESS ADMIN
Submitted To:
Prof. Dharmesh Shah
(Asst. Professor, NRIBM)
Prof. Viral Pandya
(Asst. Professor, NRIBM)
itute of Business Manag
A
rand Project Report on
anagement at State Bank of M
LMENT OF PROJECT STUDY COURSE, IN TWO YEAR
SS ADMINISTRATION PROGRAMME OF GUJARAT U
hah
Subm
Sandip A. Makwa
Luv D. Palk
(Batch: 2008-10)
agement
k of Mysore
WO YEARS FULL TIME
UJARAT UNIVERSITY)
Submitted By:
akwana (08056)
. Palkar (08064)
N. R. Institu
This is to certify that
Mr. Sandip A. Makwa Mr. Sandip A. Makwa Mr. Sandip A. Makwa Mr. Sandip A. Makwa
students of N.R.Institute
their grand project on “
in partial fulfillment o
Programme of Gujarat U
been submitted elsewhere
_________________________
Dr. Hitesh Ruparel
Director In-charge,
NRIBM
Date: / / 2010
Place: Ahmedabad
nstitute of Business Management
CERTIFICATE CERTIFICATE CERTIFICATE CERTIFICATE
wana (08056) wana (08056) wana (08056) wana (08056) and and and and Mr. Luv D. Palk Mr. Luv D. Palk Mr. Luv D. Palk Mr. Luv D. Palk
te of Business Management has successf
“Credit Risk Management Credit Risk Management Credit Risk Management Credit Risk Management at at at at State Ba State Ba State Ba State Ba
of two years Master of Business A
t University. This is their original wor
ere.
_____________________________
Prof. Dharmesh Shah
Asst. Professor, NRIBM &
Internal Project Guide
______________
Prof. Vir
Asst. Profess
Internal Pr
ent
alkar (08064 alkar (08064 alkar (08064 alkar (08064) )) )
essfully completed
Bank of Mysore Bank of Mysore Bank of Mysore Bank of Mysore” ”” ”
s Administration
work and has not
_______________________
of. Viral Pandya
st. Professor, NRIBM &
nternal Project Guide
ii
Preface
Banks are regarded as the blood of the nation’s economy without them one cannot imagine
economy moving. Therefore banks should be operated very efficiently.
Advance is heart and recovery is oxygen for the bank and to survive it is necessary to give
advances and recover the amount at the appropriate time. Through credit risk management
we have tried to learn the various aspects related to credit appraisal and credit policy of
SBM. Credit RiskManagement covers all the areas right from the beginning like inquiry till
the loan is paid up.
We are preparing comprehensive report on “Credit Risk Management at State Bank of
Mysore”. The basic idea of project is to augment our knowledge about the industry in its
totality and appreciate the use of an integrated loom. This makes us more conscious about
Industry and its pose and makes us capable of analyzing Industry’s position in the
competitive market. This may also enhance our logical abilities.
There are various aspects, which have been studied in detail in the project and have been
added to this project report.
Though credit management, a very vast topic, we have tried to incorporate to the best of our
capacity from all possible aspects in this project.
Sandip A. Makwana
Luv D. Palkar
iii
Acknowledgement
A journey is easier when we travel together. Interdependence is certainly more important
than
independence. It will always be our pleasures to thank those who have helped us in making
this project a lifetime experience for us.
We would like to express our heartiest gratitude to State Bank of Mysore, for giving us an
opportunity to work with its Ahmedabad Branch, in the Department of Loans and Advances,
our Institute and important persons associated with this project as without their guidance
and hard work we 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 the
Credit Risk Management.
We would also like to extend our gratitude to Mr. Nagesh B. (Assistant General Manager)for
giving us an opportunity to join them to know and learn various aspects of the Loans and
Advances in the organization.
It is our privilege to thank Mr. Navneet Dwivedi (Assistant Manager)whose guidance has
made us learn and understand the finer and complicated aspects of banking, in general and
of Credit Risk Management 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.
Our heartiest gratitude extends to our faculty Prof. Dharmesh Shah (Assistant Professor,
NRIBM)and Prof. Viral Pandya (Assistant Professor, NRIBM) who have helped us in every
aspect of our work.
Finally, we thank all those who directly and indirectly contributed to this project.
23
rd
March, 2010 Sandip A. Makwana
Ahmedabad
Luv D. Palkar
iv
Executive Summary
Our prima facie objective for taking up this project is to acquire knowledge of banking
sector and to take a practical exposure and expertise of credit risk management.
The Credit Risk Management 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, and Financial 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
mattersregarding 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?
The scope of credit structure is incomplete without examination of credit proposal. Credit
proposal has to be examined from the point of 6 C’s viz. Character, Capacity, Capital,
Condition, Collateral and Cash flow.
Initially we have introduced banking as a whole sector in India. Earlier banking industry
was highly protected by sovereign government but in 1991 it has opened the door in the
form of liberalization for the growth and progressive future of this sector. Banking as a
sector provides life and blood in the form of finance for the industrial growth.
As our objective is to gain practical exposure it was necessary to be precise and focused to a
particular bank so as to understand their techniques of Credit Risk Management;we have
v
taken up State Bank of Mysore as a part of banking network in India. For better
understanding of Credit Risk Management, we have also studied the loan proposals
provided by SBM.
The Credit Policy of State Bank of Mysore has undergone changes to cope with
theenvironmental changes, tap the available opportunities, achieve their commercial
objective, fulfill social obligations and adhere to mandatory directed lending norms over the
years. The credit policy consists of both fund based credit exposure and non fund based
credit exposure.
One of the important monitoring aspects in the credit risk management 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.
After analyzing the proposal and Credit Risk Management process, we have rationalized our
observation and tried to provide practical and feasible suggestions that may help them to
improve upon their present practices.
Table of Contents
Chapter 1
Research Methodology ............................................................................................................................. 1
1.1) Introduction to Credit Risk Management ....................................................................................................... 1
1.2) Objectives of the Study ......................................................................................................................................... 1
1.3) Research Design....................................................................................................................................................... 1
1.4) Sources of Data ......................................................................................................................................................... 1
1.5) Expected contribution of the study ................................................................................................................. 2
1.6) Beneficiaries of the Study .................................................................................................................................... 2
1.7) Limitations ................................................................................................................................................................. 2
Chapter 2
Introduction to Banking Sector ........................................................................................................... 3
2.1) History of Banking in India ................................................................................................................................. 3
2.2) Reserve Bank of India (RBI) ............................................................................................................................... 7
Banking structure .................................................................................................................................................... 8
2.3) Types of banks ....................................................................................................................................................... 9
2.3.1) Scheduled Banks.................................................................................................................................................... 9
2.3.2) Non-scheduled banks ....................................................................................................................................... 12
2.4) Opportunities and Challenges for Players ................................................................................................. 14
2.5) Current trend in banking .................................................................................................................................. 15
Chapter 3
Industry Analysis ....................................................................................................................................... 16
3.1) Competitive Forces Model (Porter’s Five-Force model) ..................................................................... 16
3.2) SWOT Analysis ...................................................................................................................................................... 18
Chapter 4
Introduction to SBM ................................................................................................................................. 21
4.1) SBM - Introduction ................................................................................................................................................ 21
4.2) Key areas of operation ....................................................................................................................................... 22
4.3) Technical Initiatives ............................................................................................................................................ 24
Chapter 5
Credit Risk Management ....................................................................................................................... 25
5.1) Introduction ........................................................................................................................................................... 25
5.2) Definition ................................................................................................................................................................. 26
5.3) Scope of Credit Risk............................................................................................................................................. 26
5.4) what is the role of Credit Analysis? .............................................................................................................. 27
5.5) Credit Risk Management Process ............................................................................................................. 28
5.5.1) Collect Obligor and Loan data...................................................................................................................... 28
5.5.2) Compute Credit Risk ........................................................................................................................................ 29
5.5.3) Monitor and Manage Risk Rating ............................................................................................................... 31
5.5.4) Manage portfolio and allocate capital ...................................................................................................... 31
5.5.5) Summary of the key priority areas ............................................................................................................ 32
5.6) Significance of Credit Risk Measurement and Management ............................................................. 34
Chapter6
Overview Of Credit Appraisal ............................................................................................................. 36
6.1) Brief overview of credit ..................................................................................................................................... 36
6.2) Basic Types of Credit ....................................................................................................................................... 37
6.2.1) Brief Overview of Loans: .............................................................................................................................. 38
(A) Fund Base .................................................................................................................................................. 38
(B) Non-Fund Base ........................................................................................................................................ 45
6.3) Credit Risk Assessment (CRA) ................................................................................................................... 49
6.3.1) Indian Scenario: ............................................................................................................................................... 49
6.3.2) SBM Scenario: ................................................................................................................................................... 49
6.3.3) Credit Risk Assessment (CRA) – Minimum Scores / Hurdle Rates ............................................ 50
6.3.4) Salient Features of CRA Models: ............................................................................................................... 52
(a) Type of Models .......................................................................................................................................... 52
(b) Type of Ratings ......................................................................................................................................... 52
(c) Type of Risks Covered ........................................................................................................................... 53
(i) Borrower Rating ............................................................................................................................... 53
(ii) Facility Rating (Regular Model) ................................................................................................ 53
(d) New Rating Scales ................................................................................................................................... 54
6. 4) Comparative Analysis of Credit Risk Appraisal ........................................................................................ 57
Chapter 7
Risk Management in Banks .................................................................................................................. 59
7.1) Introduction ........................................................................................................................................................... 59
7.2) Classification of Risks ......................................................................................................................................... 59
Chapter 8
SBM Norms for Credit Appraisal & Credit Risk management ............................................ 62
8.1) Loan Policy – An Introduction .................................................................................................................... 62
Credit Appraisal Standards ......................................................................................................................... 64
(A) Qualitative ................................................................................................................................................ 64
(B) Quantitative ............................................................................................................................................. 64
Required Documents for Process of Loan ............................................................................................ 67
Delegation of Powers ..................................................................................................................................... 67
Pricing .................................................................................................................................................................. 69
Credit Monitoring & Supervision ............................................................................................................. 70
8.2) Loan Administration - Pre-Sanction Process..................................................................................... 72
8.2.1) Appraisal ............................................................................................................................................................. 72
8.2.2) Assessment ........................................................................................................................................................ 79
8.2.3) Sanction ............................................................................................................................................................... 80
8.2.4) Monitoring Delay in Processing Loan Proposal ................................................................................. 81
8.3) Loan Administration - Post Sanction Credit Process .................................................................... 82
8.3.1) Need ...................................................................................................................................................................... 82
8.3.2) Stages of post sanction process................................................................................................................. 82
8.4) Types of Lending Arrangements ............................................................................................................... 83
A. Sole Banking ................................................................................................................................................ 83
B. Consortium Lending ................................................................................................................................ 83
C. Multiple Banking Arrangement ........................................................................................................... 84
D. Credit Syndication .................................................................................................................................... 84
Chapter 9
Proposals and Analysis .......................................................................................................................... 86
Proposal: I – GDP Ltd. ..................................................................................................................................................... 86
Analysis – GDP Ltd. ............................................................................................................................................................. 93
Proposal: II – CAB Ltd. .................................................................................................................................................... 95
Analysis – CAB Ltd. ...........................................................................................................................................................102
Proposal: III – IMP Ltd. ................................................................................................................................................104
Analysis – IMP Ltd. ...........................................................................................................................................................110
Proposal: IV - ABC Enterprises Ltd. ......................................................................................................................111
Analysis - ABC Enterprises Ltd. ..................................................................................................................................114
Proposal: V - VANRAJ Tractors ...............................................................................................................................116
Analysis - VANRAJ Tractors ..........................................................................................................................................117
Comparative Analysis of the proposals .............................................................................................................119
Proposal I & II ..............................................................................................................................................................119
Proposal III & IV .........................................................................................................................................................120
Chapter 10 Findings ..................................................................................................................................... 121
Chapter 11 Suggestions .............................................................................................................................. 122
Chapter 12 Conclusion ................................................................................................................................ 123
Bibliography ...................................................................................................................................................... 124
Appendix ....................................................................................................................................................... A1-A10
Credit Risk Management at SBM
N R Institute of Business Management Page 1
Chapter 1
Research Methodology
1.1) Introduction to Credit Risk Management
Credit risk "is the risk to a bank's earnings or capital base arising from a borrower's failure to
meet the terms of any contractual or other agreement it has with the bank. Credit risk arises
from all activities where success depends on counterparty, issuer or borrower
performance".
Credit appraisal means an investigation/assessment done by the bank before providing any
loans & advances/project finance & also checks the commercial, financial & industrial viability of
the project proposed its funding pattern & further checks the primary & collateral security cover
available for recovery of such funds.
1.2) Objectives of the Study
x The main objective of the study is, to evaluate the Credit Appraisal system & Risk
Assessment Model for effective credit risk management.
# Sub-Objectives:
x To understand the commercial, financial & technical viability of the proposal
proposed & it's funding pattern.
x To understand the pattern for primary & collateral security cover available for
recovery of such funds and management of credit risk.
1.3) Research Design
Ö It is a descriptive research.
1.4) Sources of Data
Primary Data:
x Information collected from the Credit Appraisal Officer of Bank as well as
informal interviews with Assistant General Manager and Assistance Manager.
Research Methodology
N R Institute of Business Management Page 2
Secondary Data:
x Details regarding the Live Cases of applicant companies which are provided by the
Bank
x E-circulars of Bank
x Books
x Library research
x Websites
1.5) Expected contribution of the study
This study will help in understanding the credit Risk Management system at SBM& to
understand how to reduce various risk parameters, which are broadly categorized into
financial risk, business risk, industrial risk & management risk, associated in providing any
loans or advances or project finance.
1.6) Beneficiaries of the Study
Researcher
This report will help researcher in improving knowledge about the credit appraisal system
and to have practical exposure of the credit appraisal scenario in bank.
Management Student
The project will help the management student to know the patterns of credit appraisal in
bank.
Bank
The project will help bank in reducing the credit risk parameters. It will also help to reduce
risk associated in providing any loans & advances or project finance in future and to
overcome the loopholes.
1.7) Limitations
x As the credit risk management is one of the crucial areas for any bank, some of the
technicalities are not revealed which might cause destruction to the information and
our exploration of the problem.
x Credit appraisal system includes various types of detail studies for different areas of
analysis, but due to time constraint, our analysis will be of limited areas only.
Credit Risk Management at SBM
N R Institute of Business Management Page 3
Chapter 2
Introduction to Banking Sector
2.1) History of Banking in India
Without a sound and effective banking system in India it cannot have a healthy economy.
The banking system of India should not only be hassle free but it should be able to meet
new challenges posed by the technology and any other external and internal factors.
The word bank is derived from the Italian banca, which is derived from German and means
bench. The terms bankrupt and “broke” are similarly derived from bancarotta, which refers
to an out of business bank, having its bench physically broken. Moneylenders in Northern
Italy originally did business in open areas, or big open rooms, with each lender working
from his own bench or table.
Banking in India originated in the first decade of 18th century with The General Bank of
India coming into existence in 1786. This was followed by Bank of Hindustan. Both these
banks are now defunct. The oldest bank in existence in India is the State Bank of India being
established as "The Bank of Bengal" in Calcutta in June 1806. A couple of decades later,
foreign banks like Credit Lyonnais started their Calcutta operations in the 1850s. At that
point of time, Calcutta was the most active trading port, mainly due to the trade of the
British Empire, and due to which banking activity took roots there and prospered. The first
fully Indian owned bank was the Allahabad Bank, which was established in 1865.
By the 1900s, the market expanded with the establishment of banks such as Punjab
National Bank, in 1895 in Lahore and Bank of India, in 1906, in Mumbai - both of which
were founded under private ownership. The Reserve Bank of India formally took on the
responsibility of regulating the Indian banking sector from 1935. After India's
independence in 1947, the Reserve Bank was nationalized and given broader powers.
For the past three decades India's banking system has several outstanding achievements to
its credit. The most striking is its extensive reach. It is no longer confined to only
metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to
the remote corners of the country. This is one of the main reasons of India's growth process.
Introduction to Banking Sector
N R Institute of Business Management Page 4
The government's regular policy for Indian bank since 1969 has paid rich dividends with
the nationalization of 14 major private banks of India.
Not long ago, an account holder had to wait for hours at the bank counters for getting a
draft or for withdrawing his own money. Today, he has a choice. Gone are days when the
most efficient bank transferred money from one branch to other in two days. Now it is
simple as instant messaging or dials a pizza. Money has become the order of the day.
The first bank in India, though conservative, was established in 1786. From 1786 till today,
the journey of Indian Banking System can be segregated into three distinct phases. They are
as mentioned below:
x Early phase from 1786 to 1969 of Indian Banks
x Nationalization of Indian Banks and up to 1991 prior to Indian banking sector
Reforms
x New phase of Indian Banking System with the advent of Indian Financial & Banking
Sector Reforms after 1991
x Scenario of Bank as per Phase I, Phase II and Phase III
Phase I
The General Bank of India was set up in the year 1786 followed by Bank of Hindustan and
Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay
(1840) and Bank of Madras (1843) as independent units and called it Presidency Banks.
These three banks were amalgamated in 1920 and Imperial Bank of India was established
which started as private shareholders banks, mostly Europeans shareholders.
In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab
National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and
1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and
Bank of Mysore were set up. The Reserve Bank of India which is the Central Bank was
created in 1935 by passing Reserve Bank of India Act, 1934 which was followed up with the
Banking Regulations in 1949. These acts bestowed Reserve Bank of India (RBI) with wide
ranging powers for licensing, supervision and control of banks. Considering the
proliferation of weak banks, RBI compulsorily merged many of them with stronger banks in
1969.
During the first phase the growth was very slow and banks also experienced periodic
Credit Risk Management at SBM
N R Institute of Business Management Page 5
failures between 1913 and 1948. There were approximately 1100 banks, mostly small.
To streamline the functioning and activities of commercial banks, the Government of India
came up with The Banking Companies Act, 1949 which was later changed to Banking
Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of
India was vested with extensive powers for the supervision of banking in India as the
Central Banking Authority.
During those day public has lesser confidence in the banks. As an aftermath deposit
mobilization was slow. Abreast of it the savings bank facility provided by the Postal
department was comparatively safer. Moreover, funds were largely given to traders.
Phase II
Government took major steps in this Indian Banking Sector Reform after independence. In
1955, it nationalized Imperial Bank of India with extensive banking facilities on a large scale
especially in rural and semi-urban areas. It formed State Bank of India to act as the principal
agent of RBI and to handle banking transactions of the Union and State Governments all
over the country.
Seven banks forming subsidiary of State Bank of India was nationalized in 1960 on 19th
July, 1969, major process of nationalization was carried out. It was the effort of the then
Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country were
nationalized.
Second phase of nationalization Indian Banking Sector Reform was carried out in 1980 with
seven more banks. This step brought 80% of the banking segment in India under
Government ownership.
The following are the steps taken by the Government of India to Regulate Banking
Institutions in the Country:
1949: Enactment of Banking Regulation Act.
1955: Nationalization of State Bank of India.
1959: Nationalization of SBI subsidiaries.
1961: Insurance cover extended to deposits.
Introduction to Banking Sector
N R Institute of Business Management Page 6
1969: Nationalization of 14 major banks.
1971: Creation of credit guarantee corporation.
1975: Creation of regional rural banks.
1980: Nationalization of seven banks with deposits over 200 crore.
After the nationalization of banks, the branches of the public sector bank India rose to
approximately 800% in deposits and advances took a huge jump by 11,000%. Banking in
the sunshine of Government ownership gave the public implicit faith and immense
confidence about the sustainability of these institutions.
Phase III
This phase has introduced many more products and facilities in the banking sector in its
reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set
up by his name which worked for the liberalization of banking practices.
The country is flooded with foreign banks and their ATM stations. Efforts are being put to
give a satisfactory service to customers. Phone banking and net banking is introduced. The
entire system became more convenient and swift. Time is given more importance than
money.
The financial system of India has shown a great deal of resilience. It is sheltered from any
crisis triggered by any external macroeconomics shock as other East Asian Countries
suffered.
This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital
account is not yet fully convertible, and banks and their customers have limited foreign
exchange exposure.
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2.2) Reserve Bank of India (RBI)
The central bank of the country is the Reserve Bank of India (RBI). It was established in
April 1935 with a share capital of Rs. 5 crore on the basis of the recommendations of the
Hilton Young Commission. The share capital was divided into shares of Rs. 100 each fully
paid which was entirely owned by private shareholders in the beginning. The Government
held shares of nominal value of Rs. 2,20,000.
Reserve Bank of India was nationalized in the year 1949. The general superintendence and
direction of the Bank is entrusted to Central Board of Directors of 20 members, the
Governor and four Deputy Governors, one Government official from the Ministry of Finance,
ten nominated Directors by the Government to give representation to important elements
in the economic life of the country, and four nominated Directors by the Central
Government to represent the four local Boards with the headquarters at Mumbai, Kolkata,
Chennai and New Delhi. Local Boards consist of five members each Central Government
appointed for a term of four years to represent territorial and economic interests and the
interests of co-operative and indigenous banks.
The Reserve Bank of India Act, 1934 was commenced on April 1, 1935. The Act, 1934 (II of
1934) provides the statutory basis of the functioning of the Bank.
The Bank was constituted for the need of following:
¾ To regulate the issue of banknotes
¾ To maintain reserves with a view to securing monetary stability and
¾ To operate the credit and currency system of the country to its advantage
Introduction to Banking Sector
N R Institute of Business Management Page 8
Banking structure
Credit Risk Management at SBM
N R Institute of Business Management Page 9
2.3) Types of banks
2.3.1) Scheduled Banks
Scheduled banks are those banks that come under the purview of the second schedule of
Reserve Bank of India act 1934. The banks that are included under this schedule are those
that satisfy the criteria laid down vide section 42(6) of the act.
1) The bank is dealing in banking business in India only.
2) The paid up capital and total funds of the bank should not be less than five lacs.
3) It should convince RBI that its activities would not be against the interest of the
investors.
4) The bank must be:
¾ State co-operative bank, or
¾ A company according to the definition of the companies act 1956, or
¾ An institution notified by the central government, or
¾ A corporation or a company incorporated by or under any law in force in any place
outside India.
Thus, Indian Commercial Banks, Foreign commercial banks, and state cooperative banks
fulfilling the above conditions are considered as scheduled banks. Moreover under the RBI
Act section 42, the central Government has declared the following banks as scheduled
banks.
i. State bank of India and its 7 subsidiary banks,
ii. 20 Nationalized banks, and
iii. Urban banks
In June 1980 there were 149 scheduled banks which included
i. Public Sector banks
ii. Private sector banks
iii. Foreign exchange banks and
iv. State cooperative banks.
A bank which wants to register its name as scheduled bank has apply to the central
government. On receiving such applications, the central government orders RBI to
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investigate Banks’ accounts. If RBI gives favorable reports, the central government
sanctions its proposal, and the bank is listed under schedule annexure II and is considered
as a scheduled bank.
Some co-operative banks come under the category of scheduled commercial banks though
not all cooperative banks.
# PUBLIC SECTOR BANKS
Public sector banks are those in which the government of India or the RBI is a majority
shareholder. These banks include the State Bank of India (SBI) and its subsidiaries, other
nationalized banks, and regional rural banks (RRBs). Over 70% of the aggregate branches in
India are those of the public sector banks. Some of the leading banks in this segment include
Allahabad Bank, Canara Bank, Bank Of Maharashtra, Central Bank Of India, Indian overseas
bank, state bank of India, State bank of Patiala, state bank of Bikaner and Jaipur, state bank
of Travancore, bank of Baroda, Bank of India, oriental bank of commerce, UCO Bank, Union
Bank of India, Dena Bank and corporation Bank.
# PRIVATE SECTOR BANKS
Private Banks are essentially comprised of 2 types:
Old banks
The old private sector banks comprise those, which were operating before banking
nationalization act was passed in 1969. On account of their small size, and regional
operations, these banks were not nationalized these banks face intense rivalry from the
new private banks and the foreign banks. The banks that are included in this segment
include: Bank Of Madura ltd.(now a part of ICICI bank), Bharat overseas bank ltd., Bank of
Rajasthan, Karnataka bank ltd., Lord Krishna bank ltd., the Catholic Syrian bank ltd., the
Dhanlakshmi bank ltd., the federal bank ltd., the Jammu & Kashmir bank ltd., The
KarurVyasya bank ltd., The Lakshmi Vilas bank ltd., The Nedungadi Bank ltd. and Vysya
Bank.
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New banks
The new private sector banks were established when the banking regulation act was
amended in 1993. Financial institutions promoted several of these banks. After the initial
licenses, The RBI has granted no more licenses. These banks are gearing up to face the
foreign banks by focusing on service and technology. Currently, these banks are on an
expansion spree, spreading into semi-urban areas and satellite towns. The leading banks
that are included in this segment includes bank of Punjab ltd., Centurion Bank ltd., HDFC
Bank ltd., ICICI Bank corporation ltd., CITI Bank ltd., IndusInd Bank ltd. And UTI bank ltd.
# Co-operative banks
Co-operative banks act as substitutes for money lenders, and offer timely and adequate
short-term and long-term institutional credit at reasonable rates of interest. Co-operative
banks are relatively similar in terms of functions to the other banks except for the following:
a) They are organized and managed on the principle of co-operation, self-health, and
mutual health.
b) They operate under the rule of “One member, one vote”.
c) Operate on “No profit, no loss” basis.
d) Co-operative bank conducts all the main banking functions of the deposit mobilization,
supply of credit and provision of remittance facility. Co-operative Banks offer limited
banking products and are functionally specialists in agriculture- related products, and
even in providing housing loans of late. Urban co-operative banks offer working capital
loans and term loan as well.
e) Co-operative banks primarily operate in the agriculture and rural sector. However,
UCBs, SCBs, and CCBs function in the semi urban, urban, and metropolitan areas too.
f) Co-operative banks are probably the first government sponsored, government-
supported, and government- subsidized financial agency in India. They get financial and
other aid from the reserve bank of India NABARD, central governments and state
governments. They are the “Most favored” banking sector with risk of nationalization.
g) Co-operative banks normally concentrate on “High revenue” niche retail segments.
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# Development Banks
Development banks are primarily intended to encourage industrial development by
providing adequate flow of funds to industrial projects. In other words, these institutions
undertake the responsibility of aiding all- round development in the country’s economy by
promoting new industrial projects, and providing financial assistance for the expansion,
diversification, and up gradation of the existing units. Development banks may be classified
as all India developments banks and regional development banks. While all India
development banks include industrial development banks of India and industrial finance
corporation of India, examples of regional development banks include state finance
corporation and state industrial development corporation.
2.3.2) Non-scheduled banks:
The banks, which are not included in the second schedule of RBI act, 1934, are known as
non-scheduled banks. Such banks total share capital is less than 5 lacs. These banks are not
governed according to the RBI act and they receive no benefits from the RBI. These banks
have no place in the list of recognized banks of the RBI. These banks are not much trusted
by the people and they do not get handsome deposits. Since 1951 the numbers of such
banks have been gradually decreasing. In 1979 there were only 5 non-scheduled banks.
Generally now days we found many co-operative banks which are belongs to the non-
scheduled co-operative banks. Following are the types of non-scheduled banks they are
work like the schedule banks but here the difference in it status and it not having the status
of the scheduled banks.
a. Deposits bank
b. Co-operative banks
c. Central banks
d. Exchange banks
e. Investment or industrial banks
f. Land development banks
g. Savings banks
a) Deposits banks:
Generally, banks which provide short-term loans to business and industrial units and which
mobilize savings of people as deposits are called deposit banks. Deposit banks accept
deposits from people, and provide short-term advances. They provide over draft and cash
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credit facilities to merchants. To meet long-term requirement of industrial units is not
possible for these banks. They accept 3 types of deposits saving bank deposits, fix deposits
and current account deposits. They accept these deposits which are payable on demand or
on short notice, and provide funds to trading and commercial units for short durations.
b) Cooperative Banks
Cooperative banks meet the short-term financial needs of farmers. Agriculturists, Petty
farmers and artisans organized themselves on cooperative principles and form cooperative
societies and banks. Cooperative banks raise funds through various means, besides
receiving all kinds of deposits to make them available as lendable funds to its members. In
India developed cooperative banks supply finance for agriculture and non-agriculture
activities.
c) Central Banks
A central bank is a special institution which controls and regulatesthe entire banking
structure of country. It also strives to maintain monetary stability of the country. Central
bank is also known as the Apex bank of the country. Since it functions in the best interest of
the country and making profits is unknown to it, it is entrusted the right it issue currency
notes. No other bank is allowed this right. It operates in close cooperation with the
government of implementing economic policies, thereby promoting economic development.
d) Exchange Banks:
There is a difference in financing of foreign trade and financing of internal trade. Generally a
person carrying on international trade requires foreign currencies to meet this obligation. It
is here that exchange banks play the role of financing the dealer for setting transactions
involved in foreign trade, there are specialized banks for exchange business. In India, there
is an export-import bank (EXIM).
e) Investment or industrial banks:
Investment banks provide long-term credit to industries. They raise their funds by way of
share capital, debentures, and long-term deposits from the public. They also raise fund by
the issue of bonds for business operations and government agencies. Usually they
underwrite fresh issue of shares and debentures of companies. Such banks also buy the
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entire issue of new securities of public limited companies and try to get them subscribed at
a higher price by the public.
f) Land Development Banks:
Land development banks were earlier known as land mortgage banks. In India, there is
limited number of such banks. There are special institutions providing long-term loans to
agricultures and farmers. They provide loans on security of land and other immovable
properties. They supply long-term funds for periods exceeding 6 years. Agriculturists and
farmers need such funds for making permanent improvements to land and for buying
farming machinery and equipment.
g) Savings Banks:
Saving banks are specialized institutions, which encourage general public to save something
from their earnings. In other words such banks pool the small savings of middle and lower
income sections of society. They are the banks in the true sense of the term and their main
aim is to promote and collect of the public. Not only the depositors are given interest, but
also they are allowed to withdraw in times of need. The numbers of withdrawal are,
however, restricted. Separate saving banks are organized in various nations. The
government can also run a savings bank. In India the postal department runs the postal
saving bank allover the country. It is very popular in rural areas where no branches of
established commercial bank operate. In urban areas, commercial bank handles savings
business.
2.4) Opportunities and Challenges for Players
The bar for what it means to be a successful player in the sector has been raised. Four
challenges must be addressed before success can be achieved. First, the market is seeing
discontinuous growth driven by new products and services that include opportunities in
credit cards, consumer finance and wealth management on the retail side, and in fee-based
income and investment banking on the wholesale banking side.
These require new skills in sales & marketing, credit and operations. Second, banks will no
longer enjoy windfall treasury gains that the decade-long secular decline in interest rates
provided. This will expose the weaker banks. Third, with increased interest in India,
competition from foreign banks will only intensify. Fourth, given the demographic shifts
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resulting from changes in age profile and household income, consumers will increasingly
demand enhanced institutional capabilities and service levels from banks.
2.5) Current trend in banking
Currently (2009), banking in India is generally fairly mature in terms of supply, product
range and reach-even though reach in rural India still remains a challenge for the private
sector and foreign banks. In terms of quality of assets and capital adequacy, Indian banks
are considered to have clean, strong and transparent balance sheets relative to other banks
in comparable economies in its region. The Reserve Bank of India is an autonomous body,
with minimal pressure from the government. The stated policy of the Bank on the Indian
Rupee is to manage volatility but without any fixed exchange rate-and this has mostly been
true.
With the growth in the Indian economy expected to be strong for quite some time-
especially in its services sector-the demand for banking services, especially retail banking,
mortgages and investment services are expected to be strong. One may also expect M&As,
takeovers, and asset sales.
Currently, India has 88 scheduled commercial banks (SCBs) - 28 public sector banks (that is
with the Government of India holding a stake), 29 private banks (these do not have
government stake; they may be publicly listed and traded on stock exchanges) and 31
foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs.
According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75
percent of total assets of the banking industry, with the private and foreign banks holding
18.2% and 6.5% respectively.
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Chapter3
Industry Analysis
3.1) Competitive Forces Model (Porter’s Five-Force model)
Prof. Michael Porter’s competitive forces Model applies to each and every company as well
as industry. This model with regards to the Banking Industry is presented below:
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1. Rivalry among existing firms
With the process of liberalization, competition among the existing banks has increased.
Each bank is coming up with new products to attract the customers and tailor made loans
are provided. The quality of services provided by banks has improved drastically.
2. Potential Entrants
Previously the Development Financial Institutions mainly provided project finance and
development activities. But they now entered into retail banking which has resulted into
stiff competition among the exiting players.
3. Threats from Substitutes
Banks face threats from Non-Banking Financial Companies. NBFCs offer a higher rate of
interest.
4. Bargaining Power of Buyers
Corporate can raise their funds through primary market or by issue of GDRs, FCCBs. As a
result they have a higher bargaining power. Even in the case of personal finance, the buyers
have a high bargaining power. This is mainly because of competition.
5. Bargaining Power of Suppliers
With the advent of new financial instruments providing a higher rate of returns to the
investors, the investments in deposits is not growing in a phased manner. The suppliers
demand a higher return for the investments.
Overall Analysis
The key issue is how banks can leverage their strengths to have a better future. Since the
availability of funds is more and deployment of funds is less, banks should evolve new
products and services to the customers. There should be a rational thinking in sanctioning
loans, which will bring down the NPAs. As there is an expected revival in the Indian
economy Banks have a major role to play. Funding corporate at a low cost of capital is a
special requisite.
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3.2) SWOT Analysis
The banking sector is also taken as a proxy for the economy as a whole. The performance of
bank should therefore, reflect “Trends in the Indian Economy”. Due to the reforms in the
financial sector, banking industry has changed drastically with the opportunities to the
work with, new accounting standards new entrants and information technology. The
deregulation of the interest rate, participation of banks in project financing has changed in
the environment of banks.
The performance of banking industry is done through SWOT Analysis. It mainly helps to
know the strengths and Weakness of the industry and to improve will be known through
converting the opportunities into strengths. It also helps for the competitive environment
among the banks.
STRENGTHS
1. Availability of Funds
There are seven lakh crore wroth of deposits available in the banking system. Because of
the recession in the economy and volatility in capital markets, consumers prefer to deposit
their money in banks. This is mainly because of liquidity for investors.
2. Banking network
After nationalization, banks have expanded their branches in the country, which has helped
banks build large networks in the rural and urban areas. Private Banks allowed operating
but they mainly concentrate in metropolis.
3. Large Customer Base
This is mainly attributed to the large network of the banking sector. Depositors in rural
areas prefer banks because of the failure of the NBFCs.
4. Low Cost of Capital
Corporate prefers borrowing money from banks because of low cost of capital. Middle
income people who want money for personal financing can look to banks as they offer at
very low rates of interests. Consumer credit forms the major source of financing by banks.
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WEAKNESSES
1. Loan Deployment
Because of the recession in the economy the banks have idle resources to the tune of 3.3
lakh crore. Corporate lending has reduced drastically
2. Powerful Unions
Nationalization of banks had a positive outcome in helping the Indian Economy as a whole.
But this had also proved detrimental in the form of strong unions, which have a major
influence in decision-making. They are against automation.
3. Priority Sector Lending
To uplift the society, priority sector lending was brought in during nationalization. This is
good for the economy but banks have failed to manage the asset quality and their intensions
were more towards fulfilling government norms. As a result lending was done for non-
productive purposes.
4. High Non-Performing Assets
Non-Performing Assets (NPAs) have become a matter of concern in the banking industry.
This is because of change in the total outstanding advances, which has to be reduced to
meet the international standards.
OPPORTUNITIES
1. Universal Banking
Banks have moved along the valve chain to provide their customers more products and
services. For example: - SBI is into SBI home finance, SBI Capital Markets, SBI Bonds etc.
2. Differential Interest Rates
As RBI control over bank reduces, they will have greater flexibility to fix their own interest
rates which depends on the profitability of the banks.
3. High Household Savings
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Household savings has been increasing drastically. Investment in financial assets has also
increased. Banks should use this opportunity for raising funds.
4. Overseas Markets
Banks should tape the overseas market, as the cost of capital is very low.
5. Interest Banking
The advance in information technology has made banking easier. Business can effectively
carried out through internet banking.
THREATS
1. NBFCs, Capital Markets and Mutual funds
There is a huge investment of household savings. The investments in NBFCs deposits,
Capital Market Instruments and Mutual Funds are increasing. Normally these instruments
offer better return to investors.
2. Change in the Government Policy
The change in the government policy has proved to be a threat to the banking sector.
3. Inflation
The interest rates go down with a fall in inflation. Thus, the investors will shift his
investments to the other profitable sectors.
4. Recession
Due to the recession in the business cycle the economy functions poorly and this has proved
to be a threat to the banking sector. The market oriented economy and globalization has
resulted into competition for market share. The spread in the banking sector is very
narrow. To meet the competition the banks has to grow at a faster rates and reduce the
overheads. They can introduce the new products and develop the existing services.
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Chapter4
Introduction to SBM
STATE BANK OF MYSORE
Working for a better tomorrow
Mission
“A premier commercial Bank in Karnataka, with all India presence, committed to provide
consistently superior and personalized customer service backed by employee pride and will
to excel, earn progressively high returns for its shareholders and be a responsible corporate
citizen contributing to the well being of the society.”
4.1) SBM - Introduction
State Bank of Mysore was established in the year 1913 as Bank of Mysore Ltd. under the
patronage of the erstwhile Govt. of Mysore, at the instance of the banking committee headed
by the great Engineer-Statesman, Late Dr. Sir M.Visvesvaraya. Subsequently, in March 1960,
the Bank became an Associate of State Bank of India. State Bank of India holds 92.33% of
shares. The Bank's shares are listed in Bangalore, Chennai, and Mumbai stock exchanges.
The Bank has a widespread network of 682 branches (as on 30.09.2009)and20 extension
counters spread all over India which includes5 specialized SSI branches, 4 Industrial Finance
branches, 3 Corporate Accounts Branches, 4 specialized Personal Banking Branches, 10
Agricultural Development Branches, 3 Treasury branches, 1 Asset Recovery Branch and 8
Service Branches, offering wide range of services to the customers.
The Bank has a dedicated workforce of 9720 employees consisting of 3169 supervisory staff,
6551 non-supervisory staff (as on 31.03.2008). The skill and competence of the employees
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have been kept updated to meet the requirement of our customers keeping in view the
changes in the environment. The Chairman of State Bank of India is also the Chairman of
this Bank; The Managing Director is assisted by a Chief General Manager and 6 General
Managers.
The paid up capital of the Bank is Rs.360 Millions as on 31.03.2009 out of which State Bank
of India holds 92.33%. The net worth of the Bank as on 31.03.2009 is Rs.1619.44 Crores and
the Bank has achieved a capital adequacy ratioof12.99% as at the end of March 2009. The
Bank has an enviable track record of earning profits continuously and uninterrupted
payment of dividend since its inception in 1913. The Bank earned a net profit of Rs.336.91
Crores for the year ended March 2009 and earnings per share are at Rs.94.
Total deposits of the Bank as at the end of March 2009 isRs.32915.76 Crores and the total
advances stood at Rs. 25616.05 Crores which include export credit of Rs. 1158.13 Crores. The
Forex Merchant turnover of the Bank is Rs.19607.42 Crores and the Forex Trading turnover is
Rs.82197.27 Crores at the end of March 2009.
4.2) Key areas of operation:
1) Personal Banking Schemes:
The personal banking scheme consists of the following types of services:
¾ Personal loan
¾ Mortgage loan
¾ Housing loans
¾ Educational loan
¾ Cash Key: To meet unforeseen expenses, without premature withdrawal of term
deposit. Immediate overdraft facility is available
¾ ATM Facility: Round the clock ATM facility for customers of Bangalore city and
different parts of the country.
2) Commercial And Institutional Banking Schemes:
¾ Scheme for Traders-Liberalized Trade Finance: State Bank of Mysore has designed
schemes for traders to meet their working capital needs – under C&I and SME Segment.
The following categories of borrowers will be covered:
» Small business enterprises.
» Retail traders/ wholesale traders.
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» Professional and Self employed.
¾ Handy Loans Scheme - For Trade and Services sector: Handy Loan can be availed for :
» Holding stocks / Receivables
» Acquisition of land and buildings for establishing trading house
» Building construction & renovation of offices, showrooms, godowns, etc.
» Purchase of equipment, furniture & vehicles
» Augmenting networking capital
» Payment of long term deposits / advances to supplier
» General trade purposes
¾ Corporate Loan (Earlier Name: Short Term Corporate Loan):The Short Term
Corporate Loan is essentially in the form of Term Loan for corporate for certain
specific purposes with maturity not exceeding three years
¾ Current Account Plus: The services offered under this services are as follows:
» Issue of 30 DDs cumulative value not exceeding Rs.25 lacs per month free of charges
» Collection of 30 outstation cheques per month with a cumulative value of Rs.10 lacs,
free of collection charges (This facility is only for the account holder’s instruments
and not for third party cheques). Handling charges of Rs.20/- per instrument to be
collected
» SBI Life policy of Rs. 1 lakh coverage. In the unfortunate event of death, SBI Life
would pay the assured to the nominee. In the event of the death due to an accident,
SBI Life would pay the Nominee double the sum assured. Free of cost, for
individuals/proprietor of concern. In case of Partnership firms / Company Accounts
any one partner/ Director.
¾ Rent Plus: This scheme is to meet liquidity mismatch / any other purpose of the
applicants.
3) Agricultural Schemes:
The schemes under agricultural are as under:
¾ Kisan Gold Card Scheme
¾ Kisan Credit Card Scheme
¾ GraminBhandaranYojana (GBY)
¾ Scheme for Combined Harvesters
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¾ Kisan Chakra Scheme
4) Micro & Small Enterprises Scheme: The various schemes under MSE schemes are as
follows:
¾ Credit Guarantee Fund Trust Scheme For Micro & Small Enterprises (CGTMSE)
¾ Loans to Micro & Small Enterprises (MSEs)
¾ Small Business Finance
¾ Small Business Enterprises
¾ Professionals & Self-Employed persons
¾ Transport Operators
¾ LaghuUdyami Credit Card Scheme
4.3) Technical Initiatives:
State Bank of Mysore is the first Karnataka-based Bank with fully networked branches. The
Bank made significant investment in order to upgrade technology and the major
developments are as under:
(1) Core Banking Solution: Which contains,
¾ Facilitates 24 X 7 Banking
¾ Anywhere Banking
¾ Integration with strategic sectors
¾ Business Process Re-engineering (BPR) enabler
(2) Internet Banking
(3) Real Time Gross Settlement (RTGS)
(4) National Electronic Funds Transfer (NEFT) System
(5) Mobile Banking
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Chapter5
Credit Risk Management
“Banks are in the business of managing risk,
not avoiding it……………”
5.1) Introduction
Lending has always been the primary function of banking, and accurately assessing a
borrower's creditworthiness has
always been the only method of
lending successfully. The method of
analysis varies from borrower to
borrower. It also varies in function of
the type of lending being considered.
For example, the banking risks in
financing the building of a hotel or rail
project, or providing lending secured
by assets or a large overdraft for a
retail customer would vary considerably. For the financing of the project, you would look to
the funds generated by future cash flows to repay the loan, for asset secured lending, you
would look at the assets and for an overdraft facility, you would look at the way the account
has been run over the past few years.
Credit risk is the oldest risk among the various types of risks in the financial system,
especially in banks and financial institutions due to the process of intermediation. Managing
credit risk has formed the core of the expertise of these institutions. While the risk is well
known, growth in the markets, disintermediation, and the introduction of a number of
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innovative products and practices have changed the way credit risk is measured and
managed in today's environment.
5.2) Definition
Credit risk "is the risk to a bank's earnings or capital base arising from a borrower's failure
to meet the terms of any contractual or other agreement it has with the bank. Credit risk
arises from all activities where success depends on counterparty, issuer or borrower
performance". Credit risk enters the books of a bank the moment the funds are lend,
deployed, invested or committed in any form to counterparty whether the transaction is on
or off the balance sheet.
5.3) Scope of Credit Risk
It can be understood from the above that credit risk arises from a whole lot of banking
activities apart from traditional lending activity such as trading in different markets,
investment of funds, provision of portfolio management services, providing different type of
guarantees and opening of letters of credit in favour of customers etc.
For example, even though guarantee is viewed as a non-fund based product, the moment a
guarantee is given, the bank is exposed to the possibility of the non- funded commitment
turning into a funded position when the guarantee is invoked by the entity in whose favour
the guarantee was issued by the bank. This means that credit risk runs across different
functions performed by a bank and has to be viewed as such.
The nature, nomenclature and the quantum of credit risk may vary depending on a number
of factors. The internal organization of credit risk management should recognize this for
effective credit risk management. Credit risk can be segmented into two major segments viz.
intrinsic and portfolio (or concentration) credit risks. The focus of the intrinsic risk is
measurement of risk at individual loan level.
This is carried out at lending unit level. Portfolio credit risk arises as a result of
concentration of the portfolio to a particular sector, geographic area, industry, type of
facility, type of borrowers, similar rating, etc. Concentration risk is managed at the bank
level as it is more relevant at that level.
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5.4) what is the role of Credit Analysis?
The role of credit analysis generally encounters the following questions:
x In which stage of the life cycle the
companyis?
x Is the company's business cyclical or
counter cyclical?
x How will this affect the long-term cash
flow of the firm?
x What are the considerations of
generaleconomic conditions and, if appropriate, political conditions in the country
where the company is operating?
Credit analysis supports the work of marketing officers by evaluating companies before
lending money to them. This is essential so that new loan requests can be processed, a
company's repayment ability assessed, and existing relationships monitored. The extent of
the credit analysis is determined by
¾ The size and nature of the enquiry,
¾ The potential future business with the company,
¾ The availability of security to support loans,
¾ The existing relationship with the customer.
The analysis must also determine whether the information submitted is adequate for
decision-making purposes, or if additional information is required. An analysis can
therefore cover a wide range of issues.
For example, in evaluating a loan proposal for a company, it may be necessary to:
¾ Obtain credit and trade references,
¾ Examine the borrower's financial condition,
¾ Consult with legal counsel regarding a particular aspect of the draft loan agreement.
By making these checks you are ensuring that your report does not look at a company's
creditworthiness in a narrowly defined sense. You will be taking the further step of deciding
whether the provisions in the loan agreement are appropriate for the borrower's financial
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condition. Often it will be necessary for the analyst to place the assessment of the
borrower's financial condition within the wider context of the conditions existing in the
industry in which it is operating.
5.5) Credit Risk Management Process
Credit risk is the largest and most elementary risk faced by banks. It essentially focuses on
determining likelihood of default or credit deterioration and how costly it will turn out to be
if it does occur. And this is true for consumer lending (retail) or corporate lending
(commercial) in banking.
A comprehensive Credit Risk Management Process encompasses the following steps:
Fig.1: Processes of a typical Credit risk management lifecycle
5.5.1) Collect Obligor and Loan data
The very foundation of a sound credit risk management system lies in the data that it gets.
The inputs needed in this stage are the obligor (borrower), Facility (Loan) and external
(ratings) data. This is first critical step in any loan process and all necessary data about the
obligor needs to be collected. Fig 2. highlights the key tasks and challenges involved in this
step.
Fig.2: Key tasks and chal enges involved in col ecting obligor & Loan Data
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The key steps here include,
Get the Obligor Data: The crucial task here is to get the financial, demographic and
qualitative data related to the obligor. A majority of the data comes from the financial
statements but other sources also exist for example past repayment performances.
Get the Loan Data: Next on, the system must beadequately designed to capture Loan data
related to the type of loan, amount, maturity etc accurately. Of particular concern here is
data related to collaterals, guarantees and contract terms on netting and liquidation. These
must be accurately captured in the system as they are crucial in the rating process.
Get External Ratings Data: The system must be capable enough to pull relevant data from
external systems such as data from rating agencies and also information such as loan data
from internal systems.
5.5.2) Compute Credit Risk
The next and one of the most crucial phases is calculating the credit risk in the form of risk
ratings to meaningfully differentiate risk among different firms or exposures. Fig 3 shows a
typical credit risk calculation scenario.
Fig.3: Key tasks and challenges involved in Computing Credit Risk
Key Tasks
The basic approach involves combining internal rating models (point of time) with external
risk information (through the cycle). The basic tasks involved in the rating process of a
Commercial obligor are highlighted as follows:
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Develop Rating Model: The obligor has to be rated using an appropriate model for example
there are different models for a Commercial & Industrial category obligor and a Commercial
Real Estate category obligor.
Calculate Probability of Default (PD): The Probability of Default is the likelihood that a loan
will not be repayed and fall into default. The credit history of the counterparty and nature of
the investment will all be taken into account to calculate the PD figures. The following steps
will commonly be used
x Analyze the credit risk aspects of the
counterparty; This will involve not only
the quantitative aspects of the obligor
based on his/her financial statements
but also qualitative factors related to
contingencies, management quality and
other factors which are yet to be
reflected.
Fig. 4 shows a sample of quantitative
and qualitative factors in a typical risk
grading model for a commercial obligor.
x Map the counterparty to an internal risk grade which has an associated PD.
Calculate Loss Given Default (LGD), Exposure At Default (EAD) & Expected Loss (EL):The
Credit Risk Solution also needs to calculate
¾ Loss Given Default – It is the magnitude of likely loss on the exposure in the event of
default. Both quantitative and qualitative factors are used to calculate Facility LGD
which may include Government guarantees, Collateral Support, Guarantor Support
etc.
¾ Exposure At Default - It is defined as the exposure to the borrower at any point of
time.
¾ Expected Loss – It is calculated using the PD, LGD and EAD together. It is the
probability weighted loss which is also used for pricing.
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5.5.3) Monitor and Manage Risk Rating
The job is not over with the credit risk rating process. In fact, it is quintessential to monitor
and manage the risk ratings as highlighted below in Fig 5
Fig .5: Key tasks and chal enges involved in Monitoring and managing Risk Rating
Key Tasks
Develop Workflow to manage approval of Ratings: The Credit Risk Solution should ensure
that the risk ratings and exceptions go through proper approvals by appropriate authorities
as laid down by guidelines such as the Bank’s credit policy. The workflow should also
accord traceability to ratings, changes and approvals.
Ensure notification on external rating changes: The system should ensure that external
ratings changes or other material changes are reflected as early and accurately as possible
in the credit risk ratings of an obligor. The system should ensure ratings are reviewed
periodically and also based on criteria such as likelihood of credit changes.
Interface with Internal Collections: Adequate interface with internal collections is needed so
that the system is updated consistently with any default information.
Perform Back Testing of Ratings: The system should provide for back testing and
calibrating credit risk models within Basel-II guidelines.
5.5.4) Manage portfolio and allocate capital
Portfolio Management has become one of the most difficult challenges in the financial
world especially from the point of view of credit risk management. Efficient portfolio
management and capital allocation is a process which an organization must put on the top
of its agenda. Illustrated below in Fig 6 are the steps in this process
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Fig 6: Key tasks and chal enges involved in Portfolio Management and Capital Al ocation
Key Tasks
Compute and monitor Portfolio risk: The System must be capable of computing and
monitoring the credit risk at a portfolio level and also enable drill down based upon criteria
such as different lines of businesses etc. The system should provide interface with a risk
engine to calculate regulatory and economic capital, allocate capital and calculate RAROC
Allow creation of SPVs for transfer of risk: The system must facilitate the creation of SPVs for
the appropriate transfer of credit risk.
Reporting on risk: The system must be capable enough to satisfy the reporting requirements
of the organization. There are different levels of reporting that are required especially in the
case of portfolio management.
Stress Testing/ Scenario Analysis: The system should also allow for stress testing of the
portfolio under differing conditions specially taking into consideration varying economic
circumstances.
5.5.5) Summary of the key priority areas
It will be quite safe to assume that any competitive and proactive financial institution must
have already started laying down the foundation blocks of a robust credit risk management
system. However it would be pertinent to summarize the key priority areas for this
process. These areas are highlighted in Fig 7.
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Fig 7: Key Priority Areas in Credit Risk management
Notification of External Rating changes: It is crucial that an organization effectively uses a
combination of internal models with external ratings. Therefore changes in the external
inputs should be reflected as soon as possible in the internal ratings. This can be achieved
through the use of notifications in the form of real time alerts.
Data Architecture: A robust data backbone is crucial to enable credit assessment process.
The data backbone should have adequate and accurate data history. Care should be taken
to make sure the data design incorporates relevant data fields which are required in current
and future models.
Back Testing: The models should be properly back tested to improvise them and also for
regulatory approvals.
Compute & Monitor Portfolio Risk: Measuring and managing individual credit ratings
contribute to the management of portfolio risk. This is a crucial phase for the risk
department within the organization as credit risk levels have to be maintained within
statutory and organizational requirements.
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5.6) Significance of Credit Risk Measurement and Management
Increase in Bankruptcies:
Compared to the past, bankruptcies have increased. As a result of this, the permanent,
accurate credit risk analysis practices h a v e become more important than in the past.
Deregulation:
Innovation stimulated by deregulation has led to new entrants into the markets to provide
services. The credit risk assessment of the new entrants is very much essential for the well
functioning of the market.
Disintermediation:
As large institutions with strong credit quality are less dependent on bank funds, banks are
left to serve institutions with weaker credit quality. A recent study by Subramanian and
Umakrishnan (2004) of 876 corporate in India, the bank debt to total debt ratio for very
small firms (sales turnover not more than Rs. 10 crores per annum) was 73% while the
ratio for very large firms (sales turnover Rs. 1000 crores and above per annum) was only
41%. A similar fall in the ratio was witnessed as the size measured by sale turnover
increased. This disintermediation has led to fall in the overall credit quality of the lending
book, increasing the importance of credit risk measurement and management.
Shrinking Margins on Loans:
Trends in international markets reveal that the interest margins or spreads, i.e. the
difference between interest income and interest expenses has been falling. Apart from other
factors, the increasing competition in the market is cited as the major reason for this.
Growth of off-Balance Sheet Risks:
The phenomenal expansion of the Over-the- Counter (OTC) derivative products which carry
counterparty risk unlike the exchange traded derivatives has increased the exposure of a
number of banks to such products.
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Volatility in the Value of Collateral:
It has been observed that predicting the market value of collateral held against loan is very
difficult. This may lead to a situation where the value of collateral may fall below the value
of loan granted against it. Falling value of the collateral had been the cause for banking
crises in well developed countries such as Switzerland and Japan.
Advances in Finance Theory and Computer Technology:
These advances have paved the way for banks to test very sophisticated credit risk models
that would not have been possible in the absence of finance theory and computer
technology.
Risk-based Capital Regulations:
Apart from the above, the development of risk- based capital requirements pronounced by
the Basle Committee has been one of the important drivers of credit risk initiatives. This is
more so with the Basle Accord -II which recognizes the differences in credit quality in the
form of ratings and availability of collateral unlike the previous accord which is in force till
date.
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Chapter6
Overview Of Credit Appraisal
Credit appraisal means an investigation/assessment done by the banks before providing
any loans & advances/project finance & also checks the commercial, financial & technical
viability of the project proposed, its funding pattern & further checks the primary &
collateral security cover available for recovery of such funds.
6.1) 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 pay 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.
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.
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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.
6.2) 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,
andwater. 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 daysor
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 orthe
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
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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 creditcard
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.
6.2.1) Brief Overview of Loans:
Loans can be of two types fund base & non-fund base:
FUND BASE includes NON-FUND BASE includes
Working Capital Letter of Credit
Term Loan Bank Guarantee
Bill Discounting
(A) FUND BASE
¾ WORKING CAPITAL: -
1. 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.
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2. Definition
Working capital is defined as the funds required to carry 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 programme, the
materials & marketing mix.
3. Methods & application
SEGMENTS LIMITS METHODS
SSI
UPTO 5 CRORES Traditional method &Nayak Committee method
ABOVE 5 CRORES Projected Balance Sheet Method
SBF All loans Traditional/ Turnover Method
C&I TRADE &
SERVICES
UPTO Rs. 1 CRORE
Traditional method for trade & projected
turnover method
ABOVE Rs. 1 CRORE
& UPTO Rs. 5
CRORE
Projected Balance Sheet Method & Projected
Turnover Method.
ABOVE Rs. 5 CRORE Projected Balance Sheet Method
C&I INDUSTRIAL
UNITS
BELOW Rs. 25 Lacs TRADITIONAL METHOS
Above Rs. 25 Lacs
but up to Rs. 5
crores
Projected Balance Sheet Method & Projected
Turnover Method
ABOVE Rs. 5 Crores Projected Balance Sheet Method
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¾ 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:
x The purpose of the term loan is for acquisition of capital assets.
x The term loan is an advance not repayable on demand but only in installments
ranging over a period of years.
x 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.
x 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 programme 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.
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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
x Technical Feasibility - To determine the suitability of the technology selected & the
adequacy of the technical investigation & design
x Economic Feasibility - To ascertain the extent of profitability of the project & its
sufficiency in relation to the repayment obligations pertaining to term assistance
x Financial Feasibility - To determine the accuracy of cost estimates, suitability of the
envisaged pattern of financing & general soundness of the capital structure and
x Managerial Competency – To ascertain that competent men are behind the project to
ensure its successful implementation & efficient management after commencement
of commercial production.
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
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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) Labour – The labour requirements of a project, need to be assessed with special care.
Though labour in terms of unemployed persons is abundant in the country, there is
shortage of trained personnel. The quality of labour 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.
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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.
1) How big is the market?
2) How much it is likely to grow?
3) 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.
b) 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.
c) 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, tyres for automobiles). The market analysis in this case should cover
the market for the ultimate product.
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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 break even 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.
¾ Break-even point:
In a manufacturing unit, if at a particular level of production, the totalmanufacturing 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.
¾ 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
Coverage Ratio
=
Cash accruals
Maturing annual obligations
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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 programme should be so stipulated that
the ratio is comfortable.
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.
(B) NON-FUND BASE
(1) LETTER OF CREDIT
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.
¾ 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
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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.
¾ 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.
¾ 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 its 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
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transferred even more than once.
(2) 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 theapplicant
in case of his default.
Thus, guarantee is a collateral contract, consequential to a main contract between the
applicant & the beneficiary.
¾ 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.
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g) Bid bonds on behalf of exporters
h) Export performance guarantees on behalf of exporters favoring the Customs
Department under EPCG scheme.
¾ 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
¾ 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
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f) not stipulating any onerous clause, &
g) not containing any clause for automatic renewal of the bank guarantee on its expiry
6.3) 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, 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.
6.3.1) Indian Scenario:
¾ In Indian banks, there was no systematic method of Credit Risk Assessment till late
1980’s/ early 1990’s.
¾ Health Code System (1985) / IRAC norms (1993) are Asset (loan) classification systems,
not CRA systems.
¾ RBI came out with its guidelines on Risk Management Systems in Banks in 1999 &
Guidance Note on Management of Credit in October, 2002.
6.3.2) SBM Scenario:
However, like in many other fields, in the field of Credit Risk Assessment too, SBM played a
proactive & pioneering role. Bank had its Credit Rating System in 1988. Then, the CRA
system was introduced in the Bank in 1996. The first CRA model was rolled out in 1996 to
take care of exposures to the C & I (Manufacturing) segment. Thereafter, separate models
for SSI segments were introduced in 1998, when the C&I (Mfg.) CRA model was developed
Overview of Credit Appraisal
N R Institute of Business Management Page 50
for Non Banking Finance Companies (NBFCs) too.
As of now, in SBM, CRA is the most important component of the Credit Appraisal exercise
for all exposures > 25 lacs & a very important tool in decision-making (a Decision Support
System) as well as in pricing.
6.3.3) Credit Risk Assessment (CRA) – Minimum Scores / Hurdle Rates
1. The CRA models adopted by the Bank take into account all possible factors, which go
into appraising the risks, associated with a loan. These have been categorized broadly
into financial, business, industrial & management risks and are rated separately. To
arrive at the overall risk rating, the factors duly weighted are aggregated & calibrated to
arrive at a single point indicator of risk associated with the credit decision.
2. Financial parameters: The assessment of financial risk involves appraisal of the
financial strength of the borrower based on performance & financial indicators. The
overall financial risk is assessed in terms of static ratios, future prospects & risk
mitigation (collateral security / financial standing).
3. Industry parameters: The following characteristics of an industry which pose varying
degrees of risk are built into Bank’s CRA model:
¾ Competition
¾ Industry outlook
¾ Regulatory risk
¾ Contemporary issues like WTO etc.
4. Management parameters: The management of an enterprise / group is rated onthe
following parameters:
¾ Integrity (corporate governance)
¾ Track record
¾ Managerial competence / commitment
¾ Expertise
¾ Structure & systems
¾ Experience in the industry
¾ Credibility: ability to meet sales projections
¾ Credibility: ability to meet profit (PAT) projections
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¾ Length of relationship with the Bank
¾ Strategic initiatives
¾ Payment record
Bank has introduced New Rating Scales for borrower for giving loans. Rating is given on the
basis of scores out of 100. Bank gives loans to the borrower as per their rating like SBM
gives loans to the borrower up to SB8 rating as it has average risk till SB8 rating. From SB9
rating the risk increases. Thus, SBM do not give loans after SB8 rating.
5. The risk parameters as mentioned above are individually scored to arrive at an
aggregate score of 100 (subject to qualitative factors – negative parameters). The
overall score thus obtained (out of a max. of 100) is rated on a 16 point scale from
SB1/SBTL1 to SB 16 /SBTL16.
¾ CRA model also stipulates a minimum score under financial, business, industry and
management risk parameters for a proposal to be considered acceptable in a given
form.
The details of such minimum scores are as under:
a. Minimum scores – General
b. Minimum scores under Management Risk : (‘Integrity/Corporate Governance’, ‘Track
Record’ and ‘Managerial Competence/ Commitment’)
An applicant unit will be required to score minimum 2 marks each (out of 3) in the
above three parameters of Management Risk to qualify for Bank’s assistance. In case of
existing accounts if the company scores less than this stipulated minimum marks (02),
the Bank would explore all possibilities to exercise exit option.
c. Minimum Score under Business Risk:
Compliance of Environment Regulations to qualify for financial assistance, an applicant
unit would have to secure full marks (02) under the parameter, “Compliance of
Environment Regulations.” In case, the existing units in the books of the bank do not
secure full marks (02), the bank would explore all possibilities for the exercise of exit
option.
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N R Institute of Business Management Page 52
d. Hurdle Scores:
RISK TYPES
REGULAR MODEL SIMPLIFIED MODEL
EXISTING
COMPANY
NEW
COMPANY
EXISTING
COMPANY
NEW
COMPANY
FINANCIAL RISK 25/65 10/25 30/70 15/35
BUSINESS & INDUSTRY
RISK
12/20 16/30 10/20 20/40
MANAGEMANT RISK 8/15 22/45 5/10 13/25
AGGREGATE HURDLE
SCORE
45/100 48/100 45/100 48/100
OVERALL HURDLE GRADE SB10 SB10 SB10 SB10
6.3.4) Salient Features of CRA Models:
(a) Type of Models
No.
Exposure Level (FB + NFB
Limits )
Non – Trading
Sector
(C&I , SSI , AGL)
Trading Sector
( Trade & Services)
(i) Over Rs. 5.00 crore Regular Model Regular Model
(ii) Rs 0.25 crore to Rs. 5.00 crore Simplified Model Simplified Model
(b) Type of Ratings
No. Model Type of Rating
(i) Regular Model
Borrower Rating
Facility Rating
(ii) Simplified Model Borrower Rating
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N R Institute of Business Management Page 53
(c) Type of Risks Covered:
(i) Borrower Rating
No.
Risk Category
Maximum Score
Regular Model Simplified Model
Existing
Company
New
Company
Existing
Company
New
Company
(i) Financial Risk (FR) 65 25(65 x 0.39) 70 35 (70/2)
(ii) Qualitative Factors (-‘ve) (-10) (-10) (-10) (-10)
(iii)
Business & Industry Risk
(BR& IR) /Business
Risk(for Trading Sector)
20 30 (20 x 1.5) 20 40 (20 x 2)
(iv) Management Risk (MR) 15 45 ( 15 x 3) 10 25 ( 10 x 2.5)
(v)
Qualitative Parameter
(External Rating)
(+5) (+5) (+5) (+ 5)
Total 100 100 100 100
(ii) Facility Rating (Regular Model)
NO.
Parameter Maximum Score
(a) Risk Drivers for Loss Given Default (LGD)
(i)
Current Ratio
[Working Capital/ Non-Fund Based Facility (except Capex)]
OR Project Debt/Equity
[Term Loan/Non-Fund Based Facility (for Capex)]
6
(ii) Nature of Charge 4
(iii) Nature of Charge 6
(iv) Geography 2
(v)
Unit Characteristics
(a) Leverage/ Enforcement of Collateral-4
(b) Safety, Value & Existence of Assets-4
8
(vi)
Macro-Economic Conditions
(a)GDP Growth Rate : Impact of Business Cycle- 2
(b) Insolvency Legislation in the Jurisdiction-1
(c) Impact of Systemic/Legal Factors on Recovery-1
(d) Time Period for Recovery-1
5
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N R Institute of Business Management Page 54
(vii) Total Security (Primary + Collateral) 60
(b) Risk Drivers for Exposure at Default (EAD)
(i)
Nature of Commitment
(Revolving/Non-Revolving)
1
(ii) Credit Quality of Borrower 5
(iii) Tenor of Facility 3
Total Score 100
(d) New Rating Scales - Borrower Rating: 16 Rating Grades
No.
Borrower
Rating
Range of
Scores
Risk Level Comfort Level
1 SB1 94-100 Virtually Zero Risk Virtually Absolute Safety
2 SB2 90-93 Lowest Risk Highest Safety
3 SB3 86-89 Lower Risk Higher Safety
4 SB4 81-85 Low Risk High Safety
5 SB5 76-80
Moderate Risk with Adequate
Cushion
Adequate Safety
6 SB6 70-75
Moderate Risk Moderate Safety
7 SB7 64-69
8 SB8 57-63
Average Risk Above safety threshold
9 SB9 50-56
10 SB10 45-49
Acceptable Risk (Risk
Tolerance Threshold)
Safety Threshold
11 SB11 40-44 Borderline risk Inadequate safety
12 SB12 35-39 High Risk Low safety
13 SB13 30-34 Higher Risk Lower safety
14 SB14 25-29 Substantial risk Lowest safety
15 SB15